Settlement Risk vs. Credit Risk management, difference, whereas, between

brain_wash_your

What is the difference between the two? In the risk management section it says settlement risk is a non-financial risk whereas credit risk is a financial risk. The descriptions of the two sound the same to me. What's the difference?

thommo77

Settlement Risk --> Risk that counterparty will fail to deliver the terms of a contract.
Credit risk --> default risk, downgrade risk, credit spread risk

mp3bu

Settlement Risk = Herstatt Risk

cityboy

not trying to be too picky but surely failure to delivery is the same as default risk?

pennyless

a firm can fail to deliver on a contract standalone but need not go bankrupt.

so failure to settle a contract is not the same as default.

IAmNeil

Thanks janakisri!

Windjam

I think you're describing the credit risk part of the contract. but I am not sure who settles such a contract. If it is exchange traded thyere is little to zero credit risk, if it is with a AAA bank you probably have recourse of some kind ( maybe a bailout? )

former

BTON04 Wrote:
-------------------------------------------------------
> This happens all the time in derivative contracts
> not traded on the exchange.

- to restate this correctly, the settlement risk exists i derivative contracts that are traded between two counterparties (eg GS and Morgan Stanley). And yes my point was that settlement does involve an element of "credit risk", therefore was seeking clarification.

mp3bu

I think settlement risk comprises both credit risk and liquidity risk ( but with a focus on liquidity ) .

Credit risk ALONE by itself denotes that one party is insolvent and is not likely to ever be able to settle.

In settlement risk , they may miss a payment or two but are otherwise solvent.

thommo77

I think settlement risk comprises both credit risk and liquidity risk ( but with a focus on liquidity ) .

Credit event ALONE by itself denotes that one party is insolvent and is not likely to ever be able to settle.

In settlement risk event , they may miss a payment or two but are otherwise solvent.

settlement risk event can happen due to liquidity without credit event happening , due to temporary liquidity crisis . But can happen due to other horrible or shady circumstances as well:

Schweser points to Hertstatt when a German bank was told to stop business at the end of the current day , but had already taken in payments from various counterparties. At the end of the day , these counterparties did not get their dues in foreign currencies or whatever instrument they had paid for ( cash flows ) .They became fully exposed even when they were almost fully hedged against this bank on their books.

This kind of problem is impossible for a default model to capture

Morning : full faith , Evening : Fully busted. i.e. settlement risk event occurred.