President & Chief Executive Officer
Royal Bank of Canada
Canada-UK Chamber of Commerce
November 16, 2009
Good afternoon ladies and gentlemen — thank you Mike,
for that kind introduction and for giving me the honour to
speak with you again.
It was almost a year ago, to the day, that Bank of Canada
Governor Mark Carney delivered to this luncheon remarks about
the directions of reforms required for the global financial
system. We find ourselves today having made much progress
but with much still in front of us in terms of the rules,
regulations and operating models of the world's financial
Today, I would like to comment on some of the differentials
for Canada and RBC but, more importantly, discuss the impending
regulatory reforms that seek to mitigate a future crisis on
our economies and the global banking sector. While this may
seem like a somewhat dull topic, it is of critical importance
not just to the financial system but to the foundation of
our economy and everyone in this room.
As you might expect, I have a bias towards a regulatory model
that finds the right balance between risk and reward while
enabling the banking industry to not only grow and thrive
but to act as a catalyst for economic growth, innovation and
It is critical, in my view, that, — as a result of
the mistakes that led the financial system to the edge of
the abyss — that we not put in place new rules and regulations
that impede the ability of the market to operate efficiently.
Now because this is the Canada/UK Chamber, I will start by
providing perspective on why Canada and our banking system
performed much better than others during this crisis (particularly
compared to those in the U.S. and the U.K.). But before doing
so, I would like to refresh your knowledge about RBC.
Today, we are the 13th largest bank in the world by market
capitalization. As a matter of interest the last time I spoke
with you in April 2006, we ranked 27th — and that was
in a universe of banks that is dramatically different than
today. I wish we had moved up the rankings for reasons other
than the general decline of the industry, but nonetheless
we are one of the world's largest and most profitable financial
We are a diversified financial company with five business
platforms: Canadian Banking, International Banking, Insurance,
Wealth Management and Capital Markets. We have operations
in 55 countries around the world with approximately 80,000
employees serving 18 million clients. In Europe we have approximately
3000 employees with about 1500 in London mostly in our Global
Capital Markets and Wealth Management divisions.
The scale of our operations continues to grow and this year
we were proud to be voted best overall credit house in Europe
in "Credit Magazine's 2009 European Credit Awards",
"Employer of the Year" by the City of London Corporation
and recognized by Private Banker International with its award
for "Outstanding Private Bank in North America. Unlike
many who were pulling back from the market we are continuing
to invest and are not only gaining recognition but market
share as well. I might note that we were selected a couple
of weeks ago as one of three joint book runners on the UK
Government 7 billion Gilt issue, a testament to the strength
of our global fixed income business.
With that backdrop, I would like to put into perspective
why the Canadian banking system outperformed during what was
a global financial crisis, particularly given the global nature
of our businesses.
I should say at the outset that we were not without our challenges
in Canada. The non-bank asset-backed commercial paper market
was a 35 billion dollar issue that our system and markets
had to manage through and, with respect to individual performance,
some Canadian banks faced significant challenges in terms
of write-downs and financial results.
In our case, we managed to be very profitable through the
crisis, notwithstanding significant mark to market losses
and a stressed U.S. retail bank. But regardless of individual
performance, the Canadian system, as a whole, performed extremely
well with no bailouts or government support required beyond
central bank and government financing programs that were instituted
on market terms.
While there are several reasons for the success of Canadian
banks, I'd like to focus my discussion on three broad themes:
- good macroeconomic fundamentals
- a conservative risk appetite, and
- a sound regulatory regime.
With regards to good fundamentals, the IMF recently stated
that Canada is better placed than many countries to weather
the global financial turbulence and worldwide recession: Its
expectations are that Canada's economic growth in 2010 will
be stronger than any other G7 country.
The Canadian economy has not been immune from the global
economic downturn, but it has been insulated by a foundation
of sound macroeconomic policies and a strong monetary framework.
Heading into the crisis, Canada ran 11 straight years of
fiscal surpluses, giving Canada the lowest net debt to GDP
ratio in the G-7.
As noted by the BBC's Economics Editor, Stephanie Flanders,
the sober management of Canada's public finances left room
for a decent-sized stimulus package, which led her to call
Canada a "goodie two-shoes" economy.
Today, the combination of accommodative monetary and fiscal
policy is pulling the Canadian economy from recession slowly
and delicately. But equally important is that our strong fundamentals
have muted the impact of the global and Canadian recession
on our markets, companies and individual Canadians when compared
to countries like the United Kingdom.
The fiscal challenges that Canada had in the 1980s and early
1990s, resulted in the Canadian public recognizing the importance
of balanced budgets and, politically, fiscal discretion was
embraced, which was not the case for many other G8 countries
and, particularly, the United States.
Fiscal prudence was a major differential for Canada going
into the crisis and will, hopefully, be a major differentiator
Conservative risk appetite
The conservative risk profile of Canadian banks is becoming
increasingly well known and respected. In addition, Canada's
banks are generally well diversified geographically and across
Despite having a leading global capital markets business
with significant operations in Toronto, New York and London,
RBC has been a more conservative participant in markets for
the more exotic instruments than many of our global counterparts.
Our structured credit business in London, for example, experienced
major write-downs but its size and scale relative to our capital
base and balance sheet made it manageable. Our strategic objective
is for our wholesale operation to represent between 20% —
30% of our normalized business and we worked hard to maintain
that balance even when excess liquidity as accommodative markets
made it easy to aggressively grow wholesale assets.
Most major Canadian banks demonstrated notable capacity for
being profitable even during the peak of the global economic
crisis and our banks have historically carried higher levels
and better quality capital than their global counterparts
with less leverage across all parts of the system.
In addition, all of the major Canadian banks have a national
distribution network — RBC's is the largest —
with a strong deposit base that makes us less dependent on
wholesale funding. We also have a diversified, global funding
strategy which reduces our costs and makes us less reliant
on funding from one single source.
This is not to say that Canadian banks are unblemished by
the crisis: As a result of the financial crisis, they have
had cumulative write-downs of 22 billion dollars from the
second quarter of 2007 to the end of the third quarter of
this year. But when measured as a percentage of book value
or earnings, these levels are dramatically lower than banks
in the U.S., Europe and the U.K.
This individual and collective performance prompted both
Moody's and the World Economic Forum to declare Canada as
home to the world's soundest banks in each of the past two
years. By contrast, the World Economic Forum ranked the banking
systems in the U.K. and U.S. at 126th and 108th, respectively,
out of 133 countries.
Sound regulatory regime
The third characteristic of Canadian banks is a sound regulatory
regime which requires proactive management and monitoring
of capital levels and leverage.
While Basel II requires Tier 1 and total capital ratios of
4 per cent and 8 per cent respectively, Canadian banks are
required by our lead regulator to hold at least 7 per cent
and 10 per cent, respectively.
As at the end of our third quarter, RBC's Tier 1 capital
ratio was 12.9 per cent, significantly higher than our regulatory
minimums and stronger than most of our global peers. Importantly,
our tangible common equity ratio was 9.1 per cent and while
Tier 1 is important, there is nothing like bedrock common
In the short term, I believe it is important to be conservatively
capitalized — and clearly, at this level, we carry capital
well above the regulatory minimums. But in this market, our
capital strength provides us with a competitive advantage
along with substantial flexibility to both grow and maintain
We have tremendous opportunities to invest in our existing
businesses and toward other opportunities consistent with
our corporate strategy. Over time, our ratios are likely to
trend down slightly as we take advantage of attractive ways
to deploy capital but in this period of economic and regulatory
uncertainty it is prudent to keep them high. This is, however,
in contrast to much of our global competition, particularly
in Europe, which will be required to significantly increase
core-capital and decrease balance sheet leverage to meet future
Quality of capital is only one side of the equation, with
leverage being the other. I believe that excessive leverage
was perhaps the greatest contributing factor to the problems
at many banks because capital rules risk-adjust assets and
the assets that caused such stress in many banks were "highly
rated assets" therefore, requiring very little capital.
If you are levered at 50 to one, it doesn't take much of a
decline in your asset values to wipe out your equity and that
is exactly what happened to many banks, particularly in Europe.
RBC and other Canadian banks operate under a binding constraint
on our leverage. The leverage at RBC — while amongst
the highest in Canada — is very low relative to many
banks around the world. Since the start of this decade the
rate of growth of assets at many banks was significantly higher
than the rate of growth of capital a trend that played a great
part in the collapse of many financial institutions.
Another contributing factor to the success of the Canadian
banking system is that we have a more conservative domestic
While there were many causes of the financial crisis, and
blame can be shared by politicians, regulators, financial
institutions, credit rating agencies and investors, the primary
cause of the crisis was a massive failure of public policy
and regulation in the U.S. residential real estate market
which initiated and significantly contributed to the financial
Canadian rules require bank-originated mortgages with a loan-to-value
ratio greater than 80 per cent to be insured. Canadian consumers
are discouraged from carrying excessive debt as mortgage interest
is not tax-deductible, and our mortgage products are typically
for five-year terms with 25-year amortization periods. There
are no teasers or hybrids, and prepayment penalties discourage
Further, in Canada the majority of mortgages outstanding
are held on the balance sheet of the originators, whereas
in the U.S. the majority of mortgages are securitized and
held off the originators balance sheet.
What was the worst performing asset class in the United States
and other countries was one of the best in the Canadian system.
Importantly, however, I would note that from a public policy
perspective, while our market is more conservative, the rate
of homeownership in Canada is comparable to the U.S.
In summary, there were a number of factors that sheltered
the Canadian banking system from the fate of others but the
structure of the system was able to weather the storm and
our governance structure should be an example to others.
With that brief overview, let me turn more specifically to
the challenges facing our industry today.
As policymakers talk through potential reforms at the G-20
table and in other forums, they must commit to a prudent set
of rules that resist the temptation for over-regulation while
at the same time end the perception that there are institutions
that are too big to fail, and restore both accountability
and risk of bank performance to management, creditors and
shareholders. It is a tricky balance but critical to the functioning
of not just the financial system but the economy in general.
As was made clear by Canadian regulators recently, market
discipline must be re-asserted in the financial services sector,
lest companies take on more risk than optimal. In addition,
our regulators have been consistent in saying that failure
of institutions should be a viable option in a global framework,
and that there must be penalties for any failure.
The underlying approach to the Canadian regulatory model
is principles-based — relying on the judgment of management
and advisors of institutions, rather than the "security
blanket of excess capital." Such a system demands that
good risk management and governance become embedded in all
operations of a company, not merely exercises to satisfy a
This view reflects the value of companies creating integrated
and disciplined risk management programs. At RBC, our enterprise
risk management activity is led by our Chief Risk Officer
who reports directly to me. Our risk management framework
is built on a foundation of a strong risk management culture,
supported by a robust enterprise-wide set of policies, procedures
and limits that involve our risk management professionals,
business segments and other functional teams. This cross-enterprise
partnership is designed to ensure the ongoing alignment of
business strategies and activities within our risk appetite.
Clearly, from our experience and that of the Canadian sector,
a model based on good governance and prudent management works
well to mitigate risk while promoting market competitiveness,
functioning and efficiency.
Industry leaders, policymakers and those drafting regulatory
reforms must recognize that the financial system is more about
confidence and perception than technical measures of liquidity
and solvency. While living wills and other wind down mechanism
are worth discussing, these kinds of measures will not work
in isolation if we have a systemic meltdown like we did in
the Fall of 2008. At the height of the crisis, when Lehman
went down, others would have followed regardless of their
liquidity or level profitability because the market viewed
balance sheets as too large and illiquid relative to capital
under-pinning. Regulators must ensure that within their National
Markets that institutions are sufficiently capitalized and
manage their risk sufficiently to prevent a collapse from
a market and economic crisis because they will inevitably
occur. Good international regulation has to start with good
But because a financial instrument created in one jurisdiction
often relies on counterparties in another, there is an imperative
for regulators to coordinate monitoring and response, and
to ensure markets are continuously available. The past crisis,
which showed an unexpected speed and severity of the financial
contagion, proved that every country has a vested interest
in an internationally coordinated effort to create a more
sustainable financial framework.
To avoid a similar meltdown and to ensure future competitive
markets, we need better and more consistent national regulation
alongside global oversight and cooperation.
Further, the impact of adopting future reforms without global
coordination will be felt in the reduced competitiveness of
markets and, perhaps more importantly, stifled economic growth.
With this in mind, I want to point out developments that
I find concerning and counterproductive to instilling confidence
in the global financial system. These developments could,
in my view, undermine effective regulation and the global
banking sector's ability to facilitate economic prosperity.
First, a common theme of most reform initiatives being considered
is increased capital requirements. Higher capital requirements
are required. However, I am concerned that too much emphasis
on individual reforms and prescriptive rules will outweigh
consideration of their cumulative impact and their cost to
Given the scope of the crisis and public demands for redress,
the agenda for regulatory change is ambitious and, in the
case of many proposed initiatives, still at a fairly conceptual
stage. Policymakers must resist the temptation to see over-regulation
as a panacea for future crisis.
In addition, they must be cognizant of the risks of unintended
consequences of too much change being implemented over a short
period of time.
Higher minimum levels of both Tier 1 capital and Tangible
Common Equity should be mandatory but the levels should be
standard, straight forward and reflect the appropriate risk/reward
of business. We should avoid the "piling on effect"
that could result from regulatory or policy makers in different
jurisdictions wanting to impose their own specific requirements.
Regulators are discussing minimum capital levels, premiums
for systemically important institutions, deducting goodwill
from core equity, eliminating the value of deferred taxes,
significant increase for operating risk capital, special financial
transaction taxes, reducing the ability of institutions to
manage capital globally, counter cyclical capital level mechanisms
and the list goes on.
We must remember that for the financial industry to maintain
its market confidence and credit ratings — it must be
able to generate reasonable returns. The cost of higher equity
levels and inefficient regulation will ultimately be passed
on in the form of higher credit cost and it is, therefore,
important to ensure that regulation doesn't overreact and
choke off economic growth.
Implementing reforms that are not fully thought through pose
stark risks to the industry and the financial system itself.
Whatever direction reforms take, they must be straight forward,
easily understood and not vulnerable to misinterpretation
I have strong concerns that reforms may be implemented in
different jurisdictions along uneven and uncoordinated timelines.
Reforms implemented at different times by different regulators
create competitive disadvantages for banks under the purview
of early adopting regulators. Consistency and a level playing
field must, in my view, be a core principle or the world can
be held hostage to the lowest common denominator. I believe
banks in different jurisdictions are operating under different
assumptions and would encourage constant standards across
International harmonization, of specific regulations —
such as liquidity and capital standards — and their
implementation timelines, is critical to ensuring the marketplace
The other area where there seems to be differing views is
on maximum leverage ratios. Again, in my view, it is essential
that we have consistent international regulations that cap
leverage ratios at levels that reduce the risk of crisis from
inflated and illiquid balance sheets. When you look at the
ratio between capital and assets of some banks since the beginning
of the decade it is staggering and the banks that aggressively
grew assets — in many cases irrespective of return on
those assets — were those that were most exposed when
the crisis hit.
We need time to allow institutions to get to a common level
but, in my view, it is essential that there is an international
standard that caps leverage relative to core equity. Capital
formulas — on their own — did not work last time
why should they next time.
As I understand the fundamental objective of the G-20 discussions,
reforms should create a global financial system that supports
worldwide economic growth and confidence in the financial
In considering new rules, authorities should, in my view,
embrace the following principles:
Any new rules and regulations should seek to create a level
playing field for all global institutions.
There must be co-operation and agreement to arrive at internationally
accepted definitions and requirements for capital and liquidity,
and the timing of their implementation.
We should avoid overly complicated formulas or special surcharges
or taxes that will stifle growth.
Tier 1 capital and tangible common equity standards should
be increased but they should be determined as a result of
collaboration among global regulators to achieve a coordinated
and harmonized implementation plan that does not over price
credit and choke off economic growth.
And leverage ratios of financial institutions should be capped
at levels that prevent a systemic collapse from a decline
in asset values.
I will conclude this afternoon by saying that the fallout
from the historically significant events of the past two year's
demands thoughtful response.
From my point of view, any reform must fit into a framework
that balances risk and reward while enabling the banking sector
to succeed and facilitate economic growth, innovation and
Now is not the time to be tempted to score political points
and hastily implement new rules and regulations that impede
the ability of the market to operate efficiently. Compensation
principles must be aligned with risk taking but compensation
was not the cause of the financial crisis.
Policymakers must find a way to resolve the need for reforms
with a globally agreed upon solution. The last two years of
crisis and instability have taught us well that the interdependencies
of the financial sector span all borders.
I urge regulators and policymakers to see to it that we are
equally interconnected when it comes to setting the stage
Thank you for inviting me.