Policy on Payment System Risk, 79109-79127 [E8-30627]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 73, Number 248 (Wednesday, December 24, 2008)]
[Notices]
[Pages 79109-79127]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-30627]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1345]


Policy on Payment System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Policy statement.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
has adopted revisions to part II of its Policy on Payment System Risk 
(PSR) that are designed to improve intraday liquidity management and 
payment flows for the banking system, while also helping to mitigate 
credit exposures of the Federal Reserve Banks (Reserve Banks) from 
daylight overdrafts. The adopted changes to the PSR policy are 
substantially the same as those proposed for comment, including a new 
approach that explicitly recognizes the role of the central bank in 
providing intraday balances and credit to healthy depository 
institutions, a zero fee for collateralized daylight overdrafts, a 50 
basis point (annual rate) charge for uncollateralized daylight 
overdrafts, and a biweekly daylight overdraft fee waiver of $150. The 
implementation of the changes will take place between the fourth 
quarter of 2010 and first quarter of 2011. A specific date will be 
announced by the Board at least 90 days in advance. The Board also 
approved for foreign banking organizations (FBO) an interim policy 
change related to the calculation of the deductible amount from 
daylight overdraft fees under the existing policy and early 
implementation of the proposed streamlined procedure for maximum 
daylight overdraft capacity (max cap). The interim policy change for 
the deductible and streamlined max cap procedure will be effective on 
March 26, 2009. In addition, the Board endorsed a four-prong strategy, 
which includes these policy changes, through which the Federal Reserve 
and industry will address related intraday liquidity, operational, and 
credit risks in the wholesale payment system.

DATES: Effective Dates: The policy will take effect between the fourth 
quarter of 2010 and first quarter of 2011 with a specific date 
announced at least 90 days in advance.
    The interim policy for the deductible and streamlined max cap 
procedure will be effective on March 26, 2009.

FOR FURTHER INFORMATION CONTACT: Jeffrey Marquardt, Deputy Director 
(202-452-2360) or Susan Foley, Assistant Director (202-452-3596), 
Division of Reserve Bank Operations and Payment Systems, Board of 
Governors of the Federal Reserve System; for users of 
Telecommunications Device for the Deaf (``TDD'') only, contact (202) 
263-4869.

SUPPLEMENTARY INFORMATION:

I. Background

    On March 7, 2008, the Board requested comment on a new approach to 
intraday central bank balances and credit that formally recognizes the 
role of the central bank in providing such balances and credit to 
depository institutions and encourages them to collateralize explicitly 
their daylight overdrafts.\1\ The Board proposed a policy of supplying 
intraday balances to healthy depository institutions predominantly 
through explicitly collateralized daylight overdrafts. Under this 
proposal, the Board would allow depository institutions to pledge 
collateral voluntarily to secure daylight overdrafts, and 
collateralized daylight overdrafts would be charged a zero fee. To 
further encourage the voluntary use of collateral, the Board would 
raise the fee for uncollateralized daylight overdrafts to 50 basis 
points (annual rate) from the current 36 basis points. The Board also 
proposed increasing the biweekly daylight overdraft fee waiver to $150 
from $25 to minimize the effect of the proposed policy changes on 
institutions that use small amounts of daylight overdrafts. In 
addition, the Board proposed changes to other elements of the PSR 
policy dealing with daylight overdrafts, including adjusting net debit 
caps, streamlining max cap procedures for certain FBOs, eliminating the 
current deductible for daylight overdraft fees, and increasing the 
penalty daylight overdraft fee for ineligible institutions to 150 basis 
points (annual rate) from the current 136 basis points.
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    \1\ See 73 FR 12417, March 7, 2008.
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    The Federal Reserve has been reviewing for several years the long-
term effects of operational, market, and policy changes by the industry 
and the Federal Reserve on intraday liquidity, operational, and credit 
risks in the payment system, including intraday account overdrafts at 
the Reserve

[[Page 79110]]

Banks.\2\ The proposed changes reflect the culmination of this work, 
along with companion efforts by the banking industry.
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    \2\ As part of its review, in June 2006, the Board published for 
public comment the Consultation Paper on Intraday Liquidity 
Management and the Payments System Risk Policy (71 FR 35679, June 
21, 2006) seeking information from financial institutions and other 
interested parties on their experience in managing liquidity, 
operational, and credit risks related to Fedwire funds transfers, 
especially late-day transfers. The paper included a list of detailed 
objectives relating to safety and efficiency that the Board has 
previously used to conduct payment system risk analysis. An 
important goal of the consultation process was to identify 
opportunities to improve the safety/efficiency trade-offs in the 
payment system over the long run. For a summary of comments on the 
consultation paper, see 73 FR 12417, March 7, 2008.
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    Significant changes to U.S. payment and settlement systems over the 
past twenty-five years have helped reduce systemic risk. In accord with 
U.S. and international risk policies and standards, several of these 
changes have relied increasingly on the use of central bank money--in 
this context, balances that financial institutions and private clearing 
and settlement organizations hold in accounts at Reserve Banks--to 
strengthen the management of credit and liquidity risk in private-
sector clearing and settlement arrangements. Such changes have had the 
effect of increasing significantly the intraday demand for central bank 
money and hence the demand for daylight overdrafts at the Reserve 
Banks.
    Overall, however, the combined effect of changes at clearing and 
settlement organizations, depository institutions' intraday liquidity 
management strategies, and late-day market activity has been to shift 
the sending of larger Fedwire funds transfers to later in the day. From 
an operational risk perspective, waiting to send large payments late in 
the day increases the potential magnitude of liquidity dislocation and 
risk in the financial industry if late-in-the-day operational 
disruptions occur. An increase in such risk is particularly troublesome 
in an era of heightened concern about operational disruptions 
generally.
    To address the combination of intraday liquidity, operational, and 
credit risks in the wholesale payment system, the Board considered 
changes to its PSR policy, which sets out the general public policy 
objectives of safety and efficiency for payment and settlement systems. 
The changes to the PSR policy, however, are only one effort under a 
four-pronged strategy involving the Federal Reserve and the financial 
industry. The second effort involves the Reserve Banks working with the 
industry to investigate the potential development of a liquidity-saving 
mechanism for the Fedwire Funds System.\3\ The third and fourth efforts 
involve The Clearing House Interbank Payment System (CHIPS) and 
Depository Trust & Clearing Corporation identifying opportunities to 
improve transaction processing and liquidity use in their systems and 
processes that relate to large-value funds and securities settlement, 
respectively.\4\
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    \3\ The creation of a liquidity-saving mechanism would conserve 
on account balances or daylight overdrafts and would also reduce the 
amount of collateral needed to achieve costless daylight overdrafts 
under the zero fee for collateralized daylight overdrafts. The 
liquidity-saving mechanism could involve adding new features to the 
Fedwire Funds Service that depository institutions could use to 
coordinate better the timing and settlement of their payments as 
well as to economize on the use of intraday central bank money, 
daylight overdrafts, and collateral. The existing real-time gross 
settlement functionality of Fedwire would be retained.
    \4\ CHIPS is a real-time final payment system operated by The 
Clearing House Payments Company. In January 2001, The Clearing House 
implemented operational and rule changes to allow all transactions 
settled in CHIPS to be final upon release from a central queuing 
system. Depository Trust & Clearing Corporation operates six 
subsidiaries that provide clearance, settlement, and information 
services for many financial instruments, including equities, 
corporate and municipal bonds, government and mortgage-backed 
securities, money market instruments, and over-the-counter 
derivatives.
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II. Summary of Comments and Analysis

    The Board received nineteen comment letters on its proposed policy. 
The commenters included thirteen commercial banking organizations, four 
trade organizations, one private-sector clearing and settlement system, 
and the Federal Reserve Bank of New York's Payment Risk Committee.\5\ 
Most commenters (seventeen) supported the proposed policy changes. One 
commenter opposed the proposed policy because it does not believe fees 
are necessary to encourage the pledging of collateral if net debit caps 
are in place to control the Reserve Banks' risk. One commenter did not 
indicate support or opposition.
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    \5\ The Payment Risk Committee (PRC) is sponsored by the Federal 
Reserve Bank of New York and works to identify and analyze issues of 
mutual interest related to risk in payments and settlement. The 
institutions represented on the PRC include Bank of America, Bank of 
New York Mellon, Bank of Tokyo-Mitsubishi UFJ, Citibank, Deutsche 
Bank, HSBC, JPMorgan Chase, State Street, UBS, Wachovia, and Wells 
Fargo. The Wholesale Customer Advisory Group (WCAG) advises the 
Wholesale Product Office on business issues and is composed of 
depository institutions that are major users of Fedwire. 
Institutions represented on this group include ABN AMRO, Bank of 
America, Bank of New York Mellon, Citibank, Deutsche Bank, HSBC, 
JPMorgan Chase, Key Bank, Mellon Financial, State Street, SunTrust, 
UBS, US Bank, US Central Credit Union, Wachovia, and Wells Fargo.
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Comments on Proposed PSR Policy Changes

    Several commenters noted that the new approach and specifically the 
zero fee for collateralized overdrafts would contribute to an increase 
in intraday liquidity and an overall reduction in operational and 
credit risks in the payment system. They also believed that the 
proposed policy would provide an incentive for institutions to reduce 
payments held in internal queues to manage liquidity use, and that the 
earlier release of these payments would increase the velocity of 
overall payment flows and liquidity circulation. Other commenters 
commended the Board for recognizing explicitly its role in providing 
intraday balances and credit, for introducing a two-tiered pricing 
system, and for proposing changes that improve the balance between 
payment system safety and efficiency objectives.
    While commenters acknowledged areas where the proposed changes 
would likely achieve positive outcomes, such as encouraging the release 
of more payments from internal liquidity queues, a few commenters 
indicated that they did not believe the proposed policy changes would 
address fully the late-day compression of Fedwire funds transfers. As 
of third quarter 2008, 31 percent of the value of Fedwire payments are 
sent after 5 p.m., a 41 percent increase from just 10 years ago.\6\ 
This growth is driven by the largest-valued payments (the 99th 
percentile), which averaged about $1.25 billion through mid-2008. The 
compression results to a certain extent from payments held in liquidity 
queues until later in the day but is also importantly driven by 
processes at clearing and settlement organizations and late-day market 
activity. For instance, private-sector payment systems have created a 
structural demand for intraday central bank balances and related credit 
averaging about $50 billion per day. This credit supports these 
systems' routine settlement and risk management activities, and the 
associated balances are released late in the day. On peak days, this 
demand for balances can exceed $150 billion. A significant proportion 
of such balances are not currently released to depository institutions 
until after 4:30 p.m. for general use in the payment system. Overall, 
from an operational risk perspective, the compression of payments, 
particularly large payments, sent late in the day increases the 
potential magnitude of liquidity dislocation and risk in the financial

[[Page 79111]]

industry if late-in-the-day operational disruptions should occur.
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    \6\ All times referenced are eastern time.
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Comments on Four-Prong Strategy Involving Federal Reserve and Industry 
Efforts

    Several commenters recognized that additional efforts are needed to 
address the late-day compression of payments and strongly encouraged 
continued work on the three other efforts under the four-prong strategy 
endorsed by the Board. The three other efforts cover the potential 
development of a liquidity-saving mechanism for the Fedwire Funds 
Service, improvements in payments processing for CHIPS, and 
improvements in liquidity usage within the Depository Trust & Clearing 
Corporation, particularly its Depository Trust Company (DTC) 
subsidiary.\7\ These initiatives have been a collaborative effort by 
the Federal Reserve and industry and are ongoing.
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    \7\ DTC provides custody and settlement services for corporate 
and municipal securities and money market instruments. DTC is a 
member of the Federal Reserve System and a clearing agency 
registered with the Securities and Exchange Commission.
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    The Reserve Banks have been exploring with the industry the 
possibility of developing a liquidity-saving mechanism for the Fedwire 
Funds Service. Such a mechanism would also potentially economize on the 
amount of collateral needed to settle a given value of transactions. 
For example, the creation of the mechanism could further encourage the 
coordinated release of payments held in the liquidity queues of 
depository institutions by reducing the total liquidity (and 
collateral) used to fund those payments. Four comment letters, one of 
which represented sixteen large depository institutions, strongly 
supported the development of a liquidity-saving mechanism. One 
commenter specifically discussed the efficiency gains of moving 
payments from individual institution queues to a centralized queue that 
would enable timely matching and offsetting of payments.
    As part of industry efforts, CHIPS, working with its members, has 
pursued ideas to facilitate faster matching and offsetting of large-
value payments throughout the day to reduce the number of unresolved 
payments that need to be settled at the end of the CHIPS operating day. 
Similarly, DTC has explored possible operational and technical changes 
that may reduce liquidity used in its systems and processes related to 
securities settlement. The money market instrument clearing and 
settlement processes, in particular, currently requires a substantial 
amount of liquidity to be transferred to and remain at DTC until end-
of-day settlement around 4:30 p.m. when the liquidity is released back 
to DTC's participants. Several comment letters strongly supported 
ongoing efforts by CHIPS and DTC. Many of these commenters stressed the 
importance of taking further steps to ease end-of-day liquidity 
``traps.''
    The Board fully supports continued progress on the three efforts. 
The Board agrees that the approved changes to the PSR policy alone are 
not sufficient to address late-day payment compression and liquidity 
pressures in the payment system. The Board approved the revised PSR 
policy based on the expectation that the financial industry will 
continue to pursue the elements of the four-prong strategy to address 
the combination of related intraday liquidity, operational, and credit 
risks in the wholesale payment and settlement system. In addition, 
further efforts may be needed to review market clearing and settlement 
practices that help push payments later in the day than may be 
necessary.

Revised PSR policy

    As noted in the Board's Consultation Paper on Intraday Liquidity 
Management and the Payments System Risk Policy and in its request for 
comment on proposed changes to the PSR policy, the Board conducted a 
broad policy review.\8\ A key component of this review included 
assessing anew the role of the central bank in the payment system. 
Current thinking about the role of central banks in providing intraday 
balances to the payment system has evolved significantly over the past 
twenty years and now explicitly recognizes that central banks have an 
important role in providing intraday (central bank money) balances to 
foster the smooth operation and settlement of payment systems.\9\
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    \8\ See 71 FR 35679, June 21, 2006, and 73 FR 12417, March 7, 
2008.
    \9\ See ``The Role of Central Bank Money in the Payment 
System,'' Committee on Payment and Settlement Systems, August 2003 
at https://www.bis.org/publ/cpss55.pdf.
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    In view of this perspective, the Board proposed adopting a new 
approach to enhance intraday liquidity and the flow of payments, while 
controlling risk to the Reserve Banks. The approach would
    (1) Explicitly recognize that the Federal Reserve has an important 
role in providing intraday balances and credit to foster the smooth 
operation of the payment system.
    (2) Provide temporary, intraday balances to healthy depository 
institutions predominantly through collateralized intraday overdrafts.
    (3) Reduce over time the reliance of the banking industry on 
uncollateralized daylight credit if this can be done without 
significantly disrupting the operation of the payment system or causing 
other unintended adverse consequences.
    Commenters generally supported this new approach and did not 
recommend changes. Several commenters requested information about how 
collateral management and monitoring systems would be changed in 
implementing the approach. One commenter also noted that the complexity 
of collateral management could introduce a new type of operational risk 
that would need to be managed. The Board recognizes that under the 
revised policy depository institutions will have an increased need to 
manage actively their collateral pledged to the Reserve Banks. In the 
past, depository institutions have pledged significant amounts of loans 
as collateral for discount window and PSR purposes, along with smaller 
amounts of securities. Loan collateral traditionally has had a low 
opportunity cost. For some institutions and at certain times, however, 
securities can be an important source of collateral pledged to the 
Reserve Banks and could play an important role in fine-tuning 
collateral positions to meet daily PSR needs. In some cases, 
institutions may also seek to pledge securities on an intraday basis 
and not keep them on deposit at a Reserve Bank overnight. The Reserve 
Banks will be implementing changes over both the short and long term to 
their operational systems and processes in anticipation of depository 
institutions' changing needs for collateral management. These changes 
are discussed later in the collateral section.
    The Board also received one comment letter that supported the 
collateralization portion of the new approach but opposed moving to a 
mandatory collateral regime. The move toward voluntary 
collateralization under the new approach reflects the Board's 
sensitivity to sudden and disruptive changes in policy, the possibility 
of creating unintended intraday liquidity and operational risks for the 
payment system, and the potential burden on the banking industry. An 
important aspect of the new approach is the shift to a greater use of 
collateral in a way that minimizes the cost and administrative burden 
of the policy on most users of daylight overdrafts.
    Overall, the Board believes the new approach significantly improves 
the tradeoffs between safety and efficiency

[[Page 79112]]

objectives of the PSR policy for the payment system and its 
participants. In approving this approach, the Board expects 
institutions to reduce over time their reliance on uncollateralized 
daylight credit. If this does not occur, the Board may choose, for 
example, to evaluate the effectiveness of the level of the fee for 
uncollateralized overdrafts in encouraging the transition to a 
predominantly collateralized daylight overdraft regime. The Board will 
also continue to monitor developments over time, and at some future 
date, may evaluate the costs and benefits of moving further toward a 
fully collateralized structure.

Specific Changes to Revised PSR policy

    To implement the new approach, the Board has approved changes to 
certain terms and fees for providing daylight overdrafts. The following 
table summarizes the specific elements of the current and revised PSR 
policy.

 Table--Summary of Key Elements of the Current and Revised PSR Policy *
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                                 Current policy        Revised policy
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Collateral                    Required for problem  Additional provision
                               institutions** and    that explicitly
                               institutions with     applies collateral
                               max caps.             pledged by
                               Collateral            institutions to
                               eligibility and       daylight overdrafts
                               margins same as for   for pricing
                               discount window.      purposes.
Fee for collateralized        36 basis points.....  Zero fee.
 daylight overdrafts.
Fee for uncollateralized      36 basis points.....  50 basis points.
 daylight overdrafts.
Deductible..................  10 percent of an      Replaced by zero fee
                               institution's         for collateralized
                               capital measure.      daylight overdrafts
                                                     and fee waiver.
Fee waiver..................  Up to $25 biweekly..  $150 biweekly ***.
Net debit cap...............  Two-week average      Two-week average
                               limit and higher      limit eliminated;
                               single-day limit.     single-day limit
                               Ex post counseling    retained.
                               if exceed limit.      Flexibility in ex
                                                     post counseling if
                                                     fully
                                                     collateralized.
Max cap.....................  Additional            Streamlined process
                               collateralized        for certain FBOs up
                               capacity above net    to a limit
                               debit cap for self-   (effective March
                               assessed              26, 2009). Minor
                               institutions.         changes apply for
                                                     all institutions.
Penalty fee for ineligible    136 bps.............  150 bps.
 institutions.
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* Access to daylight credit would continue to be available only to
  institutions with regular access to the discount window as is the case
  today.
** Problem institutions are institutions that are in weak financial
  condition and should refrain from incurring daylight overdrafts and
  institutions that chronically incur daylight overdrafts in excess of
  their net debit caps in violation of the PSR policy.
*** The proposed $150 waiver would be subtracted from the gross fees (in
  a two-week reserve-maintenance period) assessed on any depository
  institution eligible to incur daylight overdrafts. This procedure
  differs from the current policy in which the waiver only eliminates
  gross fees of institutions that have charges less than or equal to $25
  in a two-week period but includes a deductible.

    To assist institutions in understanding the effect of the revised 
policy on their daylight overdraft fees, the Board has made available a 
simplified fee calculator. The calculator enables institutions to 
provide daylight overdraft and collateral data to estimate their 
daylight overdraft fees under the revised PSR policy. The calculator 
will be available until 30 days after the to-be-announced effective 
date of the revised policy and is located on the Board's Web site at 
https://www.federalreserve.gov/apps/RPFCalc/.

A. Collateral

    The Board proposed supplying intraday balances to healthy 
depository institutions predominantly through explicitly collateralized 
daylight overdrafts provided by Reserve Banks. The Board proposed 
allowing the use of collateral to be voluntary to avoid disrupting the 
operation of the payment system and increasing the cost burden of the 
policy on a large number of smaller users of daylight overdrafts. As 
part of the proposal, collateral eligibility and margins would remain 
the same for PSR policy purposes as for the discount window.\10\ The 
pledging of in-transit securities would remain a collateral option for 
PSR purposes at Reserve Banks' discretion.\11\
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    \10\ See https://www.frbdiscountwindow.org/ for information on 
the discount window and PSR collateral acceptance policy and 
collateral margins.
    \11\ In-transit securities are book-entry securities transferred 
over the Fedwire securities system that have been purchased by a 
depository institution but not yet paid for or owned by the 
institution's customers.
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    The comment letters generally supported the application of 
collateral to daylight overdrafts, specifically with a zero fee. 
Several commenters noted that, broadly across the industry, 
institutions will likely increase the amount of collateral pledged to 
Reserve Banks. Several commenters addressed how their individual 
institutions may adjust collateral positions or payments activities in 
response to a zero fee for collateralized overdrafts and higher fee for 
uncollateralized overdrafts. Three commenters stated they would 
increase collateral pledged with their Reserve Bank. Two commenters 
stated that they had enough collateral to cover any potential daylight 
overdraft and would not pledge additional collateral. In addition, six 
commenters noted that deciding whether to pledge collateral would 
depend on the opportunity cost of collateral in relation to the cost of 
the daylight overdraft.
    Commenters overall believed there could be a substantial 
opportunity cost to pledge collateral depending on market conditions 
and whether the lowest-cost collateral has already been pledged for 
discount window purposes by a depository institution. One commenter 
estimated the cost of collateral at between 26 and 50 basis points for 
collateral that has already been pledged but potentially much higher 
for currently unpledged collateral that might be needed to obtain 
incremental intraday liquidity. Another commenter estimated the cost of 
additional collateral to exceed 50 basis points. Other commenters 
discussed the potential high cost to pledge additional collateral but 
did not provide estimates. Two commenters noted that the cost of 
collateral would be relatively high in a volatile market when demand 
for collateral increases and supply is scarce. Another commenter noted 
that, in order to cover all potential daylight overdrafts, the 
institution would incur a high monthly expense to

[[Page 79113]]

overcollateralize its daylight overdraft balance. For many of these 
institutions, the decision to pledge higher-cost collateral would 
depend on the opportunity cost of pledging a particular asset relative 
to the level of the uncollateralized daylight overdraft fee.
    Some commenters also responded to the Board's question on the 
potential effects of the collateral policy on other financial market 
activities. Five commenters noted that pledging collateral for daylight 
overdraft purposes would reduce the pool for funding or investing 
activities. Conversely, two commenters believed that the policy would 
not have an effect on market activity because of the wide range of 
collateral accepted by Reserve Banks.
    Two commenters requested that collateral pledged for daylight 
overdrafts be automatically available to cover unforeseen overnight 
overdrafts, which in effect creates an overnight discount window loan. 
Two commenters wanted the ability to pledge collateral through a 
central cross-border utility accessed by multiple central banks. The 
cross-border utility would enable global institutions to manage more 
effectively collateral held in different jurisdictions and to take 
advantage of differences in time zones. Finally, one commenter asked 
that deadlines to pledge and withdraw collateral be extended to cover 
the settlements of DTC and CHIPS and be as late as the close of the 
Fedwire Funds Service. Today, the Reserve Banks accept pledges of some 
securities up until 3 p.m. Securities held in the Fedwire Securities 
Service, however, can be pledged to the Reserve Banks up until 7 p.m. 
(or a half-hour after the Fedwire Funds Service closes).
    While commenters raised several points for the Board's 
consideration, commenters appeared to have few significant concerns 
with the proposed voluntary collateralization regime. The most 
significant concern, which was raised by the majority of commenters, 
related to system and process enhancements for collateral management 
and monitoring at the Reserve Banks. For some commenters, support for 
the proposed policy was contingent on increased efficiency in 
collateral processing and real-time or near-real-time information on 
collateral pledged. About half the commenters expressed strong 
preferences that the Reserve Banks' collateral management systems 
facilitate the pledging and withdrawal of securities intraday. Five 
commenters also made suggestions to expand the range of eligible 
collateral, including additional types of cross-border securities. The 
Board recognizes that enhancements to collateral management systems and 
processes are an important aspect of implementing the revised PSR 
policy, and the Federal Reserve is developing a plan to mitigate the 
concerns raised as discussed in the next section.
    On balance, the Board believes that the proposed voluntary 
collateralization regime will better meet the needs of the Reserve 
Banks and industry than the current policy. The Board also believes 
that unencumbered collateral pledged to Reserve Banks should be 
available to support the use of intraday credit.\12\ In addition, the 
Board believes that it is important for consistency to maintain for PSR 
policy purposes the same collateral eligibility and margins as for the 
discount window.\13\
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    \12\ Under some circumstances, rules for determining whether 
collateral is available may differ for PSR and discount window 
purposes. For example, under term lending (announced July 30, 2008), 
institutions requesting an advance of more than 28 days will need to 
hold an additional 33 percent of collateral in excess of the 
collateral required for the advance. This additional collateral may 
not available for discount window purposes but would be considered 
available (unencumbered) for PSR purposes.
    \13\ In-transit securities would also remain an eligible 
collateral option for PSR policy purposes at the Reserve Banks' 
discretion. Reserve Banks will require detailed information on a 
minute-by-minute basis to be submitted.
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    Collateral management. The Federal Reserve is in the process of 
assessing its collateral-management systems and processes. It has 
identified a number of possible improvement opportunities and has begun 
engaging the industry in dialogue about needed and desired 
functionality and process improvements.\14\
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    \14\ The Federal Reserve is also in dialogue with depository 
institutions interested in pledging in-transit collateral for 
pricing purposes to discuss new data requirements and processes.
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    Based on comment letters and initial industry discussions, the 
Federal Reserve identified a number of changes that it intends to 
implement prior to the effective date of the revised policy. This 
short-term strategy involves several initiatives to improve the 
pledging and withdrawal of specific types of securities. The strategy 
also includes increasing information available intraday and interday on 
pledged collateral through the Reserve Banks' Account Management 
Information application (AMI).\15\ In addition, the Federal Reserve 
will be publishing general timing guidelines for collateral pledging 
and withdrawal to help institutions better track when collateral is 
determined to be pledged to and released by the Reserve Banks.
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    \15\ AMI is an online tool offered by the Reserve Banks that 
supplies real-time information about an institution's Federal 
Reserve account balance and provides access to a variety of summary 
and detail reports.
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    Following the effective date for the revised PSR policy, the 
Reserve Banks will continue with initiatives to improve the pledging 
and withdrawal process for securities collateral. These initiatives 
will largely be similar to those in the short-term strategy but include 
enhancements involving sufficient complexity and resource requirements 
that completion may not be possible before the implementation date of 
the new policy. Some of these enhancements may take place relatively 
soon--perhaps within six months--after the implementation date, while 
others may take somewhat longer. Collectively, these enhancements 
should enable greater rates of straight-through processing of 
securities collateral by the Reserve Banks and quicker withdrawal of 
unencumbered securities, and should provide tools to assist 
institutions in monitoring intraday their daylight overdraft and 
collateral positions.
    Over the longer term, the Reserve Banks intend to collaborate with 
the industry to identify additional enhancements that will continue to 
improve the efficiency and effectiveness of processes for pledging, 
withdrawing, and monitoring of collateral. The Federal Reserve expects 
that institutions' needs will evolve and grow as they gain experience 
with the revised PSR policy and with the collateral-management 
enhancements the Reserve Banks implement in the short and medium term.
    Over time, the Federal Reserve will be providing more-specific 
information to the industry about upcoming enhancements to collateral 
and information systems. This communication will help institutions 
understand the forthcoming changes and will also help them identify any 
changes they may need to make to their systems.

B. Fees for Collateralized Daylight Overdrafts

    The Board proposed lowering the fee for collateralized daylight 
overdrafts to zero and raising the uncollateralized daylight overdraft 
fee to 50 basis points to encourage institutions to pledge collateral 
and to reduce payments held in liquidity-management queues. The 
commenters strongly supported the proposal of a zero fee for 
collateralized daylight overdrafts. Most commenters believed that a 
zero fee for collateralized daylight overdrafts will encourage 
institutions that queue payments for liquidity purposes to release more 
of those payments earlier in the day.

[[Page 79114]]

Commenters acknowledged that institutions may still hold some payments 
in liquidity queues for reasons including counterparty risk, internal 
comfort with daylight overdraft levels, and uncollateralized daylight 
overdraft fee management. One institution noted that it believed the 
zero fee would help change certain depository institutions' tactical 
behavior of only sending payments when payments are received in order 
to reduce daylight overdraft costs. Another commenter believed a zero 
fee was appropriate because charging for collateralized overdrafts 
would amount to an unfair tax.
    The majority of commenters noted that the zero fee for 
collateralized daylight overdrafts would also likely lead depository 
institutions to increase collectively intraday credit use. Five 
commenters believed that their individual institution's intraday credit 
use would increase, while three other commenters estimated no change to 
their institution's use. The credit risk to the Reserve Banks from the 
predicted increases in daylight overdraft use would be controlled by 
traditional banking tools used in providing credit (eligibility 
requirements, collateral, caps, and monitoring). In addition, as 
institutions release payments earlier from liquidity queues, liquidity 
should circulate more quickly with a resulting faster flow of payments 
and thus on net mitigate somewhat the predicted increase in daylight 
overdraft use. On balance, the Board believes that setting the 
collateralized daylight overdraft fee at zero will improve tradeoffs 
among liquidity, operational, and credit risks in the payment system.
    The Board requested comment on two possible changes in market 
practices as a result of the zero fee for collateralized daylight 
overdrafts. One question covered the possible effect on the market for 
early return of fed funds loans. Several commenters believed that the 
practice of returning fed funds loans earlier would be positively 
affected, at least somewhat, by the proposed two-tiered pricing. 
Specifically, the fee reduction could increase the incentive to return 
fed funds loans earlier for institutions that have sufficient 
collateral to cover any overdraft incurred. One commenter believed a 
change would not happen automatically without market intervention to 
encourage the early return. Another commenter was unsure of any changes 
because of uncertain market dynamics and the historical resistance to 
return funds early. Some comments suggest that certain institutions may 
be more willing to return fed funds loans earlier. At the same time, 
institutions that, under the revised policy, have sufficient collateral 
to cover their daylight overdrafts may not have a significant incentive 
to demand the early return of funds. Overall, it is difficult at this 
stage to predict the net effect on the market for the early return of 
fed funds loans.
    The Board also requested comment on whether collateralized 
overdrafts at a zero fee would eliminate incentives for depository 
institutions and their customers to process securities used in 
repurchase agreements early in the morning. The Board was concerned 
that a zero overdraft fee could remove the incentive for the early 
processing of securities, which it has viewed as an important 
operational success by the banking and securities industry from the 
time daylight overdraft fees were first implemented. Prior to the 
introduction of daylight overdraft fees in 1994, U.S. government 
securities dealers would arrange for and deliver securities designated 
for repurchase agreements largely after noon, creating a late-day 
compression of payments and securities deliveries in the Fedwire 
Securities Service operating day. Consequently, it was not uncommon for 
the Fedwire Securities Service operating day to be extended until 4 
p.m. or later to address the volume of transfers that arrived late in 
the afternoon.\16\ In anticipation of being charged daylight overdraft 
fees, the U.S. government securities dealers (and their clearing banks) 
introduced processes and technology that facilitated the arrangement of 
repurchase agreements and delivery of the securities early in the 
morning. By arranging trades and delivering securities early in the 
morning, dealers gained use of the incoming cash from their 
counterparties in the repurchase agreements, reducing the duration of 
their daylight overdrafts. On the return leg, counterparties to the 
repurchase agreements also began sending back the securities to the 
dealers first thing in the morning. This market movement shifted the 
peak in daylight overdrafts significantly earlier in the morning and 
reduced dramatically securities-related daylight overdrafts.
---------------------------------------------------------------------------

    \16\ The Fedwire Securities service operating hours today are 
8:30 a.m. to 3:30 p.m.
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    Most commenters believed that practices either would not change or 
were unsure if practices would change because of well-established 
current procedures and technology that support the market. One 
commenter, however, expressed concern that the zero fee for 
collateralized daylight overdrafts may have unintended consequences on 
the government securities market. The commenter believed that over time 
certain participants in the government securities market will revert to 
pre-1994 behavior without the cost incentive rooted in daylight 
overdraft fees to deliver securities early.
    While it is not possible at this stage to know how U.S. government 
securities dealers will respond to a zero fee for collateralized 
daylight overdrafts for depository institutions, the Board does believe 
that competing business or processing incentives, such as managing 
securities inventories, may result in some change in behavior to shift 
later the delivery of securities. The change initially may be limited 
to certain types of securities or to specific dealers and thus would be 
of minor consequence. The main concern is that a change will become 
pervasive, undoing the successes achieved under the initial regime of 
charging for daylight overdrafts.
    Some mitigating factors may influence the magnitude of behavioral 
changes. The market for early deliveries is well entrenched today and 
is supported by automation. A significant change in this market may 
require institutions to make systems changes, which could be costly. In 
addition, the $50 million limit on the size of securities transfers 
over Fedwire Securities Service reduces the incentive to build 
positions. Securities dealers in the past held securities until near 
the close of the Fedwire Securities Service operating day to ensure 
they could complete the delivery in full and avoid costly failures to 
deliver. This practice is said to continue in some cases even today.
    While the Board continues to be concerned about the possible effect 
of a zero fee on the timing of securities transfers, it believes there 
are significant benefits in reducing the fee to zero for collateralized 
daylight overdrafts. This view is also strongly supported by the 
comment letters. The Board believes that a zero fee for collateralized 
daylight overdrafts provides incentives for institutions to release 
funds transfers held in internal queues for liquidity reasons, 
improving liquidity circulation and reducing operational risk in the 
Fedwire Funds Service. A zero fee also creates incentives to pledge 
additional collateral to the Reserve Banks, mitigating their credit 
risk in providing intraday balances. On balance, the Board believes the 
expected benefits warrant reducing the fee for collateralized daylight 
overdrafts to zero.
    The Board, however, will monitor delivery practices in the 
securities market to determine if securities transfers shift later in 
the day. To assist

[[Page 79115]]

in this monitoring, the Board will require government securities 
clearing banks to submit data to the Board before and after the 
implementation of the revised policy to help identify shifts in 
behavior by dealers; the data collection requirements will be discussed 
directly with the clearing banks.\17\ If a substantial shift does 
occur, the Board will take appropriate steps as needed. The Board 
strongly believes that reverting to pre-1994 behavior of late 
deliveries of securities poses unacceptable operational risks to the 
payment system.
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    \17\ While the Board has access to data indicating the timing of 
transfers by depository institutions over the Fedwire Funds Service 
and Fedwire Securities Service, these data do not provide 
sufficiently detailed information to track effectively when dealers 
are delivering securities designated for repurchase agreements.
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C. Fees for Uncollateralized Daylight Overdrafts

    The Board proposed raising the fee to 50 from 36 basis points 
(annual rate) for uncollateralized daylight overdrafts to encourage the 
collateralization of daylight overdrafts.\18\
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    \18\ In calculating an institution's fees, the value of 
unencumbered collateral pledged to the Reserve Banks will be 
subtracted from negative Federal Reserve account balances at the end 
of each minute to determine the institution's uncollateralized 
negative Federal Reserve account balance. The uncollateralized 
negative Federal Reserve account balance per minute will be summed 
and divided by the number of minutes in the Fedwire Funds Service 
operating day to arrive at the average daily uncollateralized 
daylight overdraft, which will be assessed a 50 basis point fee 
(annual rate). The value of collateral pledged is the same for PSR 
and discount window purposes.
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    While acknowledging the intent of increasing the uncollateralized 
fee, some commenters raised concerns that the higher fee may introduce 
liquidity challenges for collateral-constrained institutions. These 
commenters generally believed that institutions without sufficient 
collateral to support daylight overdrafts would have an incentive to 
hold payments for liquidity purposes to avoid daylight overdraft 
charges. Commenters, including an organization representing sixteen 
large depository institutions, stated that the collective benefits from 
speeding up the flow of payments would only be attained if all 
participants acted for the collective good rather than minimizing 
individual institutions' own costs and risks. These commenters also 
indicated that they would not continue to release payments from queues 
if counterparties did not reciprocate.
    To mitigate the risk that institutions do not act for the overall 
benefit of the industry, several commenters discussed options for 
monitoring and promoting bilateral payment flows. Two commenters 
suggested individual institutions monitor counterparties, while two 
other commenters recommended the Federal Reserve monitor institutions' 
activities. Two commenters also suggested that the Federal Reserve 
devise incentives for institutions to release payments queued prior to 
2 p.m., including time-of-day pricing.
    It will be important for the industry and Federal Reserve to 
monitor changes in payment activities over time to evaluate whether 
institutions continue to hold payments for liquidity reasons. It is not 
fully clear, however, whether the fee increase to 50 basis points would 
exacerbate this problem for some institutions and whether institutions 
will queue payments to some degree at any positive fee, including at a 
zero fee, for reasons of internal liquidity risk management. On 
balance, the Board believes that the increase to 50 basis points for 
uncollateralized daylight overdrafts is appropriate in conjunction with 
the fee reduction to zero for collateralized daylight overdrafts. The 
changes together balance the overall tradeoffs between safety and 
efficiency by providing incentives to pledge collateral, which 
mitigates the Reserve Banks' risks, and incentives to increase the flow 
of payments, which increases liquidity circulation.

D. Deductible and Fee Waiver

    The Board proposed eliminating the deductible as a source of free 
intraday credit with the intent of providing such credit through 
collateralized daylight overdrafts charged at a zero fee. The Board 
also proposed to increase the fee waiver to $150 from $25 to reduce the 
burden of the PSR policy on institutions that use small amounts of 
daylight overdrafts. As proposed, the $150 waiver would be subtracted 
from the gross fees (in a two-week reserve-maintenance period) assessed 
on any user of daylight overdrafts in contrast to the current waiver 
that only applies to gross fees of institutions that have charges less 
than or equal to $25 (in a two-week reserve-maintenance period).\19\
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    \19\ The waiver would not result in refunds or credits to an 
institution and cannot be carried to another reserve maintenance 
period. The waiver would not apply to institutions subject to the 
penalty fee.
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    While none of the comment letters explicitly addressed the 
introduction of a higher fee waiver, two commenters strongly supported 
the elimination of the deductible. These commenters believed this 
change would remove a competitive disparity they have identified 
between FBOs and U.S.-chartered depository institutions. Under the 
current policy, U.S.-chartered depository institutions receive a net 
debit cap and deductible based on their worldwide capital, while FBOs 
receive a net debit cap and deductible based on no more than 35 percent 
of their worldwide capital. By eliminating the deductible for all 
depository institutions and providing free collateralized intraday 
credit to eligible depository institutions, including FBOs, the revised 
policy will address the concerns that some commenters expressed 
regarding the negative incentive effects of the deductible 
calculations.
    The Board believes it is still appropriate to provide some amount 
of free uncollateralized liquidity to depository institutions to reduce 
the administrative burden on Reserve Banks and on a large number of 
depository institutions that incur small amounts of uncollateralized 
daylight overdrafts. The Board believes that the $150 fee waiver will 
serve those purposes under the revised PSR policy. With the Board 
adopting these changes, institutions should receive ample free 
liquidity through zero-priced collateralized daylight overdrafts. In 
addition, most small users of uncollateralized intraday credit should 
not observe a change in their daylight overdraft charges between the 
current and revised PSR policies.

E. Net Debit Caps \20\
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    \20\ Net debit caps limit the aggregate amount of daylight 
credit that the Reserve Banks extend. Net debit caps are a function 
of qualifying capital and a multiplier per cap category. There are 
four cap categories: (in ascending order) zero, exempt-from-filing, 
de minimis, and self assessed (which includes high, above-average, 
and average multipliers).
---------------------------------------------------------------------------

    The Board proposed eliminating the current two-week average cap on 
daylight overdrafts for healthy depository institutions while retaining 
the higher single-day cap. Under the proposal, the single-day cap would 
apply to the total of collateralized and uncollateralized daylight 
overdrafts.\21\ The Board did not receive specific comments on the 
removal of the two-week net debit cap or retention of the single-day 
net debit cap.
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    \21\ Under the current policy, net debit caps limit the amount 
of uncollateralized daylight overdrafts, while max caps limit the 
amount of approved collateralized capacity in addition to the 
uncollateralized amount allowed under net debit caps. Under the 
revised policy, the single-day cap will limit the total of 
collateralized and uncollateralized daylight overdrafts within the 
predefined net debit cap amount, and any collateralized portion 
would not increase the total amount. Institutions needing capacity 
that exceeds the net debit cap will still need to apply for a max 
cap.
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    The Board also proposed providing Reserve Banks additional 
flexibility in

[[Page 79116]]

the administration of net debit caps for fully collateralized daylight 
overdrafts. The Reserve Bank may forgo ex post counseling for two 
incidents of fully collateralized overdrafts per two consecutive 
reserve-maintenance periods (four weeks).\22\ The additional 
flexibility would apply to institutions that have de minimis or self-
assessed net debit caps or max caps.\23\ Exempt-cap institutions are 
excluded from this additional flexibility because they already are 
allowed to exceed their cap limit twice in two consecutive reserve-
maintenance periods. Zero cap institutions will not be eligible. The 
Board did not receive any comments on the proposed additional 
flexibility for ex post counseling.
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    \22\ The ex post counseling regime includes a series of actions 
by the Reserve Bank that are aimed at deterring an institution from 
violating the PSR policy by exceeding its net debit cap. These 
actions may include an assessment of the causes of the overdrafts, a 
counseling letter to the institution, a review of the institution's 
account-management practices, and an assessment of whether a higher 
net debit cap may be warranted. In situations involving problem 
institutions, the Reserve Bank may assign the institution a zero cap 
and impose other account controls, such as requiring the institution 
to pledge collateral; imposing clearing balance requirements; 
rejecting Fedwire funds transfers, ACH credit originations, or 
National Settlement Service transactions that would cause or 
increase an institution's daylight overdraft; or requiring the 
institution to prefund certain transactions.
    \23\ FBOs will continue to be monitored at their cap level in 
real time. If an institution's account is monitored in real time, 
any outgoing Fedwire funds transfer, National Settlement Service 
transaction, or ACH credit origination that exceeds available funds 
is rejected. If an FBO exceeds its cap periodically due to payments, 
such as securities transactions, that are not covered under a real-
time monitor, the Reserve Bank may waive counseling if the daylight 
overdrafts are fully collateralized.
---------------------------------------------------------------------------

    The Board continues to believe that it is appropriate and prudent 
to have limits on intraday credit even when the credit is fully 
collateralized. Collateral may not always be sufficient to protect 
against credit risks. While haircuts on collateral help mitigate the 
risk that the liquidation value of collateral will fall below the 
credit exposure, they are not designed to eliminate the risk entirely. 
Thus, limits or caps complement the use of collateral in risk 
mitigation. Among other things, caps provide a risk management tool for 
institutions and the Reserve Banks in measuring and managing the size 
of exposures and take some pressure off the use of haircuts to address 
credit risks.
    The Board also continues to believe that flexibility may be 
appropriate in counseling an institution if the daylight overdraft is 
fully collateralized. This flexibility to waive counseling reflects the 
lower risk of a fully collateralized daylight overdraft relative to an 
uncollateralized daylight overdraft. The limited number of waivers 
reflects the fact that collateral may not fully protect a Reserve Bank 
and that frequent violations of agreed caps may suggest other concerns 
about a depository institution.
    Based on this analysis, the Board adopted the proposed changes to 
net debit caps. The elimination of the two-week average cap will 
increase the routine daylight overdraft capacity of institutions with 
self-assessed caps approximately 50 percent from the current policy. 
The Board also adopted the proposed additional flexibility in 
counseling an institution exceeding its cap when its daylight 
overdrafts are fully collateralized.

F. Maximum Daylight Overdraft Capacity

    During its policy review, the Board evaluated potential 
simplifications to the current process through which institutions may 
apply for max caps. First, the Board proposed removing the requirement 
that institutions must have already explored other alternatives to 
address their increased liquidity needs before considering a max cap. A 
depository institution interested in obtaining a max cap would contact 
its administrative Reserve Bank, which would work with the institution 
to determine an appropriate capacity level based on the business case 
and would assess relevant financial and supervisory information in 
making such a credit decision. None of the comment letters addressed 
this proposed change.
    Second, the Board proposed a streamlined max cap procedure that 
would allow eligible FBOs to acquire additional capacity that in total 
would provide up to 100 percent of worldwide capital times the self-
assessed cap multiple. The streamlined procedure would enable a 
financial holding company or SOSA 1-rated institution to request from 
its administrative Reserve Bank a max cap without documenting a 
specific business need for additional capacity or providing a board of 
directors resolution authorizing the request for a max cap.\24\ The 
Reserve Bank would assess the ability of eligible FBOs to manage the 
intraday capacity permitted by the max cap as part of its review of 
relevant financial and supervisory information. The Reserve Bank, in 
consultation with the home country supervisor, would engage in initial 
as well as periodic dialogue with the institution that would be 
analogous to the periodic review of liquidity plans performed with 
U.S.-chartered institutions to ensure the institution's intraday 
liquidity risk is managed appropriately. Under this proposal, however, 
if an FBO requests capacity in excess of 100 percent of worldwide 
capital times the self-assessed cap multiple, it would be subject to 
the general max cap procedure applicable to all institutions.
---------------------------------------------------------------------------

    \24\ The FBO would still be required to complete a self-
assessment and provide a board of directors resolution for the self-
assessed cap.
---------------------------------------------------------------------------

    Four commenters supported the proposed streamlined max cap 
procedure for FBOs that are financial holding companies or SOSA 1-rated 
institutions. The commenters believed that the streamlined max cap 
would facilitate institutions' managing their payments activity. Three 
of these commenters, however, requested that the Board reconsider 
calculating the net debit cap for financial holding company or SOSA 1-
rated FBOs on 100 percent (rather than up to 35 percent) of their 
worldwide capital without requiring collateral for the additional 
capacity. The commenters stated that the streamlined max cap would 
continue to create a competitive disadvantage for FBOs by not allowing 
them to decide whether to pledge collateral to support daylight 
overdrafts, while U.S.-chartered depository institutions can make 
business decisions regarding how much, if at all, to collateralize. One 
commenter believed that a mandatory collateralized regime would resolve 
this disparity by requiring all institutions to collateralize 100 
percent of their overdrafts. Another commenter representing several 
FBOs noted that if all institutions collateralized their daylight 
overdrafts as a result of the proposed policy changes, the streamlined 
max cap procedure would make any differences largely moot as a 
practical matter.
    The Board continues to view the max cap as an important tool in 
helping Reserve Banks and depository institutions manage intraday risk 
in a manner that supports the payment needs of individual institutions 
and the payment system as a whole. The Board believes the proposed 
changes will introduce additional flexibility into this program, 
thereby improving the flow of payments and liquidity in the payment 
system, and will more effectively reflect the strategic direction of 
the new policy. The Board also continues to believe the streamlined max 
cap procedure effectively balances the safety and efficiency objectives 
of the PSR policy and improves the position of FBOs. The procedure 
provides a more efficient method for FBOs to gain additional capacity 
than current procedures while helping to resolve the increased risk

[[Page 79117]]

associated with FBOs because of the timeliness and scope of available 
supervisory information and other supervisory issues that may arise 
because of the cross-border nature of the FBO's business (for example, 
application of different legal regimes).
    The Board has adopted the proposed change to remove the 
requirements to pursue first all other options. The Board has also 
approved the proposed streamlined max cap procedure. In addition, the 
Board has approved an early implementation date for the streamlined max 
cap procedure on March 26, 2009. The early implementation should help 
FBOs manage their payment activity more effectively, particularly when 
combined with the deductible changes under the interim policy 
(discussed later).

G. Penalty Fees

    The Board proposed to increase the penalty fee for daylight 
overdrafts to 150 from 136 basis points. The penalty rate structure has 
traditionally been the regular daylight overdraft fee plus 100 basis 
points. The Board did not receive any comments related to the increase 
in fees.
    The Board continues to believe that it is appropriate to maintain a 
100 basis point spread between the regular and penalty rates for 
daylight overdrafts and adopted the proposed penalty fee of 150 basis 
points. The penalty rate will continue to be applied to institutions 
that incur daylight overdrafts but do not have regular access to the 
discount window and thus are not eligible under the PSR policy for 
intraday credit.

H. Implementation

    Al