Financial skulduggery is as old as finance itself. What is shocking, however, about Jerome Kerviel, a futures trader at leading French bank Societe Generale, is the scale of his reported deception. The fraud he allegedly perpetrated through unauthorised trades in European futures markets has cost his employer Euro4.9 billion (HK$56 billion), the largest in banking history. The case should ring alarm bells with lenders and investment banks around the world. Other banks may yet have similar loopholes exposed. Greater safeguards must be put in place to prevent such crimes in future.
Societe Generale appears not to have learned from the Nick Leeson affair more than a decade ago. The original 'rogue trader' destroyed Barings by similarly hiding massive losses. Since then, western institutions have supposedly made highly sophisticated internal monitoring and compliance systems foolproof. However, a single middle-level trader at one of France's top banks has been able to bypass safeguards and traded billions for months without being detected. Whether or not he acted alone is a question that investigators will have to answer.
The latest disclosure could not have come at a worst time for both Societe Generale and the global equity markets reeling from a wider banking crisis. On top of the scandal, the bank has to write off Euro2.05 billion in losses stemming from the subprime mortgage meltdown in the US. Some people believe Societe Generale's fire sale of Mr Kerviel's futures and derivatives contributed to the steep market declines on Monday. The drops prompted the US Federal Reserve to cut interest rates by three-quarters of a percentage point. Whatever the truth of the matter, it probably did not help that the French bank was selling large positions into a falling, panicky market.
The alleged fraud appears unrelated to the larger banking and credit crunch. However, together, they raise doubts about the ability of financial institutions to manage risks - both within their internal operations and with outside investments. The subprime meltdown sparked a banking crisis because these institutions used faulty models that underestimated the risks of complex financial instruments based on those housing mortgages and assets.
Frauds are often uncovered during times of financial distress because rogue traders can no longer hide their crimes. Financial institutions may be shell-shocked by the latest market turmoil, but they can least afford to be complacent now. This is especially the case for institutions in emerging economies. They are still learning and adopting up-to-date international risk and security management. But, as Societe Generale shows, even these advanced systems are not foolproof.
Disclosure of massive frauds can easily precipitate market panic. Given the bubbles that have been brewing in places such as the mainland, their financial markets can become extremely jittery. Regulators and banking chiefs must, therefore, be especially vigilant at this time.