Banking and Trading. Bank Analyzer for Non-Financial Companies - Chapter II

Dear,
Last week I received the feed-back of some readers to the post “Bank Analyzer for Non-Financial Companies - Chapter I.”; thanks for that, I really appreciate.

http://sapbank.blogspot.com/2014/01/bank-analyzer-for-non-financial.html

In their emails, most of them expressed doubts about the incentives for a Non-Financial Company implementing Bank Analyzer.

As I commented in my answers, there’re two reasons for a company, Financial or Non-Financial to implement Bank Analyzer.

- Capital Optimization/Risk Management.

- Regulatory Compliance.

I’ll focus today in the Regulatory Compliance.

It’s true that the regulatory framework for Banks is harder than for non-financial companies, but as you probably know, the new Dodd-Frank regulation on Over-The-Counter derivatives trading also applies to Non-Financial companies. For instance, Oil & Gas companies, in which derivatives’ trading is an intrinsic part of their business, are subject to this regulation.

http://www.ey.com/US/en/Industries/Oil---Gas/Dodd-Frank--what-oil-and-gas-companies-need-to-know

But we’re just at the beginning of the Systemic Change, and regulation will change to drive the economy towards the new Capital efficiency paradigm.

A good example is the US Congress “concern” about the involvement of investment banks, like Goldman Sachs or Morgan Stanley, in the commodity trading, which are posing at risk the stability of the financial system.

http://www.reuters.com/article/2014/01/15/us-commodities-banks-senate-idUSBREA0E07Q20140115

http://www.bloomberg.com/news/2014-01-13/fed-said-to-release-plan-to-limit-banks-commodities-activities.html

http://www.nytimes.com/2014/01/16/business/lawmakers-to-press-for-tighter-rules-on-physical-commodities.html?_r=0

Commodity trading is a core activity of investment banks, limiting their involvement in the commodity trading business means two things.

- Reducing their opportunities to do business.

- Eliminating risky (capital consuming) assets from their balance sheet.

Is this not a symptom of the systemic change of the financial system I’ve been describing you for the last 5 years, from a Business model based in volume to a business model based in efficient Capital management?

Additionally, “Lawmakers are saying that dealing in commodities could create conflicts of interest and lead to market manipulation by deposit-taking institutions”, and this is bad.

And the question is, why this was good 20 years ago, when Glass–Steagall Act, which assured the separation between commercial and investing banking, was repealed?

At the time, we were said that regulation limited the growth potential of the economy. Is it ok limiting the growth potential of the economy today?

You know my opinion, speculation is not good or bad, it’s just the consequence of an economic model based in capital consumption.

http://blogs.sap.com/banking/2011/11/16/the-financial-system-speculators-and-the-recession-dream/

In the old model, wasting capital was not an issue as it was abundant, not anymore.

The legislator is telling us today that in the new model is not convenient that banks are involved in commodity trading, and they prefer this activity to be performed by the natural market agent; Oil, Gas, Mining, Companies, etc.

If so, shouldn't we, as SAP consultants, look at those companies and analyzing integrated scenarios for managing their “banking” business processes?

I’m doing it already and I’ll share my findings with you in future posts, I hope you enjoy them.

Looking forward to read your opinions.
K. Regards,
Ferran.

Bank Analyzer for Non-Financial Companies - Chapter I.

Dear,

When we say that in the new model Capital Optimization is the priority we don’t mean only for Banks, but for all economic activities. Many companies, especially big corporations, are aware of this Systemic Change, and they are developing In-House Banking programs to be aligned with the new paradigm.

We talked about it in a previous post.
http://blogs.sap.com/banking/2012/01/18/in-house-banking-its-not-what-it-looks-like/

Some years ago, SAP released the In-House Cash module, as a component of the Financial Supply Chain Management area.  The solution has many advantages over other competitors, especially in integrated scenarios with other SAP ECC components (Purchasing, Sales, Treasury and Risk, Cash-Management, etc.). 
  
Unfortunately, this is not sufficient for covering the requirements of an In-House Banking solution in the new environment of Capital scarcity. As I mentioned in the post above, in the new model, in-house banking is not only about cash-concentration or wire transfer costs reduction, it’s mainly about capital optimization. 

For instance; two affiliates of the same multinational group can clear their Foreign Exchange exposures by signing Intra-group Forex contracts, reducing their capital consumption due to currency exchange volatility.

Fortunately, with Bank Analyzer, SAP has also developed the best piece of software for Capital Optimization, the question is, how to leverage its advantages in non-financial companies? 

I’ll answer the question with one example of the Oil industry.
Some could think that a confirmed Sales Order of Crude Oil is just a logistics contract, but technically is also a Financial Transaction with the following characteristics.

- Financial Transaction Type: Over-The-Counter Forward Contract.
- Underline: Crude Oil
- Forward Price: Confirmed Sales Price.
- Settlement Type: Physical Delivery.
- Forward Date: Invoice Date.

From a Market Risk perspective, the above forward contract represents an off-balance exposure, and consequently a capital consumption determined by the Value at Risk of the exposure, which depends on the underline price and volatility.

From a Credit Risk perspective, the confirmed sales order represents a Credit Risk exposure which also consumes capital. If the sales order is modelled as a Financial Transaction, the Credit Risk engine of Bank Analyzer can calculate the Credit Equivalent Amount of the Forward Contract. With the CEA and the Rating of the counterpart it will also calculate the Expected Loss, the Loss Given Default and the Capital consumed.
  
The Historical Database of Bank Analyzer and the Credit Risk module of SAP ECC offer powerful functionalities for determining the Rating of the Counterparty according to Internal and External models. We talked about it in previous posts.

http://sapbank.blogspot.co.uk/2013/05/rating-scoring-and-sap-banking-chapter-i.html

http://sapbank.blogspot.com/2013/06/rating-scoring-and-sap-banking-chapter.html

As you can see, representing the logistics process in Bank Analyzer gives the company executives’ visibility of the expected losses and consumed capital due to Financial Risk.

Having visibility of the Capital consumed is the first step of an efficient management of this critical resource; we’ll discuss in detail how to do it in a future post.

Looking forward to read your opinions.
K. Regards,
Ferran.

Bank Analyzer and the Systemic Change.

Dear,

In my opinion, one of the key documents for understanding the current financial crisis is the paper “Has Financial Development Made the World Riskier?”, by the current Governor of the Reserve Bank of India and former Chief Economist at the International Monetary Fund; Mr. Raghuram Rajan.

http://www.nber.org/papers/w11728.pdf?new_window=1

In his paper, Mr. Rajan warned that Bank's executives were encouraged to take risks which could have catastrophic consequences for the financial system.

Mr. Rajan published his paper in 2005 receiving a negative response. Just two years later, his vision was proved to be prophetic, with the explosion of the financial crisis.

Capital consumption is a consequence of Risk, when we determine the Capital consumed by an Investment; it comes from its Counterparty Risk (Risk Weighted Assets) and its Market Risk (Value at Risk).  Saying that bank’s executives are encouraged to take risk, means that the Financial System is oriented to consume capital.

Some of the most critical dangers described by Mr. Rajan’s paper are still present in the current Financial System; some decisions towards a more stringent regulation have been taken, but we’re at the very beginning of the process.

For instance, the current liquidity injections of the Central Banks are feeding the next financial crisis, or more exactly, they are just delaying the systemic consequences of maintaining an exhausted Financial System based in volume and oriented to capital consumption.

Read carefully last June's speech of the General Manager of the Bank for International Settlements, Mr Jaime Caruana; “Making the most of borrowed time”

https://www.bis.org/speeches/sp130623.htm

When the borrowed time is over, we’ll see the real consequences of the current systemic crisis as the Financial System moves from a model based in Volume to a model based in Efficient Capital Management.

The new regulation, Basel III, IFRS, Dodd-Frank, European Market Infrastructure Regulation and others that will come are just the driver of the Systemic Change.

Managing this community for more than 5 years has given me the opportunity of contacting and exchanging opinions with many people; some of them are Bankers, or IT Managers of Banks. In general, they’re concerned by the new regulation and the capacity of their IT infrastructure for providing the regulatory reports.

Some weeks ago, I had the opportunity of discussing about Bank Analyzer with an executive of a medium size Bank which is considering the implementation of Bank Analyzer, or some of its competitors, Oracle, Sunguard, etc.

He asked me a very intriguing, but also interesting question.

Why should my Bank implement Bank Analyzer, when other competitors offer less complex systems that also support IFRS and Basel III?

My answer; Bank Analyzer is complex because is the most complete modelization of the reality, and as the reality is complex, Bank Analyzer has to be complex.

If you believe that the new regulation is just a temporary fashion you will not understand the competitive advantages of Bank Analyzer. But if you think that the Financial System is in the middle of a Systemic Change, you will appreciate an IT infrastructure which can help your Bank in the biggest challenge it has confronted in decades.

Happy 2014 to everybody, it's going to be interesting.

Looking forward to read your opinions.
K. Regards,
Ferran.