Time duration of transactions settlement- magazine Economy and Business

 

Sasho Trajkovski

For almost all of the banks which were researched in the G-10 countries group, the minimum exposure that the banks face in their individual transactions (regardless if these are spot or forward transactions), time duration of Status I lasts from one to two working days. This time duration of Status I relate when all the currencies are traded with, except Japanese Yens. Time duration of Status I in trading with Japanese Yens lasts up to three working days, counting from the day when the FEYCS members can sent irrevocable instructions for paying with Yens in the Japanese payment system[1] .

As supplement to this, time duration of financial transactions settlement is continued for additional one to two working days (time duration of Status U). As a result of the previously said, it would take more than three working days (if holidays and weekend occur between these three working days, the days would be much more) from the beginning of risk emergence that the banks are facing in its operation, containing in it the time necessary for complete transaction processing.

Seeing from the view point of the banks, with the settlement of purchased currencies before the settlement of currencies that were sold, they may face risk of not being able to cancel the currency they sell. In such cases, they are forced to pay out the currency they sold, even in cases when it is clear that they will not get the currency they agreed to. This case occurs mainly when transactions are concluded in zones of huge time difference.  It is best to use settlement system, which could make settlement of two currencies simultaneously[2] .

Most settlement systems offer excellent conditions in view of operational efficiency as are, speed, very low costs, protection against technical risks), but are not offering terms of control for risk exposure of transactions which are settling at the moment.

For example, there are automatic regimes of operations in the very systems, which accelerate the process of exchange of transactions and their settlement.

One of those automated processes of operation is Straight-Through Processing (STP) which provides tremendous benefits for all participants at the financial markets. Straight-through processing operates in such manner that if all the expected preconditions in the given payment instructions delivered to the correspondent banks are met (name of the Bank user, SWIFT code of the Bank user, IBAN-International Banking Account Number of the assets user, amount), assets are being transferred automatically through the computer system of the correspondent bank, without checking if the data are correct or not. Thus, the time duration of the settlement is shortened, but also the risk control that the financial and non-financial institutions face with, is decreased.

Second problem which occurs in use of the automated processes is that the time period for canceling the order is reduced. Because the processes are automated, and go through the correspondent bank for few moments only, it is necessary for the counter side which sends the payment instructions to be certain in its instructions. If error occurs in the given instructions, there should be immediate reaction, because due to automation, the money has already been transferred to the bank user. All this may increase the risk in operation.

Frequently, the banks in their operation are exposed to many risk types in their FX transactions. There were cases when the banks were exposed to risk overnight, as well as during weekends and holidays. Size of which the Bank is exposed to depends on how long period of time the agreed financial transactions cover. Also, important is the period necessary for settlement of these transactions.

If the minimum amount of exposure of settlement of FX transactions lasts 48 hours, the value of undertaken trades will always bear risky sign. But, if there is a need of additional 24 hours for verification of the final settlement for each purchased currency, the value of the undertaken trades shall bear with it even higher risky sign[3].

Detailed statistic indicates that each bank is measuring differently the time it is exposed to risk. Frequently it happens that time not to be measured correctly. Their exposure to risk may reach huge size, be valued to extreme amounts and contribute to inappropriate measurement of exposure and huge losses for the institution itself. Risk exposure depends on what counter parties are at issue. It happens that the institutions to operate in routine and by inertia, that if the counter party in recent occasions have proven to be party which meets the liabilities that it shall continue to do so in future. Because of that, according to the research that were made,  many banks have stated that they agree with  such counter parties transactions  in amount up to 1 mill USD, with one counter party, for one day only, without identifying what is the current situation of that counter party. If such practice is transformed to the actual risk that the financial institutions are facing, this exposure may be up to two or three times higher than those amounts, and the bilateral exposure to risk may lead to weakening of the bank capital and exceed the short-term credit exposure of the bank relative to other counter parties.

 

[1] Committee on Payment and Settlement Systems of the central banks of the Group of Ten countries, Settlement risk in FX transactions, 1996, page 8-11

[2] Basel Committee on banking supervision, Liquidity risk: Management and supervisory challenges, 2008, page 5.

[3] Committee on Payment and Settlement Systems of the central banks of the Group of Ten countries, Settlement risk in FX transactions, 1996, page 10

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