Mr. Kelley reports on the Year 2000 progress of the banking and financial
Testimony of Mr. Edward W. Kelley, Jr., a member of the
services sector in the United States
Board of Governors of the US Federal Reserve System, on the Year 2000 progress of the banking
and financial services sector, before the Committee on Banking and Financial Services of the US
House of Representatives on 17/9/98.
Thank you for again inviting me to appear before this Committee to discuss the
Year 2000 issue. This problem poses a major challenge to public policy: the stakes are enormous,
nothing less than the preservation of a safe and sound financial system that can continue to
operate in an orderly manner when the clock rolls over at midnight on New Year's Eve and the
millennium arrives. The Year 2000 problem will touch much more than just our financial
systems and could temporarily have adverse effects on the performance of the overall US
economy as well as the economies of many, or all, nations if not corrected. As I said last April in
testimony before the Senate Committee on Commerce, Science, and Transportation, some of the
more adverse scenarios are not without a certain plausibility, if this challenge were being
ignored. But it is not being ignored. While it is impossible today to precisely forecast the impact
of this event, and the range of possibilities runs from minimal to extremely serious, an enormous
amount of work is being done in anticipation of the rollover of the millennium, and I am
optimistic that this work will pay off.
In that spirit, let me update you on what the Federal Reserve has done to address
the Year 2000 issue. Since I last testified here in November 1997, the Federal Reserve has met
the goals that we set for ourselves. We have:
• renovated our mission-critical applications and nearly completed our internal
testing;
• opened our mission-critical systems to customers for testing;
• progressed significantly in our contingency planning efforts;
• implemented a policy concerning changes to our information systems; and
concluded our initial review of all banks subject to our supervisory authority.
•
While these accomplishments are indicative of our significant progress in
addressing the Year 2000 issue, much work remains. In the testing area, we are finalizing plans
for concurrent testing of multiple mission-critical applications by customers. We are
coordinating with the Clearing House for Interbank Payment Systems (CHIPS) and the Society
for Worldwide Interbank Financial Telecommunications (SWIFT) to provide a common test day
for customers of Fedwire and these two systems. We have a System-wide project underway to
enhance our contingency plans to address failures external to the Federal Reserve. We are
conducting a second round of supervisory reviews of banks subject to our supervisory authority
and also actively coordinating with various domestic and international Year 2000 organizations.
This morning I would like to discuss these achievements and the important aspects of the job that
remain ahead of us.
Federal Reserve Readiness
The Federal Reserve has completed the renovation of its mission-critical systems,
and we are nearing the conclusion of our internal Year 2000 testing efforts. Internal testing
includes both individual applications and application interfaces, such as the exchange of data
between Fedwire and our Integrated Accounting System. Testing is conducted through a
combination of two elements: one is future-dating our computer systems to verify the readiness
of our information technology, and the other is testing critical future date processing within our
business applications. Communications network components are also being tested and certified
in special test lab environments at the Federal Reserve Automation Services and the Board of
Governors. The Reserve Banks and the Board have implemented test century date change (CDC)
local area networks to verify the readiness of vendor provided products and internal applications
that operate in network-based computing environments. With the exception of a few systems that
will be replaced by March 1999, we will complete the testing activities and implement our
mission-critical applications in production by year-end 1998.
On June 29, 1998, we made our future-dated test environment available to
customers for Year 2000 testing; the crucial testing period will extend through 1999. Depository
institutions which are Federal Reserve customers, and thus rely on our payment applications such
as Fedwire, Fed ACH, and check processing systems, can test century rollover and leap year
transactions six days a week. On six weekends this fall, depository institutions will be able to test
Year 2000 test dates with several applications simultaneously. We are providing assistance to our
customers who test with us, and have provided them, through a series of Century Date Change
bulletins, with technical information and guidelines concerning the testing activity.
By the end of August, almost 400 customers, including the US Treasury, had
conducted CDC testing with the Federal Reserve, and the number scheduling tests is increasing
rapidly. These tests encompass ten of our mission-critical applications. To ensure that the
nation's larger banks are taking advantage of this testing opportunity, we intend to contact any
that have not availed themselves of this service. Several foreign banking organizations have
begun to test large dollar payment systems with the Federal Reserve and CHIPS. Most large
foreign banks will participate in the September 26, 1998, coordinated test in which Fedwire,
CHIPS, and SWIFT are participating.
Like most information technology environments, ours are composed primarily of
vendor hardware and software products. To assess the Year 2000 readiness of these
environments, as well as our building systems such as vault and climate control systems, we have
created an automated inventory of the vendor products that we use and are tracking the Year
2000 compliance status of those products. Although the Federal Reserve has made progress in
independently testing vendor products, we will continue these efforts.
In prior testimony, I have noted the critical dependence of banks on
telecommunication services and the need to ensure the readiness of telecommunication service
providers. To foster a better understanding of the importance of information sharing by the
telecommunications industry, I wrote to Federal Communications Commissioner Powell about
this issue. Commissioner Powell has been responsive and has provided us and others with
information regarding the FCC's oversight and plans. The Federal Reserve is also participating in
the Telecommunications Sector Group of the President's Council on Year 2000 Conversion. In
addition, the Federal Reserve is monitoring telecommunication carriers to assess whether those
used by the Federal Reserve will be Year 2000 compliant. We are pleased with the
responsiveness of the telecommunications industry: plans for industry testing are well under way,
with participation from the major service providers, as well as their suppliers.
Contingency Planning
As the nation's central bank, the Federal Reserve is actively engaged in
contingency planning for both operational disruptions and systemic risks. An internal CDC
Council consisting of senior managers is coordinating contingency planning across the Federal
Reserve's various functions and is fostering a cohesive approach to internal readiness and
interaction with the financial community. In general, the banking industry's focus has also
progressed from the renovation of systems to business continuity and contingency planning.
Contingency planning for the Federal Reserve includes payments systems, currency availability
and distribution, information processing, the discount window, and the supervision function. We
will also play an important role in coordinating with the financial community concerning issues
such as systemic risk and cross-border payments.
Operational Contingency
The Federal Reserve's plans for operational continuity build on existing
contingency plans. As you know, we have long maintained comprehensive contingency plans
that are routinely tested and have been implemented during natural disasters and other
disruptions. These plans cover our internal systems, as well as the services we provide to
depository institutions. In June 1998, each of the Federal Reserve's business offices completed
assessments of the adequacy of existing contingency scenarios to address CDC risks.
Federal Reserve CDC contingency workgroups are identifying problems external
to the Federal Reserve that may arise when the date changes to 2000, such as those affecting
telecommunications providers, large financial institutions, utility companies, other key financial
market participants, and difficulties abroad that affect US markets or institutions. The
workgroups are developing corresponding recommendations to mitigate those problems. The
Federal Reserve plans to finalize contingency plans reflecting these recommendations by
November 30, 1998. We will continue to refine our CDC contingency plans as necessary
throughout 1999. In fourth quarter 1998, we will focus our efforts on how to test our contingency
plans to ensure their operational effectiveness at the century rollover.
Change Management
As a part of our operational readiness planning, the Federal Reserve is developing
procedures to manage the risks posed by changes to information systems in 1999 and the first
quarter of 2000. After the scheduled completion of testing and implementation of our critical
applications, changes to Federal Reserve policies, rules, regulations, and services that generate
changes to critical information systems create the risk that those systems may no longer be CDC
compliant. Consequently, we have established guidelines to significantly limit policy and
operational changes, as well as internal hardware and software changes, during late 1999 and
early 2000 in order to minimize the risks and complexities of problem resolution associated with
the introduction of new processing components.
By limiting changes to our systems, we will not only provide a stable internal
processing environment entering the Year 2000, but we will also minimize changes that our
customers could be required to make to their applications that interface with our software. In
addition, we intend to aggressively coordinate with other institutions that typically generate
policy and operational changes in the financial industry. We intend to publish our guidelines to
assist other organizations facing similar issues and I would urge that Congress, as well as other
federal agencies, consider adoption of such change management policies as we move into 1999.
Currency
As I noted earlier, cash availability and processing is an issue we have considered
in the contingency planning process. We have regularly met the public's heightened demand for
US currency in peak seasons or in extraordinary situations, such as natural disasters. We recently
submitted our fiscal year 1999 currency printing order to the Department of the Treasury's
Bureau of Engraving and Printing and we increased the size of next year's print order due to
Year 2000 considerations. With this order, we will substantially increase the amount of currency
either in circulation or in Federal Reserve vaults over current levels by late 1999. We believe this
increase in the level of currency should be ample to meet the public's demand for extra cash
during the period surrounding the century rollover. This is a precautionary step on our part -- we
believe it is prudent to print more currency than we think will be required than to risk not
printing enough. While we do not anticipate any extraordinary demand for cash, we believe it is
important that the public have complete confidence that sufficient supplies of currency will be
available. In effect, the Federal Reserve is accelerating the timing of currency printing; we are
planning for a possible short-lived increased demand for cash and will be able to reduce future
print orders to lower-than-normal levels.
As we monitor the public's demand for currency, we can introduce other measures
to further increase cash levels. First, the recent currency order with the Bureau of Printing and
Engraving is for the federal fiscal year 1999, so that there will be time to print additional notes in
the last three months of 1999. Second, we can change the print order to increase production of
higher denomination notes. Third, we can increase staff in Reserve Bank cash operation
functions to improve the turnaround time required to process cash deposits and move currency
back into circulation. Finally, as a last resort, we can hold off the destruction of old or worn
currency.
Liquidity
Another contingency planning issue for the Federal Reserve is liquidity. Despite
their best efforts, some depository institutions could encounter problems in the rollover in
maintaining reliable computer systems, and these problems may or may not affect their funding
positions. To the extent necessary, the Federal Reserve is prepared to lend, in appropriate
circumstances and with adequate collateral, to depository institutions when market sources of
funding are not reasonably available. The terms and conditions of such lending may depend upon
the circumstances causing the liquidity shortfall.
Financial Sector Initiatives
The Federal Reserve and private industry have intensified cooperative efforts to
address contingency planning. The Year 2000 Contingency Planning Working Group of the New
York Clearing House (NYCH), the Securities Industry Association (SIA), and the Federal
Reserve are developing coordinated contingency plans for the Year 2000 and will act as liaison
with other industry groups addressing contingency planning on behalf of banks, securities firms,
exchanges, clearance and settlement organizations, regulators, and international markets. Among
other things, the Working Group is considering plans for the establishment of Year 2000
communications centers throughout the country, and perhaps internationally. Primarily, such
centers would facilitate the exchange of up-to-date information on developing problems and
issues among participants and enhance the development of consensus, when necessary, to
coordinate timely responses to problems.
The Federal Reserve is assisting in the government's coordination of the Year
2000 effort within the financial industry by participating in the Financial Institutions Sector
Group of the President's Council on Year 2000 Conversion. A senior Board official who chairs
this Sector Group has been working with representatives of government financial organizations,
including the federal banking agencies, the Department of the Treasury, the Securities and
Exchange Commission, and other agencies responsible for various financial intermediaries, to
assess the Year 2000 readiness of the financial industry and formulate strategies for addressing
interagency Year 2000 issues.
Bank Supervision
I would now like to turn to our industry oversight activities. The Federal Reserve
met its goal, set in May 1997, of conducting a Year 2000 supervisory review of all banks subject
to our supervisory authority by June 1998. This public commitment and visible effort did much
to stimulate industry action on the Year 2000 issue. We have also established ties and are
providing significant support to numerous public and private groups, both domestic and
international, that are addressing the Year 2000 readiness of their respective constituencies.
As part of our outreach program, we continually emphasize the critical
significance of ensuring that computer systems and applications are Year 2000 compliant and the
complexity of the managerial and technological challenges that the required effort presents for all
enterprises. For entities such as financial institutions that rely heavily on computers to provide
financial services to customers, achieving Year 2000 compliance in mission-critical systems is
essential for maintaining the quality and continuity of customer services.
While bank supervisors can provide guidance, encouragement, and strong formal
and informal supervisory incentives to the banking industry to address this challenge, it is
important to recognize that we cannot be ultimately responsible for ensuring or guaranteeing the
Year 2000 readiness and viability of the banking organizations we supervise. Rather, the boards
of directors and senior management of banks and other financial institutions must be responsible
for ensuring that the institutions they manage are able to provide high quality and continuous
services from the first day in January of the Year 2000. As we have emphasized continually
during the past sixteen months, this critical obligation must be among the very highest of
priorities for bank management and boards of directors.
Policy Guidance and Supervisory Reviews
The Federal Reserve continues to work closely with the other banking agencies
that comprise the Federal Financial Institutions Examination Council (FFIEC) to address the
banking industry's Year 2000 readiness. A series of seven advisory statements has been issued
since I was last here in November 1997, including statements on the nature of Year 2000
business risk, the importance of service provider readiness, the means to address customer risk,
the need to respond to customer inquiries, the critical importance of testing, the urgency of
effective contingency planning, and the need to address the readiness of fiduciary activities. As a
result of these advisory statements, the extent of the industry's Year 2000 efforts has
significantly intensified. These statements can be found in their entirety at
http://www.federalreserve.gov/Y2K.
Compliance with these statements is assessed during the conduct of supervisory
reviews. Through June 30, the Federal Reserve had conducted reviews of approximately 1,600
organizations. Information and data collected during these reviews has proven to be reliable,
consistent with our overall supervisory experience which is heavily dependent on an extensive
on-site examination program. These reviews have resulted in a significant focus of attention on
the subject matter within the industry and identified several issues warranting additional attention
by the supervisors, particularly the need for the supplemental guidance on testing and
contingency planning. It is critical that banks avail themselves of every opportunity to test
mission-critical systems internally and with their counterparties, and recurring testing may be
warranted as additional systems are renovated to assure that those systems already tested are not
adversely affected.
Based on the reviews completed by the Federal Reserve, the vast majority of
banking organizations are making satisfactory progress in their Year 2000 planning and readiness
efforts. About four percent are rated "needs improvement" and fewer than one percent are rated
"unsatisfactory". In these cases, the Federal Reserve has initiated intensive supervisory
followup. Working closely with state banking departments, the Federal Reserve is making a concerted
effort to focus additional attention on those particular banking organizations that are deemed
deficient in their Year 2000 planning and progress.
Deficient organizations have been informed of their status through supervisory
review comments, meetings with senior management or the board of directors, and deficiency
notification letters calling for submission of detailed plans and formal responses to the
deficiencies noted. Such organizations are then subject to increased monitoring and supervisory
follow-up including more frequent reviews. Restrictions on expansionary activities by Year 2000
deficient organizations have also been put into place. As a result of these letters, organizations
once deemed deficient have taken significant steps to enhance their Year 2000 programs and
over half have been upgraded to satisfactory.
The Federal Reserve has commenced Phase II of its supervision program which
covers the nine months from July 1998 through March 1999. During this second phase, we will
conduct another round of supervisory reviews focused on Year 2000 testing and contingency
planning. In addition, we have committed to conducting another review of the information
systems service providers and will distribute the results to the serviced banks.
Assessment of Review Results
Based on these reviews and other interactions with the industry, it appears that
financial institution progress in renovating mission-critical systems has advanced notably since
the Federal Reserve and the other banking agencies escalated efforts to focus the industry's
attention on ensuring Year 2000 readiness. Banking organizations are making substantial
headway toward Year 2000 readiness and, with some exceptions, are on track to meet FFIEC
guidelines.
Specifically, the FFIEC guidelines call for the completion of internal testing of
mission critical systems by year-end 1998. Most large organizations are nearing completion of
the renovation of their mission-critical systems and are vigorously testing those that have been
renovated. Smaller organizations are working closely with their service providers in an effort to
confirm that the efforts under way will assure the readiness and reliability of the services and
products on which they depend.
Information Systems Service Providers
The banking agencies are examining the Year 2000 readiness of certain
information systems service providers and software vendors that provide services and products to
a large number of banking organizations. These examinations are often conducted on an
interagency basis. The Federal Reserve has participated in reviews of sixteen national service
providers and twelve national software vendors. In addition, the banking agencies are examining
selected regional service providers and software vendors.
These examinations assess the overall Year 2000 program management of the
firms and confirm their plans to support products for Year 2000 readiness. To help banking
organizations assess the Year 2000 readiness and dependability of their service providers and to
encourage examined service providers to cooperate fully with the industry's efforts, the banking
agencies are distributing the results of Year 2000 reviews of service providers and software
vendors to the serviced banks. The information in the reports is not a certification of the
readiness of the service provider, and it is still incumbent on each bank to work closely with its
service providers to prepare for the century date change. Service providers and software vendors
serving the banking industry are keenly aware of the industry's reliance on their products and
services, and most consider their Year 2000 readiness to be their highest priority in order for
them to remain competitive in an aggressive industry.
Credit Quality
FFIEC guidelines call for banks to have a plan to assess customer Year 2000
readiness by June 30, 1998, and to complete an assessment of their customers' Year 2000
readiness by September 30, 1998, in order to better understand the risks faced by the bank if
customers are unable to meet their obligations on a timely basis. Even though our Phase I Year
2000 examinations were conducted before the June 30, 1998, milestone, our examiners noted
that most organizations either had begun planning or had initiated their customer assessment
programs.
We have seen no signs that credit quality has deteriorated as a result of Year 2000
readiness considerations, although it is still early. Results from a Federal Reserve Senior Loan
Officer Opinion Survey on Bank Lending Practices (May 1998) indicated that respondents
generally include Year 2000 preparedness in their underwriting and loan review standards.
Another survey of Senior Loan Officers is to be conducted in November in order to obtain a
more timely picture of any deterioration in credit quality related to the Year 2000.
Efforts have also been made to prompt the nation's largest banks that syndicate
large loans to address the Year 2000 readiness of their borrowers. Through the Shared National
Credit Program, banks that syndicate credits over $20 million are asked to provide the banking
agencies with information pertaining to the banks' efforts to assess the readiness of the
borrowers. This initiative has helped large lenders understand that they need to consider their
customers' readiness in their risk management programs.
Additional Outreach Initiatives
The Federal Reserve is participating in numerous outreach initiatives with the
banking industry, trade associations, regulatory authorities, and other groups that are hosting
conferences, seminars, and training opportunities focusing on the Year 2000 and helping
participants understand better the issues that need to be addressed. Partly in response to the
requirements of the Examination Parity and Year 2000 Readiness for Financial Institutions Act,
which calls for the banking agencies to conduct seminars for bankers on the Year 2000, the
federal banking agencies have been working with state banking departments as well as national
and local bankers' associations to develop coordinated and comprehensive efforts at improving
the local and regional programs intended to focus attention on the Year 2000. In the first six
months of 1998, the Federal Reserve has participated in over 230 outreach initiatives reaching
over 14,000 bankers. Another 100 outreach initiatives are scheduled for the third quarter of 1998.
In addition, our public web site provides extensive information on our Year 2000 supervision
program and on other resources available to the industry to help prepare for the millennium.
International Coordination
International cooperation on Year 2000 has intensified over the past several
months because of the efforts of the public sector Joint Year 2000 Council (Joint Council) and
the private sector Global 2000 Coordinating Group (G-2000). As you recall from your hearings
on international issues in June, Mr. Ernest Patrikas, then Chairman of the Joint Council and a
senior official of the Federal Reserve Bank of New York, testified on the global efforts of the
Joint Council to enhance international initiatives by financial regulators. His successor as
Chairman of the Joint Council, Federal Reserve Governor Roger Ferguson, is continuing those
efforts and is working closely with an external consultative committee composed of
representatives from international financial services providers, international financial market
associations, financial rating agencies, and a number of other international industry associations.
The Joint Council is working to foster better awareness and understanding of Year 2000 issues
on the part of regulators around the world; for example, the Joint Council is sponsoring a series
of regional seminars for banking, insurance, and securities supervisors.
The G-2000 includes more than forty financial institutions from over twenty
countries that are addressing country assessments, testing, and contingency planning, as well as
other issues. The group has developed a standard framework for assessing individual country
preparations for the century date change and also will address the Year 2000 readiness of
financial institutions, service providers, and the countries' infrastructures. This framework is
being used to collect information and assess the readiness of about twenty major countries by the
end of this year, with others scheduled for in-depth reviews in 1999.
The Basle Committee on Banking Supervision continues to be active on Year
2000 issues, both within the Joint Council and separately, as part of its normal supervisory
activities. Year 2000 will be a major issue to be discussed at the International Conference of
Bank Supervisors in October. The Basle Committee is also planning a follow-up survey on Year
2000 progress.
Closing Remarks
Financial institutions have made significant progress in renovating their systems
to prepare for the Year 2000 and much has been accomplished to ensure the continuation of
reliable services to the banking public at the century rollover. We are committed to a rigorous
program of industry testing and contingency planning and, through our supervisory initiatives, to
identifying those organizations that most need to apply additional attention to Year 2000
readiness. The Federal Reserve has renovated its mission-critical applications, and we are
nearing the completion of our internal testing activities. To manage the risks posed by
subsequent changes to these systems, the Federal Reserve has instituted guidelines to
significantly limit policy, operational, hardware, and software changes during late 1999 and early
2000. Going forward, we will continue our industry and international coordination efforts,
including participation in the President's Council on Year 2000 Conversion, the Joint Year 2000
Council, and trade associations, to assist the industry in preparing for the Year 2000.
In closing, I would like to thank the Committee for its extensive efforts to focus
the industry's attention on this significant matter. Awareness of the extent and importance of this
challenge is a critical first step in meeting it, and the Committee's participation has been most
helpful.