The Rogue Trader: The man behind bankruptcy of 200 year old bank

In the fast-paced world of finance, financial gains are frequently hailed as a sign of success. However, the tale of Barings Bank, a British financial giant that crumbled in 1995 after 233 years of operation, shows us a darker side to exceptional returns. Nick Leeson, a young trader stationed at Singapore, is the central figure in this cautionary tale that exposes the perils of unchecked ambition, the importance of proper oversight, and the need for a healthy dose of scepticism.

Leeson initially started by executing client trades for Barings Bank, but his role soon expanded. He was entrusted with a strategy called arbitrage, a technique designed to exploit price discrepancies between futures contracts on various exchanges. This involved entering reverse positions in 2 markets to earn guaranteed returns. However, Leeson strayed from the plan. He was granted permission to implement this arbitrage strategy in 1992, concentrating on Nikkei futures contracts that were listed on the Osaka Securities Exchange (OSE) and the Singapore International Monetary Exchange (SIMEX). Rather than adopting this cautious strategy, Leeson gamble on the markets, resulting in large losses for Barings.

To cover his tracks, Leeson took advantage of a major flaw in Barings' Singapore operations. In addition to overseeing trading operations, he was also in charge of the back-office functions, which included keeping track of and recording financial positions. This dual role opened up a lot of room for manipulation.

Leeson essentially became judge, jury, and executioner – he could make trades, hide the losses, and make it look like he was generating profits for the bank. He created a hidden account, cleverly disguised as number "88888," to manipulate records. Through clever accounting manoeuvres

, he managed to turn a around £200 million of loss in 1994 into an enticing £102 million profit. The London headquarters of Barings was blind to this flagrant fabrication for some time. Encouraged by his first success with deception, Leeson kept going in this risky direction.

However, red flags began to sprout in late 1994. Barings' risk management team, whose job is to identify and prevent financial dangers, noticed something fishy. Leeson's reported profits were too good to be true. They were suspiciously consistent and much higher than what was considered normal. The team voiced concerns, but Leeson's superiors disregarded them—possibly because they were enticing, with big bonuses linked to the bank's reported performance.

It's possible these bonuses exceeded £1 million based on the bank's overall performance, which Leeson's fabricated profits significantly inflated. It was already too late when Barings discovered the underlying truth of the situation. The hidden losses were like an enormous snowball that kept getting bigger as it went downhill.

Barings couldn't recover. The fake profits Leeson made hid a colossal £827 million loss, more than double the bank's available capital of £340 million. The once-proud bank was forced to shut down and was eventually acquired by ING, a Dutch bank, for a measly sum of £1.

The fall of Barings Bank serves as a stark reminder of several crucial lessons:

1.      Separation of Duties: Don't let one person control both making trades and recording financial results. This creates a huge opportunity for manipulation and fraud.

2.      Scrutinize Unusual Profits: If something seems too good to be true in the financial world, it probably is. Investigate exceptional returns thoroughly, especially profits exceeding industry benchmarks, to ensure they're genuine and not the result of risky activities.

3.      Don't Ignore Red Flags: Risk management exists for a reason. When warnings are raised, they need to be taken seriously, even if they're inconvenient or challenge assumptions.

4.      Healthy Scepticism is Key: Especially when dealing with promises of high returns, a healthy dose of scepticism is essential. Don't blindly trust complex models or claims of market mastery. Independent verification is crucial.

5.      Regulation Matters: The Barings collapse might have been avoided under regulations implemented just a few years later. These regulations included setting capital adequacy requirements for market risk and limits on concentration risks. For instance, the Basel Committee's 1996 amendment required banks to report risks exceeding 10% of their capital and prohibited them from taking positions exceeding 25% of their capital.

Nick Leeson's story is a cautionary tale worth £827 million because it highlights the need for strong risk management, independent financial performance verification, and a healthy dose of scepticism when dealing with extraordinary returns. By taking note of these historical errors, we can contribute to the creation of a financial system that is more open and safe.

Documentary/ Movie Recommended: Rogue trader