Tighter capital rules could leave Canadian banks uncompetitive, RBC's McKay warns

Canadian banks would be at disadvantage if U.S., Europe don’t follow through on agreed capital requirements

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Canadian regulators should rethink capital requirements imposed on the country’s largest financial institutions if banks in the United States and Europe are not forced to follow through with the strict final stages of the international risk management regime put in place following the 2008 financial crisis, the head of Canada’s largest bank says.

“We cannot get out of sync with our two major competitive markets, Europe and America,” Royal Bank of Canada chief executive Dave McKay said in an interview this week. “A level playing field is really important.”

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United States Federal Reserve chairman Jerome Powell signalled an about-face on a plan to raise large bank capital requirements when he spoke before the U.S. Congress on March 6, saying significant changes would be made to the “Basel III endgame” proposal, which encompasses an internationally agreed set of measures created in the wake of the 2008 financial crisis and includes minimum capital requirements to guard against market risk. His surprise statement followed pushback from banks in the U.S., which lobbied to avoid the final, most stringent stage of the protocol, arguing it would hurt everyday Americans by potentially reducing the amount of money banks had available to lend.

Canada’s Office of the Superintendent of Financial Institutions, meanwhile, has updated its bank rules to reflect the final package of Basel III reforms and put them into effect for Canada’s banks in 2023.

“We’ve gotten out front on Basel III, expecting those markets to follow,” said McKay, whose bank has significant operations in the United States. “If anything changes, we have to rethink that trajectory.”

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Canadian banks would no longer be competitive if Canadian and international regulators are out of step, he said, adding that while European regulators have committed to implementing the final stages of Basel III measures, they have been slow to do so.

“The cost (of an uneven playing field) is we have to hold more capital against the same customer,” McKay said. “That makes you uncompetitive. If you have to hold more capital against the same client, then you need more revenue to get the same return, and therefore you have to have a higher rate.”

A crosswalk sign flashes red in Toronto's financial district.
A crosswalk sign flashes red in Toronto’s financial district. Photo by Cole Burston/Bloomberg

The Basel III measures were developed by the Basel Committee on Banking Supervision in response to the financial crisis that toppled banks including Washington Mutual, as well as the investment banks Lehman Brothers and Bear Stearns, and pushed others to the brink. The new rules, which include requirements for banks to maintain sufficient capital cushions to absorb losses as well as liquidity to meet obligations such as deposits in a timely manner, were internationally accepted in 2017 and implementation since then has been staggered.

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McKay said it’s not a certainty that the global financial regulatory landscape will be lopsided, but it’s something Canadian banks are closely watching.

“I think we have to advocate for a level playing field,” McKay said. “The U.S. situation’s not done, so we still have to see how the U.S. plays out.”

Much of the investor focus on Royal Bank in the past year has been on its U.S. wealth management subsidiary, City National, which did well for about eight years before starting to post losses last year in the wake of the collapse of Silicon Valley Bank. 

I think we have to advocate for a level playing field

Dave McKay

“Its growth trajectory outstripped its operational capability, and we’ve got to fix that,” McKay said, adding that the Los Angeles-based bank has nearly tripled in size since Royal Bank bought it for US$5.4 billion in 2015, not long after he took over as CEO of the Canadian bank. The U.S. private and commercial bank was known as the “bank to the stars” because its high-net-worth clients included celebrities such as Arnold Schwarzenegger and Frank Sinatra.

Over the past year, however, City National, now part of RBC’s wealth management division, has been challenged by high interest rates and credit conditions in the United States in the fallout from Silicon Valley Bank’s implosion in March 2023. Funding costs rose amid deposit outflows and the parent company had to step in last fall to shore up liquidity with a capital injection and the purchase of debt securities. In the first quarter posted in February, however, City National reported its third straight loss: $22 million.

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McKay said top-level management changes announced late last year, along with restructuring and cost cutting to improve the efficiency and profitability, will put City National back on track with a “more normalized profit rate” by 2025.

“We’re well on our way to fixing that,” he said, adding that the focus will be on slower, more profitable growth through initiatives including technology platform efficiencies and cross-selling opportunities.

“We signalled to the market that notwithstanding the challenges we faced in the latter part of the year — just two quarters largely due to a number of market issues around deposits and a little bit of credit loss given a high interest rate environment in the U.S. — that we expect to see City National be a good tailwind for RBC.”

Snow falls around Royal Bank's headquarters in Toronto.
Snow falls around Royal Bank’s headquarters in Toronto. Photo by Peter J. Thompson/National Post

McKay said the U.S. wealth management franchise is poised to benefit from RBC’s $13.5-billion purchase of HSBC Bank Canada, which closed March 28, with HSBC clients successfully ported over to RBC on the weekend.

“There’s certainly operational efficiencies on the West Coast between the two groups,” McKay said. “As you look at the expertise that HSBC brings to us that’s in short supply in the Canadian and U.S. marketplace — cybersecurity expertise, risk management expertise, compliance expertise, risk expertise — those are all hot skills in the market … skills that we struggle, honestly, to hire in California.”

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In January, City National was hit with a US$65-million civil monetary penalty by the Office of the Comptroller of the Currency, which found “systemic deficiencies in the bank’s risk management and internal controls.” The agency also issued a cease-and-desist order requiring City National to take “broad and comprehensive corrective actions” to improve, among other things, its anti-money laundering, fair lending and investment management practices.

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McKay said HSBC’s expertise in these areas will be at the forefront of a global banking hub Royal Bank committed to build in British Columbia over the next five years as part of a package to win approval for the acquisition. Other commitments included creating Canadian jobs and financing construction of new housing across the country.

Meanwhile, if City National bounces back as he expects, the U.S. wealth management franchise could be expanded at some point through bolt-on acquisitions. But that will depend, in part, on the regulatory landscape.

“We always are out looking for opportunities, but the primary job is organic growth right now,” McKay said. “We will still have the capital to do that at the end of the day but I would say, given the uncertainty in the U.S. bank environment right now on rules and regulation, it’s very difficult to seriously consider any opportunity.”

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