Reducing foreign exchange settlement risk: a progress report

July 1998

Foreword

In 1996 the G-10 central banks launched a major campaign to reduce foreign exchange settlement risk. The chosen strategy was founded on the belief that the private sector, with the active support of the public sector, had the power to contain the risk that first came into focus at the time of the 1974 failure of Bankhaus Herstatt. Recognising, however, that success was not guaranteed, the Committee on Payment and Settlement Systems has monitored progress closely for two years to determine the need for further action.

This report, prepared on behalf of the CPSS by its Steering Group on Settlement Risk in Foreign Exchange Transactions, concludes that encouraging progress has been made over the past two years but more needs to be done. Many individual institutions have significantly enhanced the way they manage their foreign exchange settlement exposures, groups of institutions have been working constructively on risk-reducing multicurrency services, and a number of key payment systems have benefited from useful improvements. However, many banks still do not manage their exposures appropriately and industry efforts have not yet realised their full risk-reducing potential.

Thus, despite significant progress, the potential consequences of a disruption in the foreign exchange settlement process remain considerable. As a result, the G-10 central banks have decided to reaffirm and strengthen the strategy launched in 1996, and the report sets out how this is being done. Prompt action to tackle foreign exchange settlement risk remains essential and I strongly believe that continued implementation of the strategy, with the private and public sectors working in concert, is the best way forward.

Bringing the work to this point has been a major accomplishment, and the CPSS is very grateful for the efforts of the Steering Group, which has benefited greatly from the leadership of its chairmen during the past two years - Christopher J. McCurdy (1996-1997) and Lawrence M. Sweet (1997-1998), both of the Federal Reserve Bank of New York.

William J. McDonough, Chairman  
Committee on Payment and Settlement Systems  
President of the Federal Reserve Bank of New York