|
Why Do We Need Compensation Rules?
Compensation rules provide consistent procedures for financial institutions when a claim arises from a problem in an interbank check, wire or security transaction. Problems include, but are not limited to:
- · Payment received late or early
- · Transaction of wrong amount
- · Funds debited or credited to the wrong account(s) or the wrong bank
- · Funds debited when they should have been credited or vice versa
This document reviews:
- · How rules came about
- · Establishing NCUIC
- · Rules Development
- · Assumptions Underlying the Rules
How Rules Came About
Banks began to explore the need for consistent compensation rules in the 1970s, when it became apparent that a uniform means of settling compensation claims related to value transfers among financial institutions was badly needed. At that time, each claim was negotiated separately – a cumbersome and time-consuming process – which meant that there often were variations in the rates used for the same type of claim. Further complicating matters, domestic transactions were handled differently from international transactions, resulting in the necessity of defining what constituted an “international transaction.”
Institutions following different rules faced the problem of deciding which rules set to use to settle inter-institution claims. As a result, some institutions simply refused to pay certain types of claims. Others kept track of the practices followed by each institution they dealt with. But as claim volume rose, this system became prohibitively clumsy.
In response, major clearing houses and other multibank organizations began developing their own sets of rules for member banks, thus establishing procedures for intra-clearing house claims. The rules of the different organizations were generally compatible among the groups. While there were still differences between the rules of one clearing house and the next (and only the larger clearing houses were involved), much common ground was established – a major step toward standardization.
Establishing NCUIC
Flagship organizations include the then-titled U.S. Council on International Banking (CIB), the New York Clearing House (NYCH), the California Bankers Clearing House (CBCH), the Chicago Clearing House (CCH), and the NCUIC (still in its formative stage as the Nationwide Task Force for Uniform Interest Compensation).
NCUIC rules were not intended to replace rules adopted by various clearing houses and organizations for their own members’ use, but rather to provide a framework for situations in which no other common set of rules applied. Given the role of clearing houses in the process and their standardized nature, however, the NCUIC rules have been adopted or closely replicated by many clearing houses.
Rules Development
NCUIC rules continue to evolve because not all possible situations are covered. In addition, new types of claims arise in response in changes to market conditions and product offerings, requiring new rules. Important topics still need to addressed, including the key question of whether to extend coverage to non-bank banks or to other payment systems.
In the rules development process, the rules reflect the best approach in areas where there is consensus reigns, even when views of individual members of the formative organizations varied. This approach avoids bogging down the rule-making process.
In the meantime, when a payment dispute or claims arises that the rules do not specifically address, NCUIC and its member banks strive to cooperate in settling such claims so that no party is unduly injured or enriched. Such instances also serve to highlight areas for new rules; the resolution of these cases may drive the rule development process.
Assumptions Underlying the Rules
A thorough understanding of the concepts and assumptions underlying NCUIC rules help users analyze each situation that may call for the use of the rules to determine what section(s) of the rules apply(ies). The assumptions are set forth below in italics, with explanations following.
1. Funds on deposit generate earnings. A bank’s principal business is creating income by lending or investing funds held on deposit. Failure to deposit funds on a timely basis or in an insufficient amount damages the bank, causing it to forego the earned income, or forcing it to borrow to meet its reserve requirements. Here compensation is a process of loss recovery, not one of income generation. Thus, compensation payments are usually debited /credited to expense accounts.
2. Banks are unduly enriched when funds are deposited erroneously. Since banks invest or lend funds on deposit, it is assumed that even erroneous deposits are interest-earning. Additionally, since a bank maintains reserves against the funds in question, it enjoys the use of those funds less the reserve requirement. On the other hand, the bank entitled to the funds in question but which has not received them foregoes earnings on those funds. Consequently, NCUIC rules ensure that no party is unduly enriched by holding funds it should not have, and that no party shall be injured as a result of a problem originating at another bank.
3. All banks earn at a single rate. This simplifying assumption to allows uniformity in the handling of claims and reduces the number of disputes. Banks have access to the Federal Funds market, either directly or through their correspondents, and the overwhelming majority of banks are active in this market. In recognition of this, NCUIC rules rely on the average daily Federal Funds rate published by the Federal Reserve Bank of New York as the most appropriate rate with which to calculate compensation amounts.
4. All banks have the same reserve requirement. Once again, this simplifying assumption is made to expedite the handling of claims and minimize disputes.
5. A delayed payment causes an overdraft equal to the amount of the payment. There are two reasons for making this assumption. First, there is the confidentiality of customer information. Furnishing an outside party with the actual amount of a customer’s overdraft (as opposed to the amount of the payment) might reveal what the customer’s balance was before the error. Second, the customer may be at a loss even if the account was not overdrawn. Because the funds were not in the customer’s account, the average balance in the account dropped, which might result in additional bank charges. For these reasons, compensation is computed using the amount of the payment, not the amount of the overdraft.
6. The NCUIC rules apply only to interbank claims. NCUIC rules do not apply if a problem originates elsewhere than with a bank. For example, if a payment is delayed because the originating customer did not instruct the bank to make the payment, the rules do not apply. It is therefore important to research each case thoroughly to determine the problem’s origin. Any decision to compensation where the problem can be traced to a third party is a matter of internal policy. However, NCUIC is now reviewing whether to extend rules coverage to member non-banks.
7. An additional cost is incurred when funds are deposited to the wrong account. Consider a situation where funds are deposited to Customer A’s account, but should have been deposited to Customer B’s account. The institution must, of course, pay reserves on the funds in Customer A’s account, but it also must pay reserves on the (assumed) overdraft in Customer B’s account. For this reason, compensation payments for a change of beneficiary are calculated on the reserve requirements only. This applies even if the funds have not been credited to a customer’s account but rather to a suspense account, or if no entry at all has been made.
8. “Use of funds” is not the only cost involved in handling compensation items. Each time an institution processes a compensation claim, it incurs a cost. Time and resources spent researching the claim, then making entries and adjustments. A $200 fee may be imposed under the rules as reimbursement for the administrative cost. Moreover, a $750 fee may be imposed in certain cases as an incentive for the prompt return of funds under indemnity, and to reduce the number of missent payments. This larger fee also includes the $200 administrative fee.
If you have questions on the assumptions or on other NCUIC matters, call Nancy Grant, Senior Director, NCUIC, at 703-561-3911. (Typical office hours: 9:00am-6:00pm ET.)
|
