Dear colleagues,
The energy crisis that is manifested in the increase in prices is weakening growth and the generation of capital. Additionally, excess debt, the largest in history, is overconsuming capital.
If capital is overconsumed and not regenerated at the same rate due to weak growth, capital becomes scarce. And capital is the most important resource of the Financial System.
As capital becomes scarce, the efficient management of all forms of capital is becoming increasingly important.
A valuable form of capital is collateral; collateralization of exposures is one of the main risk mitigation techniques as it reduces capital consumption and provisions amounts for counterparty and market risk exposures.
But collateral management is an activity poorly executed by the majority of banks, which represents an opportunity to generate a competitive advantage for those who improve the management of their collaterals.
There are multiple reasons why collateral management is inefficient. The most visible one is that collateralization agreements are potential assets of the bank that only become effective in the case of default of the counterparty and the implementation of the guarantees. In the meantime, it is only shown in the Financial Statements by reducing the amount of provisions, and in some cases, although rare, as off-balance sheet entries.
As the vast majority of the bank's Information Systems position the General Ledger at the main source of their analytical information. And as I said before, the Financial Statements do not allow a precise representation of the collateralization agreements, all collateral management activities end up being improvable.
The SAP Integrated Financial and Risk Architecture is a much more robust architecture for representing a bank's rights, obligations, assets, liabilities, and solvency statements, including collateralization agreements. But describing the SAP Integrated Financial and Risk Architecture is not the objective of this article. If you are interested, you can find some references to it in previous articles of my blog and it is a topic that I will return to in the future.
Any inventory of best practices for efficient collateral management and capital optimization should include collateral mobilization. And what is collateral mobilization?
Collateral mobilization is a two-step activity.
1) Identification of the eligible collateral.
2) Efficient allocation of collateral to exposures.
Identification of eligible collateral requires deep integration of the bank's collateral management system and the customer information system. The technical attributes of the assets that can be used in collateralization agreements will determine their fair value, foreseeable evolution, potential haircuts and behavior in stressed scenarios.
Once identified the eligible collateral with an accurate description of its main attributes, the second step of collateral mobilization describes how to efficiently allocate the collateral portions to the exposures.
Collateralization of exposures reduces capital consumption up to a maximum level at which the exposure is overcollateralized and allocating more portions of collateral does not produce a further reduction in capital consumed.
This collateral surplus could be utilized more efficiently by allocating it to other undercollateralized exposures, reducing the bank's total capital consumption. This is a functionality that, if properly implemented, is provided by the SAP Bank Analyzer Credit Risk System. It is also known as dynamic collateral management, and I wrote about it in previous articles that you also can find in my blog.
As capital requirements become increasingly stringent and growth and income potential remain limited, return on assets weighted by capital consumption becomes very challenging. This trend is already becoming visible and will continue to grow as the systemic crisis evolves.
In this challenging environment of capital scarcity, bankers will be incentivized to manage efficiently all forms of capital, including collateral. Collateral mobilization reduces provisions and capital consumption, and also releases bank’s resources for further investment, improving return of assets weighted by capital consumption. A very good reason to be in the strategic agenda of the bank’s executives.
We are at the last steps of a transition period from a model of strong growth and limited debt to a model of limited growth and excess of debt. Massive injections of liquidity following 2008 bailouts and unconventional monetary policies by central banks have helped maintain some level of stability in capital markets.
Unfortunately these actions have just delayed the effects of the capital crisis paying the price of even higher levels of debt over consuming capital and natural resources scarcity weakening the economic growth and capital generation.
As financial stress grows up, the ability to efficiently manage capital, including collateral, is becoming increasingly important. SAP Banking value proposition lies in its ability to certify and improve the eligibility of a bank's collateral and the efficient distribution of collateral portions to exposures providing the necessary process and technology for collateral mobilization.
Finally, SAP Banking competitive advantage comes not only from its ability to meet regulatory reporting requirements, but also from its disclosure capabilities. These capabilities will be invaluable in the new environment of capital scarcity that will emerge from this systemic crisis.
You are not as solvent as you are but also as your counterparties recognize you are.
This is just an example of the competitive advantage of SAP Banking for the management of collaterals and a brief description of its potentialities.
These potentialities are the guidelines followed by our team in the construction of our Capital Optimization system, built on top of the SAP Integrated Financial and Risk Architecture.
Our Capital Optimization system “speaks” with the business processes of our clients' SAP Systems (70% of the world’s GDP) translating them in terms of Capital and Liquidity generation and consumption. With this information the Capital Optimization system measures the deficits and surpluses of capital and liquidity of the business processes and 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
I look forward to reading your comments.
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
