The Collapse of Barings: Events and the Aftermath
Written Report Case: The Collapse of Barings
Derivatives & Risk Control
The Collapse of Barings: The Events and The Aftermath
Group Write-up
Written Report Case: The Collapse of Barings Executive Summary Barings Bank after two centuries of successful operations became a victim of a rogue trader. US$1.3 billion in losses outweighed bank’s own capital of US$850 million. Management negligence, lack of internal controls, poor risk management and excessive risk-taking strategy brought the bank to its ultimate collapse in Feb 1994. Throughout his tenure from 1992 to early 1995, the star-trader-turnedrogue, Nick Leeson, was consistently misleading the senior management to believe that his entire strategy was based on arbitrage between Simex and Osaka stock exchanges. It turned out he was taking leveraged bets on the Japanese Index, Nikkei 225. A single event, Kobe earthquake on January 1995, a black swan event of a kind, triggered the index to fall by 1,000 points, the opposite direction to what Mr.Leeson was heavily betting for. Ironically, Leeson followed the suit of traders’ common mistake by doubling his bets hoping to recover losses. The collapse of Barings is an example of a crash due to market risk and fraud. There are several reasons that are worth mentioning for understanding what happened: Reliance on a single trader: the 28 year old Nick Leeson was profiting of a relevant freedom to engage in risky trading strategies due to his previous performance (in 1994, the revenue attributed to Leeson were about £28.5 millions), specifically: o Engaging in a speculative strategy (instead of the approved arbitrageur strategy) o Requesting funds to supposedly close temporary differences in clients’ accounts in between trades that were actually used to cover losses on the margin account of the Bank (neither of the two practices were allowed by the exchanges) Lack of internal control: the organizational structure lacked clear accountabilities (Leeson was to
Derivatives & Risk Control
The Collapse of Barings: The Events and The Aftermath
Group Write-up
Written Report Case: The Collapse of Barings Executive Summary Barings Bank after two centuries of successful operations became a victim of a rogue trader. US$1.3 billion in losses outweighed bank’s own capital of US$850 million. Management negligence, lack of internal controls, poor risk management and excessive risk-taking strategy brought the bank to its ultimate collapse in Feb 1994. Throughout his tenure from 1992 to early 1995, the star-trader-turnedrogue, Nick Leeson, was consistently misleading the senior management to believe that his entire strategy was based on arbitrage between Simex and Osaka stock exchanges. It turned out he was taking leveraged bets on the Japanese Index, Nikkei 225. A single event, Kobe earthquake on January 1995, a black swan event of a kind, triggered the index to fall by 1,000 points, the opposite direction to what Mr.Leeson was heavily betting for. Ironically, Leeson followed the suit of traders’ common mistake by doubling his bets hoping to recover losses. The collapse of Barings is an example of a crash due to market risk and fraud. There are several reasons that are worth mentioning for understanding what happened: Reliance on a single trader: the 28 year old Nick Leeson was profiting of a relevant freedom to engage in risky trading strategies due to his previous performance (in 1994, the revenue attributed to Leeson were about £28.5 millions), specifically: o Engaging in a speculative strategy (instead of the approved arbitrageur strategy) o Requesting funds to supposedly close temporary differences in clients’ accounts in between trades that were actually used to cover losses on the margin account of the Bank (neither of the two practices were allowed by the exchanges) Lack of internal control: the organizational structure lacked clear accountabilities (Leeson was to