[Federal Register Volume 67, Number 163 (Thursday, August 22, 2002)]
[Notices]
[Pages 54424-54427]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-21454]


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FEDERAL RESERVE SYSTEM

Docket No. R-1111


Policy Statement on Payments System RiskPotential Longer-Term 
Policy Direction

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board is announcing its decision not to pursue in the 
foreseeable future the following policy options as part of a potential 
longer-term direction for the Board's payments system risk policy (PSR 
policy): (1) lowering self-assessed net debit caps and eliminating two-
week average caps and (2) rejecting all payments with settlement-day 
finality that would cause an institution to exceed its daylight 
overdraft capacity level. The Board will, however, continue analyzing 
the benefits and drawbacks of a two-tiered pricing regime for daylight 
overdrafts in which institutions that pledge collateral to the Reserve 
Banks would pay a lower fee on their collateralized daylight overdrafts 
than on their uncollateralized daylight overdrafts.

FOR FURTHER INFORMATION CONTACT: Jeff Stehm, Assistant Director (202/
452-2217), Stacy Coleman, Manager (202/452-2934), or John Gibbons, 
Senior Financial Services Analyst (202/452-6409), Division of Reserve 
Bank Operations and Payment Systems; for users of Telecommunication 
Devices for the Deaf (TDD) only, contact 202/263-4869.

SUPPLEMENTARY INFORMATION:
I. Background: In June 2001, the Board requested comment on a number of 
modifications to the PSR policy, including several near-term changes 
and a potential longer-term direction.\1\ These requests for comment 
resulted from a broad review of the Board's PSR policy. This review 
evaluated the effectiveness of the Board's daylight credit policies, 
recognizing that significant changes had occurred in the banking, 
payments, and regulatory environment in the past few years. In 
conducting its review, the Board evaluated the effect of past policy 
actions on depository institutions' behavior and on the markets 
generally and also considered the effect of various payment system 
initiatives on payments activity and the demand for daylight credit.
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    \1\ The Board's current policy is described in the Policy 
Statement on Payments System Risk. The policy statement can be found 
at http://www.federalreserve.gov/paymentsystems/psr/policy.pdf.
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    Following the public comment period for the near-term changes, the 
Board made several changes to the policy, including allowing depository 
institutions with self-assessed net debit caps to pledge collateral to 
the Federal Reserve in order to access additional daylight overdraft 
capacity above their net debit cap levels and modifying the criteria 
used to determine a foreign banking organization's U.S. capital 
equivalency measure (66 FR 64419, December 13, 2001). Currently, the 
Board is focusing on the potential longer-term direction for the PSR 
policy. The policy options identified in the request for comment 
included the following: (1) lowering self-assessed net debit caps and 
eliminating two-week average caps, (2) rejecting all payments with 
settlement-day finality that would cause an institution to exceed its 
daylight overdraft capacity level, referred to as universal real-time 
monitoring (URTM), and (3) implementing a two-tiered pricing regime for 
daylight overdrafts in which institutions that pledge collateral to the 
Reserve Banks would pay a lower fee on their collateralized daylight 
overdrafts than on their uncollateralized daylight overdrafts (66 FR 
30208, June 5, 2001).\2\
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    \2\ Payments with settlement-day finality include Fedwire funds 
and book-entry securities transfers, net settlement service (NSS) 
transactions, automated clearing house (ACH) credit transactions, 
and cash withdrawals.
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II. Summary of Comments and Analysis
    The following section describes the options proposed in June 2001 
for a potential longer-term PSR policy direction, summarizes and 
analyzes the comments received on the proposals, and discusses the 
rationale for not pursuing lower self-assessed net debit caps or URTM 
in the foreseeable future and for continuing to analyze a two-tiered 
pricing regime. The Board received a total of thirty-six comment 
letters on its potential longer-term PSR policy direction. The 
commenters included nineteen commercial banking organizations and seven 
of their trade associations, three clearing organizations, two other 
trade associations, and five Federal Reserve Banks. Not all commenters, 
however, addressed each of the options identified in the potential 
longer-term direction.
A. Net Debit Cap Levels
    The Board evaluated 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 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. 
An institution may request a self-assessed cap (average, above average, 
or high) by completing a

[[Page 54425]]

self-assessment.\3\ Alternatively, a depository institution may request 
a de minimis cap by submitting a board-of-director resolution to its 
Reserve Bank, or its Reserve Bank may assign an exempt-from-filing cap. 
A Reserve Bank also 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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    \3\ 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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    Twenty-nine organizations commented on lowering the single-day net 
debit cap and eliminating the two-week average cap. Of those 
organizations, sixteen did not support the proposal. Commenters 
generally did not support lowering the single-day net debit cap and 
eliminating the two-week average cap because of concerns about reduced 
flexibility in a depository institution's ability to process payments. 
Of the thirteen commenters that supported a lower single-day net debit 
cap and the elimination of the two-week average cap, most believed that 
Reserve Banks could reduce potential credit exposure while not 
affecting most depository institutions' ability to process payments. 
Several commenters also noted that eliminating the two-week average cap 
could reduce some of the policy's administrative burden. Finally, 
several commenters stated that institutions affected by a lower single-
day net debit cap should have sufficient flexibility because depository 
institutions can now gain additional overdraft capacity by pledging 
collateral.
    Three commenters that supported lowering net debit cap levels 
recommended that the Board lower them gradually to allow institutions 
an adjustment period and to allow the Federal Reserve time to evaluate 
the effects of lower net debit caps on the payments system. One 
organization that supported lowering net debit caps recommended that 
the policy allow institutions to exceed their net debit cap up to 20 
percent on an infrequent basis without requiring collateral. Another 
organization supported lowering net debit caps as long as limits on 
collateralized daylight overdraft capacity above the net debit cap were 
set sufficiently high that institutions would not experience liquidity 
constraints.
    The Board believes that reducing self-assessed net debit caps and 
eliminating two-week average caps generally would not affect most 
depository institutions' account-management and payment activities. In 
its request for comment, the Board noted that 96 percent of depository 
institutions with self-assessed net debit caps use less than 50 percent 
of their daylight overdraft capacity for their average peak overdrafts. 
Furthermore, Reserve Banks' credit exposure would be reduced by less 
than 5 percent if those institutions with self-assessed net debit caps 
that currently use more than 50 percent of their daylight overdraft 
capacity reduced their peak overdrafts to within the proposed net debit 
cap limits. As a result, lower net debit caps likely would not 
materially reduce Reserve Bank credit exposure. The current net debit 
cap limits do, however, provide institutions greater flexibility in 
managing their payments flows. In addition, the actual or potential 
liquidity implications of payment system initiatives, such as the 
Continuous Linked Settlement (CLS) system, have not been fully realized 
both in terms of the liquidity demands resulting from its 
implementation and its interaction with other payment systems. These 
potential liquidity demands, especially in times of financial market 
stress, need to be understood more fully for the Board to evaluate 
thoroughly the benefits and drawbacks of lowering self-assessed single-
day net debit caps and eliminating two-week average caps.
    The drawbacks of reduced flexibility in managing payment flows 
during a period of structural change in the payments system appear to 
outweigh the potential efficiencies gained by reducing administrative 
burden from lowering single-day net debit caps and eliminating two-week 
average caps. Accordingly, the Board will not consider lowering self-
assessed single-day net debit caps and eliminating two-week average 
caps as a policy option in the foreseeable future.
B. Monitoring in Real Time All Institutions' Payments With Settlement-
Day Finality
    The Board also evaluated the benefits and drawbacks of 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 an account holder's overdrafts to exceed its net debit 
cap.\4\
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    \4\ ABMS provides intraday account information to the Reserve 
Banks and depository institutions. It serves as both an information 
source and a monitoring tool. ABMS is used primarily to give 
authorized Reserve Bank personnel a mechanism to control and monitor 
account activity for selected institutions. It 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 daylight overdraft 
capacity and collateral limits, Fedwire funds and book-entry 
securities transfers, net settlement service transactions, and other 
payment activity.
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    Thirty-one organizations commented on URTM. Of those organizations 
that responded, twenty-four did not support implementing URTM. Most 
commenters did not support URTM because of concerns that it could be 
unnecessarily restrictive for healthy depository institutions and could 
cause or exacerbate disruptions in the payments system. Many commenters 
also highlighted URTM's potential effects on ACH credit originations. 
In particular, several commenters raised concerns about URTM requiring 
prefunding for ACH credit originations and the potential negative 
effects on the value-dating aspect of ACH.\5\ One commenter that 
supported URTM, however, stated that preventing institutions from 
exceeding their net debit cap with overdrafts due to payments with 
settlement-day finality would reduce risk in the payments system. 
Another commenter supported URTM because it likely would have only 
negligible effects on delays in the payments system and payments would 
be rejected or processed based on real-time balances.
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    \5\ Value dating allows originators to submit ACH transactions 
for settlement on a later, specified date.
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    If the Board were to implement URTM, a number of commenters 
recommended that it do so gradually to minimize potential disruptions 
to the payments system. For example, some commenters recommended 
introducing URTM by rejecting only Fedwire funds transfers at first and 
adding additional payment types later. Several commenters also 
recommended pending payments, instead of rejecting them, and making 
individual credit decisions on each payment. Under URTM the potential 
volume of payments that might be pended and need to be reviewed to make 
a credit decision could increase significantly, especially in times of 
market stress. Payments processing could be negatively affected as a 
result. In addition, the order in which payments could be released and 
an institution's access to its pended payments queue are issues that 
would need to be addressed in considering this option.
    The Board believes the primary benefit of URTM is that it allows 
Reserve Banks to better manage the small, yet important, risk that a 
depository institution could unexpectedly fail with a significant 
daylight overdraft position that far

[[Page 54426]]

exceeds its net debit cap. The Board, however, also recognizes the 
benefits of financially healthy depository institutions having 
flexibility in managing their payment activity, especially during times 
of financial market stress. A policy that places a hard cap on daylight 
credit might cause or exacerbate disruptions for a given depository 
institution's payment flows or the payments system more generally. In 
addition, the liquidity implications related to CLS and its interaction 
with other payments systems need to be understood more fully for the 
Board to evaluate thoroughly the benefits and drawbacks of URTM. 
Concerns over disrupting the payments system, especially during times 
of market stress, likely outweigh the benefits of managing daylight 
overdrafts for unexpected failures of depository institutions. As a 
result, the Board will not implement URTM as a policy option in the 
foreseeable future.
C. Two-Tiered Pricing Regime
    The Board will continue 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. In evaluating the level of the daylight overdraft fee, the 
Board is considering policy changes that might more efficiently balance 
the costs, risks, and benefits associated with the provision of Federal 
Reserve intraday credit.
    The daylight overdraft fee is a critical component of the PSR 
policy, and its modification in 1995 was the impetus for the Board's 
PSR policy review.\6\ During the policy review, the Board compared 
Federal Reserve daylight credit extensions and private-sector lending 
under line-of-credit arrangements in assessing policy alternatives that 
might create a more efficient balance of the costs, risks, and benefits 
associated with Federal Reserve intraday credit. The most notable 
distinction between daylight credit extensions and private-sector 
lending is that private-sector lenders usually charge a lower rate when 
loans are 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 accept or 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 any collateral that a depository institution pledges to a 
Reserve Bank can be used to offset any of the institution's obligations 
to the Reserve Bank.\8\
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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 effective daylight 
overdraft fee equals 27 basis points.
    \7\ The current policy allows depository institutions with self-
assessed net debit caps to pledge collateral to gain additional 
capacity above their net debit caps.
    \8\ The majority of the collateral pledged to the Reserve Banks 
is pledged for discount window purposes. Federal Reserve Operating 
Circulars 1 and 10 provide Reserve Banks with a security interest in 
any of a depository institution's assets in the possession or 
control of, or maintained with, a Reserve Bank. These assets include 
collateral pledged to the Reserve Banks as well as items in the 
process of collection and any investment property that the 
institution may legally encumber.
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    Twenty-six organizations commented on two-tiered pricing. Twenty-
two of those organizations supported some form of a two-tiered pricing 
regime. Most commenters favored a two-tiered pricing mechanism because 
they believed that it would reduce risk to the public sector and 
provide depository institutions the ability to weigh the costs and 
benefits of lower-rate collateralized credit with higher-rate 
uncollateralized credit.
    One commenter that did not support two-tiered pricing stated that 
many smaller community banks might not be able to pledge collateral to 
receive a lower price, possibly placing them at a competitive 
disadvantage relative to larger depository institutions that likely are 
capable of pledging sufficient collateral to receive a lower price on 
most of their overdrafts. The Board is sensitive to policies that place 
certain depository institutions at a competitive advantage relative to 
other depository institutions. Most small depository institutions, 
however, generally do not pay daylight overdraft fees because they use 
little or no daylight credit. When pricing was introduced, the Board 
purposely permitted a minimal level of free overdrafts for most 
depository institutions based on the institution's capital. The purpose 
was to exempt from fees a very large number of depository institutions 
that account for a very small portion of total overdrafts.\9\ As a 
result, the Board does not believe that small depository institutions 
would be disadvantaged by a two-tiered pricing policy relative to large 
depository institutions.
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    \9\ For depository institutions with regular access to the 
discount window, Reserve Banks also waive daylight overdraft fees if 
the charge for a reserve maintenance period is twenty-five dollars 
or less.
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    A number of commenters indicated that they would support two-tiered 
pricing only if lower-priced collateralized daylight credit could be 
used before uncollateralized daylight credit. In developing a two-
tiered pricing regime, the Board intends to allow depository 
institutions with collateral pledged to the Federal Reserve to be 
charged the collateralized price for intraday credit used up to the 
level of collateral pledged as long as the collateral is not securing 
other outstanding obligations. Any additional intraday credit used that 
was uncollateralized would be priced higher. Moreover, depository 
institutions with self-assessed net debit caps that have been approved 
for collateralized daylight overdraft capacity above their net debit 
caps would be able to use the collateral pledged for this purpose to 
receive the collateralized price on the first dollars of daylight 
credit used. A few other commenters indicated that they support two-
tiered pricing only if the rate for collateralized daylight credit is 
lower than the current rate.
    Because two-tiered pricing may help balance the costs and benefits 
of providing daylight credit, and such a policy is more consistent with 
standard industry practices, the Board will continue to analyze the 
benefits and drawbacks of two-tiered pricing, taking into consideration 
the issues raised by commenters.
III. 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.\10\ Under these procedures, the Board 
assesses 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 will mitigate the adverse competitive effects, the Board 
will determine whether the expected benefits are significant enough to 
proceed with the change despite the

[[Page 54427]]

adverse effects. The Board believes maintaining the status quo while 
continuing to analyze two-tiered pricing will have no adverse effect on 
the ability of other service providers to compete effectively with the 
Federal Reserve Banks in providing similar services.
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    \10\ 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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IV. 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 this notice 
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 this notice.

    By order of the Board of Governors of the Federal Reserve 
System, August 19, 2002.
Jennifer J. Johnson
Secretary of the Board.
[FR Doc. 02-21454 Filed 8-21-02; 8:45 am]
BILLING CODE 6210-01-S