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l l★K

Federal Reserve Bank
of Dallas

September 11, 2002

DALLAS, TEXAS
75265-5906

Notice 02-48

TO: The Chief Executive Officer of each
financial institution and others concerned
in the Eleventh Federal Reserve District
SUBJECT
Payments System Risk—Potential Longer-Term Policy Direction
DETAILS
The Board of Governors of the Federal Reserve System has announced its decision not to
pursue in the foreseeable future the following policy options as part of a potential longer-term direction for the Board’s payments system risk policy:
1) Lowering self-assessed net debit caps and eliminating two-week average caps and
2) Rejecting all payments with settlement-day finality that would cause an institution to
exceed its daylight overdraft capacity level.
The Board will, however, continue analyzing the benefits and drawbacks of a two-tiered
pricing regime for daylight overdrafts in which institutions that pledge collateral to Reserve Banks
would pay a lower fee on their collateralized daylight overdrafts than on their uncollateralized
daylight overdrafts.
ATTACHMENT
A copy of the Board’s notice as it appears on pages 54424–27, Vol. 67, No. 163 of the
Federal Register dated August 22, 2002, is attached.
MORE INFORMATION
For more information, please contact this Bank’s Reserve and Risk Management Division
at (214) 922-5584. Paper copies of this notice or previous Federal Reserve Bank notices can be
printed from our web site at http://www.dallasfed.org/banking/notices/index.html.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

54424

Federal Register / Vol. 67, No. 163 / Thursday, August 22, 2002 / Notices

SUMMARY: The Board is announcing its
decision not to pursue in the foreseeable
future the following policy options as
part of a potential longer–term direction
for the Board’s payments system risk
policy (PSR policy): (1) lowering self–
assessed net debit caps and eliminating
two–week average caps and (2) rejecting
all payments with settlement–day
finality that would cause an institution
to exceed its daylight overdraft capacity
level. The Board will, however,
continue analyzing the benefits and
drawbacks of a two–tiered pricing
regime for daylight overdrafts in which
institutions that pledge collateral to the
Reserve Banks would pay a lower fee on
their collateralized daylight overdrafts
than on their uncollateralized daylight
overdrafts.
FOR FURTHER INFORMATION CONTACT: Jeff
Stehm, Assistant Director (202/452–
2217), Stacy Coleman, Manager (202/
452–2934), or John Gibbons, Senior
Financial Services Analyst (202/452–
6409), Division of Reserve Bank
Operations and Payment Systems; for
users of Telecommunication Devices for
the Deaf (TDD) only, contact 202/263–
4869.
SUPPLEMENTARY INFORMATION:
I. Background: In June 2001, the Board
requested comment on a number of
modifications to the PSR policy,
including several near–term changes
and a potential longer–term direction.1
These requests for comment resulted
from a broad review of the Board’s PSR
policy. This review evaluated the
effectiveness of the Board’s daylight
credit policies, recognizing that
significant changes had occurred in the
banking, payments, and regulatory
environment in the past few years. In
conducting its review, the Board
evaluated the effect of past policy
actions on depository institutions’
behavior and on the markets generally
and also considered the effect of various
payment system initiatives on payments
activity and the demand for daylight
credit.
Following the public comment period
for the near–term changes, the Board
made several changes to the policy,
including allowing depository
institutions with self–assessed net debit
caps to pledge collateral to the Federal
Reserve in order to access additional
daylight overdraft capacity above their
net debit cap levels and modifying the

criteria used to determine a foreign
banking organization’s U.S. capital
equivalency measure (66 FR 64419,
December 13, 2001). Currently, the
Board is focusing on the potential
longer–term direction for the PSR
policy. The policy options identified in
the request for comment included the
following: (1) lowering self–assessed net
debit caps and eliminating two–week
average caps, (2) rejecting all payments
with settlement–day finality that would
cause an institution to exceed its
daylight overdraft capacity level,
referred to as universal real–time
monitoring (URTM), and (3)
implementing a two–tiered pricing
regime for daylight overdrafts in which
institutions that pledge collateral to the
Reserve Banks would pay a lower fee on
their collateralized daylight overdrafts
than on their uncollateralized daylight
overdrafts (66 FR 30208, June 5, 2001).2
II. Summary of Comments and Analysis
The following section describes the
options proposed in June 2001 for a
potential longer–term PSR policy
direction, summarizes and analyzes the
comments received on the proposals,
and discusses the rationale for not
pursuing lower self–assessed net debit
caps or URTM in the foreseeable future
and for continuing to analyze a two–
tiered pricing regime. The Board
received a total of thirty–six comment
letters on its potential longer–term PSR
policy direction. The commenters
included nineteen commercial banking
organizations and seven of their trade
associations, three clearing
organizations, two other trade
associations, and five Federal Reserve
Banks. Not all commenters, however,
addressed each of the options identified
in the potential longer–term direction.
A. Net Debit Cap Levels
The Board evaluated the benefits and
drawbacks of reducing self–assessed
single–day net debit caps to levels near
those of the current two–week average
caps and eliminating two–week average
net debit caps. Under the Board’s PSR
policy, the Reserve Banks establish
limits or net debit caps on the maximum
amount of uncollateralized daylight
credit that depository institutions may
incur in their Federal Reserve accounts.
Net debit caps are calculated by
applying a cap multiple from one of six
cap classes to a depository institution’s
capital measure. An institution may
request a self–assessed cap (average,
above average, or high) by completing a

1 The Board’s current policy is described in the
Policy Statement on Payments System Risk. The
policy statement can be found at http://
www.federalreserve.gov/paymentsystems/psr/
policy.pdf.

2 Payments with settlement–day finality include
Fedwire funds and book–entry securities transfers,
net settlement service (NSS) transactions,
automated clearing house (ACH) credit transactions,
and cash withdrawals.

ACTION:

FEDERAL RESERVE SYSTEM
Docket No. R–1111

Policy Statement on Payments System
RiskPotential Longer–Term Policy
Direction
AGENCY: Board of Governors of the
Federal Reserve System.

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Federal Register / Vol. 67, No. 163 / Thursday, August 22, 2002 / Notices
self–assessment.3 Alternatively, a
depository institution may request a de
minimis cap by submitting a board–of–
director resolution to its Reserve Bank,
or its Reserve Bank may assign an
exempt–from–filing cap. A Reserve
Bank also may assign a zero cap in
consideration of certain factors, or a
depository institution that wants to
restrict its own use of Federal Reserve
daylight credit may request a zero cap.
Twenty–nine organizations
commented on lowering the single–day
net debit cap and eliminating the two–
week average cap. Of those
organizations, sixteen did not support
the proposal. Commenters generally did
not support lowering the single–day net
debit cap and eliminating the two–week
average cap because of concerns about
reduced flexibility in a depository
institution’s ability to process payments.
Of the thirteen commenters that
supported a lower single–day net debit
cap and the elimination of the two–
week average cap, most believed that
Reserve Banks could reduce potential
credit exposure while not affecting most
depository institutions’ ability to
process payments. Several commenters
also noted that eliminating the two–
week average cap could reduce some of
the policy’s administrative burden.
Finally, several commenters stated that
institutions affected by a lower single–
day net debit cap should have sufficient
flexibility because depository
institutions can now gain additional
overdraft capacity by pledging
collateral.
Three commenters that supported
lowering net debit cap levels
recommended that the Board lower
them gradually to allow institutions an
adjustment period and to allow the
Federal Reserve time to evaluate the
effects of lower net debit caps on the
payments system. One organization that
supported lowering net debit caps
recommended that the policy allow
institutions to exceed their net debit cap
up to 20 percent on an infrequent basis
without requiring collateral. Another
organization supported lowering net
debit caps as long as limits on
collateralized daylight overdraft
capacity above the net debit cap were
set sufficiently high that institutions
would not experience liquidity
constraints.
The Board believes that reducing self–
assessed net debit caps and eliminating
two–week average caps generally would
3 The

self–assessment requires an institution to
evaluate and rate its creditworthiness, intraday
funds management and controls, customer credit
policies and controls, operating controls, and
contingency procedures to support a higher
daylight overdraft cap.

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not affect most depository institutions’
account–management and payment
activities. In its request for comment,
the Board noted that 96 percent of
depository institutions with self–
assessed net debit caps use less than 50
percent of their daylight overdraft
capacity for their average peak
overdrafts. Furthermore, Reserve Banks’
credit exposure would be reduced by
less than 5 percent if those institutions
with self–assessed net debit caps that
currently use more than 50 percent of
their daylight overdraft capacity
reduced their peak overdrafts to within
the proposed net debit cap limits. As a
result, lower net debit caps likely would
not materially reduce Reserve Bank
credit exposure. The current net debit
cap limits do, however, provide
institutions greater flexibility in
managing their payments flows. In
addition, the actual or potential
liquidity implications of payment
system initiatives, such as the
Continuous Linked Settlement (CLS)
system, have not been fully realized
both in terms of the liquidity demands
resulting from its implementation and
its interaction with other payment
systems. These potential liquidity
demands, especially in times of
financial market stress, need to be
understood more fully for the Board to
evaluate thoroughly the benefits and
drawbacks of lowering self–assessed
single–day net debit caps and
eliminating two–week average caps.
The drawbacks of reduced flexibility
in managing payment flows during a
period of structural change in the
payments system appear to outweigh
the potential efficiencies gained by
reducing administrative burden from
lowering single–day net debit caps and
eliminating two–week average caps.
Accordingly, the Board will not
consider lowering self–assessed single–
day net debit caps and eliminating two–
week average caps as a policy option in
the foreseeable future.
B. Monitoring in Real Time All
Institutions’ Payments With Settlement–
Day Finality
The Board also evaluated the benefits
and drawbacks of URTM, which is
defined as using the Reserve Banks’
Account Balance Monitoring System
(ABMS) to reject any payment with
settlement–day finality that would
cause an account holder’s overdrafts to
exceed its net debit cap.4
4 ABMS provides intraday account information to
the Reserve Banks and depository institutions. It
serves as both an information source and a
monitoring tool. ABMS is used primarily to give
authorized Reserve Bank personnel a mechanism to
control and monitor account activity for selected
institutions. It also provides a means for institutions

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Thirty–one organizations commented
on URTM. Of those organizations that
responded, twenty–four did not support
implementing URTM. Most commenters
did not support URTM because of
concerns that it could be unnecessarily
restrictive for healthy depository
institutions and could cause or
exacerbate disruptions in the payments
system. Many commenters also
highlighted URTM’s potential effects on
ACH credit originations. In particular,
several commenters raised concerns
about URTM requiring prefunding for
ACH credit originations and the
potential negative effects on the value–
dating aspect of ACH.5 One commenter
that supported URTM, however, stated
that preventing institutions from
exceeding their net debit cap with
overdrafts due to payments with
settlement–day finality would reduce
risk in the payments system. Another
commenter supported URTM because it
likely would have only negligible effects
on delays in the payments system and
payments would be rejected or
processed based on real–time balances.
If the Board were to implement
URTM, a number of commenters
recommended that it do so gradually to
minimize potential disruptions to the
payments system. For example, some
commenters recommended introducing
URTM by rejecting only Fedwire funds
transfers at first and adding additional
payment types later. Several
commenters also recommended pending
payments, instead of rejecting them, and
making individual credit decisions on
each payment. Under URTM the
potential volume of payments that
might be pended and need to be
reviewed to make a credit decision
could increase significantly, especially
in times of market stress. Payments
processing could be negatively affected
as a result. In addition, the order in
which payments could be released and
an institution’s access to its pended
payments queue are issues that would
need to be addressed in considering this
option.
The Board believes the primary
benefit of URTM is that it allows
Reserve Banks to better manage the
small, yet important, risk that a
depository institution could
unexpectedly fail with a significant
daylight overdraft position that far
to obtain information concerning their intraday
balances for managing daylight overdrafts. This
information includes opening balances, a
depository institution’s daylight overdraft capacity
and collateral limits, Fedwire funds and book–entry
securities transfers, net settlement service
transactions, and other payment activity.
5 Value dating allows originators to submit ACH
transactions for settlement on a later, specified date.

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Federal Register / Vol. 67, No. 163 / Thursday, August 22, 2002 / Notices

exceeds its net debit cap. The Board,
however, also recognizes the benefits of
financially healthy depository
institutions having flexibility in
managing their payment activity,
especially during times of financial
market stress. A policy that places a
hard cap on daylight credit might cause
or exacerbate disruptions for a given
depository institution’s payment flows
or the payments system more generally.
In addition, the liquidity implications
related to CLS and its interaction with
other payments systems need to be
understood more fully for the Board to
evaluate thoroughly the benefits and
drawbacks of URTM. Concerns over
disrupting the payments system,
especially during times of market stress,
likely outweigh the benefits of managing
daylight overdrafts for unexpected
failures of depository institutions. As a
result, the Board will not implement
URTM as a policy option in the
foreseeable future.
C. Two–Tiered Pricing Regime
The Board will continue evaluating
the benefits and drawbacks of
implementing a two–tiered pricing
regime that would assess a lower fee on
collateralized daylight overdrafts than
on uncollateralized daylight overdrafts.
In evaluating the level of the daylight
overdraft fee, the Board is considering
policy changes that might more
efficiently balance the costs, risks, and
benefits associated with the provision of
Federal Reserve intraday credit.
The daylight overdraft fee is a critical
component of the PSR policy, and its
modification in 1995 was the impetus
for the Board’s PSR policy review.6
During the policy review, the Board
compared Federal Reserve daylight
credit extensions and private–sector
lending under line–of–credit
arrangements in assessing policy
alternatives that might create a more
efficient balance of the costs, risks, and
benefits associated with Federal Reserve
intraday credit. The most notable
distinction between daylight credit
extensions and private–sector lending is
that private–sector lenders usually
charge a lower rate when loans are
collateralized. Collateralized lending
generally carries a lower interest rate
than uncollateralized lending because
taking collateral lowers the lender’s risk,
allowing for a lower credit risk
6 The current daylight overdraft fee is 36 basis
points, quoted as an annual rate on the basis of a
24–hour day. To obtain the daily overdraft fee for
the standard Fedwire operating day, the 36–basis–
point fee is multiplied by the fraction of the 24–
hour day during which Fedwire is scheduled to
operate. For example, under the current 18–hour
Fedwire operating day, the effective daylight
overdraft fee equals 27 basis points.

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premium. In most situations, the
Reserve Banks do not require collateral
when extending daylight credit to
depository institutions.7 When Reserve
Banks accept or require collateral for
daylight credit extensions, however, the
same daylight overdraft fee applies to
both collateralized and uncollateralized
daylight overdrafts. The Board also
notes that the majority of Federal
Reserve daylight credit extensions are
currently implicitly collateralized
because any collateral that a depository
institution pledges to a Reserve Bank
can be used to offset any of the
institution’s obligations to the Reserve
Bank.8
Twenty–six organizations commented
on two–tiered pricing. Twenty–two of
those organizations supported some
form of a two–tiered pricing regime.
Most commenters favored a two–tiered
pricing mechanism because they
believed that it would reduce risk to the
public sector and provide depository
institutions the ability to weigh the
costs and benefits of lower–rate
collateralized credit with higher–rate
uncollateralized credit.
One commenter that did not support
two–tiered pricing stated that many
smaller community banks might not be
able to pledge collateral to receive a
lower price, possibly placing them at a
competitive disadvantage relative to
larger depository institutions that likely
are capable of pledging sufficient
collateral to receive a lower price on
most of their overdrafts. The Board is
sensitive to policies that place certain
depository institutions at a competitive
advantage relative to other depository
institutions. Most small depository
institutions, however, generally do not
pay daylight overdraft fees because they
use little or no daylight credit. When
pricing was introduced, the Board
purposely permitted a minimal level of
free overdrafts for most depository
institutions based on the institution’s
capital. The purpose was to exempt
from fees a very large number of
depository institutions that account for
a very small portion of total overdrafts.9
7 The current policy allows depository
institutions with self–assessed net debit caps to
pledge collateral to gain additional capacity above
their net debit caps.
8 The majority of the collateral pledged to the
Reserve Banks is pledged for discount window
purposes. Federal Reserve Operating Circulars 1
and 10 provide Reserve Banks with a security
interest in any of a depository institution’s assets
in the possession or control of, or maintained with,
a Reserve Bank. These assets include collateral
pledged to the Reserve Banks as well as items in
the process of collection and any investment
property that the institution may legally encumber.
9 For depository institutions with regular access
to the discount window, Reserve Banks also waive

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As a result, the Board does not believe
that small depository institutions would
be disadvantaged by a two–tiered
pricing policy relative to large
depository institutions.
A number of commenters indicated
that they would support two–tiered
pricing only if lower–priced
collateralized daylight credit could be
used before uncollateralized daylight
credit. In developing a two–tiered
pricing regime, the Board intends to
allow depository institutions with
collateral pledged to the Federal Reserve
to be charged the collateralized price for
intraday credit used up to the level of
collateral pledged as long as the
collateral is not securing other
outstanding obligations. Any additional
intraday credit used that was
uncollateralized would be priced
higher. Moreover, depository
institutions with self–assessed net debit
caps that have been approved for
collateralized daylight overdraft
capacity above their net debit caps
would be able to use the collateral
pledged for this purpose to receive the
collateralized price on the first dollars
of daylight credit used. A few other
commenters indicated that they support
two–tiered pricing only if the rate for
collateralized daylight credit is lower
than the current rate.
Because two–tiered pricing may help
balance the costs and benefits of
providing daylight credit, and such a
policy is more consistent with standard
industry practices, the Board will
continue to analyze the benefits and
drawbacks of two–tiered pricing, taking
into consideration the issues raised by
commenters.
III. Competitive Impact Analysis
The Board has established procedures
for assessing the competitive impact of
rule or policy changes that have a
substantial impact on payments system
participants.10 Under these procedures,
the Board assesses whether a change
would have a direct and material
adverse effect on the ability of other
service providers to compete effectively
with the Federal Reserve in providing
similar services due to differing legal
powers or constraints, or due to a
dominant market position of the Federal
Reserve deriving from such differences.
If no reasonable modifications will
mitigate the adverse competitive effects,
the Board will determine whether the
expected benefits are significant enough
to proceed with the change despite the
daylight overdraft fees if the charge for a reserve
maintenance period is twenty–five dollars or less.
10 These procedures are described in the Board’s
policy statement ‘‘The Federal Reserve in the
Payments System’’, as revised in March 1990 (55 FR
11648, March 29, 1990).

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Federal Register / Vol. 67, No. 163 / Thursday, August 22, 2002 / Notices
adverse effects. The Board believes
maintaining the status quo while
continuing to analyze two–tiered
pricing will have no adverse effect on
the ability of other service providers to
compete effectively with the Federal
Reserve Banks in providing similar
services.
IV. Paperwork Reduction Act
In accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. ch.
3506; 5 CFR 1320 Appendix A.1), the
Board has reviewed this notice under
the authority delegated to the Board by
the Office of Management and Budget.
No collections of information pursuant
to the Paperwork Reduction Act are
contained in this notice.
By order of the Board of Governors of the
Federal Reserve System, August 19, 2002.
Jennifer J. Johnson
Secretary of the Board.
[FR Doc. 02–21454 Filed 8–21–02; 8:45 am]
BILLING CODE 6210–01–S

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102