Massive fraud at SocGen jolts credit markets

Just when it looked like things couldn't get any worse for the financial world, Société Gé*érale, one of its most respected banks, stunned the market yesterday by announcing a €4.9bn (£3.7bn) loss caused by a rogue trader who evaded the bank's controls to make huge bets on stock markets.

France's second-biggest bank said the trader, Jérôme Kerviel, had secretly set up unauthorised bets on futures linked to European share indices. The Governor of the Bank of France, Christian Noyer, said SocGen was not guilty of wrongdoing and that M. Kerviel's ability as a "computer genius" had allowed him to escape the bank's internal controls.

But the news sent shivers through credit markets already living in fear of further shocks from the credit crunch which has battered confidence in the world banking system. The three-month sterling Libor – the rate at which banks lend to each other – jumped as concerns about counterparty risk re-emerged. "Risk management controls seem to have failed in an environment where there is already little investor confidence," said Dresdner Kleinwort credit analysts. "Fourth-quarter results updates by European banks could bring more negative surprises."

Until the markets froze last summer, banks were booming in a seemingly serene world of risk that appeared to be widely dispersed around the world. SocGen's huge loss could trigger fears that internal risk systems – said to have been overhauled by major banks since the collapse of Barings in the 1990s – have also been allowed to slip.

David Dearman, a partner at forensic accountants PKF, said: "The lessons of the Nick Leeson and Barings case in 1995 appear to have been forgotten by some. The biggest risk, of course, is always complacency. I can only trust that the procedures adopted in the City a decade ago are working and being regularly reviewed but there will undoubtedly be some very nervous senior people in the industry today."

The news could also undermine efforts by Nicolas Sarkozy, the French president, to turn Paris into a financial centre to rival London. France has sought to capitalise on the Northern Rock crisis in Britain to push for pan-European regulation and there were concerns in the UK that M. Sarkozy would use his presidency of the European Union to strengthen Paris.

SocGen also revealed a €2.05bn write down linked to sub-prime loans and bond insurers in the US. The bank announced an emergency €5.5bn rights issue to shore up its capital position. The discounted share offer follows huge capital raisings by Citi-group and Merrill Lynch in the US to bolster their buffers against default.

M. Kerviel had worked in the bank's middle office – a link between traders and those who settle their deals – before becoming a trader of uncomplex share derivatives transactions intended to minimise risks on SocGen's trading book. He was said to have "deep knowledge" of the bank's risk controls that allowed him to evade them and take unauthorised positions that were discovered at the weekend.

It is impossible for banks to eliminate the risk of rogue trading. But analysts said a trader who had worked in risk control should have been monitored far more closely because he would have the knowledge to get around the bank's systems if he wanted to.

Moody's cut its ratings on SocGen's financial strength and long-term debt and deposits by a notch. The rating agency said its investment banking business could be damaged if it did not sort out its internal weaknesses quickly.

The banking industry has been buffeted by bad news since Aug-ust's collapse in confidence in once-buoyant debt markets. A survey showed that the market value of the global financial services industry fell 7.2 per cent last year – stripping out currency effects – the first drop since 2002.

The shock was felt mainly in Western markets where companies lost a total of $1trn (£500bn) in value as faith was shaken in the world's most powerful banks, the Oliver Wyman survey said. By contrast, emerging markets thrived.