Herstatt Risk: The 1974 Failure That Reshaped Currency Settlement

[Shadow Trader]

Herstatt risk takes its name from Bankhaus Herstatt, a German bank closed by regulators in June 1974 during the business day. Several counterparties had already paid deutsche marks to the bank earlier in Frankfurt, expecting dollars to arrive later in New York. Because of the time zone gap, the dollars never came.

The episode showed that currency trades have a particular weakness. Two payments occur in different places and at different times, so one party can be fully paid out while the other is still waiting. The loss is the whole principal amount, not merely a small market movement.

Time zones still matter. Asian currencies often settle many hours before dollar payments, which is precisely the type of gap that exposed Herstatt counterparties. The industry response included bilateral netting, central bank oversight and, later, payment versus payment settlement.

For market participants the history explains several modern features, from settlement cutoffs to credit limits set by liquidity providers. It also illustrates a broader principle: price risk and settlement risk are different. A trader can manage the first with position sizing, while the second belongs to the infrastructure and the institutions that sit behind the screen.