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Attachment to the Testimony of Governor Edward W. Kelley, Jr. Before the Committee on Banking and Financial Services, U.S. House of Representatives September 17, 1998 |
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The Federal Reserve System and the Year 2000
Status Report and Summary of Activities
The Year 2000 computer problem is commonly known as the "century date change" or "Y2K" problem. The problem has arisen because many business application programs written over the past thirty years use only two-digit date fields to specify the year, e.g., "97" to represent "1997." On January 1, 2000, unless business applications, operating systems software, hardware, and embedded technologies, found for example in building control systems, are corrected, many computers with date-sensitive programs will recognize the year as "00" and may assume the year to be 1900 rather than 2000. Because dates are used in dollar-value transactions, calculations, and records maintained by the Federal Reserve and the financial services industry, the problem affects virtually every business area and application. The Federal Reserve System, consisting of the Board of Governors and twelve Reserve Banks, established a Year 2000 project office in 1995 and designated the program as the Century Date Change (CDC) project. The Federal Reserve's project addresses CDC readiness for all information technology in the Federal Reserve System. Our greatest focus, however, has been on our mission-critical systems, those that support the delivery of financial services, the regulation of depository institutions, and the conduct of monetary policy. While the Federal Reserve's primary focus is on its own readiness, a large part of our project is devoted to communicating with customers and our business partners, such as vendors and utilities. The Federal Reserve's CDC program employs three main efforts: compliance, communication, and administration.
A member of the Board of Governors is directing the Federal Reserve's Year 2000 efforts. A team of senior Federal Reserve managers provides overall direction and coordination of project implementation with Federal Reserve product offices, business areas, operations, and information technology functions. A CDC Council, including selected members and staff of the Board of Governors, the Reserve Banks, and the central business product offices, has been established to ensure communication and coordination of project implementation. The Board of Governor's Public Affairs office has been working with the Reserve Banks' public information staffs to provide information and address issues of concern to the public. The Federal Reserve's program to manage the risks posed by the Year 2000 was evaluated by OMB in conjunction with their review of the plans and status of independent agencies. In the May 15, 1998, report, "Progress on Year 2000 Conversions," OMB described the Federal Reserve as having made "excellent progress on all phases" and having conducted "excellent outreach." The following table summarizes the status as of June 1998 of systems being repaired.
Agency-wide Status of the Total Number of Mission-critical Systems
* The Federal Reserve tracks the progress of businesses or entities as System-level "components." Generally, there are two types of components: (1) applications shared or centralized, and (2) organizational units - specifically the Reserve Banks, the Board, and Federal Reserve Automation Services (FRAS). ** These systems are on schedule to be replaced by March 1999.
Status of Data Exchanges
Testing The Federal Reserve has prepared special central environments for testing high-risk dates, such as the rollover to the Year 2000 and leap year processing. Testing is conducted through a combination of future-dating systems to verify the readiness of our information technology infrastructure, and testing critical future date processing within our applications and in the interfaces to other institutions. Network communications components are also being tested and certified in special test lab environments. We have implemented test local-area networks to verify the CDC readiness of vendor-provided products and internal applications that operate in network-based computing environments. Testing with external customers began on June 29, 1998, and will continue throughout 1999. Depository institutions may test the century rollover (12/31/1999 through 01/03/2000) and leap year (02/28/2000 through 03/01/2000) periods with individual applications Monday through Friday, 8:00 a.m. to 8:00 p.m. ET and 8:00 a.m. to 5:00 p.m. ET on Saturday. The Federal Reserve will offer six "shared testing day" weekends in 1998 during which depository institutions may test Year 2000 dates with multiple applications. As part of this effort, the Federal Reserve is coordinating with the Clearing House for Interbank Payments Systems (CHIPS) and the Society for Worldwide Interbank Financial Telecommunication (SWIFT) to provide a common test day for customers of Fedwire and these two systems. Federal Reserve applications that are renovated to remedy Year 2000 problems undergo unit and integration testing by the information technology staffs, as well as acceptance testing by the business users. At the completion of the user acceptance testing process, the business owner reviews the renovation process and the unit, integration, and acceptance test results to validate the application as CDC compliant. Applications and systems, as well as environmental software and interfaces that are modified following CDC certification will be retested to ensure that they remain CDC compliant. Local Reserve Bank internal audit departments perform reviews of test processes. Moreover, Board of Governors staff, with the assistance of an outside consultant, is providing external oversight of testing activities. In the first half of 1998, Board of Governors staff conducted focused reviews of the progress toward CDC compliance of over sixty-five Federal Reserve applications. The review teams found no significant areas of concern and identified numerous best practices. Both the Reserve Bank audit departments and the Board of Governors staff provide independent verification of application readiness and reporting.
Costs
Contingency Planning The Federal Reserve is also identifying external supplier and business partner failures that would pose potential systemic risk or might cause widespread disruption to the payment system applications or the support infrastructure. We are currently focusing on contingency planning for Year 2000-related disruptions, such as those which could affect telecommunications providers, large banks, utility companies and difficulties abroad that affect U.S. markets or institutions. The Federal Reserve is working closely with the Securities Industry Association (SIA) and the New York Clearing House (NYCH), which operates the CHIPS large dollar payments system, on the issue of domestic and international contingency planning. Cash availability and processing is an issue the Federal Reserve has considered in the contingency planning process. The Federal Reserve has regularly met the public's heightened demand for U.S. currency in peak seasons or in extraordinary situations, such as natural disasters. The fiscal year 1999 currency printing order was recently submitted to the Department of the Treasury's Bureau of Engraving and Printing, and the order was increased due to Year 2000 considerations. With this order, we will increase the amount of currency either in circulation or in Federal Reserve vaults substantially over current levels by late 1999. This increase in the level of currency should be ample to meet the public's demand for extra cash during the period surrounding the century rollover. This is a precautionary step -- we believe it is prudent to print more currency than we think will be required than to risk not printing enough. While the Federal Reserve does not anticipate any extraordinary demand for cash, it is important that the public have complete confidence that sufficient supplies of currency will be available. In effect, the Federal Reserve is accelerating the timing of currency printing by planning for a possible short-lived increased demand for cash and will be able to reduce future print orders to lower-than-normal levels. If the public's demand for currency increases, other measures can be introduced to further increase cash levels. First, the recent currency order with the Bureau of Printing and Engraving is for fiscal year 1999, so that there will be time to print additional notes in the last 3 months of 1999. Second, the print order can be changed to increase production of higher denomination notes. Third, an increase of staff in Reserve Bank cash operation functions would improve the turnaround time required to process cash deposits and move currency back into circulation. Finally, as a last resort, the destruction of old or worn currency can be slowed. Despite their best efforts, some depository institutions may experience operating difficulties, either as a result of their own computer problems or those of their customers, counterparties, or others. The Federal Reserve plans to be prepared to provide institutions with information on the balances in their accounts throughout the day. We will be prepared to lend, in appropriate circumstances and with adequate collateral, to depository institutions if market sources of funding are not reasonably available.
Federal Reserve Oversight of the Banking Industry The Federal Reserve issued approximately 130 deficiency notification letters in the 1997-1998 period to organizations rated less than satisfactory in their Year 2000 progress and planning. These letters required corrective action plans, monthly monitoring of progress, and restrictions on expansionary activities. The Federal Reserve considers an applicant's Year 2000 rating and project management, as well as those of the target organization when evaluating the merits of merger and acquisition proposals. Phase II of the Year 2000 Supervision Program, extending from July 1, 1998, through March 31, 1999, includes a second round of Year 2000 supervisory reviews of all state member banks and selected other organizations, including U.S. branches and agencies of foreign banks, bank holding companies, service providers, and software vendors. The program will focus on an evaluation of progress on Year 2000 testing and contingency planning as well as on compliance with guidance statements issued to date. Examiner resources involved in Year 2000 efforts have increased steadily over the last twelve months and at present more than 225 examiners support Year 2000 supervisory activities. All Year 2000 examination findings and ratings assigned by the banking agencies are strictly confidential and are not made available to the public in accordance with long-established statutory prohibitions on disclosure of confidential examination information.
Service Providers
Additional Activities The Federal Reserve is assisting in the government's coordination of the Year 2000 effort within the financial industry by participating in the Financial Institutions Sector Group of the President's Council on Year 2000 Conversion. A senior Board official who chairs this Sector Group has been working with representatives of government financial organizations, including the federal banking agencies, the Department of the Treasury, the Securities and Exchange Commission, and other agencies responsible for various financial intermediaries, to assess the Year 2000 readiness of the financial industry and formulate interagency strategies for addressing Year 2000 issues. The systemic risk posed by a disruption in operations at any one of the nation's largest banking organizations, securities exchanges, clearing houses, or payment systems has been of concern to the Federal Reserve and the other banking agencies since the initial development of the FFIEC Year 2000 supervision program. Concerted efforts by the Federal Reserve, together with the SIA and NYCH, have been initiated to work closely with selected exchanges, clearing houses, and payment systems on matters pertaining to Year 2000 readiness. To assess the risk to the FDIC insurance fund and to plan for the orderly resolution of possible bank failures resulting from Year 2000-related disruptions, Federal Reserve staff has been working closely with the FDIC and other agencies to address the issues associated with closing a troubled bank before the century change. With respect to testing between banks and other parties, cooperative efforts by many of the largest banks in the New York market, together with the SIA and the NYCH, have included commencement of transaction testing between counterparties. The testing involved the electronic trading of securities and the flow of information between and through all parties to the transaction. Additional testing of a comparable nature is scheduled for the future as well. The level of international cooperation concerning Year 2000 has increased significantly over the past several months, primarily due to the efforts of the public sector Joint Year 2000 Council (Joint Council) and the private-sector Global 2000 Coordinating Group (G-2000). The Joint Council is pursuing a range of initiatives to help ensure a high level of attention is given to the Year 2000 challenge within the global financial supervisory community. Initiatives include sharing information on regulatory and supervisory strategies and approaches, discussion of possible contingency measures, and serving as a point-of-contact for national and international private-sector initiatives. Federal Reserve Governor Roger Ferguson chairs the Joint Council. A series of regional meetings with supervisory authorities will be conducted this year during the fourth quarter. The Basle Committee on Banking Supervision continues to be active on Year 2000 issues, both within the Joint Council and separately as part of its normal supervisory activities. Year 2000 is featured prominently on the agenda for the upcoming International Conference of Bank Supervisors to be held in Australia in October. The Federal Reserve has had extensive communications with foreign bank supervisors regarding the Year 2000 readiness of banks operating in the U.S. and in their respective countries. The Federal Reserve Board has forwarded to Congress a proposal for an amendment to the Federal Reserve Act to make certain types of discount window loans to banks eligible as collateral to back Federal Reserve notes. The amendment is regarded as a technical correction to the Act to ensure that collateral requirements for currency are maintained in the event of certain types of discount window lending. This amendment was passed unanimously by the House Banking Committee and is attached to the President's Working Group's bill, the Financial Contract Netting Improvement Act of 1998. No other legislative proposals are expected at this time.
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