TD Bank 2014 Annual Report Download - page 88

TD BANK GROUP ANNUAL REPORT 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS86
The following table shows the sensitivity of net interest income
(pre-tax) by currency for those currencies where the Bank has
material exposure.
(millions of Canadian dollars) October 31, 2014 October 31, 2013
100 bps 100 bps 100 bps 100 bps
Currency increase decrease increase decrease
Canadian dollar $ 354.4 $ (354.3) $ 309.1 $ (309.1)
U.S. dollar1 83.7 (31.1) 252.9 (63.4)
$ 438.1 $ (385.4) $ 562.0 $ (372.5)
1 EaR sensitivity has been measured using a 25 bps rate decline for U.S. interest
rates, corresponding to an interest rate environment that is floored at 0%.
SENSITIVITY OF PRE-TAX EARNINGS AT RISK BY CURRENCY
TABLE 57
Managing Non-trading Foreign Exchange Risk
Foreign exchange risk refers to losses that could result from changes in
foreign-currency exchange rates. Assets and liabilities that are denomi-
nated in foreign currencies have foreign exchange risk.
The Bank is exposed to non-trading foreign exchange risk from its
investments in foreign operations. When the Bank’s foreign currency
assets are greater or less than its liabilities in that currency, they
create a foreign currency open position. An adverse change in foreign
exchange rates can impact the Bank’s reported net interest income
and shareholders’ equity, and also its capital ratios.
Minimizing the impact of an adverse foreign exchange rate change
on reported equity will cause some variability in capital ratios, due to
the amount of RWA that are denominated in a foreign currency. If the
Canadian dollar weakens, the Canadian dollar equivalent of the Bank’s
RWA in a foreign currency increases, thereby increasing the Bank’s
capital requirement. For this reason, the foreign exchange risk arising
from the Bank’s net investments in foreign operations is hedged to the
point where capital ratios change by no more than an acceptable
amount for a given change in foreign exchange rates.
Managing Investment Portfolios
The Bank manages a securities portfolio that is integrated into the
overall asset and liability management process. The securities portfolio
is managed using high quality low risk securities in a manner appropri-
ate to the attainment of the following goals: (1) to generate a targeted
credit of funds to deposits in excess of lending; (2) to provide a suffi-
cient margin of liquid assets to meet unanticipated deposit and loan
fluctuations and overall funds management objectives; (3) to provide
eligible securities to meet collateral requirements and cash manage-
ment operations; and (4) to manage the target interest rate risk profile
of the balance sheet. Strategies for the investment portfolio are
managed based on the interest rate environment, balance sheet mix,
actual and anticipated loan demand, funding opportunities, and the
overall interest rate sensitivity of the Bank. The Risk Committee reviews
and approves the Enterprise Investment Policy that sets out limits for
the Bank’s own portfolio.
WHY MARGINS ON AVERAGE EARNING ASSETS
FLUCTUATE OVER TIME
As previously noted, the objective of the Bank’s approach to
asset/liability management is to ensure that earnings are stable and
predictable over time, regardless of cash flow mismatches and the
exercise of embedded options. This approach also creates margin
certainty on fixed rate loans and deposits as they are booked.
Despite this approach however, the margin on average earning
assets is subject to change over time for the following reasons:
• margins earned on new and renewing fixed-rate products
relative to the margin previously earned on matured products
will affect the existing portfolio margin;
• the weighted-average margin on average earning assets will shift
as the mix of business changes; and/or
• changes in the prime Bankers’ Acceptances (BA) basis and the lag
in changing product prices in response to changes in wholesale
rates may have an impact on margins earned.
The general level of interest rates will affect the return the Bank
generates on its modeled maturity profile for core deposits and the
investment profile for its net equity position as it evolves over time.
The general level of interest rates is also a key driver of some modeled
option exposures, and will affect the cost of hedging such exposures.
The Bank’s approach tends to moderate the impact of these factors
over time, resulting in a more stable and predictable earnings stream.
The Bank uses simulation modeling of net interest income to assess
the level and changes in net interest income to be earned over time
under various interest rate scenarios.
The model also includes the impact of projected product volume
growth, new margin, and product mix assumptions.
Operational Risk
Operational risk is the risk of loss resulting from inadequate
or failed internal processes or systems or from human activities
or from external events.
Operating a complex financial institution exposes the Bank’s busi-
nesses to a broad range of operational risks, including failed transac-
tion processing and documentation errors, fiduciary and information
breaches, technology failures, business disruption, theft and fraud,
workplace injury and damage to physical assets as a result of internal
or outsourced business activities. The impact can result in significant
financial loss, reputational harm or regulatory censure and penalties.
Operational risk is embedded in all of the Bank’s business activities
including the practices for managing other risks such as credit, market
and liquidity risk. The Bank must mitigate and manage operational risk
so that it can create and sustain shareholder value, successfully execute
the Bank’s business strategies, operate efficiently, and provide reliable,
secure and convenient access to financial services. The Bank maintains
a formal enterprise-wide operational risk management framework that
emphasizes a strong risk management and internal control culture
throughout TD.
Under Basel, the Bank uses the Standardized Approach to calcu-
late operational risk regulatory capital. The Bank’s operational risk
management framework, described below, has been enhanced to
meet the requirements of the Advanced Measurement Approach for
operational risk and work is underway to obtain regulatory approval
for implementation.