Businesses around the world have an ever-increasing important task for practicing smart collateral management. The globally faced financial pressures caused by massive credit, bank, and financial institution failures and the stringent governmental regulations imposed as a result have lead to a need for financial institutions to adopt new solutions for managing and monitoring collateral. One of the main solutions for better management and monitoring of collateral is through the use of financial services technology.
Financial services technology from a collateral management standpoint may help to limit the genuine risk that improperly managed collateral can lead to institutional failure. Collateral can take on many forms including currency, stocks and bonds, real estate, jewellery, commodities, and other equitable securities and valuable assets. One form of collateral or another is almost always required for certain types of financial transactions including derivatives, business lending, and consumer lending. Financial institutions most commonly encounter the need for collateral within derivative transactions.
Derivative transactions do not involve tangible exchanges of assets, but rather are agreements to exchange assets at a later date. Essentially the agreement to perform a financial transaction at a later time has value determined by another underlying item. The potential scenarios that result in derivative transactions are infinite, as they can be based on anything and applied to any financial situation. Placing collateral in a derivative transaction helps to secure that the obligation will be met if the outcome of the underlying item causes the derivative transaction to work in the other parties favour.
Due to these highly complex financial transactions requiring collateral, proper collateral management would be extremely difficult to maintain without the aid of a financial services technology. Technology focusing on collateral is most often seen in the form of sophisticated software programs and exchanges that are maintained on private and local networks or on the Internet. Most of the sophisticated software available has features such as valuation of collateral across various financial markets. Proper valuation of collateral allows for further calculation of exposure to potential losses if a derivative transaction should work against a financial institution. This data and analysis can then further aide in risk management in relation to collateral.
Other considerations from financial services technology focused on collateral management include potential reductions in the costs associated with collateral transactions. Better management of collateral allows for more efficient and effective use of financial resources. The abilities of software to alert and automatically perform trending and analysis limits the number of personnel required to manually review and monitor market fluctuations in collateral values. The savings from these types of administrative cost reductions can be of added benefit to many financial institutions seeking to reduce operational costs. Another factor favouring proper management of collateral include regulatory requirements to do so. The Sarbanes-Oxley Act of 2002, which was created to ensure financial responsibility and transparency, requires proper process controls and monitoring of financial activities including derivative transactions.
Financial institutions all over the world are currently being faced with unprecedented pressures to actively monitor their activities. As many of these activities are cantered around derivative transactions that are almost always backed with collateralization by either one or both parties, it is therefore important for financial institutions to practice proper collateral management. With institutional failures from banks to investment firms, the financial institutions have a responsibility today more than ever to ensure financial transactions are handled with the due diligence they require.