CASE STUDY: Barings Bank, 1995, United Kingdom
In February 1995, Barings Bank declared bankruptcy. Barings Bank was the United Kingdom’s oldest merchant bank, founded in 1762. Nick Leeson, who was appointed the general manager of the Barings Futures subsidiary in Singapore in 1993, was assigned to exploit low-risk arbitrage opportunities that would leverage price differences in similar equity derivatives on the Singapore Money Exchange (SIMEX) and the Osaka exchange markets. However, due to a lack of higher supervision, he was was given control over both the trading and back-office functions. He began taking much riskier positions by trading different amounts on contracts of different types on the two exchanges. The derivatives contracts on the Singapore and the Japanese foreign exchange markets were highly dependent on the market conditions in 1993 and 1994.
When the market became volatile, losses in Leeson’s trading account began to accumulate, forcing him to increase his bets in an attempt to recover losses. He created a special secret account to keep track of his losses, account number 88888. This account had originally been set up to cover up a mistake made by an inexperienced member of the trading team, which led to a loss of £20,000. Leeson then used this account to cover his mounting trading losses.
Finally, the Nikkei index dropped sharply after the Jan. 17, 1995 Kobe earthquake in Japan, and the losses exceeded $1 billion. The fraud was only exposed when Nick Leeson failed to show up at work at his Singapore office in February 1995; he was attempting to flee from Kuala Lumpur to England in order to escape the tough Far Eastern justice system. The bank was unable to sustain the loss and announced bankruptcy. Here is an extract from Leeson’s book “Rogue Trader” (1997, pp. 2-3), about his last trading day:
“I knew I’d still lost millions of pounds, but I didn’t know how many. I was too frightened to find out-the numbers scared me to death. . . . I’d gone in trying to reduce the position and ended up buying another 4,000 contracts. . . . Traders looked at me and knew I’d done an amazing volume of trade; they marveled at the sheer amount of business I’d got through. They wondered whether I was dealing for myself or for clients, and whether I’d hedged, protected my position. But they knew-as the whole of Asia did-that I’d built up an exposure to over £11 billion worth of Japanese shares. They were doing their sums and they reckoned I was well long: it was hard to conceal it when you stand for over 40 percent of the Singapore market. The rest of the market had smelled what Barings back in London were completely ignoring: that I was in so deep there was no way out.”
A month later, in March 1995, the bank was purchased by the Dutch Bank ING for £1 sterling! In November 1995 Nick Leeson was sentenced to 6.5 years in a Singaporean jail. This is another example of the dramatic consequences of internal fraud, unauthorized trading and poor internal surveillance and control.
Intelligent Investors, listen up…
Leeson didn’t have the ability to take a loss. If you look at the great disasters in markets on an individual basis, they are mostly individuals who refused to take a loss. They waited for the market to reflect their belief about the market. Long-Term Capital Management (LTCM), Leeson – Jesse Livermore – you can be the best and the brightest, but without the knowledge of your own limitations and the discipline such knowledge brings, you court disaster. Word.
