[Extract from the conclusion of the Bank Of England Report on the Collapse of Barings]

THE BANK OF ENGLAND

Supervision by the Bank

13.56

As noted in Section 1 of this report, the conclusions expressed
here are those of the independent members of the Board. The
ex-officio members have not participated in this part of the
report.

13.57

The Bank was at all relevant times the consolidated supervisor of
the Barings Group and lead regulator of BB&Co. The supervision was
primarily carried out by its Supervision and Surveillance Division
(S&S). The only relevant supervision for the purposes of this
report was that of S&S. From April 1991 the senior manager in that
division with responsibility for UK merchant banks (including
Barings) was Thompson. Until March 1993 he reported to the Head of
Banking Supervision, Barnes; from that date he reported to the
Head of Major UK Banks Supervision Division, Sergeant, who in turn
reported to the Deputy Director in charge of S&S, Foot (from
September 1993). Thompson had a number of different individual
analysts assisting him over a period of time in supervising
Barings.

13.58

The Bank was told of the intention of Barings' management to apply
BB&Co's standards of control to BSL. The Bank regarded the
controls in Barings as informal but effective. It had confidence in
Baring's senior management, many of whom were longstanding
Barings' employees. Accordingly, it placed greater reliance on
statements made to it by management than it would have done had
this degree of confidence not existed. With regard to Barings'
overseas subsidiaries the Bank undertook no reviews. In that
respect, it placed reliance on what it was told by Barings and its
auditors and reporting accountants (C&L); on the existence of a
'connected lending' limit on BB&Co's (or the solo consolidated
group's) exposure to the overseas securities subsidiaries of 25%
of unconsolidated (or solo consolidated) capital base; and (in
accordance with recognised supervisory practice) on the
supervision performed by the relevant overseas regulators.

13.59

While the Bank's supervision was primarily focused on BB&Co, as the
authorised institution, the Bank's supervisory responsibilities
extended, and were understood by the Bank to extend, to the
activities of other parts of the Group insofar as such activities
were capable of affecting the financial soundness and reputation
of BB&Co.

13.60

In the event, Barings in London received false information from its
subsidiary, BFS, and Barings in London itself failed to
distinguish adequately between its house and client trading. In
consequence, it was not aware that it was not complying with the
connected lending limit and not providing the Bank with accurate
information. It is true that the Bank knew that the Far Eastern
operations of Barings were reporting very significant profits; it
knew that there were issues relating to large exposures and that
large and increasing funding was required for these operations;
and it would have appreciated that there could be reputational
risks to BB&Co arising from any significant default in these
operations. However, we consider that the Bank reasonably placed
reliance on local regulators of the overseas operations; and it
was also entitled to place reliance on the explanations given by
management as to the profitability of these operations and on
other information provided by Barings to the Bank.

13.61 

Had the Bank had a greater understanding of Barings' Far Eastern
operations and a greater awareness of the degree of control of
these operations as exercised by Barings in London it would have
been better placed to supervise the consolidated group. There does
not appear to have been any guideline or system in place within
the Bank for determining whether the situation with regard to a
member of a banking group for which the Bank was responsible for
consolidated supervision was material such that it could effect
the well-being of the bank. Although consolidated supervision
requires an evaluation of risks presented to a bank by the
activities of other members of the same group that evaluation is
left to the unaided discretion of individual managers. We consider
that there should be guidelines to assist this process. From this
a wider lesson can be identified and it is one which we address in
Section 14 of this report.

Large Exposures

13.62

One key aspect of the Bank's supervision for the purposes of
monitoring credit risk was the large exposures rules which it
imposed, or which were imposed by the Act, on banks. These
included a requirement that (to the extent that the Bank had a
discretion to allow exposures to exceed 25% capital base) BB&Co
should first notify the Bank of any proposed exposures that would
exceed 25% of its or its Group's capital base; and from 1 January
1994 a requirement (under the EU Large Exposure Directive) that,
subject to certain specific exceptions and transitional
arrangements, consolidated large exposures should not exceed 25%
of consolidated capital base.

13.63

In 1993 Thompson permitted Barings, by what he described as an
'informal concession', to exceed the 25% limit with regard to the
Group's exposure to OSE. This concession, not surprisingly, was
taken by Barings also to apply to its exposure to SIMEX. Further,
Barings apparently took the concession to release it from the
obligation to pre-notify those exposures. The concession was
granted without any apparent reference to more senior management
at the Bank, which was a breach of the relevant internal Bank
guideline. Moreover, no limit was at any time imposed on the
concession. In consequence, Barings in London was prepared to allow
exposures to the exchanges often to exceed 25% and latterly (by
February 1995) to reach 73% on OSE and 40% on SIMEX. We consider
that this informal concession, permitting Barings to exceed the 25%
limit and without imposing any limit on the concession, was an
error of judgement. Although we do not suggest that the Bank could,
on the information then known to it, have appreciated that this
concession involved any material risk to Barings, the unfortunate
consequence of this concession, which continued over a lengthy
period, was to facilitate the increasing transactions being
undertaken by BFS.

13.64

The informal concession was granted pending a review within the
Bank as to whether Barings could be exempted from the 25% limit in
respect of its exposures to overseas exchanges. Barings referred
this matter to the Bank in January 1993. It was recognised that it
involved a policy issue but nothing was done by the Bank to
progress it until May 1994. Even the coming into effect of the EU
Large Exposure Directive on 1 January 1994 did not cause the Bank
to consider whether it should continue the concession, which had
been granted pending resolution of the issues regarding the
correct treatment of the exchange exposures. Barings prompted the
Bank, by their letter of 29 April 1994, for a response. While the
Bank's S&S Policy Group was then consulted, it was only asked the
narrow question whether exposures could be reported net of
segregated clients' funds. The point was then discussed by
Thompson at a meeting with senior management of Barings on 18 May
1994. The result of this meeting was that the Bank, through
Thompson, indicated that it would write to Barings setting out its
understanding of the position. Again, nothing was done until
eventually (January 1995) the question as to whether there could be
an exemption from the 25% limit in respect of exposures to
exchanges was raised with the Bank's S&S Policy Group, who
confirmed that no such exemption was possible. This view was then
passed on to Barings by Thompson by letter dated 1 February 1995.

13.65

We have considered whether, but for this delay, the unauthorised
trading activities within BFS might have been curtailed or
uncovered earlier. If the Group's exposure to OSE had been kept
within the 25% limit throughout the period from 1 January 1994
(the date on which the EU Large Exposures Directive took effect),
the authorised 'switching' activity between OSE and SIMEX would
have had to be reduced in the absence of third party guarantees of
the exchange exposures. The maintenance of smaller positions,
however, would not necessarily have caused a curtailment in
Leeson's unauthorised activities until around the end of January
1995. Until that time the concealment of the unauthorised
activities booked in account '88888' was unrelated to the
authorised 'switching' business; and therefore, because all trades
in account '88888' were through SIMEX, they would not have been
affected by any reduction of exposure to OSE. However, from the
end of January 1995 the funding ostensibly obtained for authorised
'switching' activity was used in part to finance the unauthorised
activities. From that time, therefore, had the 25% limit been
strictly enforced and complied with and in the absence of third
party guarantees of the exchange exposures, Leeson would have had
either to curtail significantly the positions on account '88888';
or to call for significantly increased funding from London by way
of 'top up'; or to seek some other unauthorised means of funding
the positions. If the second course had been adopted it might have
caused senior management at Barings to investigate the positions
and thereby uncover account '88888'.

13.66

We are therefore unable to determine whether or not the delay on
the part of the Bank in imposing the 25% limit with regard to
Barings' exposure to OSE was a contributory factor in Barings'
collapse. Nevertheless, we consider that the delay was
unacceptable; the Bank was not entitled to assume that the delay
would be inconsequential.

Solo consolidation

13.67

A lack of rigour was also displayed by the Bank in the context of
the solo consolidation of BSL with BB&Co towards which Barings had
been moving from 1992. This was a very significant step - since it
would result in BSL (a substantial securities operation) being
included in the unconsolidated returns submitted by BB&Co to the
Bank and in BSL being, in effect, treated as one with BB&Co for
capital adequacy and large exposures purposes. It was also novel,
being the first solo consolidation of such a kind which the Bank
had experienced. Yet the Bank failed properly to address all the
issues regarding the solo consolidation of BSL with BB&Co or to
finalise conclusions on points which had been raised.

13.68

Sergeant, in handwritten notes to Thompson dated 20 October 1993,
made a number of relevant comments as to whether solo
consolidation was appropriate. There is no record of all the issues
raised by her being properly answered. By the letter from Thompson
to Barings of 4 November 1993 a number of proposals were put
forward, with the Bank indicating that it was prepared to treat
BSL as solo consolidated with BB&Co on a provisional basis, pending
further review by the Bank. But there was no follow up to this
letter; nor (although the letter indicated that the Bank was
giving consideration to whether solo consolidation was appropriate)
does there appear to have been any further review (save with regard
to capital adequacy measurements) undertaken by the Bank. Given the
novelty of solo consolidating a substantial securities company with
a bank, and the questions already raised, we believe that the
matter should not have been left on this provisional basis with no
further consideration of all the outstanding issues being
undertaken after 1993. Indeed, the whole issue of the solo
consolidation of BSL & BB&Co was of sufficient importance to
warrant its being referred up to the highest level within the
Bank. We would have expected that the matter, because of its
novelty and importance, would then have been referred to BoBS
itself.

13.69

In consequence of the informality with which solo consolidation
was permitted, important points - including the need to give a
direction under Section 38(3) of the Act - were not addressed. As
a result the criminal sanctions potentially available under Section
38 in respect of failures to make reports of large exposures as
required by that section were not extended to cover transactions
of BSL; although we accept that BB&Co would probably have
established that no offence had been committed because it did not
know the facts requiring it to make the reports.

13.70

We consider that the Bank did not fully assess the impact of BSL
being solo consolidated with BB&Co. A consequence of solo
consolidation was that no limit was imposed on the amount that
could be advanced by BB&Co to BSL; as a result, owing to the
inadequate controls within BIB the remittance of large advances
from BB&Co via BSL to BFS, ostensibly to finance client trading
but in fact (as it has transpired) substantially to finance the
concealed trading, was in practice facilitated. We accept that it
could not have been appreciated by the Bank at the time that such
trading on the part of BFS would be so facilitated, and we also
accept that solo consolidation was not of itself the cause of the
collapse. Nevertheless we consider that, because of its
importance, the Bank should not have permitted solo consolidation
of BSL with BB&Co to continue on a provisional basis for so long
without a proper analysis of the issues that arose.