Recent trading losses at Daiwa Bank Ltd., on top of other, similar incidents at Barings PLC and Chemical Banking Corp., means banks need to intensify internal controls, particularly over trading risks, bankers and analysts said.
"What this shows is that even at the most sophisticated institutions in the world there is a tremendous lack of basic controls," said Andre Cappon, president of CBM Group, a New York-based financial consulting firm.
"It shows that rogue traders can foil most of the controls in place and that the only way to get around that is to have redundancy in the controls system and checks upon checks."
Don Reading, managing vice president at First Manhattan Consulting Group, agreed. "Daiwa said that they relied heavily on individual trust. You need more formal oversight procedures as well," he said.
The $1.1 billion loss at Daiwa is the third major trading fiasco banks have reported since the end of last year. In December, Chemical Banking Corp. incurred a $70 million loss after one of its traders extended his limits in foreign exchange trading. In March, Barings PLC, a British merchant bank, incurred a $1 billion loss from unauthorized derivatives trading in Singapore.
Analysts said the problem of internal controls has grown as banks expand proprietary trading in an effort to make up for slackening revenues in their traditional lending businesses.
They note that both the speed of transactions and the amounts involved have increased enormously in recent years, setting the stage for potentially large losses.
Both U.S. and foreign financial supervisors have emphasized that banks need to increase their internal controls because regulators are simply not in a position to monitor thousands of transactions at thousands of institutions daily.
As far back as three years ago, the Federal Reserve Bank of New York warned of "several instances of basic internal control weaknesses in the trading operations of both domestic and foreign banks."
"I think this is another wake-up call about the importance of internal controls," said Peter Bakstansky, a spokesman for the Federal Reserve Bank of New York.
However, analysts said the problem has been compounded by globalization. This, they added, has made supervision more complex and opened the door to rogue operations.
"It's no coincidence this happened away from the head office, and no coincidence Nick Leeson was at Barings in Singapore rather than in London," said Mr. Reading.
The problem is partly cultural and psychological, some analysts say. They noted that the Japanese banking operations are to a large extent built around individual trust and were not equipped to monitor large-scale fraud.
But they also said that banks in general are going to have to extend the same kinds of controls over traders that are exerted over all other areas.
"Management tends to be intimidated by big-time, fast-talking traders with strong personalities," said Mr. Cappon. "But when management makes exceptions to the rules, they become de facto accomplices."
