BAI panel eyes pitfalls of longer Fed Wire day.

A key panel discussion at the Bank Administration Institute's recent Money Transfer Conference in New York generated more questions than answers on the increasingly thorny issue of payment system risk.

The focus was on 1997, when the Federal Reserve's Fed Wire network is to extend its operating day to 18 hours, from the current 12.

The move is designed to reduce risks in interbank foreign exchange settlements by making Fed Wire available during the operating hours of many overseas central banks.

According to payments industry veterans on the BAI panel, the change requires closer working relationships among central bankers, clearing organizations, and commercial bankers.

Bruce J. Summers, senior vice president of the Federal Reserve Bank of Richmond, Va., and head of the Fed study group that proposed extended hours, led the discussion with John R. Mohr, executive vice president of the New York Clearing House Association, and Yawar Shah, senior vice president and chief administrative officer of Chemical Banking Corp.'s Geoserve unit.

Mr. Shah laid out many of the questions the banking industry and the Fed must resolve within the next 12 months.

"How do you engineer a close of business earlier, given that Fed Wire will be opening at 12:30 a.m. (Eastern time), when many of the banking demand deposit accounting processes have not finalized?" Mr. Shah asked.

He noted potential problems for West Coast banks, since "12:30 a.m. New York time is 9:30 p.m. West Coast time. [They] have an extraordinary challenge in reengineering their close of business."

Though participation in the expanded Fed Wire hours will be voluntary, according to Fed sources, the largest foreign exchange players have indicated they have little choice but to go along with the new schedule.

Mr. Shah also raised the issue of how to deal with banks that open early in an effort to pad their Fed accounts with incoming funds from other institutions. Such a scenario could saddle the sending banks with more intraday overdrafts and associated costs.

Several banks, he said, are considering counterparty controls and monitoring capabilities to try to head off such situations.

Addressing other issues, Mr. Shah said customers soon may demand payment confirmations, which may "require the Fed to have a real-time data base of who is open and who is not."

Mr. Summers said the idea of a real-time data base had arisen before. He said such a data base would be "difficult and ultimately perhaps impossible" for the Federal Reserve to maintain.

He further asserted that, since confirmations are essentially customer service issues for banks, "this may be an area where there is some self-regulation on the part of the industry with respect to best practices in operating a funds transfer business on an expanded schedule."

Despite that opinion, Mr. Summers said the Fed is sensitive to industry concerns about the operational implications of extended hours.

Nevertheless, he said, the new hours are the best way to improve the safety and efficiency of U.S. dollar settlements and to meet the needs of financial markets, including those overseas that rely on the dollar.

Because the U.S. currency is used in the vast majority of foreign exchange transactions, Mr. Summers said, the initiatives of private organizations such as the New York Clearing House Interbank Payments System, or CHIPS, will play a large part in risk management.

CHIPS processes about 200,000 interbank transactions dally, aggregating $1 trillion or more. Mr. Mohr said the New York Clearing House and its member banks are now doing a strategic review of CHIPS.

Mr. Mohr said four changes in CHIPS are possible within a year, perhaps including an earlier opening to coincide with the Fed Wire's.

Other changes might include introduction of rolling or multiple settlements. This would synchronize CHIPS settlements with the closings of Asian and European markets.

"We are looking at combining an early opening with the rolling settlement or periodic settlement of CHIPS," Mr. Molar said. "This would enable the CHIPS system to approximate a PVP, or payment-versus-payment, environment."

PVP, described by bankers as perhaps the only true solution to settlement risk, is simultaneous matching and sending of a foreign exchange transaction.

George Thomas, senior vice president at the New York Clearing House Association, said true PVP would be possible within five years only if central banks obtained and coordinated real-time gross settlement systems.

Mr. Thomas, who discussed CHIPS' strategies at a later session, acknowledged that many obstacles confront PVP. The private sector must wrestle with them, he said, because "if it's done by the public sector, it won't happen in our lifetime."

CHIPS is also examining the collateral requirements designed to ensure system liquidity even if the institution with the largest debit cap failed. There may also be reductions of participating banks' net debit caps.

Mr. Thomas emphasized that any changes in CHIPS would occur gradually so as not to cause the disruptions that are the major concern about all such risk reduction efforts.

Earlier, Mr. Summers addressed another concern among bankers: upcoming changes in Fed Wire messaging formats.

These changes, to be adopted during the next two years, are designed to make Fed Wire more compatible with the formats used by CHIPS and the Society for Worldwide Interbank Financial Telecommunication, or SWIFT.

Many banks want the formats in place and tested before they begin operational changes to accommodate an 18-hour day. That request was addressed in a recent letter from the American Bankers Association, which urged the Fed to delay the changeover to longer hours until the messaging formats are in use.

The ABA claimed that the industry would face needless costs and burdens in making operational changes before the messaging formats are in place.

Mr. Summers said three years should be ample time to adapt to the new hours. It is important, he added, "to be realistic about and sensitive to such resource and cost issues.

"At the same time, however, I must emphasize the Federal Reserve's interest in providing needed services to address what is widely acknowledged to be the biggest source of payment systems risk, namely Herstatt risk, in the time frame required by the markets."

"Herstatt" was the name of a German bank that collapsed in 1974, nearly causing an unraveling of the chain of CHIPS payments, which in turn could have threatened financial workings worldwide.

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