Barings Bank

~ the last words ~

Francis Baring and his brother John set up as merchants in London in 1762 and drifted into finance the way most merchant banks did, by lending against the cargoes they were already handling. Within forty years they were the largest financial house in Britain. In 1802 Barings and Hope & Co. of Amsterdam underwrote the Louisiana Purchase, which meant that a London bank supplied the cash that Napoleon then used to prosecute a war against Britain, and did so with the tacit knowledge of a British government that preferred the Americans to have Louisiana. The Duc de Richelieu made the famous remark in 1818: there were six great powers in Europe, and the sixth was Baring Brothers.

The bank nearly died once before. In 1890 it was overexposed to Argentine and Uruguayan debt when the Buenos Aires economy came apart, and the Bank of England put together a consortium to guarantee Barings' liabilities rather than let the failure take the City with it. That rescue is one of the founding episodes of central banking as it is now practiced. It is also the reason everyone in the City in 1995 assumed a similar rescue would be assembled, because one had been assembled before.

By the 1990s Barings was a mid-sized house with a very long pedigree and a modern derivatives arm it did not properly understand. It was the Queen's bank. It had underwritten governments. Its risk committee was looking at a Singapore operation that was reporting extraordinary profits from what was supposed to be low-risk arbitrage, and nobody senior went and checked.

~ the record ~

~ account 88888 ~

Nick Leeson arrived in Singapore in 1992 and ran Barings Futures there from a position that should never have existed. He was head of trading on the floor of SIMEX and he was also in charge of the back office that settled and reconciled those trades. The person taking the risk was the person confirming what the risk had been, which removes the single control that every trading floor on earth is built around.

The strategy on paper was arbitrage between the Nikkei 225 futures contracts trading in Singapore and Osaka, capturing small price differences with no directional exposure. What Leeson was actually doing by 1994 was selling straddles, a bet that the Nikkei would stay inside a narrow band, and covering every loss by writing it into account 88888, which had been opened as an error account for a junior's mistake and never closed. London saw the profits from the legitimate book and funded the margin calls on the hidden one without ever asking what the margin was for.

At 05:46 on 17 January 1995 the Kobe earthquake struck. The Nikkei fell hard and kept falling, which is the one thing a short straddle cannot survive. Leeson doubled the position trying to push the index back up on his own, a private individual attempting to move a national stock market with somebody else's money, and the hole went from large to fatal in five weeks.

~ one pound ~

The losses were found on 23 February 1995. Leeson left a note on his desk that said "I'm sorry" and flew to Kuala Lumpur with his wife. The total came to £827 million, which was more than twice the bank's entire reported capital, and this time the Bank of England looked at the number over the weekend and declined to organize a rescue. Barings was declared insolvent on Sunday 26 February.

ING bought the whole thing in the first days of March for a nominal one pound. Taking it on meant taking on the liabilities, and £660 million went in behind the purchase to make the balance sheet stand up. Leeson was picked up in Frankfurt on 2 March while changing planes and then fought extradition for most of the year, and Singapore got him on 23 November. He got six and a half years in Changi and served about four before being released with colon cancer. His memoir came out in 1996 and Ewan McGregor played him in the film three years after that.

~ what the city learned ~

Segregation of duties stopped being a paragraph in a manual and became the first thing an auditor looks for. Front office and back office were pulled apart at every bank that had been sloppy about it, and the Board of Banking Supervision report published in July 1995 was blunt about how little senior management in London had ever asked. Jérôme Kerviel lost Société Générale 4.9 billion euros in January 2008 running a comparable gap between what he traded and what he was allowed to confirm.

~ the pedigree for sale ~

ING ran the investment bank as ING Barings until 2004 and then dropped the word. The asset management arm carried on and is now Barings LLC under MassMutual, with tens of billions under management and an archive in London full of nineteenth-century letters of credit. So the name is alive and the bank is not, which is the ordinary arrangement in finance: what gets sold in these deals is the reputation, and the institution that earned it is left in the receivers' hands.

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