Royal Bank of Canada at RBC Capital Markets Canadian Bank CEO Conference
Jan 10, 2017 AM EST
RY.TO - Royal Bank of Canada
Royal Bank of Canada at RBC Capital Markets Canadian Bank CEO Conference
Jan 10, 2017 / 01:35PM GMT
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Corporate Participants
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* Dave McKay
Royal Bank of Canada - President & CEO
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Presentation
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Unidentified Participant [1]
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But we did have an event last week. We had Basel sort of delay meetings and in effect it looks like from a capital point of view there could be some delays in implementing some of the Basel's recommendations in the coming year.
So maybe starting with you, Royal had a very strong common equity Tier 1 ratio and 10.8% is where we left off 2016. So why don't we talk just generally about capital levels, what do you view as appropriate and generation and so on. So maybe we'll just start there.
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Dave McKay, Royal Bank of Canada - President & CEO [2]
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Sure. There certainly is still uncertainty in the overall Basel IV regulatory environment and they are struggling to bring this to a conclusion and there is lots of variables at play obviously. For our perspective, while our targets have crept up a little bit, we still target roughly 10.5%, in that range, as our target capital level. And so we are carrying a surplus right now.
We have strong capital generation ability, we have had a very good year generating capital; we made our largest acquisition ever a year ago. Close that acquisition you saw some deterioration obviously down to the high 9s in our ratio and we built it up very quickly; sit there with a strong capital position now, strong capital generation ability of 25 to 30 basis points a quarter after we fund organic growth.
So I think we are in a very, very strong capital position with enormous flexibility to deploy capital to organic growth, further organic growth to use capital for dividends obviously and for share buybacks.
So we have enormous flexibility and we feel really good having executed a very strong strategic transaction for RY and enormous capital flexibility. And there is no requirement for us to hold 10.8%; OSFI has not told us to say hold higher capital; we are holding that for strategic flexibility, which is nice to have.
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Unidentified Participant [3]
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What stage is too much? Do we get 11.5%? I mean, is that when you really kick in a buyback in dividend increases or --?
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Dave McKay, Royal Bank of Canada - President & CEO [4]
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Certainly, as you see, you hold more capital, you have flexibility deteriorates your ROEs obviously as you're holding that capital before deployment. I don't know if there is a level that is too high. Adding flexibility for the future and pre-funding an acquisition if you want to make an acquisition -- I'm sure we'll talk about that -- is a better way of doing it and having flexibility for uncertainty. So I think strategic flexibility is an important option to have in today's world and I think we certainly have that with RY.
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Unidentified Participant [5]
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And so, what would be the priority then if we were looking at acquisitions? I mean, the sense that I get in discussions with people is that they often look to Royal to now further expand upon -- on City National. Would that be a priority for you or --?
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Dave McKay, Royal Bank of Canada - President & CEO [6]
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Absolutely. We -- first and foremost, you have heard me say this many times, we have so much organic growth opportunity with City National; that is the first place we will deploy marginal capital for growth in our asset base.
As you've heard, we are expanding our commercial capability, but we are also expanding into jumbo mortgages and that is a very exciting customer acquisition that allows us to grow in new geographies very well, allows us to grow in existing footprints, cross-selling across our customer base private banking products and commercial banking to our Wealth franchise and vice versa.
So enormous cross sell and growth, that is really the focus of management right now. We laid out last June our five-year growth trajectory. It's very exciting. We are starting to sense that those rate increases that were built into that forecast are coming a little quicker than we thought. We've just got very strong asset sensitivity in that business, which is one of the reasons we are so excited about the deposit platform that City National has and that asset sensitivity is very, very good for a bottom line.
So organic growth, number one and number two. How would we look at an acquisition in the US to build out the City National franchise? One, you could offer geographic expansion within our existing footprint of California and New York.
California has as many people, 30-million-plus, as Canada does. So you have to look at California as a market like Canada, even more concentrated. So there is enormous opportunity, just in the state of California, to continue to fill in our footprint to look at growth in that state where we already have a strong brand, we have a strong presence. So we have enormous growth opportunity there.
New York City we just opened another branch again and expand there. We just opened an office in Washington, in Minneapolis; we are looking at other markets. So growing there. So any acquisition we look at would give us geographic expansion in our footprint or into those footprints.
Two, it would have to provide synergies around cross-sell. We bring a bigger product shelf; we bring a bigger balance sheet to an acquisition, so we'd have to see those same synergies that we saw with City National.
And the additional synergy that we'd have to see is cost synergy. And it is the cost synergy around IT operations, functions that allows you to have a more accretive transaction much sooner than you would with City National.
So when you bring all those synergies together that is what we are looking for, that strategic expansion. And we think that is a winning formula for the shareholder and a winning formula for our customer franchise.
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Unidentified Participant [7]
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These kinds of acquisitions in this environment would be difficult and presumably the stocks have had a great (multiple speakers).
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Dave McKay, Royal Bank of Canada - President & CEO [8]
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Yes, valuations are absolutely challenging right now. So we spent three years getting ready to do the City National transaction, we researched it, we thought about it, we got to know management and that process paid off well. So I think timing is really important, being ready for the right time.
But you are right, valuations make putting that formula together much more challenging now than it has ever been and therefore shareholder return in an accretive transaction is very important to us.
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Unidentified Participant [9]
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And size wise, does it matter size wise? If you are looking for significant synergies presumably you have to be on the sizable material side for Royal.
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Dave McKay, Royal Bank of Canada - President & CEO [10]
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Not necessarily. There is wonderful private banks, private commercial banks that fit our model out there that are smaller than City National that would give us a geographic expansion to a given market, whether it is a state or a large urban market. So those would be very attractive to us.
It doesn't have to be of size to be accretive to this franchise. And we always have a geographic expansion model. We can start organically, start in a [market], build a footprint and then follow in when we get to know the market and how we want to attack it. So it does not have to be of size -- of the size of City National to be successful.
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Unidentified Participant [11]
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Okay, since we are speaking of the US why don't we talk about the US business? And first and foremost maybe, can you speak about what your outlook is for the economy? And what are you sort of looking at for 2017 in the US per se?
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Dave McKay, Royal Bank of Canada - President & CEO [12]
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We certainly see the US economy being stronger even pre pro growth administration, with the new administration taking over, the Trump administration. So we see the US economy growing right now at a little over 2% pre-policy change in new policy. Canadian economy growing sub 2% at 1.8% but stabilized. You have seen some positive numbers in December out of the Canadian economy on jobs; on exports and the sustainability of that we are following closely.
So we do see a stronger growth agenda in the United States. We do anticipate pro growth policy coming out the new administration, the impact unknown. Obviously we are all trying to quantify that. But that would be a boost; it would potentially lead to higher rates which is very good for a franchise in the United States.
For every 25 basis points increase in US rates it is roughly [CAD]50 million of net income for a franchise alone in the United States. So roughly CAD35 million for City National plus then another CAD15 million for our existing Wealth franchise.
So that pro growth strategy in the US is very attractive to invest. So we see strong opportunities in the US market for our capital markets franchise which has enormous momentum. We are seeing very constructive markets in the US on the leveraged lending side, on the M&A side, on the rate side, flow rate side, so our trading activities are strong.
So we are seeing really positive business conditions in the US. And you can see a little bit better performance in that too depending on the timing of the administration's policy changes.
So in Canada we still see stable markets. We expect to see consistent growth that we saw last year; a bit of a shift from consumer lending into investments and deposits which we feel very good because we have got the strongest franchise to capitalize on that, particularly on the Wealth side. We have got enormous momentum in our Wealth franchise with assets under management growth and the share of the growth we are capturing in the marketplace.
So Canada still strong capital market opportunities, M&A and lending capability. We're seeing very strong Wealth momentum in the Canadian market and strong demand from customers. And we are still seeing a good credit card, good mortgage, good commercial lending demand and I think you will see greater increase as business confidence continues to grow in Canada.
Having said that that will sum up to somewhere between 1.8% and 2%, which in today's world is still decent growth. Not what we really aspire to but still decent growth that can drive kind of mid-single-digit volume growth. And stable NIMs and with good cost control and some better outcomes on PCL you could see strong performance in the retail bank.
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Unidentified Participant [13]
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So you mentioned in there the sensitivity to interest rates. You said 25 basis points would be about CAD50 million, CAD35 million from City National and CAD15 million. Now that is very specific to just those enterprises and nothing else baked into that number presumably.
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Dave McKay, Royal Bank of Canada - President & CEO [14]
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Just the US Wealth franchise.
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Unidentified Participant [15]
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How quickly would that hit?
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Dave McKay, Royal Bank of Canada - President & CEO [16]
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First year.
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Unidentified Participant [17]
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First year. Okay, so the 25 basis points we have already had presumably will have this impact and hopefully we get some more throughout the year.
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Dave McKay, Royal Bank of Canada - President & CEO [18]
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Yes.
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Unidentified Participant [19]
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Okay, that is good. And then maybe just sticking with the US, but maybe thinking about the capital markets business in the US. Under this kind of outlook that you have noted here with rising rates, with the strongest economy, what would the outlook be for the RBC Capital Markets business out of the US?
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Dave McKay, Royal Bank of Canada - President & CEO [20]
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We will earn more money in the US than we do in other markets. So for capital markets the US is our primary market. We have built a strong capability, we are a top 10 investment bank based on fees in the US marketplace. We are seeing strong M&A pipelines. We are seeing constructive credit markets, good leveraged lending, good investment grade business. Right now our trading, our FIC businesses are strong.
So I think you are seeing a really healthy US marketplace on capital markets. We will continue to deploy marginal capital into our US lending book for a lend-to-originate strategy as we try to cross sell. We do cross sell exceptionally well.
I think we have had a very good year where we have gone back into our client franchise and we have kind of optimized our capital against relationships that weren't producing that cross sell and redeployed it to new, which has allowed us to really rebuild our capital ratios and continue to grow our franchise in a more optimal way.
I think we are ready to deploy more marginal capital into our capital markets lending businesses, as I said, in the US. Because the cross sell there -- Canadian marketplace very, very strong, also with good momentum. And our European capital markets franchise just came off a record year.
It is a slow build client by client, but we are taking advantage of disrupted competitors in the marketplace, distracted competitors. We are putting a little bit of capital into that business. But the team performed very, very well last year both on the trading side and on the investment banking and lending side.
So I think US number one, Canada number two, Europe improving story. And therefore I think that is a differentiated story for us, having capabilities in our capital markets franchise across all three of those regions, which are showing momentum including Europe -- we feel very good about.
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Unidentified Participant [21]
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And so then maybe touching back on something else you mentioned in the discussion on the economies such as in Canada that would be more commercial oriented versus consumer oriented in terms of growth in the loan. So maybe just picking up on the retail side.
We have had quite a number of changes happening to the mortgage market here in Canada and maybe there are some changes coming on the horizon as well with risk sharing. Can you maybe share with us what has this meant for your bank so far if anything? And what are your expectations for the mortgage market here in Canada?
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Dave McKay, Royal Bank of Canada - President & CEO [22]
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We still see a good mortgage market because demand drivers are still healthy, demand drivers are immigration, household formation in the country. Immigration tends to concentrate in the cities that have the most acute price moves, which the GTA being number one source of immigrants, the West Coast and Montreal and other areas of the country.
So demand drivers are concentrated combined with short supply in those key markets have driven very concerning price increases on the government side, which certain policy changes are coming in to try to alleviate. We support those policy changes because we want a long-term sustainable market for all Canadians and I think those policy changes are important.
The most recent policy changes that you refer to really are aimed at the first-time home buyer, will impact that first-time home buyer. You will see a moderation I think of growth there even without any rate increases in the country. But you will still see overall, given demand drivers, relatively good growth in the 3%, 4%, 5% range.
So I think it is balanced; it will be a little more balanced across the country. You have seen the stabilization of the Alberta marketplace, very strong Toronto, Quebec is doing well. So I think overall you'll see sources of growth that still drive good performance.
We are very happy with our performance in our mortgage book. We shifted our growth profile out of Vancouver into other markets and we have done very well. We have gained market share, our margins are good and we are very happy with the performance of our mortgage business. And our credit card business had an outstanding year. We are very, very excited because that is a growth platform for the future in a number of ways that we should probably talk about.
So good growth in the consumer side but slowing growth. I think accelerated growth on the investment side, accelerated growth on the deposit side, accelerated growth on the commercial side. And I would say we are not happy with the way our commercial business has performed, it has been a couple of years now.
I think we didn't have a risk appetite and a responsiveness to the market that we needed with very aggressive competitors. I think we have regained that I think; I'm seeing signs now that I am a little happier with. So I think we have underperformed on the commercial side, we have underperformed on the auto lending side for risk reasons and the loss of a large customer franchise.
I think we will regain that momentum over the coming year, albeit I do expect auto lending to slow off record highs the coming year but still be a strong marketplace. So I think some of those businesses led to us falling from a premium performance to the middle of the pack when it comes to volumes.
Our cost performance I think in the business was very strong, particularly after you normalize for one-time charges, which does destroy book value per share. It is not a free charge that you get to build earnings with that some people seem to forget.
So when you normalize, as you should, and as you all do on the buy side, I think our cost performance is very, very strong. And we're down 1,100 FTE in our retail business. We do it through attrition, we have been doing it for seven or eight years, we're going to continue to do it.
We still see a significant cost opportunity in our network and we are going to continue to manage that over time. As our customers' choice preferences shift from a kind of full-serve world into a partial self-serve full-serve and then into a self-serve world, managing that transition presents an opportunity to create shareholder value.
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Unidentified Participant [23]
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And all of this without a restructuring charge. Is that still the going --?
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Dave McKay, Royal Bank of Canada - President & CEO [24]
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I never say never. A restructuring charge for us would be something comes at us unplanned or there is a significant shift we have to make in the business that we couldn't get ahead of I think. I am really proud of the franchise that we got ahead of most of the things that we needed to get ahead of so far and we have been able to reposition our cost base.
And we are the most efficient producer in the country and we are going to continue to drive that lower even without interest-rate increases which we benefit from significantly in our deposit franchise and our lending franchise. We have got very high asset sensitivity given our strong core deposit base. So we can drive our productivity ratio lower at the Canadian banking side and we will do a better job in creating operating leverage at the overall top of the house [ROI].
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Unidentified Participant [25]
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Interestingly, some of your competitors here in Canada have provided overall efficiency targets for the next few years. And some of them rather aggressively reducing efficiency. Do you have an overall efficiency target in mind for Royal?
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Dave McKay, Royal Bank of Canada - President & CEO [26]
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I do more at the retail bank side where we are trying to drive that down below 40%. So I would say that is where I am most focused because I think that is where the biggest opportunity is.
At the top of the house we have done a number of things, we will continue to use technology to optimize our cost structure across our functions. I think there's a significant opportunity to leverage technology with good people to take down cost in finance for example using [BOTs] and GL reconciliation BOTs are an example. There is all kinds of amazing things that are happening out there -- blockchain we will probably talk about.
So on the functional side there is opportunity. We have been managing things like the capital markets compensation structure. As the industry comes down it has presented an opportunity for us to move that ratio down and create shareholder value and increase our ROEs. We are very proud of the ROEs that we drive in our capital markets franchise, they're industry-leading and we work very hard at that. And it is the efficiency of the franchise, it is all the variables that we pull.
And technology, we are working very hard shifting spending from business as usual and maintenance into the development side. And I think that shift has been quite significant but will continue to be significant as we bring new projects on. And we decrease the billions that we spend just keeping things going under our legacy environment.
So I think there is significant opportunity at the top of the house, there is opportunity within the retail bank of the network rationalization and this is a long-term journey. I think the key is and the way we think about it philosophically is customer first. You can't get ahead of your customer, you have got to move at the pace of your customer. You can rocket ahead of this and not have your customer with you.
So customer sat along the way and engagement is mission critical to us, not just taking out cost. And we are very proud that we are the most efficient producer, we have driven our cost structure down, we are number one in JD Power and we've got absolutely outstanding employee engagement. And those three variables we manage as a group because that creates shareholder value.
And as we bring our cost structure down you have the other two with you or you can damage the franchise. So doing all three is not easy. And I think we are doing it really, really well. And those -- two metrics that I will constantly talk about is how do our customers feel about our changes, how do our employees feel about our changes. Are we at the right pace? Are we getting too far ahead? If we get a shock how fast can we adjust?
If someone comes at us with a disruptive technology how fast can we adjust? How much flexibility have we built into our cost structure that I can take a step function down? We plan for that. We plan for a shock to the system to say, okay, our margins have been cut, we have lost revenue stream, how fast can we take out cost? And we have got plans for that.
But in its isolation, if you executed that, you would get too far ahead of your customer and you would lose revenue. So you have to plan for it but you have to execute with all three variables and I think we are doing that really well.
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Unidentified Participant [27]
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Maybe at this point I just want to point out if you have any questions please raise your hand; Drew will come by and pick up the card. So you touched on something which I think is thematically something that I have faced a lot of questions on for the last year, which is technology in your spend.
So I am not expecting too many CEOs to tell me how much they spend on technology. But I am just curious if you can provide a rough outline for us with respect to your spend on technology. If you are not willing to talk about actual dollars maybe talk about what the spend is for back office, customer facing, FinTech disruption, can you give us some sort of a general sense of where Royal is pushing the spend and what the return is on that spend?
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Dave McKay, Royal Bank of Canada - President & CEO [28]
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So, no, I'm not going to give you absolute numbers. But the first message is scale is critical because there is so many things we have to do in parallel. We have an enormous amount of spend that goes to regulatory compliance in the US and Canada, radar, risk, that the regulators are forcing us to do. And it costs the same for every bank to do them. If you have scale and you can continue to do that across scale that is absolutely critical.
So you have to manage your regulatory changing environment which consumes people's time, which consumes real dollars on your technology side. Two, you have got to keep processing hundreds and billions -- millions and billions of transactions every day and you are going to continue to do that and change that.
And then you allocate a significant part of your budget, an increasing part of your budget, which I talked to before, to different types of change. One, digitizing your existing bank, digitizing your customer experience, creating new capabilities. So we have launched apps on the reward side this year that are a big part of our future foundation. We digitized our customer experience. So we are all continuing to do that, which is absolutely critical.
The second area, and I don't think at the end of the day that is a differentiating function. We are all going to digitize who we are today at different speeds. I think the only key advantage there is scale -- that you can do all of this at the same time because you are two or three times the budget and the OpEx expense over the same type of capability build.
We all have to digitize roughly the same things, right, transaction experience, mortgage experience, credit card experience, deposit experience, all of that requires similar types of work. I don't think there is any rocket science in this stuff, it is just a matter of getting to it. Some will do it a little bit better than others, fix it, catch up.
But at the end of the day I do not believe that that is a differentiating factor, other than you can do it all at the same time and get a little bit ahead. But others will catch up and you will get a little bit ahead in one area a little bit behind depending on which bank focuses on what. But at the end of the day this is all buildable things that everybody should be able to do across the marketplace. So I just don't think that is a different chaining capability to digitize who you are today.
The differentiating capabilities are really around platform effects. So as an organization we have to respond to two types of disruptive forces, one, disruptive technologies. Disruptive technologies right now that I focus on are blockchain and AI.
You have to incorporate those capabilities into your operations environment, into your security environment, into your customer interface and your employee interface, both blockchain as a transformative technology and AI as a transformative technology, to serve customers, to integrate your employee with the customer, and to allow the customer to self-serve in those channels.
Critical technologies, we are very focused on that, and you have seen me talk a lot and invest a lot in AI and blockchain. Those are technologies in themselves that have to be incorporated with a partner or adopted by yourself.
Then there is disruptive players and disruptive players take two forms. One, FinTech trying to build a better digital version and a better process version digitally of who you are today. And that is where most of the market has been focused. And back to my previous comment, it is not a differentiating capability. You can build a slicker investment process, a slicker Robo investor process. That is easily replicatable.
We built a Robo investor in our labs in California in three months and it cost less than CAD20 million. And whether it cost CAD30 million or CAD20 million or it took six months or seven months it was easy to replicate in a lab and is very creatable. So that gap will get closed.
It is very difficult to take that model, add a brand to it and acquire a customer. And that takes a lot of money and a lot of time. And that is where I do not worry as much about someone building a slicker digital version of who I am today and attacking on that. I will be able to replicate that. It is a margin question in how fast can I take out the cost, as we just talked about. But it is not a capability that I can't match and close and create.
Then there is disruptive player that is a platform player. And that is where we should be talking now. And the platform player is the one that is trying to create an ecosystem whether it is a lifestyle ecosystem or an commerce ecosystem. And you know the players I am talking about that take a customer's life and a customer's journey, create a digital experience around that, it is invaluable and financial services gets embedded into that overall value chain.
And now we are trying to, A, desperately attach ourselves to someone else's ecosystem and we are margin takers at that point. Or we're not even part of it at all. And that is where we are focused as an organization in building out platform ecosystems that require a couple of core capabilities that we think are differentiating factors.
One, it requires customer scale franchise. You have to have a certain scale in a marketplace to have enough customers to attract partners, to have the data which is the other component. Number two, you have to have great data about your customer to create a platform effect. And data becomes a battleground and data requires a customer franchise that is rich in data. And where the richness of data is is in the deposit franchise and the credit card franchise.
And that is why this markets are so important to us and that is why we feel really good about where we are. You have to have a platform like a rewards platform that accesses that customer and engages that customer in a very different way. And a frequency of weekly, if not semiweekly, if not daily, in that platform ecosystem play. And you have to have brand -- you have to have brand scalability, data, capability to compete against the platform effects that could come out of the [FANG].
So I think that is how I look at the world of technology and disruption and where we are spending an enormous amount of our time thinking about platform effects. Probably more data than you wanted, but --.
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Unidentified Participant [29]
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No, that was great. Maybe on top of that, what do you think is going to be the most disruptive thing we see here in Canada over the next year or two from a technology point of view?
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Dave McKay, Royal Bank of Canada - President & CEO [30]
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AI.
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Unidentified Participant [31]
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Artificial intelligence. Fair enough.
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Dave McKay, Royal Bank of Canada - President & CEO [32]
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As a capability tool to improve our performance, absolutely. As a technology that engages customers in a multi variant form, absolutely. So it is a fascinating technology. And you are seeing a lot -- you're going to see the government focus on it, you just saw an op-ed in the paper from (inaudible) government on it. There is a lot of investment discussion about AI creating new capabilities. And it is a tool that we are very excited about harnessing within our own organization.
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Questions and Answers
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Unidentified Participant [1]
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One of the questions from the audience, which is on this topic, so I thought we would -- I will just (multiple speakers).
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Dave McKay, Royal Bank of Canada - President & CEO [2]
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Yes, fire away.
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Unidentified Participant [3]
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How do you know the Bank is secure from cyber threats?
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Dave McKay, Royal Bank of Canada - President & CEO [4]
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That is another area where we invest heavily. So as we talked about customer facing effects, we have operational digital investments and we have security investments. We spend an enormous amount of time and money and we talk about it with the Board significantly.
And we -- there is enormous cooperation among federal government, among governments across North America. There is enormous cooperation at the institutional levels, across our banks and across our financial institutions as we share information to protect ourselves against and protect the confidence and security of our system.
So we are constantly vigilant. And you are constantly building and working with the best people, building defenses. And we spare no expense in that because it is about the confidence and the safety and security of our overall payment system and we collaborate across institutions because it is the confidence of the Canadian payment system and the Canadian banking industry that is critical.
And we feel that at some point we are only as strong as the weakest player in there. And if one gets compromised that could hurt others. So we partner very well in this with the government, with each other, sharing information, building the best defenses that we can get. And we feel very good about what we do and how we handle it.
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Unidentified Participant [5]
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And so, another question from the audience is unrelated to FinTech but is related to risks that you face. So we thought we would ask this one as well. Please discuss risks of growing your commercial lending as industry loans growing high-single-digits led by construction real estate, GDP is less than 2% and the US may introduce a border tax. So can you discuss the risk of growing the commercial lending in such an environment?
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Dave McKay, Royal Bank of Canada - President & CEO [6]
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It is a great question. There is so much uncertainty around trade policy and we talk about that internally. We have got an incredibly diversified book across the country. We work very closely with our customers. At the end of the day I think we will find out over the near-term if there is going to be an impact. There is so much positives about the trade that happens between the two countries, you have to be hopeful that we are able to see our way through that.
Our northern states obviously benefit the most from that and they are very strong Republican states and they had a big impact in the election. Hopefully they will be able to influence the course and direction of this overall dialogue. But it has created uncertainty around potential policy change.
And obviously you build that into your risk strategy, into your thought process in the short-term. But the benefits to having this incredible trading partnership have accrued over decades. And hopefully the numbers will tell the story and we will get to a good place for both economies because I think that is the objective, to get to a good place for both economies. And I think trade, pro-trade agenda is good for that.
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Unidentified Participant [7]
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Do you change your Commercial Lending criteria at all in the face of any of this? Is there any actual tweaks that you'd make to some of your policies?
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Dave McKay, Royal Bank of Canada - President & CEO [8]
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I think you are more cautious on the growth side. You certainly want to support your customers through this uncertain period and then adjust. But no, I don't think you drastically change things given the potential for change right now. But you certainly can be careful about your growth and where you grow until you have greater certainty on the outcome. But supporting our customers through this is very, very important. But it is a significant uncertainty.
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Unidentified Participant [9]
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And I have another question here. Are you worried that the move higher in rates, which hasn't occurred because of a stronger Canadian growth, will finally end both the national housing bubble as well as historically low PCLs? Is the NIM benefit just a drop in the bucket versus if PCLs normalize?
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Dave McKay, Royal Bank of Canada - President & CEO [10]
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Right, [I get that. Sorry, is the] --.
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Unidentified Participant [11]
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So effectively the question is, there hasn't really been a move higher in rates --
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Dave McKay, Royal Bank of Canada - President & CEO [12]
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Canadian rates.
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Unidentified Participant [13]
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-- in Canadian rates.
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Dave McKay, Royal Bank of Canada - President & CEO [14]
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Yes.
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Unidentified Participant [15]
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But if it does, will it finally end the housing bubble? Will it create a housing bubble? And will the NIM expansion effectively not matter at that point because you have very high PCLs?
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Dave McKay, Royal Bank of Canada - President & CEO [16]
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No, I don't think an increase in rates will have a significant impact on PCLs. We adjudicate our customers with a higher interest rate expectation anyway. That was part of the policy change that you just saw, but we were doing most of that anyway, that we adjudicate on a higher rate. We have built in interest rate increases into our existing book and an existing adjudication of our customers on our book now. So we sensitized a higher rate, so that will not create a significant shift.
I mean number one, PCL is driven by job loss and cash flow disruption. That is number one. Not by interest-rate sensitivity, which we plan for. So as long as the economy is reasonably strong and I watch the unemployment rate, that is a driver of consumer credit loss in our economy. And a rate increase I would expect would be supported by a relatively strong economy and strong employment or that wouldn't increase rates.
So you will not see that cause and effect. So, rate increases should drive better NIMs, particularly those with very strong core deposit franchises like we have, as we are able to be invest those free funded deposits into higher yielding rates.
And it has been a very difficult five-year journey as our book rolls off on the mortgage and consumer lending side and they are funded by these deposits, we are funding them -- we are lending at lower and lower rates which is compressing our NIMs along the way. And that NIM expansion on the way up we're really looking forward to because that would signify a stronger economy and therefore you wouldn't have the offset from PCL on that type of dynamic.
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Unidentified Participant [17]
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So, we are running out of time. So I thought, as I would with all speakers today, I think I'm just going to leave final words to you. So, Dave, what would you like the investors here to walk away with as a message?
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Dave McKay, Royal Bank of Canada - President & CEO [18]
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We are very excited about our franchise. We have got a diversified franchise across Canada, the US, and Europe, that is our capital markets franchise. A very strong Wealth franchise that is positioned to capture growth going forward both in Canada as it has been for a long period of time, but now in the US marketplace for the first time.
And we have got the leading domestic retail franchise that has great geographic diversity built in to capture growth whether it occurs in the West, Central Canada and the East, we have got the best geographic diversification. We do not have any business gaps, we've got strong franchises across consumer lending, consumer deposits, business lending, business deposits.
So wherever growth occurs, whatever form it takes in North America, we are now positioned to capture that growth profile with premium franchises. And therefore the diversification of our business is really, I think, going to start playing out over the coming 18 months. So I think we are feeling very good about what we have, particularly with the addition of City National, to grow this franchise and create shareholder value.
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Unidentified Participant [19]
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Okay, with that I would like to thank you very much for participating.
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Dave McKay, Royal Bank of Canada - President & CEO [20]
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Thank you. Thanks. Have a great conference.
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Unidentified Participant [21]
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Thank you.
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