Procter & Gamble-Bankers Trust
Financial disasters have brought to light some really opportunistic behavior and serious frauds. As there is so much trust towards banks, bankers, and brokers, the stock market has repeatedly collapsed to unprecedented levels. Frauds and lack of transparency play a big role in major losses to even the biggest of companies. One such case is the Procter & Gamble and Bankers Trust case.
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Background on Procter & Gamble-Bankers Trust:
In the year 1903, a number of national banks in New York formed a trusted company called Bankers Trust with the motive of providing trust services to their customers across the country. Along with trust and commercial banking services, it functioned as a ‘bankers bank’ by holding reserves of other banks and trusts as well as loaning them funds whenever required. Procter & Gamble- the American multinational consumer goods corporation- was looking to hedge its risks by using methods that made small gains wherever possible. To hedge, they used swaps of fixed debt for floating-rate debt along with futures, options, and currency trades.
Agreement between P&G and Bankers trust:
P&G entered into high-risk complex derivatives with Bankers Trust which was known to be one of the best in risk management. As per the agreement, P&G entered into two vanilla swaps contracts with Bankers trust for hedging. The contracts were floating rate notes in Deutsche marks and dollars. The bets were made with an assumption that the interest rates would go down. Furthermore, P&G bet twenty to one in favor of a fall in interest rates.
What went wrong?
A lot of the investors thought the rates would increase and so positions should be cleared before they did. Greenspan raised the interest rates as the market predicted causing P&G to lose heavy amounts of money. Bankers Trust had not clearly articulated the implicit risk in their contract. The CFO of P&G said they had no knowledge of the details of the contract and so were unaware that losses could be made.
Aftermath:
P&G sued Bankers Trust for $195 million. BT argued that P&G had its own set of experts to do interest rate forecast and that they didn’t complain when they had made profits. In the end, the parties settled out of court for $78 million. BT endured great reputational risk.
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Lessons learned:
- Bankers Trust lost the trust of its valued clients and customers and came forward about the processes breaks in the system.
- They were dealing with complex derivatives and took advantage of their client’s trust by not being transparent about the risks.
- The employees were under the pressure of meeting targets and took extensive measures to meet them. This led to BT not prioritizing their clients.
Had the Bankers Trust management and employees been more transparent while communicating with their clients, the business and reputation would’ve been good and they could’ve remained one of the top players in risk management.
Author – Abha Shetty
About the author – Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.
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