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The fear that dares to speak its name

Ask any central banker what is his worst nightmare and he's likely to say one word: Herstatt. Herstatt means gridlock in the world's financial system as hundreds of banks, which yesterday trusted each other to make payments, no longer do. What can shatter that trust? A technical snarl-up, a political shock, or worst of all, the sudden failure of a major bank. By David Shirreff

On October 7 in Florence, the plumbers of the world's financial markets will attempt heroically to put aside their differences and cooperate. In theory they are all trying to avert the same disaster. In practice, for the last few years, they have been pulling in different directions and pursuing at least five different solutions.

The disaster is Herstatt risk, something the world has come close to only once, in 1974, when Bankhaus Herstatt in Cologne was shut down by the German banking supervisors. The closure, at 3.30pm German time, left all of Herstatt's dollar foreign exchange transactions half completed in New York, where it was still only 10.30am. The panic caused, even by that small number of failed payments, resulted in dislocation and gridlock in the foreign exchange markets.

Leading bankers and central bankers vowed it should never happen again. And it hasn't. In 22 years, including the collapse of several banks ­ Continental Illinois, Drexel Burnham Lambert, Barings ­ and disruptions such as the 1990 invasion of Kuwait and the 1991 attempted Russian coup, there has been no gridlock of Herstatt proportions.

But the only thing preventing it has been fast-thinking central bankers.

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