Royal Bank of Canada at CIBC Eastern Institutional Investor Conference

Sep 21, 2016 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at CIBC Eastern Institutional Investor Conference
Sep 21, 2016 / 01:10PM GMT 

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Corporate Participants
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   *  Janice Fukakusa
      Royal Bank of Canada - CAO and CFO

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Presentation
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Unidentified Participant   [1]
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 Okay. Welcome back, everybody. Our next participant is Janice Fukakusa. She is a CFO and Chief Administrative Officer of Royal Bank -- RBC Financial Group, I guess. Since joining in 1985, she has held various positions across several businesses. She is a 2014 winner of the CFO of the year award, so time to get that one again. She is the longest-running CFO in Canadian banking today, which I think is actually an important point because there's an awful lot going on in Canadian banking today, and I think that experience must be quite helpful.

 I'm just going to launch right in the questions if that's okay, and I want to start on expenses. I know you get tired of being asked about something you don't do, which is restructuring charges, so I'm not going to go there. But I would like to get your thoughts around the evolution of your expense base when you think about the fact that you don't take these restructuring charges, and you think about the fact that there's an awful lot of stuff going on, whether it's the compliance spending, fintech spending, branch reorganization and all that. How do you think about managing those older economy expenses and being able to invest in the future without having to take the odd step back?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [2]
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 That's a good question, and thank you for not asking me about restructuring charges. I think -- when you look at managing our expense base, it is a journey. And I would say that for the past 10 years we have been on the journey, which is it's about keeping our costs down and taking actual run rate costs out so that we can reinvest in some of the things like technology going forward.

 So if you look at the types of initiatives that we typically have on the go at any point in time, a lot is about process -- eliminating a lot of steps in the process. We have a lot of -- we have done geographic consolidation of expense base in areas like Europe, where we operate many platforms but only need one base. Our whole view is that you should take as much out of the back end as you can so you can reinvest in both our clients and also reinvest in the future.

 So if you look at where we are taking the cost out, it would be through initiatives like digitization of things like checks or the way that we process mortgages to reduce the number of touches on that. Then we will take that and invest it in digitization for end-to-end work. So, what I would say is that this is a journey, and that's why we always say that it is a two- to three-year time horizon between when you start the investment and when that investment will yield good cost savings and reductions that you can reinvest.

 If you look at our technology and operations spend, we have about -- we migrated from 80% on run-the-bank, and run-the-bank is the stuff that you talked about. It's everything from, of course, mission-critical delivery, mission-critical cyber, making sure we have all the regulatory spend. You've heard a lot about things like data aggregation, those sort of thing -- everything that we need to ensure that we maintain the trust of our clients and can deliver on a daily basis and 20% on change-the-bank. What we have done over the past two to three years is migrate that ratio to 75/25 now, and we think in the next few years it will be 70/30.

 The relevance of that is that when you look at increasing the change the bank that much, it is about doing more on agility, rapid digitization. We have to make sure that everything that we do at the retail bank can be done online, too. It's the table stakes for us. So that is why we think it's more evolutionary than revolutionary. We have, of course, used restructuring charges in certain environments where we have to get really a wholesale take down quickly of the cost base because we think that it's the only way to step forward, and that would be in the Caribbean in our investor and treasure services business. You saw some of that in our Web management international business.

 So it really is about having even trajectories. I would say that in a challenging revenue environment or a low growth environment, we are focused on operating leverage at the 1% to 2% range. Because the other point about sizing programs like that is you need constant ongoing vigilance to make sure your expense base isn't growing. Even if you think it's growing for investment, you have to have a governor around it.

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Unidentified Participant   [3]
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 When I hear digitization, what I hear is a lot of cost investment; let's call it investment. I'm not exactly sure what that gets you. I mean, it makes it more efficient over time. Does it grow revenue, do you think, or is this just a cost that brings your structural maintenance capital expenditures higher?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [4]
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 I think that there are two types of digitization. The back-office digitization is about taking cost out. If you look at digitization in the concept of supporting Internet banking, it is about both client acquisition and client retention because different demographics of our clients like to deal with the bank in different ways. And we think it is table stakes in terms of having that capability so that we can retain the client and then expand our services or cost out to the client. So I think it is -- it depends on where you are using it.

 I would say that in terms of cost of digitization, the difference between what we're doing today and what we would've done three or four years ago is -- so three or four years ago, for example, we changed our whole mortgage front-end system and the interface that we had with our mortgage reps and the client. That would've been a two- to three-year program with a lot of spend. When we look at digitization, we pair that with agility. So, the size of programs are a lot smaller and they are a lot quicker to come to fruition, and we iterate a lot. Let me give you an example of a business you may not even think of in terms of digitization with our clients.

 In our investor services business, we have -- we service asset managers who want to see instant different portfolio cuts of information and returns and all of that and be able to deal with their securities. And that is something that in a traditional environment, if we had done it in the past, we would have gone to them, said what do you need, work it out, get it done, and then back to them in a few months.

 We have started these digitization -- we call it a rapid digitization team where we have everyone in the same room, and we have direct interface with our clients. They say what they want, they code it through the output, send it over to them, so there's this constant loop in what they are doing. And in that way, I think we have way more client engagement. We have less risk of spending a lot of money to do the wrong thing, and it really is a client retention tool. So that is something you don't even think about in terms of digitization, but I think it's a good example of changing the amount and trajectory of spend to make sure it's more effective.

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Unidentified Participant   [5]
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 It's an interesting example because I guess I have often thought of Royal Bank's philosophy about technology, and you can correct me if I'm wrong on this, is more around process improvement than it is necessarily on the client-facing side. We will get the app when everyone else has the app, but we're going to have the better rails onto which to install that app so that it works better and it's more efficient. Is that the correct philosophy? Is that the thinking is all about process and investing in that middle office -- the back office? Or do you think you are -- you need to spend more on the, call it, innovation agenda?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [6]
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 I think what you see is the dual hat. We will continue to invest in process, but what we're saying is that, given the environment today, we need to be interacting with clients and providing real-time feedback and having our development cycle attuned to the needs of our clients. We think that it is really important in the context of the revenue environment slowing and the fact that there is a lot of self-selection that we need to be at the forefront of doing that. So, it's part of what we do.

 That doesn't mean that when we put an app out, it's not going to be mission-critical. Because by the time we put the app out, yes, it has to be mission-critical, hooked into our back end, that sort of thing. But what it means is more a faster cycle to test and learn and interface. So, instead of taking the time to go through a step process, if you get everyone in the room, you will iterate faster and you will come to a solution faster.

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Unidentified Participant   [7]
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 When you think about your size -- I know a number of years ago Dave put out a bit of a stretch target when he was running the PNC Bank in terms of where the efficiency ratio could go. When you think about your size and how much of this investment has to happen, is there room for a material decrease in that efficiency ratio -- improvement in efficiency, or is it now modern operating leverages is what you are targeting and that's what you're going to be able to get? How far down can this thing go?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [8]
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 I think from an efficiency ratio perspective -- operating leverage is about the cadence of spend. Efficiency ratios are about how you can use your scale. And I would say that when you look at our scale and the number of transactions we process and as we continue to digitize, we think that the low 40%s for an efficiency ratio is quite attainable, even in today's revenue environment. And, of course, efficiency ratios also have a revenue component. And as the economy turns up, we think that we can do even better. So I would say that leveraging scale is first and foremost in our minds. And because we have done a lot of the back end to economize and get the expenses down, we think yes, the target of low 40s is quite attainable.

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Unidentified Participant   [9]
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 Going to switch gears a little bit. I want to talk a little bit about capital. And it's going to come at it from a slightly different position in that a while back, there were concerns after City National that the bank had drawn down the capital position perhaps too far. I know you didn't share that opinion, but there were concerns. And around the same time, there was a discussion about the global SIFI and permanently higher capital requirements.

 When you think about where your capital sits today, it's built up quite substantially from that position. Are you comfortable on an absolute basis? Is that how you think of it, or is it a relative game that you are more concerned with? Then when you think about the global SIFI potential, is that important enough to take evasive maneuvers on, or does it just come -- if it comes, we don't worry about it so much?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [10]
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 I think with respect to our capital position, it is both absolute and relative. Where we sit with the 10.5% CT1 ratio is somewhere where we want to be. We think we have enough flexibility given our regulatory requirements that we don't perceive that there is any risk of being offside. And we think that we have an acceptable level to continue to grow, which is important for us.

 I think that what you will have seen over the last year to two years is our focus on balance sheet optimization, and focusing on the use of capital versus the returns and how that capital is adding to earnings growth. So you will see in businesses like Capital Markets a way more efficient use of capital and -- so when you look at the potential headwinds in terms of regulatory -- new regulatory requirements to that, we think that there is definitely going to be different regulatory requirements. But we think that we have the capability to earn into them going forward.

 If we take the G-SIFI and the potential impact on IVC, we would -- we are -- our metric is fairly close. And it's a function of the denominator, which is the comparator banks that are being used in the denominator -- the comparator G-SIFIs, and then it's a function of exchange rates, too, and where the euro is vis-a-vis the Canadian dollar.

 But I would say that we are constantly looking at that to see if potentially we will be a G-SIFI because it takes us into a different category, but we don't believe it takes us into a different category in terms of our capital requirements immediately. Because if you look at the D-SIFI buffer that OSFI has added to all of the Canadian banks, it is about being competitive across the board. The G-SIFI, if there is a capital buffer -- if our metric goes -- it will be towards the bottom end of all of the G-SIFIs. That's about a 1% buffer. And we know that they are not additives; they are either/or. And we think that when you look at it from a regulatory capital perspective, given where our ratios are today, I don't think we're thinking we have to do anything differently to suspend growth or suspend any of our activity in order to deal with it. So, yes, we are constantly looking at it.

 There is also reporting requirements and that sort of stuff. But basically, by and large, we are on them now because of the D-SIFI regime.

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Unidentified Participant   [11]
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 It just feels like a club you don't want to be a part of. But it sounds like you're not prepared to take evasive maneuvers because one of the other factors, of course, is business mix. And you could ultimately take evasive maneuvers if you wanted to permanently stay off it, but it would at the very least curtail your growth for a while.

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [12]
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 I think that for us, we look at the fundamentals of every business. You have seen us look at fundamentals and do things like gross on businesses. And in some businesses, getting to different assets like our sale of our home and auto is about being very solid and growing our client franchises and our ability to distribute and how we could make that work without doing manufacturing. So, there's always going to be stuff like that. I would say that we don't look at complexity from a G-SIFI perspective and allow that to override our business strategies, because I think from us -- for us, it's all about growing shareholder value.

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Unidentified Participant   [13]
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 We've touched on complexity as an issue from the expense base, which -- it adds an interesting layer given how many countries and different businesses you operate in in those countries. When you think about coming regulatory change, we are now -- we're moving into areas that nobody really understands well -- fundamental review of the trading book and net stable funding ratios and all that kind of stuff. Is this a bit of a -- is it, A -- is it a larger issue for you because of your larger capital markets business? And, B, should we be paying a lot more attention to this stuff than we are paying currently? How transformational is the next round? Because everyone is focused on, okay, CET1 is 10.5; regulatory is done. Is this still a big issue in front of you, and should we be nervous about it?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [14]
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 I think there is an issue around the fact that, at the margin, Basel and the regulators would always prefer more capital rather than less. I think that the uncertainty is time framing, but all the signals that seem to be coming out of even Basel and what is written about in articles. And with our own regulator is that concept of earning into capital. And I think the different -- because the rules are all directed towards more capital.

 And despite the fact that we have heard that the intent is not to grow capital in the system but maybe redistribute the capital, it is about at the margin having more capital held by the entities. But I think the concept of time framing is extremely important in that, in the prior amendments to capital and all of that, it is immediate. We need to do this. Whereas the posturing is more about making sure that you can grow into it, that you are not impeding the role of financial institutions in the economies of the areas they operate in, and more of a smooth transition.

 So, absolutely, we have a whole team that goes through all of these numbers all the time and does modeling. And we do a lot of what-if scenarios and stress testing to know what our parameters are. We are pretty conservative, so if we think something is in the pipe, we may -- for example, on the liquidity contingency ratio, you know that we were ahead of other jurisdictions in terms of putting that rule in. But we would obviously ourselves be looking at how we can get there quicker. So, we are always looking at those aspects of it, but I think that the difference in capital outlook is about the duration or the time-framing path to go into the new ratios.

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Unidentified Audience Member   [15]
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 You said conservative and stress testing. So what does that look like? What does a conservative stress test look like on the bank? Because typically the things that happen are anticipated, or else you would have already planned for them. So is it a 2008 -- is it a real estate crisis that Canada had in the late 1980s? What does that look like for --

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [16]
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 All of the above of what you talked about. If you look at -- the way that we do it, of course, is what is a one-in-25-year event, one-in-50 and one-in-100, and how do you tier up the stress testing? One of the things that happens in stress testing is that our regulator gives us scenarios, and the scenarios are pretty conservative. So we run our own stress testing, and the scenarios they give us are pretty conservative. We are operating under -- and we will be under the CCAR regime in the US. So we see what the stress testing is there because we are actually modeling it out in our US operations. We test that out on our own total bank.

 So the stress testing is about tail events. That's -- because usually in a diversified earnings model, business as usual, there are offsets in the stress testing. So some of the stress testing is about things that really wouldn't happen all at once. But overlay -- we overlay them, and the regulator also wants these overlays to see about capital resiliency and levels.

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Unidentified Participant   [17]
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 Since we got started talking about stress testing, I'm going to ask you about loan losses. Because one of the areas that has come up -- and it's always difficult to know the answer until the game is played. But the bank had been aggressively or, let's say, quickly growing loans in the United States in particular. Then the energy price fell off a cliff. So, has the development of that portfolio been more or less what you would've expected? And is -- are you comfortable that we are approaching at least the plateau in terms of what loan losses related to the energy book? And particularly in the US, but perhaps on both sides of the border it would be.

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [18]
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 I think you are right about our loan growth. We had more rapid loan growth over the past four to five years. Part of that is because of the base that we started from in terms of being -- we started from a pretty low base. So, there was a lot of growth to basically get to a more normalized growth trajectory, and what you are seeing today is a more normalized growth trajectory.

 With the energy book, we are satisfied with the way the book looks today because that's where we had our business initiated. So when we look at oil and gas and the E&P portfolio, half of it is in the US, half of it is in Canada. We have been in energy for decades, and we've been through many price cycles in energy. And I would say that if you look at where we stand in the energy portfolio, you would have seen that our PCL ramped up and it sort of tailed off a little bit. We have -- we are very cautious in saying that we think that is over because oil prices are still in the 40%s, but we're seeing a lot more activity.

 And I think if you look at the oil and gas book itself and our exposures in E&P, they are all fully secured. And in Canada, they are fully secured with proven and producing; same in the US, by and large. So you have the best assets of the Company. In a restructuring, you are there at the table, and so from that perspective it's not a new activity for us. It is a fairly long cycle in terms of price. And what you are seeing today, I think, is that even for the companies that could be in an impaired loan bucket or in restructuring, there are more levers available now in terms of asset sales or restructuring.

 So I think that you can never say you are comfortable with a book that -- where you still don't know what the end-game is. But I would say that we haven't seen anything in the environment that leads us to believe that we should be uncomfortable.

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Unidentified Participant   [19]
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 When you think about the rest of the book, we've been at or near trough levels of losses for some time. And maybe it's just the fact that rates are so low. And we don't typically stay at trough levels for as long as we have stayed at trough. Are you seeing any signs that things may be turning in one direction or another, or is it -- it is a stable operating environment and that's the world we live in for a while?

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Unidentified Participant   [20]
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 Well, we see a fairly stable operating environment. We don't see any contagion from the oil and gas. And even on the retest side, you see an uptick in unsecured loan defaults -- credit card defaults, that sort of thing. But it's not paralyzing in the least and very isolated in the region. For example, in Alberta it's like that, but in BC and Ontario, our loan quality is going up because of the economic resiliency and growth in those areas.

 So we haven't seen anything at all in the rest of the corporate book and no knock-on or whatever, and we monitor it very carefully. And we think that it -- that there is some good positioning going forward because we're seeing a little more activity in the US in terms of the issuance and deals getting done. So I think there is to some degree a slightly better environment that we are looking at.

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Unidentified Participant   [21]
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 I want to spend a little bit of time on City National, where it's been a few quarters now, I guess, and talk a little bit about how the immigration is going, what you've learned about the business that has surprised you, what you are -- what's going well, what's going not as well as you would like.

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [22]
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 I think City National, we definitely have a focus on getting revenue synergies. So I would say that we would have, when we did our business case, thought about revenue synergies. But we didn't really think that they were going to happen as quickly as they are happening. So this real positive work going on in terms of things like our Wealth Management franchise. Our broker dealer franchise reports to Russell Goldsmith, the CEO of City National. So we see some really good collaboration in joint marketing, for example. They started in Southern California.

 And what we're seeing is that our clients in the wealth network are business owners, and they see an outlet for City National to do commercial lending or do private banking, so we are seeing a lot of great activity there. We are seeing, with our capital markets, franchise there, the ability for City National to partner with capital markets and, together with the exposures, get a better positioning on the corporate side. That opens opportunities for things that City National does well, like leasing or franchise financing, to get that going with the corporate side.

 So I think that -- and then we are -- of course, there's a lot of referrals from Canada down into City National. So I would say our -- we want them to continue to grow. They are hiring people. The way City National grows is to expand their coverage. They are hiring teams of people in the market that actually look to the RBC balance sheet and look to our strong credit rating to actually give them comfort about the staying power of the business. So I would say that is going really well.

 When -- what could really -- what is taking a little longer than we anticipated is, of course, it is mission-critical that your risk and finance get aligned 100% on day one, which it was. But I would say that there is a lot more in terms of building of capability to comply with the broader base of US operations we have. So we talked a little bit about CCAR and what has to be done there.

 So I think that we are staffing up in those areas of City National and also in the US generally to actually make sure we comply with all of the regs and get a lot of the reporting that is integrated done.

 So I think that would be something that we never fully anticipated. We knew we had to do that, but we are really ramping that side up. And we are -- we know there's expense synergies there, but we are specifically not saying we're going to go heavy on the expense synergies. We want to make sure the revenue works first.

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Unidentified Participant   [23]
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 It actually leads to an interesting area because -- we spoke about technology earlier, and Royal Bank clearly has the scale in Canada to invest more than anybody else, arguably. And City National does not have the scale relative to its peers in the United States to have done the same thing. So, what is the status of the technology and the investments in that market? I worry a little bit more about fintech in the United States than I worry about it in Canada because of the nature of the marketplace. So, in terms of fintech -- in terms of just technology, period -- where is that bank? And are there negative synergies as you have to invest to get their systems up to speed?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [24]
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 City National has about 100,000 clients, and they are all very high-touch. But, of course, they have an Internet banking capability in all of that. What we are finding is that, for example, on data contracts and things like that, where we are signing up because we are heavily into it in Canada, it gives them the opportunity to actually tag along and move their agenda faster.

 They also have an operational software -- like it's a home office, sort of a software that really helps their clients' business managers manage cash flow in that. We look at that capability. And we're thinking to ourselves if we can industrialize that, is it possible that we can offer that to our Canadian commercial clients.

 So we are -- what we're seeing is more mutual use of that sort of stuff. And definitely City National has looked and is constantly looking at all of our digital capability and seeing how they can actually leverage off that to provide it down a faster basis to their clients.

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Unidentified Participant   [25]
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 Is that one of the things that changes in so-called bank of the future? We always just ignored potential cross-border synergies and cross-border scale. Does cross-border scale exist and does it matter, then, as you think about the next 10 years in banking?

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 Janice Fukakusa,  Royal Bank of Canada - CAO and CFO   [26]
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 I think it exists and it will matter, but we haven't proven it out. And I think that's why we started with the revenue synergies because we know that there are some scale possibilities, but we have to make sure we have a pretty good growth engine that it makes it possible to do that.

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Unidentified Participant   [27]
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 Well, we are out of time. Thank you very much for your participation. This is your chance. Much appreciated.




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