Among the approaches that clearing houses in the G-10 countries employ to manage credit risks and liquidity risks from the failure of a private settlement bank are: (1) the establishment of strict criteria for the choice of settlement banks; (2) the use of multiple settlement banks; (3) the use of other procedures that minimise the amounts and the duration of exposures to settlement banks; and (4) the maintenance of clearing house financial resources to cover any losses or liquidity pressures that might result from a failure.

The most basic safeguard against settlement bank failure is the selection of highly creditworthy banks. However, clearing houses appear to recognise that credit judgements inevitably are fallible and take further steps to limit their risks. In all but one case, clearing houses that employ private settlement banks use multiple banks. This tends to diversify the risks of settlement bank failure. However, the degree of diversification achieved will depend both on the correlations of failure probabilities between the various settlement banks and on the distribution among the different banks of clearing members and of amounts owed by those members. Moreover, as discussed in Section 3, when multiple settlement banks are employed, transfers of funds between the settlement banks are required. Completion of these transfers may not be possible until some time after the clearing house's accounts at the settlement banks have been credited for any amounts owed by clearing members. Such delays lengthen the duration of exposures to the settlement banks and thereby increase the clearing house's credit and liquidity risks. By contrast, when a single private settlement bank is used, if debits and credits to the clearing house's account are posted simultaneously, the clearing house's exposure is the net amount collected, if any, from all clearing members, which will always be less than or equal to the sum of its exposures to settlement banks when multiple settlement banks are used.⁵⁰

When multiple banks are used, clearing houses may seek to minimise both the amount and the duration of their exposures to these banks through contractual means. Settlement agreements may provide that debits and credits to the clearing house's account at the individual settlement banks are posted simultaneously, thereby ensuring that the exposures are the net amounts, rather than the gross amounts, owed by clearing members at each settlement bank.⁵¹ They also may provide that balancing transfers between settlement banks are effected as soon as possible, thereby minimising the duration of the exposures. As noted earlier, the clearing house is exposed to settlement bank failure only if it occurs after its account at the bank has been credited and before the funds have been irrevocably transferred to another bank. Even in this case, however, the clearing house's agreement with its settlement banks may shift the risk of settlement bank failure to the non-defaulting settlement banks that were expecting to receive funds from the failed bank to balance the clearing house's accounts.

Finally, if despite these various measures a settlement bank failure should result in losses and liquidity pressures for a clearing house, it would seek to use its financial resources to cover those losses. However, as already noted, the size and liquidity of available clearing house resources vary quite considerably and may not be adequate to meet losses and liquidity pressures from a clearing member's default. Because settlement banks collect funds from multiple clearing members, the amount of risk in the event of failure of a settlement bank could substantially exceed the largest amount due from any single clearing member. Moreover, unlike the case of failure of a clearing member, no margin collateral would be available to offset losses from the failure of a settlement bank.⁵²

Footnotes:

⁴⁸ As noted above, however, the use of central banks as settlement banks may increase the duration of a clearing house's credit exposures to its clearing members because of the limited hours of operation at most central banks and, in some cases, because central bank payment systems are still deferred net settlement systems.

⁴⁹ The legal agreements may shift the risks of settlement bank failure to the other settlement banks or to the clearing members.

⁵⁰ This is because of the more comprehensive netting of amounts owed by and owed to the clearing house on the single settlement bank's books.

⁵¹ In some cases, however, a credit to the clearing house's account (and corresponding debits to clearing members' accounts) at an individual settlement bank is effected several hours before the clearing house's account is debited (and clearing members' accounts are credited).

⁵² A clearing house usually has no right to use the margin assets of non-defaulting clearing members to cover losses or meet liquidity demands.