Intraday Management of Bank Reserves: The Effects of Caps and Fees on Daylight Overdrafts
Hancock, Diana, Wilcox, James A., Humphrey, David B., Journal of Money, Credit & Banking
I. BACKGROUND AND POLICY ISSUES
Each business day, financial institutions in the United States electronically transfer funds to each other via two large-dollar electronic payments systems, CHIPS and Fedwire. CHIPS (Clearing House Interbank Payments System) is a private system operated by the New York Clearing House. Fedwire is operated by the Federal Reserve System and may be accessed directly by financial institutions that have reserve or clearing accounts with Federal Reserve Banks (hereafter referred to as "reserve accounts"). Although nonbank depository financial institutions such as savings and loan associations have direct access to Fedwire, the overwhelming number of direct Fedwire users are commercial banks. For simplicity, we refer to all institutions that use Fedwire as "banks." Fedwire also comprises a book-entry securities system for the electronic delivery of U.S. Treasury and agency securities against (electronic) payment for those securities. The book-entry securities system allows immediate and simultaneous delivery of securities and corresponding payment in immediately available funds.
Large-dollar electronic payments systems are an integral part of payments and clearing mechanisms in the United States. During 1994, for example, the dollar value of, fund, transferred over Fedwire and CHIPS was $506 trillion - about seventy-five times GDP. thus. tin an average business day in 1994, more than $2 trillion of payments were transmitted via these two systems. In addition, nearly $145 trillion of government securities transfers were processed over the Fedwire book-entry system during 1994.
In recent decades. even while the banking industry was growing faster than real economic activity, the dollar value of funds transmitted via large-dollar electronic payments systems was growing relative to the size of banks. Panel a of Figure 1 plots the ratio of the annual averages of the daily value of electronic funds transfers to the stock of total bank liabilities.(1) Two decades ago, daily transfers were less than one-tenth as large as total bank liabilities. By the mid-1990s, the ratio had risen to seven times its value in the early 1970s.
Panel b of Figure 1 shows that over the same period, the sum of banks' reserve and clearing balances (hereafter referred to as reserve balances) at Federal Reserve Banks relative to their total liabilities fell markedly: After averaging close to 4 percent in the early 1970s, reserve balances as a proportion of liabilities averaged less than 1 percent by the mid-1990s. As a consequence, the value of banks' electronic payments relative to their reserve balances increased dramatically: By 1994, the ratio of the value of Fedwire transfers to reserve balances was about forty times its 1973 value (Figure 1, panel c).
As their reserve balances at the start of the business day (relative to their liabilities decreased, banks became more and more likely to overdraw their reserve accounts during the business day by larger and larger amounts. Before 1994, the Federal Reserve System extended the resulting intraday credit to banks at no cost, which fostered various financial market practices that resulted in daylight overdrafts.(2)
By the early 1980s, banks, daylight overdrafts of their reserve accounts had become very large, and regulators recognized that at some point a very large bank might be unable to repay its unsecured, and possibly very large, overdraft. Figure 2 plots the real maximum aggregate daylight overdraft for each month February 1985 through September 1995.(3) During the period, the maximum aggregate value of daylight overdrafts grew as rapidly as the value of transfers, which in turn grew faster than the value of bank liabilities. Figure 2 also shows averages of the daily overdraft maximums and averages of overdrafts for those months. By the early 1990s, daily maximum aggregate overdrafts often exceeded $150 billion and averaged about $125 billion. …