Payment Intermediation Risks

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Payment intermediation risks • Credit risk is when a participant who is liable to pay a will be delivered before their own accounts are debit- specified amount is unable to do so. ed. If the payment order is refused or queued, this can • Liquidity risk is when a participant who is liable to pay produce a chain reaction in which all participants are a specified amount is unable to do so in a suitable left waiting for the others. Since this is not a default, form. Funds may be available, but not in the form unlike systemic risk, the gridlock can be unblocked needed to meet the liability. For example, payment with temporary measures, e.g. technical netting of the may be stipulated in Deutschmarks but the only funds queue. available are dollars, which cannot be converted into • Moral hazard is a false sense of security among par- Deutschmarks within the stipulated time. ticipants, whereby the general market has an unfound- • Settlement risk is a collective term for credit risk and ed faith that, for example, the central bank or state will liquidity risk. come to the system’s rescue in the event of any trou- ble. The risk is that participants acting in such faith • Systemic risk is when default by one participant pro- will make decisions in order to take advantage of the duces a chain reaction among the others, preventing situation. the completion of settlements. Two main methods are used to reduce systemic risk: Collective responsibility • Technical risk is when a technical failure leads to sub- among all system participants for a default on the part stantial disruption of the payment flow and/or settle- of one participant, whose net debit is then shared out ments. Technical risk can also lead to lack of confi- according to specified rules. However, this arrange- dence in the system as such and uncertainty regarding ment may lead to defaults by other participants. its finality and efficiency. Unwinding, which may conceivably lead to defaults by • Herstatt risk is named after the German bank Bank- other participants who expected the delivery of sub- haus Herstatt, which was closed at short notice in stantial funds from the defaulting party. 1974. This is a form of credit risk, whereby delivery • Gridlock mainly occurs in real time gross settlement and payment do not take place simultaneously and one systems where insufficient credit is available. It occurs party to the transaction can cancel either delivery or when participants expecting payments make payments payment. This risk occurs mainly in foreign exchange of their own, in the faith that the expected payment trading. MONETARY BULLETIN 2000/1 1.

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