Full text of District Notices (Federal Reserve Bank of Dallas) : Federal Reserve Policy Statement on Payments System Risk, Notice 92-97

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F ederal R eserve Bank
OF DALLAS
T O N Y J . S A L V A G G IO

DALLAS, TEXAS 75222

F IR S T V IC E PR ES ID EN T

October 8, 1992
Notice 92-97
TO:

The Chief Executive Officer of each
member bank and others concerned in
the Eleventh Federal Reserve District
SUBJECT
Federal Reserve Policy Statement on
Payments System Risk
DETAILS

The Board has compiled an updated, comprehensive statement of its
previously-adopted policies regarding payments system risk reduction, includ­
ing policies to control Federal Reserve risk, policies for private-sector
networks, and other related policies. This statement incorporates all of the
policy modifications adopted by the Board since the last published comprehen­
sive statement in 1987, and supersedes all other published statements. No new
policies are included in this compilation. The effective date of the policy
statement was August 20, 1992.
The revised policy statement refers to a Users’ Guide, which was
distributed to depository institutions in March 1988 to assist them in
implementing the Board’s policies as they appeared in the 1987 policy state­
ment. New Users’ Guides reflecting current policies are now in the process of
being prepared. They will be made available to depository institutions in
this District upon publication.
ATTACHMENT
A copy of the Board’s notice as it appears on pages 40455-66, Vol.
57, No. 172, of the Federal Register dated September 3, 1992, is attached.
MORE INFORMATION
For more information, please contact the DFI Monitoring Division at
(214) 922-5584 or 922-5585. For additional copies of this Bank’s notice,
please contact the Public Affairs Department at (214) 922-5254.
Sincerely,

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 (BOO) 392-4162,
Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

FEDERAL RESERVE SYSTEM
Federal Reserve Policy Statement on
Payments System Risk
Board of Governors of the
Federal Reserve System.
a c t i o n : Policy statement.
AGENCY:

The Board has compiled an
updated, comprehensive statement of its
previously-adopted policies regarding
payments system risk reduction,
including policies to control Federal
Reserve risk, policies for private-sector
networks, and other related policies.
This statement incorporates all of the
policy modifications adopted by the
Board since the last published
comprehensive statement in 1987, and
supersedes all other published
statements. No new policies are
included in this compilation.
EFFECTIVE DATE: August 20,1992.
su m m ary :

FOR FURTHER INFORMATION CONTACT:

40455

developed policies regarding certain
small-dollar systems, such as national
ACH net settlement and ATM networks
The Federal Reserve first published a
policy statement on its payments system
risk reduction program in 1985 (50 FR
21120, May 22,1985) and published an
updated “interim" statement in 1987 (52
FR 29255, August 6,1987). Since 1987,
the Board has made several additions *o
its payments system risk reduction
policy, including policies regarding
private delivery-against-payment
securities systems, offshore dollarclearing and netting systems, and
rollovers and continuing contracts (54
FR 26104, 26092, 26107, respectively,
June 21,1989). In 1990, the Board
modified the Federal Reserve risk
reduction policy with respect to bookentry securities transactions, net debit
caps, capital measurements, and
application of the policy to agencies and
branches of foreign banks (55 FR 22087,
May 31,1990).
The Board has compiled an updated,
comprehensive statement of its
previously-adopted policies regarding
payments system risk reduction,
including policies to control Federal
Reserve risk, policies for private-sector
networks, and other related policies.
This statement incorporates all of the
policy modifications adopted by the
Board since the last published
comprehensive statement in 1987, and
supersedes all other published
statements. No new policies are
included in this compilation. The policy
statement is set out below:

Florence M. Young; Assistant Director
(202/452-3955), Division of Reserve Bank
Operations and Payment Systems;
Stephanie Martin, Senior Attorney (202/ Federal Reserve System Policy Statement On
Payments System Risk
452-3198), Legal Division. For the
Introduction
hearing impaired only.
Telecommunications Device for the Deaf
I. Federal Reserve Policy
(TDD), Dorothea Thompson (202/452A.
Daylight Overdraft Definition
3544), Board of Governors of the Federal
Reserve System, 20th and C Streets,
B. [Reserved]
NW., Washington, DC 20551.
C. Capital
SUPPLEMENTARY INFORMATION: During
1. U.S. Chartered Institutions
the past seven years, the Federal
2. U.S. Agencies and Branches of Foreign
Reserve System has developed a
Banks
program to address payments system
risk. Risk can arise from transactions on D. Net Debit Caps
the Federal Reserve’s wire transfer
1. Cap Set Through Self-Assessment
system (Fedwire), from other types of
2. De Minimis Cap
payments, including checks and
3. Exemption From Filing
automated clearing house (ACH)
4. Special Situations
transactions, and from transactions on
a. Edge and Agreement Corporations
private large-dollar networks that permit
b. Bankers' Banks
their participants to transmit payment
c. Zero-Cap Depository Institutions
messages throughout the day with
E. Book-entry Securties Transaction
settlement of net positions at the end of
1. Collateralization
the day. The Federal Reserve has
2. Transfer Size Limit
addressed primarily large-dollar
payments systems but has also

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

F. Inter-affiliate Transfers
G. Third-party Access Arrangements
H. Monitoring
1. Ex Post
2. Real Time
3. Multi-District Institutions
4. ACH Controls
II. Policies far Private-Sector Networks
A. Private Large-Dollar Funds Transfer
Networks
B. Private Delivery-Against-Payment
Securities Systems
C. Offshore Dollar-Clearing and Netting
Systems
D. Private Small-Dollar Clearing and
Settlement Systems
1. National ACH Net Settlement
I, Small-Dollar ATM Networks
III. Other Policies
A. Rollovers and Continuing Contracts
Federal Reserve System Policy
Statement oh Payments System Risk
Introduction!
The Federal Reserv e System h a s
developed this policy statem ent to
address paym ents system risk. Risk can
arise from transactions on the Federal
Reserve’s wire transfer system
(Fedwire), from other types of payments,
including checks and autom ated
clearing house (ACH) transactions, and
from transactions on private large-dollar
netw orks that permit their participants
to transm it paym ent m essages
throughout the day w ith settlement of
net positions at the end of the day. This
policy statem ent is addressed primarily
to large-dollar paym ents system s1 and
incorporates the Federal Reserve’s
policies to reduce Federal Reserve risk
as well as risk on various types of
private-sector networks.
The Federal Reserve Banks face direct
risks of loss should depository
institutions2 be unable to settle their
1 In a changing technological and regulatory
environm ent it is not possible or desirable to adopt
an all-inclusive anti perm anent definition of a
"large-dollar paym ents system” for the purposes of
Federal Reserve risk control policy. In determining
w hether any particular system is a “large-dollar”
system, the Board will consider any of the following
four factors: (13 the employment of m ultilateral
netting arrangem ents, (2) the use of sam e-day
settlement, (3) the routine processing of a significant
number of individual paym ents larger than $50,000,
and (4) the possibility that any one participant coaid
b e exposed to a net debit position a t the tim e of
settlement in excess of its capital.
* In this policy statem ent, the term s “depository
institution” or "institution” will be used to refer Hot
only to institutions defined as "depository
institutions'* by 12 U.S.C. 481(b)(1)(A), but also to
U.S. branches and agencies of foreign banks, Edge
and agreement corporations, and b ankers’ banks,
unless the context indicates a different reading.

intraday (“daylight”) overdrafts in their
Federal Reserve accounts before the end
of the day. Moreover, systemic risk may
occur if an institution participating on a
private large-dollar paym ents network
w ere unable or unwilling to settle its net
debit position. If this w ere to occur, the
institution’s creditors on that netw ork
might also be unable to settle their
commitments. Serious repercussions
could, as a result, spread to other
participants in the private network, to
other depository institutions not
participating in the network, and to the
nonfinancial economy generally. A
Peserve Bank could be exposed to an
indirect risk if its policies did not
address this systemic risk. Finally,
depository institutions create risk by
permitting their customers, including
other depository institutions, to transfer
uncollected balances in anticipation of
their coverage before the end of the day.
The Board is aw are that large-dollar
netw orks are an integral part of the
clearing and settlem ent system s and
that it is of vital importance to keep the
paym ents mechanism operating w ithout
significant disruption. It is because of
the importance of avoiding such
disruptions that the Board continues to
seek to reduce the risks of settlem ent
failures that could cause these
disruptions, The Board is also, aw are
that some intraday credit m ay be
necessary to keep the paym ents
mechanism running smoothly and
efficiently. The reduction an d control of
intraday credit risks, although essential,
m ust be accomplished in a m anner that
will minimize disruptions to the
paym ents mechanism. The Board
anticipates that, by relying largely on
the efforts of individual institutions to
identify, control, and reduce their own
exposures, and by establishing
guidelines for use by institutions, the
goal of reducing and controlling risks
will not unduly disrupt the smooth
operation of the paym ents mechanism.
The Board emphasizes that it is not
condoning daylight overdrafts in Federal
Reserve accounts..Although some
intraday credit m ay be necessary, the
Board anticipates that, as a result of its
policies, there will continue to be a
reduction in the number of institutions
consistently relying on intraday credit
supplied by the Federal Reserve to
conduct their business. The Board also
expects to continue observing, over
time, a reduction in the volume of
intraday credit at those institutions with
a pattern of substantial reliance on such
credit. The Board will continue to

monitor the effect of its policies on the
payments system.
The general methods used to control
intraday credit exposures are explained
in the policies below. These method®
include caps on net debits incurred by
depository institutions in their accounts
at Federal Reserve Banks,
collateralization, in certain situations, of
overdrafts at the Federal Reserve due to
book-entry securities transactions,
bilateral credit limits betw een
institutions on private large-dollar
networks, and credit and liquidity
safeguards for private delivery-againstpaym ent systems. To assist depository
institutions in implementing the Board’s
policies, the Federal Reserve has
prepared a Users' Guide to the policy
statement. The Users’ Guide explains in
detail how the polities apply to various
types of depository institutions, the selfassessm ent procedures for establishing
a net debit cap, and the role of the
institutions’ boards of directors in
oveiseeing the implementation of risk
reduction efforts by the institutions.
Depository institutions may obtain the
Users’Guide from their local Reserve
Bank.
1!. Federal Reserve Policy

A. Daylight Overdraft Definition
A daylight overdraft occurs w hen a
depository institution’s Federal Reserve
account is in a negative position during
the business day. The Reserve Banks
use an ex post system to m easure
daylight overdrafts, calculating intraday
Federal Reserve account positions as
follows: At the opening of business,
each institution's closing balance from
the previous day is adjusted by the net
of all ACH transactions. Original issues
of Treasury securities® are posted no
earlier than 9:15 a.m. Eastern Time (ET),
and redemption and interest payments
for Treasury and government agency
securities are posted by 9:15'a.m. ET,
Funds and book-entry securities
transfers are posted throughout the day
as. they are processed. After the close of
business, all other transactions, such as
check and currency and coin
transactions, are totalled. If the net of
these transactions is a credit, it is posted
as though it occurred at the opening of
business; if the net is a debit, it ia posted
as though it occurred' at the. close, of
business.
» New issues of government agency securities am
posted as the securities are delivered over Fedwire

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices
B. [Reserved]
C. Capital
1. U.S. Chartered Institutions.
For depository 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—“qualifying”
capital for commercial and savings
banks, "risk-based” capital for savings
and loan associations, and total
regulatory reserves for credit unions.
Other U.S. chartered entities that incur
overdrafts in Federal Reserve accounts
should provide similar data to their
Reserve Banks.
In some instances, further adjustments
to capital are required. For example,
virtually all Edge and agreement
corporations are subsidiaries of
depository institutions that may
themselves use intraday credit. Capital
would be double-counted if both the
parent and the Edge or agreement
corporation subsidiary used intraday
credit based on their own capital bases.
Accordingly, if a parent elects to permit
its Edge or agreement corporation
subsidiary to use daylight credit, any
risk-based capital attributable to the
Edge or agreement corporation
subsidiary that is reflected on the
parent's balance sheet must be
subtracted from the parent's capital. The
parent may choose, however, to use all
of its capital for its Own cap and to
prohibit its Edge or agreement
corporation subsidiary from using
intraday credit.
2, U.S. Agencies and Branches of
Foreign Banks.
For U.S. agencies and branches of
foreign banks, net debit caps for
uncollateralized overdrafts in Federal
Reserve accounts are multiples of
consolidated “U.S. capital
equivalency,"4 All net debit caps are
4 The term “U.S. capital equivalency" has been
chosen merely as the most convenient term of art.
The use of the term for purposes of this policy
statem ent is not m eant to suggest that the Board
presently intends that this m easure necessarily
should be used to m easure a foreign bank's capital
position in the United States for prudential or other
purposes.

conditioned on the Reserve Bank's
judgment that the U S. agency or branch
of the foreign bank has satisfactory U.S.
funding capability and potential eligible
collateral for a discount window loan,
should it be unable to cover its daylight
overdraft by the end of the day.
A foreign bank whose home-country
supervisor adheres to the Basle Capital
Accord may determine its
uncollateralized daylight overdraft
capacity by applying its cap multiple to
a U.S. capital equivalency equal to the
greater of 10 percent of worldwide
capital or 5 percent of the total liabilities
of each agency or branch, including
acceptances, but excluding accrued
expenses and amounts due and other
liabilities to offices, branches, and
subsidiaries of the foreign bank. In the
absence of contrary information, the
Reserve Banks presume that all banks
chartered in G-10 countries meet the
acceptable prudential capital and
supervisory standards and will consider
any bank chartered in any other nation
that adopts the Basle Capital Accord
standards (or requires capital at least as
great and in the same form as called for
by the Accord) eligible for the Reserve
Banks' review for meeting acceptable
prudential capital and supervisory
standards.
To determine the net debit cap for
uncollateralized overdrafts for all other
foreign banks, cap multiples are applied
to the U.S. capital equivalency measured
as the greater of (1) the sum of the
amount of capital (but not surplus)
which would be required of a national
bank being organized at each agency or
branch location, or (2) the sum of 5
percent of the total liabilities of each
agency or branch, including
acceptances, but excluding accrued
expenses and amounts due and other
liabilities to offices, branches, and
subsidiaries of the foreign bank.
All foreign banks, regardless of their
cap for uncollateralized overdrafts, may
incur total overdrafts up to an amount
equal to their cap multiple times 10
percent of their worldwide capital, as
Idng as the amount of the overdraft
above the uncollateralized overdraft cap
is collateralized, In addition, all foreign
banks m ay elect to collateralize all or a
portion of their overdrafts related to
book-entry securities activity. This
policy offers all foreign banks, under
terms that reasonably limit Reserve
Bank risk, a level of overdrafts based on
the same proportion of their worldwide
capital. Banks chartered in countries
that follow the Basle Accord and that
have demonstrated collateral and
funding capacity that would result in a
net debit cap based on 10 percent of

worldwide capital are not permitted to
incur overdrafts above their cap, except
for book-entry securities overdrafts,
even with collateral. All other foreign
banks may incur overdrafts to the same
extent as banks from Basle Accord
countries, i.e., up to their cap multiple
times 10 percent of their worldwide
capital, provided that sufficient
collateral is posted for any overdrafts in
excess of. the cap based on their U.S.
capital equivalency.

D. Net Debit Caps
To limit the aggregate amount of
daylight credit extended by Reserve
Banks, each institution that incurs
daylight overdrafts in its Federal
Reserve account must adopt a net debit
cap, i.e., a ceiling on the aggregate net
debit position that it can incur during a
given interval. Alternatively, if an
institution’s daylight overdrafts
generally do not exceed the lesser of $10
million or 20 percent of capital, the
institution may qualify for the exemptfrom-filing status. Subject to the
provisions for special situations
described below, an institution must be
financially healthy and eligible to
borrow from the discount window in
order to adopt a cap greater than zero or
qualify for die filing exemption.
Cap categories and associated cap
levels, set as multiples of capital, are
listed below:
Net Debit Cap Multiples
Cap Category
High..................
Above Avg..........
Average..............
Exempt-fromfiiing.................
Zero......__ _— ....

Two-Week
Avg.

Single Day

1.50
1.125
0.75
0.20

2.25
1.875
1.125
0.20

$10 miilion
(0.20)
0.0

$10 million
(0.20)
0.0

An institution is expected to avoid
incurring net debits that, on average
over a two-week period, exceed the twow eek average cap, and, on any day,
exceed the single-day cap. The twoweek average cap provides flexibility, in
recognition that fluctuations in
payments can occur from day-to-day.
The purpose of the higher single-day cap
is to limit excessive daylight overdrafts
on any day and to assure that
institutions develop internal controls
that focus on the exposures each day, as
well as over time.
The two-week average cap ss
measured against the average, over a

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

two-week reserve maintenance period,
of an institution’s daily maximum net
debit positions in its Federal Reserve
account. In calculating the two-week
average, individual days on which an
institution is in an aggregate net credit
position throughout the day are treated
as if the institution was in a net position
of zero. The number of days used in
calculating the average is the number of
business days the institution’s Reserve
Bank is open during the reserve
maintenance period.
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 prohibit the use of Federal
Reserve intraday credit if (1) an
institution's use of daylight credit is
deemed by the institution’s supervisor to
be unsafe or unsound, (2) an institution
does not qualify for a cap exemption,
does not perform a self-assessment, or
does not file a board-of-directorsapproved de minimis cap, and (3) an
institution poses an excessive risk to a
Reserve Bank.
The net debit cap provisions of this
policy apply to foreign banks to the
same extent as they apply to U.S.
institutions. The Reserve Banks will
advise home-country supervisors of
banks with U.S. branches and agencies
of the daylight overdraft capacity of
banks under their jurisdiction, as well as
of other pertinent conditions related to
their caps. Home-country supervisors
that request information on the
overdrafts in the Federal Reserve
accounts of their banks will be provided
that information on a regular basis.
1. Cap Set Through Self-Assessment
An institution that wishes to establish
a net debit cap category of high, above
average, or average must perform a selfassessment of its own creditworthiness,
credit policies, and operational controls,
policies, and procedures.6 The
assessment of creditworthiness should
address the overall financial condition
of the institution, placing emphasis on
conformance of the institution's capital
with supervisory sUndards for capital
adequacy. The institution should also
assess its procedures for evaluating the
financial condition of its customers and
s This assessm ent should be done on an
individual institution basis, treating as separate
entities each commercial bank, each Edge
corporation (and its branches), each thrift
instihition, etc. An exception is m ade ini the case of
U.S. agencies and branches of foreign banks.
Because these entities have no existence separate
from the foreign bank, all the U.S. offices of foreign
banks (excluding U.S. chartered bank subsidiaries
and U.S. chartered Edge subsidiaries) should be
treated as a consolidated family relying on the
foreign bank's capital

should establish intraday credit limits
that reflect these assessments. Finally,
an institution should ensure that its
operational controls permit it to contain
its use of Federal Reserve intraday
credit and restrict its customers’ use of
credit to the limits it has established.
The Users’ Guide to the Board’s
Payments System Risk Reduction Policy,
available from any Reserve Bank,
includes a detailed explanation of the
steps that should be taken by a
depository institution in performing a
self-assessment to establish a net debit
cap.
Each institution’s board of directors is
expected to review the self-assessment
and determine the appropriate cap
category. The process of selfassessment, with board-of-directors
review, should be conducted at least
once in each 12-month period. A cap
determination may be reviewed and
approved by the board of directors of a
holding company parent of a depository
institution, or the parent of an Edge or
agreement corporation, provided that (1)
the self-assessment is performed by
each entity incurring daylight
overdrafts, (2) the entity’s cap is based
on the entity’s own capital (adjusted to
avoid double-counting), and (3) each
entity maintains for its primary
supervisor’s review its own file with
supporting documents for its selfassessment and a record of the parent’s
board-of-directors review.8
In applying these guidelines, each
institution is expected to maintain a file
for examiner review that includes (1)
worksheets and supporting analysis
developed in its self-assessment of its
own risk category, (2) copies of senior
management reports to the board of
directors of the institution or its parent
(as appropriate) regarding that selfassessment, 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.7
* A foreign b ank should undergo the sam e selfassessm ent process as a domestic bank in
determining a net debit cap for its U.S. branches
and agencies. Many foreign banks, however, do not
have the same managem ent structure as U.S.
depository institutions, and adjustm ents should b e
made as appropriate. W here a foreign bank’s board
of directors has a more limited role to play in the
bank’s managem ent than a U.S. board, the selfassessm ent and cap category should be reviewed by
senior m anagem ent a t the foreign bank’s h ead office
that exercises authority over the foreign bank
equivalent to the authority exercised by a board of
directors over a U.S. depository institution. In eases
w here the board of directors exercises authority
equivalent to that of a U.S. board, cap
determ ination should be m ade by the board of
directors.
, fa most cases, it may not be possible for the U.S.
examiners to review the m inutes of the meeting of a

As part of its normal examination, the
depository institution’s examiners will
review the contents of the selfassessment file.8 The objective of this
review is to assure that the institution
has applied the guidelines seriously and
diligently, that the underlying analysis
and methodology 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,
would generally not require a
modification of the self-assessment cap
category unless the level of daylight
credit used by the institution constitutes
an unsafe or unsound banking practice.
The contents of the self-assessment
cap category file will be considered
confidential by the institution's
examiner. Similarly, the actual cap level
selected by the institution will be held
confidential by the Federal Reserve and
the institution's examiner. (However,
cap information will be shared with the
home country supervisor of agencies
and branches of foreign banks.)
2. De Minimis Cap
Many depository 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 selfassessment process and to ease the
burden on the Federal-Reserve of
administering caps, the Board will allow
institutions that meet reasonable safety
standards to incur de minimis amounts
of daylight overdrafts without
performing a self-assessment. A
depository institution may incur daylight
overdrafts up to 20 percent of capital, if
a board-of-directors resolution is
submitted.
Reserve Banks will review the status
of a de minimis cap institution that
exceeds its cap on a single day or, on
average, over a two-week reserve
maintenance period and will decide if
the de minimis cap should be
foreign bank's board of directors o r other
appropriate managem ent group at which the selfassessm ent w as discussed, fa lieu of this, the file on
the self-assessm ent that is made available for
exam iner review by the U.S. offices of a foreign
bank should contain the report on the selfassessm ent made to the foreign bank’s senior
management by the m anagement of U.S. operations,
to addition, the file should also contain a record of
the appropriate senior m anagem ent's response. As
in the case of U.S. institutions, this review and
confirmation should be completed every year.
• Between examinations, exam iners or Reserve
Bank staff may contact an institution about its cap if
statistical or supervisory reports or a d hoc
information suggest that there may have been a
change h i the Institution’s position.

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices
maintained or if the institution will be
required to perform a self-assessment
and file for a higher cap. An institution
choosing to use a de minimis cap must
submit to its Reserve Bank at least once
each year a copy of the resolution of its
board of directors (or its holding
company's board) approving the
depository institution’s use of daylight
credit up to the de minimis level.
3. Exemption From Filing
Depository institutions that only
rarely incur overdrafts in their Federal
Reserve accounts that exceed the lesser
of $10 million or 20 percent of their
capital are excused from performing
self-assessments and filing board-ofdirectors resolutions with their Reserve
Banks. This dual test is designed to limit
the filing exemption to depository
institutions that create only low-dollar
risks to the Reserve Banks and that
incur small overdrafts relative to their
capital.
The Reserve Bank will review the
status of an exempt depository
institution that incurs overdrafts in its
Federal Reserve account in excess of
$10 million or 20 percent of capital on
more than two days in any two rolling
two-week reserve maintenance periods.
The Reserve Bank will decide if the
exemption should be maintained or if
the institution will be required to file for
a cap. Even for depository institutions
meeting the size and frequency
standards, the exemption would be
granted at the discretion of the Reserve
Bank.
4. Special Situation

fully collateralize all overdrafts in their
Federal Reserve accounts. To protect
the Reserve Banks from excessive risk
in conjunction with the collateralization
policy, the Board strongly urges each
Edge or agreement corporation to
restrain its use of intraday credit by
establishing a net debit cap b ased on its
own capital in the same m anner as any
other depository institution. For
purposes of net debit caps, the Board
suggests that all branches of an Edge or
agreement corporation be consolidated.
This policy reflects the lack of access of
these institutions to the discount
window and the possibility that the
parent of an Edge or agreement
corporation may be unable or unwilling
to cover its subsidiary’s overdraft on a
timely basis.
At the same time, the Board believes
it is preferable for Edge and agreement
corporation subsidiaries of U.S. banks,
together with their parents, to arrange
their affairs in a w ay that would allow
them to continue to service their
customers and at the same time reduce
risk exposures. Specifically, the Board
notes that the parent of an Edge or
agreement corporation could fund its
subsidiary during the day over Fedwire
a n d /o r the parent could substitute itself
for its subsidiary on private networks.
Such an approach by the parent could
both reduce systemic risk exposure and
permit the Edge or agreement
corporation to continue to service it3
customers. Edge and agreement
subsidiaries of foreign banks are treated
in the same m anner as their
domestically-owned counterparts.
b. Bankers' Banks.10 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 payment
services. To protect Reserve Banks from
potential losses resulting from bankers'
banks' daylight o verdrafts, bankers'
banks should refrain from incurring
overdrafts and should post collateral to
cover any funds or book-entry securities
overdrafts they do incur. Bankers’ banks
may voluntarily waive their exemption
from reserve requirements, thus gaining
access to the discount w indow and
avoiding the requirement to post
collateral for all overdrafts. Such

Special risks are presented by the
participation on Fedwire of Edge and
agreement corporations, bankers' banks
that do not maintain reserves, and
institutions that have been assigned a
cap of zero by their Reserve Bank. Some
of these entities are major participants
in privately-operated, large-dollar
clearing and settlement systems, often
making and receiving a large volume of
payments on behalf of their affiliates
and parent organizations. Most of these
institutions lack regular discount
window access. In developing its policy
for these institutions, the Board has
sought to balance the goal of reducing
and managing risk in the payments
under section 25 of the-Federal Reserve Act (.12
system, including risk to the Federal
U.S.C. 601-604a j.
Reserve, with that of minimizing the
40 For the purposes of this policy, a bankers' bank
adverse effects on the payments
is a financial institution that is not required to
operations of these institutions.
m aintain reserves under the Board’s Regulation D
a. Edge and Agreement Corporations,®(12 CF.R part 204) because it is organized solely to
do business w ith other financial institutions, is
Edge and agreement corporations must
6 T hese institutions are organized under section
25(a) of the Federal Reserve Act {12 U.S.C. 611-631)
or have an agreement or undertaking with the Board

owned primarily by the financial institutions with
which it does business,, and does not do business
with the general public and is not a depository
institution as defined in the Board’s Regulation A
(12 CFR 201.2(a)).

40459

bankers’ banks would be subject to the
same policy as other depository
institutions.
c. Zero-Cap Depository Institutions.
Some depository institutions have caps
of zero that are imposed by Reserve
Banks because of the institutions’
financially troubled status, because of
Board policy (such as limited-purpose
trust companies], or because the
institution itself requested a zero cap.
Regardless of whether it has access to
the discount window, if a depository
institution on which a Reserve Bank has
imposed, or that has adopted, a zero cap
incurred a funds-related overdraft, the
Reserve Bank would counsel the
institution and may monitor the
institution’s activity in real-time and
reject or pend any Fedwire funds tranfer
instruction that would cause an
overdraft. Because the timing of bookentry securities transfers are not fully
within the control of the receiving
depository institution, the Board will
allow depository institutions with caps
of zero that have access to the discount
window to continue to incur book-entry
overdrafts, but will require that such
overdrafts be collateralized even if they
are infrequent and modest.

E. Book-entry Securities Transactions
1. Collateralization
A depository institution’s funds and
book-entry securities overdrafts are
combined for purposes of determining
an institution’s compliance with its cap.
Financially healthy depository
institutions with positive caps that
frequently exceed their caps by material
amounts solely due to book-entry
securities transactions are required to
collateralize all of their book-entry
securities overdrafts. To determine
whether an institution exceeds its net
debit cap due solely to book-entry
securities activity, the Reserve Bank
determines what activity in an
institution’s Federal Reserve account is
attributable to funds transfers and other
payment transactions and what activity
is attributable to book-entry securities
transactions. Book-entry securities
balances are calculated by posting
charges for original issues of Treasury
securities and credits for interest and
redemption payments for Treasury and
government agency book-entry
securities at 9:15 a.m. ET and posting
credits and debits from transfers of
book-entry securities as they occur. A
book-entry securities overdraft occurs
when an institution's book-entry
securities balance, less any credit in its
funds balance, is a net debit.

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

For the purposes of this policy,
"frequently" means more than three
occasions in two rolling two-week
reserve maintenance periods, and
“material amounts” means in excess of
10 percent of cap. For example, a
depository institution with a $50 million
cap that meets the “frequent” and
“material” tests and has a $70 million
overdraft— $30 million due to funds
transfers and $40 million due to bookentry securities transactions—will be
required to collateralize the entire $40
million book-entry securities overdraft.
In addition, all financially healthy
depository institutions with positive
caps may choose to collateralize all or
part of their book-entry securities
overdrafts, even if they have not
exceeded their caps. Such secured
overdrafts shall not be included with
those overdrafts measured against their
caps. For example, a financially healthy
depository institution with a $50 million
cap and a $30 million overdraft—$15
million due to funds transfers and $15
million due to book-entry securities
transfers—would ordinarily have excess
capacity of $20 million. Such an
institution may increase its excess
capacity by $15 million by
collateralizing all of its book-entry
securities overdrafts (or may increase its
excess capacity by less than $15 million
by collateralizing some portion of its
book-entry securities overdrafts). Such
an institution may not increase its cap of
$50 million by over-collateralizing its
book-entry securities overdrafts or by
collateralizing any part of its funds
overdrafts. At the same time, if an
institution that voluntarily collateralizes
its book-entry securities overdrafts and
those overdrafts become frequent and
material, the institution will be required
to collateralize 100 percent of its bookentry securities overdrafts.
Depository institutions have some
flexibility as to the specific type of
collateral they may pledge to secure
book-entry securities overdrafts. The
Reserve Banks will not give preference
to a particular type of collateral, such as
securities in transit, discount window
collateral, or stable pools of collateral,
unless a preference is desired by the
depository institution. All collateral
must be acceptable to the Reserve Bank.
2. Transfer Size Limit
Secondary market book-entry
securities transfers on Fedwire are
limited to a transfer size of $50 million
par value. This limit is intended to
induce multiple deliveries to reduce
position-building by dealers, a major
cause of book-entry securities
overdrafts; participants may choose to

limit their trade size as well. This
limitation does not apply to:
(a) original issue deliveries of bookentry securities from a Reserve Bank to
a depository institution or,
(b) transactions sent to or by a
Reserve Bank in its capacity as fiscal
agent of the United States, government
agencies, or international organizations.
Thus, requests to strip or reconstitute
Treasury securities, or to convert bearer
or registered securities to or from bookentry form, are exempt from this
limitation. Also exempt are pledges of
securities to a Reserve Bank as principal
(e.g., discount window collateral) or as
agent (e.g., Treasury Tax and Loan
collateral).

G. Third-Party Access Arrangements

The Board will allow, under certain
conditions, arrangements whereby a
depository institution or other entity
(“the service provider”) could initiate
Fedwire transfers from the Federal
Reserve account of another depository
institution. Such arrangements will be
permitted provided:
1. The institution whose account is
being charged (the “institution”) retains
control of the credit-granting process by
individually approving each transfer or
establishing credit limits within which
the service provider can act..
2. The service provider must be an
affiliate of the institution, or, if the
institution approves each individual
transaction, an unaffiliated company.
F. Inter-Affilliate Transfers
All service providers must be subject to
Although the institutions affiliated
examination.
through common holding company
3. The service provider must not
ownership are not permitted to
permit or initiate transfers that would
consolidate their wire transfer activity
exceed individual customer credit limits
and capital for the purpose of
without first obtaining the institution’s
monitoring compliance with this policy,
permission.
such institutions may engage in funds
4. The service provider must have the
transfers over Fedwire that are intended
operational ability to ensure that the
to simulate consolidation among
aggregate funds transfer activity of the
affiliated depository institutions and
institution does not result in daylight
that create a pattern of daylight
overdrafts in excess of the institution’s
overdrafts up to the sending institution’s
cap.
net debit cap, provided the following
5. All Fedwire transfer activity must
conditions are met:
be posted to the institution’s account,
1. Each of the individual sending
and the institution will remain
depository institutions’ boards of
responsible for its account.
directors approve, at least once each
6. The institution’s board of directors
year, the intraday extension of credit to
must approve the specifics of the
the specified affiliate(s),11 and sends a
arrangement, including: (a) the
copy of the directors’ resolution to its
operational transfer of its Fedwire
Reserve Bank.
transfer activity to the service provider;
2. During the regular examination, the
(b) the net debit cap for the activity to
individual institution’s primary federal
be processed by the service provider;
supervisor reviews the timeliness of
and (c) the credit limits for any inter­
board-of-directors resolutions, the
affiliate funds transfers.
establishment by the institution of limits
7. The institution and the service
on credit extensions to each affiliate, the provider must execute an agreement
establishment by the institution of
with the relevant Reserve Banks
controls to assure that credit extensions delineating the terms of the agreement.
stay within such limits, and notes
8. The institution must have adequate
whether credit extensions have in fact
back-up procedures and facilities to
stayed within those limits.
cover equipment failure or other
The Board notes that the adoption of
developments affecting the adequacy of
this policy regarding transfers among
the service being provided. This back-up
depository institution affiliates does not must provide the Reserve Bank with the
in any way change the treatment of
ability to terminate a service provider
depository institutions and their Edge
arrangement.
and agreement corporation subsidiaries.
9. The institution must have the ability
The ability of a parent institution to
to monitor transfers being made on its
fund its Edge or agreement subsidiaries
behalf.
on an intraday basis remains
10. The institution must provide an
unchanged, so long as the parent
opinion of counsel that the arrangement
remains within its own cap.
is consistent with corporate
separateness and does not violate
11 The provision of this policy statem ent that
branching restrictions.
allows a holding company to establish caps for its
11. The primary supervisor must not
depository institution subsidiaries does not apply to
this requirement.
object to the arrangement.

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices
12. No individual with decision­
making responsibilities relating to the
Fedwire transfer area may hold such a
position in more than one affiliated
institution participating in an approved
arrangement
13. The institution must have in place
an adequate audit program to review the
arrangements at least annually to
confirm that these requirements are
being m et
in order to assure consistency with
the Board's policy, each new
arrangement should be reviewed by the
Director of the Division of Reserve Bank
Operations and Payment Systems prior
to approval by the Reserve Bank.

f t. Monitoring
t. Ex Post
Under the ex post monitoring
procedure, an institution with a net
debit position in excess of its cap will be
contacted by its Reserve Bank.12 The
Reserve Bank will counsel the
institution, discussing ways to reduce its
excessive use of intraday credit. Each
Reserve Bank retains the right to protect
its risk exposure from individual
institutions by unilaterally reducing
Fedwire caps, imposing collateralization
or clearing balance requirements,
holding or rejecting Fedwire transfers
during the day until the institution has
collected balances in its Federal
Reserve account, or, in extreme cases,
taking the institution off-line or
prohibiting it from using Fedwirn.

net debit cap. One Reserve Bank will act
as administrative Reserve Bank and will
have overall risk-management
responsibilities for institutions
maintaining accounts in more than one
Federal Reserve district. In the case of
families of branches and agencies of the
same foreign bank, net debit cap
compliance will be monitored by the
Reserve Bank that exercises the Federal
Reserve’s oversight responsibilities
under the International Banking Act.13
The administrative Reserve Bank may
determine, in consultation with Reserve
Banks in whose territory other U.S.
agencies or branches of the same foreign
bank are located and with the
management of the foreign bank’s U.S.
operations, that branches and agencies
outside its district either will not be
permitted to incur overdrafts in Federal
Reserve accounts or must allocate part
or all of the foreign family’s net debit
cap (and the responsibility for
administering part or all of the collateral
requirement) to a Reserve Bank in
whose district one or more of the foreign
offices operate.14 For domestic
depository institutions that have
branches in multiple Federal Reserve
districts, the administrative Reserve
Bank generally will be the Reserve Bank
where the head office of the bank is
located.

4. ACH Controls
To reduce risk in the ACH mechanism
associated with the origination of ACH
credit transactions by institutions that
are experiencing financial difficulties,
2. Real Time
the Reserve Banks:
A Reserve Bank will apply real-time
(a) will monitor ACH credit payments
monitoring to an individual institution’s
originated by such depository
position when the Reserve Bank
Institutions;
believes that it faces excessive risk
(b) may require advanced funding or
exposure, e.g.. from problem banks or
other assurance of payment or may
institutions with chronic overdrafts in
reject payments if it appears the
excess of what the Reserve Bank
originating depository institution will
determines is prudent. In such a case,
not have sufficient funds on the
the Reserve Bank will control its risk
settlement day; and
exposure by monitoring the institution's
(c) will review origination patterns for
position on a real-time basis, rejecting or all ACH originators of debit and credit
delaying transfers if the account balance payments.
would otherwise be exceeded, and
In addition, a Reserve Bank may defer
taking other prudential actions.
the availability of some or all of the
3. Multi-District Institutions
A depository institution that chooses
to access Fedwire through accounts in
more than one Federal Reserve district
is expected to manage its accounts so
that its aggregate net debit position
across all accounts does not exceed its
12 F.ven if the institution is not a stale member
bunk, the Reserve Bank can make this contact when
an overdraft occurs in a reserve or clearing account
or when the institution is in a net debit position on a
wire system that settles on the hooka of the Federal
Reserve.

' 3 12 U.S.C. 3101-3108.
* * 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 assum e 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 assum es management
responsibility, monitoring data will be forwarded to
the designated adm inistrator for use in the
supervisory process.

40461

credit from debit payments originated
by an institution that the Reserve Bank
believes will not have sufficient
balances to pay return items when they
are presented.
Further details on Federal Reserve
ACH controls are set out in the Uniform
ACH Operating Circular, available from
each Reserve Bank.
II. Policies For Private-Sector Networks

A. Private Large-Dollar Funds Transfer
Networks
Any large-dollar payments system
obtaining net settlement services from a
Federal Reserve Bank must establish
liquidity and credit controls that provide
a reasonable degree of assurance that
settlement can be achieved on the
settlement day. Under the Board’s
policy, no private large-dollar payments
network is eligible for Reserve Bank net
settlement services unless it:
(1) Requires each participant to
establish bilateral net credit limits vis-avis each other participant on that
network,15
(2) Establishes a system to reject or
hold any payment that would exceed
such limits, and
(3) Establishes and monitors in real
time network-specific net debit limits.
In order that Reserve Banks may
properly monitor the use of intraday
credit, no future or existing large-dollar
network will be permitted lo settle on
the books of a Reserve Bank unless its
members authorize the network to
provide position data to the Reserve
Bank on request.
In setting bilateral net credit limits,
each participant on a network must
determine for itself the maximum dollar
amount of net transfers (i.e., the excess
of the value received over the value
sent) that it is willing to accept from
each other participant on that network.
The Board believes that bilateral net
credit limits reduce risk by enabling an
institution to identify and control the
exposure it could face in the event of a
settlement failure. The volume of
daylight exposure that each participant
is willing to accept from each other
participant is likely to be quite large
when aggregated across the network.
Moreover, participants may be unaware
of the credit made available to a given
sender by other potential receivers. For
this reason, bilateral net credit limits
,B Bilateral net credit limits do not apply to
Fedwire transfers because the Federal Reserve
provides final credit to the receiver when the
amount of the payment order is credited to the
receiver’s account or when the payment order is
sent to the receiver, whichever is earlier (12 CFR
210.31(a)). Reserve Banks, however, may take action
to reduce their credit exposure.

40462

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

should be supplemented by networkspecific net debit caps, which will limit
the aggregate amount of risk a
participant may present to the network.
The federal bank examiners will,
during regular examinations, review and
comment on the procedures used by
each institution in establishing,
monitoring, reviewing, and modifying
bilateral net credit limits, and ensure
that institutions understand their
potential exposures with each other
participant over more than one network
and in more than one market.
Avoidance of Risk Reduction M easures
The Board believes that the use of
Fedwire for the avoidance of Federal
Reserve or private-sector risk reduction
measures is not appropriate. The Board
seeks to prevent institutions from
participating in bilateral netting
arrangements that provide only
payments netting under which gross
payment messages are exchanged
during the day and settled at the end of
the day by using Fedwire to adjust net
positions bilaterally. Such arrangements
would be difficult for Reserve Banks to
detect and would be outside of Federal
Reserve and private-sector risk control
measures. They still, however, present
the same risks to the payments
mechanism that other net settlement
arrangements present because
settlement failures are possible, and
such failures could have deleterious
consequences to the paym ents system.
The Board realizes, however, that
certain netting arrangements are not
intended to avoid risk reduction
measures and can, in fact, reduce risk.
For example, institutions may, by means
of novation, net transactions prior to
settlement, with each participant legally
obligated only for the resultant net
position. This arrangement reduces risk
because it replaces gross transactions
with the smaller net obligation, and
failures to settle would almost alw ays
involve smaller exposures (and less
systemic risk) than with simple bilateral
net settlement. The Board’s policy on
limiting avoidance techniques is not
intended to restrict this kind of netting
arrangement.

B, Private Delivery-Against-Payment
Securities Systems
Private delivery-against-payment
securities systems that settle on a net,
same-day basis entail credit and
liquidity risks for their participants and
for the payments system in general. The
Board believes that these systems
should include risk-controj features if
they are to rely on Fedwire for ultimate
settlement. The need for such risk
controls is becoming increasingly

important in view of these systems’
potential for growth, their high volumes,
and the possible future course of the
Federal Reserve’s paym ents system risk
reduction program, e.g., pricing intraday
Fedwire funds and book-entry
overdrafts.
Delivery-against-payment securities
systems, as described below, are
expected to adopt appropriate liquidity
and credit safeguards in order to ensure
that settlem ent occurs in a timely
fashion and that the participants do not
face excessive intraday risks. In view of
the continuing evolution of these
systems, the Board has established
general guidelines rather than specifying
the exact form such safeguards should
take. Reversals or “unw inds” of funds
and securities transfers, however, are
not considered appropriate liquidity
control measures.
The policy addresses four issues:
|1) Liquidity safeguards for ensuring
settlement;
(2) Provisions for reversals;
(3) Credit safeguards, such as
collateral and netting features; and
14) Open settlem ent accounting, These
components, an d the scope and
regulatory implications of this policy,
are described below.
Scope of the Policy
. This policy is specifically targeted at
large-scale private delivery-againstpaym ent securities systems that settle
their obligations on a net, same-day
basis over Fedwire, either directly or
indirectly. These systems settle
securities transactions for their
participants by transferring securities
and the accompanying payment
obligations on the books of a clearing
corporation or a depository institution
operating the system and arrange for
final settlem ent of the funds positions on
a net basis at the end of the processing
day. Settlement on a “net basis” m eans
that the funds obligations are netted
among all participants, so that a
participant can settle obligations to or
from many counterparties by making a
single transfer to or from the system..
"Same-day” settlement m eans that the
appropriate funds and securities
transfers are settled on the day that a
delivery-against-payment request is
entered into the system. "Large-scale”
systems are those systems that routinely
process a significant num ber of
individual transfers larger than $50,000
or that would permit any one participant
to be exposed to a net debit position at
the time of settlem ent in excess of its
capital.
This policy applies to system s that
function primarily as a m eans of
transferring securities and funds

between participants. If a firm or bank
is providing clearing services to a
customer, and these sen/ices focus
primarily on the bilateral relation
betw een the clearer and the customer,
the firm or bank would not be viewed as
a system under this policy. Moreover, at
least'initially, a system that is an
integral component of a full service
bank, such, that obligations that settle on
an item-by-item basis are the direct
obligations of the bank, will not be
subject, to this policy because of the
existing supervisory oversight of a
bank's liquidity and credit resources.
This policy applies to systems in the
United States that transfer debt and
equity securities, including those not
eligible for Fedwire. The policy does not
apply to system s dealing w ith other
financial instruments, such as futures
and options.
This policy is directed at limiting th e
risks arising out of the intraday credit
generated in private delivery-againstpayment systems. The policy does not
address other potential sources of risk in
these systems, such as inadequate
management or facilities. The Board
expects that these system s will be
subject to regulatory oversight because
they are typically clearing agencies
subject to supervision by the Securities
and Exchange Commission, or because
they are limited purpose trust companies
subject to state or federal banking
supervision, or both. These supervisors
have broad responsibility for ensuring
the safety and integrity of these systems.
Liquidity Safeguards
Because they give rise to the
extension of intraday credit, private
delivery-against-payment system s rely
on payments by participants w ith net
obligations to the system (“net debtor”
participants) in order to make settlement
payments to participants with net
obligations due from the system (“net
creditor” participants). In the absence of
appropriate safeguards, the failure by a
single participant w ith a net debit
position may delay settlement of the
system. The result of a system’s failure
to settle in a timely m anner will be that
participants do not receive the transfers
of funds and securities that they
expected and that they, therefore, may
not be able to conclude other
transactions outside the system.
Because settlem ent typically occurs at
the end of the day, the system and net
creditor participants will have relatively
little time to react to any failure that .
may occur.
This policy seeks to ensure that
private systems settle in a timely
manner, so that participants can rely on

Federal Register / Vol. 57, No. 172 / Thursday, September 3. 1992 / Notices
the funds or securities obtained as a
result of transfers through the system,
The importance of ensuring reliable
transfers is due in part to the fact that
these systems generally allow
participants to re-transfer funds credits
err securities acquired during the day. If,
for example, a participant sold securities
early in the day and later used his funds
credits to purchase other securities, then
a failure in the settlement of the earlier
transaction could result in a failure of
the settlement of the later transaction.
The Board believes that private
systems should protect timely settlement
By adopting safeguards that are
commensurate with the risk of
settlement failure. The Board recognizes
that a private system relying on intraday
credit will not be able to guarantee
timely settlement of funds and securities
transfers under all conceivable
circumstances and, therefore, that such
a system cannot make an absolute
guarantee of settlement finality. At a
minimum, however, a system must have
sufficient safeguards so that it will be
able to settle on time if any one of its
major participants defaults. In addition,
the Board strongly encourages systems
to adopt settlement safeguards beyond
this required minimum.
Liquidity arrangements that will
enable a system to make end-of-day
settlement payments are crucial
settlement safeguards. Liquidity
safeguards adopted by private deliveryagainst-payment systems should include
provisions that give the system access to
sources of readily available funding that
will support timely settlement in case a
participant is unable to settle its
obligation. Funding sources could, for
example, include prearranged lines of
credit or a pool of funds contributed by
the participants. The system should
limit, on an intraday basis, the size of
potential net debit positions to ensure
that these liquidity sources will be
adequate.
Because settlement risks and structure
may vary in different systems, the Board
does not consider it appropriate to
specify the exact structure of acceptable
safeguards. One example of an
appropriate liquidity safeguard may be a
cap on the net debit funds position that
may be incurred by an individual
participant, which is tied to the liquidity
resourced available to the system and/
or to the participant If such a cap is
used, it may be appropriate for it to be
administered in a flexible manner, with
due regard for liquidity and credit risks
and for the efficient operation of the
system.

Reversals
Currently, certain systems permit
reversals of transfers of funds and
securities to facilitate settlement if a
participant defaults. By reversing
transactions, the systems try to reduce
the obligations of the defaulting
participant. However, settlement with
reversals will not ease the liquidity
problems caused by a default; reversals
will simply transfer a liquidity shortfall
from the defaulter to another participant
and will do so at the end of the day,
when it may be difficult to arrange for
alternate sources of liquidity. The return
of securities, with the resulting reversal
of a funds credit, may cause the
participant receiving the returned
securities to default on its obligations.
Thus, settlement using reversals will not
achieve this policy’s objective, because
participants will not be able to rely on
transfers of funds and securities if
transfers may be reversed.
Because the Board does not view
reversals as a satisfactory liquidity
safeguard, the systems covered by this
policy should not use reversals as a
substitute for liquidity arrangements,
such as those discussed above, in order
to ensure timely settlement.
Credit Safeguards
As stated above, these systems
effectively allow participants to use
intraday credit when receiving
securities. All participants may be
affected by one participant's failure to
repay this credit The Board, therefore,
believes that these systems should
adopt clear loss-allocation rules and
should minimize credit risks incurred
through the system. Methods of reducing
credit risk may vary in different
systems. Appropriate methods include
requiring contributions by all
participants to a fund that may be used
in the event of a default or requiring the
pledging of a sufficient volume of
marked-to-market collateral. The loss
allocation schedule should not increase
risks to the system. In particular, the
system should calculate the loss
resulting from a default on the basis of
the net obligations of the defaulter
rather than on the basis of the
underlying gross obligations between
the defaulter and its counterparties.
Thus, the Board would find a loss
allocation scheme to be unacceptable if
it reversed all transactions between the
defaulter and other participants.
This policy, including the restriction
on reversals, is not intended to prevent
a system from allocating credit losses to
the counterparty of a defaulter based on
the business dealings between the
counterparty and the defaulter. It may

40463

be appropriate and prudent for a system
to have rules that would require
participants who have dealt with the
defaulter to be responsible, after
settlement, for the related loss. These
arrangements could well include
returning securities to the counterparty
to help absorb the loss.
Open Settlement Accounting
As1delivery-versus-payment systems
grow in size and volume, the timely and
orderly completion of end-of-day
settlements takes on an increased
importance for the settlement of other
large-dollar payments systems. As a
general matter, the Board believes that it
will be easier for market participants
and supervisors to monitor and protect
against settlement risks if current
information is readily available.
Participants in a delivery-againstpayment system should therefore have
up-to-date information on their net
position and on the settlement progress
of the system, and appropriate market
supervisors should have ready access to
current intraday information on both the
system’s settlement and participants’
positions. For those systems wishing to
use Fedwire payments as a means of
settlement, the Board encourages the
use of Federal Reserve Bank net
settlement services rather than
individual wire payments that cannot be
distinguished from all other Fedwire
payments. This policy is in no way
intended to broaden access to Federal
Reserve services; neither Fedwire nor
net settlement services will be available,
as a general matter, to non-member,
non-depository institutions.

C. Offshore Dollar-Clearing and Netting
System s 16
For some time, the Board has been
sensitive to the risks associated with the
actual and potential development of
netting and clearing arrangements for
U.S. dollar payments located outside the
United States. In particular, the Board
has been concerned that the steps being
taken to reduce systemic risk in U.S.
large-dollar payments systems may
themselves induce the further
development of “offshore” dollar
payments systems. These offshore
systems can settle through payments on
the Federal Reserve's wire transfer
system (Fedwire) or the New York
Clearing House’s Clearing House
Interbank Payments System (CHIPS),
but may operate without adequate
16 The Board adopted this policy statement in
June 1989 as an interim measure to address offshore
clearing and netting systems until an international
consensus is reached among central banks and
bank supervisory authorities.

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

international understanding of the
procedures for the m anagement of risks
monetary, financial, and supervisory
and without any form of official
issues raised by the development of
oversight. The Board also recognizes
offshore or cross-border netting
that the development of offshore
clearing and netting arrangem ents raises arrangem ents.17
At the sam e time, the Board
issues of concern which go beyond the
recognizes that the. technological,
immediate question of paym ent risks in
market, and regulatory Incentives that
the U.S. banking system.
Banks in all countries have been
are giving rise to the growth of these
experiencing strong incentives to reduce arrangem ents will continue to operate.
payment flows and credit exposures. As The Board believes that it is important,
an apparent consequence, there is an
therefore, to begin to address the
increasing number of proposed or actual potential policy concerns raised by the
further development of offshore netting
interbank netting arrangem ents which
and clearing system s for U.S. dollar
affect an offset or netting of amounts
due betw een banks, arising not only
paym ents and the risks th at these
from payment instructions but also from systems may create. This is particularly
the settlement of foreign exchange and
the case in light of the significant steps
that have been and are being taken by
other financial contracts, on either a
bilateral or m ultilateral basis. W hen
the Federal Reserve and the U.S.,
banking industry to address payment
located outside the country of issue of
the currency subject to the netting, these risk issues. These include both the
arrangements have the potential to alter Board’s ongoing payments system risk
significantly the structure of the
reduction program and the efforts of the
N ew York Clearing House Association
international interbank clearing and ■
settlement process.
to improve CHIPS participants’
In response to these, developments,
aw areness of paym ent risks, to control
the Group of Experts on Payments
the level of daylight exposures within
Systems from the G-10 central banks,
CHIPS, and now to adopt settlement
meeting at the Bank for International
finality procedures.18
Settlements (BIS) in Basle, Switzerland,
Offshore clearing of U.S. dollar
studied a variety of paym ent and
payments, for subsequent net settlement
currency netting arrangements. The BIS
in the United States, may create
Payments Experts' "Report on Netting
transaction and other efficiencies for
Schemes” primarily addresses the
participants in such offshore systems., If,
allocation of credit and liquidity risk in
however, the allocation of credit and
various netting structures and draw s
liquidity risks associated w ith the
general conclusions as to w hether these
netting and settlem ent is not clearly
risks are increased or decreased by the
understood or defined, offshore dollar
different “institutional forms” .of netting. clearing arrangements may well
The Board believes that, in so doing, the obscure, or even increase, the level of
Report of the Payments Experts provides systemic risk in U.S. large-dollar
a valuable starting point for the
payments system s as well as in the
consideration of risk in the international . international dollar settlem ent process
payment process.
generally. The BIS Report notes that this
In addition, the Report notes that a
shifting.of risk “can be particularly
number of broader monetary, financial,
.troubling w here the transaction cost
and supervisory policy implications are
efficiencies are enjoyed by banks
associated w ith the further development located in one country, but the credit
of netting arrangements for interbank
and liquidity risks associated w ith the
m arkets. Netting systems for foreign
settlement of payments resulting from
currency payments and contracts have
that netting system may be experienced
the potential to create changes in the
in the banking system of another
financial character of affected interbank country.” This is precisely w hat can
m arkets, as w ell as in the cross-border
happen when U.S. dollar paym ents are
relationships betw een national banking
netted in systems outside of the United
systems.. These changes, in turn, raise
States and subsequently settled through
questions about the extent and quality
CHIPS or Fedwire.
of central banks’ oversight and
Because of the potential for offshore
supervision of settlements in their
dollar clearing systems both to shift risk
respective currencies, including the
to U.S. large-dollar payments systems
allocation of supervisory responsibility
among various central banks and
17 In November 1990, the "Report of the
national supervisory authorities.
Committee on Interbank Netting Schemes of the
On the basis of this preliminary work, Central Banks of the Group of Ten Countries” w as
the Governors of the G-10 central banks published by the BIS, Federal Reserve staff is
reviewing the Board's policies on offshore dollarhave determined that a further study of
clearing and netting systems.
these broader issues be undertaken with
18 CHIPS adopted settlement finality procedures
a view toward establishing an
in October 1990.

and to be used to avoid the Board’s
domestic risk reduction policies, the
Board believes that it is appropriate for
it to provide preliminary guidance on the
framework within which offshore dollar
systems should operate. The Board
recognizes that the question of the
degree of oversight and supervision of
offshore clearing and netting systems
can only be fully addressed on a
cooperative basis among central banks
and national bank supervisory
authorities. In the interim, the Board’s
approach to offshore dollar clearing and
netting system s will be guided by the
following general principles:
1. An offshore dollar clearing or
netting system, which settles directly or
indirectly through CHIPS or Fedwiie,
should at a minimum be subject to
oversight or supervision, as a system, by
a relevant central bank o r supervisory
authority.
2. The participants should be
responsible for clearly identifying the
operational, liquidity, and credit risks
created within the system and for
assuring the prudent management of
these risks.
3. The system should have
arrangem ents in place that provide for
the finality of settlement obligations and
the practical m eans to assure the timely
satisfaction of these obligations.
4. The direct or indirect settlement of
the system’s obligations through CHIPS
or Fedwire should be conducted by an
identified settlem ent agent, in the United
States, so that satisfaction of the
settlem ent obligations can be readily
ascertained by the participants, the
Federal Reserve, and other relevant
central banks and supervisory
authorities.
Consistent w ith the foregoing interim
principles, the Federal Reserve is
prepared to work with the central bank
a n d /o r supervisory authorities of the
country in which an offshore dollar
clearing or netting system is located, on
a cooperative basis, to assure the
continuing adequacy of the system’s,
procedures for controlling risk.
The Board believes that these interim
principles are consistent w ith the
concerns identified by the BIS Payments
Experts Group. The minimal conditions
that they would impose on offshore
clearing and netting systems are similar
to the risk-reduction procedures that
have been established for CHIPS. These
principles should not be regarded as
establishing a policy of either
encouraging or discouraging the
operation of offshore dollar payments
systems. Rather, they represent an
initial attempt by the Board to indicate
the minimum structural features that the

Federal Register / Vo). 57, No, 172 / Thursday, September 3, 1992 / Notices
Board believes are appropriate for
offshore dollar clearing arrangements.
These principles also presume a
cooperative international approach to
the supervision of offshore clearing and
netting arrangements.
D. Private Small-Dollar Clearing and

Settlement Systems
1. National ACH Net Settlement
In October 1990, the Board approved a
proposal under which the Federal
Reserve would provide net settlement
services to depository institutions
participating in a national, multilateral
automated clearing house (ACH)
clearing arrangement The factors
considered by the Board in 1990,
discussed below, would also apply to
any future proposals for national ACH
net settlement services.
Assurance of settlement. The ACH is
generally considered a small-dollar
payment mechanism, and the settlement
positions of ACH participants tend to be
small relative to capital. Additionally,
unlike large-dollar funds transfer
systems, such as CHIPS, ACH payments
typically are exchanged in batches
before the settlement day. Payments
received by ACH participants, therefore,
generally are not used to fund
subsequent payments to participants
within the system. These two factors—
the relatively low value of payments
and the single flow of payments—result
in less systemic credit and liquidity risk
for participants in ACH clearing
arrangements than for participants in
large-dollar payments systems.
Nevertheless, a national ACH
network that receives settlement
services from the Federal Reserve
should take steps to minimize the risk
exposure of its participants should one
of the participants be unable to fund its
net debit position at the designated
settlement time. The Board does not
mandate specific risk control provisions
but will consider the effectiveness of
provisions suggested by the participants
in a clearing and settlement
arrangement Among the types of credit
and liquidity controls that should be
considered by such clearing and
settlement arrangements are (a)
objective admission criteria and ongoing
■monitoring of participants’ adherence to
those criteria, (b) bilateral credit limits,
(c) net debit caps, and (d) gross
origination caps.
For example, an ACH network might
control credit risk by evaluating the
creditworthiness of participants and
setting specific credit criteria for
admission or by requiring each
participant to establish bilateral credit
limits with each other participant in a

multilateral clearing arrangement. If a
relatively large number of institutions
use a national ACH clearing
arrangement, however, setting and
maintaining bilateral limits may be
difficult operationally. On the other
hand, setting net debit settlement caps
provides a means to limit the risk that
any one participant can impose upon the
group. Gross origination caps serve a
similar purpose.
Recasts and unwinds. Because of the
potential systemic risks, the Board will
examine closely any ACH clearing
arrangements that provide for recasting
or unwinding the settlement in the event
of a participant default. Generally, the'
Board does not view recasts or unwinds
as satisfactory liquidity controls. It is
important to determine the degree of
systemic risk associated with a
multilateral ACH clearing arrangement
in order to assess whether a settlement
guarantee should be required or whether
a settlement recast would be an
acceptable alternative. For example, if
simulations of a participant’s failure to
settle indicate that the degree of
systemic risk associated with the recast
is relatively low and that participants
should be able to cover the changes in
their settlement positions caused by a
recast, the Board may conclude that a
settlement guarantee is not necessary to
avoid potential systemic problems.
Moreover, a relatively wide distribution
of ACH payments would tend to limit
the exposure of any one participant to
the inability of another participant to
settle.
Although the degree of systemic risk
associated with ACH clearing
arrangements is relatively low, a
network’s reliance upon a complete
unwind, if a settlement cannot be
achieved in an orderly fashion, raises
concerns. If such an event were to occur,
it would cause disruption because a
potentially large number of payments
would not be made as planned. A
national ACH network seeking Federal
Reserve settlement services should
incorporate appropriate risk controls
and should be able to demonstrate that
the possibility of an unwind would be
remote.
Finality of payment. The Board will
consider the extent to which settlement
entries under the national-ACH network
are final. For- example, use of Fedwire
by participants to make settlement
payments would provide finality for net
settlement entries by the designated
settlement time, which could be
relatively early in the day, assuming
that all participants in net debit
positions are able to fund their
positions. The use of Fedwire for
settlement may also reduce temporal

40465

risk, again assuming all net debtors are
able to fund their positions.
Additionally, the Reserve Banks' risk is
minimized because of the controls used
to monitor Fedwire.
Operational concerns. The national
ACH network should be able to assure
the Board that settlement through a
Reserve Bank would not cause serious
operational problems for the network or
any service provider to the network. In
addition to operating capabilities, the
Board will consider a service provider’s
financial viability and its ability to
demonstrate that it can provide efficient
ACH processing services.
2. Small-Dollar ATM Networks
A small-dollar electronic funds
transfer or automated teller machine
(ATM) network may request settlement
services from a Federal Reserve Bank.
The Board has delegated to the Director
of the Division of Reserve Bank
Operations and Payment Systems, with
the concurrence of the General Counsel,
authority to approve such arrangements
under the following conditions: The
standard net settlement service
agreement must stipulate that net
settlement entries are to be considered
provisional until the business day
following the presentment of a
statement to the Federal Reserve in
order to ensure the settling depository
institutions’ ability to cover their net
debit positions. The network must agree
that large-dollar payments will not be
processed under any circumstances and
that the Federal Reserve may terminate
net settlement services immediately if
there is any indication that the network
is being used for large-dollar transfers.
The network must agree to provide
information to the Federal Reserve
regarding its operations and
transactions when requested. The
Federal Reserve has the right to modify
or terminate the agreement at any time.
m . Other Policies
A. Rollovers and Continuing Contracts
The Board believes that the use of
market innovations, such as federal
funds or Eurodollar rollovers or
continuing contracts, to reduce daylight
overdrafts in Federal Reserve accounts
and on the New York Clearing House’s
Clearing House Interbank Payments
System (CHIPS) is consistent with the
Board’s policy concerning daylight
overdrafts. The Board urges market
participants to consider using such
innovations for these and other financial
instruments where feasible. In doing so,
participants should be mindful that
implementing changes of this type may

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Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices

involve incremental costs, at least
transitionally, and modified risk
positions. Accordingly, participants
should evaluate these factors and take
them into account when selecting and
negotiating with counterparties.
Many overnight interbank federal
funds and other similar purchases and
sales are negotiated in the morning with
the funds being sent over Fedwire in the
afternoon. Typically, the previous day’s
overnight borrowings are returned to the
seller in the early morning, thus leaving
a midday time gap of three or more
hours between the morning repayment
and the receipt of that same day’s new
borrowing. Often these transactions are
between the same two banks for the
same amount. This funding time gap can
contribute to daylight overdrafts for the
borrowing institution and create risk to
Reserve Banks.
Rollovers are interbank overnight
transactions where the principal doe9
not change and is not returned the next
day to the seller but, instead, is rolled
over for the next overnight period. The
overnight interest rate is negotiated
daily between buyer and seller. The
maturity is one business day, or no
maturity is specified, and the
arrangement may be cancelled at any
time by either party. The Board
understands that national bank lending
limits would not apply to federal funds
transactions that have a maturity of one
business day or no stated maturity and
require no advance notice for
termination. Because the rollover
procedure eliminates the daily
movement of principal on Fedwire and
the corresponding time gap that could
otherwise exist between repayment of
the previous day’s borrowings and
receipt of new reborrowing, daylight
overdrafts are reduced.
Continuing contracts are similar to
rollovers. With a rollover, the size of
each day’s sale is the same. With a
continuing contract, the size of each
day’s sale can vary, and only the
difference in principal from the previous
day’s borrowing is moved over Fedwire
or CHIPS. Such arrangements reduce the
size of the daily movement of principal
on Fedwire and CHIPS and also
eliminate the time gap that could
otherwise exist between repayment of
the previous day’s borrowings and
receipt of new reborrowing, thereby
reducing daylight overdrafts in Federal
Reserve accounts or net debits on
CHIPS. When the same maturity
conditions apply to a continuing
contract as apply to a rollover (one
business day or unspecified maturity

and cancellation at any time by either
party) national bank lending limits do
not apply.
Each participant should satisfy itself
that it has the flexibility to negotiate
amounts, rates, and maturity options
before using these practices for federal
funds, Eurodollars, or other financial
instruments. Either of these practices,
rollovers or continuing contracts, can
reduce daylight overdrafts or intraday
net debits, and their prudential use by
the banking industry is consistent with
the Federal Reserve's policy of reducing
intraday exposures on Fedwire and
CHIPS. When borrowing banks reduce
their daylight overdrafts by use of these
practices, some extra operational costs
and risks may be incurred by either
party compared to current arrangements
in the overnight market. For example,
sellers of federal funds and other
instruments may have to develop
alternative audit trail procedures and
may accept some additional risk of
repayment since funds would not be
returned each day before they would be
relent. In addition, buyers of federal
funds and other instruments may
experience some extra initial operating
costs to set up rollover arrangements
between themselves and lending banks
and may have to pay a higher rate to
induce lenders to commit their funds for
a longer time. However, these costs and
risks, if any, should be reflected in the
rate or rate spread received and paid.
Although it is unclear whether rates on
daily interbank funds transactions will
fall relative to rates paid for rollovers,
continuing contracts, or term funds, or
whether the reverse will occur, the
Board believes that the negotiation of
terms relative to the use of these
arrangements should be left to the free
operation of the private market.
The Board also supports efforts to
encourage timely return of overnight
federal funds and other borrowings and
encourages operational improvements
that would consistently allow timely
receipt of funds purchased soon after a
seller negotiates a sale. Similar
arrangements and industry standards
were suggested for federal funds by the
American Bankers Association in July
1986.
By order of the Board of Governors of the
Federal Reserve System, August 23,1982.
Jennifer J. Johnson,

Associate Secretary of the Board.
[FR Doc. 82-21207 Filed 9-2-S2; 6:45 am)
BKJJNQ CODE S210-01-F