[Federal Register Volume 69, Number 230 (Wednesday, December 1, 2004)]
[Notices]
[Pages 69926-69940]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-26444]



[[Page 69926]]

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FEDERAL RESERVE SYSTEM

[Docket No. OP-1191]


Policy on Payments System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has adopted several revisions to its Policy on 
Payments System Risk (PSR policy). Specifically, the Board revised its 
expectations for risk management in payments and securities settlement 
systems as previously set out in part II of the PSR policy, Policies 
for Private-Sector Systems, and expanded the scope of this part to 
cover Federal Reserve payments and securities settlement systems. The 
Board also reorganized the policy such that the more general Risk 
Management in Payments and Securities Settlement Systems now 
constitutes part I of the policy, while Federal Reserve Daylight Credit 
Policies constitute part II. Finally, the Board has deleted part III of 
the policy, entitled ``Other Policies.''

DATES: Revisions described in this notice will take effect on January 
2, 2005.

FOR FURTHER INFORMATION CONTACT: Jeff Stehm, Assistant Director (202) 
452-2217, or Doug Conover, Senior Analyst (202) 452-2887, Division of 
Reserve Bank Operations and Payment Systems; for the hearing impaired 
only: Telecommunications Device for the Deaf, (202) 263-4869.

SUPPLEMENTARY INFORMATION

I. Background

    On April 26, 2004, the Board requested comment on proposed changes 
to part II of its Policy Statement on Payments System Risk addressing 
risk management in payments and securities settlement systems (69 FR 
22512). Key aspects of the proposal included an expansion of the 
policy's scope to include the Federal Reserve Banks' (Reserve Banks) 
payments and securities settlement services, revised general risk 
management expectations for all systems subject to the policy, and the 
incorporation of the Core Principles for Systemically Important Payment 
Systems (Core Principles) and Recommendations for Securities Settlement 
Systems (Recommendations) as the Board's minimum standards for 
systemically important systems.\1\ The proposed changes did not affect 
part I of the PSR policy, Federal Reserve Daylight Credit Policies, 
other than to renumber it as part II.
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    \1\ The Core Principles were developed by the Committee on 
Payment and Settlement Systems (CPSS) of the central banks of the 
Group of Ten countries, and the Recommendations were developed by 
the CPSS in conjunction with the Technical Committee of the 
International Organization of Securities Commissions (IOSCO). The 
full reports on the Core Principles and the Recommendations are 
available at http://www.bis.org.
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    The Board proposed these revisions to update the policy in light of 
current industry and supervisory risk-management approaches and the 
recent publication of new international risk-management standards for 
payments and securities settlement systems. Over the course of several 
years, the Federal Reserve has worked with other central banks and 
securities regulators to develop standards to strengthen payments and 
securities settlement infrastructures. These efforts initially produced 
the Lamfalussy Minimum Standards, which were incorporated into the 
Board's PSR policy in 1994.\2\ More recently, this work resulted in the 
publication of the Core Principles and the Recommendations. The Core 
Principles extend and replace the Lamfalussy Minimum Standards, while 
the Recommendations provide, for the first time, explicit standards for 
securities settlement systems.\3\
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    \2\ 59 FR 67534, Dec. 29, 1994. The Lamfalussy Minimum Standards 
were set out in the ``Report of the Committee on Interbank Netting 
Schemes of the Central Banks of the Group of Ten Countries,'' 
published by the Bank for International Settlements in November 
1990.
    \3\ Both sets of standards are part of the Financial Stability 
Forum's Compendium of Standards that have been widely recognized and 
endorsed by U.S. authorities as integral to strengthening global 
financial stability. Both sets of standards were published by the 
relevant committees for public comment before being adopted in their 
final form.
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    In addition to establishing specific standards, however, the Core 
Principles and Recommendations call for central banks to state clearly 
their roles and policies regarding payments and securities settlement 
systems, assess compliance with the Core Principles and the 
Recommendations when overseeing relevant systems, and coordinate with 
other authorities in overseeing systems. Moreover, the Core Principles 
and Recommendations are intended to apply to systems operated by 
central banks as well as the private sector. The policy revisions 
proposed by the Board in April were designed to meet these and other 
expectations.

II. Summary of Comments and Analysis

    The Board received eight comments on the proposed policy--three 
from private-sector payment system operators, two from industry 
associations, two from commercial banks, and one from the Federal 
Reserve Bank of Richmond. Comments generally supported the substantive 
policy revisions set out in the proposal, but varied in regard to the 
Board's series of specific questions on the policy threshold, the 
definition of a system, the general policy expectations, and the 
criteria for determining a systemically important system. Several 
commenters also discussed risks related to third-party access in ACH 
systems.
    The final policy retains all substantive aspects of the proposed 
policy. The final policy, however, includes several minor changes that 
address specific comments. The final policy also includes other 
editorial and technical corrections, including several changes to make 
the new introduction consistent with recent revisions to the Federal 
Reserve Daylight Credit Policies, as published on September 28, 2004 
(69 FR 57917). Finally, in an action not proposed in April, the Board 
also deleted part III of the policy.

Policy Threshold

    Five of the eight commenters offered specific comments on the $5 
billion policy threshold. Three commenters suggested that the threshold 
be modified to be more inclusive by lowering the threshold or by 
suggesting additional quantitative or qualitative criteria. One 
commenter stated that the $5 billion threshold would leave out certain 
unnamed systems that should be covered by the policy for reasons of 
both systemic risk and competitive equity. Several commenters 
specifically supported the threshold, pointing out the current approach 
would ``result in a level playing field'' and ``ensure a consistent 
regulatory approach.''
    In contrast, one commenter suggested that the threshold be modified 
to be less inclusive, specifically by raising the threshold to $10 
billion. This commenter cited the original intent of the $5 billion 
threshold as described in January 1999 as exempting from the policy 
smaller systems that are not likely to ``pose systemic risks or other 
significant risk concerns.''\4\ The commenter argued that the $5 
billion threshold was appropriate in 1999, but due to economic growth, 
the level is no longer appropriate, as some systems with gross 
settlement near $5 billion per day still pose no systemic risk 
concerns. This commenter and one other suggested that the threshold be 
increased periodically.
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    \4\ 63 FR 34888, June 26, 1998.
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    The Board agrees with the opinions of several commenters who 
pointed out the value of a simple policy threshold in ensuring a 
consistent approach and transparent application of the policy. In

[[Page 69927]]

fact, the $5 billion gross settlement threshold was adopted in response 
to industry comments in 1998 that largely opposed the use of more 
complex formulas in favor of a simple, numerical threshold. With regard 
to the absolute level of the threshold, the Board continues to believe 
that the $5 billion level appropriately eliminates any administrative 
burden of complying with the policy for those systems that are unlikely 
to pose significant risk concerns. The Board sees no reason to modify 
the existing threshold at this time.

Definition of a System

    Of the four commenters that specifically addressed the definition 
of ``system'' as set out in proposed policy, three agreed that the 
definition was ``reasonable and appropriate,'' especially the exemption 
for bilateral relationships, such as in traditional correspondent 
banking. One commenter, however, suggested that the Board clarify the 
relationship between the ``general definition'' of a system and the 
three characteristics typically ``embodied'' by such systems. The final 
policy explains how the Board may use these characteristics in 
determining whether a particular arrangement meets the policy's 
definition of a system.

General Policy Expectations

    All eight commenters expressed support for the general risk 
management expectations set out in part B of the proposed policy. 
Several offered strong support for these revisions. Two commenters 
raised questions about whether risks related to third-party access to 
payment systems, especially ACH systems, would fall under the general 
risk-management expectations (these comments are discussed below).
    One commenter sought additional clarity on how systems should 
assess their dependencies and inter-relationships with other payment 
and securities settlement systems. This same commenter suggested that, 
where appropriate, oversight efforts associated with the revised policy 
be conducted through existing bank supervisory programs, citing a 
minimization in regulatory burden. The final policy elaborates on the 
Board's expectation that a system understand the risks posed by its 
various relationships with other systems, and clarifies the Board's 
intent to minimize unnecessary burden on systems subject to the policy, 
including coordinating, where possible, any assessments of compliance 
with the policy with other supervisory attentions to a system. The 
final policy also clarifies that systems currently falling below the $5 
billion threshold for applying the policy, though not subject to the 
policy, are nonetheless encouraged to implement a sound risk-management 
framework.

Criteria for Systemic Importance

    Four of the eight commenters suggested modifications to the 
criteria for determining ``systemically important'' systems that were 
set out in the proposed policy for assessing whether the Core 
Principles or Recommendations would be applicable to a payments or 
securities settlement system. Two commenters suggested that the 
criteria needed more clarity so that systems and their participants can 
know whether a particular system would be considered systemically 
important. These same commenters also suggested that the policy include 
some indicators that suggest when a system is not systemically 
important. One commenter suggested the inclusion of a seventh 
criterion, whether ``a failure of the system would cause significant or 
extended loss of investor or consumer confidence.'' A fourth commenter 
suggested that the policy clarify whether a system would be considered 
systemically important if it met only one of the six criteria.
    The Board decided to retain the six proposed criteria for systemic 
importance. These criteria are based upon the description of 
``systemically important systems'' provided in the Core Principles, 
adjusted to be applicable to securities settlement systems and to 
provide consistency with the criteria previously set out in the policy 
for applying the Lamfalussy Standards. Regarding the suggestion that 
the policy include a list of exclusions or characteristics of systems 
that are not systemically important, the Board believed that this type 
of change could introduce unnecessary conflicts with the existing 
criteria. On whether to add a seventh explicit criterion regarding 
investor or consumer confidence, the Board believes that these changes 
would unnecessarily broaden the definition of systemically important in 
a potentially ambiguous manner, and with possible unintended 
consequences. For example, such a criterion may suggest that many 
retail systems, such as debit card, credit card, and ACH systems, be 
considered systemically important regardless of any limited potential 
to spread credit and liquidity shocks through the financial system.
    To address commenters' concerns about transparency regarding 
whether the Board considers a particular system to be systemically 
important for purposes of the PSR policy, the final policy states that 
the Board will separately inform each system subject to the policy as 
to whether they are or are not considered systemically important. This 
revision retains necessary flexibility in the criteria for systemic 
importance, but provides clarity for each system subject to the policy 
as to whether the Board expects them to meet the standards for 
systemically important systems.

Third-Party Access

    Three commenters focused their comments on the risks regarding 
``third-party access'' to ACH systems. Two of these organizations 
offered specific suggestions on how to address third-party risks in the 
ACH. Both suggested that the policy include a requirement that all 
third-party arrangements be subject to the approval of the sponsoring 
institution's board of directors or other senior management body. One 
of the two suggested that ACH operators provide tools for institutions 
to manage these risks, and controls that should, at a minimum, include 
gross debit limits. The third commenter did not make these specific 
suggestions and instead suggested that the Board request comment on a 
``specific proposal'' to address these risks.
    The Federal Reserve is interested in risks related to third-party 
access in ACH networks, and through the Federal Reserve Banks' role as 
an ACH operator, is taking steps to address these risks. For example, 
the Federal Reserve Bank presidents recently circulated a letter to 
depository institutions outlining the risks and possible risk 
mitigation techniques related to ACH debit originations, including 
third-party originators. The Federal Reserve Banks also have offered to 
work with ACH participants and the ACH rule-making body to discuss 
these risks. The Federal Reserve Banks are also examining possible 
enhancements to FedACH that could strengthen depository institutions' 
controls over ACH activity settling through their accounts.
    In recent years, however, the Board specifically moved away from 
addressing outsourcing and third-party access risks in the context of 
the PSR policy. In August 1995, the Board sought comment on the 
benefits and costs of adopting third-party access provisions for ACH 
credit transfers in the PSR policy.\5\ The Board's analysis of this 
issue, however, indicated that the costs, complexity, and operational 
effect of potential changes outweighed the risk reduction benefits. An 
ACH third-party access policy was never adopted.

[[Page 69928]]

Moreover, in April 2001, the Board rescinded the third-party Fedwire 
access section of the PSR policy, adopted in 1987, stating that such 
access, when properly managed by depository institutions, poses little 
additional risk to the Federal Reserve and does not warrant the 
administrative burden imposed by the third-party access policy.\6\ The 
Board also stated that as part of the ongoing supervisory process, 
banking organizations are expected to address and manage risks that may 
arise out of third-party arrangements.\7\
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    \5\ 60 FR 42413, Aug. 15, 1995.
    \6\ 66 FR 19165, April 13, 2001.
    \7\ Federal Reserve and other FFIEC supervisors have issued 
guidance concerning third-party access risk, and continue to work to 
identify specific types of ACH flows and businesses that may pose 
special risks to depository institutions. See SR Ltr. 01-16 (July 3, 
2001), SR Ltr. 00-4 (February 29, 2000).
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Deletion of Part III

    Given the changes to the policy that the Board is adopting in this 
notice and the changes adopted in recent revisions to the policy 
concerning Federal Reserve Daylight Credit Policies, the Board has 
decided to delete part III of the PSR policy, entitled Other Policies. 
Part III encourages, but does not require, depository institutions to 
use rollovers and continuing contracts in federal funds and Eurodollars 
to minimize their use of daylight credit in their Federal Reserve 
accounts. The Board adopted this aspect of the policy in 1989 as 
guidance for depository institutions. Given the incentives to manage 
daylight credit provided by the implementation of daylight overdraft 
fees in 1994, the Board believes that depository institutions have the 
appropriate incentives to incorporate the practices encouraged in part 
III into their daylight credit management procedures, and that specific 
guidance in this area is no longer necessary.

IV. Regulatory Flexibility Act Analysis

    The Board has determined that these revisions to the PSR policy 
would not have a significant economic impact on a substantial number of 
small entities. The policy requires payments and securities settlement 
systems to address material risks in their systems. The policy applies 
to relatively large systems, i.e., those that expect to settle an 
aggregate gross value exceeding $5 billion on any day during the next 
twelve-month period. Thus, the policy is designed to minimize 
regulatory burden on smaller systems that do not raise material risks. 
Although small financial institutions may participate in payments or 
securities settlement systems that are subject to the policy, the 
compliance burden largely falls on system operators and not on 
individual participants.

V. Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of rule or policy changes that have a substantial impact on 
payments system participants.\8\ Under these procedures, the Board will 
assess whether a change would have a direct and material adverse effect 
on the ability of other service providers to compete effectively with 
the Federal Reserve in providing similar services due to differing 
legal powers or constraints, or due to a dominant market position of 
the Federal Reserve deriving from such differences. If no reasonable 
modifications would mitigate the adverse competitive effects, the Board 
will determine whether the anticipated benefits are significant enough 
to proceed with the change despite the adverse effects. The PSR policy 
provides that Reserve Bank payments and securities settlement systems 
will be treated similarly to private-sector systems and thus should 
have no material adverse effect on the ability of other service 
providers to compete effectively with the Federal Reserve Banks in 
providing payments and securities settlement services.
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    \8\ These procedures are described in ``The Federal Reserve in 
the Payments System,'' as revised in March 1990 (55 FR 11648, March 
29, 1990).
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VI. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
ch. 3506; 5 CFR part 1320 Appendix A.1), the Board has reviewed the 
policy 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 revisions to the PSR 
policy.

VII. Federal Reserve Policy on Payments System Risk

    The PSR policy is revised, effective January 2, 2005, to read as 
follows:

Introduction
Risks in Payments and Securities Settlement Systems
I. Risk Management in Payments and Securities Settlement Systems
    A. Scope
    B. General Policy Expectations
    C. Systemically Important Systems
    1. Standards for Systemically Important Payments Systems
    2. Standards for Systemically Important Securities Settlement 
Systems
II. 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

    Payments and securities settlement systems are critical components 
of the nation's financial system. The smooth functioning of these 
systems is vital to the financial stability of the U.S. economy. Given 
the importance of these systems, the Board has developed this policy to 
address the risks that payments and securities settlement systems 
present to the financial system and to the Federal Reserve Banks 
(Reserve Banks).
    In adopting this policy, the Board's objectives are to foster the 
safety and efficiency of payments and securities settlement systems. 
These policy objectives are consistent with (1) the Board's long-
standing objectives to promote the integrity, efficiency, and 
accessibility of the payments mechanism; (2) industry and supervisory 
methods for risk management; and (3) internationally accepted risk 
management standards and practices for systemically important payments 
and securities settlement systems.\1\
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    \1\ For the Board's long-standing objectives in the payments 
system, see ``The Federal Reserve in the Payments System,'' 
September 2001, FRRS 9-1550, available at http://www.federalreserve.gov/paymentsystems/pricing/frpaysys.htm.
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    Part I of this policy sets out the key risk management expectations 
of the Board that public- and private-sector payments and securities 
settlement systems should meet in the design and operation of those 
systems. Under the policy, all payments and securities settlement 
systems that expect to settle an aggregate gross value exceeding $5 
billion on any day during the next twelve months are expected to 
implement a risk management

[[Page 69929]]

framework that is appropriate for the risks they pose to the system 
operator, system participants, and the financial system more broadly. 
Systemically important payments and securities settlement systems are 
also expected to meet more specific standards based upon the Core 
Principles for Systemically Important Payments Systems (Core 
Principles) and the Recommendations for Securities Settlement Systems 
(Recommendations), respectively.\2\
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    \2\ The Core Principles were developed by the Committee on 
Payment and Settlement Systems of the central banks of the Group of 
Ten countries (CPSS) and the Recommendations were developed by the 
CPSS in conjunction with the Technical Committee of the 
International Organization of Securities Commissions (IOSCO). The 
full reports on the Core Principles and the Recommendations are 
available at http://www.bis.org.
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    Part II of this policy governs the provision of intraday or 
``daylight'' credit in accounts at the Reserve Banks and sets out the 
general methods used by the Reserve Banks to control their intraday 
credit exposures. Under this part, 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.\3\ Although some intraday credit may be necessary, 
the Board expects that, as a result of this policy, 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 effects of its daylight credit 
policies on the payments system.
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    \3\ In part II of this policy, 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, and bankers' 
banks, limited purpose trust companies, government-sponsored 
enterprises, and international organizations, unless the context 
indicates a different reading.
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Risks in Payments and Securities Settlement Systems

    The basic risks in payments and securities settlement systems are 
credit risk, liquidity risk, operational risk, and legal risk. In the 
context of this policy, these risks are defined as follows.\4\
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    \4\ These definitions of credit risk, liquidity risk, and legal 
risk are based upon those presented in the Core Principles and the 
Recommendations. The definition of operational risk is based on the 
Basel Committee on Banking Supervision's ``Sound Practices for the 
Management and Supervision of Operational Risk.'' See these 
publications at http://www.bis.org for a fuller discussion of these 
risks.
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    Credit Risk. The risk that a counterparty will not settle an 
obligation for full value either when due, or anytime thereafter.
    Liquidity Risk. The risk that a counterparty will not settle an 
obligation for full value when due.
    Operational Risk. The risk of loss resulting from inadequate or 
failed internal processes, people, and systems, or from external 
events. This type of risk includes various physical and information 
security risks.
    Legal Risk. The risk of loss because of the unexpected application 
of a law or regulation or because a contract cannot be enforced.
    These risks arise between financial institutions as they settle 
payments and securities transactions and must be managed by 
institutions, both individually and collectively.<SUP>5 6</SUP> 
Multilateral payments and securities settlement systems, in particular, 
may increase, shift, concentrate, or otherwise transform risks in 
unanticipated ways. These systems also may pose systemic risk to the 
financial system where the inability of a system participant to meet 
its obligations when due may cause other participants to be unable to 
meet their obligations when due. The failure of one or more 
participants to settle their payments or securities transactions, in 
turn, could create credit or liquidity problems for other participants, 
the system operator, or other financial institutions. Systemic risk 
might lead ultimately to a disruption in the financial system more 
broadly or undermine public confidence in the nation's financial 
infrastructure.
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    \5\ The term ``financial institution,'' as generally used in 
part I of this policy, includes organizations, such as depository 
institutions, securities dealers, and other institutions, that act 
as intermediaries in financial markets and engage in financial 
activities for themselves and their customers.
    \6\ Several existing regulatory and bank supervision guidelines 
and policies also are directed at institutions' management of the 
risks posed by interbank payments and settlement activity. For 
example, Federal Reserve Regulation F (12 CFR part 206) directs 
insured depository institutions to establish policies and procedures 
to avoid excessive exposures to any other depository institutions, 
including exposures that may be generated through the clearing and 
settlement of payments.
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    These risks stem, in part, from the multilateral and time-sensitive 
credit and liquidity interdependencies among financial institutions. 
These interdependencies often create complex transaction flows that, in 
combination with a system's design, can lead to significant demands for 
intraday credit, either on a regular or extraordinary basis. Some level 
of intraday credit is appropriate to ensure the smooth functioning of 
payments and securities settlement systems. To the extent that 
financial institutions or the Reserve Banks are the direct or indirect 
source of such intraday credit, they may face a direct risk of loss if 
daylight credit is not extinguished as planned. In addition, measures 
taken by Reserve Banks to limit their intraday credit exposures may 
shift some or all of the associated risks to private-sector systems.
    The smooth functioning of payments and securities settlement 
systems is also critical to certain public policy objectives in the 
areas of monetary policy and banking supervision. The effective 
implementation of monetary policy, for example, depends on both the 
orderly settlement of open market operations and the efficient 
distribution of reserve balances throughout the banking system via the 
money market and payments system. Likewise, supervisory objectives 
regarding the safety and soundness of depository institutions must take 
into account the risks payments and securities settlement systems pose 
to depository institutions that participate directly or indirectly in, 
or provide settlement, custody, or credit services to, such systems.
    Through this policy, the Board expects financial system 
participants, including the Reserve Banks, to manage appropriately the 
settlement and systemic risks arising in payments and securities 
settlement systems, consistent with the smooth operation of the 
financial system. This policy is designed to fulfill that aim by (1) 
informing all financial system participants and system operators of the 
basic risks that arise in the settlement process, and encouraging the 
management of these risks (2) describing the Board's general 
expectations for risk management in payment and securities settlement 
systems subject to this policy, (3) providing explicit risk management 
standards for systemically important systems, and (4) establishing the 
policy conditions governing the provision of Federal Reserve intraday 
credit to account holders. The Board's adoption of this policy in no 
way diminishes the primary responsibilities of financial system 
participants generally and settlement system operators, participants, 
and Federal Reserve accountholders more specifically, to address the 
risks that may arise through their operation of, or participation in, 
payments and securities settlement systems.

I. Risk Management in Payments and Securities Settlement Systems

    This part sets out the Board's expectations regarding the 
management of risk in payments and securities settlement systems, 
including those operated by the Reserve Banks. The Board will be guided 
by this part, in conjunction with relevant laws and other Federal 
Reserve policies, when (1)

[[Page 69930]]

supervising state member banks, bank holding companies, and 
clearinghouse arrangements, including the exercise of authority under 
the Bank Service Company Act, where applicable,\7\ (2) setting the 
terms and conditions for the use of Federal Reserve payments and 
settlement services by system operators and participants, (3) 
developing and applying policies for the provision of intraday credit 
to Reserve Bank account holders, and (4) interacting with other 
domestic and foreign financial system authorities on payments and 
settlement risk management issues. The Board's adoption of this policy 
is not intended to exert or create new supervisory or regulatory 
authority over any particular class of institutions or arrangements 
where the Board does not currently have such authority.
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    \7\ 12 U.S.C. 1861 et seq.
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    Where the Board does not have direct or exclusive supervisory or 
regulatory authority over systems covered by this policy, it will work 
with other domestic and foreign financial system authorities to promote 
effective risk management in payments and securities settlement 
systems. The Board encourages other relevant authorities to consider 
the principles embodied in this policy when evaluating the payments and 
securities settlement risks posed by and to the systems and individual 
system participants that they oversee, supervise, or regulate. In 
working with foreign financial system authorities, the Board will be 
guided by Responsibility D of the Core Principles, Recommendation 18 of 
the Recommendations, and the ``Principles for Cooperative Central Bank 
Oversight of Cross-border and Multi-currency Netting and Settlement 
Schemes'' and related documents.\8\ The Board believes these 
international principles provide an appropriate framework for 
cooperating with foreign authorities to address risks in cross-border, 
multicurrency, and, where appropriate, offshore payments and securities 
settlement systems.
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    \8\ The ``Principles for Cooperative Central Bank Oversight and 
Multi-currency Netting and Settlement Schemes'' are set out in the 
``Report of the Committee on Interbank Netting Schemes of the 
central banks of the Group of Ten countries'' (Lamfalussy Report). 
The Lamfalussy Report is available at http://www.bis.org/cpss/cpsspubl.htm.
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A. Scope
    This policy applies to public- and private-sector payments and 
securities settlement systems that expect to settle a daily aggregate 
gross value of U.S. dollar-denominated transactions exceeding $5 
billion on any day during the next 12 months.\9\ For purposes of this 
policy, a payments or securities settlement system is considered to be 
a multilateral arrangement (three or more participants) among financial 
institutions for the purposes of clearing, netting, and/or settling 
payments or securities transactions among themselves or between each of 
them and a central party, such as a system operator or central 
counterparty.\10\ In determining whether a particular arrangement meets 
this definition, the Board may consider, but will not be limited to, 
whether the arrangement exhibits one or more of the following 
characteristics: (1) A set of rules and procedures, common to all 
participants, that govern the clearing or settlement of payments or 
securities transactions, (2) a common technical infrastructure for 
conducting the clearing or settlement process, and (3) a risk 
management or capital structure where at least some losses would be 
borne by participants rather than the arrangement's operator, central 
counterparty or guarantor, or shareholders or owners.
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    \9\ The `next' twelve-month period is determined by reference to 
the date a determination is being made as to whether the policy 
applies to a particular system. Aggregate gross value of U.S dollar-
denominated transactions refers to the total dollar value of 
individual U.S. dollar transactions settled in the system which also 
represents the sum of total U.S. dollar debits (or credits) to all 
participants prior to or in absence of any netting of transactions.
    \10\ A system includes all of the governance, management, legal 
and operational arrangements used to effect settlement as well as 
the relevant parties to such arrangements, such as the system 
operator, system participants, and system owners. The types of 
systems that may fall within the scope of this policy include, but 
are not limited to, large-value funds transfer systems, automated 
clearinghouse (ACH) systems, check clearinghouses, and credit and 
debit card settlement systems, as well as central counterparties, 
clearing corporations, and central depositories for securities 
transactions. For purposes of this policy, the system operator is 
the entity that manages and oversees the operations of the system. 
For the definition of financial institution, see footnote 5.
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    These systems may be organized, located, or operated within the 
United States (domestic systems), outside the United States (offshore 
systems), or both (cross-border systems) and may involve other 
currencies in addition to the U.S. dollar (multicurrency systems). The 
policy also applies to any system based or operated in the United 
States that engages in the settlement of non-U.S. dollar transactions 
if that system would be otherwise subject to the policy.\11\
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    \11\ The daily gross value threshold will be calculated on a 
U.S. dollar equivalent basis.
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    This policy does not apply to bilateral relationships between 
financial institutions and their customers, such as traditional 
correspondent banking and correspondent securities clearing 
arrangements, including, for example, government securities clearing 
services provided to securities dealers by banks or correspondent 
clearing services provided by broker-dealers. The Board believes that 
these relationships do not constitute ``a system'' for purposes of this 
policy and that relevant safety and soundness issues associated with 
these relationships are more appropriately addressed through the 
supervisory and regulatory process. This policy also does not apply to 
clearance or settlement systems for exchange-traded futures and options 
that fall under the oversight of the Commodities and Futures Trading 
Commission or the Securities and Exchange Commission.
B. General Policy Expectations
    The Board expects payments and securities settlement systems within 
the scope of this policy to implement a risk management framework 
appropriate for the risks the system poses to the system operator, 
system participants, and other relevant parties as well as the 
financial system more broadly. A risk management framework is the set 
of objectives, policies, arrangements, procedures, and resources that a 
system employs to limit and manage risk. While there are a number of 
ways to structure a sound risk management framework, all frameworks 
should:
    <bullet> Clearly identify risks and set sound risk management 
objectives;
    <bullet> Establish sound governance arrangements;
    <bullet> Establish clear and appropriate rules and procedures; and,
    <bullet> Employ the resources necessary to achieve the system's 
risk management objectives and implement effectively its rules and 
procedures.
    The Board also expects any system it deems to be systemically 
important both to establish a sound risk management framework and to 
comply with the more detailed standards set out in Section I.C. The 
Board will seek to understand how and whether systems subject to this 
policy achieve a sound risk management framework and, if relevant, meet 
the detailed standards for systemically important systems. In addition, 
the Board encourages systems with settlement activity below the $5 
billion threshold, though not subject to this policy, to consider 
implementing some or all of the elements of a sound risk management 
framework.\12\
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    \12\ The Board may ask a system approaching the policy threshold 
to provide limited information on trends in its gross settlement 
activity to determine when that system might become subject to the 
policy. Systems approaching the threshold should anticipate meeting 
the expectations of this policy.

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[[Page 69931]]

    Identify Risks and Set Sound Risk Management Objectives. The first 
element of a sound risk management framework is the clear 
identification of all risks that have the potential to arise in or 
result from the system's settlement process and the development of 
clear and transparent objectives regarding the system's tolerance for 
and management of such risks.
    System operators should identify the forms of risk present in their 
system's settlement process as well as the parties posing and bearing 
each risk. In particular, system operators should identify the risks 
posed to and borne by themselves, the system participants, and other 
key parties such as a system's settlement banks, custody banks, and 
third-party service providers. System operators should also analyze 
whether risks might be imposed on other external parties and the 
financial system more broadly.
    In addition, system operators should analyze how risk is 
transformed or concentrated by the settlement process. System operators 
should also consider the possibility that attempts to limit one type of 
risk could lead to an increase in another type of risk. Moreover, 
system operators should be aware of risks that might be unique to 
certain instruments, participants, or market practices. System 
operators should also analyze how risks are correlated among 
instruments or participants.\13\
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    \13\ Where systems have inter-relationships with or dependencies 
on other systems, system operators should also analyze whether and 
to what extent any cross-system risks arise and who bears them. 
Examples of such dependencies include, but are not limited to, 
financial and legal relationships, such as cross-margining, cross-
collateralization, or cross-guarantees, operational relationships, 
such as shared platforms or networks, inter-system links to move 
transactions between systems, and tiered settlement dependencies 
(e.g. reliance on a second system to settle net obligations).
---------------------------------------------------------------------------

    Based upon its clear identification of risks, a system should 
establish its risk tolerance, including the levels of risk exposure 
that are acceptable to the system operator, system participants, and 
other relevant parties. The system operator should then set risk 
management objectives that clearly allocate acceptable risks among the 
relevant parties and set out strategies to manage this risk. Risk 
management objectives should be consistent with the objectives of this 
policy, the system's business purposes, and the type of instruments and 
markets for which the system clears and settles. Risk management 
objectives should also be communicated to and understood by both the 
system operator's staff and system participants.
    System operators should re-evaluate their risks in conjunction with 
any major changes in the settlement process or operations, the 
instruments or transactions settled, a system's rules or procedures, or 
the relevant legal and market environments. Systems should review their 
risk management objectives regularly to ensure that they are 
appropriate for the risks posed by the system, continue to be aligned 
with the system's purposes, remain consistent with this policy, and are 
being effectively adhered to by the system operator and participants.
    Sound Governance Arrangements. Systems should have sound governance 
arrangements to implement and oversee their risk management frameworks. 
The responsibility for sound governance rests with a system operator's 
board of directors or similar body and with the system operator's 
senior management. Governance structures and processes should be 
transparent; enable the establishment of clear risk management 
objectives; set and enforce clear lines of responsibility and 
accountability for achieving these objectives; ensure that there is 
appropriate oversight of the risk management process; and enable the 
effective use of information reported by the system operator's 
management, internal auditors, and external auditors to monitor the 
performance of the risk management process.\14\ Individuals responsible 
for governance should be qualified for their positions, understand 
their responsibilities, and understand their system's risk management 
framework. Governance arrangements should also ensure that risk 
management information is shared in forms, and at times, that allow 
individuals responsible for governance to fulfill their duties 
effectively.
---------------------------------------------------------------------------

    \14\ The internal audit function should be independent of those 
responsible for day-to-day operational and other business functions.
---------------------------------------------------------------------------

    Clear and Appropriate Rules and Procedures. Systems should 
implement rules and procedures that are appropriate and sufficient to 
carry out the system's risk management objectives and that have a well-
founded legal basis. Such rules and procedures should specify the 
respective responsibilities of the system operator, system 
participants, and other relevant parties. Rules and procedures should 
establish the key features of a system's settlement and risk management 
design and specify clear and transparent crisis management procedures 
and settlement failure procedures, if applicable.\15\
---------------------------------------------------------------------------

    \15\ Examples of key features that might be specified in a 
system's rules and procedures are controls to limit participant-
based risks, such as membership criteria based on participants' 
financial and operational health, limits on settlement exposures, 
and the procedures and resources to hedge, margin, or collateralize 
settlement exposures. Other examples of key features might be 
business continuity requirements and loss allocation procedures.
---------------------------------------------------------------------------

    Employ Necessary Resources. Systems should ensure that the 
appropriate resources and processes are in place to allow them to 
achieve their risk management objectives and effectively implement 
their rules and procedures. In particular, the system operator's staff 
should have the appropriate skills, information, and tools to apply the 
system's rules and procedures and achieve the system's risk management 
objectives. System operators should also ensure that their facilities 
and contingency arrangements, including any information system 
resources, are sufficient to meet their risk management objectives.\16\
---------------------------------------------------------------------------

    \16\ Such arrangements may also be subject to various 
supervisory guidelines, such as the ``Interagency Paper on Sound 
Practices to Strengthen the Resilience of the U.S. Financial 
System.'' (68 FR 17809, April 11, 2003)
---------------------------------------------------------------------------

    The Board recognizes that payments and securities settlement 
systems differ widely in terms of form, function, scale, and scope of 
activities and that these characteristics result in differing 
combinations and levels of risks. Thus, the exact features of a 
system's risk management framework should be tailored to the risks of 
that system. The Board also recognizes that the specific features of a 
risk management framework may entail trade-offs between efficiency and 
risk reduction and that payments and securities settlement systems will 
need to consider these trade-offs when designing appropriate rules and 
procedures. In considering such trade-offs, however, it is critically 
important that systems take into account the costs and risks that may 
be imposed on all relevant parties, including parties with no direct 
role in the system.
    To determine whether a system's current or proposed risk management 
framework is consistent with this policy, the Board will seek to 
understand how a system achieves the four elements of a sound risk 
management framework set out above. In this context, it may be 
necessary for the Board to obtain information from system operators 
regarding their risk management framework, risk management objectives, 
rules and procedures, significant legal analyses, general risk 
analyses, analyses of the credit and liquidity effects of settlement 
disruptions, business continuity plans, crisis management procedures, 
and

[[Page 69932]]

other relevant documentation.\17\ It may also be necessary for the 
Board to obtain data or statistics on system activity on an ad-hoc or 
ongoing basis. All information provided to the Federal Reserve for the 
purposes of this policy will be handled in accordance with all 
applicable Federal Reserve policies on information security, 
confidentiality, and conflicts of interest. In seeking to obtain 
information and in determining whether a system's risk management 
framework is consistent with this policy, the Board intends to minimize 
unnecessary burden on systems, and will coordinate its activities, if 
practicable, with supervisory attentions to the system.
---------------------------------------------------------------------------

    \17\ To facilitate analysis of settlement disruptions, systems 
with significant settlement flows may need to develop the capability 
to simulate credit and liquidity effects on participants and on the 
system resulting from one or more participant defaults, or other 
possible sources of settlement disruption. Such simulations may need 
to include, if appropriate, the effects of changes in market prices, 
volatilities, or other factors.
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C. Systemically Important Systems
    In addition to establishing a risk management framework that 
includes the key elements described above, the Board expects 
systemically important payments and securities settlement systems to 
comply with the detailed standards set out in this section.\18\ To 
determine whether a system is systemically important for purposes of 
this policy, the Board may consider, but will not be limited to, one or 
more of the following factors:
---------------------------------------------------------------------------

    \18\ The Board will separately inform systems subject to the 
policy as to whether they are or are not systemically important.
---------------------------------------------------------------------------

    <bullet> Whether the system has the potential to create significant 
liquidity disruptions or dislocations should it fail to perform or 
settle as expected;
    <bullet> Whether the system has the potential to create large 
credit or liquidity exposures relative to participants' financial 
capacity;
    <bullet> Whether the system settles a high proportion of large-
value transactions;
    <bullet> Whether the system settles transactions for critical 
financial markets; \19\
---------------------------------------------------------------------------

    \19\ The ``Interagency Paper on Sound Practices to Strengthen 
the Resilience of the U.S. Financial System'' defines critical 
financial markets as the markets for federal funds, foreign 
exchange, and commercial paper; U.S. government and agency 
securities; and corporate debt and equity securities.
---------------------------------------------------------------------------

    <bullet> Whether the system provides settlement for other systems;
    <bullet> Whether the system is the only system or one of a very few 
systems for settlement of a given financial instrument.
    Systemically important systems are expected to meet specific risk 
management standards because of their potential to cause major 
disruptions in the financial system. The Board, therefore, expects 
systemically important payments systems to comply with the standards 
listed in section I.C.1. Securities settlement systems of systemic 
importance are expected to comply with the standards listed in section 
I.C.2. Some systemically important systems, however, may present an 
especially high degree of systemic risk, by virtue of their high volume 
of large-value transactions or central role in the operation of 
critical financial markets. Because all systems are expected to employ 
a risk management framework that is appropriate for their risks, the 
Board may expect these systems to exceed the standards set out below.
    The Board acknowledges that payments and securities settlement 
systems vary in terms of the range of instruments they settle and 
markets they serve. It also recognizes that systems may operate under 
different legal and regulatory constraints and within particular market 
infrastructures or institutional frameworks. The Board will consider 
these factors when assessing how a systemically important system 
addresses a particular standard.
    The Board's standards for systemically important payments and 
securities settlement systems are based, respectively, on the Core 
Principles and the Recommendations. The Core Principles and the 
Recommendations are two examples of recent initiatives pursued by the 
international financial community to strengthen the global financial 
infrastructure.\20\ The Federal Reserve worked closely with other 
central banks to develop and draft the Core Principles and with other 
central banks and securities regulators to develop and draft the 
Recommendations. These standards are part of the Financial Stability 
Forum's Compendium of Standards that have been widely recognized, 
supported, and endorsed by U.S. authorities as integral to 
strengthening the stability of the financial system.
---------------------------------------------------------------------------

    \20\ The Core Principles draw extensively on the previous work 
of the CPSS, most importantly the Report of the Committee on 
Interbank Netting Schemes of the Central Banks of the Group of Ten 
Countries (the Lamfalussy Minimum Standards). The Core Principles 
extend the Lamfalussy Minimum Standards by adding several principles 
and broadening the coverage to include systemically important 
payments systems of all types, including gross settlement systems 
and hybrid systems, operated by either the public or private sector. 
The Core Principles also address the responsibilities of central 
banks in applying the Core Principles.
---------------------------------------------------------------------------

1. Standards for Systemically Important Payments Systems
    1. The system should have a well-founded legal basis under all 
relevant jurisdictions.
    2. The system's rules and procedures should enable participants to 
have a clear understanding of the system's impact on each of the 
financial risks they incur through participation in it.
    3. The system should have clearly defined procedures for the 
management of credit risks and liquidity risks, which specify the 
respective responsibilities of the system operator and the participants 
and which provide appropriate incentives to manage and contain those 
risks.
    4. The system should provide prompt final settlement on the day of 
value, preferably during the day and at a minimum at the end of the 
day.
    5. A system in which multilateral netting takes place should, at a 
minimum, be capable of ensuring the timely completion of daily 
settlements in the event of an inability to settle by the participant 
with the largest single settlement obligation.
    6. Assets used for settlement should preferably be a claim on the 
central bank; where other assets are used, they should carry little or 
no credit risk and little or no liquidity risk.
    7. The system should ensure a high degree of security and 
operational reliability and should have contingency arrangements for 
timely completion of daily processing.
    8. The system should provide a means of making payments which is 
practical for its users and efficient for the economy.
    9. The system should have objective and publicly disclosed criteria 
for participation, which permit fair and open access.
    10. The system's governance arrangements should be effective, 
accountable and transparent.
2. Standards for Systemically Important Securities Settlement Systems
    The CPSS-IOSCO Recommendations apply to the full set of 
institutional arrangements for confirmation, clearance, and settlement 
of securities transactions, including those related to market 
convention and pre-settlement activities. As such, not all of these 
standards apply to all systems. Moreover, the standards applicable to a 
particular system also will vary based on the structure of the market 
and the system's design.
    While the Board endorses the CPSS-IOSCO Recommendations in their 
entirety, its primary interest for

[[Page 69933]]

purposes of this policy is in those standards related to the settlement 
aspects of securities transactions, including the role of central 
counterparties and central depositories, the delivery of securities 
against payment, and related risks.\21\ The Board expects that systems 
engaged in the management or conduct of settling securities 
transactions and their participants to comply with the expectations set 
forth in the applicable Recommendations. Securities settlement systems 
also may wish to consult the Assessment Methodology for 
``Recommendations for Securities Settlement Systems'' for further 
guidance on each standard.\22\
---------------------------------------------------------------------------

    \21\ The CPSS and the Technical Committee of IOSCO have recently 
developed a separate set of Recommendations for Central 
Counterparties, which are intended to supersede those elements of 
the Recommendations for Securities Settlement Systems that are 
applicable to central counterparties. The Board will review the new 
recommendations and determine whether it is appropriate to 
incorporate them into this policy.
    \22\ CPSS and Technical Committee of IOSCO (November 2002). 
Available at http://www.bis.org.
---------------------------------------------------------------------------

    1. Securities settlement systems should have a well-founded, clear 
and transparent legal basis in the relevant jurisdictions.
    2. Confirmation of trades between direct market participants should 
occur as soon as possible after trade execution, but no later than the 
trade date (T+0). Where confirmation of trades by indirect market 
participants (such as institutional investors) is required, it should 
occur as soon as possible after the trade execution, preferably on T+0, 
but no later than T+1.
    3. Rolling settlement should be adopted in all securities markets. 
Final settlement should occur no later than T+3. The benefits and costs 
of a settlement cycle shorter than T+3 should be evaluated.
    4. The benefits and costs of a central counterparty should be 
evaluated. Where such a mechanism is introduced, the central 
counterparty should rigorously control the risks it assumes.
    5. Securities lending and borrowing (or repurchase agreements and 
other economically equivalent transactions) should be encouraged as a 
method for expediting the settlement of securities transactions. 
Barriers that inhibit the practice of lending securities for this 
purpose should be removed.
    6. Securities should be immobilized or dematerialized and 
transferred by book entry in a central securities depository to the 
greatest extent possible.
    7. Central securities depositories should eliminate principal risk 
by linking securities transfers to funds transfers in a way that 
achieves delivery versus payment.
    8. Final settlement should occur no later than the end of the 
settlement day. Intraday or real time finality should be provided where 
necessary to reduce risks.
    9. Central securities depositories that extend intraday credit to 
participants, including central securities depositories that operate 
net settlement systems, should institute risk controls that, at a 
minimum, ensure timely settlement in the event that the participant 
with the largest payment obligation is unable to settle. The most 
reliable set of controls is a combination of collateral requirements 
and limits.
    10. Assets used to settle the ultimate payment obligations arising 
from securities transactions should carry little or no credit or 
liquidity risk. If central bank money is not used, steps must be taken 
to protect central securities depository members from potential losses 
and liquidity pressures arising from the failure of the cash settlement 
agent whose assets are used for that purpose.
    11. Sources of operational risk arising in the clearing and 
settlement process should be identified and minimized through the 
development of appropriate systems, controls and procedures. Systems 
should be reliable and secure, and have adequate, scalable capacity. 
Contingency plans and backup facilities should be established to allow 
for the timely recovery of operations and completion of the settlement 
process.
    12. Entities holding securities in custody should employ accounting 
practices and safekeeping procedures that fully protect customers' 
securities. It is essential that customers' securities be protected 
against the claims of a custodian's creditors.
    13. Governance arrangements for central securities depositories and 
central counterparties should be designed to fulfill public interest 
requirements and to promote the objectives of owners and users.
    14. Central securities depositories and central counterparties 
should have objective and publicly disclosed criteria for participation 
that permit fair and open access.
    15. While maintaining safe and secure operations, securities 
settlement systems should be cost-effective in meeting the requirements 
of users.
    16. Securities settlement systems should use or accommodate the 
relevant international communication procedures and standards in order 
to facilitate efficient settlement of cross-border transactions.
    17. Central securities depositories and central counterparties 
should provide market participants with sufficient information for them 
to identify and evaluate accurately the risks and costs associated with 
using the central securities depository or central counterparty 
services.
    18. Securities settlement systems should be subject to transparent 
and effective regulation and oversight. Central banks and securities 
regulators should cooperate with each other and with other relevant 
authorities.
    19. Central securities depositories that establish links to settle 
cross-border trades should design and operate such links to reduce 
effectively the risks associated with cross-border settlement.

II. Federal Reserve Daylight Credit Policies

    This part outlines the methods used to control intraday overdraft 
exposures in Federal Reserve accounts. These methods include limits on 
daylight overdrafts in institutions' Federal Reserve accounts and 
collateralization, in certain situations, of daylight overdrafts at the 
Federal Reserve.
    To assist institutions in implementing this part of the policy, the 
Federal Reserve has prepared two documents: the Overview of the Federal 
Reserve's Payments System Risk Policy on Daylight Credit (Overview) and 
the Guide to the Federal Reserve's Payments System Risk Policy on 
Daylight Credit (Guide).\23\ The Overview summarizes the Board's policy 
on the provision of daylight credit, 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.
---------------------------------------------------------------------------

    \23\ Available at http://www.federalreserve.gov/paymentsystems/PSR.
---------------------------------------------------------------------------

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,

[[Page 69934]]

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 \24\
Opening Balance (Previous Day's Closing Balance)
    Post throughout business day:

    \24\ 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).
---------------------------------------------------------------------------

<plus-minus> Fedwire funds transfers.
<plus-minus> Fedwire book-entry securities transfers.
<plus-minus> 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>25</SUP> 26 27
---------------------------------------------------------------------------

    \25\ 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.
    \26\ The term ``interest and redemption payments'' refers to 
payments of principal, interest, and redemption on securities 
maintained on the Fedwire Securities Service.
    \27\ 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.\28\
---------------------------------------------------------------------------

    \28\ 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:

<plus-minus> Government and commercial ACH credit transactions.\29\
---------------------------------------------------------------------------

    \29\ 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).\30\
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    \30\ 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:

<plus-minus> Main account administrative investment or withdrawal from 
TIP.
<plus-minus> Special Direct Investment (SDI) administrative investment 
or withdrawal from TIP.
+ 31 CFR part 202 account deposits from TIP.
- Uninvested paper tax (PATAX) 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.\31\
---------------------------------------------------------------------------

    \31\ 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.\32\
---------------------------------------------------------------------------

    \32\ 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.\33\
---------------------------------------------------------------------------

    \33\ 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.\34\
---------------------------------------------------------------------------

    \34\ See footnote 25.
---------------------------------------------------------------------------

+ 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.\35\
---------------------------------------------------------------------------

    \35\ See footnote 33.

---------------------------------------------------------------------------
    Post beginning at 9:15 a.m. eastern time:

- Original issues of Treasury securities.\36\
---------------------------------------------------------------------------

    \36\ 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:

<plus-minus> ACH debit transactions.
+ EFTPS investments from ACH debit transactions.

    Post at 11 a.m. eastern time and hourly thereafter:

<plus-minus>Commercial check transactions, including returned 
checks.<SUP>37, 38</SUP>
---------------------------------------------------------------------------

    \37\ 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.
    \38\ 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.

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[[Page 69935]]

<plus-minus>Check corrections amounting to $1 million or more.\39\
---------------------------------------------------------------------------

    \39\ Corrections are account entries made to correct 
discrepancies detected by a Reserve Bank during the initial 
processing of checks.
---------------------------------------------------------------------------

+ Currency and coin deposits.
+ Credit adjustments amounting to $1 million or more.\40\
---------------------------------------------------------------------------

    \40\ Adjustments are account entries made to correct 
discrepancies detected by an institution after entries have posted 
to its account and are made at the request of the institution.

    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.\41\
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    \41\ 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.
<plus-minus> 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: \42\

    \42\ 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.
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+ Penalty abatements from TIP.

    Post after the close of Fedwire Funds Service:

<plus-minus> 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).\43\ The effective daily rate is 
calculated by dividing the effective annual rate by 360.\44\ 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.
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    \43\ 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.
    \44\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft rate is truncated to 0.0000089.
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    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 II.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.\45\ 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 II.E.
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    \45\ Under the current 21.5-hour Fedwire operating day, the 
effective daily deductible rate is rounded to 0.0000042.
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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 II.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\46\..........  $10 million or      $10 million or
                                   0.20.               0.20

[[Page 69936]]

 
Zero............................  0.0...............  0.0
------------------------------------------------------------------------
\46\ 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.

    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.\47\ 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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    \47\ 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 qualify for a positive net 
debit cap (see section II.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.\48\ The assessment of creditworthiness is 
based on the institution's supervisory rating and Prompt Corrective 
Action (PCA) designation.\49\ 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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    \48\ 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.
    \49\ 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).
---------------------------------------------------------------------------

    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.\50\
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    \50\ 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.
---------------------------------------------------------------------------

    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.\51\
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    \51\ 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.
---------------------------------------------------------------------------

    As part of its normal examination, the institution's examiners may 
review the contents of the self-assessment file.\52\ 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

[[Page 69937]]

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.
---------------------------------------------------------------------------

    \52\ 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 II.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 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 II.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.\53\ U.S. capital equivalency is equal to the following:
---------------------------------------------------------------------------

    \53\ 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.
---------------------------------------------------------------------------

    <bullet> 35 percent of capital for FBOs that are financial holding 
companies (FHCs).\54\
---------------------------------------------------------------------------

    \54\ 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)).
---------------------------------------------------------------------------

    <bullet> 25 percent of capital for FBOs that are not FHCs and have 
a strength of support assessment ranking (SOSA) of 1.\55\
---------------------------------------------------------------------------

    \55\ 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.
---------------------------------------------------------------------------

    <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

[[Page 69938]]

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>\56,57\</SUP> This policy is intended to 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.\58\ 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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    \56\ 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.
    \57\ 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.
    \58\ 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).
---------------------------------------------------------------------------

    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.\59\ 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.
---------------------------------------------------------------------------

    \59\ 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.\60\

    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 II.F., ``Monitoring'').
---------------------------------------------------------------------------

    \60\ 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.
---------------------------------------------------------------------------

    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.\61\ 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.
---------------------------------------------------------------------------

    \61\ See footnote 25.
---------------------------------------------------------------------------

    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

[[Page 69939]]

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.\62\ 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 II.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.\63\
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    \62\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft penalty rate is truncated to 
0.0000338.
    \63\ 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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1. Edge and Agreement Corporations \64\
    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.
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    \64\ 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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    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 \65\
    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.
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    \65\ For the purposes of this policy, a bankers' bank is a 
depository institution that is not required to maintain reserves 
under the Board's Regulation D (12 CFR part 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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    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 \66\
    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.
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    \66\ For the purposes of this policy, 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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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

[[Page 69940]]

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.\67\
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    \67\ 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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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.\68\ 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.\69\
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    \68\ 12 U.S.C. 3101-3108.
    \69\ 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, November 24, 2004.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 04-26444 Filed 11-30-04; 8:45 am]
BILLING CODE 6210-01-P