Dynamic Collateral Management with SAP Bank Analyzer and the Blockchain.

Dear,

In my opinion, the Blockchain is the most important innovation of the Finance Technology in the last years.

The Blockchain represents to the Internet of Value, what the TCP IP Protocol represented for the Internet of Information 25 years ago.

In the same way that it was difficult to imagine Facebook, Amazon, Skype or Netflix 25 years ago, it's difficult to imagine the services that Blockchain will support in the future.

Today, we know that some services are about to be implemented in the Blockchain, some of the most important ones are:

International Payments.
http://www.ibtimes.co.uk/

Securities Trading.
http://www.wired.com/2015/12/

Both are major achievements in terms of efficiency and transparency, but today I'm going to focus on some implications of the second one.

As we discussed in previous blogs, we're in the middle of a systemic crisis whose main characteristic is Capital Scarcity, as a consequence Capital Optimization will be the priority of the Financial System that will emerge of this crisis.

Capital has many shapes, and one of the most important is collateral, consequently Efficient Management of Collaterals is a critical activity in Capital Optimization.

Securities are one of the most usual forms of collateral, they're liquid assets traded in an organized market which provides them an updated price.

Blockchain provides a revolutionary technology for the efficient trading of securities, as securities trading and ownership are moved to a public, efficient and structured database like the Blockchain, the opportunities of improving the use of these securities in collateral agreements also increase.

Efficient use collateral rights require reduce the Loss Given Default of the exposures by implementing risk mitigation techniques, but avoiding over-collateralization which freezes capital without generating any return.

But balancing collaterals and exposures in order or improving the Risk Adjusted Return on Capital (RAROC) is not an easy task. The Loss Given Default depends on the rating of the counterpart (or his Probability of Default), and the value of the collateral fluctuates every second. Consequently the assignment of Collateral portions of a Collateral Pool to the bank's exposures should be a dynamic activity, that must be adjusted as the market and counterparty situations change.

For instance, as the rating of the counterparty improves, or the collateral value increases, the LGD will be reduced till it achieves a limit (full collateralization) in which better rating or more col lateralization are not improving the Risk Weighted Assets. This collateral excess could be used as a guarantee in another transaction, like a Repurchase Agreement, which will improve the portfolio return, without compromising capital consumption.

On the other hand, if collateral value declines or counterparty rating gets worse, higher portions of the collateral pool will be required for reducing capital consumption.

But the above theory presents practical constrains; in order of facilitating the optimal distribution of collaterals we need some requirements to be covered.

- Accurate calculation of the collateralization levels of the bank's exposures.

- Efficient (including inexpensive transactions) trade of collateral rights.

SAP Bank Analyzer is the answer to the first request, Blockchain is the answer to the second.

With Bank Analyzer we can guarantee an accurate measure of the capital consumed by the bank's portfolio, individually or by portfolios.

Additionally, we can implement alerts in the Analytical Layer of Bank Analyzer Credit Risk Module, informing the Bank's Capital Manager of the exception situations (under or over capitalization) which will trigger his attention in order of taking corrective actions.

But we also need that the transaction costs (including fees, transaction speed and settlement risk) are reduced, because if not, the potential profits of managing dynamically the bank's collateral will be reduced by the transaction costs.

This is exactly what blockchain is offering us, efficient, inexpensive and transparent trading of securities rights.

But securitization and efficient management of collaterals also presents other challenges, we'll talk about them in future blogs.

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

Looking forward to read your opinions.

May the Force be with you.

Ferran.

Total Loss Absorbing Capacity and SAP Bank Analyzer.

Dear,
Three weeks ago, the Financial Stability Board issued the final version of the Total Loss-Absorbing Capacity standard for global systemically important banks (G-Sibs).

http://www.financialstabilityboard.org/2015/11/tlac-press-release/

This standard will have a profound impact in the reconfiguration of the Financial System, and in my opinion, the development of the SAP Banking industry.

But what is the Total Loss Absorbing Capacity Standard  (TLAC) standard?

The TLAC standard is an evolution of the Basel III agreement, which establishes the Capital Requirements for 30 banks identified as global systemically important, and considered by the Basel Committee on Banking Supervision as “Too Big to Fail”.

According to the TLAC rule, From 1 January 2019, the Capital requirement  for G-Sibs will be at least 16% of their risk-weighted assets (RWA's), increasing to at least 18% from 1 January 2022.

There's an exception, particularly relevant for Chinese banks, which establishes that emerging market G-SIBs must meet the 16% RWA minimum TLAC requirement no later than 1 January 2025, and the 18% RWA minimum TLAC requirement before 1 January 2028.

Considering that Basel III rules require banks to meet a minimum total capital ratio of 10.5% by 2019, the TLAC rule nearly doubles the Capital requirements for global systemically important banks.

But the current economic environment of limited growth, increasing competition and very low interest rates, supposes a serious handicap for generating profits. Doubling capital requirements in 3-4 years, will force the G-SIBs to raise capital from external sources.

On the other hand, this is also going to have an impact in the non-global systemically important banks, as the market will identify them as less solvent, increasing their cost of capital.

We've discussed here, that the Financial System started in 2008 a systemic change, from a model based in Volume, to a model based in Efficient Capital Management, the TLAC standard is just another milestone in the transformation process.

Recently, we visited a customer for a Bank Analyzer-IFRS 9 (impairment) presentation, and he mentioned that it was difficult to get the necessary budget for the implementation project, because the project was purely regulatory, without a direct impact on the business.

Big mistake, the new regulation, limited economic growth and over-leveraged economy are making capital very scarce.

Capital is the most critical resource of a bank; consequently, capital scarcity is driving the systemic transformation towards capital efficiency, with a very deep impact in the business strategy and processes.

If capital efficiency is the priority, banking information systems must be aligned with the new paradigm, supporting capital optimization activities.

Keep in mind that optimizing a resource starts by measuring accurately this resource and the processes consuming it. The Integrated Financial and Risk Architecture of SAP Bank Analyzer is the answer to the first requirement, and the robustness,  completeness of the data model, and integration between the Transactional and Analytical components of SAP Banking is the answer to the second one.

That's why a Bank Analyzer IFRS (AFI) implementation should be identified as a business driven project. Managing a bank under the new paradigm, means managing the business processes with the objective of optimizing the capital consumption.

Impairment calculations measure the capital consumed due to the Expected Loss of a Credit Portfolio, and consequently, determine the capital available for lending an investing. If we don't understand this, we're not understanding the systemic change.

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

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

BCBS 239 Principles and SAP Bank Analyzer.

Dear,
As you all know the starting of the Financial Crisis in 2007-2008 represented an inflexion point in the implementation of a regulatory framework in the Financial System.

A particularly important milestone is the document from the Basel Committee on Banking Supervision: "Principles for effective risk data aggregation and risk reporting".

http://www.bis.org/publ/bcbs239.pdf

The fourteen principles "recommended" by the committee define the architecture that banks have to implement in order of being compliant in the new financial system that is emerging from the Financial Crisis.

This represents a huge endeavor which will attract a very important part of the banks resources, and taking the wrong decision can seriously jeopardize the bank´s future capabilities.

Recently I had a very interesting conversation with a client about the capabilities of SAP Bank Analyzer for fulfilling IFRS 9 and IFRS 15 requirements.

During the conversation; the client mentioned that the current bank´s IT priority is the centralized management of risk data.

Actually, what they had in mind are the 14 principles of the Basel Committee, let´s see how the IFRA of Bank Analyzer is the best answer to them.

Principle 1
Governance – A bank’s risk data aggregation capabilities and risk reporting practices should be subject to strong governance arrangements consistent with other principles and guidance established by the Basel Committee.

SAP Bank Analyzer proposal.
The Financial Database is a centralized and robust repository of the risk data, and properly build, provides the Single Source of Truth for all the bank´s risk data, which is the foundation for strong reporting capabilities.

In a complex landscape of Transactional Systems, only the Source Data Layer of Bank Analyzer provides the Single Source of Truth for the bank´s Master and Transactional Data, which is currently spread in multiple systems with heterogeneous data-models.

Processing this Single Source of Truth data in an homogenous centralized system for calculating the Accounting and Solvency position of the bank is the responsibility of the Bank Analyzer - Process and Methods Layer.

Storing the calculation results in homogenous and consistent repository of metadata is the Results Data Layer main capability.

Finally, reporting this data with very strong analytical and reconciliation capabilities is the value proposition of the Analytical Layer.

Principle 2
Data architecture and IT infrastructure – A bank should design, build and maintain data architecture and IT infrastructure which fully supports its risk data aggregation capabilities and risk reporting practices not only in normal times but also during times of stress or crisis, while still meeting the other Principles.

SAP Bank Analyzer proposal.
Bank Analyzer fully supports the Stress Testing requirements for Solvency and Liquidity established by the Basel agreements. But more than that, the completeness of the data model, opens the gate to implement new risk engines for fulfilling future requirements, without modifying the data architecture.

Principle 3
Accuracy and Integrity – A bank should be able to generate accurate and reliable risk data to meet normal and stress/crisis reporting accuracy requirements. Data should be aggregated on a largely automated basis so as to minimise the probability of errors.

SAP Bank Analyzer proposal.
The Bank Analyzer architecture offers strong Extract and Transformation capabilities and a complete template of Primary Objects which will assure data accuracy, assuming of course  that the implementation team has the capacity and willingness to follow the SAP´s implementation best practices.

This is just an introduction. It´s very difficult to express in just one post the implications all these principles, but we will discuss this topic again in future posts.

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

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

Optimizing Capital in Oil and Gas companies with SAP APO and Bank Analyzer - Chapter II.

Dear,

In the last blog we discussed how Capital Scarcity can hit very hard to Oil companies which are not ready to the challenges of this new scenario.

https://www.linkedin.com/pulse/optimizing-capital-oil-gas-companies-sap-apo-bank-analyzer-frances?trk=mp-reader-card

Today, we´ll look at some alternatives to improve the efficient management of Capital in Oil companies by combining the functionalities of SAP APO and SAP Bank Analyzer.

Some of the required functionalities are not available yet; current Bank Analyzer versions don´t have strong Market Risk Analyzers, including Value at Risk calculations. But these functionalities have been offered for years in SEM Banking (considered by many the precursor of Bank Analyzer), and in my opinion, it´s a matter of time that they´re included in Bank Analyzer.

Going back to the point, we saw in the previous blog that an Oil company with a very efficient Supply Chain can still face Capital tensions ending in bankruptcy due to the Oil Market Risk. 

What can we do for improving the business plan including this risk?

First thing we must understand is that a Production Order or a Storage Unit of a Volatile product, like Oil, can be represented in Finance by a Financial Transaction (or Financial Instrument), whose underline is the Volatile product (Oil).  With this integration, a potential Market Risk Analyzer engine of Bank Analyzer would be able of giving us the Expected Losses due to the Value at Risk of the Underline.

On the other hand, the company can hedge the potential Market Risk losses by selling the Oil to a customer. But then it will be exposed to potential losses due to Counterparty Risk. 

Again, representing the Sales Order Items as Financial Transactions in Bank Analyzer, and providing the Rating of the Business Partner to the Credit Risk Engine, the system will give us the Expected Losses of the Financial Transaction (including the Expected Loss at committing with a Sales Order, by using Credit Conversion Factors).

By calculating the consumed Capital due to Market Risk Volatility and Credit Risk of the Exposures, Bank Analyzer will give us the Free Capital of the Company in every planning cycle.

As Free Capital is a measure of the Market and Credit Risks that the company can tolerate without suffering Solvency tensions, it´s actually determining a bottleneck in the amount of Oil that the company can extract, refine, store, distribute and sell.

Bottlenecks of the Supply Chain are represented in SAP APO by Resources and Capacities; and the Supply Network Planner will generate Planned and Production Orders only if the company has available capacity.

Making an analogy, in the same way that the Oil Company will not extract more Oil than its refining capacity, the company should not extract more Oil than the amount of Volatility that it can support without becoming insolvent. And in case the Oil can be sold immediately, hedging the Market Risk Volatility, it shouldn´t extract more oil than the amount whose Credit Risk Expected Loss is higher than the Company´s free Capital.

The standard APO element for modeling this "Free Capital-Capacity", would be an APO-Supply Network Planning bucket Resource.

Nevertheless, the available and consumed Capacity in this resource will be provided by an external engine, the Free Capital Calculator of Bank Analyzer.

Simplifying, in case Volatility and Counterparty Risk is low, Bank Analyzer will represent the situation with available Capacity in the bucket resource. On the contrary when Volatility and Credit Risk are high, Bank Analyzer will communicate less available Capacity to the bucket Resource.

The company has also to look Capital Consumed by its Market Demand on the Long Term Demand Planning activities, we´ll see how to model it in a future post.

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

Looking forward to read your opinions.

K. Regards,

Ferran.

Optimizing Capital in Oil and Gas companies with SAP APO and Bank Analyzer - Chapter I.

Dear,

The current financial and economic crisis has many manifestations; capital markets volatility, unemployment, social unrest...

They all are effects of the crisis but none of them is the cause of the crisis; as this crisis represents the exhaustion of an economic model, based on growing as much as possible, without considering the capital consumed in the process.

Today Capital has become scarce, making capital optimization the main priority.

Volatility of the commodities price is an interesting example; we've been said that Oil price is falling as a consequence of the Shale Oil revolution. But if we look at the price of other commodities like Gold, Platinum, Silver or Palladium we'll see that their prices have also fallen dramatically in the last moths.

Capital consumed in the commodities production and trading, manifests itself as Value at Risk, or in other words with the Volatility of the commodities price.

Today, many commodities traders, Oil, Gas and Mining companies are suffering financial difficulties and stopping strategic plans, as a consequence of the losses (capital consumed) they had in the last months.

According to the Wood Mackenzie consultancy group, $200 billion of investment have been delayed as a consequence of the drop in oil prices.

http://www.bloomberg.com/news/articles/2015-07-27/oil-majors-delay-200-billion-of-spending-wood-mackenzie-says

Has anybody thought how much capital has been wasted as a consequence of that?

Executives of those companies must learn the lesson, and take decisions putting Capital Optimization at the center of the strategic and tactical plans.

Some weeks ago, we discussed how to optimize the capital consumed in investment activities with SAP Bank Analyzer.

https://www.linkedin.com/pulse/capital-optimization-investment-activities-sap-bank-frances-gil?trk=mp-reader-card

In a future post, we'll see how to integrate Capital Optimization in the analysis of strategic decisions.

But today we'll look at the impact of inefficient capital management in the tactical planning of an Oil and Gas company.

Let's look at a simplified representation of the Supply Chain of an Oil company; extraction, refinement and distribution. Every step of the value chain represents a potential bottleneck, with a critical resource that needs to be managed in order of managing efficiently the Value Chain.

For instance, it would be inefficient extracting more Oil than the company's refinement capability. In the same way it would be inefficient refining more Oil than what the company can store or distribute.

Efficient management of the Supply Chain requires a holistic optimization of all the logistic resources, looking at all the bottlenecks of the Supply Chain.

But the recent crisis has made clear that this approach is incomplete, as it optimizes the logistic resources but it does not look at other bottlenecks which are critical in the new economic model.

If we look at the balance sheet of an Oil company we'll see that an important part of its Assets are the inventory of Oil stored, refined and distributed.

And remember that Volatility on the price of Oil increases the capital consumed due to Value at Risk, reducing the company solvency.

The higher the assets price volatility, the higher the capital consumed.

The company can hedge the market risk of the Oil price volatility by selling the Oil. Every Sales Order Item represents a Forward Contract, hedging the risk of the Oil price volatility; and at the same time, it also represents a Credit Risk exposure, that consumes the company’s capital.

Finally, if a company consumes more capital than it has, it becomes insolvent, very risky situation that many Oil companies are facing today.

Consequently we have to include Financial Capital in the Optimization of the Supply Chain, we'll see how to do it in the next post.

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

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

Get Ready for IFRS requirements in Telecommunications Companies with SAP Bank Analyzer.

Dear,
A common mistake is assuming that Bank Analyzer functionalities are only applicable to banks.

Bank Analyzer is basically a Capital Optimization engine, and this functionalities are applicable to any business or industry, as they're all facing the challenges of the new environment of Capital Scarcity.

Maybe the confusion comes from the name; Bank Analyzer implies that its functionalities are limited to banks, when this is not the case.

In fact, you probably know that some years ago SAP released the Insurance Analyzer system, which is basically a Bank Analyzer system enhanced with some templates addressed to model Insurance Products.

http://help.sap.com/insurance-fsia/

In a future post we'll talk about Insurance Analyzer, but today we'll look at other potential markets for Bank Analyzer that have not received proper attention by Sales and Marketing teams.

IFRS 9 requires financial assets belonging to the business model, whose objective is to collect contractual cash flows, containing expected payments of principal and interest, to be measured at amortized cost.

We all know that Loans fall in this classification (by the way, that's why we're implementing Bank Analyzer-AFI) but Receivables also fall in the same classification with the same requirements.

We also can look at the materiality of the differences between purely Nominal Accounting and Amortized Cost measurements, and that would help us to identify potential candidates for implementing Bank Analyzer in non-purely financial business.

In my opinion, a particularly interesting example are Telecommunications companies. If we look at their balance sheet structures, we'll see that the Accounts Receivable is a very significant part of their Assets, which makes them an interesting target for implementing accurate Accounting Systems, capable of fulfilling Amortized Cost measurements.

Another reason which makes this target interesting is purely technical. Many telecommunications companies use SAP Billing and Revenue Management for Telecommunications, integrated with SAP Contract Accounts Receivables and Payables (FICA).

SAP FICA is an excellent tool for the management of Accounts Receivables, including sub-ledger functionalities, but limited to Nominal Accounting Principles, and insufficient for managing the new regulatory requirements in Revenue Recognition.

For the moment, most of the Telecommunications companies are fulfilling their IFRS requirements, with Business Segment based adjustments of their Accounts Receivable values on the General Ledger.

We're going to see that this is not a good approach in the middle-term

The International Accounting Standards Board is already working in IFRS 15 which is increasing significantly the disclosure requirements on Revenue recognition, from Contracts with Customers

http://www.ifrs.org/current-projects/iasb-projects/revenue-recognition/Pages/Revenue-Recognition.aspx

Fulfilling these requirements will require the use of a Financial Sub-ledger, capable of managing contract-based, amortized cost valuations; one of the basic functionalities of SAP Bank Analyzer.

Taking advantage of the Bank Analyzer functionalities, by Telecommunications Companies using SAP Billing processes, will require the integration of the FICA base Accounts Receivables Contracts, Business Partners and FICA Business Transactions, with the Bank Analyzer Source Data Layer - Primary Objects.

Once the Accounts Receivable Contracts have been properly integrated as Financial Transaction in the Bank Analyzer SDL, there're no limitations in the use of the Bank Analyzer Risk Engines for fulfilling the company accounting requirements and new disclosure regulations.

We've worked recently in a Proof of Concept of this integration and we'll give you more details of it in a future post.

Looking forward to read your opinions.

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

K. Regards,
Ferran.

Old and New Banking. Accumulating Capital vs. Making Capital flow.

Dear,

The main characteristic of the new Financial System is Capital efficiency.

Over-leveraged Financial System and Limited growth make Capital scarce. Additionally, regulators are aware that an over-leveraged Financial System becomes insolvent with limited growth, consequently they increase capital requirements making Free Capital even scarcer.

At the same time technology is making possible new business models that compete with the traditional Financial System with dramatic reductions of the capital consumed.

In the old financial system, accumulating capital was a prerequisite before the capital could be invested or allocated. Regulation forces banks to collect the necessary capital for covering its potential losses, due to its exposure to Credit Risk (Risk Weighted Assets) or Market Risk (Value at Risk).

The more risk the bank is exposed to, the higher its capital requirements become.

Banks issue capital, debt, hybrid securities and deposits for covering their capital and liquidity requirements, these requirements must be covered before they can lend funds to their borrowers, otherwise they will face solvency issues, liquidity tensions and fines.

On the other hand, technology is making possible new models of financial services capable of operate without limiting capital requirements.

I'll explain it with an example from Foreign Exchange services.

Imagine that you’re a EU vendor dealing with a US customer, you must be ready to be paid in USD.

But as you don´t want to take the risk of suffering losses due to USD/EUR currency exchange fluctuations, you will hedge your risk signing a Forex Forward contract with your bank, paying a fee for transferring the risk to it.

As the bank will be exposed to Foreign Exchange Market Risk and potential losses, the bank needs to have Free Capital available in order of offering the service.

Consequently, the bank has to accumulate capital, for covering its potential losses, before it offers the service.

But in the last years we’ve seen new and more efficient alternatives for offering FOREX services in a Peer to Peer model.

https://transferwise.com/

http://kantox.com/en

These companies convert funds to foreign currency, for instance from EUR to USD, with requirements of other customers in the other direction (USD to EUR).

The foreign exposures are assumed by the counter-parties; the P2P platform only connects them and intermediates in the payments, “notarizing” the transaction.

The P2P platforms don´t assume any foreign exchange risk; neither require capital to cover it. Consequently, they can offer their services at a much lower price than traditional banking.

In fact, increasing capital requirements and scarcity are also increasing their competitive advantage.

You can find a more detailed explanation of the P2P model in the following post I wrote three years ago.

http://blogs.sap.com/banking/2011/12/21/new-models-capital-optimization-kantox/

Another example is P2P Lending; in traditional lending, the bank has to accumulate capital for covering its capital requirements, derived from the credit risk that the bank is exposed since the moment it commits to lend funds to a borrower.

But in P2P lending, the platforms connect people (or companies) requiring funds with investors willing to lend them. Again, the P2P platforms don´t have to accumulate capital before starting the process, because they do not assume the credit and market risk. As a consequence, they can offer their services with more competitive fees to the borrowers and investors.

https://www.prosper.com/

And this is just the beginning, new models of disintermediation are going to be more common and efficient with the disruptive technologies supporting bitcoin, blockchain or ethereum.

We’ll talk about them in future posts.

Looking forward to read your opinions.

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

K. Regards,
Ferran.