A logo on Royal Bank Plaza is pictured on Bay Street in Toronto on Friday, July 25, 2014.DARREN CALABRESE/The Globe and Mail
There is one analyst vocally calling for Royal Bank of Canada to drop its internal benchmark of keeping capital markets earnings to one quarter of the bank's overall profit.
So far, the bank is hewing to the limit, even though capital markets earnings bumped over that limit slightly in the last quarter (as new chief executive officer David McKay took great pains to point out on the bank's conference call).
Peter Routledge at National Bank of Financial says the bank is misguided in limiting its growth in capital markets.
"Some observers argue that RY must limit its growth in capital markets, maintaining this segment's contribution in the neighborhood of 25% of total earnings, and justify this self-imposed limitation on the view that capital markets activities contain exorbitant tail risks that will ultimately threaten the bank's capital. We disagree."
He points to a number of reasons. Even when the financial crisis hit, RBC's capital markets arm "earned its way through this infamous period and avoided the financial traps into which many other financial institutions fell. The segment also avoided material earnings hits during the equity market correction of the early 2000s."
That was no accident, he argues. RBC is simply better at risk-return calculations. "This competitive advantage would, if the bank decided to exploit it more aggressively, enable the bank to expand its capital markets revenues and earnings without putting shareholder capital at undue risk."
Why focus more on capital markets? Because the bank's Canadian banking segment cannot do the heavy lifting on profits forever.
"This segment faces material revenue headwinds today and will, at some point in the future, have to absorb rising loan losses which are presently at cyclical lows. In short, RY could one day lose its premium valuation if the bank artificially restrains growth in capital markets and then suffers falling or stagnant earnings in Canadian Banking."
Mr. McKay should drop the notion of a 25 per cent cap for this reason. Just stop talking about it, period, he argues.
"Instead, we hope the bank ceases to refer to the 25% earnings mix limitation and let RBC Capital Markets' contribution drift higher as it extends the segment's very compelling growth and return trajectory. If Canadian Banking's contribution stalls, the board may have no other choice."