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Allied Irish Bank Fraud
Transcript of Allied Irish Bank Fraud
Proprietary Trading Risk
Proprietary trading is a high-risk activity - It is not just a question of market risk. Many institutions find it difficult to manage and control a proprietary trading business effectively. The potential operational risks may outweigh the potential market returns.
Risk Management Architecture
Risk management structure and practices within Allfirst's currency trading operations were seriously flawed. The operational risks that this implies can quickly transform the typically large market risk exposures incurred in a proprietary trading environment into hard losses.
Lessons we learn
The Bank should have straight-through electronic processing.
AIB had straight_through electronic processing in their Dublin, London and New York offices by integrating two products, Opics and Tropics. The tracking of foreign exchange transactions was centralized in the back office using Opics, while at the front office trading desk Tropics captured currency trades electronically.
Unfortunately, the Opics_Tropics integration did not happen at Allfirst so that many processes continued to be handled manually, transactions went through that didn’t have bona fide sellers and buyers, and trades faked at the front office could not be caught at the back office.
Crossmar Matching Service is lacked
It is used by parent AIB, an automated matching service to confirm trades to legally acknowledge the transaction. Allfirst handled most confirmations by fax, providing a lag time for Rusnak to enter non_existent trades for currency options to counteract the effect of his bad trades.
The story starts...
Risk inside&What we learn
Allied Irish Banks Fraud
Chu Dongyang Lou Xinzhi
How much is the loss that John Rusnak caused?
$691 MILLION !!!
What happened exactly?
The loss was large enough to wipe out 60% of AIB's 2001 earnings and significantly decrease its capital.
Lessons we learn
Proprietary trading (also "prop trading") occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money, as opposed to depositors' money, so as to make a profit for itself.
Rusnak's positions revealed a staggering loss of $691 million. Allfirst and its parent bank Allied Irish hoped that Rusnak was party to a grander conspiracy to fleece the bank for profit, but Rusnak had not earned anything above his regular salary and bonuses.
Rusnak cooperated with the FBI and revealed how he had been able to maneuver around the bank's loose restrictions. Rusnak's transparency with the FBI hurt Allfirst because it had no one to blame but its own permissive policies.
No senior official was forced to resign over the affair, but the scandal badly dented the bank's reputation and those of some senior executives.
Allied Irish's stock fell sharply.
John Rusnak was sentenced to seven and a half years in prison and fined $1 million.
The relationship between parent company and overseas units needs to be clear
It is enormously important that there is unambiguous accountability. In some areas, it was not clear who was accountable to whom, and the reporting lines within Allfirst and between Allfirst and AIB were blurred.
Strong and enforceable back-office controls are essential
There were independent back-office staff overseeing Rusnak's activities. But Rusnak was able to persuade back-office staff to let normal procedures slip. Back-office staff must be empowered to stand by their guns if they have concerns about trading activity.
The heads of AIB will probably roll when an independent investigation is completed. After announcing the losses on February 6, AIB said that Mr. Rusnak's colleagues did not become suspicious of his activities until mid-January. But AIB CEO Micheal Buckley has admitted that they actually become concerned in late December, When David Cronin, head of Allfirst's treasury department, advised the trader to reduce his position.
Did Mr Cronin alert AIB?
Mr Cronin, an experienced banker well known in AIB's Dublin headquarters, seems not to have alerted senior executives.
What contact did AIB have with Allfirst's treasury operations?
AIB's head office had no direct communication with Allfirst's treasury operation, other than access to automated statistics on risk exposure, which were probably meaningless. If Mr. Rusnak was cooking the books, it was only after his losses came to light that the group acted on a recommendation to centralize its treasury operations in Dublin.
Allied Irish Banks - Ireland's second-biggest bank - was formed in 1966 as a new company that acquired three Irish banks: Provincial Bank of Ireland, the Royal Bank of Ireland, and the Munster & Leinster Bank.
Allfirst, formerly knows as First Maryland Bancorp, was partially acquired by AIB in 1983. By 1989, Maryland was merged into AIB as a wholly-owned subsidiary. It’s name was changed to Allfirst in 1999.
John Rusnak is a former currency trader at Allfirst bank, then part of AIB Group, in Baltimore, Maryland, United States.
According to AIB chief executive Michael Buckley, John Rusnak was not a 'star trader'. Described as a 'family man' with two children, Rusnak was far from the archetype of the Wall Street 'master of the universe'. But his trading activities appear to have much in common with more flamboyant rogue traders, such as Barings' Nick Leeson.
Allied Irish Banks
Bet on yen
In 1993, Allfirst Bank hired a currency trader to shift the bank's FX operations from a merely hedging endeavor to one that would yield profits and boost the bank's bottom line. To this end, Allfirst brought on John Rusnak, who had a decent track record in foreign currency trading at Fidelity and Chemical Bank. Specifically, Rusnak seemed adept at matching options with forward contracts to hedge against risk.
John Rusnak was bullish on the yen. He believed the yen had taken all the damage it could following the bursting of the Japanese bubble. Further, Rusnak believed the yen would appreciate consistently against the dollar. Under these conditions, a trader normally would buy forward contracts to get yen for cheaper than market value, while hedging the position with a combination of put and call options. In practice, Rusnak was so bullish on the yen that he neglected to hedge his forward contracts. His luck held, however, until a series of policy changes in Asia led to crisis on the Asian market and prompted a long slide in the value of the yen and other Asian currencies.
Conceal the losses
With his unhedged positions facing losses, Rusnak panicked. He entered false options into the system that made it look like his positions were hedged. While the options kept the bank from discovering the losses, he set about doubling his bets on the rise of the yen. Rusnak convinced his superiors that a prime brokerage account would allow him to achieve higher profits from the growing currency operations. Prime brokerage accounts generally are given to hedge funds and high profile traders with a lot of capital to play with. However, Rusnak was granted the account despite the fact that, unknown to his superiors, he already was working in the red.
Bet more on yen
With his new account, Rusnak increased the size of his trades and kept his losses hidden by using options and a higher level FX contract called a historical rate rollover. This allowed him to hold off realizing his losses, while still betting more on the yen. It also meant that the total value of the FX operations at Allfirst was increasing. Even though the losses were barely detectable, the increasing amount of capital being tied up in the currency market was obvious.When the bank demanded that Rusnak release some of the capital to ease its balance sheet of the heavy skew towards the FX market, the house of cards came tumbling down.
Start of the story
Bet on yen
Nick Leeson (born 25 February 1967) is a former derivatives broker whose fraudulent, unauthorised speculative trading caused the spectacular collapse of Barings Bank, the United Kingdom's oldest investment bank, for which he was sentenced to prison.