Barings bank collapse

Barings Bank was one of the oldest and most renowned merchant banks in the United Kingdom, until its collapse in 1995 due to a loss of over £800 million.

History

Barings Bank was founded in 1762 to finance the trade of textiles. Barings financed a number of public projects in Europe, North and South Americas in the 19th century. During the years 1880-1890 Barings offered large loans to the governments of Uruguay and Argentina. In subsequent years the largest banks of these countries got into financial trouble, which in turn lead to suspension of withdrawals and an ensuing panic in the banking sector. This is when the total value of Barings assets fell by a third and its solvency was at stake. To the rescue came the Bank of England, which along with other London merchant banks financed Barings' recovery. During the 1980s Barings was known for its strong position on the emerging markets. Its brokerage, Barings Securities Limited, played a crucial role in Asia and Latin America.

Activities of Nick Leeson

Nick Leeson started at Barings in 1989 as a futures and options trader. In March 1992 he relocated to Singapore where he took over as head of office, which worked on an OTC market in London and arbitraging in Tokyo and Hong Kong. Leeson was directly responsible for the purchase and setting termination dates for futures as well as settlements. This allowed him to avoid internal auditing.

His arbitraging activity involved taking advantage of price differentials between the Japanese and Singapore markets on future contacts. While the London office saw these as free of risk, due to Leeson's practice of gambling on unauthorised positions, the Bank lost £827 million.

Leeson first losses started at £2 million in 1992, which two years later reached £208 million. All this time losses were reported to a special account 88888, which the London office had no access to. The profits on authorised positions were reported on other accounts.

The real trouble started in January 1994, when Leeson put at one point about 40000 contracts on the market. The gamble would have been profitable, had it not been for the earthquake in Kobe which resulted in a downturn on the Japanese market. The losses had been discovered and Leeson fled to Germany, where he was arrested. The control over Barings' was handed over to commissary administration. On March 6, 1995 Barings' was purchased by ING bank for a nominal sun of £1.

Conclusions

The collapse of Barings was due to unauthorised and ultimately catastrophic activity of Leeson. The following conclusions were drawn:

• management has a duty to understand their area of business,
• responsibility for each business activity has to be clearly established,
• internal controls are necessary, including independent risk management,
• management and the audit committee needs to ensure that weaknesses identified by an internal audit are resolved.

Examples of Barings bank collapse

1. *The collapse of Barings Bank was caused by the reckless and fraudulent trades of Nick Leeson, the head of operations in the Singapore office. Leeson had made unauthorized discretionary trades in Barings’ account, putting the bank’s capital at risk. When these trades went bad, Barings’ capital was completely wiped out and the bank was forced to declare bankruptcy.
2. *The collapse of Barings was also caused by a lack of adequate risk management and internal controls. Barings had taken on too much risk and had failed to implement proper controls to monitor their trading activity, resulting in Leeson’s fraudulent trades going undetected until it was too late.
3. *Barings had also suffered from a lack of transparency and communication between its various offices. This caused a delay in the detection of Leeson’s trades and ultimately led to the bank’s collapse.

Advantages of Barings bank collapse

The collapse of Barings Bank in 1995 had a number of advantages. These included:

• The collapse of the bank acted as a warning to the global financial system, highlighting the need for improved risk management and greater oversight. This was seen in the more stringent rules and regulations that were introduced in the wake of the collapse, such as the Basel Accords which sought to ensure that banks had sufficient capital reserves to cover potential losses.
• The failure of Barings Bank forced the international banking sector to reassess its risk management strategies and to embrace more rigorous financial controls. This meant that banks became more cautious in their lending and investment decisions and that they had to adhere to stricter rules and regulations.
• The collapse of Barings Bank also highlighted the importance of corporate governance in a large banking institution. This led to the introduction of new corporate governance regulations aimed at ensuring that executives and directors of banks are held accountable for their actions.

Limitations of Barings bank collapse

The collapse of Barings Bank resulted in a number of limitations on the financial sector. These include:

• A lack of trust in the financial sector: The collapse of Barings Bank had a negative impact on the trustworthiness of the financial sector. People were less likely to trust financial institutions, which led to a decrease in investments and a decrease in the amount of capital available to the sector.
• Increased regulation: The failure of Barings Bank led to increased regulation of the financial sector by government agencies. Banks had to comply with stricter regulations, such as increased capital requirements and more stringent risk management requirements.
• More stringent lending practices: Banks had to become more conservative in their lending practices and were more likely to reject loan applications due to the increased uncertainty in the sector.
• A decrease in profitability: The increased regulations and stricter lending practices led to a decrease in profitability for banks. This meant that banks had less capital available for investments, making it difficult for them to grow their businesses.
• Increased costs: Banks had to increase their costs in order to comply with the new regulations, which further decreased their profitability.
• Decreased innovation: Banks had to focus on compliance with regulations, rather than on innovation, which meant that they were unable to stay ahead of the competition.

Barings bank collapse — recommended articles

Market disruption — Bankers Bank — Credit management — Death from overwork — European Coal and Steel Community — Uninsurable risk — Forms of corruption — Continental model of corporate governance — Currency crisis

References

• Brown, A. D. (2005). Making sense of the collapse of Barings Bank. Human Relations, 58(12), 1579-1604.

Author: Anna Opalińska