Clearing house Interbank Payment System (CHIPS)

Clearing House A clearing house is a financial 1institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions. These transactions may be executed on a futures exchange or securities exchange, as well as off-exchange in the over-the-counter (OTC) market. A clearing house purpose is to reduce the risk of one (or more) clearing firm failing to honour its trade settlement obligations. A clearing house reduces the settlement risks by netting offsetting transactions between multiple counterparties, by requiring collateral deposits (also called "margin deposits"), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing firm's collateral on deposit. Once a trade has been executed by two counterparties either on an exchange, or in the OTC markets, the trade can be handed over to a clearing house which then steps between the two original traders' clearing firms and assumes the legal counterparty risk for the trade. This process of transferring the trade title to the clearing house is called novation. It can take fractions of seconds in highly liquid futures markets; or days, or even weeks in some OTC markets.

Overview of CHIPS: CHIPS is the largest private-sector U.S.-dollar funds-transfer system in the world. In 2012, CHIPS cleared and settled an average of $1.5 trillion in cross-border and domestic payments daily. To provide fast, final payments while maximizing liquidity efficiency for participating banks, CHIPS operates2 on a global business day and utilizes a sophisticated liquidity savings mechanism. CHIPS sets the industry standard for resiliency, reliability, and innovation in

http://en.wikipedia.org/wiki/Clearing_house_(finance)

http://www.chips.org

funds transfers. Leading banks worldwide, as well as their correspondents and customers, find CHIPS a trusted partner in the U.S.-dollar clearing and settlement services.
CHIPS acts as a netting engine, where payments between parties are netted against each other instead of the full dollar value of both trades being sent.

CHIPS (Clearing House)

Drawer

Payee

Receiving Bank

Participating Bank

CHIPS Operation:

Managing Risks :
Control of credit and liquidity risk is a primary concern. CHIPS has procedures and features that manage this risk. Financial Risk on CHIPS Financial risks on CHIPS may be classified as credit risk or liquidity risk. CREDIT RISK Credit risk is defined as the exposures between participants that arise in systems in which there is a delay between a payments acceptance by the system for settlement and its final settlement. LIQUIDITY RISK CHIPS participants, like participants on any payment system, including real-time gross settlement systems, may face liquidity risks in obtaining the funding necessary to make payments over the system. Risk Management By CHIPS Before the start of business CHIPS requires participants/banks to deposit a predetermined amount each day. CHIPS does not release any payment order if the amount at the current position is less than the payment order, no participants current position is permitted to fall below zero. All payment orders are netted upon release to the receiving participant. CHIPS has credit criteria for participants to ensure participants have access to sources of credit and liquidity sufficient to pay promptly each day their opening position and their closing position requirements. New York State Banking Department or a fed regulatory authority must regulate the Prospective participants to ensure that participants are examined regularly and are operating in a sound manner, and prospective participants are subject to a credit evaluation by CHIPCo.

Credit Criteria for Participants

To overcome the credit and liquidity risk on any funds-transfer system is to ensure that the individual participants are creditworthy. CHIPS reduces the risk of the end-of-day closing procedure by ensuring that banks that would have to pay that

requirement, are creditworthy. CHIPS accomplish this as follows:

1. All banks must be regulated by a state or a federal bank regulatory authority. This ensures that banks are examined on a regular basis to determine whether they are in compliance with applicable laws and are operating in a sound manner. 2. The CHIPS Rules provide that each bank must have access to sources of credit and liquidity to enable it to pay promptly each day its opening position requirement and its closing position requirement. 3. The Clearing House judges whether a prospective bank has the required liquidity, in part, through credit reports on the prospective bank from a recognized

rating agency. Credit reports may also be obtained on current participants. References:
http://www.chips.org http://en.wikipedia.org/wiki/Clearing_House_Interbank_Payments_System