The Irish bank has closed its foreign exchange trading operations at the Baltimore headquarters of Allfirst pending a full investigation into the incident, which appears to have involved a lone trader covering foreign exchange spot losses with bogus currency options contracts. The FBI has begun a nationwide manhunt for John Rusnak, the trader at the centre of the investigation, who the bank claims has been missing since the weekend.

The losses are expected to reduce AIB's 2001 net income by EUR596 million ($516 million) to EUR401 million. Shares in the bank dipped by 23% to EUR10.5 as news of the fraud hit the wires. The impact of the losses will reduce AIB's Tier 1 capital ratio from 7.2% to 6.4% with total capital reducing from 10.8% to 9.9%. Standard & Poor's is reportedly reviewing the bank's A+ credit rating for a possible downgrade.

Group chief executive Michael Buckley says: "We are hugely disappointed that our Allfirst control procedures failed to uncover this situation at an earlier stage. The investigation now underway will determine not only how it arose but also how we can guard against any recurrence."

Market insiders have expressed amazement at the scale of the losses and the fact that they were not uncovered earlier.

"It is a shame that the early coverage focussed on the misuse of derivatives. It sounds like the trader, who used to run the dollar/DEM options book at Chemical Bank in New York, tried to cover his spot losses with fictitious options trades," says David Gershon, chief executive at SuperDerivatives, the online options pricing system.

AIB has confirmed that the trader covered his tracks by artificially entering bogus currency options contracts into the bank's risk management systems. "The established control procedures in Allfirst Treasury should have identified these fictitious transactions," says the bank. "The lapse in the application of these controls is currently under investigation."

AIB has suspended five staff members, including the treasurer of Allfirst and the heads of treasury fund management and investment operations, pending the outcome of its investigations.

SuperDerivatives Gershorn believes the trader must have entered a counterparty's name for these trades into his risk management systems. "It is inconceivable that he didn't. We have made it a goal of ours to improve transparency and all aspects of risk management for the currency options market," he adds. "Clearly, such an example shows how important it is for the whole market to have a benchmark pricing system."