Jeremy Warner in Davos: SocGen fraud deepens crisis</B>

Already reeling from the crisis in credit markets, the banking system needed a major fraud like a hole in the head. News that a rogue trader has almost completely wiped out the profits for last year of Société Générale, prompting France's second-largest bank to seek an emergency injection of €5.5bn (£4.1bn) of new equity, has further heightened the sense of a financial system out of control and no longer able to manage its own risk.

Here in Davos, bankers are beginning to wonder what else might lie in store for their beleaguered industry. One CEO cited Mao Zedong's perversion of the English proverb: "Remember, it is always darkest just before it is totally black." In any case, few here are yet betting on an early dawn, despite the series of initiatives being launched by US policymakers to ease the crisis.

Where there's financial crisis there is invariably fraud, and in a way it is remarkable that it has taken a full six months of turmoil in the capital markets for one of this magnitude to come to light. The roots of all banking crises lie in financial excess, and in periods of excess there is nearly always deception and theft.

In point of fact, there are no direct links between the Société Générale fraud and the sub-prime mortgages meltdown at the heart of the wider banking crisis. The French bank fell victim to a rogue trader dealing outside his authority in equity index futures, not mortgage-backed securities. Yet the debacle seems symbolic of the collapse in traditional banking standards which seems to have engulfed the banking system as a whole. Even accepting that the trader was hiding his positions from his superiors, and that he learned the techniques by which he managed this charade by working in back office compliance, it beggars belief that he could have financed such a wild gamble on the equity markets without anyone noticing.

The size of the losses chalked up and the scale of the positions that Jérôme Kerviel must have been running to create such an implosion makes the antics of Nick Leeson at Barings Bank in the mid-1990s look positively pedestrian by comparison. In the case of Mr Leeson, it later transpired that the Barings hierarchy knew about the solvency rule-busting degree of capital that was being devoted to their trader's wheeler-dealing, though they had no understanding of the risks he was running.

Likewise in this case, capital would have had to be committed, and counterparties would have needed to satisfy themselves that they were dealing with bankable trades, while the build-up of such massive positions by a single player must surely have been a talking point among market professionals for weeks, and that talk should have been fed back to the Société Gé*érale hierarchy. How could oversight systems have broken down to such an extent, rival bankers are asking here.

Whatever the explanation for these failings, there can be no excuse, and though for the time being the chairman, Daniel Bouton, is being asked by his board to stay on to help sort out the mess, it can only be a matter of time before his resignation is accepted. As I say, this is a fraud apparently not directly connected to the wider crisis in the banking system. Yet it is not wholly unrelated, and it will further damage public confidence in the reliability of some of the world's largest financial institutions.

M. Kerviel's mischief also raises intriguing questions about the way policymakers are handling the credit crisis. The conspiracy theorists are out in force here to speculate on the chain of events. It is inconceivable that Société Gé*érale would not have told the European Central Bank of the difficulties it had run into. Were these warnings communicated to the US Federal Reserve, and did they contribute to the three-quarter point cut in interest rates on Tuesday?

The Fed yesterday denied any advance knowledge, but it's clear that the collapse in equity markets this week, which helped prompt the Fed's emergency rate cut, was exagerrated by SocGen's wholesale liquidation of the long positions in index futures which M. Kerviel had built up. According to rumours circulating in Davos, which SocGen will need to counter, the bank also massively shorted stock markets after learning of the fraud but before it was announced publicly.

Still, in every cloud there is a silver lining, and for London at least, it will be a relief to see Paris once more occupying its traditional position as the laughing stock of financial markets. For the British Government too, it offers the slender hope that now everyone has got something else to talk about other than Northern Rock. The tables are reversed on the schadenfreude so recently expressed by French bankers about Britain's own banking travails.