Credit-Anstalt Bank of Austria Fails

Date May 8, 1931

The first of a series of European bank failures and restructurings, the failure of the Credit-Anstalt Bank shook international financial markets and led to a worsening of the worldwide depression.

Locale Vienna, Austria

Key Figures

• Montagu Norman (1871-1950), governor of the Bank of England
• Lionel Walter Rothschild (1868-1937), chairman of the Austrian Credit-Anstalt creditors’ committee
• Alexander Spitzmüller (1862-1953), director of the reorganization of the Credit-Anstalt
• Adrianus Johannes van Hengel (1886-1936), general director of the Credit-Anstalt

Summary of Event

The failure of the Credit-Anstalt Bank of Austria, of which the Austrian government was informed on May 8, 1931, was announced to the world on May 11, 1931. The Credit-Anstalt was one of the leading banks of Austria, both before and after World War I. Its failure precipitated a rush by international lenders to repatriate loans made during the heady days of the late 1920’s. The repatriation of foreign loans, intricately linked to one another, forced the entire delicate financial structure of Europe into crisis, deepened the depression that had begun the preceding year, and contributed to the rise of radical political movements in Central Europe.

Prior to World War I, the Credit-Anstalt had been part of a network of Austrian banks that had provided much of the credit used by business and commerce in Eastern Europe. The number of banks needed to finance the businesses of an empire was far larger than the number needed simply to finance the businesses of the small Austrian republic that emerged from the peace treaties settling World War I. During the 1920’s, this oversupply of financial institutions was gradually corrected by the merger of a number of Viennese banks, often under pressure from the Austrian government. One of the chief mergers was that of the Credit-Anstalt with the Boden-Kredit-Anstalt (Farm Credit Institute) in 1929. As the accountants of the Credit-Anstalt struggled to incorporate the loans and deposits of the Farm Credit Institute into their own portfolio, they were appalled to discover that the Farm Credit Institute had a negative net worth, a strain that, in the existing conditions, it was difficult for the Credit-Anstalt to absorb.

The Credit-Anstalt of 1931 was substantially an international bank. It had major equity interests in the states created from the Austrian Empire, having invested in eleven banks and at least forty industrial firms, including a Romanian sugar refinery. Besides the equity investments, the bank provided credit for many of the firms in which it had invested. Most of these firms were producers of primary products, a sector that experienced severe overcapacity in the late 1920’s. A highly competitive world market put a severe squeeze on profits, to the point at which the profitability of many of the bank’s investments was questionable.

The Credit-Anstalt crisis began on Friday, May 8, 1931. The bank discovered a shortfall of 166 million schillings in its cash position. This information was provided to the Austrian government, with a request that the government guarantee the bank’s liabilities. After an intense weekend of negotiation, during which the bank sought to pressure the government with the argument that it was “too big to fail,” it was agreed that the government would guarantee the bank’s liabilities. In return, the bank’s shares would be devalued by 25 percent, the government would receive shares amounting to one-third of the total, and the Austrian National Bank would become a 10 percent shareholder. It was the government’s intention to place its shares on the market at the earliest opportunity.

The financial difficulties of the Credit-Anstalt were revealed to the world on May 11, 1931. Even though the Austrian government announced that it was providing a guarantee of the bank’s liabilities, depositors rushed to withdraw their funds, many of them purchasing foreign exchange, which the bank discounted at the Austrian National Bank. These losses forced the Austrian National Bank to seek an international loan through the Bank for International Settlements (BIS) in Basel, Switzerland. The BIS brokered a loan underwritten by twelve national banks, but in return it required that the Austrian National Bank guarantee the entire Credit-Anstalt operation. The Austrian government put two-thirds of its annual budget on the line in this guarantee.

The run on the Credit-Anstalt was so large that the first BIS loan of 100 million schillings (about $14 million) was used up by early June. The Austrian National Bank asked for a second loan, to be arranged by the BIS. This loan contained the additional requirement that the Austrian government itself should obtain from foreign sources a longer-term loan, with a maturity of two to three years, in the amount of 150 million schillings. The French exhibited substantial reluctance about this project, particularly because they were concerned about a proposed Austro-German customs union that had recently been proposed. Meanwhile, the Bank of England’s governor, Montagu Norman, came to the rescue with a seven-day loan to the Austrian government. This loan was extended several times and was replaced in the fall by a loan brokered by the League of Nations.

The effective insolvency of the Credit-Anstalt required reorganization of the bank. Discussions over reorganization began in May and continued throughout the summer and fall. A committee was formed from representatives of the bank’s creditors, the Austrian government, and the Austrian National Bank. The head of the committee was Lionel Walter Rothschild, representing the creditors. The Rothschild family owned about one-third of the bank’s shares. English interests, chiefly the Bank of England and the Anglo-Austrian Bank of London, owned another third. American interests, including Kuhn, Loeb and Company and the Guarantee Trust Company of New York, also had large positions. The principal government representative on the reorganization committee was Alexander Spitzmüller, briefly a director of the Credit-Anstalt before the war and also a former finance minister of the Austrian Empire. He had presided over the liquidation of the old Austro-Hungarian National Bank in the early 1920’s.

The task of reorganization, in which Spitzmüller appears to have played the most active role, was to liquidate the assets of the bank, in the form of its industrial investments and credits, with some residual falling to the bank. Generally the reorganization was gentle to debtors, refusing to advance further credit but allowing extended payment opportunities.

A further obligation of the reorganization committee was to determine the extent to which the stockholders would suffer losses. The original plan, in which the foreign creditors’ shares would lose 25 percent of their value, was no longer acceptable to the international bankers. Negotiations continued into the next year, when it was finally agreed that, in return for a further devaluation of the foreign creditors’ shares, some of the losses would be made good by annuities that would be paid by the Austrian government over a seven-year period. No payments were made in 1934 and 1935, and in 1936 the Austrian government refused to make any payments. A new agreement was reached. The reorganized Credit-Anstalt loaned the Austrian government cash to compensate, in part, the annuity claimants. In return, the government agreed to pay the sum back in annual payments over forty years while also paying residual annuities to the foreign creditors over a twenty-year period.

During the summer and fall of 1931, aided by increased interest rates on deposits, the Credit-Anstalt was able to resume normal operations, decreasingly relying on discounting with the Austrian National Bank. The appointment of a Dutchman, Adrianus Johannes van Hengel, as the bank’s director in February, 1932, restored confidence in the bank. It was able to function in normal fashion, although its sphere of activity had been essentially restricted to Austria.

Significance

The effects of the failure of the Credit-Anstalt were far-reaching. The countries of Eastern Europe, which for decades had relied on Viennese banks for credit, were deprived of a major source of finance. Those of the bank’s assets outside Austria that did not have to be liquidated were turned over to a new company, organized in Monaco. The proceeds of this latter operation were intended to help pay off investors in the Credit-Anstalt.

Of much greater importance, however, was the international financial crisis precipitated by the failure of the Credit-Anstalt. The run on the Credit-Anstalt frightened depositors throughout Central Europe, particularly in Germany, where large banks began to lose deposits at an alarming rate in June of 1931. Most of these withdrawals were either in the form of foreign currency credits, particularly British pounds, or gold. The banking crisis in Germany was made worse by restrictions placed on the German central bank, the Reichsbank, by the Allies, in conjunction with the revisions of reparations payments in 1924 and 1929-1930. These rules made it impossible for the Reichsbank to rediscount notes issued by the other commercial banks.

The run on German banks continued into the summer, precipitating the failure of the Darmstaedter Bank in July. The German government responded in the same manner as the Austrian government. It guaranteed the deposits at the Darmstaedter and subsequently forced its merger with another large bank, the Dresdner. These commitments, combined with large withdrawals from most of the large German banks, put the Reichsbank itself in jeopardy. The Reichsbank appealed to the central banks of England, France, and the United States for help. These central banks supplied several loans of several hundred million dollars to prevent the depletion of the Reichsbank’s stock of gold and foreign credits. Strict exchange controls were imposed that continued in effect throughout the 1930’s.

The crisis in the banks and the precarious position of the Reichsbank’s foreign credits and gold supply made it obvious that the major foreign currency transactions required by the various reparations agreements would not take place. President Herbert Hoover had proposed a moratorium on reparations payments as early as mid-June. Because he did not simultaneously offer a moratorium on inter-Allied debts, substantial negotiations were required before the moratorium could take effect. The French agreed to the moratorium on July 6, in return for a commitment that a proposed Austro-German customs union would not form.

The banking crisis also had implications internally for most of the countries of Europe. In order to attract deposits, the banks had to raise the interest rates they were offering. They then had to charge higher interest rates on loans to pay the cost of interest on deposits. These higher rates had the usual effect of severely restricting the credit available to small businesses, which in turn were constrained in the amount of business they could do. Many were obliged to lay off workers, adding to the rapidly growing level of unemployment.

The international banking crisis was also responsible for forcing the British to abandon the gold standard. After suspending conversion of paper money into gold during the war, the British government had returned to the gold standard in 1925 in the hope of restoring Great Britain’s position as the economic and financial center of the industrialized world. When the future of the European banks became suspect, and when the Bank of England made substantial loans to shore up the Central European currencies, suspicion was transferred to the soundness of the pound. Those who had deposits in London sought to convert them to gold, and a severe run on the Bank of England’s gold supply followed. On September 30, 1931, the British government suspended payment in gold.

The United States was not immune to the effects of the Credit-Anstalt failure. The general contraction of foreign credits affected U.S. banks, many of which had made a significant number of international loans to various European banks. The resultant contraction of the money supply produced deflation in both Europe and the United States, making the depression in the United States worse than it might otherwise have been.

The worsening depression had political consequences. In Central Europe, it provoked a sharp increase in voting for radical political parties and almost certainly contributed to the growing support for the Nazis among disillusioned German voters. A similar development occurred in Austria. Even in countries that remained democratic, the lack of funds available for borrowing forced budgetary policies that precluded deficit financing to lessen the impact of unemployment. Both Germany and Great Britain cut back on public subsidy of the unemployed. Governments throughout Europe hewed to balanced budgets in the face of a downward spiral in tax revenues. The depression was made worse worldwide by the ramifications of the failure of the Credit-Anstalt Bank of Austria.

Bibliography

Bennett, Edward W. Germany and the Diplomacy of the Financial Crisis, 1931. 1962. Reprint. Cambridge, Mass.: Harvard University Press, 1981. Classic study of the 1931 financial crisis.

James, Harold. The German Slump: Politics and Economics, 1924-1936. New York: Oxford University Press, 1986. Primarily focuses on the economic crisis in Germany but also discusses the contribution of the Credit-Anstalt failure to the development of the international financial crisis. Provides insight into the larger implications of the Credit-Anstalt collapse.

Kindleberger, Charles P. The World in Depression, 1929-1939. Rev. ed. Berkeley: University of California Press, 1986. Relates the antecedents of the Credit-Anstalt failure and provides a broad discussion of the ramifications of the failure. Includes a brief summary of the events leading up to the crisis of May, 1931.

Schubert, Aurel. The Credit-Anstalt Crisis of 1931. New York: Cambridge University Press, 1991. Thorough analysis includes examination of the causes of the crisis as well as the responses to it. Features tables, bibliography, and index.

Spitzmüller, Alexander. Memoirs of Alexander Spitzmüller, Freiherr von Harmersbach (1862-1953). Translated and edited by Carvel de Bussy. New York: Columbia University Press, 1987. Provides numerous details of the reorganization of the Credit-Anstalt. Given that Spitzmüller was a man with a very large ego, this account should be read with some caution.

Stiefel, Dieter. “The Reconstruction of the Credit-Anstalt.” In International Business and Central Europe, 1918-1939, edited by Alice Teichova and P. L. Cottrell. Leicester, England: Leicester University Press, 1983. Provides a balanced and detailed account of the collapse of the Credit-Anstalt. Commentary by other scholars following the chapter offers insight into some of the more controversial issues surrounding the crisis.