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The Collapse of Barings Bank Prakar Kandelwal Gaurav Varshney Gaurav Sabhahit Sahil Soi Akash Arora Dheeraj Negi

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Page 1: Barings Semifinal

The Collapse of Barings Bank

Prakar KandelwalGaurav VarshneyGaurav Sabhahit

Sahil SoiAkash Arora

Dheeraj Negi

Page 2: Barings Semifinal

Contents Background of Barings Nicholas Leeson How Leeson Broke Barings Barings Inadequate Controls

Page 3: Barings Semifinal

Background of Barings Founded in 1762.

Barings gradually diversified from wool into many other commodities, providing financial services

necessary for the rapid growth of international trade. 

Concurred as the sixth great European power at the Congress of Vienna in 1815

Page 4: Barings Semifinal

Background of Barings During the years of 1830s and 1840s,

Barings became the most influential financial house in U.S.

A Financial Crisis in 1890

Provided loans to Argentina in 1824 Debt crisis in Argentina in 1888 Reported company’s liabilities of over

21 million pounds sterling

Page 5: Barings Semifinal

Background of Barings Rescued by the British government and

the Bank of England

Impact of Argentine Debt Crisis Withdrew all transaction in

North American continent

Firm’s management was relegated to consulting small firms and wealthy people, which includes British Royal family

Page 6: Barings Semifinal

Background of Barings Repair of Company’s Reputation

Success in consulting the royal family asset management

Success in giving advice for stock and bonds for small British firms

Moved back into American finance scene in 1980s

Page 7: Barings Semifinal

Background of Barings Expansion to Asia

Opened a stock brokerage operation in Tokyo during the mid 1980s

Expanded its operation by establishing offices in Singapore

Page 8: Barings Semifinal

Background of Barings Leeson Crisis in 1995

Nick Leeson, a lone manager in the company’s Singapore office made speculative trades on future market, which broke the company

ING, Dutch financial service company, bought Barings at the fire sale price of just £1 in June 1995

Page 9: Barings Semifinal

Nicholas Leeson The son of a plasterer from the London suburb of Watford

28-year-old trader who never graduated from college

Gained knowledge through numerous investment establishment positions

Page 10: Barings Semifinal

Nicholas Leeson

Working at the Singapore International Monetary Exchange

In charge of both making deals and overseeing the paperwork on these deals

Page 11: Barings Semifinal

Nicholas Leeson Accused of losing the $1.3 billion

Charged with forgery and cheating on December 1, 1995

Sentenced to six and a half years

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How Leeson Broke Barings? Arrived in Singapore in 1992

Arbitrage opportunities of Nikkei 225 futures between SIMEX and OSE

Leeson’s Singapore office is terribly understaffed – errors frequently occurred

Error account “88888” created by a new phone clerk: Loss of £20,000

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Why did Nick Leeson establish a bogus error account (88888) when a legitimate account (99002) already existed?

• Nick Leeson established a bogus error account (88888) when a legitimate account (99002) already existed in order to conceal his unauthorized trading activities.

• While the legitimate error account was known to Barings Securities in London, the bogus account was not.

• However, the bogus account was known to SIMEX as a customer account, not as an error account. In this way Leeson could hide his balances and losses from London – but not Singapore.

• One the other hand, SIMEX thought the bogus error account, 88888, was a legitimate customer account rather than a proprietary Barings account.

Page 14: Barings Semifinal

How Leeson Broke Barings? How did he do that?

Cross-trade technique with a real account “92000” and the error account “88888”

In November and December 1994 Sold 34,400 options (straddles)

Year Reported (Million) Actual (Million)1993 +£ 8.83 -£ 211994 +£ 28.53 -£ 1851995 +£ 18.57 -£ 619

Page 15: Barings Semifinal

How Leeson Broke Barings? Fantasy: Leeson is a genius – Created 50%

of Barings’ 1994 profits

Reality: Leeson is a loser – Loss of $296 million in 1994 alone

Lack of accountability allowed Lesson to hide loses.

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How Leeson Broke Barings?

4Q 1994 - January 1995 Nikkei in a range of 19,000 – 19,500 Leeson held long futures of 3,000 Nikkei

225 equity contracts

Nikkei 225日経平均株価

Page 17: Barings Semifinal

How Leeson Broke Barings?

Straddles: Profitable (Premium) if Nikkei traded

within or near strikes between 18,500 – 20,000

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How Leeson Broke Barings?

January 17, 1995 Kobe Earthquake Nikkei dropped sharply as people took cash out

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How Leeson Broke Barings?

January 20 – February, 1995 Leeson launched aggressive buying

program: (3,000) 55,206 March contracts and 5,650 June contracts

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How Leeson Broke Barings?

Barings collapsed – could not meet huge trading obligations

Outstanding futures positions of $27 billion (Barings’ capital was $615 million)

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Barings Inadequate Controls

Lesson controlled both the dealing desk and the back office

Leeson removed account “88888” from daily accounts sent to Barings

Barings ignored internal auditor’s reports

Page 22: Barings Semifinal

Barings Inadequate Controls Problems with Senior management

Showed little interest in the Singapore Branch

Had only a vague understanding of derivatives

Did not have a precise breakdown of Leeson’s profits

Failed to question capital requests by Leeson to fund margin accounts

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Barings Inadequate Controls Problems with Barings Funding

Control Measures

No distinction between proprietary and customer trades

Ignorance to credit risks

Page 24: Barings Semifinal

Barings Inadequate Controls Supervision Problems

Leeson’s superiors did not accept responsibility over him

No one investigated a default in account “88888”

Page 25: Barings Semifinal

Aftermath Broadhust and Ledgerwood report in 1993

caux round table based in Switzerland adopted International Code for multinational Firms in Europe which identifies 5 basic principles:

1. Stake holder Responsibility2. Social Justice3. Mutual Support4. Environmental Concerns5. Avoidance of illicit operations concept

practices.

Page 26: Barings Semifinal

Aftermath SIMEX appointed an International Advisory

Panel which recommended following best practices:

1. Upgrading of clearing system.2. Promotion of information sharing among

exchanges.3. Devising comprehensive internal risk

analysis procedures to identify high risk accounts.

Page 27: Barings Semifinal

Conclusion

Incompetent

management

An unlikely series of

events in the

market

One rogue trader

Page 28: Barings Semifinal

Things to RememberPrincipal’s Agent Problem: Should be catered by Swetarship or

Trusteeship.

Accountability and Transparency.

Firms Should not tolerate compromise on ethics.

Page 29: Barings Semifinal

Any Questions?