Herstatt Risk to Banks on Y2K

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Y2K Threat To Banks

-- spider (spider0@usa.net), October 01, 1999


I have seen this article posted several times, but I do not understand exactly what this is...

"The term, Newsbytes notes, derives from a single loss-making event, which occurred in 1974 after the closure of a German bank."

What does this mean, bank run or what?

-- (y2kfallback@yahoo.com), October 01, 1999.

A short explanation of what happened in 1974 can be found here:


A longer explanation of it is at:


And here's a snip from another URL:

http://www.google.com/search?q=cache:5514774&dq=cache:risk.ifci.ch/134 710.htm


The most well-known example of settlement risk is the failure of a small German bank, Bankhaus Herstatt in 1974. On 26th June 1974, the firm's banking licence was withdrawn, and it was ordered into liquidation during the banking day; but after the close of the German interbank payments system (3:30pm local time). Some of Herstatt Bank's counterparties had irrevocably paid Deutschemarks to the bank during the day but before the banking licence was withdrawn. They had done so in good faith, believing they would receive US dollars later in the same day in New York. But it was only 10:30 am in New York when Herstatt's banking business was terminated. Herstatt's New York correspondent bank suspended all outgoing US dollar payments from Herstatt's account, leaving its counterparties fully exposed to the value of the Deutschemarks they had paid the German bank earlier on in the day. 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. It is however an inappropriate term since it has materialised in other cases and under differing circumstances. The collapse of US investment bank Drexel Burnham Lambert in 1990, Bank of Credit and Commerce International the following year and Barings in 1995 are all excellent case study material for 'Herstatt' risk. The more appropriate name for 'Herstatt' risk is foreign exchange settlement or cross-currency settlement risk. The amount at risk equals the full amount of currency purchased and lasts from the time that a payment instruction (for the currency sold) can no longer be cancelled unilaterally until the time the currency purchased is received with finality (irrevocable and unconditional).


-- Linkmeister (link@librarian.edu), October 01, 1999.

You have NO idea what pandemonium is untill you have been the Trading Room of a bank, oh say Chase Manhattan when Herstatt failed.

It wasn't pretty.

-- K. Stevens (kstevens@ It's ALL going away in January.com), October 01, 1999.

At the IBM UK site that Linkmeister referenced above, there's a very interesting profile of the project undertaken by the Group of Twenty (G20) countries to address "Herstatt Risk": The CLS Bank Project

It all sounds very impressive. One problem: the CLS Bank isn't scheduled to begin operations until the third quarter of 2000.

-- Mac (sneak@lurk.hid), October 01, 1999.

[ Fair Use: For Educational/Research Purposes Only ]

Y2K Threat To Banks, By Steve Gold, Newsbytes, October 01, 1999

Research just published by International Monitoring suggests that the Y2K information technology (IT) issue - now under 90 days away - poses a massive threat to the world's banks.

Nick Gogerty, a spokesperson for the Y2K research firm, told Newsbytes that the risk potential runs into the order of trillions of dollars.

"Most large banks have addressed Y2K compliance and feel secure about their internal systems and controls. There are, however, significant Y2K threats posed to institutional banking outside of the normal operational control of banks," he said.

Gogerty said that retail threats such as deposit runs are already being handled by national central banks regulatory authorities to varying degrees. Institutional banking and trading face different threats.

The firm says that, recently, a risk analyst passed on the following anecdote from a conference for senior bankers and traders. A senior banker was explaining the benefits of his firms new risk management system. Another senior banker nodded and acknowledged the cost and sophistication of the effort. The first banker summed up his position by stating that, "Y2K is a small risk relative to the day-to-day running of the bank."

The second banker replied: "That's ironic, I've heard that Herstatt risk could be the real turd in the Y2K punchbowl."

International Monitoring said the banker's colorful phrase piqued the firm's interest. Herstatt risk, the company says, is rare - so rare, in fact, that most bankers don't know the term.

The term, Newsbytes notes, derives from a single loss-making event, which occurred in 1974 after the closure of a German bank.

The firm says that this piece of economic trivia could become relevant in the coming months, as its estimates indicate that Herstatt risk may be the most significant risk ever faced by the international banking system.

International Monitoring says that the Y2K IT issue will most likely shift many forms of institutional banking risk. The potential for financial gridlock due to Herstatt risk could involve trillions of dollars being stuck in systemic gridlock.

Unfortunately, the firm says, neither the BIS, IMF, Global 2000 Working Group, or The World Bank has a fully international coordinated response policy for such situations.

As a result of its research, International Monitoring, has released a 44-page paper highlighting five main risk areas for institutional banks. An excerpt from the paper can be found on the Web at


Post-Christmas looks to be more than interesting.

-- Ashton & Leska in Cascadia (allaha@earthlink.net), October 04, 1999.

Monday October 18, 2:34 pm Eastern Time

Company Press Release

SOURCE: Foreign Exchange Committee

Foreign Exchange Committee Issues Y2K Guidelines

NEW YORK, Oct. 18 /PRNewswire/ -- The Foreign Exchange Committee, joined by a number of international financial industry associations and committees in Australia, Canada, England, Japan, Singapore and the United States, today issued guidelines designed to minimize confusion associated with any foreign exchange contracts (including options and swaps) that fail to settle as a result of Y2K-related events that affect clearing banks or central banks.

The recommended guidelines, known as ``Y2K: Best Practice in the Foreign Exchange Market,'' include background information, the terms of the Best Practice, general notes and a statement as to how the Best Practice is to be used.

In general, the Best Practice recommends a short waiting period after a Y2K event occurs that affects a clearing bank or a central bank.

If the Y2K event is not remedied within the specified waiting period, the Best Practice states that some or all affected transactions may be liquidated at then current market prices.

Parties are, of course, free to mutually agree to take actions other than as specified in the Best Practice.

The guidelines do not apply to a failure to settle as a result of a Y2K problem within the systems of a party to a contract, which would be covered by the non-payment provision of the applicable contract.

Parties to transactions will retain the rights and remedies provided in their contractual arrangements.

In particular, the Best Practice would not change credit provisions and defaults unrelated to Y2K events.

The guidelines reflect commercially reasonable standards for market participants and provide guidance to regulators and tribunals who may be asked to consider the actions of participants in the foreign exchange market in the event of problems resulting from the millennium date change.

It is anticipated that foreign exchange market participants both inside and outside of the U.S. will use the guidelines.

The guidelines were prepared by a joint Working Group of the Financial Markets Lawyers Group and the Foreign Exchange Committee's Operations Managers Working Group.

The Foreign Exchange Committee is sponsored by, but independent of, the Federal Reserve Bank of New York.

A copy of the Best Practice is available at the Foreign Exchange Committee's website at http://www.ny.frb.org/fxc.

The Australian Financial Markets Association, The British Bankers' Association, the Canadian Foreign Exchange Committee, the Emerging Markets Traders Association, the International Swaps and Derivatives Association, Inc., and the Singapore Foreign Exchange Market Committee have joined in the issuance of this Best Practice. The Tokyo Foreign Exchange Market Committee has endorsed this Best Practice, which is currently being considered by trade associations in other countries.

SOURCE: Foreign Exchange Committee


-- Just (following@the.news), October 18, 1999.

Because we now have so many more multinational businesses than we did in 1974 the Herstatt phenomenon is really applicable to many types of commodities besides currency, and many types of businesses besides banks. After all, isn't this what Intel is talking about when they say that the supply problems caused by the earthquake in Taiwan will eventually prevent them from meeting their desired production and earnings levels? Any business that is dependent upon the infrastructure of a foreign country is going to assume a much higher risk factor than a business operating exclusively within the U.S.

-- @ (@@@.@), October 18, 1999.

Thursday October 21, 4:48 am Eastern Time

ISDA to make no recommendation on Y2K grace period

TOKYO, Oct 21 (Reuters) - The International Swap and Derivatives Association (ISDA) has decided not to make any recommendation regarding the adoption of a grace period to pursue any payment or settlement problems due to Y2K issues, a senior ISDA official said on Thursday.

``We've concluded that we will not be making any recommendations with respect to grace periods...the feeling being that we are largely well prepared (for Y2K),'' said Richard E. Grove, ISDA executive director and CEO.

Grove was speaking at a news briefing in Tokyo held by the ISDA, the industry body for the multi-billion dollar over-the- counter derivatives market. In September, ISDA said it may recommend that its members apply a three-day waiting period to enforce failure to pay or default arising from Y2K computer glitches. The Y2K or millennium bug may affect computers which are not programmed to recognise the switch to the 2000 date, causing malfunctions and problems with electronic money transfers and other data transactions.

Separately, ISDA officials said the body would announce a decision next March on whether to make the exercise of certain in-the-money options contracts automatic, even if the holder of the option does not actually exercise it.

The practice of making the exercise of in-the-money options automatic is already being used in currency options trading.

But there is debate about whether such a practice should also be adopted for over-the-counter (OTC) interest rate options such as OTC swaptions, the officials said. ``It's a question of whether options which are expired in-the- money should be deemed automatically exercised, if it were a profitable option,'' said ISDA chairman Mark Harding.

Such a change may be adopted in order to avoid problems arising from cases in which holders of profitable options contracts forget to exercise them, Harding said.

ISDA officials said the key issue is determining the ``threshold'' levels at which in-the-money options should be considered automatically exercised.

``There is a consensus that at some point, the exercise should be automatic. The real discussion is how close to the strike (price) would you have the exercise (made automatic),'' Grove said.

Even if an option contract is in the money, if the underlying financial instrument is hovering near the strike price of the option, it may not be clear whether exercising that option would be desirable for the owner. ``In all likelihood, there would be some threshold where exercise would be needed to be done manually,'' Grove said.


-- Just (following@the.news), October 22, 1999.

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