Canadian Chartered Banks Presented by: Lisa Lin Jodi Leung Julie Zhong David Jung Simon Choi.

Canadian Chartered BanksCanadian Chartered BanksPresented by: Presented by:

Lisa LinLisa LinJodi LeungJodi LeungJulie ZhongJulie ZhongDavid JungDavid JungSimon ChoiSimon Choi

Today’s AgendaToday’s Agenda

• Overview of IndustryOverview of Industry

• Major CompetitorsMajor Competitors

• Product OverviewProduct Overview

• Revenue CompositionRevenue Composition

• Regulatory Environment (Bank Act)Regulatory Environment (Bank Act)

• ScotiabankScotiabank

Overview of IndustryOverview of Industry

The banking industry includes 21 The banking industry includes 21 domestic banks, 23 foreign bank domestic banks, 23 foreign bank subsidiaries and 22 foreign bank subsidiaries and 22 foreign bank branches operating in Canada. In total, branches operating in Canada. In total, these institutions manage almost $1.8 these institutions manage almost $1.8 trillion in assetstrillion in assets

Source: Canadian Bankers Association (2007)Source: Canadian Bankers Association (2007)


• Banks account for over 55 per cent of the total Banks account for over 55 per cent of the total assets of the Canadian financial services assets of the Canadian financial services sector, with the six largest domestic banks sector, with the six largest domestic banks accounting for over 91 per cent of the assets of accounting for over 91 per cent of the assets of the banking industrythe banking industry

• Canada’s banks play an important role in the Canada’s banks play an important role in the national clearing and settlement system, which national clearing and settlement system, which is among the most efficient payment systems is among the most efficient payment systems in the worldin the world

Source: Department of Finance Canada, PwCSource: Department of Finance Canada, PwC


The average rate of return on common The average rate of return on common equity was 15.7 percent in 2005 despite equity was 15.7 percent in 2005 despite Enron-related litigation charges and Enron-related litigation charges and pressure on the spread marginspressure on the spread margins

Source: PwCSource: PwC

• Bank of Montreal Bank of Montreal

• CIBCCIBC

• Royal Bank of CanadaRoyal Bank of Canada

• TD Canada TrustTD Canada Trust

• National Bank of CanadaNational Bank of Canada

Major CompetitorsMajor Competitors


Each year we see new foreign and domestic Each year we see new foreign and domestic players in Canada. Among the entrants over players in Canada. Among the entrants over the past few years have been Bank West, the past few years have been Bank West, Canadian Tire Bank, Ubiquity Bank, CS Alterna Canadian Tire Bank, Ubiquity Bank, CS Alterna Bank, Dundee Wealth Bank, ICICI Bank Bank, Dundee Wealth Bank, ICICI Bank Canada and Capital One Bank Canada and Capital One Bank


• Strong rivalry in the banking industry because…Strong rivalry in the banking industry because…– consumers have low switching costsconsumers have low switching costs– lots of firms that are equal in size and capability lots of firms that are equal in size and capability

– high exit/entry barriers (government regulations)high exit/entry barriers (government regulations)

• Canadian banks are facing increased competition from Canadian banks are facing increased competition from other established financial service providers and new other established financial service providers and new foreign entrants. New technology and the Internet are foreign entrants. New technology and the Internet are also enabling competitors to enter the market without also enabling competitors to enter the market without having to invest in branches, which presents further having to invest in branches, which presents further challenges to Canada’s banking industry.challenges to Canada’s banking industry.

Product OverviewProduct Overview

• Business/Operating LinesBusiness/Operating Lines– Personal and Business Banking:Personal and Business Banking: meet the credit, deposit meet the credit, deposit

and payment needs of clients; loans, travelers’ cheques, and payment needs of clients; loans, travelers’ cheques, overdraft protection, money ordersoverdraft protection, money orders

– Wealth Management:Wealth Management: estate planning, GICs, mutual funds, estate planning, GICs, mutual funds, managed asset programs, tax advicemanaged asset programs, tax advice

– Corporate and Investment Banking:Corporate and Investment Banking: supply equity, manage supply equity, manage client funds and offer advice on corporate takeovers, mergers client funds and offer advice on corporate takeovers, mergers and re-organizationsand re-organizations

• TechnologyTechnology– Internet banking, ATMInternet banking, ATM

85% of retail banking transactions are done electronically85% of retail banking transactions are done electronically

Revenue CompositionRevenue Composition

• Profits - Almost $12 billion in 2005 from the Big 6 Profits - Almost $12 billion in 2005 from the Big 6 • Interest income, the difference between what they pay Interest income, the difference between what they pay

you in interest and what the banks charge someone you in interest and what the banks charge someone else to borrowelse to borrow– LoansLoans– MortgagesMortgages– Credit cardsCredit cards– BondsBonds– T-BillsT-Bills

• Canadian banks make almost half of their revenues Canadian banks make almost half of their revenues (47%) from interest income(47%) from interest income

• Investment Banking (the rest)Investment Banking (the rest)– UnderwritingUnderwriting– CommissionsCommissions– Wealth managementWealth management

• Service fees (5%)Service fees (5%)

International PresenceInternational Presence

• Canadian banks are wringing profits like never before from their Canadian banks are wringing profits like never before from their operations outside Canada. Bank of Montreal has bought Harris operations outside Canada. Bank of Montreal has bought Harris Bank of Chicago; TD has bought New England-based Banknorth; Bank of Chicago; TD has bought New England-based Banknorth; Royal Bank has bought Centura Banks of North CarolinaRoyal Bank has bought Centura Banks of North Carolina

• Scotiabank (the most "international" of Canada's big banks) has Scotiabank (the most "international" of Canada's big banks) has such an extensive presence in Mexico, the Caribbean and Latin such an extensive presence in Mexico, the Caribbean and Latin America that, in a recent quarter, it earned almost as much profit America that, in a recent quarter, it earned almost as much profit from those foreign markets as it generated from its banking from those foreign markets as it generated from its banking operations in Canadaoperations in Canada

• Taken as a whole, chartered banks got 28 per cent of their 2004 Taken as a whole, chartered banks got 28 per cent of their 2004 revenues from outside the country. And with a freeze since 1998 revenues from outside the country. And with a freeze since 1998 on big banks merging with each other, the Big Six are increasingly on big banks merging with each other, the Big Six are increasingly looking beyond Canada's borders for profits they can bring back looking beyond Canada's borders for profits they can bring back home.home.

Regulatory EnvironmentRegulatory Environment

• Bank Act, the federal government is responsible for the regulation of the Bank Act, the federal government is responsible for the regulation of the banking industry in Canada.banking industry in Canada.

• Due to the hybrid nature of the banks’ activities, some of their subsidiary Due to the hybrid nature of the banks’ activities, some of their subsidiary activities such as trustee services and securities dealing are provincially activities such as trustee services and securities dealing are provincially regulated (OSC)regulated (OSC)

• The Office of the Superintendent of Financial Institutions (OSFI) is the The Office of the Superintendent of Financial Institutions (OSFI) is the federal agency principally responsible for supervising all federally federal agency principally responsible for supervising all federally regulated financial institutions and pension plans. OSFI’s role is to regulated financial institutions and pension plans. OSFI’s role is to safeguard policyholders, depositors and pension plan members from safeguard policyholders, depositors and pension plan members from undue loss, and to advance and administer a regulatory framework that undue loss, and to advance and administer a regulatory framework that contributes to public confidence in a competitive financial system.contributes to public confidence in a competitive financial system.

• The Canada Deposit Insurance Corporation protects depositors by The Canada Deposit Insurance Corporation protects depositors by providing deposit insurance. To encourage well-managed member providing deposit insurance. To encourage well-managed member institutions, it also promotes standards of sound business and financial institutions, it also promotes standards of sound business and financial practices.practices.

Scotiabank

Organizational StructureOrganizational Structure

Scotiabank

Domestic Banking

International Banking

Scotia Capital

Retail and Small Business Banking

Commercial Banking

Wealth Management

Global Corporate & Investment

Banking

Global Capital Markets

ScotiaMcleod ScotiaCassels ScotiaTrust

Net Income by Business UnitsNet Income by Business Units

Net IncomeNet Income

Financial Statement

Financial Institutes’ AccountingFinancial Institutes’ Accounting

• Section 308 of the Bank Act governs financial institute’s accounting

• F/s need to be prepared in accordance to Canadian GAAP with a reconciliation between Canadian and US accounting measurements

• The consolidated f/s eliminates intercompany transactions and balances

• Foreign monetary assets and liabilities are translated into Canadian dollars using the rate prevailing at the end of the fiscal period. Revenues and Expenses are translated using average exchange rate.

Financial Institutes’ AccountingFinancial Institutes’ Accounting

Estimates with greatest uncertainty includes:

• Allowance for credit losses• Fair value for financial instruments• Corporate income taxes• Pensions and other employees futures benefits

(ESOP)• Other-than-temporary impairment of investment

securities• Primary beneficiary of a variable interest entity (VIE)

Accrual Interest and A/R

Direct Unsecured Obligations

Realized

Risk Management

Risk Management FrameworkRisk Management Framework

Board of Directors & Board Committees

Chief Executive Officer

Executive and Risk Committee

Audit and Conduct Review Committee

Liability Committee

Systems Planning and

Policy Committee

Risk Policy Committee

Strategic Transaction Investment Committee

Senior Credit Committee(s)

Market Risk Management &

Policy Committee

Reputational Risk Committee

Types of RiskTypes of Risk

• Credit Risk

• Market Risk

• Liquidity Risk

• Operational Risk

• Environmental Risk

• Reputational Risk

Credit RiskCredit Risk

• Credit risk is the risk of loss resulting from the failure of a borrower or counterparty to honour its financial or contractual obligations to the Bank.

• Credit risk is created in the Bank’s direct lending operations, and in its funding, investment and trading activities where counterparties have repayment or other obligations to the Bank.


• Corporate and Commercial– Assessment criteria:

Current and projected financial results and credit statistics IndustryEconomic trendsGeopolitical riskManagement

– Duel risk rating systemBorrower risk – industry sector and/or business linesCredit facilities – facilities’ structural and collateral-

related elements

– Risk-adjusted return on equity profitability model


• Consumer and Small Business– Customer-centric approach

Adjudication software calculates the maximum debt for which a customer qualifies

– Risk rating systemCustomer’s credit historyInternal credit score – predictive credit scoring models

Market RiskMarket Risk

Market risk is the risk of loss in our trading, funding and investment positions that results from exposure to interest rates, credit spreads, foreign currency rates, and equity and commodity prices.


Funding Investments TradingInterest rate risk

Foreign currency risk

Interest rate risk


Equities risk

Credit spread risk

Interest rate risk


Equities risk

Credit spread risk

Commodities risk

• Market risk category– Interest rate risk– Foreign currency risk– Equities risk– Credit spread risk– Commodities risk


• Interest rate risk– The risk of loss due to: changes in the level, slope, and

curvature of the yield curve; the volatility of interest rates; and mortgage prepayment rates

– Manages with the objective of enhancing net interest income within established risk tolerances.

• Foreign currency risk– The risk of loss due to changes in spot and forward prices, and

the volatility of currency exchange rates

– Net investments in self-sustaining foreign operations and from its net corporate foreign currency positions

– Hedge: foreign currency spot and forward contract, option

– Primarily denominated in U.S. dollars and Mexican pesos


• Equity risk – The risk of loss due to changes in the prices, and the volatility,

of individual equity instruments and equity indices– Equity investments include common and preferred shares, as

well as a diversified portfolio of third-party managed funds

• Credit spread risk– The risk of loss due to changes in the market price of credit, or

the creditworthiness of a particular issuer

• Commodity price risk– The risk of loss due primarily to changes in spot and forward

prices, and the volatility, of precious and base metals


• Market Risk Measurement– Value at risk (VAR)

A statistical measure that estimates the potential loss in value of the Bank’s trading positions due to adverse market movements, over a defined time horizon (1-day) with a specified confidence level (99%)


– Stress testingExamines the impact that abnormally large swings in market factors and periods of prolonged inactivity might have on trading portfolios

– Sensitivity analysis and simulation modelingSensitivity analysis assesses the effect of changes in interest rates on current earnings and on the economic value of assets and liabilities Simulation models enable the Bank to assess interest rate risk under a variety of scenarios over time. The models incorporate assumptions about growth, planned business mix, changes in interest rates, shape of the yield curve, embedded product options, maturities and other factors


– Gap analysis• Assess the interest rate sensitivity of the Bank’s retail, wholesale

banking and international operations• A liability gap occurs when more liabilities than assets are subject

to interest rate changes during a given time period.• An asset-sensitive position arises when more assets than

liabilities are subject to rate changes.

Liquidity RiskLiquidity Risk

• The risk that the Bank is unable to meet its financial obligations in a timely manner at reasonable prices

• Financial obligations include– Liabilities to depositors– Payments due under derivative contracts– Settlement of securities borrowing and repurchase

transactions– Lending and investment commitments.

Liquidity RiskLiquidity Risk

• Liquidity risk management – maintain confidence of depositors and

counterparties– enable core businesses to generate revenue

• Key elements of liquidity risk framework are:– Measurement and modelling– Funding diversification– Core liquidity– Stress testing– Contingency planning

Liquidity ProfileLiquidity Profile

Operational RiskOperational Risk

• The risk of loss, whether direct or indirect, to which the Bank is exposed due to external events, human error, or the inadequacy or failure of processes, procedures, systems or controls

• Can result in financial loss, regulatory sanctions and damage to the Bank’s reputation

Operational RiskOperational Risk

• Operational risk management approach: – Accountability– A robust internal control environment– An effective organization structure – An effective program to promote compliance

with relevant laws and regulatory requirements

– An operational risk management framework

Reputational RiskReputational Risk

• Reputational risk is the risk that negative publicity regarding Scotiabank’s conduct or business practices, whether true or not, will adversely affect its revenues, operations or customer base, or require costly litigation or other defensive measures.

• Who ensure that the Bank is seen to be acting with high ethical standards?

– Reputational Risk Committee– Legal Department– Corporate Secretary– Corporate & Government Affairs and Compliance

Departments

Reputational RiskReputational Risk

• How to manage?– Codes of conduct– Corporate governance– Risk management programs

• All directors, officers and employees have a responsibility to conduct their activities in accordance with the Scotiabank Guidelines for Business Conduct, and in a manner that minimizes reputational risk.

• Believes that if all employees follow the guidelines, reputational risk will minimize.

Environmental RiskEnvironmental Risk

• Environmental risk refers to the possibility that environmental concerns involving the Scotiabank Group or its customers could affect the Bank’s financial performance.

• To keep all kinds of concurrent and potential clients interested and keep their accounts in Scotiabank

Environmental RiskEnvironmental Risk

• Identify the Bank’s role in the environmental responsibilities– Address the issues of climate change– Protection of biodiversity– Promotion of sustainable forestry practices

• To ensure environmentally responsible manner:Ongoing interaction with government, industry and stakeholders in countries where it operates

• Sponsor of the – Carbon Disclosure Project in Canada– which provides corporate disclosure to the investment

community on greenhouse gas (GHG) emissions and climate change management

DerivativesDerivatives• The Bank uses derivatives to

– Generate revenues from trading activities, – Manage market and credit risks,– Lower its cost of capital

• Derivatives trading was a record of $585 million and contributed 57% of total trading revenue

DerivativesDerivatives

• Interest rate exposures: Interest rate swaps, futures and options

• Foreign currency risk exposures: Forward contracts, swaps and options

• Credit exposures: credit default swaps(credit return swap and credit linked notes)

Credit DerivativesCredit Derivatives• Credit derivatives can be defined as arrangements that

allow one party (protection buyer or originator) to transfer credit risk of a reference asset, which it may or may not own, to one or more other parties (the protection sellers).

• Buyer seeks ways to avoid a certain risk• Seller seeks ways to be exposed to a certain risk

• Credit default swap (Two parties):

The counterparty (Seller) agrees to insure this risk in exchange of regular periodic payments (essentially an insurance premium). If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal.

Credit DerivativesCredit Derivatives• At October 31, 2006, credit derivatives used to mitigate

exposures in the portfolios totaled $1,420 million (notional amount), compared to $444 million at October 31, 2005. This increase is indicative of the Bank’s active portfolio management program. The industries with significant protection purchased include the media and oil and gas sectors.

• The Bank’s use of credit derivatives increased year over year, as notional principal amounts rose by $13.7 billion to $34.8 billion.

• Mostly used in:– Bank’s trading businesses, where the activity includes trading with

customers, structured transactions and modest proprietary trading.– Investment and loan portfolios. Credit protection is sold as an alternative

to bond or loan assets, while credit protection is bought to manage credit exposures.

Employee Stock OptionsEmployee Stock Options

• Employee stock options granted have Tandem Stock Appreciation Rights (Tandem SAR):– To either exercise the stock option for shares– Or to exercise the Tandem SAR and thereby

receive the intrinsic value of the stock option in cash.

• Tandem SARs are settled in cash so they are recorded in other liabilities

• Fair value based on Black-Scholes pricing model

Thank You!

Any Questions?

Canadian Chartered Banks Presented by: Lisa Lin Jodi Leung Julie Zhong David Jung Simon Choi.

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Transcript of Canadian Chartered Banks Presented by: Lisa Lin Jodi Leung Julie Zhong David Jung Simon Choi.