[Federal Register Volume 73, Number 46 (Friday, March 7, 2008)]
[Notices]
[Pages 12417-12443]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 08-971]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1309]


Policy on Payments System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Policy statement; request for comment.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
requests comment on proposed changes to its Payments System Risk (PSR) 
policy that would adopt a new strategy for providing intraday balances 
and credit to depository institutions and encourage such institutions 
to collateralize their daylight overdrafts. The Board believes changes 
to the Federal Reserve's current strategy for providing intraday 
balances and credit to the banking industry would help loosen liquidity 
constraints and reduce operational risk. Specifically, the Board 
proposes to adopt a policy of supplying intraday balances to healthy 
depository institutions predominantly through explicitly collateralized 
daylight overdrafts provided at a zero fee. The Board would allow 
depository institutions to pledge collateral voluntarily to secure 
daylight overdrafts but would encourage the voluntary pledging of 
collateral to cover daylight overdrafts by raising the fee for 
uncollateralized daylight overdrafts to 50 basis points (annual rate) 
from the current 36 basis points. The Board also proposes to increase 
the biweekly daylight overdraft fee waiver to $150 from $25 to minimize 
the effect of the proposed policy changes on institutions that use 
small amounts of daylight overdrafts (small users). In addition, the 
proposed policy would involve changes to other elements of the PSR 
policy dealing with daylight overdrafts, including adjusting net debit 
caps, streamlining maximum daylight overdraft capacity (max cap) 
procedures for certain foreign banking organizations (FBOs), 
eliminating the current deductible for daylight overdraft fees, and 
increasing the penalty daylight overdraft fee for ineligible 
institutions to 150 basis points (annual rate) from the current 136 
basis points.

DATES: Comments must be received on or before June 4, 2008.

ADDRESSES: You may submit comments, identified by Docket No. OP-1309, 
by any of the following methods:
    <bullet> Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm. 
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> E-mail: <a href="/cdn-cgi/l/email-protection#5e2c3b392d703d3133333b302a2d1e383b3a3b2c3f322c3b2d3b2c283b70393128"><span class="__cf_email__" data-cfemail="85f7e0e2f6abe6eae8e8e0ebf1f6c5e3e0e1e0f7e4e9f7e0f6e0f7f3e0abe2eaf3">[email protected]</span></a>. Include the 
docket number in the subject line of the message.
    <bullet> Fax: (202) 452-3819 or (202) 452-3102.
    <bullet> Mail: Address to Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site 
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed

[[Page 12418]]

electronically or in paper in Room MP-500 of the Board's Martin 
Building (20th and C Streets, NW.) between 9 a.m. and 5 p.m. on 
weekdays.

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

SUPPLEMENTARY INFORMATION: 

I. Background

    The Federal Reserve's Payments System Risk (PSR) policy sets out 
the general public policy objectives of safety and efficiency for 
payments and settlement systems. Over the past few years, the Federal 
Reserve has been reviewing the long-term effects of market, 
operational, and policy changes by the financial industry and the 
Federal Reserve on intraday liquidity, operational, and associated 
credit risks in financial markets and the payments system, including 
account overdrafts (daylight overdrafts) at the Federal Reserve Banks 
(Reserve Banks). On June 21, 2006, the Board published for public 
comment the Consultation Paper on Intraday Liquidity Management and the 
Payments System Risk Policy (consultation paper) that sought 
information from financial institutions and other interested parties on 
their experience in managing liquidity, operational, and credit risks 
related to Fedwire funds transfers, especially late-day transfers.\1\ 
The paper included a list of detailed objectives relating to safety and 
efficiency that the Board has previously used to conduct payments 
system risk analysis. An important goal of the consultation process was 
to identify opportunities to improve the safety/efficiency trade-offs 
in the payments system over the long run.
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    \1\ See 71 FR 35679, June 21, 2006.
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    Significant changes to U.S. payments and settlement systems over 
the past twenty-five years have helped reduce systemic risk. In accord 
with U.S. and international risk policies and standards, several of 
these changes have relied increasingly on the use of central bank 
money--in this context, balances that financial institutions and 
private clearing and settlement organizations hold in accounts at 
Reserve Banks--to strengthen the management of credit and liquidity 
risk in private-sector clearing and settlement arrangements. Such 
changes have had the effect of increasing significantly the intraday 
demand for central bank money and hence the demand for daylight 
overdrafts at the Reserve Banks, which are a major source of these 
funds.
    In addition, the combined effect of depository institutions' 
intraday liquidity management strategies, changes at clearing and 
settlement organizations, and late-day market activity has been to 
shift the sending of larger Fedwire funds transfers to later in the 
day. From an operational risk perspective, delaying the sending of 
large payments until late in the day increases the potential magnitude 
of liquidity dislocation and risk in the financial industry if late-in-
the-day operational disruptions should occur. An increase in such risk 
is particularly troublesome in an era of heightened concern about 
operational disruptions generally.
    Given the growing demand for intraday central bank money and 
accompanying daylight overdrafts, as well as the shift of larger 
Fedwire payments to later in the day, the Board believes that 
significant further steps are appropriate to mitigate the growing 
credit exposures of the Reserve Banks, while also improving intraday 
liquidity management for the banking system and augmenting liquidity 
provided. The consultation paper requested views on potential changes 
in market practices, operations, and the Federal Reserve's PSR policy 
that could reduce liquidity, operational, and credit risks. These 
proposed changes would not affect the provisions of part I of the PSR 
policy, which deal with risk management in private-sector systems.

II. Comments and Analysis

    The Board received twenty-three public comment letters in response 
to its consultation paper.\2\ The majority of these letters were from 
commercial banking organizations and from several private-sector 
clearing and settlement systems, industry groups, and trade 
organizations. In addition, the Board received comments from one 
Reserve Bank and one individual. Almost all commenters explicitly 
expressed concern about the operational risk associated with the 
increasing concentration of late-day payments. Most commenters 
identified payment queuing at depository institutions, particularly the 
queuing of payments to settle large money market transactions, as a 
liquidity conservation strategy that contributes to institutions 
sending payments late in the day.\3\ A majority of commenters also 
agreed that some private-sector clearing and settlement systems absorb 
a considerable amount of intraday liquidity in connection with their 
risk-management processes. Further, some commenters identified market 
constraints, such as the late-day settlements of tri-party repo 
transactions, and the processes and settlement procedures of The 
Depository Trust Company (DTC) and The Clearing House Interbank Payment 
System (CHIPS) as important contributors to the concentration of late-
day payments.\4\
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    \2\ Copies of all public comments on the consultation paper can 
be found on the Board's website at http://www.federalreserve.gov/generalinfo/foia/index.cfm?doc_id=OP%2D1257&doc_ver=1.
    \3\ Payment queuing is a tool used by some depository 
institutions to hold a payment internally until sufficient funds--
available balances or credit line--become available to send the 
payment to the Fedwire funds transfer system or another system. Some 
payments are held in queues because a customer has insufficient 
balances or credit to fund the payments. Other payments may be held 
to manage the level of account daylight overdrafts at the Reserve 
Bank or the associated fees.
    \4\ CHIPS is a real-time final payments system operated by The 
Clearing House Payments Company. In January 2001, The Clearing House 
implemented operational and rule changes to allow all transactions 
settled in CHIPS to be final upon release from a central queuing 
system. DTC is a subsidiary of the Depository Trust and Clearing 
Corporation, which operates six subsidiaries that provide clearance, 
settlement, and information services for many financial instruments, 
including equities, corporate and municipal bonds, government and 
mortgage-backed securities, money market instruments, and over-the-
counter derivatives. DTC provides custody and settlement services 
for corporate and municipal securities and money market instruments. 
DTC is a member of the Federal Reserve System and a clearing agency 
registered with the Securities and Exchange Commission.
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    The comments also addressed the specific market, operational, and 
PSR policy options set forth in the consultation paper. The majority of 
commenters strongly supported greater use of collateral and two-tiered 
pricing of daylight overdrafts by the Federal Reserve under the PSR 
policy.\5\ Several institutions expressed strong support for a zero fee 
for collateralized daylight overdrafts, similar to policies followed by 
other central banks. Most commenters also stressed that they should 
have the ability to use unencumbered collateral already pledged to the 
discount window to support their daylight overdrafts.
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    \5\ In 2001, the Board requested comment on two-tier pricing as 
a long-term PSR policy direction and, based on comments, agreed to 
continue evaluating the benefits and drawbacks of implementing such 
a regime. See 66 FR 30208, June 5, 2001 and 67 FR 54424, August 22, 
2002.
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    Several commenters also strongly supported continued work on 
potential opportunities to conserve liquidity within DTC and CHIPS. 
These comments endorsed the work performed by the Federal Reserve Bank 
of New

[[Page 12419]]

York's Payment Risk Committee (PRC) and Wholesale Customer Advisory 
Group (WCAG) during the consultation period. The PRC and WCAG conducted 
a liquidity survey to understand better the determinants of late-day 
payments.\6\ The results of the survey prompted the formation of four 
workgroups to evaluate liquidity improvement opportunities for CHIPS, 
DTC, tri-party repo payments, and broker-dealer payments.
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    \6\ The Payment Risk Committee (PRC) is sponsored by the Federal 
Reserve Bank of New York and works to identify and analyze issues of 
mutual interest related to risk in payments and settlement. The 
institutions represented on the PRC include Bank of America, Bank of 
New York, Bank of Tokyo-Mitsubishi UFJ, Citibank, Deutsche Bank, 
HSBC, JPMorgan Chase, State Street, UBS, Wachovia, and Wells Fargo. 
The Wholesale Customer Advisory Group (WCAG) advises the Wholesale 
Product Office on business issues and is composed of depository 
institutions that are major users of Fedwire. Institutions 
represented on this group include ABN AMRO, Bank of America, Bank of 
New York, Citibank, Deutsche Bank, HSBC, JPMorgan Chase, Key Bank, 
Mellon Financial, State Street, SunTrust, UBS, U.S. Bank, U.S. 
Central Credit Union, Wachovia, and Wells Fargo.
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    The workgroup focused on CHIPS processing found that the CHIPS 
algorithm can leave a number of large-value payments unresolved in the 
system for significant periods of time, resulting in some institutions 
redirecting payments to the Fedwire funds transfer system at the end of 
the day; these payments are in addition to the daily Fedwire funds 
transfers that are part of the CHIPS' end-of-day funding procedures 
around 5:15 p.m. The workgroup and CHIPS identified possible 
opportunities to release unresolved payments for settlement earlier, 
including changing some of the system controls. The workgroup that 
focused on DTC largely examined the money market instrument clearing 
and settlement processes and the reasons a substantial amount of 
liquidity is transferred to and remains at DTC, especially between 1 
and 3 p.m. This liquidity is then released as part of settlement around 
4:30 p.m. The workgroup and DTC tried to identify ways to reduce the 
length of time of the settlement process, to encourage institutions to 
manage better liquidity at DTC, and to enhance operations and certain 
controls. The other two workgroups on broker-dealer payments and on 
tri-party payments largely focused on documenting processes and 
procedures to educate the PRC and WCAG members so they could better 
understand why these payments are key determinants of late-in-the-day 
payments. The results from each of the workgroups were shared as part 
of the comment process and were cited for continued work by commenters.
    Commenters were split in terms of support for developing a 
liquidity-saving mechanism for the Fedwire funds transfer system.\7\ 
Eight of the thirteen respondents that commented on the possible 
introduction of a liquidity-saving mechanism encouraged further 
exploration of this idea, while the remaining five expressed some 
concerns. Those respondents that were supportive noted that a 
liquidity-saving mechanism could help reduce the length of time that 
large-value payments sit in internal queues at depository institutions. 
One commenter specifically suggested that the Federal Reserve focus on 
a liquidity-saving system for the exchange of broker-dealer and tri-
party repo payments, which are typically large-value payments. Other 
supporters strongly favored a centralized queuing system for all 
Fedwire funds transfer payments and mentioned systems used or under 
development in other countries.\8\ Concerns about developing a 
liquidity-saving mechanism included the possibility that it could 
undermine the real-time gross settlement attribute of the Fedwire funds 
transfer system, create a competitive disadvantage for a private-sector 
payments system, or significantly increase the cost of making Fedwire 
funds transfer payments.
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    \7\ The creation of a liquidity-saving mechanism could involve 
adding new features to the Fedwire funds transfer system that 
depository institutions could use to coordinate better the timing 
and settlement of their payments as well as to economize on the use 
of intraday central bank money, daylight overdrafts, and collateral. 
The existing real-time gross settlement functionality of Fedwire 
would be retained. In particular, a depository institution could 
still designate that a Fedwire funds transfer settle immediately as 
it does today. The new features, for example, could allow depository 
institutions to designate certain types of payments, possibly 
including payments generated by certain types of transactions, to be 
placed into a central queuing system and settled using algorithms 
that allow the liquidity provided by incoming payments to a 
depository institution to be used as far as possible to settle that 
institution's outgoing payments.
    \8\ Versions of liquidity-saving mechanisms are used by CHIPS 
and Target 2 in the European Union. Such features will also be 
included in the new wire transfer systems in Japan and other 
countries.
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    Commenters had different views on the idea of time-of-day pricing, 
which would vary the fee charged for daylight overdrafts through the 
day so that overdrafts incurred earlier in the day would incur a lower 
fee than overdrafts incurred late in the day. While some commenters 
supported time-of-day pricing as an incentive to send funds transfers 
earlier in the day, others requested additional information about the 
idea. Still other commenters pointed out that the effectiveness of 
time-of-day pricing would be constrained by the reality of late 
afternoon trade settlements, such as tri-party repo payments and Fed 
funds loans.
    Commenters expressed limited or no support for the creation of an 
intraday market to exchange liquidity, an expansion of the market for 
early return of Fed funds loans, or throughput requirements for the 
Fedwire funds transfer system. Most respondents thought that an 
intraday market would not be helpful in addressing the late-day 
concentration of payments and would be costly and complex to establish. 
In terms of expanding the market for early return of Fed funds loans, 
several commenters were uncertain about the effects of such a change on 
late-day payments. In addition, a majority of respondents did not 
support the introduction of throughput requirements for the Fedwire 
funds transfer system, primarily because of the potential difficulty of 
administering and enforcing such requirements. Throughput requirements 
are used by some systems around the world to encourage certain 
percentages of payments volume to be submitted by predetermined times. 
Three commenters, however, were somewhat supportive provided the 
throughput requirements were voluntary, implemented jointly with a 
central queue, or in conjunction with brief, intermittent periods when 
institutions could coordinate sending Fedwire funds transfers.
    The Board received several comment letters raising concerns about 
the policy's treatment of the daylight overdrafts of foreign banking 
organizations (FBOs). The commenters stated that the U.S. capital 
equivalency measure used to determine FBO net debit caps and 
deductibles in the calculation of daylight overdraft limits and fees is 
discriminatory and results in a competitive disadvantage for these 
organizations and in their delaying payments. This assertion is based 
on the fact that U.S.-chartered depository institutions receive a net 
debit cap and deductible based on their worldwide capital, while FBOs 
receive a net debit cap based on no more than 35 percent of their 
worldwide capital (referred to as the U.S. capital equivalency) and a 
deductible based on their U.S. capital equivalency.\9\ As a result, 
FBOs are

[[Page 12420]]

eligible for considerably lower daylight overdraft capacity and free 
intraday credit than are U.S.-chartered depository institutions with 
equivalent worldwide capital. The commenters asked the Board to 
calculate FBO deductibles using 100 percent of their worldwide capital, 
as is done for U.S.-chartered institutions. The commenters also 
asserted that the existing formula used to determine the net debit cap 
cannot be justified, particularly in the case of FBOs which are 
considered to be both ``well capitalized'' and ``well managed'' for 
U.S. regulatory (FHC) purposes or which have received the highest rated 
``strength-of-support assessment'' (SOSA 1).\10\
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    \9\ In 2001, the Board modified the criteria to determine 
eligible capital and raised the percent of capital used in 
calculating net debit caps and the deductible. The percent of 
capital used increased from as much as 10 percent to up to 35 
percent. See also 66 FR 30205, June 5, 2001.
    \10\ For an FBO, the policy incorporates the SOSA rankings and 
FHC status in determining U.S. capital equivalency. 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. The SOSA ranking is based on a scale of 1 through 3, 
with 1 representing the lowest level of supervisory concern.
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    Finally, the Board received a few other comments. One responder 
suggested changing the posting rules for automated clearinghouse (ACH) 
debit transfers so that settlements from credit and debit transfers are 
posted simultaneously with only the net amount of funds increasing or 
decreasing the balances of depository institutions held at Reserve 
Banks.\11\ The Board has issued a separate Federal Register notice 
requesting comment on shifting from 11 a.m. to 8:30 a.m., eastern time, 
the posting time for commercial and government ACH debit transfers that 
are processed by the Reserve Banks' FedACH service.\12\ The earlier 
posting time would make the postings of commercial and government ACH 
debit and credit transfers simultaneous.
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    \11\ Currently FedACH credit transfer and debit transfer 
transactions post at 8:30 a.m. and 11 a.m. eastern time, 
respectively.
    \12\ All times referenced are eastern time.
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    Some commenters raised ideas for changes other than those suggested 
in the consultation paper, including lowering fees for securities-
related daylight overdrafts, allowing individual banks to coordinate 
informally the sending of Fedwire funds transfers, and reducing the 
maximum payment size allowed through the Fedwire funds transfer system. 
Finally, several commenters addressed a question in the consultation 
paper about the payment of interest on reserves and the possible effect 
on depository institutions' intraday liquidity management. Most 
responders believed that the Federal Reserve's payment of interest on 
reserve balances would not affect intraday liquidity management or 
stated that its effect on liquidity was unknown without further 
information.
    Overall, the public comment letters and the extensive PRC and WCAG 
investigations into intraday liquidity and late-day payments issues 
validate a number of concerns raised in the consultation paper. It has 
also become clear that no single policy or operational change would 
address all of the intraday liquidity, risk, and payments issues that 
the Board and the industry have identified. However, a series of steps 
by both the private sector and the Federal Reserve could help.
    To address the combination of intraday liquidity, operational, and 
credit risks in the wholesale payments system, the Board believes that 
the Federal Reserve and industry should pursue a four-pronged strategy. 
The Board should review its PSR policy and consider adjusting the terms 
and pricing of daylight overdrafts. The Reserve Banks should work with 
the industry and investigate options for developing a liquidity-saving 
mechanism for the Fedwire funds transfer system. Additionally, working 
with the PRC, CHIPS and The Depository Trust and Clearing Corporation 
should explore opportunities for improving payments processing and 
liquidity use in their systems and processes relating to large-value 
funds and securities settlement, respectively. This request for comment 
focuses on the Board's PSR policy and recommends changes in strategy, 
terms, and pricing for the provision of intraday credit by the Reserve 
Banks.

III. New Strategy for PSR Policy

    The current policy of providing uncollateralized daylight 
overdrafts at an administered fee grew out of a Board study in the late 
1980s that reviewed options for reducing the volume of intraday credit 
provided by the Reserve Banks. A fundamental premise of this work was 
that intraday credit is a necessary but undesirable aspect of the 
payments system and should be reduced whenever possible. This premise 
is expressed in the introduction to the current PSR policy as follows:

    [T]he Board expects depository institutions to manage their 
Federal Reserve accounts effectively and minimize their use of 
Federal Reserve daylight credit. Although some intraday credit may 
be necessary, the Board expects that, as a result of this policy, 
relatively few institutions will consistently rely on intraday 
credit supplied by the Federal Reserve to conduct their 
business.\13\
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    \13\ See the Policy on Payment System Risk http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, pg. 2.

    In reviewing the current PSR policy, the Board identified five 
major concerns related to risk and efficiency that together suggest 
that a change in the Federal Reserve's approach to the provision of 
daylight overdrafts is warranted at this time.\14\ First, the data 
indicate a long-term trend of declining end-of-day balances held in 
Federal Reserve accounts which, in turn, implies an increasing need by 
institutions for daylight credit from the Reserve Banks to fund 
payments-system transactions. Second, the Board notes that some 
financial utilities can absorb large amounts of intraday funding from 
participants to meet their risk management requirements. These funding 
requirements result in large transfers of balances from participants' 
Federal Reserve accounts that often are not reversed until the late 
afternoon. Third, data, as well as comments on the consultation paper, 
make clear that many large depository institutions hold a significant 
number of large-value payments in ``liquidity queues'' primarily to 
avoid daylight overdraft fees; such queuing can delay payments across 
the financial markets. Fourth, data show that Reserve Banks' credit 
exposure has increased over time in real terms despite Reserve Banks 
charging fees. On certain days, the peak overdraft of the banking 
system can exceed $210 billion. In 2007, the average daily overdraft of 
the banking system as a whole was approximately $60 billion and the 
average daily peak overdraft was approximately $160 billion. Finally, 
daylight overdraft fees paid by the banking system have continued to 
rise, increasing the cost burden of the PSR policy on the industry. 
Daylight overdraft fees for 2007 totaled approximately $65 million, 
compared with $32.2 million in 2003. Because there are systemic reasons 
for the increased demand for intraday balances and credit as well as 
evidence that the current pricing approach is creating liquidity queues 
and increasing late-day operational risk, the Board concluded that its 
current strategy of seeking to minimize daylight overdrafts should be 
reassessed.
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    \14\ Please see appendix I for a full discussion of these 
issues.
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    The Board also notes that thinking about the role of central banks 
in providing intraday balances to the payments system has evolved 
significantly over the past twenty years.

[[Page 12421]]

A 2003 study by the G-10 Committee on Payments and Settlements Systems 
summarized this change in perspective and explicitly recognized that 
central banks have an important role in providing intraday (central 
bank money) balances to foster the smooth operation and settlement of 
payments systems.\15\ In essence, this view is an extension to the 
intraday market of the traditional role of central banks in supplying 
overnight balances to the banking industry to meet financial market 
demand for liquidity and operating balances. While some of the demand 
of the banking industry for intraday balances can be met by overnight 
balances, when the level of those balances is inadequate, a central 
bank will need to supply additional funds through the temporary 
provision of intraday funds, which could include using mechanisms such 
as daylight overdraft facilities.
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    \15\ ``Because the settlement of each payment involves a direct 
transfer of the settlement asset, [real time gross settlement] 
systems require substantially more of the asset to ensure smooth 
payment flows. To enable this, most central banks provide intraday 
credit to banks participating in these systems in quantities which 
in some cases dwarf the banks' overnight balances or their overnight 
borrowing from the central bank.'' See ``The Role of Central Bank 
Money in the Payment System,'' Committee on Payment and Settlement 
Systems, August 2003 at http://www.bis.org/publ/cpss55.pdf.
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    The Board believes that a new strategy would enhance intraday 
liquidity management while controlling risk to the Reserve Banks and 
would build on the Board's 2001 proposal to consider two-tiered pricing 
for daylight overdrafts.\16\ This strategy would
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    \16\ The strategy is consistent with the public policy 
objectives in the current PSR policy to foster the safety and 
efficiency of payments and settlement systems as well as the version 
of these objectives used in developing the Board's original pricing 
proposals in 1988. At that time, the safety objectives were stated 
as low direct credit risk to the Federal Reserve, low direct credit 
risk to the private sector, low systemic risk, and rapid final 
payments. The efficiency objectives were stated as a low operating 
expense of making payments, equitable treatment of all service 
providers and users in the payments system, effective tools for 
implementing monetary policy, and low transaction costs in the 
Treasury market. See ``Controlling Risk in the Payment System,'' 
Report of the Task Force on Controlling Payments System Risk to the 
Payments System Policy Committee of the Federal Reserve System, 
Board of Governors of the Federal Reserve System, August 1988.
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    (1) Explicitly recognize that the Federal Reserve has an important 
role in providing intraday balances to foster the smooth operation of 
the payments system.
    (2) Provide temporary, intraday balances to healthy depository 
institutions predominantly through collateralized intraday overdrafts.
    (3) Reduce over time the reliance of the banking industry on 
uncollateralized daylight credit if this can be done without 
significantly disrupting the operation of the payments system or 
causing other unintended adverse consequences.
    In brief, the rationale for the new strategy is that modern 
payments and settlement systems, including Fedwire, CHIPS, CLS, and 
DTC, require significant amounts of intraday balances or liquidity for 
smooth operations and that the role of a central bank is to meet 
reasonable market needs of participants in these systems for this 
liquidity.\17\ In addition, under current policies, overnight balances 
are not sufficient to address these needs and, as a result, temporary, 
intraday balances through intraday credit must be provided by daylight 
overdrafts.\18\ Intraday credit is now widely and explicitly provided 
by central banks to support the operation of payments and settlement 
systems, including by the Eurosystem, Bank of Japan, and Bank of 
England. Typically this daylight credit is collateralized, but no fee 
is charged.
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    \17\ See The Role of Central Bank Money in the Payment System, 
Committee on Payment and Settlement Systems, August 2003. (http://www.bis.org/publ/cpss55.pdf).
    \18\ Policy decisions that will be made to exercise the Federal 
Reserve's new statutory authority to pay interest on reserves 
beginning in October 2011 could increase the level of overnight 
balances held at the Reserve Banks and consequently reduce the 
demand for daylight overdrafts to provide intraday balances.
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    The proposed new strategy would explicitly use collateral augmented 
by the framework of net debit caps to control credit risk to the 
Reserve Banks in providing daylight overdrafts and would link the fees 
charged for daylight overdrafts to the amount of collateral provided. 
The same collateral eligibility criteria and haircuts would be used for 
both overnight and intraday credit. Unencumbered collateral pledged for 
discount window or PSR purposes could be used to support intraday 
credit provided at the reduced daylight overdraft fee. The benefits of 
encouraging the pledge of collateral would extend beyond the reduced 
intraday credit exposure of the Reserve Banks and would include 
enhanced emergency preparedness. Under the proposed policy, eligible 
institutions would have an additional incentive to sign borrowing 
documents with the Reserve Banks and pledge collateral, which would 
enable such institutions to borrow from the discount window, if needed.
    Controlling credit risk by taking collateral is a time-honored 
risk-management technique. It is used explicitly in some cases today by 
the Reserve Banks in the daylight overdraft program.\19\ Moreover, 
under Operating Circular 10, depository institutions grant Reserve 
Banks a lien on collateral pledged to the Reserve Bank as well as any 
other property in the possession or control of, or maintained with, any 
Reserve Bank, to secure discount window loans and any other 
obligations, such as daylight overdrafts, owing to any Reserve 
Bank.\20\
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    \19\ Pledging collateral is generally limited to securing 
maximum capacity (overdraft capacity above the net debit cap) or 
protecting Reserve Banks against risk from problem depository 
institutions.
    \20\ Under Operating Circular 1, depository institutions also 
grant Reserve Banks a lien on certain assets to secure any 
obligation owing to any Reserve Bank: ``To secure any overdraft in 
the master account, as well as any other obligation, now existing or 
arising in the future, of the account holder to any Reserve Bank, 
the account holder grants to the Reserve Bank all the account 
holder's right, title, and interest in property, whether now owned 
or hereafter acquired, in the possession or control of, or 
maintained with, any Reserve Bank.''
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    The new strategy would retain a net debit cap regime for all 
depository institutions.\21\ The net debit cap would focus on 
addressing low-probability risks and not unduly constraining normal 
demands for balances and credit. Industry best practices and 
supervisory guidance support the use of borrowing limits, or caps, even 
for collateralized risk exposures as a prudent credit risk management 
tool. Caps also serve as a useful mechanism for both Reserve Banks and 
institutions in terms of setting benchmarks for the maximum expected 
usage of daylight credit and supporting collateral.
---------------------------------------------------------------------------

    \21\ The current cap is a function of qualifying capital, which 
varies based on the entity type. The qualifying capital is mutipled 
by the cap mutliplier for cap categories to determine each 
institution's limit. One limit applies for single-day use and 
another for two-week average use, but these limits generally are not 
binding. If an institution exceeds its cap, the Reserve Bank will 
counsel the institution ex post. For additional information, see the 
Guide to the Federal Reserve's Payments System Risk Policy at http://www.federalreserve.gov/paymentsystems/psr/guide.pdf.
---------------------------------------------------------------------------

    The new strategy also reflects the Board's sensitivity to avoiding 
sudden and disruptive changes in policy that would not be in the public 
interest and would not advance efforts to improve payments system 
efficiency and safety. Hence, an element of the new strategy is to move 
toward a greater use of collateral in a way that minimizes the cost and 
administrative burden of the policy on most users of daylight 
overdrafts. As a general matter, the Board believes that requiring 
depository institutions to pledge collateral to support daylight 
overdrafts would be consistent with reducing Reserve Bank credit risk, 
with existing discount window practices, and with the policies

[[Page 12422]]

of other central banks. The Board is concerned, however, about the 
potential implications of moving to a mandatory collateral regime at 
this time, because of the uncertain effects such a move might have on 
intraday liquidity and operational risk, as well as the burden on the 
banking industry.\22\ The Board will continue to monitor developments 
over time and to evaluate the costs and benefits of moving further 
toward a collateralized structure.
---------------------------------------------------------------------------

    \22\ Historically, the Board has sought to minimize the cost and 
administrative burden of the PSR policy on institutions that do not 
rely significantly on the use of daylight overdrafts to make 
payments.
---------------------------------------------------------------------------

IV. Discussion of Proposed PSR Policy Changes

    To implement this new strategy, the Federal Reserve System will 
need to adjust its current terms and fees for providing daylight 
overdrafts. The Board believes that the following points summarize in 
broad terms the elements of a new PSR policy that would be consistent 
with such a change in strategy:
    <bullet> Explicitly encourage the pledging of collateral to support 
intraday credit and apply unencumbered discount window collateral to 
intraday credit.
    <bullet> Eliminate the fee for collateralized intraday credit.
    <bullet> Increase the fee for uncollateralized intraday credit.
    <bullet> Retain a modified version of the single-day daylight 
overdraft cap to limit the ultimate size of Reserve Bank risk 
exposures.
    <bullet> Adopt measures to limit the impact of policy changes on 
depository institutions that are relatively small users of intraday 
credit.

Table 1 summarizes the specific elements of the current and proposed 
PSR policy.

Table 1.--Summary of Key Elements of the Current and Proposed PSR Policy
                                  \23\
------------------------------------------------------------------------
                                 Current policy        Proposed policy
------------------------------------------------------------------------
Collateral..................  Required for problem  Additional provision
                               institutions \24\     that explicitly
                               and institutions      applies collateral
                               with max caps.        pledged by healthy
                               Collateral            institutions to
                               eligibility and       daylight overdrafts
                               margins same as       in their Reserve
                               discount window.      Bank accounts.
Fee for collateralized        36 basis points.....  Zero fee.
 daylight overdrafts.
Fee for uncollateralized      36 basis points.....  Increase to 50 basis
 daylight overdrafts.                                points.
Deductible..................  10 percent of an      Replaced by zero fee
                               institution's         for collateralized
                               capital measure.      daylight overdrafts
                                                     and increased fee
                                                     waiver.
Fee waiver..................  Up to $25 biweekly..  $150 biweekly.\25\
Net debit cap...............  Two-week average      Two-week average
                               limit and higher      limit is
                               single-day limit.     eliminated;
                                                     adjusted policy for
                                                     single-day limit.
Max cap.....................  Additional            Streamlined process
                               collateralized        for certain FBOs up
                               capacity above net    to a limit; minor
                               debit cap for self-   changes for all
                               assessed              institutions.
                               institutions.
Penalty fee for ineligible    136 bps.............  Increase to 150 bps.
 institutions.
------------------------------------------------------------------------

    To assist institutions in understanding the effect of the proposed 
policy on their daylight overdraft fees, the Board has developed a 
simplified fee calculator. The calculator enables institutions to 
provide daylight overdraft and collateral data to estimate their 
daylight overdraft fees under the proposed policy. The calculator is 
located on the Board's Web site at https://www.federalreserve.gov/apps/RPFCalc/.
---------------------------------------------------------------------------

    \23\ Access to daylight credit would continue to be available 
only to institutions with regular access to the discount window as 
is the case today.
    \24\ Problem institutions are institutions that are in weak 
financial condition and should refrain from incurring daylight 
overdrafts and institutions that chronically incur daylight 
overdrafts in excess of their net debit caps in violation of the PSR 
policy.
    \25\ The proposed $150 waiver would be subtracted from the gross 
fees (in a two-week reserve-maintenance period) assessed on any 
depository institution eligible to incur daylight overdrafts. This 
procedure differs from the current policy in which the waiver only 
eliminates gross fees of institutions that have charges less than or 
equal to $25 in a two-week period.
---------------------------------------------------------------------------

    A. Collateral. To help meet institutions' demand for intraday 
balances while mitigating Reserve Bank credit risk, the Board would 
adopt a policy of supplying intraday balances predominately through 
explicitly collateralized daylight overdrafts provided by Reserve Banks 
to healthy depository institutions at a zero fee. To avoid disrupting 
the operation of the payments system and increasing the cost burden on 
a large number of smaller users of daylight overdrafts, the Board would 
allow the use of collateral to be voluntary, but a system of two-tiered 
fees would be adopted to encourage the industry to make greater use of 
collateral. Unencumbered discount window collateral would explicitly 
collateralize daylight overdrafts, and collateralized overdrafts would 
be charged a zero fee. Collateral eligibility and margins would remain 
the same for PSR policy purposes as for the discount window.\26\ In 
addition, the pledging of in-transit securities would remain an 
eligible collateral option for PSR purposes at Reserve Banks' 
discretion.\27\
---------------------------------------------------------------------------

    \26\ See http://www.frbdiscountwindow.org/ for information on 
the discount window and PSR collateral acceptance policy and 
collateral margins.
    \27\ In-transit securities are book-entry securities transferred 
over the Fedwire securities system that have been purchased by a 
depository institution but not yet paid for or owned by the 
institution's customers.
---------------------------------------------------------------------------

    Of the twenty-three responses to the consultation paper, fourteen 
commenters addressed the question regarding greater use of collateral 
to cover daylight overdrafts. All fourteen commenters supported greater 
use of collateral (particularly to obtain a lower daylight overdraft 
fee). A number of the respondents specifically argued for voluntary or 
partial collateralization of intraday credit. Several respondents also 
commented that collateralized overdrafts should be free of charge or 
subject to an adjusted daylight overdraft fee. Most commenters stated 
that their support for greater use of collateral was contingent upon 
being able to use unencumbered discount window collateral to support 
intraday credit.
    The Board considered whether it should require collateralization of 
all daylight overdrafts at this time. The Board generally believes that 
requiring depository institutions to pledge collateral to support 
daylight overdrafts

[[Page 12423]]

would be consistent with reducing Reserve Bank credit risk, existing 
discount window practices, and the policies of other central banks. 
However, the potential effect on intraday liquidity and operational 
risk, along with the burden on the banking industry of a move to 
mandatory collateral, suggests caution. For example, requiring 
collateral could result in institutions being subject to rejected 
payments or high ``penalty'' fees if they exceed the amount of pledged 
collateral, could increase payment queuing by institutions without 
sufficient collateral to pledge, and could add significant compliance 
costs to the banking industry. Indeed, one respondent specifically 
stated in its comment letter that it was not supportive of moving to a 
mandatory collateral regime for daylight overdrafts even at a zero fee. 
For all these reasons, at this time, the Board is proposing a voluntary 
collateral regime for daylight overdrafts.
    The Board has long recognized that accepting collateral from 
institutions would help control intraday credit risk to Reserve Banks. 
Moving towards greater collateralization of daylight overdrafts was 
hampered in the past by concerns about administration costs to 
depository institutions, incentive effects, and other unintended 
consequences. Most of these concerns have been addressed over time.
    In the early 1980s, the aggregate amount of collateral pledged to 
the discount window was quite low relative to intraday credit extended, 
and many depository institutions had not signed the necessary legal 
agreements with their Reserve Banks. During early PSR policy 
consultations, there was also concern about the administrative costs of 
pledging and monitoring additional collateral and about the possibility 
that Fedwire or other payments could be disrupted if a depository 
institution did not have sufficient collateral at a particular point 
during the day. Since the 1980s, however, the quantity of collateral 
pledged to the discount window has increased dramatically. In 
particular, pledges to the discount window began to increase as a 
result of industry and Federal Reserve actions to address contingencies 
prior to the century date change and following September 11th.\28\ As 
of year-end 2007, more than $980 billion in assets were pledged for 
discount window and PSR purposes, most of which was unencumbered by 
outstanding discount window loans.\29\
---------------------------------------------------------------------------

    \28\ In the early 1990s, the Reserve Banks began standardizing 
policies regarding eligible asset types, acceptance criteria, and 
valuation. By the mid 1990s, the Reserve Banks allowed multiparty 
pledges through DTC. In the late 1990s, the Reserve Banks began 
using market pricing for securities valuation, started allowing for 
nonbank custodian and foreign custodian (Clearstream and Euroclear) 
arrangements, and began accepting a broader array of asset types of 
collateral. New types of eligible assets since that time have 
included non-AAA ABS, AAA collateralized debt obligations, 
commercial mortgage-backed securities, trust preferred securities, 
credit union mutual funds, GSE stock, STRIPS, German jumbo 
Pfandbriefe, and certain other foreign currency-denominated assets.
    \29\ This collateral value reflects lendable value based on the 
Reserve Banks' margins and does not include pledges of in-transit 
securities.
---------------------------------------------------------------------------

    Most of the largest users of daylight overdrafts have sufficient 
unencumbered collateral pledged to the Reserve Banks to cover their 
average level of daylight overdrafts. In addition, as table 1 
indicates, during the fourth quarter of 2007, fifteen of the twenty 
largest users of intraday credit would have been able to cover the 
average peak amount of daylight overdrafts using existing pledged 
collateral. In particular, the maximum peak overdrafts of eight of 
these institutions would have been covered by their current collateral 
pledges. It is highly likely that additional collateral would be 
pledged to cover intraday credit if appropriate incentives existed.

   Table 2.--The Number of Top Daylight Overdrafters Able To Collateralize Borrowings With Existing Collateral
                                                     Pledges
                                                    [Q4 2007]
----------------------------------------------------------------------------------------------------------------
                                                                     Number of institutions that have existing
                                                    Cumulative                 collateral to cover:
                                                    percent of   -----------------------------------------------
                                                      average                                      Maximum daily
                                                     daylight         Average      Average peak       peak of
                                                    overdrafts       daylight       of daylight      daylight
                                                                   overdrafts *    overdrafts *     overdrafts
----------------------------------------------------------------------------------------------------------------
Top 10..........................................              75               8               7               3
Top 20..........................................              84              18              15               8
Top 50..........................................              94              46              40              28
Top 100.........................................              97              91              68              47
Top 200.........................................              98             174             119             80
----------------------------------------------------------------------------------------------------------------
* The data are quarterly averages of daily data.

    One issue that has not changed since the 1980s is that a 
substantial number of depository institutions, mainly smaller 
institutions, use intraday credit but have not signed borrowing 
agreements with their Reserve Banks (about 1,500 of 4,400 institutions 
that make some use of intraday credit). In addition, another 1,700 
institutions that use intraday credit have borrowing agreements, but 
have not pledged any collateral to the Reserve Banks. Thus, the Board 
recognizes that the policy needs to avoid imposing an undue burden on 
small users of daylight credit or on the Reserve Banks. The new fee 
waiver is intended to minimize the burden on small users of the 
proposed policy changes.
    Another historical administrative concern has been the cost and 
practicality of Reserve Banks' perfecting their security interests in 
collateral and monitoring that collateral to manage their credit risk. 
Today, it is a routine matter for a Reserve Bank to file a Uniform 
Commercial Code financing statement with state authorities to perfect 
its security interest in any and all bank assets that are pledged. The 
Reserve Banks have implemented automated systems to track collateral 
held at the Reserve Banks, by third-party custodians, and by the 
borrowers themselves. In addition, the Reserve Banks monitor borrower 
eligibility to participate in a borrower-in-custody program. On 
balance, although improvements can always be made in procedures and 
systems, significant improvements have been made over time that address 
the earlier administrative concerns about explicitly collateralizing 
the daylight overdrafts of

[[Page 12424]]

depository institutions that routinely use large amounts of intraday 
credit.
    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.
    Additionally, there was concern that reliance on collateral alone 
might result in Reserve Banks providing excessive amounts of credit to 
particular depository institutions and present the Reserve Banks with 
reputational and residual credit risks. Although the Board proposes to 
relax some aspects of the net debit cap program, caps on total intraday 
credit extensions would remain in place to help address these risks. 
Eliminating the two-week average net debit cap and retaining the higher 
single-day cap for healthy depository institutions has the effect of 
raising caps approximately 50 percent from the current policy. This 
increase coupled with the incentive to collateralize daylight 
overdrafts is consistent with the strategy of providing additional 
balances and credit for the payments system. Other central banks that 
provide collateralized intraday credit at a zero price have not 
reported problems with excessive growth in the level of intraday 
credit.
    The Board's main concern about unintended consequences has been 
that by taking collateral, the Reserve Banks could be inadvertently 
shifting credit risk to unsecured and uninsured creditors of an 
institution or to the Federal Deposit Insurance Corporation's (FDIC) 
deposit insurance fund. With regard to unsecured creditors of a 
depository institution, the concern is whether these creditors would 
know about the institution's pledge to a Reserve Bank and have an 
opportunity to reduce their exposure to the depository institution, 
increase compensation for increased risk, or take other appropriate 
action. The public filing of financing statements by Reserve Banks and 
the existence of automated services for searching for liens mitigates 
this concern.
    The Board's concerns about the implications for the FDIC's 
insurance fund predate changes in Reserve Bank collateral 
administration practices and the FDIC's adoption of ``least cost'' 
resolution policies pursuant to the FDIC Improvement Act of 1991. The 
Board believes that the evolution of the PSR policy and related 
procedures have helped to address its concerns. Under the current PSR 
policy, an ``institution must be financially healthy and have regular 
access to the discount window'' in order to qualify to receive daylight 
credit from its Reserve Bank.\30\ Under the implementation scheme for 
net debit caps, a financially healthy institution is essentially 
defined as at least an adequately capitalized depository institution 
that has a supervisory rating of CAMELS-3 or higher.\31\ Moreover, a 
Reserve Bank may ``limit or prohibit an institution's use of Federal 
Reserve intraday credit if * * * the institution's use of daylight 
credit is deemed by the institution's supervisor to be unsafe or 
unsound.'' \32\ Thus, if supervisory issues arise with an institution, 
supervisors, including the OCC and FDIC, would be and have been 
consulted about the financial condition of an institution that is using 
or seeking to use intraday credit. In some circumstances, Reserve Banks 
impose real-time controls to reject outgoing Fedwire funds transfers 
that would cause a depository institution's account to exceed a limit, 
including a limit of zero.\33\ While residual risks may exist, PSR 
policies and procedures as well as FDIC legislation have been 
significantly enhanced in ways that help control both risk to the 
Reserve Banks and to the FDIC insurance fund.
---------------------------------------------------------------------------

    \30\ See the Payment System Risk Policy at http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, p. 22.
    \31\ The CAMELS ratings apply to commercial banks, savings and 
loan associations, natural person credit unions, and bankers' banks. 
Other supervisory rating structures apply for FBOs and corporate 
credit unions. The Reserve Banks use these supervisory ratings and 
other factors to determine credit risk and whether they will extend 
daylight overdraft capacity.
    \32\ See the Policy on Payment System Risk at http://www.federalreserve.gov/paymentsystems/psr/policy07.pdf, p.23.
    \33\ The Reserve Banks use real-time monitoring to prevent 
selected institutions from effecting certain transactions--outgoing 
Fedwire funds transfers, National Settlement Services transactions, 
or automated clearing house (ACH) credit originations--if their 
accounts lack sufficient funds to cover the payments. Generally, a 
Reserve Bank will apply real-time monitoring to an institution's 
position when the Reserve Bank believes that it faces a greater 
level of risk exposure, for example from problem institutions or 
institutions with chronic overdrafts in excess of what the Reserve 
Bank determines is prudent.
---------------------------------------------------------------------------

    On balance, the Board believes that explicitly accepting collateral 
for daylight overdrafts on a voluntary basis offers important 
improvements in policy. In particular, collateralized daylight 
overdrafts will support liquidity and operational risk reduction for 
the payments system, long-term credit risk reduction for the Reserve 
Banks, and a more-reasonable cost burden on the industry.
    B. Fees for collateralized daylight overdrafts. The Board proposes 
lowering the fee to zero for collateralized daylight overdrafts to 
encourage institutions to pledge collateral and to reduce payments held 
in liquidity-management queues. The value of unencumbered collateral 
pledged at the Reserve Banks for PSR or discount window purposes would 
be applied in the determination of daylight overdraft fees assessed to 
institutions.
    Of the twelve commenters that addressed two-tier pricing with a 
lower fee for collateralized overdrafts, most were highly supportive, 
particularly if the fee on collateralized daylight credit were zero. 
The other commenters raised questions or issues for the Board's 
consideration. For instance, one commenter that supported two-tier 
pricing expressed some concern about the potential cost and complexity 
of implementing a two-tier pricing system. Another mentioned the 
likelihood that two-tier pricing would increase the level of daylight 
overdrafts. In addition, several institutions specifically requested 
that all unencumbered collateral pledged to the Reserve Bank for 
discount window or PSR purposes be considered in calculating an 
institution's fees.
    The Board has previously raised the possibility of a two-tier 
pricing system for collateralized and uncollateralized daylight 
overdrafts. In 2001, the Board requested comment on two-tier pricing as 
a long-term PSR policy direction. \34\ Then, as now, most commenters 
were supportive of such a regime. In August 2002, the Board stated that 
it would continue to study two-tier pricing for collateralized and 
uncollateralized overdrafts.\35\ The Board also specified that the 
Reserve Banks would charge the collateralized rate on daylight 
overdrafts up to the value of collateral pledged and then apply the 
uncollateralized rate to the remaining daylight overdrafts.
---------------------------------------------------------------------------

    \34\ 66 FR 30208, June 5, 2001.
    \35\ 67 FR 54424, August 22, 2002.
---------------------------------------------------------------------------

    To determine a collateralized fee, the Board has reviewed 
historical papers and discussions of overdraft pricing, industry 
comments and discussions surrounding the consultation paper, and the 
practices of other major central banks. There is no definitive economic 
literature on whether there is a nonzero intraday rate of interest that 
should be

[[Page 12425]]

used in calculating fees for collateralized intraday central bank 
credit. There are different views. One view argues that it would be 
anomalous if the general term structure of interest rates contained a 
major discontinuity between the overnight rate and the intraday rate 
but without showing how to determine the existence and level of an 
intraday rate. Another view essentially holds that intraday balances 
provided by central banks should be priced at the marginal social cost 
of production, which is approximately zero for central banks. This view 
is reinforced by recent academic work suggesting that the role of 
central bank intraday balances and credit is to help coordinate the 
settlement of payments and not ultimately to finance underlying real 
economic activity.
    From the economic literature, a reasonable perspective is that 
central banks should target a rate for providing collateralized 
daylight balances and credit that advances the policy objectives of the 
central bank. Further, because there is no evidence from other 
countries that intraday rates affect central bank macroeconomic goals, 
such as inflation or unemployment, a central bank has the flexibility 
to set an intraday rate to advance its payments system objectives of 
safety and efficiency. This is the intraday credit pricing strategy 
generally followed by other major central banks, and there have not 
been any reported effects on the central banks' ability to achieve 
their monetary policy objectives.
    The Board's view is that setting the collateralized daylight 
overdraft fee at zero would improve tradeoffs among liquidity, 
operational, and credit risks in the payments system. Although the 
amount of intraday credit provided could well increase, credit risk to 
the Reserve Banks would be controlled by traditional banking tools used 
in providing credit (eligibility requirements, collateral, caps, and 
monitoring). The Board also believes that credit risk to depository 
institutions could decrease somewhat because greater liquidity would 
imply faster payments and settlements and a correspondingly shorter 
duration of intraday risk on customer accounts and counterparty 
settlements. Similarly, liquidity would likely circulate more quickly 
with the faster flow of payments as the incentive for depository 
institutions to queue payments for liquidity purposes declines. 
Operational risk from late-day payments would also likely decline 
somewhat if depository institutions release payments generated earlier 
in the day from their internal afternoon liquidity queues.
    In addition, some theoretical literature and discussions with 
bankers suggest that setting the collateralized fee at even a low rate 
above zero might continue to provide incentives to queue and delay 
payments. For example, small incentives can lead to strategic behavior 
by depository institutions in which each waits for the other to send 
payments that essentially provide the liquidity to avoid (priced) 
daylight overdrafts, which in turn leads to a generalized delay of 
payments until late in the day. Discussions with depository 
institutions tend to confirm that, if a payment is not time-sensitive, 
they may very well hold that payment to reduce overdraft charges that 
affect their budgets. Thus, the Board believes that the industry may 
continue to hold back payments at any positive fee for collateralized 
intraday credit.
    The Board recognizes that a zero fee for collateralized intraday 
credit is unlikely to reduce the share of late-day payments back to 
pre-2000 levels. As validated by the PRC and WCAG survey, a number of 
late-day payments are not originated until late in the day, and many of 
these are unlikely to be affected by changes to daylight overdraft 
fees. For example, late-day money market investments will of necessity 
generate late-day payments.
    In weighing the reasons for charging a zero fee for collateralized 
daylight overdrafts, the Board identified at least two potential 
unintended consequences. First, the Board is concerned that a zero fee 
for collateralized overdrafts could eliminate incentives for depository 
institutions and their customers to return securities used in 
repurchase agreements early in the morning. The practice of early 
return grew out of a coordinated effort by the clearing banks and the 
market to respond to the implementation of overdraft fees in 1994 by 
delivering government and agency securities held under certain types of 
repurchase agreements back to borrowers of funds and their banks early 
in the morning.\36\ The concern is that removing the overdraft fee 
could remove the incentive for the early returns of securities, which 
has been viewed as an important operational success in the securities 
industry. Initial discussions with some depository institutions suggest 
that the early return of securities has become an entrenched practice 
in the market and it would not be reversed if there were a zero fee for 
collateralized daylight overdrafts.
---------------------------------------------------------------------------

    \36\ These deliveries take place over the Fedwire securities 
(delivery-versus-payment) system, with the account of the depository 
institution delivering securities credited with the accompanying 
funds and the depository institution receiving the security debited 
for those funds. The depository institutions and their large 
customers delivering securities control the delivery process. Fees 
provide a significant incentive for institutions to return (deliver) 
securities early in the day and obtain the corresponding funds 
credits in order to limit daylight overdrafts at a Reserve Bank. 
These early deliveries have the corresponding effect of generating 
priced daylight overdrafts in the accounts of institutions receiving 
securities, which, in turn, provides incentives to settle new trades 
or initiate new deliveries quickly.
---------------------------------------------------------------------------

    Second, the Board is concerned that a collateralized overdraft fee 
of zero would reduce the incentives of depository institutions to 
invest in a new liquidity-saving mechanism for the Fedwire funds 
transfer system or to improve practices in using CHIPS or DTC.\37\ This 
is a clear risk to the overall four-prong strategy for addressing 
liquidity, operational, and credit risk. Other countries, such as 
Germany, have seen a demand for liquidity-saving mechanisms even with 
zero overdraft fees, but those demands may have been motivated by 
depository institutions' desire to save collateral capacity in a regime 
of mandatory collateralization of intraday credit.
---------------------------------------------------------------------------

    \37\ Work with the industry on models for a liquidity-saving 
mechanism for the Fedwire funds transfer system began in August 
2007.
---------------------------------------------------------------------------

    While the Board is concerned about these possible unintended 
consequences, it must balance these concerns with its goal of reducing 
liquidity, operational, and credit risks. On balance, the Board 
believes that charging a zero fee for collateralized overdrafts will 
contribute to overall risk reduction.
    C. Fees for uncollateralized daylight overdrafts. In a regime in 
which the Board expects the pledging of collateral to become the norm, 
but remain voluntary to avoid the disruptions of rejecting payments 
that could occur under mandatory collateralization, the fee for 
uncollateralized overdrafts takes on a new role of providing a 
significant incentive to collateralize overdrafts. In the past, the 
Board has suggested assessing a ``risk premium'' for uncollateralized 
overdrafts by estimating the spread between the overnight Federal funds 
rate and the Treasury general collateral repo rate.\38\ In 2001, the 
Board cited a risk premium of 12 to 15 basis points.\39\ Although the

[[Page 12426]]

current fee of 36 basis points is higher than this risk premium if a 
zero fee is charged for collateralized daylight overdrafts, the fee 
arguably reflects allowances for variation in the risk premium across 
time and across borrowers.\40\ Under the proposed strategy to encourage 
the voluntary pledging of collateral, the Board proposes a more-
significant spread between collateralized and uncollateralized daylight 
overdrafts that exceeds previous estimates of the risk premium. 
Specifically, the Board proposes raising the fee to 50 from 36 basis 
points (annual rate) for uncollateralized daylight overdrafts to 
encourage the collateralization of daylight overdrafts.\41\ The Board 
notes that the proposed 50 basis point fee for uncollateralized credit 
would be less than the final fee of 60 basis points for daylight credit 
originally announced by the Board in 1994 but never implemented.\42\
---------------------------------------------------------------------------

    \38\ The spread between the overnight Federal funds rate and the 
Treasury general collateral repo rate can be used as a proxy or 
measure of credit risk. The spread can be volatile over short 
periods, reflecting changes in the availability of Treasury 
collateral. The average spread since 1991 is 7 basis points, with a 
standard deviation of 17 basis points. From 2000 to 2007, the 
average spread was between 6 and 10 basis points, while from mid-
1980 to 2000, the spread was closer to 12 to 15 basis points.
    \39\ See 66 FR 30208, June, 5, 2001.
    \40\ Another possible proxy of credit risk is the rate 
associated with credit default swaps for major depository 
institutions. Between January 2001 and December 2007, the median 
spread for an index of one-year credit default swaps on major 
depository institutions was 10 basis points (standard deviation of 
10 basis points). The minimum and maximum for the index were 1 and 
63 basis points, respectively.
    \41\ In calculating an institution's fees, the value of 
collateral pledged to the Reserve Banks will be subtracted from 
negative account balances at the end of each minute. All minutes 
where the negative account balance exceeds the value of collateral 
pledged will be summed and divided by the number of minutes in the 
Fedwire operating day to arrive at a daily uncollateralized daylight 
overdraft, which would be assessed the 50 basis point (annual) fee. 
The value of collateral pledged is the same for PSR and discount 
window purposes.
    \42\ As a result of the sizeable reductions in daylight 
overdrafts achieved by the introduction of fees, as well as concerns 
about the possible effects of further rapid fee increases, the Board 
announced in March 1995 that it would increase the fee to 36 basis 
points rather than the planned 48 basis points. Originally, the 
Board planned to phase in over three years a fee of 60 basis points 
in steps of 24, 48, and 60 basis points.
---------------------------------------------------------------------------

    The 50 basis point fee for uncollateralized overdrafts would 
provide a strong incentive for a depository institution to pledge 
collateral to its Reserve Bank in an amount sufficient to reduce or 
eliminate the depository institution's charges for its use of daylight 
credit. In addition, the fee for uncollateralized credit would 
discourage the use of uncollateralized daylight credit by those 
depository institutions that have not pledged sufficient collateral to 
support their payments activity. If uncollateralized credit increases, 
however, the fee for uncollateralized credit could be raised at a 
future date to limit further the use of such credit. At this time, the 
50 basis point spread between collateralized and uncollateralized 
daylight overdrafts sufficiently underscores the Board's new strategy 
about the importance of pledging collateral to obtain intraday balances 
and to reduce the Reserve Banks' credit risk.
    D. Deductible. The Board has long sought to minimize the burden of 
the PSR policy on institutions that use small amounts of daylight 
overdrafts by adopting a series of special provisions in the 
administration of daylight overdraft pricing and net debit caps. These 
provisions reflect the highly concentrated incidence of overdrafts at 
twenty depository institutions, which incur about 80 percent of 
daylight overdrafts. Two important components of the current PSR policy 
are the deductible from daylight overdraft fees based on an 
institution's capital and a $25 biweekly fee waiver.\43\ In essence, an 
amount of free uncollateralized intraday credit is provided through 
these provisions. The Board proposes to eliminate the deductible but 
also proposes to increase the fee waiver (discussed in the next 
section) to minimize the burden of the policy changes on small users of 
daylight overdrafts.
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    \43\ Daylight overdraft charges are reduced by a deductible, 
which is calculated using 10 percent of eligible capital. The 
deductible was created with the introduction of pricing to provide 
some amount of free liquidity to the payments system, to compensate 
depository institutions for periodic outages of Reserve Bank 
computer systems, and to enhance operational simplicity by exempting 
small users of intraday credit. The Reserve Banks also waive fees of 
up to $25 or less in any two-week reserve-maintenance period. The 
waiver reduces administrative burden on Reserve Banks and a large 
number of depository institutions that incur small fees.
---------------------------------------------------------------------------

    Continuing to provide significant amounts of free uncollateralized 
credit to large institutions through the deductible would be 
inconsistent with the strategy of emphasizing the provision of intraday 
credit through collateralized overdrafts at a zero fee. Retaining the 
deductible would weaken the incentives for depository institutions to 
pledge collateral to cover overdrafts and would not decrease risk to 
the Reserve Banks. In particular, the largest users of daylight credit 
would be able to use collateral to cover a significant portion of their 
overdrafts and then use their deductible to avoid fees on a significant 
amount of uncollateralized credit, undermining the incentive effects of 
fees on uncollateralized daylight overdrafts. Further, to the extent 
the deductible historically provided a source of free liquidity to 
depository institutions, it would no longer be needed because 
collateralized credit would provide an alternative source of free 
intraday liquidity. In addition, eliminating the deductible and 
increasing the fee waiver would provide a simpler and more-uniform way 
to provide a de minimis amount of free uncollateralized credit and 
would help limit the cost burden of the policy on small users of 
daylight overdrafts.
    Further, the Board believes that by eliminating the deductible for 
all depository institutions and providing free collateralized intraday 
credit to eligible depository institutions, including FBOs, the 
proposed policy changes would address the negative incentive effects of 
the deductible calculations on FBOs that the commenters identified. 
FBOs would be assessed the same fees as U.S.-chartered depository 
institutions, which, under the proposal, would be zero for 
collateralized daylight overdrafts and 50 basis points for 
uncollateralized overdrafts.
    E. Fee waiver and treatment of small users of daylight overdrafts. 
The Board continues to believe that it is important to reduce the 
burden of the PSR policy on institutions that use small amounts of 
daylight overdrafts. In setting the fee waiver amount, the Board sought 
to balance the risk faced by Reserve Banks from uncollateralized 
overdraft exposures against the administration costs to Reserve Banks 
and depository institutions from fee assessments and collateral 
arrangements. The Board proposes to limit the burden for institutions 
that use small amounts of daylight overdrafts by increasing the fee 
waiver to $150 from $25. The waiver would be subtracted from the gross 
fees (in a two-week reserve-maintenance period) assessed on any user of 
daylight overdrafts.\44\ This procedure differs from the current policy 
in which the waiver only eliminates gross fees of institutions that 
have charges less than or equal to $25 in a two-week period. This 
approach would avoid a discontinuity in applying the waiver, which may 
create incentives for delaying payments to prevent a large marginal 
increase in fees.
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    \44\ The proposed waiver would not result in refunds or credits 
to an institution. The waiver would not apply to institutions 
subject to the penalty fee.
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    An institution is defined as a small user of daylight credit if the 
institution has an exempt cap, which is the smallest positive cap under 
the policy, or if the institution averages less than $1 million a day 
in daylight overdrafts. The Board has historically considered exempt-
cap institutions to be small users of daylight overdrafts.\45\ In

[[Page 12427]]

addition, a number of institutions with higher cap levels regularly 
incur similar small amounts of daylight overdrafts. The level of $1 
million, in 2007 dollars, is based on levels historically considered 
small.\46\ Through the waiver, the Board intends to limit the burden 
for virtually all exempt-cap institutions and to cover the routine 
overdraft activity of institutions that average less than $1 million a 
day in daylight overdrafts.
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    \45\ See 51 FR 45054, December 16, 1986, and 52 FR 29255, August 
6, 1987.
    \46\ See 51 FR 45054, December 16, 1986.
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    The Board considered a range of waiver amounts from $100 to $250. 
At the $150 waiver, the amount of free credit provided limits the 
burden for virtually all exempt-cap institutions and covers the routine 
overdraft activity of small users. Beyond a $150 waiver, the number of 
small users that would be paying higher fees diminishes only 
marginally, and mid-to-large users of daylight overdrafts benefit 
increasingly. On balance, the Board determined that the associated 
increase in uncollateralized Reserve Bank exposure per day of 
increasing the waiver amount outweighed the marginal decrease in the 
number of small users paying higher fees. In addition, a higher waiver 
amount would decrease the incentive to pledge collateral for those mid-
to-large users of daylight overdrafts benefiting from the waiver 
increase.
    Based on fourth-quarter 2007 daylight overdraft and collateral 
values, table 3 shows that the proposed $150 waiver would eliminate or 
reduce fees for 99.2 percent of small users of daylight overdrafts. The 
vast majority of these institutions do not pay fees under the current 
policy. The waiver, however, would not eliminate or reduce fees paid 
for all small users because some of these institutions incur relatively 
high daylight overdrafts on peak days, which could result in fees. In 
particular, the $150 waiver generally covers routine daylight overdraft 
activity for small users but may not cover the highest one or two 
business days in the quarter. Because of this peak overdraft activity, 
an estimated thirty-five small users could pay higher fees based on 
fourth-quarter data if they did not pledge (additional) collateral. The 
actual number of depository institutions that could incur higher fees 
will vary over time based on daylight overdrafts incurred and 
collateral pledged. In practice, there are few institutions, especially 
small users, that would pay fees across all two-week periods in which 
fees are assessed in a given year.
[GRAPHIC] [TIFF OMITTED] TN07MR08.000

    The average annual increase in fees for each of the thirty-five 
institutions is approximately $180. Of the thirty-five institutions, a 
small number could incur an increase in average fees between $500 and 
$1,000 in a year, while the other institutions could incur increases of 
less than $500 in a year (or less than $20 in a two-week period). The 
higher fees are associated with peak levels of daylight overdraft 
activity relative to the amounts of collateral pledged. Each small user 
could eliminate increases in fees by pledging $8 million, on average, 
in (additional) collateral. As of the fourth-quarter 2007, only about 
14 percent of these small users had collateral pledged, although two-
thirds had signed borrowing documents with their administrative Reserve 
Banks.
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    \47\ The fee data for mid-to-large users and all users exclude 
one institution that is an outlier in comparison to the other 
institutions that could be paying higher fees. The annual average 
increase in fees more than doubles for mid-to-large institutions and 
all users with the inclusion of this institution. This institution 
would incur a fee increase of almost $3 million per year. The next 
highest increases in fees are $475,000 and $260,000 per year.
---------------------------------------------------------------------------

    Table 3 also shows that over half (52 percent) of institutions that 
incur mid-to-high levels of daylight overdrafts (mid-to-large users) 
would have

[[Page 12428]]

sufficient collateral to eliminate or reduce their fees paid, while 
slightly less than half (48 percent) of mid-to-large users could face 
higher fees or would need to pledge collateral. Much of their overdraft 
activity was excluded from fees under the deductible of the current 
policy.
    The average annual increase in fees across the 125 mid-to-large 
users paying higher fees is approximately $18,350 (or $690 per two-week 
period). The large majority of these institutions (about 75 percent) 
would incur an increase in average fees of less than $10,000 per year 
(less than $375 in a two-week period). Many of the mid-to-large users 
have pledged collateral and have signed borrowing documents. Pledging 
(additional) collateral of $90 million on average per institution would 
avoid any increase in fees.
    The Board recognizes that institutions will be interested in the 
effect of the proposed changes on their daylight overdraft fees. To 
assist institutions, the Board has developed a simple fee calculator. 
The calculator enables institutions to provide daylight overdraft and 
collateral data to estimate their daylight overdraft fees under the 
proposed policy. The calculator is located on the Board's Web site at 
https://www.federalreserve.gov/apps/RPFCalc/.
    F. Net debit caps. Based, in part, on the expectation of some 
additional collateralization of daylight overdrafts and the potential 
need to provide more credit to the industry, the Board proposes to 
eliminate the current two-week average cap on daylight overdrafts for 
healthy depository institutions and retain the higher single-day cap. 
The effect is to increase the routine daylight overdraft capacity of 
healthy institutions with self-assessed caps approximately 50 percent 
from the current policy. The single-day cap will apply to the total of 
collateralized and uncollateralized daylight overdrafts.
    The Board also proposes to provide additional flexibility in the 
administration of net debit caps for fully collateralized daylight 
overdrafts. If an institution incurs an overdraft above its single-day 
cap, the Board proposes the following new ex post monitoring and 
counseling procedures.
    (1) If any part of the overdraft is uncollateralized, the current 
ex post counseling regime would be used.\48\ Counseling may include a 
discussion of ways the institution could manage more effectively its 
account as well as other possible Reserve Bank actions, such as 
reducing the net debit cap and rejecting certain payment transactions, 
that would enable the Reserve Bank to protect its risk exposure from 
the institution.
---------------------------------------------------------------------------

    \48\ The ex post counseling regime includes a series of actions 
by the Reserve Bank that are aimed at deterring an institution from 
violating the PSR policy by exceeding its net debit cap. These 
actions depend on the institution's history of daylight overdrafts 
and financial condition. Initial actions taken by the Reserve Bank 
may include an assessment of the causes of the overdrafts, a 
counseling letter to the institution, and a review of the 
institution's account-management practices. If policy violations 
continue to occur, the Reserve Bank may take additional actions, 
which may include encouraging the institution to file a cap 
resolution or perform a self-assessment to obtain a higher net debit 
cap or to apply for maximum daylight overdraft capacity. In 
situations in which an institution continues to violate the PSR 
policy, and counseling and other Reserve Bank actions have been 
ineffective, the Reserve Bank may assign the institution a zero cap. 
The Reserve Bank may also impose other account controls that it 
deems prudent, such as requiring the institution to pledge 
collateral, imposing clearing balance requirements; rejecting 
Fedwire funds transfers, ACH credit originations, or National 
Settlement Service transactions that would cause or increase an 
institution's daylight overdraft; or requiring the institution to 
prefund certain transactions.
---------------------------------------------------------------------------

    (2) If the overdraft is fully collateralized, the Reserve Bank 
would generally consider the condition an ``overlimit'' situation and 
would be able to ``waive counseling'' for two incidents of overlimit, 
fully collateralized overdrafts per two consecutive reserve-maintenance 
periods (four weeks). Incidents of overlimit, fully collateralized 
overdrafts beyond the two waivable incidents would be subject to ex 
post counseling.
    The overlimit flexibility would apply to institutions that have de 
minimis or self-assessed net debit caps or max caps.\49\ Exempt-cap 
institutions are already allowed under the policy to incur up to two 
cap breaches in two consecutive reserve-maintenance periods. Zero cap 
institutions would not be eligible. The overlimit flexibility would 
also be in addition to other permissible waivers, such as waivers due 
to Reserve Banks' errors.
---------------------------------------------------------------------------

    \49\ FBOs will continue to be monitored at their cap level in 
real time. If an institution's account is monitored in real time, 
any outgoing Fedwire funds transfer, National Settlement Service 
transaction, or ACH credit origination that exceeds available funds 
is rejected.
---------------------------------------------------------------------------

    The overlimit flexibility allows a depository institution to obtain 
additional fully collateralized credit beyond the established single-
day cap on an infrequent basis if the depository institution has fully 
collateralized all of its daylight overdrafts-both those above and 
those below its cap--when the event occurs. The proposed waiver of 
counseling for overlimit overdrafts, if they are fully collateralized, 
reflects their lower risk to a Reserve Bank relative to an overlimit 
condition for uncollateralized credit. The Board recognizes that the 
Reserve Banks may need to be flexible in granting fully collateralized 
credit to carry out the intent of the new policy. The additional 
flexibility also reinforces the new explicit policy emphasis on 
collateralized intraday credit. The limited number of waivers, however, 
reflects the fact that collateral may not fully protect a Reserve Bank 
and that frequent breaches of agreed caps may reflect other concerns 
about a depository institution, including an inability to manage its 
account at a Reserve Bank or to manage its customers' activity. In 
addition, max caps would continue to be available at a Reserve Bank's 
discretion to deal with cases in which routine additional capacity is 
needed by healthy institutions.
    The overlimit flexibility also recognizes that from a supervisory 
perspective counterparty credit risk management systems allow for bank 
management to approve exceptions to those limits under appropriate 
conditions, assuming the proper degree of management attention is 
focused on such decisions. A waiver of what is currently called a 
``breach'' of a daylight overdraft cap can be likened to an 
``approval'' of an overlimit condition vis-[agrave]-vis a counterparty 
credit risk exposure limit.
    The Board examined the need to retain the net debit cap structure 
for institutions that fully collateralize overdrafts and concluded that 
it is still appropriate and prudent to have limits on intraday credit 
even when the credit is fully collateralized. First, prudent banking 
practice and current supervisory guidance support placing limits on 
counterparty credit exposures even when other tools such as collateral 
(with haircuts) are used to control risk. The basis for this guidance 
is that collateral alone should not be regarded as sufficient 
protection against counterparty credit risk but that a range of tools 
should be used to manage risk, including credit limits. Haircuts on 
collateral help mitigate the risk that counterparty credit exposure 
that is intended to be collateralized will remain collateralized when 
the value of the collateral declines. Haircuts themselves, however, may 
change more slowly than the value of collateral for a variety of 
operational, market, and policy reasons. Limits or caps complement the 
use of collateral in risk mitigation. Among other things, they aim to 
constrain the size of exposures in the first place rather than to 
mitigate the risk of loss on exposures of a given size. Moreover, 
limits may be used to limit

[[Page 12429]]

exposure to extreme risks and take some pressure off the use of 
haircuts to address such risks.
    Second, daylight overdrafts operate more like drawings on lines of 
credit than discrete loans. Limits help the Reserve Banks set 
expectations about the quantity of their potential exposures and help 
depository institutions to keep their use of credit within prudent and 
agreed-upon bounds. Further, credit limits serve as standardized 
benchmarks for analyzing and comparing credit usage across depository 
institutions and over time.
    Third, the net debit caps, in particular, are based on customer 
account and operational management policies at a depository institution 
in addition to factors such as credit risk. Specifically, depository 
institutions are required under the PSR policy to take four factors 
into account when determining self-assessed caps, including their 
creditworthiness; intraday funds management and related controls; 
customer credit policies and related controls; and operating controls 
and contingency procedures. These factors figure prominently in 
supervisory guidance on managing risk in wholesale payments systems and 
are also based on recommendations provided to the Board by the banking 
industry in the 1980s.\50\ The issue of reputational risk is also a 
factor in current supervisory guidance. The process of establishing and 
renewing caps compels a depository institution and its management to 
focus on a range of interrelated aspects of risk in controlling credit 
and operational exposures both to a depository institution and to 
Reserve Banks.
---------------------------------------------------------------------------

    \50\ See Association of Reserve City Bankers, The Final Report 
of the Risk Control Task Force, prepared with the assistance of the 
Bank Administration Institute and Robert Morris Associates (October 
1984).
---------------------------------------------------------------------------

    Overall, there is a reasonable and prudent basis for placing caps 
on collateralized overdrafts. Hence there is also a reasonable and 
prudent basis for placing caps on overdrafts that are collateralized 
voluntarily or not collateralized at all.\51\ The Board recognizes that 
other central banks have not employed net debit caps in addition to 
collateral in managing risk from intraday credit. Most central banks 
seem to have viewed the provision of intraday credit as a simple 
extension of practices with respect to overnight credit policy. These 
central banks, however, have adopted mandatory collateral policies and 
typically accept a much smaller range of collateral than the Reserve 
Banks. Further, some major central banks have not had the technical 
capability to conduct the comprehensive centralized tracking of 
intraday credit extensions that has been developed by the Federal 
Reserve over the past twenty years.
---------------------------------------------------------------------------

    \51\ Limits on daylight overdrafts also address the possibility 
of ``adverse selection'' in a system of voluntary collateralization. 
In essence, depository institutions in weaker operational or 
financial condition might be quicker to pledge collateral to obtain 
larger amounts of intraday credit than stronger banks, for example, 
to ensure that critical payments are made on time. In the 
theoretical literature, caps or limits are frequently characterized 
as helping to deal with adverse selection issues in credit markets. 
Although Reserve Banks typically have access to supervisory 
information about their borrowers, including their history and 
management, the Reserve Banks may have imperfect information, which 
may be another argument for caps as a useful tool in limiting 
residual risk from such problems.
---------------------------------------------------------------------------

    Lastly, the Board considered the FBOs' request to increase the 
fractions used to calculate the U.S. capital equivalency in determining 
net debit caps. Under the current policy, the most-highly rated FBOs 
receive 35 percent (instead of 100 percent) of their worldwide capital 
for the U.S. capital equivalency. FBOs with weaker ratings receive 
lower measures of U.S. capital equivalency. In 2007, FBOs as a group 
incurred average peak overdrafts that were less than 50 percent of 
their single-day capacity. A few FBOs may approach their cap limits on 
certain liquidity-intensive payment days, but it does not appear that 
FBOs are generally constrained by current cap levels. The Board 
recognizes, however, that the behavioral changes of individual FBOs and 
other depository institutions following a change in daylight overdraft 
policy are somewhat uncertain. For example, some institutions may 
prefer to release payments more quickly, incurring periods of increased 
daylight overdrafts, if they have the capacity to do so. To facilitate 
the earlier release of payments, the Board is proposing to streamline 
the process for the maximum daylight overdraft capacity (max cap) 
program, which provides additional capacity on a fully collateralized 
basis, for certain FBOs (discussed in the next section).
    G. Maximum daylight overdraft capacity. Currently, depository 
institutions with self-assessed net debit caps are eligible to pledge 
additional collateral to their Reserve Banks to secure intraday credit 
in excess of their net debit cap under the max cap program.\52\ As part 
of the consultation process, the Board received two comments on the max 
cap program. The commenters indicated preferences for greater 
flexibility and consistency across Reserve Banks in the implementation 
of the program.
---------------------------------------------------------------------------

    \52\ Current procedures associated with max caps can be found in 
the Guide to the Federal Reserve's Payments System Risk, which is 
available at http://www.federalreserve.gov/paymentsystems/psr/mainguide.pdf.
---------------------------------------------------------------------------

    Under the new strategy, the max cap would continue to act as a tool 
to provide healthy institutions with flexibility in addressing their 
intraday liquidity needs. In particular, the Board proposes to take a 
more-favorable view of extending collateralized credit to financially 
sound institutions demonstrating a business need for additional 
daylight overdraft capacity. The current policy states:

    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. 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 Board proposes to remove the requirement that institutions must 
have already explored other alternatives to address their increased 
liquidity needs. This statement is inconsistent with the proposed 
strategic direction of the new policy. A depository institution 
interested in obtaining a max cap would still need to contact its 
administrative Reserve Bank, which would work with the institution to 
determine an appropriate capacity level and would assess relevant 
financial and supervisory information in making such a credit decision.
    In addition, the Board proposes allowing an FBO that is a financial 
holding company or SOSA 1-rated institution to request from its 
administrative Reserve Bank a max cap without documenting a specific 
business need for additional capacity or providing a max cap board of 
directors resolution.\53\ The streamlined max cap would enable these 
FBOs to acquire additional capacity that in total would provide up to 
100 percent of worldwide capital times the self-assessed cap multiple. 
A financial holding company is currently eligible for uncollateralized 
capacity of 35 percent of worldwide

[[Page 12430]]

capital times the cap multiple. The streamlined max cap would provide 
additional collateralized capacity of 65 percent of worldwide capital 
times the cap multiple.\54\ While streamlined, the Reserve Bank would 
retain the right to assess the ability of eligible FBOs to manage the 
intraday capacity permitted by the max cap as part of reviewing 
financial and supervisory information. Specifically, the Reserve Bank, 
in consultation with the home country supervisor, would engage in 
initial as well as periodic dialogue with the institution that is 
analogous to the periodic review of liquidity plans performed with U.S. 
institutions to ensure the institution's intraday liquidity risk is 
managed appropriately.
---------------------------------------------------------------------------

    \53\ The FBO would still be required to complete a self-
assessment and provide a board of directors resolution for the self-
assessed cap.
    \54\ A SOSA-1 rated institution is eligible for uncollateralized 
capacity of 25 percent of worldwide capital times the cap multiple. 
The streamlined max cap would provide additional collateralized 
capacity of 75 percent of worldwide capital times the cap multiple.
---------------------------------------------------------------------------

    The Board believes the streamlined max cap is appropriate for the 
group of FBOs with which the Reserve Banks have lower supervisory 
concerns. If an FBO requests capacity in excess of 100 percent of 
worldwide capital times the self-assessed cap multiple, however, it 
would be subject to the full max cap process applicable to all 
institutions.
    H. Foreign Banking Organizations. The fractional allowance for 
worldwide capital of FBOs used in calculating net debit caps and 
deductibles historically has been based on risk differences between 
FBOs and U.S.-chartered depository institutions. The Federal Reserve's 
access to supervisory information on FBOs is generally not as timely or 
complete as the information about U.S.-chartered institutions. In 
addition, the Federal Reserve incurs legal risk with respect to the 
application of foreign insolvency laws to FBOs. The existing cap limit 
and daylight overdraft fee have helped to control credit risk from FBOs 
to the Reserve Banks.
    The Board, however, is proposing several changes to the treatment 
of FBOs under the PSR policy that would address the concerns of the 
FBOs while managing the risk to the Reserve Banks. The Board believes 
that by eliminating the deductible for all depository institutions and 
providing free collateralized intraday credit to eligible depository 
institutions, including FBOs, the proposed policy changes would address 
the negative incentive effects of the deductible calculations that the 
commenters have identified. In addition, as discussed in the previous 
section, the Board proposes to streamline the max cap process for 
certain FBOs. Today, if an FBO is constrained by the cap limit on a 
frequent basis or on specific days, it may apply to its Reserve Bank 
for a max cap. While the Board believes this program has provided 
sufficient flexibility for FBOs to obtain additional capacity, the 
Board recognizes that the business case and board of directors 
resolution required to obtain a max cap could be slow or cumbersome. 
This procedure may not be warranted for financial holding companies and 
SOSA-1-rated FBOs to acquire additional capacity that in total provides 
up to 100 percent of worldwide capital times the self-assessed cap 
multiple.
    I. Penalty fees. Institutions that do not have regular access to 
the discount window are not eligible under the PSR policy to incur 
daylight overdrafts. In 1994, the Board announced that it would apply a 
penalty fee to these institutions if they did incur daylight 
overdrafts.\55\ The Board believed that the penalty rate would provide 
incentives to these institutions to avoid situations that could cause a 
daylight overdraft. The penalty rate adopted by the Board was equal to 
the regular daylight overdraft fee plus 100 basis points. Thus, given 
the proposed increase in the fee for uncollateralized daylight 
overdrafts, the Board proposes to increase the penalty fee 
correspondingly from 136 to 150 basis points.
---------------------------------------------------------------------------

    \55\ See 59 CFR 8979, February 24, 1994.
---------------------------------------------------------------------------

    J. Timing considerations and issues for Reserve Bank and depository 
institution implementation. The Reserve Banks will need a significant 
lead time to adjust internal processes and systems to the proposed PSR 
policy changes. These changes will affect the Reserve Banks' credit 
risk management and accounting software applications. The Board 
anticipates that institutions' systems could also require some 
adjustments. The Board expects that a revised PSR policy could be 
implemented in approximately two years from the announcement of a final 
rule. The Board, however, could implement the proposed changes to the 
max cap program for FBOs on an earlier date.

V. Questions

    The Board requests comments on all aspects of the proposed PSR 
policy changes, including the new strategy, collateral, fees for 
collateralized daylight overdrafts, fees for uncollateralized daylight 
overdrafts, net debit caps, max caps, deductibles, fee waivers, penalty 
fees, and implementation timeline.
    In addition to comments on all aspects of the proposed PSR policy 
changes, the Board would appreciate responses to the following 
questions.
General
    (1) Does your institution believe that the introduction of a zero 
fee for collateralized daylight overdrafts will contribute to an 
overall reduction in liquidity, operational, and credit risks in the 
payments system? Would it reduce these risks for depository 
institutions, their customers, or financial utilities?
    (2) What procedural or systems changes do you expect to make as a 
result of this proposed policy change?
Collateral
    (3) Does your institution regularly use Federal Reserve daylight 
credit, and does your institution currently have sufficient 
unencumbered eligible collateral to pledge to the Reserve Banks to take 
advantage of a zero fee for collateralized overdrafts? By your 
estimate, what proportion of your expected average and peak overdraft 
would you intend to collateralize?
    (4) Would your institution's intraday credit use increase or 
decrease from current levels? Do you expect the intraday credit usage 
of depository institutions as a group to increase or decrease from 
current levels?
    (5) While the proposal envisages no fee for collateralized 
overdrafts, institutions will face an opportunity cost to pledge 
collateral. How difficult or costly would it be to collateralize 
daylight overdrafts? What opportunity costs would your institution face 
in pledging (additional) eligible assets to the Reserve Bank to 
collateralize daylight overdrafts? What are the costs of entering into 
the Reserve Banks' borrowing documents?
    (6) How would the adoption of this new PSR strategy, which 
explicitly links collateral to daylight overdrafts and pricing of 
daylight overdrafts, affect the availability of collateral for other 
financial market activity? How might it affect other creditors and 
other payments system participants?
    (7) What (additional) collateral management capabilities would your 
institution expect of its Reserve Bank (such as changes to the 
frequency or means of obtaining collateral reports, the ability to move 
directly and quickly collateral in and out of pledge accounts, and so 
on)?
    (8) If you do not currently have a borrowing agreement or pledge 
any collateral, would you expect to do so? If so, would the rationale 
rest on the use of daylight overdrafts or overnight extensions of 
credit?

[[Page 12431]]

Pricing
    (9) To what extent would your institution make payments earlier in 
the day as a result of the proposed pricing changes? If your 
institution holds payments in a liquidity queue, would your institution 
continue to hold payments, particularly large-value payments, in a 
liquidity queue under the proposed policy changes? If so, under what 
circumstances would your institution continue to queue payments? What 
further steps would encourage queue reductions?
    (10) Does your institution believe that the introduction of a zero 
fee for collateralized daylight overdrafts could lead to changes in 
practices for returning early securities used in repurchase agreements? 
What changes might institutions expect?
    (11) Does your institution believe that the introduction of a zero 
fee for collateralized daylight overdrafts and the higher (50 basis 
point) fee for uncollateralized daylight overdrafts could lead to 
changes in practices for the early return of fed funds loans? What 
changes might institutions expect?
    (12) If your institution would face potentially higher fees on its 
daylight overdrafts, how will your institution adjust its collateral 
position or payments activities in response to the Board's proposed 
fees?

VI. Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of a rule or policy change that has a substantial effect on 
payments systems participants.\56\ Under these procedures, the Board 
assesses whether a change would have had a direct and material adverse 
effect on the ability of other service providers to compete 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 
modification would mitigate the adverse competitive effects, the Board 
will determine whether the expected benefits are significant enough to 
proceed with the change despite the adverse effects.
---------------------------------------------------------------------------

    \56\ These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' as revised 
in March 1990. (55 FR 11648, March 29, 1990).
---------------------------------------------------------------------------

    Intraday balances of central bank money help ensure the smooth flow 
of payments systems whether operated by the Reserve Banks or private-
sector clearing and settlement systems. The demand for intraday 
balances at the Reserve Banks for processing payments for private-
sector clearing and settlement systems can substantially exceed the 
supply of overnight balances in Federal Reserve accounts, making 
intraday credit from the Reserve Banks the key marginal source of 
intraday funding for the market and for making payments, particularly 
over the Reserve Banks' payments systems. For some large users of 
intraday credit, the proposed PSR policy changes may result in a 
reduction in daylight overdraft fees and thus lower explicit costs of 
using central bank money to fund payments activity. The lower explicit 
cost of using intraday balances of central bank money will lower the 
implicit cost of using the Reserve Banks' payments services. The Board, 
however, does not believe this lower cost will have an adverse material 
effect on the ability of other service providers to compete with the 
Reserve Banks because private-sector clearing and settlement systems 
will gain from the lower explicit cost of funding net debit caps and 
other risk and operational controls employed by those systems. 
Generally, the Board expects that both the Reserve Banks and private-
sector clearing and settlement systems will benefit to some extent from 
the reduced costs for daylight overdrafts.

VII. Paperwork Reduction Act

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

VIII. Appendix I

    The Board has identified five major concerns related to risk or 
efficiency that together suggest a change in the Federal Reserve's 
approach to the provision of intraday credit and the PSR policy is 
warranted at this time. These concerns include the declining level of 
overnight balances, the intraday funding needs of financial utilities, 
payments delays, continued growth in Reserve Bank credit exposure, and 
cost burden on the payments system.
    A. Level of overnight balances. First, the current level of 
overnight reserve and clearing balances is not sufficient to meet the 
intraday liquidity needs of the banking industry and the payments 
system. In 1988, overnight balances held at the Reserve Banks were 
approximately $39 billion. Since that time, changes in market practices 
(especially the introduction of retail sweep programs) and reserve 
requirements have reduced overnight balances to an average of 
approximately $16 billion in 2007; average daylight overdraft and 
(average) peak daylight overdrafts in 2007 were four and ten times 
overnight (closing) balances, respectively.

[[Page 12432]]

[GRAPHIC] [TIFF OMITTED] TN07MR08.001

    B. Intraday funding of financial utilities. Second, with the 
encouragement of the Federal Reserve and the industry, virtually all 
commercial paper is now held at DTC in book-entry form and issued and 
paid through that organization. In addition, trades of most publicly 
listed stocks and corporate bonds are also settled through DTC. As a 
result, DTC's members transfer substantial sums over the Fedwire funds 
transfer system to DTC's clearing account at the Federal Reserve Bank 
of New York beginning in the early afternoon to help meet DTC's risk-
management requirements.\57\ Most of these funds are not released by 
DTC back to the market until final DTC settlement occurs around 4:30 
p.m.\58\ As a result, for most of the afternoon, the demand for 
intraday balances at the Reserve Banks for processing other payments 
far exceeds the supply of overnight balances in Federal Reserve 
accounts, making intraday credit from the Reserve Banks the key 
marginal source of intraday funding for the market and for making 
payments, particularly over the Federal Reserve's payments systems. 
Under these circumstances, the provision of substantial amounts of 
daylight balances and credit by the Reserve Banks is necessary for the 
smooth functioning of Fedwire and the payments system more broadly. 
Private-sector payments systems have created a structural demand for 
daylight central bank credit averaging about $50 billion per day to 
support their settlement and risk management activities. On peak days, 
this demand can exceed $150 billion. The large magnitude of these 
amounts is inconsistent with the premise of the current PSR policy that 
relatively few institutions should rely on daylight credit from the 
Federal Reserve and use should be minimal.
---------------------------------------------------------------------------

    \57\ The use of intraday balances of central bank money to 
manage risk is explicitly endorsed by international risk standards 
applicable to securities settlement systems such as DTC and 
incorporated in the Board's PSR policy. See also ``Recommendations 
for securities settlement systems,'' Committee on Payment and 
Settlement Systems and Technical Committee of the International 
Organization of Securities Commissions, Bank for International 
Settlements, November 2001.
    \58\ DTC is not permitted to incur daylight overdrafts. It ends 
each day with a positive balance close to zero in its clearing 
account.
---------------------------------------------------------------------------

    C. Payments delays. Third, the policy of pricing daylight 
overdrafts and the implied quantity of intraday credit supplied to the 
market has encouraged depository institutions to delay sending Fedwire 
payments until later in the operating day, creating added operational 
risk for the markets. The concern that pricing would cause payments 
delays has been a long-standing concern associated with the PSR policy. 
Although delays were not observed in the early years of the policy, in 
recent years depository institutions have sent an increasing share of 
the value of payments made over the Fedwire funds transfer system later 
in

[[Page 12433]]

the day. In the period 1985 to 1990, data indicate that about 14 
percent of the value of daily Fedwire payments were sent after 5 
p.m.\59\ The data in chart 2, however, indicate that the share of the 
value of Fedwire payments sent after 5 p.m. has grown steadily, 
averaging about 22 percent by 1998 and increasing to about 32 percent 
by 2007. The chart illustrates that this growth is driven largely by 
the largest-valued payments (the 99th percentile), which averaged 
almost $1 billion in 2007.
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    \59\ In 1995, the value of Fedwire funds transfers after 5 p.m. 
was approximately 16 percent. See Richards, Heidi Willmann, Daylight 
overdraft fees and the Federal Reserve's Payment System Risk Policy, 
Federal Reserve Bulletin, December 1995.
    The Fedwire funds transfer system closes at 6:30 p.m.
    [GRAPHIC] [TIFF OMITTED] TN07MR08.002
    
    The PRC and WCAG study make clear that key depository institutions 
hold back (large-value) Fedwire funds transfers in so-called 
``liquidity queues'' during the afternoon in order to manage their 
daylight overdraft levels and avoid fees.\61\ Additional funds 
transfers, which may be designated for CHIPS, Fedwire funds, or book 
transfers, are held in customer credit queues generally awaiting 
sufficient funds to be transferred to an account to release the 
payments. Modifications to the policy for providing intraday liquidity, 
coupled with more-efficient use of liquidity, could ease some of these 
problems. Daylight overdraft fees alone, however, are not responsible 
for the late-day concentration of payments. PRC/WCAG members report 
that an increasing number of large-value payments are now originated 
later in the day because of later investment activities in the 
financial market and late closing times for major settlement systems.
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    \60\ Data are for funds transfers only and exclude transactions 
sent or received by CHIPS, DTC, or CLS Bank International (CLS). 
CLS, which is an Edge Corporation supervised by the Federal Reserve, 
offers payment-versus-payment settlement of foreign exchange trades.
    \61\ Payments may be held in several types of queues once the 
depository institution receives an instruction from a customer to 
make a Fedwire funds transfer. If a customer instructs the 
depository institution to make a payment and the customer does not 
have sufficient balances or intraday credit with the institution, it 
may hold the payment in a ``credit queue'' until funds become 
available. Once the payment is cleared from the credit queue, the 
depository institution may send the payment or may move the payment 
to another queue in its process, such as the liquidity queue. A 
depository institution may use the liquidity queue to manage its 
daylight overdraft position with the Reserve Bank. The liquidity 
queue can help the institution manage daylight overdraft fees, avoid 
cap breaches, manage bilateral exposures, and so on.

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[[Page 12434]]

    In addition, in its public comment letter the Federal Reserve Bank 
of Chicago identified the delay of time-critical funds transfers used 
to complete the daily cycle of collecting and disbursing margin 
payments in the derivatives markets as a further concern related to the 
general delay of large-value payments. In particular, the Federal 
Reserve Bank of Chicago conducted a confidential study to determine the 
time elapsed between the delivery of payment instructions by clearing 
organizations to money settlement banks and the execution of those 
instructions in relation to the contractual commitments of these banks 
to make timely payments (within one hour). The study provides evidence 
of substantial delays in interbank balancing payments for the exchange-
traded derivatives markets during a period when there were no major 
financial market disruptions. The comment letter states that ``a 
nontrivial percentage was made exceptionally late (3 to 9\1/2\ hours). 
Furthermore, we find that the payments associated with the biggest 
delays tend to have the largest dollar value.'' Overall, the delay of 
key time-critical payments could be a source of added systemic risk 
during periods of financial turbulence, and concerns could extend to 
other organizations. These types of concerns clearly did arise in the 
1987 stock market break.\62\
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    \62\ See the Report of The Presidential Task Force on Market 
Mechanisms, January 1988, for a study of the 1987 stock market 
break.
---------------------------------------------------------------------------

    D. Long-term Reserve Bank intraday credit exposure. Fourth, the 
long-term trend in daylight overdrafts indicates that they have 
continued to grow in both nominal and real terms despite the Reserve 
Banks' charging fees. Chart 3 provides inflation-adjusted annual 
averages of average daylight overdraft values from 1986 to 2007. The 
annualized growth rate of these average daylight overdrafts for about 
the past ten years has been about same as the annualized growth rate of 
the combined value of Fedwire funds and securities transfers. Given the 
demand for intraday liquidity to make payments, it is not clear that a 
policy of continuing to rely heavily on charging fees for daylight 
overdrafts will be successful in limiting growth of the credit risk 
exposure of the Reserve Banks.
[GRAPHIC] [TIFF OMITTED] TN07MR08.003


[[Page 12435]]


    E. Cost burden on the payments system. Fifth, the policy of 
charging fees has become a significant cost burden on the banking 
industry and the payments system. The Federal Reserve has collected 
over $450 million in daylight overdraft fees from the beginning of the 
pricing program in 1994 through the end of 2007. The fees collected 
from depository institutions, however, have increased almost 20 percent 
per year on a compound annualized basis since 2003, with approximately 
$65 million collected in 2007. Chart 4 illustrates this substantial 
growth in fees, especially over the past several years.\63\ To date, no 
losses have been associated with the provision of daylight overdraft 
credit. The growing cost of the daylight overdraft fees to the industry 
raises the question of whether there is a less-expensive and more-
effective way to manage risk.
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    \63\ While the fees have increased substantially over the past 
few years, the largest increase was 35 percent on an annualized 
basis following the implementation of the new policy limiting 
overdrafts of government-sponsored enterprises in July 2006. The fee 
increase is not surprising because the policy shifted the provision 
of intraday credit from the Reserve Banks to depository 
institutions. The PSR policy change for government-sponsored 
enterprises and certain international organizations is available at 
http://www.federalreserve.gov/boarddocs/press/other/2004/20040205/default.htm. (See also 69 FR 57917, September 28, 2004.)
[GRAPHIC] [TIFF OMITTED] TN07MR08.004

    Overall, the challenges with the existing PSR policy suggest that 
significant changes are justified in order to advance its overarching 
risk and efficiency objectives.

IX. Federal Reserve Policy on Payments System Risk

    If the Board adopted these proposed changes, it would amend the 
``Federal Reserve Policy on Payments System Risk'' Section II as 
follows.

Introduction [Revised]
Risks in Payments and Settlement Systems [Revised]
I. Risk Management in Payments and Settlement Systems [No Change]
    A. Scope
    B. General policy expectations
    C. Systemically important systems
    1. Principles for systemically important payments systems
    2. Minimum standards for systemically important securities 
settlement systems and central counterparties
    3. Self-assessments by systemically important systems
II. Federal Reserve Intraday Credit Policies [II and II B through II 
G Revised]
    A. Daylight overdraft definition and measurement [No Change]
    B. Collateral
    C. Pricing
    D. Net debit caps

[[Page 12436]]

    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
    E. Maximum daylight overdraft capacity
    1. General procedure
    2. Streamlined procedure for certain FBOs
    F. 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
    G. Monitoring
    1. Ex post
    2. Real time
    3. Multi-district institutions
    H. Transfer-size limit on book-entry securities [No Change]

Introduction

    Payments and 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 settlement activity 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 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 principles and minimum 
standards for systemically important payments and settlement 
systems.\64\
---------------------------------------------------------------------------

    \64\ 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.
---------------------------------------------------------------------------

    Part I of this policy sets out the Board's views, and related 
principles and minimum standards, regarding the management of risks in 
payments and settlement systems, including those operated by the 
Reserve Banks. In setting out its views, the Board seeks to encourage 
payments and settlement systems, and their primary regulators, to take 
the principles and minimum standards in this policy into consideration 
in the design, operation, monitoring, and assessing of these systems. 
The Board also will be guided by this part, in conjunction with 
relevant laws and other Federal Reserve policies, when exercising its 
authority over certain systems or their participants, when providing 
payments and settlement services to systems, or when providing intraday 
credit to Federal Reserve account holders.
    Part II of this policy governs the provision of intraday credit or 
``daylight overdrafts'' in accounts at the Reserve Banks and sets out 
the general methods used by the Reserve Banks to control their intraday 
credit exposures.\65\ Under this part, the Board explicitly recognizes 
that the Federal Reserve has an important role in providing intraday 
balances and credit to foster the smooth operation of the payments 
system. The Reserve Banks provide intraday balances by way of supplying 
temporary, intraday credit to healthy depository institutions, 
predominantly through collateralized intraday overdrafts at zero 
price.<SUP>66, 67</SUP> The Board believes that such a strategy 
enhances intraday liquidity, while controlling risk to the Reserve 
Banks. Over time, the Board aims to reduce the reliance of the banking 
industry on uncollateralized intraday credit by providing incentives to 
collateralize daylight overdrafts. The Board also aims to limit the 
burden of the policy on healthy depository institutions that use small 
amounts of intraday credit.
---------------------------------------------------------------------------

    \65\ To assist depository institutions in implementing this part 
of the Board's payments system risk policy, the Federal Reserve has 
prepared two documents, the ``Overview of the Federal Reserve's 
Payments System Risk Policy'' and the ``Guide to the Federal 
Reserve's Payments System Risk Policy,'' which are available on line 
at http://www.federalreserve.gov/paymentsystems/PSR/relpol.htm. The 
``Overview of the Federal Reserve's Payments System Risk Policy'' 
summarizes the Board's policy on the provision of intraday credit, 
including net debit caps and daylight overdraft fees. The overview 
is intended for use by institutions that incur only small amounts of 
daylight overdrafts. The ``Guide to the Federal Reserve's Payments 
System Risk Policy'' 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.
    \66\ The term ``depository institution,'' as used in this 
policy, refers not only to institutions defined as ``depository 
institutions'' in 12 U.S.C. 461(b)(1)(A), but also to U.S. branches 
and agencies of foreign banking organizations, Edge and agreement 
corporations, trust companies, and bankers' banks, unless the 
context indicates a different reading.
    \67\ The Board's earlier strategy expected depository 
institutions to manage their accounts effectively while minimizing 
the use of Federal Reserve's intraday credit. The rationale for the 
current strategy is that modern payments and settlement systems 
require significant amounts of intraday balances or liquidity for 
smooth operation. The role of the central bank is to meet reasonable 
market needs of participants in these systems for this liquidity.
---------------------------------------------------------------------------

    Through this policy, the Board expects financial system 
participants, including the Reserve Banks, to reduce and control 
settlement and systemic risks arising in payments and settlement 
systems, consistent with the smooth operation of the financial system. 
This policy is designed to provide intraday balances and credit while 
controlling the Reserve Bank risk by (1) making financial system 
participants and system operators aware of the types of basic risks 
that arise in the settlement process and the Board's expectations with 
regard to risk management, (2) setting explicit risk management 
expectations for systemically important systems, and (3) 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 account holders more specifically, to address the 
risks that may arise through their operation of, or participation in, 
payments and settlement systems.

Risks in Payments and Settlement Systems

    The basic risks in payments and settlement systems are credit risk, 
liquidity risk, operational risk, and legal risk. In the context of 
this policy, these risks are defined as follows.\68\
---------------------------------------------------------------------------

    \68\ These definitions of credit risk, liquidity risk, and legal 
risk are based upon those presented in the Core Principles for 
Systemically Important Payment Systems (Core Principles) and the 
Recommendations for Securities Settlement Systems (Recommendations 
for SSS). 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,'' available at 
http://www.bis.org/publ/bcbs96.htm. Each of these definitions is 
largely consistent with those included in the Recommendations for 
Central Counterparties (Recommendations for CCP).
---------------------------------------------------------------------------

    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.

[[Page 12437]]

    These risks arise between financial institutions as they settle 
payments and other financial transactions and must be managed by 
institutions, both individually and collectively.<SUP>69,</SUP> 
<SUP>70</SUP> Multilateral payments and 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 other financial transactions, 
in turn, could create credit or liquidity problems for other 
participants, the system operator, or depository 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.
---------------------------------------------------------------------------

    \69\ The term ``financial institution,'' as used in this policy, 
includes a broad array of types of organizations that engage in 
financial activity, including depository institutions and securities 
dealers.
    \70\ 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 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.
---------------------------------------------------------------------------

    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. The Board 
explicitly recognizes that the Federal Reserve has an important role in 
providing intraday balances and credit to foster the smooth operation 
of the payments system. To the extent that financial institutions or 
the Reserve Banks are the direct or indirect source of intraday credit, 
they may face a direct risk of loss if daylight overdrafts are 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 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 settlement systems pose to depository institutions 
that participate directly or indirectly in, or provide settlement, 
custody, or credit services to, such systems.

I. Risk Management in Payments and Settlement Systems [No Change]

II. Federal Reserve Intraday Credit Policies [II and II B through II H 
Revised]

    This part outlines the methods used to provide intraday credit to 
ensure the smooth functioning of payments and settlement systems, while 
controlling credit risk to the Reserve Banks associated with such 
intraday credit. These methods include voluntary collateralization of 
intraday credit, a limit on total daylight overdrafts in institutions' 
Federal Reserve accounts, and a fee for uncollateralized daylight 
overdrafts. This part also provides a fee waiver to limit the impact of 
collateralization on depository institutions that use relatively small 
amounts of intraday credit.
    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 Intraday Credit (Overview) and 
the Guide to the Federal Reserve's Payments System Risk Policy on 
Intraday Credit (Guide).\71\ The Overview summarizes the Board's policy 
on the provision of intraday credit, including net debit caps, daylight 
overdraft fees for collateralized and uncollateralized overdrafts, and 
the fee waiver. It is intended for use by institutions that incur only 
small amounts of 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.
---------------------------------------------------------------------------

    \71\ Available at http://www.federalreserve.gov/paymentsystems/PSR/relpol.htm.
---------------------------------------------------------------------------

A. Daylight Overdraft Definition and Measurement [No change]
B. Collateral
    To help meet institutions' demand for intraday balances while 
mitigating Reserve Bank credit risk, the Board supplies intraday 
balances predominantly through explicitly collateralized daylight 
overdrafts provided by Reserve Banks to healthy depository institutions 
at a zero fee.\72\ The Board offers pricing incentives to encourage 
greater collateralization (see section II.C.). To avoid disrupting the 
operation of the payments system and increasing the cost burden on a 
large number of institutions using small amounts of daylight 
overdrafts, the Board allows the use of collateral to be voluntary.
---------------------------------------------------------------------------

    \72\ Collateral is also used to manage risk posed by daylight 
overdrafts of problem institutions (institutions in a weak or 
deteriorating financial condition), entities not eligible for 
Federal Reserve intraday credit (see Section II.F.) and institutions 
that have obtained maximum daylight overdraft capacity (see Section 
II.E.).
---------------------------------------------------------------------------

    Collateral eligibility and margins remain the same for PSR policy 
purposes as for the discount window.\73\ Unencumbered discount window 
collateral can be used to collateralize daylight overdrafts. The pledge 
of in-transit securities remains an eligible collateral option for PSR 
purposes at Reserve Banks' discretion.\74\
---------------------------------------------------------------------------

    \73\ See http://www.frbdiscountwindow.org/ for information on 
the discount window and PSR collateral acceptance policy and 
collateral margins.
    \74\ In-transit securities are book-entry securities transferred 
over the Fedwire Securities Service that have been purchased by a 
depository institution but not yet paid for or owned by the 
institution's customers.
---------------------------------------------------------------------------

C. Pricing
    Under the voluntary collateralization regime, the fee for 
collateralized overdrafts is set at zero, while the fee for 
uncollateralized overdrafts is 50 basis points. The two-tiered fee for 
collateralized and uncollateralized overdrafts is intended to provide a 
strong incentive for a depository institution to pledge collateral to 
its Reserve Bank to reduce or eliminate the institution's 
uncollateralized daylight overdrafts and associated charges for its use 
of intraday credit.
    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 
uncollateralized daylight overdraft charges during the period.
    Daylight overdraft fees for uncollateralized overdrafts (or the 
uncollateralized portion of a partially collateralized overdraft) are 
calculated using an annual rate of 50 basis points, quoted on the basis 
of a 24-hour day and a 360-day year. To obtain the effective annual 
rate for the standard Fedwire

[[Page 12438]]

operating day, the 50-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 
44.79 basis points (50 basis points multiplied by 21.5/24).\75\ The 
effective daily rate is calculated by dividing the effective annual 
rate by 360.\76\ An institution's daily daylight overdraft charge is 
equal to the effective daily rate multiplied by the institution's 
average daily uncollateralized daylight overdraft.
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    \75\ 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.
    \76\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft rate is truncated to 0.0000124.
---------------------------------------------------------------------------

    An institution's average daily uncollateralized daylight overdraft 
is calculated by dividing the sum of its negative uncollateralized 
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. Fully collateralized end-of-minute negative balances 
are similarly set to zero.
    The daily daylight overdraft charge is reduced by a fee waiver of 
$150, which is primarily intended to minimize the burden of the PSR 
policy on institutions that use small amounts of intraday credit. The 
waiver is subtracted from gross fees in a two-week reserve-maintenance 
period.\77\
---------------------------------------------------------------------------

    \77\ The waiver shall not result in refunds or credits to an 
institution.
---------------------------------------------------------------------------

    Certain institutions are subject to a penalty fee and modified 
daylight overdraft fee calculation as described in section II.F. The 
fee waiver is not available to these institutions.\78\
---------------------------------------------------------------------------

    \78\ The fee waiver is not available to Edge and agreement 
corporations, bankers' banks that have not waived their exemption 
from reserve requirements, limited-purpose trust companies, and 
government-sponsored enterprises and international organizations. 
These types of institutions do not have regular access to the 
discount window and, therefore, are expected not to incur daylight 
overdrafts in their Federal Reserve accounts.
---------------------------------------------------------------------------

D. Net Debit Caps
1. Definition
    In accord with sound risk management practices, to limit the amount 
of intraday credit that a Reserve Bank extends to an individual 
institution and the associated risk, each institution incurring 
daylight overdrafts in its Federal Reserve account must adopt a net 
debit cap, that is, a ceiling on the total daylight overdraft position 
that it can incur during any given day. 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.D.2.) and their associated cap levels, 
set as multiples of capital measure, are listed below:

                         Net Debit Cap Multiples
------------------------------------------------------------------------
            Cap category                         Cap multiple
------------------------------------------------------------------------
High................................  2.25
Above average.......................  1.875
Average.............................  1.125
De minimis..........................  0.4
Exempt-from-filing \79\.............  $10 million or 0.20
Zero................................  0
------------------------------------------------------------------------

The cap is applied to the total of collateralized and uncollateralized 
daylight overdrafts. For the treatment of overdrafts that exceed the 
cap, see Section II.G.
---------------------------------------------------------------------------

    \79\ The net debit cap for the exempt-from-filing category is 
equal to thelesser of $10 million or 0.20 multiplied by the capital 
measure.

    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 further limit or prohibit an institution's 
use of Federal Reserve intraday credit if (1) the institution's 
supervisor determines that the institution is unsafe or unsound; (2) 
the institution does not qualify for a positive net debit cap (see 
section II.D.2.); or (3) the Reserve Bank determines that the 
institution poses excessive risk.
    While capital measures differ, the net debit cap provisions of this 
policy apply similarly to foreign banking organizations (FBOs) as 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.\80\ The assessment of creditworthiness is 
based on the institution's supervisory rating and Prompt Corrective 
Action (PCA) designation.\81\ 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

[[Page 12439]]

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 includes a detailed explanation of the self-
assessment process.
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    \80\ 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.
    \81\ An insured depository institution is (1) ``well 
capitalized'' if it significantly exceeds the required minimum level 
for each relevant capital measure, (2) ``adequately capitalized'' if 
it meets the required minimum level for each relevant capital 
measure, (3) ``undercapitalized'' if it fails to meet the required 
minimum level for any relevant capital measure, (4) ``significantly 
undercapitalized'' if it is significantly below the required minimum 
level for any relevant capital measure, or (5) ``critically 
undercapitalized'' if it fails to meet any leverage limit (the ratio 
of tangible equity to total assets) specified by the appropriate 
federal banking agency, in consultation with the FDIC, or any other 
relevant capital measure established by the agency to determine when 
an institution is critically undercapitalized (12 U.S.C. 1831o).
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    Each institution's board of directors must review that 
institution's self-assessment and recommended cap category. The process 
of self-assessment, with board-of-directors review, should be conducted 
at least once in each twelve-month period. A cap determination may be 
reviewed and approved by the board of directors of a holding company 
parent of an institution, provided that (1) the self-assessment is 
performed by each entity incurring daylight overdrafts, (2) the 
entity's cap is based on the measure of the entity's own capital, and 
(3) each entity maintains for its primary supervisor's review its own 
file with supporting documents for its self-assessment and a record of 
the parent's board-of-directors review.\82\
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    \82\ An FBO should undergo the same self-assessment process as a 
domestic bank in determining a net debit cap for its U.S. branches 
and agencies. Many FBOs, however, do not have the same management 
structure as U.S. institutions, and adjustments should be made as 
appropriate. If an FBO's board of directors has a more limited role 
to play in the bank's management than a U.S. board has, the self-
assessment and cap category should be reviewed by senior management 
at the FBO's head office that exercises authority over the FBO 
equivalent to the authority exercised by a board of directors over a 
U.S. institution. In cases in which the board of directors exercises 
authority equivalent to that of a U.S. board, cap determination 
should be made by the board of directors.
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    In applying these guidelines, each institution should maintain a 
file for examiner review that includes (1) worksheets and supporting 
analysis used in its self-assessment of its own cap category, (2) 
copies of senior-management reports to the board of directors of the 
institution or its parent (as appropriate) regarding that self-
assessment, and (3) copies of the minutes of the discussion at the 
appropriate board-of-directors meeting concerning the institution's 
adoption of a cap category.\83\
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    \83\ In addition, for FBOs, the file that is made available for 
examiner review by the U.S. offices of an FBO should contain the 
report on the self-assessment that the management of U.S. operations 
made to the FBO's senior management and a record of the appropriate 
senior management's response or the minutes of the meeting of the 
FBO's board of directors or other appropriate management group, at 
which the self-assessment was discussed.
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    As part of its normal examination, the institution's examiners may 
review the contents of the self-assessment file.\84\ The objective of 
this review is to ensure that the institution has applied the 
guidelines appropriately and diligently, that the underlying analysis 
and method were reasonable, and that the resultant self-assessment was 
generally consistent with the examination findings. Examiner comments, 
if any, should be forwarded to the board of directors of the 
institution. The examiner, however, generally would not require a 
modification of the self-assessed cap category, but rather would inform 
the appropriate Reserve Bank of any concerns. The Reserve Bank would 
then decide whether to modify the cap category. For example, if the 
institution's level of daylight overdrafts constitutes an unsafe or 
unsound banking practice, the Reserve Bank would likely assign the 
institution a zero net debit cap and impose additional risk controls.
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    \84\ 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 net debit cap during a 
two-week reserve-maintenance period and will decide if additional 
action should be taken (see section II.G.).
    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 intraday credit up to the de minimis 
level. The Reserve Banks will review the status of any institution with 
a de minimis net debit cap that exceeds its net debit cap during a two-
week reserve-maintenance period and will decide if additional action 
should be taken (see section II.G.).
    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 whether the exemption should be maintained, the 
institution should be required to file for a cap, or counseling should 
be performed (see section II.G.). 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 intraday 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.F.). Recently chartered

[[Page 12440]]

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.\85\ U.S. capital equivalency is equal to the following
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    \85\ The term ``U.S. capital equivalency'' is used in this 
context to refer to the particular capital measure used to calculate 
net debit caps and does not necessarily represent an appropriate 
capital measure for supervisory or other purposes.
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    <bullet> 35 percent of capital for FBOs that are financial holding 
companies (FHCs) \86\
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    \86\ The Gramm-Leach-Bliley Act defines a financial holding 
company as a bank holding company that meets certain eligibility 
requirements. In order for a bank holding company to become a 
financial holding company and be eligible to engage in the new 
activities authorized under the Gramm-Leach-Bliley Act, the Act 
requires that all depository institutions controlled by the bank 
holding company be well capitalized and well managed (12 U.S.C. 
1841(p)). With regard to a foreign bank that operates a branch or 
agency or owns or controls a commercial lending company in the 
United States, the Act requires the Board to apply comparable 
capital and management standards that give due regard to the 
principle of national treatment and equality of competitive 
opportunity (12 U.S.C. 1843(l)).
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    <bullet> 25 percent of capital for FBOs that are not FHCs and have 
a strength of support assessment ranking (SOSA) of 1 \87\
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    \87\ The SOSA ranking is composed of four factors, including the 
FBO's financial condition and prospects, the system of supervision 
in the FBO's home country, the record of the home country's 
government in support of the banking system or other sources of 
support for the FBO; and transfer risk concerns. Transfer risk 
relates to the FBO's ability to access and transmit U.S. dollars, 
which is an essential factor in determining whether an FBO can 
support its U.S. operations. The SOSA ranking is based on a scale of 
1 through 3, with 1 representing the lowest level of supervisory 
concern.
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    <bullet> 10 percent of capital for FBOs that are not FHCs and are 
ranked a SOSA 2
    <bullet> 5 percent of ``net due to related depository 
institutions'' for FBOs that are not FHCs and are ranked a SOSA 3
An FBO that is a FHC or has a SOSA rating of 1 may be eligible for a 
streamlined procedure (see Section II.E.) for obtaining additional 
collateralized intraday credit under the maximum daylight overdraft 
capacity provision.
    Granting a net debit cap, or any extension of intraday credit, to 
an institution is at the discretion of the Reserve Bank. In the event a 
Reserve Bank grants a net debit cap or extends intraday credit to a 
financially healthy SOSA 3-ranked FBO, the Reserve Bank may require 
such credit to be fully collateralized, given the heightened 
supervisory concerns with SOSA 3-ranked FBOs.
E. Maximum Daylight Overdraft 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 payments systems may function effectively and 
efficiently and to remove barriers, as appropriate, to foster risk-
reducing payments 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>88 89</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 
payments system initiatives.\90\ The Board believes that providing 
extra liquidity to these few institutions should help prevent 
liquidity-related market disruptions.
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    \88\ 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.
    \89\ 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.
    \90\ Institutions may consider applying for a maximum daylight 
overdraft capacity level for daylight overdrafts resulting from 
Fedwire funds transfers, Fedwire book-entry securities transfers, 
National Settlement Service entries, and ACH credit originations. 
Institutions incurring daylight overdrafts as a result of other 
payment activity may be eligible for administrative counseling 
flexibility (59 FR 54915-18, Nov. 2, 1994).
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1. General Procedure
    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. 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.
    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 =
net debit cap +
collateralized capacity \91\
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    \91\ 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 net debit cap.

    The Reserve Banks will review the status of any institution that 
exceeds its maximum daylight overdraft capacity 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.G.).
    Institutions with exempt-from-filing and de minimis net debit caps 
may not obtain additional daylight overdraft

[[Page 12441]]

capacity by pledging additional 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 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.
2. Streamlined Procedure for Certain FBOs
    An FBO that is a FHC or has a SOSA rating of 1 and has a self-
assessed net debit cap may request from its Reserve Bank a streamlined 
procedure under the maximum daylight overdraft capacity provision. 
These FBOs are not required to provide documentation of the business 
need or obtain the board of directors' resolution for collateralized 
capacity in an amount that exceeds its current net debit cap (which is 
based on up to 35 percent worldwide capital times its cap multiple), as 
long as the requested additional capacity is 100 percent or less of 
worldwide capital times a self-assessed cap multiple.\92\ In order to 
ensure that intraday liquidity risk is managed appropriately and that 
the FBO will be able to repay daylight overdrafts, eligible FBOs under 
the streamlined procedure will be subject to initial and periodic 
reviews of liquidity plans that are analogous to the liquidity reviews 
undergone by U.S. institutions.\93\ If an eligible FBO requests 
capacity in excess of 100 percent of worldwide capital times the self-
assessed cap multiple, it would be subject to the general procedure.
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    \92\ For example, a financial holding company is eligible for 
uncollateralized capacity of 35 percent of worldwide capital times 
the cap multiple. The streamlined max cap procedure would provide 
such an institution with additional collateralized capacity of 65 
percent of worldwide capital times the cap multiple.
    \93\ The liquidity reviews will be conducted by the 
administrative Reserve Bank, in consultation with each FBO's home 
country supervisor.
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F. 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.\94\ Institutions that have been 
assigned a zero cap by their Reserve Banks are also subject to special 
considerations under this policy based on the risks they pose. In 
developing its policy for these institutions, the Board has sought to 
balance the goal of reducing and managing risk in the payments system, 
including risk to the Federal Reserve, with that of minimizing the 
adverse effects on the payments operations of these institutions.
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    \94\ 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 completed privatization at 
the end of 2004. The Reserve Banks no longer act as fiscal agents 
for new issues of Sallie Mae securities, and Sallie Mae is not 
considered a GSE.
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    Regular access to the Federal Reserve discount window generally is 
available to institutions that are subject to reserve requirements. If 
an institution that is not subject to reserve requirements and thus 
does not have regular discount-window access were to incur a daylight 
overdraft, the Federal Reserve might end up extending overnight credit 
to that institution if the daylight overdraft were not covered by the 
end of the business day. Such a credit extension would be contrary to 
the quid pro quo of reserves for regular discount-window access as 
reflected in the Federal Reserve Act and in Board regulations. Thus, 
institutions that do not have regular access to the discount window 
should not incur daylight overdrafts in their Federal Reserve accounts.
    Certain institutions are subject to a daylight-overdraft penalty 
fee levied against the average daily daylight overdraft incurred by the 
institution. These include Edge and agreement corporations, bankers' 
banks that are not subject to reserve requirements, and limited-purpose 
trust companies. The annual rate used to determine the daylight-
overdraft penalty fee is equal to the annual rate applicable to the 
daylight overdrafts of other institutions (50 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.\95\ 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.F.
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    \95\ Under the current 21.5-hour Fedwire operating day, the 
effective daily daylight-overdraft penalty rate is truncated to 
0.0000373.
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    Institutions that are subject to the daylight-overdraft penalty fee 
are not eligible for the $150 fee waiver and are subject to a minimum 
fee of $25 on any daylight overdrafts incurred in their Federal Reserve 
accounts.\96\ While such institutions may be required to post 
collateral (see sections II.F.), they are not eligible for the lower 
fee associated with collateralized daylight overdrafts.
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    \96\ 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 \97\
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    \97\ These institutions are organized under section 25A of the 
Federal Reserve Act (12 U.S.C. 611-631) or have an agreement or 
undertaking with the Board under section 25 of the Federal Reserve 
Act (12 U.S.C. 601-604(a)).
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    Edge and agreement corporations should refrain from incurring 
daylight overdrafts in their Federal Reserve accounts. In the event 
that any daylight overdrafts occur, the Edge or agreement corporation 
must post collateral to cover the overdrafts. In addition to posting 
collateral, the Edge or agreement corporation would be subject to the 
daylight-overdraft penalty rate levied against the average daily 
daylight overdrafts incurred by the institution, as described above.
    This policy reflects the Board's concerns that these institutions 
lack regular access to the discount window and that the parent company 
may be unable or unwilling to cover its subsidiary's overdraft on a 
timely basis. The Board notes that the parent of an Edge or agreement 
corporation could fund its subsidiary during the day over Fedwire or 
the parent could substitute itself for its subsidiary on private 
systems. Such an approach by the parent could both reduce systemic risk 
exposure and permit the Edge or agreement corporation to continue to

[[Page 12442]]

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 \98\
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    \98\ 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 204) because it is organized 
solely to do business with other financial institutions, is owned 
primarily by the financial institutions with which it does business, 
and does not do business with the general public. Such bankers' 
banks also generally are not eligible for Federal Reserve Bank 
credit under the Board's Regulation A (12 CFR 201.2(c)(2)).
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    Bankers' banks are exempt from reserve requirements and do not have 
regular access to the discount window. They do, however, have access to 
Federal Reserve payments services. Bankers' banks should refrain from 
incurring daylight overdrafts and must post collateral to cover any 
overdrafts they do incur. In addition to posting collateral, a bankers' 
bank would be subject to the daylight-overdraft penalty fee levied 
against the average daily daylight overdrafts incurred by the 
institution, as described above.
    The Board's policy for bankers' banks reflects the Reserve Banks' 
need to protect themselves from potential losses resulting from 
daylight overdrafts incurred by bankers' banks. The policy also 
considers the fact that some bankers' banks do not incur the costs of 
maintaining reserves as do some other institutions and do not have 
regular access to the discount window.
    Bankers' banks may voluntarily waive their exemption from reserve 
requirements, thus gaining access to the discount window. Such bankers' 
banks are free to establish net debit caps and would be subject to the 
same policy as other institutions. The policy set out in this section 
applies only to those bankers' banks that have not waived their 
exemption from reserve requirements.
3. Limited-Purpose Trust Companies \99\
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    \99\ 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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    The Federal Reserve Act permits the Board to grant Federal Reserve 
membership to limited-purpose trust companies subject to conditions the 
Board may prescribe pursuant to the Act. As a general matter, member 
limited-purpose trust companies do not accept reservable deposits and 
do not have regular discount-window access. Limited-purpose trust 
companies should refrain from incurring daylight overdrafts and must 
post collateral to cover any overdrafts they do incur. In addition to 
posting collateral, limited-purpose trust companies would be subject to 
the same daylight-overdraft penalty rate as other institutions that do 
not have regular access to the discount window.
4. Government-Sponsored Enterprises and International Organizations
    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.
G. 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. Overdrafts above the cap for institutions with de minimis, self-
assessed and max caps may be treated differently, depending on whether 
the overdraft is collateralized.\100\ If the overdraft is fully 
collateralized, the Reserve Bank may consider the condition an 
overlimit situation and may waive counseling for two incidents of 
overlimit, fully collateralized overdrafts per two consecutive two-week 
reserve-maintenance periods (the total of four weeks). If instances of 
overlimit, fully collateralized overdrafts are beyond the approved 
number of overlimit incidents or if any part of the overdraft is 
uncollateralized, the Reserve Bank will apply normal counseling 
procedures.
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    \100\ There are no changes in monitoring of exempt institutions: 
overdrafts above the exempt cap limit, regardless of whether such 
overdrafts are collateralized or uncollateralized, should no more 
than twice in two consecutive two-week reserve-maintenance periods 
(the total of four weeks).
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    Each Reserve Bank retains the right to protect its risk exposure 
from individual institutions by unilaterally reducing net debit caps, 
imposing (additional) 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 (additional) collateral.\101\
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    \101\ 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

[[Page 12443]]

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.\102\ 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.\103\
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    \102\ 12 U.S.C. 3101-3108.
    \103\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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H. Transfer-Size Limit on Book-Entry Securities [No change]

    By order of the Board of Governors of the Federal Reserve 
System, February 28, 2008.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 08-971 Filed 3-6-08; 8:45 am]
BILLING CODE 6210-01-P


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