[Federal Register Volume 63, Number 239 (Monday, December 14, 1998)]
[Notices]
[Pages 68768-68771]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33048]
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FEDERAL RESERVE SYSTEM
[Docket R-1014]
Federal Reserve Bank Services
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice.
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SUMMARY: The Board has decided to retain the current thirty-minute
settlement period at the end of the Fedwire funds transfer operating
day and not to implement restrictions on respondent bank transfers
during the last fifteen minutes of the settlement period, from 6:15
p.m. to 6:30 p.m. eastern time.
FOR FURTHER INFORMATION CONTACT: Louise Roseman, Associate Director
(202/452-2789), Jeff Stehm, Manager (202/452-2217), or Gina Sellitto,
Financial Services Analyst (202/728-5848), Division of Reserve Bank
Operations and Payment Systems. For the hearing impaired only:
Telecommunications Device for the Deaf (TDD), Diane Jenkins (202/452-
3749).
SUPPLEMENTARY INFORMATION:
I. Background
In October 1989, the Board requested comment on a proposal to
segment the last half hour of the Fedwire funds transfer operating day,
from 6:00 p.m. to 6:30 p.m. eastern time (all times stated are eastern
time), into two settlement periods (54 FR 41681, October 11, 1989). The
first fifteen minutes would be reserved for any bank-to-bank funds
transfers, including transfers sent or received by depository
institutions on behalf of respondent bank customers. The second fifteen
minutes would be reserved for transfers sent or received by
[[Page 68769]]
depository institutions for their own accounts. At that time, the Board
did not adopt a segmented settlement period because of the concerns
expressed by commenters and the lack of strong industry support (55 FR
18755, May 4, 1990). The Board, however, indicated that it would
monitor developments with regard to reserve account management and
determine whether segmenting the settlement period should be
reconsidered at a later date.
In response to the Board's request for comment on a return to a
system of lagged reserve requirements (62 FR 60671, November 10, 1997),
the New York Clearing House Association (NYCHA) pointed out that
several developments since 1990 make the banks' task of managing their
reserve positions more difficult. These developments include (1) a
significant reduction in reserve balances resulting from reductions in
reserve requirements in 1990 and 1992 and the use of retail sweep
accounts starting in 1994, and (2) a reduction in the pool of available
buyers of federal funds due to consolidation in the banking industry.
In light of these developments, NYCHA noted that correspondents
cannot know their reserve positions with certainty until Fedwire has
closed because respondent banks are able to use the entire Fedwire
settlement period from 6:00 p.m. to 6:30 p.m. to move funds into and
out of accounts at their correspondent banks.1 The
unexpected receipt of funds for a respondent bank very late in the day
could result in the correspondent bank having more reserves than
planned, which may be difficult to invest late in the day without a
significant rate concession. Likewise, a late-in-the-day request to pay
out funds on behalf of a respondent bank may result in a reserve
shortfall at the correspondent bank that may be difficult and costly
for the correspondent to fund.
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\1\ NYCHA members have indicated that their concerns relate
primarily to late-in-the-day transfers on behalf of foreign
respondent banks and that transfers on behalf of domestic respondent
banks are generally not performed after 6:15 p.m.
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NYCHA also argues that unanticipated excess or deficit reserve
positions create uncertainty and volatility in the federal funds rate.
It believes that a segmented Fedwire funds transfer settlement period
would allow each bank to calculate its reserve position with greater
accuracy and facilitate a more efficient and orderly interbank funding
market. NYCHA, therefore, requested that the Board reconsider a two-
part settlement period, in which the last fifteen minutes of the
Fedwire funds transfer operating day, from 6:15 p.m. to 6:30 p.m., are
reserved exclusively for transfers sent by and received for a bank's
own account.
The Board's decision on lagged reserves (63 FR 15069, March 30,
1998) indicated that it would continue to review the idea of a
segmented settlement period and other ideas for reducing volatility in
the federal funds market. As part of this review, the Board requested
comment in June 1998 on the costs, benefits, and desirability of a
segmented Fedwire settlement period (63 FR 31777, June 10, 1998). In
its request for comment, the Board raised questions regarding (1) the
potential benefits, costs, and drawbacks of restrictions on respondent
transfers during the last fifteen minutes of the Fedwire operating day,
including the effects on reserve account management, federal funds rate
volatility, and respondent payment services, and (2) implementation
alternatives and other operational considerations.
II. Summary of Comments
The Board received twenty-seven responses to its request for
comment. About three-quarters of the commenters were commercial banks
or bank holding companies. The number of commenters by type of
organization were as follows:
Clearing House Associations........................................ 2
Commercial Banking Organizations................................... 20
Consumer Payment System............................................ 1
Credit Union....................................................... 1
Federal Reserve Banks.............................................. 2
Trade Association.................................................. 1
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Total public comments.......................................... 27
Twelve commenters supported the Board's adoption of a Fedwire
segmented settlement period, including Bank of America, Bank of New
York, Citibank, N.A., First Bank of San Luis Obispo, MBNA America Bank,
N.A., NationsBank Corporation, NYCHA, The Peoples State Bank of Clyde,
PFF Bank & Trust, Republic National Bank of New York, State Bank of
Southern Utah, and Winnsboro State Bank & Trust Company. Ten commenters
opposed the proposal, including Bank Boston, N.A., Bankers Clearing
House, The Federal Reserve Bank of Atlanta, The Federal Reserve Bank of
Richmond, Firstar Bank Milwaukee, N.A., First Chicago NBD Corporation,
First Maryland Bancorp, State Street Bank and Trust, UMB Bank, and
Wachovia Corporation. Five commenters neither supported nor opposed a
Fedwire segmented settlement period but offered comments on certain
aspects of the proposal, including Alcoa Tenn Federal Credit Union,
Canyon Creek National Bank, Independent Bankers Association of America,
Mellon Bank, N.A., and Visa U.S.A., Inc.
Given the mix of views expressed in the comments and the lack of an
industry consensus, Board staff invited the commenters to participate
in a discussion of the proposal in October 1998. The purpose of this
discussion was to clarify the views and concerns of the commenters
regarding late-day transfers and reserve account management. Although
the discussion helped to clarify commenters' views, no new information
was received that provided a compelling case for a segmented settlement
period.
A. Effects of Late-Day Transfers on Correspondent Banks
Depository institutions hold balances at the Federal Reserve to
meet reserve and clearing balance requirements and to facilitate their
payment transactions. In the past, reserve and clearing balance
requirements resulted in total required balances that were usually
above the level needed for payment purposes. That is, the level of
total required balances in relation to payment demands generally
provided sufficient protection against overnight overdrafts in
depository institutions' Federal Reserve accounts. In this environment,
payment-related demand generally and late-day transfers more
specifically did not usually have a significant influence on the
overall demand for balances at the Federal Reserve and end-of-day
reserve management requirements.
Regulatory reductions in reserve requirements and financial
innovations such as retail sweep accounts have lowered required reserve
balances during the 1990s. Although depository institutions have
responded to lower required reserves by holding additional required
clearing balances, the total required balances held by depository
institutions at the Federal Reserve have dropped to historically low
levels. In an environment of low required balances, payment-related
demand for balances more frequently appears to exceed the demand for
balances to meet total balance requirements. Payment-related demand is
difficult to measure and to predict.2 Consequently,
uncertain
[[Page 68770]]
payment-related demand coupled with low total required balances may
lead to greater volatility in the federal funds rate, both during the
day and across days.
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\2\ Cheryl L. Edwards, ``Open Market Operations in the 1990s,''
Federal Reserve Bulletin, vol. 83 (November 1997), pp. 859-874;
Gordon H. Sellon, Jr. and Stuart E. Weiner, ``Monetary Policy
Without Reserve Requirements: Analytical Issues,'' Federal Reserve
Bank of Kansas City, Economic Review (Fourth Quarter 1996), pp. 5-
24; James A. Clouse and Douglas W. Elmendorf, ``Declining Required
Reserves and the Volatility of the Federal Funds Rate,'' Working
Paper (Board of Governors of the Federal Reserve System, June 1997);
and Craig Furfine, ``Interbank Payments and the Daily Federal Funds
Rate,'' Working Paper (Board of Governors of the Federal Reserve
System, August 1998).
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On the other hand, the extent of the effect of declining required
balances on the volatility of the funds rate is not clear. For example,
the volatility of the funds rate since 1996 has not risen significantly
(at least until recent weeks) despite declining total required balances
and increasing payment flows. This result may be due, in part, to
improvements by depository institutions in their information systems
and their use of real-time balance information from the Federal Reserve
to manage their Federal Reserve balances more closely during the day.
In addition, the Federal Reserve, through its open market operations,
has responded to days of heightened payment flows by supplying reserves
more generously on those days.
Although volatility has not increased significantly, commenters
noted that the late-day rate in the federal funds market can be quite
volatile. First Chicago NBD Corporation (FCN), for example, pointed out
that the federal funds market after 6:15 p.m. is not very efficient and
indicated that unexpected late-day funding needs could cause large
changes in the federal funds rate.
Other commenters noted that a sizable portion of federal funds
transactions occur late in the day. They cited the Board's May 1998
Senior Financial Officer Survey, which indicated that on a typical day
16 percent of federal funds transactions are arranged and 18.3 percent
of federal funds purchases are delivered after 6:00 p.m. On days
characterized by especially volatile payment flows, these figures
increase to 17 percent and 20.6 percent respectively. The survey also
indicated that the shift toward later federal funds transactions might,
in part, reflect the combined effects of low required reserve account
balances and payment system risk policies such as daylight overdraft
caps and charges for daylight overdraft credit. Some commenters
supported this finding by indicating that foreign respondents draw down
on their intraday credit lines with their U.S. correspondents early in
the morning in order to provide intraday funding of their Federal
Reserve accounts and avoid daylight overdraft charges or cap breaches.
These funds are returned to the correspondent late in the day,
potentially complicating the correspondent's ability to manage its
reserve account position.
Those who supported the proposal argued that the benefits of a
segmented settlement period for Fedwire outweighed any negative
effects. The benefits cited by commenters included a more orderly
settlement of reserve positions, reduced uncertainty in the management
of reserve positions, and reduced volatility in the federal funds rate.
UMB Bank and Wachovia, which both opposed the proposal, agreed that a
segmented settlement period would facilitate reserve account management
for most banks with active respondent customers. Mellon Bank, which was
neutral on the proposal, indicated that large money center institutions
with respondent customers that make late-day transfers would benefit
from a Fedwire segmented settlement period. The commenters, however,
did not quantify the frequency with which late-day respondent transfers
occur, the cost of late-day reserve account management difficulties, or
the number of depository institutions likely to be affected by any
restrictions on late-day transfers.
With regard to operational issues related to implementation of a
segmented settlement period, comments were also mixed. Of the
supporters, four preferred the use of as-of adjustments, two preferred
operational changes to Fedwire, and the remaining six institutions did
not express a particular view.3 In addition, of the
institutions that either opposed the proposal or were neutral, one
institution said, if adopted, the proposal should be implemented using
as-of adjustments and three institutions preferred operational changes
to Fedwire. Supporters of as-of adjustments indicated that their use
would provide flexibility to permit payments that do not disadvantage
the receiving bank to be accommodated at the discretion of the
receiving bank. Commenters opposing the use of as-of adjustments,
however, indicated that their use would result in the proposal being
implemented unevenly, would not provide a sufficient deterrent to late-
day transfers, and would be difficult to enforce. They further
indicated that the as-of process does not eliminate the uncertainty of
late-day payments because as-of adjustments are granted only after the
fact and are neither automatically given nor necessarily beneficial.
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\3\ A Fedwire segmented settlement period could be implemented
by allowing the receiving institution the option to reverse an
improperly sent transfer on the same day. If this was not possible
prior to the final close of Fedwire, then on the following day the
receiving bank could request that the Federal Reserve function an
as-of adjustment to its reserve position and the reserve position of
the sending bank. Under another approach, the Fedwire funds transfer
system might be modified to incorporate a new type code and/or new
edit criteria to detect and reject transfers sent on behalf of
respondents after 6:15 p.m.
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Supporters of operational changes to Fedwire believed that such
changes would be the most effective means of restricting respondent
transfers. Although several other commenters agreed with the
effectiveness of this approach, they did not support potentially costly
operational changes to Fedwire and the internal systems of a large
number of banks to accommodate the concerns of a limited number of
money center banks. Commenters were also concerned about implementing
any operational changes to Fedwire at a time when depository
institutions are preparing for the century date change.
B. Effects on Respondents and Private Clearing Arrangements
Responses varied on the effects of late-day transfer restrictions
on respondent institutions. In most cases, the commenters who supported
the proposal believed that transfer restrictions on respondents would
not significantly impede liquidity management, while the commenters who
opposed the proposal believed that restrictions could hamper
respondents' ability to manage their reserve positions.
NYCHA indicated that a significant portion of the activity that has
caused difficulty for its members is attributable to respondents that
maintain their own Federal Reserve accounts as well as accounts at
correspondents. According to NYCHA, there is very little late-day
transfer activity by banks that maintain reserve balances through pass-
through correspondents. The Independent Bankers Association of America
(IBAA) indicated that community banks typically execute their Fedwire
funds transfers and their investment and reserve account management
decisions much earlier than 6:00 p.m. Two other commenters said that
their internal cut-off times for processing respondent customer
transfers are prior to the close of the Fedwire funds transfer
operating day.
In contrast, other commenters argued that late-day transfer
restrictions could hamper respondents' ability to manage their reserve
positions, especially if their current reserve management practices
include late-day federal funds transactions with respondent banks or
because respondents fund their balances at other banks through late-day
transfers. These commenters preferred to have greater flexibility for
moving funds late in the day. Firstar and Bank Boston said that they
regularly send and
[[Page 68771]]
receive funds transfers on behalf of their respondent customers between
6:15 and 6:30 p.m. and that they believe the cost of implementation and
the inconvenience to their respondent bank customers of a segmented
settlement period outweigh the reserve management benefits. Mellon Bank
also indicated that because respondent banks would have to meet an
earlier funding deadline than would depository institutions that are
direct Federal Reserve account holders, respondents would not be able
to participate fully in the federal funds market, presumably making the
market more illiquid and potentially more volatile.
In addition to these concerns, the Bankers Clearing House indicated
that late-day transfer restrictions may create logistical and
competitive problems for some West Coast clearing services. In
particular, if a private clearing organization's settlement service has
a limited ability to move final funds late in the day, it may not be
able to compete effectively with similar Federal Reserve services.
Similarly, Visa U.S.A., Inc. expressed concern that the VisaNet ACH
settlement arrangement might be affected adversely if respondent
transfers were limited during the last fifteen minutes of the Fedwire
funds transfer operating day. Several of the VisaNet ACH settlement
participants settle on behalf of respondent depository institutions.
III. Conclusion
The Board has decided not to adopt a Fedwire segmented settlement
period. Although a segmented settlement period might provide an
additional tool for reducing uncertainty in payment flows by some
banks, the operations of other entities would be restricted. It is not
clear that such an approach would significantly reduce uncertainty and
volatility for the market as a whole. For example, respondent banks
might react to late-day transfer restrictions by advancing the timing
of their funds transfers to just prior to their Fedwire cutoff time.
The possible effect of advancing the timing of respondent transfers
might be an increase in market volatility during this earlier period,
albeit possibly to a level somewhat less than that currently
experienced very late in the day. Even if a segmented settlement period
did not shift volatility earlier, it would likely result in a reduction
of volatility only during the last fifteen minutes of the Fedwire
operating day. A significant reduction in overall volatility as a
result of a segmented settlement period, therefore, seems unlikely.
Moreover, only a limited number of institutions have indicated
difficulties in managing their Federal Reserve positions because of
late-day respondent transfers. To a large extent, these difficulties
are a result of the businesses in which correspondent banks have chosen
to engage, such as intraday credit lines and late-day respondent
transfer processing. In the Board's view, affected correspondent banks
should weigh the benefits of providing late-day payment services to
their respondent customers against any reserve management difficulties
that the provision of such services may cause. If a correspondent
determines that late-day transfers are causing excessive reserve
management difficulties, the Board believes that the correspondent can
take steps on its own to mitigate these problems. Individual banks, for
example, can impose internal cut-off times for sending and receiving
respondent transfers that are earlier than the Fedwire
deadlines.4 Establishing earlier cut-off times for outgoing
respondent transfers will prevent late-day, unanticipated funds
outflows from a correspondent's Federal Reserve account. Likewise,
earlier cut-off times for incoming respondent transfers, although
incapable of preventing the inflow of funds from respondent banks,
should encourage respondent banks to process their Fedwire payments
earlier because transfers received after a correspondent's cut-off time
can be credited to the respondent's account as of the next banking day.
Many banks currently impose such internal cut-off times for processing
customer wire transfers. Some banks, however, were concerned that if
they were to impose earlier internal cut-off times for respondent
transfers, they may lose these customers to other institutions that did
not impose such deadlines. These banks indicated that the only uniform
way to control late-day respondent transfers without creating
competitive issues among correspondent banks was to impose Federal
Reserve restrictions on respondent banks. The Board does not believe
that such competitive issues warrant the imposition by the Federal
Reserve of respondent transfer restrictions.
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\4\ State law allows depository institutions to establish fixed
cut-off times for the processing of payment orders. Uniform
Commercial Code (UCC) Article 4A Section 106(a) states that a
receiving bank may fix a cut-off time or times on a funds-transfer
business day for the receipt and processing of payment orders.
Different cut-off times may apply to different senders or categories
of payment orders. If a payment order is received after the
appropriate cut-off time on a funds transfer business day, the
receiving bank may treat the payment order as received at the
opening of the next funds transfer business day.
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Finally, implementation of a segmented settlement period would
involve potentially costly operational changes to Fedwire or the use of
as-of adjustments to correct improperly sent transfers. Operational
changes would not only affect the Federal Reserve, but also the
internal systems of a large number of banks. Likewise, as-of
adjustments would involve time-consuming exception processing and
augment uncertainty in reserve projections.
IV. Analysis of Competitive Effects
The Board has established procedures for assessing the competitive
effects of rule or policy changes that have a substantial impact on
payment system participants.5 Under these procedures, the
Board will assess whether a change would have a direct and material
adverse effect on the ability of other service providers to compete
effectively with the Federal Reserve in providing similar services
because of differing legal powers or constraints or because of a
dominant market position of the Federal Reserve deriving from such
differences. The Board's decision not to adopt a Fedwire segmented
settlement period will not adversely affect the ability of other
service providers to compete with the Federal Reserve in the provision
of large-value electronic funds transfer services.
\5\ These procedures are described in the Board's policy
statement, ``The Federal Reserve in the Payments System,'' as
revised in March 1990 (55 FR 11648, March 29, 1990).
By order of the Board of Governors of the Federal Reserve
System, December 8, 1998.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 98-33048 Filed 12-11-98; 8:45 am]
BILLING CODE 6210-01-P