DEFINITION of Credit Checking
Credit checking, with regards to forex, is performed on the financial backing of the counterparties in a forex transaction. This credit check ensures that both parties have the means necessary to cover their leveraged positions in the trade and is done before the transaction takes place.
A credit check in the forex market is much like the credit check a landlord makes on a potential tenant. The landlord is doing a background check to see if the prospective tenant can afford to make the regular rental payments on time.
BREAKING DOWN Credit Checking
Without the process of credit checking, one party in a forex transaction would have no assurances as to the creditworthiness of the other party involved. By engaging in credit checking before transactions take place, confidence is maintained that each party has enough credit to carry out and honor the deal.
Since the financial crisis, regulation across all markets has become more strict making credit checks a more arduous and lengthy task. n addition to checks, most firms have increased capital requirements for customers, which has acted as a form of a credit check, or safety net against bad losses.
In January 2015, when the Swiss National Bank (SNB) pulled the peg between the franc and the euro, the value of the franc rose by as much as 25 percent in a matter of minutes, which wiped out margin traders, and the losses were borne by the brokers. While credit checks could not have aided these losses, the increase in capital requirements has reduced the magnitude should an event like this occur again.