Learning lessons from NAB

Comment

The post-mortem report into the A$360 million ($270 million) options trading losses at National Australia Bank (NAB) makes truly shocking reading. The catalogue of errors in risk management, financial controls and back-office validation – some of which are outrageously basic – are reminiscent of the failures at Barings and Allied Irish Banks, lessons that should already have been learned by any bank with a derivatives business.

Perhaps one of the most astonishing revelations contained in the PricewaterhouseCoopers report, which was published on March 12, concerns the calculation of value-at-risk (VAR). It seems the bank’s market risk and prudential control department had been having difficulty calculating VAR for the currency options business for the past three years, and that during this time, the VAR numbers were generally considered to be unreliable. The bank’s system was eventually upgraded last October. The result? Consistently higher VAR numbers than the limits assigned to the options desk. Rather than look into these figures further, though, the VAR calculations continued to be dismissed as unreliable by bank management.

This raises a number of questions. First, why didn’t anyone think to look more closely into the forex options desk’s transactions? The VAR limit breaches were a huge, glaring sign that all was not as it should have been within the options portfolio. But more to the point, what was the bank doing running a forex options business in the first place if it couldn’t measure the risk reliably? And knowing they couldn’t measure VAR accurately, why wasn’t the bank’s management watching the forex options portfolio like a hawk?

There were other startling revelations in the report. Some of the checks and controls by the back office were at best shoddy, at worst non-existent. For instance, junior back-office staff stopped checking internal options trades from October, without the knowledge of their managers, after they interpreted an email from one of the traders to mean that they no longer had to check and validate these transactions. What’s more, the traders were somehow able to get away with entering false dealing rates into the trading system for at least two years, possibly longer. No-one picked up on this.

If there is anything positive to come out of the report, it’s that other banks will hopefully take note of what went wrong at NAB and double-check that their own controls and systems aren’t as lax. For NAB’s part, the new management has been refreshingly candid about the mistakes the bank made, and has promised to address each of the risk management failures in turn. Nonetheless, the scandal has done untold damage to NAB’s reputation, and this will take much much longer than systems failures to resolve. You can read our cover story on the NAB losses on pages 9–12.

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