C a n a d i a n B a n k s 2 0 Canadian Banks 1 6 | E m b r 2016 a c in g t h e F Embracing the in T e c h m o v FinTech movement e m e n t | P e r s p e c t iv e s o n t h e C a n a d ia n b Perspectives on the a n kin Canadian banking industry g in d u s t r y www.pwc.com/ca/canadianbanks Contents 02 Embracing the FinTech movement 04 The big picture: Canadian banks’ 2015 performance 06 Peter Aceto—Tangerine Bank: Perspectives from an original disruptor 07 Canada’s FinTech ecosystem: Evolving but not yet thriving 10 What’s at stake? 11 Challenges new FinTech companies face in the Canadian market 12 A way forward 14 The emerging API economy: A key FinTech facilitator 15 How can regulators address FinTech? 16 Continued ROE and margin compression pressure 18 Snapshots of the Big Six 19 BMO 21 Scotiabank 23 CIBC 25 NBC 27 RBC 29 TD 31 Appendices 40 Financial Services publications 42 Financial Services leadership team Preface Our 2016 report on Canada’s banking sector finds Canada’s Big Six banks generating strong revenues and posting solid returns. They also improved their 2016 first quarter results in relation to last year—despite low economic growth and falling commodity prices. As these headwinds affect the Canadian economy and banking sector, the banks are working hard to respond to a growing and potentially profound shift in the financial services world. A host of new players have emerged, eager to use financial technology—FinTech—solutions to disrupt the global banking industry. Capitalizing on the latest mobile, cloud and digital technologies, FinTech start- ups are targeting the intersection of profit pools and customer pain points with innovative, easy-to-use and cost-efficient solutions. The Canadian banks are not standing still and are devising strategies and initiatives to innovate and embrace the FinTech movement. In our report, we explore how banks are collaborating with FinTechs to bring new solutions to market and help create a vibrant environment that combines the financial stability of banks with a creative and entrepreneurial spirit. You can read more of our observations on the state of Canada’s banks—and our perspectives—in the pages that follow. Diane Kazarian Bill McFarland National Financial Services Leader CEO and Senior Partner Perspectives on the Canadian banking industry 1 Embracing the FinTech movement Perspectives on the Canadian banking industry Canada’s banks delivered another strong performance in 2015, both in terms of revenue and profitability, a very impressive feat against a backdrop of low economic growth. Economically, 2016 doesn’t look to be much better with lower demand and a potential continuation of slumping commodity prices. Unemployment has been climbing to a two- year high of 7.2%1 and may be tested in 2016, particularly in oil-producing provinces. These factors must be considered when coupled with the uncertainty of a low Canadian dollar and a forecasted modest increase in US demand for Canadian exports. The banks need to navigate these cool economic conditions and find profitable growth where household debt burden hit an all-time high of 163.7%2 (debt to income ratio), coupled with a low interest rate environment. This will continue to impact the banks’ net interest margins. Importantly, the banking industry is very focused on the potential disruption at the hands of a group of new companies that are using financial technology (FinTech) to target key aspects of the banks’ value chain. 1. “Labour Force Survey, January 2016”. Statistics Canada. February 5, 2016. http://www.statcan.gc.ca/daily-quotidien/160205/cg-a002-eng.htm. Retrieved February 26, 2016. 2. “National balance sheet and financial flow accounts, third quarter 2015”. Statistics Canada. December 14, 2015. http://www.statcan.gc.ca/daily-quotidien/151214/dq151214a-eng.htm. Retrieved February 26, 2016. 2 Canadian Banks 2016 Embracing the FinTech movement The quickly growing number of smartphone users worldwide as well as an “[Digital] is no longer just technology or increasing middle class—all potential new banking customers—continue to work in favour of emerging financial companies that embrace the FinTech a cost centre . . . digital has now become model. And with a credit card and access to the Internet, a start-up can be up and running in days. Developments such as these are reducing the barriers a revenue generator and cost saver, a of entry, and we’re seeing unprecedented levels of FinTech start-up activity around the world. productivity play.” These new companies are well funded and they’re relentlessly focused on delivering customer-centric solutions with innovative, inexpensive and Cesar Rainusso simpler offerings. More importantly, FinTechs are smaller and more nimble, Vice President and Head of North American Digital Channels, unencumbered by large, existing businesses and costly infrastructure. They Bank of Montreal aren’t as constrained by the regulatory environment. And they can more PwC Changing the game—The age of digital and disruptors event, easily capitalize on the latest cloud and open-source technologies, big data November 3, 2015 and analytics, and greenfield infrastructure. FinTech upstarts aren’t the only ones trying to shake up the banking value chain—technology giants such as Apple and Google also aim to seize market To achieve this, a FinTech ecosystem needs to be embedded into the banks’ share from banks. These potential rivals can use their innovation know-how, transformation strategies to drive change across the organization—people, global scale and powerful brands to make inroads into banks’ traditional processes and technologies. It will challenge banks to really understand territory by extracting the most profitable aspects of banks’ business. For where FinTechs are succeeding and either prepare to collaborate and example, Apple has launched Apple Pay, its mobile payment platform, integrate them meaningfully or compete. In particular, recognizing that broadly in the United States, United Kingdom and China. In Australia and FinTech comprises three categories of companies will help banks devise Canada, the launch has been limited to date. Google has also looked into response strategies. These categories are: financial service providers (where disrupting the financial services value chain by registering as a mortgage the FinTech provides a competing offering), accretive services and user loan broker and providing mortgage search capabilities in the United experiences (where the FinTech provides a service atop incumbent financial Kingdom and select states in the United States. It’s little wonder that 81% services) and technology solution providers to financial institutions (where of global banking CEOs see the pace of technological change as a threat to the FinTech provides a solution to incumbent banks). growth; more than half (56%) view new market entrants such as FinTechs as a similar threat.3 As the FinTech-driven movement gains momentum, This forms a spectrum of strategic responses that recognizes that not all Canada’s banks are monitoring the evolution of this emerging ecosystem and FinTechs pose the same threats—or opportunities—to banks. In many cases, actively pursuing opportunities to play an integral part in it. Banks recognize they can be viewed as enablers to traditional innovation and continuous that they have much to gain from FinTechs’ innovations: soon, many FinTech- improvement. It is important that banks continue to embrace a long-term driven offerings may become pivotal elements in banks’ operating models, approach to investment and risk taking that gives innovation the space it enabling banks to reduce costs, reach underserved markets and open up new needs to flourish. In the end, these efforts will help build a Canadian FinTech products and revenue streams. ecosystem whose members are able to take on global competitors—and win. 3. “Creating a platform for competitive regeneration.” PwC 19th Annual global CEO survey—Key findings in the banking and capital markets sector. February 2016. http://www.pwc.com/gx/en/ceo-agenda/ceosurvey/2016/banking-and-capital-markets.html. Perspectives on the Canadian banking industry 3 Embracing the FinTech movement The big picture: Canadian banks’ 2015 performance Despite low economic growth, falling commodity prices and the severe As a whole, Canadian banks responded to the slowing economy, slump in the energy sector, Canada’s Big Six banks4 performed well, restructuring some operations to increase efficiencies, streamline their achieving strong revenues and posting solid returns. cost base and become fitter, faster organizations. They will most likely continue to do so by keeping their focus on core productivity measures The Big Six banks’ average consolidated revenues were and increased risk management. However, as they’ve reduced CA$21.4 billion in 2015, up 4.3% from CA$20.5 billion in 2014. spending in some areas, many banks are making heavy investments in However, average return on equity was 15.6%, down from 16.6% the technology as they continue to transform their customer experience, year before, continuing the decline we’ve observed and commented automate processes, comply with regulatory demands and enhance on in recent years. digital capabilities. From a productivity perspective, the banks continued their efforts to To date, despite a number of headwinds affecting the Canadian increase efficiency and streamline their cost base; however, despite economy and the banking sector, the Big Six as a group improved these efforts, the overall efficiency was 58.4% in 2015, up slightly their 2016 first quarter results compared to the same quarter last year. from 57.9% in 2014. Among their Big Six peers, RBC and Scotiabank From a revenue perspective, the banks grossed a total revenue of continued to post the lowest efficiency ratio. CA$34.5 billion compared to CA$33.2 billion achieved last year, which represents a growth of 3.9%, and managed to work this growth down to the bottom line, growing their net income attributable to common shareholders from CA$8.4 to CA$8.6 billion—an increase of 1.8% over the same quarter last year.  4. “Big Six” in this report refers to Canada’s six major banks: National Bank of Canada (NBC), Royal Bank of Canada (RBC), the Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CIBC), the Bank of Nova Scotia (Scotiabank) and Toronto- Dominion Bank (TD). 4 Canadian Banks 2016 Embracing the FinTech movement Figure 1: 2015 at a glance summary—Key metrics as at or for the year ended October 31, 20151 BMO BNS CIBC NBC RBC TD 2015 2014 2013 2015 2014 2013 2015 2014 2013 2015 2014 2013 2015 2014 2013 2015 2014 2013 Total market return2 -3.0% 16.8% 28.0% -7.0% 12.9% 21.3% 1.6% 20.4% 17.7% -13.9% 20.6% 21.6% -2.7% 18.3% 27.4% 0.4% 19.8% 21.7% Market capitalization ($ billions) 48.9 53.0 46.8 74.0 84.0 76.6 39.8 40.8 35.4 14.6 17.3 14.7 107.9 115.4 100.9 99.6 102.4 87.9 Net income ($ millions) 4,405 4,333 4,248 7,213 7,298 6,697 3,590 3,215 3,400 1,619 1,538 1,554 10,026 9,004 8,429 8,024 7,883 6,662 Efficiency ratio 64.2% 65.3% 63.3% 53.4% 52.6% 53.5% 63.9% 63.7% 59.6% 58.6% 58.6% 58.6% 52.8% 51.8% 52.6% 57.5% 55.1% 55.2% Earnings per share 6.59 6.44 6.27 5.70 5.69 5.19 8.89 7.87 8.24 4.56 4.36 4.34 6.75 6.03 5.60 4.22 4.15 3.46 Gross impaired loans ($ millions) 1,959 2,048 2,544 4,658 4,200 3,701 1,419 1,434 1,547 457 486 395 2,285 1,977 2,201 3,244 2,731 2,962 Consolidated revenue3 ($ millions) 18,135 16,718 16,263 24,049 23,604 21,343 13,856 13,376 12,783 5,746 5,464 5,163 35,321 34,108 30,867 31,426 29,961 27,262 Total non-interest expenses ($ millions) 12,182 10,921 10,297 13,041 12,601 11,587 8,861 8,525 7,614 3,665 3,423 3,165 18,638 17,661 16,227 18,073 16,496 15,042 Employee head count 46,353 46,778 45,631 89,214 86,932 83,874 44,201 44,424 43,039 17,014 17,056 16,675 72,839 73,498 74,247 81,483 81,137 78,748 Total capital ratio 14.4% 14.3% 13.7% 13.4% 13.9% 13.5% 15.0% 15.5% 14.6% 14.0% 15.1% 15.0% 14.0% 13.4% 14.0% 14.0% 13.4% 14.2% Notes 1. Canadian banks’ results are in CA$ and include The Bank of Montreal (BMO), The Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). 2. Calculated by change in share price plus dividends. 3. Consolidated revenue is net of insurance policyholder benefits, claims and acquisition expense. Note: Other than the impact of stock splits, prior years’ data is consistent with prior year annual reports. PPeerrssppeeccttiivveess oonn tthhee CCaannaaddiiaann bbaannkkiinngg iinndduussttrryy 55 Embracing the FinTech movement Tangerine Bank: Perspectives from an original disruptor Today’s new and emerging FinTech firms aren’t the first The technology revolution, powered by huge advances to attempt to shake up the Canadian banking sector. In in digital, mobile, analytics and the cloud, is the key 1997, Tangerine Bank—then known as ING Direct— to meeting consumers’ new expectations, and that’s arrived in Canada with a very different view of what created opportunities for today’s FinTech firms to banking could be. With nearly 20 years of experience in usurp banks’ traditional territory. Aceto understands bringing unconventional thinking to Canadian banking, how technology can be used to disrupt the status Tangerine CEO Peter Aceto has a unique perspective on quo—because technology has long been central to what’s happening today. Tangerine’s competitive strategy. Not that Tangerine invests in technology for technology’s sake, he adds. Aceto believes the banking sector finds itself facing a “It’s all about making things easy for our customers. confluence of social and technological revolutions. The That’s what drives the test about what technology social revolution is driven by consumers’ loss of trust choices we make,” he says. in corporations—not just financial institutions—over the last 10 years. This steady erosion of trust means Marvelling at the speed with which technology has that consumers now think very differently about transformed banking over the past 20 to 30 years, who they want to work for, buy from and do business Aceto thinks it’s virtually impossible to predict what Peter Aceto, Tangerine CEO with, observes Aceto. Expectations have changed too: banking will look like in 10 years. Will Canada’s big “Consumers are demanding a different experience,” he banks be outplayed by newer, nimbler FinTechs? Aceto says. “They’re expecting experiences that simplify their is positive about the banks’ chances. The big players lives, that make things easy.” are thinking about technology in ways they never have before, he observes, and they’re very focused on solving this problem. “I think the banks in this country solve whatever problems that they need to solve.” 6 Canadian Banks 2016 Embracing the FinTech movement Canada’s FinTech ecosystem: Evolving but not yet thriving There’s progress… established an innovation lab at Communitech, announced a partnership with Moven, a mobile personal financial management platform, and announced that it would collaborate on technology solutions targeting Amid the excitement over FinTech disruption, the banks’ own innovations customer and employee experience in Cisco’s new Toronto Innovation in financial technology are sometimes overlooked. Canada’s banks have Centre. RBC has also been active in developing partnerships by announcing brought Canadians the Interac system, Moneris payments processing and testing of payments with Nymi Wristband technology and, more recently, email money transfers, along with web and mobile banking. ING Direct— an alliance with Uber for loyalty rewards. In early 2016, BMO entered now Tangerine—launched its branchless bank first in Canada. CIBC- the FinTech domain with the launch of SmartFolio, a digital portfolio backed PC Financial provided grocery giant Loblaws with the country’s management service, designed to compete with both traditional players first ‘white-label’ bank and BMO launched Mbanx, the first direct-to- and ‘robo-advisers.’ customer bank, in 1996. In early 2015, CIBC announced its partnership with MaRS to create a new corporate innovation hub, which would join MaRS’s new FinTech cluster. …but more needs to happen In addition, it announced a referral partnership with Thinking Capital, a Canadian online small business lender.5 Scotiabank has jumped into the Canada’s banks understand that innovation is critical. However, their long small business lending space with an investment in Kabbage, a US-based development cycles, legacy systems, organizational structures and other online small business lender. Scotiabank also announced its internal challenges may at times not allow them to keep pace with today’s rapid Digital Factory—designed to focus on technology and mobile banking, shifts in technology and customer needs. often partnering with external FinTechs and other start-ups. TD has 5. “CIBC forges ‘fintech’ partnership that will offer faster loans to compete with online lenders”. November 18, 2015. http://business.financialpost.com/news/fp-street/cibc-forges-fintech-partnership-that-will-offer-faster-loans-to- compete-with-online-lenders. Retrieved February 26, 2016. Perspectives on the Canadian banking industry 7 Embracing the FinTech movement Figure 2: Components of the FinTech ecosystem n n ovatio n v estme I n I nt Bu sinesses WCahnaatd’si arena Flliyn Tneecehd eecdo issy csotenmtin—uaedn iennvveisrtomnmenetn itn t bhuaitl dwiinllg p ar ohdeualcteh yth, he olistic innovative offerings needed to compete in the years to come. If Canada’s banks don’t keep up, they run the risk that outside competitors will bring their proven, successful offerings to Canada and slowly erode market share. Universities F inTech ancial instituti TInhniso ivs ahtoiown t.h Ce aencaodsyas itse mno cwo uhlodm weo trok .more than 80 FinTech firms, and the n o Fi ns number of highly promising developments in the country keeps growing.6 The ecosystem, especially in the GTA-Waterloo and Vancouver areas, is already home to all the major banks, leading universities and a thriving S calability pee d to mar technology start-up culture. The labs, incubators and accelerators are well Gov ernment S ket sTiatuleantetd m toix e. nTahbele f oraupnidda, tdioisntrsa ocft iaonn -ifnrneeo vinantiovvea etniovnir. onment are already s in place. Continuing to embrace a talent mix, where creative millennials and experienced financial talent complement each other, can foster the connections, trust and understanding needed to move innovations forward quickly. T alent mi R e gulatio x n 6. “OMERS snapshot shows how much Canadian FinTech sector has grown in six months”. August 26, 2015. http://betakit. com/omers-snapshot-shoes-how-much-canadian-fintech-sector-has-grown-in-six-months/. Retrieved February 26, 2016. 8 Canadian Banks 2016