London Whale. LIBOR Rigging. FX Scandal. Gold Manipulation. It looks like we'll never get rid of rogue trading completely in big banks. That’s a huge problem.
All big banks engage in some form of trading on the financial markets. It’s part of the banking business in the same way as an electricity company is active on the electricity markets. Much of the trading is done in risk hedging purposes, which is comparable to taking out an insurance policy. Some banks also engage in proprietary trading, which means that they trade various markets on their own account, so as to make a profit for themselves.
There’s no problem with trading in itself. Without trading we wouldn’t have efficient financial markets. The problem is unauthorized and illegal trading driven by greed, moral hazard, and stupidity.
This kind of unauthorized trading is called rogue trading and it can occur both within risk hedging and prop trading. The term Rogue Trader was made famous by the 1990’s book and film about Nick Leeson, who single-handedly with aggressive and speculative futures trading caused the collapse of Barings Bank (established in 1762).
Another infamous Rogue Trader was "The London Whale” Bruno Iksil, who in 2012 caused direct losses of around $6 billion for JPMorgan Chase with huge positions in the Credit Default Swap (CDS) market. Take a wild guess where the nickname “Whale” came from.
Then there was Jérôme Kerviel, a trader at Société Générale, who by forgery and unauthorized use of the bank's computers caused direct trading losses of around €5 billion in 2008.
The list goes on. The losses are incomprehensible. And it’s not just unauthorized trading, but also outright market manipulation and rigging. For interesting rigging cases, take a look at the Libor (interest rate) rigging scandal or the Forex (FX) scandal.
You’d think that all the added bank supervision, regulation, and corporate governance had taken care of the problem? Unfortunately, yesterday we heard straight from the Credit Suisse CEO that banks still can’t control what they have in their books.
According to the CEO "the firm’s traders had ramped up holdings of distressed debt and other illiquid positions without many senior leaders’ knowledge, helping lead to a first-quarter loss in the markets business.”
We hear about this all the time. We know the reasons behind the phenomena. Still we're unable to get rid of it. Expect to see more blatant cases in the future as well and never keep your assets in just one bank.