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The Institutional Risk Analyst

© 2003-2024 | Whalen Global Advisors LLC  All Rights Reserved in All Media |  ISSN 2692-1812 

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The Fed Takes a Baby Step Forward in Payments

"In the last analysis, no mechanical system can be entirely 'fail safe' and also be commercially viable."

Paul Volcker


Punta del Este | In the waning days of 2019, the Federal Reserve Board took what is perhaps its most positive and significant policy action of the year – but not by providing liquidity to the money markets or adjusting monetary policy. Rather, the Board of Governors approved modifications to the Federal Reserve Banks' National Settlement Service (NSS) and Fedwire® Funds Service to support enhancements to the same-day automated clearinghouse (ACH) service. Specifically:

  • The National Settlement Service will close at 6:30 p.m. ET, one hour later than its current closing at 5:30 p.m. ET. The opening time for the National Settlement Service will remain at 7:30 a.m. ET.

  • The Fedwire Funds Service will close at 7:00 p.m. ET, 30 minutes later than its current cutoff at 6:30 p.m. ET. The Fedwire Funds third-party cutoff will occur at 6:45 p.m. ET, 45 minutes later than its current cutoff at 6:00 p.m. ET. The opening time for the Fedwire Funds Service will remain at 9 p.m. ET on the previous calendar day.

  • The Reserve Banks will modify their current practice of maintaining a two-hour window between the closing and the reopening of the Fedwire Funds Service to maintain only a 90-minute window.

  • The Reserve Banks will raise the threshold for granting extensions to the Fedwire Funds Service closing time from $1 billion to $3 billion. The Reserve Banks, in consultation with the Board, will determine whether further increases to the threshold are warranted to maintain the regular and consistent open of the Fedwire Funds Service at 9:00 p.m. ET.

  • The Board is amending part II of the Payment System Risk (PSR) policy to add a new 6:00 p.m. ET posting time for same-day ACH transactions, remove the current 5:30 p.m. ET posting time for ACH return transactions, and make conforming changes to the daylight overdraft fee calculation.

In a previous issue of The Institutional Risk Analyst, “George Selgin on Frozen Money Markets & Competing With the Fed in Payments,” we discussed the possibility of the Fed doing even more to support greater access to real time payments via ACH. While these changes fall short of what we discussed with Dr. Selgin, the additional time allowed for same-day ACH transfers should provide very tangible benefits to consumers and the US economy as a whole.

This evolutionary process is difficult for the Fed, in part because of the key role it plays as the hub in the multi-trillion-dollar world of global payments and as liquidity provider to US banks. For many years, the Fed has crafted policy regarding the FedWire and NSS with risk foremost in mind, but advances in technology are forcing the US central bank to move faster in terms of modernizing the world of payments.

Many readers of The Institutional Risk Analyst are too young to remember the fateful day in November 1985, when a computer glitch prevented the Bank of New York, predecessor of Bank of New York Mellon (BK), from settling its daily securities sales and financing positions with the Federal Reserve Bank of New York. A similar problem had almost brought Manufacturers Hanover Trust Co to its knees earlier in the week, forcing the Fed to make an extraordinary $4 billion discount window loan to that entity. In those days, $4 billion was a great deal of money.

Jay Rosenstein and Bartlett Naylor described the event in American Banker in December 1985:

“The Bank of New York is the primary clearing agent for a number of major Wall Street brokers that buy and sell US Treasury instruments and other government securities. Last month, following a busy day processing transactions, the bank’s computerized link to the government securities network broke down and disrupted processing throughout the market. And since the Bank of New York was unable to transfer securities and collect payment from buyers before the end of the day, it had a deficit in its account at the New York Fed that had to be funded by the $22.6 billion overnight loan.”

In 1985, the total assets of Bank of New York were not quite $30 billion, forcing the institution to pledge all of its assets to the Fed as collateral on the discount window loan – the largest emergency advance ever made by the Fed up to that time. The swift action by the New York Fed under President E. Gerald Corrigan averted a calamity, but the event caused great consternation in Congress. In the wake of the Fed’s rescue of Bank of New York, the Board placed additional controls and penalties upon daylight overdrafts on the FedWire.

“I am concerned about the apparent concentration of responsibility for government securities transactions among the 35 or so primary dealers,” stated Ferdinand St Germain (D-RI), Chairman of the House Banking Committee. In a reference to the failure of Continental Illinois Bank only a year before, he asked: “Are we not courting Continental-scale problems by permitting financial operations of such enormous magnitude and significance to be handled by so few institutions?”

But the more immediate problem facing the Fed of New York that day was that the 90 minute breakdown in communications between Bank of New York and other firms had caused investors to start turning away from the bank and its clients. The disruption at Bank of New York, while brief, was enough to disrupt the securities markets and cause firms to stop honoring trades.

"Most importantly," Corrigan told John Berry of the Washington Post, "there was also some evidence that investors were seeking to break trades and financing transactions with firms serviced by the Bank of New York." At the time there were four large clearing banks in New York, including Irving Trust and Manufacturers Hanover, both of which have since been acquired by BK and JPMorgan Chase (JPM), respectively.

Today the securities markets are even more concentrated and therefore brittle than they were 35 years ago. As the Fed moves forward with efforts to accommodate the ever-growing volume of financial payments and the related need for financing, the institutional memory of not just 2008 but of other, more idiosyncratic risk events such as the near collapse of Bank of New York haunt the dreams of Fed officials responsible for clearing and payments.

One senior Congressional staffer focused on payments told The Institutional Risk Analyst: "It is great that the Federal Reserve is preparing to enter the 21st-century just as the rest of us are preparing to enter the third decade of the 21st-century." Suffice to say that the changes implemented by the Fed last week are perhaps less than we'd like to see, but nonetheless are an important step forward in making the dream of same day payments a reality for million of consumers, businesses and financial institutions around the world. ¡Feliz Año Nuevo!



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