Dear,
We saw in the previous post that, as regulators have concerns about the accuracy and auditability of complex Internal Rating and Risk Weighted Assets calculations, they have decided the implementation of a simple Leverage Ratio in the Basel III agreement, for preventing over-leverage.
http://sapbank.blogspot.com/2014/11/the-dog-frisbee-and-sap-bank-analyzer.html
I also commented that a "Not Risk-Weighted” ratio, which does not estimate capital consumption, it is not the best approach for fixing the issues of the Financial System, as the main problem is not only over-leverage, but capital scarcity.
With strong economic growth, an over-leveraged Financial System could be sustainable, without economic growth an over-leveraged Financial System is in serious risk of insolvency.
A common mistake is thinking that capital optimization is a centralized function, which happens in the headquarters of the bank. On the contrary, capital management is spread all over the bank, but we need an integrated system to make it visible.
Rating methods are based on estimating the probability of a counterpart not fulfilling his obligations, and they’re based on the following logic.
1) Analyzing the characteristics that will drive the counterpart behavior, and classify the counterpart in a group or segment, with the same characteristics.
2) Measure the number of default events in the group and determine a statistical pattern.
3) Determine the probability of default of the members of the group, according to the statistical pattern.
But let’s not forget that the validity of any statistical analysis relies in the validity of the collected data, and collecting and processing valid data is more challenging than what it looks like.
Let me give you an example.
Let’s imagine that an account manager decides to capitalize the due amounts and extend the loan term of a customer, this event can represent two different realities.
1) The customer has a growing and successful business and it requires additional capital to finance the growth.
2) The customer is insolvent and can’t fulfill his obligations.
In the first case, the account manager is allocating the bank’s capital efficiently; in the second one he is hiding a default event and wasting the bank’s capital.
In both cases we’ll see exactly the same transaction, capitalization of due amounts and extension of the payment term; the difference is not the transaction but the “Transaction Reason”.
The account manager normally should have the information for deciding if the customer is solvent or not. But still, some questions rise up.
- Are account managers decisions, always driven by capital efficiency?
- If yes, are the banking information systems capable of proving it to the regulatory authorities?
- If not, are the risk models including the statistical bias?
Efficient Capital management requests, that the operational banking system stores the risk analysis of the loan extension, and the argumentation of the decision. And then, transfer this information to the analytical banking system, so it can be reviewed audited and controlled.
I have been implementing SAP systems for 20 years and SAP Banking for the last 9. I don’t see legacy systems capable of providing the integrated vision, necessary for disclosing all the relevant risk information. That’s why regulators have to implement simple, leverage and “not risk-weighted” ratios.
Remember, capital scarcity requires capital efficiency, and capital efficiency requires an integrated and holistic vision of the banking processes.
This post is just an example; we will see others in future posts.
We saw in the previous post that, as regulators have concerns about the accuracy and auditability of complex Internal Rating and Risk Weighted Assets calculations, they have decided the implementation of a simple Leverage Ratio in the Basel III agreement, for preventing over-leverage.
http://sapbank.blogspot.com/2014/11/the-dog-frisbee-and-sap-bank-analyzer.html
I also commented that a "Not Risk-Weighted” ratio, which does not estimate capital consumption, it is not the best approach for fixing the issues of the Financial System, as the main problem is not only over-leverage, but capital scarcity.
With strong economic growth, an over-leveraged Financial System could be sustainable, without economic growth an over-leveraged Financial System is in serious risk of insolvency.
A common mistake is thinking that capital optimization is a centralized function, which happens in the headquarters of the bank. On the contrary, capital management is spread all over the bank, but we need an integrated system to make it visible.
Rating methods are based on estimating the probability of a counterpart not fulfilling his obligations, and they’re based on the following logic.
1) Analyzing the characteristics that will drive the counterpart behavior, and classify the counterpart in a group or segment, with the same characteristics.
2) Measure the number of default events in the group and determine a statistical pattern.
3) Determine the probability of default of the members of the group, according to the statistical pattern.
But let’s not forget that the validity of any statistical analysis relies in the validity of the collected data, and collecting and processing valid data is more challenging than what it looks like.
Let me give you an example.
Let’s imagine that an account manager decides to capitalize the due amounts and extend the loan term of a customer, this event can represent two different realities.
1) The customer has a growing and successful business and it requires additional capital to finance the growth.
2) The customer is insolvent and can’t fulfill his obligations.
In the first case, the account manager is allocating the bank’s capital efficiently; in the second one he is hiding a default event and wasting the bank’s capital.
In both cases we’ll see exactly the same transaction, capitalization of due amounts and extension of the payment term; the difference is not the transaction but the “Transaction Reason”.
The account manager normally should have the information for deciding if the customer is solvent or not. But still, some questions rise up.
- Are account managers decisions, always driven by capital efficiency?
- If yes, are the banking information systems capable of proving it to the regulatory authorities?
- If not, are the risk models including the statistical bias?
Efficient Capital management requests, that the operational banking system stores the risk analysis of the loan extension, and the argumentation of the decision. And then, transfer this information to the analytical banking system, so it can be reviewed audited and controlled.
I have been implementing SAP systems for 20 years and SAP Banking for the last 9. I don’t see legacy systems capable of providing the integrated vision, necessary for disclosing all the relevant risk information. That’s why regulators have to implement simple, leverage and “not risk-weighted” ratios.
Remember, capital scarcity requires capital efficiency, and capital efficiency requires an integrated and holistic vision of the banking processes.
This post is just an example; we will see others in future posts.
Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
Looking forward to read your opinions.
K. Regards,
Ferran.
K. Regards,
Ferran.
