Herstatt risk

  

Definition

Cross-currency settlement risk that arises where the working hours of inter-bank fund transfer systems do not overlap due to time zone differences. In this situation, failure by one counterparty to settle its side of the deal starts a chain reaction of cross-defaults. It is named after a small German bank (Bankhaus Herstatt) which failed in June 1974 during the period it was supposed to settle a contract after having received the payment from the counterparty. That failure caused a string of cascading defaults in a rapid sequence, totaling a loss of $620 million to the international banking sector. This risk is magnified many times over in the current foreign exchange markets where some 1,500 billion dollar is traded every day compared to the daily volume of about 10 billion dollar when Bankhaus Herstatt failed.

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