Settlement Risk

There are several instances where one party of an agreement fails to pay his or her liabilities to other party or parties. This involves a different type of risk that is related to the financial market and termed as settlement risk. The credit risk and liquidity risk are parts of settlement risk. One can also quote settlement risk as the possibility of not getting back the amount that is expected from any counter party. The settlement risk is not only related to the default of payment but at the same time, the settlement risk is also related to the difference in time of payment. The settlement risk can also be transformed into the principal risk and can cause huge loss to the related companies.

Settlement risk is also known as ‘Herstatt risk’. Herstatt was a famous bank in Germany. In 1974, the bank accepted foreign currency. However, the exchange price of the currency was not provided by the bank to the providers of foreign currency because the regulators stopped the operation of the bank. This is one of the well-known examples of settlement risk till now.

For different kinds of financial tools that depend on a particular mode of transaction, there is definitely some kind of settlement risk related to the process. But settlement risk is mainly related to the forex market. Everyday transaction in this market is very high and it is also one of the major reasons that settlement risk was a major problem for the forex market some years ago. But at present, continuously linked settlement method is providing a safer environment for forex trading and minimizing the settlement risks through eradicating time difference from the exchange process.

To encourage the use of modern technologies in currency transaction process, to maintain international standards regarding the process and more than anything else, to make the transaction process much more secured for every party involved in the transaction, a committee was formed that is known as CPSS or Committee on Payment and Settlement Systems. At present this committee is performing efficiently and reducing the settlement risk factor from the currency transaction process.

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Last Updated on : 1st July 2013

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