Royal Bank of Canada
Annual Report 2019

Plain-text annual report

C T G 150 Y S A Bold Future Our Purpose Helping clients thrive and communities prosper. Guided by our Vision to be among the world’s most trusted and successful financial institutions, and driven by our Purpose, we aim to be: > The undisputed financial services leader in Canada > The preferred partner to corporate, institutional and high net worth clients and their businesses in the U.S. > A leading financial services partner valued for our We are guided by our Values: > Client First > Collaboration > Accountability > Diversity & Inclusion expertise in select global financial centres > Integrity TABLE OF CONTENTS 2019 Highlights Chair Message CEO Message 2 4 Management’s Discussion and Analysis Enhanced Disclosure Task Force Recommendations Index Reports and Consolidated Financial Statements 12 110 111 Ten-Year Statistical Review Glossary Shareholder Information 5 212 213 216 Connect with us: facebook.com/rbc instagram.com/rbc twitter.com/@RBC linkedin.com/company/rbc www.youtube.com/user/RBC rbc.com/ar2019 Who we are BY THE NUMBERS 85,000+ employees 17 million clients 36 countries Royal Bank of Canada is a global financial institution with a purpose-driven, principles-led approach to delivering leading performance. Our success comes from the 85,000+ employees who bring our Vision, Values and strategy to life so we can help our clients thrive and communities prosper. As Canada’s biggest bank, and one of the largest in the world based on market capitalization, we have a diversified business model with a focus on innovation and providing exceptional experiences to our 17 million clients in Canada, the U.S. and 34 other countries. How we achieved success is as important as what we achieved. In addition to delivering record financial results this year, you’ll read about how we put our clients at the centre of everything we do, create an exceptional employee experience and make our communities stronger. Why invest? > Diversified business model with leading client franchises > Market leader with a focused growth strategy > Financial strength underpinned by prudent risk and cost management > Innovation is in our DNA > Leading corporate citizen Royal Bank of Canada: Annual Report 2019 1 2019 Highlights Clients 7.2 million active digital users(1) Top 10 Global Investment Bank by fees(2) 11 out of 11 top rankings among the big five Canadian banks in the 2019 Ipsos Financial Service Excellence Awards Outstanding Global Private Bank in North America for the fourth year in a row(3) $100 billion commitment to finance companies and projects with environmental and social benefits by 2025 €500 million inaugural green bond issuance to fund a portfolio of environmental assets Canada’s Most Valuable Brand named by Brand Finance Employees #3 globally in the 2019 Refinitiv Diversity & Inclusion Index, ranking over 7,000 listed companies 46% women executives(4) 19% minority executives(4)(5) 18% young people(6) 95% of employees are proud to be part of RBC(7) $14.6 billion in competitive compensation and benefits 86% of employees are inspired by our purpose of helping clients thrive and communities prosper(7) Communities $137 million provided through RBC Future Launch® reaching over 1.9 million Canadian youth through 500+ partner programs since 2017 $4 billion in support of our communities as one of the largest taxpayers in Canada, and as a taxpayer in other countries where we operate(8) $9.9 million raised through RBC Race for the Kids in support of youth and children’s charities globally Carbon neutral since 2017 achieved net-zero carbon emissions in our global operations as part of our strategy to accelerate clean growth(10) $19 million raised through our annual Employee Giving Campaign by employees and retirees in Canada for 4,000+ charities $130 million donated to nearly 5,000 charitable organizations globally through cash donations and community investments(9) Represents 90-day active customers in Canadian Banking only. (1) (2) Dealogic, YTD as at October 31, 2019. (3) Private Banker International Global Wealth Awards 2019. (4) Represents data as at October 31, 2019 for our businesses in Canada governed by the Employment Equity Act. (6) Headcount under 30 globally, excluding City National Bank and BlueBay Asset Management employees. (7) 2019 Employee Opinion Survey (EOS). (8) Refer to page 88 for additional information. (9) Includes employee volunteer grants and gifts in kind, as well contributions to non-profits and non-registered charities. Figure does not include sponsorships. (5) Based on employee self-identification and aligned to the definitions of the Employment Equity Act in (10) Achieved carbon neutrality through energy and emission reduction programs, and the purchase of Canada and the U.S. Equal Employment Opportunities Commission. renewable energy credits and high-quality carbon offsets. 2 Royal Bank of Canada: Annual Report 2019 Shareholders $8.75 diluted earnings per share (EPS), up from $8.36 in 2018 16.8% return on equity (ROE), down from 17.6% in 2018 12.1% common equity tier 1 (CET1) ratio, up from 11.5% in 2018 $4.07 dividends declared per share, increased by $0.30 since 2018 55% of profits returned to our shareholders through dividends(1) and repurchases $5.7 billion remainder of our profit available to reinvest in future growth Earnings by business segment(3) 49% 21% 20% 6% 4% Personal & Commercial Banking Capital Markets Wealth Management Insurance Investor & Treasury Services 3-YEAR(5) 5-YEAR(5) 9% 17.1% 11.5% 46% 3-YEAR 12% 11% 8% 17.3% 11.2% 46% 5-YEAR 10% 8% Strong earnings net income (C$ billion) $12.9 $12.4 2018 2019 ANNUALIZED DIVIDEND INCREASE OF: 8% One year 7% Ten year(2) Financial performance metrics MEDIUM-TERM OBJECTIVES(4) Diluted EPS growth of 7%+ ROE of 16%+ Strong capital ratio (CET 1) Dividend payout ratio of 40%-50% Total shareholder return(6) RBC Global peer average (1) Includes dividends paid on both common and preferred shares. Dividends were $5.8 billion on common shares and $0.3 billion on preferred shares. (2) Compound Annual Growth Rate. (3) Excludes Corporate Support. (4) A medium-term (3-5 year) objective is considered to be achieved when the performance goal is met in either a 3- or 5-year period. (5) Diluted EPS growth is calculated using a Compound Annual Growth Rate (CAGR). ROE, CET1 and dividend payout ratio are calculated using an average. (6) Annualized TSR is calculated based on the TSX common share price appreciation plus reinvested dividend income. Source: Bloomberg, as at October 31, 2019. RBC is compared to our global peer group. The peer group average excludes RBC; for the list of peers, please refer to pages 15-16. Royal Bank of Canada: Annual Report 2019 3 Message from Katie Taylor Imaginative leadership will ensure a prosperous future for both RBC and the communities it serves. That message was delivered to a gathering of RBC shareholders following the Second World War, and it rings true today. It is the willingness to reimagine – and disrupt – the way RBC operates that helps the bank create meaningful value in our clients’ lives. And as this year’s results attest, RBC’s approach continues to resonate in the marketplace, reinforcing its stature as one of the most trusted and successful financial institutions in the world. The primary role of the Board is to support RBC’s executive team to sustain the bank’s leadership position today, and into the future. To this end, we act as stewards and provide oversight to ensure the bank’s strategic plans and priorities create value and align with our risk appetite. Importantly, we do so on a continuous basis – constructively challenging management and monitoring initiatives. We provide guidance to the bank’s leadership team as it anticipates the ever-evolving needs of its clients while seizing the right business opportunities in a rapidly changing and increasingly competitive global marketplace. Sustaining success over the long term also requires a pipeline of qualified leaders. To ensure continuity, the Board oversees talent management and succession planning. In 2019, this included key appointments for the Group Head, Capital Markets and the Chief Administrative Officer. Culture is critical in any winning organization. Directors champion the core values underpinning the way the bank operates – internally and externally. For us, leadership is about setting an example for others. To this end, we work with management to set the right tone, and signal the behaviours each and every employee must embody. We recognize the value of respectful and inclusive workplaces, where people can speak up for the good of RBC, and in turn, contribute to the business and brand in meaningful ways. In 2019, our Governance Committee 4 Royal Bank of Canada: Annual Report 2019 continued to enhance Board and Committee reporting on conduct and culture matters and proactively monitored emerging trends and best practices. Risk management is another core focus area. Millions of people and thousands of communities trust RBC to act prudently and be a model corporate citizen. The Board oversees risk management on an enterprise-wide basis and carefully assesses whether management’s plans appropriately balance strategic opportunities with risk discipline. An important area of focus that relates to both risk management and community and social impact is climate change. As part of the Board’s oversight, several important steps were taken in 2019, including the development of an enterprise climate change strategy, advancement of our capabilities in climate risk management, and the enhancement of our climate-related disclosures to better align with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures. In all of this, continuing our history of demonstrating the highest standards of good governance is an essential foundation for strong performance and fundamental to the bank’s success. Directors contribute to effective and transparent oversight by setting the structure through which management work to meet our strategic objectives and achieve long-term value for our shareholders, as well as the clients, communities and other stakeholders who we are privileged to serve. Building upon an already very strong Board, we were pleased to appoint a new RBC director, Frank Vettese, who brings a wide array of global experience to our discussions. RBC continues to unlock the imagination and insights of its people to create even greater value for its clients, and the communities where RBC operates. Your Board is proud to support the CEO and Group Executive team in making this happen through sound counsel, a supportive culture, strong risk management, and good governance. On this very special year, when we celebrate our 150th anniversary, the Board appreciates everything Dave McKay, his leadership team and our incredibly talented employees have done to celebrate the bank’s storied history, and set it up for an exciting future. We are confident in the bank’s strategic direction and believe the bank’s purpose-led approach will help clients thrive and communities prosper for years to come. Kathleen Taylor Chair of the Board Message from Dave McKay A Bold Future One hundred and fifty years ago, our Halifax founders expanded aggressively westward to support the ambitions of a young and growing country. In doing so, a powerful statement was made about the kind of company we set out to be: RBC moves ‘quick to the frontier’ to help clients thrive and communities prosper. The same bold spirit has propelled us forward ever since; whether that’s by entering new markets and geographies, expanding our value proposition, or reimagining the role we play in our clients’ lives. RBC is here to build a better future for those we serve. Progress towards this goal can be measured by the scale and strength of our franchise in Canada, the U.S. and across our global footprint; the engagement of our people; the meaningful value we create for our clients; the investments we make in the community; and the strong financial performance we delivered in 2019. In my conversations with the Board, this balanced approach defines what a performance scorecard means to RBC. Royal Bank of Canada: Annual Report 2019 5 CEO MESSAGE I’m particularly proud of our employee engagement levels. They reached new heights in 2019, surpassing external benchmarks of high-performing companies in North America. In part, this is a reflection of our culture, which provides our people with opportunities to achieve their long-term career objectives. This includes helping our employees gain the skills to thrive in the workplace of the future. Equally important, RBCers believe in our Values, understand our Vision, and are motivated by our Purpose – to help clients thrive and communities prosper. Strong engagement translates into employees going above and beyond to deliver for our clients. Across our five business segments, client satisfaction levels increased in 2019 – and in many cases, RBC is leading our Canadian and global peers. Thanks to our employees, we are developing deeper and more meaningful relationships with those we serve, and attracting new clients. Indeed, our aim is to add 2.5 million new clients by 2023. Our volume of business, revenue and market share growth speaks to the trust clients have placed in us, and the value we continue to create for them. It also tells us that the significant investments we’re making in talent, technology and our trusted global brand, are paying off. We are proud of the contributions we make in the communities where we work and live – our long-term success depends on it. That begins with caring deeply about what matters most to our community stakeholders. In 2019, this included thousands of employees volunteering hundreds of thousands of hours to make life better in Canada, the U.S. and around the world. And since our inception, we have donated more than $1 billion to local communities and causes. Through our resources and talented people, RBC is casting light on important conversations about our collective future, and acting as a catalyst to move these conversations forward. In the near term, we expect the world to remain in the midst of profound change and disruption, driven by a wide array of geopolitical, economic and technological forces as well as social and demographic trends. TRANSFORMING THE EMPLOYEE EXPERIENCE In a world where change is constant, having the right people in the right roles is key to how we create more value for our clients. We are building opportunities and experiences that not only attract top talent, but also inspire our people to grow and embark on exciting career paths across RBC. Our culture is built on innovation and inclusion. Behind every technology and business agility project, there are diverse teams delivering advice, products and services, while developing new skills and advancing their careers. Our teams are working and thinking differently because we’re nurturing a growth mindset and providing unique learning opportunities so our people can thrive in the new world of work. (1) 2019 Employee Opinion Survey. 6 Royal Bank of Canada: Annual Report 2019 This year, 93%(1) of our employees said they feel confident they can learn new skills to adapt as their job changes. This tells us we’re succeeding in delivering exceptional employee experiences that unlock the potential of our people. We know that our ability to harness diverse skills and perspectives is essential to driving engagement, and, ultimately, to building the bank of the future and achieving our Purpose of helping clients thrive and communities prosper. The proof is in our culture “Building a culture of diversity and inclusion where everyone can thrive and feel a sense of belonging is key to attracting the best talent. It’s also how we differentiate ourselves and earn our clients’ trust. Our team tapped into this strength as the sole advisor to BB&T in their merger of equals with SunTrust – the largest deal of its kind since the financial crisis.” Vinnie Badinehal Head, Financial Institutions Group, Capital Markets As RBC navigates this evolving world, we will strive to build long-term sustainable client franchises in our core markets that are focused on delivering a premium return on equity, and support earnings growth and value creation for all our stakeholders. To do so, we will leverage our scale, strong risk and capital management and diversified business mix to drive long- term growth. We are proud to be recognized as the most valuable brand in Canada and a top 100 global brand, and will continue to find new and exciting ways to bring it to life to foster unique and powerful bonds with our clients and communities. This includes partnering with other market- leading brands and developing capabilities to differentiate our offerings. We will sustain our technological leadership by investing significantly in our digital and innovation strategies, enabling RBC to deliver even more insights and advice that create meaningful value for our clients. Our differentiated technology platform and strong data foundation are supporting business growth, operational efficiencies and leading-edge capabilities. RBC’s next-generation delivery platform, including a multi-cloud strategy, accelerates our ability to bring products and services to market quickly, scale across our businesses, and leverage world-class artificial intelligence (AI) and analytics to deliver superior business outcomes. Our leaders and teams will keep looking for ways to make our business less complex to run, and faster to operate. Strength in our second home market Growth in the U.S. remains a key pillar of our strategy. We generated 23%(1) of our revenue in the U.S. in 2019, and will continue building our businesses and leveraging synergies across our teams. We’re seizing the right opportunities to gain market share, attract top talent and expand our footprint in new and existing markets. From every transaction and trade, to our advice and technology, our teams work across geographies and business lines to deliver results for clients and drive shareholder value. 13,000+ employees across our businesses in the U.S. Expanded City National’s presence in Los Angeles, New York, Washington, and opened in Miami 10th largest investment bank(2) advisors in U.S. Wealth in the U.S. with 35 offices Management across in 23 states 1,900+ 42 states LEADING PARTNERSHIPS We believe in the power of partnerships to help us bring new value-added products and services to market faster. It’s why we partnered our best-in-class RBC Rewards® program with iconic brands like Expedia, WestJet, Petro-Canada, Indigo and many more – to provide our clients with a unique rewards program that gives them more of what they actually want and unparalleled flexibility. They can even pay bills with their points – a first in Canada. With rewards like this and strong partners, we’ve maintained a leadership position in premium travel with both our Avion flagship card and WestJet co-brand card. Our value proposition extends even further. This year, we teamed up with Microsoft to launch RBC Go Digital, bringing together our cutting-edge financing solutions with Microsoft’s technology to help our commercial clients accelerate their digital transformation and journey towards achieving their business goals. And, to bring more choice and expertise to the Canadian Exchange-Traded Fund (ETF) market, we introduced RBC iShares. This strategic alliance between RBC Global Asset Management and BlackRock Canada connects our clients to the largest and broadest ETF lineup in Canada with over $60 billion in assets across 150 ETFs. It’s a win-win. By partnering with industry leaders and retailers, we’re increasing engagement and enhancing our day-to-day relevance to expand our reach and deliver a differentiated experience for our clients. This will continue to be a fundamental part of our growth story as we build the bank of the future. (1) Excludes Corporate Support. (2) Dealogic, based on global investment bank fees, YTD at October 31, 2019. Royal Bank of Canada: Annual Report 2019 7 CEO MESSAGE And we will attract and grow the best talent, placing our diverse and inclusive culture at the centre of what we do and how we do things. Our people will always be what differentiates RBC in the marketplace. Our willingness to reimagine – and disrupt – the way we operate will ensure RBC remains relevant in our clients’ lives. The RBC story tells us we are at our best when we are at our boldest. It’s in our DNA. The dividend of bold decisions Consider one way we are challenging our business model to build the bank of the future. We don’t just digitize existing products, we co-create new services and experiences. Importantly, these efforts extend beyond what you expect from a bank. RBC Ventures is a great example. It supports innovation and the development of technologies by co-investing and partnering to develop new products and services – such as searching for a home, managing household chores, or assisting with mobility needs. By doing so, we play a more integral role in people’s lives which, in turn, broadens our value proposition. To date, 17 ventures are making life easier for our clients. For instance, Ownr has helped nearly 12,000 Canadians start small businesses, and in 2019, we went further to empower small businesses by introducing Dipp, a digital platform that helps owners acquire new customers and grow their revenues. Bold to the future Acting boldly in an age of change and disruption is central to our ongoing success. The same could be said for the countries we operate in, including our home market, Canada, where the majority of our employees and shareholders reside. This nation is certainly not immune to many of the world’s challenges and opportunities. I’ve spoken publicly on a number of them throughout the year which, I believe, is one of my responsibilities as the CEO of one of the largest Canadian employers. Let me highlight three areas of focus that require bold leadership from both the public and private sector. We mirror these initiatives internally through leadership programs for women and minorities, inclusive behaviour training programs, employee resource groups that boost inclusion, and with measurable goals to further diversify our talent pipeline. Active engagement is vital to creating an inclusive and respectful work environment. This year, 92%(1) of our employees said they feel they are treated with respect, and 90%(1) said that management supports diversity in the workplace: recognizing, respecting and leveraging differences. We all benefit when we build and protect a culture where everyone can contribute, and has the opportunity to reach their full potential. IMPACT THROUGH INCLUSION Diversity and inclusion is more than just a value at RBC; it’s critical to our success as an organization and in our communities. That’s why we have a bold vision that applies inside and outside of RBC – to unleash the full potential of diversity, and drive innovation and growth more broadly. This translates into taking steps that drive meaningful change: joining the Equality Fund in Canada to bring our expertise in sustainable finance to fund projects that advance gender equality, supporting key legal initiatives that bolster LGBT+ rights globally, and working with organizations like the Toronto Region Immigrant Employment Council to mentor newcomers. It’s about speaking up for and about inclusion. (1) 2019 Employee Opinion Survey. 8 Royal Bank of Canada: Annual Report 2019 “Being part of the team that advises RBC in its support of initiatives that protect LGBT+ rights has been a highlight of my career. I’ve seen firsthand how the company ‘walks the talk’ as we take a stand in key causes that align with our values. I’ve had the opportunity to bring my passion for the legal world to projects that have a positive impact in our communities.” Lisa Ford Senior Counsel, RBC Law Group Climate change is one of the most pressing issues of our age. It’s a primary concern of our employees, clients, many shareholders and the public, including the youngest generations who are, in many regards, leading the conversation. There is general agreement on the reality of a warming climate and the various causes of climate change. But talking about the way forward has done more to divide than unite our efforts to mitigate carbon emissions. Coming together starts with a common vision – one that is economically beneficial and politically acceptable to Canadians. RBC will elevate its efforts to convene leaders, and act as a catalyst for meaningful change. This year, RBC announced a business target of $100 billion in sustainable financing by 2025. These funds will support investments in sustainable companies and projects that today are widely recognized as contributing to the low-carbon, sustainable economy of the future. We’re also committed to advancing the way we assess climate- related risks, provide climate-related disclosures and support our clients in this pursuit. In doing so, we must be pragmatic. Fossil fuels will continue to be the primary source of energy to warm our homes, cook our meals, and travel to and from work over the next decade. Moreover, global energy demand will continue to rise which is, in part, the result of a growing population. Canada needs to meet this demand by selling our oil and gas overseas, where we can derive a premium for our goods and, in turn, generate public monies to invest further in clean energy and, more broadly, social programs. Indeed, our oil and gas sector already stands out as an investor in clean tech – let’s build on its momentum so that the industry plays a central role in the transition to a low-carbon economy in Canada and around the world. TAKING ACTION TOWARDS A SUSTAINABLE FUTURE We believe capital can be a force for positive change, and we know we have an essential role to play in supporting the move to a sustainable future. Sustainable finance also represents a growth opportunity for our business and our clients – this is clearly demonstrated by our new business target: $100 billion in sustainable finance by 2025. It’s also why we established a Sustainable Finance team within Capital Markets – to support the growing number of corporate and institutional clients globally who view Environmental, Social and Governance factors as important considerations in their corporate strategy and investment process. We are committed to an enterprise climate strategy aimed at accelerating clean growth and supporting our clients in the low-carbon transition through five key actions: > Supporting clients in the low-carbon transition with RBC products, services and advice > Advancing RBC’s capabilities in climate risk management and publishing annual disclosures aligned to the Task Force on Climate-related Financial Disclosures > Achieving net-zero carbon emissions in global operations annually > Speaking up for smart climate solutions > Using technology to address complex environmental challenges For more information, see the RBC Climate Blueprint available at https://www.rbc.com/community-social-impact/reporting-performance/ Royal Bank of Canada: Annual Report 2019 9 CEO MESSAGE DIFFERENTIATED ADVICE AND INSIGHTS Our size and scale set us apart, but it’s more than that. We’ve combined our trusted brand with a differentiated technology platform and data scale to simplify and enhance our clients’ banking experience. Whether it’s expanding personalized services like MyAdvisor®, which reached more than 1.4 million clients this year, or better serving our more than four million mobile users(1) with tailored experiences – we’re unlocking extraordinary insights and advice to bring our clients’ biggest ambitions to life. We’re also developing world-class AI capabilities to boost our clients’ financial confidence because we know every dollar counts. With the introduction of NOMI Budgets, we helped our clients set more than 730,000 budgets, and NOMI Find & Save® has helped our active clients save an average of $197 per month. For our business clients, real-time data and insights are game changers. Sorting through mountains of information about customer preferences and industry trends is the new normal. So we launched RBC Insight Edge, a Canadian first, which provides our advisors with actionable insights to help our 27,000+ retail business clients make more informed decisions to grow their businesses. Likewise, we scaled RBC Elements™ for our Capital Markets clients. Our research and data science team have redefined what’s possible when it comes to data analytics to produce differentiated research. To date, they’ve delivered more than 70 unique reports to clients globally. By investing in new capabilities, technologies and business models, we’re bringing the physical and digital worlds together to provide our clients with best-in-class digital experiences at the speed they expect. Because we’re not just thinking about what isn’t, but what could – and can – be. (1) Represents 90-day active customers in Canadian Banking Only. 10 Royal Bank of Canada: Annual Report 2019 A technological revolution sweeping the world presents Canada with huge opportunities. We are well positioned, for instance, to be a global hub of data innovation. But some high profile data events have undermined consumer confidence in the way some organizations handle the data economy. Trust will underpin our digital economy. Ottawa’s introduction of a Data Charter is an important step forward in helping provide a framework. But, at the end of the day, it’s actions not words that will instill public trust. Leaders in the public and private sectors must work together to define societal norms around personal data usage. RBC has a clear approach to how we think about data. Transparency is key. People need to know how the data is used. It’s also vital that consumers understand what they receive for sharing their data. And organizations must help people exercise control of what personal information is shared and used. Additionally, RBC has made significant investments in cutting-edge technology to protect our customers and our business every day. We’ve nearly doubled our investment in cyber security technology over the last five years. We lead and convene industry initiatives. A federal government advisory committee on AI is co-chaired by an RBC executive who oversees Borealis AI™, our research institute. RBC also collaborates with a wide range of stakeholders on industry- wide strategies including training, commercial acceleration and applied research and development. The world of work is also changing in profound and permanent ways. Even as many jobs transform, or disappear, millions more are expected to be created. Digital literacy will be essential for workers at all career stages in the new skills economy. There is also an increasing need for human skills – the ability to communicate and collaborate; to think creatively and critically. At RBC, we are helping all employees develop the skills to prepare them for the future of work. But there’s more we can do. Safeguarding trust Protecting our clients’ privacy and upholding their trust is core to our Purpose. We’ve built a team of over 500 cybersecurity specialists to enhance our capabilities and keep pace with the fast-changing landscape. At Borealis AI™, we’re researching and developing artificial intelligence tools to stay ahead of the curve. And we’ve invested $5 million to support the Rogers Cybersecure Catalyst, a centre for education in cybersecurity at Ryerson University, to help address the cyber skills gap in Canada. Our current system – educators and employers alike – does not adequately teach or train youth and workers to develop the portfolio of skills that help people thrive in the workplace. We need to rethink the way we teach and prepare all workers, including the next generation. Work-integrated learning programs, such as co-ops, can help break down this barrier. Research suggests university co-op graduates achieved higher earnings and employment rates than their non-co-op peers. RBC has developed a number of programs to help youth get work experience, develop skills and grow their professional network. This summer, we welcomed more than 1,600 students to RBC from nearly 100 colleges and universities from across Canada and the U.S. And we established a partnership with Riipen to increase access to, and deliver, experiential learning for post-secondary students. This initiative is part of our 10-year, $500-million commitment to empowering youth for the jobs of tomorrow through RBC Future Launch®. History shows that Canada has the courage and conviction to overcome challenges and seize opportunity. RBC is convinced history will repeat itself, thanks to an incredible mix of people, ideas and resources. Let’s harness these advantages to advance our ambitions. And let’s do it in a way that stays true to our national character. That means engaging on key issues such as supplying the world’s energy needs while still moving towards a low-carbon economy. It means deploying our competitive strengths in the digital economy while protecting personal privacy. And it means rethinking how we prepare the next generation of workers for jobs that don’t yet exist today. You can count on RBC to forge new paths to innovate and reimagine our business. Indeed, we are on a path that very few can achieve: a journey to transform our bank for the benefit of our shareholders, employees, clients and communities. PREPARING THE NEXT GENERATION There are seven million young people in Canada between the ages of 15 and 29(1). We believe that we have a collective opportunity – and a responsibility – to help them prepare for the future of work. Young people deserve to succeed, and that’s why we created RBC Future Launch®. It’s important to get this right; Canada’s future prosperity is counting on it. 1.9 million youth across Canada reached through RBC Future Launch® 77% of youth surveyed reported feeling better prepared for the future(2) Empowering youth to pursue impactful careers means equipping them with skills, networks, work experience and access to mental well-being support and services so they can face a changing workforce with confidence. We are building tools and engineering opportunities through RBC Upskill®, RBC Career Launch®, Ten Thousand Coffees, and Riipen, and supporting initiatives like WE Are Social Entrepreneurs and Boys & Girls Clubs of Canada, to accelerate their readiness for the changing world of work. We’ve also expanded our national network of charitable partners, allowing us to reach more youth across Canada. And they’re telling us our investments are making a difference so we’re going to keep building on these efforts and leading the conversation. We are excited about the horizon ahead of us. Banking for students by students Dave McKay President and Chief Executive Officer “Banking with RBC is more than managing money. Our goal is to empower young people to learn about money management and to confidently take on their financial future,” said Erica Nielsen, Vice-President, Payments and Banking. That’s why we launched a customized, easy-to-use banking experience geared specifically to students within the RBC Mobile app. (1) Statistics Canada, 2018 Demographic Estimates Program. (2) Based on a sample of 14,000 survey responses from Future Launch program participants. Royal Bank of Canada: Annual Report 2019 11 Management’s Discussion and Analysis Management’s Discussion and Analysis (MD&A) is provided to enable a reader to assess our results of operations and financial condition for the fiscal year ended October 31, 2019, compared to the preceding fiscal year. This MD&A should be read in conjunction with our 2019 Annual Consolidated Financial Statements and related notes and is dated December 3, 2019. All amounts are in Canadian dollars, unless otherwise specified, and are based on financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), unless otherwise noted. Additional information about us, including our 2019 Annual Information Form, is available free of charge on our website at rbc.com/investorrelations, on the Canadian Securities Administrators’ website at sedar.com and on the EDGAR section of the United States (U.S.) Securities and Exchange Commission’s (SEC) website at sec.gov. Information contained in or otherwise accessible through the websites mentioned does not form part of this report. All references in this report to websites are inactive textual references and are for your information only. Table of contents Caution regarding forward- looking statements 12 Overview and outlook Financial performance 14 13 Selected financial and other highlights 13 14 About Royal Bank of Canada Vision and strategic goals 14 Economic, market and regulatory review and outlook Defining and measuring success through total shareholder returns 15 16 Overview 16 Impact of foreign currency translation 16 17 Total revenue Provision for credit losses 18 Insurance policyholder benefits, claims and acquisition expense Non-interest expense Income and other taxes Client assets Business segment results Results by business segment How we measure and report our business segments 18 18 19 19 21 21 21 Key performance and non-GAAP measures Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Quarterly financial information Fourth quarter performance Quarterly results and trend analysis Financial condition Condensed balance sheets Off-balance sheet arrangements Risk management Top and emerging risks Overview Enterprise risk management Transactional/positional risk drivers Credit risk Market risk Liquidity and funding risk Insurance risk 22 24 28 33 36 38 42 42 42 43 44 44 45 47 47 49 50 54 54 66 71 82 Operational/regulatory compliance Strategic risk drivers risk drivers Operational risk Regulatory compliance risk 82 82 83 84 84 Strategic risk Reputation risk 84 Legal and regulatory environment risk 85 86 Competitive risk 86 86 87 Systemic risk Macroeconomic risk drivers Overview of other risks Capital management Capital, liquidity and other regulatory developments Accounting and control matters Critical accounting policies and estimates Controls and procedures Related party transactions Supplementary information Enhanced Disclosure Task Force recommendations index 90 98 99 99 102 102 102 110 Caution regarding forward-looking statements From time to time, we make written or oral forward-looking statements within the meaning of certain securities laws, including the “safe harbour” provisions of the United States Private Securities Litigation Reform Act of 1995 and any applicable Canadian securities legislation. We may make forward-looking statements in this 2019 Annual Report, in other filings with Canadian regulators or the SEC, in other reports to shareholders, and in other communications. Forward-looking statements in this document include, but are not limited to, statements relating to our financial performance objectives, vision and strategic goals, the Economic, market, and regulatory review and outlook for Canadian, U.S., European and global economies, the regulatory environment in which we operate, the Strategic priorities and Outlook sections for each of our business segments, and the risk environment including our liquidity and funding risk, and includes our President and Chief Executive Officer’s statements. The forward-looking information contained in this document is presented for the purpose of assisting the holders of our securities and financial analysts in understanding our financial position and results of operations as at and for the periods ended on the dates presented, as well as our financial performance objectives, vision and strategic goals, and may not be appropriate for other purposes. Forward-looking statements are typically identified by words such as “believe”, “expect”, “foresee”, “forecast”, “anticipate”, “intend”, “estimate”, “goal”, “plan” and “project” and similar expressions of future or conditional verbs such as “will”, “may”, “should”, “could” or “would”. By their very nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties, which give rise to the possibility that our predictions, forecasts, projections, expectations or conclusions will not prove to be accurate, that our assumptions may not be correct and that our financial performance objectives, vision and strategic goals will not be achieved. We caution readers not to place undue reliance on these statements as a number of risk factors could cause our actual results to differ materially from the expectations expressed in such forward-looking statements. These factors – many of which are beyond our control and the effects of which can be difficult to predict – include: credit, market, liquidity and funding, insurance, operational, regulatory compliance, strategic, reputation, legal and regulatory environment, competitive and systemic risks and other risks discussed in the risk sections of this 2019 Annual Report including information technology and cyber risk, privacy, data and third-party related risks, geopolitical uncertainty, Canadian housing and household indebtedness, regulatory changes, digital disruption and innovation, climate change, the business and economic conditions in the geographic regions in which we operate, the effects of changes in government fiscal, monetary and other policies, tax risk and transparency, and environmental and social risk. We caution that the foregoing list of risk factors is not exhaustive and other factors could also adversely affect our results. When relying on our forward-looking statements to make decisions with respect to us, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. Material economic assumptions underlying the forward-looking statements contained in this 2019 Annual Report are set out in the Economic, market and regulatory review and outlook section and for each business segment under the Strategic priorities and Outlook headings. Except as required by law, we do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by us or on our behalf. Additional information about these and other factors can be found in the risk sections of this 2019 Annual Report. 12 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Overview and outlook Selected financial and other highlights (Millions of Canadian dollars, except per share, number of and percentage amounts) Total revenue Provision for credit losses (PCL) Insurance policyholder benefits, claims and acquisition expense (PBCAE) Non-interest expense Income before income taxes Net income Segments – net income Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Net income Selected information Earnings per share (EPS) – basic – diluted Return on common equity (ROE) (1) (2) Average common equity (1) Net interest margin (NIM) – on average earning assets, net (3) PCL on loans as a % of average net loans and acceptances PCL on performing loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances Gross impaired loans (GIL) as a % of loans and acceptances Liquidity coverage ratio (LCR) (4) Capital ratios and Leverage ratio Common Equity Tier 1 (CET1) ratio Tier 1 capital ratio Total capital ratio Leverage ratio Selected balance sheet and other information (5) Total assets Securities, net of applicable allowance Loans, net of allowance for loan losses Derivative related assets Deposits (3) Common equity Total capital risk-weighted assets Assets under management (AUM) Assets under administration (AUA) (6) Common share information Shares outstanding (000s) – average basic – average diluted – end of period Dividends declared per common share Dividend yield (7) Dividend payout ratio Common share price (RY on TSX) (8) Market capitalization (TSX) (8) Business information (number of) Employees (full-time equivalent) (FTE) Bank branches Automated teller machines (ATMs) Period average US$ equivalent of C$1.00 (9) Period-end US$ equivalent of C$1.00 $ $ $ $ $ $ $ $ $ $ $ $ 2019 46,002 1,864 4,085 24,139 15,914 12,871 6,402 2,550 806 475 2,666 (28) 12,871 8.78 8.75 16.8% 75,000 1.61% 0.31% 0.04% 0.27% 0.46% 127% 12.1% 13.2% 15.2% 4.3% Table 1 2019 vs. 2018 Increase (decrease) 8.0% $ 3,426 42.6% 557 52.7% 1,409 5.7% 1,306 1.0% 154 $ $ $ 440 3.5% 374 285 31 (266) (111) 127 440 6.2% 12.6% 4.0% (35.9)% (4.0)% n.m. 3.5% $ 4.6% 0.39 4.7% 0.39 (80) bps n.m. 8.9% $ 6,100 (3) bps n.m. 8 bps n.m. 1 bps n.m. 7 bps n.m. n.m. 9 bps n.m. 400 bps n.m. n.m. n.m. n.m. 60 bps 40 bps 60 bps (10) bps 2018 42,576 1,307 2,676 22,833 15,760 12,431 6,028 2,265 775 741 2,777 (155) 12,431 8.39 8.36 17.6% 68,900 1.64% 0.23% 0.03% 0.20% 0.37% 123% 11.5% 12.8% 14.6% 4.4% $ 1,428,935 249,004 618,856 101,560 886,005 77,816 512,856 762,300 5,678,000 1,434,779 1,440,682 1,430,096 4.07 4.1% 46% 106.24 151,933 82,801 1,327 4,600 0.752 0.759 $ $ $ $ $ 1,334,734 222,866 576,818 94,039 836,197 73,552 496,459 671,000 5,533,700 $ 94,201 26,138 42,038 7,521 49,808 4,264 16,397 91,300 144,300 7.1% 11.7% 7.3% 8.0% 6.0% 5.8% 3.3% 13.6% 2.6% 1,443,894 1,450,485 1,438,794 3.77 3.7% 45% 95.92 138,009 $ (0.6)% (9,115) (0.7)% (9,803) (0.6)% (8,698) 8.0% 0.30 40 bps n.m. n.m. 100 bps 10.8% 10.1% $ 10.32 13,924 81,870 1,333 4,537 0.776 0.760 931 (6) 63 $ (0.024) $ (0.001) 1.1% (0.5)% 1.4% (3.1)% (0.1)% $ $ $ $ (1) (2) (3) (4) Average amounts are calculated using methods intended to approximate the average of the daily balances for the period. This includes Average common equity used in the calculation of ROE. For further details, refer to the Key performance and non-GAAP measures section. These measures may not have a standardized meaning under generally accepted accounting principles (GAAP) and may not be comparable to similar measures disclosed by other financial institutions. For further details, refer to the Key performance and non-GAAP measures section. Commencing Q4 2019, the interest component and the accrued interest payable recorded on certain deposits carried at Fair Value Through Profit and Loss (FVTPL) previously presented in trading revenue and deposits, respectively, are presented in net interest income and other liabilities, respectively. Comparative amounts have been reclassified to conform with this presentation. LCR is the average for the three months ended for each respective period and is calculated in accordance with the Office of the Superintendent of Financial Institutions’ (OSFI) Liquidity Adequacy Requirements (LAR) guideline. For further details, refer to the Liquidity and funding risk section. Represents year-end spot balances. AUA includes $15.5 billion and $8.1 billion (2018 – $16.7 billion and $9.6 billion) of securitized residential mortgages and credit card loans, respectively. Defined as dividends per common share divided by the average of the high and low share price in the relevant period. Based on TSX closing market price at period-end. Average amounts are calculated using month-end spot rates for the period. (5) (6) (7) (8) (9) n.m. not meaningful Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 13 About Royal Bank of Canada Royal Bank of Canada is a global financial institution with a purpose-driven, principles-led approach to delivering leading performance. Our success comes from the 85,000+ employees who bring our vision, values and strategy to life so we can help our clients thrive and communities prosper. As Canada’s biggest bank, and one of the largest in the world based on market capitalization, we have a diversified business model with a focus on innovation and providing exceptional experiences to our 17 million clients in Canada, the U.S. and 34 other countries. Learn more at rbc.com. Our business segments are described below. Personal & Commercial Banking Provides a broad suite of financial products and services in Canada, the Caribbean and the U.S. The meaningful relationships with our clients is underscored by the breadth of our products, our depth of expertise and the features of our digital solutions. Wealth Management Serves affluent, high net worth (HNW) and ultra-high net worth (UHNW) clients from our offices in key financial centres mainly in Canada, the U.S., the United Kingdom (U.K.), Europe, and Asia. We offer a comprehensive suite of investment, trust, banking, credit and other wealth management solutions. We also provide asset management products to institutional and individual clients through our distribution channels and third-party distributors. Insurance Offers a wide range of solutions including creditor, life, health, home, auto, travel, wealth, and annuities to individuals as well as reinsurance advice and solutions, and business insurance services to business and group clients. Investor & Treasury Services Acts as a specialist provider of asset services, a leader in Canadian cash management and transaction banking services, and a provider of treasury services to institutional clients worldwide. Capital Markets Provides expertise in banking, finance and capital markets to corporations, institutional investors, asset managers, governments and central banks around the world. We serve clients from 70 offices in 15 countries across North America, the U.K. & Europe, and Australia, Asia & other regions. Corporate Support Corporate Support consists of Technology & Operations, which provides the technological and operational foundation required to effectively deliver products and services to our clients, Functions, which includes our finance, human resources, risk management, internal audit and other functional groups, as well as our Corporate Treasury function. Vision and strategic goals Our business strategies and actions are guided by our vision, “To be among the world’s most trusted and successful financial institutions.” Our three strategic goals are: (cid:129) (cid:129) (cid:129) In Canada, to be the undisputed leader in financial services; In the U.S., to be the preferred partner to corporate, institutional and high net worth clients and their businesses; and In select global financial centres, to be a leading financial services partner valued for our expertise. For our progress in 2019 against our business strategies and strategic goals, refer to the Business segment results section. Economic, market and regulatory review and outlook – data as at December 3, 2019 The predictions and forecasts in this section are based on information and assumptions from sources we consider reliable. If this information or these assumptions are not accurate, actual economic outcomes may differ materially from the outlook presented in this section. Canada The Canadian economy is expected to grow by 1.6% in calendar 2019, which is down from a 1.9% increase in calendar 2018. Business investment has declined amid an uncertain global economic backdrop, rising trade tensions, and challenges in the energy sector. Strong labour market conditions and rising wages have supported household income growth, but consumer spending has been moderate due to elevated debt levels and higher debt service costs. While the Bank of Canada (BoC) has left its overnight rate unchanged at 1.75% since October 2018, Canadian borrowing costs have declined due to global central bank easing. The BoC has signaled a willingness to lower rates if the global outlook deteriorates further and weakness in manufacturing and investment spreads to the rest of the economy. Canadian GDP growth is expected to remain slightly below the economy’s longer-run trend in calendar 2020 amid moderate growth in consumer spending and housing as well as slow business investment. U.S. The U.S. economy is expected to grow by 2.3% in calendar 2019, which is down from a 2.9% increase in calendar 2018. Consumer spending growth has remained strong, though the stimulative effect of 2018’s tax cuts has faded. Job growth has slowed in calendar 2019 relative to calendar 2018 though the unemployment rate has declined further. Following sluggish growth in calendar 2018, housing activity continued to slow in early calendar 2019 due to the dragging impact from higher interest rates in 2018, but has picked up more recently with the Federal Reserve (Fed) cutting interest rates. Business investment growth has 14 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis slowed with rising trade tensions and uncertainty about the global economic outlook weighing on sentiment. The Fed cut its benchmark interest rate for the third time in calendar 2019 in October but signaled that further rate cuts are unlikely as long as the economic outlook evolves in line with its expectations. U.S. GDP growth is expected to slow further in calendar 2020 with business investment and exports remaining subdued while consumer spending is expected to increase at a more moderate, but still healthy rate. Europe Euro area GDP is expected to grow by 1.2% in calendar 2019, which is down from a 1.9% increase in calendar 2018. Growth in Germany, the euro area’s largest economy, has slowed amid a sustained downturn in the industrial sector. Growth in other major euro area economies remains modest, with weakness in manufacturing generally being offset by stronger services sector activity. The European Central Bank (ECB) announced additional monetary policy stimulus in September, cutting its key interest rate further into negative territory and restarting quantitative easing. Growth in the U.K. is expected to slow to 1.3% in calendar 2019 from 1.4% in calendar 2018 as ongoing uncertainty about Brexit continues to weigh on business sentiment and investment. Euro area GDP growth is expected to remain steady at a relatively modest pace in 2020, with some help from slightly more stimulative fiscal policy, while growth in the U.K. economy is expected to slow further. Financialmarkets Government bond yields remain historically low due to low inflation and expectations that monetary policy will remain accommodative for an extended period. Monetary policy stimulus, and more recently optimism regarding U.S.-China and Brexit deals, has supported equity markets. Oil prices have been relatively flat in recent months as global demand concerns have offset geopolitical risks. Yield curves in Canada and the U.S. remain flat, suggesting investors remain concerned about the risk of an economic downturn. Regulatory environment We continue to monitor and prepare for regulatory developments and changes in a manner that seeks to ensure compliance with new requirements, while mitigating adverse business or financial impacts to the extent practicable. Such impacts could result from new or amended laws or regulations and the expectations of those who enforce them. Significant developments include continuing changes to global and domestic standards for capital and liquidity, global trade agreements, legislative developments on data privacy, amendments to anti-money laundering regulations and the U.S., the U.K. and European regulatory reforms. For a discussion on risk factors resulting from these and other developments which may affect our business and financial results, refer to the risk sections. For further details on our framework and activities to manage risks, refer to the risk and Capital management sections. Defining and measuring success through total shareholder returns Our focus is to maximize total shareholder returns (TSR) through the achievement of top half performance compared to our global peer group over the medium-term (3-5 years), which we believe reflects a longer-term view of strong and consistent financial performance. Maximizing TSR is aligned with our three strategic goals discussed earlier and we believe represents the most appropriate measure of shareholder value creation. TSR is a concept used to compare the performance of our common shares over a period of time, reflecting share price appreciation and dividends paid to common shareholders. The absolute size of TSR will vary depending on market conditions, and the bank’s relative position reflects the market’s perception over a period of time of our overall performance relative to our peers. Financial performance objectives are used to measure our performance against our medium-term TSR objectives and are used as goals as we execute against our strategic priorities. We review and revise these financial performance objectives as economic, market and regulatory environments change. By focusing on our medium-term objectives in our decision-making, we believe we will be well-positioned to provide sustainable earnings growth and solid returns to our common shareholders. The following table provides a summary of our 3-year and 5-year performance against our medium-term financial performance objectives: Financial performance compared to our medium-term objectives Medium-term objectives (1) Diluted EPS growth of 7% + ROE of 16% + Strong capital ratio (CET1) (3) Dividend payout ratio 40% – 50% 3-year (2) 9% 17.1% 11.5% 46% Table 2 5-year (2) 8% 17.3% 11.2% 46% (1) (2) (3) A medium-term (3-5 year) objective is considered to be achieved when the performance goal is met in either a 3- or 5-year period. Diluted EPS growth is calculated using a Compound Annual Growth Rate (CAGR). ROE, CET1 and dividend payout ratio are calculated using an average. For further details on the CET1 ratio, refer to the Capital Management section. For 2020, our medium-term financial performance objectives will remain unchanged. We compare our TSR to that of a global peer group approved by our Board of Directors (the Board). The global peer group remains unchanged from last year and consists of the following 10 financial institutions: (cid:129) Canadian financial institutions: Bank of Montreal, Canadian Imperial Bank of Commerce, Manulife Financial Corporation, National Bank of Canada, Power Financial Corporation, The Bank of Nova Scotia, and Toronto-Dominion Bank. U.S. banks: JPMorgan Chase & Co. and Wells Fargo & Company. International banks: Westpac Banking Corporation. (cid:129) (cid:129) Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 15 Medium-term objectives – 3- and 5-year TSR vs. peer group average Royal Bank of Canada Peer group average (excluding RBC) Table 3 3-year TSR (1) 5-year TSR (1) 12% Top half 11% 10% Top half 8% (1) The 3- and 5-year annualized TSR are calculated based on our common share price appreciation as per the TSX closing market price plus reinvested dividends for the period October 31, 2016 to October 31, 2019 and October 31, 2014 to October 31, 2019, respectively. Common share and dividend information For the year ended October 31 Common share price (RY on TSX) – close, end of period Dividends paid per share Increase (decrease) in share price Total shareholder return 2019 $ 106.24 4.00 10.8% 15.2% $ 2018 95.92 3.70 (4.9)% (1.0)% 2017 $ 100.87 3.40 20.4% 25.0% $ 2016 83.80 3.20 12.1% 16.8% $ Table 4 2015 74.77 3.04 (6.5)% (3.0)% Financial performance Overview 2019 vs. 2018 Net income of $12,871 million increased $440 million or 4% from a year ago. Diluted EPS of $8.75 was up $0.39 or 5% and ROE of 16.8% was down 80 bps. Our Common Equity Tier 1 (CET1) ratio was 12.1%, up 60 bps from a year ago. Our results reflected strong earnings in Personal & Commercial Banking and Wealth Management, and solid results in Insurance, partially offset by lower results in Investor & Treasury Services and Capital Markets. Our results also reflected the impact in the prior year of the U.S Tax Reform which resulted in the write-down of net deferred tax assets, as well as an increase due to the impact of foreign exchange translation. Personal & Commercial Banking earnings increased mainly due to average volume growth of 7% and higher spreads. These factors were partially offset by higher PCL and an increase in staff-related costs as well as technology and related costs. Wealth Management results increased mainly due to higher average fee-based client assets, an increase in net interest income and a gain on the sale of the private debt business of BlueBay of $134 million (after-tax). These factors were partially offset by increased costs in support of business growth, higher variable compensation commensurate with revenue growth and higher PCL. Insurance earnings were up mainly due to the impact of new longevity reinsurance contracts, partially offset by higher claims costs. Investor & Treasury Services results decreased primarily due to lower funding and liquidity revenue, severance and related costs associated with repositioning of the business, as well as lower revenue from our asset services business. Capital Markets results were down driven by lower revenue in Corporate and Investment Banking, higher PCL and higher technology and related costs. These factors were partially offset by a lower effective tax rate largely reflecting changes in earnings mix, higher revenue in Global Markets and the impact of foreign exchange translation. Corporate Support net loss was $28 million, largely due to the impact of an unfavourable accounting adjustment, residual unallocated costs and unfavourable tax impacts, partially offset by asset/liability management activities. Net loss was $155 million in the prior year, largely due to the impact of the U.S. Tax Reform of $178 million as noted above, partially offset by asset/liability management activities. For further details on our business segment results and CET1 ratio, refer to the Business segment results and Capital management sections, respectively. Impact of foreign currency translation The following table reflects the estimated impact of foreign currency translation on key income statement items: (Millions of Canadian dollars, except per share amounts) Increase (decrease): Total revenue PCL Non-interest expense Income taxes Net income Impact on EPS Basic Diluted Table 5 2019 vs. 2018 $ $ 339 7 203 13 116 0.08 0.08 16 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis The relevant average exchange rates that impact our business are shown in the following table: (Average foreign currency equivalent of C$1.00) (1) U.S. dollar British pound Euro (1) Average amounts are calculated using month-end spot rates for the period. Total revenue (Millions of Canadian dollars) Interest and dividend income Interest expense (1) Net interest income NIM (1) Insurance premiums, investment and fee income Trading revenue (1) Investment management and custodial fees Mutual fund revenue Securities brokerage commissions Service charges Underwriting and other advisory fees Foreign exchange revenue, other than trading Card service revenue Credit fees Net gains on investment securities Share of profit in joint ventures and associates Other Non-interest income Total revenue 2019 0.752 0.591 0.670 Table 6 2018 0.776 0.578 0.654 2019 $ 41,333 21,584 $ 19,749 1.61% Table 7 2018 $ 33,021 15,069 $ 17,952 1.64% $ $ 5,710 995 5,748 3,628 1,305 1,907 1,815 986 1,072 1,269 125 76 1,617 4,279 1,150 5,377 3,551 1,372 1,800 2,053 1,098 1,054 1,394 147 21 1,328 $ 26,253 $ 46,002 $ 24,624 $ 42,576 (1) Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. 2019 vs. 2018 Total revenue increased $3,426 million or 8%, largely due to higher net interest income and an increase in insurance premiums, investment and fee income (Insurance revenue). Higher investment management and custodial fees and other revenue also contributed to the increase. The impact of foreign exchange translation also increased total revenue by $339 million. These factors were partially offset by lower underwriting and other advisory fees. Net interest income increased $1,797 million or 10%, largely due to average volume growth and higher spreads in Personal and Commercial Banking and Wealth Management. Higher trading revenue and lending revenue in Capital Markets and the impact of foreign exchange translation also contributed to the increase. Net interest income was also impacted by lower funding and liquidity revenue, which was more than offset by the related gains on non-trading derivatives in Other revenue. NIM was down 3 bps compared to last year mainly due to changes in average earning asset mix with volume growth primarily in reverse repos and lower funding and liquidity revenue. These factors were partially offset by improved spreads in Canadian Banking and Wealth Management. The impact associated with lower funding and liquidity revenue was more than offset by the related gains on non-trading derivatives in Other revenue. Insurance revenue increased $1,431 million or 33%, mainly due to the change in fair value of investments backing our policyholder liabilities and business growth in International Insurance, both of which are largely offset by in PBCAE. Realized investment gains also contributed to the increase. These factors were partially offset by lower group annuity sales, which are largely offset in PBCAE. Investment management and custodial fees increased $371 million or 7%, due to higher average fee-based client assets reflecting market appreciation and net sales, and the impact of foreign exchange translation. Other revenue increased $289 million or 22%, primarily due to gains on non-trading derivatives in our funding and liquidity business, which were largely offset in Net interest income and a gain on the sale of the private debt business of BlueBay. The change in the fair value of the hedges related to our U.S. share-based compensation plans, which was largely offset in Non- interest expense, also contributed to the increase. These factors were partially offset by lower net gains in our non-trading investment portfolios. The prior year also included a gain related to the sale of a mutual fund product and its associated team, a favourable accounting adjustment related to City National and a gain related to the reorganization of Interac. Underwriting and other advisory fees decreased $238 million or 12%, mainly due to lower equity origination primarily in North America and lower M&A largely in Europe and Canada. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 17 Additional trading information (Millions of Canadian dollars) Total trading revenue Net interest income (1) Non-interest income (1) Total trading revenue Total trading revenue by product Interest rate and credit Equities Foreign exchange and commodities Total trading revenue Table 8 2019 2018 $ 2,266 995 $ 3,261 $ 1,664 1,037 560 $ 3,261 $ $ $ $ 1,960 1,150 3,110 1,573 1,014 523 3,110 (1) Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. 2019 vs. 2018 Total trading revenue of $3,261 million, which is comprised of trading-related revenue recorded in Net interest income and Non-interest income, was up $151 million or 5%, mainly due to higher fixed income trading revenue across all regions and the impact of foreign exchange translation. Provision for credit losses 2019 vs. 2018 Total PCL increased $557 million from the prior year. PCL on loans increased $608 million or 47% from the prior year, mainly due to higher provisions on impaired loans in Personal & Commercial Banking, Capital Markets and Wealth Management. The PCL ratio on loans increased 8 bps. For further details on PCL, refer to Credit quality performance in the Credit risk section. Insurance policyholder benefits, claims and acquisition expense (PBCAE) 2019 vs. 2018 PBCAE of $4,085 million increased $1,409 million or 53% from the prior year, mainly reflecting the change in fair value of investments backing our policyholder liabilities and lower favourable investment-related experience. Business growth in International Insurance and higher claims costs also contributed to the increase. These factors were partially offset by lower group annuity sales and the favourable impact of new longevity reinsurance contracts. Non-interest expense (Millions of Canadian dollars, except percentage amounts) Salaries Variable compensation Benefits and retention compensation Share-based compensation Human resources Equipment Occupancy Communications Professional fees Amortization of other intangibles Other Non-interest expense Efficiency ratio (1) Efficiency ratio adjusted (2) $ 2019 6,600 5,706 1,876 418 $ 14,600 1,777 1,635 1,090 1,305 1,197 2,535 $ 24,139 52.5% 53.6% Table 9 $ 2018 6,077 5,597 1,779 323 $ 13,776 1,593 1,558 1,049 1,379 1,077 2,401 $ 22,833 53.6% 53.1% Efficiency ratio is calculated as Non-interest expense divided by Total revenue. (1) (2) Measures have been adjusted by excluding the change in fair value of investments backing our policyholder liabilities. These are non-GAAP measures. For further details, refer to the Key performance and non-GAAP measures section. 18 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis 2019 vs. 2018 Non-interest expense increased $1,306 million or 6%, primarily due to increased costs in support of business growth and higher staff-related costs, the impact of foreign exchange translation, as well as an increase in technology and related costs, including digital initiatives. Higher variable compensation commensurate with revenue growth, severance and related costs associated with repositioning of our Investor & Treasury Services business, and the change in fair value of our U.S. share-based compensation plans, which was largely offset in revenue, also contributed to the increase. Our efficiency ratio of 52.5% decreased 110 bps from last year. Excluding the change in fair value of investments backing our policyholder liabilities, our efficiency ratio of 53.6% increased 50 bps from last year. Efficiency ratio excluding the change in fair value of investments backing our policyholder liabilities is a non-GAAP measure. For further details, including a reconciliation, refer to the Key performance and non-GAAP measures section. Income and other taxes (Millions of Canadian dollars, except percentage amounts) Income taxes Other taxes Value added and sales taxes Payroll taxes Capital taxes Property taxes Insurance premium taxes Business taxes Total income and other taxes Income before income taxes Effective income tax rate Effective total tax rate (1) Table 10 2019 3,043 $ 2018 3,329 $ $ 519 738 73 139 30 55 1,554 $ $ 4,597 $ 15,914 19.1% 26.3% $ 468 687 80 132 29 37 1,433 $ $ 4,762 $ 15,760 21.1% 27.7% (1) Total income and other taxes as a percentage of income before income taxes and other taxes. 2019 vs. 2018 Income tax expense decreased $286 million or 9% from last year, primarily due to an increase in income from lower tax rate jurisdictions and the impact of the U.S. Tax Reform which resulted in the write-down of net deferred tax assets in the prior year. These factors were partially offset by higher income before income taxes. The effective income tax rate of 19.1% decreased 200 bps, primarily due to an increase in income from lower tax rate jurisdictions and the impact of the U.S. Tax Reform which resulted in the write-down of net deferred tax assets in the prior year. Other taxes increased $121 million or 8% from 2018, mainly due to higher value added and sales taxes commensurate with purchase activity, and higher payroll taxes driven by higher staff-related costs. Client assets Assets under administration Assets under administration (AUA) are assets administered by us which are beneficially owned by our clients. We provide services that are administrative in nature, including safekeeping, collecting investment income, settling purchase and sale transactions, and record keeping. Underlying investment strategies within AUA are determined by our clients and generally do not impact the administrative fees that we receive. Administrative fees can be impacted by factors such as asset valuation level changes from market movements, types of services administered, transaction volumes, geography and client relationship pricing based on volumes or multiple services. Our Investor & Treasury Services business is the primary business segment that has AUA with approximately 76% of total AUA, as at October 31, 2019, followed by our Wealth Management and Personal & Commercial Banking businesses with approximately 19% and 5% of total AUA, respectively. 2019 vs. 2018 AUA increased $144 billion or 3% compared to last year, mainly reflecting market appreciation and net sales. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 19 The following table summarizes AUA by geography and asset class: AUA by geographic mix and asset class (Millions of Canadian dollars) Canada (1) Money market Fixed income Equity Multi-asset and other Total Canada U.S. (1) (2) Money market Fixed income Equity Multi-asset and other Total U.S. Other International (1) Money market Fixed income Equity Multi-asset and other Total International Total AUA Table 11 2019 2018 $ 35,300 752,000 652,000 902,100 $ 2,341,400 $ $ $ 26,500 114,500 189,600 226,700 557,300 44,100 358,200 787,900 1,589,100 $ $ $ $ $ 31,800 706,800 635,700 934,500 2,308,800 26,400 103,500 173,200 193,400 496,500 43,900 356,000 871,700 1,456,800 $ 2,779,300 $ 2,728,400 $ 5,678,000 $ 5,533,700 (1) (2) Geographic information is based on the location from where our clients are serviced. Amounts have been revised from those previously presented. Assets under management Assets under management (AUM) are assets managed by us which are beneficially owned by our clients. Management fees are paid by the investment funds and other clients for the investment capabilities of an investment manager and can also cover administrative services. Management fees may be calculated daily, monthly or quarterly as a percentage of the AUM, depending on the distribution channel, product and investment strategies. In general, equity strategies carry a higher fee rate than fixed income or money market strategies. Fees are also impacted by asset mix and relationship pricing for clients using multiple services. Higher risk assets generally produce higher fees, while clients using multiple services can take advantage of synergies which reduce the fees they are charged. Certain funds may have performance fee arrangements. Performance fees are recorded when certain benchmarks or performance targets are achieved. These factors could lead to differences on fees earned by products and therefore net return by asset class may vary despite similar average AUM. Our Wealth Management segment is the primary business segment with approximately 99% of total AUM. 2019 vs. 2018 AUM increased $91 billion or 14% compared to last year, mainly reflecting market appreciation and net sales. The following table presents the change in AUM for the year ended October 31, 2019: Client assets – AUM (Millions of Canadian dollars) AUM, beginning balance (1) Institutional inflows Institutional outflows Personal flows, net Total net flows Market impact Acquisition/dispositions Foreign exchange 2019 Money market Fixed income Total $ 25,000 $ 184,000 $ 79,100 $ 382,900 $ 671,000 111,000 (105,100) 31,200 15,900 (18,100) 25,900 55,200 (51,700) 800 33,400 (32,300) 5,600 6,500 (3,000) (1,100) Equity Multi-asset and other 4,300 500 – 100 6,700 16,900 (100) (600) 2,400 9,400 (900) – 23,700 33,200 (4,500) 200 37,100 60,000 (5,500) (300) Total market, acquisition/dispositions and foreign exchange impact AUM, balance at end of year 600 16,200 8,500 28,900 54,200 $ 29,900 $ 206,900 $ 90,000 $ 435,500 $ 762,300 (1) Amounts have been revised from those previously presented. 20 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Table 12 2018 Total $ 639,900 104,600 (98,600) 30,400 36,400 (9,200) – 3,900 (5,300) $ 671,000 Business segment results Results by business segments (Millions of Canadian dollars, except percentage amounts) Net interest income (2) Non-interest income (2) Total revenue PCL PBCAE Non-interest expense Net income before income taxes Income tax Net income ROE (3) Average assets $ $ $ $ Personal & Commercial Banking Wealth Management Insurance 2019 Investor & Treasury Services Capital Markets (1) Corporate Support (1) 12,653 $ 5,212 17,865 $ 1,448 – 7,768 2,993 $ 9,150 12,143 $ 117 – 8,813 – $ (44) $ 5,710 2,389 5,710 $ – 4,085 606 2,345 $ – – 1,725 4,043 $ 4,245 8,288 $ 299 – 5,096 104 $ (453) (349) $ – – 131 Table 13 2018 Total 17,952 24,624 42,576 1,307 2,676 22,833 15,760 3,329 12,431 Total 19,749 $ 26,253 46,002 $ 1,864 4,085 24,139 12,871 $ 16.8% 8,649 $ 2,247 3,213 $ 663 1,019 $ 213 620 $ 145 2,893 $ 227 (480) $ (452) 15,914 $ 3,043 6,402 $ 2,550 $ 806 $ 475 $ 2,666 $ (28) $ 27.2% $ 466,200 $ 17.4% 39.6% 17.6% 98,500 $ 17,600 $ 146,100 $ 666,500 $ 41,300 $ 1,436,200 $ 1,294,900 13.2% 11.4% n.m. (1) (2) (3) Net interest income, Non-interest income, Total revenue, Net income before income taxes, and Income tax are presented in Capital Markets on a teb basis. The teb adjustment is eliminated in the Corporate Support segment. For a further discussion, refer to the How we measure and report our business segments section. Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. This measure may not have a standardized meaning under GAAP and may not be comparable to similar measures disclosed by other financial institutions. For further details, refer to the Key performance and non-GAAP measures section. n.m. not meaningful How we measure and report our business segments Our management reporting framework is intended to measure the performance of each business segment as if it were a stand- alone business and reflects the way that the business segment is managed. This approach is intended to ensure that our business segments’ results include all applicable revenue and expenses associated with the conduct of their business and depicts how management views those results. Key methodologies The following outlines the key methodologies and assumptions used in our management reporting framework. These are periodically reviewed by management to ensure they remain valid. Expense and tax allocation To ensure that our business segments’ results include expenses associated with the conduct of their business, we allocate costs incurred or services provided by Technology & Operations and Functions, which are directly undertaken or provided on the business segments’ behalf. For other costs not directly attributable to our business segments, including overhead costs and other indirect expenses, we use our management reporting framework for allocating these costs to each business segment in a manner that is intended to reflect the underlying benefits. In 2018, Corporate Support included the impact of the write-down of net deferred tax assets related to the U.S. Tax Reform. Capital attribution Our management reporting framework also determines the attribution of capital to our business segments in a manner that is intended to consistently measure and align economic costs with the underlying benefits and risks associated with the activities of each business segment. The amount of capital assigned to each business segment is referred to as attributed capital. Unattributed capital and associated net charges are reported in Corporate Support. For further information, refer to the Capital management section. Funds transfer pricing Funds transfer pricing refers to the pricing of intra-company borrowing or lending for management reporting purposes. We employ a funds transfer pricing process to enable risk-adjusted management reporting of segment results. This process determines the costs and revenue for intra-company borrowing and lending of funds after taking into consideration our interest rate risk and liquidity risk management objectives, as well as applicable regulatory requirements. Provisions for credit losses PCL is recorded to recognize estimated credit losses on all financial assets, except for financial assets classified or designated as fair value through profit or loss (FVTPL) and equity securities designated as fair value through other comprehensive income (FVOCI), which are not subject to impairment assessment. For details on our accounting policy on Allowance for credit losses (ACL), refer to Note 2 of our 2019 Annual Consolidated Financial Statements. PCL is included in the results of each business segment to fully reflect the appropriate expenses related to the conduct of each business segment. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 21 In addition to the key methodologies described above, the following are the key aspects of how some of our business segments are managed and reported: (cid:129) Wealth Management reported results also include disclosure in U.S. dollars, primarily for U.S. Wealth Management (cid:129) (cid:129) (including City National) as we review and manage the results of this business largely in this currency. Capital Markets results are reported on a teb basis, which grosses up total revenue from certain tax-advantaged sources (Canadian taxable corporate dividends and the U.S. tax credit investment business) to their effective taxable equivalent value with a corresponding offset recorded in the provision for income taxes. We record the elimination of the teb adjustments in Corporate Support. We believe these adjustments are useful and reflect how Capital Markets manages its business, since it enhances the comparability of revenue and related ratios across taxable revenue and our principal tax-advantaged sources of revenue. The use of teb adjustments and measures may not be comparable to similar GAAP measures or similarly adjusted amounts disclosed by other financial institutions. Corporate Support results include all enterprise level activities that are undertaken for the benefit of the organization that are not allocated to our five business segments, such as enterprise funding, securitizations, net charges associated with unattributed capital, and consolidation adjustments, including the elimination of the teb gross-up amounts. Key performance and non-GAAP measures Performance measures Return on common equity We measure and evaluate the performance of our consolidated operations and each business segment using a number of financial metrics, such as net income and ROE. We use ROE, at both the consolidated and business segment levels, as a measure of return on total capital invested in our business. Management views the business segment ROE measure as a useful measure for supporting investment and resource allocation decisions because it adjusts for certain items that may affect comparability between business segments and certain competitors. Our consolidated ROE calculation is based on net income available to common shareholders divided by total average common equity for the period. Business segment ROE calculations are based on net income available to common shareholders divided by average attributed capital for the period. For each segment, average attributed capital includes the capital required to underpin various risks as described in the Capital management section and amounts invested in goodwill and intangibles. The attribution of capital involves the use of assumptions, judgments and methodologies that are regularly reviewed and revised by management as deemed necessary. Changes to such assumptions, judgments and methodologies can have a material effect on the business segment ROE information that we report. Other companies that disclose information on similar attributions and related return measures may use different assumptions, judgments and methodologies. The following table provides a summary of our ROE calculations: Calculation of ROE (Millions of Canadian dollars, except percentage amounts) Net income available to common shareholders Total average common equity (1) (2) ROE (3) Personal & Commercial Banking Wealth Management Insurance 2019 Investor & Treasury Services Table 14 2018 Capital Markets Corporate Support Total Total $ 6,309 $ 2,498 $ 798 $ 461 $ 2,584 $ 23,200 27.2% 14,350 17.4% 2,000 39.6% 3,500 22,750 (59) $ 12,591 $ 12,115 68,900 75,000 9,200 13.2% 11.4% n.m. 16.8% 17.6% Total average common equity represents rounded figures. The amounts for the segments are referred to as attributed capital. ROE is based on actual balances of average common equity before rounding. (1) (2) (3) n.m. not meaningful Non-GAAP measures We believe that certain non-GAAP measures described below are more reflective of our ongoing operating results and provide readers with a better understanding of management’s perspective on our performance. These measures enhance the comparability of our financial performance for the year ended October 31, 2019 with the results from last year. Non-GAAP measures do not have a standardized meaning under GAAP and may not be comparable to similar measures disclosed by other financial institutions. The following discussion describes the non-GAAP measures we use in evaluating our operating results. Results excluding specified item There were no specified items for the years ended October 31, 2019 and October 31, 2018. Our results for the year ended October 31, 2017 were impacted by the following specified item: (cid:129) Our share of a gain related to the sale by our payment processing joint venture Moneris of its U.S. operations to Vantiv, Inc., which was $212 million (before- and after-tax) and recorded in Personal & Commercial Banking. 22 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis The following tables provide calculations of our Personal & Commercial Banking and Canadian Banking results and measures excluding the specified item for the year ended October 31, 2017 for the purpose of calculating the adjusted operating leverage ratio for the year ended October 31, 2018, which is a non-GAAP measure: Personal & Commercial Banking Table 15 (Millions of Canadian dollars, except percentage amounts) Total revenue PCL Non-interest expense Net income before income taxes Net income Other information Non-interest expense Total revenue Efficiency ratio Revenue growth rate Non-interest expense growth rate Operating leverage (1) Includes foreign currency translation. Canadian Banking 2017 Item excluded As reported Gain related to the sale by Moneris (1) Adjusted $ $ $ $ $ $ $ $ 15,863 1,054 7,176 7,633 5,755 7,176 15,863 45.2% 5.7% 3.5% 2.2% (212) $ 15,651 1,054 7,176 – – (212) $ (212) $ 7,421 5,543 – (212) $ 7,176 15,651 45.9% 4.3% 3.5% 0.8% Table 16 Adjusted (Millions of Canadian dollars, except percentage amounts) As reported 2017 Item excluded Gain related to the sale by Moneris (1) Total revenue PCL Non-interest expense Net income before income taxes Net income Other information Non-interest expense Total revenue Efficiency ratio Revenue growth rate Non-interest expense growth rate Operating leverage (1) Includes foreign currency translation. $ $ $ $ $ $ $ $ 14,877 1,016 6,423 7,438 5,571 6,423 14,877 43.2% 6.2% 3.8% 2.4% (212) $ 14,665 1,016 6,423 – – (212) $ (212) $ 7,226 5,359 – (212) $ 6,423 14,665 43.8% 4.7% 3.8% 0.9% Efficiency ratio excluding the change in fair value of investments in Insurance Our efficiency ratio is impacted by the change in fair value of investments backing our policyholder liabilities, which is reported in revenue and largely offset in PBCAE. The following table provides calculations of our consolidated efficiency ratio excluding the change in fair value of investments backing our policyholder liabilities: Consolidated non-GAAP efficiency ratio 2019 Item excluded (Millions of Canadian dollars, except percentage amounts) Total revenue Non-interest expense Efficiency ratio As reported $ 46,002 24,139 52.5% Change in fair value of investments backing policyholder liabilities $ Adjusted (987) $ 45,015 24,139 – 53.6% 2018 Item excluded Change in fair value of investments backing policyholder liabilities Table 17 Adjusted $ 435 – $ 43,011 22,833 53.1% As reported $ 42,576 22,833 53.6% Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 23 Personal & Commercial Banking Personal & Commercial Banking provides a broad suite of financial products and services to individuals and businesses for their day-to-day banking, investing and financing needs. We are focused on building meaningful relationships with our clients, underscored by our exceptional client experience, the breadth of our products, our depth of expertise and the features of our digital solutions. > 14 million Number of clients > 7 million Active digital users in Canada(1) 35,467 Employees Revenue by business lines $17.9 billion Total revenue 72% Personal Banking 23% Business Banking 5% Caribbean and U.S. Banking We operate through two businesses – Canadian Banking and Caribbean & U.S. Banking. Canadian Banking serves our home market in Canada, where we maintain top (#1 or #2) rankings in market share in this competitive environment for all key retail and business products. We have the largest branch network, the most ATMs and one of the largest mobile sales networks across Canada. In Caribbean & U.S. Banking, we offer a broad range of financial products and services in targeted markets. In Canada, we compete with other Schedule 1 banks, independent trust companies, foreign banks, credit unions, caisses populaires and auto financing companies. In the Caribbean, our competition includes banks, trust companies and investment management companies serving retail and corporate clients, as well as public institutions. In the U.S., we compete primarily with other Canadian banking institutions that have U.S. operations. 2019 Operating environment › Following the rising interest rate environment throughout fiscal 2018, we experienced higher net interest margin this year. However, market interest rates moderated in the latter half of this year, as the overall economic outlook softened. › Consumer spending has been supported by strong labour markets and income growth, though the impact of last year’s interest rate increases has raised debt servicing costs for some Canadian households. › Homebuyers have adjusted to stricter mortgage regulations and benefitted from declining mortgage rates this year. This has led to an improvement in housing activity, which has contributed to solid growth in residential mortgages this year. › Business loan growth remained strong, however, it moderated slightly since the beginning of the calendar year. A decline in energy sector investment, an uncertain global growth environment and trade tensions have likely contributed to more modest growth in lending. › After relatively benign credit conditions in the prior year, we returned to a more normalized level of credit losses towards the end of 2019. › Growth in our investment product balances was driven by market returns, despite volatility experienced largely during the beginning of this year. › Client expectations continue to evolve, driving the digitization of our business. As a result, we continued to invest in digital solutions to improve the client experience and deliver personalized advice. › The Caribbean continued to experience challenges in various regions resulting in weak to moderate economic growth during the year. (1) 24 Represents 90-day active clients Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Strategic priorities OUR STRATEGY PROGRESS IN 2019 PRIORITIES IN 2020 Transform how we serve our clients Accelerate our growth Continued to provide exceptional and secure client experiences via our digital platforms, including a student mobile banking experience that is the first-of-its-kind in Canada Continued to innovate our branch network, including expansion of student and newcomer formats Continued to give clients more value for their loyalty points by offering the flexibility to pay bills with RBC Rewards® points Continued to provide personalized advice and valued banking solutions to our existing and new clients, including key high-growth and high-value segments such as retirees, youth, newcomers, business owners and high net worth clients Advanced our partnership with Petro-Canada, which helped our clients realize savings on gas while also earning RBC Rewards® and Petro- Canada points Continued to achieve exceptional growth while helping clients save money on travel with our WestJet credit card Deliver anytime, anywhere solutions to our clients across all channels, seamlessly integrating mobile and digital services into our clients’ lives Continue to reimagine our branch network to meet the evolving needs of our clients Focus on engaging key high growth client segments and enabling our advisors to build new and deeper relationships and achieve industry- leading volume growth Establish key partnerships to continue to add value for our clients Rapidly deliver digital solutions to our clients Continued to release significant additional functionalities in our RBC Mobile app, including credit and debit card lock features Deliver more personalized insights to improve the client experience while continuing to simplify and digitize everyday banking Launched NOMI BudgetsTM that leverages artificial intelligence (AI) to analyze clients’ spending patterns to help them stay on track to achieve their financial goals Continued to roll out MyAdvisor®, an online advice platform that digitally connects our clients to an advisor, resulting in over 1.4 million clients with a personalized investment plan Continued to invest in InvestEase®, a low-cost automated investment advice and portfolio management business, with the launch of the responsible investing portfolio and no minimum requirement features Enhanced the digital experience for our business clients with the ability to open accounts online and obtain credit digitally as well as launched new capabilities allowing them to gain insights to grow their business with RBC Insight EdgeTM Continued to prioritize investments in programs that simplify, digitize and automate experiences for clients, as well as enabling employees to deliver relevant and expert advice Continued to simplify operations, de-risk the business and improve internal controls, while transforming our business through digitization and physical footprint optimization Enhance the digital experience for our small business and commercial clients and make it easier for them to transact with us Invest in new tools and capabilities and proactively seek ways to simplify and streamline internal processes and the client experience Become the premier digitally-enabled relationship bank while accelerating growth in key client segments, continue to transform the client experience to drive profitability and continue to simplify our operations Growth in U.S. cross-border client activity through the implementation of new account opening processes and continued leveraging of our brand marketing and sales enablement strategies driving accelerated growth Deliver an improved digitally-enabled real estate lending experience, expand marketing and develop partnerships to provide personalized value to clients, and enhance the deposit gathering capabilities of the banking platform Innovate to become a more agile and efficient bank In the Caribbean In the U.S. Outlook Canada’s economy is expected to grow by 1.6% in calendar 2019, with a slightly stronger 1.7% pace in calendar 2020. Despite the BoC leaving its policy rate unchanged during fiscal 2019, market interest rates have declined, due in part to easing by other central banks globally. We expect the low interest rate environment, alongside a strong labour market and growing population, to continue to support housing demand in 2020. The impact of this is expected to be solid loan volume growth offset by interest margin compression. We will continue to pursue industry-leading volume growth, operational efficiency efforts and channel transformation to achieve our vision of being a digitally-enabled relationship bank. In the Caribbean, we expect weak to moderate growth throughout the region. We will continue to de-risk the business, improve our operating efficiency and focus on growth strategies in target markets. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 25 Personal & Commercial Banking (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Net interest income Non-interest income Total revenue PCL on performing assets PCL on impaired assets PCL Non-interest expense Income before income taxes Net income Revenue by business Canadian Banking Personal Banking Business Banking Caribbean & U.S. Banking Key ratios ROE NIM Efficiency ratio Operating leverage Operating leverage adjusted (1) Selected balance sheet and other information Average total assets Average total earning assets, net Average loans and acceptances, net Average deposits Other information AUA (2), (3) Average AUA AUM (3) Number of employees (FTE) Credit information PCL on impaired loans as a % of average net loans and acceptances Other selected information – Canadian Banking $ $ $ $ $ 2019 12,653 $ 5,212 17,865 109 1,339 1,448 7,768 8,649 6,402 $ 16,894 $ 12,843 4,051 971 27.2% 2.84% 43.5% 2.4% n.a. 466,200 $ 445,200 447,100 393,200 283,800 $ 276,100 5,000 35,467 0.30% Table 18 2018 11,776 5,140 16,916 115 1,158 1,273 7,526 8,117 6,028 15,970 12,237 3,733 946 27.6% 2.78% 44.5% 1.7% 3.2% 442,500 423,100 423,700 361,700 266,500 271,800 4,700 35,573 0.26% Net income NIM Efficiency ratio Operating leverage Operating leverage adjusted (4) 5,860 2.73% 42.5% 1.5% 3.1% These are non-GAAP measures. Measures for the year ended October 31, 2018 have been adjusted by excluding our Q1 2017 share of the gain related to the sale of the U.S. operations of Moneris of $212 million (before- and after-tax). For further details, including a reconciliation, refer to the Key performance and non-GAAP measures section. AUA includes securitized residential mortgages and credit card loans as at October 31, 2019 of $15.5 billion and $8.1 billion, respectively (October 31, 2018 – $16.7 billion and $9.6 billion). Represents year-end spot balances. These are non-GAAP measures. The year ended October 31, 2018 operating leverage ratio in Canadian Banking of 1.5% was impacted by our share of the gain related to the sale of the U.S. operations of Moneris of $212 million (before- and after-tax) in the year ended October 31, 2017, which was a specified item. For further details, including a reconciliation, refer to the Key performance and non-GAAP measures section. The year ended October 31, 2018 revenue and expense growth rates in Canadian Banking were 7.3% and 5.8%, respectively. Excluding our share of the gain related to the sale of Moneris, as noted above, the year ended October 31, 2018 adjusted revenue growth rate was 8.9%. 6,168 $ 2.79% 41.8% 2.0% n.a. $ (1) (2) (3) (4) n.a. not applicable Financial performance 2019 vs. 2018 Net income increased $374 million or 6% from last year, mainly due to average volume growth of 7% and higher spreads. These factors were partially offset by higher PCL and an increase in staff-related costs as well as technology and related costs. Total revenue increased $949 million or 6% from last year, largely reflecting average volume growth of 6% in loans and 9% in deposits and improved spreads. NIM increased 6 bps, mainly due to improved spreads on deposits in Canadian Banking, reflecting higher interest rates, partially offset by the impact of competitive pricing pressures. PCL increased $175 million or 14%, largely reflecting higher provisions on impaired loans in our commercial portfolios in Canadian Banking. PCL on impaired loans ratio increased 4 bps. For further details, refer to Credit quality performance in the Credit risk section. Non-interest expense increased $242 million or 3%, primarily attributable to higher staff-related costs and an increase in technology and related costs, including digital initiatives. Average loans and acceptances increased $23 billion or 6%, largely due to 6% growth in residential mortgages and 11% growth in business loans. Average deposits increased $32 billion or 9%, reflecting 9% growth in both business and personal deposits. Business line review Personal Banking Personal Banking offers a full range of products focused on meeting the needs of our individual Canadian clients at every stage of their lives through a wide range of financing and investment products and services. This includes home equity financing, 26 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis personal lending, chequing and savings accounts, private banking, indirect lending (including auto financing), mutual funds and self-directed brokerage accounts, Guaranteed Investment Certificates (GICs), credit cards, and payment products and solutions. We rank #1 or #2 in market share for all key Personal Banking products in Canada and our retail banking network is the largest in Canada with 1,201 branches and 4,240 ATMs. We have over 7 million credit card accounts and 23% market share of Canada’s credit card purchase volume. Financial performance Total revenue increased $606 million or 5% compared to last year largely reflecting volume growth in deposits and residential mortgages and improved spreads on deposits, partially offset by the impact of competitive pricing pressures. Average residential mortgages increased 6% compared to last year, mainly due to strong mortgage origination as well as high levels of client retention. Average deposits increased 9% from last year, largely reflecting acquisitions of new clients and an increase in activity from existing clients. Selected highlights Table 19 Average residential mortgages, personal loans and deposits (Millions of Canadian dollars) (Millions of Canadian dollars, except number of) Total revenue Other information Average residential mortgages Average other loans and acceptances, net Average deposits Average credit card balances Credit card purchase volumes Branch mutual fund balances (1) Average branch mutual fund balances AUA – Self-directed brokerage (1) Number as at October 31: Branches ATMs (1) Represents year-end spot balances. 2019 2018 $ 12,843 $ 12,237 $ 249,600 $ 235,700 80,200 202,800 18,100 117,900 147,900 151,500 82,900 79,800 221,400 19,100 125,800 162,000 155,300 89,500 1,201 4,240 1,203 4,194 280,000 240,000 200,000 160,000 120,000 80,000 40,000 0 Business Banking 120,000 100,000 80,000 60,000 40,000 20,000 0 2019 2018 2019 2018 2019 2018 Residential mortgages Deposits Other loans and acceptances Business Banking offers a wide range of lending, leasing, deposit, investment, foreign exchange, cash management, auto dealer financing, trade products, and services to small and medium-sized commercial businesses across Canada. With one of the largest teams of relationship managers and specialists in the industry, our commitment to client experience and trusted advice has earned us leading market share in business lending and deposits. Financial performance Total revenue increased $318 million or 9% compared to last year, largely reflecting average volume growth of 10%. Average loans and acceptances increased 11% and average deposits were up 9%, mainly due to new account acquisitions as well as deepening of our existing client relationships. Selected highlights (Millions of Canadian dollars) Total revenue Other information (average) Loans and acceptances, net Deposits Caribbean & U.S. Banking Table 20 Average business loans and acceptances and business deposits (Millions of Canadian dollars) 2019 2018 $ 4,051 $ 3,733 $ 89,400 $ 80,800 153,400 140,600 120,000 100,000 80,000 60,000 40,000 20,000 0 180,000 150,000 120,000 90,000 60,000 30,000 0 2019 2018 2019 2018 Business loans and acceptances Business deposits Our Caribbean Banking business offers a comprehensive suite of banking products and services, as well as international financing and trade promotion services through extensive branch, ATM, online and mobile banking networks. Our U.S. Banking business serves the banking needs of our Canadian retail and small business clients in the U.S. across all 50 states. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 27 Financial performance Total revenue was up $25 million or 3% from last year, primarily due to the impact of foreign exchange translation. Average loans and acceptances increased 4% and average deposits increased 1%, primarily due to the impact of foreign exchange translation. Selected highlights Table 21 Average loans and deposits (Millions of Canadian dollars) (Millions of Canadian dollars, except number of and percentage amounts) Total revenue Other information NIM Average loans and acceptances, net Average deposits AUA (1) Average AUA AUM (1) Number as at October 31: Branches ATMs (1) Represents year-end spot balances. Wealth Management $ $ 2019 971 $ 2018 946 4.13% 9,300 $ 18,500 6,700 7,100 4,900 52 287 3.95% 8,900 18,300 7,700 8,200 4,700 57 269 10,000 8,000 6,000 4,000 2,000 0 20,000 16,000 12,000 8,000 4,000 0 2019 2018 2019 2018 Loans and acceptances Deposits Wealth Management is a global business serving clients in key financial centres. We serve HNW and UHNW individual and institutional clients with a comprehensive suite of advice-based solutions and strategies to help them achieve their financial goals. $12.1 billion Total revenue > 5,200 Client-facing advisors > $22 billion AUA net flows Assets under Administration (AUA) Assets under Management (AUM) $1,062 billion Total AUA $756 billion Total AUM 91% Personal 8% Institutional 1% Mutual Funds 39% Personal 31% Institutional 30% Mutual Funds Our lines of businesses include Canadian Wealth Management, U.S. Wealth Management (including City National), Global Asset Management (GAM), and International Wealth Management. (cid:129) Canadian Wealth Management is the largest full-service wealth advisory business in Canada, as measured by AUA, serving HNW and UHNW clients (cid:129) U.S. Wealth Management (including City National) also encompasses our private client group (PCG) and correspondent and advisor services (CAS) businesses. PCG is the 7th largest full-service wealth advisory firm in the U.S., as measured by number of advisors, and City National is a premier U.S. private and commercial bank serving HNW, UHNW and commercial clients (cid:129) GAM is the largest retail fund company in Canada as well as a leading institutional asset manager (cid:129) International Wealth Management serves HNW and UHNW clients primarily through key financial centres in Europe, the U.K., and Asia 2019 Operating environment › The Fed raised its policy rate once in the first half of the year, and subsequently made three cuts towards the latter part of 2019, resulting in a net reduction of 50 basis points in fiscal 2019. The resulting NIM compression in the latter part of the year was more than offset by strong volume growth and market appreciation in our U.S. businesses as we continued to grow in select U.S. markets. › The wealth management industry continued to face the challenge of adapting in an environment of rapid technological advancements, shifting investor preferences, stricter regulations and changing demographics. › Amid ongoing trade tensions and market volatility, growth in our client assets was driven by market returns, our relationship- focused advisory network, distribution scale and the strength of our brand. › We continued to prioritize investments in digital solutions to maintain our competitive advantage, increase efficiencies in response to rapidly changing client preferences and address regulatory requirements. › After relatively benign credit conditions in the prior year, we returned to a more normalized level of credit losses towards the end of 2019. 28 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Strategic priorities OUR STRATEGY PROGRESS IN 2019 PRIORITIES IN 2020 In Canada, be the premier service provider for HNW and UHNW clients Extended our position as industry leader in our full-service private wealth business Continue to retain and attract top-performing and new advisors to strengthen our talent advantage Continued to focus on holistic wealth planning, including advisor training on intergenerational and business wealth transfer (e.g., delivery of Money in Motion and Financial Literacy programs) Fully rolled out RBC Premier Banking to deepen banking relationships with Wealth Management clients Enhanced our digital and data capabilities to drive increased client satisfaction and advisor productivity Invested further in capabilities, technology and talent needed to grow our U.S. Wealth Management business, including solid execution on our technology transformation Continued expansion in City National’s existing footprint, including growing our presence within the entertainment ecosystem through the acquisition of FilmTrack, as well as solid progress on expanding offerings to select high growth markets with strong U.S. Wealth Management and Capital Markets presence, including greater New York City and D.C. areas Enhanced our distribution capabilities by leveraging our global strengths, while delivering an exceptional client experience Focused on delivering a differentiated client experience by leveraging our global capabilities In the U.S., become the leading private and commercial bank and wealth manager in our key markets In select global financial centres, become the most trusted regional private bank In asset management, be a leading, diversified asset manager focused on global institutional and North American retail clients Maintained #1 market share in Canadian mutual fund AUM Launched the RBC iShares strategic alliance, bringing Canadian investors the largest and most comprehensive ETF solution suite in Canada Deliver a differentiated client experience through enriched advisor-client interactions and compelling digital experiences Broaden and deepen client relationships by leveraging combined strengths across our other business segments Streamline and simplify the business to continue improving efficiency and advisor productivity Continue to strive to deliver an exceptional client experience for targeted HNW, UHNW, middle market and business banking segments Leverage the combined strengths within U.S. Wealth Management (including City National) and Capital Markets with a view to accelerating growth in the U.S. Build out digital capabilities to improve client experience and drive operational efficiencies Focus on growing market share in target markets Continue to leverage our global strengths to better serve clients Continue to deliver an exceptional client experience Continue to increase business effectiveness and talent capabilities Continue to evolve our product capabilities to meet existing client needs, while expanding our ability to reach a broader distribution landscape Build a sustainable and differentiated global institutional business which materially contributes to the success of GAM Outlook Global economies are likely to continue to experience uncertainty driven in part by ongoing geopolitical tensions and trade conflicts. Central banks in Canada and the U.S. are closely monitoring the impacts on the economy. We expect our businesses will continue to lead in domestic markets and grow market share in the HNW and UHNW client segments globally, leveraging the strength of our brand and through continually enhancing our solutions and capabilities to address evolving client needs. We will continue to deliver world class client experiences by investing in our people and technology to drive digitized solutions. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 29 Wealth Management (Millions of Canadian dollars, except number of, percentage amounts and as otherwise noted) Net interest income Non-interest income Fee-based revenue Transaction and other revenue Total revenue PCL on performing assets PCL on impaired assets Total PCL Non-interest expense Income before income taxes Net income Revenue by business Canadian Wealth Management U.S. Wealth Management (including City National) U.S. Wealth Management (including City National) (US$ millions) Global Asset Management International Wealth Management Key Ratios ROE NIM Pre-tax margin (1) Selected balance sheet Average total assets Average total earning assets, net Average loans and acceptances, net Average deposits Other information AUA (2) (3) AUM (2) Average AUA Average AUM PCL on impaired loans as a % of average net loans and acceptances Number of employees (FTE) Number of advisors (4) $ $ $ $ 2019 2,993 $ 6,903 2,247 12,143 37 80 117 8,813 3,213 2,550 $ 3,294 $ 6,112 4,601 2,361 376 17.4% 3.55% 26.5% 98,500 $ 84,400 63,600 95,800 Table 22 2018 2,602 6,447 1,877 10,926 (19) 4 (15) 8,070 2,871 2,265 3,048 5,419 4,209 2,092 367 16.3% 3.45% 26.3% 89,600 75,500 55,500 92,300 $ 1,062,200 $ 755,700 1,027,400 717,500 0.13% 18,613 5,296 970,500 664,900 962,600 664,500 0.01% 17,975 5,042 Estimated impact of U.S. dollar, British pound and Euro translation on key income statement items (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Increase (decrease): Total revenue Non-interest expense Net income Percentage change in average U.S. dollar equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 Percentage change in average Euro equivalent of C$1.00 2019 vs. 2018 $ 169 130 30 (3)% 2% 2% (1) (2) (3) (4) Pre-tax margin is defined as Income before income taxes divided by Total revenue. Represents year-end spot balances. In addition to Canadian Wealth Management, U.S. Wealth Management (including City National), and International Wealth Management, AUA includes $6,000 million (2018: $5,800 million) related to GAM. Represents client-facing advisors across all our wealth management businesses. Client assets – AUA (Millions of Canadian dollars) AUA, beginning balance Asset inflows Asset outflows Total net flows Market impact Acquisitions/dispositions Foreign exchange Total market, acquisition/dispositions and foreign exchange impact AUA, balance at end of year 2019 970,500 $ 315,500 (293,400) 22,100 72,100 (2,200) (300) 69,600 1,062,200 $ $ $ Table 23 2018 929,200 292,600 (261,600) 31,000 5,600 (5,700) 10,400 10,300 970,500 30 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Client assets – AUM (Millions of Canadian dollars) AUM, beginning balance (1) Institutional inflows Institutional outflows Personal flows, net Total net flows Market impact Acquisition/dispositions Foreign exchange Total market, acquisition/ dispositions and foreign exchange impact 2019 Money market 25,000 $ 55,200 (51,700) 800 4,300 500 – 100 Fixed income 182,000 $ 33,400 (32,300) 5,700 6,800 16,700 (100) (600) Equity $ 79,100 6,500 (3,000) (1,200) 2,300 9,400 (900) – Multi-asset and other $ 378,800 $ 15,900 (18,100) 25,700 23,500 33,100 (4,500) 200 Total 664,900 $ 111,000 (105,100) 31,000 36,900 59,700 (5,500) (300) Table 24 2018 Total 634,100 104,500 (98,500) 30,200 36,200 (9,200) – 3,800 AUM, balance at end of year $ 600 29,900 $ 16,000 204,800 8,500 $ 89,900 28,800 $ 431,100 $ 53,900 755,700 $ (5,400) 664,900 (1) Amounts have been revised from those previously presented. AUA by geographic mix and asset class (Millions of Canadian dollars) Canada (1) Money market Fixed income Equity Multi-asset and other Total Canada U.S. (1) (2) Money market Fixed income Equity Multi-asset and other Total U.S. Other International (1) Money market Fixed income Equity Multi-asset and other Total International Total AUA (1) (2) Geographic information is based on the location from where our clients are served. Amounts have been revised from those previously presented. Table 25 2019 2018 $ $ $ $ 23,200 $ 36,300 90,500 255,800 405,800 $ 26,100 $ 114,500 189,600 213,100 543,300 $ $ 17,700 $ 13,500 39,500 42,400 $ 113,100 $ $ 1,062,200 $ 20,500 35,400 86,700 225,300 367,900 26,000 103,500 173,300 180,100 482,900 16,100 12,300 49,100 42,200 119,700 970,500 Financial performance 2019 vs. 2018 Net income increased $285 million or 13%, from a year ago, mainly due to higher average fee-based client assets, an increase in net interest income and a gain on the sale of the private debt business of BlueBay of $134 million (after-tax). These factors were partially offset by increased costs in support of business growth, higher variable compensation commensurate with revenue growth and higher PCL. Total revenue increased $1,217 million or 11%, primarily due to higher average fee-based client assets reflecting market appreciation and net sales, and an increase in net interest income largely driven by average loan growth of 15%, and higher spreads. The impact of foreign exchange translation, a gain on the sale of the private debt business of BlueBay of $151 million and the change in the fair value of the hedges related to our U.S. share-based compensation plans, which was largely offset in non-interest expense, also contributed to the increase. PCL increased $132 million, primarily in U.S. Wealth Management (including City National). PCL on impaired loans ratio increased 12 bps, mainly in a few sectors, including consumer discretionary and consumer staples. For further details, refer to Credit quality performance in the Credit risk section. Non-interest expense increased $743 million or 9%, primarily due to increased costs in support of business growth mainly reflecting higher staff-related costs and higher variable compensation commensurate with revenue growth. The impact of foreign exchange translation and the change in the fair value of our U.S. share-based compensation plans, which was largely offset in revenue, also contributed to the increase. AUA and AUM increased $92 billion or 9% and $91 billion or 14%, respectively, primarily due to market appreciation and net sales. Business line review Canadian Wealth Management Canadian Wealth Management includes our full-service Canadian wealth advisory business, which is the largest in Canada as measured by AUA, with over 1,850 investment advisors providing comprehensive financial solutions to HNW and UHNW clients. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 31 Additionally, we provide discretionary investment management and estate and trust services to our clients through approximately 90 investment counsellors and over 100 trust professionals across Canada. We compete with domestic banks and trust companies, investment counselling firms, bank-owned full-service brokerages and boutique brokerages, mutual fund companies and global private banks. In Canada, bank-owned wealth managers continue to be the major players. Financial performance Revenue increased $246 million or 8% from a year ago, primarily due to higher average fee-based client assets reflecting market appreciation and net sales and the impact of a favourable accounting adjustment. Selected highlights Table 26 Average AUA and AUM (Millions of Canadian dollars) (Millions of Canadian dollars) Total revenue Other information Average loans and acceptances, net Average deposits AUA (1) AUM (1) Average AUA Average AUM $ $ 2019 3,294 $ 2018 3,048 3,700 $ 3,600 17,300 368,900 100,200 370,300 97,900 17,100 407,000 116,700 391,100 109,400 500,000 400,000 300,000 200,000 100,000 0 (1) Represents year-end spot balances. U.S. Wealth Management (including City National) 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 2019 2018 2019 2018 AUA AUM U.S. Wealth Management (including City National) also encompasses PCG and our CAS businesses. PCG is the 7th largest full- service wealth advisory firm in the U.S., as measured by number of advisors, with over 1,900 financial advisors. Our CAS businesses deliver clearing and execution services for small to mid-sized independent broker-dealers and registered investment advisor firms. City National provides comprehensive financial solutions to affluent individuals, entrepreneurs, professionals, their businesses and their families and provides a premier banking and financial experience through a high-touch service model, proactive advice and financial solutions. City National offers a broad range of lending, deposit, cash management, international banking, equipment financing, wealth management and other products and services. In the U.S., we operate in a fragmented and highly competitive industry. Our competitors include other broker-dealers, commercial banks and other financial institutions that service HNW and UHNW individuals, entrepreneurs and their businesses. Financial performance Revenue increased $693 million or 13%. In U.S. dollars, revenue increased $392 million or 9%, mainly due to an increase in net interest income largely driven by average loan growth of 14% and higher spreads, an increase in average fee-based client assets reflecting market appreciation and net sales, and the change in the fair value of the hedges related to our U.S. share-based compensation plans, which was largely offset in non-interest expense. NIM increased 9 bps, mainly due to higher interest rates, partially offset by higher funding and deposit costs. Selected highlights Table 27 Average AUA and AUM (Millions of U.S. dollars) (Millions of Canadian dollars, except as otherwise noted) Total revenue Other information (Millions of U.S. dollars) Total revenue NIM Average earning assets, net Average loans, guarantees and letters of credit, net Average deposits AUA (1) AUM (1) Average AUA Average AUM (1) Represents year-end spot balances. Global Asset Management 2019 6,112 $ 2018 5,419 $ $ 4,601 $ 3.37% 4,209 3.28% $ 56,100 $ 50,900 42,400 50,200 412,600 123,700 393,900 112,800 37,300 48,600 367,100 102,900 366,100 100,600 500,000 400,000 300,000 200,000 100,000 0 2019 2018 2019 2018 AUA AUM 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Global Asset Management provides global investment management services and solutions for individual and institutional investors in Canada, the U.K., the U.S., Europe and Asia. We provide a broad range of investment management services through mutual, pooled and private funds, fee-based accounts and separately managed portfolios. We distribute our investment solutions through a broad network of bank branches, our self-directed and full-service wealth advisory businesses, independent third-party advisors and private banks, and directly to individual clients. We also provide investment solutions directly to institutional clients, including pension plans, insurance companies, corporations, and endowments and foundations. We are the largest retail fund company in Canada as well as a leading institutional asset manager. We face competition in Canada from banks, insurance companies and asset management organizations. The Canadian fund management industry is large and mature, but remains a relatively fragmented industry. In the U.S., our asset management business offers investment management solutions and services primarily to institutional investors and competes with independent asset management firms, as well as those that are part of national and international banks, and insurance companies. 32 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Internationally, through our global capabilities of BlueBay and RBC Global Asset Management®, we offer investment management solutions for institutions and, through private banks including RBC Wealth Management®, to HNW and UHNW investors. We face competition from asset managers that are part of international banks as well as national and regional asset managers in the geographies where we serve clients. Financial performance Revenue increased $269 million or 13%, mainly due to a gain on the sale of the private debt business of BlueBay of $151 million as we have focused on growing our core business and complementary strategies, and higher average fee-based client assets reflecting market appreciation and net sales. Table 28 Average AUM (Millions of Canadian dollars) Selected highlights (Millions of Canadian dollars) Total revenue Other information Canadian net long-term mutual fund sales (1) Canadian net money market mutual fund sales (redemptions) (1) AUM (2) Average AUM $ $ 2019 2,361 $ 2018 2,092 8,263 $ 5,908 552 467,200 449,700 562 421,100 428,200 (1) (2) As reported to the Investment Funds Institute of Canada. Includes all prospectus-based mutual funds across our Canadian GAM businesses. Represents year-end spot balances. International Wealth Management 500,000 400,000 300,000 200,000 100,000 0 2019 2018 AUM International Wealth Management includes operations in Europe, the U.K., and Asia. We provide customized and integrated trust, banking, credit and investment solutions to HNW and UHNW clients and corporate clients in key financial centres in Europe, the U.K., and Asia. Competitors to our International Wealth Management business comprise global wealth managers, traditional offshore private banks, and domestic wealth managers. Financial performance Revenue increased $9 million or 2%, primarily due to an increase in net interest income driven by higher spreads. Selected highlights (Millions of Canadian dollars) Total revenue Other information Average loans, guarantees and letters of credit, net Average deposits AUA (1) AUM (1) Average AUA Average AUM (1) Represents year-end spot balances. Insurance Table 29 Average AUA and AUM (Millions of Canadian dollars) $ $ 2019 376 $ 2018 367 4,400 $ 11,900 105,900 8,800 106,700 8,600 4,800 12,500 112,800 8,300 114,300 8,800 160,000 120,000 80,000 40,000 0 16,000 12,000 8,000 4,000 0 2019 2018 2019 2018 AUA AUM RBC Insurance® offers a wide range of solutions including creditor, life, health, home, auto, travel, wealth, and annuities to individuals as well as reinsurance advice and solutions, and business insurance services to business and group clients. $5.7 billion Total revenue > 5 million Number of clients 2,927 Employees RBC Insurance® is among the largest Canadian bank-owned insurance organizations and operates under two business lines: Canadian Insurance and International Insurance. In Canada, we offer our products and services through a wide variety of channels: advice centers, RBC Insurance stores, mobile advisors, digital, mobile and social platforms, independent brokers, and travel partners. Outside Canada, we operate globally in the reinsurance and retrocession markets offering life, disability and longevity reinsurance products. Premiums and Deposits $4.6 billion Total premiums and deposits 56% Life and Health 41% Annuity and Segregated Fund Deposits 3% Property and Casualty Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 33 2019 Operating environment › The insurance industry continued to face a number of challenges and opportunities, including changing client preferences and digital and mobile transformation impacting all aspects of the business. In Canada, provincial and federal regulators have expanded their focus on sales practices and fair treatment of customers. Insurers globally have been investing in products and building distribution capacity in order to achieve higher operational efficiencies and manage expenses. To overcome these challenges and take advantage of these opportunities, we continued to evolve our robust frameworks, controls, and risk culture to protect clients and meet the expectations of both federal and provincial regulators. › We continued to invest in digital capabilities to enhance access and convenience, reduce costs and deliver value to clients beyond traditional insurance products and services. › In Europe, life insurance companies are actively managing longevity risk to preserve capital and to mitigate the volatility of pension costs. As a result, the longevity reinsurance market has become highly competitive and attractive to many global reinsurers. We continued to achieve strong growth in this market within our risk tolerance. Strategic priorities OUR STRATEGY PROGRESS IN 2019 PRIORITIES IN 2020 Improve distribution effectiveness and efficiency Launched the redesigned RBC Simplified Term Digital Application to our field sales and advice centres, improving reliability and simplifying the application process for our simplified term life insurance offering Continue to improve our distribution effectiveness and efficiency by enhancing our proprietary distribution channels and focusing on the delivery of technology and operational solutions Deepen client relationships Simplify.Agile.Innovate Completed a technology transformation initiative to deliver a single integrated platform, which provides a better experience for clients, employees and plan administrators Began testing new business models, concepts and product ideas focused on the underinsured market; in order to provide innovative ways for clients to acquire the coverage that they need Introduced the Family Compassionate Care Rider. This is a first of its kind in the Canadian insurance industry and provides an optional Individual Disability Insurance product rider, which pays a monthly benefit to the insured in the event of spousal/child terminal illness Launched an industry-first segregated fund assessment tool which allows advisors to guide clients through the process, ensuring product recommendations are aligned with clients’ needs, goals and risk profile Launched mobile device coverage on selected Avion credit cards, providing protection to clients if a mobile device is lost, stolen or accidentally damaged Launched the Fundamental Series disability electronic application to our proprietary sales and brokerage channels offering a streamlined, quick and seamless experience for users Deepen client relationships by continuing to be an innovative, client-focused provider of a full suite of insurance solutions for mass underserved, mass affluent and HNW clients Simplify and innovate by accelerating our digital initiatives’ time-to-market, improving quality and cost effectiveness Pursue select international opportunities to grow our reinsurance business Achieved very strong growth in our longevity reinsurance business due to heightened market activity in 2019 Pursue niche opportunities in mortality and longevity markets to grow our reinsurance business within our risk tolerance Outlook The insurance industry will continue to experience substantial forces of change, innovation and disruption. In this rapidly evolving industry, we will seek to maintain our strength through investments in technology, product and service innovation and efficient digital distribution channels. We will also continue to re-define how we advise our clients to provide them peace of mind. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. 34 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Insurance (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Non-interest income Net earned premiums Investment income (1) Fee income Total revenue Insurance policyholder benefits and claims (1) Insurance policyholder acquisition expense Non-interest expense Income before income taxes Net income Revenue by business Canadian Insurance International Insurance Key ratios ROE Selected balance sheet and other information Average total assets Other information Premiums and deposits (2) Canadian Insurance International Insurance Insurance claims and policy benefit liabilities Fair value changes on investments backing policyholder liabilities (1) Number of employees (FTE) Table 30 2019 2018 3,984 $ 4,032 1,569 30 157 217 5,710 4,279 3,749 2,391 336 285 606 602 1,019 1,001 775 806 $ 3,643 $ 2,213 2,067 2,066 $ $ $ 39.6% 39.3% $ 17,600 $ 15,800 $ 4,604 $ 4,647 2,415 2,584 2,189 2,063 $ 11,401 $ 10,000 (435) 2,964 987 2,927 (1) (2) Investment income can experience volatility arising from fluctuation of assets designated as FVTPL. The investments which support actuarial liabilities are predominantly fixed income assets designated as FVTPL. Consequently, changes in the fair values of these assets are recorded in the Consolidated Statements of Income and are largely offset by changes in the fair value of the actuarial liabilities, the impact of which is reflected in Insurance policyholder benefits, claims and acquisition expense (PBCAE). Premiums and deposits include premiums on risk-based insurance and annuity products, and individual and group segregated fund deposits, consistent with insurance industry practices. Financial performance 2019 vs. 2018 Net income increased $31 million or 4% from a year ago, mainly due to the impact of new longevity reinsurance contracts, partially offset by higher claims costs. Total revenue increased $1,431 million or 33%, mainly due to the change in fair value of investments backing our policyholder liabilities and business growth in International Insurance, both of which are largely offset in PBCAE as indicated below. Realized investment gains also contributed to the increase. These factors were partially offset by lower group annuity sales, which are largely offset in PBCAE as indicated below. PBCAE increased $1,409 million or 53%, mainly reflecting the change in fair value of investments backing our policyholder liabilities and lower favourable investment-related experience. Business growth in International Insurance and higher claims costs also contributed to the increase. These factors were partially offset by lower group annuity sales and the favourable impact of new longevity reinsurance contracts. Non-interest expense increased $4 million or 1%. Business line review Canadian Insurance We offer life, health, travel, home and auto insurance products (in partnership with Aviva Canada), wealth accumulation solutions, and payout annuities to individual, group, HNW and business clients across Canada. Our life and health portfolio includes universal life, term life, critical illness, disability, and group benefits such as long term disability, and health and dental. Our travel products include out-of-province/country medical coverage, and trip cancellation and interruption insurance. Our group annuities business helps defined benefit pension plan sponsors better manage and control risk. RBC Insurance has a set of strategies and initiatives with a goal to build our momentum and position us for growth in a product line where companies are increasingly looking to transfer the risks associated with their pension obligations to insurance companies – either through group annuity contract or longevity swap products. In Canada, the majority of our competitors specialize in life and health or property and casualty products. We hold a leading market position in disability insurance products, have a significant presence in life and travel products, and have a growing presence in wealth solutions as well as in home and auto through our distribution agreement with Aviva. Financial performance Total revenue increased $1,430 million or 65% from last year, primarily reflecting the change in fair value of investments backing our policyholder liabilities, which is largely offset in PBCAE, and realized investment gains. These factors were partially offset by lower group annuity sales, which is largely offset in PBCAE. Premiums and deposits decreased $169 million or 7%, as lower group annuity sales were partially offset by growth across other product lines. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 35 Selected highlights (Millions of Canadian dollars) Total revenue Other information Premiums and deposits Life and health Property and casualty Annuity and segregated fund deposits Fair value changes on investments backing policyholder liabilities 2019 $ 3,643 Table 31 2018 $ 2,213 $ 1,328 131 $ 1,280 126 956 1,178 1,099 (434) International Insurance Premiums and deposits (Millions of Canadian dollars) 3,000 2,500 2,000 1,500 1,000 500 0 2019 2018 Annuity and segregated fund Property and casualty Life and health International Insurance is primarily comprised of our reinsurance businesses which insure risks of other insurance and reinsurance companies. We offer life, disability and longevity reinsurance products. The global reinsurance market is competitive and is dominated by a few large players, with significant presence in the U.S., the U.K. and Europe. Financial performance Total revenue increased $1 million due to business growth, primarily in longevity reinsurance and higher favourable reinsurance contract renegotiations. These factors were offset by the change in the fair value of investments backing our policyholder liabilities, which is largely offset in PBCAE. Premiums and deposits increased $126 million or 6%, reflecting growth in longevity reinsurance. Selected highlights Table 32 (Millions of Canadian dollars) Total revenue Other information Premiums and deposits Life and health Property and casualty Annuity Fair value changes on investments backing policyholder liabilities Investor & Treasury Services 2019 $ 2,067 2018 $ 2,066 $ 1,254 (1) 936 $ 1,225 (5) 843 (112) (1) Investor & Treasury Services is a specialist provider of asset services, a leader in Canadian cash management and transaction banking services, and a provider of treasury services to institutional clients worldwide. $4.3 trillion Assets under administration 13.2% Return on equity $58.8 billion Average client deposits Revenue by Geography $2.3 billion Total revenue 43% North America 30% Europe (Ex. U.K.) 14% U.K. 13% Asia-Pacific We deliver asset, transaction banking, treasury, and other services to safeguard client assets, maximize liquidity, and manage risk across multiple jurisdictions. While we compete against the world’s largest global custodians, we remain a specialist provider with a focus on providing best-in-class asset services to sophisticated investors. We compete in selected countries in North America, Europe, the U.K., and Asia-Pacific. We specialize in creating digitally-enabled client-centric products and services. We have top-rated global custody, transfer agency and securities lending products. We are a leading provider of Canadian dollar cash management, correspondent banking and trade finance for financial institutions globally and we provide short-term funding and liquidity management for the bank. 36 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis 2019 Operating environment › Investments to execute efficiency opportunities and improve the client experience drove higher costs. In Q4, we recognized severance and related costs associated with repositioning of the business to improve cost structures and drive efficiencies. › Results in our asset services business reflected challenging market conditions in the earlier part of 2019 and secular industry headwinds. › The outlook on interest rates drove lower earnings in treasury services and resulted in margin compression associated with our client deposits. Strategic priorities OUR STRATEGY Be #1 in Canada PROGRESS IN 2019 PRIORITIES IN 2020 Increased AUA in Canada by 5% year-over-year Continue to grow income and market share among Canadian asset managers, investment counsellors, pension funds, insurance companies and transaction banking clients Compete in segments and markets which offer the highest risk-adjusted returns Lead in selected fast growing asset servicing segments and markets to support our clients’ growth Continued to expand relationships in our chosen markets, fueling our business in Luxembourg and Ireland Deliver seamless digital client experiences and employ technology to enable our clients’ success Continued to invest in infrastructure and automation to increase the robustness of our technology platforms Continue to provide our clients with seamless digital journeys and secure, robust and continuous service Rolled-out new functionality on our web-based portal (RBC One®), which provides clients with access to data, dynamic reporting and analytics Provided clients with secure, flexible access to their data via Application Program Interfaces (APIs) Enhanced our alternative asset services offering Design and re-engineer our services to improve client satisfaction, efficiency and risk controls Continue to use technology and data insights to solve our clients’ current and future challenges Outlook In 2020, our focus is to enable our clients’ success and to be the best at what we do in our chosen markets, by operating as one highly-skilled and client-focused team. We will execute on our repositioning initiatives with the aim to return to growth and higher levels of profitability. While we expect the global asset services industry to remain challenging in the near-term, our specialized products and services are well-positioned to grow in the continuously changing operating environment. We will continue to deliver class-leading capabilities to our clients by creating a culture of quality, collaboration and innovation, and focusing investment in digitally-enabled solutions. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Investor & Treasury Services (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Net interest income Non-interest income Total revenue PCL Non-interest expense Net income before income taxes Net income Key Ratios ROE Selected balance sheet information Average total assets Average deposits Average client deposits Average wholesale funding deposits Other Information AUA (1) Average AUA Number of employees (FTE) Represents year-end spot balances. (1) $ $ $ 2019 (44) $ 2,389 2,345 – 1,725 620 475 $ $ 13.2% 146,100 175,100 58,800 116,300 Table 33 2018 297 2,294 2,591 1 1,617 973 741 23.5% 132,100 161,200 58,600 102,600 $ 4,318,100 4,262,300 4,684 $ 4,283,100 4,377,300 4,846 Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 37 Financial performance 2019 vs. 2018 Net income decreased $266 million or 36%, primarily due to lower funding and liquidity revenue, severance and related costs, as well as lower revenue from our asset services business. Total revenue decreased $246 million or 9%, mainly due to lower funding and liquidity revenue primarily driven by the impact of reduced money market opportunities in the current year and lower gains from the disposition of certain securities. Lower revenue from our asset services business due to challenging market conditions throughout the earlier part of 2019 and lower client activity also contributed to the decrease. Non-interest expense increased $108 million or 7%, mainly due to severance and related costs associated with repositioning of the business. Capital Markets RBC Capital Markets® is a premier global investment bank providing expertise in banking, finance and capital markets to corporations, institutional investors, asset managers, governments and central banks around the world. Our professionals ensure that clients receive the advice, products, and services their businesses need from 70 offices in 15 countries. Our presence extends across North America, the U.K. & Europe, and Australia, Asia & other regions. > 15,500 Number of clients #10 Global league rankings(1) 4,269 Employees Revenue by Geography We operate two main business lines, Corporate and Investment Banking and Global Markets. $8.3 billion Total revenue 51% U.S. 29% Canada 14% U.K. & Europe 6% Australia, Asia & other regions In North America, we offer a full suite of products and services which include corporate and investment banking, equity and debt origination and distribution, as well as sales and trading. In Canada, we are a market leader with a strategic presence in all lines of capital markets businesses. In the U.S., we have a full industry sector coverage and investment banking product range and compete with large U.S. and global investment banks as well as smaller regional firms. We have leading capabilities in credit, secured lending, municipal finance, fixed income, currencies & commodities, equities and advisory. Outside North America, we have a select presence in the U.K. & Europe, Australia, Asia & other markets. In the U.K. & Europe, we offer a diversified set of capabilities in key sectors of expertise such as energy, mining, infrastructure, industrial, consumer, healthcare, technology and financial services. In Australia and Asia, we compete with global and regional investment banks in targeted areas aligned to our global expertise, including fixed income distribution and currencies trading, secured finance and corporate and investment banking. 2019 Operating environment › We saw an industry-wide decrease in investment banking activities in fiscal 2019 due to challenging market conditions. The market was negatively impacted by ongoing political and economic uncertainty, trade tensions and elevated equity valuations. The global investment banking fee pool was down 11 %(1) in fiscal 2019 compared to the prior year with decreases across the majority of products, most notably in loan syndication and equity origination activity. Despite the challenging industry environment, we improved our ranking to 10th place in global league tables(1). › The trading environment at the beginning of fiscal 2019 was characterised by an increase in volatility, reflecting some of the factors noted above. The volatility benefited our equity derivatives business by driving higher client activity. We also saw lower liquidity and widening of credit spreads in the first two months of fiscal 2019 which drove lower corporate bond trading with a pickup in activity in January 2019. The second half of fiscal 2019 was characterized by heightened levels of market uncertainty which drove lower results in our equity and interest rate trading businesses. Overall, our trading businesses performed well despite a less favourable market environment in the current year. › After relatively benign credit conditions in the prior year, we returned to a more normalized level of credit losses towards the end of 2019. (1) 38 Source: Dealogic, based on global investment bank fees, Fiscal 2019 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Strategic priorities OUR STRATEGY To be among the world’s most successful investment banks by serving clients in the most attractive markets Deepen client relationships as an innovative, trusted partner PROGRESS IN 2019 PRIORITIES IN 2020 Improved our ranking to 10th(1) place in the global league table Successfully maintained #1 market share position in Canada(1) and ranked Best Investment Bank in Canada(2) Successfully grew our M&A advisory practice which was reflected in attaining 10th place ranking for advising on announced U.S. M&A deals this year(3) U.K./Europe Equity Capital Markets (ECM) ranking improved to 16th place in the global league table, from 28th place in fiscal 2018(1) Continued focus on the largest users of our products and have strengthened our senior coverage teams in the U.S., the U.K. and Europe by adding more senior bankers to the platform Invested in technology and innovation to enhance existing capabilities to drive growth in our Global Markets business, including investment in an artificial intelligence powered platform Expanded and strengthened our product offering within the Global Markets business Continued to win significant mandates and won our largest-ever U.S. advisory mandate as sole financial advisor to Branch Banking and Trust Company (BB&T) in its merger of equals with SunTrust, a transaction with a value of US$66 billion when announced in February 2019 Maintain our leadership position in Canada Continue to be the Canadian leader in the U.S., our largest market with the best opportunity for growth Continue to be a leader in targeted areas in the U.K., Europe and Asia-Pacific aligned with our global expertise Support our clients by partnering with them to understand their strategic objectives and delivering solutions to achieve their goals Continue to grow and strengthen our senior coverage teams Focus on long-term client relationships aligned with our global capabilities Continue to drive technology innovations through our data strategy, electronification and artificial intelligence initiatives Collaborate to deliver clients our full suite of global products and services Continue to focus on deepening client relationships by driving cross business collaboration within RBC Capital Markets and across the enterprise Continue disciplined approach to managing costs and risk, maintain a balance between investment banking and trading revenue and align our resources around top client opportunities Drive collaboration, simplify our business and optimize capital use to earn high risk- adjusted returns on assets and equity Continued to drive increased collaboration across our geographies and businesses to provide our clients with holistic solutions Continued to focus on efficient deployment of our capital and growth throughout our businesses by reducing unproductive assets and re-allocating capital to businesses that provide higher returns and increased profitability Acted as exclusive financial advisor to Permira Funds on the acquisition of Cambrex Corporation and provided committed debt financing in support of the transaction valued at approximately US$2.4 billion Outlook Despite a challenging market environment in fiscal 2019, we have made good progress on delivering on our strategic priorities. In our investment banking business, we have been successful in winning more and higher quality mandates. In 2020, we expect solid momentum in our investment banking business, driven by M&A fees as we are participating in a number of marquee transactions that have been announced across various sectors. Global Markets performed well in 2019 despite macro headwinds as we have a diversified geographic and product mix which can perform well even in challenging market environments. We expect these businesses to continue to see solid performances into 2020 by continuing to leverage investments in technology innovation, expanding and strengthening our product offering and focusing on ensuring financial resources are deployed appropriately to key target clients in an effort to maximize return. Our lending business will continue to focus on Risk Weighted Asset optimization and the execution of client plans. Although regulatory headwinds continue to impact earnings growth, we will look to drive strategic value from recent technology investments and continually optimize our capital deployment. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. (1) (2) (3) Source: Dealogic, based on global investment bank fees, Fiscal 2019 Source: Global Finance and Euromoney 2019 Source: BNN Bloomberg based on announced M&A deals as at October 31, 2019 Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 39 Capital Markets (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Net interest income (1), (2) Non-interest income (1), (2) Total revenue (1) PCL on performing assets PCL on impaired assets Total PCL Non-interest expense Net income before income taxes Net income Revenue by business Corporate and Investment Banking Global Markets Other Key ratios ROE Selected balance sheet and other information Average total assets Average trading securities Average loans and acceptances, net Average deposits (2) Other information Number of employees (FTE) Credit information PCL on impaired loans as a % of average net loans and acceptances $ $ $ $ $ $ $ $ 2019 4,043 4,245 8,288 36 263 299 5,096 2,893 2,666 3,792 4,663 (167) 11.4% 666,500 102,100 99,800 77,300 4,269 0.26% Table 34 2018 3,328 5,070 8,398 (13) 61 48 4,960 3,390 2,777 4,113 4,496 (211) 13.0% 576,300 95,800 85,000 70,100 4,162 0.07% Estimated impact of U.S. dollar, British pound and Euro translation on key income statement items (Millions of Canadian dollars, except percentage amounts) Increase (decrease): Total revenue Non-interest expense Net income Percentage change in average U.S. dollar equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 Percentage change in average Euro equivalent of C$1.00 2019 vs. 2018 $ 148 67 67 (3)% 2% 2% (1) (2) The teb adjustment for 2019 was $450 million (2018 – $542 million). For further discussion, refer to the How we measure and report our business segments section. Commencing Q4 2019, the interest component and the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in trading revenue and deposits, respectively, are presented in net interest income and other liabilities, respectively. Comparative amounts have been reclassified to conform with this presentation. Revenue by region (Millions of Canadian dollars) 10,000 7,500 5,000 2,500 0 2019 2018 Australia, Asia & other regions Europe U.S. Canada Financial performance 2019 vs. 2018 Net income decreased $111 million or 4%, driven by lower revenue in Corporate and Investment Banking, higher PCL and higher technology and related costs. These factors were partially offset by a lower effective tax rate largely reflecting changes in earnings mix, higher revenue in Global Markets and the impact of foreign exchange translation. Total revenue decreased $110 million or 1%, largely due to lower loan syndication activity, lower equity origination primarily in North America, and lower M&A largely in Europe and Canada. These factors were partially offset by the impact of foreign exchange translation, lower residual funding costs and higher fixed income trading revenue across all regions. PCL increased $251 million, driven by an increase in provisions on impaired loans in the oil & gas and industrial products sectors and higher provisions on performing loans. PCL on impaired loans ratio increased 19 bps. For further details, refer to Credit quality performance in the Credit risk section. Non-interest expense increased $136 million or 3%, largely due to the impact of foreign exchange translation and higher technology and related costs, partially offset by lower compensation on decreased results. 40 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Business line review Corporate and Investment Banking Corporate and Investment Banking comprises our corporate lending, loan syndication, debt and equity origination, M&A advisory services, client securitization and the global credit businesses. For debt and equity origination, revenue is allocated between Corporate and Investment Banking and Global Markets based on the contribution of each group in accordance with an established agreement. Financial performance Corporate and Investment Banking revenue of $3,792 million decreased $321 million or 8% as compared to last year. Investment banking revenue decreased $435 million or 21%, primarily due to lower loan syndication activity, lower M&A primarily in Europe and Canada, lower equity origination mainly in North America, and reduced municipal banking activity. These factors were partially offset by the impact of foreign exchange translation. Lending and other revenue increased $114 million or 6%, reflecting the impact of foreign exchange translation, as well as increased client activity mainly in the U.S. Selected highlights Table 35 Breakdown of total revenue (Millions of Canadian dollars) (Millions of Canadian dollars) Total revenue (1) Breakdown of revenue (1) Investment banking Lending and other (2) Other information Average assets Average loans and acceptances, net $ $ 2018 2019 3,792 $ 4,113 1,672 $ 2,107 2,120 2,006 $ 86,400 $ 74,400 61,100 76,700 (1) (2) The teb adjustment for the year ended October 31, 2019 was $80 million (October 31, 2018 – $224 million). For further discussion, refer to the How we measure and report our business segments section. Comprises our corporate lending, client securitization, and global credit businesses. 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Global Markets 2019 2018 Investment banking Lending and other Global Markets comprises our fixed income, foreign exchange, equity sales and trading, repos and secured financing and commodities businesses. Financial performance Total revenue of $4,663 million increased $167 million or 4% as compared to last year. Revenue in our Fixed income, currencies and commodities business increased $28 million or 1%. Revenue in our Equities business increased $30 million or 3%, primarily due to higher equity trading revenue mainly in North America, partially offset by lower equity origination primarily in North America. Revenue in our Repo and secured financing business increased $109 million or 9%, mainly due to increased client activity. Selected highlights Table 36 Breakdown of total revenue (Millions of Canadian dollars) (Millions of Canadian dollars) Total revenue (1) Breakdown of revenue (1) Fixed income, currencies and commodities Equities Repo and secured financing (2) Other information Average assets $ $ 2019 4,663 2,150 1,166 1,347 $ $ 2018 4,496 2,122 1,136 1,238 $ 583,700 $ 508,900 (1) (2) The teb adjustment for the year ended October 31, 2019 was $370 million (October 31, 2018 – $318 million). For further discussion, refer to the How we measure and report our business segments section. Comprises our secured funding businesses for internal businesses and external clients. 5,000 4,000 3,000 2,000 1,000 0 Other 2019 2018 Repo and secured financing Global equities Fixed income, currencies and commodities Other includes our legacy portfolio, which mainly consists of our U.S. commercial mortgage-backed securities and structured rates in Asia. Financial performance Revenue increased $44 million or 21% as compared to last year, largely due to lower residual funding costs. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 41 Corporate Support Corporate Support consists of Technology & Operations, which provide the technological and operational foundation required to effectively deliver products and services to our clients, Functions, which includes our finance, human resources, risk management, internal audit and other functional groups, as well as our Corporate Treasury function. Reported results for Corporate Support mainly reflect certain activities related to monitoring and oversight of enterprise activities which are not allocated to business segments. For further details, refer to the How we measure and report our business segments section. Corporate Support (Millions of Canadian dollars, except as otherwise noted) Net interest income (loss) (1) Non-interest income (loss) (1) Total revenue (1) Non-interest expense Income (loss) before income taxes (1) Income taxes (recoveries) (1) Table 37 $ $ 2019 104 (453) (349) 131 (480) (452) $ (28) $ 2018 (51) (483) (534) 58 (592) (437) (155) Net income (loss) (2) Teb adjusted. (1) Net income reflects income attributable to both shareholders and Non-Controlling Interests (NCI). Net income attributable to NCI for the year ended October 31, 2019 was (2) $(1) million (October 31, 2018 – $22 million). Due to the nature of activities and consolidation adjustments reported in this segment, we believe that a comparative period analysis is not relevant. The following identifies material items affecting the reported results in each year. Total revenue and income taxes (recoveries) in each period in Corporate Support include the deduction of the teb adjustments related to the gross-up of income from Canadian taxable corporate dividends and the U.S. tax credit investment business recorded in Capital Markets. The amount deducted from revenue was offset by an equivalent increase in income taxes (recoveries). The teb amount for the year ended October 31, 2019 was $450 million and was $542 million last year. The following identifies the material items, other than the teb impacts noted previously, affecting the reported results in each year. 2019 Net loss was $28 million, largely due to the impact of an unfavourable accounting adjustment, residual unallocated costs and unfavourable tax impacts, partially offset by asset/liability management activities. 2018 Net loss was $155 million, largely due to the impact of the U.S. Tax Reform of $178 million which was primarily related to the write- down of net deferred tax assets, partially offset by asset/liability management activities. Quarterly financial information Fourth quarter performance Q4 2019 vs. Q4 2018 Fourth quarter net income of $3,206 million was down $44 million or 1% from last year. Diluted EPS of $2.18 was down $0.02 and ROE of 16.2% was down 140 bps. Lower results in Investor & Treasury Services, Capital Markets and Insurance were partially offset by strong earnings in Wealth Management and Personal & Commercial Banking. Our results also reflected a net loss in Corporate Support. Total revenue increased $701 million or 7%, largely due to the change in the fair value of investments backing our policyholder liabilities, which is largely offset in PBCAE as indicated below, and an increase in net interest income reflecting average volume growth in Canadian Banking and U.S. Wealth Management (including City National), partially offset by lower spreads in U.S. Wealth Management (including City National), and a gain on the sale of the private debt business of BlueBay. Higher average fee-based client assets reflecting market appreciation and net sales, higher fixed income trading revenue, realized investment gains in Insurance, and the change in fair value of the hedges related to our U.S. share-based compensation plans, which was largely offset in non-interest expense, also contributed to the increase. These factors were partially offset by lower group annuity sales, which are largely offset in PBCAE as indicated below, and lower M&A and equity trading revenue in Capital Markets. Total PCL increased $146 million and the PCL ratio on loans of 32 bps increased 9 bps from last year, due to higher provisions in Personal & Commercial Banking, Capital Markets, and Wealth Management. After relatively benign credit conditions in the prior year, we returned to a more normalized level of credit losses towards the end of 2019. PBCAE increased $160 million or 32%, mainly due to the change in fair value of investments backing our policyholder liabilities, lower favourable investment-related experience, business growth and lower favourable reinsurance contract renegotiations. Lower favourable annual actuarial assumption updates, largely related to unfavourable mortality, morbidity and commission experience, partially offset by favourable economic assumptions, and higher claims costs also contributed to the increase. These factors were partially offset by lower group annuity sales and the favourable impact of new longevity reinsurance contracts. Non-interest expense increased $437 million or 7%, mainly due to severance and related costs associated with repositioning of our Investor & Treasury Services business. Increased costs in support of business growth and higher staff-related costs, the change in the fair value of our U.S. share-based compensation plans, which was largely offset in revenue, and the impact of an unfavourable accounting adjustment in Corporate Support also contributed to the increase. 42 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Income tax expense increased $2 million from last year. The effective income tax rate increased from 17.5% last year to 17.8%, mainly due to higher favourable tax adjustments in the prior year, partially offset by higher tax-exempt income in the current year. Q4 2019 vs. Q3 2019 Net income of $3,206 million was down $57 million or 2% compared to the prior quarter, primarily due to severance and related costs associated with repositioning our Investor & Treasury Services business and higher PCL. Lower results in Capital Markets driven by lower M&A and lower equity origination, and the impact of an unfavourable accounting adjustment in Corporate Support also contributed to the decrease. These factors were partially offset by a gain on the sale of the private debt business of BlueBay, and the favourable impact of new longevity reinsurance contracts in the current quarter in Insurance. Quarterly results and trend analysis Our quarterly results are impacted by a number of trends and recurring factors, which include seasonality of certain businesses, general economic and market conditions, and fluctuations in the Canadian dollar relative to other currencies. The following table summarizes our results for the last eight quarters (the period): Quarterly results (1) (Millions of Canadian dollars, except per share and percentage amounts) Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets (2) Corporate Support (2) Total revenue PCL PBCAE Non-interest expense Income before income taxes Income taxes Net income EPS – basic – diluted Effective income tax rate Period average US$ equivalent of C$1.00 Q4 $ 4,568 3,187 1,153 566 1,987 (91) $ 11,370 499 654 6,319 $ 3,898 692 $ 3,206 2.19 $ 2.18 17.8% $ 0.755 2019 2018 Q3 $ 4,546 3,029 1,463 561 2,034 (89) $ 11,544 425 1,046 5,992 $ 4,081 818 $ 3,263 2.23 $ 2.22 20.0% Q2 $ 4,333 2,979 1,515 587 2,169 (84) $ 11,499 426 1,160 5,916 $ 3,997 767 $ 3,230 2.20 $ 2.20 19.2% Q1 $ 4,418 2,948 1,579 631 2,098 (85) $ 11,589 514 1,225 5,912 $ 3,938 766 $ 3,172 2.15 $ 2.15 19.5% Q4 $ 4,364 2,740 1,039 624 2,056 (154) $ 10,669 353 494 5,882 $ 3,940 690 $ 3,250 2.21 $ 2.20 17.5% Q3 $ 4,284 2,798 1,290 620 2,157 (124) $ 11,025 346 925 5,858 $ 3,896 787 $ 3,109 2.10 $ 2.10 20.2% Q2 $ 4,103 2,605 806 671 2,010 (141) $ 10,054 274 421 5,482 $ 3,877 817 $ 3,060 2.06 $ 2.06 21.1% Table 38 Q1 $ 4,165 2,783 1,144 676 2,175 (115) $ 10,828 334 836 5,611 $ 4,047 1,035 $ 3,012 2.02 $ 2.01 25.6% $ 0.754 $ 0.751 $ 0.749 $ 0.767 $ 0.767 $ 0.778 $ 0.794 (1) (2) Fluctuations in the Canadian dollar relative to other foreign currencies have affected our consolidated results over the period. Teb adjusted. For further discussion, refer to the How we measure and report our business segments section. Seasonality Seasonal factors may impact our results in certain quarters. The first quarter has historically been stronger for our Capital Markets businesses. The second quarter has fewer days than the other quarters, which generally results in a decrease in net interest income and certain expense items. The third and fourth quarters include the summer months which results in lower client activity and may negatively impact the results of our Capital Markets brokerage business. Trend analysis Earnings have generally trended upward over the period. However, results in the first quarter of 2019 were impacted by challenging market conditions throughout the earlier part of the quarter. Quarterly earnings are also affected by the impact of foreign exchange translation. Personal & Commercial Banking revenue has benefitted from solid volume growth since the beginning of the period. Higher spreads across the period reflecting higher interest rates have been partially offset by the impact of competitive pricing pressures. Overall, however, market interest rates have moderated in the latter half of the 2019. Wealth Management revenue has generally trended upwards primarily due to growth in average fee-based client assets which benefitted from market appreciation and net sales. Net interest income has also increased largely driven by volume growth across the period and the impact of higher interest rates throughout the majority of the period. The impact of the U.S. Fed rate cuts resulted in lower spreads in the fourth quarter of 2019. A gain on the sale of the private debt business of BlueBay contributed to the increase in the fourth quarter of 2019. The change in the fair value of the hedges related to our U.S. share- based compensation plans, which is largely offset in Non-interest expense, also contributed to fluctuations in revenue over the period. Insurance revenue fluctuated over the period, primarily due to the impact of changes in the fair value of investments backing our policyholder liabilities. Revenue has benefited from business growth in Canadian and International Insurance over the majority of the period with lower group annuity sales impacting the fourth quarter of 2019. Investor & Treasury Services revenue has been impacted by fluctuations in market conditions and client activity across the period. The first half of 2018 trended higher due to generally higher market volatility, growth in client deposits, and increased client activity from our asset service business, combined with an improvement in funding and liquidity performance. Revenue from our funding and liquidity business was impacted by reduced money market opportunities in the current year and our asset services business was impacted by challenging market conditions during the first half of 2019. The latter part of the period was impacted by lower client activity and lower client deposit margins. Capital Markets revenue is influenced, to a large extent, by market conditions that impact client activity in our Corporate and Investment Banking and Global Markets businesses, with the first quarter results generally stronger than the remaining quarters. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 43 The second quarter of 2018 experienced lower equity originations driven by lower market activity, decreased fixed income trading across all regions, and lower equity trading revenue in the U.S. The decline experienced in the fourth quarter of 2018 largely resulted from lower fixed income trading revenue. Client activity in 2019 was impacted by challenging market conditions resulting in lower investment banking fee revenues experienced across the industry. The impact of challenging market conditions also resulted in lower equity trading revenue in the second half of 2019. PCL on performing assets has fluctuated over the period as it is impacted by volume growth, changes in portfolio mix, model changes and macroeconomic conditions. PCL saw lower provisions and higher recoveries on impaired loans across a few sectors for the majority of 2018. The fourth quarter of 2018 was also impacted by the restructuring of portfolios in Barbados. After relatively benign credit conditions in 2018, we returned to a more normalized level of credit losses towards the end of 2019. PBCAE has fluctuated quarterly as it includes the changes to the fair value of investments backing our policyholder liabilities and business growth, including the impact of group annuity sales, both of which are largely offset in Revenue. PBCAE has also fluctuated due to investment-related experience and claims costs over the period. Since late 2018, PBCAE has been positively impacted by favourable reinsurance contract renegotiations. Actuarial adjustments, which generally occur in the fourth quarter of each year, also impact PBCAE results. While we continue to focus on efficiency management activities, Non-interest expense generally trended upwards over the period. Growth mainly reflects higher costs in support of business growth and our ongoing investments in technology and related costs, including digital initiatives, and higher staff-related costs, including variable compensation. The increase in the fourth quarter of 2019 reflected severance and related costs associated with repositioning of our Investor & Treasury Services business. Our effective income tax rate has fluctuated over the period, mostly due to various levels of tax adjustments and changes in earnings mix. The first quarter of 2018 was adversely impacted by the U.S. Tax Reform, which resulted in the write-down of net deferred tax assets, however, this was more than offset during 2018 by the ongoing lower corporate tax rate. The first quarter of 2019 included a write-down of deferred tax assets resulting from a change in the corporate tax rate in Barbados. Financial condition Condensed balance sheets (Millions of Canadian dollars) Assets Cash and due from banks Interest-bearing deposits with banks Securities, net of applicable allowance (1) Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Other – Derivatives – Other (2) Total assets Liabilities Deposits (3) Other – Derivatives – Other (2), (3) Subordinated debentures Total liabilities Equity attributable to shareholders Non-controlling interests Total equity Total liabilities and equity Table 39 2019 2018 $ $ 26,310 38,345 249,004 306,961 30,209 36,471 222,866 294,602 426,086 195,870 (3,100) 101,560 87,899 $ 1,428,935 399,452 180,278 (2,912) 94,039 79,729 $ 1,334,734 $ 886,005 98,543 350,947 9,815 1,345,310 83,523 102 83,625 $ 1,428,935 $ 836,197 90,238 319,213 9,131 1,254,779 79,861 94 79,955 $ 1,334,734 (1) (2) (3) Securities are comprised of trading and investment securities. Other – Other assets and liabilities include Segregated fund net assets and liabilities, respectively. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. 2019 vs. 2018 Total assets increased $94 billion or 7% from last year. Foreign exchange translation increased total assets by $2 billion. Cash and due from banks was down $4 billion or 13%, mainly due to lower deposits with central banks, reflecting our short- term cash management activities. Interest-bearing deposits with banks increased $2 billion or 5%, largely due to higher deposits with central banks, reflecting our cash management activities. Securities, net of applicable allowance, were up $26 billion or 12%, largely driven by higher government debt securities, driven by client and business activities. Higher equity trading securities, reflecting favourable market conditions, also contributed to the increase. Assets purchased under reverse repurchase agreements (reverse repos) and securities borrowed increased $12 billion or 4%, driven by client and business activities, partially offset by higher financial netting. Loans (net of Allowance for loan losses) were up $42 billion or 7%, primarily due to volume growth, which was driven by higher residential mortgages loans and wholesale loans. Derivative assets were up $8 billion or 8%, mainly attributable to higher fair values on interest rate contracts, partially offset by lower fair values on foreign exchange contracts. 44 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Other assets were up $8 billion or 10%, driven by higher customers’ liability under acceptances and higher commodities trading receivables, driven by client demand. Higher cash collateral also contributed to the increase. Total liabilities increased $91 billion or 7% from last year. Foreign exchange translation increased total liabilities by $2 billion. Deposits increased $50 billion or 6%, mainly as a result of higher business and retail deposits, driven by client activities. Derivative liabilities were up $8 billion or 9%, mainly attributable to higher fair values on interest rate contracts, partially offset by lower fair values on foreign exchange contracts. Other liabilities increased $32 billion or 10%, mainly attributable to higher obligations related to repurchase agreements due to increased client activity, partially offset by higher financial netting. Higher obligations related to securities sold short and higher acceptances also contributed to the increase. Total equity increased $4 billion or 5% reflecting earnings, net of dividends and share repurchases, redemptions of preferred shares and the impact of lower discount rates on the remeasurement of our employee benefit plans, partially offset by favourable returns on plan assets. Off-balance sheet arrangements In the normal course of business, we engage in a variety of financial transactions that, for accounting purposes, are not recorded on our Consolidated Balance Sheets. Off-balance sheet transactions are generally undertaken for risk, capital and funding management purposes which benefit us and our clients. These include transactions with structured entities and may also include the issuance of guarantees. These transactions give rise to, among other risks, varying degrees of market, credit, liquidity and funding risk, which are discussed in the Risk management section. We use structured entities to securitize our financial assets as well as assist our clients in securitizing their financial assets. These entities are not operating entities, typically have no employees, and may or may not be recorded on our Consolidated Balance Sheets. In the normal course of business, we engage in a variety of financial transactions that may qualify for derecognition. We apply the derecognition rules to determine whether we have transferred substantially all the risks and rewards or control associated with the financial assets to a third party. If the transaction meets specific criteria, it may qualify for full or partial derecognition from our Consolidated Balance Sheets. Securitizations of our financial assets We periodically securitize our credit card receivables and residential and commercial mortgage loans primarily to diversify our funding sources, enhance our liquidity position and for capital purposes. We also securitize residential and commercial mortgage loans as part of our sales and trading activities. We securitize our credit card receivables, on a revolving basis, through a consolidated structured entity. We securitize single and multiple-family residential mortgages through the National Housing Act Mortgage-Backed Securities (NHA MBS) program. The majority of our securitization activities are recorded on our Consolidated Balance Sheets as we do not meet the derecognition criteria. During 2019, we did not derecognize any mortgages securitized through the NHA MBS program. As at October 31, 2018, we derecognized $1.3 billion of mortgages where both the NHA MBS and the residual interests in the mortgage pools were sold to third parties resulting in the transfer of substantially all of the risks and rewards. For further details, refer to Note 6 and Note 7 of our 2019 Annual Consolidated Financial Statements. We also periodically securitize commercial mortgage loans by selling them in collateral pools, which meet certain diversification, leverage and debt coverage criteria, to structured entities, one of which is sponsored by us. Securitized commercial mortgage loans are derecognized from our Consolidated Balance Sheets as we have transferred substantially all of the risks and rewards of ownership of the securitized assets. During the year ended October 31, 2019, we securitized $696 million of commercial mortgages (October 31, 2018 – $352 million). Our continuing involvement with the transferred assets is limited to servicing certain of the underlying commercial mortgages sold. As at October 31, 2019, there was $1.9 billion of commercial mortgages outstanding that we continue to service related to these securitization activities (October 31, 2018 – $1.5 billion). Involvement with unconsolidated structured entities In the normal course of business, we engage in a variety of financial transactions with structured entities to support our customers’ financing and investing needs, including securitization of our clients’ financial assets, creation of investment products, and other types of structured financing. We have the ability to use credit mitigation tools such as third-party guarantees, credit default swaps, and collateral to mitigate risks assumed through securitization and re-securitization exposures. The process in place to monitor the credit quality of our securitization and re-securitization exposures involves, among other things, reviewing the performance data of the underlying assets. We affirm our ratings each quarter and formally confirm or assign a new rating at least annually. For further details on our activities to manage risks, refer to the Risk management section. Below is a description of our activities with respect to certain significant unconsolidated structured entities. For a complete discussion of our interests in consolidated and unconsolidated structured entities, refer to Note 7 of our 2019 Annual Consolidated Financial Statements. RBC-administered multi-seller conduits We administer multi-seller conduits which are used primarily for the securitization of our clients’ financial assets. Our clients primarily use our multi-seller conduits to diversify their financing sources and to reduce funding costs by leveraging the value of high-quality collateral. The conduits offer us a favourable revenue stream and risk-adjusted return. We provide services such as transaction structuring, administration, backstop liquidity facilities and partial credit enhancements to the multi-seller conduits. Revenue for all such services amounted to $254 million during the year (October 31, 2018 – $262 million). Our total commitment to the conduits in the form of backstop liquidity and credit enhancement facilities is shown below. The total committed amount of these facilities exceeds the total amount of the maximum assets that may have to be purchased by the conduits under the purchase agreements. As a result, the maximum exposure to loss attributable to our backstop liquidity and credit enhancement facilities is less than the total committed amounts of these facilities. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 45 Liquidity and credit enhancement facilities As at October 31 (Millions of Canadian dollars) Backstop liquidity facilities Credit enhancement facilities (3) Total Notional of committed amounts (1) $ 37,935 1,706 $ 39,641 2019 Allocable notional amounts $ 36,229 1,706 $ 37,935 Maximum exposure to loss (2) $ 36,229 1,706 $ 37,935 Notional of committed amounts (1) 38,342 $ 2,149 40,491 $ Table 40 Maximum exposure to loss (2) 36,193 2,149 38,342 $ $ 2018 Allocable notional amounts $ 36,193 2,149 $ 38,342 (1) (2) (3) Based on total committed financing limit. Not presented in the table above are derivative assets with a fair value of $97 million (October 31, 2018 –$nil) which are a component of our total maximum exposure to loss from our interests in the multi-seller conduits. Refer to Note 7 of our 2019 Annual Consolidated Financial Statements for more details. Includes $14 million (October 31, 2018 - $22 million) of Financial standby letters of credit. As at October 31, 2019, the notional amount of backstop liquidity facilities we provide decreased by $407 million or 1% from last year. The decrease as compared to last year was primarily due to lower outstanding securitized assets in the multi-seller conduits. The notional amount of partial credit enhancement facilities we provide decreased by $443 million from last year. The decrease in the credit enhancement facilities reflects lower client usage. Maximum exposure to loss by client type Table 41 As at October 31 (Millions of dollars) Outstanding securitized assets Credit cards Auto loans and leases Student loans Trade receivables Equipment receivables Consumer loans Dealer floor plan receivables Fleet finance receivables Insurance premiums Residential mortgages Transportation finance Total Canadian equivalent 2019 2018 US$ C$ Total C$ US$ C$ Total C$ $ 4,258 9,003 1,777 2,338 1,479 2,150 910 602 213 – 1,498 $ 24,228 $ 510 2,882 – – – – 878 306 286 1,014 153 $ 6,029 $ 6,117 14,738 2,340 3,079 1,948 2,831 2,077 1,099 566 1,014 2,126 $ 37,935 $ 4,406 10,726 1,707 2,220 1,581 1,387 833 614 122 – 1,335 $ 24,931 $ 510 2,148 – – – – 852 306 194 1,377 153 $ 5,540 $ 6,308 16,260 2,246 2,921 2,080 1,825 1,948 1,113 355 1,377 1,909 $ 38,342 $ 31,906 $ 6,029 $ 37,935 $ 32,802 $ 5,540 $ 38,342 Our overall exposure decreased by 1% compared to last year, reflecting a decrease in the outstanding securitized assets of the multi-seller conduits. Correspondingly, total assets of the multi-seller conduits decreased by $398 million or 1% from last year, primarily due to decreases in the Auto loans and leases and Residential mortgages asset classes, which were offset by increases in the Consumer loans, Insurance premiums and Transportation finance asset classes. 100% of multi-seller conduits assets were internally rated A or above, consistent with last year. All transactions funded by the unconsolidated multi-seller conduits are internally rated using a rating system which is largely consistent with that of the external rating agencies. Multiple independent debt rating agencies review all of the transactions in the multi-seller conduits. Transactions financed in the U.S. multi-seller conduits are reviewed by Moody’s Investors Service (Moody’s), Standard & Poor’s (S&P) and Fitch Ratings (Fitch). Transactions in the Canadian multi-seller conduits are reviewed by DBRS and Moody’s. Each applicable rating agency also reviews ongoing transaction performance on a monthly basis and may publish reports detailing portfolio and program information related to the conduits. As at October 31, 2019, the total asset-backed commercial paper (ABCP) issued by the conduits amounted to $23.8 billion, a decrease of $1.1 billion or 4.4% from last year. The decrease in the amount of ABCP issued by the multi-seller conduits compared to last year is primarily due to lower client usage. The rating agencies that rate the ABCP rated 100% (October 31, 2018 – 71%) of the total amount issued within the top ratings category. Structured finance We invest in auction rate securities (ARS) of certain trusts which fund their long-term investments in student loans by issuing short-term senior and subordinated notes. Our maximum exposure to loss in these ARS trusts as at October 31, 2019 was $60 million (October 31, 2018 – $176 million). The decrease in our maximum exposure to loss was primarily related to sales to third parties and redemptions. We also provide liquidity facilities to certain municipal bond Tender Option Bond (TOB) trusts in which we have an interest but do not consolidate because the residual certificates issued by the TOB trusts are held by third parties. As at October 31, 2019, our maximum exposure to loss from these unconsolidated municipal bond TOB trusts was $3.1 billion (October 31, 2018 – $2.4 billion). The increase in our maximum exposure to loss relative to last year was primarily due to the addition of new trusts. We provide senior warehouse financing to discrete unaffiliated structured entities that are established by third parties to acquire loans and issue term collateralized loan obligations (CLO). A portion of the proceeds from the sale of the term CLO is used to fully repay the senior warehouse financing that we provide. As at October 31, 2019, our maximum exposure to loss associated with the outstanding senior warehouse financing facilities was $253 million (October 31, 2018 – $837 million). The decrease in our maximum exposure to loss relative to last year was related to the termination of existing financing facilities. We provide senior financing to unaffiliated structured entities that are established by third parties to acquire loans. These facilities tend to be longer in term than the CLO warehouse facilities and benefit from credit enhancement designed to cover a 46 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis multiple of historical losses. As at October 31, 2019, our maximum exposure to loss associated with the outstanding senior financing facilities was $2.8 billion (October 31, 2018 – $1.8 billion). The increase in our maximum exposure to loss relative to last year was driven by the addition of new financing facilities. Investment funds We invest in hedge funds primarily to provide clients with desired exposures to reference funds. As we make investments in the reference funds, exposures to the funds are simultaneously transferred to clients through derivative transactions. Our maximum exposure to loss in the reference funds is limited to our investments in the funds. As at October 31, 2019, our maximum exposure to loss was $1.8 billion (October 31, 2018 – $2.7 billion). The decrease in our maximum exposure to loss relative to last year was due to reduced holdings in third-party investment funds. We also provide liquidity facilities to certain third-party investment funds. The funds issue unsecured variable-rate preferred shares and invest in portfolios of tax exempt bonds. As at October 31, 2019, our maximum exposure to these funds was $275 million (October 31, 2018 – $275 million). Third-party securitization vehicles We hold interests in certain unconsolidated third-party securitization vehicles, which are structured entities. We, as well as other financial institutions, are obligated to provide funding to these entities up to our maximum commitment level and are exposed to credit losses on the underlying assets after various credit enhancements. As at October 31, 2019, our maximum exposure to loss in these entities was $10.7 billion (October 31, 2018 – $10.2 billion). The increase in our maximum exposure to loss compared to last year reflects growth in the securitized assets in these entities and the impact of foreign currency translation. Interest and non-interest income earned in respect of these investments was $195 million (October 31, 2018 – $126 million). Guarantees, retail and commercial commitments We provide our clients with guarantees and commitments that expose us to liquidity and funding risks. Our maximum potential amount of future payments in relation to our commitments and guarantee products as at October 31, 2019 amounted to $380.3 billion compared to $392.7 billion last year. The decrease compared to last year was driven primarily by lower business activity in securities lending indemnifications partially offset by growth in both commitments to extend credit and financial standby letters of credit. Refer to Liquidity and funding risk and Note 25 of our 2019 Annual Consolidated Financial Statements for details regarding our guarantees and commitments. Risk management We are in the business of managing the risks inherent to the financial services industry as we aim to create maximum value for our shareholders, clients, employees and communities. The ability to manage risk is a core competency of the bank, and is supported by our strong risk conduct and risk-aware culture. Our view of risks is dynamic, reflecting the pace of change in the financial services industry. Top and emerging risks An important component of our risk management approach is to ensure that top risks and emerging risks, as they evolve, are identified, managed, and incorporated into our existing risk management assessment, measurement, monitoring and escalation processes. These practices ensure a forward-looking risk assessment is maintained by management in the course of business development and as part of the execution of ongoing risk oversight responsibilities. Top and emerging risks are discussed by senior management and the Board on a regular basis. We have developed separate definitions for Top Risks and Emerging Risks, as well as supplementary internal guidance, to support enterprise-wide identification and assessment of all material risks, including those that are not readily apparent. (cid:129) (cid:129) A Top Risk is a risk already identified and well understood that could materially impact our financial results, reputation, business model, or strategy in the short to medium term. An Emerging Risk is one that could materially impact our financial results, reputation, business model, or strategy, but is distinguished by a lack of clarity with respect to the probabilities, impacts, timing, and/or ranges of potential outcomes. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 47 Top Risks Description Information Technology and Cyber Risks Privacy, Data and Third Party Related Risks Information technology (IT) and cyber risks remain as top risks, not only for the financial services sector, but for other industries worldwide. We are subject to heightened risks in the form of cyber-attacks, data breaches, cyber extortion and similar compromises, due to the size, scale, and global nature of our operations, our heavy reliance on the internet to conduct day-to-day business activities, our intricate technological infrastructure and our use of third party service providers. Additionally, clients’ use of personal devices can create further avenues for potential cyber-related incidents as the bank has little or no control over the safety of these devices. As the volume and sophistication of cyber-attacks continue to increase, the resulting implications could include business interruptions, service disruptions, financial loss, theft of intellectual property and confidential information, litigation, enhanced regulatory attention and penalties, and reputational damage. Furthermore, the adoption of emerging technologies, such as cloud computing, artificial intelligence (AI) and robotics, call for continued focus and investment to manage our risks effectively. For details on how we are managing these risks, refer to the Operational risk section. The management, use, and protection of data is a top risk given the high value attributed to data and the potential exposure to operational risks, reputational risks, and regulatory compliance risks. The growing importance of effective privacy and information management practices and controls has been demonstrated by the pace and size of recent regulatory enforcement. Further, as we continue to partner with third party service providers and adopt new technologies and business models (e.g., cloud computing), our potential exposure to these risks increases. For details on how we are managing these risks, refer to the Operational risk section. Geopolitical Uncertainty Persisting trade tensions, policy changes, and uncertainties pertaining to Brexit and the political direction of the U.S., U.K. and Europe, have continued to impact global economic growth prospects and market sentiment. The Canadian economy is vulnerable to continued trade tensions given the country’s trading relationships with the U.S. and China. Tensions also remain elevated between China and the U.S. as they continue to negotiate a trade deal. In addition, the changing political landscape in Hong Kong and ongoing tensions in the Middle East add further to global and economic uncertainty. Canadian Housing and Household Indebtedness The Government of Canada, and a number of provincial governments, have introduced measures to respond to concerns related to housing affordability in certain markets and elevated levels of Canadian household debt. Lower mortgage rates, along with a solid labour market and strong population growth, helped spark a recovery in the Canadian housing market in 2019. The turnaround, however, has been slower in Western Canada due to the presence of additional cooling measures in British Columbia, coupled with more modest economic growth in Alberta and Saskatchewan. Low interest rates should help ease upward pressures on household debt service ratios but should interest rates begin to rise, this could have materially negative credit implications for our broader consumer lending activities. Regulatory Changes We operate in multiple jurisdictions, and the continued introduction of new or revised regulations leads to increasing focus across the organization on meeting higher regulatory requirements across a number of different markets. Financial and other reforms coming into effect, across multiple jurisdictions, such as the Canadian Anti-Money Laundering regulations and Interest Rate Benchmark Reform, continue to provide challenges and impact our operations and strategies. For more details, refer to the Legal and regulatory environment risk section. Emerging Risks Description Digital Disruption and Innovation Demographic trends, evolving client expectations, the increased power to analyze data and the emergence of disruptors are creating competitive pressures across a number of sectors. Established technology companies, newer competitors, and regulatory changes continue to foster new business models that could challenge traditional banks and financial products. In addition, these trends and developments are eliciting re-energized efforts from traditional competitors to meet the evolving needs of clients and compete with non-traditional competitors. Finally, the adoption of new technologies, such as AI and machine learning, presents opportunities for us, but could result in new and complex risks that would need to be managed effectively. Climate Change Extreme weather events and the global transition to a low carbon economy could result in a broad range of impacts, including potential strategic, reputational, structural and credit related risks for us and our clients. In addition, climate change regulations, frameworks, and guidance are rapidly emerging and evolving across the globe. Increasing regulatory expectations create a new set of compliance risks that need to be managed. For details on how we are managing these risks, refer to the Environmental and social risk discussion within the Overview of other risks section. 48 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Overview As a global financial institution with a diversified business model, we actively manage a variety of risks to help protect and enable our businesses by following these risk management principles: Risk Management Principles (cid:129) (cid:129) (cid:129) Effectively balance risk and reward to enable sustainable growth; Shared responsibility for risk management; Always uphold our Purpose and Vision, and consistently abide by our Values and Code of Conduct to maintain our reputation and the trust of our clients, colleagues and communities; Undertake only risks we understand and make thoughtful and future-focused risk decisions; (cid:129) (cid:129) Maintain a healthy and robust control environment to protect our stakeholders; (cid:129) (cid:129) Use judgment and common sense; Always be operationally prepared and financially resilient for a potential crisis. The dynamic nature of the financial services industry, and technological innovation, necessitate that our processes, tools and practices are continuously improving and responsive to the changing landscape and emerging risks. We accomplish this through an effective and evolving risk management approach. All risk-taking activities and exposures are within the Board-approved risk appetite, risk limits and corresponding capital and liquidity requirements. We ensure that our business activities and transactions provide an appropriate balance of return for the risks assumed and the costs incurred. Our organizational design and governance processes ensure that our Group Risk Management (GRM) function is independent from the businesses it supports. Risk drivers We define risk as the potential for downside volatility of earnings or an adverse effect on our resilience, due to losses or an undesirable outcome with respect to volatility of actual earnings in relation to expected earnings, capital adequacy or liquidity. Our principal risks include credit, market, liquidity, insurance, operational, regulatory compliance, strategic, reputation, legal and regulatory environment, competitive, and systemic risks, which have been classified into four categories based on the level of control and influence that we can exert against these risks. These categories are maintained by GRM and reviewed regularly to ensure all principal risks are reflected. This classification methodology provides a common language and discipline for the identification and assessment of risk in existing businesses, new businesses, products or initiatives, as well as acquisitions and alliances. LessLess Macroeconomic Strategic e c n e u fl n I & l o r t n o C MoreMore Adverse changes in the macroeconomic environment can impact the real economy or the financial system in any of the regions in which we operate. – Examples include deterioration in the Canadian housing market, abrupt changes in the geopolitical environment, or unfavourable global trade agreements. Resultant impacts can materialize as loss of revenue, as well as realization of credit, market or operational risk losses. Macroeconomic risk is the least controllable type of risk arising from the business environment in which we operate. However, we have controls in place to mitigate the impacts. These include our diversified business model and funding sources, financial crisis management strategies and protocols, stress testing programs, and product and geographic diversification. Business strategy is a major driver of our risk appetite, including acquisitions and dispositions, responses to threats posed by non-traditional competitors and responses to proposed changes in the regulatory environment. Choosing the wrong strategy, or poorly executing on the correct strategy, could have reputational risk consequences, impact our revenue mix, and/or affect our exposure to earnings volatility and loss absorption capacity. We have a fair degree of control and influence we can exert in managing strategic and reputation risk. While the legal and regulatory environment and competitive risks are less controllable, we seek to influence them through our role as a corporate entity and as an active participant in the Canadian and global financial services industry. Operational / Regulatory Compliance The complexity and scope of our operations across the globe exposes us to operational and regulatory compliance risks, which include fraud, anti-money laundering, cybersecurity and conduct risk. We have a certain level of control over these risks through our people and systems as well as how we respond to external events. Transactional / Positional Credit, market, liquidity and insurance risks are an integral part of our day-to-day business activities. We earn revenue by taking these transactional / positional risks. We understand these risks well and have the greatest level of control and influence over them. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 49 Enterprise risk management Under the oversight of the Board and senior management, the Enterprise Risk Management Framework (ERMF) provides an overview of our enterprise-wide programs for managing risk, including identifying, assessing, measuring, controlling, monitoring and reporting on the significant risks that face the organization. Risk governance We have an effective and well-established governance framework in place to ensure that risks impacting our businesses are identified, appropriately categorized, assessed, managed and communicated to the Board in a timely manner. The risk governance framework has been established, and is maintained in alignment with, the expectations of the Office of the Superintendent of Financial Institutions (OSFI), the Basel Committee on Banking Supervision’s (BCBS) corporative governance principles, and the requirements and expectations of other regulators in the jurisdictions and businesses in which we conduct business, and in accordance with industry best practices. The Board oversees the implementation of our risk management framework, while employees at all levels of the organization are responsible for managing the day-to-day risks that arise in the context of their mandates. As illustrated below, we use the three lines of defence governance model to ensure that risks are appropriately and adequately managed throughout the enterprise in order to achieve our strategic objectives. BOARD OF DIRECTORS RISK COMMITTEE AUDIT COMMITTEE GOVERNANCE COMMITTEE HUMAN RESOURCES COMMITTEE The Board establishes the tone from above, approves our risk appetite, provides oversight and carries out its risk management mandate primarily through its committees which include the Risk Committee, the Audit Committee, the Governance Committee and the Human Resources Committee. The Risk Committee oversees our risk management program by ensuring that the policies, procedures and controls used by management are sufficient to keep risks within our risk appetite. The Risk Committee’s oversight role is designed to ensure that the risk management function is adequately independent from the businesses whose activities it reviews. Its oversight activities include the review of the GRM function which evaluates GRM’s success against its key priorities, the mandate of the Chief Risk Officer (CRO), the GRM organizational structure, and the function’s budget and resources. The Audit Committee assists the Board in its oversight of (i) the integrity of our financial statements; (ii) the qualifications, performance and independence of our external auditors; (iii) the performance of our internal audit function and internal controls; and (iv) compliance with legal and regulatory requirements. The Governance Committee recommends individuals for Board member election or re-election, oversees the process for evaluating Board members, and oversees management of conduct, including breaches of the Code of Conduct. Additional responsibilities include (i) developing and recommending governance frameworks, principles and policies to the Board; (ii) overseeing corporate citizenship matters; (iii) monitoring developments in corporate governance and adapting best practices; and (iv) reviewing shareholder proposals and recommending responses to the Board. The Human Resources Committee assists the Board in its oversight of compensation policies and programs, compensation for the CEO and Group Executives (GE), as well as compensation risk management. It also oversees our pension plans, key talent management strategies and practices, and management succession plans. GROUP EXECUTIVES AND GROUP RISK COMMITTEE Actively shapes enterprise risk appetite and recommends it for Board approval. Establishes the tone from above and visibly supports and communicates enterprise risk appetite, ensuring that sufficient resources and expertise are in place to help provide effective oversight of adherence to the enterprise risk appetite. Ensures principles, policies, authorities, resources, responsibilities and reporting are in place to support the control infrastructure necessary for an effective enterprise-wide risk management program. Oversees conduct and risk culture strategy and key activities. The Compensation Risk Management Oversight Committee (CRMOC) oversees the design of major compensation programs to ensure alignment with sound risk management principles and that risks that may not be fully captured in our current financial performance are appropriately considered in variable compensation payouts, including enterprise risk profile relative to risk appetite. The CRMOC ensures our compensation programs align with the Financial Stability Board (FSB) Principles for Sound Compensation Practices and Implementation Standards (FSB Principles) and other applicable guidance and best practices. FIRST LINE OF DEFENCE SECOND LINE OF DEFENCE THIRD LINE OF DEFENCE RISK OWNERS RISK OWNERS RISK OVERSIGHT RISK OVERSIGHT INDEPENDENT ASSURANCE INDEPENDENT ASSURANCE Employees in the business and support functions embedded in the business Accountable for: Identification; Assessment; Mitigation; Monitoring; and Reporting of risk against approved policies and appetite RISK MANAGEMENT GLOBAL COMPLIANCE The CRO has direct access to the Risk Committee The Chief Compliance Officer (CCO) and the Chief Anti-Money Laundering Officer (CAMLO) have direct access to the Audit Committee Establishes risk management practices and provides risk guidance Provides oversight of the effectiveness of First Line risk management practices Monitors and independently reports on the level of risk against established risk appetite Internal Audit Independent assurance to management and the Board on the effectiveness of risk management practices 50 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis i t e p p Ris k A Risk appetite Effective risk management protects us from unacceptable losses or undesirable outcomes with respect to earnings volatility, capital adequacy or liquidity, reputational risk or other risks while supporting and enabling our overall business strategy. It requires the clear articulation of our risk appetite, which is the amount and type of risk that we are able and willing to accept in the pursuit of our business objectives, and how our risk profile will be managed in relation to our risk appetite. Our risk appetite provides clear boundaries and sets an overall tone for balancing risk-reward trade-offs to ensure the long- term viability of the organization. Our Enterprise Risk Appetite Framework (ERAF) outlines the foundational aspects of our approach to risk appetite, articulates risk appetite statements and their supporting measures and associated constraints, guides design and implementation of risk appetite, and defines roles and responsibilities for its implementation and oversight. It also outlines our risk posture as the expression of the anticipated shift in risk profile as a result of changes in objectives, strategies, or external and other factors over a one year timeframe. Our risk appetite is articulated in several complimentary qualitative and quantitative risk appetite statements, which can be applied at the enterprise, business segment, business unit and legal entity levels. Risk appetite is also integrated into our strategic, financial, and capital planning processes, as well as ongoing business decision- making processes. It is reviewed annually by senior management for recommendation to the Board for approval. t e F r amework Co m p o n e n t s Risk Capacity Risk Appetite Risk Limits Risk Profile Risk Posture Quantitative Statements Qualitative Statements Risk Appetite Statements (cid:129) (cid:129) (cid:129) Manage earnings volatility and exposure to future losses under normal and stressed conditions. Avoid excessive concentrations of risk. Ensure sound management of operational and regulatory compliance risk. Ensure capital adequacy and sound management of liquidity and funding risk. (cid:129) (cid:129) Maintain strong credit ratings and a risk profile that is in the top half of our peer group. (cid:129) (cid:129) Undertake only risk we understand and make thoughtful and future-focused risk decisions. Effectively balance risk and reward to enable sustainable growth. (cid:129) Maintain a healthy and robust control environment to (cid:129) (cid:129) protect our stakeholders. Always be operationally prepared and financially resilient for a potential crisis. Always uphold our Purpose and Vision and consistently abide by our Values and Code of Conduct to maintain our reputation and the trust of our clients, colleagues, and communities. Our qualitative risk appetite statements are based on our Risk Management Principles, which aim to articulate clear motivations for taking on, or avoiding, non-financial and less quantifiable risks, such as reputation and conduct risks. Our quantitative risk appetite statements are underpinned by specific quantitative risk measures. Risk measurement Our ability to measure risks is a key component of our enterprise-wide risk and capital management processes. Certain measurement methodologies are common to a number of risk types, while others only apply to a single risk type. While quantitative risk measurement is important, we also place reliance on qualitative factors. For those risk types that are difficult to quantify, we place greater emphasis on qualitative risk factors and assessment of activities to gauge the overall level of risk to ensure that they are within our risk appetite. In addition, we use judgment-based risk measures and various risk techniques, such as stress testing, and scenario and sensitivity analyses to assess and measure risks. Our primary methods for measuring risk include: (cid:129) Quantifying expected loss: Assesses earnings at risk and is a representation of losses that are statistically expected to occur in the normal course of business in a given time period; Quantifying unexpected loss: Assesses capital at risk under stressed conditions and is a statistical estimate of the amount by which actual earnings depart from the expected, over a specified time horizon; Stress testing: Provides a forward-looking perspective and evaluates the potential effects of a set of specified changes in risk factors, corresponding to exceptional but plausible adverse economic and financial market events; and Back-testing: Compares the realized values to the parameter estimates that are currently used to ensure the parameters remain appropriate for regulatory and economic capital calculations. (cid:129) (cid:129) (cid:129) Assessing the viability of long-term business plans and strategies; Stress testing Stress testing is an important component of our risk management framework. Stress testing results are used for: (cid:129) (cid:129) Monitoring our risk profile relative to our risk appetite in terms of earnings and capital at risk; (cid:129) (cid:129) (cid:129) (cid:129) Setting limits; Identifying key risks to, and potential shifts in, our capital and liquidity levels, as well as our financial position; Enhancing our understanding of available mitigating actions in response to potential adverse events; and Assessing the adequacy of our target capital and liquidity levels. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 51 Our enterprise-wide stress tests evaluate key balance sheet, income statement, leverage, capital, and liquidity impacts arising from risk exposures and changes in earnings. The results are used by the Board, Group Risk Committee (GRC) and senior management risk committees to understand our performance drivers under stress, and review stressed capital, leverage, and liquidity ratios against regulatory thresholds and internal targets. The results are also incorporated into our Internal Capital Adequacy Assessment Process (ICAAP) and capital plan analyses. We annually evaluate a number of enterprise-wide stress scenarios over a multi-year horizon, featuring a range of severities. Our Board reviews the recommended scenarios, and GRM leads the scenario assessment process. Results from across the organization are integrated to develop an enterprise-wide view of the impacts, with input from subject matter experts in GRM, Corporate Treasury, Finance, and Economics. Recent scenarios evaluated include global recessions, equity market corrections, higher sovereign risks, a global trade war, increases in interest rates, real estate price corrections, and shocks to credit spreads and commodity markets. Ongoing stress testing and scenario analyses within specific risk types, such as market risk, liquidity risk, structural interest rate risk, retail and wholesale credit risk, operational risk, and insurance risk, supplement and support our enterprise-wide analyses. Results from these risk-specific programs are used in a variety of decision-making processes including risk limit setting, portfolio composition evaluation, risk appetite articulation and business strategy implementation. In addition to ongoing enterprise-wide and risk specific stress testing programs, we use ad hoc and reverse stress testing to deepen our knowledge of the risks we face. Ad hoc stress tests are one-off analyses used to investigate developing conditions or to stress a particular portfolio in more depth. Reverse stress tests, starting with a severe outcome and aiming to reverse- engineer scenarios that might lead to it, are used in risk identification and understanding of risk/return boundaries. In addition to internal stress tests, we participate in a number of regulator-required stress test exercises, on a periodic basis, across several jurisdictions. Model governance and validation Quantitative models are used for many purposes including, but not limited to, the valuation of financial products, the identification, measurement and management of different types of risk, stress testing, assessing capital adequacy, informing business and risk decisions, measuring compliance with internal limits, meeting financial reporting and regulatory requirements, and issuing public disclosures. Model risk is the risk of adverse financial and/or reputational consequences to the enterprise arising from the use or misuse of models at any stage throughout its life cycle and is managed through our model risk governance and oversight structure. The governance and oversight structure, which is implemented through our three lines of defence governance model, is founded on the basis that model risk management is a shared responsibility across the three lines spanning all stages of the model’s life cycle. We are evolving our governance model to take into account the growing use of AI methods and applications in our models across our organization. Prior to their use, models are subject to an independent validation and approval by our enterprise model risk management function, a team of modelling professionals with reporting lines independent of those of the model owners, developers and users. The validation ensures that models are sound and capable of fulfilling their intended use. In addition to independently validating models prior to use, our enterprise model risk management function provides controls that span the life-cycle of a model, including model change management procedures, requirements for ongoing monitoring, and annual assessments to ensure each model continues to serve its intended purpose. Risk control Our enterprise-wide risk management approach is supported by a comprehensive set of risk controls that are defined in our ERMF. The ERMF serves as the foundation for our approach to risk management and sets the expectations for the development and communication of policies, the establishment of formal independent risk review and approval processes, and the establishment of delegated authorities and limits. The ERMF is further reinforced and supported by a number of additional Board-approved risk frameworks, various policies thereunder and a comprehensive set of risk controls. Together, our risk frameworks and supporting policies provide direction and insight on how respective risks are identified, assessed, measured, managed, mitigated, monitored and reported. The enterprise-wide policies are considered our minimum requirements, articulating the parameters within which business groups and employees must operate. 52 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Enterprise Risk Policy Architecture Enterprise Risk Management Framework Enterprise Conduct Framework Enterprise Risk Appetite Framework Credit Risk Management Framework Market Risk Management Framework Operational Risk Management Framework Information Technology Risk Management Framework Reputation Risk Management Framework Regulatory Compliance Management Framework Insurance Risk Management Framework Capital Management Framework Liquidity Risk Management Framework Data Management Framework Supporting Risk-Specific Enterprise-Wide Policies (examples) Credit Risk Mitigation Policy Market Risk Policy Operational Risk Management Policy Information Security Policy Fiduciary Risk Policy Privacy Policy Insurance Risk Mitigation Policy Dividend Policy Liquidity Risk Policy Data Policy Enterprise-Wide Policies for Multiple Risk Types (e.g. Product Risk Review and Approval Policy; Risk Limits Policy; Stress-Testing Policy) Segment or Region Specific Risk Policy and Procedures The approval hierarchy for risk frameworks and policy documents: Board of Directors or Board Committees Senior management committees (e.g. Policy Review Committee, Operational Risk Committee, Asset Liability Committee) for most policies. The Board or Board Committee approval is required in some instances (e.g. RBC Code of Conduct, Dividend Policy) Generally by business or Functional Unit management/committees. Group Risk Management approval is required if there are significant risk implications Risk review and approval processes Risk review and approval processes are established by GRM based on the nature, size and complexity of the risk involved. In general, the risk review and approval process involves a formal review and approval by an individual, group or committee that is independent from the originator. The approval responsibilities are governed by delegated authorities and risk limits based on the following categories: transactions, projects and initiatives, and new products and services. Authorities and limits Risk appetite is designed to account for strategic and forward-looking considerations whereas authorities and risk limits are used to govern and monitor our day-to-day business activities. Delegated authorities and limits for credit, market, liquidity and insurance risks are established by the Board and delegated to senior management at levels below risk appetite and regulatory requirements. Senior management can then delegate some or all of their authorities onwards to others in the organization. The delegated authorities enable the approval of single name, geographic and industry sectors, and product and portfolio exposures within defined parameters and limits. They are also used to manage concentration risk, establish underwriting and inventory limits for trading and investment banking activities and set market risk tolerances. Transactions that exceed senior management’s authorities require the approval of the Risk Committee of the Board. Reporting Enterprise, business segment, business unit and legal entity level risk monitoring and reporting are critical components of our enterprise risk management program and support the ability of senior management and the Board to effectively perform their risk management and oversight responsibilities. In addition, we publish a number of external reports on risk matters to comply with regulatory requirements. On a quarterly basis, we provide to senior management and the Risk Committee of the Board our Enterprise Risk Report which includes, among others, top and emerging risks, risk profile relative to our risk appetite, portfolio quality metrics and a range of risks we face along with an analysis of the related issues, key trends and, when required, management actions. On an annual basis, we provide a benchmarking review to the Board which compares our performance to peers across a variety of risk metrics and includes a composite risk scorecard providing an objective measure of our ranking relative to the peer group. In addition to our regular risk monitoring, other risk specific presentations are provided to and discussed with senior management and the Board on top and emerging risks or changes in our risk profile. Conduct and risk culture Our values set the tone of our organizational culture and translate into desired behaviours as articulated in our Code of Conduct and leadership model. We define conduct as the manifestation of culture through the behaviours, judgment, decisions, and actions of the organization and its individuals. Our organizational direction establishes the expectation of good conduct outcomes as the operating norm for the organization, all employees, and third party service providers operating on our behalf, thereby allowing our good conduct to drive positive outcomes for our clients, our employees, stakeholders, financial markets and our reputation. We hold ourselves to the highest standards of conduct to build the trust of our clients, investors, colleagues and community. The desired outcomes from effective conduct and risk culture practices align with our values and support our risk appetite statements. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 53 Risk culture is a subset of our overall culture that influences how, individually and collectively, we take and manage risks. It helps us identify and understand risks, openly discuss risks, and act on the organization’s current and future risks. Our risk culture practices, which are aligned with the FSB’s four fundamental risk culture practices, are: (cid:129) (cid:129) (cid:129) (cid:129) Tone from above; Accountability; Effective challenge; and Incentives and performance management. These practices are largely grounded in our existing risk management and human resource disciplines and protocols, and, when combined with the elements of effective leadership and values, provide a base from which the resulting conduct and risk culture can be assessed, monitored, sustained and subjected to ongoing enhancement. On a regular basis, management communicates behavioural expectations to our employees with an emphasis on conduct and values. Our leadership model also supports and encourages effective challenge between the businesses and control functions. These behavioural expectations are supported by multiple online tools and resources which are designed to help employees live our values, report misconduct and raise concerns, including those that might have ethical implications. We are committed to fostering an environment where employees feel safe to speak up without retaliation. Employees have the ability to report matters through a global anonymous Conduct Hotline. In addition, our Code of Conduct makes it the employee’s responsibility to be truthful, respect others, and comply with laws, regulations and our policies. Anyone who breaches or fails to report an actual or possible breach of the Code of Conduct is subject to corrective or disciplinary action. This can range from reprimands and impacts on performance ratings and compensation, to termination. Organizational Direction Values Leadership Model Code of Conduct Sets expected outcomes Drives actual outcomes Conduct Outcomes Clients Financial Markets Employees Our Reputation Strategy Influences Organizational Practices (including Sales Conduct and Practices) Influences Risk Culture Apply lessons learned from Conduct Risk and Misconduct Conduct Behaviours Judgement Decisions Actions The shaded text along with the tables specifically marked with an asterisk (*) in the following sections of the MD&A represent our disclosures on credit, market and liquidity and funding risks in accordance with IFRS 7, Financial Instruments: Disclosures, and include discussion on how we measure our risks and the objectives, policies and methodologies for managing these risks. Therefore, these shaded text and marked tables represent an integral part of our 2019 Annual Consolidated Financial Statements. Transactional/positional risk drivers Credit risk Credit risk is the risk of loss associated with an obligor’s potential inability or unwillingness to fulfill its contractual obligations on a timely basis and may arise directly from the risk of default of a primary obligor (e.g., issuer, debtor, counterparty, borrower or policyholder), indirectly from a secondary obligor (e.g., guarantor or reinsurer), through off-balance sheet exposures, contingent credit risk and/or transactional risk. Credit risk includes counterparty credit risk arising from both trading and non-trading activities. The responsibility for managing credit risk is shared broadly following the three lines of defence governance model. The Board delegates credit risk approval authorities to the President & CEO and CRO. Credit transactions in excess of these authorities must be approved by the Risk Committee of the Board. To facilitate day-to-day business activities, the CRO has been empowered to further delegate credit risk approval authorities to individuals within GRM, the business segments, and functional units as necessary. Ensuring credit quality is not compromised for growth; We balance our risk and return by setting the following objectives for the management of credit risk: (cid:129) (cid:129) Mitigating credit risk in transactions, relationships and portfolios; (cid:129) Using our credit risk rating and scoring systems or other approved credit risk assessment or rating methodologies, policies and tools; Pricing appropriately for the credit risk taken; (cid:129) 54 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) Detecting and preventing inappropriate credit risk through effective systems and controls; Applying consistent credit risk exposure measurements; Ongoing credit risk monitoring and administration; Transferring credit risk to third parties where appropriate through approved credit risk mitigation techniques (e.g., sale, hedging, insurance, securitization); and Avoiding activities that are inconsistent with our values, Code of Conduct or policies. The Enterprise Credit Risk Management Framework (ECRMF) describes the principles, methodologies, systems, roles and responsibilities, reports and controls that exist for managing credit risk within the enterprise. Additional supporting policies exist that are designed to provide further clarification of roles and responsibilities, acceptable practices, limits and key controls within the enterprise. Credit risk measurement We quantify credit risk at both the individual obligor and portfolio levels to manage expected credit losses and minimize unexpected losses in order to limit earnings volatility and ensure we are adequately capitalized. We employ a variety of risk measurement methodologies to measure and quantify credit risk for our wholesale and retail credit portfolios. The wholesale portfolio is comprised of businesses, sovereigns, public sector entities, banks and other financial institutions, as well as certain high net worth individuals and small businesses. The retail portfolio is comprised of residential mortgages, personal loans, credit cards, and small business loans. Our credit risk rating systems are designed to assess and quantify the risk inherent in credit activities in an accurate and consistent manner. The resulting ratings and scores are then used for both client- and transaction-level risk decision-making and as key inputs for our risk measurement and capital calculations. Measurement of economic and regulatory capital Economic capital, which is our internal quantification of risks, is used for limit setting and internal capital adequacy and allocation of capital to Insurance. Our methodology for allocating capital to our business segments, other than Insurance, is based on regulatory requirements. For further details, refer to the Capital management section. In measuring credit risk to determine regulatory capital, two principal approaches are available: Internal Ratings Based (IRB) Approach and Standardized Approach. The Standardized Approach applies primarily to our Caribbean banking operations and City National and is based on risk weights prescribed by OSFI that are used to calculate risk-weighted assets (RWA) for credit risk exposure. The IRB Approach, which applies to most of our credit risk exposures, utilizes three key parameters which form the basis of our credit risk measures for both regulatory and economic capital. (cid:129) Probability of default (PD): An estimated percentage that represents the likelihood of default within a given time period of an obligor for a specific rating grade or for a particular pool of exposure. Exposure at default (EAD): An amount expected to be owed by an obligor at the time of default. Loss given default (LGD): An estimated percentage of EAD that is not expected to be recovered during the collections and recovery process. (cid:129) (cid:129) These parameters are determined based primarily on historical experience from internal credit risk rating systems in accordance with supervisory standards. Each credit facility is assigned an LGD rate that is largely driven by factors that impact the extent of losses anticipated in the event the obligor defaults. These factors mainly include seniority of debt, collateral and the industry sector in which the obligor operates. Estimated LGD rates draw primarily on internal loss experiences. Where we have limited internal loss data, we also refer to appropriate external data to supplement the estimation process. LGD rates are estimated to reflect conditions that might be expected to prevail in a period of an economic downturn, with additional conservatism added to reflect data limitations and statistical uncertainties identified in the estimation process. EAD is estimated based on the current exposure to the obligor and the possible future changes in that exposure driven by factors such as the nature of the credit commitment. As with LGD, rates are estimated to reflect an economic downturn, with added conservatism to reflect data and statistical uncertainties identified in the modelling process. Estimates of PD, LGD and EAD are updated, and then validated and back-tested by an independent validation team within the bank, on an annual basis. In addition, quarterly monitoring and back-testing is performed by the estimation team. These ratings and risk measurements are used to determine our expected losses as well as economic and regulatory capital, setting of risk limits, portfolio management and product pricing. Financial and regulatory measurement distinctions Expected loss models are used for both regulatory capital and accounting purposes. Under both models, expected losses are calculated as the product of PD, LGD and EAD. However, there are certain key differences under current Basel and IFRS reporting frameworks which could lead to significantly different expected loss estimates, including: (cid:129) Basel PDs are based on long-run averages over an entire economic cycle. IFRS PDs are based on current conditions, adjusted for estimates of future conditions that will impact PD under probability-weighted macroeconomic scenarios. Basel PDs consider the probability of default over the next 12 months. IFRS PDs consider the probability of default over the next 12 months only for instruments in stage 1. Expected credit losses for instruments in stage 2 are calculated using lifetime PDs. Basel LGDs are based on severe but plausible downturn economic conditions. IFRS LGDs are based on current conditions, adjusted for estimates of future conditions that will impact LGD under probability-weighted macroeconomic scenarios. (cid:129) (cid:129) For further details, refer to the Critical accounting policies and estimates section. Gross credit risk exposure Gross credit risk is categorized as i) lending-related and other credit risk or ii) trading-related credit risk; and is calculated based on the Basel III framework. Under this method, EAD for all lending-related and other credit transactions and trading- related repo-style transactions is calculated before taking into account any collateral and is inclusive of an estimate of Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 55 potential future changes to that credit exposure. EAD for derivatives is calculated inclusive of collateral in accordance with regulatory guidelines. Lending-related and other credit risk includes: (cid:129) Loans and acceptances outstanding, undrawn commitments, and other exposures, including contingent liabilities such as letters of credit and guarantees, debt securities carried at FVOCI or amortized cost and deposits with financial institutions. Undrawn commitments represent an estimate of the contractual amount that may be drawn upon at the time of default of an obligor. Trading-related credit risk includes: (cid:129) Repo-style transactions, which include repurchase and reverse repurchase agreements and securities lending and borrowing transactions. For repo-style transactions, gross exposure represents the amount at which securities were initially financed, before taking collateral into account. Derivative amounts which represent the credit equivalent amount, as defined by OSFI as the replacement cost plus an add-on amount for potential future credit exposure, scaled by a regulatory factor. (cid:129) Credit risk assessment Wholesale credit risk The wholesale credit risk rating system is designed to measure the credit risk inherent in our wholesale credit activities. Each obligor is assigned a borrower risk rating (BRR), reflecting an assessment of the credit quality of the obligor. Each BRR has a PD calibrated against it. The BRR differentiates the riskiness of obligors and represents our evaluation of the obligor’s ability and willingness to meet its contractual obligations on time over a three year time horizon. The assignment of BRRs is based on the evaluation of the obligor’s business risk and financial risk through fundamental credit analysis, as well as data-driven modelling. The determination of the PD associated with each BRR relies primarily on internal default history since 2006. PD estimates are designed to be a long-run average of our experience across the economic cycle in accordance with regulatory guidelines. Our rating system is designed to stratify obligors into 22 grades. The following table aligns the relative rankings of our 22-grade internal risk ratings with the external ratings used by S&P and Moody’s. Internal ratings map* Table 42 Ratings Business and Bank Sovereign BRR S&P Moody’s Description PD Bands 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 0.0000% – 0.0300% 0.0000% – 0.0155% 1+ 0.0000% – 0.0300% 0.0156% – 0.0265% 1H 0.0301% – 0.0375% 0.0266% – 0.0375% 1M 0.0376% – 0.0490% 0.0491% – 0.0650% 0.0651% – 0.0810% 0.0811% – 0.1120% 0.1121% – 0.1800% 0.1801% – 0.2620% 0.2621% – 0.3845% 0.3846% – 0.6480% 0.6481% – 0.9625% 0.9626% – 1.4070% 1.4071% – 2.1785% 2.1786% – 3.4210% 3.4211% – 5.2775% 5.2776% – 7.9410% 7.9411% – 11.4475% 11.4476% – 19.6535% 19.6536% – 99.9990% 100% 100% 1L 2+H 2+M 2+L 2H 2M 2L 2-H 2-M 2-L 3+H 3+M 3+L 3H 3M 3L 4 5 6 AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C D Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C C Investment Grade Non-investment Grade Impaired * This table represents an integral part of our 2019 Annual Consolidated Financial Statements. Counterparty credit risk Counterparty credit risk is the risk that a party with whom the bank has entered into a financial or non-financial contract will fail to fulfill its contractual agreement and default on its obligation. It incorporates not only the contract’s current value, but also considers how that value can move as market conditions change. Counterparty credit risk usually arises from trading-related derivative and repo-style transactions. Derivative transactions include forwards, futures, swaps and options, and can have underlying references that are either financial (e.g., interest rate, foreign exchange, credit, or equity) or non-financial (e.g., precious metal and commodities). For further details on our derivative instruments and credit risk mitigation, refer to Note 8 of our 2019 Annual Consolidated Financial Statements. Trading counterparty credit activities are undertaken in a manner consistent with the relevant requirements under the ECRMF and the Enterprise Market Risk Management Framework (EMRMF), in line with our credit risk management policy documents and with approval in accordance with the appropriate delegated authorities. 56 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis The primary risk mitigation techniques for trading counterparty credit risk are close-out netting and collateralization. Close-out netting considers the net value of contractual obligations between counterparties in a default situation, thereby reducing overall credit exposure. Collateralization is when a borrower pledges assets as security, which provides recourse to the lender in the event of default. The policies that we maintain in relation to the recognition of risk mitigation from these techniques incorporate such considerations as: (cid:129) The use of standardized agreements such as the International Swaps and Derivatives Association (ISDA) Master Agreement and Credit Support Annex (CSA); Restricting eligible collateral to high quality liquid assets, primarily cash and highly-rated government securities, subject to appropriate haircuts; and The use of initial margin and variation margin arrangements in accordance with regulatory requirements and internal risk standards. (cid:129) (cid:129) Similarly, for securities finance and repurchase trading activity we mitigate counterparty credit risk via the use of standardized securities finance agreements, and by taking collateral generally in the form of eligible liquid securities. We also mitigate counterparty credit risk through the use of central counterparties (CCPs). These highly-regulated entities intermediate trades between participating bilateral counterparties and mitigate credit risk through the use of initial and variation margin and the ability to net offsetting trades amongst participants. The specific structure and capitalization, including contingent capital arrangements, of individual CCPs are analyzed as part of assigning an internal counterparty credit risk rating and determining appropriate counterparty credit risk limits. Wrong-way risk Wrong-way risk is the risk that exposure to a counterparty is adversely correlated with the credit quality of that counterparty. There are two types of wrong-way risk: (cid:129) Specific wrong-way risk, which exists when our exposure to a particular counterparty is positively correlated with the PD of the counterparty due to the nature of our transactions with them (e.g., loans collateralized by shares or debt issued by the counterparty or a related party). Specific wrong-way risk over-the-counter (OTC) derivative trades are done on an exception basis only, and are permitted only when explicitly pre-approved by GRM. Factors considered in reviewing such trades include the credit quality of the counterparty, the nature of the asset(s) underlying the derivative and the existence of credit mitigation. General wrong-way risk, which exists when there is a positive correlation between the PD of the counterparties and general macroeconomic or market factors. This typically occurs with derivatives (e.g., the size of the exposure increases) or with collateralized transactions (e.g., the value of the collateral declines). We monitor general wrong-way counterparty credit risk using a variety of metrics including stress scenarios, investment strategy concentration, the ability of counterparties to generate cash and liquidity, liquidity of the collateral and terms of financing. (cid:129) Retail credit risk Credit scoring is the primary risk rating system for assessing obligor and transaction risk for retail exposures. Scoring models use internal and external data to assess and “score” borrowers, predict future performance and manage limits for existing loans and collection activities. Credit scores are one of the factors employed in the acquisition of new clients and management of existing clients. The credit score of the borrower is used to assess the predicted credit risk for each independent acquisition or account management action, leading to an automated decision or guidance for an adjudicator. Credit scoring improves credit decision quality, adjudication timeframes and consistency in the credit decision process and facilitates risk-based pricing. To arrive at a retail risk rating, borrower scores are categorized and associated with PDs for further grouping into risk rating categories. The following table maps PD bands to various risk levels for retail exposures: Internal ratings map* Table 43 PD bands 0.000% – 1.718% 1.719% – 6.430% 6.431% – 99.99% 100% Description Low risk Medium risk High risk Impaired/Default * This table represents an integral part of our 2019 Annual Consolidated Financial Statements. Credit risk mitigation We seek to reduce our exposure to credit risk through a variety of means, including the structuring of transactions and the use of collateral. Structuring of transactions Specific credit policies and procedures set out the requirements for structuring transactions. Risk mitigants include the use of guarantees, collateral, seniority, loan-to-value requirements and covenants. Product-specific guidelines set out appropriate product structuring as well as client and guarantor criteria. Collateral When we advance credit, we often require obligors to pledge collateral as security. The extent of risk mitigation provided by collateral depends on the amount, type and quality of the collateral taken. Specific requirements relating to collateral valuation and management are set out in our credit risk management policies. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 57 The types of collateral used to secure credit or trading facilities within the bank are varied. For example, our securities financing and collateralized OTC derivatives activities are primarily secured by cash and highly-rated liquid government and agency securities. Wholesale lending to business clients is often secured by pledges of the assets of the business, such as accounts receivable, inventory, operating assets and commercial real estate. In Canadian Banking and Wealth Management, collateral typically consists of a pledge over a real estate property, or a portfolio of debt securities and equities trading on a recognized exchange. (cid:129) We employ a risk-based approach to property valuation. Property valuation methods include automated valuation models (AVM) and appraisals. An AVM is a tool that estimates the value of a property by reference to market data including sales of comparable properties and price trends specific to the Metropolitan Statistical Area in which the property being valued is located. Using a risk-based approach, we also employ appraisals which can include drive-by or full on-site appraisals. (cid:129) We continue to actively manage our entire mortgage portfolio and perform stress testing, based on a combination of increasing unemployment, rising interest rates and a downturn in real estate markets. (cid:129) We are compliant with regulatory requirements that govern residential mortgage underwriting practices, including loan-to-value parameters and property valuation requirements. There were no significant changes regarding our risk management policies on collateral or to the quality of the collateral held during the period. Credit risk approval The Board, GE, GRC and other senior management committees work together to ensure the ECRMF and supporting policies, processes and procedures exist to manage credit risk and approve related credit risk limits. Reports are provided to the Board, the GRC, and senior executives to keep them informed of our risk profile, including significant credit risk issues, shifts in exposures and trending information, to ensure appropriate and timely actions can be taken where necessary. Our enterprise-wide credit risk policies set out the minimum requirements for the management of credit risk in a variety of borrower, transactional and portfolio management contexts. Transaction approval Credit transactions are approved in accordance with the delegated credit risk approval authorities and are subject to our credit rules policy, which outlines the minimum standards for managing credit risk at the individual client relationship and/or transaction level. Product approval Proposals for credit products and services are comprehensively reviewed and approved under a risk assessment framework and are subject to approval authorities which increase as the level of risk increases. New and amended products must be reviewed relative to all risk drivers, including credit risk. All existing products must be reviewed following a risk-based assessment approach on a regular basis. Credit risk limits (cid:129) Credit risk limits are set by the Board and take into account both regulatory constraints and internal risk management judgment. Limits are established at the following levels: single name limits (notional and economic capital), geographic (country and region) limits (notional and economic capital), industry sector limits (notional and economic capital), product and portfolio limits, and underwriting and distribution risk limits. These limits apply across businesses, portfolios, transactions and products. (cid:129) We manage credit exposures and limits to ensure alignment with our risk appetite, to maintain our target business mix and to ensure that there is no undue concentration risk. (cid:129) Concentration risk is defined as the risk arising from large exposures that are highly correlated such that their ability to meet contractual obligations could be similarly affected by changes in economic, political or other risk drivers. Credit concentration limits are reviewed on a regular basis after taking into account business, economic, financial and regulatory environments. (cid:129) Credit risk administration Loan forbearance In our overall management of borrower relationships, economic or legal reasons may necessitate forbearance to certain clients with respect to the original terms and conditions of their loans. We have specialized groups and formalized policies that direct the management of delinquent or defaulted borrowers. We strive to identify borrowers in financial difficulty early and modify their loan terms in order to maximize collection and to avoid foreclosure, repossession, or other legal remedies. In these circumstances, a borrower may be granted concessions that would not otherwise be considered. Examples of such concessions to retail borrowers may include rate reduction, principal forgiveness and term extensions. Concessions to wholesale borrowers may include restructuring the agreements, modifying the original terms of the agreement and/or relaxation of covenants. For both retail and wholesale loans, the appropriate remediation techniques are based on the individual borrower’s situation, our policy and the customer’s willingness and capacity to meet the new arrangement. 58 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Credit risk exposure by portfolio, sector and geography The following table presents our credit risk exposures under the Basel regulatory defined classes and reflects exposures at default (EAD). The classification of our sectors aligns with our view of credit risk by industry. Beginning in Q1 2019 we have prospectively implemented the standardized approach for measuring counterparty credit risk (SA-CCR) under the Capital Adequacy Requirements (CAR) guidelines, which primarily impacted on-balance sheet cash collateral and derivatives exposures. Credit risk exposure by portfolio, sector and geography Table 44 October 31 2019 October 31 2018 (1) As at Credit risk (2) Counterparty credit risk (3) Credit risk (2) Counterparty credit risk (3) On-balance sheet amount Off-balance sheet amount (4) Repo-style Undrawn Other (5) transactions Derivatives Total exposure On-balance sheet amount Off-balance sheet amount (4) Repo-style Undrawn Other (5) transactions Derivatives Total exposure $ 316,047 $ 64,825 $ 26,834 61,095 73,530 13,927 – $ – 72 $ 403,976 $ 152,282 $ 72 $ – $ – – – $ – $ – – – $ 380,872 $ 100,364 75,094 556,330 $ 298,555 $ 59,840 $ 24,223 54,170 65,617 12,693 376,948 $ 138,150 $ $ 9,084 $ 9,710 45,444 15,972 5,346 8,165 30,194 667 1,468 105,011 7,793 4,604 16,507 1,698 1,738 61,178 25,528 4,855 5,390 9,189 1,677 1,744 $ 6,990 1,857 8,641 8,543 10,661 21,023 848 688 8,120 8,237 5,704 2,722 4,209 1,769 12,372 11,811 9,645 6,557 19,233 382 46 $ 298 615 766 518 1,390 2,749 516 97 1,432 565 229 398 878 397 1,374 1,148 109 2,141 4,266 2 – $ – 46,601 – – – 118,239 81 – 8,228 – 9 9 – – – 35 – – – 8 79 $ 1,217 17,908 533 1,116 1,551 16,688 1,146 27 7,214 644 2,355 309 227 192 728 1,645 1,872 1,844 3,347 19,904 $ 371,218 $ 151,756 $19,934 $ 173,210 $ 80,546 $ 10,953 $ 18,215 112,425 25,912 15,523 21,767 188,893 3,258 2,280 130,005 17,239 12,901 19,945 7,012 4,096 75,652 40,167 16,481 15,932 36,035 21,973 796,664 $ 8,510 $ 8,936 47,868 15,784 4,662 6,186 25,798 1,234 1,140 110,192 7,751 4,843 16,157 1,486 1,899 54,490 23,892 7,957 5,861 9,357 1,931 1,760 $ 6,435 1,734 7,928 6,316 10,704 22,345 1,269 933 7,566 8,219 5,152 956 3,886 1,836 11,832 12,452 12,116 5,600 19,598 303 – $ – 52 52 $ 43 $ 345 549 587 517 1,483 2,164 359 89 1,798 686 178 389 917 425 1,338 877 134 2,185 3,561 1 – $ – – – $ – $ – – – $ 358,395 89,840 66,915 515,150 – $ – 52,394 – – – 110,246 – – 9,476 – 15 11 – – – 2 – – – 126 45 $ 504 26,313 293 672 1,717 30,580 352 23 7,182 455 1,967 157 184 115 385 551 1,534 1,270 2,581 11,898 10,358 16,220 128,858 24,592 12,167 20,090 191,133 3,214 2,185 136,214 17,111 12,155 17,670 6,473 4,275 68,045 37,774 21,741 14,916 35,097 14,259 $ 775,194 $ 304,038 $20,006 $ 173,210 $ 80,546 $ 1,352,994 $ 742,882 $ 287,090 $ 18,677 $ 172,270 $ 88,778 $ 1,309,697 $ 551,503 $ 224,258 $ 9,890 $ 149,514 41,860 32,317 58,344 18,600 2,836 8,694 1,258 164 65,915 $ 55,391 40,529 11,375 37,273 $ 17,387 21,644 4,242 888,839 $ 289,330 123,891 50,934 510,445 $ 205,875 $ 9,387 $ 60,172 147,543 18,450 54,061 2,593 30,833 7,981 1,150 159 78,172 $ 41,897 48,874 3,327 29,195 $ 16,059 39,719 3,805 833,074 273,652 162,254 40,717 $ 775,194 $ 304,038 $20,006 $ 173,210 $ 80,546 $ 1,352,994 $ 742,882 $ 287,090 $ 18,677 $ 172,270 $ 88,778 $ 1,309,697 365,934 $ 148,940 $ 18,625 $ 172,270 $ 88,778 $ 794,547 (Millions of Canadian dollars) Retail Residential secured (6) Qualifying revolving (7) Other retail Total retail Wholesale Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Total wholesale Total exposure (8) By geography (9) Canada U.S. Europe Other International Total exposure (8) (1) (2) (3) (4) (5) (6) (7) (8) (9) Amounts previously reflected gross credit exposures. EAD for standardized exposures are reported net of allowance for impaired assets and EAD for internal ratings based exposures are reported gross of all allowance for credit losses and partial write-offs as per regulatory definitions. Counterparty credit risk EAD reflects exposure amounts after netting. Collateral is included in EAD for repo-style transactions to the extent allowed by regulatory guidelines. EAD for undrawn credit commitments and other off-balance sheet amounts are reported after the application of credit conversion factors. Includes other off-balance sheet exposures such as letters of credit and guarantees. Includes residential mortgages and home equity lines of credit. Includes credit cards, unsecured lines of credit and overdraft protection products. Excludes securitization, banking book equities and other assets not subject to the standardized or internal ratings based approach. Geographic profile is based on country of residence of the borrower. 2019 vs. 2018 Total credit risk exposure increased $43 billion or 3% from last year, primarily due to business growth in loans and acceptance exposures in our retail and wholesale portfolios, partially offset by decreases related to on-balance sheet cash collateral and derivatives due to the adoption of SA-CCR in Q1 2019. Retail exposure increased $41 billion or 8%, largely driven by business growth. Wholesale exposure was up $2 billion, primarily driven by business growth in loans, acceptances and increased securities, largely offset by decreases related to the adoption of SA-CCR, as noted above. The geographic mix of our credit risk exposure changed slightly from the prior year. Our exposure in Canada, the U.S., Europe and Other International was 66%, 21%, 9%, and 4%, respectively (October 31, 2018 – 64%, 21%, 12% and 3%, respectively). Our exposure in Canada increased $56 billion or 7% compared to the prior year, largely driven by business growth in loans and acceptances exposures, partially offset by decreases in repo-style transactions, mainly from lower volume. Our exposure in the U.S. increased $16 billion or 6% compared to the prior year, mainly due to business growth in repo-style transactions. Our exposure in Europe decreased $38 billion or 24% compared to the prior year, reflecting a reduction of on-balance sheet cash collateral and derivatives, both due to the adoption of SA-CCR, as noted above. Lower repo-style transactions, loans and deposits with central banks, also contributed to the decrease. Our exposure in Other International increased $10 billion or 25% compared to the prior year, primarily due to business growth in repo-style transactions. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 59 Net European exposure by country and client type (1), (2) As at October 31 2019 Asset type Client type Loans Repo-style Outstanding Securities (3) $ 8,624 $ 1,388 956 10,248 $ 5,421 8,001 transactions Derivatives Financials Sovereign Corporate 4,184 $ 12,700 $ 2,435 $ 416 214 4,392 1,904 1,005 6,499 Total Total 8,352 $ 23,487 $ 20,078 7,227 1,830 9,417 9,211 808 10,668 Table 45 October 31 2018 (Millions of Canadian dollars) U.K. Germany France Total U.K., Germany, France Ireland Italy Portugal Spain Total peripheral Luxembourg (4) Netherlands (4) Norway Sweden Switzerland Other Total other Europe Net exposure to Europe (5) $ $ $ $ $ $ 431 $ 2 40 473 $ 486 $ – 58 2 546 $ 334 $ 100 10 18 204 330 996 $ 10,968 $ 23,670 $ 839 $ 84 – 348 1,271 $ 2,254 $ 1,089 182 280 1,025 1,971 97 $ 721 9 111 938 $ 9,096 $ 778 2,331 1,907 3,882 2,233 6,801 $ 20,227 $ 4,814 $ 18,996 $ 9,939 $ 10,990 $ 39,925 $ 40,163 931 677 33 1,443 800 $ 1,467 $ 125 8 399 646 $ 62 59 116 45 $ 16 – 59 821 67 520 634 – 5 21 $ 120 $ 883 $ 660 $ 39 $ 1,883 $ 8,492 $ 283 30 20 197 284 707 2,287 1,537 746 1,567 2 47 396 3,489 1,302 853 $ 8,727 $ 13,728 $ 3,084 1,332 $ 2,875 $ 1,348 $ 11,723 $ 9,000 1,541 2,250 2,815 219 2,553 1,871 292 2,225 4,308 1,073 5,308 6,835 1,949 4,818 3,795 6,422 $ 28,877 $ 28,624 19,040 $ 44,835 $ 2,015 $ 5,787 $ 28,606 $ 24,327 $ 18,744 $ 71,677 $ 71,871 (1) (2) (3) (4) (5) Geographic profile is based on country of risk, which reflects our assessment of the geographic risk associated with a given exposure. Typically, this is the residence of the borrower. Exposures are calculated on a fair value basis and net of collateral, which includes $120.5 billion against repo-style transactions (October 31, 2018 – $111.1 billion) and $11.4 billion against derivatives (October 31, 2018 – $11.6 billion). Securities include $9.4 billion of trading securities (October 31, 2018 – $16.2 billion), $22.5 billion of deposits (October 31, 2018 – $23.3 billion), and $12.9 billion of debt securities carried at FVOCI (October 31, 2018 – $12.5 billion). Excludes $1.5 billion (October 31, 2018 – $2.5 billion) of exposures to supranational agencies. Reflects $1.0 billion of mitigation through credit default swaps, which are largely used to hedge single name exposures and market risk (October 31, 2018 – $1.2 billion). 2019 vs. 2018 Net credit risk exposure to Europe decreased $0.2 billion from last year, mainly driven by lower trading securities, largely in Germany, mainly offset by higher loans, across a few countries, and higher derivatives. Our European corporate loan book is managed on a global basis with underwriting standards reflecting the same approach to the use of our balance sheet as we have applied in both Canada and the U.S. PCL on loans during the year was $77 million. The gross impaired loans ratio of this loan book was 44 bps, up 34 bps from last year, mainly in the industrial products and other services sectors. 60 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Residential mortgages and home equity lines of credit (insured vs. uninsured) Residential mortgages and home equity lines of credit are secured by residential properties. The following table presents a breakdown by geographic region. Residential mortgages and home equity lines of credit Table 46 (Millions of Canadian dollars, except percentage amounts) Region (2) Canada Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories Total Canada (3) U.S. (4) Other International (4) Total International Total As at October 31, 2019 Residential mortgages Home equity lines of credit Insured (1) Uninsured Total Total $ 7,715 12,385 36,195 20,688 8,951 14,711 $ 100,645 1 5 52% $ 36 28 53 49 28 7,169 22,091 92,947 18,143 9,238 37,534 35% $ 187,122 17,011 3,307 – – 48% $ 14,884 34,476 64 129,142 72 38,831 47 18,189 51 52,245 72 65% $ 287,767 17,012 3,312 100 100 $ 6 –% $ 20,318 100% $ 20,324 $ 100,651 33% $ 207,440 67% $ 308,091 $ $ $ $ 1,838 3,512 16,585 6,324 2,363 8,267 38,889 1,652 1,373 3,025 41,914 As at October 31, 2018 Residential mortgages Home equity lines of credit Insured (1) Uninsured Total Total (Millions of Canadian dollars, except percentage amounts) Region (2) Canada $ Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories 7,616 13,045 38,708 20,615 9,007 15,452 54% $ 41 33 55 51 32 6,398 18,911 77,649 16,738 8,503 33,189 46% $ 14,014 31,956 59 116,357 67 37,353 45 17,510 49 48,641 68 Total Canada (3) U.S. (4) Other International (4) $ 104,443 1 7 39% $ 161,388 13,492 3,140 – – 61% $ 265,831 13,493 3,147 100 100 Total International $ 8 –% $ 16,632 100% $ 16,640 Total $ 104,451 37% $ 178,020 63% $ 282,471 $ $ $ $ 1,926 3,730 16,811 6,706 2,534 8,436 40,143 2,099 1,513 3,612 43,755 (1) (2) (3) (4) Insured residential mortgages are mortgages whereby our exposure to default is mitigated by insurance through the Canada Mortgage and Housing Corporation (CMHC) or other private mortgage default insurers. Region is based upon address of the property mortgaged. The Atlantic provinces are comprised of Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick, and B.C. and territories are comprised of British Columbia, Nunavut, Northwest Territories and Yukon. Total consolidated residential mortgages in Canada of $288 billion (October 31, 2018 – $266 billion) is largely comprised of $263 billion (October 31, 2018 – $243 billion) of residential mortgages and $7 billion (October 31, 2018 – $7 billion) of mortgages with commercial clients, of which $4 billion (October 31, 2018 – $4 billion) are insured mortgages, both in Canadian Banking, and $18 billion (October 31, 2018 – $16 billion) of residential mortgages in Capital Markets held for securitization purposes. Home equity lines of credit include term loans collateralized by residential mortgages. Home equity lines of credit are uninsured and reported within the personal loan category. As at October 31, 2019, home equity lines of credit in Canadian Banking were $39 billion (October 31, 2018 – $40 billion). Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 61 Residential mortgages portfolio by amortization period The following table provides a summary of the percentage of residential mortgages that fall within the remaining amortization periods based upon current customer payment amounts, which incorporate payments larger than the minimum contractual amount and/or higher frequency of payments. Residential mortgages portfolio by amortization period Table 47 As at October 31 2019 October 31 2018 Canada U.S. and other International Total Canada U.S. and other International Total 72% 24 3 1 38% 62 – – 70% 26 3 1 70% 23 5 2 40% 60 – – 68% 25 5 2 100% 100% 100% 100% 100% 100% Amortization period ≤ 25 years > 25 years ≤ 30 years > 30 years ≤ 35 years > 35 years Total Average loan–to–value (LTV) ratios The following table provides a summary of our average LTV ratio for newly originated and acquired uninsured residential mortgages and Homeline products by geographic region: Average LTV ratio Table 48 For the year ended October 31 2019 Uninsured October 31 2018 Uninsured Residential mortgages (1) Homeline products (2) Residential mortgages (1) Homeline products (2) Region (3) Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories U.S. Other International Average of newly originated and acquired for the period (4), (5) Total Canadian Banking residential mortgages portfolio (6) 74% 72 70 73 74 68 74 71 71% 57% 74% 73 68 72 74 65 n.m. n.m. 69% 50% 73% 72 70 73 74 67 71 60 70% 55% 74% 73 67 71 74 64 n.m. n.m. 68% 49% (1) (2) (3) (4) (5) Residential mortgages exclude residential mortgages within the Homeline products. Homeline products are comprised of both residential mortgages and home equity lines of credit. Region is based upon address of the property mortgaged. The Atlantic provinces are comprised of Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick, and B.C. and territories are comprised of British Columbia, Nunavut, Northwest Territories and Yukon. The average LTV ratio for newly originated and acquired uninsured residential mortgages and Homeline products is calculated on a weighted basis by mortgage amounts at origination. For newly originated mortgages and Homeline products, LTV is calculated based on the total facility amount for the residential mortgage and Homeline product divided by the value of the related residential property. (6) Weighted by mortgage balances and adjusted for property values based on the Teranet – National Bank National Composite House Price Index. n.m. not meaningful 62 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Credit quality performance The following credit quality performance tables and analysis provide information on loans, which represents loans, acceptances and commitments, and other financial assets. Provision for credit losses Table 49 For the year ended (Millions of Canadian dollars, except percentage amounts) Personal & Commercial Banking Wealth Management Capital Markets Corporate Support and other PCL – Loans PCL – Other financial assets Total PCL PCL on loans is comprised of: Retail Wholesale PCL on performing loans Retail Wholesale PCL on impaired loans PCL – Loans PCL on loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances Additional information by geography (1) Canada Residential mortgages Personal Credit cards Small business Retail Wholesale PCL on impaired loans U.S. Retail Wholesale PCL on impaired loans Other International Retail Wholesale PCL on impaired loans PCL on impaired loans $ October 31 2019 1,470 117 304 – $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,891 (27) 1,864 133 67 200 1,092 599 1,691 1,891 0.31% 0.27% 32 488 505 36 1,061 292 1,353 12 223 235 19 84 103 1,691 October 31 2018 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,245 (15) 52 1 1,283 24 1,307 116 7 123 1,011 149 1,160 1,283 0.23% 0.20% 44 458 456 30 988 80 1,068 4 64 68 19 5 24 1,160 (1) Geographic information is based on residence of the borrower. 2019 vs. 2018 Total PCL was $1,864 million. PCL on loans of $1,891 million increased $608 million, or 47% from the prior year, due to higher provisions in Capital Markets, Personal & Commercial Banking and Wealth Management. The PCL ratio on loans of 31 bps increased by 8 bps. PCL on performing loans of $200 million increased $77 million, reflecting higher provisions in Wealth Management and Capital Markets, partially offset by lower provisions in Personal & Commercial Banking. PCL on impaired loans of $1,691 million increased $531 million, due to higher provisions in Personal & Commercial Banking, Capital Markets and Wealth Management. PCL on other financial assets of $(27) million, compared to $24 million in the prior year, primarily related to Personal & Commercial Banking. The prior year included provisions related to the restructuring of portfolios in Barbados, while the current year reflected recoveries, mainly due to favourable parameter updates. PCL on loans in Personal & Commercial Banking increased $225 million, largely reflecting higher provisions on impaired loans in our Canadian Banking commercial and retail portfolios. This was partially offset by lower provisions on our performing loans, mainly due to favourable macroeconomic factors, largely offset by unfavourable changes in portfolio mix. PCL on loans in Wealth Management increased $132 million, primarily in U.S. Wealth Management (including City National). PCL on impaired loans increased $76 million, mainly in a few sectors, including consumer discretionary and consumer staples. PCL on performing loans increased by $56 million, largely due to higher repayments and maturities in the prior year. The current year also reflected unfavourable changes in macroeconomic factors compared to last year. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 63 PCL on loans in Capital Markets increased $252 million, largely driven by an increase in provisions on impaired loans, mainly in the oil & gas and industrial products sectors. Higher provisions on performing loans, mainly driven by unfavourable changes in macroeconomic factors compared to the prior year, also contributed to the increase. Gross impaired loans (GIL) (Millions of Canadian dollars, except percentage amounts) Personal & Commercial Banking Wealth Management Capital Markets Corporate Support and other Total GIL Canada (1) Retail Wholesale GIL U.S. (1) Retail Wholesale GIL Other International (1) Retail Wholesale GIL Total GIL Impaired loans, beginning balance Classified as impaired during the period (new impaired) (2) Net repayments (2) Amounts written off Other (2), (3) Impaired loans, balance at end of period GIL as a % of related loans and acceptances Total GIL as a % of related loans and acceptances Personal & Commercial Banking Canadian Banking Caribbean Banking Wealth Management Capital Markets Table 50 As at and for the year ended $ October 31 2019 1,712 266 998 – $ $ $ $ $ $ 2,976 788 678 1,466 36 869 905 272 333 605 2,976 2,183 3,749 (657) (1,776) (523) October 31 2018 $ $ $ $ $ $ $ 1,605 203 375 – 2,183 723 396 1,119 23 401 424 327 313 640 2,183 2,576 2,228 (615) (1,444) (562) $ 2,976 $ 2,183 0.46% 0.37% 0.29% 5.05% 0.39% 1.02% 0.37% 0.37% 0.26% 6.36% 0.34% 0.41% (1) (2) (3) Geographic information is based on residence of the borrower. Certain GIL movements for Canadian Banking retail and wholesale portfolios are generally allocated to new impaired, as return to performing status, Net repayments, sold, and exchange and other movements amounts are not reasonably determinable. Certain GIL movements for Caribbean Banking retail and wholesale portfolios are generally allocated to Net repayments and new impaired, as return to performing status, sold, and foreign exchange translation and other movements amounts are not reasonably determinable. Includes return to performing status during the period, recoveries of loans and advances previously written off, sold, and foreign exchange translation and other movements. 2019 vs. 2018 Total GIL of $2,976 million increased $793 million or 36% from the prior year, and the total GIL ratio of 46 bps increased 9 bps, primarily reflecting higher impaired loans in Capital Markets. Higher impaired loans in Personal & Commercial Banking and Wealth Management also contributed to the increase. GIL in Personal & Commercial Banking increased $107 million or 7%, primarily due to higher impaired loans in our Canadian Banking commercial and retail portfolios, partially offset by lower impaired loans in our Caribbean Banking portfolios. GIL in Wealth Management increased $63 million or 31%, primarily reflecting higher impaired loans in U.S. Wealth Management (including City National), mainly in a few sectors, including consumer discretionary and consumer staples, partially offset by repayments and write-offs. GIL in Capital Markets increased $623 million or 166%, mainly due to new impaired loans in the oil & gas and utilities sectors, partially offset by sales and repayments. 64 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Allowance for credit losses – Loans and acceptances Table 51 (Millions of Canadian dollars) Personal & Commercial Banking Wealth Management Capital Markets Corporate Support and other ACL on loans ACL on other financial assets Total ACL ACL on loans is comprised of: Retail Wholesale ACL on performing loans ACL on impaired loans Additional information by geography (1) Canada Retail Wholesale ACL on impaired loans U.S. Retail Wholesale ACL on impaired loans Other International Retail Wholesale ACL on impaired loans ACL on impaired loans As at $ October 31 2019 2,710 252 455 2 $ $ $ $ $ $ $ $ $ $ $ $ 3,419 45 3,464 1,886 701 2,587 832 187 172 359 1 141 142 156 175 331 832 October 31 2018 $ $ $ $ $ $ $ $ $ $ $ $ $ 2,536 202 347 3 3,088 71 3,159 1,753 635 2,388 700 168 92 260 1 164 165 166 109 275 700 (1) Geographic information is based on residence of the borrower. 2019 vs. 2018 Total ACL of $3,464 million increased $305 million or 10% from the prior year, largely reflecting an increase of $331 million in ACL on loans. ACL on performing loans of $2,587 million increased $199 million from the prior year, reflecting higher ACL in Personal & Commercial Banking, Capital Markets and Wealth Management, mainly driven by volume growth and unfavourable changes in portfolio mix. ACL on impaired loans of $832 million increased $132 million from the prior year, mainly due to higher provisions, partially offset by write-offs, in Capital Markets and Personal & Commercial Banking. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 65 Market risk Market risk is defined to be the impact of market prices upon our financial condition. This includes potential gains or losses due to changes in market determined variables such as interest rates, credit spreads, equity prices, commodity prices, foreign exchange rates and implied volatilities. The measures of financial condition impacted by market risk are as follows: 1. 2. 3. 4. Positions whose revaluation gains and losses are reported in Revenue, which includes: a) Changes in the fair value of instruments classified or designated as fair value through profit and loss (FVTPL), and b) Hedge ineffectiveness. CET1 capital, which includes: a) All of the above, plus b) Changes in the fair value of FVOCI securities where revaluation gains and losses are reported as Other comprehensive income (OCI), c) Changes in the Canadian dollar value of investments in foreign subsidiaries, net of hedges, due to foreign exchange translation, and d) Changes in the fair value of employee benefit plan deficits. CET1 ratio, which includes: a) All of the above, plus b) Changes in RWA resulting from changes in traded market risk factors, and c) Changes in the Canadian dollar value of RWA due to foreign exchange translation. The economic value of the Bank, which includes: a) Points 1 and 2 above, plus b) Changes in the economic value of other non-trading positions, net interest income, and fee based income, as a result of changes in market risk factors. Market risk controls – FVTPL positions As an element of the ERAF, the Board approves our overall market risk constraints. GRM creates and manages the control structure for FVTPL positions which ensures that business is conducted consistent with Board requirements. The Market and Trading Credit Risk function within GRM is responsible for creating and managing the controls and governance procedures that ensure that risk taken is consistent with risk appetite constraints set by the Board. These controls include limits on probabilistic measures of potential loss such as Value-at-Risk and Stressed Value-at-Risk as defined below: Value-at-Risk (VaR) is a statistical measure of potential loss for a financial portfolio computed at a given level of confidence and over a defined holding period. We measure VaR at the 99th percentile confidence level for price movements over a one-day holding period using historic simulation of the last two years of equally weighted historic market data. These calculations are updated daily with current risk positions, with the exception of certain less material positions that are not actively traded and are updated on at least a monthly basis. Stressed Value-at-Risk (SVaR) is calculated in an identical manner as VaR with the exception that it is computed using a fixed historical one-year period of extreme volatility and its inverse rather than the most recent two-year history. The stress period used is the interval from September 2008 through August 2009. SVaR is calculated daily for all portfolios, with the exception of certain less material positions that are not actively traded and are updated on at least a monthly basis. VaR and SVaR are statistical estimates based on historical market data and should be interpreted with knowledge of their limitations, which include the following: (cid:129) (cid:129) (cid:129) VaR and SVaR will not be predictive of future losses if the realized market movements differ significantly from the historical periods used to compute them. VaR and SVaR project potential losses over a one-day holding period and do not project potential losses for risk positions held over longer time periods. VaR and SVaR are measured using positions at close of business and do not include the impact of trading activity over the course of a day. We validate our VaR and SVaR measures through a variety of means – including subjecting the models to vetting and validation by a group independent of the model developers and by back-testing the VaR against daily marked-to-market revenue to identify and examine events in which actual outcomes in trading revenue exceed the VaR projections. Stress Tests – Our market risk stress testing program is used to identify and control risk due to large changes in market prices and rates. We conduct stress testing daily on positions that are marked-to-market. The stress tests simulate both historical and hypothetical events which are severe and long term in duration. Historical scenarios are taken from actual market events and range in duration up to 90 days. Examples include the equity market crash of 1987 and the global financial crisis of 2008. Hypothetical scenarios are designed to be forward-looking at potential future market stresses, and are designed to be severe but plausible. We are constantly evaluating and refining these scenarios as market conditions change. Stress results are calculated assuming an instantaneous revaluation of our positions with no management action. These measures are computed on all positions that are FVTPL for financial reporting purposes, with the exception of those in a designated hedging relationship and those in our insurance businesses. 66 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Market risk measures – FVTPL positions VaR and SVaR The following table presents our Market risk VaR and Market risk SVaR figures for 2019 and 2018. Market risk VaR* Table 52 (Millions of Canadian dollars) Equity Foreign exchange Commodities Interest rate (1) Credit specific (2) Diversification (3) Market risk VaR Market risk Stressed VaR October 31, 2019 For the year ended October 31, 2018 For the year ended As at 22 3 2 13 5 (17) 28 85 $ $ $ Average 19 $ 4 2 14 5 (17) 27 106 $ $ High 32 13 4 19 6 n.m 45 161 $ $ $ Low 11 2 1 11 4 n.m. 15 76 $ $ $ As at 34 12 2 15 5 (29) 39 91 $ $ $ Average 14 $ 4 2 17 5 (17) 25 79 $ $ $ High 40 12 3 30 6 n.m. $ 44 $ 149 Low 6 2 1 10 4 n.m. 13 40 $ $ $ This table represents an integral part of our 2019 Annual Consolidated Financial Statements. General credit spread risk and funding spread risk associated with uncollateralized derivatives are included under interest rate VaR. Credit specific risk captures issuer-specific credit spread volatility. * (1) (2) (3) Market risk VaR is less than the sum of the individual risk factor VaR results due to portfolio diversification. n.m. not meaningful 2019 vs. 2018 Average market risk VaR of $27 million increased $2 million from the prior year, mainly reflecting the impact of heightened equity market volatility from the first and fourth quarter of fiscal 2019, balanced out by lower average inventory levels in our fixed income portfolio. Average SVaR of $106 million increased $27 million from the prior year, largely due to growth in certain fixed income portfolios sustained since the first quarter of fiscal 2019, in addition to the impact from heightened equity market volatility mentioned above. The following chart displays a bar graph of our daily trading profit and loss and a line graph of our daily market risk VaR. We had 1 day of losses totaling $0.4 million in 2019, which did not exceed VaR on that day. Trading revenue and VaR (Millions of Canadian dollars) 60 40 20 0 -20 -40 -60 0 1 8 v 1, 2 o N 0 1 9 n 3 1, 2 J a 0 1 9 0 , 2 r 3 p A 0 1 9 J u l 3 1, 2 0 1 9 c t 3 1, 2 O Trading Revenue Market Risk VaR Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 67 The following chart displays the distribution of daily trading profit and loss in 2019 and 2018 with 1 day of losses in 2019 of $0.4 million as mentioned above. The largest reported profit was $33 million with an average daily profit of $14 million. Trading Revenue for the year ended October 31, 2019 (teb) s y a D f o r e b m u N n i y c n e u q e r F 110 100 90 80 70 60 50 40 30 20 10 0 5 2 - 5 1 - 5 - 5 5 1 5 2 5 3 5 4 5 5 Daily net trading revenue (C$ millions), excluding structured entities 2019 2018 Market risk measures for assets and liabilities of RBC Insurance We offer a range of insurance products to clients and hold investments to meet the future obligations to policyholders. The investments which support actuarial liabilities are predominantly fixed income assets designated as FVTPL. Consequently, changes in the fair values of these assets are recorded in the Consolidated Statements of Income and are largely offset by changes in the fair value of the actuarial liabilities, the impact of which is reflected in Insurance policyholder benefits, claims and acquisition expense. As at October 31, 2019, we held assets in support of $11.4 billion liabilities with respect to insurance obligations (October 31, 2018 – $10.0 billion). Market risk controls – Structural Interest Rate Risk (SIRR) positions(1) The interest rate risk arising from traditional banking products, such as deposits and loans, is referred to as SIRR and is subject to limits and controls. SIRR measures also include related hedges as well as the interest rate risk from securities held for liquidity management. Factors contributing to SIRR include the mismatch between asset and liability repricing dates, relative changes in asset and liability rates, and other product features that could affect the expected timing of cash flows, such as options to pre-pay loans or redeem term deposits prior to contractual maturity. The Board approves the risk appetite for SIRR, and the Asset-Liability Committee (ALCO), along with GRM, provides ongoing governance of SIRR measurement and management through risk policies, limits, operating standards and other controls. SIRR reports are reviewed regularly by GRM, ALCO, the GRC, the Risk Committee of the Board and the Board. Details on the non-trading risks included in SIRR are outlined in Table 54. SIRR measurement To monitor and control SIRR, we assess two primary metrics, Net Interest Income (NII) risk and Economic Value of Equity (EVE) risk, under a range of market shocks, scenarios, and time horizons. Market scenarios include currency-specific parallel and non-parallel yield curve changes and interest rate volatility shocks. In measuring NII risk, detailed structural balance sheets and income statements are dynamically simulated to determine the impact of market stress scenarios on projected NII. Assets, liabilities and off-balance sheet positions are simulated over various time horizons. The simulations incorporate product maturities, renewals and growth along with prepayment and redemption behaviour. Product pricing and volumes are forecast based on past experience and expectations for a given market stress scenario. EVE risk captures the market value sensitivity of structural positions to changes in rates. In measuring EVE risk, deterministic (single-scenario) and stochastic (multiple-scenario) valuation techniques are applied to detailed spot position data. NII and EVE risks are measured for a range of market risk stress scenarios which include extreme but plausible changes in market rates and volatilities. These SIRR measures do not include the benefit of management actions. Management of NII and EVE risk is complementary and supports our efforts to generate a sustainable high-quality NII stream. NII and EVE risks for specific units are measured daily, weekly or monthly depending on their materiality, complexity and hedge strategy. A number of assumptions affecting cash flows, product re-pricing and the administration of rates underlie the models used to measure NII and EVE risk. The key assumptions pertain to the expected funding profile of mortgage rate commitments, fixed rate loan prepayment behaviour, term deposit redemption behaviour, and the treatment of non-maturity deposits. All assumptions are derived empirically based on historical client behaviour and product pricing with consideration of possible forward-looking changes. All models and assumptions used to measure SIRR are subject to independent oversight by GRM. Market risk measures – Structural Interest Rate Sensitivities The following table shows the potential before-tax impact of an immediate and sustained 100 bps and 200 bps increase or decrease in interest rates on projected 12-month NII and EVE for our structural balance sheet, assuming no subsequent hedging. Rate floors are applied within the declining rates scenarios, with floor levels set based on rate changes experienced globally. Interest rate risk measures are based upon interest rate exposures at a specific time and continuously change as a result of business activities and management actions. (1) 68 SIRR positions include impact of derivatives in hedge accounting relationships and FVOCI securities used for interest rate risk management. Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Market risk – SIRR measures* EVE risk NII risk (1) 2019 Table 53 2018 (Millions of Canadian dollars) Before-tax impact of: 100 bps increase in rates 100 bps decrease in rates Before-tax impact of: 200 bps increase in rates 200 bps decrease in rates Canadian dollar impact U.S. dollar impact (2) Total Canadian dollar impact U.S. dollar impact (2) Total EVE risk NII risk (1) $ $ (1,151) $ (205) $(1,356) $ (107) 1,027 920 351 (486) (2,311) $ (690) $(3,001) $ (86) 2,030 1,944 620 (1,071) $ $ 128 (151) $ 479 (637) $(1,140) $ 755 505 (582) 247 (285) $ 867 (1,356) $(2,407) $ 1,067 923 (1,370) * (1) (2) This table represents an integral part of our 2019 Annual Consolidated Financial Statements. Represents the 12-month NII exposure to an instantaneous and sustained shift in interest rates. Represents the impact on the SIRR portfolios held in our City National and U.S. banking operations. As at October 31, 2019, an immediate and sustained -100 bps shock would have had a negative impact to our NII of $637 million, up from $582 million last year. An immediate and sustained +100 bps shock at the end of October 31, 2019 would have had a negative impact to our EVE of $1,356 million, up from $1,140 million reported last year. The year-over-year change in NII sensitivity is largely attributed to balance sheet growth, while the year-over-year change in EVE sensitivity is mainly due to net growth in fixed rate assets. During 2019, NII and EVE risks remained well within approved limits. Market risk measures for other material non-trading portfolios Investment securities carried at FVOCI We held $57.7 billion of investment securities carried at FVOCI as at October 31, 2019, compared to $48.5 billion in the prior year. We hold debt securities carried at FVOCI primarily as investments, as well as to manage liquidity risk and hedge interest rate risk in our non-trading banking balance sheet. As at October 31, 2019, our portfolio of investment securities carried at FVOCI is interest rate sensitive and would impact OCI by a pre-tax change in value of $7 million as measured by the change in the value of the securities for a one basis point parallel increase in yields. The portfolio also exposes us to credit spread risk of a pre-tax change in value of $20 million, as measured by the change in value for a one basis point widening of credit spreads. The value of the investment securities carried at FVOCI included in our SIRR measure as at October 31, 2019 was $9.9 billion. Our investment securities carried at FVOCI also include equity exposures of $0.4 billion as at October 31, 2019, compared to $0.4 billion in the prior year. Non-trading foreign exchange rate risk Foreign exchange rate risk is the potential adverse impact on earnings and economic value due to changes in foreign currency rates. Our revenue, expenses and income denominated in currencies other than the Canadian dollar are subject to fluctuations as a result of changes in the value of the average Canadian dollar relative to the average value of those currencies. Our most significant exposure is to the U.S. dollar, due to our operations in the U.S. and other activities conducted in U.S. dollars. Other significant exposures are to the British pound and the Euro, due to our activities conducted internationally in these currencies. A strengthening or weakening of the Canadian dollar compared to the U.S. dollar, British pound and the Euro could reduce or increase, as applicable, the translated value of our foreign currency denominated revenue, expenses and earnings and could have a significant effect on the results of our operations. We are also exposed to foreign exchange rate risk arising from our investments in foreign operations. For unhedged equity investments, when the Canadian dollar appreciates against other currencies, the unrealized translation losses on net foreign investments decreases our shareholders’ equity through the other components of equity and decreases the translated value of the RWA of the foreign currency-denominated asset. The reverse is true when the Canadian dollar depreciates against other currencies. Consequently, we consider these impacts in selecting an appropriate level of our investments in foreign operations to be hedged. Derivatives related to non-trading activity Derivatives are also used to hedge market risk exposure unrelated to our trading activity. Hedge accounting is elected where applicable. These derivatives are included in our SIRR measure and other internal non-trading market risk measures. We use interest rate swaps to manage our SIRR, funding and investment activities. Interest rate swaps are also used to hedge changes in the fair value of certain fixed-rate instruments. We also use foreign exchange derivatives to manage our exposure to equity investments in subsidiaries that are denominated in foreign currencies, particularly the U.S. dollar, British Pound, and Euro. For further details on the application of hedge accounting and the use of derivatives for hedging activities, refer to Notes 2 and 8 of our 2019 Annual Consolidated Financial Statements. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 69 Linkage of market risk to selected balance sheet items The following tables provide the linkages between selected balance sheet items with positions included in our trading market risk and non-trading market risk disclosures, which illustrates how we manage market risk for our assets and liabilities through different risk measures: Linkage of market risk to selected balance sheet items Table 54 (Millions of Canadian dollars) Assets subject to market risk Cash and due from banks Interest-bearing deposits with banks Securities Trading Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Segregated fund net assets Other Derivatives Other assets Assets not subject to market risk (3) Total assets Liabilities subject to market risk Deposits Segregated fund liabilities Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities Subordinated debentures Liabilities not subject to market risk (4) Total liabilities Total equity Total liabilities and equity As at October 31, 2019 Market risk measure Balance sheet amount Traded risk (1) Non-traded risk (2) Non-traded risk primary risk sensitivity $ 26,310 $ 38,345 – 22,287 $ 26,310 16,058 Interest rate Interest rate 146,534 102,470 136,609 – 9,925 102,470 Interest rate, credit spread Interest rate, credit spread, equity 306,961 246,068 60,893 426,086 195,870 (3,100) 1,663 101,560 79,802 6,434 10,876 7,111 – – 99,318 4,648 415,210 188,759 (3,100) 1,663 2,242 75,154 1,428,935 $ 526,917 $ 895,584 886,005 $ 1,663 99,137 – $ 786,868 1,663 35,069 35,069 – Interest rate Interest rate Interest rate Interest rate Interest rate Interest rate, foreign exchange Interest rate Interest rate Interest rate 226,586 98,543 79,040 9,815 8,589 218,612 96,512 8,918 – 7,974 2,031 70,122 9,815 Interest rate Interest rate, foreign exchange Interest rate Interest rate 1,345,310 $ 458,248 $ 878,473 83,625 1,428,935 $ $ $ $ $ (1) (2) (3) (4) Traded risk includes positions that are classified or designated as FVTPL and positions whose revaluation gains and losses are reported in revenue. Market risk measures of VaR and SVaR and stress testing are used as risk controls for traded risk. Non-traded risk includes positions used in the management of the SIRR and other non-trading portfolios. Other material non-trading portfolios include positions from RBC Insurance and investment securities, net of applicable allowance, not included in SIRR. Assets not subject to market risk include $6,434 million of physical and other assets. Liabilities not subject to market risk include $8,589 million of payroll related and other liabilities. 70 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis (Millions of Canadian dollars) Assets subject to market risk Cash and due from banks Interest-bearing deposits with banks Securities Trading Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Segregated fund net assets Derivatives Other assets Assets not subject to market risk (3) Total assets Liabilities subject to market risk Deposits (4) Segregated fund liabilities Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities Subordinated debentures Liabilities not subject to market risk (4), (5) Total liabilities Total equity Total liabilities and equity As at October 31, 2018 Market risk measure Balance sheet amount Traded risk (1) Non-traded risk (2) Non-traded risk primary risk sensitivity $ 30,209 36,471 $ – 20,277 $ 30,209 16,194 Interest rate Interest rate 128,258 94,608 120,163 – 8,095 Interest rate, credit spread 94,608 Interest rate, credit spread, equity 294,602 219,108 75,494 Interest rate $ $ 4,307 9,128 – – 91,275 2,259 466,517 81,432 – 32,247 201,839 87,352 7,661 – 395,145 171,150 (2,912) 1,368 2,764 69,396 Interest rate Interest rate Interest rate Interest rate Interest rate, foreign exchange Interest rate $ $ 861,511 754,765 1,368 – 4,975 2,886 64,455 9,131 Interest rate Interest rate Interest rate Interest rate, foreign exchange Interest rate Interest rate $ 410,531 $ 837,580 399,452 180,278 (2,912) 1,368 94,039 71,655 6,706 1,334,734 836,197 1,368 32,247 206,814 90,238 72,116 9,131 6,668 1,254,779 79,955 1,334,734 $ $ $ $ $ (1) (2) (3) (4) (5) Traded risk includes positions that are classified or designated as FVTPL and positions whose revaluation gains and losses are reported in revenue. Market risk measures of VaR and SVaR and stress testing are used as risk controls for traded risk. Non-traded risk includes positions used in the management of the SIRR and other non-trading portfolios. Other material non-trading portfolios include positions from RBC Insurance and investment securities, net of applicable allowance, not included in SIRR. Assets not subject to market risk include $6,706 million of physical and other assets. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in liabilities not subject to market risk. Amounts have been reclassified to conform with this presentation. Liabilities not subject to market risk include $6,668 million of payroll related and other liabilities. Liquidity and funding risk Liquidity and funding risk (liquidity risk) is the risk that we may be unable to generate sufficient cash or its equivalents in a timely and cost-effective manner to meet our commitments as they come due. Liquidity risk arises from mismatches in the timing and value of on-balance sheet and off-balance sheet cash flows. Our liquidity profile is structured to ensure that we have sufficient liquidity to satisfy current and prospective commitments in both normal and stressed conditions. To achieve this goal, we operate under a comprehensive Liquidity Risk Management Framework (LRMF) and Pledging Policy. We also employ several liquidity risk mitigation strategies that include: Achieving an appropriate balance between the level of exposure allowed under our risk appetite and the cost of risk (cid:129) mitigation; (cid:129) Maintaining broad funding access, including preserving and promoting a reliable base of core client deposits and ongoing access to diversified wholesale funding sources; A comprehensive liquidity stress testing program, contingency, recovery and resolution planning and status monitoring to ensure sufficiency of unencumbered marketable securities and demonstrated capacity to monetize specific asset classes; Governance of pledging activity through limits and liquid asset buffers for potential pledging activity; Timely and granular risk measurement information; Transparent liquidity transfer pricing and cost allocation; and Our three lines of defense governance model. (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) Risk control Our liquidity risk objectives, policies and methodologies are reviewed regularly, and are updated to reflect changing market conditions and business mix. This includes aligning with local regulatory developments. We continue to maintain liquidity and funding that is appropriate for the execution of our strategy. Liquidity risk remains well within our risk appetite. The Board annually approves the delegation of liquidity risk authorities to senior management. The Risk Committee of the Board annually approves the LRMF and the Pledging Policy and is responsible for their oversight. The Board, the Risk Committee of the Board, the GRC and the ALCO regularly review reporting on our enterprise-wide liquidity position. The GRC, the Policy Review Committee (PRC) and/or the ALCO also review liquidity documents prepared for the Board or its committees. (cid:129) The PRC annually approves the Liquidity Risk Policy (LRP), which establishes minimum risk control elements in accordance with the Board-approved risk appetite and the LRMF. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 71 (cid:129) The ALCO annually approves the Liquidity Contingency Plan (LCP) and provides strategic direction and oversight to Corporate Treasury, other functions, and business segments on the management of liquidity. These policies are supported by operational, desk and product-level policies that implement risk control elements, such as parameters, methodologies, management limits and authorities that govern the measurement and management of liquidity. Stress testing is also employed to assess the robustness of the control framework and inform liquidity contingency plans. Risk measurement Liquidity risk is measured by applying scenario-specific assumptions against our assets and liabilities and off-balance sheet commitments to derive expected cash flow profiles over varying time horizons. For example, government bonds generally can be quickly and easily converted to cash without significant loss of value regardless of their contractual maturity. Similarly, while relationship-based deposits contractually can be withdrawn immediately, in practice, these balances can be relatively stable sources of funding depending on several factors, such as the nature of the client and their intended use. Risk methodologies and underlying assumptions are periodically reviewed and validated to ensure their alignment with our operating environment, expected economic and market conditions, rating agency preferences, regulatory requirements and generally accepted industry practices. To manage liquidity risk within our liquidity risk appetite, we set limits on various metrics reflecting a range of time horizons and severity of stress conditions and develop contingency, recovery and resolution plans. Our liquidity risk measurement and control activities are divided into three categories as follows: Structural (longer-term) liquidity risk To guide our secured and unsecured wholesale term funding activities, we employ an internal metric to manage and control the structural alignment between long-term illiquid assets and longer-term funding sourced from wholesale investors and core relationship deposits. Tactical (shorter-term) liquidity risk To address potential immediate cash flow risks in times of stress, we use short-term net cash flow limits to control risk of material units, subsidiaries and currencies, and perform stress testing assessments. Net cash flow positions are determined by applying internally-derived risk assumptions and parameters to known and anticipated cash flows for all material unencumbered assets, liabilities and off-balance sheet activities. Encumbered assets are not considered a source of available liquidity. We also control tactical liquidity by adhering to enterprise-wide and unit-specific prescribed regulatory standards, such as LCR. Contingency liquidity risk Contingency liquidity risk planning assesses the impact of sudden stress events and our planned responses. Our LCP, maintained and administered by Corporate Treasury, has been developed to guide our potential responses to liquidity crises. Under leadership of Corporate Treasury, both enterprise and regional Liquidity Crisis Teams (LCT) meet regularly to assess our liquidity status, approve the LCP, and in times of stress provide valuable linkages to front line and risk functions to support the crisis management process. LCT’s include members from key business segments, GRM, Finance, Operations, and Communications with relevant subject matter expertise. Our stress tests, which include elements of scenario and sensitivity analyses, measure our prospective exposure to systemic and RBC-specific events over a period of several weeks. Different levels of severity are considered for each type of crisis with some scenarios reflecting multiple-downgrades to our credit ratings. The contingency liquidity risk planning process identifies contingent funding needs (e.g., draws on committed credit and liquidity lines, demands for more collateral and deposit run-off) and sources (e.g., contingent liquid asset sales and incremental wholesale funding capacity) under various stress scenarios, and as a result, informs requirements for our earmarked unencumbered liquid asset portfolios. Our unencumbered liquid asset portfolios consist of diversified, highly rated and liquid marketable securities, overnight government reverse repos and deposits with central banks. These portfolios are subject to minimum asset quality levels and, as appropriate, other eligibility guidelines (e.g., maturity, diversification and eligibility for central bank advances) to maximize ready access to additional cash should it be required. These securities, when added to other unencumbered liquid assets that we hold as a result of capital markets or other activities, contribute to our liquidity reserve, and are reflected in the asset encumbrance disclosures shown below. Liquidity reserve and asset encumbrance The following tables provide summaries of our liquidity reserve and asset encumbrance. In both tables, unencumbered assets represent, to varying degrees, a ready source of funding. Unencumbered assets are the difference between total and encumbered assets from both on- and off-balance sheet sources. The encumbered assets include: (i) bank-owned liquid assets that are either pledged as collateral (e.g., repo financing and derivative pledging) or not freely available due to regulatory or internal policy requirements (e.g., earmarked to satisfy mandatory reserve or regional capital adequacy requirements and to maintain continuous access to payment and settlement systems); (ii) securities received as collateral from securities financing and derivative transactions which have either been re-hypothecated where permissible (e.g., to obtain financing through repos or to cover securities sold short) or have no liquidity value since re-hypothecation is prohibited; and (iii) illiquid assets that have been securitized and sold into the market or that have been pledged as collateral in support of structured term funding vehicles. As per our liquidity management framework and practice, encumbered assets are not considered a source of liquidity. 72 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Liquidity reserve Our liquidity reserve consists of available unencumbered liquid assets as well as uncommitted and undrawn central bank borrowing facilities that could be accessed under extraordinary circumstances subject to satisfying certain preconditions as set by various central banks (e.g., BoC, the Fed, Bank of England, and Bank of France). Although unused wholesale funding capacity, which is regularly assessed, could be another potential source of liquidity to mitigate stressed conditions, it is excluded in the determination of the liquidity reserve. Liquidity reserve Table 55 As at October 31, 2019 (Millions of Canadian dollars) Cash and due from banks Interest-bearing deposits with banks Securities issued or guaranteed by sovereigns, central banks or multilateral development banks (1) Other securities Undrawn credit lines granted by central banks (2) Other assets eligible as collateral for discount (3) Other liquid assets (4) Total liquid assets (Millions of Canadian dollars) Cash and due from banks Interest-bearing deposits with banks Securities issued or guaranteed by sovereigns, central banks or multilateral development banks (1) Other securities Undrawn credit lines granted by central banks (2) Other assets eligible as collateral for discount (3) Other liquid assets (4) Total liquid assets (Millions of Canadian dollars) Royal Bank of Canada Foreign branches Subsidiaries Total unencumbered liquid assets Securities received as collateral from securities financing and derivative transactions Bank-owned liquid assets $ 26,310 $ 38,345 Total liquid assets 26,310 $ 38,345 – $ – Encumbered liquid assets Unencumbered liquid assets 23,450 38,016 2,860 $ 329 206,960 90,026 9,534 109,327 21,732 311,019 115,261 517,979 205,287 345,753 96,184 172,226 109,103 – – – 9,534 109,327 21,732 – 9,534 – 21,316 109,327 416 462,072 $ 502,234 $ 426,280 $ 928,514 $ 466,442 $ As at October 31, 2018 Securities received as collateral from securities financing and derivative transactions Bank-owned liquid assets $ 30,209 $ 36,471 Total liquid assets 30,209 $ 36,471 – $ – Encumbered liquid assets Unencumbered liquid assets 27,636 36,105 2,573 $ 366 188,911 78,090 9,988 99,120 19,758 261,119 126,209 450,030 204,299 – – – 9,988 99,120 19,758 297,681 84,589 – – 19,406 $ 462,547 $ 387,328 $ 849,875 $ 404,615 $ 152,349 119,710 9,988 99,120 352 445,260 As at October 31 2019 $ 224,063 71,062 166,947 $ 462,072 October 31 2018 $ 219,197 73,015 153,048 $ 445,260 (1) (2) (3) (4) Includes liquid securities issued by provincial governments and U.S. government-sponsored entities working under U.S. Federal government’s conservatorship (e.g., Federal National Mortgage Association and Federal Home Loan Mortgage Corporation). Includes loans that qualify as eligible collateral for the discount window facility available to us at the Federal Reserve Bank of New York (FRBNY). Amounts are at face value and would be subject to collateral margin requirements applied by the FRBNY to determine collateral value/borrowing capacity. Access to the discount window borrowing program is conditional on meeting requirements set by the FRBNY and borrowings are typically expected to be infrequent and due to uncommon occurrences requiring temporary accommodation. Represents our unencumbered Canadian dollar non-mortgage loan book (at face value) that could, subject to satisfying conditions precedent to borrowing and application of prescribed collateral margin requirements, be pledged to the BoC for advances under its Emergency Lending Assistance (ELA) program. ELA is not considered a source of available liquidity in our normal liquidity risk profile but could in extraordinary circumstances, where normal market liquidity is seriously impaired, allow us and other banks to monetize assets eligible as collateral to meet requirements and mitigate further market liquidity disruption. The balance also includes our unencumbered mortgage loans that qualify as eligible collateral at Federal Home Loan Bank (FHLB). Encumbered liquid assets amount represents cash collateral and margin deposit amounts pledged related to OTC and exchange-traded derivative transactions. The liquidity reserve is typically most affected by routine flows of client banking activity where liquid asset portfolios adjust to the change in cash balances, and additionally from capital markets activities where business strategies and client flows may also affect the addition or subtraction of liquid assets in the overall calculation of the liquidity reserve. Corporate Treasury also affects liquidity reserves through the management of funding issuances where reserves absorb timing mismatches between debt issuances and deployment into business activities. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 73 2019 vs. 2018 Total liquid assets increased $79 billion or 9%, primarily due to an increase in securities received as collateral under collateral swap and reverse repurchase transactions as well as the on-balance sheet securities portfolio. The increase in collateral received was offset by a corresponding increase in collateral pledged under encumbered liquid assets due to repurchase and collateral swap transactions. Asset encumbrance The table below provides a summary of cash, securities and other assets, distinguishing between those that are encumbered or available for sale or use as collateral in secured funding transactions. Other assets, such as mortgages and credit card receivables, can also be monetized, albeit over longer timeframes than those required for marketable securities. As at October 31, 2019, our unencumbered assets available as collateral comprised 29% of total assets (October 31, 2018 – 29%). Asset encumbrance Table 56 October 31 2019 October 31 2018 As at Encumbered Unencumbered Encumbered Unencumbered (Millions of Canadian dollars) collateral Other (1) Pledged as Available as collateral (2) Other (3) Pledged as collateral Other (1) Available as collateral (2) Other (3) Total $ – $ 2,860 $ 23,450 $ – $ – $ 2,573 $ 27,636 $ – $ 30,209 Total 26,310 $ Cash and due from banks Interest-bearing deposits with banks Securities Trading Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed (4) Loans Retail Mortgage securities Mortgage loans Non-mortgage loans Wholesale Allowance for loan losses Segregated fund net assets Other Derivatives Other (5) Total assets – 329 38,016 – 38,345 – 366 36,105 – 36,471 44,431 16,376 – – 99,420 2,683 146,534 86,045 49 102,470 40,640 12,195 – – 84,270 3,348 128,258 82,351 62 94,608 399,013 22,793 49,325 5,214 476,345 348,597 22,188 53,590 5,722 430,097 31,345 42,103 7,094 – – – – 21,316 – – – – – – – – 40,401 22,598 62,204 34,882 – – – 171,644 48,697 160,988 (3,100) 1,663 71,746 236,345 117,995 195,870 (3,100) 1,663 – 416 101,560 64,504 101,560 86,236 34,286 36,959 8,553 – – – – 19,406 – – – – – – – – 36,234 17,784 59,611 32,478 – – – 157,208 48,817 147,800 (2,912) 1,368 70,520 211,951 116,981 180,278 (2,912) 1,368 – 352 94,039 58,603 94,039 78,361 $ 561,678 $ 25,982 $ 456,757 $ 553,902 $ 1,598,319 $ 500,636 $ 25,127 $ 430,411 $ 514,055 $ 1,470,229 (1) (2) (3) (4) (5) Includes assets restricted from use to generate secured funding due to legal or other constraints. Includes loans that could be used to collateralize central bank advances. Our unencumbered Canadian dollar non-mortgage loan book (at face value) could, subject to satisfying conditions for borrowing and application of prescribed collateral margin requirements, be pledged to the BoC for advances under its ELA program. It also includes our unencumbered mortgage loans that qualify as eligible collateral at FHLB. We also lodge loans that qualify as eligible collateral for the discount window facility available to us at the FRBNY. ELA and other central bank facilities are not considered sources of available liquidity in our normal liquidity risk profile. However, banks could monetize assets meeting collateral criteria during periods of extraordinary and severe disruption to market-wide liquidity. Other unencumbered assets are not subject to any restrictions on their use to secure funding or as collateral but would not be considered readily available since they may not be acceptable at central banks or for other lending programs. Includes bank-owned liquid assets and securities received as collateral from off-balance sheet securities financing, derivative transactions, and margin lending. Includes $22.8 billion (October 31, 2018 – $22.2 billion) of collateral received through reverse repurchase transactions that cannot be rehypothecated in its current legal form. The Pledged as collateral amount represents cash collateral and margin deposit amounts pledged related to OTC and exchange-traded derivative transactions. Funding Funding strategy Core funding, comprising capital, longer-term wholesale liabilities and a diversified pool of personal and, to a lesser extent, commercial and institutional deposits, is the foundation of our structural liquidity position. Deposit and funding profile As at October 31, 2019, relationship-based deposits, which are the primary source of funding for retail loans and mortgages, were $594 billion or 51% of our total funding (October 31, 2018 – $545 billion or 50%). The remaining portion is comprised of short- and long-term wholesale funding. Funding for highly liquid assets consists primarily of short-term wholesale funding that reflects the monetization period of those assets. Long-term wholesale funding is used mostly to fund less liquid wholesale assets and to support liquidity asset buffers. On April 18, 2018, the Department of Finance published bail-in regulations under the Canada Deposit Insurance Corporation (CDIC) Act and the Bank Act, which became effective September 23, 2018. Senior long-term debt issued by the bank on or after September 23, 2018, that has an original term greater than 400 days and is marketable, subject to certain exceptions, is subject to the Canadian Bank Recapitalization (Bail-in) regime. Under the Bail-in regime, in circumstances when the Superintendent of Financial Institutions has determined that a bank may no longer be viable, the Governor in Council may, upon a recommendation of the Minister of Finance that he or she is of the opinion that it is in the public interest to do so, grant an order directing the CDIC to convert all or a portion of certain shares and liabilities of that bank into common shares. As at October 31, 2019, the notional value of issued and outstanding long-term debt subject to conversion under the Bail-in regime was $20,320 million (October 31, 2018 – $4,467 million). For further details on our wholesale funding, refer to the Composition of wholesale funding tables below. 74 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Long-term debt issuance During 2019, we continued to experience more favourable unsecured wholesale funding access and pricing compared to many global peers. We issued, either directly or through our subsidiaries, unsecured long-term funding of $19.1 billion in various currencies and markets, which was more than offset by maturities. We primarily use residential mortgage and credit card securitization programs as alternative sources of funding and for liquidity and asset/liability management purposes. Our total secured long-term funding includes outstanding mortgage-backed securities (MBS) sold, covered bonds that are collateralized with residential mortgages and securities backed by credit card receivables. Compared to 2018, our outstanding MBS sold decreased $1.8 billion. Our covered bonds and securitized credit card receivables increased $2.3 billion and decreased $1.5 billion, respectively. For further details, refer to the Off-balance sheet arrangements section. Long-term funding sources* (Millions of Canadian dollars) Unsecured long-term funding Secured long-term funding Subordinated debentures Table 57 As at October 31 2019 $ 94,662 63,853 9,788 $ 168,303 October 31 2018 $ 102,325 64,843 9,397 $ 176,565 * This table represents an integral part of our 2019 Annual Consolidated Financial Statements. Our wholesale funding activities are well-diversified by geography, investor segment, instrument, currency, structure and maturity. We maintain an ongoing presence in different funding markets which allows us to continuously monitor market developments and trends, identify opportunities and risks, and take appropriate and timely actions. We operate longer-term debt issuance registered programs. The following table summarizes these programs with their authorized limits by geography. Programs by geography Canada (cid:129) Canadian Shelf Program – $25 billion U.S. (cid:129) U.S. Shelf Program – US$40 billion Table 58 Europe/Asia (cid:129) European Debt Issuance Program – US$40 billion (cid:129) Global Covered Bond Program – €32 billion (cid:129) Japanese Issuance Programs – ¥1 trillion We also raise long-term funding using Canadian Senior Notes, Canadian National Housing Act MBS, Canada Mortgage Bonds, credit card receivable-backed securities, Kangaroo Bonds (issued in the Australian domestic market by foreign firms) and Yankee Certificates of Deposit (issued in the U.S. domestic market by foreign firms). We continuously evaluate opportunities to expand into new markets and untapped investor segments since diversification expands our wholesale funding flexibility, minimizes funding concentration and dependency, and generally reduces financing costs. As presented in the following charts, our current long-term debt profile is well-diversified by both currency and product. Maintaining competitive credit ratings is also critical to cost-effective funding. Long-term debt (1) – funding mix by currency of issuance Long-term debt (1) – funding mix by product Other 10% Euro 19% Canadian dollar 36% October 31, 2019 U.S. dollar 35% Cards securitization 5% October 31, 2019 Unsecured funding 53% Covered Bonds 29% MBS/CMB (2) 13% (1) Based on original term to maturity greater than 1 year (1) (2) Based on original term to maturity greater than 1 year Mortgage-backed securities and Canada Mortgage Bonds Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 75 The following table provides our composition of wholesale funding based on remaining term to maturity: Composition of wholesale funding (1) As at October 31, 2019 Less than 1 month 1 to 3 months 3 to 6 months 6 to 12 months Less than 1 year sub-total 1 year to 2 years 2 years and greater $ 4,087 $ – $ 388 $ 33 $ 4,508 $ – $ – $ 2,917 12,037 17,390 22,038 54,382 132 2,542 3,188 6,543 3,905 16,178 – – – Table 59 Total 4,508 54,514 16,178 11 2,293 9,183 14,188 25,675 18,856 29,756 74,287 847 – – – 9,489 676 524 – 2,000 1,224 171 1,796 6,282 – 157 1,342 727 2,305 998 1,663 3,036 3,047 8,587 2,998 12,533 1,810 3,523 14,337 2,500 141 5,047 11,015 23,426 4,290 9,976 9,893 17,585 46,350 9,788 22,650 $ 19,893 $ 21,942 $ 41,910 $ 47,199 $ 130,944 $ 41,299 $ 83,510 $ 255,753 $ 10,339 $ 9,554 3,929 $ 14,621 $ 6,937 $ 18,013 27,289 40,262 35,826 $ 17,860 $ 34,441 $ 95,118 23,439 49,069 88,127 167,626 (Millions of Canadian dollars) Deposits from banks (2) Certificates of deposit and commercial paper Asset-backed commercial paper (3) Senior unsecured medium- term notes (4) Senior unsecured structured notes (5) Mortgage securitization Covered bonds/asset- backed securities (6) Subordinated liabilities Other (7) Total Of which: Secured Unsecured (Millions of Canadian dollars) Deposits from banks (2) Certificates of deposit and commercial paper Asset-backed commercial paper (3) Senior unsecured medium- term notes (4) Senior unsecured structured notes (5) Mortgage securitization Covered bonds/asset-backed securities (6) Subordinated liabilities Other (7) Total Of which: Secured Unsecured As at October 31, 2018 Less than 1 month 1 to 3 months 3 to 6 months 6 to 12 months Less than 1 year sub-total 1 year to 2 years 2 years and greater $ 4,507 $ 10 $ 42 $ – $ 4,559 $ – $ – $ Total 4,559 3,658 9,000 20,994 14,926 48,578 1,908 2,581 5,877 6,197 16,563 197 – 132 48,907 – 16,563 122 185 – – – 7,639 6,132 7,424 8,090 21,768 23,125 33,513 78,406 215 2,473 21 – 1,658 353 527 4,641 – 419 693 1,099 5,409 1,103 1,189 1,446 4,099 10,071 1,103 10,905 2,603 3,027 8,581 2,993 4 5,608 12,193 26,861 5,301 9,122 9,657 19,319 45,513 9,397 20,031 $ 18,019 $ 22,090 $ 40,277 $ 38,706 $ 119,092 $ 40,530 $ 92,730 $ 252,352 $ 8,292 9,727 $ 5,666 16,424 $ 11,045 29,232 $ 12,706 26,000 $ 37,709 81,383 $ 11,608 28,922 $ 39,054 53,676 $ 88,371 163,981 (1) (2) (3) (4) (5) (6) (7) Excludes bankers’ acceptances and repos. Excludes deposits associated with services we provide to banks (e.g., custody, cash management). Only includes consolidated liabilities, including our collateralized commercial paper program. Includes deposit notes. Includes notes where the payout is tied to movements in foreign exchange, commodities and equities. Includes credit card and mortgage loans. Includes tender option bonds (secured) of $8,014 million (October 31, 2018 – $6,978 million), bearer deposit notes (unsecured) of $4,813 million (October 31, 2018 – $4,084 million) and other long-term structured deposits (unsecured) of $9,823 million (October 31, 2018 – $8,969 million). 76 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Credit ratings Our ability to access unsecured funding markets and to engage in certain collateralized business activities on a cost-effective basis are primarily dependent upon maintaining competitive credit ratings. Credit ratings and outlooks provided by rating agencies reflect their views and methodologies. Ratings are subject to change, based on a number of factors including, but not limited to, our financial strength, competitive position, liquidity and other factors not completely within our control. The following table presents our major credit ratings(1): Credit ratings Table 60 Short-term debt Legacy senior long-term debt (2) Senior long-term debt (3) Outlook Moody’s (4) Standard & Poor’s (5) Fitch Ratings (6) DBRS (7) P-1 A-1+ F1+ R-1(high) Aa2 AA- AA AA (high) A2 A AA AA stable stable stable stable As at December 3, 2019 (1) (2) Credit ratings are not recommendations to purchase, sell or hold a financial obligation inasmuch as they do not comment on market price or suitability for a particular investor. Ratings are determined by the rating agencies based on criteria established from time to time by them, and are subject to revision or withdrawal at any time by the rating organization. Includes senior long-term debt issued prior to September 23, 2018 and senior long-term debt issued on or after September 23, 2018 which is excluded from the Bail-in regime. Includes senior long-term debt issued on or after September 23, 2018 which is subject to conversion under the Bail-in regime. (3) (4) On August 1, 2019, Moody’s affirmed our ratings with a stable outlook. (5) (6) (7) On June 24, 2019, Standard & Poor’s affirmed our ratings with a stable outlook. On October 22, 2018, Fitch Ratings affirmed our ratings with a stable outlook. On June 18, 2019, DBRS revised our outlook to stable from positive, upgraded our legacy senior long-term debt rating to AA (high) from AA and upgraded our senior long-term debt rating to AA from AA (low). Additional contractual obligations for rating downgrades We are required to deliver collateral to certain counterparties in the event of a downgrade to our current credit rating. The following table provides the additional collateral obligations required at the reporting date in the event of a one-, two- or three- notch downgrade to our credit ratings. These additional collateral obligations are incremental requirements for each successive downgrade and do not represent the cumulative impact of multiple downgrades. The amounts reported change periodically as a result of several factors, including the transfer of trading activity to centrally cleared financial market infrastructures and exchanges, the expiration of transactions with downgrade triggers, the imposition of internal limitations on new agreements to exclude downgrade triggers, as well as normal course mark-to-market of positions with collateralized counterparties moving from a negative to a positive position. There is no outstanding senior debt issued in the market that contains rating triggers that would lead to early prepayment of principal. Additional contractual obligations for rating downgrades Table 61 As at October 31 2019 October 31 2018 (Millions of Canadian dollars) Contractual derivatives funding or margin requirements Other contractual funding or margin requirements (1) One-notch downgrade Two-notch downgrade Three-notch downgrade One-notch downgrade Two-notch downgrade Three-notch downgrade $ 165 $ 64 $ 124 $ 125 $ 45 $ 191 180 176 – 185 176 – (1) Includes GICs issued by our municipal markets business out of New York. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 77 Liquidity Coverage Ratio (LCR) The LCR is a Basel III metric that measures the sufficiency of high-quality liquid assets (HQLA) available to meet liquidity needs over a 30-day period in an acute stress scenario. The BCBS and OSFI regulatory minimum coverage level for LCR is currently 100%. OSFI requires Canadian banks to disclose the LCR using the standard Basel disclosure template and calculated using the average of daily LCR positions during the quarter. Liquidity coverage ratio (1) Table 62 For the three months ended October 31 2019 July 31 2019 (Millions of Canadian dollars, except percentage amounts) Total unweighted value (average) (2) Total weighted value (average) Total unweighted value (average) (2) Total weighted value (average) High-quality liquid assets Total high-quality liquid assets (HQLA) Cash outflows Retail deposits and deposits from small business customers, of which: Stable deposits (3) Less stable deposits Unsecured wholesale funding, of which: Operational deposits (all counterparties) and deposits in networks of cooperative banks (4) Non-operational deposits Unsecured debt Secured wholesale funding Additional requirements, of which: Outflows related to derivative exposures and other collateral requirements Outflows related to loss of funding on debt products Credit and liquidity facilities Other contractual funding obligations (5) Other contingent funding obligations (6) Total cash outflows Cash inflows Secured lending (e.g., reverse repos) Inflows from fully performing exposures Other cash inflows Total cash inflows $ $ Total HQLA Total net cash outflows Liquidity coverage ratio n.a. $ 234,605 n.a. $ 224,629 $ $ $ 266,868 89,565 177,303 303,129 133,484 145,888 23,757 n.a. 265,287 57,869 7,761 199,657 19,108 441,413 n.a. 313,698 15,692 43,442 $ 20,417 2,687 17,730 137,946 31,907 82,282 23,757 33,904 72,268 33,108 7,761 31,399 19,108 7,999 291,642 $ 52,469 11,154 43,442 $ $ $ 258,989 88,841 170,148 302,672 130,030 148,207 24,435 n.a. 269,355 66,828 6,080 196,447 20,370 431,682 n.a. 327,511 14,399 55,667 19,680 2,665 17,015 142,038 31,079 86,524 24,435 33,351 82,274 44,430 6,080 31,764 20,370 7,842 305,555 56,368 9,909 55,667 n.a. $ 107,065 n.a. $ 121,944 Total adjusted value $ 234,605 184,577 127% Total adjusted value $ 224,629 183,611 122% (1) The LCR is calculated in accordance with OSFI’s LAR guideline, which, in turn, reflects liquidity-related requirements issued by the BCBS. The LCR for the quarter ended October 31, 2019 is calculated as an average of 63 daily positions. (2) With the exception of other contingent funding obligations, unweighted inflow and outflow amounts are items maturing or callable in 30 days or less. Other contingent (3) funding obligations also include debt securities with remaining maturity greater than 30 days. As defined by the BCBS, stable deposits from retail and small business customers are deposits that are insured and are either held in transactional accounts or the bank has an established relationship with the client making the withdrawal unlikely. (4) Operational deposits from customers other than retail and small and medium-sized enterprises (SMEs), are deposits which clients need to keep with the bank in order to facilitate their access and ability to use payment and settlement systems primarily for clearing, custody and cash management activities. Other contractual funding obligations primarily include outflows from unsettled securities trades and outflows from obligations related to securities sold short. Other contingent funding obligations include outflows related to other off-balance sheet facilities that carry low LCR runoff factors (0% – 5%). (5) (6) n.a. not applicable We manage our LCR position within a target range that reflects our liquidity risk tolerance and takes into account business mix, asset composition and funding capabilities. The range is subject to periodic review in light of changes to internal requirements and external developments. We maintain HQLAs in major currencies with dependable market depth and breadth. Our treasury management practices ensure that the levels of HQLA are actively managed to meet target LCR objectives. Our Level 1 assets, as calculated according to OSFI LAR and the BCBS LCR requirements, represent 83% of total HQLA. These assets consist of cash, placements with central banks and highly rated securities issued or guaranteed by governments, central banks and supranational entities. LCR captures cash flows from on- and off-balance sheet activities that are either expected or could potentially occur within 30 days in an acute stress scenario. Cash outflows result from the application of withdrawal and non-renewal factors to demand and term deposits, differentiated by client type (wholesale, retail and small- and medium-sized enterprises). Cash outflows also 78 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis arise from business activities that create contingent funding and collateral requirements, such as repo funding, derivatives, short sales of securities and the extension of credit and liquidity commitments to clients. Cash inflows arise primarily from maturing secured loans, interbank loans and non-HQLA securities. LCR does not reflect any market funding capacity that we believe would be available in a stress situation. All maturing wholesale debt is assigned 100% outflow in the LCR calculation. Q4 2019 vs. Q3 2019 The average LCR for the quarter ended October 31, 2019 was 127%, which translates into a surplus of approximately $50 billion, compared to 122% in the prior quarter. The increase in the LCR surplus from the previous quarter is primarily due to a change in funding and business mix. Contractual maturities of financial assets, financial liabilities and off-balance sheet items The following tables provide remaining contractual maturity profiles of all our assets, liabilities, and off-balance sheet items at their carrying value (e.g., amortized cost or fair value) at the balance sheet date. Off-balance sheet items are allocated based on the expiry date of the contract. Details of contractual maturities and commitments to extend funds are a source of information for the management of liquidity risk. Among other purposes, these details form a basis for modelling a behavioural balance sheet with effective maturities to calculate liquidity risk measures. For further details, refer to the Risk measurement section. Contractual maturities of financial assets, financial liabilities and off-balance sheet items Table 63 (Millions of Canadian dollars) Assets Cash and deposits with banks Securities Trading (1) Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans, net of applicable allowance Other Customers’ liability under acceptances Derivatives Other financial assets Total financial assets Other non-financial assets Total assets Liabilities and equity Deposits (2) Unsecured borrowing Secured borrowing Covered bonds Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other financial liabilities Subordinated debentures Total financial liabilities Other non-financial liabilities Equity Total liabilities and equity Off-balance sheet items Financial guarantees Lease commitments Commitments to extend credit Other credit-related commitments Other commitments Total off-balance sheet items As at October 31, 2019 Less than 1 month 1 to 3 months 3 to 6 months 6 to 9 months 9 to 12 months 1 year to 2 years 2 years to 5 years 5 years and greater With no specific maturity Total $ 62,095 $ 3 $ – $ – $ – $ – $ – $ – $ 2,557 $ 64,655 96,229 14 45 10 21 64 97 8,601 41,453 146,534 3,069 3,960 3,857 2,886 3,511 16,203 24,638 43,907 439 102,470 164,870 23,097 62,971 17,145 41,569 25,854 10,985 28,796 14,993 29,533 133 120,524 – 232,364 – 51,049 11,440 90,494 306,961 618,856 12,940 5,668 28,296 5,119 8,635 1,400 27 4,265 1,193 – 3,227 48 – 3,547 61 – 9,815 169 – 18,753 277 – 47,649 1,861 (24) 1 2,164 18,062 101,560 35,469 $396,264 2,907 $ 99,247 1,475 $76,810 108 $45,952 865 $51,666 109 $146,908 1,373 $276,129 1,507 $153,067 1,696 $148,524 24,328 $1,394,567 34,368 $399,171 $100,722 $76,918 $46,817 $51,775 $148,281 $277,636 $154,763 $172,852 $1,428,935 $ 50,872 2,588 – $ 36,251 4,874 – $47,307 10,679 4,828 $38,376 3,596 – $42,885 2,395 5,255 $ 28,886 10,351 10,818 $ 51,557 19,535 13,263 $ 20,230 5,755 5,677 $470,027 – – $ 786,391 59,773 39,841 12,944 5,119 35,069 – 27 – – – – – – – – – – – 192,855 6,325 29,008 – 14,281 7,779 1,066 – 13,462 4,519 849 – 6 3,430 290 – – 3,442 443 – 4 9,155 272 – – 17,348 701 316 – 46,515 8,510 9,499 1 – 5,978 30 691 – 18,091 35,069 226,586 98,543 41,830 9,815 $329,661 1,314 – $ 69,370 5,288 – $81,671 276 – $45,698 154 – $54,420 142 – $ 59,486 898 – $102,720 903 – $ 96,186 11,179 – $476,727 9,217 83,625 $1,315,939 29,371 83,625 $330,975 $ 74,658 $81,947 $45,852 $54,562 $ 60,384 $103,623 $107,365 $569,569 $1,428,935 $ 427 69 2,996 469 35 $ 2,409 137 6,367 934 – $ 2,088 204 8,821 1,615 – $ 2,829 197 10,655 1,863 – $ 2,382 198 11,638 1,365 – $ 986 719 41,740 191 – $ 5,394 1,619 150,267 634 – $ 45 3,032 27,827 10 – $ 48 – 3,865 92,392 484 $ 16,608 6,175 264,176 99,473 519 $ 3,996 $ 9,847 $12,728 $15,544 $15,583 $ 43,636 $157,914 $ 30,914 $ 96,789 $ 386,951 (1) (2) Trading debt securities classified as FVTPL have been included in the less than 1 month category as there is no expectation to hold these assets to their contractual maturity. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base for our operations and liquidity needs, as explained in the preceding Deposit and funding profile section. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 79 (Millions of Canadian dollars) Assets Cash and deposits with banks Securities Trading (1) Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans, net of applicable allowance Other Customers’ liability under acceptances Derivatives Other financial assets As at October 31, 2018 Less than 1 month 1 to 3 months 3 to 6 months 6 to 9 months 9 to 12 months 1 year to 2 years 2 years to 5 years 5 years and greater With no specific maturity Total $ 64,201 $ 2 $ – $ – $ – $ – $ – $ – $ 2,477 $ 66,680 86,551 20 22 16 1 52 72 6,982 34,542 128,258 3,529 6,855 1,419 2,593 2,399 12,989 25,061 39,396 367 94,608 168,810 22,534 66,854 14,967 28,828 21,079 10,298 26,753 11,692 25,271 552 122,687 – 211,768 – 44,191 7,568 87,568 294,602 576,818 10,774 6,070 25,670 4,788 10,179 873 94 4,930 938 1 4,032 78 – 3,030 157 5 11,130 112 – 18,067 231 – 36,581 1,758 (21) 20 2,120 15,641 94,039 31,937 Total financial assets Other non-financial assets $ 388,139 $ 104,538 $ 57,310 $ 43,771 $ 42,550 $ 147,527 $ 255,199 $ 1,809 1,268 590 364 559 971 1,352 128,908 $ 134,641 $ 1,302,583 32,151 24,113 1,125 Total assets Liabilities and equity Deposits (2), (3) Unsecured borrowing Secured borrowing Covered bonds Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other financial liabilities (3) Subordinated debentures Total financial liabilities Other non-financial liabilities Equity $ 389,948 $ 105,806 $ 57,900 $ 44,135 $ 43,109 $ 148,498 $ 256,551 $ 130,033 $ 158,754 $ 1,334,734 $ 46,793 $ 33,849 $ 47,209 $ 30,511 $ 36,116 $ 34,641 $ 50,792 $ 5,433 1,499 23,388 16,360 7,135 10,022 2,340 – 9,321 2,579 4,232 2,982 6,571 – 10,775 4,787 32,247 – 146,205 5,998 27,414 – 44,248 8,585 1,003 – 94 – 9,030 4,650 582 – 1 – – – 5 – – – 91 4,176 233 – – 3,311 414 103 – 9,808 154 – – 17,205 522 318 14,844 $ 440,246 $ 5,902 3,432 – – – 36,496 7,633 8,710 – – – – 7,240 9 733 – 735,001 64,322 36,874 15,662 32,247 206,814 90,238 38,688 9,131 $ 271,772 $ 99,043 $ 73,465 $ 41,944 $ 47,158 $ 61,765 $ 108,585 $ 992 – 5,095 – 346 – 183 – 157 – 765 – 868 – 77,017 $ 448,228 $ 1,228,977 25,802 7,947 79,955 79,955 9,449 – Total liabilities and equity $ 272,764 $ 104,138 $ 73,811 $ 42,127 $ 47,315 $ 62,530 $ 109,453 $ 86,466 $ 536,130 $ 1,334,734 Off-balance sheet items Financial guarantees Lease commitments Commitments to extend credit Other credit-related commitments Other commitments $ 532 $ 2,026 $ 1,647 $ 2,696 $ 1,337 $ 66 4,122 577 141 131 3,417 795 – 194 8,736 1,586 – 199 9,667 1,498 – 194 11,406 1,324 – 1,910 $ 695 33,030 478 – 4,179 $ 1,517 168,071 680 – 1,125 $ 2,814 23,899 148 – 50 $ – 269 107,499 556 15,502 5,810 262,617 114,585 697 Total off-balance sheet items $ 5,438 $ 6,369 $ 12,163 $ 14,060 $ 14,261 $ 36,113 $ 174,447 $ 27,986 $ 108,374 $ 399,211 (1) (2) (3) Trading debt securities classified as FVTPL have been included in the less than 1 month category as there is no expectation to hold these assets to their contractual maturity. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base for our operations and liquidity needs, as explained in the preceding Deposit and funding profile section. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other financial liabilities. Amounts have been reclassified to conform with this presentation. 80 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Contractual maturities of financial liabilities and off-balance sheet items – undiscounted basis The following tables provide remaining contractual maturity analysis of our financial liabilities and off-balance sheet items. The amounts disclosed in the following table are the contractual undiscounted cash flows of all financial liabilities (e.g., par value or amount payable upon maturity). The amounts do not reconcile directly with those in our consolidated balance sheets as the table incorporates only cash flows relating to payments on maturity and do not recognize premiums, discounts or mark-to-market adjustments recognized in the instruments’ carrying values as at the balance sheet date. Financial liabilities are based upon the earliest period in which they are required to be paid. For off-balance sheet items, the undiscounted cash flows potentially payable under financial guarantees and commitments to extend credit are classified on the basis of the earliest date they can be called. Contractual maturities of financial liabilities and off-balance sheet items – undiscounted basis* Table 64 (Millions of Canadian dollars) Financial liabilities Deposits (1) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures Off-balance sheet items Financial guarantees (2) Lease commitments Commitments to extend credit (2) Total financial liabilities and off-balance sheet items (Millions of Canadian dollars) Financial liabilities Deposits (1), (3) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities (3) Subordinated debentures Off-balance sheet items Financial guarantees (2) Lease commitments Commitments to extend credit (2) As at October 31, 2019 On demand Within 1 year 1 year to 2 years 2 years to 5 years 5 years and greater Total $ 406,042 $ 315,398 $ 50,218 $ 83,651 $ 30,560 $ 885,869 – – 18,091 35,125 5,977 617 – 412,636 220,592 31,794 – 621,000 – – 4 190 – – – – 640 316 – – – 8,512 9,499 18,091 35,125 226,573 41,753 9,815 50,412 84,607 48,571 1,217,226 $ 16,608 $ – $ – $ – $ – $ – 226,021 242,629 805 38,148 38,953 719 6 725 1,619 1 1,620 3,032 – 3,032 16,608 6,175 264,176 286,959 $ 655,265 $ 659,953 $ 51,137 $ 86,227 $ 51,603 $ 1,504,185 As at October 31, 2018 On demand Within 1 year 1 year to 2 years 2 years to 5 years 5 years and greater Total $ 382,847 $ 287,928 $ 52,108 $ 91,154 $ 24,240 $ 838,277 – – 7,240 1,753 – 391,840 15,657 32,222 199,574 28,568 103 564,052 5 – – 98 – – – – 383 318 – – – 7,700 8,710 15,662 32,222 206,814 38,502 9,131 52,211 91,855 40,650 1,140,608 $ 15,502 $ – $ – $ – $ – $ – 224,058 239,560 784 38,528 39,312 695 2 697 1,517 29 1,546 2,814 – 2,814 15,502 5,810 262,617 283,929 Total financial liabilities and off-balance sheet items $ 631,400 $ 603,364 $ 52,908 $ 93,401 $ 43,464 $ 1,424,537 * (1) This table represents an integral part of our 2019 Annual Consolidated Financial Statements. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base for our operations and liquidity needs, as explained in the preceding Deposit and funding profile. (2) We believe that it is highly unlikely that all or substantially all of these guarantees and commitments will be drawn or settled within one year, and contracts may expire (3) without being drawn or settled. The management of the liquidity risk associated with potential extensions of funds is outlined in the preceding Risk measurement section. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Amounts have been reclassified to conform with this presentation. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 81 Insurance risk Insurance risk refers to the potential financial loss that may arise where the amount, timing and/or frequency of benefit and/or premium payments under insurance and reinsurance contracts are different than expected. Insurance risk is distinct from those risks covered by other parts of our risk management framework (e.g., credit, market and operational risk) where those risks are ancillary to, or accompany, the risk transfer. The four insurance sub-risks are: morbidity, mortality, longevity and travel risk. Our Insurance Risk Framework provides an overview of our processes and tools for identifying, assessing, managing, mitigating and reporting on the insurance risks that face the organization. These are also supported by our robust three lines of defence governance structure. Operational/regulatory compliance risk drivers Operational risk Operational risk is the risk of loss or harm resulting from people, inadequate or failed internal processes and systems or from external events. Operational risk is inherent in all of our activities and third party activities and failure to manage operational risk can result in direct or indirect financial loss, reputational impact or regulatory censure. Our management of operational risk follows the three lines of defence governance model, encompassing the organizational roles and responsibilities for a co-ordinated enterprise-wide approach. For further details, refer to the Risk management – Enterprise risk management section. Operational Risk Framework We have an Enterprise Operational Risk Framework which sets out the processes to identify, assess, monitor, measure, report and communicate on operational risk. The processes are established through the following: (cid:129) Risk identification and assessment tools, including the collection and analysis of risk event data, help risk owners understand and proactively manage operational risk exposures. Risk assessments ensure alignment between risk exposures and efforts to manage them. Management uses outputs of these tools to make informed risk decisions. Risk monitoring tools alert management to changes in the operational risk profile. When paired with escalation and monitoring triggers, risk monitoring tools can identify risk trends, warn management of risk levels that approach or exceed defined limits, as well as prompt actions and mitigation plans to be undertaken. Risk capital measurement provides credible estimation of potential risk exposure, surfaces risk vulnerabilities, and informs strategic and capital planning decisions, which ultimately ensures that the bank is sufficiently resilient to withstand operational risk losses both in normal times and under stress situations. Risk reporting and communication processes ensure that relevant operational risk information is made available to management in a timely manner to support risk-informed business decisions. (cid:129) (cid:129) (cid:129) Conclusions from the operational risk programs enable learning based on what has happened to us, whether it could happen elsewhere in the bank, and what controls we need to amend or implement. These conclusions support the articulation of our operational risk appetite and are used to inform the overall level of operational risk exposure which thereby defines our operational risk profile. This profile includes significant operational risk exposures, potential new and emerging exposures and trends, and overall conclusions on the control environment and risk outlook. We proactively identify and investigate corporate insurance opportunities to mitigate and reduce potential future impacts of operational risk. We consider the potential risks and rewards of our decisions to strike the balance between accepting potential losses versus incurring costs of mitigation, the expression of which is in the form of our operational risk appetite. Our operational risk appetite is established at the Board level and cascaded throughout each of our business segments. Management reports have been implemented at various levels to support proactive management of operational risk and transparency of risk exposures. These reports are provided to senior management on a regular basis and provide detail on the main drivers of the risk status and trend for each of our business segments and the bank overall. In addition, changes to the operational risk profile that are not aligned to our business strategy or operational risk appetite are identified and discussed at GRC and the Risk Committee of the Board. 82 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Our operations expose us to many different operational risks, which may adversely affect our businesses and financial results. The following list is not exhaustive, as other factors could also adversely affect our results. Risk Description Cybersecurity We have a dedicated team of technology and cybersecurity professionals that manage a comprehensive program to help protect the organization against breaches and other incidents by ensuring appropriate security and operational controls are in place. We continue to strengthen our cyber-control framework and to improve our resilience and cybersecurity capabilities including 24 hour monitoring and alerting of potentially suspicious security events and incidents. Throughout the year, investments continued to be made on the program and multiple scenarios and simulations were conducted to test our resiliency strategy. Data management and privacy The use and management of data and the governance over data, are becoming increasingly important as we continue to invest in digital solutions and innovation, as well as, expanding our business activities. This is also reflected through recent regulatory developments relating to privacy, such as the General Data Protection Regulation by the European Union (EU) and the California Consumer Privacy Act (CCPA). Refer to the Legal and regulatory environment risk section. The Chief Privacy Office and the Chief Data Officer partner with cross-functional teams to develop and implement enterprise-wide standards and practices that describe how data (including personal information) is used, protected, managed and governed. Money laundering and Terrorist financing Third party risk We maintain an enterprise-wide program designed to deter, detect and report suspected money laundering and terrorist financing activities across our organization, while ensuring compliance with the laws and regulations of the various jurisdictions in which we operate. Our Global AML Compliance Group is dedicated to the continuous development and maintenance of robust policies, guidelines, training and risk-assessment tools and models to help our employees deal with ever-evolving money laundering and terrorist financing risks. The global anti-money laundering/anti-terrorist financing program is regularly evaluated to ensure it remains aligned with industry standards, best practices and all applicable laws, regulations and guidance. Risks of non-compliance include enforcement actions, criminal prosecutions and reputational damage. We have a risk-based enterprise-wide program designed to provide oversight for third party relationships that enables us to respond effectively to events that can cause service disruptions, financial loss or various other risks that could impact us. Our approach to third party risk mitigation is outlined in policies and standards that establish the minimum requirements for identifying and managing risks throughout the engagement with a third party, while ensuring compliance with global regulatory expectations. Operational risk capital We have been approved by OSFI to use the Advanced Measurement Approach (AMA) for operational risk capital measurement subject to the application of a Standardized Approach (TSA) floor. Currently, TSA calculates operational risk capital based on an OSFI-established percentage of 3 years’ average gross income for pre-determined industry standardized business activities. AMA is determined using our internal Operational Risk Measurement System which includes internal loss experience, external loss experience, scenario analysis, and Business Environment Internal Control Factors. RBC Bank (Georgia), RBC Caribbean, and City National will continue using TSA. RBC Insurance (including insurance recoveries) is not in the scope of operational risk capital calculations. We do not account for mitigation through insurance or any other risk transfer mechanism in our AMA model. Effective in Q1 2020, OSFI will require banks to use only TSA for operational risk capital calculations as the use of AMA will no longer be allowed. This change comes in effect pending the implementation of the new Standardized Approach (SA) for measurement of operational risk capital under the final Basel III reforms. The SA methodology is based on the Business Indicator Component (BIC), which is a financial statement-based proxy for operational risk, and the Internal Loss Multiplier, a scaling factor that is based on the internal average historical losses and the BIC. Once implemented, SA will replace TSA. Operational risk loss events During 2019, we did not experience any material operational risk loss events. For further details on our contingencies, including litigation, refer to Notes 25 and 26 of our 2019 Annual Consolidated Financial Statements. Regulatory compliance risk Regulatory compliance risk is the risk of potential non-conformance with laws, rules, regulations and prescribed practices in any jurisdiction in which we operate. Issues regarding compliance with laws and regulations can arise in a number of areas in a large complex financial institution such as the bank, and are often the result of inadequate or failed internal processes, people or systems. Laws and regulations are in place to protect the financial and other interests of our clients, investors and the public. As a large-scale global financial institution, we are subject to numerous laws and extensive and evolving regulation by governmental agencies, supervisory authorities and self-regulatory organizations in Canada, the U.S., Europe and other jurisdictions in which Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 83 we operate. In recent years, such regulation has become increasingly extensive and complex. In addition, the enforcement of regulatory matters has intensified. Recent resolution of such matters involving other global financial institutions have involved the payment of substantial penalties, agreements with respect to future operation of their business, actions with respect to relevant personnel and guilty pleas with respect to criminal charges. Operating in this increasingly complex regulatory environment and intense regulatory enforcement environment, we are and have been subject to a variety of legal proceedings, including civil claims and lawsuits, criminal charges, regulatory examinations, investigations, audits and requests for information by various governmental regulatory agencies and law enforcement authorities in various jurisdictions, and we anticipate that our ongoing business activities will give rise to such matters in the future. Changes to laws, including tax laws, regulations or regulatory policies, as well as the changes in how they are interpreted, implemented or enforced, could adversely affect us, for example, by lowering barriers to entry in the businesses in which we operate, increasing our costs of compliance, or limiting our activities and ability to execute our strategic plans. Further, there is no assurance that we always will be, or be deemed to be, in compliance with laws, regulations or regulatory policies. Accordingly, it is possible that we could receive a judicial or regulatory judgment or decision that results in fines, damages, penalties, and other costs or injunctions, criminal convictions, or loss of licenses or registrations that would damage our reputation, and negatively impact our earnings and ability to conduct some of our businesses. In addition, we are subject to litigation arising in the ordinary course of our business and the adverse resolution of any litigation could have a significant adverse effect on our results or could give rise to significant reputational damage, which in turn could impact our future business prospects. Our Regulatory Compliance Management Framework outlines how we manage and mitigate the regulatory compliance risks associated with failing to comply with, or adapt to, current and changing laws and regulations in the jurisdictions in which we operate. Regulatory compliance risk includes the regulatory risks associated with financial crimes (which include, but are not limited to, money laundering, bribery and sanctions), privacy, market conduct, consumer protection, business conduct, prudential and other generally applicable non-financial requirements. Specific compliance policies, procedures and supporting frameworks have been developed to manage regulatory compliance risk. Strategic risk drivers Strategic risk Strategic risk is the risk that the enterprise or particular business areas will make inappropriate strategic choices, or will be unable to successfully implement selected strategies or achieve the expected benefits. Business strategy is a major driver of our risk appetite and consequently the strategic choices we make in terms of business mix determine how our risk profile changes. Responsibility for selecting and successfully implementing business strategies is mandated to the individual heads of each business segment. Oversight of strategic risk is the responsibility of the heads of the business segments and their operating committees, the Enterprise Strategy group, the GE, and the Board. The Enterprise Strategy group supports the management of strategic risk through the strategic planning process, articulated within our Enterprise Strategic Planning Policy, ensuring alignment across our business, financial, capital and risk planning. Our annual business portfolio review and project approval request processes help identify and mitigate strategic risk by ensuring strategies for new initiatives, lines of business, and the enterprise as a whole align with our risk appetite and risk posture. GRM provides oversight of strategic risk by providing independent review of these processes, establishing enterprise risk frameworks, and independently monitoring and reporting on the level of risk established against our risk appetite metrics in accordance with the three lines of defence governance model. For details on the key strategic priorities for our business segments, refer to the Business segment results section. Reputation risk Reputation risk is the risk of an adverse impact on stakeholders’ perception of the bank due to i) an activity of the bank, its representatives, third party service providers or clients, or ii) public sentiment towards a global or industry issue. Our reputation is rooted in the perception of our stakeholders, and the trust and loyalty they place in us is core to our purpose as a financial services organization. A strong and trustworthy reputation will generally strengthen our market position, reduce the cost of capital, increase shareholder value, strengthen our resiliency, and help attract and retain top talent. Conversely, damage to our reputation can result in reduced share price and market capitalization, increased cost of capital, loss of strategic flexibility, inability to enter or expand into markets, loss of client loyalty and business, or regulatory fines and penalties. The sources of reputation risk are widespread; risk to our reputation can occur in connection with credit, regulatory, legal and operational risks. We can also experience reputation risk from a failure to maintain an effective control environment, exhibit good conduct or have strong risk culture practices. Managing our reputation risk is an integral part of our organizational culture and our overall enterprise risk management approach, as well as a priority for employees and our Board. Our Board-approved Reputation Risk Management Framework provides an overview of our approach to identify, assess, manage, monitor and report on reputation risk. This framework outlines governance authorities, roles and responsibilities, and controls and mechanisms to manage our reputation risk, including our culture of integrity, compliance with our Code of Conduct and operating within our risk appetite. Our governance of reputation risk aims to be holistic and provide an integrated view of potential reputation issues across the organization. This governance structure ensures that ownership and accountability for reputation risk are understood across the enterprise, both proactive and reactive reputation risk decisions are escalated to a senior executive committee for review and evaluation, and reporting on reputation risk is comprehensive and integrated. 84 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Legal and regulatory environment risk Legal and regulatory environment risk is the risk that new or modified laws and regulations, and the interpretation or application of those laws and regulations, will negatively impact the way in which we operate, both in Canada and in the other jurisdictions in which we conduct business. The full impact of some of these changes on our business will not be known until final rules are implemented and market practices have developed in response. We continue to respond to these and other developments and are working to minimize any potential adverse business or economic impact. The following provides a high-level summary of some of the key regulatory changes that have potential to increase our costs, impact our profitability and increase the complexity of our operations. Global Uncertainty Trade policy remains a risk to the global economic outlook. Throughout 2019, the International Monetary Fund lowered its 2019 and 2020 global growth projections due to continued geopolitical uncertainty, weaker than anticipated global trade activity and softening inflation. While Canada, the U.S. and Mexico successfully renegotiated the North American Free Trade Agreement, it remains uncertain whether the new Canada-United States-Mexico Agreement (CUSMA) will be ratified by the end of calendar 2019. The Canadian economy is vulnerable to continued trade tensions given Canada’s trading relationships with both the U.S. and China. Tensions remain elevated between China and the U.S. as they continue to negotiate a trade deal. The outcome of the Brexit negotiations remains uncertain, as the EU granted the U.K. an extension until January 31, 2020 to determine the terms of its withdrawal from the EU. Consumer Protection The Canadian federal government has focused its attention on issues relating to consumer protection and the sales practices of banks. While the government’s proposed legislative changes to consumer protection provisions applicable to banks were approved on December 13, 2018, some of the changes have not yet become effective and the government remains in the early stages of developing a regulatory framework to support the new provisions. Privacy In May 2019, the Canadian government released a digital charter with principles for data use and governance, along with proposed privacy law reforms that include greater individual control over data and stronger regulatory enforcement and oversight. In addition, in June 2019, the Standing Senate Committee on Banking, Trade and Commerce released its report calling for urgent legal reform to quickly advance open banking. Although timing is uncertain, significant reform is anticipated that may impact Canadian and international business processes and privacy risk management practices. Outside of Canada, unprecedented privacy breach fines and settlements have been issued, demonstrating increasing regulatory vigilance and enforcement. The CCPA, which becomes effective on January 1, 2020, is currently the most comprehensive state privacy law in the U.S., and includes numerous new and expanded privacy requirements and obligations for companies doing business in the state, or collecting California residents’ personal information. The U.S. Regional Head of Privacy is coordinating activities across our U.S. businesses, and a U.S. Information Governance and Privacy Committee was established to monitor the implementation of the CCPA and future state privacy laws as well as to oversee privacy issues. Legislative and regulatory developments are also being closely monitored since the General Data Protection Regulation became law in the EU. The Office of the Privacy Commissioner of Canada (OPC) continues to call for more modern legislation, including the ability to audit businesses and fine companies that do not adhere to privacy laws. These actions demonstrate the ongoing trend toward increased regulatory intervention in the use and safeguarding of personal information, and we are reviewing the potential implications for our various businesses. Our Global Privacy Program is responsible for ensuring our organization meets these evolving global principles. Canadian Anti-Money Laundering (AML) regulations In July 2019, amendments to Canada’s Proceeds of Crime (Money Laundering) and Terrorist Financing Act regulations were released and will become effective by June 2021. These amendments aim to improve the effectiveness of Canada’s anti-money laundering and counter-terrorism financing regime, and to improve compliance with international standards. New regulations, which represent increased oversight and regulatory monitoring, will require substantial changes to our client-facing, transaction and payment processing, and records management systems mainly due to the need for the capture of additional client data. Canadian Housing Market and Consumer Debt The Government of Canada and a number of provincial governments have introduced measures to respond to concerns relating to the level and sustainability of Canadian household debt. Risks in this area continue to be closely monitored with further regulatory responses possible depending on market conditions and any heightened concerns that may be raised. Interest Rate Benchmark Reform London Interbank Offered Rate (LIBOR) is the most widely referenced benchmark interest rate across the globe for derivatives, bonds, loans and other floating rate instruments; however, there is a regulator-led push to transition the market from LIBOR and certain other benchmark rates to alternative risk-free, or nearly risk-free, rates that are based on actual overnight transactions. However, some regulators and market participants continue to evaluate other options. In addition to the U.S. and U.K., regulators and national central banks internationally, including the BoC, have warned the market they will need to be prepared for certain benchmark rates to be discontinued at the end of 2021. Derivatives, floating rate notes and other financial contracts whose terms extend beyond 2021, and that refer to certain benchmark rates as the reference rate, will be impacted. For further details, refer to the Critical accounting policies and estimates section. Other Regulatory Initiatives Impacting Financial Services in Canada Several initiatives are underway or contemplated. From the perspective of the federal government this includes: a consultation process on the merits of open banking in a Canadian context; a consultation on the digital/data-driven economy; and consultations on the details of its deposit insurance review. From a provincial perspective, the Canadian Securities Administrators are engaged in a consultation process on registration and business conduct rules relating to OTC derivatives products, including bank activities in this area. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 85 United States Tax Reform The majority of the provisions of the U.S. Tax Cuts and Jobs Act legislation (U.S. Tax Reform), which was passed in December 2017, took effect at the beginning of calendar 2018 or for fiscal years beginning in 2018. Regulations clarifying certain aspects of the new law, however, continue to be released. In December 2018, the U.S. Treasury released proposed regulations clarifying some of the international tax provisions of the law. In December 2019, the U.S. Treasury released final regulations and additional proposed regulations clarifying many of the rules for calculating a Base Erosion Anti-Abuse Tax (BEAT). We are currently reviewing the impact of these regulations and are awaiting release of further guidance on other international tax provisions. United States Regulatory Initiatives Policymakers continue to evaluate and implement reforms to various U.S. financial regulations, which could result in either expansion or reduction to the U.S. regulatory requirements and associated changes in compliance costs. For example, the SEC has enacted Regulation Best Interest that establishes new standards of conduct for broker-dealers that make investment recommendations to retail customers. Broker-dealers will be required to comply starting in June 2020. Additionally, since August 2019, the financial regulatory agencies responsible for implementing the Volcker Rule have adopted amendments revising the requirements regarding proprietary trading and compliance programs, which are expected to reduce our related compliance costs. In October 2019, the Fed and the Federal Deposit Insurance Corporation (FDIC) finalized rules related to resolution plans for bank holding companies, insured depository institutions, as well as foreign banks and their intermediate holding companies. Also in October 2019, the Fed, FDIC, and the Office of the Comptroller of the Currency (OCC) finalized rules related to enhanced prudential standards, regulatory capital, and liquidity requirements for foreign banking organizations operating in the U.S. We will continue to monitor developments and any resulting implications for us. U.K. and European Regulatory Reform In addition to the implications from Brexit, other forthcoming regulatory initiatives include: (cid:129) (cid:129) Transaction reporting of securities financing transactions which is expected to take effect in the second calendar quarter of 2020, extended from its previous effective date of the first calendar quarter of 2019; and The EU’s Central Securities Depositary Regulation rules which are intended to increase discipline in the settlement of securities transactions and is scheduled to take effect in September 2020. For further details on regulatory capital and related requirements, refer to the Capital management section and the Capital, liquidity and other regulatory developments section. Competitive risk Competitive risk is the risk of an inability to build or maintain a sustainable competitive advantage in a given market or markets, and includes the potential for loss of market share due to competitors offering superior products and services. Competitive risk can arise within or outside the financial sector, from traditional or non-traditional competitors, domestically or globally. There is intense competition for clients among financial services companies in the markets in which we operate. Client loyalty and retention can be influenced by a number of factors, including new technology used or services offered by our competitors, relative service levels and prices, product and service attributes, our reputation, actions taken by our competitors, and adherence with competition and anti-trust laws. Other companies, such as insurance companies and non-financial companies, as well as new technological applications, are increasingly offering services traditionally provided by banks. This competition could also reduce our revenue which could adversely affect our results. We identify and assess competitive risks as part of our overall risk management process. Our products and services are regularly benchmarked against existing and potential competitors. In addition, we regularly conduct risk reviews of our products, services, mergers and acquisitions as well as ensure adherence to competition and anti-trust laws. Our annual strategy-setting process also plays an integral role in managing competitive risk. Macroeconomic risk drivers Systemic risk Systemic risk is the risk that the financial system as a whole, or a major part of it – either in an individual country, a region, or globally – is put in real and immediate danger of collapse or serious damage with the likelihood of material damage to the economy, and that this will result in financial, reputation, legal or other risks for us. Our earnings are significantly affected by the general business and economic conditions in the geographic regions in which we operate. These conditions include consumer saving and spending habits as well as consumer borrowing and repayment patterns, business investment, government spending, exchange rates, sovereign debt risks, the level of activity and volatility of the capital markets, strength of the economy and inflation. For example, an extended economic downturn may result in higher unemployment and lower family income, corporate earnings, business investment and consumer spending, and could adversely affect the demand for our loan and other products and result in higher provisions for credit losses. Given the importance of our Canadian operations, an economic downturn in Canada or in the U.S. would largely affect our personal and business lending activities in our Canadian banking businesses, including mortgages and credit cards, and could significantly impact our results of operations. The U.S. economy is vulnerable to trade tensions with China as they continue to negotiate a trade deal. The Canadian economy is vulnerable to trade tensions with, and between, the U.S. and China, given Canada’s trade relationship with both nations. Our earnings are also sensitive to changes in interest rates. While the Bank of Canada left its policy rate unchanged in 2019, market interest rates have generally declined, due in part to easing by other central banks globally. A continuing low interest rate environment in Canada, the U.S. and globally would result in net interest income being unfavourably impacted by spread compression across many of our businesses while an increase in interest rates would benefit our businesses. However, a significant increase in interest rates could also adversely impact household balance sheets. This could result in credit deterioration which might negatively impact our financial results, particularly in some of our Personal & Commercial Banking and Wealth Management businesses. 86 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Deterioration in global capital markets could result in volatility that would impact results in Capital Markets, while in Wealth Management weaker market conditions would lead to lower average fee-based client assets and transaction volumes. In addition, worsening financial and credit market conditions may adversely affect our ability to access capital markets on favourable terms and could negatively affect our liquidity, resulting in increased funding costs and lower transaction volumes in Capital Markets and Investor & Treasury Services. Systemic risk is considered to be the least controllable risk facing us. Our ability to mitigate this risk when undertaking business activities is limited, other than through collaborative mechanisms between key industry participants, and, as appropriate, the public sector, to reduce the frequency and impact of these risks. The two most significant measures in mitigating the impact of systemic risk are diversification and stress testing. Our diversified business model, portfolios, products, activities and funding sources help mitigate the potential impacts from systemic risk. We also mitigate systemic risk by establishing risk limits to ensure our portfolio is well-diversified, and concentration risk is reduced and remains within our risk appetite. Stress testing involves consideration of the simultaneous movements in a number of risk factors. It is used to ensure our business strategies and capital planning are robust by measuring the potential impacts of credit, market, liquidity, and operational risks on us, under adverse economic conditions. Our enterprise-wide stress testing program evaluates the potential effects of a set of specified changes in risk factors, corresponding to exceptional but plausible adverse economic and financial market events. These stress scenarios are evaluated across the organization, and results are integrated to develop an enterprise-wide view of the impacts on our financial results and capital requirements. For further details on our stress testing, refer to the Enterprise risk management section. Overview of other risks In addition to the risks described in the Risk management section, there are other risk factors, described below, which may adversely affect our businesses and financial results. The following discussion is not exhaustive as other factors could also adversely affect our results. Government fiscal, monetary and other policies Our businesses and earnings are affected by monetary policies that are adopted by the BoC, the Fed in the U.S., the ECB in the EU and monetary authorities in other jurisdictions in which we operate, as well as the fiscal policies of the governments of Canada, the U.S., Europe and such other jurisdictions. Such policies can also adversely affect our clients and counterparties in Canada, the U.S. and internationally, which may increase the risk of default by such clients and counterparties. Tax risk and transparency Tax risk refers to the risk of loss related to unexpected tax liabilities. The tax laws and systems that are applicable to us are complex and wide-ranging. As a result, we ensure that any decisions or actions related to tax always reflect our assessment of the long-term costs and risks involved, including their impact on our reputation and our relationship with clients, shareholders, and regulators. Our approach to taxation is grounded in principles which are reflected in our Code of Conduct, is governed by our Enterprise Tax Risk Management Policy, and incorporates the fundamentals of our risk drivers. Oversight of our tax policy and the management of tax risk is the responsibility of the GE, the CFO and the Senior Vice President, Taxation. We discuss our tax position with the Audit Committee on a regular basis and discuss our tax strategy with the Audit and Risk Committees. Our tax strategy is designed to ensure transparency and support our business strategy, and is aligned with our corporate vision and values. We seek to maximize shareholder value by ensuring that our businesses are structured in a tax-efficient manner while considering reputational risk by being in compliance with all laws and regulations. Our framework seeks to ensure that we: (cid:129) (cid:129) Act with integrity and in a straightforward, open and honest manner in all tax matters; Ensure tax strategy is aligned with our business strategy supporting only bona fide transactions with a business purpose and economic substance; Ensure all intercompany transactions are conducted on arm’s length terms; Ensure our full compliance and full disclosure to tax authorities of our statutory obligations; and Endeavour to work with the tax authorities to build positive long-term relationships and where disputes occur, address them constructively. (cid:129) (cid:129) (cid:129) With respect to assessing the needs of our clients, we consider a number of factors including the purpose of the transactions. We seek to ensure that we only support bona fide client transactions with a business purpose and economic substance. Should we become aware of client transactions that are aimed at evading their tax obligations, we will not proceed with the transactions. We operate in 36 countries worldwide. Our activities in these countries are subject to both Canadian and international tax legislation and other regulations, and are fully disclosed to the relevant tax authorities. The Taxation group and GRM both regularly review the activities of all entities to ensure compliance with tax requirements and other regulations. Given that we operate globally, complex tax legislation and accounting principles have resulted in differing legal interpretations between the respective tax authorities we deal with and ourselves, and we are at risk of tax authorities disagreeing with prior positions we have taken for tax purposes. When this occurs, we are committed to an open and transparent dialogue with the tax authorities to ensure a quick assessment and prompt resolution of the issues where possible. Failure to adequately manage tax risk and resolve issues with tax authorities in a satisfactory manner could adversely impact our results, potentially to a material extent in a particular period, and/or significantly impact our reputation. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 87 Tax contribution In 2019, total income and other tax expense, including income taxes in the Consolidated Statements of Comprehensive Income and Changes in Equity, to various levels of governments globally totalled $4.0 billion (2018 – $5.0 billion). In Canada, total income and other tax expense for the year ended October 31, 2019 to various levels of government totalled $2.9 billion (2018 – $3.8 billion). Income and other tax expense – by category (Millions of Canadian dollars) Income and other tax expense – by geography (Millions of Canadian dollars) 6,000 5,000 4,000 3,000 2,000 1,000 0 6,000 5,000 4,000 3,000 2,000 1,000 0 2019 2018 2019 2018 Business taxes Insurance premium taxes Property taxes Other International U.S. Canada Capital taxes Payroll taxes Income taxes Value added and sales tax For further details on income and other tax expense, refer to the Financial performance section. Environmental and social risk Environmental and social (E&S) risk is the risk that an E&S issue associated with a client, transaction, product, supplier or activity will create a risk of loss of financial, operational, legal and/or reputational value to us. E&S issues include, but are not limited to, site contamination, waste management, land and resource use, biodiversity, water quality and availability, climate change, environmental regulation, human rights, Indigenous Peoples’ rights and community engagement. GRM is responsible for developing and maintaining policies to identify, assess, monitor and report on E&S risk, and for their regular review and update. E&S risk policies seek to identify sectors, clients and business activities that may be exposed to E&S risk; apply enhanced due diligence and escalation procedures, as necessary; and establish requirements to manage, mitigate and monitor E&S risk. Business segments and corporate functions are responsible for incorporating E&S risk management requirements within their operations. We recognize the importance of E&S risk management practices and processes and are committed to regular and transparent disclosure. As a signatory to the Equator Principles (EP), we report annually on projects assessed according to the EP framework. RBC Global Asset Management (GAM) and BlueBay Asset Management LLP are signatories to the United Nations Principles for Responsible Investment (UN PRI) and report annually on their responsible investment activities to the UN PRI. RBC Europe Limited (RBCEL), a wholly owned subsidiary of the bank, is a signatory to the Green Bond Principles and reports annually on its green bond underwriting activities. Our Corporate Citizenship team sets our corporate environmental strategy and reports annually on our performance in our Environmental, Social & Governance (ESG) Performance Report. We also publish an annual Modern Slavery Act Statement, which sets out the steps that we have taken to ensure that slavery and human trafficking are not taking place in our supply chains or our business, and disclosures that consider the recommendations of the FSB’s Task Force on Climate-related Financial Disclosures (TCFD). TCFD Disclosure Governance The Board and its Committees oversee senior management who is responsible for execution of the management of E&S risks and opportunities, which include climate change. The Board provides oversight of our strategic approach to climate change and our E&S risks, which includes how we manage climate-related risks and opportunities. GRM has a dedicated E&S risk team that develops approaches to identify, assess, monitor and report on climate-related risks, as appropriate. Performance goals on climate-related risks have been established at the management level. Strategy We recognize we have a role to play in accelerating the transition to a low-carbon economy and to mitigate the risks associated with climate change. Global practices in the identification, assessment and management of climate-related risks and opportunities are constantly evolving and we maintain our focus on supporting our clients with our financial products, services and advice as the transition will necessitate access to capital markets, bank debt and other funding solutions. Our participation in the rapidly evolving sustainable finance and green bond market is an element to the low carbon transition. We have committed to providing $100 billion in sustainable finance to support our clients in renewable energy, clean transportation and other socially and environmentally beneficial activities. We issued our inaugural €500 million 5-year green bond which funds a portfolio of assets primarily in the categories of renewable energy and green buildings. These activities are aligned with the Green Bond Principles noted above, and the Social Bond Principals, that promote integrity in the social bond market. 88 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Risk Management Climate change may be a driver of other risk types including systemic, regulatory, competitive, strategic, reputation, credit, and market risk. Climate change was initially identified in 2017 as an emerging risk and, as such, our strategy and approach to managing it is reported on a regular basis to senior management and the Board. We define climate risk as risks related to the transition to a lower-carbon economy (transition risks) and risks related to the physical impacts of climate change (physical risks). We conduct portfolio, client and scenario analyses to assess our exposure to, and the impact of, climate-related risks. We may be exposed to climate risk through emerging regulatory and legal requirements, disruptions to our operations and services, and the products and services we provide to our clients. We regularly review the risks that we face and the actions to mitigate these risks: Emerging regulatory and legal requirements Disruptions to operations and client services (cid:129) Climate change regulations, frameworks, and guidance that apply to banks, insurers and asset managers are rapidly evolving. The BoC and European Central Bank Financial Systems Reviews were published in May 2019 and address the financial and economic risks of climate change. While no specific requirements have been released, we will continue to monitor development. (cid:129) RBCEL established a Senior Management Function responsible for the financial risk from climate change, and has developed an initial plan for meeting the Bank of England Prudential Regulation Authority’s Supervisory Statement SS3/19 and Policy Statement PS11/19. (cid:129) For clients in sectors categorized as medium and high environmental risk, such as those in carbon- intensive sectors, we evaluate whether clients have assessed and quantified the regulatory impacts of climate change. (cid:129) We identify properties that we lease or own, which contain business processes and supporting applications that require enhanced facility infrastructure to mitigate site disruptions, such as those caused by extreme weather events. We classify critical environment sites based on our business risk tolerance for site-specific downtime and, among other things, site location, power supply, exposure to flooding, geological stability and other hazards. (cid:129) We take steps to mitigate and adapt to climate change through our building design and our purchasing decisions. (cid:129) As required, we assess the impact of climate-related events (e.g., floods, hurricanes) on our businesses and client operations. (cid:129) We provide products, services and advice to assist clients in responding to climate-related risks and opportunities (i.e., carbon trading services, green bond underwriting, clean technology lending and advisory services and responsible investing). (cid:129) We maintain a diversified lending portfolio, which improves our resilience to geographic or sectoral downturns and minimizes concentrations of credit exposure. Products and services we provide (cid:129) Each business segment is responsible for identifying material climate-related risks and opportunities, which are integrated into risk management processes as necessary. We have conducted climate scenario analysis on parts of our portfolio to assess the impact of transition and physical risk drivers under different scenarios, including a 2oC scenario. (cid:129) Our asset management businesses integrate ESG issues into their investment process when doing so may have a material impact on investment risk or return. (cid:129) RBC Insurance® provides policy administration for property and casualty products sold through Aviva Canada Inc., and is therefore not directly exposed to climate-related risks associated with these products. The insurance industry as a whole has exposure to longer-term shifts in climate patterns, such as rising temperatures and hurricanes, which may indirectly impact our Insurance business results. Metrics & Targets We have commitments associated with financing, investments, risk management and carbon reduction in our operations, research, partnerships, and philanthropy. As a signatory to the Carbon Disclosure Project, we have publicly reported climate- related data since 2003, including multi-year data in accordance with the Greenhouse Gas (GHG) Protocol. We also receive third- party limited assurance on our energy and emissions metrics. Other factors Other factors that may affect our results include changes in government trade policy, changes in accounting standards and their effect on our accounting policies, estimates and judgments, currency and interest rate movements in Canada, the U.S., and other jurisdictions in which we operate or conduct business, changes to our credit ratings, the timely and successful development of new products and services, technological changes, effective design, implementation and execution of processes and their associated controls, fraud by internal and external parties, the possible impact on our business from disease or illness that affects local, national or global economies, disruptions to public infrastructure, including transportation, communication, power and water, international conflicts and other political developments including those relating to the war on terrorism, and our success in anticipating and managing the associated risks. We caution that the foregoing discussion of risk factors, many of which are beyond our control, is not exhaustive and other factors could also affect our results. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 89 Capital management We actively manage our capital to maintain strong capital ratios and high ratings while providing strong returns to our shareholders. In addition to the regulatory requirements, we consider the expectations of credit rating agencies, depositors and shareholders, as well as our business plans, stress tests, peer comparisons and our internal capital ratio targets. Our goal is to optimize our capital usage and structure, and to provide support for our business segments and clients. We also aim to generate better returns for our shareholders, while protecting depositors and creditors. Capital management framework Our capital management framework establishes policies and processes for defining, measuring, raising and investing all forms of capital in a coordinated and consistent manner. It sets our overall approach to capital management, including guiding principles and roles and responsibilities relating to capital adequacy and transactions, dividends, solo capital and management of RWA and leverage ratio exposures. We manage and monitor capital from several perspectives, including regulatory capital and solo capital. Our capital planning process is dynamic and involves various teams including Finance, Corporate Treasury, GRM, Economics and our businesses, and covers internal capital ratio targets, potential capital transactions as well as projected dividend payouts and share repurchases. This process considers our business operating plans, enterprise-wide stress testing and ICAAP, regulatory capital changes and requirements, accounting changes, internal capital requirements, rating agency metrics and solo capital. Our capital plan is established on an annual basis and is aligned with the management actions included in the annual business operating plan, which includes forecast growth in assets and earnings taking into account our business strategies, the projected market and economic environment, and peer positioning. This includes incorporating potential capital transactions based on our projected internal capital generation, business forecasts, market conditions and other developments, such as accounting and regulatory changes, that may impact capital requirements. All of the components in the capital plan are monitored throughout the year and are revised as deemed appropriate. Capital impacts of stress scenarios Enterprise-wide Stress Testing Capital impacts of stress scenarios Total capital requirements ICAAP Capital Plan and Business Operating Plan Capital available and target capital ratios Our enterprise-wide stress testing and annual ICAAP processes provide key inputs for capital planning, including setting internal capital ratio targets. The stress scenarios are evaluated across the organization, and results are integrated to develop an enterprise-wide view of financial impacts and capital requirements, which in turn facilitate the planning of mitigating actions to absorb adverse events. ICAAP assesses capital adequacy and requirements covering all material risks, with a cushion for plausible contingencies. In accordance with OSFI guidelines, major components of our ICAAP process include comprehensive risk assessment, stress testing, capital assessment and planning, Board and senior management oversight, monitoring and reporting and internal control review. Our internal capital targets are established to maintain robust capital positions in excess of OSFI’s Basel III regulatory targets. The stress test results of our enterprise-wide stress testing and ICAAP processes are incorporated into the OSFI Capital Buffers, Domestic Systemically Important Bank (D-SIB)/Globally Systemically Important Bank (G-SIB) surcharge, and Domestic Stability Buffer (DSB), with a view to ensure that the bank has adequate capital to underpin risks and absorb losses under all plausible stress scenarios given our risk profile and appetite. In addition, we include a discretionary cushion on top of OSFI’s regulatory targets to maintain capital strength for forthcoming regulatory and accounting changes, peer comparatives, rating agencies sensitivities and solo capital level. The Board is responsible for the ultimate oversight of capital management, including the annual review and approval of the capital plan. ALCO and GE share responsibility for capital management and receive regular reports detailing our compliance with approved limits and guidelines. The Audit and Risk Committees jointly approve the ICAAP process. The Audit Committee is also responsible for the ongoing review of internal controls over capital management. Basel III Our consolidated regulatory capital requirements are determined by guidelines issued by OSFI, which are based on the minimum Basel III capital ratios adopted by the BCBS. The BCBS set the Basel III transitional requirements for CET1 capital, Tier 1 capital and Total capital ratios at 6.375%, 7.875% and 9.875%, respectively for 2018, and were fully phased-in to 7.0%, 8.5% and 10.5%, respectively, effective for us in the first quarter of 2019 (including minimums plus capital conservation buffer of 2.5%). However, other than providing phase-out rules for non-qualifying capital instruments, OSFI required Canadian banks to meet the BCBS Basel III targets for CET1, Tier 1 capital and Total capital ratios in 2013. Effective the first quarter of 2016, we were required to include an additional 1% risk-weighted capital surcharge to each tier of capital for the above all-in requirements given our designation as a D-SIB by OSFI in 2013 (similar to five other Canadian banks designated as D-SIBs). Effective January 1, 2014, OSFI allowed Canadian banks to phase in the Basel III Credit Valuation Adjustment (CVA) risk capital charge over a five-year period ending December 31, 2018. As of January 1, 2019, the CVA scalars were fully phased-in for each tier of capital, resulting in all tiers of capital having the same risk-weighted assets value. In fiscal 2018, the CVA scalars were 80%, 83% and 86% for CET1, Tier 1 and Total capital, respectively. Under Basel III, banks select from two main approaches, the Standardized Approach or the IRB Approach, to calculate their minimum regulatory capital required to support credit, market and operational risks. We adopted the Basel III IRB approach to calculate credit risk capital for consolidated regulatory reporting purposes. While the majority of our credit risk exposures are 90 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis reported under the Basel III IRB Approach for regulatory capital purposes, certain portfolios continue to use the Basel III Standardized Approach for credit risk (for example, our Caribbean Banking operations and City National). For consolidated regulatory reporting of market risk capital, we use both Internal Models-based and Standardized Approaches. For consolidated regulatory reporting of operational risk, we currently use the higher of TSA and the AMA; however, effective in Q1 2020 we will be required to use the current TSA as the use of the AMA will no longer be allowed. We determine our regulatory leverage ratio based on OSFI’s Leverage Requirements (LR) Guideline, which reflects the BCBS Basel III leverage ratio requirements. We are required to maintain a minimum leverage ratio that meets or exceeds 3%. All federally regulated banks with a Basel III leverage ratio total exposure exceeding €200 billion at their financial year-end are required, at a minimum, to publicly disclose in the first quarter following their year-end, the twelve indicators used in the G-SIB assessment methodology, with the goal of enhancing the transparency of the relative scale of banks’ potential global systemic importance and data quality. The FSB publishes an updated list of G-SIBs annually. On November 22, 2019, we were re-designated as a G-SIB by the FSB. This designation requires us to maintain a higher loss absorbency requirement (common equity as a percentage of RWA) of 1%. As the D-SIB requirement is equivalent to the G-SIB requirement of 1% of RWA, the G-SIB designation had no further impact to the loss absorbency requirements on our CET1 ratio. On April 18, 2018, OSFI released its final guideline on Total Loss Absorbing Capacity (TLAC), which applies to Canadian D-SIBs as part of the Federal Government’s Bail-in regime. The guideline is consistent with the TLAC standard released on November 9, 2015 by the FSB for institutions designated as G-SIBs, but tailored to the Canadian context. The TLAC requirement is intended to address the sufficiency of a systemically important bank’s loss absorbing capacity in supporting its recapitalization in the event of its failure. TLAC is defined as the aggregate of Tier 1 capital, Tier 2 capital, and other TLAC instruments, which allow conversion in whole or in part into common shares under the CDIC Act and meet all of the eligibility criteria under the guideline. TLAC requirements established two minimum standards, which are required to be met effective November 1, 2021: the risk- based TLAC ratio, which builds on the risk-based capital ratios described in the CAR guideline, and the TLAC leverage ratio, which builds on the leverage ratio described in OSFI’s Leverage Requirements guideline. OSFI has provided notification requiring systemically important banks to maintain a minimum TLAC ratio of 23.5%, which includes the revised DSB effective October 31, 2019 of 2.0% of RWA, as noted below, and a TLAC leverage ratio of 6.75%. We began issuing bail-in eligible debt in the fourth quarter of 2018 and this has contributed to increasing our TLAC ratio. We expect our TLAC ratio to increase through normal course refinancing of maturing unsecured term debt. On June 20, 2018, OSFI announced that all D-SIBs are required to publicly disclose their Pillar 2 DSB as part of their quarterly disclosures, similar to other current capital-related disclosure requirements. The level of the buffer will range between 0% and 2.5% of the entity’s total RWA and is currently set at 2.0% of total RWA (1.5% of total RWA in 2018) for the six systemically important banks in Canada. The DSB requirements must be met at the CET1 capital level. OSFI will undertake a review of the DSB on a semi-annual basis, in June and December, and will publicly announce any changes at that time. Effective November 1, 2018, we were required to adopt OSFI’s revisions to the CAR guidelines relating to the Securitization framework and the Standardized Approach for measuring counterparty credit risk. Our adoption reflected the permissible grandfathering and transitioning of certain exposures under these frameworks. On November 1, 2019, the impact of adoption of IFRS 16, and removal of allowed grandfathering and transitioning treatment for certain securitization and counterparty credit risk exposures is expected to decrease our CET1 ratio by approximately 25-30bps. For further details on regulatory developments during the year, refer to the Capital, liquidity and other regulatory developments section. The following table provides a summary of OSFI’s current regulatory target ratios under Basel III and Pillar 2 requirements. We are in compliance with all current capital and leverage requirements imposed by OSFI: Basel III – OSFI regulatory targets Basel III capital and leverage ratios OSFI regulatory target requirements for large banks under Basel III Minimum Capital Buffers (1) Minimum including Capital Buffers D-SIB/G-SIB Surcharge (2) Minimum including Capital Buffers and D-SIB/G-SIB surcharge (2) RBC capital and leverage ratios as at October 31, 2019 Domestic Stability Buffer (3) Table 65 Minimum including Capital Buffers, D-SIB/G-SIB surcharge and Domestic Stability Buffer Common Equity Tier 1 Tier 1 capital Total capital Leverage ratio 4.5% 6.0% 8.0% 3.0% 2.5% 2.5% 2.5% n.a. 7.0% 8.5% 10.5% 3.0% 1.0% 1.0% 1.0% n.a. 8.0% 9.5% 11.5% 3.0% 12.1% 13.2% 15.2% 4.3% 2.0% 2.0% 2.0% n.a. 10.0% 11.5% 13.5% 3.0% The capital buffers include the capital conservation buffer and the countercyclical capital buffer as prescribed by OSFI. A capital surcharge, equal to the higher of our D-SIB surcharge and the BCBS’s G-SIB surcharge, is applicable to risk-weighted capital. Effective October 31, 2019, OSFI has further raised the DSB from 1.75% (in Q2 2019) to 2.0% of RWA. (1) (2) (3) n.a. not applicable. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 91 Regulatory capital, RWA and capital ratios Under Basel III, regulatory capital consists of CET1, Additional Tier 1 and Tier 2 capital. CET1 capital comprises the highest quality of capital. Regulatory adjustments under Basel III include full deductions of certain items and additional capital components that are subject to threshold deductions. Tier 1 capital comprises predominantly CET1 and Additional Tier 1 items including non-cumulative preferred shares that meet certain criteria. Tier 2 capital primarily includes subordinated debentures that meet certain criteria and certain loan loss allowances. Total capital is defined as the sum of Tier 1 and Tier 2 capital. Preferred shares and subordinated debentures issued after January 1, 2013 require Non-viability contingent capital requirement (NVCC) features to be included into regulatory capital. NVCC requirements ensure that non-common regulatory capital instruments bear losses before banks seek government funding. Regulatory capital ratios are calculated by dividing CET1, Tier 1 and Total capital by their respective RWA. The following chart provides a summary of the major components of CET1, Additional Tier 1 and Tier 2 capital. Total Capital Tier 1 Capital Common Equity Tier 1 (CET1) + Additional Tier 1 Capital + Tier 2 Capital Common shares Retained earnings Other components of equity Non-controlling interests in subsidiaries CET1 instruments Goodwill and other intangibles Deferred tax assets on loss carryforwards Defined benefit pension funds assets Non-significant investments in CET1 instruments of Financial Institutions (2) Shortfall of provisions to expected losses Significant investments in insurance subsidiaries and CET1 instruments in other Financial Institutions Mortgage servicing rights Deferred tax assets relating to temporary differences Higher quality capital s n o i t c u d e D d l o h s e r h T ) 1 ( s n o i t c u d e D Preferred shares Non-controlling interests in subsidiaries Tier 1 instruments Subordinated debentures Certain loan loss allowances Non-controlling interests in subsidiaries Tier 2 instruments Non-significant investments in Tier 1 instruments of Financial Institutions (2) Significant investments in other Financial Institutions and insurance subsidiaries Tier 1 instruments Non-significant investments in Tier 2 instruments of Financial Institutions (2) Significant investments in other Financial Institutions and insurance subsidiaries Tier 2 instruments Lower quality capital (1) (2) First level: The amount by which each of the items exceeds a 10% threshold of CET1 capital (after all deductions but before threshold deductions) will be deducted from CET1 capital. Second level: The aggregate amount of the three items not deducted from the first level above and in excess of 15% of CET1 capital after regulatory adjustments will be deducted from capital, and the remaining balance not deducted will be risk-weighted at 250%. Non-significant investments are subject to certain CAR criteria that drive the amount eligible for deduction. The following tables provide details on our regulatory capital, RWA, and capital and leverage ratios. Our capital position remains strong and our capital and leverage ratios remain well above OSFI regulatory targets: Regulatory capital, risk-weighted assets (RWA) and capital and leverage ratios Table 66 (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Capital (1) CET1 capital Tier 1 capital Total capital Risk-weighted Assets (RWA) used in calculation of capital ratios (1), (2) CET1 capital RWA Tier 1 capital RWA Total capital RWA Total capital RWA consisting of: (1) Credit risk Market risk Operational risk Total capital RWA Capital ratios and Leverage ratio (1) CET1 ratio Tier 1 capital ratio Total capital ratio Leverage ratio Leverage ratio exposure (billions) As at October 31 2019 October 31 2018 $ 62,184 67,861 77,888 $ 512,856 512,856 512,856 $ 417,835 28,917 66,104 $ 512,856 12.1% 13.2% 15.2% 4.3% 1,570 $ $ 57,001 63,279 72,494 $ 495,528 495,993 496,459 $ 401,534 32,209 62,716 $ 496,459 11.5% 12.8% 14.6% 4.4% 1,451 $ (1) (2) Capital, RWA, and capital ratios are calculated using OSFI’s CAR guideline based on the Basel III framework. The Leverage ratio is calculated using OSFI Leverage Requirements Guideline based on the Basel III framework. In fiscal 2018, amounts included CVA scalars of 80%, 83% and 86%, respectively. 92 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Regulatory Capital (Millions of Canadian dollars) CET1 capital: instruments and reserves and regulatory adjustments Directly issued qualifying common share capital (and equivalent for non-joint stock companies) plus related stock surplus Retained earnings Accumulated other comprehensive income (and other reserves) Directly issued capital subject to phase out from CET1 (only applicable to non-joint stock companies) Common share capital issued by subsidiaries and held by third parties (amount allowed in group CET1) Regulatory adjustments applied to CET1 under Basel III Common Equity Tier 1 capital (CET1) Additional Tier 1 capital: instruments and regulatory adjustments Directly issued qualifying Additional Tier 1 instruments plus related stock surplus Directly issued capital instruments to phase out from Additional Tier 1 Additional Tier 1 instruments issued by subsidiaries and held by third parties (amount allowed in group AT1) Regulatory adjustments applied to Additional Tier 1 under Basel III Additional Tier 1 capital (AT1) Tier 1 capital (T1 = CET1 + AT1) Tier 2 capital: instruments and provisions and regulatory adjustments Directly issued qualifying Tier 2 instruments plus related stock surplus Directly issued capital instruments subject to phase out from Tier 2 Tier 2 instruments issued by subsidiaries and held by third parties (amount allowed in group Tier 2) Collective allowance Regulatory adjustments applied to Tier 2 under Basel III Tier 2 capital (T2) Total capital (T1 + T2) 2019 vs. 2018 Continuity of CET1 ratio (Basel III) Table 67 As at October 31 2019 October 31 2018 $ 17,888 55,680 4,248 – 12 (15,644) $ 62,184 $ 4,175 1,500 2 – $ 5,677 $ 67,861 $ 6,998 2,509 25 495 – $ 10,027 $ 77,888 $ $ $ $ $ $ $ $ 17,922 50,807 4,823 – 13 (16,564) 57,001 3,825 2,450 3 – 6,278 63,279 6,230 2,509 14 462 – 9,215 72,494 136 bps 11 bps (42) bps (21) bps (12) bps (9) bps (1) bps 12.1% 11.5% October 31, 2018 (1) Internal capital generation (2) Model updates Share repurchases Pension and post- employment benefit obligations RWA growth (excluding regulatory changes, model updates, and FX) Regulatory changes Other October 31, 2019 (1) (1) (2) Represents rounded figures. Internal capital generation of $6.8 billion which represents Net income available to shareholders, less common and preferred shares dividends. Our CET1 ratio was 12.1%, up 60 bps from last year, mainly reflecting internal capital generation, partially offset by higher RWA, share repurchases and the impact of lower discount rates in determining our pension and other post-employment benefit obligations. Our Tier 1 capital ratio of 13.2% was up 40 bps, reflecting the factors noted above under the CET1 ratio. Tier 1 capital ratio was also negatively impacted by the net redemption of preferred shares. Our Total capital ratio of 15.2% was up 60 bps, reflecting the factors noted above under the Tier 1 ratio. Total capital ratio was also favourably impacted by the net issuance of subordinated debentures. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 93 Our Leverage ratio of 4.3% was down 10 bps, mainly reflecting higher leverage ratio exposures, share repurchases, and the net redemption of preferred shares, partially offset by internal capital generation. The increase in leverage exposures was primarily attributable to growth in retail and wholesale lending, repo-style transactions, securities and the impact of regulatory changes. Basel III RWA OSFI requires banks to meet minimum risk-based capital requirements for exposures to credit risk, operational risk, and, where they have significant trading activity, market risk. RWA is calculated for each of these risk types and added together to determine total RWA. In addition, a minimum capital floor requirement must be maintained as prescribed under OSFI’s CAR guidelines. Effective February 1, 2018, the capital floor requirement was set to 75% of RWA as calculated under current Basel III standardized credit risk and market risk approaches as defined in the CAR guidelines. If the capital requirement is less than the required threshold, a floor adjustment to RWA must be applied to the reported RWA as prescribed by OSFI CAR guidelines. Total capital risk-weighted assets As at October 31 (Millions of Canadian dollars, except percentage amounts) Credit risk Lending-related and other Residential mortgages Other retail Business Sovereign Bank Total lending-related and other Trading-related Repo-style transactions Derivatives – including CVA – CET1 phase-in adjustment Total trading-related Total lending-related and other and trading-related Bank book equities Securitization exposures Regulatory scaling factor Other assets Total credit risk Market risk Interest rate Equity Foreign exchange Commodities Specific risk Incremental risk charge Total market risk Operational risk 2019 Risk-weighted assets Table 68 2018 Standardized approach Advanced approach Other Total Total Average of risk- weights (2) 8% $ 21% 59% 7% 22% 29% $ 8,204 $ 15,425 $ 6,635 46,474 1,045 1,672 52,808 168,868 8,355 5,976 64,030 $ 251,432 $ – $ 23,629 $ 21,919 – 55,669 – 205,735 – 11,437 – 10,239 – $315,462 $ 304,999 59,443 215,342 9,400 7,648 Exposure (1) $ 278,628 277,818 364,274 143,261 35,425 $ 1,099,406 $ 909,124 1% $ 109 $ 10,238 $ 122 $ 10,469 $ 8,116 90,896 $ 1,000,020 $ 2,099,426 3,248 64,989 n.a. 20,155 $ 2,187,818 37% 4% $ 17% $ 141% 12% n.a. 143% 19% $ 1,194 31,173 1,303 $ 28,808 $13,975 $ 44,086 $ 39,289 18,570 33,617 13,853 – 4,962 n.a. n.a. 65,333 $ 280,240 $13,975 $359,548 $ 344,288 – 4,161 – 9,984 – 16,608 28,821 25,562 70,295 $ 304,744 $42,796 $417,835 $ 400,603 4,583 2,832 17,089 n.a. 4,583 7,794 17,089 28,821 2,155 $ 1,082 1,548 237 7,144 – 5,109 $ 2,299 208 59 1,741 7,335 – $ 7,264 $ 9,497 – 3,865 – 962 – 190 – 8,005 – 9,690 – $ 28,917 $ 32,209 n.a. $ 66,104 $ 62,716 88,031 $ 382,029 $42,796 $512,856 $ 495,528 3,381 1,756 296 8,885 7,335 12,166 $ 16,751 $ 5,570 $ 60,534 465 88,031 $ 382,029 $42,796 $512,856 $ 495,993 – – – – 466 88,031 $ 382,029 $42,796 $512,856 $ 496,459 $ $ $ $ $ $ CET1 capital risk-weighted assets (3) Additional CVA adjustment, prescribed by OSFI, for Tier 1 capital Tier 1 capital risk-weighted assets (3) Additional CVA adjustment, prescribed by OSFI, for Total capital Total capital risk-weighted assets (3) $ 2,187,818 $ 2,187,818 $ 2,187,818 (1) (2) (3) Total exposure represents exposure at default which is the expected gross exposure upon the default of an obligor. This amount is before any allowance against impaired loans or partial write-offs and does not reflect the impact of credit risk mitigation and collateral held. Represents the average of counterparty risk weights within a particular category. In 2018, there were three different levels of RWAs for the calculation of the CET1, Tier 1 and Total capital ratios arising from the option we chose for the phase-in of the CVA capital charge. As a result, the CVA scalars of 80%, 83% and 86% were applied to CET1, Tier 1 and Total capital ratios, respectively. n.a. not applicable. 94 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis 2019 vs. 2018 During the year, CET1 RWA was up $17 billion, mainly driven by business growth in wholesale and retail lending as well as the impact of regulatory changes relating to the phase-out of CVA scalars and revisions to the CAR guidelines. These factors were partially offset by model updates relating to standardized to AIRB portfolio conversion in retail banking, derivatives parameters enhancement and market risk. Selected capital management activity The following table provides our selected capital management activity: Selected capital management activity Table 69 (Millions of Canadian dollars, except number of shares) Tier 1 capital Common shares activity Issued in connection with share-based compensation plans (1) Purchased for cancellation Issuance of preferred shares, Series BO (2) (3) Redemption of preferred shares, Series AD (2) Redemption of preferred shares, Series AJ (2) Redemption of preferred shares, Series AK (2) Redemption of preferred shares, Series AL (2) Tier 2 capital Issuance of July 25, 2029 subordinated debentures (3) (4) Redemption of July 17, 2024 subordinated debentures (4) For the year ended October 31, 2019 Issuance or redemption date Number of shares (000s) Amount November 2, 2018 November 24, 2018 February 24, 2019 February 24, 2019 February 24, 2019 1,900 $ (10,251) 14,000 (10,000) (13,579) (2,421) (12,000) 136 (126) 350 (250) (339) (61) (300) July 25, 2019 July 17, 2019 $ 1,500 (1,000) (1) (2) (3) (4) Amounts include cash received for stock options exercised during the period and includes fair value adjustments to stock options. For further details, refer to Note 21 of our 2019 Annual Consolidated Financial Statements. Non-Viable Contingent Capital (NVCC) instruments. For further details, refer to Note 19 of our 2019 Annual Consolidated Financial Statements. On February 23, 2018, we announced a normal course issuer bid (NCIB) to purchase up to 30 million of our common shares. This NCIB was completed on February 26, 2019, with 9.7 million common shares repurchased and cancelled at a total cost of approximately $947 million. On February 27, 2019, we announced an NCIB to purchase up to 20 million of our common shares, commencing on March 1, 2019 and continuing until February 29, 2020, or such earlier date as we complete the repurchase of all shares permitted under the bid. Since the inception of this NCIB, the total number of common shares repurchased and cancelled was approximately 6.6 million, at a cost of approximately $682 million. In 2019, the total number of common shares repurchased and cancelled under our NCIB programs was approximately 10.3 million. The total cost of the shares repurchased was $1,030 million. We determine the amount and timing of the purchases under the NCIB, subject to prior consultation with OSFI. Purchases may be made through the TSX, the NYSE and other designated exchanges and alternative Canadian trading systems. The price paid for repurchased shares is at the prevailing market price at the time of acquisition. On November 2, 2018, we issued 14 million Non-Cumulative 5-Year Rate Reset Preferred Shares Series BO at a price of $25 per share. On November 24, 2018, we redeemed all 10 million Non-Cumulative First Preferred Shares Series AD at a price of $25 per share. On February 24, 2019, we redeemed all 2.4 million Non-Cumulative Floating Rate First Preferred Shares Series AK, all 13.6 million Non-Cumulative 5-Year Rate Reset First Preferred Shares Series AJ, and all 12 million Non-Cumulative 5-Year Rate Reset First Preferred Shares Series AL, at a price of $25 per share. On July 17, 2019, we redeemed all $1,000 million of our outstanding NVCC 3.04% subordinated debentures due on July 17, 2024 for 100% of their principal amount plus interest accrued to, but excluding, the redemption date. On July 25, 2019, we issued $1,500 million of NVCC subordinated debentures. The notes bear interest at a fixed rate of 2.74% per annum until July 25, 2024, and at the three-month Canadian Dollar Offered Rate (CDOR) plus 0.98% thereafter until their maturity on July 25, 2029. On October 18, 2019, we also announced our intention to redeem all $2,000 million of our outstanding 2.99% subordinated debentures due on December 6, 2024 for 100% of their principal amount plus interest accrued to, but excluding, the redemption date, on December 6, 2019. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 95 Dividends Our common share dividend policy reflects our earnings outlook, payout ratio objective and the need to maintain adequate levels of capital to support business plans. In 2019, our dividend payout ratio was 46%, which met our dividend payout ratio target of 40% to 50%. Common share dividends paid during the year were $5.8 billion. Selected share data (1) (Millions of Canadian dollars, except number of shares and as otherwise noted) Common shares issued Treasury shares – common shares Common shares outstanding Stock options and awards Outstanding Exercisable Available for grant First preferred shares issued Non-cumulative Series W (2) Non-cumulative Series AA Non-cumulative Series AC Non-cumulative Series AD (3) Non-cumulative Series AE Non-cumulative Series AF Non-cumulative Series AG Non-cumulative Series AJ (4) Non-cumulative Series AK (4) Non-cumulative Series AL (4) Non-cumulative Series AZ (5), (6) Non-cumulative Series BB (5), (6) Non-cumulative Series BD (5), (6) Non-cumulative Series BF (5), (6) Non-cumulative Series BH (6) Non-cumulative Series BI (6) Non-cumulative Series BJ (6) Non-cumulative Series BK (5), (6) Non-cumulative Series BM (5), (6) Non-cumulative Series BO (5), (6) Non-cumulative Series C-2 (7) Preferred shares issued Treasury shares – preferred shares (8) Preferred shares outstanding Dividends Common Preferred (9) 2019 2018 Number of shares (000s) 1,430,678 (582) Amount $ 17,645 (58) 1,430,096 $ 17,587 Dividends declared per share $ 4.07 Number of shares (000s) Amount 1,439,029 (235) $ 17,635 (18) 1,438,794 $ 17,617 Table 70 Dividends declared per share $ 3.77 7,697 2,980 8,171 12,000 12,000 8,000 – 10,000 8,000 10,000 – – – 20,000 20,000 24,000 12,000 6,000 6,000 6,000 29,000 30,000 14,000 20 227,020 34 227,054 $ 300 300 200 – 250 200 250 – – – 500 500 600 300 150 150 150 725 750 350 31 $ 1.23 1.11 1.15 – 1.13 1.11 1.13 0.22 0.23 0.27 0.96 0.96 0.90 0.90 1.23 1.23 1.31 1.38 1.38 1.27 US$67.50 $ $ $ 5,706 1 5,707 5,840 269 $ 8,504 3,726 9,262 12,000 12,000 8,000 10,000 10,000 8,000 10,000 13,579 2,421 12,000 20,000 20,000 24,000 12,000 6,000 6,000 6,000 29,000 30,000 – 20 300 300 200 250 250 200 250 339 61 300 500 500 600 300 150 150 150 725 750 – 31 $ 1.23 1.11 1.15 1.13 1.13 1.11 1.13 0.88 0.78 1.07 1.00 0.98 0.90 0.90 1.23 1.23 1.31 1.38 1.38 – US$ 67.50 251,020 114 $ 6,306 3 251,134 $ 6,309 $ 5,442 285 For further details about our capital management activity, refer to Note 21 of our 2019 Annual Consolidated Financial Statements. Effective February 24, 2010, we have the right to convert these shares into common shares at our option, subject to certain restrictions. On November 24, 2018, we redeemed all 10 million Non-Cumulative First Preferred Shares Series AD at a price of $25 per share. (1) (2) (3) (4) On February 24, 2019, we redeemed all 2.4 million Non-Cumulative Floating Rate First Preferred Shares Series AK, all 13.6 million Non-Cumulative 5-Year Rate Reset First Preferred Shares Series AJ, and all 12 million Non-Cumulative 5-Year Rate Reset First Preferred Shares Series AL, at a price of $25 per share. Dividend rate will reset every five years. NVCC instruments. Represents 815,400 depositary shares relating to preferred shares Series C-2. Each depositary share represents one-fortieth interest in a share of Series C-2. Positive amounts represent a short position in treasury shares. Dividends on preferred shares excludes distributions to non-controlling interests. (5) (6) (7) (8) (9) As at November 29, 2019, the number of outstanding common shares was 1,430,517,057, net of treasury shares held of 206,508, and the number of stock options and awards was 7,654,702. NVCC provisions require the conversion of the capital instrument into a variable number of common shares in the event that OSFI deems a bank to be non-viable or a federal or provincial government in Canada publicly announces that a bank has accepted or agreed to accept a capital injection. If a NVCC trigger event were to occur, our NVCC capital instruments, which are the preferred shares Series AZ, BB, BD, BF, BH, BI, BJ, BK, BM, BO, and subordinated debentures due on September 29, 2026, June 4, 2025, January 20, 2026, January 27, 2026 and July 25, 2029, would be converted into RBC common shares pursuant to an automatic conversion formula with a conversion price based on the greater of: (i) a contractual floor price of $5.00, and (ii) the current market price of our common shares at the time of the trigger event (10-day weighted average). Based on a floor price of $5.00 and including an estimate for accrued dividends and interest, these NVCC capital instruments would convert into a maximum of 2,973 million RBC common shares, in aggregate, which would represent a dilution impact of 67.52% based on the number of RBC common shares outstanding as at October 31, 2019. 96 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Attributed capital Effective November 1, 2018, our methodology for allocating capital to our business segments is based on the Basel III regulatory capital requirements, with the exception of Insurance. For Insurance, the allocation of capital is based on fully diversified economic capital. Risk-based capital attribution provides a uniform base for performance measurement among business segments, which compares to our overall corporate return objective and facilitates management decisions in resource allocation in conjunction with other factors. The calculation and attribution of capital involves a number of assumptions and judgments by management which are monitored to ensure that the regulator capital framework remains comprehensive and consistent. The models are benchmarked to leading industry practices via participation in surveys, reviews of methodologies and ongoing interaction with external risk management industry professionals. For additional information on the risks highlighted below, refer to the Risk management section. RWA (C$ millions) (1) $417,835 Credit 28,917 Market Operational 66,104 $512,856 Royal Bank of Canada 62% 5 10 Attributed capital (1) Credit Market Operational Goodwill and other intangibles Other(2) 20 3 Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets RWA (C$ millions) (1) $157,355 Credit 305 Market Operational 26,228 $183,888 RWA (C$ millions) (1) $62,955 Credit 801 Market Operational 17,665 $81,421 RWA (C$ millions) (1), (3) $10,026 Credit – Market Operational – $10,026 RWA (C$ millions) (1) $15,844 Credit 6,292 Market Operational 4,927 $27,063 RWA (C$ millions) (1) $164,414 Credit 20,807 Market Operational 16,760 $201,981 68% 0 11 Attributed capital (1) Credit Market Operational Goodwill and other intangibles Other(2) 19 2 39% 0 12 Attributed capital (1) Credit Market Operational Goodwill and other intangibles Other(2) 49 0 Attributed capital (1) Based on Economic Capital: Credit Market Operational Goodwill and other intangibles Other(2) 10% 20 11 10 49 47% 22 14 Attributed capital (1) Credit Market Operational Goodwill and other intangibles Other(2) 15 2 74% 10 7 Attributed capital (1) Credit Market Operational Goodwill and other intangibles Other(2) 7 2 (1) (2) (3) RWA amount represents period-end spot balances. Attributed Capital represents average balances. Other includes (a) non-Insurance segments: equity required to underpin Basel III regulatory capital deductions other than Goodwill and other intangibles and (b) Insurance segment: equity required to underpin risks associated with business, fixed assets and insurance risks. Insurance RWA represents our investments in the insurance subsidiaries capitalized at the regulatory prescribed rate as required under OSFI CAR guideline. Other considerations affecting capital Capital treatment for equity investments in other entities is determined by a combination of accounting and regulatory guidelines based on the size or nature of the investment. Three broad approaches apply as follows: Consolidation: entities which we control are consolidated on our Consolidated Balance Sheets. (cid:129) Deduction: certain holdings are deducted from our regulatory capital. These include all unconsolidated “substantial (cid:129) investments,” as defined by the Bank Act (Canada) in the capital of financial institutions, as well as all investments in insurance subsidiaries. Risk weighting: equity investments that are not deducted from capital are risk-weighted at a prescribed rate for determination of capital charges. (cid:129) Regulatory capital approach for securitization exposures Our securitization regulatory capital approach reflects Chapter 7 of OSFI’s CAR guidelines. For our securitization exposures, we use an internal assessment approach (IAA) for exposures related to our ABCP business, and as per regulatory guidelines for other securitization exposures we use a combination of approaches including an external ratings-based approach, an internal ratings based approach and a standardized approach. While our IAA rating methodologies are based in large part on criteria that are published by External Credit Assessment Institutions (ECAIs) such as S&P and therefore are similar to the methodologies used by these institutions, they are not identical. Our ratings process includes a comparison of the available credit enhancement in a securitization structure to a stressed level of Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 97 projected losses. The stress level used is determined by the desired risk profile of the transaction. As a result, we stress the cash flows of a given transaction at a higher level in order to achieve a higher rating. Conversely, transactions that only pass lower stress levels achieve lower ratings. Most of the other securitization exposures (non-ABCP) carry external ratings and we use the external rating for determining the proper capital allocation for these positions. We periodically compare our own ratings to ECAIs ratings to ensure that the ratings provided by ECAIs are reasonable. GRM is responsible for providing risk assessments for capital purposes in respect of all our banking book exposures. GRM is independent of the business originating the securitization exposures and performs its own analysis, sometimes in conjunction with but always independent of the applicable business. GRM has developed asset class specific criteria guidelines which provide the rating methodologies for each asset class. The guidelines are reviewed periodically and are subject to the ratings replication process mandated by Pillar I of the Basel rules. Capital, liquidity, and other regulatory developments Capital Pillar 3 disclosure requirements In December 2018, the BCBS issued its third and final phase of the Pillar 3 disclosure requirements, Pillar 3 disclosure requirements – updated framework. This phase incorporates revisions and additions to the Pillar 3 framework arising from the finalization of the Basel III reforms in December 2017, such as additional disclosure requirements comparing RWA as determined by banks’ internal models against results based on the standardized approach, and new disclosure requirements on asset encumbrance and capital distribution constraints. The phase three requirements, together with the phase one and two disclosure requirements released in January 2015 and March 2017, respectively, complete the Pillar 3 framework. The phase one requirements were effective for us in the fourth quarter of 2018. At this time, OSFI has not yet released the implementation date for the BCBS phase two and three disclosure requirements. Minimum Capital Requirements for Market Risk On January 19, 2019, the BCBS released its final standards on the Minimum capital requirement for market risk, which replaces an earlier version published in January 2016. The revisions refined the standardized approach framework, clarified the scope of exposures subject to market risk capital requirements, revised the assessment process for evaluating the adequacy of internal risk management models, and revised the requirements for identifying risk factors eligible for internal modelling. The BCBS expects member jurisdictions to implement these revisions by 2022. We currently expect OSFI to release their draft guidelines for public consultation in 2020. Basel III reforms On July 18, 2019, OSFI revised its capital requirements for operational risk applicable to deposit taking institutions. Currently, we are required to apply the higher of the current Basel III Standardized Approach (TSA) and the Advanced Measurement Approach (AMA) for measuring operational risk. Effective Q1 2020, institutions will be required to use the current TSA as the use of AMA will no longer be allowed. We do not expect an impact to our capital ratios resulting from this change. Liquidity Liquidity Adequacy Requirements (LAR) Guidelines On April 11, 2019, OSFI issued the final LAR guidelines for LCR, Net Cumulative Cash Flow, Net Stable Funding Ratio and liquidity monitoring tools. This concluded public consultations on guidelines affecting the liquidity reserves banks are required to hold in order to withstand stress, how banks fund their balance sheets and the monitoring of related metrics. We are well positioned to comply with the final rules, and changes are not expected to have a material impact on our ability to provide our full range of retail and wholesale financial services. The revised guideline will be effective January 1, 2020. Net Stable Funding Ratio Disclosure On April 11, 2019, OSFI finalized the Net Stable Funding Ratio (NSFR) Disclosure Requirements guideline. In line with the guideline, we will disclose our consolidated NSFR and its major components in a template prescribed by OSFI on a quarterly basis and it will complement the information that we already disclose about our LCR position. The new disclosure requirements are effective January 31, 2021 and we are well positioned to comply with the new requirements. Other Regulatory Changes Large Exposure Limits Guideline On April 10, 2019, OSFI revised its Large Exposure Limits guideline, which is intended to constrain the maximum loss an institution could face in the event of a sudden failure of a counterparty by limiting exposures to a single counterparty or interconnected group of companies. The guideline enhances existing policies for managing the risks of large exposures and ensures consistent and robust practices across all the systemically important banks in Canada. We will be required to implement the new guideline in the first quarter of 2020 and we are well positioned to stay below the limits. Interest rate risk management guidelines On May 30, 2019, OSFI revised its Interest Rate Risk Management guidelines providing more comprehensive guidance on practices relating to the stress testing scenarios, risk assessment and governance, including standardized interest rate scenarios. We will be required to implement the new guidelines on January 1, 2020 and we are well positioned to comply with the new requirements. 98 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Accounting and control matters Critical accounting policies and estimates Application of critical accounting policies, judgments, estimates and assumptions Our significant accounting policies are described in Note 2 of our 2019 Annual Consolidated Financial Statements. Certain of these policies and related estimates are recognized as critical because they require us to make particularly subjective or complex judgments about matters that are inherently uncertain and significantly different amounts could be reported under different conditions or using different assumptions. Our critical accounting judgments, estimates and assumptions relate to the fair value of financial instruments, allowance for credit losses, goodwill and other intangible assets, employee benefits, consolidation, derecognition of financial assets, application of the effective interest method, provisions, insurance claims and policy benefit liabilities, income taxes, and deferred revenue on our customer loyalty program. Our critical accounting policies and estimates have been reviewed and approved by our Audit Committee, in consultation with management, as part of their review and approval of our significant accounting policies, judgments, estimates and assumptions. Changes in accounting policies During the first quarter, we adopted IFRS 15 Revenue from Contracts with Customers (IFRS 15). As permitted by the transition provisions of IFRS 15, we elected not to restate comparative period results; accordingly, all comparative information is presented in accordance with our previous accounting policies, as indicated below. As a result of the adoption of IFRS 15, we reduced our opening retained earnings by $94 million(1), on an after tax basis as at November 1, 2018 (the date of initial application), to align with the recognition of certain fees with the transfer of the performance obligations. Fair value of financial instruments The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We determine fair value by incorporating factors that market participants would consider in setting a price, including commonly accepted valuation approaches. We give priority to third-party pricing services and valuation techniques with the highest and most consistent accuracy. The level of accuracy is determined over time by comparing third-party price values to traders’ or system values, other pricing service values and, when available, actual trade data. Other valuation techniques are used when a price or quote is not available. Some valuation processes use models to determine fair value. We have a systematic and consistent approach to control the use of models. In determining fair value, a hierarchy is used which prioritizes the inputs to valuation techniques. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs. Fair values established based on this hierarchy require the use of observable market data whenever available. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model inputs that are either observable, or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 inputs include one or more inputs that are unobservable and significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available at the measurement date. The availability of inputs for valuation may affect the selection of valuation techniques. The classification of a financial instrument in the fair value hierarchy for disclosure purposes is based upon the lowest level of input that is significant to the measurement of fair value. Where observable prices or inputs are not available, management judgment is required to determine fair values by assessing other relevant sources of information such as historical data, proxy information from similar transactions, and through extrapolation and interpolation techniques. For more complex or illiquid instruments, significant judgment is required to determine the model used, select the model inputs, and in some cases, apply valuation adjustments to the model value or quoted price for inactively traded financial instruments. The selection of model inputs may be subjective and the inputs may be unobservable. Unobservable inputs are inherently uncertain as there is little or no market data available from which to determine the level at which the transaction would occur under normal business circumstances. Appropriate parameter uncertainty and market risk valuation adjustments for such inputs and other model risk valuation adjustments are assessed in all such instances. Valuation adjustments may be subjective as they require significant judgment in the input selection, such as the probability of default and recovery rate, and are intended to arrive at a fair value that is determined based on assumptions that market participants would use in pricing the financial instrument. The realized price for a transaction may be different from its recorded value that was previously estimated using management judgment, and may therefore impact unrealized gains and losses recognized in Non-interest income – Trading revenue or Other. Allowance for credit losses An allowance for credit losses (ACL) is established for all financial assets, except for financial assets classified or designated as FVTPL and equity securities designated as FVOCI, which are not subject to impairment assessment. Assets subject to impairment assessment include certain loans, debt securities, interest-bearing deposits with banks, customers’ liability under acceptances, accounts and accrued interest receivable, and finance and operating lease receivables. Off-balance sheet items subject to impairment assessment include financial guarantees and undrawn loan commitments. We measure the ACL on each balance sheet date according to a three-stage expected credit loss impairment model: (cid:129) Stage 1 – From initial recognition of a financial asset to the date on which the asset has experienced a significant increase in credit risk relative to its initial recognition, a loss allowance is recognized equal to the credit losses expected to result from defaults occurring over the 12 months following the reporting date. Stage 2 – Following a significant increase in credit risk relative to the initial recognition of the financial asset, a loss allowance is recognized equal to the credit losses expected over the remaining lifetime of the asset. (cid:129) Performing financial assets (cid:129) (1) Revised from the amount previously presented. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 99 (cid:129) Impaired financial assets (cid:129) Stage 3 – When a financial asset is considered to be credit-impaired, a loss allowance is recognized equal to credit losses expected over the remaining lifetime of the asset. Interest income is calculated based on the carrying amount of the asset, net of the loss allowance, rather than on its gross carrying amount. The ACL is a discounted probability-weighted estimate of the cash shortfalls expected to result from defaults over the relevant time horizon. For loan commitments, credit loss estimates consider the portion of the commitment that is expected to be drawn over the relevant time period. For financial guarantees, credit loss estimates are based on the expected payments required under the guarantee contract. For finance lease receivables, credit loss estimates are based on cash flows consistent with the cash flows used in measuring the lease receivable. The ACL represents an unbiased estimate of expected credit losses on our financial assets as at the balance sheet date. Judgment is required in making assumptions and estimations when calculating the ACL, including movements between the three stages and the application of forward looking information. The underlying assumptions and estimates may result in changes to the provisions from period to period that significantly affect our results of operations. For further information on allowance for credit losses, refer to Notes 2 and 5 of our 2019 Annual Consolidated Financial Statements. Goodwill and other intangible assets We allocate goodwill to groups of cash-generating units (CGU). Goodwill is not amortized and is tested for impairment on an annual basis, or more frequently if there are objective indications of impairment. We test for impairment by comparing the recoverable amount of a CGU with its carrying amount. We estimate the value in use and fair value less costs of disposal of our CGUs primarily using a discounted cash flow method which incorporates each CGU’s internal forecasts of revenues and expenses. Significant management judgment is applied in the determination of expected future cash flows (uncertainty in timing and amount), discount rates (based on CGU-specific risks) and terminal growth rates. CGU-specific risks include country risk, business/operational risk, geographic risk (including political risk, devaluation risk and government regulation), currency risk and price risk (including product pricing risk and inflation). If the forecast earnings and other assumptions in future periods deviate significantly from the current amounts used in our impairment testing, the value of our goodwill could become impaired. We assess for indicators of impairment of our other intangible assets at each reporting period. If there is an indication that an asset may be impaired, an impairment test is performed by comparing the carrying amount of the intangible asset to its recoverable amount. Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the CGU to which the asset belongs. Significant judgment is applied in estimating the useful lives and recoverable amounts of our intangible assets and assessing whether certain events or circumstances constitute objective evidence of impairment. We do not have any intangible assets with indefinite lives. For further details, refer to Notes 2 and 10 of our 2019 Annual Consolidated Financial Statements. Employee benefits We sponsor a number of benefit programs for eligible employees, including registered pension plans, supplemental pension plans, health, dental, disability and life insurance plans. The calculation of defined benefit expenses and obligations depends on various assumptions such as discount rates, healthcare cost trend rates, projected salary increases, retirement age, and mortality and termination rates. Discount rates are determined using a yield curve based on spot rates from high quality corporate bonds. All other assumptions are determined by us and are reviewed by the actuaries. Actual experience that differs from the actuarial assumptions will affect the amounts of benefit obligations and remeasurements that we recognize. The weighted average assumptions used and the sensitivity of key assumptions are presented in Note 17 of our 2019 Annual Consolidated Financial Statements. Consolidation of structured entities Subsidiaries are those entities, including structured entities, over which we have control. We control an entity when we are exposed, or have rights, to variable returns from our involvement with the entity and have the ability to affect those returns through our power over the investee. We have power over an entity when we have existing rights that give us the current ability to direct the activities that most significantly affect the entity’s returns (relevant activities). Power may be determined on the basis of voting rights or, in the case of structured entities, other contractual arrangements. We are not deemed to control an entity when we exercise power over an entity as the agent of a third party or parties. In determining whether we are acting as an agent, we consider the overall relationship between us, the investee and other parties to the arrangement with respect to the following factors: (i) the scope of our decision making power; (ii) the rights held by other parties; (iii) the remuneration to which we are entitled; and (iv) our exposure to variability of returns. The determination of control is based on the current facts and circumstances and is continuously assessed. In some circumstances, different factors and conditions may indicate that various parties control an entity depending on whether those factors and conditions are assessed in isolation or in totality. Significant judgment is applied in determining whether we control an entity, specifically, assessing whether we have substantive decision making rights over the relevant activities and whether we are exercising our power as a principal or an agent. We consolidate all subsidiaries from the date control is transferred to us, and cease consolidation when an entity is no longer controlled by us. Our consolidation conclusions affect the classification and amount of assets, liabilities, revenues and expenses reported in our Consolidated Financial Statements. For further details, refer to Note 7 of our 2019 Annual Consolidated Financial Statements. Derecognition of financial assets We periodically enter into transactions in which we transfer financial assets such as loans or mortgage-backed securities to structured entities or trusts that issue securities to investors. We derecognize the assets when our contractual rights to the cash flows from the assets have expired; when we retain the rights to receive the cash flows but assume an obligation to pay those cash flows to a third party subject to certain pass-through requirements; or when we transfer our contractual rights to receive the cash flows and substantially all of the risks and rewards of the assets have been transferred. When we retain substantially all 100 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis of the risks and rewards of the transferred assets, the transferred assets are not derecognized from our Consolidated Balance Sheets and are accounted for as secured financing transactions. When we neither retain nor transfer substantially all risks and rewards of ownership of the assets, we derecognize the assets if control over the assets is relinquished. If we retain control over the transferred assets, we continue to recognize the transferred assets to the extent of our continuing involvement. Management’s judgment is applied in determining whether we have transferred or retained substantially all risk and rewards of ownership of the transferred financial asset. The majority of assets transferred under repurchase agreements, securities lending agreements, and in our Canadian residential mortgage securitization transactions do not qualify for derecognition. As a result, we continue to record the associated transferred assets on our Consolidated Balance Sheets and no gains or losses are recognized for those securitization activities. Otherwise, a gain or loss is recognized on securitization by comparing the carrying amount of the transferred asset with its fair value at the date of the transfer. For further information on derecognition of financial assets, refer to Notes 2 and 6 of our 2019 Annual Consolidated Financial Statements. Application of the effective interest method Interest is recognized in Interest income and Interest expense in the Consolidated Statements of Income generally for all interest bearing financial instruments using the effective interest method. The effective interest rate is the rate that discounts estimated future cash flows over the expected life of the financial asset or liability to the net carrying amount upon initial recognition. Significant judgment is applied in determining the effective interest rate due to uncertainty in the timing and amounts of future cash flows. Provisions Provisions are liabilities of uncertain timing or amount and are recognized when we have a present legal or constructive obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are measured as the best estimate of the consideration required to settle the present obligation at the reporting date. Significant judgment is required in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. We record provisions related to litigation, uncertain tax positions, asset retirement obligations and other items. The forward-looking nature of these estimates requires us to use a significant amount of judgment in projecting the timing and amount of future cash flows. We record our provisions on the basis of all available information at the end of the reporting period and make adjustments on a quarterly basis to reflect current expectations. Should actual results differ from our expectations, we may incur expenses in excess of the provisions recognized. Insurance claims and policy benefit liabilities Insurance claims and policy benefit liabilities represent current claims and estimates for future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method, which incorporates assumptions for mortality, morbidity, policy lapses and surrenders, investment yields, policy dividends, operating and policy maintenance expenses, and provisions for adverse deviation. Key assumptions are reviewed annually and updated in response to actual experience and market conditions. Liabilities for property and casualty insurance represent estimated provisions for reported and unreported claims. Liabilities for life and property and casualty insurance are included in Insurance claims and policy benefit liabilities. Changes in Insurance claims and policy benefit liabilities are included in the Insurance policyholder benefits, claims and acquisition expense in our Consolidated Statements of Income in the period in which the estimates change. Refer to Note 15 of our 2019 Annual Consolidated Financial Statements for further information. Income taxes We are subject to income tax laws in various jurisdictions where we operate, and the complex tax laws are potentially subject to different interpretations by us and the relevant taxation authority. Management’s judgment is applied in interpreting the relevant tax laws and estimating the expected timing and amount of the provision for current and deferred income taxes. A deferred tax asset or liability is determined for each temporary difference based on the tax rates that are expected to be in effect in the period that the asset is realized or the liability is settled. Where the temporary differences will not reverse in the foreseeable future, no deferred tax amount is recognized. On a quarterly basis, we review whether it is probable that the benefits associated with our deferred tax assets will be realized, using both positive and negative evidence. Refer to Note 23 of our 2019 Annual Consolidated Financial Statements for further information. Future changes in accounting policy and disclosure IFRS 16 Leases(IFRS 16) In January 2016, the IASB issued IFRS 16, which sets out the principles for the recognition, measurement, presentation and disclosure of leases. The standard removes the current requirement for lessees to classify leases as finance leases or operating leases by introducing a single accounting model that requires the recognition of right-of-use assets and lease liabilities on the balance sheet for most leases. Lessees will recognize interest expense on the lease liability and depreciation expense on the right-of-use asset in the statement of income. IFRS 16 will be effective for us on November 1, 2019. We will adopt IFRS 16 by adjusting our Consolidated Balance Sheet as at November 1, 2019, the date of initial application, with no restatement of comparative periods. On transition to IFRS 16, we intend to apply certain practical expedients, including the following: (cid:129) (cid:129) Election to not separate lease and non-lease components, to be applied to our real estate leases; Election to measure the right-of-use asset as if IFRS 16 had been applied since the commencement date of the lease, to be applied on a lease-by-lease basis to a select number of properties; and Exemption from recognition for short-term and low value leases. (cid:129) Based on current estimates, the adoption of IFRS 16 as at November 1, 2019 is expected to result in increases to total assets and total liabilities of approximately $5 billion, primarily representing leases of premises and equipment previously classified as operating leases, and a reduction to retained earnings of approximately $0.1 billion, net of taxes. The adoption of IFRS 16 is also expected to decrease our CET1 capital ratio by approximately 14 bps. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 101 Interest Rate Benchmark Reform In September 2019, the IASB issued amendments to IFRS 9 Financial Instruments, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures (Amendments) which modify certain hedge accounting requirements to provide relief from the potential effect of uncertainty caused by the Interest Rate Benchmark Reform, prior to the transition to alternative interest rates. The Amendments will be effective for us on November 1, 2020, with earlier adoption permitted. To manage our transition to alternative interest rates, we have implemented a comprehensive enterprise-wide program and governance structure that focuses on key areas of impact including contract changes with clients, capital and liquidity planning, financial reporting and valuation, systems, processes, education and communication. The exact timing of our transition and assessment of the implications are uncertain as the interest rate replacement process differs across major jurisdictions. We will continue to monitor regulatory guidance and expect to adjust our implementation accordingly. ConceptualFrameworkforFinancialReporting(ConceptualFramework) In March 2018, the IASB issued its revised Conceptual Framework. This replaces the previous version of the Conceptual Framework issued in 2010. The revised Conceptual Framework will be effective on November 1, 2020. We are currently assessing the impact of adoption on our Consolidated Financial Statements. IFRS 17 InsuranceContracts(IFRS 17) In May 2017, the IASB issued IFRS 17 to establish a comprehensive global insurance standard which provides guidance on the recognition, measurement, presentation and disclosures of insurance contracts. IFRS 17 requires entities to measure insurance contract liabilities at their current fulfillment values using one of three approaches. This new standard will be effective for us on November 1, 2021 and will be applied retrospectively with restatement of comparatives unless impracticable. In June 2019, the IASB issued an exposure draft to amend IFRS 17, including deferral of the effective date by one year. We will continue to monitor the IASB’s developments. We are currently assessing the impact of adopting this standard and the proposed amendments on our Consolidated Financial Statements. Controls and procedures Disclosure controls and procedures Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports filed or submitted under Canadian and U.S. securities laws is recorded, processed, summarized and reported within the time periods specified under those laws and include controls and procedures that are designed to ensure that information is accumulated and communicated to management, including the President and Chief Executive Officer, and the Chief Financial Officer, to allow timely decisions regarding required disclosure. As of October 31, 2019, management evaluated, under the supervision of and with the participation of the President and Chief Executive Officer and the Chief Financial Officer, the effectiveness of our disclosure controls and procedures as defined under rules adopted by the U.S. SEC. Based on that evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of October 31, 2019. Internal control over financial reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. However, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. See Management’s Report on Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm. There were no changes in our internal control over financial reporting during the year ended October 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Related party transactions In the ordinary course of business, we provide normal banking services and operational services, and enter into other transactions with associated and other related corporations, including our joint venture entities, on terms similar to those offered to non-related parties. We grant loans to directors, officers and other employees at rates normally accorded to preferred clients. In addition, we offer deferred share and other plans to non-employee directors, executives and certain other key employees. For further information, refer to Notes 12 and 27 of our audited 2019 Annual Consolidated Financial Statements. Supplementary information Selected annual information (Millions of Canadian dollars, except as otherwise noted) Total revenue Net income attributable to: Shareholders Non-controlling interest Basic earnings per share (in dollars) Diluted earnings per share (in dollars) Dividends declared per common shares (in dollars) Total assets Deposits (1) 2019 46,002 $ 12,860 11 $ 12,871 8.78 $ 8.75 $ $ 4.07 $1,428,935 $ 886,005 Table 71 2018 2017 $ 42,576 $ 40,669 12,400 31 11,428 41 $ 12,431 $ 11,469 8.39 $ 8.36 $ $ 3.77 $1,334,734 $ 836,197 7.59 $ 7.56 $ $ 3.48 $1,212,853 $ 789,036 (1) Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. 102 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Net interest income on average assets and liabilities Table 72 (Millions of Canadian dollars, except for percentage amounts) (1) 2019 2018 2017 2019 2018 2017 2019 2018 2017 Average balances Interest Average rate Assets Deposits with other banks Canada U.S. Other International Securities Trading Investment, net of applicable allowance Asset purchased under reverse repurchase agreements and securities borrowed Loans (2) Canada Retail Wholesale U.S. Other International Total interest-earning assets Non-interest-bearing deposits with other banks Customers’ liability under acceptances Other assets Total assets Liabilities and shareholders’ equity Deposits (3) Canada U.S. Other International (4) Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Subordinated debentures Other interest-bearing liabilities Total interest-bearing liabilities Non-interest-bearing deposits Acceptances Other liabilities (4) Total liabilities Equity Total liabilities and shareholders’ equity Net interest income and margin Net interest income and margin (average earning assets) Canada U.S. Other International (4) Total $ 10,990 $ 25,392 20,463 56,845 10,300 $ 27,522 21,587 11,380 $ 21,508 17,215 59,409 50,103 231 $ 505 (53) 683 198 $ 429 (61) 566 146 2.10% 1.92% 1.28% 0.89 192 (0.18) (31) 1.99 (0.26) 1.56 (0.28) 307 1.20 0.95 0.61 130,647 97,764 228,411 125,153 90,470 215,623 130,816 83,787 214,603 346,173 266,709 205,993 379,853 89,503 469,356 96,492 32,430 598,278 364,473 77,985 442,458 79,695 28,932 551,085 350,155 74,955 425,110 75,967 27,201 528,278 4,573 2,254 6,827 8,960 15,352 4,988 20,340 3,099 1,424 24,863 3,785 1,885 5,670 3,520 1,379 4,899 5,536 3,021 13,533 3,682 17,215 3,008 1,026 11,672 3,534 15,206 2,391 1,080 21,249 18,677 3.50 2.31 2.99 2.59 4.04 5.57 4.33 3.21 4.39 4.16 3.02 2.08 2.63 2.69 1.65 2.28 2.08 1.47 3.71 4.72 3.89 3.77 3.55 3.86 3.33 4.71 3.58 3.15 3.97 3.54 1,229,707 29,430 17,447 159,599 2.69 – – – $1,436,200 $ 1,294,900 $ 1,186,600 $41,333 $ 33,021 $ 26,904 2.88% 2.55% 2.27% 1,092,826 31,695 16,015 154,395 998,977 23,953 14,550 149,114 33,021 – – – 26,904 – – – 41,333 – – – 3.36 – – – 3.02 – – – $ 555,467 $ 97,563 83,349 513,240 $ 98,651 77,414 498,134 $10,420 $ 7,718 $ 5,560 1.88% 1.50% 1.12% 0.81 79,354 0.83 69,532 1,524 1,044 1,313 811 1.56 1.25 1.33 1.05 640 578 736,379 34,799 262,929 9,405 16,496 689,305 647,020 32,642 37,205 184,934 9,131 15,352 128,831 9,460 14,839 12,988 1,995 6,147 365 89 9,842 1,627 3,261 322 17 6,778 1,515 1,396 270 19 1.76 5.73 2.34 3.88 0.54 1.43 4.98 1.76 3.53 0.11 1.05 4.07 1.08 2.85 0.13 21,584 – – – 1,060,008 133,702 17,473 143,948 931,364 129,696 16,030 142,122 837,355 122,800 14,549 139,293 1.19 – – – $1,355,131 $ 1,219,212 $ 1,113,997 $21,584 $ 15,069 $ 9,978 1.59% 1.24% 0.90% n.a. n.a. $1,436,200 $ 1,294,900 $ 1,186,600 $21,584 $ 15,069 $ 9,978 1.50% 1.16% 0.84% $1,436,200 $ 1,294,900 $ 1,186,600 $19,749 $ 17,952 $ 16,926 1.38% 1.39% 1.43% 15,069 – – – 9,978 – – – 2.04 – – – 1.62 – – – 81,052 72,607 75,720 n.a. n.a. n.a. n.a. $ 700,153 $ 329,655 199,898 637,214 $ 275,895 179,717 $1,229,706 $ 1,092,826 $ 595,790 $14,375 $ 13,076 $ 12,104 2.05% 2.05% 2.03% 1.43 243,276 159,912 0.85 998,978 $19,749 $ 17,952 $ 16,926 1.61% 1.64% 1.69% 4,058 1,316 3,469 1,353 3,616 1,260 1.23 0.66 1.31 0.70 (1) (2) (3) (4) Insurance segment assets and liabilities are included in Other assets and Other liabilities, respectively. Interest income includes loan fees of $672 million (2018 – $621 million; 2017 – $561 million). Deposits include personal chequing and savings deposits with average balances of $189 billion (2018 – $182 billion; 2017 – $178 billion), interest expense of $1.1 billion (2018 – $0.8 billion; 2017 – $0.5 billion) and average rates of 0.6% (2018 – 0.4%; 2017 – 0.3%). Deposits also include term deposits with average balances of $421 billion (2018 – $389 billion; 2017 – $353 billion), interest expense of $9.2 billion (2018 – $7.4 billion; 2017 – $5.2 billion) and average rates of 2.19% (2018 – 1.89%; 2017 – 1.48%). Commencing Q4 2019, the interest component and the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in trading revenue and deposits, respectively, is presented in net interest income and other liabilities respectively. Comparative amounts have been reclassified to conform with this presentation. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 103 Change in net interest income Table 73 (Millions of Canadian dollars) (1) Assets Deposits with other banks Canada (3) U.S. (3) Other international (3) Securities Trading Investment, net of applicable allowance Asset purchased under reverse repurchase agreements and securities borrowed Loans Canada Retail Wholesale U.S. Other international Total interest income Liabilities Deposits Canada U.S. Other international (4) Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Subordinated debentures Other interest-bearing liabilities Total interest expense Net interest income 2019 vs. 2018 Increase (decrease) due to changes in 2018 vs. 2017 Increase (decrease) due to changes in Average volume (2) Average rate (2) Net change Average volume (2) Average rate (2) Net change $ $ $ 13 (33) 3 166 152 20 109 5 622 217 $ 33 76 8 788 369 $ $ (14) 54 (8) (152) 110 66 183 (22) 417 396 52 237 (30) 265 506 1,649 1,775 3,424 890 1,625 2,515 571 544 634 124 1,248 762 (543) 274 $ 3,823 $ 4,489 $ 635 (14) 62 108 1,375 10 1 2,177 1,646 $ $ 2,067 225 171 260 1,511 33 71 $ 4,338 $ 151 $ $ 1,819 1,306 91 398 8,312 2,702 211 233 368 2,886 43 72 6,515 1,797 477 143 117 70 1,384 5 500 (123) $ 1,687 $ 4,431 $ 169 156 66 (186) 608 (9) 1 805 882 $ $ 1,990 517 167 298 1,257 61 (3) $ 4,287 $ 144 $ $ 1,861 148 617 (53) 6,118 2,159 673 233 112 1,865 52 (2) 5,092 1,026 (1) (2) (3) (4) Insurance segment assets and liabilities are included in Other assets and Other liabilities, respectively. Volume/rate variance is allocated on the percentage relationships of changes in balances and changes in rates to the total net change in net interest income. Geographic classification for selected assets and liabilities is based on the domicile of the booking point of the subject assets and liabilities. Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. Loans and acceptances by geography Table 74 As at October 31 (Millions of Canadian dollars) 2019 2018 2017 2016 2015 Canada Residential mortgages Personal Credit cards Small business Retail Wholesale (1) U.S. Retail Wholesale Other International Retail Wholesale Total loans and acceptances Total allowance for credit losses Total loans and acceptances, net of allowance for credit losses $ 287,767 $ 265,831 82,112 18,793 4,866 81,547 19,617 5,434 394,365 142,334 371,602 118,627 $ 536,699 $ 490,229 $ 255,799 82,022 17,491 4,493 $ 241,800 82,205 16,601 3,878 $ 229,987 84,637 15,516 4,003 359,805 99,158 344,484 86,130 334,143 80,284 $ 458,963 $ 430,614 $ 414,427 24,850 53,784 78,634 6,871 17,838 21,033 59,476 80,509 6,817 17,837 24,709 24,654 $ 640,042 $ 595,392 (2,933) $ 636,918 $ 592,459 (3,124) 18,100 55,037 73,137 7,265 21,870 29,135 17,134 59,349 76,483 7,852 21,733 29,585 5,484 34,702 40,186 8,556 24,536 33,092 $ 561,235 $ 536,682 $ 487,705 (2,159) (2,235) (2,029) $ 559,076 $ 534,447 $ 485,676 (1) In 2015, we reclassified $4 billion from Investment securities (Available-for-sale securities under IAS 39) to Loans. 104 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Loans and acceptances by portfolio and sector (1) Table 75 As at October 31 (Millions of Canadian dollars) Residential mortgages Personal Credit cards Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors 2019 $ 308,091 92,250 20,311 5,434 $ 426,086 2018 2017 2016 2015 $ 282,471 92,700 19,415 4,866 $ 270,348 92,294 18,035 4,493 $ 254,998 93,466 17,128 3,878 $ 233,975 94,346 15,859 4,003 $ 399,452 $ 385,170 $ 369,470 $ 348,183 9,369 9,788 2,005 16,741 5,290 8,145 24,961 6,368 1,486 4,252 7,388 4,606 14,657 1,179 1,717 54,032 21,373 4,757 5,426 8,826 1,590 8,325 8,761 1,826 15,453 4,497 6,061 21,350 5,569 1,101 4,103 7,607 4,635 8,987 1,301 1,853 49,889 18,467 7,018 5,347 8,239 5,551 7,397 8,319 1,163 14,428 4,581 5,599 15,448 4,475 913 9,624 5,674 4,086 8,867 1,114 1,586 44,759 16,492 4,867 5,223 6,870 4,580 6,538 7,293 1,536 13,543 5,024 5,346 10,139 7,255 1,100 8,538 5,722 5,235 7,221 1,456 1,626 38,164 17,092 5,765 5,110 8,752 4,757 6,068 6,625 1,911 8,195 3,111 6,763 7,965 8,485 1,171 7,631 4,958 2,017 7,040 1,518 1,635 32,057 12,769 4,590 5,044 6,209 3,760 Wholesale Total loans and acceptances Total allowance for credit losses $ 213,956 $ 640,042 (3,124) $ 195,940 $ 176,065 $ 167,212 $ 139,522 $ 595,392 $ 561,235 $ 536,682 $ 487,705 (2,933) (2,159) (2,235) (2,029) Total loans and acceptances, net of allowance for credit losses $ 636,918 $ 592,459 $ 559,076 $ 534,447 $ 485,676 (1) Sectors have been revised from those previously presented to align with our view of credit risk by industry. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 105 Gross impaired loans by portfolio and geography (1) Table 76 As at October 31 (Millions of Canadian dollars, except for percentage amounts) Residential mortgages Personal Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Wholesale Acquired credit-impaired loans Total GIL (2) (3) Canada Residential mortgages Personal Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Wholesale Total U.S. Retail Wholesale Total Other International Retail Wholesale Total Total GIL (2) (3) Allowance on impaired loans (4) Net impaired loans GIL as a % of loans and acceptances Residential mortgages Personal Small business Retail Wholesale Total Allowance on impaired loans as a % of GIL (4) $ 2019 732 306 57 1,095 $ 37 28 10 171 51 509 81 – 35 5 92 16 7 1 12 408 134 12 13 211 35 1,868 13 $ 2,976 $ 481 250 57 788 36 18 10 71 24 97 – – 9 5 48 4 2 1 10 195 65 11 13 59 – 678 $ 1,466 $ $ 36 869 905 $ 272 333 $ 605 $ 2,976 (832) $ 2,144 0.24% 0.33% 1.05% 0.26% 0.88% 0.46% 27.96% $ 2018 725 302 44 1,071 $ 29 7 18 138 23 230 80 – 9 15 42 2 8 2 3 290 73 8 58 8 48 1,091 21 $ 2,183 $ 431 248 44 723 29 5 18 62 10 38 1 – 9 11 31 1 – 2 3 134 24 7 11 – – 396 $ 1,119 $ $ 23 401 424 $ 2017 634 276 38 948 $ 28 29 26 77 55 318 113 – 7 8 34 70 25 3 4 340 158 12 7 10 48 1,372 256 $ 2,576 $ $ $ $ 323 198 38 559 22 4 26 54 10 16 3 – 7 2 25 2 1 3 4 182 47 10 7 1 – 426 985 59 736 795 $ 2016 709 304 46 1,059 $ 37 43 2 181 36 1,263 114 – 21 2 43 66 70 15 16 225 97 27 31 79 58 2,426 418 $ 3,903 $ 368 228 46 642 27 9 – 105 14 56 – – 21 2 40 4 3 12 16 105 58 24 10 16 – 522 $ 1,164 $ 56 1,736 $ 1,792 $ 2015 646 299 45 990 $ 41 11 2 130 41 154 110 – 28 2 45 6 183 17 24 274 54 28 38 57 50 1,295 – $ 2,285 $ 356 223 45 624 39 8 – 76 15 38 – – 5 1 39 6 2 7 24 137 52 28 15 20 – 512 $ 1,136 $ $ 10 204 214 $ 327 313 $ 640 $ 2,183 (700) $ 1,483 $ 345 451 $ 796 $ 2,576 (737) $ 1,839 $ 380 567 $ 947 $ 3,903 (809) $ 3,094 $ 356 579 $ 935 $ 2,285 (654) $ 1,631 0.26% 0.33% 0.90% 0.27% 0.57% 0.37% 32.08% 0.23% 0.30% 0.85% 0.25% 0.92% 0.46% 28.61% 0.28% 0.33% 1.19% 0.29% 1.69% 0.73% 20.72% 0.28% 0.32% 1.13% 0.28% 0.93% 0.47% 28.64% (1) (2) (3) (4) 106 Sectors have been revised from those previously presented to align with our view of credit risk by industry. Effective November 1, 2017, the definition of gross impaired loans has been shortened for certain products to align with a definition of default of 90 days past due under IFRS 9. Past due loans greater than 90 days not included in impaired loans were $189 million in 2019 (2018 – $179 million; 2017 – $307 million; 2016 – $337 million; 2015 – $314 million). For further details, refer to Note 5 of our 2019 Annual Consolidated Financial Statements. Effective November 1, 2017, GIL excludes $229 million of acquired credit impaired loans related to our acquisition of City National that have returned to performing status. Effective November 1, 2017, represents Stage 3 ACL on loans, acceptances, and commitments under IFRS 9 and Allowances for impaired loans under IAS 39. Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Provision for credit losses by portfolio and geography (1) (Millions of Canadian dollars, except for percentage amounts) Residential mortgages Personal Credit cards Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Wholesale Acquired credit-impaired loans Total PCL on impaired loans (2) Canada Residential mortgages Personal Credit cards Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Wholesale Total (2) U.S. Retail Wholesale Other International Retail Wholesale Total PCL on impaired loans (2) Total PCL on performing loans (3) Total PCL on other financial assets Total PCL PCL on loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances (2) $ 2019 51 487 518 36 1,092 $ 8 10 – 61 33 98 – – 9 6 104 30 – – 57 57 35 7 9 70 5 599 – $ 1,691 $ 32 488 505 36 1,061 8 4 – 24 14 34 – – 5 4 27 28 – – 45 53 29 5 9 2 1 292 $ 1,353 $ $ 12 223 235 $ 19 84 $ 103 $ 1,691 200 (27) $ 1,864 0.31% 0.27% $ 2018 51 462 468 30 1,011 $ 1 5 (1) 81 1 1 – – 3 4 8 (21) 3 – 2 13 22 – 32 1 (8) 147 2 $ 1,160 $ 2017 56 409 435 32 932 $ 4 14 3 12 6 (28) (18) – 3 1 11 4 – (4) 1 120 20 8 1 5 53 216 2 $ 1,150 Table 77 $ 2015 47 388 378 32 845 $ 8 2 (1) 43 8 47 47 – 5 1 (1) 1 19 7 3 28 17 4 5 9 – 252 – $ 1,097 $ 2016 77 458 442 34 1,011 $ 10 13 (3) 20 10 320 1 – 3 – 10 7 1 6 3 34 (1) 1 (6) 16 30 475 10 $ 1,496 $ $ 44 458 456 30 988 $ $ 42 459 435 34 970 33 413 426 32 904 2 1 3 20 3 (17) – – 3 1 8 1 – 1 1 43 15 9 2 – (1) 95 999 3 117 120 $ $ $ $ 25 6 $ 31 $ 1,150 – 10 3 – 27 5 99 – – 4 1 8 2 1 5 3 23 18 1 3 – – 213 $ 1,183 $ $ 1 227 228 $ 41 44 $ 85 $ 1,496 50 27 393 371 32 823 8 2 – 29 6 22 – – 1 1 2 2 – 2 3 12 18 4 3 1 – 116 939 1 40 41 $ $ $ $ 21 96 $ 117 $ 1,097 – $ 1,150 0.21% 0.21% $ 1,546 0.29% 0.28% $ 1,097 0.24% 0.24% 1 1 (1) 28 2 4 – – 3 1 6 1 – – 1 14 17 – 2 – – 80 $ 1,068 $ $ 4 64 68 $ 19 5 $ 24 $ 1,160 123 24 $ 1,307 0.23% 0.20% (1) (2) (3) Sectors have been revised from those previously presented to align with our view of credit risk by industry. Effective November 1, 2017, represents Stage 3 PCL under IFRS 9 and PCL on impaired loans under IAS 39. Effective November 1, 2017, represents Stage 1 and 2 PCL on loans, acceptances, and commitments under IFRS 9 and PCL for loans not yet identified as impaired under IAS 39. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 107 Allowance on loans by portfolio and geography (1) (2) Table 78 (Millions of Canadian dollars, except percentage amounts) Allowance on loans at beginning of year Provision for credit losses (2) Write-offs by portfolio Residential mortgages Personal Credit cards Small business Retail Wholesale Total write-offs by portfolio Recoveries by portfolio Residential mortgages Personal Credit cards Small business Retail Wholesale Total recoveries by portfolio Net write-offs Exchange rate and other Total allowance on loans at end of year Allowance against impaired loans (3) Canada Residential mortgages Personal Small business Retail Agriculture Automotive Banking Consumer discretionary Consumer staples Oil & gas Financial services Financing products Forest products Governments Industrial products Information technology Investments Mining & metals Public works & infrastructure Real estate & related Other services Telecommunication & media Transportation Utilities Other sectors Wholesale U.S. Retail Wholesale Other International Retail Wholesale Total allowance on impaired loans (3) Allowance on performing loans (4) Residential mortgages Personal Credit cards Small business Retail Wholesale Off-balance sheet and other items Total allowance on performing loans (4) Total allowance on loans Key ratios Allowance on loans as a % of loans and acceptances Net write-offs as a % of average net loans and acceptances 2019 $ 3,088 1,891 2018 $ 2,976 1,283 2017 $ 2,326 1,150 2016 $ 2,120 1,546 2015 $ 2,085 1,097 (45) (600) (655) (36) $ (1,336) $ (440) $ (1,776) $ $ $ $ 8 126 137 8 279 43 322 (51) (552) (599) (35) (53) (543) (565) (38) (42) (556) (564) (40) (64) (494) (497) (40) $ (1,237) $ (1,199) $ (1,202) $ (1,095) $ (207) $ (226) $ (321) $ (243) $ (1,444) $ (1,425) $ (1,523) $ (1,338) $ $ $ $ 8 121 131 7 267 65 332 $ $ $ $ 8 116 131 9 264 66 330 $ $ $ $ 5 111 122 10 248 38 286 $ $ $ $ 7 105 119 10 241 34 275 $ (1,454) (106) $ 3,419 $ (1,112) (59) $ (1,095) (131) $ (1,237) (103) $ (1,063) 1 $ 3,088 $ 2,250 $ 2,326 $ 2,120 $ $ $ $ $ $ $ $ $ $ $ 50 115 22 187 6 3 – 11 2 29 – – 7 5 11 3 2 1 1 35 34 11 10 1 – 172 359 1 141 142 156 175 331 832 223 792 832 39 $ $ $ $ $ $ $ $ $ $ $ 43 107 18 168 4 4 1 22 3 4 – – 3 1 8 – – – 1 28 7 3 3 – – 92 260 1 164 165 166 109 275 700 206 754 760 33 $ 1,886 $ 701 $ 1,753 $ 635 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 31 91 19 141 5 4 2 18 2 4 1 – 3 1 9 1 – 3 1 47 17 4 2 – – 124 265 1 150 151 168 153 321 737 128 391 379 37 935 487 91 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 35 105 20 160 6 4 – 20 4 7 – – 5 1 10 1 1 3 2 29 19 4 3 – – 119 279 2 177 179 180 171 351 809 96 385 386 45 912 514 91 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 27 96 19 142 5 4 – 20 3 1 – – 3 – 13 2 – 1 2 35 13 6 2 1 – 111 253 1 47 48 169 184 353 654 83 396 386 45 910 465 91 $ 2,587 $ 3,419 0.53% 0.24% $ 2,388 $ 1,513 $ 1,517 $ 1,466 $ 3,088 $ 2,250 $ 2,326 $ 2,120 0.52% 0.20% 0.40% 0.20% 0.43% 0.23% 0.43% 0.23% (1) (2) (3) (4) Sectors have been revised from those previously presented to align with our view of credit risk by industry. Includes loans, acceptances, and commitments. Effective November 1, 2017, represents Stage 3 ACL on loans, acceptances, and commitments under IFRS 9 and Allowance for impaired loans under IAS 39. Effective November 1, 2017, represents Stage 1 and Stage 2 ACL on loans, acceptances, and commitments under IFRS 9 and Allowance for loans not yet identified as impaired under IAS 39. 108 Royal Bank of Canada: Annual Report 2019 Management’s Discussion and Analysis Credit quality information by Canadian province Table 79 (Millions of Canadian dollars) Loans and acceptances Atlantic provinces (1) Quebec Ontario Alberta Other Prairie provinces (2) B.C. and territories (3) Total loans and acceptances in Canada Gross impaired loans (4) Atlantic provinces (1) Quebec Ontario Alberta Other Prairie provinces (2) B.C. and territories (3) Total GIL in Canada Provision for credit losses on impaired loans (5) Atlantic provinces (1) Quebec Ontario Alberta Other Prairie provinces (2) B.C. and territories (3) 2019 2018 2017 2016 2015 $ 27,008 62,734 257,009 71,165 33,278 85,505 $ 536,699 $ 25,305 58,067 225,606 69,497 32,101 79,653 $ 24,471 56,749 202,272 68,051 31,318 76,102 $ 23,947 53,518 185,434 66,277 30,143 71,295 $ 23,040 51,197 175,315 64,902 29,490 70,483 $ 490,229 $ 458,963 $ 430,614 $ 414,427 $ $ $ 94 250 290 448 215 169 1,466 73 104 844 175 85 72 $ $ $ $ $ $ 89 185 227 335 176 107 1,119 59 94 678 116 68 53 77 176 213 284 125 110 985 66 85 617 112 64 55 999 $ $ $ $ $ $ 101 207 336 313 93 114 1,164 67 92 654 226 64 80 $ 1,183 $ 93 213 341 224 115 150 1,136 57 96 590 77 52 67 939 Total PCL on impaired loans in Canada $ 1,353 $ 1,068 $ (1) (2) (3) (4) (5) Comprises Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick. Comprises Manitoba and Saskatchewan. Comprises British Columbia, Nunavut, Northwest Territories and Yukon. Effective November 1, 2017, the definition of gross impaired loans has been shortened for certain products to align with a definition of default of 90 days past due under IFRS 9. Effective November 1, 2017, represents Stage 3 PCL under IFRS 9 and PCL on impaired loans under IAS 39. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2019 109 EDTF recommendations index We aim to present transparent, high-quality risk disclosures by providing disclosures in our 2019 Annual Report and Supplementary Financial Information package (SFI), and Pillar 3 Report, in accordance with recommendations from the FSB’s Enhanced Disclosure Task Force (EDTF). Information within the SFI and Pillar 3 Report is not and should not be considered incorporated by reference into our 2019 Annual Report. The following index summarizes our disclosure by EDTF recommendation: Type of Risk Recommendation Disclosure Annual Report page SFI page Location of disclosure General Risk governance, risk management and business model Capital adequacy and risk-weighted assets (RWA) Liquidity Funding Market risk Credit risk Other 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Table of contents for EDTF risk disclosure Define risk terminology and measures Top and emerging risks New regulatory ratios Risk management organization Risk culture Risk in the context of our business activities Stress testing Minimum Basel III capital ratios and Domestic systemically important bank surcharge Composition of capital and reconciliation of the accounting balance sheet to the regulatory balance sheet Flow statement of the movements in regulatory capital Capital strategic planning RWA by business segments Analysis of capital requirement, and related measurement model information RWA credit risk and related risk measurements Movement of risk-weighted assets by risk type Basel back-testing Quantitative and qualitative analysis of our liquidity reserve Encumbered and unencumbered assets by balance sheet category, and contractual obligations for rating downgrades Maturity analysis of consolidated total assets, liabilities and off-balance sheet commitments analyzed by remaining contractual maturity at the balance sheet date Sources of funding and funding strategy Relationship between the market risk measures for trading and non-trading portfolios and the balance sheet Decomposition of market risk factors Market risk validation and back-testing Primary risk management techniques beyond reported risk measures and parameters Bank’s credit risk profile Quantitative summary of aggregate credit risk exposures that reconciles to the balance sheet Policies for identifying impaired loans Reconciliation of the opening and closing balances of impaired loans and impairment allowances during the year Quantification of gross notional exposure for OTC derivatives or exchange- traded derivatives Credit risk mitigation, including collateral held for all sources of credit risk Other risk types Publicly known risk events 110 49-54, 213-214 47-48 90-94 49-54 50-54 97 51-52, 66 90-94 – – 90-94 – 55-58 – – 51, 55 72-74, 78-79 74, 77 79-80 74-76 70-71 66-69 66 66-69 1 – – – – – – – – 20-23 24 – 25 * * 25 37 – – – – – – – – 54-65, 156-163 104-109 26-37,* * 56-58, 99-100, 129-132 – – 28,33 59 57-58 82-89 85-86, 201-202 39 36 – – * 110 These disclosure requirements are satisfied or partially satisfied by disclosures provided in our Pillar 3 Report as at October 31, 2019 and October 31, 2018. Royal Bank of Canada: Annual Report 2019 Index for Enhanced Disclosure Task Force recommendations REPORTS AND CONSOLIDATED FINANCIAL STATEMENTS Reports Notes to Consolidated Financial Statements 112 Management’s Responsibility for Financial Reporting 112 Management’s Report on Internal Control over 113 117 Financial Reporting Independent Auditor’s Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements 120 Consolidated Balance Sheets 121 122 123 Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Equity 124 Consolidated Statements of Cash Flows 125 125 139 153 156 163 164 168 177 178 180 181 181 182 182 185 185 190 190 191 191 194 196 198 199 201 203 204 205 206 207 Note 1 General information Note 2 Summary of significant accounting policies, estimates and judgments Note 3 Fair value of financial instruments Note 4 Securities Note 5 Loans and allowance for credit losses Note 6 Derecognition of financial assets Note 7 Structured entities Note 8 Derivative financial instruments and hedging activities Note 9 Premises and equipment Note 10 Goodwill and other intangible assets Note 11 Significant dispositions Note 12 Joint ventures and associated companies Note 13 Other assets Note 14 Deposits Note 15 Insurance Note 16 Segregated funds Note 17 Employee benefits – Pension and other post-employment benefits Note 18 Other liabilities Note 19 Subordinated debentures Note 20 Trust capital securities Note 21 Equity Note 22 Share-based compensation Note 23 Income taxes Note 24 Earnings per share Note 25 Guarantees, commitments, pledged assets and contingencies Note 26 Legal and regulatory matters Note 27 Related party transactions Note 28 Results by business segment Note 29 Nature and extent of risks arising from financial instruments Note 30 Capital management Note 31 Offsetting financial assets and financial liabilities 209 Note 32 Recovery and settlement of on-balance sheet assets and liabilities 210 Note 33 Parent company information Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 111 Management’s Responsibility for Financial Reporting The accompanying consolidated financial statements of Royal Bank of Canada were prepared by management, which is responsible for the integrity and fairness of the information presented, including the many amounts that must of necessity be based on estimates and judgments. These consolidated financial statements were prepared in accordance with the Bank Act (Canada) and International Financial Reporting Standards as issued by the International Accounting Standards Board. Financial information appearing throughout our Management’s Discussion and Analysis is consistent with these consolidated financial statements. Our internal controls are designed to provide reasonable assurance that transactions are authorized, assets are safeguarded and proper records are maintained. These controls include quality standards in hiring and training of employees, policies and procedures manuals, a corporate code of conduct and accountability for performance within appropriate and well- defined areas of responsibility. The system of internal controls is further supported by a compliance function, which is designed to ensure that we and our employees comply with securities legislation and conflict of interest rules, and by an internal audit staff, which conducts periodic audits of all aspects of our operations. The Board of Directors oversees management’s responsibilities for financial reporting through an Audit Committee, which is composed entirely of independent directors. This Committee reviews our consolidated financial statements and recommends them to the Board for approval. Other key responsibilities of the Audit Committee include reviewing our existing internal control procedures and planned revisions to those procedures, and advising the directors on auditing matters and financial reporting issues. Our Chief Compliance Officer and Chief Internal Auditor have full and unrestricted access to the Audit Committee. The Office of the Superintendent of Financial Institutions Canada (OSFI) examines and inquires into our business and affairs as deemed necessary to determine whether the provisions of the Bank Act are being complied with, and that we are in sound financial condition. In carrying out its mandate, OSFI strives to protect the rights and interests of our depositors and creditors. PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm appointed by our shareholders upon the recommendation of the Audit Committee and Board, has performed an independent audit of the consolidated financial statements in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board as stated in their Independent Auditor’s Report and Report of Independent Registered Public Accounting Firm, respectively. The auditors have full and unrestricted access to the Audit Committee to discuss their audit and related findings. David I. McKay President and Chief Executive Officer Rod Bolger Chief Financial Officer Toronto, December 3, 2019 Management’s Report on Internal Control over Financial Reporting Management of Royal Bank of Canada is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the President and Chief Executive Officer and Chief Financial Officer and effected by the Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. It includes those policies and procedures that: (cid:129) Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions related to and dispositions of our assets; (cid:129) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and our receipts and expenditures are made only in accordance with authorizations of our management and directors; and (cid:129) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. Also, projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management evaluated, under the supervision of and with the participation of the President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our internal control over financial reporting as of October 31, 2019, based on the criteria set forth in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that, as of October 31, 2019, internal control over financial reporting was effective based on the criteria established in the Internal Control – Integrated Framework (2013). The effectiveness of our internal control over financial reporting as of October 31, 2019, has been audited by PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm, as stated in their Report of Independent Registered Public Accounting Firm, which appears herein. David I. McKay President and Chief Executive Officer Rod Bolger Chief Financial Officer Toronto, December 3, 2019 112 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Independent Auditor’s Report To the Shareholders and Board of Directors of Royal Bank of Canada Ouropinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Royal Bank of Canada and its subsidiaries (together, the Bank) as at October 31, 2019 and 2018, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS). What we have audited The Bank’s consolidated financial statements comprise: (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) the consolidated balance sheets as at October 31, 2019 and 2018; the consolidated statements of income for the years then ended; the consolidated statements of comprehensive income for the years then ended; the consolidated statements of changes in equity for the years then ended; the consolidated statements of cash flows for the years then ended; and the notes to the consolidated financial statements, which include a summary of significant accounting policies. Certain required disclosures have been presented elsewhere in the Management’s Discussion and Analysis, rather than in the notes to the consolidated financial statements. These disclosures are cross-referenced from the consolidated financial statements and are identified as audited. Basisforopinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Independence We are independent of the Bank in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements. Keyauditmatters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements for the year ended October 31, 2019. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. Key audit matters ValuationoftheAllowanceforCreditLosses(ACL) Refer to Note 2, Summary of significant accounting policies, estimates and judgments, Note 4, Securities and Note 5, Loans and allowance for credit losses The Bank’s ACL for financial assets was $3,440 million as at October 31, 2019, and represents management’s estimate of expected credit losses on financial assets as at the balance sheet date. Performing financial assets are categorized as Stage 1 from initial recognition to the date on which the asset has experienced a significant increase in credit risk relative to its initial recognition. Performing financial assets transfer into Stage 2 following a significant increase in credit risk relative to the initial recognition. Impaired financial assets are categorized as Stage 3 when the asset is considered to be credit-impaired. As disclosed by management, the measurement of expected credit losses is a complex calculation that involves a large number of interrelated inputs and assumptions such as the financial asset’s probability of default, loss given default, and exposure at default discounted at the reporting date. Management’s estimation of expected credit losses in Stage 1 and Stage 2 considers five distinct future macroeconomic scenarios, each of which includes forward-looking information designed to capture a wide range of possible outcomes and are weighted according to management’s expectation of the relative likelihood of the range of outcomes that each scenario represents at the reporting date. Management’s scenarios include a base case, upside and downside scenarios which are set by adjusting the base projections to construct reasonably How our audit addressed the key audit matters Our approach to addressing the matter involved the following procedures, amongst others: (cid:129) testing the effectiveness of controls relating to the valuation of the ACL, including controls over the design of multiple future macroeconomic scenarios, the determination and application of the weightings for these scenarios, and the completeness and accuracy of the data inputs underlying the ACL calculation; (cid:129) testing management’s process for determining the Stage 1 and Stage 2 ACL, including evaluating the appropriateness of the models used to determine the Stage 1 and Stage 2 ACL, testing the completeness, accuracy, and relevance of underlying data used in the model, and evaluating the reasonableness of significant assumptions related to the determination of significant increases in credit risk relative to the initial recognition of the financial asset, the determination of the future macroeconomic scenarios and the weights assigned thereto; (cid:129) testing the appropriateness of the complex expected credit loss calculation and its interrelated inputs and assumptions with the assistance of professionals with specialized skill and knowledge; and (cid:129) evaluating management’s assumptions related to the determination of macroeconomic scenarios which involved evaluating the identification of material portfolios of financial assets that have exhibited a non-linear nature of potential credit losses, and evaluating the reasonableness of potential credit losses under the five future macroeconomic scenarios considering the Bank’s historical loss experience. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 113 How our audit addressed the key audit matters Our approach to addressing the matter involved the following procedures, amongst others: (cid:129) testing the effectiveness of controls relating to management’s goodwill impairment test, including controls over the determination of the recoverable amount of the CGU; (cid:129) testing management’s process for determining the recoverable amount of the CGU, evaluating the appropriateness of the discounted cash flow model, and testing the completeness, accuracy, and relevance of underlying data used in the model; (cid:129) evaluating the significant assumptions used by management, including the discount rates, terminal growth rates, and future cash flows and adjustments made thereto to approximate the considerations of a prospective third- party buyer; (cid:129) evaluating management’s discounted cash flow model and certain significant assumptions, including the discount rates and terminal growth rates with the assistance of professionals with specialized skill and knowledge; and (cid:129) evaluating management’s assumptions related to terminal growth rates and future cash flows which involved evaluating whether the assumptions used by management were reasonable considering (i) the current and past performance of the CGU; (ii) the consistency with external market data and industry data; and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Key audit matters (continued) possible scenarios that are more optimistic and pessimistic, respectively, than the base case. Two additional downside scenarios are designed for the real estate and energy sectors to capture the non-linear nature of potential credit losses across the Bank’s portfolios of financial assets. We determined that the valuation of the ACL is a matter of most significance to the audit of the current year consolidated financial statements due to: (cid:129) significant judgment required by management when designing the future macroeconomic scenarios and assigning weights to each scenario to determine the Stage 1 and Stage 2 ACL. This in turn led to a high degree of auditor subjectivity in performing audit procedures relating to these scenarios; (cid:129) significant auditor judgment and significant audit effort necessary to evaluate audit evidence as the measurement of expected credit losses is a complex calculation that involves a large volume of data, interrelated inputs and assumptions; and (cid:129) the audit effort included the use of professionals with specialized skill and knowledge to assist in evaluating the audit evidence obtained. GoodwillImpairmentAssessmentoftheCaribbeanBanking CashGeneratingUnit(CGU) Refer to Note 2, Summary of significant accounting policies, estimates and judgments, and Note 10, Goodwill and other intangible assets The goodwill allocated to the Caribbean Banking CGU was $1,727 million. Management conducts an impairment test as of August 1 of each year by comparing the carrying value of each CGU to its recoverable amount. For the Caribbean Banking CGU, management calculated the recoverable amount as the fair value less costs of disposal using a discounted cash flow model that projects future cash flows based on management forecasts, adjusted to approximate the considerations of a prospective third-party buyer, over a 5-year period. Cash flows beyond the initial 5-year period are assumed by management to increase at a constant rate using a nominal long-term growth rate. As disclosed by management, the Caribbean continued to experience challenges in various regions resulting in weak to moderate economic growth during the year. As at August 1, 2019, the recoverable amount of the Caribbean Banking CGU, based on management’s estimated fair value less costs of disposal, was 126% of its carrying amount. As management has disclosed, the determination of fair value using a discounted cash flow model requires the use of significant judgment to determine the inputs and the model is most sensitive to changes in future cash flows, discount rates, and terminal growth rates applied to cash flows beyond the forecast period. If the post-tax discount rate was increased by 1.8%, holding other individual factors constant, the recoverable amount would approximate the carrying amount. We determined that the goodwill impairment assessment of the Caribbean Banking CGU is a matter of most significance to the audit of the current year consolidated financial statements due to: (cid:129) significant judgment required by management when determining the fair value of the CGU including future cash flows and adjustments made thereto to approximate the considerations of a prospective third-party buyer, discount rates and terminal growth rates. This in turn led to a high degree of auditor judgment and subjectivity in performing procedures over management’s calculation of the recoverable amount of the CGU, and evaluating audit evidence; and (cid:129) the audit effort included the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained. 114 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements How our audit addressed the key audit matters Our approach to addressing the matter involved the following procedures, amongst others: (cid:129) testing the effectiveness of controls relating to the evaluation of uncertain tax positions; (cid:129) testing management’s process used in estimating the amount of future cash flows relating to uncertain tax positions; (cid:129) evaluating the appropriateness of the methods used; (cid:129) testing the completeness, accuracy, and relevance of underlying data used; (cid:129) evaluating the reasonableness of significant assumptions used by management for estimating the results of tax positions that are under audit or appeal by relevant taxation authorities; and (cid:129) professionals with specialized skill and knowledge were used to assist in assessing the significant assumptions, including the application of relevant tax laws and whether it is probable that the relevant tax authorities will accept the tax positions and evidence used by management in determining and projecting the amount of future cash flows. Key audit matters (continued) UncertainTaxPositions Refer to Note 2, Summary of significant accounting policies, estimates and judgments, and Note 23, Income taxes The Bank is subject to income tax laws in various jurisdictions where it operates and the complex tax laws are potentially subject to different interpretations by management and relevant taxation authorities. In some cases, the Bank has received reassessments denying the tax deductibility of dividends from transactions including those with Tax Indifferent Investors. As disclosed by management, significant judgment is required in the interpretation of the relevant tax laws, and the determination of the Bank’s tax provision, which includes management’s best estimate of tax positions that are under audit or appeal by relevant taxation authorities. The forward-looking nature of these estimates requires management to use a significant amount of judgment in projecting the timing and amount of future cash flows. As management has further disclosed, management records provisions related to uncertain tax positions on the basis of all available information at the end of the reporting period to reflect current expectations. We determined that uncertain tax positions are a matter of most significance to the audit of the current year consolidated financial statements due to: (cid:129) significant judgment required by management, including a high degree of estimation uncertainty, when interpreting the relevant tax laws and projecting the amount of future cash flows relating to uncertain tax positions. This in turn led to a high degree of auditor judgment and subjectivity in performing procedures to evaluate the uncertain tax positions; and (cid:129) the audit effort included the use of professionals with specialized skill and knowledge to assist in evaluating the audit evidence obtained. Otherinformation Management is responsible for the other information. The other information comprises the Management’s Discussion and Analysis and the information, other than the consolidated financial statements and our auditor’s report thereon, included in the annual report. Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Responsibilitiesofmanagementandthosechargedwithgovernancefortheconsolidatedfinancialstatements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, management is responsible for assessing the Bank’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Bank or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Bank’s financial reporting process. Auditor’sresponsibilitiesfortheauditoftheconsolidatedfinancialstatements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 115 As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: (cid:129) Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Bank’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Bank to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Bank to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. PricewaterhouseCoopers LLP Chartered Professional Accountants, Licensed Public Accountants Toronto, Canada December 3, 2019 116 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors of Royal Bank of Canada OpinionsontheFinancialStatementsandInternalControloverFinancialReporting We have audited the accompanying consolidated balance sheets of Royal Bank of Canada and its subsidiaries (together, the Bank) as of October 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for the years then ended, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Bank’s internal control over financial reporting as of October 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Bank as of October 31, 2019 and 2018, and its financial performance and its cash flows for the years then ended in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS). Also in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of October 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the COSO. BasisforOpinions The Bank’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Bank’s consolidated financial statements and on the Bank’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Bank in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. DefinitionandLimitationsofInternalControloverFinancialReporting An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. An entity’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. CriticalAuditMatters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Valuation of the Allowance for Credit Losses (ACL) As described in Notes 2, 4 and 5 to the consolidated financial statements, the Bank’s ACL for financial assets was $3,440 million as at October 31, 2019, and represents management’s estimate of expected credit losses on financial assets as at the balance sheet date. Performing financial assets are categorized as Stage 1 from initial recognition to the date on which the asset has experienced a significant increase in credit risk relative to its initial recognition. Performing financial assets transfer into Stage 2 following a significant increase in credit risk relative to the initial recognition. Impaired financial assets are categorized as Stage 3 when the asset is considered to be credit-impaired. As disclosed by management, the measurement of expected credit losses is a complex calculation that involves a large number of interrelated inputs and assumptions such as the financial asset’s probability of default, loss given default, and exposure at default discounted at the reporting date. Management’s estimation of expected credit losses in Stage 1 and Stage 2 considers five distinct future macroeconomic scenarios, each of which includes forward-looking information designed to capture a wide range of possible outcomes and are weighted according to Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 117 management’s expectation of the relative likelihood of the range of outcomes that each scenario represents at the reporting date. Management’s scenarios include a base case, upside and downside scenarios which are set by adjusting the base projections to construct reasonably possible scenarios that are more optimistic and pessimistic, respectively, than the base case. Two additional downside scenarios were designed for the real estate and energy sectors to capture the non-linear nature of potential credit losses across the Bank’s portfolios of financial assets. The principal consideration for our determination that performing procedures relating to the valuation of the ACL is a critical audit matter is that there was significant judgment required by management when designing the future macroeconomic scenarios and assigning weights to each scenario to determine the Stage 1 and Stage 2 ACL. This in turn led to a high degree of auditor subjectivity in performing audit procedures relating to these scenarios. In addition, significant auditor judgment and significant audit effort was necessary to evaluate audit evidence as the measurement of expected credit losses is a complex calculation that involves a large volume of data, interrelated inputs and assumptions. The audit effort also included the use of professionals with specialized skill and knowledge to assist in evaluating the audit evidence obtained. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of the ACL, including controls over the design of multiple future macroeconomic scenarios, the determination and application of the weightings for these scenarios, and the completeness and accuracy of the data inputs underlying the ACL calculation. These procedures also included, among others, testing management’s process for determining the Stage 1 and Stage 2 ACL, including evaluating the appropriateness of the models used to determine the Stage 1 and Stage 2 ACL, testing the completeness, accuracy, and relevance of underlying data used in the model, and evaluating the reasonableness of significant assumptions related to the determination of significant increases in credit risk relative to the initial recognition of the financial asset, the determination of the future macroeconomic scenarios and the weights assigned thereto. Professionals with specialized skill and knowledge were used to assist in testing the appropriateness of the complex expected credit loss calculation and its interrelated inputs and assumptions. Evaluating management’s assumptions related to the determination of macroeconomic scenarios involved evaluating the identification of material portfolios of financial assets that have exhibited a non-linear nature of potential credit losses, and evaluating the reasonableness of potential credit losses under the five future macroeconomic scenarios considering the Bank’s historical loss experience. Goodwill Impairment Assessment of the Caribbean Banking Cash Generating Unit (CGU) As described in Notes 2 and 10 to the consolidated financial statements, the goodwill allocated to the Caribbean Banking CGU was $1,727 million. Management conducts an impairment test as of August 1 of each year by comparing the carrying value of each CGU to its recoverable amount. For the Caribbean Banking CGU, management calculated the recoverable amount as the fair value less costs of disposal using a discounted cash flow model that projects future cash flows based on management forecasts, adjusted to approximate the considerations of a prospective third-party buyer, over a 5-year period. Cash flows beyond the initial 5-year period are assumed by management to increase at a constant rate using a nominal long-term growth rate. As disclosed by management, the Caribbean continued to experience challenges in various regions resulting in weak to moderate economic growth during the year. As at August 1, 2019, the recoverable amount of the Caribbean Banking CGU, based on management’s estimated fair value less costs of disposal, was 126% of its carrying amount. As management has disclosed, the determination of fair value using a discounted cash flow model requires the use of significant judgment to determine the inputs and the model is most sensitive to changes in future cash flows, discount rates, and terminal growth rates applied to cash flows beyond the forecast period. If the post-tax discount rate was increased by 1.8%, holding other individual factors constant, the recoverable amount would approximate the carrying amount. The principal consideration for our determination that performing procedures relating to the goodwill impairment assessment of the Caribbean Banking CGU is a critical audit matter is that there was significant judgment required by management when determining the fair value of the CGU including future cash flows and adjustments made thereto to approximate the considerations of a prospective third-party buyer, discount rates and terminal growth rates. This in turn led to a high degree of auditor judgment and subjectivity in performing procedures over management’s calculation of the recoverable amount of the CGU, and evaluating audit evidence. In addition, the audit effort included the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment test, including controls over the determination of the recoverable amount of the CGU. These procedures also included, among others, testing management’s process for determining the recoverable amount of the CGU, evaluating the appropriateness of the discounted cash flow model, and testing the completeness, accuracy, and relevance of underlying data used in the model. These procedures also included evaluating the significant assumptions used by management, including the discount rates, terminal growth rates, and future cash flows and adjustments made thereto to approximate the considerations of a prospective third-party buyer. Professionals with specialized skill and knowledge were used to assist in evaluating management’s discounted cash flow model and certain significant assumptions, including the discount rates and terminal growth rates. Evaluating management’s assumptions related to terminal growth rates and future cash flows involved evaluating whether the assumptions used by management were reasonable considering (i) the current and past performance of the CGU, (ii) the consistency with external market data and industry data; and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Uncertain Tax Positions As described in Note 2 to the consolidated financial statements, the Bank is subject to income tax laws in various jurisdictions where it operates and the complex tax laws are potentially subject to different interpretations by management and relevant taxation authorities. In some cases, as described in Note 23, the Bank has received reassessments denying the tax deductibility of dividends from transactions including those with Tax Indifferent Investors. As disclosed by management, significant judgment is required in the interpretation of the relevant tax laws, and the determination of the Bank’s tax provision, which includes management’s best estimate of tax positions that are under audit or appeal by relevant taxation authorities. The forward-looking nature of these estimates requires management to use a significant amount of judgment in projecting the timing and amount of future cash flows. As management has further disclosed, management records provisions related to uncertain tax positions on the basis of all available information at the end of the reporting period to reflect current expectations. 118 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements The principal consideration for our determination that performing procedures relating to the uncertain tax positions is a critical audit matter is that there was significant judgment required by management, including a high degree of estimation uncertainty, when interpreting the relevant tax laws and projecting the amount of future cash flows relating to uncertain tax positions. This in turn led to a high degree of auditor judgment and subjectivity in performing procedures to evaluate the uncertain tax positions. In addition, the audit effort included the use of professionals with specialized skill and knowledge to assist in evaluating the audit evidence obtained. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the evaluation of uncertain tax positions. These procedures also included, among others, testing management’s process used in estimating the amount of future cash flows relating to uncertain tax positions. This involved evaluating the appropriateness of the methods used, testing the completeness, accuracy, and relevance of underlying data used, and evaluating the reasonableness of significant assumptions used by management for estimating the results of tax positions that are under audit or appeal by relevant taxation authorities. Professionals with specialized skill and knowledge were used to assist in assessing the significant assumptions, including the application of relevant tax laws and whether it is probable that the relevant tax authorities will accept the tax positions, and evidence used by management in determining and projecting the amount of future cash flows. PricewaterhouseCoopers LLP Chartered Professional Accountants, Licensed Public Accountants Toronto, Canada December 3, 2019 We have served as the Bank’s auditor since 2016. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 119 Consolidated Balance Sheets (Millions of Canadian dollars) Assets Cash and due from banks Interest-bearing deposits with banks Securities (Note 4) Trading Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans (Note 5) Retail Wholesale Allowance for loan losses (Note 5) Segregated fund net assets (Note 16) Other Customers’ liability under acceptances Derivatives (Note 8) Premises and equipment (Note 9) Goodwill (Note 10) Other intangibles (Note 10) Other assets (Note 13) Total assets Liabilities and equity Deposits (Note 14) Personal Business and government Bank Segregated fund net liabilities (Note 16) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives (Note 8) Insurance claims and policy benefit liabilities (Note 15) Other liabilities (Note 18) Subordinated debentures (Note 19) Total liabilities Equity attributable to shareholders (Note 21) Preferred shares Common shares Retained earnings Other components of equity Non-controlling interests Total equity Total liabilities and equity As at October 31 2019 October 31 2018 $ 26,310 $ 30,209 38,345 36,471 146,534 102,470 249,004 306,961 426,086 195,870 621,956 (3,100) 618,856 1,663 18,062 101,560 3,191 11,236 4,674 49,073 187,796 $ 1,428,935 $ 294,732 565,482 25,791 886,005 1,663 18,091 35,069 226,586 98,543 11,401 58,137 447,827 128,258 94,608 222,866 294,602 399,452 180,278 579,730 (2,912) 576,818 1,368 15,641 94,039 2,832 11,137 4,687 44,064 172,400 $ 1,334,734 $ 270,154 533,522 32,521 836,197 1,368 15,662 32,247 206,814 90,238 10,000 53,122 408,083 9,815 1,345,310 9,131 1,254,779 5,707 17,587 55,981 4,248 83,523 102 83,625 6,309 17,617 51,112 4,823 79,861 94 79,955 $ 1,428,935 $ 1,334,734 The accompanying notes are an integral part of these Consolidated Financial Statements. David I. McKay President and Chief Executive Officer David F. Denison Director 120 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Consolidated Statements of Income (Millions of Canadian dollars, except per share amounts) Interest and dividend income (Note 3) Loans Securities Assets purchased under reverse repurchase agreements and securities borrowed Deposits and other Interest expense (Note 3) Deposits and other Other liabilities Subordinated debentures Net interest income Non-interest income Insurance premiums, investment and fee income (Note 15) Trading revenue Investment management and custodial fees Mutual fund revenue Securities brokerage commissions Service charges Underwriting and other advisory fees Foreign exchange revenue, other than trading Card service revenue Credit fees Net gains on investment securities Share of profit in joint ventures and associates (Note 12) Other Total revenue Provision for credit losses (Notes 4 and 5) Insurance policyholder benefits, claims and acquisition expense (Note 15) Non-interest expense Human resources (Notes 17 and 22) Equipment Occupancy Communications Professional fees Amortization of other intangibles (Note 10) Other Income before income taxes Income taxes (Note 23) Net income Net income attributable to: Shareholders Non-controlling interests Basic earnings per share (in dollars) (Note 24) Diluted earnings per share (in dollars) (Note 24) Dividends per common share (in dollars) The accompanying notes are an integral part of these Consolidated Financial Statements. For the year ended October 31 2019 October 31 2018 $ $ 24,863 6,827 8,960 683 41,333 12,988 8,231 365 21,584 19,749 5,710 995 5,748 3,628 1,305 1,907 1,815 986 1,072 1,269 125 76 1,617 26,253 46,002 1,864 4,085 14,600 1,777 1,635 1,090 1,305 1,197 2,535 24,139 15,914 3,043 $ 12,871 $ 12,860 11 $ 12,871 $ 8.78 8.75 4.07 $ $ $ $ 21,249 5,670 5,536 566 33,021 9,842 4,905 322 15,069 17,952 4,279 1,150 5,377 3,551 1,372 1,800 2,053 1,098 1,054 1,394 147 21 1,328 24,624 42,576 1,307 2,676 13,776 1,593 1,558 1,049 1,379 1,077 2,401 22,833 15,760 3,329 12,431 12,400 31 12,431 8.39 8.36 3.77 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 121 Consolidated Statements of Comprehensive Income (Millions of Canadian dollars) Net income Other comprehensive income (loss), net of taxes (Note 23) Items that will be reclassified subsequently to income: Net change in unrealized gains (losses) on debt securities and loans at fair value through other comprehensive income Net unrealized gains (losses) on debt securities and loans at fair value through other comprehensive income Provision for credit losses recognized in income Reclassification of net losses (gains) on debt securities and loans at fair value through other comprehensive income to income Foreign currency translation adjustments Unrealized foreign currency translation gains (losses) Net foreign currency translation gains (losses) from hedging activities Reclassification of losses (gains) on foreign currency translation to income Reclassification of losses (gains) on net investment hedging activities to income Net change in cash flow hedges Net gains (losses) on derivatives designated as cash flow hedges Reclassification of losses (gains) on derivatives designated as cash flow hedges to income Items that will not be reclassified subsequently to income: Remeasurements of employee benefit plans (Note 17) Net fair value change due to credit risk on financial liabilities designated as fair value through profit or loss Net gains (losses) on equity securities designated at fair value through other comprehensive income Total other comprehensive income (loss), net of taxes Total comprehensive income (loss) Total comprehensive income attributable to: Shareholders Non-controlling interests The accompanying notes are an integral part of these Consolidated Financial Statements. For the year ended October 31 2019 $ 12,871 October 31 2018 $ 12,431 192 (14) (133) 45 65 5 2 1 73 (559) (135) (694) (942) 51 25 (866) (1,442) $ 11,429 $ 11,419 10 $ 11,429 $ $ $ (70) (9) (94) (173) 840 (237) – – 603 150 107 257 724 123 (2) 845 1,532 13,963 13,931 32 13,963 122 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements y t i u q e f o s t n e n o p m o c r e h t O 9 1 0 2 , 1 3 r e b o t c O d e d n e r a e y e h t r o F l a t o T y t i u q e g n i l l o r t n o c - n o N o t e l b a t u b i r t t a s t n e n o p m o c w o l f h s a C y c n e r r u c s e i t i r u c e s d e n i a t e R s t s e r e t n i s r e d l o h e r a h s y t i u q e f o s e g d e h n o i t a l s n a r t s n a o l d n a s g n i n r a e y t i u q E r e h t o l a t o T n g i e r o F I C O V F y r u s a e r T – s e r a h s n o m m o c d e r r e f e r p s e r a h s s e r a h s y r u s a e r T – s e r a h s n o m m o C d e r r e f e r P ) 4 9 ( – 5 5 9 9 7 , $ 4 9 $ 1 6 8 9 7 , $ 3 2 8 4 , $ 8 8 6 $ 7 4 1 4 , $ ) 2 1 ( $ 2 1 1 1 5 , $ ) 8 1 ( ) 4 9 ( – – – – ) 4 9 ( – 1 6 8 9 7 , $ 4 9 $ 7 6 7 9 7 , $ 3 2 8 4 , $ 8 8 6 $ 7 4 1 4 , $ ) 2 1 ( $ 8 1 0 1 5 , $ ) 8 1 ( 6 8 4 ) 0 3 0 1 ( , ) 0 5 9 ( 2 2 5 5 , ) 4 6 5 5 ( , ) 3 2 ( ) 1 7 2 ( ) 0 4 8 5 ( , 5 ) 2 4 4 1 ( , 1 7 8 2 1 , – – – – – – – ) 2 ( – 1 1 ) 1 ( 6 8 4 ) 0 3 0 1 ( , ) 0 5 9 ( 2 2 5 5 , ) 4 6 5 5 ( , ) 3 2 ( ) 9 6 2 ( ) 0 4 8 5 ( , 5 ) 1 4 4 1 ( , 0 6 8 2 1 , – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – ) 5 7 5 ( ) 4 9 6 ( 4 7 5 2 6 3 8 , $ 2 0 1 $ 3 2 5 3 8 , $ 8 4 2 4 , $ ) 6 ( $ 1 2 2 4 , $ – – – – – – – – – – 5 4 3 3 – – – – ) 4 0 9 ( 5 ) 3 2 ( ) 9 6 2 ( ) 0 4 8 5 ( , ) 6 6 8 ( 0 6 8 2 1 , – – – – – – – – – 0 4 3 5 , ) 0 8 3 5 ( , 2 8 1 ) 4 8 1 ( – – $ 5 3 6 7 1 , $ 6 0 3 6 , $ $ 5 3 6 7 1 , $ 6 0 3 6 , $ – – – – – – – – – 6 3 1 ) 6 2 1 ( – 0 5 3 ) 0 5 9 ( – – – – – – – – y t i u q e f o s t n e n o p m o c r e h t O 8 1 0 2 , 1 3 r e b o t c O d e d n e r a e y e h t r o F l a t o T y t i u q e g n i l l o r t n o c - n o N o t e l b a t u b i r t t a s t n e n o p m o c w o l f h s a C y c n e r r u c s e i t i r u c e s s t s e r e t n i l s r e d o h e r a h s y t i u q e f o s e g d e h n o i t a l s n a r t s n a o l d n a y t i u q E r e h t o l a t o T n g i e r o F I C O V F i d e n a t e R i s g n n r a e y r u s a e r T – s e r a h s n o m m o c d e r r e f e r p s e r a h s s e r a h s y r u s a e r T – s e r a h s n o m m o C d e r r e f e r P 1 9 7 3 7 , $ 9 9 5 $ 2 9 1 3 7 , $ 5 7 2 4 , $ 1 3 4 $ 5 4 5 3 , $ 9 9 2 $ 1 0 8 4 4 , $ ) 7 2 ( $ – $ 0 3 7 7 1 , $ 3 1 4 6 , $ 2 9 ) 2 2 5 1 ( , ) 5 0 1 ( ) 0 0 5 ( 8 3 7 5 , ) 6 2 7 5 ( , ) 0 1 ( ) 2 2 3 ( ) 2 4 4 5 ( , ) 2 ( 2 3 5 1 , 1 3 4 2 1 , – – – – – – – ) 7 3 ( – 1 3 1 ) 0 0 5 ( – 2 9 ) 5 0 1 ( ) 2 2 5 1 ( , ) 0 1 ( 8 3 7 5 , ) 6 2 7 5 ( , ) 5 8 2 ( ) 2 4 4 5 ( , ) 2 ( 1 3 5 1 , 0 0 4 2 1 , – – – – – – – – – ) 8 3 1 ( – 6 8 6 – – – – – – – – – – – – – – – – – – – – – – 7 5 2 2 0 6 – – – – – – – – – ) 8 3 1 ( – ) 3 7 1 ( 2 – – – – ) 5 3 3 1 ( , ) 0 1 ( ) 2 4 4 5 ( , ) 5 8 2 ( 6 3 1 5 4 8 0 0 4 2 1 , – – – – – – – – – – – – – – 9 7 4 5 , ) 0 7 4 5 ( , 9 5 2 ) 6 5 2 ( – – – – – – – – – – 2 9 ) 7 8 1 ( – – ) 7 0 1 ( – – – – – – – – – $ $ 3 – 3 – – – – – – – – – 1 – – – – – – 3 y t i u q E n i s e g n a h C f o s t n e m e t a t S d e t a d i l o s n o C n o i t a l l e c n a c r o f d e s a h c r u p s e r a h s n o m m o C r e h t o d n a s e r a h s d e r r e f e r p n o s d n e d i v i D s d r a w a n o i t a s n e p m o c d e s a b - e r a h S s e r a h s n o m m o c n o s d n e d i v i D s e r a h s d e r r e f e r p f o n o i t p m e d e R s e r a h s y r u s a e r t f o s e s a h c r u P s e r a h s y r u s a e r t f o s e l a S d o i r e p f o g n i n n i g e b t a e c n a l a b d e t s u j d A l a t i p a c e r a h s f o s e u s s I y t i u q e n i s e g n a h C e m o c n i t e N r e h t O d o i r e p f o g n i n n i g e b t a e c n a l a B ) 2 e t o N ( j t n e m t s u d a n o i t i s n a r T ) s r a l l i o d n a d a n a C f o s n o i l l i M ( s e x a t f o t e n , ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o l a t o T n o i t a l l e c n a c r o f d e s a h c r u p s e r a h s n o m m o C s e i t i r u c e s l a t i p a c t s u r t f o n o i t p m e d e R s e r a h s d e r r e f e r p f o n o i t p m e d e R r e h t o d n a s e r a h s d e r r e f e r p n o s d n e d i v i D s d r a w a n o i t a s n e p m o c d e s a b - e r a h S s e r a h s n o m m o c n o s d n e d i v i D s e r a h s y r u s a e r t f o s e s a h c r u P s e r a h s y r u s a e r t f o s e l a S e m o c n i t e N r e h t O d o i r e p f o g n i n n i g e b t a e c n a l a B l a t i p a c e r a h s f o s e u s s I y t i u q e n i s e g n a h C ) s r a l l i o d n a d a n a C f o s n o i l l i M ( s e x a t f o t e n , ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o l a t o T Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 123 5 5 9 9 7 , $ 4 9 $ 1 6 8 9 7 , $ 3 2 8 4 , $ 8 8 6 $ 7 4 1 4 , $ ) 2 1 ( $ 2 1 1 1 5 , $ ) 8 1 ( $ $ 5 3 6 7 1 , $ 6 0 3 6 , $ d o i r e p f o d n e t a e c n a l a B . s t n e m e t a t S l a i c n a n i F d e t a d i l o s n o C e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e h T $ 1 8 9 5 5 , $ ) 8 5 ( $ $ 5 4 6 7 1 , $ 6 0 7 5 , $ d o i r e p f o d n e t a e c n a l a B Consolidated Statements of Cash Flows (Millions of Canadian dollars) Cash flows from operating activities Net income Adjustments for non-cash items and others Provision for credit losses Depreciation Deferred income taxes Amortization and impairment of other intangibles Net changes in investments in joint ventures and associates Losses (Gains) on investment securities Losses (Gains) on disposition of businesses Adjustments for net changes in operating assets and liabilities Insurance claims and policy benefit liabilities Net change in accrued interest receivable and payable Current income taxes Derivative assets Derivative liabilities Trading securities Loans, net of securitizations Assets purchased under reverse repurchase agreements and securities borrowed Obligations related to assets sold under repurchase agreements and securities loaned Obligations related to securities sold short Deposits, net of securitizations Brokers and dealers receivable and payable Other Net cash from (used in) operating activities Cash flows from investing activities Change in interest-bearing deposits with banks Proceeds from sales and maturities of investment securities Purchases of investment securities Net acquisitions of premises and equipment and other intangibles Proceeds from dispositions Cash used in acquisitions Net cash from (used in) investing activities Cash flows from financing activities Redemption of trust capital securities Issuance of subordinated debentures Repayment of subordinated debentures Issue of common shares, net of issuance costs Common shares purchased for cancellation Issue of preferred shares, net of issuance costs Redemption of preferred shares Sales of treasury shares Purchases of treasury shares Dividends paid Dividends/distributions paid to non-controlling interests Change in short-term borrowings of subsidiaries Net cash from (used in) financing activities Effect of exchange rate changes on cash and due from banks Net change in cash and due from banks Cash and due from banks at beginning of period (1) Cash and due from banks at end of period (1) Cash flows from operating activities include: Amount of interest paid Amount of interest received Amount of dividends received Amount of income taxes paid For the year ended October 31 2019 October 31 2018 $ 12,871 $ 12,431 1,864 627 (519) 1,307 (74) (213) (158) 1,401 199 (26) (7,521) 8,305 (18,276) (42,672) (12,359) 19,772 2,822 49,808 (480) (2,413) 14,265 (1,874) 65,377 (72,435) (2,261) 173 (106) (11,126) – 1,500 (1,100) 105 (1,030) 350 (950) 5,522 (5,564) (6,025) (2) (263) (7,457) 419 (3,899) 30,209 26,310 19,984 39,500 2,209 2,977 1,307 569 459 1,083 (1) (149) (40) 218 162 (2,707) 984 (1,889) 2,297 (41,477) (73,626) 63,730 2,239 48,499 147 3,238 17,474 (3,809) 57,108 (59,286) (1,980) 14 (65) (8,018) (500) – – 72 (1,522) – (105) 5,738 (5,726) (5,640) (37) – (7,720) 66 1,802 28,407 30,209 13,513 31,386 1,706 5,818 $ $ $ $ (1) We are required to maintain balances with central banks and other regulatory authorities. The total balances were $2.6 billion as at October 31, 2019 (October 31, 2018 – $2.4 billion; October 31, 2017 – $2.3 billion). The accompanying notes are an integral part of these Consolidated Financial Statements. 124 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 1 General information Royal Bank of Canada and its subsidiaries (the Bank) provide diversified financial services including Personal and Commercial Banking, Wealth Management, Insurance, Investor and Treasury Services and Capital Markets products and services on a global basis. Refer to Note 28 for further details on our business segments. The parent bank, Royal Bank of Canada, is a Schedule I Bank under the Bank Act (Canada) incorporated and domiciled in Canada. Our corporate headquarters are located at Royal Bank Plaza, 200 Bay Street, Toronto, Ontario, Canada and our head office is located at 1 Place Ville-Marie, Montreal, Quebec, Canada. Our common shares are listed on the Toronto Stock Exchange and New York Stock Exchange with the ticker symbol RY. These Consolidated Financial Statements are prepared in compliance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). Unless otherwise stated, monetary amounts are stated in Canadian dollars. Tabular information is stated in millions of dollars, except as noted. These Consolidated Financial Statements also comply with Subsection 308 of the Bank Act (Canada), which states that, except as otherwise specified by the Office of the Superintendent of Financial Institutions Canada (OSFI), our Consolidated Financial Statements are to be prepared in accordance with IFRS. Except where otherwise noted, the accounting policies outlined in Note 2 have been consistently applied to all periods presented. On December 3, 2019, the Board of Directors authorized the Consolidated Financial Statements for issue. Note 2 Summary of significant accounting policies, estimates and judgments The significant accounting policies used in the preparation of these Consolidated Financial Statements, including the accounting requirements prescribed by OSFI, are summarized below. These accounting policies conform, in all material respects, to IFRS. Except where otherwise noted, the same accounting policies have been applied to all periods presented. General Use of estimates and assumptions In preparing our Consolidated Financial Statements, management is required to make subjective estimates and assumptions that affect the reported amount of assets, liabilities, net income and related disclosures. Estimates made by management are based on historical experience and other assumptions that are believed to be reasonable. Key sources of estimation uncertainty include: determination of fair value of financial instruments, the allowance for credit losses, insurance claims and policy benefit liabilities, pensions and other post-employment benefits, income taxes, carrying value of goodwill and other intangible assets, litigation provisions, and deferred revenue under the credit card customer loyalty reward program. Accordingly, actual results may differ from these and other estimates thereby impacting our future Consolidated Financial Statements. Refer to the relevant accounting policies in this Note for details on our use of estimates and assumptions. Significant judgments In preparation of these Consolidated Financial Statements, management is required to make significant judgments that affect the carrying amounts of certain assets and liabilities, and the reported amounts of revenues and expenses recorded during the period. Significant judgments have been made in the following areas and discussed as noted in the Consolidated Financial Statements: Consolidation of structured entities Fair value of financial instruments Allowance for credit losses Employee benefits Goodwill and other intangibles Note 2 Note 7 Note 2 Note 3 Note 2 Note 4 Note 5 Note 2 Note 17 Note 2 Note 10 Application of the effective interest method Note 2 Derecognition of financial assets Income taxes Provisions Note 2 Note 6 Note 2 Note 23 Note 2 Note 25 Note 26 Basis of consolidation Our Consolidated Financial Statements include the assets and liabilities and results of operations of the parent company, Royal Bank of Canada, and its subsidiaries including certain structured entities, after elimination of intercompany transactions, balances, revenues and expenses. Consolidation Subsidiaries are those entities, including structured entities, over which we have control. We control an entity when we are exposed, or have rights, to variable returns from our involvement with the entity and have the ability to affect those returns through our power over the investee. We have power over an entity when we have existing rights that give us the current ability to direct the activities that most significantly affect the entity’s returns (relevant activities). Power may be determined on the basis of voting rights or, in the case of structured entities, other contractual arrangements. We are not deemed to control an entity when we exercise power over an entity in an agency capacity. In determining whether we are acting as an agent, we consider the overall relationship between us, the investee and other parties to the arrangement with respect to the following factors: (i) the scope of our decision-making power; (ii) the rights held by other parties; (iii) the remuneration to which we are entitled; and (iv) our exposure to variability of returns. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 125 Note 2 Summary of significant accounting policies, estimates and judgments (continued) The determination of control is based on the current facts and circumstances and is continuously assessed. In some circumstances, different factors and conditions may indicate that different parties control an entity depending on whether those factors and conditions are assessed in isolation or in totality. Significant judgment is applied in assessing the relevant factors and conditions in totality when determining whether we control an entity. Specifically, judgment is applied in assessing whether we have substantive decision-making rights over the relevant activities and whether we are exercising our power as a principal or an agent. We consolidate all subsidiaries from the date we obtain control and cease consolidation when an entity is no longer controlled by us. Our consolidation conclusions affect the classification and amount of assets, liabilities, revenues and expenses reported in our Consolidated Financial Statements. Non-controlling interests in subsidiaries that we consolidate are shown on our Consolidated Balance Sheets as a separate component of equity which is distinct from equity attributable to our shareholders. The net income attributable to non-controlling interests is separately disclosed in our Consolidated Statements of Income. Investments in joint ventures and associates Our investments in associated corporations and limited partnerships over which we have significant influence are accounted for using the equity method. The equity method is also applied to our interests in joint ventures over which we have joint control. Under the equity method of accounting, investments are initially recorded at cost, and the carrying amount is increased or decreased to recognize our share of the investee’s net profit or loss, including our proportionate share of the investee’s Other comprehensive income (OCI), subsequent to the date of acquisition. Non-current assets held for sale and discontinued operations Non-current assets (and disposal groups) are classified as held for sale if their carrying amounts will be recovered principally through a sale transaction rather than through continuing use. This condition is satisfied when the asset is available for immediate sale in its present condition, management is committed to the sale, and it is highly probable to occur within one year. Non-current assets (and disposal groups) classified as held for sale are measured at the lower of their previous carrying amount and fair value less costs to sell and if significant, are presented separately from other assets on our Consolidated Balance Sheets. A disposal group is classified as a discontinued operation if it meets the following conditions: (i) it is a component that can be distinguished operationally and financially from the rest of our operations and (ii) it represents either a separate major line of business or is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations. Disposal groups classified as discontinued operations are presented separately from our continuing operations in our Consolidated Statements of Income. Changes in accounting policies During the first quarter, we adopted IFRS 15 Revenue from Contracts with Customers (IFRS 15). As permitted by the transition provisions of IFRS 15, we elected not to restate comparative period results; accordingly, all comparative information is presented in accordance with our previous accounting policies, as indicated below. As a result of the adoption of IFRS 15, we reduced our opening retained earnings by $94 million(1), on an after tax basis as at November 1, 2018 (the date of initial application), to align with the recognition of certain fees with the transfer of the performance obligations. Financial Instruments Classification of financial assets Financial assets are measured at initial recognition at fair value, and are classified and subsequently measured at fair value through profit or loss (FVTPL), fair value through other comprehensive income (FVOCI) or amortized cost based on our business model for managing the financial instruments and the contractual cash flow characteristics of the instrument. Debt instruments are measured at amortized cost if both of the following conditions are met and the asset is not designated as FVTPL: (a) the asset is held within a business model that is Held-to-Collect (HTC) as described below, and (b) the contractual terms of the instrument give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding (SPPI). Debt instruments are measured at FVOCI if both of the following conditions are met and the asset is not designated as FVTPL: (a) the asset is held within a business model that is Held-to-Collect-and-Sell (HTC&S) as described below, and (b) the contractual terms of the instrument give rise, on specified dates, to cash flows that are SPPI. All other debt instruments are measured at FVTPL. Equity instruments are measured at FVTPL, unless the asset is not held for trading purposes and we make an irrevocable election to designate the asset as FVOCI. This election is made on an instrument-by-instrument basis. Business model assessment We determine our business models at the level that best reflects how we manage portfolios of financial assets to achieve our business objectives. Judgment is used in determining our business models, which is supported by relevant, objective evidence including: (cid:129) How the economic activities of our businesses generate benefits, for example through trading revenue, enhancing yields or hedging funding or other costs and how such economic activities are evaluated and reported to key management personnel; The significant risks affecting the performance of our businesses, for example, market risk, credit risk, or other risks as described in the Risk Management section of Management’s Discussion and Analysis, and the activities undertaken to manage those risks; Historical and future expectations of sales of the loans or securities portfolios managed as part of a business model; and (cid:129) (cid:129) (1) Revised from the amount previously presented. 126 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements (cid:129) The compensation structures for managers of our businesses, to the extent that these are directly linked to the economic performance of the business model. Our business models fall into three categories, which are indicative of the key strategies used to generate returns: (cid:129) (cid:129) (cid:129) HTC: The objective of this business model is to hold loans and securities to collect contractual principal and interest cash flows. Sales are incidental to this objective and are expected to be insignificant or infrequent. HTC&S: Both collecting contractual cash flows and sales are integral to achieving the objective of the business model. Other fair value business models: These business models are neither HTC nor HTC&S, and primarily represent business models where assets are held-for-trading or managed on a fair value basis. SPPI assessment Instruments held within a HTC or HTC&S business model are assessed to evaluate if their contractual cash flows are comprised of solely payments of principal and interest. SPPI payments are those which would typically be expected from basic lending arrangements. Principal amounts include par repayments from lending and financing arrangements, and interest primarily relates to basic lending returns, including compensation for credit risk and the time value of money associated with the principal amount outstanding over a period of time. Interest can also include other basic lending risks and costs (for example, liquidity risk, servicing or administrative costs) associated with holding the financial asset for a period of time, and a profit margin. Where the contractual terms introduce exposure to risk or variability of cash flows that are inconsistent with a basic lending arrangement, the related financial asset is classified and measured at FVTPL. Securities Trading securities include all securities that are classified as FVTPL by nature and securities designated as FVTPL. Obligations to deliver trading securities sold but not yet purchased are recorded as liabilities and carried at fair value. Realized and unrealized gains and losses on these securities are generally recorded as Trading revenue or Non-interest income – Other. Dividends and interest income accruing on Trading securities are recorded in Interest income. Interest and dividends accrued on interest- bearing and equity securities sold short are recorded in Interest expense. Investment securities include all securities classified as FVOCI and amortized cost. All investment securities are initially recorded at fair value and subsequently measured according to the respective classification. Investment securities carried at amortized cost are measured using the effective interest method, and are presented net of any allowance for credit losses, calculated in accordance with our policy for Allowance for credit losses, as described below. Interest income, including the amortization of premiums and discounts on securities measured at amortized cost are recorded in interest income. Impairment gains or losses recognized on amortized cost securities are recorded in Provision for credit losses (PCL). When a debt instrument measured at amortized cost is sold, the difference between the sale proceeds and the amortized cost of the security at the time of the sale is recorded as Net gains on Investment securities in Non-interest income. Debt securities carried at FVOCI are measured at fair value with unrealized gains and losses arising from changes in fair value included in Other components of equity. Impairment gains and losses are included in PCL and correspondingly reduce the accumulated changes in fair value included in Other components of equity. When a debt instrument measured at FVOCI is sold, the cumulative gain or loss is reclassified from Other components of equity to Net gains on Investment securities in Non-interest income. Equity securities carried at FVOCI are measured at fair value. Unrealized gains and losses arising from changes in fair value are recorded in Other components of equity and not subsequently reclassified to profit or loss when realized. Dividends from FVOCI equity securities are recognized in Interest income. We account for all of our securities using settlement date accounting and changes in fair value between the trade date and settlement date are reflected in income for securities measured at FVTPL, and changes in the fair value of securities measured at FVOCI between the trade and settlement dates are recorded in OCI except for changes in foreign exchange rates on debt securities, which are recorded in Non-interest income – Other. Fair value option A financial instrument with a reliably measurable fair value can be designated as FVTPL (the fair value option) on its initial recognition even if the financial instrument was not acquired or incurred principally for the purpose of selling or repurchasing. The fair value option can be used for financial assets if it eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets or liabilities, or recognizing related gains and losses on a different basis (an accounting mismatch). The fair value option can be elected for financial liabilities if: (i) the election eliminates an accounting mismatch; (ii) the financial liability is part of a portfolio that is managed on a fair value basis, in accordance with a documented risk management or investment strategy; or (iii) there is an embedded derivative in the financial or non-financial host contract and the derivative is not closely related to the host contract. These instruments cannot be reclassified out of the FVTPL category while they are held or issued. Financial assets designated as FVTPL are recorded at fair value and any unrealized gain or loss arising due to changes in fair value is included in Trading revenue or Non-interest income – Other, depending on our business purpose for holding the financial asset. Financial liabilities designated as FVTPL are recorded at fair value and fair value changes attributable to changes in our own credit risk are recorded in OCI. Own credit risk amounts recognized in OCI will not be reclassified subsequently to net income. The remaining fair value changes not attributable to changes in our own credit risk are recorded in Trading revenue or Non-interest income – Other, depending on our business purpose for holding the financial liability. Upon initial recognition, if we determine that presenting the effects of own credit risk changes in OCI would create or enlarge an accounting mismatch in net income, the full fair value change in our debt designated as FVTPL is recognized in net income. To make that determination, we assess whether we expect that the effects of changes in the liability’s credit risk will be offset in profit or loss by a change in the fair value of another financial instrument measured at FVTPL. Such an expectation is based on an economic relationship between the characteristics of the liability and the characteristics of the other financial instrument. The determination is made at initial recognition and is not reassessed. To determine the fair value adjustments on our debt instruments designated as FVTPL, we calculate the present value of the instruments based on the contractual cash flows over the term of the arrangement by using our effective funding rate at the beginning and end of the period. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 127 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Determination of fair value The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We determine fair value by incorporating all factors that market participants would consider in setting a price, including commonly accepted valuation approaches. The Board of Directors provides oversight on valuation of financial instruments, primarily through the Audit Committee and Risk Committee. The Audit Committee reviews the presentation and disclosure of financial instruments that are measured at fair value, while the Risk Committee assesses the adequacy of governance structures and control processes for the valuation of these instruments. We have established policies, procedures and controls for valuation methodologies and techniques to ensure that fair value is reasonably estimated. Major valuation processes and controls include, but are not limited to, profit and loss decomposition, independent price verification (IPV) and model validation standards. These control processes are managed by either Finance or Group Risk Management and are independent of the relevant businesses and their trading functions. Profit and loss decomposition is a process to explain the fair value changes of certain positions and is performed daily for trading portfolios. All fair value instruments are subject to IPV, a process whereby trading function valuations are verified against external market prices and other relevant market data. Market data sources include traded prices, brokers and price vendors. We give priority to those third-party pricing services and prices having the highest and most consistent accuracy. The level of accuracy is determined over time by comparing third-party price values to traders’ or system values, to other pricing service values and, when available, to actual trade data. Quoted prices for identical instruments from pricing services or brokers are generally not adjusted unless there are issues such as stale prices. If multiple quotes for identical instruments are received, fair value is based on an average of the prices received or the quote from the most reliable vendor, after the outlier prices that fall outside of the pricing range are removed. Other valuation techniques are used when a price or quote is not available. Some valuation processes use models to determine fair value. We have a systematic and consistent approach to control the use of models. Valuation models are approved for use within our model risk management framework. The framework addresses, among other things, model development standards, validation processes and procedures and approval authorities. Model validation ensures that a model is suitable for its intended use and sets parameters for its use. All models are revalidated regularly by qualified personnel who are independent of the model design and development. Annually our model risk profile is reported to the Board of Directors. IFRS 13 Fair Value Measurement permits an exception, through an accounting policy choice, to measure the fair value of a portfolio of financial instruments on a net open risk position basis when certain criteria are met. We have elected to use this policy choice to determine the fair value of certain portfolios of financial instruments, primarily derivatives, based on a net exposure to market or credit risk. We record valuation adjustments to appropriately reflect counterparty credit quality of our derivative portfolio, differences between the actual counterparty collateral discount curve and standard overnight index swap (OIS) discounting for collateralized derivatives, funding valuation adjustments (FVA) for uncollateralized and under-collateralized over-the-counter (OTC) derivatives, unrealized gains or losses at inception of the transaction, bid-offer spreads, unobservable parameters and model limitations. These adjustments may be subjective as they require significant judgment in the input selection, such as implied probability of default (PD) and recovery rate, and are intended to arrive at a fair value that is determined based on assumptions that market participants would use in pricing the financial instrument. The realized price for a transaction may be different from its recorded value, previously estimated using management judgment. Valuation adjustments may therefore impact unrealized gains and losses recognized in Non-interest income – Trading revenue or Other. Valuation adjustments are recorded for the credit risk of our derivative portfolios in order to arrive at their fair values. Credit valuation adjustments (CVA) take into account our counterparties’ creditworthiness, the current and potential future mark-to-market of transactions and the effects of credit mitigants such as master netting and collateral agreements. CVA amounts are derived from estimates of exposure at default (EAD), PD, recovery rates on a counterparty basis and market and credit factor correlations. EAD is the value of expected derivative related assets and liabilities at the time of default, estimated through modelling using underlying risk factors. PD is implied from the market prices for credit protection and the credit ratings of the counterparty. When market data is unavailable, it is estimated by incorporating assumptions and adjustments that market participants would use for determining fair value using these inputs. Correlation is the statistical measure of how credit and market factors may move in relation to one another. Correlation is estimated using historical data. CVA is calculated daily and changes are recorded in Non-interest income – Trading revenue. FVA are also calculated to incorporate the cost and benefit of funding in the valuation of uncollateralized and under- collateralized OTC derivatives. Future expected cash flows of these derivatives are discounted to reflect the cost and benefit of funding the derivatives by using a funding curve, implied volatilities and correlations as inputs. Where required, a valuation adjustment is made to reflect the unrealized gain or loss at inception of a financial instrument contract where the fair value of that financial instrument is not obtained from a quoted market price or cannot be evidenced by other observable market transactions based on a valuation technique incorporating observable market data. A bid-offer valuation adjustment is required when a financial instrument is valued at the mid-market price, instead of the bid or offer price for asset or liability positions, respectively. The valuation adjustment takes into account the spread from the mid-market price to either the bid or offer price. Some valuation models require parameter calibration from such factors as market observable option prices. The calibration of parameters may be sensitive to factors such as the choice of instruments or optimization methodology. A valuation adjustment is also estimated to mitigate the uncertainties of parameter calibration and model limitations. In determining fair value, a hierarchy is used which prioritizes the inputs to valuation techniques. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Determination of fair value based on this hierarchy requires the use of observable market data whenever available. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model inputs that are either observable, or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 inputs are one or more inputs that are unobservable and significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available at the measurement 128 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements date. The availability of inputs for valuation may affect the selection of valuation techniques. The classification of a financial instrument in the hierarchy for disclosure purposes is based upon the lowest level of input that is significant to the measurement of fair value. Where observable prices or inputs are not available, management judgment is required to determine fair values by assessing other relevant sources of information such as historical data, proxy information from similar transactions, and through extrapolation and interpolation techniques. For more complex or illiquid instruments, significant judgment is required in the determination of the model used, the selection of model inputs, and in some cases the application of valuation adjustments to the model value or quoted price for inactively traded financial instruments, as the selection of model inputs may be subjective and the inputs may be unobservable. Unobservable inputs are inherently uncertain as there is little or no market data available from which to determine the level at which the transaction would occur under normal business circumstances. Appropriate parameter uncertainty and market risk valuation adjustments for such inputs and other model risk valuation adjustments are assessed in all such instances. Loans Loans are debt instruments recognized initially at fair value and are subsequently measured in accordance with the Classification of financial assets policy provided above. The majority of our loans are carried at amortized cost using the effective interest method, which represents the gross carrying amount less allowance for credit losses. Interest on loans is recognized in Interest income using the effective interest method. The estimated future cash flows used in this calculation include those determined by the contractual term of the asset and all fees that are considered to be integral to the effective interest rate. Also included in this amount are transaction costs and all other premiums or discounts. Fees that relate to activities such as originating, restructuring or renegotiating loans are deferred and recognized as Interest income over the expected term of such loans using the effective interest method. Where there is a reasonable expectation that a loan will be originated, commitment and standby fees are also recognized as interest income over the expected term of the resulting loans using the effective interest method. Otherwise, such fees are recorded as other liabilities and amortized into Non-interest income over the commitment or standby period. Future prepayment fees on mortgage loans are not included as part of the effective interest rate at origination. If prepayment fees are received on a renewal of a mortgage loan before maturity, the fee is included as part of the effective interest rate, and if not renewed, the prepayment fee is recognized in interest income at the prepayment date. For loans carried at amortized cost or FVOCI, impairment losses are recognized at each balance sheet date in accordance with the three-stage impairment model outlined below. Allowance for credit losses An allowance for credit losses (ACL) is established for all financial assets, except for financial assets classified or designated as FVTPL and equity securities designated as FVOCI, which are not subject to impairment assessment. Assets subject to impairment assessment include loans, debt securities, interest-bearing deposits with banks, customers’ liability under acceptances, accounts and accrued interest receivable, and finance and operating lease receivables. ACL on loans measured at amortized cost is presented in Allowance for loan losses. ACL on debt securities measured at FVOCI is presented in Other components of equity. Other financial assets carried at amortized cost are presented net of ACL on our Consolidated Balance Sheets. Off-balance sheet items subject to impairment assessment include financial guarantees and undrawn loan commitments. ACL on off-balance sheet items is separately calculated and included in Other Liabilities – Provisions. We measure the ACL on each balance sheet date according to a three-stage expected credit loss impairment model: (cid:129) Stage 1 – From initial recognition of a financial asset to the date on which the asset has experienced a significant increase in credit risk relative to its initial recognition, a loss allowance is recognized equal to the credit losses expected to result from defaults occurring over the 12 months following the reporting date. Stage 2 – Following a significant increase in credit risk relative to the initial recognition of the financial asset, a loss allowance is recognized equal to the credit losses expected over the remaining lifetime of the asset. (cid:129) Performing financial assets (cid:129) (cid:129) Impaired financial assets (cid:129) Stage 3 – When a financial asset is considered to be credit-impaired, a loss allowance is recognized equal to credit losses expected over the remaining lifetime of the asset. Interest income is calculated based on the carrying amount of the asset, net of the loss allowance, rather than on its gross carrying amount. The ACL is a discounted probability-weighted estimate of the cash shortfalls expected to result from defaults over the relevant time horizon. For loan commitments, credit loss estimates consider the portion of the commitment that is expected to be drawn over the relevant time period. For financial guarantees, credit loss estimates are based on the expected payments required under the guarantee contract. For finance lease receivables, credit loss estimates are based on cash flows consistent with the cash flows used in measuring the lease receivable. Increases or decreases in the required ACL attributable to purchases and new originations, derecognitions or maturities, and changes in risk, parameters and exposures due to changes in loss expectations or stage transfers are recorded in PCL. Write-offs and recoveries of amounts previously written off are recorded against ACL. The ACL represents an unbiased estimate of expected credit losses on our financial assets as at the balance sheet date. Judgment is required in making assumptions and estimations when calculating the ACL, including movements between the three stages and the application of forward looking information. The underlying assumptions and estimates may result in changes to the provisions from period to period that significantly affect our results of operations. Measurement of expected credit losses Expected credit losses are based on a range of possible outcomes and consider all available reasonable and supportable information including internal and external ratings, historical credit loss experience, and expectations about future cash flows. The measurement of expected credit losses is based primarily on the product of the instrument’s PD, loss given default (LGD), and EAD discounted to the reporting date. The main difference between Stage 1 and Stage 2 expected credit losses for performing financial assets is the respective calculation horizon. Stage 1 estimates project PD, LGD and EAD over a maximum period of 12 months while Stage 2 estimates project PD, LGD and EAD over the remaining lifetime of the instrument. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 129 Note 2 Summary of significant accounting policies, estimates and judgments (continued) An expected credit loss estimate is produced for each individual exposure. Relevant parameters are modeled on a collective basis using portfolio segmentation that allows for appropriate incorporation of forward looking information. To reflect other characteristics that are not already considered through modelling, expert credit judgment is exercised in determining the final expected credit losses. For a small percentage of our portfolios which lack detailed historical information and/or loss experience, we apply simplified measurement approaches that may differ from what is described above. These approaches have been designed to maximize the available information that is reliable and supportable for each portfolio and may be collective in nature. Expected credit losses are discounted to the reporting period date using the effective interest rate. Expected life For instruments in Stage 2 or Stage 3, loss allowances reflect expected credit losses over the expected remaining lifetime of the instrument. For most instruments, the expected life is limited to the remaining contractual life. An exemption is provided for certain instruments with the following characteristics: (a) the instrument includes both a loan and undrawn commitment component; (b) we have the contractual ability to demand repayment and cancel the undrawn commitment; and (c) our exposure to credit losses is not limited to the contractual notice period. For products in scope of this exemption, the expected life may exceed the remaining contractual life and is the period over which our exposure to credit losses is not mitigated by our normal credit risk management actions. This period varies by product and risk category and is estimated based on our historical experience with similar exposures and consideration of credit risk management actions taken as part of our regular credit review cycle. Products in scope of this exemption include credit cards, overdraft balances and certain revolving lines of credit. Judgment is required in determining the instruments in scope for this exemption and estimating the appropriate remaining life based on our historical experience and credit risk mitigation practices. Assessment of significant increase in credit risk The assessment of significant increase in credit risk requires significant judgment. Movements between Stage 1 and Stage 2 are based on whether an instrument’s credit risk as at the reporting date has increased significantly relative to the date it was initially recognized. For the purposes of this assessment, credit risk is based on an instrument’s lifetime PD, not the losses we expect to incur. The assessment is generally performed at the instrument level. Our assessment of significant increases in credit risk is performed at least quarterly based on three factors. If any of the following factors indicates that a significant increase in credit risk has occurred, the instrument is moved from Stage 1 to Stage 2: (1) We have established thresholds for significant increases in credit risk based on both a percentage and absolute change in lifetime PD relative to initial recognition. For our wholesale portfolio, a decrease in the borrower’s risk rating is also required to determine that credit risk has increased significantly. (2) Additional qualitative reviews are performed to assess the staging results and make adjustments, as necessary, to better reflect the positions whose credit risk has increased significantly. (3) Instruments which are 30 days past due are generally considered to have experienced a significant increase in credit risk, even if our other metrics do not indicate that a significant increase in credit risk has occurred. The thresholds for movement between Stage 1 and Stage 2 are symmetrical. After a financial asset has transferred to Stage 2, if its credit risk is no longer considered to have significantly increased relative to its initial recognition, the financial asset will move back to Stage 1. For certain instruments with low credit risk as at the reporting date, it is presumed that credit risk has not increased significantly relative to initial recognition. Credit risk is considered to be low if the instrument has a low risk of default, and the borrower has the ability to fulfill their contractual obligations both in the near term and in the longer term, including periods of adverse changes in the economic or business environment. Certain interest-bearing deposits with banks, assets purchased under reverse repurchase agreements, insurance policy loans, and liquidity facilities extended to our multi-seller conduits have been identified as having low credit risk. Use of forward-looking information The measurement of expected credit losses for each stage and the assessment of significant increase in credit risk considers information about past events and current conditions as well as reasonable and supportable projections of future events and economic conditions. The estimation and application of forward-looking information requires significant judgment. The PD, LGD and EAD inputs used to estimate Stage 1 and Stage 2 credit loss allowances are modelled based on the macroeconomic variables (or changes in macroeconomic variables) that are most closely correlated with credit losses in the relevant portfolio. Each macroeconomic scenario used in our expected credit loss calculation includes a projection of all relevant macroeconomic variables used in our models for a five year period, subsequently reverting to long-run averages. Macroeconomic variables used in our expected credit loss models include, but are not limited to, unemployment rates, gross domestic product growth rates, equity return indices, commodity prices, and Canadian housing prices. Depending on their usage in the models, macroeconomic variables may be projected at a country, province/state or more granular level. Our estimation of expected credit losses in Stage 1 and Stage 2 is a discounted probability-weighted estimate that considers a minimum of three future macroeconomic scenarios. Our base case scenario is based on macroeconomic forecasts published by our internal economics group. Upside and downside scenarios vary relative to our base case scenario based on reasonably possible alternative macroeconomic conditions. Additional and more severe downside scenarios are designed to capture a broader range of potential credit losses in certain sectors. Scenario design, including the identification of additional downside scenarios, occurs at least on an annual basis and more frequently if conditions warrant. Scenarios are designed to capture a wide range of possible outcomes and weighted according to our best estimate of the relative likelihood of the range of outcomes that each scenario represents. Scenario weights take into account historical frequency, current trends, and forward-looking conditions and are updated on a quarterly basis. All scenarios considered are applied to all portfolios subject to expected credit losses with the same probabilities. Our assessment of significant increases in credit risk is based on changes in probability-weighted forward-looking lifetime PDs as at the reporting date, using the same macroeconomic scenarios as the calculation of expected credit losses. 130 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Definition of default The definition of default used in the measurement of expected credit losses is consistent with the definition of default used for our internal credit risk management purposes. Our definition of default may differ across products and consider both quantitative and qualitative factors, such as the terms of financial covenants and days past due. For retail and wholesale borrowers, except as detailed below, default occurs when the borrower is more than 90 days past due on any material obligation to us, and/or we consider the borrower unlikely to make their payments in full without recourse action on our part, such as taking formal possession of any collateral held. For certain credit card balances, default occurs when payments are 180 days past due. For these balances, the use of a period in excess of 90 days past due is reasonable and supported by observable data on write-off and recovery rates experienced on historical credit card portfolios. The definition of default used is applied consistently from period to period and to all financial instruments unless it can be demonstrated that circumstances have changed such that another definition of default is more appropriate. Credit-impaired financial assets (Stage 3) Financial assets are assessed for credit-impairment at each balance sheet date and more frequently when circumstances warrant further assessment. Evidence of credit-impairment may include indications that the borrower is experiencing significant financial difficulty, probability of bankruptcy or other financial reorganization, as well as a measurable decrease in the estimated future cash flows evidenced by the adverse changes in the payments status of the borrower or economic conditions that correlate with defaults. An asset that is in Stage 3 will move back to Stage 2 when, as at the reporting date, it is no longer considered to be credit-impaired. The asset will transfer back to Stage 1 when its credit risk at the reporting date is no longer considered to have increased significantly from initial recognition, which could occur during the same reporting period as the transfer from Stage 3 to Stage 2. When a financial asset has been identified as credit-impaired, expected credit losses are measured as the difference between the asset’s gross carrying amount and the present value of estimated future cash flows discounted at the instrument’s original effective interest rate. For impaired financial assets with drawn and undrawn components, expected credit losses also reflect any credit losses related to the portion of the loan commitment that is expected to be drawn down over the remaining life of the instrument. When a financial asset is credit-impaired, interest ceases to be recognized on the regular accrual basis, which accrues income based on the gross carrying amount of the asset. Rather, interest income is calculated by applying the original effective interest rate to the amortized cost of the asset, which is the gross carrying amount less the related ACL. Following impairment, interest income is recognized on the unwinding of the discount from the initial recognition of impairment. ACL for credit-impaired loans in Stage 3 are established at the borrower level, where losses related to impaired loans are identified on individually significant loans, or collectively assessed and determined through the use of portfolio-based rates, without reference to particular loans. Individually assessed loans (Stage 3) When individually significant loans are identified as impaired, we reduce the carrying value of the loans to their estimated realizable value by recording an individually assessed ACL to cover identified credit losses. The individually assessed ACL reflects the expected amount of principal and interest calculated under the terms of the original loan agreement that will not be recovered, and the impact of time delays in collecting principal and/or interest (time value of money). The estimated realizable value for each individually significant loan is the present value of expected future cash flows discounted using the original effective interest rate for each loan. When the amounts and timing of future cash flows cannot be estimated with reasonable reliability, the estimated realizable amount may be determined using observable market prices for comparable loans, the fair value of collateral underlying the loans, and other reasonable and supported methods based on management judgment. Individually-assessed allowances are established in consideration of a range of possible outcomes, which may include macroeconomic or non-macroeconomic scenarios, to the extent relevant to the circumstances of the specific borrower being assessed. Assumptions used in estimating expected future cash flows reflect current and expected future economic conditions and are generally consistent with those used in Stage 1 and Stage 2 measurement. Significant judgment is required in assessing evidence of credit-impairment and estimation of the amount and timing of future cash flows when determining expected credit losses. Changes in the amount expected to be recovered would have a direct impact on PCL and may result in a change in the ACL. Collectively assessed loans (Stage 3) Loans that are collectively assessed are grouped on the basis of similar risk characteristics, taking into account loan type, industry, geographic location, collateral type, past due status and other relevant factors. The collectively-assessed ACL reflects: (i) the expected amount of principal and interest calculated under the terms of the original loan agreement that will not be recovered, and (ii) the impact of time delays in collecting principal and/or interest (time value of money). The expected principal and interest collection is estimated on a portfolio basis and references historical loss experience of comparable portfolios with similar credit risk characteristics, adjusted for the current environment and expected future conditions. A portfolio specific coverage ratio is applied against the impaired loan balance in determining the collectively- assessed ACL. The time value of money component is calculated by using the discount factors applied to groups of loans sharing common characteristics. The discount factors represent the expected recovery pattern of the comparable group of loans, and reflect the historical experience of these groups adjusted for current and expected future economic conditions and/or industry factors. Significant judgment is required in assessing evidence of impairment and estimation of the amount and timing of future cash flows when determining expected credit losses. Changes in the amount expected to be recovered would have a direct impact on PCL and may result in a change in the ACL. Write-off of loans Loans and the related ACL are written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, they are generally written off after receipt of any proceeds from the realization of collateral. In circumstances where the net realizable value of any collateral has been determined and there is no reasonable expectation of further recovery, write off may be earlier. For credit cards, the balances and related allowance for credit losses are generally written off when payment is 180 days past due. Personal loans are generally written off at 150 days past due. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 131 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Modifications The original terms of a financial asset may be renegotiated or otherwise modified, resulting in changes to the contractual terms of the financial asset that affect the contractual cash flows. The treatment of such modifications is primarily based on the process undertaken to execute the renegotiation and the nature and extent of the expected changes. Modifications which are performed for credit reasons, primarily related to troubled debt restructurings, are generally treated as modifications of the original financial asset. Modifications which are performed for other than credit reasons are generally considered to be an expiry of the original cash flows; accordingly, such renegotiations are treated as a derecognition of the original financial asset and recognition of a new financial asset. If a modification of terms does not result in derecognition of the financial asset, the carrying amount of the financial asset is recalculated as the present value of the renegotiated or modified contractual cash flows, discounted at the original effective interest rate and a gain or loss is recognized. The financial asset continues to be subject to the same assessments for significant increase in credit risk relative to initial recognition and credit-impairment, as described above. A modified financial asset will transfer out of Stage 3 if the conditions that led to it being identified as credit-impaired are no longer present and relate objectively to an event occurring after the original credit-impairment was recognized. A modified financial asset will transfer out of Stage 2 when it no longer satisfies the relative thresholds set to identify significant increases in credit risk, which are based on changes in its lifetime PD, days past due and other qualitative considerations. The financial asset continues to be monitored for significant increases in credit risk and credit-impairment. If a modification of terms results in derecognition of the original financial asset and recognition of the new financial asset, the new financial asset will generally be recorded in Stage 1, unless it is determined to be credit-impaired at the time of the renegotiation. For the purposes of assessing for significant increases in credit risk, the date of initial recognition for the new financial asset is the date of the modification. Derivatives When derivatives are embedded in other financial instruments or host contracts, such combinations are known as hybrid instruments. Some of the cash flows of a hybrid instrument vary in a way similar to a stand-alone derivative. If the host contract is a financial asset within the scope of IFRS 9, the classification and measurement criteria are applied to the entire hybrid instrument as described in the Classification of financial assets section of Note 2. If the host contract is a financial liability or an asset that is not within the scope of IFRS 9, embedded derivatives are separately recognized if the economic characteristics and risks of the embedded derivative are not clearly and closely related to the host contract, unless an election has been made to elect the fair value option, as described above. The host contract is accounted for in accordance with the relevant standards. Derivatives are primarily used in trading activities. Derivatives are also used to manage our exposure to interest, currency, credit and other market risks. The most frequently used derivative products are interest rate and foreign exchange swaps, options, futures and forward rate agreements, equity swaps and credit derivatives. All derivative instruments are recorded on our Consolidated Balance Sheets at fair value. When derivatives are used in trading activities, the realized and unrealized gains and losses on these derivatives are recognized in Trading revenue in Non-interest income. Derivatives with positive fair values are reported as Derivative assets and derivatives with negative fair values are reported as Derivative liabilities. In accordance with our policy for offsetting financial assets and financial liabilities, the net fair value of certain derivative assets and liabilities are reported as an asset or liability, as appropriate. Valuation adjustments are included in the fair value of Derivative assets and Derivative liabilities. Premiums paid and premiums received are shown in Derivative assets and Derivative liabilities, respectively. When derivatives are used to manage our own exposures, we determine for each derivative whether hedge accounting can be applied, as discussed in the Hedge accounting section below. Derecognition of financial assets Financial assets are derecognized from our Consolidated Balance Sheets when our contractual rights to the cash flows from the assets have expired, when we retain the rights to receive the cash flows of the assets but assume an obligation to pay those cash flows to a third party subject to certain pass-through requirements or when we transfer our contractual rights to receive the cash flows and substantially all of the risk and rewards of the assets have been transferred. When we retain substantially all of the risks and rewards of the transferred assets, the transferred assets are not derecognized from our Consolidated Balance Sheets and are accounted for as secured financing transactions. When we neither retain nor transfer substantially all risks and rewards of ownership of the assets, we derecognize the assets if control over the assets is relinquished. If we retain control over the transferred assets, we continue to recognize the transferred assets to the extent of our continuing involvement. Management’s judgment is applied in determining whether the contractual rights to the cash flows from the transferred assets have expired or whether we retain the rights to receive cash flows on the assets but assume an obligation to pay for those cash flows. We derecognize transferred financial assets if we transfer substantially all the risks and rewards of the ownership in the assets. When assessing whether we have transferred substantially all of the risk and rewards of the transferred assets, management considers the Bank’s exposure before and after the transfer with the variability in the amount and timing of the net cash flows of the transferred assets. In transfers in which we retain the servicing rights, management has applied judgment in assessing the benefits of servicing against market expectations. When the benefits of servicing are greater than fair value, a servicing asset is recognized in Other assets in our Consolidated Balance Sheets. When the benefits of servicing are less than fair value, a servicing liability is recognized in Other liabilities in our Consolidated Balance Sheets. Derecognition of financial liabilities We derecognize a financial liability from our Consolidated Balance Sheets when our obligation specified in the contract expires, or is discharged or cancelled. We recognize the difference between the carrying amount of a financial liability transferred and the consideration paid in our Consolidated Statements of Income. Interest Interest is recognized in Interest income and Interest expense in the Consolidated Statements of Income for all interest-bearing financial instruments. The effective interest rate is the rate that discounts estimated future cash flows over the expected life of 132 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements the financial asset or liability to the net carrying amount upon initial recognition. Significant judgment is applied in determining the effective interest rate due to uncertainty in the timing and amounts of future cash flows. Dividend income Dividend income is recognized when the right to receive payment is established. This is the ex-dividend date for listed equity securities, and usually the date when shareholders have approved the dividend for unlisted equity securities. Transaction costs Transaction costs are expensed as incurred for financial instruments classified or designated as FVTPL. For other financial instruments, transaction costs are capitalized on initial recognition. For financial assets and financial liabilities measured at amortized cost, capitalized transaction costs are amortized through net income over the estimated life of the instrument using the effective interest method. For financial assets measured at FVOCI that do not have fixed or determinable payments and no fixed maturity, capitalized transaction costs are recognized in net income when the asset is derecognized or becomes impaired. Offsetting financial assets and financial liabilities Financial assets and financial liabilities are offset on the balance sheet when there exists both a legally enforceable right to offset the recognized amounts and an intention to settle on a net basis, or realize the asset and settle the liability simultaneously. Assets purchased under reverse repurchase agreements and sold under repurchase agreements We purchase securities under agreements to resell (reverse repurchase agreements) and take possession of these securities. We monitor the market value of the securities purchased and additional collateral is obtained when appropriate. We have the right to liquidate the collateral held in the event of counterparty default. Reverse repurchase agreements are treated as collateralized lending transactions. We also sell securities under agreements to repurchase (repurchase agreements), which are treated as collateralized borrowing transactions. The securities received under reverse repurchase agreements and securities delivered under repurchase agreements are not recognized on, or derecognized from, our Consolidated Balance Sheets, respectively, unless the risks and rewards of ownership are obtained or relinquished. Reverse repurchase agreements and repurchase agreements are carried on our Consolidated Balance Sheets at the amounts at which the securities were initially acquired or sold, except when they are classified or designated as FVTPL and are recorded at fair value. Interest earned on reverse repurchase agreements is included in Interest income, and interest incurred on repurchase agreements is included in Interest expense in our Consolidated Statements of Income. Changes in fair value for reverse repurchase agreements and repurchase agreements designated as FVTPL are included in Trading revenue or Other in Non-interest income. Hedge accounting We have elected to continue to apply the hedge accounting principles under IAS 39 instead of those under IFRS 9. We use derivatives and non-derivatives in our hedging strategies to manage our exposure to interest rate, currency, credit and other market risks. Where hedge accounting can be applied, a hedge relationship is designated and documented at inception to detail the particular risk management objective and strategy for undertaking the hedge transaction. The documentation identifies the specific asset, liability or anticipated cash flows being hedged, the risk that is being hedged, the type of hedging instrument used and how effectiveness will be assessed. We assess, both at the inception of the hedge and on an ongoing basis, whether the hedging instruments are ‘highly effective’ in offsetting changes in the fair value or cash flows of the hedged items. A hedge is regarded as highly effective only if the following criteria are met: (i) at inception of the hedge and throughout its life, the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, and (ii) actual results of the hedge are within a pre-determined range. In the case of hedging a forecast transaction, the transaction must have a high probability of occurring and must present an exposure to variations in cash flows that could ultimately affect the reported net profit or loss. Hedge accounting is discontinued when it is determined that the hedging instrument is no longer effective as a hedge, the hedging instrument or hedged item is terminated or sold, or the forecast transaction is no longer deemed highly probable. Refer to Note 8 for the fair value of derivatives and non-derivative instruments categorized by their hedging relationships, as well as derivatives that are not designated in hedging relationships. Fair value hedges In a fair value hedging relationship, the carrying value of the hedged item is adjusted for changes in fair value attributable to the hedged risk and recognized in Non-interest income. Changes in fair value of the hedged item, to the extent that the hedging relationship is effective, are offset by changes in the fair value of the hedging derivative, which are also recognized in Non-interest income. When hedge accounting is discontinued, the carrying value of the hedged item is no longer adjusted and the cumulative fair value adjustments to the carrying value of the hedged items are amortized to Net income over the expected remaining life of the hedged items. We predominantly use interest rate swaps to hedge our exposure to changes in a fixed interest rate instrument’s fair value caused by changes in interest rates. Cash flow hedges In a cash flow hedging relationship, the effective portion of the change in the fair value of the hedging derivative, net of taxes, is recognized in OCI and reclassified to profit or loss as the associated hedged forecast transaction occurs, while the ineffective portion is recognized in Non-interest income. When hedge accounting is discontinued, the cumulative amounts previously recognized in Other components of equity are reclassified to Net interest income during the periods when the variability in the cash flows of the hedged item affects Net interest income. Unrealized gains and losses on derivatives are reclassified immediately to Net income when the hedged item is sold or terminated early, or when the forecast transaction is no longer expected to occur. We predominantly use interest rate swaps to hedge the variability in cash flows related to a variable-rate asset or liability. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 133 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Net investment hedges In hedging our foreign currency exposure to a net investment in a foreign operation, the effective portion of foreign exchange gains and losses on the hedging instruments, net of applicable taxes, is recognized in OCI and the ineffective portion is recognized in Non-interest income. The amounts, or a portion thereof, previously recognized in Other components of equity are recognized in Net income on the disposal, or partial disposal, of the foreign operation. We use foreign exchange contracts and foreign currency-denominated liabilities to manage our foreign currency exposures to net investments in foreign operations having a functional currency other than the Canadian dollar. Guarantees Financial guarantee contracts are contracts that contingently require us to make specified payments (in cash, other assets, our own shares or provision of services) to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. Liabilities are recognized on our Consolidated Balance Sheets at the inception of a guarantee for the fair value of the obligation undertaken in issuing the guarantee. Financial guarantees are subsequently remeasured at the higher of (i) the amount initially recognized less accumulated amortization and (ii) our best estimate of the present value of the expenditure required to settle the present obligation at the end of the reporting period. If the financial guarantee contract meets the definition of a derivative, it is measured at fair value at each balance sheet date and reported under Derivatives on our Consolidated Balance Sheets. Insurance and segregated funds Premiums from long-duration contracts, primarily life insurance, are recognized when due in Non-interest income – Insurance premiums, investment and fee income. Premiums from short-duration contracts, primarily property and casualty, and fees for administrative services are recognized in Insurance premiums, investment and fee income over the related contract period. Unearned premiums of the short-duration contracts, representing the unexpired portion of premiums, are reported in Other liabilities. Investments made by our insurance operations are classified as FVOCI instruments and amortized cost instruments, except for investments supporting the policy benefit liabilities on life and health insurance contracts and a portion of property and casualty contracts. These are designated as FVTPL with changes in fair value reported in Insurance premiums, investment and fee income. Insurance claims and policy benefit liabilities represent current claims and estimates for future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method (CALM), which incorporates assumptions for mortality, morbidity, policy lapses and surrenders, investment yields, policy dividends, operating and policy maintenance expenses and provisions for adverse deviation. These assumptions are reviewed at least annually and updated in response to actual experience and market conditions. Liabilities for property and casualty insurance represent estimated provisions for reported and unreported claims. Liabilities for life and property and casualty insurance are included in Insurance claims and policy benefit liabilities. Changes in Insurance claims and policy benefit liabilities are included in the Insurance policyholder benefits, claims and acquisition expense in our Consolidated Statements of Income in the period in which the estimates change. Premiums ceded for reinsurance and reinsurance recoveries on policyholder benefits and claims incurred are reported in income and expense as appropriate. Reinsurance recoverables, which relate to paid benefits and unpaid claims, are included in Other assets. Acquisition costs for new insurance contracts consist of commissions, premium taxes, certain underwriting costs and other costs that vary with the acquisition of new contracts. Deferred acquisition costs for life insurance products are implicitly recognized in Insurance claims and policy benefit liabilities by CALM. For property and casualty insurance, these costs are classified as Other assets and amortized over the policy term. Segregated funds are lines of business in which we issue an insurance contract where the benefit amount is directly linked to the market value of the investments held in the underlying fund. The contractual arrangement is such that the underlying segregated fund assets are registered in our name but the segregated fund policyholders bear the risks and rewards of the funds’ investment performance. Liabilities for these contracts are calculated based on contractual obligations using actuarial assumptions and are at least equivalent to the surrender or transfer value calculated by reference to the value of the relevant underlying funds or indices. Segregated funds’ assets and liabilities are separately presented on our Consolidated Balance Sheets. As the segregated fund policyholders bear the risks and rewards of the funds’ performance, investment income earned by the segregated funds and expenses incurred by the segregated funds are offset and are not separately presented in our Consolidated Statements of Income. Fee income we earn from segregated funds includes management fees, mortality, policy administration and surrender charges, and these fees are recorded in Non-interest income – Insurance premiums, investment and fee income. We provide minimum death benefit and maturity value guarantees on segregated funds. The liability associated with these minimum guarantees is recorded in Insurance claims and policy benefit liabilities. Liability adequacy tests are performed for all insurance contract portfolios at each balance sheet date to ensure the adequacy of insurance contract liabilities. Current best estimates of future contractual cash flows, claims handling and administration costs, and investment returns from the assets backing the liabilities are taken into account in the tests. When the test results indicate that there is a deficiency in liabilities, the deficiency is charged immediately to our Consolidated Statements of Income by writing down the deferred acquisition costs in Other assets and/or increasing Insurance claims and policy benefit liabilities. Employee benefits – Pensions and other post-employment benefits Our defined benefit pension expense, which is included in Non-interest expense – Human resources, consists of the cost of employee pension benefits for the current year’s service, net interest on the net defined benefit liability (asset), past service cost and gains or losses on settlement. Remeasurements of the net defined benefit obligation, which comprise actuarial gains and losses and return on plan assets (excluding amounts included in net interest on the net defined benefit liability), are recognized immediately in OCI in the period in which they occur. Actuarial gains and losses comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred), as well as the effects of changes in 134 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements actuarial assumptions. Amounts recognized in OCI will not be reclassified subsequently to net income. Past service cost is the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment and is charged immediately to income. For each defined benefit pension plan, we recognize the present value of our defined benefit obligations less the fair value of the plan assets as a defined benefit liability reported in Other liabilities – Employee benefit liabilities on our Consolidated Balance Sheets. For plans where there is a net defined benefit asset, the amount is reported as an asset in Other assets – Employee benefit assets on our Consolidated Balance sheets. The calculation of defined benefit expenses and obligations requires significant judgment as the recognition is dependent on discount rates and various actuarial assumptions such as healthcare cost trend rates, projected salary increases, retirement age and mortality and termination rates. Due to the long-term nature of these plans, such estimates and assumptions are subject to inherent risks and uncertainties. For our pension and other post-employment benefit plans, the discount rate is determined by reference to market yields on high quality corporate bonds. Since the discount rate is based on currently available yields, and involves management’s assessment of market liquidity, it is only a proxy for future yields. Actuarial assumptions, set in accordance with current practices in the respective countries of our plans, may differ from actual experience as country specific statistics are only estimates of future employee behaviour. These assumptions are determined by management and are reviewed by actuaries at least annually. Changes to any of the above assumptions may affect the amounts of benefits obligations, expenses and remeasurements that we recognize. Our contributions to defined contribution pension plans are expensed when employees have rendered services in exchange for such contributions. Defined contribution pension expense is included in Non-interest expense – Human resources. Share-based compensation We offer share-based compensation plans to certain key employees and to our non-employee directors. To account for stock options granted to employees, compensation expense is recognized over the applicable vesting period with a corresponding increase in equity. Fair value is determined by using option valuation models, which take into account the exercise price of the option, the current share price, the risk free interest rate, the expected volatility of the share price over the life of the option and other relevant factors. When the options are exercised, the exercise price proceeds together with the amount initially recorded in equity are credited to common shares. Our other share-based compensation plans include performance deferred share plans and deferred share unit plans for key employees (the Plans). The obligations for the Plans are accrued over their vesting periods. The Plans are settled in cash. For cash-settled awards, our accrued obligations are adjusted to their fair value at each balance sheet date. For share- settled awards, our expected obligations recognized in equity are based on the fair value of our common shares at the date of grant. Changes in our obligations, net of related hedges, are recorded as Non-interest expense – Human resources in our Consolidated Statements of Income with a corresponding increase in Other liabilities for cash-settled awards and in Retained earnings for share-settled awards. Compensation expense is recognized in the year the awards are earned by plan participants based on the vesting schedule of the relevant plans, net of estimated forfeitures. The compensation cost attributable to options and awards granted to employees who are eligible to retire or will become eligible to retire during the vesting period, is recognized immediately if the employee is eligible to retire on the grant date or over the period between the grant date and the date the employee becomes eligible to retire. Our contributions to the employee savings and share ownership plans are expensed as incurred. Income taxes Income tax comprises current tax and deferred tax and is recognized in our Consolidated Statements of Income except to the extent that it relates to items recognized directly in equity, in which case it is recognized in equity. Current income tax payable on profits is recognized as an expense based on the applicable tax laws in each jurisdiction in the period in which profits arise, calculated using tax rates enacted or substantively enacted by the balance sheet date. Deferred tax is recognized on temporary differences between the carrying amounts of assets and liabilities for accounting and tax purposes. A deferred income tax asset or liability is determined for each temporary difference, except for earnings related to our subsidiaries, branches, associates and interests in joint ventures where the temporary differences will not reverse in the foreseeable future and we have the ability to control the timing of reversal. Deferred tax assets and liabilities are determined based on the tax rates that are expected to be in effect in the period that the asset is realized or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted at the balance sheet date. Current tax assets and liabilities are offset when they are levied by the same taxation authority on either the same taxable entity or different taxable entities within the same tax reporting group (which intends to settle on a net basis), and when there is a legal right to offset. Deferred tax assets and liabilities are offset when the same conditions are satisfied. Our Consolidated Statements of Income include items that are non-taxable or non-deductible for income tax purposes and, accordingly, this causes the income tax provision to be different from what it would be if based on statutory rates. Deferred income taxes accumulated as a result of temporary differences and tax loss carryforwards are included in Other assets and Other liabilities. On a quarterly basis, we review our deferred income tax assets to determine whether it is probable that the benefits associated with these assets will be realized; this review involves evaluating both positive and negative evidence. We are subject to income tax laws in various jurisdictions where we operate, and the complex tax laws are potentially subject to different interpretations by us and the relevant taxation authorities. Significant judgment is required in the interpretation of the relevant tax laws, and the determination of our tax provision, which includes our best estimate of tax positions that are under audit or appeal by relevant taxation authorities. We perform a review on a quarterly basis to incorporate our best assessment based on information available, but additional liability and income tax expense could result based on decisions made by the relevant tax authorities. The determination of our deferred tax asset or liability also requires significant management judgment as the recognition is dependent on our projection of future taxable profits and tax rates that are expected to be in effect in the period the asset is realized or the liability is settled. Any changes in our projection will result in changes in deferred tax assets or liabilities on our Consolidated Balance Sheets, and also deferred tax expense on our Consolidated Statements of Income. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 135 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Business combinations, goodwill and other intangibles All business combinations are accounted for using the acquisition method. Non-controlling interests, if any, are recognized at their proportionate share of the fair value of identifiable assets and liabilities, unless otherwise indicated. Identifiable intangible assets are recognized separately from goodwill and included in Other intangibles. Goodwill represents the excess of the price paid for the business acquired over the fair value of the net identifiable assets acquired on the date of acquisition. Goodwill Goodwill is allocated to cash-generating units or groups of cash-generating units for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. Impairment testing is performed annually as at August 1, or more frequently if there are objective indicators of impairment, by comparing the recoverable amount of a cash-generating unit (CGU) with its carrying amount. The recoverable amount of a CGU is the higher of its value in use and its fair value less costs of disposal. Value in use is the present value of the expected future cash flows from a CGU. Fair value less costs of disposal is the amount obtainable from the sale of a CGU in an orderly transaction between market participants, less disposal costs. The fair value of a CGU is estimated using valuation techniques such as a discounted cash flow method, adjusted to reflect the considerations of a prospective third-party buyer. External evidence such as binding sale agreements or recent transactions for similar businesses within the same industry is considered to the extent that it is available. Significant judgment is involved in estimating the model inputs used to determine the recoverable amount of our CGUs, in particular future cash flows, discount rates and terminal growth rates, due to the uncertainty in the timing and amount of cash flows and the forward-looking nature of these inputs. Future cash flows are based on financial plans agreed by management which are estimated based on forecast results, business initiatives, planned capital investments and returns to shareholders. Discount rates are based on the bank-wide cost of capital, adjusted for CGU-specific risks and currency exposure as reflected by differences in expected inflation. Bank-wide cost of capital is based on the Capital Asset Pricing Model. CGU-specific risks include country risk, business/operational risk, geographic risk (including political risk, devaluation risk, and government regulation), currency risk, and price risk (including product pricing risk and inflation). Terminal growth rates reflect the expected long-term gross domestic product growth and inflation for the countries within which the CGU operates. Changes in these assumptions may impact the amount of impairment loss recognized in Non-interest expense. The carrying amount of a CGU includes the carrying amount of assets, liabilities and goodwill allocated to the CGU. If the recoverable amount is less than the carrying value, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the CGU and then to the other non-financial assets of the CGU proportionately based on the carrying amount of each asset. Any impairment loss is charged to income in the period in which the impairment is identified. Goodwill is stated at cost less accumulated impairment losses. Subsequent reversals of goodwill impairment are prohibited. Upon disposal of a portion of a CGU, the carrying amount of goodwill related to the portion of the CGU sold is included in the determination of gains or losses on disposal. The carrying amount is determined based on the relative fair value of the disposed portion to the total CGU. Other intangibles Intangible assets represent identifiable non-monetary assets and are acquired either separately or through a business combination, or generated internally. Intangible assets acquired through a business combination are recognized separately from goodwill when they are separable or arise from contractual or other legal rights, and their fair value can be measured reliably. The cost of a separately acquired intangible asset includes its purchase price and directly attributable costs of preparing the asset for its intended use. In respect of internally generated intangible assets, cost includes all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Research and development costs that are not eligible for capitalization are expensed. After initial recognition, an intangible asset is carried at its cost less any accumulated amortization and accumulated impairment losses, if any. Intangible assets with a finite-life are amortized on a straight-line basis over their estimated useful lives as follows: computer software – 3 to 10 years; and customer relationships – 10 to 20 years. We do not have any intangible assets with indefinite lives. Intangible assets are assessed for indicators of impairment at each reporting period. If there is an indication that an intangible asset may be impaired, an impairment test is performed by comparing the carrying amount of the intangible asset to its recoverable amount. Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the CGU to which the asset belongs. If the recoverable amount of the asset (or CGU) is less than its carrying amount, the carrying amount of the intangible asset is written down to its recoverable amount as an impairment loss. An impairment loss recognized previously is reversed if there is a change in the estimates used to determine the recoverable amount of the asset (or CGU) since the last impairment loss was recognized. If an impairment loss is subsequently reversed, the carrying amount of the asset (or CGU) is revised to the lower of its recoverable amount and the carrying amount that would have been determined (net of amortization) had there been no prior impairment. Due to the subjective nature of these estimates, significant judgment is required in determining the useful lives and recoverable amounts of our intangible assets, and assessing whether certain events or circumstances constitute objective evidence of impairment. Estimates of the recoverable amounts of our intangible assets rely on certain key inputs, including future cash flows and discount rates. Future cash flows are based on sales projections and allocated costs which are estimated based on forecast results and business initiatives. Discount rates are based on the bank-wide cost of capital, adjusted for asset- specific risks. Changes in these assumptions may impact the amount of impairment loss recognized in Non-interest expense. Other Translation of foreign currencies Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at rates prevailing at the balance sheet date. Foreign exchange gains and losses resulting from the translation and settlement of these items are recognized in Non-interest income in the Consolidated Statements of Income. Non-monetary assets and liabilities that are measured at historical cost are translated into Canadian dollars at historical rates. 136 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Assets and liabilities of our foreign operations with functional currencies other than Canadian dollars are translated into Canadian dollars at rates prevailing at the balance sheet date, and income and expenses of these foreign operations are translated at average rates of exchange for the reporting period. Unrealized gains or losses arising as a result of the translation of our foreign operations along with the effective portion of related hedges are reported in Other components of equity on an after-tax basis. Upon disposal or partial disposal of a foreign operation, an appropriate portion of the accumulated net translation gains or losses is included in Non-interest income. Premises and equipment Premises and equipment includes land, buildings, leasehold improvements, computer equipment, furniture, fixtures and other equipment, and are stated at cost less accumulated depreciation, except for land which is not depreciated, and accumulated impairment losses. Cost comprises the purchase price, any costs directly attributable to bringing the asset to the location and condition necessary for its intended use, and the initial estimate of any disposal costs. Depreciation is recorded principally on a straight-line basis over the estimated useful lives of the assets, which are 25 to 50 years for buildings, 3 to 10 years for computer equipment, and 5 to 10 years for furniture, fixtures and other equipment. The amortization period for leasehold improvements is the lesser of the useful life of the leasehold improvements or the lease term plus the first renewal period, if reasonably assured of renewal, up to a maximum of 10 years. Depreciation methods, useful lives, and residual values are reassessed at each reporting period and adjusted as appropriate. Gains and losses on disposal are recorded in Non-interest income. Premises and equipment are assessed for indicators of impairment at each reporting period. If there is an indication that an asset may be impaired, an impairment test is performed by comparing the asset’s carrying amount to its recoverable amount. After the recognition of impairment, the depreciation charge is adjusted in future periods to reflect the asset’s revised carrying amount. If an impairment is later reversed, the carrying amount of the asset is revised to the lower of the asset’s recoverable amount and the carrying amount that would have been determined (net of depreciation) had there been no prior impairment loss. The depreciation charge in future periods is adjusted to reflect the revised carrying amount. Provisions Provisions are liabilities of uncertain timing or amount and are recognized when we have a present legal or constructive obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are measured as the best estimate of the consideration required to settle the present obligation at the reporting date. Significant judgment is required in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. We record provisions related to litigation, uncertain tax positions, asset retirement obligations and other items. We are required to estimate the results of ongoing legal proceedings, tax positions that are under audit or appeal by relevant taxation authorities, and expenses to be incurred to dispose of capital assets. The forward-looking nature of these estimates requires us to use a significant amount of judgment in projecting the timing and amount of future cash flows. We record our provisions on the basis of all available information at the end of the reporting period and make adjustments on a quarterly basis to reflect current expectations. It may not be possible to predict the resolution of these matters or the timing of their ultimate resolution. Should actual results differ from our expectations, we may incur expenses in excess of the provisions recognized. Where appropriate, we apply judgment in limiting the extent of our provisions-related disclosures as not to prejudice our positions in matters of dispute. When some or all of the economic benefits required to settle a provision are expected to be recovered from a third party, such as an insurer, a separate asset is recognized if it is virtually certain that reimbursement will be received. Commissions and fees – Policies applicable beginning November 1, 2018 (IFRS 15) Commissions and fees primarily relate to Investment management and custodial fees, Mutual fund revenue, Securities brokerage commissions, Services charges, Underwriting and other advisory fees, Card service revenue and Credit fees, and are recognized based on the applicable service contracts with customers. Investment management and custodial fees and Mutual fund revenue are generally calculated as a percentage of daily or period-end net asset values (NAV) based on the terms of the contract with customers and are received monthly, quarterly, semiannually or annually, depending on the terms of the contract. Investment management and custodial fees are generally derived from assets under management (AUM) when our clients solicit the investment capabilities of an investment manager or from assets under administration (AUA) where the investment strategy is directed by the client or a designated third party manager. Mutual fund revenue is derived from the daily NAV of the mutual funds. Investment management and custodial fees and Mutual fund revenue are recognized over time when the service is provided to the customer, provided that it is highly probable that a significant reversal in the amount of revenue recognized will not occur. Commissions earned on Securities brokerage services and Service charges that are related to the provision of specific transaction-type services are recognized when the service is fulfilled. Where services are provided over time, revenue is recognized as the services are provided. Underwriting and other advisory fees primarily relate to underwriting of new issuances of debt or equity and various advisory services. Underwriting fees are generally expressed as a percentage of the funds raised through issuance and are recognized when the service has been completed. Advisory fees vary depending on the scope and type of engagement and can be fixed in nature or contingent on a future event. Advisory fees are recognized over the period in which the service is provided and are recognized only to the extent that it is highly probable that a significant reversal in the amount of revenue will not occur. Card service revenue primarily includes interchange revenue and annual card fees. Interchange revenue is calculated as a fixed percentage of the transaction amount and recognized when the card transaction is settled. Annual card fees are fixed fees and are recognized over a 12 month period. Credit fees are primarily earned for arranging syndicated loans and making credit available on undrawn facilities. The timing of the recognition of credit fees varies based on the nature of the services provided. When service fees and other costs are incurred in relation to commissions and fees earned, we record these costs on a gross basis in either Non-interest expense – Other or Non-interest expense – Human resources based on our assessment of whether we have primary responsibility to fulfill the contract with the customer and have discretion in establishing the price for the commissions and fees earned, which may require judgment. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 137 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Commissions and fees – Policies applicable prior to November 1, 2018 (IAS 18 – Revenue) Portfolio management and other management advisory and service fees are recognized based on the applicable service contracts. Fees related to provision of services including asset management, wealth management, financial planning and custody services that cover a specified service period, are recognized over the period in which the service is provided. Investment management and custodial fees are generally calculated as a percentage of daily or period-end net asset values, and are received monthly, quarterly, semi-annually or annually, depending on the terms of the contracts. Management fees are generally derived from AUM when our clients solicit the investment capabilities of an investment manager and administrative fees are derived from AUA where the investment strategy is directed by the client or a designated third party manager. Performance-based fees, which are earned upon exceeding certain benchmarks or performance targets, are recognized only when the benchmark or performance targets are achieved. Fees such as underwriting fees and brokerage fees that are related to the provision of specific transaction type services are recognized when the service has been completed. When service fees and other costs are incurred in relation to commissions and fees earned and we have significant risks and rewards associated with delivering the service, we record these costs on a gross basis in either Non-interest expense – Other or Non-interest expense – Human resources, as applicable. Leasing A lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed upon period of time in return for a payment or series of payments. A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of the leased asset to the lessee, where title may or may not eventually be transferred. An operating lease is a lease other than a finance lease. Operating leases When we are the lessee in an operating lease, we record rental payments on a straight-line basis over the lease term in Non-interest expense. Finance leases When we are the lessee in a finance lease, we initially record both the leased asset and the related lease obligation in Premises and equipment, Other intangibles and Other liabilities on our Consolidated Balance Sheets at an amount equal to the fair value of the leased asset or, if lower, the present value of the minimum lease payments, each determined at the date of inception of the lease. Initial direct costs directly attributed to the lease are recognized as an asset under the finance lease. Earnings per share Earnings per share is computed by dividing Net income available to common shareholders by the weighted average number of common shares outstanding for the period. Net income available to common shareholders is determined after deducting dividend entitlements of preferred shareholders, any gains (losses) on redemption of preferred shares net of related income taxes and the net income attributable to non-controlling interests. Diluted earnings per share reflects the potential dilution that could occur if additional common shares are assumed to be issued under securities or contracts that entitle their holders to obtain common shares in the future, to the extent such entitlement is not subject to unresolved contingencies. For contracts that may be settled in cash or in common shares at our option, diluted earnings per share is calculated based on the assumption that such contracts will be settled in shares. Income and expenses associated with these types of contracts are excluded from the Net income available to common shareholders, and the additional number of shares that would be issued is included in the diluted earnings per share calculation. This includes certain convertible shares with the conversion assumed to have taken place at the beginning of the period or on the date of issue, if later. For stock options whose exercise price is less than the average market price of our common shares, using the treasury stock method, they are assumed to be exercised and the proceeds are used to repurchase common shares at the average market price for the period. The incremental number of common shares issued under stock options and repurchased from proceeds is included in the calculation of diluted earnings per share. Share capital We classify a financial instrument that we issue as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. Our common shares held by us are classified as treasury shares in equity and accounted for at weighted average cost. Upon the sale of treasury shares, the difference between the sale proceeds and the cost of the shares is recognized in Retained earnings. Financial instruments issued by us are classified as equity instruments when there is no contractual obligation to transfer cash or other financial assets. Incremental costs directly attributable to the issue of equity instruments are included in equity as a deduction from the proceeds, net of tax. Financial instruments that will be settled by a variable number of our common shares upon their conversion by the holders as well as the related accrued distributions are classified as liabilities on our Consolidated Balance Sheets. Dividends and yield distributions on these instruments are classified as Interest expense in our Consolidated Statements of Income. Future changes in accounting policy and disclosure The following standards have been issued, but are not yet effective for us. IFRS 16 Leases(IFRS 16) In January 2016, the IASB issued IFRS 16, which sets out the principles for the recognition, measurement, presentation and disclosure of leases. The standard removes the current requirement for lessees to classify leases as finance leases or operating leases by introducing a single accounting model that requires the recognition of right-of-use assets and lease liabilities on the balance sheet for most leases. Lessees will recognize interest expense on the lease liability and depreciation expense on the right-of-use asset in the statement of income. IFRS 16 will be effective for us on November 1, 2019. We will adopt IFRS 16 by adjusting our Consolidated Balance Sheet as at November 1, 2019, the date of initial application, with no restatement of comparative periods. On transition to IFRS 16, we intend to apply certain practical expedients, including the following: (cid:129) Election to not separate lease and non-lease components, to be applied to our real estate leases; 138 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements (cid:129) (cid:129) Election to measure the right-of-use asset as if IFRS 16 had been applied since the commencement date of the lease, to be applied on a lease-by-lease basis to a select number of properties; and Exemption from recognition for short-term and low value leases. Based on current estimates, the adoption of IFRS 16 as at November 1, 2019 is expected to result in increases to total assets and total liabilities of approximately $5 billion, primarily representing leases of premises and equipment previously classified as operating leases, and a reduction to retained earnings of approximately $0.1 billion, net of taxes. The adoption of IFRS 16 is also expected to decrease our CET1 capital ratio by approximately 14 bps. IFRS Interpretations Committee Interpretation 23 Uncertaintyoverincometaxtreatments (IFRIC 23) In June 2017, the IASB issued IFRIC 23, which provides guidance on the recognition and measurement of tax assets and liabilities under IAS 12 Income taxes when there is uncertainty over income tax treatments. IFRIC 23 will be effective for us on November 1, 2019. We do not expect the adoption of this interpretation to impact our consolidated financial statements. Interest Rate Benchmark Reform In September 2019, the IASB issued amendments to IFRS 9 Financial Instruments, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures (Amendments) which modify certain hedge accounting requirements to provide relief from the potential effect of uncertainty caused by the Interest Rate Benchmark Reform, prior to the transition to alternative interest rates. The Amendments will be effective for us on November 1, 2020, with earlier adoption permitted. To manage our transition to alternative interest rates, we have implemented a comprehensive enterprise-wide program and governance structure that focuses on key areas of impact including contract changes with clients, capital and liquidity planning, financial reporting and valuation, systems, processes, education and communication. We are currently assessing the impact of adoption on our Consolidated Financial Statements. Conceptual Framework for Financial Reporting (Conceptual Framework) In March 2018, the IASB issued its revised Conceptual Framework. This replaces the previous version of the Conceptual Framework issued in 2010. The revised Conceptual Framework will be effective on November 1, 2020. We are currently assessing the impact of adoption on our Consolidated Financial Statements. IFRS 17 Insurance Contracts (IFRS 17) In May 2017, the IASB issued IFRS 17 to establish a comprehensive global insurance standard which provides guidance on the recognition, measurement, presentation and disclosures of insurance contracts. IFRS 17 requires entities to measure insurance contract liabilities at their current fulfillment values using one of three approaches. This new standard will be effective for us on November 1, 2021 and will be applied retrospectively with restatement of comparatives unless impracticable. In June 2019, the IASB issued an exposure draft to amend IFRS 17, including deferral of the effective date by one year. We will continue to monitor the IASB’s developments. We are currently assessing the impact of adopting this standard and the proposed amendments on our Consolidated Financial Statements. Note 3 Fair value of financial instruments Carrying value and fair value of financial instruments The following tables provide a comparison of the carrying and fair values for each classification of financial instruments. Embedded derivatives are presented on a combined basis with the host contracts. For measurement purposes, they are carried at fair value when conditions requiring separation are met. (Millions of Canadian dollars) Financial assets Interest-bearing deposits with banks Securities Trading Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans, net of applicable allowance Retail Wholesale Other Derivatives Other assets (1) Financial liabilities Deposits Personal Business and government (2) Bank (3) Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities (4) Subordinated debentures Carrying value and fair value Carrying value Fair value As at October 31, 2019 Financial instruments classified as FVTPL Financial instruments designated as FVTPL Financial instruments classified as FVOCI Financial instruments designated as FVOCI Financial instruments measured at amortized cost Financial instruments measured at amortized cost Total carrying amount Total fair value $ – $ 22,283 $ – $ – $ 16,062 $ 16,062 $ 38,345 $ 38,345 137,600 – 137,600 8,934 – 8,934 – 57,223 57,223 246,068 – 275 7,055 7,330 101,560 3,156 242 1,856 2,098 – – – 95 451 546 – – – 463 463 – – – – – – – 44,784 44,784 – 45,104 45,104 146,534 102,470 249,004 146,534 102,790 249,324 60,893 60,894 306,961 306,962 423,469 185,413 608,882 – 50,375 424,416 184,645 609,061 424,081 194,775 618,856 425,028 194,007 619,035 – 50,375 101,560 53,531 101,560 53,531 $ 140 $ 151 – 291 17,394 111,389 3,032 131,815 $ 277,198 453,942 22,759 753,899 $ 277,353 $294,732 $294,887 564,076 565,482 452,536 25,805 25,791 22,773 884,768 886,005 752,662 35,069 – – – 35,069 35,069 – 98,543 (1,209) – 218,612 – 91 – 7,974 – 61,039 9,815 7,974 – 61,024 9,930 226,586 98,543 59,921 9,815 226,586 98,543 59,906 9,930 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 139 Note 3 Fair value of financial instruments (continued) Carrying value and fair value Carrying value Fair value As at October 31, 2018 Financial instruments classified as FVTPL Financial instruments designated as FVTPL Financial instruments classified as FVOCI Financial instruments designated as FVOCI Financial instruments measured at amortized cost Financial instruments measured at amortized cost Total carrying amount Total fair value $ – $ 20,274 $ – $ – $ 16,197 $ 16,197 $ 36,471 $ 36,471 7,227 – 7,227 – 190 1,540 1,730 – – – 48,093 48,093 – 94 458 552 – – – 406 406 – – – – – – – 46,109 46,109 – 45,367 45,367 128,258 94,608 222,866 128,258 93,866 222,124 75,494 75,490 294,602 294,598 397,102 170,236 567,338 – 46,205 394,051 168,087 562,138 397,455 179,363 576,818 394,404 177,214 571,618 – 46,205 94,039 47,578 94,039 47,578 (Millions of Canadian dollars) Financial assets Interest-bearing deposits with banks Securities Trading Investment, net of applicable allowance 121,031 – 121,031 Assets purchased under reverse repurchase agreements and securities borrowed 219,108 Loans, net of applicable allowance Retail Wholesale Other Derivatives Other assets (1) Financial liabilities Deposits 69 7,129 7,198 94,039 1,373 Personal Business and government (2), (3) Bank (4) $ 150 $ (11) – 139 14,602 102,597 7,072 124,271 Other Obligations related to securities sold short Obligations related to assets sold under 32,247 – repurchase agreements and securities loaned Derivatives Other liabilities (3), (5) Subordinated debentures – 90,238 (1,434) – 201,839 – 18 – $ $ 255,402 430,936 25,449 711,787 255,115 $ 270,154 $ 269,867 533,744 533,522 431,158 32,534 32,521 25,462 836,145 836,197 711,735 – – 32,247 32,247 4,975 – 55,766 9,131 4,976 – 55,729 9,319 206,814 90,238 54,350 9,131 206,815 90,238 54,313 9,319 (1) (2) (3) (4) (5) Includes Customers’ liability under acceptances and financial instruments recognized in Other assets. Business and government deposits include deposits from regulated deposit-taking institutions other than banks. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Amounts have been reclassified to conform with this presentation. Bank deposits refer to deposits from regulated banks and central banks. Includes Acceptances and financial instruments recognized in Other liabilities. Financial assets designated as fair value through profit or loss For our financial assets designated as FVTPL, we measure the change in fair value attributable to changes in credit risk as the difference between the total change in the fair value of the instrument during the period and the change in fair value calculated using the appropriate risk-free yield curves. For the years ended October 31, 2019 and October 31, 2018, there were no significant changes in the fair value of the loans and receivables designated as FVTPL attributable to changes in credit risk. As at October 31, 2019, the extent to which credit derivatives or similar instruments mitigate the maximum exposure to credit risk was $514 million (October 31, 2018 – $nil). Financial liabilities designated as fair value through profit or loss For our financial liabilities designated as FVTPL, we take into account changes in our own credit spread and the expected duration of the instrument to measure the change in fair value attributable to changes in credit risk. . As at or for the year ended October 31, 2019 (1) (Millions of Canadian dollars) Term deposits Personal Business and government (3) Bank (4) Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Contractual maturity amount $ 17,307 $ 110,763 3,031 131,101 Carrying value 17,394 111,389 3,032 131,815 218,604 91 218,612 91 $ 349,796 $ 350,518 Difference between carrying value and contractual maturity amount Changes in fair value attributable to changes in credit risk included in OCI for positions still held During the period Cumulative (2) $ $ 87 626 1 714 8 – 722 $ $ 3 (76) – (73) – – (73) $ 22 210 – 232 – – $ 232 140 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements . As at or for the year ended October 31, 2018 (1) (Millions of Canadian dollars) Term deposits Personal Business and government (3), (5) Bank (4) Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Contractual maturity amount $ 14,726 $ 102,640 7,067 124,433 Carrying value 14,602 102,597 7,072 124,271 201,924 18 201,839 18 326,375 $ 326,128 $ Difference between carrying value and contractual maturity amount Changes in fair value attributable to changes in credit risk included in OCI for positions still held During the period Cumulative (2) $ $ (124) (43) 5 (162) (85) – (247) $ $ (41) (134) – (175) – – (175) $ 19 285 – 304 – – $ 304 (1) (2) (3) (4) (5) There are no changes in fair value attributable to changes in credit risk included in net income for positions still held. The cumulative change is measured from the initial designation of the liabilities as FVTPL. For the year ended October 31, 2019, $4 million of fair value losses previously included in OCI relate to financial liabilities derecognized during the year (October 31, 2018 – $7 million fair value losses). Business and government term deposits include amounts from regulated deposit-taking institutions other than regulated banks. Bank term deposits refer to amounts from regulated banks and central banks. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Amounts have been reclassified to conform with this presentation. Net gains (losses) from financial instruments classified and designated as fair value through profit or loss Financial instruments classified as FVTPL, which includes mainly trading securities, derivatives, trading liabilities, and financial assets and liabilities designated as FVTPL are measured at fair value with realized and unrealized gains and losses recognized in Non-interest income. (Millions of Canadian dollars) Net gains (losses) (1) Classified as fair value through profit or loss (2) Designated as fair value through profit or loss (3), (4) By product line (1) Interest rate and credit (4), (5) Equities Foreign exchange and commodities For the year ended October 31 2019 October 31 2018 $ $ $ $ 3,564 (1,821) 1,743 1,534 (144) 353 1,743 $ $ $ $ (265) 2,067 1,802 1,535 (164) 431 1,802 (1) (2) (3) (4) (5) Excludes the following amounts related to our insurance operations and included in Insurance premiums, investment and fee income in the Consolidated Statements of Income: Net gains from financial instruments designated as FVTPL of $1,303 million (October 31, 2018 – losses of $400 million). Excludes derivatives designated in a hedging relationship. Refer to Note 8 for net gains (losses) on these derivatives. For the year ended October 31, 2019, $1,810 million of net fair value losses on financial liabilities designated as FVTPL, other than those attributable to changes in our own credit risk, were included in Non-interest income (October 31, 2018 – gains of $2,052 million). Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. Includes gains (losses) recognized on cross currency interest rate swaps. Net interest income from financial instruments Interest and dividend income arising from financial assets and financial liabilities and the associated costs of funding are reported in Net interest income. (Millions of Canadian dollars) Interest and dividend income (2), (3) Financial instruments measured at fair value through profit or loss (4) Financial instruments measured at fair value through other comprehensive income Financial instruments measured at amortized cost Interest expense (2) Financial instruments measured at fair value through profit or loss (4) Financial instruments measured at amortized cost Net interest income For the year ended October 31 2019 October 31 2018 (1) $ 12,103 1,132 28,098 41,333 $ 10,507 11,077 21,584 $ 19,749 $ $ $ 7,800 802 24,419 33,021 6,542 8,527 15,069 17,952 (1) (2) (3) (4) Amounts have been revised from those previously presented. Excludes the following amounts related to our insurance operations and included in Insurance premiums, investment and fee income in the Consolidated Statements of Income: Interest income of $486 million (October 31, 2018 – $479 million), and Interest expense of $4 million (October 31, 2018 – $4 million). Includes dividend income for the year ended October 31, 2019 of $2,057 million (October 31, 2018 – $1,561 million), which is presented in Interest and dividend income in the Consolidated Statements of Income. Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 141 Note 3 Fair value of financial instruments (continued) Fee income arising from financial instruments For the year ended October 31, 2019, we earned $5,270 million in fees from banking services (October 31, 2018 – $5,426 million). For the year ended October 31, 2019, we also earned $12,117 million in fees from investment management, trust, custodial, underwriting, brokerage and other similar fiduciary services to retail and institutional clients (October 31, 2018 – $11,944 million). These fees are included in Non-interest income. Fair value of assets and liabilities measured at fair value on a recurring basis and classified using the fair value hierarchy (Millions of Canadian dollars) Financial assets Interest-bearing deposits with banks Securities Trading Debt issued or guaranteed by: Canadian government (1) Federal Provincial and municipal U.S. state, municipal and agencies (1) Other OECD government (2) Mortgage-backed securities (1) Asset-backed securities Non-CDO securities (3) Corporate debt and other debt Equities Investment Debt issued or guaranteed by: Canadian government (1) Federal Provincial and municipal U.S. state, municipal and agencies (1) Other OECD government Mortgage-backed securities (1) Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Assets purchased under reverse repurchase agreements and securities borrowed Loans Other Derivatives Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Total gross derivatives Netting adjustments Total derivatives Other assets Financial liabilities Deposits Personal Business and government (4) Bank Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Total gross derivatives Netting adjustments Total derivatives Other liabilities October 31, 2019 October 31, 2018 Fair value measurements using Netting Fair value measurements using Netting Level 1 Level 2 Level 3 adjustments Fair value Level 1 Level 2 Level 3 adjustments Fair value As at $ – $ 22,283 $ – $ $ 22,283 $ – $ 20,274 $ – $ $ 20,274 14,655 – 2,050 2,786 – – 1 38,309 5,474 11,282 39,584 3,710 482 1,333 23,643 1,925 – – 58 – – 2 21 1,219 57,801 87,433 1,300 – – 210 – – – – – 42 657 2,898 20,666 4,251 2,675 7,300 849 17,537 127 252 56,960 – – 246,068 9,294 1 – – 2,852 – 2,853 46,095 40,768 169 12,674 (712) 98,994 – – – – 27 – – 153 294 474 – 680 349 48 – 11 15 423 (710) 1,119 1,960 77 20,129 11,282 41,692 6,496 482 1,335 23,665 41,453 146,534 657 2,898 20,876 4,251 2,702 7,300 849 17,690 463 57,686 246,068 9,974 46,445 40,816 169 15,537 (697) 102,270 (710) 101,560 3,156 8,342 – 2,068 1,151 – – 2 30,847 42,410 – – – – – – – – 42 42 – – 1 – – 5,868 – 5,869 6,231 11,350 31,030 9,018 1,001 1,023 22,303 2,547 84,503 238 1,554 18,136 1,470 2,174 6,239 863 17,227 127 48,028 219,108 8,929 33,862 43,253 38 11,654 (631) 88,176 – – 66 – – 110 21 1,148 1,345 – – – – – – – 192 237 429 – 551 222 53 – 296 6 577 (583) 1,020 288 65 14,573 11,350 33,164 10,169 1,001 1,133 22,326 34,542 128,258 238 1,554 18,136 1,470 2,174 6,239 863 17,419 406 48,499 219,108 9,480 34,085 43,306 38 17,818 (625) 94,622 (583) 94,039 1,373 $62,025 $522,992 $ 2,954 $ (710) $ 587,261 $ 49,341 $ 469,306 $ 2,967 $ (583) $ 521,031 $ – $ 17,378 $ 111,540 – 3,032 – 156 $ – – $ $ 17,534 111,540 3,032 – $ – – 14,362 $ 102,591 7,072 390 $ (5) – 20,512 14,557 – 218,612 39,165 40,183 282 15,776 12 – – – 2,675 – 2,675 – – 934 27 – 206 (7) 35,069 17,732 14,515 218,612 – 201,839 29,620 41,836 94 13,730 29 – – – 4,369 – 4,369 40,099 40,210 282 18,657 5 99,253 (710) 98,543 (1,118) – – 726 32 – 380 5 95,418 1,160 (710) 85,309 1,143 (583) $ 14,752 102,586 7,072 32,247 201,839 30,346 41,868 94 18,479 34 90,821 (583) 90,238 (1,416) 102 (1,280) 60 170 (1,654) 68 $23,289 $459,257 $ 1,376 $ (710) $ 483,212 $ 22,271 $ 424,034 $ 1,596 $ (583) $ 447,318 (1) (2) (3) (4) As at October 31, 2019, residential and commercial mortgage-backed securities (MBS) included in all fair value levels of trading securities were $22,365 million and $nil (October 31, 2018 – $16,776 million and $nil), respectively, and in all fair value levels of Investment securities were $6,474 million and $2,046 million (October 31, 2018 – $4,713 million and $1,348 million), respectively. OECD stands for Organisation for Economic Co-operation and Development. CDO stands for collateralized debt obligations. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. 142 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Fair values of our significant assets and liabilities measured on a recurring basis are determined and classified in the fair value hierarchy table using the following valuation techniques and inputs. Interest-bearing deposits with banks The majority of our Interest-bearing deposits with banks are designated as FVTPL. These FVTPL deposits are composed of short- dated deposits placed with banks, and are included in Interest-bearing deposits with banks in the fair value hierarchy table. The fair values of these instruments are determined using the discounted cash flow method. The inputs to the valuation models include interest rate swap curves and credit spreads, where applicable. They are classified as Level 2 instruments in the hierarchy as the inputs are observable. Government bonds (Canadian, U.S. and other OECD governments) Government bonds are included in Canadian government debt, U.S. state, municipal and agencies debt, Other OECD government debt and Obligations related to securities sold short in the fair value hierarchy table. The fair values of government issued or guaranteed debt securities in active markets are determined by reference to recent transaction prices, broker quotes, or third- party vendor prices and are classified as Level 1 in the hierarchy. The fair values of securities that are not traded in active markets are based on either security prices, or valuation techniques using implied yields and risk spreads derived from prices of actively traded and similar government securities. Securities with observable prices or rate inputs as compared to transaction prices, dealer quotes or vendor prices are classified as Level 2 in the hierarchy. Securities where inputs are unobservable are classified as Level 3 in the hierarchy. Corporate and U.S. municipal bonds The fair values of corporate and U.S. municipal bonds, which are included in Corporate debt and other debt, U.S. state, municipal and agencies debt and Obligations related to securities sold short in the fair value hierarchy table, are determined using either recently executed transaction prices, broker quotes, pricing services, or in certain instances, the discounted cash flow method using rate inputs such as benchmark yields (Canadian Dealer Offered Rate, LIBOR and other similar reference rates) and risk spreads of comparable securities. Securities with observable prices or rate inputs are classified as Level 2 in the hierarchy. Securities where inputs are unobservable are classified as Level 3 in the hierarchy. Asset-backed securities and Mortgage-backed securities Asset-backed securities (ABS) and MBS are included in Asset-backed securities, Mortgage-backed securities, Canadian government debt, U.S. state, municipal and agencies debt, and Obligations related to securities sold short in the fair value hierarchy table. Inputs for valuation of ABS and MBS are, when available, traded prices, dealer or lead manager quotes, broker quotes and vendor prices of the identical securities. When prices of the identical securities are not readily available, we use industry standard models with inputs such as discount margins, yields, default, prepayment and loss severity rates that are implied from transaction prices, dealer quotes or vendor prices of comparable instruments. Where security prices and inputs are observable, ABS and MBS are classified as Level 2 in the hierarchy. Otherwise, they are classified as Level 3 in the hierarchy. Equities Equities consist of listed and unlisted common shares, private equities, mutual funds and hedge funds with certain redemption restrictions and are included in equities and obligations for securities sold short. The fair values of common shares are based on quoted prices in active markets, where available, and are classified as Level 1 in the hierarchy. Where quoted prices in active markets are not readily available, fair value is determined based on quoted market prices for similar securities or through valuation techniques, such as multiples of earnings and the discounted cash flow method with forecasted cash flows and discount rate as inputs. Private equities are classified as Level 3 in the hierarchy as their inputs are not observable. Hedge funds are valued using Net Asset Values (NAV). If we can redeem a hedge fund at NAV prior to the next quarter end, the fund is classified as Level 2 in the hierarchy. Otherwise, it is classified as Level 3 in the hierarchy. Loans Loans include base metal loans, corporate loans, banker acceptances and asset-backed financing loans. Fair values are determined based on market prices, if available, or discounted cash flow method using the following inputs: market interest rates, base metal commodity prices, market based spreads of assets with similar credit ratings and terms to maturity, LGD, expected default frequency implied from credit derivative prices, if available, and relevant pricing information such as contractual rate, origination and maturity dates, redemption price, coupon payment frequency and day count convention. Loans with market prices or observable inputs are classified as Level 2 in the hierarchy and loans with unobservable inputs that have significant impacts on the fair values are classified as Level 3 in the hierarchy. Derivatives The fair values of exchange-traded derivatives, such as interest rate and equity options and futures, are based on quoted market prices and are classified as Level 1 in the hierarchy. OTC derivatives primarily consist of interest rate contracts, foreign exchange contracts and credit derivatives. The exchange-traded or OTC interest rate, foreign exchange and equity derivatives are included in Interest rate contracts, Foreign exchange contracts and Other contracts, respectively, in the fair value hierarchy table. The fair values of OTC derivatives are determined using valuation models when quoted market prices or third-party consensus pricing information are not available. The valuation models, such as discounted cash flow method or Black-Scholes option model, incorporate observable or unobservable inputs for interest and foreign exchange rates, equity and commodity prices (including indices), credit spreads, corresponding market volatility levels, and other market-based pricing factors. Other adjustments to fair value include bid-offer, CVA, FVA, OIS, parameter and model uncertainties, and unrealized gain or loss at inception of a transaction. A derivative instrument is classified as Level 2 in the hierarchy if observable market inputs are available or the unobservable inputs are not significant to the fair value. Otherwise, it is classified as Level 3 in the hierarchy. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 143 Note 3 Fair value of financial instruments (continued) Securities borrowed or purchased under resale agreements and securities loaned or sold under repurchase agreements In the fair value hierarchy table, these instruments are included in Assets purchased under reverse repurchase agreements and securities borrowed, and Obligations related to assets sold under repurchase agreements and securities loaned. The fair values of these contracts are determined using valuation techniques such as the discounted cash flow method using interest rate curves as inputs. They are classified as Level 2 instruments in the hierarchy as the inputs are observable. Deposits A majority of our deposits are measured at amortized cost but certain deposits are designated as FVTPL. These FVTPL deposits include deposits taken from clients, issuances of certificates of deposits and promissory notes, and interest rate and equity linked notes. The fair values of these instruments are determined using the discounted cash flow method and derivative option valuation models. The inputs to the valuation models include benchmark yield curves, credit spreads, interest rates, equity and interest rate volatility, dividends and correlation, where applicable. They are classified as Level 2 or 3 instruments in the hierarchy, depending on the significance of the unobservable credit spreads, volatility, dividend and correlation rates. Quantitative information about fair value measurements using significant unobservable inputs (Level 3 Instruments) The following table presents fair values of our significant Level 3 financial instruments, valuation techniques used to determine their fair values, ranges and weighted averages of unobservable inputs. As at October 31, 2019 (Millions of Canadian dollars, except for prices, percentages and ratios) Fair value Range of input values (1), (2) Products Reporting line in the fair value hierarchy table Assets Liabilities Valuation techniques Significant unobservable inputs (3) Low High Weighted average / Inputs distribution Non-derivative financial instruments Auction rate securities Corporate debt Government debt and municipal bonds U.S. state, municipal and agencies debt Asset-backed securities Corporate debt and other debt Loans U.S. state, municipal and agencies debt Mortgage-backed securities Corporate debt and other debt 58 2 24 680 – 27 150 Discounted cash flows Discount margins Default rates 1.60% 3.00% 3.00% 3.00% Price-based Discounted cash flows Price-based Discounted cash flows Prepayment rates Recovery rates 8.00% 8.00% 96.50% 96.50% Prices Credit spread Credit enhancement $ 20.00 $131.78 $ 1.02% 11.34% 11.82% 15.75% Prices Yields $ 65.50 $100.00 $ 4.70% 6.63% Private equities, hedge fund investments and related equity derivatives Equities Derivative related liabilities 1,513 Market comparable Price-based 10 Discounted cash flows EV/EBITDA multiples P/E multiples EV/Rev multiples Liquidity discounts (4) Discount rate NAV / prices (5) 4.00X 9.70X 0.90X 24.90X 29.90X 5.93X 10.00% 40.00% 10.00% 12.00% n.a. n.a. Derivative financial instruments (6) Interest rate derivatives and Derivative related assets Derivative related liabilities interest-rate-linked structured notes (7) Equity derivatives and equity- linked structured notes (7) Other (8) Total 380 943 Discounted cash flows Option pricing model Interest rates CPI swap rates IR-IR correlations FX-IR correlations FX-FX correlations 1.27% 1.40% 2.16% 2.00% 19.00% 67.00% 29.00% 56.00% 68.00% 68.00% Discounted cash flows Option pricing model Dividend yields Equity (EQ)-EQ correlations EQ-FX correlations EQ volatilities 0.10% 8.77% 34.00% 95.40% (71.40)% 30.50% 4.00% 110.00% Derivative related assets Deposits Derivative related liabilities Derivative related assets Other assets Deposits Derivative related liabilities Other liabilities 11 32 77 156 180 – 27 60 $ 2,954 $ 1,376 1.65% 3.00% 8.00% 96.50% 110.30 6.18% 13.13% 65.67 5.80% 10.23X 16.11X 3.55X 17.64% 10.45% n.a. Even Even Even Even Even Lower Middle Middle Upper 144 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements As at October 31, 2018 (Millions of Canadian dollars, except for prices, percentages and ratios) Fair value Range of input values (1), (2) Products Reporting line in the fair value hierarchy table Assets Liabilities Valuation techniques Significant unobservable inputs (3) Low High Weighted average / Inputs distribution Non-derivative financial instruments Auction rate securities U.S. state, municipal and agencies debt Asset-backed securities 45 110 Corporate debt Government debt and municipal bonds Corporate debt and other debt Loans U.S. state, municipal and agencies debt Mortgage-backed securities Corporate debt and other debt Private equities, hedge fund investments and related equity derivatives Equities Derivative related liabilities 28 551 21 – 185 1,385 Discounted cash flows Price-based Discounted cash flows Price-based Discounted cash flows Discount margins Default rates Prepayment rates Recovery rates 1.32% 3.00% 4.00% 96.50% 2.70% 3.00% 5.50% 97.50% Prices $ Credit spread Credit enhancement 72.00 $ 123.06 $ 0.90% 11.80% 11.30% 15.80% Prices $ Yields 65.50 $ 100.00 $ 3.50% 7.60% Market comparable Price-based 24 Discounted cash flows EV/EBITDA multiples P/E multiples EV/Rev multiples Liquidity discounts (4) Discount rate NAV / prices (5) Interest rates CPI swap rates IR-IR correlations FX-IR correlations FX-FX correlations 6.16X 9.10X 0.90X 10.00% 10.52% n.a. 2.30% 1.90% 19.00% 29.00% 68.00% 17.80X 26.41X 6.63X 40.00% 10.52% n.a. 3.00% 2.10% 67.00% 56.00% 68.00% 1.95% 3.00% 4.56% 96.59% 103.84 4.50% 13.10% 66.41 5.75% 14.46X 18.26X 4.86X 18.27% 10.52% n.a. Even Even Even Even Even Lower Middle Middle Upper Derivative related assets Derivative related liabilities 260 Discounted cash flows Option pricing model 740 Derivative financial instruments (6) Interest rate derivatives and interest-rate-linked structured notes (7) Equity derivatives and equity- linked structured notes (7) Other (8) Derivative related assets Deposits Derivative related liabilities Derivative related assets Other assets Deposits Derivative related liabilities Other liabilities Discounted cash flows Dividend yields Option pricing model Equity (EQ)-EQ correlations EQ-FX correlations EQ volatilities 0.30% 8.40% (55.00)% 100.00% 30.50% (71.40)% 8.00% 164.00% 390 328 281 36 65 (5) 51 68 $ 2,967 $ 1,596 Total (1) (2) (3) (4) (5) (6) (7) (8) The low and high input values represent the actual highest and lowest level inputs used to value a group of financial instruments in a particular product category. These input ranges do not reflect the level of input uncertainty, but are affected by the different underlying instruments within the product category. The input ranges will therefore vary from period to period based on the characteristics of the underlying instruments held at each balance sheet date. Where provided, the weighted average of the input values is calculated based on the relative fair values of the instruments within the product category. The weighted averages for derivatives are not presented in the table as they would not provide a comparable metric; instead, distribution of significant unobservable inputs within the range for each product category is indicated in the table. Price-based inputs are significant for certain debt securities and are based on external benchmarks, comparable proxy instruments or pre-quarter-end trade data. For these instruments, the price input is expressed in dollars for each $100 par value. For example, with an input price of $105, an instrument is valued at a premium over its par value. The acronyms stand for the following: (i) Enterprise Value (EV); (ii) Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA); (iii) Price / Earnings (P/E); (iv) Revenue (Rev); (v) Consumer Price Index (CPI); (vi) Interest Rate (IR); (vii) Foreign Exchange (FX); and (viii) Equity (EQ). Fair value of securities with liquidity discount inputs totalled $255 million (October 31, 2018 – $207 million). NAV of a hedge fund is total fair value of assets less liabilities divided by the number of fund units. Private equities are valued based on NAV or valuation techniques. The range for NAV per unit or price per share has not been disclosed for the hedge funds or private equities due to the dispersion of prices given the diverse nature of the investments. The level of aggregation and diversity within each derivative instrument category may result in certain ranges of inputs being wide and inputs being unevenly distributed across the range. In the table, we indicated whether the majority of the inputs are concentrated toward the upper, middle, or lower end of the range, or evenly distributed throughout the range. The structured notes contain embedded equity or interest rate derivatives with unobservable inputs that are similar to those of the equity or interest rate derivatives. Other primarily includes certain insignificant instruments such as commodity derivatives, foreign exchange derivatives, contingent considerations, bank-owned life insurance and retractable shares. n.a. not applicable Sensitivity to unobservable inputs and interrelationships between unobservable inputs Yield, credit spreads/discount margins A financial instrument’s yield is the interest rate used to discount future cash flows in a valuation model. An increase in the yield, in isolation, would result in a decrease in a fair value measurement and vice versa. A credit spread/discount margin is the difference between a debt instrument’s yield and a benchmark instrument’s yield. Benchmark instruments have high credit quality ratings, similar maturities and are often government bonds. The credit spread/discount margin therefore represents the discount rate used to determine the present value of future cash flows of an asset to reflect the market return required for uncertainty in the estimated cash flows. The credit spread/discount margin for an instrument forms part of the yield used in a discounted cash flow method. Funding spread Funding spreads are credit spreads specific to funding or deposit rates. A decrease in funding spreads, on its own, will increase the fair value of our liabilities, and vice versa. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 145 Note 3 Fair value of financial instruments (continued) Default rates A default rate is the rate at which borrowers fail to make scheduled loan payments. A decrease in the default rate will typically increase the fair value of the loan, and vice versa. This effect will be significantly more pronounced for a non-government guaranteed loan than a government guaranteed loan. Prepayment rates A prepayment rate is the rate at which a loan will be repaid in advance of its expected amortization schedule. Prepayments change the future cash flows of a loan. An increase in the prepayment rate in isolation will result in an increase in fair value when the loan interest rate is lower than the current reinvestment rate, and a decrease in the prepayment rate in isolation will result in a decrease in fair value when the loan interest rate is lower than the current reinvestment rate. Prepayment rates are generally negatively correlated with interest rates. Recovery and loss severity rates A recovery rate is an estimation of the amount that can be collected in a loan default scenario. The recovery rate is the recovered amount divided by the loan balance due, expressed as a percentage. The inverse concept of recovery is loss severity. Loss severity rate is an estimation of the loan amount not collected when a loan defaults. The loss severity rate is the loss amount divided by the loan balance due, expressed as a percentage. Generally, an increase in the recovery rate or a decrease in the loss severity rate will increase the loan fair value, and vice versa. Volatility rates Volatility measures the potential variability of future prices and is often measured as the standard deviation of price movements. Volatility is an input to option pricing models used to value derivatives and issued structured notes. Volatility is used in valuing equity, interest rate, commodity and foreign exchange options. A higher volatility rate means that the underlying price or rate movements are more likely to occur. Higher volatility rates may increase or decrease an option’s fair value depending on the option’s terms. The determination of volatility rates is dependent on various factors, including but not limited to, the underlying’s market price, the strike price and maturity. Dividend yields A dividend yield is the underlying equity’s expected dividends expressed as an annual percentage of its price. Dividend yield is used as an input for forward equity price and option models. Higher dividend yields will decrease the forward price, and vice versa. A higher dividend yield will increase or decrease an option’s value, depending on the option’s terms. Correlation rates Correlation is the linear relationship between the movements in two different variables. Correlation is an input to the valuation of derivative contracts and issued structured notes when an instrument’s payout is determined by correlated variables. When variables are positively correlated, an increase in one variable will result in an increase in the other variable. When variables are negatively correlated, an increase in one variable will result in a decrease in the other variable. The referenced variables can be within a single asset class or market (equity, interest rate, commodities, credit and foreign exchange) or between variables in different asset classes (equity to foreign exchange, or interest rate to foreign exchange). Changes in correlation will either increase or decrease a financial instrument’s fair value depending on the terms of the instrument. Interest rates An interest rate is the percentage amount charged on a principal or notional amount. Increasing interest rates will decrease the discounted cash flow value of a financial instrument, and vice versa. Consumer Price Index swap rates A CPI swap rate is expressed as a percentage of an increase in the average price of a basket of consumer goods and services, such as transportation, food and medical care. An increase in the CPI swap rate will cause inflation swap payments to be larger, and vice versa. EV/EBITDA multiples, P/E multiples, EV/Rev multiples, and liquidity discounts Private equity valuation inputs include EV/EBITDA multiples, P/E multiples and EV/Rev multiples. These are used to calculate either enterprise value or share value of a company based on a multiple of earnings or revenue estimates. Higher multiples equate to higher fair values for all multiple types, and vice versa. A liquidity discount may be applied when few or no transactions exist to support the valuations. Credit Enhancement Credit enhancement is an input to the valuation of securitized transactions and is the amount of loan loss protection for a senior tranche. Credit enhancement is expressed as a percentage of the transaction sizes. An increase in credit enhancement will cause the credit spread to decrease and the tranche fair value to increase, and vice versa. Interrelationships between unobservable inputs Unobservable inputs, including the above discount margin, default rate, prepayment rate, and recovery and loss severity rates, may not be independent of each other. For example, the discount margin can be affected by a change in default rate, prepayment rate, or recovery and loss severity rates. Discount margins will generally decrease when default rates decline or when recovery rates increase. 146 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Changes in fair value measurement for instruments measured on a recurring basis and categorized in Level 3 (Millions of Canadian dollars) Assets Securities Trading Debt issued or guaranteed by: U.S. state, municipal and agencies Asset-backed securities Non-CDO securities Corporate debt and other debt Equities Investment Mortgage-backed securities Corporate debt and other debt Equities Loans Other Net derivative balances (3) Interest rate contracts Foreign exchange contracts Other contracts Valuation adjustments Other assets Liabilities Deposits Personal Business and government Other Other liabilities For the year ended October 31, 2019 Fair value at beginning of period Gains (losses) included in earnings Gains (losses) included in OCI (1) Purchases (issuances) Settlement (sales) and other (2) Transfers into Level 3 Transfers out of Level 3 Fair value at end of period Gains (losses) included in earnings for positions still held $ 66 $ – $ 1 $ – $ (9) $ – $ – $ 58 $ 110 21 1,148 1,345 – 192 237 429 551 (504) 21 (84) 1 65 15 1 (76) (60) – (3) – (3) 40 (79) 12 131 – 28 – 1 2 4 – 24 16 40 2 – – 2 – – – – 333 333 27 – 5 32 (123) (2) (226) (360) – (60) 36 (24) – – 39 39 – – – – – – (1) (1) – – – – 830 (481) 55 (317) 2 21 1,219 1,300 27 153 294 474 680 (197) – (131) – – 217 (6) 18 21 (16) (7) 4 (38) – – (15) (10) (93) – – (585) 21 (195) 22 77 $ 1,824 $ 69 $ 48 $ 867 $ (631) $ 53 $ (436) $ 1,794 $ $ (390) $ 5 (38) $ – – $ – (102) $ – (68) (16) (1) 1 29 $ (214) $ – 24 – – 559 $ (5) (156) $ – – (60) $ (453) $ (54) $ (1) $ (101) $ 53 $ (214) $ 554 $ (216) $ – 3 1 (20) (16) n.a. n.a. n.a. n.a. 19 (42) 32 115 – 27 135 – – (12) (12) Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 147 Note 3 Fair value of financial instruments (continued) For the year ended October 31, 2018 Fair value at beginning of period Gains (losses) included in earnings Gains (losses) included in OCI (1) Purchases (issuances) Settlement (sales) and other (2) Transfers into Level 3 Transfers out of Level 3 Fair value at end of period Gains (losses) included in earnings for positions still held (Millions of Canadian dollars) Assets Securities Trading Debt issued or guaranteed by: U.S. state, municipal and agencies $ 508 $ 16 $ (3) $ – $ (455) $ – $ – $ 66 $ Asset-backed securities Non-CDO securities Corporate debt and other debt Equities Investment Mortgage-backed securities Corporate debt and other debt Equities Loans Other Net derivative balances (3) Interest rate contracts Foreign exchange contracts Other contracts Valuation adjustments Other assets Liabilities Deposits Personal Business and government Other Other liabilities $ $ 196 30 923 1,657 – 29 220 249 477 (455) 21 (181) (16) – 28 (2) (160) (118) – (30) – (30) (3) 21 (10) 34 – (5) 2 – 37 36 – 6 20 26 (3) – (4) (2) – – – – 395 395 – 125 – 125 450 67 11 (88) – 71 (116) (2) (170) (743) – (144) (3) (147) (291) 73 2 (42) 17 (1) – – 125 125 – 206 – 206 16 7 5 (36) – – – (5) (2) (7) – – – – (95) (217) (4) 231 – – 110 21 1,148 1,345 – 192 237 429 551 (504) 21 (84) 1 65 1,752 $ (111) $ 53 $ 1,031 $ (1,132) $ 323 $ (92) $ 1,824 $ (465) $ – (36) $ – (4) $ – (301) $ 5 (24) – (1) (53) 44 $ (431) $ – 10 – – 803 $ – (390) $ 5 – (68) $ (489) $ (36) $ (5) $ (349) $ 54 $ (431) $ 803 $ (453) $ (1) 1 (1) (24) (25) n.a. n.a. n.a. n.a. 14 (3) (5) 79 – (5) 55 (8) – 4 (4) (1) (2) (3) These amounts include the foreign currency translation gains or losses arising on consolidation of foreign subsidiaries relating to the Level 3 instruments, where applicable. The unrealized gains on Investment securities recognized in OCI were $43 million for the year ended October 31, 2019 (October 31, 2018 – gains of $33 million) excluding the translation gains or losses arising on consolidation. Other includes amortization of premiums or discounts recognized in net income. Net derivatives as at October 31, 2019 included derivative assets of $423 million (October 31, 2018 – $577 million) and derivative liabilities of $1,160 million (October 31, 2018 – $1,143 million). n.a. not applicable Transfers between fair value hierarchy levels for instruments carried at fair value on a recurring basis Transfers between Level 1 and Level 2, and transfers into and out of Level 3 are assumed to occur at the end of the period. For an asset or a liability that transfers into Level 3 during the period, the entire change in fair value for the period is excluded from the Total realized/unrealized gains (losses) included in earnings column of the above reconciliation, whereas for transfers out of Level 3 during the period, the entire change in fair value for the period is included in the same column of the above reconciliation. Transfers between Level 1 and 2 are dependent on whether fair value is obtained on the basis of quoted market prices in active markets (Level 1). During the year ended October 31, 2019, transfers out of Level 1 to Level 2 included Other contracts, consisting of derivative related assets and derivative related liabilities of $1,996 million and $621 million, respectively and Trading U.S. state, municipal and agencies debt of $1,250 million and Obligations related to securities sold short of $202 million. During the year ended October 31, 2018, transfers out of Level 1 to Level 2 included $529 million of Trading U.S. state, municipal and agencies debt and $809 million of Obligations related to securities sold short. During the year ended October 31, 2019, there were no significant transfers out of Level 2 to Level 1. During the year ended October 31, 2018, transfers out of Level 2 to Level 1 included $65 million of Trading U.S. state, municipal and agencies debt and $96 million of Obligations related to securities sold short. Transfers between Level 2 and Level 3 are primarily due to either a change in the market observability for an input, or a change in an unobservable input’s significance to a financial instrument’s fair value. During the year ended October 31, 2019, significant transfers out of Level 2 to Level 3 included $214 million of Personal deposits, due to changes in the significance of unobservable inputs. During the year ended October 31, 2018, significant transfers out of Level 2 to Level 3 included $125 million of Trading Equities, $206 million of Corporate debt and other debt and $431 million of Personal deposits. 148 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements During the year ended October 31, 2019, significant transfers out of Level 3 to Level 2 included: (cid:129) (cid:129) $317 million of Loans, due to changes in the significance of unobservable inputs. $86 million of OTC equity options in Other contracts comprised of $459 million of derivative related assets and $373 million of derivative related liabilities, due to changes in the market observability of inputs. $559 million of Personal deposits, due to changes in the significance of unobservable inputs. (cid:129) During the year ended October 31, 2018, significant transfers out of Level 3 to Level 2 included: (cid:129) $217 million of interest rate swaps in Interest rate contracts comprised of $244 million of derivative related assets and $27 million of derivative related liabilities. $231 million of OTC equity options in Other contracts comprised of $703 million of derivative related assets and $934 million of derivative related liabilities. $803 million of Personal deposits. (cid:129) (cid:129) Positive and negative fair value movements of Level 3 financial instruments from using reasonably possible alternative assumptions A financial instrument is classified as Level 3 in the fair value hierarchy if one or more of its unobservable inputs may significantly affect the measurement of its fair value. In preparing the financial statements, appropriate levels for these unobservable input parameters are chosen so that they are consistent with prevailing market evidence or management judgment. Due to the unobservable nature of the prices or rates, there may be uncertainty about the valuation of these Level 3 financial instruments. The following table summarizes the impacts to fair values of Level 3 financial instruments using reasonably possible alternative assumptions. This sensitivity disclosure is intended to illustrate the potential impact of the relative uncertainty in the fair value of Level 3 financial instruments. In reporting the sensitivities below, we offset balances in instances where: (i) the move in valuation factors cause an offsetting positive and negative fair value movement, (ii) both offsetting instruments are in Level 3, and (iii) exposures are managed and reported on a net basis. With respect to overall sensitivity, it is unlikely in practice that all reasonably possible alternative assumptions would simultaneously be realized. (Millions of Canadian dollars) Securities Trading Debt issued or guaranteed by: U.S. state, municipal and agencies Asset-backed securities Corporate debt and other debt Equities Investment Mortgage-backed securities Corporate debt and other debt Equities Loans Derivatives Other assets Deposits Derivatives Other Other liabilities October 31, 2019 October 31, 2018 As at Positive fair value movement from using reasonably possible alternatives Negative fair value movement from using reasonably possible alternatives Positive fair value movement from using reasonably possible alternatives Negative fair value movement from using reasonably possible alternatives Level 3 fair value Level 3 fair value $ 58 $ 2 21 1,219 27 153 294 680 423 77 $ $ 2,954 $ (156) $ (1,160) (60) $ (1,376) $ 1 $ – – 13 1 15 26 9 6 – 71 $ 4 $ 20 – 24 $ (1) $ – – (14) (1) (13) (27) (12) (3) – (71) $ (4) $ (17) – (21) $ 66 $ 110 21 1,148 – 192 237 551 577 65 2,967 $ (385) $ (1,143) (68) (1,596) $ – $ 7 – 12 – 19 24 5 20 – 87 $ 12 $ 47 – 59 $ (1) (10) – (12) – (16) (26) (7) (18) – (90) (11) (54) – (65) Sensitivity results As at October 31, 2019, the effects of applying other reasonably possible alternative assumptions to the Level 3 asset positions would be an increase of $71 million and a decrease of $71 million in fair value, of which $43 million and $42 million would be recorded in Other components of equity, respectively. The effects of applying these assumptions to the Level 3 liability positions would result in a decrease of $24 million and an increase of $21 million in fair value. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 149 Note 3 Fair value of financial instruments (continued) Level 3 valuation inputs and approaches to developing reasonably possible alternative assumptions The following is a summary of the unobservable inputs used in the valuation of the Level 3 instruments and our approaches to developing reasonably possible alternative assumptions used to determine sensitivity. Financial assets or liabilities Asset-backed securities, corporate debt, government debt, municipal bonds and loans Auction rate securities Private equities, hedge fund investments and related equity derivatives Interest rate derivatives Equity derivatives Sensitivity methodology Sensitivities are determined based on adjusting, plus or minus one standard deviation, the bid-offer spreads or input prices if a sufficient number of prices is received, adjusting input parameters such as credit spreads or using high and low vendor prices as reasonably possible alternative assumptions. Sensitivity of ARS is determined by decreasing the discount margin between 13% and 17% and increasing the discount margin between 27% and 31%, depending on the specific reasonable range of fair value uncertainty for each particular financial instrument’s market. Changes to the discount margin reflect historical monthly movements in the student loan ABS market. Sensitivity of direct private equity investments is determined by (i) adjusting the discount rate by 2% when the discounted cash flow method is used to determine fair value, (ii) adjusting the price multiples based on the range of multiples of comparable companies when price-multiples- based models are used, or (iii) using an alternative valuation approach. The private equity fund, hedge fund and related equity derivative NAVs are provided by the fund managers, and as a result, there are no other reasonably possible alternative assumptions for these investments. Sensitivities of interest rate and cross currency swaps are derived using plus or minus one standard deviation of the inputs, and an amount representing model and parameter uncertainty, where applicable. Sensitivity of the Level 3 position is determined by shifting the unobservable model inputs by plus or minus one standard deviation of the pricing service market data including volatility, dividends or correlations, as applicable. Bank funding and deposits Sensitivities of deposits are calculated by shifting the funding curve by plus or minus certain basis points. Structured notes Sensitivities for interest-rate-linked and equity-linked structured notes are derived by adjusting inputs by plus or minus one standard deviation, and for other deposits, by estimating a reasonable move in the funding curve by plus or minus certain basis points. Fair value for financial instruments that are carried at amortized cost and classified using the fair value hierarchy (Millions of Canadian dollars) Interest-bearing deposits with banks Amortized cost securities (2) Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Other assets Deposits Personal Business and government Bank Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures As at October 31, 2019 Fair value always approximates carrying value (1) 16,062 $ – Fair value may not approximate carrying value Fair value measurements using Level 1 – $ 523 $ Level 2 – 44,581 $ Level 3 – – $ Total – 45,104 Total fair value $ 16,062 45,104 48,784 66,647 6,596 73,243 49,761 – – – – – 12,110 352,717 173,274 525,991 469 187,850 523 583,151 195,583 296,166 15,093 506,842 7,974 50,601 8 $ 565,425 $ – – – – – – – – 81,179 155,646 7,671 244,496 – 445 9,864 – 12,110 60,894 5,052 4,775 9,827 145 9,972 591 724 9 1,324 – 9,978 58 357,769 178,049 535,818 614 424,416 184,645 609,061 50,375 593,646 781,496 81,770 156,370 7,680 245,820 277,353 452,536 22,773 752,662 – 10,423 9,922 7,974 61,024 9,930 $ 254,805 $ 11,360 $ 266,165 $ 831,590 150 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements As at October 31, 2018 Fair value may not approximate carrying value Fair value measurements using (Millions of Canadian dollars) Fair value always approximates carrying value (1) Interest-bearing deposits with banks Amortized cost securities (2) Assets purchased under reverse repurchase agreements and securities borrowed $ Loans Retail Wholesale Other assets Deposits Personal Business and government Bank Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities (3) Subordinated debentures 16,197 – 57,099 65,847 8,889 74,736 45,559 Level 1 $ – 470 $ – – – – – Level 2 – 44,897 18,391 323,114 154,781 477,895 480 193,591 470 541,663 184,887 270,349 15,218 470,454 4,264 46,195 – $ 520,913 $ – – – – – – – – 69,606 160,010 10,235 239,851 712 406 9,260 $ Level 3 $ – – – 5,090 4,417 9,507 166 9,673 622 799 9 1,430 – 9,128 59 Total – 45,367 18,391 328,204 159,198 487,402 646 551,806 70,228 160,809 10,244 241,281 712 9,534 9,319 $ Total fair value 16,197 45,367 75,490 394,051 168,087 562,138 46,205 745,397 255,115 431,158 25,462 711,735 4,976 55,729 9,319 $ 250,229 $ 10,617 $ 260,846 $ 781,759 (1) (2) (3) Certain financial instruments have not been assigned to a level as the carrying amount always approximates their fair values due to their short-term nature (instruments that are receivable or payable on demand, or with original maturity of three months or less) and insignificant credit risk. Included in Securities – Investment, net of applicable allowance on the Consolidated Balance Sheets. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Amounts have been reclassified to conform with this presentation. Fair values of financial assets and liabilities carried at amortized cost and disclosed in the table above are determined using the following valuation techniques and inputs. Amortized cost securities Fair values of government bonds, corporate bonds, and ABS are based on quoted prices. Fair values of certain Non-OECD government bonds are based on vendor prices or the discounted cash flow method with yield curves of other countries’ government bonds as inputs. For ABS, where market prices are not available, the fair value is determined using the discounted cash flow method. The inputs to the valuation model generally include market interest rates, spreads and yields derived from comparable securities, prepayment, and LGD. Assets purchased under reverse repurchase agreements and securities borrowed, and Obligations related to assets sold under repurchase agreements and securities loaned Valuation methods used for the long-term instruments are described in the Fair value of assets and liabilities measured on a recurring basis and classified using the fair value hierarchy section of this note. The carrying values of short-term instruments generally approximate their fair values. Loans – Retail Retail loans include residential mortgages, personal and small business loans and credit cards. For residential mortgages, and personal and small business loans, we segregate the portfolio based on certain attributes such as product type, contractual interest rate, term to maturity and credit scores, if applicable. Fair values of these loans are determined by the discounted cash flow method using applicable inputs such as prevailing interest rates, contractual and posted client rates, client discounts, credit spreads, prepayment rates and loan-to-value ratios. Fair values of credit card receivables are also calculated based on a discounted cash flow method with portfolio yields, write-offs and monthly payment rates as inputs. The carrying values of short- term and variable rate loans generally approximate their fair values. Loans – Wholesale Where market prices are available, wholesale loans are valued based on market prices. Otherwise, fair value is determined by the discounted cash flow method using the following inputs: market interest rates and market based spreads of assets with similar credit ratings and terms to maturity, LGD, expected default frequency implied from credit default swap prices, if available, and relevant pricing information such as contractual rate, origination and maturity dates, redemption price, coupon payment frequency and date convention. Deposits Deposits are comprised of demand, notice, and term deposits which include senior deposit notes we have issued to provide us with long-term funding. Fair values of term deposits are determined by one of several valuation techniques: (i) for term deposits and similar instruments, we segregate the portfolio based on term to maturity. Fair values of these instruments are determined by the discounted cash flow method using inputs such as client rates for new sales of the corresponding terms; and (ii) for senior deposit notes, we use actual traded prices, vendor prices or the discounted cash flow method using a market interest rate curve and our funding spreads as inputs. The carrying values of demand, notice, and short-term term deposits generally approximate their fair values. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 151 Note 3 Fair value of financial instruments (continued) Other assets and Other liabilities Other assets and Other liabilities include receivables and payables relating to certain commodities. Fair values of the commodity receivables and payables are calculated by the discounted cash flow method using applicable inputs such as market interest rates, counterparties’ credit spreads, our funding spreads, commodity forward prices and spot prices. Subordinated debentures Fair values of Subordinated debentures are based on market prices, dealer quotes or vendor prices when available. Where prices cannot be observed, fair value is determined using the discounted cash flow method, with applicable inputs such as market interest rates and credit spreads. 152 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 4 Securities Carrying value of securities (Millions of Canadian dollars) Trading (2) Debt issued or guaranteed by: Canadian government U.S. state, municipal and agencies Other OECD government Mortgage-backed securities Asset-backed securities Corporate debt and other debt Bankers’ acceptances Certificates of deposit Other (3) Equities Fair value through other comprehensive income (2) Debt issued or guaranteed by: Canadian government Federal Amortized cost Fair value Yield (4) Provincial and municipal Amortized cost Fair value Yield (4) U.S. state, municipal and agencies Amortized cost Fair value Yield (4) Other OECD government Amortized cost Fair value Yield (4) Mortgage-backed securities Amortized cost Fair value Yield (4) Asset-backed securities Amortized cost Fair value Yield (4) Corporate debt and other debt Amortized cost Fair value Yield (4) Equities Cost Fair value (5) Amortized cost Fair value Amortized Cost (2) Debt issued or guaranteed by: Canadian government U.S. state, municipal and agencies Other OECD government Asset-backed securities Corporate debt and other debt Amortized cost, net of allowance Fair value Total carrying value of securities 433 586 1,369 – 6,030 – – – – – – 1,597 1,598 2.1% 236 236 1.2% – – – 1 – 0.0% 1,564 1,565 1.4% – – 3,398 3,399 682 297 2,252 – 400 3,631 3,631 As at October 31, 2019 Term to maturity (1) Within 3 months 3 months to 1 year 1 year to 5 years 5 years to 10 years Over 10 years $ 1,974 771 538 – 359 $ 11,265 7,122 1,418 – 63 $ 7,783 8,601 2,211 – 308 $ – 383 2,773 – – 75 8,268 – 1,778 9,537 1,466 – 267 – 20 2,827 – $ 8,611 15,661 863 482 338 – 6 6,925 – 23,024 27,246 15,895 32,886 5 5 1.1% 4 4 4.8% 1,085 1,087 1.8% 178 178 2.1% – – – – – – 596 595 1.4% 954 953 2.7% 3,290 3,294 2.0% 3,839 3,836 2.4% – – – 8 8 3.2% 3,222 3,225 1.9% 12,668 12,673 2.0% – – – – – – – 13 14 4.5% 829 844 2.9% 1 1 3.8% 206 205 3.0% 3,982 3,972 3.2% 79 89 2.0% – – 54 57 4.2% 1,907 1,927 2.8% 13,986 14,053 2.7% – – – 2,503 2,497 2.7% 4,190 4,169 3.1% 122 138 3.1% – – 4,494 4,499 21,355 21,359 5,110 5,125 22,762 22,841 1,978 478 1,431 9 1,853 5,749 5,822 9,831 1,680 1,634 616 5,717 19,478 19,628 1,515 2,018 – – 145 3,678 3,746 – 12,190 – – 58 12,248 12,277 With no specific maturity Total $ – – – – – $ 31,411 41,692 6,496 482 1,335 – – – 41,453 41,453 433 1,070 22,162 41,453 146,534 – – – – – – – – – – – – – – – – – – – – – 248 463 248 463 – – – – – – – 655 657 1.7% 2,878 2,898 2.8% 20,787 20,876 2.5% 4,254 4,251 2.3% 2,709 2,702 2.7% 8,181 8,149 3.2% 17,655 17,690 1.9% 248 463 57,367 57,686 14,006 16,663 5,317 625 8,173 44,784 45,104 $13,060 $ 33,272 $68,083 $ 24,698 $67,975 $ 41,916 $249,004 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 153 Note 4 Securities (continued) (Millions of Canadian dollars) Trading (2) Debt issued or guaranteed by: Canadian government U.S. state, municipal and agencies Other OECD government Mortgage-backed securities Asset-backed securities Corporate debt and other debt Bankers’ acceptances Certificates of deposit Other (3) Equities Fair value through other comprehensive income (2) Debt issued or guaranteed by: Canadian government Federal Amortized cost Fair value Yield (4) Provincial and municipal Amortized cost Fair value Yield (4) U.S. state, municipal and agencies Amortized cost Fair value Yield (4) Other OECD government Amortized cost Fair value Yield (4) Mortgage-backed securities Amortized cost Fair value Yield (4) Asset-backed securities Amortized cost Fair value Yield (4) Corporate debt and other debt Amortized cost Fair value Yield (4) Equities Cost Fair value (5) Amortized cost Fair value Amortized Cost (2) As at October 31, 2018 Term to maturity (1) Within 3 months 3 months to 1 year 1 year to 5 years 5 years to 10 years Over 10 years With no specific maturity Total $ 1,860 595 1,367 – 126 $ 7,237 3,715 3,932 – 14 $ 7,983 9,836 3,456 114 215 $ 326 300 2,120 – 6,694 – 84 4,058 – 19,040 – 48 6,720 – 28,372 2,244 5,119 635 93 369 – 3 3,099 – 11,562 $ 6,599 13,899 779 794 409 – 25 5,543 – 28,048 $ – – – – – $ 25,923 33,164 10,169 1,001 1,133 – – – 34,542 34,542 326 460 21,540 34,542 128,258 – – – – – – 1,355 1,355 2.4% 225 225 0.6% – – – – – – 4,119 4,120 1.5% – – 5,699 5,700 – – – 51 51 1.7% 132 131 2.1% 86 86 2.4% – – – – – – 1,769 1,772 1.8% – – 2,038 2,040 173 169 1.7% 673 672 2.9% 2,766 2,768 2.3% 1,090 1,091 2.3% 59 59 1.6% – – – 10,785 10,783 2.0% – – 15,546 15,542 15 15 1.8% 236 234 2.0% 635 643 3.2% 67 67 1.4% 193 193 3.4% 2,662 2,657 3.6% 399 390 3.0% – – 4,207 4,199 56 54 4.5% 618 597 4.0% 13,112 13,239 3.0% 1 1 4.2% 1,924 1,922 2.9% 4,442 4,445 3.4% 367 354 4.1% – – 20,520 20,612 – 9,736 – – 78 9,814 9,399 $58,474 – – – – – – – – – – – – – – – – – – – – – 222 406 222 406 244 238 2.3% 1,578 1,554 3.1% 18,000 18,136 2.8% 1,469 1,470 2.0% 2,176 2,174 2.9% 7,104 7,102 3.4% 17,439 17,419 1.9% 222 406 48,232 48,499 – – – – – – – $ 34,948 16,433 14,328 6,787 1,069 7,492 46,109 45,367 $ 222,866 Debt issued or guaranteed by: Canadian government U.S. state, municipal and agencies Other OECD government Asset-backed securities Corporate debt and other debt Amortized cost, net of allowance Fair value Total carrying value of securities 1,762 69 2,601 – 253 4,685 4,687 $ 17,079 1,427 115 1,386 5 1,434 4,367 4,360 $ 25,447 10,863 2,231 2,800 1,035 5,566 22,495 22,286 $ 66,409 2,381 2,177 – 29 161 4,748 4,635 $ 20,509 (1) (2) (3) (4) (5) Actual maturities may differ from contractual maturities shown above as borrowers may have the right to extend or prepay obligations with or without penalties. Trading securities and FVOCI securities are recorded at fair value. Amortized cost securities, included in Investment securities, are recorded at amortized cost and presented net of allowance for credit losses. Primarily composed of corporate debt, supra-national debt, and commercial paper. The weighted average yield is derived using the contractual interest rate and the carrying value at the end of the year for the respective securities. Certain equity securities that are not held-for-trading purposes are designated as FVOCI. During the year ended October 31, 2019, we disposed of $129 million of equity securities measured at FVOCI (October 31, 2018 – $8 million). The cumulative gain on the date of disposals was $1 million (October 31, 2018 – $(1) million). 154 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Unrealized gains and losses on securities at FVOCI (1), (2) (Millions of Canadian dollars) Debt issued or guaranteed by: Canadian government Federal (3) Provincial and municipal U.S. state, municipal and agencies (3) Other OECD government Mortgage-backed securities (3) Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities October 31, 2019 October 31, 2018 As at Cost/ Amortized cost Gross unrealized gains Gross unrealized losses Fair value Cost/ Amortized cost Gross unrealized gains Gross unrealized losses Fair value $ 655 $ 3 $ (1) $ 657 $ 2,878 20,787 4,254 2,709 7,334 847 17,655 248 43 215 2 1 1 4 45 218 (23) 2,898 (126) 20,876 4,251 2,702 (5) (8) (35) (2) 7,300 849 (10) 17,690 463 (3) 244 $ 1,578 18,000 1,469 2,176 6,248 856 17,439 222 – $ 2 285 2 1 1 9 22 186 (26) (6) $ 238 1,554 (149) 18,136 1,470 2,174 (1) (3) (10) (2) 6,239 863 (42) 17,419 406 (2) $ 57,367 $ 532 $ (213) $57,686 $ 48,232 $ 508 $ (241) $48,499 (1) (2) (3) Excludes $44,784 million of held-to-collect securities as at October 31, 2019 that are carried at amortized cost, net of allowance for credit losses (October 31, 2018 – $46,109 million). Gross unrealized gains and losses includes $(3) million of allowance for credit losses on debt securities at FVOCI as at October 31, 2019 (October 31, 2018 – $11 million) recognized in income and Other components of equity. The majority of the MBS are residential. Cost/Amortized cost, Gross unrealized gains, Gross unrealized losses and Fair value related to commercial MBS are $2,051 million, $1 million, $6 million and $2,046 million, respectively as at October 31, 2019 (October 31, 2018 – $1,442 million, $nil, $6 million and $1,436 million, respectively). Allowance for credit losses on investment securities The following tables reconcile the opening and closing allowance for debt securities at FVOCI and amortized cost by stage. Reconciling items include the following: (cid:129) (cid:129) (cid:129) (cid:129) Transfers between stages, which are presumed to occur before any corresponding remeasurement of the allowance. Purchases, which reflect the allowance related to assets newly recognized during the period, including those assets that were derecognized following a modification of terms. Sales and maturities, which reflect the allowance related to assets derecognized during the period without a credit loss being incurred, including those assets that were derecognized following a modification of terms. Changes in risk, parameters and exposures, which comprise the impact of changes in model inputs or assumptions, including changes in forward-looking macroeconomic conditions; partial repayments; changes in the measurement following a transfer between stages; and unwinding of the time value discount due to the passage of time. Allowance for credit losses – securities at FVOCI (1) October 31, 2019 October 31, 2018 Performing Impaired Performing Impaired For the year ended (Millions of Canadian dollars) Balance at beginning of period Provision for credit losses Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Purchases Sales and maturities Changes in risk, parameters and exposures Write-offs Exchange rate and other Balance at end of period Stage 1 4 $ Stage 2 7 $ Stage 3 (2) – $ Total $ 11 Stage 1 Stage 2 Stage 3 $ 3 $ 22 $ – Total $ 25 – – – 5 (3) (2) – – $ 4 $ – – – – (7) 1 – (1) – – – – – – (8) – 1 – – – 5 (10) (9) – – 5 – (36) 85 (47) (8) – 2 (5) – – – (17) 7 – – – – 36 – 25 – (62) 1 – – – 85 (39) (1) (62) 3 $ (7) $ (3) $ 4 $ 7 $ – $ 11 (1) (2) Expected credit losses on debt securities at FVOCI are not separately recognized on the balance sheet as the related securities are recorded at fair value. The cumulative amount of credit losses recognized in income is presented in Other components of equity. Reflects changes in the allowance for purchased credit impaired securities. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 155 Note 4 Securities (continued) Allowance for credit losses – securities at amortized cost For the year ended (Millions of Canadian dollars) Balance at beginning of period Provision for credit losses Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Purchases Sales and maturities Changes in risk, parameters and exposures Write-offs Exchange rate and other Balance at end of period October 31, 2019 Performing Stage 1 6 $ Stage 2 32 $ Impaired Stage 3 – $ Total $ 38 October 31, 2018 Performing Impaired Stage 1 Stage 2 Stage 3 $ 9 $ 45 $ – – – 7 (1) (6) – (1) – – – – – (15) – 2 $ 5 $ 19 $ – – – – – – – – – – – – 7 (1) (21) – 1 3 (7) – 5 (3) (2) – 1 (3) 7 (2) – (11) (3) – (1) $ 24 $ 6 $ 32 $ – $ 38 Total $ 54 – – – 5 (14) (5) (2) – – – – 2 – – – (2) – Credit risk exposure by internal risk rating The following table presents the fair value of debt securities at FVOCI and gross carrying amount of securities at amortized cost. Risk ratings are based on internal ratings used in the measurement of expected credit losses, as at the reporting date, as outlined in the internal ratings maps in the Credit risk section of Management’s Discussion and Analysis. (Millions of Canadian dollars) Investment securities Securities at FVOCI Investment grade Non-investment grade Impaired Items not subject to impairment (2) Securities at amortized cost Investment grade Non-investment grade Impaired Allowance for credit losses Amortized cost October 31, 2019 October 31, 2018 Performing Impaired Performing Impaired Stage 1 Stage 2 Stage 3 (1) Total Stage 1 Stage 2 Stage 3 (1) Total As at $ $ 56,671 400 – $ 57,071 $ 1 1 – 2 $ 43,681 695 – $ 44,376 5 $ 46 386 – $ 432 19 $ 44,371 $ 413 $ $ $ $ $ – – 150 150 – – – – – – $ 56,672 401 150 $ 57,223 463 $ 57,686 $ 43,727 1,081 – $ 44,808 24 $ 44,784 $ 46,956 500 – $ 479 33 – $ 47,456 $ 512 $ 44,958 367 – $ 45,325 6 $ 119 703 – $ 822 32 $ 45,319 $ 790 $ $ $ $ $ – – 125 125 – – – – – – $ 47,435 533 125 $ 48,093 406 $ 48,499 $ 45,077 1,070 – $ 46,147 38 $ 46,109 (1) (2) Includes $150 million of purchased credit impaired securities (October 31, 2018 – $125 million). Investment securities at FVOCI not subject to impairment represent equity securities designated as FVOCI. Note 5 Loans and allowance for credit losses Loans by geography and portfolio net of allowance (Millions of Canadian dollars) Retail (2) Residential mortgages Personal Credit cards (3) Small business (4) Wholesale (2), (5) Total loans Undrawn loan commitments – Retail Undrawn loan commitments – Wholesale As at October 31, 2019 Canada United States Other International Total Allowance for losses (1) Total net of allowance $ 287,767 $ 17,012 $ 81,547 19,617 5,434 124,312 7,399 439 – 53,782 3,312 $ 308,091 $ 3,304 255 – 17,776 92,250 20,311 5,434 195,870 (402) $ (762) (791) (50) (1,095) 307,689 91,488 19,520 5,384 194,775 $ 518,677 $ 78,632 $ 24,647 $ 621,956 $ (3,100) $ 618,856 208,336 101,017 5,063 176,022 801 54,982 214,200 332,021 (225) (70) 156 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements (Millions of Canadian dollars) Retail (2) Residential mortgages Personal Credit cards (3) Small business (4) Wholesale (2), (5) Total loans Undrawn loan commitments – Retail (6) Undrawn loan commitments – Wholesale (6) As at October 31, 2018 United States Other International Total Allowance for losses (1) Total net of allowance $ $ $ $ 13,493 7,172 368 – 59,442 80,475 4,007 169,910 3,147 3,416 254 – 17,767 24,584 1,250 53,797 $ 282,471 92,700 19,415 4,866 180,278 $ 579,730 204,652 319,853 $ $ (382) (841) (725) (49) (915) (2,912) (90) (64) $ 282,089 91,859 18,690 4,817 179,363 $ 576,818 Canada $ 265,831 82,112 18,793 4,866 103,069 $ 474,671 199,395 96,146 (1) (2) (3) (4) (5) (6) Excludes allowance for loans measured at FVOCI of $nil (October 31, 2018 – $1 million). Geographic information is based on residence of the borrower. The credit cards business is managed as a single portfolio and includes both consumer and business cards. Includes small business exposure managed on a pooled basis. Includes small business exposure managed on an individual client basis. Amounts have been revised from those previously presented. Loans maturity and rate sensitivity Maturity term (1) Rate sensitivity As at October 31, 2019 (Millions of Canadian dollars) Retail Wholesale Total loans Allowance for loan losses Under 1 year (2) 1 to 5 years Over 5 years Total $ 216,610 $ 187,721 $ 21,755 $ 426,086 $ 114,736 $ 304,448 $ 6,902 $ 426,086 195,870 165,502 154,445 195,870 Floating 10,913 30,512 27,329 3,039 Total Fixed Rate Non-rate- sensitive $ 371,055 $ 218,233 $ 32,668 $ 621,956 $ 142,065 $ 469,950 $ 9,941 $ 621,956 (3,100) (3,100) Total loans net of allowance for loan losses $ 618,856 $ 618,856 (Millions of Canadian dollars) Retail Wholesale Total loans Allowance for loan losses Total loans net of allowance for loan losses (1) (2) Generally, based on the earlier of contractual repricing or maturity date. Includes variable rate loans that can be repriced at the clients’ discretion without penalty. Maturity term (1) Rate sensitivity As at October 31, 2018 Under 1 year (2) 1 to 5 years Over 5 years Total Floating Fixed Rate Non-rate- sensitive Total $ 217,188 $ 163,291 $ 18,973 $ 399,452 $ 123,826 $ 268,793 $ 144,208 27,789 8,281 180,278 31,016 147,970 $ 361,396 $ 191,080 $ 27,254 $ 579,730 $ 154,842 $ 416,763 $ 6,833 $ 399,452 180,278 1,292 8,125 $ 579,730 (2,912) $ 576,818 (2,912) $ 576,818 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 157 Note 5 Loans and allowance for credit losses (continued) Allowance for credit losses October 31, 2019 October 31, 2018 For the year ended Balance at beginning of period Provision for credit losses Net write-offs (1) Exchange rate and other Balance at end of period Balance at beginning of period Provision for credit losses Net write-offs (1) Exchange rate and other Balance at end of period $ 382 $ 895 760 51 979 21 526 590 41 661 5 68 $ (37)$ (474) (518) (28) (397) (11)$ (12) – (3) 402 $ 935 832 61 (78) 1,165 – (2) 24 378 $ 826 693 49 1,010 20 47 $ (43) $ – $ 513 534 33 156 – (431) (468) (28) (142) – (13) 1 (3) (45) 1 382 895 760 51 979 21 (Millions of Canadian dollars) Retail Residential mortgages Personal Credit cards Small business Wholesale Customers’ liability under acceptances $ 3,088 $ 1,891 $ (1,454)$ (106)$ 3,419 $ 2,976 $ 1,283 $ (1,112) $ (59) $ 3,088 Presented as: Allowance for loan losses $ Other liabilities – Provisions Customers’ liability under acceptances Other components of equity 2,912 154 21 1 $ 3,100 $ 2,749 295 24 – 207 20 – $ 2,912 154 21 1 (1) Loans written-off are generally subject to continued collection efforts for a period of time following write-off. The contractual amount outstanding on loans written-off during the year ended October 31, 2019 that are no longer subject to enforcement activity was $179 million (October 31, 2018 – $83 million). The following table reconciles the opening and closing allowance for loans and commitments, by stage, for each major product category. Reconciling items include the following: (cid:129) Model changes, which generally comprise the impact of significant changes to the quantitative models used to estimate (cid:129) (cid:129) expected credit losses and any staging impacts that may arise. Transfers between stages, which are presumed to occur before any corresponding remeasurements of the allowance. Originations, which reflect the allowance related to assets newly recognized during the period, including those assets that were derecognized following a modification of terms. (cid:129) Maturities, which reflect the allowance related to assets derecognized during the period without a credit loss being incurred, (cid:129) including those assets that were derecognized following a modification of terms. Changes in risk, parameters and exposures, which comprise the impact of changes in model inputs or assumptions, including changes in forward-looking macroeconomic conditions; partial repayments and additional draws on existing facilities; changes in the measurement following a transfer between stages; and unwinding of the time value discount due to the passage of time in stage 1 and stage 2. 158 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Allowance for credit losses – Retail and Wholesale loans October 31, 2019 October 31, 2018 Performing Impaired Performing Impaired For the year ended (Millions of Canadian dollars) Stage 1 Stage 2 Stage 3 Total Stage 1 Stage 2 Stage 3 Total Residential mortgages Balance at beginning of period Provision for credit losses Model changes Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Originations Maturities Changes in risk, parameters and exposures Write-offs Recoveries Exchange rate and other Balance at end of period Personal Balance at beginning of period Provision for credit losses Model changes Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Originations Maturities Changes in risk, parameters and exposures Write-offs Recoveries Exchange rate and other Balance at end of period Credit cards Balance at beginning of period Provision for credit losses Model changes Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Originations Maturities Changes in risk, parameters and exposures Write-offs Recoveries Exchange rate and other Balance at end of period Small business Balance at beginning of period Provision for credit losses Model changes Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Originations Maturities Changes in risk, parameters and exposures Write-offs Recoveries Exchange rate and other Balance at end of period Wholesale Balance at beginning of period Provision for credit losses Model changes Transfers to stage 1 Transfers to stage 2 Transfers to stage 3 Originations Maturities Changes in risk, parameters and exposures Write-offs Recoveries Exchange rate and other Balance at end of period $ 142 $ 64 $ 176 $ 382 $ 140 $ 65 $ 173 $ 378 – 87 (13) (3) 51 (14) (104) – – – – (66) 16 (31) – (10) 104 – – – – (21) (3) 34 – – 41 (45) 8 (11) 146 $ 77 $ 179 $ – – – – 51 (24) 41 (45) 8 (11) 402 242 $ 512 $ 141 $ 895 23 544 (87) (2) 101 (31) (517) – – (1) 272 $ (48) (537) 88 (142) 1 (112) 758 – – – 520 – (7) (1) 144 – – 351 (600) 126 (11) $ 143 $ (25) – – – 102 (143) 592 (600) 126 (12) 935 161 $ 599 $ – $ 760 – 452 (81) (2) 5 (5) (358) – – 1 – (452) 81 (341) – (27) 800 – – (1) – – – 343 – – 175 (655) 137 – 173 $ 659 $ – $ 17 $ 16 $ 18 $ 11 18 (3) – 13 (5) (22) – – – 29 $ (7) (18) 3 (9) – (8) 32 – – 1 10 – – – 9 – – 27 (36) 8 (4) $ 22 $ – – – – 5 (32) 617 (655) 137 – 832 51 4 – – – 13 (13) 37 (36) 8 (3) 61 274 $ 340 $ 365 $ 979 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 20 59 (18) (2) 63 (13) (110) – – 3 142 $ 2 (59) 23 (16) 1 (10) 56 – – 2 64 4 – (5) 18 – – 34 (51) 8 (5) $ 176 $ 26 – – – 64 (23) (20) (51) 8 – 382 278 $ 427 $ 121 $ 826 (10) 712 (140) (3) 107 (33) (668) – – (1) 1 (712) 141 (157) 5 (130) 938 – – (1) (6) – (1) 160 – – 309 (552) 121 (11) 242 $ 512 $ 141 $ (15) – – – 112 (163) 579 (552) 121 (13) 895 251 $ 442 $ – $ 693 (65) 693 (123) (2) 11 (12) (592) – – – 161 $ 64 (693) 123 (227) 2 (60) 947 – – 1 599 – – – 229 – – 239 (599) 131 – $ – $ 15 $ 15 $ 19 $ – 31 (5) – 10 (4) (31) – – 1 – (31) 5 (11) – (9) 48 – – (1) – – – 11 – – 19 (35) 7 (3) 17 $ 16 $ 18 $ (1) – – – 13 (72) 594 (599) 131 1 760 49 – – – – 10 (13) 36 (35) 7 (3) 51 251 $ 352 $ 407 $ 1,010 – 145 (33) (5) 239 (162) (178) – – 1 $ 281 $ – (133) 36 (57) 44 (165) 331 – – – 396 – (12) (3) 62 – – 552 (440) 43 (79) – – – – 283 (327) 705 (440) 43 (78) (17) 207 (66) (2) 227 (153) (176) – – 3 $ 488 $ 1,165 $ 274 $ (12) (207) 93 (43) 46 (179) 289 – – 1 340 (6) – (27) 45 – – 137 (207) 65 (49) $ 365 $ (35) – – – 273 (332) 250 (207) 65 (45) 979 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 159 Note 5 Loans and allowance for credit losses (continued) Key inputs and assumptions The measurement of expected credit losses is a complex calculation that involves a large number of interrelated inputs and assumptions. The key drivers of changes in expected credit losses include the following: (cid:129) (cid:129) Changes in the credit quality of the borrower or instrument, primarily reflected in changes in internal risk ratings; Changes in forward-looking macroeconomic conditions, specifically the macroeconomic variables to which our models are calibrated, which are those most closely correlated with credit losses in the relevant portfolio; Changes in scenario design and the weights assigned to each scenario; and Transfers between stages, which can be triggered by changes to any of the above inputs. (cid:129) (cid:129) Internal risk ratings Internal risk ratings are assigned according to the risk management framework outlined under the headings “Wholesale credit risk” and “Retail credit risk” of the Credit risk section of Management’s Discussion and Analysis. Changes in internal risk ratings are primarily reflected in the PD parameters, which are estimated based on our historical loss experience at the relevant risk segment or risk rating level, adjusted for forward-looking information. Forward looking macroeconomic variables The PD, LGD and EAD inputs used to estimate stage 1 and stage 2 credit loss allowances are modelled based on the macroeconomic variables (or changes in macroeconomic variables) that are most closely correlated with credit losses in the relevant portfolio. Each macroeconomic scenario used in our expected credit loss calculation includes a projection of all relevant macroeconomic variables used in our models for a five year period, reverting to long-run averages generally within the 2 to 5 year period. Depending on their usage in the models, macroeconomic variables are projected at a country, province/state or more granular level. These include one or more of the variables described below, which differ by portfolio and region. The following table shows the primary macroeconomic variables used in the models to estimate ACL on performing loans, commitments, and acceptances. The downside scenario reflects a negative macroeconomic event occurring within the first 12 months, with conditions deteriorating for up to two years, followed by a recovery for the remainder of the period. This scenario is grounded in historical experience and assumes a monetary policy response that returns the economy to a long-run, sustainable growth rate within the forecast period. The upside scenario reflects stronger economic growth than the base scenario for the first two years, without a monetary policy response, followed by a return to a long-run sustainable growth rate within the forecast period. As at October 31, 2019 October 31, 2018 Base Scenario Upside Scenario Downside Scenario Base Scenario Upside Scenario Downside Scenario Next 12 months 2 to 5 years Next 12 months 2 to 5 years Next 12 months 2 to 5 years Next 12 months 2 to 5 years Next 12 months 2 to 5 years Next 12 months 2 to 5 years 5.8% 6.0% 3.8% 4.2% 5.4% 4.8% 3.7% 3.4% 6.6% 6.8% 4.8% 5.3% 5.8% 6.0% 3.6% 4.1% 5.7% 5.1% 3.6% 3.3% 6.8% 7.1% 4.8% 5.3% 1.6% 1.8% 1.7% 1.5% 2.4% 2.1% (2.0)% 2.8% 2.1% 1.9% (2.3)% 2.6% 1.7% 1.7% 2.1% 1.4% 2.3% 2.1% (2.0)% 2.7% 2.1% 1.9% (2.3)% 2.6% $ 59 $ 68 $ 69 $ 70 $ 43 $ 56 $ 76 $ 72 $ 88 $ 76 $ 56 $ 61 4.5% 4.7% 5.3% 2.5% (9.2)% 5.8% 0.1% 3.9% 5.3% 2.5% (9.2)% 5.8% Driver Unemployment rate: (1) Canada U.S. Gross domestic product: (2) Canada U.S. Oil price (West Texas Intermediate) average price (US$) (3) Canadian housing price index growth rate (4) (1) (2) (3) (4) Represents the average quarterly unemployment level over the period. Represents the average quarter-over-quarter gross domestic product annualized over the period. Represents the average quarterly price per barrel over the period. Growth rates are calculated on an annualized basis spanning years 2 to 5. The primary variables driving credit losses in our retail portfolios are Canadian unemployment rates, Canadian gross domestic product and Canadian housing price index. The Canadian overnight interest rate also impacts our retail portfolios. Our wholesale portfolios are affected by all of the variables in the table above; however, the specific variables differ by sector. Other variables also impact our wholesale portfolios including, but not limited to, the U.S. 10 year BBB corporate bond yields, the U.S. 10 year government bond yields, the TSX and S&P 500 indices, natural gas prices (Henry Hub) and the commercial real estate price index. Increases in the following macroeconomic variables will generally correlate with higher expected credit losses: Canadian and U.S. unemployment rates, Canadian overnight interest rates, U.S. 10 year BBB corporate bond yields, and U.S. 10 year government bond yields. Increases in the following macroeconomic variables will generally correlate with lower expected credit losses: Canadian housing price index, Canadian and U.S. gross domestic products, TSX index, S&P 500 index, oil prices, natural gas prices, and commercial real estate price index. In addition to the scenarios described above, two additional downside scenarios were designed for the energy and real estate sectors. The average oil price (West Texas Intermediate) used in our energy downside scenario in the next 12 months is $25 per barrel, and subsequently recovers to an average price of $45 per barrel in the following 2 to 5 years (October 31, 2018 – $27 and $45 per barrel). The housing price index in our real estate downside scenario contracts by 30% in the next twelve months, and subsequently recovers to an average growth rate of 11% on an annualized basis in the following 2 to 5 years (October 31, 2018 – (30)% and 11%). 160 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Scenariodesignandweightings Our estimation of expected credit losses in stage 1 and stage 2 considers five distinct future macroeconomic scenarios. Scenarios are designed to capture a wide range of possible outcomes and are weighted according to our expectation of the relative likelihood of the range of outcomes that each scenario represents at the reporting date. We then weight each scenario to take into account historical frequency, current trends, and forward-looking conditions which will change over time. The base case scenario is based on forecasts of the expected rate, value or yield for each of the macroeconomic variables identified above. The upside and downside scenarios are set by adjusting our base projections to construct reasonably possible scenarios and weightings that are more optimistic and pessimistic, respectively, than the base case. As described above, two additional downside scenarios capture the non-linear nature of potential credit losses across our portfolios. The impact of each of our five scenarios varies across our portfolios given the portfolios have different sensitivities to movements in each macroeconomic variable. The impact of weighting these multiple scenarios increased our ACL on performing loans, relative to our base scenario, by $376 million at October 31, 2019 (October 31, 2018 – $290 million). Transfers between stages Transfers between stage 1 and stage 2 are based on the assessment of significant increases in credit risk relative to initial recognition, as described in Note 2. The impact of moving from 12 months expected credit losses to lifetime expected credit losses, or vice versa, varies by product and is dependent on the expected remaining life at the date of the transfer. Stage transfers may result in significant fluctuations in expected credit losses. The following table illustrates the impact of staging on our ACL by comparing our allowance if all performing loans were in stage 1 to the actual ACL recorded on these assets. October 31, 2019 October 31, 2018 As at Performing loans (1) ACL – All performing loans in Stage 1 1,737 $ Impact of staging 826 $ Stage 1 and 2 ACL 2,563 $ ACL – All performing loans in Stage 1 Impact of staging Stage 1 and 2 ACL $ 1,526 $ 841 $ 2,367 (1) Represents loans and commitments in stage 1 and stage 2. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 161 Note 5 Loans and allowance for credit losses (continued) Credit risk exposure by internal risk rating The following table presents the gross carrying amount of loans measured at amortized cost, and the full contractual amount of undrawn loan commitments subject to the impairment requirements of IFRS 9. Risk ratings are based on internal ratings used in the measurement of expected credit losses as at the reporting date, as outlined in the internal ratings maps for Wholesale and Retail facilities in the Credit risk section of Management’s Discussion and Analysis. (Millions of Canadian dollars) Stage 1 Stage 2 Stage 3 (1) Total Stage 1 Stage 2 Stage 3 (1) Total October 31, 2019 October 31, 2018 As at Retail Loans outstanding – Residential mortgages Low risk Medium risk High risk Not rated (2) Impaired $ 238,377 $ 6,764 $ 14,033 2,843 40,030 – 1,347 2,722 726 – – $ 245,141 $ 222,026 $ 3,688 $ – – – 732 15,380 5,565 40,756 732 13,681 2,577 34,670 – 1,369 2,897 578 – – $ 225,714 15,050 – 5,474 – 35,248 – 726 726 295,283 11,559 732 307,574 272,954 8,532 726 282,212 Items not subject to impairment (3) Total Loans outstanding – Personal Low risk Medium risk High risk Not rated (2) Impaired Total Loans outstanding – Credit cards Low risk Medium risk High risk Not rated (2) Total $ 71,619 $ 1,944 $ 5,254 843 7,293 – 85,009 3,011 1,874 105 – 6,934 $ 13,840 $ 2,250 137 677 16,904 103 $ 1,827 1,432 45 3,407 Loans outstanding –Small business Low risk Medium risk High risk Not rated (2) Impaired $ Total Undrawn loan commitments – 2,200 $ 2,163 138 10 – 4,511 107 $ 563 196 – – 866 517 308,091 – $ 73,563 $ 71,763 $ 1,256 $ – – – 307 8,265 2,717 7,398 307 6,124 998 8,595 – 1,925 1,672 64 – 259 282,471 – $ 73,019 8,049 – 2,670 – 8,659 – 303 303 307 92,250 87,480 4,917 303 92,700 – $ 13,943 $ 13,185 $ – – – 4,077 1,569 722 2,234 139 764 – 20,311 16,322 – $ – – – 57 57 2,307 $ 2,726 334 10 57 5,434 2,004 $ 2,230 95 166 – 4,495 100 $ 1,632 1,331 30 3,093 46 $ 102 178 1 – 327 – $ 13,285 3,866 – 1,470 – 794 – – 19,415 – $ – – – 44 44 2,050 2,332 273 167 44 4,866 – $ 183,696 11,033 – 3,906 – 6,017 – – 204,652 Retail (4) Low risk Medium risk High risk Not rated (2) Total $ 196,743 $ 1,894 $ 8,251 851 5,861 246 208 146 – $ 198,637 $ 182,426 $ 1,270 $ – – – 8,497 1,059 6,007 10,794 3,740 5,937 239 166 80 211,706 2,494 – 214,200 202,897 1,755 Wholesale – Loans outstanding Investment grade Non-investment grade Not rated (2) Impaired Items not subject to impairment (3) Total Undrawn loan commitments – Wholesale (4) Investment grade Non-investment grade Not rated (2) Total $ 47,133 $ 119,778 5,862 – 172,773 97 $ 11,940 320 – 12,357 $ 222,819 $ 96,191 3,986 322,996 18 $ 9,007 – 9,025 – $ 47,230 $ 46,869 $ – – 1,829 131,718 6,182 1,829 106,027 6,692 – 1,829 186,959 159,588 8,911 195,870 – $ 222,837 $ 220,626 $ – – 105,198 3,986 87,894 4,246 – 332,021 312,766 324 $ 10,190 411 – 10,925 – $ 47,193 116,217 – 7,103 – 1,096 1,096 1,096 171,609 8,669 180,278 92 $ 6,995 – 7,087 – $ 220,718 94,889 – 4,246 – – 319,853 (1) (2) (3) (4) As at October 31, 2019, 86% of credit-impaired loans were either fully or partially collateralized (October 31, 2018 – 88%). For details on the types of collateral held against credit-impaired assets and our policies on collateral, refer to the Credit risk mitigation section of Management’s Discussion and Analysis. In certain cases where an internal risk rating is not assigned, we use other approved credit risk assessments or rating methodologies, policies and tools to manage our credit risk. Items not subject to impairment are loans held at FVTPL. Amounts have been revised from those previously presented. 162 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Loans past due but not impaired (1) October 31, 2019 October 31, 2018 As at (Millions of Canadian dollars) Retail Wholesale 1 to 29 days 30 to 89 days $ 3,173 $ 1,543 1,369 $ 460 186 $ 4,728 $ 3 2,006 $ 4,716 $ 1,829 $ 189 $ 6,734 $ 2,995 $ 1,246 4,241 $ 1,402 $ 468 1,870 $ 179 $ 4,576 1,714 – 179 $ 6,290 90 days and greater Total 1 to 29 days 30 to 89 days 90 days and greater Total (1) Amounts presented may include loans past due as a result of administrative processes, such as mortgage loans on which payments are restrained pending payout due to sale or refinancing. Past due loans arising from administrative processes are not representative of the borrowers’ ability to meet their payment obligations. Note 6 Derecognition of financial assets We enter into transactions in which we transfer financial assets such as loans or securities to structured entities or other third parties. The majority of assets transferred under repurchase agreements, securities lending agreements, and in our Canadian residential mortgage securitization transactions do not qualify for derecognition as we continue to be exposed to substantially all of the risks and rewards of the transferred assets, such as prepayment, credit, price, interest rate and foreign exchange risks. Transferred financial assets not derecognized Securitization of Canadian residential mortgage loans We periodically securitize insured Canadian residential mortgage loans through the creation of MBS pools under the National Housing Act MBS (NHA MBS) program. All loans securitized under the NHA MBS program are required to be insured by the Canadian Mortgage and Housing Corporation (CMHC) or a third-party insurer. We require the borrower to pay for mortgage insurance when the loan amount is greater than 80% of the original appraised value of the property (loan-to-value (LTV) ratio). For residential mortgage loans securitized under this program with LTV ratios less than 80%, we are required to insure the mortgages at our own expense. Under the NHA MBS program, we are responsible for making all payments due on our issued MBS, regardless of whether we collect the necessary funds from the mortgagor or the insurer. When a borrower defaults on a mortgage, we submit a claim to the insurer if the amount recovered from the collection or foreclosure process is lower than the sum of the principal balance, accrued interest and collection costs on the outstanding loan. The insurance claim process is managed by the insurance provider in accordance with the insurer’s policies and covers the entire unpaid loan balance plus generally up to 12 months of interest, selling costs and other eligible expenses. If an insurance claim is denied, a loss is recognized in Provision for credit losses in our Consolidated Statements of Income. The amount recorded as a loss is not significant to our Consolidated Financial Statements and no significant losses were incurred due to legal action arising from mortgage default during 2019 and 2018. We sell the NHA MBS pools primarily to a government-sponsored structured entity under the Canada Mortgage Bond (CMB) program. The entity periodically issues CMBs, which are guaranteed by the government, and sells them to third-party investors. Proceeds of the CMB issuances are used by the entity to purchase the NHA MBS pools from eligible NHA MBS issuers who participate in the issuance of a particular CMB series. Our continuing involvement includes servicing the underlying residential mortgage loans we have securitized, either ourselves or through a third-party servicer. We also act as counterparty in interest rate swap agreements where we pay the entity the interest due to CMB investors and receive the interest on the underlying MBS and reinvested assets. As part of the swaps, we are also required to maintain a principal reinvestment account for principal payments received on the underlying mortgage loans to meet the repayment obligation upon maturity of the CMB. We reinvest the collected principal payments in permitted investments as outlined in the swap agreements. We have determined that certain of the NHA MBS program loans transferred to the entity do not qualify for derecognition as we have not transferred substantially all of the risks and rewards of ownership. As a result, these transferred MBS continue to be classified as residential mortgage loans and recognized on our Consolidated Balance Sheets. The cash received for these transferred MBS is treated as a secured borrowing and a corresponding liability is recorded in Deposits – Business and government on our Consolidated Balance Sheets. Securities sold under repurchase agreements and securities loaned We also enter into transactions such as repurchase agreements and securities lending agreements where we transfer assets under agreements to repurchase them at a future date and retain substantially all of the risks and rewards associated with the assets. These transferred assets remain on our Consolidated Balance Sheets and are accounted for as collateralized borrowing transactions. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 163 Note 6 Derecognition of financial assets (continued) The following table provides information on the carrying amount and fair value of the transferred assets that did not qualify for derecognition, and their associated liabilities. October 31, 2019 October 31, 2018 As at Canadian residential mortgage loans (1), (2) Securities sold under repurchase agreements (3) Securities loaned (3) Total Canadian residential mortgage loans (1), (2) Securities sold under repurchase agreements (3) Securities loaned (3) Total $ 32,794 $ 220,250 $ 6,336 $259,380 $ 34,105 $ 202,543 $ 4,271 $ 240,919 (Millions of Canadian dollars) Carrying amount of transferred assets that do not qualify for derecognition Carrying amount of associated liabilities Fair value of transferred assets Fair value of associated liabilities Fair value of net position $ 32,757 $ 33,143 $ (386) $ 32,615 220,250 220,250 $ 220,250 6,336 259,201 6,336 $259,343 $ 6,336 259,729 – $ – $ (386) $ 33,975 202,543 4,271 240,789 33,490 $ 33,916 (426) $ 202,544 $ 202,544 4,271 $ 240,305 240,731 4,271 – $ – $ (426) (1) (2) (3) Includes Canadian residential mortgage loans transferred primarily to Canada Housing Trust at the initial securitization and other permitted investments used for funding requirements after the initial securitization. CMB investors have legal recourse only to the transferred assets, and do not have recourse to our general assets. Does not include over-collateralization of assets pledged. Note 7 Structured entities In the normal course of business, we engage in a variety of financial transactions with structured entities to support our financing and investing needs as well as those of our customers. A structured entity is an entity in which voting or similar rights are not the dominant factor in deciding control. Structured entities are generally created to achieve a narrow and well defined objective with restrictions around their ongoing activities. We consolidate a structured entity when we control the entity in accordance with our accounting policy as described in Note 2. In other cases, we may sponsor or have an interest in such an entity but may not consolidate it. Consolidated structured entities We consolidate the following structured entities, whose assets and liabilities are recorded on our Consolidated Balance Sheets. Third-party investors in these structured entities generally have recourse only to the assets of the related entity and do not have recourse to our general assets unless we breach our contractual obligations to those entities. In the ordinary course of business, the assets of each consolidated structured entity can generally only be used to settle the obligations of that entity. RBC-administered multi-seller conduits We generally do not maintain ownership in the multi-seller conduits that we administer and generally do not have rights to, or control of, their assets. However, we issue asset-backed commercial paper (ABCP) through a multi-seller conduit that does not have a first loss investor with substantive power to direct the significant operating activities of the conduit. This conduit is consolidated because we have exposure to variability of returns from performance in the multi-seller arrangements through providing transaction-specific and program-wide liquidity, credit and loan facilities to the conduit and have decision-making power over the relevant activities. As of October 31, 2019, $1.2 billion of financial assets held by the conduit was included in Loans (October 31, 2018 – $2.4 billion) and $0.7 billion of ABCP issued by the conduit was included in Deposits (October 31, 2018 – $1.3 billion) on our Consolidated Balance Sheets. Credit card securitization vehicle We securitize a portion of our credit card receivables through a structured entity on a revolving basis. The entity purchases co-ownership interests in a pool of credit card receivables and issues senior and subordinated term notes collateralized by that co-ownership interest in the underlying pool of credit card receivables. Investors who purchase the term notes have recourse only to that co-ownership interest in the underlying pool of credit card receivables. We continue to service the credit card receivables and perform an administrative role for the entity. We also retain risk in the underlying pool of credit card receivables through our retained interest in the transferred assets, the cash reserve balance we fund from time to time, and also through certain subordinated notes which we retain. Additionally, we may own some senior notes as investments or for market-making activities, we have provided subordinated loans to the entity to pay upfront expenses, and we act as counterparty to interest rate and cross currency swap agreements which hedge the entity’s interest rate and currency risk exposure. We consolidate the structured entity because we have decision-making power over the timing and size of future issuances and other relevant activities which were predetermined by us at inception. We also obtain significant funding benefits and are exposed to variability from the performance of the underlying credit card receivables through our retained interest. As at October 31, 2019, $7.1 billion of notes issued by our credit card securitization vehicle were included in Deposits on our Consolidated Balance Sheets (October 31, 2018 – $8.5 billion). 164 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Collateralized commercial paper vehicle We established a funding vehicle that provides loans to us and finances those loans by issuing commercial paper to third-party investors. The structured entity’s commercial paper carries an equivalent credit rating to RBC because we are obligated to advance funds to the entity in the event there are insufficient funds from other sources to settle maturing commercial paper. We pledge collateral to secure the loans and are exposed to the market and credit risks of the pledged securities. We consolidate the structured entity because we have decision-making power over the relevant activities, are the sole borrower from the structure, and are exposed to a majority of the residual ownership risks through the credit support provided. As at October 31, 2019, $16.2 billion of commercial paper issued by the vehicle was included in Deposits on our Consolidated Balance Sheets (October 31, 2018 – $16.6 billion). Covered bonds We periodically transfer mortgages to RBC Covered Bond Guarantor Limited Partnership (the Guarantor LP) to support funding activities and asset coverage requirements under our covered bonds program. The Guarantor LP was created to guarantee interest and principal payments under the covered bond program. The covered bonds guaranteed by the Guarantor LP are direct, unsecured and unconditional obligations of RBC; therefore, investors have a claim against the Bank which will continue if the covered bonds are not paid by the Bank and the mortgage assets in the Guarantor LP are insufficient to satisfy the obligations owing on the covered bonds. We act as general partner, limited partner, swap counterparty, lender and liquidity provider to the Guarantor LP, servicer for the underlying mortgages as well as the registered issuer of the covered bonds. We consolidate the Guarantor LP as we have the decision-making power over the relevant activities through our role as general partner and are exposed to variability from the performance of the underlying mortgages. As at October 31, 2019, the total amount of mortgages transferred and outstanding was $53.9 billion (October 31, 2018 – $53.0 billion) and $39.8 billion of covered bonds were recorded as Deposits on our Consolidated Balance Sheets (October 31, 2018 – $36.9 billion). Municipal bond TOB structures We sell taxable and tax-exempt municipal bonds into Tender Option Bond (TOB) structures, which consist of a credit enhancement (CE) trust and a TOB trust. The CE trust purchases a bond from us, financed with a trust certificate issued to the TOB trust. The TOB trust then issues floating-rate certificates to short-term investors and a residual certificate that is held by us. We are the remarketing agent for the floating-rate certificates and provide a liquidity facility to the TOB trust which requires us to purchase any certificates tendered but not successfully remarketed. We also provide a letter of credit to the CE trust under which we are required to extend funding if there are any losses on the underlying bonds. We earn interest on the residual certificate and receive market-based fees for acting as remarketing agent and providing the liquidity facility and letter of credit. We consolidate both the CE trust and TOB trust when we are the holder of the residual certificate as we have decision- making power over the relevant activities, including the selection of the underlying municipal bonds and the ability to terminate the structure, and are exposed to variability from the performance of the underlying municipal bonds. As at October 31, 2019, $8.3 billion of municipal bonds were included in Investment securities related to consolidated TOB structures (October 31, 2018 – $7.1 billion) and a corresponding $8.7 billion of floating-rate certificates were included in Deposits on our Consolidated Balance Sheets (October 31, 2018 – $7.6 billion). RBC managed investment funds We are sponsors and investment managers of mutual and pooled funds, which give us the ability to direct the investment decisions of the funds. We consolidate those mutual and pooled funds in which our interests, which include direct investment in seed capital plus management or performance fees, indicate that we are acting as a principal. As at October 31, 2019, $465 million of Trading securities held in the consolidated funds (October 31, 2018 – $548 million) and $95 million of Other liabilities representing the fund units held by third parties (October 31, 2018 – $128 million) were recorded on our Consolidated Balance Sheets. Unconsolidated structured entities We have interests in certain structured entities that we do not consolidate but have recorded assets and liabilities on our Consolidated Balance Sheets related to our transactions and involvement with these entities. The following table presents the assets and liabilities recorded on our Consolidated Balance Sheets and our maximum exposure to loss related to our interests in unconsolidated structured entities. It also presents the size of each class of unconsolidated structured entity, as measured by the total assets of the entities in which we have an interest. (Millions of Canadian dollars) On-balance sheet assets Securities Loans Derivatives Other assets On-balance sheet liabilities Derivatives Other liabilities Maximum exposure to loss (2) Multi-seller conduits (1) Structured finance As at October 31, 2019 Non-RBC managed investment funds Third-party securitization vehicles Other Total $ $ $ 75 $ – 97 – – $ 2,718 – 60 1,865 $ – – – – $ 503 $ 6,392 – – 1,517 83 244 2,443 10,627 180 304 172 $ 2,778 $ 1,865 $ 6,392 $ 2,347 $ 13,554 20 $ 30 – $ – – $ – – $ – – $ – 20 30 50 $ $ – $ $ 38,032 $ 6,446 $ – $ – $ 2,123 $ 10,756 $ – $ 2,667 $ 50 60,024 Total assets of unconsolidated structured entities $ 37,192 $ 17,571 $412,046 $ 84,282 $293,423 $ 844,514 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 165 Note 7 Structured entities (continued) (Millions of Canadian dollars) On-balance sheet assets Securities Loans Derivatives Other assets On-balance sheet liabilities Derivatives Other liabilities Maximum exposure to loss (2) Total assets of unconsolidated structured entities Multi-seller conduits (1) Structured finance As at October 31, 2018 Non-RBC managed investment funds Third-party securitization vehicles Other Total $ $ $ $ $ $ 65 $ – – – – $ 2,301 – 176 2,721 $ – – – – $ 906 $ 6,292 – – 1,647 52 288 65 $ 2,477 $ 2,721 $ 6,292 $ 2,893 $ 3,692 10,240 52 464 14,448 84 $ – 84 $ – $ – – $ – $ – – $ – $ – – $ – $ – – $ 84 – 84 38,342 $ 5,477 $ 2,981 $ 10,215 $ 3,556 $ 60,571 37,590 $ 15,776 $ 523,176 $ 67,446 $ 454,567 $ 1,098,555 (1) (2) Total assets of unconsolidated structured entities represent the maximum assets that may have to be purchased by the conduits under purchase commitments outstanding. Of the purchase commitments outstanding, the conduits have purchased financial assets totalling $23.6 billion as at October 31, 2019 (October 31, 2018 – $24.7 billion). The maximum exposure to loss resulting from our interests in these entities consists mostly of investments, loans, fair value of derivatives, liquidity and credit enhancement facilities. The maximum exposure to loss of the multi-seller conduits is higher than the on-balance sheet assets primarily because of the notional amounts of the backstop liquidity and credit enhancement facilities. Refer to Note 25. Below is a description of our involvement with each significant class of unconsolidated structured entity. Multi-seller conduits We administer multi-seller ABCP conduit programs. Multi-seller conduits primarily purchase financial assets from clients and finance those purchases by issuing ABCP. In certain multi-seller conduit arrangements, we do not maintain any ownership of the multi-seller conduits that we administer and have no rights to, or control of, its assets. As the administrative agent, we earn a residual fee for providing services such as coordinating funding activities, transaction structuring, documentation, execution and monitoring. The ABCP issued by each multi-seller conduit is in the conduit’s own name with recourse to the financial assets owned by the multi-seller conduit, and is non-recourse to us except through our participation in liquidity and/or credit enhancement facilities. We provide transaction-specific and program-wide liquidity facilities to the multi-seller conduits. In addition, we provide program-wide credit enhancement to the multi-seller conduits which obligate us to purchase assets or advance funds in the event the multi-seller conduit does not otherwise have funds from other sources, such as from the liquidity facilities, to settle maturing ABCP. In some cases, we or another third party may provide transaction-specific credit enhancement which can take various forms. We receive market-based fees for providing these liquidity and credit facilities. For certain transactions, we act as counterparty to foreign exchange forward contracts and interest rate swaps to facilitate our clients’ securitization of fixed rate and/or foreign currency denominated assets through the conduits. These derivatives expose us to foreign exchange and interest rate risks that are centrally managed by our foreign exchange trading and swap desks, respectively, and credit risk on the underlying assets that is mitigated by the credit enhancement described below. Each transaction is structured with transaction-specific first loss protection provided by the third-party seller. This enhancement can take various forms, including but not limited to overcollateralization, excess spread, subordinated classes of financial assets, guarantees or letters of credit. The amount of this enhancement varies but is generally sized to cover a multiple of loss experience. An unrelated third party (expected loss investor) absorbs losses, up to a maximum contractual amount, that may occur in the future on the assets in the multi-seller conduits before the multi-seller conduits’ debt holders and us. In return for assuming this multi-seller conduit first-loss position, each multi-seller conduit pays the expected loss investor a return commensurate with its risk position. The expected loss investor has substantive power to direct the majority of the activities which significantly impact the conduit’s economic performance, including initial selection and approval of the asset purchase commitments and liquidity facilities, approval of renewal and amendment of these transactions and facilities, sale or transfer of assets, ongoing monitoring of asset performance, mitigation of losses, and management of the ABCP liabilities. We do not consolidate these multi-seller conduits as we do not control the conduit as noted above. Structured finance We purchased U.S. ARS from certain trusts (U.S. ARS Trusts) which fund their long-term investments in student loans by issuing short-term senior and subordinated notes. We are subject to losses on these U.S. ARS Trusts if defaults are experienced on the underlying student loans; however, the principal and accrued interest on the student loans are guaranteed by U.S. government agencies. We act as auction agent for some of these entities but have no legal obligation to purchase the notes issued by these entities in the auction process. We do not consolidate these U.S. ARS Trusts as we do not have decision-making power over the investing and financing activities of the Trusts, which are the activities that most significantly affect the performance of the Trusts. Additionally, we invest in certain municipal bond TOB structures that we do not consolidate. These structures are similar to those consolidated municipal bond TOB structures described above; however, the residual certificates are held by third-parties. We provide liquidity facilities on the floating-rate certificates which may be drawn if certificates are tendered but not able to be remarketed. We do not have decision-making power over the relevant activities of the structures; therefore, we do not consolidate these structures. The assets transferred into these programs are derecognized from our Consolidated Balance Sheets. We provide senior warehouse financing to structured entities that are established by third parties to acquire loans for the purposes of issuing a term collateralized loan obligation (CLO) transaction. Subordinated financing is provided during the 166 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements warehouse phase by one or more third-party equity investors. We act as the arranger and placement agent for the term CLO transaction. Proceeds from the sale of the term CLO are used to repay our senior warehouse financing, at which point we have no further involvement with the transaction. We do not consolidate these CLO structures as we do not have decision-making power over the relevant activities of the entity, which include the initial selection and subsequent management of the underlying debt portfolio. We provide senior financing to unaffiliated structured entities that are established by third parties to acquire loans. These facilities tend to be longer in term than the CLO warehouse facilities and benefit from credit enhancement designed to cover a multiple of historical losses. We do not consolidate these structures as we do not have decision making power over the relevant activities of the entity, which include the initial selection and subsequent management of the underlying debt portfolio. Non-RBC managed investment funds We enter into fee-based equity derivative transactions with third parties including mutual funds, unit investment trusts and other investment funds. These transactions provide their investors with the desired exposure to a reference fund, and we economically hedge our exposure to these derivatives by investing in those reference funds. We also act as custodian or administrator for several funds. We do not consolidate those reference funds that are managed by third parties as we do not have power to direct their investing activities. We provide liquidity facilities to certain third-party investment funds. The funds issue unsecured variable-rate preferred shares and invest in portfolios of tax-exempt municipal bonds. Undrawn liquidity commitments expose us to the liquidity risk of the preferred shares and drawn commitments expose us to the credit risk of the underlying municipal bonds. We do not consolidate these third-party managed funds as we do not have power to direct their investing activities. Third-party securitization vehicles We hold interests in securitization vehicles that provide funding to certain third parties on whose behalf the entities were created. The activities of these entities are limited to the purchase and sale of specified financial assets from the sponsor. We, as well as other financial institutions, are obligated to provide funding up to our maximum commitment level and are exposed to credit losses on the underlying assets after various credit enhancements. Enhancements can take various forms, including but not limited to overcollateralization, excess spread, subordinated classes of financial assets, guarantees or letters of credit. The amount of this enhancement varies but is generally sized to cover a multiple of loss experience. We do not consolidate these entities as we do not have decision-making power over the relevant activities, including the entities’ investing and financing activities. Other Other unconsolidated structured entities include managed investment funds, credit investment products and tax credit funds. We are sponsors and investment managers of mutual and pooled funds, which gives us the ability to direct the investment decisions of the funds. We do not consolidate those mutual and pooled funds if we exercise our decision-making power as an agent on behalf of other unit holders. We use structured entities to generally transform credit derivatives into cash instruments, to distribute credit risk and to create customized credit products to meet investors’ specific requirements. We enter into derivative contracts, including credit derivatives, to purchase protection from these entities (credit protection) and convert various risk factors such as yield, currency or credit risk of underlying assets to meet the needs of the investors. We act as sole arranger and swap provider for certain entities and, in some cases, fulfill other administrative functions for the entities. We do not consolidate these credit investment product entities as we do not have decision-making power over the relevant activities, which include selection of the collateral and reference portfolio, and are not exposed to a majority of the benefits or risks of the entities. We created certain funds to pass through tax credits received from underlying low-income housing, historic rehabilitation real estate projects to third parties, new market tax credits or renewable energy tax credits to third parties (tax credit funds). We are sponsors of the tax credit funds as a result of our responsibility to manage the funds, arrange the financing, and perform the administrative duties of these tax credit funds. We do not consolidate the tax credit funds as the third-party investors in these funds have the decision-making power to select the underlying investments and are exposed to the majority of the residual ownership and tax risks of the funds. We also purchase passive interests in renewable energy tax credit entities created and controlled by third parties. We do not consolidate these third party funds as we do not have decision-making power over the relevant activities and our investments are managed as part of larger portfolios which are held for trading purposes. Other interests in unconsolidated structured entities In the normal course of business, we buy and sell passive interests in certain third-party structured entities, including mutual funds, exchange traded funds, and government-sponsored ABS vehicles. Our investments in these entities are managed as part of larger portfolios which are held for trading, liquidity or hedging purposes. We did not create or sponsor these entities and do not have any decision-making power over their ongoing activities. Our maximum exposure to loss is limited to our on-balance sheet investments in these entities, which are not included in the table above. As at October 31, 2019 and 2018, our investments in these entities were included in Trading and Investment securities on our Consolidated Balance Sheets. Refer to Note 3 and Note 4 for further details on our Trading and Investment securities. Sponsored entities We are a sponsor of certain structured entities in which we have interests but do not consolidate. In determining whether we are a sponsor of a structured entity, we consider both qualitative and quantitative factors, including the purpose and nature of the entity, our initial and continuing involvement and whether we hold subordinated interests in the entity. We are considered to be the sponsor of certain credit investment products, tax credit entities, RBC managed mutual funds and a commercial mortgage securitization vehicle. During the year ended October 31, 2019, we transferred commercial mortgages with a carrying amount of $696 million (October 31, 2018 – $352 million) to a sponsored securitization vehicle in which we did not have any interests as at the end of the reporting period. Financial support provided to structured entities During the years ended October 31, 2019 and 2018, we have not provided any financial or non-financial support to any consolidated or unconsolidated structured entities when we were not contractually obligated to do so. Furthermore, we have no intention to provide such support in the future. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 167 Note 8 Derivative financial instruments and hedging activities Derivative instruments are categorized as either financial or non-financial derivatives. Financial derivatives are financial contracts whose value is derived from an underlying interest rate, foreign exchange rate, credit risk, and equity or equity index. Non-financial derivatives are contracts whose value is derived from a precious metal, commodity instrument or index. The notional amount of derivatives represents the contract amount used as a reference point to calculate payments. Notional amounts are generally not exchanged by counterparties, and do not reflect our EAD. Financial derivatives Forwards and futures Forward contracts are non-standardized agreements that are transacted between counterparties in the OTC market, whereas futures are standardized contracts with respect to amounts and settlement dates, and are traded on regular futures exchanges. Examples of forwards and futures are described below. Interest rate forwards (forward rate agreements) and futures are contractual obligations to buy or sell an interest-rate sensitive financial instrument on a predetermined future date at a specified price. Foreign exchange forwards and futures are contractual obligations to exchange one currency for another at a specified price for settlement at a predetermined future date. Equity forwards and futures are contractual obligations to buy or sell at a fixed value (the specified price) of an equity index, a basket of stocks or a single stock at a predetermined future date. Swaps Swaps are OTC contracts in which two counterparties exchange a series of cash flows based on agreed upon rates applied to a notional amount. Examples of swap agreements are described below. Interest rate swaps are agreements where two counterparties exchange a series of payments based on different interest rates applied to a notional amount in a single currency. Certain interest rate swaps are transacted and settled through clearing houses which act as central counterparties. Cross currency swaps involve the exchange of fixed payments in one currency for the receipt of fixed payments in another currency. Cross currency interest rate swaps involve the exchange of both interest and notional amounts in two different currencies. Equity swaps are contracts in which one counterparty agrees to pay or receive from the other cash flows based on changes in the value of an equity index, a basket of stocks or a single stock. Options Options are contractual agreements under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or sell (put option) a security, exchange rate, interest rate, or other financial instrument or commodity at a specified price, at or by a predetermined future date. The seller (writer) of an option can also settle the contract by paying the cash settlement value of the purchaser’s right. The seller (writer) receives a premium from the purchaser for this right. The various option agreements that we enter into include but are not limited to interest rate options, foreign currency options, equity options and index options. Credit derivatives Credit derivatives are OTC contracts that transfer credit risk related to an underlying financial instrument (referenced asset) from one counterparty to another. Credit derivatives include credit default swaps, credit default baskets and total return swaps. Credit default swaps provide protection against the decline in the value of the referenced asset as a result of specified credit events such as default or bankruptcy. They are similar in structure to an option, whereby the purchaser pays a premium to the seller of the credit default swap in return for payment contingent on a credit event affecting the referenced asset. Credit default baskets are similar to credit default swaps except that the underlying referenced financial instrument is a group of assets instead of a single asset. Total return swaps are contracts where one counterparty agrees to pay or receive from the other cash amounts based on changes in the value of a referenced asset or group of assets, including any returns such as interest earned on these assets, in exchange for amounts that are based on prevailing market funding rates. Other derivative products Other contracts are stable value and equity derivative contracts. Non-financial derivatives Other contracts also include non-financial derivative products such as precious metal and commodity derivative contracts in both the OTC and exchange markets. Derivatives issued for trading purposes Most of our derivative transactions relate to client-driven sales and trading activities, and associated market risk hedging. Sales activities include the structuring and marketing of derivative products to clients, enabling them to modify or reduce risks. Trading involves market-making, positioning and arbitrage activities. Market-making involves quoting bid and offer prices to other market participants with the intention of generating revenue based on spread and volume. Positioning involves the active management of derivative transactions with the expectation of profiting from favourable movements in prices, rates, or indices. Arbitrage activities involve identifying and profiting from price differentials between markets and product types. Any realized and unrealized gains or losses on derivatives used for trading purposes are recognized immediately in Non-interest income – Trading revenue. Derivatives issued for other-than-trading purposes We also use derivatives for purposes other than trading, primarily for hedging, in conjunction with the management of interest rate, credit, equity and foreign exchange risk related to our funding, lending, investment activities and asset/liability management. Interest rate swaps are used to manage our exposure to interest rate risk by modifying the repricing or maturity characteristics of existing and/or forecasted assets and liabilities, including funding and investment activities. Purchased options are used to hedge redeemable deposits and other options embedded in consumer products. We manage our exposure to foreign 168 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements currency risk with cross currency swaps and foreign exchange forward contracts. We predominantly use credit derivatives to manage our credit exposures. We mitigate industry sector concentrations and single-name exposures related to our credit portfolio by purchasing credit derivatives to transfer credit risk to third parties. Certain derivatives and cash instruments are specifically designated and qualify for hedge accounting. From time to time, we also enter into derivative transactions to economically hedge certain exposures that do not otherwise qualify for hedge accounting, or where hedge accounting is not considered economically feasible to implement. In such circumstances, changes in fair value are reflected in Other income in Non-interest income. Notional amount of derivatives by term to maturity (absolute amounts) (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives (2) Other contracts (3) Exchange-traded contracts Interest rate contracts Futures – long positions Futures – short positions Options purchased Options written Foreign exchange contracts Futures – long positions Futures – short positions Other contracts (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives (2) Other contracts Exchange-traded contracts Interest rate contracts Futures – long positions Futures – short positions Options purchased Options written Foreign exchange contracts Futures – long positions Futures – short positions Other contracts As at October 31, 2019 (1) Term to maturity Within 1 year 1 through 5 years Over 5 years Total Trading Other than Trading $ 2,014,752 $ 179,624 $ 387 $ 2,194,763 $ 2,186,862 $ 3,294,746 83,247 77,601 1,715,266 79,264 469,910 54,756 54,985 2,693 201,489 107,054 363,947 56,657 59,840 5,026,410 462,599 464,906 3,331,025 174,042 182,690 11,652,181 719,888 725,197 11,180,497 719,888 725,197 30,523 50,416 894,250 14,409 14,969 14,724 90,436 118,805 120,247 36,985 16,395 985 55,166 425,301 3,061 3,383 3,437 18,463 1,746,774 184,846 1,789,461 72,226 73,337 20,854 310,388 1,724,606 177,622 1,743,465 72,226 73,337 20,341 303,893 187 46 – – 226,046 484,240 93,642 76,235 226,046 484,240 93,642 76,235 7,901 471,684 – – 22,168 7,224 45,996 – – 513 6,495 – – – – 28 – 214,725 – – – $ 8,850,960 $ 7,579,943 $ 4,198,173 $ 20,629,076 $ 20,067,095 $ 561,981 28 – 258,970 28 – 258,970 – – 44,245 – – – As at October 31, 2018 Term to maturity Within 1 year 1 through 5 years Over 5 years Total Trading Other than Trading $ 1,895,613 $ 4,535,040 101,663 87,254 8,788 $ – $ 1,904,401 $ 1,904,401 $ 4,377,512 155,985 156,886 2,856,403 27,273 37,217 11,768,955 284,921 281,357 11,424,094 284,921 281,357 1,397,520 30,358 347,477 33,202 37,716 1,578 81,720 38,825 32,424 2,587 2,544 30,688 4,379 767,742 11,037 12,250 5,263 66,686 22,465 23,072 3,312 1,291 616 1,170 365,880 1,807 4,515 3,424 17,409 11 6 – – 1,428,824 35,907 1,481,099 46,046 54,481 10,265 165,815 61,301 55,502 5,899 3,835 1,420,575 27,545 1,430,437 46,046 54,481 9,752 161,323 61,301 55,502 5,899 3,835 – 344,861 – – 8,249 8,362 50,662 – – 513 4,492 – – – – 277 340 228,549 – – – $ 8,854,687 $ 5,706,664 $ 3,316,103 $ 17,877,454 $ 17,460,315 $ 417,139 277 340 288,229 277 340 288,229 – – 59,308 – – 372 (1) (2) (3) On November 1, 2018, we prospectively implemented the standardized approach for measuring counterparty credit risk (SA-CCR) in accordance with the Capital Adequacy Requirements (CAR) guidelines in determining our derivative notional amounts. Credit derivatives with a notional value of $0.5 billion (October 31, 2018 – $0.5 billion) are economic hedges. Trading credit derivatives comprise protection purchased of $12.6 billion (October 31, 2018 – $6.2 billion) and protection sold of $7.7 billion (October 31, 2018 – $3.6 billion). Under SA-CCR, Other contracts exclude loan syndication derivatives of $7.7 billion. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 169 Note 8 Derivative financial instruments and hedging activities (continued) Fair value of derivative instruments (1) (Millions of Canadian dollars) Held or issued for trading purposes Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives Other contracts Held or issued for other-than-trading purposes Interest rate contracts Swaps Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Credit derivatives Other contracts As at October 31, 2019 October 31, 2018 Positive Negative Positive Negative $ 30 $ 39,669 5,898 – 45,597 11,263 529 26,569 1,242 – 39,603 169 15,356 100,725 848 848 116 193 904 1,213 – 181 2,242 31 32,570 – 6,756 39,357 11,755 223 26,188 – 898 39,064 279 18,517 97,217 742 742 118 527 501 1,146 3 140 2,031 $ 308 $ 29,340 3,211 – 32,859 13,367 174 26,837 1,540 – 41,918 38 17,668 92,483 1,226 1,226 31 212 1,145 1,388 – 150 2,764 232 25,501 – 3,471 29,204 12,929 258 25,849 – 1,272 40,308 89 18,300 87,901 1,142 1,142 33 423 1,104 1,560 5 179 2,886 Total gross fair values before: Valuation adjustments determined on a pooled basis Impact of netting agreements that qualify for balance sheet offset 102,967 (697) (710) 99,248 5 (710) $ 101,560 $ 98,543 95,247 (625) (583) 90,787 34 (583) $ 94,039 $ 90,238 (1) The fair value reflects the impact of the election to characterize the daily variation margin as settlement of the related derivative fair values as permitted by certain central counterparties. Fair value of derivative instruments by term to maturity (1) October 31, 2019 October 31, 2018 As at (Millions of Canadian dollars) Derivative assets Derivative liabilities Less than 1 year 1 through 5 years Over 5 years Total Total $ 25,342 $ 28,568 $ 47,650 $ 101,560 $ 28,241 $ 29,197 $ 36,601 $ 94,039 90,238 98,543 46,545 25,495 26,503 27,013 36,505 26,720 Less than 1 year 1 through 5 years Over 5 years (1) The fair value reflects the impact of the election to characterize the daily variation margin as settlement of the related derivative fair values as permitted by certain central counterparties. Derivative-related credit risk Credit risk from derivative transactions is generated by the potential for the counterparty to default on its contractual obligations when one or more transactions have a positive market value to us. Therefore, derivative-related credit risk is represented by the positive fair value of the instrument and is normally a small fraction of the contract’s notional amount. We subject our derivative transactions to the same credit approval, limit and monitoring standards that we use for managing other transactions that create credit exposure. This includes evaluating the creditworthiness of counterparties, and managing the size, diversification and maturity structure of the portfolio. Credit utilization for all products is compared with established limits on a continual basis and is subject to a standard exception reporting process. We use a single internal rating system for all credit risk exposure. In most cases, these internal ratings approximate the external risk ratings of public rating agencies. Offsetting is a technique that can reduce credit exposure from derivatives and is generally facilitated through the use of master netting agreements and achieved when specific criteria are met in accordance with our accounting policy in Note 2. A master netting agreement provides for a single net settlement of all financial instruments covered by the agreement in the event of default. However, credit risk is reduced only to the extent that our financial obligations to the same counterparty can be set off against obligations of the counterparty to us. We maximize the use of master netting agreements to reduce derivative-related credit exposure. Our overall exposure to credit risk that is reduced through master netting agreements may change substantially following the reporting date as the exposure is affected by each transaction subject to the agreement as well as by changes in underlying market rates. Measurement of our credit exposure arising out of derivative transactions is reduced to reflect the 170 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements effects of netting in cases where the enforceability of that netting is supported by appropriate legal analysis as documented in our trading credit risk policies. The use of collateral is another significant credit mitigation technique for managing derivative-related counterparty credit risk. Mark-to-market provisions in our agreements with some counterparties, typically in the form of a Credit Support Annex, provide us with the right to request that the counterparty pay down or collateralize the current market value of its derivatives positions when the value passes a specified threshold amount. Replacement cost and credit equivalent amounts are determined in accordance with OSFI’s non-modelled regulatory SA-CCR under the CAR guidelines beginning November 1, 2018. The replacement cost represents the total fair value of all outstanding contracts in a gain position after factoring in the master netting agreements and applicable margins, scaled by a regulatory factor. The credit equivalent amount is defined as the replacement cost plus an additional amount for potential future credit exposure also scaled by a regulatory factor. The risk-weighted equivalent is determined by applying appropriate risk-weights to the credit equivalent amount, including those risk weights reflective of model approval under the internal ratings based approach. As at October 31, 2018, the replacement cost and credit equivalent amounts were calculated under OFSI’s non-modelled regulatory current exposure method for counterparty risk. Derivative-related credit risk (1) . October 31, 2019 (2) As at (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Swaps Options purchased Options written Credit derivatives (5) Other contracts Exchange-traded contracts Replacement cost Credit equivalent amount (3) Risk-weighted equivalent (4) Replacement cost October 31, 2018 Credit equivalent amount (3) Risk-weighted equivalent (4) $ 18 6,487 149 – 2,333 3,047 404 4 156 1,972 5,439 $ 20,009 $ 73 15,911 547 256 15,822 15,678 908 213 613 10,766 19,630 $ 80,417 $ 19 6,229 326 113 3,899 4,001 285 67 40 4,853 393 $ 20,225 $ 307 9,671 610 – 4,589 9,342 443 – 71 9,709 2,912 $ 37,654 $ 324 20,321 857 – 10,944 13,718 1,100 – 770 9,959 11,285 $ 69,278 $ 13 3,363 407 – 3,439 5,002 478 – 153 4,303 225 $ 17,383 (1) (2) (3) (4) (5) The amounts presented are net of master netting agreements in accordance with CAR guidelines. On November 1, 2018, we prospectively implemented SA-CCR in accordance with CAR guidelines in determining our replacement cost, credit equivalent amount and risk- weighted equivalent. Beginning on November 1, 2018, the credit equivalent amount includes collateral in accordance with CAR guidelines. As at October 31, 2018, the credit equivalent amount included $16 billion of collateral applied. The risk-weighted balances are calculated in accordance with CAR guidelines and exclude CVA of $13 billion (October 31, 2018 – $12 billion). The October 31, 2018 amounts exclude credit derivatives issued for other-than-trading purposes related to bought protection. Replacement cost of derivative instruments by risk rating and by counterparty type Risk rating (2) Counterparty type (3) As at October 31, 2019 (1) (Millions of Canadian dollars) Gross positive replacement cost Impact of master netting agreements and applicable margins Replacement cost (after netting agreements) AAA, AA A $ 27,126 $ 38,812 $ 20,620 $ BBB BB or lower Total 16,409 $ 102,967 $ 48,509 $ Banks Other Total 18,126 $ 36,332 $ 102,967 OECD governments 23,146 35,088 16,719 8,005 82,958 47,376 17,705 17,877 82,958 $ 3,980 $ 3,724 $ 3,901 $ 8,404 $ 20,009 $ 1,133 $ 421 $ 18,455 $ 20,009 (Millions of Canadian dollars) AAA, AA A BBB BB or lower Total Banks OECD governments Other Risk rating (2) Counterparty type (3) As at October 31, 2018 Gross positive replacement cost Impact of master netting agreements $ 25,458 $ 32,693 $ 21,215 $ 24,255 14,544 15,046 15,881 $ 3,748 95,247 $ 42,937 $ 57,593 36,081 18,749 $ 33,561 $ 8,348 13,164 Total 95,247 57,593 Replacement cost (after netting agreements) $ 10,914 $ 8,438 $ 6,169 $ 12,133 $ 37,654 $ 6,856 $ 10,401 $ 20,397 $ 37,654 (1) (2) (3) On November 1, 2018, we prospectively implemented SA-CCR in accordance with CAR guidelines in determining our replacement cost. Our internal risk ratings for major counterparty types approximate those of public ratings agencies. Ratings of AAA, AA, A and BBB represent investment grade ratings and ratings of BB or lower represent non-investment grade ratings. Counterparty type is defined in accordance with CAR guidelines. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 171 Note 8 Derivative financial instruments and hedging activities (continued) Derivatives in hedging relationships We apply hedge accounting to minimize volatility in earnings and capital caused by changes in interest rates or foreign exchange rates. Interest rate and currency fluctuations will either cause assets and liabilities to appreciate or depreciate in market value or cause variability in forecasted cash flows. When a hedging relationship is effective, gains, losses, revenue and expenses of the hedging instrument will offset the gains, losses, revenue and expenses of the hedged item. Derivatives used in hedging relationships are recorded in Other Assets – Derivatives or Other Liabilities – Derivatives on the Balance Sheet. Foreign currency-denominated liabilities used in net investment hedging relationships are recorded in Deposits – Business and Government and Subordinated debentures on the Balance Sheet. Gains and losses relating to hedging ineffectiveness is recorded in Non-Interest income and amounts reclassified from hedge reserves in OCI to income is recorded in Net-interest income for Cash flow hedges and Non-interest income for Net Investment hedges. We assess and measure the effectiveness of a hedging relationship based on the change in the fair value or cash flows of the derivative hedging instrument relative to the change in the fair value or cash flows of the hedged item attributable to the hedged risk. When cash instruments are designated as hedges of foreign exchange risks, only changes in their value due to foreign exchange risk are included in the assessment and measurement of hedge effectiveness. Potential sources of ineffectiveness can be attributed to differences between hedging instruments and hedged items: (cid:129) Mismatches in the terms of hedged items and hedging instruments, for example the frequency and timing of when (cid:129) (cid:129) interest rates are reset and frequency of payment. Difference in the discounting factors between the hedged item and the hedging instrument, taking into consideration the different reset frequency of the hedged item and hedging instrument. Hedging derivatives with a non-zero fair value at inception date of the hedging relationship, resulting in mismatch in terms with the hedged item. Below is a description of our risk management strategy for each risk exposure that we decide to hedge: Interest rate risk We use interest rate contracts to manage our exposure to interest rate risk by modifying the repricing characteristics of existing and/or forecasted assets and liabilities, including funding and investment activities. The swaps are designated in either a fair value hedge or a cash flow hedge and predominately reference Interbank Offered Rates (IBORs) across multiple jurisdictions. Certain swaps will be affected by the Interest Rate Benchmark Reform as the market transitions to alternative risk free or nearly risk free rates by the end of 2021. For fair value hedges, we use interest rate contracts to manage the fair value movements of our fixed-rate instruments due to changes in benchmark interest. The interest rate swaps are entered into on a one-to-one basis to manage the benchmark interest rate risk, and its terms are critically matched to the specified fixed rate instruments. We also use interest rate swaps in fair value hedges to manage interest rate risk from residential mortgage assets and funding liabilities. Our exposure from this portfolio changes with the origination of new loans, repayments of existing loans, and sale of securitized mortgages. Accordingly, we have adopted dynamic hedging for that portfolio, in which the hedge relationship is rebalanced on a more frequent basis, such as on a bi-weekly or on a monthly basis. For cash flow hedges, we use interest rate swaps to manage the exposure to cash flow variability of our variable rate instruments as a result of changes in benchmark interest rates. The variable rate instruments and forecast transactions which reference certain IBORs will be affected by the Interest Rate Benchmark Reform. Whilst some of the interest rate derivatives are entered into on a one-to-one basis to manage a specific exposure, other interest rate derivatives may be entered into for managing interest rate risks of a portfolio of assets and liabilities. Foreign exchange risk We manage our exposure to foreign currency risk with cross currency swaps in a cash flow hedge, and foreign exchange forward contracts in a net investment hedge. Certain cash instruments may also be designated in a net investment hedge, where applicable. For cash flow hedges, we use cross currency swaps and forward contracts to manage the cash flow variability arising from fluctuations in foreign exchange rates on our issued foreign denominated fixed rate liabilities and highly probable forecasted transactions. The maturity profile and repayment terms of these swaps are matched to those of our foreign denominated exposures to limit our cash flow volatility from changes in foreign exchange rates. For net investment hedges, we use a combination of foreign exchange forwards and cash instruments, such as foreign denominated deposit liabilities, some of which reference IBORs that will be affected by the Interest Rate Benchmark Reform, to manage our foreign exchange risk arising from our investments in foreign operations. Our most significant exposures include U.S. dollar, British pound and Euro. When hedging net investments in foreign operations using foreign exchange forwards, only the undiscounted spot element of the foreign exchange forward is designated as the hedging instrument. Accordingly, changes in the fair value of the hedging instrument as a result of changes in forward rates and the effects of discounting are not included in the hedging effectiveness assessment. Foreign operations are only hedged to the extent of the liability or notional amount of the derivative; we generally do not expect to incur significant ineffectiveness on hedges of net investments in foreign operations. Equity price risk We use total return swaps in cash flow hedges to mitigate the cash flow variability of the expected payment associated with our cash settled share-based compensation plan for certain key employees by exchanging interest payments for indexed RBC share price change and dividend returns. Credit risk We predominantly use credit derivatives to economically hedge our credit exposures. We mitigate industry sector concentrations and single-name exposures related to our credit portfolio by purchasing credit derivatives to transfer credit risk to third parties. 172 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Derivative instruments designated in hedging relationships The following table presents the fair values of the derivative instruments and the principal amounts of the non-derivative liabilities, categorized by their hedging relationships, as well as derivatives that are not designated in hedging relationships. Derivatives and non-derivative instruments (1) October 31, 2019 October 31, 2018 As at Designated as hedging instruments in hedging relationships Designated as hedging instruments in hedging relationships Fair Value Cash Flow Net investment Not designated in a hedging relationship Fair Value (2) Cash Flow (2) Net investment Not designated in a hedging relationship (2) $ 146 $ 77 $ 52 $ 101,285 $ 404 $ 12 $ 13 $ 93,610 187 – 526 70 – 27,688 97,760 n.a. 4 – 413 – 28 25,565 89,793 n.a. (Millions of Canadian dollars) Assets Derivative instruments Liabilities Derivative instruments Non-derivative instruments (1) The fair value reflects the impact of the election to characterize the daily variation margin as settlement of the related derivative fair values as permitted by certain central counterparties. Amounts have been revised from those previously presented. (2) n.a. not applicable The following tables provide the maturity analysis of the notional amounts and the weighted average rates of the hedging instruments and their carrying amounts by types of hedging relationships: Fair value hedges (Millions of Canadian dollars, except average rates) Interest rate risk Interest rate contracts Hedge of fixed rate assets Hedge of fixed rate liabilities Weighted average fixed interest rate Hedge of fixed rate assets Hedge of fixed rate liabilities (Millions of Canadian dollars, except average rates) Interest rate risk Interest rate contracts Hedge of fixed rate assets Hedge of fixed rate liabilities Weighted average fixed interest rate Hedge of fixed rate assets Hedge of fixed rate liabilities As at October 31, 2019 Notional amounts Carrying amount (1) Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 4,625 16,003 $ 20,439 48,361 $ 3,909 9,065 $ 28,973 73,429 $ 2 144 $ 187 – 1.9% 1.7% 2.2% 1.8% 2.7% 1.8% 2.2% 1.7% As at October 31, 2018 Notional amounts Carrying amount (1), (2) Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 2,518 14,946 $ 12,778 47,658 $ 4,668 7,432 $ 19,964 70,036 $ 311 93 $ 4 – 1.1% 1.6% 2.4% 1.8% 2.8% 1.8% 2.3% 1.8% (1) (2) The carrying value reflects the impact of the election to characterize the daily variation margin as settlement of the related derivative fair values as permitted by certain central counterparties. Amounts have been revised from those previously presented. Cash flow hedges (Millions of Canadian dollars, except average rates) Interest rate risk Interest rate contracts Hedge of variable rate assets Hedge of variable rate liabilities Weighted average fixed interest rate Hedge of variable rate assets Hedge of variable rate liabilities Foreign exchange risk Cross currency swaps Weighted average CAD-CHF exchange rate Weighted average CAD-EUR exchange rate Weighted average USD-EUR exchange rate As at October 31, 2019 Notional amounts Carrying amount (1) Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 17,327 200 $ 11,729 54,610 $ 1,696 4,803 $ 30,752 59,613 $ $ – – – – 2.1% 2.6% $ $ 2,937 – – 1.33 2.0% 1.9% 63 – 1.48 – $ 2.6% 2.4% 88 – 1.55 – 2.1% 2.0% $ 3,088 – 1.52 1.33 $ 2 $ 526 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 173 Note 8 Derivative financial instruments and hedging activities (continued) (Millions of Canadian dollars, except average rates) Interest rate risk Interest rate contracts Hedge of variable rate assets Hedge of variable rate liabilities Weighted average fixed interest rate Hedge of variable rate assets Hedge of variable rate liabilities Foreign exchange risk Cross currency swaps Weighted average CAD-CHF exchange rate Weighted average CAD-EUR exchange rate Weighted average USD-EUR exchange rate As at October 31, 2018 Notional amounts Carrying amount (1), (2) Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 12,686 2,000 $ 12,805 38,256 $ 1,615 3,978 $ 27,106 44,234 $ $ – – – – $ 2.2% 2.1% 326 1.27 – – $ 2.4% 1.9% 2,978 – – 1.33 $ 2.7% 2.5% 153 – 1.52 – 2.3% 2.0% $ 3,457 1.27 1.52 1.33 $ 12 $ 368 (1) (2) The carrying value reflects the impact of the election to characterize the daily variation margin as settlement of the related derivative fair values as permitted by certain central counterparties. Amounts have been revised from those previously presented. Net investment hedges (Millions of Canadian dollars, except average rates) Foreign exchange risk Foreign currency liabilities Weighted average CAD-USD exchange rate Weighted average CAD-EUR exchange rate Weighted average CAD-GBP exchange rate Forward contracts Weighted average CAD-USD exchange rate Weighted average CAD-EUR exchange rate Weighted average CAD-GBP exchange rate (Millions of Canadian dollars, except average rates) Foreign exchange risk Foreign currency liabilities Weighted average CAD-USD exchange rate Weighted average CAD-EUR exchange rate Weighted average CAD-GBP exchange rate Forward contracts Weighted average CAD-USD exchange rate Weighted average CAD-EUR exchange rate Weighted average CAD-GBP exchange rate n.a. not applicable As at October 31, 2019 Notional/Principal Carrying amount Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 8,701 1.31 – – $ 5,355 1.33 1.47 1.67 $ 14,843 1.29 – 1.69 – – – – $ $ 4,144 1.31 1.51 – – – – – $ $ 27,688 1.30 1.51 1.69 $ 5,355 1.33 1.47 1.67 n.a. $ 27,859 $ 52 $ 70 As at October 31, 2018 Notional/Principal Carrying amount Within 1 year 1 through 5 years Over 5 years Total Assets Liabilities $ 3,457 1.20 – 1.91 $ 3,372 1.31 1.49 1.68 $ 18,233 1.28 – 1.69 – – – – $ $ 3,875 1.31 1.53 – – – – – $ $ 25,565 1.27 1.53 1.73 $ 3,372 1.31 1.49 1.68 n.a. $ 25,043 $ 13 $ 28 The following tables present the details of the hedged items categorized by their hedging relationships: Fair value hedges – assets and liabilities designated as hedged items As at and for the year ended October 31, 2019 Accumulated amount of fair value adjustments on the hedged item included in the carrying amount Carrying amount (Millions of Canadian dollars) Interest rate risk Fixed rate assets (1) Fixed rate liabilities (1) Assets Liabilities Assets Liabilities Balance sheet item(s): Changes in fair values used for calculating hedge ineffectiveness $29,985 $ – $ 569 $ – – 74,099 – 693 Securities – Investment, net of applicable allowance; Loans – Retail $ Deposits – Business and government; Subordinated debentures 1,028 (2,045) 174 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements As at and for the year ended October 31, 2018 Accumulated amount of fair value adjustments on the hedged item included in the carrying amount Carrying amount (Millions of Canadian dollars) Interest rate risk Fixed rate assets (1) Fixed rate liabilities (1) Assets Liabilities Assets Liabilities Balance sheet item(s): Changes in fair values used for calculating hedge ineffectiveness $ 20,172 $ – $ (529) $ – – 68,714 – (1,302) Securities – Investment, net of applicable allowance; Loans – Retail $ Deposits – Business and government; Subordinated debentures (650) 1,018 (1) As at October 31, 2019, the accumulated amount of fair value hedge adjustments remaining in the Balance Sheet for hedged items that have ceased to be adjusted for hedging gains and losses is a loss of $53 million for fixed-rate assets and a loss of $170 million for fixed-rate liabilities (October 31, 2018 – $105 million and $277 million, respectively). Cash flow and net investment hedges – assets and liabilities designated as hedged items As at and for the year ended October 31, 2019 (Millions of Canadian dollars) Cash flow hedges Interest rate risk Variable rate assets Variable rate liabilities Foreign exchange risk Fixed rate assets Fixed rate liabilities Net investment hedges Foreign exchange risk Foreign subsidiaries (Millions of Canadian dollars) Cash flow hedges Interest rate risk Variable rate assets Variable rate liabilities Foreign exchange risk Fixed rate assets Fixed rate liabilities Net investment hedges Foreign exchange risk Foreign subsidiaries n.a. not applicable Balance sheet item(s): Changes in fair values used for calculating hedge ineffectiveness Cash flow hedge/foreign currency translation reserve Continuing hedges Discontinued hedges Securities – Investment, net of applicable allowance; Loans – Retail Deposits – Business and government; Deposits – Personal Securities – Investment, net of applicable allowance; Loans – Retail Deposits – Business and government $ (608) $ 163 $ 1,274 (372) (5) 125 (1) 9 84 70 – – n.a. (7) (5,407) (871) As at and for the year ended October 31, 2018 Changes in fair values used for calculating hedge ineffectiveness Cash flow hedge/foreign currency translation reserve Continuing hedges Discontinued hedges Balance sheet item(s): Securities – Investment, net of applicable allowance; Loans – Retail Deposits – Business and government; Deposits – Personal Securities – Investment, net of applicable allowance; Loans – Retail Deposits – Business and government n.a. $ 308 $ (187) $ (171) (769) 706 477 19 60 315 (4) 95 – – (5,365) (923) Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 175 Note 8 Derivative financial instruments and hedging activities (continued) Effectiveness of designated hedging relationships (Millions of Canadian dollars) Fair value hedges Interest rate risk Interest rate contracts – fixed rate assets Interest rate contracts – fixed rate liabilities Cash flow hedges Interest rate risk Interest rate contracts – variable rate assets Interest rate contracts – variable rate liabilities Foreign exchange risk Cross currency swap – fixed rate assets Cross currency swap – fixed rate liabilities Net investment hedges Foreign exchange risk Foreign currency liabilities Forward contracts (Millions of Canadian dollars) Fair value hedges Interest rate risk For the year ended October 31, 2019 Change in fair value of hedging instrument Hedge ineffectiveness recognized in income (1) Changes in the value of the hedging instrument recognized in OCI Amount reclassified from hedge reserves to income $ (1,060) $ 2,032 (32) $ (13) $ – – 605 (1,261) 5 (125) (50) 57 8 (5) – – – – 582 (1,265) 8 (193) (50) 57 – – (25) 220 5 (106) – (2) For the year ended October 31, 2018 Change in fair value of hedging instrument Hedge ineffectiveness recognized in income (1) Changes in the value of the hedging instrument recognized in OCI Amount reclassified from hedge reserves to income Interest rate contracts – fixed rate assets Interest rate contracts – fixed rate liabilities $ 605 (1,000) $ (45) $ 18 $ – – Cash flow hedges Interest rate risk Interest rate contracts – variable rate assets Interest rate contracts – variable rate liabilities Foreign exchange risk Cross currency swap – fixed rate assets Cross currency swap – fixed rate liabilities Net investment hedges Foreign exchange risk Foreign currency liabilities Forward contracts (318) 751 (19) (61) (331) 16 (11) (1) – – – – (275) 674 (10) (137) (331) 17 – – (37) 101 (7) (165) – – (1) Hedge ineffectiveness recognized in income included losses of $70 million that are excluded from the assessment of hedge effectiveness and are offset by economic hedges (October 31, 2018 – $46 million). 176 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Reconciliation of components of equity The following table provides a reconciliation by risk category of each component of equity and an analysis of other comprehensive income relating to hedge accounting: For the year ended October 31, 2019 Foreign currency Cash flow hedge translation reserve reserve 4,147 688 $ $ For the year ended October 31, 2018 Cash flow hedge reserve $ 431 $ Foreign currency translation reserve 3,545 (Millions of Canadian dollars) Balance at the beginning of the year Cash flow hedges Effective portion of changes in fair value: Interest rate risk Foreign exchange risk Equity price risk Net amount reclassified to profit or loss: Ongoing hedges: Interest rate risk Foreign exchange risk Equity price risk De-designated hedges: Interest rate risk Foreign exchange risk Net gain on hedge of net investment in foreign operations Foreign exchange denominated debt Forward foreign exchange contracts Foreign currency translation differences for foreign operations Reclassification of losses (gains) on foreign currency translation to income Reclassification of losses (gains) on net investment hedging activities to income Tax on movements on reserves during the period Balance at the end of the year $ Note 9 Premises and equipment (683) (185) 108 24 104 (93) (219) – – – 250 (6) $ 399 (147) (18) 44 172 7 (108) – – – (92) 688 $ (50) 57 66 2 2 (3) 4,221 $ (Millions of Canadian dollars) Cost Balance at beginning of period Additions (1) Transfers from work in process Disposals Foreign exchange translation Other Balance at end of period Accumulated depreciation Balance at beginning of period Depreciation Disposals Foreign exchange translation Other Balance at end of period Net carrying amount at end of period $ 153 For the year ended October 31, 2019 Land Buildings Computer equipment Furniture, fixtures and other equipment Leasehold improvements Work in process $ 153 – – – – – $ 153 $ $ – – – – – – $ 1,399 – 4 (10) – 2 $ 1,395 $ $ $ 669 45 (8) – (3) 703 692 $ $ $ $ $ 2,123 195 84 (68) 3 (12) 2,325 1,556 273 (61) 1 (11) 1,758 567 $ $ $ $ $ 1,373 129 82 (29) (1) 3 1,557 1,051 113 (26) – (1) 1,137 420 $ $ $ $ $ 2,726 81 262 (65) 2 (5) $ 264 591 (432) – – 9 3,001 $ 432 $ 8,863 $ 1,930 196 (56) 1 3 2,074 $ – – – – – – $ 5,206 627 (151) 2 (12) $ 5,672 927 $ 432 $ 3,191 (331) 17 841 – – 75 4,147 Total $ 8,038 996 – (172) 4 (3) Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 177 Note 9 Premises and equipment (continued) (Millions of Canadian dollars) Cost Balance at beginning of period Additions (1) Transfers from work in process Disposals Foreign exchange translation Other Balance at end of period Accumulated depreciation Balance at beginning of period Depreciation Disposals Foreign exchange translation Other Balance at end of period For the year ended October 31, 2018 Land Buildings Computer equipment Furniture, fixtures and other equipment Leasehold improvements Work in process Total $ 157 – – (5) 1 – $ 153 $ $ – – – – – – $ $ $ $ $ 1,363 – 7 (17) 5 41 1,399 608 44 (10) 2 25 669 730 $ $ $ $ $ 1,875 255 44 (50) 4 (5) 2,123 1,367 246 (48) 1 (10) 1,556 567 $ $ $ $ $ 1,314 43 56 (41) 4 (3) 1,373 984 100 (34) 2 (1) 1,051 322 $ $ $ $ $ 2,586 61 184 (73) 8 (40) 2,726 1,819 179 (55) 6 (19) 1,930 796 $ $ $ $ $ 153 374 (291) – – 28 $ 7,448 733 – (186) 22 21 264 $ 8,038 – – – – – – $ 4,778 569 (147) 11 (5) $ 5,206 264 $ 2,832 Net carrying amount at end of period $ 153 (1) As at October 31, 2019, we had total contractual commitments of $338 million to acquire premises and equipment (October 31, 2018 – $273 million). Note 10 Goodwill and other intangible assets Goodwill (Millions of Canadian dollars) Balance at beginning of period Acquisitions Dispositions Currency translations Balance at end of period (Millions of Canadian dollars) Balance at beginning of period Acquisitions Dispositions Currency translations Balance at end of period Canadian Banking Caribbean Banking Canadian Wealth Management Global Asset Management U.S. Wealth Management (including City National) International Wealth Management Insurance Investor & Treasury Services Capital Markets Total For the year ended October 31, 2019 $ 2,528 $ 1,729 $ 27 – – – – (2) 579 $ – – – 1,986 $ – (20) 19 2,870 $ 71 – 2 118 $ – – 2 112 $ – – – 148 $ 1,067 $ 11,137 98 – (20) – 21 – – – – $ 2,555 $ 1,727 $ 579 $ 1,985 $ 2,943 $ 120 $ 112 $ 148 $ 1,067 $ 11,236 Canadian Banking Caribbean Banking Canadian Wealth Management Global Asset Management U.S. Wealth Management (including City National) International Wealth Management Investor & Treasury Services Capital Markets Insurance Total For the year ended October 31, 2018 $ 2,527 $ 1 – – 1,694 $ – – 35 576 $ – – 3 2,006 $ – – (20) 2,745 $ 80 (8) 53 120 $ – – (2) 112 $ – – – 148 $ 1,049 $ 10,977 81 – – (8) 87 18 – – – $ 2,528 $ 1,729 $ 579 $ 1,986 $ 2,870 $ 118 $ 112 $ 148 $ 1,067 $ 11,137 We perform our annual impairment test by comparing the carrying amount of each CGU to its recoverable amount. The recoverable amount of a CGU is represented by its value in use, except in circumstances where the carrying amount of a CGU exceeds its value in use. In such cases, the greater of the CGU’s fair value less costs of disposal and its value in use is the recoverable amount. Our annual impairment test is performed as at August 1. In our 2019 and 2018 annual impairment tests, the recoverable amounts of our Caribbean Banking and International Wealth Management CGUs were based on their fair value less costs of disposal. The recoverable amounts of all other CGUs tested were based on their value in use. Value in use We calculate value in use using a five-year discounted cash flow method, with the exception of our U.S. Wealth Management (including City National) CGU where cash flow projections covering a six-year period were used, which more closely aligns with the strategic growth plan resulting from the acquisition of City National. Future cash flows are based on financial plans agreed by management, estimated based on forecast results, business initiatives, capital required to support future cash flows and returns to shareholders. Key drivers of future cash flows include net interest margins and average interest-earning assets. The values 178 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements assigned to these drivers over the forecast period are based on past experience, external and internal economic forecasts, and management’s expectations of the impact of economic conditions on our financial results. Beyond the initial cash flow projection period, cash flows are assumed to increase at a constant rate using a nominal long-term growth rate (terminal growth rate), with the exception of our U.S. Wealth Management (including City National) CGU where we applied a mid-term growth rate consistent with our growth expectations for this business, reverting to the terminal growth rate after 10 years. Terminal growth rates are based on the current market assessment of gross domestic product and inflation for the countries within which the CGU operates. The discount rates used to determine the present value of each CGU’s projected future cash flows are based on the bank-wide cost of capital, adjusted for the risks to which each CGU is exposed. CGU-specific risks include: country risk, business/ operational risk, geographic risk (including political risk, devaluation risk, and government regulation), currency risk, and price risk (including product pricing risk and inflation). The estimation of value in use involves significant judgment in the determination of inputs to the discounted cash flow model and is most sensitive to changes in future cash flows, discount rates and terminal growth rates applied to cash flows beyond the forecast period. The sensitivity of key inputs and assumptions used was tested by recalculating the recoverable amount using reasonably possible changes to those assumptions. The post-tax discount rates were increased by 1%, terminal growth rates were decreased by 1%, and future cash flows were reduced by 10%. As at August 1, 2019, no reasonably possible change in an individual key input or assumption, as described, would result in a CGU’s carrying amount exceeding its recoverable amount based on value in use. The terminal growth rates and pre-tax discount rates used in our discounted cash flow models are summarized below. Group of cash generating units Canadian Banking Caribbean Banking Canadian Wealth Management Global Asset Management U.S. Wealth Management (including City National) International Wealth Management Insurance Investor & Treasury Services Capital Markets (1) (2) Pre-tax discount rates are determined implicitly based on post-tax discount rates. Discount rates have been revised from those previously presented. As at August 1, 2019 August 1, 2018 Discount rate (1) Terminal growth rate Discount rate (1), (2) Terminal growth rate 10.2% 11.9 11.2 11.1 11.2 10.8 11.0 10.9 11.8 3.0% 4.2 3.0 3.0 3.0 3.0 3.0 3.0 3.0 10.0% 11.8 11.2 11.0 11.0 10.1 11.0 11.2 12.4 3.0% 4.3 3.0 3.0 3.0 3.0 3.0 3.0 3.0 Fair value less costs of disposal – Caribbean Banking For our Caribbean Banking CGU, we calculated fair value less costs of disposal using a discounted cash flow method that projects future cash flows over a 5-year period. Cash flows are based on management forecasts, adjusted to approximate the considerations of a prospective third-party buyer. Cash flows beyond the initial 5-year period are assumed to increase at a constant rate using a nominal long-term growth rate. Future cash flows, terminal growth rates, and discount rates are based on the same factors noted above. This fair value measurement is categorized as level 3 in the fair value hierarchy as certain significant inputs are not observable. We use significant judgement to determine inputs to the discounted cash flow model which is most sensitive to changes in future cash flows, discount rates and terminal growth rates applied to cash flows beyond the forecast period. The sensitivity of these key inputs was tested by applying a reasonably possible change to these assumptions. As at August 1, 2019, the recoverable amount of our Caribbean Banking CGU, based on fair value less costs of disposal, was 126% of its carrying amount. If the post-tax discount rate was increased by 1.8%, holding other individual factors constant, the recoverable amount would approximate the carrying amount. No other reasonably possible change in an individual key input or assumption, including decreasing the terminal growth rates by 2.4% or reducing future cash flows by 21%, would result in the CGU’s carrying amount exceeding its recoverable amount based on fair value less costs of disposal. Fair value less costs of disposal – International Wealth Management For our International Wealth Management CGU, we calculated fair value less costs of disposal using a multiples-based approach. Each business within the CGU was valued using either a Price-to-assets-under-administration (P/AUA) or Price-to-revenue (P/Rev) multiple, as appropriate, to reflect the considerations of a prospective third-party buyer. In 2019, we applied a P/AUA multiple of 2.25% to AUA as at August 1 (August 1, 2018 – 2.5%) and a P/Rev multiple of 2.5x (August 1, 2018 – 2.5x) to revenue for the 12 months preceding the testing date. These multiples represent our best estimate from a range of reasonably possible inputs based on precedent transactions for comparable businesses. This fair value measurement is categorized as level 3 in the fair value hierarchy as certain significant inputs are not observable. The estimation of fair value less costs of disposal involves significant judgment in the determination of the appropriate valuation approach and inputs and is most sensitive to changes in the P/AUA and P/Rev multiples. These key inputs were tested for sensitivity by reducing each multiple to the low end of the range of reasonably possible inputs considered. As at August 1, 2019, no reasonably possible change in an individual key input or assumption, as described, would result in the CGU’s carrying amount exceeding its recoverable amount based on fair value less costs of disposal. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 179 Note 10 Goodwill and other intangible assets (continued) Other intangible assets (Millions of Canadian dollars) Gross carrying amount Balance at beginning of period Additions Acquisitions through business combinations Transfers Dispositions Impairment losses Currency translations Other changes Balance at end of period Accumulated amortization Balance at beginning of period Amortization charge for the year Dispositions Impairment losses Currency translations Other changes Balance at end of period Net balance at end of period (Millions of Canadian dollars) Gross carrying amount Balance at beginning of period Additions Acquisitions through business combinations Transfers Dispositions Impairment losses Currency translations Other changes Balance at end of period Accumulated amortization Balance at beginning of period Amortization charge for the year Dispositions Impairment losses Currency translations Other changes Balance at end of period Net balance at end of period Note 11 Significant dispositions For the year ended October 31, 2019 Internally generated software $ 5,984 42 – 1,009 – (94) – – Other software $ 1,582 49 16 42 (1) (6) 1 1 Core deposit intangibles Customer list and relationships In process software $ $ 1,750 – – – – – 1 (184) $ 1,768 – 6 – – – 7 (8) 1,146 1,184 – (1,051) – (42) (2) 5 Total $ 12,230 1,275 22 – (1) (142) 7 (186) $ 6,941 $ 1,684 $ 1,567 $ 1,773 $ 1,240 $ 13,205 $ (4,501) $ (1,226) $ (793) – 30 (1) 9 (121) – 2 (1) (11) (654) $ (159) – – 1 185 (1,162) $ (124) – – (6) 1 $ (5,256) $ (1,357) $ (627) $ (1,291) $ – – – – – – – $ (7,543) (1,197) – 32 (7) 184 $ (8,531) $ 1,685 $ 327 $ 940 $ 482 $ 1,240 $ 4,674 For the year ended October 31, 2018 Internally generated software Other software Core deposit intangibles Customer list and relationships In process software Total $ $ $ $ $ 5,143 40 – 798 (1) (1) 16 (11) $ 1,432 79 – 51 (1) – 11 10 5,984 $ 1,582 (3,825) (669) 1 – (11) 3 $ (1,094) (112) 1 – (7) (14) (4,501) $ (1,226) 1,483 $ 356 $ $ $ $ $ 1,715 – – – – – 35 – 1,750 (487) (153) – – (14) – (654) 1,096 $ $ $ $ $ 1,753 – 16 – – – (1) – 1,768 (1,022) (143) – – 3 – (1,162) 606 $ $ $ $ $ 892 1,111 – (849) (2) (7) 4 (3) $ 10,935 1,230 16 – (4) (8) 65 (4) 1,146 $ 12,230 – – – – – – – $ (6,428) (1,077) 2 – (29) (11) $ (7,543) 1,146 $ 4,687 Wealth Management On October 30, 2019, we completed the sale of our private debt Global Asset Management business in the United Kingdom to Dyal Capital Partners. As a result of the transaction, we recorded a pre-tax gain of $142 million in Non-interest income – Other ($134 million after-tax). The assets, liabilities and equity that were included in the disposal group are not significant. 180 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 12 Joint ventures and associated companies The following table summarizes the carrying value of our interests in joint ventures and associated companies accounted for under the equity method as well as our share of the income of those entities. (Millions of Canadian dollars) Carrying amount Share of: Net income Joint ventures Associated companies As at and for the year ended October 31 2019 178 $ October 31 2018 165 $ October 31 2019 474 $ October 31 2018 521 $ $ 107 $ 113 $ (31) $ (92) We do not have any joint ventures or associated companies that are individually material to our financial results. During the year ended October 31, 2019, we recognized impairment losses of $2 million with respect to our interests in joint ventures and associated companies (October 31, 2018 – impairment losses of $12 million). Certain of our subsidiaries, joint ventures and associates are subject to regulatory requirements of the jurisdictions in which they operate. When these subsidiaries, joint ventures and associates are subject to such requirements, they may be restricted from transferring to us our share of their assets in the form of cash dividends, loans or advances. As at October 31, 2019, restricted net assets of these subsidiaries, joint ventures and associates were $34.9 billion (October 31, 2018 – $33.9 billion). Note 13 Other assets (Millions of Canadian dollars) Cash collateral Margin deposits Receivable from brokers, dealers and clients Accounts receivable and prepaids Investments in joint ventures and associates Employee benefit assets Insurance-related assets Collateral loans Policy loans Reinsurance assets Other Deferred income tax asset Taxes receivable Accrued interest receivable Precious metals Commodity trading receivables Other As at October 31 2019 $ 15,629 5,688 2,511 4,569 652 147 $ October 31 2018 14,467 4,940 2,868 4,047 686 626 926 95 748 78 1,989 5,553 2,866 416 4,232 2,974 991 99 656 163 1,475 5,456 2,641 361 1,898 2,690 $ 49,073 $ 44,064 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 181 Note 14 Deposits (Millions of Canadian dollars) Personal Business and government (4) Bank Non-interest-bearing (5) Canada United States Europe (6) Other International Interest-bearing (5) Canada United States Europe (4), (6) Other International October 31, 2019 October 31, 2018 As at Term (3) Total Demand (1) Notice (2) $ 143,958 $ 49,806 $ 100,968 $ 294,732 $ 135,101 $ 48,873 $ 86,180 $ 270,154 533,522 32,521 $ 405,434 $ 64,593 $ 415,978 $ 886,005 $ 382,468 $ 57,778 $ 395,951 $ 836,197 Total Demand (1) Notice (2) 298,502 16,508 253,113 8,363 565,482 25,791 286,299 23,472 238,617 8,750 13,867 920 8,606 299 Term (3) $ 93,163 $ 34,632 760 5,225 5,692 $ – – 5 137 $ – – – 98,992 $ 34,632 760 5,230 88,119 $ 5,086 $ 34,098 564 5,495 – – 5 – $ 93,205 34,098 – 564 – 5,500 – 228,386 4,704 33,073 5,491 521,500 102,788 60,091 18,451 $ 405,434 $ 64,593 $ 415,978 $ 886,005 $ 382,468 $ 57,778 $ 395,951 $ 836,197 213,747 2,478 32,930 5,037 292,641 67,211 25,749 10,350 15,112 33,099 1,412 3,064 576,810 86,106 63,988 19,487 333,118 41,776 30,090 10,857 15,306 39,626 825 3,139 (1) (2) (3) (4) (5) (6) Demand deposits are deposits for which we do not have the right to require notice of withdrawal, which include both savings and chequing accounts. Notice deposits are deposits for which we can legally require notice of withdrawal. These deposits are primarily savings accounts. Term deposits are deposits payable on a fixed date, and include term deposits, guaranteed investment certificates and similar instruments. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. The geographical splits of the deposits are based on the point of origin of the deposits and where the revenue is recognized. As at October 31, 2019, deposits denominated in U.S. dollars, British pounds, Euro and other foreign currencies were $321 billion, $23 billion, $45 billion and $31 billion, respectively (October 31, 2018 – $309 billion, $20 billion, $38 billion and $31 billion, respectively). Europe includes the United Kingdom, Luxembourg, the Channel Islands, France and Italy. Contractual maturities of term deposits (Millions of Canadian dollars) Within 1 year: less than 3 months 3 to 6 months 6 to 12 months 1 to 2 years 2 to 3 years 3 to 4 years 4 to 5 years Over 5 years (1) Aggregate amount of term deposits in denominations of one hundred thousand dollars or more (2) As at October 31 2019 October 31 2018 $ 94,585 62,814 92,507 50,055 31,852 31,373 21,130 31,662 $ 415,978 $ 379,000 $ 89,553 59,109 80,773 51,798 45,550 21,127 23,863 24,178 $ 395,951 $ 362,000 (1) (2) Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. Aggregate amounts of term deposits in denominations of one hundred thousand dollars or more have been revised from those previously presented. Average deposit balances and average rates of interest (Millions of Canadian dollars, except for percentage amounts) Canada United States Europe (1) Other International For the year ended October 31, 2019 Average balances $ 650,555 129,903 63,333 26,290 Average rates 1.60% 1.17 1.15 1.20 $ 870,081 1.49% October 31, 2018 Average balances $ 603,582 131,715 59,916 23,788 Average rates 1.28% 1.00 0.91 1.11 $ 819,001 1.20% (1) Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. Note 15 Insurance Risk management Insurance risk is the risk of fluctuations in the timing, frequency or severity of insured events, relative to our expectations at the time of underwriting. We do not have a high degree of concentration risk due to our geographic diversity and business mix. Concentration risk is not a major concern for the life and health insurance business as it does not have a material level of region- 182 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements specific characteristics. Reinsurance is also used for a majority of our businesses to lower our risk profile and limit the liability on a single claim. We manage underwriting and pricing risk through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted, pricing policies by product line and centralized control of policy wordings. The risk that claims are handled or paid inappropriately is mitigated by using a range of information technology (IT) system controls and manual processes conducted by experienced staff. These, together with a range of detailed policies and procedures, ensure that all claims are handled in a timely, appropriate and accurate manner. Reinsurance In the ordinary course of business, our insurance operations reinsure risks to other insurance and reinsurance companies in order to lower our risk profile, limit loss exposure to large risks, and provide additional capacity for future growth. These ceding reinsurance arrangements do not relieve our insurance subsidiaries from our direct obligations to the insured parties. We evaluate the financial condition of the reinsurers and monitor our concentrations of credit risks to minimize our exposure to losses from reinsurer insolvency. Reinsurance amounts (ceded premiums) included in Non-interest income are shown in the table below. Net premiums and claims (Millions of Canadian dollars) Gross premiums Premiums ceded to reinsurers Net premiums Gross claims and benefits (1) Reinsurers’ share of claims and benefits Net claims For the year ended October 31 2019 4,209 (225) $ October 31 2018 4,236 (204) $ $ $ $ 3,984 3,990 (241) 3,749 $ $ $ 4,032 2,615 (224) 2,391 (1) Includes the change in fair value of investments backing our policyholder liabilities, which are largely offset in revenue. Insurance claims and policy benefit liabilities All actuarial assumptions are set in conjunction with Canadian Institute of Actuaries Standards of Practice and OSFI requirements. The assumptions that have the greatest effect on the measurement of insurance liabilities, the processes used to determine them and the assumptions used as at October 31, 2019 are as follows: Life insurance Mortality and morbidity – Mortality estimates are based on standard industry insured mortality tables, adjusted where appropriate to reflect our own experience. Morbidity assumptions are made with respect to the rates of claim incidence and claim termination for health insurance policies and are based on a combination of industry and our own experience. Future investment yield – Assumptions are based on the current yield rate, a reinvestment assumption and an allowance for future credit losses for each line of business, and are developed using interest rate scenario testing, including prescribed scenarios for determination of minimum liabilities as set out in the actuarial standards. Policyholder behaviour – Under certain policies, the policyholder has a contractual right to change benefits and premiums, as well as convert policies to permanent forms of insurance. All policyholders have the right to terminate their policies through lapse. Lapses represent the termination of policies due to non-payment of premiums. Lapse assumptions are primarily based on our recent experience adjusted for emerging industry experience where applicable. Significant insurance assumptions Life Insurance Canadian Insurance Mortality rates (1) Morbidity rates (2) Future reinvestment yield (3) Lapse rates (4) International Insurance Mortality rates (1) Future reinvestment yield (3) As at October 31 2019 October 31 2018 0.12% 1.82 3.69 0.50 0.57 3.06 0.11% 1.82 3.80 0.50 0.52 3.14 (1) (2) (3) (4) Average annual death rate for the largest portfolio of insured policies. Average net settlement rate for the individual and group disability insurance portfolio. Ultimate reinvestment rate of the insurance operations. Ultimate policy termination rate (lapse rate) for the largest permanent life insurance portfolio that relies on higher termination rate to maintain its profitability (lapse- supported policies). Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 183 Note 15 Insurance (continued) Insurance claims and policy benefit liabilities The following table summarizes our gross and reinsurers’ share of insurance liabilities at the end of the year. (Millions of Canadian dollars) Life insurance policyholder liabilities Life, health and annuity Investment contracts (1) Non-life insurance policyholder liabilities Unearned premium provision (1) Unpaid claims provision As at October 31, 2019 October 31, 2018 Gross Ceded Net Gross Ceded Net $ 11,339 $ 38 $ 11,377 $ $ $ 29 $ 62 91 $ $ 11,468 $ 601 $ 10,738 $ – 38 601 $ 10,776 $ 10,024 $ 9,982 $ 42 – $ 2 29 $ 60 89 $ 44 $ 603 $ 10,865 $ 10,068 $ 26 $ 18 2 $ 493 $ – 493 $ 9,489 42 9,531 – $ 3 3 $ 26 15 41 496 $ 9,572 (1) Insurance liabilities for investment contracts and unearned premium provision are reported in Other liabilities on the Consolidated Balance Sheets. Reconciliation of life insurance policyholder liabilities For the year ended October 31, 2019 October 31, 2018 (Millions of Canadian dollars) Balances at beginning of period New and in-force policies Changes in assumption and methodology Net change in investment contracts Balances at end of period Gross $ 10,024 $ 1,479 (122) (4) $ 11,377 $ Ceded Net 493 $ 9,531 $ 103 5 – 1,376 (127) (4) 601 $ 10,776 $ 10,024 $ Gross 9,687 $ 502 (173) 8 Ceded 393 $ 83 17 – Net 9,294 419 (190) 8 493 $ 9,531 The net increase in Insurance claims and policy benefit liabilities over the prior year was comprised of the net increase in life and health liabilities and reinsurance attributable to market movements on assets backing life and health liabilities and business growth. During the year, we reviewed all key actuarial methods and assumptions which are used in determining the policy benefit liabilities resulting in a $127 million net decrease to insurance liabilities comprised of: (i) a decrease of $104 million for revised actuarial reserves for updated growth assumptions on investments in equity and commercial real estate; (ii) a decrease of $78 million due to reinsurance contract renegotiations; (iii) a decrease of $17 million due to valuation system and data changes and (iv) an increase of $72 million arising from insurance risk related assumption updates largely due to mortality, morbidity, maintenance, property and casualty margin for adverse deviation and expense assumptions, impacting both gross and ceded insurance policyholder liabilities. Sensitivity analysis The following table presents the sensitivity of the level of insurance policyholder liabilities disclosed in this note to reasonably possible changes in the actuarial assumptions used to calculate them. The percentage change in each variable is applied to a range of existing actuarial modelling assumptions to derive the possible impact on net income. The analyses are performed where a single assumption is changed while holding other assumptions constant, which is unlikely to occur in practice. (Millions of Canadian dollars, except for percentage amounts) Increase in market interest rates (1) Decrease in market interest rates (1) Increase in equity market values (2) Decrease in equity market values (2) Increase in maintenance expenses (3) Life Insurance (3) Adverse change in annuitant mortality rates Adverse change in assurance mortality rates Adverse change in morbidity rates Adverse change in lapse rates Net income impact for the year ended Change in variable October 31 2019 1% $ 1 10 10 5 2 2 5 10 (7) $ 4 1 (3) (33) (205) (60) (205) (247) October 31 2018 (2) – 6 (8) (29) (131) (59) (188) (226) (1) (2) (3) Sensitivities for market interest rates include the expected current period earnings impact of a 100 basis points shift in the yield curve by increasing the current reinvestment rates while holding the assumed ultimate rates constant. The sensitivity consists of both the impact on assumed reinvestment rates in the actuarial liabilities and any changes in fair value of assets and liabilities from the yield curve shift. Sensitivities to changes in equity market values are composed of the expected current period earnings impact from differences in the changes in fair value of the equity asset holdings and the partially offsetting impact on the actuarial liabilities. Sensitivities to changes in maintenance expenses and life insurance actuarial assumptions include the expected current period earnings impact from recognition of increased liabilities due to an adverse change in the given assumption over the lifetime of all in-force policies. 184 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 16 Segregated funds We offer certain individual variable insurance contracts that allow policyholders to invest in segregated funds. The investment returns on these funds are passed directly to the policyholders. Amounts invested are at the policyholders’ risk, except where the policyholders have selected options providing maturity and death benefit guarantees. A liability for the guarantees is recorded in Insurance claims and policy benefit liabilities. Segregated funds net assets are recorded at fair value. All of our segregated funds net assets are categorized as Level 1 in the fair value hierarchy. The fair value of the segregated funds liabilities is equal to the fair value of the segregated funds net assets. Segregated funds net assets and segregated funds liabilities are presented on separate lines on the Consolidated Balance Sheets. The following tables present the composition of net assets and the changes in net assets for the year. Segregated funds net assets (Millions of Canadian dollars) Cash Investment in mutual funds Other assets (liabilities) net Changes in net assets (Millions of Canadian dollars) Net assets at beginning of period Additions (deductions): Deposits from policyholders Net realized and unrealized gains (losses) Interest and dividends Payment to policyholders Management and administrative fees Net assets at end of period As at October 31 2019 31 $ 1,631 1 1,663 $ October 31 2018 19 1,348 1 1,368 For the year ended October 31 2019 1,368 $ October 31 2018 1,216 557 124 39 (386) (39) 1,663 $ 537 (40) 31 (342) (34) 1,368 $ $ $ $ Note 17 Employee benefits – Pension and other post-employment benefits Plan characteristics We sponsor a number of programs that provide pension and post-employment benefits to eligible employees. The majority of beneficiaries of the pension plans are located in Canada and other beneficiaries of the pension plans are primarily located in the U.S., the U.K. and the Caribbean. The pension arrangements including investment, plan benefits and funding decisions are governed by local pension committees or trustees, who are legally segregated from the Bank, or management. Significant plan changes require the approval of the Board of Directors. Our defined benefit pension plans provide pension benefits based on years of service, contributions and average earnings at retirement. Our primary defined benefit pension plans are closed to new members. New employees are generally eligible to join defined contribution pension plans. The specific features of these plans vary by location. We also provide supplemental non-registered (non-qualified) pension plans for certain executives and senior management that are typically unfunded or partially funded. Our defined contribution pension plans provide pension benefits based on accumulated employee and Bank contributions. The Bank contributions are based on a percentage of an employee’s annual earnings and a portion of the Bank contribution may be dependent on the amount being contributed by the employee and their years of service. Our primary other post-employment benefit plans provide health, dental, disability and life insurance coverage and cover a number of current and retired employees who are mainly located in Canada. These plans are unfunded unless required by legislation. We measure our benefit obligations and pension assets as at October 31 each year. All plans are valued using the projected unit-credit method. We fund our registered defined benefit pension plans in accordance with actuarially determined amounts required to satisfy employee benefit obligations under current pension regulations. For our principal pension plan, the most recent funding actuarial valuation was completed on January 1, 2019, and the next valuation will be completed on January 1, 2020. For the year ended October 31, 2019, total contributions to our pension plans (defined benefit and defined contribution plans) and other post-employment benefit plans were $551 million and $72 million (October 31, 2018 – $594 million and $65 million), respectively. For 2020, total contributions to our pension plans and other post-employment benefit plans are expected to be $549 million and $78 million, respectively. Risks By their design, the defined benefit pension and other post-employment benefit plans expose the Bank to various risks such as investment performance, reductions in discount rates used to value the obligations, increased longevity of plan members, future inflation levels impacting future salary increases as well as future increases in healthcare costs. These risks will reduce over time due to the membership closure of our primary defined benefit pension plans and migration to defined contribution pension plans. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 185 Note 17 Employee benefits – Pension and other post-employment benefits (continued) The following table presents the financial position related to all of our material pension and other post-employment benefit plans worldwide, including executive retirement arrangements. (Millions of Canadian dollars) Canada Fair value of plan assets Present value of defined benefit obligation Net surplus (deficit) International Fair value of plan assets Present value of defined benefit obligation Net surplus (deficit) Total Fair value of plan assets Present value of defined benefit obligation Total net surplus (deficit) Effect of asset ceiling Total net surplus (deficit), net of effect of asset ceiling Amounts recognized in our Consolidated Balance Sheets Employee benefit assets Employee benefit liabilities Total net surplus (deficit), net of effect of asset ceiling As at October 31, 2019 October 31, 2018 Defined benefit pension plans Other post- employment benefit plans Defined benefit pension plans Other post- employment benefit plans $ $ $ $ $ $ $ $ $ 13,679 $ 14,428 (749) $ 1,106 $ 1,089 17 $ 14,785 $ 15,517 (732) $ (1) (733) $ 147 $ (880) (733) $ $ 1 1,722 (1,721) $ $ – 98 (98) $ $ 1 1,820 (1,819) $ – (1,819) $ $ – (1,819) (1,819) $ 12,587 $ 12,270 317 $ 977 $ 948 29 $ 13,564 $ 13,218 346 $ (1) 345 $ 626 $ (281) 345 $ 1 1,522 (1,521) – 100 (100) 1 1,622 (1,621) – (1,621) – (1,621) (1,621) The following table presents an analysis of the movement in the financial position related to all of our material pension and other post-employment benefit plans worldwide, including executive retirement arrangements. As at or for the year ended October 31, 2019 October 31, 2018 (Millions of Canadian dollars) Fair value of plan assets at beginning of period Interest income Remeasurements Return on plan assets (excluding interest income) Change in foreign currency exchange rate Contributions – Employer Contributions – Plan participant Payments Payments – amount paid in respect of any settlements Other Fair value of plan assets at end of period Benefit obligation at beginning of period Current service costs Past service costs Gains and losses on settlements Interest expense Remeasurements Actuarial losses (gains) from demographic assumptions Actuarial losses (gains) from financial assumptions Actuarial losses (gains) from experience adjustments Change in foreign currency exchange rate Contributions – Plan participant Payments Payments – amount paid in respect of any settlements Benefit obligation at end of period Unfunded obligation Wholly or partly funded obligation Total benefit obligation Defined benefit pension plans (1) $ 13,564 $ 532 Other post- employment benefit plans 1 – Defined benefit pension plans (1) $ 13,573 $ 476 Other post- employment benefit plans 1 – 910 9 339 48 (601) – (16) 14,785 $ 13,218 $ 297 1 – 510 (4) 1,977 59 12 48 (601) – 15,517 $ 29 $ 15,488 15,517 $ – – 72 18 (90) – – 1 1,622 39 – – 65 (7) 196 (23) – 18 (90) – 1,820 1,671 149 1,820 $ $ $ $ $ $ $ $ $ $ (268) (10) 409 49 (586) (64) (15) 13,564 $ 14,005 $ 359 (13) 13 484 (164) (828) (22) (15) 49 (586) (64) 13,218 $ 27 $ 13,191 13,218 $ – – 65 19 (84) – – 1 1,845 34 (25) – 66 (66) (140) (32) 5 19 (84) – 1,622 1,481 141 1,622 (1) For pension plans with funding deficits, the benefit obligations and fair value of plan assets as at October 31, 2019 were $14,329 million and $13,449 million, respectively (October 31, 2018 – $685 million and $404 million, respectively). 186 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Pension and other post-employment benefit expense The following table presents the composition of our pension and other post-employment benefit expense related to our material pension and other post-employment benefit plans worldwide. (Millions of Canadian dollars) Current service costs Past service costs Gains and losses on settlements Net interest expense (income) Remeasurements of other long term benefits Administrative expense Defined benefit pension expense Defined contribution pension expense For the year ended Pension plans $ October 31 2019 297 1 – (22) – 16 $ October 31 2018 359 (13) 13 8 – 15 Other post-employment benefit plans $ October 31 2019 39 – – 65 13 – $ October 31 2018 34 (25) – 66 (4) – $ $ 292 212 504 $ $ 382 185 567 $ $ 117 – 117 $ $ 71 – 71 Service costs for the year ended October 31, 2019 totalled $293 million (October 31, 2018 – $354 million) for pension plans in Canada and $5 million (October 31, 2018 – $(8) million) for International plans. Net interest expense (income) for the year ended October 31, 2019 totalled $(21) million (October 31, 2018 – $4 million) for pension plans in Canada and $(1) million (October 31, 2018 – $4 million) for International plans. Pension and other post-employment benefit remeasurements The following table presents the composition of our remeasurements recorded in OCI related to our material pension and other post-employment benefit plans worldwide. (Millions of Canadian dollars) Actuarial (gains) losses: Changes in demographic assumptions Changes in financial assumptions Experience adjustments Return on plan assets (excluding interest based on discount rate) For the year ended Defined benefit pension plans Other post-employment benefit plans October 31 2019 October 31 2018 October 31 2019 October 31 2018 $ (4) 1,977 59 (910) $ 1,122 $ $ (164) (828) (22) 268 (746) $ $ (11) 186 (22) – 153 $ $ (65) (134) (35) – (234) Remeasurements recorded in OCI for the year ended October 31, 2019 were losses of $1,102 million (October 31, 2018 – gains of $633 million) for pension plans in Canada and losses of $20 million (October 31, 2018 – gains of $113 million) for International plans. Investment policy and strategies Defined benefit pension plan assets are invested prudently in order to meet our longer-term pension obligations. The pension plans’ investment strategy is to hold a diversified mix of investments by asset class and geographic location in order to reduce investment-specific risk to the funded status while maximizing the expected returns to meet pension obligations. Investment of the plan’s assets follows an asset/liability framework as investment is conducted with careful consideration of the pension obligation’s sensitivity to interest rates and credit spreads which are key risk factors impacting the obligation’s value. Factors taken into consideration in developing our asset mix include but are not limited to the following: (cid:129) (cid:129) (cid:129) (cid:129) (cid:129) the nature of the underlying benefit obligations, including the duration and term profile of the liabilities; the member demographics, including expectations for normal retirements, terminations, and deaths; the financial position of the pension plans; the diversification benefits obtained by the inclusion of multiple asset classes; and expected asset returns, including asset and liability correlations, along with liquidity requirements of the plan. To implement our asset mix policy, we may invest in debt securities, equity securities, and alternative investments. Our holdings in certain investments, including common shares, debt securities rated lower than BBB and residential and commercial mortgages, cannot exceed a defined percentage of the market value of our defined benefit pension plan assets. We may use derivative instruments as either a synthetic investment to more efficiently replicate the performance of an underlying security, or as a hedge against financial risks within the plan. To manage our credit risk exposure, where derivative instruments are not centrally cleared, counterparties are required to meet minimum credit ratings and enter into collateral agreements. Our defined benefit pension plan assets are primarily comprised of debt and equity securities and alternative investments. Our equity securities generally have unadjusted quoted market prices in an active market (Level 1) and our debt securities generally have quoted market prices for similar assets in an active market (Level 2). Alternative investments and other includes cash, hedge funds, and private fund investments including infrastructure, real estate leases, private equity and debt. In the case of private fund investments, no quoted market prices are usually available (Level 2 or Level 3). These fund assets are either valued by an independent valuator or priced using observable market inputs. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 187 Note 17 Employee benefits – Pension and other post-employment benefits (continued) During the year ended October 31, 2019, the management of defined benefit pension investments focused on increased allocation to risk reducing investments and strategies, maintaining diversification, while striving to improve expected investment return. Over time, an increasing allocation to debt securities is being used to reduce asset/liability duration mismatch and hence variability of the plan’s funded status due to interest rate movement. Longer maturity debt securities, given their price sensitivity to movements in interest rates, are considered to be a good economic hedge to risk associated with the plan’s liabilities, which are discounted using predominantly long maturity bond interest rates as inputs. Asset allocation of defined benefit pension plans (1) (Millions of Canadian dollars, except percentages) Equity securities Domestic Foreign Debt securities Domestic government bonds Foreign government bonds Corporate and other bonds Alternative investments and other October 31, 2019 October 31, 2018 As at Percentage of total plan assets Quoted in active market (2) Percentage of total plan assets Quoted in active market (2) Fair value 10% 22 100% 98 $ 21 3 23 21 – – – 13 1,259 3,243 2,643 288 3,265 2,866 10% 24 100% 99 19 2 24 21 – – – 15 Fair value $ 1,544 3,215 3,014 396 3,458 3,158 $ 14,785 100% 35% $ 13,564 100% 36% (1) (2) The asset allocation is based on the underlying investments held directly and indirectly through the funds as this is how we manage our investment policy and strategies. If our assessment of whether or not an asset was quoted in an active market was based on direct investments, 36% of our total plan assets would be classified as quoted in an active market (October 31, 2018 – 40%). The allocation of equity securities in our pension plans in Canada is 33% (October 31, 2018 – 33%) and that of our International plans is 16% (October 31, 2018 – 23%). The allocation of debt securities in our pension plans in Canada is 47% (October 31, 2018 – 46%) and that of our International plans is 44% (October 31, 2018 – 42%). The allocation of alternative investments and other in our pension plans in Canada is 20% (October 31, 2018 – 21%) and that of our International plans is 40% (October 31, 2018 – 35%). As at October 31, 2019, the plan assets include 1 million (October 31, 2018 – 1 million) of our common shares with a fair value of $104 million (October 31, 2018 – $95 million) and $57 million (October 31, 2018 – $49 million) of our debt securities. For the year ended October 31, 2019, dividends received on our common shares held in the plan assets were $4 million (October 31, 2018 – $4 million). Maturity profile The following table presents the maturity profile of our defined benefit pension plan obligation. (Millions of Canadian dollars, except participants and years) Number of plan participants Actual benefit payments 2019 Benefits expected to be paid 2020 Benefits expected to be paid 2021 Benefits expected to be paid 2022 Benefits expected to be paid 2023 Benefits expected to be paid 2024 Benefits expected to be paid 2025-2029 Weighted average duration of defined benefit payments As at October 31, 2019 $ Canada 69,084 551 610 630 650 670 690 3,709 16.0 years $ International 7,635 50 50 52 52 52 53 258 19.2 years $ Total 76,719 601 660 682 702 722 743 3,967 16.2 years Significant assumptions Our methodologies to determine significant assumptions used in calculating the defined benefit pension and other post- employment benefit expense are as follows: Discount rate For the Canadian pension and other post-employment benefit plans, all future expected benefit payments at each measurement date are discounted at spot rates from a derived Canadian AA corporate bond yield curve. The derived curve is based on actual short and mid-maturity corporate AA rates and extrapolated longer term rates. The extrapolated corporate AA rates are derived from observed corporate A, corporate AA and provincial AA yields. For the International pension and other post-employment benefit plans, all future expected benefit payments at each measurement date are discounted at spot rates from a local AA corporate bond yield curve. Spot rates beyond 30 years are set to equal the 30-year spot rate. The discount rate is the equivalent single rate that produces the same discounted value as that determined using the entire discount curve. This valuation methodology does not rely on assumptions regarding reinvestment returns. Rate of increase in future compensation The assumptions for increases in future compensation are developed separately for each plan, where relevant. Each assumption is set based on the price inflation assumption and compensation policies in each market, as well as relevant local statutory and plan-specific requirements. 188 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Healthcare cost trend rates Healthcare cost calculations are based on both short and long term trend assumptions established using the plan’s recent experience as well as market expectations. Weighted average assumptions to determine benefit obligation Discount rate Rate of increase in future compensation Healthcare cost trend rates (1) – Medical – Dental As at Defined benefit pension plans Other post-employment benefit plans October 31 2019 3.0% 3.3% n.a. n.a. October 31 2018 4.0% 3.3% n.a. n.a. October 31 2019 3.3% n.a. 3.5% 3.1% October 31 2018 4.1% n.a. 3.5% 3.1% (1) For our other post-employment benefit plans, the assumed trend rates used to measure the expected benefit costs of the defined benefit obligations are also the ultimate trend rates. n.a. not applicable Mortality assumptions Mortality assumptions are significant in measuring our obligations under the defined benefit pension plans. These assumptions have been set based on country specific statistics. Future longevity improvements have been considered and included where appropriate. The following table summarizes the mortality assumptions used for material plans. As at October 31, 2019 October 31, 2018 Life expectancy at 65 for a member currently at Life expectancy at 65 for a member currently at Age 65 Age 45 Age 65 Age 45 Male Female Male Female Male Female Male Female 23.7 20.6 23.5 24.1 22.6 25.2 24.7 22.2 25.1 25.0 24.1 27.0 23.7 20.6 23.4 24.1 22.7 25.2 24.7 22.3 25.0 25.0 24.2 26.9 (In years) Country Canada United States United Kingdom Sensitivity analysis Assumptions adopted can have a significant effect on the value of the obligations for defined benefit pension and other post- employment benefit plans and are based on historical experience and market inputs. The increase (decrease) in obligation in the following table has been determined for key assumptions assuming all other assumptions are held constant. In practice, this is unlikely to occur, as changes in some of the assumptions may be correlated. The following table presents the sensitivity analysis of key assumptions for 2019. (Millions of Canadian dollars) Discount rate Impact of 100 bps increase in discount rate Impact of 100 bps decrease in discount rate Rate of increase in future compensation Impact of 50 bps increase in rate of increase in future compensation Impact of 50 bps decrease in rate of increase in future compensation Mortality rate Impact of an increase in longevity by one additional year Healthcare cost trend rate Impact of 100 bps increase in healthcare cost trend rate Impact of 100 bps decrease in healthcare cost trend rate n.a. not applicable Increase (decrease) in obligation Defined benefit pension plans Other post- employment benefit plans $ (2,248) $ 2,834 (239) 304 66 (70) 425 n.a. n.a. 1 (1) 36 81 (68) Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 189 Note 18 Other liabilities (Millions of Canadian dollars) Cash collateral Accounts payable and accrued expenses Payroll and related compensation Payable to brokers, dealers and clients Negotiable instruments Accrued interest payable (1) Deferred income Taxes payable Precious metals certificates Dividends payable Insurance related liabilities Deferred income taxes Provisions Employee benefit liabilities Commodity liabilities Other As at October 31 2019 16,195 $ 1,598 7,416 3,241 1,671 3,496 2,563 2,202 431 1,567 387 82 581 2,699 8,487 5,521 58,137 $ $ $ October 31 2018 13,907 1,531 7,073 4,078 1,693 3,072 2,259 2,071 346 1,482 364 84 507 1,902 7,315 5,438 53,122 (1) Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. Note 19 Subordinated debentures The debentures are unsecured obligations and are subordinated in right of payment to the claims of depositors and certain other creditors. The amounts presented below are net of our own holdings in these debentures, and include the impact of fair value hedges used for managing interest rate risk. (Millions of Canadian dollars, except percentage and foreign currency) Maturity August 12, 2019 (1) July 15, 2022 June 8, 2023 July 17, 2024 (2), (3) December 6, 2024 June 4, 2025 (3) January 20, 2026 (3) January 27, 2026 (3) September 29, 2026 (3) November 1, 2027 July 25, 2029 (3) October 1, 2083 June 29, 2085 Deferred financing costs Earliest par value redemption date July 17, 2019 December 6, 2019 June 4, 2020 January 20, 2021 September 29, 2021 November 1, 2022 July 25, 2024 Any interest payment date Any interest payment date Interest rate 9.00% 5.38% 9.30% 3.04% 2.99% (4) 2.48% (4) 3.31% (5) 4.65% 3.45% (6) 4.75% 2.74% (7) (8) (9) Denominated foreign currency (millions) US$75 US$150 US$1,500 TT$300 US$174 As at October 31 2019 – $ 206 110 – 1,999 997 1,483 2,023 1,009 59 1,486 224 229 9,825 $ (10) 9,815 $ $ $ $ October 31 2018 103 208 110 998 1,978 988 1,443 1,813 988 59 – 224 229 9,141 (10) 9,131 The terms and conditions of the debentures are as follows: (1) (2) (3) (4) (5) (6) (7) (8) (9) All US$75 million outstanding subordinated debentures were redeemed on August 12, 2019 for 100% of their principal amount plus interest accrued to, but excluding, the redemption date. All $1,000 million outstanding subordinated debentures were redeemed on July 17, 2019 for 100% of their principal amount plus interest accrued to, but excluding, the redemption date. The notes include non-viability contingency capital (NVCC) provisions, necessary for the notes to qualify as Tier 2 regulatory capital under Basel III. NVCC provisions require the conversion of the instrument into a variable number of common shares in the event that OSFI deems the Bank non-viable or a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection. In such an event, each note is convertible into common shares pursuant to an automatic conversion formula with a multiplier of 1.5 and a conversion price based on the greater of: (i) a floor price of $5.00 and (ii) the current market price of our common shares based on the volume weighted average trading price of our common shares on the Toronto Stock Exchange. The number of shares issued is determined by dividing the par value of the note (including accrued and unpaid interest on such note) by the conversion price and then times the multiplier. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.10% above the 3-month Canadian Dollar Offered Rate (CDOR). Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 2.35% above the 3-month CDOR. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.12% above the 3-month CDOR. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 0.98% above the 3-month CDOR. Interest at a rate of 40 basis points above the 30-day Bankers’ Acceptance rate. Interest at a rate of 25 basis points above the U.S. dollar 3-month London Interbank Mean Rate (LIMEAN). In the event of a reduction of the annual dividend we declare on our common shares, the interest payable on the debentures is reduced pro rata to the dividend reduction and the interest reduction is payable with the proceeds from the sale of newly issued common shares. 190 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements All redemptions, cancellations and exchanges of subordinated debentures are subject to the consent and approval of OSFI, except for the debentures maturing July 15, 2022. Maturity schedule The aggregate maturities of subordinated debentures, based on the maturity dates under the terms of issue, are as follows: (Millions of Canadian dollars) Within 1 year 1 to 5 years 5 to 10 years Thereafter Note 20 Trust capital securities $ October 31 2019 – 316 9,056 453 $ 9,825 We issued innovative capital instruments, RBC Trust Capital Securities (RBC TruCS), through the structured entity RBC Capital Trust (Trust). On June 30, 2018, the Trust redeemed all issued and outstanding RBC TruCS 2008-1 for cash at a redemption price of $1,000 per unit. Note 21 Equity Share capital Authorized share capital Preferred – An unlimited number of First Preferred Shares and Second Preferred Shares without nominal or par value, issuable in series; the aggregate consideration for which all the First Preferred Shares and all the Second Preferred Shares that may be issued may not exceed $20 billion and $5 billion, respectively. Common – An unlimited number of shares without nominal or par value may be issued. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 191 Note 21 Equity (continued) Outstanding share capital The following table details our common and preferred shares outstanding. (Millions of Canadian dollars, except the number of shares and dividends per share) Common shares issued Balance at beginning of period Issued in connection with share-based compensation plans (1) Purchased for cancellation (2) Balance at end of period Treasury shares – common shares Balance at beginning of period Purchases Sales Balance at end of period Common shares outstanding Preferred shares issued First preferred (3) Non-cumulative, fixed rate Series W Series AA Series AC Series AD (4) Series AE Series AF Series AG Series BH Series BI Series BJ Non-cumulative, 5-Year Rate Reset Series AJ (5) Series AL (5) Series AZ Series BB Series BD Series BF Series BK Series BM Series BO (6) Non-cumulative, floating rate Series AK (5) Non-cumulative, fixed rate/floating rate Series C-2 Treasury shares – preferred shares Balance at beginning of period (7) Purchases Sales Balance at end of period (7) Preferred shares outstanding As at and for the year ended October 31, 2019 October 31, 2018 Number of shares (thousands) Dividends declared per share Number of shares (thousands) Dividends declared per share Amount Amount 1,439,029 $ 17,635 1,900 (10,251) 136 (126) 1,452,898 $ 17,730 1,466 (15,335) 92 (187) 1,430,678 $ 17,645 $ 4.07 1,439,029 $ 17,635 $ 3.77 (235) $ (54,263) 53,916 (582) $ (18) (5,380) 5,340 (58) 1,430,096 $ 17,587 (363) $ (53,964) 54,092 (235) $ (27) (5,470) 5,479 (18) 1,438,794 $ 17,617 12,000 $ 12,000 8,000 – 10,000 8,000 10,000 6,000 6,000 6,000 300 $ 300 200 – 250 200 250 150 150 150 – – 20,000 20,000 24,000 12,000 29,000 30,000 14,000 – 20 – – 500 500 600 300 725 750 350 – 1.23 1.11 1.15 – 1.13 1.11 1.13 1.23 1.23 1.31 0.22 0.27 0.96 0.96 0.90 0.90 1.38 1.38 1.27 0.23 12,000 $ 12,000 8,000 10,000 10,000 8,000 10,000 6,000 6,000 6,000 300 $ 300 200 250 250 200 250 150 150 150 13,579 12,000 20,000 20,000 24,000 12,000 29,000 30,000 – 2,421 339 300 500 500 600 300 725 750 – 61 1.23 1.11 1.15 1.13 1.13 1.11 1.13 1.23 1.23 1.31 0.88 1.07 1.00 0.98 0.90 0.90 1.38 1.38 – 0.78 31 US$ 67.50 20 31 US$ 67.50 227,020 $ 5,706 114 $ (8,021) 7,941 34 $ 3 (184) 182 1 227,054 $ 5,707 251,020 $ 6,306 6 $ (10,215) 10,323 114 $ – (256) 259 3 251,134 $ 6,309 (1) (2) (3) Includes fair value adjustments to stock options of $29 million (2018 – $15 million). During the year ended October 31, 2019, we purchased common shares for cancellation at an average cost of $100.41 per share with a book value of $12.29 per share. During the year ended October 31, 2018, we purchased common shares for cancellation at an average cost of $99.29 per share with a book value of $12.22 per share. First Preferred Shares were issued at $25 per share with the exception of Non-Cumulative Fixed Rate/Floating Rate First Preferred Shares, Series C-2 (Series C-2) which were issued at US$1,000 per share (equivalent to US$25 per depositary share). (4) On November 24, 2018, we redeemed all 10 million issued and outstanding Non-Cumulative First Preferred Shares, Series AD, for cash at a redemption price of $25 per share. On February 24, 2019, we redeemed all 2.4 million issued and outstanding Non-Cumulative First Preferred Shares Series AK, all 13.6 million issued and outstanding Non-Cumulative 5 year Rate Reset First Preferred Shares Series AJ, and all 12 million issued and outstanding Non-Cumulative 5-year Rate Reset First Preferred Shares Series AL, at a price of $25 per share. On November 2, 2018, we issued 14 million Non-Cumulative 5-year Rate Reset First Preferred Shares, Series BO, totalling $350 million. Positive amounts represent a short position in treasury shares. (5) (6) (7) 192 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Significant terms and conditions of preferred shares As at October 31, 2019 Preferred shares First preferred Non-cumulative, fixed rate Series W (4) Series AA Series AC Series AE Series AF Series AG Series BH (5) Series BI (5) Series BJ (5) Non-cumulative, 5-Year Rate Reset (6) Series AZ (5) Series BB (5) Series BD (5) Series BF (5) Series BK (5) Series BM (5) Series BO (5) Non-cumulative, fixed rate/ floating rate Series C-2 (7) Current Annual Yield Premium Current Dividend per share (1) Earliest redemption date (2) Issue Date Redemption price (2), (3) 4.90% 4.45% 4.60% 4.50% 4.45% 4.50% 4.90% 4.90% 5.25% 3.70% 3.65% 3.60% 3.60% 5.50% 5.50% 4.80% $ .306250 .278125 .287500 .281250 .278125 .281250 .306250 .306250 .328125 .231250 .228125 .225000 .225000 .343750 .343750 .300000 2.21% 2.26% 2.74% 2.62% 4.53% 4.80% 2.38% February 24, 2010 May 24, 2011 November 24, 2011 February 24, 2012 May 24, 2012 May 24, 2012 November 24, 2020 November 24, 2020 February 24, 2021 $ January 31, 2005 April 4, 2006 November 1, 2006 January 19, 2007 March 14, 2007 April 26, 2007 June 5, 2015 July 22, 2015 October 2, 2015 May 24, 2019 August 24, 2019 May 24, 2020 November 24, 2020 May 24, 2021 August 24, 2021 February 24, 2024 January 30, 2014 June 3, 2014 January 30, 2015 March 13, 2015 December 16, 2015 March 7, 2016 November 2, 2018 25.00 25.00 25.00 25.00 25.00 25.00 26.00 26.00 26.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 6.75% 4.052% US$16.875000 November 7, 2023 November 2, 2015 US$1,000.00 (1) (2) (3) (4) (5) (6) (7) Non-cumulative preferential dividends of each Series are payable quarterly, as and when declared by the Board of Directors, on or about the 24th day (7th day for Series C-2) of February, May, August and November. Subject to the consent of OSFI and the requirements of the Bank Act (Canada), we may, on or after the dates specified above, redeem First Preferred Shares. In the case of Series AZ, BB, BD, BF, BK, BM, and BO, these may be redeemed for cash at a price per share of $25 if redeemed on the earliest redemption date and on the same date every fifth year thereafter. In the case of Series W, AA, AC, AE, AF, AG, BH, BI and BJ, these may be redeemed for cash at a price per share of $26 if redeemed during the 12 months commencing on the earliest redemption date and decreasing by $0.25 each 12-month period thereafter to a price per share of $25 if redeemed four years from the earliest redemption date or thereafter. Series C-2 may be redeemed at a price of US$1,000 on the earliest redemption date and any dividend payment date thereafter. Subject to the consent of OSFI and the requirements of the Bank Act (Canada), we may purchase the First Preferred Shares of each Series for cancellation at the lowest price or prices at which, in the opinion of the Board of Directors, such shares are obtainable. Subject to the approval of the Toronto Stock Exchange, we may, on or after February 24, 2010, convert First Preferred Shares Series W into our common shares. First Preferred Shares Series W may be converted into that number of common shares determined by dividing the current redemption price by the greater of $2.50 and 95% of the weighted average trading price of common shares at such time. The preferred shares include NVCC provisions, necessary for the shares to qualify as Tier 1 regulatory capital under Basel III. NVCC provisions require the conversion of the instrument into a variable number of common shares in the event that OSFI deems the Bank non-viable or a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection. In such an event, each preferred share is convertible into common shares pursuant to an automatic conversion formula with a multiplier of 1 and with a conversion price based on the greater of: (i) a floor price of $5 and (ii) the current market price of our common shares based on the volume weighted average trading price of our common shares on the Toronto Stock Exchange. The number of shares issued is determined by dividing the preferred share value ($25 plus declared and unpaid dividends) by the conversion price. The dividend rate will reset on the earliest redemption date and every fifth year thereafter at a rate equal to the 5-year Government of Canada bond yield plus the premium indicated. The holders have the option to convert their shares into Non-Cumulative floating rate First Preferred Shares subject to certain conditions on the earliest redemption date and every fifth year thereafter at a rate equal to the three-month Government of Canada Treasury Bill rate plus the premium indicated. The dividend rate will change on the earliest redemption date at a rate equal to the 3-month LIBOR plus the premium indicated. Series C-2 do not qualify as Tier 1 regulatory capital. Restrictions on the payment of dividends We are prohibited by the Bank Act (Canada) from declaring any dividends on our preferred or common shares when we are, or would be placed as a result of the declaration, in contravention of the capital adequacy and liquidity regulations or any regulatory directives issued under the Act. We may not pay dividends on our common shares at any time unless all dividends to which preferred shareholders are then entitled have been declared and paid or set apart for payment. Currently, these limitations do not restrict the payment of dividends on our preferred or common shares. Dividend reinvestment plan Our dividend reinvestment plan (DRIP) provides common and preferred shareholders with a means to receive additional common shares rather than cash dividends. The plan is only open to shareholders residing in Canada or the United States. The requirements of our DRIP are satisfied through either open market share purchases or shares issued from treasury. During 2019 and 2018, the requirements of our DRIP were satisfied through open market share purchases. Shares available for future issuances As at October 31, 2019, 42.9 million common shares are available for future issue relating to our DRIP and potential exercise of stock options and awards outstanding. In addition, we may issue up to 38.9 million common shares from treasury under the RBC Umbrella Savings and Securities Purchase Plan that was approved by shareholders on February 26, 2009. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 193 Note 22 Share-based compensation Stock option plans We have stock option plans for certain key employees. Under the plans, options are periodically granted to purchase common shares. The exercise price for the majority of the grants is determined as the higher of the volume-weighted average of the trading prices per board lot (100 shares) of our common shares on the Toronto Stock Exchange (i) on the day preceding the day of grant; and (ii) the five consecutive trading days immediately preceding the day of grant. The exercise price for the remaining grants is the closing market share price of our common shares on the New York Stock Exchange on the date of grant. All options vest over a four-year period, and are exercisable for a period not exceeding 10 years from the grant date. The compensation expense recorded for the year ended October 31, 2019, in respect of the stock option plans was $6 million (October 31, 2018 – $6 million). The compensation expense related to non-vested options was $3 million at October 31, 2019 (October 31, 2018 – $3 million), to be recognized over the weighted average period of 1.8 years (October 31, 2018 – 1.1 years). Analysis of the movement in the number and weighted average exercise price of options is set out below: A summary of our stock option activity and related information (Canadian dollars per share except share amounts) Outstanding at beginning of period Granted Exercised (2), (3) Forfeited in the period Outstanding at end of period Exercisable at end of period For the year ended October 31, 2019 October 31, 2018 Number of options (thousands) 7,770 1,090 (1,900) (10) 6,950 Weighted average exercise price (1) 71.40 $ 96.55 55.05 54.99 79.88 $ Number of options (thousands) 8,566 773 (1,440) (129) 7,770 Weighted average exercise price (1) 64.96 $ 102.33 50.42 78.12 71.40 $ 2,980 $ 64.24 3,726 $ 55.82 (1) (2) (3) The weighted average exercise prices reflect the conversion of foreign currency-denominated options at the exchange rates as of October 31, 2019 and October 31, 2018. For foreign currency-denominated options exercised during the year, the weighted average exercise prices are translated using exchange rates as at the settlement date. Cash received for options exercised during the year was $105 million (October 31, 2018 – $73 million) and the weighted average share price at the date of exercise was $103.15 (October 31, 2018 – $101.81). New shares were issued for all stock options exercised in 2019 and 2018. Options outstanding as at October 31, 2019 by range of exercise price (Canadian dollars per share except share amounts and years) $36.46 – $52.23 $52.60 – $69.17 $73.14 – $76.68 $78.59 – $90.23 $96.55 – $102.33 Options outstanding Options exercisable Number outstanding (thousands) 704 907 1,490 1,986 1,863 6,950 Weighted average exercise price (1) 45.63 $ 60.47 74.57 87.00 98.95 79.88 $ Weighted average remaining contractual life (years) 2.35 3.15 5.92 6.49 8.70 6.10 Number exercisable (thousands) 704 907 818 551 – 2,980 Weighted average exercise price (1) 45.63 $ 60.47 74.76 78.59 – 64.24 $ (1) The weighted average exercise prices reflect the conversion of foreign currency-denominated options at the exchange rate as of October 31, 2019. The weighted average fair value of options granted during the year ended October 31, 2019 was estimated at $5.61 (October 31, 2018 – $6.66). This was determined by applying the Black-Scholes model on the date of grant, taking into account the specific terms and conditions under which the options are granted, such as the vesting period and expected share price volatility estimated by considering the historic average share price volatility over a historical period corresponding to the expected option life. The following assumptions were used to determine the fair value of options granted: Weighted average assumptions (Canadian dollars per share except percentages and years) Share price at grant date Risk-free interest rate Expected dividend yield Expected share price volatility Expected life of option For the year ended $ October 31 2019 94.09 2.01% 3.77% 12% 6 Years $ October 31 2018 101.83 1.71% 3.66% 13% 6 Years 194 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Employee savings and share ownership plans We offer many employees an opportunity to own our common shares through savings and share ownership plans. Under these plans, the employees can generally contribute between 1% and 10% of their annual salary or benefit base for commission-based employees. For each contribution between 1% and 6%, we will match 50% of the employee contributions in our common shares. For the RBC Dominion Securities Savings Plan, our maximum annual contribution is $4,500 per employee. For the RBC U.K. Share Incentive Plan, our maximum annual contribution is £1,500 per employee. For the year ended October 31, 2019, we contributed $112 million (October 31, 2018 – $97 million), under the terms of these plans, towards the purchase of our common shares. As at October 31, 2019, an aggregate of 35 million common shares were held under these plans (October 31, 2018 – 35 million common shares). Deferred share and other plans We offer deferred share unit plans to executives, certain key employees and non-employee directors of the Bank. Under these plans, participants may choose to receive all or a percentage of their annual variable short-term incentive bonus, commission, or directors’ fee in the form of deferred share units (DSUs). The participants must elect to participate in the plan prior to the beginning of the year. DSUs earn dividend equivalents in the form of additional DSUs at the same rate as dividends on common shares. The participant is not allowed to convert the DSUs until retirement or termination of employment/directorship. The cash value of the DSUs is equivalent to the market value of common shares when conversion takes place. We also offer a deferred bonus plan for certain key employees within Capital Markets. The deferred bonus is invested as RBC share units and a specified percentage vests on each of the three anniversary dates following the grant date. Each vested amount is paid in cash and is based on the original number of share units granted plus accumulated dividends valued using the average closing price of RBC common shares during the five trading days immediately preceding the vesting date. We offer performance deferred share award plans to certain key employees, all of which vest at the end of three years. Upon vesting, the award is paid in cash and is based on the original number of RBC share units granted plus accumulated dividends valued using the average closing price of RBC common shares during the five trading days immediately preceding the vesting date. A portion of the award under certain plans may be increased or decreased up to 25%, depending on our total shareholder return compared to a defined peer group of global financial institutions. We maintain non-qualified deferred compensation plans for certain key employees in the United States. These plans allow eligible employees to defer a portion of their annual income and a variety of productivity and recruitment bonuses and allocate the deferrals among specified fund choices, including a RBC Share Accounted fund that tracks the value of our common shares. The following table presents the units granted under the deferred share and other plans for the year. Units granted under deferred share and other plans (Units and per unit amounts) Deferred share unit plans Deferred bonus plan Performance deferred share award plans Deferred compensation plans Other share-based plans For the year ended October 31, 2019 October 31, 2018 Units granted (thousands) 495 3,423 2,471 116 1,210 Weighted average fair value per unit $ 99.69 105.12 96.39 94.06 96.28 Units granted (thousands) 376 4,820 2,099 91 978 Weighted average fair value per unit 100.71 95.18 101.55 103.55 101.48 $ 7,715 $ 100.42 8,364 $ 97.85 Our liabilities for the awards granted under the deferred share and other plans are measured at fair value, determined based on the quoted market price of our common shares and specified fund choices as applicable. Annually, our obligation is increased by additional units earned by plan participants, and is reduced by forfeitures, cancellations, and the settlement of vested units. In addition, our obligation is impacted by fluctuations in the market price of our common shares and specified fund units. For performance deferred share award plans, the estimated outcome of meeting the performance conditions also impacts our obligation. The following tables present the units that have been earned by the participants, our obligations for these earned units under the deferred share and other plans, and the related compensation expenses (recoveries) recognized for the year. Obligations under deferred share and other plans October 31, 2019 October 31, 2018 As at (Millions of Canadian dollars except units) Deferred share unit plans Deferred bonus plan Performance deferred share award plans Deferred compensation plans (1) Other share-based plans Units (thousands) 5,288 8,820 5,621 3,072 1,787 24,588 (1) Excludes obligations not determined based on the quoted market price of our common shares. Carrying amount 562 937 597 326 185 2,607 $ $ Units (thousands) 4,631 10,347 5,892 3,299 2,140 26,309 Carrying amount 446 $ 990 565 317 202 $ 2,520 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 195 Note 22 Share-based compensation (continued) Compensation expenses recognized under deferred share and other plans (Millions of Canadian dollars) Deferred share unit plans Deferred bonus plan Performance deferred share award plans Deferred compensation plans Other share-based plans Note 23 Income taxes Components of tax expense (Millions of Canadian dollars) Income taxes (recoveries) in Consolidated Statements of Income Current tax Tax expense for current year Adjustments for prior years Recoveries arising from previously unrecognized tax loss, tax credit or temporary difference of a prior period Deferred tax Origination and reversal of temporary difference Effects of changes in tax rates Adjustments for prior years Recoveries arising from previously unrecognized tax loss, tax credit or temporary difference of a prior period, net Income taxes (recoveries) in Consolidated Statements of Comprehensive Income and Changes in Equity Other comprehensive income Net unrealized gains (losses) on debt securities and loans at fair value through other comprehensive income Provision for credit losses recognized in income Reclassification of net losses (gains) on debt securities and loans at fair value through other comprehensive income to income Unrealized foreign currency translation gains (losses) Net foreign currency translation gains (losses) from hedging activities Reclassification of losses (gains) on net investment hedging activities to income Net gains (losses) on derivatives designated as cash flow hedges Reclassification of losses (gains) on derivatives designated as cash flow hedges to income Remeasurements of employee benefit plans Net fair value change due to credit risk on financial liabilities designated as fair value through profit or loss Net gains (losses) on equity securities designated at fair value through other comprehensive income Share-based compensation awards Total income taxes For the year ended $ October 31 2019 77 274 294 250 106 $ 1,001 $ October 31 2018 6 139 190 80 78 $ 493 For the year ended October 31 2019 October 31 2018 $ 3,256 (26) $ (31) 3,199 (114) 29 (57) (14) (156) 3,043 51 – (60) 2 2 1 (200) (50) (333) 18 5 (9) (573) 3,351 (212) (11) 3,128 28 148 152 (127) 201 3,329 12 (5) (52) 2 (77) – 84 8 256 45 (5) 15 283 $ 2,470 $ 3,612 The effective tax rate of 19.1% decreased 200 bps, primarily due to an increase in income from lower tax rate jurisdictions and the impact of the U.S. Tax Reform which resulted in the write-down of net deferred tax assets in the prior year. The following is an analysis of the differences between the income tax expense reflected in the Consolidated Statements of Income and the amounts calculated at the Canadian statutory rate. 196 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Reconciliation to statutory tax rate (Millions of Canadian dollars, except for percentage amounts) Income taxes at Canadian statutory tax rate Increase (decrease) in income taxes resulting from Lower average tax rate applicable to subsidiaries Tax-exempt income from securities Tax rate change Other Income taxes in Consolidated Statements of Income / effective tax rate For the year ended October 31, 2019 $ 4,217 26.5% October 31, 2018 26.5% $ 4,176 (815) (310) 29 (78) $ 3,043 (5.1) (1.9) 0.1 (0.5) 19.1% (752) (285) 148 42 $ 3,329 (4.8) (1.8) 0.9 0.3 21.1% Deferred tax assets and liabilities result from tax loss and tax credit carryforwards and temporary differences between the tax basis of assets and liabilities and their carrying amounts on our Consolidated Balance Sheets. Significant components of deferred tax assets and liabilities (Millions of Canadian dollars) Net deferred tax asset/(liability) Allowance for credit losses Deferred compensation Business realignment charges Tax loss and tax credit carryforwards Deferred income Financial instruments measured at fair value through other comprehensive income Premises and equipment and intangibles Deferred expense Pension and post-employment related Other Comprising Deferred tax assets Deferred tax liabilities (Millions of Canadian dollars) Net deferred tax asset/(liability) Allowance for credit losses Deferred compensation Business realignment charges Tax loss and tax credit carryforwards Deferred income Financial instruments measured at fair value through other comprehensive income Premises and equipment and intangibles Deferred expense Pension and post-employment related Other Comprising Deferred tax assets Deferred tax liabilities As at and for the year ended October 31, 2019 Net asset beginning of period Change through equity Change through profit or loss Exchange rate differences Other Net asset end of period $ $ – 9 – – – (33) – 36 339 3 354 $ $ $ $ $ $ 695 1,033 3 203 (48) (8) (858) 55 295 21 1,391 1,475 (84) 1,391 23 197 7 (10) (11) (1) (4) (47) (6) 8 156 $ $ (2) $ 7 – – (1) – – – 9 – $ 716 1,246 10 202 (60) (1) (4) 1 3 (3) – $ – (3) – – – 6 (43) (869) 45 631 29 $ 1,907 $ 1,989 (82) $ 1,907 As at and for the year ended October 31, 2018 Net asset beginning of period Change through equity Change through profit or loss Exchange rate differences Other Net asset end of period $ (6) $ (15) – – – 19 (1) – (260) 3 $ 1 (502) (8) 188 (37) (74) 182 (23) (16) 88 $ (260) $ (201) $ $ $ $ $ 703 1,491 11 19 (11) 48 (1,003) 76 571 (54) 1,851 1,948 (97) 1,851 (3) $ 59 – (4) – (1) (36) 2 – (16) 1 $ – – – – – – – – – – – $ $ $ $ 695 1,033 3 203 (48) (8) (858) 55 295 21 1,391 1,475 (84) 1,391 The tax loss and tax credit carryforwards amount of deferred tax assets relates to losses and tax credits in our Canadian, U.S., Caribbean, and Japanese operations. Deferred tax assets of $202 million were recognized at October 31, 2019 (October 31, 2018 – $203 million) in respect of tax losses and tax credits incurred in current or preceding years for which recognition is dependent on the projection of future taxable profits. Management’s forecasts support the assumption that it is probable that the results of future operations will generate sufficient taxable income to utilize the deferred tax assets. The forecasts rely on continued liquidity and capital support to our business operations, including tax planning strategies implemented in relation to such support. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 197 Note 23 Income taxes (continued) As at October 31, 2019, unused tax losses, tax credits and deductible temporary differences of $413 million, $365 million and $nil (October 31, 2018 – $443 million, $426 million and $39 million) available to be offset against potential tax adjustments or future taxable income were not recognized as deferred tax assets. This amount includes unused tax losses of $1 million which expire within one year (October 31, 2018 – $4 million), $7 million which expire in two to four years (October 31, 2018 – $2 million) and $405 million which expire after four years (October 31, 2018 – $437 million). There are no tax credits that will expire in one year (October 31, 2018 – $nil), $60 million that will expire in two to four years (October 31, 2018 – $45 million) and $305 million that will expire after four years (October 31, 2018 – $381 million). In addition, there are no deductible temporary differences that will expire in one year (October 31, 2018 – $1 million), nor that will expire in two to four years (October 31, 2018 – $1 million) or that will expire after four years (October 31, 2018 – $37 million). The amount of temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures for which deferred tax liabilities have not been recognized in the parent bank is $17.9 billion as at October 31, 2019 (October 31, 2018 – $14.6 billion). Tax examinations and assessments We have received reassessments during the year from the Canada Revenue Agency (CRA), in respect of the 2014, 2013 and 2012 taxation years, which suggest that Royal Bank of Canada owes additional income taxes of approximately $756 million as they denied the deductibility of certain dividends. These are consistent with the reassessments received for taxation years 2011, 2010, and 2009 for approximately $434 million of additional income taxes and interest in respect of the same matter. These amounts represent the maximum additional taxes owing for those years. Legislative amendments introduced in the 2015 Canadian Federal Budget resulted in disallowed deduction of dividends from transactions with Taxable Canadian Corporations including those hedged with Tax Indifferent Investors, namely pension funds and non-resident entities with prospective application effective May 1, 2017. The dividends to which the reassessments relate include both dividends in transactions similar to those which are the target of the 2015 legislative amendments and dividends which are unrelated to the legislative amendments. It is possible that the CRA will reassess us for significant additional income tax for subsequent years on the same basis. In all cases, we are confident that our tax filing position was appropriate and intend to defend ourselves vigorously. U.S. Tax Reform The majority of the provisions in the U.S. Tax Cuts and Jobs Act legislation (U.S. Tax Reform), which was passed in December 2017, took effect at the beginning of calendar year 2018 or for fiscal years beginning in 2018. The changes include a reduction in the corporate income tax rate from 35% to 21% which resulted in a write-down of $178 million (US$142 million), primarily related to net deferred tax assets in the prior year. Note 24 Earnings per share (Millions of Canadian dollars, except share and per share amounts) Basic earnings per share Net income Preferred share dividends Net income attributable to non-controlling interests Net income available to common shareholders Weighted average number of common shares (in thousands) Basic earnings per share (in dollars) Diluted earnings per share Net income available to common shareholders Dilutive impact of exchangeable shares Net income available to common shareholders including dilutive impact of exchangeable shares Weighted average number of common shares (in thousands) Stock options (1) Issuable under other share-based compensation plans Exchangeable shares (2) Average number of diluted common shares (in thousands) Diluted earnings per share (in dollars) For the year ended October 31 2019 October 31 2018 $ $ $ 12,871 (269) (11) 12,591 1,434,779 8.78 12,591 15 12,606 1,434,779 2,011 742 3,150 $ $ $ 12,431 (285) (31) 12,115 1,443,894 8.39 12,115 15 12,130 1,443,894 2,691 742 3,158 1,440,682 8.75 $ 1,450,485 8.36 $ (1) (2) The dilutive effect of stock options was calculated using the treasury stock method. When the exercise price of options outstanding is greater than the average market price of our common shares, the options are excluded from the calculation of diluted earnings per share. For the year ended October 31, 2019, an average of 767,225 outstanding options with an average exercise price of $102.33 were excluded from the calculation of diluted earnings per share. For the year ended October 31, 2018, an average of 657,353 outstanding options with an average exercise price of $102.33 were excluded from the calculation of diluted earnings per share. Includes exchangeable preferred shares. 198 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 25 Guarantees, commitments, pledged assets and contingencies Guarantees and commitments We use guarantees and other off-balance sheet credit instruments to meet the financing needs of our clients. The table below summarizes our maximum exposure to credit losses related to our guarantees and commitments provided to third parties. The maximum exposure to credit risk relating to a guarantee is the maximum risk of loss if there was a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions, insurance policies or from collateral held or pledged. The maximum exposure to credit risk relating to a commitment to extend credit is the full amount of the commitment. In both cases, the maximum risk exposure is significantly greater than the amount recognized as a liability in our Consolidated Balance Sheets. (Millions of Canadian dollars) Financial guarantees Financial standby letters of credit Commitments to extend credit Backstop liquidity facilities Credit enhancements Documentary and commercial letters of credit Other commitments to extend credit Other credit-related commitments Securities lending indemnifications Performance guarantees Other Maximum exposure to credit losses As at October 31 2019 October 31 2018 $ 16,608 $ 15,502 36,305 1,692 268 225,911 91,625 7,061 787 36,267 2,128 268 223,954 107,239 6,955 391 Our credit review process, our policy for requiring collateral security, and the types of collateral security held are generally the same for guarantees and commitments as for loans. Our clients generally have the right to request settlement of, or draw on, our guarantees and commitments within one year. However, certain guarantees can only be drawn if specified conditions are met. These conditions, along with collateral requirements, are described below. We believe that it is highly unlikely that all or substantially all of the guarantees and commitments will be drawn or settled within one year, and contracts may expire without being drawn or settled. Financial guarantees Financial standby letters of credit Financial standby letters of credit represent irrevocable assurances that we will make payments in the event that a client cannot meet its payment obligations to the third party. For certain guarantees, the guaranteed party can request payment from us even though the client has not defaulted on its obligations. The term of these guarantees generally have a term of five to seven years. Our policy for requiring collateral security with respect to these instruments and the types of collateral security held is generally the same as for loans. When collateral security is taken, it is determined on an account-by-account basis according to the risk of the borrower and the specifics of the transaction. Collateral security may include cash, securities and other assets pledged. Commitments to extend credit Backstop liquidity facilities Backstop liquidity facilities are provided to ABCP conduit programs administered by us and third parties as an alternative source of financing in the event that such programs are unable to access commercial paper markets, or in limited circumstances, when predetermined performance measures of the financial assets owned by these programs are not met. The average remaining term of these liquidity facilities is approximately four years. The terms of the backstop liquidity facilities do not require us to advance money to these programs in the event of bankruptcy or insolvency and generally do not require us to purchase non-performing or defaulted assets. Credit enhancements We provide partial credit enhancement to multi-seller ABCP programs administered by us to protect commercial paper investors in the event that the collections on the underlying assets together with the transaction-specific credit enhancements or the liquidity facilities prove to be insufficient to pay for maturing commercial paper. Each of the asset pools is structured to achieve a high investment-grade credit profile through credit enhancements from us and other third parties related to each transaction. The average remaining term of these credit facilities is approximately three years. Documentary and commercial letters of credit Documentary and commercial letters of credit, which are written undertakings by us on behalf of a client authorizing a third party to draw drafts on us up to a stipulated amount under specific terms and conditions, where some are collateralized based on the underlying agreement with the client and others are collateralized by cash deposits or other assets of the third party which may include the underlying shipment of goods to which they relate. Other commitments to extend credit Commitments to extend credit represent unused portions of authorizations to extend credit in the form of loans, bankers’ acceptances or letters of credit where we do not have the ability to unilaterally withdraw the credit extended to the borrower. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 199 Note 25 Guarantees, commitments, pledged assets and contingencies (continued) Other credit-related commitments Securities lending indemnifications In securities lending transactions, we act as an agent for the owner of a security, who agrees to lend the security to a borrower for a fee, under the terms of a pre-arranged contract. The borrower must fully collateralize the security loaned at all times. As part of this custodial business, an indemnification may be provided to securities lending customers to ensure that the fair value of securities loaned will be returned in the event that the borrower fails to return the borrowed securities and the collateral held is insufficient to cover the fair value of those securities. These indemnifications normally terminate without being drawn upon. The term of these indemnifications varies, as the securities loaned are recallable on demand. Collateral held for our securities lending transactions typically includes cash, securities that are issued or guaranteed by the Canadian government, U.S. government or other OECD countries or high quality debt or equity instruments. Performance guarantees Performance guarantees represent irrevocable assurances that we will make payments to third-party beneficiaries in the event that a client fails to perform under a specified non-financial contractual obligation. Such obligations typically include works and service contracts, performance bonds, and warranties related to international trade. The term of these guarantees can range up to five to seven years. Our policy for requiring collateral security with respect to these instruments and the types of collateral security held is generally the same as for loans. When collateral security is taken, it is determined on an account-by-account basis according to the risk of the borrower and the specifics of the transaction. Collateral security may include cash, securities and other assets pledged. Indemnifications In the normal course of our operations, we provide indemnifications which are often standard contractual terms to counterparties in transactions such as purchase and sale contracts, fiduciary, agency, licensing, custodial and service agreements, clearing system arrangements, participation as a member of exchanges, director/officer contracts and leasing transactions. These indemnification agreements may require us to compensate the counterparties for costs incurred as a result of changes in laws and regulations (including tax legislation) or as a result of litigation claims or statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of these indemnification agreements vary based on the contract. The nature of the indemnification agreements prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay to counterparties. Historically, we have not made any significant payments under such indemnifications. Uncommitted amounts Uncommitted amounts represent undrawn credit facilities for which we have the ability to unilaterally withdraw the credit extended to the borrower at any time. These include both retail and commercial commitments. As at October 31, 2019, the total balance of uncommitted amounts was $287 billion (October 31, 2018 – $264 billion). Other commitments We act as underwriter for certain new issuances under which we alone or together with a syndicate of financial institutions purchase the new issue for resale to investors. In connection with these activities, our commitments were $35 million as at October 31, 2019, (October 31, 2018 – $141 million). We invest in private companies, directly or through third party investment funds, including Small Business Investment Companies, real estate funds and Low Income Housing Tax Credit funds. These funds are generally structured as closed-end limited partnerships wherein we hold a limited partner interest. For the year ended October 31, 2019, we have unfunded commitments of $684 million (October 31, 2018 – $948 million) representing the aggregate amount of cash we are obligated to be contributed as capital to these partnerships under the terms of the relevant contracts. Pledged assets and collateral In the ordinary course of business, we pledge assets and enter into collateral agreements with terms and conditions that are usual and customary to our regular lending, borrowing and trading activities recorded on our Consolidated Balance Sheets. The following are examples of our general terms and conditions on pledged assets and collateral: (cid:129) (cid:129) (cid:129) (cid:129) The risks and rewards of the pledged assets reside with the pledgor. The pledged asset is returned to the pledgor when the necessary conditions have been satisfied. The right of the pledgee to sell or re-pledge the asset is dependent on the specific agreement under which the collateral is pledged. If there is no default, the pledgee must return the comparable asset to the pledgor upon satisfaction of the obligation. We are also required to provide intraday pledges to the Bank of Canada when we use the Large Value Transfer System (LVTS), which is a real-time electronic wire transfer system that continuously processes all Canadian dollar large-value or time-critical payments throughout the day. The pledged assets earmarked for LVTS activities are normally released back to us at the end of the settlement cycle each day. Therefore, the pledged assets amount is not included in the table below. For the year ended October 31, 2019, we had on average $4.9 billion of assets pledged intraday to the Bank of Canada on a daily basis (October 31, 2018 – $4.0 billion). There are infrequent occasions where we are required to take an overnight advance from the Bank of Canada to cover a settlement requirement, in which case an equivalent value of the pledged assets would be used to secure the advance. There were no overnight advances taken on October 31, 2019 and October 31, 2018. 200 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Assets pledged against liabilities and collateral assets held or re-pledged (Millions of Canadian dollars) Sources of pledged assets and collateral Bank assets Loans Securities Other assets Client assets (1) Collateral received and available for sale or re-pledging Less: not sold or re-pledged Uses of pledged assets and collateral Securities borrowing and lending Obligations related to securities sold short Obligations related to securities lent or sold under repurchase agreements Securitization Covered bonds Derivative transactions Foreign governments and central banks Clearing systems, payment systems and depositories Other As at October 31 2019 October 31 2018 $ 80,542 55,544 21,316 157,402 $ 79,798 48,993 19,406 148,197 448,338 (49,325) 399,013 402,187 (53,590) 348,597 $ 556,415 $ 496,794 $ 146,590 34,686 229,905 47,254 42,103 26,448 5,963 4,804 18,662 $ 556,415 $ 119,087 32,247 209,353 49,997 36,959 21,110 5,058 4,006 18,977 $ 496,794 (1) Primarily relates to Obligations related to securities lent or sold under repurchase agreements, Securities lent and Derivative transactions. Lease commitments Operating lease commitments We are obligated under a number of non-cancellable operating leases for premises and equipment. These leases have various terms, escalation and renewal rights. The lease agreements do not include any clauses that impose any restriction on our ability to pay dividends, engage in debt financing transactions, or enter into further lease agreements. The minimum future lease payments under non-cancellable operating leases are as follows. October 31, 2019 October 31, 2018 As at (Millions of Canadian dollars) Future minimum lease payments No later than one year Later than one year and no later than five years Later than five years Less: Future minimum sublease payments to be received Net future minimum lease payments Note 26 Legal and regulatory matters Land and buildings $ 721 2,251 3,039 6,011 (25) $ $ 5,986 $ Equipment Land and buildings Equipment 88 101 – 189 – 189 $ $ 684 2,081 2,816 5,581 (11) $ 5,570 $ 103 137 – 240 – 240 We are a large global institution that is subject to many different complex legal and regulatory requirements that continue to evolve. We are and have been subject to a variety of legal proceedings, including civil claims and lawsuits, regulatory examinations, investigations, audits and requests for information by various governmental regulatory agencies and law enforcement authorities in various jurisdictions. Some of these matters may involve novel legal theories and interpretations and may be advanced under criminal as well as civil statutes, and some proceedings could result in the imposition of civil, regulatory enforcement or criminal penalties. We review the status of all proceedings on an ongoing basis and will exercise judgment in resolving them in such manner as we believe to be in our best interest. This is an area of significant judgment and uncertainty and the extent of our financial and other exposure to these proceedings after taking into account current accruals could be material to our results of operations in any particular period. The following is a description of our significant legal proceedings. London interbank offered rate (LIBOR) regulatory investigations and litigation Royal Bank of Canada and other U.S. dollar panel banks have been named as defendants in private lawsuits filed in the U.S. with respect to the setting of U.S. dollar LIBOR including a number of class action lawsuits which have been consolidated before the U.S. District Court for the Southern District of New York. The complaints in those private lawsuits assert claims against us and other panel banks under various U.S. laws, including U.S. antitrust laws, the U.S. Commodity Exchange Act, and state law. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 201 Note 26 Legal and regulatory matters (continued) In addition to the LIBOR actions, in January 2019, a number of financial institutions, including Royal Bank of Canada and RBC Capital Markets LLC, were named in a purported class action in New York alleging violations of the U.S. antitrust laws and common law principles of unjust enrichment in the setting of LIBOR after the Intercontinental Exchange took over administration of the benchmark interest rate from the British Bankers’ Association in 2014. Based on the facts currently known, it is not possible at this time for us to predict the ultimate outcome of these proceedings or the timing of their resolution. Royal Bank of Canada Trust Company (Bahamas) Limited proceedings On April 13, 2015, a French investigating judge notified Royal Bank of Canada Trust Company (Bahamas) Limited (RBC Bahamas) of the issuance of an ordonnance de renvoi referring RBC Bahamas and other unrelated persons to the French tribunal correctionnel to face the charge of complicity in estate tax fraud relating to actions taken relating to a trust for which RBC Bahamas serves as trustee. RBC Bahamas believes that its actions did not violate French law and contested the charge in the French court. On January 12, 2017, the French court acquitted all parties including RBC Bahamas and on June 29, 2018, the French appellate court affirmed the acquittals. The acquittals are being appealed. On October 28, 2016, Royal Bank of Canada was granted an exemption by the U.S. Department of Labor that will allow Royal Bank of Canada and its current and future affiliates to continue to qualify for the Qualified Professional Asset Manager exemption under the Employee Retirement Income Security Act despite any potential conviction of RBC Bahamas in the French proceeding for a temporary one year period from the date of conviction. An application to grant more lengthy exemptive relief is pending. RBC Bahamas continues to review the trustee’s and the trust’s legal obligations, including liabilities and potential liabilities under applicable tax and other laws. Based on the facts currently known, it is not possible at this time to predict the ultimate outcome of these matters; however, we believe that the ultimate resolution will not have a material effect on our consolidated financial position, although it may be material to our results of operations in the period it occurs. Interchange fees litigation Since 2011, seven proposed class actions have been commenced in Canada: Bancroft-Snell v. Visa Canada Corporation, et al., 9085-4886 Quebec Inc. v. Visa Canada Corporation, et al., Coburn and Watson’s Metropolitan Home v. Bank of America Corporation, et al. (Watson), Macaronies Hair Club and Laser Centre Inc. v. BofA Canada Bank, et al., 1023926 Alberta Ltd. v. Bank of America Corporation, et al., The Crown & Hand Pub Ltd. v. Bank of America Corporation, et al., and Hello Baby Equipment Inc. v. BofA Canada Bank, et al. The defendants in each action are VISA Canada Corporation (Visa), MasterCard International Incorporated (MasterCard), Royal Bank of Canada and other financial institutions. The plaintiff class members are Canadian merchants who accept Visa and/or MasterCard branded credit cards for payment. The actions allege, among other things, that from March 2001 to the present, Visa and MasterCard conspired with their issuing banks and acquirers to set default interchange rates and merchant discount fees and that certain rules (Honour All Cards and No Surcharge) have the effect of increasing the merchant discount fees. The actions include claims of civil conspiracy, breach of the Competition Act (the Act) interference with economic relations and unjust enrichment. The claims seek unspecified general and punitive damages. In Watson, a decision to partially certify the action as a class proceeding was released on March 27, 2014, and was appealed. On August 19, 2015, the British Columbia Court of Appeal struck the plaintiff class representative’s cause of action under section 45 of the Act and reinstated the plaintiff class representative’s cause of action in civil conspiracy by unlawful means, among other rulings. In October 2016, the trial court in Watson denied a motion by the plaintiff to revive the stricken section 45 Competition Act claim, and also denied the plaintiff’s motion to add new causes of action. The Supreme Court of Canada declined the B.C. class action plaintiffs’ request to appeal the decision striking the plaintiffs’ cause of action under section 45 of the Competition Act. The trial in the Watson proceeding has been rescheduled from October 14, 2019 to October 19, 2020. In 9085-4886 Quebec Inc. v. Visa Canada Corporation, et al., the Quebec-court dismissed the Competition Act claims by Quebec merchants for post-2010 damages and certified a class action as to the remaining claims. The merchants appealed and on July 25, 2019, the Quebec Court of Appeal allowed the appeal to also authorize the merchants to proceed under section 45 of the Competition Act for claims after March 12, 2010 and for claims under section 49 of the Competition Act. Based on the facts currently known, it is not possible at this time for us to predict the ultimate outcome of these proceedings or the timing of their resolution. Foreign exchange matters Various regulators are conducting inquiries regarding potential violations of antitrust law by a number of banks, including Royal Bank of Canada, regarding foreign exchange trading. Beginning in 2015, putative class actions were brought against Royal Bank of Canada and/or RBC Capital Markets, LLC in the United States and Canada. These actions were each brought against multiple foreign exchange dealers and allege, among other things, collusive behaviour in global foreign exchange trading. In August 2018, the U.S. District Court entered a final order approving RBC Capital Markets’ pending settlement with class plaintiffs. In November 2018, certain institutional plaintiffs who had previously opted-out of participating in the settlement filed their own lawsuit in US District Court. The Canadian class actions and one other U.S. action that is purportedly brought on behalf of different classes of plaintiffs remain pending. In its discretion Royal Bank of Canada may choose to resolve claims, litigations, or similar matters at any time. Based on the facts currently known, it is not possible at this time to predict the ultimate outcome of the Foreign Exchange Matters or the timing of their ultimate resolution. Other matters We are a defendant in a number of other actions alleging that certain of our practices and actions were improper. The lawsuits involve a variety of complex issues and the timing of their resolution is varied and uncertain. Management believes that we will ultimately be successful in resolving these lawsuits, to the extent that we are able to assess them, without material financial impact to the Bank. This is, however, an area of significant judgment and the potential liability resulting from these lawsuits could be material to our results of operations in any particular period. Various other legal proceedings are pending that challenge certain of our other practices or actions. While this is an area of significant judgment and some matters are currently inestimable, we consider that the aggregate liability, to the extent that we are able to assess it, resulting from these other proceedings will not be material to our consolidated financial position or results of operations. 202 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 27 Related party transactions Related parties Related parties include associated companies, post-employment benefit plans for the benefit of our employees, key management personnel (KMP), the Board of Directors (Directors), close family members of KMP and Directors, and entities which are, directly or indirectly, controlled by, jointly controlled by or significantly influenced by KMP, Directors or their close family members. Key management personnel and Directors KMP are defined as those persons having authority and responsibility for planning, directing and controlling our activities, directly or indirectly. They include the senior members of our organization called the Group Executive (GE). The GE is comprised of the President and Chief Executive Officer and individuals that report directly to him, including the Chief Administrative Officer, Chief Financial Officer, Chief Human Resources Officer, Group Chief Risk Officer, Chief Strategy & Corporate Development Officer, and Group Heads for Wealth Management and Insurance, Capital Markets and Investor & Treasury Services, Technology & Operations, and Personal & Commercial Banking. The Directors do not plan, direct, or control the activities of the entity; they oversee the management of the business and provide stewardship. Compensation of Key management personnel and Directors For the year ended (Millions of Canadian dollars) Salaries and other short-term employee benefits (1) Post-employment benefits (2) Share-based payments $ October 31 2019 26 2 44 72 $ $ October 31 2018 34 2 42 78 $ (1) (2) Includes the portion of the annual variable short-term incentive bonus that certain executives elected to receive in the form of DSUs. Refer to Note 22 for further details. Directors receive retainers but do not receive salaries and other short-term employee benefits. Directors do not receive post-employment benefits. Stock options, stock awards and shares held by Key management personnel, Directors and their close family members (Millions of Canadian dollars, except number of units) Stock options (1) Other non-option stock based awards (1) RBC common and preferred shares As at October 31, 2019 October 31, 2018 No. of units held 2,372,714 1,481,096 463,362 4,317,172 Value $ 51 157 49 $ 257 No. of units held 2,154,835 1,440,002 453,316 4,048,153 Value $ 37 138 43 $ 218 (1) Directors do not receive stock options or any other non-option stock based awards. Transactions, arrangements and agreements involving Key management personnel, Directors and their close family members In the normal course of business, we provide certain banking services to KMP, Directors, and their close family members. These transactions were made on substantially the same terms, including interest rates and security, as for comparable transactions with persons of a similar standing and did not involve more than the normal risk of repayment or present other unfavourable features. As at October 31, 2019, total loans to KMP, Directors and their close family members were $8 million (October 31, 2018 – $10 million). We have no stage 3 allowance or provision for credit losses relating to these loans as at and for the years ended October 31, 2019 and October 31, 2018. No guarantees, pledges or commitments have been given to KMP, Directors or their close family members. Joint ventures and associates In the normal course of business, we provide certain banking and financial services to our joint ventures and associates, including loans, interest and non-interest bearing deposits. These transactions meet the definition of related party transactions and were made on substantially the same terms as for comparable transactions with third parties. As at October 31, 2019, loans to joint ventures and associates were $222 million (October 31, 2018 – $225 million) and deposits from joint ventures and associates were $180 million (October 31, 2018 – $203 million). We have no stage 3 allowance or provision for credit losses relating to loans to joint ventures and associates as at and for the years ended October 31, 2019 and October 31, 2018. $1 million of guarantees have been given to joint ventures and associates for the year ended October 31, 2019 (October 31, 2018 – $1 million). Other transactions, arrangements or agreements involving joint ventures and associates (Millions of Canadian dollars) Commitments and other contingencies Other fees received for services rendered Other fees paid for services received As at or for the year ended $ October 31 2019 430 47 128 October 31 2018 621 41 150 $ Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 203 Note 28 Results by business segment Composition of business segments For management purposes, based on the products and services offered, we are organized into five business segments: Personal & Commercial Banking, Wealth Management, Insurance, Investor & Treasury Services and Capital Markets. Personal & Commercial Banking provides a broad suite of financial products and services to individuals and businesses for their day-to-day banking, investing and financing needs through two businesses: Canadian Banking and Caribbean & U.S. Banking. In Canada, we provide a broad suite of financial products and services through our large branch network, automated teller machines, and mobile sales network. In the Caribbean and the U.S., we offer a broad range of financial products and services in targeted markets. Non-interest income in Personal & Commercial Banking mainly comprises Mutual fund revenue, Service charges and Card service revenue. Wealth Management serves high net worth and ultra-high net worth individual and institutional clients with a comprehensive suite of advice-based solutions and strategies to help them achieve their financial goals through our line of businesses in Canada, the U.S., the U.K., Europe and Asia, including Canadian Wealth Management, U.S. Wealth Management (including City National), Global Asset Management, and International Wealth Management. Non-interest income in Wealth Management mainly comprises Investment management and custodial fees, Mutual fund revenue and Securities brokerage commissions. Insurance has operations in Canada and globally, operating under two business lines: Canadian Insurance and International Insurance, providing a wide range of life, health, home, auto, travel, wealth, annuities and reinsurance advice and solutions as well as creditor and business insurance services to individual, business and group clients. In Canada, we offer our products and services through our proprietary distribution channels, comprised of the field sales force, advice centers and online, as well as through independent insurance advisors and affinity relationships. Outside Canada, we operate in reinsurance and retrocession markets globally offering life, disability and longevity reinsurance products. Non-interest income in Insurance comprises Insurance premiums, investment and fee income. Investor & Treasury Services is a provider of asset, cash management, transaction banking, and treasury services to institutional clients worldwide. We also provide Canadian dollar cash management, correspondent banking and trade finance for financial institutions globally and short-term funding and liquidity management for the bank. Non-interest income in Investor & Treasury Services mainly comprises Investment management and custodial fees. Capital Markets provides expertise in banking, finance and capital markets to corporations, institutional investors, asset managers, governments and central banks around the world in our two main business lines: Corporate and Investment Banking and Global Markets. In North America, we offer a full suite of products and services which include corporate and investment banking, equity and debt origination and distribution, as well as sales and trading. Outside North America, we have a select presence in the U.K. & Europe, Australia, Asia & other markets. In the U.K. & Europe, we offer a diversified set of capabilities in our key sectors of expertise such as energy, mining and infrastructure, industrial, consumer, healthcare, technology and financial services. Non-interest income in Capital Markets mainly includes Trading revenue, Underwriting and other advisory fees and Credit fees. All other enterprise level activities that are not allocated to these five business segments, such as enterprise funding, securitizations, net charges associated with unattributed capital, and consolidation adjustments, including the elimination of the Taxable equivalent basis (Teb) gross-up amounts, are included in Corporate Support. Teb adjustments gross up income from certain tax-advantaged sources from Canadian taxable corporate dividends and U.S. tax credit investments recorded in Capital Markets to their effective tax equivalent value with the corresponding offset recorded in the provision for income taxes. Management believes that these Teb adjustments are necessary for Capital Markets to reflect how it is managed and enhances the comparability of revenue across our taxable and tax-advantaged sources. Our use of Teb adjustments may not be comparable to similarly adjusted amounts at other financial institutions. The Teb adjustment for the year ended October 31, 2019 was $450 million (October 31, 2018 – $542 million). Geographic segments For geographic reporting, our segments are grouped into Canada, United States and Other International. Transactions are primarily recorded in the location that best reflects the risk due to negative changes in economic conditions and prospects for growth due to positive economic changes. This location frequently corresponds with the location of the legal entity through which the business is conducted and the location of our clients. Transactions are recorded in the local currency and are subject to foreign exchange rate fluctuations with respect to the movement in the Canadian dollar. Management reporting framework Our management reporting framework is intended to measure the performance of each business segment as if it were a stand- alone business and reflects the way that the business segment is managed. This approach is intended to ensure that our business segments’ results include all applicable revenue and expenses associated with the conduct of their business and depicts how management views those results. We regularly monitor these segment results for the purpose of making decisions about resource allocation and performance assessment. These items do not impact our consolidated results. The expenses in each business segment may include costs or services directly incurred or provided on their behalf at the enterprise level. For other costs not directly attributable to one of our business segments, we use a management reporting framework that uses assumptions and methodologies for allocating overhead costs and indirect expenses to our business segments and that assists in the attribution of capital and the transfer pricing of funds to our business segments in a manner that consistently measures and aligns the economic costs with the underlying benefits and risks of that specific business segment. Activities and business conducted between our business segments are generally at market rates. All other enterprise level activities that are not allocated to our five business segments are reported under Corporate Support. 204 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Our assumptions and methodologies used in our management reporting framework are periodically reviewed by us to ensure that they remain valid. The capital attribution methodologies involve a number of assumptions that are revised periodically. (Millions of Canadian dollars) Net interest income (2) Non-interest income Total revenue Provision for credit losses Insurance policyholder benefits, claims and acquisition expense Non-interest expense Net income (loss) before income taxes Income taxes (recoveries) Net income Non-interest expense includes: Depreciation and amortization Impairment of other intangibles Total assets Total assets include: Additions to premises and equipment and intangibles Total liabilities (Millions of Canadian dollars) Net interest income (2), (3) Non-interest income (3) Total revenue Provision for credit losses Insurance policyholder benefits, claims and acquisition expense Non-interest expense Net income (loss) before income taxes Income taxes (recoveries) For the year ended October 31, 2019 Investor & Treasury Services Insurance Capital Markets (1) Corporate Support (1) 4,043 $ 4,245 8,288 299 104 $ (453) (349) – Total Canada 19,749 $ 14,375 $ 26,253 14,037 United States 4,058 $ 6,411 Other International 1,316 5,805 46,002 1,864 28,412 1,512 10,469 282 Personal & Commercial Banking $ 12,653 $ 5,212 Wealth Management 2,993 $ 9,150 17,865 1,448 12,143 117 – 7,768 8,649 2,247 – 8,813 3,213 663 – $ (44) $ 5,710 5,710 – 4,085 606 1,019 213 2,389 2,345 – – 1,725 620 145 $ 6,402 $ 2,550 $ 806 $ 475 $ 2,666 $ (28) $ 12,871 $ 9,177 $ 2,060 $ – 5,096 2,893 227 – 131 (480) (452) 4,085 24,139 2,800 12,175 15,914 3,043 11,925 2,748 – 7,994 2,193 133 7,121 70 1,285 3,970 1,796 162 1,634 $ 632 $ 593 $ 48 $ 143 $ 408 $ – $ 1,824 $ 1,176 $ 486 $ 162 – – – 44 2 64 110 20 54 36 $ 481,720 $ 106,579 $ 19,012 $ 144,406 $ 634,313 $ 42,905 $ 1,428,935 $ 753,142 $ 399,792 $ 276,001 $ 408 $ 565 $ 44 $ 142 $ 491 $ 621 $ 2,271 $ 1,326 $ 669 $ 276 $ 481,745 $ 106,770 $ 19,038 $ 144,378 $ 634,126 $ (40,747) $ 1,345,310 $ 669,543 $ 399,800 $ 275,967 Personal & Commercial Banking 11,776 $ 5,140 $ Wealth Management For the year ended October 31, 2018 Investor & Treasury Services Insurance – $ 297 $ 4,279 4,279 – 2,676 602 1,001 226 2,294 2,591 1 – 1,617 973 232 Capital Markets (1) Corporate Support (1) 3,328 $ 5,070 8,398 48 (51) $ (483) (534) – Total 17,952 $ 24,624 42,576 1,307 Canada 13,076 $ 12,698 25,774 1,259 – 4,960 3,390 613 – 58 (592) (437) 2,676 22,833 15,760 3,329 1,347 11,634 11,534 2,661 2,602 $ 8,324 10,926 (15) – 8,070 2,871 606 16,916 1,273 – 7,526 8,117 2,089 United States 3,616 $ 6,080 Other International 1,260 5,846 9,696 41 – 7,322 2,333 402 7,106 7 1,329 3,877 1,893 266 1,627 Net income $ 6,028 $ 2,265 $ 775 $ 741 $ 2,777 $ (155) $ 12,431 $ 8,873 $ 1,931 $ Non-interest expense includes: Depreciation and amortization Impairment of other intangibles $ 579 $ 544 $ 36 $ 124 $ 363 $ – $ 1,646 $ 1,102 $ 389 $ 155 – – – 1 1 4 6 4 1 1 Total assets $ 453,879 $ 93,063 $ 16,210 $ 136,030 $ 590,950 $ 44,602 $ 1,334,734 $ 680,276 $ 384,921 $ 269,537 Total assets include: Additions to premises and equipment and intangibles $ 279 $ 431 $ 45 $ 187 $ 442 $ 579 $ 1,963 $ 1,196 $ 503 $ 264 Total liabilities $ 453,878 $ 93,162 $ 16,289 $ 135,944 $ 590,582 $ (35,076) $ 1,254,779 $ 600,619 $ 384,816 $ 269,344 (1) (2) (3) Taxable equivalent basis. Interest revenue is reported net of interest expense as we rely primarily on net interest income as a performance measure. Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. Note 29 Nature and extent of risks arising from financial instruments We are exposed to credit, market and liquidity and funding risks as a result of holding financial instruments. Our risk measurement and objectives, policies and methodologies for managing these risks are disclosed in the shaded text along with those tables specifically marked with an asterisk (*) in the Credit risk section of Management’s Discussion and Analysis. These shaded text and tables are an integral part of these Consolidated Financial Statements. Concentrations of credit risk exist if a number of our counterparties are engaged in similar activities, are located in the same geographic region or have comparable economic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in economic, political or other conditions. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 205 Note 29 Nature and extent of risks arising from financial instruments (continued) Concentrations of credit risk indicate the relative sensitivity of our performance to developments affecting a particular industry or geographic location. The amounts of credit exposure associated with certain of our on- and off-balance sheet financial instruments are summarized in the following tables. (Millions of Canadian dollars, except percentage amounts) On-balance sheet assets other than derivatives (1) Derivatives before master netting agreements (2), (3) Off-balance sheet credit instruments (4) Committed and uncommitted (5) Other (Millions of Canadian dollars, except percentage amounts) On-balance sheet assets other Canada % United States % Europe % International % Total Other As at October 31, 2019 $ 646,567 69% $ 189,240 20% $ 60,554 6% $ 50,642 5% $ 947,003 19,544 19% 23,250 23% 53,752 52% 6,421 6% 102,967 $ 666,111 64% $ 212,490 20% $ 114,306 11% $ 57,063 5% $ 1,049,970 $ 367,907 67% $ 148,326 27% $ 67,410 58% 15,246 13% 29,462 31,934 28% 5% $ 5,774 1% $ 1,491 1% 551,469 116,081 $ 435,317 65% $ 163,572 25% $ 61,396 9% $ 7,265 1% $ 667,550 Canada % United States % Europe % Other International % Total As at October 31, 2018 than derivatives (1) $ 594,823 66% $ 184,040 21% $ 60,645 7% $ 50,486 6% $ 889,994 Derivatives before master netting agreements (2), (3) 18,364 19% 20,053 21% 50,767 53% 6,063 7% 95,247 $ 613,187 62% $ 204,093 21% $ 111,412 11% $ 56,549 6% $ 985,241 Off-balance sheet credit instruments (4) Committed and uncommitted (5) Other $ 345,545 66% $ 142,692 27% $ 79,399 61% 14,852 11% 31,530 34,849 27% 6% $ 7,140 1% $ 987 1% 526,907 130,087 $ 424,944 65% $ 157,544 24% $ 66,379 10% $ 8,127 1% $ 656,994 (1) (2) (3) (4) (5) Includes assets purchased under reverse repurchase agreements and securities borrowed, loans and customers’ liability under acceptances. The largest concentrations in Canada are Ontario at 56% (October 31, 2018 – 54%), the Prairies at 16% (October 31, 2018 – 18%), British Columbia and the territories at 14% (October 31, 2018 – 14%) and Quebec at 10% (October 31, 2018 – 10%). No industry accounts for more than 35% (October 31, 2018 – 32%) of total on-balance sheet credit instruments. The classification of our sectors aligns with our view of credit risk by industry. Sectors have been revised from those previously presented. A further breakdown of our derivative exposures by risk rating and counterparty type is provided in Note 8. Excludes valuation adjustments determined on a pooled basis. Balances presented are contractual amounts representing our maximum exposure to credit risk. Represents our maximum exposure to credit risk. Retail and wholesale commitments respectively comprise 43% and 57% of our total commitments (October 31, 2018 – 42% and 58%). The largest concentrations in the wholesale portfolio relate to Financial services at 13% (October 31, 2018 – 14%), Utilities at 11% (October 31, 2018 – 11%), Real estate & related at 9% (October 31, 2018 – 9%), Other services at 7% (October 31, 2018 – 8%), and Oil & gas at 7% (October 31, 2018 – 7%). The classification of our sectors aligns with our view of credit risk by industry. Sector percentages have been revised from those previously presented. Note 30 Capital management Regulatory capital and capital ratios OSFI formally establishes risk-based capital and leverage targets for deposit-taking institutions in Canada. We are required to calculate our capital ratios using the Basel III framework. Under Basel III, regulatory capital includes Common Equity Tier 1 (CET1), Tier 1 and Tier 2 capital. CET1 capital mainly consists of common shares, retained earnings and other components of equity. Regulatory adjustments under Basel III include deductions of goodwill and other intangibles, certain deferred tax assets, defined benefit pension fund assets, investments in banking, financial and insurance entities, and the shortfall of provisions to expected losses. Tier 1 capital comprises predominantly CET1 and Additional Tier 1 items including non-cumulative preferred shares that meet certain criteria. Tier 2 capital includes subordinated debentures that meet certain criteria, certain loan loss allowances and non-controlling interests in subsidiaries Tier 2 instruments. Total capital is the sum of CET1, additional Tier 1 capital and Tier 2 capital. Regulatory capital ratios are calculated by dividing CET1, Tier 1 and Total capital by risk-weighted assets. The leverage ratio is calculated by dividing Tier 1 capital by an exposure measure. The exposure measure consists of total assets (excluding items deducted from Tier 1 capital) and certain off-balance sheet items converted into credit exposure equivalents. Adjustments are also made to derivatives and secured financing transactions to reflect credit and other risks. 206 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements During 2019 and 2018, we complied with all Pillar 1 capital and leverage requirements, including the domestic stability buffer, imposed by OSFI. (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Capital (1) CET1 capital Tier 1 capital Total capital Risk-weighted Assets (RWA) used in calculation of capital ratios (1), (2) CET1 capital RWA Tier 1 capital RWA Total capital RWA Total capital RWA consisting of: (1) Credit risk Market risk Operational risk Total capital RWA Capital ratios and Leverage ratio (1) CET1 ratio Tier 1 capital ratio Total capital ratio Leverage ratio Leverage ratio exposure (billions) As at October 31 2019 October 31 2018 $ 62,184 67,861 77,888 $ 512,856 512,856 512,856 $ 417,835 28,917 66,104 $ 512,856 12.1% 13.2% 15.2% 4.3% 1,570 $ $ 57,001 63,279 72,494 $ 495,528 495,993 496,459 $ 401,534 32,209 62,716 $ 496,459 11.5% 12.8% 14.6% 4.4% 1,451 $ (1) (2) Capital, RWA, and capital ratios are calculated using OSFI’s CAR guideline based on the Basel III framework. The Leverage ratio is calculated using OSFI Leverage Requirements Guideline based on the Basel III framework. In fiscal 2018, amounts included CVA scalars of 80%, 83% and 86%, respectively. Note 31 Offsetting financial assets and financial liabilities Offsetting within our Consolidated Balance Sheets may be achieved where financial assets and liabilities are subject to master netting arrangements that provide the currently enforceable right of offset and where there is an intention to settle on a net basis, or realize the assets and settle the liabilities simultaneously. For derivative contracts and repurchase and reverse repurchase arrangements, this is generally achieved when there is a market mechanism for settlement (e.g., central counterparty exchange or clearing house) which provides daily net settlement of cash flows arising from these contracts. Margin receivables and margin payables are generally offset as they settle simultaneously through a market settlement mechanism. Amounts that do not qualify for offsetting include master netting arrangements that only permit outstanding transactions with the same counterparty to be offset in an event of default or occurrence of other predetermined events. Such master netting arrangements include the International Swaps and Derivatives Association Master Agreement or certain derivative exchange or clearing counterparty agreements for derivative contracts, global master repurchase agreement and global master securities lending agreements for repurchase, reverse repurchase and other similar secured lending and borrowing arrangements. The amount of financial collateral received or pledged subject to master netting arrangements or similar agreements but do not qualify for offsetting refers to the collateral received or pledged to cover the net exposure between counterparties by enabling the collateral to be realized in an event of default or the occurrence of other predetermined events. Certain amounts of collateral are restricted from being sold or re-pledged unless there is an event of default or the occurrence of other predetermined events. The tables below provide the amount of financial instruments that have been offset on the Consolidated Balance Sheets and the amounts that do not qualify for offsetting but are subject to enforceable master netting arrangements or similar agreements. The amounts presented are not intended to represent our actual exposure to credit risk. Financial assets subject to offsetting, enforceable master netting arrangements or similar agreements Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2019 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) (Millions of Canadian dollars) Assets purchased under reverse repurchase agreements and securities borrowed Derivative assets (3) Other financial assets Gross amounts of financial assets before balance sheet offsetting Amounts of financial liabilities offset on the balance sheet Net amount of financial assets presented on the balance sheet Impact of master netting agreements Financial collateral received (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 374,617 88,996 994 464,607 $ $ 69,420 710 281 70,411 $ $ 305,197 88,286 713 394,196 $ $ 527 62,524 1 63,052 $ 303,539 15,458 89 $ 319,086 $ $ 1,131 10,304 623 12,058 $ $ 1,764 13,274 – 15,038 $ $ 306,961 101,560 713 409,234 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 207 Note 31 Offsetting financial assets and financial liabilities (continued) As at October 31, 2018 Amounts subject to offsetting and enforceable netting arrangements Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) (Millions of Canadian dollars) Assets purchased under reverse repurchase agreements and securities borrowed Derivative assets (3) Other financial assets (4) Gross amounts of financial assets before balance sheet offsetting Amounts of financial liabilities offset on the balance sheet Net amount of financial assets presented on the balance sheet Impact of master netting agreements Financial collateral received (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 312,392 81,770 1,636 395,798 $ $ 18,379 583 814 19,776 $ $ 294,013 81,187 822 376,022 $ $ 481 57,010 – 57,491 $ $ 292,412 14,720 244 307,376 $ $ 1,120 9,457 578 11,155 $ $ 589 12,852 – 13,441 $ $ 294,602 94,039 822 389,463 (1) (2) (3) (4) Financial collateral is reflected at fair value. The amount of financial instruments and financial collateral disclosed is limited to the net balance sheet exposure, and any over-collateralization is excluded from the table. Includes cash collateral of $11.6 billion (October 31, 2018 – $10.7 billion) and non-cash collateral of $307.5 billion (October 31, 2018 – $296.7 billion). Includes cash margin of $3.6 billion (October 31, 2018 – $2.2 billion) which offset against the derivative balance on the balance sheet. Amounts have been revised from those previously presented. Financial liabilities subject to offsetting, enforceable master netting arrangements or similar agreements Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2019 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) (Millions of Canadian dollars) Obligations related to assets sold under repurchase agreements and securities loaned Derivative liabilities (3) Other financial liabilities Gross amounts of financial liabilities before balance sheet offsetting Amounts of financial assets offset on the balance sheet Net amount of financial liabilities presented on the balance sheet Impact of master netting agreements Financial collateral pledged (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 294,758 $ 84,624 492 379,874 $ 69,420 $ 710 281 70,411 $ 225,338 $ 83,914 211 309,463 $ 527 $ 224,506 $ 62,524 1 13,540 – 63,052 $ 238,046 $ 305 $ 7,850 210 8,365 $ 1,248 $ 14,629 – 15,877 $ 226,586 98,543 211 325,340 Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2018 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) (Millions of Canadian dollars) Obligations related to assets sold under repurchase agreements and securities loaned Derivative liabilities (3) Other financial liabilities (4) Gross amounts of financial liabilities before balance sheet offsetting Amounts of financial assets offset on the balance sheet Net amount of financial liabilities presented on the balance sheet Impact of master netting agreements Financial collateral pledged (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 225,193 76,877 991 303,061 $ $ 18,379 583 814 19,776 $ $ 206,814 76,294 177 283,285 $ $ 481 57,010 – 57,491 $ 206,106 11,446 – $ 217,552 $ $ 227 7,838 177 8,242 $ $ – 13,944 – 13,944 $ $ 206,814 90,238 177 297,229 (1) (2) (3) (4) Financial collateral is reflected at fair value. The amount of financial instruments and financial collateral disclosed is limited to the net balance sheet exposure, and any over-collateralization is excluded from the table. Includes cash collateral of $11.5 billion (October 31, 2018 – $11.1 billion) and non-cash collateral of $226.5 billion (October 31, 2018 – $206.5 billion). Includes cash margin of $1.3 billion (October 31, 2018 – $2.3 billion) which offset against the derivative balance on the balance sheet. Amounts have been revised from those previously presented. 208 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Note 32 Recovery and settlement of on-balance sheet assets and liabilities The table below presents an analysis of assets and liabilities recorded on our Consolidated Balance Sheets by amounts to be recovered or settled within one year and after one year, as at the balance sheet date, based on contractual maturities and certain other assumptions outlined in the footnotes below. As warranted, we manage the liquidity risk of various products based on historical behavioural patterns that are often not aligned with contractual maturities. Amounts to be recovered or settled within one year, as presented below, may not be reflective of our long-term view of the liquidity profile of certain balance sheet categories. (Millions of Canadian dollars) Assets Cash and due from banks (1) Interest-bearing deposits with banks Securities Trading (2) Investment, net of applicable allowance Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Segregated fund net assets Other Customers’ liability under acceptances Derivatives (2) Premises and equipment Goodwill Other intangibles Other assets Liabilities Deposits (3), (4) Segregated fund net liabilities Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives (2) Insurance claims and policy benefit liabilities Other liabilities (4) Subordinated debentures As at Within one year October 31, 2019 After one year Within one year October 31, 2018 After one year Total Total $ 24,822 $ 38,345 1,488 $ – 26,310 $ 38,345 28,583 $ 36,471 1,626 $ – 30,209 36,471 137,772 17,283 8,762 85,187 146,534 102,470 121,152 16,795 7,106 77,813 128,258 94,608 306,828 133 306,961 294,049 553 294,602 108,382 48,737 317,704 147,133 – 1,663 426,086 195,870 (3,100) 1,663 97,414 43,280 302,038 136,998 – 1,368 399,452 180,278 (2,912) 1,368 18,062 99,792 – – – 38,775 – 1,768 3,191 11,236 4,674 10,298 $ 838,798 $ 593,237 $ 1,428,935 $ 18,062 101,560 3,191 11,236 4,674 49,073 15,635 91,833 – – – 33,578 15,641 6 94,039 2,206 2,832 2,832 11,137 11,137 4,687 4,687 44,064 10,486 778,790 $ 558,856 $ 1,334,734 $ 719,933 $ 166,072 $ 886,005 $ 1,663 1,663 – 669,682 $ 166,515 $ – 1,368 18,091 32,668 – 2,401 18,091 35,069 15,657 29,725 5 2,522 836,197 1,368 15,662 32,247 226,582 97,415 1,726 41,612 1,999 206,814 90,238 10,000 53,122 9,131 $1,140,026 $ 205,284 $ 1,345,310 $ 1,048,689 $ 206,090 $ 1,254,779 206,813 88,112 1,691 36,906 103 1 2,126 8,309 16,216 9,028 226,586 98,543 11,401 58,137 9,815 4 1,128 9,675 16,525 7,816 (1) (2) (3) (4) Cash and due from banks are assumed to be recovered within one year, except for cash balances not available for use by the Bank. Trading securities classified as FVTPL and trading derivatives are presented as within one year as this best represents in most instances the short-term nature of our trading activities. Non-trading derivatives are presented according to the recovery or settlement of the hedging transaction. Demand deposits of $405 billion (October 31, 2018 – $382 billion) are presented as within one year due to their being repayable on demand or at short notice on a contractual basis. In practice, these deposits relate to a broad range of individuals and customer-types which form a stable base for our operations and liquidity needs. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 209 Note 33 Parent company information The following table presents information regarding the legal entity of Royal Bank of Canada with its subsidiaries presented on an equity accounted basis. Condensed Balance Sheets (Millions of Canadian dollars) Assets Cash and due from banks Interest-bearing deposits with banks Securities Investments in bank subsidiaries and associated corporations (1) Investments in other subsidiaries and associated corporations Assets purchased under reverse repurchase agreements and securities borrowed Loans, net of allowance for loan losses Net balances due from bank subsidiaries (1) Other assets Liabilities and shareholders’ equity Deposits (2) Net balances due to bank subsidiaries (1) Net balances due to other subsidiaries Other liabilities (2) Subordinated debentures Shareholders’ equity As at October 31 2019 October 31 2018 $ $ $ $ 14,264 $ 22,279 118,716 37,234 73,785 123,755 526,078 – 152,422 1,068,533 $ 681,509 $ 2,678 36,594 254,678 975,459 9,551 83,523 1,068,533 $ 16,398 20,261 111,072 34,547 69,063 107,941 494,922 4,329 137,821 996,354 642,271 – 38,985 226,475 907,731 8,762 79,861 996,354 (1) (2) Bank refers primarily to regulated deposit-taking institutions and securities firms. Commencing Q4 2019, the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in deposits is presented in other liabilities. Comparative amounts have been reclassified to conform with this presentation. Condensed Statements of Income and Comprehensive Income (Millions of Canadian dollars) Interest income (1) Interest expense (2) Net interest income Non-interest income (2), (3) Total revenue Provision for credit losses Non-interest expense Income before income taxes Income taxes Net income before equity in undistributed income of subsidiaries Equity in undistributed income of subsidiaries Net income Other comprehensive income (loss), net of taxes Total comprehensive income For the year ended October 31 2019 27,630 $ 14,966 $ October 31 2018 22,578 10,662 12,664 5,569 18,233 1,730 9,212 7,291 1,568 5,723 7,137 12,860 $ (1,441) 11,419 $ 11,916 6,119 18,035 1,294 9,085 7,656 1,546 6,110 6,321 12,431 1,532 13,963 $ $ (1) (2) (3) Includes dividend income from investments in subsidiaries and associated corporations of $27 million (October 31, 2018 – $12 million). Commencing Q4 2019, the interest component of the valuation of certain deposits carried at FVTPL previously presented in trading revenue is presented in net interest income. Comparative amounts have been reclassified to conform with this presentation. Includes a nominal share of profit (losses) from associated corporations (October 31, 2018 – $(31) million). 210 Royal Bank of Canada: Annual Report 2019 Consolidated Financial Statements Condensed Statements of Cash Flows (Millions of Canadian dollars) Cash flows from operating activities Net income Adjustments to determine net cash from operating activities: Change in undistributed earnings of subsidiaries Change in deposits, net of securitizations (1) Change in loans, net of securitizations Change in trading securities Change in obligations related to assets sold under repurchase agreements and securities loaned Change in assets purchased under reverse repurchase agreements and securities borrowed Change in obligations related to securities sold short Other operating activities, net (1) Net cash from (used in) operating activities Cash flows from investing activities Change in interest-bearing deposits with banks Proceeds from sales and maturities of investment securities Purchases of investment securities Net acquisitions of premises and equipment and other intangibles Change in cash invested in subsidiaries Change in net funding provided to subsidiaries Net cash from (used in) investing activities Cash flows from financing activities Issue of subordinated debentures Repayment of subordinated debentures Issue of common shares, net of issuance costs Common shares purchased for cancellation Issue of preferred shares, net of issuance costs Redemption of preferred shares Dividends paid Net cash from (used in) financing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year Supplemental disclosure of cash flow information Amount of interest paid (1) Amount of interest received Amount of dividends received Amount of income taxes paid For the year ended October 31 2019 October 31 2018 $ 12,860 $ 12,431 (7,137) 39,238 (31,744) 2,350 12,449 (15,814) 797 (8,149) 4,850 (2,018) 37,963 (39,461) (1,266) 332 4,616 166 1,500 (1,100) 105 (1,030) 350 (950) (6,025) (7,150) (2,134) 16,398 14,264 $ 14,574 $ 25,883 1,694 1,789 (6,321) 38,331 (26,281) 3,730 49,811 (58,326) 2,600 763 16,738 603 30,355 (32,561) (1,173) 93 (3,363) (6,046) – – 72 (1,522) – (105) (5,640) (7,195) 3,497 12,901 16,398 9,475 20,490 1,414 3,562 $ $ (1) Commencing Q4 2019, the interest component and the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in trading revenue and deposits, respectively, is presented in net interest income and other liabilities respectively. Comparative amounts have been reclassified to conform with this presentation. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2019 211 Ten-year statistical review Condensed Balance Sheets (Millions of Canadian dollars) (1) Assets Cash and due from banks Interest-bearing deposits with banks Securities, net of applicable allowance (2) Assets purchased under reverse repurchase agreements and securities borrowed Loans net of allowance Other Total Assets Liabilities Deposits (3) Other (3) Subordinated debentures Trust capital securities Non-controlling interest in subsidiaries Total Liabilities Equity attributable to shareholders Non-controlling interest Total equity Total liabilities and equity 2019 2018 2017 2016 2015 2014 2013 2012 2011 2011 2010 IFRS CGAAP $ 26,310 $ 38,345 249,004 30,209 $ 36,471 222,866 28,407 $ 32,662 218,379 14,929 $ 27,851 236,093 12,452 $ 22,690 215,508 17,421 $ 8,399 199,148 15,550 $ 9,039 182,710 12,428 $ 10,246 161,602 12,428 6,460 167,022 $ 13,247 $ 12,181 179,558 8,440 13,254 183,519 306,961 618,856 189,459 84,947 347,530 175,446 $1,428,935 $1,334,734 $1,212,853 $1,180,258 $1,074,208 $ 940,550 $ 859,745 $ 823,954 $ 793,833 117,517 408,850 126,079 112,257 378,241 149,180 135,580 435,229 144,773 186,302 521,604 193,479 220,977 542,617 169,811 174,723 472,223 176,612 294,602 576,818 173,768 449,490 9,815 – n.a. $ 886,005 $ 836,197 $ 789,036 $ 757,589 $ 697,227 $ 614,100 $ 563,079 $ 512,244 $ 479,102 263,625 8,749 894 n.a. $1,345,310 $1,254,779 $1,138,425 $1,108,646 $1,010,264 $ 886,047 $ 810,285 $ 779,033 $ 752,370 259,174 7,615 – n.a. 239,763 7,443 – n.a. 264,088 7,859 – n.a. 341,295 9,762 – n.a. 305,675 7,362 – n.a. 340,124 9,265 – n.a. 409,451 9,131 – n.a. 83,523 102 79,861 73,829 71,017 94 599 595 62,146 1,798 52,690 1,813 47,665 1,795 43,160 1,761 39,702 1,761 83,625 41,463 $1,428,935 $1,334,734 $1,212,853 $1,180,258 $1,074,208 $ 940,550 $ 859,745 $ 823,954 $ 793,833 79,955 74,428 71,612 63,944 54,503 49,460 44,921 84,947 296,284 165,485 72,698 273,006 175,289 $ 751,702 $ 726,206 $ 444,181 $ 414,561 263,030 6,681 727 2,256 256,124 7,749 – 1,941 $ 709,995 $ 687,255 41,707 38,951 n.a. n.a. 41,707 38,951 $ 751,702 $ 726,206 Condensed Income Statements (Millions of Canadian dollars) (1) Net interest income (3) Non-interest income (3), (4) Total revenue (4) Provision for credit losses (5) Insurance policyholder benefits, claims and acquisition expense Non-interest expense (4) Non-controlling interest Net income from continuing operations Net loss from discontinued operations Net income Other Statistics – reported IFRS $ 2019 19,749 $ 26,253 46,002 1,864 2018 17,952 $ 24,624 42,576 1,307 2017 16,926 $ 23,743 40,669 1,150 2016 16,531 $ 22,264 38,795 1,546 2015 14,771 $ 20,932 35,703 1,097 4,085 24,139 n.a. 12,871 – $ 12,871 $ 2,676 22,833 n.a. 12,431 – 3,053 21,794 n.a. 11,469 – 3,424 20,526 n.a. 10,458 – 2,963 19,020 n.a. 10,026 – 12,431 $ 11,469 $ 10,458 $ 10,026 $ 2014 14,116 $ 19,992 34,108 1,164 3,573 17,661 n.a. 9,004 – 9,004 $ 2013 13,249 $ 17,433 30,682 1,237 2,784 16,214 n.a. 8,342 – 8,342 $ 2012 12,439 16,708 29,147 1,299 3,621 14,641 n.a. 7,558 (51) 7,507 2011 11,357 16,281 27,638 1,133 3,358 14,167 n.a. 6,970 (526) 6,444 $ $ CGAAP 2011 10,600 $ 16,830 27,430 975 3,360 14,453 104 6,650 (1,798) 4,852 $ 2010 10,338 15,744 26,082 1,240 3,546 13,469 99 5,732 (509) 5,223 (Millions of Canadian dollars, except percentages and per share amounts) (1) PROFITABILITY MEASURES (6) Earnings per shares –basic –diluted Return on common equity (7), (8) Return on risk-weighted assets (9) Efficiency ratio (4) KEY RATIOS PCL on impaired loans as a % of average net loans and acceptances (10) Net interest margin (average earning assets, net) (3), (7) SHARE INFORMATION Common shares outstanding (000s) – end of period Dividends declared per common share Dividend yield (11) Dividend payout ratio Book value per share Common share price (RY on TSX) (12) Market capitalization (TSX) (12) Market price to book value CAPITAL MEASURES – CONSOLIDATED (13) Common Equity Tier 1 capital ratio Tier 1 capital ratio Total capital ratio Leverage Ratio $ $ $ $ $ 2019 2018 2017 2016 2015 2014 2013 2012 2011 2011 2010 IFRS CGAAP 8.78 $ 8.75 $ 16.8% 2.52% 52.5% 0.27% 1.61% 1,430,096 4.07 $ 4.1% 46% 54.41 $ 106.24 $ 151,933 1.95 12.1% 13.2% 15.2% 4.3% 8.39 $ 8.36 $ 7.59 $ 7.56 $ 6.80 $ 6.78 $ 6.75 $ 6.73 $ 6.03 $ 6.00 $ 5.53 $ 5.49 $ 4.96 $ 4.91 $ 17.6% 2.55% 53.6% 17.0% 2.49% 53.6% 16.3% 2.34% 52.9% 18.6% 2.45% 53.3% 19.0% 2.52% 51.8% 19.7% 2.67% 52.8% 19.6% 2.70% 50.2% 4.25 4.19 18.7% 2.44% 51.3% $ $ 3.21 $ 3.19 $ 12.9% 1.87% 52.7% 3.49 3.46 14.9% 2.03% 51.6% 0.20% 0.21% 0.28% 0.24% 0.27% 0.31% 0.35% 0.33% 0.34% 0.45% 1.64% 1.69% 1.70% 1.71% 1.86% 1.88% 1.97% 1.86% 1.84% 1.99% 1,438,794 1,452,535 1,484,235 1,443,955 1,443,125 1,441,722 1,445,846 3.77 $ 3.7% 45% 51.12 $ 95.92 $ 3.48 $ 3.8% 46% 46.41 $ 100.87 $ 3.24 $ 4.3% 48% 43.32 $ 83.80 $ 3.08 $ 4.1% 46% 39.51 $ 74.77 $ 2.84 $ 3.8% 47% 33.69 $ 80.01 $ 2.53 $ 4.0% 46% 29.87 $ 70.02 $ 2.28 $ 4.5% 46% 26.52 $ 56.94 $ 138,009 1.88 146,554 2.17 124,476 1.93 107,925 1.89 115,393 2.38 100,903 2.34 11.5% 12.8% 14.6% 4.4% 10.9% 12.3% 14.2% 4.4% 10.8% 12.3% 14.4% 4.4% 10.6% 12.2% 14.0% 4.3% 9.9% 11.4% 13.4% n.a. 9.6% 11.7% 14.0% n.a. 82,296 2.15 n.a. 13.1% 15.1% n.a. 1,438,522 2.08 3.9% 45% 24.25 48.62 69,934 2.00 n.a. n.a. n.a. n.a. 1,438,522 $ $ $ 2.08 $ 3.9% 47% 25.65 $ 48.62 $ 69,934 1.90 n.a. 13.3% 15.3% n.a. 1,423,203 2.00 3.6% 52% 23.99 54.39 77,502 2.27 n.a. 13.0% 14.4% n.a. (1) (3) (2) (4) Effective November 1, 2018, we adopted IFRS 15 Revenue from Contracts with Customers. Results from periods prior to November 1, 2018 are reported in accordance with IAS 18 Revenue in this 2019 Annual Report. Effective November 1, 2017, we adopted IFRS 9 Financial Instruments (IFRS 9). Results from periods prior to November 1, 2017 are reported in accordance with IAS 39 Financial Instruments: Recognition and Measurement (IAS 39) in this 2019 Annual Report. Securities are comprised of trading and investment securities. Under IFRS 9, investment securities represent debt and equity securities at FVOCI and debt securities at amortized cost, net of the applicable allowance. Under IAS 39, investment securities represented available-for-sale securities and held-to-maturity securities. Commencing Q4 2019, the interest component and the accrued interest payable recorded on certain deposits carried at FVTPL previously presented in trading revenue and deposits, respectively are presented in net interest income and other liabilities respectively. As at November 1, 2016, comparative amounts have been reclassified to conform with this presentation. Effective Q4 2017, service fees and other costs incurred in association with certain commissions and fees earned are presented on a gross basis in non-interest expense. As at November 1, 2014, comparative amounts have been reclassified to conform with this presentation. Under IFRS 9, PCL relates primarily to loans, acceptances, and commitments, and also applies to all financial assets except for those classified or designated as FVTPL and equity securities designated as FVOCI. Prior to the adoption of IFRS 9, PCL related only to loans, acceptances, and commitments. PCL on loans, acceptances, and commitments is comprised of PCL on impaired loans (Stage 3 PCL under IFRS 9 and PCL on impaired loans under IAS 39) and PCL on performing loans (Stage 1 and Stage 2 PCL under IFRS 9 and PCL on loans not yet identified as impaired under IAS 39). Ratios for 2010-2012 represent continuing operations. Average amounts are calculated using methods intended to approximate the average of the daily balances for the period. This includes Average common equity used in the calculation of ROE. For further details, refer to the Key performance and non-GAAP measures section of the MD&A. These measures may not have a standardized meaning under generally accepted accounting principles (GAAP) and may not be comparable to similar measures disclosed by other financial institutions. For further details, refer to the Key performance and non-GAAP measures section of the MD&A. (9) Return on risk-weighted assets (RWA) for fiscal 2011 is based on RWA reported under Canadian Generally Accepted Accounting Policies (CGAAP) and Income reported under IFRS. (10) PCL on impaired loans represents Stage 3 PCL under IFRS 9 and PCL on impaired loans under IAS 39. Stage 3 PCL under IFRS 9 is comprised of lifetime credit losses of credit- (6) (7) (8) (5) impaired loans, acceptances and commitments. (11) Defined as dividends per common share divided by the average of the high and low share price in the relevant period. (12) Based on TSX closing market price at period-end. (13) Effective 2013, we calculated the capital and leverage ratios using the Basel III framework unless otherwise stated. 2010-2012 capital and leverage ratios were calculated using the Basel II framework. Capital and leverage ratios for 2011 were determined under CGAAP and Basel II framework. 212 Royal Bank of Canada: Annual Report 2019 Ten-year statistical review Glossary Acceptances A bill of exchange or negotiable instrument drawn by the borrower for payment at maturity and accepted by a bank. The acceptance constitutes a guarantee of payment by the bank and can be traded in the money market. The bank earns a “stamping fee” for providing this guarantee. Allowance for credit losses (ACL) The amount deemed adequate by management to absorb expected credit losses as at the balance sheet date. The allowance is established for all financial assets subject to impairment assessment, including certain loans, debt securities, customers’ liability under acceptances, financial guarantees, and undrawn loan commitments. The allowance is changed by the amount of provision for credit losses recorded, which is charged to income, and decreased by the amount of write-offs net of recoveries in the period. Asset-backed securities (ABS) Securities created through the securitization of a pool of assets, for example auto loans or credit card loans. Assets under administration (AUA) Assets administered by us, which are beneficially owned by clients, as at October 31, unless otherwise noted. Services provided in respect of assets under administration are of an administrative nature, including safekeeping, collecting investment income, settling purchase and sale transactions, and record keeping. Assets under management (AUM) Assets managed by us, which are beneficially owned by clients, as at October 31, unless otherwise noted. Services provided in respect of assets under management include the selection of investments and the provision of investment advice. We have assets under management that are also administered by us and included in assets under administration. Attributed capital Attributed capital is based on the Basel III regulatory capital requirements and economic capital. Commercial mortgage-backed securities (CMBS) Securities created through the securitization of commercial mortgages. Commitments to extend credit Unutilized amount of credit facilities available to clients either in the form of loans, bankers’ acceptances and other on-balance sheet financing, or through off-balance sheet products such as guarantees and letters of credit. Common Equity Tier 1 (CET1) capital A regulatory Basel III capital measure comprised mainly of common shareholders’ equity less regulatory deductions and adjustments for goodwill and intangibles, defined benefit pension fund assets, shortfall in allowances and other specified items. Common Equity Tier 1 capital ratio A risk-based capital measure calculated as CET1 capital divided by risk-weighted assets. Covered bonds Full recourse on-balance sheet obligations issued by banks and credit institutions that are fully collateralized by assets over which investors enjoy a priority claim in the event of an issuer’s insolvency. Credit default swaps (CDS) A derivative contract that provides the purchaser with a one-time payment should the referenced entity/entities default (or a similar triggering event occur). Derivative A contract between two parties, which requires little or no initial investment and where payments between the parties are dependent upon the movements in price of an underlying instrument, index or financial rate. Examples of derivatives include swaps, options, forward rate agreements and futures. The notional amount of the derivative is the contract amount used as a reference point to calculate the payments to be exchanged between the two parties, and the notional amount itself is generally not exchanged by the parties. Auction rate securities (ARS) Debt securities whose interest rates are regularly reset through an auction process. Dividend payout ratio Common dividends as a percentage of net income available to common shareholders. Earnings per share (EPS), basic Calculated as net income available to common shareholders divided by the average number of shares outstanding. Earnings per share (EPS), diluted Calculated as net income available to common shareholders divided by the average number of shares outstanding adjusted for the dilutive effects of stock options and other convertible securities. Expected credit losses The difference between the contractual cash flows due to us in accordance with the relevant contractual terms and the cash flows that we expect to receive, discounted to the balance sheet date. Average earning assets Average earning assets include interest- bearing deposits with other banks including certain components of cash and due from banks, securities, assets purchased under reverse repurchase agreements and securities borrowed, loans, and excludes segregated fund net assets and other assets. The averages are based on the daily balances for the period. Basis point (bp) One one-hundredth of a percentage point (.01%). Collateral Assets pledged as security for a loan or other obligation. Collateral can take many forms, such as cash, highly rated securities, property, inventory, equipment and receivables. Collateralized debt obligation (CDO) Securities with multiple tranches that are issued by structured entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand. Funding Valuation Adjustment Funding valuation adjustments are calculated to incorporate cost and benefit of funding in the valuation of uncollateralized and under- collateralized OTC derivatives. Future expected cash flows of these derivatives are discounted to reflect the cost and benefit of funding the derivatives by using a funding curve, implied volatilities and correlations as inputs. Guarantees and standby letters of credit These primarily represent irrevocable assurances that a bank will make payments in the event that its client cannot meet its financial obligations to third parties. Certain other guarantees, such as bid and performance bonds, represent non-financial undertakings. Hedge A risk management technique used to mitigate exposure from market, interest rate or foreign currency exchange risk arising from normal banking operations. The elimination or reduction of such exposure is accomplished by establishing offsetting positions. For example, assets denominated in foreign currencies can be offset with liabilities in the same currencies or through the use of foreign exchange hedging instruments such as futures, options or foreign exchange contracts. Hedge funds A type of investment fund, marketed to accredited high net worth investors, that is subject to limited regulation and restrictions on its investments compared to retail mutual funds, and that often utilize aggressive strategies such as selling short, leverage, program trading, swaps, arbitrage and derivatives. High-quality liquid assets (HQLA) Assets are considered to be HQLA if they can be easily and immediately converted into cash at little or no loss of value during a time of stress. Homeline products This is comprised of residential mortgages and secured personal loans whereby the borrower pledges real estate as collateral. International Financial Reporting Standards (IFRS) IFRS are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board. Impaired loans Loans are classified as impaired when there has been a deterioration of credit quality to the extent that management no longer has reasonable assurance of timely collection of the full amount of principal and interest in accordance with the contractual terms of the loan agreement. Credit card balances are not classified as impaired as they are directly written off after payments are 180 days past due. Leverage Ratio A Basel III regulatory measure, the ratio divides Tier 1 capital by the sum of total assets plus specified off-balance sheet items. Fair value Fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Liquidity Coverage Ratio (LCR) The Liquidity Coverage Ratio is a Basel III metric that measures the sufficiency of HQLA available to meet net short-term financial obligations over a thirty day period in an acute stress scenario. Glossary Royal Bank of Canada: Annual Report 2019 213 Loan-to-value (LTV) ratio Calculated based on the total facility amount for the residential mortgage and homeline product divided by the value of the related residential property. Master netting agreement An agreement between us and a counterparty designed to reduce the credit risk of multiple derivative transactions through the creation of a legal right of offset of exposure in the event of a default. Net interest income The difference between what is earned on assets such as loans and securities and what is paid on liabilities such as deposits and subordinated debentures. Net interest margin (on average earning assets) Calculated as net interest income divided by average earning assets. Normal course issuer bid (NCIB) A program for the repurchase of our own shares for cancellation through a stock exchange that is subject to the various rules of the relevant stock exchange and securities commission. Notional amount The contract amount used as a reference point to calculate payments for derivatives. Off-balance sheet financial instruments A variety of arrangements offered to clients, which include credit derivatives, written put options, backstop liquidity facilities, stable value products, financial standby letters of credit, performance guarantees, credit enhancements, mortgage loans sold with recourse, commitments to extend credit, securities lending, documentary and commercial letters of credit, note issuances and revolving underwriting facilities, securities lending indemnifications and indemnifications. Office of the Superintendent of Financial Institutions Canada (OSFI) The primary regulator of federally chartered financial institutions and federally administered pension plans in Canada. OSFI’s mission is to safeguard policyholders, depositors and pension plan members from undue loss. Operating leverage The difference between our revenue growth rate and non-interest expense growth rate. Options A contract or a provision of a contract that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. Provision for credit losses (PCL) The amount charged to income necessary to bring the allowance for credit losses to a level determined appropriate by management. This includes provisions on performing and impaired financial assets. finance their activities, and financing in the form of multiple contractually-linked instruments. Repurchase agreements These involve the sale of securities for cash and the simultaneous repurchase of the securities for value at a later date. These transactions normally do not constitute economic sales and therefore are treated as collateralized financing transactions. Return on common equity (ROE) Net income available to common shareholders, expressed as a percentage of average common equity. Reverse repurchase agreements These involve the purchase of securities for cash and the simultaneous sale of the securities for value at a later date. These transactions normally do not constitute economic sales and therefore are treated as collateralized financing transactions. Risk-weighted assets (RWA) Assets adjusted by a regulatory risk-weight factor to reflect the riskiness of on and off-balance sheet exposures. Certain assets are not risk-weighted, but deducted from capital. The calculation is defined by guidelines issued by OSFI. For more details, refer to the Capital management section. Securities lending Transactions in which the owner of a security agrees to lend it under the terms of a prearranged contract to a borrower for a fee. The borrower must collateralize the security loan at all times. An intermediary such as a bank often acts as agent for the owner of the security. There are two types of securities lending arrangements: lending with and without credit or market risk indemnification. In securities lending without indemnification, the bank bears no risk of loss. For transactions in which the bank provides an indemnification, it bears the risk of loss if the borrower defaults and the value of the collateral declines concurrently. Securities sold short A transaction in which the seller sells securities and then borrows the securities in order to deliver them to the purchaser upon settlement. At a later date, the seller buys identical securities in the market to replace the borrowed securities. Securitization The process by which various financial assets are packaged into newly issued securities backed by these assets. Structured entities A structured entity is an entity in which voting or similar rights are not the dominant factor in deciding who controls the entity, such as when the activities that significantly affect the entity’s returns are directed by means of contractual arrangements. Structured entities often have restricted activities, narrow and well defined objectives, insufficient equity to Standardized Approach Risk weights prescribed by OSFI are used to calculate risk-weighted assets for the credit risk exposures. Credit assessments by OSFI- recognized external credit rating agencies of S&P, Moody’s, Fitch and DBRS are used to risk- weight our Sovereign and Bank exposures based on the standards and guidelines issued by OSFI. For our Business and Retail exposures, we use the standard risk weights prescribed by OSFI. Taxable equivalent basis (teb) Income from certain specified tax advantaged sources (eligible Canadian taxable corporate dividends) is increased to a level that would make it comparable to income from taxable sources. There is an offsetting adjustment in the tax provision, thereby generating the same after-tax net income. Tier 1 capital Tier 1 capital comprises predominantly of CET1 capital, with additional Tier 1 items such as preferred shares, innovative instruments and non-controlling interests in subsidiaries Tier 1 instruments. Tier 2 capital Tier 2 capital consists mainly of subordinated debentures that meet certain criteria, certain loan loss allowances and non-controlling interests in subsidiaries’ Tier 2 instruments. Total capital and total capital ratio Total capital is defined as the total of Tier 1 and Tier 2 capital. The total capital ratio is calculated by dividing total capital by risk- weighted assets. Tranche A security class created whereby the risks and returns associated with a pool of assets are packaged into several classes of securities offering different risk and return profiles from those of the underlying asset pool. Tranches are typically rated by ratings agencies, and reflect both the credit quality of underlying collateral as well as the level of protection based on the tranches’ relative subordination. Unattributed capital Unattributed capital represents common equity in excess of common equity attributed to our business segments and is reported in the Corporate Support segment. Value-at-Risk (VaR) A generally accepted risk-measurement concept that uses statistical models based on historical information to estimate within a given level of confidence the maximum loss in market value we would experience in our trading portfolio from an adverse one-day movement in market rates and prices. 214 Royal Bank of Canada: Annual Report 2019 Glossary Principal subsidiaries (Millions of Canadian dollars) Principal subsidiaries (1) Royal Bank Holding Inc. RBC Insurance Holdings Inc. RBC Life Insurance Company R.B.C. Holdings (Bahamas) Limited RBC Caribbean Investments Limited Royal Bank of Canada Insurance Company Ltd. Investment Holdings (Cayman) Limited RBC (Barbados) Funding Ltd. Capital Funding Alberta Limited RBC Global Asset Management Inc. RBC Investor Services Trust RBC Investor Services Bank S.A. RBC (Barbados) Trading Bank Corporation As at October 31, 2019 Carrying value of voting shares owned by the Bank (3) $ 65,288 Principal office address (2) Toronto, Ontario, Canada Mississauga, Ontario, Canada Mississauga, Ontario, Canada Nassau, New Providence, Bahamas George Town, Grand Cayman, Cayman Islands St. Michael, Barbados George Town, Grand Cayman, Cayman Islands St. Michael, Barbados Calgary, Alberta, Canada Toronto, Ontario, Canada Toronto, Ontario, Canada Esch-sur-Alzette, Luxembourg St. James, Barbados RBC US Group Holdings LLC (2) RBC USA Holdco Corporation (2) RBC Capital Markets, LLC (2) City National Bank RBC Dominion Securities Limited RBC Dominion Securities Inc. RBC Finance S.à r.l./B.V. (2) RBC Holdings (Luxembourg) S.A R.L. RBC Holdings (Channel Islands) Limited Royal Bank of Canada (Channel Islands) Limited RBC Europe Limited Royal Bank Mortgage Corporation The Royal Trust Company Royal Trust Corporation of Canada Toronto, Ontario, Canada New York, New York, U.S. New York, New York, U.S. Los Angeles, California, U.S. Toronto, Ontario, Canada Toronto, Ontario, Canada Amsterdam, Netherlands Luxembourg, Luxembourg Jersey, Channel Islands Guernsey, Channel Islands London, England Toronto, Ontario, Canada Montreal, Quebec, Canada Toronto, Ontario, Canada 22,329 10,068 2,907 2,570 1,321 858 298 (1) (2) (3) The Bank directly or indirectly controls each subsidiary. Each subsidiary is incorporated or organized under the law of the state or country in which the principal office is situated, except for RBC US Group Holdings LLC and RBC USA Holdco Corporation which are incorporated under the laws of the State of Delaware, U.S., RBC Capital Markets, LLC, which is organized under the laws of the State of Minnesota, U.S., and RBC Finance S.à r.l. / B.V. which is a company incorporated in the Netherlands with its official seat in Amsterdam, the Netherlands, and place of effective management, central administration, and principal establishment in Luxembourg, Grand Duchy of Luxembourg. The carrying value of voting shares is stated as the Bank’s equity in such investments. Principal subsidiaries Royal Bank of Canada: Annual Report 2019 215 Shareholder Information Corporate headquarters Street address: Royal Bank of Canada 200 Bay Street Toronto, Ontario M5J 2J5 Canada Tel: 1-888-212-5533 Mailing address: P.O. Box 1 Royal Bank Plaza Toronto, Ontario M5J 2J5 Canada website: rbc.com Transfer Agent and Registrar Main Agent: Computershare Trust Company of Canada 1500 Robert-Bourassa Blvd. Suite 700 Montreal, Quebec H3A 3S8 Canada Tel: 1-866-586-7635 (Canada and the U.S.) or 514-982-7555 (International) Fax: 514-982-7580 website: computershare.com/rbc Co-Transfer Agent (U.S.): Computershare Trust Company, N.A. 250 Royall Street Canton, Massachusetts 02021 U.S.A. Co-Transfer Agent (U.K.): Computershare Investor Services PLC Securities Services – Registrars P.O. Box 82, The Pavilions, Bridgwater Road, Bristol BS99 6ZZ U.K. Stock exchange listings (Symbol: RY) Common shares are listed on: Canada – Toronto Stock Exchange (TSX) U.S. – New York Stock Exchange (NYSE) Switzerland – Swiss Exchange (SIX) All preferred shares are listed on the TSX with the exception of the series C-2. The related depository shares of the series C-2 preferred shares are listed on the NYSE. Valuation day price For Canadian income tax purposes, Royal Bank of Canada’s common stock was quoted at $29.52 per share on the Valuation Day (December 22, 1971). This is equivalent to $7.38 per share after adjusting for the two-for-one stock split of March 1981 and the two-for- one stock split of February 1990. The one-for-one stock dividends in October 2000 and April 2006 did not affect the Valuation Day amount for our common shares. Shareholder contacts For dividend information, change in share registration or address, lost stock certificates, tax forms, estate transfers or dividend reinvestment, please contact: Computershare Trust Company of Canada 100 University Avenue, 8th Floor Toronto, Ontario M5J 2Y1 Canada Direct deposit service Shareholders in Canada and the U.S. may have their RBC common share dividends deposited directly to their bank account by electronic funds transfer. To arrange for this service, please contact our Transfer Agent and Registrar, Computershare Trust Company of Canada. Eligible dividend designation For purposes of the Income Tax Act (Canada) and any corresponding provincial and territorial tax legislation, all dividends (and deemed dividends) paid by RBC to Canadian residents on both its common and preferred shares, are designated as “eligible dividends”, unless stated otherwise. Common share repurchases We are engaged in a Normal Course Issuer Bid (NCIB) which allows us to repurchase for cancellation, up to 20 million common shares during the period spanning from March 1, 2019 to February 29, 2020, when the bid expires, or such earlier date as we may complete the purchases pursuant to our Notice of Intention filed with the Toronto Stock Exchange. We determine the amount and timing of the purchases under the NCIB, subject to prior consultation with the Office of the Superintendent of Financial Institutions Canada. A copy of our Notice of Intention to file a NCIB may be obtained, without charge, by contacting our Corporate Secretary at our Toronto mailing address. Tel: 1-866-586-7635 (Canada and the U.S.) or 514-982-7555 (International) Fax: 1-888-453-0330 (Canada and the U.S.) or 416-263-9394 (International) email: service@computershare.com For other shareholder inquiries, please contact: Shareholder Relations Royal Bank of Canada 200 Bay Street South Tower Toronto, Ontario M5J 2J5 Canada Tel: 416-955-7806 Financial analysts, portfolio managers, institutional investors For financial information inquiries, please contact: Investor Relations Royal Bank of Canada 200 Bay Street South Tower Toronto, Ontario M5J 2J5 Canada Tel: 416-955-7802 or visit our website at rbc.com/investorrelations 2020 Quarterly earnings release dates First quarter Second quarter May 27 Third quarter Fourth quarter August 26 December 2 February 21 2020 Annual Meeting The Annual Meeting of Common Shareholders will be held on Wednesday, April 8, 2020, at 9:30 a.m. (Eastern Time) at the Metro Toronto Convention Centre, 255 Front Street West, Toronto, Ontario, Canada Dividend dates for 2020 Subject to approval by the Board of Directors Common and preferred shares series W, AA, AC, AE, AF, AG, AZ, BB, BD, BF, BH, BI, BJ, BK, BM and BO Preferred shares series C-2 (US$) Record dates January 27 April 23 July 27 October 26 January 28 April 27 July 28 October 27 Payment dates February 24 May 22 August 24 November 24 February 7 May 7 August 7 November 6 Governance Summaries of the significant ways in which corporate governance practices followed by RBC differ from corporate governance practices required to be followed by U.S. domestic companies under the NYSE listing standards are available on our website at rbc.com/governance. Information contained in or otherwise accessible through the websites mentioned in this report to shareholders does not form a part of this report. All references to websites are inactive textual references and are for your information only. Trademarks used in this report include the LION & GLOBE Symbol, ROYAL BANK OF CANADA, RBC, RBC CAPITAL MARKETS, RBC CAPITAL TRUST, RBC ELEMENTS, RBC FUTURE LAUNCH, RBC GLOBAL ASSET MANAGEMENT, RBC INSURANCE, RBC REWARDS, RBC WEALTH MANAGEMENT, MYADVISOR, NOMI FIND & SAVE, RBC UPSKILL, RBC CAREER LAUNCH, INVESTEASE and RBC ONE which are trademarks of Royal Bank of Canada used by Royal Bank of Canada and/or by its subsidiaries under license. All other trademarks mentioned in this report which are not the property of Royal Bank of Canada, are owned by their respective holders. 216 Royal Bank of Canada: Annual Report 2019 Shareholder information 81104 (12/2019) 

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