FIN 444

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

account named Error Account 88888

Leesons strategies

Leeson sold straddles, earned premium 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

Premium earned from straddle by Leeson

Poor control procedure

Funding - Maintain a minimum balance in

accounts. 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

(contd)
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 pass off as much trade
as he wished into this form.

Baringss 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 (contd)

Tougher poor control procedure One
of the main reasons as to why this entire
debacle happened was because the
management were not accountable 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 account not monitored
Payment of margin on unauthorized trade
Improper segregation of client funds and
financial requirement
Management not entirely involved: serious
lack of control