Barings Bank

Barings Bank, PLC, was a British merchant bank founded in 1763 and known as the “Queen's Bank.” The bank was one of the world's most highly regarded financial institutions before it suddenly collapsed due to the actions of a 28-year-old rogue trader, Nick Leeson, operating from the bank's Singapore affiliate. The sad tale of Barings highlights the need for financial institutions to adopt strict internal control procedures to monitor the positions established by traders on the institutions' behalf.

Leeson was supposed to be conducting stock index arbitrage between Japanese stock index futures contracts traded in Japan and similar futures contracts traded on the Singapore exchange (SIMEX). Such trading involves buying the cheaper contract and simultaneously selling the more expensive one, then reversing the trade when the price difference has narrowed or disappeared. The strategy seeks to capture small and temporary pricing discrepancies between markets. Theoretically, stock index arbitrage is risk free, and properly executed arbitrage transactions involve very low levels of actual risk. The risk is limited, because of the close relationship between a stock index futures contract and the underlying stock index itself.

However, Leeson apparently strayed from his strategy in late 1994 and early 1995. Through the futures markets and using options on futures, Leeson made very large one-sided bets that Japanese stocks would rise. The Kobe earthquake in January 1995, however, rocked the entire Japanese economy and led to a dramatic drop in the Japanese stock market. The highly leveraged bets on a rising Japanese market turned out to be giant losers. These losses completely exhausted the capital of Barings, which declared bankruptcy and was acquired by the Dutch investment bank ING for one pound British sterling on March 3, 1995.

When Barings filed for bankruptcy in February 1995, it was discovered that Leeson, in the name of Barings, had established (and concealed in an error account) outstanding notional futures positions on Japanese equities of $7 billion. In addition, Leeson had outstanding notional futures positions on Japanese bonds and euroyen totaling $20 billion. Leeson had also sold Nikkei put and options with a nominal value of about $7 billion. The reported capital of Barings at the time was $615 million. In a short period, Leeson's trades lost about $1.4 billion. Leeson's actions were overlooked because of poor risk oversight and poor internal controls at the bank. The bank had allowed Leeson to be both a risk taker and a risk monitor. The bank had ignored internal warnings about this conflict of interest, perhaps because it appeared on paper as if Leeson's trades were highly profitable. After the losses became public, Leeson was arrested, convicted, and sentenced to a 61/ 2-year prison term in Singapore. By 1999, Leeson was out of prison, giving speeches on the dangers posed by rogue traders at $100,000 per appearance, appearing in commercials on behalf of brokerage firms, playing celebrity online poker, and receiving numerous job offers in risk management. In 1999, a movie appeared, titled Rogue Trader, based on Leeson's autobiography of the same name. In 2005, he took a marketing job with an Irish football team.

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