Herstatt Bank lost DEM 470M on FX — the bank that invented settlement risk

Bankhaus Herstatt was a small German private bank based in Cologne. Despite its modest size, the bank had built a major foreign exchange trading operation, making large speculative bets on currency movements. The bank's founder, Iwan D. Herstatt, allowed the FX desk to take positions that far exceeded the bank's capital base.

In June 1974, Herstatt had accumulated massive short positions against the US dollar, betting that the dollar would weaken. When the dollar strengthened instead, the bank's losses rapidly exceeded its capital. German regulators shut down the bank on June 26, 1974 — but only after the close of the German banking day.

The timing of the closure created chaos in international payments. Herstatt's counterparties had already paid deutsche marks to the bank in settlement of FX trades, expecting to receive US dollars later that same day. When the bank was closed, the dollars were never delivered, leaving counterparties exposed to losses of approximately $200 million.

The incident gave rise to the term 'Herstatt risk' — the risk that one party in a foreign exchange transaction pays the currency it sold but does not receive the currency it bought. This settlement risk became a fundamental concern in international banking and eventually led to the creation of CLS Bank, a system designed to eliminate settlement risk in FX trading.

The bank failed after German payments settled but before dollar deliveries, exposing $200M in losses and creating the term 'Herstatt risk' for settlement failure.

Herstatt's FX desk took speculative positions far exceeding the bank's capital, betting against the dollar in a market that moved the wrong way.

The timing of the bank's closure, after German payments had settled but before US dollar payments were due, created a settlement gap that the banking system had never planned for.

No mechanism existed in 1974 to ensure simultaneous settlement of cross-border payments, leaving Herstatt's counterparties exposed when the bank failed between the two legs of FX trades.

Herstatt Bank was small enough to fail and large enough to teach the world a lesson. The term 'Herstatt risk' still describes every settlement in international banking.