The next Big Bang moves a step nearer

Even some household names have back-office systems that are held together with string and sealing wax - and they may not be giving the right answers

It is just possible that something useful may come out of the Barings collapse. Like airline passengers at 10,000 feet who suddenly remember to check if there is a pilot on board, directors of most banks trading derivatives in the City are now beginning to re-examine how their rocket scientists and dealers are controlled.

It would certainly be wrong to blacken every bank's reputation with Barings' incompetence, since London has a fair share of world leaders in managing the derivatives business, the majority of them, it has to be said, American owned. Once the audits prompted by the Baring crisis have been done, most directors will no doubt feel entitled to breathe a sigh of relief. Jolly good, we have a pilot, and we think he knows how to read the instruments.

But if Barings, which seemed so solid and sensible, can fool itself so badly, it is a reasonable assumption that the directors of a number of other banks will be sleeping uneasily for the next few months. It is one thing to locate a potential problem in the back office, but quite another to sort it out overnight. In the meantime, securities businesses cannot be simply closed down.

The back office is shorthand for a complex set of functions that keep track of trading day by day, settle with customers and analyse the bank's overall risk, which means calculating the loss or profit for every deal on the books that has not expired. There is, as yet, no single computer system which does all that and feeds out the answers at the press of a button. Consultants involved in back-office work say there is a constant struggle to make hardware and software designed for several different functions work together, and nobody has yet found the perfect answer.

The objective is to give senior managers a true and up-to-date picture of risks the bank is running, and thus the ability to spot problems in time to cut back or hedge positions. According to one top consultant, even some household names have back-office systems that are "held together with string and sealing wax" and they may not be giving the right answers or delivering information on time.

While those problems are being addressed, there are a number of rather simpler things that can be done. Top of the list is to ensure that no subsidiary, no matter how far-flung, allows a dealer anywhere near the settlement department, the most basic flaw in Barings. And the second is to send the chairman on a derivatives course, followed by an in-depth seminar on risk management. One large bank insists that nothing new or innovative is done in the derivatives business unless it can be explained to the chairman - and he clearly signals that he understands it.

Meanwhile, Barings has almost certainly brought Big Bang Mark II much nearer. Last autumn, merchant banks and securities firms were sounding each other out about alliances and mergers. Talks speeded up when Deutsche Bank announced heavy new investment in London, but went on the back burner after the fiasco of Warburgs' failed deal with Morgan Stanley. Now the talks are becoming serious again, and they make sense.

There are persistent reports that Schroders is still interested in Rothschild's stake in Smith New Court as a platform for a merger, an idea discussed last year. Fortified by a return to decent profits, Kleinwort Benson has been insisting that it intends to stay independent, but it is one of the smaller integrated investment banks and the argument for collaborating with a partner with deeper pockets remains as forceful as ever.

Where that leaves Robert Fleming, Cazenove, Lazards and others is unclear, apart from the certainty that they must be thinking hard about their positions. At the top end of the market, NatWest Markets' interest in Barings confirms that it has some serious gaps in its coverage, despite an enormous balance sheet. Add to that the new investment banking competition in London from Deutsche Bank and the threat that ING or the ABN Amro consortium will establish strong positions through the purchase of Barings, and it is clearly time to get a move on before all the possible targets are snapped up.

The market sees

a one-way bet

Central banks have started spitting into the wind, and the results are just as messy as you would expect. The US Federal Reserve decided yesterday was the day to weigh into the foreign exchange markets in an attempt to bid the dollar back up from its latest post-war low against the yen. A small amount of intervention on Thursday had no effect, so the Bank of Japan and European central banks took up the baton, and the Fed bought greenbacks aggressively itself yesterday.

At a rough guess, the central bankers have made the hedge funds and banks who were selling dollars $2-3bn richer in the past day and a half. They have not made the dollar any stronger. The dollar-sellers have been happy to sell to the only buyers in the market.

It is one of those episodes where the currency market sees a one-way bet. It is little over a week since Fed chairman Alan Greenspan told Congress that US interest rates might be near their peak. There is little chance of a sharp jump in US rates.

In fact, American monetary policy has been pretty loose all through the cycle. The world is awash with dollars, thanks to the enormous US trade deficit and capital outflows during the era of super-low US interest rates. International investors see little reason to hold more dollar assets rather than German or Japanese.

Waves of money are moving exchange rates, and the tide is drawing funds into the safest of safe havens. No matter how aggressive the central banks are about their intervention, and no matter how tough they talk, they cannot change this basic geography.

Intervention will not work without a change in policy to back it up - as the administration has been pointing out forcefully to the Mexicans in recent weeks. If the Fed wants to reverse the dollar's fall, it will have to start showing as much concern about its own currency as it does about the peso.

For the Americans, as for the Mexicans, the lesson is that if a country has an unsustainable trade deficit funded by short-term capital inflows, its currency is in big trouble. If $50bn was barely enough to stabilise the peso, the central banks cannot begin to intervene on a scale big enough to prop up the dollar, and the Fed should stop asking its fellow- bankers to waste their reserves.