Any other business | 24 September 2011

UBS: the bank that lost the formula to turn Mr Hyde back into Dr Jekyll

‘Thank you, UBS,’ writes the FT columnist Martin Wolf, who as a member of the Vickers commission on banking reform was one of its strongest proponents of the ‘ring-fencing’ of retail banks to protect them from the casino follies of securities trading. There could hardly have been ‘a better illustration of the unregulatable risks to which investment banks are exposed’. Indeed, the management failure that allowed Kweku Adoboli to rack up $2.3 billion of trading losses over a three-year period offers such vivid evidence for the ‘casino’ label that only the owners of real casinos can now seriously object to it — on the grounds that they apply far tighter risk controls than banks do. I’m reminded of a scene in Martin Scorsese’s 1995 film Casino, in which one ‘rogue trader’ has his skull crushed in a vice.

Whether Adoboli turns out to have been dishonest on a grand scale or just blindingly incompetent, the episode highlights two disturbing aspects of the banking scene. The first is the nature of the stuff he was trading. ‘You have been warned,’ I wrote on 4 June about explosive growth in the market for ‘exchange traded funds’ that mimic the performance of stockmarkets and commodities. A relatively simple, low-cost device for investors, ETFs offer scope for the banks who create them to make extra profit through complex derivatives deals — that was Adoboli’s role — rather than merely holding a basket of the assets whose value the ETF is supposed to reflect. The Bank of England and the Financial Stability Board in Basel already regard ETFs as a ticking bomb; this story proves them right.

The second lesson to be drawn is the way in which banks mutated into monsters during the easy-money era, and have lost the formula that turns Mr Hyde back into Dr Jekyll.