The discount window

An abstract for this article is not availableDiscount window ; Federal Reserve banks

Credit derivatives: an overview

Arising from financial institutions' need to hedge and diversify credit risk, credit derivatives have now become a major investment tool. Almost all credit derivatives take the form of the credit default swap, which transfers default risk from one party to another. Most credit default swaps were once written on single names, but since 2004 the major impetus to growth and market liquidity has been credit default swaps on indexes. ; This paper examines the mechanics, risks, and market for credit default swaps, provides an overview of pricing and dealers' risk-management role, discusses the costs and benefits of credit derivatives, and outlines some recent policy issues. ; The author notes that, in the early years of credit derivatives, the major challenges facing these instruments involved resolving ambiguities in reference entities and defining credit events. Since the introduction of index trading and the widespread entry of hedge funds, however, the challenges have been settlement after credit events and addressing operational backlogs stemming from an increase in novations. Now that hedge funds are an established part of the market, the next important issue is likely to be whether credit derivatives activity will move to exchanges.Credit derivatives

The discount window

Money market

Daylight overdrafts and payments system risks

During the last several years, the banking community has become increasingly aware of the risks faced by participants on electronic funds transfer (EFT) networks. Of particular concern have been the volume and incidence of “daylight overdrafts” on Fedwire and the risk of systemic failure due to the failure of a participant on one of the private EFT networks. In this article, David L. Mengle develops an economic framework for analyzing the risks borne by network participants, and then discusses several alternative risk reduction measures. Mengle argues that, on Fedwire, pricing of daylight overdrafts would create incentives for banks to reduce such overdrafts and would serve to lower the risk now assumed by the public. On the private networks, he suggests that a discount window lending policy to avert system failure could be structured to give banks incentives to limit risk exposure. Although current policies seek to reduce risks by placing direct controls on daylight overdrafts, it may be advisable to supplement these policies with measures that force banks to face the costs they impose on the rest of the payments system.Banks and banking ; Payment systems ; Risk

Behind the money market: clearing and settling money market instruments

Payment systems ; Money market

The case for interstate branch banking

During the 1980’s, many states relaxed laws restricting branching, and most states opened up their borders to entry by out-of-state bank holding companies. This article suggests that both banks and consumers would benefit if laws were further modified to permit bank holding companies to consolidate their interstate subsidiaries into branch networks. While such a change is likely to lead to a smaller number of large banks (although those remaining would operate nationwide), there would probably be little change in the number of small banks serving local markets.Interstate banking ; Branch banks

Daylight overdrafts and payments system risks

During the last several years, the banking community has become increasingly aware of the risks faced by participants on electronic funds transfer (EFT) networks. Of particular concern have been the volume and incidence of “daylight overdrafts” on Fedwire and the risk of systemic failure due to the failure of a participant on one of the private EFT networks. In this article, David L. Mengle develops an economic framework for analyzing the risks borne by network participants, and then discusses several alternative risk reduction measures. Mengle argues that, on Fedwire, pricing of daylight overdrafts would create incentives for banks to reduce such overdrafts and would serve to lower the risk now assumed by the public. On the private networks, he suggests that a discount window lending policy to avert system failure could be structured to give banks incentives to limit risk exposure. Although current policies seek to reduce risks by placing direct controls on daylight overdrafts, it may be advisable to supplement these policies with measures that force banks to face the costs they impose on the rest of the payments system.Banks and banking ; Payment systems ; Risk

Behind the money market: clearing and settling money market instruments

When a money market instrument is traded, the clearing and settlement process establishes the change in ownership. Because the process involves both costs and risks, money market participants have developed means of making clearing and settlement more efficient and less risky.Money market ; Payment systems

Behind the money market: clearing and settling money market instruments

When a money market instrument is traded, the clearing and settlement process establishes the change in ownership. Because the process involves both costs and risks, money market participants have developed means of making clearing and settlement more efficient and less risky.Money market ; Payment systems

The future of deposit insurance: an analysis of the alternatives

Deposit insurance, while reducing the threat of bank runs, also lessens bankers’ incentives to control risks. Reforms of the deposit insurance system are necessary to discourage excessive risk taking such as characterized the recent S&L crisis. The adoption of market value accounting, early closing of failed banks, and exposing uninsured depositors and creditors to losses—all would give bankers less incentives to take excessive risks with insured deposits.Deposit insurance ; Bank failures