Understanding the Bank Analyzer - Results Data Layer. Chapter II.

Dear,
Last week, we look at the open architecture of the Results Data Layer, in terms of the opportunity it represents for integrating non-Bank Analyzer data which is required for Accounting or Capital Requirements purposes.

On the current stage of the transitionary period, this is a very important feature. There’re many reasons (economic, strategic, technical ...) why we’re having heterogeneous landscapes in the Banking Systems, with SAP and non-SAP components coexisting in the same technological infrastructure. On this environment, open architectures facilitating the integration between former silo-style components are a necessary requirement.

But on the other hand, and in the middle of the systemic change, the open architecture of the Bank Analyzer-RDL is an opportunity for implementing new integrated scenarios that were not feasible some years ago.

This year I've been collaborating part-time in an advisory role for a European client who implemented AFI some years ago and now it’s considering a Profit Analyzer implementation.

In this particular case, we analyzed the possibilities of calculating the process costs of impaired loans.
Simplifying; in addition to the process costs of a performing loan, impaired loans also generate additional process costs for the bank (dunning and collection costs, collateral liquidation costs, etc.).

The probability of Loan becoming impaired is represented by the probability of default of the counterpart. This means that the standard process costs are related to the probability of default of the counterpart, the higher the probability of default the higher the potential process costs.

Collecting the historical real process costs in the Controlling modules (Activity Based Costing, Cost Center Accounting, Profitability Analysis, etc.) is well known functionality of SAP-ECC.

The Bank has a very detailed analysis of its process costs, including Activity Based Costing models, supported with data collected by their CRM System and leveraged to the SAP-ECC Controlling Components. Amongst other parameters, the Bank is capable of capturing most of the process costs by client type.

By including the Rating of the Counterpart as a reporting dimension in Profitability Analysis we will get an accurate tracking of the real costs of the process costs according the rating of the counterparts, including dunning costs, collection costs, etc.

In the proposed model we would transfer the historical real costs to SAP Business Planning and Consolidation. From there we will build planning models for estimating the evolution of future process costs by counterparty ratings.

Finally, the calculated plan costs and the estimated standard costs will be transferred to the RDL for two purposes.

- Making the basis of the standard costs, escalated by counterpart rating, in the AFI sub-ledger.

- Tracking the dispersion between estimated planned process-costs, estimated standard costs and real costs, and consequently the accuracy of the standard costs.

This is just an example of the integration capabilities of the SAP Banking business suite, I’m sure that as the market comes with new requests we’ll find new opportunities to show them.

K. Regards,
Ferran.

Understanding the Bank Analyzer - Results Data Layer. Chapter I.

Dear,

One of the last components in joining the Layers architecture of Bank Analyzer has been the Results Data Layer (RDL), which is available since the Version 5.

When 7 years ago I was working in my first Bank Analyzer project, the system didn't have a Results Data Layer. The functions of storing results data coming from the Process and Methods Layer, was performed by the Results Data Base, which was an evolution of the component with the same name in SEM Banking.

At the time, we heard that with the new Bank Analyzer 5.0, the RDB was going to be replaced by a new component called RDL, whose main difference with the RDB is that the RDL supports the storage of non-Bank Analyzer originated data.

My first Bank Analyzer project was a Credit Risk/Basel II implementation in Bank Analyzer 4.2. When the project team heard about the RDL we saw it could be very useful for storing risk parameters (Loss Given Default, Exposure at Default, etc.) of risk exposures not-included in the scope of the project, and whose risk parameters, were not calculated by Bank Analyzer.

As the RDL was not available at the time we follow the work around of storing the data directly in the Operational Data Stores and Infocubes for the Basel II regulatory reporting of BIW; obviously with a much weaker level of integration.

The main priority for the Bank’s executives at the time was to get the approval by the audit authorities of the central bank. For the audit authorities there was no much difference in using the RDL or not, as they did not have the capacity of checking the source of the data provided in the reporting results.

Integrated systems, capable of offering reconciling functionalities between the Transactional and Analytical Banking systems, were not available at the time, and the capacity of the auditors for requesting these reconcilable reports was very limited.

This is one of the reasons while the Financial Situation is what it is, reconciliation capabilities between Analytical and Transactional Banking information are “control oriented” functionalities. We come from a Banking system driven by volume, in which capital consumption control was not the priority, with the catastrophic consequences we witnessed in 2008 and we’re still suffering 5 years later.

By the way, if we want make SAP Banking a successful business, we should educate the audit authorities about its reconciliation and reporting capabilities.

Remember; solvency is not only what it is, it is also what it looks like.

http://sapbank.blogspot.com.es/2010/07/stress-testing-what-solvency-is-and.html

After this first Bank Analyzer project I always have had the Results Data Layer available for the integration of accounting or credit risk data that for some reasons (project scope, technical limitations, etc.) could not be managed by the standard Bank Analyzer flow (Source Data Layer -> Process and Methods Layer -> Results Data Layer).

A typical example is the uploading Provision postings for Impaired Loans in the Bank Analyzer RDL. As previous versions of Bank Analyzer couldn't calculate provisions for impaired loans, we would calculate those provisions in the Reserves for Bad Debts module of IS-Banking, and upload the accounting postings of those provisions directly in the RDL. Consequently, the Bank enjoyed in the AFI sub-ledger the full vision of the Loans valuation, including impairment provisions.

Another example is the calculation of Hedge Accounting adjustments; valuation of Derivatives products and Hedge Accounting adjustments are initially calculated outside of Bank Analyzer and uploaded to the RDL; from there they enjoy the standard integration with the Financial Statements and the General Ledger.

But the open architecture of the RDL opens the gate for more challenging integration scenarios; we’ll talk about some of them next week.

K. Regards,
Ferran.

Collateral Mobilisation and Bank Analyzer Value Proposition.

Dear,

In a new era of Capital Scarcity, efficient management of any form of Capital is the most critical activity.

Collateral is a form of Capital, over-collateralized assets means having non-allocated capital. The new model comes with very limited growth potential and bringing any contribution to GDP growth, reducing the capital consumption will be the priority.

Bankers will be incentived to manage efficiently any form of Capital, including collateral, by the constantly higher capital requirements and limited growth and revenues potential.

We already can see this tendency, but it will grow as we cross the systemic crisis towards the new model.

A very interesting example of this tendency is a new discipline called Collateral Mobilisation

http://www.youtube.com/watch?v=mVcgRLqBOsM

We’ll look in detail at the Collateral Mobilization and its characteristics in a future post, but today, I’d like to focus in the important role SAP Bank Analyzer must play in this critical activity of Collateral Management efficiency.

As you probably remember we’ve commented in the past that we’re in a transitionary period of the Systemic Crisis.

Since Hank Paulson’s rescue package of 2008, followed by the unconventional monetary policies of the Central Banks, Financial markets have been flooded with Massive Liquidity Injections.

http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008

http://en.wikipedia.org/wiki/Quantitative_easing

Apparently, those liquidity injections have prevented the world to fall in a Depression, maintaining some level of stability in the Capital Markets.

But some authorized voices are warning that those measures have inflated another huge bubble whose burst can bring catastrophic consequences.

http://www.huffingtonpost.com/2013/10/14/nobel-prize-bubble-housing_n_4098409.html

We’ve already mentioned here last June speech of Mr Jaime Caruana, General Manager of the Bank for International Settlements; “Making the most of borrowed time”.

https://www.bis.org/speeches/sp130623.htm

Quantitative Easing of the U.S. Federal Reserve, bond-buying programmes of the European Central Bank and the Bank of Japan have only one purpose, maintaining some level of stability in the Capital Markets, giving time to the construction of the new Financial System. In Mr. Jaime Caruana’s words, they are just borrowing time.

But those measures have also accelerated the un-sustainability of the debt bubble bringing the unconventional monetary policies close to the end.

http://www.economist.com/content/global_debt_clock

Either the end of the unconventional monetary policies bring the burst of the Capital Markets bubbles or the authorities succeed in deflating them; in both cases, we’ll see at the time how the lack of solvency in the Financial System becomes visible, drying massive amounts of liquidity from it.

On this scenario, it will be necessary enjoying a system for mobilising any form Capital in order of allocating it efficiently.

The key word is eligibility; mobilising capital (or collateral) means transporting it from where it lies to where is needed; meaning, trading collateral for cash or another underline.

But solvency also means confidence; and consequently, capital scarcity will come with lack of confidence.

In an environment of distrust, making collateral eligible for mobilisation will require proving its core value, and here comes the value proposition of Bank Analyzer, certifying and improving the eligibility of the Bank’s collateral.

Once again, Bank Analyzer is not only about providing regulatory reporting, its competitive advantage comes from its disclosure capabilities and they are going to be very valuable in the new model.

Looking forward to read your opinions.

K. Regards,

Ferran.

Margin Calls - Collaterals Management and Bank Analyzer Part III

Dear,

As you probably know, SAP Bank Analyzer does not have yet, the recognition it deserves in the Investment Banking industry.

Ironically, it could be a very powerful element of an Investment Bank IT landscape, particularly in combination with other SAP Banking components.

A very interesting example is the management of Margin Calls.

Margin Calls are a very critical requirement in Investment Banking and Capital Markets trading.

Simplifying, the business scenario is as it follows.

Brokers demand investors collateralize their exposures in order to open a position. For keeping the position opened, the broker will require a specific level of collateralization ratio to be maintained (this is a regulatory requirement in most of the jurisdictions).

During normal operations the fair value of the position and the collateral fluctuate every day (actually, every second). If the fair value of the position or the collateral drops, reducing the collateralization ratio below a determined level (called maintenance requirement), a “margin call” will be triggered, requesting additional guarantees to the investor.

If the investor fails to provide the additional guarantees, the broker will close the position.

The question is; does Bank Analyzer have strong functionalities for covering the "margin call" requirements of an Investment Bank?

If we check the Bank Analyzer menu, we will not find any “margin call” transaction (actually we can find it in SAP-TRM).

On the other hand, if we look at the detailed requirements of a margin call scenario, we’ll see that we can handle it by combining the functionalities of several SAP Banking components, even more efficiently than what best of breed trading products can offer today.

We saw some weeks ago, how Bank Analyzer can make an accurate calculation of Financial Collaterals.

sapbank.blogspot.com/2013/10/collaterals-management-and-bank.html 

Let’s see how to run an enhanced calculation of the collateralization ratio.

Most of Trading Systems determine the minimum collateralization ratio as a quotient between the collaterals fair value and the exposures at risk.

This is an incomplete model because it does not include the Probability of Default of the counterpart, and it does not seem logical to request the same level of collateralization to a risky and a very reliable investor.

Basel II/Basel III agreements give us the foundation for and enhanced calculation of the Collateralization level, which should estimate the Loss Given Default and Probability of Default of the exposure, which depend on the Rating of the Counterparty (Advanced IRB).

The main advantage of this “enhanced” calculation of the collateralization ratio is efficient Capital Management; remember that Collateral is a form of Capital.

Once again, we’re in the middle of a Systemic Crisis which is transforming the Financial System from a business model based in Volume to a business model based in Efficient Capital Management.

Bank Analyzer-Credit Risk Analyzer supports the calculation of LGD and PD parameters according to the Advanced IRB approach, which is the foundation for the enhanced calculation of the collateralization ratio.

Once we’ve calculated the LGD and PD with Bank Analyzer-CRA, determining the enhanced collateralization ratio, and triggering margin call alerts are just reporting requirements, is supported by the reporting functionalities of Netweaver.

I’m aware that the enhanced calculation of the collateralization ratio with Bank Analyzer-CRA presents some performance challenges for big portfolios in very dynamic trading markets, but this is the added value of including SAP-HANA into the landscape.

At the end, we’re talking about Efficient Capital Management, the driver of the new Financial System.

Looking forward to read your opinions.

K. Regards.

Ferran.

I wish it were your decision Mr. Bernanke – Chapter IV

Dear,

While I’m writing this post, the main concern of the economic world is a political agreement; will politicians raise the US debt ceiling or will they force the government default?

http://www.bbc.co.uk/news/business-24511283

I don’t think we’re going to see a US default this week, because nobody is interested in bursting the US debt bubble yet. But that’s not the question. The question is; can US politicians prevent the default, just by increasing the leverage?

Of course not, according to www.usdebtclock.org, the US national debt is approximately 17 trillion USD (148.000 USD per taxpayer), and more important, US interest payments in 2013 will be 2.8 trillion USD (24.000 USD per taxpayer).

What the debt levels are showing us is the exhaustion of an economic model based in wasting capital, and increasing the debt ceiling means buying time while we build the new model based on efficient capital management.  At this point, it’s very recommendable to read last June's speech of Mr. Jaime Caruana, General Manager of the Bank for International Settlements.

http://www.bis.org/speeches/sp130623.htm?ql=1

But are the economic elites actually making the most of borrowed time?; what concrete actions are being taken towards the new paradigm?

Just an example; while everybody is looking at Washington, hoping for an agreement between democrats and republicans, much more important decisions are taken at the other side of the world.

http://www.reuters.com/article/2013/10/10/us-ecb-china-swap-idUSBRE9990A220131010

US dollar has been a key player on the economic model that western world has enjoyed since the Great Depression and the end of the Second World War, and since then, it has become the international trade and reserve currency.

But the end of the model comes in parallel with the fall of the preponderance of the US currency; as investors become concern about the solvency of the FED, a new multilateral model shows up.

Since the starting of the Financial Crisis on 2008, FED balance sheet has grown from 1 to 3.5 trillion USD (1 trillion in MBS’s). What’s the risk and capital consumption associated to this exposure?

http://blogs.wsj.com/economics/2013/09/17/a-look-inside-the-feds-balance-sheet-16/tab/interactive/

While the European Central Bank and the People's Bank of China make movements, addressed to replace the USD in their trade relationships, they’re also building the foundation of a new international currency system.

European and Chinese central banks are building a stability framework for Forex risk limitation on their bilateral trade (by the way, reducing capital consumption), and implicitly, limiting trade unbalances to sustainable levels.

Once again, we’re moving from a financial system based in volume, to a financial system based in efficient capital management.

The new currency system was already recommended by the International Monetary Fund in 2010 in order of assuring world’s financial stability.

http://www.imf.org/external/np/pp/eng/2010/041310.pdf

Financial stability is the key; growing by wasting capital and injecting liquidity, with no collateral support, will be visibly unsustainable very soon, and it will painfully give birth to the new model.

Signs are already there, but we prefer to believe that everything is a political game, and the agreement between the Tea Party and the Obama administration will solve our problems.

Sometimes reality is so hard that we prefer dreaming, till somebody else wakes us up.

Looking forward to read your opinions.

Kindest Regards,
Ferran.

Over the Counter Derivatives, Capital scarcity and Collateral Management.

Dear

As you probably know, one of the major exponents of the current debt bubble and responsible of the 2008 Financial Crash are the Over the Counter Derivatives.

These Financial Contracts are just bets on the fluctuation of a Financial Parameter, called underline (Stock Market Indexes, Foreign Exchange Rates, Interest rates, Commodities Prices, etc.).

Over the Counter Derivatives were responsible of one of the worst moments of the 2008 Financial Crisis when on September the United States Federal Reserve Bank injected 85 billion USD to prevent the AIG’s collapse. This is the largest government bailout of a private company in U.S. history.

Just for giving you an idea of the size of the OTC Derivatives bubble, according to the estimations of the Bank for International Settlements (Central Bank of the Central Banks), the OTC derivatives market has a nominal size of more than 600 trillion USD, approximately 10 times the world’s GDP.

The danger of this bubble is very well known; for instance, on 2002 Warren Buffett called them “Financial Weapons of mass destruction”.

On the 2009 summit in Pittsburgh, G20 leaders agreed the regulation of the OTC derivatives market.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=auIe3UTJncpY

Unfortunately, today's situation is not much better than in 2008, the destructive capacity of the derivatives market is even bigger than it was at the time, and the everyday closer rising of the interest rates has the capacity of bursting the bubble.

On a recent speech, Mr. Stephen G Cecchetti, Head of the Monetary and Economic Department of the Bank for International Settlements advocated for the regulation of the OTC derivatives market.

http://www.bis.org/speeches/sp130912.pdf

He also mentions the concerns among the banking community about the collateral restrictions generated by the implementation of the regulation.

This is a wrong perception, collateral scarcity is not a consequence of the regulation; it just makes it visible. The chain of events is as it follows.

1)      Growth rates are going to be lower due to natural resources scarcity and global debt.

2)      Low growth rates produce capital scarcity.

3)      Capital scarcity requires managing it efficiently.

4)      Stringent regulation and higher collateral requirements reduce free capital available to invest, and drives efficient Capital Management.

Don’t forget that collateral is just a form of capital, and efficient capital management requires efficient collateral management.

In the meantime, the most urgent concern is deflating the derivatives bubble before it bursts. As you could see in the last weeks, keeping the interest rates low is more difficult every day, and rising interest rates are one of the most dangerous scenarios for debt bubbles, including derivatives bubbles (which are just another form of debt).

For giving some hints of the magnitude of the problem, consider this.

On 1929 Financial Crisis which triggered the great depression there was no such thing as derivatives, just debt and stocks.

The total value of the United States stock market is estimated at 23 trillion USD, while US banks have exposures in derivatives markets by 223 trillion USD

http://www.forbes.com/sites/halahtouryalai/2013/03/28/risk-is-back-americas-big-banks-are-knee-deep-in-derivatives/

When the new deal bailed out the US economy, the national debt was only 16% of the annual GDP while today is over 100% of annual GDP.

The only option is Efficient Capital management and efficient collateral management is one of its components.

During this month I’m going to focus on the SAP Banking capabilities for efficient collateral management, I hope this post gives an idea of the necessity of making it happen.

Looking forward to read your opinions.

K. Regards,

Ferran.

Collaterals management and Bank Analyzer - Chapter II.

Dear,

Last week we discussed the importance of a centralized and integrated management of the Bank’s collaterals.

http://sapbank.blogspot.com/2013/09/collaterals-management-and-bank.html

Today, I’d like to look specifically at the issues and requirements on the valuation of Collaterals, particularly Financial Collaterals.

Valuation of collaterals is a critical issue in Collaterals Management; any hair-cut damaging the value of the collateral will penalize its capacity as a risk mitigator, and it will increase the potential losses of the Bank, and its Capital consumption.

We have two types of Assets that can be used as Collaterals, Physical and Financial (Non-Physical).

SAP Collaterals Management has powerful functionalities for determining market and lending values of the collateral from external valuations. ,

But for the valuation of Financial Collaterals, SAP-CMS offers us another excellent opportunity of integration with other SAP Banking components.

Bank Analyzer is a very detailed and sophisticated tool for valuating Financial Transactions and Financial Instruments. Additionally, valuations are always opinions; even regulatory valuations can be different (IFRS, US-GAAP, etc.).

Integrating Financial Collaterals objects with the multi-accounting valuation functionalities of Bank Analyzer will give us a detailed and complete tool for valuating them.

More importantly, integrating Collaterals Management with the risk management tools of Bank Analyzer (Strategy Analyzer) and future Analyzers (ALM) will leverage those functionalities for valuating Financial Collaterals on stressed and simulated scenarios, and estimate potential hair-cuts.

You’re probably aware already of the advantages in terms of Total Cost of Ownership and Single Truth DataSources for the Bank, of the integrated architecture proposed above.

But this is just the beginning, as we move deeper into the Financial Crisis and the Financial System feels the scarcity of Capital, we will discover new advantages on having a holistic vision of Collaterals Management, integrating the Transactional and Analytical Banking scopes.

For instance, as the Basel II and Basel III agreements recognize, there’s an optimal distribution of Collateral bundles to exposures which minimizes the Capital Requirements for the portfolio of assets.

Actually, the Credit Risk Analyzer of Bank Analyzer supports this functionality on the Level 2 of the Capital Requirements Calculation; this is the foundation of a Capital Optimization technique called “Dynamic Collateral Management”.

Reducing Capital requirements the Bank achieves better Capitalization ratios, and consequently lower Cost of Capital (the less risky investment, the lower the capital cost) and new investment opportunities, as better capitalization also means the opportunity of allocate the free capital in new exposures.

This is just an example, the new Financial System, driven by the new paradigm of Capital Management efficiency, will require holistic information systems which assure the optimal utilization of the banks’ capital.

As I mentioned in the past; Capital Optimization is not just a portfolio management activity, it involves the whole Bank, and requires a seamless integration between the Transactional and Analytical Banking information systems,

With these premises, I don’t think any software company is in the position of competing with SAP for offering the required holistic vision and seamless integration between the Banking Information System components that the new Financial System is going to demand.

Looking forward to read your opinions.

Kindest Regards,

Ferran.