FINANCIAL SECTOR ASSESSMENT PROGRAM

UNITED STATES OF AMERICA

SELECTED ISSUES ON LIQUIDITY RISK MANAGEMENT IN 

FEDWIRE FUNDS AND PRIVATE SECTOR PAYMENT SYSTEMS

TECHNICAL NOTE

MAY 2010

INTERNATIONAL MONETARY FUND

MONETARY AND CAPITAL MARKETS DEPARTMENT
4053526
 Contents Page 

Glossary .....................................................................................................................................3 

Executive Summary ...................................................................................................................4 

I. Overview ................................................................................................................................7 

II. Central Bank Policy in Providing Liquidity to Payment Systems 

and Critical Market Infrastructures ............................................................................................9

A. Observations on the Current Daylight Credit Policy ..............................................10

B. Main Features of the New Daylight Credit Policy ..................................................12

C. Assessment of the New Daylight Credit Policy of the Fed .....................................13 

III. Efforts to Reduce Late-Day Settlement in Payment Systems and 

Market Infrastructures ..............................................................................................................13

A. Liquidity Saving Mechanism in Fedwire Funds .....................................................14

B. Reducing End-of-Day Settlement in CHIPS ...........................................................15 

IV. Risk Management ..............................................................................................................17

A. Concentration of Settlement....................................................................................17

B. Stress Testing and Simulations ...............................................................................18

C. Operational Resilience ............................................................................................19

D. Access of Systemically Important Infrastructures to Central Bank Services .........20

E. Interdependencies ....................................................................................................20

Tables 

1. Overview of the Large Value Payment Systems Operating in the United States ..................7

2. Comparison of Intraday Credit Policies Between the U.S. and Selected Countries ............10

3. Key Elements of the Current and Revised PSR Policy for Daylight Credit ........................12

Box 

1. Overview of the CHIPS Settlement Model ..........................................................................16
3 

GLOSSARY

CHIPS Clearing House Interbank Payments System 

CLS Continuous Linked Settlement 

CMS Collateral Management System 

CPSIPS CPSS Core Principles for Systemically Important Payment Systems 

CPSS Committee on Payment and Settlement Systems 

DTC Depository Trust Company 

EPN Electronic Payments Network 

FBOs Foreign Banking Organizations 

Fed Federal Reserve 

FICC Fixed Income Clearing Corporation 

FX Foreign Exchange 

IOSCO International Organization of Securities Commissions 

MCA Monetary Control Act 

PRC Payment Risk Committee 

PSR Payment System Risk 

RTGS Real Time Gross Settlement System 

SSS Securities Settlement System 

WCAG Wholesale Customer Advisory Group 

 
4 

EXECUTIVE SUMMARY1

The U.S. payment and settlement systems continued to function smoothly during the 

2007-2008 period of market stress. This owed both to the robustness of the systems’ risk 

management and infrastructure and to the actions by the Federal Reserve (Fed) to sharply 

increase balances held at the Federal Reserve Banks by financial institutions (reserve 

balances). 

However, especially as the Fed’s extraordinary liquidity support is withdrawn, 

underlying vulnerabilities within the system will need to be addressed, most notably: 

 Intraday credit from the Fed is largely in the form of uncollateralized but capped 

daylight overdrafts (where uncollateralized intraday overdraft caps are generally set 

as a percentage of the capital of the financial institution), subject to an administered 

fee. Caps and fees encourage some large depository institutions to delay settlement of 

large-value funds payments over Fedwire Funds (the Fed’s Real Time Gross 

Settlement (RTGS) system) until late in the day, especially for fees avoidance 

purposes. 

 The fact that the Fedwire Funds system provides neither a central queuing/payment 

offsetting mechanism nor other liquidity saving features exacerbates the problem of 

late payments in Fedwire Funds.2

These issues pose risks both domestically and internationally. Domestically, the increase 

in late-in-the-day payments leaves the payment system as a whole more vulnerable in case of 

a late-in-the-day operational disruption. Internationally, the end-of-day closure of U.S. 

payment systems effectively means the worldwide “end-of day” so a liquidity disruption in 

the U.S. system could constitute a critical shock that could propagate systemic risk at the 

following day opening in Asia and Europe. 

The new intraday liquidity policy of the Fed, to be implemented late 2010 or early 2011, 

will help address some of the risks presently facing the payment system. The new 

Payment System Risk (PSR) policy promotes the collateralization of intraday credit. 

Collateralized overdrafts under the new policy will not be charged a fee and will therefore 

work both to reduce the incentive to delay certain payments until late in the day, as well as to 

reduce the Fed’s credit risk from providing intraday credit. Although substantial, the 

effectiveness of these changes (and others underway) in encouraging Fedwire participants to 

send payments earlier in the day will need to be assessed over the medium term, and it 

remains to be seen whether additional steps to amend the intraday credit framework (e.g., 

relaxing further or removing net debit caps) would also help. 

 

1

 This Technical Note was prepared by Frédéric Hervo (external expert, Banque de France). 

2

 Some of this functionality is, however, provided by CHIPS, a private-sector funds transfer system. 
5 

While an asymmetric treatment of foreign banking organizations (FBOs) exists 

regarding the calculation of the capital measure for caps and the fee deductible, policy 

provisions implemented in March 2009 substantially addressed this asymmetry. For 

example, highly-rated FBOs are eligible for a fee deductible based on 100 percent of 

worldwide capital, the same capital measure used for U.S. chartered institutions, and highlyrated FBOs are eligible for additional collateralized capacity under a streamlined process. 

Additionally, under the new policy, the fee deductible is eliminated for all institutions—

FBOs and U.S. chartered institutions. While these changes represent substantial progress 

toward the equitable treatment of FBOs, additional steps could be considered to provide a 

more level playing field relative to U.S. banks while ensuring an adequate level of comfort 

with respect to credit risk mitigation. 

Steps are needed to amend Fedwire’s settlement procedures for tri-party repo 

transactions, Depository Trust Company (DTC), and Clearing House Interbank 

Payments System (CHIPS) to discourage late-in the-day payments. The Fed identified a 

four-prong approach, including revising the PSR policy, exploring the introduction of a 

liquidity saving mechanism for Fedwire Funds, and making liquidity improvements for 

CHIPS and DTC, to move payments earlier in the day.3

 The CHIPS system has been 

successful in reducing the amount of payments processed late, especially by encouraging its 

participants voluntarily to provide supplemental funding earlier. However, further efforts in 

this area should be encouraged especially since the underlying risks may re-emerge as 

liquidity levels return to normal. 

ONGOING EFFORTS AND RECOMMENDATIONS

Ongoing efforts 

 Over the past several years, the Fed has outlined steps to improve the payment system, 

including the following: 

 Implement and take further steps, as appropriate, to increase collateralized 

intraday credit and reduce uncollateralized overdrafts as a way to (i) strengthen 

the credit risk management of the Reserve Banks, (ii) incentivize institutions to 

send large-value funds payments earlier in the day, and (iii) further align the 

treatment of FBOs and U.S. chartered banks. 

 Explore the introduction of liquidity-saving features in Fedwire Funds. 

 Support the continued efforts by the private sector to reduce late-in-the-day 

settlements associated primarily with tri-party repo and settlement processes in 

DTC and CHIPS. 

 

3

 73 FR 79110, December 24, 2008. 
6 

Recommendations 

 In line with the Administration’s proposal, the Fed Banks should be granted the legal 

right to give access to accounts and liquidity to systemically important post-trade market 

infrastructures as an additional buffer to mitigate systemic risk. 

 The Fed, in cooperation with other relevant agencies, should continue to review the 

ability of payment, clearing, and settlement systems to cope with extreme liquidity stress 

scenarios in light of the lessons of the crisis, on the basis of stress testing scenarios and 

simulations, taking into account the concentration of payment and settlement services, as 

well as the complex interdependencies among systems. 

 
7 

I. OVERVIEW

1. The U.S. wholesale payment infrastructure comprises two systems, which are of 

a systemic importance and settle in central bank money. The Fed Banks’ Fedwire Funds 

Services (Fedwire) is a real time gross settlement system (RTGS) operated by the Fed, while 

the Clearing House Interbank Payments System (CHIPS) is a private sector system 

combining net and gross real time settlement. In addition to these domestic systems, 

payments services are offered by Continuous Linked Settlement Bank International (CLS 

Bank), which operates payment versus payment settlement services in 17 currencies mainly 

for foreign exchange (FX) related transactions.4

Table 1. Overview of the Large Value Payment Systems Operating in the 

United States 

System Average daily 

value 

(Q2 2009 – 

USD trillion) 

Percentage 

change from 

one year ago 

Average daily 

volume 

(Q2 2009 – 

thousands) 

Percentage 

change from 

one year ago 

Number of 

direct 

participants 

Fedwire 

Funds 

2.49 - 15.8 498 - 5.6 7,300 

CHIPS 1.43 - 33.2 330 - 9.7 48 

CLS* 3.34 - 20.6 590 + 15.9 59 

*CLS data excludes Memorial Day, a U.S. dollar holiday. 

2. In contrast, the U.S. retail payment infrastructure is more fragmented. There are 

two national Automated Clearing House operators: the Reserve Banks and Electronic 

Payments Network (EPN, a private sector entity) and several regional and interregional 

check image exchanges and card payment schemes. 

3. The U.S. wholesale payment infrastructure is at the heart of a complex network 

of critical interdependencies, both from domestic and international perspectives. The 

most significant example is CLS Bank, which is linked for funding purposes to the RTGS 

systems of the 17 central banks for the currencies currently eligible in the system. 

4. U.S. payment and settlement systems were a source of strength throughout the 

2007-2008 period of market stress. The systems performed well, including the 

implementation of participant failure management procedures, despite the significant 

challenges arising from unprecedented financial market stresses, higher than normal and more 

variable payment and settlement volumes and values, the financial difficulties of a number of 

 

4

 Although this report covers issues related to CLS, a full review of CLS risk management is beyond its scope. 
8 

individual financial institutions, and a higher degree of uncertainty regarding counterparty risk. 

Despite these challenges, the U.S. systems were able to complete settlement on the day of value. 

5. The settlement and operational risk management frameworks for the U.S. 

payment systems appear to be robust. A formal assessment of the compliance of the 

various systems with international standards, namely the Committee on Payment and 

Settlement System (CPSS) Core Principles for Systemically Important Payment Systems 

(CPSIPS), was not performed. Self-assessments of Fedwire Funds, CHIPS and CLS Bank, 

conducted prior to the mission, suggested a full compliance of the three systems with 

CPSIPS.5

6. During the turmoil, the Fed, the Securities and Exchange Commission, the 

Commodity Futures Trading Commission, the Treasury Department and other 

regulators undertook significant action to help ensure the smooth functioning of the 

financial markets, including the payments system. These included massive liquidity 

injections to help address the dislocation of the interbank market from September 2008 

onwards, as well as obtaining Congressional approval for an accelerated implementation of 

payment of interest on reserves. As a result, reserve balances rose from an average of around 

US$9 billion in early 2008 to over US$1 trillion in October 2009. This increase in reserve 

balances did not prevent, however, a temporary increase in the demand for intraday credit 

during the crisis, likely reflecting among other factors an increase in values transferred over the 

Fedwire Funds and Securities services, and risk aversion. For instance, during the period which 

followed the collapse of Lehman Brothers (between September 15 and October 24, 2008) the 

use of daylight overdrafts by Fedwire Funds participants increased about 50 percent 

compared to the previous quarter. 

7. In recent decades, the increased use of gross settlement and real time finality in 

payment systems have mitigated or even eliminated a large part of settlement risk but 

have created additional structural demand for intraday credit. The emergence of some 

categories of time-critical payments as a risk management tool for some systems (e.g., CLS 

Bank funding requirements) that have to be completed within tight intraday deadlines have 

also increased intraday liquidity pressures. 

8. Increased demand for intraday credit, which has been observed in most 

industrial countries, is exacerbated by specific features in the United States. Starting in 

the late 1980s, financial institutions began decreasing their overnight reserve balances. More 

recently, late-in-the-day payments associated with the settlement of tri-party repo grew, and 

settlement procedures in CHIPS and DTC tended to lock up significant amounts of liquidity 

until late in the day. 

 

5

 See http://www.treas.gov/offices/international-affairs/standards/standards.shtml.
9 

II. CENTRAL BANK POLICY IN PROVIDING LIQUIDITY TO PAYMENT SYSTEMS

AND CRITICAL MARKET INFRASTRUCTURES

9. Since the 1980s, the Fed was explicit in its desire to limit its provision of intraday 

credit, reflecting a desire to insulate the Fed System from credit risk. As a result, while 

daylight overdrafts are uncollateralized, access is capped and subject to a fee.6 Collateral is 

typically required for overdrafts above the net debit cap (but still subject to a maximum cap).7

The control over the level of intraday credit provided and fees are the main tools used by the 

Fed to minimize the use of daylight overdrafts by participants.8

 This differs from most central 

banks in other major financial centers, where the practice is typically to provide 

collateralized intraday credit without a fee or cap. 

10. In 2008, the Board of the Governors approved a revision to its PSR policy that 

permits and encourages the collateralization of intraday credit for all depository 

institutions. Provisions significantly improving the equity of the policy’s treatment of FBOs 

went into effect in March 2009, and the remaining provisions of the new policy will go into 

effect upon the implementation of the full policy in late 2010 or early 2011. These changes 

build on a review process and formal public consultation that was initiated in 2001 (the 

proposals are discussed below). In the revised PSR policy, the Board maintains its policy 

objectives of balancing safety and efficiency and explicitly recognizes the role of the central 

bank in providing intraday credit to healthy depository institutions.9

 

6

 The net debit cap is based on a multiple of the capital measure of the institution that is linked to an assessment 

of creditworthiness. The cap can be increased based on business need and the institution’s risk characteristics. 

7

 Overnight loans from the discount window facility of the Federal Reserve are, however, fully collateralized, 

and potential borrowers establish standing pools of collateral to cover these loans. The Federal Reserve has a 

general lien upon any unencumbered discount window collateral to cover a failure to extinguish an 

uncollateralized daylight overdraft. 

8

 During the public consultation on revisions to the PSR policy in 2008, the Board shifted its approach from 

treating intraday credit as inherently undesirable to acknowledging the role of the central bank in providing 

intraday credit to healthy depository institutions: “In the past, the Board also had concerns that accepting 

collateral to address Reserve Bank credit risk for daylight overdrafts would not provide strong incentives to 

reduce the level of intraday credit. In particular, there was concern that because of the wide range of collateral 

accepted by the Reserve Banks, depository institutions would have weak incentives to reduce their use of 

intraday credit. Under the new strategy, the purpose of Reserve Banks accepting collateral is not to control the 

level of overdrafts per se, but to mitigate credit risk to the Reserve Banks when they provide intraday balances 

and credit needed for the smooth operation of the payments system.” The revisions will be implemented in late 

2010 or early 2011, but until the revisions take effect, the policy continues to state that “the Board expects 

depository institutions to manage their Federal Reserve accounts effectively and minimize their use of Federal 

Reserve daylight credit.” 

9

 73 FR 79109, December 24, 2008. 
10 

Table 2. Comparison of Intraday Credit Policies between the U.S. and 

Selected Countries

 Use of Collateral Maximum 

Amount/cap 

Fee/Interest 

Canada Collateralized (pledge) No Free 

Eurosystem Collateralized (pledge/repo) No Free 

Japan Collateralized No Free 

United Kingdom Collateralized (repo) No10 Free 

United States 

(current policy) 

Only for problem institutions and 

institutions with maximum caps 

Yes Yes 

A. Observations on the Current Daylight Credit Policy 

11. Many large depository institutions defer until late in the day sending a 

significant number of large-value funds transfers due to a number of market factors 

and to avoid daylight overdraft fees. The Fedwire Funds system does not provide a 

queuing/payment offsetting mechanism to its participants, making the completing of 

payments in the RTGS payment system highly dependent upon the availability of a sufficient 

daylight overdraft capacity or balances. Although Fedwire Funds has one of the widest 

operating hours among major RTGS payment systems (i.e., the operating day of Fedwire 

Funds for the value date D starts on D-1 at 9:00 p.m. ET and closes at 6:30 p.m. on D), more 

than 60 percent of payment value in 2008 was settled after 3:30 p.m., more than 40 percent 

after 4:30 p.m. and more than 30 percent after 5:00 p.m. The share of the value of payments 

sent after 5:00 p.m. grew by 10 percentage points between 1998 and 2007, driven largely by 

the largest payments, including the funds transfers used to complete the daily cycle of 

financial market settlement payments. Late-day payments are related to a number of factors, 

including efforts to avoid fees on daylight overdrafts from the Fed. These late-day payments 

raise potential systemic concerns, given the uncertainty this leaves with regard to completion 

of large and critical payments at value date. 

12. An additional concern is that access of depository institutions to uncollateralized 

daylight overdrafts leaves the Fed subject to credit risk. However, the Fed has a robust 

program in place to mitigate the risks posed by extending daylight overdrafts and no credit 

losses have been experienced to date.11 The Fed’s exposure to daylight overdrafts has 

 

10 However, if more than £ 1 billion is to be borrowed, the borrowing institution must ensure that the securities 

of any single issuer (other than the U.K. government and the Bank of England) comprise no more than 

25 percent of the total collateral it has repoed to the Bank. 

11 The Reserve Banks monitor the financial condition of institutions to ensure they meet the safety and 

soundness requirements to access intraday credit. Monitoring tools include, but are not limited to, supervisory 

information, analytical reporting, and predictive models. Net debit caps establish limits on the amount of 
11 

decreased in 2009, owing to the increase in reserve balances held by banks. In 2007 the 

average daily overdraft of the banking system as a whole was approximately US$60 billion 

and the average daily peak overdraft US$160 billion. In 2009, the average and peak daylight 

overdrafts stood at US$10 and US$55 billion, respectively.12 While demand for daylight 

overdrafts is not expected to remain at 2009 levels, the future demand for daylight overdrafts 

is unclear for a number of reasons, including the level of balances that banks will hold as 

banking conditions normalize, as well as changes resulting from the revised PSR policy. 

13. The Fed’s daylight credit policy has also imposed administrative and technical 

costs. The largest users of intraday credit (representing less than 3 percent of institutions 

with intraday credit but comprising the most active players in Fedwire Funds) must 

undertake a comprehensive self-assessment of their creditworthiness in order to justify their 

net debit cap (see “Guide to the Fed’s Payment System Risk Policy on Daylight Credit”). In 

addition, participants are subject to fees on daylight overdrafts, which stood at US$32.2 

million in 2003, peaked at US$65 million in 2007, and dropped to US$5 million in 2009. 

Therefore, some participants, primarily a handful of the largest users, have built systems to 

manage internal queues of payments and monitor intraday liquidity usage, in order to 

minimize fees paid on the use of their daylight overdraft capacity. 

14. The existing daylight credit policy also does not ensure a completely level playing 

field between domestic-chartered institutions and foreign participants in their use of 

Fedwire. Until March 2009, the capital used in determining the net debit cap for FBOs was 

limited to 35 percent of the capital of the parent company of the U.S. branch or subsidiary of 

the FBO (instead of 100 percent of the capital for U.S. domestic institution), even for the 

most-highly rated ones.13 In 2007, FBOs as a group incurred average peak overdrafts that 

were less than 50 percent of their single day capacity. Although FBOs are generally 

unconstrained by their caps, some FBOs may have approached their limits on certain 

liquidity intensive payment days, before the crisis. This lower cap also reduces the so-called 

“deductible” amounts, i.e., a waiver reducing the fee applied to the daylight overdraft, since 

it is calculated with reference to a capital measure. During the mission, some anecdotal 

evidence was provided by private sector participants suggesting that some FBOs limit or 

refrain from self-clearing in the payment system and channel their payment flows to U.S. 

chartered banks, or delay non-time-critical payments as late in the day as possible. In 

March 2009, the most creditworthy FBOs were granted a streamlined process for receiving 

additional collateralized capacity up to the value of their net debit cap calculated on 

100 percent of their capital. Additionally, these FBOs were granted a fee deductible based on 

 intraday credit to any institution. Finally, institutions that pose elevated credit risk are placed on a “watch list” 

for more frequent monitoring and additional targeted risk mitigation steps, as appropriate. 

12 Source for daylight overdraft data: http://www.federalreserve.gov/paymentsystems/psr_dlod.htm. 

13 In countries where the provision of intraday credit is unlimited but fully collateralized, foreign participants 

are usually treated like domestic participants. 
12 

100 percent of capital. The reasons stated in the PSR policy for the differential treatment are 

the greater difficulty in assessing the creditworthiness of FBO and the greater risk that may 

be implied by foreign insolvency laws. However, alternative tools may be considered, 

including a jurisdiction-by-jurisdiction analysis of the materiality of these risks, which may 

at the same time provide for adequate risk containment without raising the same levelplaying field concerns as a blanket penalty. 

B. Main Features of the Future Daylight Credit Policy 

15. The Fed’s new strategy would explicitly encourage the use of collateral to 

contain credit risk in providing daylight overdrafts. Collateralized daylight overdrafts 

would be charged a zero fee, and to encourage collateralized borrowing, the fee for 

uncollateralized daylight overdrafts would be increased to 50 basis points (annual rate) from 

the current 36 basis points. In addition, the two-week average net debit cap would be 

eliminated, while retaining the higher single-day cap for healthy depository institutions, 

which would effectively raise caps by approximately 50 percent. Access to daylight credit 

would continue to be available only to institutions with regular access to the discount 

window, with the same collateral eligibility criteria and haircuts used for both overnight and 

intraday credit. Unencumbered collateral pledged for discount window purposes could be 

used to support intraday credit. 

Table 3. Key Elements of the Current and Revised PSR policy for Daylight 

Credit

Main patterns Current policy Revised policy 

Collateral Required for problem institutions 

and institutions with max caps 

Pledging collateral will be explicitly 

encouraged through a more 

favorable pricing of collateralized 

daylight overdrafts 

Fee for collateralized daylight 

overdrafts 

36 basis points Zero fee 

Fee for uncollateralized 

daylight overdrafts 

36 basis points 50 basis points 

Deductible amount (subtracted 

from fees levied on daylight 

overdrafts) 

10 percent of an institution’s 

capital measure 

Replaced by zero fee for 

collateralized daylight overdrafts 

and fee waiver 

Fee waiver Up to US$25 biweekly US$150 biweekly 

Net debit cap Two-week average limit and 

higher single-day limit. Ex-post 

counseling if exceed limit 

Two-week average limit 

eliminated; single-day limit 

retained. Flexibility in ex post 

counseling if fully collateralized 

Max cap Additional collateralized capacity 

above net debit cap for selfassessed institutions 

Streamlined process for certain 

FBOs up to a limit (effective 

March 26, 2009). Minor changes 

apply for all institutions 

Penalty fee for ineligible 

institutions 

136 bps 150 bps 

 Source: Notice of the Federal Reserve Board of Governors of December 24, 2008 on the revised PSR Policy. 
13 

C. Comments on the Future Daylight Credit Policy 

16. Experience will determine whether the new policy sufficiently encourages 

participants to move to voluntary collateralized daylight credit and reduce late-in-theday payments. The higher fee for uncollateralized overdrafts would need to be compared 

with the opportunity costs of delivering collateral. Because the range of collateral accepted 

by the Fed is very broad relative to other liquidity sources, the opportunity cost of pledging 

new collateral will likely not be significant.14 As of end 2009, US$1.2 trillion in assets were 

pledged with the Reserve Banks mainly for discount window purposes, most of which was 

unencumbered by loans, with no real opportunity cost. Less than 60 percent of mid-to-large 

users have collateral pledged for discount window purposes (less than 50 percent of total 

users) although more than 90 percent have documents signed with the Reserve Banks to do it. 

Most of the largest users of daylight overdrafts, however, have sufficient unencumbered 

collateral pledged to the Reserve Banks to cover their average level of daylight overdrafts. 

17. The changes implemented in March 2009 have already helped to ease the 

significantly stricter limitations faced by FBOs. The calculation of the deductible, which 

was the main concern for FBOs, has been aligned with U.S. chartered institutions for the 

highest-rated FBOs (these represent 10 percent of foreign participants and 40 percent of 

FBOs’ use of intraday credit). FBOs will continue to be monitored at their cap level in real 

time, whereas only 5 percent of institutions are monitored in real time (for the others there is 

ex post control and corrective measures required in case of need). When there is real time 

monitoring of an institution, any outgoing Fedwire Funds transfer that exceeds available 

funds is rejected. 

18. The Board of Governors may consider further changes to increase the use of 

collateralized intraday credit over the medium term and following appropriate cost 

benefit analysis. Although the new policy will relax some aspects of the net debit cap 

program, caps on total intraday credit will remain. As mentioned in the revised PSR Policy, 

“the Board may in the future consider the costs and benefits of moving further toward a fully 

collateralized structure.” 

III. EFFORTS TO REDUCE LATE-DAY SETTLEMENT IN PAYMENT SYSTEMS 

AND MARKET INFRASTRUCTURES

19. The Fed is working on three other areas to help address late-in-the-day 

payments and liquidity pressures in the payment systems. When in 2008 the Fed 

approved the revised PSR policy, there was an expectation that the financial industry would 

continue to review market clearing and settlement practices and pursue the elements of a so-

 

14 The range of assets eligible to be pledged as collateral to the Federal Reserve, includes ABS, AAA 

collateralized debt obligations, commercial mortgage-backed securities, loans, and certain foreign currencydenominated assets. See http://www.frbdiscountwindow.org/discountmargins.cfm?hdrID=21&dtlID=83. 
14 

called “four-prong strategy” to address intraday liquidity, and operational and credit risks in 

the wholesale payment and settlement system. The three other efforts cover the potential 

development of a liquidity saving mechanism for Fedwire Funds, reducing the aggregate 

value of end-of-day settlement in CHIPS, and improvements in intraday liquidity usage for 

DTC.15 

A. Liquidity Saving Mechanism in Fedwire Funds 

20. The Fed Banks have been exploring with the industry the possibility of 

developing a liquidity-saving mechanism for Fedwire Funds. Over the past decade, the 

trend in the new generation of RTGS payment systems, e.g., in Europe and Japan, has been 

to incorporate queuing and offsetting arrangements, which save a large amount of the 

liquidity needed to complete settlement while retaining the immediate finality of gross real 

time systems. Fedwire Funds is currently a traditional RTGS system, without any queuing 

mechanism or liquidity saving features. 

21. Introducing a liquidity-saving mechanism would economize on the amount of 

intraday credit and collateral needed to settle a given value of transactions. It could also 

encourage the coordinated release of payments held in the liquidity queues of participants by 

reducing the total liquidity (and collateral in the new intraday credit policy to be 

implemented soon) used to fund those payments. In the current framework, where 

participants manage internal payment queues, there is no visibility of the incoming payments 

queued by their counterparties, which complicates intraday liquidity management.16 

22. The implementation of a liquidity-saving mechanism in Fedwire Funds would 

need to be economically viable. Under the Monetary Control Act (MCA) of 1980, fees for 

the financial services provided by the Reserve Banks (which include the operation of 

Fedwire Funds and Securities) must be set, over the long run, to recover the actual costs 

incurred to provide the services, as well as costs the Reserve Banks would have incurred and 

imputed profits they would have expected to earn if they were private sector firms. These 

legal requirements are seen by the Fed and by the users as a powerful tool to promote 

efficiency and provide for equitable competition. The recent decline of volumes in Fedwire 

 

15 These initiatives have been a collaborative effort by the Federal Reserve and the industry, especially 

elaborated in the context of the Payment Risk Committee (PRC) and of the Wholesale Customer Advisory 

Group (WCAG). The PRC is sponsored by the Federal Reserve Bank of New York and works to identify and 

analyze issues of mutual interest related to risk in payments and settlement. The WCAG advises the Wholesale 

Product Office of the Federal Reserve Bank of New York, which is in charge of the management of Fedwire 

Funds and Securities. The composition of both PRC and WCAG consists of the largest institutions, domestic 

and foreign. 

16 In the context of the PRC and WCAG work, the development of a liquidity-saving mechanism was supported 

by most of the largest institutions, especially the foreign participants as efficiency gains of moving payments 

from individual institution queues to a centralized queue that would enable timely matching, offsetting of 

payments and increased transparency. Some institutions, however, expressed a different view, emphasizing that 

CHIPS already provides liquidity-saving features and that there is no interest in having also such an 

arrangement in Fedwire Funds. 
15 

Funds (as in most payment and settlement systems in the U.S. and in industrialized countries) 

and the implications of policy actions could make full cost recovery more challenging. 

B. Reducing End-of-Day Settlement in CHIPS 

23. The settlement model used by CHIPS is very robust and eliminates the 

settlement risk associated with classical net deferred settlement systems. From a liquidity 

management perspective, the system is also very efficient as it minimizes the amount of 

funding in central bank money that is needed to complete the settlement of large values and 

volumes of underlying payments, thanks to its offsetting algorithm. 

24. The smooth functioning of the system and its ability to avoid trapping liquidity 

until the end of the day is, however, dependent upon the behavior of its participants to: 

(i) send on a given day payments in CHIPS that do not significantly differ from their 

average profile used by the central system to calculate their initial prefunding requirement; 

(ii) provide supplemental pay-in funding as needed during the day to avoid gridlocks and 

queuing payments until the end-of-day; and (iii) fulfill their end-of-day final prefunding to 

permit the settlement of the remaining payments. 

25. Until recently, the value of payments that remain pending until the end of the 

day was significant. A few hundred payment messages were still queued after the cut-off 

of CHIPS and many were significant in value terms (ranging between US$85 billion to 

US$100 billion on average in 2007). The completion of payments in the queue after the cutoff of CHIPS is contingent on the participants in a negative closing position paying in 

additional funds, which averaged in aggregate between US$50–60 billion. 

26. These pending payments have adverse consequences in terms of liquidity 

management. Since some large value payments are only settled and final at the end of the 

day, it prevents the re-use of the funds by the receiving banks earlier in the day, including the 

possibility for long banks in CHIPS to withdraw and re-use the liquidity for completing 

payments in Fedwire Funds. This represents an additional obstacle for settlement in Fedwire 

earlier in the day. 

27. Two initiatives have helped reduce end-of-day pending payments. On the 

receiving side, CHIPS has experimented with increasing the cap on participants’ current 

positions (which limits the maximum amount of liquidity that any participant can accumulate 

to twice its initial position before the 5:00 p.m. closure of the system) and releasing the cap 

constraint earlier in the day. In several steps, the cap was increased to 6 times the initial 

position) from twice the initial position and the cap constraint was released earlier, moving 

from 5:00 p.m. to 3:00 p.m. On the sending side, CHIPS has also encouraged its participants 

to provide voluntarily more supplemental funding within the day, without waiting for the 

end-of-day final funding. From April 2008 to September 2009, the amount of supplemental 

 
16 

Box 1. Overview of the CHIPS Settlement Model 

The settlement model implemented by CHIPS since 2001, though partly on a bilateral or multilateral net basis, allows 

for immediate finality of payments, thanks to a pre-funding arrangement in central bank money. This reflects the 

trend observed in many countries for the past decade, to combine the benefits of RTGS settlement to provide real time 

finality with the liquidity saving features of net settlement systems. 

To facilitate the settlement process, CHIPS maintains an account at the Federal Reserve Bank of New York on behalf 

of its participants. Each CHIPS participant must prefund the account each day in the amount of an opening primary 

position requirement, which, once funded via Fedwire funds transfer to the CHIPS account, is used to settle payment 

orders throughout the day. The amount of the initial prefunding is calculated weekly by CHIPS based on the size and 

number of transactions by the participant and cannot be removed by participants during the day. 

During the operating day, participants submit payment orders to a centralized queue maintained by CHIPS. Each 

payment is settled immediately if the transaction does not result in either a negative primary position for the sender or 

a position for the receiver that is greater than twice its initial primary position (half of the value and more than 

90 percent of payments are settled on this gross basis). If a payment cannot be settled using the funds in the CHIPS 

account, an optimization algorithm attempts to match the payment order with other payments in the queue against 

which it can be bi- or multilaterally offset and released with finality at the time of release from the queue. Debits and 

credits to the current primary position are reflected only in CHIPS’s records and are not recorded on the books of the 

Federal Reserve Bank of New York. 

Payments remain in the queue until they can be settled by the funds in the participant’s position, offset against another 

payment, or deleted by the participant. The sender can also intervene to release queued payments by transferring more 

funds from its Fedwire account to feed a CHIPS balance, called the supplemental position, that is separate from the 

primary position. Supplemental prefunding can be withdrawn by the participant from CHIPS, subject to the constraint 

that the amount withdrawn must be the lesser of their current supplemental position and the total supplemental 

prefunding paid-in by the participant. The sender can also earmark payments with “urgent” or “preferred” priorities to 

be released immediately from the queue by tying funds from the supplemental position to these payments ahead of 

time. 

At 17:00 ET, CHIPS attempts to match, net, set off, and release as many of the remaining payment orders in the 

queue as possible without putting any participant in a negative position. A multilateral net position for the residual 

payments pending in the queue is provisionally added to each participant’s current combined position (which is the 

aggregation of the participant’s primary position and supplemental position) to calculate the final net position. Each 

participant with a negative final position has 30 minutes to transfer that amount, called final prefunding, to the CHIPS 

account through Fedwire. Once all of the final prefunding transfers have been received, CHIPS uses this liquidity to 

release and settle all remaining payment orders in the queue. CHIPS then transfers the remaining positive balances to 

the participants through Fedwire. If any participant fails to make its final prefunding payment (which happened only 

once since 2001), CHIPS attempts to settle as many payments as possible using the available funds in the system. 

The CHIPS settlement model greatly minimizes the settlement risk at stake in traditional deferred net settlement 

systems, which are exposed to the settlement failure of participants in a debit position. A failure in these systems has 

the effect of deferring or impeding final settlement of all balances stemming from the system, and ultimately of 

unwinding the operations of the defaulter(s). This may lead to unexpected changes in positions of non defaulting 

participants, late in the day with associated liquidity pressures that may cause second round defaults and systemic risk 

propagation. 
17 

funding was increased by more than eight times. These two initiatives have reduced 

significantly the volume and value of payments pending in the CHIPS queue at the end of the 

day (under US$20 billion in September 2009, less than 11⁄2 percent of the total value settled 

daily) and also the amount of final funding (around US$12 billion) required to release 

pending payments. 

28. Further efforts in this area should be encouraged. One issue is the fact that 

supplemental funding during the day remains voluntary, and is not subject to a binding rule. 

The criticality of this may become obvious as clearing balances return to more normal levels.

IV. RISK MANAGEMENT

29. The crisis illustrates the need for robust risk management. This includes: 

(i) taking into account the consequences of the high concentration of settlement activities; 

(ii) maintaining up-to-date stress testing liquidity scenarios to review the adequacy of risk 

management controls and increase awareness of risks with participants; (iii) continuing ongoing actions aimed at strengthening operational resilience; (iv) ensuring adequate access to 

central bank liquidity; and (v) taking account of critical interdependencies. 

A. Concentration of Settlement 

30. The U.S. large-value payment systems exhibit a significant level of concentration 

of flows among a few key participants. In Fedwire Funds, whereas there are about 7,500 

participants, the largest participant represented in 2008 on average around 20 percent of 

settled value, the top five participants represented 63 percent, and the top 10 participants 

represented 79 percent. In CHIPS, 64 percent of the value is settled by the top five 

participants. Concentration levels in both systems are comparable to those in most other 

major industrial countries. This concentration can be related to several factors, including 

concentration of the banking system and of the correspondent banking business. However, 

such concentration is a potential source of vulnerability. Even in Fedwire Funds and CHIPS, 

where settlement patterns expose participants to little or no credit risk, the unexpected 

unavailability of a major participant (because of an operational failure or due to an 

insolvency or liquidity problem) for an operating day would likely raise substantial liquidity 

pressures for the other participants. 

31. Similar concentration risks arise in the case of CLS Bank, which provides a 

settlement system for foreign exchange transactions. The CLS system is designed to 

ensure a simultaneous exchange of both legs of an FX transaction in order to eliminate 

settlement risk. Its risk management framework relies inter alia on a settlement model 

backed by: (i) funding requirements in central bank money calculated on a multilateral net 

basis; and (ii) a set of position limits aimed at ensuring that the net values of the short 

positions of participants could not exceed their funding capacity and the capacity of CLS 
18 

Bank to draw on liquidity facilities from liquidity providers.17 However, the level of 

concentration in settlements among settlement members is very high in the CLS system, due 

in part to some settlement members settling for third parties that represent very large 

positions.18 

32. Nonetheless, CLS Bank performed well during the crisis. Major dislocations were 

avoided since the settlement member that represented Lehman Brothers did not exercise its 

right to rescind the transactions entered on behalf of Lehman Brothers and completed its 

settlement obligations on Lehman’s behalf. Even when a settlement member acting on behalf 

of a third party did exercise its right to rescind the transactions, as in the case of Refco’s 

failure, the CLS system continued to function. In part this reflects the fact that CLS Bank 

does not guarantee settlement as a CCP would do. 

33. CLS Bank and its members should take advantage of the current review to 

consider providing more direct access to some of the largest third parties, to the extent 

consistent with possible legal limitations to direct membership. Direct access of large-scale 

or systemically important third parties (e.g., CCPs) is being discussed within the CLS 

community, and this step would reduce the counterparty risk borne by third parties on their 

intermediary settlement member.

B. Stress Testing and Simulations 

34. CLS Bank conducts a range of stress and back-testing scenarios to review the 

adequacy of its risk management procedures. The simulations include inter alia the 

 

17 Pay-in requirements in the 17 currencies have to be completed by specified times, because of the time-zone 

differences which oblige CLS Bank to have a funding period compatible with the overlapping opening hours of 

the different RTGS systems. However, the settlement of the USD funding, which intervenes at a period of time 

where there are very few competing payments to complete clearly puts less pressure on banks’ intraday liquidity 

management than the funding in European and especially in Asian currencies. Another source of liquidity 

pressure is the so-called CLS Pay-In Call, which is the first means of raising additional liquidity in the event 

that a settlement member fails to satisfy its funding requirements. “Pay-In Call for settlement” would be issued 

to settlement members that have unsettled payment instructions with the failing settlement member, in order to 

maximize the number and value of settled payment instructions for that date. Pay-In Calls could pose significant 

liquidity issues because they are unexpected. The multilateral aspect of funding has substantially decreased the 

amount of liquidity necessary to settle with finality underlying FX transactions. CLS Bank has provided a 

liquidity management tool for reducing further the settlement members’ funding obligations. This tool is the 

In/Out swap program, which permits settlement members to enter into bilateral intra-day FX swap transactions 

to reduce their short positions in certain currencies and other settlement members’ long positions in those same 

currencies. The “out” leg of this I/O swap being settled outside CLS, it re-introduces settlement risk. One 

solution to mitigate this risk would be to create an additional same-day settlement session, which would allow 

settling in CLS Bank the “out” leg of the I/O Swaps. However, this project, which has been discussed for some 

time, may in turn create more liquidity pressure for funding in certain currencies. 

18 The terms on which a member agrees to provide such services to third parties are governed through private 

arrangements that do not directly involve CLS Bank. The increase in the number of third parties in recent years 

has been one important avenue to broaden the system’s penetration in the FX market (which is estimated to be 

around 55 percent of the value of total trades in April 2006 according to the CPSS report “Progress in Reducing 

Foreign Exchange Settlement Risk,” May 2008). 
19 

adequacy of haircuts and the failure of the settlement member with the single largest funding 

obligation in a single currency. In light of the crisis, CLS Bank is working on some more 

extreme scenarios, like the failure of all settlement members of a given currency to complete 

their funding and the simultaneous failure of the liquidity providers in the same currency. 

The enrichment of stress testing scenarios is welcome as it is useful to continuously adjust 

the risk control measures. 

35. CHIPS and its parent Clearing House are developing stress testing programs. 

CHIPS, in particular, has instituted a program to ensure that participants understand the 

consequences of a failure of one or more banks to honor their closing positions and to 

encourage participants to develop liquidity contingency plans. The Clearing House is also 

running and sharing with its participants simulations of the inability of participants to fund 

their positions in CHIPS. These scenarios include simulations of the failure of one or more 

banks to pay all their funding of the day or their closing position requirements, and the 

results are presented to the CHIPS business committee. 

C. Operational Resilience 

36. The three payment systems operating in the U.S. have in place state of the art 

and highly resilient arrangements to mitigate operational risk. Fedwire, CHIPS and CLS 

Bank maintain very high levels of availability exceeding 99.9 percent, comprehensive 

business continuity plan (BCP) arrangements, capacity planning and apply best practices in 

terms of security requirements. CHIPS and CLS Bank have full synchronous mirroring of 

data between their two respective data centers, which allows for a quick recovery from the 

back-up site, in case of a disruption in the primary site, while Fedwire has multiple out-ofregion back-up data centers. BCP arrangements cover a wide range of threats, including 

pandemic ones. Alongside the implementation of the 2003 interagency paper on sound 

practices to strengthen the operational resilience of the U.S. financial system, issued in the 

post 9/11 context, additional measures have been undertaken to strengthen further the 

operational resilience of payment systems, including action by CHIPS to establish a new, 

remote data center in 2008. 

37. Another important issue is to consider the occurrence of an operational problem 

in the context of a stressed market situation. During the crisis, systems were able to 

process unexpected peak volumes without major problem. However, there is still the question 

of how market participants would react to a major operational problem, e.g. affecting a key 

participant in a payment system, occurring in a general context of serious concerns about 

credit and liquidity risks. Adequate preparation for such a scenario requires continuous 

initiatives to strengthen operational resilience of systems and their participants. Bank 

supervisors address these issues on an ongoing basis as part of the supervisory process. 
20 

D. Access of Systemically Important Infrastructures to Central Bank Services 

38. The Administration’s proposed legislation (Title VIII) would also entitle the 

Fed to open an account and provide access to discount window credit for financial 

market utilities designated as systemically important. The current framework limits 

account access to state member banks, other depository institutions, and certain other 

institutions specified by statute. Therefore, while bank-chartered infrastructures may 

maintain an account with the Fed, other non-bank financial market infrastructures cannot 

have accounts. For instance, the Fixed Income Clearing Corporation (FICC), which is the 

central counterparty for government bonds, is not allowed to open an account either in 

Fedwire Funds or in Fedwire Securities. This leads to a greater reliance on commercial banks 

by financial market infrastructures to perform settlement.19 Allowing systematically 

important market infrastructures to settle in central bank money would limit settlement risk. 

In addition, financial market infrastructures may face extreme stress scenarios for which an 

adequate access to central bank credit (on terms and conditions to be decided by the Board) 

would be an additional buffer to mitigate systemic risk.20 

39. Measures which would facilitate settlement in central bank money for 

systemically important infrastructures and access to credit are recommended. Giving 

non-bank financial market infrastructures access to a central bank account and liquidity under 

terms and conditions established by the Federal Reserve Board would need to be coupled 

with a strong oversight framework and full compliance of the systems with U.S. regulatory 

requirements regarding risk management and, as appropriate, consistent with international 

standards. 

E. Interdependencies 

40. The U.S. payment systems are highly interconnected globally. This reflects the 

participation of a large number of both U.S. and foreign internationally-active institutions, as 

well as the critical role that the CHIPS and (especially) the CLS systems play in settling cross 

border payments. Moreover, U.S. payment systems represent the worldwide end of day, 

which means that a disruption there could have important spillover effects at the following 

day opening of systems in Asia and Europe. 

41. Given the importance of these interdependencies, the U.S. authorities should 

continue on-going initiatives with a view to carry out a comprehensive risk mapping 

exercise. It is important to take into account of all types of interdependencies within 

 

19 For more details, see the assessment of FICC against CPSS/IOSCO Recommendations for Securities 

Settlement System (SSSs). 

20 Examples of such risk include difficulties in timely liquidation or obtaining liquidity against collateral 

because of a market dislocation, or the difficulty for a CCP to find depository banks to hold safely margins 

collected from its participants. 
21 

settlement systems and across systems (e.g., funding linkages between CHIPS and Fedwire 

Funds).