Daiwa Case Study

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An ERisk.com Case Study

Daiwa Bank

O

n July 13, 1995, Daiwa Bank’s Toshihide Iguchi confessed, in a 30-page letter to the president of his bank in Japan, that he had lost around $1.1 billion while dealing in US Treasury bonds. The executive vice president of Daiwa’s New York branch had traded away the bank’s money over 11 years – an extraordinarily long period for such a fraud to run – while using his position as head of the branch’s securities custody department to cover up the loss by selling off securities owned by Daiwa and its customers. The trading loss was one of the largest of its kind in history. But it was the cover-ups by Iguchi over a period of years, and then by senior managers at Daiwa between July 13 and September 18 1995, when the bank eventually reported the loss to the US Federal Reserve Board, that did the real damage. These led to criminal indictments against the bank and its officers and, eventually, to one of Japan’s largest commercial banks being kicked out of the US markets. Unlike Barings Bank, which was swallowed up by similar failures in risk management earlier in the same year, Daiwa’s $200 billion of assets and $8 billion of reserves meant it was big enough to survive the hit. But punishment by US regulators and public humiliation dealt a massive blow to Daiwa’s reputation. The scandal set in train a longterm change in strategy as Daiwa reigned in its international ambitions and concentrated on its core businesses in Japan and Southeast Asia. There were also long-term per-

Lessons learned
G Risk-taking functions must be segregated from record-keeping and risk assessment functions. It's a lesson that's now been largely learned in terms of segregating traders from the back office - but it has much wider applications; G Structural problems in risk management don't put themselves right. Daiwa had many warning signals about the way risk management was organised at the New York branch, but chose to believe that local management had learned its lesson; G Massive fraud can continue for many years in an environment of lax controls: Iguchi made his confession not because he feared he was about to be caught, but instead when he realised that the situation might otherwise carry on indefinitely; G Years after an event, failures in risk management remain a threat to the personal finances of senior executives if the executives can be shown to have acted inappropriately. sonal repercussions for Daiwa’s senior managers. Five years after the debacle broke, on 20 September 2000, in a decision that was immediately challenged, a Japanese court in Osaka told 11 current and former board members and top executives from Daiwa to pay the bank $775 million in damages. The record-breaking award, which followed legal action by shareholders, was to atone for the management failure of oversight, attempted cover-ups, and the breakdown of risk management in the New York branch that led up to the debacle. Treasury securities as part of Daiwa’s services to its pension fund customers. During the 1980s the New York desk became a significant force in the US government debt market and was designated as a primary market dealer in 1986. When Iguchi was promoted to become a trader in 1984, he did not relinquish his back-office duties. All in all, he supervised the securities custody department at the New York branch from approximately 1977 right through to 1995. This lack of segregation, a relatively common feature of small trading desks in the early 1980s but already a discredited practice by the early 1990s, led to Daiwa’s downfall. Daiwa’s New York branch managed the custody of the US Treasury bonds that it bought, and those that it bought on behalf of its customers, via a sub-custody account held at Bankers Trust. Through this account, interest on the bonds was collected and dispersed, and bonds were transferred or sold according to the

The Story
Toshihide Iguchi, a Kobe, Japanborn US citizen who majored in...
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