The Barings Bank Collapse - A Case Study Finance Project, 2008 Instructor: Prof. Gopal K. Basak Report prepared by: Dwaipayan Ghosh (QE0701) Uday Tharar (QE0703) Priyam Banerjee (QE0705) Programme: M.S. (Q.E.) 2 nd Year

Report prepared by:

Dwaipayan Ghosh (QE0701)

Uday Tharar (QE0703)

Priyam Banerjee (QE0705)

Founded in 1762 by Sir Francis Baring The oldest mercantile bank in London until its collapse in 1995 Nick Leeson in 1990’s lost $1.4 billion speculating – primarily on futures contracts.

Founded in 1762 by Sir Francis Baring

The oldest mercantile bank in London until its collapse in 1995

Nick Leeson in 1990’s lost $1.4 billion speculating – primarily on futures contracts.

Derivative trading by Barings The chain of events which led to the collapse of the bank The control and risk management lessons to be learnt from this collapse

Derivative trading by Barings

The chain of events which led to the collapse of the bank

The control and risk management lessons to be learnt from this collapse

In 1802, it helped finance the Louisiana Purchase Panic of 1890-- efforts in underwriting got the firm into serious trouble through overexposure to Argentine and Uruguayan debt Ties with King George V and British Monarchy 2 nd World War saw the British government using Barings to liquidate assets in the US and elsewhere to finance the war effort

In 1802, it helped finance the Louisiana Purchase

Panic of 1890-- efforts in underwriting got the firm into serious trouble through overexposure to Argentine and Uruguayan debt

Ties with King George V and British Monarchy

2 nd World War saw the British government using Barings to liquidate assets in the US and elsewhere to finance the war effort

Financial instruments whose value changes in response to the changes in underlying variables Derivatives fall into two major categories— over-the-counter (OTC) derivatives (swaps) exchange-traded derivatives (futures) Since mid-80s volumes and value of futures,options and swaps contracts traded have increased astronomically

Financial instruments whose value changes in response to the changes in underlying variables

Derivatives fall into two major categories—

over-the-counter (OTC) derivatives (swaps)

exchange-traded derivatives (futures)

Since mid-80s volumes and value of futures,options and swaps contracts traded have increased astronomically

Barings was brought to its knees by Nick Leeson in a Singapore office He was employed by Barings to profit from low risk arbitrage opportunities between derivatives contracts on the SIMEX and Japan’s Osaka Exchange Leeson left a $1.4 billion hole in Barings’ balance sheet due to his unauthorized derivatives speculation,causing the 233-year-old bank’s demise

Barings was brought to its knees by Nick Leeson in a Singapore office

He was employed by Barings to profit from low risk arbitrage opportunities between derivatives contracts on the SIMEX and Japan’s Osaka Exchange

Leeson left a $1.4 billion hole in Barings’ balance sheet due to his unauthorized derivatives speculation,causing the 233-year-old bank’s demise

He grew up in London’s Watford suburb Worked for Morgan Stanley after graduating university Leeson then joined Barings (Jakarta) to sort through back-office mess involving £100 million of share certificates Successfully rectified the situation in 10 months Then transferred to Singapore and worked with a lot of power & freedom

He grew up in London’s Watford suburb

Worked for Morgan Stanley after graduating university

Leeson then joined Barings (Jakarta) to sort through back-office mess involving £100 million of share certificates

Successfully rectified the situation in 10 months

Then transferred to Singapore and worked with a lot of power & freedom

Was supposed to be arbitraging Instead of hedging, gambled on the future direction of the Japanese markets Had long futures positions on OSE Was not short on SIMEX Kobe earthquake of January 17, 1995 led to the crash of Nikkei and his investments

Was supposed to be arbitraging

Instead of hedging, gambled on the future direction of the Japanese markets

Had long futures positions on OSE

Was not short on SIMEX

Kobe earthquake of January 17, 1995 led to the crash of Nikkei and his investments

Used account no. 88888 for unauthorized speculation to cover losses Ended with huge losses(GBP 827 MM) The activities of Nick Leeson led to the fall of Barings Leeson after being arrested for his activities

Used account no. 88888 for unauthorized speculation to cover losses

Ended with huge losses(GBP 827 MM)

The activities of Nick Leeson led to the fall of Barings

Use of Cross Trade Breaking down the total number of contracts into several different trades Changed the trade prices thereon to cause profits Profits credited to 'switching' accounts & losses to be charged to account ' 88888 ‘ Details of this account were never transmitted to the treasury or risk control offices in London

Use of Cross Trade

Breaking down the total number of contracts into several different trades

Changed the trade prices thereon to cause profits

Profits credited to 'switching' accounts & losses to be charged to account ' 88888 ‘

Details of this account were never transmitted to the treasury or risk control offices in London

Effectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back office He had the final say on payments, ingoing and outgoing confirmations and contracts reconciliation statements accounting entries position reports Leeson was considered perfectly placed to relay false information back to London

Effectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back office

He had the final say on

payments,

ingoing and outgoing confirmations and contracts

reconciliation statements

accounting entries

position reports

Leeson was considered perfectly placed to relay false information back to London

The Board of Banking Supervision conducted an inquiry Did not necessitate any change to the framework of regulation Some existing arrangements needed to be improved Like better understanding of non-banking businesses undertaken by the banking groups they were responsible for

The Board of Banking Supervision conducted an inquiry

Did not necessitate any change to the framework of regulation

Some existing arrangements needed to be improved

Like better understanding of non-banking businesses undertaken by the banking groups they were responsible for

A number of important lessons for senior bank managers including the importance of internal controls & audit processes We think the following should be avoided by ba nks Lack of internal checks and balances Lack of understanding of the business Poor supervision of employees Lack of a clear reporting line

A number of important lessons for senior bank managers including the importance of internal controls & audit processes

We think the following should be avoided by ba nks

Lack of internal checks and balances

Lack of understanding of the business

Poor supervision of employees

Lack of a clear reporting line

Leeson was convicted of fraud and sentenced to six and a half years imprisonment Film made on Leeson’s biography, Rogue Trader Fall of Barings was a wake-up call for financial institutions all over the world The trading and back office functions were not delineated in Barings leading to its collapse

Leeson was convicted of fraud and sentenced to six and a half years imprisonment

Film made on Leeson’s biography, Rogue Trader

Fall of Barings was a wake-up call for financial institutions all over the world

The trading and back office functions were not delineated in Barings leading to its collapse

Management wanted to enter a new market but Bank was not prepared for the activity on a derivate market Stronger competition search additional profits gave so much control only to the one person Derivates in recent years a powerful tool in the hands of traders Strict regulations are needed in order to avoid the next Barings

Management wanted to enter a new market but Bank was not prepared for the activity on a derivate market

Stronger competition search additional profits gave so much control only to the one person

Derivates in recent years a powerful tool in the hands of traders

Strict regulations are needed in order to avoid the next Barings

Thank You!!

Thank You!!