The Allied Irish Saga

16 February 2002

The U.S. Dollar 750 million foreign exchange losses attributed to a foreign exchange dealer is similar to the Barings episode in many respects. Quite apart from a single 'rogue trader' responsible for massive losses, the similarity extends to the fact that this time as well, the bank was trading in Japanese Yen and U.S. Dollar contracts. But the underlying issues clearly indicate that venerable blue chip banks were caught off-guard by the activity in a foreign locale, where for cultural and other reasons, the respective banks were doing business but unable to fully impose their own standards of supervision and control. It is true that the two mishaps are not similar in one respect i.e. while Leeson bankrupted Barings, John Rusnak simply caused a massive hole in the current year's profits of Allied Irish Bank. Nick Leeson lost Sterling 860 million in unauthorized Japanese equity derivatives and Japanese Yen related activities. Therefore what was fatal for Barings has turned out to be a bit of a fraud and worse a highly embarrassing and hugely expensive dent to the financial strength and image of the Allied Irish Bank.

The Celtic tiger is thus not mortally wounded but will certainly wish to introspect. A more critical matter at stake is that speculative trades that more and more international banks indulge in are increasing in scale as banks wish to make "super profits".

This greed syndrome is all pervasive and so much of proprietary trading is supported by huge capital, systems and controls that big banks almost believe that they are incomplete or immature without engaging and relying on a highly paid "trading team". When derivatives first arrived on the scene, they had the potential to both "hedge and minimise risks" as well as create and expand risks exponentially. Again the big boys employed the best brains i.e. the mathematical wizards and the rocket scientists, to obtain competitive advantage, exploit arbitrage opportunities, engage in financial engineering and create products and services that few other than the financial engineers themselves, fully understand ! Whereas the larger investment banks have techno-savvy executives who understand the intricacies of the derivatives, the large investment banks such as Barings, particularly with a traditional, 'commercial banking mindset', could never fathom what is involved. They however liked to belong to the jet-set of the banking world and some of them fashionably "dropped names and terminology" and many of them did not have the humility to confess their lack of understanding ! Reasonably, what is needed are independent trainers, who will simplify the complex financial jigsaw puzzles for the senior executives and board members, so that they can make informed decisions.

The other manifestation of greed is the tendency to want to make something out of nothing. Whether it is foreign exchange, derivatives or commodities trading, in many instances, they end up as 'zero-sum' games. If one scratched the surface, these then become speculative or taking bets on future movements of interest rates or currencies or commodities or a combination of them. Derivatives involve minimal outlay but yet you are able to compound your exposure. It then really becomes a small bet for a relatively huge gain or loss.

The other difficulty with speculative (or proprietary - the politically correct expression!) trading is that it is tempting not to cut losses. You are always hoping that the next big movement will be in your favour and therefore, you hang on, hoping to turn the tide, reverse your fortune and in that sense, this is now different from the roulette table or the horse racing with all its pulsating highs and lows. It is a different matter whether commercial banks which are trusts or repositories of customer funds, should be indulging in trading. Again it becomes a bit of a moral high ground, as everything that one does, can be regarded as speculative or taking a view.

The Allied Irish fiasco happening on the back of the Enron debacle, has clearly unnerved the markets. Fear has suddenly replaced greed as investors vote with their feet from any corporate exposures that they are uncomfortable with. Others see ghosts where there are none. It is reported that some of the traders have even sold their stocks short (i.e. sold what they did not have) with a view to buying them; after spreading rumours of a particular stock such as Tycos. All these phenomena are again a matter for the regulators. Allied Irish as indeed Enron were subject to regulation by the domestic central banking authorities in the U.S. and audited by globally renowned firms. It is inconceivable that such losses can occur in one day. Actually they did over a period of time. In the case of Enron, the Special Purpose Entities (SPEs) were in existence for many months, if not years, before they were uncovered. It is a similar case with Allied Irish. This is where one must question the quality and depth of regulatory and corporate governance; in the so-called 'mature' economies.

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.

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