Herstatt bank


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Herstatt bank

  2. 2. HISTORY OF HERSTATT BANK <ul><li>Herstatt Bank  was a privately owned bank in the  German  city of Cologne. </li></ul><ul><li>Jwan David herstatt with his friend Hens Gerling started bank in june 1956. </li></ul><ul><li>Danny Dattel was heading the foreign exchange department which used to work to a large extent without control and with little contact to the other divisions </li></ul><ul><li>The failure of the Herstatt bank is classic case of settlement risk and its implications, particularly in cross-border forex transactions. </li></ul>
  3. 3. WHAT IS SETTLEMENT RISK? <ul><li>Settlement risk  is the  risk  that a  counterparty  does not deliver a  security  or its  value  in cash per agreement when the security was traded after the other  counterparty  or counterparties have already delivered security or cash value per the  trade  agreement. </li></ul>
  4. 4. Background of the collapse <ul><li>On June 26, 1974, German regulators forced the troubled Bank Herstatt into liquidation . </li></ul><ul><li>That day, a number of banks had released payment of  DEM  to Herstatt in Frankfurt in exchange for USD that was to be delivered in New York. </li></ul><ul><li>Because of time-zone differences, Herstatt ceased operations between the times of the respective payments. </li></ul><ul><li>  The counterparty banks did not receive their USD payments. </li></ul>
  5. 5. <ul><li>Responding to the cross-jurisdictional implications of the Herstatt debacle, the  G-10  countries (the G-10 is actually eleven countries: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) and Luxembourg formed a standing committee under the auspices of the  Bank for International Settlements  (BIS) Called the Basel Committee on Banking Supervision </li></ul>
  6. 6. WHAT IS A HERSTATT RISK? <ul><li>The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk . </li></ul><ul><li>It is the risk arising from the time delivery lag between two currencies . </li></ul>
  7. 7. IS HERSTATT RISK THE REASON FOR COLLAPSE OF HERSTATT BANK? <ul><li>The Herstatt crisis is well known in international finance because of ‘ Herstatt risk . </li></ul><ul><li>On the eve of closure of the bank, many banks still had foreign exchange contracts with Herstatt for settlement on that date. </li></ul><ul><li>Hence, Herstatt risk represented operational risk for those banks which were exposed to the default of Herstatt. But, Herstatt risk was not a reason for the Herstatt crisis . </li></ul>
  8. 8. MITIGATION OF HERSTATT RISK <ul><li>Continuous Linked Settlement ( CLS Group Holdings AG and subsidiary companies) was created in September 2002 by a number of the world's largest banks for the purpose of settling foreign exchange flows amongst themselves (and their customers and other third-parties). </li></ul><ul><li>Till September 2007 it settled about 325,000 instructions a day in 15 currencies with an average daily value exceeding US$3.3 trillion. </li></ul><ul><li>A key feature of CLS is the settlement of gross-value instructions with multi-lateral net funding. </li></ul><ul><li>On average, CLS netting efficiency is in the region of 98%; that is to say, each trillion dollars of gross value settled might require aggregate pay-ins of &quot;only&quot; $20 billion. </li></ul>
  9. 9. <ul><li>Real time gross settlement (RTGS) : RTGS systems are defined as systems in which both processing and final settlement of funds transfer instructions take place continuously. </li></ul><ul><li>RTGS systems settles task in a quick succession , that creates credibility between the two parties </li></ul><ul><li>Over the counter (OTC): b ilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. </li></ul><ul><li>It is usually from an investment bank to its clients directly. </li></ul><ul><li>It is mostly done via the computer or the telephone </li></ul>
  10. 10. <ul><li>Central bank payment and settlement services (CPSS) with respect to cross-border and multi-currency : It is dealing with multi-currency delivery-versus-payment (multi-DVP). </li></ul><ul><li>Delivery-versus-payment means that the final transfer of one asset occurs if, and only if, the final transfer of an(other) asset(s) occurs. Assets could be monetary assets (such as foreign exchange), securities or other financial instruments. </li></ul><ul><li>It supports the extension of domestic payment systems operating hours, establishing cross-border operational links between domestic payments systems or multi-currency accounts and settlement facilities provided by a central bank. </li></ul><ul><li>CPSS Strategy : 1. the first step towards reducing settlement risk and containing systemic risk is for each institution to understand the nature and scope of its settlement exposures </li></ul>
  11. 11. <ul><li>2. To help banks come to grips with settlement risk, the report outlines a methodology to measure foreign exchange settlement risk </li></ul><ul><li>3. steps to shorten the time lags within the settlement process. </li></ul>
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