Professional Documents
Culture Documents
If we
look at our bank statements, we can see computer errors, for example. And at the same time,
there's negligence. A lot of people turned a Nelsonic blind eye to what he (Leeson) was doing
because he seemed to be bringing in the profits." 1
- David Frost, Executive Producer, Rogue Trader.
"It could happen again because the incentives are the same, if not greater. The rewards are very
great and that's a temptation for people." 2
- Neil Wilson, Editor of Futures and Options Week.
Introduction
On February 26, 1995, Barings Bank (Barings) - the United Kingdom's (UK) oldest
and one of its most reputed banks - declared it was bankrupt.
The bank with a total net worth of $900 mn had suffered losses in excess of $1 bn.
These losses were result of the gross mismanagement of the bank's derivatives
trading operations by Nicholas William Leeson (Leeson), the General Manager of
Barings Future in Singapore (BFS).
BFS had been established to look after the bank's Singapore International Monetary
Exchange (SIMEX) trading operations. Leeson's job was to make arbitrage profits by
taking the advantage of price differences of similar contracts on the SIMEX
(Singapore) and Osaka stock exchanges. In spite of not having the authority, he
traded in options and maintained un-hedged positions. He acted beyond the scope
of his job, and was able to conceal his unauthorized derivatives trading activities.
Due to the senior management's carelessness and lack of knowledge of derivatives
trading, the bank landed up in a major financial mess.
When Barings finally went into receivership3 on February 27, 1995, it had an
outstanding notional futures position on Japanese equities and bonds of US$ 27 bn
(US$ 7 bn on Nikkei 225 equity contracts and US$ 20 bn on Japanese government
bond (JGB) and Euroyen contracts).4
Analysts said that the situation demanded that banks the world over must tighten
their internal control procedures.
Background Note
Barings was founded in 1762, by Francis Baring who set up a merchant banking
business in Mincing Lane in London, UK. The business grew rapidly during the period
1798 to 1814.
It became one of the most influential financial houses during the 1830s and 1840s.
The British government paid Barings commissions to raise money to finance wars
against the US and France during the mid 1800s.
During 1860-1890, Barings raised $500 mn for the US and Canadian governments
and was regarded as London's biggest 'American House.' Barings was also involved
in providing loans to Argentina during this period. In 1890, Barings was on the verge
of bankruptcy when Argentina defaulted on bond payments. However, the Bank of
England and several other major banks in London came forward to bail out the
bank.
This crisis had a major impact on Barings and led the bank to withdraw all its
business on the North American continent. Barings then took up the business of
providing consultancy to small firms and wealthy people, including the British royal
family.
Excerpts
Events Leading to the Fall
Soon after joining BSL, Leeson applied and got a transfer to Jakarta, Indonesia. Due
to his excellent performance, Barings management promoted Leeson to General
Manager of BFS in Singapore in April 1992.
In BFS, Leeson's job was to leverage on the arbitrage opportunities on similar equity
derivatives between SIMEX and the Osaka stock exchange (OSE). To take the
advantage of the arbitrage opportunity, Leeson had to adopt the following strategy -
if Leeson was long on the OSE, he had to be short twice the number of contracts on
SIMEX . The arbitrage trading strategy required Leeson to buy at a lower price on
one exchange and sell simultaneously at a higher price on the other, reversing the
trade when the price difference had narrowed or become zero. The market risk in
arbitrage was minimal because positions were always matched. Leeson was not
given any authority to trade in options or maintain any overnight un-hedged
positions.
Why Did it Happen?
Industry analysts felt that the fall of Barings served as a classic example of poor risk
management practices. The bank had completely failed to institute a proper
managerial, financial and operational control system.