TUCSON, Ariz. - Skyrocketing foreign exchange volumes and the increasing globalization of financial markets are forcing banks and regulators to take a fresh look at how better to reduce risk in their payment systems, speakers at an international banking conference said last week.
The so-called "hot money" that flows around the globe with the touch of a computer key has propelled the foreign exchange market from a $1 billion- a-day business in 1974 to one in which $1 trillion changes hands daily.
This explosive trend had many bankers who attended last week's conference of the U.S. Council on International Banking uneasily recalling the 1974 failure of Bankhaus Herstatt. The German bank was shuttered after it taken in all its foreign currency receipts in Europe, but before it had sent out its U.S. dollar payments.
The incident sent shock waves through the international banking system, and raised fears that a failure of single large financial institution could bring down entire large-dollar funds transfer systems like Fed Wire and the Clearing House Interbank Payments System.
"All of the central banks are concerned about settlement risk," said Federal Reserve Board Vice Chairman Alan Blinder, who gave the keynote address at the conference. "We haven't quite solved the Herstatt risk problem yet," he noted, although a committee of central bankers based in Basel, Switzerland, has been looking into the issue.
"I think most central banks see a need for improvement there," Mr. Blinder added. "You're trying to walk a fine line that increases coordination and cooperation without actually ceding authority over to an international (regulatory) body. But a corollary to that is that it is a slow process."
Other speakers at the conference said that while the input of central bankers like those on the Basel committee has been helpful, banks themselves can do much more to help reduce settlement risk.
Robert White, a senior vice president in charge of foreign exchange trading at London-based Standard Chartered Bank, said a study published last year found there was "a wide range of current market practices" with respect to settling currency transactions.
"The risk in settling a single day's trades can last 72 hours," Mr. White said. "This compounding effect can have a tremendous impact on (raising) settlement risk."
Mr. White said banks can dramatically reduce their exposure in the foreign exchange settlement process by improving their back-office procedures and by entering into "netting" arrangements, where multiple debits and credits are combined into a single payment.
Lorraine Hricik, a senior vice president at Chase Manhattan Bank, said bankers need to move away from the mentality that payment services is a commodity business where negligible profit margins don't adequately cover for the risks financial institutions take on.
"In spite of the critical importance of the payment system to domestic and global commerce, it is taken for granted, largely because banks have been so successful in developing and operating a reliable and transparent system to exchange value," Ms. Hricik said.
She urged bankers "to think outside the box" to come up with more valued-added services surrounding funds transfers systems, such as electronic data interchange of corporate invoices and other trade-related documentation.