Dear,
In recent weeks, long-term Japanese government bond rates have been rising due to investor concerns about inflation, government spending, and interest rate hikes by the Bank of Japan.
In recent years, the Bank of Japan's low interest rates, necessary to keep interest on Japan's high debt under control, created a yen carry trade, where investors borrowed in yen at low costs and purchased assets with stronger yields abroad.
This mechanism has financed investments in other markets, such as the US.
However, if Japanese debt yields rise, this carry trade mechanism will cease. Investors will have less incentive to finance assets outside of Japan, eventually liquidating US assets to obtain liquidity under the pressure of the rising interest burden on Japanese debt.
When we reach this point, and we will because the debt is growing unstoppably, the Japanese debt problem will spread to the United States and from there to the rest of the world. Let's not forget that Japan is the largest foreign holder of US debt.
As SAP consultants, none of us are in a position to stop the forces of the macroeconomic environment, and therefore our goal must be to act to guide our actions in helping our clients navigate the stormy seas of rising Capital Costs.
Ultimately, rising government debt yields will accentuate the strain on the financial system and make it difficult for companies to finance their investments.
For all of the above reasons, reducing Capital Costs, or in other words, Optimizing Capital, is becoming critical.
Let's look at what a Capital Optimization process looks like.
1) The first step in a Capital Optimization process is to accurately measure the capital consumed in each market segment to which the bank is exposed.
This is the main value proposition of SAP Bank Analyzer's Integrated Financial and Risk Architecture.
Bank Analyzer's Credit Risk module will calculate the Risk-Weighted Assets for each contract, each risk exposure in the bank's portfolio, and, consequently, the Regulatory Capital consumed.
Once the capital consumed by each contract/exposure is known, we can aggregate it according to the analytical dimensions defined in Bank Analyzer's results data layer, thus understanding the capital consumed in each market segment in which the bank operates.
Alternatively, SAP Bank Analyzer's Credit Portfolio also provides us with the economic capital consumed by market segment and all the complementary parameters to the capital consumed.
2) The second step in a Capital Optimization process is the efficient allocation of collateral to exposures to reduce Risk-Weighted Assets and capital consumption.
The allocation of collateral to exposures is not always static. A 1-to-1 allocation of one collateral to one exposure is a trivial case, but it is common for several (n) exposures to be allocated to several (m) collaterals.
If (n) exposures are allocated to (m) collaterals, an optimal distribution of collateral portions across exposures occurs, reducing Risk-Weighted Assets and, consequently, capital consumption. This is the basis of dynamic collateral management, which we discussed in a previous blog post and will discuss again in a future one.
https://www.linkedin.com/pulse/dynamic-collateral-management-capital-optimization-sap-frances-gil/
Bank Analyzer's credit risk module has robust capabilities for optimal collateral allocation to exposures in Level 2 of the risk-weighted asset calculation. These capabilities analyze Probabilities of Default and Exposures at Default, as well as Collateral Values, efficiently adjusting the allocation of collateral portions to Exposures.
3) The third step in a Capital Optimization process is to maximize the bank's profit by reducing Capital Consumption. Each market segment has a potential expected profit, and each market segment has a potential expected loss and, consequently, potential capital consumption.
Capital Optimization involves identifying the market segments with the highest Expected Profit weighted by the market segment's Expected Capital Consumption.
This is the most complex element of a Capital Optimization process, as it requires a doubly synchronized simulation to find a solution that minimizes Risk-Weighted Assets and maximizes Expected Profit.
This optimization engine is not yet available, but Bank Analyzer's Integrated Financial and Risk Architecture has been designed to provide an integrated and reconcilable view of Risk and Accounting.
The IFRA is the technical basis for running the simulation cycles that capital managers must implement to achieve optimal bank portfolio planning, reducing RWA while maximizing expected profit.
Finally, the future will require automatic calculation and simulation of bank investments to propose optimal sales and execution planning. I have personally worked on some of these models, adapting the theory of constraints to portfolio management.
These simulations require very powerful computing capabilities, but that is the value that SAP HANA brings to solving the problem.
The last 12 years our team has worked in modeling all the economic events and business flows represented in the SAP systems of the Real Economy, in terms of Capital and Liquidity consumption and generation. With this information, our systems measure how to offer Financial Instruments for covering Capital and Liquidity gaps or investing Capital and Liquidity surpluses, optimizing the Capital and Liquidity consumption of the system.
We are working on presenting our system to the market, and looking for business partners and investors, if you are interested do not hesitate in contacting me at
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Looking forward to reading your opinions.
Kindest Regards,
Ferran Frances-Gil.
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