We recently compiled a list of the 10 Best Diversified Bank Stocks to Buy Now. In this article, we are going to take a look at where Royal Bank of Canada (NYSE:RY) stands against the other diversified bank stocks.

With 2024 heading to a close, the banking industry continues to be one of the most dynamic ones. While consumer and media attention has been fixated on technology due to the revolutionary potential offered by artificial intelligence, banks have slowly been adjusting to the market, industry, and economic conditions created by 24 year high interest rates in America.

The usual culprit behind the turmoil is the Federal Reserve. After the mini banking crisis in America last year that saw some of the biggest banks go under, Federal Reserve officials sped up rule changes to ensure that the biggest banks in America can maintain stability. These banks are called Global Systematically Important Banks (GSIBs) and they are selected on the basis of criteria that determine their importance to the global financial systems.

The initial set of these rules called the Basel III Endgame, would significantly increase the capital that GSIBs would have had to set aside to maintain stability. Within these banks, the largest would be required to increase their RiskWeighted Assets (RWAs) to jump. to 20%, with analysts expecting back then that banks would have to set aside their retained earnings (post net income money usually returned to shareholders or used to fund growth) for as much as four years to fund the. new requirements.

Naturally, the big banks weren’t pleased. Not only did the new rules propose disallowing the banks’ use of internal risk models to determine capital requirements, but they also targeted non interest income by including it in the calculations for determining operational risk. This income stream covers different areas, such as fees from payment processing and card transactions, and it had become a great way for big banks in particular to beef up their income statement during 2020 when interest rates were at a historic low. According to data from S&P Market Intelligence, banks with assets greater than $10 billion saw their noninterest income rise by 3.5% between Q1 2021 and Q1 2022. The growth trend was sharper for the broader industry over a longer horizon. Between Q1 2019 and Q1 2022, net interest income for US banks fell by 0.89% while noninterest income jumped by 17.2%.

The resistance from the banks worked, as Fed Chairman Jerome Powell shared with Congress in March that he was “confident that the final product will be one that has broad support at the Fed and in the broader world.” The Fed Chair was particularly moved by results from an independent study that showed that 97% of the comments submitted in response to the rules were critical of them. The banks’ push back came right when Basel regulators proposed changing the way in which big banks calculate their GSIB surcharge, to prevent them from window dressing their risk metrics at year end. According to calculations from Reuters, a 0.5% reduction in the GSIB surcharge saves America’s top two biggest banks a cumulative $16 billion, and the changes in this area could require the banks to use the average of their daily risk values during the reporting year.

Powell’s comments were followed by Fed Vice Chair for Supervision Michael Barr announcing in September that the new rules would now require big banks’ capital to increase by 9% as opposed to 19%. For banks with assets lower than $250 billion, their capital would increase between 3% to 4%, Barr added. The Fed official commented to reporters that “there are benefits and costs to increasing capital requirements. The changes we intend to make will bring these two important objectives into better balance, in light of the feedback we have received.”

Sounds good right? Think again, as banks and their investors weren’t pleased. The day Barr announced the new rules, the S&P’s bank stock index dropped by 2.70% before paring some of the losses to close 0.82% lower. However, bank investors weren’t disappointed only by the new rules. They were also digesting comments from top banking executives at the Barclays conference in New York; comments which saw the bank stock index drop by 3.1% the day after Barr released the vastly friendlier rules to close 1% lower.

At the conference, Goldman’s CEO warned that the bank could experience a 10% drop in trading revenue or the revenue that it earns from trading fixed income securities, currencies, and commodities. Citi CFO Mark Mason warned that market revenue could drop by 4%, while JPM’s operations chief Daniel Pino warned investors that their net interest income expectations were too high. The bank’s shares fell by 7.5% and closed the day 5.2% lower.

However, not all is dour for bank stock investors. According to McKinsey’s 2023 Annual Banking Review, the industry’s net interest margin improvements courtesy of high interest rates grew profits by $280 billion in 2022 and bumped the return on equity (ROE) to 12%. Global banking net income sat at a six year high of $1.3 trillion in 2022, and the report projected it to further grow to $1.4 trillion in 2023.

Our Methodology

To make our list of the best diversified bank stocks to buy, we ranked the 40 largest diversified banks in the world traded on the NASDAQ or NYSE by their market capitalization and picked out the stocks with the highest number of hedge fund investors in Q2 2024.

Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).

Royal Bank of Canada (NYSE:RY)

Number of Hedge Fund Holders In Q2 2024: 21

Royal Bank of Canada (NYSE:RY) is one of the biggest banks in Canada with close to 100,000 employees. Like other diversified banks, it generates a significant portion of its revenue from noninterest income. In fact, for Royal Bank of Canada (NYSE:RY), its revenue is split a precise half by its interest and noninterest income. For the first nine months of its FY2024, Royal Bank of Canada (NYSE:RY) earned C$42.2 billion in revenue, out of which C$20.2 billion and C$21.9 billion were through its interest and noninterest income, respectively. The bank has already started to position itself for lower interest income through the start of the rate cut cycle in Canada. This is because Royal Bank of Canada (NYSE:RY) completed a mega acquisition of HSBC’s Canada operations in March 2024. The deal added C$134 billion in assets and 130 branches into its portfolio, which substantially bolsters Royal Bank of Canada (NYSE:RY)’s position in the Canadian banking market. As of its Q3, the bank’s CET1 ratio was 13%, which protects it well against any turbulence in case of an economic downturn.

Royal Bank of Canada (NYSE:RY)’s management is aware of the broader macro economic risks to its business. Here’s what it had to say during the Q3 2024 earnings call:

“Before discussing our business results in greater detail, I will provide my perspective on the macro environment where the U.S. has outperformed a softening Canadian macro backdrop. In Canada, higher interest rates and rising unemployment are impacting consumer spending and business investment. This in turn has led to a moderating non-shelter inflation and lower GDP per capita. Contrast, U.S. inflation remains above the targeted range. However, there are signs that the restrictive interest rate policy is stabilizing supercore inflation measures, while the U.S. labor market remains resilient. Declining job openings and rates of attrition point to some weakening. The short-term divergence of monetary policy between the Bank of Canada and the U.S. Federal Reserve is expected to narrow ahead of expected and accelerating U.S. interest rate cuts, with positive implications for yield curves.

While there’s a higher degree of geopolitical uncertainty and volatility, our diversified businesses are well positioned for the macro driven shifts in the operating environment. We expect to see the benefits of lower short-term interest rates and capital markets activity, constructive equity markets, availability of credit, improved debt serviceability and the flow of money from deposits into investments. As we continue to provide our clients with valued advice and solutions amidst a complex backdrop. We’re also delivering on our strategic priorities across our largest businesses and geographies, including expanding our funding and transaction banking capabilities.”

Overall RY ranks 8th on our list of the best diversified bank stocks to buy now. While we acknowledge the potential of RY as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than RY but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article is originally published at Insider Monkey.