Enterprise Risk Management Symposium

September 29 - October 1, 2014, Chicago, IL

Paper submitted for the:

ENTERPRISE RISK MANAGEMENT

CANADIAN BEST PRACTICES HOW DID THEY GET THERE?

Lois Tullo ltullo@jlt.net

Abstract A practical application paper from Lois Tullo, Schulich School of Business, York University,

Canadian banks have been voted the world strongest banks for 5 years in a row by Bloomberg. However,

Canadian banks did not always demonstrate ERM best practices. How did they get there? This paper puts forth three key factors that lead Canads’s top 5 banks to emerge as leaders in ERM practices. First a visionary and

demanding regulatory environment, second, burning platforms which spurred the leadership of Canadian banks to recognize the value of ERM, and to invest in ERM, and third the people, processes, systems and data that are

evident in the best practices at each of the Canadian banks.

Lois Tullo has been teaching risk management and Financial Services for 17 years, to MBAs, undergrads, and Executives. She was previously, CFO for CIBC Finance Inc. (a $6 Billion subsidiary of CIBC), interim responsibility for risk management, and past BOD for Jameson Bank. C.A., C.P.A., M.B.A., B.Comm.

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Table of Contents

Acknowledgements

Executive Summary ................................................................................................... 3

Strongest Global Banks - Canadian .......................................................................... 3

Figure 1 – Canadian Banks Ratios .............................................................. 4

Figure 2 - Return on Tangible Common Equity .......................................... 5

Factor 1 – The Regulatory Environment ..................................................................... 6

Impact of Canada’s Stability ........................................................................ 8

Figure 3 – G-7 Net debt as a % of nominal GDP ......................................... 9

Factor 2 & 3 – Burning Platforms, ERM Leadership, and ERM best practices ......... 10

BNS – ....................................................................................................................... 11

Figure 4 – BNS Net Impaired Loans .......................................................... 11

Figure 5 – BNS Total Allowance as % of Loans ........................................ 12

Figure 6 – BNS Loan Loss Provisions ....................................................... 12

CIBC – ...................................................................................................................... 15

Figure 7 – CIBC ROA ................................................................................ 16

Figure 8 – CIBC RORWA .......................................................................... 17

Figure 9 – CIBC Net Impaired Loans ........................................................ 19

TD – ......................................................................................................................... 21

Figure 10 – TD RORWA ............................................................................ 21

Figure 11 – TD Net Impaired Loans .......................................................... 22

BMO – ...................................................................................................................... 25

Figure 12 – BMO Retail Net Interest Margin.............................................. 25

RBC – ....................................................................................................................... 27

Figure 13 – RBC ROCE ............................................................................ 27

Figure 14 – RBC Earning by business segment and geography ............... 29

Figure 15 – Canadian Bank VaR ............................................................... 30

Conclusion – ............................................................................................................ 32

Appendix 1 – Canadian Bank Ratios ......................................................... 33

Appendix 2 – Canadian CROs .................................................................. 31

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Acknowledgments

My students and I have been privileged to learn from the expertise and experience of the CROs in Canadian Banks over the past 17 years. I would like to thank them for hosting us at their institutions and sharing their wisdom with us. Robert Mark was the first CRO to host my class, and at that time he also shared his manuscript for his later publish book, Risk Management, with Michel Crouhy, and Dan Galai which became the foundation for my class teaching. Also to Andrew Aziz from Algorithmics who has been an inspiration to many of my student to enter the field of risk management. To my friend and colleague Brian O’Donnell, new Chief Data Officer at CIBC, who has been a constant supporter and lecturer to my class over the years, thank you.

At the Schulich School of Business I would like to thank Gordon Roberts who hired me so many years ago, and to Fred Gorbet and James Darroch who have mentored me and who have given me opportunities to develop in my career.

I would also like to thank my wonderful husband Joe Tullo, who has made it possible for me to have a wonderful career split between teaching and raising my family, MaryJo, Naomi, and Joseph. Last, I would like to thank my parents, Lois and Albert Morrison for sacrificing early so that I could enjoy the benefits of education.

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Enterprise Risk Management - Canadian Best Practices

How did they get there?

Executive Summary

Canadian Banks ERM practices are the foundation that guided them successfully

through the latest financial crisis. Canadian banks are now ranked at the top of

Bloomberg’s Strongest Banks. But the question is – how did they get there? There are

important lessons that can be learned from the example of how ERM has developed in

Canada. ERM is the synergy of environment, culture, regulation, people, and

circumstances. This article illustrates the development of Canadian bank ERM best

practices, and focuses on the three factors of ERM best practices. The first factor of

ERM best practices is the regulatory environment, second is burning platform of

substantial loss events that lead the bank leadership to realize the importance of ERM,

and third the ERM best practices capabilities of people, systems, and data.

Strongest Global Banks - Canadian

Canadian banks are now judged to be strong, stable, and profitable. The IMF’s survey

of Canadian banks listed them as “stable, resilient, prudently regulated, and rich … and

have been among the most profitable since 2008”1.

What does a best practice ERM bank look like? The top 5 Canadian banks (BOM, BNS,

CIBC, TD, and RBC) all exhibit in Appendix 1 – Canadian Bank Ratios:

a high profitability ratio;

a high ratio of a bank’s CET1;

a high ratio Tier 1 capital to its risk-weighted assets;

a low ratio of nonperforming assets to total assets;

a high ratio of reserves for loan losses to nonperforming assets (NPA);

a high ratio of deposits to funding;

and a competitive efficiency ratio.

1 FINANCIAL SECTOR ASSESSMENT PROGRAM, Canadian Banks Safe and Sound, Housing Poses Risks, IMF Survey

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As demonstrated below in Figure 1 the top 5 Canadian Banks are all within or exceed

the target ROE range of 10 – 15 %, exceed the BIS III all in CET1 ratio of 8%, and are

well below the target NPA/Total assets of 3%.

Figure 12

The Canadian banking industries long run return on tangible common equity

continues to reflect the rewards of strong ERM practices, as see in Figure 2.

2 Canadian Bank Annual Reports

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

0.35%

0.40%

0.45%

0.50%

0%

5%

10%

15%

20%

Canadian Bank Ratio's 2013

ROE CET1 (all in) NPA/Total asset

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Figure 23

The results of the last 5 years have been particularly strong for all the Canadian Banks.

However, they did not develop ERM best practices overnight.

Canadian banks were not always considered to demonstrate ERM best practices.

Comparatively, in the early nineties US banks had a significantly higher loan loss

reserve ratio but a significantly lower non-performing loan ratio than Canadian banks.

The difference in the best measure of loan problems over the period, the charge-off

ratio, was statistically and economically insignificant. The pre-tax, pre-provision

earnings of US banks were significantly greater than that of Canadian banks and US

banks also had a higher Tier 1 capital to total assets ratio.4

Canada traditionally had a significantly higher exposure to high-risk assets/loans than its global peers. As a multiple of common equity, Canadian banks’ exposure to lesser developed countries (LDC) loans was 10.9x the exposure level of U.S. banks in 1982, with commercial real estate (CRE) exposure being 2.5x its U.S. counterparts in the early 1990s and Telco exposure 6.7x larger. The high exposure to high-risk assets was further compounded by single name concentration within these high-risk sectors, especially CRE in the early 1990s. Canadian banks had single name exposure as high as 35% of common equity in 1985 and 20% in 1992

3 RBC Canadian Bank Chart Book (Q3/13) 4 BANK OF FINLAND DISCUSSION PAPERS; 33 2003; Iftekhar Hasan – Larry D. Wall, Research Department; 1.12.2003 http://www.suomenpankki.fi/pdf/110653.pdf, Last accessed May 20, 2014

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with single name exposure now estimated at only 2% of common equity, with very few exceptions. The Canadian banking system’s historical leverage to credit and concentration can be reflected by the fact that the Canadian banking system absorbed $40 billion in loan loss provisions from 1984 to 1994 on a common equity base of only $14 billion.5

In the period from 1980 to 1994 Canadian banks experienced three significant periods

of loan loss as well as the fall out of the 1987 crash of the financial markets;

Losses to: 1) Lesser Developed Countries (LDCs largely - Mexico, Brazil, Venezuela, and

Argentina). In 1982 loan loss experience as a percentage of loans rose to: TD 0.56%, BNS 0.84%, CIBC 0.88%, RB 1.02%, and BMO 1.13%.

2) the energy sector (Dome Petroleum) in the mid-80s, and 3) the commercial real estate sector (Olympia & York) from 90 – 94.6

Paul-Chowdhury’s research published in 1999 showed that the lessons learned from the

sector-specific loan losses were often not broadly disseminated across the bank and did

not travel well in the face of performance pressures of asset price bubbles, learnings

were systematically eroded and frequently ignored.7

In a Swedish banking industry study of the early 90s, Eriksson (1996)8, noted that the

banks that experienced the greatest losses were the ones that had expanded their

commercial lending most aggressively in the late 80s, and had the following in common:

transfers of ownership, substantial layoffs, management changes, revised

organizational structures, and more centralized decision making through tighter credit

evaluation and control procedures. In the period of 1980 to 1993 many of these

characteristics were evident in the top 5 Canadian banks.

5 The Credit Cycle - Banks Positioned to Outperform, Scotia Capital, MAY 12, 2009 http://financialsector.blogspot.ca/2009/05/credit-cycle-banks-positioned-to.html, Last accessed May 20, 2014 6 The Canadian economy, EIR, Volume 9, Number 30, August 10, 1982 http://www.larouchepub.com/eiw/public/1982/eirv09n30-19820810/eirv09n30-19820810_006-big_five_banks_near_the_edge_of.pdf, Last accessed May 20, 2014 7 Paul-Chowdhury, Catherine M., BANK LEARNING FROM SECTOR-SPECIFIC CREDIT LOSSES, National Library of Canada, 1999, http://www.collectionscanada.gc.ca/obj/s4/f2/dsk1/tape7/PQDD_0009/NQ40285.pdf 8 Eriksson, K., ”Management Stability and Change in Banking”, 1996, in Schuster, L., Intercultural Bank Management. Fritz Knapp Verlag, Frankfurt am Main

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During this time period, leadership at Canadian regulatory agencies and at the Bank of

Canada and the Department of Finance were struggling with the implications of these

losses to the Financial Sector and the Canadian economy as a whole.

Factor 1 – The Regulatory Environment

The conservative Canadian banking regulatory environment has been one of the

determinants of a strong risk management culture in Canada. In July of 19879 the

Canadian government passed the Financial Institutions and Deposit Insurance

Amendment Act, and the Office of the Superintendent of Financial Institutions Act

outlining stricter regulation on the Canadian Banking Industry. Later that same year the

Department of Insurance and the Office of the Inspector General of Banks were

consolidated to create the Office of the Superintendent of Financial Institutions (OSFI).

OSFI was given the powers to supervise and regulate all federally regulated financial

institutions. The streamlining of the underlying regulatory Acts, and the Agencies that

were responsible for them set the stage to address the risk management challenges

that were foreshadowed by the worsted crash to date of the market in October of 1987.

In 1988 Canadians were contributing authors and early adopters of the Group of 30

publication on best practices in risk management. The role of Senior Management was

outlined to play the key role in ensuring that risk is controlled in a manner that is

consistent with the overall risk management and capital policies approved by their

Board of Directors. Canadian Banks were among the first in the world to appoint Chief

Risk Officers (CRO) that reported directly to the CEO, and to establish risk committees

of the Board. CIBC appointed Robert (Bob) Mark their first CRO in 1997. In May of

2001, Bob Mark and Michel Crouhy10 gave a presentation outlining EMR best practices

that encompass most of the theories that are implemented in BIS II and are currently

being implemented through BIS III. Visionary insight into what was required to meet the

needs of a volatile financial market was evident in Canada as early as 2001.

Unfortunately, each of the Canadian top 5 banks needed to face their own burning

platform before they truly bought into the importance of ERM.

9 Office of the Superintendent of Financial Institutions, Government of Canada, 2014http://www.osfi-bsif.gc.ca/Eng/osfi-bsif/Pages/hst.aspx, accessed May 20. 10 Dr. Michel Crouhy, Dr. Robert Mark, Risk Management in the Derivatives Markets, May 7, 2001 presentation to Derivatives and Risk Management in Mexico

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In May of 1996, Bill C-1511, legislation clarified OSFI's prime responsibilities as helping

to minimize losses to depositors and shareholders, and to contribute to public

confidence in the Canadian financial system. OSFI's mandate included promoting sound

business and risk management practices. Their mandate stressed the importance of

early intervention. The requirements in the Canadian Bank Act set the stage for

avoiding the worsted of the Credit Crisis. Canadian regulation required an Assets to

Capital Management leverage ratio of 20:1, that foreign banks maintain the same

capital requirements for their subsidiaries as Canadian banks, and rules that disallow

Adjustable Rate Mortgages.

Canadian banks were among the first banks to in implement BIS I, I+, II, II+ and III.

Many banks, including large US and European banks have not yet fully implemented

BIS II, yet alone BIS III. The Canadian banking environment was heavily influenced by

Nicholas D. Le Pan as the Superintendent of OSFI (2001-2006), concurrently the head

of the global implementation committee for BIS II. Nick required the implementation of

BIS II in Canada by November 1, 2007. While Nick’s successor Julie Dickson required

implementation of BIS III all-in minimum capital ratios plus a conservation ratio by

November 1, 201312.

Early implementation of each of the BIS accords required all of the Canadian banks to

align their systems architecture with their risk architecture. This forced the Canadian

banks, earlier than other international banks, to rationalize their databases, and to make

the investments in their underlying financial systems to support the economic and

regulatory capital allocation algorithms.

Impact of Canada’s Stability

Canada’s economic stability also provides a strong foundation for Canada’s Banks. The

Canadian government was one of the few that was not required to provide bailouts to

their financial institutions. However, if it was required, Canada’s Debt to GDP ratio is

the lowest among the G7 countries.

11 Office of the Superintendent of Financial Institutions, Government of Canada, 2014http://www.osfi-bsif.gc.ca/Eng/osfi-bsif/Pages/hst.aspx, accessed May 20. 12 Office of the Superintendent of Financial Institutions, Government of Canada, 2014http://www.osfi-bsif.gc.ca/Eng/osfi-bsif/Pages/hst.aspx, accessed May 20.

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Figure 3

(4) S&P, International Monetary Fund (IMF), RBC Economics Research

The rating agencies have demonstrated concern about the riskiness of Global banks,

including the Canadian banks. On June 21, 2012, Moody's cut RBC's (and 14 other

global banks) long-term deposit rating due to exposure to volatile capital markets.

RBC’s rating was cut from Aa1 by two notches to Aa3.13

Systematic risk is still a concern of the rating agencies concerning Canadian Banks.

"High levels of consumer indebtedness and elevated housing prices leave Canadian

13 GREENWOOD, John, Moody’s downgrades RBC two notches, June 21, 2012, http://business.financialpost.com/2012/06/21/moodys-downgrades-rbc-down-two-notches/, last accessed May 20, 2014

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banks more vulnerable than in the past to downside risks the Canadian economy

faces," David Beattie, vice-president at Moody's said in a note.

Canadian consumer debt has risen to a record-high 165 per cent of disposable income

in the third quarter of 2012, up from 137 per cent in mid-2007. On Jan 28, 2013, Moody

responded to the increased debt held by Canadians by downgraded 6 of Canada’s

banks. TD, Canada's second-largest bank by market capitalization, had its pristine top-

level Aaa rating dropped to Aa1, while Bank of Nova Scotia and Desjardins were

dropped from Aa1 to Aa2. BMO, CIBC, and National Bank of Canada were dropped

from Aa2 to Aa3. The outlook for all six banks remains stable, and their short-term credit

ratings were re-affirmed. Flaherty said in a statement, adding that even after the

downgrades, "Moody's rating of Canadian banks continues to be among the highest in

the world."14

The Canadian mortgage market differs significantly from the US market. Canadian

banks have full recourse except in Alberta, and shorter stay periods than in the US.

Government insured mortgages average 51% of all outstanding for the top Canadian

banks ranging between 20% – 70%15. Interest in Canada is also not deductible as it is

in the US, creating a culture where Canadian are more incented to pay off their

mortgage early than Americans. The loan to value ratio is also substantially lower in

Canada. All of these factors aid in reducing the credit risk that Canadian banks are

exposed to.

Factors 2 & 3 – Burning Platforms, ERM Leadership and the resulting ERM Best

Practices

Each of the Canadian banks faced their own burning platform which was one of the

significant proponents that pushed their leadership to realize the value of ERM. The

organizational learning at the top 5 Canadian banks crystalized at different moments in

14 Moody's downgrades 6 Canadian banks,CBC News Business, http://www.cbc.ca/news/business/moody-s-downgrades-6-canadian-banks-1.1330855, last accessed May 20, 2014 15 Canadian Bank Annual Reports

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time, and in recognizing the value of ERM. Subsequent investment in ERM over the

long haul lead to the eventual reaping of the benefit of their investment.

Bank of Nova Scotia (BNS)

BNS has a long history of being a credit risk centric bank. BNS personnel demonstrate

a deep understanding and involvement in the credit risk management process. The

credit risk management team has for over 2 decades been required to defend their

positions and decisions to the Senior Executive Management team.

BNS faced its first burning platforms in 1992 and 1993 as they were faced with loan

losses to Mexico. BNS has experienced low Net Impaired Loans since 1996, but has

maintain a more conservative than industry Total allowance as a % of Loans.

Figure 416

16 RBC Canadian Bank Chart Book (Q3/13)

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Figure 517

Figure 618

17 RBC Canadian Bank Chart Book (Q3/13) 18 RBC Canadian Bank Chart Book (Q3/13)

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Early in 2001 BNS had an opportunity to improve their international expansion team

expertise by learning from two burning platforms:

1. In Mexico, an employee fraud which resulted in the death of their bank manager

and conviction of 16 bank employees for $16 million of missing funds.19 2. In the political and economic chaos that followed Argentina's defaulting on its

foreign debt of $95 billion in December 2001, the operations of Banco Scotiabank Quilmes were suspended by the local government because of liquidity problems, after Scotiabank refused to inject more capital into the troubled bank. In September 2002 Scotiabank sold the assets of its Argentinean bank to two small local banks, and it also took a C$540 million after tax write-down on its investment there. The result was that net income fell to C$1.8 billion for the year, down 17 percent from the $2.17 billion figure recorded the year previous.20

The Bank of Nova Scotia exited Argentina by entering into a transaction with Banco Comafi and Banco Bansud to provide continuity for depositors and employment for the maximum number of employees, all of whom received severance from BNS.21

The $540 million write-off due to the default of government in Argentina was one of

BNS’s burning platform. This, along with their embedded leadership belief in the

importance of credit risk management, strong credit risk management professionals,

and the stable Canadian regulatory environment has led to above industry performance

for Canada’s most internationally diversified bank.

BNS continued to enhance their risk management as a strategic and operational

component to their M&A, and subsequent implementation teams. Exporting their risk

management expertise, processes, and underlying system. BNS has developed one of

the best country risk assessment teams that are involved with all their joint ventures and

acquisitions. McKinsey’s study of 250 JVs estimated that at least 40 to 60 percent of

completed JVs have underperformed or failed outright. Even companies with many JVs

struggle, even though best practices are well-known and haven’t changed for decades.

19 Julia Sisler, Scotiabank manager’s death probe reveals multimillion-dollar fraud CBCNews, Oct 19, 2013, http://www.cbc.ca/news/scotiabank-manager-s-death-probe-reveals-multimillion-dollar-fraud-1.2125652 20 Teather, David, Argentina orders banks to close, April 20, 2002, http://www.theguardian.com/world/2002/apr/20/argentina.davidteather, last accessed May 20, 2014 21 Letter from Pamela Agnew Director Public Affairs to Dr. Haslam author of “Argentina: Governance in Cfile:///C:/Users/Lois%20Tullo/Downloads/MoF48_5_Avoiding_blind_spots.pdf,Last accessed May 20, 2014risis, April 9, 2003 http://www.focal.ca/pdf/Argentina_Scotiabank_Governance%20Crisis%20Correction_April%209%202003.pdf last accessed May 20, 2014

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Most interviewees demonstrated best practices of: a clear business rational with strong

internal alignment, careful selection of partners, balanced and equitable structure,

forethought regarding exit contingencies, and strong governance and decision

processes. However, many identified that JVs struggled with insufficient planning to

respond to eventual changes in risk.22

At BNS, they built ERM into the JV process from the beginning with a through risk

assessment of the entire deal including: the country, the entity, the management, the

processes, the systems, the assets and liabilities. Creating a new country CRO position

within the JV that was filled by a BNS executive and reported to the Canadian CRO

provided a transfer of knowledge and a sustained interest in the new JV.

BNS is methodical in their analysis of JVs and has not fallen into the pitfall of rushing to

complete the deal. BNS’s history demonstrates a slow and steady investment process

to avoid risk through first taking a small investment position, then when results have

been positive over several years increasing that investment, and often many years later

taking a wholly owned position.

In 1993, The Bank of Nova Scotia (Scotiabank) acquired an 8.5% interest in

Grupo Financiero Inverlat and in 1996 was awarded a management contract by

the Mexican government. In November 2000 Scotiabank took control of the

company when it increased its ownership to 55%. In April 2003 it acquired an

additional 36% and in March 2004 acquiring yet another 6% of the shares

bringing its total ownership stake to 97%.23

BNS also experience a burning platform in the area of US corporate loan losses in

2002, specifically in the telecom, power, and energy trading markets resulting in an

increase in their specific provision of $493 million. This resulted in a refocusing of their

capital markets business to aggressively manage credit risk to reduce loan losses,

particularly in the United States; and to incrementally change their product mix from

capital-intensive lending to more capital-efficient products.

22 Chao, John; Rinaudo, Eileen Kelly; Uhlaner, Robert;, Avoiding bling spots in your next joint venture, McKinsey on Finance, Number 48, Autumn 2013; file:///C:/Users/Lois%20Tullo/Downloads/MoF48_5_Avoiding_blind_spots.pdf ; Last accessed May 20, 20 23 Scotiabank Inverlat A Brief History, The Bank of Nova Scotia, http://www.scotiabank.com/ca/common/pdf/about_scotia_fr/correspondentBanking13101.pdf last accessed May 20, 2014

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With BNS refocusing of their product mix away from capital-intensive products it was

able to weather the credit crisis of 2007/08 relatively well.

However another platform burned in the form of Counterparty Credit risk losses

and BNS took an $890 million hit before tax in its fourth quarter on trading losses

tied to bankrupt Lehman Brothers holdings as well as lower securities and

derivatives valuations.24

The lessons that BNS learned in 2001, 2002, and 2008 have been successfully

implemented and have led to their above industry performance through expansion

through joint ventures teams. BNS has implemented Basel III on an all-in basis, has fully

capitalized their counterparty risk capital, and enhanced their monitoring and

measurement of counterparty credit risk. BNS uses the internal model method (IMM) for

calculating their CCR regulatory capital to deal with new rules and constraints around

CCR. BNSs credit valuation adjustment (CVA) materializes the market value of

counterparty credit risk on the market transactions of their trading portfolio providing

protection against the type of losses experienced through the credit crisis.25

BNS has continued with its commitment to ERM best practices with the promotion of

Brian Porter past CRO, to the position of CEO. See Appendix 1 for the timeline of

CROs in Canada.

Canadian Imperial Bank of Commerce (CIBC)

For the past 20 years CIBC has excelled at the quantitative analysis of risk and were

the first in Canada have their internal models for market, credit and operational risk

approved by OSFI. However, it was not until 2007 when CEO Gerry McCaughey

demonstrated his belief in the importance of Risk Management by first realigning CIBCs

business units to heavily focus on the retail sector, and second transferring his CFO,

Tom Woods into the CRO position, that CIBC fully benefit from their quantitative risk

management expertise.

24 Langton, James; Nov 20, 2008, TD warns of credit trading losses in fourth quarter http://www.investmentexecutive.com/-/news-47047 last accessed May 20, 2014 25 BNS Annual report 2002, http://www.scotiabank.com/ca/common/pdf/about_scotia/archived_report7366.pdf

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CIBC has finally dowsed their burning platforms. CIBC experienced more volatility than

the other Canadian banks. In Q2 of 1992, CIBC was the largest Canadian lender to

Olympia and York causing them to take a loan loss provisions of $1.19 billion26. In 1998

they wrote down $400 million trading loss from CIBC World Markets US division.27

Negative equity exposure, lead to eventual downsizing of US operations of CIBC World

Markets and sale of CIBC Oppenhiemers.

Figure 728

In 2002 CIBC’s reported earnings were only $653 million, down $1,033 million from 2001. This was primarily due to a restructuring charge in the U.S. electronic banking operations, CIBC had expanded their electronic banking (debit cards) through Amicus and expansion of storefront banking in Safeway and WinDixie outlets. The U.S. was a cheque based culture at that time and CIBC failed to evaluate the operational risk of market readiness for electronic banking. In 2002 CIBC also saw lower revenue from CIBC World Markets including a provision for

26 CIBC annual report, 1992 27 CIBC annual report, 1998 28 RBC Canadian Bank Chart Book (Q3/13)

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Enron related charges, and a higher provision for credit losses for Global Crossings Ltd and Teleglobe Inc.29

Two thousand and five saw a blazing platform that had been started in 2001, this was in

the form of litigation and regulatory fines to settle Enron claims.

JULY 29, 2003: CIBC had earlier been accused of helping Enron to hide debt. "CIBC aided and abetted certain Enron officers in breaching their fiduciary duties," Enron's court-appointed examiner Neal Batson reported in 200330

The loss US$4.3 billion before tax, included a $2.53-billion after-tax charge, for settlement of litigation related to Enron Corp., the bankrupt U.S. energy trader. Settlements on two Enron-related matters were completed Aug. 2, 2005.31

These losses had a significantly negative effect on RORWA.

Figure 832

Operational risk losses continued to make the headlines of another burning platform to

stress the strategic importance of risk management.

29 CIBC annual report 2002, https://www.cibc.com/ca/pdf/investor/02-anl-rpt.pdf , Last accessed May 20, 2014 30 CIBC shares slip on $2.4B US Enron lawsuit settlement, CBCnew, April 2, 2005, http://www.cbc.ca/news/business/cibc-shares-slip-on-2-4b-us-enron-lawsuit-settlement-1.550760 31 Lam, Eric CIBC ranked 15th in largest global bank losses for 2008, July 02, 2009 http://www2.canada.com/business/fp/capital+markets+named+primary+dealer+york/1768253/story.html?id=1750700 32 RBC Canadian Bank Chart Book (Q3/13)

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In November (2005) after Wade Peer complained that the bank had been sending errant faxes to his junkyard in Ridgeley, W. Va., for three years. He claimed he continued to receive them even after notifying CIBC of the problem, and is suing the bank for allegedly clogging his fax lines and interfering with his business. CIBC has since implemented an internal ban on faxes, and chief executive officer John Hunkin issued a public apology to customers.33

CIBC’s final burning platform and the impetus for change in 2008 was the

mortgage backed securities (MBS) crisis. CIBC experience a loss on the

structured credit run-off business of $7.3 billion ($4.9 billion after-tax). CIBC had

the largest involvement in the purchasing, selling, and investing of their own

capital of all the Canadian banks. CIBC was not alone in its credit crisis losses.

Comparative losses in 2008 were Royal Bank of Scotland $US 59.3 billion,

Citigroup US$53 billion, and Wells Fargo & Co. US$47.8 billion, with the

Washington Mutual being the largest outright bank failure in history.34

These final losses were the burning platforms for CIBC’s BOD and Executive to

announce the Board’s highest priority was an increased focus on risk management

capabilities and processes in 2008. CIBC’s new risk appetite statement outlined this

change. “We want CIBC to be a financial institution that delivers high quality earnings

while maintaining a lower than average risk profile”.35

CIBC implemented the following changes to align themselves with their new risk

appetite.

Further emphasized their focus on capital strength and managed their capital

position to conclude 2008 with a Tier 1 capital ratio of 10.5%

Placed their structured credit business in run-off to focus their efforts to reduce

risk in that area

Exited non-core businesses that did not align with their risk posture and strategy

Enhanced talent and experience within their executive management team

Issued $2.9 billion of common equity

Continued to invest in their retail franchise, CIBC Retail Markets,

Refocused their CIBC World Markets strategy on four core businesses

Strengthened their risk capabilities

Strengthened their funding profile through new public issuance, private

securitized issuance and reduced needs

33 Sinclair, Stewart;OSFI to review CIBC faxing debacle, The Globe and Mail, January 31, 2005 34 Lam, Eric CIBC ranked 15th in largest global bank losses for 2008, July 02, 2009

http://www2.canada.com/business/fp/capital+markets+named+primary+dealer+york/1768253/story.html?id=1750700 35 CIBC annual report 2008

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Completed several transactions with various counterparties to reduce their

remaining U.S. residential mortgage market exposure36

Since 2008, significant changes to CIBC’s product profile from a retail/world market split

of 40/60 has shifted to 75/25. Along with the strengthening of the CRO position and

Risk Committee of the Board, CIBC has achieved their higher than industry RORWA

while maintaining lower than industry Net Impaired Loans.

Figure 937

CIBC has also made significant improvement in their operational risk management

practices. Operational risk (OR) took on a strategic place at CIBC when it decided to be

the first and only bank so far to implement the Basel II AMA Operational Risk

Framework. This exercise has pushed CIBC to focus on OR to improve their data

management, to identify, track, measure and predict OR losses, model OR losses,

clarifying distribution assumptions, identifying correlations and dependences of OR

losses, compare them to external loss databases, and finally allocating OR capital

against these OR losses. As a result of this focus CIBC has not realized any significant

36 ibid 37 RBC Canadian Bank Chart Book (Q3/13)

20

OR losses, and calculates their OR RWA at 18 Billion and currently allocates the

highest percentage of Capital to OR RWA of 13% or $1.4 Billion.38

CIBC uses the three lines of defence model to manage operational risk. Business lines

are their first line of defence and have primary responsibility for the day-to-day

management of operational risk inherent in their products and activities. Functionally

independent governance groups, representing their second line of defence, are

responsible for maintaining a robust operational risk management framework and

providing operational risk oversight. Their third line of defence is Internal Audit who

independently opines on the design and operating effectiveness of the controls that

support their operational risk management program.

CIBC’s operational risk management framework requires risk assessments to undergo

rigorous independent reviews and challenges from governance groups in their

respective areas of expertise. Tools such as key risk indicators are used to identify

changes their risk profile before the risks become acute. Their internal control

framework highlights critical internal controls across the bank which are subjected to

ongoing testing and review to ensure that they are effective in mitigating their

operational risk exposures.

CIBC has a long history of allocating capital to OR. Twenty-five years previous CIBC’s

RAROC framework set the foundation for allocating risk weighted capital including

operational risk. CIBC now determines operational risk capital using both a scenario

based as well as a loss distribution approach that uses outputs from their risk

assessment tools, including actual internal loss experiences, loss scenarios based on

internal/external loss data and management expertise, audit findings and the results of

risk and control self-assessments. CIBC attributes operational risk capital at the line of

business level. Capital represents the “worst-case loss” within a 99.9% confidence level

and is determined for each loss event type and production/ infrastructure/ corporate

governance line of business.

38 CIBC annual report 2013

21

The results of the capital calculations are internally back-tested each quarter. Internal

loss data is compared to the model output at a loss type and line of business level to

identify areas in which the actual loss experience differs from the predicted results.

External loss data is grouped into major themes and compared against the scenarios

used in the model to ensure that the model addresses all relevant fat tailed events (i.e.,

stress scenarios). Gaps identified through back-testing are reflected in revisions to the

relevant parameters of the model. CIBC’s Risk Management Validation group validates

the OR assumptions, model, internal and external loss data.

TD Financial

TD Financial incorporates its ERM best practices into its Customer Centric leadership

position in the market place. TD’s “Know Your Customer” practice has lead TD to be a

profitable leader in the North American retail segment. TD’s view that risk management

is strategic is emphasised with the announcement that Bharat Masrani, former CRO and

head of North American retail banking, with take over as CEO November, 2014. See

Appendix 1 Canadian CROs.

TD has produced above industry Return on Risk Weighted Assets (RORWA) since the

challenges that they faced and over came in the 2002/03 time period.

Figure 1039

39 RBC Canadian Bank Chart Book (Q3/13)

22

For the past 10 years, TD has been able to maintain a lower than industry Net Impaired

Loan ratio. This is even more significant as TD has the largest exposure to the US

market with their investment in BankNorth in 2004, and expansion to 100% ownership in

2008.

Figure 1140

Early in 2002 TD enhanced its focus on the retail sector with its acquisition of Canada

Trust. The strategy of focussing on the retail sector was confirmed in 2002/03 when:

TD’s provision for credit losses jumped in 2002 to $2,925 million from $620 million in 2001. The increase was mainly related to significant credit deterioration in the telecommunications and utility sectors, exposures to companies impacted by malfeasance and the fallout from the political instability in Argentina.41

The bank increased its specific provisions for the fourth quarter 0f 2002 by $175 million and took a $600 million sectorial provision. Credit challenges at this time appear to be mainly power and power-generation related versus telecom and corporate fraud-related concerns in July, when the bank announced $850 million in sectorial provisions. The bank also plans to draw down its $600 million sectorial telecom provision by $185 million in Q4. The bank did not expect to draw this down until 2003. The bank took a total of $2.925 billion in provisions, or 2.20% of loans and acceptances (less repos) in fiscal 2002, almost triple the

40 ibid 41 TD annual report 2002, http://www.td.com/document/PDF/ar2002/td-ar2002-ar2002-di-di.pdf last accessed May 20, 2014

23

bank group average. On November 28, 2002 TD reported its first annual loss, outgoing chairman Charles Baillie says “I feel dreadful”.42

Changes were made to TDs lending standards, and their procedures and practices. TD

reduced the total amount of capital available for corporate lending and implemented an

enhanced credit framework with stricter industry, portfolio and name concentration

limits. TD’s corporate loan book was divided into core and non-core relationships. Loans

in the non-core book were exited, a process that they completed over the next three-

year period. A new organizational structure was put in place to lead and support these

initiatives, and lines of responsibility and accountability emphasized.43

Enron, the burning platform of 2001/2002, also affected TD slightly.

On August 18, 2005 TD agreed to pay more than $500 million US to liquidate

various types of financial fallout from its investment in the bankrupt U.S. energy

trader Enron. After Enron's announcement, TD's CEO, Ed Clark, said the

settlement is not tantamount to any admission of wrongdoing but rather is a

better option than the "time, expense and unpredictability" of litigation. Fifty-

million dollars US of the sum will go as partial settlement of Enron's claims

against 10 banks, including TD, on grounds that they "aided and abetted" frauds

which they could have prevented. TD earmarked $300 million US for use in

eventual settlement of a securities class-action suit pending in Texas.44

TD used the Enron situation to learn from their venture into structured products to exit

the business.

According to management, they “just didn’t like the risk embedded in all those

complex, financially engineered investment vehicles.” TD also refused to sell

asset backed products because they deemed them to be too risky. They also

avoided sub-prime lending in the US, only lending to creditworthy clients in areas

of the country that were relatively stronger.45

In 2007, when other banks were struggling with the credit crisis, TD having exited

sustained minimal impact. However, operational risk was TD’s burning platform.

November 17, 2007, in London, the Financial Services Authority revealed that it

has fined TD almost $1 billion for having failed to control a dishonest bond trader.

Trader Richard Brignall, who resigned on March 9, confessed to his employer

42 http://www.wednesday-night.com/T-TD-Archive.asp last accessed May 20, 2014 43 2007 TD Bank ARCHIVE, http://www.td.com/document/PDF/ar2002/td-ar2002-ar2002-di-di.pdf last accessed May 20, 2014 44 http://www.wednesday-night.com/T-TD-Archive.asp last accessed May 20, 2014 45 Thomas, Karen, Nov 19, 2013, 5 Years After the Crash – TD: A Case Study in Solid and Prudent Business Practices, The Motley Fool Website, http://www.fool.ca/2013/09/19/5-years-after-the-crash-td-a-case-study-in-solid-and-prudent-business-practices/

24

that for almost two years he had booked false values on his trading positions to

hide losses and also entered fictitious trades.

Meanwhile in Toronto, Ontario Court of Appeal overturned a lower court ruling by

finding that a $150-million class-action suit could proceed. The suit alleged there

were undisclosed and unauthorized VISA foreign currency transaction fees

between 1986 and 2003.46

Integrating TDs international operations into the risk management best practices was

not without challenge. Operational risk is defined by the BIS as "the risk of direct or

indirect loss resulting from inadequate or failed internal processes, people, and systems

or from external events”. The size of the loss is not always the most substantial.

Operational risk in the form of Reputational risk can have significant damage even when

the dollar amount is not a large percentage of the banks net income. TD US

experienced 3 burning platforms before the TDs experience in managing retail

operational risk was migrated into the culture of TDs US operation.

TD Bank's US operations suffered performance-related delays of an acquired

older system which adversely affected operations for several days in late 2009.47

Fort Lauderdale attorney Scott Rothstein’s $1.4 billion Ponzi scheme may have

imploded in 2009, its fallout continues to reach the headlines with regularity. On

Sept 24, 2013, Toronto-Dominion Bank (TD Bank) agreed to hand over $52

million to the US government for facilitating the white-collar con that rocked

South Florida and earned Rothstein a 50-year prison sentence. The trigger for

this round of payouts was the SEC bringing civil action against the bank and its

former regional VP Frank Spinosa, who toward the end of the scheme is alleged

to have deceived investors regarding the amount of available funds available in

Rothstein’s depleted accounts. TD Bank was previously ruled liable in US District

Court for $257 million in judgments and has also had to deliver $72 million to the

case’s bankruptcy trustee in recovery efforts.48

On May 11, 2012 Canada’s second-biggest lender, reached a preliminary agreement to pay $62 million to settle litigation accusing it of overcharging customers on overdraft fees for checking accounts. The settlement would resolve claims by consumer account holders who sued over fees charged to debit cards attached to their checking accounts. U.S. District Judge James

46 http://www.wednesday-night.com/T-TD-Archive.asp last accessed May 20, 2014 47 Nelsestuen, Rodney; Operational Risk Management: A 21st Century Mandate for the Corner Office, TowerGroup. April 2011, http://www.fisglobal.com/ucmprdpub/groups/public/documents/document/mvp0_024512.pdf, last accessed May 20, 2014 48 Hackard, Michael, TD Bank Hit Again Over Rothstein Ponzi, Posted in Bankruptcy Clawback News, Ponzi Profiles, http://www.ponziclawbacks.com/2013/09/24/td-bank-hit-again-over-rothstein-ponzi/, last accessed May 20, 2014

25

Lawrence King in Miami must approve the settlement. On April 3, King certified the case as a class-action, or group, lawsuit.49

Since 2009, similar to CIBC, TD has taken the initiative to develop the AMA framework

and process for Operational Risk. TD expanded their operational risk group under

senior vice-president of operational risk, Ken Swenson, as well as hiring 3 senior

operational risk specialist into the OR group. Procedures in Canada are being

implemented in TD Bank US as well.

Bank of Montreal (BMO)

BMO has risen from Canada’s 5th largest bank to 4th place in the Canada market

through its expansion in the US through Harris Bank and most recently their purchase of

Marshall & Ilsley. BMO has successfully integrated their Canadian ERM into a US

footprint. BMO’s world class risk disclosure is now enhanced by their integration of the

Financial Stability Board’s Enhanced Disclosure Task Force requirements. BMO has

been able to successfully integrate these 2 expansions and focus on improving their

retail net interest margin since 2009.

Figure 1250

49 Voreacos, David; Nesmith, Susannah; TD Bank Agrees to Pay $62 Million in Overdraft Fee Lawsuit; http://www.bloomberg.com/news/2012-05-11/td-bank-agrees-to-pay-62-million-in-overdraft-fee-lawsuit.html, last accessed May 20, 2014 50 RBC Canadian Bank Chart Book (Q3/13)

26

BMO’s burning platforms were on the commercial side of the business.

In 2007 synergy of market, credit and operational risk let to a pretax loss of about $680 million on wrong-way bets on natural gas trading.51 In 2007 market became increasingly illiquid and volatility dropped to historically low levels. Hedging services to their clients, led them to be market makers in this segment. The large position was a result of active market making in the period during which there were fewer client transactions as prices declined and a significant reduction in volatility and liquidity.52

To address the weaknesses that allowed the wrong-way bets on natural gas, BMO

significantly reduced its presence in this market segment, and brought in a high level

consulting firm to do a full risk assessment. Recommendations out of this avoided a

significant level of losses that could have been realized had BMO not drawn back from

the structured products market in 2007.

BMO was somewhat affected by the turmoil of the credit crisis, but due to its previous burning platform, and subsequent risk management improvements these losses were held to $490 million pre-tax, mainly from hedged transactions with ACA a monoline insurer, and trading and structured credit-related positions. BMO liquidated these positions and had no further exposure to ACA or transactions that were hedged with ACA.53

These items lowered earnings per share in the first quarter by approximately 70

cents. BMO’s Tier 1 Capital Ratio remained strong and was 9.51% as at October 31,

2007 under the Basel I methodology.

BMO was ranked best among its financial institution peers for Corporate Reporting in

Financial Services. Judges commended BMO for presenting a compelling shareholder

proposition in an annual report that focuses on strategy and the bank's ability to deliver

51 Elena Logutenkova, Elena; JPMorgan’s $2 billion loss ranks among biggest trading debacles; Bloomberg News; May 11, 2012; http://business.financialpost.com/2012/05/11/jpmorgans-2-billion-loss-ranks-among-biggest-trading-debacles/, Last accessed May, 20, 2014 52 BMO Financial Group to Report Mark-to-Market Commodity Trading Losses In The Second Quarter Of Fiscal 2007; April 27, 2007; http://www.bmo.com/bmo/files/news%20release/3/1/FAQs%20-%20mark_to_market%20-%20eng.pdf; Last Accessed May 20, 2014

53 BMO Financial Group to Reflect Charges in First Quarter Earnings, Proposes Support for Links and Parkland Structured Investment Vehicles (SIVs), Provides Update on Apex/Sitka Trust and Announces Senior Management Changes,TORONTO; February 19, 2008; http://www.bmo.com/bmo/files/news%20release/4/1/Feb1908_SIVsSMEN.html; Last Accessed May 20, 2014

27

on its targets. On October 29, 2012, the Enhanced Disclosure Task Force (EDTF) of

the Financial Stability Board published its first report, Enhancing the Risk Disclosures of

Banks. BMO’s risk management disclosure has a reader friendly index in BMO 2013

annual report on page 75 and 76 which outlines where each of the EDTF requirements

are disclosed.54

Royal Bank of Canada (RBC)

RBC is Canada’s largest, most diversified, and most profitable bank. RBC’s ERM has

driven them to diversify their risk across business segments and geographies, resulting

in less dependence upon any one business unit. RBCs return on Common Equity has

traditionally been higher that industry peers, except in 1982, and 92/93.

Figure 1355

54 BMO Financial Group Receives Award of Excellence for Corporate Reporting in Financial Services; Marketwire; Nov. 22, 2012; https://newsroom.bmo.com/press-releases/bmo-financial-group-receives-award-of-excellence-f-tsx-bmo-201211220836495001; Last Accessed May 20, 2014 55 RBC Canadian Bank Chart Book (Q3/13)

28

RBC experienced similar burning platforms as their Canadian counterparties.

Commercial sector specific losses in real estate, telecommunications, and energy.

RBC’s diversification strategy, since 1994, has been sufficient to smooth any

subsequent losses that they have encountered.

May 30, 1992 - Royal Bank, Canada's largest, disclosed that it had a US $647.4 million exposure to Olympia & York Developments Ltd., the commercial real estate giant owned by the Reichmann family of Toronto. Provisions for credit losses in 1992 jumped to $2,050 million.56

In 2001 and 2002 provisions for loan losses almost doubled to $1,119 million, influenced by the losses incurred in the telecommunications sector, (Nortel).57

In 2003 RBC set aside CAD 591 million to cover potential legal costs associated with several lawsuits alleging that the bank had helped Enron Corporation manipulate its financial statements.58

RBC also incurred losses as a result of the Credit Crisis, however, relatively smaller

than their peers.

RBC - May 29, 2008 - The write-downs — $714 million before tax — shrank

earnings of the bank's RBC Capital Markets unit to $13 million, down $337 million

from a year ago. The write-downs were in areas such as U.S. subprime

mortgages, U.S. commercial mortgage-backed securities and U.S. auction-rate

securities, all damaged by market turmoil that left banks around the world with

U.S. assets of doubtful value.59

The Credit Crisis also affected RBC in a different way than its Canadian peers. RBC

had the largest exposure to the US real estate market in the South East. RBCs

heralded investment in RBC Centura in 2001 now subjected them to both an

overexposure in retail mortgages, but also to commercial loans to real estate

developers. Disproportionate losses in the US division led to RBC eventual sale of its

US assets in 2012.

56 Canada Bank Loan Losses; May 30, 1992; The New York Times, Archives; http://www.nytimes.com/1992/05/30/business/canada-bank-loan-losses.html; Last accessed May 20, 2014 57 RBC Annual Report 2004; http://www.rbc.com/investorrelations/ar_04/english/pdf/cdn/RBC_AR04_Cdn_Supp.pdf Last accessed May20, 2014 58 Gale Directory of Company Histories: Royal Bank of Canada; http://www.answers.com/topic/royal-bank-of-canada#ixzz32SFwAi5o; Last accessed May 20, 2014 59 RBC profit falls 27 per cent amid U.S. market woes, “We are not happy about these write-downs,' CEO says CBC News Posted: May 29, 2008; http://www.cbc.ca/news/business/rbc-profit-falls-27-per-cent-amid-u-s-market-woes-1.719892, Last accessed May 20, 2014

29

RBC Centura had lost more than $3-billion since 2007, RBC took a $1-billion write-down on the assets in 2009. In March, 2012, RBC sold its US assets. RBC recorded a loss of $1.6-billion (Canadian) after-tax in the quarter, including a $1.3-billion goodwill write-off, however the price tag was more than what most analysts were expected the bank to fetch.60

With RBCs exit from the US retail market, its diversification strategy refocused on the

global investment industry, in the US, Europe and Asia.

May. 27 2011 - The crisis, for RBC, became a catalyst not to shrink from Wall

Street, but to grow. Poaching talent became easier; in the United States alone,

RBC's capital markets staff has increased by 24 per cent since 2008, as

hundreds of bankers have been added to its ranks. The unit hired about 380

people in Europe just last year and now the bank is ramping up in Asia. Now

among the top 12 investment banks globally, ranked by fees, it wants to crack

the top 10.61

Figure 1462

With this increased focus on investment banking, this also heightened its focus on

market risk management. This was signalled by the appointment of Mark Hughes, who

60 RBC ends foray into U.S. retail banking with sale to PNC; Grant Robertson,The Globe and Mail, Monday, Jun. 20 2011; http://www.theglobeandmail.com/globe-investor/rbc-ends-foray-into-us-retail-banking-with-sale-to-pnc/article4260245/, Last accessed May 20, 2014 61 How RBC made the most of the financial crisis, Perkins, Tara; Robertson, Grant; The Globe and Mail; May. 27 2011; http://www.theglobeandmail.com/globe-investor/how-rbc-made-the-most-of-the-financial-crisis/article598773/; Last accessed May 20, 2014 62 RBC Annual Report, 2013

30

was chief operating officer, RBC Capital Markets, as chief risk officer, effective January

10, 2014.

RBC has implemented both a stressed calibration framework to ensure that regulatory

capital will be sufficient in periods of significant market stress. As the crisis showed, it is

precisely during stress periods that capital is most critical to absorb losses. Reducing

the cyclicality of market risk capital charges is a key objective of RBC. RBC’s capital

framework is calibrated to a period of significant financial market stress in both the

internal models-based and standardised approaches.

RBC has also moved from reporting Value-at-Risk (VaR) to Expected Shortfall (ES) or

Stressed VaR. A number of weaknesses were identified with using VaR for

determining regulatory capital requirements, including its inability to capture “tail risk”.

RBC uses a SVaR 99% confidence interval vs a 97.5% Basel requirement. RBC has the

most conservative estimate of VaR and SVaR compared to their Canadian peers.63

Figure 1564

63 RBC Annual Report, 2013 64 BMO, CIBC, RBC, BNS, TD annual reports

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2113

VA

R $

millio

ns

Years

Canadian FI VAR(2007 - 2011) Stressed Var (2012 and 2013)

BMO

CIBC

RBC

BNS

TD

31

RBC has also implemented credit valuation adjustments (CVA). Under these rules, RBC

capitalise the impact of changes in their counterparties’ credit spreads on the CVAs for

all OTC derivatives, net of allowable hedges.

RBC has also implemented the Incremental Risk Charge (IRC) and the Comprehensive

Risk Measure (CRM). They incorporate market liquidity risk through stress testing

varying liquidity horizons in the market risk metric. This is to account for the fact that

they might be unable to promptly hedge or exit certain risk positions without materially

affecting market prices.

RBC has instituted a Market and Trading Credit Risk (MTCR) group to establish market

risk policies and limits, develop quantitative techniques and analytical tools, vet trading

models and systems, maintain the Value-at-Risk (VaR) and stress risk measurement

systems, and provide enterprise risk reporting on trading activities. This group also

provides independent oversight on trading activities, including the establishment and

administration of trading operational limits, market risk and counterparty credit limit

compliance, risk analytics, and the review and oversight of non-traditional or complex

transactions.65

RBCs MTRC groups effectiveness is currently being challenged. RBC is the only

Canadian bank that is part of the Libor rate setting cartel.

RBC – March 14, 2014 - RBC among 16 banks named in U.S. Libor case - RBC is named in the latest suit because it was at “all times relevant” a member of the panel that helped set the U.S. dollar Libor rate, and because it “engaged in financial transactions related to U.S. dollar Libor” with banks that fell into receivership. The FDIC said RBC’s conduct, along with the 15 other banks, caused substantial losses to 38 banks that the U.S. regulator had taken into receivership since 2008, including Washington Mutual Bank and IndyMac Bank. RBC was specifically named for swap agreements it had entered into with both WaMu and IndyMac. “The closed banks’ losses flowed directly from, among other things, the harm to competition caused by the fraud and collusion alleged in the complaint,” the FDIC said in the lawsuit.66

65 http://www.rbc.com/community-sustainability/_assets custom/pdf/RBC%20CDP6%20Submission.pdf, Last accessed May 14,

2014 66RBC among 16 banks named in U.S. Libor case, Kiladze, Tim; The Globe and Mail; Friday, Mar. 14 2014; http://www.theglobeandmail.com/report-on-business/royal-bank-of-canada-among-16-banks-sued-by-us-regulator/article17498755/, Last accessed May 20, 2014

32

As of the writing of this article RBC has not been fined by the European Commission

who has fined 8 international financial institutions a total of € 1 712 468 000 for

participating in illegal cartels in markets for financial derivatives covering the European

Economic Area (EEA). Let’s hope that RBC has not been too close to the flame for

their platform to catch fire.

The Euro interest rate derivatives (EIRD) cartel fines have been levied against Deutsche Bank for €465 million (30% leniency reduction), Société Générale €445 million (5% leniency reduction), RBS for €131 million (50% leniency reduction), and Barclays received full immunity for revealing the existence of the cartel and avoided a fine of €690 million. The Yen interest rate derivatives (YIRD) cartel fines have been levied against RBS for €260 million (no reduction), Deutsche Bank €259 million (35% and 30% leniency reduction), JPMorgan for €79 million (no reduction), Citigroup €70 million (35%, 100% and 40% leniency reduction of €55 millio), RP Martin €0.25 million (25% leniency reduction) and UBS received full immunity for revealing the existence of the cartel and avoided a fine of €2.5 billion.67

Conclusion

Canadian banks have for the last 5 years been selected as the world’s strongest banks.

The ERM environment in Canada and within Canadian banks has been the foundations

that this strong performance has been built upon. The visionary and conservative

regulatory environment required Canadian banks to re-align their risk appetites with the

reality of a more complex and increasingly volatile environment. Canadian banks have

overcome their burning platforms in the area of credit, market and operational risk, and

have used them as an opportunity for positive change, and have emerged stronger for

it. It has not been an easy road to the Canadian banks to reach to place where they are

today, but the men and women who work in the industry should be pleased with the

progress that has been made in the area of ERM.

67 Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry; European Commission, Press release, 4 December 2013; http://europa.eu/rapid/press-release_IP-13-1208_en.htm

33

Appendix 1 – Canadian Bank Ratios

BMO CIBC RBC SB TD

ROE 14.9% 20.9% 19.4% 16.4 14.0%

CET1 (all in) 9.9% 9.4% 9.6% 9.1% 9.0%

Tier 1 (all in) 11.4% 11.6% 11.7% 11.1% 11.0%

NPA/Total asset 2,354/537,299 =

4.3%

427/398,389

= 0.10%

2,201/860,819

= 0.25%

1,808/743,788

= 0.243%

2,692/862,500

= 0.312%

Allowance for LL

/NPA(GIL)

1,970/(2,354) =

0.84

1,698/427

= 3.97

2,050/2,201

= 0.931

3,273/1,808

= 1.81

2,855 / 2,692

= 1.06

Deposits/funding 220.3/220.3+128.4

= 63.1%

125/246

= 50.8%

359/664

= 54%

224/334 =

67%

462.7/149.9

+462.7=75.5%

Efficiency ratio 63.3% 59.6% 47.2% 53.5% 55.2%

RWA 215,094 151,338 318,981 288,246 286,355

34

Appendix 2

Ro

yal Ban

k

CIB

C

TD B

ank

BM

O

Scotiab

ank

Can

adian

Ch

ief Risk O

fficers

Rep

ortin

g directly to

CEO

, un

less title ind

icates EVP

1998

1

99

8

20

00

2

00

2

20

04

20

06

2

00

8

20

10

2

01

2

20

14

Tod

ay

Mark H

ugh

es 1

/10

/20

14

Step

hen

Hart

9/1

/20

13

Laura D

otto

ri-Attan

asio

6/1

1/2

01

3

Surjit R

ajpal

1/5

/20

11

Ro

b P

itfield

9/1

/20

10

Mark C

hau

vin, V

ice Ch

air 5

/1/2

01

0

Tom

Flynn

3

/1/2

00

8

Tom

Wo

od

s 1

/8/2

00

8 K

en

Kilgo

ur

5/3

1/2

00

7

Mark C

hau

vin, EV

P

12

/1/2

00

6

Steve

n M

cGirr

9/4

/20

05 B

rian J. P

orter

9/1

/20

05

Ro

be

rt L. McG

lashan

, EVP

1/1

7/2

00

5

Mo

rten

Friis

7/1

/20

04

Wayn

e Fo

x 1

1/1

7/2

00

3

Bh

arat Masran

i 5

/22

/20

03

Tho

mas Sp

encer

Vice C

hair

6/1

3/2

00

2

Ro

nald

G. R

oge

rs 5

/10

/20

02

Suzan

ne B

. Labarge

2/1

/19

99

Tho

mas Sp

encer

EVP

3/1

/19

98

Ro

bert M

ark 1

/17

/19

98 Jo

hn

F. M. C

rean, SV

P

1/1

/19

98