INTERVIEW: Suzanne Labarge has opened the doors to ERM at Royal Bank of Canada

RMA Journal, The, March, 2001 by Pamela Martin, Beverly Foster

Is it comforting to be able to predict the future or nervewracking to know there's just so much you can do about it? Canada's economy typically lags the U.S. economy--by eight to 12 months. And as the U.S. economy appears to be slowing markedly, Canada is watching closely.

Royal Bank is Canada's largest financial institution, with US$195.7 billion in total assets and some 50,000 employees. Suzanne Labarge is a vice chairman of the bank and its chief risk officer, responsible for ensuring a comprehensive and forward-looking risk management process in place throughout the institution. The bank is involved in a broad cross-section of financial services activities including capital markets and securities underwriting, sales, trading, and insurance in addition to traditional banking. Labarge also serves as a member of the Institute of International Finance's High Level Private Sector Finance Group on Bank Capital Adequacy Reforms.

Royal Bank considers itself a conservative risk-taker and credits its enterprise-wide risk management system with better-informed and more strategic risk-taking, better relations between Risk Management and the banks' businesses, and faster response times for clients. Labarge considers credit, operational, and regulatory risks to be the key challenges facing all banks in the coming months. In January, The RMA Journal interviewed Labarge about her perspectives on the economy, the Group Risk Management setup at Royal Bank, and her role as risk overseer.

RMAJ: Given the economic impact of the 4th quarter, and a weakening economic picture in the U.S. that has weakened, where do you think we are in the credit cycle?

SL: Canada is not seeing the same things that are occurring in the U.S. yet, because our economy tends to lag the U.S. by eight to 12 months, but I do believe we're at the stage where problems that have been building up over the cycle have begun to surface. And although banks are now feeling the impact of deteriorating credits, we certainly haven't hit bottom yet. From the time an economic downturn begins, it really takes about 12 months before the hulk of the loan losses are realized. Whether we have a soft economic landing or a thud, our watch lists most certainly will continue to grow and our workout people will be dealing with more problem loans by the beginning of 2002.

RMAJ: Royal Bank is an active participant in the capital markets. How do you think things have been holding up over the last few months? Are the market risk models working?

SL: Royal Bank is not a big market risk-taker-we deal primarily in developed markets. The bank is not large enough to put the infrastructure in place or absorb the kind of potential losses we've seen in emerging markets.

Our market risk model seems to be holding up quite well, yet we also have chosen to fortify it with several braces. We have product limits, notional limits, currency limits, and more, all in addition to market limits, to keep our exposure low. Back-testing has not revealed any flaws to date. I can't speak for the models being used for emerging markets, however, because for these markets, the past and the present do not necessarily go well together.

When you hear about problems with models, it's usually because a bank has hit a fat tail. It's not necessarily the model that's wrong-it's just that one day out of a hundred with high losses. Problems usually are due to something other than the model itself.

RMAJ: Have you done anything to adjust your market risk models since the fall of 1998, the last period of significant capital markets turmoil?

SL: The Fall 1998 situation was very different, in that it was much more pervasive. It was triggered by a liquidity issue started by other markets. This time there is just enormous volatility, which actually provides opportunities for our traders. Models understand and work very well within market turbulence. What we haven't had is a sudden shock to the system, such as the Russian default or the Asian crisis, that can disrupt all the models. I'm not convinced that the emerging market economies are robust enough at this juncture to withstand another shock.

There's been a lot of liquidity in the credit market because institutions other than banks have been willing to take on credit risk. But the beginnings of a credit liquidity squeeze are with us now. The question is whether companies will have enough liquidity to get through this part of the cycle. The capital markets, in terms of bond issuance and equity issuance, have dried up for certain names; this creates its own set of credit issues. We are seeing very little trading going on in the high-yield side of the business. That's because the nonbanks have pulled out of the market. The banks, meanwhile, are not reducing their appetite for credit, but they're not going to take on more loans to replace what has dried up in the marketplace.

In the last recession, companies were not as dependent on public credit markets. If anything happened, it was a bank credit crunch. Now it's a market credit crunch at the lower end.