Barings Bank (1762 to 1995) was the oldest merchant bank in London until its collapse in 1995 after the chief derivative traders, Nick Leeson, lost £827 million speculating primarily on futures contracts in Singapore.
As it is claimed that major cause of Baring's crisis was due to the trading strategy that Leeson adopted, the trading activities of Leeson within the bank would be examined in the essay to explain why these strategies were inadaquate and data from scholars will be presented to support the saying.
Examination on Leeson's strategy Strategies
During the period between 1992 and 1995, Nichole Leeson was actively involved in the option trading activities. While he was only authorized to engaged in the arbitrage operation between SIMEX and the exchanges in Japan, he opened an account "88888" in Barings Futures Singapore, taking in Japanese Government Bond (JGB) futures and Nikkei futures on SIMEX and Osaka futures exchanges for a period of 2 1/2 year without authorization. With his inadequate trading strategies and the failure of bank's risk control management, Barings went bankrupt by the end of Feb 1995.
The largest part of Baring's losses came from the massive long position in Nikkei Futures. By early 1995, Leeson adopted a trading strategy of long position in Nikkei futures, short positions in JGB futures and a "short volatility" position in Nikkei exchange traded options. Although he had the experience of translating from a ï¿¡6 million loss position back to a splendid profit in July 1993, the position of future markets turned against him in Feb 1995.
Refers to Stephen J. and Onno W. (2001), they believes that Leeson has adopted a doubling strategy in the Nikkei future market through various tests and the analysis of raw data. Also, based on the trading activities that Leeson has been involved, it is confirmed that he has applied a trading strategy which expanded his position when prices when decreasing.
As Leeson continuously adopting the doubling strategy by expanding his long position in Nikkei Futures to 49% of the open interest in the March 1995 contract and 24% in the June 1995 contract (BoE, §4.25), Barings was unable to meet the margin requirement from SIMEX . As a results, Barings collapsed with a ï¿¡827 million of unreported lost by Feb 1995.
With the past experience of July 1993, Leeson believes that there were a possibility for the stock price to rise by expanding his position. Leeson (1996) quoted that since he was determined to win back the losses, he traded harder and harder, risking more and more by redoubled his exposure. Also, as he long massive position the day after the Kobe (Japan) earthquakes, this shows that he was expecting the price of Nikkei would pick up again. He attempted to stabilize the market himself by buying future contacts in order to prevent more losses on his option transactions. These explain the reasons of Leeson that adopted the doubling strategy. However, as due to the fact that Nikkei were continuously falling after Leeson massive long position on it, Barings was no longer being sufficiently solvent. All the evidences above has illustrate that the trading strategies of Leeson was inadequate and the systemic risk control was not comprehensive within the bank. These lead to a result of Baring's collapse.
Moreover , the data from Reserve Bank of Australia Bulletin shows that, if the position has been discovered and stopped by the Barings Group in Dec 1994, it would have been only a quarter of total loss and might not bring to the crisis of Barings. However, Kane and DeTrask ( 1999, p.216) states that "the Barings management may even known about Leeson's exposures and allowed him to expand his bets as the only chance to avert disaster."
Conclusion
The essay has examined the trading activities of Mr. Nicholas Leeson, the chief derivatives trader of Barings bank in Singapore until the bank's collapse in Feb1995.It is claimed that the main eventual cause which leads to the bank's crisis was the trading strategy that followed by Leeson. He has adopted a doubling strategy in the three future markets: Nikkei futures Japanese Government Bonds (JGB) and Euroyan Futures who expanded his position as the prices were falling and this result to Bankruptcy of the Bank.
Moreover, apart from the inadequate strategy that was applied by Leeson. The failure of risk and control management within the bank is also another significant cause of Baring's crisis which could not be neglected. The deficiency of internal control within the Barings Group has encourages the unauthorised financial derivatives trading activities by Leeson and leads to the financial Crisis of the Bank.
From the case of the Baring's crisis, it has drawn lessons to banking institutions that the improvement in the control management in the bank is vital. This would help to lower the systematic risk and avoid traders such as Leeson who could apply the doubling strategy with enormous amount of money without authorization in the bank.
Biblography
Bank of England (BoE), Board of Banking Supervision, July 1995. Report of the Board of Banking Supervision Inquiry into the Circumstances of the Collapse of Barings. London, ordered by the House of Commons.
Brown, Stephen J. & Steenbeek, Onno W., 2001. "Doubling: Nick Leeson's trading strategy," Pacific-Basin Finance Journal, Elsevier, vol. 9 (2001), pages 83-99
http://en.wikipedia.org/wiki/Barings_Bank
Jan Körnert, 2003. The Barings crises of 1890 and 1995: causes, courses, consequences and the danger of domino effects, Journal of International Financial Markets, Institutions and Money, Volume 13, Issue 3, July 2003, Pages 187-209
Kane, E.J., DeTrask, K., 1999. Breakdown of accounting controls at Barings and Daiwa: Benefits of using opportunity-cost measures for trading activity. Pacific-Basin Finance Journal 7 (3-4), 203-228.
Leeson, N., 1996. Rogue Trader. London: Little, Brown and Co., London.
Reserve Bank of Australia Bulletin, Implications of Barings Collapse for Bank Supervisors, November 1995
