English Historical Review Vol. CXXIX No.

540 Advance Access publication September 26, 2014

© The Author 2014. Published by Oxford University Press. doi:10.1093/ehr/ceu261
This is an Open Access article distributed under the terms of the Creative Commons Attribution
License ([Link] which permits unrestricted reuse, distribution,
and reproduction in any medium, provided the original work is properly cited.

Summer in the City: Banking Failures of 1974

and the Development of International Banking
Supervision*

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Since the global financial crisis of 2008, there have been a multitude
of efforts to enhance prudential supervision and regulation of the
international financial system. This has progressed across a confusion
of national, international and supranational authorities, many of
which date back to the 1970s, such as the Basel Committee on Banking
Supervision. This article draws on the archives of banks and regulators
in order to explore how the architecture of international banking
supervision was developed in response to a series of banking scandals
in the summer of 1974. This new evidence shows the reluctance which
the British authorities displayed in coming to terms with new risks in
the global banking system, and the influence this approach had on the
operations of the Basel Committee from its origins in 1975.
The relationship between regulators and the regulated in financial
services has attracted considerable academic attention, partly because
banking systems operate differently from other markets.1 The systemic
macroeconomic importance of national banking systems makes
a strong case for prudential supervision by an outside body, but
information asymmetry in financial services and the importance of
reputation and private information as key bank assets all complicate the
ability to engage in transparent prudential supervision. In particular,
the potential for so-called regulatory capture—whereby regulators are
heavily influenced by bankers acting in their own interest—is especially
strong between central banks and the banking system because of the
close connections that are required to supervise complex financial
transactions where highly specialised knowledge is needed for the
identification and diagnosis of problems.2 In many financial markets
the complexity of transactions and speed of innovation has also led to
the development of forms of self-regulation through industry standards
or professional codes.3 A further incentive for self-regulation lies in the
* Research was funded by the Economic and Social Research Council, RES-062-23-2423. I am
grateful also for the assistance of Dr Emmanuel Mourlon-Druol.
1. J.R. Barth, G. Caprio and R. Levine, Rethinking Bank Regulation: Till Angels Govern
(Cambridge, 2006); M. Dewatripont, J.C. Rochet and J. Tirole, Balancing the Banks: Global
Lessons from the Financical Crisis (Princeton, NJ, 2010).
2. Staff involved in prudential supervision may have inferior understanding to that of those
employed in banks themselves, partly because the salaries in supervisory institutions are lower
than in banks: E. Ribakova, ‘Liberalization, Prudential Supervision and Capital Requirements:
The Policy Trade-Offs’, I[nternational] M[onetary] F[und] Working Paper, WP/05/136, July 2005.
3. For example, the self-regulation of stock markets and foreign exchange brokers. The importance
of self-regulation was highlighted in the Report of the Committee to Review the Functioning of Financial
Institutions [the Wilson Committee], British Parliamentary Papers 1980, Cmnd. 7937, pp. 288–98.
EHR, CXXIX. 540 (October 2014)
1130 Summer in the City
vulnerability of otherwise sound banks to rogue business conducted
by a small number of institutions; therefore it is in the interests of
well-managed banks to ensure that others operate to the same high
standards. In this way, systemic vulnerability increases incentives for
market leaders to impose discipline. Finally, trust is an important
component of the structures required to ensure compliance, since the

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information necessary for prudential supervision often incorporates
market-sensitive data, and the private information contained in
investment portfolios and strategies is a valuable asset for banks. For
all of these reasons, the relationship between banks and supervisors or
regulators is complex and prone to failures.
These difficulties inherent in prudential supervision are magnified
on the international level. Because national banking systems are
fundamental to macroeconomic policy, their supervision is a jealously
guarded prerogative of national regulators. However, the highly
integrated nature of national banking systems and their vulnerability
to cross-border contagion in the context of globalised financial markets
provides a strong rationale for some form of multilateral oversight.
Moreover, because rules incur costs for banks, they need to be coordinated
to avoid regulatory competition which would leave the global system
vulnerable by eroding the competitiveness of those jurisdictions where
banks are subject to effective (but costly) supervision and regulation.
Shortcomings in international prudential supervision were an
important factor in causing the turbulence which occurred in the
international banking markets of the 1970s. From 1968 to 1973, a range
of factors contributed to the growth and intensification of international
banking: greater international liquidity, innovations in the Eurodollar
market, deregulation of capital flows, technological advances in
information systems, the rise of new offshore financial centres, and rapid
internationalisation of banks with a consequent variety of governance
structures (including branches, subsidiaries, cross-shareholding and
bank consortia). The volatile environment created by these changes
was exacerbated by the sharp increase in the price of oil introduced by
the Organisation of the Petroleum Exporting Countries (OPEC) in
October 1973, only six months after the US dollar exchange rate had
been floated for the first time in forty years. This prompted a quick
reversal of the market exuberance that had been evident before the
third quarter of 1973, leaving many institutions exposed to liquidity
shocks and sudden fluctuations in the dollar exchange rate.
This article examines how a series of bank failures in the summer of
1974 affected longer term trends in international banking supervision.
In the end, the total losses attributable to bank failures were relatively
small, the systemic effects were limited and the ensuing credit
contraction was short-lived, but the episode had a durable impact on
international banking regulation. It provided a warning to national
regulators and prompted the amendment of legislation and procedures
EHR, CXXIX. 540 (October 2014)
 B a n k i n g Fa i lu r e s o f 1 974 1131
to close gaps in national banking supervision. At the international
level, Group of Ten (G10) central bankers responded by launching the
Basel Committee on Banking Supervision at the beginning of 1975.4
While the collapse of the Bankhaus Herstatt has been widely regarded
as having prompted the launch of the Basel Committee, new archival
evidence shows that the Committee was unable to produce a plan to

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address the specific causes of the Herstatt collapse and turned instead
to addressing the causes of other banking scandals.
The first section of this article sets out the economic and policy
environment for the events of 1974. The following sections explore
three important episodes of banking failures: the collapse of
Bankhaus Herstatt, the Lloyds Lugano rogue trading scandal and
the failure of the Israel-British Bank. Each of these case studies
highlights wider international supervisory and regulatory challenges
which lay at the core of the fragility of the banking system in the
1970s, and which shaped the later evolution of the international
financial system.

The most important systemic shock of the early 1970s was the end
of the pegged exchange rate system established at the Bretton Woods
conference in 1944. Assumptions about the importance of stable
exchange rates for the smooth running of the international monetary
system had the consequence that from 1945 to 1973 most countries
pegged the value of their currency in terms of the US dollar with
infrequent adjustments. In the wake of speculative capital flows in
the summer of 1971, the gold value of the dollar came under pressure
and convertibility was temporarily suspended in August before a
general realignment of exchange rates was arranged at the Smithsonian
conference of December 1971. The new framework was short-lived; in
June 1972 sterling floated and from then on confidence in the value
of the dollar evaporated. By March 1973 the Japanese Yen and most
of the European currencies were also floating against the US dollar.
Twenty-five years of relatively stable exchange rates had come to an
end, and global financial markets entered a new era of exchange rate
risk operated by traders with no experience of such a system.
A second institutional change for Britain was the introduction of
Competition and Credit Control in London in September 1971, which
was designed to free up competition in the British banking system and
introduce a more market-based monetary policy using interest rates,
reserve ratios and special deposits rather than direct controls on bank
4. The Group of Ten at this time included representatives from Belgium, Canada, France,
Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the
United States. The governors of their central banks formed the core governing body for the Bank
for International Settlements.

EHR, CXXIX. 540 (October 2014)

1132 Summer in the City
lending. The consequence was a rapid increase in liquidity and the
5

beginning of a property lending boom as exchange rates became more

volatile. In the USA the dollar was allowed to float downward from
March 1973, falling from DM2.97/$ to DM2.30/$ between February
and July. There followed a sharp reversal with the onset of the OPEC
oil crisis in October 1973 and tighter monetary policy in the USA, so by

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early February 1974 the dollar was back to DM2.76.
The contraction in liquidity broke the UK property boom in the
autumn of 1973 leaving the so-called ‘fringe banking’ sector in the
City of London illiquid.6 London money-market rates rose sharply in
February 1974, from less than 0.5% to almost 2.5%, and then soared
to 6% in June. These banks were vulnerable through imprudent
property lending during the boom based on short-term money-market
borrowing.7 Many of the institutions caught out were less experienced
hire-purchase companies that had diversified into property lending,
but Britain’s large clearing banks were drawn into the resolution of the
crisis through the now famous ‘lifeboat’ scheme directed by the Bank
of England. Fears that the public would confuse the ‘fringe’ wholesale
market with the retail deposit banks prompted a coordinated response
from the large commercial banks, led by the Bank of England. The
perceived self-interest of other banks in preventing a general banking
crisis involved them in a range of solutions to forestall a wider panic.
Operation ‘Lifeboat’ is usually viewed as a success insofar as there was
no contagion to the domestic retail market and the UK avoided the
liquidity and monetary consequences of a run on the banks. More
generally, however, the crisis drew the Bank of England into a structured
bail-out scheme with considerable risk that tied up its resources just
at the time of shocks to the international banking system. Moreover,
the crisis had the broader consequence that the Bank of England
found itself being criticised for its use of public resources to rescue
imprudent banks.
The secondary banking crisis in London in 1974 showed that the
domestic system was vulnerable to lax supervision, highly leveraged real-
estate lending and imprudent trading, but the international banking
environment faced even more severe challenges. From the late 1950s,
the offshore Eurodollar market in London had provided unsupervised
opportunities for a range of financial institutions which drew a huge
number of new actors into the market. The internationalisation of
banking accelerated rapidly from the late 1960s onwards in response
to the increased demand for services by multinational enterprises,

5. See F. Capie, The Bank of England: 1950s to 1979 (Cambridge, 2010), pp. 500–07.
6. M. Reid, The Secondary Banking Crisis, 1973–75: Its Causes and Course (London, 1982).
For a recent archive-based account of the secondary banking crisis in London, see Capie, Bank of
England, pp. 524–86.
7. This crisis was echoed in the causes of the failure of Northern Rock in 2007, where low-
interest, high-risk mortgages had been funded through wholesale borrowing.

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1133
financial and IT innovation and the differences between the regulatory
environments in international banking centres.8 American banks were
the most aggressive in international markets. By 1974, 125 US banks
had overseas branches compared with only 43 five years before, and the
assets of these overseas branches had risen from 6% to 14% of the total
assets of US commercial banks.9

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In addition to the expansion of banks into established financial
centres in Europe, new offshore centres such as Guernsey, Nassau and
later the Cayman Islands attracted opportunistic companies seeking
to evade supervisors. After a scandal over the Bank of Sark (a vehicle
for the American fraudster, Philip M. Wilson), Guernsey introduced
legislation to set constraints on companies establishing themselves as
‘banks’ in the late 1960s so that only companies clearly associated with
well-known and reputable banking, insurance or trust companies could
engage in banking. In this case, reputation was used to short-circuit
the expensive prudential vetting of applicants. These gestures did not,
however, prevent the proliferation of new banking ventures of uncertain
reliability. In early 1972, a rush of financial institutions registered in
Tortola in the British Virgin Islands, several of which appeared to have
weak or even fraudulent foundations. One of the most prominent of
these was the Inter-Cambio International SA registered in Panama
with links to the Sovereign Trust Company registered in Prince Edward
Island, and under the surveillance of the Canadian authorities.10 Some
of these offshore tax havens still have a reputation for encouraging illicit
behaviour; however, the main casualties of illegal trading in the 1970s
were banks in the large US and European financial centres.11
The events of the summer of 1974 did not develop into a banking
crisis as defined, for example, by extensive and prolonged bank runs
such as those which took place during the 1930s.12 But the underlying
conditions at the time were similar to those which prevailed during
previous crises: asset markets boomed and crashed, interest rates rose

8. J. Kelly, Bankers and Borders: The Case of American Banks in Britain (Cambridge, MA,
1977); S. Battilossi, ‘Banking with Multinationals: British Clearing Banks and the Euromarkets’
Challenge, 1958–76’, in S. Battilossi and Y. Cassis, eds., European Banks and the American
Challenge: Competition and Cooperation in International Banking under Bretton Woods (Oxford,
2002), pp. 103–34; R. Roberts (with C. Arnander), Take Your Partners: Orion, the Consortium
Banks and the Transformation of the Euromarkets (London, 2001).
9. J. Spero, The Failure of the Franklin National Bank (New York, 1980), pp. 18–19.
10. T[he] N[ational] A[rchives], T 236/1529, N.L. Wicks, H[er] M[ajesty’s]T[reasury], to A.R.
Powell, F[oreign and] C[ommonwealth] O[ffice], 29 Mar. 1972, passing on intelligence from a
private investigator, Stuart Allen.
11. See, for example, R. Palan, R. Murphy and C. Chavagneux, Tax Havens: How Globalization
Really Works (Ithaca, NY, 2011).
12. A. Demirguc-Kunt and E. Detrigiache, ‘The Determinants of Banking Crises: Evidence
from Industrial and Developing Countries’, World Bank/IMF Policy Research Working Paper
No. 1828, (Washington, DC, 1997). The international crisis does not appear among most lists
of banking crises, although the domestic secondary banking crisis in London does: see, for
example, C.M. Reinhart and K.S. Rogoff, This Time is Different: Eight Centuries of Financial
Folly (Princeton, NJ, 2009).

EHR, CXXIX. 540 (October 2014)

1134 Summer in the City
sharply, and exchange markets fluctuated wildly. In all of the three
cases discussed below there were common themes: banks were caught
out by imprudent speculation on the foreign exchange market, they
were subject to a tightening of international interest rates and liquidity,
and they were all to some extent the victims of illegal or fraudulent
behaviour. Moreover, all three cases were used as justification for the

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establishment of the Basel Committee on Banking Supervision in 1975
and were discussed at its initial meetings. These cases revealed the
vulnerability of supervisors to fraud through false reporting and the
lack of procedures for external corroboration of such reports.

II

The I.W. Herstatt Bankhaus in Germany was the most famous victim
of the summer, with liabilities of $840 million set against assets of $380
million.13 The Herstatt bank was majority owned by Hans Gerling
(who held 81.4% of the shares) had more than 50,000 customers and
was among the top eighty largest banks in Germany.14 Rumours about
overtrading began in the summer of 1973, a year before the final collapse,
but the German Supervisory Office (Bundesaufsichtsamt für das
Kreditwesen, or BaKred) did not require reports of forward exchange
commitments; therefore the bank’s positions were not visible to the
relevant national supervisor. The Bank of England claimed credit for
warning the German authorities of the bank’s over-trading in foreign
exchange, after which Iwan Herstatt (the founder of the eponymous
bank) was questioned, but successfully reassured the supervisors that ‘all
was in order’. The German authorities sought further such assurances
in the autumn of 1973 and again in December.15 Bankhaus Herstatt
also attracted the attention of the Bank of England in the autumn of
1973 when Richard Hallett spoke to Iwan Herstatt about over-trading
and excess positions in the Eurodollar market.16 Herstatt’s explanation
to the German authorities was that although there was a large forward
book of foreign exchange commitments, this was ‘because they had
very important Ruhr customers who had entered into large forward
contracts with the Bank, which the Bank, in turn, had covered in the
market. Consequently, their forward book, though large did not leave
them with exposed positions’.17 But no evidence was produced for
the cover.
13. J.W. Markham, A Financial History of the United States (3 vols., Armonk, NY, 2002), ii. 20.
14. A. Busch, Banking Regulation and Globalization (Oxford, 2009), p. 100.
15. London, B[ank] o[f ] E[ngland Archives], 394A/2, Memo of 26 June 1974, and J.L. Sangster,
Memo of Gold and Foreign Exchange Meeting, Basel, 11 July 1974, admitted by Tungeler of
Bundesbank.
16. BoE, 394A/2, Memo of 26 June 1974. The London representative was Ditmar Gebhard.
17. BoE, 394A/2, Memo for Sir Christopher McMahon (Executive Director, Bank of
England) and Governor’s Private Secretary, 4 July 1974. Account of discussion with Stauch of
Bundesaufsichtsamt für das Kreditwesen.

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1135
In mid-February 1974, Stauch of BaKred wrote to Herstatt’s auditors
requesting a close examination of the forward book and they gave
Herstatt a clean bill of health at the end of March.18 BaKred was
reassured, until returns at the end of April showed that the Cologne
parent of Herstatt had greatly increased its claims on a Luxembourg
subsidiary, bringing them to nearly one billion DM. BaKred told

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Gerling (the principal shareholder) to investigate, and he wrote to Iwan
Herstatt in early May 1974 asking for an explanation. This was not
forthcoming until the end of the month when Herstatt gave a further
reassurance that all was in order. Gerling was not satisfied; the full
position was clarified only in the third week of June 1974 when reports
revealed the bank had suffered DM470 million in losses against capital
and had reserves of only DM44 million, though the actual losses were
much higher.
After years of investigation and several trials, a number of the eight
defendants in the case were convicted of fraud in August 1983 and
sentenced to a mixture of fines and prison terms for illegally concealing
their losses. In total, five dealers and officers of the bank were convicted,
of whom one received a suspended sentence. Herstatt himself was
convicted in 1984 and sentenced to four and a half years in prison but
he appealed and was finally given a two-year suspended sentence for
breach of trust in 1987.
Herstatt’s losses arose from short positions (mainly against the US
dollar) in forward contracts ranging up to four years, but most of which
fell due within the next twelve months.19 In common with other banks,
Herstatt was heavily involved in the foreign exchange market and it had
accumulated significant losses as the US dollar exchange rate fluctuated
wildly from the last quarter of 1973 onwards.20 At meetings with
BaKred, the Landeszentralbank in Dusseldorf, and the three largest
German banks (Deutschebank, Commerzbank and Dresdnerbank)
Gerling offered to pay off the loss himself over 15 years, but the banks
were not convinced that the total losses had yet been determined
and would not agree to act as a guarantor for Gerling for such a long
period. Moreover, Gerling’s personal wealth depended on a range of
‘closed companies’ that were not fully transparent themselves. In the
afternoon of 26 June, Gerling withdrew his personal undertaking and
BaKred ‘put up Herstatt’s shutters’.21 Despite the chaos caused in the

18. The Basel Committee’s own account of the Herstatt collapse is inaccurate with regard to the
timing of the initial Federal Banking Supervisory Office’s investigation, stating that it only became
involved in March 1974: Basel Committee on Banking Supervision, ‘Bank Failures in Mature
Economies’, BCBS Working Paper No. 13 (Basel, Apr. 2004).
19. BoE, 394A/2, J.L. Sangster, Memo of Gold and Foreign Exchange Meeting, Basel, 11 July
1974.
20. K.H. Nadelmann, ‘Rehabilitating International Bankruptcy Law: Lessons Taught by
Herstatt and Company’, New York University Law Review, lii (Apr. 1977), pp. 1–35.
21. BoE, 394A/2, Memo for McMahon and Governor’s Private Secretary, 4 July 1974. Account
of discussion with Stauch of Bundesaufsichtsamt für das Kreditwesen.

EHR, CXXIX. 540 (October 2014)

1136 Summer in the City
international financial markets by closing the bank while the New York
market was still open, the Bundesbank said the decision was not their
responsibility and was in accordance with the law. Once BaKred was
persuaded that the bank could not be rescued, they were legally bound
to close it immediately at close of business in Germany.
The Herstatt bank was closed at 16:30 local time or 10:30 New York

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time, having taken on claims in European time but not yet making
US dollar transfers to counterparties in New York time, leaving the
correspondent banks out of pocket. This gave rise to the term ‘Herstatt
Risk’ to describe the risk of settling foreign exchange transactions across
time-zones. Fears about further collapses led to the suspension of the
Clearing House Interbank Payments System (CHIPS) and contracted
the efficiency of interbank settlement for months afterward.22 In
addition, the Herstatt failure prompted withdrawals from commercial
banks in Germany, a sharp increase in Eurodollar market interest rates,
and a contraction in international banking activity as banks around the
world repatriated their assets.23
While Herstatt was a relatively small institution, the systemic effects
of its collapse were significant because of the damage it caused to trust
in inter-bank relations. This lapse in trust arose both from the evident
fraud engaged in by Herstatt traders and also from the German official
response, which did not take into account the interests of Herstatt’s
international creditors. Trust thus broke down among bankers, between
bankers and regulators, and among regulators. In the aftermath of
the bank collapse, the Governor of the Bank of England urged Denis
Healey, the new Chancellor of the Exchequer, to discourage the German
Chancellor Helmut Schmidt from making any derogatory remarks
about the Eurocurrency markets that might exacerbate their unsettled
state and to tell him that ‘any future troubles in the German banking
system should be handled in such a way as not to unsettle international
markets’.24 Confidence in smaller and lesser-known banks eroded with
the consequence that they had to raise interest rates in order to attract
deposits, thus ‘bidding the market up’.25 Japanese banks in London in
particular were instructed in mid-July 1974 not to pay a premium for
Eurodollar deposits in an attempt to try to contain the rate inflation.26
This crisis therefore exposed conflict between jurisdictions and drew
central banks into the market to ameliorate the effects on liquidity.
As trust eroded, small banks were squeezed out of foreign exchange
business and the Bank of England offered to provide liquidity. Slater
Walker, for example, complained to the Bank of England that they

22. CHIPS was set up in April 1970 by nine leading US banks and came to dominate
international settlements in US dollars.
23. Busch, Banking Regulation and Globalization, p. 100.
24. BoE, 349A/2, Governor’s Brief for Chancellor of the Exchequer, 17 July 1974.
25. Ibid.
26. BoE, 394A/2, Memo from Dealing Room, 18 July 1974.

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1137
might be forced into temporary default because of the difficulties they
were experiencing in getting into the market. The Bank of England
generously offered to help through the Discount Office if necessary,
and this support was subsequently offered to other banks which
encountered similar problems.27 Charterhouse Japhet, for example,
found itself squeezed out of the foreign exchange market, removed from

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dealing lists, or its limits reduced.28 The head of the bank, M.H.W.
Wells asked George Blunden (the head of supervision at the Bank of
England) to reassure markets by providing ‘clear evidence to the banking
community that we [Bank of England] are looking more closely at
banks’ business and examining their figures more frequently’. Wells
evidently viewed enhanced supervision as an important calming force
for the market: a way to enhance the credibility of smaller institutions
and restore lost trust.29 Blunden replied asking for a quid pro quo of
market intelligence, noting that reassurance on procedures would be
forthcoming ‘in the next month or two’ and ‘asked him [Wells] to
ensure that if, when we asked for more information, there was resistance
from other Accepting Houses, he would ensure that in the Committee
Japhets supported our request. He promised to do this.’ This exchange
emphasises the informal channels of market intelligence between the
Bank of England and the City, and the symbiotic relationship between
trust and transparency.
The Bank of England had long had close personal relations with
the main banks in London and their supervision model relied on
mutual trust: they trusted bankers to act in the market’s best interest
and operated a light personal touch in the supervision of operations.30
Capie has noted that supervision was not a prominent focus of the
Bank of England’s activities and that the Radcliffe Committee Report
of 1957 expressly confirmed that there ‘was no formal control over other
banks and no duty of inspection’, with the Discount Office gathering
informal information, opinions and gossip through its interactions with
the market.31 However, Kynaston has shown that in the City during
the 1940s and 1950s, ‘everyone who mattered knew almost everyone
else who did’32 and that this personal knowledge underpinned trust
among bankers and also between the Bank of England and the City.
The Governor of the Bank of England claimed in 1957 that ‘if I want to
27. BoE, 304A/2, Memo by J.L. Sangster, for Hallett and McMahon, 18 July 1974. Slater
Walker was later involved in a scandal of its own and had to be rescued by the Bank of England in
1977: Capie, Bank of England, pp. 556–64.
28. BoE, 394A/2, George Blunden, Note for the Record, 25 July 1974.
29. Regulation can substitute for or complement trust in financial markets: B.I. Carlin,
F. Dorobantu and S. Viswanathan, ‘Public Trust, the Law, and Financial Investment’, Journal
of Financial Economics, xcii (2009), pp. 321–41.
30. C.R. Schenk, ‘The New City and the State, 1959–1971’, in R. Michie, ed., The British
Government and the City of London in the Twentieth Century (Cambridge, 2004), pp. 322–39.
31. Capie, Bank of England, pp. 589–90. See also D. Kynaston, The City of London, IV: A Club
No More, 1945–2000 (London, 2001).
32. Kynaston, City of London, p. 203.

EHR, CXXIX. 540 (October 2014)

1138 Summer in the City
talk to representatives of British banks … we can usually get together
in one room in about half-an-hour’.33 Conversely, Burn has detailed the
movement of senior Bank of England personnel into merchant banks
on retirement from the Bank in the 1950s and 1960s and the role of the
Bank as a ‘praetorian guard’ to the City, defending its interests even
where they may have conflicted with the public interest.34 In the new

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environment from the late 1960s onwards of globalising capital markets
with many new entrants, this informal supervisory model was no longer
adequate, but it took some time for more formal arrangements to be
introduced.
Erosion of trust also affected international clearing between
banks. A week after Herstatt was closed, clearing banks in New York
introduced a ‘recall’ provision on 1 July 1974, whereby they reserved
the right to recall funds transferred to correspondent banks up to 10:00
on the day following issue. The amount of foreign clearing in New
York had reached about $60 billion per day, leaving a large exposure.
At first the New York banks delayed transfers until they were matched
by in-payments but this almost brought the clearing process to a halt,
with the consequence that it had to be extended until 01:00 on three
consecutive days.35 The number of recalls was low (two or three per
day, mainly on account of small banks) but the Committee of London
Clearing Bankers protested that the new provisions led to damaging
uncertainty in London.36 Swiss and Dutch bankers were also vociferous
objectors, but London was the world’s second largest international
clearer, so the impact was greatest there. In effect the new procedure
meant that international payments conducted through the electronic
CHIPS did not become final until the business day following the date
on which the payment order was released. The recall provisions were
finally lifted on 4 November 1974. But what became clear during the
Herstatt failure was that the banking system had become inter-linked in
complex ways that spread vulnerability and that this was enhanced by
the innovation of electronic settlement, which speeded up irreversible
transfers with an underlying assumption that all members were reliable
partners.
Most London banks were unscathed directly by the Herstatt collapse
and the principal arena for creditors was New York. Table 1 demonstrates
that Moscow Norodny Bank had the largest notional losses, but it
appeared to suffer no ill effects since it was backed by its owners, the
Russian Central Bank. Hill Samuel in London complained bitterly
about their $21 million losses and tried through the German embassy

33. Kynaston, City of London, pp. 205–6.

34. G. Burn, The Re-Emergence of Global Finance (Basingstoke, 2006), pp. 103–4.
35. BoE, 394A/2, Memo of BIS Gold and Foreign Exchange Committee meeting at BIS, 10
July 1974.
36. BoE, 394A/2, Minutes of meeting of the London Foreign Exchange Sub-Committee, 12
July 1974.

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1139
Table 1. Losses of Banks in London due to Herstatt Bankhaus collapse
(USD million)
Williams and Glyn’s $9m deposit
Chase Manhattan $5m swap
Moscow Norodny $365m swaps

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Union Bank of Switzerland $25m swap
Hill Samuel $21m swap
United Bank of Kuwait $190m swap
First Wisconsin National Bank of $10m swap
Milwaukee
Antony Gibbs $1.25m swap

Source: BoE, 349A/2, Memos by J.L. Sangster, 27 June 1974 and 29 July 1974.

in London as well as the Bundesbank to get their money refunded.

Their problem was typical: the timing of the closure of Herstatt caught
Hill Samuel OHG (their German office) between two sides of a spot
transaction of DM54m paid to Herstatt before the counterpart of $21m
could be received in New York. When Hill Samuel complained at the
Bank of England, Richard Hallett (adviser to the Governors) ‘expressed
some surprise at the size of this deal with Herstatt whose name had
been suspect in London for some time’.37 Clearly market gossip was
intended to encourage caveat emptor.
Herstatt’s main correspondent bank was Chase Manhattan Bank
in New York, which was caught with about $620m of transfers due
to customers on account of Herstatt.38 As soon as Chase heard that
Herstatt was suspended, they froze payments out of the account (with
about $156m in it), but continued to accept incoming transfers. In
Cologne on 17 December about 3000 creditors of Herstatt appeared
at an open meeting to make claims. The German settlement allowed
for private customers to retrieve 65% of their claims, foreign banks to
retrieve 55% of their claims and German banks only 45%. This suggests
an assumption that German banks should have had better monitoring
systems in their dealings with a German bank compared to foreign
banks, and that private customers were the least responsible for taking
on excessive risk and so should get the largest reimbursement.
The Bank of England responded to the Herstatt crisis by increasing
the frequency of returns from British registered banks, doubling the
number of staff dealing with the returns and asking (on a voluntary

37. BoE, 394A/2, Memo by R.C.C. Hallett, 1 July 1974. Hill Samuel later sued the Bundesbank
successfully.
38. J.D. Decker, ‘International Insolvency: The Case of Herstatt’, American Bar Association
Journal, lxii (1976), pp. 1290–95.

EHR, CXXIX. 540 (October 2014)

1140 Summer in the City
basis) more specific questions including ones about provisions against
bad debt, free resources and other ratios as well as liquidity ratios. Each
return ‘was signed by a responsible officer of the bank to the effect that
no information which he thought that the Bank of England should
know had been deleted or left out of the form. The idea was to develop
a kind of automatic trigger mechanism which would point out troubles

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before they became serious.’39 This monitoring still relied on honest
reporting, however. The Bank of England also requested and received
letters of comfort from the shareholders of consortium banks in London
that they would act as lenders of last resort for their subsidiaries. While
not binding, Galpin claimed later at the Basel Committee that this
‘had had a considerable effect in restoring confidence’.40 In both cases,
the Bank of England formalised the implicit trust arrangements with
banks, by committing them to non-binding written versions, but did
not change the law or compel changes in behaviour.
The most important institutional response to the Herstatt collapse
aimed at replacing mutual trust with formal regulation occurred
in Germany.41 From January 1974 the Bundesbank had guaranteed
deposits up to DM20,000 per person, so the Herstatt collapse obliged
the Bundesbank to pay about DM100m in order to compensate
depositors. Local authorities in the Cologne area, carnival clubs and
Catholic churches were the main losers of deposits.42 In response in
September 1974, the Bundesbank set up the Liquiditate-Konsortialbank
(LiKoBank) ‘to assist otherwise healthy banks which seem likely to get
into liquidity difficulties, the aim being to avoid a loss of confidence
in the German banking system as a whole’.43 The LiKoBank was a
limited liability joint venture with DM1 billion in capital (DM250m
paid up) shared between the Bundesbank (30%), the German Banks’
Association (30%) and the Savings Banks’ Association (26.5%), with
smaller associations sharing the remaining 13.5%. It aimed to enhance
systemic confidence when a single bank neared collapse by being a
lender of last resort for otherwise solvent institutions confronted by
liquidity problems and it represented a more permanent precautionary
response to provide emergency liquidity than the Lifeboat in London.

39. Basel, Switzerland, B[ank for] I[nternational] S[ettlements] A[rchive], 1.3s(3), vol. 18.,
Informal Record of the First Meeting of the Committee on Banking Regulations and Supervisory
Practices (CBRSP), 6–7 Feb. 1975.
40. Ibid.
41. Herstatt was not the only German bank to be caught out. An earlier casualty was WestLB,
created in 1969 from the merger of Landesbank für Westfalen Girozentrale, Münster, and the
Rheinsche Girozentrale und Provinzialbank, Düsseldorf. As with others, its rapid expansion
resulted in failures of internal governance that exposed it to unauthorised and imprudent lending
in 1973, leading to losses of $150 million.
42. BoE, 394A/2, J.L. Sangster, Memo of Gold and Foreign Exchange Meeting, Basel, 11 July
1974.
43. BoE, 1A179/17, Memo, Mar. 1978. LiKoBank is mentioned in G. Franke, ‘The Bundesbank’s
Role in Banking Supervision’, in Deutsche Bundesbank, ed., Fifty Years of the Deutsche Mark:
Central Bank and the Currency in Germany since 1948 (Oxford, 1999).

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1141
This solution arose because the Bundesbank could not legally provide
credit except against good security, so it required a separate but linked
vehicle that could issue bills against pledged assets of banks in trouble
that would then be discounted by the Bundesbank. By 1978 LiKo
had been involved in one public rescue (DM300m for the Hessische
Landesbank [Helaba]’ support fund in December 1976)44 but had also

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undertaken smaller and less public forms of support.
The Herstatt episode also clearly exposed the vulnerability of
London markets to the actions of supervisors in other jurisdictions
through the global capital market. To calm the markets in the midst of
the crisis, the G10 central bank governors issued a joint communiqué
on 10 September 1974 in which they pledged:
To intensify the exchange of information between central banks on
the activities of banks operating in the international market and, where
appropriate, to tighten further the regulations governing foreign exchange
positions.
While rejecting any formal responsibility for central banks to be
a lender of last resort in the Eurodollar market, ‘they were satisfied
that means are available for that purpose and will be used if and when
necessary’.45 The market was reassured and the high interest rates and
credit rationing receded; although, as Atkin notes, ‘fear replaced avarice
as the driving force on the global foreign exchange markets’.46
For a relatively small bank, the collapse of Herstatt had a considerable
systemic effect, and attracted the attention of the international policy
community. In particular, the Herstatt scandal is generally credited
with the launch of the Basel Committee on Banking Supervision
(BCBS) at the Bank for International Settlements (BIS) and certainly
influenced its original terms of reference, which included the design
of an early-warning system to forestall contagious crises.47 In the wake
of the cross-border effects of the bank crises of the summer of 1974,
the Governors of the G10 central banks decided at their monthly
meeting in December 1974 to establish a new committee, the ‘main
objective [of which] was to help ensure bank solvency and liquidity’,
starting with an extensive BIS survey of existing regulations and

44. P.A. Johnson, The Government of Money: Monetarism in Germany and the United States
(Ithaca, NY, 1998), p. 88.
45. G10 Central Bank Governors’ Communique, 10 Sept. 1974, quoted in C. Goodhart, The
Basel Committee on Banking Supervision: A History of the Early Years (Cambridge, 2010), p. 39.
46. J. Atkin, The Foreign Exchange Market of London: Development since 1900 (Abingdon,
2005), p. 145.
47. For links from Herstatt to the Basel Committee, see Markham, Financial History of the US,
ii. 20; D. Wood, Governing Global Banking: The Basel Committee and the Politics of Financial
Globalisation (London, 2005), pp. 48–50; The Economist, 18 May 2006, ‘One Basel leads to
another’: ‘The Basel rules have their origin in the failure of Germany’s Herstatt Bank in 1974.
Herstatt defaulted on contracts with banks overseas, highlighting the need for more international
co-operation among banking regulators’. Goodhart also emphasises Herstatt over other bank
collapses and does not discuss the Lloyds Lugano debacle: Goodhart, The Basel Committee.

EHR, CXXIX. 540 (October 2014)

1142 Summer in the City
supervisory practices and which was also ‘to give particular attention
to the need for an early warning system.’48 The Committee included
two representatives from each country; one for supervision and one for
foreign exchange, reflecting the joint causes of the banking crisis of the
previous summer. Its chairman, George Blunden, head of supervision at
the Bank of England, noted at the first meeting that his understanding

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of the Governors’ discussions was that ‘it was not intended that the
Committee should engage in far-fetched attempts to harmonise
countries’ supervisory techniques’ but rather to share best practice,
concentrating ‘on problems affecting external, international markets’
rather than the domestic sphere.49 It was clear that the chairman was
determined that no supra-national organisation should emerge from
the Committee and that the sovereignty of national regulators was
paramount. By the time the Committee met, the markets had steadied
and the Eurodollar deposit rate had fallen below 7%, from its peak of
more than 14% in the summer of 1974. Banks were generally assumed
to have been chastened by the crisis, supervisors were in the process of
tightening up national regulations and practices, and the urgency for
more ambitious reform had receded.
The ‘early warning system’ took up much of the discussion at the
second meeting of the Committee in April 1975.50 The goal was to
identify potential liquidity and credit problems that had cross-border
implications sufficiently early for remedial action to be taken to prevent
a crisis. Blunden’s draft paper noted three sources of information on
banks’ activities: statistical reports by banks, examination of banks, and
informal contacts within the market. Drawing from these, he suggested
that an international early-warning system could comprise:
a. exchange of information ‘as and when signs of trouble appear in one
country’s banking system that could have international repercussions’,
b. inspection of foreign branches and subsidiaries by the home authorities
(in addition to the host)
c. requiring foreign branches and subsidiaries to transmit home any reports
they made to their host authorities.51

It is hard to see how this comprised an early-warning ‘system’ since

problems could arise between inspections, although it did cover the
gap in international supervision by requiring that foreign branches and
subsidiaries of banks reported to both their host and home authorities.
Nevertheless, Herstatt had been frequently inspected, but this had not
prevented or detected the fraud that brought the bank down. Moreover,

48. BISA, 1.3a(3), vol. 18, BS/75/5, Informal Record of the First Meeting of the CBRSP, 6–7
Feb. 1975.
49. Ibid.
50. Ibid.
51. BISA, 1.3a(3), vol. 18, BS/75/27, Note on the Committee’s first round of discussions on early
warning systems, 30 May 1975.

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 B a n k i n g Fa i lu r e s o f 1 974 1143
while most authorities (except those of Switzerland and Luxembourg)
agreed to allow foreign inspectors to visit on a reciprocal basis, there
were legal obstacles that prevented banks from sharing the returns they
prepared for their home supervisors with outsiders.
There was no appetite (particularly on the part of the chairman)
for an international ‘structure similar to those that already existed in

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individual countries’, or for a more formal institutional response to the
Governors’ request. Blunden’s initial draft asserted strongly that ‘(a) an
international early-warning system must be based on national early-
warning systems. (b) the Committee should itself be the focal point for
an international early-warning system.’52 In other words, there should
be no new multilateral or supranational institution to act as a clearing
house for market surveillance.
Having rejected substantial reform, the Committee members spent
much of their second meeting debating Blunden’s suggestion that
they act as a forum to exchange informal ‘gossip’ that could alert their
counterparts in other countries to potential problems arising from the
international operations of their national banks. There was no immediate
consensus or enthusiasm; Japan was a firm opponent. Rei Masunaga of
the Bank of Japan made it clear that ‘the Japanese delegation could
not commit itself either to passing on rumours to other committee
members or to the idea that action should be taken if rumours about a
Japanese bank were received from other members of the Committee’.
Pierre Fanet of the French Commission de Contrôle des Banques
remarked that ‘it was hard for him to imagine that information based
simply on rumours, or even on accusations, could be transmitted to the
supervisory authorities of other countries’. Rodney Galpin of the Bank
of England disagreed, stating that ‘there should be a moral obligation
to report the potential areas of difficulty to the countries that might
be affected’. Herman Baeyens of the Belgian Commission Bancaire
‘stressed that he could not be expected to warn other countries in case
he should learn about the difficulties of a Belgian bank; but at the same
time he would be glad to be informed by other Committee members
when there were rumours about a Belgian bank’. In sum, interference in
the trust relationship between supervisors and their national banks was
resisted, even if it would alert other interested jurisdictions to potential
losses, but gossip from other countries was potentially useful.53
As his proposals for sharing informal information came under
criticism, Blunden stated that ‘the only clear and firm remit the
Committee had had from the Governors concerned the setting up of
an international early warning system’, and on this point the Governors
therefore required a tangible proposal. On the other hand, he asserted
52. BISA, 1.3a(3), vol. 18, Discussion draft of a report to the Governors on an international
early-warning system, 24 Mar. 1975.
53. BISA, 1.3a(3), vol. 18, BS/75/31, Informal Record of the Second Meeting of the CBRSP,
24–25 Apr. 1975.

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1144 Summer in the City
that ‘the only possible and useful kind of international early warning
system would result from the establishment of contacts … for the
purpose of confidential exchanges of relevant information picked
up by their own national warning systems. This was the answer they
should give to the Governors on this question’.54 But there remained
doubts about the quality of information that might be passed in the

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form of rumour or gossip and whether it would bear the weight of any
subsequent action by the national regulatory authorities.
In the case of the Herstatt collapse, the Committee discussions
clarified that the German regulators would not have been obliged to
pass on their concerns to supervisors in other countries, as to do so could
have further imperilled the bank and breached secrecy norms; but they
concluded that other supervisors might usefully have passed on rumours
from their own jurisdictions that Herstatt was in trouble. Blunden
noted that, ‘had the Committee existed last year, the information which
would undoubtedly have been transmitted would probably have been
very helpful to the German authorities. In fact some hints had been
given but they did not seem to have got through’.55 The information
was thus meant to flow to the responsible authority but not from it—so
gossip about foreign banks in each jurisdiction could be shared but there
would be no responsibility to share information about domestic banks’
operations gleaned from existing confidential supervisory reports.
Trust in confidentiality has long been an important element in the
supervisory regimes of most countries; it is the basis for the release of
market-sensitive information by the banks to the authorities. This trust
would be threatened if it were understood that details could be shared
with the authorities in other jurisdictions, prompting unpredictable
outcomes if the data were to be leaked to banking partners or customers.
Nevertheless, the Bank of England and others were willing to consider
breaching this confidence in the case of foreign banks operating in their
jurisdictions. The framework of loyalty and trust, therefore, extended
only between a bank and its national supervisor while foreign branches
or subsidiaries were viewed as outside the close relations of the national
regulatory system. The proposal might be interpreted as encouraging a
form of self-regulation among international banks themselves by involving
them in reporting on each other to their home authorities. However, there
were doubts about the banks’ willingness to take on this responsibility.
The Belgian representative noted that Belgian banks would ‘consider it as
a denunciation to tell the authorities any bad news it might have about
another bank’.56 The Belgian banker, it seems, was not a gossip.

54. BISA, 1.3a(3), vol. 18, BS75/40, Informal Record of the Third Meeting of the CBRSP, 19–20
June 1975.
55. BISA, 1.3a(3), vol. 18, BS/75/31, Informal Record of the Second Meeting of the CBRSP,
24–25 Apr. 1975.
56. BISA, 1.3a(3), vol. 18, BS/75/27, Note on the Committee’s First Round of Discussions on
Early-Warning Systems (Revised), 30 May 1975.

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 B a n k i n g Fa i lu r e s o f 1 974 1145
Blunden agreed to revise his paper to take account of these objections
and also of legal and institutional obstacles (for example in Switzerland
and Luxembourg) that prevented supervisors from other jurisdictions
inspecting branches, subsidiaries or joint ventures. In the meantime,
the Committee agreed to share updates on changes to their supervisory
and regulatory frameworks at each meeting in order to promote best

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practice. It became a standing agenda item for the early meetings of the
Committee that each representative team would update the others on
their reform plans and circulate any new regulatory changes. Both the
British and American representatives reported at the second meeting
that they had introduced changes to procedures ‘as a result of the
Committee’s discussions’; so this process seemed to bear fruit.57
In the end, in the absence of an agreement on the appropriateness
of sharing gossip or the ability to develop a consistent framework to
share statistical material arising from banking supervision, Blunden
drafted a shorter and more general paper for the next Governors’
meeting on Early Warning.58 The paper was explicitly submitted to
the BIS Governors in a personal capacity ‘prepared by him and on his
own responsibility’ rather than as an agreed paper by the Committee.59
Nevertheless, the Committee members agreed to the main principle:
that there was ‘no question of the Committee producing a great
new international early warning system’. The sovereignty of national
systems was not to be challenged—so there was no suggestion that
practices would be harmonised beyond the sharing of best practice
on a voluntary basis through the Committee and ensuring that there
were no gaps in supervision of international banking. Blunden advised
that sharing market rumours could be useful for early warning, but
would need to be voluntary and based on a confidential relationship
of trust among central bankers. He noted that the Committee itself
was deliberately developing these relationships and had exchanged
addresses and telephone numbers—a rather limited initiative. By the
end of the Committee’s third meeting, therefore, a more coordinated
system to ensure that contagious international banking crises could be
nipped in the bud was rejected in favour of continuing semi-formal
personal contacts among supervisors and those with their ear to the
foreign exchange markets.

57. Galpin (UK) noted that banks would be asked for details of their ten largest outstanding
loans. Willey (USA) noted that ‘partly as a result of the initiative taken by the Committee the
Federal Reserve Bank of New York was now trying to organise better its contacts with member
banks … in the direction of what could be considered an early warning system’. BISA, Banking
Supervision File No. 1, BS/75/31, Informal Record of the Second Meeting of the CBRSP, 24–25
Apr. 1975.
58. BISA, 1.3a(3), vol. 18, BS/75/30, Preliminary Report to the Governors by the CBRSP on
International Early-Warning Systems; BISA, 1.3a(3), vol. 18, BS/75/40, Informal Record of the
Third Meeting of the CBRSP, 19–20 June 1975.
59. This contradicts Goodhart’s comment that this was an agreed BCBS paper: Goodhart, The
Basel Committee, pp. 127–8.

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1146 Summer in the City

III

The Committee’s work was further reinforced by the less well-known

cases of Lloyds Lugano and the Israel-British Bank. Both of these
banking crises demonstrated the need to fill the structural lacunae in

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the supervision of international banks and improve governance of the
foreign exchange markets rather than simply improving the flow of
information on individual banks between jurisdictions.
In August 1974, a rogue trader in the branch of Lloyds Bank
International (LBI) in Lugano, Switzerland was responsible for trading
losses of £32m or $78m (equivalent to £500 million in 2011 as a share of
GDP).60 In respect of Lloyds’ overall balance sheet, this was equivalent
to about 40% of the group’s pre-tax profits in the first half of 1974 and
the losses were paid off within a few weeks. But the episode exposed
how vulnerable even large and reputable banks were to the actions of
low-ranking employees in remote markets. More generally, the Lloyds
scandal finally prompted the Bank of England to take over some
responsibility for prudential supervision of overseas branches of British
banks, a sphere that it had previously studiously ignored.
The rogue trading episode at Lloyds Bank International provided
a subsequently familiar story of escalating trading losses. A young
trader exceeded his trading limits and sought to cover his initial losses
by increasingly reckless betting on the foreign exchange market. He
continued to accumulate losses on open positions from January 1974
until a correspondent bank finally alerted his head office in August
1974. He hid evidence from his manager and head office and was
subsequently convicted of fraud. At first the Bank of England planned
to allow Lloyds Bank to deal with the scandal, and indeed the losses were
covered by 2 September. However, the Treasury argued successfully that
some greater official oversight was required to avoid a repetition of such
scandals in the future.61 John L. Sangster at the Bank of England noted
that ‘prima facie the losses sustained by the LBI branch in Lugano
suggest that we first turn to the foreign exchange area and impose
some sort of reporting and possibly limits akin to those that we impose
on banks in the UK’. 62 But these limits were aimed at protecting the
foreign exchange reserves, not at monitoring the prudence of banks’
foreign exchange positions per se. Sangster mused, ‘do we then just
shrug our shoulders at the losses incurred by LBI Lugano? There is
sometimes a management advantage in not overloading administrative
procedures by over-reacting to a single instance of loss. But there is

60. TNA, T 233/2942, Memo from D. Wass to Financial Secretary Lawrence Airey, 12 Aug.
1974.
61. TNA, T 233/2942, Memo by Derek Mitchell, 22 Aug. 1974; S.A. Robson, Chancellor of
Exchequer’s office, to Private Secretary to Financial Secretary, 29 Aug. 1974.
62. BoE, 349A/2, Memo by J.L. Sangster for McMahon, 19 Sept. 1974.

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 B a n k i n g Fa i lu r e s o f 1 974 1147
a problem in the LBI Lugano area which we have to probe, perhaps
to satisfy our own misgivings and certainly to satisfy the paternalistic
instincts of HMT [Her Majesty’s Treasury]’.63
The Bank of England’s attitude contrasts with that of the Federal Reserve
in the USA. In late 1972 Chase Manhattan requested authority to invest
more in its Swiss subsidiary, and claimed that Swiss law prevented Chase

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from complying with the Fed’s requests for information on its operations
and activities.64 The Fed refused the request and replied firmly that their
supervisory reach ‘extend[s] to the operations and activities of a bank no
matter where conducted, including its foreign branches and subsidiaries,
since all rest on the capital and senior management capabilities of the
bank’. It was ‘essential’ for the head office to have internal controls and
supervision ‘to assess and to control exposure resulting from potential
losses, insufficient liquidity and inadequate management’ and that the
US authorities should have access to these records and information. These
principles were enshrined in section 25 of the Federal Reserve Act. The
Fed specifically advised member banks that their systems should provide
information on risk assets, liquidity, contingencies and both internal and
external audits as a form of control. In the end, Chase agreed to collect
customers’ waivers to allow the subsidiary to make the information
available to the US banking authorities at Chase’s head office in New
York without breaking Swiss banking secrecy laws.65 Unlike the Bank of
England, the US authorities thus took a robust view of their supervisory
oversight of the overseas offices of American banks, particularly in the
opaque legal environment of Switzerland.
A crucial aspect of the Lugano affair, which led the Bank of England
to accept greater responsibility, was Lloyds Bank’s claim for foreign
exchange to meet the losses of $78m. On 19 August Lloyds was allowed
by buy $25m directly from the foreign exchange reserves rather than
through the market. The crisis thus led to a direct drain on the foreign
exchange reserves, although this only amounted to 0.5% of convertible
currencies held in the reserves. Ordinarily, banks were required to
borrow funds in the Eurodollar market to transfer to branches overseas
or to buy the currency in the foreign exchange market. On this occasion
the Bank allowed a direct claim on the reserves because of ‘the size
of the initial amount required, the desire to protect the bank’s name,
the fact that the funds were wanted for the next day rather than for
ordinary value, and the general state of the market’.66 The remainder
of the transfer to cover losses (approximately $45m) was accumulated
and transferred by Lloyds through the foreign exchange market over

63. Ibid.
64. New York, [Archives of the] F[ederal] R[eserve] B[ank of ] N[ew] Y[ork], Volker files,
142572 ‘C’, Letter from Tynan Smith, Secretary of the Federal Reserve Board of Governors, to
W.S. Ogden, Executive VP, Chase Manhattan Bank, 17 May 1973.
65. FRBNY, Volker files, 142572 ‘C’, Memo for files by E.F. Kipfstuhl, 31 May 1973.
66. TNA, T 233/2942, J. Hollom to D. Mitchell, 27 Aug. 1974.

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1148 Summer in the City
the following two weeks. It thus became clear that the responsibility to
support foreign branches of UK banks posed a potential claim on the
foreign exchange reserves, which was a central focus of the activities of
the Bank of England.
Helping banks out with their foreign currency liabilities was
controversial. Richard Hallett (Adviser to the Governors of the Bank

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of England) was rather pessimistic about the prospects for using the
foreign-exchange reserves for this purpose more widely.67 There were
legal objections since the reserves were to be used only to avoid pressure
on sterling. Moreover, in practical terms, the offer of such support
would have to be very rapid to forestall contagion, but the ultimate
liability was often not known until much later. He cited the case of the
Israel-British Bank, where ‘if the Israel British had been a true London
bank we might, so soon after Herstatt, have committed the reserves at
once. It is only now emerging that their assets are largely of dubious
value; and the effect on London and sterling has proved in the event to
be negligible’. Rather than support to help a bank already in difficulty,
Hallett emphasised that ‘there are a number of preventive measures
[in the Eurocurrency market] which it is important to keep in play
all the time, such as inter alia avoiding the undue pressures for which
the Japanese have recently been responsible, keeping a close watch on
the temperature of the market and ensuring that the banks appreciate
their responsibilities and do not add to the problems by unwise
behaviour’ as well as not letting government borrowing strain the
market’s liquidity. Market intelligence was also gleaned from particular
participants. For example, Stonor at Rothschild International and Raw
at Italian International Bank both had telephone conversations with
the Executive Director of the Bank of England, Sir Kit McMahon, to
report on their ability to access the Eurocurrency markets in August
1974.68
It was not only overseas branches of British banks where governance
was problematic. International Westminster (IW), a subsidiary of
NatWest, also found itself with unauthorised credit risk in 1973 as a
result of ‘a new branch which very quickly expanded turnover to an
almost incredible extent’.69 In the first half of 1973 the IW branch
in Frankfurt entered into deals totalling $4.5 billion with the Banca
Privata Italiana, a vehicle for the fraudster Michele Sindona. Although
these deals were entirely covered in the market and therefore there
was no exchange risk, they did constitute a substantial credit risk.
The deals were gradually run off at maturity in the second half of
the year and reporting systems between the subsidiary and NatWest
were strengthened. Another example was the suspension of the Swiss
67. BoE, 394A/2, R. Hallett, Memo for McMahon, ‘Rescue Action in the Euro-currency
Markets’, 25 July 1974.
68. BoE, 394A/2, McMahon Report to Governor, 2 Aug. 1974.
69. BoE, 394A/2, Note by J.L. Sangster, 8 Nov. 1974.

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 B a n k i n g Fa i lu r e s o f 1 974 1149
International Credit Bank in October 1974. In this case the London
representative office was clearly deemed to be the responsibility of the
home Swiss Federal Banking Commission. The London office was not
an authorised foreign exchange dealer but it did have limited exchange
facilities; at the time, about £3m of sterling deposits and $20m in non-
sterling deposits was at risk.70

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In October 1974, the Bank of England began to draft a letter to be
sent to all banks in London reminding them of best practice in their
internal supervisory practices. This might seem a minor initiative, but
formal letters such as these, while not enforceable, did carry significant
weight and were not sent out frequently. At the time the foreign
exchange positions of branches and subsidiaries overseas were not
included in the regular returns made to the Bank of England. However,
the Bank emphasised the potential cost to the UK’s foreign exchange
reserves if losses on foreign exchange markets needed to be covered.71
The letter was sent to all of the 113 authorised banks registered in the
UK, and to the 141 authorised branches of foreign banks in London in
December 1974.
As finally composed, the letter called on banks to undertake a
review of internal regulations and foreign exchange limits and set out
an indicative check-list for that review summarised in Table 2. The
major change in practice was that the Bank asked to be informed of
the limits and authorisations that head offices allowed for each of
their overseas branches and subsidiaries, and to report when these
changed and how frequently they received reports from these offices.
This marked an important departure in the Bank’s oversight of the
foreign activities of London-registered banks.72 Additionally, the
Governor recommended that market discipline through reports from
correspondent banking relationships should be used to corroborate
internal reports from overseas offices. Lawrence Airey, Deputy
Secretary to the Treasury, found this to be ‘the most promising of the
various measures proposed so far’, since the list of checks in the Bank’s
letter were already operated in prominent banks such as Lloyds.73 But
the real significance of the letter was the Bank of England’s acceptance
of responsibility for prudential supervision of overseas branches and
subsidiaries of British banks. A minor banking scandal thus effected
a substantial change in principle in the UK regulatory framework.
An even smaller bank was soon to prompt even greater changes at an
international level.

70. TNA, T 233/2958, Note for the Record by R.H. Seebohm, 10 Oct. 1974.
71. BoE, 349A/2, Draft letter from Governor to Chairmen of British Banks, 25 Oct. 1974; BoE,
349A/2, Note by Fenton to Blunden, 30 Oct. 1974.
72. BoE, 349A/2, Letter from Governor to British Banks, 20 Dec. 1974.
73. TNA, T 233/2958, L. Airey to Principal Private Secretary to Chancellor of Exchequer, 23
Dec. 1974.

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1150 Summer in the City
Table 2. Letter of Guidance for Banks to Control their Overseas Branches
Bank of England BoE to be told the foreign exchange trading limits
Prudential Supervision applied to overseas branches and subsidiaries
External Corroboration Central management should randomly seek
second confirmations of outstanding forward
contracts from correspondent banks

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Check with a correspondent’s main office if it
notices a branch of that bank suddenly increasing
operations in forward market
Self-Regulation Dealers can be exposed by management imposing
ambitious profit targets
Monitor relations between dealers and brokers
Forward deals confirmed immediately, not delayed
until instructions are passed just prior to maturity
Dealers should never write their own outgoing
confirmations or receive incoming confirmations
Snap checks of dealing between regular internal
audits

Source: BoE, 349A/2, Letter from Governor to Banks, 20 Dec. 1974.

IV

The Herstatt crisis was the proximate cause of the failure of a small
Israeli bank, which also had far-reaching policy implications, although
it was not itself systemically important. The Israel-British Bank Ltd
(IBB) had a subsidiary IBB (London) Ltd., which collected mainly
foreign currency deposits in London and remitted them to the head
office in Tel Aviv. Since it was an authorised bank in London, it had no
limits to its foreign exchange dealing and was not closely supervised.
After Herstatt Bank’s deposits were frozen, three of IBB (London)’s
customer banks were unable to renew their deposits, amounting to
about $18 million. IBB (London) was unable to redeem the deposits
with its own cash, leading to a liquidity problem.74 Additionally, there
were undisclosed losses on the foreign exchange market, originally
believed to amount to about $4m and DM6m. Further deposits were
withdrawn and by mid-July it was believed that it would require
about $77 million (£50m) to make good these deposits.75 After further
investigation, it emerged that both offices of IBB had been involved in
fraud, as was discovered through the Bank of Israel noticing that the
currency book of the Tel Aviv office was mismatched. The head office
74. This detail is from a Swiss newspaper report in the Schweizerische Finanzzeitung in TNA,
T 233/2958, sent by the Bank of England to the Treasury, 31 July 1974.
75. TNA, T 233/2958, Note by T.U. Burgner, 12 July 1974.

EHR, CXXIX. 540 (October 2014)

 B a n k i n g Fa i lu r e s o f 1 974 1151
in Tel Aviv was suspended on 9 July and the London office closed on 11
July. Walter Nathan Williams, a British national, had originally owned
the bank and, after he died in 1971, his sons-in-law (Harry Landy
and Joshua Bension) took over control of the boards of both banks.
They continued to report transfers to Tel Aviv on the IBB (London)
books, but in fact credited the funds to four family-owned companies

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registered in Liechtenstein. Repayments of principal and interest from
Liechtenstein were reported as coming from head office but in July
1974 they ceased to be remitted, leaving the banks insolvent. The Bank
of Israel reported to the Basel Committee in August 1975 that the Tel
Aviv head office had used a Swiss bank to hide its loans to the Williams
family businesses from Israel’s supervisory authorities, and asked the
Basel Committee to promote ‘closer cooperation on the international
level in order to prevent multinational banks from taking advantage of
differences that will inevitably continue to exist between the regulatory
regimes of various countries’.76
The Bank of England’s position was that the parent bank in Israel was
responsible for making good the foreign currency losses and that the
Bank of England would not sell foreign exchange from the UK reserves
for this purpose. This firm approach found support in the Treasury.77
The Bank of Israel quickly accepted responsibility for the Israel-British
Bank in Tel Aviv (guaranteeing deposits and putting the bank into
the management of Bank Leumi), but the Israeli government refused
to allow them to take over the London subsidiary without further
investigation of its business.78 In the meantime, the chairman, Harry
Landy (a British national) was persuaded by the Bank of England to
take on NatWest and the merchant bankers Rea Brothers as advisers.79
The Bank of England was adamant that it would not bear responsibility
for the deposits of the London subsidiary and that the foreign exchange
reserves would not be used to support a foreign-controlled bank. The
Treasury began to wonder whether it might be worth spending the $77
million to avoid a loss of confidence in the City if that was threatened.
However, the scandal at IBB (London) did not appear to have any
contagious effects since it was a small bank and had taken deposits from
a large number of parties so no other bank was particularly exposed.80
Given the dangers of setting a precedent of British responsibility for
subsidiaries, the Treasury requested formally that it expected to be
consulted about any further action if the Israeli authorities could
not be persuaded to take responsibility.81 The Department of Trade
76. FRBNY, Samuel Cross Files, Box 107314, BS/75/47, Paper by Meir Heth, Director, Bank of
Israel, for Basel Committee, Aug. 1975.
77. TNA, T 233/2958, T.U. Burgner memo for Littler, 9 July 1974.
78. TNA, T 233/2958, C.W. France, Note of Conversation of Governor Richardson with
Chancellor of Exchequer, 11 July 1974.
79. TNA, T 233/2958, Note by T.U. Burgner, 12 July 1974.
80. Ibid.
81. TNA, T 233/2958, T.U. Burgner to E.B. Bennett (Bank of England), 15 July 1974.

EHR, CXXIX. 540 (October 2014)

1152 Summer in the City
(responsible for authorising banks to deal in foreign exchange) was
concerned that this meant that authorised dealers in London would
not be ‘assured of rescue if they are foreign controlled’. They worried
that this would not have been understood by many depositors, such as
insurance companies and building societies.82 ‘Authorisation’ seemed to
imply some level of supervision and responsibility that was not fulfilled

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by the Bank of England’s actual practice.
On the morning of Friday 2 August 1974, Moshe Sanbar, Governor
of the Bank of Israel, told Richardson that he could not recommend
to his government that it assume any responsibility for IBB (London),
since ‘there is no doubt in my mind that this institution has engaged
in unsound and irresponsible practices’.83 This decision implicitly put
the blame on the Bank of England for failing to exercise prudential
supervision, a claim made explicitly in the Treasury. R.H. Seebohm at
the Treasury remarked that ‘the Bank seem to have exercised no thorough
supervision of IBB and much explanation will be called for’.84 That day
IBB (London) applied to go into voluntary liquidation and six days later,
after a report by Binder Hamlyn on the London office, Bension was
arrested in Tel Aviv. IBB (London) at this point had about £3–5 million
of ‘good’ assets plus a range of assets related to Landy companies and
personal loans to Landy of about £1 million. Deposits amounted to the
equivalent of £40 million including liabilities to ‘reputable’ banks and
the Crown Agents, although no single deposit exceeded £2 million.85
The Williams family also controlled two insurance companies who had
deposits (Sentinal life assurance and National Insurance and Guarantee
property insurance) as well as a property company, London City and
Westcliff. Also, a travel company, Apal Travel, held a licence from
the Civil Aviation Authority against a £140,000 bond by IBB which
was also at risk, affecting some 10,000 British holidaymakers, and it
subsequently ceased trading. The systemic banking threat, however,
was considered to be minimal given the broad spread of depositors, so
the Bank of England remained opposed to bailing out depositors.
In September the Bank of England anticipated that a Canadian
company would take over the Williams empire and meet most of
the liabilities of IBB (London), but this plan was later abandoned.86
By early October the Bank of England had finally conceded that it
would contribute to bailing out depositors in London through a
transfer to the Bank of Israel if the Bank of Israel would also take some

82. TNA, T 233/2958, R.H. Seebohm to Unwin, 17 July 1974.

83. TNA, T 233/2958, Telegram from Moshe Sanbar (Bank of Israel) to Gordon Richardson,
2 Aug. 1974.
84. TNA, T233/2958, R.H. Seebohm, Memo, 9 Aug. 1974.
85. Banks with deposits included United California Bank, North Carolina National Bank,
International Westminster Bank, Girard Trust of Philadelphia and Crown Agents. There were
more than 200 creditors: Financial Times, 4 Jan. 1975. Harry Landy and four other executives
were convicted of fraud in 1979, but their convictions were quashed on appeal.
86. TNA, T 233/2958, Memo by R.H. Seebohm for the Postmaster General, 16 Sept. 1974.

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 B a n k i n g Fa i lu r e s o f 1 974 1153
responsibility for London depositors. The negotiations were prolonged
until September 1975 when the Bank of Israel agreed to relinquish its
DM30m deposit (c.£5.5m) with IBB (London) so long as the Bank
of England agreed to contribute £3m to meet claims against IBB
(London), although the Bank of Israel still refused to accept that the
subsidiary fell inside Israel’s prudential and regulatory jurisdiction.87

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The deal allowed all personal depositors owed less than £25,000 to be
repaid in full, remaining creditors about 38%, and the Williams family
interests nil.88 The Bank of England’s position was that its concession
was only due to the fact that the failure occurred before it was clear to
the market that subsidiaries and branches should look to their home
authorities for support, thereby making clear that it did not establish a
precedent for the Bank bailing out foreign-owned banks in the future.89
The IBB debacle also led directly to Governor Richardson pressing for
a collective ruling at the BIS on responsibilities for different forms of
international banking institution even before the foundation of the
Basel Committee.90 This subsequently became the primary focus of the
Committee’s deliberations, culminating in the Concordat of 1975 after
it had rejected the ‘early warning system’ prompted by the Herstatt
collapse.
Goodhart has shown that potential lacunae between host and home
supervisors had occupied the predecessor of the Basel Committee, the
Groupe de Contact.91 The issue was again raised by the Dutch central
banker, Huib Muller, at the first meeting of the Basel Committee when
discussing the BIS summary of members’ supervisory practices. Muller
remarked at the end of the tour de table that several national authorities
waived compliance from domestic regulations for foreign branches and
subsidiaries, and he ‘felt very strongly that the countries granting such
waivers should report this to the monetary authorities responsible for
the parent banks … otherwise there might be an important gap in
the system of bank supervision’.92 He suggested that the Committee
should discuss the issue further and it was added to the agenda for the
next meeting.93 In preparation, Muller was tasked with developing a
framework to allocate supervisory responsibilities for the next meeting.94
Various views were expressed at the Committee’s second meeting
during the discussion of Muller’s framework allocating supervisory
responsibility to hosts and parent authorities. Goodhart has discussed
87. The Guardian, 11 Sept. 1975.
88. TNA, T 233/2958, Note for the Record by R.H. Seebohm, 10 Oct. 1974.
89. TNA, T 233/2958, R.H. Seebohm to Bridgeman, 11 Sept. 1975.
90. Goodhart, The Basel Committee, p. 39. Goodhart describes Richardson as a ‘driving force’
behind the founding of the BCBS (p. 56).
91. Goodhart, The Basel Committee, pp. 16–23. Muller was a founder of the EEC central bank
Groupe de Contact in 1972.
92. BISA, 1.3a(3), vol. 18, Informal Record of the First Meeting of the CBRSP, 6–7 Feb. 1975.
93. BISA, 1.3a(3), vol. 18, Informal Record of the First Meeting of the CBRSP, 6–7 Feb. 1975.
94. Muller prepared a matrix of supervision for different international banking institutions.
His paper is published as an appendix in Goodhart, The Basel Committee, pp. 115–19.

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1154 Summer in the City
the contents of the Muller paper but not the details of the debate,
which are now available from newly released archives.95 The German
representatives insisted that the host authority had supervisory
responsibility in all cases, be they branches, subsidiaries or joint
ventures. Galpin of the Bank of England agreed that hosts should
supervise joint ventures and subsidiaries, but the host should only

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supervise the domestic market activities of foreign branches. The
Swiss representative agreed, particularly since foreign supervisors
were not allowed into the Swiss jurisdiction. The French, Belgian and
Luxembourg representatives however, disagreed, and argued that home
countries had to take responsibility for supervising liquidity since
the parent bank could be responsible for meeting the commitments
of overseas offices. The French representative also pointed out legal
obstacles to ‘transgressions of banking secrecy by the branches or
subsidiaries that were investigated’ by parent supervisory authorities.
Dahl, the US representative, suggested that parent authorities might
not feel able to rely completely on the host country’s supervision and
summarised the view that, ‘while host authorities had an interest in
the affairs of branches and subsidiaries in their own markets, it was
the parent bank and the parent authority which had the responsibility
of looking at the liquidity and the solvability of an entire banking
organisation’. What the discussion revealed was the importance of
communication among supervisory jurisdictions no matter where
primary responsibility lay. This principle was later enshrined in the
Basel Concordat which was finally approved in September 1975.96 The
Concordat concluded that ‘it is not possible to draw up clear-cut rules
for determining exactly where the responsibility for supervision can
best be placed in any particular situation’ and suggested instead that
the sharing of information between jurisdictions should be improved.
By 1979 the Basel Committee had agreed that parent authorities should
monitor their home institutions on a consolidated basis in order to
capture their overseas business. But the exchange of information and
cross-border cooperation continued to be an obstacle to comprehensive
supervision of the global banking system.97

The failure of a range of banks across Europe and the USA in the
mid-1970s exposed weaknesses in a variety of institutional structures
operating across different national jurisdictions and revealed the limits

95. Goodhart, The Basel Committee, pp. 96–100.

96. BISA, BS/75/44e, Report to the Governors on the Supervision of Banks’ Foreign
Establishments, 25 Sept. 1975, [Link]
97. See Goodhart, The Basel Committee, pp. 96–103, for the development of the Concordat. For
more recent expression of the persistent obstacles, see Basel Committee on Banking Supervision,
High-Level Principles for the Cross-Border Implementation of the New Accord (Basel, Aug. 2003).

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 B a n k i n g Fa i lu r e s o f 1 974 1155
to trust in a rapidly changing international banking environment. The
prevalence of fraudulent activity exposed during this period strained
the traditional boundaries of trust among bankers and between bankers
and regulators, and prompted consideration of regulatory changes to
substitute for trust. The Bank of England responded reluctantly by
formalising its relationships with banks in London through letters

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of guidance and requiring signatures attesting to honest reporting.
However, it took another five years until the first statutory regulations
for banks were introduced in the UK in the Banking Act of 1979.
At an international level, the G10 central bankers called for a new
systemic response for ‘early warning’ from their new Basel Committee,
but they were left with a set of vague assurances from the Committee
chairman that developing trust among members of the committee would
enhance communication and help forestall future crises. The emphasis
on building social capital among supervisors to monitor markets was
extrapolated from the British model of supervision in the City of
London, but it did not attract majority support among the Committee
members themselves. The members of the Basel Committee also
attempted to establish a common set of rules to distribute supervisory
jurisdiction, but only reached agreement on general principles because
of reluctance to share private bank information across national borders.
After the abandonment of the early-warning system, the main
preoccupation of the Basel Committee was to fill the apparent gaps
in supervisory oversight for international banks, both branches and
subsidiaries. This issue did not arise from the Herstatt collapse but from
the less famous IBB (London) and Lloyds Bank International affairs
which exposed more clearly the jurisdictional gaps. Although the losses
were not great and there was no systemic effect, the extent of rogue
trading at the Lugano office of one of the major London clearing banks
prompted an overhaul of domestic banking supervision to fill the gap in
the British system which had hitherto ignored the foreign branches of
London banks. As the guidance to banks was developed, it expanded to
encompass not only branches but also subsidiaries of UK banks.
For the Bank of England, the prolonged conflict with the Bank of Israel
over responsibility for a London subsidiary of a foreign bank, and the
eventual decision partially to bail out creditors, provided a stark lesson on
the need to clarify jurisdiction for international banks. They had assumed
that a tacit principle of responsibility of home offices for branches would
extend to subsidiaries but this was clearly not the case. They had to
acknowledge that their own understanding was not necessarily shared by
the wider banking community and in the end the Bank of England had to
contribute to the bail-out by providing ‘new’ money, whereas the Bank of
Israel merely wrote off its deposit at the IBB (London).
The banking failures of 1974 prompted a reassessment of the systems
that had been developed in the more stable environment of capital
controls and pegged exchange rates that had prevailed during the first
EHR, CXXIX. 540 (October 2014)
1156 Summer in the City
three decades after the end of the Second World War. But, while the
archival record shows that policy-makers identified the challenges of
supervising cross-border and global banking systems in the 1970s, their
responses were piecemeal. Rather than a coordinated and comprehensive
framework, national regulators responded according to the local
characteristics of their markets and the opportunity to depart from

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this national focus through the Basel Committee was missed. Instead,
the records of the initial meetings of the Committee demonstrate the
important role played by the Chairman George Blunden in promoting
an informal non-statutory approach based on national frameworks.
Best practice in supervising international banking was gradually
formalised by the Basel Committee into the core ‘Principles for the
Supervision of Banks’ Foreign Establishments’ in 1983 in the midst of a
much more disastrous international banking failure: the Latin American
debt crisis. This concordat again called for cooperation to overcome
gaps in supervision by focusing on monitoring consolidated accounts
of international banks by parent authorities.98 But sharing information
among national supervisors—a goal that had been identified at the
first meeting of the Basel Committee—remained intractable, and was
the subject of further proclamations and guidelines during the 1990s
as the Basel Committee embarked on a prolonged process of devising
industry standards for minimum bank capital.99 Concern about the
persistent flaws in the supervision and regulation of international
banking and finance was renewed as a result of the global financial crisis
of 2007–8. In 2009, the Financial Stability Board brought together a
broader range of central banks, the Basel Committee, International
Monetary Fund, European Central Bank, Organisation for Economic
Cooperation and Development and World Bank ‘to develop and
promote the implementation of effective regulatory, supervisory and
other financial sector policies’.100 In particular, attention has been
devoted to formalising cross-border cooperation for globally systemic
financial institutions.101 Thus, despite the dramatic changes which have
occurred in the nature of global financial markets over the past forty
years, the challenges to the regulatory and supervisory system first
identified in the banking scandals of 1974 have persisted.

University of Glasgow C atherine R . S chenk

98. Basel Committee on Banking Supervision, Principles for the Supervision of Banks’ Foreign
Establishments (Basel, 1983), [Link]
99. Id., Core Principles for Effective Banking Supervision (Basel, 1997; rev. 2006).
100. See [Link]
101. Progress within the EU was signalled by the transfer of supervision of the Single
Supervisory Mechanism to the European Central Bank in October 2013.

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