Barings Bank

Barings Bank

Industry	Banking
Founded	1762
Defunct	February 26,1995
Fate	Collapsed (Purchased for £1 by ING).
Successor	ING Group
Headquarters	London
Key people	Sir Francis Baring (founder),Nick Leeson

Barings Bank (1762 to 1995) was the oldest merchant bank in London until its collapse in 1995 after one of the bank's employees, Nick Leeson, lost £827 million ($1.3 billion) speculating - primarily - on futures contracts.

History

Barings Bank was founded in 1762 as the 'John and Francis Baring Company' by Sir Francis Baring, the son of John Baring, originally from Bremen, Germany. They were initially based in Cheapside. The Baring family lives in both Germany and England.

In 1806, his son Alexander Baring joined the firm and they renamed it Baring Brothers & Co., merging it with the London offices of Hope & Co., where Alexander worked with Henry Hope. Around this time they relocated to Bishopsgate, where their headquarters remained for decades, undergoing several refurbishments.

Barings had a long and storied history. In 1802, it helped finance the Louisiana Purchase, despite the fact that Britain was at war with France, and the sale had the effect of financing Napoleon's war effort. Technically, the United States did not purchase Louisiana from Napoleon, but from the Baring brothers and Hope & Co.. Payment was made in US bonds, which Napoleon sold to Barings at a discount of 87 1/2 per $100. As a result, Napoleon received only $8,831,250 in cash. Alexander Baring, working for Hope & Co., conferred with the French Director of the Public Treasury François Barbé-Marbois in Paris and then went to the United States to pick up the bonds before taking them to France.

A fall off in business and a lack of good leadership in 1820s caused Barings to cede its dominance in the City of London to the relatively new firm of N M Rothschild & Sons. Barings remained a powerful firm, however, and in the 1830s and 1840s its position in financing trade led to the bank becoming heavily involved in marketing American securities. With a marked decline in merchanting in 1850s and 1860s, a commercial credit business provided the firm with its 'bread and butter' income. By the 1870s Barings was increasingly specialising in trading international securities, especially from the United States, Canada, and Argentina.

During the 1880s, daring efforts in underwriting (the bank often purchased stock outright to sell later at a premium) got the firm into serious trouble through overexposure to Argentine and Uruguayan debt, and the bank had to be rescued by a consortium organized by the governor of the Bank of England, William Lidderdale, in the Panic of 1890. Although recovery from the incident was swift, the bank lost its dominant position and a limited company - Baring Brothers & Co., Limited - was formed to which the business of the old partnership was transferred. The liquidity problems of the old house were settled by a loan from the Bank of England.

Barings did not return to issuing on a substantial scale until 1900, concentrating on securities in the United States and Argentina. Its new, restrained manner made it a more appropriate representative of the British establishment, and the company established ties with King George V, beginning a close relationship with the British monarchy that would endure until Barings' collapse. (Diana, Princess of Wales, was the great granddaughter of one of the Barings family.) The descendants of the original five male branches of the Baring family were all elevated to the peerage, with the titles Baron Revelstoke, Earl of Northbrook, Baron Ashburton, Baron Howick of Glendale and Earl of Cromer. The company's restraint during this period would cost it its pre-eminence in the world of finance, but would later pay dividends when its refusal to take a chance on financing Germany's recovery from World War I saved it the painful losses experienced by other British banks at the onset of the Great Depression.

During the Second World War, the British government used Barings to liquidate assets in the United States and elsewhere to help finance the war effort. After the war, Barings was overtaken in size and influence by other banking houses, but remained an important player in the market, until 1995.

1995 collapse

Despite surviving the Napoleonic Wars and both World Wars, Barings was brought down in 1995 due to unauthorized trading by its head derivatives trader in Singapore, Nick Leeson.

At the time of the massive trading loss, Leeson was supposed to be arbitraging, seeking to profit from differences in the prices of Nikkei 225 futures contracts listed on the Osaka Securities Exchange in Japan and the Singapore International Monetary Exchange. Such arbitrage involves buying futures contracts on one market and simultaneously selling them on another at higher price. Since everyone tries to take advantage of a price difference on a publicly traded futures contract, the margins on arbitrage trading are small or even wafer thin. Consequently, the volumes traded by arbitrageurs must be very large to gain any meaningful profit. However, in arbitrage, one is buying something at one market while selling the same good at another market at the same time. Consequently, almost all risks are hedged and the strategy is not very risky. Certainly it would not have bankrupted the bank. For example, one could buy a futures contract on Nikkei worth $100 million on one day but at the same time sell the same product in Singapore for say $100,001,000. Though a person would have bought and sold nearly 200 million, their profit is only $1,000, that is 1,000 dollars for a 100 million dollar investment. However, instead of hedging his positions, Leeson gambled on the future direction of the Japanese markets. If one uses the above example, one could buy $100 million worth of Nikkei futures contracts then hope that the contract price goes up in future. In this instance, even a percentage change of the price would create 1 million dollar worth of profit or loss.

According to Eddie George, the Governor of the Bank of England, Leeson began doing this at the end of January 1995. Due to a series of internal and external events, his unhedged losses escalated rapidly.

Internal auditing

Under Barings Futures Singapore's management structure through 1995, Leeson doubled as both the floor manager for Barings' trading on the Singapore International Monetary Exchange and head of settlement operations. In the latter role, he was charged with ensuring accurate accounting for the unit. The positions would normally have been held by two different employees. As trading floor manager, Leeson reported to the head of settlement operations, an office inside Barings Bank which he himself held, which short-circuited normal accounting and internal control/audit safeguards. In effect, Leeson was able to operate with no supervision from London. After the collapse, several observers, including Leeson himself, placed much of the blame on the bank's own deficient internal auditing and risk management practices.

People at the London end of Barings were all so know-all that nobody dared ask a stupid question in case they looked silly in front of everyone else.

— Nick Leeson, Rogue Trader (1996)

Some people did raise eyebrows about Leeson's activities but were ignored.

Awaiting breakdown from my buddy Nick … (once they creatively allocate the numbers).

— Brenda Granger, Head of Futures and Options Settlements in London, January 1995 internal e-mail

Corruption

Because of the absence of oversight, Leeson was able to make seemingly small gambles in the futures arbitrage market at Barings Futures Singapore and cover for his shortfalls by reporting losses as gains to Barings in London. Specifically, Leeson altered the branch's error account, subsequently known by its account number 88888 as the "five-eights account", to prevent the London office from receiving the standard daily reports on trading, price, and status. Leeson claims the losses started when one of his colleagues bought contracts when he should have sold them, costing Barings £20,000.

By December 1994, Leeson had cost Barings £200 million. He reported to British tax authorities a £102 million profit. If the company had uncovered his true financial dealings then, collapse might have been avoided as Barings still had £350 million of capital.

Kobe earthquake

Using the hidden five-eights account, Leeson began to aggressively trade in futures and options on the Singapore International Monetary Exchange. His decisions routinely resulted in losses of substantial sums, but he used money entrusted to the bank by subsidiaries for use in their own accounts. He falsified trading records in the bank's computer systems, and used money intended for margin payments on other trading. As a result, he appeared to be making substantial profits. However, his luck ran out when the Kobe earthquake sent the Asian financial markets into a tailspin. Leeson bet on a rapid recovery by the Nikkei, which failed to materialize.

Discovery

On 23 February 1995, Leeson left Singapore to fly to Kuala Lumpur. Barings Bank auditors finally discovered the fraud around the same time that Barings' chairman, Peter Baring, received a confession note from Leeson. Leeson's activities had generated losses totalling £827 million (US$1.3 billion), twice the bank's available trading capital. The collapse cost another £100 million. The Bank of England attempted a weekend bailout, but it was unsuccessful. Employees around the world did not receive their bonuses. Barings was declared insolvent on 26 February 1995 and appointed administrators began managing the finances of Barings Group and its subsidiaries. The same day, the Board of Banking Supervision of the Bank of England launched an investigation led by Britain's Chancellor of the Exchequer and their report was released on 18 July 1995. Lord Bruce of Donington, in the House of Lords' debate on the report, said:

Even the provisional conclusions of the report are interesting. I should like to give them to the House so that we may be reminded what the supervisory body itself decided at the end of such investigation as it was able to make. It stated on page 250:

"Barings' collapse was due to the unauthorised and ultimately catastrophic activities of, it appears, one individual (Leeson) that went undetected as a consequence of a failure of management and other internal controls of the most basic kind".

The words I venture to emphasise to your Lordships are these:

"as a consequence of a failure of management and other internal controls of the most basic kind".

Noble Lords who have read through paragraph 14.2 of the report will be aware that it specifies these deficiencies. The report states:

"Management teams have a duty to understand fully the businesses they manage".

Really! They really have to understand the businesses! I would have thought that it was an elementary assumption to make that the controllers should understand the nature of the businesses they are trying to control.

The next requirement is this:

"Responsibility for each business activity has to be clearly established and communicated".

Hooray for that! I wonder how businesses in this country manage in their generality to continue without that qualification.

The third requirement is:

"Clear segregation of duties is fundamental to any effective control system".

Tut, tut! We are now treating the real elementum of the whole art and science of management, and it needs to be repeated here.

The report continues:

"Relevant internal controls, including independent risk management, have to be established for all business activities".

Hooray for that! These are matters of plain, ordinary common sense. One does not need to be an accountant or a management consultant to be aware of that.

Finally:

"Top management and the Audit Committee have to ensure that significant weaknesses, identified to them by internal audit or otherwise, are resolved quickly".

Well, well, well! These are all respects which this control body finds were absent from Barings. Do noble Lords really know what is being said? It is being said that Barings ought not to have been authorised bankers from the beginning, because any business — I do not care whether it is a whelk stall (one must not insult whelk stall owners in the context of this catastrophe) or what — knows that these are the basic conditions for the continuance of the business. It seems to me that the Bank of England ought never to have authorised this concern without verifying that all these conditions were in place.

Aftermath

ING, a Dutch bank, purchased Barings Bank in 1995 for the nominal sum of £1 and assumed all of Barings' liabilities, forming the subsidiary ING Barings. In 2001, ING sold the U.S.-based operations to ABN Amro for $275 million, and folded the rest of ING Barings into its European banking division. This left only the asset management division, Baring Asset Management. In March 2005, BAM was then split and sold by ING to MassMutual (acquiring BAM’s investment management activities and the rights to use the Baring Asset Management name) and Northern Trust (acquiring BAM’s Financial Services Group). Barings Bank therefore no longer has a separate corporate existence, although the Barings name still lives on as the MassMutual subsidiary, Baring Asset Management.

Leeson was sentenced to six and a half years in prison in Singapore, but was released early in 1999 after being diagnosed with colon cancer. Despite grim forecasts at the time, he did not succumb to the disease.

See also

• Re Barings plc (No.5) [1999] 1 BCLC 433
• Leonard Ingrams, former Managing Director and founder of Garsington Opera.
• Rogue Trader 1999 film starring Ewan McGregor.
• Jérôme Kerviel, trader with Société Générale who lost approximately €4.9 billion.
• Galway United F.C., for whom Nick Leeson, instrumental in Barings' colapse, is now employed.
• CITIC Pacific#2008 foreign exchange losses controversy

Further reading

• Drummond, Helga (2007). The Dynamics of Organizational Collapse: The Case of Barings Bank. London: Routledge. ISBN 0-415-39961-6. {{cite book}}: Check |isbn= value: checksum (help)
• Fay, Stephen (1997). The Collapse of Barings. New York: W.W. Norton. ISBN 0-393-04055-0.
• Leeson, Nicholas William (1996). Rogue Trader: How I Brought down Barings Bank and Shook the Financial World. Boston: Little, Brown. ISBN 0-316-51856-5. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
• Hunt, Luke (1996). Barings Lost: Nick Leeson and the Collapse of Barings Plc. Singapore: Butterworth-Heinemann Asia. ISBN 9-810-06802-6. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
• Rawnsley, Judith H. (1995). Total Risk: Nick Leeson and the Fall of Barings Bank. New York: Harper Business. ISBN 0-887-30781-7. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
• Gapper, John (1995). All that Glitters: The Fall of Barings. London: Hamish Hamilton. ISBN 0-241-13699-7. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
• Ziegler, Philip (1988). The Sixth Great Power: Barings 1762–1929. London: Collins. ISBN 0-002-17508-8.

External links

• Nick Leeson Official Website of the Barings Rogue Trader
• http://www.numa.com/ref/barings/
• http://www.nytimes.com/books/first/f/fay-collapse.html
• Sir Miles Rivett-Carnac, Bt - Daily Telegraph obituary