The Wall Street Journal-20080125-Fraud At Societe Generale- Vast Deception Puts Risk Controls Under Scrutiny- Wisdom of Handing Off More of the Task to Banks Is Thrown Into Question
Return to: The_Wall_Street_Journal-20080125
Fraud At Societe Generale: Vast Deception Puts Risk Controls Under Scrutiny; Wisdom of Handing Off More of the Task to Banks Is Thrown Into Question
Societe Generale's surprise disclosure that a lone rogue trader racked up 4.9 billion euros ($7.2 billion) in losses raised fresh concerns about banks' ability to manage their risks, and about regulators' efforts to police them.
European markets boomed yesterday as many investors shrugged off the French bank's announcement. But experts on regulation -- and some policy makers -- saw the fraud as a troubling signal that regulators may have ceded too much responsibility for risk management to banks.
"The losses are too big, and I don't understand why there wouldn't be systems in place that would catch this," said Chris Rexworthy, an expert on systems and controls at London-based IMS Consulting, which advises firms on regulatory compliance.
Experts note that it is difficult to create safeguards that a determined and intelligent fraudster can't circumvent. Societe Generale Co-Chief Executive Philippe Citerne portrayed the rogue employee, Jerome Kerviel, who had worked in the bank's back office before becoming a trader, as a "smart" individual with an "intimate and malicious" knowledge of the bank's procedures, such as the specific days when checks were conducted. Bank officials believe he worked late into the night, hacking into the Societe Generale's computer systems to get around controls designed to prevent traders from building large and unduly risky positions.
"We can't have a controller behind every trader at every bank in the country at every moment," said Christian Noyer, governor of the Bank of France, at a news conference yesterday. "Even the best laws and the best police can't always stop someone who is determined to defraud the system."
Mr. Noyer said the Bank of France undertook 17 routine investigations on site at Societe Generale in 2006 and 2007. Regulators examined the bank's models for evaluating risk, especially in sophisticated financial derivatives and products, and its system of controls.
Still, the incident at Societe Generale throws into question the prevailing trend in banking regulation, which has been to place more onus on banks to manage their own risks. That approach is enshrined in the latest set of international banking rules, known as Basel 2, which came into effect for European banks at the end of last year.
"The regulators have been trying to rely more on the institutions they are regulating," said Richard Portes, president of the London- based Centre for Economic Policy Research and professor of economics at London Business School. "There is a lesson from an event like this, that...regulators should be doing more to look inside the banks at their procedures and even at their personnel, as well as just at the numbers."
One thing regulators and banks can and should do is "provide incentives for people working with the fraudster to catch the fraud," said Charles Goodhart, program director of regulation and financial stability at the London School of Economics and a former member of the Bank of England's monetary-policy committee.
The alleged fraud comes at a time when the world's regulatory framework is already in question amid banks' vast losses on complex mortgage investments. European policy makers have been pushing to improve their ability to deal with potential crises at cross-border banks such as Societe Generale, which does a large portion of its business outside France and takes deposits across Europe.
At a meeting next month, finance ministers from the Group of Seven leading nations are expected to discuss the creation of an early- warning system that would help national regulators assess risks emanating from beyond their borders. None of the proposals specifically addresses safeguards against fraud, which fall largely within the scope of the national regulators.
"This shows that even big, complex financial institutions are at risk, and the cross-border activities of those institutions suggest that you can't simply have the home regulator in charge," said Mr. Portes. "There really must be more coordination, before you get a cross-border disaster."
Even as the Bank of France launched an investigation into the alleged fraud at France's second-largest bank by market value, it strenuously defended its oversight methods and insisted that the country's banks remain in sound health. But French Finance Minister Christine Lagarde, speaking before the French Senate, said she had asked the regulator to propose tougher "operational controls."
"How is it possible that despite the controls undertaken by the banking commission, none of these embezzlements done by this employee were detected?" she asked. Societe Generale is the second French bank to suffer a "rogue-trader" incident in recent months. Credit Agricole SA, one of Societe Generale's competitors, said in August that a similar trading incident cost it 230 million euros in the third quarter.
---
Mark Whitehouse contributed to this article.
