Risk Management at National Australia Bank

In 2004, the National Bank of Australia announced an AUD$360 million loss that arose from unauthorized foreign exchange deals. A selected few traders from the foreign exchange department kept incurred over a period of time while keeping the losses deceptively concealed (Dellaportas, Cooper, & Braica, 2007). The regulation authorities in Australia are strict and so cases of this magnitude have been rare. The National Bank of Australia had put up measures to deal with such risks but these proved ineffective. This paper analyses the situation as it was and reviews measures that should d have been put in place to ensure such cases were avoided.

The losses were incurred by four currency option traders who continued to take risks that were higher than they were allowed to over the period between 2002 and 2004 (Gup, 2007; Dellaportas, Cooper, & Braica, 2007). While the losses were incurred over such a long time, the bank’s administration did not know about it. The culture of the organization was cited as a major source of these errors. The escalation of these losses was mainly over the last four months of 2003 and January 2004 when the scandal was discovered.

The four traders succeeded in doing this by concealing losses and smoothing losses over a period of over two years. It is also likely that these activities had been going on since 1998 (Ubels, 2004). The traders entered untrue information into their trading systems to conceal losses. The three primary methods exploited by these traders were using wrong revaluation rates, entering false transactions and recording genuine transactions incorrectly. According to Ubel (2004), risk management measures ran short of serving their purpose in eliminating the risk for a period of over two years. The operations of the company were also not properly supervised hence leading to the four traders’ ability to take advantage of the loopholes in the systems to conceal their weaknesses. Upon assessment by the PricewaterhouseCoopers, various loopholes were identified in the company’s risk management system.

First, the company continued to identify a large number of limit breaches which were repeated daily (Ubels, 2004). Nobody, however, strived to pursue the matter further. While procedures were followed to identify scenarios where limit breaches were committed, the company continued to ignore the matter for as long time (Gup, 2007; Farooqi, 2005). The risk management procedures did not provide for how further action was supposed to be done. The company culture made an immense contribution with this regard to ensure that the four traders were immune to further investigation for a long time. To most persons at the organization, it became normal for the foreign exchange department to breach limits continuously.

Second, the systems that were used to calculate the value at risk within the organization were disparate (Ubels, 2004). The company had learned about this problem for a period of over two years. However, the company continued to postpone the matter as it was not considered a matter of priority (Dellaportas, Cooper, & Braica, 2007). Specifically, the company knew that the method of calculating the value at risk employed in the company was unreliable in the foreign exchange options department. However, no action was taken to resolve the matter until after the problem had gone out of hand.

Thirdly, the traders continued to use false rates through the product control unit without being discovered (Tyson-Chan, 2006). The product control unit did not conduct sufficient confirmation to ensure that the information granted to it was reasonable or within the parameters of the current market conditions (Tyson-Chan, 2006). The product control unit did not follow appropriate procedures in determining if the reports delivered by the foreign exchange option section were reliable.

The company lacked financial controls. Basic financial procedures would have been sufficient to identify the losses that were being concealed in the company earlier (New York Times, 2004). The company should have:

• Investigated transactions that were made at off-market rates,
• Analyzed customer and proprietary profit and loss deal volumes,
• Analyzed and corroborated loss and profit drivers nature and risk of portfolio, and market price size and movements,
• Analyzed deal type concentrations of the portfolio, and
• Reviewed the month-end rates of revaluation (Dellaportas, Cooper, & Braica, 2007).

Had the company had any of the financial control systems in place, it would have discovered the issue far earlier than it had before the losses had escalated.

Recommendations

Proper measures should have been put in place to ensure that the phenomenon had not occurred. First, the company should have maintained current forecasts in the foreign exchange rates (Horcher, 2005). The biggest losses had occurred after the traders made investments continuously in one currency. The department had assumed that the US dollar was always performing. With this piece of information, the company had always invested heavily in the US dollar. At one point, they had made tremendous losses when the US dollar dropped in value by 10 percent against the Australian dollar (Ubels, 2004). When the traders made this loss, they invested more heavily in the US dollar anticipating that the US dollar was going to improve and help them out of the losses they had made and concealed. Instead, the US dollar’s health continued to underperform (Gup, 2007). The company continued to make losses which were then concealed throughout. Had the company made forecasts available to the departments, the risk would have been avoided. If the traders had an idea of the trends followed by the foreign currencies, they would have foretold the future of the foreign currencies hence making informed decisions.

Secondly, the company could have provided employee training and skills improvement (Horcher, 2005). With sufficient training, the traders would have been in a position to make more informed decisions while investing. The decision to always invest on the US dollar was rather uninformed. With proper training, the traders would have been able to invest in other currencies as well. While the US dollar was performing, it would have been wiser to invest on the Australian dollar.

Thirdly, the company should have ensured that there was adequate reporting of progress to team, management and team (Horcher, 2005). The scandal at National Australian Bank was discovered by a junior employee in the bank. If the bank had put up this strategy, the management as well other senior employees would have discovered the disparities earlier on (Johnston, 2004). The discovery by the junior employee was an accidental phenomenon rather than planned and informed.

Fourthly, the company should implement appropriate measures to guard against illegal activities (Horcher, 2005). The traders continued to involve the company in illegal activities for a period of over two years. If the company had put up measures to prevent such activities, it would have been easier to eliminate the cases. Measures that would have put up include prompt action being taken whenever limits were breached and thorough investigations of reports whenever they were submitted.

In conclusion, the National Australian Bank had immense losses in 2004 that occurred as a result of laxity from the risk management team. The company failed to implement measures to combat such activities. The bank was also not prompt with dealing with risk exposure. While legal action has since been taken against those who caused the scandals, it would have been more important to handle the situation by using preventive measures (Tyson-Chan, 2006). Risk management is a very important department in any company. It is vital that this department should be strengthened and enhanced.

References

Dellaportas, S., Cooper, B. J., & Braica, P. (2007). Leadership, Culture and Employee Deceit: the case of the National Australia Bank. Corporate Governance: An International Review, 15(6), 1442-1452. doi:10.1111/j.1467-8683.2007.00597.x

Farooqi, S. (2005). Final chapter of NAB trading scandal begins. Risk, 18(4), 9.

Gup, B. E. (2007). Basel II: operational risk and corporate culture. Corporate Governance in Banking: A Global Perspective,” Edward Elgar, Northampton Mass, 134-150.

Horcher, K. (2005). Essentials of financial risk management. Hoboken, NJ: Wiley.

Johnston, E. (2004, December 22). Former Dealer at Australian Bank Is Charged in Currency Case. Wall Street Journal – Eastern Edition. p. C3.

New York Times, (2004, February 3). Chief of Australian Bank Quits in Trading Scandal. New York Times. p. W1.

Tyson-Chan, D. (2006). NAB rogue traders jailed. Money Management, 20(25), 14.

Ubels, H. (2004, Mar 15). Junior staffers cited for stopping National Australia Bank scandal. Wall Street Journal Retrieved from http://search.proquest.com/docview/398934973?accountid=8289