Dear,
As a consequence of the COVID-19 outbreak pressure on the banking system is growing and higher defaults on debt are imminent. And many now expect a shock to the financial sector similar in magnitude to the 2008 crisis.
Bank’s capital is the main concern, many workers lost their jobs and paychecks. Restaurants, hotels, and airplanes all emptied. And consumers and businesses now face steep losses in income and potentially widespread bankruptcies.
The Basel Committee in Banking Supervision has reminded the importance of has reminded the importance of risk weighted accounting and capital consumption.
“The Committee reiterates the importance of expected credit loss (ECL) accounting frameworks as a forward-looking measure of credit losses, and expects banks to continue to apply the relevant frameworks for accounting purposes.”
https://www.bis.org/press/p200403.htm
https://www.bis.org/bcbs/publ/d498.pdf
Due to the extraordinary situation, the Committee has decided to postpone the implementation of the revised G-SIB framework by one year, from 2021 to 2022, and the two final implementation phases of the framework for margin requirements for non-centrally cleared derivatives by one year.
But this economic environment and the governments initiatives are also going to increase global debt which combined with recession is making capital very scarce.
As free capital becomes scarce, it also becomes more expensive, driving the Systemic Transformation of the Financial System from a model based in Volume to a model based in Efficient Management of Capital.
Financial Assets consume Capital in three main ways:
- Credit Risk.
- Market Risk.
- Operational Risk.
The Basel III agreement establishes the main metric for measuring the Capital consumed due to Credit Risk exposure of the Financial Assets, and builds the foundation for the calculating the Capital requirements of a Financial Institution.
The Basel III agreement distinguishes between the Expected and Unexpected Loss produced by a Credit Risk exposure, the first one must be covered by Impairment Provisions, and the second one by Capital.
A valid model of capital optimization must reduce the capital consumed on credit risk exposures by limiting both, the Expected and the Unexpected Loss at the same time.
The Internal Rating Based Approach, both Foundation and Advanced gives us an opportunity for building a holistic Credit Risk Optimization System, as the Credit Risk model used for determining the Probability of Default, and the Loss Given Default and Exposure at Default (in case of the Advanced Approach) can be used, with some adjustments, as a basis for determining the Impairment Provisions.
In this model, the Impairment Provision is compared with the Expected Loss; if the Expected Loss is higher than the provision, the excess of Expected Loss is reduced from the capital.
On the other hand, if the Expected Loss is lower than the provision, banks may recognize the difference in Tier 2 capital up to a maximum of 0.6% of credit risk-weighted assets.
http://www.bis.org/publ/bcbs128.pdf
This holistic management of Capital Requirements and Impairment Provisions requires a integrated modeling of Risk and Accounting, which is exactly the foundation of the Integrated Financial and Risk Architecture of SAP Bank Analyzer.
From release 8, SAP Bank Analyzer offers the Impairment Processes submodule, fully integrated with the Accounting for Financial Instruments module.
The Impairment Processes of Bank Analyzer offer:
- Automatic determination of the percentage of Expected Loss from the Rating and the Delinquency Bands of the Exposures.
- Dynamic classification of the Financial Assets in the Bad or Good book by processing the Impairment Events.
- Determination of the Accruing Status of the Impaired and Performing Assets according to the IFRS requirements.
- Determination of Expected Loss, Provision Amounts, Write-down and Write-off, and the unwinding for the Exposures, including Off-Balance Exposures by using Credit Conversion Factors.
- Posting of the Impairment Provisions on the Bank Analyzer sub-ledger fully integrated with the Accounting Processes.
- Transfer of the Impairment Provisions to the General Ledger and complete reconciliation of the Impairment Provisions between the sub-ledger and the General Ledger.
And this is just the beginning; as mentioned above, the Integrated Financial and Risk architecture of SAP Bank Analyzer opens the gate for more complete representations of the banks capital consumption, we'll talk about them in future blogs.
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
As a consequence of the COVID-19 outbreak pressure on the banking system is growing and higher defaults on debt are imminent. And many now expect a shock to the financial sector similar in magnitude to the 2008 crisis.
Bank’s capital is the main concern, many workers lost their jobs and paychecks. Restaurants, hotels, and airplanes all emptied. And consumers and businesses now face steep losses in income and potentially widespread bankruptcies.
The Basel Committee in Banking Supervision has reminded the importance of has reminded the importance of risk weighted accounting and capital consumption.
“The Committee reiterates the importance of expected credit loss (ECL) accounting frameworks as a forward-looking measure of credit losses, and expects banks to continue to apply the relevant frameworks for accounting purposes.”
https://www.bis.org/press/p200403.htm
https://www.bis.org/bcbs/publ/d498.pdf
Due to the extraordinary situation, the Committee has decided to postpone the implementation of the revised G-SIB framework by one year, from 2021 to 2022, and the two final implementation phases of the framework for margin requirements for non-centrally cleared derivatives by one year.
But this economic environment and the governments initiatives are also going to increase global debt which combined with recession is making capital very scarce.
As free capital becomes scarce, it also becomes more expensive, driving the Systemic Transformation of the Financial System from a model based in Volume to a model based in Efficient Management of Capital.
Financial Assets consume Capital in three main ways:
- Credit Risk.
- Market Risk.
- Operational Risk.
The Basel III agreement establishes the main metric for measuring the Capital consumed due to Credit Risk exposure of the Financial Assets, and builds the foundation for the calculating the Capital requirements of a Financial Institution.
The Basel III agreement distinguishes between the Expected and Unexpected Loss produced by a Credit Risk exposure, the first one must be covered by Impairment Provisions, and the second one by Capital.
A valid model of capital optimization must reduce the capital consumed on credit risk exposures by limiting both, the Expected and the Unexpected Loss at the same time.
The Internal Rating Based Approach, both Foundation and Advanced gives us an opportunity for building a holistic Credit Risk Optimization System, as the Credit Risk model used for determining the Probability of Default, and the Loss Given Default and Exposure at Default (in case of the Advanced Approach) can be used, with some adjustments, as a basis for determining the Impairment Provisions.
In this model, the Impairment Provision is compared with the Expected Loss; if the Expected Loss is higher than the provision, the excess of Expected Loss is reduced from the capital.
On the other hand, if the Expected Loss is lower than the provision, banks may recognize the difference in Tier 2 capital up to a maximum of 0.6% of credit risk-weighted assets.
http://www.bis.org/publ/bcbs128.pdf
This holistic management of Capital Requirements and Impairment Provisions requires a integrated modeling of Risk and Accounting, which is exactly the foundation of the Integrated Financial and Risk Architecture of SAP Bank Analyzer.
From release 8, SAP Bank Analyzer offers the Impairment Processes submodule, fully integrated with the Accounting for Financial Instruments module.
The Impairment Processes of Bank Analyzer offer:
- Automatic determination of the percentage of Expected Loss from the Rating and the Delinquency Bands of the Exposures.
- Dynamic classification of the Financial Assets in the Bad or Good book by processing the Impairment Events.
- Determination of the Accruing Status of the Impaired and Performing Assets according to the IFRS requirements.
- Determination of Expected Loss, Provision Amounts, Write-down and Write-off, and the unwinding for the Exposures, including Off-Balance Exposures by using Credit Conversion Factors.
- Posting of the Impairment Provisions on the Bank Analyzer sub-ledger fully integrated with the Accounting Processes.
- Transfer of the Impairment Provisions to the General Ledger and complete reconciliation of the Impairment Provisions between the sub-ledger and the General Ledger.
And this is just the beginning; as mentioned above, the Integrated Financial and Risk architecture of SAP Bank Analyzer opens the gate for more complete representations of the banks capital consumption, we'll talk about them in future blogs.
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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