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Barings Bank DisasterIntroductionIt was founded in 1762 and was owned by theBaring familyof German origin.Barings Bankwas an Englishmerchant bankbased inLondon, and one of theworld's oldest merchant banks.The bank collapsed in 1995 after suffering losses of 827 million ($1.3 billion) resulting from poor speculative investments, primarily infutures contracts, conducted by an employee namedNick Lesson working at its office inSingapore.Focal points addressed in PresentationHow is it possible that this one man was able to cripple a financial giant?What was the role of senior management in this situation and did they contribute to the demise? How effective were the internal control systems and was the Singapore operations managed effectively?How certain deficiencies in internal controls and risk management systems impacted the bank and ultimately led to its collapse?

Good old daysBarings Bankwas founded in 1762 as theJohn and Francis Baring CompanybyFrancis Baring, with his older brotherJohn Baring.in 1802, Barings and Hope were called on to facilitate the largest land purchase in history - theLouisiana Purchase.in the 1880s, daring efforts inunderwritinggot the firm into serious trouble through overexposure to Argentine and Uruguayan debt. Through the organizational skills of the governor of the Bank of England,William Lidderdale, a consortia of banks was arrangedto bail Barings out and support a bank restructuring.The company established ties with KingGeorge V, beginning thus a close relationship with theBritish monarchy. Termed as Queens bank by Elizabeth IIIntroducing : The Rogue TraderNicholas Leeson Worked for Morgan Stanley after graduating universityLeeson had been the star trader of the bank.Leeson then joined Barings (Jakarta) to sort through back-office mess involving 100 million of share certificatesSuccessfully rectified the situation in 10 monthsThen transferred to Singapore and worked with a lot of power & freedom

Lesson Doubling StrategyAn attribute of doubling strategy is that the inevitable & devastating loss is preceded by a period of high returns with low volatility.Leesons trading activities mainly involved three futures market: Futures on the Nikkei 225 stock index Futures on 10-year Japanese Government bonds Euro yen futuresLeesons main assignment was to arbitrage between SIMEX and Japanese exchanges in the futures contracts.Instead of arbitraging, he was speculating, financing SIMEXs margin requirements by selling options & borrowing huge amounts of money from Barings head office in London.Kobe earthquake of January 17, 1995 led to the crash of Nikkei and his investments

Lessons Deceptive strategiesUse of Cross TradeBreaking down the total number of contracts into several different tradesChanged the trade prices thereon to cause profitsProfits credited to 'switching' accounts & losses to be charged to account ' 88888 Details of this account were never transmitted to the treasury or risk control offices in LondonThe 1995 CollapseNicholas bought a substantial number of contracts, 11,000 on the 20th of January 1995, just three days after the earthquake in Kobe. Probably, he thought that the market had overreacted and that the fall of the Nikkei 225 from 20,000 to 18,950 was only temporary.But the Nikkei 225 dropped even further and by Monday 23rd 1995, the Nikkei 225 was around 17,950. At the end of February 1995, Nicholas Leeson had leveraged his position to $7bn, holding about 61,000 contracts.The margin calls were enormous and Barings Tokyo London had to transfer urgently a massive $835 m to Barings Singapore in January and February to cover the margin calls on Simex. These calls made finally Barings bankrupt as its reported capital was only of $635m.Management FailureEffectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back officeHe had the final say onpayments,ingoing and outgoing confirmations and contractsreconciliation statementsaccounting entriesposition reportsLeeson was considered perfectly placed to relay false information back to London

Regulation in ResponseThe Board of Banking Supervision conducted an inquiryDid not necessitate any change to the framework of regulationSome existing arrangements needed to be improvedLike better understanding of non-banking businesses undertaken by the banking groups they were responsible forSIMEX assumed that Barings was hedging and not speculating when it granted an exemption on the number of contracts that Barings could hold.In addition, the speculative position of Barings was hidden due to use of an omnibus account to clear trades. With an omnibus account, the identity of the brokers account is hidden from the exchange and clearing house.Observation and Lesson learntRaised the standards of internal controls and compliance.Banks are better capitalized which makes them less likely to collapse in case of future rogue trader strikes.Stronger competition in search additional profits gave so much control only to the one personFront and back office operations are carried out independently from each other. Although lessons have been learnt there are loopholes. The market is always changing in terms of products , complexity, and vulnerability to fraud within and supervision from outside. It seemed that the management were satisfied with the short term profit; they were unaware of important activities of the companyThe institution was in funding risk due to enormous unhedging position

Maximizing the WealthThere are certain things a financial manager can do to maximize the wealth:Assess risk appetite of firm and capital baseAggressive yet ethical tradingNo doubling policyMaintain a system of checks and balances in tradingDefine limits and credit profilesConduct unannounced spot audits

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