SAP Account Origination and Bank Analyzer.

Dear,

We all know that SAP Banking is about integration, and most likely you have seen and read that main advantages of integration are lower Total Cost of Ownership, improved Data Management and Governance, Best Practices in Process Management, etc.

All the above is true and all those facts have made SAP the market leader in Enterprise Management Software for the last 40 years.

On the other hand, an SAP Banking implementation is a huge investment, an investment which is going to determine the strategy of the organization for decades.

If I was the President of a Bank and had to take a decision like this, I would expect to hear stronger, non trivial arguments, which helped me to take the decision.

We’re crossing a systemic crisis which is driving the Financial System from a business model based in volume to a business model based in efficient Capital Management. For taking a strategic decision I expect strategic arguments, if the Financial System is in the middle of a systemic change, I want to know that my decision will position my bank into the new model.

If the answer is Capital Optimization, the question should be what SAP Banking will offer me to drive my Bank towards the new paradigm?

Capital Optimization is not just about Portfolio Management, it’s embedded in the Bank’s business processes, from the Account Origination till the Corporate decisions.

Let me give you an example.

Tracking the consumption of a critical resource is the main priority if we want to optimize it. Does SAP Banking help me to track the Capital Consumption on my Bank?

Capital Consumption does not start with accounting relevant transactions. For instance, the commitment of a Loan does not have any accounting impact (only disbursement has). But a committed, not disbursed loan represents a Free-Line which consumes capital.

A committed, non disbursed Loan starts in the Origination process, and the integration of Account Origination and Bank Analyzer is more than an interface; it’s a seamless integration based in common semantics. With this approach is easier to support bi-directional communications, and sometimes, they can be very useful.

I worked for a client sometime ago in an efficiency and business process analysis; during the assignment, we discovered that the branches did not reduce the free-line of non-fully disbursed loans, even when by contract the client was not allowed to further disbursements.

This means that the free-line did not exist anymore but that was not represented in the Information System. From the Bank’s perspective, that “virtual” free-line meant increasing wrongly the Capital Requirements of the Bank. As the free-line does not have accounting relevance, nobody noticed. Or more exactly, the Bank’s executives knew that it was happening, but they could not measure the impact and correct the problem. This is serious when Capital is the more scarce and critical resource for a Bank nowadays. Giving visibility to this type of shortcomings is what the integrated proposal of SAP Banking is about.

There’re other examples, and I hope we have the chance of discussing about them in the next weeks, but I promised to a friend that I was going to write about SAP Account Origination this week, so here you have it.

By the way, this is what the Fed said this week about Capital Planning.

http://ca.reuters.com/article/businessNews/idCABRE97I0S920130819

Capital Optimization is the answer to this Systemic Crisis, and the closer we're to the crash the more visible will be.

Looking forward to read your opinions.

Kindest Regards,

Ferran.

Implicit Ratings; Uncertainty, Efficiency and Capital Waste.

Dear,
As we discussed last week, we have two main families of assets valuation.
- Historical Value Accounting.
- Fair Value Accounting.

http://sapbank.blogspot.com.es/

The second includes risk and capital consumption, the first doesn’t as there’s no uncertainty in past events.

In a world of limited Capital, estimating risk is a critical activity; incorrect risk estimations will driver wrong valuations and capital waste.

In Corporate Finance we identify three types of Risk (this is just a classification; there’re others).

- Credit Risk.- The Risk that our counterpart don’t fulfill his obligations.
- Market Risk.- The Risk that the value of an asset fluctuates due to market events.
- Operational Risk.- The Risk that of making an operational mistake.

In Credit Risk estimation, we measure the Rating, which is an estimation of the statistical probability that our counterpart is not willing or able of fulfilling his obligations.

Again, we have two methods of estimating the rating.

- We look at the past.
- We look at the future.

We also can ask for an expert opinion (Rating Agency), but whatever methods they use, they will look at the past, at the future or both (mixed methods).

Looking at the past means measuring the past credit events of the counterpart, or other counterparts similar to him (Historization). Looking at the future means “making a bet”.
We’re in the middle of a Systemic Crisis, we’ve enjoyed high growth rates on the last 70 years, but Capital scarcity is making very challenging to keep those rates in the future.

Can we estimate the uncertainty of the future, just by looking at the past events, when we assume that the environment will be radically different?

An alternative is “making a bet” or even better, measuring the bets of many experts. For doing that we can use a Financial Derivative called Credit Default Swap.

Finance Mathematics provide us with a function which determines the value of a CDS according the Rating of its counterpart, the inverse function will determine the Rating according to the value of the CDS. We call it "Implicit Rating".

But the question remains, what is the Value of the CDS?

Let’s assume for a second that Capital Markets are Perfectly Competitive Markets (we know they’re not), under this assumption trade price would be very close (ideally identical) to the value of the asset, and consequently trade price of CDS’s would disclose the Rating of the counterpart.

But we know we’re far from being in a Perfectly Competitive Capital Markets; the real power is concentrated in a small number of Investment Funds, Hedge Funds and Shadow Banking agents. They have the ability of determining the price of the assets and consequently the Rating of the counterparts. On the process, they drive Capital allocation activities, inflating and bursting bubbles according to their interests.

In a world of limited Capital, growing by inflating and bursting bubbles is a big issue. Can we move to the new model if we don’t improve the transparency and efficiency of the Capital Markets?

I don’t think so.

Looking forward to read your opinions.

K. Regards,

Ferran.

Fair Value Accounting, Historical Value Accounting and Bank Analyzer.

Dear,

One of the most sensitive topics in the Capitalist System is the recognition of the Assets Value.

As a difference of many other economic events, payment, debts, terms of payment, interest calculation, etc. Assets Valuation is a controversial matter. The first belong to the group of economic facts, the second are just opinions.

For instance; once defined the Financial Conditions of a Loan, there’s only one result of the Interests Calculation.

But there’s not a unique valuation of the value of a house (or any other asset). We can request expert appraisals, and we’ll get as many valuations as expert opinions.

Assets valuation is a critical activity. In every economic transfer, both agents (buyer and seller) need to make an agreement about the value of the transferred asset, without an agreement on the value of an asset there’s no trade and without trading there’s no modern economy.

By the way, the infamous “Toxic Assets”, responsible of the 2008 Financial Crisis are just the consequence of an abrupt disagreement in the value of some Financial Assets. As the market agents cannot agree in the trade price, the asset becomes illiquid and the market freezes. If the volume of illiquid assets and the disagreement in its value is big enough, they’re capable of triggering a huge financial crisis.

Additionally, assets valuation plays a very significant role in Capital Allocation. If the economic agents expect a revaluation of an asset or family of assets, they will see them as an investment opportunity and capital will be allocated in them. If the expected valuation is not finally translated into real Profits, the investor will have wasted Capital, the most critical resource.

Traditionally, we have worked with two families of Assets Valuation/Accounting methods; Cost Accounting and Fair Value Accounting. The first one looks at the past transactions of the asset, the second looks at the current/future realizable value of the asset.

Obviously, Historical Valuation does not estimate risk, as there’s no uncertainty in past events.

On the other hand, Risk is a very relevant Capital consumer. Historical accounting is easier to implement, but as it does not estimate Risk, it’s not accurate enough in a world of limited Capital.

Fair Value Accounting does estimate risk, but it also requires much more reliable information, confidence, transparency and disclosure; without them Fair Value Accounting is useless.

In my opinion Assets Valuation rules are going to experience a very deep transformation in the oncoming years. IFRS is just one step in the transformation that will get speed with the Systemic Change driven by the current Systemic crisis. Personally I’m an advocate of an Accounting System which looks at the value generation foundation of the Assets, as the fundamental component of the Value recognition.

http://sapbank.blogspot.co.uk/2013/07/collaterals-and-underlines-accounting.html

http://sapbank.blogspot.co.uk/2013/07/collaterals-and-underlines-accounting_27.html

We’re going to see deep changes in the next years; it sounds logic that during the transition period, multiple valuation models are going to be required. Consequently, Accounting Information Systems need to be prepared for supporting parallel accounting models, something that Bank Analyzer is ready to offer.

Looking forward to read your comments.

K. Regards,

Ferran.

Real Estate Rentals Securitization and Bank Analyzer.

Dear,

This week, several Financial Institutions announced that they are offering a new securitization program of Real Estate Rental contracts.

http://online.wsj.com/article/SB10001424127887324170004578638093802889384.html

Securitization is a very promising business for the next years; the Financial System is suffering huge capitalization difficulties, and removing Risk from their Balance Sheets, by securitizing Assets, is an excellent way of improving the Banks’ Capital Ratios.

The market opportunities are abundant, and as the above article shows, include new concepts in securitization.

Last months I've been collaborating with the Architects of TXS, responsible of the development of Funding Management, a critical component of the End to End Securitization and Syndication processes in SAP http://www.txs.de/txs-en.aspx

The outcome of this collaboration is very promising, as offering an End to End Integrated solutions for Securitization in SAP is a very significant competitive advantage (increased visibility, lower Total Cost of Ownership, etc.).

Today, I’d like to share with you how to manage an End to End Securitization process of Real Estate Rental contracts with SAP, just as the example described in the above article.

Managing a Securitization process of Real Estate Renting contracts in SAP is quite natural; let me give you a brief description of the process.

SAP has a great solution for Real Estate renting management, as part of the ECC Financial Accounting components (Real Estate Management & Flexible Real Estate Management). The main object is the Real Estate Contract which contains the conditions for generating the expected cash-flows of the Asset.

Replicating the Real Estate contract as a Financial Transaction of the Bank Analyzer SDL is supported by the Bank Analyzer architecture, either by using the ETL or developing specific services.

The postings (payments, renewals, etc.) in the Renting Contract will have to be transferred as Business Transactions; once we include the other Primary Objects (Business Partners, Collaterals, etc.) will have the complete scenario modeled in Bank Analyzer.

Funding Management 2.0 has also a quite open architecture, and it’s feasible to develop the necessary interfaces with ECC- Real Estate and Bank Analyzer for supporting the payment distribution functionalities (including waterfall processes, provisions generation, etc.) from the Renting Contracts Pool to the Especial Purpose Vehicle.

Finally; Issuing, Trading and managing the Payment obligations of the Securities is very well supported by the Treasury and Risk Management Component of SAP-ECC.

Additionally managing Real Estate contracts is a mature industry for SAP with a very significant market share, those are business facts that should help to position SAP Banking components for securitizing those contracts.

In addition to all the above, there’s a very important concern on the development of the Securitization Industry. As the article highlights, after the Financial Crisis there’s a relevant lack of trust on the transparency of the Securitization Processes. And for offering transparency and control, there’s no better value proposition than the integrated architecture of SAP.

By the way, Securitization will play a very important Role in the new Financial System driven by Efficient Capital Management. But it will a new model of Securitization, we’ll talk about it in a future post.

Once again, Disclosure is the word.

Looking forward to read your opinions.

K. Regards,

Ferran.