Canadian Imperial Bank of Commerce

Background

In 1994, the Canadian Imperial Bank of Commerce (“CIBC” , the “Bank”, or the “Company”), a major commercial bank in Canada, decided that its Canadian commercial banking presence and limited foreign presence was not enough to remain competitive in the future. Major world investment banks were encroaching on its traditional client base, and the Company realized that it had to change in order to survive in the increasingly global financial services arena. At the time, CIBC also saw an opportunity to be the first major Canadian bank to have an established global capital markets position, and with this discovery, “[B]uilding a global capability became CIBC’s competitive imperative.”

Before they could redesign the Bank, however, management had to determine the new products and services that would help them to attract and retain clients in Canada and overseas markets. To do this, they had to understand the financial needs of their client base and how those needs would change in the future. After careful analysis, management decided that a key cornerstone of their investment bank would be a global capability in derivatives. They believed that increasingly global trade would result in increased exposure to foreign exchange and interest rate risk for their clients, and they thought that they could help their clients manage these risks through derivatives. Success in this business would also put the Bank on par with major US investment banks that had traditionally been the market leaders for this product. CIBC chose to follow this strategy despite the poor reputation of derivatives in the press; indeed, the president of CIBC Wood Gundy saw derivatives as crucial financial instruments of the future,

“By managing risk down, derivatives can make the difference between profit or loss, competitive success or failure...To condemn derivatives is like preaching about the danger of seatbelts. Derivatives are first and foremost a risk management tool. They are fundamentally and absolutely necessary to take full advantage of global markets.”

To accomplish this objective, the Bank began to improve its technology base and to hire outside experts to join the Bank to develop its new capabilities.

Derivatives and Risk Management at CIBC

Derivatives are financial instruments that depend on the prices of underlying assets or financial instruments to determine their value. A simple example of a derivative product is a call option on a stock. A call option gives the owner the right to buy a given stock at a specified price (the strike price); as the price of the stock rises above the strike price, the value of the call option to an investor also increases. Such an option is a very simple form of derivative; many more complex instruments exist that are priced based on underlying commodity prices, currency rates, and interest rates. Their use in the market place is widespread; in fact, in recent surveys conducted by the Bank, 55% and 41% of Canadian and American respondents, respectively, indicated that they use derivatives, mostly to hedge against earnings volatility.

The value chain for derivative financial products is relatively simple. Salespeople call on their accounts to solicit orders for either standard or customized derivatives. Once an order is received, the specifications are given to derivative structurers for pricing. They use various financial theories and formulas to analyze the volatility of the underlying assets, instruments or rates and to determine an appropriate price. The price and terms are then relayed back to the customer by the salesperson, and the product is either accepted or rejected by the customer. Under certain circumstances, the product may be restructured or reworked, depending on the customer’s needs and willingness to pay.

There are two key elements in the delivery of this product: people and technology. Derivative technology (the formulas and pricing techniques) is very complex, and it requires highly sophisticated training and knowledge to develop and operate (like that available in the Sloan School’s Financial Engineering Track). The hardware and software that support these individuals is equally if not more important. Computer systems for these products have to provide significant computing power on demand. In addition to being able to crunch a lot of numbers very quickly, systems also have to be able to collect and tie in data streams from diverse sources to help the analysts do their job. Of these two elements, though, the more critical development priority for management is the hardware and software infrastructure. Although people are important, traders and analysts are readily available for hire (at the right price); systems take time to design and build and have a legacy value that individuals may not. Thus, computer technology is the critical component to CIBC’s ability to compete in this market -- it makes the value chain possible.

Computer technology is also critical to CIBC’s needs to manage the risk associated with derivatives and the other financial products that it sells. Due especially to the volatile nature of many derivatives, the Bank must track its exposure (on as close to a real time basis as possible) and be able to change its capital allocation across products and markets to protect itself against market movements. The Bank has developed a tracking system that provides detailed risk assessments at the end of each business day; such tracking allows the Bank’s senior management to measure its risk profile in various sectors and to test the sensitivities of their positions to market changes, for example to a 0.10% change in interest rates. According to Ian Camacho, president and director of CIBC's Project RISC (Risk Information Systems & Calculator), to run the banking business safely, CIBC "need[s] to be able to ask 'what if.’ Say something happens like the Gulf War. You need to be able to ask 'What if there's a spike in oil prices? What if gold prices rally?' You need to be able to run scenarios and get a different look at your risk." The risk management systems put in place by the Bank enable them to meet this objective and thereby gives them the confidence to make loans and structure derivatives without “betting the Bank”; the systems make the value creation occurring within the rest of the Bank possible over the long term.

Enhanced Business Opportunities

If product creation/manufacturing and protection of the Bank were all that the technology allowed the Bank to do, the technology would be considered quite valuable. Instead of limiting itself, though, the Bank has used its expertise in both systems and derivative technologies to impact on the demand side of its business.

CIBC has partnered with Hewlett Packard to create the Frontier system. This off-the-shelf risk management system is marketed by the partners to “mid-sized banks which want to leverage CIBC’s risk management expertise and don’t want to spend the money and time it takes to develop a system in-house.” Although this system faces competition in the market place, as a market leader in derivatives and risk management, CIBC lends the product significant credibility. In addition, having such a product available opens up new business opportunities and accounts for CIBC that it may not have had in the past. Thus, in this case, the risk management technology not only has an impact on the “main” value chain of the Bank, but it also has become its own business with corresponding production and sales processes.

Another way that the Bank has been able to leverage its use of derivatives technology is to offer a series of courses on financial products to existing and potential clients. According to one course director, “[T]he aim of the course is clearly goodwill. Our best client is an educated client. We try to give them very objective information on how, for example, swaps are priced, and what the risks are.” By educating its potential client base, then, the Bank can broaden its appeal as well as the overall amount of derivatives used in the market place. In this fashion, CIBC can use its technological edge to impact the initial part of the value chain outlined above: the sales call. This education program makes more sales calls possible, and (hopefully) leads to a higher number of orders from clients.

Summary

Following its decision to enter investment banking, CIBC built a globally recognized capability in derivatives. For this strategy to succeed long term, however, the Bank had to build a complementary expertise in risk management systems to enable the Bank to manage the risks associated with its new business. The technologies involved have proven profitable for the Bank. Net loan losses for the Bank were down 11% in (1995 compared to 1994); total assets were up by 19%; and net income was up 14%. More importantly than these results, though, the technologies have opened up new markets, and they have also fostered the growth of the derivatives business itself. The Company is set for future growth and has recently begun widescale expansion into Asia, using its position in derivatives as an entry tool. Its bet has paid off. Now the challenge of building new businesses is before them.