Effects of Barings Collapse

3 March 2017

Effects of Barings Collapse on the Banking Industry The uncovered loss of GBP 830 million led to a liquidity crisis for the Barings Bank , the collapse of the bank, which shocked all people, not only the financial world. Over the weekend of February 25 and 26, the management of Barings tried to arrange for a bailout by the Bank of England. Several investment banks gathered to discuss the possibility of raising enough private money to recapitalize Barings before the Tokyo market reopened on Monday morning.

This attempt failed because of the size of Barings’s positions in Japenese derivatives contracts, many of them still open and liable to incur still bigger losses. None of the banks wanted to take on these contracts without a large fee or a guarantee from the Bank of England that it would cover these losses. The Bank of England decided that it was not prepared to put the British taxpayers’ money at risk.

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On March 3, the Dutch financial group ING offered to purchase the majority of its assets and liabilities for one single pound sterling.

As there were no other options available, Barings’ directors accepted the offer of ING. This action allowed for the protection of the bank’s depositors and creditors. However, shareholders suffered the majority of the loss. Immediately following the collapse, for instance, there was no sense of crisis in Singapore even though the ill-fated bets had been made there. SIMEX, which traded the futures and options that made up Leeson’s positions, limited the effects of the crisis by taking over Barings’s contracts and managing their liquidation, thereby keeping losses at a minimum.

Other effects of the collapse such as the damage done to London’s reputation for safe financial dealing and personal losses incurred by a number of Barings’s investors, is considered as a price paid for taking part in risky financial games. Moreover, February 26, 1995 was not the first time when Barings had ’gone bust’. The first ’Barings Crisis’ happened in London in 1890, however Barings managed to recover from that loss as it had other financial institutions in similar situations.

Regarding the global financial system, inititally there were worries that the revelations about Barings might lead to a loss of confidence in the global financial system as well as in the financial position of many banks engaged in derivatives trading. However, there was no sign of a negative effect from the Barings collapse. On the contrary, the failure of Barings was seen as having little to do with derivatives trading and much more to do with the lack of internal management controls at Barings.

Though, Barings’s collapse had some serious impacts on the international financial markets. For instance, in Tokyo nervousness caused by the Barings collapse sent stock prices downward very quickly. The Nikkei index closed down 660. 33 points, or 3. 8 percent, the largest one-day fall since the financial shock of the Kobe earthquake itself. The Barings failure pushed stock prices down in more than a dozen of countries in Asia and Europe because investors intended to recover their assets without getting caught at the time of the collapse.

In addition, the British pound fell a lot against the German mark. These results show that a single financial institution located in one country (in this case in England) was able to establish trading practices in a second nation thousands of miles away (in Singapore), and thereby affect financial markets worldwide (in Hong Kong, Japan, England) through its mismanaged operations. So far, the United States has not been mentioned as being very much affected by the Barings collapse.

Though, American inverstors should be concerned by international market disruptions such as those created by the Barings collapse. For instance, not long ago U. S. investors used to purchase mutual funds and closed-end funds which invest in foreign securities markets as well as acquiring the debt and equity securities of foreign issuers. As one of the further consequences of the collapse of Barings Bank, a syndicate at the Lloyd’s of London insurance market announced on 2 February 1998 that it had sold its first insurance policy covering banks for the risk of ’rouge trader’.

During the mid-90s the financial world observed several significant collapses of various companies which were quite active in the field of derivatives and securities. The most well-know ones are the followings: Metallgesellschaft (1993), Kidder Peabody (April 1994), Bankers Trust (September-October 1994), Orange County (December 1994), Daiwa (September 1995). The primary concern for bank regulators to address in the aftermath of Barings is systematic risk.

Systematic risk means the risk that illiquidity or failure of one institution, and its inabilty to meet its obligations when due, will lead to the illiquidity or failure of other financial institutions. Banks that engage in derivative activities without careful thinking are exposed to great risk and, as a result of this, face significant potential losses that could mean a dangeour for major firms or even for the financial system as a whole. The inability of one bank to meet its obligations has the likelihood to lead to a domino effect, toppling one financial institution after another.

Another possibility is that investors lose confidence in the financial market, that is in case of a market disturbance, an otherwise containable market downturn can be made into an illiquidity-driven crash. Barings did not cause a domino effect, nor did the effects of Barings rise to the level of an illiquidity-driven crash. Though, the ever-increasing development and the use of derivatives and other innovative financial instruments suggest that any lessons from past failures should be taken into consideration.

Any type of financial debacle carrries with it a risk that threatens the stability of financial markets and investors’ confidence in those markets. Conclusion: The Barings collapse did not result in worldwide financial crisis, nor did it topple institution after institution when it failed to meet its own obligations on SIMEX future contracts. However, it is the interplay of these observations that makes the Barings story not only interesting but important in the context of global financial institutions.

The collapse may have alerted the world to the fact that derivatives are risky, that losses can spiral out of control virtually overnight, and that the effects of a failed financial institution are not only local but international. This case became a quite typical lesson, and the bankers, economists, financial experts, and the government regulators through out the world began to concentrate on not only restrictions and regulations externally through egislation and policies, but also supervisions of internal individual activities. If, as a result of the Barings collapse, financial institutions evaluate and improve internal contols on risk management and regulators undertake a more cooperative global approach, probably Barings-style collapses can be prevented in the future. At least, increasing the level of confidence investors have in the long-term stability of financial markets can only serve to benefit all those associated with them.

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