Full text of Federal Reserve Bank of New York Circulars : Comprehensive Policy Statement on Payments System Risk

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FEDERAL RESERVE BANK
OF NEW YORK
September 24, 1992

COM PREHENSIVE POLICY STATEMENT
ON PAYMENTS SYSTEM RISK

To All Depository Institutions, and Others
Concerned, in the Second Federal Reserve District:

The Board of Governors of the Federal Reserve System has compiled a revised comprehensive
statement of its previously adopted policies concerning payments system risk reduction. The
statement includes policies to control Federal Reserve and private-sector risk, and other related
policies, and incorporates all of the policy modifications adopted by the Board since its last published
comprehensive statement in 1987. The revised statement reflects only previously announced
policies; no new policies are included.
The revised policy statement makes reference to a Userd Guide, which was distributed to
depository institutions in March 1988 to assist them in implementing the Board’s policies as they
appeared in the 1987 policy statement. New Users’ Guides reflecting current policies are now in
the process of being prepared; they will be made available to depository institutions in this District
upon publication.
Enclosed — for depository institutions — is the text of the revised statement, as reprinted from
the Federal Register of September 3; others may obtain copies at this Bank (33 Liberty Street) from
the Issues Division on the first floor, or by contacting our Circulars Division (Tel. No. 212-720-5215
or 5216). Questions regarding the statement may be directed to our supervisory liaison officer, James
K. Hodgetts, Assistant Vice President (Tel. No. 212-720-5898), or to me (Tel. No. 212-720-7766).




R ichard J. G elson ,

Daylight Overdraft Liaison Officer.




fir-1 6 5 7 5
Thursday
September 3, 1992
Vol. 57, No. 172
Pp. 40455-66

COMPREHENSIVE FEDERAL RESERVE
POLICY STATEMENT
ON PAYMENTS SYSTEM RISK
(August 20, 1992)




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

40455

policies regarding certain
small-dollar systems, such as national
ACH net settlement and ATM networks
The Federal Reserve first published a
policy statement on its payments system
risk reduction program in 1985 (50 FR
21120, May 22,1985) and published an
updated “interim” statement in 1987 (52
FR 29255, August 8,1987). Since 1987,
the Board has made several additions *o
its payments system risk reduction
policy, including policies regarding
private delivery-against-payment
securities systems, offshore dollarclearing and netting systems, and
FEDERAL RESERVE SYSTEM
rollovers and continuing contracts (54
FR 26104, 26092, 26107, respectively,
Federal Reserve Policy Statement on
June 21,1989). In 1990, the Board
Payments System Risk
modified the Federal Reserve risk
reduction policy with respect to bookAGENCY: Board of Governors of the
Federal Reserve System.
entry securities transactions, net debit
caps, capital measurements, and
ACTION: Policy statement.
application of the policy to agencies and
SUMMARY: The Board has compiled an
branches of foreign banks (55 FR 22087,
updated, comprehensive statement of its May 31,1990).
previously-adopted policies regarding
The Board has compiled an updated,
payments system risk reduction,
comprehensive statement of its
including policies to control Federal
previously-adopted policies regarding
Reserve risk, policies for private-sector
payments system risk reduction,
networks, and other related policies.
including policies to control Federal
This statement incorporates all of the
Reserve risk, policies for private-sector
policy modifications adopted by the
networks, and other related policies.
Board since the last published
This statement incorporates all of the
comprehensive statement in 1987, and
policy modifications adopted by the
supersedes all other published
Board since the last published
statements. No new policies are
comprehensive statement in 1987, and
included in this compilation.
supersedes all other published
EFFECTIVE DATE: August 20, 1992.
statements. No new policies are
FOR FURTHER INFORMATION CONTACT:
included in this compilation. The policy
Florence M. Young, Assistant Director
(202/452-3955), Division of Reserve Bank statement is set out below:
Operations and Payment Systems;
Stephanie Martin, Senior Attorney (202/ Federal Reserve System Policy Statement On
Payments System Risk
452-3198). Legal Division. For the
hearing impaired only:
Introduction
Telecommunications Device for the Deaf
I. Federal Reserve Policy
(TDD), Dorothea Thompson (202/452A.
Daylight Overdraft Definition
3544), Board of Governors of the Federal
Reserve System. 20th and C Streets,
B. [Reserved]
NW., Washington, DC 20551.
C. Capital
SUPPLEMENTARY INFORMATION: During
1. U.S. Chartered Institutions
the past Beven years, the Federal
2 . U.S. Agencies and Branches of Foreign
Reserve System has developed a
Banks
program to address payments system
risk. Risk can arise from transactions on D. Net Debit Caps
the Federal Reserve’s wire transfer
1. Cap Set Through Self-Assessment
system (Fedwire), from other types of
2. De Minimis Cap
payments, including checks and
2. Exemption From Filing
automated clearing house JACHJ
4. Special Sitnatkms
transactions, and from transactions on
a. Edge and Agreement Corporations
private large-dollar networks that permit
b. Bankers’ Banks
their participants to transmit payment
c. Zero-Cap Depository Institutions
messages throughout the day with
E.
Book-entry Secarties Transactiosn
settlement of net positions at the end of
1.
Collateralization
the day. The Federal Reserve has
2. Transfer Size Limit
addressed primarily large-dollar
payments systems but has also
d e v e lo p e d

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

F. Inter-affiliate Transfers
G. Third-party Access Arrangements
H. Monitoring
1. Ex Post
2. Real Time
3. Multi-District Institutions
4. ACH Controls

intraday (“daylight”) overdrafts in their
Federal Reserve accounts before the end
of the day. Moreover, systemic risk may
occur if an institution participating on a
private large-dollar payments network
were unable or unwilling to settle its net
debit position. If this were to occur, the
institution’s creditors on that network
II. Policies for Private-Sector Networks
might also be unable to settle their
commitments. Serious repercussions
A. Private Large-Dollar Funds Transfer
Networks
could, as a result, spread to other
participants in the private network, to
B. Private Delivery-Against-Payment
other depository institutions not
Securities Systems
participating in the network, and to the
C. Offshore Dollar-Clearing and Netting
nonfinancial economy generally. A
Systems
Reserve Bank could be exposed to an
D. Private Small-Dollar Clearing and
indirect risk if its policies did not
Settlement Systems
address this systemic risk. Finally,
1. National ACH Net Settlement
depository institutions create risk by
2. Small-Dollar ATM Networks
permitting their customers, including
other depository institutions, to transfer
III. Other Policies
uncollected balances in anticipation of
A. Rollovers and Continuing Contracts
their coverage before the end of the day.
Federal Reserve System Policy
The Board is aware that large-dollar
Statement on Payments System Risk
networks are an integral part of the
Introduction
clearing and settlement systems and
that it is of vital importance to keep the
The Federal Reserve System has
payments mechanism operating without
developed this policy statement to
address payments system risk. Risk can significant disruption. It is because of
the importance of avoiding such
arise from transactions on the Federal
Reserve’s wire transfer system
disruptions that the Board continues to
(Fedwire), from other types of payments, seek to reduce the risks of settlement
including checks and automated
failures that could cause these
clearing house (ACH) transactions, and disruptions. The Board is also aware
from transactions on private large-dollar that some intraday credit may be
networks that permit their participants
necessary to keep the payments
to transmit payment messages
mechanism running smoothly and
throughout the day with settlement of
efficiently. The reduction and control of
net positions at the end of the day. This intraday credit risks, although essential,
policy statement is addressed primarily must be accomplished in a manner that
to large-dollar payments systems1 and
will minimize disruptions to the
incorporates the Federal Reserve’s
payments mechanism. The Board
policies to reduce Federal Reserve risk
anticipates that, by relying largely on
as well as risk on various types of
the efforts of individual institutions to
private-sector networks.
identify, control, and reduce their own
The Federal Reserve Banks face direct exposures, and by establishing
risks of loss should depository
guidelines for use by institutions, the
institutions2 be unable to settle their*
goal of reducing and controlling risks
will not unduly disrupt the smooth
1 In a changing technological and regulatory
operation of the payments mechanism.
environment, it is not possible or desirable to adopt
an all-inclusive and permanent definition of a
The Board emphasizes that it is not
"large-dollar payments system” for the purposes of
condoning daylight overdrafts in Federal
Federal Reserve risk control policy. In determining
Reserve accounts. Although some
whether any particular system is a "large-dollar"
system, the Board will consider any of the following intraday credit may be necessary, the
four factors: (1) the employment of multilateral
Board anticipates that, as a result of its
netting arrangements, (2) the use of same-day
settlement, (3) the routine processing of a significant policies, there will continue to be a
reduction in the number of institutions
number of individual payments larger than $50000,
and (4) the possibility that any one participant could consistently relying on intraday credit
be exposed to a net debit position at the time of
supplied by the Federal Reserve to
settlement in excess of its capital.
conduct their business. The Board also
* In this policy statement, the terms "depository
expects to continue observing, over
institution" or "institution” will be used to refer not
only to institutions defined as "depository
time, a reduction in the volume of
institutions" by 12 U.S.C. 461(b)(1)(A), but also to
intraday credit at those institutions with
U.S. branches and agencies of foreign banks, Edge
a pattern of substantial reliance on such
and agreement corporations, and bankers' banks,
unless the context indicates a different reading.
credit. The Board will continue to




monitor the effect of its policies on the
payments system.
The general methods used to control
intraday credit exposures are explained
in the policies below. These methods
include caps on net debits incurred by
depository institutions in their accounts
at Federal Reserve Banks,
collateralization, in certain situations, of
overdrafts at the Federal Reserve due to
book-entry securities transactions,
bilateral credit limits between
institutions on private large-dollar
networks, and credit and liquidity
safeguards for private delivery-againstpayment systems. To assist depository
institutions in implementing the Board s
policies, the Federal Reserve has
prepared a Users’ Guide to the policy
statement. The Users’Guide explains in
detail how the policies apply to various
types of depository institutions, the selfassessment procedures for establishing
a net debit cap, and the role of the
institutions’ boards of directors in
overseeing the implementation of risk
reduction efforts by the institutions.
Depository institutions may obtain the
Users’ Guide from their local Reserve
Bank.
I. Federal Reserve Policy
A Daylight Overdraft Definition
A daylight overdraft occurs when a
depository institution’s Federal Reserve
account is in a negative position during
the business day. The Reserve Banks
use an ex post system to measure
daylight overdrafts, calculating intraday
Federal Reserve account positions as
follows: At the opening of business,
each institution’s closing balance from
the previous day is adjusted by the net
of all ACH transactions. Original issues
of Treasury securities3 are posted no
earlier than 9:15 a.m. Eastern Time |ET),
and redemption and interest payments
for Treasury and government agency
securities are posted by 9:15 a.m. ET.
Funds and book-entry securities
transfers are posted throughout the day
as they are processed. After the close of
business, all other transactions, such as
check and currency and coin
transactions, are totalled. If the net of
these transactions is a credit, it is posted
as though it occurred at the opening of
business; if the net is a debit, it is posted
as though it occurred at the close of
business.
* New issues of government agency securities art
posted as the securities are delivered over Fedwire

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices
B. [Reserved]

conditioned on the Reserve Bank’s
judgment that the U.S. agency or branch
C. Capital
of the foreign bank has satisfactory U.S.
funding capability and potential eligible
1. U.S. Chartered Institutions.
collateral for a discount window loan,
should it be unable to cover its daylight
For depository institutions chartered
overdraft by the end of the day.
in the United States, net debit caps are
A foreign bank whose home-country
multiples of “qualifying” or similar
supervisor adheres to the Basle Capital
capital measures that consist of those
Accord may determine its
capital instruments that can be used to
uncollateralized daylight overdraft
satisfy risk-based capital standards, as
capacity by applying its cap multiple to
set forth in the capital adequacy
a U.S. capital equivalency equal to the
guidelines of the federal financial
greater of 10 percent of worldwide
regulatory agencies. All of the federal
capital or 5 percent of the total liabilities
financial regulatory agencies collect, as of each agency or branch, including
part of their required reports, data on
acceptances, but excluding accrued
the amount of capital that can be used
expenses and amounts due and other
for risk-based purposes—“qualifying”
liabilities to offices, branches, and
capital for commercial and savings
subsidiaries of the foreign bank. In the
banks, “risk-based” capital for savings
absence of contrary information, the
and loan associations, and total
Reserve Banks presume that all banks
regulatory reserves for credit unions.
chartered in G-10 countries meet the
Other U.S. chartered entities that incur
acceptable prudential capital and
overdrafts in Federal Reserve accounts
supervisory standards and will consider
should provide similar data to their
any bank chartered in any other nation
Reserve Banks.
that adopts the Basle Capital Accord
In some instances, further adjustments standards (or requires capital at least as
great and in the same form as called for
to capital are required. For example,
by the Accord) eligible for the Reserve
virtually all Edge and agreement
Banks' review for meeting acceptable
corporations are subsidiaries of
prudential capital and supervisory
depository institutions that may
standards.
themselves use intraday credit. Capital
To determine the net debit cap for
would be double-counted if both the
uncollateralized overdrafts for all other
parent and the Edge or agreement
foreign banks, cap multiples are applied
corporation subsidiary used intraday
credit based on their own capital bases. to the U.S, capital equivalency measured
Accordingly, if a parent elects to permit as the greater of (1) the sum of the
amount of capital (but not surplus)
its Edge or agreement corporation
which would be required of a national
subsidiary to use daylight credit, any
bank being organized at each agency or
risk-based capital attributable to the
branch location, or (2) the sum of 5
Edge or agreement corporation
percent of the total liabilities of each
subsidiary that is reflected on the
agency or branch, including
parent's balance sheet must be
subtracted from the parent’s capital. The acceptances, but excluding accrued
expenses and amounts due and other
parent may choose, however, to use all
liabilities to offices, branches, and
of its capital for its own cap and to
subsidiaries of the foreign bank.
prohibit its Edge or agreement
All foreign banks, regardless of their
corporation subsidiary from using
cap for uncollateralized overdrafts, may
intraday credit.
incur total overdrafts up to an amount
equal to their cap multiple times 10
2. U.S. Agencies and Branches of
percent of their worldwide capital, as
Foreign Banks.
long as the amount of the overdraft
above the uncollateralized overdraft cap
For U.S. agencies and branches of
is collateralized. In addition, all foreign
foreign banks, net debit caps for
banks may elect to collateralize all or a
uncollateralized overdrafts in Federal
portion of their overdrafts related to
Reserve accounts are multiples of
book-entry securities activity. This
consolidated “U.S. capital
policy offers all foreign banks, under
equivalency.”4 Ail net debit caps are
terms that reasonably limit Reserve
Bank risk, a level of overdrafts based on
4 The term “U.S. capital equivalency" has been
the same proportion of their worldwide
chosen merely as the most convenient term of art
The use of the term for purposes of thia policy
capital. Banks chartered in countries
statement is not meant to suggest that the Board
that follow the Basle Accord and that
presently intends that this measure necessarily
have demonstrated collateral and
should be used to measure a foreign bank's capital
funding capacity that would result in a
position in the United States for prudential or other
purposes.
net debit cap based on 10 percent of




40457

worldwide capital are not permitted to
incur overdrafts above their cap, except
for book-entry securities overdrafts,
even with collateral. All other foreign
banks may incur overdrafts to the same
extent as banks from Basle Accord
countries, i.e., up to their cap multiple
times 10 percent of their worldwide
capital, provided that sufficient
collateral is posted for any overdrafts in
excess of the cap based on their U.S.
capital equivalency.
D. Net Debit Caps
To limit the aggregate amount of
daylight credit extended by Reserve
Banks, each institution that incurs
daylight overdrafts in its Federal
Reserve account must adopt a net debit
cap, i.e., a ceiling on the aggregate net
debit position that it can incur during a
given interval. Alternatively, if an
institution's daylight overdrafts
generally do not exceed the lesser of $10
million or 20 percent of capital, the
institution may qualify for the exemptfrom-filing status. Subject to the
provisions for special situations
described below, an institution must be
financially healthy and eligible to
borrow from the discount window in
order to adopt a cap greater than zero or
qualify for the filing exemption.
Cap categories and associated cap
levels, set as multiples of capital, are
listed below:
Net Debit Cap Multiples
Cap Category
High...............
Above Avg.......
Average-------De Minimis—.....

Exempt-fromfWng............

Zero......... .....

Two-Week
Avg.

Single Day

1.50
1.125
0.75
0.20

2.25
1.875
1.125
0.20

$10 million
(0.20)

$10 million
(0.20)

0.0

0.0

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

40458

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

two-week reserve maintenance period,
of an institution’s daily maximum net
debit positions in its Federal Reserve
account. In calculating the two-week
average, individual days on which an
institution is in an aggregate net credit
position throughout the day are treated
as if the institution was in a net position
of zero. The number of days used in
calculating the average is the number of
business days the institution’s Reserve
Bank is open during the reserve
maintenance period.
The Board’s policy on net debit cap9
is based on a specific set of guidelines
and some degree of examiner oversight
Under the Board’s policy, a Reserve
Bank may prohibit the use of Federal
Reserve intraday credit if (1) an
intstitution’s use of daylight credit is
deemed by the institution’s supervisor to
be unsafe or unsound, (2) an institution
does not qualify for a cap exemption,
does not perform a self-assessment or
does not file a board-of-directorsapproved de minimis cap, and (3) an
institution poses an excessive risk to a
Reserve Bank.
The net debit cap provisions of this
policy apply to foreign banks to the
same extent as they apply to U.S.
institutions. The Reserve Banks will
advise home-country supervisors of
banks with U.S. branches and agencies
of the daylight overdraft capacity of
banks under their jurisdiction, as well as
of other pertinent conditions related to
their caps. Home-country supervisors
that request information on the
overdrafts in the Federal Reserve
accounts of their banks will be provided
that information on a regular basis.
1. Cap Set Through Self-Assessment
An institution that wishes to establish
a net debit cap category of high, above
average, or average must perform a selfassessment of its own creditworthiness,
credit policies, and operational controls,
policies, and procedures.6 The
assessment of creditworthiness should
address the overall financial condition
of the institution, placing emphasis on
conformance of the institution’s capital
with supervisory standards for capital
adequacy. The institution should also
assess its procedures for evaluating the
financial condition of its customers and
BThis assessment should be done on an
individual Institution basis, treating as separate
entities each commercial bank, each Edge
corporation (and its branches), each thrift
insti'ution, etc. An exception is made in the case of
U S. agencies and branches of foreign banks.
Because these entities have no existence separate
from the foreign bank, all the U.S. offices of foreign
banks (excluding U.S. chartered bank subsidiaries
and U.S. chartered Edge subsidiaries) should be
treated as a consolidated family relying on the
foreign bank's capital




should establish intraday credit limits
that reflect these assessments. Finally,
an institution should ensure that its
operational controls permit it to contain
its use of Federal Reserve intraday
credit and restrict its customers’ use of
credit to the limits it has established.
The Users’Guide to the Board’s
Payments System Risk Reduction Policy,
available from any Reserve Bank,
includes a detailed explanation of the
steps that should be taken by a
depository institution in performing a
self-assessment to establish a net debit
cap.
Each institution’s board of directors is
expected to review the self-assessment
and determine the appropriate cap
category. The process of selfassessment, with board-of-directors
review, should be conducted at least
once in each 12-month period. A cap
determination may be reviewed and
approved by the board of directors of a
holding company parent of a depository
institution, or the parent of an Edge or
agreement corporation, provided that (1)
the self-assessment is performed by
each entity incurring daylight
overdrafts, (2) the entity’s cap is based
on the entity's own capital (adjusted to
avoid double-counting), and (3) each
entity maintains for its primary
supervisor’s review its own file with
supporting documents for its self;
assessment and a record of the parent's
board-of-directora review.6
In applying these guidelines, each
institution is expected to maintain a file
for examiner review that includes (1)
worksheets and supporting analysis
developed in its self-assessment of its
own risk category, (2) copies of senior
management reports to the board of
directors of the institution or its parent
(as appropriate) regarding that selfassessment, and (3) copies of the
minutes of the discussion at the
appropriate board-of-directors meeting
concerning the institution’s adoption of
a cap category.7
6 A foreign bank should undergo the same selfassessment process as a domestic bank in
determining a net debit cap for its U.S. branches
and agencies. Many foreign banks, however, do not
have the same management structure as U.S.
depository institutions, and adjustments should be
made as appropriate. Where a foreign bank's board
of directors has a more limited role to play in the
bank’s management than a U.S. board, the selfassessment and cap category should be reviewed by
senior management at the foreign bank’s head office
that exercises authority over the foreign bank
equivalent to the authority exercised by a board of
directors over a U.S. depository institution In cases
where the board of directors exercises authority
equivalent to that of a U.S. board, cap
determination should be made by the board of
directors.
7 In most cases, it may not be possible for the U.S.
examiners to review the minutes of the meeting of a

As part of its normal examination, the
depository institution’s examiners will
review the contents of the selfassessment file.8 The objective of this
review is to assure that the institution
has applied the guidelines seriously and
diligently, that the underlying analysis
and methodology were reasonable, and
that the resultant self-assessment was
generally consistent with the
examination findings. Examiner
comments, if any, should be forwarded
to the board of directors of the
institution. The examiner, however,
would generally not require a
modification of the self-assessment cap
category unless the level of daylight
credit U9ed by the institution constitutes
an unsafe or unsound banking practice.
The contents of the self-assessment
cap category file will be considered
confidential by the institution’s
examiner. Similarly, the actual cap level
selected by the institution will be held
confidential by the Federal Reserve and
the institution’s examiner. (However,
cap information will be shared with the
home country supervisor of agencies
and branches of foreign banks.)
2. De Minimis Cap
Many depository institutions incur
relatively small overdrafts and thus
pose little risk to the Federal Reserve.
To ease the burden on these small
overdrafters of engaging in the selfassessment process and to ease the
burden on the Federal Reserve of
administering caps, the Board will allow
institutions that meet reasonable safety
standards to incur de minimis amounts
of daylight overdrafts without
performing a self-assessment. A
depository institution may incur daylight
overdrafts up to 20 percent of capital, if
a board-of-directors resolution is
submitted.
Reserve Banks will review the status
of a de minimis cap institution that
exceeds its cap on a single day or, on
average, over a two-week reserve
maintenance period and will decide if
the de minimis cap should be
foreign bank's board of directors or other
appropriate management group at which the selfassessment was discussed. In lieu of this, the hie on
the self-assessment that is made available for
examiner review by the U.S. offices of a foreign
bank should contain the report on the selfassessment made to the foreign bank’s senior
management by the management of U.S. operations.
In addition, the file should also contain a record cf
the appropriate senior management’s response. As
in the case of U.S. institutions, this review and
confirmation should be completed every' year.
8
Between examinations, examiners or Reserve
Bank staff may contact an institution about its cap if
statistical or supervisory reports or ad hoc
information suggest that there may have bean a
change in the institution’s position.

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

3

40459

bankers’ banks would be subject to the
fully collateralize all overdrafts in their
maintained or if the institution will be
same policy as other depository
Federal Reserve accounts. To protect
required to perform a self-assessment
the Reserve Banks from excessive risk
and file for a higher cap. An institution
institutions.
in conjunction with the collateralization
choosing to use a de minimis cap must
c.
Zero-Cap Depository Institutions.
submit to its Reserve Bank at least once policy, the Board strongly urges each
Some depository institutions have caps
each year a copy of the resolution of its Edge or agreement corporation to
of zero that are imposed by Reserve
restrain its use of intraday credit by
board of directors (or its holding
Banks because of the institutions’
establishing a net debit cap based on its financially troubled status, because of
company's board) approving the
own capital in the same manner as any
depository institution’s use of daylight
Board policy (such as limited-purpose
other depository institution. For
credit up to the de minimis level.
trust companies), or because the
purposes of net debit caps, the Board
3. Exemption From Filing
institution
itself requested a zero cap.
suggests that all branches of an Edge or
Regardless
of whether it has access to
Depository institutions that only
agreement corporation be consolidated.
the
discount
window, if a depository
rarely incur overdrafts in their Federal
This policy reflects the lack of access of
institution on which a Reserve Bank has
Reserve accounts that exceed the lesser these institutions to the discount
imposed, or that has adopted, a zero cap
of $10 million or 20 percent of their
window and the possibility that the
incurred a funds-related overdraft, the
capital are excused from performing
parent of an Edge or agreement
self-assessments and Filing board-ofcorporation may be unable or unwilling Reserve Bank would counsel the
institution and may monitor the
directors resolutions with their Reserve to cover its subsidiary’s overdraft on a
institution’s activity in real-time and
Banks. This dual test is designed to limit timely basis.
reject or pend any Fedwire funds tranfer
the filing exemption to depository
At the same time, the Board believes
institutions that create only low-dollar
instruction that would cause an
it is preferable for Edge and agreement
risks to the Reserve Banks and that
overdraft Because the timing of bookcorporation subsidiaries of U.S. banks,
incur small overdrafts relative to their
entry securities transfers are not fully
together with their parents, to arrange
capital.
within the control of the receiving
their affairs in a way that would allow
The Reserve Bank will review the
depository institution, the Board will
them to continue to service their
status of an exempt depository
customers and at the same time reduce
allow depository institutions with caps
institution that incurs overdrafts in its
risk exposures. Specifically, the Board
of zero that have access to the discount
Federal Reserve account in excess of
notes that the parent of an Edge or
window to continue to incur book-entry
$10 million or 20 percent of capital on
agreement corporation could fund its
overdrafts, but will require that such
more than two days in any two rolling
subsidiary during the day over Fedwire
overdrafts be collateralized even, if they
two-week reserve maintenance periods. and/or the parent could substitute itself are infrequent and modest.
The Reserve Bank will decide if the
for its subsidiary on private networks.
E. Book-entry Securities Transactions
exemption should be maintained or if
Such an approach by the parent could
the institution will be required to file for both reduce systemic risk exposure and 1. Collateralization
a cap. Even for depository institutions
permit the Edge or agreement
A depository institution's funds and
meeting the size and frequency
corporation to continue to service its
standards, the exemption would be
book-entry securities overdrafts are
customers. Edge and agreement
granted at the discretion of the Reserve subsidiaries of foreign banks are treated combined for purposes of determining
Bank.
in the same manner as their
an institution’s compliance with its cap.
domestically-owned
counterparts.
Financially
healthy depository
4. Special Situations
b.
Bankers’Banks.10 Bankers' banks institutions with positive caps that
Special risks are presented by the
are exempt from reserve requirements
frequently exceed their caps by material
participation on Fedwire of Edge and
and do not have regular access to the
amounts solely due to book-entry
agreement corporations, bankers’ banks discount window. They do, however,
securities transactions are required to
that do not maintain reserves, and
have access to Federal Reserve payment collateralize all of their book-entry
institutions that have been assigned a
services. To protect Reserve Banks from securities overdrafts. To determine
cap of zero by their Reserve Bank. Some potential losses resulting from bankers’ whether an institution exceeds its net
of these entities are major participants
banks' daylight overdrafts, bankers’
debit cap due solely to book-entry
in privately-operated, large-dollar
banks should refrain from incurring
securities activity, the Reserve Bank
clearing and settlement systems, often
overdrafts and should post collateral to determines what activity in an
making and receiving a large volume of cover any funds or book-entry securities institution's Federal Reserve account is
payments on behalf of their affiliates
overdrafts they do incur. Bankers' banks attributable to funds transfers and other
and parent organizations. Most of these may voluntarily waive their exemption
institutions lack regular discount
from reserve requirements, thus gaining payment transactions and what activity
is attributable to book-entry securities
window access. In developing its policy access to the discount window and
transactions. Book-entry securities
avoiding the requirement to post
for these institutions, the Board has
balances
are calculated by posting
collateral for all overdrafts. Such
sought to balance the goal of reducing
charges
for
original issues of Treasury
and managing risk in the payments
securities and credits for interest and
under section 25 of the Federal Reserve Act (12
system, including risk to the Federal
redemption payments for Treasury and
U.S.C. 601-604a).
Reserve, with that of minimizing the
10 For the purposes of this policy, a bankers' bank government agency book-entry
adverse effects on the payments
is a financial institution that is not required to
securities at 9:15 a.m. ET and posting
operations of these institutions.
maintain reserves under the Board's Regulation D
credits and debits from transfers of
a.
Edge and Agreement Corporations.9(12 CFR part 204) because it is organized solely to
book-entry securities as they occur. A
do business with other financial institutions, is
Edge and agreement corporations must
owned primarily by the financial institutions with
book-entry securities overdraft occurs
which it does business, and does not do business
when an institution’s book-entry
• These institutions are organized under section
with the general public and is not a depository
securities balance, less any credit in its
25(a) of the Federal Reserve Act (12 U.S.C. 611-631)
institution as defined in the Board's Regulation A
or have an agreement or undertaking with the Board (12 CFR 201.2(a)).
funds balance, is a net debit.




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

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




limit their trade size as well. This
limitation does not apply to:
(a) original issue deliveries of bookentry securities from a Reserve Bank to
a depository institution or,
(b) transactions sent to or by a
Reserve Bank in its capacity as fiscal
agent of the United States, government
agencies, or international organizations.
Thus, requests to strip or reconstitute
Treasury securities, or to convert bearer
or registered securities to or from bookentry form, are exempt from this
limitation. Also exempt are pledges of
securities to a Reserve Bank as principal
[e.g., discount window collateral) or as
agent [e.g., Treasury Tax and Loan
collateral).
F. Inter-Affilliate Transfers
Although the institutions affiliated
through common holding company
ownership are not permitted to
consolidate their wire transfer activity
and capital for the purpose of
monitoring compliance with this policy,
such institutions may engage in funds
transfers over Fedwire that are intended
to simulate consolidation among
affiliated depository institutions and
that create a pattern of daylight
overdrafts up to the sending institution’s
net debit cap, provided the following
conditions are met:
1. Each of the individual sending
depository institutions’ boards of
directors approve, at least once each
year, the intraday extension of credit to
the specified affiliate(s),11 and sends a
copy of the directors’ resolution to its
Reserve Bank.
2. During the regular examination, the
individual institution’s primary federal
supervisor reviews the timeliness of
board-of-directors resolutions, the
establishment by the institution of limits
on credit extensions to each affiliate, the
establishment by the institution of
controls to assure that credit extensions
stay within such limits, and notes
whether credit extensions have in fact
stayed within those limits.
The Board notes that the adoption of
this policy regarding transfers among
depository institution affiliates does not
in any way change the treatment of
depository institutions and their Edge
and agreement corporation subsidiaries.
The ability of a parent institution to
fund its Edge or agreement subsidiaries
on an intraday basis remains
unchanged, so long as the parent
remains within its own cap.
11 The provision of this policy statement that
allows a bolding company to establish caps for its
depository institution subsidiaries does not apply to
this requirement.

G. Third-Party Access Arrangements
The Board will allow, under certain
conditions, arrangements whereby a
depository institution or other entity
(“the service provider”) could initiate
Fedwire transfers from the Federal
Reserve account of another depository
institution. Such arrangements will be
permitted provided:
1. The institution whose account is
being charged (the “institution”) retains
control of the credit-granting process by
individually approving each transfer or
establishing credit limits within which
the service provider can act.
2. The service provider must be an
affiliate of the institution, or, if the
institution approves each individual
transaction, an unaffiliated company.
All service providers must be subject to
examination.
3. The service provider must not
permit or initiate transfers that would
exceed individual customer credit limits
without first obtaining the institution’s
permission.
4. The service provider must have the
operational ability to ensure that the
aggregate funds transfer activity of the
institution does not result in daylight
overdrafts in excess of the institution’s
cap.
5. All Fedwire transfer activity must
be posted to the institution's account,
and the institution will remain
responsible for its account
6. The institution’s board of directors
must approve the specifics of the
arrangement, including: (a) the
operational transfer of its Fedwire
transfer activity to the service provider;
(b) the net debit cap for the activity to
be processed by the service provider;
and (c) the credit limits for any inter­
affiliate funds transfers.
7. The institution and the service
provider must execute an agreement
with the relevant Reserve Banks
delineating the terms of the agreement.
8. The institution must have adequate
back-up procedures and facilities to
cover equipment failure or other
developments affecting the adequacy of
the service being provided. This back-up
must provide the Reserve Bank with the
ability to terminate a service provider
arrangement.
9. The institution must have the ability
to monitor transfers being made on its
behalf.
10. The institution must provide an
opinion of counsel that the arrangement
is consistent with corporate
separateness and does pot violate
branching restrictions.
11. The primary supervisor must not
object to the arrangement.

Federal Register / VoL 57, No. 172 / Thursday. September 3, 1992 / Notices
12. No individual with decision­
making responsibilities relating to the
Fedwire transfer area may hold such a
position in more than one affiliated
institution participating in an approved
arrangement.
13. The institution must have in place
an adequate audit program to review the
arrangements at least annually to
confirm that these requirements are
being met.
In order to assure consistency with
the Board's policy, each new
arrangement should be reviewed by the
Director of the Division of Reserve Bank
Operations and Payment Systems prior
to approval by the Reserve Bank.
H. Monitoring
I. Ex Post
Under the ex post monitoring
procedure, an institution with a net
debit position in excess of its cap will be
contacted by its Reserve Bank.** The
Reserve Bank will counsel the
institution, discussing ways to reduce its
excessive use of intraday credit. Each
Reserve Bank retains the right to protect
its risk exposure from individual
institutions by unilaterally reducing
Fedwire caps, imposing collateralization
or clearing balance requirements,
holding or rejecting Fedwire transfers
dining the day until the institution has
collected balances in its Federal
Reserve account, or, in extreme cases,
taking the institution off-line or
prohibiting it from using Fedwire.
2. Real Time
A Reserve Bank will apply real-time
monitoring to an individual institution's
position when the Reserve Bank
believes that it faces excessive risk
exposure, e.g., from problem banks or
institutions with chronic overdrafts in
excess of what the Reserve Bank
determines is prudent. In such a case,
the Reserve Bank will control its risk
exposure by monitoring the institution’s
position on a real-time basis, rejecting or
delaying transfers if the account balance
would otherwise be exceeded, and
taking other prudential actions.
3. Multi-District Institutions
A depository institution that chooses
to access Fedwire through accounts in
more than one Federal Reserve district
is expected to manage its accounts so
that its aggregate net debit position
across all accounts does not exceed its
11 Even if the institution is not a state member
bank, the Reserve Bank can make this contact when
an overdraft occurs in a reserve or clearing account
or when the institution is in a net debit position on a
wire system that settles on the books of the Federal
Reserve.




net debit cap. One Reserve Bank will act
as administrative Reserve Bank and will
have overall risk-management
responsibilities for institutions
maintaining accounts in more than one
Federal Reserve district. In the case of
families of branches and agencies of the
same foreign bank, net debit cap
compliance will be monitored by the
Reserve Bank that exercises the Federal
Reserve’s oversight responsibilities
under the International Banking A ct13
The administrative Reserve Bank may
determine, in consultation with Reserve
Banks in whose territory other U.S.
agencies or branches of the same foreign
bank are located and with the
management of the foreign bank’s U.S.
operations, that branches and agencies
outside its district either will not be
permitted to incur overdrafts in Federal
Reserve accounts or must allocate part
or all of the foreign family's net debit
cap (and the responsibility for
administering part or all of the collateral
requirement) to a Reserve Bank in
whose district one or more of the foreign
offices operate.14 For domestic
depository institutions that have
branches in multiple Federal Reserve
districts, the administrative Reserve
Bank generally will be the Reserve Bank
where the head office of the bank is
located.
4. ACH Controls
To reduce risk in the ACH mechanism
associated with the origination of ACH
credit transactions by institutions that
are experiencing financial difficulties,
the Reserve Banks:
(a) will monitor ACH credit payments
originated by such depository
institutions;
(b) may require advanced funding or
other assurance of payment or may
reject payments if it appears the
originating depository institution will
not have sufficient funds on the
settlement day; and
(c) will review origination patterns for
all ACH originators of debit and credit
payments.
In addition, a Reserve Bank may defer
the availability of some or all of the
13 12 U.S.C. 3101-310&
14 As in the case of Edge and agreement
corporations and their branches, with the approval
of the designated administrative Reserve Bank, a
second Reserve Bank may assume the responsibility
of managing and monitoring the net debit cap of
particular foreign branch and agency families. This
would often be the case when the payments activity
and national administrative office of the foreign
branch and agency family is located in one district
while the oversight responsibility under the
International Banking Act is in another district. If a
second Reserve Bank assumes management
responsibility, monitoring data will be forwarded to
the designated administrator for use in the
supervisory process.

40461

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

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

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




important in view of these systems’
potential for growth, their high volumes,
and the possible future course of the
Federal Reserve’s payments system risk
reduction program, e.g., pricing intraday
Fedwire funds and book-entry
overdrafts.
Delivery-against-payment securities
systems, as described below, are
expected to adopt appropriate liquidity
and credit safeguards in order to ensure
that settlement occurs in a timely
fashion and that the participants do not
face excessive intraday risks. In view of
the continuing evolution of these
systems, the Board has established
general guidelines rather than specifying
the exact form such safeguards should
take. Reversals or "unwinds” of funds
and securities transfers, however, are
not considered appropriate liquidity
control measures.
The policy addresses four issues:
(1) Liquidity safeguards for ensuring
settlement;
(2) Provisions for reversals;
(3) Credit safeguards, such as
collateral and netting features; and
(4) Open settlement accounting. These
components, and the scope and
regulatory implications of this policy,
are described below.
Scope of the Policy
This policy is specifically targeted at
large-scale private delivery-againstpayment securities systems that settle
their obligations on a net, same-day
basis over Fedwire, either directly or
indirectly. These systems settle
securities transactions for their
participants by transferring securities
and the accompanying payment
obligations on the books of a clearing
corporation or a depository institution
operating the system and arrange for
final 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 settle obligations to or
from many counterparties by making a
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 this system. "Large-scale”
systems are those systems that routinely
process a significant number of
individual transfers larger than $50,000
or that would permit any one participant
to be exposed to a net debit position at
the time of 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
bank, such that obligations that settle on
an item-by-item basis are the direct
obligations of the bank, will not be
subject to this policy because of the
existing supervisory oversight of a
bank’s liquidity and credit resources.
This policy applies to systems in the
United States that transfer debt and
equity securities, including those not
eligible for Fedwire. The policy does not
apply to 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 the
extension of 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, the failure by a
single participant with a net debit
position may delay settlement of 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, therefore, may
not be able to conclude other
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
private systems settle in a timely
manner, so that participants can rely on

Federal Register / Vol. 57, No. 172 / Thursday, September 3, 1992 / Notices
the funds or securities obtained as a
result of transfers through the system.
The importance of ensuring reliable
transfers is due in part to the fact that
these systems generally allow
participants to re-transfer funds credits
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 recdgnizes
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. Hie 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.




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

40463

be appropriate and prudent for a system
to have rules that would require
participants who have dealt with the
defaulter to be responsible, after
settlement, for the related loss. These
arrangements could well include
returning securities to the counterparty
to help absorb the loss.
Open Settlement Accounting
As delivery-versus-payment systems
grow in size and volume, the timely and
orderly completion of end-of-day
settlements takes on an increased
importance for the settlement of other
large-dollar payments systems. As a
general matter, the Board believes that it
will be easier for market participants
and supervisors to monitor and protect
against settlement risks if current
information is readily available.
Participants in a delivery-againstpayment system should therefore have
up-to-date information on their net
position and on the settlement progress
of the system, and appropriate market
supervisors should have ready access to
current intraday information on both the
system’s settlement and participants’
positions. For those systems wishing to
use Fedwire payments as a means of
settlement, the Board encourages the
use of Federal Reserve Bank net
settlement services rather than
individual wire payments that cannot be
distinguished from all other Fedwire
payments. This policy is in no way
intended to broaden access to Federal
Reserve services; neither Fedwire nor
net settlement services will be available,
as a general matter, to non-member,
non-depository institutions.
C. Offshore Dollar-Clearing and Netting
Systems16
For some time, the Board has been
sensitive to the risks associated with the
actual and potential development of
netting and clearing arrangements for
U.S. dollar payments located outside the
United States. In particular, the Board
has been concerned that the steps being
taken to reduce systemic risk in U.S.
large-dollar payments systems may
themselves induce the further
development of “offshore” dollar
payments systems. These offshore
systems can settle through payments on
the Federal Reserve's wire transfer
system (Fedwire) or the New York
Clearing House’s Clearing House
Interbank Payments System (CHIPS),
but may operate without adequate
*• The Board adopted this policy statement in
June 1989 as an interim measure to address offshore
clearing and netting systems until an international
consensus is reached among central banks and
bank supervisory authorities.

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

procedures for the management of risks
and without any form of official
oversight. The Board also 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 is 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 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 that, 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.*7
At the same time, the Board
recognizes that the technological,
market, and regulatory incentives that
are giving rise to the growth of these
arrangements wilhcontinue 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
to improve CHIPS participants’
awareness of payment risks, to control
the level of daylight exposures within
CHIPS, and now to adopt settlement
finality procedures.18
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
17 In November 1990, the "Report of the
Committee on Interbank Netting Schemes pf the
Central Banks of the Group of Ten Countries" was
published by the BIS. Federal Reserve staff is
reviewing the Board's policies on offshore dollarclearing and netting systems.
*• CHIPS adopted settlement finality procedures
in October 1990.

and tobe used to avoid the Board’s
domestic risk reduction policies, the
Board believes that it is appropriate forit to provide preliminary guidance on the
framework within which offshore dollar
systems should operate. The Board
recognizes that the question of the
degree of oversight and supervision of
offshore clearing and netting systems
can only be fully addressed on a
cooperative basis among central banks
and national bank supervisory
authorities. In the interim, the Board’s
approach to offshore dollar clearing and
netting 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
assuring the prudent management of
these risks.
3. The system should have
arrangements in place that 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 minimum structural features that the

Federal Register / Vo). 57, No. 172 / Thursday, September 3, 1992 / Notices
Board believes are appropriate for
offshore dollar clearing arrangements.
These principles also presume a
cooperative international approach to
the supervision of offshore clearing and
netting arrangements.
D. Private Small-Dollar Clearing and
Settlement Systems
1. National ACH Net Settlement
In October 1990, the Board approved a
proposal under which the Federal
Reserve would provide net settlement
services to depository institutions
participating in a national, multilateral
automated clearing house (ACH)
clearing arrangement. The factors
considered by the Board in 1990,
discussed below, would also apply to
any future proposals for national ACH
net settlement services.
Assurance of settlem ent The ACH is
generally considered a small-dollar
payment mechanism, and the settlement
positions of ACH participants tend to be
small relative to capital. Additionally,
unlike large-dollar funds transfer
systems, such as CHIPS, ACH payments
typically are exchanged in batches
before the settlement day. Payments
received by ACH participants, therefore,
generally are not used to fund
subsequent payments to participants
within the system. These two factors—
the relatively low value of payments
and the single flow of payments—result
in less systemic credit and liquidity risk
for participants in ACH clearing
arrangements than for participants in
large-dollar payments systems.
Nevertheless, a national ACH
network that receives settlement
services from the Federal Reserve
should take steps to minimize the risk
exposure of its participants should one
of the participants be unable to fund its
net debit position at the designated
settlement time. The Board does not
mandate specific risk control provisions
but will consider the effectiveness of
provisions suggested by the participants
in a clearing and settlement
arrangement. Among the types of credit
and liquidity controls that should be
considered by such clearing and
settlement arrangements are (a)
objective admission criteria and ongoing
monitoring of participants’ adherence to
those criteria, (b) bilateral credit limits,
(c) net debit caps, and (d) gross
origination caps.
For example, an ACH network might
control credit risk by evaluating the
creditworthiness of participants and
setting specific credit criteria for
admission or by requiring each
participant to establish bilateral credit
limits with each other participant in a




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

40465

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

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

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




and cancellation at any time by either
party) national bank lending limits do
not apply.
Each participant should satisfy itself
that it has the flexibility to negotiate
amounts, rates, and maturity options
before using these practices for federal
funds, Eurodollars, or other financial
instruments. Either of these practices,
rollovers or continuing contracts, can
reduce daylight overdrafts or intraday
net debits, and their prudential use by
the banking industry is consistent with
the Federal Reserve’s policy of reducing
intraday exposures on Fedwire and
CHIPS. When borrowing banks reduce
their daylight overdrafts by use of these
practices, some extra operational costs
and risks may be incurred by either
party compared to current arrangements
in the overnight market. For example,
sellers of federal funds and other
instruments may have to develop
alternative audit trail procedures and
may accept some additional risk of
repayment since funds would not be
returned each day before they would be
relent. In addition, buyers of federal
funds and other instruments may
experience some extra initial operating
costs to set up rollover arrangements
between themselves and lending banks
and may have to pay a higher rate to
induce lenders to commit their funds for
a longer time. However, these costs and
risks, if any, should be reflected in the
rate or rate spread received and paid.
Although it is unclear whether rates on
daily interbank funds transactions will
fall relative to rates paid for rollovers,
continuing contracts, or term funds, or
whether the reverse will occur, the
Board believes that the negotiation of
terms relative to the use of these
arrangements should be left to the free
operation of the private market.
The Board also supports efforts to
encourage timely return of overnight
federal funds and other borrowings and
encourages operational improvements
that would consistently allow timely
receipt of funds purchased soon after a
seller negotiates a sale. Similar
arrangements and industry standards
were suggested for federal funds by the
American Bankers Association in July
1980.
By order o f the Board o f G overnors o f the
F ed eral R eserv e S ystem , A ugust 23,1992.

Jennifer J. Johnson,
Associate Secretary of the Board
[FR D oc. 92-21207 F iled 3 -2 -92; 6:i5 «ra]
BILLING CODE S210-01-F