Magazine article American Banker

G20 Eyes Formation of a Settlement Bank to Cut Risk in Foreign Exchange Transactions

Magazine article American Banker

G20 Eyes Formation of a Settlement Bank to Cut Risk in Foreign Exchange Transactions

Article excerpt

Representatives of a prestigious banking consortium are developing plans for a clearing organization that would reduce the risk in foreign-exchange transactions.

The consortium, known as the G20, would form a limited purpose bank that would settle both sides of a trade simultaneously.

Because the deal would be irrevocable, in a process called continuous linked settlement, it would reduce the risk of losses that can occur when a bank fails and cannot cover an exposed position.

Banks would maintain accounts at the settlement bank in various currencies. If they have sufficient sums on deposit to cover a transaction, settlement could occur in any currency.

What they are concerned about is "Herstatt risk," a reference to the 1974 failure of Bankhaus Herstatt of Cologne, Germany.

When regulators closed the bank, it was in receipt of German marks from New York banks that expected to be paid dollars later in the day. A similar failure of greater proportion could have brought down the world financial system.

In a presentation to Swift's annual Sibos conference, executives from G20 banks described a clearing house structure that, they said, could build upon existing netting systems to reduce the risk posed by unsettled foreign exchange deals.

A report in March by the Bank for International Settlements concluded that forex settlement risk is larger than most banks realize because transactions can remain unsettled for two or three days.

Laurence M. Sweet from the Bank for International Settlements said:

"A bank's actual exposure when settling a foreign exchange trade equals the full amount of the currency purchased, and lasts from the time a payment instruction for the currency sold can no longer be canceled unilaterally until the time the currency purchased is received with finality. …

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