Download - The Return of The Rogue
The Return of The Rogue
Silicon Flat IronsJune 5, 2009
Kimberly D. Krawiec
What is Op Risk?
The risk of loss from inadequate or failed internal processes, people, and systems or from external events
Historically, a residual risk category i.e. not market or credit = operational
New focus & importance, thanks to Basel II and market changes
Basic Thesis
Bad – maybe worst of all alternatives Require capital cushion, but use internal
models
Limited effectiveness Banks w/ highest op risk levels are least
likely to credibly assess
Basic Thesis
High costs: Definition, modeling, and data problems Enforcement likely to be lacking Room for interest groups –lawyers,
accountants, risk management experts – to capture definition and management
Incentive to “manage the model,” rather than op risk
Alternatives
Status quo Plausible deniability re: other limits
Do it better Future:
incentivize market-based solutions (e.g. insurance)
Non-financial metrics Other proposals – compensation
revisions
Jerome Kerviel – Societe Generale Authorized to engage in client sales and
arbitrage Not authorized to take directional
positions Fraud = series of unauthorized directional
positions in equities and equity futures Concealed by a series of fictitious
transactions Note that subsequent investigation turned
up numerous violations
3 Concealment Techniques Entry then cancellation of fictitious
trades 947 transactions
“matched” trades – i.e. purchase/sale of equal quantities at different “off market” prices, thus generating gain or loss as needed 115 transactions
Intra-monthly provisions 9 transactions
Actual v. Authorized Earnings
Fictitious Transactions
Nicholas Leeson
28-year-old trader who never graduated from college
Barings Bank desk at the Singapore International Monetary Exchange
In charge of both trading and settlement
Nicholas Leeson
Accused of losing $1.3 billion
Charged with forgery and trading violations on December 1, 1995
Sentenced to six and a half years
Leeson and Barings
Short Straddles: Profitable (Premium) if Nikkei traded
within or near strikes between 18,500 – 20,000
Leeson and Barings
4Q 1994 - January 1995 Nikkei in a range of 19,000 – 19,500 Recall that Leeson’s goal = 18,500-
20,000
Nikkei 225日経平均株価
Leeson and Barings
January 17, 1995 Kobe Earthquake Nikkei dropped sharply Leeson goes long
Leeson and Barings
January 20 – February, 1995 Leeson launched aggressive buying
program: 55,206 March contracts and 5,650 June contracts
Leeson and Barings
Barings collapsed – could not meet huge trading obligations
Outstanding futures positions of $27 billion (Barings’ capital was $615 million)
1050023ST 17
Osaka Securities Exchange10 largest net Nikkei 225 futures positions
0 5,000 10,000 15,000 20,000
17.02.95
BaringsParibasSalomonJP MorganBNPSBCYamaichiSoc GenTokyo MitsubishiBZW
Do it better
Improbable profits Esp. in light of experience level and
authorized trading strategy Unusual trades (real and/or fictitious)
in terms of type and/or volume Back office issues
Bully back office, evasive answers Ignored inquiries from regulators,
exchanges, competitors, other employees