The increased time between a payment instruction and settlement finality introduces which type of risk?

The correct answer is settlement risk. This type of risk arises when there is a time gap between when a payment instruction is initiated and when the transaction is actually settled, which can lead to uncertainties regarding the completion of the transaction. During this interval, if one party fails to fulfill their obligations—whether due to insolvency, operational issues, or counterparty defaults—there is a risk that the transaction will not be completed as planned.

Settlement risk is particularly significant in payment systems where the transfer of funds does not occur instantaneously. As transactions can take longer to process due to various factors such as batch processing times or differences in time zones, the longer the delay, the greater the chance that one party may encounter difficulties that impact their ability to complete the transaction.

In contrast, credit risk pertains to the possibility that a counterparty will default on their obligation to pay, liquidity risk involves the inability to obtain cash or liquid assets to meet obligations, and market risk concerns losses due to changes in market prices. While these risks can also have financial implications, they stem from different underlying issues than those associated with the time delay in settlement. Hence, the nature of the risk specifically tied to the delay before completion of payment settles is classified as settlement risk.