Brian Porter Speech – March 21, 2018
An address by Brian Porter, President and Chief Executive Officer, at the University of Toronto’s Rotman School of Management.
Thank you, Tiff, for that kind introduction and for inviting me to participate in this conference.
I’m happy to be here.
I’d be remiss if I didn’t use this opportunity to point out that Tiff was a big contributor to Canada’s stability and strength during the Global Financial Crisis – or the “GFC” – at the Bank of Canada and the Department of Finance.
I want to thank you, Tiff, for your leadership and public service.
With my time today, I intend to talk about some of the key lessons from the GFC, why Canada did well, and whether or not we’re prepared for the next crisis.
Following that, I would be happy to take any questions you may have.
As you’ve heard, I was Scotiabank’s Chief Risk Officer during the GFC. The experience was formative for me – both personally and professionally.
The GFC was truly unprecedented, in terms of both the rate and pace at which financial contagion spread from financial markets to Main Street.
At the time, we all observed how quickly market confidence can be lost and how negative market sentiment can become a self-reinforcing cycle that fuels uncertainty and panic.
Ten years later, I can still recall the sleepless nights and thousands of hours of calls and meetings held with my colleagues and counterparts, as well as the Bank of Canada, OSFI, government leaders and other stakeholders.
The story of the GFC is well-documented, including by many in this room.
So, I won’t rehash all of the details here.
However, it is worth recognizing that the causes of the GFC are many and complex.
Faulty business models – such as Lehman’s funding of its real estate investments and Northern Rock’s overdependence on funding short and lending long – are certainly part of the explanation.
In some cases, lack of engagement at the Board level, poor government policy and gaps in regulation – including irresponsible pro-homeownership policies – enabled bad behaviour.
Against this backdrop, the performance of Canada’s banking sector throughout the GFC showed the strength of Canadian financial institutions as well as its oversight mechanisms.
A major contributor to Canada’s relative success was the ease with which all of the key players– FIs, government, regulators and other stakeholders – worked together to restore stability.
While I think it’s fair to say that Canada was not a net contributor to the GFC, we were not blameless.
A good example was Asset Backed Commercial Paper (known as ABCP).
ABCP is commercial paper backed by corporate and commercial receivables like auto loans and mortgages.
At its height, close to $20 billion worth of ABCP was sold into Canada, representing roughly $200 billion of underlying credit assets.
Unfortunately some of the participants pushed the boundaries too far and the market seized up.
As a market participant, I can tell you that no one would have thought that a crisis of this scale would have been triggered in the sleepy commercial paper market.
There are two takeaways from what happened in the ABCP market:
Firstly, investors seeking higher yields lacked knowledge about what they were buying.
And secondly, even though ABCP was highly rated by rating Agencies, liquidity in the underlying assets was not there at a time of stress.
I strongly believe that Banks are a critical part of the economic and social fabric of the countries in which they operate.
This is a responsibility that we, at Scotiabank, take very seriously.
Taxpayer-funded bailouts in the U.S. and the UK, resulted in an erosion of trust and confidence in the financial system as a whole, and we are all still living with some of the political, economic and social consequences.
I derived many insights and lessons from my own experience over the course of the GFC.
In the spirit of the conference’s theme of readiness for the next financial crisis, I’d like to spend the rest of my time today sharing my insights with you.
I have organized my thoughts around 5 themes:
- The key role played by prudential regulatory oversight;
- The importance of strong capital levels and high levels of liquid investments;
- The critical aspect of knowing your customers and their intentions;
- The need for thoughtful diversification; and
- The pervasive importance of building a strong risk culture.
I’ll speak to each of these insights, elaborate on what we can learn from them, and what we ought to avoid based on our sightline into the GFC.
I’ll begin with prudential regulatory oversight.
Canada’s success during the GFC is a source of pride for me, and, I would imagine, for many of us in this room.
Our country’s relative performance wasn’t mere luck. It was the result of sound policies, good choices and high-quality people.
In particular, our principles-based – as opposed to a prescriptive – model is designed to strike a proper balance between prudential considerations and commercial flexibility and innovation.
That enabled our government to respond to the GFC in a reasonable and practical fashion.
Ahead of the crisis, Canada had higher capital standards than the Basel II global minimums, and also had a 20-to-1 cap on leverage.
As mentioned, when the GFC did strike, we were able to mobilize the necessary stakeholders and respond quickly and thoughtfully.
Conservative risk tolerance is in our DNA at Scotiabank, and other Canadian Banks, which, ultimately, helped keep leverage ratios low, and asset quality high.
It’s part of the reason why our banking system continues to be internationally recognized, and why Canada’s regulatory model has become a basis for global regulatory policymaking.
A great deal of work has been done in the post-crisis years to strengthen our system.
But, of course, there is always more work to be done.
While the financial system globally is stronger today than it was before the Crisis, there is no room for complacency with regards to emerging threats.
A good example is cybersecurity, which entails safeguarding our Bank’s, and our client’s, data.
Fighting this emerging threat has become a top priority for the industry.
As we say at Scotiabank, “You’re only as safe as you were yesterday.”
To help protect the Bank’s perimeter, we have partnered with Viola Group and Team8, two prominent Israeli technology firms.
We are also working with regulators and government, as appropriate, to develop solutions that keep our system – and our Bank – secure.
The second lesson I want to touch on has to do with capital levels.
As CEO, I spend much of my time thinking about how to allocate shareholder capital strategically and responsibly.
For me personally, the GFC drove home the importance of maintaining balance sheet strength and optionality.
Leading up to the GFC, Scotiabank was well-capitalized and appropriately funded.
But how we think about capital has evolved considerably.
Let me explain…
By the first quarter of 2008, most Banks were adhering to Basel II, which improved the risk sensitivity of capital requirements and generally made the system better lenders.
In fact, Canadian Banks entered the GFC with capital levels above the regulatory minimums.
That said, Basel II did not adequately address capital’s role in absorbing losses and did not sufficiently focus on common equity.
Instead, Basel II set minimum capital levels, which included preferred shares and subordinated debentures.
In a number of cases, these capital levels were insufficient to withstand a significant shock to the financial system.
Following the GFC, in 2013, Basel III requirements were introduced, which addressed many of the lessons from the GFC.
The main Basel III requirement, common equity tier 1, sets a minimum common equity level while recognizing that certain assets, such as intangibles and deferred tax assets, are unlikely to be realizable in the event of another global crisis.
In Canada, OSFI accelerated Basel III’s adoption timelines.
Today we are in an even better position.
Scotiabank’s common equity tier 1 ratio today is 11.75%, which provides us with strength and optionality to deploy capital across our footprint.
At 11.75%, we are holding almost 50% more common equity versus the amount we held around the time of the GFC.
This overall improvement in capital levels makes banks much more resilient and better prepared to respond to the next downturn.
While these higher capital levels have had the impact of reducing returns, we are still able to earn a return well above our cost of capital.
At the Bank, we’ve taken a few other steps to strengthen our balance sheet.
For example, we’ve extended the duration of some of our funding, making us less reliant on short-term money market funding and less exposed to a liquidity event.
We have also been successful in gathering more deposits from our 24 million customers.
The combination of a stronger liquidity profile and stronger capital levels, affords us with greater financial flexibility and greater resilience.
Moving on, it is absolutely critical to know your customers and their intentions.
I believe one of the reasons Scotiabank came through the GFC in a strong position was because of our focus on our customers.
In fact, some of the strongest relationships we have today were forged in difficult times.
Banks play a vital role as a “shock absorber” in times of financial stress.
In other words, well-functioning Banks are able to provide capital and liquidity to the market during periods of volatility
To do so, however, requires sound judgement.
That means, whether we’re onboarding a big asset manager or a small business client, we understand what our customers need today and what their intentions are.
This was a key difference between the US and Canadian banking systems.
With regard to residential mortgages, during the GFC, Canada maintained – in fact, we still adhere to – an ‘originate and hold’ approach, whereas the US practiced an ‘originate and distribute’ approach.
Our mortgage product is all held in our branch network where we know our clients and their financial goals.
While our neighbours to the South were selling off risky mortgage assets, we chose to keep our clients’ mortgages on our balance sheets.
As a bank, our job is to provide liquidity.
It has been our success in lending that has allowed Scotiabank to succeed for nearly two centuries.
Another of our core prudential and business strengths is diversification, across both business lines and markets.
In our case, Scotiabank has a balanced approach to diversification; we are not overly-dependant on any one customer, market, or product.
We see this as a real strength and a core principle of our operating model, one that was evident during the GFC.
In fact, Scotiabank was profitable throughout the crisis, even in the most difficult period.
Today, we operate in 47 countries, however, beyond Canada, our ongoing focus is on the Pacific Alliance region, which is comprised of Mexico, Peru, Chile and Colombia.
These countries have stable governments, strong economies and banking systems, and attractive demographics, with young and growing populations.
From a lending book perspective, our diversification is a key competitive advantage that sets us apart from our peers.
It’s worth noting that despite experiencing some negative effects of the GFC, the countries of the Pacific Alliance faired very well during the crisis.
Our footprint is key to our investment thesis and our well-diversified platform continues to afford us with great optionality. The fifth and most important lesson is about risk culture.
In a financial crisis, risk happens quickly and lost market confidence follows immediately.
Organizations such as ours need to have a deep understanding of and respect for risk and liquidity.
It seems self-evident, but this point can’t be taken for granted.
Leading up to the GFC, many banks around the world did not have a formal – and in many cases, an informal – risk appetite.
Post-GFC, regulators require that risk appetite is set and overseen by the Board.
In addition, regulators explicitly review all aspects of a bank’s risk appetite and provide input where they see deficiencies or inconsistencies.
At Scotiabank, we view our risk appetite as foundational.
It sets the rules of engagement for every part of the Bank – from retail products to corporate lending – and is subject to constant review.
Our global risk management function has evolved considerably over the past several years and now includes many non-financial risks and areas of focus, including cyber, IT, Anti-Money Laundering, reputational risk, data, privacy, compliance and conduct, just to name a few.
We expect that the Bank’s risk function will continue to evolve with the shifting risk landscape and with changing technology trends.
For example we are working to optimize the use of data – traditional and non-traditional – to drive even better risk insights.
We’re also investing in people, processes and technology to drive efficiency and accuracy when it comes to risk.
That includes things such as smart automation for risk adjudication, to reduce fraud and inform better lending decisions.
These investments are only one component of our annual technology spend, which grew by 14% over last year, and now sits at more than $3 billion.
As I reflect on the GFC, I’m proud of the fact that Scotiabank had strong leadership and conscientious employees who didn’t agree with, and in fact resisted, many of the risky activities that precipitated the GFC.
That includes badly-structured and illiquid paper that happened to be rated Triple “A”.
We would pass on products if we didn’t understand how they would trade, or how they were valued.
At the time, the analyst community said we were being too conservative and encouraged us to take more risk.
But we stuck to our strong risk culture, which, with the benefit of hindsight, ended up being a very good thing.
The GFC was a powerful reminder that maintaining a strong risk culture matters.
It also underscored the need to train and embed talented risk practitioners across the enterprise.
We believe that by entrenching risk into all business lines and functions across the organization, we are building an even better Bank.
Rotman’s Master of Financial Risk Management is a great example of a program dedicated to preparing people for a career in a critically important field.
I understand this year’s class is with us today.
Risk is a very important function and the skills you are gaining are widely-applicable.
In fact, many of Scotiabank’s senior leaders have experience in Risk Management, and I can tell you that the Bank is better off because of it.
You’ve chosen a great field of study, and I wish you well as you move forward in the program.
Let me wrap up with one final observation.
Even with the growing prevalence of new technologies, such as machine learning – which, by any measure, is helping to make lending safer – banking is a judgement business.
The reality is, sometimes we’re going to makes loans we shouldn’t, and sometimes we don’t make loans we should. But that’s part of banking, and always will be.
A decade ago, we saw what happened when sound judgement took a back seat to irresponsible practices and reckless behaviour.
Though it could be the topic of another speech entirely, I believe that much of the political and social volatility we have witnessed over the past few years can be traced back to the disruption caused during the GFC.
It is a powerful reminder of the importance of maintaining public trust and confidence, which are not only the foundation of our industry, they are the foundation of our society.
The past decade has been one of rebuilding.
At Scotiabank, we work hard every day to earn and maintain the trust of our 24 million customers.
I would argue that adhering to the five insights I’ve shared today can help the entire industry build and strengthen pubic trust and confidence.
There are no excuses. We must get this right.
Thank you very much for your time and attention, and I would be happy to take your questions.