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---

### Executive Summary — Overview and Key Findings
- The U.S. payment and settlement systems continued to function smoothly during the 2007-2008 period of market stress due to the robustness of systems’ risk management and infrastructure and actions by the Federal Reserve (Fed) to sharply increase reserve balances.
- Underlying vulnerabilities remain as extraordinary Fed liquidity support is withdrawn:
  - Intraday credit from the Fed is largely in the form of uncollateralized but capped daylight overdrafts (unsecure intraday overdraft caps are generally set as a percentage of the capital of the financial institution), subject to an administered fee. Caps and fees encourage some large depository institutions to delay settlement of large-value funds payments over Fedwire Funds until late in the day, especially for fees avoidance purposes.
  - Fedwire Funds provides neither a central queuing/payment offsetting mechanism nor other liquidity saving features, which exacerbates late payments in Fedwire Funds.
- Domestic and international risks from late-in-the-day payments:
  - Domestically, increased late-in-the-day payments leave the system more vulnerable to late-day operational disruption.
  - Internationally, the end-of-day closure of U.S. payment systems effectively defines the worldwide “end-of day”; a liquidity disruption in the U.S. system could propagate systemic risk at the following day opening in Asia and Europe.
- The Fed’s new Payment System Risk (PSR) policy, to be implemented late 2010 or early 2011, promotes collateralization of intraday credit:
  - Collateralized overdrafts under the new policy will not be charged a fee and are expected to reduce incentives to delay payments and reduce the Fed’s credit risk from providing intraday credit.
  - The effectiveness of these changes in encouraging earlier payments needs assessment over the medium term; additional steps (e.g., relaxing or removing net debit caps) may also be needed.

### Key statistics on U.S. payment systems (Q2 2009)
- Fedwire Funds:
  - Average daily value: 2.49 (USD trillion)
  - Percentage change from one year ago: - 15.8
  - Average daily volume: 498 (thousands)
  - Percentage change from one year ago: - 5.6
  - Number of direct participants: 7,300
- CHIPS:
  - Average daily value: 1.43 (USD trillion)
  - Percentage change from one year ago: - 33.2
  - Average daily volume: 330 (thousands)
  - Percentage change from one year ago: - 9.7
  - Number of direct participants: 48
- CLS*:
  - Average daily value: 3.34 (USD trillion)
  - Percentage change from one year ago: - 20.6
  - Average daily volume: 590 (thousands)
  - Percentage change from one year ago: + 15.9
  - Number of direct participants: 59
  - *CLS data excludes Memorial Day, a U.S. dollar holiday.
- Reserve balances rose from an average of around US$9 billion in early 2008 to over US$1 trillion in October 2009.
- During September 15 to October 24, 2008 (post-Lehman), use of daylight overdrafts by Fedwire Funds participants increased about 50 percent compared to the previous quarter.
- Fedwire operating hours for value date D: starts on D-1 at 9:00 p.m. ET and closes at 6:30 p.m. on D.
- In 2008:
  - More than 60 percent of payment value was settled after 3:30 p.m.
  - More than 40 percent after 4:30 p.m.
  - More than 30 percent after 5:00 p.m.
  - The share of payment value sent after 5:00 p.m. grew by 10 percentage points between 1998 and 2007.

### Central Bank Policy in Providing Liquidity to Payment Systems
- Historical Fed approach:
  - Since the 1980s the Fed limited intraday credit: daylight overdrafts are uncollateralized, access is capped and subject to a fee. Collateral is typically required for overdrafts above the net debit cap.
  - Net debit cap is based on a multiple of the capital measure of the institution; the cap can be increased based on business need and the institution’s risk characteristics.
  - Overnight loans from the discount window are fully collateralized.
- International comparison (summary):
  - Canada, Eurosystem, Japan, United Kingdom — collateralized intraday credit, no fee (free).
  - United States (current policy at time of writing) — collateral used for problem institutions and institutions with maximum caps; fee charged.
- 2008 PSR policy revision:
  - Permits and encourages collateralization of intraday credit for all depository institutions.
  - Provisions improving equity of treatment for foreign banking organizations (FBOs) went into effect March 2009; remaining provisions to take effect upon full implementation in late 2010 or early 2011.
  - The revised PSR maintains policy objectives of balancing safety and efficiency and explicitly recognizes the central bank’s role in providing intraday credit to healthy depository institutions.

### Observations on Daylight Credit Policy and Payment Timing Behavior
- Many large depository institutions defer large-value transfers until late in the day to avoid daylight overdraft fees.
- Fedwire Funds lacks queuing/payment offsetting mechanism; completing payments in the RTGS system depends on sufficient daylight overdraft capacity or balances.
- Late-day payment concentration:
  - More than 60 percent of payment value in 2008 settled after 3:30 p.m., more than 40 percent after 4:30 p.m., and more than 30 percent after 5:00 p.m.
  - The share of value sent after 5:00 p.m. increased by 10 percentage points between 1998 and 2007, driven largely by largest payments and settlement of daily financial market cycles.
- Late-day payments are linked to market factors and fee avoidance, raising systemic concerns about completion of large and critical payments at value date.

### Fed Strategy to Reduce Late-Day Settlement and Liquidity-Saving Measures
- Four-prong approach identified by the Fed:
  - Revising the PSR policy (promoting collateralized intraday credit).
  - Exploring introduction of a liquidity saving mechanism for Fedwire Funds.
  - Making liquidity improvements for CHIPS and DTC.
  - Supporting private sector efforts to reduce late-in-the-day settlements associated with tri-party repo and settlement processes in DTC and CHIPS.
- CHIPS progress:
  - Encouraged voluntary supplemental funding earlier; successful in reducing late processing but further efforts should be encouraged as risks may re-emerge when liquidity returns to normal.

### Treatment of Foreign Banking Organizations (FBOs)
- Prior asymmetry:
  - Until March 2009, capital used to determine net debit cap for FBOs was limited to 35 percent of parent-company capital (instead of 100 percent for U.S. domestic institutions).
- March 2009 changes:
  - Highly-rated FBOs are eligible for a fee deductible based on 100 percent of worldwide capital, the same capital measure used for U.S. chartered institutions.
  - Highly-rated FBOs are eligible for additional collateralized capacity under a streamlined process.
  - Under the new policy, the fee deductible is eliminated for all institutions—FBOs and U.S. chartered institutions.
- Additional steps could be considered to provide a more level playing field relative to U.S. banks while ensuring adequate credit risk mitigation.

### Ongoing Efforts and Recommendations (Executive Summary)
Ongoing efforts:
- Implement and take further steps, as appropriate, to increase collateralized intraday credit and reduce uncollateralized overdrafts to:
  - (i) strengthen credit risk management of the Reserve Banks,
  - (ii) incentivize institutions to send large-value funds payments earlier in the day,
  - (iii) further align treatment of FBOs and U.S. chartered banks.
- Explore introduction of liquidity-saving features in Fedwire Funds.
- Support continued private sector efforts to reduce late-in-the-day settlements associated primarily with tri-party repo and settlement processes in DTC and CHIPS.

Recommendations:
- In line with the Administration’s proposal, the Fed Banks should be granted the legal right to give access to accounts and liquidity to systemically important post-trade market infrastructures as an additional buffer to mitigate systemic risk.
- The Fed, in cooperation with other relevant agencies, should continue to review the ability of payment, clearing, and settlement systems to cope with extreme liquidity stress scenarios in light of crisis lessons, on the basis of stress testing scenarios and simulations, taking into account concentration of payment and settlement services and complex interdependencies among systems.

---

### Daylight Overdrafts — Risks, Trends, and Policy Details
- Credit risk to the Fed:
  - The Fed is subject to credit risk from allowing uncollateralized daylight overdrafts, but "the Fed has a robust program in place to mitigate the risks posed by extending daylight overdrafts and no credit losses have been experienced to date."
- Monitoring and controls:
  - Reserve Banks monitor financial condition of institutions via supervisory information, analytical reporting, and predictive models.
  - Net debit caps establish limits; institutions posing elevated credit risk are placed on a "watch list".
- System exposure trends:
  - 2007: average daily overdraft of the banking system approximately US$60 billion; average daily peak overdraft US$160 billion.
  - 2009: average daylight overdrafts US$10 billion; average daily peak US$55 billion.
- Administrative and distributional costs:
  - Largest users (representing less than 3 percent of institutions with intraday credit) must undertake comprehensive self-assessments.
  - Participants subject to fees on daylight overdrafts: US$32.2 million in 2003; peaked at US$65 million in 2007; dropped to US$5 million in 2009.
  - Some large participants built internal queue systems to minimize fees.

### Main Features of the Revised PSR Policy (Current policy → Revised policy)
- Collateral:
  - "Required for problem institutions and institutions with max caps" → "Pledging collateral will be explicitly encouraged through a more favorable pricing of collateralized daylight overdrafts"
- Fee for collateralized daylight overdrafts:
  - 36 basis points → Zero fee
- Fee for uncollateralized daylight overdrafts:
  - 36 basis points → 50 basis points
- Deductible amount (subtracted from fees levied on daylight overdrafts):
  - 10 percent of an institution’s capital measure → Replaced by zero fee for collateralized daylight overdrafts and fee waiver
- Fee waiver:
  - Up to US$25 biweekly → US$150 biweekly
- Net debit cap:
  - Two-week average limit and higher single-day limit; ex-post counseling if exceed limit → Two-week average limit eliminated; single-day limit retained. Flexibility in ex post counseling if fully collateralized
- Max cap:
  - Additional collateralized capacity above net debit cap for self-assessed institutions → Streamlined process for certain FBOs up to a limit (effective March 26, 2009). Minor changes apply for all institutions
- Penalty fee for ineligible institutions:
  - 136 bps → 150 bps
- Additional details:
  - Collateralized daylight overdrafts would be charged a zero fee.
  - Fee for uncollateralized daylight overdrafts increased to 50 basis points (annual rate) from the current 36 basis points.
  - The two-week average net debit cap would be eliminated while retaining the higher single-day cap for healthy depository institutions (effectively raising caps by approximately 50 percent).
  - Access to daylight credit would continue to be available only to institutions with regular access to the discount window, with the same collateral eligibility criteria and haircuts used for both overnight and intraday credit.
  - Unencumbered collateral pledged for discount window purposes could be used to support intraday credit.

### Comments and Considerations on the Revised Policy
- Uncertainty remains whether the new policy will sufficiently encourage voluntary collateralized daylight credit and reduce late-in-the-day payments; experience will determine effectiveness.
- Incentive trade-off: higher fee for uncollateralized overdrafts needs comparison with opportunity costs of delivering collateral. The Fed accepts a broad range of collateral relative to other liquidity sources, so opportunity cost of pledging new collateral will likely not be significant.
- As of end 2009, US$1.2 trillion in assets were pledged with the Reserve Banks mainly for discount window purposes, most unencumbered by loans, "with no real opportunity cost."
- Collateral usage by participants:
  - Less than 60 percent of mid-to-large users have collateral pledged for discount window purposes (less than 50 percent of total users).
  - More than 90 percent have documents signed with the Reserve Banks to pledge collateral.
  - Most of the largest users of daylight overdrafts have sufficient unencumbered collateral pledged to cover their average level of daylight overdrafts.
- Longer-term consideration: the Board of Governors "may in the future consider the costs and benefits of moving further toward a fully collateralized structure."

---

### Liquidity-Saving Mechanism for Fedwire Funds
- Context:
  - New-generation RTGS systems (e.g., Europe and Japan) incorporate queuing and offsetting to save liquidity while retaining immediate finality; Fedwire Funds currently lacks queuing or liquidity-saving features.
- Potential benefits:
  - Economize on intraday credit and collateral needed to settle a given value of transactions.
  - Encourage coordinated release of payments held in participants’ liquidity queues by reducing total liquidity and collateral used to fund payments.
  - Current participant-managed internal queues provide no visibility of incoming payments queued by counterparties, complicating intraday liquidity management.
- Economic viability constraint:
  - Under the Monetary Control Act (MCA) of 1980, Reserve Bank fees must recover actual costs plus costs the Reserve Banks would have incurred and imputed profits they would have expected to earn as private sector firms.
  - Declines in Fedwire volumes and implications of policy actions could make full cost recovery more challenging.
- Industry views:
  - Development of a liquidity-saving mechanism was supported by most of the largest institutions, especially foreign participants.
  - Some institutions argued CHIPS already provides liquidity-saving features and opposed duplication in Fedwire Funds.

### CHIPS — Reducing End-of-Day Settlement: Findings and Outcomes
- CHIPS settlement model:
  - Liquidity-efficient due to its offsetting algorithm; prefunding arrangement in central bank money with an opening primary position calculated weekly.
  - Centralized queue with optimization algorithm; final prefunding process at 17:00 ET with 30 minutes for participants with negative final positions to transfer final prefunding.
- End-of-day pending payments (pre-initiatives):
  - In 2007, a few hundred messages remained queued after CHIPS cut-off; queued values ranged between US$85 billion to US$100 billion on average.
  - Completion of queued payments required aggregate supplemental pay-in funding averaging between US$50–60 billion.
  - Pending payments prevented reuse of funds earlier in the day and obstructed Fedwire settlement earlier in the day.
- Initiatives and outcomes:
  - CHIPS increased cap on participants’ current positions (from twice the initial position to as much as 6 times the initial position) and released cap constraint earlier in the day (from 5:00 p.m. to 3:00 p.m.).
  - CHIPS encouraged participants to provide more supplemental funding within the day.
  - Result: From April 2008 to September 2009, the amount of supplemental funding increased by more than eight times.
  - By September 2009, payments pending in the CHIPS queue at end of day were under US$20 billion (less than 1½ percent of the total value settled daily), and final funding required to release pending payments was around US$12 billion.

---

### Risk Management — Overview and Recommendations
- Crisis experience demonstrates need for robust risk management covering:
  - consequences of the high concentration of settlement activities;
  - up-to-date stress testing liquidity scenarios;
  - strengthening operational resilience;
  - ensuring adequate access to central bank liquidity; and
  - taking account of critical interdependencies.

#### A. Concentration of Settlement — Findings and Risks
- Concentration in U.S. large-value payment systems:
  - Fedwire Funds: about 7,500 participants; the largest participant represented in 2008 on average around 20 percent of settled value; the top five participants represented 63 percent; the top 10 participants represented 79 percent.
  - CHIPS: 64 percent of the value is settled by the top five participants.
- Potential vulnerability: unexpected unavailability of a major participant for an operating day would likely raise substantial liquidity pressures for other participants.
- CLS Bank concentration:
  - Settlement members show very high concentration; some settlement members settle for third parties with very large positions.
  - CLS Bank’s settlement model relies on funding requirements in central bank money calculated on a multilateral net basis and position limits.
- Recommendation:
  - CLS Bank and its members should consider providing more direct access to some large third parties, to the extent consistent with legal limitations to direct membership.
  - Direct access of large-scale or systemically important third parties (e.g., CCPs) is being discussed and would reduce counterparty risk borne by third parties on their intermediary settlement member.

#### B. Stress Testing and Simulations — Practices and Enhancements
- CLS Bank practices:
  - Conducts stress and back-testing scenarios including failure of the settlement member with the single largest funding obligation in a single currency.
  - Working on more extreme scenarios post-crisis, including failure of all settlement members of a given currency to complete their funding and simultaneous failure of liquidity providers in the same currency.
  - Enrichment of stress testing scenarios is welcomed to continuously adjust risk control measures.
- CHIPS and The Clearing House practices:
  - Developing stress testing programs and simulations; running and sharing simulations of inability of participants to fund positions; results presented to the CHIPS business committee.

#### C. Operational Resilience — Current Strengths and Remaining Issues
- Current arrangements:
  - Fedwire, CHIPS and CLS Bank maintain very high levels of availability exceeding 99.9 percent.
  - Comprehensive business continuity plan (BCP) arrangements, capacity planning, and security best practices.
  - CHIPS and CLS Bank have full synchronous mirroring of data between their two respective data centers; Fedwire has multiple out-of-region back-up data centers.
  - BCP arrangements cover threats including pandemic ones.
- Remaining concern:
  - The reaction of market participants to a major operational problem in a stressed market remains uncertain.
  - Recommendation: continuous initiatives to strengthen operational resilience of systems and their participants; bank supervisors to address these issues as part of the supervisory process.

#### D. Access of Systemically Important Infrastructures to Central Bank Services — Issues and Recommendations
- Current legal framework limits Fed account access to state member banks, other depository institutions, and certain other institutions specified by statute; non-bank financial market infrastructures cannot have accounts.
- Consequence: non-bank infrastructures (e.g., Fixed Income Clearing Corporation (FICC)) cannot open an account in Fedwire Funds or Fedwire Securities, increasing reliance on commercial banks for settlement.
- Potential benefits of change:
  - Allowing systemically important market infrastructures to settle in central bank money would limit settlement risk.
  - Adequate access to central bank credit would provide an additional buffer in extreme stress scenarios.
- Recommendation:
  - Facilitate settlement in central bank money for systemically important infrastructures and access to credit under terms and conditions established by the Federal Reserve Board, coupled with a strong oversight framework and full compliance with U.S. regulatory requirements and international standards as appropriate.

#### E. Interdependencies — Scope and Action
- U.S. payment systems are highly interconnected globally due to participation of many U.S. and foreign internationally-active institutions and the critical role CHIPS and CLS play in settling cross border payments.
- U.S. payment systems represent the worldwide end of day; disruption could have spillover effects at the following day opening of systems in Asia and Europe.
- Recommendation:
  - U.S. authorities should continue on-going initiatives to carry out a comprehensive risk mapping exercise, taking into account interdependencies within and across settlement systems (e.g., funding linkages between CHIPS and Fedwire Funds).

*Prepared as part of IMF technical analysis.*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview
- The U.S. payment and settlement systems continued to function smoothly during the 2007-2008 period of market stress due to the robustness of systems’ risk management and infrastructure and actions by the Federal Reserve (Fed) to sharply increase reserve balances.
- Underlying vulnerabilities remain as extraordinary Fed liquidity support is withdrawn, notably:
  - Intraday credit from the Fed is largely in the form of uncollateralized but capped daylight overdrafts (where uncollateralized intraday overdraft caps are generally set as a percentage of the capital of the financial institution), subject to an administered fee. Caps and fees encourage some large depository institutions to delay settlement of large-value funds payments over Fedwire Funds until late in the day, especially for fees avoidance purposes.
  - Fedwire Funds provides neither a central queuing/payment offsetting mechanism nor other liquidity saving features, which exacerbates late payments in Fedwire Funds.
- Domestic and international risks from late-in-the-day payments:
  - Domestically, increased late-in-the-day payments leave the system more vulnerable to late-day operational disruption.
  - Internationally, the end-of-day closure of U.S. payment systems effectively defines the worldwide “end-of day”; a liquidity disruption in the U.S. system could propagate systemic risk at the following day opening in Asia and Europe.
- The Fed’s new Payment System Risk (PSR) policy, to be implemented late 2010 or early 2011, promotes collateralization of intraday credit:
  - Collateralized overdrafts under the new policy will not be charged a fee and are expected to reduce incentives to delay payments and reduce the Fed’s credit risk from providing intraday credit.
  - The effectiveness of these changes in encouraging earlier payments needs assessment over the medium term; additional steps (e.g., relaxing or removing net debit caps) may also be needed.

### Key statistics on U.S. payment systems (Q2 2009)
- Fedwire Funds: Average daily value 2.49 (USD trillion); Percentage change from one year ago - 15.8; Average daily volume 498 (thousands); Percentage change from one year ago - 5.6; Number of direct participants 7,300.
- CHIPS: Average daily value 1.43 (USD trillion); Percentage change from one year ago - 33.2; Average daily volume 330 (thousands); Percentage change from one year ago - 9.7; Number of direct participants 48.
- CLS*: Average daily value 3.34 (USD trillion); Percentage change from one year ago - 20.6; Average daily volume 590 (thousands); Percentage change from one year ago + 15.9; Number of direct participants 59.
  - *CLS data excludes Memorial Day, a U.S. dollar holiday.
- Reserve balances rose from an average of around US$9 billion in early 2008 to over US$1 trillion in October 2009.
- During September 15 to October 24, 2008 (post-Lehman), use of daylight overdrafts by Fedwire Funds participants increased about 50 percent compared to the previous quarter.
- Fedwire operating hours for value date D: starts on D-1 at 9:00 p.m. ET and closes at 6:30 p.m. on D.
- In 2008, more than 60 percent of payment value was settled after 3:30 p.m., more than 40 percent after 4:30 p.m., and more than 30 percent after 5:00 p.m. The share of payment value sent after 5:00 p.m. grew by 10 percentage points between 1998 and 2007.

### Central Bank Policy in Providing Liquidity to Payment Systems and Critical Market Infrastructures
- Historical Fed approach:
  - Since the 1980s the Fed limited intraday credit to insulate the Fed System from credit risk: daylight overdrafts are uncollateralized, access is capped and subject to a fee. Collateral is typically required for overdrafts above the net debit cap (but still subject to a maximum cap).
  - Net debit cap is based on a multiple of the capital measure of the institution that is linked to an assessment of creditworthiness; the cap can be increased based on business need and the institution’s risk characteristics.
  - Overnight loans from the discount window are fully collateralized.
- International comparison (Table 2): Canada, Eurosystem, Japan, United Kingdom — collateralized intraday credit, no fee (free). United States (current policy) — only for problem institutions and institutions with maximum caps; Yes (use of collateral); Maximum amount/cap: Yes; Fee/Interest: Yes.
- 2008 PSR policy revision:
  - Permits and encourages collateralization of intraday credit for all depository institutions.
  - Provisions improving equity of treatment for foreign banking organizations (FBOs) went into effect March 2009; remaining provisions to take effect upon full implementation in late 2010 or early 2011.
  - The revised PSR maintains policy objectives of balancing safety and efficiency and explicitly recognizes the central bank’s role in providing intraday credit to healthy depository institutions.

### Observations on Current Daylight Credit Policy and Payment Timing Behavior
- Many large depository institutions defer large-value transfers until late in the day to avoid daylight overdraft fees.
- Fedwire Funds lacks queuing/payment offsetting mechanism; completing payments in the RTGS system depends on sufficient daylight overdraft capacity or balances.
- Late-day payment concentration:
  - More than 60 percent of payment value in 2008 settled after 3:30 p.m., more than 40 percent after 4:30 p.m., and more than 30 percent after 5:00 p.m.
  - The share of value sent after 5:00 p.m. increased by 10 percentage points between 1998 and 2007, driven largely by largest payments and settlement of daily financial market cycles.
- Late-day payments are linked to market factors and fee avoidance, raising systemic concerns about completion of large and critical payments at value date.

### Efforts to Reduce Late-Day Settlement and Liquidity-Saving Measures
- The Fed identified a four-prong approach to move payments earlier in the day:
  - Revising the PSR policy (promoting collateralized intraday credit).
  - Exploring introduction of a liquidity saving mechanism for Fedwire Funds.
  - Making liquidity improvements for CHIPS and DTC.
  - Supporting private sector efforts to reduce late-in-the-day settlements associated with tri-party repo and settlement processes in DTC and CHIPS.
- CHIPS has been successful in reducing late processing by encouraging voluntary supplemental funding earlier, but further efforts should be encouraged as risks may re-emerge when liquidity returns to normal.

### Treatment of Foreign Banking Organizations (FBOs)
- An asymmetric treatment of FBOs existed regarding the calculation of the capital measure for caps and the fee deductible.
- March 2009 policy changes substantially addressed this asymmetry:
  - Highly-rated FBOs are eligible for a fee deductible based on 100 percent of worldwide capital, the same capital measure used for U.S. chartered institutions.
  - Highly-rated FBOs are eligible for additional collateralized capacity under a streamlined process.
  - Under the new policy, the fee deductible is eliminated for all institutions—FBOs and U.S. chartered institutions.
- Additional steps could be considered to provide a more level playing field relative to U.S. banks while ensuring adequate credit risk mitigation.

### Ongoing Efforts and Recommendations
Ongoing efforts:
- Implement and take further steps, as appropriate, to increase collateralized intraday credit and reduce uncollateralized overdrafts to:
  - (i) strengthen credit risk management of the Reserve Banks,
  - (ii) incentivize institutions to send large-value funds payments earlier in the day,
  - (iii) further align treatment of FBOs and U.S. chartered banks.
- Explore introduction of liquidity-saving features in Fedwire Funds.
- Support continued private sector efforts to reduce late-in-the-day settlements associated primarily with tri-party repo and settlement processes in DTC and CHIPS.

Recommendations:
- In line with the Administration’s proposal, the Fed Banks should be granted the legal right to give access to accounts and liquidity to systemically important post-trade market infrastructures as an additional buffer to mitigate systemic risk.
- The Fed, in cooperation with other relevant agencies, should continue to review the ability of payment, clearing, and settlement systems to cope with extreme liquidity stress scenarios in light of crisis lessons, on the basis of stress testing scenarios and simulations, taking into account concentration of payment and settlement services and complex interdependencies among systems.

*Prepared as part of IMF technical analysis.*

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

### 12. An additional concern is that access of depository institutions to uncollateralized daylight overdrafts leaves the Fed subject to credit risk

### Risks, trends, and monitoring of daylight overdrafts
- The Fed is subject to credit risk from allowing uncollateralized daylight overdrafts, but "the Fed has a robust program in place to mitigate the risks posed by extending daylight overdrafts and no credit losses have been experienced to date."
- The Reserve Banks monitor the financial condition of institutions to ensure they meet safety and soundness requirements to access intraday credit. Monitoring tools include supervisory information, analytical reporting, and predictive models.
- Net debit caps establish limits on the amount of intraday credit to any institution. Institutions that pose elevated credit risk are placed on a "watch list" for more frequent monitoring and additional targeted risk mitigation steps.
- System exposure trends:
  - 2007: average daily overdraft of the banking system approximately US$60 billion; average daily peak overdraft US$160 billion.
  - 2009: average daylight overdrafts US$10 billion; average daily peak US$55 billion.
- Future demand for daylight overdrafts is uncertain due to factors including the level of balances banks will hold as conditions normalize and changes from the revised PSR policy.

### Administrative and distributional costs of current policy
- Administrative and technical costs:
  - Largest users (representing less than 3 percent of institutions with intraday credit but comprising the most active players in Fedwire Funds) must undertake comprehensive self-assessments to justify their net debit cap.
  - Participants are subject to fees on daylight overdrafts: US$32.2 million in 2003; peaked at US$65 million in 2007; dropped to US$5 million in 2009.
  - Some large participants have built systems to manage internal queues and monitor intraday liquidity to minimize fees.
- Distributional issues between domestic-chartered institutions and foreign banking organizations (FBOs):
  - Until March 2009, capital used to determine net debit cap for FBOs was limited to 35 percent of parent-company capital (instead of 100 percent for U.S. domestic institutions).
  - In 2007, FBOs as a group incurred average peak overdrafts less than 50 percent of their single day capacity.
  - March 2009 changes: most creditworthy FBOs granted streamlined process for additional collateralized capacity up to net debit cap calculated on 100 percent of capital; granted a fee deductible based on 100 percent of capital.
  - Highest-rated FBOs represent 10 percent of foreign participants and 40 percent of FBOs’ use of intraday credit.
  - FBOs continue to be monitored at their cap level in real time; only 5 percent of institutions are monitored in real time (others have ex post control and corrective measures).

### Main features of the future daylight credit policy (Revised PSR policy)
- Policy intent: explicitly encourage use of collateral to contain credit risk in providing daylight overdrafts.
- Key elements (current policy → revised policy):
  - Collateral: "Required for problem institutions and institutions with max caps" → "Pledging collateral will be explicitly encouraged through a more favorable pricing of collateralized daylight overdrafts"
  - Fee for collateralized daylight overdrafts: 36 basis points → Zero fee
  - Fee for uncollateralized daylight overdrafts: 36 basis points → 50 basis points
  - Deductible amount (subtracted from fees levied on daylight overdrafts): 10 percent of an institution’s capital measure → Replaced by zero fee for collateralized daylight overdrafts and fee waiver
  - Fee waiver: Up to US$25 biweekly → US$150 biweekly
  - Net debit cap: Two-week average limit and higher single-day limit; ex-post counseling if exceed limit → Two-week average limit eliminated; single-day limit retained. Flexibility in ex post counseling if fully collateralized
  - Max cap: Additional collateralized capacity above net debit cap for self-assessed institutions → Streamlined process for certain FBOs up to a limit (effective March 26, 2009). Minor changes apply for all institutions
  - Penalty fee for ineligible institutions: 136 bps → 150 bps
- Additional details:
  - Collateralized daylight overdrafts would be charged a zero fee to encourage pledging collateral.
  - Fee for uncollateralized daylight overdrafts increased to 50 basis points (annual rate) from the current 36 basis points.
  - The two-week average net debit cap would be eliminated while retaining the higher single-day cap for healthy depository institutions (effectively raising caps by approximately 50 percent).
  - Access to daylight credit would continue to be available only to institutions with regular access to the discount window, with the same collateral eligibility criteria and haircuts used for both overnight and intraday credit.
  - Unencumbered collateral pledged for discount window purposes could be used to support intraday credit.

### Comments and considerations on the revised policy
- Uncertainty whether the new policy will sufficiently encourage voluntary collateralized daylight credit and reduce late-in-the-day payments; experience will determine effectiveness.
- Incentive trade-off: higher fee for uncollateralized overdrafts needs comparison with opportunity costs of delivering collateral. The Fed accepts a broad range of collateral relative to other liquidity sources, so opportunity cost of pledging new collateral will likely not be significant.
- As of end 2009, US$1.2 trillion in assets were pledged with the Reserve Banks mainly for discount window purposes, most unencumbered by loans, "with no real opportunity cost."
- Collateral usage by participants:
  - Less than 60 percent of mid-to-large users have collateral pledged for discount window purposes (less than 50 percent of total users).
  - More than 90 percent have documents signed with the Reserve Banks to pledge collateral.
  - Most of the largest users of daylight overdrafts have sufficient unencumbered collateral pledged to cover their average level of daylight overdrafts.
- Longer-term consideration: the Board of Governors "may in the future consider the costs and benefits of moving further toward a fully collateralized structure."

### Efforts to reduce late-day settlement in payment systems and market infrastructures
- The Fed is working on three additional areas to address late-in-the-day payments and liquidity pressures:
  - Potential development of a liquidity-saving mechanism for Fedwire Funds.
  - Reducing the aggregate value of end-of-day settlement in CHIPS.
  - Improvements in intraday liquidity usage for DTC.
- These initiatives were collaborative efforts by the Federal Reserve and the industry, notably in the Payment Risk Committee (PRC) and Wholesale Customer Advisory Group (WCAG).

### Liquidity-saving mechanism in Fedwire Funds
- Context:
  - New-generation RTGS systems (e.g., Europe and Japan) incorporate queuing and offsetting to save liquidity while retaining immediate finality; Fedwire Funds is currently a traditional RTGS system without queuing or liquidity-saving features.
- Potential benefits:
  - Would economize on intraday credit and collateral needed to settle a given value of transactions.
  - Could encourage coordinated release of payments held in participants’ liquidity queues by reducing total liquidity and collateral used to fund payments.
  - Current participant-managed internal queues provide no visibility of incoming payments queued by counterparties, complicating intraday liquidity management.
- Economic viability constraint:
  - Under the Monetary Control Act (MCA) of 1980, Reserve Bank fees must recover actual costs plus costs the Reserve Banks would have incurred and imputed profits they would have expected to earn as private sector firms.
  - Declines in Fedwire volumes and implications of policy actions could make full cost recovery more challenging.
- Industry views:
  - Development of a liquidity-saving mechanism was supported by most of the largest institutions, especially foreign participants.
  - Some institutions argued CHIPS already provides liquidity-saving features and opposed duplication in Fedwire Funds.

### Reducing end-of-day settlement in CHIPS — findings and initiatives
- CHIPS settlement model:
  - Eliminates settlement risk of classical net deferred settlement systems and is liquidity-efficient due to its offsetting algorithm.
  - Prefunding arrangement in central bank money with an opening primary position calculated weekly by CHIPS.
  - Centralized queue with optimization algorithm to offset payments; final prefunding process at 17:00 ET with 30 minutes for participants with negative final positions to transfer final prefunding.
- End-of-day pending payments (pre-initiatives):
  - In 2007, a few hundred messages remained queued after CHIPS cut-off; queued values ranged between US$85 billion to US$100 billion on average.
  - Completion of queued payments required aggregate supplemental pay-in funding averaging between US$50–60 billion.
  - Pending payments prevented reuse of funds earlier in the day and obstructed Fedwire settlement earlier in the day.
- Initiatives and outcomes:
  - Receiving-side: CHIPS increased cap on participants’ current positions (from twice the initial position to as much as 6 times the initial position) and released cap constraint earlier in the day (from 5:00 p.m. to 3:00 p.m.).
  - Sending-side: CHIPS encouraged participants to provide more supplemental funding within the day.
  - Result: From April 2008 to September 2009, the amount of supplemental funding increased by more than eight times.
  - By September 2009, payments pending in the CHIPS queue at end of day were under US$20 billion (less than 1½ percent of the total value settled daily), and final funding required to release pending payments was around US$12 billion.

*Source: IMF staff summary of Federal Reserve PSR policy discussion and related payment system analyses.*

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

### _cr10122 - 28. Further efforts in this area should be encouraged. One issue is the fact that 

### IV. RISK MANAGEMENT — Overview
- Crisis experience demonstrates the need for robust risk management covering:
  - taking into account the consequences of the high concentration of settlement activities;
  - maintaining up-to-date stress testing liquidity scenarios to review the adequacy of risk management controls and increase awareness of risks with participants;
  - continuing on-going actions aimed at strengthening operational resilience;
  - ensuring adequate access to central bank liquidity; and
  - taking account of critical interdependencies.

### A. Concentration of Settlement — Findings and Risks
- U.S. large-value payment systems exhibit significant concentration of flows among a few key participants:
  - Fedwire Funds: about 7,500 participants; the largest participant represented in 2008 on average around 20 percent of settled value; the top five participants represented 63 percent; the top 10 participants represented 79 percent.
  - CHIPS: 64 percent of the value is settled by the top five participants.
- Concentration comparable to most other major industrial countries and related to concentration of the banking system and of the correspondent banking business.
- Potential vulnerability: unexpected unavailability of a major participant (operational failure, insolvency, or liquidity problem) for an operating day would likely raise substantial liquidity pressures for other participants.
- CLS Bank concentration:
  - Settlement members show very high concentration, in part because some settlement members settle for third parties with very large positions.
  - CLS Bank’s settlement model relies inter alia on:
    - funding requirements in central bank money calculated on a multilateral net basis; and
    - a set of position limits to ensure net short positions do not exceed participants’ funding capacity and CLS Bank’s capacity to draw on liquidity facilities from liquidity providers.
- Performance during crisis:
  - CLS Bank performed well; major dislocations were avoided when the settlement member representing Lehman Brothers did not rescind and completed settlement obligations on Lehman’s behalf.
  - When a settlement member acting for a third party did rescind (Refco), the CLS system continued to function.
  - CLS Bank does not guarantee settlement as a CCP would do.
- Recommendation:
  - CLS Bank and its members should consider providing more direct access to some large third parties, to the extent consistent with legal limitations to direct membership.
  - Direct access of large-scale or systemically important third parties (e.g., CCPs) is being discussed and would reduce counterparty risk borne by third parties on their intermediary settlement member.

### B. Stress Testing and Simulations — Practices and Enhancements
- CLS Bank practices:
  - Conducts stress and back-testing scenarios including adequacy of haircuts and failure of the settlement member with the single largest funding obligation in a single currency.
  - Working on more extreme scenarios post-crisis, including:
    - failure of all settlement members of a given currency to complete their funding; and
    - simultaneous failure of the liquidity providers in the same currency.
  - Enrichment of stress testing scenarios is welcomed to continuously adjust risk control measures.
  - Additional operational liquidity features noted (from explanatory text): pay-in timing differences across 17 currencies; CLS Pay-In Call as a first means to raise additional liquidity; In/Out swap program to reduce short positions, noting the “out” leg settled outside CLS re-introduces settlement risk and a same-day settlement session could mitigate but may create more liquidity pressure.
- CHIPS and The Clearing House practices:
  - Developing stress testing programs and simulations.
  - Instituted a program to ensure participants understand consequences of failure to honor closing positions and to encourage liquidity contingency plans.
  - Running and sharing simulations of inability of participants to fund positions, including failure of one or more banks to pay all funding of the day or closing position requirements; results presented to the CHIPS business committee.

### C. Operational Resilience — Current Strengths and Remaining Issues
- Current arrangements:
  - Fedwire, CHIPS and CLS Bank maintain very high levels of availability exceeding 99.9 percent.
  - Comprehensive business continuity plan (BCP) arrangements, capacity planning, and best practices in security requirements.
  - CHIPS and CLS Bank have full synchronous mirroring of data between their two respective data centers for quick recovery; Fedwire has multiple out-of-region back-up data centers.
  - BCP arrangements cover a wide range of threats, including pandemic ones.
  - Post-9/11 interagency paper on sound practices implemented; CHIPS established a new remote data center in 2008.
- Remaining concern:
  - Consideration of an operational problem occurring in a stressed market situation (e.g., a key participant affected amid serious credit and liquidity concerns).
  - Although systems processed unexpected peak volumes during the crisis, the reaction of market participants to a major operational problem in a stressed market remains uncertain.
  - Recommendation: continuous initiatives to strengthen operational resilience of systems and their participants; bank supervisors to address these issues as part of the supervisory process.

### D. Access of Systemically Important Infrastructures to Central Bank Services — Issues and Recommendations
- Current legal framework limits account access at the Federal Reserve to state member banks, other depository institutions, and certain other institutions specified by statute; non-bank financial market infrastructures cannot have accounts.
- Consequence:
  - Bank-chartered infrastructures may have a Fed account; non-bank infrastructures (e.g., Fixed Income Clearing Corporation (FICC)) cannot open an account in Fedwire Funds or Fedwire Securities, increasing reliance on commercial banks for settlement.
- Potential benefits of change:
  - Allowing systemically important market infrastructures to settle in central bank money would limit settlement risk.
  - Adequate access to central bank credit (on terms and conditions to be decided by the Board) would provide an additional buffer in extreme stress scenarios.
- Recommendation:
  - Measures to facilitate settlement in central bank money for systemically important infrastructures and access to credit are recommended.
  - Giving non-bank financial market infrastructures access to a central bank account and liquidity under terms and conditions established by the Federal Reserve Board should be coupled with a strong oversight framework and full compliance of the systems with U.S. regulatory requirements regarding risk management and, as appropriate, consistent with international standards.

### E. Interdependencies — Scope and Action
- U.S. payment systems are highly interconnected globally due to:
  - participation of a large number of U.S. and foreign internationally-active institutions; and
  - the critical role CHIPS and CLS play in settling cross border payments.
- U.S. payment systems represent the worldwide end of day; disruption could have important spillover effects at the following day opening of systems in Asia and Europe.
- Recommendation:
  - U.S. authorities should continue on-going initiatives to carry out a comprehensive risk mapping exercise.
  - It is important to take into account all types of interdependencies within settlement systems and across systems (e.g., funding linkages between CHIPS and Fedwire Funds).

*Source: _cr10122 - 28. Further efforts in this area should be encouraged. One issue is the fact that*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10122.pdf_