[Federal Register Volume 63, Number 243 (Friday, December 18, 1998)]
[Notices]
[Pages 70132-70135]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33575]
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FEDERAL RESERVE SYSTEM
[Docket No. R-1032]
Settlement-day Finality for Automated Clearing House Credit
Transactions
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice.
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SUMMARY: The Board is requesting comment on the benefits and drawbacks
of providing settlement finality on the morning of the settlement day
for ACH credit transactions processed by the Federal Reserve.
DATES: Comments must be submitted on or before March 18, 1999.
ADDRESSES: Comments should refer to Docket No. R-1032 and may be mailed
to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW,
Washington, DC 20551. Comments may also be delivered to the Board's
mail room between 8:45 a.m. and 5:15 p.m. on weekdays, and to the
security control room at all other times. The mail room and the
security control rooms are accessible from the courtyard entrance on
20th Street between Constitution Avenue and C Street, NW. Comments will
be available for inspection and copying by members of the public in the
Freedom of Information Office, Room MP-500, between 9:00 a.m. and 5:00
p.m. weekdays, except as provided in section 261.8 of the Board's Rules
Regarding Availability of Information.
FOR FURTHER INFORMATION CONTACT: Wesley M. Horn, Manager, ACH Payments
(202/452-2756); Myriam Y. Payne, Senior Financial Services Analyst,
Payment Systems Risk and Net Settlement (202/452-3219); Jeffrey S. H.
Yeganeh, Senior Financial Services Analyst (202/728-5801), Division of
Reserve Bank Operations and Payment Systems; for the hearing impaired
only, contact Diane Jenkins, Telecommunication Device for the Deaf
(TDD) (202/452-3544).
SUPPLEMENTARY INFORMATION:
I. Background
The Board is considering the merits of providing settlement
finality on the morning of the settlement day for ACH credit
transactions processed by the Federal Reserve Banks. The issue of
settlement finality for ACH transactions processed by the Reserve Banks
has been a subject of industry discussion since the 1980s. Currently,
the Reserve Bank's uniform ACH operating circular gives the Reserve
Banks the right to reverse settlement for either debit or credit
transactions until 8:30 a.m. eastern time on the morning of the
business day following the settlement day. A Reserve Bank can reverse
settlement if it does not receive actually and finally collected funds
from the depository institution funding the payments (the originating
depository financial institution (ODFI) in the case of credit
transactions or the receiving depository financial institution (RDFI)
in the case of debit transactions) by 8:30 a.m. eastern time on the
morning of the business day following the settlement day, with
notification to the ODFIs and RDFIs as soon as possible thereafter. In
comparison, private-sector ACH operators provide settlement finality
either on the settlement day or on the business day after the
settlement day, depending on the type of net settlement arrangement the
operator uses. The Board expects that all private-sector ACH operators
will be able to provide settlement-day finality to their customers once
the Reserve Banks fully implement their enhanced settlement service (63
FR 60000, November 6, 1998).
The Board requested comment on proposals to improve settlement
finality for ACH transactions processed by the Reserve Banks in 1986
and 1989. The 1986 proposal would have provided settlement finality for
ACH credit transactions of $5,000 or less at 1:00 p.m. local time on
the settlement day and for ACH credit transactions of more than $5,000
and ACH debit transactions when the Reserve Bank received actually and
finally collected funds (51 FR 45043, December 16, 1986). The 1989
proposal would have provided settlement finality for ACH credit
transactions at 6:30 p.m. local time on the settlement day and for ACH
debit transactions at 10:00 a.m. local time on the business day after
settlement. Commenters did not support either proposal because neither
provided finality at the opening of business on the settlement day (54
FR 8822, March 2, 1989).
[[Page 70133]]
Over the last several years, there have been renewed calls for the
Reserve Banks to improve the finality of the ACH mechanism to reduce
the interbank settlement risk. The Settlement Risk Management Task
Force, sponsored by the National Automated Clearing House Association
(NACHA) and the National Organization of Clearing Houses, and NACHA's
Vision 2000 report called for finality of settlement at opening of
business on the settlement day for ACH credit transactions. In
addition, the January 1998 report of the Committee on the Federal
Reserve in the Payments Mechanism stated that the Federal Reserve would
explore changes, including changes to ACH finality, that could more
effectively support the needs of existing and emerging retail payments
methods.1
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\1\ Committee on the Federal Reserve in the Payments Mechanism,
The Federal Reserve in the Payments Mechanism (Board of Governors of
the Federal Reserve System, January 1998), p. 33. The report can be
found on the Board's website at http://www.federalreserve.gov/
boarddocs/press/General/1998/19980105.
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The credit risks associated with ACH debit transactions and ACH
credit transactions are different and, thus, the Board believes that
each must be addressed separately. In the case of ACH debit
transactions, the ODFI is exposed to two kinds of credit risk when it
makes funds available to the originator. First, the ODFI is exposed to
the risk that the RDFI may fail and that the settlement for the entries
would be reversed. Second, the ODFI is exposed to credit risk if the
RDFI returns the item within its return deadline, or as long as sixty
days later in the case of an unauthorized transaction. Because the
RDFI's ability to return items would remain unchanged under any
proposal to improve settlement finality for debit transactions,
speeding the settlement finality would not materially reduce the ODFI's
credit risk. As a result, the Board is not seeking comment on any
change to the finality for settlement of ACH debit transactions.
The Board, however, is considering whether there is merit in
providing settlement finality on the morning of the settlement day for
ACH credit transactions processed by the Federal Reserve. Specifically,
the Board is considering making the settlement for ACH credit
transactions final when posted, which is currently 8:30 a.m. eastern
time on the day of settlement. In the case of ACH credit transactions,
NACHA rules require that the RDFI make funds available to its customers
on the settlement day.2 As a result, the RDFI is at risk if
(1) the ODFI fails, (2) its customers withdraw funds that have been
made available before the settlement was final, (3) the Reserve Banks
later reverse the settlement, and (4) the RDFI is unable to recover the
funds from its customers.
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\2\ NACHA Rules Section 4.4.1 requires an RDFI to make funds
from credit entries available to its customers on the settlement
day. Further, for credit entries to a consumer's account that are
made available to the RDFI by 5:00 p.m. local time on the day before
the settlement day, the RDFI must make the funds available by
opening of business on the settlement day.
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The Board believes that if the Federal Reserve were to provide
settlement-day finality for ACH credit transactions, it should adopt
risk control measures commensurate with those used in connection with
other Federal Reserve services with similar finality characteristics.
Current risk control measures for the ACH service include ex post
monitoring of daylight overdraft trends, requiring an ODFI at imminent
risk of failure to prefund the value of the ACH transactions it
originates, and reversing ACH credit transactions if an ODFI is unable
to settle for those transactions. Under these risk control measures,
the Reserve Banks have never reversed a settled ACH credit file due to
the failure of an ODFI, which has contributed to the public's
confidence in the ACH system. Because of this success, some commenters
on the previous proposals have concluded that the current risk control
measures are sufficient to allow the Reserve Banks to provide finality
at the opening of business on the settlement day without the adoption
of more stringent risk controls. The Board, however, does not believe
that these measures provide Reserve Banks with adequate protection from
settlement risk if settlement were to become final before the Reserve
Banks knew whether depository institutions could fund the payments.
Moreover, if the industry were confident that the Federal Reserve's
current risk controls were sufficient, it likely would not be
advocating the adoption of settlement-day finality to reduce RDFI risk.
The Board believes that the risk control measures needed to provide
settlement-day finality for ACH credit payments processed through the
Federal Reserve Banks should be commensurate with those provided in the
Fedwire funds transfer service and the enhanced settlement service, as
these services provide final and irrevocable settlement at the time a
transaction is credited to the depository institution's account. The
funds transfer and the enhanced settlement services use real-time
account balance monitoring for depository institutions that fall within
established risk parameters as a prerequisite for making payments
final. For institutions monitored in real time, a funds transfer or a
settlement entry initiated through the enhanced settlement service will
not be processed unless the institution's available account balance is
sufficient to cover the debit entry.3 Most depository
institutions, however, are not monitored in real time. The account
activity of an institution that is not monitored in real time is
monitored for compliance with the daylight overdraft transaction
posting rules on an ex post basis. As a result, Reserve Banks are able
to control their credit risk exposure by monitoring the account
balances of a selected group of depository institutions in real time,
thereby restricting those institutions' access to Federal Reserve
intraday credit. Providing settlement-day finality for ACH credit
transactions without applying risk control measures similar to those
used for Fedwire funds transfers and enhanced settlement entries may
create incentives for monitored institutions to move payments from
Fedwire to the ACH to avoid risk management controls.
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\3\ The available account balance includes the depository
institution's Federal Reserve account balance plus any available
intraday credit.
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The Board also believes that if the Federal Reserve were to provide
settlement-day finality for the ACH credit transactions it processes,
it should use risk control measures similar to those used to provide
settlement-day finality for ACH transactions processed by private-
sector operators. It is anticipated that most private-sector service
providers will use the enhanced settlement service to provide
settlement-day finality for ACH transactions. As a result, the Board
believes that risk control measures used in the Federal Reserve's ACH
service should be commensurate with those used in the enhanced
settlement service.
II. Improving Settlement Finality for ACH Credit Transactions
Processed by the Federal Reserve
The Board believes that if it were to improve the settlement
finality for ACH credit transactions processed by the Federal Reserve
by making settlement final when it is posted, which is currently 8:30
a.m. eastern time on the day of settlement, it should adopt appropriate
risk control measures. The Board has considered other alternatives to
improve settlement finality for ACH
[[Page 70134]]
credit transactions.4 Providing settlement-day finality for
ACH credit transactions using real-time risk control measures, however,
is complicated by the use of value-dating in the ACH mechanism. Because
of value-dating, an ACH credit transaction may be processed up to two
days prior to the settlement day. The funds to pay for the ACH credit
transactions, however, are not deducted from the ODFI's account until
the settlement day. As a result, absent any action to debit funds, a
balance check of the ODFI's account at the time that a transaction is
processed would be ineffective in managing risk. In contrast, in the
funds transfer and enhanced settlement services, a balance check at the
time that a transaction is processed is an effective risk management
tool because the actions taken to process and settle for the
transaction are almost simultaneous. As a result, the Board believes
that the expanded use of prefunding at the time that transactions are
processed would be an appropriate risk control mechanism to achieve
improvements in the finality for the settlement of ACH credit
transactions. Under prefunding, the Federal Reserve eliminates the
settlement risk by substituting itself for the ODFI as obligor to
settle for the ACH credit transactions.
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\4\ The Board has considered eliminating value-dating in its ACH
service, which would allow the Reserve Banks to monitor balances and
settle transactions on the same day. The Board, however, does not
believe that this alternative is practical because it would
fundamentally change the nature of the ACH service and disrupt
established and effective business practices of ODFIs and their
customers. The Board has also considered processing ACH transactions
as they are received, monitoring balances on the settlement day, and
reversing transactions originated by institutions monitored in real
time early on the settlement day if sufficient funds were
unavailable to settle the transactions. The Board believes that if
this alternative were adopted, the risk to an RDFI would not be
reduced measurably because it might be unable to reverse credits to
its customers' accounts in a timely fashion after receipt of a
reversal file. Further, under this alternative, an ODFI would be
unable to re-initiate transactions for the intended settlement date,
which may undermine the perceived reliability of the ACH.
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The Board believes that any ODFI that is being monitored in real
time, or that would be monitored in real time if it participated in a
service that uses real-time monitoring, should be required to prefund
all of the ACH credit transactions it originates. If the ODFI's
available account balance were sufficient, the transactions would be
processed and released to the RDFIs and the ODFI's account would be
debited for the amount of the transactions. On the settlement day, the
ODFI may receive an as-of adjustment to compensate it for the float
caused by the prefunding requirement. If the ODFI's available account
balance were not sufficient, the transactions would not be processed
until the ODFI funded the account.
If an ODFI were not being monitored in real time, it would not be
required to prefund its ACH credit originations and incoming files
would be processed as they are today. If the ODFI fails, the Reserve
Banks would reserve the right to reverse the ACH credit originations
that have not yet settled. Reserve Banks, however, would not reverse
transactions that had already settled. For example, a depository
institution that is not required to prefund originates $1,000 worth of
credit transactions on Monday with $300 to settle on Tuesday and $700
to settle on Wednesday. If the institution fails on Tuesday, the
Reserve Banks could bear the loss for the $300 that settled Tuesday
morning but may reverse the transactions that were intended to settle
on Wednesday. The reversal entries would be included in the files that
RDFIs would receive Wednesday morning.
The Reserve Banks believe that the system changes required to
implement the risk controls needed for settlement-day finality could be
available in early 2001. The Banks do not believe that these changes
would materially increase the cost of the Federal Reserve's ACH
service.
III. Comment is Requested on the Effect of Settlement-Day Finality
on the Attractiveness of the Federal Reserve's ACH Service and on
the ACH System More Generally
The Board is interested in commenters' views on the benefits and
drawbacks associated with adopting morning of settlement-day finality
for ACH credit transactions processed by the Federal Reserve. The Board
is also interested in whether commenters believe that providing
settlement-day finality would, on net, increase or reduce the
attractiveness of the Federal Reserve's ACH service and of the ACH
system more generally.
The Board requests comment on the extent to which morning-of-
settlement-day finality would promote ACH volume growth, whether
certain types of transactions would be more likely to be made by ACH
credit transactions if the Federal Reserve moved to settlement-day
finality, and which payment methods are currently used to make these
payments. The impetus for the industry's recommendation that the
Federal Reserve adopt morning-of-settlement-day finality is the desire
to eliminate RDFIs' current risk exposure associated with having to
make funds from ACH credit transactions available to their customers
prior to the time that settlement of those funds becomes final. This
risk, however, has not translated into a loss to any RDFI to date as
the Federal Reserve has never reversed a settled ACH file due to the
failure of an ODFI to fund its settlement. Further, it does not appear
that this risk exposure has discouraged depository institutions'
participation in the ACH system. The Board also requests comment on
whether settlement-day finality would facilitate product innovation in
the ACH service and if so, how.
The Board is interested in commenters' views on the extent to which
the differences in finality provided by ACH operators influence
depository institutions' choice of operator. Currently, one private-
sector ACH operator (Visa) provides settlement-day finality for its ACH
transactions, but the Federal Reserve and the other private-sector ACH
operators (the New York Automated Clearing House and the American
Clearing House) provide next-day settlement finality.
The Board requests comment on the extent to which the public's
confidence in the ACH system might be adversely affected if credit
transactions are not settled on the intended settlement day and
whether, as a result, the attractiveness of the ACH system might be
reduced. As discussed above, if the Board were to approve morning-of-
settlement-day finality for ACH credit transactions, the Reserve Banks
would implement risk control measures commensurate with those used in
the Fedwire funds transfer service and in the enhanced settlement
service by requiring all institutions monitored in real time to prefund
the amount of their ACH credit originations. While these risk control
measures would reduce the settlement risk to RDFIs, the measures would
increase the likelihood that the transactions of institutions monitored
in real time might no longer settle on their intended settlement day
even though they would likely settle in today's environment. Currently,
the Federal Reserve settles for ACH credit transactions for these ODFIs
on the settlement day and has until the next morning, which is when the
settlement would become final, to ensure that the ODFI has funded the
transactions. Under the risk control measures discussed above, if the
ODFI is being monitored in real time and its available account balance
is not sufficient to fund the payments prior to processing, the
transactions may not settle on the intended settlement day. Settlement
may also be delayed if the ODFI were able to arrange for funding later.
As a
[[Page 70135]]
result, payroll and other direct deposit files could be rejected or
delayed, which might increase concerns regarding the reliability of the
ACH mechanism and retard the growth of electronically initiated
payments.
In addition, the Board requests comment on the extent to which the
ACH system would become less attractive to institutions required to
prefund their credit transactions if those institutions were required
to modify their internal procedures. The expanded prefunding
requirement would require ODFIs that are monitored in real time to fund
ACH transactions earlier than is currently the case and might require
processing changes at the ODFI or its designated sending point(s). The
earlier funding would increase the cost of processing ACH transactions
to those institutions. Further, the ODFI may be required to submit
separate batches for credit transactions and debit transactions to
avoid the possibility that debit transactions included in mixed batches
might be held.
In the case of an ODFI that settles through the account of a
correspondent settlement agent, the Board is interested in commenters'
views on whether the Federal Reserve should base the prefunding
requirements on the condition of the correspondent or the ODFI.
Currently, Reserve Banks require prefunding based on the financial
condition of the ODFI and not that of the correspondent. In either
case, if transactions could not be processed because the
correspondent's account had an insufficient account balance to prefund
ACH credit transactions originated by the ODFI, both the ODFI and the
correspondent would be notified. Further, if the Reserve Banks based
their prefunding requirement on the risk profile of the correspondent
settlement agent, the correspondent would not be permitted to terminate
a settlement designation for transactions that have been accepted by
the Federal Reserve for processing.
Finally, the Board is interested in commenters' suggestions
regarding alternative risk control approaches, different from that
described in this notice, that would establish risk controls equivalent
to those used in the Fedwire funds transfer service and in the enhanced
settlement service and that may be better suited to the ACH
environment.
IV. Competitive Impact Analysis
In assessing the competitive impact of improving the finality for
the settlement of ACH credit transactions, the Board considers whether
there will be a direct and material adverse effect on the ability of
other service providers to compete with the Federal Reserve due to
differing legal powers or due to the Federal Reserve's dominant market
position deriving from such legal differences.5
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\5\ The Federal Reserve in the Payments System, FRRS 7-145.2
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Although the Federal Reserve's ACH does not derive its dominant
market position from legal differences, the fact that the Federal
Reserve maintains accounts directly or indirectly for all depository
institutions to settle may make it easier from some institutions'
perspective to use the Federal Reserve's services. The enhanced
settlement service was designed, in part, to offset that potential
advantage by making it easier for a private-sector entity to function
settlement entries to depository institutions nationwide. As was
mentioned earlier, the enhanced settlement service will check the
available account balance of all depository institutions that are being
monitored in real time. If the Reserve Banks were to improve the
settlement finality for the ACH transactions they process without
implementing similar risk controls, competitive questions might be
raised. The Board, however, believes that the expanded use of
prefunding provides risk controls commensurate with those of the
enhanced settlement service.
While private-sector operators that use the Fedwire-based or
enhanced settlement service will be able to offer settlement-day
finality for the ACH credit transactions they process, differences
would remain between the characteristics of their settlement finality
and those of the Federal Reserve's ACH service, assuming the Board
adopts settlement-day finality as described in this notice. In
particular, the need to reverse ACH credit transactions that cannot be
funded would largely be eliminated in the Federal Reserve's ACH service
because of the prefunding of those transactions by ODFIs with higher
risk profiles. In contrast, private operators, to the extent that they
accept participants with higher risk profiles, would need to reverse
ACH credit transactions that had been previously processed and
delivered to RDFIs if the OFDI could not fund its net debit position on
the settlement day. (Private ACH operators, however, generally do not
provide services to institutions that do not meet their criteria for
admission and participation. These criteria are based, in part, on the
financial condition of the institutions.) From the perspective of the
RDFIs, avoiding the risk of reversing transactions that had already
been posted to receivers' accounts may make the risk management
associated with the Federal Reserve's ACH service more attractive than
that of the private operators. From the perspective of some ODFIs,
however, the Federal Reserve's risk management would likely be
considered more burdensome and therefore less attractive than that of
the private operators. The Federal Reserve's ACH service would require
some ODFIs to fund their gross ACH credit originations before
transactions are processed while private-sector operators require ODFIs
to fund their net positions at the time of settlement. The provision of
as-of adjustments for prefunding, however, could mitigate this burden
somewhat. In general, the Board does not believe that settlement-day
finality for ACH credit transactions processed by the Federal Reserve
and conditioned on the expanded use of prefunding would adversely
affect competition in the provision of interbank ACH services.
By order of the Board of Governors of the Federal Reserve
System, December 14, 1998.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 98-33575 Filed 12-17-98; 8:45 am]
BILLING CODE 6210-01-P
