A massive fraud by a junior rogue trader has punched a $7 billion hole in the finances of French bank Societe Generale, leaving its credibility in tatters and forcing it to get emergency cash.
France's central bank and government scrambled to shore up confidence in the banking system after Societe Generale, France's second-biggest bank, said on Thursday it had been the victim of massive and exceptional fraud resulting in losses of 4.9 billion euros.
Anxious to rebuild its shattered capital, the bank announced a capital increase of 5.5 billion euros, instead of beating a path to cash-rich sovereign wealth funds, as some U.S. banks have done during the recent credit slump.
It said the increase had already been underwritten by rival banks.
SocGen, one of France's oldest banks and a world leader in free-wheeling modern financial derivatives, said the losses came to light at the weekend and blamed a young backroom trader whom it said had tried to cover up bad bets on the stock market.
It was an extremely sophisticated fraud in the way it was concealed, said Societe Generale Chairman Daniel Bouton, who offered to resign but has been asked to stay on.
Shares in the bank fell more than 6 percent to 74 euros.
It is a serious case, but at the same time it has nothing to do with the situation on the financial markets, said Prime Minister Francois Fillon, speaking in Davos, Switzerland.
The Bank of France announced an inquiry by the Banking Commission. Governor Christian Noyer said SocGen had been able to overcome the crisis because it was very solid.
If fraud is proved, the loss will be the biggest caused by a single trader, dwarfing the $1.4 billion loss by trader Nick Leeson that brought down British bank Barings in the 1990s.
SocGen declined to name the trader, but said he had been suspended pending dismissal after confessing to his actions.
It described him as a man in his thirties who had worked for SocGen since 2002 and earned less than 100,000 euros a year.
He now faces legal action from Societe Generale, which is in turn already being sued by a group of 100 angry shareholders.
The bank accused the trader of taking massive fraudulent positions in 2007 and 2008 on European equity market indexes, meaning he was gambling on broad movements in share prices.
When the bank discovered the concealed trades on January 19 and 20, it decided to close the positions in the market as quickly as possible, but this coincided with a sharp market sell-off, and the bank's losses on the deals spiraled to 4.9 billion euros.
NOT ONE OF OUR STARS
Like Leeson before him, the trader apparently benefited from knowledge of the bank's control systems after working in the back office of its trading rooms, according to SocGen.
It said he had used a scheme of elaborate fictitious transactions to try to cover up his mistakes, but did not accuse him of profiting personally from his actions.
He was not one of our stars, said a senior board member who declined to be named.
The announcement sent a shiver through the world banking industry, which is suffering a credit crunch as high-risk U.S. mortgage borrowers default on their loans.
Lehman Brothers CEO and Chairman Richard Fuld called it everyone's worst nightmare in a comment from the World Economic Forum in Davos, Switzerland.
In addition to the fraud, SocGen unveiled a further writedown of 2.05 billion euros related to the credit crunch.
We get the feeling that the financial markets have become a big casino which has lost control. It seems incredible that the Societe Generale can lose 5 billion through one operator, said Alain Crouzat, a portfolio manager at Montsegur Finance.
Others said the crisis at SocGen, one of the top 10 banks in the eurozone by market value, could spell trouble elsewhere.
The most serious thing is that this puts into doubt the risk-management systems at some banks, said Fortis analyst Carlos Garcia. You can't suddenly announce this from one day to the next a hit of $7 billion. In the light of this, what we've done is to downgrade banks that are very linked to trading income or whose capital base is weak.
Analysts said the episode would have a major impact on the reputation of SocGen, which was founded in 1864 and is one of France's most prestigious blue-chip companies.
Several said the bank, which has for years been coveted by larger French rival BNP Paribas, could face a battle to remain independent.
Shares in BNP rose 7 percent.
SocGen said it expected a 2007 net profit of between 600 and 800 million euros, well below its 2006 profit figure.
(Editing by Will Waterman)