Next Sunday European Banks Stress Tests and SAP Banking value proposition.

Dear,
Next Sunday October 26th, 2014 at 12:00 PM (CET) the European Central Bank (ECB) will make public the results of its assessment, checking the health of the 130 biggest banks of the euro area.

https://www.ecb.europa.eu/press/pr/date/2014/html/pr141010.en.html

Controlling the solvency of the financial system is the main responsibility of a bank’s supervisor. If he detects that a bank is undercapitalized, immediate actions must be taken, from requesting its recapitalization or blocking the bank’s dividends policy, till forcing its liquidation.

The regulatory capital that a bank must hold is a percentage of its Risk Weighted Assets, which must be big enough for covering future losses generated by borrowers not fulfilling their obligations. Currently, the regulatory capital calculation is determined by the Basel 3 agreement; but both, the required percentage of the Risk Weighted Assets and its calculation has changed over the time.

http://www.bis.org/bcbs/basel3.htm

We’ll analyze in a future post why the measuring of solvency has changed over the years, but today we’ll look at the difficulties of performing this calculation.

Calculating the Risk Weighted Assets requires looking at the future, and building a statistical model for determining the probability of default of the bank counterparts (PD), the bank’s exposure to the counterpart at the moment of default (EAD), and the share of the asset that is lost when the counterpart defaults (Loss Given Default).

Let’s have a look at the main challenges of the European case, there’re two difficulties for achieving efficient and comparable results of the capital analysis.

- Different national regulations. For instance, every country has different insolvency, liquidation and debt restructuring regulations. This has a direct impact in the value of the collaterals, the EAD and the RWA.

- Technical difficulties.

The first point requires European coordination for establishing a single regulatory framework; this is happening already, and it will be reinforced by the ECB, as it becomes the unique supervisor in the Eurozone.

The second point is the most interesting, even if the regulation requires more transparency (and it will); providing this transparency today is technically impossible.

We mentioned above that the RWA calculation relies in a statistical model; which as any statistical calculation requires looking at a sample data whose behavior can be extrapolated to a bigger group.

Current banking systems are running on obsolete and non-integrated technologic infrastructures with heterogeneous data-models. Building statistically reliable models in these conditions is simply impossible.

Most, in fact all, banks use simplifications for covering the lack of accurate data for building their statistical models.

This is what the FED said about these models, after reviewing this year US banks solvency tests.

“Banks made assumptions that weren't always well documented or supported, did only cursory validation checks in some cases, and made assumptions without knowing if they were doable”

http://www.reuters.com/article/2014/10/17/us-banks-fed-stresstests-idUSKCN0I626Q20141017

This is the main competitive advantage of SAP Banking; a holistic and deeply integrated information system capable of supporting accurate and transparent capital calculations.

In a financial system of scarce capital, what could be more important than managing it efficiently?

We’ll analyze this value proposition in detail in future posts; but for the moment, let’s wait for the results of next Sunday solvency tests, I think they’re going to be interesting.

Looking forward to read your opinions.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
K. Regards,
Ferran.

Active Risk Management with SAP HANA and Bank Analyzer.

Dear,
As technology and globalization of the Capital Markets incentives Financial Innovation, new activities are becoming popular, a particularly interesting one is the concept of Active Risk Management.

Active Risk Management objective is improving the performance of a portfolio with dynamic trading and use of derivatives.

The basic idea is looking at the market continuously searching for arbitrage opportunities and taking positions anticipating the market’s behavior.

Historically SAP Banking has not had a strong position as an Active Risk Management platform. 

Active Risk Management requires very fast simulation functionalities, as the main driver of this discipline is anticipating market’s decisions. 

Obviously this only can be achieved by running statistical computer simulations and building market behavior patterns which support the decision making process.

Those of you who have had exposure to Bank Analyzer, know that it’s far from being a fast system as it requires a high level of data accuracy for running the standard calculation processes. 

On the contrary, Active Risk management requires very quick decisions, supported by decision taking models based on limited and fast changing information. 

Simplifying, Bank Analyzer looks at the sustainability and long term performance of the bank’s portfolios, while Active Risk Management looks at the real time market opinion about the potential value generation of the portfolio components.

But today, the scenario is ready to change, impacted by two forces; new regulation and breakthrough technology.

Since 2008 Financial Crisis, new banking directives regulating financial instruments trading have been constantly increasing liquidity and capital requirements that financial institutions participating on trading
markets must fulfill. Typical examples are the European Market Infrastructure Regulation

http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm

and the Dodd-Frank act (particularly Chapter VII) in the US.

http://www.sec.gov/spotlight/dodd-frank/derivatives.shtml

The US and European regulatory framework present relevant differences, but they coincide in two principles.

- Increase Capital requirements to financial institutions participating on derivatives trading.

- Incentive central cleared trade of derivatives with higher requirements of disclosure, collateralization and supervision.

On the side of technology, SAP is delivering new HANA Powered components which increase significantly their performance. For example; stress testing simulations which could take hours with previous Bank Analyzer releases, can be run in minutes taking advantage of the In-Memory computing paradigm.

The combination of both drivers, regulation and breakthrough technology, is going to be a very relevant competitive advantage for SAP Bank Analyzer, when it comes to future Active Risk Management initiatives.

SAP Banking has the holistic data model for being compliant with more stringent regulatory requirements; and with HANA, it enjoys a new technology for speeding statistical simulations on fast changing environments.

We’re at the beginning of the transition period; as the financial system travels to the new model, regulation will become more stringent, incentivizing efficient capital management and penalizing speculative trade. 
In this scenario, the combination of the Analytical Capabilities of Bank Analyzer powered by SAP HANA will close the gap between regulatory requirements and business needs. 

I tried to explain it in a post nearly 3 years ago.

http://blogs.sap.com/banking/2012/02/01/capital-optimization-sap-hana/

SAP HANA is not about doing the same things faster, it’s about doing new things.

Looking forward to read your opinions.

Join the SAP Banking community at: http://www.linkedin.com/e/gis/92860

K. Regards,

Ferran.

Accounts Receivable Securitization with SAP Bank Analyzer. Chapter II

Dear,

As we saw in the previous post, capital scarcity is incentivizing securitization as an alternative to banking credit which is becoming very expensive in the current economic environment.

We also saw that new regulation is increasing the reporting requirements in the securitization industry.

http://sapbank.blogspot.com/2014/10/accounts-receivable-securitization-with.html

Today, we’ll see how we can combine several SAP components to build a holistic and efficient securitization process for accounts receivables.

The process starts with a standard sales and invoicing process in SAP-ECC Sales module.

For building the securitization process we must integrate the sales invoices as a Financial Transactions in the Bank Analyzer Source Data Layer. The Financial Transaction Cash-Flows will be determined from the Invoice Amount, Invoice Date and Payment conditions.

The counterparty of the Financial Transaction is the invoice payer, and we’ll read his rating from the Credit Risk data of the business partner in SAP ECC.

Once the invoices (or more exactly invoices items) have been modeled as Bank Analyzer Financial Transactions, we will use the Risk Engines of Bank Analyzer for generating the reporting requirements, and prepare the pool of loans according to the definition of the securitization tranches.

The AFI and Credit Risk modules of Bank Analyzer are an excellent base to support the analysis of the account receivables (modeled as Financial Transactions) that the company is going to securitize.

Once the securitized pool of assets is transferred (sold) to the Special Purpose Vehicle, we will use the Treasury and Risk Management module of SAP ECC for building the securities (assets backed by the securitized account receivables). Management and trading of the securities is fully supported by the Treasury and Risk Management module of SAP ECC.

In real life, a portion of the customers will fail to fulfill their obligations. The relevant information (rating) will be transferred from Credit Risk to the Bank Analyzer system, and the Bank Analyzer risk and price engines will calculate the loss of value on the account receivables. This valuation is the basis for determining the value of the securities, and drives the dividends payment, according to the securities conditions (interest rate, tranches, priority, etc.).

Building this process with SAP components has several advantages.

Many corporations, which are starting to securitize accounts receivables for covering their financing requirements, are long term users of SAP Sales, and Accounting modules.

For years, they have collected the credit risk information of their clients, which is the basis information for determining the customer rating, build the assets tranches and calculate the value of the securitized assets.

As the securitized assets (accounts receivables) have been integrated in Bank Analyzer, the company will enjoy all the Bank Analyzer functionalities for fulfilling the regulatory reporting requirements. They’re modeled as Financial Transactions, fully integrated in the standard Bank Analyzer data-model, so from Bank Analyzer perspective there’re no technical limitations.

Finally, if the company integrates all the account receivables and sales invoices in Bank Analyzer, it will have the capacity of comparing their securitization costs with the cost of capital of non-securitized assets.

Remember, capital scarcity is driving a systemic change in the whole economic system and Bank Analyzer is very well positioned to manage and optimize capital in multiple business scenarios.

I’ve been working for the last 7 years in analyzing and designing capital optimization models by using Bank Analyzer functionalities, and I will share with you in future posts.

Looking forward to read your opinions.

K. Regards,

Ferran.

Accounts Receivable Securitization with SAP Bank Analyzer. Chapter I.

Dear,

The main consequence of the Capital scarcity, and main trigger of the economic crisis which has followed the 2008 financial crisis, it is lack of credit. 

Credit is the most important capital allocation mechanisms in a modern economy. Quoting Ben Bernanke: “Credit has the ability to build a modern economy, but lack of credit has the ability to destroy it”

That’s the trigger of the current crisis, and the main constraint of the economic model that will emerge from it. As capital scarcity is not a temporary fashion, the financial system will be reshaped for offering alternative and more efficient capital allocation mechanisms.

A particularly relevant one is securitization, which is becoming a popular alternative to the scarce banking credits. 

Securitization has been used traditionally for allocating capital supported by many types of assets; mortgages, auto-loans, credit card debt obligations, etc.

But the tendency is to use it with many other assets. Today, we will see how many corporations are securitizing their receivables as a mechanism for financing their operations.

Trading receivables for cash is nothing new, corporations used to sell their receivables, with a discount, to factoring companies (or factoring divisions of banks). Unfortunately, in the current economic environment, the mechanism has become very expensive limiting its use.

On the other hand, replacing factoring with securitization presents difficulties too. Since 2008 financial crisis securitization industry has been seriously damaged, and only in the last months has experienced some recovery (influenced by the low interest rate policies of the last years).

For details, I recommend you to read the following paper of the OECD.

http://www.oecd.org/finance/financial-markets/48620405.pdf

As the low interest rates policy is not sustainable in the long term, new regulation is being proposed and implemented in order of making securitization more attractive to potential investors.

For details, it’s very recommendable the following report of the Bank for International Settlements.

http://www.bis.org/publ/joint26.pdf

For those of you, who don’t have the time to read the above documents, let me give you a brief conclusion.

Securitization industry is requiring a more stringent regulation and higher levels of disclosure and transparency for playing its role in the new environment of capital scarcity and limited economic growth.

That’s exactly what we can offer with Bank Analyzer; a robust technology framework for fulfilling the new regulatory requirements of the securitization industry.

As corporations use securitization will be required to comply with the regulatory framework of the industry, and software capable of fulfilling the regulatory reporting will be required.

The main difficulty is integrating non-banking sales and invoicing processes into the Bank Analyzer architecture. 

We already saw in previous posts that Bank Analyzer can be used by non-financial companies. 

http://sapbank.blogspot.com/2014/01/bank-analyzer-for-non-financial.html

http://sapbank.blogspot.com/2014/01/banking-and-trading-bank-analyzer-for.html

In a future post we’ll see how to integrate sales invoices in Bank Analyzer, so we’ll have all the necessary data for utilizing the system functionalities for supporting securitization requirements. 

At this point, let me remind you that the challenges of the capital scarcity are not limited to the financial system, but they impact the whole economy. As a consequence, the whole economic system that will emerge from this crisis will be driven by the efficiency paradigm.

Looking forward to read your opinions.

K. Regards,

Ferran.

Fees management and business transformation with SAP Banking. Chapter II.

Dear,

The traditional shape of the Financial System is being challenged by two drivers; capital scarcity and new business models facilitated by the technology revolution.

We saw last week how Banking fees are an example of the transformation from both perspectives; regulation and new competitors with alternative value propositions.

http://sapbank.blogspot.com/2014/09/fees-management-and-business.html

But the question remains, what are the traditional banks alternatives in the new scenario?

For answering the question we must remember that in the new environment capital is scarce, and whatever action we take it must be aligned with the principle of efficient capital management.

When banks executives plan to generate profits by providing a service to their customers, they must weight them with the cost of the allocated resources. Consequently, determining accurately service costs becomes a priority.

I mentioned last week, that SAP can offer best of breed functionalities for analyzing and tracking banking services costs; this is the basis for calculating the margin of the service, expected profits and return on the allocated capital.

In a financial contract, like a customer account, multiple services are provided, by internal and external service providers. Let’s have a look to some of them and the costs involved.

- Maintenance of the customer account provided by the customer account manager, or other Human Resources, supported by processes and technology.

- Withdrawal of cash in an ATM machine (from the bank or a third party bank). This means that the bank will support maintenance costs of its ATM machine or fees from another bank.

- Overdrawn facility, meaning that the bank has to allocate capital and liquidity for fulfilling the service.

Let’s have a look at the tools provided by SAP Banking for managing these scenarios.

Cost of processes.- We have several typologies that must be analyzed with different approaches.

Human resources costs can be direct like the bonus of the account manager, or indirect like call center manpower. In both cases the Management Accounting modules of SAP ECC, including Cost Center Accounting, Activity Based Costing will support the determination of the costs and consequently margins and profitability.

Assets amortization, including hardware, software, buildings, can be accurately calculated with ECC modules like Assets Accounting, and the ECC Controlling modules.

Data extracted from the calculations above will support the estimation of a tariff based standard cost that we can include in Bank Analyzer for determining process costs on contract level.

Fees cost from another bank can be posted directly on contract level (if provided by the billing interface with the third party). Additionally the withdrawal could happen in foreign currency, triggering P&L effects due to forex fluctuations between the withdrawal posting date and the clearing date with the third party bank. The whole construction is supported by Bank Analyzer AFI and Profit Analyzer.

Capital and funding costs (including impairment costs) related to the overdrawn facility are fully supported by the AFI and Profit Analyzer modules of Bank Analyzer.

All the above is just a brief description of the functionalities provided by SAP Banking, real scenarios are more challenging and interesting.

Looking forward to read your opinions.

K. Regards,

Ferran.

Fees management and business transformation with SAP Banking. Chapter I

Dear,
One of the main complains that consumers have about their bank is its fees policy.

When the customer is charged with fees, he requests to talk to a banking representative about it, he tries to get the fee reversed; and if this is not possible, he wants at least a reasonable explanation of the logic behind it.

On the other hand, management of fees is becoming a part of the bank’s revenue, particularly as very low interest rates and slow economy are making challenging for many financial institutions to improve their bottom line.

Banking fees had climbed every year since 1942, when the FDIC started collecting the data, and since then have been an important part of the relationship between the customer and his bank.

But this is going to change in the oncoming years, or at least this is the tendency we can see from a recent study of the US Federal Deposit Insurance Corp which shows that banking fees have dropped nearly 21% to $32.5 billion last year from $41.1 billion in 2009

http://www.marketwatch.com/story/bank-fee-income-in-decline-for-first-time-since-1940s-2014-09-03

What are the causes of this tendency change?

Mainly two reasons, new regulation and changes in market behavior.

For instance, Dodd-Frank establishes that the amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction. 

http://www.icba.org/files/ICBASites/PDFs/DoddFrankActInterchangeProvisions.pdf

In addition, mobility paradigm provides customers with instant access to their bank balances from computers and smart phones making them less likely to spend more money than they have in their accounts, and consequently reducing overdraft fees.

In fact, the Fed released a survey in March showing that the most common use of smartphone banking apps is checking balances and tracking transactions.


http://www.federalreserve.gov/econresdata/consumers-and-mobile-financial-services-report-201403.pdf

But reduction on Banks profits for fees are just the first sign of something bigger, technology is changing the rules of the game, and new, better positioned players, are ready to get their part of the cake.

New players like Paypal, Google, Amazon,Apple or Alibaba are integrating Financial Services in their online platforms, and challenging the traditional Banks position in the market.

The dominant position of these companies in the Internet provides them with a competitive advantage which is growing with the introduction of new technologies like Near Field Communication.

http://en.wikipedia.org/wiki/Near_field_communicationhttp://www.reuters.com/article/2014/09/04/us-apple-iwatch-idUSKBN0GZ2A820140904

A good example is Apple, which with Apple Store and ITunes, possess one of the biggest databases of Credit Cards in the world, capitalizing the market knowledge provided by it for promoting their own payment methods is a matter of time.

http://www.bloomberg.com/video/apple-s-iwallet-can-be-new-creative-leap-sculley-_KSwAkmQQ5utfiwTu9XPdg.htmlhttp://www.cnet.com/news/how-an-apple-iwallet-might-work/

What SAP Banking can offer in the new scenario?

SAP has the know-how for tracking and analysing profits and costs for services, including multidimensional Profits and Loss Analysis, Activity 
Based Costing, Services Product Costing, etc.

This know-how has been incorporated to the SAP Banking business suite, including SAP Bank Analyzer which is fully integrated with the traditional profits and costs tracking solutions of SAP ECC (Management
Accounting).

I have been working recently in some projects with strong requirements in fees analysis and customers profitability,

I’ll give you some details about them in a future post.

Looking forward to read your opinions.

K. Regards,
Ferran.

November 2014 and milestones on the systemic change.

Dear,

In every process of change every day is different than the day before, but when change is completed historians mark in the calendar those special days which explain the change.

For instance, if we look at the history of modern economy, we will find special days like the Black Tuesday, when the markets decided to believe that the Roaring Twenties were over, triggering the most devastating stock market crash in the history of the United States and starting the Great Depression.

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

September 15, 2008 is also an interesting day, when the US authorities decided to let Lehman Brothers fall.

On the previous weekend several alternatives were put in the table; merging Lehman with Bank of America as they did with Merrill Lynch, bailing out the bank as they did with Bear Stearns or AIG, or mixed solutions like bailing out the bank and selling the good assets to Barclays.

But the decision was letting fall the fourth-largest investment bank in the US; changing the rules of the game for the first time in 80 years.

November 2014 will be another milestone; by then, the new Single Supervisory Mechanism of the European Central Bank will issue the results of the stress tests that will make public what is the “real” situation of the European Banking System.

Since the starting of the financial crisis in 2007/2008 we have seen several audits of the financial system, telling us that the financial system was solvent, and acknowledging some months later that more capital was needed.

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

This time is going to be different as it has to be different, rumors say that 9 European banks are going to fail and 51 billion Euros are going to be needed for recapitalizing the system. Other rumours are more pessimistic and predict that 100 billion euros will be required.

http://www.reuters.com/article/2014/09/03/banks-goldman-survey-idUKL1N0R32IL20140903

Whatever the final figure is, the important consequence will be that the banking European system is undercapitalized.

But, only the European banks have solvency difficulties?

Of, course not.

In a global financial system everybody is connected and affected by the others; and what happens to one, it happens to the system.

Once again, look at the global debt clock.

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

According to it, every Belgian carries a public debt of $45,405.40, every Briton $40,456.90, every French $37,989.90, every Spaniard $23,093.85, every Greek $27,189.68, etc.

And don't forget that on top of this mountain of public debt, the financial system is full of private debt, carried by corporations and individuals.

Are capital markets naive enough for believing that this debt can be paid?

Assuming that European banks, main holders of European public debt, need 51 billion Euros of Capital, with very low public debt interest rates; how much capital are they going to need, when capital markets decide to become anxious and raise the spreads?

I asked the same question to a reader of my blog, with management responsibilities in a European bank, who contacted me some months ago. He acknowledged that more capital is going to be needed and capital optimization is going to be a critical activity.

Unfortunately, he was not able of describing any concrete action for optimizing capital management on his bank.

Intriguing, isn't it?

By the way, in my opinion issuing shares or subordinated debt means increasing capitalization levels, not optimizing capital management.

Looking forward to read your opinions.

K. Regards,
Ferran.