Temptations of modest salaries and big bonuses

JUST when we thought the reputation of big business had hit rock bottom with the Enron scandal, along comes a rogue trader at Allied Irish Banks to prove us wrong. After Nick Leeson bankrupted Barings in 1995, regulators around the world bolted the stable doors, set up 'failsafe' protections against fraud and congratulated themselves on a job well done. All it has taken is one smart middle-ranking banker to drive a coach and horses through these protections.

All the financial watchdogs in the world cannot protect a bank from unscrupulous activity any more than bars on the windows stop bank robberies.

In some respects banks bring difficulties on themselves. Staff, particularly on the trading desks where John Rusnak worked, receive modest basic salaries but huge bonuses for successful deals. There are incentives to take massive risks. And when trades go wrong there is an ever bigger incentive to take further risks and try to make good the profits before head office - in the AIB case, in far-off Dublin and the City of London - knows something has gone badly wrong.

It appears that Rusnak took an enormous gamble on the foreign exchange markets, expecting perhaps the dollar to weaken against the euro and other currencies at a time when it got stronger. Under normal circumstances this would not be a critical matter because the trader will have taken out a kind of insurance contract to hedge against these losses.

Early accounts from AIB suggest that Rusnak, perhaps with the collusion of colleagues, laid a false paper trail for superiors who believed the losses were covered. In this respect the AIB scam looks very similar to that at Barings.

BUT there is a significant difference. AIB, with stock market quotations in London, New York and Dublin, is not one of the world's richest banks but it does have a strong enough capital base. It is able to absorb a loss on the scale announced without bringing the whole pack of cards down.

What is causing some surprise in the City is why Allfirst, which is essentially a regional retail banking operation serving ordinary personal customers throughout Maryland, should be conducting large-scale foreign exchange transactions at all. The only foreign currency that retail bankers are normally likely to handle would be for customers' overseas holidays.

Baltimore is a large port, so there is the possibility that Allfirst was acting for commercial clients. But it is also a violent city known as a magnet for organised crime so there must be the possibility of a more sinister plot behind AIB's woes.

As for the way in which AIB and its American subsidiaries are regulated, there does appear to be some unfortunate comparisons with Barings. The further a bank is away from its home regulator, the harder it is for the bank inspectors to do their stuff.

Under the present system, everyday regulation is delegated to the Maryland state authorities (who issue the banking licences) and the Federal Reserve, the US central bank. This fragmented system of regulation does offer scope for the unscrupulous banker or trader to pull the wool over the eyes of the supervisors by playing one off against the other, preventing any one group of monitors having the full picture.

THIS is among the key reasons why, after Labour came to office in Britain, it created a monolithic City regulator in the shape of the Financial Services Authority with powers to gain access to every part of a bank's business.

It was determined that the split between the supervision of banking firms and share dealing firms - which was at the heart of the Barings debacle - would not happen again.

The other big change which has taken place since Barings is that one by one the merchant, investment and smaller commercial banks have been merged or taken over to create giant worldwide banking concerns such as Britain's HSBC and America's Citibank and JP Morgan Chase. Such behemoths are large enough to absorb even the biggest losses and frauds without causing scarcely a ripple.

Although the loss of £ 530m to AIB is a terrible shock, which could eventually cost the Dublin bank its independence, it is not that different to some of the recent losses seen in the financial markets.

Only this week, the British insurer Royal & SunAlliance announced that its entire profits had been wiped out as a result of claims arising from asbestos, the Enron collapse and 11 September. Even more spectacular, JP Morgan Chase has been forced to take losses of up to £2bn over its dealings with Enron.

Banks which get it so wrong find their share price plunges, the responsible executives fall on their swords and eventually the weakened institution is taken over by one that is stronger. The ambition of Irish banks to become players on a world stage has been dealt a devastating blow.