A bank pays the rupee leg of an FX trade in the morning and the dollars are due in the evening. The counterparty is shut by its regulator in the afternoon. What was the exposure, what is the risk called, and what would have removed it?

Hesperan had the full Rs 420 crore at risk for seven hours, from 10 am to 5 pm. This is settlement risk, often called Herstatt risk: one leg of an exchange is paid and the other is not yet received. It dwarfs the ordinary replacement cost of the trade, about Rs 2.5 crore if the rate moved 50 paise. Payment versus payment settlement, netting and settlement limits would have removed or capped it.

Buying a second-hand phone online and paying before it is posted is the everyday version. Until the parcel arrives you have handed over the full price and hold a promise. From 10 am to 5 pm Hesperan has paid Rs 420 crore and received nothing, so its exposure is the entire principal. When the counterparty fails in between, Hesperan becomes an unsecured creditor of the failed bank for the full amount.

Before either side pays, a failed FX trade costs only what it takes to replace it. If the rupee has moved to 84.50, buying USD 50 million elsewhere costs Rs 2.5 crore more; that is pre-settlement riskThe risk that a counterparty fails before a trade settles, measured by what it would cost to replace the trade at current prices.. Settlement risk on the same trade is about 168 times larger, Rs 420 crore against Rs 2.5 crore, because it is the principal rather than the price change. It lasts only hours, which is why it is easy to overlook and why it was named after a German bank whose closure in 1974 left counterparties paid out on one leg and unpaid on the other.

Three, in order of strength. Payment versus payment settlement releases both legs together or neither, so the gap in the timeline never opens; where a market has such a system or a central counterparty for FX, trades routed through it carry no principal risk. Netting reduces the amounts: if Hesperan also owed the same bank dollars on other trades that day, only the difference would move. Settlement limits treat each counterparty's daily settlement flows like a credit line, approved and monitored, so no single bank can take Rs 420 crore of intraday exposure without a credit decision.

One operational control matters too: know the time after which your payment cannot be recalled, and the time by which you would know the other leg had failed. Hesperan's gap was seven hours. Shortening it, or holding the rupee payment until the counterparty's condition is confirmed, is cheap. Confirm which settlement arrangements are available in your market and currency pair before relying on any of them.