[Federal Register Volume 64, Number 221 (Wednesday, November 17, 1999)]
[Notices]
[Pages 62673-62676]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-29991]


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FEDERAL RESERVE SYSTEM

[Docket No. R-1032]


Settlement-day Finality for Automated Clearing House Credit 
Transactions

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has decided to make the settlement for ACH credit 
transactions processed by the Federal Reserve final when posted, which 
is currently 8:30 a.m. eastern time on the day of settlement. The Board 
considered a number of risk control measures and has decided to require 
prefunding for any ACH credit originations that settle through the 
Federal Reserve account of a depository institution that is being 
monitored in real time. The Board believes that settlement-day finality 
for ACH credit transactions will reduce risk to receiving depository 
financial institutions (RDFIs) and receivers and that the prefunding 
requirement will permit the Reserve Banks to manage their settlement 
risk as effectively as they do for other services with similar finality 
characteristics. The changes will be implemented by the Reserve Banks 
in early 2001 to permit time for necessary software modifications. A 
specific implementation date will be announced three months in advance 
of the effective date.

FOR FURTHER INFORMATION CONTACT: Jack K. Walton II, Manager, Retail 
Payments (202/452-2660); Myriam Y. Payne, Manager, Payment Systems Risk 
(202/452-3219); or Jeffrey S. H. Yeganeh, Senior Financial Services 
Analyst (202/728-5801), Division of Reserve Bank Operations and Payment 
Systems; for the hearing impaired only, contact Diane Jenkins, 
Telecommunications Device for the Deaf (202/452-3544), Board of 
Governors of the Federal Reserve System, 20th and C Streets NW, 
Washington D.C. 20551.

SUPPLEMENTARY INFORMATION:

Background

    In December 1998, in response to renewed calls from the banking 
industry to reduce the interbank settlement risk by improving the 
finality of ACH credit transactions, the Board requested comment on the 
benefits and drawbacks of making settlement for ACH credit transactions 
processed by the Federal Reserve Banks final when posted, which is 
currently 8:30 a.m. eastern time on the day of settlement (63 FR 70132, 
December 18, 1998). The Reserve Bank's uniform ACH operating circular 
gives the Reserve Banks the right to reverse settlement for credit 
transactions until 8:30 a.m. eastern time on the business day following 
the settlement day (Reserve Bank Operating Circular 4, Section 11.2). 
Specifically, a Reserve Bank can reverse settlement if it does not 
receive actually and finally collected funds from the originating 
depository financial institution (ODFI) by 8:30 a.m. eastern time on 
the business day following the settlement day. The Reserve Bank's 
current ACH risk control measures include ex post monitoring of 
daylight overdraft trends, requiring an ODFI at imminent risk of 
failure to prefund the value of the ACH credit transactions it 
originates, and reversing ACH credit transactions if an ODFI is unable 
to settle for those transactions. Under these risk control measures, 
the Reserve Banks have never incurred a financial loss due to the 
failure of an ODFI to settle for its ACH credit transactions.
    The Board noted, however, that it did not believe that current risk 
control measures provided Reserve Banks with adequate protection from 
settlement risk if settlement were to become final before the Reserve 
Banks knew whether depository institutions could fund the payments. 
Moreover, because the ACH is a value-dated mechanism and transactions 
could be processed two days before settlement, a simple balance check 
of an institution's settlement account at the time that a transaction 
is processed would be ineffective in managing risk. While an 
institution's available account balance may be sufficient to settle for 
its ACH credit originations at the time they are processed, those funds 
may be unavailable at the time of settlement.1
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    \1\ An institution's available balance includes its Federal 
Reserve account balance plus any available intraday credit.
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    Further, the Board noted that if the Reserve Banks were to provide 
settlement-day finality for ACH credit transactions, they should adopt 
risk control measures commensurate with those used in connection with 
other Federal Reserve services with similar finality characteristics, 
such as the Fedwire funds transfer service and the enhanced net 
settlement service. The Board believed that the adoption of 
commensurate risk controls would be critical to preventing the creation 
of incentives for monitored institutions to move payments from Fedwire 
to the ACH to avoid risk management controls. Specifically, the funds 
transfer and enhanced net settlement services, which provide final and 
irrevocable settlement at the time a transaction is credited to the 
depository institution's account, use real-time account balance 
monitoring to manage settlement risk. Reserve Banks apply real-time 
monitoring to a depository institution when they believe that 
additional controls over the institution's account activity are 
appropriate. For example, Reserve Banks apply real-time monitoring to 
institutions in weak financial condition or to institutions with 
chronic overdrafts in excess of what the Reserve Banks determine is 
prudent.2 When a depository institution is monitored in real 
time, Reserve Banks control their risk exposure by rejecting or 
delaying certain payment transactions with immediate finality if the 
institution's account balance would be exceeded.3

[[Page 62674]]

Thus, for institutions monitored in real time, a funds transfer or 
enhanced net settlement entry will not be processed unless the 
institution's available account balance is sufficient to fund the debit 
entry. The Board believed that a prefunding requirement for depository 
institutions being monitored in real time would enable Reserve Banks to 
manage their settlement risk using risk control measures that are 
commensurate with those used in services with similar finality 
characteristics.
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    \2\ The majority of depository institutions currently being 
monitored in real time are being monitored for reasons other than 
financial condition.
    \3\ Most depository institutions, however, are not monitored in 
real time. The account activity of an institution that is not 
monitored in real time is monitored for compliance with the daylight 
overdraft transaction posting rules on an ex post basis. As a 
result, Reserve Banks are able to control their credit risk exposure 
by monitoring the account balances of a selected group of depository 
institutions in real time, thereby restricting those institutions' 
access to Federal Reserve intraday credit.
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Summary of Comments

    The Board received twenty-nine comment letters in response to its 
December 1998 request for comment. The following table shows the number 
of comments by the category of commenter:

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                                                              Number of
                   Category of commenter                      responses
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Banks and bank holding companies...........................           11
Associations representing depository institutions..........            9
Federal Reserve Banks......................................            5
Corporate credit unions....................................            2
Associations representing corporations.....................            1
Government agencies........................................            1
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    Total..................................................           29
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    Twenty-seven commenters supported and two commenters opposed 
settlement-day finality for ACH credit transactions processed by the 
Reserve Banks. Further, nine commenters specifically supported and 
three commenters opposed the use of prefunding, as outlined in the 
December 1998 request for comment, as a risk control measure. Twenty-
one commenters cited the reduced risk to RDFIs and receivers as a 
benefit of settlement-day finality for ACH credit transactions. 
Additionally, five commenters believed that settlement-day finality 
would increase confidence in the ACH, facilitate product innovation, be 
consistent with settlement finality offered by private-sector ACH 
operators, and be consistent with the National Automated Clearing House 
Association's (NACHA) rules for consumer entries and marketplace 
practices for corporate entries.4 Eight commenters believed 
that the overall attractiveness of the ACH would increase and five 
commenters noted that the creditworthiness of the ACH would improve as 
a result of prefunding.
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    \4\ NACHA Operating Rules Section 4.4.1 requires an RDFI to make 
funds from credit entries available for cash withdrawal on the 
settlement day. Further, for credit entries to a consumer's account 
that are made available to the RDFI by 5:00 p.m. local time on the 
day before the settlement day, the RDFI must make the funds 
available for cash withdrawal by opening of business on the 
settlement day.
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    Several commenters noted, however, that the risk of credit 
transactions not settling on the intended settlement day, the potential 
difficulty of prefunding transactions deposited shortly before the 3:00 
a.m. deposit deadline, and the liquidity drain on ODFIs (or their 
correspondents) that are required to prefund represent potential 
drawbacks of settlement-day finality with prefunding as a risk control 
measure. Seven commenters suggested that ODFIs that are required to 
prefund might have to alter their funding practices, which may put them 
at a competitive disadvantage in providing origination services. 
Further, nine commenters believed that if ACH credit transactions were 
rejected or delayed due to the prefunding requirement, the public's 
confidence in the ACH would be undermined.
    Six commenters believed that prefunding for an ODFI that settles 
its ACH transactions through a correspondent should be based on the 
ODFI's risk profile and not that of the correspondent. These commenters 
believed that, because the ODFI is ultimately obligated to settle for 
the transactions and because a correspondent would not be permitted to 
revoke the settlement designation for transactions that had already 
been processed, prefunding should be based on the ODFI's financial 
condition. These commenters also stated that requiring prefunding based 
on the correspondent's risk profile would result in the disclosure of 
information regarding the financial condition of the correspondent. 
Three commenters, however, believed that prefunding should be based on 
the risk profile of the correspondent because the correspondent settles 
for the transactions and that the correspondent should manage its risk 
by monitoring the creditworthiness of the ODFIs to whom it provides 
services.
    The commenters were asked about alternative risk control measures 
that the Reserve Banks could use to manage their risk. Six commenters 
suggested that the Reserve Banks collateralize the ACH credit 
originations of ODFIs monitored in real time. These commenters believed 
that, through the use of collateral, the Reserve Banks could grant 
settlement-day finality with little risk of loss that might result from 
the failure of an ODFI. Also, one commenter supported the use of the 
Reserve Banks' enhanced net settlement service and one commenter 
supported the use of origination caps for ODFIs monitored in real time.
    Some commenters indicated that if the Reserve Banks granted 
settlement-day finality for ACH credit transactions, settlement 
finality would no longer be a consideration in the choice of ACH 
operator. Other commenters suggested that settlement-day finality was 
not a major factor in the choice of ACH operator. Six commenters 
believed that settlement-day finality would result in an increase in 
the use of the ACH for various reasons, including reduction in risk, 
ACH product innovation (such as cross-border ACH services), and a shift 
of volume from other payment mechanisms, such as check and Fedwire 
funds transfer. A few commenters believed that settlement-day finality 
would not have a major influence on ACH volume.

Requiring Prefunding To Manage the Reserve Banks' Settlement Risk

    After carefully considering the comments received, the Board has 
decided to make the settlement for ACH credit transactions processed by 
the Reserve Banks final when posted, which is currently 8:30 a.m. on 
the settlement day. Further, the Board has decided to require 
prefunding for any ACH credit originations that settle through a 
settlement account that is being monitored in real time. The Board 
believes that this prefunding requirement will permit the Reserve Banks 
to manage their settlement risk as effectively as they do for other 
services with similar finality characteristics. Prior to the 
implementation of settlement-day finality and prefunding, the Reserve 
Banks will have to modify their software and revise their ACH operating 
circular. To permit time to make the required changes, settlement-day 
finality for ACH credit transactions will be implemented in early 2001. 
A specific implementation date will be announced three months in 
advance of the effective date.
    Under prefunding, if an ODFI's settlement account is being 
monitored in real time, the Reserve Banks would process the 
transactions only after the settlement account has been debited. On the 
settlement day, the Reserve Banks would credit the RDFI's settlement 
account with final funds. 5 If the available balance in the 
ODFI's

[[Page 62675]]

settlement account were not sufficient to fund the transactions, the 
transactions would generally not be processed until the settlement 
account was funded. Most ODFI settlement accounts are not monitored in 
real time, however. In these cases, ACH credit originations would not 
be prefunded and the incoming files would be processed as they are 
today. If an institution that settles an ODFI's ACH transactions fails 
unexpectedly, the Reserve Banks would reserve the right to reverse the 
ACH credit transactions that have not yet settled and would send 
reversal files to RDFIs for those transactions. Reserve Banks, however, 
would not reverse transactions that had already settled, as the 
settlement would have been final.
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    \5\  The Reserve Banks will not provide as-of adjustments to 
compensate institutions for the float generated through the 
prefunding requirement. The Board expects that ODFIs will modify 
their operations to minimize the costs associated with prefunding by 
depositing ACH credit transactions closer to the deposit deadline.
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    The Board has decided to use prefunding to manage risk for several 
reasons. First, the Board believes that the prefunding of ACH credit 
transactions that settle through accounts that are monitored in real 
time would establish risk control measures for the Reserve Banks' ACH 
service that are commensurate with those used in the Fedwire funds 
transfer and enhanced net settlement services. The adoption of 
commensurate risk controls should discourage monitored institutions 
from moving payments from Fedwire to the ACH to avoid risk management 
controls. Second, the Board identified concerns with the alternate risk 
control measures suggested by the commenters.
    Specifically, commenters suggested the use of collateral, the use 
of the enhanced net settlement service, and the use of origination caps 
as risk control measures. The use of collateral as a risk control 
measure is inconsistent with the Board's payments system risk policy 
that restricts the use of collateral for intraday extensions of central 
bank credit to overdrafts resulting from book-entry securities 
transfers and certain other special situations. As the Board, over 
time, reviews its payments system risk policy, it will examine the 
appropriateness of the policy's restrictions on the use of collateral. 
The Board, however, believes that it would be inappropriate to modify 
its payments system risk policy solely for the purpose of granting 
settlement-day finality for ACH credit transactions when other viable 
options are available. The suggestion that the Reserve Banks use the 
enhanced net settlement service to settle ACH transactions they process 
does not take into account other risk controls that private settlement 
arrangements typically employ to facilitate a smooth settlement 
process. For example, while Reserve Banks make ACH services available 
to all institutions regardless of financial condition, private-sector 
ACH operators typically manage their risk by using membership criteria 
to exclude financially troubled institutions from participation in 
their private ACH exchange. The use of membership criteria enables 
private-sector ACH operators to help ensure that the net settlement for 
their ACH exchanges takes place without difficulty and in a timely 
fashion. Finally, the use of origination caps, as a risk control 
measure, would not protect the Reserve Banks from the risk of financial 
loss should there be insufficient funds in the account where ACH credit 
originations are designated to settle.
    The Board recognizes a number of drawbacks associated with 
prefunding as a risk control measure but does not believe that they are 
of sufficient magnitude to prevent the adoption of settlement-day 
finality for ACH credit transactions using prefunding to control risk. 
The Board agrees with commenters that if ACH credit transactions are 
delayed or do not settle on the intended settlement day, then the 
public's confidence in the ACH could be undermined. While short-term 
disruptions may occur if settlements are delayed or do not settle on 
the intended settlement day, the Board believes that, in the long term, 
market forces should result in fewer delayed settlements as originators 
more closely monitor the condition of their ODFIs and ODFIs more 
closely monitor the condition of their correspondents. The Board also 
recognizes that it may be difficult for an institution being monitored 
in real time to prefund gross ACH transactions, particularly near the 
3:00 a.m. deposit deadline. This situation will likely necessitate 
changes in operational or funding practices at these institutions as 
they will have to ensure that they have sufficient funds in their 
settlement accounts to fund their ACH gross originations.
    Finally, the Board has decided that, in cases where an ODFI uses a 
correspondent to settle for its ACH transactions, the prefunding 
requirement should be based on whether the correspondent's account is 
being monitored in real time. While an ODFI is ultimately responsible 
for settling its ACH transactions, some ODFIs do not have account 
relationships with the Federal Reserve and designate a correspondent 
settlement account to settle their ACH transactions. When an ODFI's ACH 
credit transactions settle through a correspondent, the potential for 
insufficient funds in the correspondent's account at the time of 
settlement is a function of the risk profile of the correspondent. 
Thus, the risk profile of the correspondent is critical in the 
management of the Reserve Bank's settlement risk. If the correspondent 
is being monitored in real time, the Reserve Banks would require the 
correspondent to prefund the ODFI's ACH credit transactions. If the 
correspondent is not being monitored in real time, the Reserve Banks 
would not require prefunding for ACH credit transactions that settle 
through the correspondent.

Competitive Impact Analysis

    In assessing the competitive impact of granting settlement-day 
finality for ACH credit transactions processed by the Reserve Banks, 
the Board considers whether there will be a direct and material adverse 
effect on the ability of other service providers to compete with the 
Federal Reserve due to differing legal powers or due to the Federal 
Reserve's dominant market position deriving from such legal 
differences.\6\
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    \6\  The Federal Reserve in the Payments System, FRRS 7-145.2
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    Although the Federal Reserve's ACH service does not derive its 
dominant market position from legal differences, the fact that the 
Federal Reserve maintains accounts directly or indirectly for all 
depository institutions to settle may make it easier for some 
institutions to use the Federal Reserve's services. The enhanced net 
settlement service was designed, in part, to offset that potential 
advantage by making it easier for a private-sector entity to function 
settlement entries to depository institutions nationwide. As was 
discussed above, the enhanced net settlement service checks the 
available account balance of depository institutions that are being 
monitored in real time and debits the accounts of institutions in a net 
debit position if sufficient funds are available; otherwise, the 
settlement is delayed until funding situation is resolved. If the 
Reserve Banks were to improve the settlement finality for the ACH 
transactions they process without implementing similar risk controls, 
competitive questions might be raised. The Board, however, believes 
that the expanded use of prefunding provides risk controls commensurate 
with those of the enhanced settlement service.
    While private-sector operators that use the Fedwire-based or 
enhanced net settlement service will be able to offer settlement-day 
finality for the ACH credit transactions they process, they typically 
do not require prefunding from participants with higher risk profiles. 
As

[[Page 62676]]

discussed above, private-sector ACH operators manage their settlement 
risk by limiting their services to those institutions that meet their 
admission criteria. Nevertheless, private-sector ACH operators could 
require prefunding from their participants as an additional risk 
control measure, if they chose to do so. Thus, the Board does not 
believe that settlement-day finality for ACH credit transactions 
processed by the Federal Reserve and conditioned on the expanded use of 
prefunding would adversely affect competition in the provision of 
interbank ACH services.

    By order of the Board of Governors of the Federal Reserve 
System, November 10, 1999.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 99-29991 Filed 11-16-99; 8:45 am]
BILLING CODE 6210-01-P