How to lose half a billion

Allied Irish Bank's admission that it has lost more than £500m on the foreign exchange markets thanks to a trader who has since absconded sounds impossible to believe.

Except, of course, that it happened in 1995, when Nick Leeson brought down Barings Bank, after losing at least £800m in the derivatives market.

After Leeson people are expected to have much tighter systems in place... Internal controls, auditors, even regulators are looking very bad over this

London trader

No-one is suggesting that AIB is going under. AIB is a retail bank with deep pockets, while Barings was badly undercapitalised.

But still the implications are serious.

The complexity of the trading - and the memory of how Nick Leeson broke Barings - means that oversight systems should have been much more robust, market watchers say.

"This isn't going to hurt AIB as badly as Barings in financial terms," one London trader told BBC News Online.

"But after Leeson people are expected to have much tighter systems in place. Their internal controls, the auditors, even the regulators are looking very, very bad over this.

There could well be other skeletons in the cupboard

London trader

"And there could be others like this. The big investment banks have really tight procedures, but the more staid mid-tier outfits have never been looked at as closely.

"There could well be other skeletons in the cupboard."

Missing, believed lost

Still, to the layman the idea of a bank "discovering" that it has lost half a billion pounds in buying and selling foreign currency sounds like lunacy.

But the hole Allied Irish Banks has discovered in its accounts pales beside the sheer magnitude of foreign exchange trading worldwide.
AIB said the fraud
Consisted of a very large number of trades
Was a sophisticated conspiracy
Probably involved internal and external collusion
Might have been for financial benefit for individuals or just a mess


Trillions of dollars pass daily through the forex markets, as they are known - the same money, churning from one currency to another minute by minute.

Traders look for fluctuations in exchange rates, and take advantages of situations where a rate looks promising compared with where they think it is likely to move in the future.

On the face of it, that is not too complicated a proposition.

But bets can go wrong, so traders cover their backs by hedging: using options, bets with another institution that will pay out if a currency falls or rises a certain amount by a certain date.

The theory is that the options will offset losses should a guess go wrong. If it goes right, then the option does not have to be cashed in, and the only cost is the commission for taking out what amounts to insurance in the first place.

Cooking the books

It is this part of the forex business which is hurting AIB.

Early indications are that its trader ran up huge losses by backing - metaphorically speaking - the wrong horse with what AIB chief executive Michael Buckley has called "a very, very large number of trades".

Traders are meant to follow strict rules on allowable risk, given the huge sums that can be lost.

But this man did not get authorisation for his bets, and so he tried to cover his tracks. He created imaginary options deals in the firm's books, deals which never took place.

A cursory glance would have made it seem that the books balanced, that the losses were being matched by profits on options elsewhere which were the mirror image of the failed trades.

Somehow, the "back office" - the part of a trading operation which checks what the front-line traders are doing and looks after the book-keeping - overlooked it.

AIB believes that could well be the result of an internal conspiracy.

As any unlucky gambler knows, once you fall deep into the red the bets needed to get back out again soon spiral out of control.

And before long, $750m had simply evaporated.