Herstatt Risk: The 1974 Bank Collapse That Changed Forex Settlement

Herstatt risk, also called settlement risk, is the danger that you pay your side of a currency trade but never receive the other side, because the counterparty fails in between. It is named after Bankhaus Herstatt, a private bank in Cologne that German regulators closed on 26 June 1974.

Banks that had paid Deutsche Marks to Herstatt in Germany that day were still waiting for the dollars due to them in New York when the bank was shut. Those dollars never came.

The collapse was small by today's standards, but it changed how the global currency market is supervised and settled, and its name is still used by central banks fifty years later.

What went wrong at Herstatt

After floating exchange rates arrived in 1973, many banks expanded into currency trading, and Herstatt bet heavily on the dollar. Those bets went wrong. Its foreign exchange losses grew to about 470 million marks, according to widely cited accounts, against capital of around 44 million marks. When the scale became clear, Germany's banking supervisor withdrew its licence and closed it.

The timing turned a bank failure into a market crisis. Regulators closed it in the afternoon, German time, after it had received Deutsche Mark payments from counterparties in Germany. But before New York had opened for the day, when it would have paid out the dollars it owed in return.

How the time-zone gap works

Every currency is settled through its home country's payment system during that country's business hours. A trade of marks for dollars meant two separate payments in two places at different times. For several hours each day, a bank that had already paid its side was fully exposed to the other bank failing before paying theirs. Herstatt showed that this was not a theoretical risk.

The shock spread. Banks became wary of paying anyone before receiving payment, settlement slowed, and New York's payment system was disrupted for days. A Bank of England blog drawing on its archives describes how quickly the damage travelled between financial centres.

What regulators did next

At the end of 1974 the central bank governors of the G10 countries set up a committee on banking supervision, based at the Bank for International Settlements in Basel. Today it is the Basel Committee on Banking Supervision, which writes the international capital rules for banks. Herstatt, along with the failure of Franklin National Bank in the US the same year, was a direct cause.

The deeper fix took much longer. In 2002 banks launched CLS, a specialist system that settles both sides of a currency trade at the same moment, a method called payment-versus-payment (PvP). If one side does not pay, neither side's payment goes through, so the Herstatt gap disappears.

Herstatt was not alone in 1974

The mid-1970s were a dangerous time for banks learning to trade floating currencies. In the same year, Franklin National Bank in New York, then one of the largest banks in the US, collapsed after heavy foreign exchange losses and other problems. Lloyds Bank's branch in Lugano, Switzerland, also reported large currency losses from unauthorised trading in 1974. Supervisors realised that many banks had built big currency positions without the systems or capital to manage them.

Those failures pushed regulators to require proper limits on open currency positions, regular reporting of exposures, and cooperation between countries' supervisors. A bank in one country could now fail because of trades settled in another, so no single regulator could see every exposure. International cooperation, organised through the BIS in Basel, became the answer, and it remains the model today.

Is Herstatt risk gone?

Not completely. The Bank for International Settlements' 2025 survey found that only about 36% of average daily currency settlement went through PvP arrangements that remove the risk. Much of the rest used methods that reduce it, such as netting trades between the same banks. But some trades, particularly in currencies that CLS does not cover, are still settled the old way.

Central banks keep pushing for wider use of PvP, especially as trading in emerging-market currencies grows. The topic sounds technical, but it is about whether money promised is money received.

Does settlement risk affect retail traders?

Not directly. When you trade with a retail broker, you are not exchanging currencies with another bank; you hold a contract with your broker, and profits and losses are settled in your account currency. Your main counterparty risk is the broker itself, which is why regulation and segregated client money matter. The lesson carries over: always know who holds your money and what happens if they fail. Our guide to choosing a forex broker covers the checks.

Lessons

• Counterparty risk is real. A trade is only as good as the firm on the other side of it.
• Timing creates exposure. Any gap between paying and receiving is a window for loss.
• Small failures can spread. Herstatt was a modest bank, yet it disrupted payments worldwide.
• Regulation follows crises. Many of today's rules exist because something like Herstatt went wrong first.

Frequently asked

Related reading

• The history of forex
• The Nixon Shock of 1971
• How to identify the best forex broker
• Types of forex accounts