Barings Bank Case
Barings Bank, which was founded in 1762, is known to be one of the world’s oldest merchant banks, eminent for having facilitated the Louisiana Purchase. The bank proclaimed bankruptcy in 1995 after losing £827 million (approximately $1.3 billion) due to unauthorized trading activities from one of its employees, Nick Leeson.
Barings Bank had many shortages in its risk management policies and course of action that allowed for Leeson’s blatant abuse. The most protuberant deficiency was that Leeson headed both the trading desk and the settlement functioning; duties usually filled by different categories of people. In other words, Leeson succeeding settling and accounting for his trades, which permitted him to conceal his fraudulent activities. Not only was Leeson able to hide his losses of £200 million, but in 1994 he delineated a profit of £102 million, which amounted to 10% of Barings’ annual profit.
As Barings Bank’s head derivatives trader in Singapore, Nick Leeson was approved to arbitrage derivative contracts listed on both the Osaka Securities Exchange and the Singapore International Monetary Exchange. The approved plan was to buy on one exchange and sell on the other for a small profit. However, instead of arbitraging, Leeson created directional bets on future contracts (and other complimentary derivatives) by buying and holding them. He started dropping money on his positions and decided to increase the size of the bet, using money from other areas of the bank to cover his losses. This continued for around 2.5 years till the time the Kathe obe earthquake caused a heavy turndown in the Asian markets, which resulted in the £827 million loss for Leeson and Barings Bank.
Amidst the collapse of Barings Bank, financial companies became more watchful of the need to separate the control groups from the trading groups simultaneously regulators across the world also became more aware of risk management. Currently, the FDIC advocates that all banks question their employees (especially those who are in risk-taking and managing roles) to conduct an annual consecutive two-week vacation, as an internal safeguard against fraud.
The Barings collapse is another reminder of the serious issues which can take place within banks. In this situation, the hardships failed in a banking group with a history spanning over 230 years. Contrary to initial and popular reactions to the downfall, however, the Barings experience says less about the ‘problems’ with banks' use of derivatives than about the problems that arise when risk management systems and practices and accounting procedures are unproductive. The experience also demonstrates certain issues that can take place where there is dishonest action and fraud on the part of senior bank staff.
Shivam Kumar Singh,
Kautilya, IBS Mumbai.