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Federal R eserve Bank OF DALLAS W ILLIAM H. WALLACE DALLAS. TEXAS 75222 FIRST V IC E P R E S ID E N T AND C H IE F O P ER A TIN G O FFIC ER July 11, 1989 Circular 89-41 TO: The Daylight Overdraft Coordinator or the Chief Executive Officer of the financial institution addressed SUBJECT Proposals for Modifying the Payments System Risk Reduction Program DETAILS On May 31, 1989, the Board of Governors of the Federal Reserve System considered a series of proposed modifications to its Payments System Risk Reduction Program. The Board has decided to seek public comment on the proposed modifications. Comments will be due on November 17, 1989. Several policy statements, however, were adopted by the Board and are effective at once. Attached is a copy of the Federal Register notice that provides more detail about the public comment period and the proposals. Also included is a set of highlights of the proposals that are of most interest to and consistent with your institution's activities. Beginning in early August, you will also receive a series of reports that will indicate how the proposals will affect your institution. OTHER MATTERS If you wish to update the name of your daylight overdraft coordinator on our mailing list, please send a letter containing the name of the new coordinator to the attention of Robert G. Feil, Manager, Reserve Maintenance Division, Federal Reserve Bank of Dallas, Station K, Dallas, Texas 75222. ATTACHMENTS The Board's press release and the material as published in the Federal Register are attached. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) MORE INFORMATION For more information about the proposals, please contact Paul Elzner at (214) 698-4439, Virginia Rodriguez at (214) 698-4228, or James Smith at (214) 651-6140. Sincerely yours, FEDERA^RESERVEpressrelease For immediate release June 16, 1989 The Federal Reserve Board today issued for public comment proposed changes to its Large Dollar Payment System Risk policy designed to reduce risk to the Federal Reserve and the payments system in general. Comments must be submitted to the Board by November 17, 1989. The requests for comment are detailed in three Dockets. Docket No. R-0668 contains proposals that would provide for a fee of 25 basis points, phased in over three years, for consolidated funds and book-entry average daily Fedwire overdrafts in excess of a deductible of 10 percent of risk-based capital. To accommodate pricing, the Board is also proposing various changes to the posting and cap procedures, including a proposal that will exempt depository institutions with a low level of overdrafts from filing for a cap or performing a self-evaluation. In view of the proposed deductible and cap exemption, the Board anticipates that a relatively small number of depository institutions would be subject to either pricing or caps. Docket No. R -0 6 6 9 requests comment on a proposed policy to include both book-entry and funds overdrafts in a combined Fedwire overdraft measurement under the existing cap structure. Unlike the pricing proposal, which deals with average Fedwire overdrafts, the caps continue to apply to peak overdrafts. (OVER) A . W n ’E R S A R T FEDERAL RESERVE S r S T E M -2The proposal would require depository institutions that frequently or routinely exceed their Fedwire cap by material amounts solely because of book-entry transfers to collateralize their total Fedwire exposure. The proposal sets guidelines on the types of collateral preferred and how collateral should be identified and would also establish guidelines for Reserve Banks to implement the policy. Docket No. R-0670 requests comment on a proposed risk reduction policy that would require collateralization of the total amount of Fedwire overdrafts (funds and book-entry) of foreign banks operating through U.S. agencies and branches if such overdrafts exceed the banks' Fedwire cap. The Board's notices are attached. - Attachments 0 - 26090 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices collateral and identification of collateral and also establishes guidelines for the Reserve Banks to implement the policy. OATES: Comments must be submitted on or before November 17,1989. a d d r e s s e s : Comments, which should refer to Docket No. R-0669, may be mailed to the Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551, Attention: Mr. William W. Wiles, Secretary; or may be delivered to Room B-2223 between 8:45 a.m. and 5:00 p.m. All comments received at the above address will be included in the public file and may be inspected at Room B1122 between 8:45 a.m. and 5:15 p.m. FOR FURTHER INFORMATION CONTACT: FEDERAL RESERVE SYSTEM [D o c k et N o. R -0669] RIN 7100-A A 76 Proposals to Modify the Payments System Risk Reduction Program; Book-Entry Securities Transfers a g e n c y : Board of Governors of the Federal Reserve System. a c t i o n : Request for comment. The Board is requesting comment on a proposed policy to reduce the risks to the Federal Reserve arising from daylight overdrafts associated with transfers or book-entry securities on Fedwire. This policy is proposed in conjunction with the other requests for comments and policy statements regarding the Board’s payments system risk reduction program, published elsewhere in today's Federal Register. The proposed policy would require depository institutions that frequently exceed their Fedwire caps by material amounts solely because of book-entry transfers to collateralize their total Fedwire overdrafts. The proposal sets guidelines regarding preferred types of su m m a ry : Edward C. Ettin, Deputy Director, Division of Research and Statistics (202/ 452-3368): Florence Young, Assistant Director, Division of Federal Reserve Bank Operations (202/452-3926); Oliver I. Ireland, Associate General Counsel (202/452-3625) or Stephanie Martin, Attorney (202/452-3198), Legal Division; for the hearing impaired only. Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: This is one of three proposals regarding payments system risk that the Board is issuing for public comment today. The others concern pricing of overdrafts on the Federal Reserve's wire transfer system (“Fedwire”) and related overdraft measurement and cap proposals (Docket No. R-0668) as well as the daylight overdraft policy for U.S. branches and agencies of foreign banks (Docket No. R-0670). The Board encourages all interested parties to comment on each of these proposals. The Board urges that in filing comments on these proposals, commenters prepare separate letters for each proposal, identifying the appropriate docket number on each. This procedure will facilitate the Board's processing and analysis of the comments on these proposals by ensuring that each comment is quickly brought to the attention of those responsible for analyzing each specific proposal. In addition, the Board encourages entities that plan to submit identical comments, such as affiliated institutions within a holding company, to consolidate their efforts; the Board will give equal consideration to one letter signed by a number of commenters as it would to numerous identical letters submitted by those commenters. Comments are due November 17,1989, and the Board does not intend to extend the comment period beyond that date. In addition to its requests for comment, the Board is also issuing today three risk-related policy statements regarding private deliveryagainst-payment systems (Docket No. R-0665), offshore clearing and netting systems (Docket No. R-0666), and rollovers and continuing contracts (Docket No. R-0667). Background The Board’s current payments system risk reduction program establishes a maximum amount of intraday funds overdrafts that depository institutions are permitted to incur over both Fedwire and private large-dollar payments systems. The maximum, or cap, is a multiple of a depository institution's adjusted primary capital and is based on a self-evaluation of a depository institution’s creditworthiness, credit policies, and operational controls. Since the initiation of the policy in 1986, the daylight overdrafts on Fedwire associated with book-entry transfers have been exempt from the cap limit3, pending development of procedures to bring these extensions of credit by Reserve Banks within the ambit of the policy. (For additional background on the Board’s payments system risk reduction program, see Docket No. R0668, elsewhere in today’s Federal Register.) For depository institutions that are major clearers of government securities, however, such caps would have to be sizeable to cover the overdrafts associated with the operations of an efficient market for U.S. government securities.1 As described more fully below, the Board proposes changes to its payments system risk reduction program that will more fully secure the Reserve Banks, while continuing to provide flexibility to depository institutions engaged in clearing U.S. government securities. Proposed policy regarding book-entry securities transfers. The Board is requesting comment on the following multi-faceted proposal to deal with book-entry overdrafts: • To combine book-entry overdrafts with funds overdrafts to create a combined Fedwire overdraft within the existing cap structure; 1 For foreign banks, caps that reflect their world wide capital would allow overdrafts of a size that would be inappropriate given their U.S. assets subject to U.S. supervision and their U.S. funding capacity. (For the Board's proposals regarding foreign banks see Docket No. R-0670, elsewhere in today’s Federal Register.) In the case of foreign banks, collateral has been looked to as the means to secure overdrafts above the cap level and has been considered in the past as a means of securing bookentry related overdrafts. In reviewing this policy, the Board has concluded that partial collateralization of Fedwire overdrafts is not desirable. Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices • To require depository institutions that frequently exceed their Fedwire cap by material amounts solely because of book-entry transfers to collateralize their total Fedwire exposure; • To use discount window collateral not in use for that purpose held either by the Reserve Bank or the depository institution as the first preferred source of collateral and other assets held by the depository institution as the second preferred source of collateral; and • To use as a final source of collateral, book-entry securities being transferred, in the interim marked on the depository institution’s own books, and, in the long run, segregated and valued in real time on the books of the Reserve Bank. As previously noted, the Board’s current payments system risk reduction program exempts book-entry related daylight overdrafts from cross-system net debit caps. In making this decision, the Board realized that, for the vast majority of depository institutions, book-entry overdrafts are small in size and present limited risk to the Federal Reserve System. By far, the majority of book-entry overdrafts are concentrated in a few clearing banks which serve the major dealers and brokers in government securities. Restricting the overdrafts of these banks could impede the smooth functioning of the government securities market. On two previous occasions the Board has issued for public comment proposals that would deal with the risks arising from book-entry overdrafts by requiring that such overdrafts be collateralized (50 FR 21132, May 22,1985, and 51 FR 45048, December 16,1986). On both occasions, commenters have agreed that the Federal Reserve should be protected by collateral but have argued that the means proposed to do so were too restrictive and rigid in nature. The previous proposals focused on the use of those book-entry securities in transit that give rise to the overdraft as collateral rather than on other possible types of collateral. Commenters argued that reliance on this collateral would burden book-entry processing with complex and costly control processes. As a result, a collateralization policy has not been adopted, though the underlying causes of book-entry overdrafts have been at least partially addressed by a limit on transaction size, increased secrutiny of dealer clearing practices, and issuance of guidelines for dealer clearance behavior. These measures to control book-entry overdrafts have had some success, particularly as they relate to the value of overdrafts per dollar of securities transferred and to the size and timing of peak overdrafts at large clearing banks. Book-entry related overdrafts, however, still account for 60 percent of all Fedwire peak intraday overdrafts and have an average peak value of approximately $60 billion per day. Further, these overdrafts continue to be highly concentrated at a small number of depository institutions, primarily clearing banks located in New York City. The four largest clearing banks, while reducing their overdrafts for the reasons noted above, still account for about two-thirds of all book-entry related daylight overdrafts. The ten largest clearing banks account for approximately 80 percent of all such overdrafts. The government securities markets could be seriously disrupted if these institutions were significantly restricted in their ability to provide intraday credit to their customers. On the other hand, if one of these institutions were to experience a problem requiring overnight funding, the overdrafts involved could present considerable risk to its Reserve Bank. Thus, there continues to be a need to develop a program that will protect the Federal Reserve by collateralizing large book-entry overdrafts while at the same time recognizing the wide disparity among depository institutions incurring overdrafts and the types of business such overdrafts reflect In response to this need, the Board has developed a proposal that integrates book-entry overdrafts with funds overdrafts for measurement purposes and provides for flexible treatment of the relatively few institutions that incur very large overdrafts. This proposal has several aspects. First it recognizes that book-entry overdrafts are similar to those created by funds transfers in that both expose the Federal Reserve to the risk of loss. Thus, there seems to be little reason to continue the policy of separating the two types of overdrafts and creating, at times, misleading the two types of overdrafts and creating, at times, misleading overdraft data for individual depository institutions. For the vast majority of depository institutions, combining book-entry and funds overdrafts under the current oap structure would have little effect. In the last quarter of 1988, only six depository institutions with assets over $1 billion and 41 with assets under $1 billion would have experienced increases in their cap utilization rates of more than 25 percent under such a program. Of those 47 depository institutions, only 15 would have exceeded their caps as a result of the inclusion of book-entry overdrafts. Five large depository institutions whose total overdrafts exceeded their caps because of their 26091 book-entry overdrafts are major clearing banks. The total Fedwire overdrafts of these depository institutions (all of which would be collateralized under the proposal, as discussed below) account for almost 40 percent of the aggregate Federal Reserve direct credit risks resulting from daylight overdrafts. The ten remaining banks that would exceed their cap due to book-entry overdrafts account for only 0.2 percent of total Fedwire overdrafts. The Board believes that book-entry and funds overdrafts should be combined under the current cap program. The Board does not believe, however, that the few depository institutions severely affected should be required to reduce overdraft levels, as they would be if caps had been exceeded as a result of funds transfers. Rather, the Board proposes that these depository institutions be asked to collateralize the total exposure they create for Reserve Banks from funds and book-entry overdrafts. This collateralization policy will apply only to these depository institutions that frequently incur total Fedwire daylight overdrafts that, solely because of bookentry related overdrafts, are materially in excess of their Fedwire caps. All other depository institutions will be expected to manage their total overdrafts (funds and book-entry) within the existing cap system, with the exception of occasional, modest daylight overdrafts that are due solely to bookentry transfers. A second aspect of the Board’s proposal would provide that collateral cover the entire daylight overdraft of an affected depository institution, not just that created by book-entry overdrafts. This reflects the reality that, if Federal Reserve lending at the discount window is needed, the entire credit must be collateralized, not just that portion created by book-entry transfers or that amount in excess of the depository institution's cap. The third aspect of the Board's proposal involves the type of collateral to be used to secure the overdraft. The Board believes that discount window and other pools of acceptable collateral, held either by the Reserve Bank or by the depository institution, should be relied upon, to the extent possible, to cover daylight overdrafts. Discount window collateral and portfolio pools of assets are more easily identified than the book-entry securities being transferred that are eligible for pledge to secure overdrafts. Such collateral would cover a large portion of many large depository institutions’ overdrafts. Moreover, using existing discount 28092 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1S89 / Notices window collateral and asset pools as a primary source of collateral for overdrafts minimizes the need to rely on book-entry securities being transferred as collateral and would help to avoid potential conflicting claims on these securities. Some depository institutions may be able to pledge the securities being transferred by some customers, primarily brokers and dealers, to cover the depository institution’s book-entry overdrafts, but depending on the availability of discount window collateral and asset pools this may not be necessary in all cases. Any security agreement between a Reserve Bank and a depository institution will exclude collateral that the institution is not authorized to pledge. Each depository institution subject to this collateralization requirement will be expected to work with its Reserve Bank to develop the mix of discount window collateral, other asset pools, and incoming book-entry securities to be used as collateral. The resulting program of collateralization will thus be customized to the depository institution so as to accommodate its business needs as well as to provide adequate protection to the Reserve Bank. The final aspect of the Board’s collateralization proposal concerns the manner in which rights to collateral in the form of book-entry securities being transferred will be conveyed to Reserve Banks. Ideally, such securities would be segregated in real-time on Reserve Banks’ books, valued at market price less appropriate haircuts, and released from pledge to the Reserve Banks only as daylight overdrafts are extinguished. Such a process would involve extensive operational changes at both depository institutions and Reserve Banks, requiring a long lead time for development and implementation. Thus, the Board believes that using incoming book-entry securities as collateral should be accomplished in two phases, interim and long run. In the interim, those depository institutions that would find it necessary to repledge customer securities to Reserve Banks would mark the repledged collateral on their own books and not segregate the collateral at the Reserve Bank. Unfortunately, under this arrangement, a Reserve Bank could not assure on a real-time basis that the total collateral actually pledged, i.e., discount window collateral, other asset pools, and securities being transferred and marked on the depository institution's books, would be sufficient to cover the depository institution’s overdraft. However, as an interim measure, the intraday pledge of bookentry securities, recorded on the books of the overdrafting depository institution, would reduce the unsecured credit risk now incurred by the Reserve Banks. In the long run. intraday on-line valuation and segregation capabilities, similar to the services clearing banks now provide their customers, will be available as a result of the Reserve Banks’ decision to design and develop a new book-entry operating system. This effort i3 expected to take threee to five years to implement and will require extensive changes by Reserve Banks, depository institutions, and the major government securities dealers. Concurrently, the Department of the Treasury is in the process of revising its regulations that govern the legal transfer of interests in U.S. government securities. The Reserve Banks will be working with all interested parties to assure that the future book-entry securities system not only provides the means of efficiently and prudently securing Fedwire book-entry daylight overdrafts, but also includes the capabilities, procedures, and protections that will serve the future needs of the clearing banks, the dealer community, and their customers. The Board expects the Reserve Banks to implement the new book-entry securities program with considerable flexibility. Reserve Banks are to require any depository institution that frequently exceeds its Fedwire cap because of book-entry overdrafts to collateralize its entire overdraft However, the specific application of the collateral requirement is to be worked out by the Reserve Bank and the depository institution on a case-by-case basis. Reserve Banks will determine the definition of “frequently and materially" on a flexible basis, and will work to perfect an interest in the types of collateral the depository institution can most easily provide. It would be expected that both the type and loan value of the collateral would be consistent with each Reserve Bank’s discount window policies, even if the collateral used is not routinely taken for discount window purposes. Finally, if book-entry securites being transferred are needed as collateral. Reserve Banks will work with each depository institution to determine what internal processes are needed to ensure the best rspledge of securities that can be effected. To implement this proposal. Reserve Banks will: • Work flexibly with each depository institution affected by the proposal; • Accept only the type and loan value of collateral that would be broadly consistent with the Bank's discount window policies; • Develop model agreements for pledging collateral held in the possession of Reserve Banks, held for discount window purposes by the depository institution, or repiedged by the institution as a result of customer book-entry transfer business; and • Develop a new book-entry system that will provide the means for segregation and valuation of book-entry securities being transferred on Reserve Bank books. By order of the Board of Governors of the Federal Reserve System. June 15,1989. William W. Wiles, Secretary o f the Board. [FR Doc. 89-14640 Filed 6-20-09; 8:45 am] BILLING CODE 6210-01-*» (Docket No. R-0666] RIN 7100-AA78 Interim Policy Statement on Offshore Netting and Clearing Arrangements AGENCY: Board of Governors of the Federal Reserve System. a c t i o n : Interim Policy Statement. The Board is issuing an interim policy statement to establish guiding principles for any offshore dollar clearing or settlement system settling directly or indirectly on Fedwire or CHIPS. The Board believes that adherence to the policy statement will result in a reduction in risk on largedollar payments systems in the United States. This interim policy statement is issued in conjunction with the Board’s requests for comments on proposals regarding its payments system risk reduction program and its policy statements regarding private deliveryagain&t-payment systems and rollovers and continuing contracts, published elsewhere in today’s Federal Register. EFFECTIVE DATE: June 15,1989. su m m a ry : FOR FURTHER INFORMATION CONTACT: Edward C. Ettin, Deputy Director, Division of Research and Statistics (202/ 452-3368] or Jeffrey C. Marquardt. Senior Economist Division of International Finance (202-452-3697); for the hearing impaired only: Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202-452-3544). SUPPLEMENTARY INFORMATION: The Board of Governors of the Federal Reserve System has issued the following policy statement concerning offshore netting and clearing arrangements. This policy statement is being issued in Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices conjunction with the Board's requests for comments on proposals regarding its payments system risk reduction program and its policy statements regarding private delivery-against-payment systems and rollovers and continuing contracts, published elsewhere in today’s Federal Register. Interim Policy Statement on Offshore Dollar Clearing and Netting Systems 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 of 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 procedures for the management of risks and without any form of official oversight However, the Board recognizes that the development of offshore clearing and netting arrangements raises issues of concern which go beyond the immediate question of payment risks in the U.S. banking system. Banks in all countries have been experiencing strong incentives to reduce payment flows and credit exposures. As an apparent consequence, there are an increasing number of proposed or actual interbank netting arrangements which affect an offset or netting of amounts due between banks, arising not only from payment instructions but also from the settlement of foreign exchange and other financial contracts, on either a bilateral or multilateral basis. When located outside of the country of issue of the currency subject to the netting, these arrangements have the potential to alter significantly the structure of the international interbank clearing and settlement process. In response to these developments, the Group of Experts on Payments Systems from the G-10 central banks, meeting at the Bank for International Settlements (“BIS") in Basle, Switzerland, studied a variety of payment and currency netting arrangements. The BIS Payments Experts' “Report on Netting Schemes" primarily addresses the allocation of credit and liquidity risk in various netting structures and draws general conclusions as to whether these risks are increased or decreased by the different “institutional forms" of netting. The Board believes th a t in so doing, the Report of the Payments Experts provides a valuable starting point for the consideration of risk in the international payment process. In addition, the Report notes that a number of broader monetary, financial, and supervisory policy implications are associated with the further development of netting arrangements for interbank markets. Netting systems for foreign currency payments and contracts have the potential to create changes in the financial character of affected interbank markets, as well as in the cross-border relationships between national banking systems. These changes, in turn, raise questions about the extent and quality of central banks' oversight and supervision of settlements in their respective currencies, including the allocation of supervisory responsibility among various central banks and national supervisory authorities. On the basis of this preliminary work, the Governors of the G-10 central banks have determined that a further study of these broader issues be undertaken with a view toward establishing an international understanding of the monetary, financial, and supervisory issues raised by the development of offshore or cross-border netting arrangements. The Board welcomes the development of a cooperative study of netting and offshore payments issues by the G-10 central banks. The Board hopes that this work can provide the foundation for a consensus, among central banks and national supervisory authorities, on the nature and extent of supervision appropriate for netting arrangements as well as on the monetary and financial policy issues associated with netting. At the same time, however, the Board recognizes that the technological, m arket and regulatory incentives that are giving rise to the growth of these arrangements will continue to operate. The Board believes that it is important therefore, to begin to address the potential policy concerns raised by the further development of offshore netting and clearing systems for U.S. dollar payments and the risks that these systems may create. This is particularly the case in light of the significant steps that have been and are being taken by the Federal Reserve and the U.S. banking industry to address payment risk issues. These include both the Board’s ongoing payments system risk reduction program and the efforts of the New York Clearing House Association 26093 to improve CHIPS participants’ awareness of payment risks, to control the level of daylight exposures within CHIPS, and now to adopt settlement finality procedures. Offshore clearing of U.S. dollar payments, for subsequent net settlement in the United States, may create transaction and other efficiencies for participants in such offshore systems. If. however, the allocation of credit and liquidity risks associated with the netting and settlement is not clearly understood or defined, offshore dollar clearing arrangements may well obscure, or even increase, the level of systemic risk in U.S. large dollar payments systems as well as in the international dollar settlement process generally. The BIS Report notes that this shifting of risk “can be particularly troubling where the transaction cost efficiencies are enjoyed by banks located in one country, but the credit and liquidity risks associated with the settlement of payments resulting from that netting system may be experienced in the banking system of another country.” This is precisely what can happen when U.S. dollar payments are netted in systems outside of the United States and subsequently settled through CHIPS or Fedwire. Because of the potential for offshore dollar clearing systems both to shift risk to U.S. large-dollar payments systems 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. However, pending the conclusion of the study of netting by the G-10 central banks and the outcome of any further international consultations, the Board’s approach to offshore dollar clearing and netting systems will be guided by the following general principles: 1. An offshore dollar clearing or netting system, which settles directly or indirectly through CHIPS or Fedwire, should at a minimum be subject to oversight or supervision, as a system, by a relevant central bank or supervisory authority. 2. The participants should be responsible for clearly identifying the operational, liquidity, and credit risks created within the system and for 26094 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices assuring the prudent management of these risks. 3. The system should have arrangements in place which provide for the finality of settlement obligations and the practical means 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 settlement agent, in the United States, so that satisfaction of the settlement"obligations can be readily ascertained by the participants, the Federal Reserve, and other relevant central banks and supervisory authorities. Consistent with the foregoing interim principles, the Federal Reserve is prepared to work with the central bank and/or 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 with 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 m inim um structural features that the 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. By order of the Board of Governors of the Federal Reserve System, June 15,1989. William W. Wiles, Secretary o f the Board. [FR Doc. 14637 Filed 6-20-89; 8:45 amj BILLING CODE 6210-01-M [D o c k et No. R -0668] RIN 7100-A A 76 Proposals To Modify the Payments System Risk Reduction Program; Pricing, Overdraft Measurement, and Caps AGENCY: Board of Governors of the Federal Reserve System. ACTION: Request for comment. The Board is requesting comment on proposed changes to its SUMMARY: payments system risk reduction program. The proposals would provide for a fee of 25 basis points, phased in over three years, for average daily consolidated funds and book-entry Fedwire overdrafts in excess of a deductible of 10 percent of risk-based capital. To accommodate pricing and reduce the administrative burden to depository institutions, the Board is also proposing various changes to the procedures used for measuring daylight overdrafts and the current cap structure. These proposals are being issued in conjunction with the other requests for comment and policy statements regarding the payments system risk reduction program published elsewhere in today’s Federal Register. d a t e s : Comments must be submitted on or before November 17,1989. ADDRESSES: Comments, which should refer to Docket No. R-0668, may be mailed to the Board of Governors of the Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551, Attention: Mr. William W. Wiles, Secretary; or may be delivered to Room B-2223 between 8:45 a.m. and 5:00 p.m. All comments received at the above address will be included in the public file and may be inspected at Room B1122 between 8:45 a.m. and 5:15 p.m. FOR FURTHER INFORMATION CONTACT: Edward C. Ettin, Deputy Director, Division of Research and Statistics (202/ 452-3368); Bruce Summers, Associate Director (202/452-2231) or Florence Young, Assistant Director (202/4523926), Division of Federal Reserve Bank Operations^ Oliver I. Ireland, Associate General Counsel (202/452-3625) or Stephanie Martin, Attorney (202/4523198), Legal Division; for the hearing impaired only: Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: This is one of three proposals regarding payments system risk that the Board is issuing for public comment today. The others concern daylight overdrafts related to book-entry securities transfers (Docket No. R-0669) and the daylight overdraft policy for foreign banks with U.S. branches and agencies (Docket No. R-0670). The Board encourages all interested parties to comment on each of these proposals. The Board urges that, in filing comments on these proposals, commenters prepare separate letters for each proposal, identifying the appropriate docket number on each. This procedure will facilitate the Board's processing and analysis of the comments on these proposals by ensuring that each comment is quickly brought to the attention of those responsible for analyzing each specific proposal. In addition, the Board encourages entities that plan to submit identical comments, such as affiliated institutions within a holding company, to consolidate their efforts; the Board will give equal consideration to one letter signed by a number of commenters as it would to numerous identical letters submitted by those commenters. Comments are due November 17,1939, and the Board does not intend to extend the comment period beyond that date. In addition to its requests for comment, the Board is also issuing today three risk-related policy statements regarding private deliveryagainst-payment systems (Docket No. R-0665), offshore clearing and netting systems (Docket No. R-0G66), and rollovers and continuing contracts (Docket No. R-0667). Background The Board has been concerned for some time about the risks associated with large-dollar payments systems. The Federal Reserve Banks would face direct risks of loss in the event that Fedwire users are unable to cover their intraday overdrafts by the end of the business day. Moreover, on a private large-dollar network that permits its participants to transmit payment messages throughout the day with settlement of net positions at the end of the day, the inability or unwillingness of a participant to settle its net debit position would expose the banking system to systemic risk. Systemic risk occurs when institutions unable to settle on private large-dollar payments networks cause their creditors on those networks, in turn, to be unable to settle their own commitments. As a result, serious repercussions could spread to other participants in the network, to other depository institutions not participating in the private network, and to the nonfinancial economy generally. In such circumstances, the Federal Reserve would bear an indirect risk if it sought to avoid or limit this systemic risk. Finally, on both private wire systems or Fedwire, depository institutions will face risk by permitting their customers, including other depository institutions, to make transfers against uncollected or insufficient balances in anticipation of their coverage before the end of the day. In April 1985, the Board adopted a policy to reduce the risks that largedollar payments systems, including Fedwire, present to the Federal Reserve, to the depository institutions using them, to the banking system, and to other sectors of the economy (50 FR 21120, . Federal Register / Vol. 54, No. 118 / W ednesday, June 21 1989 / Notices May 22,1985). This policy, in effect established a maximum amount of intraday funds overdrafts, or intraday credit extensions, that depository institutions and other entitites. such as Edge corporations and foreign banks with U.S. branches and agencies (hereafter “depository institutions”) are permitted to incur over both Fedwire and private large-dollar payments systems. The maximum, or cap, is a multiple of a depository institution's adjusted primary capital and is based on the depository institution’s selfevaluation of its own creditworthiness, credit policies, and operational controls. The guidelines for performing the selfevaluation were established by the Board and the documentation supporting each depository institution's rating is reviewed by the institution’s primary supervisory agency examiners. In July 1967, the Board adopted a number of modifications to its daylight overdraft policy, including a two-step, 25 percent reduction in the cross-system net debit caps, thus reducing the maximum daylight overdraft permitted to an individual depository institution (52 FR 29255, August 6 , 1987). The Board's policy was designed to be binding only on depository institutions with the largest overdrafts, and, even after the reduction of caps that waseffective in 1988, the use of intraday credit by virtually all depository institutions remained generally unconstrained. Only a very small number of the depository institutions required to file a cap incur overdrafts that amount to as much as 80 percent of their caps. However, overdraft levels have remained relatively stable, and overdrafts as a percentage of the dollars transferred over Fedwire have declined. Moreover, management of individual depository institutions and the Board's Large Dollar Payments System Advisory Group have indicated that as a result of the Board's policy, senior managers of depositary institutuians have focused on intraday credit risks. Reportedly, they have taken steps to eliminate many of the payment practices that had presented risk to depository institutions, the Federal Reserve, and the banking and payments systems in general. In 1987, the Board's Payments System Policy Committee requested two studies to assist in its consideration of future payments system risk reduction policies. The Board's Large Dollar Payments System Advisory Group was specifically asked to propose policy recommendations, and a Federal Reserve System staff task force was asked to review options but to make no policy recommendations. Both reports were published by the Board in August 1988.1 To test the impact of pricing, posting rules, and cap changes, the Board used data from a survey for the two weeks ending February 10,1988. This survey provided detailed transactions data for all depository institutions. Cap multiples in force in 1989 were applied to survey cap categories. The normal data flow for monitoring daylight overdrafts is reported only for depository institutions incurring overdrafts under present daylight overdraft measurement procedures and includes only summary level information on transactions processed. During the comment period, the Reserve Banks will provide individual depository institutions with information on their own overdraft profiles under both the current and proposed posting procedures as well as information on any fees that would be assessed to that each depository institution can determine for itself how the proposals would affect its position. After reviewing the Advisory Group’s and the staff’s reports as well as the survey data, the Board developed a series of proposals to reduce the aggregate level of payments system risk further. These proposals assume private sector systemic risk will be reduced by the implementation of settlement finality on the New York Clearing House's Clearing House Interbank Payments System ("CHIPS’*) network and that other sources of systemic risk will be controlled by policy statements regarding private-sector deliveryagainst-payment systems and offshore netting and clearing arrangements (see Docket Nos. R-0685 and R-0686, elsewhere in today’s Federal Register). Against this background, the Board’s proposals seek to shift a higher proportion of risk to the private sector, reducing the share of such risk borne by Reserve Banks. Presented in this docket are proposals to establish a program for pricing the daily average value of all Fedwire overdrafts in excess of a deductible, to facilitate pricing by revising the defintion and measurement of daylight overdrafts, to exempt from caps those depository institutions with relatively small overdrafts, and to exclude from the cross-system net debit 1A Strategic Phm fo r Managing R isk in the Paym entt System : Report o f the Large Dollar Payments System A dvisory Group to die Payments System Policy Comm ittee o f the Federal Reserve System (Washington. 1988) and Controlling R isk in the Paym ents System ; Report o f the Task Force on Controlling Payments System R isk to the Payments System Policy Comm ittee o f the Federal Reserve System (Washington, U88) are available from the Secretary of the Board at the address noted above or from the Daylight Overdraft Liaison Officer of each Federal Reserve Bank. 26095 cap net debits on CHIPS after settlement finality is adopted on CHIPS. Other proposals issued for comment today would apply the existing cap structure to all overdrafts, including Fedwire book-entry overdrafts, and would require collateral for all Fedwire overdrafts for (1) any depository institution whose total Fedwire overdrafts frequently and materially exceed its Fedwire cap solely because of book-entry overdrafts and (2) any foreign bank with a U.S. agency or branch whose Fedwire overdrafts exceed its cap multiple times its U.S. capital equivalency. (See Docket Nos. R-0669 and R-0670, elsewhere in today’s Federal Register.) As indicated above, all of these proposals should be evaluated in the context of settlement finality on CHIPS and the adoption of systemic riskreducing policies on private-sector delivery-against-payment systems for securities activity, netting arrangements, and offshore dollar clearing systems. Moreover, proposed revisions in the rules on finality for automated clearing house (“ACH”) transactions processed by the Reserve Banks should also be considered (see the Board’s request for comment on ACH finality, 54 FR 8822, March 2,1989). Proposals regarding daylight overdraft pricing, posting, and caps are discussed in detail below. Pricing Fedwire Overdrafts The Board is'requesting public comment on a change in its payments system risk reduction policy that would provide for a fee of 25 basis points, phased in over three years in increments of 10,10, and 5 basis points, for average daily consolidated funds and book-entry Fedwire overdrafts in excess of a deductible of 10 percent of risk-based capital. Explicit fees or charges for Fedwire daylight credit are expected to create incentives for depository institutions to reduce Fedwire overdrafts, thereby reducing direct Federal Reserve risk and contributing to economic efficiency. The Board expects that payments system participants as a result of the market incentives established by the combination of Fedwire daylight overdraft pricing and settlement finality on CHIPS, will lower the level and more efficiently allocate the distribution of Fedwire and private sector intraday credit flows.2 * The Board believe* that settlement finality and other risk-oonsti»inmg steps on existing and evolving U.S. and offshore clearing and settlement systems will partially offset pricing-induced shifts of payments away from Fedwire and will redace overall systemic risk. See Docket Nos. R-06B5 and R-0660 elsewhere in today's Federal Register. 26096 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices Application o f Pricing to Total Fedwire Overdrafts. The Board is proposing that pricing apply to bookentry related overdrafts as well as funds overdrafts. The Board is requesting comment in a separate docket on the inclusion of book-entry securities in the total measure of overdrafts (see Docket No. R-0669). As in the case of funds overdrafts, pricing book-depository institutions to reduce these overdrafts. Moreover, failing to price book-entry overdrafts while pricing funds overdrafts would create incentives to avoid charges for funds overdrafts through manipulation of book-entry transfers. For example, depository institutions in funds overdraft could deliver book-entry securities to. another depository institution in order to receive a credit from the Federal Reserve to offset their priced funds overdrafts. If book-entry overdrafts were not priced, the receiver of the securities would incur a book-entry overdraft that is free (but, perhaps, requiring the posting of collateral with the Reserve Bank) and could charge the sender of the securities any rate below the Federal Reserve charge on funds overdrafts. The loan could be secured by the securities being transferred. Pricing of book-entry overdrafts is unlikely to disrupt the U.S. government securities market, to constrain open market operations, or to increase the cost of Treasury financing. Each 10 basis points of overdraft charge amounts to only $2.70 per million per day, and, on average, each dollar of book-entry overdrafts is associated with six or seven dollars of transfers. The increase in the cost of the average transfer of less than $10 million is thus consideably smaller than the traditional minimum market bid-ask spread for Treasury securities, which is l/64th of a percentage point or about $165 per million dollars transferred. Average Overdrafts. The Board is proposing that pricing be applied to the average level of total Fedwire overdrafts. Overdrafts would be measured at equally-spaced intervals throughout the day, and the average overdraft would be the sum of all of the overdraft measurements divided by the number of intervals.8 Average overdraft 5 Currently, overdraft values are measured at 15minute intervals for both average and peak overdrafts. Federal Reserve staff is reviewing the feasibility of measuring overdrafts at shorter intervals (e.g„ by second or minute) and whether the averaging period should be fixed (e.g., the “normal" hour* over which Fedwire is open) or the actual period Fedwire is open at each Reserve Bank. pricing more closely reflects the Federal Reserve credit actually used during the day by individual depository institutions. Average overdraft pricing is also likely to induce depository institutions to focus on managing their overdraft positions more or less continuously over the day rather than concentrating on only the time periods when overdrafts are at or close to their peak. Average overdraft pricing also permits more flexibility to the depository institution in managing overdraft levels, a particularly important advantage if book-entry related overdrafts are priced because the overdrafting depository institution will not be able to control when securities are delivered and when such overdrafts occur with the same precision as is possible with funds overdrafts. The Board considered but decided against pricing peak rather than average overdrafts. Peak pricing would levy a fee on the Reserve Banks’ maximum exposure and would also be consistent with the debit caps applied to peak overdrafts. Peak pricing, however, would be unlikely to provide incentives for depository institutions to reduce their overdraft levels once the peak has been reached, depending on the dynamics of other depository institutions’ responses to pricing. In addition, if fees were assessed only for the peak overdraft, the duration of the Reserve Banks’ exposure would not be considered. The Board believes that average overdraft pricing is, on balance, superior to peak overdraft pricing and proposes that the Reserve Banks assess daily fees for average total intraday Fedwire overdrafts. Daily and two-week average debit caps would continue to apply to peak intraday values of such overdrafts in excess of $10 million and 20 percent of capital (as discussed below). Deductible. The Board proposes that the amount of overdrafts subject to pricing be decreased by a deductible of 10 percent of risk-based capital. The deductible amount would be subtracted from the average intraday total Fedwire overdraft (funds and book-entry) each day to determine the amount of such overdrafts subject to pricing. An important purpose of the deductible would be to provide a certain amount of free Fedwire overdrafts to offset, partially or in full, those overdrafts incurred due to circumstances beyond the control of the depository institution. The deductible would provide some liquidity to the payments mechanism and would address the inevitable lack of synchronization of payments in a complex economy. The deductible would also offset, in part, the Fedwire charge for overdrafts that may be beyond the control of the depository institution because of a computer problem at a Reserve Bank. The downtime associated with such problems can artificially affect the overdraft of a depository institution as payments cannot be sent or received. Reserve Bank operating problems affect the distribution of daylight overdrafts among institutions, benefitting some and harming others. A fixed deductible, as proposed, provided each day to address unpredictable downtime would likely overcompensate on some days and undercompensate on others. Depository institutions benefitting from a deductible on some days may have to absorb any downtime effects on other days for which a charge might be levied. The Board believes that, on average, depository institutions would not be unfairly charged and that Reserve Banks could make adjustments in exceptional circumstances. The Board proposes that Reserve Banks be permitted to adjust the amount of overdrafts subject to pricing for individual depository institutions on a ad hoc basis to deal with unusual circumstances, such as extended operational difficulties. In general, however, the Reserve Banks should assume that the deductible is sufficient to offset all but very lengthy operating outages at Reserve Banks and other unusual events. The deductible would also offset some of the impact on individual depository institutions of the loss of opening-of-day non-wire net credits under the new posting rules (see discussion below). For example, a deductibe could offset the end-of-day Federal Reserve recognition of credits for checks and commerical ACH, the proceeds of which depository institutions may be required to make available to their customers at the opening of the business day according to the provisions of Regulation CC (12 CFR Part 229) or the guidelines of the National Automated Clearing House Association (“NACHA"). Regulation CC requires depository institutions to make the proceeds of certain categories of checks deposited by 2:00 p.m. available to their customers for withdrawal at the opening of business on the business day following the banking day of deposit. These “nextday availability” checks include Treasury checks, Postal money orders, checks drawn on Federal Reserve Banks and Federal Home Loan Banks, cashier’s, teller’s, and certified checks, and state and local government checks. Similarly, NACHA guidelines encourage depository institutions to make ACH Federal- Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices credit transactions available to consumers for withdrawal by opening of business on the settlement day. Under the posting proposal, discussed below, depository institutions generally would not receive credit for overdraft measurement pruposes for "next-day availability” checks or for commercial ACH credit transactions by the time that the funds should be available to their customers for withdrawal under Regulation CC and NACHA guidelines. Consequently, these depository institutions may incur an overdraft. The Board believes that these types of overdrafts would be rare, in view of the fact that most of the withdrawals of the proceeds of “next-day availability” checks and commercial ACH credits are likely to be by check or by cash withdrawal. Check withdrawals would not affect a depository institution’s intraday balance because the debits for the check presentments would be recognized after the close of Fedwire. Furthermore, cash withdrawls would not affect a depository institution's intraday reserve balance. The proposal would* cause depository institutions to incur overdraft costs for these checks and ACH credits only if the proceeds were wired out on the settlement day. For most depository institutions, these overdraft costs would be covered by the deductible. Another reason for a deductible is to exclude from pricing the large number of mainly smaller depository institutions that incur de minimis overdrafts. Among the over 5,000 depository institutions that incurred overdrafts on at least one day during the final quarter of 1988 (measured by the current posting rules), over 90 percent of total Fedwire (funds and book-entry) average overdrafts were incurred by the largest 50 overdrafters. The Board believes that the burden of imposing charges on the 4,500 to 5,000 depository institutions that present ony 1 or 2 percent of the risk exceeds the benefit of reducing this small amount of risk. Depository institutions that choose to access Fedwire through multiple accounts would be required to allocate their deductible in the same proportion as the allocation of their caps. One administering Reserve Bank would still have overall risk management responsibility, even though each Reserve Bank would administer the charges for each overdrafting account. The Board considered the impact of various deductibles (based on capital) during the test period. If there were no deductible, all 5,040 depository institutions incurring overdrafts in the test period would have been subject to pricing on their total average overdrafts. which amount to $37.3 billion. (During the same period, these depository institutions’ daily peak overdrafts amounted to $120 billion.) A deductible of 10 percent would exempt 4,821 depository institutions from pricing, and only 219 would have been subject to pricing. These 219 depository institutions would have had $34.0 billion of average overdrafts but would have paid fees on only $25.5 billion of overdrafts, the difference being overdrafts at depository institutions subject to pricing that would be exempted by the deductible. The 4,821 totally exempt depository institutions would have incurred $3.3 billion of average overdrafts. As the deductible rises, the number of depository institutions subject to pricing falls as do both the aggregate overdrafts at depository institutions subject to pricing and the amount of overdrafts actually priced. At a 20 percent deductible, for example, only 118 depository institutions would have been subject to pricing in the test period; these depository institutions would have accounted for almost 80 percent of all average overdrafts, but fees would have been assessed on only 50 percent of all average overdrafts. The pricing deductible would be independent and separate from the test for exempotion from filing for a cap (discussed below). The cap exemption deals with intraday peak..values and determines which depository institutions would be exempt from filing for a Fedwire net debit cap. The pricing deductible determines the amount of daily average intraday overdrafts subject to fees (if any) by Reserve Banks. A depository institution could be subject to a cap and operate close to its cap level for part of the day and not be subject to fees, depending on its intraday overdraft pattern. Similarly, a depository institution could conceivably be exempt from filing for a cap, but be subject to pricing because it had overdrafts for most of the day above the 10-percent-of-capital pricing deductible, even though its peak overdraft remained below the 20 percent of capital exemption-from-filing-for-cap level. The Board specifically requests comment on whether deductible schemes other than the one proposed would be appropriate. In addition, the Board requests comment on whether there are any additional actions that could be taken by Reserve Banks or depository institutions to alleviate the problems caused by overdrafts beyond the control of depository institutions. For example, would it be feasible to accelerate lthe posting time, for overdraft measurement purposes, of 26097 those "next-day availability” checks that bear unique routing numbers, such as Treasury, Federal Reserve Bank, and Federal Home Loan Bank checks and U.S. Postal Service money orders? Size o f Charge. The Board is proposing an initial Fedwire overdraft charge of 25 basis points (annual rate) to be phased-in over three years, with the effective initial date 12 to 18 months after the Board’s final adoption of a program to price Fedwire overdrafts.'* The Board intends to implement pricing three to six months after new procedures for measuring daylight overdrafts are effective (see below). In setting the level of the Federal Reserve charge for priced Fedwire overdrafts, the Board seeks a price that is high enough to induce risk-reducing changes by depository institutions and their customers. The price should not be so high, however, as to slow payments flows or drastically increase the public’s cost of making payments. According to data collected during the test period, a fee of 25 basis points for daily average Fedwire overdrafts in excess of a 10 percent of capital deductible, before any response on the part of depository institutions to reduce their overdrafts, would result in the 15 largest overdrafters paying almost 90 percent of the total charges. (Sixty percent of the fees would have been levied against the four largest bookentry securities clearing banks.) By the 100th largest overdrafter, the annual fee would be less than $3,000 and by the 150th it would be about $400. The Fedwire overdraft price will be applied only on business days; the actual annual cost to a depository institution of an explicit price is only a fraction of the annual percentage rate. The number of husiness days varies each year, but the fraction is approximately 251/365, or about 30 percent lower than an annual rate that levies' fees for all calendar days. The actual rate each day is 1/365 of the annual rate fee. The Board requests comment on the level of the proposed fee as well as on the three-step phase-in schedule. Defining Overdrafts and Application of Caps Measuring Overdrafts The Board’s daylight overdraft pricing proposal would give funds an intraday value and, therefore, would require precision in measuring intraday 4 The Federal Reserve will retain its current penalty for overnight overdrafts of 10 percent or the federal funds rate plus 2 percentage points, whichever is higher. 26098 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / N otices overdrafts. Such precision requires fixing the time at which all payment transactions by Reserve Banks are recognized to have occurred for daylight overdraft measurement purposes. The Board proposes that, for purposes of measuring daylight overdrafts, a depository institution's opening balance at the Reserve Bank be adjusted by (1) credits for U.S. Treasury and government agency book-entry securities interest payments; (2) credits for U.S. Treasury and government agency book-entry securities redemption proceeds; (3) credits for U.S. Treasury ACH recurring credit transactions; and (4) debits for new issues of U.S. Treasury book-entry securities. During the day, this adjusted opening balance would be adjusted for Fedwire funds and book-entry securities transactions as they occur. At 23)0 pan. local time of the Reserve Bank, Treasury direct and special direct investment credits would be reflected. After the close of Fedwire, all non-wire and commercial ACH transactions would be included, regardless of whether the net of those transactions were a credit or A debit.* This overdraft measurement proposal would apply equally to all depository institutions with Reserve Bank accounts, including U.S. chartered banks, foreign banks with U.S. agencies and branches, thrifts, bankers' banks, limited purpose trust companies, nonbank banks,• and any other such entities. The precise measurement of daylight overdrafts requires a set of rules to determine when during the day debits and credits to a depository institution’s account at a Reserve Bank are determined to have occurred "Posting" for the purpose of measuring daylight overdrafts is not necessarily synonymous with the time at which payments become final or the time at which the current rights to receive funds accrue, although finality of payment is one of the criteria the Board used to develop the daylight overdraft measurement rules. The actual timing of entering transactions on the Reserve Banks’ books varies depending on operational procedures. Fedwire 5 Generally, credit for, and repayment of, discount window loans for healthy depository institution* would be included among the non-wire transactions posted for daylight overdraft measurement purposes ai the end of the day. This treatment would assure that the discount window loans were not used to fund daylight overdrafters and would make the discount rate a price for a 24-hour credit and, hence, more relevant for monetary policy purposes ill conjunction with a 24-hour federal funds rate. ‘ The posting changes would not affect the overdraft restrictions forno&bank banks established by the Competitive Equality Banking Act of 1987. transactions, whether funds or bookentry transfers, are debited or credited as they are processed and are considered to be final payments when the receiver of funds is advised by the Reserve Bank of the credit Rules governing non-wire payments transafers, however, generally are provisional for some period of time and refer to a particular “day” as the measuring unit of availability, without indicating the time during the day at which payment participants are either entitled to the use of the funds received or have been relieved of their payments obligation to the Federal Reserve. Even if the Federal Reserve were not contemplating pricing Fedwire overdrafts, it would be desirable to clarify the time at which the debtorcreditor relationship between a depository institution and its Reserve Bank changes as the result of the recognition of a payment. Independent of overdraft pricing or cap policies in the United States, technology and the globalization of financial instruments and transactions are increasingly causing money, securities, and capital markets to operate on a 24-hour basis. In such an environment, trading in dollar instruments and dollar payments in one part of the world occurs while US. markets and Reserve Banks are closed and vice versa. In a 24-hour global m arket depository institutions in the United States and abroad need to know more precisely the time of day that dollar payments are recognized to have occurred by the Federal Reserve. Even if such global developmetns were not in progress, a clarificaiton would permit depository institutions to ascertain their intraday rights and responsibilities visa-vis Reserve Banks and to evaluate their risks accordingly. Under the current deiiiution of daylight overdrafts, all non-ACH, nonwire transactions are netted at the end of the banking day; if the net is a crew dit and if that net is a d ebit the debit is deducted from the end-of-day position. The net of ail ACH transactions is posted as if the transactions occurred at the opening of business, regardless of whether the net is a debit or a credit. This ex post measure thus allows a depository institution to use all of its non-wire net credits to offset any wire debits during the day, but postpones the need to cover non-wire, non-ACH net debits until the close of the day. The current transitional, system of posting debits and credits for daylight overdraft measurement purposes gives the benefit of the doubt to depository institutions. Two drawbacks of this system are that it creates intraday float in the measurement of daylight overdrafts in that depository institutions with net credits can use them before those with net debits are charged and many depository institutions are unable to monitor their overdraft levels effectively during the banking day. Because the Board’s payments system risk reduction program is reaching maturity, the Board believes that the initial transaction posting procedures must be modified now. In developing a proposal to establish the time at which non-wire transactions would be recognized for daylight overdraft measurement purposes (herein after referred to as "posting changes ’), the Board w as guided by a desire to eliminate intraday float and to keep the posting rules simple and easy to use. The Board believes that measurement procedures shoud not provide intraday float to payments system participants. Thus, the processing of a payment transaction should not result in a reduction of one depository institution’s measured overdraft (or an increase in its credit balance) before another depository institution’s overdraft is increased (or its credit balance reduced). The principle of eliminating aggregate Federal Reserve intraday float is independent of the credit risk arising from the transactions. For example, there may be only minimal Federal Reserve risk resulting from granting early-in-the-day credit for checks collected through the Federal Reserve, even though the Reserve Banks do not charge paying institutions until late on the presentment day. However, by providing early-in-the-day credit to the collecting institution without an offsetting debit to the paying institution, the Federal Reserve would b e permitting the collecting institution to use Federal Reserve credit without regard to that depository institution’s cap, deductible, or any Reserve Bank fee. Furthermore, if explicit fees for overdrafts are adopted, and if the timing of debits and credits for each transaction were not nearly simultaneous at Reserve Banks, depository institutions would have an incentive to create float by writing each other checks to create free overdraft capacity. As intraday credit begins to have value, eiiher through pricing or the evolution to 24-hour global markets, intraday Federal Reserve float becomes a taxpayer subsidy. Similar concerns were one reason that the Congress mandated, in Section 11A of the Federal Reserve Act, that Federal Reserve Banks should charge for float Federal Register / Vol. 54, No. 118 /' W ednesday, June 21, 1989 / Notices In addition, the new daylight overdraft measure should be simple to understand and to use in controlling intraday overdrafts. If depository institutions are to be charged a fee for incurring a Fedwire overdraft, the procedures for measuring overdrafts should facilitate their ability to control their positions and determine their intraday balances accurately. Measures that would include transactions retroactively after the transaction day is complete do not meet this test.7 Treasury transactions. The proposed opening-of-day credits and debits for certain U.S. Treasury transactions reflect Treasury obligations and tha mechanics of the book-entry system. Interest and redemption payments on the debt are due at the opening of business on the payment date. Similarly, institutions purchasing Treasury securities receive title to the securities at the opening of business on the settlement date and should pay for the securities upon receipt Treasury Department regulations for recurring ACH payments require depository institutions to make federal government direct deposit ACH payments available to consumers at the opening of business on the payment date, and the Board has provided for such credits to depository institutions in the proposal. Reserve Banks would modify their accounting systems to separate Treasury and commercial ACH credit transactions. Because the Treasury’s account will be debited for ACH credit transactions at the same time that depository institutions will be credited for those transactions, this posting rule will not create intraday float. Treasury ACH payments can be distinguished from certain next-day availability checks, discussed'above, which are also required by regulation to be made available for withdrawal by the opening of business. Unlike the Treasury ACH payments, posting the next-day availability check credits at the opening of the day would create intraday float because the checks will not have been presented to the paying institutions the opening of the day. Under the Treasury’s direct and special direct investment programs, excess balances are placed with designated depositories that pay interest on the deposits to the Treasury from the day of receipt until the day of withdrawal. Because depository institutions must pay interest from the 1 The Large Dollar Payment* System Advisory Group noted that the inability of depository institution* to control their overdraft position accurately would be inconsistent with a program of either binding caps or overdraft pricing. transfer date, they should receive credit for the transafer early enough to be able to invest the funds that day without incurring an overdraft. Some depositories are advised of direct investments the day before the deposits are received, and others are advised on the day of deposit. While it might be feasible to grant credit for deposits known in advance at the opening of business, it is generally not possible to grant credit for same-day deposits until 2:00 p.m. local time. Because one posting time would be less complex and should not disadvantage depository institutions, the Board believes the credits for Treasury direct and special direct investments should be posted at 2:00 p.m. local time of the Reserve Bank. The repayment of these investments is effected by Treasury calls, and the Board proposes that debits for calls be posted after the close of Fedwire on the day of the Treasury call. To ensure that no intraday float is created, the Treasury’s account would be debited or credited for book-entry, ACH, and direct investment transactions at the same time that depository institutions receive the corresponding debit and credit entries in their accounts. Other Non-wire Transactions. For purposes of measuring daylight overdrafts, the Board proposes that all other non-wire and commercial ACH transactions be posted simultaneously, which eliminates the creation of intraday float, after the close of Fedwire. In addition to eliminating float posting non-wire transactions at the end of the day would assure that the depository institutions on either side of a transaction would have complete information as to the amount and account to be debited or credited and that depository institutions would not incur daylight overdrafts subject to charges and caps that are due to debits that are only provisional and may not be binding if the institution fails. The Board considered and rejected various other arguments for posting nonwire debits and credits earlier in the day. For example, although commercial ACH credit transactions are generally known in advance of settlement day and both the debit and credit for these transfers could be posted at the opening of business, the Board did not propose such a rule, in part because the openingof-day debit might disadvantage originators that no longer obtain opening-of-day net credit for other nonACH, non-wire transfers. Moreover, consumers typically withdraw cash or write checks on the proceeds of commercial ACH credit payments on settlement day, which, unlike funds 260S9 tran sfers, w ould n ot affect a d epository in stitu tio n 's in tra d ay reserv e b alan ce. Thus, crediting receiving depository institu tio ns at the close of Fedw ire should n ot create significant costs. Posting check transactions to the collecting and paying depositor}' institutions' accounts after the close of Fedwire on the availability date is consistent with the elimination of intraday float and providing banks with information to enable them to manage their accounts. Although Reserve Banks present most checks to paying depository institutions in the morning, they present some checks as late as 2.-00 p.m. for same-day paym ent If an earlier posting time were established, paying depository institutions in the western time zones (Alaska, Hawaii, and the West Coast) might be debited before checks were presented to them and, therefore, before they were aware of the amount of the debit. Further, to avoid intraday float, if check debits and credits were to be recorded earlier than after the close of Fedwire, the time established must be a standard time nationwide. If the timing of the credits and debits were based on the local time of the Reserve Bank holding the depository institution’s account float would be created due to time zone differences. In addition, it is not operationally feasible to credit some checks, i.e., those that have been presented to paying depository institutions, earlier than other checks that are presented later in the day. In addition, the Board believes it is important to establish a time at which a paying depository institution becomes obligated for a debit. Regulation ] (12 CFR Part 210) requires a depository institution to pay for checks presented by a Reserve Bank by the close of the banking day on which the checks are presented. Debiting the paying depository institution for checks presented at an earlier time during the day might require a depository institution to pay for checks before they have been presented and before the depository institution has had an opportunity to verify the charge. Moreover, private sector collecting depository institutions are often not able to obtain same-day payment for checks presented to paying depository institutions without payment of a presentment fee; in some cases they are unable to do so even if presentment fees are offered. For these reasons, the Board does not believe that debiting institutions for checks presented earlier than the close of business would be an 26100 Federal Register / Vol. 54, No. 118 / W ednesday, June 21. 1989 / Notices equitable solution for either paying or collecting depository institutions.8 The new posting rules are intended to facilitate pricing of Fedwire overdrafts by allowing depository institutions to determine with certainty their account . balance at the Reserve Bank at any time during the day.. The Board does not anticipate that these posting rules will significantly increase the pricing burden on depositor institutions, particularly given the deductible equal to 10 percent of risk-based capital, which will provide some compensation for overdrafts directly caused by the new positing rules. The Board recognizes that it is common practice for depository institutions to extend credit to creditworthy corporate customers by permitting them to use non-wire credits, such as check credits, on the availablility/settlement date to cover funds transfers during the day. In such cases, depository institutions have determined that their customers are sufficiently creditworthy to recover any funds should the non-wire transactions be returned or not paid. Under the proposal, most depository institutions will have the option to continue their current practices of providing credit to customers in anticipation of later cover or collection of final funds. A small number of depository institutions, however, may incur a cost in the form of a Federal Reserve fee on average overdrafts above a deductible amount for using intraday Federal Reserve credit to finance the transactions. As discussed above, given the 10 percent pricing deductible proposed by the Board, the incidence of that higher cost is likely to extend to very few depository institutions. In view of the lack of finality of most non-wire payments and the goals to ■ In April 1988, the Board published for comment a same-day payment concept, which would enable private sector collecting depository institutions to receive payment for checks presented to paying depository institutions prior to 2:00 p.m. in same-day funds, without the imposition of presentment fees. Adoption of the concept would provide private collecting depository institutions with the same presentment abilities Reserve Banks currently have (53 FR 11911. April 11.1988). Board staff is currently analyzing the comments received and reviewing alternatives suggested by several commenters. If a viable alternative is developed and proposed for public comment it could incorporate payment options, chosen at the discretion of the paying depository institution, that would provide for payment to the collecting bank after the close of Fedwire on the day of presentment Thus, paying depository institutions would not be obligated to pay for checks presented by private collecting depository institutions earlier in the day than they would be debited for checks presented by Reserve Banks. The Board could also propose a similar change to Regulation CC regarding the timing of payment by a depositary bank for returned checks. eliminate Federal Reserve float and to provide depository institutions with an accurate measurement of their overdraft position throughout the day, the Board requests comment on whether it would be desirable to post certain non-wire transactions, such as commercial ACH, local clearinghouse, or other transactions earlier in the day. Application o f Cap The Board is proposing that the current cap system continue, with certain modifications that would exempt small depository institutions from the requirement to file for a cap and make the de minimis cap more useful for some larger institutions. In addition, the Board proposes that CHIPS net debits be excluded from the cross-system debit cap once settlement finality is implemented on CHIPS. These changes are intended to facilitate compliance with the Board's overall risk policy. In a related proposal issued for comment today (see Docket No. R-0669 elsewhere in today's Federal Register) the Board has proposed that book-entry overdrafts be included within the current debit caps. While the Board believes that pricing should reduce Fedwire overdrafts significantly, until more experience is gained, it would be premature to remove caps or the selfevaluation process for depository institutions. Exemption o f small overdrafters. The Board proposes that depository institutions that only very rarely incur daily total peak Fedwire (funds and book-entry) overdrafts in excess of the lesser of $10 million or 20 percent of their risk-based capital be excused from performing self-evaluations or filing board-of-director’s resolutions with their Reserve Banks. This exemption would, however, be granted at the discretion of each Reserve Bank. Reserve Banks would be expected to take the necessary steps (e.g., coordination and consultation with supervisory personnel within the Reserve Bank and at other agencies) to limit their risk exposures to those depository institutions under financial duress or in any other way presenting unusual risk to the Reserve Banks. This risk-exposure control could include real-time monitoring and imposition of lower caps or zero caps. Depository institutions, of course, would continue to be free to file for a cap if they chose to do so and would be required to do so if they began to exceed the exemption limits. Currendy, a depository institution that incurs Fedwire funds overdrafts infrequendy is only required to file an annual board-of-directors resolution with the Reserve Bank authorizing the depository institution to incur occasional Fedwire overdrafts up to $500,000 or 20 percent of capital, whichever is less (the de minimis cap). All other depository institutions wishing to incur Fedwire overdrafts must conduct an annual self-evaluation, based on Federal Reserve criteria, obtain their board's resolution of approval, and maintain supporting files for examiner review. These procedures have focused director and senior management attention on the risks of daylight credit exposure and the need to adopt prudential internal control procedures and policies. A number of observers within and outside the Federal Reserve System, however, have questioned the need to apply the policy to all overdrafters. The Board does not believe it would be prudent to excuse depository institutions with a small absolute level of overdrafts from the limits of the overdraft policy if the overdrafts are large relative to the depository institution’s capital. Similarly, from a Federal Reserve risk perspective, large overdrafts should not be excluded from the policy just because such overdrafts are a small portion of the depository institution’s capital. Both the prudential and Reserve Bank risk concerns could be addressed by a dual test that considered both the size of the overdraft and its relationship to the capital position of the depository institution incurring the overdraft. Of the 5,040 depository institutions that would have incurred an overdraft under the proposed posting procedure in the February 1988 test period, about 4,600 had overdrafts that were both less than $10 million and 20 percent of the depository institution’s capital. These overdrafts were neither large relative to the depository institution’s capital nor to the risk exposure of Reserve Banks. These 4,600 depository institutions accounted for only $1.7 billion of Fedwire overdrafts, less than 1.5 percent of the total.9 This exemption greatly reduces the administrative burden of the Board's payments system risk reduction policy, with only marginal increases in potential direct Federal Reserve risk. * Indicative of the large number of very small overdrafters, the number of depository institutions does not change significantly as the $10 million overdraft threshold is increased to $25 million (4,835), or decreased to $5 million (4,544). Similarly, changing the capital ratio has modest impact at the same dollar level: at a $10 million overdraft level, a 10 percent overdraft-to-capital ratio would exempt 4.383 depository institutions and a 50 percent ratio would exempt 4.708 depository institutions. Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices De Minimis Cap. Under the current de minimis cap, a depository institution may incur overdrafts up to the lesser of ?0 percent of adjusted primary capital (or "U.S. capital equivalency” for foreign banks’ overdrafts on Fedwire) or $500,000, so long as the institution does not incur daylight overdrafts on a regular basis. The depository institution must file a board-of-directors’ resolution with its Reserve Bank approving its use of a de minimis cap but need not engage in a full self-evaluation process. The Board is proposing a new de minimis cap category with no frequency or dollar-limit tests, but still requiring a board-of-directors’ resolution to obtain the 20 percent of capital cap. A small number of depository institutions would benefit if the existing de minimis cap were modified to remove the $500,000 limit and the frequency test, retaining only the 20 percent of capital constraint This modified cap category would differ from the exempt category in two ways: (1) While retaining a 20 percent of capital constraint, it would have no $10 million limit and, hence, would be of value only to larger depository institutions; and (2) it would, like the present de minimis cap, require board-of-director filing, but not a self-evaluation. The modified de minimis cap would be a useful transition grouping for larger depository institutions between the proposed exempt-from-cap-filing category and the lowest cap requiring self-evaluation and board-of-directors’ resolutions. Exclusion o f CHIPS Net Debits. Provided that settlement finality is implemented on CHIPS, the Board proposes that the cross-system sender net debit cap be eliminated, with the current cap multiples applied only to total Fedwire overdrafts. Under current procedures, Fedwire caps are reduced by any net debit on CHIPS. When these procedures were adopted, they were intended to control not only the use of Federal Reserve intraday credit, but also to serve as a check on systemic risk. With reasonable means of assuring settlement finality, the system risk associated with the potential failure of a CHIPS participant to settle should be reduced significantly. Each participant would have an increased incentive to be cautious in setting bilateral net credit limits for other participants. Moreover, shifts of Fedwire payments to CHIPS to avoid Fedwire overdraft fees would be likely to result in expanded exchanges of payments among the few largest CHIPs participants. If this assumption is correct net debit positions subject to cross-system caps should not change significantly as participants both receive and send more on CHIPS. Finally, elimination of the cross-system cap would be consistent with the policy statement on private book-entry systems that the Board issued today (see Docket No. R-0665, elsewhere in today’s Federal Register), which does not impose the cross-system cap on those systems that adhere to the policy statement on risk control and settlement finality. CHIPS serves almost 140 participating banks. Twenty-two of these participants are settling banks, i.e., at the end of the day, they settle the day’s transactions on a net basis both for their own account and as correspondents for non settling participants. Settlement is effected at the end of the day when Fedwire payments by those settling depository institutions in debit position are made to a settlement account at the New York Reserve Bank, followed by Fedwire transfers from the settlement account to all settling depository institutions in net credit position. The payments volume on CHIPS, more than three-quarters of which is associated with foreign exchange and Eurodollar transfers, is somewhat larger than Fedwire funds transfers (about $700 versus about $660 billion per day in the fourth quarter of 1988). However, the average aggregate peak intraday net debit position on CHIPS is smaller than Fedwire funds daylight overdrafts (about $45 billion per day versus $60 to $65 billion per day). Although less than Fedwire, the net daylight credit exposure on CHIPS still represents a potential major systemic risk should a CHIPS participant be unable to setde its net debit position. To reduce the systemic risk on CHIPS, the Board in recent years has encouraged the NYCH to adopt riskreducing measures. Thus, in 1984, the NYCH implemented a system of network bilateral credit limits, and in 1985 established CHIPS-specific sender net debit caps. The former requires each participant to make an assessment of the creditworthiness of its counterparty, and the latter establishes a limit on the total exposure any one bank can create on CHIPS. Despite these steps, if a participant is unable to settle its debit position at the end of the day, the CHIPS rules provide that payments to and from that participant be “backed out” of the settlement and new net positions calculated for the remaining participants; the calculation of the new net positions could continue until settlement is achieved. Despite this potential for revised setdem ent participants permit most of their 26101 customers to use credits for CHIPS payments during settlement day, while reserving the right to charge back such credits if the transferring bank does not settle its CHIPS position. Simulations of the impact of a CHIPS participant’s inability to settle suggest that such failures to settle could drastically change the net position of other participants, inducing a series of failures to settle by them. Thus, the current CHIPS rules and the practices of participants could lead to the systemic failure of depository institutions and/or pressure on the Federal Reserve to provide liquidity assistance while losses and solvency problems are determined. The Federal Reserve has encouraged the NYCH to adopt settlement finality for CHIPS. Settlement finality would assure that CHIPS payments will be settled each day, even if one large, or several smaller, participants are unable to setde. Thus, liquidity pressures will be dealt with immediately, while allocation of losses can be resolved at a later time. In response to these concerns, the NYCH has developed a plan to implement settlement finality in late 1990 or early 1991 based on the netting of payments and a.formula for sharing the risk of the remaining uncovered net debits. Settlement finality on CHIPS does not eliminate private direct credit risk. Under the NYCH plan, specified CHIPS participants must cover the net debit of the failed participant, but that share is of a size unlikely to cause the failure of any one of them. Although the NYCH plan would provide for settlement finality on the day of a participant’s failure to settle, there is some uncertainty as to whether the calculated multilateral net positions are legally binding obligations. The FederaL Reserve is encouraging the NYCH to explore means of assuring that certainty, but even with uncertainty, the proposed CHIPS setdement finality will produce a substantial reduction of systemic risk. In addition, because of the added settlement obligation aspects of the NYCH plan for settlement finality on CHIPS, CHIPS bilateral credit limits may be reduced and some small participants can be expected to withdraw from CHIPS. The number of transactions and the dollar volume of payments on CHIPS is likely to decline only moderately after settlement finality, as long as those depository institutions leaving CHIPS can find correspondents willing to conduct business for them. In fact, volume could increase with shifts from Fedwire if Fedwire overdrafts are priced 26102 Federal Register / Vol. 54. No. 118 / W ednesday, June 21. 1989 / Notices The exclusion of CHIPS net debits from caps would benefit the 35 CHIPS participants that have large net debits on that system. Elimination of the crosssystem cap would increase their ability to conduct Fedwire activity within their cap. The CHIPS activity of the remaining 105 participants does not generally result in a high cross-system cap utilization rate, and thus elimination of the cross-system cap would not affect these institutions. The approximately 50 foreign banks that incur net debits on CHIPS would be virtually unaffected by the elimination of cross-system caps. Currently, foreign banks are allowed to incur Fedwire overdrafts up to the amount o f their Fedwire cap (based on U.S. capital equivalency), regardless of CHIPS debits. Foreign banks cross-system debit caps are based on world-wide capital, and they are permitted to incur Fedwire overdrafts above their Fedwire caps (up to their cross-system caps) by posting collateral for the amount of such overdrafts in excess of their Fedwire caps. Under the proposed revisions to the foreign bank overdraft policy, however, foreign banks exceeding their Fedwire cap woudihave to collateralize the entire amount of their Fedwire overdraft not just the amount over their Fedwire cap. Under the proposal, foreign banks could have Fedwire overdrafts up to the amount of their cap multiplied by their world-wide capital if all of those overdrafts were collateralized. (See Docket No. R-0670, elsewhere in today's Federal Register.) Capital The Board proposes, for the purpose of determining caps, that all domestic depository institutions'use the samedefinition- o f "capital” that bank supervisors will require U.S. commercial banks to use for meeting their risk-based capital requirements. Depository institutions that choose to access Fedwire through multiple accounts would continue to be required to allocate their capital for debit cap purposes to each Reserve Bank at which they incur overdrafts; one administering Reserve Bank would still have overall risk-management responsibilities. If CHIPS overdrafts are excluded from caps, foreign banks would be relieved of reportiing worldwide capital for the purpose of computing their cross-system debit cap. Under the proposal, the only foreign bank overdrafts subject to cap would be Fedwire overdrafts based on U.S. capital equivalency. £ however, the foreign bank overdraft policy is changedas discussed above, foreign banks would b e required to report their wordwide capital if they wished to incur collateralized Fedwire overdrafts, which would be limited to their cap multiplied by their world-wide capital. In that case, those foreign banks whose home countries participated in the Basle Accord might, in the name of reduced burden, be given the option of reporting either their lower (but easier to report) world-wide equity capital for cap purposes or their capital in accordance with the Basle Accord as applied by home country supervisors. The "capital” concept that has been used in the payments system risk reduction policy to determine the maximum permissible overdrafts (the cap multiple times capital) is primary capital less certain intangible assets. This "adjusted” primary capital concept for commercial banks is refined for other types of depository institutions to be consistent with the bank concept given any special institutional characteristics of these depository institutions.10 In the past year, the U.S. bank supervisory agencies have adopted new risk-based capital requirements consistent with the Basle Accord. (See 54 FR 4188, January 27,1989.) The new requirements will be phased in from 1990 through 1992. For consistency, it would be desirable if the capital base used for the Board’s daylight overdraft policy were the same as that used for certain other supervisory purposes, such as the computation of risk-based capital. The new international risk-based capital standard divides capital into two tiers. Tier I is composed of “pure equity’" less goodwill.1* Tier I alone would be 10 "Primary" capital for commercial banka is common stock, perpetual preferred stock, surplus, undivided profits, contingency and other-capital reserves, cumulative foreign currency transaction adjustments, qualifying mandatory convertible instruments, allowance for possible loans and lease loses (exclusive of any allocated transfer risk reserves), and minority interest in equity accounts of consolidated subsidiaries. Intangible assets are subtracted from.this total to obtain "adjusted” primary capital. (Equity capital of Edge corporation subsidiaries is also subtracted from the parent's capital if the parent permits the subsidiary to incur its own overdrafts). For savings and loan associations and federal savings banks, “primary" capital is composed of perpetual preferred stock, permanent reserves or guaranty stock, contributed capital, qualifying mutual capital certificates, net worth certificates, income capital certificates, retained earnings, and all general valuation allowances. From this total are deducted deferred net lasses on loans and other assets sold; goodwill, and other-intangible assets to obtain "adjusted" primary capital. Mutual savings banks’ capital measures are similar. 11 Common-Stock, surplus, undivided profits, capital reserves, cumulative foreign currency translation-adjustments, and the minority Interest in consolidated subsidiaries. While goodwill is deducted, in general, mortgage servicing rights and. other identifiable intangible assets are no t smaller than adjusted primary capital for all depository institutions. Tier II (which cannot exceed Tier I) is composed of certain forms of hybrid capital, preferred stock, subordinated debt (up to 50 percent of Tier I capital), and loan loss reserves (up to 1.25 percent of risk-weighted assets).12 For most banks, the sum of the two tiers exceeds their adjusted primary capital, as the inclusion of subordinated debt and hybrid capital in Tier II exceeds the reduction due to the limited inclusion of loan reserves now fully included in primary capital. The ratio of estimated risk-based capital to adjusted primary capital at the 286 U.S. chartered banks that, in the February 1988 test period, had overdrafts of sufficient size to require filing for a cap suggests, on average, that risk-based capital for U.S. banks incurring overdrafts subject to cap would be about 15 to 25 percent higher than adjusted primary capital, increasing maximum permissible overdrafts by that am ount The Administration's proposal to address the thrift problem and to modify the regulatory structure of the thrift industry would apply bank capital standards to thrift institutions, other than credit unions, by 1991. In the test period, only 13 thrifts (excluding credit unions) incurred overdrafts above the exemption leveL As might be expected, some of these entities would face larger increases in capital requirements than banks. About half of them, however, would have no increase in capital for overdraft purposes because most of the regulatory accounting adjustments are already eliminated from adjusted primary capital for thrifts.13 In the aggregate, the 60 thrifts (including credit unions) with Fedwire overdrafts in excess of the exemption level incurred only about $300 million of overdrafts in the February 1988 test period, about 0.2 percent o f total Fedwire overdrafts. ** More specifically, hybrid capital is the sum of net equity contract notes and equity commitment notes: preferred stock must be noncumulative perpetual preferred, subordinated debt is the sum-of limited life preferred and subordinated notes and debentures, and loan loss reserves must-be general provisions and not for specific assets. 1 Deferred net lasses on loans and assets sold 3 and goodwill are deducted from both current and proposed capital; risk-based capital would generally permit the inclusion of mortgage servicing rights and other intangibles (existing goodwill is grandfathered through 1892. and then excluded), while all forms of intangibles are now excluded from adjusted primary capital; net worth and income capital certificates are included in adjusted primary capital but woulcf be excluded from the new capital standard; FSUC and FDIC notes could serve to raise capital under both standards. Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices Impact o f Proposal on Cap Utilization According to the data collected during the February 1988 survey, under the current posting procedure, excluding book-entry overdrafts and with no exemptions or exclusions, 3,414 depository institutions with $92.7 billion of intraday peak overdrafts subject to cap would be covered by the current daylight overdraft policy. If book-entry overdrafts were added to the amount subject to cap assuming the current overdraft measurement methodology and no exemptions of small overdrafters or exclusions of CHIPS net debits, the number of overdrafters would have risen by only 100 or so depository institutions, but the amount of overdrafts subject to cap could have increased by over $40 billion to $133.8 billion. The proposed modification of posting procedures would have raised the total number of depository institutions with overdrafts by almost 1,600 depository institutions to 5,097,14 and would have raised the aggregate level of overdrafts an additional $17 billion to $150.8 billion. This latter increase in overdrafts and overdrafters reflects the shift of non-wire net credits from opening-of-day to close-of-day posting for about 2,700 depository institutions that had such credits in the test period. It is this shift in posting that accounts for the large increase in the number of overdrafters. However, the inclusion of book-entry overdrafts accounts for two-thirds of the dollar increase in overdrafts. If CHIPS net debits were removed from overdraft calculations and then smaller overdrafters were excused from filing for the Fedwire cap, the number of depository institutions that would have had to file for either a de minimis or other cap in the test period would fall to less than 450. However, the total Fedwire overdrafts at depository institutions subject to caps would have fallen only from $120.2 billion to $118.4 billion. Thus, with the small overdrafter exemption and the CHIPS exclusion, most depository institutions would not be directly affected by the change in the posting rules, and the amount of Fedwire overdrafts subject to the policy would be reduced by only a small amount One hundred forty-three depository institutions would have exceeded their 1* During the test period, about 2,100 depository institutions incurred overdrafts under the posting proposal that would not have done so under the current policy, but over 400 would have ceased overdrafting under the proposal because their current opening-of-day ACH debits and/or late afternoon non-wire net debits would not be posted until after the close of Fedwire. cap during the test period under the proposed rules. Most of the overdrafts above cap are at a small number of depository institutions that exceed their caps because of book-entry overdrafts. In fact the four major book-entry clearers accounted for virtually all of the overdrafts in excess of cap. As discussed in Docket No. R-0669, the Board is proposing that such depository institutions be permitted to exceed their cap, provided they post collateral. Thus, the cap per se is not a constraint for these depository institutions. Most of the remaining overdrafts at depository institutions that would have exceeded their cap in the test period where at six large banks that would have exceeded their caps due to the proposed posting change. About onehalf of the overdrafts at these six banks, and an even larger amount at other depository institutions (including some of the major book-entry clearers) was related to the settlement for maturing commercial paper.1* The Depository Trust Company ("DTC") is expanding its existing same-day settlement system to include book-entry processing for commercial paper. Both the proposed posting procedures and pricing for overdrafts should accelerate this effort The DTC book-entry system will virtually eliminate Fedwire overdrafts associated with commercial paper issuance, transfers, and redemption, removing a substantial part of the overdrafts above cap associated with the posting proposal. During the test period, a significant part of the remaining overdrafts above cap, as well as those at a small number of other depository institutions with high cap utilization rates, were at correspondent banks that had only modest overdrafts under the current posting procedure. These depository institutions now benefit from openingof-day posting of net credits for checks they collect on their own behalf and for respondents through the Federal Reserve and/or through local clearinghouses that settle on the books of the Reserve Banks. These credits would be recognized at the end of the day under the proposal. *• Maturing commercial paper is presented to paying agent depository institutions by custodian or collecting depository institutions. New York Clearing House members settle such paper, n e t as part of the New York Clearing House net settlement on the books of the Federal Reserve Bank of New York. Those.depository institutions in a net credit position on the net settlement now receive that credit at the opening of the day. Under the proposal this credit would be received after the close of business. In addition, issuing agent depository institutions often provide the issuers with proceeds of new issues before investors have transferred funds to the issuing agent depository institution. 26103 Eighty-seven depository institutions incurred a modest level of overdrafts that exceeded their proposed 20percent-of-capital de minimis caps because of the new posting rules. Some of these depository institutions could file for non-cfe minimis caps and operate with the new posting procedures. Bankers’ banks cannot avoid the impact of the posting proposal by filing for a cap. Bankers’ banks are exempt from reserve requirements and, hence, do not have access to the discount window. Depository institutions without such access may not incur Fedwire overdrafts because they may, in some circumstances, have no other way to cover a daylight overdraft at the end of the day. Some bankers’ banks may choose to become member banks in order to gain access to the discount window and thus avoid a restriction on the size of deposit a member bank may place with the bankers’ bank.1* However, Congress intended that discount window access be available only to a depository institution that is subject to reserves.17 A bankers’ bank eligible to become a member may have access to the discount window upon approval provided it agrees to maintain reserves. Nine bankers’ banks have done so. Because the Board has ruled that credit unions may not become member banks, this access to the discounty window is not available to corporate credit unions.1* Thus, bankers’ banks organized as credit unions may not incur daylight overdrafts on Fedwire so long aa they qualify as bankers’ banks. They would have access, and would be subject to reserve requirements, if they fail to qualify as bankers' banks. For example, it may be possible for credit unions organized as bankers' banks to amend their charter so as to become depository institutions eligible for Federal Reseve credit. The Board requests comment on the effect of the risk proposals on bankers’ banks and possible solutions to any problems. During the test period, 43 bankers' banks, virtually all of which were corporate credit unions, incurred overdrafts under the proposal, mainly as the result of the loss of opening-of-day net credits for non-wire transactions. '• Section 19(e) of the Federal Reserve Act provides that nomember bank shall keep on deposit with any depository institution without access to the discount window under section 10(b) of that Act a sum in excess of 10 percent of the member bank's capital and surplus. 17 Colloguy of Congressmen S t Germain and Wirth, 128 Cong. Rec. H2291 (March 27.1980). *• See letter from Secretary of the Board to Federal Reserve Bank of Minneapolis, S-540, August 6,1942. 26104 Federal Register / Vol. 54, No. 118. / W ednesday, June 21, 1989 / Notices While none incurred an overdraft as high as $50 million, the total overdrafts of such depository institutions were $200 million. Only three of the depository institutions could have met the exemption proposal if they were eligible: for i t Relative to capital, their overdrafts under the proposed measuring procedure would in virtually all cases not permit them to operate within any cap constraint, if they were permitted to have a cap. Bankers’ banks would thus, under the proposal, have to hold larger balances, reduce their federal funds sales, or take similar actions to reduce their wire payments relative to their wire inflows and balances. In view of the proposal’s impact on the overdraft level of various types of institutions, die Board requests comment on alternative approaches to the treatment of Fedwire overdrafts over cap. For example, should some level of overdrafts in excess of cap continue to be permitted in extraoridinary cases at the discretion o f the Fedeal Reserve Bank? Further; some overdrafts are readily secured and generally self liquidating. For example, under the terms of Section 4-208 of the Uniform Commercial Code, depository institutions handling a check for collection may have a security interest in the check until payment is received. Overdrafts in excess of cap incurred in anticipation of check credits would be paid routinely when the credit is posted. Should such readily secured, selfliquidating overdrafts, ox other sectored overdrafts, in excess of cap be permitted? Who should bear the cost of maintaining collateral if collateralized overdrafts in excess of cap were permitted? Would permitting collateralized ovedrafts in excess of capincrease risks to other creditors of overdrafting depository institutions? Federal Reserve Operational Modificati ons for Pricing Federal Reserve operating outages could affect intraday liquidily in the banking system and thereby contribute to measured overdrafts atindividual depository institutions. Therefore Fedwire’s operating reliability is critical to the success o f the payments system risk reduction program. To assure greater Fedwire reliability, the Federal Reserve Banks are improving overall Fedwire processing performance and developing and implementing disaster recovery capabilites for Fedwire operations. Fedwire's reliability is high and has been improving steadily. The time Fedwire was unavailable (hiring business hours, decreased sharply in second quarter of 1990. As indicated in 1988. Funds transfer downtime Docket No. R-0670, the effective date for decreased by almost 50 percent and securities transfer downtime decreased requiring collateral of all Fedwire overdrafts of foreign banks with by approximately 40 percent from the 1987 levels. In. 1988, the funds transfer Fedwire overdrafts exceeding their cap and securities transfer systems achieved > based on U.S. capital equivalency would 99.59 percent and 99.41 percent also be in the second quarter of 1990. availability, respectively. The Board proposes that the use of Hardware and software systems that risk-based capital to compute debit caps will reduce the likelihood of Fedwire as well as the. other cap and daylight outages and facilitate more rapid overdraft measurement proposals recovery from operations problems are become effective in late 1990 or early being implemented to improve reliability 1991. CHIPS settlement finality is also further, fa addition, the Federal Reserve expected to occur within this time is strengthening its disaster recovery frame, and thus CHIPS net debits would capabilities to minimize the likelihood of be excluded from the cross-system net a prolonged service, disruption. The New debit cap in late 1990 or early 191)1. York Reserve Bank has demonstrated in Approximately three months altar disaster recovery simulations at its adoption of the overdraft measurement dedicated contingency sitB , the ability to changes, Reserve Banks would begin recover Fedwire operations, reconcile sending mock bills to depository funds and securities transfers, and institutions as if pricing were being resume processing of new transfers applied. The Board proposes th a t by within four hours of a disaster; The mid-1991. Reserve Banks would, begin Chicago and San Francisco Reserve assessing the first 10 basis points of the Banks also currently have, or are in the 25 basis point charge. The second 10 process of establishing, dedicated basis points would be applied in midbackup: sites: for Fedwire processing. 1992 and the final 5 basis points in midThe remaining Reserve Banks share a 1993. The Board reserves the right to disaster recovery site located in accelerate or extend the phase-in period Culpeper; Virginia. depending on market responses. Tlie Federal Reserve pricing for daylight Board also reserves the right to overdrafts will re quire that reliable terminate the phase-in at a lower price information be m ade available to than 25 basis points or to continue the depository institutions by their Reserve phase-in to a higher price, depending on Banks regarding the depositary market responses. institutions’ payment activity affecting By order of the Board of Governors of the their reserve or clearing accounts during Federal Reserve System. June 15,1989. the day. The Reserve Banks have William W. WUes, developed a n Account Balance Secretary o f die Board. Monitoring System t“ABM&”)i which [FR Doc. 89-14636 Filed 6-20-89: 8:45 am] will enable depository institutions to obtain their current account balance W tU N Q CODE w rra-O t-M during the day. The ASMS will reflect the depository institution’s opening [D o c k et No. R-G665] balance,, funds; and securities transfers as they occur, and selected non-wire RIN 7100-A A 76 transactions that would be posted to- the monitor periodically during the day Policy Statement on Private Deliveryconsistent with this proposal. While Agatnst-Payment Systems some institutions may rely on ABMS exclusively, other institutions may use it AGCNCYr Board of Governors of the Federal Reserve System. in conjunction with their own internal monitoring systems. ABMS will be a c t i o n ; Policy statement. available to depository institutions; s u m m a r y : The Board is issuing a policy before any pricing scheme in statement establishing guiding principles implemented. for reducing risk on delivery-againstProposed Implementation Schedule payment systems that settle on a net same-day basis over the Federal The Board proposes that the new Reserve’s wire transfer system. The payments system risk reduction policy Board believes that adherence to the be implemented in a series of staggered policy statement will reduce systemic effective dates. As indicated on Docket No. R-0669, Fedwire debit caps would risk for both die Federal Reserve and be applied to total Fedwire overdrafts system participants. This policy (funds and book-entry), with collateral' statement is issued in conjunction with required for total Fedwire overdrafts the Board’s requests for comments on exceeding the Fedwire cap because of proposals regarding its payments system book-entry securities transfers, in the risk reduction program and its policy Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices statements regarding offshore clearing systems and rollovers and continuing contracts, published elsewhere in today’s Federal Register. EFFECTIVE DATE: June 15,1989. FOR FURTHER INFORMATION CONTACT: Edward C. Ettin, Deputy Director, Division of Research and Statistics (202452-3368); Oliver I. Ireland, Associate General Counsel (202-452-3825) or Stephanie Martin, Attorney (202-4523198), Legal Division; for the hearing impaired only: Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202-452-3544). SUPPLEMENTARY INFORMATION: The Board is concerned about the systemic risk associated with private large-dollar payments and clearing systems. Hie potential systemic risk caused by the failure of a private system participant to settle its obligations can be far broader than the direct credit risk exposure to the Federal Reserve if a depository institution were unable to settle its net debit position on the Federal Reserve’s wire transfer system (“Fedwire"). The receiver of a Fedwire payment is insulated from any losses associated with the failure of the sender because the receiver of the transfer receives good funds from the Federal Reserve upon receipt of advice of the credit; the Federal Reserve absorbs the direct credit risk that otherwise would be borne by counterparties to Fedwire payments.1 Thus, the repercussions of the failure of an overdrafting sender on Fedwire to setde its obligations end with the loss to the Federal Reserve; no systemic losses are incurred by direct or indirect creditors of the Federal Reserve. In contrast, the creditor of participants on private networks are subject to systemic risk. This risk occurs because the direct counterparties of a failing participant may bear losses that in turn may affect their ability to meet their own settlement and other obligations. Additional indirect credit relationships may exist among participants in a network or in interbank credit relationships outside of payments networks. These indirect credit relationships and their attendant credit risks increase systemic risks associated with the failure of a participant to settle on a private network. 1The private sector still feces credit losses outside of the payments system associated with a failing depositary Institution. Such indirect privatesector risks increase when the Reserve Banks reduce their direct credit risk by taking collateral to cover their daylight credit extensions. Faalare of a sender would then cease no losses for Reserve Banks even though the receiver obtains foil payment: other creditors of the failed depository institution, however, have fewer assets against which to make a claim. The Board is issuing a policy statement to address intraday credit risks arising out of the delivery of securities against payment through systems other than Fedwire. The Board believes that private book-entry systems have the potential to (1) Reduce operating risk by supplanting separate physical delivery and wire payment for definitive instruments; (2) lower operational costs by setting net positions rather than each underlying transaction, which also reduces the volume of funds necessary for settlement; and (3) reduce credit exposures by reducing the volume of intraday credit extensions. In addition, such systems lend themselves to techniques that permit participants to establish credit discipline amoung themselves. With the proper safeguards, such as collateral, debit caps, bilateral credit limits, pre-arranged lossallocation formulas, and legally binding netting and close-out arrangements (e.g., novation), these systems can also be risk-reducing. In addition, such riskreducing safeguards would serve to focus the attention of system participants on their own risk exposure. The Board’s policy statement establishes general guidelines to ensure that settlement occurs in a timely fashion and that participants do not face excessive intraday risk. Guidelines are established in four areas: (1) Liquidity safeguards for ensuring settlement, (2) provisions for reversals, (3) credit safeguards, such as collateral and netting features, and (4) cpen settlement accounting. The rules and procedures of those delivery-against-payment systems that use the Federal Reserve's net settlement services would be subject to prior and ongoing review on a case-bycase basis by the Federal Reserve in accordance with the Board’s policy statem ent Policy Statement On Private DeliveryAgainst-Payment 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. This policy statement provides guidance on payment risk management for those delivery-against-payment systems that settle their end-of-day obligations directly or indirecdy over Fedwire. The policy specifically addresses intraday credit risks arising out of the delivery of securities against payment through systems other than the Federal Reserve's wire transfer system (“Fedwire”). These systems meet the criteria listed in the Board’s definition of 261G5 a large-dollar payments system, but generally will not be subject to the specific measures adopted as part of the Board’s risk reduction program, such as cros3-system debit caps, provided that these systems conform to the requirements of this policy statement. The Board believes that these systems should include risk-controlling 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 and high volume and the possible future course of the Federal Reserve's payments system risk reduction program, e.g., pricing intraday Fedwire funds and bock-entry overdrafts. The Board is, therefore, establishing the following general policy framework for the treatment of the payment risk in private-sector deliveryagainst-payment systems under its risk reduction program. Delivery-against-payment securities systems, as described below, are expected to adopt appropriate liquidity and credit safeguards in order to ensure that setdement 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 decided to establish general guidelines rather than to specify the exact form such safeguards should take. Reversals or “unwinds” of funds and securities transfers, however, are not considered appropriate liquidity control measures. The policy addresses four issues: (1) Liquidity safeguards for ensuring setdement; (2) provisions for reversals; (3) credit safeguards, such as collateral and netting features; and (4) open settlement accounting. These components, and the scope and regulatory implications of this policy, are described below. Scope of the Policy. This policy statement is specifically targeted at large-scale private delivery-againstpayment securities system s that 3ettie their obligations on a net, same-day basis over Fedwire, eith er directly or indirectly. These systems setde securities transactions for their participants by tranfemng securities and the accompanying payments obligations on the books of a clearing corporation or a depository institution operating the system and arrange for final settlement of the funds positions on a net basis at the end of the processing day. Settlement on a “net basis” means that the funds obligations are netted among all participants, so that a participant can setde obligations to or from many counterparties by making a 26106 Federal Register / Vol. 54, No. 118 / W ednesday. June 21, 1989 / Notices single transfer to or from the system. "Same day" settlement means 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 number of individual transfers larger than $50,C O O or that would permit any one participant to be exposed to a net debit position at the time of settlement in excess of its capital. This policy applies to systems that function primarily as a means of transferring securities and funds between participants. If a firm or bank is providing clearing services to a customer, and these services focus primarily on the bilateral relation between 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 ban, 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 systems dealing with other financial instruments, such as futures and options. This policy is directed at limiting the 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 systems 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 intraday credit, private delivery-against-payment systems rely on payments by-participants with 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, failure by a single participant with a net debit position may delay all settlement transfers by the system. The result of a system's failure to settle in a timely manner will be that participants do not receive the transfers of funds and securities that they expected and that they may need to conclude transactions outside the system. Because settlement 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 these private systems settle in a timely manner, so that participants can rely on 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 or 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 resources 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. Generally, net debits incurred by a depository institution within the system will not be applied to cross-system net debit caps established under the risk reduction program, which are applicable to Fedwire or CHIPS, nor will net credits on these systems be available as offsets. 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 if the system’s liquidity arrangements permit settlement. 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 market-to-market collateral. The loss Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices 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. It is worth noting that this policy statement, 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 be appropriate and prudent for a system to have rules which 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. As the systems described in this policy grow in size and volume, the timely and orderly completion of end-of-day settlements take 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-against-payment system should therefore have up-to-date information on theim et 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 nondepository institutions. By order of the Board of Governors of the Federal Reserve System, June 15,1989. W illiam W . W iles, Secretary o f the Board. [FR Doc. 89-14638 Filed 6-20-89; 8:45 am] BILLING COOC (210-01-M [D o c k et N o. R -0667] RIN 7100-A A 76 Policy Statement on Rollovers and Continuing Contracts To Reduce Daylight Overdrafts Board of Governors of the Federal Reserve System. a c t i o n : Policy statement. agency: The Board is issuing a policy statement encouraging the prudential use of rollovers and continuing contracts to reduce daylight overdrafts on Fedwire. The Board believes that the use of such arrangements is consistent with its overall payments system risk reduction program. This policy statement is being issued in conjunction with the Board’s requests for comments on proposals regarding its payments system risk reduction program and its policy statements regarding private delivery-against-payment systems and offshore clearing systems, published elsewhere in today's Federal Register. EFFECTIVE DATE: June IS, .1989. SUMMARY: FOR FURTHER INFORMATION CONTACT: Edward C. Ettin, Deputy Director, Division of Research and Statistics (202/ 452-3368) or Oliver L Ireland, Associate General Counsel, Legal Division (202/ 452-3625); for the hearing impaired only. Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: The Board of Governors of the Federal Reserve System has issued the following policy statement concerning rollovers and continuing contracts to reduce daylight overdrafts. This policy statement is being issued in conjunction with the Board's requests for comments on proposals regarding its payments system risk reduction program and its policy statements regarding private delivery-against-payment systems and offshore clearing systems, published elsewhere in today’s Federal Register. Policy Statement on Rollovers and Continuing Contracts To Reduce Daylight Overdrafts The Board of Governors of the Federal Reserve System believes that the use of market innovations, such as federal funds or Eurodollar rollovers or continuing contracts, to reduce daylight overdrafts on the Federal Reserve’s wire transfer system (“Fedwire”) and 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 26107 these and other financial instruments where feasible. In doing so, participants should be mindful that implementing changes of this type may 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 of the borrowing institution and create risk to Reserve Banks. Rollovers are interbank overnight transactions where the principal does 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 arangement may be cancelled at any time by either fcarty. 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 Fedwire daylight overdrafts or net debits on CHIPS. When the same maturity conditions apply to a continuing contract as apply to a 26108 Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices rollover (one business day or unspecified maturity and cancellation at any time by either party) national bank lending limits do not apply. An industry task force that evaluated alternatives for reducing the level of daylight overdrafts absorbed by the federal funds and Eurodollar markets sought to devise improved settlement practices, e.g., rollovers and continuing contracts, that sustain the present rate negotiation mechanism. 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. E ther 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 m arket For example, sellers of federal funds and other instruments may have to develop alternative audit trail procedures and may accept some addition risk of repayment since funds would not be returned each day before they would be relent In additiorvbuyers 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 p aid On balance, however, it is unclear whether rates on interbank funds transferred daily over Fedwire and CHIPS will fall relative to rates paid for rollovers, continuing contracts, or term funds, or whether the reverse will occur. The Board believes that it is important that the negotiation of terms relative to the use of these arrangements be left to the free operation of the private m arket 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, June 15,1989. William W. Wiles, Secretary o f the Board. [FR Doc. 89-14639 Filed 6-20-89; 8:45 am) BILL] NO COOC 62 10-0 1-M [D o c k e t N o. R -0670] RIN 7 1 0 0 -AA76 Proposals To Modify the Payments System Risk Reduction Program; U.S. Agencies and Branches of Foreign Banks AGENCY: Board of Governors of the Federal Reserve System. ACTION: Request for comment. SUMMARY: The Board is requesting comment on a proposed risk reduction policy that would require collateralization of all Fedwire overdrafts (funds and book-entry) of foreign banks operating through U.S. agencies and branches if such overdrafts exceed the banks’ Fedwire cap. This policy is proposed in conjunction with the other requests for comment and policy statements regarding the Board's payments system risk reduction program, published elsewhere in today’s Federal Register. DATES: Comments must be submitted on or before November 17,1989. a d d r e s s e s : Comments, which should refer to Docket No. R-0670, may be mailed to the Board of Governors of the Federal Reserve System. 20th and C Streets, N W , Washington, DC 20551, Attention: Mr. William W. Wiles. Secretary; or may be delivered to Room B-2223 between 8:45 a.m. and 5:00 pjn. All comments received at the above address will be included in the public file and may be inspected at Room B1122 between 8:45 a.m. and 5:15 p.m. FOR FURTHER INFORMATION CONTACT: Edward C. Ettin. Deputy Director. Division of Research and Statistics [202/ 452-3368), Jeffrey C. Marquardt, Senior Economist Division of International Finance (202/452-3697); for the hearing impaired only. Telecommunications Device for the Deaf, Eamestine Hill or Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: This is one of three proposals regarding payments system risk reduction that the Board is issuing for public comment today. H ie others concern pricing of overdrafts on the Federal Reserve’s wire transfer system (“Fedwire") and related overdraft measurement and caps proposals (Docket No. R-0668), as well as the inclusion of book-entry securities transfers in the measurement of Fedwire overdrafts (Docket No. R-0669). The Board encourages all interested parties to comment on each of these proposals. The Board urges that in filing comments on these proposals, commenters prepare separate letters for each proposal, identifying the appropriate docket number on each. This procedure will facilitate the Board’s processing and analysis of the comments on these proposals by ensuring that each comment is quickly brought to the attention of those responsible for analyzing each specific proposal. In addition, the Board encourages entities that plan to submit identical comments, such as affiliated institutions within a holding company, to consolidate their efforts; the Board will give equal consideration to one letter signed by a number of commenters as it would to numerous identical letters submitted by those commenters. Comments are due November 17,1989, and the Board does not intend to extend the comment period beyond that date. In addition to its requests for comment, the Board is also issuing today three risk-related policy statements regarding private deliveryagainst-payment systems (Docket No. R-0665), offshore clearing and netting systems (Docket No. R-0666), and rollovers and continuing contracts (Docket No. R-0667). In April 1985, the Board of Governors adopted a policy to reduce risk on largedollar payments systems. This policy, which was implemented in March 1986, established a maximum amount of intraday funds overdrafts that depository institutions are permitted to incur over both Fedwire and private large-dollar payments systems. The maximum, or cap, is a multiple of a depository institution's adjusted primary capital and is based on a self-evaluation of a depository institution’s creditworthiness, credit policies, and operational controls. In July 1987, the Board adopted a number of modifications to the daylight overdraft policy, including a two-step, 25 percent reduction in the cross-system net debit caps, thus reducing the maximum daylight overdrafts permitted to individual depository institutions.1 The Board has applied its daylight overdraft policy to foreign banks as well as domestic institutions in a manner consistent with the policy of “national treatment," i.e., applying similar rules to foreign entities operating within the United States as are applied to domestic institutions. In this regard, U.S. 1 These reductions became effective in January and May 1988. See 52 FR 29255 (August 8,1987). Federal Register / Vol. 54, No. 118 / W ednesday, June 21, 1989 / Notices subsidiary banks owned by foreign banks are treated identically to all other U.S. banks under the program. The policy for branches and agencies of foreign banks, however, of necessity, takes into account certain differences between these entities and domestically-chartered institutions, including the following: (1) Most of a foreign bank’s assets and liabilities are located and controlled outside of the United States and only the operations of the U.S. branches and agencies are subject to supervisory review by U.S. authorities, and (2) for many foreign banks, the volume of dollar payments that would flow through their U.S. branch network is substantial relative to the level of their assets in the United States and their local dollar funding capacity. As such, there may be practical limits on the ability of branches and agencies of foreign banks to raise funds in the market, either through unsecured borrowings or by providing collateral in an acceptable form, to meet liquidity needs in the event of credit or operational problems. In this initial policy, the Board based the cross-system cap (for Fedwire and CHIPS * combined) for branches of foreign banks on their world-wide capital, but based the Fedwire cap (for Fedwire funds overdrafts) on a surrogate for capital in the U.S. ("U.S. capital equivalency” s), which is significantly smaller than world-wide capital. Foreign banks with U.S. branches and agencies are permitted to incur Fedwire overdrafts above their Fedwire caps (up to the cross-system cap) by posting collateral for the amount of such overdrafts in excess of their Fedwire caps. A few foreign banks operating through U.S. branches and agencies have indicated that Fedwire caps are too binding for their dollar payments business, that their Fedwire caps do not recognize their world-wide strength, and that their U.S. operations do not involve the kind of assets to permit the posting of collateral for larger Fedwire overdrafts. In the summer of 1987, the Board reconsidered its policy in light of > “CHIPS" is the Clearing House Interbank Payments System, operated by the New York Clearing House. * U:S. capital equivalency is defined as the greater of (1) the sum of the amount of capital (but not surplus) that would be required of a national bank being organized at each branch or agency location or (2) the sum of 5 percent of the total liabilities of each branch or agency; including acceptances, but excluding (a) accrued expenses and (b) amounts due and other liabilities to offices, branches, and subsidiaries of the foreign bank. these concerns and determined that the policy should not be changed. This decision was based in part on the fact that U.S. branches and agencies of foreign banks were generally operating well within their Fedwire caps and seemed to be able to obtain large volumes of private intraday credit on CHIPS. Foreign bank representatives have noted that the Basle Accord capital standards should meet or alleviate the Board’s concerns about the capital positions and supervision of foreign banks with U.S. branches and agencies. In early 1989, the Institute of International Bankers renewed its request that the Board permit world wide capital to be used as the base for determining Fedwire caps for foreign banks operating in the U.S. through branches and agencies. There continues to be little evidence, however, that foreign banks are seriously constrained in their access to U.S. payments systems, despite rapid growth in their overdrafts. Since the Board's policy was initiated, both Fedwire funds and CHIPS daily average peak overdrafts of U.S. branches and agencies of foreign banks have risen more rapidly than have those of U.S.chartered entities. In the fourth quarter of 1988,64 branches or agencies of foreign banks incurred $6.4 billion of Fedwire funds overdrafts, and 96 incurred $31.0 billion of CHIPS net debits. Very few of these entities use their Fedwire cap intensively, however the few who do exceed their Fedwire cap under the proposed policy would have to collateralize the total amount of their Fedwire overdraft The Board does not believe that the current daylight overdraft policy is causing a hardship for foreign banks. Moreover, given the lack of U.S. asset base and potential limits on dollar funding capacity that would apply to some foreign banks, the current policy appears to be sound. Including bookentry overdrafts under the cap policy (see Docket No. R-0669) would have virtually no impact on the Fedwire cap utilization of foreign banks operating through U.S. branches and agencies. However, the proposed collateral policy for book-entry overdrafters requires that collateral be posted by U.S.-chartered depository institutions for all Fedwire overdrafts if the Fedwire cap is exceeded because of book-entry overdrafts. A parallel policy for those U.S. branches and agencies of foreign banks that exceed their Fedwire cap based on U.S. capital equivalency would 26109 provide that collateral be posted equal to the total Fedwire overdrafts, not just the amount in excess of the cap. The current policy that permits U.S. branches and agencies of foreign banks to incur uncollateralized Fedwire overdrafts up to their Fedwire cap based on U.S. capital equivalency would not be changed Under the proposal, foreign banks could have Fedwire overdrafts up to the amount of their cap multiplied by their world-wide capital if all of those overdrafts were collateralized. At the current time, such a policy change would have virtually no impact on foreign banks, which use CHIPS much more than Fedwire and have relatively low Fedwire cap utilization rates. Such a change would also serve as better protection for Reserve Banks if large exposures do occur. Accordingly, the Board is soliciting public comment on a proposal that would extend the collateral requirements to all Fedwire overdrafts (funds and book-entry) of foreign banks operating through U.S. branches and agencies if such overdrafts exceed their Fedwire cap. The Board also requests comment on the proposed general overdraft policy (see Docket No. R-0668) as it applies to these entities.4 Specifically, the Board is requesting comment on the relative burdens and benefits of the proposed collateral policy versus maintaining the current policy (but including book-entry overdrafts in the total Fedwire overdrafts subject to cap). The Board is also requesting comment on alternative definitions of U.S. capital equivalency, particularly in light of the recent international accord on the definition of bank capital. Commenters are asked to suggest alternative definitions that would provide a reasonable balance between the practical U.S. asset and dollar liquidity limits of foriegn banks and the interests of foreign banks in more flexible access to Fedwire. By order of the Board of Governors of the Federal Reserve System, June 15,1989. W illiam W . W iles, Secretary o f the Board. [FR Doc. 89-14641 Filed 8-20-89; 8:45 am] BILUNG COOE 6210-01-M * Edge corporations would continue, as now, to bo required to post collateral for all their Fedwire overdrafts. No change in policy is being proposed for these entities. Highlights of Proposals for Modifying the Payment System Risk Reduction Policy for Small and Intermediate Size Depository Institutions Defining Fedwire Overdrafts • Includes both funds and book-entry overdrafts for caps and pricing. • Measurement modified through change in sequence of posting of non-wire transactions. (See table on reverse side.) Net Debit Caps • A depository institution (DI) is exempt from filing if its daily peak Fedwire overdrafts are less than $10 million and 20 percent of risk-based capital (Tier I and Her II). Virtually all small and intermediate size DIs are expected to be exempt from filing. • Annual self-evaluation and board-of-directors’ resolution are required for all other cap categories • If filing for caps is required, the caps apply to intraday peak values with dual caps for single days and two week averages of peak values. • Caps based on sum of Tier I and Her n risk-based capital • Regardless of cap standing, file board-of-directors’ resolution if either of the following occurs: •another entity is authorized to make Fedwire transfers from your account or receive book-entry transfers for your account •a DI makes transfers to an affiliated DI to fund the affiliate’s reserve account intraday Erising • Daily amount of Fedwire overdrafts subject to pricing: •Average daily intraday total funds and book-entry Fedwire overdrafts •In excess of 10 percent of risk-based capital (the “deductible”) •P h ased -in over three years • Price is 25 basis points (annual rate) or 0.685 cents per day per $1,000 of average overdrafts in excess of deductible • Virtually all small and intermediate DIs are expected to be exempt from pricing because their average overdrafts will be less than their deductible Federal Funds and RP Lending • The Board supports modification of federal funds and RP lending arrangements so as to eliminate or reduce repayment each morning followed by re-lending to the same borrower each afternoon (causing daylight overdrafts for borrower) • However, lenders should be aware of the resultant slightly reduced liquidity and should satisfy themselves that the terms and conditions of such arrangements maintain their flexibility. NOTE: Comments are due on these proposals on November 17,1989. All the proposals, if implemented, would be phased in from mid-1990 to mid-1993. Federal funds and RP lending policy effective at once. Posting Rules for Measuring Fedwire Daylight Overdrafts PrepQsed Current Opening Balance (- Previous day’s closing balance) Plus Opening balance (- Previous day’s closing balance) Plus or Minus Posted at opening: U.S. Treasury and government agency book-entry interest credits Plus Posted ex post at opening: Net of ACH Credit and Debit Transactions Posted at opening: U.S. Treasury and government agency book-entry redemption (maturity credits) Posted ex post at opening: Net credits (if any) from "all other" (non-wire) transactions that day Equals Plus Posted at opening: U.S. Treasury ACH credits Minus Plus Adjusted opening balance Plus or Minus Posted at opening: U.S. Treasury book-entry new issue debits Fedwire funds and book-entry transfers as they occur Equsls Adjusted opening balance Minus Posted ex post at close of Fedwire: Net debits (if any) from “all other” (non-wire) transactions that day Equals Plus or Minus Fedwire funds and book-entry transfers as they occur Plus Posted at 2:00 p.m. (local time): Treasury direct (and special direct) investments Equals Fedwire closing balance Plus or Minus Posted after close of Fedwire: Commercial ACH and “all other” transactions (non-wire debits and credits) Equals Closing balance Closing balance