Remarks to the BBA (British Bankers' Association)
President & Chief Executive Officer
Royal Bank of Canada
July 13, 2010
Good morning. It's a pleasure to be here in London, the world's
greatest financial center, a distinction that I hope it will
be able to maintain. This is a market in which RBC has - and
plans to continue to invest. We now have close to 3,000 employees
in the UK and Channel Islands and our intention is to continue
to expand, particularly, in our capital markets and wealth
But rather than comment on this market, what I would like
to do is highlight some features about the Canadian banking
system and the reason for its resilience over the past three
years. Without sounding smug, I do believe our model can be
very instructive as other regions, including the UK, tackle
their own reform.
In addition, I will provide some perspective on the financial
crisis and resulting global regulation and what I see as some
of our industry's shared challenges as we emerge from the
worst financial crisis since the Great Depression. I am not
sure how much my comments will correlate with the title "Stability,
Competiveness and Service" but suffice to say that getting
regulation right is critical to our industry being able to
compete and succeed.
In June, I spent a week in Europe with many of my banking
counterparts and, more recently, attended the G20 meetings
in Toronto. Clearly, it's a very difficult global environment
but I did leave those meetings feeling somewhat more confident
about the collective willingness to address the challenges
ahead. There is clearly a recognition that the uncertainty
of financial regulation combined with global fiscal imbalances,
pose great risk to economic stability and it was helpful to
see some progress with respect to commitments from the G20
countries in these areas.
Having said that, particularly throughout Europe and the
United States, slow economic growth, continued volatility
and uncertainty over sovereign debt are major overhangs and
social unrest will only be exacerbated where spending cuts
and tax increases are the only option. While fiscal imbalances
must be addressed it is, on top of this difficult situation,
that regulatory reform will be imposed, and as it is currently
proposed, the impact will be challenging for both banks and
the economies they facilitate.
But before I share with you my views on regulation and what
is needed to return the world's banking system to one of strength
and stability, I'd like to talk about why Canadian banks have
proven to be more resilient. In my view, some of the reasons
for that strength is instructive to what should be incorporated
into new global regulations.
Now the common wisdom is that Canada is so tightly entwined
with the US economy that when it sneezes, we catch a cold.
Yet throughout the global financial crisis, when the US and
Europe succumbed to double pneumonia, Canada felt but a twinge
and carried on. The IMF attributed the country's resiliency
to three things: one, sound macroeconomic policy, two, proactive
response by government and regulators to the crisis, and three,
well capitalized, well managed banks. The one that they missed,
perhaps the most important, was the structure of our housing
and mortgage market which was a major contributor to the strength
of our system. Canada has indeed been a fertile place for
banks to lay down strong roots and given the regulatory and
taxation challenges being contemplated or implemented in other
regions, we would expect it to grow in terms of relative attractiveness.
Over the past decade, Canada's strong economy, its fiscal
policies, its governments and its regulators have fostered
the growth of a world class financial services industry. The
banking business in Canada, as compared to G8 banking systems,
is more competitive, more cost effective for its customers,
and far more accessible due to a leading edge branch and technology-based
distribution network. With Canada being a nation of early
adopters of technology, it's no coincidence that electronic
banking is more widely used among Canadians than most markets.
Competition among the six large banks ensures that Canadians
have significant choice and amongst the lowest banking fees
in the world. Canada's banking system is sometimes referred
to as an oligopoly yet we have more large banks that compete
aggressively than virtually any country in Europe including
It was not, as is sometimes reported in the media, the conservative,
boring nature of Canada's banks that lead to greater stability,
but rather a combination of good fiscal and regulatory policy
by government and sound strategies and, risk management implemented
by most of the major banks. Finally, and importantly there
was a little bit of luck.
While many, factors contributed to the global financial crisis,
the root cause was a massive failure of public policy and
regulation in the U.S. residential real estate market. In
its simplest terms, a perfect storm was created by the convergence
of the American ideological pursuit of home ownership as a
right rather than a possibility. Public policy facilitated
this ideology through government sponsored enterprises like
Fannie Mae and Freddie Mac, interest deductibility on mortgage
payments, legislation that encouraged high risk lending and
mortgage products whose features went well beyond reasonable
Wall Street was not, as is often painted by politicians and
media, the root cause of the crisis -- but it was complicit.
The financial industry jumped on the bandwagon and mortgage
securitization grew into a major business - much of it outside
of the regular banking system. Banks, investment banks and
GSEs enthusiastically pooled large bundles of mortgages, and
sold them off in tranches to banks and investors around the
world. Home financing became so available that the only criteria
for a mortgage in the U.S. seemed to be a pulse. House prices
continued to rise, and millions of Americans enthusiastically
signed up with lenders (many aided by unscrupulous brokers)
to take their fair share of the booming house market.
Inevitably, as is the case with all asset bubbles, the perfect
storm had arrived. When consumers began defaulting on mortgages,
the housing bubble collapsed. Securities tied to U.S. real
estate plummeted, financial institutions around the world
were damaged, investor confidence disappeared, and governments
and central banks were required to step in to support specific
institutions and the financial system.
Mortgages secured by U.S. residential real estate found their
way onto the balance sheets of many global financial institutions
and investors through complex securitization structures. This
dislocation between origination and holder of the debt was
fundamental to the problem. In contrast within Canada, the
majority of mortgages outstanding are held on the balance
sheets of originating banks and as a result they are properly
Canada does not have a sub prime market of any significance
and high ratio mortgages are required to be insured. Our term
mortgage products are typically five years with 25-year amortization
periods and there are few teasers or hybrids, and prepayment
penalties discourage refinancing booms. And unlike the US,
mortgage payments are not tax deductible, which effectively
encourages consumers to maximize their monthly mortgage payments
rather than build equity in their homes. The result of these
structural differences was that the worst performing asset
class in the U.S. was a source of strength our banking system.
In my view, this was the biggest differentiator in terms of
relative performance between the banking sector in Canada
and the United States.
Now here is the catch which highlights the policy failure
in the United States. Home ownership levels in Canada are
actually higher than they are in the United States. While
the US residential mortgage market was the primary cause,
we all know that its helpmate in sparking a global financial
crisis was excessive leverage in the financial system. The
destructive power of leverage was compounded in the banking
industry by capital rules that risk-adjust assets and the
assets that caused such stress in many banks were "highly
rated assets" and therefore, required very little capital.
Who would have forecasted that "AAA" assets would
underperform "BBB" assets, and 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 financial institutions. It's also why the Financial
Stability Board recommended a leverage ratio to supplement
risk-based measures of regulatory capital.
Among the G7 nations, only Canadian and US bank regulators
impose leverage caps. Canada has a leverage cap of 20:1 and
since the major investment dealers are all owned by banks
and thus subject to leverage constraints, fewer problems emerged.
The situation was different in the US, where many of the largest
financial institutions were independent and unconstrained
investment banks. Europe has never constrained leverage for
banks or investment banks - in my judgment, a mistake.
In our industry, it is easier to grow assets and, therefore,
revenues but much more difficult to grow franchises and risk
adjusted returns on assets. And history has showed us that
even the highest rated asset classes can suffer, with European
sovereign debt the latest example. The market place and compensation
structures encourage asset and revenue growth rather than
earnings and returns and management and boards failed to keep
this growth in check. Balance sheets ballooned and ROA declined;
in hindsight a recipe for failure which dragged down the most
aggressive banks. Leverage limits not only act as a governor
on excessive growth, they force banks to more judicially allocate
capital and justify expansion.
As to capital requirements, Canada was also more stringent
than other jurisdictions and significantly tougher than those
called for by Basel II. Our minimum Tier 1 capital was 7%
of risk weighted assets. The U.S. was 6%, and the UK and other
G7 countries were 4%. Going into the crisis most of Canadian
banks had tier one ratios in excess of 9% significantly higher
than the requirement of Canadian regulators. This combination
of less leverage and higher capital levels was a major source
of strength as our system managed through the market turmoil
and should, in my view, be the primary focus of regulatory
An additional differentiator in Canada, particularly relevant
to the UK today was the strong fiscal position that our country
enjoyed going into the crisis. Coming out of the recession
of the 1980's Canada's fiscal structure was such that it was
referred to by the Wall Street Journal as "an honourary
member of the third world". As a result, fiscal discipline
became the order of the day, with the full support of the
electorate I might add, and this led to fifteen years of successive
budgetary surpluses and the lowest debt to GDP levels in the
G8. A strong national balance sheet provided much greater
flexibility to manage the fallout. We were fortunate that
our fiscal re-balancing process occurred during a period of
strong global growth, a luxury that will not likely be afforded
governments today, but regardless of the economy, governments
must get out in front of this potential tidal wave.
It strikes me as I make country comparison that every country's
culture is stereotyped to some extent, and I know that many
equate Canadians with modesty and humbleness. You may be reassessing
this stereotype at this point in my speech. The truth is that
events like the financial crisis test the mettle of every
organization. For a time we were knee deep in the mess, and
worried not just about our balance sheet but the domino effect
of the disaster around us both domestically and internationally.
In the end, our market related losses were approximately C$4
billion, large on an absolute basis but less than 15% of our
capital base. If the truth be told, I would never have thought
I could survive $4 billion of market related losses but on
a relative basis it was manageable and thanks to diversification,
we were able to earn our way through the losses and reported
strong results notwithstanding the market related losses.
Canada was certainly not without our problems as some financial
institutions suffered tremendous losses, our securitization
markets collapsed, many conduits had to be restructured and
our credit markets dried up. But the fundamentals of the country
and underlying strength of the banking system allowed us to
respond aggressively to restore confidence. Those institutions
that had significant losses were able to maintain ongoing
operations without government intervention and earn their
way back to restored confidence.
Events like a global financial crisis are the true test of
not just your people but also your organization's risk structure.
One element of RBC's risk structure is diversification, geographically
and by business line. Our five business platforms, Canadian
Banking, International Banking, Insurance, Wealth Management
and Capital Markets, have different risk profiles at any given
point in the cycle.
We also strategically cap our wholesale operation to 20%
to 30% of our normalized business to keep our diversified
business model in optimal balance and reduce our dependence
on wholesale funding.
In my judgment, business mix will become a much greater differentiator
among financial institutions in the future and individual
banks will be required to make tough decisions. But these
decisions should not be made by governments or by regulators
but rather by management and boards. We should not want regulation
to discourage diversification, as is the case with some current
proposals, as diversification can both reduce risk and drive
innovation. If regulation pushes banks all in the same direction
it will, in my view, increase systemic risk.
The crisis underscored how important it is to ensure that
risk adjusted capital is properly allocated and to effectively
stress test for risks. This is a much better way to reduce
growth of certain high risk businesses than by outright restriction.
We don't just need more regulation, we need smart regulation
and I am concerned that some proposals will encourage institutions
to make bad decisions.
No matter how excellent one's relationship is with regulators,
one seldom wishes for more attention. However, it is clear
that regulators will rightly be paying more attention to all
banks as our industry has failed to manage between shareholder
returns, safety and soundness and serving the public interest.
But in the face of this, my hope is that smart regulation
coupled with sensible supervision, is balanced and builds
on lessons we've learned while keeping our industry strong,
vital and stable.
- I hope we achieve uniform implementation across all jurisdictions.
The speed at which the recent financial crisis spread to
all corners of the globe shows how porous and interlinked
national economies and markets are, and, in an integrated
world, we need uniform regulation that creates a level playing
field across economies and markets.
- I hope that there are reasonable implementation timelines,
sufficient to test systems and ensure that clients are not
negatively impacted but with clarity and transparency that
removes the current uncertainty from the market. We don't
need the decade it took to do Basel II, which as you know
was never implemented in the US, but we must ensure we agree
on a set of rules that does not strangle credit and capital
- I hope that relative costs and benefits are carefully
weighed to avoid three potential problems: new and unnecessary
costs to taxpayers, institutionalized government involvement
in private sector risk management, and a shackled financial
structure that is less responsive to client needs and market
- And I hope that any the new regulation builds on what
we already know works well (such as the Canadian model)
to secure a strong and stable financial system.
It is important that regulators focus on the real issues
that will reduce systemic risk and move beyond extraneous
political issues, such as the now discarded, international
bank tax. On this one, Canada - rightly -balked and, it's
interesting, three quarters of Canadians have stated their
opposition to this tax. It is difficult to sell in a country
where its banks functioned relatively well throughout the
There is no reason that individual countries should not impose
special taxes to help deal with those deficits, as was done
in the UK, but it is a taxation issue and has little to do
with regulation. You would be interested to know that in tackling
our deficits in the 1990's Canada imposed it's own "bank
tax" in the form of a tax on the capital of financial
institutions, a tax which is just now in the final stages
of being phased out. It was a Canadian only tax and yet it
did not impair our ability to compete. But a global tax to
"insure the system" would not accomplish its goals
and to quote our central bank governor, Mark Carney (now Chairman
of the Committee on the Global Financial System), "risks
increased moral hazard".
Citizens of other countries where the financial system was
crippled or injured are much more aggressive in their support
for radical surgery, such as certain provisions embedded in
the U.S. financial reform bill. In many cases, this is more
than a measured conversation about how to improve the future
functioning of the financial system; there is a deep seated,
retributive anger, some of the roots of which I've discussed.
What troubles me about proposals like the bank tax, or proposals
like, what is often referred to as the Volker rule, is not
the cost but the belief that in them lays the solution for
a stable financial structure. Such proposals are not solutions
for the future, they are levies on the past.
For instance, restrictions in proprietary trading in banks
would not have saved Lehman, Bear Sterns, AIC, Fannie Mae
or Freddy Mac and, in fact, trading was one of the most profitable
activities of banks throughout the crisis and helped offset
major losses in retail banking operations. Proper risk capital
allocation against trading businesses is a much better solution
in that it would automatically restrict higher risk activities
but, at the same time, would allow banks to make their own
decisions around business strategy and capital allocation.
The most important component of global regulation are the
negotiations around what is often referred to as "Basel
III" and echoing the fears of any 19th century person
contemplating a hospital stay, I am concerned that the proposed
cures are worse than the disease.
As you know, Basel III's proposed rules are supposed to be
a starting point for discussion. Ironically, these proposed
rules, for all their good intentions, will negatively impact
even the healthiest bank's balance sheets in terms of capital,
leverage ratios and liquidity and compromise economic growth.
The proposals are so complex and onerous that we run the risk
of an agreement that lacks transparency and integrity, or
one that results in non-uniform implementation.
I expect you have all reviewed Basel III and know that it
has redefined capital and risk assets, the effect of which
is to turn swans into ugly ducklings. Canadian banks, as an
example, would be lifted from their position as well capitalized,
liquid financial institutions and recast as undercapitalized.
Banks that passed the "real life" stress test may
fail the theoretical one - a pretty good indication of flawed
Basel III's new definition of capital optically slashes the
capital ratios of banks. The only real world change, other
than investor alarm at this sudden slide in ratios, is that
the redefinition of allowable capital may demonstrate that
the funding supply is too small to address the capital shortfall.
Basel III leverage rules use a very restrictive definition
of capital and an overly expansive definition of risk assets.
The net result of doing so optically increases the leverage
and would encourage banks to get rid of low risk assets (such
as insured mortgages) and replace them with higher risk assets
- hardly a way to reduce risk. Rational investment decisions
made based on existing capital rules are, in some cases, now
inconsistent with the proposed rules. And specific capital
deductions in a host of areas will push banks to restructure
in a way that could increase their risk profile.
On the whole, my view is that if well-capitalized Canadian
banks can be painted as risky, overleveraged and undercapitalized
by Basel III, think how banks truly beleaguered by the financial
crisis will end up.
Some estimate the banking system would be required to raise
over a trillion dollars of equity. All of this raises the
question of whether there will be enough global capital to
make up for these regulatory requirements, and what the impact
will be on competition, credit availability and pricing for
Many analysts estimate that costs for the full range of regulatory
reforms being considered would increase prices for consumers
and the IIF estimates that it would reduce GDP by 3% in Japan,
Europe and the US alone and reduce jobs by almost 10 million.
Now people can disagree with those numbers, as many central
bankers were quick to do, but show me an economic model where
the amount of capital in banking increases dramatically and
regulatory costs escalate significantly where at least a portion
is not born by borrowers and the broader economy.
The bottom line is there is no free lunch. The industry must
generate a reasonable return in order to attract capital and
maintain its credit standing and, therefore, any increased
cost of capital will be reflected in the cost of credit and
In my view, Industry and regulators should accept that the
rules as drafted must be re-calibrated. At a minimum, national
regulators should have some discretion regarding implementation
to recognize different regulatory and legal frameworks. Going
into this crisis, the banking system had too little equity,
too much leverage and not enough liquidity. We can address
these issues with balanced and straight forward reforms that
don't choke the system. Focus on reasonable changes to these
three areas, focus on strong local supervision and hold management
and boards accountable to a higher level of performance.
One of today's challenges is that different constituents
have different interests. As bankers, we are concerned about
growth and returns - regulators about safety and soundness
- central bankers with the competing interests of systemic
risk and economic growth - and politicians have to deal with
significant public discourse. Having said that, there has
never been a time where there is a greater need for these
constituents to work together while unfortunately the opposite
is occurring. There is more focus on attribution of blame
for the past than ensuring success in the future. We need
balance and the regulatory discussion needs representation
of bank shareholders and customers.
We must find the right balance that ensures market stability
with reduced systemic risk while at the same time encourages
investment, innovation and capital formation. There is a lack
of transparency and integrity in the numbers and this uncertainty
does not serve the system well. If, for instance, we simply
used the Basel II definition of capital and imposed significantly
higher Tier 1 and common equity ratios (say 8% and 6% respectively)
and applied a reasonably defined leverage ratio and ensured
common standards around areas like trading risk capital allocation
--- the system would move forward and systemic risk would
be significantly reduced. If we have strong local regulations
and hold management and boards accountable for risk standards,
at least for now, a great deal of uncertainty would be removed
with much reduced systemic risk.
If we get back to basics, we can, in my view, confirm the
approach by the time of the November G20 summit in Korea.
The approach would create certainty for institutions, and
would avoid allocating scare resource to proposals that risk
our global economic recovery. The choice is between action
and delay - my vote is to act now and to act quickly but responsibly.
Now despite the financial crisis and my particularly negative
view on regulatory risk, there have been and still are opportunities
for banks with the strength and stability to seize them. We
saw the opportunity to spend money to build our brand in the
US and UK over the past three years. The financial crisis
presented good marketing opportunities for RBC to differentiate
itself on its strength and stability, and we took them, to
great advantage as we invested heavily in our business.
The crisis also created the opportunity for us to extend
credit and get paid a reasonable return. Prior to the crisis,
there was no alignment between risk and reward and credit
became a loss leader to get you at the table for advisory
work. For the system to work properly, banks must get paid
for extending credit and the associated risks.
As the storm subsides, strong banks will, in my view, get
stronger, and weak banks will be pressured to restructure.
This suggests an era of opportunity for potential acquisitions
but not until we have a clear line of sight on the true value
of assets and clarity on regulation. As long as uncertainty
and volatility remain, finding the right time to buy at the
right price is like trying to catch a falling knife -- but
ultimately our industry will restructure.
There is no question in my mind that all of us in the banking
system will have to adjust to a new normal in our industry.
It is too simple to suggest a return to the basics of banking
as we operate in one of the most dynamic and innovative global
industries. The new normal will require a greater focus on
the customer, value added products, and innovation that enhances
product fulfillment and reduces the cost of delivery. In my
view, the relationship between our industry and government
and perhaps more importantly - society in general - will permanently
shift and those who manage that paradigm will be winners.
Banks have a social responsibility - and the sooner the industry
steps up and fulfills its expectations, the better off we
Banks will have to restructure their business mix to ensure
that capital is being deployed in the most efficient and effective
manner because neither the marketplace, nor regulators, will
tolerate marginal returns on excess capital. The result will
be restructuring of balance sheets and assets and those that
can adapt will benefit and those that are complacent and hope
for a return to the "good old days" will atrophy.
Our intention is to adapt and take advantage of this shift
to refocus and ensure our model and business mix maximizes
The public's distrust of our system climbed when individuals
saw the value of their retirement savings and/or homes plummet,
and this distrust soared further when it became clear that
many different participants - financial institutions, regulators,
politicians, and investors - played a role in causing this
As our markets restructure, as our companies rebuild and
as confidence and trust are restored, there is understandably
a great cry from customers, regulators and stakeholders for
more accountability, more responsibility and more transparency.
Today we have the opportunity and obligation to show that
we understand our role to underpin the world economy.
As I enter my second decade as CEO of The Royal Bank of Canada,
I've noticed that my focus is shifting more and more to engaging
our people - much more than I did in my early years as leader.
Our most important assets ride the elevators and enter our
branches everyday: they make our reputation strong or weak,
they make it easy or hard to attract top talent and attract
and retain good clients. They are the ones that must seize
the opportunities ahead and drive innovation. How committed,
engaged and client-focused they are is ultimately a function
of our culture. Values and values-based cultures have come
to forefront with the financial crisis. Customers are looking
at their banks anew. They are taking a greater interest in
who we are and what we stand for. This curiosity is about
more than balance sheets and capital ratios. They want to
know about our strength as it relates to respect, trust and
integrity, not just capital. They want to know if we really
do put clients first. The new normal says we must, or else
reputational risk, not to mention regulation, will weaken
and destroy franchises. During these challenging economic
times, it is essential that we move the regulatory discussion
in a way that reduces uncertainty and enables our industry
to fulfill its important role in economic growth and capital
Regulatory uncertainty and improperly calibrated rules are
our industry's great risk and we all have a collective obligation
to our constituents to get it right.
Once again, I would like to thank BBA for inviting me to
speak this morning.