Plotting the death of settlement risk
No more panic waiting for that dollar payment to come in: the solution is at hand. Within three years the world's leading banks expect to have a mutual bank in place that will accept and digest the bulk of their foreign exchange deals, reducing settlement risk to zero. So where's the catch? By David Shirreff.
As if European monetary union (Emu) and the year 2000 (Y2K) problem weren't enough, banks face another giant technology challenge over the next two years - constructing a mechanism to eliminate foreign exchange settlement risk.
The centre of it is a Continuous Linked Settlement Bank (CLS Bank), which will act as a turntable for the bulk of the world's foreign exchange transactions. Last month, IBM won the contract to build the system, which will have to reconcile accounts in multiple currencies and link up with real-time payment systems in scores of countries. But the project won't be functional until September 2000 at the earliest.
To use the CLS system, banks will have to adapt the way they process and monitor foreign exchange transactions, and revolutionize their approach to correspondent banking. Countries' real-time gross settlement systems must be brought up to scratch. There are big implications for the management of liquidity by individual banks, and for the payments systems themselves. Central banks aren't satisfied that reducing settlement risk won't shift the risk elsewhere and cause liquidity problems.