Value criteria 3: Long-term prospects

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The greatest barrier to entry in banking is regulation. This comes from the fact that regulators ensure that there are only a few major banks in the country, and it is extremely difficult to regulate many banks. Additionally, controlling the number of large banks to a small number helps control the flow of money through the economy. There are two factors in the banking system that provide extra secure; low cost service, the safety and stability of the financial system. In order to enter the market, the company is required a significant amount of capital and governance. 

 

In terms of withdrawing and depositing funds, there is no substitute product to banks except for credit unions. A survey conducted by FirstOntario Credit Union shows that approximately 40% of clients are dissatisfied with the services of their bank, and the service fees charged by banks and the fact that most credit unions do not charge service fees is a major part of this dissatisfaction. 

 

Furthermore, banks also face threat from other non-financial competitors. The insurance companies and mutual fund companies provide banking services that can be also obtained from banks, while companies with big names are also offering new payment methods such as loans to attract more customers. 

 

RBC continues to focus on extending their number one position in Canada as a leading financial institution by continuing to grow their volumes to increase market share. Internationally, they are “building premier, globally competitive businesses that primarily serve corporate, institutional and high net worth clients” (RBC). 

 

RBC’s brand also helps to attract top-tier employees, which helps position their global franchise in capital markets and wealth management in order to deliver profitable long-term growth. With a combination of employee excellence and top-quality service they look attract new business from competitors with a core value-driven culture.

 

RBC aims to combat this issue by offering more end-to-end services, or “ecosystems” which covers wider customer needs than only financial, such as when they want to start their own business, sell their house, or find a new car.

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Value criteria 4: Stability

 

Industry Analysis

In Canada there are a total of 88 banks and 5,907 branches across the country since 2017 (Canadian Bankers Association). The banking system in Canada is often referred to as being the safest in the world. However, the banking industry is highly cyclical to the economy activities. 

 

According to PWC, there will be a major upskilling of the workforce in banking industry in 2020. By increasing use of electronic banking from customers and the growth of available data, banks in Canada have begun to focus on building a workforce with skills for a digital world.

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Crypto currencies

Although the rise in use of crypto currency has drawn a great deal of focus from Canadian banks, the Bank of Canada is developing ways to better manage and safely invest with. 

 

 

Impact of COVID-19 - volatility earnings 

​As of May 1, 2020, 11:00 am, the number of infected cases in Canada is 53,657. The virus spread largely in Canada and more significantly in the United States, many activities involve a large group of people would need to be cancelled or postponed. 

 

With the sudden production suspension, it would lead to a shortage of demand and supply and a short-term loss of salary which increases the default rate. The Canadian and American administration have taken actions such as decrease the bank interest rate to prevent future erosion of the economy. RBC’s net income is unfavorably impacted by lower interest rate in Canada and the United States since it mainly operates in the two countries. Because of the potential effect on the net income of RBC, we can predict a lagged effect on the share price.

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Personal banking contributes the highest percentage in banks’ revenue. In order to find out potential default risk, we can have a look on the S&P indices. The composite default index is a sum of the four types default indices, which includes auto default index, first mortgage default index, second mortgage default index, and bankcard default index. 

 

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Auto default rate and first mortgage default rate slightly decrease in the past 3 months. The bankcard default rate shows a relatively high increase of 0.99% over the past quarter. As of May 4th 2020, there is a relatively stable trend in the composite default index under the pandemic. 

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Bankcard default rate might not ramp up in the next quarter as people spend less due to the uncertainty of employment state. According to various public estimate, the credit card and debit card usage have declined about a range of 30% to 60%. On the other hand, the first mortgage default rate would see an increase if the government is failed to provide more financial support. 

 

 

 

 

 

 

 

 

This is a good example that government’s financial support helps. On March 23rd, US federal government announced to provide another stimulus package, which is the unlimited assets purchase. Firms with financial issues can issue bonds during this time, and the government will promise to buy it. The steam of cash can help banks and other businesses to stay float and to solve the insolvency problem. On the same day, the stock market rebooted. The stock prices include RBC and other banks rallied.

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Another thing to note is that the S&P auto default rate and bankcard default rate are fluctuated during the past three to five years. The banks have incorporated this factor in the risk model. RBC is able to comfortably handle the 5 year high in composite default rate, while also be preparing for a possible higher default rate due to the impact of the pandemic without having insolvency problem.

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COVID-19 virus outbreak is a kind of systematic risk that many companies cannot eliminate. However, RBC’s risk control methods would help them mitigate and limit the potential effects from systematic risk. According to their 2019 annual report, they have two significant measures which are diversification and enterprise-wide stress testing program where helped them became one of the first companies recovered from 2008 recession. 

 

According to an article in The Globe and Mail, RBC capital market’s staff has increased by 24% since 2008 and many bankers from Lehman Brothers, the fourth-largest investment bank in the United States in 2008, went to RBC to seek for job opportunities. After the corona virus outbreak, there would be many human resources available in the market result from the layoff due to the outbreak, and this provides a great opportunity for RBC to recruit more talents. On the other hand, we believe with the previous successful recover of RBC, it would convince investor to invest in RBC and its share price would rebound.