Market Risk, Value at Risk and SAP Bank Analyzer.

Dear,

As we commented in previous posts, SAP Bank Analyzer does not have an strong Market Risk engine yet, particularly if we compare Bank Analyzer functionalities with other competitors like Sunguard.

Anyway, SAP Bank Analyzer is being designed with the holistic purpose of measuring and managing the main risks a financial institution is exposed to.

Credit Risk is very well covered with the correspondent Bank Analyzer risk engine, Liquidity Risk is very well covered by Bank Analyzer in combination with the SAP HANA-Liquidity Risk Management solution, and it’s a matter of time that SAP enhances the Strategy Analyzer sub-module of Bank Analyzer for covering the requirements of an strong Market Risk solution.

Strategy Analyzer sub-module of Bank Analyzer supports GAP Analysis and Net Present Value Analysis of the bank’s portfolio, examining the cash-flows at Financial Transaction or Financial Instrument level (contract level).

Strategy Analyzer requires to be provided with alternative, scenario based, market data sets and the contract Financial Conditions of the Financial Transactions and Financial Instruments. With this information, the Source Data Layer cash-flow generator will provide the scenario based cash-flows, and the risk engine calculator will give us the scenario based valuation of the portfolio, according to the correspondent market data set.

The complete modelization of the Financial Position Objects in the Bank Analyzer Results Data Layer supports the alternative scenario-based valuations of the portfolio.

Selecting properly the granularity of the characteristics contained in the Financial Database will guarantee a seamless transformation of the Results Data Layer positions on an analytical risk hierarchy.

All the above can be very useful to banks which have already implemented the Accounting for Financial Instruments module of Bank Analyzer.

After AFI has been fully implemented, enhancing the capabilities of Bank Analyzer for supporting GAP and Net Present Value analysis of the bank’s portfolio requires a relatively low effort.

But as I mentioned before, this is not enough to be considered a best of breed Market Risk technology, and I thought it would be a good idea to look at what functionalities should be included in SAP Bank Analyzer from Market Risk perspective.

GAP Analysis and Net Present Value Analysis represent the foundation of Market Risk Analysis as they told us the expected value and the cost of opportunity of our portfolio, in alternative or even stressed scenarios, but they don’t tell us what’s the statistical probability and the confidence level of the analysis.

In order of including this relevant information on the results of our analysis SAP Bank Analyzer should include an strong Value at Risk calculator, and this is precisely what SAP Bank Analyzer does not have today.

For those of you who are not familiar with the Value at Risk concept, Value at Risk is a statistical technique used to measure and quantify the level of financial risk in an investment portfolio over a specific time frame.

Value at Risk calculation is measured in three dimensions; the amount of potential loss (already provided by Net Present Value and GAP Analysis, but also the probability of that calculated loss, and the time frame in which the Market Risk event should occur.

This information is extremely useful to bank’s executives and risk managers, as it provides an statistical measure of the level of market risk the bank is exposed to, in every portfolio and by all risk hierarchy dimensions.

Additionally, detailed control of the evolution on the value at risk parameters will provide the basis for triggering alerts in case actual valuations are suffering deviations from the expected results, as Basel III agreement requires.

Looking forward to read your opinions.

Kindest Regards,

Ferran

Systemic crisis and capital scarcity. How did we arrive here?

Dear,
Since 2008 Financial Crisis, we decided to believe, conscious or unconsciously, that the crisis was just an accident; the sad consequence of the actions of a bunch of selfish, reckless banks’ executives, who blinded by greed, had converted the Capital Markets in a global casino of Credit Default Swaps, Mortgage Backed Securities and other exotic and incomprehensible financial instruments.
https://www.youtube.com/watch?v=iszwuX1AK6A
We can blame the bankers if that’s going to make us feel better; but if we really want to understand the magnitude of the problem, we need a little bit more than watching a great film.
If this was just a Banking crisis, it could be fixed by reshaping the banking system, but this is a systemic crisis which requires a systemic change. Obviously, in a capitalist model, the Financial System plays a protagonist role. Reshaping the financial System, it is a very important part of the solution, but it can’t be “the solution”.
For understanding this crisis it will help to have a look at the graphs below.
http://en.wikipedia.org/wiki/File:Oil_Prices_1861_2007.svghttp://upload.wikimedia.org/wikipedia/commons/e/e0/Components-of-total-US-debt.jpg
In the first graph, we see the historical evolution of the oil prices; as we can see, since the end of the Second World War till 1970’s decade, Oil prices had been kept relatively stable. And then as a consequence of the USA peak oil production and market cartelization, prices started to rise abruptly.
http://en.wikipedia.org/wiki/1973_oil_crisis
Oil is the most critical natural resource, and main responsible of the amazing period of growth the humanity has enjoyed since the starting of the Second Industrial Revolution.
http://en.wikipedia.org/wiki/Second_Industrial_Revolution
As higher prices of the resource responsible of feeding world’s economic engine made it less affordable, world’s economic growth should have slowed down, but it’s never easy to accept that unemployment rises, poverty increases and tomorrow we’re living worse than today.
Consequently, world’s leaders looked for an alternative source of growth that could maintain the economic engine running.
After some years of crisis, they found the alternative; global debt have been kept stable since the end of the Second World War, and it showed up as the alternative to finance economic growth, that could not be supported by cheap oil prices anymore.
The brilliant idea was replacing cheap oil by solvency, as the main resource to maintain economic growth.
Some constrains had to be eliminated; financial regulation, implemented after the 1930’s Great Depression limited the transformation; consequently a new era of financial deregulation started.
After that, maintaining economic growth by consuming financial solvency was possible. We started the new era of a Financial System driven by volume, starting a new phase of economic growth which was going to last during the following 30 years.
By 2008 financial solvency was consumed and became scarce, triggering the current systemic crisis, which started in the financial system, and spread on the following years, to the whole economy and society.
Six years later, we’re close to learn that we don’t have an alternative resource for maintaining historical rates of economic growth. Once again, our main problem is maintaining economic growth.
http://blogs.sap.com/banking/2011/12/07/its-growth-stupid/
As we’re in a capitalist system, banks are at the center of problem again, becoming protagonists of the transformation. When next November, European Central Bank audits make visible the financial system undercapitalization, we will start the new era of a financial system driven by efficient capital management, with multiple ramifications in the economy and society.
Looking forward to read your opinions.
K. Regards.
Ferran.