If you explain what Source Data Aggregation of Bank Analyzer is, please do it right.

Dear, 
Last week I was talking to a customer who is considering implementing Source Data Aggregation in its Bank Analyzer - Accounting for Financial Instruments System. 

For those of you who are not familiar with Source Data Aggregation, let me give you a brief description of the functionality. 

Source Data Aggregation is a standard functionality of Bank Analyzer, fully available from release 7 which has the objective of reducing the size of the database in accounting calculations with no information lost. For doing that the system stores RDL related data aggregating the information of homogenous contracts. 

But reducing the size of a database with no information lost requires to follow some rules. 

1) We must identify the components which offer a better opportunity for reducing the database size. 
Simplifying, Bank Analyzer stores data in the Source Data Layer and the Results Data Layer. 
The Source Data Layer stores the Primary Objects (Master Data, Transactional Data and Market Data), while the Results Data Layer stores the interpretation of the Transactional Data from Accounting Principles (AFI calculations) and Basel III Credit-Risk Calculations. 

If you check the size of the Bank Analyzer database, you will see that the size of the tables storing Results Data Layer data is much bigger than Source Data Layer data. Consequently, we have a much better opportunity of reducing the database size by looking at the RDL instead of the SDL. 

2) We need to understand how can we reduce the size of the database and not loosing information in the process. 

The valuation of Financial Contracts follows two basic approaches; Nominal and Fair Value. Bank Analyzer supports both approaches. For some products, like Customer Accounts (Saving or Checking) the difference between both valuations is immaterial, for others like Mortgage Loans the difference between Nominal Accounting and Fair Value Accounting is very significant. 

On the other hand, calculations for determining the components of the Nominal Valuation of Financial Transactions are contained in the Transactional Banking System and consequently they´re also available in the Source Data Layer. 

Simplifying; we have an opportunity of reducing the size of the database by reducing the Results Data Layer related data, and not loosing information in the process by aggregating Nominal Accounting based products (like current or savings accounts). 

My customer was explained the above, but as my customer is an smart person he asked; how can I get the nominal accounting data by contract level (Current and Savings Accounts) if that data is not available by contract in the Results Data Layer? 

Unfortunately whoever explained him the Source Data Layer Aggregation functionality forgot to mention that this data can be obtained very easily from the Source Data Layer, that has not been aggregated, so he thought he was losing information by using Source Data Aggregation. 

This post is a simplification and it can never replace the proper analysis that must be performed before a Source Data Aggregation project is implemented. 

I just tried to make a point with it, SAP Bank Analyzer is an amazing product, but implementing it requires to follow some rules, and it´s important we explain those rules properly. 

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

Capital Optimization in Trading Activities with SAP Bank Analyzer.

Dear,

In the last post we look at the SAP Banking capabilities for Investment Management in an environment of Capital scarcity. 

https://www.linkedin.com/pulse/capital-optimization-investment-activities-sap-bank-analyzer-frances?trk=object-title  

After receiving some feed-back, I think there’s a little confusion with the concept of investment and SAP related functionalities, we’ll look at them in this post. In general, capital allocation activities are classified in two big groups; investing and trading. 

The goal of an investor is making profit by allocating capital over an extended period of time, comparable to the life-time of the asset in which he’s investing. For instance, an investor would buy a building for renting it and make profit. 

On the other hand, a trader goal is making profit by buying and selling assets in a short period of time.  

Looking at the previous example, a trader would buy a building for selling it after some months at a higher price. 

A couple of weeks ago, we saw how purely investment activities are managed with SAP Investment Management, and how can we integrate SAP Investment Management with SAP Bank Analyzer for managing efficiently the capital allocated to investment projects. 

This week, we’ll see how to manage trading activities efficiently, by combining the functionalities of Treasury and Risk Management with the functionalities of Bank Analyzer. 

The Treasury and Risk Management module has two sub-modules; Transaction Manager and Position Management. 

• Transaction Manager manages the trading contracts. 

• Position Management calculates the Accounting Values and Capital Consumed by the trading contracts.To some extend Position Management is an old version of Bank Analyzer (also called SEM-Banking). 

Transaction Manager offers all the necessary functionality for the operational management of the trading contracts.

• Business Parthers of the contracts. 

• Financial Conditions of the contracts. 

• Clearing Accounts for managing the payments and collections. • Cash-Flows generation. 

• Products Management for supporting most of the necessary trading contracts types (Forward Contracts, Options, Futures, Commercial Paper, Equities, Forex, Swaps, Bonds, etc.) 

On the other hand, Position Management (SEM-Banking) offers Accounting and Capital Management functionalities, but this solution is being replaced by Bank Analyzer, which comes with a more robust architecture. 

Fortunately, the integration between Transaction Manager and Bank Analyzer is quite simple.

Transaction Manager Data-model uses Financial Transactions and Business Transactions as Bank Analyzer does.

Transaction Manager also supports securities (called classes), that would be integrated in the Bank Analyzer Source Data Layer as Financial Instruments.

As you can see, integrating Transaction Manager as trade solution, with Bank Analyzer for covering the Accounting and Capital Management requirements is an excellent alternative for the management of trading contracts in an environment of capital scarcity. 

For instance, a real estate company promotes and manages the construction of a building, but it gets the necessary capital issuing bonds that will be acquired by investors. 

Traders could be interested on those bonds, as they expect its value to rise, and sell them when the market value has risen.

The capital allocation will be managed with a Transaction Manager contract, with the Holding Category “Held for Trading”. 

Position Management (SEM-Banking) could also manage the accounting and capital consumption effects of the trading contract, but as we said they’re old solutions meant to be replaced by Bank Analyzer. 

Finally, trading contracts can require the management of logistics operations, particularly when the trading partners have agreed on physical settlement of the contract. 

We’ll talk about this scenario in a future post. 

Looking forward to read your opinions.

K. Regards,

Ferran.

Capital Optimization in Investment Activities with SAP Bank Analyzer.

Dear,
The concept of Capital is deeply related to the concept of Risk. Risky activities consume more capital than safe ones. 

Investing is one of the most risky activities of the financial system. As difference to lending, where repayment cash-flows are determined by the contract conditions, investors’ returns depend on the profitability of the investment, which by nature are non-deterministic.

There’s the common misconception that SAP doesn’t have strong solutions for Investment Management, but this has more to do with lack of knowledge about the capabilities of the SAP business suite than with the reality.

Managing an Investment has two components; Operational and Analytical.

- The Operational Component includes the activities which assure the efficient execution of the Investment Project, including logistics requirements, milestones, control of costs and execution times, etc.

- The Analytical Component includes the budgeting and accounting activities of the Investment, including the Capital Management Activities.
SAP Enterprise Core Components has offered Investment Management functionalities for many years; including their seamless integration with the Projects System, Materials Management, Sales and Distribution and Plant Maintenance Modules.

I personally implemented the SAP Investment Management functionalities in several clients more than 10 years ago.

On the other hand, the SAP ECC modules lack in strong Capital Management functionalities of the Investment Projects, and this is a very important handicap in times of Capital scarcity.

Fortunately, this limitation can be easily solved by integrating the Investment Management functionalities of SAP ECC with the Capital Management functionalities of SAP Bank Analyzer.

Typically, the Investment Process starts with the definition of an Investment Program in SAP ECC, which is the hierarchical definition of the Investment Positions.

Every Investment Position is assigned to One or Several Investment Orders, Work Breakdown Structures or Appropriation Requests (which at the end will be Investment Orders or Work Breakdown Structures).

The Investment Orders and Work Breakdown Structures, represent containers of the Investment Program Cash-Flows.

And this is the key integration point between SAP ECC Investment Management and SAP Bank Analyzer.

In Bank Analyzer we also have a standard Primary Object for containing Cash-Flows, which is the Financial Transaction.

Replicating the Orders and Work Breakdown Structures, as Bank Analyzer Financial Transactions, will put the Bank Analyzer Capital Management functionalities at disposal of the Investment Program requirements.

Every Order, Work Breakdown Structures and Financial Transaction represents a collection of expected cash-flows, which have a probability of becoming actual cash-flows, according to the risks associated to the Investment Position.

Giving to Bank Analyzer the relevant probabilities of default and expected volatilities of the expected cash-flows, the Risk engines will provide the capital costs associated to the investment positions, and the Fair Value of the investment positions.

Although powerful market risk engines (including Value at Risk calculations) are still not available in the current versions of Bank Analyzer, it’s just a matter of time that they’re included in new releases.

During the execution of the Investment Project, actual flows will be posted in the Orders and Work Breakdown Structures, these flows will be transferred to Bank Analyzer as Business Transactions adjusting the Fair Value and Capital consumption of the correspondent Financial Transactions.

Efficient Capital management is the most critical activity of the new Financial System that will emerge of the current systemic crisis.

The SAP business suite can be a very important asset in this situation, but we need to improve the market recognition of its capabilities.

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

The main challenge of Deutsche Bank is not its business model, but Capital Optimization.

Dear,
Some days ago, several finance news agencies published comments about the rumors that the Deutsche Bank’s board is considering a dramatic reduction of its retail division.

http://www.reuters.com/article/2015/03/21/us-deutsche-bank-restructuring-idUSKBN0MH0LA20150321

http://www.cnbc.com/id/102339240

http://www.bloombergview.com/articles/2015-03-25/deutsche-bank-doesn-t-want-checking-accounts

Last night I talked about it with a former executive of Deutsche Bank and reader of this blog.

If rumors become true, it would mean a drastic change in the bank’s strategy, considering that just 5 years ago Deutsche Bank acquired Postbank and its 14 million retail clients for 6.3 billion Euros.

https://www.db.com/medien/en/content/press_releases_2010_3173.htm

With the acquisition of Postbank, Deutsche Bank doubled its number of retail customers (from 10 million to 24 million) and branches (from 1,800 to 2,900 in Germany).

Josef Ackermann, chairman of the bank's management board at the time of Postbank acquisition, said in a statement: "In the future, the Deutsche Bank Group will have more stable revenues and a more balanced earnings mix".

Unfortunately, what Mr. Ackerman expected to be “more stable revenues” has ended in higher costs and limited profits.

On 2010, before Postbank acquisition, Deutsche Bank was generating more than 80 percent of its profits from investment banking.

But remember that just two years earlier, the difficulties and insolvencies of the main investment banks (Lehman Brothers, Bear Stearns, Merrill Lynch, etc.) brought very bad reputation to their business model.

A logical alternative was growing in the retail banking, for instance acquiring Postbank.

But today, the challenges are quite different; very low interest rates and limited economic growth is making very difficult for banks to make significant profits in the retail business.

Just one thing is common in the challenges of 2008, 2010 and 2015, capital scarcity of the financial system, a very critical issue which is here to stay.

You could read it here before; capital scarcity is driving a paradigm change of the Financial System, from a business model based in volume to a business model based in efficient capital management.

I can imagine, that 5 years ago, when Deutsche Bank’s executives considered Postbank acquisition, they asked themselves “what would be the profits generated by the investment”.

This is a good question in times of capital abundance, but in times of capital scarcity the question should have been slightly different; “what would be the profits generated by the investment, weighted by capital consumption”.

Today, forced by rising capital requirements and limited profits, Deutsche Bank’s executives are considering a reduction of the bank’s retail arm, getting cash to raise capital and improving their solvency ratios, but it’s likely that they will have to offer a discounted price to do so.

Determining the profit of an investment weighted by capital consumption is the core value of SAP Bank Analyzer, planning the profit of the bank’s investments weighted by capital consumption is the next step.

Just last week I was discussing these ideas with a colleague, when I tried to explain him why SAP Bank Analyzer is not just an Accounting System but an Integrated Financial and Risk System.

The quick answers is that an Accounting System would tell you what’s the value of the bank’s portfolio, while an Integrated Financial and Risk System tells you what’s the value of your portfolio, and how much capital is consumed by the bank, for holding the portfolio.

I’m sure that Deutsche Bank’s executives are very aware of the difference.

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

Clearing Houses, Payment Engine, Capital Optimization and SAP Bank Analyzer.

Dear,
A couple of weeks ago, the EU General Court in Luxembourg ruled that the European Central Bank lacks legal powers to dictate the location of the clearing of euro-denominated trades.

http://www.bloomberg.com/news/articles/2015-03-04/u-k-defeats-ecb-in-clash-over-city-of-london-s-clearinghouses

The decision concerns the ECB’s policy requiring clearinghouses handling euro-denominated trades to be located in the 19-nation currency bloc, a proposal that would have threaten London’s position as Financial Capital of Europe.

Clearing houses play a very important role in the Financial System; they’re the financial institutions that provide clearing and settlement services for financial and commodities derivatives and securities transactions. They act as third parties to all futures and options contracts; as a buyer to every clearing member seller and a seller to every clearing member buyer.

This responsibility comes with a lot of power for the clearing houses in the capital allocation processes; by facilitating some transactions in front of others, clearing houses have the capacity of influencing the international flows of Capital.

A couple of years ago, in the middle of the Euro crisis, you could read the following post about the power of the clearing houses in the new model.

http://blogs.sap.com/banking/2012/07/04/the-role-of-the-clearing-houses-in-a-liquidity-crisis/

In the old model of Capital abundance, efficient Capital management was not a priority for the clearing houses. In general, and with little exceptions, financial agents decided to believe that the chances of a clearing house becoming insolvent were zero. An interesting exception to this rule was the Black Monday of 1987 when freezing capital markets were close to pull down several clearing houses with catastrophic consequences for the financial system and the whole economy.

Former US Federal Reserve chairman Ben Bernanke, is one of the greatest experts in the 1987 crash and he’s well aware of the weaknesses of the Financial System and the critical role that the Clearing Houses are going to play in the new environment of Capital scarcity. Just four years ago, he gave the following speech.

http://www.federalreserve.gov/newsevents/speech/bernanke20110404a.htm

The SAP banking business suite provides two components for supporting the functions and responsibilities of the Clearing Houses and other Clearing Partners in new Financial System that will emerge from the Financial Crisis.

- Payment Engine.- Which helps banks and other financial institutions to determine the most efficient route in their Capital allocation flows.

- Bank Analyzer with its Integrated Financial and Risk Architecture, which supports the efficient management of Capital in the financial institutions (including Clearing Houses).

But overall, SAP Banking provides integrated capabilities that will support integrated scenarios for improving capital efficiency on the management of capital flows.

Today, when a bank determines the preferred route for Capital transfers, it follows “static” routes looking at traditional parameters like “Fees” or “Service Level Agreements”.

As we move deeper into the financial crisis, selecting one route in front of other will require considering the capital costs of the alternative routes.

This will open the gate to new scenarios in Capital Optimization, at the end efficient capital management is not just a requirement for banks, but the most critical activity of the whole financial system.

Looking forward to read your opinions.

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

K. Regards,
Ferran.

Managing non-evident Capital Costs with SAP Bank Analyzer. Chapter IV

Dear,
As we commented in the previous post, the difficulties of integrating Bank Analyzer as a sub-ledger of non-financial processes are more related to marketing reasons and perceptions than real technical constrains.

I will try to make a simple description on this post.
The main objects for modelling a business deal in the Accounting for Financial Instruments module (sub-ledger scenario) of Bank Analyzer are the following.

- Business Partner. It’s the Physical or Legal Person with whom our company is having a business relationship.

- Financial Transaction (or Financial Instrument). It’s the representation of the financial contract that our company has with the business partner.

- Business Transaction. It’s an event of the real world, relevant for accounting which can potentially trigger a flow in a GL Account.

The objects above are not specific of a financial deal, but in fact to most, if not all, business deals.

All business deals have a counterparty with which our company is having the business relationship, the business agreement is represented by a contract (Financial Transaction), and a number of events happen in the real world, in relation to the contract, and can trigger flows in GL Accounts (Business Transactions).

For instance, let’s look at typical sales business deal, represented in SAP by a Sales Order, a Delivery (with Post Goods Issue) and an Invoice.

Every Item of the Sales Order represents the commitment of delivering a number of goods (or services), at a delivery date for an agreed price.

The Item of the Sales Order also represents the conclusion of a forward contract for delivering an underline (goods or services) at an agreed date (forward date) and price, with a Payment Date which is determined by the Delivery Date and the Payment Term.

On forward date we will create a logistics delivery (actually some days in advance as for fulfilling the delivery date we also must consider the picking, packing, transportation times, etc.) and the correspondent accounting entry as the forward contract has been settled. 

At that moment our Sales Order Item (Forward Contract) has become an Account Receivable that will be cleared (if the counterparty fulfils his obligations) at Payment Date.
As you can see, there’s a parallelism in the business flow of a standard Sales and Distribution process with the events of a Derivatives Trading business flow.

The main difference between these two modelizations of the business deal is that the Sales and Distribution modelization puts the focus in the logistics process, while the derivatives trading modelization puts the focus in the Capital consumption (Market and Credit Risk).

Modeling the Sales and Distributions Process as a Forward Contract in Bank Analyzer gives us the opportunity of determining:

- The Capital Consumption due to Credit Risk, by determining the Exposure at Default from the Credit equivalent amount of the derivative and the Probability of Default of the counterparty (business partner on the deal). 

- The Capital Consumption due to Market Risk by running a Value at Risk calculation (in future Bank Analyzer releases). 

For years, capital was abundant and it was not necessary to estimate the Capital consumption due to Credit and Market Risk of most of business deals; that’s why we could afford modelling the business processes neglecting its importance. 

But today, we’re in the middle of a systemic crisis generated by the new environment of capital scarcity. In this new environment, we can’t afford neglecting the cost of the capital that we consume in a business deal. 

Consequently we’ll have to build information systems which include accurate measurements of the cost of capital of the business deal, and include them in the calculation of its contribution margin.

In my opinion, SAP Bank Analyzer technology is the answer to this requirement.

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

Managing non-evident Capital Costs with SAP Bank Analyzer. Chapter III

Dear,
In the last posts, we’ve discussed the importance of managing Credit Risk and Capital Costs in non-financial processes.

https://www.linkedin.com/pulse/managing-non-evident-capital-costs-sap-bank-analyzer-chapter-frances?trk=object-title

https://www.linkedin.com/pulse/managing-non-evident-capital-costs-sap-bank-analyzer-ferran-frances?trk=object-title

The necessity of managing capital costs is nothing new; it’s the natural consequence of managing the risks associated to an economic activity. What is new is the relative importance of the capital costs in the economic analysis of a business event.

During most of the 20th Century, and particularly since the end of the Second World War (including the plans for reconstructing Europe and Japan) and the implementation of the Breton Woods Agreements, capital was abundant and inexpensive.

In this environment of capital abundance, costs of capital were easily covered by high margins and strong economic growth. Consequently there was no incentive in managing capital efficiently. For decades, the economic world chose to believe that resources were unlimited and wasting capital not an issue.

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

With the Oil crisis of the 70’s, we discovered that natural resources were limited, challenging the economic growth.

http://en.wikipedia.org/wiki/1973_oil_crisis

At the same time that some initiatives were implemented for managing resources more efficiently, world’s leaders looked for another resource which could be wasted for feeding economic growth.

The alternative was consuming solvency by increasing debt, in other words, replacing cheap oil by solvency as a resource for feeding economic growth.

http://www.imf.org/external/pubs/ft/fandd/2011/03/picture.htm

This is the starting point in the deregulation of the financial system.

www.cepr.net/documents/publications/dereg-timeline-2009-07.pdf

Analyzing what´s the alternative for sustaining economic growth goes far beyond the objectives of this post, I just want to highlight two points.

• Sustaining economic growth on increasing debt is not possible anymore.

• Capital requirements are a percentage of Risk Weighted Assets (Percentage of Debt Weighted by the Risk of the Counterparty + Leverage Ratio); consequently as global debt is historically high, capital requirements should be historically high.

The two points above describe why the financial system is operating in a new environment of Capital Scarcity; and this is serious because Capital is the main resource of the Financial System.

In economy, when a critical resource becomes scarce we recognize it criticality and scarcity by increasing its price. These are the increasing capital costs that we’re discussing here. Higher costs of capital start in the financial system, and then they are spread by investing and lending through the whole economic system.

In the new environment, managing capital costs becomes mandatory, and particularly we must include them as part of the contribution margin of any business deal, obviously this necessity depends on the weight of capital consumption in the contribution margin.

For instance, the capital costs involved in the trade of 20.000 Barrels of Brent Oil for being delivered in 12 months, and paid in foreign currency, are not even close to the capital costs of buying 20 cans of beer in the local Walmart. But in both cases, the weight of capital costs involved in contribution margin of the deal are much higher than 30 years ago.

We have an excellent tool in the SAP Business Suite, Bank Analyzer, for determining Capital Costs (on the current releases only Credit Risk Capital Costs) and include them in the calculation of the contribution margin.

The difficulty seems to be integrating Bank Analyzer in the management of non-financial business processes; and judging by the emails I’ve received in the last weeks, this is an extended concern amongst the readers of this blog.

In my opinion, the difficulties have more to do with marketing reasons and perceptions than with technical constraints. We’ll talk about them in the next post.

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