Clearing House Interbank Payments System Essay ⋆ Business Essay Examples ⋆ EssayEmpire

A wire transfer system for large-value wholesale real-time interbank settlements, the Clearing House Interbank Payments System (CHIPS) is the largest private-sector global clearing house for cross-border dollar transactions, accounting for 95 percent of all international payments conducted in dollars. Wholesale payments are large interbank payments for purposes such as commercial transactions, bank loans, and securities transactions. CHIPS engages predominantly in large trade-related transactions and foreign exchange transactions denominated in dollars. CHIPS also accounts for 5 percent of U.S. domestic large-value business-to-business payments. CHIPS is owned by 46 member banks from 22 countries and is operated by the Clearing House, an association that is owned by 22 major U.S. member banks. CHIPS can be used by any banking organization with a regulated U.S. presence.

CHIPS was created in 1970 by the New York Clearing House, and according to former Federal Reserve chairman Alan Greenspan, it represented “the most significant qualitative change in clearing house arrangements.” Transfers between banks occur in two parts: clearing and settlement. Clearing is when payment information is sent and received between participants. Settlement is when actual payment occurs. In 1970 CHIPS was the first real-time payments process whereby payments were electronically cleared the same day and then settled the next day. In October 1981 CHIPS added same day settlements. By 2001 settlements became final almost instantly. For banks, this reduces the risk they incur by having any significant amount of time between clearing and settlement.

Banks have two main options when processing interbank payments in dollars: Fedwire, operated by the Federal Reserve Bank, and CHIPS. CHIPS has some distinct advantages over Fedwire. One advantage is that CHIPs uses a patented multilateral netting settlements process. CHIPS keeps track of payments coming in and out of a particular bank’s account and releases a single payment whenever the bank is in a positive position so that it will never be in an overdraft position. This is different from Fedwire, which processes transactions individually using a real-time gross settlement process that may leave banks occasionally in overdraft positions that must be settled by the end of the day. The Fed charges fees on those overdraft positions. Thus CHIPS reduces overdraft fees. CHIPS reduces the number of transactions between international and domestic banks during the day and processes more than $2 trillion per day.

While CHIPS and Fedwire are competitors, CHIPS could not operate without Fedwire. CHIPS uses Fedwire to conduct its transactions. Banks participating in CHIPS use a joint CHIPS account at the Federal Reserve to set aside funds for CHIPS transactions. They pre-fund the account to meet settlements throughout the day. Late in the day, there is a second chance to fund any settlements that could not be met with the initial balance. Those settlements are not released unless the bank is in a positive position. If the bank chooses not to be in a positive position, those payments are deleted and the bank can settle them using Fedwire directly. This is one disadvantage to using CHIPS over Fedwire. Payments made via Fedwire are final and irrevocable. Some payments made over CHIPS may not be final until the settlements are made final at the end of the day.

Bibliography:

Clearing House Interbank Payments System, www.chips.org (cited March 2009);
Alan Greenspan, “Clearing and Settlement: Past and Future,” Federal Reserve Archival System for Economic Research, fraser.stlouisfed.org (cited March 2009);
New York Federal Reserve, www.newyorkfed.org (cited March 2009);
“Wholesale Payments Systems,” Federal Financial Institutions Examination Council, www.ffiec.gov (cited March 2009).

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