On 26 February 1995, Barings plc, the UK’s oldest merchant bank, was placed into administration following trading loses by a Singapore subsidiary that exceeded the capital of the bank. This article explores the collapse from a human factors perspective and asks whether the (apparently) sudden collapse of the Bank should have come as a surprise.

By reviewing some of the organisational and leadership failings, it then identifies lessons for other industries.

How did Barings Bank fail?

Barings Bank was founded in 1762 and was owned by the Barings family. It counted royalty amongst its high-net-worth clients. Barings specialised in corporate finance and debt trading, having a very conservative outlook.

In the 1980s and 90s, the Bank became involved in the trading of equities (securities) through the purchase of a stock-broking firm.

Nicholas Leeson became a trader in the Singapore office in 1992, working for the Bank’s subsidiary Barings Futures Singapore. Trading on the Singapore International Monetary Exchange (SIMEX), Leeson opened an error account, 88888. This account was originally intended to record errors by inexperienced traders and to be closed each day, but over the next two years, Leeson used this account to hide losses from his own trading. This was facilitated by Leeson being promoted to General Manager of Barings Futures Singapore in June 1993. In this senior role, he was responsible for the trading activities (the “front office”) and the processing of settlement paperwork in the back office.

Leeson was authorised to conduct arbitrage or “switching” activities, taking advantage of small discrepancies in prices between the Singapore (SIMEX) and Japanese (OSE) exchanges. This involved buying futures contracts on the Nikkei 225 Index on one exchange and selling nearly identical products on the other exchange. By doing this in large amounts and at the same time on both exchanges, a profit could be made. This was a low risk strategy and did not involve an “open” position on the exchange.

However, Leeson was also taking unauthorised positions in Nikkei futures and Japanese Government Bond (JGB) futures on both the SIMEX and Japanese futures exchanges. He also took exchange-traded options against the Nikkei Index on these two exchanges. A detailed explanation of these financial instruments isn’t necessary here, just the understanding that if the markets moved against him, Leeson was exposing the capital of Barings plc to unlimited potential losses.

Leeson appeared to be performing well; profits in Singapore increased significantly – along with his profile in the company.

In January 1995, an auditor identified a discrepancy in the accounts of Barings Futures Singapore, but Leeson explained this with a fabrication relating to a transaction between the Bank and US investment firm Spear, Leeds & Kellogg. Eventually, deception with such forged documents would lead to Leeson’s conviction for fraud.

Leeson continued to trade heavily, needing the Nikkei Index to rise. However after an earthquake in Japan on 17 January 1995, the Nikkei 225 Index dropped heavily, increasing his losses. Towards the end of February, all markets in which he held open positions turned against him, and his losses escalated.

On 23 February 1995, a settlements clerk in Singapore raised another discrepancy with Leeson, but was unable to obtain an explanation from the trader. Leeson sent a resignation letter and fled from Singapore that night, leading to an immediate investigation and the discovery of huge losses. The majority of trading losses occurred in 1995. Although he was involved in unauthorised trading for over two years, note that a quarter of the losses were incurred on a single day. At 27 February 1995 the loss was £827 million, but this increased to £927 million once all trading positions were closed out.

The Bank of England attempted to organise a rescue plan, but no-one was willing to bail them out, as the total losses from open positions were at that point unknown. Barings Bank was placed into administration – sending a strong signal to the financial industry that banks will be allowed to fail.

The blame game

Following a detailed inquiry, a report by the Board of Banking Supervision (BBS) concluded that the failure of Barings Bank was due to the unauthorised trading activities of one person. This report was discussed in Parliament:

“This failure is, of course, a blow to the City of London. But it appears to be a specific incident unique to Barings, centred on one rogue trader in Singapore” (The Chancellor of the Exchequer, Mr. Kenneth Clarke, 1995)

Following charges of fraud and forgery, Leeson was sentenced to six and a half years in a Singapore prison, and served four years. Had the Nikkei index increased in value and his trades been successful, Leeson may have been seen as a hero, rather than a villain.

But could the collapse of a bank be the work of just one person? And were there really no implications or lessons for other financial institutions?

“Rogue Trader” – or poor management?

Although the official report into the Bank’s failure placed emphasis on the sole trader Leeson (leading to a book and film titled Rogue Trader), the Board of Banking Supervision did recognise that leadership failures enabled Leeson’s activities:

“We consider that those with direct executive responsibility for establishing effective controls must bear much of the blame …. others at lower levels of management were also at fault for failing to act effectively in relation to their own responsibilities” (Board of Banking Supervision, 1995, para 13.11)

Given this recognition that there were failures of leadership and management, I have included below an overview of some of the key human and organisational failures that contributed to the collapse of Barings Bank.

Organisational change

There are reports of a “culture clash” in the Barings organisation, between the merchant bankers and the security traders. A case of “them” and “us”. Old money (conservative) versus new money (entrepreneurial). The significant contribution to the Barings Group profits from the security trading in Asia was reported to worsen the relationship.

Partly to address these concerns, in 1994 the traditional merchant banking and the new trading business were merged into one entity: Barings Investment Bank. Many specialists in securities left at this time and the merchant bankers now had oversight of the trading business (that they didn’t fully understand). However, at the time of the collapse, there wasn’t a clear or complete organisational chart. A breakdown in relationships between London and Singapore, together with ambiguous accountabilities reduced effective financial control over Singapore trading. The seeds of the collapse were sown.

Roles, responsibilities and reporting lines

The reporting lines for Leeson were unclear, and this was hampered by the matrix organisational structure. As a result of the lack of clarity, Leeson was not properly supervised. His roles and responsibilities were not clearly defined, and he was able to operate Barings Futures Singapore almost entirely alone. The inadequate supervision over the Singapore office was known by the Bank (within the Asia region at least).

Several managers admitted to the Inquiry that they were confused either about their responsibilities, those of others, or who was responsible for Barings Futures Singapore.

“No one in management accepts responsibility for Leeson’s activities between October 1993 and 1 January 1995” (Board of Banking Supervision, 1995, para 7.9)

Understandably, many managers interviewed by the Inquiry denied that Leeson reported to them personally. The complex matrix structure of the Barings organisation enabled this confusion. The matrix structure also compounded difficult relationships between several senior managers.

The confusion over roles and responsibilities and ineffective communications reduced the management control over Barings Futures Singapore. And the dangers of not segregating the “front office” and “back office” functions were not addressed, allowing Leeson’s unauthorised trading to continue.

Failure to heed warnings

As we often see in major disasters, there were several warning signs that preceded the event. However, these warnings didn’t prevent a collapse of the Bank.

In January 1995, the Singapore International Monetary Exchange (SIMEX) expressed concerns to Barings’ senior management regarding the large volume of trading of Nikkei futures and options. SIMEX wanted assurance that the Bank could fund its margin calls, should there be adverse market movements. The management team assured the Exchange that the Bank had sufficient funds to support these trades.

Letters from SIMEX to Barings also referred to the 88888 account (and its large funding requirements), but concerns were not adequately followed up by management.

The extremely high level of funding that was required to finance Leeson’s activities should have sounded alarm bells in London. He was able to demand (and receive) huge sums in order to cover his losses. It wasn’t clear to senior managers in London whether these payments were loans to clients for trading, or funds for trading by Barings (i.e., house trading).

These funds, transferred from London to Singapore, significantly eroded Barings’ capital. The credit implications of making these payments to the Singapore subsidiary were apparently not assessed.

An internal audit conducted in August 1994 raised concerns that Leeson was in charge of both trading (front office) and settlement activities (back office), exposing the Bank to great risks, and that responsibility for the two offices should be separated “to reduce the possibility of error and fraud”. A similar concern was raised in an audit report in October 1994. But given the significant profits generated by Leeson, this practice was allowed to continue by the Bank. Little did they know that huge losses were already hidden in the 88888 account (approx. £208 million at the end of 1994). If the unauthorised activities were identified at this time, the Bank could have been saved from insolvency.

“It is becoming very clear that our systems and control culture are distinctly flaky” (Memo to Barings CEO, 25 Nov 1994, three months before the collapse)

Besides the concerns raised by Regulators and internal audits, concerns were also circulating in the industry in January and February 1995, particularly relating to the very large position on the Osaka Securities Exchange (OSE). This led to a query to Barings from the Bank for International Settlements in January 1995. These rumours and market concerns were known to management in London.

Perhaps the critical information was there to be discovered or listened to, but it did not reach the right people at the right time, or they failed to take appropriate action.

Profits and bonuses: Lack of challenge

The remuneration policy of Barings gave directors and senior employees a direct interest in the business. Bonus payments were a significant proportion of remuneration, for example, the bonus for directors would form 75% of total pay (base pay being the other 25%).

Approximately 50% of company profits would form the bonus pool. Operating profits of the Barings Group were £37 million in 1994. Of this, £28.5 million was contributed by Leeson’s (supposedly risk free) “switching” activities. The apparent high profitability of the Singapore trading activities relative to the low level of risks (as perceived by management in London), should have been a warning sign, according to the Inquiry.

But there was no real investigation or challenge as to the very high profitability of Leeson’s activities. Management did not inquire as to how a part of the business that they considered to be risk free could contribute so much to the Bank’s profits. Despite the significant profits, and the huge funding required from London, Barings’ management did not fully understand the business that was generating these profits.

This lack of challenge may have in part been due to the apparent profits generated by Leeson’s activities and the impact on bonus payments. There appears to have been a reluctance to challenge the star performer.

Regulatory oversight

Barings was supervised by the Bank of England (BoE). The Inquiry found that the BoE had confidence in Barings’ senior management (many of whom where long standing employees):

“It placed greater reliance on statements made to it by management than it would have done had this degree of confidence not existed” (Board of Banking Supervision, 1995, para 13.58)

Regarding overseas subsidiaries, such as Barings Futures Singapore, the BoE did not carry out any reviews, but relied on the reports from Barings or its auditors. The Inquiry felt that it was appropriate for the BoE to place reliance on the explanations of management and to assume that local regulators had oversight of Barings’ overseas operations. The Securities and Futures Authority (FSA) was a regulator of the Barings business, but also did not monitor the firm’s subsidiaries. The Inquiry considers that this is a responsibility of the FSA, where subsidiaries could impact on the financial integrity of the business.

There are Regulations requiring banks to report any exposure that exceeds 25% of its capital to the Bank of England. The positions being taken by Barings on SIMEX far exceeded this limit. They did not report this to the BoE, but had an “informal concession” or arrangement with the BoE, which was a breach of its own guidelines:

“We consider that this informal concession, permitting Barings to exceed the 25% limit and without imposing any limit on the concession, was an error of judgment” (Board of Banking Supervision, 1995, para 13.63)

Although the BoE may not have fully appreciated the implications of the concession, this unfortunately facilitated the increasing unauthorised transactions by Leeson in Singapore.

Conclusions and reflections

From the Inquiry report, it’s clear that the collapse of Barings plc was the result of unauthorised transactions by Leeson, but that his activities were enabled by underlying failures in management control. There was insufficient oversight of his activities, and several warning signs went unattended. There were clear failures of monitoring, audit and review.

Even if some of the individual red flags were missed, taken together they provided the Bank with a clear warning of the dangers to which it was exposed. In many of the other incidents discussed on this website, a failure to heed warning signs is a common thread.

“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” (Board of Banking Supervision, 1995, para 14.1)

In any organisation, individuals may fail unintentionally, or choose to circumvent rules for a wide variety of reasons. Knowing that this is the case, implementing a robust system of checks and balances is critical to managing potential human failures. Audits (whether internal or by external parties), even if they are of the right quality, are worth little if the findings are not addressed in a timely manner.

The failure of Barings plc illustrates that major disasters do not happen overnight. Although Leeson played a pivotal role, there was a large incubation period when various organisational failings were either unnoticed or were not fully appreciated.

Company leadership needs to understand the gap between what is thought to be happening and what is really happening (work-as-planned versus work-as-done).

All companies should reflect on the lessons from this incident, for example:

1. What internal controls are most relevant to your business? And how do you know that they are performing as intended?
2. How do you ensure that recommendations from audits reach the right audience, and are robustly considered?
3. If you have multiple locations or a wide range of different activities, do you have a Group internal audit function (and one that has access to the CEO)?
4. What are the equivalents of “front office” and “back office” in your organisation? How do you segregate the roles and responsibilities of these?
5. Do you understand all aspects of your business well enough to be able to ask the right questions?
6. Are there certain activities or functions where only one individual is able to answer all key questions about that area?
7. Do you have an up-to-date and complete organisational chart?
8. Does your organisational structure enable effective communications between departments?
9. Do you have an independent risk management function that oversees all aspects of risk?
10. Where there’s potential to earn significant bonuses, will your internal checks and balances identify any unintended effects of these remuneration arrangements?

Further reading

Inquiry into the circumstances of the collapse of Barings, Board of Banking Supervision, 18 July 1995.

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