Dear community members,
On my opinion the last financial crisis has taught us that we need to manage Liquidity, Profit and Risk in a Systemic approach as the three magnitudes are deeply related and must be managed together in a Systemic approach.
A painful but clear example is the Lehman Brothers Bank collapse on September 2008.
Some authors have blamed the securitization as the main factor which produce the Lehman insolvency (and others which were rescued by the governments at the last minute).
Nevertheless a more deeply analysis of the events, it may show us a different picture.
The securitization itself could have helped to clean the Balance Sheet, swapping long term consolidated assets (Mortgages) by cash.
Unfortunately the securitization process created also an “unexpected” problem.
Many Banks issued the Securitized Bonds in the form of Commercial Paper with a maturity of less than 1 year, when the original mortgages have maturities of 30 years. Doing that the Bank was also getting an additional profit as the long Interest Rates are usually higher than short term interest rates.
Unfortunately there was a basic issue here, as the Bank was financing long term investments with very short term liabilities, and consequently creating liquidity tensions. The securitization was drying the Bank liquidity.
On this situation any short term financing difficulty could put the system at risk and make many banks insolvent as it finally happened.
We can find many explanations to the lack of control which finally produce the catastrophe. It’s not my intention here to make an exhaustive list, but to look at some technical limitations we can find on the current Information Systems.
As we all now, most of the Financial Information Systems set the General Ledger as the center to all the subsystems which finally communicate the Financial Status. The Financial Statements have become the main document for communicating the Bank Solvency.
Unfortunately the General Ledger is a Flat Structure designed for informing about Profit and Value of the Assets and Liabilities, but it has limitations for disclosing Liquidity and Risk.
For instance we can look at the Securitization issue I commented at the beginning;
In a securitization process with very different maturities on the Assets and the Liabilities we are generating liquidity tensions. And the origin of these liquidity tensions is very difficult to “disclose” by using the General Ledger alone.
The standard approach is using different accounts for Assets/Liabilities with different maturity groupings; long term, short term, etc.
But even that approach does not give us all the information.
Let me describe it with another simple example.
Let’s look at the Accounts Receivable of a company. We check how that account evolves every period, and we see that the account balance is growing; what does it mean?
Directly two explanations come to my mind, maybe our sales are growing, or maybe our clients are failing to pay on time.
Just by looking to the General Ledger – Balance Sheet is difficult to say what is really happening, and of course the consequences and measures that we must take are totally different.
For disclosing all those effects we need an enriched structure, a Cash-Flow based accounting system.
But this mail has become too long, so I’ll explain the concept in another post.
Looking forward to know your views.
Regards.
Ferran.
On my opinion the last financial crisis has taught us that we need to manage Liquidity, Profit and Risk in a Systemic approach as the three magnitudes are deeply related and must be managed together in a Systemic approach.
A painful but clear example is the Lehman Brothers Bank collapse on September 2008.
Some authors have blamed the securitization as the main factor which produce the Lehman insolvency (and others which were rescued by the governments at the last minute).
Nevertheless a more deeply analysis of the events, it may show us a different picture.
The securitization itself could have helped to clean the Balance Sheet, swapping long term consolidated assets (Mortgages) by cash.
Unfortunately the securitization process created also an “unexpected” problem.
Many Banks issued the Securitized Bonds in the form of Commercial Paper with a maturity of less than 1 year, when the original mortgages have maturities of 30 years. Doing that the Bank was also getting an additional profit as the long Interest Rates are usually higher than short term interest rates.
Unfortunately there was a basic issue here, as the Bank was financing long term investments with very short term liabilities, and consequently creating liquidity tensions. The securitization was drying the Bank liquidity.
On this situation any short term financing difficulty could put the system at risk and make many banks insolvent as it finally happened.
We can find many explanations to the lack of control which finally produce the catastrophe. It’s not my intention here to make an exhaustive list, but to look at some technical limitations we can find on the current Information Systems.
As we all now, most of the Financial Information Systems set the General Ledger as the center to all the subsystems which finally communicate the Financial Status. The Financial Statements have become the main document for communicating the Bank Solvency.
Unfortunately the General Ledger is a Flat Structure designed for informing about Profit and Value of the Assets and Liabilities, but it has limitations for disclosing Liquidity and Risk.
For instance we can look at the Securitization issue I commented at the beginning;
In a securitization process with very different maturities on the Assets and the Liabilities we are generating liquidity tensions. And the origin of these liquidity tensions is very difficult to “disclose” by using the General Ledger alone.
The standard approach is using different accounts for Assets/Liabilities with different maturity groupings; long term, short term, etc.
But even that approach does not give us all the information.
Let me describe it with another simple example.
Let’s look at the Accounts Receivable of a company. We check how that account evolves every period, and we see that the account balance is growing; what does it mean?
Directly two explanations come to my mind, maybe our sales are growing, or maybe our clients are failing to pay on time.
Just by looking to the General Ledger – Balance Sheet is difficult to say what is really happening, and of course the consequences and measures that we must take are totally different.
For disclosing all those effects we need an enriched structure, a Cash-Flow based accounting system.
But this mail has become too long, so I’ll explain the concept in another post.
Looking forward to know your views.
Regards.
Ferran.
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