There are frauds and then there are frauds, however for sheer audacity the loss heaped on Société Générale by Jérôme Kervie through trader has few equals in corporate history. That a 31-year-old junior trader can cost a conservative French bank $7 billion in looses before he is discovered show astounding lack of corporate accountability and auditing oversight.
It appears that the trader consistently placed wrong bets on the derivative markets through investments that reduced stock futures. What is mysterious in this whole affair is the amount of money that was hedged. It is difficult to believe for an outsider that a 31-year-old junior executive can have access to funding on that scale in a multi national bank.
It appears that nothing as been learned by international banking system from the collapse of Bearings another bank that had its impressive legacy junked by a relatively junior trader Nick Lesson in 1995. If anything the money involved in that disaster $1.38 billion appears small in comparison to the latest loss faced by the French banking giant. That is if a billion dollars can be termed as small beers in the first place.
The Indian banking industry will do well to learn lessons from this collapse. At the center of the fraud is the working of derivative products that shift risk from one owner to another. In times of economic dynamism, banks and investment firms put premium on risk taking; the juicy yearly bonuses are determined by profit from trading in complex derivatives, which shift risks almost as soon as an instrument is closed to another more intricate mechanism.
While there is a clear economic advantage in allowing risk to be diversified if the process of this risk diversification is not in the ambit of either internal audit or external regulations the result can be a catastrophic.In India the derivative market is in its infancy. It would be prudent to act quickly and put in place regulations especially regarding positions that an individual or an entity can take vis a vis actual underlying value of its assets. Not regulating the derivative markets could well lead to a banking collapse in India in the near future. Regulators need to keep up with the mathematical models that rule today’s stock markets.
It appears that the trader consistently placed wrong bets on the derivative markets through investments that reduced stock futures. What is mysterious in this whole affair is the amount of money that was hedged. It is difficult to believe for an outsider that a 31-year-old junior executive can have access to funding on that scale in a multi national bank.
It appears that nothing as been learned by international banking system from the collapse of Bearings another bank that had its impressive legacy junked by a relatively junior trader Nick Lesson in 1995. If anything the money involved in that disaster $1.38 billion appears small in comparison to the latest loss faced by the French banking giant. That is if a billion dollars can be termed as small beers in the first place.
The Indian banking industry will do well to learn lessons from this collapse. At the center of the fraud is the working of derivative products that shift risk from one owner to another. In times of economic dynamism, banks and investment firms put premium on risk taking; the juicy yearly bonuses are determined by profit from trading in complex derivatives, which shift risks almost as soon as an instrument is closed to another more intricate mechanism.
While there is a clear economic advantage in allowing risk to be diversified if the process of this risk diversification is not in the ambit of either internal audit or external regulations the result can be a catastrophic.In India the derivative market is in its infancy. It would be prudent to act quickly and put in place regulations especially regarding positions that an individual or an entity can take vis a vis actual underlying value of its assets. Not regulating the derivative markets could well lead to a banking collapse in India in the near future. Regulators need to keep up with the mathematical models that rule today’s stock markets.
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