Financial Update (October-December 2001)

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Federal Reserve Fulfills Classic
Central Bank Role in Crisis

Picture of Cash Department
The Federal Reserve Banks and their branches remained open and operating in the aftermath of the Sept. 11 attacks to ensure the continuation of vital payment services, including cash, checks and electronic payments, as well as the provision of liquidity.

The terrorist attacks of Sept. 11, 2001, are etched in Americans' minds today in much the same way that Dec. 7, 1941, is recalled by earlier generations as a "day of infamy." While shock, horror, anger and uncertainty reverberated across the globe in the wake of the tragedy, many individuals and organizations came together to ensure vital services continued to be provided during the crisis.

Among those organizations was the Federal Reserve System, which, in its role as the nation's central bank, helped bring a sense of stability to the nation's financial system, businesses and consumers during the crisis. Some of the ways the Fed fulfilled this role included providing sufficient liquidity to financial markets, facilitating the functioning of the nation's payment system, and offering guidance to the state-chartered banks and bank holding companies it supervises.

Liquidity in times of uncertainty
Liquidity, or the ability to quickly convert an asset to cash, is an essential component of the banking system. During uncertain times—much as the days following the Sept. 11 terrorist attacks when some financial markets were closed—the Federal Reserve may be called upon to provide additional liquidity to assist institutions whose ability, or whose customers' ability, to receive payments has been disrupted. The Fed can inject liquidity into the financial system in several ways.

One way is through its discount window (see related article). Within a few hours of the Sept. 11 attack, the Federal Reserve put the word out in a brief press release that the Fed’s operations were open and that the discount window was available to meet banks' liquidity needs, which were numerous in the following days.

A recap of discount window borrowing provides perspective. On Sept. 5, the Wednesday before the attack, borrowing from all Federal Reserve Banks totaled approximately $195 million. On the day after the attack, Sept. 12, lending peaked at a record $45.6 billion. By Sept. 19, discount window lending receded to $2.7 billion and by Sept. 26 to $95 million.

In addition to discount window lending, another way the Fed can provide liquidity is through open market operations at the Federal Reserve Bank of New York. On the day after the attack, the New York Fed injected $38 billion in liquidity through overnight repurchase agreements, also called repos. A repo occurs when the Fed buys securities from dealers who agree to repurchase them by a specified date at a specified price. Because the added reserves will automatically be extinguished when the repos mature, this arrangement is a way of temporarily injecting reserves into the financial system. Repos peaked at a record of over $81 billion by Friday, Sept. 14, but a week later they totaled a more typical $1 billion.

Picture of Check Relay
By the evening of Sept. 13, the Fed received permission from the FAA to resume check transport flights.

Keeping payments moving
The Federal Reserve Banks and their branches also remained open and operating in the aftermath of the attacks to ensure the continuation of vital payment services, including large-dollar electronic transfers, lower-valued automated clearinghouse (ACH) transactions, check processing and currency distribution.

The Federal Reserve's electronic payment systems—the Fedwire funds and securities transfer system and the ACH system — continued to function smoothly. To accommodate banks with operating problems, however, the Fed extended the normal Fedwire closing time until late into the night on several days following the attacks.

The demand for cash increased moderately right after the attacks, not unlike the increase experienced after severe storms or other disruptions. Demand quickly returned to normal levels. Throughout the crisis and its aftermath, Federal Reserve Banks and their branches maintained an ample supply of currency and armored carriers reported no difficulties in making deliveries.

Keeping checks moving
As part of its payment service activities, the Federal Reserve processes approximately one-third of the nation's checks. Check processing and check transportation encountered a number of problems as a result of the Federal Aviation Administration's (FAA) grounding of virtually all commercial aviation flights in the days immediately following the Sept. 11 attacks. To address these problems, the Fed took several steps.

First, the Fed announced that it would continue to honor check deposits based on previously published schedules even though the normal flow of returned items in many cases was interrupted because of air travel limitations. Honoring checks based on these schedules meant that the Federal Reserve would be responsible for any "float" that was incurred during the return process. (Float is the difference between the total value of checks in the process of collection that have been credited to banks' reserve accounts and the value of those collected but not yet credited.) Checks processed electronically, which represent about 25 percent of the Fed’s overall check processing volume, were not affected by the grounding of flights.

From a check transportation perspective, the Fed managed the crisis by going nationwide with some of the contingency plans it has in place for regional weather delays. The Fed began to move processed checks en route to their final destinations via ground transportation instead of the contracted air transporters that normally fly checks for the Fed.

On the evening of Sept. 11, the Fed moved approximately 70–75 percent of its normal check volume for that day, and on the following evening the Fed moved approximately 60–70 percent of its normal volume. By the third evening, the Fed received permission from the FAA to resume check transport flights, but it took the Fed several additional days to work through all of the built-up check volume.

Guidance to banks
As the central bank, the Fed also provides supervisory guidance to the banking institutions it regulates. In this role, the Fed encouraged these institutions to be flexible as they worked with borrowers and other customers who were directly or indirectly affected by the attacks. In its guidance, the Fed asked banking organizations to take "prudent steps to make credit available to sound borrowers" and assured lenders that such practices were consistent with safe and sound banking practices while also in the public interest.

Another statement from the Fed and other banking regulatory agencies asked banking organization managers to contact their primary supervisors should their regulatory capital ratios temporarily decline because of balance-sheet growth resulting from meeting customers' needs.

What you’d expect from a central bank
In yet another capacity, the Fed worked with law enforcement agencies, providing expertise on financial aspects of these agencies' criminal investigations—including technical advice on tracing wire transfers and analyzing bank records.

The Fed also continued to act on behalf of the U.S. economy, lowering the federal funds rate and discount rate in September, on the Monday after the attack, and in early October at its regularly scheduled Federal Open Market Committee meeting.

Through all of its efforts in the wake of the Sept. 11 terrorist attack, the Fed helped bring confidence to the banking and financial system by supplying sufficient liquidity, by ensuring that the payments system continued to function and by providing supervisory guidance to the banking institutions it regulates. Through these efforts, the Fed demonstrated the vitally important functions of a central bank in a time of crisis.