solvency
didyou know?
The business of BIS II
Knowledge by number
Psychological change
Creating clarity
Quality counts
What'sNewS Issue 3 Moy/June 2001
In our next issue, What's NewS will
take a close look at a major issue in
solvency management - securitiza-
tion. We'li be introducing the new
European head and updating you on
ourglobal securitization plans.
embark on riskier business where margins
are higher. Current solvency rules (BIS I),
which require 8% of all loaned capital to
be put aside as a 'protective buffer', make
no distinction between different types of
loans. Because Iending rules are 'blind' -
loans to an established corporate are
treated the same way as loans to a small
start-up company - 'real risk' is not accu-
rately reflected in our books. In future,
monthly business reports will include 'ex-
pected losses', ensuring that the moment a
deal is done, its risk is readily visible and
accounted for. Such a system helps keep
everyone focused on good-quality busi
ness. However, quite some work has to be
done before expected losses can be used.
Much of this necessary information will
become available as RI prepares for transi-
tion to BIS II.
How does this work? Controller Sammy
Woe explains: 'Each rnonth, we make the
following calculations for business activi-
ties: we take the net result, and subtract
the 'cost of capital'. The resulting eco
nomie value-added (EVA) should be zero
or more. By looking at EVA-type meas-
ures, people are given valuable new insight
into their performance. The net result may
look promising, but after the cost of capi
tal and risk subtractions it may not. That
way you see who is adding value, and who
is not.'
According to Bos, implementing such
measures is the key to changing the way
regional, product and relationship man
agers approach and use solvency. 'Witit
any "free" resource - air, water, the roads,
parks,' he explains, 'people tend to be less
careful and attentive when there are no
consequences for their behaviour. Sol
vency functions in very much the same
way. It's a limited resource, and up until
now it has been free. So of course people
asked for as much of it as they could.
Some offices still reward people on the ba
sis of P&I, ignoring solvency, RoS or EVA.
In this situation, more solvency allows you
to do more business, and that means more
P&l, and greater personal gains. But if we
change that equation, and ask people for a
fee, then it's seen as an investment. People
will have to think more carefully about
solvency usage because now there are ex-
pectations and consequences.'
There are also great gains to be had in
terms of efficiënt and transparent opera-
tions. Key reporting dates in the year - 30
June and 31 December - are often a stress-
ful time for many of us. Business activities
that have exceeded solvency limits must
scramble to reduce the total amount of
business. But with 'cost for capital' and its
improved monthly reporting, business ac
tivities will be monitored throughout the
year. Exceeding limits at month-end re-
sults in a penalty (starting in September
2001this fee is higher for key reporting
dates. 'We're talking better business
throughout the year,' Bos says. 'Improving
and regulating the figures every month
means more transparency in our books.
It's also important to think about what re-
ally happens in those stressful periods.
People may have been working on a deal
for weeks, and no matter how profitable
that transaction may have become, they
Learning to live with less solvency is
not just about budgets. The change
of approach is also a key clement in
RI's preparation for the BIS II regula-
tions. Set for implementation in 2004,
BIS II is just around the corner. In fact,
each deal with maturity after 1 January
2004 will be affected by BIS II. In the
current system, or BIS I, banks are re-
quired to maintain 8% of all solvency
used in Iending on their balance sheets.
That figure is independent of the
client's credit quality. Comments Jan
Bos, 'People must realize that many of
the transactions done today will mature
in the time of BIS II. A deal done today
make look great in terms of BIS I, but it
may be terrible according to BIS II.
are often forced to pull out to corne down
to limit. The "reporting date rush" is sim-
ply bad management - we have to start
managing our solvency position as of the
first day of the year.'
Inherent to all this discussion is the issue
of who we choose to do our business with.
The solvency team points out two key
ways we can cut back on solvency - exit-
ing non-core and unprofitable business,
and creating new securitization programs.
In short - it's all about the cliënt. If we're
working with the right cliënt - top-level
corporates in F&A and TMI, offering
knowledge-based services - then we know
we are where we want to be. 'We're seeing
a lot of creativity in the way people are
approaching their clients,' Bos says. 'And
while it's great to see, as controllers we
have to make sure that our approach re-
mains consistent. Europe shouldn't come
up with a definition of RoS for new trans
actions that doesn't work for Asia or the
other way around. Communication plays
an important role in all of this - what we
think about solvency must penetrate every
level of management. Since these decisions
on solvency have been made, many people
have come to us for advice if they're in-
volved in a deal that requires a lot of
solvency. This is all about changing
people's mindset and attitudes, and that
takes time, energy and commitment from
us all.'
Any transaction with a maturity longer
than three years must be
considered very carefully. Somewhere
in the credit approval process, the im
pact of BIS II on a deal must be
captured.' To give people a tooi to
estimate the BIS II solvency require-
ment, a BIS II calculator is currently
being built. Variables for a transaction
can simply be entered and, based on
the estimates of BIS II limits, the pro
gram will teil them what the new sol
vency requirements are. This calcula
tor, built in cooperation with Adriaan
Kukler's group, should become avail
able in early June. What's NewS will be
monitoring BIS II preparations in
coming issues.
