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The Fall of Barings Bank

Abstract:
The case discusses how Nicholas William Leeson's (Leeson) unauthorized trading in
derivatives led to the fall of Barings Bank, the oldest and one of the most reputed banks
in the UK.
It describes the complete sequence of events leading to the fall of the bank.
The case also highlights the reasons for the fall, including the lack of proper managerial
supervision and operational control systems, and the mismanagement of the bank's
derivatives operations.
Issues:

The reasons that led to the fall of Barings Bank

Importance of proper supervision and control systems in a bank to mitigate risks
Introduction:

On February 26, 1995, Barings Bank (Barings) - the United Kingdom's (UK) oldest and
one of its most reputed banks - declared it was bankrupt.
The bank with a total net worth of $900 mn had suffered losses in excess of $1 bn.
These losses were result of the gross mismanagement of the bank's derivatives trading
operations by Nicholas William Leeson (Leeson), the General Manager of Barings Future
in Singapore (BFS).
BFS had been established to look after the bank's Singapore International Monetary
Exchange (SIMEX) trading operations. Leeson's job was to make arbitrage profits by
taking the advantage of price differences of similar contracts on the SIMEX (Singapore)
and Osaka stock exchanges.
In spite of not having the authority, he traded in options and maintained un-hedged
positions. He acted beyond the scope of his job, and was able to conceal his unauthorized
derivatives trading activities.
Due to the senior management's carelessness and lack of knowledge of derivatives
trading, the bank landed up in a major financial mess.
When Barings finally went into receivership on February 27, 1995, it had an outstanding

notional futures position on Japanese equities and bonds of US$ 27 bn (US$ 7 bn on

Nikkei 225 equity contracts and US$ 20 bn on Japanese government bond (JGB) and
Euroyen contracts).
Analysts said that the situation demanded that banks the world over must tighten their
internal control procedures.
Background Note

Barings was founded in 1762, by Francis Baring who set up a merchant banking business
in Mincing Lane in London, UK. The business grew rapidly during the period 1798 to
1814.
It became one of the most influential financial houses during the 1830s and 1840s. The
British government paid Barings commissions to raise money to finance wars against the
US and France during the mid 1800s.
During 1860-1890, Barings raised $500 mn for the US and Canadian governments and
was regarded as London's biggest 'American House.' Barings was also involved in
providing loans to Argentina during this period. In 1890, Barings was on the verge of
bankruptcy when Argentina defaulted on bond payments. However, the Bank of England
and several other major banks in London came forward to bail out the bank.
This crisis had a major impact on Barings and led the bank to withdraw all its business on
the North American continent. Barings then took up the business of providing
consultancy to small firms and wealthy people, including the British royal family.
Barings advised the royal family on the management of their assets, and also gave advice
to small British firms on investing in stocks and bonds. For the next several decades, the
bank grew well and earned significant profits. In the 1980s, the bank started operating in
the US again. In 1984, Barings acquired the stock broking arm of Henderson
Crosthwaite, which later became BSL.
Prior to its merger with the banking business (Baring Brothers & Company) in 1993, BSL
was run as a separate company. Incorporated in September 1986, BFS held a non-clearing
membership of SIMEX. In February 1992, BFS applied for clearing membership of
SIMEX...

Excerpts
Events Leading to the Fall

Soon after joining BSL, Leeson applied and got a transfer to Jakarta, Indonesia. Due to
his excellent performance, Barings management promoted Leeson to General Manager of
BFS in Singapore in April 1992.

In BFS, Leeson's job was to leverage on the arbitrage opportunities on similar equity
derivatives between SIMEX and the Osaka stock exchange (OSE). To take the advantage
of the arbitrage opportunity, Leeson had to adopt the following strategy - if Leeson was
long on the OSE, he had to be short twice the number of contracts on SIMEX. The
arbitrage trading strategy required Leeson to buy at a lower price on one exchange and
sell simultaneously at a higher price on the other, reversing the trade when the price
difference had narrowed or become zero. The market risk in arbitrage was minimal
because positions were always matched. Leeson was not given any authority to trade in
options or maintain any overnight un-hedged positions...
Why Did it Happen?
Industry analysts felt that the fall of Barings served as a classic example of poor risk
management practices. The bank had completely failed to institute a proper managerial,
financial and operational control system.
Due to the lack of effective control and supervision, Leeson got an opportunity to conduct
his unauthorized trading activities and was able to reduce the likelihood of their
detection. Analysts felt that this disaster happened for the following reasons.
SEPERATION OF FRONT AND BACK OFFICE DUTIES
The back office is responsible for recording and settling trades transacted by the front
office, by accepting/releasing securities and payments for trades, and reconciling them
with details sent by the bank's counterparties and assessing the accuracy of prices...
The End Result

The fall of Barings not only shocked the financial markets world over, it also exposed
their vulnerability. On February 26, 1995, Barings was declared insolvent under the UK
Insolvency Act, 1986.
Administrators were appointed to take control of the assets of the bank and its
subsidiaries. A week later, all the assets and liabilities of Barings Bank and its
subsidiaries (except BFS) were acquired by the Internationale Nederlanden Groep NV
(ING).
ING was looking to expand its investment banking business especially in Asia, where
Barings had an extensive business network involving merchant banking activities such as
investment banking, corporate banking, venture capital and capital markets operations,
together with securities trading and asset management. ING paid one pound for Barings
and took on the responsibility of paying the entire $1 bn debts that Barings had
accumulated...