The Hongkong and Shanghai Banking Corporation (HSBC) has started offering continuous linked settlement (CLS) to Indian Banks. CLS is an industry initiative to reduce foreign exchange settlement risk through the simultaneous exchange of currency values through CLS Bank.
CLS was launched worldwide on September 9 by CLS Bank which has been incorporated in New York. It operates from London. HSBC is one of the founding shareholders of CLS Bank. Currently seven global currencies are available through CLS including the US dollar, euro, yen, sterling, and Swiss francs.
According to Rajeev Bhargava, head-institutional banking, HSBC, the forex market is now mostly spot and is settled two days later due to differences in time zones. Banks can be at risk because they pay out the currency they sell before they receive the one they have bought.
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He added that the CLS would essentially address the settlement risk. Also through CLS banks will only have to make the net payments at the end of the day and this in turn will help banks to raise lesser resources with the result that the liquidity management pressure would be less. The expected reduction in liquidity needs for the market in general is expected to be at 80 per cent.
According to Pranam Wahi, head-corporate and institutional banking, HSBC, the settlement risk is essentially a credit risk. If both banks are in the same country the settlement risk is lesser. "There are a lot of hidden benefits in using the CLS. It will lower the transaction costs for banks and also the volumes in the market will go up," he added.
CLS guarantees no loss of principal. If there is a default, the bank will receive its principal which it had paid to the other bank.
According to Wahi, most Indian Banks will join as third party participants as to become a member a bank will have to pay $5 million and it makes sense for international players as they can leverage it more.
The volumes in the global forex market is estimated at currently $1.2 trillion while that in India is at around $2.3 billion.