Why Barclays is a good example of the Systemic Change?

Dear,
Some weeks ago it was announced that Barclays was going to reduce significantly its Investment Banking division and firing 7500 employees.

http://www.bloomberg.com/news/2014-04-23/barclays-may-cut-7-500-at-investment-bank-bernstein-says.html

Furthermore, the bank also announced that the new bank´s strategy will bring a workforce reduction of 19000 employees by 2016

http://www.theguardian.com/business/2014/may/08/barclays-to-cut-19000-jobs-scale-back-investment-bank-antony-jenkins

We also read that the Bank will park 90 billion Euros worth of risk-weighted assets from the investment bank in a bad bank.

http://www.reuters.com/article/2014/05/08/barclays-restructuring-idUSL6N0NU1LJ20140508

And finally, Barclays Chief Executive Officer of the Americas division and top-paid executive, Hugh McGee resigned some weeks ago because the bank´s focus is going to be regulation.

“My focus has always been on clients, but given the need for Barclays leadership to focus on regulatory issues for the foreseeable future, I have decided that it is time for me to move on”

http://dealbook.nytimes.com/2014/04/29/head-of-barclays-u-s-business-to-step-down/?_php=true&_type=blogs&_r=0

For understanding the recent events, we have to look at Barclays recent history.

On September 2008, Barclays tried to purchase the investment-banking and trading divisions of Lehman Brothers, but the acquisition was not approved by the British regulatory authorities.

As you know, Lehman filed for bankruptcy on September 15, 2008.

On September 20, 2008 Barclays acquired the core business of Lehman Brothers with the approval of US Bankruptcy Court, becoming a top player, in the selected club of Wall Street´s investment banks.

After 2008 financial crisis, following the governments rescue packages and central banks liquidity injections, results looked very positive for investment banks, including Barclays.

http://online.wsj.com/news/articles/SB10001424052748703581204576033514054189044

But unfortunately, this was never a conjunctural crisis, as others that the capitalistic suffered periodically on the 20th century.

This is a systemic crisis and is forcing a systemic change of the financial system.

Last year's Barclays' strategy has been making the bank growing, increasing its size and volume.

At the same time, the bank increased its Risk Weighted Assets and consumed Capital.

In the old model this would have been a successful strategy, but this is not the case anymore.

In the new model, a successful strategy must not target volume, but efficient capital management, this is the painful lesson that Barclays is learning today.

When Barclays executives decide to park 90 billion Euros in a bad bank (400 billion pounds on the next 3 years), they´re trying to reduce the capital consumed by those assets.

They know that capital is scarce and it will be more scarce in the next future. Consequently, reducing capital consumption becomes Barclays top priority.

Some days ago, I discussed about this with a good friend, who has an executive position in a middle size bank; he told me that the scenario is scary.

I agree, systemic changes can be scary; but they also come with opportunities.

SAP Banking is very well positioned to support banks transformation, according to the new challenges of the systemic change.

I´ve personally worked in the design of a Capital Optimization model, supported by Bank Analyzer technology, that will offer an answer to some of the challenges of the new financial system.

Scary? Maybe

Pessimistic? Never

Looking forward to read your opinions.
Kindest Regards,
Ferran.

Comprehensive Capital Assessment Review and Bank Analyzer – Chapter III

Dear,

Last weeks we looked at the Credit Risk module of Bank Analyzer and reviewed some of its competitive advantages for running the Comprehensive Capital Assessment Reviews that FED is running in the US banks, and ECB is running in the European Banks.

http://sapbank.blogspot.com/2014/04/comprehensive-capital-assessment-review.html

http://sapbank.blogspot.com/2014/04/comprehensive-capital-assessment-review_20.html

Amongst them, the main one is the holistic vision of Risk and Accounting that the Integrated Financial and Risk Architecture offers.

Today, we’re finalizing this collection of posts about the Comprehensive Capital Assessment Reviews, by looking at the final objective of the Capital Reviews.

Capital Reviews must measure the Capital Coverage of the bank, verifying if the Bank has a capital buffer, big enough for supporting stressed scenarios, like those suffered by the Financial System during the worst days of the 2008 financial crisis.

In case the analyzed bank has enough capital, there’re no more actions to be taken; but in case the bank is suffering a capital shortage, the regulatory authorities will take immediate actions for assuring the regulatory capital levels are recovered.

These recapitalization actions have an impact in the Banks reputation and reduce the stock value of the shareholders.

http://www.investmentexecutive.com/-/five-banks-fail-fed-stress-tests-         

As the systemic crisis evolves, capital requirements will become higher, making it more expensive; consequently shareholders will request higher returns on their investments.

On the other hand stocks value depend on the banks’ profits, and require the bank investing, and assuming risks, that will increase the bank’s Risk Weighted Assets and consumed Capital.

This is a difficult equation, executives have to optimize the return on bank´s investments, minimizing, at the same time, the capital consumed.

There’re many techniques and actions for Capital Optimization; a particularly relevant one is the optimal distribution of collaterals.

Basel agreements, including Basel III, recognize the importance of collateralization as risk mitigation technique for reducing the Capital requirements of the Bank. 

In the simplistic case, collateralization is built in a one-to-one relationship to the risk exposure, but in many cases, the relationship is established between several risk exposures and a collateral pool (containing several individual collateral assets).

In the second case, there’s an optimal distribution of the collaterals to the risk exposures, limiting individual over-collateralizations and assuring the reduction of the total capital requirements of the collateralized exposures.

The risk of the collateralized exposures and value of the collaterals change dynamically, as the probabilities of default, ratings and hair-cuts are dynamic magnitudes, dependent on the economic conditions of the business segments; consequently the optimal distribution of collaterals also changes dynamically.

Bank Analyzer Credit Risk supports (in the Level 2 of the Credit Risk calculation) the dynamic calculation of the optimal distribution of a collateral pool to the individual collateralized exposures, reducing the capital requirements (capital consumed).

This optimal distribution of collateral rights is the foundation of the Dynamic Collateral Management; a new discipline with a growing recognition in the last years.

We’ll talk about it in more detail in a future post.

Looking forward to read your opinions.

K. Regards,

Ferran.

Comprehensive Capital Assessment Review and Bank Analyzer – Chapter II

Dear,

Last week we briefly talked about the Comprehensive Capital Assessment Reviews that FED is running in the US banks, and ECB is running in the European Banks.

We also looked at the Integrated Financial and Risk Architecture of Bank Analyzer and how it can play a very important role in them, as a central repository of the credit risk exposures of a Bank.

http://sapbank.blogspot.com/2014/04/comprehensive-capital-assessment-review.html

As you probably know, the Integrated Financial and Risk Architecture provides an integrated framework to manage the Accounting and Solvency requirements of banks. 

This integrated framework of Accounting and Solvency is not just an elegant architecture, or a nice to have value proposition; it’s the foundation of any holistic capital optimization model. 

The Basel agreement recognizes explicitly the value of this integrated vision; but in general, this not very well known by the implementation partners and consultants, and what is worse, by our potential clients. 

This is an improvement opportunity; if we succeed in translating properly the technical advantages of Bank Analyzer as value propositions for regulatory fulfillment and capital requirements optimization, we’ll increase the chances of Bank Analyzer being chosen in front other competitors. 

Capital Assessment Reviews’ objective is demonstrating that the bank has enough capital to absorb the potential losses, protecting the bank’s depositors and economics stability.  

The Basel agreement determines potential losses of the Bank’s portfolio from the Value at Risk for a certain confidence level. The Value at Risk is divided in two statistical areas, called Expected Losses and Unexpected Losses.

Capital Optimization requires developing an statistically valid, risk management model, capable of reducing the Expected and Unexpected losses of the bank’s portfolio.

Expected Losses must be covered by Accounting Provisions and Unexpected Losses must be covered by capital, determined from the Risk Weighted Assets calculation.

Additionally, the International Financial Reporting Standards specify how banks must calculate their impairment accounting provisions.

And finally, the Basel agreement specifies that any shortfall in the accounting provisions for covering expected losses should be deducted equally from Tier 1 and Tier 2 capital and any excess on the accounting provisions will be eligible for inclusion in Tier 2 capital. 

The Basel agreement is telling us in the above paragraph that there’s a deep link between Accounting provisions and Risk Weighted Assets calculation, in order to determine the Bank’s capital requirements. 

Consequently, developing a complete optimizing model of the bank’s capital requirements requires a holistic accounting and risk management vision, precisely what the Integrated Financial and Risk Architecture of Bank Analyzer proposes. 

Let me end this post with an analogy, efficiency was not a concern for automotive industry while Oil was abundant and cheap. As Oil becomes scarce and prices raise, drivers demand efficient and hybrid cars. Cars manufacturers which have the answer to that market demand are transforming the automotive industry. 

After the financial crisis, fulfilling the regulation and reducing the capital requirements is a priority for banks’ executives. 

SAP has the business value proposition to answer this requirement and transform the industry, and it will do it; we just have to improve the way we communicate this value proposition.

Looking forward to read your opinions.

Kindest Regards.

Ferran.

Comprehensive Capital Assessment Review and Bank Analyzer – Chapter I

Dear,
A former colleague asked me last week if Bank Analyzer would be useful for the current Comprehensive Capital Assessment Review and Stress Tests that US Banks have passed recently.

You can find some information here
http://www.federalreserve.gov/newsevents/press/bcreg/ccar_20140326.pdf

This is, and it’s going to be, a very hot topic for all the Banks, and it’s important we all know the Bank Analyzer capabilities in this area.

Since 2008 Financial Crisis impacted the entire U.S. economy (actually the world’s economy), banks’ capital requirements have been the top’s priority for the regulators

Basel III, Dodd-Frank and EMIR, amongst other regulations, have increased significantly the Capital Requirements of the Financial System players; with the intention, at least theoretical, of preventing another collapse.

Determining the Capital Requirements of a Bank is a quite sensitive matter, low capital requirements incentive banks executives to take risks and increase the short term banks results, and too high capital requirements would reduce available capital to invest, impacting the bank’s results and economic growth.

The main objective on the determination of the Capital Requirements of a Bank is the calculation of its Risk Weighted Assets; remember that the Capital Requirements are defined as a percentage of the Risk Weighted Assets.

Determining the risk weighted assets is a challenging activity; there’re several accepted approaches (standardized, Foundation IRB, Advanced IRB) and the banks also have some flexibility in their implementation.

Determining the Risk Weighted Assets also require determining the Probability of Default and Rating of the counterpart.

And for making it a little bit more complicated; we also have to consider that the rating of a counterpart is a dynamic magnitude, which depends on the economic environment, and how it affects the business segment that the counterpart belongs to.

Determining the evolution of the rating of the counterpart means looking at the future, and as we don’t know the future, we have to create simulated “stressed” scenarios, and estimating the rating of the counterparts on those stressed scenarios.

Bank Analyzer has very powerful tools for calculating the rating of the counterparts on basis and stressed scenarios.

Typically, we have the Historical Database in which we can model the bank’s internal statistic models for estimating the current and future Probability of Default of the counterparts, by classifying them in business segments and looking at the past performance of those business segments.

Building integrated scenarios also requires a holistic vision of the risks and risk hedging strategies of our portfolio, and this is a very important value proposition of SAP Bank Analyzer.

In general, Banks are far from having a centralized and holistic repository of their risk exposures; on the contrary, their information systems have been built as a collection of silo-style systems with very poor, if any, integration.

Typically Banks have several repositories of risk; for retail banking, consumer loans, home loans, corporate banking, derivatives, etc.; all of them sustained by different technologies, with non-consolidated and non-homogenous master and transactional data.

Expecting an accurate determination of the Bank’s Risk Weighted Assets on these conditions requires a big deal of optimism.

On the contrary, Bank Analyzer has been built on the Integrated Financial and Risk Architecture, which is capable of managing holistically, all the Credit Risk Exposures of a Bank, and it’s meant to be capable of managing all the Bank’s risk and its accounting implications.

But I run out of space with this post, I’ll continue next week.

Looking forward to read your opinions.

K. Regards,
Ferran.

Single Euro Payments Area. Market concentration and SAP Banking opportunities.

Dear,

By August the 1st, 2014 all the Banking payments in Europe should be processed with the unified format of the Single Euro Payments Area.

The Single Euro Payments Area is an initiative of the European Union with the objective of simplifying the process of cross-border bank transfers denominated in euro, by creating common payment instruments in its area of application.

http://ec.europa.eu/internal_market/payments/sepa/index_en.htm

The final objective is turning the fragmented national banking markets of the Euro-zone into a single domestic one.

Most of the European credit institutions have successfully enhanced their payment systems on time.

http://www.bankingtech.com/210552/eba-clearing-reports-uptick-in-sepa-payments/

But SEPA's full implementation is just the beginning of this unification process; European authorities are already planning additional regulations on credit cards, risk management, etc.

By the autumn of this year the European Central Bank will become the principal supervisor of the credit institutions of the area.

http://www.ecb.europa.eu/ssm/html/index.en.html

The homogenization of processes and regulatory framework is reducing cross-border barriers and bringing new competitors into the domestic markets.

At the same time we’ll see how limited growth is driving margins down and increasing pressure for costs reduction.

In this scenario, a critical competitive advantage is developing economies of scale, standardizing processes and technology.

That’s the idea, efficiency, costs reduction. Once again, the driver of the new financial system emerging of this Financial Crisis will not be driven by volume, but by efficient management of the resources.

Additionally, capital scarcity due to the higher Capital requirements of Basel III, collateral requirements in the derivatives market, and limited growth of the developed economies will bring higher competition on the Capital Markets; and ultimately, new waves of concentration amongst financial institutions.

Does SAP Banking have the answer to these challenges?

Of course it does; SAP has demonstrated in the last 40 years to have the know-how for becoming the world’s leader on deploying integrated, cross-border, multi-language, multi-currency and consolidated information systems.

The consolidated approach is embedded in the SAP Banking architecture from many perspectives.

ECC system deployed multi-company, multi-currency functionalities many years ago, supporting smoothly integrated cross-border business process.

This approach is also incorporated to the SAP Banking business suite; for instance, Banking Services has no restrictions for supporting multi-company, multi-currency and cross-border functionalities; and Bank Analyzer, in combination with Business Planning and Consolidation, and the reporting capabilities of Business Information Warehouse has the capabilities for offering the consolidated vision of the Capital/Risk and Accounting position of a globalized Financial Group.

Keep the word in mind, Assets Consolidation.

Since 2008 crisis, and in spite of the bad reputation of the “Too Big to Fail”, we see that the number of players is being reduced, consolidating assets in bigger and bigger financial conglomerates, reducing operational costs and increasing their systemic influence.

Is there any difference between the old “Too Big to Fail” and the new “Consolidated” model?

Yes there is, the old model was driven by volume and the new one will be driven by efficient Capital Management. Size matters, but it’s not the key point here.

But this post has become too long, we’ll discuss about it another week.

Looking forward to read your opinions.

K. Regards,

Ferran.

Margin Debt. Subprime Crisis 2.0 - Chapter II

Dear,
Expansionary cycles of low interest rates and liquidity injections have the tendency of inflating economic bubbles. As the bubble inflates, positive perception of the investors keeps interest rates low, increasing leverage and rising markets valuation. 

Even when the spreads rise, ending the expansionary cycle, we don’t know how big the bubble is, we only will when the correction is complete, and the process can take months, even years.

It happened before and it will happen again. 

Remember that the subprime crisis started on February 2007 and we were not aware of its severity till September 2008.

We saw a couple of weeks ago, that some emerging economies have started the correction, as a consequence of the different perception on the interest rates evolution, triggered by US FED tapering.

http://sapbank.blogspot.com/2014/02/subprime-crisis-20.html

As in 2007, the general perception is that this is not that serious, US economy is performing well, and the Chinese real estate crisis is far from here.
Be careful with that feeling, don´t forget we’re in a globalized economy, in the middle of a systemic crisis; consequently what happens to one affects the system. 

Different economies make the crisis take different shapes, but the root cause is common, Capital Scarcity; and the solution has to be also global and coordinated.

Let’s look now at the symptoms in the developed economies.

A very interesting one is the total Margin debt level, which hit a historical record of $451B last January

http://video.foxbusiness.com/v/3323760203001/margin-debt-levels-hit-record-451b-in-january/#sp=show-clips

For those of you who are not familiar with the term, Margin Debt is the dollar value of securities purchased on margin within an account, and it’s a clear indicator of leverage levels and investors feelings. As the investors have positive feelings about the market evolution, they increase their leverage, buying securities at margin.

If the market perception changes, for instance, triggered by a rise of the interest rates, this huge margin debt will become a very large number of margin calls coming due, increasing the selling pressure and bursting the bubble. 

2008 subprime crisis was inflated by a long period of low interest rates; when the bubble burst, and with the intention of avoiding a global depression, Central Banks reduced interest rates, and injected huge amounts of liquidity in the Financial System.

Injecting liquidity for avoiding a depression is an old solution which worked in the past, when capital was abundant. 

Unfortunately, today we are in a new era of capital scarcity; a new era coming with new challenges, which require new strategies. In a capital scarce environment, injecting liquidity for preventing a depression, triggered by a debt crisis, it just makes the debt crisis bigger.

Someday we´ll see, that what Central Banks have done during the last five years, is trying to avoid a global fire with gasoline.

Last five years liquidity injections have delayed the depression and inflated a new bubble. 

When the new bubble bursts, it will be visible that capital is very scarce, even more scarce than five years ago.

The only alternative is building a new Financial System, with the priority of making efficient use of Capital, but transforming the Financial System is a herculean effort, and that´s why we are in a systemic crisis.

Looking forward to read your opinions.
K. Regards,
Ferran.

After ten years, now it's the time for SAP Banking

Dear,

Last week I talked to a friend who was one of the first Bank Analyzer consultants in Europe, but he moved to other businesses years ago.

He told me that SAP Banking has been just a hope for more than 10 years and he thinks that the situation is not different today.

I disagree; today we’re confronting a systemic crisis, forcing a much more stringent regulation, which is driving a profound change in the Financial System, from a business model based in Volume to a business model based in efficient Capital Management.

Today, and in the next years, SAP AG and the whole ecosystem of partners and consultants, have the opportunity to play a principal role in the systemic change,

During this month, we’ll see the strategy on the Assets Quality Review that the ECB is performing during 2014 in the European Banks. 

http://www.reuters.com/article/2014/02/03/us-ecb-banks-idUSBREA1200320140203

There have been previous audits of the solvency of the European Banking System, giving guarantees on the solvency of the Irish, Spanish, British, German, Greek banks…, and we discovered some months later that they were severely under-capitalized and had to be bailed-out.

This time is going to be different, it has to be different; today financial authorities have the protocol for shutting-down a non viable bank that has been “successfully” tested in Cyprus. They have the book and they’re going to use it.

After that, we all will be aware of what Capital means, what the consequences of its scarcity are and why it has to be managed efficiently.

For the last 7 years the center of my interests have been Capital Optimization; a wide discipline with implications in every corner of the financial system. You can find some ideas here.

http://blogs.sap.com/banking/tag/capital-optimization/

But the posts above are a very tiny description of the endeavor. From time to time I’m invited by some senior executives of Banks, (who have been reading my posts for a while, or know somebody who does) to share and exchange some ideas about Capital Optimization.

When I explained them that Capital Optimization is much more than Portfolio Management, and extend its implications to every activity, (from Loans Origination to Collateral Management, from Securitization to Payments Claim) requiring to be managed in a integrated model, they understand the size of the challenge and show their concerns about the feasibility of the objective.

I also understand the difficulties, but I’m also aware of the implications of avoiding the transformation. 

For those of you, who think I’m wrong, please remember the words of Michel Barnier (Member of the European Commission responsible for the Internal Market and Services).

 

"We need a new deal between financial regulation and society. A deal in which financial services are back at the service of the real economy. And at the service of citizens. Citizens who are also taxpayers. Those same taxpayers who are paying the bill of bailing out the banks. Citizens and taxpayers who have lost all trust in the financial system. Who don’t believe it works for them. And who won't forgive us if we don’t learn all the lessons of the crisis. And change what needs to be changed in the financial sector.This must be the starting point of any "new deal" between the world of finance and society: restoring trust"

 

 http://europa.eu/rapid/press-release_SPEECH-10-178_en.htm?locale=en

And now, tell me who can offer the technology infrastructure to put Capital at the center of the financial system, reflecting clearly the implications of the peripheral activities; from determining the Free Line of a non-fully disbursed loan in Banking Services, to reduce the rating of a counterpart, after an IRB estimation in the Historical Database of Bank Analyzer.

Explaining why SAP is the only software offering this holistic approach is the reason why I founded this community and the main objective of every post.

Looking forward to read your opinions.

K. Regards,

Ferran.