Dynamic Collateral Management and Capital Optimization with SAP Banking.

 Dear,

Capital is the most critical resource of the Financial System. In the last decades, due to excess debt and weak economic growth, Capital has become very scarce.

According to the European Banking Authority, European banks face a 135 billion euro capital shortfall.

https://www.reuters.com/article/eu-banks-regulator/eu-watchdog-says-banks-face-135-billion-euro-capital-shortfall-idINL8N2433U3

While other sources warn that the capital shortfall of the European banks could be 600 billion euro.

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/eurozone-banks-may-face-8364-600b-capital-shortfall-in-systemic-crisis-8211-economists-59238561

If Capital is scarce, the most critical activity of the Financial System is Capital Optimization and this is driving the transformation of the Financial System, from a model based in Volume to a model based in Efficient Capital Management.

One of the most effective techniques in Capital Optimization is Dynamic Management of Collaterals, let me give you a brief description of the concept.

A classical method for Risk Mitigation (Capital consumption reduction), recognized by all the Basel agreements and solvency regulations, is collateralization. Consequently, collateral rights are part of the Capital of an organization.

On collateral management we can follow two basic approaches.

• Static Collateral Management. The Bank has an exposure (receivable or asset) and requires a collateral right for hedging the Default Risk of the exposure. Normally, the higher the exposure, the higher the collateral that the Bank will require. The collateralization degree will be determined by the difference between the amount of the Exposure and the value of the collateral.

• Dynamic Collateral Management. On the other hand, according to the Basel agreement, Capital consumption (solvency) does not depend directly on the Bank’s exposure, but on the Bank’s exposures “weighted” but the exposures’ risk. Consequently collateralization degree depends on the risk of the exposure, and it changes (dynamically) with it.

The difference on the above approaches has relevant consequences for Capital Management.

In the first case, collateralization does not depend on the exposure’s risk (rating), but only on its size (the risk of the collateral value is somehow considered if we update the collateral value regularly), while in the second approach the risk of the exposure is integrated on the Risk Weighted Assets Calculation and consequently on the collateralization degree.

The second approach is more sensitive to risk and permits a more efficient management of the Collateral, and consequently, the Solvency and Capital.

This is particularly useful when a group of collaterals is covering a group of exposures; determining the most efficient distribution of the collaterals to the exposures reduces the capital consumed which is the foundation of the Dynamic Management of Collaterals, one of the main Capital Optimization techniques.

The last 11 years our team has worked in modelling all the rights, obligations, assets, liabilities, economic events and value flows represented in the SAP systems of the Real Economy, in terms of Capital and Liquidity consumption and generation. With this information, our systems measure how to offer Financial Instruments for covering Capital and Liquidity gaps or investing Capital and Liquidity surpluses, optimizing the Capital and Liquidity consumption of the system.

We are working on presenting our system to the market, and looking for business partners and investors, if you are interested do not hesitate in contacting me at ferran.frances@capitency.com

Looking forward to reading your opinions.

Kindest Regards,

Ferran Frances.

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

Activity Based Capital Optimization with SAP Banking.

Dear,

Many economists agree that we are at the end of a Financial System model.

For instance, Larry Summers, 71st Secretary of the Treasury for President Clinton and the Director of the National Economic Council for President Obama, has described the current economic environment as "Secular Stagnation; a prolonged period in which satisfactory growth can only be achieved by unsustainable financial conditions”

http://larrysummers.com/2017/06/07/secular-stagnation/

For decades strong economic growth has made Capital abundant, but this started to change in the last decades of the last century when economic growth became weaker and global debt rose until becoming the highest in the history of capitalism.

                              Source: World Bank.

Excess of debt consumes Capital and weak economic growth prevents Capital generation, this is why Capital has become scarce, and Capital is the most important resource of the Financial System.

If Capital is scarce the priority is Capital Optimization and this is the driver of the New Financial System that will emerge from this crisis.

Capital Optimization requires maximizing the Return of Investments weighted by Capital consumption.

Capital consumption is directly proportional to the Risk Weighted Assets, this means that Optimizing Capital is synonymous with reducing the risk of the economic activities, and risk is always reduced by applying information.

 

As the economy becomes a Information based Economy, processes have become more important than tangible assets; you can look at the examples of Amazon, Google, Facebook, Netflix, etc.

In order to optimize the Capital consumed in a process we need to determine the value generated by the process, the assets we have to allocate to the process and the risk of suffering losses on the assets (tangible & untangible) allocated to the process.

The Activity Based Costing of the SAP Enterprise Core Components System, in combination with other SAP ECC modules like Profit Center Accounting, Production & Internal Orders, and specially with the multi-dimensional accounting capabilities of the Universal Journal of S4 HANA are an excellent starting point.

ABC Processes, Profit Centers and Orders support the tracking of value generation with sophisticated activity cost driver templates. At the end "activating" a cost is estimating the capacity of the process of generating value from the cost.

The estimation of the value generation is the first step on the Capital Optimization process.

The following step is estimating the risk exposure associated to the value generation. When we establish the link between the risk exposure and the value generation drivers, we will be in the position of reducing the coefficient of capital consumption for value generation (by allocating the information that will reduce the risk).

Processes of the Information economy come with enormous amount of data, this is growing every second  and it is growing much faster with the implementation of new technologies like the Internet of Things.

Not all the data have the same relevancy on reducing the capital consumption of the process and the objective is identifying the relevant data, structuring the data in relevant information and finally developing models for integrating the information in the process, reducing risk and consequently Capital Consumption.

For the last 12 years our team has analyzed business processes modeled in SAP System for modeling the cost drivers of these processes in terms of Capital consumption and generation.

With this information, we can optimize the expected profit of a business process, weighted by its Capital consumption, which is the objective of a Capital Optimization system.

Looking forward to reading your opinions.

Kindest Regards,

Ferran Frances.

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

Specialized Lending, Capital Flows Tracking and Capital Optimization with SAP Banking.

Dear,
The Financial System is in process of Systemic Change from a model based in Volume to a model based in Efficient Management of Capital.

Excess of Debt (consumes Capital) and weak economic growth (limits Capital generation) has generated an economic environment of Capital scarcity. Do not forget that Capital is the most important resource of the Financial System.

Many strategic thinkers have detected the threat and the systemic change, but most of them have failed in proposing solutions.

In 2012 McKinsey released the paper “Capital Management. Banking’s new imperative” whose title is self-explanatory.

https://www.mckinsey.com/~/media/mckinsey/dotcom/client_service/risk/working%20papers/38_capital%20management%20bankings%20new%20imperative.ashx

Since them many others have made analog warnings and issued similar papers. Just google “Banking Capital Optimization” (without quotes) and you will find many comments, articles and papers about this topic.

While global debt keeps growing and natural resources scarcity puts a brake on economic growth, Capital scarcity becomes bigger and bigger making it more urgent to find solutions.

In July 2019 the European Banking Authority estimated the Capital shortage of the european banking system at 135 billion euro. This estimation does not include the economic impact of the COVID-19 pandemic.

https://www.reuters.com/article/eu-banks-regulator/eu-watchdog-says-banks-face-135-billion-euro-capital-shortfall-idINL8N2433U3

German economists Moritz Schularick, Sascha Steffen and Tobias Tröger warned that the Capital shortage of the European Banking System could achieve 600 billion euro due to the economic consequences of the COVID-19 pandemic.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3638031

Additionally we should include the impact on the economic growth and Capital of the costs of the energy transition process that the world’s economies are confronting in the oncoming months and for a very long period of time.

Larry Summers, 71st Secretary of the Treasury for President Clinton and the Director of the National Economic Council for President Obama, described the current economic environment as "Secular Stagnation; a prolonged period in which satisfactory growth can only be achieved by unsustainable financial conditions”

http://larrysummers.com/2017/06/07/secular-stagnation/

Capital scarcity is not a hypothesis, it is a fact. Its effects are already visible but they are going to be much more visible very soon.

If Capital is and it is going to be scarce, Capital Optimization is mandatory, and the question is do we have feasible proposals for Capital Optimization?

The first pillar in a Capital Optimization design requires measuring where, when and how Capital is consumed, and tracking the Capital flows amongst organizations, partners, counterparties, etc.

This is known, and there are and there have been initiatives for improving the tracking of Capital flows; Specialized Lending is an example.

Specialized Lending is a method of funding in which the lender looks primarily at the revenues generated by one or many clearly identified assets, both as the sources of repayment and as collaterals for the loan. Specialized Lending uses Special Purpose Vehicles which are legal entities owning the assets; isolating the assets and their generated revenues from other counterparties or exposures.
As you can see, capital flows are encapsulated to the business activities of the Special Purpose Vehicle, and then tracked and accurately evaluated.

The difficulty is this is not a flexible construction and the involved operational costs are quite high.

On the other hand, SAP has been modelling and tracking accurately capital flows of the real economy for 30 years. SAP integration capabilities facilitate evaluating individually the business flows, estimating their fulfillment and generating the accounting entries accordingly.

By estimating the risk involved in the exposures of these capital flows, we would have a very accurate measurement of the Capital consumption of them (capital consumption is directly proportional to the risk weighted exposures).

This is what we have done during the last 12 years; we have analyzed the capital flows of the real economy, modelled in SAP systems, and built a systematic model for estimating the risk weighted exposures of these business flows, tracking them individually as they are transferred amongst counterparties.

With this information, we can measure the expected profit of a business process, weighted by its Capital consumption, which is the first pillar of a Capital Optimization system.

Looking forward to reading your opinions.

Kindest Regards,

Ferran Frances.

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

Why will SAP Banking be the leader in Capital Optimization?

Dear,

The financial system is drowning due to lack of capital. Excess of debt consumes massive amounts of Capital and weak economic growth limits Capital generation.

According to the European Banking Authority, european banks face a 135 billion euro capital shortfall.

https://www.reuters.com/article/eu-banks-regulator/eu-watchdog-says-banks-face-135-billion-euro-capital-shortfall-idINL8N2433U3

While other sources warn that the capital shortfall of the european bank could be 600 billion euro.

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/eurozone-banks-may-face-8364-600b-capital-shortfall-in-systemic-crisis-8211-economists-59238561

Capital is the most critical resource of the Financial System, and if we are in the new environment of capital scarcity, capital optimization becomes the most critical activity.

McKinsey made it very clear in this 2012 paper.

https://www.mckinsey.com/business-functions/risk/our-insights/capital-management-bankings-new-imperative

The final objective of Capital Optimization is maximizing the economic profit weighted by Capital consumption, including all the inflows and outflows of the process. And the first step in a Capital Optimization process is measuring accurately how much Profit or Loss is generated in an economic process and how much Capital is consumed.

This efficiency driven value proposition has been at the center of SAP architecture from the beginning. The first question we can answer in an integrated system is how the company operations drive profit generation. With the first versions of SAP R3 Analytical Accounting (even with R2), executives could answer the question, where and how we make money or suffer losses.

With Profit Center accounting, and even more with the New General Ledger of SAP ECC, we could include assets and liabilities value in the efficiency measurement process. The question was not limited to where and how companies make money or suffer losses, as we could include the assets and liabilities involved in the process, we could determine the Return of the Investment.

But as Capital has become escarce, in addition to determining Profit and invested assets, we also must estimate the potential losses due to risk exposure (Expected Loss, Value at Risk, etc.), which at the end is another word for calling Capital consumption.

But calculating the losses due to risk exposure requires measuring the exposure and its ponderation of risk, and here is when SAP becomes the absolute leader in providing answers to our questions.

Capital consumption flows from companies to their counterparties and they have to be tracked for optimizing Capital. 

If we look at a Loan, we can simplistly think that the exposure is the disbursed amount; this is how it is modelled in many legacy banking systems. But actually the committed and not disbursed amount (free line) is also part of the exposure. 

The not disbursed commitments are also called off-balance exposures, which means that they are not represented in traditional “on-balance” Financial Statements. This is another limitation for legacy banking systems which have the Financial Statements at the center of their regulatory reporting architecture.

In the real economy there are many commitments, bilateral firmed commitments like a Contract, unilateral firmed commitments like an Offer (an Option that the other counterparty will accept or not) or less formalized like a Quotation.

When a Financial Instrument provides Capital and Liquidity to a company, all the risk exposures of the company and their risk ponderations determine the company solvency, and consequently the Capital consumption of the company counterparty (bank or not).

During the last 30 years, SAP has become the absolute leader in measuring and tracking exposures and risk in big and medium size corporations, which is the basis of Capital consumption in the real economy.

As the Financial System has to be transformed from a model based in volume to a model based in Capital Optimization, it requires to track the flows of Capital consumption. All these capital consumption flows are already in SAP systems, speaking SAP language. The only alternative is that the financial system “speaks” the same language in order of tracking the capital consumption flows. This is what SAP professionals call “Integration”.

The last 11 years our team has worked in modelling all the economic events and business flows represented in the SAP systems of the Real Economy, in terms of Capital and Liquidity consumption and generation. With this information, our systems measure how to offer Financial Instruments for covering Capital and Liquidity gaps or investing Capital and Liquidity surpluses, optimizing the Capital and Liquidity consumption of the system. 

We are working on presenting our system to the market, and looking for business partners and investors, if you are interested do not hesitate in contacting me at ferran.frances@capitency.com

Looking forward to reading your opinions.

Kindest Regards,

Ferran Frances.

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