In February, 1995, Nick Leeson, a “rogue” trader for Barings Bank, UK, single-handedly caused the financial collapse of a bank that had been in existence for hundreds of years. In fact, Barings had financed the Louisiana Purchase between the US and France in 1803. Leeson was dealing in risky financial derivatives in the Singapore office of Barings. He was the lone trader there and was betting heavily on options for both the Singapore (SIPEX) and Nikkei exchange indexes. These are similar to the Dow Jones Industrial Average (DJIA) and the S&P500 indexes here in the US.
In the early 90s, Barings decided to get into the expanding futures/options business in Asia. They established a Tokyo office to begin trading on the Tokyo Exchange. Later, they would look to open a Singapore office for trading on the SIMEX. Leeson requested to set-up the accounting and settlement functions there and direct trading floor operations (different from trading). The London office granted his request and he went to Singapore in April, 1992. Initially, he could only execute trades on behalf of clients and the Tokyo office for "arbitrage" (Lesson 10) purposes. After a good deal of success in this area, he was allowed to pursue an official trading license on the SIMEX. He was then given some "discretion" in his executions meaning; he could place orders on his own (speculative, or "proprietary" trading).
Even after given the right to trade, Leeson still supervised accounting and settlements. And there was no direct oversight of his "book" and he even set-up a "dummy" account in which to funnel losing trades. So, as far as the London office of Barings was concerned, he was always making money because they never saw the losses and rarely questioned his request for funds to cover his "margin calls" (Lesson 3). He took on huge positions as the market seemed to "go his way." He also "wrote" options, taking-on huge risk (Lesson 10).
He was, in fact, perpetuating a "hoax" in his record-keeping to hide losses. He would set the prices put into the accounting system and "cross-trade" between the legitimate, internal, accounts and his fictitious "88888" account. He would also record trades that were never executed on the Exchange.
In January, 1995, a huge earthquake hit Japan, sending its financial markets reeling. The Nikkei crashed, which adversely affected Leeson's position (remember, he had been selling Options). It was only then that he tried to hedge his postions, but it was too late. By late February, he faxed a letter of resignation, and when his position was discovered, he had lost ($1.4 billion USD). Barings, the bank which financed the Louisiana Purchase between the US and France, became insolvent and was sold to a competing bank for $1.00!
(If you are interested in more details regarding this infamous case, you can read "Rogue Trader" by Nick Leeson himself. There is also a movie of the same name starring Ewan McGregor which should be available for rent in DVD format.)
The following two cases are brief descriptions of similar, catastrophic losses by traders with little, or no, oversight.
This case study consists of the “Report of the Board of Banking Supervision Inquiry into the Circumstances of the Collapse of Barings, 18 July 1995.”
- Massive Losses incurred by Nick Leeson, the General Manager and Head Trader of Barings Financial Services (BFS) by reason of unauthorised and concealed trading activities within BFS.
- The true position was not noticed earlier by reason of a serious failure of controls and managerial confusion within Barings.
- The external auditors, supervisors or regulators of Barings had not detected the true position prior to the collapse.
- Operational Risk – A lack of segregation between front and back office. Leeson was permitted throughout to
remain in charge of both front office and back office at BFS.
- Operational Risk – The lack of understanding of BFS’s trading activities, the lack of reconciliation to client records of the funding provided by Barings in London to BFS and the lack of verification of the (false) information provided by BFS, the deficiencies and inaccuracies in large exposure reporting to the Bank of England.
- Operational Risk – The system of checks and balances necessary for the proper management and control of a financial institution failed in the case of Barings with regard to BFS in a most serious way, at a number of levels and in more than one location.
- Management teams have a duty to understand fully the businesses they manage.
- Responsibility for each business activity has to be clearly established and communicated.
- Clear segregation of duties is fundamental to any effective control system.
- Relevant internal controls, including independent risk management, have to be established for all business activities.
- Top management and the Audit Committee have to ensure that significant weaknesses, identified to them by internal audit or otherwise, are resolved quickly.
PRM Official Reading
The Official Reading for Barings Bank case for PRM exam can be downloaded from here.
Barings Bank Video
The following documentary titled “25 Million Pounds” is a study of Nick Leeson and the collapse of Barings Bank. Won the Best Science and Nature Documentary in the 1998 San Francisco International Film Festival.
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