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Certified International Payment

TM
Systems Professional (CIPSP)

Module 2
Risks in Payment Systems

MVL Consulting Private Limited


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Module Objective

At the end of this module, you will understand:


1. What is settlement risk ?
2. Why is it important to control settlement risk ?
3. How is settlement risk mitigated?

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Page 1
Settlement Risk

Credit risk or Herstatt Risk


First payers risk
Receivers risk
Unwinding risk
Liquidity risk
Systemic risk
Operational risk
Legal risk
General business risk
Custody and investment risk

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First payer/Receivers/Unwinding Risk

X
X
Roger makes payment to Sports Shop. Sports Shop does not deliver.
This is called the First Payers Risk
Roger makes payment to Sports Shop. Sports Shop delivers the Kit.
Subsequently, the cheque issued by Roger bounces.
In this instance, Sports Shop delivered the kit thinking that Roger has paid.
This is called the Receivers Risk
Roger makes payment to Sports Shop. Sports Shop delivers the Kit.
Subsequently, Dhoni issues Stop Payment instructions to his bank.
In this instance, Sports Shop delivered the kit thinking that Roger has paid.
This is called the Unwinding Risk
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Page 2
Herstatt Risk June 26, 1974 3.30 PM
Newsflash:
Bankhaus Herstatt is liquidated
by German Central Bank

Herstatt liquidated before Bankhaus Herstatt

X
it paid US Banks

US Banks
paid Herstatt

Transaction
US Banks to pay DEM equivalent of USD 620 Mio
Herstatt Bank to pay US Banks USD 620 Mio
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Why did this happen ?

Mainly due to time zone differences.


What is the moral of the story
Longer the time between two parts of the transaction, higher is the
settlement risk.

Settlement Risk

Time

Cash RTGS Hybrids DNS

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Page 3
Liquidity Risk
X
X
Roger walks into Sports Shop Sports Store and purchases a kit
While checking out, he finds that he has forgotten his wallet at Home.
Roger now faces what is called as the Liquidity Risk

Instead of cash, Roger pays Sports Shop by cheque.


When the cheque is presented to Rogers bank, the balance is inadequate.
Roger now faces what is called as the Liquidity Risk

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Systemic risk

$25,000 $20,000 $35,000 $ 50,000

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What is operational risk?
The risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and
systems or from external events.
Excludes reputational and strategic risks
Includes legal risks

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Hey!, with so many risks how do you run a bank ?


BIS/IOSCO
Principles for Financial Market Infrastructures
Monitoring tools for intraday liquidity management
Liquidity coverage ratio (LCR)/Net Stable Funding Ratio (NSFR)

Settlement risk mitigation


Carefully chosen members
Intra-day liquidity arrangements
Debit caps/limits
Collateral requirements
Loss sharing arrangements
Third party guarantee
Novation/Central Counter-Party
Standard documentation e.g. ISDA master agreements
Robust systems

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THANK YOU!

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