Disruption of the Supply Chains, Systems Dynamics, Theory of Constraints and Capital Optimization with SAP Banking.

 Dear,

Logistics chains have been under great pressure since the fall of 2020. When societies recovered activity after coming out of the COVID-19 confinements, and consumption recovered, including a certain rebound in demand, the goods began to to accumulate in the ports, freight prices skyrocketed and inventories began to drop.

Complex supply chains have a tendency to behave this way. The complexity of the supply chain increases its entropy, and when an unexpected event occurs, the disruption is transmitted through the system, multiplying its effects. This nonlinear behavior is called the bullwhip effect, also known as the Forrester effect, and was first described by MIT Professor Jay Forrester's, in his book Industrial Dynamics (1961).

In 1984, the Israeli Physicist Eliyahu M. Goldratt proposed the Theory of Constraints as a solution to the non-linear behavior of organizations, described by Systems Dynamics. According to this Theory of Management, Organizations can achieve their Objectives, managing a reduced number of magnitudes or restrictions. Dr. Goldratt published his proposal in the management-oriented novel The Goal (1984).

During the last 30 years, SAP has transformed organizations by establishing a common language that allows them to integrate their processes, manage their constraints holistically, reduce their entropy and improve efficiency.

First, integrating intracompany processes, then intercompany processes within and outside its group of companies.

In 1998 SAP released its Advanced Planner & Optimizer software, which following the proposals of the Theory of Constraints, has multiplied the efficiency of Supply Chains and reduced the number of their disruptions.

Unfortunately, the economic system is under a level of stress that is not comparable to any other in the last 30 years. The complexity of supply chains has grown exponentially as a result of globalization, and in the last 3 years they have suffered the impact of several events with great disruptive potential. It was first hit by the worst pandemic since the 1918 influenza pandemic, followed by rising raw material and energy prices, multiplied by Russia's military intervention in Ukraine.

In this stressed environment, not all organizations are experiencing the impact of disruption in the same way. Those that have invested efficiently in implementing the Technology and Processes proposed by the best logistics practices (SAP Best Practices), have a greater capacity to manage bottlenecks, proposing alternatives, prioritizing corrective actions, reducing costs and improving, within possible, the level of service.

By reducing costs and improving the level of service, more efficient companies are improving their competitive position against those that lack these capabilities, improving their results, market capitalization and future solvency.

Integrating the business processes between the supply chain partners allows them to detect and manage the bottlenecks with the greatest disruptive potential in the system as a whole. Reducing the stress of these bottlenecks improves the resilience of the entire system, something critical when we manage complex, non-linear, highly entropic systems that can experience chaotic behavior.

The financial system is also a complex, non-linear, highly entropic and potentially chaotic system. The destructive potential of periodic financial crises and recessions, and the less frequent but much more destructive depressions, are ample proof of this.

I have worked as a SAP Consultant for 30 years, first in Real Economy (SD, MM, PP, APO, BIW, etc.) and since 2007, also as a SAP Analytical Banking Consultant.

From my first day as a SAP Banking Analytics consultant, I was impressed by the lack of integration of banking processes and the destructive potential of its disruption, as we all experienced in 2008.

As befits the value proposition that the company has offered for half a century, SAP Banking has solid proposals for the integration of financial processes, with benefits analogous to those that this integration has brought to the real economy. However, and despite what many of us thought in 2009, after the financial crisis of the previous year, the transformation of processes in the Financial System is far from having taken place.

Moreover, in the same way that the integration of processes in the real economy began between departments of the same legal entity but grew to incorporate external partners, the Financial System should integrate the processes of the real economy and is far from achieving it.

This is serious because the stressful economic environment, in addition to debt levels unseen in the history of capitalism, are a powerful disruptive force in the financial system. This disruptive force has the potential to destabilize the system and cause non-linear effects and without integration we will be unable to manage the bottlenecks, as proposed by the Theory of Constraints.

I detected this risk in 2010 and started working on a process integration proposal based on SAP Best Practices for financial services and real economy industries, and on top of it, the principles described by System Dynamics and the Theory of Constraints. 

During these years I explained the proposal to other colleagues and we put together a team to integrate financial and non-financial processes supported by SAP technology.

Our proposal measures the Capital and Liquidity consumed and generated by the processes of the real economy, detecting the deficits and surpluses of capital and liquidity of the process. With this information, it proposes financial instruments to offset these deficits and surpluses, optimizing the consumption of capital and liquidity 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 to contact 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

Process Integration, Dynamic Collateral Management and Capital Optimization with SAP Banking.

Dear,

Capital is the most critical resource of the Financial System, and it has become very scarce as a result of excessive indebtedness and weak economic growth.

https://edition.cnn.com/2022/05/05/investing/double-dip-recession-economy-inflation/index.html

https://blogs.imf.org/2022/04/11/dangerous-global-debt-burden-requires-decisive-cooperation/

If Capital is scarce, the most critical activity of the Financial System is Capital Optimization that drives and will drive its transformation from the current model based on Volume to a new model based on Efficient Capital Management.

One of the most effective techniques in Capital Optimization is Dynamic Collateral Management which I will try to describe in this article.

A classic method for Risk Mitigation (Reduction of capital consumption), recognized by all the Basel agreements and solvency regulations, is the management of guarantees or collateralization.

In collateral management we can follow two approaches.

• Static collateral management. The Bank has an exposure (account receivable or asset) and requests guarantees to cover the Default Risk of the exposure. The greater the exposure, the greater the collateral required. The degree of collateralization is determined by the difference between the amount of the exposure and the value of the guarantee.

• Dynamic collateral management. On the other hand, according to the Basel agreement, Capital consumption does not depend directly on the Bank's exposure to Risk, but rather on Risk exposures “weighted” by the risk level of the exposures. Consequently, the requested level of collateralization depends on the amount and risk of the exposure, and the value and risk of the collateral, and it changes (dynamically) with them.

If we analyze in detail the two previous approaches, we will see that the decision to follow one or the other has significant consequences in the management of capital.

In the first case, the collateralization does not depend on the risk of the exposure and the collateral (rating), but only on the Degree of Collateralization with respect to the Exposure Amount. On the contrary, in the second case, the risk of the collateral and the exposure are included in the Calculation of Risk-Weighted Assets and, consequently, in the degree of collateralization.

The second approach is more risk sensitive allowing more efficient collateral management, and it is particularly useful when a pool of collaterals covers multiple exposures. Determining the most efficient allocation of collateral to exposures reduces the capital consumed. This reduction in Capital consumption is the basis of Dynamic Collateral Management, one of the main Capital Optimization techniques.

Balancing collateral and exposures to optimize return on risk-adjusted capital (RAROC) is no easy task. The Loss Given Default depends on the amount of the exposure and counterparty's rating (or its Probability of Default), and the value and rating of the collateral. All these magnitudes are continuously fluctuating. Consequently, the allocation of Collateral portions from a Collateral Pool to the bank's exposures must be a dynamic activity that must be adjusted as the market and counterparty’s conditions change.

For example, as the counterparty's rating improves, or the value of the collateral increases, the Loss Given Default will be reduced until it reaches a limit, in which a better rating or greater collateralization does not reduce the risk-weighted assets. This collateral excess can be released and used in another risk exposure, improving the performance of the portfolio, without penalizing the bank’s capital consumption.

On the other hand, if the value of the collateral declines or the counterparty's rating worsens, higher portions of the collateral pool will be required to reduce capital consumption, triggering, if needed, a margin call.

This technique is very useful in environments of scarcity of Capital but requires an accurate calculation of the collateralization levels of the bank's exposures.

At this point we should ask ourselves; how to obtain the information required for the dynamic calculation of the collateralization levels?

The answer has been provided by SAP for the last 30 years; “Process Integration”.

The business processes of companies in the real economy generate and consume capital and liquidity, but with a maturity mismatch that comes from the business maturation cycle. Simplifying, the business process consumes resources at the beginning of the business cycle and generates revenue at the end. If this maturity mismatch is not covered with internal resources, it will be covered by the financial system, obtaining a yield that remunerates the investor for the cost of Capital.

Detailed modeling of the capital consumption of the process, including the exposures and their risk weighting, provides the capacity of dynamique and efficient allocation of collaterals, reducing the capital consumption of the system.

Approximately 70% of the world's GDP is managed with SAP systems, offering an accurate measure of resource consumption and revenue generation, as well as its planning and deviations from planned values. Just the information we need to calculate capital consumption and generation and efficiently allocate available collateral.

Our system, built on SAP technology, integrates with the processes of the real economy (managed with SAP), and determines its capital and liquidity consumption. With this information, it proposes financial instruments that cover deficits or excesses of capital and liquidity, adjusting the price to the risk of the operation.

We are working on presenting our system to the market and looking for business partners and investors. If you are interested, do not hesitate to contact 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

How SAP is building the most successful Metaverse and Capital Optimization with SAP Banking.

Dear,

In the last few months, we have become familiar with Mark Zuckerberg's Metaverse initiative, which promises us a virtual world focused on social connection and facilitated by Virtual and Augmented Reality.

Personally, I have doubts about the short-term potential of the initiative, and the capacity of monetizing it in the short-medium term. Before his corporation loses the competitive edge it gained from the successful launch of Facebook 18 years ago.

Furthermore, and with much less publicity in the mass media, SAP is developing a network that will revolutionize business interaction much sooner than most expect.

The success of an initiative is the result of two forces, market pull and technology push, or in other words what the technology offers and what the market demands.

SAP Business Network for Supply Chain has come at the best time to successfully combine the two forces.

SAP Business Network for Supply Chain is an open logistics network that connects business partners for inter-company collaboration and insights. SAP Logistics Business Network provides a central entry point to manage logistics transactions, exchange documents with key business partners, and gain transparency across the complete value chain.

https://www.youtube.com/watch?v=0Jp46bdOCY4&list=PLmGEBnWFTjqRlZIf5EaqJNUEoJecbJ5WX&index=3

SAP is the Information Technology that manages approximately 70% of the world's GDP and in the last 30 years has standardized business processes, to the point of becoming the language with which organizations interact.

The integration processes between companies managed with SAP such as Purchases, Sales, Logistics Planning, etc. are carried out fundamentally with this Technology, enjoying that compatibility and homogeneity of processes and thereby reducing integration costs and improving coordination between them.

Standardization is not limited to Technology but also to Human-Computer interaction. As a curiosity, you can find how many Logistics Director or Financial Director job offers require knowledge of SAP.

As I heard a colleague say a few weeks ago; "SAP is to today's business community what the Latin language was to the Roman Empire."

Additionally, The global business community has been under severe stress since December 2019. First, the COVID-19 pandemic and the corresponding lockdowns, which reduced economic activity until the summer of 2021. With the economic revival came supply chain disruptions that were increasing during the Autumn of 2021 until they got out of control with the Russian military intervention in Ukraine.

The shortage of energy, raw materials and all kinds of products and services is not going to disappear in the short-medium term, in fact for many experts it is structural.

In this environment, only the coordination of business processes, based on the availability of accurate and real-time information on the status of these processes, can improve the level of service and reduce the waste of resources.

For all of the above, SAP Business Network for Supply Chain is going to have rapid acceptance, much faster than Mark Zuckerberg's Metaverse. It is in a position to offer what the market demands in a time of great need.

But this great initiative has a limitation, among the business partners that participate and collaborate, we will not find Financial Services providers.

The reason is the scant presence of SAP technology in banking and insurance corporations, which isolates them from business reality because they do not speak the same language. And it prevents them from being effectively integrated into the business processes of 70% of the World's GDP.

Our team detected this opportunity 10 years ago and we started working on the solution.

Optimizing solvency and liquidity requires synchronizing flows of consumption and generation of capital and liquidity, with business flows, sharing information that allows synchronization.

To do so, we follow the same logic that SAP has followed in its deployment in the real economy for the last 30 years. First we implement the SAP Banking processes, following the SAP Best Practices.

Second, we modeled the business processes of the real economy, in terms of generation and consumption of capital and liquidity, on SAP Banking systems.

In this way, we have the technology to proactively offer financial instruments, covering the capital and liquidity gaps of the business processes and optimizing the consumption of capital and liquidity of the system. 

Making an analogy, it would be like the Vendor Managed Inventory processes, typical of logistics, but adapted to the reality and constraints of Financial Services.

We are working on presenting our system to the market and looking for business partners and investors. If you are interested, do not hesitate to contact 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