Dear,
Capital Optimization requires efficient planning, providing management with the necessary information for having resources when they are requested, and taking corrective actions in case of deviations.
Planning relies in accurate Product Costing, assuring that profit and margin objectives are fulfilled in every financial period.
Product Costing for Financial Products has three dimensions; Risk driven Capital Costs, Funding Costs and Process Costs.
1) Risk driven Capital Cost.- IFRS 9 and Basel III require that every bank develops a Risk Model which supports the estimation of the Expected Loss of every Financial Asset. The Expected Loss represent the values of the potential losses in a Financial Asset, multiplied by the probability of that loss occurring, and it is the basis for determining the Fair Value Provisions and Capital Requirements of the Bank. The Fair Value Provisions and Capital Requirements represent a cost for the bank, which must be included in the Product Costing estimations of the bank.
Bank Analyzer -AFI supports the determination of the Fair Value Provisions (IFRS 9) and Bank Analyzer – Credit Risk supports the determination of the Credit Risk Capital Requirements (Basel III), according to the Expected Loss of the Financial Asset. Credit Risk Capital Requirements can be included in the Financial Asset Statement (AFI sub-ledger) as Off-Balance Postings, representing the Capital Cost of the Financial Asset, assuring that the sales price will cover the Risk Driven Capital Costs.
Assuming that the bank has a consistent common risk model per Financial Asset, it means that we can assume a direct relationship between the Expected Loss for Capital Requirements (Basel III) and Fair Value (IFRS 9), to the extent that gives the bank an opportunity to reduce Fair Value provisions in case of excess of Capital Requirements determination.
This double approach of the Expected Loss (Solvency and Accounting) per Financial Asset is a very interesting Value Proposition of the Integrated Financial and Risk Architecture.
Bank Analyzer stores the Expected Loss in the Credit Risk Result Type, and the Fair Value Provisions on the Accounting Result Type of the Results Data Layer. In both cases the results are stored individually per every Financial Asset which opens the gate for representing the Capital Requirements as Accounting Provisions per Financial Asset.
Capital Requirements must be determined under base and stressed scenarios, for this reason, in practical terms, Product Cost Planning requires the bank use Standard Costs, that must be reconcilable with the Expected Loss of the banks risk model, and Capital requirements estimations. This reconciliation is also supported by the Integrated Financial and Risk Architecture of Bank Analyzer.
2) Funding Costs.- The bank has to get liquidity from the market, compensating the liquidity consumed in Lending and Investing. Bank Clients and Capital Markets provide this liquidity at an interest rate, which represents a cost, that the bank must include in the cost estimations of its products.
Liquidity requirements fulfillment are a shared responsibility by all the bank branches and Treasury department. Some branches get liquidity that others consume, with the Treasury department compensating liquidity requirements or excess in the Capital Markets. In exchange for covering the liquidity requirements of other branches, liquidity providers receive internal transfer of the funding cost value (transfer price for liquidity). We’ll talk about this in more detail in a future blog.
3) Process Costs.- In order of getting clients and managing investing and contracts with them, the bank needs resources; staff, information systems, branches, etc. Every contract has to support a fair distribution of its related banks costs, assuring that the selling price is higher enough for assuring a positive margin. The fair distribution of the banks process costs is achieved with the cost analysis model of the bank, using Management Accounting techniques for services like Activity Base Costing, Internal Cost Orders, Cost Center Accounting, etc.
As you can see above, the first two families of costs are financial services driven, while the third is general services driven. Integrating all in the same Financial Statement requires a seamless integration between the Analytical Banking and the ERP System. This is the main advantage of combining SAP Bank Analyzer and S4 HANA Universal Journal, combining in the a unified Financial Statement, all the revenues and cost of a Financial Instrument, so the bank will have the profits and losses of every business segment, and the allocated capital.
We looked at the concept briefly in a previous blog.
https://www.linkedin.com/pulse/why-bank-analyzer-afi-sub-ledger-anymore-chapter-ii-ferran-frances/
And we will come back to this topic, in more detail, in a future one.
Looking forward to read your opinions.
K. Regards,
Ferran.
Capital Optimization requires efficient planning, providing management with the necessary information for having resources when they are requested, and taking corrective actions in case of deviations.
Planning relies in accurate Product Costing, assuring that profit and margin objectives are fulfilled in every financial period.
Product Costing for Financial Products has three dimensions; Risk driven Capital Costs, Funding Costs and Process Costs.
1) Risk driven Capital Cost.- IFRS 9 and Basel III require that every bank develops a Risk Model which supports the estimation of the Expected Loss of every Financial Asset. The Expected Loss represent the values of the potential losses in a Financial Asset, multiplied by the probability of that loss occurring, and it is the basis for determining the Fair Value Provisions and Capital Requirements of the Bank. The Fair Value Provisions and Capital Requirements represent a cost for the bank, which must be included in the Product Costing estimations of the bank.
Bank Analyzer -AFI supports the determination of the Fair Value Provisions (IFRS 9) and Bank Analyzer – Credit Risk supports the determination of the Credit Risk Capital Requirements (Basel III), according to the Expected Loss of the Financial Asset. Credit Risk Capital Requirements can be included in the Financial Asset Statement (AFI sub-ledger) as Off-Balance Postings, representing the Capital Cost of the Financial Asset, assuring that the sales price will cover the Risk Driven Capital Costs.
Assuming that the bank has a consistent common risk model per Financial Asset, it means that we can assume a direct relationship between the Expected Loss for Capital Requirements (Basel III) and Fair Value (IFRS 9), to the extent that gives the bank an opportunity to reduce Fair Value provisions in case of excess of Capital Requirements determination.
This double approach of the Expected Loss (Solvency and Accounting) per Financial Asset is a very interesting Value Proposition of the Integrated Financial and Risk Architecture.
Bank Analyzer stores the Expected Loss in the Credit Risk Result Type, and the Fair Value Provisions on the Accounting Result Type of the Results Data Layer. In both cases the results are stored individually per every Financial Asset which opens the gate for representing the Capital Requirements as Accounting Provisions per Financial Asset.
Capital Requirements must be determined under base and stressed scenarios, for this reason, in practical terms, Product Cost Planning requires the bank use Standard Costs, that must be reconcilable with the Expected Loss of the banks risk model, and Capital requirements estimations. This reconciliation is also supported by the Integrated Financial and Risk Architecture of Bank Analyzer.
2) Funding Costs.- The bank has to get liquidity from the market, compensating the liquidity consumed in Lending and Investing. Bank Clients and Capital Markets provide this liquidity at an interest rate, which represents a cost, that the bank must include in the cost estimations of its products.
Liquidity requirements fulfillment are a shared responsibility by all the bank branches and Treasury department. Some branches get liquidity that others consume, with the Treasury department compensating liquidity requirements or excess in the Capital Markets. In exchange for covering the liquidity requirements of other branches, liquidity providers receive internal transfer of the funding cost value (transfer price for liquidity). We’ll talk about this in more detail in a future blog.
3) Process Costs.- In order of getting clients and managing investing and contracts with them, the bank needs resources; staff, information systems, branches, etc. Every contract has to support a fair distribution of its related banks costs, assuring that the selling price is higher enough for assuring a positive margin. The fair distribution of the banks process costs is achieved with the cost analysis model of the bank, using Management Accounting techniques for services like Activity Base Costing, Internal Cost Orders, Cost Center Accounting, etc.
As you can see above, the first two families of costs are financial services driven, while the third is general services driven. Integrating all in the same Financial Statement requires a seamless integration between the Analytical Banking and the ERP System. This is the main advantage of combining SAP Bank Analyzer and S4 HANA Universal Journal, combining in the a unified Financial Statement, all the revenues and cost of a Financial Instrument, so the bank will have the profits and losses of every business segment, and the allocated capital.
We looked at the concept briefly in a previous blog.
https://www.linkedin.com/pulse/why-bank-analyzer-afi-sub-ledger-anymore-chapter-ii-ferran-frances/
And we will come back to this topic, in more detail, in a future one.
Looking forward to read your opinions.
K. Regards,
Ferran.
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