In 1995, the fraudulent actions of a 28-year-old, named Nick Leeson, brought down the world’s second oldest merchant bank situated in London, Barings Bank. The bank suffered extensive losses amounting to £827 million due to massive trading losses by Leeson, who was then based in the Singapore branch of the bank, as the head derivatives trader.
Nick Leeson was supposed to be conducting arbitrage trades, from the differences in prices of Nikkei 225 futures contracts listed on the Osaka Securities Exchange in Japan, with those listed on the Singapore International Monetary Exchange (SIMEX). Normally, the bank approved of strategies that involved buying from one market and immediately selling it in another, at a small profit. Nick went against the norms and held onto these positions, gambling on the direction of the futures markets, leading to a catastrophic accumulation of unhedged losses.
What followed is one of the biggest frauds in global banking history ever.
Founded in 1762, Barings Bank was one of the oldest and largest merchant banks in the world. During World War II, the assets of the bank were liquidated by the British government, in a bid to fund its war efforts. It was consequently bought by several influential names and remained an important market player till its demise.
In July 1989, the then 22-year-old Nick Leeson joined the bank, in the settlements department. He was a skilled derivatives trader, with a history of making large profits in speculative trading. Over the years, he assumed various critical roles in the bank, which he successfully fulfilled. For instance, in his posting at the Jakarta, Indonesia, branch, he successfully managed to sort and settle £100 million worth of back office contracts, which were pending for a long time.
In April 1992, Leeson was sent to Singapore, to run the back-office of the bank’s derivatives operations at the Singapore International Monetary Exchange (SIMEX).
In July 1992, a new bank employee working under Leeson suffers a small loss. Previously, an account technician had created Account 88888 for Leeson, which was a kind of “error account.” This was initially created for inexperienced traders, who could report their losses in it from time to time.
Leeson didn’t want to appear incompetent to the top management, so he hid the loss in this error account. This would, however, be only the first of many losses that he would continue to hide in the account. The account was eventually appropriated by him, which he excluded from the general reporting lines.
In the meantime, he continued his attempts to turn the losses around through aggressive speculative trading, which unfortunately led to even bigger losses. Interestingly, around this time, Leeson passed the SIMEX trading exam, which provided him the opportunity to trade on the exchange floor for some time. Here, the bank neglected to mention an important detail regarding him; he had previously failed to acquire the City of London trading license due to a pending county court case against him. It would ultimately prove fatal for the bank.
By the end of September 1992, Leeson had made such large unauthorized trades in the Japan Nikkei futures index that Account 88888 now held losses worth £6 million. He didn’t report these losses to the bank. In fact, in December 1992, he actually reported profits worth £102 million to the British tax authorities, for which he was rewarded £150,000 as bonus, along with his handsome salary.
By March 1993, Neeson was appointed the head of the derivatives trading department in Singapore, which made it easier for him to conceal his losses. Till July 1994, he continued to wildly invest in Nikkei futures, all of which led to massive losses. An internal audit procedure around this time made the bank aware of discrepancies in the accounting reports, but they chose to trust the decisions made by Nick Leeson, who they considered their star trader. By the end of 1994, Account 88888 had losses worth £208 million.
In January 1995, Nick Leeson was again questioned by the audit officials regarding missing pieces in his accounting trail. He concocted stories regarding paper trades brokered by some clients and furnished proof for that, somehow. It was at this time that he became nervous and attempted to reverse all his losses, by betting everything he had. Unfortunately, Japan was hit by a massive earthquake in Kobe, which sent the index plummeting to dangerously low levels. The market didn’t recover as per his expectations, and he decided to flee to Kuala Lumpur, Malaysia.
The sum total of losses in the error account stood at £862 million at the end of January 1995, which increased to £1 billion, by the time Barings Bank investigated and discovered the account. The amount was double the valuation of the bank’s trading capital. On February 26, 1995, after a frantic bailout attempt by the Bank of England, the bank was declared insolvent.
On March 6, 1995, the 233-year-old Barings Banks was officially acquired by Dutch investment group, ING, for a meager £1, to form the subsidiary, ING Barings. This was later sold to ABN Amro, in 2001. Approximately 1,200 people lost their jobs in Singapore, after the collapse. The collapse alone cost £100 million.
At the same time, Leeson was apprehended in Frankfurt, where he stayed until his extradition to Singapore. He pled guilty on two counts – deceiving the bank auditors with forged documents and cheating the SIMEX in the trading exam. Leeson was sentenced to six and a half years in prison in Singapore, of which he served only 4 years, when he was diagnosed with colon cancer. In prison, he published a book called Rogue Trader. Today, he is a renowned figure in the financial industry, for his discussions on improper internal controls in financial institutions.
Leeson, along with the Singaporean authorities, heavily criticised Barings Banks for its failed internal controls and internal corruption. In July 1995, the Board of Banking Supervision of the Bank of England released its investigative reports, which mentioned how the bank had failed in account management and even the most basic forms of communications regarding responsibilities in business activities.
The Barings Banks debacle is one of the top examples of the need for efficient internal controls and risk management in financial institutions.