The Naïveté of a French Bank

All major financial institution around the globe had their eyes wide open today when they found out that the second largest bank in France had lost $7.14 billion due to a massive fraud made by a solitary trader.

French bank Societe Generale (SocGen) said today it has uncovered a 4.9 billion euro ($7.14 billion) fraud — one of history’s biggest — by a single trader whose scheme of fictitious transactions was discovered as stock markets began to falter in recent days.

Three sources at the defrauded bank said that the name of the “genius of fraud” is Jerome Kerviel, 31, a trader on the bank’s equity derivatives desk earning less than 100,000 euros ($14,700) a year. Jerome Kerviel was responsible for basic futures hedging on European equity market indexes. That means he made bets on how the markets would perform at a future date.

Let me further explain the term “derivatives” to understand exactly what Jerome Kerviel did at the bank.

“Derivatives are financial instruments whose value is derived from the value of something else. They generally take the form of contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a particular point in time. The main types of derivatives are futures, forwards, options, and swaps.” [Wikipedia Encyclopedia]

Because the trader previously had worked in trading accounting offices, “he would have known how the risk management worked,” commented Kinner Lakhani, an analyst at ABN Amro in London who specializes in Societe Generale shares. In a conference call with analysts on Thursday, bank officials “talked about this guy bypassing systems and setting up false counter-trades.”

Axel Pierron, senior analyst at Celent, an international financial research and consulting firm, was stunned that 13 years after the Barings collapse, something similar has happened.

Nick Leeson, the British bank Barings Singapore general manager of futures trading, lost 860 million pounds — then worth $1.38 billion — on Asian futures markets, wiping out the bank’s cash reserves. The company had been in business for more than 230 years.

“The situation reveals that banks, despite the implementation of sophisticated risk management solutions, are still under the threat that an employee with a good understanding of the risk management”, he said.

“We get the feeling that the financial markets have become a big casino which has lost control. It seems incredible that the Societe Generale can lose 5 billion through one operator,” said Alain Crouzat, a portfolio manager at Montsegur Finance.

Analysts said the episode would have a major impact on the reputation of SocGen, which was founded in 1864.

It’s beyond me how one person, no matter how bright he might be, can make a bank the size of the SocGen lose $7.14 billion. Let’s analyze this amount in perspective. The annual budget for the Republic of Panama, the country where I live in, is $8.3 billion. This means that this “financial genius” perpetuated fraudulent transactions in the amount of $7.14 billion representing 86 percent of the annual budget of one whole country with 3.8 million inhabitants. The idea is absolutely preposterous!

I don’t know about you, but this is difficult to swallow. There’s something fishy here. In my opinion, there must be other high ranking bank officials involved. A full investigation by the proper French banking authorities is warranted. How naïve can a bank be?

Derivatives Traders at the Chicago Board of Trade
(Credit: Wikipedia Encyclopedia)

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