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Royal Bank of Canada President and CEO David McKay addresses shareholders during the bank's annual general meeting in Montreal, Wednesday, April 6, 2016.

Graham Hughes/THE CANADIAN PRESS

Two days after an unprecedented leak linked some of the world's largest lenders to alleged tax evasion and money laundering, Royal Bank of Canada went on the defensive over its ties to a Panama-based law firm used to set up offshore tax havens.

The leaked documents, now known as the Panama Papers, stole the show at RBC's annual meeting in Montreal on Wednesday. Chief executive officer Dave McKay faced a chorus of questions about the bank's relationship with law firm Mossack Fonseca, through which the bank allegedly registered 378 shell companies.

"You have to operate within the laws and regulations of a country. And you have to comply with them. We take that very seriously," Mr. McKay said. RBC repeatedly stressed there is a difference between tax planning – a category that includes products such as tax-deductible RRSPs – and illegal tax avoidance. Mr. McKay also said the bank has a special team going through the data related to the bank's use of Mossack Fonseca.

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For years, RBC pursued a growth strategy that pushed heavily into the Caribbean and Latin America.

The bank's wealth management platform also targets high-net-worth customers, who are the primary users of tax planning services. Its $5.4-billion (U.S.) acquisition of City National last year was designed to serve rich clients. At the same time, governments and regulators have increased their scrutiny of tax-avoidance schemes.

The intensifying scrutiny has frustrated RBC executives for more than a year, according to multiple sources. Before the Panama Papers were leaked, France's tax-evasion watchdog had alleged RBC's Bahamian subsidiary participated in tax fraud and money laundering activities involving billionaire international art dealer Guy Wildenstein.

RBC has never been proven guilty of any wrongdoing. In the French case, the leading prosecutor has repeatedly delayed the process and RBC has consistently denied participating in any illegal activities.

RBC also prides itself on having avoided global scandals such as the rigging of the London interbank offer rate (Libor) and the sale of fraudulent mortgage securities, both of which resulted in multibillion-dollar settlements against several global banks. "We're very proud of our culture," Mr. McKay said. "We believe in doing the right thing."

Of Canada's banks, though, RBC typically draws the most attention, given its standing as the country's biggest company. Yet rivals have faced similar woes.

Canadian Imperial Bank of Commerce also operates in the Caribbean, and three years ago the bank discovered it had potential problems within its regional wealth management operation, according to sources. To clamp down, CIBC separated its clients into two buckets: those who had a legitimate reason for a Caribbean bank account (such as to support local relatives or to buy a vacation home) and those who had not. Anyone without an obvious reason was asked to provide documentation of tax compliance – which upset many clients. Those who refused had their accounts frozen, and some were eventually dropped.

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After the three-year review, as much as one-third of CIBC's Caribbean wealth assets under management were removed, according to someone familiar with the exercise. CIBC disputes that figure and says some accounts may have been closed simply as a preventive measure.

Other Canadian banks have paid large fines. Between 2013 and 2015, Toronto-Dominion Bank paid $72.5-million to settle lawsuits stemming from an alleged Ponzi scheme it failed to spot in one of its Florida branches.

The frustration felt by RBC and its rivals is largely rooted in the banks' efforts to clamp down on clients' bad behaviour in the past few years. People in the industry say HSBC PLC's $1.9-billion penalty in 2012 over being used to launder Mexican drug cartel money sent ripples through the industry.

The fallout has led to a push by global banks to build up anti-money-laundering (AML) teams. From 2013 to 2014, British banks created more than 2,150 anti-money-laundering jobs, a rise of more than 50 per cent from the previous year. At RBC, the AML group founded in 2001 had three people; by the end of 2016, it is expected to employ between 750 and 800 people, or more than half of its global compliance head count.

"It is true they have lots of people; it is true they spend lots of money," Christine Duhaime, a Canadian lawyer who specializes in anti-money-laundering rules, said of Canadian banks. The problem: "The level of sophistication and knowledge is a lot lower than anywhere else in the [developed] banking world."

AML specialists also admit that things can slip through the cracks. "Even for a bank that is really determined to be ethical, it is really difficult," said Roy Cullen, a former parliamentary secretary who helped set up Canada's anti-money-laundering regime. He also serves as the Canadian representative to GOPAC, the Global Organization of Parliamentarians Against Corruption.

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The corruption scandal ensnaring FIFA, soccer's global governing body, illustrates the extent to which good intentions can backfire. When the scandal broke last year, the U.S. Justice Department revealed that some FIFA officials used CIBC FirstCaribbean International Bank accounts to move money. In one instance, relating to a $600,000 wire transfer in 2003, CIBC did its best to document the source of funds by asking for a paper track record. It was later alleged that FIFA executive Chuck Blazer and unnamed co-conspirators created a backdated consulting agreement with a Panamanian company to cover it up.

In response to such difficulties, many banks have been cutting ties altogether. National Bank of Canada pulled out of the Caribbean in 2007 by selling its Bahamian subsidiary. "If you're doing the due diligence you're supposed to on each case, it's not scalable," said someone familiar with the decision.

The standards for verification are now so high that it takes armies of people to research potential clients and payments – which eats into profit margins.

RBC recently followed a similar route. Shortly after Mr. McKay became CEO in 2014, the bank started closing its Latin American and Caribbean wealth operations, and recently sold its Swiss private banking subsidiary. Sources say there were two key reasons for the moves: The bank lacked scale to expand in Latin American countries such as Chile and Brazil, and it also worried about reputational risks in the Caribbean.

The way the system is designed, the buck stops with the banks, Ms. Duhaime said. "Whether they like it or not, they are the police force."

With files from reporter David Berman in Toronto

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