Allied Irish Bank (AIB) is the largest bank in Ireland, and its significant investments in the United States. Great Britain and Europe make it important internationally. As the largest private sector employer in Ireland and the second largest public company, it is difficult to overstate AIB's importance on its home turf. 40 percent of the banked population there are customers. The company's assets are valued at approximately EUR 80 million, making it one of the world's 200 largest banks and placing it among the Financial Times 500 top Global Companies.
The Ireland's second biggest bank, Allied Irish Bank, revealed that it was investigating an apparent currency fraud at its Baltimore, which is based subsidiary, Allfirst, perpetrated by a trader, John Rusnak on 6 February 2002. Since Nick Leeson brought down Barings bank in 1995, that evident became clear that the scale and nature of the losses would make the Allied Irish Bank story on of the biggest 'scandal trader' scandals.
The problem started in the treasury operation of Allfirst in Baltimore, Maryland, where John Rusnak, Allfirst's Baltimore Headquarters, bought and sold currencies, mainly US dollars for Japanese yen. It appears that Mr. Rusnak, who had worked for Allfirst for seven years, bet wrongly that the yen would weaken against the dollar and then allegedly covered up the losses. To make matters worse his bets were unauthorized, although there is no suggestion that he benefited personally. He later compounded the situationby selling a number of real deap-in-the-money option to counterparties for high premiums, racking up huge unrecorded liabilities for the bank. Estimates of the total losses to AIB or Allfirst from the debacle now stand at around $691 million.
While the bank's solvency was not threatened in the immediate aftermath of the losses discovery, the bank was able to absorb the losses by one-time charge on earnings. The loss was large enough to wipe out 60 percent of AIB's 2001 earnings and significantly deplete its capital. Senior AIB official was not forced to resign over the affair but the scandal badly dented the bank's reputation may result in a takeover of the weakened bank by another institution.
The risk management lessons of the case apparently had to be learnt all over again. In particular, the need for strong supervision of trading activity by back-office staff and risk managers, and for parent firm to be intimately aware of what is taking place at overseas units. Bank risk managers, who had begun to think of errant traders as a phenomenon of the past, are having to face up to the fact that a new generation of rogues may still be able to evade risk controls, including such industry standards as value-at-risk.
AFTERMATH
A currency fraud which occur at Baltimore-based subsidiary namely Allfirst. This fraud perpetrated by John Rusnak. The debacle of Allfirst's trading cost $691.2 million. To cover the losses, it needs E596 million in February 2002 which is the same as $520 million against 2001 earnings which was announced by AIB. An independent investigation was carried out by AIB commissioned former US Comptroller of the Currency Eugene Ludwig with the help of Promontory Financial Group and US law firm Wachtell, Lipton, Rosen & Katz. It reaches some penetrating and damning conclusions about the risk management failure at Allfirst even the Ludwig Report begins with a warning that it was prepared under time constraint.
Flawed architecture of Allfirst's trading operations was one of the key shortcomings. It was resulted in potential risks that outweighed potential rewards. Rusnak did not carrying out transactions on behalf of customers but trading in essentially the same way a hedge fund might and taking directional bets on the market. A lone trader in Baltimore did not enjoy any competitive advantage since it not access to the scale and expertise of a large hedge fund. Thus, the basic operations at Allfirst were fundamentally flawed.
The management in Dublin and Baltimore did not give a full attention to Allfirst trading operation. Trading operation was not part of Allfirst's core business and did not expect a large amount of profits and formal risk limits. The outside control group were discouraged from getting the information about Rusnak's trade were compounded the treasury management weaknesses. AIB Group risk, AIB senior management, Allfirst senior management and the boards of both banks were assumed that the Allfirst trading activities was control sufficiently.
There are some criticisms that relate with the currency trading business. First it the robustness of risk reporting practices and the second one is in Allfirst's trading area, AIB'S apparent failure to heed concerns raised by regulators about the risk management. It also states that Mr Rusnak was the person who is able to take advantage of the inexperience of back-office staff. In the wake of Ludwig Report, AIB announced on April 19 that the appointment of a de facto chief risk officer would be filled by John Heimann, who is ex-US Comptroller of the currency and banker with experience at Merrill Lynch, and the Federal Deposit Insurance Corporation. This appointment was held to oversee the risk management across the AIB group.
The management would be centralized so that it is easy to control all treasury activities throughout the group in Dublin. It would end all proprietary treasury activities at Allfirst and also at AIB's Polish division. Because of this crisis, AIB said six individual whose are responsible for the failure of the oversight of Rusnak's activities. Some of them are Cronin and Ray. Board of directors neither accept the resignations of Michael Buckley and Lochlann Quinn whose are AIB chief executive and chairman respectively.
Most of banking analyst suggests that AIB might choose to sell Allfirst to US buyer. This suggestion was made after the publication of the Ludwig Report. They suggest this decision because it had some serious strategic implications for the future of the business. AIB may concentrate on home business and some other oversea operations in Poland.
LESSONS LEARNED
We can get more lessons from the case of the study. Some of the lessons are similar with the other trader cases like lack of clear reporting lines, inadequate supervision of employees and failure to control fully the business that an overseas office was engaged in. Now, we can learn more lessons about the key risk management from the study. The lesson that we can get is not just a question of market risk but the proprietary trading is also become a high-risk activity. We can say that because it is difficult to manage and control a proprietary trading business when a small outfit without access to the information, expertise and economies of scale of much larger financial institution. Hence, the potential operational risks may outweigh the potential market returns.
Besides that, the other lessons that we will get is risk management architecture is so crucial. This is because, the risk management structure and practices within Allfirst's currency trading operations were seriously flawed. This statement has been mentioned from the Ludwig report. On the other hand, an Erisk commentary also describe that the operational can quickly transform the typically large market risk exposures which are incurred in a proprietary trading into hard losses. So, based on these explanations, we want to stress again, the risk management architecture is crucial.
In addition, the relationship between parent company and overseas units is important in trading. These both party needs to be clear between each other so that will not have a problem in the future. Ludwig Report also explains that the relationship between parent company and overseas units needs to be clear so that not exist unambiguous accountability and it is very important. If there is not clear for who was accountable to whom, so the reporting lines between the both parties become blurred. So, that's why we said that the relationship between parent company and overseas units needs to be clear.
Last but not least, the other lessons that we get from the study is strong and enforceable back-office are essential and important. There were independent back-office staff overseeing Rusnak's activities, not same with Barings' Singapore unit. However, from the Ludwig report, they said that Rusnak was able to persuade back-office staff to let normal procedure slip. They also describe that, if the back-office have concern about trading activity, they must be empowered to stand by their guns. So, these are the lessons that we get from the study.
