Nick Leeson & the fall of Barings Bank


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Nick Leeson & the fall of Barings Bank

  1. 1. How Leeson Broke Barings Group Members: Farzana Afreen Musharraf 053 168 530 Syed Abu Yousuf 053 395 530 Syed M Fahim 061 209 030 Mahboob Sadi Bhuiyan 062 187 530 Mushfique Mannan 062 506 530 Waleed Bin Newaz 062 594 530 FIN 444
  2. 2. Background <ul><li>Barings Bank, 233 year old investment bank </li></ul><ul><li>One of the most prestigious financial institutions in England </li></ul><ul><li>Had a lot of exposure in the banking sector </li></ul><ul><ul><li>Comparatively low expertise in the derivatives and international markets </li></ul></ul><ul><li>Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson </li></ul><ul><ul><li>Value reduced from $500 million to $1.60 million </li></ul></ul>
  3. 3. Who was Nick Leeson? <ul><li>Former derivatives broker, caused the collapse of Barings Bank </li></ul><ul><li>Used to secretly trade futures contracts on both the Nikkei and JGB </li></ul><ul><li>Barings suffered huge loss because of his inefficiency </li></ul>
  4. 4. What Leeson did <ul><li>Leeson engaged in unauthorized activities almost as soon as he started trading in Singapore </li></ul><ul><ul><li>However, he was successful in hiding his deception </li></ul></ul><ul><li>Leeson was not short on SIMEX </li></ul><ul><ul><li>He was long approximately the number of contracts he was supposed to be short </li></ul></ul><ul><li>Used to hide unauthorized trades in an account named Error Account 88888 </li></ul>
  5. 5. Leeson’s strategies <ul><li>Leeson sold straddles, earned premium selling over 37000 straddles over a 14 month period </li></ul><ul><ul><li>Proved to a very profitable type of trading </li></ul></ul><ul><li>He moved away from Barings as soon as he realized losses were mounting </li></ul><ul><li>Took advantage of the big position that Barings had to bet against the firm </li></ul><ul><li>Tried to sustain the market by: </li></ul><ul><ul><li>Buying massive amounts of Nikkei stock index futures </li></ul></ul><ul><ul><li>Selling JGB futures, betting interest rates would rise </li></ul></ul>
  6. 6. Premium earned from straddle by Leeson
  7. 7. Poor control procedure <ul><li>Funding - Maintain a minimum balance in accounts. This minimum balance is called the margin requirements for most exchanges. Similarly, Nick Leeson was also required to maintain margin against the positions he was taking. </li></ul><ul><li>Credit risk - When the Barings London office used to send the funds for margin requirements of their clients in the SIMEX, lending money to these clients to trade at the exchange. Leeson kept on asking for more and more funds, while increasingly less and less clients seemed to be closing their positions </li></ul>
  8. 8. Poor control procedure (cont’d) <ul><li>Market risk - Risk reports were misrepresentations as Leeson was in charge of both back and front office. This meant that he was in charge of the trading as well as settling the trades. </li></ul><ul><li>No limits - Barings did not impose any limitations on the proprietary trading activities of the BSF, because of which Leeson was free to pass off as much trade as he wished into this form. </li></ul>
  9. 9. Barings’s fall <ul><li>Short term strategy developed by Leeson which might not be convenient on the long run </li></ul><ul><li>With large scale investment Leeson manipulated the market but failed to change its trend </li></ul><ul><li>Unauthorized activities remained silent for a long time as Leeson managed to hide it well </li></ul><ul><li>Concept of overtrading or aggressive trading is not a wise option as the company inclined towards much risky asset management. </li></ul>
  10. 10. What could have been done <ul><li>Segregation of front and back office – Would have effectively reduced the kind of activities that Leeson was involved in </li></ul><ul><li>Involvement of senior management – It seemed that the management were satisfied with the short term profit; they were unaware of important activities of the company </li></ul><ul><li>Adequate capital - The institution was in funding risk due to enormous unhedging position </li></ul>
  11. 11. What could have been done (cont’d) <ul><li>Tougher poor control procedure – One of the main reasons as to why this entire debacle happened was because the management were not accountable to certain activities </li></ul><ul><li>Increased supervision – Management did not step in and were mostly unaware of the activities that Leeson was involved in </li></ul>
  12. 12. How wealth can be maximized <ul><li>There are certain things a financial manager can do to maximize the wealth: </li></ul><ul><li>Assess risk appetite of firm and capital base </li></ul><ul><ul><li>Before formulating any investment strategies, the finance manager must first assess the risk appetite of the concerned firm. The extent to which the firm can expose themselves to risk must be discussed. </li></ul></ul><ul><li>Aggressive yet ethical trading </li></ul><ul><ul><li>When conducting arbitrage constant trading vigilance is a must. </li></ul></ul>
  13. 13. How wealth can be maximized (cont’d) <ul><li>No ‘doubling’ policy </li></ul><ul><ul><li>Has the bad effect of increasing the risk exposure of the party making him/her more vulnerable to huge losses. </li></ul></ul><ul><li>Maintain a system of ‘checks and balances’ in trading </li></ul><ul><ul><li>Individuals should be put in charge of trading in the front office and settlement and accounts in the back office. </li></ul></ul>
  14. 14. How wealth can be maximized (cont’d) <ul><li>Define limits and credit profiles </li></ul><ul><ul><li>Very important to define these limits and create credit profiles and limits for customers. </li></ul></ul><ul><li>Conduct unannounced spot audits </li></ul><ul><ul><li>It was a spot audit that revealed the huge mess created by Leeson. Therefore it is essential to conduct such spot audits in future as this would ensure problems are dealt with </li></ul></ul>
  15. 15. To sum it up… <ul><li>Leeson communicated false information, eventually leading to the fall of Barings </li></ul><ul><li>Error account not monitored </li></ul><ul><li>Payment of margin on unauthorized trade </li></ul><ul><li>Improper segregation of client funds and financial requirement </li></ul><ul><li>Management not entirely involved: serious lack of control </li></ul>
  16. 16. THANK YOU !!!