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Replacement risk arises when a bank has an obligation to one party where the discharge of that obligation is conditional on a third party meeting its obligation to the bank. For example, the bank may have sold stock to the first party. It intends to deliver this stock using stock it has bought but not yet received from a third party. If the third party fails to deliver its stock the bank will have to buy it from the market at a potentially higher price.
The most common primary cause of bank failures is insolvency arising from credit losses. This is followed by failure to manage interest rate risk and foreign exchange risk. Failures arising from fraud, market risk and liquidity risk tend to hit the headlines but are far less common than those due to these first two factors.