Dear SAP Banking Community members.
Last weekend I had a very interesting discussion with a colleague about Average Balances of Accounts, its purpose, foundation, etc.
The average balance of an account can be calculated (basically) in two different ways.
- Un-weighted.- The balance is calculated by dividing the beginning balance plus the ending balance by two.
- Weighted.- The balance calculation takes into account how long the balance remains at specific levels during the measurement period.
Average balances are very common in Banking for many different purposes.
- Distribution of process/internal costs when we don’t have better drivers of cost analysis.
- Calculation of funding costs for Financial Instruments with not-deterministic cash-flows.
- Generation of management information by looking at the evolution of the average balance.
- …
In my opinion average balances which are still a very important element in Banking management are going to lose influence as the new regulation drives the Banking system towards the new efficiency paradigm.
Just some examples,
- If we look at the evolution of the Average Balances of the Accounts Receivable and we see a growing evolution of the Average Balance we can think that it’s a positive sign, as It’s describing an increasing of our volume. But it’s also possible that the evolution of the average balance is depicting higher levels of defaulting (negative sign).
- As you know derivatives and structured products are becoming more and more popular. The value of those off-balance Financial Instruments depend on market events affecting their underline, and many of them can jump from being Assets to become Liabilities as the market events trigger the activation of the contract conditions.
- Some exposures can be valuated according to different standards (Mark2Model, Market2Market, etc) and consequently the average balances of the holding accounts will be impacted by the valuation criteria.
The new banking system will require a detailed analysis of exposures based, not in the average balance of GL accounts but in the valuation of contracted/expected cash-flows and probabilities of being fulfilled. This kind of information can never be provided by a flat structure like a GL-Account, and taking decisions by simply looking at its evolution can drive banks managers to make mistakes.
There have been several initiatives for moving the center of the Bank health evaluation from the General Ledger to a more holistic visions. For instance, from the 90’s the CAMELS ratings system (Capital adequacy, Asset quality, Management, Earnings, and Liquidity and Sensitivity to market risk) has achieved some popularity
On the other hand those initiatives are confronting the limitations of current Banking IT architectures, as generating holistic visions without integrated systems is a huge challenge (amongst many other activities, reconciliation is a nightmare).
SAP has a lot of value to offer in this area as the Bank Analyzer Financial Database offers the integrated vision of Solvency, Liquidity and Value the new regulation requires.
Of course, average balances can be generated as a particular deliverable like the GL integration or other regulatory reporting, but the future will be integrated or it will not be.
Looking forward to read your opinions.
Kindest Regards.
Ferran.
Last weekend I had a very interesting discussion with a colleague about Average Balances of Accounts, its purpose, foundation, etc.
The average balance of an account can be calculated (basically) in two different ways.
- Un-weighted.- The balance is calculated by dividing the beginning balance plus the ending balance by two.
- Weighted.- The balance calculation takes into account how long the balance remains at specific levels during the measurement period.
Average balances are very common in Banking for many different purposes.
- Distribution of process/internal costs when we don’t have better drivers of cost analysis.
- Calculation of funding costs for Financial Instruments with not-deterministic cash-flows.
- Generation of management information by looking at the evolution of the average balance.
- …
In my opinion average balances which are still a very important element in Banking management are going to lose influence as the new regulation drives the Banking system towards the new efficiency paradigm.
Just some examples,
- If we look at the evolution of the Average Balances of the Accounts Receivable and we see a growing evolution of the Average Balance we can think that it’s a positive sign, as It’s describing an increasing of our volume. But it’s also possible that the evolution of the average balance is depicting higher levels of defaulting (negative sign).
- As you know derivatives and structured products are becoming more and more popular. The value of those off-balance Financial Instruments depend on market events affecting their underline, and many of them can jump from being Assets to become Liabilities as the market events trigger the activation of the contract conditions.
- Some exposures can be valuated according to different standards (Mark2Model, Market2Market, etc) and consequently the average balances of the holding accounts will be impacted by the valuation criteria.
The new banking system will require a detailed analysis of exposures based, not in the average balance of GL accounts but in the valuation of contracted/expected cash-flows and probabilities of being fulfilled. This kind of information can never be provided by a flat structure like a GL-Account, and taking decisions by simply looking at its evolution can drive banks managers to make mistakes.
There have been several initiatives for moving the center of the Bank health evaluation from the General Ledger to a more holistic visions. For instance, from the 90’s the CAMELS ratings system (Capital adequacy, Asset quality, Management, Earnings, and Liquidity and Sensitivity to market risk) has achieved some popularity
On the other hand those initiatives are confronting the limitations of current Banking IT architectures, as generating holistic visions without integrated systems is a huge challenge (amongst many other activities, reconciliation is a nightmare).
SAP has a lot of value to offer in this area as the Bank Analyzer Financial Database offers the integrated vision of Solvency, Liquidity and Value the new regulation requires.
Of course, average balances can be generated as a particular deliverable like the GL integration or other regulatory reporting, but the future will be integrated or it will not be.
Looking forward to read your opinions.
Kindest Regards.
Ferran.
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