Barings Goes Bust: How A Single Prop Trader Took Down One Of Britain's Oldest Banks

Wisdom passed down through generations often serves investors well in markets. "Don't put all your eggs in one basket" is a good lesson about portfolio diversification and risk management. 

But there's another old saying that applies to markets, at least in some situations: "One bad apple can spoil the whole bunch." Barings Bank, one of England's oldest and most influential institutions, learned this the hard way when its lack of internal controls allowed a renegade prop trader to get himself — and the firm— in hot water.

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Risk (Mis)management

Barings Bank was one of Britain's most renowned financial firms, with a history dating to the early 1760s. In Jules Verne's 1872 classic "Around The World In 80 Days," Barings Bank holds the £20,000 ($24,894) wager check while Phileas Fogg attempts to beat the clock in his global circumnavigation. 

In the early 1990s, Barings Bank sought to expand its operations and hired a young hotshot trader named Nick Leeson at its Singapore office. Leeson was inexperienced but bold, and his early trading strategies raked in profits for Barings. Leeson earned Barings £2 million in 1992, specializing in futures and derivatives, and his success allowed his trading activity to go largely unsupervised.

Encouraged by his lack of supervision and increasingly lucrative bonuses, Leeson began to take on more risk. But he did more than execute risky trades — he began to cover up losses using so-called "error accounts," which were meant to be dummy accounts used to fix trading errors. Barings executives failed to notice the deception, and Leeson kept hiding bad trades in the error account while reporting his wins to his bosses. 

Digging Deeper By Doubling Down

Barings Bank might have avoided a death sentence if Leeson had just come clean once it was apparent trouble was brewing. But like a tilting gambler, Leeson adopted a martingale system in which he doubled his wager after every losing investment. If one trade lost £200,000, he'd throw £400,000 into the next trade. 

Additionally, Leeson began hiding increasingly larger losses in his secretive account. A £2 million negative balance in 1992 expanded to £23 million by 1993. By 1994, the account was over £208 million in the red, and Leeson was getting desperate. In a rash move, he placed a futures trade that would profit if volatility remained low in Japan's Nikkei 225 index. Leeson's timing could not have been worse — an earthquake struck the following day, rattling Asian markets and destroying Leeson's positions.

The scandal's aftermath was swift and brutal. Leeson left the bank with losses beyond its available capital, and his deceit earned him a criminal conviction and four years in a Singapore prison cell. Barings Bank barreled into bankruptcy and was eventually sold for a single pound to Dutch competitor ING Group. In three years, Leeson's reckless trading and subsequent fraud had turned Barings Bank from a respected institution to a defunct failure.

Prop traders often have to deal with conflicting emotions. On one hand, the most profitable traders are the ones who receive funding, but on the other, too much risk can sink a portfolio and a reputation. Prop trading isn't for the faint-hearted. But if you have an eye for trading (and the stomach to handle volatility), consider a prop trading challenge like the Bootcamp program offered by The 5ers, where you can get started with $100,000 in demo capital for less than $100.

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