Herstatt risk - Investment & Finance Definition
The risk that the other party in a transaction may not fulfill the terms of the contract or trade. The term originated and is used in the foreign exchange market. For example, Herstatt risk is the danger that one party in a foreign exchange transaction faces after delivering the currency it sold to the buyer until it receives the currency it bought from the other party. The term comes from an actual situation that occurred in the 1970s when Germany’s Herstatt Bank failed to pay what it owed in a forex transaction after the other side had met its obligations. Quicker settlement periods enabled by the improvement of computer systems have helped diminish Herstatt risk. The danger of Herstatt risk is that the failure of one party to fulfill the transaction will cause a ripple effect of other parties defaulting.