Most people think the Federal Reserve, a government regulated agency, clears all high volume monetary transactions flowing through the US system.
In reality, though, there are two electronic funds transfer (EFT) systems. One is run by the government. The second is a private clearing network.
The private system is called CHIPS, which stands for the Clearing House Interbank Payments System. It is a privately held clearing house owned by less than 50 banks. The CHIPS network settles over a trillion USD per day, including about 250,000 interbank payments.
The Fedwire Funds Services is operated by the Federal Reserve Banking System. Therefore, it is regulated by the government. About 50,000 banks belong to the Fedwire system.
Banks send large transactions that are time sensitive the Fedwire. Transactions that are less time sensitive generally go through CHIPS.
What is the reason that a bank would chose to clear transactions through CHIPS rather than the Fedwire? It’s all about money, of course. The CHIPS system is less expensive and makes banks more money.
CHIPS is a consolidator or netting engine. This means transactions are combined, resulting in fewer transactions. Consolidation decreases credit exposure and reduces operational costs and settlement risks.
CHIPS also lets banks hold on to their money, therefore making more money for the banks. Sound confusing? Let’s simplify the process.
Suppose you owe Harry $100. Another person, Fred also owes Harry $100. One solution would be for to pay Harry $100 and Fred to pay Harry $100. Clearing through CHIPS would consolidate your payment and Fred’s payment into 1 lump settlement. It settles $200 to Harry. Harry has $200 immediately and can invest it to make more money.
In the same scenario, suppose the Fedwire was used instead of CHIPS.
The Fedwire requires settlement in two separate transactions. It would settle your $100 to Harry in one transaction. In a second transaction, Fred’s $100 would settle to Harry. Fred must wait for each transaction to clear before he has access to the full $200.
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