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

Re:Docket No. R-1111
     Policy Statement on Payments System Risk
     Potential Longer-Term Policy Direction

Dear Ms. Johnson:

The Association for Financial Professionals (AFP) welcomes the opportunity to respond to the Board's request for comment on the benefits and drawbacks of policy options being evaluated as part of a longer-term direction for its payments system risk policy.

AFP represents about 15,000 finance and treasury professionals who, on behalf of over 5,000 corporations and other organizations, are significant participants in the payments system.  Organizations represented by its members are drawn generally from the Fortune 1,000 companies and the largest of the middle market companies.  Many of AFP's members have responsibility for originating and receiving automated clearing house (ACH) payments and wire transfers on behalf of their organizations.  They thus have a sizeable stake in Federal Reserve policies that impact electronic payments mechanisms.  In developing this letter, AFP solicited comments from members of its Government Relations Committee and Payments Advisory Group, as well as from over 60 regional AFP associations.

After examining the impact of universal real-time monitoring (URTM)—and the associated requirement to prefund ACH credit originations—AFP concludes that the drawbacks of this policy option far outweigh the benefits.   It could cause businesses to convert many payments that are currently made electronically back to checks, counter to the Board's long-term policy.

AFP recommends that the goal of controlling payments system risk can best be achieved by a more finely tuned approach to financially risky institutions rather than by applying a universal principle to all financial institutions.  The obstacles to payment system efficiency, cost-effectiveness and innovation created by the URTM option substantially outweigh any risk-reduction benefits that might be gained.

Universal real-time monitoring (URTM)

Under the URTM policy option, the Reserve Banks' Account Balance Monitoring System (ABMS) would be used to monitor in real time all payments with settlement-day finality and to reject those payments that would cause an institution to exceed its net debit cap or daylight overdraft capacity level.  Payments with settlement-day finality include automated clearing house credit transactions, Fedwire funds transfers and enhanced net settlement service (NSS) transactions.

The Reserve Banks currently reject final payments from certain higher-risk financial institutions if the payments would cause overdrafts that exceed those institutions' available account balances or net debit cap.  The Board's proposal would use URTM to extend real-time enforcement of daylight overdraft capacity levels to all depository institutions.  According to the Board, this policy would allow the Reserve Banks to manage better the small, yet important, risk that a depository institution could unexpectedly fail with a significant daylight overdraft position that far exceeds its net debit cap. 

Sound public policy calls for increased use of electronic payments

The Federal Reserve Board seeks to balance the goals of payments system efficiency and innovation with the requirements for safety and soundness.  AFP has long worked in cooperation with the Federal Reserve to promote the migration from checks to electronic payments.  We have encouraged innovation in electronic payment services, supported the development of payment standards, and informed the corporate community about promising new electronic payments applications in the ACH area.

These efforts are particularly relevant to the challenging environment in which the country's payment systems operate today and for the foreseeable future.  Greater use of electronic payments will decrease reliance on the physical transportation and delivery of checks, while reducing the risk of float.  The operational redundancy and disaster recovery procedures of electronic payment systems were successfully displayed during the recent crisis.  The Board's efforts to reduce payments risk exposure should not—and need not—increase its exposure to other types of risk by reducing reliance on electronic payment systems.

AFP recognizes that the Board seeks to limit its credit exposure from financially weak institutions.  We suggest that the Board deal with the specific risks arising from those institutions rather than apply its action to the financial community as a whole.

Negative impact of the requirement to prefund ACH credits

A URTM policy would most severely alter the cost/benefit equation for ACH credit originations.  Specifically, it would require all ACH credit originators to prefund their originations at the time the

ACH files are processed by Reserve Bank ACH Operators, a requirement now limited to higher-risk financial institutions.  In its policy paper, the Board recognizes that the requirement to prefund could compromise ACH value dating—the process that allows depository institutions to originate credit transactions in advance of settlement date.  The consequences are summarized below.

• Increases costs

Financial institutions often originate ACH credit files one or two days in advance of settlement date.  If they are required to fund their originations when they submit their ACH files for processing, they are likely pass these costs along to their business customers, and those costs can be substantial.  The reduced cost differential between ACH payments and checks may cause many companies to revert to check payments, especially when they consider the float advantage to be gained.

It is difficult to quantify the burden of prefunding costs on corporate originators because we do not know how financial institutions' prefunding requirements will be calculated.  Would ACH credits originated for next-day settlement be netted against credits incoming on settlement date?  Would they be netted against the value of ACH debits originated for settlement on that day?

Companies submit ACH files at various times of the day and evening to take advantage of finality and pricing differentials.  They will incur higher costs if they must submit ACH files through "premium-priced" windows to avoid prefunding.

Increased ACH costs may also discourage the development of innovative electronic solutions for consumer and corporate bill paying and other Web-based payment services.

• Reduces payment system reliability, especially for direct deposit of payroll

Availability at the opening of business on settlement day is essential for direct deposit of payroll to compete successfully with paychecks.  According to NACHA rules, if an ACH credit file is made available to the receiving depository financial institution by 5:00 p.m. local time on the banking day prior to settlement date, the funds must be available for withdrawal by consumers at the opening of business on settlement day.  One- and two-day processing lead times enable receiving financial institutions to make payroll available on time.  If companies and financial institutions wish to avoid prefunding costs, they would submit their files at the latest time possible, thereby potentially delaying availability.  Delayed availability jeopardizes the reliability of the ACH system.  Employees might revoke their direct deposit authorizations and demand paychecks.

Because ACH credit transactions are used to make tax payments, Federal and state governments will also feel the effects, while businesses will be burdened with the paperwork involved in dealing with late payment penalties.

• Delays error resolution and the solution of operational problems

The Board acknowledges in its request for comment that financial institutions' ability to process ACH transactions in advance of settlement date has major operational advantages.  It allows them to resolve operational problems and correct errors with minimal effect on ACH participants before settlement occurs, so that processing deadlines are met and funds availability and business practices are not disrupted.  If prefunding were required, institutions would delay submitting their files for processing.  Operational problems might not be resolved in advance of settlement date and payments would not settle on a timely basis.

These problems could be exacerbated on heavy transaction days, such as the 15^th and end of month, when many employees are paid.

Controlling payments system risk should not be a handicap to efficiency

The Board is concerned that a depository institution could fail in a significant daylight overdraft position.  AFP would point out, however, that financial institutions take steps to protect themselves from the risk that might arise from corporate ACH origination.  Depository institutions are required by NACHA rules and bank regulators to establish and monitor their credit exposure to corporate originators for ACH credits.  This exposure is reported in "ACH credit files outstanding" and is designed to control the risk to a financial institution that its originating customers cannot pay the amount of their credit transactions on settlement date.  Financial institutions abide by the "know your customer" rule regarding credit exposure for ACH transactions.  Value dating controls risk by giving financial institutions advance information about the dollar amount of ACH credits originated by their customers, enabling them to better manage their own credit exposure.

The Board reports that the majority of depository institutions do not fully use their daylight overdraft capacity.  Approximately 97 percent of all account holders use less than 50 percent of their net debit caps for their average peak overdrafts.  The Board concluded that most institutions should not experience rejected payments under URTM.  However, they would be required to prefund ACH credits.

It appears, therefore, that the disruption to the ACH system caused by prefunding would have far greater negative consequences than the benefits to be gained by controlling the payments risk caused by a small number of depository institutions. 

The Board states that its system for monitoring overdraft collateralization cannot currently be applied in the ACH value-dating process.   However, the Board has, through its regulatory processes, identified certain higher-risk financial institutions that are already required to prefund ACH originations.  Rather than requiring all financial institutions to prefund ACH credits, AFP suggests that the Board expand the definition of, or financial criteria for, risky institutions and require prefunding of only those institutions.

AFP appreciates the opportunity to comment on the Federal Reserve's potential longer-term policy direction.  Please call Arlene S. Chapman of AFP at 301-961-8825 if you have questions about the Association's position.

Sincerely,

Alvin C. Rodack, CCM
Associate Treasurer
Ohio State University
Chairman
AFP Government Relations Committee

Donald L. Hollingsworth, CCM
Assistant Treasurer
Ameren Corporation
Chairman
AFP Payments Advisory Group