Comprehensive Capital Assessment Review and Bank Analyzer – Chapter II

Dear,

Last week we briefly talked about the Comprehensive Capital Assessment Reviews that FED is running in the US banks, and ECB is running in the European Banks.

We also looked at the Integrated Financial and Risk Architecture of Bank Analyzer and how it can play a very important role in them, as a central repository of the credit risk exposures of a Bank.

http://sapbank.blogspot.com/2014/04/comprehensive-capital-assessment-review.html

As you probably know, the Integrated Financial and Risk Architecture provides an integrated framework to manage the Accounting and Solvency requirements of banks. 

This integrated framework of Accounting and Solvency is not just an elegant architecture, or a nice to have value proposition; it’s the foundation of any holistic capital optimization model. 

The Basel agreement recognizes explicitly the value of this integrated vision; but in general, this not very well known by the implementation partners and consultants, and what is worse, by our potential clients. 

This is an improvement opportunity; if we succeed in translating properly the technical advantages of Bank Analyzer as value propositions for regulatory fulfillment and capital requirements optimization, we’ll increase the chances of Bank Analyzer being chosen in front other competitors. 

Capital Assessment Reviews’ objective is demonstrating that the bank has enough capital to absorb the potential losses, protecting the bank’s depositors and economics stability.  

The Basel agreement determines potential losses of the Bank’s portfolio from the Value at Risk for a certain confidence level. The Value at Risk is divided in two statistical areas, called Expected Losses and Unexpected Losses.

Capital Optimization requires developing an statistically valid, risk management model, capable of reducing the Expected and Unexpected losses of the bank’s portfolio.

Expected Losses must be covered by Accounting Provisions and Unexpected Losses must be covered by capital, determined from the Risk Weighted Assets calculation.

Additionally, the International Financial Reporting Standards specify how banks must calculate their impairment accounting provisions.

And finally, the Basel agreement specifies that any shortfall in the accounting provisions for covering expected losses should be deducted equally from Tier 1 and Tier 2 capital and any excess on the accounting provisions will be eligible for inclusion in Tier 2 capital. 

The Basel agreement is telling us in the above paragraph that there’s a deep link between Accounting provisions and Risk Weighted Assets calculation, in order to determine the Bank’s capital requirements. 

Consequently, developing a complete optimizing model of the bank’s capital requirements requires a holistic accounting and risk management vision, precisely what the Integrated Financial and Risk Architecture of Bank Analyzer proposes. 

Let me end this post with an analogy, efficiency was not a concern for automotive industry while Oil was abundant and cheap. As Oil becomes scarce and prices raise, drivers demand efficient and hybrid cars. Cars manufacturers which have the answer to that market demand are transforming the automotive industry. 

After the financial crisis, fulfilling the regulation and reducing the capital requirements is a priority for banks’ executives. 

SAP has the business value proposition to answer this requirement and transform the industry, and it will do it; we just have to improve the way we communicate this value proposition.

Looking forward to read your opinions.

Kindest Regards.

Ferran.

Comprehensive Capital Assessment Review and Bank Analyzer – Chapter I

Dear,
A former colleague asked me last week if Bank Analyzer would be useful for the current Comprehensive Capital Assessment Review and Stress Tests that US Banks have passed recently.

You can find some information here
http://www.federalreserve.gov/newsevents/press/bcreg/ccar_20140326.pdf

This is, and it’s going to be, a very hot topic for all the Banks, and it’s important we all know the Bank Analyzer capabilities in this area.

Since 2008 Financial Crisis impacted the entire U.S. economy (actually the world’s economy), banks’ capital requirements have been the top’s priority for the regulators

Basel III, Dodd-Frank and EMIR, amongst other regulations, have increased significantly the Capital Requirements of the Financial System players; with the intention, at least theoretical, of preventing another collapse.

Determining the Capital Requirements of a Bank is a quite sensitive matter, low capital requirements incentive banks executives to take risks and increase the short term banks results, and too high capital requirements would reduce available capital to invest, impacting the bank’s results and economic growth.

The main objective on the determination of the Capital Requirements of a Bank is the calculation of its Risk Weighted Assets; remember that the Capital Requirements are defined as a percentage of the Risk Weighted Assets.

Determining the risk weighted assets is a challenging activity; there’re several accepted approaches (standardized, Foundation IRB, Advanced IRB) and the banks also have some flexibility in their implementation.

Determining the Risk Weighted Assets also require determining the Probability of Default and Rating of the counterpart.

And for making it a little bit more complicated; we also have to consider that the rating of a counterpart is a dynamic magnitude, which depends on the economic environment, and how it affects the business segment that the counterpart belongs to.

Determining the evolution of the rating of the counterpart means looking at the future, and as we don’t know the future, we have to create simulated “stressed” scenarios, and estimating the rating of the counterparts on those stressed scenarios.

Bank Analyzer has very powerful tools for calculating the rating of the counterparts on basis and stressed scenarios.

Typically, we have the Historical Database in which we can model the bank’s internal statistic models for estimating the current and future Probability of Default of the counterparts, by classifying them in business segments and looking at the past performance of those business segments.

Building integrated scenarios also requires a holistic vision of the risks and risk hedging strategies of our portfolio, and this is a very important value proposition of SAP Bank Analyzer.

In general, Banks are far from having a centralized and holistic repository of their risk exposures; on the contrary, their information systems have been built as a collection of silo-style systems with very poor, if any, integration.

Typically Banks have several repositories of risk; for retail banking, consumer loans, home loans, corporate banking, derivatives, etc.; all of them sustained by different technologies, with non-consolidated and non-homogenous master and transactional data.

Expecting an accurate determination of the Bank’s Risk Weighted Assets on these conditions requires a big deal of optimism.

On the contrary, Bank Analyzer has been built on the Integrated Financial and Risk Architecture, which is capable of managing holistically, all the Credit Risk Exposures of a Bank, and it’s meant to be capable of managing all the Bank’s risk and its accounting implications.

But I run out of space with this post, I’ll continue next week.

Looking forward to read your opinions.

K. Regards,
Ferran.