Herstatt Risk

Overview

Herstatt risk is named after the failure of Bankhaus Herstatt, which highlighted principal exposure caused by time-zone differences in currency settlement. The paying party can lose the full delivered amount rather than only a replacement-cost difference.

The risk arises when settlement legs are not simultaneous and may be amplified by cut-off times, intermediaries, liquidity constraints, legal uncertainty, or operational delays. Confirmation that one payment was sent does not prove receipt of the reciprocal currency.

Payment-versus-payment arrangements, netting, counterparty limits, collateral, synchronized instructions, and real-time monitoring reduce exposure. Firms should measure the period from irrevocable payment until final receipt and include failed or delayed settlement in liquidity planning.

Herstatt risk is foreign-exchange settlement exposure where one party pays its currency but the counterparty fails before delivering the other currency. Herstatt risk exposes full principal across unsynchronized currency legs, making payment-versus-payment and strict timing controls the preferred protections.

For Herstatt Risk, the assessment should evaluate foreign-exchange settlement exposure where one party pays its currency but the counterparty fails before delivering the other currency. The assessment record should separate observed evidence supporting foreign-exchange settlement exposure where one party pays its currency but the counterparty fails before delivering the other currency from assumptions, state the time horizon and existing controls, and identify who owns any remaining exposure. Monitoring should test whether the conditions described in foreign-exchange settlement exposure where one party pays its currency but the counterparty fails before delivering the other currency have changed enough to require a new rating, treatment, or approval.

Decision-makers should use findings about foreign-exchange settlement exposure where one party pays its currency but the counterparty fails before delivering the other currency to select treatment, assign remediation, set review thresholds, and document why any residual exposure is accepted.