Business and Personal Finance Dictionary

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• HERSTATT RISK
  
  Definition: The risk to Counterparty A in the settlement of a foreign currency transaction with Counterparty B, that A would deliver its payment to B, but B might not pay, as agreed. If A and B deliver their payments in different time zones, then Herstatt risk occurs regularly. However, in 1994 a report indicated that Herstatt risk lasts more than one day in a significant portion of transactions. The eponymous Bankhaus Herstatt defaulted on a number of currency transactions when it failed in 1974. Example: Bank A might agree to deliver DEM in Frankfurt at 3 p.m., in exchange for Bank B’s delivery of USD in New York at 3 p.m. on the same day. Although the times appear the same, the New York delivery comes later, because of the difference in time zones. Comment: The potential for Herstatt risk has increased enormously, over the past decades, as daily currency transactions increased from about $10 billion in 1973 and about $1.25 billion in 1995. Actual defaults have been few, but when Barings collapsed, it failed to deposit $47.8 million worth of pesetas in a Deutsche Bank branch in Spain. Efforts to avoid the problem include bilateral "netting" arrangements, extended hours for the FedWire system, and clearing houses. References: "Ghostbusters," The Economist, 3/16/96. .
  
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