[Not many people are interested in going into the depths of economic issues as they are always shrouded in terrifying terminologies and a maze of numbers. But I have attempted to take a very important issue out of this confusion and put it in simple terms so that it is abundantly clear what goes on behind the scenes.]
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| Nick Leeson in his heydays. |
In 1995 one
of the biggest banking houses of Britain, the Barings House collapsed due to
the reckless activities of a single ‘Rogue Trader’, Nick Leeson. This
spectacular collapse has been blamed on several factors – the lack of a proper
hierarchy of command and control, a lack of proper risk management systems,
greed on the part of Nick Leeson and the officials at Barings, and on the
ignorance of the upper management about the securities market. Even though all
these factors influenced what was to become the most catastrophic collapse of a
financial institution in Britain in the twentieth century, to understand the
collapse it is necessary to understand the economic condition of Britain during
the first half of the 1990s, as it was the prevailing economic conditions that
influenced decisions being taken at the Barings Bank and at the National level
that would ultimately lead to the collapse.
The
Barings Bank, which was the oldest merchant bank in Britain and boasted as its
clients, the Queen, had an office in Singapore called the Baring Securities
(Singapore) Limited (BSS) that was trading on the SIMEX (today’s Singapore
Exchange). Nick Leeson, who was working in the back office in the Barings Bank
was made the general manager of BSS and was also given responsibility of the
back office in 1992. He passed the necessary exams and also became the head
trader in the Singapore branch. He began to carry out unauthorized speculations
in the futures “linked to the Nikkei 225 and Japanese government bonds (JGB) as
well as options on the Nikkei”. The Barings Bank did not allow its traders to
invest its own capital in the market but rather to invest its customers’
capital at their behest. Nick Leeson began to speculate in the market using the
capital of the bank using an anonymous client as an excuse. All the losses he
incurred was hidden in the error account 88888. By the end of 1993 the account
was losing 23 million pounds and by the end of 1994 this had increased to 208 million
pounds. With his control over the back office he was able to subvert the losses
and show only profits which made him a star trader of the Barings Bank. As his
losses in the 88888 account mounted, he asked more and more money from the
London office, which was provided to him without much questions. The disaster
came to the notice of the Barings management only on the 23rd of
February 1995, when Nick Leeson went on the run and did not come to office –
the error account now showed a loss of 875 million pounds. By the end of
February the Barings Bank had been declared bankrupt and sold off to the Dutch
company, ING, for the value of one pound. Nick Leeson was arrested for fraud
and imprisoned.
It
is beyond doubt that it was the speculations of Nick Leeson that caused the
collapse, it is what allowed him to do so that has interested us. Official
investigations and academic research into this collapse of the Barings Bank
have brought to light many reasons behind this. It has been pointed out that
there was an absence of proper checks and balances in the workings of the bank
that allowed Leeson to trade and manage the accounts in the back office at the
same time. Also, there was a lot of ambiguity in the command structure that
made it unclear who Leeson had to report to. Since there was more than one
person who was responsible for parts of his duties, he was able to play one
against the other to his advantage. The greed of the management has also been
regarded as a factor behind allowing Leeson to continue trading even while
asking for huge sums of money to be transferred from London. He was showing
huge profits to the company, based on which the employees were getting their
bonuses – no one seemed to have any reason to question this unbelievable
profits, putting them down to Leeson’s better knowledge of the securities trade
and his ability as a trader.
The
above mentioned reasons were definitely responsible for the collapse of the
oldest bank in Britain but I believe that we have looked at this issue from a
very narrow perspective, focusing only on the circumstances of the bank. To
understand the reason behind why the bank reacted to Nick Leeson and his
trading in such a way, it is necessary to take a much broader look. We need to
look at the British economy at that time.
The
beginning of the 1990s saw a severe recession in Britain and a steady rise in
inflation from 1993 to 1995. Added to this was the humiliating exit of the
pound from the European Exchange Rate Mechanism in 1992 that made matters
worse. The positive outlook that had prevailed over the last decade seemed to
have come to an end. There was also large scale unemployment. The Bank of
England was still under the government and was charged with controlling
inflation. In this economic turmoil the profits that the Barings Bank was
making through Nick Leeson’s trading in Singapore came as a blessing. The high
profitability of the investment of the bank in the growing markets of the East
provided a beacon of hope. The Bank of England also refrained from intervening
into the financial matters of the bank and gave the managers an open field.
Being the only sector making such huge rofits during 1993-1994, no one
questioned the authenticity of the presented profits or the risks involved. The
management also became complacent and let matters stand as they were.
Investigations
and research into the collapse of the Barings Bank have not at all regarded the
economic environment of Britain during this time. There is a need to understand
how the economic climate of a nation influences business decisions across
organizations – in this case, how it influenced the Bank of England’s and the
Barings Bank’s management decisions that allowed them to be so complacent.
There was definitely a lack of financial risk management mechanisms, management
control and human ego and greed involved in the financial fraud that led to the
collapse of the bank, but it would be an error to omit looking at the influence
that the British economy had on the decisions taken by the management of the
organizations. Such a broader perspective, coupled with the narrower
perspectives will help us understand the issue in a more holistic way, and may
even provide us ways to better understand economic decision making.
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