THE DOWNFALL OF BARINGS BANK,

COMPARISON OF CONVENTIONAL
AND ISLAMIC CORPORATE
GOVERNANCE
MOHD ARIEF AZREE BIN ARIFIN
MUHAMMAD SYAMIL BIN IBRAHIM
Introduction

■ Objective
– To examine the comparison of Conventional and Islamic Corporate Governance
– To examine the reason of the downfall of Barings Bank

■ Methodology
Methodology used is qualitative methodology using secondary data
Background of Barring Banks

■ Barings, 233 years old investment bank, founded in 1762.

■ One of the most prestigious financial institutions in England.
■ Barings collapsed on February 26, 1995 due to activities of one trader, Nick Leeson
– Leeson is a former derivatives broker
– Used to secretly trade futures contracts on both the Nikkei and JGB
– Barings suffered huge loss because of his inefficiency
– Use of Cross Trade
– Breaking down the total number of contracts into several different trades
– Details of this account were never transmitted to treasury or risk control offices
in London
- Leeson engaged in unauthorized
activities almost as soon as he started
in Singapore
- Used to hide unauthorized trades in
an account named Error Account
88888
HOW?
- Leeson sold straddles, earned
premium about 37000 straddles over
14 months
- Moved away from Barings as he
realized losses were mounting
- Tried to sustain the market by :
•Buying massive amounts of Nikkei
stock index futures
•selling JGB futures, betting interest
rates would rise.
- Kobe earthquake of January 17,
1996 led too the crash of Nikkei and
his investments
- Ended with huge losses (GBP 827
MM)
 Cont …

■ How did he do that?

– Cross-trade technique with a real account “92000” and
the error account “88888”
Year Reported (Million) Actual (Million)
1993 +£ 8.83 -£ 21
1994 +£ 28.53 -£ 185
1995 +£ 18.57 -£ 619
■ In November and December 1994
– Sold 34,400 options (straddles)
Lessons to be learned

■ Effectively let Leeson settle hos own trades by putting him in charge of both the
dealing desk and the back office.
■ The importance of internal controls and audit processes.
■ The following should be avoided by banks:
– Lack of internal checks and balances
– Lack of understanding of the business
– Poor supervision of employees
– Lack of a clear reporting line.
– No limitation on the proprietary trading activities
Literature Review
■ Opaque in Banking
Gerard Caprio et. al. (2002) finds that performance of banks are difficult to be assessed where there is no
efficient secondary market. Variety of ‘compensation’ packages that allow managers to benefit at the
expense of the long-run health of financial institution and dire implications for those who provide funds to
intermediaries in the form of debt contracts.
■ Absence of Internal Control
Steven (2008) argues that Barings downfall was due to the absence of oversight. Laura (1997) argues that
weakness of controls due to vested interest is in the way.
■ Short Term Remuneration Package
It was observed that Gerard Caprio et. al. (2002) and Laura (1997) agrees that remuneration package that
is skewered to short term goals will fuel greed.
Cont …
■ Islamic Principles of Governance
Abdussalam (2009) stated that Islamic Principles in Corporate Governance segregated into several
principles. One principle is the rights of shareholders and key ownership functions. Second is disclosure
and transparency which affirms the accountability with shariah compliance.
It boils down to accountability is not only to company or board or stakeholders but also to Allah the ultimate
authority who leads to welfare and success, holistic and integrative guidance, negotiation and co-operation
and consultation and consensus seeking for each decision with related stakeholders.
Comparison Conventional And Islamic
Corporate Governance
Conventional
Rights of Shareholders
Ownership resides with shareholders
General Meeting the main decision making
Stakeholders based on structure and importance
Disclosure and transparency
Accountability to law, guidelines and policies
Objectives as set out by the companies memorandum
and article of association
The role of stakeholders in corporate governance
Accountable to ensure sustainable organisation
Accountable to increase shareholders value
Corporate social responsibility policy
Islamic
Property as trust from God
Society as stakeholders
Accountability not only to stakeholders but also to God,
the ultimate owner
Accountability with law, shariah compliance, guidelines
and policies
Socio-economic objectives related to firms’ control and
accountability to all its stakeholders
Islamic accountability to Falah and social welfare
orientation
Haram/Halal dichotomy in transaction
Social & individual welfare from both spiritual and
material
Consideration to whole community.
Comparison Conventional And Islamic
Corporate Governance
Conventional
The responsibilities of the board
Strategic guidance
Monitoring of management
Accountability to company and stakeholders
Islamic
Accountability not only to company or board or
stakeholders but also to Allah the ultimate authority who
leads to welfare and success
Holistic and integrative guidance
Consultation and consensus seeking for each decision
with related stakeholders
FINDING & DISCUSSION
 Conventional Governance View
Issue Action Taken
■ Steven (2008) and Laura (1997)
highlighted on lack of internal control • Separation of trading and
■ Leeson headed both the trading desk and settlement desk
settlement operations
• Enhanced Risk Management
■ Leeson was able to settle and account for
his own trades. Thus hide his losses of controls
£200 million
Case Study: Barings Bank, Ethical Systems
Point of View 2014

• With these controls in place, the motivation of registering high

profits and incentives does not help realign the governance and
ethics.
 Islamic Governance View
Issue Principles
■ Steven (2008) and Laura (1997) • “Allah has promised to those
highlighted on lack of internal control
among you who believe and work
■ Leeson headed both the trading desk and righteous deed that He will
settlement operations assuredly make them succeed
■ Leeson was able to settle and account for and grant them viceregency in
his own trades. Thus hide his losses of the land just as He made those
£200 million
before them succeed others”. Al-
Nur, 24:55
Point of View
• Motivation to fulfill duties as righteous deed will realign the
governance and ethics.
• Discussion or consultation will ensure better outcome than going
it alone.
 Conventional Governance View
Issue
■ Martingale Strategy or Doubling Down
strategy is based on luck (Gharar)
Action Taken
• Enhanced Risk Management
controls
• Taking leverage to invest is a
double edge sword. It will
worsen in a bear market

Point of View
• Taking position / view with leverage is rewarded
 Islamic Governance View
Issue Principles
■ Leeson uses Martingale Strategy or
Doubling Down strategy. It is based on
• “…squander not your property
luck (Gharar) amongst yourself unjustly
(batil) except it will be a trade
among you by mutual
consent…” Al Nisa 4:29
Gharar, Islamic Markets
Point of View
• Taking position / view with leverage is rewarded
 Conventional Governance View
Issue Action Taken
■ Gerard Caprio et. al. (2002) Opaque in
Banking creates variety of ‘compensation’
• Transparency and disclosures
packages to stakeholders on
transactions and remuneration

Point of View
• Does not address the unavailability of secondary market.
 Islamic Governance View
Issue Principles
■ Gerard Caprio et. al. (2002) Opaque in
Banking creates variety of ‘compensation’
• “…squander not your property
packages amongst yourself unjustly
(batil) except it will be a trade
among you by mutual
consent…” Al Nisa 4:29
Gharar, Islamic Markets
Point of View
• Justified compensation and transparent packages
 Conventional Governance View
Issue Action Taken
■ Gerard Caprio et. al. (2002) Opaque in
Banking creates variety of ‘compensation’
• Transparency and disclosures
packages to stakeholders on
transactions and remuneration

Point of View
• Does not address the unavailability of secondary market.
 Islamic Governance View
Issue Principles
■ Gerard Caprio et. al. (2002) Opaque in
Banking creates variety of ‘compensation’
• “…squander not your property
packages amongst yourself unjustly
(batil) except it will be a trade
among you by mutual
consent…” Al Nisa 4:29
Gharar, Islamic Markets
Point of View
• Justified compensation and transparent packages
• Accountability not only to company or board or stakeholders but
also to Allah the ultimate authority who leads to welfare and
success
Conclusion

1) Management teams have a duty to understand fully the business they manage;
2) Responsibility for each business activity has to be clearly established and
communicated;
3) Clear segregation of duties is fundamental to any effective control system;
4) Relevant internal controls, including independent risk management, have to be
established for all business activities;
5) Top management and the Audit Committee have to ensure that significant
weaknesses, identified to them by internal audit or otherwise, are resolved
quickly;
6) Property as trust from God;
7) Stakeholders are inclusive of community at large and accountability not only to
stakeholders but also to God, the ultimate owner;
8) Objective of the company and the individual not only for profit but for the hereafter