Collapse of Barrings Bank Essay Example

Chief trader and also with his experience of the back-office, he was in charge of back-office duties such as accounting for the transactions (Stock Market, 2008). This lack of segregation of duties has lead to one of the most infamous financial demises of the century. The tasks of Leeson and his fellow traders were only to conduct transactions for futures and options for clients and also for other firms within Barings Bank.And also to look for arbitraging price difference for Nikkei 225 futures traded on the SIMEX and Japan’s Osaka exchange. The arbitrage policy was seen by Management as quite a low risk strategy and Leeson and his team were meant to make an amount of small profits rather than spectacular profits (Risk Glossary, 2008).

Since this was so low risk Leeson was allowed to both execute and settle his own trades so basically he did all the paperwork to account for his trades without any supervision.But Leeson started making unauthorised speculation on Nikkei 225 stock index futures and Japanese Government Bonds (JGB) (Stock Market, 2008). He started taking outright positions on the two exchanges and this was the beginning of the end for Barrings Bank. Nick Leeson opened up a secret error trading account ‘88888’ to facilitate his unauthorised trading, which he used to conceal his substantial losses (Wikipedia, nd). He adopted a trading strategy known as a Straddle; his objective was to sell call and put options on the same underlying instrument and make a profit (Erisk, 2008).

This was a very risky strategy, a far call from the low risk strategy of Arbitrage; it had the capacity to produce good profits if the

market was stable but also the chance to accrue great losses if they became volatile (Erisk, 2008). He started losing money from the beginning and to make up for this he started making bigger trades which only increased his losses. He started basing most of his trades on emotion rather than calculation of risks and this had a big impact. By the end of 1994 Leeson had run up losses of up to ? 200 million(Stock Market, 2008).

By early 2005, Leeson had taken a strategy which saw him hold long positions in Nikkei Futures, short positions in Japanese Government Bonds and a short volatility position in Nikkei exchange traded options. For Leeson to have made a profit, it would have required futures prices on Nikkei index to have increased and Japanese Government Bond prices to have decreased and also there to have been low volatility in Nikkei Index (RBA, 2008). But the exact opposite happened and Leeson made huge losses. And as an inexperienced trader he did not know when to cut his losses, he kept making even larger trades to make up for the losses.

Leeson had accumulated a huge position by mid-February of about 50% open interest in the Nikkei futures and around 85% interest in the JGB futures (Risk Glossary, 2008). But it was sheer bad luck that an earthquake hit Kobe in Japan. This led to this Nikkei Index dropping by 7%. Despite this Leeson expected the Index to stabilise so he purchased even more contracts.

But there was to be no rebound, by February 25, 1995 the total losses suffered by Leeson was €827 million thus soon after discovering this Barings

Bank had to declare itself bankrupt (Stock Market, 2008). Question 3During the crisis, it was unknown to the senior management team the trading activities that was undertaken by Nick Leeson. Their reaction towards knowing the underlying activities brought them to a state of shock. “Andrew Tuckey and Peter Norris seemed on the verge of tears” (Fay, 1996).

This shows that their attitude towards the crisis was quite daunting. Peter Barings the chairman of Barings Plc agreed that the there was lack of effective controls with regards to Barings Futures Singapore. It allowed Leeson to undertake unauthorised actions towards trading and prevent detection of his activities.He also stated “that those with direct executive responsibility for establishing effective controls must bear much of the blame” (Numa, 2008). This shows quite an aggressive attitude to blame others to be held responsible. Understandably it is the responsibility of direct executives but they not to take all the blame as there was a lack of internal control within the Barings matrix structure.

It was advised by the auditors that there was lack of segregation of duties at Barings Futures Singapore but there was no implementation of any changes.Despite being advised to implement such changes, the senior management showed a lax attitude and didn’t take any actions for the reason being they wanted to accept the profit figures coming from BFS. This negligence attitude cost Barings its failure to bankruptcy from the incurred losses. Some of the measures that may have prevented the losses incurred are: Proper supervision of employees Clearly there was a lack of supervision upon Leeson. There was no one directly responsible to monitor his trading strategies.

His immediate

boss Simon Jones was in charge of both Barings Securities (Singapore) Limited (BSS) and Barings Futures Singapore (BFS). Because Jones was so primarily concerned with the affairs at BSS, he devoted little attention to BFS and let alone Leeson to almost entirely operate BFS (Numa, 2008). If Jones had equally concerned himself in both BSS and BFS operations, Leeson wouldn’t have been able to undertake unauthorised actions towards trading activities due to supervision from his boss. Adequate internal checks and balances There was no adequate internal checks and balances within Barings.Leeson being the General Manager of BFS was responsible for the back office and executing trading.

Due to lack of internal checks and balances he was able to conceal his unauthorised trading activities for over a year because he managed both the trading and back office functions. If there were adequate internal checks and balances, this would have prevented Leeson to conceal unauthorised trading activities. A thorough understanding of business The senior managers at Barings came primarily from a merchant banking background and knew very little about trading.Therefore Leeson was allowed to buy and sell futures contracts and was allowed freedom to do so since management believed that Leeson was carrying out a low-risk profit with matched positions on the Singapore International Monetary Fund (Simex) and the Osaka Exchange (New York Times, 2008). If the senior managers and auditors understood how the trades work, then they would have realised that making such large arbitrage profits wouldn’t be obtained without increasing the level of associated risk with the arbitrage and thus with anxiety would have questioned Leeson about the large profits he was generating.

A clear reporting

line There was not a clear reporting line for Leeson’s activities from which he facilitated his fraud. James complained that Leeson had two reporting lines; one to Simon Jones and the other to Gordon Bowser (Fay, 1996). Due to lack of clear reporting lines Leeson was able to hide his activities so if a clear reporting line was established within the firm, it would have made it difficult for Leeson to execute transactions and hide its losses. Separation of duties At Barings Futures Singapore there was clearly a lack of separation of duties.Nick Leeson being the General Manager was in charge of trading activities on the floor of the exchange.

With the trading he was simultaneously the head of settlement operations, charged with ensuring accurate accounting for the trades (Wikipedia, 2008). This allowed Leeson to cover the losses and show profits for which he was praised. One person shouldn’t clearly be responsible for the two jobs. It should be carried out by two separate individuals where work can be reconciled and chances of fraudulent activities are reduced.Effective oversight from Headquarters & Management Actions In the case of Barings collapse, there was no oversight from headquarters on the operations executed at BFS.

Also there was no effective communication between senior management (Numa, 2008). If headquarters had a proper oversight over BFS then they would have recognised the lack of internal controls within the firm structure and could have prevented from losses further incurring in the early stages.Also there was a lack of responsibility from the senior managers, the auditors had warned Barings senior executives that Leeson could override bank’s control as he was in charge of

both trading and settlements but the senior management did not take any appropriate actions (New York Times, 2008). If appropriate management actions were taken in the early stages, then Barings could have saved itself from the collapse. Question 4 Due to the speculative trading on futures contracts by one trader, the company incurred at least ? 1. 4 billion of losses in derivatives trading and was declared bankrupt in February 1995.

In the aftermath of Barings being declared bankrupt, a Dutch bank ING purchased the bank for one pound sterling one month later and absorbed all of its liabilities. This bankruptcy also affected other companies such as UK merchant bank. Its shares had sharply decreased due to Barings collapse. Also other companies had some aftermath according to Reuters report “Kleinwort Benson Group Plc had fallen 39p to 581, Schroder’s Plc 35p to 1,475, S. G.

Warburg Group Plc 28p to 690 and Gerrard & National Holdings Plc 27 to 411”. (Reuters, 1995). The responsibility for this situation was not only by one individual but ltimately the whole management of Barings Bank as the company’s lack of separation of duties between the front and back offices within BFS which enabled Nick Leeson to have total control. After fleeing Singapore when Leeson unauthorised trading was about to be discovered, he was finally apprehended in Frankfurt, Germany and then extradited back to Singapore where he was sentenced to Six and a half years on charges of Fraud.

During his time there he got diagnosed with cancer and was divorced by his wife. But he survived all that and was released in 1999 for good behaviour.He now resides in Ireland

and is the Chief Executive Officer for an Irish football club. As the other management and executives who were found partially responsible, they resigned in May, 1995 (Reuters, nd). Question 5 On the 27th of February, the Chancellor of Exchequer announced there would be an inquiry by the board of Banking Supervision. Its aim was to investigate the reasons of the collapse and draw the lessons from this experience, for the Bank of England’s supervisory arrangements and the structure of regulations within the UK financial system more generally (RBA, 2008).

The reaction of the market regulator in response to the collapse was quite rapid as it announced an inquiry on Barings on the following day of the collapse. After a thorough investigation, the Board recommended to the Bank of England to ensure that the banks that they overlooked would implement in the future that management has responsibility to understand all aspects of the business and a clear responsibility assigned for each activity.And also put in place relevant internal controls that included better risk management for all business activities and also to resolve quickly all the weaknesses that are identified to them by top management and audit committees. It also advised that Bank of England improves their liaison with other regulators and supervisors to enhance better understanding of financial services businesses and to improve their traded markets team which examine banks risk models by increasing the number and skills of people that were available for on site visit.And also for better internal consultations on derivatives of the banks trading activities and other credit portfolios (RBA, 2008).

On the 16th & 17th May 1995, representatives of regulatory bodies

of 16 countries responsible for supervising the world’s futures and options markets determined to issue the Windsor Declaration in the aftermath of Barings debacle. They reached an agreement 1) to put in place mechanisms that enhanced co-operation and communication between regulators and market authorities to minimise the adverse consequences caused by defaults or other failures.And the other work undertaken should better facilitate more consistent protection among regulators 2) with respect to protection of customer positions, funds and assets; 3) to develop better by market authorities in regards to treatment of positions and funds in a financial disruption of a member firm so as to isolate the problem at the failing firm; 4) with respect to regulatory co-operation emergencies, the development for control and management of a major of a business disruption by an financial intermediary, market members and markets. (U. S Commodity Futures Trading Commission, 2008)In conclusion Nick Leeson was primarily responsible for the collapse of Barings.

His speculative trading for derivatives generated substantial losses which led the 233 years old bank to bankruptcy. Nick was able to speculate and hide his losses as he was in charge of both front and back office. If the senior management of Barings had taken more responsibility for internal checks and balances, Nick’s unauthorised trading would have been detected at an earlier stage which could have prevented the bank from bankruptcy. This has become milestone case in the history of banking and a text book example of accounting fraud.