CUNA Comment Letter

Federal Reserve System’s Payments System Risk (PSR) Policy

November 16, 2001

Ms. Jennifer J. Johnson, Secretary
Board of Governors of the Federal Reserve System
20th and C Streets, NW
Washington, D.C. 20551

Re: Docket No. R-1111

Dear Ms. Johnson:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on the potential changes to the Federal Reserve System’s Payments System Risk (PSR) Policy that were published in the Federal Register on June 6, 2001. As a national trade association, CUNA represents more than 90 percent of the nation’s 10,600 state and federal credit unions.

Summary of CUNA’s Position

Background
The Federal Reserve has a Payments System Risk Policy that establishes maximum limits (net debit caps) and fees on daylight overdrafts in the accounts that depository institutions place with the Federal Reserve Banks. Daylight overdrafts are the credits depository institutions use when they overdraw their Federal Reserve Bank accounts. The Federal Reserve has asked for comments on the following options regarding the limit it places on the net debit cap levels for financial institutions. The Federal Reserve proposes lowering a financial institution’s daily net debit cap level to the level that a financial institution may carry on average over two weeks. If the daily cap were lowered, then the two-week average net debit cap would be eliminated. The Federal Reserve also proposes a stratified fee structure whereby institutions pledging collateral to the Reserve Banks pay a lower fee on their daylight overdrafts that have collateral than on their daylight overdrafts without collateral. Finally, the Federal Reserve proposes implementing a system that would monitor in real time all payments with settlement-day finality and that would reject those payments that would cause an institution to exceed its net debit cap or daylight overdraft capacity level.

Discussion
The Federal Reserve asked for comments on how institutions currently operate and would be affected by a reduction in the daily debit cap. If the daily debit cap were reduced, then financial institutions might monitor more closely their daily debit cap to make sure they do not exceed it. As a result, institutions might delay the processing of some payments in order to avoid incurring fees for daylight overdrafts. Although such delays could adversely affect the efficient flow of payments through the payments system, we believe flexible payments system risk policies will reduce the likelihood of gridlock in the payments system. In addition, another affect of lowering the daily debit cap would be that institutions with self-assessed net debit cap levels might pledge additional collateral to increase their daylight overdraft capacity for the purpose of avoiding fees.

The Federal Reserve System also asked for comments on how financial institutions manage their daily debit cap levels. Most financial institutions have peak days on which their daylight overdraft levels are higher than usual. On days that are not peak days, financial institutions target maximum daylight overdraft levels that are far enough below the two-week average cap limit to compensate for the higher overdraft levels on peak days.

CUNA recommends that the Federal Reserve reduce the daily debit cap gradually by lowering it in equal increments over a period of time. A gradual decrease will enable the Federal Reserve to carefully monitor the impact of decreasing daily debit cap levels on the payments system and to make adjustments to its policies, if necessary. A gradual reduction will provide financial institutions with adequate time both to modify their procedures and systems for monitoring and managing daylight overdraft levels and to evaluate whether pledging collateral is appropriate to minimize the potential costs of daylight overdrafts.

The Federal Reserve asked for comments on whether it should adopt a two-tiered pricing schedule based on whether or not financial institutions pledge collateral for their daylight overdrafts. CUNA supports the Federal Reserve’s proposal to establish lower fees for daylight overdrafts that are supported by collateral rather than for those daylight overdrafts without collateral. If the fees are priced appropriately, then this structure will encourage financial institutions to pledge collateral for overdrafts, which will help mitigate payment system risk. Under such a system, financial institutions would probably use collateral already pledged to a Reserve Bank as the collateral for daylight overdrafts, and institutions would pledge additional collateral only if it would be necessary to reduce their overall daylight overdraft fees and expenses.

The Federal Reserve should take care to set fees for daylight overdrafts at appropriate levels. If fees are set too low they could cause an imbalance in the allocation of collateral in the financial markets. To prevent market imbalances as a result of financial institutions’ reallocating collateral, CUNA recommends the Federal Reserve limit the amount of collateralized daylight overdraft credit available to each financial institution and/or expand the types of collateral it accepts for daylight overdrafts.

The Federal Reserve also asked for comments on whether the PSR policy should include a universal real-time monitoring (URTM) system that would monitor in real time all payments with settlement-day finality and that would reject those payments that would cause an institution to exceed its net debit cap or daylight overdraft capacity level. The primary benefit of URTM is that it could keep daylight overdrafts, caused by payments with settlement day finality, from exceeding financial institutions’ net debit cap levels. Eliminating these overdrafts would reduce the overall risk to the payments system. A potential drawback to URTM is that it could reject payments, causing payment delays and, consequently, gridlock within the payments system.

CUNA recommends that URTM be implemented for all payments with settlement-day finality provided the Federal Reserve permits financial institutions to pledge collateral for daylight overdrafts for amounts over their net debit cap limits. If the Federal Reserve implemented a URTM system for only some payment methods, then there might be drawbacks. For instance, if the Federal Reserve implemented URTM for only Fedwire funds transfers and net settlement services (NSS) transactions, we believe some financial institutions would be motivated to process their large-dollar payments as ACH credits to avoid URTM’s real-time monitoring of their overdraft positions.

However, if the Federal Reserve decides to use URTM only for Fedwire and NSS transactions, then we recommend the Federal Reserve implement URTM using a phased approach. For example, URTM could first be applied to NSS transactions and then, six months later, applied to Fedwire funds transfers. Such an approach provides financial institutions adequate time to develop their daylight overdraft management and monitoring systems.

The Federal Reserve notes that under URTM, all ACH credit originators would have to prefund. We request that the Federal Reserve clarify whether ACH originators must prefund only for the amount that will exceed their net debit cap level or for the full amount of their originations. If the Federal Reserve intends to set a new standard for originators by requiring prefunding of the full amount of a credit origination, the Federal Reserve should permit originators to pledge collateral as an alternative to prefunding their originations.

The Federal Reserve asked what disruptions in settlement arrangements could occur if the Federal Reserve were to implement URTM for NSS transactions. If URTM were implemented for NSS transactions, then an NSS transaction might be delayed if the financial institution involved does not have sufficient overdraft capacity to cover its portion of the transaction.

Above are CUNA’s comments on the potential changes to the PSR policy. If you have any further questions, please contact me at (202) 682-4200.

Sincerely,

Michelle Q. Profit
Assistant General Counsel