Dynamic Collateral Management with SAP Bank Analyzer and the Blockchain.

Dear,

In my opinion, the Blockchain is the most important innovation of the Finance Technology in the last years.

The Blockchain represents to the Internet of Value, what the TCP IP Protocol represented for the Internet of Information 25 years ago.

In the same way that it was difficult to imagine Facebook, Amazon, Skype or Netflix 25 years ago, it's difficult to imagine the services that Blockchain will support in the future.

Today, we know that some services are about to be implemented in the Blockchain, some of the most important ones are:

International Payments.
http://www.ibtimes.co.uk/

Securities Trading.
http://www.wired.com/2015/12/

Both are major achievements in terms of efficiency and transparency, but today I'm going to focus on some implications of the second one.

As we discussed in previous blogs, we're in the middle of a systemic crisis whose main characteristic is Capital Scarcity, as a consequence Capital Optimization will be the priority of the Financial System that will emerge of this crisis.

Capital has many shapes, and one of the most important is collateral, consequently Efficient Management of Collaterals is a critical activity in Capital Optimization.

Securities are one of the most usual forms of collateral, they're liquid assets traded in an organized market which provides them an updated price.

Blockchain provides a revolutionary technology for the efficient trading of securities, as securities trading and ownership are moved to a public, efficient and structured database like the Blockchain, the opportunities of improving the use of these securities in collateral agreements also increase.

Efficient use collateral rights require reduce the Loss Given Default of the exposures by implementing risk mitigation techniques, but avoiding over-collateralization which freezes capital without generating any return.

But balancing collaterals and exposures in order or improving the Risk Adjusted Return on Capital (RAROC) is not an easy task. The Loss Given Default depends on the rating of the counterpart (or his Probability of Default), and the value of the collateral fluctuates every second. Consequently the assignment of Collateral portions of a Collateral Pool to the bank's exposures should be a dynamic activity, that must be adjusted as the market and counterparty situations change.

For instance, as the rating of the counterparty improves, or the collateral value increases, the LGD will be reduced till it achieves a limit (full collateralization) in which better rating or more col lateralization are not improving the Risk Weighted Assets. This collateral excess could be used as a guarantee in another transaction, like a Repurchase Agreement, which will improve the portfolio return, without compromising capital consumption.

On the other hand, if collateral value declines or counterparty rating gets worse, higher portions of the collateral pool will be required for reducing capital consumption.

But the above theory presents practical constrains; in order of facilitating the optimal distribution of collaterals we need some requirements to be covered.

- Accurate calculation of the collateralization levels of the bank's exposures.

- Efficient (including inexpensive transactions) trade of collateral rights.

SAP Bank Analyzer is the answer to the first request, Blockchain is the answer to the second.

With Bank Analyzer we can guarantee an accurate measure of the capital consumed by the bank's portfolio, individually or by portfolios.

Additionally, we can implement alerts in the Analytical Layer of Bank Analyzer Credit Risk Module, informing the Bank's Capital Manager of the exception situations (under or over capitalization) which will trigger his attention in order of taking corrective actions.

But we also need that the transaction costs (including fees, transaction speed and settlement risk) are reduced, because if not, the potential profits of managing dynamically the bank's collateral will be reduced by the transaction costs.

This is exactly what blockchain is offering us, efficient, inexpensive and transparent trading of securities rights.

But securitization and efficient management of collaterals also presents other challenges, we'll talk about them in future blogs.

Join the SAP Banking community at: http://www.linkedin.com/e/gis/92860

Looking forward to read your opinions.

May the Force be with you.

Ferran.

Total Loss Absorbing Capacity and SAP Bank Analyzer.

Dear,
Three weeks ago, the Financial Stability Board issued the final version of the Total Loss-Absorbing Capacity standard for global systemically important banks (G-Sibs).

http://www.financialstabilityboard.org/2015/11/tlac-press-release/

This standard will have a profound impact in the reconfiguration of the Financial System, and in my opinion, the development of the SAP Banking industry.

But what is the Total Loss Absorbing Capacity Standard  (TLAC) standard?

The TLAC standard is an evolution of the Basel III agreement, which establishes the Capital Requirements for 30 banks identified as global systemically important, and considered by the Basel Committee on Banking Supervision as “Too Big to Fail”.

According to the TLAC rule, From 1 January 2019, the Capital requirement  for G-Sibs will be at least 16% of their risk-weighted assets (RWA's), increasing to at least 18% from 1 January 2022.

There's an exception, particularly relevant for Chinese banks, which establishes that emerging market G-SIBs must meet the 16% RWA minimum TLAC requirement no later than 1 January 2025, and the 18% RWA minimum TLAC requirement before 1 January 2028.

Considering that Basel III rules require banks to meet a minimum total capital ratio of 10.5% by 2019, the TLAC rule nearly doubles the Capital requirements for global systemically important banks.

But the current economic environment of limited growth, increasing competition and very low interest rates, supposes a serious handicap for generating profits. Doubling capital requirements in 3-4 years, will force the G-SIBs to raise capital from external sources.

On the other hand, this is also going to have an impact in the non-global systemically important banks, as the market will identify them as less solvent, increasing their cost of capital.

We've discussed here, that the Financial System started in 2008 a systemic change, from a model based in Volume, to a model based in Efficient Capital Management, the TLAC standard is just another milestone in the transformation process.

Recently, we visited a customer for a Bank Analyzer-IFRS 9 (impairment) presentation, and he mentioned that it was difficult to get the necessary budget for the implementation project, because the project was purely regulatory, without a direct impact on the business.

Big mistake, the new regulation, limited economic growth and over-leveraged economy are making capital very scarce.

Capital is the most critical resource of a bank; consequently, capital scarcity is driving the systemic transformation towards capital efficiency, with a very deep impact in the business strategy and processes.

If capital efficiency is the priority, banking information systems must be aligned with the new paradigm, supporting capital optimization activities.

Keep in mind that optimizing a resource starts by measuring accurately this resource and the processes consuming it. The Integrated Financial and Risk Architecture of SAP Bank Analyzer is the answer to the first requirement, and the robustness,  completeness of the data model, and integration between the Transactional and Analytical components of SAP Banking is the answer to the second one.

That's why a Bank Analyzer IFRS (AFI) implementation should be identified as a business driven project. Managing a bank under the new paradigm, means managing the business processes with the objective of optimizing the capital consumption.

Impairment calculations measure the capital consumed due to the Expected Loss of a Credit Portfolio, and consequently, determine the capital available for lending an investing. If we don't understand this, we're not understanding the systemic change.

Join the SAP Banking community at: http://www.linkedin.com/e/gis/92860

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

BCBS 239 Principles and SAP Bank Analyzer.

Dear,
As you all know the starting of the Financial Crisis in 2007-2008 represented an inflexion point in the implementation of a regulatory framework in the Financial System.

A particularly important milestone is the document from the Basel Committee on Banking Supervision: "Principles for effective risk data aggregation and risk reporting".

http://www.bis.org/publ/bcbs239.pdf

The fourteen principles "recommended" by the committee define the architecture that banks have to implement in order of being compliant in the new financial system that is emerging from the Financial Crisis.

This represents a huge endeavor which will attract a very important part of the banks resources, and taking the wrong decision can seriously jeopardize the bank´s future capabilities.

Recently I had a very interesting conversation with a client about the capabilities of SAP Bank Analyzer for fulfilling IFRS 9 and IFRS 15 requirements.

During the conversation; the client mentioned that the current bank´s IT priority is the centralized management of risk data.

Actually, what they had in mind are the 14 principles of the Basel Committee, let´s see how the IFRA of Bank Analyzer is the best answer to them.

Principle 1
Governance – A bank’s risk data aggregation capabilities and risk reporting practices should be subject to strong governance arrangements consistent with other principles and guidance established by the Basel Committee.

SAP Bank Analyzer proposal.
The Financial Database is a centralized and robust repository of the risk data, and properly build, provides the Single Source of Truth for all the bank´s risk data, which is the foundation for strong reporting capabilities.

In a complex landscape of Transactional Systems, only the Source Data Layer of Bank Analyzer provides the Single Source of Truth for the bank´s Master and Transactional Data, which is currently spread in multiple systems with heterogeneous data-models.

Processing this Single Source of Truth data in an homogenous centralized system for calculating the Accounting and Solvency position of the bank is the responsibility of the Bank Analyzer - Process and Methods Layer.

Storing the calculation results in homogenous and consistent repository of metadata is the Results Data Layer main capability.

Finally, reporting this data with very strong analytical and reconciliation capabilities is the value proposition of the Analytical Layer.

Principle 2
Data architecture and IT infrastructure – A bank should design, build and maintain data architecture and IT infrastructure which fully supports its risk data aggregation capabilities and risk reporting practices not only in normal times but also during times of stress or crisis, while still meeting the other Principles.

SAP Bank Analyzer proposal.
Bank Analyzer fully supports the Stress Testing requirements for Solvency and Liquidity established by the Basel agreements. But more than that, the completeness of the data model, opens the gate to implement new risk engines for fulfilling future requirements, without modifying the data architecture.

Principle 3
Accuracy and Integrity – A bank should be able to generate accurate and reliable risk data to meet normal and stress/crisis reporting accuracy requirements. Data should be aggregated on a largely automated basis so as to minimise the probability of errors.

SAP Bank Analyzer proposal.
The Bank Analyzer architecture offers strong Extract and Transformation capabilities and a complete template of Primary Objects which will assure data accuracy, assuming of course  that the implementation team has the capacity and willingness to follow the SAP´s implementation best practices.

This is just an introduction. It´s very difficult to express in just one post the implications all these principles, but we will discuss this topic again 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.

Optimizing Capital in Oil and Gas companies with SAP APO and Bank Analyzer - Chapter II.

Dear,

In the last blog we discussed how Capital Scarcity can hit very hard to Oil companies which are not ready to the challenges of this new scenario.

https://www.linkedin.com/pulse/optimizing-capital-oil-gas-companies-sap-apo-bank-analyzer-frances?trk=mp-reader-card

Today, we´ll look at some alternatives to improve the efficient management of Capital in Oil companies by combining the functionalities of SAP APO and SAP Bank Analyzer.

Some of the required functionalities are not available yet; current Bank Analyzer versions don´t have strong Market Risk Analyzers, including Value at Risk calculations. But these functionalities have been offered for years in SEM Banking (considered by many the precursor of Bank Analyzer), and in my opinion, it´s a matter of time that they´re included in Bank Analyzer.

Going back to the point, we saw in the previous blog that an Oil company with a very efficient Supply Chain can still face Capital tensions ending in bankruptcy due to the Oil Market Risk. 

What can we do for improving the business plan including this risk?

First thing we must understand is that a Production Order or a Storage Unit of a Volatile product, like Oil, can be represented in Finance by a Financial Transaction (or Financial Instrument), whose underline is the Volatile product (Oil).  With this integration, a potential Market Risk Analyzer engine of Bank Analyzer would be able of giving us the Expected Losses due to the Value at Risk of the Underline.

On the other hand, the company can hedge the potential Market Risk losses by selling the Oil to a customer. But then it will be exposed to potential losses due to Counterparty Risk. 

Again, representing the Sales Order Items as Financial Transactions in Bank Analyzer, and providing the Rating of the Business Partner to the Credit Risk Engine, the system will give us the Expected Losses of the Financial Transaction (including the Expected Loss at committing with a Sales Order, by using Credit Conversion Factors).

By calculating the consumed Capital due to Market Risk Volatility and Credit Risk of the Exposures, Bank Analyzer will give us the Free Capital of the Company in every planning cycle.

As Free Capital is a measure of the Market and Credit Risks that the company can tolerate without suffering Solvency tensions, it´s actually determining a bottleneck in the amount of Oil that the company can extract, refine, store, distribute and sell.

Bottlenecks of the Supply Chain are represented in SAP APO by Resources and Capacities; and the Supply Network Planner will generate Planned and Production Orders only if the company has available capacity.

Making an analogy, in the same way that the Oil Company will not extract more Oil than its refining capacity, the company should not extract more Oil than the amount of Volatility that it can support without becoming insolvent. And in case the Oil can be sold immediately, hedging the Market Risk Volatility, it shouldn´t extract more oil than the amount whose Credit Risk Expected Loss is higher than the Company´s free Capital.

The standard APO element for modeling this "Free Capital-Capacity", would be an APO-Supply Network Planning bucket Resource.

Nevertheless, the available and consumed Capacity in this resource will be provided by an external engine, the Free Capital Calculator of Bank Analyzer.

Simplifying, in case Volatility and Counterparty Risk is low, Bank Analyzer will represent the situation with available Capacity in the bucket resource. On the contrary when Volatility and Credit Risk are high, Bank Analyzer will communicate less available Capacity to the bucket Resource.

The company has also to look Capital Consumed by its Market Demand on the Long Term Demand Planning activities, we´ll see how to model it in a future post.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

Looking forward to read your opinions.

K. Regards,

Ferran.

Optimizing Capital in Oil and Gas companies with SAP APO and Bank Analyzer - Chapter I.

Dear,

The current financial and economic crisis has many manifestations; capital markets volatility, unemployment, social unrest...

They all are effects of the crisis but none of them is the cause of the crisis; as this crisis represents the exhaustion of an economic model, based on growing as much as possible, without considering the capital consumed in the process.

Today Capital has become scarce, making capital optimization the main priority.

Volatility of the commodities price is an interesting example; we've been said that Oil price is falling as a consequence of the Shale Oil revolution. But if we look at the price of other commodities like Gold, Platinum, Silver or Palladium we'll see that their prices have also fallen dramatically in the last moths.

Capital consumed in the commodities production and trading, manifests itself as Value at Risk, or in other words with the Volatility of the commodities price.

Today, many commodities traders, Oil, Gas and Mining companies are suffering financial difficulties and stopping strategic plans, as a consequence of the losses (capital consumed) they had in the last months.

According to the Wood Mackenzie consultancy group, $200 billion of investment have been delayed as a consequence of the drop in oil prices.

http://www.bloomberg.com/news/articles/2015-07-27/oil-majors-delay-200-billion-of-spending-wood-mackenzie-says

Has anybody thought how much capital has been wasted as a consequence of that?

Executives of those companies must learn the lesson, and take decisions putting Capital Optimization at the center of the strategic and tactical plans.

Some weeks ago, we discussed how to optimize the capital consumed in investment activities with SAP Bank Analyzer.

https://www.linkedin.com/pulse/capital-optimization-investment-activities-sap-bank-frances-gil?trk=mp-reader-card

In a future post, we'll see how to integrate Capital Optimization in the analysis of strategic decisions.

But today we'll look at the impact of inefficient capital management in the tactical planning of an Oil and Gas company.

Let's look at a simplified representation of the Supply Chain of an Oil company; extraction, refinement and distribution. Every step of the value chain represents a potential bottleneck, with a critical resource that needs to be managed in order of managing efficiently the Value Chain.

For instance, it would be inefficient extracting more Oil than the company's refinement capability. In the same way it would be inefficient refining more Oil than what the company can store or distribute.

Efficient management of the Supply Chain requires a holistic optimization of all the logistic resources, looking at all the bottlenecks of the Supply Chain.

But the recent crisis has made clear that this approach is incomplete, as it optimizes the logistic resources but it does not look at other bottlenecks which are critical in the new economic model.

If we look at the balance sheet of an Oil company we'll see that an important part of its Assets are the inventory of Oil stored, refined and distributed.

And remember that Volatility on the price of Oil increases the capital consumed due to Value at Risk, reducing the company solvency.

The higher the assets price volatility, the higher the capital consumed.

The company can hedge the market risk of the Oil price volatility by selling the Oil. Every Sales Order Item represents a Forward Contract, hedging the risk of the Oil price volatility; and at the same time, it also represents a Credit Risk exposure, that consumes the company’s capital.

Finally, if a company consumes more capital than it has, it becomes insolvent, very risky situation that many Oil companies are facing today.

Consequently we have to include Financial Capital in the Optimization of the Supply Chain, we'll see how to do it in the next post.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

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

Get Ready for IFRS requirements in Telecommunications Companies with SAP Bank Analyzer.

Dear,
A common mistake is assuming that Bank Analyzer functionalities are only applicable to banks.

Bank Analyzer is basically a Capital Optimization engine, and this functionalities are applicable to any business or industry, as they're all facing the challenges of the new environment of Capital Scarcity.

Maybe the confusion comes from the name; Bank Analyzer implies that its functionalities are limited to banks, when this is not the case.

In fact, you probably know that some years ago SAP released the Insurance Analyzer system, which is basically a Bank Analyzer system enhanced with some templates addressed to model Insurance Products.

http://help.sap.com/insurance-fsia/

In a future post we'll talk about Insurance Analyzer, but today we'll look at other potential markets for Bank Analyzer that have not received proper attention by Sales and Marketing teams.

IFRS 9 requires financial assets belonging to the business model, whose objective is to collect contractual cash flows, containing expected payments of principal and interest, to be measured at amortized cost.

We all know that Loans fall in this classification (by the way, that's why we're implementing Bank Analyzer-AFI) but Receivables also fall in the same classification with the same requirements.

We also can look at the materiality of the differences between purely Nominal Accounting and Amortized Cost measurements, and that would help us to identify potential candidates for implementing Bank Analyzer in non-purely financial business.

In my opinion, a particularly interesting example are Telecommunications companies. If we look at their balance sheet structures, we'll see that the Accounts Receivable is a very significant part of their Assets, which makes them an interesting target for implementing accurate Accounting Systems, capable of fulfilling Amortized Cost measurements.

Another reason which makes this target interesting is purely technical. Many telecommunications companies use SAP Billing and Revenue Management for Telecommunications, integrated with SAP Contract Accounts Receivables and Payables (FICA).

SAP FICA is an excellent tool for the management of Accounts Receivables, including sub-ledger functionalities, but limited to Nominal Accounting Principles, and insufficient for managing the new regulatory requirements in Revenue Recognition.

For the moment, most of the Telecommunications companies are fulfilling their IFRS requirements, with Business Segment based adjustments of their Accounts Receivable values on the General Ledger.

We're going to see that this is not a good approach in the middle-term

The International Accounting Standards Board is already working in IFRS 15 which is increasing significantly the disclosure requirements on Revenue recognition, from Contracts with Customers

http://www.ifrs.org/current-projects/iasb-projects/revenue-recognition/Pages/Revenue-Recognition.aspx

Fulfilling these requirements will require the use of a Financial Sub-ledger, capable of managing contract-based, amortized cost valuations; one of the basic functionalities of SAP Bank Analyzer.

Taking advantage of the Bank Analyzer functionalities, by Telecommunications Companies using SAP Billing processes, will require the integration of the FICA base Accounts Receivables Contracts, Business Partners and FICA Business Transactions, with the Bank Analyzer Source Data Layer - Primary Objects.

Once the Accounts Receivable Contracts have been properly integrated as Financial Transaction in the Bank Analyzer SDL, there're no limitations in the use of the Bank Analyzer Risk Engines for fulfilling the company accounting requirements and new disclosure regulations.

We've worked recently in a Proof of Concept of this integration and we'll give you more details of it in a future post.

Looking forward to read your opinions.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

K. Regards,
Ferran.

Old and New Banking. Accumulating Capital vs. Making Capital flow.

Dear,

The main characteristic of the new Financial System is Capital efficiency.

Over-leveraged Financial System and Limited growth make Capital scarce. Additionally, regulators are aware that an over-leveraged Financial System becomes insolvent with limited growth, consequently they increase capital requirements making Free Capital even scarcer.

At the same time technology is making possible new business models that compete with the traditional Financial System with dramatic reductions of the capital consumed.

In the old financial system, accumulating capital was a prerequisite before the capital could be invested or allocated. Regulation forces banks to collect the necessary capital for covering its potential losses, due to its exposure to Credit Risk (Risk Weighted Assets) or Market Risk (Value at Risk).

The more risk the bank is exposed to, the higher its capital requirements become.

Banks issue capital, debt, hybrid securities and deposits for covering their capital and liquidity requirements, these requirements must be covered before they can lend funds to their borrowers, otherwise they will face solvency issues, liquidity tensions and fines.

On the other hand, technology is making possible new models of financial services capable of operate without limiting capital requirements.

I'll explain it with an example from Foreign Exchange services.

Imagine that you’re a EU vendor dealing with a US customer, you must be ready to be paid in USD.

But as you don´t want to take the risk of suffering losses due to USD/EUR currency exchange fluctuations, you will hedge your risk signing a Forex Forward contract with your bank, paying a fee for transferring the risk to it.

As the bank will be exposed to Foreign Exchange Market Risk and potential losses, the bank needs to have Free Capital available in order of offering the service.

Consequently, the bank has to accumulate capital, for covering its potential losses, before it offers the service.

But in the last years we’ve seen new and more efficient alternatives for offering FOREX services in a Peer to Peer model.

https://transferwise.com/

http://kantox.com/en

These companies convert funds to foreign currency, for instance from EUR to USD, with requirements of other customers in the other direction (USD to EUR).

The foreign exposures are assumed by the counter-parties; the P2P platform only connects them and intermediates in the payments, “notarizing” the transaction.

The P2P platforms don´t assume any foreign exchange risk; neither require capital to cover it. Consequently, they can offer their services at a much lower price than traditional banking.

In fact, increasing capital requirements and scarcity are also increasing their competitive advantage.

You can find a more detailed explanation of the P2P model in the following post I wrote three years ago.

http://blogs.sap.com/banking/2011/12/21/new-models-capital-optimization-kantox/

Another example is P2P Lending; in traditional lending, the bank has to accumulate capital for covering its capital requirements, derived from the credit risk that the bank is exposed since the moment it commits to lend funds to a borrower.

But in P2P lending, the platforms connect people (or companies) requiring funds with investors willing to lend them. Again, the P2P platforms don´t have to accumulate capital before starting the process, because they do not assume the credit and market risk. As a consequence, they can offer their services with more competitive fees to the borrowers and investors.

https://www.prosper.com/

And this is just the beginning, new models of disintermediation are going to be more common and efficient with the disruptive technologies supporting bitcoin, blockchain or ethereum.

We’ll talk about them in future posts.

Looking forward to read your opinions.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

K. Regards,
Ferran.

Determining Free Capital with SAP Bank Analyzer.

Dear,
Last month I was invited to a conference for speaking about Capital Optimization, and a common concern was how to implement quickly a Capital Optimization system.

Unfortunately there're no magic potions or shortcuts when it comes to implementing Capital Optimization systems.

Capital Optimization is a logical process, but the implementation of an accurate Capital Management system, is one of the most complex activities that a bank can face today.

Anyway, the Financial Crisis (systemic change) is also making it the most critical one, so it is going to happen, whatever it takes.

If you want to implement a Capital Optimization system, you need to start by building an Information System which provides an accurate measure of the Capital Consumed by business process and market segment, under base and stressed scenarios, as a consequence you will obtain an accurate determination of the Bank´s Free Capital.

In my opinion, SAP Bank Analyzer provides the best technological infrastructure for achieving accurate estimations of the Capital consumed by business process, market segment or micro-portfolio.

Determining Free Capital requires managing holistically information from different sources; information which bank´s are processing today in isolated, silo-style systems, with very limited integration.

Capital is consumed mainly by Impairment Provisions, Portfolio Depreciations, Risk Weighted Assets, Value At Risk of the bank's portfolio, Capital Requirements due to Operational and Conduct Risk, and in more sophisticated models, Capital Costs associated with physical assets, support business process, etc.

SAP Bank Analyzer provides Risk Engines for accurate calculations of the Capital Consumed by the bank´s Risk Weighted Assets, Impairment Provisions and Portfolio Valuations, and more than that, provides a holistic integration of the calculations results in an homogenous metadata-base (Financial Database-Results Data Layer).

This is interesting because, Risk Provisions and Portfolio Valuations are purely accounting data while Capital consumed by the Risk Weighted Assets is solvency related data.

The Financial Database-Results Data Layer has been built as a flexible hierarchy, which permits storing data coming from different origins (Accounting and Solvency), in an integrated framework of common characteristics (Results Data Area); fulfilling the specific technical requirements of the different data, with alternative Result Types and Categories.

Current versions of Bank Analyzer don´t offer Risk Engines for determining the capital consumed by Value At Risk, Operational Risk and Conduct Risk. But they can be calculated with other systems (some of them are also offered by SAP) and, taking advantage of the Open Architecture of the Bank Analyzer-IFRA, being integrated into the Financial Data Base model, facilitating and accurate measure of the bank´s capital consumption.

Finally, we said that Capital Consumption and Free Capital Determination models should include the impact of physical assets and support activities. This is probably one of the main competitive advantages of the SAP Banking business suite.

SAP has more than 30 years of experience providing best of breed Management Accounting solutions (Cost Center Accounting, Cost and Investment Orders, Activity Based Costing, etc.) for determining costs associated to support business processes and physical assets.
Integrating those Cost Models into the Results Data Layer with CVMP processes is perfectly feasible, including all the necessary components for an accurate determination of the bank´s Capital Consumption and Free Capital.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

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

Managing Conduct Risk with SAP Bank Analyzer.

Dear,

Last years, many scandals have come to light in the Financial Industry; scandals like Libor and Forex manipulations, Tax Evasion practices, etc. 

Coinciding with the imposition of fines to some of the biggest and most powerful banks for these compliance violations, we’ve seen a new concept called Conduct Risk, showing up in banking publications, speeches and forums. But what’s exactly the “Conduct Risk”?

We still don't have a regulatory definition of what’s Conduct Risk, but several approximations to the concept have been proposed by regulators in different jurisdictions.

Personally,  I like the description proposed by Daniel K. Tarullo, member of the Board of Governors of the Federal Reserve Board and chairman of the Federal Financial Institutions Examination Council. In his speech "Reforming Culture and Behavior in the Financial Services Industry" of October last year. He described it as the risk of malfunctioning controls and operations due to unethical practices. 

http://www.federalreserve.gov/newsevents/speech/tarullo20141020a.htm  

The Basel Committee on Banking Supervision is already aware of the necessity of building a regulatory framework addressed to Conduct Risk and recently issued the consultative document "Corporate governance principles for banks".

http://www.bis.org/publ/bcbs294.htm

Before that, on 2013, the British Financial Conduct Authority provided a very interesting guide for a company to asses Conduct Risk.

https://www.fca.org.uk/static/fca/documents/fca-risk-outlook-2013.pdf

Banks are responsible of building systems preventing Conduct Risk and unethical behavior. Considering that settlement costs of unethical related activities in recent years are more than 21.000 Million Euros, it looks like an interesting opportunity.

The broad scope of Conduct Risk makes difficult to describe a holistic architecture for managing it; from cases of banks being fined for selling products considered too complex for the risk profile of some of their customers; to banks receiving fines for money laundry or supporting tax evasion.

In my opinion, there’s no better candidate to fulfill the requirement than the Integrated Financial and Risk Architecture of Bank Analyzer. Let me explain you why.

In the same way banks are moving from silo-style to centralized holistic systems for the management of Credit, Market or Liquidity risk, the same rule applies for defining the architecture of a Conduct Risk System.

A holistic management of Conduct Risk requires an integrated vision of economic Facts and the interpretation of those Facts, and this is in the core values of the Integrated Financial and Risk Architecture of Bank Analyzer.

The Source Data Layer is a centralized container of Facts, mirroring economic events happening in the Transactional Banking System. But the Source Data Layer also requires that economic Facts have been homogenized in a single Data Model which makes feasible to track those economic Facts amongst individual processes.

For instance; while is a common issue that banks can have several operational systems with different versions of their account holders ratings, in Bank Analyzer we enjoy a unified vision of the Business Partner and all his attributes.

How can the bank claim that it has run a proper analysis of the Risk Profile of its customers if it’s unable of storing a Single Truth of their Rating?

We don’t have a Conduct Risk Analyzer in Bank Analyzer yet, but we can take advantage of the Open Architecture of the Integrated Financial and Risk Architecture for connecting with other systems fulfilling the specific functions.

For instance, many banks are building Anti-Money-Laundering systems tracking suspicious transactions in their silo-style, poorly integrated network of transactional systems. 

As we have all the Business Transactions in the Bank Analyzer Source Data Layer, it would be much more efficient to track suspicious Business Transactions in the centralized and homogenous repository that the Source Data Layer represents.

I’ve seen many customers thinking that Bank Analyzer is just a Sub-Ledger (Accounting System); this is a limited understanding of the Integrated Financial and Risk Architecture whose capabilities go far beyond that.

But this post has become too long; we’ll come back to this topic in a future one.

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

Join the SAP Banking community at: http://www.linkedin.com/e/gis/92860

Efficient Management of Real Estate contracts with SAP Bank Analyzer.

Dear,
Managing Real Estate Properties has become an important activity for banks all over the world.

Since the burst of the US Real Estate bubble on 2007 and later in other countries, banks have covered their potential losses taking ownership of the Real Estate Collaterals of their failed Mortgage Loans.

Some of those Real Estate properties are activated by being rented to the market, becoming Financial Assets whose value must be determined according to the regulations of the International Financial Reporting Standards.

On May 2001, the International Accounting Standards Board (IASB) issued IFRS 13 (Fair Value measurement), as a single source of guidance for measuring the fair value of Financial Assets, including Real Estate Lease Out contracts.

http://www.ifrs.org/Documents/FairValueMeasurementFeedbackstatement_May2011.pdf

http://www.ifrs.org/Current-Projects/IASB-Projects/Fair-Value-Measurement/Pages/Fair-Value-Measurement.aspx

http://www.iasplus.com/en/standards/ifrs/ifrs13

According to IFRS 13, there are generally three approaches that can be used to derive fair value: the market approach, the income approach and the cost approach. To measure fair value, management should use valuation techniques consistent with one or more of these approaches.

Real estate assets are often unique and not traded on a regular basis, producing lack of observable input data for identical assets. For that reason, the income approach is the preferred method for real estate fair value measurement. Consequently, fair value measurements of real estate assets will require the following inputs.

- Cash flow forecast using the entity’s own data
- Yields based on the management estimation
- Yield adjustments based on management’s assumptions about uncertainty/risk
- Assumptions about future development of parameters (for example, vacancy, rent) that are not derived from the market

The Flexible Real Estate module of SAP Enterprise Core Components provides strong functionalities for the management of Real Estate Assets, including Cash-flow generation from the financial conditions of the Lease Out contracts, which can be the foundation for the cash-flow forecast required by IFRS 13.

On the other hand, Flexible Real Estate lacks on strong functionalities for Yields determination and adjustments based on potential counterparty or market events (Counterparty and Market Risk).

Fortunately, we have the option of taking advantage of the SAP Bank Analyzer capabilities for the generation and management of the required inputs and the subsequent valuation of the Lease Out Contracts according to the income approach, or what is the same, the discounted cash-flows valuation technique.

For doing that we need to follow some basic requirements for the integration of the Lease Out contracts on the Financial Database of SAP Bank Analyzer.

The first activity is modeling the Lease Out contracts as Financial Transactions on the Bank Analyzer Source Data Layer by creating a specific template.

Once the Financial Transactions are created in the Source Data Layer, we can transfer the cash-flows generated in SAP Flexible Real Estate module to the Bank Analyzer-Source Data Layer. Alternatively, we can transfer the Lease Out contract Financial Conditions and reproduce the cash-flows generation in the Bank Analyzer SDL.

For the transfer we can use SAP Services or the Extract and Transformation Layer of Bank Analyzer. Since release 8.0 Bank Analyzer has very powerful functionalities for transferring Financial Assets with SAP Services, and in my opinion is also the best option for integrating Real Estate contracts.

Additionally, we’ll have to create new Business Transaction classes and Types, and the correspondent Items, for modeling in the Source Data Layer the accounting events posted on the Lease Out contract.

Finally we’ll have to adjust the calculation procedures of the Processes and Methods Layer for supporting the new Business Transaction Types.

Planned and Actual Maintenance costs of the Real Estate properties are managed by the Plants Maintenance module of SAP ECC, and transferred to Bank Analyzer as expected and actual cash-flows, for generating the correspondent accounting entries in the Lease Out contract sub-ledger.

In conclusion, combining Flexible Real Estate and Bank Analyzer, SAP provides a holistic solution for the management of Real Estate contracts, according to the most recent regulation of the International Accounting Standard Board.

Join the SAP Banking community at: http://www.linkedin.com/e/gis/92860

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

Omnichannel Architecture and SAP Bank Analyzer.

Dear,
The Digital Banking revolution is transforming the way in which customers interact with banks. Smart-phones, Computers, Phone Banking, Branches or even Social Networks offer multiple communication channels and bring the opportunity for a deeper relationship between the bank and their customers.

On the other hand, obsolete processes and legacy systems are far from being ready to be aligned with the new paradigm. Many, if not most, of the banks are incapable of managing holistically all their interaction channels.

For instance, different channels have different response times, presenting contradictory experiences and generating a distorted image of the bank to the customer and vice-versa.

The response to this challenge is the convergence of physical and virtual channels, putting the customer at the centre; this approach is normally called Omnichannel Architecture.

Personally, I don’t think the name Omnichannel is a fortunate one, digital banking is not only a technical revolution but also a social one. The context of the interaction is as important as the channel through which is happening.

For instance, when we access to a banking service in Facebook, what’s the interaction channel, Internet, PC, Smartphone, Tablet or Facebook?

On the other hand, the context of banking interaction in Facebook is potentially very different to a traditional Online Banking interaction, and they can be both Internet based.

What’s most relevant in this case, the context in which the transaction is requested and fulfilled, the channel in which the interaction occurred, or both analytical dimensions must be analyzed?

Determining the analytical dimensions of the bank’s portfolio will define the analytical business segments, and this is the most critical activity in a Bank Analyzer implementation.

Managing a bank requires analyzing the business segments in which the bank is investing and finding an answer to some important questions.

For instance:

- Expected return weighted by capital consumed in the business segment.

- Liquidity generation and consumption by business segment.

- Value at Risk by business segment.

Digital banking requires defining the business segments according to a multidimensional matrix of customer types, ratings, syndication agreements, origination channels, transaction contexts, etc.

Traditionally; business segments performance has been measured by a combination of manual calculations, spreadsheets and silo based reporting systems, with very limited integration with the accounting and capital management systems.

SAP Bank Analyzer – Integrated Financial and Risk Architecture offers a solution to the above issue with multidimensional capital management and performance measurement tools, fully reconcilable with the Accounting Systems.

There’re some rules to be followed in the definition of the Business segments

-Dimensions should cover, without overlapping, any present or future opportunity for capital allocation.

-Key Figures must be capable of representing, without overlapping, all the necessary performing indicators (fees, costs, capital, short-term receivables, etc.)

Suboptimal definitions of the business segments and performing indicators will limit the future system capabilities. And once the system has been initialized is challenging to modify the structure of the Financial Database, especially for generating historical data according to the new structure, so you better do it right at the first shot.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

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

Asset backed crypto-currencies and derivatives in the blockchain.

Dear,

Two weeks ago we looked at the opportunity that Bitcoin (the most popular crypto-currency) represents for efficient management of payments .

https://www.linkedin.com/pulse/bitcoin-sap-banking-ferran-frances?trk=hp-feed-article-title

But, we know that Bitcoin is a very volatile currency which makes it unsuitable for offering other Financial Services like Loans or Deposits.

If you take a loan in Bitcoins, the Forex volatility of the Bitcoin can increase your debt or reduce your deposit value very quickly; for that reason, even merchants using Bitcoin, try to convert their Bitcoins to local currencies like USD or EUR, just after receiving their payments.

Investing and lending is a substantial component of the Financial System, and we’ll not be able of building a robust Financial System supported by crypto-currencies, till we don’t fix the volatility issue.

Additionally, volatility in the value of assets and liabilities, included crypto-currencies, increases the Value at Risk of the exposures, with its correspondent capital consumption, and this is a big issue in times of capital scarcity.

In order of tackling the crypto-currencies volatility issue, the next evolution in the world of the crypto-currencies are the "asset backed crypto-currencies".

And remember, what’s important about the crypto-currencies is not the currency itself, but the technology which makes them possible; “The Blockchain”.

Asset backed crypto-currencies are derivative contracts (forward contracts) posted and managed in the blockchain. The underline of those derivative contracts is a commonly traded asset, like Gold, US dollars, Euros or Chinese Yuan Renminbis, which gives transparency to the value of the asset backed crypto-currency and reduces its volatility.

In fact, as in any other forward contract, the value of the asset backed crypto-currency matches the value of its underline (spot price) at maturity date, building the mechanism for reducing the crypto-currency volatility value.

The underline of the derivative can be physical, but this is not necessary, as the asset backed crypto-currencies can also be built as synthetic derivatives with cash settlement, mitigating the counterparty risk by introducing higher collateral requirements.

Derivatives trade is one of the biggest opportunities for Blockchain based startups; the volume of the Over-The-Counter derivatives market is around $700 trillion negotiating in a very expensive and inefficient market, which has become even more expensive with the introduction of the new regulatory framework (Dodd-Frank in the US and
EMIR in Europe) and their increasing capital requirements.

The dominance of big banks in derivatives trade has been already threatened by new startups like trueEX, which three years after receiving authorization from the U.S. Commodity Futures Trading Commission, manages around 20% of the Interest Rate Swaps market in the U.S

https://www.trueex.com/about-us

But these startups are still subject to the ruling of the clearinghouses network.

What will be the impact of replacing them with a much more transparent and efficient network, like the blockchain?

Think about it, the financial system, as we know it, is being threatened by three major forces.

- Over-leverage and capital scarcity.

- More stringent regulation.

- A technology revolution introducing more efficient and dynamic players.

Do you think that obsolete banking technology and processes are going to survive to this revolution?

Traditional banks have to reshape, implementing best practices, and integrated systems capable of providing capital efficiency and supporting the technology revolution.

We’re working already on the integration of new technologies like blockchain in standard SAP processes; I’ll describe some of them in future posts.

Looking forward to read your opinions.

K. Regards,

Ferran.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

Collateral Optimization with SAP Bank Analyzer.

Dear,

New regulation requesting central clearing of derivatives contracts and higher capital requirements, limited economic growth, and an overleveraged financial system are putting much pressure in collaterals management departments of financial institutions, for providing an efficient management of their instruments.

Unfortunately, collateral optimization is a discipline limitedly known for most of bank’s collateral managers.

Collateral optimization function has two main dimensions.

• Transactional management of the collateral rights.

• Utilization and distribution of the collateral rights.

In a future post we’ll look at the first dimension, but today we’ll focus in the efficient utilization and distribution of collateral rights.

The collateralization problem requires the allocation of a heterogeneous set of collateral pools to a number of assets with different values, maturities and risks estimations.

Solving the collateral optimization problem requires finding the optimal distribution of the collateral portions to the assets, which minimizes the bank’s capital requirements.

I’m sure you’re aware that in a real life example; solving the problem requires, evaluating a huge number of different combinations, of assets and collateral portions.

Traditionally, the process of allocating collateral portions against assets has been performed as a manual function. In this approach, collateral managers, choose the most suitable collateral portion, as collateral requirements are identified. They perform the function by trying to reduce maturity mismatches, estimating potential haircuts, etc. 

Once the link has been established, it will not be dissolved till the collateral requirement disappears or the collateralization agreement expires.

While this could be considered an optimal allocation of the collateral rights in times of capital abundance, it’s far from being optimal in scenarios of capital scarcity.

The optimal solution requires considering, not just the new collateral rights and available portions, but the full inventory of the bank’s assets and collateral pools, and estimate if a more optimal distribution can be achieved, by redeploying the collaterals pool to the full inventory of assets.

Don’t forget that the reality is dynamic; and for instance, changes in the yield, rating of the counterparty, or the collateral value will impact the optimal solution of the collateral distribution problem.

As a consequence of these dynamically changing equation, collateral optimization requires continues rebalancing of the bank’s collateral allocation.

In order of running this process, the IT infrastructure of the bank requires a central repository of assets and collateral rights, which is at the core of the value proposition of the Integrated Financial and Risk Architecture of Bank Analyzer.

Currently SAP Bank Analyzer offers the Optimal Collateral Distribution functionality of the Basel III - Credit Risk module, which is insufficient for being considered a proper Collateral Optimization System for dynamically managed portfolios. But, we’re working in the integration of the necessary objects and results with external third-party systems, capable of running the optimization process.

In a previous post, we look at a practical example of the Bank Analyzer-Special Ledgers’ capabilities.

https://www.linkedin.com/pulse/special-ledgers-sap-bank-analyzer-ferran-frances?trk=hp-feed-article-title

This is another good example; taking profit of the robust modeling of collateral data in the Source Data Layer, and the flexibility of storing the optimization and simulation results in the Special Ledgers of the Results Data Layer, we can build the central repository that the collateral optimization process requires.

Looking forward to read your opinions.

K. Regards,

Ferran.

Bitcoin and SAP Banking.

Dear,
If I ask you if you’ve heard about Bitcoin, I’m sure you all know it’s a cryptographic virtual currency.

But if I ask you about Blockchain, I think it will be the first time that many of you have seen this word.

Blockchain is the protocol supporting Bitcoin payment transactions, and the technology which is going to drive the biggest transformation in payment methods, since Bank of America launched the first credit card on 1958 (BankAmericard).

The first reason is cost; Bitcoin fees are very low (zero in most cases), while Creditcard fees are around 3.5% of the transaction value.

On the other hand, you probably know that Bitcoin is a very volatile currency (due to its low monetary mass compared to the major currencies), but this weakness has opened the opportunity of new services for hedging the Forex risk in Bitcoin transactions, the most popular one is bitpay
https://bitpay.com/

Combine a new technology, capable of a dramatic reduction of payment costs, with a world of limited economic growth, putting pressure on reducing costs; and you will understand the opportunity that Bitcoin represents.

And remember that the real importance of Bitcoin is not in the currency, but in the Blockchain technology.

In few words, Blockchain is a shared public and encrypted, decentralized ledger.

Every payment in the Bitcoin network is posted as a transaction in the Blockchain ledger, opening the gate for posting, not only the transfer of money, but any agreement, representing a right or obligation, with its correspondent value.

Financial Contracts (Loans, Deposits, Options, Forward Contracts, Swaps) are just that, transfers of rights and obligations, and their correspondent value, between two counterparties.

With the Blockchain protocol, we have the capacity of developing new services for value transfer, encapsulated in “smart” financial contracts.

Blockchain represents to the Internet of Value, what the TCP/IP protocol has represented to the Internet of Data.

When Vint Cerf and Bob Kahn developed the TCP/IP protocol in the 70’s nobody could imagine that Facebook or Linkedin were going to change the way that humans interact. In the same way, it’s very difficult to imagine how new services developed on Blockchain are going to change the way in which value is transferred.

In the next 10 years we’re going to see many startups developing new services on top of the Blockchain protocol, services that will modify the shape of the financial system forever.

At the same time, the mobility paradigm is changing the interaction model between the financial system agents.

SAP is aware of the importance of this paradigm change, that’s why it’s delivered SAP Fiori, opening the gate for the integration of internet services in the SAP Banking landscape, including Blockchain services.

https://www.sapappsdevelopmentpartnercenter.com/en/build/sap-netweaver-gateway/sap-fiori/

But the transformation can’t be limited to the interface; the opportunities of the technology change are also threats for those who are not capable of reshaping their business processes according to the new paradigm.

And the question is; how to reshape your business processes if they rely in obsolete legacy systems developed when Internet was not even a dream.

I’ve worked as SAP consultant for more than 20 years, and in SAP Banking for the last 10. When I look at the bank’s systems; I see business processes isolated in silos of information supported by multiple, heterogeneous customer and products databases.

By making these processes visible on the Internet they are just showing their weaknesses to new and more agile competitors. Paypal is a good example.

We’re working already in new business processes leveraging SAP Technology towards the new paradigm; you will see some examples in the next posts.

Today is the time to start the change, tomorrow can be late.

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