Herstatt Bank collapsed on currency bets — and created 'Herstatt risk'

Bankhaus Herstatt was founded in Cologne in 1955 by Ivan David Herstatt, backed by industrialists Herbert Quandt and Hans Gerling. It grew rapidly through aggressive foreign-exchange trading, and by 1973 it was the 35th largest bank in Germany with over DM2 billion in assets. But its capital base was only DM44 million — a fraction of what it was betting.

In 1973–1974, the Bretton Woods system collapsed and currencies became wildly volatile. Herstatt's traders bet heavily that the US dollar would strengthen. Instead, the dollar plummeted. By June 1974, the bank had accumulated DM470 million in foreign-exchange losses — more than ten times its capital. The losses were catastrophic relative to the bank's size, but the true disaster was the timing of the collapse.

On June 26, 1974, German banking regulators shut Herstatt down at 16:30 local time — 10:30 AM in New York. Several counterparty banks had already paid Deutsche Marks to Herstatt in Frankfurt in exchange for US dollars that were due to arrive in New York later that day. Herstatt was closed before it could deliver the dollars, leaving those banks holding the wrong side of the trade. The term 'Herstatt risk' — settlement risk in foreign-exchange transactions — entered the banking lexicon, and the event spurred the creation of the Basel Committee on Banking Supervision.

Regulators closed it mid-settlement, after counterparties paid marks but before dollars arrived, creating Herstatt risk and the Basel Committee.

Herstatt's traders made a massive one-way bet that the dollar would strengthen against the mark. When the dollar fell instead, the bank lost DM470M — over ten times its capital.

The bank was dangerously undercapitalised for its trading volume. With only DM44M in capital against DM2B in assets, a single wrong bet wiped it out completely.

The timing of the shutdown — after European markets closed but before US markets did — created settlement risk for counterparties that had already paid Herstatt in marks but had not received dollars.

A bank that bets more than its capital on a single market direction is not a bank — it is a gamble. Herstatt's DM470M in losses on DM44M of capital destroyed the bank and created a new risk category.