Implications of Netting Arrangement for Bank Risk in Foreign Exchange Transactions

With dollar amounts in this lofty range, participants in the foreign exchange market could incur substantial losses if the other parties to their transactions ~s’ere to default on the payments required to settle their side of the transactions. To reduce the costs of transactions and limit the size of these possible losses, some banks engage in bilateral netting of their foreign exchange transactions.’ In bilateral netting, two banks exchange daily only the net units of currencies in the transactions between them.