The Federal Reserve's two-week-old policy of charging fees for overdrafts that arise during the business day in reserve accounts appears to be working as intended, a Fed official said Monday at a funds transfer conference.
The fees were adopted by the Fed on April 14 to give banks an incentive to reduce their so-called "daylight" overdrafts, which had risen from average daily peaks of $80 billion in 1985 for the reserve system, to average daily peaks of $150 billion last year.
While definitive numbers have not yet been tallied, Carol Barrett, senior vice president of electronic payment and fiscal services for the Federal Reserve Bank of New York, said "it is safe to say on the securities side we have seen a dramatic reduction in average and peak overdrafts."
Book Entry Securities Wire
About two-thirds of the overdrafts come from the Fed's book entry securities wire, in which banks' reserve accounts are debited for purchases of treasury and agency backed securities.
In an interview following her speech at the White Papers Inc. conference in New York, Ms. Barrett said that the reduction in daylight overdrafts was larger than the drop that occurred in a weeklong test by the Public Securities Association earlier this year.
In this test, banks and securities dealers were asked to behave as if they were being charged for daylight overdrafts, even though no fees were levied.
During the period, average securities-related daylight overdrafts declined by 15% to $85 billion a day.
Ms. Barrett cautioned that it is too early to be sure that the fees will continue to work. But she and other speakers were optimistic that the policy will be a success.
The Fed's goal is to protect the integrity of the payment system. The fear is that if a bank with a large daylight overdraft should fail, it could bankrupt the reserve system, or set off a financial panic.Charging for DaylightOverdrafts Pricing formula Add minute-by-minute negative balances in a bank's reserve account and divide by 600 minutes. Subtract 10% of a bank's risk-based capital from the average overdraft.Multiply eligible overdraft by interest rate. Interest rates 10 basis for 12 months, points ending April 1995 20 basis for 12 months, points ending April 1996 25 basis after April 1996 points Inception date: April 14, 1994 Source: Federal Reserve
The fees give banks their first financial incentive to minimize daylight overdrafts, since previously these overdrafts were free, and banks only paid interest on overnight overdrafts.
Concern Over Overdraft Fees
But many bankers worry that daylight overdraft fees could actually increase payment system risk.
The concern is that in order to reduce daylight overdrafts, banks will wait to receive funds from other parties before sending out payments, or delay funds transfers until the end of the day.
This could set off a chain reaction, leading to a so-called gridlock situation that freezes payment activity.
There are also concerns that the payments that now flow through the Fed will be moved to private-sector systems, like the Chips network, which don't affect banks' intra-day overdrafts, but also don't carry the full backing of the Fed.
Ms. Barrett and other speakers said that none of these things have happened thus far.
For example, Ms. Barrett said that Fedwire funds transfer activity has been normal.
John R. Mohr, executive vice president of the New York Clearing House Association, which runs Chips, said that his group was not trying to take Fedwire traffic, and that he did not expect a large migration to occur.
Ms. Barrett added that securities transfers, especially so-called repos, in which banks buy securities from dealers to hold overnight, and return the securities first thing the morning, are being completed an hour or two earlier than was the norm before the fees.
This reduces the morning overdraft positions of banks that are big players in this business, especially Chemical Banking Corp. and Bank of New York Co., the dominant securities processors for primary dealers in Treasuries.
Treasuries are so large that they cause the bulk of the securities-related daylight overdrafts in the Federal Reserve system.
George C. White, president of White Papers, a Montclair, N.J., consultancy, said that securities dealers had complained that they couldn't manage their operations in such a way that they would be able to complete repos early in the morning.
He added that changes in behavior show that the complaints were unfounded.
"There were such fears about this thing," Mr. White said. "It just goes to show that if you put a value on something, people can change."
Mr. White added that an informal survey he did indicated that most banks have not decided how to pass on daylight overdraft fees to customers.
The first bills for daylight overdrafts are due from the Fed in the middle of May, and Mr. White said that banks will likely refine their pricing policies then.