Risk Areas Of The Royal Bank Of Canada Finance Essay - Free Essay Example

Royal Bank of Canada (RBC) is the largest bank in Canada in terms of the assets and market capitalization. It provides diversified financial services including Canadian and international banking for personal users and commercial users, wealth management services, insurance, corporate and investment banking, capital markets and transaction processing services. Risks are lack of certainty of outcome and they are measured by set of probabilities in order to estimate the loss. A superior wealthy financial service company should be able to solve any expected risks and unexpected risks to minimize the loss for all shareholders. The main purpose of this report is to examine how a financial intermediary faces the potential risk management challenges. The purpose of this research paper is to identify three major risk areas that Royal Bank of Canada has identified in its annual report. We will target one of these risks and provide further information on the actions that the bank takes to manage that risk. The sources of information will be the banks website, annual report by the banks and the concept that we have learned from this course and other sources as well. Risk Management The management of Royal Bank discussed different type of risk management in its 2010 annual report. The analysis is provided to enable the existing or potential clients, shareholders to assess how RBC has managed the risks with proper rules and guidelines. Royal Bank has an unique system to manage the following risks: credit risk, market risk, liquidity risk, operational risk, strategic risk, regulatory and legal risk, reputation risk, insurance risk, environment risk and other risk factors. In this report, three major risk areas that we will be briefly discussed are credit risk, market risk and reputation risk. Credit risk will be analyzed in detailed. 1) Credit risk Credit risk is 2) Market risk Market risk is 3) Reputation risk Reputation is one of the successful factors in all businesses or organizations. A good reputation can build trust and confidence with the clients and the shareholders. Reputation risk is a possible risk that the organization or its representative Detailed Examination on Credit Risk Let us define credit risk in two ways. The first way is how Saunders defines it. The textbook defines credit risk as not getting paid in full, whereas RBC defines credit risk not getting paid at all. This term varies across organizations. RBC is exposed to credit risk in many ways since they offer a wide variety of services and products in Canada and around the world that rely on customers credit. In almost all of their products it is trust-based, and credit-based.  Some of these services and products include: asset-backed financing margin lending securities lending and project finance loans credit cards lines and letters of credit, residential and commercial mortgages. How the Bank Examine the Credit Risk The way RBC examines risk is by quantifying the credit risk, at both individual and portfolio levels, with an aim to minimize expected and unexpected losses. They use different tools to assess risk for wholesale and retail portfolios. The wholesale aspect consists of med to large size businesses, sovereign and bank exposures, while the retail portfolios consist of residential mortgages, lines of credit, credit cards, and small business loans. RBC makes an approach in two ways under the Basel II, Advanced Internal Rating Based and Standardized. The key parameters they use can be broken into 3 parts: Probability of Default (PD): measures the probability of default by a obligor within one-year of signing the contract for a loan. Exposure at default (EAD): the remaining amount owed to the bank at the time default. Loss given default (LGD): estimated percentage of the EAD that will not be recovered in the event of default. When it comes to rated exposures, mainly in the bank classes, RBC assigns the risk-weight based on OSFIs standardized mapping. When it comes to unrated exposures, mainly in the small business and retail classes, RBC will generally apply pre-determined risk weights brought on by OSFI along with the guidelines that theyve set, where they consider techniques to deal with exposure type, credit risk mitigation and counterparty. Wholesale credit Portfolio This system built to measure the credit risk in their wholesale lending activities. How this system works is each obligor is assigned a borrowers risk rating or BRR and every BRR is assigned PD. The BRR is essentially what differentiates one borrower from another in terms how likely they will have a hard time paying back their obligations if things do right in the economy. Retail credit Portfolio When it comes to the retail portfolios, credit scoring is way of assessing primary risk of an obligor in paying its debt. Credit scoring is achieved by acquiring new clien ts, or by managing existing clients to estimate future credit performance. During the acquisition scoring model, credit risk on a person is established based on past employment data, or other external credit bureaus to estimate future credit performance. So the best example would be a person just applying for a first time credit card. Usually students are in this category. Those who never had one usually begin with a low limit credit card until they develop a credit history. Behavioural scoring is a continuous monitoring process on a persons credit. The best example for this would be a person getting their very first credit card and been using it for some time. The bank that issued this persons card and took a risk by issuing this card, can now observe his or her performance and determine their credibility for future references. Every banks main purpose is to minimize default risk and to reduce the chances of giving somebody some loans or credit that they might not recover at all. After a person has been using credit cards for some time, it is easier to get approved the second time since they have established a credit history with another bank already. What determines a good credit is if the person has been paying their debt on time, making the minimum payments on time, whether they applied for a loan or not, thing of that nature. Applying for too many credit cards can also reduce someones credit rating and it takes a long time to recover from a bad credit. One important place that we never think of that dips out credit rating is at the dealerships. Even if you go in just to take a look at the car you want, the next thing is before you buy a car, the salesperson will ask for a drivers license to have your credit checked to see if youre eligible for a loan commitment to own the car. Sometime we get in the moment and dont think about it but does bring down your credit rating. One example of that is, I was interested in a Dodge so I kept going into diffe rent Dodge dealerships asking about that one car. Everywhere I went they asked to check my credit. At one point my credit went from Approved to Not Approved because I had my credit checked everywhere, sometimes in other provinces in case I wanted to have the car brought to BC. When I went to Ford dealership for another car, the finance manager printed out my credit history and asked me why I had so many Dodge listed. After I explained my situation, he advised me that was the reason my credit dropped but knew otherwise it would be more than enough to get a Ford, so I was approved! Credit Risk Mitigation Structuring of transaction: Includes the use of guarantees, security, seniority and covenants. The third-party guarantors that RBC deals with are primarily Sovereign-sponsored agencies. Collateral: RBC makes sure they receive some sort of collateral on larger loans, depending on the borrower, and what type of loan.