Weak Economic Growth, Capital Scarcity and Capital Optimization with SAP Banking.

Dear,

In recent months, as the world economy reactivated after the COVID-19 shock, we have seen rapid growth in energy prices.

During the industrial era, economic growth has been coupled with energy consumption. If this trend continues, and nothing suggests that it will break, the decrease in energy availability, either due to the depletion of natural sources, or the need to fight against climate change will weaken economic growth.

https://edition.cnn.com/2021/10/26/business/gas-prices-energy-crisis-schwarzman/index.html

As, in addition, excess debt reduces the capital available in the Financial System, we find ourselves in a new structural environment of capital shortage.

Capital is the most important resource of the Financial System, if we are in a new environment of capital scarcity the priority of the Financial System is and it will be capital optimization.

If you do a search in Google of the type "banking capital optimization" you will find many entries explaining the importance of optimizing capital, but there is not much documentation describing the steps of a capital optimization process. I will try to do it briefly in this blog.

1) The first step in a Capital Optimization process is measuring accurately the Capital consumed in every market segment that the bank is exposed to.

This is the main value proposition of the Integrated Financial and Risk Architecture of SAP Bank Analyzer.

Bank Analyzer – Credit Risk module will calculate the Risk Weighted Assets of every contract, every risk exposure of the bank’s portfolio, and consequently the Regulatory Capital consumed.

Once we know the Capital consumed by every Contract/Exposure, we can aggregate the Capital consumed according to the analytical dimensions that we have defined in the Bank Analyzer-Results Data Layer, and consequently we will know the Capital consumed in every market segment in which the bank operates.

Alternatively, the SAP Bank Analyzer Credit Portfolio also gives us the Economic Capital consumed by market segment, and all the complementary parameters to the Capital consumed.

2) The second step in a Capital Optimization process is the efficient assignment of Collaterals to exposures for reducing the Risk Weighted Assets and the Capital consumed.

The assignment of Collaterals to Exposures is not always a static assignment. The 1 to 1 assignment of a Collateral to an exposure is just the trivial case, but it’s usual that several (n) exposures are assigned to several (m) collaterals.

In case (n) exposures are assigned to (m) collaterals there’s an Optimal Distribution of the Collateral portions to the Exposures, which reduces the Risk Weighted Assets, and consequently the Capital consumption. This is the basis of the Dynamic Management of Collaterals that we discussed in a previous blog, and we will analyze again in a future one.

https://sapbank.blogspot.com/2012/09/capital-management-chapter-v-dynamic.html

The Bank Analyzer – Credit Risk Module has strong capabilities for the Optimal Distribution of Collaterals to Exposures in the Level 2 of the Calculation of the Risk Weighted Assets. These capabilities look at the Probabilities of Default and Exposures at Default of the Exposures and the Collateral Values, adjusting efficiently the assignment of Collateral portions to Exposures.

3) The third step of a Capital Optimization process is maximizing the Bank's profit reducing the Capital Consumed. Every market segment has a potential expected profit, and every market segment has a potential Expected Loss, and consequently a potential Capital Consumption.

Optimizing Capital means identifying the market segments with higher Expected Profit weighted by the Expected Capital consumed of the market segment.

This is the most difficult element of a Capital Optimization process, because it requires a double-synchronized simulation, looking for a solution which minimizes the Risk Weighted Assets maximizing the Expected Profit.

This optimization engine is still not available, but the Integrated Financial and Risk Architecture of Bank Analyzer has been designed for having an Integrated and Reconcilable vision of Risk and Accounting (Profit).

The IFRA is the technical foundation for running cycles of simulation that Capital Managers should run for achieving the Optimal Planning of the bank’s portfolio, reducing the RWA and maximizing at the same time the expected Profit.

Finally, the future will require the automatic calculation and simulation of banks investments, for proposing the Optimal Sales and Execution planning of the Bank. I’ve personally worked in some of these models, by adapting the Theory of Constraints to portfolio management.

These simulations require very strong computing capabilities, but this is the value that SAP HANA provides for solving the problem.

Looking forward to reading 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

Capital Scarcity and Capital Optimization with SAP Banking.

Dear,

As some of you know, I have mentioned in previous messages that the banking system is facing a systemic transformation, from a model based on Volume to a model based in Efficient Management of Capital.

Two forces are moving the financial system towards a new environment of capital scarcity; global debt, the highest in the history of capitalism, and weak economic growth.

There are many estimations of the Global Debt, you can find a very detailed one on the IMF website.

https://www.imf.org/external/datamapper/datasets/GDD

Weak economic growth is coming as a consequence of the energy and other natural resources scarcity, including climate change, and threatened natural environment.

Ultra Expansive monetary policies of the central banks are still maintaining liquidity of the capital markets but they are also exacerbating the rise of energy and natural resources prices.

Some people are warning that the economy is falling in an inflationary cycle; I disagree.

Although they are inflated by the monetary policies, current prices rise have the shape of an external shock, but they will not produce an inflationary crisis. Actually, as we already saw in the 2008 financial crisis, they will trigger a capital crisis.

Sustaining the inflationary cycle requires that demand can respond to offering prices rise, increasing its buying capacity. But this is not possible because automation and robotization are pushing salaries down, and global debt also prevents increasing demand capacity by borrowing funds.

As the prices rise we will see demand destruction that will stabilize prices, but with a constrained offering and demand. This means less economic activity and consequently weaker capital generation.

In this new environment we have to find processes and technology for optimizing capital. I have spent most of my professional career looking at SAP technology capacity for capital optimization. You can find some of what I have written about the topic by google “SAP Banking capital optimization” (without quotes).

SAP has always been about capital optimization. By making information available through the Supply Chain, companies have been able to increase level of service and reduce inventory, production and transportation costs (optimizing tangible capital).

Same principle applies for solvency and liquidity optimization. I discovered this in 2008 and I started to work on the integration of the processes of the real economy with the financial economy. This integration provides the information for reducing risk and optimizing solvency. As most of the real economy business processes are run on SAP, the answer of how to integrate the financial and non-financial economy was easy.

Since then I have been working on modeling the business processes of the real economy in terms of capital and liquidity consumption and generation. This is the same logic followed by the SAP Integrated Financial and Risk Architecture for Financial Instruments (Securities and Over the Counter), but there is no reason for doing the same with non-financial business processes (Sales and Purchase Orders, Forecasts, Production Orders, etc.).

As we have the complete view of the Capital and Liquidity position and evolution of the company, we can proactively provide Financial Instruments for covering capital and liquidity gaps or investment opportunities for capital and liquidity surpluses. For those of you who are familiar with the concept of Supply Chain management it is a similar concept, but instead of replenishing goods (tangible capital), the system provides solvency and liquidity, with the objective of reducing the capital consumption of the system.

Optimizing capital means improving the margin weighted by capital consumption, or in other words, including the cost of capital in the margin calculation.

Calculating the cost of capital requires a holistic vision of the business processes because it spreads on them. But it also looks at the expected future maturity of the investment, consequently requires integration between planning and execution.

Only SAP can offer this holistic vision and that’s why SAP Banking will be the leader in capital optimization when its value proposition is fully understood.

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