Barings Bank

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

Barings Bank (1762 to 1995) was the oldest merchant bank in London[1] until its collapse in 1995 after one of the bank's employees, Nick Leeson, lost £827 million ($1.3 billion) due to speculative investing, primarily in futures contracts, at the bank's Singapore office.

Contents

History

Sir Francis Baring (left), with brother John Baring and son-in-law Charles Wall, in a painting by Sir Thomas Lawrence

1762–1890

Barings Bank was founded in 1762 as the John and Francis Baring Company by Francis Baring, with his older brother John as a mostly silent partner.[2] They were sons of John (né Johan) Baring, wool trader of Exeter, born in Bremen, Germany. The company began in offices off Cheapside and within a few years moved to larger quarters in Mincing Lane.[3] Barings gradually diversified from wool into many other commodities, providing financial services necessary for the rapid growth of international trade. By 1790, Barings had greatly expanded its resources, both through Francis' efforts in London and by association with leading Amsterdam bankers Hope & Co. In 1793, the increased business necessitated a move to larger quarters in Devonshire Square. Francis and his family lived upstairs, above the offices.

In 1800, John retired and the company was reorganized as Francis Baring and Co. Francis' new partners were his eldest son Thomas (later to be Sir Thomas Baring, 2nd Baronet) and son-in-law Charles Wall. Then, in 1802, Barings and Hope were called on to facilitate the largest land purchase in history - the Louisiana Purchase. This was accomplished 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 purchased Louisiana from Barings and Hope, not from Napoleon.[citation needed] After a $3 million down payment in gold, the remainder of the purchase was made in U.S. bonds, which Napoleon sold to Barings through Hope and Company of Amsterdam [4] at a discount of 87½ per $100. Francis' second son Alexander, working for Hope & Co., made the arrangements in Paris with François Barbé-Marbois, Director of the Public Treasury. Alexander then sailed to the United States and back to pick up the bonds and deliver them to France.

In 1803, Francis began to withdraw from active management, bringing in Thomas' younger brothers Alexander and Henry to become partners in 1804. The new partnership was called Baring Brothers & Co., which it remained until 1890. The offspring of these three brothers became the future generations of Barings leadership. In 1806, the company relocated to 8 Bishopsgate, where they stayed for the remaining life of the company, the property undergoing several expansions and refurbishments,[3] and finally putting up a new high-rise building in 1981.

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 rival firm of N M Rothschild & Sons. Barings remained a powerful firm, however, and in the 1830s the leadership of new American partner Joshua Bates, together with Thomas Baring, son of Sir Thomas Baring, 2nd Baronet, began a turnaround. Bates advocated a shift in Barings' efforts from Europe to the Americas, believing that greater opportunity lay in the West. In 1832, a Barings office was established in Liverpool specifically to capitalize on new North American opportunities. In 1843, Barings became exclusive agent to the U.S. government, a position they held until 1871.

Barings was next appointed by Sir Robert Peel with supplying 'Indian corn' or Maize to Ireland as a famine relief foodstuff between November 1845 and July 1846 following the failure of the staple potato crop. The company declined to act beyond 1846 when the government instructed them to restrict purchases to within the United Kingdom. Baring Brothers refused any commission for work performed in the cause of Famine relief. Their position as prime purchasers of Indian corn was assumed by Erichson, a corn factor of Fenchurch St, London.[5]

In 1851, Baring and Bates brought in another American, Russell Sturgis as partner. Despite the embarrassment to his partners caused by his sympathies for the South in the American Civil War, Sturgis proved a capable banker and, following the death of Bates in 1864, gradually assumed a leadership role in the firm. In the 1850s and 1860s, commercial credit business provided the firm with its 'bread and butter' income. Thomas Baring's nephew Edward, son of Henry Baring, became a partner in 1856. By the 1870s, under the emerging leadership of "Ned" Baring, later the 1st Baron Revelstoke, Barings increasingly involved in international securities, especially from the United States, Canada, and Argentina. Barings cautiously and successfully ventured into the North American railroad boom following the Civil War. A new railroad town in British Columbia was renamed Revelstoke, in honor of the leading partner of the bank that enabled the completion of the Canadian-Pacific Railway.

Later in the 1880s, daring efforts in underwriting got the firm into serious trouble through overexposure to Argentine and Uruguayan debt. In 1890, Argentine president Miguel Juárez Celman was forced to resign following the Revolución del Parque, and the country was close to defaulting on its debt payments. This crisis finally exposed the vulnerability of Barings position. Lacking sufficient reserves to support the Argentine bonds until they got their house in order, the bank had to be rescued by a consortium organized by the governor of the Bank of England, William Lidderdale. The resulting turmoil in financial markets became known as the Panic of 1890.

1891–1929

Although the rescue avoided what could have been a worldwide financial collapse, Barings never regained its dominant position. A limited liability company - Baring Brothers & Co., Ltd. - was formed, to which the viable business of the old partnership was transferred. The assets of the old house and several partners were taken over and liquidated to repay the rescue consortium, with guarantees provided by the Bank of England. Lord Revelstoke and others lost their partnerships along with their personal fortunes, which were pledged to support the bank. It was almost ten years before the debts were paid off. Revelstoke did not live to see this accomplished, dying in 1892.[2]

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, under the leadership of Edward's son John, made Barings a more appropriate representative of the British establishment. The company established ties with King George V, beginning thus a close relationship with the British monarchy that would endure until Barings' collapse in 1995. Diana, Princess of Wales, was a great-granddaughter of a Baring. Descendants of five of the branches of the Baring family tree have been elevated to the peerage: Baron Revelstoke, Earl of Northbrook, Baron Ashburton, Baron Howick of Glendale and Earl of Cromer. The company's restraint during this period cost it its pre-eminence in the world of finance, but later paid dividends when its refusal to take a chance on financing Germany's recovery from World War I saved it some of the most painful losses experienced by other British banks at the onset of the Great Depression.[2]

1929–1995

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.[6]

1995 collapse

Despite surviving the Great Depression 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 a 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. In arbitrage, one is buying something at one market while selling the same goods in another market at about 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 and 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 buying on one market and immediately selling on another market for a small profit, the strategy approved by his superiors, Leeson bought on one market then held on to the contract, gambling 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, 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.[7]

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. By allowing Leeson, as trading floor manager, to settle his own trades, Barings short-circuited normal accounting and internal control/audit safeguards. In effect, Leeson was able to operate with no supervision from London—an arrangement that made it easier for him to hide his losses.[8] 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 raised 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 she 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.[9]

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, and 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.[10]

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.[9] The Bank of England attempted an unsuccessful weekend bailout.[11] 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:[12]

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[10] 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.[13] 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).[14][15] Barings Bank therefore no longer has a separate corporate existence, although the Barings name still lives on as the MassMutual subsidiary, Baring Asset Management. With the failure of Barings, N M Rothschild & Sons is the only name remaining from the glory days of 19th-century British merchant banking.

After learning of Barings' collapse (and realizing he was certain to be jailed for his actions), Leeson booked a flight to London where he intended to surrender to British police in hopes of serving prison time in the United Kingdom as opposed to Singapore. However, he was apprehended by German authorities when he landed in Frankfurt. Leeson spent the next several months in German custody unsuccessfully fighting extradition back to Singapore. British authorities declined to pursue extradition of Leeson back to the United Kingdom.

Leeson was eventually 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.

Leeson's Trading Jacket

On 5 April 2007, The Guardian newspaper reported that KPMG, the liquidators of Barings PLC, had sold a trading jacket thought to have been worn by Nick Leeson while trading on SIMEX in Singapore. The jacket was offered for sale on eBay but it failed to reach its reserve price despite a highest bid of £16,100. It was subsequently sold for £21,000.[16] In October 2007 a similar jacket used by Leeson's team but not thought to have been worn by Leeson himself sold at auction for £4,000.[17]

See also

Notes

  1. ^ Reason, James (1997). Managing the Risks of Organizational Accidents. Ashgate Publishing Limited. pp. 29. 
  2. ^ a b c Ziegler, Philip (1988). The Sixth Great Power: Barings 1762–1929. London: Collins. ISBN 0-002-17508-8. 
  3. ^ a b D. Kinaston. The City of London, Volume I. London:Pimlico, 1994
  4. ^ http://www.archives.gov/publications/prologue/2003/spring/louisiana-purchase.html
  5. ^ A Dictionary of Irish History, D.J.Hickey & J.E.Doherty, Gill and Macmillan, Dublin, 1980. Pp. page 24. ISBN 0-7171-1567-4
  6. ^ "Barings Bank WW2". Wardsbookofdays. http://www.wardsbookofdays.com. 
  7. ^ "A Fallen Star". The Economist 334 (7904): pp. 19–21. March 4. http://web.ebscohost.com/ehost/detail?vid=1&hid=13&sid=c651ab37-4191-4bf3-a275-e23e6ef543f7%40sessionmgr9 
  8. ^ "Case Study : Barings". Sungard Bancware Erisk. http://www.erisk.com/Learning/CaseStudies/Barings.asp. Retrieved 2007-11-18. 
  9. ^ a b "Implications of the Barings Collapse for Bank Supervisors" (pdf). Reserve Bank of Australia. 1995. Archived from the original on 2007-09-01. http://web.archive.org/web/20070901054955/http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_nov95/bu_1195_1.pdf. Retrieved 2007-11-18. 
  10. ^ a b Howard Chua-Eoan (2007). "The Collapse of Barings Bank, 1995". TIME magazine. http://www.time.com/time/2007/crimes/18.html. Retrieved 2007-11-18. 
  11. ^ Reason, James (1997). Managing the Risks of Organizational Accidents. Ashgate Publishing Limited. pp. 28–34. 
  12. ^ Testimony of Lord Bruce of Donington : "Lords Hansard text for 21 Jul 1995". http://www.parliament.the-stationery-office.co.uk/pa/ld199495/ldhansrd/vo950721/text/50721-14.htm. Retrieved 2007-11-27. 
  13. ^ Kapner, Suzanne (2001-01-31). "WORLD BUSINESS BRIEFING: EUROPE; MORE RESTRUCTURING BY ING GROUP". New York Times. http://query.nytimes.com/gst/fullpage.html?res=9D03EFD61F3FF932A05752C0A9679C8B63&n=Top/News/Business/Companies/ING%20Groep%20N.V.. Retrieved 2007-11-26. 
  14. ^ "ING Group agrees to sell Baring Asset Management". ING Group. 2004-11-22. http://www.ing.com/group/showdoc.jsp?menopt=&docid=092370_EN&lang=en. Retrieved 2007-11-26. 
  15. ^ "ING ends link with Baring name". BBC News. 2004-11-22. http://news.bbc.co.uk/1/hi/business/4031649.stm. Retrieved 2007-11-26. 
  16. ^ Wearden, Graeme (2007-04-05). "Nick Leeson's jacket raises £21,000". The Guardian (London). http://www.guardian.co.uk/business/2007/apr/05/money1. Retrieved 2010-04-26. 
  17. ^ http://www.norwood.org.uk/contact-us/pr-media/newsarchive/2007/Fundraising+News/distressed_investing_dinner_2007.htm

Further reading

  • Drummond, Helga (2007). The Dynamics of Organizational Collapse: The Case of Barings Bank. London: Routledge. ISBN 0-415-39961-6. 
  • Fay, Stephen (1997). The Collapse of Barings. New York: W.W. Norton. ISBN 0-393-04055-0. 
  • Jacque, Laurent L. (2010). Global Derivative Debacles: From Theory to Malpractice. Singapore: World Scientific. ISBN 978-981-283-770-7.  Chapter 10: Barings, pp. 143–178.
  • Leeson, Nicholas William; Whitley, Edward (1996). Rogue Trader: How I Brought down Barings Bank and Shook the Financial World. Boston: Little, Brown. ISBN 0-316-51856-5. 
  • Hunt, Luke; Heinrich, Karen (1996). Barings Lost: Nick Leeson and the Collapse of Barings Plc.. Singapore: Butterworth-Heinemann Asia. ISBN 9-810-06802-6. 
  • Rawnsley, Judith H.; Leeson, Nicholas William (1995). Total Risk: Nick Leeson and the Fall of Barings Bank. New York: Harper Business. ISBN 0-887-30781-7. 
  • Gapper, John; Denton, Nicholas (1995). All that Glitters: The Fall of Barings. London: Hamish Hamilton. ISBN 0-241-13699-7. 
  • Ziegler, Philip (1988). The Sixth Great Power: Barings 1762–1929. London: Collins. ISBN 0-002-17508-8. 

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