Aggregate Risk

What Is Aggregate Risk?

Aggregate risk is frequently defined as the total amount of an institution's exposure to foreign exchange counterparty risk getting from a single client.

Foreign exchange (FOREX) contracts — both spot and forward — include a counterparty who is responsible for holding up their side of an agreement. In the event that an institution has settled on too numerous agreements with a single client, it might experience huge losses assuming the client can't pay their side of every one of their agreements. We could draw the similarity here with the concentrated risk for a B2B company who has the majority of its business with a single business and on the off chance that this last option defaults or changes to another vendor, the loss will be high.

Aggregate risk that is too high in light of the fact that too many contracts are held with a single counterparty is an effectively avoidable problem. An institution would have to broaden its wellsprings of counterparty risk by holding agreements with a wide number of clients.

Aggregate risk in forex may likewise be defined as the total exposure of an entity to changes or vacillations in currency rates.

Grasping Aggregate Risk

Banks and financial institutions closely monitor aggregate risk to limit their exposure to adverse financial turns of events —, for example, a credit crunch or even insolvency — emerging at a counterparty or client. This is accomplished through position limits that specify the maximum dollar amount of open transactions that can be placed into for spot and forward currency contracts anytime.

Aggregate risk limits will generally be bigger for well established counterparties and clients with sound credit ratings, and will be lower for clients who are either new or have lower credit ratings.

Illustration of Aggregate Risk

XYZ Corporation has several outstanding forex contracts with ABC Company. ABC Company has arrived at a position limit and can never again go into extra contracts with XYZ Corporation until it finishes off a portion of its current positions.

These limits are in place to safeguard XYZ Corporation from taking on too much counterparty risk, or aggregate risk, with ABC Company. Assuming ABC Company couldn't pay its side of the contracts, XYZ Corporation would need to limit its exposure to that loss.