Herstatt Bank

Herstatt Bank was a privately owned bank in the German city of Cologne. It went bankrupt on 26 June 1974 in a famous incident illustrating settlement risk in international finance.

It led to the creating of the Basel Committee on Banking Supervision a committee comprises representatives from central banks and regulatory authorities to help find ways to avoid such risks in future.^[1]

History

On 26 June 1974, German regulators forced the troubled Bank Herstatt into liquidation. That day, a number of banks had released payment of Deutsche Marks (DEM) to Herstatt in Frankfurt in exchange for US Dollars (USD) that were to be delivered in New York. Because of time zone differences, Herstatt ceased operations between the times of the respective payments. The counterparty banks did not receive their USD payments.

Responding to the cross-jurisdictional implications of the Herstatt debacle, the G-10 countries (the G-10 is actually eleven countries: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States), Luxembourg and Spain formed a standing committee under the auspices of the Bank for International Settlements (BIS). Called the Basel Committee on Banking Supervision, the committee comprises representatives from central banks and regulatory authorities. This type of settlement risk, in which one party in a foreign exchange trade pays out the currency it sold but does not receive the currency it bought, is sometimes called Herstatt risk.

The failure of Herstatt Bank was a key factor that led to the worldwide implementation of real-time gross settlement (RTGS)systems, which ensure that payments between one bank and another are executed in real-time and are considered final. The work on these issues was coordinated by the Basel Committee on Banking Supervision under the Bank for International Settlements.

The continuous linked settlement platform (CLS), was launched almost 30 years later in 2002. This payment versus payment (PVP) process enables member banks to trade foreign currencies without assuming the settlement risk associated with the process, whereby a counterparty could fail before delivering their leg of the transaction.

References