Thanks to Colin over at Bankwatch for this one on losses suffered by the Bank of Montreal (BMO). At first sight it looks like just another bad day at the office for some traders – until you see the amount (currently estimated) as having been lost (CAD 680m – just over a quarter’s profit) and the bank’s reaction. This looks like a textbook case of how not to announce this to the market.
BMO seems to have broken a few of the rules on releasing bad news to the market. They started with a low loss number and, since then, have been increasing it. Once the reaction got too strong they now appear to have clammed up, cancelling press conferences is never a good idea.
The losses themselves are large – there is no other way to put it. As a result I suspect that the losses are not normal trading losses and that the two individuals who “no longer work for the company” were off on an adventure of their own with the bank’s money.
This always means that the losses are not “trading” losses properly so called – but operational risk losses. They can only be called trading losses if the bank knew the positions were being run and were either managing them within normal procedures or had set up specific procedures to deal with these positions. To put it bluntly – if the bank knew these positions were out there and tolerated them then they were/are fools.
These sorts of positions are properly the domain of hedge funds, not commercial banks.
If, as I suspect, these positions were not under the control of the bank then that means that internal controls either were inadequate or broke down in several places (it must be several – good internal controls typically need several points of failure). Either way, look for some much better explanations over the next few weeks and / or some serious sackings.
The point? Large losses are almost exclusively operational risk breakdowns in nature. Banks typically focus on credit risk, regarding it as the core of their business. They are right that it is the core of the business, but how many banks have failed quickly by credit losses? What will blindside you and sink a bank is poor operational risk management.
6 comments
21 May, 2007 at 17:27
raincoaster
Interesting post. I (as a Canuck) must admit to experiencing a large jolt of Schadenfreude when hearing that a Canadian bank has had an “unauthorized withdrawl”. Yay. Simply: yay.
21 May, 2007 at 20:40
Andrew
Slightly different here in Oz as most of us now hold shares in the banks through our pension funds. We can look at Canuck banks with Schadenfreude , though.
I will be interested to see the full story, though. It looks to me like one party on the other side has made all that money. I wonder if anyone in that company (Optionable Inc.) will be making a rapid move overseas. Brazil anyone?
28 May, 2007 at 12:56
André Levy
Ditto. :)
André Levy
Manager, Operational Risk
Australian Prudential Regulation Authority
31 May, 2007 at 11:05
Steve Edney
Will be interesting to get the full story. The implication would seem to be the traders had managed to cover the losses, in colusion with the broker in the hope that they would revert, and they could get away with it ala NAB.
I wonder if there will be an independent report on it the way NAB did with PWC, (which makes for an interesting read – much better than the APRA version).
4 June, 2007 at 16:41
RodClarke
I wonder whatever happened to the Whisteblower a NAB??? From what I recall the person was a young woman. Hopefully she got a job at APRA.
This really is a wake up call for auditors. Are operational risk “events” normal disturbuted? can inferences be drawn from the test results of a random sample of transactions? or are these events what Nassim Taleb calls “Black Swans”? and if so how do we stop them?
4 June, 2007 at 20:07
Andrew
To me the audit profession needs to take what they call a “controls based approach” to these type of events. Testing controls – their effectiveness and / or their presence is the only way to pick the possibility of these up. Simply checking the paperwork will not do so – checking that the controls are in place and working effectively might.
In the end, the chances of them doing so in the face of someone trying to cover their tracks is not particularly high. They do their job every day and the auditors might be in there only once or twice a year. This is why good, strong senior management is so important. The “tone from the top” is vital. The problem at the NAB was the tone was wrong. As the report (at p. 72) put it – “…NAB’s highly regimented culture acted to impede transparency and mollify the message when it involved acknowledging concerns or difficulties at operational level.”
You will never stop attempts at fraud. The trick is to pick it up early enough.
On the whistleblower – I do not believe their name was ever printed, so I do not know if we will ever know where they went.