Dear,
Recently, I gave some workshops about IFRS 16 and SAP Flexible Real Estate, and several attendants express their concerns about the cost of the implementation and the available budget.
According to them, although their companies are feeling the pressure for being compliant with the new accounting regulation, it is very difficult to get the budget for regulatory projects which are not business driven.
In my opinion, this represents a limited understanding of the impact of the new regulation in the Financial System and the whole Economy.
As we saw in previous blogs, IFRS is not a temporary fashion. The two arms of the new regulatory framework (Basel Agreements and International Financial Reporting Standards) are the logic consequence of the new economic environment, which its main characteristic is capital scarcity.
The economic environment emerging from the 2008 Financial crisis has two characteristics; limited growth (mainly due to natural resources scarcity) and excess of debt (225% of the GDP)
https://eu.usatoday.com/story/money/economy/2018/04/19/global-debt-tops-164-trillion-imf-warns/530893002/
As a consequence of these two forces; weak growth limiting capital generation, and global debt consuming capital, Capital is becoming very scarce.
And never forget that Capital is the main and most critical resource of the Financial System.
Regulators are very aware of the new economic environment, and push the Financial System towards the new paradigm, “Capital Optimization”.
Basel Agreements (Banking Solvency), IFRS 9 (Financial Instruments Accounting), IFRS 16 (Leasing Accounting), Solvency 2 (Insurance Solvency) and IFRS 17 (Insurance Accounting) have the common objective of making visible the cost of Capital of Financial Assets and Liabilities.
The above list does not represent just a compliance requirement, with limited or no impact to the business. What actually represents is a legal constrain that will drive the way in which companies operate; first Financial Companies, and later the whole economy.
If Capital is scarce and bank’s capital requirements rise, there is less capital available for lending and investing, consequently capital scarcity spreads from the Financial System to the whole economy, and all corporates feel the consequence.
We must understand that this is a Systemic change for the Financial System, from a model based in volume, to a model based in Capital Optimization.
Coming back to the initial point, IFRS 16 requires that Leasing companies make visible the cost of capital of every contract.
And as it happens with any cost, cost of capital reduces the margin and profitability, or forces the company to raise the selling price (making the company less competitive).
It sounds logic then to reduce the cost of capital of the Leasing contract. Let’s see how to do it.
Every Leasing contract represents a collection of three groups of cash-flows.
- Invoices that the lessee will pay in exchange for using the leased asset.
- Value of the leased asset at the beginning and the end of the contract.
- Maintenance costs of the leased asset.
And the value of the contract (leased asset) at the time of the contract activation is determined by discounting the above cash-flows by an interest rate, which combines the funding cost and the contract spread (representing the risk that the contract expected cash flows do not become actual).
Reducing the contract spread, reduces the capital costs and increases the company margin and profitability.
This should be the objective of an IFRS 16 implementation, reducing the capital costs by reducing the risk (spread) associated to the three groups of cash-flows of their Leasing contracts.
We will see detailed examples of the related capital optimization activities in a future blog.
Looking forward to read your opinions.
K. Regards,
Ferran.
www.capitency.com
Join the SAP Banking Group at: https://www.linkedin.com/groups/92860
Visit my SAP Banking Blog at: http://sapbank.blogspot.com/
Let's connect on Twitter: @FerranFrancesGi
Ferran.frances@capitency.com
Recently, I gave some workshops about IFRS 16 and SAP Flexible Real Estate, and several attendants express their concerns about the cost of the implementation and the available budget.
According to them, although their companies are feeling the pressure for being compliant with the new accounting regulation, it is very difficult to get the budget for regulatory projects which are not business driven.
In my opinion, this represents a limited understanding of the impact of the new regulation in the Financial System and the whole Economy.
As we saw in previous blogs, IFRS is not a temporary fashion. The two arms of the new regulatory framework (Basel Agreements and International Financial Reporting Standards) are the logic consequence of the new economic environment, which its main characteristic is capital scarcity.
The economic environment emerging from the 2008 Financial crisis has two characteristics; limited growth (mainly due to natural resources scarcity) and excess of debt (225% of the GDP)
https://eu.usatoday.com/story/money/economy/2018/04/19/global-debt-tops-164-trillion-imf-warns/530893002/
As a consequence of these two forces; weak growth limiting capital generation, and global debt consuming capital, Capital is becoming very scarce.
And never forget that Capital is the main and most critical resource of the Financial System.
Regulators are very aware of the new economic environment, and push the Financial System towards the new paradigm, “Capital Optimization”.
Basel Agreements (Banking Solvency), IFRS 9 (Financial Instruments Accounting), IFRS 16 (Leasing Accounting), Solvency 2 (Insurance Solvency) and IFRS 17 (Insurance Accounting) have the common objective of making visible the cost of Capital of Financial Assets and Liabilities.
The above list does not represent just a compliance requirement, with limited or no impact to the business. What actually represents is a legal constrain that will drive the way in which companies operate; first Financial Companies, and later the whole economy.
If Capital is scarce and bank’s capital requirements rise, there is less capital available for lending and investing, consequently capital scarcity spreads from the Financial System to the whole economy, and all corporates feel the consequence.
We must understand that this is a Systemic change for the Financial System, from a model based in volume, to a model based in Capital Optimization.
Coming back to the initial point, IFRS 16 requires that Leasing companies make visible the cost of capital of every contract.
And as it happens with any cost, cost of capital reduces the margin and profitability, or forces the company to raise the selling price (making the company less competitive).
It sounds logic then to reduce the cost of capital of the Leasing contract. Let’s see how to do it.
Every Leasing contract represents a collection of three groups of cash-flows.
- Invoices that the lessee will pay in exchange for using the leased asset.
- Value of the leased asset at the beginning and the end of the contract.
- Maintenance costs of the leased asset.
And the value of the contract (leased asset) at the time of the contract activation is determined by discounting the above cash-flows by an interest rate, which combines the funding cost and the contract spread (representing the risk that the contract expected cash flows do not become actual).
Reducing the contract spread, reduces the capital costs and increases the company margin and profitability.
This should be the objective of an IFRS 16 implementation, reducing the capital costs by reducing the risk (spread) associated to the three groups of cash-flows of their Leasing contracts.
We will see detailed examples of the related capital optimization activities in a future blog.
Looking forward to read your opinions.
K. Regards,
Ferran.
www.capitency.com
Join the SAP Banking Group at: https://www.linkedin.com/groups/92860
Visit my SAP Banking Blog at: http://sapbank.blogspot.com/
Let's connect on Twitter: @FerranFrancesGi
Ferran.frances@capitency.com
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