[Federal Register Volume 69, Number 187 (Tuesday, September 28, 2004)]
[Notices]
[Pages 57917-57931]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-21669]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1182]


Policy Statement on Payments System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Policy statement.

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SUMMARY: The Board has revised its Policy Statement on Payments System 
Risk (PSR policy) to modify the daylight overdraft measurement rules 
(``posting rules'') for interest and redemption payments on securities 
issued by entities for which the Reserve Banks act as fiscal agents but 
whose securities are not obligations of, or fully guaranteed as to 
principal and interest by, the United States--that is, securities 
issued by government-sponsored enterprises (GSEs) and certain 
international organizations. In connection with this policy change, the 
Board supports the formation of an industry working group to promote a 
smooth transition through collaborative discussion of implementation 
issues. The working group will be coordinated through the Federal 
Reserve Banks' Wholesale Product Office in New York; organizations that 
commented on the planned policy changes, members of those 
organizations, and fiscal principals to whom the policy applies will be 
invited to participate.

[[Page 57918]]

    Additionally, the Board has revised its PSR policy to align the 
policy's treatment of the general corporate account activity (activity 
other than interest and redemption payments) of GSEs and certain 
international organizations with the treatment of account activity of 
other Federal Reserve account holders that do not have regular access 
to the Federal Reserve's discount window. Such treatment includes 
strongly discouraging daylight overdrafts and applying a penalty fee to 
daylight overdrafts that nonetheless result from these entities' 
general corporate payment activity.
    The Board has also revised its policy to reflect the recent changes 
to the operating hours of the on-line Fedwire Funds Service, to clarify 
certain items, and to remove or update items that have become 
outdated.\1\
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    \1\ Fedwire is a registered servicemark of the Federal Reserve 
Banks.

DATES: The PSR policy revisions concerning the posting rules for 
interest and redemption payments on securities issued by GSEs and 
certain international organizations and the revisions that align the 
policy's treatment of the general corporate account activity of these 
entities will take effect on July 20, 2006. The other changes to the 
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PSR policy are effective September 22, 2004.

FOR FURTHER INFORMATION CONTACT: Paul Bettge, Associate Director (202/
452-3174), Lisa Hoskins, Assistant Director (202/452-3437), or Connie 
Horsley, Senior Financial Services Analyst (202/452-5239), Division of 
Reserve Bank Operations and Payment Systems; for the hearing impaired 
only: Telecommunications Device for the Deaf, Dorothea Thompson (202/
452-3544).

SUPPLEMENTARY INFORMATION:

I. Background

    In February 2004, the Federal Reserve Board announced two intended 
revisions to its PSR policy (69 FR 6292, Feb. 10, 2004). The first 
revision would modify the daylight overdraft posting rules under the 
PSR policy to specify that Reserve Banks will release interest and 
redemption payments on the Fedwire-eligible securities issued by a GSE 
or international organization only when the issuer's Federal Reserve 
account contains funds equal to or in excess of the amount of the 
interest and redemption payments to be made.<SUP>2, 3</SUP> The second 
revision would align the PSR policy's treatment of the general 
corporate account activity of these entities with the treatment of 
activity of other account holders that do not have regular access to 
the discount window.\4\ Such treatment would include applying a penalty 
fee to daylight overdrafts resulting from these entities' general 
corporate payment activity and potentially applying additional risk 
controls as a means of deterring further the use of Federal Reserve 
daylight credit.<SUP>5, 6</SUP>
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    \2\ The GSEs include Fannie Mae, the Federal Home Loan Mortgage 
Corporation (Freddie Mac), entities of the Federal Home Loan Bank 
System (FHLBS), the Farm Credit System, the Federal Agricultural 
Mortgage Corporation (Farmer Mac), the Student Loan Marketing 
Association (Sallie Mae), the Financing Corporation, and the 
Resolution Funding Corporation. The international organizations 
include the World Bank, the Inter-American Development Bank, the 
Asian Development Bank, and the African Development Bank.
    \3\ In their role as fiscal agents, the Reserve Banks maintain 
securities issued by GSEs and international organizations on the 
Fedwire Securities Service and make interest and redemption payments 
to depository institutions on each issuer's behalf, in addition to 
providing other payment services generally related to these fiscal 
agency services.
    \4\ Under the PSR policy, an institution's eligibility to access 
daylight credit is contingent upon whether the institution is 
eligible for regular access to the Federal Reserve's discount window 
and whether it is in sound financial condition. By statute, regular 
access to the discount window generally is available to institutions 
that are subject to reserve requirements (12 U.S.C. 461(b)(7)).
    \5\ A daylight overdraft occurs when an account holder's Federal 
Reserve account is in a negative position during the business day.
    \6\ The penalty fee is equal to the regular daylight overdraft 
fee, currently 36 basis points, plus 100 basis points. A Reserve 
Bank may apply other risk controls to an account holder's payment 
activity if the account holder incurs daylight overdrafts in 
violation of the PSR policy or if the Reserve Bank believes that the 
account holder poses credit risk in excess of what the Reserve Bank 
determines to be prudent. For example, a Reserve Bank may place 
real-time controls on the account holder's payment activity, so as 
to reject those payments that would create, or increase, a daylight 
overdraft in the entity's account. These payment types include 
Fedwire funds transfers, National Settlement Service (NSS) 
transactions, and certain automated clearing house transactions. The 
Reserve Bank could also require the account holder to pledge 
collateral to cover any daylight overdrafts it does incur.
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    The policy revisions result from an assessment of the temporary 
exemption granted to GSEs under the Board's 1994 interpretation of the 
PSR policy (59 FR 25060, May 13, 1994). That earlier interpretation had 
stated that GSEs should not incur daylight overdrafts in their accounts 
and would not be allowed to adopt positive net debit caps because they 
do not have regular access to the discount window. However, in its 1994 
interpretation, the Board granted a temporary exemption from fees on 
daylight overdrafts resulting from the Reserve Banks' release of 
interest and redemption payments on Fedwire-eligible securities issued 
by GSEs prior to the issuers' full funding of such payments.\7\ The 
Board granted this temporary exemption because it was uncertain of the 
effect that daylight overdraft fees would have on securities markets 
and did not want to introduce too much change at one time. The Board, 
however, indicated that it would revisit the temporary exemption after 
market participants adjusted to the effects of daylight overdraft fees. 
In addition, the Board applied the regular daylight overdraft fee to 
the daylight overdrafts arising from the GSEs' general corporate 
funding activity, but did not apply the penalty fee that applies to 
other institutions that lack regular discount window access.\8\ The 
Board stated it was not, however, ruling out the future application of 
the penalty fee.
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    \7\ The term ``interest and redemption payments'' refers to 
payments of principal, interest, and redemption on securities 
maintained on the Fedwire Securities Service.
    \8\ To facilitate measurement of overdrafts arising from the 
different activity, the Board required the GSEs and Reserve Banks to 
establish separate GSE accounts for principal and interest activity 
(P&I account) and for general corporate payment activity (general 
account).
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    In 2000, the Board began a general evaluation of the effectiveness 
of the PSR policy's daylight overdraft fee. Recognizing that 
significant changes had occurred in the banking, payments, and 
regulatory environment since the fee was introduced in 1994, the Board 
decided to broaden its evaluation of the fee to include all aspects of 
the Federal Reserve's daylight credit policies. Based on its review, 
the Board identified growing liquidity pressures among certain payments 
system participants and, as a result, made several modifications to the 
PSR policy (66 FR 64419, Dec. 13, 2001).\9\ The Board also determined 
that the PSR policy appears to be generally effective in controlling 
risk to the Federal Reserve and creating incentives for depository 
institutions to manage their intraday credit exposures. In addition, 
the Board determined that market participants appear to have adjusted 
to daylight overdraft fees; this determination prompted an assessment 
of the Board's 1994 interpretation of the PSR policy. In conducting 
this assessment, the Board evaluated the treatment of interest and 
redemption payments on Fedwire-eligible securities issued by GSEs and 
certain international organizations as well as the treatment of other 
payment services these entities

[[Page 57919]]

use for their general corporate payment activity. The Board's 
assessment led to the policy modifications discussed below.
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    \9\ These modifications included changes to the net debit cap 
calculation for U.S. branches and agencies of foreign banks and a 
provision that would allow certain depository institutions to pledge 
collateral to the Federal Reserve in order to access additional 
daylight overdraft capacity above their net debit caps, subject to 
Reserve Bank approval.
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A. Treatment of Interest and Redemption Payments

    According to the Board's current daylight overdraft measurement 
rules, U.S. Treasury and government agency interest and redemption 
payments are posted, that is, debited from the issuers' accounts and 
credited to the receivers' accounts, by 9:15 a.m. ET and original 
issues of securities are posted on a flow basis, as they are issued, 
but no earlier than 9:15 a.m. ET.\10\ These posting rules were designed 
primarily to grant depository institutions the benefit of receiving 
interest and redemption payments on U.S. Treasury or government agency 
securities prior to debits being made to their accounts for the 
purchase of new issues. For operational ease, the Reserve Banks have 
applied the same posting rules to interest and redemption payments on 
Fedwire-eligible securities issued by GSEs and international 
organizations.
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    \10\ While transactions for various payment types are processed 
throughout the business day, daylight overdrafts in an entity's 
Federal Reserve account are calculated on an ex post basis according 
to the daylight overdraft posting rules.
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    In the course of its assessment of the 1994 policy interpretation, 
the Board found that the dollar volume of interest and redemption 
payments on Fedwire-eligible securities issued by GSEs and 
international organizations that are credited to the receiving 
depository institutions' Federal Reserve accounts prior to such 
payments being fully funded by the issuer has grown significantly and 
to very large amounts over the past ten years. In large part, this 
increase owes to the rapid growth in Fedwire-eligible securities issued 
by GSEs. In addition, for some issuers, the lag between the time the 
Reserve Banks credit depository institutions' accounts for the interest 
and redemption payments and the time the issuer covers the payments 
extends, at times, until shortly before the close of the Fedwire Funds 
Service.\11\
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    \11\ The scheduled close of the Fedwire Funds Service is 6 p.m. 
ET for third-party transfers and 6:30 pm ET for bank-to-bank 
transfers.
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    The Board determined that the practice of releasing such payments 
before they are fully funded by the issuer is neither necessary to 
achieve the Federal Reserve's statutory mission nor appropriate risk 
management policy for the central bank. To control their risks, private 
issuing and paying agents generally do not allow payments to be made 
for a securities issuer before the issuer has fully funded its 
payments. The Board, therefore, announced in February 2004 its 
intention to revise its policy to specify that the Reserve Banks will 
release interest and redemption payments on Fedwire-eligible securities 
issued by a GSE or an international organization only when the issuer's 
Federal Reserve account contains funds equal to or in excess of the 
amount of the issuer's interest and redemption payments to be made and 
provided that these funds are in the issuer's Federal Reserve account 
prior to an established cut-off hour on the Fedwire Securities 
Service.\12\ This stated policy direction was intended to eliminate the 
Federal Reserve's intraday credit exposure that results from the 
current manner in which the Reserve Banks process and post interest and 
redemption payments on securities issued by GSEs and international 
organizations to the receiving depository institutions' Federal Reserve 
accounts prior to such payments being fully funded by the issuer.
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    \12\ The Board established a cut-off hour of 4 p.m. ET by which 
issuers must fund the amount of their respective interest and 
redemption payments to be made on a given day in order for Reserve 
Banks to release such payments on that day.
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B. Treatment of Other Payment Services

    In its assessment of the 1994 policy interpretation, the Board also 
evaluated the treatment of other Federal Reserve payment services used 
by GSEs and international organizations for their general corporate 
payment activity, that is, payment activity unrelated to interest and 
redemption payments. While most of these entities only infrequently 
incur daylight overdrafts at Federal Reserve Banks as a result of their 
general corporate payment activity, a few of these entities incur such 
daylight overdrafts on an almost daily basis.
    The Board determined that GSEs and international organizations for 
which the Reserve Banks act as fiscal agents should not be permitted 
the same access to intraday credit as depository institutions because, 
by statute, the former do not have regular access to the discount 
window. Therefore, to provide uniform treatment of account holders that 
do not have regular access to the discount window, the Board announced 
its intention to apply the same penalty fee that applies to daylight 
overdrafts of these entities to daylight overdrafts that result from 
GSEs' and international organizations' general corporate payment 
activity. This policy change will be implemented concurrent with the 
posting rule change for interest and redemption payments described 
above. This policy change supersedes the Board's 1994 temporary 
exemption pertaining to GSEs, and the Board, therefore, is rescinding 
its 1994 interpretation upon implementation of the new policy.

C. Request for Comment

    With respect to the posting rule changes described above, the Board 
requested comment on how best to implement the policy change in order 
to promote a smooth market adjustment. More specifically, if market 
participants believed that a phased approach would better facilitate 
implementation of the planned change, the Board requested comment on 
the rationale for why such an approach is considered preferable to one 
of full implementation as of a single date and on the specific 
structure and objectives of any such approach. Below is a summary and 
analysis of the comments received on the planned policy changes.

II. Summary of Comments and Analysis

    The Board received ten comment letters on its proposed policy 
changes. The commenters included five commercial banking organizations, 
two GSEs, two industry groups, and one Federal Reserve Bank. The 
majority of the comments focused on different approaches for 
implementing the posting rule changes. Although several commenters 
recognized the policy changes as consistent with the overall objectives 
of the PSR policy, one commenter noted that the posting rule change may 
represent a suboptimal solution to the current practice because it may 
only redistribute credit risk from the Federal Reserve to other parties 
rather than reduce or eliminate it. Four commenters proposed the 
formation of a working group to evaluate further the impact of the 
intended policy revisions. Three commenters discussed the 
appropriateness of the 4 p.m. ET cut-off hour. Finally, one commenter 
expressed concern that issuers might prioritize funding of their 
general corporate payment activity before funding of their interest and 
redemption payments, thereby delaying interest and redemption payments 
in order to avoid daylight overdrafts and the associated penalty fee 
under the Board's revised policy.

A. Implementation Approaches

1. Phased Implementation
    Seven commenters recommended some form of a phased implementation. 
These commenters raised concerns that an abrupt change in available 
intraday liquidity under a full implementation scenario has the 
potential to increase

[[Page 57920]]

systemic risk, particularly in light of the aggregate dollar amounts 
involved and the potential loss of liquidity early in the day. Two 
commenters urged a phased approach to avert potential payments gridlock 
stemming from the loss of market liquidity early in the day, arguing 
that this gridlock could increase the risk of overnight exposure if 
payment flows were to shift to later in the day. One commenter noted 
that the policy changes could put pressure on overnight investment 
markets to return funds earlier in the day. Three commenters expressed 
uncertainty as to whether sufficient intraday credit exists among 
depository institutions generally to absorb the issuers' liquidity 
demands. These commenters raised concerns that the effects of the 
policy changes would likely be concentrated among a small number of 
institutions, such as the larger custody and clearing banks. These 
commenters also stressed that daylight overdrafts and the associated 
costs at these institutions would likely increase as a result of the 
policy changes and would make it difficult for them to serve as a 
potential source of liquidity to issuers. Another commenter raised 
concerns that full implementation with no phase-in would be 
unnecessarily burdensome to broker-dealers as well as depository 
institutions in terms of the availability and cost of daylight 
overdrafts.
    The seven commenters generally viewed a phased approach to 
implementation as preferable because they believe it would promote 
better understanding of the effects of the posting rule change among 
market participants and allow for a more gradual and orderly adjustment 
to the potential removal of liquidity currently provided early in the 
day, thereby reducing the potential for unintended consequences. One 
commenter stated that a phased implementation would also allow issuers 
time to identify and gradually access alternative sources of funding. 
Two commenters emphasized that a phased approach would have information 
value to market participants and the Federal Reserve and could provide 
the Federal Reserve with a better opportunity to observe and assess the 
effects of the policy changes prior to full implementation. One 
commenter likened phasing in this policy change to the approach the 
Board used to introduce pricing of daylight overdrafts.
    Commenters described a variety of potential phased approaches that 
attempt to address the concerns outlined above. These approaches 
include phasing in the changes by payment type, by product type, or by 
time of day. One commenter suggested treating the issuers' accounts, 
during a predefined phase-in period, similarly to those of other 
account holders that do not have regular access to the discount window, 
which implies applying a penalty fee to daylight overdrafts resulting 
from the release of the issuers' interest and redemption payments. Two 
commenters recommended piloting the changes with a subset of issuers. 
One of these commenters suggested that such an approach could begin 
prior to July 2006. Three commenters recommended that a phased 
implementation begin in July 2006. One commenter suggested adoption of 
a phased approach after a study of potential market implications. Each 
of the commenters' suggested phase-in options is described below.
    Two commenters recommended a phased implementation approach by 
payment type, whereby an issuer's principal and interest payments would 
be separated from its redemption payments. These commenters are likely 
referring to mortgage-backed securities, whose payments have a 
principal and interest component as well as a redemption component. One 
of these commenters reasoned that the funding for principal and 
interest payments is presumably more readily available than the funding 
for redemption payments because the principal and interest payments 
accrue (as the mortgages that underlie the securities are paid) and are 
invested over time and should be available on payment date, whereas 
redemption payments are funded from the proceeds of new securities 
issuances. Under these assumptions, the commenter suggested that the 
Board consider continuing to fund one type of payment and phase in the 
funding requirement on the other. Another commenter suggested the 
option of a phasing in implementation by product type under each 
issuer, whereby the provision of intraday credit supporting the release 
of interest and redemption payments on different products would be 
removed gradually.
    Three commenters addressed the potential for a phased 
implementation by time of day. One commenter suggested an approach that 
would gradually reduce the amount of time between the release of 
interest and redemption payments and the deadline for reimbursement of 
those funds. Another commenter described a similar approach whereby the 
Federal Reserve would continue to extend credit during an interim 
period in order to release the interest and redemption payments, but 
the time at which these payments are made would be pushed back 
gradually until such time that the credit is ultimately withdrawn. The 
commenter noted that this approach would ensure that interest and 
redemption payments would be made during the interim period and could 
avert precipitation of systemic liquidity problems. A third commenter, 
however, expressed concern that the latter approach may not be worth 
pursuing because the system changes required to adopt such an approach 
would be short-lived.
    One commenter suggested that the Board consider an approach whereby 
the Federal Reserve continues to fund issuers' interest and redemption 
payments in the early morning over an interim period while treating the 
issuers' accounts in the same manner as other account holders that do 
not have regular access to the discount window. The Board notes that 
such treatment includes strongly discouraging daylight overdrafts and 
applying a penalty fee to daylight overdrafts that nonetheless result. 
Under this approach, the Reserve Banks' release of the interest and 
redemption payments could result in daylight overdrafts in the issuers' 
Federal Reserve accounts to which the penalty fee would then be 
applied. The commenter reasoned that this phased approach could reduce 
the daylight overdraft implications to depository institutions as 
compared with an approach of full implementation, and it would allow 
them more time to assess the effect of the policy changes.
    Two commenters suggested the option of phasing in the policy 
changes on an issuer-by-issuer basis to allow market participants to 
gradually adjust practices. The Federal Farm Credit Banks Funding 
Corporation expressed its willingness to participate in a pilot program 
of the policy changes prior to July 2006 if the Board viewed such an 
approach as useful. This commenter, self-described as ``a smaller GSE 
debt-issuing agent,'' proposed the approach as a means for the Federal 
Reserve to gain experience with the policy changes with smaller 
organizations prior to implementation with the largest organizations 
that presumably have greater intraday credit demands.
2. Full Implementation
    One commenter supported full implementation of the planned policy 
changes, stating that the entities potentially affected by the changes 
have sufficient capability and appropriate incentives to transition to 
the new policy without further guidance from the Board. This commenter 
believed that a phased approach was unnecessary and that the policy 
changes should be implemented fully beginning July 2006.
    One commenter noted that separation of each issuers' principal and 
interest

[[Page 57921]]

payments from its redemption payments (again, likely referring to 
payments on mortgage-backed securities) and potentially further 
separation of each issuers' payments by product type would allow 
issuers to segment their respective funding requirements to potentially 
more manageable levels throughout the day. The commenter recognized 
that decisions regarding separation and prioritization of payments are 
at the discretion of each issuer, but anticipated that such an approach 
would be supported by market participants, including issuers, because 
the commenter believes the approach would reduce the potential adverse 
effects of the Board's posting rule change on financial markets 
generally and, in particular, on the marketplace for these issuers' 
securities.
    Another commenter urged consideration of an alternative method of 
processing interest and redemption payments that would involve an 
acceleration of new issue processing that allows for netting of 
refunding instruments against interest and redemption payments. The 
commenter noted that this approach could allow for periodic posting of 
debits to issuers' accounts throughout the day as opposed to the 
current process of posting single, aggregate debits early in the day 
and would reduce issuers' intraday credit needs to the residual amount 
resulting from any mismatch between new issuances and interest and 
redemption payments. This commenter suggested that the Board 
additionally consider some form of a collateralized borrowing 
arrangement or a committed, but unfunded backup line of credit to 
further offset a portion of an issuer's funding requirement.
3. Assessment of Implementation Approaches
    As mentioned, those commenters supporting a phased approach to one 
of full implementation asserted that, in general, such an approach 
would allow market participants to adapt gradually to the potential 
removal of liquidity early in the day and would decrease the potential 
for payments gridlock that could otherwise increase systemic risk. 
These commenters further asserted that a phased implementation would 
promote a better understanding among market participants, including the 
Federal Reserve, of the liquidity and operational effects of the policy 
changes.
    As explained in more detail below, the Board does not view a phased 
implementation as necessary or in the public interest. The Board 
acknowledges that the posting rule modification for the interest and 
redemption payments on securities issued by GSEs and certain 
international organizations will remove one source of free intraday 
credit and necessitate adjustments by market participants. However, 
after reviewing commenters' rationales for a phased implementation, 
including their concerns regarding liquidity and gridlock, the Board 
does not believe that commenters identified any particular aspect of 
the planned policy changes or related adjustments that would impede a 
smooth implementation or that would cause significant market 
disruptions were the new policy to become effective without a phase-in 
period. In addition, experiences with previous changes to the PSR 
policy indicate that full implementation of such changes can occur 
successfully and without disrupting payments systems, provided market 
participants have adequate lead time and engage in active planning. To 
facilitate such planning and information sharing among affected 
parties, the Board supports the formation of an industry working group, 
as described further below.
    The Board also believes that commenters' specific phased approaches 
have a number of disadvantages when compared to a full-implementation 
approach. In particular, some of the approaches, especially in their 
early stages, may not provide a good indication of the influences and 
pressures that will shape full implementation. That is, one stage of a 
phased implementation does not necessarily have predictive value for 
subsequent stages or for full implementation. The Board is concerned, 
therefore, that practices adopted under a phased implementation may not 
facilitate smooth market functioning or preparedness when full 
implementation occurs. In addition, some of the approaches impose 
explicit conditions that would not exist upon full implementation of 
the policy changes. To the extent the proposed approach differs from 
the future steady-state environment, the approach may adversely affect 
market participants' ability to adapt effectively to the policy 
changes. Finally, many of the phased approaches would require numerous 
changes in practices and systems to accommodate the various steps, with 
the consequent potential for additional costs, coordination issues, and 
increased operational risk. For these reasons, the Board believes that 
the potential drawbacks of a phased implementation outweigh the 
potential benefits, and therefore that full implementation of the 
policy changes, with adequate planning, is appropriate.
    In terms of commenters' specific concerns with the potential 
removal of liquidity early in the day, the Board believes that this 
concern is based on a belief that there may be insufficient market 
liquidity to smoothly adjust to the policy changes and that issuers 
will take little or no action to adjust their funding patterns in 
response to these changes. The Board acknowledges that while the policy 
changes will result in the removal of free Federal Reserve intraday 
credit and certain market participants will have to adjust, sufficient 
aggregate market liquidity exists to absorb the potential reduction in 
liquidity early in the day. Additionally, while the Board understands 
that there may be some uncertainty regarding the intraday timing of 
receipt of interest and redemption payments given that each issuer's 
response to the revised policy cannot be predicted, the Board believes 
it is likely that issuers have a strong business incentive to respond 
to the policy changes in a manner that would avoid potential adverse 
liquidity effects. Moreover, the Board believes that issuers and market 
participants, particularly those that receive interest and redemption 
payments on the issuers' securities, will have been provided ample time 
to engage one another in discussions regarding potential changes to 
funding patterns in response to the policy changes. These discussions 
should allow market participants to better anticipate issuer behavior 
and appropriately adjust liquidity and account management practices as 
necessary. The Board believes that the Federal Reserve's coordination 
of an industry working group may provide an effective forum for such 
discussions.
    In response to commenters' gridlock concerns, the Board notes that 
similar concerns were raised before the Board's introduction of net 
debit caps that took effect in 1986, the reduction of net debit caps 
that took effect in 1988, and the announcement of daylight overdraft 
fees in 1992 (50 FR 21120, May 22, 1985; 52 FR 29255, Aug. 6, 1987; 54 
FR 26094, June 21, 1989). With respect to the net debit cap 
introduction and subsequent reduction, the Board found no empirical 
support suggestive of any significant change to intraday payment 
patterns among depository institutions. With the introduction of 
daylight overdraft fees, while certain adjustments to payment patterns 
occurred, payments gridlock did not occur because institutions 
continued to have sufficient business incentive to ensure execution of 
their

[[Page 57922]]

customers' payments, particularly those considered to be time-critical. 
Similarly, with the posting rule change for interest and redemption 
payments, the Board believes that market participants will make some 
adjustments to their payment patterns, but that wide-ranging payments 
gridlock is highly unlikely given the payment expectations of customers 
and the business incentives that exist between counterparties. The 
Board is confident that issuers would consider these expectations and 
incentives in their decisions regarding management of their interest 
and redemption payments and their general corporate payment activity.
    Commenters also discussed approaches that the Board might consider 
with respect to full implementation of the posting rule change. 
Regarding one commenter's suggestion of netting new issuances against 
interest and redemption payments, the Board notes that this approach, 
as described by the commenter, involves a continued extension of 
Federal Reserve intraday credit to finance any mismatch in timing 
between new issuances and interest and redemption payments. This 
commenter also suggested that the Board consider some form of a 
collateralized borrowing arrangement or a backup line of credit as 
``readily available'' to further offset a portion of an issuer's 
funding requirement, which also involves a continued extension of 
Federal Reserve intraday credit. As mentioned, the Board has determined 
that the Federal Reserve will not extend intraday credit to entities 
that do not have regular access to the discount window. As such, the 
aforementioned implementation approaches are not viable.
    In summary, the Board does not view a phased implementation as 
necessary to ensure a smooth market adjustment or as preferable to an 
approach of full implementation. As such, the Board plans to implement 
fully without a phase-in the policy changes effective July 20, 2006. 
The Board believes that full implementation in July 2006 should provide 
market participants sufficient time to adjust their systems and account 
management practices, as needed, to address operational or liquidity 
concerns. The Federal Reserve will communicate operational changes 
related to this policy change with account holders in a timely manner 
over the planning period and provide opportunities to test those 
changes prior to implementation.

B. Formation of a Working Group

    Four commenters discussed the merits of forming a work group to 
discuss the planned policy changes. The general consensus among these 
commenters was that the group should be sponsored by the Federal 
Reserve with representation from a cross-section of market 
participants. The commenters' objective is to facilitate information 
sharing to minimize potential market disruptions stemming from the 
planned policy changes, such as the removal of free liquidity that has 
been provided early in the day under the current practice of releasing 
interest and redemption payments by 9:15 a.m. ET. Three of the 
commenters stated that the formation of such a group would promote 
transparency in devising an appropriate implementation plan. One of the 
commenters noted that precedent exists for forming such an industry 
group: the group formed to facilitate the migration of Ginnie Mae 
securities from the Depository Trust and Clearing Corporation to the 
Fedwire Securities Service.
    One commenter suggested that the group perform an impact study of 
the changes prior to implementation. Another commenter suggested that 
the group evaluate the credit implications of treating the issuers 
similarly to other large corporate customers. This commenter also 
recommended that the group evaluate the system requirements and 
operational issues associated with implementation. Another commenter 
suggested that the purpose of the group would be to formulate a phase-
in plan, while another stated that the group should develop a 
conversion plan and implementation schedule, regardless of whether a 
phased approach was adopted.
    One commenter suggested that the group analyze various aspects of 
the interest and redemption payment data in order to make 
recommendations on items such as the timing of each issuer's interest 
and redemption payments, possible implementation methods, potential 
sources of credit to facilitate processing of interest and redemption 
payments, and management of depository institutions' daylight 
overdrafts. The proposed analysis would include evaluation of the 
dollar amounts of historical and prospective interest and redemption 
payments as well as the current timing of and any related overdrafts 
associated with these payments. The Board notes, however, that data 
regarding individual account holders' payment or daylight overdraft 
activity are confidential, and, as such, cannot be shared without their 
permission.
    The Board recognizes that the effect of these policy changes on 
market participants may vary depending on the payment practices that 
each issuer ultimately adopts. As such, the Board sees value in 
fostering collaborative discussion among stakeholders regarding the 
policy implementation and will sponsor a working group, coordinated 
through the Federal Reserve Banks' Wholesale Product Office in New 
York. The Board believes that such a group could help to identify 
potential market adaptations to the policy changes and associated 
operational considerations. The Board also believes that the working 
group could enhance stakeholders' understanding of the future steady-
state environment and therefore minimize the potential for market 
disruptions.
    Organizations that commented on the planned policy changes, members 
of those organizations, and fiscal principals affected by these policy 
changes will be invited to participate in the working group. The Board 
notes that participation is not mandatory. In order to allow market 
participants and the Reserve Banks sufficient time to implement the 
planned policy changes on July 20, 2006, the majority of system 
requirements to implement the changes will need to be well-formulated 
by year-end 2004. Throughout implementation, the Wholesale Product 
Office will work closely with account holders to address operational 
considerations associated with the policy changes, as it does for other 
significant Fedwire-related operational changes.
    The working group may also find it useful to discuss issues 
identified by two commenters relating to account reconciliation and 
repo tracking.\13\ One commenter noted that, with the planned posting 
rule change, it would be necessary for payment recipients to receive an 
end-of-day file from the Reserve Banks to facilitate

[[Page 57923]]

reconcilement of expected interest and redemption payments with those 
that were actually released on a given day. Another commenter 
recommended that the Federal Reserve examine the effects of the policy 
changes on the repo tracking functionality currently available to 
participants on the Fedwire Securities Service, given that payments 
will be processed by individual issuer under the revised policy.
---------------------------------------------------------------------------

    \13\ Repo tracking is a facility that allows adjustments to be 
made to the accounts of participants on the Fedwire Securities 
Service to ensure that the appropriate party receives principal and 
interest payments on mortgage-backed securities that have been 
marked with a repo identifier. The holder of one of these securities 
at close of business on record date will receive the associated 
principal and interest payment. However, the holder (identified as 
the ``repo in'' party) is not entitled to this payment in 
transactions such as those involving a repurchase agreement. The 
Reserve Banks keep track of repo records and make the necessary 
adjustment to ensure that the appropriate party receives the 
payment. The ``repo in'' party will receive a funds debit, and the 
``repo-out'' party will receive a funds credit through the NSS. For 
more information, see http://www.frbservices.org/Wholesale/CM-2001/CM-221.pdf.
---------------------------------------------------------------------------

    The Board recognizes that the PSR policy changes will necessitate 
some operational changes to Federal Reserve systems and operating 
practices, such as the provision of additional files or modifications 
to allow interest and redemption payments to be released on an issuer-
by-issuer basis. As such, Reserve Banks will conduct a comprehensive 
analysis of the current processes and system requirements to determine 
the necessary modifications to implement the policy changes 
effectively. The Board believes that the working group may be 
instrumental in identifying and discussing issues of this nature.

C. Establishment of a Cut-Off Hour

    Three commenters addressed the establishment of a 4 p.m. ET cut-off 
hour by which issuers must fund their respective interest and 
redemption payments. One commenter urged the Federal Reserve to keep 
processing interest and redemption payments to the extent they are 
funded up until the close of the Fedwire Funds Service (6:30 p.m. ET) 
to avoid a technical default on the part of the issuer. Two commenters 
supported a cut-off hour earlier than 4 p.m. ET. Specifically, one of 
these commenters recommended that the cut-off hour be set at 3:30 p.m. 
ET to facilitate processing of payments dependent on the receipt of 
interest and redemption payments. Another commenter recommended a cut-
off hour more similar to that of other issuing and paying agents, 
indicating that an earlier cut-off hour would facilitate orderly end-
of-day processing and provide sufficient time for affected parties to 
make appropriate funding arrangements, if necessary. In addition, this 
commenter indicated that an earlier cut-off hour might reduce intraday 
liquidity pressures on interest and redemption payment recipients, 
presumably because it would offer greater predictability of payment 
receipt. This commenter also supported the ability for Reserve Banks to 
grant extensions of the cut-off hour in instances of significant market 
disruptions to ensure orderly settlement.
    The Board established a cut-off hour of 4 p.m. ET because it is the 
latest time by which issuers could fund their interest and redemption 
payments for release that day and still allow the Reserve Banks to 
close the Fedwire Securities Service on time.\14\ The Board views the 
establishment of a deadline no later than 4 p.m. ET as necessary to 
avoid disruptions to end-of-day processing for this and related 
systems. With respect to establishing a cut-off hour earlier than 4 
p.m. ET, the Board views it as appropriate to base the cutoff hour on 
the Reserve Banks' operational capabilities, rather than on some other 
measure, such as the funding needs of individual market participants, 
because the Board views the former basis as both objective and 
transparent.
---------------------------------------------------------------------------

    \14\ According to the Reserve Banks' Operating Circular 7, 
Fedwire Securities Account Maintenance and Transfer Services, funds-
only transactions on the Fedwire Securities Service cannot be 
processed after 4:30 p.m. ET. Interest and redemption payments on 
Fedwire-eligible securities are processed through the Fedwire 
Securities Service as funds-only transactions. As such, a 4 p.m. ET 
cut-off hour provides the Reserve Banks a 30-minute window in which 
to complete the requisite processing for funds-related transactions 
in order to close the Fedwire Securities Service on time.
---------------------------------------------------------------------------

    In the event an issuer does not fund its interest and redemption 
payments by the established cut-off hour of 4 p.m. ET, its payments 
would not be processed on that day. Requests by an issuer for 
extensions of the 4 p.m. ET funding deadline would not be granted in 
the normal course. Rather, the Reserve Banks would exercise their 
discretion in determining whether an extension is warranted in 
instances of significant market disruptions.

III. Other Policy Revisions

    In addition to the changes described above, the Board has revised 
its policy to reflect recent changes to the operating hours of the on-
line Fedwire Funds Service, to remove or update items that have become 
outdated, and to incorporate minor editorial changes to clarify 
meaning. The principal changes are described below.
    Beginning in May 2004, the Federal Reserve changed the operating 
hours of the on-line Fedwire Funds Service from 18 to 21.5 hours. 
Because daylight overdraft fees are calculated based on the number of 
hours in the Fedwire Funds Service operating day, the fee calculation 
as described in the policy has been revised. The Board notes that the 
effective daily rates for both the regular daylight overdraft fee and 
the penalty fee have been truncated at seven decimal places because of 
programming changes made to Federal Reserve systems to expedite 
processing.\15\ Similarly, the effective daily rate used to calculate 
the value of the deductible has been rounded to seven decimal 
places.\16\ The Board recognizes that these changes may affect the fee 
calculations for some account holders; however, none of the changes 
result in increased daylight overdraft fees. The revised calculation is 
described in detail in section I.B. of the policy.
---------------------------------------------------------------------------

    \15\ The effective daily rate used in the calculation of the 
regular daylight overdraft fee has been truncated to 0.0000089. The 
effective daily rate used in the calculation of the penalty daylight 
overdraft fee has been truncated to 0.0000338.
    \16\ The effective daily rate used in the calculation of any 
applicable deductible amount has been rounded to 0.0000042.
---------------------------------------------------------------------------

    The Board has modified the posting rule for payments on U.S. 
Treasury and government agency matured coupons or definitive 
securities. The posting rule now distinguishes U.S. Treasury and 
government agency securities from securities issued by GSEs or 
international organizations. Until July 20, 2006, the posting rule for 
matured coupons and definitive securities issued by GSEs and 
international organizations will continue to specify that electronic 
credits for these items will post to recipients' Federal Reserve 
accounts by 9:15 a.m. ET.\17\ Beginning on July 20, 2006, however, 
these payments will post throughout the business day as directed by the 
issuer, but only when the issuer's Federal Reserve account contains 
funds equal to or in excess of the amount of the payments to be made. 
This change is consistent with the aforementioned principle that 
entities that do not have regular access to the discount window are not 
eligible for intraday credit.
---------------------------------------------------------------------------

    \17\ The policy clarifies that most payments on matured coupons 
or definitive securities are made by check and, as such, will post 
according to the policy's established check posting rules.
---------------------------------------------------------------------------

    Finally, the Board has revised its policy to remove language 
pertaining to foreign banking organizations that became outdated as of 
February 20, 2002 and to remove language pertaining to electronic check 
presentments that became outdated as of April 1, 2002.

IV. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
ch. 3506; 5 CFR 1320 Appendix A.1), the Board has reviewed the policy 
statement under the authority delegated to the Board by the Office of 
Management and Budget. No collections of information pursuant to the 
Paperwork Reduction Act are contained in the policy statement.

[[Page 57924]]

V. Federal Reserve Policy Statement on Payments System Risk

    Section I. of the PSR policy is revised, effective September 22, 
2004, to read as follows:

Introduction

I. Federal Reserve Daylight Credit Policies
    A. Daylight Overdraft Definition and Measurement
    B. Pricing
    C. Net Debit Caps
    1. Definition
    2. Cap Categories
    a. Self-assessed
    b. De minimis
    c. Exempt-from-filing
    d. Zero
    3. Capital Measure
    a. U.S.-chartered institutions
    b. U.S. branches and agencies of foreign banks
    D. Collateralized Capacity
    E. Special Situations
    1. Edge and Agreement Corporations
2. Bankers' Banks
    3. Limited-Purpose Trust Companies
    4. Government-Sponsored Enterprises and International 
Organizations
    5. Problem Institutions
    F. Monitoring
    1. Ex Post
    2. Real Time
    3. Multi-District Institutions
    G. Transfer-Size Limit on Book-Entry Securities

Introduction

    The Federal Reserve Board has developed this policy to address the 
risks that payment systems present to the Federal Reserve Banks 
(Reserve Banks), to the banking system, and to other sectors of the 
economy. This policy is directed primarily at risks on large-dollar 
payment systems, including Federal Reserve and private-sector systems. 
Risk can arise from transactions on the Federal Reserve's real-time 
gross settlement system (Fedwire), from transactions processed in other 
Federal Reserve payment systems (for example, the automated 
clearinghouse (ACH) system), and from transactions on private large-
dollar systems.
    The Reserve Banks face direct risk of loss should institutions be 
unable to settle their intraday or ``daylight'' overdrafts in their 
Federal Reserve accounts before the end of the day.\1\ Moreover, 
systemic risk may occur if an institution participating in a private 
large-dollar payment system were unable to settle its net debit 
position. If this were to occur, the institution's creditors in that 
system might then be unable to settle their obligations in that system 
or other systems. Serious repercussions could spread to other 
participants in the private system, to other institutions not 
participating in the system, and to the nonfinancial economy generally. 
A Reserve Bank could be exposed to an indirect risk if the Federal 
Reserve's policies did not address this systemic risk. Finally, 
institutions create risk by permitting their customers, including other 
depository institutions, to incur daylight overdrafts in the 
institutions' accounts in anticipation of receiving covering funds 
before the end of the day.
---------------------------------------------------------------------------

    \1\ In this policy statement, the term ``institution'' will be 
used to refer to institutions defined as ``depository institutions'' 
in 12 U.S.C. 461(b)(1)(A), U.S. branches and agencies of foreign 
banking organizations, Edge and agreement corporations, bankers' 
banks, limited-purpose trust companies, government-sponsored 
enterprises, and international organizations, unless the context 
indicates a different reading.
---------------------------------------------------------------------------

    The Board is aware that large-dollar systems are an integral part 
of clearing and settlement systems and that it is vital to keep the 
payments mechanism operating without significant disruption. 
Recognizing the importance of avoiding such disruptions, the Board 
continues to seek to reduce the risks of settlement failures that could 
cause these disruptions. The Board is also aware that some intraday 
credit may be necessary to keep the payments mechanism running smoothly 
and efficiently. The reduction and control of intraday credit risks, 
although essential, must be accomplished in a manner that will minimize 
disruptions to the payments mechanism. The Board expects to reduce and 
control risks without unduly disrupting the smooth operation of the 
payments mechanism by establishing guidelines for use by institutions 
and relying largely on the efforts of individual institutions to 
identify, control, and reduce their own exposures.
    The Board expects institutions to manage their Federal Reserve 
accounts effectively and use Federal Reserve daylight credit 
efficiently and appropriately, in accordance with this policy. Although 
some intraday credit may be necessary, the Board expects that, as a 
result of its policies, relatively few institutions will consistently 
rely on significant amounts of intraday credit supplied by the Federal 
Reserve to conduct their business. 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 limits on 
daylight overdrafts in institutions' accounts at Reserve Banks; 
collateralization, in certain situations, of daylight overdrafts at the 
Federal Reserve; limits on the maximum level of credit exposure that 
can be produced by each participant on private large-dollar systems; 
availability of backup facilities capable of completing daily 
processing requirements for private large-dollar systems; and credit 
and liquidity safeguards for private delivery-against-payment systems. 
To assist institutions in implementing the Board's policies, the 
Federal Reserve has prepared two documents, the ``Overview of the 
Federal Reserve's Payments System Risk Policy'' (Overview) and the 
``Guide to the Federal Reserve's Payments System Risk Policy'' (Guide), 
which are available online at http://www.federalreserve.gov/ 
PaymentSystems/PSR. The Overview summarizes the Board's policy on 
payments system risk, including net debit caps and daylight overdraft 
fees and is intended for use by institutions that incur only small and 
infrequent daylight overdrafts. The Guide explains in detail how these 
policies apply to different institutions and includes procedures for 
completing a self-assessment and filing a cap resolution, as well as 
information on other aspects of the policy.

I. Federal Reserve Daylight Credit Policies

A. Daylight Overdraft Definition and Measurement

    A daylight overdraft occurs when an 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 in 
institutions' Federal Reserve accounts. Under this ex post measurement 
system, certain transactions, including Fedwire funds transfers, book-
entry securities transfers, and net settlement transactions, are posted 
as they are processed during the business day. Other transactions, 
including ACH and check transactions, are posted to institutions' 
accounts according to a defined schedule. The following table presents 
the schedule used by the Federal Reserve for posting transactions to 
institutions' accounts for purposes of measuring daylight overdrafts.

Procedures for Measuring Daylight Overdrafts \2\
---------------------------------------------------------------------------

    \2\ This schedule of posting rules does not affect the overdraft 
restrictions and overdraft-measurement provisions for nonbank banks 
established by the Competitive Equality Banking Act of 1987 and the 
Board's Regulation Y (12 CFR 225.52).
---------------------------------------------------------------------------

    Opening Balance (Previous Day's Closing Balance)
    Post Throughout Business Day:
    +/- Fedwire funds transfers.

[[Page 57925]]

    +/- Fedwire book-entry securities transfers.
    +/- National Settlement Service entries.
    Post Throughout Business Day (Beginning July 20, 2006):
    + Fedwire book-entry interest and redemption payments on securities 
that are not obligations of, or fully guaranteed as to principal and 
interest by, the United States.<SUP>3, 4, 5</SUP>
---------------------------------------------------------------------------

    \3\ The Reserve Banks act as fiscal agents for certain entities, 
such as government-sponsored enterprises (GSEs) and international 
organizations, whose securities are Fedwire-eligible but are not 
obligations of, or fully guaranteed as to principal and interest by, 
the United States. The GSEs include Fannie Mae, the Federal Home 
Loan Mortgage Corporation (Freddie Mac), entities of the Federal 
Home Loan Bank System (FHLBS), the Farm Credit System, the Federal 
Agricultural Mortgage Corporation (Farmer Mac), the Student Loan 
Marketing Association (Sallie Mae), the Financing Corporation, and 
the Resolution Funding Corporation. The international organizations 
include the World Bank, the Inter-American Development Bank, the 
Asian Development Bank, and the African Development Bank. The 
Student Loan Marketing Association Reorganization Act of 1996 
requires Sallie Mae to be completely privatized by 2008; however, 
Sallie Mae plans to complete privatization by September 2006. Upon 
privatization, the Reserve Banks will no longer act as fiscal agents 
for new issues of Sallie Mae securities, and the new Sallie Mae will 
not be considered a GSE.
    \4\ The term ``interest and redemption payments'' refers to 
payments of principal, interest, and redemption on securities 
maintained on the Fedwire Securities Service.
    \5\ The Reserve Banks will post these transactions, as directed 
by the issuer, provided that the issuer's Federal Reserve account 
contains funds equal to or in excess of the amount of the interest 
and redemption payments to be made. In the normal course, if a 
Reserve Bank does not receive funding from an issuer for the 
issuer's interest and redemption payments by the established cut-off 
hour of 4 p.m. Eastern Time on the Fedwire Securities Service, the 
issuer's payments will not be processed on that day.
---------------------------------------------------------------------------

    + Electronic payments for matured coupons and definitive securities 
that are not obligations of, or fully guaranteed as to principal and 
interest by, the United States.\6\
---------------------------------------------------------------------------

    \6\ Electronic payments for credits on these securities will 
post according to the posting rules for the mechanism through which 
they are processed, as outlined in this policy. However, the 
majority of these payments are made by check and will be posted 
according to the established check posting rules as set forth in 
this policy.
---------------------------------------------------------------------------

    Post at 8:30 a.m. Eastern Time:
    +/- Government and commercial ACH credit transactions.\7\
---------------------------------------------------------------------------

    \7\ Institutions that are monitored in real time must fund the 
total amount of their commercial ACH credit originations in order 
for the transactions to be processed. If the Federal Reserve 
receives commercial ACH credit transactions from institutions 
monitored in real time after the scheduled close of the Fedwire 
Funds Service, these transactions will be processed at 12:30 a.m. 
the next business day, or by the ACH deposit deadline, whichever is 
earlier. The Account Balance Monitoring System provides intraday 
account information to the Reserve Banks and institutions and is 
used primarily to give authorized Reserve Bank personnel a mechanism 
to control and monitor account activity for selected institutions. 
For more information on ACH transaction processing, refer to the ACH 
Settlement Day Finality Guide available through the Federal Reserve 
Financial Services Web site at http://www.frbservices.org.
---------------------------------------------------------------------------

    + Treasury Electronic Federal Tax Payment System (EFTPS) 
investments from ACH credit transactions.
    + Advance-notice Treasury investments.
    + Treasury checks, postal money orders, local Federal Reserve Bank 
checks, and EZ-Clear savings bond redemptions in separately sorted 
deposits; these items must be deposited by 12:01 a.m. local time or the 
local deposit deadline, whichever is later.
    - Penalty assessments for tax payments from the Treasury Investment 
Program (TIP).\8\
---------------------------------------------------------------------------

    \8\ The Reserve Banks will identify and notify institutions with 
Treasury-authorized penalties on Thursdays. In the event that 
Thursday is a holiday, the Reserve Banks will identify and notify 
institutions with Treasury-authorized penalties on the following 
business day. Penalties will then be posted on the business day 
following notification.
---------------------------------------------------------------------------

    Post at 8:30 a.m. Eastern Time and Hourly, on the Half-Hour, 
Thereafter:
    +/- Main account administrative investment or withdrawal from TIP.
    +/- Special Direct Investment (SDI) administrative investment or 
withdrawal from TIP.
    + 31 CFR Part 202 account deposits from TIP.
    - Uninvested paper tax (PATAX) tax deposits from TIP.
    - Main account balance limit withdrawals from TIP.
    - Collateral deficiency withdrawals from TIP.
    - 31 CFR Part 202 deficiency withdrawals from TIP.
    Post at 8:30 a.m., 1 p.m., and 6:30 p.m. Eastern Time:
    - Main account Treasury withdrawals from TIP.\9\
---------------------------------------------------------------------------

    \9\ On rare occasions, the Treasury may announce withdrawals in 
advance that are based on institutions' closing balances on the 
withdrawal date. The Federal Reserve will post these withdrawals 
after the close of Fedwire.
---------------------------------------------------------------------------

    Post by 9:15 a.m. Eastern Time:
    + U.S. Treasury and government agency Fedwire book-entry interest 
and redemption payments.\10\
---------------------------------------------------------------------------

    \10\ For purposes of this policy, government agencies are those 
entities (other than the U.S. Treasury) for which the Reserve Banks 
act as fiscal agents and whose securities are obligations of, or 
fully guaranteed as to principal and interest by, the United States.
---------------------------------------------------------------------------

    + Electronic payments for U.S. Treasury and government agency 
matured coupons and definitive securities.\11\
---------------------------------------------------------------------------

    \11\ Electronic payments for credits on these securities will 
post by 9:15 a.m. Eastern Time; however, the majority of these 
payments are made by check and will be posted according to the 
established check posting rules as set forth in this policy.
---------------------------------------------------------------------------

    Post by 9:15 a.m. Eastern Time (Until July 20, 2006):
    + Fedwire book-entry interest and redemption payments on securities 
that are not obligations of, or fully guaranteed as to principal and 
interest by, the United States.\12\
---------------------------------------------------------------------------

    \12\ See footnote 3.
---------------------------------------------------------------------------

    + Electronic payments for matured coupons and definitive securities 
that are not obligations of, or fully guaranteed as to principal and 
interest by, the United States.\13\
---------------------------------------------------------------------------

    \13\ See footnote 11.
---------------------------------------------------------------------------

    Post Beginning at 9:15 a.m. Eastern Time:
    - Original issues of Treasury securities.\14\
---------------------------------------------------------------------------

    \14\ Original issues of government agency, government-sponsored 
enterprise, or international organization securities are delivered 
as book-entry securities transfers and will be posted when the 
securities are delivered to the purchasing institutions.
---------------------------------------------------------------------------

    Post at 9:30 a.m. Eastern Time and Hourly, on the Half-Hour, 
Thereafter:
    + Federal Reserve Electronic Tax Application (FR-ETA) value Fedwire 
investments from TIP.
    Post at 11 a.m. Eastern Time:
    +/- ACH debit transactions.
    + EFTPS investments from ACH debit transactions.
    Post at 11 a.m. Eastern Time and Hourly Thereafter:
    +/- Commercial check transactions, including returned 
checks.<SUP>15, 16</SUP>
---------------------------------------------------------------------------

    \15\ This does not include electronic check presentments, which 
are posted at 1 p.m. local time and hourly thereafter. Paper check 
presentments are posted on the hour at least one hour after 
presentment. Paper checks presented before 10:01 a.m. Eastern Time 
will be posted at 11 a.m. Eastern Time. Presentment times will be 
based on surveys of endpoints' scheduled courier deliveries and so 
will occur at the same time each day for a particular institution.
    \16\ Institutions must choose one of two check-credit posting 
options: (1) all credits posted at a single, float-weighted posting 
time, or (2) fractional credits posted throughout the day. The first 
option allows an institution to receive all of its check credits at 
a single time for each type of cash letter. This time may not 
necessarily fall on the clock hour. The second option lets the 
institution receive a portion of its available check credits on the 
clock hours between 11 a.m. and 6 p.m. Eastern Time. The option 
selected applies to all check deposits posted to an institution's 
account. Reserve Banks will calculate crediting fractions and float-
weighted posting times for each time zone based on surveys. Credits 
for mixed cash letters and other Fed cash letters are posted using 
the crediting fractions or the float-weighted posting times for the 
time zone of the Reserve Bank servicing the depositing institution. 
For separately sorted deposits, credits are posted using the posting 
times for the time zone of the Reserve Bank servicing the payor 
institution.
---------------------------------------------------------------------------

    +/- Check corrections amounting to $1 million or more.
    +/- Currency and coin deposits.
    + Credit adjustments amounting to $1 million or more.

[[Page 57926]]

    Post at 12:30 p.m. Eastern Time and Hourly, on the Half-Hour, 
Thereafter:
    + Dynamic investments from TIP.
    Post by 1 p.m. Eastern Time:
    + Same-day Treasury investments.
    Post at 1 p.m. Local Time and Hourly Thereafter:
    - Electronic check presentments.\17\
---------------------------------------------------------------------------

    \17\ The Federal Reserve Banks will post debits to institutions' 
accounts for electronic check presentments made before 12 p.m. local 
time at 1 p.m. local time. The Reserve Banks will post presentments 
made after 12 p.m. local time on the next clock hour that is at 
least one hour after presentment takes place but no later than 3 
p.m. local time.
---------------------------------------------------------------------------

    Post at 5 p.m. Eastern Time:
    + Treasury checks, postal money orders, and EZ-Clear savings bond 
redemptions in separately sorted deposits; these items must be 
deposited by 4 p.m. Eastern Time.
    + Local Federal Reserve Bank checks; these items must be presented 
before 3 p.m. Eastern Time.
    +/- Same-day ACH transactions; these transactions include ACH 
return items, check-truncation items, and flexible settlement items.
    Post at 6:30 p.m. Eastern Time:\18\
---------------------------------------------------------------------------

    \18\ The Federal Reserve Banks will process and post Treasury-
authorized penalty abatements on Thursdays. In the event that 
Thursday is a holiday, the Federal Reserve Banks will process and 
post Treasury-authorized penalty abatements on the following 
business day.
---------------------------------------------------------------------------

    + Penalty Abatements from TIP.
    Post After the Close of Fedwire Funds Service:
    +/- All other transactions. These transactions include the 
following: local Federal Reserve Bank checks presented after 3 p.m. 
Eastern Time but before 3 p.m. local time; noncash collection; currency 
and coin shipments; small-dollar credit adjustments; and all debit 
adjustments. Discount-window loans and repayments are normally posted 
after the close of Fedwire as well; however, in unusual circumstances a 
discount window loan may be posted earlier in the day with repayment 24 
hours later, or a loan may be repaid before it would otherwise become 
due.
    Equals: Closing balance.

B. Pricing

    Reserve Banks charge institutions for daylight overdrafts incurred 
in their Federal Reserve accounts. For each two-week reserve-
maintenance period, the Reserve Banks calculate and assess daylight 
overdraft fees, which are equal to the sum of any daily daylight 
overdraft charges during the period.
    Daylight overdraft fees are calculated using an annual rate of 36 
basis points, quoted on the basis of a 24-hour day. To obtain the 
effective annual rate for the standard Fedwire operating day, the 36-
basis-point annual rate is multiplied by the fraction of a 24-hour day 
during which Fedwire is scheduled to operate. For example, under a 
21.5-hour scheduled Fedwire operating day, the effective annual rate 
used to calculate daylight overdraft fees equals 32.25 basis points (36 
basis points multiplied by 21.5/24).\19\ The effective daily rate is 
calculated by dividing the effective annual rate by 360.\20\ An 
institution's daily daylight overdraft charge is equal to the effective 
daily rate multiplied by the institution's average daily daylight 
overdraft minus a deductible valued at the deductible's effective daily 
rate.
---------------------------------------------------------------------------

    \19\ A change in the length of the scheduled Fedwire operating 
day should not significantly change the amount of fees charged 
because the effective daily rate is applied to average daylight 
overdrafts, whose calculation would also reflect the change in the 
operating day.
    \20\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft rate is truncated to 0.0000089.
---------------------------------------------------------------------------

    An institution's average daily daylight overdraft is calculated by 
dividing the sum of its negative Federal Reserve account balances at 
the end of each minute of the scheduled Fedwire operating day by the 
total number of minutes in the scheduled Fedwire operating day. In this 
calculation, each positive end-of-minute balance in an institution's 
Federal Reserve account is set to equal zero.
    The daily daylight overdraft charge is reduced by a deductible, 
valued at the effective daily rate for a 10-hour operating day. The 
deductible equals 10 percent of a capital measure (see section I.C.3., 
``Capital measure''). Because the effective daily rate applicable to 
the deductible is kept constant at the 10-hour-operating-day rate, any 
changes to the scheduled Fedwire operating day should not significantly 
affect the value of the deductible.\21\ Reserve Banks will waive fees 
of $25 or less in any two-week reserve-maintenance period. Certain 
institutions are subject to a penalty fee and modified daylight 
overdraft fee calculation as described in section I.E.
---------------------------------------------------------------------------

    \21\ Under the current 21.5-hour Fedwire operating day, the 
effective daily deductible rate is rounded to 0.0000042.
---------------------------------------------------------------------------

C. Net Debit Caps

1. Definition
    To limit the aggregate amount of daylight credit that the Reserve 
Banks extend, each institution incurring daylight overdrafts in its 
Federal Reserve account must adopt a net debit cap, that is, a ceiling 
on the uncollateralized daylight overdraft position that it can incur 
during a given interval. If an institution's daylight overdrafts 
generally do not exceed the lesser of $10 million or 20 percent of its 
capital measure, the institution may qualify for the exempt-from-filing 
cap. An institution must be financially healthy and have regular access 
to the discount window in order to adopt a net debit cap greater than 
zero or qualify for the filing exemption.
    An institution's cap category and capital measure determine the 
size of its net debit cap. More specifically, the net debit cap is 
calculated as an institution's cap multiple times its capital measure:
net debit cap = cap multiple x capital measure

    Cap categories (see section I.C.2., ``Cap categories'') and their 
associated cap levels, set as multiples of capital measure, are listed 
below:

                         Net Debit Cap Multiples
------------------------------------------------------------------------
          Cap category                Single day       Two-week  average
------------------------------------------------------------------------
High............................  2.25..............  1.50
Above average...................  1.875.............  1.125
Average.........................  1.125.............  0.75
De minimis......................  0.40..............  0.40
Exempt-from-filing \22\.........  $10 million or      $10 million or
                                   0.20.               0.20
Zero............................  0.0...............  0.0
------------------------------------------------------------------------

    An institution is expected to avoid incurring daylight overdrafts 
whose daily maximum level, averaged over a two-week period, would 
exceed its two-week average cap, and, on any day, would exceed its 
single-day cap.\23\ The two-week average cap provides flexibility, in 
recognition that fluctuations in payments can occur from day to day. 
The purpose of the higher single-day cap is to limit excessive daylight 
overdrafts on any day and to ensure that institutions develop internal 
controls that focus on their exposures each day, as well as over time.
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    \22\ The net debit cap for the exempt-from-filing category is 
equal to the lesser of $10 million or 0.20 multiplied by the 
institution's capital measure.
    \23\ The two-week period is the two-week reserve-maintenance 
period. The number of days used in calculating the average daylight 
overdraft over this period is the number of business days the 
institution's Reserve Bank is open during the reserve-maintenance 
period.
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    The Board's policy on net debit caps is based on a specific set of 
guidelines and some degree of examiner oversight. Under the Board's 
policy, a Reserve Bank may limit or prohibit an institution's use of 
Federal Reserve intraday credit if (1) the institution's use of 
daylight credit is deemed by the institution's supervisor to be unsafe 
or unsound; (2) the institution does not

[[Page 57927]]

qualify for a positive net debit cap (see section I.C.2., ``Cap 
categories''); or (3) the institution poses excessive risk to a Reserve 
Bank by incurring chronic overdrafts in excess of what the Reserve Bank 
determines is prudent.
    While capital measures differ, the net debit cap provisions of this 
policy apply to foreign banking organizations (FBOs) to the same extent 
that they apply to U.S. institutions. The Reserve Banks will advise 
home-country supervisors of the daylight overdraft capacity of U.S. 
branches and agencies of FBOs under their jurisdiction, as well as of 
other pertinent information related to the FBOs' caps. The Reserve 
Banks will also provide information on the daylight overdrafts in the 
Federal Reserve accounts of FBOs' U.S. branches and agencies in 
response to requests from home-country supervisors.
2. Cap Categories
    The policy defines the following six cap categories, described in 
more detail below: high, above average, average, de minimis, exempt-
from-filing, and zero. The high, above average, and average cap 
categories are referred to as ``self-assessed'' caps.
    a. Self-assessed. In order to establish a net debit cap category of 
high, above average, or average, an institution must perform a self-
assessment of its own creditworthiness, intraday funds management and 
control, customer credit policies and controls, and operating controls 
and contingency procedures.\24\ The assessment of creditworthiness is 
based on the institution's supervisory rating and Prompt Corrective 
Action (PCA) designation.\25\ An institution may perform a full 
assessment of its creditworthiness in certain limited circumstances, 
for example, if its condition has changed significantly since its last 
examination or if it possesses additional substantive information 
regarding its financial condition. An institution performing a self-
assessment must also evaluate its intraday funds-management procedures 
and its procedures for evaluating the financial condition of and 
establishing intraday credit limits for its customers. Finally, the 
institution must evaluate its operating controls and contingency 
procedures to determine if they are sufficient to prevent losses due to 
fraud or system failures. The ``Guide to the Federal Reserve's Payments 
System Risk Policy'' includes a detailed explanation of the self-
assessment process.
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    \24\ This assessment should be done on an individual-institution 
basis, treating as separate entities each commercial bank, each Edge 
corporation (and its branches), each thrift institution, and so on. 
An exception is made in the case of U.S. branches and agencies of 
FBOs. Because these entities have no existence separate from the 
FBO, all the U.S. offices of FBOs (excluding U.S.-chartered bank 
subsidiaries and U.S.-chartered Edge subsidiaries) should be treated 
as a consolidated family relying on the FBO's capital.
    \25\ An insured depository institution is (1) ``well 
capitalized'' if it significantly exceeds the required minimum level 
for each relevant capital measure, (2) ``adequately capitalized'' if 
it meets the required minimum level for each relevant capital 
measure, (3) ``undercapitalized'' if it fails to meet the required 
minimum level for any relevant capital measure, (4) ``significantly 
undercapitalized'' if it is significantly below the required minimum 
level for any relevant capital measure, or (5) ``critically 
undercapitalized'' if it fails to meet any leverage limit (the ratio 
of tangible equity to total assets) specified by the appropriate 
Federal banking agency, in consultation with the FDIC, or any other 
relevant capital measure established by the agency to determine when 
an institution is critically undercapitalized (12 U.S.C. 1831o).
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    Each institution's board of directors must review that 
institution's self-assessment and recommended cap category. The process 
of self-assessment, with board-of-directors review, should be conducted 
at least once in each twelve-month period. A cap determination may be 
reviewed and approved by the board of directors of a holding company 
parent of an institution, provided that (1) the self-assessment is 
performed by each entity incurring daylight overdrafts, (2) the 
entity's cap is based on the measure of the entity's own capital, 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-directors review.\26\
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    \26\ An FBO should undergo the same self-assessment process as a 
domestic bank in determining a net debit cap for its U.S. branches 
and agencies. Many FBOs, however, do not have the same management 
structure as U.S. institutions, and adjustments should be made as 
appropriate. If an FBO's board of directors has a more limited role 
to play in the bank's management than a U.S. board has, the self-
assessment and cap category should be reviewed by senior management 
at the FBO's head office that exercises authority over the FBO 
equivalent to the authority exercised by a board of directors over a 
U.S. institution. In cases in which the board of directors exercises 
authority equivalent to that of a U.S. board, cap determination 
should be made by the board of directors.
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    In applying these guidelines, each institution should maintain a 
file for examiner review that includes (1) worksheets and supporting 
analysis used in its self-assessment of its own cap category, (2) 
copies of senior-management reports to the board of directors of the 
institution or its parent (as appropriate) regarding that self-
assessment, 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.\27\
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    \27\ In addition, for FBOs, the file that is made available for 
examiner review by the U.S. offices of an FBO should contain the 
report on the self-assessment that the management of U.S. operations 
made to the FBO's senior management and a record of the appropriate 
senior management's response or the minutes of the meeting of the 
FBO's board of directors or other appropriate management group, at 
which the self-assessment was discussed.
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    As part of its normal examination, the institution's examiners may 
review the contents of the self-assessment file.\28\ The objective of 
this review is to ensure that the institution has applied the 
guidelines appropriately and diligently, that the underlying analysis 
and method 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, generally would not require a 
modification of the self-assessed cap category, but rather would inform 
the appropriate Reserve Bank of any concerns. The Reserve Bank would 
then decide whether to modify the cap category. For example, if the 
institution's level of daylight overdrafts constitutes an unsafe or 
unsound banking practice, the Reserve Bank would likely assign the 
institution a zero net debit cap and impose additional risk controls.
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    \28\ Between examinations, examiners or Reserve Bank staff may 
contact an institution about its cap if there is other relevant 
information, such as statistical or supervisory reports, that 
suggests there may have been a change in the institution's financial 
condition.
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    The contents of the self-assessment file will be considered 
confidential by the institution's examiner. Similarly, the Federal 
Reserve and the institution's examiner will hold the actual cap level 
selected by the institution confidential. Net debit cap information 
should not be shared with outside parties or mentioned in any public 
documents; however, net debit cap information will be shared with the 
home-country supervisor of U.S. branches and agencies of foreign banks.
    The Reserve Banks will review the status of any institution with a 
self-assessed net debit cap that exceeds its cap during a two-week 
reserve-maintenance period and will decide if the cap should be 
maintained or if additional action should be taken (see section I.F., 
``Monitoring'').
    b. De minimis. Many 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 self-assessment process and 
to ease the

[[Page 57928]]

burden on the Federal Reserve of administering caps, the Board allows 
institutions that meet reasonable safety and soundness standards to 
incur de minimis amounts of daylight overdrafts without performing a 
self-assessment. An institution may incur daylight overdrafts of up to 
40 percent of its capital measure if the institution submits a board-
of-directors resolution.
    An institution with a de minimis cap must submit to its Reserve 
Bank at least once in each 12-month period a copy of its board-of-
directors resolution (or a resolution by its holding company's board) 
approving the institution's use of daylight credit up to the de minimis 
level. The Reserve Banks will review the status of a de minimis cap 
institution that exceeds its cap during a two-week reserve-maintenance 
period and will decide if the de minimis cap should be maintained or if 
the institution will be required to perform a self-assessment for a 
higher cap.
    c. Exempt-from-filing. Institutions that only rarely incur daylight 
overdrafts in their Federal Reserve accounts that exceed the lesser of 
$10 million or 20 percent of their capital measure are excused from 
performing self-assessments and filing board-of-directors resolutions 
with their Reserve Banks. This dual test of dollar amount and percent 
of capital measure is designed to limit the filing exemption to 
institutions that create only low-dollar risks to the Reserve Banks and 
that incur small overdrafts relative to their capital measure.
    The Reserve Banks will review the status of an exempt institution 
that incurs overdrafts in its Federal Reserve account in excess of $10 
million or 20 percent of its capital measure on more than two days in 
any two consecutive two-week reserve-maintenance periods. The Reserve 
Bank will decide if the exemption should be maintained or if the 
institution will be required to file for a cap. Granting of the exempt-
from-filing net debit cap is at the discretion of the Reserve Bank.
    d. Zero. Some financially healthy institutions that could obtain 
positive net debit caps choose to have zero caps. Often these 
institutions have very conservative internal policies regarding the use 
of Federal Reserve daylight credit or simply do not want to incur 
daylight overdrafts and any associated daylight overdraft fees. If an 
institution that has adopted a zero cap incurs a daylight overdraft, 
the Reserve Bank counsels the institution and may monitor the 
institution's activity in real time and reject or delay certain 
transactions that would cause an overdraft. If the institution 
qualifies for a positive cap, the Reserve Bank may suggest that the 
institution adopt an exempt-from-filing cap or file for a higher cap if 
the institution believes that it will continue to incur daylight 
overdrafts.
    In addition, a Reserve Bank may assign an institution a zero net 
debit cap. Institutions that may pose special risks to the Reserve 
Banks, such as those without regular access to the discount window, 
those incurring daylight overdrafts in violation of this policy, or 
those in weak financial condition, are generally assigned a zero cap 
(see section I.E.5., ``Problem institutions''). Recently-chartered 
institutions may also be assigned a zero net debit cap.
3. Capital Measure
    As described above, an institution's cap category and capital 
measure determine the size of its net debit cap. The capital measure 
used in calculating an institution's net debit cap depends upon its 
chartering authority and home-country supervisor.
    a. U.S.-chartered institutions. For institutions chartered in the 
United States, net debit caps are multiples of ``qualifying'' or 
similar capital measures that consist of those capital instruments that 
can be used to satisfy risk-based capital standards, as set forth in 
the capital adequacy guidelines of the federal financial regulatory 
agencies. All of the federal financial regulatory agencies collect, as 
part of their required reports, data on the amount of capital that can 
be used for risk-based purposes--``risk-based'' capital for commercial 
banks, savings banks, and savings associations and total regulatory 
reserves for credit unions. Other U.S.-chartered entities that incur 
daylight overdrafts in their Federal Reserve accounts should provide 
similar data to their Reserve Banks.
    b. U.S. branches and agencies of foreign banks. For U.S. branches 
and agencies of foreign banks, net debit caps on daylight overdrafts in 
Federal Reserve accounts are calculated by applying the cap multiples 
for each cap category to the FBO's U.S. capital equivalency 
measure.\29\ U.S. capital equivalency is equal to the following:
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    \29\ The term ``U.S. capital equivalency'' is used in this 
context to refer to the particular capital measure used to calculate 
net debit caps and does not necessarily represent an appropriate 
capital measure for supervisory or other purposes.
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    <bullet> 35 percent of capital for FBOs that are financial holding 
companies (FHCs).\30\
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    \30\ The Gramm-Leach-Bliley Act defines a financial holding 
company as a bank holding company that meets certain eligibility 
requirements. In order for a bank holding company to become a 
financial holding company and be eligible to engage in the new 
activities authorized under the Gramm-Leach-Bliley Act, the Act 
requires that all depository institutions controlled by the bank 
holding company be well capitalized and well managed (12 U.S.C. 
1841(p)). With regard to a foreign bank that operates a branch or 
agency or owns or controls a commercial lending company in the 
United States, the Act requires the Board to apply comparable 
capital and management standards that give due regard to the 
principle of national treatment and equality of competitive 
opportunity (12 U.S.C. 1843(l)).
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    <bullet> 25 percent of capital for FBOs that are not FHCs and have 
a strength of support assessment ranking (SOSA) of 1.\31\
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    \31\ The SOSA ranking is composed of four factors, including the 
FBO's financial condition and prospects, the system of supervision 
in the FBO's home country, the record of the home country's 
government in support of the banking system or other sources of 
support for the FBO; and transfer risk concerns. Transfer risk 
relates to the FBO's ability to access and transmit U.S. dollars, 
which is an essential factor in determining whether an FBO can 
support its U.S. operations. The SOSA ranking is based on a scale of 
1 through 3, with 1 representing the lowest level of supervisory 
concern.
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    <bullet> 10 percent of capital for FBOs that are not FHCs and are 
ranked a SOSA 2.
    <bullet> 5 percent of ``net due to related depository 
institutions'' for FBOs that are not FHCs and are ranked a SOSA 3.
    Granting a net debit cap, or any extension of intraday credit, to 
an institution is at the discretion of the Reserve Bank. In the event a 
Reserve Bank grants a net debit cap or extends intraday credit to a 
financially healthy SOSA 3-ranked FBO, the Reserve Bank may require 
such credit to be fully collateralized, given the heightened 
supervisory concerns with SOSA 3-ranked FBOs.

D. Collateralized Capacity

    The Board recognizes that while net debit caps provide sufficient 
liquidity to most institutions, some institutions may still experience 
liquidity pressures. The Board believes it is important to provide an 
environment in which payment systems may function effectively and 
efficiently and to remove barriers, as appropriate, to foster risk-
reducing payment system initiatives. Consequently, certain institutions 
with self-assessed net debit caps may pledge collateral to their 
administrative Reserve Banks to secure daylight overdraft capacity in 
excess of their net debit caps, subject to Reserve Bank 
approval.<SUP>32, 33</SUP> This policy is intended to

[[Page 57929]]

provide extra liquidity through the pledge of collateral to the few 
institutions that might otherwise be constrained from participating in 
risk-reducing payment system initiatives.\34\ The Board believes that 
requiring collateral allows the Federal Reserve to protect the public 
sector from additional credit risk. Additionally, providing extra 
liquidity to these few institutions should help prevent liquidity-
related market disruptions.
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    \32\ The administrative Reserve Bank is responsible for the 
administration of Federal Reserve credit, reserves, and risk 
management policies for a given institution or other legal entity.
    \33\ Institutions have some flexibility as to the specific types 
of collateral they may pledge to the Reserve Banks; however, all 
collateral must be acceptable to the Reserve Banks. The Reserve 
Banks may accept securities in transit on the Fedwire book-entry 
securities system as collateral to support the maximum daylight 
overdraft capacity level. Securities in transit refer to book-entry 
securities transferred over the Fedwire Securities Service that have 
been purchased by an institution but not yet paid for and owned by 
the institution's customers.
    \34\ Institutions may consider applying for a maximum daylight 
overdraft capacity level for daylight overdrafts resulting from 
Fedwire funds transfers, Fedwire book-entry securities transfers, 
National Settlement Service entries, and ACH credit originations. 
Institutions incurring daylight overdrafts as a result of other 
payment activity may be eligible for administrative counseling 
flexibility (59 FR 54915-18, Nov. 2, 1994).
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    An institution with a self-assessed net debit cap that wishes to 
expand its daylight overdraft capacity by pledging collateral should 
consult with its administrative Reserve Bank. Institutions that request 
daylight overdraft capacity beyond the net debit cap must have already 
explored other alternatives to address their increased liquidity 
needs.\35\ The Reserve Banks will work with an institution that 
requests additional daylight overdraft capacity to determine the 
appropriate maximum daylight overdraft capacity level. In considering 
the institution's request, the Reserve Bank will evaluate the 
institution's rationale for requesting additional daylight overdraft 
capacity as well as its financial and supervisory information. The 
financial and supervisory information considered may include, but is 
not limited to, capital and liquidity ratios, the composition of 
balance sheet assets, CAMELS or other supervisory ratings and 
assessments, and SOSA rankings (for U.S. branches and agencies of 
foreign banks). An institution approved for a maximum daylight 
overdraft capacity level must submit at least once in each twelve-month 
period a board-of-directors resolution indicating its board's approval 
of that level.
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    \35\ Some potential alternatives available to an institution to 
address increased intraday credit needs include shifting funding 
patterns, delaying the origination of funds transfers, or 
transferring some payments processing business to a correspondent 
bank.
---------------------------------------------------------------------------

    If the Reserve Bank approves an institution's request, the Reserve 
Bank approves a maximum daylight overdraft capacity level. The maximum 
daylight overdraft capacity is defined as follows:

maximum daylight overdraft capacity = single-day net debit cap + 
collateralized capacity \36\

    \36\ Collateralized capacity, on any given day, equals the 
amount of collateral pledged to the Reserve Bank, not to exceed the 
difference between the institution's maximum daylight overdraft 
capacity level and its single-day net debit cap.
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    An institution that has a self-assessed net debit cap and that has 
also been approved for a maximum daylight overdraft capacity level has 
a two-week average limit equal to its two-week average net debit cap 
plus its collateralized capacity, averaged over a two-week reserve-
maintenance period. The single-day limit is equal to an institution's 
single-day net debit cap plus its collateralized capacity. The 
institution should avoid incurring daylight overdrafts whose daily 
maximum level, averaged over a two-week period, would exceed its two-
week average limit, and, on any day, would exceed its single-day limit. 
The Reserve Banks will review the status of any institution that 
exceeds its single-day or two-week limit during a two-week reserve-
maintenance period and will decide if the maximum daylight overdraft 
capacity should be maintained or if additional action should be taken 
(see section I.F., ``Monitoring'').
    Institutions with exempt-from-filing and de minimis net debit caps 
may not obtain additional daylight overdraft capacity by pledging 
collateral without first obtaining a self-assessed net debit cap. 
Likewise, institutions that have voluntarily adopted zero net debit 
caps may not obtain additional daylight overdraft capacity by pledging 
collateral without first obtaining a self-assessed net debit cap. 
Institutions that have been assigned a zero net debit cap by their 
administrative Reserve Bank are not eligible to apply for any daylight 
overdraft capacity.

E. Special Situations

    Under the Board's policy, certain institutions warrant special 
treatment primarily because of their charter types. As mentioned 
previously, an institution must have regular access to the discount 
window and be in sound financial condition in order to adopt a net 
debit cap greater than zero. Institutions that do not have regular 
access to the discount window include Edge and agreement corporations, 
bankers' banks that are not subject to reserve requirements, limited-
purpose trust companies, government-sponsored enterprises (GSEs), and 
certain international organizations.\37\ Institutions that have been 
assigned a zero cap by their Reserve Banks are also subject to special 
considerations under this policy based on the risks they pose. In 
developing its policy for these institutions, the Board has sought to 
balance the goal of reducing and managing risk in the payments system, 
including risk to the Federal Reserve, with that of minimizing the 
adverse effects on the payments operations of these institutions.
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    \37\ See footnote 3.
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    Regular access to the Federal Reserve discount window generally is 
available to institutions that are subject to reserve requirements. If 
an institution that is not subject to reserve requirements and thus 
does not have regular discount-window access were to incur a daylight 
overdraft, the Federal Reserve might end up extending overnight credit 
to that institution if the daylight overdraft were not covered by the 
end of the business day. Such a credit extension would be contrary to 
the quid pro quo of reserves for regular discount-window access as 
reflected in the Federal Reserve Act and in Board regulations. Thus, 
institutions that do not have regular access to the discount window 
should not incur daylight overdrafts in their Federal Reserve accounts.
    Certain institutions are subject to a daylight-overdraft penalty 
fee levied against the average daily daylight overdraft incurred by the 
institution. These include Edge and agreement corporations, bankers' 
banks that are not subject to reserve requirements, and limited-purpose 
trust companies. The annual rate used to determine the daylight-
overdraft penalty fee is equal to the annual rate applicable to the 
daylight overdrafts of other institutions (36 basis points) plus 100 
basis points multiplied by the fraction of a 24-hour day during which 
Fedwire is scheduled to operate (currently 21.5/24). The daily 
daylight-overdraft penalty rate is calculated by dividing the annual 
penalty rate by 360.\38\ The daylight-overdraft penalty rate applies to 
the institution's average daily daylight overdraft in its Federal 
Reserve account. The daylight-overdraft penalty rate is charged in lieu 
of, not in addition to, the rate used to calculate daylight overdraft 
fees for institutions described in section I.B. Institutions that are 
subject to the daylight-overdraft penalty fee do not benefit from a 
deductible and are subject to a minimum fee of $25 on any daylight 
overdrafts incurred in their Federal Reserve accounts.\39\
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    \38\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft penalty rate is truncated to 
0.0000338.
    \39\ While daylight overdraft fees are calculated differently 
for these institutions than for institutions that have regular 
access to the discount window, overnight overdrafts at Edge and 
agreement corporations, bankers' banks that are not subject to 
reserve requirements, limited-purpose trust companies, GSEs, and 
international organizations are priced the same as overnight 
overdrafts at institutions that have regular access to the discount 
window.

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[[Page 57930]]

1. Edge and Agreement Corporations \40\
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    \40\ These institutions are organized under section 25A of the 
Federal Reserve Act (12 U.S.C. 611-631) or have an agreement or 
undertaking with the Board under section 25 of the Federal Reserve 
Act (12 U.S.C. 601-604(a)).
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    Edge and agreement corporations should refrain from incurring 
daylight overdrafts in their Federal Reserve accounts. In the event 
that any daylight overdrafts occur, the Edge or agreement corporation 
must post collateral to cover the overdrafts. In addition to posting 
collateral, the Edge or agreement corporation would be subject to the 
daylight-overdraft penalty rate levied against the average daily 
daylight overdrafts incurred by the institution, as described above.
    This policy reflects the Board's concerns that these institutions 
lack regular access to the discount window and that the parent company 
may be unable or unwilling to cover its subsidiary's overdraft on a 
timely basis. The Board notes that the parent of an Edge or agreement 
corporation could fund its subsidiary during the day over Fedwire or 
the parent could substitute itself for its subsidiary on private 
systems. Such an approach by the parent could both reduce systemic risk 
exposure and permit the Edge or agreement corporation to continue to 
service its customers. Edge and agreement corporation subsidiaries of 
foreign banking organizations are treated in the same manner as their 
domestically owned counterparts.
2. Bankers' Banks \41\
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    \41\ For the purposes of this policy statement, a bankers' bank 
is a depository institution that is not required to maintain 
reserves under the Board's Regulation D (12 CFR 204) because it is 
organized solely to do business with other financial institutions, 
is owned primarily by the financial institutions with which it does 
business, and does not do business with the general public. Such 
bankers' banks also generally are not eligible for Federal Reserve 
Bank credit under the Board's Regulation A (12 CFR 201.2(c)(2)).
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    Bankers' banks are exempt from reserve requirements and do not have 
regular access to the discount window. They do, however, have access to 
Federal Reserve payment services. Bankers' banks should refrain from 
incurring daylight overdrafts and must post collateral to cover any 
overdrafts they do incur. In addition to posting collateral, a bankers' 
bank would be subject to the daylight-overdraft penalty fee levied 
against the average daily daylight overdrafts incurred by the 
institution, as described above.
    The Board's policy for bankers' banks reflects the Reserve Banks' 
need to protect themselves from potential losses resulting from 
daylight overdrafts incurred by bankers' banks. The policy also 
considers the fact that some bankers' banks do not incur the costs of 
maintaining reserves as do some other institutions and do not have 
regular access to the discount window.
    Bankers' banks may voluntarily waive their exemption from reserve 
requirements, thus gaining access to the discount window. Such bankers' 
banks are free to establish net debit caps and would be subject to the 
same policy as other institutions. The policy set out in this section 
applies only to those bankers' banks that have not waived their 
exemption from reserve requirements.
3. Limited-Purpose Trust Companies \42\
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    \42\ For the purposes of this policy statement, a limited-
purpose trust company is a trust company that is a member of the 
Federal Reserve System but that does not meet the definition of 
``depository institution'' in section 19(b)(1)(A) of the Federal 
Reserve Act (12 U.S.C. 461(b)(1)(A)).
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    The Federal Reserve Act permits the Board to grant Federal Reserve 
membership to limited-purpose trust companies subject to conditions the 
Board may prescribe pursuant to the Act. As a general matter, member 
limited-purpose trust companies do not accept reservable deposits and 
do not have regular discount-window access. Limited-purpose trust 
companies should refrain from incurring daylight overdrafts and must 
post collateral to cover any overdrafts they do incur. In addition to 
posting collateral, limited-purpose trust companies would be subject to 
the same daylight-overdraft penalty rate as other institutions that do 
not have regular access to the discount window.
4. Government-Sponsored Enterprises and International Organizations 
(Beginning July 20, 2006)
    The Reserve Banks act as fiscal agents for certain GSEs and 
international organizations in accordance with federal statutes. These 
institutions generally have Federal Reserve accounts and issue 
securities over the Fedwire Securities Service. The securities of these 
institutions are not obligations of, or fully guaranteed as to 
principal and interest by, the United States. Furthermore, these 
institutions are not subject to reserve requirements and do not have 
regular access to the discount window. GSEs and international 
organizations should refrain from incurring daylight overdrafts and 
must post collateral to cover any daylight overdrafts they do incur. In 
addition to posting collateral, these institutions would be subject to 
the same daylight-overdraft penalty rate as other institutions that do 
not have regular access to the discount window.
5. Problem Institutions
    For institutions that are in weak financial condition, the Reserve 
Banks will impose a zero cap. The Reserve Bank will also monitor the 
institution's activity in real time and reject or delay certain 
transactions that would create an overdraft. Problem institutions 
should refrain from incurring daylight overdrafts and must post 
collateral to cover any daylight overdrafts they do incur.

F. Monitoring

1. Ex Post
    Under the Federal Reserve's ex post monitoring procedures, an 
institution with a daylight overdraft in excess of its maximum daylight 
overdraft capacity or net debit cap may be contacted by its Reserve 
Bank. The Reserve Bank may 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 net debit caps, imposing collateralization or 
clearing-balance requirements, rejecting or delaying certain 
transactions as described below, or, in extreme cases, taking the 
institution off line or prohibiting it from using Fedwire.
2. Real Time
    A Reserve Bank will, through the Account Balance Monitoring System, 
apply real-time monitoring to an individual institution's position when 
the Reserve Bank believes that it faces excessive risk exposure, for 
example, 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 in real-time, rejecting or delaying certain 
transactions that would exceed the institution's maximum daylight 
overdraft capacity or net debit cap, and taking other prudential 
actions, including requiring collateral.\43\
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    \43\ Institutions that are monitored in real time must fund the 
total amount of their ACH credit originations in order for the 
transactions to be processed by the Federal Reserve, even if those 
transactions are processed one or two days before settlement.

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[[Page 57931]]

3. Multi-District Institutions
    Institutions, such as those maintaining merger-transition accounts 
and U.S. branches and agencies of a foreign bank, that access Fedwire 
through accounts in more than one Federal Reserve District are expected 
to manage their accounts so that the total daylight overdraft position 
across all accounts does not exceed their net debit caps. One Reserve 
Bank will act as the administrative Reserve Bank and will have overall 
risk-management responsibilities for institutions maintaining accounts 
in more than one Federal Reserve District. For domestic 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.
    In the case of families of U.S. branches and agencies of the same 
foreign banking organization, the administrative Reserve Bank generally 
is the Reserve Bank that exercises the Federal Reserve's oversight 
responsibilities under the International Banking Act.\44\ The 
administrative Reserve Bank, in consultation with the management of the 
foreign bank's U.S. operations and with Reserve Banks in whose 
territory other U.S. agencies or branches of the same foreign bank are 
located, may determine that these agencies and branches will not be 
permitted to incur overdrafts in Federal Reserve accounts. 
Alternatively, the administrative Reserve Bank, after similar 
consultation, may allocate all or part of the foreign family's net 
debit cap to the Federal Reserve accounts of agencies or branches that 
are located outside of the administrative Reserve Bank's District; in 
this case, the Reserve Bank in whose Districts those agencies or 
branches are located will be responsible for administering all or part 
of the collateral requirement.\45\
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    \44\ 12 U.S.C. 3101-3108.
    \45\ 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.
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G. Transfer-Size Limit on Book-Entry Securities

    Secondary-market book-entry securities transfers on Fedwire are 
limited to a transfer size of $50 million par value. This limit is 
intended to encourage partial deliveries of large trades in order to 
reduce position building by dealers, a major cause of book-entry 
securities overdrafts before the introduction of the transfer-size 
limit and daylight overdraft fees. This limitation does not apply to 
either of the following:
    a. Original issue deliveries of book-entry securities from a 
Reserve Bank to an institution.
    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 book-entry form are 
exempt from this limitation. Also exempt are pledges of securities to a 
Reserve Bank as principal (for example, discount-window collateral) or 
as agent (for example, Treasury Tax and Loan collateral).

    By order of the Board of Governors of the Federal Reserve 
System, September 22, 2004.
Robert deV. Frierson,
Deputy Secretary of the Board.
[FR Doc. 04-21669 Filed 9-27-04; 8:45 am]
BILLING CODE 6210-01-P