BIS warns over forex settlements risk

BIS warns over forex settlements risk

By Peter Garnham

Published: May 13 2008 20:44 | Last updated: May 13 2008 20:44

More action is needed to reduce foreign exchange settlement risk to avoid a meltdown in the global financial system, the Bank for International Settlements said yesterday.

The warning came after the release of a report from the bank’s Committee on Payment and Settlement Systems, which featured the results of a survey of how more than 100 banks and other institutions active in the $3,200bn-a-day foreign exchange market managed the risks that can arise when settling transactions.

Foreign exchange settlement risk, the chance that one party to a trade pays out the currency that it is sold but does not receive the currency it bought, has long been a concern of global central bankers due to its potential to introduce systemic risk into the global financial system.

FX transactions are one of the greatest source of settlement risk exposure. In some cases, large banks have almost three times more exposure to settlement risk than to credit risk.

The sums of money involved are huge: FX transactions can involve exposures amounting to tens of billions of dollars each day, and in some cases, exposures to a single counterparty are in excess of an institution’s capital.

Tim Geithner, president of the New York Fed and chairman of the CPSS, said the financial services industry had made significant progress in dealing with foreign exchange settlement risk, but more could and should be done.

He said: “Recent market conditions emphasise how important it is that the settlement infrastructure supporting financial markets is robust and reliable, so that markets have the confidence to function normally even in adverse circumstances.”

The BIS said significant progress in eliminating settlement risk had occurred, especially since 55 per cent of FX trades were now settled through CLS Bank, which was launched by a consortium of leading global financial institutions in 2002.

However, the BIS said of the 45 per cent of FX transactions still settled outside CLS, most used traditional mechanisms that were subject to foreign exchange settlement risk.