On 26 June 1974 the German banking authorities withdrew the licence of Bankhaus I. D. Herstatt and ordered it into liquidation at the close of the German banking day. Counterparties across the Atlantic had already paid Deutsche marks that morning, expecting US dollars in New York that afternoon. The dollars never came, and the counterparties lost not a mark-to-market difference but the entire principal they had paid. The event named the risk: Herstatt risk, or FX settlement risk, the risk that you deliver the currency you sold and do not receive the currency you bought.
It is principal risk, not replacement-cost risk. If a counterparty defaults before settlement, your loss is the cost of replacing the trade, typically well under two percent of notional. If it defaults between your payment and theirs, your loss is the entire amount you paid. Worked Example 4 makes it explicit: on a $100 million USD/JPY spot deal, a 1.5% adverse move costs $1.5 million of replacement value while a settlement failure costs $100 million: 66.7 times larger.
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How long does Herstatt risk last?
It lasts hours, and geography creates it. Currency legs settle in their home real-time gross settlement systems during their home business day. The yen leg settles across BOJ-NET in the Tokyo day; the dollar leg across Fedwire in the New York day. A yen payment final at 15:00 Tokyo time (UTC+9) is final at 06:00 UTC; a dollar payment final at 18:00 New York summer time (UTC−4) is final at 22:00 UTC. The yen payer is exposed for 16 hours, a whole working day in which a supervisor somewhere may close a bank. Herstatt was closed at 15:30 Central European Time, 10:30 in New York: mid-morning, hours before the dollar leg would have settled. The BIS Committee on Payment and Settlement Systems documented all of this in Settlement risk in foreign exchange transactions (the Allsopp Report, 1996), the founding document of everything that followed.
How does payment-versus-payment settlement remove it?
The fix is structural: payment-versus-payment (PvP): the final transfer of one currency occurs if and only if the final transfer of the other occurs. Not "at about the same time"; conditionally, atomically, all-or-nothing. The dominant implementation is CLS, which settles both legs of an eligible trade simultaneously across its own books, each member holding a multi-currency account at CLS and each currency leg funded through that currency's RTGS system on a strict pay-in schedule. Per CLS's own published description, it settles over USD 8.0 trillion of payments per day in 18 of the most actively traded currencies, with over 75 settlement members and over 38,000 other users, and it shrinks funding requirements by over 96%. That last number is the second reason CLS exists: multilateral netting across every member and currency means a member funds only its net position per currency. If pay-ins are under 4% of gross, an $8.0 trillion settlement day requires under $320 billion of actual funding.
How much settlement risk is left today?
How much risk is left? The 2025 Triennial added new settlement measures, published in Uncovering FX settlement risk (BIS Quarterly Review, June 2026). On an average day in April 2025, more than $14 trillion of gross obligations were settled: $5.157 trillion (36%) through PvP systems; $4.950 trillion (35%) intragroup, inside a single institution; $2.167 trillion (15%) netted down before settlement to just $337 billion, an 84.45% compression, 6.43-to-1; $496 billion (3%) through bank accounts with timing controls; and $1.416 trillion (10%) settled gross and bilaterally with no risk mitigation at all. Of the $12.2 trillion involving CLS-eligible currency pairs, only 40% actually settled via PvP; for non-CLS-eligible pairs, 12%. Settlement fails were small: 0.01% of gross obligations, but note what that does not say: it measures operational failure in calm conditions, not the tail loss if a large counterparty is closed mid-cycle. (BIS cautions that methodological changes make the 2025 results non-comparable with 2019 and 2022; do not build a trend from them.)
How is Herstatt risk handled for the rupee?
The rupee is not a CLS currency (R6). A USD/INR trade cannot be PvP-settled in CLS. India's answer is domestic: The Clearing Corporation of India Limited (CCIL) provides guaranteed settlement of interbank USD/INR on a PvP basis with multilateral netting, net positions in both currencies computed across all accepted trades; the USD leg settling through CCIL's correspondent arrangements against member MT202 instructions, and the INR leg across members' current accounts at the RBI under a power of attorney granted at admission (CCIL, USD/INR Settlement FAQ). CCIL novates accepted trades, so members maintain no counterparty limits on each other, and holds a Settlement Guarantee Fund with margins set by a margin factor. The lesson generalises: when a currency sits outside the global PvP utility, the settlement-risk answer must be built domestically, and the quality of that answer is a real, assessable feature of the market.