From Cyprus to Frankfurt - Chapter 2.

As we discussed last week, 

Just in case Mrs. Lagarde was not clear enough, Mr. Jeroen Dijsselbloem, Dutch Finance Minister, and head of the Eurogroup of euro zone finance ministers has dissipated any possible doubt today. 

"If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'. If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders," 

http://uk.reuters.com/article/2013/03/25/uk-eurogroup-cyprus-dijsselbloem-idUKBRE92O0IL20130325 

We’re entering in a new era of Banking; consolidation, cleaning, efficient Capital Management, disclosure… those are the magic words from now on. 

Changes are always scary, but they also mean opportunities, and if we can prove that SAP Banking can offer the control mechanisms and disclosure functionalities to support efficient management of the Banks Capital, it will be at the right place, in the right time and with the right answer. 

Maybe some of you think that Mr. Dijsselbloem is insane and panic will make everybody remove their savings from the banks and keep them at home. This is not going to happen, we’ll see the reason next week. 

Looking forward to read your opinions. 

K. Regards. 
Ferran.

From Cyprus to Frankfurt.

Dear SAP Banking community members,

As we discussed some weeks ago, effects of Palliative Care are over and turmoil is back in the Financial Markets.

http://sapbank.blogspot.co.uk/2013/02/liquidity-and-palliative-care.html

We could discuss about Cyprus for hours, if it’s right or wrong to force hair-cuts in deposits below 100.000 EUR and their impact in trust.

Trust is a critical asset of the financial system, once is broken there’s no glue which fix it up. If deposits and current accounts, the most liquid asset in a Bank are not safe, preventing panic and a subsequent banking run is very difficult.

And then, what’s happened here; have the leaders of the Troika (Eurozone, IMF and European Central Bank) become insane?

At the same time that Cyprus people were demonstrating in front of their parliament and Cyprus banks, Mrs. Christine Lagarde; Managing Director, International Monetary Fund was given an important speech in the Frankfurt Finance Summit. And without mentioning Cyprus, she gave some hints of what was happening, and more important, what’s going to happen in the future.

http://www.imf.org/external/np/speeches/2013/031913.htm

On her speech, Mrs. Lagarde made clear that the Financial System has huge undercapitalization issues, and fixing them is not a priority, but the priority.

Theoretically, capitalization would improve with economic growth, but economic growth is not here and is not expected soon.

Consequently, there’s only one alternative, we have to reduce debt with write-offs, this is happening in Cyprus and very soon it will happen everywhere.

We could argue why depositors have to pay the bill before junior or senior debt holders; and the reason is Cyprus is a very special case.

Cyprus is one of the main tax heavens in the Eurozone, and 42% of the Deposits in Cyprus banks are over 500.000 Euros.

Tax heavens have been very useful for building the current mega-bubble of debt, but the exit strategy of this crisis is efficient capital management; consequently, from now on bubbles are bad. That’s the second important point of Mrs. Lagarde speech. Hard regulation for everybody; including shadow banking (and tax heavens).

The question is, why charging deposits with a new extraordinary capital tax and not writing-off other assets, like Cyprus debt? There’re two important reasons for that;

First; the main volume of Cyprus banks liabilities are deposits of foreign investors. World’s leaders want to give a lesson that tax heavens are over and this is a good way to do it.

Second; a very important part of Cyprus debt is hold by Greece banks. By solving Cyprus crisis we will worse German’s banks solvency problem. Sorry, my mistake, I meant Greece problem (or maybe not).

Of course we will face risks of panic and bank run in Italy and Spain, but this can be solved by a temporary liquidity injection and, in the worst case scenario, capital controls.

It’s probably unfair, but that’s not the point. The point is it will work; and Mrs. Lagarde knows very well.

Looking forward to read your opinions.

K. Regards.

Understanding Profit Analyzer.

Last Tuesday I was in London visiting a client interested in implementing the Profit Analyzer module of Bank Analyzer.

During the discussion some concerns were raised about the overlapping of the Profit Analyzer module of Bank Analyzer and the Management Accounting modules of SAP-ECC.

For understanding that there’s no such overlapping we must understand first the difference between Facts and Opinions, and the importance of supporting our opinions with strong arguments.

Internal Profits and Costs of a Bank are just opinions; they’re the translation of business events (payments, revenues, obsolescence of assets, etc.) according to the mental model of the Controlling team.

The controlling modules of ECC provide sophisticated tools for calculating internal Costs & Profits of the Bank under different perspectives. There’s no overlapping on using all of them at the same time; on the contrary, the more coherent explanations, coming from different perspectives, we give to support our opinions, the stronger our opinions will be.

For instance, if we implement Cost Center and Profit Center Accounting in a Bank, we’ll get a P&L analysis of the Bank results by responsibility center. On the other hand, if we use Activity Based Costing we’ll be able of analyzing the value provided by cross processes. If we follow the first approach, the second approach or even a combination of both, we’ll get different results in terms of P&L. There will not be a correct or incorrect result, the three of them are both correct and incorrect (again, they’re just opinions).

This does not mean that they are all equally valid; on the contrary; the more detailed our model is (for instance by combining Cost-Center Accounting and Activity Based Costing) the stronger our explanations will be. On the other hand, the stronger our explanations are, the more valid our conclusions will be.

With Profit Analyzer we build an analytical system of internal Profits and Costs of the Financial Transaction (contract level), including Funding Costs, Process Costs, Risk Costs, Capital Costs, etc.

With that information, we will be able of building a Bottom-Up analytical system which offers the P&L of higher organizational structures (branch, strategic business unit, etc.).

Obviously, we also can follow a Top-Down approach on our P&L analytical system; and from the results of our ECC Management Accounting system, and by using Top-Down Distributions we can achieve the P&L of a Financial Transaction.

Again, there will be an overlapping if we use both approaches?

On the contrary, we’ll have stronger arguments to support our opinions; and in times of uncertainty and luck of trust in the Financial System that’s a very important asset.

Looking forward to read your opinions.

K. Regards,

Ferran.

Why do they call it love when they mean sex?

January 25, 2011

Dear SAP Banking community members,

As you know, the Financial System is in a historical moment, the 1998 crash with the Lehman Brothers collapse as the most visible event, has triggered the deepest recession since the Great Depression of 1929.

At the same time, governments all over the world have jumped to the rescue of the main local and international Banks with initiatives like The Emergency Economic Stabilization Act of 2008 in the USA, or the United Kingdom bank rescue package plan, amongst others similar in many countries.

Simplifying, a huge amount of liquidity has been dropped in the system with the hope of stabilizing it and recovering “trust” and economic activity.

But solvency and liquidity are very different concepts. More than two years after the crash, what are the results of the rescue and stimulus plans?

Two Euro-zone countries (Ireland and Greece) have been rescued already and two more (Portugal and Spain) are moving into the dangerous area.

http://ftalphaville.ft.com/blog/2011/01/06/450981/president-trichet-are-you-watching/

The rating levels of US bonds are starting to be under discussion

http://www.cnbc.com/id/40641123

with a direct impact in the long term sustainable growth

http://www.bloomberg.com/news/2011-01-05/pimco-s-gross-says-investors-should-fear-mindless-u-s-deficit-spending.html

And what for me is the most clear indication that the liquidity and rescue packages have delayed the problem but solve nothing, without strong economic activity, oil prices have reached pre-crisis prices.

http://www.bbc.co.uk/news/business-11917152

In my opinion, we’ve transferred the solvency difficulties of the Financial System to the public system, but the lack of trust in the economy remains, and trust is in the foundation of the Capitalist system.

Some economists are warning that those dangers (and others) are nesting “another crisis”.

http://baselinescenario.com/2010/12/30/why-cant-europe-avoid-another-crisis-why-cant-the-u-s/#more-8449http://baselinescenario.com/2010/12/30/why-cant-europe-avoid-another-crisis-why-cant-the-u-s/%23more-8449

In my opinion they’re wrong. It is not another crisis, it is the same.

The only real way of recovering the trust is information, disclosure…

Liquidity as sex can be very pleasant but it does not last, love as solvency can be difficult to achieve but it does.

By the way, a funny film.

http://www.imdb.com/title/tt0105912/

Kindest Regards.

Ferran.

Theory of Constraints and Efficient Capital Management with Bank Analyzer.

Dear community members,

Those who have known me for some years know that in my opinion, the Financial Crisis is just the translation to the Financial System of a Systemic Crisis. The root cause of the Systemic Crisis is the scarcity of resources capable of generating economic growth; Oil, Natural Resources in general, Financial Solvency, etc.

What is the answer to a global scenario of scarcity of critical resources?

Efficient management of those resources, but the question remains, what’s the business model for managing efficiently those resources?

In my opinion the best answer to this this problem was pronounced years ago by the physicist Eliyahu Moshe Goldratt

http://en.wikipedia.org/wiki/Eliyahu_M._Goldratt

In his Theory of Constraints, he described how all the Systems have constraints and bottlenecks. And only by managing the bottlenecks of the System we can maximize its output, minimizing at the same time the resources consumption (in my opinion, this is the most brilliant modelization of the efficiency paradigm).

By assigning resources to a process which is not a critical bottleneck, we will not improve the output, and consequently we will be wasting scarce resources.

Let’s look at the Financial System now. What are the critical resources of any Financial Institution?

1)      Capital.

2)      Liquidity.

Any Financial Institution has to fulfill the regulatory requirements of Capital (percentage of its Risk Weighted Assets) and Liquidity.

Now, let’s look at the bottlenecks.

A Banks portfolio is just the aggregation of many micro-portfolios with homogeneous characteristics (level of risk, same geographical region, type of investment …) in a multidimensional matrix of analytical dimensions that the Bank’s managers use for managing the Bank’s portfolio.

Each micro-portfolio has:

-          A potential return of the Investment.

-          Consumes capital.

-          Consumes or Generates Liquidity

Weighting the Potential Profit of every micro-portfolio by the Capital and Liquidity that the micro-portfolio will consume, will let the Bank’s managers prioritize those micro-portfolios in which the Bank can maximize the Profit minimizing the consumption of Capital and Liquidity.

That’s the answer to the new scenario for the Financial System in which Capital (Solvency) is, and it’s going to be for many years, a very scarce and Critical Resource.

In my opinion, combining the capacity of the Bank Analyzer-Integrated Financial and Risk Architecture and the In-Memory Computing Capabilities of HANA, positions SAP in the best place for building a Capital & Liquidity optimizer like I’ve tried to describe in this post.

In case you have interest, I also gave some ideas about it in another post.

http://blogs.sap.com/banking/2012/02/01/capital-optimization-sap-hana/

Looking forward to read your opinions.

Kindest Regards,

Ferran.