Integrated Treasury and ALM solutions for Middle East banks
The Middle East has seen continued economic growth over the last few years (5.6 per cent annual growth over the past two years), which can be clearly seen through the continuing infrastructural developments and reinvestment in the region. Government policy towards regional economic cooperation due to globalization of the world economy has helped establish a number of trade and financial centres in the region. Investment in infrastructure has extended to both telecommunications and IT as each country tries to gain an economic advantage for increasing their share of global trade.
Such activity is increasing customer demands on regional banks to provide more sophisticated finance and investment products. Strong competition between regional banks along with the large number of new banks being launched, particularly to service the Islamic banking sector, is fuelling this need to improve the options offered to the local customer base.
It is also fair to say that an increased sense of nationalism among investors means more funds are being invested in the region through local banks and away from the major foreign players. This adds to the growth in complexity of the banks’ treasury and retail operations, leading to strains on existing systems and constraints caused by manual processes.
Further pressure is being brought to bear by global banking policies and regulations that are quickly being adopted and implemented in similar time scales to those of western institutions. With limited core technology in place, banks need to invest in solutions that will provide a platform for compliance within two years.
The operational requirements for treasury in Middle Eastern banks are not too dissimilar from those found in most western banks. The areas of growth we discussed above and the compliance requirements placed on the treasury operation by the local and global regulations provide a number of reasons for replacing or implementing new financial technologies. Among the more common ones:
With banks having to invest in new technology at the same time as expanding their management of bank wide risks, the majority of selection processes are including both treasury and bank asset management. This is not a traditional space solely for treasury solution vendors as the coverage of asset and liability management in these solutions are usually limited to the trading book, which is small in comparison to the overall banking book. To provide a full picture of the banks’ exposures and sensitivity to market conditions a dedicated asset and liability management (ALM) solution covering the bank wide assets (both wholesale and retail) is required.
ALM has developed quickly over the past five years in part because of the requirements of large scale accords such as Basel II and IAS 39. In traditional western banks we have seen the development of ever more sophisticated balance sheet management tools as managers have to combine traditional balance sheet data with operational risk processes/systems and credit risk. This is not only driven by the increased reporting requirements but also by the timelines, accuracy and volume of the data that needs to be analysed. ALM is no longer a monthly reporting process for the ALCO but a real time calculation of the banks’ liquidity and balance sheet exposures.
The development and growth of the Middle East banking market is now seeing these drivers and therefore requires similar tools for managing balance sheet risk. In the current market the key business drivers are the integration of budgeting and planning along with the calculation of profitability on a timely basis. It is expected that we will see more complex requirements in the future as the nature and scale of the exposures increase.
The demands on technology can be met with traditional western solutions that will provide capacity for growth in the sophistication of balance sheet management in the future. However the financial and budgetary constraints on acquiring best of breed solutions solely for ALM is a limiting factor. In this case the market is predominately green field, with no system replacement other than rudimentary Excel and in-house solutions. Scalable solutions are very much the order of the day with basic planning and balance sheet reporting as a base with the opportunity to add profitability, IAS 39 and Basel II compliance in the future.
It would make sense that with a requirement to implement new treasury solutions and the growth in complexity of asset and liability management there is significant demand for vendors to provide a complete solution. In many cases the requirements may be for a single aspect of traditional ALM (planning, budgeting or profitability) along with a front, middle and back office treasury solution. Therefore the ability to select the necessary components of a solution are financially beneficial to the customer who can select which aspects of the solution are required and do not need to buy an unnecessarily complex solution.
The goal is to provide an integrated, straight-through processing solution across treasury, cash and balance sheet management, which provides the bank with a core platform for operational and market risk management. A combined solution will fully automate the management of treasury and capital market products, help increase the efficiency of assets and liabilities and risk management, and help enhance controls. It will also provide a platform for adding additional components in the future; this becomes particularly important with the adoption of Basel II. The market is already seeing projects that cover not only treasury and ALM but full Basel II compliance as well.
The key to a selection process of an integrated treasury and ALM solution is understanding, in other words for the vendor to fully comprehend the requirements of the bank and for the bank to be able to articulate their requirements precisely. With a grey area between market risk solutions and true bank wide asset and liability management, it is important that proposed solutions will cover the customers’ needs. The customer in turn must complete a full due diligence of their requirements and the capabilities of the vendors.
While there are many benefits of providing integrated solutions we must not forget that the very nature of an ALM solution is the ability to integrate with many other bank wide systems. This allows the bank the ability to run either an integrated selection or manage independent processes for each functional area. For the vendors who can supply both solutions to be successful they must demonstrate a level of integration and project success, and thereby gain an advantage over independent solutions for different vendors.
We cannot discuss integration of treasury and ALM in the Middle East market without discussing the impact caused by Islamic banking products. While there has been growth in conventional banks (those offering traditional investments and hedging instruments) the largest growth in number has been from new Islamic banks across the region. Islamic banks are able to offer products that are compliant with Shar’iah law, which allows a method of return on investment that is accepted to the Muslim faith. It is not the intention of this article to give a complete description of all Islamic instruments, but suffice to say that one of the underlying principles is that interest should not be levied or received. Therefore systems need to manage instruments involving an exchange of funds as well as underlying assets.
For the treasury system the development required is quite significant in that the deal and workflow characteristics of each transaction need to be managed. In effect each instrument is made up of a number of underlying transactions and the system needs to be able to record and manage each leg of the instrument while providing ease of input and transaction management. Simply removing the word “interest” and replacing it with “profit” is only a small part of what is required. As more complex transactions are approved by the Shar’iah compliance committees in banks, the system must be adaptable to allow the customer to configure new product types. The use of developer kits to access the underlying logic of the application and create new instrument capture and management screens becomes critical to the customer. In such a competitive market the bank needs to respond quickly to stay ahead of the competition.
That said, the problem posed to the ALM system is less complicated in that the solution does not need to manage the underlying transaction, only the exposure and risk the instrument brings to the bank. The flexibility of ALM systems allows the instrument to be modelled in terms that are similar to conventional instruments. The reasoning for an integrated treasury and ALM solution still applies, however, there is more emphasis on the treasury system to comply with the requirements of the Islamic products offered by the bank.