Cross-Currency Settlement Risk

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DEFINITION of 'Cross-Currency Settlement Risk'

A type of settlement risk in which a party involved in a foreign exchange transaction remits the currency it has sold, but does not receive the currency it has bought. In cross-currency settlement risk, the full amount of the currency purchased is at risk. This risk exists from the time that an irrevocable payment instruction has been made by the financial institution for the sale currency, to the time that the purchase currency has been received in the account of the institution or its agent.


Also called Herstatt risk, after the small German bank, whose failure in June 1974 exemplified this risk.

INVESTOPEDIA EXPLAINS 'Cross-Currency Settlement Risk'

One reason for this risk is the difference in time zones. With foreign exchange trades globally conducted around the clock, time differences mean that the two legs of a currency transaction will generally not be settled simultaneously.

As an example of cross-currency settlement risk, consider a U.S. bank that purchases 10 million euros in the spot market at the exchange rate of EUR 1 = USD 1.40. This means that at settlement, the U.S. bank will remit US$14 million and, in exchange, will receive EUR10 million from the counterparty to this trade. Cross-currency settlement risk will arise if the U.S. bank makes an irrevocable payment instruction for US$14 million, a few hours before it receives the EUR10 million in its nostro account, in full settlement of the trade.

RELATED TERMS
  1. Cross-Currency Transaction

    A cross-currency transaction is one which involves the simultaneous ...
  2. Counterparty Risk

    The risk to each party of a contract that the counterparty will ...
  3. Nostro Account

    A bank account held in a foreign country by a domestic bank, ...
  4. Settlement Risk

    The risk that one party will fail to deliver the terms of a contract ...
  5. Vostro Account

    The account that a correspondent bank, usually located in the ...
  6. Counterparty

    The other party that participates in a financial transaction. ...
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