Banking & Capital Markets

After JK

The Kerviel trading scandal was bad. It could have been worse.
Economist StaffMay 30, 2008

Société Générale has been the object of much scrutiny and some mockery since news broke in January that Jérôme Kerviel, a lowly trader in an unexciting market, had lost his employer €4.9 billion ($7.2 billion). The French bank has taken its lumps since then—its shares are down by 28% since the start of the year and shareholders gave executives a rough ride at the annual general meeting on May 27th—but it could have been worse. In many ways SocGen has been lucky.

To be fair, the bank has earned some of that good fortune. It was quick to raise new capital, asking shareholders for €5.5 billion in February. It has replaced its chief executive: Frédéric Oudea took over from Daniel Bouton, who remains SocGen’s chairman, in May. And it has set out to tighten controls with a set of reforms that will cost more than €100m. By the time those changes have taken effect, says Mr Oudea, SocGen will lead the pack in terms of its risk oversight.

There is a lot to fix. A juicily detailed internal report, published on May 23rd, identified more than 1,000 fictitious transactions used by Mr Kerviel to offset actual bets he was making on European futures indices. Direct supervision was either weak or, for a period in 2007, entirely lacking. Alarm-bells that should have rung, such as Mr Kerviel’s reluctance to take any holidays, remained silent. Those that did ring failed to trigger a response. The bank now suspects that Mr Kerviel was being helped by a trading assistant who entered some of the made-up trades.

Just how big a governance snafu the Kerviel saga represents is a matter for debate. Mr Oudea rejects the idea of a systemic failure, arguing that the loss was a product of a particular time and place: a period of rapid growth in equity derivatives, which overstretched the bank’s capacity to monitor itself, and a peripheral trading desk where people were less jumpy about the risk of fraud.

Clients seem willing to give SocGen the benefit of the doubt. Revenue at the equities division of the investment bank tumbled by half in the first quarter, compared with the same period in 2007, but much of the fall can be put down to reduced levels of proprietary trading as the bank pegged back its trading limits.”The client-driven franchise is where one would expect to see the wound from Kerviel, but it seems to be holding up,” says Guillaume Tiberghien, an analyst at Credit Suisse.

It helps, of course, that other banks are also suffering, which is where SocGen’s luck comes in. Risk appetite is down across the board; levels of introspection about risk management are up. Delays in confirming and settling derivative trades, a blind spot exploited by Mr Kerviel, are seen as an industry-wide problem. Not only do clients lack appealing alternatives, but so do employees. With Calyon, the investment-banking arm of Crédit Agricole, shrinking, equity derivatives traders in Paris have fewer suitors than they otherwise might.

That burst of capital-raising looks prescient too: SocGen’s Tier 1 ratio of 8% is in line with the new benchmark emerging at European banks. And the chances of a takeover battle are slim when rivals are also nursing wounds, leaving Mr Oudea free to plot a course back to health. The new boss says that risk appetite at the investment bank will be dialled back up again in due course, and that more capital will flow to other businesses such as retail banking in emerging markets, consumer credit and private banking. He will doubtless face many more questions about Mr Kerviel; but this crop could have been much harsher.