Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Timing and Funding of Fedwire Funds Transfers

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Timing and Funding of Fedwire Funds Transfers

Article excerpt

* The dollar value of payments made over the Fedwire Funds Transfer service reaches its highest level between 4 p.m. and 5 p.m. each day.

* This peak in payment activity likely reflects efforts by banks to synchronize their outgoing payments with the large payment inflows they expect to receive in the late afternoon.

* By using the incoming transfers to fund outgoing payments, banks avoid the more costly alternatives of drawing down their account balances at the Federal Reserve or using overdraft credit.

* To support the banks' funding strategy, policymakers might establish formal "synchronization periods" and encourage banks to concentrate payments during these periods.

* The resulting increase in payment coordination could further reduce financing costs and minimize the number and duration of overdrafts.

The timing of payments across the Fedwire Funds Transfer service exhibits a regular pattern over the course of the day, with payment activity peaking in the late afternoon.(1) This pattern can be explained, in part, by the fact that banks derive benefits from coordinating the timing of their payment activity. Many payments made by banks during the day are offsetting. By synchronizing payments, banks can take advantage of incoming funds to make outgoing payments. The afternoon peak in activity reflects, to some extent, banks' coordination of payment timing in an attempt to tap this funding source.

A full explanation of the timing of funds transfers recognizes two factors that affect banks' intraday liquidity management. First, the timing of banks' payment activity reflects underlying customer demand. For example, settlement of financial transactions customarily takes place in the late afternoon, which tends to cause a demand for payments late in the day. Second, such timing also reflects a bank's response to customer demand for prompt payment. When responding to this demand, banks incur costs that take up expensive liquidity resources--either deposits at, or overdrafts from, the Federal Reserve System.

The liquidity cost of making a payment varies with the amount of coordination involved in payment timing. During periods of heavy payment traffic, a bank can, to a greater extent, fund an outgoing payment with incoming payments. Conversely, during off-peak times, a bank must rely more on account balances or overdrafts to fund payments, which increases the cost of making a payment. As a result, banks are induced to time their payments to coincide with an activity peak, thereby reinforcing the peak. Such behavior can lead to the observed aggregate patterns during periods of light as well as heavy payment activity.

In this article, we measure banks' alternative funding sources for Fedwire funds transfers throughout the day, using a data set that includes all banks' Fedwire funds transfers and Federal Reserve System deposits. This approach allows us to gauge the importance of incoming payments as a source of funding. We find that incoming payments used by banks to offset outgoing payments that are entered within the same minute account for 25 percent of the value of these transfers during normal activity periods and as much as 40 percent during peak periods.

This level of payment coordination is impressive. However, economic analyses suggest that activity coordination by subjects in similar environments typically falls short of the level that would allow the subjects to benefit fully from such coordination.(2) Accordingly, with many thousands of banks participating in Fedwire, there is reason to believe that the banks would prefer even greater coordination of payment activity. Furthermore, greater synchronization of payments would lead to a decrease in daylight overdrafts extended by the central bank. With these considerations in mind, we also examine a policy that might allow banks to coordinate their payment activity even more effectively: the creation of activity periods that would serve as "focal times" for entering payments. …

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