SocGen operational controls put under the spotlight

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Rumours had swirled around the market that there was bad news to come from Société Gé*érale on Wednesday, causing the bank's shares to fall more than 4 per cent. But speculation had centred on potential writedowns from the US sub-prime crisis.

SocGen had reported only minor sub-prime writedowns in the third quarter, despite holding nearly €5bn (£3.7bn) of collateralised debt obligations (CDOs) plus €550m of bonds backed by US mortgages.

The bank announced yesterday that it had indeed written down more sub-prime related assets. But the real trouble was at its highly respected equity derivatives business.

"Everyone knew there was something up at SocGen, but no one had any idea it would be this," one banker said.

Banks cannot eliminate the risk of a trader running up losses undetected. Hank Paulson, the US Treasury Secretary, said when he was chairman of Goldman Sachs that fraud would always be a threat because big banks were the size of small towns. "We will never eliminate people doing bad things. In a town of 20,000 people, there's a jail," Mr Paulson said.

But Moody's criticised SocGen yesterday, saying the bank was guilty of "serious breakdowns in the chain of operational controls". The same was true of Barings when Nick Leeson's unauthorised trading brought the bank to its knees.

Rumours of extraordinary trading had circulated widely before Mr Leeson's losses were discovered, but it appears that other institutions had not caught wind of anything odd resulting from Jérôme Kerviel's trading. Analysts said the market's ability to detect trouble would have depended on how long it was going on and what the trades were.

Mark Thomas, an analyst at Keefe Bruyette & Woods, said: "If they were sustained for any length of time there would be a large movement of cash which would raise alarms at SocGen and at counterparties."

Christian Noyer, Governor of the Bank of France, said yesterday that he learnt of the losses "in real time" over the weekend. SocGen started to unwind the positions on Monday.

Mr Noyer declined to say whether he had told the US Federal Reserve or the European Central Bank about events at SocGen. A Fed official said yesterday that the central bank did not know about SocGen's crisis when its rate-setters cut the cost of borrowing on Tuesday.

Sir Howard Davies, former chairman of the UK's Financial Services Authority, said regulatory failings could not be blamed. "Nobody thinks that a regulator can find out a trading fraud in a bank like Société Gé*érale if its own management doesn't know it... The problem is in the financial institutions themselves," Sir Howard said at the World Economic Forum in Davos.