Overview of the CHIPS payment system

The CHIPS network, which is operated by The Clearing House Payments Company LLC, is one of two wire transfer systems alongside the Federal Reserve’s Fedwire® Funds Service network used to clear large-value domestic and international US dollar (USD) payments. It clears and settles approximately $1.8 trillion worth of payments daily and has been designated¹ as a systemically important financial market utility by the Financial Stability Oversight Council given the dollar value of payments it processes and its role in cross-border dollar-denominated trade and commerce.² It differs from the Fedwire Funds Service network in that it is privately owned and uses a netting engine rather than gross settlement.

One of the CHIPS payment system’s core strengths lies in its algorithm that enables real-time, continuous net settlement, which optimizes liquidity and minimizes liquidity risks for participants. The CHIPS network plays an essential role in ensuring that large-value payments are settled efficiently and securely, using its netting process to significantly reduce the liquidity required by participating banks. This efficiency is particularly vital in today's interest rate environment, where managing liquidity is more critical than ever. In 2023, The Clearing House estimated that the CHIPS network generated $4.99 billion in economic value for its participants from its liquidity savings algorithm by reducing the amount of funding needed to settle the same value of payments relative to less liquidity-efficient payment systems, allowing participants to deploy these funds to lending or investment activities.³

As interest rates fluctuate, the cost of liquidity becomes a major concern for financial institutions, and the ability for the CHIPS payment system to minimize these costs through its advanced liquidity algorithm is a crucial advantage for CHIPS participants. The CHIPS network’s adoption of the ISO 20022 message format further strengthens its value proposition—enabling participants to potentially benefit from enhanced efficiency, enriched data content, and greater automation.

Benefits of CHIPS in high-Interest-rate environments

Over the last few years, financial institutions and participants across the United States (as well as global economies) have been impacted by significant rises and fluctuations in interest rates. In response to the COVID-19 pandemic’s economic shock, the Federal Open Market Committee (FOMC) cut interest rates to near-zero levels to stabilize financial markets and support an economic recovery. The fiscal stimulus helped the economy recover but led to significant inflationary pressures. To subdue inflation, the FOMC began to raise interest rates rapidly. The federal funds target rate stayed at the 5.25% to 5.5% range for an extended period before the FOMC began a series of rate cuts beginning in September 2024, with the last reduction coming in December 2024 to bring the target range to 4.25% to 4.5%. High interest rates have had a multitude of impacts across the banking sector, with higher operational costs being one key outcome. As the cost of holding liquid assets rises with interest rates, financial institutions may face increased pressure to manage their liquidity more effectively.

High interest rates can increase the opportunity cost of holding liquid assets. Banks have been required to maintain large liquidity buffers because of the Basel requirements, which have imposed successively tighter capital requirements. Basel I established minimum capital requirements primarily focused on credit risk. Basel II, implemented in the early 2000s, expanded the framework to include operational and market risks, requiring banks to hold capital against a wider array of potential losses. Basel III, developed in response to the 2008 financial crisis, imposed stricter capital and liquidity requirements, including the introduction of the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). In July 2023, the Basel III endgame was proposed; and in September 2024, the Federal Reserve indicated it would repropose Basel III endgame, including changes to credit risk, equity exposures, operational risk, and market risk.⁴

By minimizing the liquidity needed to settle payments, the CHIPS algorithm helps banks manage capital more effectively and efficiently. With interest rates still higher than they have been since 2008, even the small liquidity savings afforded by the CHIPS network can lead to significant cost savings over time for financial institutions. This reduction in liquidity demand not only lowers the direct costs associated with holding funds but also enhances a bank’s ability to deploy its capital more strategically. The CHIPS network, as demonstrated by James McAndrews and Dean Vartin in their "The use of Liquidity in CHIPS" research paper, is highly efficient in its use of liquidity relative to other global payment networks and settles payments earlier in the day than payments made on the Fedwire Funds Service.⁵ With a liquidity efficiency ratio of 21.5 and the ability to settle $61.80 for every dollar of excess funding, the CHIPS network helps ensure rapid turnover of funds, making it invaluable in managing liquidity costs effectively.

Another key benefit of the CHIPS liquidity algorithm in today’s high-interest-rate environment is its ability to reduce liquidity risk. Higher interest rates often lead to greater volatility in financial markets, which can make it more challenging for banks to predict their liquidity needs accurately. The algorithm helps mitigate this risk by ensuring that banks require less liquidity to settle their obligations, thereby reducing their exposure to interest rate fluctuations. Additionally, by lowering overall liquidity requirements, the CHIPS network enhances a bank's ability to maintain adequate reserves during periods of market stress—reducing the likelihood of liquidity shortfalls that could lead to broader 
financial instability.

Adopting ISO 20022 further strengthens the CHIPS value proposition

The migration to the ISO 20022 message format allows CHIPS participants to leverage the more detailed, structured data exchanged through the new standard. The adoption of ISO 20022 by the CHIPS network brings significant improvements in efficiency and risk management, safety and security, and customer insights and analytics—while positioning the CHIPS network to accommodate future innovations in the payments space. Below are a few examples of potential benefits that CHIPS participants can capture through the adoption of the ISO 20022 message format:

Create a competitive advantage with CHIPS today

The CHIPS liquidity algorithm is a critical tool for managing liquidity efficiently in today’s high-interest-rate environment. By minimizing the liquidity required to settle payments, it helps financial institutions reduce costs and manage liquidity risk more effectively. Even in a lower-interest-rate environment, the efficiency provided by the CHIPS payment system remains invaluable—ensuring that banks can optimize their cash management practices under any economic conditions. The importance of liquidity efficiency extends beyond individual institutions to the broader stability of the financial system.

The adoption of the ISO 20022 message format further strengthens the value of the CHIPS network to its participants by affording all the benefits of the enhanced, structured messaging format. These potential benefits include reducing operational complexity, enabling enhanced insights and analytics, and supporting more seamless integration across the payments ecosystem.Taken together, the current interest rate environment and the proliferation of the ISO 20022 messaging standard significantly enhance the value proposition and potential benefits the CHIPS system offers to its growing participant base.

Endnotes

1. The factors for designation as a systemically important financial market utility by the Financial Stability Oversight Council are: (1) the aggregate monetary value of transactions processed by the Financial Market Utilities (FMU); (2) the aggregate exposure of the FMU to its counterparties; (3) the relationship, interdependencies, or other interactions of the FMU with other FMUs or payment, clearing, or settlement activities; and (4) the effect that the failure of or a disruption to the FMU would have on critical markets, financial institutions, or the broader financial system.
2. The Clearing House, About CHIPS, accessed April 5, 2024.
3. The Clearing House, "CHIPS liquidity algorithm saves financial industry billions," news release, April 2, 2024.
4. Kyle Campbell, “Basel III Endgame: 5 things to watch,” American Banker, December 25, 2023.
5. James McAndrews and Dean Vartin, “The Use of Liquidity in CHIPS,” The Clearing House, April 2022.
6. Additional suggested reading: “CHIPS Review. Assessing the Efficiency of CHIPS: FNA Simulation prepared for The Clearing House," The Clearing House, FNA, Jan. 2023.