Baring Failure FINAL-1

8/13/2019 Baring Failure FINAL-1

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Barings Failure

BA849 Seminar in Finance

National Institute of Development Administration

Semester 3 / 2011

Ms. Supattra Maklum ID# 5310212001Ms. Linda Thipvoratrum ID# 5310212004Ms. Nodtaporn Chaichoochai ID# 5320212001Mr. Nopadol Kitsrinopadol ID# 5320212003


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Introduction

Barings Bank was Britain's oldest merchant bankestablished in 1762.

Collapsed in February 26, 1995 due to secretlyderivatives trading on both the Nikkei225 and onJGBs (Japanese Government Bonds) by NickLeeson.

The damage: $1.4 Billion lost, reducing BaringsBank value from $500 million to $1.60.


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Who is Nick Leeson?

Nicolas Leeson was born February 25, 1967.

A former derivatives broker whose fraudulent actionsbrought down Barings Bank.

During the 1980s, Leeson got a job as a clerk with a privatebank, Coutts. Then, he worked at many other banks beforesettling at Barings Bank in 1989.

He had been the star trader of the bank.

Within a year, he had made alone 10 million pounds, whichaccounts for 10% of the bank profit for that year.

BUT!!!!


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Brief Storyline

Leeson joined Barings Bank as a back office employee with100 million pound share in certification.

Successful in back office position and then was promoted to a

trader.

Leeson was transferred to Barings Singapore branch asderivatives trader between Singapore Monetary Exchange(SIMEX) & Osaka Securities Exchange (OSE).

Leeson set up Error Account 88888 to cover up a mistakemade by an inexperienced team member, which led to a loss of20,000 pounds.

Leeson then used that account to cover his own mountinglosses.


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Brief Storyline

By December 1994, the red ink hidden in account 88888totaled $512 million. Getting increase Leeson bet that theNikkei index would not drop below 19.000 points.

Leeson lost $1.4 billion due to his unauthorized speculativetrading.

Barings Bank was bankrupted.

Leeson was arrested in Frankfurt, Germany.

In December 1995, a court in Singapore sentenced him tosix and a half years in prison.

In 1999, Leeson was released.


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Barings Official Strategy

Long on the Nikkei 225 futures listed on OsakaSecurities Exchange (OSE) and short twice the

number of contracts on Singapore MonetaryExchange (SIMEX).

Official strategy: Take advantage of temporaryprice differences between SIMEX and OSE.

(Switching strategy)

It required Leeson to buy the cheaper contractand simultaneously sell the more expensive one.


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What Leeson Did.

But, Leeson did not short on SIMEX but longed the numberof contracts he was supposed to shorted.

These unauthorized trades was hidden under the accountnamed Error Account 88888.

Leeson sold straddlesHe earned premium income fromover 37,000 straddles over a 14-month period.

As losses mounted, he took on larger positions RogueTrader

He tried to sustain market by: Buying tremendous amounts of Nikkei stock index futures.

Selling Japanese government bond futures and betting thatinterest rates would rise.


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What Leeson Did.

Leeson placed bets on the direction of pricemovements on the Tokyo Stock Exchange.

He counted on the Nikkei index to rise.

If it didrebound, he would make profit on both theincreasing stock value and increasing in interestrates.

However, his luck ran out when the KobeEarthquakesent the Asian financial markets intoa tailspin.


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Straddles

Source: International Financial Risk

Institute


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Leesons Positions

Bought a substantial number ofcontracts, 11,000 after the earthquake.

Believing that fall of the Nikkei 225from 20,000 to 18,950 was onlytemporary.

Nikkei 225 dropped further and the Nikkei225 was around 17,950

At the end of February 1995, Leesonhad leveraged his position to $7 Bn,holding about 61,000 contracts(55,000 March and 6,000 June)

Source: International Financial RiskInstitute


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How Did He Deceive?

Hid the losses in secret account: Account 88888while using account 98007 (Barings London JGBArbitrage) and 98008 (Barings London Euro YenArbitrage) to report to headquarters.

He was in charge of both back and front office.

He had checks and trading reconciliations signingauthority.

He was the only one who checks and see if recordsmatched the actual sales.

No proper internal and risk management.


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Concealed the loss


Institute


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Tracks of the funding


Institute


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Profitability of Leesons Trading Activities


Institute


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Concealed Trading

Losses

Source: Bank of England, Board of Banking Supervision


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Where Did It Go Wrong?

Leeson mostly gambled on the direction ofmarkets.

A major part of his strategy involved the purchaseof Nikkei-225 futures contracts.

His only hedge was only the short position on

Japanese Government Bonds (JGB). He only made a one-sided bet.


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Why Baring Collapse

Unauthorized speculative trading.

Position of trader should be an arbitrage instead of hedging or

speculating . Incompetent management

Failure of internal controls: Managers responsible for monitoringLeesonsperformance did not do their jobs.

Fail of operational control system: No segregation of duties for the

front and back office. No clear layout of reporting lines.

Poor supervision of employees.

Incompetency of external auditors (lack of knowledge aboutderivatives).


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Lessons Learned

Something that is too good to be true Investigate!

Do not trade by gambling.

Foundations for effective internal controls is amust.

Failure to implement an effective riskmanagement system can lead to organizationscatastrophe.

Fall of Barings Bank was a wake-up call forfinancial institutions all over the world.


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Thank you

Documents

Baring Failure FINAL-1