Lessons-Learnt-from-the-NAB-disaster

NAB:LEARNINGFROMDISASTER?PatrickMcConnell∗Firstpublished–August2005–HenleyManagementCollegeUK–HWP0514©InJanuary2004,theAustralianbankingindustrywasshakenbyanannouncementthattheNationalAustraliaBank(NAB),thelargestbankinAustralia,hadincurredfinanciallossesofoverA$360million,asaresultofirregulartradingactivities.ParallelsbetweenwhathadoccurredinNABandsimilarlargelossesincurredbyAlliedIrishBankin2002andthecollapseofBaringsbankin1995,arestriking.TwoformalinquiriesweresetuptoinvestigatetheeventsatNABandbothfound,aswithBaringsandAIB,thatmanagementhad,overaprolongedperiod,ignoredwarningsignsofanimpending“disaster”.Obviously,thelessonsoftheearlierwell-publicizedfailureshadnotbeenfullylearnedbyNAB.Inaseminalworkindecisionliterature,Turneridentifiedanumberoffeaturesthatarecommontothedevelopmentof“organisational”disasters,manyofwhichareapparentineventsleadinguptothelossesatNAB.ThispaperreviewstheNABcaseusingTurner’sframeworkcomparesittotheeventsatBaringsandAIBandidentifiessomelessonsforbanks’managementandregulators.SomeimplicationsforthenewdisciplineofOperationalRiskManagementarealsoexamined.INTRODUCTIONThispaperlooksatthefailuresofmanagementthatresultedinsignificanttradinglossesattheNationalAustraliaBank(NAB)withinaframeworkforanalysingthe“developmentofdisasters”createdbyTurner(1976).Areportintotheeventsleadinguptothelossesbythebank’sprudentialsupervisor/regulator,theAustralianPrudentialRegulatoryAuthority(APRA),concludedthatthelossesweredueto“irregularcurrencyoptionstrading”byasmallgroupoftraderswithinthebank.TheAPRAreport(APRA2004)reportedthatthelosses:“Werecausedbyfourcurrencyoptionstraders,possessedofanabundanceofselfconfidence,whopositionedtheNAB’sforeigncurrencyoptionsportfoliointheexpectationthatthefallsintheUSdollarthatoccurred[in2003]wouldreverseandvolatilitywouldstabilise.Ratherthanclosingtheirpositionsasthemarketmovedagainstthem,thetraderschosetoconcealtheirtruepositions-allowingthosepositionstodeteriorateuncheckedoveraperiodofthreemonthsbeforetheywerefinallydiscovered.Bythattime,thepositionsheldweretotallyoutofcontrol[author’semphasis].”Withhindsight,theseproblemsshouldhavebeendetectedmuchearlierbutmanagement,atalllevels,ignoredobviouswarningsigns.APRAwasparticularlyscathingaboutNAB’smanagementculture:“Thatthiswaspossiblewas,firstandforemost,duetothecollusivebehaviourofthetradersthemselves.However,itcanalsobeattributedtoanoperatingenvironmentcharacterisedbylaxandunquestioningoversightbylinemanagement;pooradherencetoriskmanagementsystemsandcontrols;andweaknessesininternalgovernanceprocedures.”Theregulatorspullednopunches:“culturalissuesareattheheartofthesefailings”(APRA2004).∗[e-mail]agementechoesthatoftheinquiryintothelossesattheAllfirstsubsidiaryoftheAlliedIrishBank(AIB)in2002inthatthetraderresponsible(JohnRusnak)hadperpetrateda“carefullyplannedandmeticulouslyimplemented”fraudbutthathismanagershadfailed“foranextendedperiodtoproperlyscrutinizehistradingactivities”(Ludwig2002).NAB’sBoardwerecertainlyawareoftheAIBlosses,astheyhadreceivedareportonthecasefromtheirInternalAuditor,whichadvisedthat“therewerenoissuesofconcernforNAB”.PwC(2004)reportedthecommentsofaseniorexecutivethattheNAB’soperatingmodelwouldnotpreventa[similar]fraud“howeveritisextremelyunlikelythatamaterialfraudof[theAIB]naturewouldgoundetectedforanylengthoftime”.APRAfeltthat“inhindsight,[theAIB]reportwarrantedadeeper,moredetailedassessment”thatthatgiventoitbyNAB’smanagementandBoard.UsingTurner’sframework,thispaperidentifiessomethewarningsignsoftheimpendingdisasterthatwereignoredbyNAB’smanagement.SimilaritieswiththeAIBandBaringscasesarediscussedanddeficienciesinmanagementcontrolsareidentified.Finallysomelessonsaredrawnfromthesecases.ANALYSISOFDISASTERSInanoften-citedworkindecisionliterature,Turner(1976)examinedtheofficialreportsofanumberof“disasters”fromanorganisationalperspective.ThedisastersanalysedbyTurnerresultedinconsiderablelossoflife1andsocannotbecomparedtothefailuresofmanagementthatwereapparentatNAB.However,Turnerconsideredthatdiscussionofsuchdisastersoffers“aparadigmfordiscussionoflesstragicbutequallyimportantorganisationalandinter-organisationalfailuresofforesight”,suchassignificantfinanciallossesatamajorpubliccompany.Turneridentifiedanumberof“stages”inthe“developmentofadisaster”and“features”thatappeartobecommontothem,whicharesummarisedinTable1below.StageFeaturescommontoDisasters1.InitialBeliefsandNormsCulturallyacceptedbeliefsandprecautionarynormsandproceduresFailuretocomplywithexistingregulations2.IncubationPeriodTheaccumulationofanunnoticedsetofeventswhichareatoddswiththeacceptedbeliefs(a)Rigiditiesofbelief(b)Decoyphenomena(c)Disregardofcomplaintsfromoutsiders(d)Informationdifficultiesandnoise(e)Theinvolvementofstrangers(f)Failuretocomplywithdiscreditedorout-of-dateregulations(g)Minimisingemergentdanger3.PrecipitatingEventTheeventthatforcesitselftopublicattention4.OnsetTheimmediateconsequencesofthecollapseof“culturalprecautions”becomesapparent5.RescueandSalvageTheimmediatepost