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How Leeson Broke Barings Imran Khan 14MBMA20
Background Barings Bank, 233 year old investment bank One of the most prestigious financial institutions in England Had a lot of exposure in the banking sector
◦ Comparatively low expertise in the derivatives and international markets
Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson ◦ Value reduced from $500 million to $1.60 million
Who was Nick Leeson? Former derivatives broker, caused the collapse of Barings Bank Used to secretly trade futures contracts on both the Nikkei and JGB Barings suffered huge loss because of his inefficiency
What Leeson did
Leeson engaged in unauthorized activities almost as soon as he started trading in Singapore ◦ However, he was successful in hiding his deception
Leeson was not short on SIMEX
◦ He was long approximately the number of contracts he was supposed to be short
Used to hide unauthorized trades in an named Error 88888
Leeson’s strategies
Leeson sold straddles, earned selling over 37000 straddles over a 14 month period ◦ Proved to a very profitable type of trading
He moved away from Barings as soon as he realized losses were mounting Took advantage of the big position that Barings had to bet against the firm Tried to sustain the market by: ◦ Buying massive amounts of Nikkei stock index futures ◦ Selling JGB futures, betting interest rates would rise
earned from straddle by Leeson
Poor control procedure
Funding - Maintain a minimum balance in s. 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. 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
Poor control procedure (cont’d) 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. No limits - Barings did not impose any limitations on the proprietary trading activities of the BSF, because of which Leeson was free to off as much trade as he wished into this form.
Barings’s fall
Short term strategy developed by Leeson which might not be convenient on the long run With large scale investment Leeson manipulated the market but failed to change its trend Unauthorized activities remained silent for a long time as Leeson managed to hide it well Concept of overtrading or aggressive trading is not a wise option as the company inclined towards much risky asset management.
What could have been done
Segregation of front and back office – Would have effectively reduced the kind of activities that Leeson was involved in 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 Adequate capital - The institution was in funding risk due to enormous unhedging position
What could have been done (cont’d) Tougher poor control procedure – One of the main reasons as to why this entire debacle happened was because the management were not able to certain activities Increased supervision – Management did not step in and were mostly unaware of the activities that Leeson was involved in
To sum it up… Leeson communicated false information, eventually leading to the fall of Barings Error not monitored Payment of margin on unauthorized trade Improper segregation of client funds and financial requirement Management not entirely involved: serious lack of control
How Leeson Broke Barings Imran Khan 14MBMA20
Background Barings Bank, 233 year old investment bank One of the most prestigious financial institutions in England Had a lot of exposure in the banking sector
◦ Comparatively low expertise in the derivatives and international markets
Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson ◦ Value reduced from $500 million to $1.60 million
Who was Nick Leeson? Former derivatives broker, caused the collapse of Barings Bank Used to secretly trade futures contracts on both the Nikkei and JGB Barings suffered huge loss because of his inefficiency
What Leeson did
Leeson engaged in unauthorized activities almost as soon as he started trading in Singapore ◦ However, he was successful in hiding his deception
Leeson was not short on SIMEX
◦ He was long approximately the number of contracts he was supposed to be short
Used to hide unauthorized trades in an named Error 88888
Leeson’s strategies
Leeson sold straddles, earned selling over 37000 straddles over a 14 month period ◦ Proved to a very profitable type of trading
He moved away from Barings as soon as he realized losses were mounting Took advantage of the big position that Barings had to bet against the firm Tried to sustain the market by: ◦ Buying massive amounts of Nikkei stock index futures ◦ Selling JGB futures, betting interest rates would rise
earned from straddle by Leeson
Poor control procedure
Funding - Maintain a minimum balance in s. 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. 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
Poor control procedure (cont’d) 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. No limits - Barings did not impose any limitations on the proprietary trading activities of the BSF, because of which Leeson was free to off as much trade as he wished into this form.
Barings’s fall
Short term strategy developed by Leeson which might not be convenient on the long run With large scale investment Leeson manipulated the market but failed to change its trend Unauthorized activities remained silent for a long time as Leeson managed to hide it well Concept of overtrading or aggressive trading is not a wise option as the company inclined towards much risky asset management.
What could have been done
Segregation of front and back office – Would have effectively reduced the kind of activities that Leeson was involved in 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 Adequate capital - The institution was in funding risk due to enormous unhedging position
What could have been done (cont’d) Tougher poor control procedure – One of the main reasons as to why this entire debacle happened was because the management were not able to certain activities Increased supervision – Management did not step in and were mostly unaware of the activities that Leeson was involved in
To sum it up… Leeson communicated false information, eventually leading to the fall of Barings Error not monitored Payment of margin on unauthorized trade Improper segregation of client funds and financial requirement Management not entirely involved: serious lack of control
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