Commercial Banking Risk Management †Free Samples to Students

Question: Discuss about the Commercial Banking Risk Management. Answer: Introduction The purpose of this study is to identify the potential risk areas of a public company. This particular project identifies the qualitative and quantitative risks associated with the auditing of the financial statements of the public company. The Royal Bank of Canada has been chosen for the purpose of the study. The Royal Bank of Canada is a listed company on the Toronto Stock Exchange and is a multinational Canadian financial services company. It is the second largest bank in Canada. The bank covers more than fifteen million clients online and employs 80000 people worldwide. The bank has its headquarters in Montreal, Quebec and was founded in 1864 in Halifax. The qualitative and the quantitative risks associated with the financial operations of Royal Bank of Canada has been supported by the annual reports, management disclosures and other financial analysis that has been carried out in order to state the findings with enough evidence (Cooper, Kingyens, Paradi, 2014). Though the mathe matical figures represent a strong foundation for the proposed ideas, there are certain limitations to these figures. For instance, the fall in the net income incurred by the company in a certain financial year may be due to a particular crisis or financial event. Therefore, the huge loss incurred by the company may offset the total average financial performance of the company indicating that the company is not doing well. Here comes the role of the auditor who intends to critically scrutinize the financial statements and the performance of the company and then recommend accurate steps in order to address those issues (Mohsni Otchere, 2015). The Royal Bank of Canada has been the largest Canadian bank based on the market capital. The bank has been paying consistent or increasing dividends every year since its foundation. The company also accrues a dividend yield of 4.1% and a price to earnings ratio of 12. The financial performance of the company has also followed an upward increasing trend. In the year of 2015 the net income increased by $531 million and the net income further increased by $178 million. The total revenue also increased by 4%. In spite of such figures, there are certain risks that are faced by the company. These risks have been identified and also have been mentioned in the annual report of the company (Otchere Mohsni, 2014). The last quarter of the financial year of 2016 marked a slow phase in terms of the growth of the Royal Bank of Canada. The bank has been doing well but there have been certain risk factors that pose a threat to the company. The major or primary quantitative risk that is face by every company is the risk associated with material misstatement in the accounting statements or fraud committed in the accounting statements in order to fulfill the personal interest of the employee, committing the fraud (Embrechts Hofert, 2014). As disclosed by the annual report of the company for the financial year of 2016, there are certain areas where the probability of occurring material misstatement is high. The term material misstatement refers to the act of understatement or over statement of a particular account either by mistake or by purpose in order to commit fraud or manipulation of the books of accounts. Misstatements may also occur when certain transactions have not been recorded or they have not been entered in the books of accounts. As evident from the annual report of the company for the financial year of 2016, the non-interest income of the Royal Bank of Canada should be checked thoroughly (Smales, 2016). This means that all the transactions related to interest income should be traced back to the payments. The suppliers or the entities obligated to the bank for the payment of interest income should be interviewed and the dockets or vouchers of payments should be checked in order to ensure that the recorded and the actual amount that has been transacted is same. This will surely mitigate the occurrence of misstatement in the books of account. To be more precise, the others head under the net interest income fluctuates a bit too much. This means that other sources from whom the company has gained the interest income should be checked. An amount of $685 in the financial year of 2014, $900 in 2015 and $773 in 2016 indicates the probability of a certain anomaly in the books of accounts. Therefore, the auditor should make it a point to trace back all the transactions. Another important auditing procedure in order to handle the quantitative risk of material misstatement is calculation of the materiality for a particular financial year. Materiality refers to the permissible amount of misstatement. This means that the auditor should develop a rational method for determining the amount of materiality. If the total amount of misstatement exceeds this amount of materiality then it would be forwar ded to the upper level management or the Board of Directors (Rbc.com. Retrieved 22 November 2017, from https://www.rbc.com/investorrelations/pdf/ar_2016_e.pdf). Management Assertion The management of the Royal Bank of Canada takes enough initiative in order to mitigate the risks such as credit risk or market risk. However, the quantitative risk of material misstatement should be given prior importance. The auditor may develop the amount of materiality by assigning a rate of five percent over the net income of the financial year whose books are being audited. Therefore, the management should make it a point to review the compliance of these established standards. Surprise internal audits will also help to mitigate this risk (Tian, 2016). The next potential quantitative risk that the Royal Bank of Canada is facing is the imminent threat of cyber risk. The security related to information and other important data in the financial services sector should be high. With the technological leap that the entire banking sector has undertaken the protection of client and other relevant data has become highly important. Recent instances of cyber attacks have proved that the financial sectors or the IT departments of the respective organizations are not competent enough to save the crucial organization information from the hackers (McNeil, Frey Embrechts, 2015). The potential intangible assets that are affected by these cyber attacks are financial data, client information, goodwill of the company, trade secrets and other software related data. The Royal Bank of Canada has been facing this threat. This is requires a quantitative analysis as because this particular risk cannot be mitigated without assigning proper valuation to the assets under threat. The auditor must find out the value of these intangible assets with the help of the fair market valuation system (Cohen, Krishnamoorthy Wright, 2017). The auditor may utilize the cost approach or the income approach in order to find out the value of these intellectual assets. Thus after the valuation of the intangible assets the growth or deterioration of these assets can be measured. This can clearly indicate the effect and result of the cyber attacks or other security threats that is faced by the Royal Bank of Canada. The particular question that the auditing team needs to ask the management o f the Royal Bank of Canada is that whether they have been taking proper initiative in order to maintain the informational or client security of the bank. There should be proper application of passwords and portal codes with restricted access in order to maintain the privacy. Competent backing up processes and storage devices with enough protection should be available. Moreover, the backing up of files containing important information should be made a periodic activity by the management (Rbc.com. Retrieved 22 November 2017, from https://www.rbc.com/investorrelations/pdf/ar_2016_e.pdf). Management Assertion The management of the Royal Bank of Canada should strictly adhere to the above mentioned recommendations. The Royal Bank of Canada being a part of the financial services sector is more vulnerable to the cyber attacks. Therefore, the management in addition to the already implemented steps should be active in revaluing the intangible assets and find out the quantitative effect that the potential threat of cyber attacks has on the bank. The Royal Bank of Canada has taken enough interest in protecting the information of its clients or customers but as mentioned in the annual report, the bank still faces the looming risk of cyber attack. Therefore, the needful steps should be undertaken in order to mitigate the risk (Benoit, Hurlin Prignon, 2017). The third quantitative risk that has come up from the calculation of the significant ratios of the Royal Bank of Canada is that the bank has been facing a diminishing asset turnover ratio for the past three years. This poses a real risk which if goes unnoticed may turn out to become a potential threat for the bank. Analyses of the significant ratios have helped in arriving at such a decision. There are certain limitations of the significant ratios like economic disasters or seasonal fluctuations may tamper the accurate forecasts of these ratios. Therefore, in order to minimize the effect of such events the financial ratios have been prepared at a stretch for three consecutive financial years. In order to find out the exact quantitative risk that the bank is facing the auditor needs to appropriately calculate the financial ratios of the bank. This must be done accurately. The auditor must make sure that the figures obtained for the calculation of the financial ratios are authentic and genuine, that is, they have been traced back to point of generation and has been matched with the figures that have been recorded in the financial statements. Now, the asset turnover ratio of the Royal Bank of Canada shows a diminishing figure in the current financial year of 2016 that is 0.03. The bank has been maintaining a stable asset turnover ratio of 0.04 for the past few financial years. But the current year of 2016 show a drop in asset turnover ratio. Now the asset turnover ratio refers to the ability of an organization to utilize its assets in order to generate revenue. The more efficiently an organization deploys its assets in the generation of company revenue, the more is the asset turnover ratio. This particular ratio being constant may also be a reason of concern for the bank. A constant ratio poses that the bank is not being able to improve the efficiency of its assets for increasing the revenue generation incurred by the bank (Chu, 2015). The question that the auditor should ask the management is that what internal controls have been implemented in order to increase the efficiency of the utilization of the assets. The potential procedures that might be adopted by the bank in order to increase its asset turnover ratio is that the bank may look after the collections from its debtors, that is, increase in the collections or the accounts receivables will increase the asset turnover ratio. More importantly, increase in efficiency of utilization of the assets of the bank and implementation of technology in order to properly record the internal proceeding would help to increase the asset turnover ratio of the Royal Bank of Canada (Rbc.com. Retrieved 22 November 2017, from https://www.rbc.com/investorrelations/pdf/ar_2016_e.pdf). Management Assertion The management of the Royal Bank of Canada has implemented enough measures to overcome the credit risks. However, the consistent asset turnover ratio should have been a reason of concern. In addition to it the current value of the ratio has dropped, the management at the Royal Bank of Canada must look into this. The management for increasing the asset turnover ratio of the bank should consider the recommended steps by the auditor. The primary qualitative risk that is faced by the Royal Bank of Canada is the dangerous real estate market in Canada that poses a looming threat over the financial condition of the bank. The major reason for the downfall of the real estate market is the Great Recession that affected the real estate industry all over the world. The downfall of the real estate market in Canada has been posing a threat to the Royal Bank of Canada. The Condos in the largest cities of Canada are the most overpriced. The Condo mortgages make up 2.7% of the Royal Bank of Canadas total loan portfolio and 9.8% of the total residential mortgage portfolio. Given the financial stability and the liquidity of the Royal bank of Canada, the bank is less likely to hugely suffer due to the housing crisis in Canada. However, the auditor must ensure that the precautions from the looming crisis have been prepared before hand by the management of the Royal Bank of Canada. The housing crisis would most probably affect the short term earnings of the bank, therefore enough retained earnings or a good liquidity position of the company will be enough precaution in order to handle the impending threat ("Royal Bank of Canada: Minor Risks, Major Returns, Mean Reversion - Sure Dividend", 2017). The management of the Royal Bank of Canada should be well aware of the economic situation in which the bank is operating. Thus, the auditing question that the management needs to answer is that whether it has done enough preparation to meet the risk that may arise in the future. Thus, the management should implement enough risk control in order to mitigate the effect of such an impending crisis. The second qualitative risk that the bank is facing is the risk of low oil prices in the market of Canada. The Royal Bank of Canada has already showed signs of delayed growth due to the unprecedented fall in the oil prices in Canada. The increased rate of growth that the bank was subjected to has faced a steep obstacle due to the decrease in the oil prices. The Royal bank of Canada already has taken a hit to its earnings which may evidently lead to loss of potential customer base and corporate portfolios. The credit department of the bank received the major blow. The first quarter of the financial year of 2016 saw the bank incur a credit loss of $298 million. The only recommendation for the management by the auditor is to lower the rate of extension of credit until the bank surpasses the crisis situation ("Royal Bank of Canada: Minor Risks, Major Returns, Mean Reversion - Sure Dividend", 2017). The management of the Royal bank of Canada has been competent enough to handle the situation of low oil prices in Canada. However, the particular auditor recommendation in the above discussion may prove to be advantageous for the bank. Conclusion Therefore, as it can be understood from the above discussion Royal Bank of Canada has been in a good financial condition. However, there are certain quantitative and qualitative risks that either the bank has been facing currently or will be facing in the future. The recommendations provided after proper conducting of the auditing review may not be completely accurate as there are certain limitations of the auditing procedures carried out by the auditor. The limitation may be human error, use of judgment in assuming estimates for reporting purposes or multiple possibilities of a single accounting interpretation. However, the auditor should make sure to mitigate the occurrence of error as much as possible. References Benoit, S., Hurlin, C., Prignon, C. (2017). Pitfalls in Systemic-Risk Scoring (No. hal-01485644). Chu, K. H. (2015). Bank consolidation and stability: The Canadian experience, 18671935. Journal of Financial Stability, 21, 46-60. 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