The Barings Bank and the Rogue Trader
How many times have you heard that a single employee of the bank has caused the whole bank to shut down? How many times have you heard that a single employee was the reason behind the collapse of a 200-year old bank? I am sure, not very often. Today, we bring one such story which amazed the whole financial sector and led everyone to do some deep thinking.
About Barings Bank
Barings Bank was a British merchant bank in London which collapsed in 1995. The bank was the second oldest merchant bank (modern banks) which was founded in 1762. It went on to become one of the largest and safest banks in the world. It was a very reputed bank and it even offered personal banking services to Queen Elizabeth. Barings Bank was also popular as it was financing the Napoleonic Wars, Louisiana Purchase by the US and the Erie Canal.
In February of 1995, Nick Leeson single-handedly led the bank to bankruptcy. But how did a single man became so significant that it left no option for Barings Bank but to shut down?
The best trader in town
Nick Leeson, the former employee of Morgan Stanley, joined Barings Bank at the age of 28. He was transferred to Jakarta, the capital of Indonesia, and was able to settle £100 million worth of back-office contracts. He performed better than expected as he rectified all problems faced by them in just 10 months. This impressed the bank's senior management.
They promoted Leeson to the post of general manager of Barings Securities in Singapore. He was sent to head both front-office and back-office operations. He was also responsible for hiring new staff, including a team of traders which will help him during the market hours.
Nick Leeson was Baring's face on the trading floor. He was the person who made all the decisions regarding the trading of the bank's money in the derivatives market of SIMEX (Singapore International Monetary Exchange). He made unauthorized speculative trades which helped the bank to earn huge profits on a consistent basis. At the end of 1992, more than 10% of the bank's profits came because of Nick Leeson's wondrous trading moves. Normally, the contribution of investments in a company's profit is nowhere near 10%. This earned him unlimited trust from his London bosses. But, they were not aware of the implications their decision will have.
Nick Leeson's good luck in trading didn't last wrong and soon he started losing money. To hid his incompetency from the management, he created an '88888' account. He hid his losses in this account. In front of the senior managers, Leeson mentioned that these losses were of one of the inexperienced junior traders. Till 1993, the losses in this secret account were around £23 million. But by the end of 1994, the amount had increased exponentially to £208 million. For context, £1 is almost ₹100 today. That means this amount would have been close to ₹2,000 crores.
On January 16, 1995, Leeson used a short straddle strategy at Singapore and Tokyo stock exchanges. He was sure that the market would not have any significant movement, neither upwards nor downwards. But, he didn't know what would happen next.
On January 17, 1995, a big earthquake, registering magnitude 7.2 on the Richter scale hit Japan. This caused a sharp drop in the Asian markets, specifically Tokyo stock exchanges where the Nikkei dropped 1000 points. To cover for his losses, Leeson made more risky trades hoping that the market will lift again. He purchased even more Nikkei futures contracts in hopes that he will be able to drive the market upside alone. But to his dismay, the market fell continuously.
Failed and Fooled
One question which comes in mind after reading this is, where was the audit committee? Why was there no checks when the single account was recording such huge losses? The review committee 'failed' in their checks and were successfully 'fooled' by Nick Leeson. There were multiple factors which played in Leeson's favour. As he operated in both the front-office and back-office, he had unlimited autonomy.
He was making trades through front-office and was in command of the back-office which had the role to keep checks on the trades made by the front-office. Thus, he was making highly risky trades and was approving himself without any restrictions. That means, he had the ability to hide whatever he wanted to hide from the official books. Leeson made false declarations to regulatory authorities to avoid any strict checks on his work. He hid huge amounts of losses and forged the signatures of his seniors to get access to more money.
The Shutdown and Aftermath
By the time Barings Bank investigated and discovered the '88888' account, the losses were too big for the company to stay afloat. Nick Leeson was accountable for the losses worth £827 million. This was twice the Barings Bank available trading capital. With no way out to recoup the losses he has incurred, Leeson decided to flee away. He left a note which read “I'm sorry”.
On February 26, 1995, the 233-year-old Barings Banks bank was declared insolvent. After 10 days, on 6th March 1995, it was officially acquired by a Dutch investment group, ING. They paid a meagre amount of £1 for this acquisition, just imagine buying a bank for ₹100! The collapse caused 1,200 people to lose their jobs in Singapore alone. In 2001, ING Barings was sold to ABN Amro.
After flying away to Malaysia and Thailand, Nick Leeson was arrested in Frankfurt, Germany. He was brought back to Singapore after 9 months and was sentenced to a jail term of 6.5 years. Leeson was charged on two grounds: deceiving the bank’s auditors and cheating the Singapore exchange. He served his term in jail during which he was diagnosed with colon cancer.
After being released from his prison, Nick Leeson has started a new life. He is now a public speaker and lecturer. He is also a personal trader and gives out regular comments on market performance.