Herstatt risk, also known as “settlement risk,” refers to the risk that one side of a financial transaction will be completed while the other side is not, due to time zone differences or other factors. This can result in one side of the transaction suffering a loss, which can have knock-on effects throughout the financial system.
For example, consider a foreign exchange transaction in which a bank in New York is buying Japanese yen from a bank in Tokyo. If the bank in New York completes its side of the transaction (sending U.S. dollars to the bank in Tokyo) before the bank in Tokyo completes its side (sending Japanese yen to the bank in New York), then the bank in New York could be at risk if the bank in Tokyo fails to complete its side of the transaction. If this happens, the bank in New York could suffer a loss, which could have negative consequences for its financial stability and could potentially have wider implications for the financial system as a whole.
Herstatt risk can be mitigated by using settlement systems that allow both sides of a transaction to be completed simultaneously, such as the CLS Group’s settlement service. This ensures that both sides of the transaction are completed at the same time, reducing the risk of one side suffering a loss.
This page was last updated on January 3, 2023.