Bank losses show need for reform

The irony was probably lost on chiefs of the Swiss banking group UBS when they reported a rogue trader to London police on Thursday over Britain's biggest banking fraud, involving a loss of around US$2 billion. It was the third anniversary of the collapse of Lehman Brothers bank and the onset of the global financial crisis. The significance of the date was certainly not lost on the wider financial community, who believed that in the wake of the financial meltdown, and following a similar case that cost French bank Societe Generale more than US$6 billion, banks had eliminated such risks from their investment operations.

The scandal came as European leaders, banks and markets grapple with the uncertainty created by the euro zone sovereign debt crisis that clouds prospects for global economic growth. But the timing would have been seen as fortuitous by supporters of proposed banking reforms to quarantine the risks of derivatives trading and strengthen banks' financial resilience against losses.

The loss will not break the bank, though it needs to be put in the perspective of UBS' struggle to restore a reputation severely dented by its losses on sub-prime mortgages, which resulted in a US$60 billion bailout by the Swiss government, and an embarrassing US tax evasion case that upset the Swiss tradition of banking secrecy. That is not to mention the loss in one stroke of most of the savings targeted by cutting 3,500 jobs over two years. But it will make life harder for its businesses such as wealth management, and remind investors, particularly in the euro zone, that shocks to the system may still lie hidden in banks' balance sheets.

Investment banking is not without risks. It is worrying that rogue traders can still flourish in the wake of the meltdown and 16 years after Nick Leeson's unauthorised futures trading brought down Barings Bank in 1995.

Given the incentive of opportunities to maximise profits for a bank from dealing in clients' assets on their behalf, the question in this case is whether the activities of 31-year-old Kweku Abodoli, the trader who has been arrested in connection with the loss, involve a failure of internal risk management and technology. If so, the problem looms larger.

Profits cannot be increased without taking on extra risks. Because of past deregulation, innovations in financial technology created the illusion that these risks can be eliminated or at least managed. Thanks to Abodoli, we have been reminded of the need for regulatory reforms, such as those proposed by Britain's Vickers review, to ring fence retail personal and business banking and safeguard taxpayers from ultimate liability for such risks and the wider economy from exposure to them.