The Federal Reserve System is involved in many facets of wholesale and retail payment systems in the United States, including providing wire transfers of funds and securities; providing for the net settlement of check clearing arrangements, automated clearinghouse (ACH) networks, and other types of payment systems; clearing checks and ACH payments; and regulating certain financial institutions and overseeing certain payment systems. Responding in part to a breakdown of the check-collection system in the early 1900s, Congress established the Federal Reserve System as an active participant in the payment system in 1913. The Federal Reserve Act directs the Federal Reserve System to provide currency in the quantities demanded by the public and authorizes the Federal Reserve System to establish a nationwide check clearing system, which has resulted in the Federal Reserve System’s becoming a major provider of check clearing services. Congress modified the Federal Reserve System’s role in the payment system through the Monetary Control Act of 1980 (MCA). One purpose of the MCA is to promote an efficient nationwide payment system by encouraging competition between the Federal Reserve System and private- sector providers of payment services. The MCA requires the Federal Reserve System to charge fees for its payment services, which are to be set to recover, over the long run, all direct and indirect costs of providing the services. Before the MCA, the Federal Reserve System provided payment services to its member banks for no explicit charge. The MCA expanded access to Federal Reserve System services, allowing the Federal Reserve System to offer services to all depository institutions, not just member banks. Congress again expanded the role of the Federal Reserve in the payment system in 1987 when it enacted the Expedited Funds Availability Act.This act expanded the Federal Reserve Board’s authority to regulate certain aspects of check payments that are not processed by the Federal Reserve System. Through specific regulatory authority and its general authority as the central bank, the Federal Reserve plays an important role in the oversight of the nation’s payment systems. The Federal Reserve Board has outlined its policy regarding the oversight of private-sector clearance and settlement systems in its Policy Statement on Payment Systems Risk. The second part of this policy incorporates risk management principles for such systems. The Federal Reserve System competes with the private sector in providing wholesale payment services. Wholesale payment systems are designed to clear and settle time-critical and predominantly large-value payments.The two major wholesale payment systems in the United States are the Fedwire funds transfer system, owned and operated by the Federal Reserve System, and the Clearing House Interbank Payments System (CHIPS), which is owned and operated by the Clearing House Service Company LLC, a subsidiary of the New York Clearing House Association LLC (NYCHA) for use by the participant owners of the Clearing House Interbank Payments Company LLC (CHIPCo). Fedwire is a real-time gross settlement (RTGS) system through which transactions are cleared and settled individually on a continuous basis throughout the day. CHIPS began operations in 1970 as a replacement for paper-based payments clearing arrangements. Since January 22, 2001, CHIPS has operated as a real-time settlement system. Payment orders sent over CHIPS are either simultaneously debited/credited to participants’ available balances or have been netted and set off with other payment orders and the resulting balance is debited/credited against participants’ available balances throughout the day. The transfer of balances into CHIPS and payments out occur via Fedwire. The Federal Reserve System oversees CHIPS’ compliance with its Policy Statement on Payment Systems Risk. The size and aggregate levels of wholesale transactions necessitate timely and reliable settlement to avoid the risk that settlement failures would pose to the financial system. Although wholesale payments constitute less than 0.1 percent of the total number of transactions of noncash payments, they represent 80 percent of the total value of these payments. Moreover, in 1999, the value of payment flows through the two major wholesale systems in the United States, Fedwire and CHIPS, was approximately 69 times the U.S. gross domestic product in that year. The Federal Reserve System also competes with the private sector in providing retail payment services. For example, the Federal Reserve System provides ACH and check clearing services. ACH systems are an important mechanism for high-volume, moderate to low-value, recurring payments, such as direct deposit of payrolls; automatic payment of utility, mortgage, or other bills; and other business- and government-related payments. The Federal Reserve System also competes with private-sector providers of check clearing services. To do this, the Federal Reserve operates a nationwide check clearing service with 45 check processing sites located across the United States. The Federal Reserve System’s market share of payment services as of year- end 1999 is represented in table 1. During forums held by the Federal Reserve System’s Committee on the Federal Reserve System in the Payments Mechanism, held in May and June, 1997, committee members and Federal Reserve staff met with representatives from over 450 payment system participants, including banks of all sizes, clearing houses and third-party service providers, consumers, retailers, and academics. Although a few large banks and clearing houses thought the Federal Reserve System should exit the check collection and ACH businesses, the overwhelming majority of forum participants opposed Federal Reserve System withdrawal. Participants were concerned that the Federal Reserve System’s exit could cause disruptions in the payment system. The Core Principles illustrates how the central banks see their roles in pursuing their objective of smoothly functioning payment systems.Further, the Core Principles outlines central banks’ roles in promoting the safety and efficiency of systemically important payment systems that they or others operate. The laws of the countries we studied support this aspect of the Core Principles. These countries charge their central banks with broad responsibility for ensuring the smooth operation and stability of payments systems. In their basic role as banks, central banks generally are charged with acting as a correspondent bank for other institutions, providing accounts, and carrying out interbank settlements. Nonetheless, countries’ laws vary regarding the specific roles a central bank should play in the payment system. Central banks in the G-10 countries and Australia have endorsed the Core Principles, which sets forth 10 basic principles that should guide the design and operation of systemically important payment systems in all countries as well as four responsibilities of the central bank in applying the Core Principles. (The principles and responsibilities are presented in app. II.) The overarching public policy objectives for the Core Principles are safety and efficiency in systemically important payment systems. Although the Core Principles generally is considered to apply to wholesale payment systems, some payments industry officials said that some payment systems that process retail payments could reasonably be considered systemically important because of the cumulative size and volume of the payments they handle. Providing for the safety of payment systems is mostly a matter of mitigating the risks inherent to the systems. These risks are listed and defined in table 2. Core Principle IV seeks to mitigate settlement risk by endorsing prompt final settlement, preferably during the day but, minimally, at the end of the day. The two major types of wholesale payment settlement systems are RTGS and multilateral netting systems. Recently, several hybrid systems have also been developed. (These two major types of systems are described further in app. III.) In general, multilateral netting systems offer greater liquidity because gross receipts and deliveries are netted to a single position at the end of the day. An institution can make payments during the day as long as its receipts cover the payments by the end of the day. However, multilateral netting systems without proper risk controls can lead to significant systemic risk. Because transactions are processed throughout the day, but not settled until the end of the day, the inability of a member to settle a net debit position could have large unexpected liquidity effects on other system participants or the economy more broadly. RTGS systems rely on immediate and final settlement of transactions, and these systems have much less exposure to systemic risk that could result from a settlement failure. Without a system for the provision of adequate intraday credit, these systems cause potential liquidity constraints because they require that funds or credit be available at the time that a payer initiates a transaction. Efficiency in payment systems can be characterized as both operational and economic. Operational efficiency involves providing a required level and quality of payment services for minimum cost. Cost reductions beyond a certain point may result in slower, lower quality service. This creates trade-offs among speed, risk, and cost. Going beyond operational efficiency, economic efficiency refers to (1) pricing that, in the long run, covers all of the costs incurred and (2) charging those prices in a way that does not inappropriately influence the choice of a method of payment. The Core Principles sets forth four responsibilities of the central bank in applying the core principles, two of which address oversight functions. The first is that the central bank should ensure that the systemically important systems it operates comply with the Core Principles, and the second is that the central bank should oversee compliance with the Core Principles by systems it does not operate, and it should have the ability to carry out this oversight. Therefore, the Core Principles affirms the importance of central banks’ oversight responsibility for their countries’ systemically important payment systems, including those that they do not own or operate. The laws of most of the countries we studied give the central bank broad responsibility for ensuring that payment systems operate smoothly. In addition, in their basic role as banks, central banks are generally charged with providing accounts to certain financial institutions and effecting interbank settlement. While some countries are specifically charged with providing additional payment services or regulating private payment systems, others are not. Similarly, regulatory and oversight authority is not always specified in laws but is obtained through historical development and the broader mission of the central bank. The European Central Bank (ECB) is the central bank for the countries that have adopted the euro.