When Barings Bank declared bankruptcy in 1995, the world was stunned. As Britain's oldest merchant bank, Barings had weathered disasters like the Great Depression and Two World Wars - only to be later brought down by a single man in a small office in Singapore. By the time Barings uncovered his actions, it was too late. Leeson had cost the bank over $1 billion. Learn More about this.
When Barings Bank declared bankruptcy in 1995, the world was stunned. As Britain's oldest merchant bank, Barings had weathered disasters like the Great Depression and Two World Wars - only to be later brought down by a single man in a small office in Singapore. Nick Leeson, a derivatives trader employed by the bank, took unauthorized speculative positions primarily in futures linked to the Nikkei 225 and Japanese Government Bonds (JGB). What losses he incurred, he reported as gains on Barings’ spreadsheets. What funds he needed, he got by falsifying the bank's accounts. By the time Barings uncovered his actions, it was too late. Leeson had cost the bank over $1 billion.
Experts believe that the reason for the bank’s collapse was inadequate risk management. Had Barings insisted on supervising Leesons's actions or conducting an external audit, the situation could have been identified earlier and a crisis averted.
Risk management is becoming a crucial part of business strategy. Without it, thousands of people are adversely affected - shareholders, bankers, employees, customers and even the government who spends millions of dollars trying to bail a bank out.
To ensure that banks are equipped to manage risks, the Basel II Capital Accord was created by the Basel Committee for Banking Supervision.
What is Basel II?
Basel II summary: Basel II (also cited as Basel 2), also known as the International Convergence of Capital Measurement and Capital Standards, helps international banks and financial institutions safeguard themselves against operational and financial risks. It does this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds enough capital reserves on hand to offset its risks.
While risk management has always been a core banking function, banks were earlier permitted to develop their own risk methodologies. With Basel II, each bank has to follow minimum risk methodology standards, develop their own risk management framework and ensure regulatory supervision.
Extending Basel II to IT
Implementing Basel II standards using Basel II compliance software is especially important in today's world where IT systems - the vortex of financial and banking information - are vulnerable to risks.
In 1995, a leading U.S. bank found that its accounts had been compromised. A hacker had illegally transferred $10 million from the bank’s accounts to chosen recipients across the world. Although most of the money was recovered, the incident revealed that even powerful banks can fall prey to security threats.
Banks need an effective risk management framework. After all, their systems deal with millions of customers and trillions of dollars every day. A lot of these transactions are automated and are routed across myriad systems, servers and networks. Consider the Automated Clearing House Network through which 11,000 banks and financial institutions offer electronic payment services; or ATM networks which route transaction requests between the user, host processor and bank in a matter of seconds; or CRM systems which contain extensive and confidential customer information. Each of these systems needs to be fully functional and secured.
Technology is only becoming more complex as banks extend their services to international markets. Business process outsourcing allows employees in one country to access customer information from another. In such an environment, a single unsecured network could be hacked into either externally or internally. Millions of dollars could be stolen, accounts misrepresented or confidential information made public.
Apart from the human element, IT systems are subject to other risks such as utility disruptions, software failures, hardware failures, data entry errors and accounting errors. Compounding these issues is the threat of natural disasters or vandalism which can irreparably damage physical assets.
Clearly the risks that financial institutions face are enormous. But by following Basel II requirements, they can work towards building a safer financial system and improving customer and investor confidence.
Surmounting the challenges of Basel II compliance
Developing a risk management framework can be extremely challenging. Banks need to analyze risk reports and risk heat maps, assess and test controls, and choose the appropriate risk mitigating strategy. Adequate capital then has to be allocated. The whole process can be costly in terms of money, time, effort, technology and personnel required.
For best results, the risk management framework should be integrated across the entire value chain. This is not only complex and costly, it also requires management approval.
What banks need is a single platform that centralizes, streamlines and automates compliance and IT risk management.
Banks and financial institutions that look to build a centralized, integrated risk framework stand to gain. With MetricStream’s single platform solution, they can reduce their capital requirements, manage risks effectively, aid in decision-making and maximize business performance.