Clearing House Interbank Payments System (CHIPS) – Definition

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Clearing House Interbank Payments System (CHIPS) Definition

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 world’s largest private payment clearing systems.

A Little More on What is the Clearing House Interbank Payments System (CHIPS)

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.

References for Clearing House Interbank Payments System (CHIPS)

Academic Research on Clearing House Interbank Payments System (CHIPS)

Systemic risk in the netting system, Angelini, P., Maresca, G., & Russo, D. (1996). Journal of Banking & Finance, 20(5), 853-868. A bank that goes through sudden solvency or liquidity issue may prevent the claims settlement of the direct creditors, that, in turn, may put the other institutions’ settlements on risk. This article makes a statistical analysis of the Domino Effect potential size in the Italian netting system. The authors simulate the settlement failure of a participant and measure the effect on the rest of the system. Only 4% of participants were sufficiently large to trigger crisis and less than 1% defaulted because of the systematic reasons. The monetary loss was less than 3% of the daily funds’ flow on average using the clearing system. Some other US authors have found a much larger effect of systematic risk.

Financial crises, payment system problems, and discount window lending, Flannery, M. J. (1996). Journal of money, credit and banking, 28(4), 804-824. A financial crisis, in a developed country, passes on to the payment system, rapidly. It depends on private credit extensions in many economies. Several authors suggest that during a crisis, the central bank does not provide appropriate aggregate liquidity. This strategy requires well-performing private credit markets to direct the liquidity to illiquid and solvent firm. The author develops a private lending model that states, a crisis is a time when creditors are not sure of how to estimate financial risks. So, they rationally withdraw from loan making onward. In this situation, a government creditor can make social welfare better as a last resort.

The topology of interbank payment flows, Soramäki, K., Bech, M. L., Arnold, J., Glass, R. J., & Beyeler, W. E. (2007). Physica A: Statistical Mechanics and its Applications, 379(1), 317-333. In this paper, the authors examine the network topology of the payments of interbank transferred over the FFS (Fedwire Funds Service) between commercial banks. The findings are that the network has low connectivity and average path length. It means a tightly connected banks core with which other banks interlink. Scale-Free degree distribution is there over a substantial limit. The authors observe that the network properties changed significantly in the instant aftermath of 11th Sep 2001.

Contagion and efficiency in gross and net interbank payment systems, Freixas, X., & Parigi, B. (1998). Journal of Financial Intermediation, 7(1), 3-31. Though in many industries states, various interbank payment systems work, they know a little about the properties of efficiency and risk. So, how we should design a payment system? The authors satisfy this question by making a comparison of 2 major types of payment systems, i.e. net and gross, in a structure where uncertainty creates from many sources, the consumption location, the return on investment and the consumption time. We can make payments across locations by transferring liquidity directly or claims against the financial institution in the other location. The authors characterize the equilibria in the 2 systems and show the trade-off between efficiency and safety.

Interbank exposures: Quantifying the risk of contagion, Furfine, C. H. (2003). Journal of money, credit and banking, 111-128. This research has been carried out to check the degree to which one bank failure leads to the subsequent collapse of other financial institutions. The author uses unique data on interbank flows of payment and quantifies the bilateral federal funds’ magnitude. This is to simulate the effect of different failure scenarios. The findings of this research are that contagion risk is economically small.

Controlling risk in payment systems, Rochet, J. C., & Tirole, J. (1996). L Journal of Money, Credit and Banking, 28(4), 832-862.The considerable development in the volume of trade on the interbank payment systems and maximum increase in intraday overdrafts have caused serious concerns about the payment systems allowing central banks to tackle disturbances and give incentives to private institutions. This study lays stress on the insufficient research assortment on payment systems and rules. It presents an analytical structure which suggests protecting the flexibility of interbank overdraft facilities. It gives 3 measures: bilateral debt caps reinterpretation as bilateral credit lines, defining mutual overdraft facilities broadly and a gross payment system transactions such that the central bank should monitor positions in a better way and avoid systematic risk.

Daylight overdraft fees and the Federal Reserve’s payment system risk policy, Richards, H. W. (1995). Fed. Res. Bull., 81, 1065. In this paper, the payment system of the Federal Reserve has been discussed. The author provides details of its risk policy and also about the charges for daylight overdraft.

Money in electronic commerce: Digital cash, electronic fund transfer, and ecash, Panurach, P. (1996). Communications of the ACM, 39(6), 45-50. The traditional payment methods that were paper-based and come with a lot of inherent weaknesses, networking firms and their customers across the world, today, have minimum 3 pervasive electronic options for the numbers movement in their online accounts. In this paper, the author highlights the role of money in e-commerce. How does digital cash flows and funds are transferred electronically? He also explains the use of e-cash.

Clearing and payment systems: The role of the central bank, Summers, B. J. (1991). Fed. Res. Bull., 77, 81. This paper elaborates 2 themes of the central bank seminar related to payment system problems. First is the interdependence of various functions that, generally, a central bank performs. So, it demands more coordination and cooperation in multiple disciplines of central banking as compared to the payment system. The 2nd theme is the central bank’s role in handling the financial crisis. The author emphasizes on the payment systems of a nation that is hit by the financial crisis directly and first of all. So, the role of central bank in payment and clearing systems has been reviewed properly.

The process of financial innovation, Silber, W. L. (1983). The American Economic Review, 73(2), 89-95. This paper contains arguments presented by the author that many financial innovations emerge as firms’ response to related constraints. Unlike other authors, he does not agree that firms introduce new monetary techniques and products just for getting around state strictures. New services are mostly provided to handle the uncertainty occurred due to interest rates. The author states that technology suggests that ATMs and NASDAQ like electronic exchanges could develop without any effect of rules and other constraints. The financial innovation process gives economic advantages that are as real as the progress in physical technology.

A framework for analyzing efficiency, risks, costs, and innovations in the payments system, Berger, A. N., Hancock, D., & Marquardt, J. C. (1996). Journal of Money, Credit and Banking, 28(4), 696-732. In the financial system, the payment instruments market (checks, cash, funds transfer electronically) is a very important and interesting market. Economically, the payment instruments demand is equal to the demand for assets, other financial instruments, goods and services. The customers and sellers should not only mutually agree on the quantity and price, but also agree on the payment method to be used in the exchange. Hence, the buyer becomes the payor and the seller acts as a payee. Together they ask for a payment instrument having equal value to the goods exchanged. The authors present a framework to analyse costs, efficiency, innovations and risks in the payment system.

Recent developments in wholesale payments systems, Emmons, W. R. (1997). Federal Reserve Bank of St. Louis Review, 79(6), 23. Payment systems have commonly 2 components, i.e. wholesale and retail. The wholesale payment system deals in large transfers in which banks pay to each other while the retail system is engaged in small transfers relatively in which nonbank institutions or individuals send and receive payment. In Switzerland and Basle, the BIS (Bank for International Settlements) has presently published reports on different aspects of the wholesale system. The goal is to convey the central bank and the contributors of payment system about present practices in this system. This paper briefly describes the reforms to G-10 wholesale system.

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