[Federal Register Volume 73, Number 46 (Friday, March 7, 2008)]
[Notices]
[Pages 12417-12443]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 08-971]
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FEDERAL RESERVE SYSTEM
[Docket No. OP-1309]
Policy on Payments System Risk
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Policy statement; request for comment.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
requests comment on proposed changes to its Payments System Risk (PSR)
policy that would adopt a new strategy for providing intraday balances
and credit to depository institutions and encourage such institutions
to collateralize their daylight overdrafts. The Board believes changes
to the Federal Reserve's current strategy for providing intraday
balances and credit to the banking industry would help loosen liquidity
constraints and reduce operational risk. Specifically, the Board
proposes to adopt a policy of supplying intraday balances to healthy
depository institutions predominantly through explicitly collateralized
daylight overdrafts provided at a zero fee. The Board would allow
depository institutions to pledge collateral voluntarily to secure
daylight overdrafts but would encourage the voluntary pledging of
collateral to cover daylight overdrafts by raising the fee for
uncollateralized daylight overdrafts to 50 basis points (annual rate)
from the current 36 basis points. The Board also proposes to increase
the biweekly daylight overdraft fee waiver to $150 from $25 to minimize
the effect of the proposed policy changes on institutions that use
small amounts of daylight overdrafts (small users). In addition, the
proposed policy would involve changes to other elements of the PSR
policy dealing with daylight overdrafts, including adjusting net debit
caps, streamlining maximum daylight overdraft capacity (max cap)
procedures for certain foreign banking organizations (FBOs),
eliminating the current deductible for daylight overdraft fees, and
increasing the penalty daylight overdraft fee for ineligible
institutions to 150 basis points (annual rate) from the current 136
basis points.
DATES: Comments must be received on or before June 4, 2008.
ADDRESSES: You may submit comments, identified by Docket No. OP-1309,
by any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Jennifer J. Johnson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, NW., Washington, DC 20551.
All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed
[[Page 12418]]
electronically or in paper in Room MP-500 of the Board's Martin
Building (20th and C Streets, NW.) between 9 a.m. and 5 p.m. on
weekdays.
FOR FURTHER INFORMATION CONTACT: Jeffrey Marquardt, Deputy Director
(202-452-2360) or Susan Foley, Assistant Director (202-452-3596),
Division of Reserve Bank Operations and Payment Systems, Board of
Governors of the Federal Reserve System; for users of
Telecommunications Device for the Deaf (``TDD'') only, contact (202)
263-4869.
SUPPLEMENTARY INFORMATION:
I. Background
The Federal Reserve's Payments System Risk (PSR) policy sets out
the general public policy objectives of safety and efficiency for
payments and settlement systems. Over the past few years, the Federal
Reserve has been reviewing the long-term effects of market,
operational, and policy changes by the financial industry and the
Federal Reserve on intraday liquidity, operational, and associated
credit risks in financial markets and the payments system, including
account overdrafts (daylight overdrafts) at the Federal Reserve Banks
(Reserve Banks). On June 21, 2006, the Board published for public
comment the Consultation Paper on Intraday Liquidity Management and the
Payments System Risk Policy (consultation paper) that sought
information from financial institutions and other interested parties on
their experience in managing liquidity, operational, and credit risks
related to Fedwire funds transfers, especially late-day transfers.\1\
The paper included a list of detailed objectives relating to safety and
efficiency that the Board has previously used to conduct payments
system risk analysis. An important goal of the consultation process was
to identify opportunities to improve the safety/efficiency trade-offs
in the payments system over the long run.
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\1\ See 71 FR 35679, June 21, 2006.
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Significant changes to U.S. payments and settlement systems over
the past twenty-five years have helped reduce systemic risk. In accord
with U.S. and international risk policies and standards, several of
these changes have relied increasingly on the use of central bank
money--in this context, balances that financial institutions and
private clearing and settlement organizations hold in accounts at
Reserve Banks--to strengthen the management of credit and liquidity
risk in private-sector clearing and settlement arrangements. Such
changes have had the effect of increasing significantly the intraday
demand for central bank money and hence the demand for daylight
overdrafts at the Reserve Banks, which are a major source of these
funds.
In addition, the combined effect of depository institutions'
intraday liquidity management strategies, changes at clearing and
settlement organizations, and late-day market activity has been to
shift the sending of larger Fedwire funds transfers to later in the
day. From an operational risk perspective, delaying the sending of
large payments until late in the day increases the potential magnitude
of liquidity dislocation and risk in the financial industry if late-in-
the-day operational disruptions should occur. An increase in such risk
is particularly troublesome in an era of heightened concern about
operational disruptions generally.
Given the growing demand for intraday central bank money and
accompanying daylight overdrafts, as well as the shift of larger
Fedwire payments to later in the day, the Board believes that
significant further steps are appropriate to mitigate the growing
credit exposures of the Reserve Banks, while also improving intraday
liquidity management for the banking system and augmenting liquidity
provided. The consultation paper requested views on potential changes
in market practices, operations, and the Federal Reserve's PSR policy
that could reduce liquidity, operational, and credit risks. These
proposed changes would not affect the provisions of part I of the PSR
policy, which deal with risk management in private-sector systems.
II. Comments and Analysis
The Board received twenty-three public comment letters in response
to its consultation paper.\2\ The majority of these letters were from
commercial banking organizations and from several private-sector
clearing and settlement systems, industry groups, and trade
organizations. In addition, the Board received comments from one
Reserve Bank and one individual. Almost all commenters explicitly
expressed concern about the operational risk associated with the
increasing concentration of late-day payments. Most commenters
identified payment queuing at depository institutions, particularly the
queuing of payments to settle large money market transactions, as a
liquidity conservation strategy that contributes to institutions
sending payments late in the day.\3\ A majority of commenters also
agreed that some private-sector clearing and settlement systems absorb
a considerable amount of intraday liquidity in connection with their
risk-management processes. Further, some commenters identified market
constraints, such as the late-day settlements of tri-party repo
transactions, and the processes and settlement procedures of The
Depository Trust Company (DTC) and The Clearing House Interbank Payment
System (CHIPS) as important contributors to the concentration of late-
day payments.\4\
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\2\ Copies of all public comments on the consultation paper can
be found on the Board's website at http://www.federalreserve.gov/generalinfo/foia/index.cfm?doc_id=OP%2D1257&doc_ver=1.
\3\ Payment queuing is a tool used by some depository
institutions to hold a payment internally until sufficient funds--
available balances or credit line--become available to send the
payment to the Fedwire funds transfer system or another system. Some
payments are held in queues because a customer has insufficient
balances or credit to fund the payments. Other payments may be held
to manage the level of account daylight overdrafts at the Reserve
Bank or the associated fees.
\4\ CHIPS is a real-time final payments system operated by The
Clearing House Payments Company. In January 2001, The Clearing House
implemented operational and rule changes to allow all transactions
settled in CHIPS to be final upon release from a central queuing
system. DTC is a subsidiary of the Depository Trust and Clearing
Corporation, which operates six subsidiaries that provide clearance,
settlement, and information services for many financial instruments,
including equities, corporate and municipal bonds, government and
mortgage-backed securities, money market instruments, and over-the-
counter derivatives. DTC provides custody and settlement services
for corporate and municipal securities and money market instruments.
DTC is a member of the Federal Reserve System and a clearing agency
registered with the Securities and Exchange Commission.
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The comments also addressed the specific market, operational, and
PSR policy options set forth in the consultation paper. The majority of
commenters strongly supported greater use of collateral and two-tiered
pricing of daylight overdrafts by the Federal Reserve under the PSR
policy.\5\ Several institutions expressed strong support for a zero fee
for collateralized daylight overdrafts, similar to policies followed by
other central banks. Most commenters also stressed that they should
have the ability to use unencumbered collateral already pledged to the
discount window to support their daylight overdrafts.
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\5\ In 2001, the Board requested comment on two-tier pricing as
a long-term PSR policy direction and, based on comments, agreed to
continue evaluating the benefits and drawbacks of implementing such
a regime. See 66 FR 30208, June 5, 2001 and 67 FR 54424, August 22,
2002.
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Several commenters also strongly supported continued work on
potential opportunities to conserve liquidity within DTC and CHIPS.
These comments endorsed the work performed by the Federal Reserve Bank
of New
[[Page 12419]]
York's Payment Risk Committee (PRC) and Wholesale Customer Advisory
Group (WCAG) during the consultation period. The PRC and WCAG conducted
a liquidity survey to understand better the determinants of late-day
payments.\6\ The results of the survey prompted the formation of four
workgroups to evaluate liquidity improvement opportunities for CHIPS,
DTC, tri-party repo payments, and broker-dealer payments.
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\6\ The Payment Risk Committee (PRC) is sponsored by the Federal
Reserve Bank of New York and works to identify and analyze issues of
mutual interest related to risk in payments and settlement. The
institutions represented on the PRC include Bank of America, Bank of
New York, Bank of Tokyo-Mitsubishi UFJ, Citibank, Deutsche Bank,
HSBC, JPMorgan Chase, State Street, UBS, Wachovia, and Wells Fargo.
The Wholesale Customer Advisory Group (WCAG) advises the Wholesale
Product Office on business issues and is composed of depository
institutions that are major users of Fedwire. Institutions
represented on this group include ABN AMRO, Bank of America, Bank of
New York, Citibank, Deutsche Bank, HSBC, JPMorgan Chase, Key Bank,
Mellon Financial, State Street, SunTrust, UBS, U.S. Bank, U.S.
Central Credit Union, Wachovia, and Wells Fargo.
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The workgroup focused on CHIPS processing found that the CHIPS
algorithm can leave a number of large-value payments unresolved in the
system for significant periods of time, resulting in some institutions
redirecting payments to the Fedwire funds transfer system at the end of
the day; these payments are in addition to the daily Fedwire funds
transfers that are part of the CHIPS' end-of-day funding procedures
around 5:15 p.m. The workgroup and CHIPS identified possible
opportunities to release unresolved payments for settlement earlier,
including changing some of the system controls. The workgroup that
focused on DTC largely examined the money market instrument clearing
and settlement processes and the reasons a substantial amount of
liquidity is transferred to and remains at DTC, especially between 1
and 3 p.m. This liquidity is then released as part of settlement around
4:30 p.m. The workgroup and DTC tried to identify ways to reduce the
length of time of the settlement process, to encourage institutions to
manage better liquidity at DTC, and to enhance operations and certain
controls. The other two workgroups on broker-dealer payments and on
tri-party payments largely focused on documenting processes and
procedures to educate the PRC and WCAG members so they could better
understand why these payments are key determinants of late-in-the-day
payments. The results from each of the workgroups were shared as part
of the comment process and were cited for continued work by commenters.
Commenters were split in terms of support for developing a
liquidity-saving mechanism for the Fedwire funds transfer system.\7\
Eight of the thirteen respondents that commented on the possible
introduction of a liquidity-saving mechanism encouraged further
exploration of this idea, while the remaining five expressed some
concerns. Those respondents that were supportive noted that a
liquidity-saving mechanism could help reduce the length of time that
large-value payments sit in internal queues at depository institutions.
One commenter specifically suggested that the Federal Reserve focus on
a liquidity-saving system for the exchange of broker-dealer and tri-
party repo payments, which are typically large-value payments. Other
supporters strongly favored a centralized queuing system for all
Fedwire funds transfer payments and mentioned systems used or under
development in other countries.\8\ Concerns about developing a
liquidity-saving mechanism included the possibility that it could
undermine the real-time gross settlement attribute of the Fedwire funds
transfer system, create a competitive disadvantage for a private-sector
payments system, or significantly increase the cost of making Fedwire
funds transfer payments.
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\7\ The creation of a liquidity-saving mechanism could involve
adding new features to the Fedwire funds transfer system that
depository institutions could use to coordinate better the timing
and settlement of their payments as well as to economize on the use
of intraday central bank money, daylight overdrafts, and collateral.
The existing real-time gross settlement functionality of Fedwire
would be retained. In particular, a depository institution could
still designate that a Fedwire funds transfer settle immediately as
it does today. The new features, for example, could allow depository
institutions to designate certain types of payments, possibly
including payments generated by certain types of transactions, to be
placed into a central queuing system and settled using algorithms
that allow the liquidity provided by incoming payments to a
depository institution to be used as far as possible to settle that
institution's outgoing payments.
\8\ Versions of liquidity-saving mechanisms are used by CHIPS
and Target 2 in the European Union. Such features will also be
included in the new wire transfer systems in Japan and other
countries.
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Commenters had different views on the idea of time-of-day pricing,
which would vary the fee charged for daylight overdrafts through the
day so that overdrafts incurred earlier in the day would incur a lower
fee than overdrafts incurred late in the day. While some commenters
supported time-of-day pricing as an incentive to send funds transfers
earlier in the day, others requested additional information about the
idea. Still other commenters pointed out that the effectiveness of
time-of-day pricing would be constrained by the reality of late
afternoon trade settlements, such as tri-party repo payments and Fed
funds loans.
Commenters expressed limited or no support for the creation of an
intraday market to exchange liquidity, an expansion of the market for
early return of Fed funds loans, or throughput requirements for the
Fedwire funds transfer system. Most respondents thought that an
intraday market would not be helpful in addressing the late-day
concentration of payments and would be costly and complex to establish.
In terms of expanding the market for early return of Fed funds loans,
several commenters were uncertain about the effects of such a change on
late-day payments. In addition, a majority of respondents did not
support the introduction of throughput requirements for the Fedwire
funds transfer system, primarily because of the potential difficulty of
administering and enforcing such requirements. Throughput requirements
are used by some systems around the world to encourage certain
percentages of payments volume to be submitted by predetermined times.
Three commenters, however, were somewhat supportive provided the
throughput requirements were voluntary, implemented jointly with a
central queue, or in conjunction with brief, intermittent periods when
institutions could coordinate sending Fedwire funds transfers.
The Board received several comment letters raising concerns about
the policy's treatment of the daylight overdrafts of foreign banking
organizations (FBOs). The commenters stated that the U.S. capital
equivalency measure used to determine FBO net debit caps and
deductibles in the calculation of daylight overdraft limits and fees is
discriminatory and results in a competitive disadvantage for these
organizations and in their delaying payments. This assertion is based
on the fact that U.S.-chartered depository institutions receive a net
debit cap and deductible based on their worldwide capital, while FBOs
receive a net debit cap based on no more than 35 percent of their
worldwide capital (referred to as the U.S. capital equivalency) and a
deductible based on their U.S. capital equivalency.\9\ As a result,
FBOs are
[[Page 12420]]
eligible for considerably lower daylight overdraft capacity and free
intraday credit than are U.S.-chartered depository institutions with
equivalent worldwide capital. The commenters asked the Board to
calculate FBO deductibles using 100 percent of their worldwide capital,
as is done for U.S.-chartered institutions. The commenters also
asserted that the existing formula used to determine the net debit cap
cannot be justified, particularly in the case of FBOs which are
considered to be both ``well capitalized'' and ``well managed'' for
U.S. regulatory (FHC) purposes or which have received the highest rated
``strength-of-support assessment'' (SOSA 1).\10\
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\9\ In 2001, the Board modified the criteria to determine
eligible capital and raised the percent of capital used in
calculating net debit caps and the deductible. The percent of
capital used increased from as much as 10 percent to up to 35
percent. See also 66 FR 30205, June 5, 2001.
\10\ For an FBO, the policy incorporates the SOSA rankings and
FHC status in determining U.S. capital equivalency. The SOSA ranking
is composed of four factors, including the FBO's financial condition
and prospects, the system of supervision in the FBO's home country,
the record of the home country's government in support of the
banking system or other sources of support for the FBO; and transfer
risk concerns. The SOSA ranking is based on a scale of 1 through 3,
with 1 representing the lowest level of supervisory concern.
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Finally, the Board received a few other comments. One responder
suggested changing the posting rules for automated clearinghouse (ACH)
debit transfers so that settlements from credit and debit transfers are
posted simultaneously with only the net amount of funds increasing or
decreasing the balances of depository institutions held at Reserve
Banks.\11\ The Board has issued a separate Federal Register notice
requesting comment on shifting from 11 a.m. to 8:30 a.m., eastern time,
the posting time for commercial and government ACH debit transfers that
are processed by the Reserve Banks' FedACH service.\12\ The earlier
posting time would make the postings of commercial and government ACH
debit and credit transfers simultaneous.
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\11\ Currently FedACH credit transfer and debit transfer
transactions post at 8:30 a.m. and 11 a.m. eastern time,
respectively.
\12\ All times referenced are eastern time.
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Some commenters raised ideas for changes other than those suggested
in the consultation paper, including lowering fees for securities-
related daylight overdrafts, allowing individual banks to coordinate
informally the sending of Fedwire funds transfers, and reducing the
maximum payment size allowed through the Fedwire funds transfer system.
Finally, several commenters addressed a question in the consultation
paper about the payment of interest on reserves and the possible effect
on depository institutions' intraday liquidity management. Most
responders believed that the Federal Reserve's payment of interest on
reserve balances would not affect intraday liquidity management or
stated that its effect on liquidity was unknown without further
information.
Overall, the public comment letters and the extensive PRC and WCAG
investigations into intraday liquidity and late-day payments issues
validate a number of concerns raised in the consultation paper. It has
also become clear that no single policy or operational change would
address all of the intraday liquidity, risk, and payments issues that
the Board and the industry have identified. However, a series of steps
by both the private sector and the Federal Reserve could help.
To address the combination of intraday liquidity, operational, and
credit risks in the wholesale payments system, the Board believes that
the Federal Reserve and industry should pursue a four-pronged strategy.
The Board should review its PSR policy and consider adjusting the terms
and pricing of daylight overdrafts. The Reserve Banks should work with
the industry and investigate options for developing a liquidity-saving
mechanism for the Fedwire funds transfer system. Additionally, working
with the PRC, CHIPS and The Depository Trust and Clearing Corporation
should explore opportunities for improving payments processing and
liquidity use in their systems and processes relating to large-value
funds and securities settlement, respectively. This request for comment
focuses on the Board's PSR policy and recommends changes in strategy,
terms, and pricing for the provision of intraday credit by the Reserve
Banks.
III. New Strategy for PSR Policy
The current policy of providing uncollateralized daylight
overdrafts at an administered fee grew out of a Board study in the late
1980s that reviewed options for reducing the volume of intraday credit
provided by the Reserve Banks. A fundamental premise of this work was
that intraday credit is a necessary but undesirable aspect of the
payments system and should be reduced whenever possible. This premise
is expressed in the introduction to the current PSR policy as follows:
[T]he Board expects depository institutions to manage their
Federal Reserve accounts effectively and minimize their use of
Federal Reserve daylight credit. Although some intraday credit may
be necessary, the Board expects that, as a result of this policy,
relatively few institutions will consistently rely on intraday
credit supplied by the Federal Reserve to conduct their
business.\13\
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\13\ See the Policy on Payment System Risk http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, pg. 2.
In reviewing the current PSR policy, the Board identified five
major concerns related to risk and efficiency that together suggest
that a change in the Federal Reserve's approach to the provision of
daylight overdrafts is warranted at this time.\14\ First, the data
indicate a long-term trend of declining end-of-day balances held in
Federal Reserve accounts which, in turn, implies an increasing need by
institutions for daylight credit from the Reserve Banks to fund
payments-system transactions. Second, the Board notes that some
financial utilities can absorb large amounts of intraday funding from
participants to meet their risk management requirements. These funding
requirements result in large transfers of balances from participants'
Federal Reserve accounts that often are not reversed until the late
afternoon. Third, data, as well as comments on the consultation paper,
make clear that many large depository institutions hold a significant
number of large-value payments in ``liquidity queues'' primarily to
avoid daylight overdraft fees; such queuing can delay payments across
the financial markets. Fourth, data show that Reserve Banks' credit
exposure has increased over time in real terms despite Reserve Banks
charging fees. On certain days, the peak overdraft of the banking
system can exceed $210 billion. In 2007, the average daily overdraft of
the banking system as a whole was approximately $60 billion and the
average daily peak overdraft was approximately $160 billion. Finally,
daylight overdraft fees paid by the banking system have continued to
rise, increasing the cost burden of the PSR policy on the industry.
Daylight overdraft fees for 2007 totaled approximately $65 million,
compared with $32.2 million in 2003. Because there are systemic reasons
for the increased demand for intraday balances and credit as well as
evidence that the current pricing approach is creating liquidity queues
and increasing late-day operational risk, the Board concluded that its
current strategy of seeking to minimize daylight overdrafts should be
reassessed.
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\14\ Please see appendix I for a full discussion of these
issues.
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The Board also notes that thinking about the role of central banks
in providing intraday balances to the payments system has evolved
significantly over the past twenty years.
[[Page 12421]]
A 2003 study by the G-10 Committee on Payments and Settlements Systems
summarized this change in perspective and explicitly recognized that
central banks have an important role in providing intraday (central
bank money) balances to foster the smooth operation and settlement of
payments systems.\15\ In essence, this view is an extension to the
intraday market of the traditional role of central banks in supplying
overnight balances to the banking industry to meet financial market
demand for liquidity and operating balances. While some of the demand
of the banking industry for intraday balances can be met by overnight
balances, when the level of those balances is inadequate, a central
bank will need to supply additional funds through the temporary
provision of intraday funds, which could include using mechanisms such
as daylight overdraft facilities.
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\15\ ``Because the settlement of each payment involves a direct
transfer of the settlement asset, [real time gross settlement]
systems require substantially more of the asset to ensure smooth
payment flows. To enable this, most central banks provide intraday
credit to banks participating in these systems in quantities which
in some cases dwarf the banks' overnight balances or their overnight
borrowing from the central bank.'' See ``The Role of Central Bank
Money in the Payment System,'' Committee on Payment and Settlement
Systems, August 2003 at http://www.bis.org/publ/cpss55.pdf.
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The Board believes that a new strategy would enhance intraday
liquidity management while controlling risk to the Reserve Banks and
would build on the Board's 2001 proposal to consider two-tiered pricing
for daylight overdrafts.\16\ This strategy would
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\16\ The strategy is consistent with the public policy
objectives in the current PSR policy to foster the safety and
efficiency of payments and settlement systems as well as the version
of these objectives used in developing the Board's original pricing
proposals in 1988. At that time, the safety objectives were stated
as low direct credit risk to the Federal Reserve, low direct credit
risk to the private sector, low systemic risk, and rapid final
payments. The efficiency objectives were stated as a low operating
expense of making payments, equitable treatment of all service
providers and users in the payments system, effective tools for
implementing monetary policy, and low transaction costs in the
Treasury market. See ``Controlling Risk in the Payment System,''
Report of the Task Force on Controlling Payments System Risk to the
Payments System Policy Committee of the Federal Reserve System,
Board of Governors of the Federal Reserve System, August 1988.
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(1) Explicitly recognize that the Federal Reserve has an important
role in providing intraday balances to foster the smooth operation of
the payments system.
(2) Provide temporary, intraday balances to healthy depository
institutions predominantly through collateralized intraday overdrafts.
(3) Reduce over time the reliance of the banking industry on
uncollateralized daylight credit if this can be done without
significantly disrupting the operation of the payments system or
causing other unintended adverse consequences.
In brief, the rationale for the new strategy is that modern
payments and settlement systems, including Fedwire, CHIPS, CLS, and
DTC, require significant amounts of intraday balances or liquidity for
smooth operations and that the role of a central bank is to meet
reasonable market needs of participants in these systems for this
liquidity.\17\ In addition, under current policies, overnight balances
are not sufficient to address these needs and, as a result, temporary,
intraday balances through intraday credit must be provided by daylight
overdrafts.\18\ Intraday credit is now widely and explicitly provided
by central banks to support the operation of payments and settlement
systems, including by the Eurosystem, Bank of Japan, and Bank of
England. Typically this daylight credit is collateralized, but no fee
is charged.
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\17\ See The Role of Central Bank Money in the Payment System,
Committee on Payment and Settlement Systems, August 2003. (http://www.bis.org/publ/cpss55.pdf).
\18\ Policy decisions that will be made to exercise the Federal
Reserve's new statutory authority to pay interest on reserves
beginning in October 2011 could increase the level of overnight
balances held at the Reserve Banks and consequently reduce the
demand for daylight overdrafts to provide intraday balances.
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The proposed new strategy would explicitly use collateral augmented
by the framework of net debit caps to control credit risk to the
Reserve Banks in providing daylight overdrafts and would link the fees
charged for daylight overdrafts to the amount of collateral provided.
The same collateral eligibility criteria and haircuts would be used for
both overnight and intraday credit. Unencumbered collateral pledged for
discount window or PSR purposes could be used to support intraday
credit provided at the reduced daylight overdraft fee. The benefits of
encouraging the pledge of collateral would extend beyond the reduced
intraday credit exposure of the Reserve Banks and would include
enhanced emergency preparedness. Under the proposed policy, eligible
institutions would have an additional incentive to sign borrowing
documents with the Reserve Banks and pledge collateral, which would
enable such institutions to borrow from the discount window, if needed.
Controlling credit risk by taking collateral is a time-honored
risk-management technique. It is used explicitly in some cases today by
the Reserve Banks in the daylight overdraft program.\19\ Moreover,
under Operating Circular 10, depository institutions grant Reserve
Banks a lien on collateral pledged to the Reserve Bank as well as any
other property in the possession or control of, or maintained with, any
Reserve Bank, to secure discount window loans and any other
obligations, such as daylight overdrafts, owing to any Reserve
Bank.\20\
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\19\ Pledging collateral is generally limited to securing
maximum capacity (overdraft capacity above the net debit cap) or
protecting Reserve Banks against risk from problem depository
institutions.
\20\ Under Operating Circular 1, depository institutions also
grant Reserve Banks a lien on certain assets to secure any
obligation owing to any Reserve Bank: ``To secure any overdraft in
the master account, as well as any other obligation, now existing or
arising in the future, of the account holder to any Reserve Bank,
the account holder grants to the Reserve Bank all the account
holder's right, title, and interest in property, whether now owned
or hereafter acquired, in the possession or control of, or
maintained with, any Reserve Bank.''
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The new strategy would retain a net debit cap regime for all
depository institutions.\21\ The net debit cap would focus on
addressing low-probability risks and not unduly constraining normal
demands for balances and credit. Industry best practices and
supervisory guidance support the use of borrowing limits, or caps, even
for collateralized risk exposures as a prudent credit risk management
tool. Caps also serve as a useful mechanism for both Reserve Banks and
institutions in terms of setting benchmarks for the maximum expected
usage of daylight credit and supporting collateral.
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\21\ The current cap is a function of qualifying capital, which
varies based on the entity type. The qualifying capital is mutipled
by the cap mutliplier for cap categories to determine each
institution's limit. One limit applies for single-day use and
another for two-week average use, but these limits generally are not
binding. If an institution exceeds its cap, the Reserve Bank will
counsel the institution ex post. For additional information, see the
Guide to the Federal Reserve's Payments System Risk Policy at http://www.federalreserve.gov/paymentsystems/psr/guide.pdf.
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The new strategy also reflects the Board's sensitivity to avoiding
sudden and disruptive changes in policy that would not be in the public
interest and would not advance efforts to improve payments system
efficiency and safety. Hence, an element of the new strategy is to move
toward a greater use of collateral in a way that minimizes the cost and
administrative burden of the policy on most users of daylight
overdrafts. As a general matter, the Board believes that requiring
depository institutions to pledge collateral to support daylight
overdrafts would be consistent with reducing Reserve Bank credit risk,
with existing discount window practices, and with the policies
[[Page 12422]]
of other central banks. The Board is concerned, however, about the
potential implications of moving to a mandatory collateral regime at
this time, because of the uncertain effects such a move might have on
intraday liquidity and operational risk, as well as the burden on the
banking industry.\22\ The Board will continue to monitor developments
over time and to evaluate the costs and benefits of moving further
toward a collateralized structure.
---------------------------------------------------------------------------
\22\ Historically, the Board has sought to minimize the cost and
administrative burden of the PSR policy on institutions that do not
rely significantly on the use of daylight overdrafts to make
payments.
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IV. Discussion of Proposed PSR Policy Changes
To implement this new strategy, the Federal Reserve System will
need to adjust its current terms and fees for providing daylight
overdrafts. The Board believes that the following points summarize in
broad terms the elements of a new PSR policy that would be consistent
with such a change in strategy:
Explicitly encourage the pledging of collateral to support
intraday credit and apply unencumbered discount window collateral to
intraday credit.
Eliminate the fee for collateralized intraday credit.
Increase the fee for uncollateralized intraday credit.
Retain a modified version of the single-day daylight
overdraft cap to limit the ultimate size of Reserve Bank risk
exposures.
Adopt measures to limit the impact of policy changes on
depository institutions that are relatively small users of intraday
credit.
Table 1 summarizes the specific elements of the current and proposed
PSR policy.
Table 1.--Summary of Key Elements of the Current and Proposed PSR Policy
\23\
------------------------------------------------------------------------
Current policy Proposed policy
------------------------------------------------------------------------
Collateral.................. Required for problem Additional provision
institutions \24\ that explicitly
and institutions applies collateral
with max caps. pledged by healthy
Collateral institutions to
eligibility and daylight overdrafts
margins same as in their Reserve
discount window. Bank accounts.
Fee for collateralized 36 basis points..... Zero fee.
daylight overdrafts.
Fee for uncollateralized 36 basis points..... Increase to 50 basis
daylight overdrafts. points.
Deductible.................. 10 percent of an Replaced by zero fee
institution's for collateralized
capital measure. daylight overdrafts
and increased fee
waiver.
Fee waiver.................. Up to $25 biweekly.. $150 biweekly.\25\
Net debit cap............... Two-week average Two-week average
limit and higher limit is
single-day limit. eliminated;
adjusted policy for
single-day limit.
Max cap..................... Additional Streamlined process
collateralized for certain FBOs up
capacity above net to a limit; minor
debit cap for self- changes for all
assessed institutions.
institutions.
Penalty fee for ineligible 136 bps............. Increase to 150 bps.
institutions.
------------------------------------------------------------------------
To assist institutions in understanding the effect of the proposed
policy on their daylight overdraft fees, the Board has developed a
simplified fee calculator. The calculator enables institutions to
provide daylight overdraft and collateral data to estimate their
daylight overdraft fees under the proposed policy. The calculator is
located on the Board's Web site at https://www.federalreserve.gov/apps/RPFCalc/.
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\23\ Access to daylight credit would continue to be available
only to institutions with regular access to the discount window as
is the case today.
\24\ Problem institutions are institutions that are in weak
financial condition and should refrain from incurring daylight
overdrafts and institutions that chronically incur daylight
overdrafts in excess of their net debit caps in violation of the PSR
policy.
\25\ The proposed $150 waiver would be subtracted from the gross
fees (in a two-week reserve-maintenance period) assessed on any
depository institution eligible to incur daylight overdrafts. This
procedure differs from the current policy in which the waiver only
eliminates gross fees of institutions that have charges less than or
equal to $25 in a two-week period.
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A. Collateral. To help meet institutions' demand for intraday
balances while mitigating Reserve Bank credit risk, the Board would
adopt a policy of supplying intraday balances predominately through
explicitly collateralized daylight overdrafts provided by Reserve Banks
to healthy depository institutions at a zero fee. To avoid disrupting
the operation of the payments system and increasing the cost burden on
a large number of smaller users of daylight overdrafts, the Board would
allow the use of collateral to be voluntary, but a system of two-tiered
fees would be adopted to encourage the industry to make greater use of
collateral. Unencumbered discount window collateral would explicitly
collateralize daylight overdrafts, and collateralized overdrafts would
be charged a zero fee. Collateral eligibility and margins would remain
the same for PSR policy purposes as for the discount window.\26\ In
addition, the pledging of in-transit securities would remain an
eligible collateral option for PSR purposes at Reserve Banks'
discretion.\27\
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\26\ See http://www.frbdiscountwindow.org/ for information on
the discount window and PSR collateral acceptance policy and
collateral margins.
\27\ In-transit securities are book-entry securities transferred
over the Fedwire securities system that have been purchased by a
depository institution but not yet paid for or owned by the
institution's customers.
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Of the twenty-three responses to the consultation paper, fourteen
commenters addressed the question regarding greater use of collateral
to cover daylight overdrafts. All fourteen commenters supported greater
use of collateral (particularly to obtain a lower daylight overdraft
fee). A number of the respondents specifically argued for voluntary or
partial collateralization of intraday credit. Several respondents also
commented that collateralized overdrafts should be free of charge or
subject to an adjusted daylight overdraft fee. Most commenters stated
that their support for greater use of collateral was contingent upon
being able to use unencumbered discount window collateral to support
intraday credit.
The Board considered whether it should require collateralization of
all daylight overdrafts at this time. The Board generally believes that
requiring depository institutions to pledge collateral to support
daylight overdrafts
[[Page 12423]]
would be consistent with reducing Reserve Bank credit risk, existing
discount window practices, and the policies of other central banks.
However, the potential effect on intraday liquidity and operational
risk, along with the burden on the banking industry of a move to
mandatory collateral, suggests caution. For example, requiring
collateral could result in institutions being subject to rejected
payments or high ``penalty'' fees if they exceed the amount of pledged
collateral, could increase payment queuing by institutions without
sufficient collateral to pledge, and could add significant compliance
costs to the banking industry. Indeed, one respondent specifically
stated in its comment letter that it was not supportive of moving to a
mandatory collateral regime for daylight overdrafts even at a zero fee.
For all these reasons, at this time, the Board is proposing a voluntary
collateral regime for daylight overdrafts.
The Board has long recognized that accepting collateral from
institutions would help control intraday credit risk to Reserve Banks.
Moving towards greater collateralization of daylight overdrafts was
hampered in the past by concerns about administration costs to
depository institutions, incentive effects, and other unintended
consequences. Most of these concerns have been addressed over time.
In the early 1980s, the aggregate amount of collateral pledged to
the discount window was quite low relative to intraday credit extended,
and many depository institutions had not signed the necessary legal
agreements with their Reserve Banks. During early PSR policy
consultations, there was also concern about the administrative costs of
pledging and monitoring additional collateral and about the possibility
that Fedwire or other payments could be disrupted if a depository
institution did not have sufficient collateral at a particular point
during the day. Since the 1980s, however, the quantity of collateral
pledged to the discount window has increased dramatically. In
particular, pledges to the discount window began to increase as a
result of industry and Federal Reserve actions to address contingencies
prior to the century date change and following September 11th.\28\ As
of year-end 2007, more than $980 billion in assets were pledged for
discount window and PSR purposes, most of which was unencumbered by
outstanding discount window loans.\29\
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\28\ In the early 1990s, the Reserve Banks began standardizing
policies regarding eligible asset types, acceptance criteria, and
valuation. By the mid 1990s, the Reserve Banks allowed multiparty
pledges through DTC. In the late 1990s, the Reserve Banks began
using market pricing for securities valuation, started allowing for
nonbank custodian and foreign custodian (Clearstream and Euroclear)
arrangements, and began accepting a broader array of asset types of
collateral. New types of eligible assets since that time have
included non-AAA ABS, AAA collateralized debt obligations,
commercial mortgage-backed securities, trust preferred securities,
credit union mutual funds, GSE stock, STRIPS, German jumbo
Pfandbriefe, and certain other foreign currency-denominated assets.
\29\ This collateral value reflects lendable value based on the
Reserve Banks' margins and does not include pledges of in-transit
securities.
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Most of the largest users of daylight overdrafts have sufficient
unencumbered collateral pledged to the Reserve Banks to cover their
average level of daylight overdrafts. In addition, as table 1
indicates, during the fourth quarter of 2007, fifteen of the twenty
largest users of intraday credit would have been able to cover the
average peak amount of daylight overdrafts using existing pledged
collateral. In particular, the maximum peak overdrafts of eight of
these institutions would have been covered by their current collateral
pledges. It is highly likely that additional collateral would be
pledged to cover intraday credit if appropriate incentives existed.
Table 2.--The Number of Top Daylight Overdrafters Able To Collateralize Borrowings With Existing Collateral
Pledges
[Q4 2007]
----------------------------------------------------------------------------------------------------------------
Number of institutions that have existing
Cumulative collateral to cover:
percent of -----------------------------------------------
average Maximum daily
daylight Average Average peak peak of
overdrafts daylight of daylight daylight
overdrafts * overdrafts * overdrafts
----------------------------------------------------------------------------------------------------------------
Top 10.......................................... 75 8 7 3
Top 20.......................................... 84 18 15 8
Top 50.......................................... 94 46 40 28
Top 100......................................... 97 91 68 47
Top 200......................................... 98 174 119 80
----------------------------------------------------------------------------------------------------------------
* The data are quarterly averages of daily data.
One issue that has not changed since the 1980s is that a
substantial number of depository institutions, mainly smaller
institutions, use intraday credit but have not signed borrowing
agreements with their Reserve Banks (about 1,500 of 4,400 institutions
that make some use of intraday credit). In addition, another 1,700
institutions that use intraday credit have borrowing agreements, but
have not pledged any collateral to the Reserve Banks. Thus, the Board
recognizes that the policy needs to avoid imposing an undue burden on
small users of daylight credit or on the Reserve Banks. The new fee
waiver is intended to minimize the burden on small users of the
proposed policy changes.
Another historical administrative concern has been the cost and
practicality of Reserve Banks' perfecting their security interests in
collateral and monitoring that collateral to manage their credit risk.
Today, it is a routine matter for a Reserve Bank to file a Uniform
Commercial Code financing statement with state authorities to perfect
its security interest in any and all bank assets that are pledged. The
Reserve Banks have implemented automated systems to track collateral
held at the Reserve Banks, by third-party custodians, and by the
borrowers themselves. In addition, the Reserve Banks monitor borrower
eligibility to participate in a borrower-in-custody program. On
balance, although improvements can always be made in procedures and
systems, significant improvements have been made over time that address
the earlier administrative concerns about explicitly collateralizing
the daylight overdrafts of
[[Page 12424]]
depository institutions that routinely use large amounts of intraday
credit.
In the past, the Board also had concerns that accepting collateral
to address Reserve Bank credit risk for daylight overdrafts would not
provide strong incentives to reduce the level of intraday credit. In
particular, there was concern that because of the wide range of
collateral accepted by the Reserve Banks, depository institutions would
have weak incentives to reduce their use of intraday credit. Under the
new strategy, the purpose of Reserve Banks accepting collateral is not
to control the level of overdrafts per se, but to mitigate credit risk
to the Reserve Banks when they provide intraday balances and credit
needed for the smooth operation of the payments system.
Additionally, there was concern that reliance on collateral alone
might result in Reserve Banks providing excessive amounts of credit to
particular depository institutions and present the Reserve Banks with
reputational and residual credit risks. Although the Board proposes to
relax some aspects of the net debit cap program, caps on total intraday
credit extensions would remain in place to help address these risks.
Eliminating the two-week average net debit cap and retaining the higher
single-day cap for healthy depository institutions has the effect of
raising caps approximately 50 percent from the current policy. This
increase coupled with the incentive to collateralize daylight
overdrafts is consistent with the strategy of providing additional
balances and credit for the payments system. Other central banks that
provide collateralized intraday credit at a zero price have not
reported problems with excessive growth in the level of intraday
credit.
The Board's main concern about unintended consequences has been
that by taking collateral, the Reserve Banks could be inadvertently
shifting credit risk to unsecured and uninsured creditors of an
institution or to the Federal Deposit Insurance Corporation's (FDIC)
deposit insurance fund. With regard to unsecured creditors of a
depository institution, the concern is whether these creditors would
know about the institution's pledge to a Reserve Bank and have an
opportunity to reduce their exposure to the depository institution,
increase compensation for increased risk, or take other appropriate
action. The public filing of financing statements by Reserve Banks and
the existence of automated services for searching for liens mitigates
this concern.
The Board's concerns about the implications for the FDIC's
insurance fund predate changes in Reserve Bank collateral
administration practices and the FDIC's adoption of ``least cost''
resolution policies pursuant to the FDIC Improvement Act of 1991. The
Board believes that the evolution of the PSR policy and related
procedures have helped to address its concerns. Under the current PSR
policy, an ``institution must be financially healthy and have regular
access to the discount window'' in order to qualify to receive daylight
credit from its Reserve Bank.\30\ Under the implementation scheme for
net debit caps, a financially healthy institution is essentially
defined as at least an adequately capitalized depository institution
that has a supervisory rating of CAMELS-3 or higher.\31\ Moreover, a
Reserve Bank may ``limit or prohibit an institution's use of Federal
Reserve intraday credit if * * * the institution's use of daylight
credit is deemed by the institution's supervisor to be unsafe or
unsound.'' \32\ Thus, if supervisory issues arise with an institution,
supervisors, including the OCC and FDIC, would be and have been
consulted about the financial condition of an institution that is using
or seeking to use intraday credit. In some circumstances, Reserve Banks
impose real-time controls to reject outgoing Fedwire funds transfers
that would cause a depository institution's account to exceed a limit,
including a limit of zero.\33\ While residual risks may exist, PSR
policies and procedures as well as FDIC legislation have been
significantly enhanced in ways that help control both risk to the
Reserve Banks and to the FDIC insurance fund.
---------------------------------------------------------------------------
\30\ See the Payment System Risk Policy at http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, p. 22.
\31\ The CAMELS ratings apply to commercial banks, savings and
loan associations, natural person credit unions, and bankers' banks.
Other supervisory rating structures apply for FBOs and corporate
credit unions. The Reserve Banks use these supervisory ratings and
other factors to determine credit risk and whether they will extend
daylight overdraft capacity.
\32\ See the Policy on Payment System Risk at http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, p.23.
\33\ The Reserve Banks use real-time monitoring to prevent
selected institutions from effecting certain transactions--outgoing
Fedwire funds transfers, National Settlement Services transactions,
or automated clearing house (ACH) credit originations--if their
accounts lack sufficient funds to cover the payments. Generally, a
Reserve Bank will apply real-time monitoring to an institution's
position when the Reserve Bank believes that it faces a greater
level of risk exposure, for example from problem institutions or
institutions with chronic overdrafts in excess of what the Reserve
Bank determines is prudent.
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On balance, the Board believes that explicitly accepting collateral
for daylight overdrafts on a voluntary basis offers important
improvements in policy. In particular, collateralized daylight
overdrafts will support liquidity and operational risk reduction for
the payments system, long-term credit risk reduction for the Reserve
Banks, and a more-reasonable cost burden on the industry.
B. Fees for collateralized daylight overdrafts. The Board proposes
lowering the fee to zero for collateralized daylight overdrafts to
encourage institutions to pledge collateral and to reduce payments held
in liquidity-management queues. The value of unencumbered collateral
pledged at the Reserve Banks for PSR or discount window purposes would
be applied in the determination of daylight overdraft fees assessed to
institutions.
Of the twelve commenters that addressed two-tier pricing with a
lower fee for collateralized overdrafts, most were highly supportive,
particularly if the fee on collateralized daylight credit were zero.
The other commenters raised questions or issues for the Board's
consideration. For instance, one commenter that supported two-tier
pricing expressed some concern about the potential cost and complexity
of implementing a two-tier pricing system. Another mentioned the
likelihood that two-tier pricing would increase the level of daylight
overdrafts. In addition, several institutions specifically requested
that all unencumbered collateral pledged to the Reserve Bank for
discount window or PSR purposes be considered in calculating an
institution's fees.
The Board has previously raised the possibility of a two-tier
pricing system for collateralized and uncollateralized daylight
overdrafts. In 2001, the Board requested comment on two-tier pricing as
a long-term PSR policy direction. \34\ Then, as now, most commenters
were supportive of such a regime. In August 2002, the Board stated that
it would continue to study two-tier pricing for collateralized and
uncollateralized overdrafts.\35\ The Board also specified that the
Reserve Banks would charge the collateralized rate on daylight
overdrafts up to the value of collateral pledged and then apply the
uncollateralized rate to the remaining daylight overdrafts.
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\34\ 66 FR 30208, June 5, 2001.
\35\ 67 FR 54424, August 22, 2002.
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To determine a collateralized fee, the Board has reviewed
historical papers and discussions of overdraft pricing, industry
comments and discussions surrounding the consultation paper, and the
practices of other major central banks. There is no definitive economic
literature on whether there is a nonzero intraday rate of interest that
should be
[[Page 12425]]
used in calculating fees for collateralized intraday central bank
credit. There are different views. One view argues that it would be
anomalous if the general term structure of interest rates contained a
major discontinuity between the overnight rate and the intraday rate
but without showing how to determine the existence and level of an
intraday rate. Another view essentially holds that intraday balances
provided by central banks should be priced at the marginal social cost
of production, which is approximately zero for central banks. This view
is reinforced by recent academic work suggesting that the role of
central bank intraday balances and credit is to help coordinate the
settlement of payments and not ultimately to finance underlying real
economic activity.
From the economic literature, a reasonable perspective is that
central banks should target a rate for providing collateralized
daylight balances and credit that advances the policy objectives of the
central bank. Further, because there is no evidence from other
countries that intraday rates affect central bank macroeconomic goals,
such as inflation or unemployment, a central bank has the flexibility
to set an intraday rate to advance its payments system objectives of
safety and efficiency. This is the intraday credit pricing strategy
generally followed by other major central banks, and there have not
been any reported effects on the central banks' ability to achieve
their monetary policy objectives.
The Board's view is that setting the collateralized daylight
overdraft fee at zero would improve tradeoffs among liquidity,
operational, and credit risks in the payments system. Although the
amount of intraday credit provided could well increase, credit risk to
the Reserve Banks would be controlled by traditional banking tools used
in providing credit (eligibility requirements, collateral, caps, and
monitoring). The Board also believes that credit risk to depository
institutions could decrease somewhat because greater liquidity would
imply faster payments and settlements and a correspondingly shorter
duration of intraday risk on customer accounts and counterparty
settlements. Similarly, liquidity would likely circulate more quickly
with the faster flow of payments as the incentive for depository
institutions to queue payments for liquidity purposes declines.
Operational risk from late-day payments would also likely decline
somewhat if depository institutions release payments generated earlier
in the day from their internal afternoon liquidity queues.
In addition, some theoretical literature and discussions with
bankers suggest that setting the collateralized fee at even a low rate
above zero might continue to provide incentives to queue and delay
payments. For example, small incentives can lead to strategic behavior
by depository institutions in which each waits for the other to send
payments that essentially provide the liquidity to avoid (priced)
daylight overdrafts, which in turn leads to a generalized delay of
payments until late in the day. Discussions with depository
institutions tend to confirm that, if a payment is not time-sensitive,
they may very well hold that payment to reduce overdraft charges that
affect their budgets. Thus, the Board believes that the industry may
continue to hold back payments at any positive fee for collateralized
intraday credit.
The Board recognizes that a zero fee for collateralized intraday
credit is unlikely to reduce the share of late-day payments back to
pre-2000 levels. As validated by the PRC and WCAG survey, a number of
late-day payments are not originated until late in the day, and many of
these are unlikely to be affected by changes to daylight overdraft
fees. For example, late-day money market investments will of necessity
generate late-day payments.
In weighing the reasons for charging a zero fee for collateralized
daylight overdrafts, the Board identified at least two potential
unintended consequences. First, the Board is concerned that a zero fee
for collateralized overdrafts could eliminate incentives for depository
institutions and their customers to return securities used in
repurchase agreements early in the morning. The practice of early
return grew out of a coordinated effort by the clearing banks and the
market to respond to the implementation of overdraft fees in 1994 by
delivering government and agency securities held under certain types of
repurchase agreements back to borrowers of funds and their banks early
in the morning.\36\ The concern is that removing the overdraft fee
could remove the incentive for the early returns of securities, which
has been viewed as an important operational success in the securities
industry. Initial discussions with some depository institutions suggest
that the early return of securities has become an entrenched practice
in the market and it would not be reversed if there were a zero fee for
collateralized daylight overdrafts.
---------------------------------------------------------------------------
\36\ These deliveries take place over the Fedwire securities
(delivery-versus-payment) system, with the account of the depository
institution delivering securities credited with the accompanying
funds and the depository institution receiving the security debited
for those funds. The depository institutions and their large
customers delivering securities control the delivery process. Fees
provide a significant incentive for institutions to return (deliver)
securities early in the day and obtain the corresponding funds
credits in order to limit daylight overdrafts at a Reserve Bank.
These early deliveries have the corresponding effect of generating
priced daylight overdrafts in the accounts of institutions receiving
securities, which, in turn, provides incentives to settle new trades
or initiate new deliveries quickly.
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Second, the Board is concerned that a collateralized overdraft fee
of zero would reduce the incentives of depository institutions to
invest in a new liquidity-saving mechanism for the Fedwire funds
transfer system or to improve practices in using CHIPS or DTC.\37\ This
is a clear risk to the overall four-prong strategy for addressing
liquidity, operational, and credit risk. Other countries, such as
Germany, have seen a demand for liquidity-saving mechanisms even with
zero overdraft fees, but those demands may have been motivated by
depository institutions' desire to save collateral capacity in a regime
of mandatory collateralization of intraday credit.
---------------------------------------------------------------------------
\37\ Work with the industry on models for a liquidity-saving
mechanism for the Fedwire funds transfer system began in August
2007.
---------------------------------------------------------------------------
While the Board is concerned about these possible unintended
consequences, it must balance these concerns with its goal of reducing
liquidity, operational, and credit risks. On balance, the Board
believes that charging a zero fee for collateralized overdrafts will
contribute to overall risk reduction.
C. Fees for uncollateralized daylight overdrafts. In a regime in
which the Board expects the pledging of collateral to become the norm,
but remain voluntary to avoid the disruptions of rejecting payments
that could occur under mandatory collateralization, the fee for
uncollateralized overdrafts takes on a new role of providing a
significant incentive to collateralize overdrafts. In the past, the
Board has suggested assessing a ``risk premium'' for uncollateralized
overdrafts by estimating the spread between the overnight Federal funds
rate and the Treasury general collateral repo rate.\38\ In 2001, the
Board cited a risk premium of 12 to 15 basis points.\39\ Although the
[[Page 12426]]
current fee of 36 basis points is higher than this risk premium if a
zero fee is charged for collateralized daylight overdrafts, the fee
arguably reflects allowances for variation in the risk premium across
time and across borrowers.\40\ Under the proposed strategy to encourage
the voluntary pledging of collateral, the Board proposes a more-
significant spread between collateralized and uncollateralized daylight
overdrafts that exceeds previous estimates of the risk premium.
Specifically, the Board proposes raising the fee to 50 from 36 basis
points (annual rate) for uncollateralized daylight overdrafts to
encourage the collateralization of daylight overdrafts.\41\ The Board
notes that the proposed 50 basis point fee for uncollateralized credit
would be less than the final fee of 60 basis points for daylight credit
originally announced by the Board in 1994 but never implemented.\42\
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\38\ The spread between the overnight Federal funds rate and the
Treasury general collateral repo rate can be used as a proxy or
measure of credit risk. The spread can be volatile over short
periods, reflecting changes in the availability of Treasury
collateral. The average spread since 1991 is 7 basis points, with a
standard deviation of 17 basis points. From 2000 to 2007, the
average spread was between 6 and 10 basis points, while from mid-
1980 to 2000, the spread was closer to 12 to 15 basis points.
\39\ See 66 FR 30208, June, 5, 2001.
\40\ Another possible proxy of credit risk is the rate
associated with credit default swaps for major depository
institutions. Between January 2001 and December 2007, the median
spread for an index of one-year credit default swaps on major
depository institutions was 10 basis points (standard deviation of
10 basis points). The minimum and maximum for the index were 1 and
63 basis points, respectively.
\41\ In calculating an institution's fees, the value of
collateral pledged to the Reserve Banks will be subtracted from
negative account balances at the end of each minute. All minutes
where the negative account balance exceeds the value of collateral
pledged will be summed and divided by the number of minutes in the
Fedwire operating day to arrive at a daily uncollateralized daylight
overdraft, which would be assessed the 50 basis point (annual) fee.
The value of collateral pledged is the same for PSR and discount
window purposes.
\42\ As a result of the sizeable reductions in daylight
overdrafts achieved by the introduction of fees, as well as concerns
about the possible effects of further rapid fee increases, the Board
announced in March 1995 that it would increase the fee to 36 basis
points rather than the planned 48 basis points. Originally, the
Board planned to phase in over three years a fee of 60 basis points
in steps of 24, 48, and 60 basis points.
---------------------------------------------------------------------------
The 50 basis point fee for uncollateralized overdrafts would
provide a strong incentive for a depository institution to pledge
collateral to its Reserve Bank in an amount sufficient to reduce or
eliminate the depository institution's charges for its use of daylight
credit. In addition, the fee for uncollateralized credit would
discourage the use of uncollateralized daylight credit by those
depository institutions that have not pledged sufficient collateral to
support their payments activity. If uncollateralized credit increases,
however, the fee for uncollateralized credit could be raised at a
future date to limit further the use of such credit. At this time, the
50 basis point spread between collateralized and uncollateralized
daylight overdrafts sufficiently underscores the Board's new strategy
about the importance of pledging collateral to obtain intraday balances
and to reduce the Reserve Banks' credit risk.
D. Deductible. The Board has long sought to minimize the burden of
the PSR policy on institutions that use small amounts of daylight
overdrafts by adopting a series of special provisions in the
administration of daylight overdraft pricing and net debit caps. These
provisions reflect the highly concentrated incidence of overdrafts at
twenty depository institutions, which incur about 80 percent of
daylight overdrafts. Two important components of the current PSR policy
are the deductible from daylight overdraft fees based on an
institution's capital and a $25 biweekly fee waiver.\43\ In essence, an
amount of free uncollateralized intraday credit is provided through
these provisions. The Board proposes to eliminate the deductible but
also proposes to increase the fee waiver (discussed in the next
section) to minimize the burden of the policy changes on small users of
daylight overdrafts.
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\43\ Daylight overdraft charges are reduced by a deductible,
which is calculated using 10 percent of eligible capital. The
deductible was created with the introduction of pricing to provide
some amount of free liquidity to the payments system, to compensate
depository institutions for periodic outages of Reserve Bank
computer systems, and to enhance operational simplicity by exempting
small users of intraday credit. The Reserve Banks also waive fees of
up to $25 or less in any two-week reserve-maintenance period. The
waiver reduces administrative burden on Reserve Banks and a large
number of depository institutions that incur small fees.
---------------------------------------------------------------------------
Continuing to provide significant amounts of free uncollateralized
credit to large institutions through the deductible would be
inconsistent with the strategy of emphasizing the provision of intraday
credit through collateralized overdrafts at a zero fee. Retaining the
deductible would weaken the incentives for depository institutions to
pledge collateral to cover overdrafts and would not decrease risk to
the Reserve Banks. In particular, the largest users of daylight credit
would be able to use collateral to cover a significant portion of their
overdrafts and then use their deductible to avoid fees on a significant
amount of uncollateralized credit, undermining the incentive effects of
fees on uncollateralized daylight overdrafts. Further, to the extent
the deductible historically provided a source of free liquidity to
depository institutions, it would no longer be needed because
collateralized credit would provide an alternative source of free
intraday liquidity. In addition, eliminating the deductible and
increasing the fee waiver would provide a simpler and more-uniform way
to provide a de minimis amount of free uncollateralized credit and
would help limit the cost burden of the policy on small users of
daylight overdrafts.
Further, the Board believes that by eliminating the deductible for
all depository institutions and providing free collateralized intraday
credit to eligible depository institutions, including FBOs, the
proposed policy changes would address the negative incentive effects of
the deductible calculations on FBOs that the commenters identified.
FBOs would be assessed the same fees as U.S.-chartered depository
institutions, which, under the proposal, would be zero for
collateralized daylight overdrafts and 50 basis points for
uncollateralized overdrafts.
E. Fee waiver and treatment of small users of daylight overdrafts.
The Board continues to believe that it is important to reduce the
burden of the PSR policy on institutions that use small amounts of
daylight overdrafts. In setting the fee waiver amount, the Board sought
to balance the risk faced by Reserve Banks from uncollateralized
overdraft exposures against the administration costs to Reserve Banks
and depository institutions from fee assessments and collateral
arrangements. The Board proposes to limit the burden for institutions
that use small amounts of daylight overdrafts by increasing the fee
waiver to $150 from $25. The waiver would be subtracted from the gross
fees (in a two-week reserve-maintenance period) assessed on any user of
daylight overdrafts.\44\ This procedure differs from the current policy
in which the waiver only eliminates gross fees of institutions that
have charges less than or equal to $25 in a two-week period. This
approach would avoid a discontinuity in applying the waiver, which may
create incentives for delaying payments to prevent a large marginal
increase in fees.
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\44\ The proposed waiver would not result in refunds or credits
to an institution. The waiver would not apply to institutions
subject to the penalty fee.
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An institution is defined as a small user of daylight credit if the
institution has an exempt cap, which is the smallest positive cap under
the policy, or if the institution averages less than $1 million a day
in daylight overdrafts. The Board has historically considered exempt-
cap institutions to be small users of daylight overdrafts.\45\ In
[[Page 12427]]
addition, a number of institutions with higher cap levels regularly
incur similar small amounts of daylight overdrafts. The level of $1
million, in 2007 dollars, is based on levels historically considered
small.\46\ Through the waiver, the Board intends to limit the burden
for virtually all exempt-cap institutions and to cover the routine
overdraft activity of institutions that average less than $1 million a
day in daylight overdrafts.
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\45\ See 51 FR 45054, December 16, 1986, and 52 FR 29255, August
6, 1987.
\46\ See 51 FR 45054, December 16, 1986.
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The Board considered a range of waiver amounts from $100 to $250.
At the $150 waiver, the amount of free credit provided limits the
burden for virtually all exempt-cap institutions and covers the routine
overdraft activity of small users. Beyond a $150 waiver, the number of
small users that would be paying higher fees diminishes only
marginally, and mid-to-large users of daylight overdrafts benefit
increasingly. On balance, the Board determined that the associated
increase in uncollateralized Reserve Bank exposure per day of
increasing the waiver amount outweighed the marginal decrease in the
number of small users paying higher fees. In addition, a higher waiver
amount would decrease the incentive to pledge collateral for those mid-
to-large users of daylight overdrafts benefiting from the waiver
increase.
Based on fourth-quarter 2007 daylight overdraft and collateral
values, table 3 shows that the proposed $150 waiver would eliminate or
reduce fees for 99.2 percent of small users of daylight overdrafts. The
vast majority of these institutions do not pay fees under the current
policy. The waiver, however, would not eliminate or reduce fees paid
for all small users because some of these institutions incur relatively
high daylight overdrafts on peak days, which could result in fees. In
particular, the $150 waiver generally covers routine daylight overdraft
activity for small users but may not cover the highest one or two
business days in the quarter. Because of this peak overdraft activity,
an estimated thirty-five small users could pay higher fees based on
fourth-quarter data if they did not pledge (additional) collateral. The
actual number of depository institutions that could incur higher fees
will vary over time based on daylight overdrafts incurred and
collateral pledged. In practice, there are few institutions, especially
small users, that would pay fees across all two-week periods in which
fees are assessed in a given year.
[GRAPHIC] [TIFF OMITTED] TN07MR08.000
The average annual increase in fees for each of the thirty-five
institutions is approximately $180. Of the thirty-five institutions, a
small number could incur an increase in average fees between $500 and
$1,000 in a year, while the other institutions could incur increases of
less than $500 in a year (or less than $20 in a two-week period). The
higher fees are associated with peak levels of daylight overdraft
activity relative to the amounts of collateral pledged. Each small user
could eliminate increases in fees by pledging $8 million, on average,
in (additional) collateral. As of the fourth-quarter 2007, only about
14 percent of these small users had collateral pledged, although two-
thirds had signed borrowing documents with their administrative Reserve
Banks.
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\47\ The fee data for mid-to-large users and all users exclude
one institution that is an outlier in comparison to the other
institutions that could be paying higher fees. The annual average
increase in fees more than doubles for mid-to-large institutions and
all users with the inclusion of this institution. This institution
would incur a fee increase of almost $3 million per year. The next
highest increases in fees are $475,000 and $260,000 per year.
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Table 3 also shows that over half (52 percent) of institutions that
incur mid-to-high levels of daylight overdrafts (mid-to-large users)
would have
[[Page 12428]]
sufficient collateral to eliminate or reduce their fees paid, while
slightly less than half (48 percent) of mid-to-large users could face
higher fees or would need to pledge collateral. Much of their overdraft
activity was excluded from fees under the deductible of the current
policy.
The average annual increase in fees across the 125 mid-to-large
users paying higher fees is approximately $18,350 (or $690 per two-week
period). The large majority of these institutions (about 75 percent)
would incur an increase in average fees of less than $10,000 per year
(less than $375 in a two-week period). Many of the mid-to-large users
have pledged collateral and have signed borrowing documents. Pledging
(additional) collateral of $90 million on average per institution would
avoid any increase in fees.
The Board recognizes that institutions will be interested in the
effect of the proposed changes on their daylight overdraft fees. To
assist institutions, the Board has developed a simple fee calculator.
The calculator enables institutions to provide daylight overdraft and
collateral data to estimate their daylight overdraft fees under the
proposed policy. The calculator is located on the Board's Web site at
https://www.federalreserve.gov/apps/RPFCalc/.
F. Net debit caps. Based, in part, on the expectation of some
additional collateralization of daylight overdrafts and the potential
need to provide more credit to the industry, the Board proposes to
eliminate the current two-week average cap on daylight overdrafts for
healthy depository institutions and retain the higher single-day cap.
The effect is to increase the routine daylight overdraft capacity of
healthy institutions with self-assessed caps approximately 50 percent
from the current policy. The single-day cap will apply to the total of
collateralized and uncollateralized daylight overdrafts.
The Board also proposes to provide additional flexibility in the
administration of net debit caps for fully collateralized daylight
overdrafts. If an institution incurs an overdraft above its single-day
cap, the Board proposes the following new ex post monitoring and
counseling procedures.
(1) If any part of the overdraft is uncollateralized, the current
ex post counseling regime would be used.\48\ Counseling may include a
discussion of ways the institution could manage more effectively its
account as well as other possible Reserve Bank actions, such as
reducing the net debit cap and rejecting certain payment transactions,
that would enable the Reserve Bank to protect its risk exposure from
the institution.
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\48\ The ex post counseling regime includes a series of actions
by the Reserve Bank that are aimed at deterring an institution from
violating the PSR policy by exceeding its net debit cap. These
actions depend on the institution's history of daylight overdrafts
and financial condition. Initial actions taken by the Reserve Bank
may include an assessment of the causes of the overdrafts, a
counseling letter to the institution, and a review of the
institution's account-management practices. If policy violations
continue to occur, the Reserve Bank may take additional actions,
which may include encouraging the institution to file a cap
resolution or perform a self-assessment to obtain a higher net debit
cap or to apply for maximum daylight overdraft capacity. In
situations in which an institution continues to violate the PSR
policy, and counseling and other Reserve Bank actions have been
ineffective, the Reserve Bank may assign the institution a zero cap.
The Reserve Bank may also impose other account controls that it
deems prudent, such as requiring the institution to pledge
collateral, imposing clearing balance requirements; rejecting
Fedwire funds transfers, ACH credit originations, or National
Settlement Service transactions that would cause or increase an
institution's daylight overdraft; or requiring the institution to
prefund certain transactions.
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(2) If the overdraft is fully collateralized, the Reserve Bank
would generally consider the condition an ``overlimit'' situation and
would be able to ``waive counseling'' for two incidents of overlimit,
fully collateralized overdrafts per two consecutive reserve-maintenance
periods (four weeks). Incidents of overlimit, fully collateralized
overdrafts beyond the two waivable incidents would be subject to ex
post counseling.
The overlimit flexibility would apply to institutions that have de
minimis or self-assessed net debit caps or max caps.\49\ Exempt-cap
institutions are already allowed under the policy to incur up to two
cap breaches in two consecutive reserve-maintenance periods. Zero cap
institutions would not be eligible. The overlimit flexibility would
also be in addition to other permissible waivers, such as waivers due
to Reserve Banks' errors.
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\49\ FBOs will continue to be monitored at their cap level in
real time. If an institution's account is monitored in real time,
any outgoing Fedwire funds transfer, National Settlement Service
transaction, or ACH credit origination that exceeds available funds
is rejected.
---------------------------------------------------------------------------
The overlimit flexibility allows a depository institution to obtain
additional fully collateralized credit beyond the established single-
day cap on an infrequent basis if the depository institution has fully
collateralized all of its daylight overdrafts-both those above and
those below its cap--when the event occurs. The proposed waiver of
counseling for overlimit overdrafts, if they are fully collateralized,
reflects their lower risk to a Reserve Bank relative to an overlimit
condition for uncollateralized credit. The Board recognizes that the
Reserve Banks may need to be flexible in granting fully collateralized
credit to carry out the intent of the new policy. The additional
flexibility also reinforces the new explicit policy emphasis on
collateralized intraday credit. The limited number of waivers, however,
reflects the fact that collateral may not fully protect a Reserve Bank
and that frequent breaches of agreed caps may reflect other concerns
about a depository institution, including an inability to manage its
account at a Reserve Bank or to manage its customers' activity. In
addition, max caps would continue to be available at a Reserve Bank's
discretion to deal with cases in which routine additional capacity is
needed by healthy institutions.
The overlimit flexibility also recognizes that from a supervisory
perspective counterparty credit risk management systems allow for bank
management to approve exceptions to those limits under appropriate
conditions, assuming the proper degree of management attention is
focused on such decisions. A waiver of what is currently called a
``breach'' of a daylight overdraft cap can be likened to an
``approval'' of an overlimit condition vis-[agrave]-vis a counterparty
credit risk exposure limit.
The Board examined the need to retain the net debit cap structure
for institutions that fully collateralize overdrafts and concluded that
it is still appropriate and prudent to have limits on intraday credit
even when the credit is fully collateralized. First, prudent banking
practice and current supervisory guidance support placing limits on
counterparty credit exposures even when other tools such as collateral
(with haircuts) are used to control risk. The basis for this guidance
is that collateral alone should not be regarded as sufficient
protection against counterparty credit risk but that a range of tools
should be used to manage risk, including credit limits. Haircuts on
collateral help mitigate the risk that counterparty credit exposure
that is intended to be collateralized will remain collateralized when
the value of the collateral declines. Haircuts themselves, however, may
change more slowly than the value of collateral for a variety of
operational, market, and policy reasons. Limits or caps complement the
use of collateral in risk mitigation. Among other things, they aim to
constrain the size of exposures in the first place rather than to
mitigate the risk of loss on exposures of a given size. Moreover,
limits may be used to limit
[[Page 12429]]
exposure to extreme risks and take some pressure off the use of
haircuts to address such risks.
Second, daylight overdrafts operate more like drawings on lines of
credit than discrete loans. Limits help the Reserve Banks set
expectations about the quantity of their potential exposures and help
depository institutions to keep their use of credit within prudent and
agreed-upon bounds. Further, credit limits serve as standardized
benchmarks for analyzing and comparing credit usage across depository
institutions and over time.
Third, the net debit caps, in particular, are based on customer
account and operational management policies at a depository institution
in addition to factors such as credit risk. Specifically, depository
institutions are required under the PSR policy to take four factors
into account when determining self-assessed caps, including their
creditworthiness; intraday funds management and related controls;
customer credit policies and related controls; and operating controls
and contingency procedures. These factors figure prominently in
supervisory guidance on managing risk in wholesale payments systems and
are also based on recommendations provided to the Board by the banking
industry in the 1980s.\50\ The issue of reputational risk is also a
factor in current supervisory guidance. The process of establishing and
renewing caps compels a depository institution and its management to
focus on a range of interrelated aspects of risk in controlling credit
and operational exposures both to a depository institution and to
Reserve Banks.
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\50\ See Association of Reserve City Bankers, The Final Report
of the Risk Control Task Force, prepared with the assistance of the
Bank Administration Institute and Robert Morris Associates (October
1984).
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Overall, there is a reasonable and prudent basis for placing caps
on collateralized overdrafts. Hence there is also a reasonable and
prudent basis for placing caps on overdrafts that are collateralized
voluntarily or not collateralized at all.\51\ The Board recognizes that
other central banks have not employed net debit caps in addition to
collateral in managing risk from intraday credit. Most central banks
seem to have viewed the provision of intraday credit as a simple
extension of practices with respect to overnight credit policy. These
central banks, however, have adopted mandatory collateral policies and
typically accept a much smaller range of collateral than the Reserve
Banks. Further, some major central banks have not had the technical
capability to conduct the comprehensive centralized tracking of
intraday credit extensions that has been developed by the Federal
Reserve over the past twenty years.
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\51\ Limits on daylight overdrafts also address the possibility
of ``adverse selection'' in a system of voluntary collateralization.
In essence, depository institutions in weaker operational or
financial condition might be quicker to pledge collateral to obtain
larger amounts of intraday credit than stronger banks, for example,
to ensure that critical payments are made on time. In the
theoretical literature, caps or limits are frequently characterized
as helping to deal with adverse selection issues in credit markets.
Although Reserve Banks typically have access to supervisory
information about their borrowers, including their history and
management, the Reserve Banks may have imperfect information, which
may be another argument for caps as a useful tool in limiting
residual risk from such problems.
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Lastly, the Board considered the FBOs' request to increase the
fractions used to calculate the U.S. capital equivalency in determining
net debit caps. Under the current policy, the most-highly rated FBOs
receive 35 percent (instead of 100 percent) of their worldwide capital
for the U.S. capital equivalency. FBOs with weaker ratings receive
lower measures of U.S. capital equivalency. In 2007, FBOs as a group
incurred average peak overdrafts that were less than 50 percent of
their single-day capacity. A few FBOs may approach their cap limits on
certain liquidity-intensive payment days, but it does not appear that
FBOs are generally constrained by current cap levels. The Board
recognizes, however, that the behavioral changes of individual FBOs and
other depository institutions following a change in daylight overdraft
policy are somewhat uncertain. For example, some institutions may
prefer to release payments more quickly, incurring periods of increased
daylight overdrafts, if they have the capacity to do so. To facilitate
the earlier release of payments, the Board is proposing to streamline
the process for the maximum daylight overdraft capacity (max cap)
program, which provides additional capacity on a fully collateralized
basis, for certain FBOs (discussed in the next section).
G. Maximum daylight overdraft capacity. Currently, depository
institutions with self-assessed net debit caps are eligible to pledge
additional collateral to their Reserve Banks to secure intraday credit
in excess of their net debit cap under the max cap program.\52\ As part
of the consultation process, the Board received two comments on the max
cap program. The commenters indicated preferences for greater
flexibility and consistency across Reserve Banks in the implementation
of the program.
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\52\ Current procedures associated with max caps can be found in
the Guide to the Federal Reserve's Payments System Risk, which is
available at http://www.federalreserve.gov/paymentsystems/psr/mainguide.pdf.
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Under the new strategy, the max cap would continue to act as a tool
to provide healthy institutions with flexibility in addressing their
intraday liquidity needs. In particular, the Board proposes to take a
more-favorable view of extending collateralized credit to financially
sound institutions demonstrating a business need for additional
daylight overdraft capacity. The current policy states:
An institution with a self-assessed net debit cap that wishes to
expand its daylight overdraft capacity by pledging collateral should
consult with its administrative Reserve Bank. Institutions that
request daylight overdraft capacity beyond the net debit cap must
have already explored other alternatives to address their increased
liquidity needs. The Reserve Banks will work with an institution
that requests additional daylight overdraft capacity to determine
the appropriate maximum daylight overdraft capacity level. In
considering the institution's request, the Reserve Bank will
evaluate the institution's rationale for requesting additional
daylight overdraft capacity as well as its financial and supervisory
information.
The Board proposes to remove the requirement that institutions must
have already explored other alternatives to address their increased
liquidity needs. This statement is inconsistent with the proposed
strategic direction of the new policy. A depository institution
interested in obtaining a max cap would still need to contact its
administrative Reserve Bank, which would work with the institution to
determine an appropriate capacity level and would assess relevant
financial and supervisory information in making such a credit decision.
In addition, the Board proposes allowing an FBO that is a financial
holding company or SOSA 1-rated institution to request from its
administrative Reserve Bank a max cap without documenting a specific
business need for additional capacity or providing a max cap board of
directors resolution.\53\ The streamlined max cap would enable these
FBOs to acquire additional capacity that in total would provide up to
100 percent of worldwide capital times the self-assessed cap multiple.
A financial holding company is currently eligible for uncollateralized
capacity of 35 percent of worldwide
[[Page 12430]]
capital times the cap multiple. The streamlined max cap would provide
additional collateralized capacity of 65 percent of worldwide capital
times the cap multiple.\54\ While streamlined, the Reserve Bank would
retain the right to assess the ability of eligible FBOs to manage the
intraday capacity permitted by the max cap as part of reviewing
financial and supervisory information. Specifically, the Reserve Bank,
in consultation with the home country supervisor, would engage in
initial as well as periodic dialogue with the institution that is
analogous to the periodic review of liquidity plans performed with U.S.
institutions to ensure the institution's intraday liquidity risk is
managed appropriately.
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\53\ The FBO would still be required to complete a self-
assessment and provide a board of directors resolution for the self-
assessed cap.
\54\ A SOSA-1 rated institution is eligible for uncollateralized
capacity of 25 percent of worldwide capital times the cap multiple.
The streamlined max cap would provide additional collateralized
capacity of 75 percent of worldwide capital times the cap multiple.
---------------------------------------------------------------------------
The Board believes the streamlined max cap is appropriate for the
group of FBOs with which the Reserve Banks have lower supervisory
concerns. If an FBO requests capacity in excess of 100 percent of
worldwide capital times the self-assessed cap multiple, however, it
would be subject to the full max cap process applicable to all
institutions.
H. Foreign Banking Organizations. The fractional allowance for
worldwide capital of FBOs used in calculating net debit caps and
deductibles historically has been based on risk differences between
FBOs and U.S.-chartered depository institutions. The Federal Reserve's
access to supervisory information on FBOs is generally not as timely or
complete as the information about U.S.-chartered institutions. In
addition, the Federal Reserve incurs legal risk with respect to the
application of foreign insolvency laws to FBOs. The existing cap limit
and daylight overdraft fee have helped to control credit risk from FBOs
to the Reserve Banks.
The Board, however, is proposing several changes to the treatment
of FBOs under the PSR policy that would address the concerns of the
FBOs while managing the risk to the Reserve Banks. The Board believes
that by eliminating the deductible for all depository institutions and
providing free collateralized intraday credit to eligible depository
institutions, including FBOs, the proposed policy changes would address
the negative incentive effects of the deductible calculations that the
commenters have identified. In addition, as discussed in the previous
section, the Board proposes to streamline the max cap process for
certain FBOs. Today, if an FBO is constrained by the cap limit on a
frequent basis or on specific days, it may apply to its Reserve Bank
for a max cap. While the Board believes this program has provided
sufficient flexibility for FBOs to obtain additional capacity, the
Board recognizes that the business case and board of directors
resolution required to obtain a max cap could be slow or cumbersome.
This procedure may not be warranted for financial holding companies and
SOSA-1-rated FBOs to acquire additional capacity that in total provides
up to 100 percent of worldwide capital times the self-assessed cap
multiple.
I. Penalty fees. Institutions that do not have regular access to
the discount window are not eligible under the PSR policy to incur
daylight overdrafts. In 1994, the Board announced that it would apply a
penalty fee to these institutions if they did incur daylight
overdrafts.\55\ The Board believed that the penalty rate would provide
incentives to these institutions to avoid situations that could cause a
daylight overdraft. The penalty rate adopted by the Board was equal to
the regular daylight overdraft fee plus 100 basis points. Thus, given
the proposed increase in the fee for uncollateralized daylight
overdrafts, the Board proposes to increase the penalty fee
correspondingly from 136 to 150 basis points.
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\55\ See 59 CFR 8979, February 24, 1994.
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J. Timing considerations and issues for Reserve Bank and depository
institution implementation. The Reserve Banks will need a significant
lead time to adjust internal processes and systems to the proposed PSR
policy changes. These changes will affect the Reserve Banks' credit
risk management and accounting software applications. The Board
anticipates that institutions' systems could also require some
adjustments. The Board expects that a revised PSR policy could be
implemented in approximately two years from the announcement of a final
rule. The Board, however, could implement the proposed changes to the
max cap program for FBOs on an earlier date.
V. Questions
The Board requests comments on all aspects of the proposed PSR
policy changes, including the new strategy, collateral, fees for
collateralized daylight overdrafts, fees for uncollateralized daylight
overdrafts, net debit caps, max caps, deductibles, fee waivers, penalty
fees, and implementation timeline.
In addition to comments on all aspects of the proposed PSR policy
changes, the Board would appreciate responses to the following
questions.
General
(1) Does your institution believe that the introduction of a zero
fee for collateralized daylight overdrafts will contribute to an
overall reduction in liquidity, operational, and credit risks in the
payments system? Would it reduce these risks for depository
institutions, their customers, or financial utilities?
(2) What procedural or systems changes do you expect to make as a
result of this proposed policy change?
Collateral
(3) Does your institution regularly use Federal Reserve daylight
credit, and does your institution currently have sufficient
unencumbered eligible collateral to pledge to the Reserve Banks to take
advantage of a zero fee for collateralized overdrafts? By your
estimate, what proportion of your expected average and peak overdraft
would you intend to collateralize?
(4) Would your institution's intraday credit use increase or
decrease from current levels? Do you expect the intraday credit usage
of depository institutions as a group to increase or decrease from
current levels?
(5) While the proposal envisages no fee for collateralized
overdrafts, institutions will face an opportunity cost to pledge
collateral. How difficult or costly would it be to collateralize
daylight overdrafts? What opportunity costs would your institution face
in pledging (additional) eligible assets to the Reserve Bank to
collateralize daylight overdrafts? What are the costs of entering into
the Reserve Banks' borrowing documents?
(6) How would the adoption of this new PSR strategy, which
explicitly links collateral to daylight overdrafts and pricing of
daylight overdrafts, affect the availability of collateral for other
financial market activity? How might it affect other creditors and
other payments system participants?
(7) What (additional) collateral management capabilities would your
institution expect of its Reserve Bank (such as changes to the
frequency or means of obtaining collateral reports, the ability to move
directly and quickly collateral in and out of pledge accounts, and so
on)?
(8) If you do not currently have a borrowing agreement or pledge
any collateral, would you expect to do so? If so, would the rationale
rest on the use of daylight overdrafts or overnight extensions of
credit?
[[Page 12431]]
Pricing
(9) To what extent would your institution make payments earlier in
the day as a result of the proposed pricing changes? If your
institution holds payments in a liquidity queue, would your institution
continue to hold payments, particularly large-value payments, in a
liquidity queue under the proposed policy changes? If so, under what
circumstances would your institution continue to queue payments? What
further steps would encourage queue reductions?
(10) Does your institution believe that the introduction of a zero
fee for collateralized daylight overdrafts could lead to changes in
practices for returning early securities used in repurchase agreements?
What changes might institutions expect?
(11) Does your institution believe that the introduction of a zero
fee for collateralized daylight overdrafts and the higher (50 basis
point) fee for uncollateralized daylight overdrafts could lead to
changes in practices for the early return of fed funds loans? What
changes might institutions expect?
(12) If your institution would face potentially higher fees on its
daylight overdrafts, how will your institution adjust its collateral
position or payments activities in response to the Board's proposed
fees?
VI. Competitive Impact Analysis
The Board has established procedures for assessing the competitive
impact of a rule or policy change that has a substantial effect on
payments systems participants.\56\ Under these procedures, the Board
assesses whether a change would have had a direct and material adverse
effect on the ability of other service providers to compete 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
modification would mitigate the adverse competitive effects, the Board
will determine whether the expected benefits are significant enough to
proceed with the change despite the adverse effects.
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\56\ 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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Intraday balances of central bank money help ensure the smooth flow
of payments systems whether operated by the Reserve Banks or private-
sector clearing and settlement systems. The demand for intraday
balances at the Reserve Banks for processing payments for private-
sector clearing and settlement systems can substantially exceed the
supply of overnight balances in Federal Reserve accounts, making
intraday credit from the Reserve Banks the key marginal source of
intraday funding for the market and for making payments, particularly
over the Reserve Banks' payments systems. For some large users of
intraday credit, the proposed PSR policy changes may result in a
reduction in daylight overdraft fees and thus lower explicit costs of
using central bank money to fund payments activity. The lower explicit
cost of using intraday balances of central bank money will lower the
implicit cost of using the Reserve Banks' payments services. The Board,
however, does not believe this lower cost will have an adverse material
effect on the ability of other service providers to compete with the
Reserve Banks because private-sector clearing and settlement systems
will gain from the lower explicit cost of funding net debit caps and
other risk and operational controls employed by those systems.
Generally, the Board expects that both the Reserve Banks and private-
sector clearing and settlement systems will benefit to some extent from
the reduced costs for daylight overdrafts.
VII. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR 1320 Appendix A.1), the Board reviewed the proposed PSR
policy under the authority delegated to the Board by the Office of
Management and Budget. No collection of information pursuant to the
Paperwork Reduction Act is contained in the policy statement.
VIII. Appendix I
The Board has identified five major concerns related to risk or
efficiency that together suggest a change in the Federal Reserve's
approach to the provision of intraday credit and the PSR policy is
warranted at this time. These concerns include the declining level of
overnight balances, the intraday funding needs of financial utilities,
payments delays, continued growth in Reserve Bank credit exposure, and
cost burden on the payments system.
A. Level of overnight balances. First, the current level of
overnight reserve and clearing balances is not sufficient to meet the
intraday liquidity needs of the banking industry and the payments
system. In 1988, overnight balances held at the Reserve Banks were
approximately $39 billion. Since that time, changes in market practices
(especially the introduction of retail sweep programs) and reserve
requirements have reduced overnight balances to an average of
approximately $16 billion in 2007; average daylight overdraft and
(average) peak daylight overdrafts in 2007 were four and ten times
overnight (closing) balances, respectively.
[[Page 12432]]
[GRAPHIC] [TIFF OMITTED] TN07MR08.001
B. Intraday funding of financial utilities. Second, with the
encouragement of the Federal Reserve and the industry, virtually all
commercial paper is now held at DTC in book-entry form and issued and
paid through that organization. In addition, trades of most publicly
listed stocks and corporate bonds are also settled through DTC. As a
result, DTC's members transfer substantial sums over the Fedwire funds
transfer system to DTC's clearing account at the Federal Reserve Bank
of New York beginning in the early afternoon to help meet DTC's risk-
management requirements.\57\ Most of these funds are not released by
DTC back to the market until final DTC settlement occurs around 4:30
p.m.\58\ As a result, for most of the afternoon, the demand for
intraday balances at the Reserve Banks for processing other payments
far exceeds the supply of overnight balances in Federal Reserve
accounts, making intraday credit from the Reserve Banks the key
marginal source of intraday funding for the market and for making
payments, particularly over the Federal Reserve's payments systems.
Under these circumstances, the provision of substantial amounts of
daylight balances and credit by the Reserve Banks is necessary for the
smooth functioning of Fedwire and the payments system more broadly.
Private-sector payments systems have created a structural demand for
daylight central bank credit averaging about $50 billion per day to
support their settlement and risk management activities. On peak days,
this demand can exceed $150 billion. The large magnitude of these
amounts is inconsistent with the premise of the current PSR policy that
relatively few institutions should rely on daylight credit from the
Federal Reserve and use should be minimal.
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\57\ The use of intraday balances of central bank money to
manage risk is explicitly endorsed by international risk standards
applicable to securities settlement systems such as DTC and
incorporated in the Board's PSR policy. See also ``Recommendations
for securities settlement systems,'' Committee on Payment and
Settlement Systems and Technical Committee of the International
Organization of Securities Commissions, Bank for International
Settlements, November 2001.
\58\ DTC is not permitted to incur daylight overdrafts. It ends
each day with a positive balance close to zero in its clearing
account.
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C. Payments delays. Third, the policy of pricing daylight
overdrafts and the implied quantity of intraday credit supplied to the
market has encouraged depository institutions to delay sending Fedwire
payments until later in the operating day, creating added operational
risk for the markets. The concern that pricing would cause payments
delays has been a long-standing concern associated with the PSR policy.
Although delays were not observed in the early years of the policy, in
recent years depository institutions have sent an increasing share of
the value of payments made over the Fedwire funds transfer system later
in
[[Page 12433]]
the day. In the period 1985 to 1990, data indicate that about 14
percent of the value of daily Fedwire payments were sent after 5
p.m.\59\ The data in chart 2, however, indicate that the share of the
value of Fedwire payments sent after 5 p.m. has grown steadily,
averaging about 22 percent by 1998 and increasing to about 32 percent
by 2007. The chart illustrates that this growth is driven largely by
the largest-valued payments (the 99th percentile), which averaged
almost $1 billion in 2007.
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\59\ In 1995, the value of Fedwire funds transfers after 5 p.m.
was approximately 16 percent. See Richards, Heidi Willmann, Daylight
overdraft fees and the Federal Reserve's Payment System Risk Policy,
Federal Reserve Bulletin, December 1995.
The Fedwire funds transfer system closes at 6:30 p.m.
[GRAPHIC] [TIFF OMITTED] TN07MR08.002
The PRC and WCAG study make clear that key depository institutions
hold back (large-value) Fedwire funds transfers in so-called
``liquidity queues'' during the afternoon in order to manage their
daylight overdraft levels and avoid fees.\61\ Additional funds
transfers, which may be designated for CHIPS, Fedwire funds, or book
transfers, are held in customer credit queues generally awaiting
sufficient funds to be transferred to an account to release the
payments. Modifications to the policy for providing intraday liquidity,
coupled with more-efficient use of liquidity, could ease some of these
problems. Daylight overdraft fees alone, however, are not responsible
for the late-day concentration of payments. PRC/WCAG members report
that an increasing number of large-value payments are now originated
later in the day because of later investment activities in the
financial market and late closing times for major settlement systems.
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\60\ Data are for funds transfers only and exclude transactions
sent or received by CHIPS, DTC, or CLS Bank International (CLS).
CLS, which is an Edge Corporation supervised by the Federal Reserve,
offers payment-versus-payment settlement of foreign exchange trades.
\61\ Payments may be held in several types of queues once the
depository institution receives an instruction from a customer to
make a Fedwire funds transfer. If a customer instructs the
depository institution to make a payment and the customer does not
have sufficient balances or intraday credit with the institution, it
may hold the payment in a ``credit queue'' until funds become
available. Once the payment is cleared from the credit queue, the
depository institution may send the payment or may move the payment
to another queue in its process, such as the liquidity queue. A
depository institution may use the liquidity queue to manage its
daylight overdraft position with the Reserve Bank. The liquidity
queue can help the institution manage daylight overdraft fees, avoid
cap breaches, manage bilateral exposures, and so on.
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[[Page 12434]]
In addition, in its public comment letter the Federal Reserve Bank
of Chicago identified the delay of time-critical funds transfers used
to complete the daily cycle of collecting and disbursing margin
payments in the derivatives markets as a further concern related to the
general delay of large-value payments. In particular, the Federal
Reserve Bank of Chicago conducted a confidential study to determine the
time elapsed between the delivery of payment instructions by clearing
organizations to money settlement banks and the execution of those
instructions in relation to the contractual commitments of these banks
to make timely payments (within one hour). The study provides evidence
of substantial delays in interbank balancing payments for the exchange-
traded derivatives markets during a period when there were no major
financial market disruptions. The comment letter states that ``a
nontrivial percentage was made exceptionally late (3 to 9\1/2\ hours).
Furthermore, we find that the payments associated with the biggest
delays tend to have the largest dollar value.'' Overall, the delay of
key time-critical payments could be a source of added systemic risk
during periods of financial turbulence, and concerns could extend to
other organizations. These types of concerns clearly did arise in the
1987 stock market break.\62\
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\62\ See the Report of The Presidential Task Force on Market
Mechanisms, January 1988, for a study of the 1987 stock market
break.
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D. Long-term Reserve Bank intraday credit exposure. Fourth, the
long-term trend in daylight overdrafts indicates that they have
continued to grow in both nominal and real terms despite the Reserve
Banks' charging fees. Chart 3 provides inflation-adjusted annual
averages of average daylight overdraft values from 1986 to 2007. The
annualized growth rate of these average daylight overdrafts for about
the past ten years has been about same as the annualized growth rate of
the combined value of Fedwire funds and securities transfers. Given the
demand for intraday liquidity to make payments, it is not clear that a
policy of continuing to rely heavily on charging fees for daylight
overdrafts will be successful in limiting growth of the credit risk
exposure of the Reserve Banks.
[GRAPHIC] [TIFF OMITTED] TN07MR08.003
[[Page 12435]]
E. Cost burden on the payments system. Fifth, the policy of
charging fees has become a significant cost burden on the banking
industry and the payments system. The Federal Reserve has collected
over $450 million in daylight overdraft fees from the beginning of the
pricing program in 1994 through the end of 2007. The fees collected
from depository institutions, however, have increased almost 20 percent
per year on a compound annualized basis since 2003, with approximately
$65 million collected in 2007. Chart 4 illustrates this substantial
growth in fees, especially over the past several years.\63\ To date, no
losses have been associated with the provision of daylight overdraft
credit. The growing cost of the daylight overdraft fees to the industry
raises the question of whether there is a less-expensive and more-
effective way to manage risk.
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\63\ While the fees have increased substantially over the past
few years, the largest increase was 35 percent on an annualized
basis following the implementation of the new policy limiting
overdrafts of government-sponsored enterprises in July 2006. The fee
increase is not surprising because the policy shifted the provision
of intraday credit from the Reserve Banks to depository
institutions. The PSR policy change for government-sponsored
enterprises and certain international organizations is available at
http://www.federalreserve.gov/boarddocs/press/other/2004/20040205/default.htm. (See also 69 FR 57917, September 28, 2004.)
[GRAPHIC] [TIFF OMITTED] TN07MR08.004
Overall, the challenges with the existing PSR policy suggest that
significant changes are justified in order to advance its overarching
risk and efficiency objectives.
IX. Federal Reserve Policy on Payments System Risk
If the Board adopted these proposed changes, it would amend the
``Federal Reserve Policy on Payments System Risk'' Section II as
follows.
Introduction [Revised]
Risks in Payments and Settlement Systems [Revised]
I. Risk Management in Payments and Settlement Systems [No Change]
A. Scope
B. General policy expectations
C. Systemically important systems
1. Principles for systemically important payments systems
2. Minimum standards for systemically important securities
settlement systems and central counterparties
3. Self-assessments by systemically important systems
II. Federal Reserve Intraday Credit Policies [II and II B through II
G Revised]
A. Daylight overdraft definition and measurement [No Change]
B. Collateral
C. Pricing
D. Net debit caps
[[Page 12436]]
1. Definition
2. Cap categories
a. Self-assessed
b. De minimis
c. Exempt-from-filing
d. Zero
3. Capital measure
a. U.S.-chartered institutions
b. U.S. branches and agencies of foreign banks
E. Maximum daylight overdraft capacity
1. General procedure
2. Streamlined procedure for certain FBOs
F. Special situations
1. Edge and agreement corporations
2. Bankers' banks
3. Limited-purpose trust companies
4. Government-sponsored enterprises and international
organizations
5. Problem institutions
G. Monitoring
1. Ex post
2. Real time
3. Multi-district institutions
H. Transfer-size limit on book-entry securities [No Change]
Introduction
Payments and settlement systems are critical components of the
nation's financial system. The smooth functioning of these systems is
vital to the financial stability of the U.S. economy. Given the
importance of these systems, the Board has developed this policy to
address the risks that payments and settlement activity present to the
financial system and to the Federal Reserve Banks (Reserve Banks).
In adopting this policy, the Board's objectives are to foster the
safety and efficiency of payments and settlement systems. These policy
objectives are consistent with (1) the Board's long-standing objectives
to promote the integrity, efficiency, and accessibility of the payments
mechanism; (2) industry and supervisory methods for risk management;
and (3) internationally accepted risk management principles and minimum
standards for systemically important payments and settlement
systems.\64\
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\64\ For the Board's long-standing objectives in the payments
system, see ``The Federal Reserve in the Payments System,''
September 2001, FRRS 9-1550, available at http://www.federalreserve.gov/paymentsystems/pricing/frpaysys.htm.
---------------------------------------------------------------------------
Part I of this policy sets out the Board's views, and related
principles and minimum standards, regarding the management of risks in
payments and settlement systems, including those operated by the
Reserve Banks. In setting out its views, the Board seeks to encourage
payments and settlement systems, and their primary regulators, to take
the principles and minimum standards in this policy into consideration
in the design, operation, monitoring, and assessing of these systems.
The Board also will be guided by this part, in conjunction with
relevant laws and other Federal Reserve policies, when exercising its
authority over certain systems or their participants, when providing
payments and settlement services to systems, or when providing intraday
credit to Federal Reserve account holders.
Part II of this policy governs the provision of intraday credit or
``daylight overdrafts'' in accounts at the Reserve Banks and sets out
the general methods used by the Reserve Banks to control their intraday
credit exposures.\65\ Under this part, the Board explicitly recognizes
that the Federal Reserve has an important role in providing intraday
balances and credit to foster the smooth operation of the payments
system. The Reserve Banks provide intraday balances by way of supplying
temporary, intraday credit to healthy depository institutions,
predominantly through collateralized intraday overdrafts at zero
price.66, 67 The Board believes that such a strategy
enhances intraday liquidity, while controlling risk to the Reserve
Banks. Over time, the Board aims to reduce the reliance of the banking
industry on uncollateralized intraday credit by providing incentives to
collateralize daylight overdrafts. The Board also aims to limit the
burden of the policy on healthy depository institutions that use small
amounts of intraday credit.
---------------------------------------------------------------------------
\65\ To assist depository institutions in implementing this part
of the Board's payments system risk policy, the Federal Reserve has
prepared two documents, the ``Overview of the Federal Reserve's
Payments System Risk Policy'' and the ``Guide to the Federal
Reserve's Payments System Risk Policy,'' which are available on line
at http://www.federalreserve.gov/paymentsystems/PSR/relpol.htm. The
``Overview of the Federal Reserve's Payments System Risk Policy''
summarizes the Board's policy on the provision of intraday credit,
including net debit caps and daylight overdraft fees. The overview
is intended for use by institutions that incur only small amounts of
daylight overdrafts. The ``Guide to the Federal Reserve's Payments
System Risk Policy'' explains in detail how these policies apply to
different institutions and includes procedures for completing a
self-assessment and filing a cap resolution, as well as information
on other aspects of the policy.
\66\ The term ``depository institution,'' as used in this
policy, refers not only to institutions defined as ``depository
institutions'' in 12 U.S.C. 461(b)(1)(A), but also to U.S. branches
and agencies of foreign banking organizations, Edge and agreement
corporations, trust companies, and bankers' banks, unless the
context indicates a different reading.
\67\ The Board's earlier strategy expected depository
institutions to manage their accounts effectively while minimizing
the use of Federal Reserve's intraday credit. The rationale for the
current strategy is that modern payments and settlement systems
require significant amounts of intraday balances or liquidity for
smooth operation. The role of the central bank is to meet reasonable
market needs of participants in these systems for this liquidity.
---------------------------------------------------------------------------
Through this policy, the Board expects financial system
participants, including the Reserve Banks, to reduce and control
settlement and systemic risks arising in payments and settlement
systems, consistent with the smooth operation of the financial system.
This policy is designed to provide intraday balances and credit while
controlling the Reserve Bank risk by (1) making financial system
participants and system operators aware of the types of basic risks
that arise in the settlement process and the Board's expectations with
regard to risk management, (2) setting explicit risk management
expectations for systemically important systems, and (3) establishing
the policy conditions governing the provision of Federal Reserve
intraday credit to account holders. The Board's adoption of this policy
in no way diminishes the primary responsibilities of financial system
participants generally and settlement system operators, participants,
and Federal Reserve account holders more specifically, to address the
risks that may arise through their operation of, or participation in,
payments and settlement systems.
Risks in Payments and Settlement Systems
The basic risks in payments and settlement systems are credit risk,
liquidity risk, operational risk, and legal risk. In the context of
this policy, these risks are defined as follows.\68\
---------------------------------------------------------------------------
\68\ These definitions of credit risk, liquidity risk, and legal
risk are based upon those presented in the Core Principles for
Systemically Important Payment Systems (Core Principles) and the
Recommendations for Securities Settlement Systems (Recommendations
for SSS). The definition of operational risk is based on the Basel
Committee on Banking Supervision's ``Sound Practices for the
Management and Supervision of Operational Risk,'' available at
http://www.bis.org/publ/bcbs96.htm. Each of these definitions is
largely consistent with those included in the Recommendations for
Central Counterparties (Recommendations for CCP).
---------------------------------------------------------------------------
Credit Risk. The risk that a counterparty will not settle an
obligation for full value either when due or anytime thereafter.
Liquidity Risk. The risk that a counterparty will not settle an
obligation for full value when due.
Operational Risk. The risk of loss resulting from inadequate or
failed internal processes, people, and systems, or from external
events. This type of risk includes various physical and information
security risks.
Legal Risk. The risk of loss because of the unexpected application
of a law or regulation or because a contract cannot be enforced.
[[Page 12437]]
These risks arise between financial institutions as they settle
payments and other financial transactions and must be managed by
institutions, both individually and collectively.69,
70 Multilateral payments and settlement systems, in
particular, may increase, shift, concentrate, or otherwise transform
risks in unanticipated ways. These systems also may pose systemic risk
to the financial system where the inability of a system participant to
meet its obligations when due may cause other participants to be unable
to meet their obligations when due. The failure of one or more
participants to settle their payments or other financial transactions,
in turn, could create credit or liquidity problems for other
participants, the system operator, or depository institutions. Systemic
risk might lead ultimately to a disruption in the financial system more
broadly or undermine public confidence in the nation's financial
infrastructure.
---------------------------------------------------------------------------
\69\ The term ``financial institution,'' as used in this policy,
includes a broad array of types of organizations that engage in
financial activity, including depository institutions and securities
dealers.
\70\ Several existing regulatory and bank supervision guidelines
and policies also are directed at institutions' management of the
risks posed by interbank payments and settlement activity. For
example, Federal Reserve Regulation F (12 CFR 206) directs insured
depository institutions to establish policies and procedures to
avoid excessive exposures to any other depository institutions,
including exposures that may be generated through the clearing and
settlement of payments.
---------------------------------------------------------------------------
These risks stem, in part, from the multilateral and time-sensitive
credit and liquidity interdependencies among financial institutions.
These interdependencies often create complex transaction flows that, in
combination with a system's design, can lead to significant demands for
intraday credit, either on a regular or extraordinary basis. The Board
explicitly recognizes that the Federal Reserve has an important role in
providing intraday balances and credit to foster the smooth operation
of the payments system. To the extent that financial institutions or
the Reserve Banks are the direct or indirect source of intraday credit,
they may face a direct risk of loss if daylight overdrafts are not
extinguished as planned. In addition, measures taken by Reserve Banks
to limit their intraday credit exposures may shift some or all of the
associated risks to private-sector systems.
The smooth functioning of payments and settlement systems is also
critical to certain public policy objectives in the areas of monetary
policy and banking supervision. The effective implementation of
monetary policy, for example, depends on both the orderly settlement of
open market operations and the efficient distribution of reserve
balances throughout the banking system via the money market and
payments system. Likewise, supervisory objectives regarding the safety
and soundness of depository institutions must take into account the
risks payments and settlement systems pose to depository institutions
that participate directly or indirectly in, or provide settlement,
custody, or credit services to, such systems.
I. Risk Management in Payments and Settlement Systems [No Change]
II. Federal Reserve Intraday Credit Policies [II and II B through II H
Revised]
This part outlines the methods used to provide intraday credit to
ensure the smooth functioning of payments and settlement systems, while
controlling credit risk to the Reserve Banks associated with such
intraday credit. These methods include voluntary collateralization of
intraday credit, a limit on total daylight overdrafts in institutions'
Federal Reserve accounts, and a fee for uncollateralized daylight
overdrafts. This part also provides a fee waiver to limit the impact of
collateralization on depository institutions that use relatively small
amounts of intraday credit.
To assist institutions in implementing this part of the policy, the
Federal Reserve has prepared two documents: the Overview of the Federal
Reserve's Payments System Risk Policy on Intraday Credit (Overview) and
the Guide to the Federal Reserve's Payments System Risk Policy on
Intraday Credit (Guide).\71\ The Overview summarizes the Board's policy
on the provision of intraday credit, including net debit caps, daylight
overdraft fees for collateralized and uncollateralized overdrafts, and
the fee waiver. It is intended for use by institutions that incur only
small amounts of daylight overdrafts. The Guide explains in detail how
these policies apply to different institutions and includes procedures
for completing a self-assessment and filing a cap resolution, as well
as information on other aspects of the policy.
---------------------------------------------------------------------------
\71\ Available at http://www.federalreserve.gov/paymentsystems/PSR/relpol.htm.
---------------------------------------------------------------------------
A. Daylight Overdraft Definition and Measurement [No change]
B. Collateral
To help meet institutions' demand for intraday balances while
mitigating Reserve Bank credit risk, the Board supplies intraday
balances predominantly through explicitly collateralized daylight
overdrafts provided by Reserve Banks to healthy depository institutions
at a zero fee.\72\ The Board offers pricing incentives to encourage
greater collateralization (see section II.C.). To avoid disrupting the
operation of the payments system and increasing the cost burden on a
large number of institutions using small amounts of daylight
overdrafts, the Board allows the use of collateral to be voluntary.
---------------------------------------------------------------------------
\72\ Collateral is also used to manage risk posed by daylight
overdrafts of problem institutions (institutions in a weak or
deteriorating financial condition), entities not eligible for
Federal Reserve intraday credit (see Section II.F.) and institutions
that have obtained maximum daylight overdraft capacity (see Section
II.E.).
---------------------------------------------------------------------------
Collateral eligibility and margins remain the same for PSR policy
purposes as for the discount window.\73\ Unencumbered discount window
collateral can be used to collateralize daylight overdrafts. The pledge
of in-transit securities remains an eligible collateral option for PSR
purposes at Reserve Banks' discretion.\74\
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\73\ See http://www.frbdiscountwindow.org/ for information on
the discount window and PSR collateral acceptance policy and
collateral margins.
\74\ In-transit securities are book-entry securities transferred
over the Fedwire Securities Service that have been purchased by a
depository institution but not yet paid for or owned by the
institution's customers.
---------------------------------------------------------------------------
C. Pricing
Under the voluntary collateralization regime, the fee for
collateralized overdrafts is set at zero, while the fee for
uncollateralized overdrafts is 50 basis points. The two-tiered fee for
collateralized and uncollateralized overdrafts is intended to provide a
strong incentive for a depository institution to pledge collateral to
its Reserve Bank to reduce or eliminate the institution's
uncollateralized daylight overdrafts and associated charges for its use
of intraday credit.
Reserve Banks charge institutions for daylight overdrafts incurred
in their Federal Reserve accounts. For each two-week reserve-
maintenance period, the Reserve Banks calculate and assess daylight
overdraft fees, which are equal to the sum of any daily
uncollateralized daylight overdraft charges during the period.
Daylight overdraft fees for uncollateralized overdrafts (or the
uncollateralized portion of a partially collateralized overdraft) are
calculated using an annual rate of 50 basis points, quoted on the basis
of a 24-hour day and a 360-day year. To obtain the effective annual
rate for the standard Fedwire
[[Page 12438]]
operating day, the 50-basis-point annual rate is multiplied by the
fraction of a 24-hour day during which Fedwire is scheduled to operate.
For example, under a 21.5-hour scheduled Fedwire operating day, the
effective annual rate used to calculate daylight overdraft fees equals
44.79 basis points (50 basis points multiplied by 21.5/24).\75\ The
effective daily rate is calculated by dividing the effective annual
rate by 360.\76\ An institution's daily daylight overdraft charge is
equal to the effective daily rate multiplied by the institution's
average daily uncollateralized daylight overdraft.
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\75\ A change in the length of the scheduled Fedwire operating
day should not significantly change the amount of fees charged
because the effective daily rate is applied to average daylight
overdrafts, whose calculation would also reflect the change in the
operating day.
\76\ Under the current 21.5-hour Fedwire operating day, the
effective daily daylight-overdraft rate is truncated to 0.0000124.
---------------------------------------------------------------------------
An institution's average daily uncollateralized daylight overdraft
is calculated by dividing the sum of its negative uncollateralized
Federal Reserve account balances at the end of each minute of the
scheduled Fedwire operating day by the total number of minutes in the
scheduled Fedwire operating day. In this calculation, each positive
end-of-minute balance in an institution's Federal Reserve account is
set to equal zero. Fully collateralized end-of-minute negative balances
are similarly set to zero.
The daily daylight overdraft charge is reduced by a fee waiver of
$150, which is primarily intended to minimize the burden of the PSR
policy on institutions that use small amounts of intraday credit. The
waiver is subtracted from gross fees in a two-week reserve-maintenance
period.\77\
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\77\ The waiver shall not result in refunds or credits to an
institution.
---------------------------------------------------------------------------
Certain institutions are subject to a penalty fee and modified
daylight overdraft fee calculation as described in section II.F. The
fee waiver is not available to these institutions.\78\
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\78\ The fee waiver is not available to Edge and agreement
corporations, bankers' banks that have not waived their exemption
from reserve requirements, limited-purpose trust companies, and
government-sponsored enterprises and international organizations.
These types of institutions do not have regular access to the
discount window and, therefore, are expected not to incur daylight
overdrafts in their Federal Reserve accounts.
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D. Net Debit Caps
1. Definition
In accord with sound risk management practices, to limit the amount
of intraday credit that a Reserve Bank extends to an individual
institution and the associated risk, each institution incurring
daylight overdrafts in its Federal Reserve account must adopt a net
debit cap, that is, a ceiling on the total daylight overdraft position
that it can incur during any given day. If an institution's daylight
overdrafts generally do not exceed the lesser of $10 million or 20
percent of its capital measure, the institution may qualify for the
exempt-from-filing cap. An institution must be financially healthy and
have regular access to the discount window in order to adopt a net
debit cap greater than zero or qualify for the filing exemption.
An institution's cap category and capital measure determine the
size of its net debit cap. More specifically, the net debit cap is
calculated as an institution's cap multiple times its capital measure:
net debit cap =
cap multiple x capital measure
Cap categories (see section II.D.2.) and their associated cap levels,
set as multiples of capital measure, are listed below:
Net Debit Cap Multiples
------------------------------------------------------------------------
Cap category Cap multiple
------------------------------------------------------------------------
High................................ 2.25
Above average....................... 1.875
Average............................. 1.125
De minimis.......................... 0.4
Exempt-from-filing \79\............. $10 million or 0.20
Zero................................ 0
------------------------------------------------------------------------
The cap is applied to the total of collateralized and uncollateralized
daylight overdrafts. For the treatment of overdrafts that exceed the
cap, see Section II.G.
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\79\ The net debit cap for the exempt-from-filing category is
equal to thelesser of $10 million or 0.20 multiplied by the capital
measure.
The Board's policy on net debit caps is based on a specific set of
guidelines and some degree of examiner oversight. Under the Board's
policy, a Reserve Bank may further limit or prohibit an institution's
use of Federal Reserve intraday credit if (1) the institution's
supervisor determines that the institution is unsafe or unsound; (2)
the institution does not qualify for a positive net debit cap (see
section II.D.2.); or (3) the Reserve Bank determines that the
institution poses excessive risk.
While capital measures differ, the net debit cap provisions of this
policy apply similarly to foreign banking organizations (FBOs) as to
U.S. institutions. The Reserve Banks will advise home-country
supervisors of the daylight overdraft capacity of U.S. branches and
agencies of FBOs under their jurisdiction, as well as of other
pertinent information related to the FBOs' caps. The Reserve Banks will
also provide information on the daylight overdrafts in the Federal
Reserve accounts of FBOs' U.S. branches and agencies in response to
requests from home-country supervisors.
2. Cap Categories
The policy defines the following six cap categories, described in
more detail below: high, above average, average, de minimis, exempt-
from-filing, and zero. The high, above average, and average cap
categories are referred to as ``self-assessed'' caps.
a. Self-assessed. In order to establish a net debit cap category of
high, above average, or average, an institution must perform a self-
assessment of its own creditworthiness, intraday funds management and
control, customer credit policies and controls, and operating controls
and contingency procedures.\80\ The assessment of creditworthiness is
based on the institution's supervisory rating and Prompt Corrective
Action (PCA) designation.\81\ An institution may perform a full
assessment of its creditworthiness in certain limited circumstances,
for example, if its condition has changed significantly since its last
examination or if it possesses additional substantive information
regarding its financial condition. An institution performing a self-
assessment must also evaluate its intraday funds-management procedures
and its procedures for evaluating the financial condition of and
establishing
[[Page 12439]]
intraday credit limits for its customers. Finally, the institution must
evaluate its operating controls and contingency procedures to determine
if they are sufficient to prevent losses due to fraud or system
failures. The Guide includes a detailed explanation of the self-
assessment process.
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\80\ This assessment should be done on an individual-institution
basis, treating as separate entities each commercial bank, each Edge
corporation (and its branches), each thrift institution, and so on.
An exception is made in the case of U.S. branches and agencies of
FBOs. Because these entities have no existence separate from the
FBO, all the U.S. offices of FBOs (excluding U.S.-chartered bank
subsidiaries and U.S.-chartered Edge subsidiaries) should be treated
as a consolidated family relying on the FBO's capital.
\81\ An insured depository institution is (1) ``well
capitalized'' if it significantly exceeds the required minimum level
for each relevant capital measure, (2) ``adequately capitalized'' if
it meets the required minimum level for each relevant capital
measure, (3) ``undercapitalized'' if it fails to meet the required
minimum level for any relevant capital measure, (4) ``significantly
undercapitalized'' if it is significantly below the required minimum
level for any relevant capital measure, or (5) ``critically
undercapitalized'' if it fails to meet any leverage limit (the ratio
of tangible equity to total assets) specified by the appropriate
federal banking agency, in consultation with the FDIC, or any other
relevant capital measure established by the agency to determine when
an institution is critically undercapitalized (12 U.S.C. 1831o).
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Each institution's board of directors must review that
institution's self-assessment and recommended cap category. The process
of self-assessment, with board-of-directors review, should be conducted
at least once in each twelve-month period. A cap determination may be
reviewed and approved by the board of directors of a holding company
parent of an institution, provided that (1) the self-assessment is
performed by each entity incurring daylight overdrafts, (2) the
entity's cap is based on the measure of the entity's own capital, and
(3) each entity maintains for its primary supervisor's review its own
file with supporting documents for its self-assessment and a record of
the parent's board-of-directors review.\82\
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\82\ An FBO should undergo the same self-assessment process as a
domestic bank in determining a net debit cap for its U.S. branches
and agencies. Many FBOs, however, do not have the same management
structure as U.S. institutions, and adjustments should be made as
appropriate. If an FBO's board of directors has a more limited role
to play in the bank's management than a U.S. board has, the self-
assessment and cap category should be reviewed by senior management
at the FBO's head office that exercises authority over the FBO
equivalent to the authority exercised by a board of directors over a
U.S. institution. In cases in which the board of directors exercises
authority equivalent to that of a U.S. board, cap determination
should be made by the board of directors.
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In applying these guidelines, each institution should maintain a
file for examiner review that includes (1) worksheets and supporting
analysis used in its self-assessment of its own cap category, (2)
copies of senior-management reports to the board of directors of the
institution or its parent (as appropriate) regarding that self-
assessment, and (3) copies of the minutes of the discussion at the
appropriate board-of-directors meeting concerning the institution's
adoption of a cap category.\83\
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\83\ In addition, for FBOs, the file that is made available for
examiner review by the U.S. offices of an FBO should contain the
report on the self-assessment that the management of U.S. operations
made to the FBO's senior management and a record of the appropriate
senior management's response or the minutes of the meeting of the
FBO's board of directors or other appropriate management group, at
which the self-assessment was discussed.
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As part of its normal examination, the institution's examiners may
review the contents of the self-assessment file.\84\ The objective of
this review is to ensure that the institution has applied the
guidelines appropriately and diligently, that the underlying analysis
and method were reasonable, and that the resultant self-assessment was
generally consistent with the examination findings. Examiner comments,
if any, should be forwarded to the board of directors of the
institution. The examiner, however, generally would not require a
modification of the self-assessed cap category, but rather would inform
the appropriate Reserve Bank of any concerns. The Reserve Bank would
then decide whether to modify the cap category. For example, if the
institution's level of daylight overdrafts constitutes an unsafe or
unsound banking practice, the Reserve Bank would likely assign the
institution a zero net debit cap and impose additional risk controls.
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\84\ Between examinations, examiners or Reserve Bank staff may
contact an institution about its cap if there is other relevant
information, such as statistical or supervisory reports, that
suggests there may have been a change in the institution's financial
condition.
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The contents of the self-assessment file will be considered
confidential by the institution's examiner. Similarly, the Federal
Reserve and the institution's examiner will hold the actual cap level
selected by the institution confidential. Net debit cap information
should not be shared with outside parties or mentioned in any public
documents; however, net debit cap information will be shared with the
home-country supervisor of U.S. branches and agencies of foreign banks.
The Reserve Banks will review the status of any institution with a
self-assessed net debit cap that exceeds its net debit cap during a
two-week reserve-maintenance period and will decide if additional
action should be taken (see section II.G.).
b. De minimis. Many institutions incur relatively small overdrafts
and thus pose little risk to the Federal Reserve. To ease the burden on
these small overdrafters of engaging in the self-assessment process and
to ease the burden on the Federal Reserve of administering caps, the
Board allows institutions that meet reasonable safety and soundness
standards to incur de minimis amounts of daylight overdrafts without
performing a self-assessment. An institution may incur daylight
overdrafts of up to 40 percent of its capital measure if the
institution submits a board-of-directors resolution.
An institution with a de minimis cap must submit to its Reserve
Bank at least once in each 12-month period a copy of its board-of-
directors resolution (or a resolution by its holding company's board)
approving the institution's use of intraday credit up to the de minimis
level. The Reserve Banks will review the status of any institution with
a de minimis net debit cap that exceeds its net debit cap during a two-
week reserve-maintenance period and will decide if additional action
should be taken (see section II.G.).
c. Exempt-from-filing. Institutions that only rarely incur daylight
overdrafts in their Federal Reserve accounts that exceed the lesser of
$10 million or 20 percent of their capital measure are excused from
performing self-assessments and filing board-of-directors resolutions
with their Reserve Banks. This dual test of dollar amount and percent
of capital measure is designed to limit the filing exemption to
institutions that create only low-dollar risks to the Reserve Banks and
that incur small overdrafts relative to their capital measure.
The Reserve Banks will review the status of an exempt institution
that incurs overdrafts in its Federal Reserve account in excess of $10
million or 20 percent of its capital measure on more than two days in
any two consecutive two-week reserve-maintenance periods. The Reserve
Bank will decide whether the exemption should be maintained, the
institution should be required to file for a cap, or counseling should
be performed (see section II.G.). Granting of the exempt-from-filing
net debit cap is at the discretion of the Reserve Bank.
d. Zero. Some financially healthy institutions that could obtain
positive net debit caps choose to have zero caps. Often these
institutions have very conservative internal policies regarding the use
of Federal Reserve intraday credit or simply do not want to incur
daylight overdrafts and any associated daylight overdraft fees. If an
institution that has adopted a zero cap incurs a daylight overdraft,
the Reserve Bank counsels the institution and may monitor the
institution's activity in real time and reject or delay certain
transactions that would cause an overdraft. If the institution
qualifies for a positive cap, the Reserve Bank may suggest that the
institution adopt an exempt-from-filing cap or file for a higher cap if
the institution believes that it will continue to incur daylight
overdrafts.
In addition, a Reserve Bank may assign an institution a zero net
debit cap. Institutions that may pose special risks to the Reserve
Banks, such as those without regular access to the discount window,
those incurring daylight overdrafts in violation of this policy, or
those in weak financial condition, are generally assigned a zero cap
(see section II.F.). Recently chartered
[[Page 12440]]
institutions may also be assigned a zero net debit cap.
3. Capital Measure
As described above, an institution's cap category and capital
measure determine the size of its net debit cap. The capital measure
used in calculating an institution's net debit cap depends upon its
chartering authority and home-country supervisor.
a. U.S.-chartered institutions. For institutions chartered in the
United States, net debit caps are multiples of ``qualifying'' or
similar capital measures that consist of those capital instruments that
can be used to satisfy risk-based capital standards, as set forth in
the capital adequacy guidelines of the federal financial regulatory
agencies. All of the federal financial regulatory agencies collect, as
part of their required reports, data on the amount of capital that can
be used for risk-based purposes--``risk-based'' capital for commercial
banks, savings banks, and savings associations and total regulatory
reserves for credit unions. Other U.S.-chartered entities that incur
daylight overdrafts in their Federal Reserve accounts should provide
similar data to their Reserve Banks.
b. U.S. branches and agencies of foreign banks. For U.S. branches
and agencies of foreign banks, net debit caps on daylight overdrafts in
Federal Reserve accounts are calculated by applying the cap multiples
for each cap category to the FBO's U.S. capital equivalency
measure.\85\ U.S. capital equivalency is equal to the following
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\85\ The term ``U.S. capital equivalency'' is used in this
context to refer to the particular capital measure used to calculate
net debit caps and does not necessarily represent an appropriate
capital measure for supervisory or other purposes.
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35 percent of capital for FBOs that are financial holding
companies (FHCs) \86\
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\86\ The Gramm-Leach-Bliley Act defines a financial holding
company as a bank holding company that meets certain eligibility
requirements. In order for a bank holding company to become a
financial holding company and be eligible to engage in the new
activities authorized under the Gramm-Leach-Bliley Act, the Act
requires that all depository institutions controlled by the bank
holding company be well capitalized and well managed (12 U.S.C.
1841(p)). With regard to a foreign bank that operates a branch or
agency or owns or controls a commercial lending company in the
United States, the Act requires the Board to apply comparable
capital and management standards that give due regard to the
principle of national treatment and equality of competitive
opportunity (12 U.S.C. 1843(l)).
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25 percent of capital for FBOs that are not FHCs and have
a strength of support assessment ranking (SOSA) of 1 \87\
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\87\ The SOSA ranking is composed of four factors, including the
FBO's financial condition and prospects, the system of supervision
in the FBO's home country, the record of the home country's
government in support of the banking system or other sources of
support for the FBO; and transfer risk concerns. Transfer risk
relates to the FBO's ability to access and transmit U.S. dollars,
which is an essential factor in determining whether an FBO can
support its U.S. operations. The SOSA ranking is based on a scale of
1 through 3, with 1 representing the lowest level of supervisory
concern.
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10 percent of capital for FBOs that are not FHCs and are
ranked a SOSA 2
5 percent of ``net due to related depository
institutions'' for FBOs that are not FHCs and are ranked a SOSA 3
An FBO that is a FHC or has a SOSA rating of 1 may be eligible for a
streamlined procedure (see Section II.E.) for obtaining additional
collateralized intraday credit under the maximum daylight overdraft
capacity provision.
Granting a net debit cap, or any extension of intraday credit, to
an institution is at the discretion of the Reserve Bank. In the event a
Reserve Bank grants a net debit cap or extends intraday credit to a
financially healthy SOSA 3-ranked FBO, the Reserve Bank may require
such credit to be fully collateralized, given the heightened
supervisory concerns with SOSA 3-ranked FBOs.
E. Maximum Daylight Overdraft Capacity
The Board recognizes that while net debit caps provide sufficient
liquidity to most institutions, some institutions may still experience
liquidity pressures. The Board believes it is important to provide an
environment in which payments systems may function effectively and
efficiently and to remove barriers, as appropriate, to foster risk-
reducing payments system initiatives. Consequently, certain
institutions with self-assessed net debit caps may pledge collateral to
their administrative Reserve Banks to secure daylight overdraft
capacity in excess of their net debit caps, subject to Reserve Bank
approval.88 89 This policy is intended to provide extra
liquidity through the pledge of collateral to the few institutions that
might otherwise be constrained from participating in risk-reducing
payments system initiatives.\90\ The Board believes that providing
extra liquidity to these few institutions should help prevent
liquidity-related market disruptions.
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\88\ The administrative Reserve Bank is responsible for the
administration of Federal Reserve credit, reserves, and risk
management policies for a given institution or other legal entity.
\89\ Institutions have some flexibility as to the specific types
of collateral they may pledge to the Reserve Banks; however, all
collateral must be acceptable to the Reserve Banks. The Reserve
Banks may accept securities in transit on the Fedwire book-entry
securities system as collateral to support the maximum daylight
overdraft capacity level. Securities in transit refer to book-entry
securities transferred over the Fedwire Securities Service that have
been purchased by an institution but not yet paid for and owned by
the institution's customers.
\90\ Institutions may consider applying for a maximum daylight
overdraft capacity level for daylight overdrafts resulting from
Fedwire funds transfers, Fedwire book-entry securities transfers,
National Settlement Service entries, and ACH credit originations.
Institutions incurring daylight overdrafts as a result of other
payment activity may be eligible for administrative counseling
flexibility (59 FR 54915-18, Nov. 2, 1994).
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1. General Procedure
An institution with a self-assessed net debit cap that wishes to
expand its daylight overdraft capacity by pledging collateral should
consult with its administrative Reserve Bank. The Reserve Banks will
work with an institution that requests additional daylight overdraft
capacity to determine the appropriate maximum daylight overdraft
capacity level. In considering the institution's request, the Reserve
Bank will evaluate the institution's rationale for requesting
additional daylight overdraft capacity as well as its financial and
supervisory information. The financial and supervisory information
considered may include, but is not limited to, capital and liquidity
ratios, the composition of balance sheet assets, CAMELS or other
supervisory ratings and assessments, and SOSA rankings (for U.S.
branches and agencies of foreign banks). An institution approved for a
maximum daylight overdraft capacity level must submit at least once in
each twelve-month period a board-of-directors resolution indicating its
board's approval of that level.
If the Reserve Bank approves an institution's request, the Reserve
Bank approves a maximum daylight overdraft capacity level. The maximum
daylight overdraft capacity is defined as follows:
maximum daylight overdraft capacity =
net debit cap +
collateralized capacity \91\
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\91\ Collateralized capacity, on any given day, equals the
amount of collateral pledged to the Reserve Bank, not to exceed the
difference between the institution's maximum daylight overdraft
capacity level and its net debit cap.
The Reserve Banks will review the status of any institution that
exceeds its maximum daylight overdraft capacity limit during a two-week
reserve-maintenance period and will decide if the maximum daylight
overdraft capacity should be maintained or if additional action should
be taken (see section II.G.).
Institutions with exempt-from-filing and de minimis net debit caps
may not obtain additional daylight overdraft
[[Page 12441]]
capacity by pledging additional collateral without first obtaining a
self-assessed net debit cap. Likewise, institutions that have
voluntarily adopted zero net debit caps may not obtain additional
daylight overdraft capacity without first obtaining a self-assessed net
debit cap. Institutions that have been assigned a zero net debit cap by
their administrative Reserve Bank are not eligible to apply for any
daylight overdraft capacity.
2. Streamlined Procedure for Certain FBOs
An FBO that is a FHC or has a SOSA rating of 1 and has a self-
assessed net debit cap may request from its Reserve Bank a streamlined
procedure under the maximum daylight overdraft capacity provision.
These FBOs are not required to provide documentation of the business
need or obtain the board of directors' resolution for collateralized
capacity in an amount that exceeds its current net debit cap (which is
based on up to 35 percent worldwide capital times its cap multiple), as
long as the requested additional capacity is 100 percent or less of
worldwide capital times a self-assessed cap multiple.\92\ In order to
ensure that intraday liquidity risk is managed appropriately and that
the FBO will be able to repay daylight overdrafts, eligible FBOs under
the streamlined procedure will be subject to initial and periodic
reviews of liquidity plans that are analogous to the liquidity reviews
undergone by U.S. institutions.\93\ If an eligible FBO requests
capacity in excess of 100 percent of worldwide capital times the self-
assessed cap multiple, it would be subject to the general procedure.
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\92\ For example, a financial holding company is eligible for
uncollateralized capacity of 35 percent of worldwide capital times
the cap multiple. The streamlined max cap procedure would provide
such an institution with additional collateralized capacity of 65
percent of worldwide capital times the cap multiple.
\93\ The liquidity reviews will be conducted by the
administrative Reserve Bank, in consultation with each FBO's home
country supervisor.
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F. Special Situations
Under the Board's policy, certain institutions warrant special
treatment primarily because of their charter types. As mentioned
previously, an institution must have regular access to the discount
window and be in sound financial condition in order to adopt a net
debit cap greater than zero. Institutions that do not have regular
access to the discount window include Edge and agreement corporations,
bankers' banks that are not subject to reserve requirements, limited-
purpose trust companies, government-sponsored enterprises (GSEs), and
certain international organizations.\94\ Institutions that have been
assigned a zero cap by their Reserve Banks are also subject to special
considerations under this policy based on the risks they pose. In
developing its policy for these institutions, the Board has sought to
balance the goal of reducing and managing risk in the payments system,
including risk to the Federal Reserve, with that of minimizing the
adverse effects on the payments operations of these institutions.
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\94\ The Reserve Banks act as fiscal agents for certain
entities, such as government-sponsored enterprises (GSEs) and
international organizations, whose securities are Fedwire-eligible
but are not obligations of, or fully guaranteed as to principal and
interest by, the United States. The GSEs include Fannie Mae, the
Federal Home Loan Mortgage Corporation (Freddie Mac), entities of
the Federal Home Loan Bank System (FHLBS), the Farm Credit System,
the Federal Agricultural Mortgage Corporation (Farmer Mac), the
Student Loan Marketing Association (Sallie Mae), the Financing
Corporation, and the Resolution Funding Corporation. The
international organizations include the World Bank, the Inter-
American Development Bank, the Asian Development Bank, and the
African Development Bank. The Student Loan Marketing Association
Reorganization Act of 1996 requires Sallie Mae to be completely
privatized by 2008; however, Sallie Mae completed privatization at
the end of 2004. The Reserve Banks no longer act as fiscal agents
for new issues of Sallie Mae securities, and Sallie Mae is not
considered a GSE.
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Regular access to the Federal Reserve discount window generally is
available to institutions that are subject to reserve requirements. If
an institution that is not subject to reserve requirements and thus
does not have regular discount-window access were to incur a daylight
overdraft, the Federal Reserve might end up extending overnight credit
to that institution if the daylight overdraft were not covered by the
end of the business day. Such a credit extension would be contrary to
the quid pro quo of reserves for regular discount-window access as
reflected in the Federal Reserve Act and in Board regulations. Thus,
institutions that do not have regular access to the discount window
should not incur daylight overdrafts in their Federal Reserve accounts.
Certain institutions are subject to a daylight-overdraft penalty
fee levied against the average daily daylight overdraft incurred by the
institution. These include Edge and agreement corporations, bankers'
banks that are not subject to reserve requirements, and limited-purpose
trust companies. The annual rate used to determine the daylight-
overdraft penalty fee is equal to the annual rate applicable to the
daylight overdrafts of other institutions (50 basis points) plus 100
basis points multiplied by the fraction of a 24-hour day during which
Fedwire is scheduled to operate (currently 21.5/24). The daily
daylight-overdraft penalty rate is calculated by dividing the annual
penalty rate by 360.\95\ The daylight-overdraft penalty rate applies to
the institution's average daily daylight overdraft in its Federal
Reserve account. The daylight-overdraft penalty rate is charged in lieu
of, not in addition to, the rate used to calculate daylight overdraft
fees for institutions described in section II.F.
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\95\ Under the current 21.5-hour Fedwire operating day, the
effective daily daylight-overdraft penalty rate is truncated to
0.0000373.
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Institutions that are subject to the daylight-overdraft penalty fee
are not eligible for the $150 fee waiver and are subject to a minimum
fee of $25 on any daylight overdrafts incurred in their Federal Reserve
accounts.\96\ While such institutions may be required to post
collateral (see sections II.F.), they are not eligible for the lower
fee associated with collateralized daylight overdrafts.
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\96\ While daylight overdraft fees are calculated differently
for these institutions than for institutions that have regular
access to the discount window, overnight overdrafts at Edge and
agreement corporations, bankers' banks that are not subject to
reserve requirements, limited-purpose trust companies, GSEs, and
international organizations are priced the same as overnight
overdrafts at institutions that have regular access to the discount
window.
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1. Edge and Agreement Corporations \97\
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\97\ These institutions are organized under section 25A of the
Federal Reserve Act (12 U.S.C. 611-631) or have an agreement or
undertaking with the Board under section 25 of the Federal Reserve
Act (12 U.S.C. 601-604(a)).
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Edge and agreement corporations should refrain from incurring
daylight overdrafts in their Federal Reserve accounts. In the event
that any daylight overdrafts occur, the Edge or agreement corporation
must post collateral to cover the overdrafts. In addition to posting
collateral, the Edge or agreement corporation would be subject to the
daylight-overdraft penalty rate levied against the average daily
daylight overdrafts incurred by the institution, as described above.
This policy reflects the Board's concerns that these institutions
lack regular access to the discount window and that the parent company
may be unable or unwilling to cover its subsidiary's overdraft on a
timely basis. The Board notes that the parent of an Edge or agreement
corporation could fund its subsidiary during the day over Fedwire or
the parent could substitute itself for its subsidiary on private
systems. Such an approach by the parent could both reduce systemic risk
exposure and permit the Edge or agreement corporation to continue to
[[Page 12442]]
service its customers. Edge and agreement corporation subsidiaries of
foreign banking organizations are treated in the same manner as their
domestically owned counterparts.
2. Bankers' Banks \98\
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\98\ For the purposes of this policy, a bankers' bank is a
depository institution that is not required to maintain reserves
under the Board's Regulation D (12 CFR 204) because it is organized
solely to do business with other financial institutions, is owned
primarily by the financial institutions with which it does business,
and does not do business with the general public. Such bankers'
banks also generally are not eligible for Federal Reserve Bank
credit under the Board's Regulation A (12 CFR 201.2(c)(2)).
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Bankers' banks are exempt from reserve requirements and do not have
regular access to the discount window. They do, however, have access to
Federal Reserve payments services. Bankers' banks should refrain from
incurring daylight overdrafts and must post collateral to cover any
overdrafts they do incur. In addition to posting collateral, a bankers'
bank would be subject to the daylight-overdraft penalty fee levied
against the average daily daylight overdrafts incurred by the
institution, as described above.
The Board's policy for bankers' banks reflects the Reserve Banks'
need to protect themselves from potential losses resulting from
daylight overdrafts incurred by bankers' banks. The policy also
considers the fact that some bankers' banks do not incur the costs of
maintaining reserves as do some other institutions and do not have
regular access to the discount window.
Bankers' banks may voluntarily waive their exemption from reserve
requirements, thus gaining access to the discount window. Such bankers'
banks are free to establish net debit caps and would be subject to the
same policy as other institutions. The policy set out in this section
applies only to those bankers' banks that have not waived their
exemption from reserve requirements.
3. Limited-Purpose Trust Companies \99\
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\99\ For the purposes of this policy, a limited-purpose trust
company is a trust company that is a member of the Federal Reserve
System but that does not meet the definition of ``depository
institution'' in section 19(b)(1)(A) of the Federal Reserve Act (12
U.S.C. 461(b)(1)(A)).
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The Federal Reserve Act permits the Board to grant Federal Reserve
membership to limited-purpose trust companies subject to conditions the
Board may prescribe pursuant to the Act. As a general matter, member
limited-purpose trust companies do not accept reservable deposits and
do not have regular discount-window access. Limited-purpose trust
companies should refrain from incurring daylight overdrafts and must
post collateral to cover any overdrafts they do incur. In addition to
posting collateral, limited-purpose trust companies would be subject to
the same daylight-overdraft penalty rate as other institutions that do
not have regular access to the discount window.
4. Government-Sponsored Enterprises and International Organizations
The Reserve Banks act as fiscal agents for certain GSEs and
international organizations in accordance with federal statutes. These
institutions generally have Federal Reserve accounts and issue
securities over the Fedwire Securities Service. The securities of these
institutions are not obligations of, or fully guaranteed as to
principal and interest by, the United States. Furthermore, these
institutions are not subject to reserve requirements and do not have
regular access to the discount window. GSEs and international
organizations should refrain from incurring daylight overdrafts and
must post collateral to cover any daylight overdrafts they do incur. In
addition to posting collateral, these institutions would be subject to
the same daylight-overdraft penalty rate as other institutions that do
not have regular access to the discount window.
5. Problem Institutions
For institutions that are in weak financial condition, the Reserve
Banks will impose a zero cap. The Reserve Bank will also monitor the
institution's activity in real time and reject or delay certain
transactions that would create an overdraft. Problem institutions
should refrain from incurring daylight overdrafts and must post
collateral to cover any daylight overdrafts they do incur.
G. Monitoring
1. Ex Post
Under the Federal Reserve's ex post monitoring procedures, an
institution with a daylight overdraft in excess of its maximum daylight
overdraft capacity or net debit cap may be contacted by its Reserve
Bank. Overdrafts above the cap for institutions with de minimis, self-
assessed and max caps may be treated differently, depending on whether
the overdraft is collateralized.\100\ If the overdraft is fully
collateralized, the Reserve Bank may consider the condition an
overlimit situation and may waive counseling for two incidents of
overlimit, fully collateralized overdrafts per two consecutive two-week
reserve-maintenance periods (the total of four weeks). If instances of
overlimit, fully collateralized overdrafts are beyond the approved
number of overlimit incidents or if any part of the overdraft is
uncollateralized, the Reserve Bank will apply normal counseling
procedures.
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\100\ There are no changes in monitoring of exempt institutions:
overdrafts above the exempt cap limit, regardless of whether such
overdrafts are collateralized or uncollateralized, should no more
than twice in two consecutive two-week reserve-maintenance periods
(the total of four weeks).
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Each Reserve Bank retains the right to protect its risk exposure
from individual institutions by unilaterally reducing net debit caps,
imposing (additional) collateralization or clearing-balance
requirements, rejecting or delaying certain transactions as described
below, or, in extreme cases, taking the institution off line or
prohibiting it from using Fedwire.
2. Real Time
A Reserve Bank will, through the Account Balance Monitoring System,
apply real-time monitoring to an individual institution's position when
the Reserve Bank believes that it faces excessive risk exposure, for
example, from problem banks or institutions with chronic overdrafts in
excess of what the Reserve Bank determines is prudent. In such a case,
the Reserve Bank will control its risk exposure by monitoring the
institution's position in real time, rejecting or delaying certain
transactions that would exceed the institution's maximum daylight
overdraft capacity or net debit cap, and taking other prudential
actions, including requiring (additional) collateral.\101\
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\101\ Institutions that are monitored in real time must fund the
total amount of their ACH credit originations in order for the
transactions to be processed by the Federal Reserve, even if those
transactions are processed one or two days before settlement.
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3. Multi-district Institutions
Institutions, such as those maintaining merger-transition accounts
and U.S. branches and agencies of a foreign bank, that access Fedwire
through accounts in more than one Federal Reserve District are expected
to manage their accounts so that the total daylight overdraft position
across all accounts does not exceed their net debit caps. One Reserve
Bank will act as the administrative Reserve Bank and will have overall
risk-management responsibilities for institutions maintaining accounts
in more than one Federal Reserve District. For domestic institutions
that have branches in multiple Federal Reserve Districts, the
administrative Reserve Bank generally
[[Page 12443]]
will be the Reserve Bank where the head office of the bank is located.
In the case of families of U.S. branches and agencies of the same
foreign banking organization, the administrative Reserve Bank generally
is the Reserve Bank that exercises the Federal Reserve's oversight
responsibilities under the International Banking Act.\102\ The
administrative Reserve Bank, in consultation with the management of the
foreign bank's U.S. operations and with Reserve Banks in whose
territory other U.S. agencies or branches of the same foreign bank are
located, may determine that these agencies and branches will not be
permitted to incur overdrafts in Federal Reserve accounts.
Alternatively, the administrative Reserve Bank, after similar
consultation, may allocate all or part of the foreign family's net
debit cap to the Federal Reserve accounts of agencies or branches that
are located outside of the administrative Reserve Bank's District; in
this case, the Reserve Bank in whose Districts those agencies or
branches are located will be responsible for administering all or part
of the collateral requirement.\103\
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\102\ 12 U.S.C. 3101-3108.
\103\As in the case of Edge and agreement corporations and their
branches, with the approval of the designated administrative Reserve
Bank, a second Reserve Bank may assume the responsibility of
managing and monitoring the net debit cap of particular foreign
branch and agency families. This would often be the case when the
payments activity and national administrative office of the foreign
branch and agency family is located in one District, while the
oversight responsibility under the International Banking Act is in
another District. If a second Reserve Bank assumes management
responsibility, monitoring data will be forwarded to the designated
administrator for use in the supervisory process.
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H. Transfer-Size Limit on Book-Entry Securities [No change]
By order of the Board of Governors of the Federal Reserve
System, February 28, 2008.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 08-971 Filed 3-6-08; 8:45 am]
BILLING CODE 6210-01-P