Dear,
Since 12 years ago I wrote the first SAP Banking post in this community, I always tried to explain that we are in the middle of a Systemic Transformacion of the Financial System, from a model based in Volume to a model based in Capital Optimization.
In theory, Optimizing Capital is a logical activity, it means determining the price of a Financial Instrument by taking all the costs into account (including Capital costs), or in other words, maximizing the return of a Financial Instrument (or a Portfolio) weighted by its Capital Consumption.
In an economic environment enjoying strong economic growth and limited debt, Capital is abundant. The world enjoyed this economic environment for most of Capitalism history.
If Capital is abundant there is no much difference between maximizing the return of a Financial Instrument or maximizing the return of the Financial Instrument weighted by Capital consumption.
In some sense, this has been a common understanding in the economic model which emerged after the Second World War. For instance, in the early 60s, the US President John F Kennedy popularized the quote "A rising tide lifts all the boats" meaning that the focus of an economy should be growth.
Unfortunately, the current economic environment is very different; today's economy has the most limited growth of the Capitalism history and the same applies for global debt which is also the biggest in history.
This was systematically analyzed in the early 70s by the Club of Rome that Commissioned the report "The Limits of Growth" which clearly established the unsustainability of an economic model sustained by unlimited growth in a World of Limited Resources.
https://en.wikipedia.org/wiki/The_Limits_to_Growth
Decreasing is not an option, natural resources scarcity and pollution make unlimited growth impossible. Some economists predict that scientific discoveries and technology improvements will find new ways to fuel economic growth, although simple observation of the rising global debt and dependency of the fossil sources of energy make clear that this is not the case.
It is not my intention to start a debate about the Limits of Growth, in my opinion there are many reliable sources of information where you can validate the conclusions of the Club of Rome report. If you think these conclusions are not valid, this blog will not be interesting to you.
The Financial System decisions are based on the hypothesis that, in general, counterparties fulfill their obligations. Consequently, the logical investment strategy is allocating Capital on those activities with higher expected returns, paying less attention to the risk of the investment.
But when Capital becomes scarce, Risk management becomes critical and it must be at the center of the Financial decisions.
This is a principle brilliantly explained in 2005 by the Chief Economist of the International Monetary Fund and future Governor of the Reserve Bank of India, Dr. Raghuram Rajan.
https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp082705
Managing Risk is mainly managing Information and consequently Information Systems are at the foundation of Risk Management.
I have been SAP consultant for nearly 30 years, and the last 14 focused in Analytical Banking. For years I have expected the transformation of the banks information systems, a transformation that has not started yet.
For instance, the Financial Statements are still considered one of the main deliverables for auditing the health of a bank; Financial Statements with tens of thousands of GL-Accounts, with very limited tracking capabilities of the source of the Account's balance.
Additionally, Accounting Principles offer very limited capacity for representing critical solvency magnitudes.
Can any of you explain to us how to properly model commitments, probabilities of default, loss given defaults, value at risk or risk weighted assets in a Financial Statement?
I know that Solvency is reported with specific frameworks like FINREP, COREP, FFIEC, etc. but they are built by collecting most of the data from the Financial Statements, which are not suited for storing Solvency Information.
On the other side, the SAP Integrated Financial and Risk Architecture offers a multi-functional representation of the main bank's regulatory requirements, with a balanced and reconcilable representation of the economic events in Accounting and Solvency magnitudes.
With the integrated analytical capabilities of the Integrated Financial and Risk Architecture is feasible to answer the question, "what is the return of a Financial Instrument weighted by its Capital Consumption?". This is for me the main question and the starting point of a Capital Optimization Process.
Looking forward to reading your comments.
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
