[Federal Register Volume 66, Number 108 (Tuesday, June 5, 2001)]
[Notices]
[Pages 30208-30214]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-13982]


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FEDERAL RESERVE SYSTEM

[Docket No. R-1111]


Policy Statement on Payments System Risk; Potential Longer-Term 
Policy Direction

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comment on policy.

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SUMMARY: The Board is requesting comment on the benefits and drawbacks 
of various policy options that it is evaluating as part of a potential 
longer-term direction for its payments system risk (PSR) policy. The 
longer-term policy options include the following: (1) Lowering single-
day net debit cap levels to approximately the current two-week average 
cap levels and eliminating the two-week average net debit cap, (2) 
implementing a two-tiered pricing regime for daylight overdrafts such 
that institutions pledging collateral to the Reserve Banks pay a lower 
fee on their collateralized daylight overdrafts than on their 
uncollateralized daylight overdrafts, and (3) monitoring in real time 
all payments with settlement-day finality and rejecting those payments 
that would cause an institution to exceed its net debit cap or daylight 
overdraft capacity level.

EFFECTIVE DATE: Comments must be received by October 1, 2001.

ADDRESSES: Comments, which should refer to Docket No. R-1111, may be 
mailed to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551 
or mailed electronically to [email protected].

[[Page 30209]]

Comments addressed to Ms. Johnson also may be delivered to the Board's 
mailroom between 8:45 a.m. and 5:15 p.m. and to the security control 
room outside of those hours. Both the mailroom and the security control 
room are accessible from the courtyard entrance on 20th Street between 
Constitution Avenue and C Street, NW. Comments may be inspected in Room 
MP-500 between 9:00 a.m. and 5:00 p.m. weekdays, pursuant to 
Sec. 261.12, except as provided in Sec. 261.14, of the Board's Rules 
Regarding Availability of Information, 12 CFR 261.12 and 261.14.

FOR FURTHER INFORMATION CONTACT: Paul Bettge, Associate Director (202/
452-3174), Stacy Coleman, Manager (202/452-2934), or John Gibbons, 
Senior Financial Services Analyst (202/452-6409), Division of Reserve 
Bank Operations and Payment Systems.

SUPPLEMENTARY INFORMATION: This is one of five notices regarding 
payments system risk that the Board is issuing for public comment 
today. Three near-term proposals concern the net debit cap calculation 
for U.S. branches and agencies of foreign banks (Docket No. R-1108), 
modifications to the procedures for posting electronic check 
presentments to depository institutions' Federal Reserve accounts for 
purposes of measuring daylight overdrafts (Docket No. R-1109), and the 
book-entry securities transfer limit (Docket No. R-1110). The Board is 
also issuing today an interim policy statement and requesting comment 
on the broader use of collateral for daylight overdraft purposes 
(Docket No. R-1107). Furthermore, to reduce burden associated with the 
PSR policy, the Board recently rescinded the interaffiliate transfer 
(Docket No. R-1106) and third-party access policies (Docket No. R-
1100).
    The Board requests that in filing comments on these proposals, 
commenters prepare separate letters for each proposal, identifying the 
appropriate docket number on each. This will facilitate the Board's 
analysis of all comments received.

I. Background

    Beginning in 1985, the Board adopted and subsequently modified a 
policy to reduce the risks that payment systems present to the Federal 
Reserve Banks, to the banking system, and to other sectors of the 
economy. An integral component of the PSR policy was to control 
depository institutions' use of intraday Federal Reserve credit, 
commonly referred to as ``daylight credit'' or ``daylight overdrafts.'' 
The Board intended to address the Federal Reserve's risk as well as 
risks to various types of private-sector networks, primarily large-
dollar payments systems. Risk can arise from transactions on the 
Federal Reserve's wire transfer system (Fedwire), from other types of 
payments, including checks and automated clearing house transactions, 
and from transactions on private large-dollar networks.
    The Federal Reserve Banks face direct risk of loss should 
depository institutions be unable to settle their daylight overdrafts 
in their Federal Reserve accounts before the end of the day. Moreover, 
systemic risk might occur if an institution participating on a private 
large-dollar payments network were unable or unwilling to settle its 
net debit position. If such a settlement failure occurred, the 
institution's creditors on that network might also be unable to settle 
their commitments. Serious repercussions could, as a result, spread to 
other participants in the private network, to other depository 
institutions not participating in the network, and to the nonfinancial 
economy generally. A Reserve Bank could be exposed to indirect risk if 
Federal Reserve policies did not address this systemic risk.
    The 1985 policy required all depository institutions incurring 
daylight overdrafts in their Federal Reserve accounts as a result of 
Fedwire funds transfers to establish a maximum limit, or net debit cap, 
on those overdrafts (50 FR 21120, May 22, 1985). In subsequent years, 
the Federal Reserve modified and expanded the original PSR policy by 
reducing net debit cap levels and addressing the risk controls for 
activities such as book-entry securities transfers, large-dollar 
multilateral netting systems, and certain private securities clearing 
and settlement systems.
    In 1986, the Board requested comment on reducing net debit cap 
levels (51 FR 45050, December 15, 1986). At that time, the Board noted 
that it purposely set the original net debit cap levels relatively high 
so that institutions and examiners could gain experience with the caps. 
In 1987, the Board announced that it would reduce cap levels by 25 
percent and stated that it would evaluate further reductions in the 
future (52 FR 29255, August 6, 1987). In May 1990, the Board issued a 
revised policy statement that incorporated the exempt-from-filing net 
debit cap, changed the existing de minimis cap, and included book-entry 
securities transfers in measuring institutions' overdrafts against 
their caps (55 FR 22087 and 22092, May 31, 1990).
    In 1989, the Board requested comment on a proposed change to its 
payments system risk reduction program that would assess a fee of 60 
basis points, phased in over three years, for average daily overdrafts 
in excess of a deductible of 10 percent of risk-based capital (54 FR 
26094, June 21, 1989). The fee was to be phased in as 24 basis points 
in 1994, 48 basis points in 1995, and 60 basis points in 1996. The 
purpose of the fee was to encourage behavior that would reduce risk and 
increase efficiency in the payments system. The Board approved the 
proposed policy change in 1992 and began pricing daylight overdrafts in 
April 1994 (57 FR 47084, October 14, 1992).\1\
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    \1\ To facilitate the pricing of daylight overdrafts, the 
Federal Reserve adopted a modified method of measuring daylight 
overdrafts that more closely reflects the timing of actual 
transactions affecting an institution's intraday Federal Reserve 
account balance. This measurement method incorporates specific 
account posting times for different types of transactions.
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    In March 1995, the Board decided to raise the daylight overdraft 
fee to 36 basis points instead of the 48 basis points originally 
announced (60 FR 12559, March 7, 1995). Because aggregate daylight 
overdrafts fell approximately 40 percent after the introduction of 
fees, the Board was concerned that raising the fee to 48 basis points 
could produce undesirable market effects contrary to the objectives of 
the risk-control program. The Board believed, however, that an increase 
in the overdraft fee was needed to provide additional incentives for 
institutions to reduce overdrafts related to funds transfers. The Board 
stated it would evaluate further fee increases two years after the 1995 
fee increase.
    In considering its commitment to evaluate further fee increases, 
the Board recognized that significant changes have occurred in the 
banking, payments, and regulatory environment in the past few years 
and, as a result, is conducting a broad review of the Federal Reserve's 
daylight credit policies. During the course of its review, the Board 
has evaluated the effectiveness of the current daylight credit policies 
and determined that these policies appear to be generally effective in 
reducing risk to the Federal Reserve and creating incentives for 
depository institutions to control and manage their intraday credit 
exposures. In addition, the Board determined that the current policy is 
well understood by the industry and that private-sector participants 
generally have benefited from the policy's risk controls.

[[Page 30210]]

    As part of this review, the Board refined the objective that would 
guide its formulation and evaluation of daylight credit policies. The 
Board's daylight credit policy objective is to attain an efficient 
balance among the costs and risks associated with the provision of 
Federal Reserve intraday credit, including the comprehensive costs and 
risks to the private sector of managing Federal Reserve account 
balances, and the benefits of intraday liquidity. The Board used 
certain criteria to evaluate the effectiveness of policy options. These 
criteria include credit risk to the public sector, Federal Reserve 
resource costs of monitoring and counseling credit usage, private-
sector resource costs of monitoring credit usage, payment delays and 
gridlock, and private-sector opportunity costs.

II. Potential Longer-Term Policy Options

    A. Net Debit Cap Levels
    The Board is evaluating the benefits and drawbacks of reducing 
self-assessed single-day net debit caps to levels near those of the 
current two-week average caps and eliminating the two-week average net 
debit caps. Under the Board's PSR policy, the Reserve Banks establish 
limits or net debit caps on the maximum amount of uncollateralized 
daylight credit that depository institutions may incur in their Federal 
Reserve accounts. Net debit caps are calculated by applying a cap 
multiple from one of six cap classes to a depository institution's 
capital measure. (See Cap Multiple Matrix below.) A Reserve Bank may 
assign the exempt-from-filing cap without a depository institution 
taking any action. A depository institution may request a de minimis 
cap by submitting a board-of-directors resolution to its Reserve Bank, 
or the institution may request a self-assessed cap (average, above 
average, and high) by completing a self-assessment.\2\ Reserve Banks 
may assign a zero cap in consideration of certain factors, or a 
depository institution that wants to restrict its own use of Federal 
Reserve daylight credit may request a zero cap.
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    \2\ The self-assessment requires an institution to evaluate and 
rate its creditworthiness, intraday funds management and controls, 
customer credit policies and controls, operating controls, and 
contingency procedures to support a higher daylight overdraft cap.
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    When the Board adopted its net debit cap framework in 1985, it 
implemented two cap multiples for depository institutions with self-
assessed caps: one for the maximum allowable overdraft on any day 
(single-day cap) and one for the maximum allowable average of the peak 
daily overdrafts in a two-week period (two-week average cap). The 
Federal Reserve implemented the higher single-day cap to limit 
excessive daylight overdrafts on any day and to ensure that 
institutions develop internal controls that focus on daily exposures. 
The purpose of the two-week average cap was to reduce the overall 
levels of overdrafts while allowing for daily payment fluctuations.

                                               Cap Multiple Matrix
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                                                                   Cap multiples
          Cap categories          ------------------------------------------------------------------------------
                                                 Single day                           Two-week average
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Zero.............................  0.....................................  0
Exempt-from-filing \3\...........  $10 million or 0.20...................  $10 million or 0.20
De minimis.......................  0.40..................................  0.40
Average..........................  1.125.................................  0.75
Above average....................  1.875.................................  1.125
High.............................  2.25..................................  1.50
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    As \3\ part of the Board's current PSR policy review and its 
commitment to evaluate further cap reductions, the Board reviewed 
depository institutions' use of their daylight overdraft capacity. The 
Board found that more than 96 percent of institutions with self-
assessed net debit caps use less than 50 percent of their daylight 
overdraft capacity for their average peak overdrafts.\4\ To evaluate 
further the effects of reducing the single-day net debit cap to about 
the two-week average net debit cap, Board staff compared depository 
institutions' daily peak overdrafts with their respective two-week 
average caps. Compared with the current single-day net debit cap, an 
additional 7 percent of depository institutions with self-assessed caps 
(approximately twenty) would regularly exceed their single-day net 
debit cap if it were reduced to the two-week average levels. If 
depository institutions that have pledged collateral with the Reserve 
Banks were to use their collateral to increase their daylight overdraft 
capacity, less than 4 percent (approximately twelve) more depository 
institutions would regularly exceed their reduced net debit caps.\5\ In 
addition, some of these institutions would exceed their reduced net 
debit caps because of certain non-Fedwire activity. These depository 
institutions would likely be eligible for counseling flexibility. 
Because few account holders with self-assessed caps would regularly 
exceed a net debit cap reduced to the two-week average levels, it 
appears that most depository institutions generally manage their daily 
overdraft activity within the two-week average cap level. This analysis 
suggests that current single-day net debit cap levels may commit 
Reserve Banks to potential credit exposures in excess of what is needed 
to facilitate the smooth operation of the payment system. The Board 
believes that in conjunction with allowing institutions with self-
assessed net debit caps to pledge collateral for daylight overdraft 
capacity above their caps, reducing self-assessed net debit caps could 
improve the balance between the public-sector costs of providing 
daylight credit and the net private-sector benefits of using daylight 
credit.
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    \3\ The net debit cap for the exempt-from-filing category is 
equal to the lesser of $10 million or 20 percent of risk-based 
capital.
    \4\ Approximately 300 depository institutions currently have 
self-assessed caps. Of these depository institutions, approximately 
20 percent use more than 70 percent of their overdraft capacity for 
their peak overdrafts. The majority of institutions using more than 
70 percent of their daylight overdraft capacity for their peak 
overdrafts are doing so because of substantial non-Fedwire payment 
activity. The current policy provides ``counseling flexibility'' for 
depository institutions with de minimis and self-assessed caps that 
exceed their net debit caps as a result of certain non-Fedwire 
payment activity. Most of the institutions referenced above would 
fall into this category. The Federal Reserve, therefore, would not 
subject depository institutions that are provided counseling 
flexibility to additional counseling for certain non-Fedwire related 
cap breaches and would not require these institutions to post 
collateral or adopt a zero cap.
    \5\ Published elsewhere in today's Federal Register is the 
Board's interim policy statement that allows depository institutions 
with self-assessed caps to pledge collateral above their net debit 
caps for additional daylight overdraft capacity.

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[[Page 30211]]

    The Board believes that, if it were to reduce single-day net debit 
caps to about the same level as the current two-week average net debit 
caps, eliminating the two-week average caps should simplify the policy. 
Eliminating the two-week average cap also should reduce some of the 
administrative cost and burden of complying with the policy. The Board, 
however, recognizes that reducing single-day net debit caps could 
impose costs on certain depository institutions because some may 
consider their unused overdraft capacity as a safeguard to manage 
infrequent or unexpected liquidity needs. Finally, the Board believes 
that the current daylight overdraft limits for depository institutions 
with exempt-from-filing and de minimis net debit caps are adequate and 
should not be modified at this time.
    The Board seeks comment on the benefits and drawbacks of reducing 
self-assessed single-day net debit caps to levels near those of the 
current two-week average net debit caps and eliminating the two-week 
average net debit caps. The Board also requests comment on the 
following questions:
    1. In conjunction with the policy change that would allow 
institutions with self-assessed net debit caps to pledge collateral for 
Federal Reserve daylight credit above their net debit caps, would 
reducing self-assessed net debit caps improve the balance between the 
public-sector costs of providing daylight credit and the net private-
sector benefits of using daylight credit?
    2. How would a reduction in the single-day net debit cap level 
affect the way institutions manage their Federal Reserve accounts with 
respect to daylight overdrafts? Do institutions target a maximum level 
of daylight overdrafts that is at or below their two-week average caps? 
How much additional capacity between routine peak overdrafts and the 
current single-day net debit cap is prudent or necessary?
    3. Would lowering the single-day net debit caps for self-assessed 
institutions cause depository institutions to delay sending payments, 
potentially increasing overdrafts at other depository institutions?
    4. Should the Board consider a policy that gradually moves 
uncollateralized net debit caps to significantly lower levels (for 
example, to the levels associated with the de minimis net debit cap) 
and require all depository institutions to post collateral for 
overdrafts beyond the net debit cap?

B. Two-Tiered Pricing Regime

    The Board is also evaluating the benefits and drawbacks of 
implementing a two-tiered pricing regime that would assess a lower fee 
on collateralized daylight overdrafts than on uncollateralized daylight 
overdrafts. The daylight overdraft fee is a critical component of the 
PSR policy, and its modification in 1995 was the impetus for the 
Board's current review of its daylight credit policies.\6\ The initial 
implementation of a 24-basis-point daylight overdraft fee in 1994 
caused a 40 percent decrease in daylight overdrafts in Federal Reserve 
accounts, mostly related to changes in the timing of book-entry 
securities transfers. Daylight overdrafts caused by Fedwire funds 
transfers (funds overdrafts) declined slightly after the implementation 
of fees; however, funds overdrafts began to rise again even before the 
1995 modified fee increase. On an average annual basis since 1995, 
overdrafts caused by Fedwire book-entry securities transfers (book-
entry securities overdrafts) have decreased almost 10 percent per year 
and the value of Fedwire book-entry securities transfers has grown more 
than 5 percent per year; whereas funds overdrafts and the value of 
Fedwire funds transfers have grown between 15 and 18 percent per year. 
The growth in funds overdrafts appears to be directly related to the 
growth in large-value funds transfers. Even though funds overdrafts 
have grown substantially, the relationship between average funds 
overdrafts and the value of Fedwire funds transfers has remained 
relatively constant since the late 1980s.
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    \6\ The current daylight overdraft fee is 36 basis points, 
quoted as an annual rate on the basis of a 24-hour day. To obtain 
the daily overdraft fee for the standard Fedwire operating day, the 
36-basis-point fee is multiplied by the fraction of the 24-hour day 
during which Fedwire is scheduled to operate. For example, under the 
current 18-hour Fedwire operating day, the daylight overdraft fee 
equals 27 basis points.
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    In evaluating the level of the daylight overdraft fee, the Board is 
considering policy changes that might result in a more efficient 
balance of the costs, risks, and benefits associated with the provision 
of Federal Reserve intraday credit. The Board believes that daylight 
overdraft fees have been effective in reducing overdrafts from book-
entry securities transfers and provide a strong incentive for 
institutions to continue controlling their overdrafts. From its 
inception, the fee was intended to create economic incentives for the 
largest daylight overdrafters to reduce and allocate more efficiently 
their use of daylight credit. The Board notes that since the Federal 
Reserve began pricing daylight overdrafts in 1994, less than 4 percent 
of account holders pay fees in a given year and the majority of these 
institutions pay less than $1,000 per year. In addition, the largest 
users of daylight credit, in general depository institutions with 
assets greater than $10 billion, pay more than 95 percent of aggregate 
daylight overdraft fees.
    While the Board believes that daylight overdraft fees have been 
relatively effective, it also recognizes that the daylight overdraft 
pricing policy has imposed costs on the industry and that some 
depository institutions consider the policy burdensome. To assess 
policy alternatives that might create a more efficient balance of the 
costs, risks, and benefits associated with Federal Reserve intraday 
credit, the Board compared Federal Reserve daylight credit extensions 
and private-sector lending under line-of-credit arrangements. The most 
notable distinction between daylight credit extensions and private-
sector lending is that private loans are often collateralized. 
Collateralized lending generally carries a lower interest rate than 
uncollateralized lending because taking collateral lowers the lender's 
risk, allowing for a lower credit risk premium. In most situations, the 
Reserve Banks do not require collateral when extending daylight credit 
to depository institutions.\7\ When Reserve Banks require collateral 
for daylight credit extensions, however, the same daylight overdraft 
fee applies to both collateralized and uncollateralized daylight 
overdrafts. The Board also notes that the majority of Federal Reserve 
daylight credit extensions are currently implicitly collateralized 
because depository institutions that pledge collateral must sign the 
applicable agreements in Operating Circular 10, which provides the 
Reserve Banks with a secured interest in any collateral recorded on the 
Reserve Banks' books.\8\
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    \7\ The current policy requires that ``frequent and material'' 
book-entry securities overdrafters fully collateralize these 
overdrafts. Book-entry securities overdrafts become frequent and 
material when an account holder exceeds its net debit cap, solely 
because of book-entry securities transactions, on more than three 
days in any two consecutive reserve maintenance periods and by more 
than 10 percent of its capacity. The policy also allows financially 
healthy U.S. branches and agencies of foreign banks for which the 
home-country supervisor does not adhere to the Basle Capital Accord 
to incur daylight overdrafts above their net debit caps up to an 
amount equal to their cap multiples times 10 percent of their 
worldwide capital, provided that any overdrafts above the net debit 
caps are collateralized.
    \8\ The majority of the collateral pledged to the Reserve Banks 
is pledged for discount window purposes.

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[[Page 30212]]

    The Board is considering the benefits and drawbacks of implementing 
a two-tiered or differential pricing regime for daylight overdrafts. 
The fundamental argument for a two-tiered pricing regime is that such a 
regime might achieve a better balance between the benefits and costs of 
collateralized overdrafts relative to uncollateralized overdrafts, 
including the public sector's costs and risks as well as the private 
sector's opportunity costs of pledging collateral. Under a differential 
pricing regime, depository institutions that have pledged collateral 
with the Federal Reserve would receive the collateralized price for 
intraday credit used up to the level of collateral.\9\ In addition, 
while the interim policy statement does not permit depository 
institutions with exempt or de minimis caps to increase their daylight 
overdraft capacity by pledging collateral to the Federal Reserve, these 
institutions would be allowed to pledge collateral in order to receive 
the lower daylight overdraft fee. A lower fee on collateralized 
daylight credit than on uncollateralized daylight credit might also 
provide an extra incentive for the largest daylight overdrafters to 
maintain their current levels of collateral pledged to the Reserve 
Banks or to pledge additional collateral. The relative price of 
collateralized to uncollateralized daylight credit, however, would 
likely influence the degree to which depository institutions would 
maintain their collateral levels or pledge additional collateral.\10\
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    \9\ To estimate the spread between collateralized and 
uncollateralized lending, the Board sought a financial market 
measure of the risk differential between collateralized and 
uncollateralized credit extensions. Because loans of federal funds 
are uncollateralized, while loans through repurchase agreements are 
collateralized, the spread between the federal funds rate and the 
interest rate for repurchase agreements on general Treasury 
collateral provides the closest available approximation of this risk 
differential. The federal funds-repurchase agreement spread averaged 
12 to 15 basis points at a 24-hour annualized rate over the period 
since the mid-1980s. As much as possible, this estimate was adjusted 
for days of unusual supply pressures in the federal funds-repurchase 
market.
    \10\ Administrative costs incurred by depository institutions in 
identifying, segregating, auditing, or transporting collateral to 
conform with Reserve Bank requirements could affect the relative 
price of collateralized to uncollateralized daylight credit.
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    While private-sector lenders generally price collateralized lending 
cheaper than uncollateralized lending because it is typically less 
risky, the Board is concerned that differential pricing of daylight 
credit could have broader public policy implications. For example, the 
collateralization of daylight credit could disadvantage junior 
creditors in the event that a depository institution fails in a 
daylight overdraft position. It is unclear whether junior creditors 
take the Federal Reserve's extensions of daylight credit into account 
when making their own loans. Consequently, it may be appropriate when 
setting the collateralized daylight overdraft fee to include some 
measure of the additional risk that junior creditors bear as a result 
of collateralized Federal Reserve daylight credit extensions. If 
Federal Reserve daylight credit extensions were to dilute private-
sector creditors' claims dollar for dollar, it might be appropriate to 
treat collateralized and uncollateralized Federal Reserve daylight 
credit extensions as equally risky and price them at the same level. In 
addition, a marginal increase in collateralized Federal Reserve 
overdrafts could potentially exacerbate any scarcity of available 
collateral to support financial market activities.\11\
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    \11\ Bank for International Settlements, Committee on the Global 
Financial System, Collateral in wholesale financial markets: recent 
trends, risk management and market dynamics, March 2001 (Bank for 
International Settlements, 2001).
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    The Board plans to continue evaluating the benefits and drawbacks 
of a two-tiered pricing regime for daylight overdrafts. To assess 
better the impact of such a policy change, the Board requests comment 
on all aspects of differential pricing. The Board is also requesting 
comment on the following questions:
    1. What are the major drawbacks and benefits of a two-tiered 
pricing regime for collateralized and uncollateralized daylight 
overdrafts in Federal Reserve accounts?
    2. If Reserve Banks would accept the same types of collateral 
currently accepted for discount window purposes, how might two-tiered 
pricing affect the industry, especially with respect to the 
availability of collateral for other financial market activity? How 
might two-tiered pricing affect creditors and other participants?
    3. Would a two-tiered daylight overdraft pricing regime cause 
institutions to pledge additional collateral to the Federal Reserve or 
would they primarily use collateral already pledged to a Reserve Bank?
    4. If collateralized daylight overdrafts were subject to a fee 
lower than the current 36-basis-point fee, would institutions' daylight 
credit usage change from current levels?
    5. Currently, Federal Reserve daylight credit is generally provided 
only to financially healthy depository institutions that have regular 
access to the discount window and are subject to supervisory 
examination. Does taking collateral from these depository institutions 
provide the Federal Reserve a sufficient reduction in risk to warrant a 
lower fee?

C. Monitoring in Real Time All Institutions' Payments With Settlement-
Day Finality

    The Board is also evaluating the benefits and drawbacks of 
universal real-time monitoring (URTM), which is defined as using the 
Reserve Banks' Account Balance Monitoring System (ABMS) to reject any 
payment with settlement-day finality that would cause any account 
holder's overdrafts to exceed its net debit cap.\12\ Payments with 
settlement-day finality include Fedwire funds and book-entry securities 
transfers, enhanced net settlement service (NSS) transactions, 
automated clearing house (ACH) credit transactions, and cash 
withdrawals.13 14
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    \12\ The ABMS provides intraday account information to the 
Reserve Banks and depository institutions. ABMS serves as both an 
information source and a monitoring control tool. ABMS is used 
primarily to give authorized Reserve Bank personnel a mechanism to 
control and monitor account activity for selected institutions. ABMS 
also provides a means for institutions to obtain information 
concerning their intraday balances for managing daylight overdrafts. 
This information includes opening balances, a depository 
institution's net debit capacity and collateral limits, Fedwire 
funds and book-entry securities transfers, enhanced Net Settlement 
Service (NSS) transactions, and other payment activity from the 
Integrated Accounting System.
    \13\ The Board likely would not subject book-entry securities 
transfers to real-time rejects for institutions that pledge in-
transit collateral. In-transit collateral is securities purchased by 
a depository institution but not yet paid for and owned by its 
customers.
    \14\ ACH credit transactions will have settlement-day finality 
beginning in mid-2001. The Board, however, recognizes that including 
ACH credit transactions under URTM could have implications for the 
value dating of ACH transactions, wherein originators may submit 
transactions for settlement on a later, specified date.
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    Reserve Banks can monitor any account holder's balance and its 
payment activities in real time using the ABMS. The Reserve Banks 
currently reject, for specific depository institutions falling within 
established parameters, certain final payments that would cause 
overdrafts to exceed these account holders' available account balances 
or net debit cap.\15\ As a result, Reserve Banks are able to control 
their credit exposure from certain higher-risk institutions by 
restricting those institutions' access to Federal Reserve intraday 
credit to specified levels

[[Page 30213]]

through real-time monitoring of their account balances.\16\
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    \15\ The Reserve Banks monitor in real time Fedwire funds 
transfers and NSS transactions for institutions meeting the 
established risk parameters. Currently, the Reserve Banks are 
monitoring in real time approximately five percent of account 
holders; however, the number of monitored institutions generally 
increases as the health of the financial industry weakens.
    \16\ The account activity of an institution that is not 
monitored in real time is monitored for compliance with the daylight 
overdraft posting rules on an after-the-fact or ex post basis.
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    Real-time enforcement of depository institutions' daylight 
overdraft capacity levels through URTM could allow the Reserve Banks to 
manage better the small, yet important, risk that a depository 
institution could unexpectedly fail with a significant daylight 
overdraft position that far exceeds its net debit cap. URTM also could 
assist Reserve Banks and depository institutions in managing Federal 
Reserve accounts by preventing depository institutions from exceeding 
their net debit caps with payments that have settlement-day finality. 
As a result, URTM would likely reduce costs associated with the Reserve 
Banks' administration of the policy.
    The Board is considering URTM for payments with settlement-day 
finality because they represent greater credit risk to the Federal 
Reserve than payments without settlement-day finality. Payments with 
settlement-day finality also represent the majority of the dollar value 
of payments that the Federal Reserve processes. Because Reserve Banks 
may return or reverse payments that do not have settlement-day 
finality, such as checks and ACH debit transactions, these payments 
pose less risk to the Federal Reserve if the payor institution 
defaults.
    While URTM provides advantages by monitoring all accounts in real 
time, the Board has concerns about potential negative consequences of 
URTM. Specifically, the Board is concerned about possible adverse 
effects on the government-securities market from rejecting book-entry 
securities transfers. The Board also is concerned about URTM creating 
disruptions for net settlement arrangements and ACH participants. 
Finally, URTM raises significant policy issues related to payment 
delays or gridlock.
    To evaluate the potential adverse effects of URTM, the Board 
reviewed depository institutions' daylight credit use over the past 
several years and found that the majority of depository institutions 
generally do not fully use their daylight overdraft capacity. 
Approximately 97 percent of all account holders use less than 50 
percent of their net debit caps for their average peak overdrafts. Even 
if net debit caps were reduced to the two-week average level, as 
described previously in the first policy option, most institutions 
should not experience rejected payments under URTM. In addition, the 
Board's interim policy statement that allows depository institutions to 
pledge collateral for additional daylight overdraft capacity should 
alleviate potential payment disruptions over the long term as 
depository institutions adjust their behavior.
    While the Board does not believe that URTM would disrupt the 
payments system over the long term, URTM could cause payments gridlock 
under circumstances of severe financial market stress or significant 
liquidity shortages. In the event of gridlock, the Federal Reserve has 
systems and procedures to detect, evaluate, and address payments 
gridlock. The Federal Reserve's communication protocols and problem 
escalation procedures are well established and designed to manage any 
critical payments system problem quickly and effectively.\17\
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    \17\ The Federal Reserve System extensively tested and used 
these protocols and procedures to prepare for and manage the Y2K 
rollover period.
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    While several payment types, such as book-entry securities 
transfers or NSS transactions, raise issues related to implementing 
URTM, monitoring ACH credit originations for all account holders 
presents a number of additional issues. The most significant concern is 
that URTM could compromise ACH value dating. Value dating allows 
depository institutions to originate credit transactions one or two 
days in advance of the settlement date. When the Board approved 
settlement-day finality for ACH credit transactions, it required all 
institutions monitored in reject mode to prefund their originations at 
the time the files are processed (64 FR 62673, November 17, 1999). 
Prefunding was required so that risk controls for ACH credit 
transactions were similar to those of other payment services with 
similar finality characteristics, such as Fedwire funds transfers. In 
the current monitoring environment, only a subset of credit originators 
are required to prefund. Under a URTM environment, all ACH credit 
originators would have to prefund. As a result, depository institutions 
that send files one or two days in advance could perceive prefunding as 
costly. To avoid prefunding one or two days in advance, many depository 
institutions might originate their ACH files in the early morning hours 
of the settlement day, thereby eliminating certain benefits of ACH 
value dating.
    Value dating ACH transactions allows originating and receiving 
depository institutions to process large numbers of transactions in 
advance of the settlement date and time. Processing ACH transactions in 
advance of the settlement date and time often allows institutions to 
resolve operational problems with minimal effects on ACH participants 
and to post the transactions to their customers' accounts in a timely 
manner. In addition, advanced knowledge of the transactions that will 
settle over the next several days allows institutions to manage their 
account positions better and to handle incorrect or erroneous 
transactions before settlement occurs.
    A policy change that potentially discourages value dating or 
encourages originating depository institutions to submit files later 
than they do today could fundamentally change the nature of the ACH 
service and disrupt established and effective business practices for 
ACH participants. For example, an operational problem or funding 
problem might cause an originating depository institution to miss the 
close of the ACH processing cycle. By missing the close of the 
processing cycle, the ACH payments intended for settlement that same 
day would not settle on a timely basis. Missed settlements could impose 
undue costs on receiving institutions and their customers and undermine 
the perceived reliability of ACH. Applying URTM to ACH could, 
therefore, increase costs to some unknown extent for most ACH 
participants, including originating institutions, receiving 
institutions, and their customers.
    To alleviate the prefunding issue, some respondents to the request 
for comment on ACH settlement-day finality proposed collateral as an 
alternative to prefunding (63 FR 70132, December 18, 1998). Because of 
the value-dating nature of ACH, the Federal Reserve systems in place 
today would not be effective for monitoring the collateralization of 
ACH credit transactions over several days. The ABMS and other systems 
would have to be modified significantly to substitute collateral for 
prefunding if the transactions are not submitted on the same day as the 
intended settlement day; the Board is uncertain of the cost or timing 
of systems modifications that would be necessary to implement this 
functionality. Under the conditions described in the interim policy 
statement, some depository institutions submitting ACH credit 
transactions on the day of settlement will be able to secure additional 
daylight overdraft capacity.
    The Board plans to continue evaluating the benefits and drawbacks 
of URTM, including the benefits and drawbacks of implementing URTM for 
all payments with settlement-day

[[Page 30214]]

finality and implementing URTM for only a subset of those payments. One 
of the Board's primary concerns with implementing URTM for only a 
subset of payments, for example for Fedwire funds transfers and NSS 
transactions, is whether this would create an incentive for liquidity 
constrained depository institutions to move payments from Fedwire and 
NSS to the ACH to avoid the real-time monitor. Another concern is 
whether implementing URTM for only a subset of payments creates a 
competitive advantage for the Federal Reserve's ACH service.\18\ To 
assess better the effect of such policy changes, the Board requests 
comment on all aspects of URTM. The Board also requests comment on the 
following questions:
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    \18\ Competitive issues might be raised if the Reserve Banks 
were to monitor in real time all Fedwire funds transfers and NSS 
transactions but not all ACH credit transactions. Private-sector ACH 
operators that use the Federal Reserve's Fedwire-based or enhanced 
net settlement service might have some participants that experience 
rejected settlement payments under URTM while most Federal Reserve 
ACH credit transactions would not be subject to real-time 
monitoring. Depository institutions that are concerned about 
settlement disruptions through private-sector ACH operators might 
find the Federal Reserve's ACH service more attractive; however, 
these institutions might find that certain benefits from using 
private-sector ACH services sufficiently offset concerns about 
settlement disruptions. In addition, under any monitoring 
environment, depository institutions meeting certain risk parameters 
would be required to prefund their Federal Reserve ACH credit 
transactions. For those institutions, the Federal Reserve's ACH 
service might not be more attractive than private-sector ACH 
services.
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    1. What would be the benefits and drawbacks of URTM?
    2. If the Federal Reserve were to implement URTM, should it do so 
for all payments with settlement-day finality? If not, which payments 
should the Federal Reserve include under URTM? 19 20
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    \19\ To analyze more fully the potential for payment 
disruptions, Board staff developed a simulation of URTM for Fedwire 
funds transfers, book-entry securities transfers, and NSS 
transactions. The URTM simulation for Fedwire funds, book-entry 
securities, and NSS activity showed that under current net debit cap 
levels, ABMS would delay approximately 40 payments out of almost 
500,000 per day. In addition, the average value of a delayed payment 
was about $3.2 million and the average delay was around an hour. 
Using the two-week average net debit cap levels, the simulation 
showed that ABMS would delay approximately 50 payments out of almost 
500,000 per day and the average value of a delayed payment was about 
$11.4 million with an average delay of about an hour.
    \20\ While the URTM simulation did not demonstrate significant 
NSS transaction delays, the Board notes that given the nature of the 
net settlement service, the delay of any payment into a net 
settlement arrangement would hold up settlement for the entire 
arrangement.
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    3. If the Federal Reserve implemented URTM for only Fedwire funds 
transfers and NSS transactions, would this action increase risk of 
large-dollar payments moving from Fedwire or NSS to the ACH? \21\ Would 
this provide the Federal Reserve with a competitive advantage in 
providing ACH services?
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    \21\ Under any monitoring environment, depository institutions 
meeting certain risk parameters would be required to prefund ACH 
credit transactions.
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    4. What are the most significant benefits and drawbacks of 
implementing URTM for only Fedwire funds transfers and NSS transactions 
initially and continuing to evaluate moving other payments to URTM as 
the Federal Reserve and the industry gain more experience with URTM?
    5. What disruptions in the government-securities market, if any, 
could occur if the Federal Reserve were to implement URTM for Fedwire 
book-entry securities transfers?
    6. What disruptions in settlement arrangements, if any, could occur 
if the Federal Reserve were to implement URTM for NSS transactions?
    7. Would URTM lead to significantly greater payment delays, or 
would there be little effect?

III. Request for Comment

    The Board requests comment on all aspects of the potential policy 
options outlined above, and on the benefits and drawbacks of 
implementing these options together or separately.

IV. Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of rule or policy changes that have a substantial impact on 
payments system participants.\22\ 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 due to differing 
legal powers or constraints, or due to a dominant market position of 
the Federal Reserve deriving from such differences. If no reasonable 
modifications would mitigate the adverse competitive effects, the Board 
will determine whether the anticipated benefits are significant enough 
to proceed with the change despite the adverse effects.
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    \22\ 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).
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    The Board does not believe that the policy options outlined above 
would have a direct and material impact on the ability of other service 
providers to compete effectively with the Reserve Banks' payments 
services. The Board believes that two of the daylight credit policies 
outlined above, lowering single-day net debit caps and universal real-
time monitoring, are generally more restrictive than the current 
policies. The Board plans to evaluate further whether implementing URTM 
for only a subset of payments creates a competitive advantage for the 
Federal Reserve's financial services. More restrictive Federal Reserve 
credit policies, however, could encourage some depository institutions 
to seek other payment service providers, thereby encouraging 
competition with the Reserve Banks. While the two-tiered pricing regime 
is generally more consistent with private-sector practices, the policy 
cannot be viewed as being more restrictive or liberal until a more 
definitive set of fees is recommended.

V. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
ch. 3506; 5 CFR 1320 Appendix A.1), the Board has reviewed the policy 
statement under the authority delegated to the Board by the Office of 
Management and Budget. No collections of information pursuant to the 
Paperwork Reduction Act are contained in the policy statement.

By order of the Board of Governors of the Federal Reserve System, May 
30, 2001.

Jennifer J. Johnson,
 Secretary of the Board.
[FR Doc. 01-13982 Filed 6-4-01; 8:45 am]
BILLING CODE 6210-01-P