Clearing House Interbank Payments System (CHIPS) - Explained
What is the CHIPS System?
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Table of ContentsWhat is the Clearing House Interbank Payments System?How Does the Clearing House Interbank Payments System Work?1980s Financial Collapse
What is the Clearing House Interbank Payments System?
The clearing house interbank payments system (popularly referred to as CHIPS for clarity) which was founded in 1970 is an abbreviation of the New York Clearing House Interbank Payment System which is controlled by the New York Clearing House Association (NYCHA). This system is primarily put in place to assist in the liquidation of multinational or international dollar transactions. Currently, CHIPS is one of the worlds largest private payment clearing systems.
How Does the Clearing House Interbank Payments System Work?
Before the period around 1913, transactions in New York City were quite messy and filled with chaos, and this was the primary reason why the CHIPS was established. This agency sought to eliminate non-transparent transactions between the banks situated in this region. Before 1913, the year in which the Fed was founded, the New York Clearing House focused primarily on stabilizing the volatility and liquidity rate of transaction markets. This has led to an improvement in the way this agency operates, as it now makes use of custom technologies and well-tapped organizational abilities to catch up to the distancing rate of differences in market transactions as well as incrementing transactional volume within the banking sector. Several decades later, CHIPS transitioned to be part of a firm known as ChipsCo particularly in 1998. However, in 2001, this agency went upon the process of transitioning into a real-time netting system. In 2007, CHIPS grew to be among the global leaders in private payment clearing systems, as it was able to handle at least 95% of international United States dollar transactions with a daily average trading volume of about 340,000, which is equivalent to $1.19trillion. CHIPS is expected to face the issues pertaining to payment clearing risks, as it is more of a privately owned agency rather than a governmental institution. This is the risk that comes with all privately owned clearing systems. There are three main types of liquidation risks in clearing systems; credit risks, operational risks, and liquidity risk.
- Credit Risk: In this case, the maturity party is unable to fulfill the guaranteed payment obligation.
- Operational Risk: This occurs when there is a probability that payments can be reversed.
- Liquidity Risk: This occurs when the clearing house has inadequate liquid assets, or any assets which takes a quick time to liquidate to process payment instructions.
Interbank payment clearing systems are mandated by the Federal Reserve to ensure that liquidation processes occur smoothly and that each main participants of such process is required to be present and supportive. This instruction is also applicable to wholesale transfer systems. In case of failures on the part of participants, the Interbank payment clearing systems have the right to penalize such participants. Currently in the interbank payment clearing systems, there has been no report of unliquidated transactions even with the risk of International liquidation. The United States decided to make amendments with the aim of cooling financial rules and transactional regulations in the 1980s. The decrees made to support this amendments are:
- Debt deregulation and Currency Control Act of the Depository Corporation
- Gao En-Saint-German Depository Corporation Act of 1982.
1980s Financial Collapse
In the 1980s, the amendments made were aimed at:
- The creation of the Federal Savings and Loan Company Clearing Fund which was controlled by the federal Deposit Insurance Corporation with the aim of dealing with the crisis in the financial savings industry.
- Empower the currency management capacity and the authority of the Federal reserve Board, and also making it a requirement to pay the deposit reserve from its members to non-member banks.
- Deposit organizations accountable to deposit reserve provisions were required to offer the statement of assets and liabilities to the committee.
The Lamfalussy Standard was later generated in 1990, in an attempt to strengthen the risk management rate of each clearing system. With this standard, participants who are unable to settle debited positions are covered by the daily settlements which would be done in a timely fashion.