Canadian Chartered Banks

Presented by: Lisa Lin Jodi Leung Julie Zhong David Jung Simon Choi

Today’s Agenda

• Overview of Industry • Major Competitors • Product Overview • Revenue Composition • Regulatory Environment (Bank Act) • Scotiabank

Overview of Industry

The banking industry includes 21 domestic banks, 23 foreign bank subsidiaries and 22 foreign bank branches operating in Canada. In total, these institutions manage almost $1.8 trillion in assets Source: Canadian Bankers Association (2007)

Overview of Industry

• Banks account for over 55 per cent of the total assets of the Canadian financial services sector, with the six largest domestic banks accounting for over 91 per cent of the assets of the banking industry • Canada’s banks play an important role in the national clearing and settlement system, which is among the most efficient payment systems in the world Source: Department of Finance Canada, PwC

Overview of Industry

The average rate of return on common equity was 15.7 percent in 2005 despite Enron-related litigation charges and pressure on the spread margins Source: PwC

Major Competitors

• Bank of Montreal • CIBC • Royal Bank of Canada • TD Canada Trust • National Bank of Canada

Major Competitors

Each year we see new foreign and domestic players in Canada. Among the entrants over the past few years have been Bank West, Canadian Tire Bank, Ubiquity Bank, CS Alterna Bank, Dundee Wealth Bank, ICICI Bank Canada and Capital One Bank

Major Competitors

• Strong rivalry in the banking industry because… – consumers have low switching costs – lots of firms that are equal in size and capability – high exit/entry barriers (government regulations) • Canadian banks are facing increased competition from other established financial service providers and new foreign entrants. New technology and the Internet are also enabling competitors to enter the market without having to invest in branches, which presents further challenges to Canada’s banking industry.

Product Overview

•

Business/Operating Lines

–

Personal and Business Banking:

and payment needs of clients; loans, travelers’ cheques, overdraft protection, money orders meet the credit, deposit –

Wealth Management:

estate planning, GICs, mutual funds, managed asset programs, tax advice –

Corporate and Investment Banking:

client funds and offer advice on corporate takeovers, mergers and re-organizations supply equity, manage •

Technology

– Internet banking, ATM 85% of retail banking transactions are done electronically

Revenue Composition

• Profits - Almost $12 billion in 2005 from the Big 6 • Interest income, the difference between what they pay you in interest and what the banks charge someone else to borrow – Loans – Mortgages – Credit cards – Bonds – T-Bills • Canadian banks make almost half of their revenues (47%) from interest income • Investment Banking (the rest) – Underwriting – Commissions – Wealth management • Service fees (5%)

International Presence

• Canadian banks are wringing profits like never before from their operations outside Canada. Bank of Montreal has bought Harris Bank of Chicago; TD has bought New England-based Banknorth; Royal Bank has bought Centura Banks of North Carolina • Scotiabank (the most "international" of Canada's big banks) has such an extensive presence in Mexico, the Caribbean and Latin America that, in a recent quarter, it earned almost as much profit from those foreign markets as it generated from its banking operations in Canada • Taken as a whole, chartered banks got 28 per cent of their 2004 revenues from outside the country. And with a freeze since 1998 on big banks merging with each other, the Big Six are increasingly looking beyond Canada's borders for profits they can bring back home.

Regulatory Environment

• Bank Act, the federal government is responsible for the regulation of the banking industry in Canada.

• Due to the hybrid nature of the banks’ activities, some of their subsidiary activities such as trustee services and securities dealing are provincially regulated (OSC) • The Office of the Superintendent of Financial Institutions (OSFI) is the federal agency principally responsible for supervising all federally regulated financial institutions and pension plans. OSFI’s role is to safeguard policyholders, depositors and pension plan members from undue loss, and to advance and administer a regulatory framework that contributes to public confidence in a competitive financial system.

• The Canada Deposit Insurance Corporation protects depositors by providing deposit insurance. To encourage well-managed member institutions, it also promotes standards of sound business and financial practices.

Scotiabank

Organizational Structure

Scotiabank Domestic Banking Retail and Small Business Banking Wealth Management International Banking Scotia Capital Commercial Banking Global Corporate & Investment Banking Global Capital Markets ScotiaMcleod ScotiaCassels ScotiaTrust

Net Income by Business Units

Net Income

Financial Statement

Financial Institutes’ Accounting

• Section 308 of the Bank Act governs financial institute’s accounting • F/s need to be prepared in accordance to Canadian GAAP with a reconciliation between Canadian and US accounting measurements • The consolidated f/s eliminates intercompany transactions and balances • Foreign monetary assets and liabilities are translated into Canadian dollars using the rate prevailing at the end of the fiscal period. Revenues and Expenses are translated using average exchange rate.

Financial Institutes’ Accounting

Estimates with greatest uncertainty includes: • Allowance for credit losses • Fair value for financial instruments • Corporate income taxes • Pensions and other employees futures benefits (ESOP) • Other-than-temporary impairment of investment securities • Primary beneficiary of a variable interest entity (VIE)

Accrual Interest and A/R

Direct Unsecured Obligations

Realized

Risk Management

Risk Management Framework

Executive and Risk Committee Board of Directors & Board Committees Audit and Conduct Review Committee Systems Planning and Policy Committee Liability Committee Senior Credit Committee(s) Chief Executive Officer Risk Policy Committee Strategic Transaction Investment Committee Market Risk Management & Policy Committee Reputational Risk Committee

Types of Risk

• Credit Risk • Market Risk • Liquidity Risk • Operational Risk • Environmental Risk • Reputational Risk

Credit Risk

• Credit risk is the risk of loss resulting from the

failure of a borrower or counterparty to honour its financial or contractual obligations

to the Bank. • Credit risk is created in the Bank’s direct lending operations, and in its funding, investment and trading activities where counterparties have repayment or other obligations to the Bank.

Credit Risk

• Corporate and Commercial – Assessment criteria: Current and projected financial results and credit statistics Industry Economic trends Geopolitical risk Management – Duel risk rating system Borrower risk – industry sector and/or business lines Credit facilities – facilities’ structural and collateral-related elements – Risk-adjusted return on equity profitability model

Credit Risk

• Consumer and Small Business – Customer-centric approach Adjudication software calculates the maximum debt for which a customer qualifies – Risk rating system C ustomer’s credit history Internal credit score – predictive credit scoring models

Market Risk

Market risk is the risk of loss in our trading, funding and investment positions that

results from exposure to interest rates, credit spreads, foreign currency rates, and equity and commodity prices.

Market Risk

• Market risk category – Interest rate risk – Foreign currency risk – Equities risk – Credit spread risk – Commodities risk Funding Interest rate risk Foreign currency risk Investments Interest rate risk Foreign currency risk Equities risk Credit spread risk Trading Interest rate risk Foreign currency risk Equities risk Credit spread risk Commodities risk

Market Risk

• Interest rate risk – The risk of loss due to: changes in the level, slope, and curvature of the yield curve; the volatility of interest rates; and mortgage prepayment rates – Manages with the objective of enhancing net interest income within established risk tolerances. • Foreign currency risk – The risk of loss due to changes in spot and forward prices, and the volatility of currency exchange rates – Net investments in self-sustaining foreign operations and from its net corporate foreign currency positions – Hedge: foreign currency spot and forward contract, option – Primarily denominated in U.S. dollars and Mexican pesos

Market Risk

• Equity risk – The risk of loss due to changes in the prices, and the volatility, of individual equity instruments and equity indices – Equity investments include common and preferred shares, as well as a diversified portfolio of third-party managed funds • Credit spread risk – The risk of loss due to changes in the market price of credit, or the creditworthiness of a particular issuer • Commodity price risk – The risk of loss due primarily to changes in spot and forward prices, and the volatility, of precious and base metals

Market Risk

• Market Risk Measurement –

Value at risk (VAR)

A statistical measure that estimates the potential loss in value of the Bank’s trading positions due to adverse market movements, over a defined time horizon (1-day) with a specified confidence level (99%)

Market Risk

–

Stress testing

Examines the impact that abnormally large swings in market factors and periods of prolonged inactivity might have on trading portfolios –

Sensitivity analysis and simulation modeling

Sensitivity analysis

rates on current earnings and on the economic value of assets and liabilities assesses the effect of changes in interest

Simulation models

enable the Bank to assess interest rate risk under a variety of scenarios over time. The models incorporate assumptions about growth, planned business mix, changes in interest rates, shape of the yield curve, embedded product options, maturities and other factors

Market Risk

–

Gap analysis

• Assess the interest rate sensitivity of the Bank’s retail, wholesale banking and international operations • A liability gap occurs when more liabilities than assets are subject to interest rate changes during a given time period.

• An asset-sensitive position arises when more assets than liabilities are subject to rate changes.

Liquidity Risk

• The risk that the Bank is unable to meet its financial obligations in a timely manner at reasonable prices • Financial obligations include – Liabilities to depositors – Payments due under derivative contracts – Settlement of securities borrowing and repurchase transactions – Lending and investment commitments.

Liquidity Risk

• Liquidity risk management – maintain confidence of depositors and counterparties – enable core businesses to generate revenue • Key elements of liquidity risk framework are: – Measurement and modelling – Funding diversification – Core liquidity – Stress testing – Contingency planning

Liquidity Profile

Operational Risk

• The risk of loss, whether direct or indirect, to which the Bank is exposed due to external events, human error, or the inadequacy or failure of processes, procedures, systems or controls • Can result in financial loss, regulatory sanctions and damage to the Bank’s reputation

Operational Risk

• Operational risk management approach: – Accountability – A robust internal control environment – An effective organization structure – An effective program to promote compliance with relevant laws and regulatory requirements – An operational risk management framework

Reputational Risk

• Reputational risk is the risk that negative publicity regarding Scotiabank’s conduct or business practices, whether true or not, will adversely affect its revenues, operations or customer base, or require costly litigation or other defensive measures.

• Who ensure that the Bank is seen to be acting with high ethical standards?

– Reputational Risk Committee – Legal Department – Corporate Secretary – Corporate & Government Affairs and Compliance Departments

Reputational Risk

• How to manage?

– Codes of conduct – Corporate governance – Risk management programs • All directors, officers and employees have a responsibility to conduct their activities in accordance with the Scotiabank Guidelines for Business Conduct, and in a manner that minimizes reputational risk. • Believes that if all employees follow the guidelines, reputational risk will minimize.

Environmental Risk

• Environmental risk refers to the possibility that environmental concerns involving the Scotiabank Group or its customers could affect the Bank’s financial performance.

• To keep all kinds of concurrent and potential clients interested and keep their accounts in Scotiabank

Environmental Risk

• Identify the Bank’s role in the environmental responsibilities – Address the issues of climate change – Protection of biodiversity – Promotion of sustainable forestry practices • To ensure environmentally responsible manner: Ongoing interaction with government, industry and stakeholders in countries where it operates • Sponsor of the – Carbon Disclosure Project in Canada – which provides corporate disclosure to the investment community on greenhouse gas (GHG) emissions and climate change management

Derivatives

• The Bank uses derivatives to – Generate revenues from trading activities, – Manage market and credit risks, – Lower its cost of capital • Derivatives trading was a record of $585 million and contributed 57% of total trading revenue

Derivatives

• Interest rate exposures: Interest rate swaps, futures and options • Foreign currency risk exposures: Forward contracts, swaps and options • Credit exposures: credit default swaps (credit return swap and credit linked notes)

Credit Derivatives

• Credit derivatives can be defined as arrangements that allow one party (protection buyer or originator) to transfer credit risk of a reference asset, which it may or may not own, to one or more other parties (the protection sellers).

• Buyer seeks ways to avoid a certain risk • Seller seeks ways to be exposed to a certain risk • Credit default swap (Two parties): The counterparty (Seller) agrees to insure this risk in exchange of regular periodic payments (essentially an insurance premium). If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal.

Credit Derivatives

• At October 31, 2006, credit derivatives used to mitigate exposures in the portfolios totaled $1,420 million (notional amount), compared to $444 million at October 31, 2005. This increase is indicative of the Bank’s active portfolio management program. The industries with significant protection purchased include the media and oil and gas sectors.

• The Bank’s use of credit derivatives increased year over year, as notional principal amounts rose by $13.7 billion to $34.8 billion.

• Mostly used in: – Bank’s trading businesses, where the activity includes trading with customers, structured transactions and modest proprietary trading.

– Investment and loan portfolios. Credit protection is sold as an alternative to bond or loan assets, while credit protection is bought to manage credit exposures.

Employee Stock Options

• Employee stock options granted have Tandem Stock Appreciation Rights (Tandem SAR): – To either exercise the stock option for shares – Or to exercise the Tandem SAR and thereby receive the intrinsic value of the stock option in cash. • Tandem SARs are settled in cash so they are recorded in other liabilities • Fair value based on Black-Scholes pricing model

Thank You!

Any Questions?