[Federal Register: October 28, 2003 (Volume 68, Number 208)]
[Notices]
[Page 61418-61444]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28oc03-59]
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FEDERAL RESERVE SYSTEM
[Docket No. OP-1165]
Federal Reserve Bank Services
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice.
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SUMMARY: The Board has approved the 2004 fee schedules for Federal
Reserve priced services and electronic connections and a private-sector
adjustment factor (PSAF) for 2004 of $179.7 million. These actions were
taken in accordance with the requirements of the Monetary Control Act
of 1980, which requires that, over the long run, fees for Federal
Reserve priced services be established on the basis of all direct and
indirect costs, including the PSAF. The Board has also approved
changing the earnings credit rate on clearing balances from the federal
funds rate to 90 percent of the three-month Treasury bill rate, and
changing the limit on the frequency of changes to contracted clearing
balances from once per month to as often as each maintenance period.
DATES: The new fee schedules become effective January 2, 2004. The
change in the earnings credit rate on clearing balances, and the change
to how often depository institutions can change contracted clearing
balances becomes effective January 8, 2004.
FOR FURTHER INFORMATION CONTACT: For questions regarding the fee
schedules: Jack K. Walton II, Assistant Director, (202/452-2660);
Gregory E. Cannella, Financial Services Analyst, (202/530-6214),
Division of Reserve Bank Operations and Payment Systems. For questions
regarding the PSAF and earnings credits on clearing balances: Lezell
Murphy, Senior Financial Analyst, (202/452-3758); or Brenda Richards,
Senior Financial Analyst, (202/452-2753); or Gregory Evans, Manager,
Financial Accounting, (202/452-3945), Division of Reserve Bank
Operations and Payment Systems. For users of Telecommunications Device
for the Deaf (TDD) only, please call 202/452-3544. Copies of the 2004
fee schedules for the check service are available from the Board, the
Federal Reserve Banks, or the Reserve Banks' financial services Web
site at http://www.frbservices.org.
[[Page 61419]]
SUPPLEMENTARY INFORMATION:
I. Priced Services
A. Discussion--From 1993 through 2002, the Reserve Banks recovered
98.8 percent of their total costs for providing priced services,
including special project costs, imputed expenses, and targeted after-
tax profits or return on equity (ROE).\1\
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\1\ These imputed expenses, such as taxes that would have been
paid, and the return on equity that would have to be earned had the
services been furnished by a private business firm, are referred to
as the private-sector adjustment factor (PSAF). The ten-year
recovery rate is based upon the pro forma income statements for
Federal Reserve Banks' priced services published in the Board's
Annual Report. Beginning in 2000, the PSAF has included additional
financing costs associated with pension assets attributable to
priced services. This ten-year cost recovery rate has been computed
as if these costs were not included in the PSAF calculations prior
to 2000. If these costs were included in the calculations, and
assuming that the Reserve Banks would not have made any
contemporaneous cost or revenue adjustments, the 10-year recovery
rate would be 97.8 percent.
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Table 1 summarizes the priced services' actual, estimated, and
budgeted cost recovery rates for 2002, 2003, and 2004, respectively.
Cost recovery is estimated to be 85.6 percent in 2003 and budgeted to
be 93.6 percent in 2004. The aggregate cost recovery rates are heavily
influenced by the performance of the check service, which accounts for
approximately 83 percent of the total cost of priced services. The
electronic services (FedACH, Fedwire funds and national settlement
(NSS), and Fedwire securities) account for approximately 17 percent of
costs, while noncash and special cash services represent a de minimis
amount.
[GRAPHIC] [TIFF OMITTED] TN28OC03.002
Table 2 presents an overview of the 2002, 2003 budget, 2003
estimate, and 2004 budget cost recovery performance by category of
major priced service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.003
[[Page 61420]]
1. 2003 Estimated Performance--In 2003, the Reserve Banks estimate
that they will recover 85.6 percent of the costs of providing priced
services, compared with the budgeted recovery rate of 93.7 percent. The
Reserve Banks do not expect to recover fully actual and imputed
expenses, incurring an overall net loss of $44.4 million, which is
$87.3 million less than the budgeted net income of $42.9 million. This
shortfall is largely driven by lower-than-expected net income from
clearing balances (NICB) and increased pension costs, as well as lower-
than-expected check service revenues and one-time costs associated with
check restructuring.\2\
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\2\ The Reserve Banks' check restructuring initiative will
reduce Federal Reserve check processing locations from 45 to 32
sites and will streamline check adjustments by 2004. (See http://www.frbservices.org/Retail/pdf/CheckRestructure-CustomerLetter.pdf.
)
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Two primary factors are contributing to the check service's
underrecovery. First, higher-than-anticipated volume declines, as well
as a shift by customers to lower priced check products as a result of
low interest rates, have resulted in check service operating revenues
in 2003 running $26.9 million below budget. The Federal Reserve
System's recent retail payments research, along with more recent
anecdotal information from the industry, indicates that check use in
the United States is continuing to decline.\3\ The deterioration in the
Reserve Banks' check volume is consistent with this nationwide trend.
Second, while the Reserve Banks have reduced operating costs in
response to the volume declines, one-time costs associated with the
check restructuring initiative have contributed to significantly lower-
than-budgeted check service cost recovery.
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\3\ See Gerdes, Geoffrey R. and Jack K. Walton II, ``The Use of
Checks and Other Noncash Payment Instruments in the United States,''
Federal Reserve Bulletin, August 2002, pp. 360-374. (See http://www.federalreserve.gov/pubs/bulletin/default.htm.
)
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2. 2004 Projected Performance--For 2004, the Reserve Banks project
a priced services cost recovery rate of 93.6 percent, with net income
of $48.2 million, as compared to target net income of $112.4 million.
The primary factors affecting 2004 cost recovery are the one-time costs
associated with planned and potential further restructuring of the
Reserve Banks' check operations and the continued decline in check
volume.
The primary risks to the Reserve Banks' ability to achieve their
budget targets are greater-than-expected costs associated with the
restructuring initiative and a steeper decline in the Reserve Banks'
check volume than the projected 8.9 percent decrease. Additionally, the
Check Clearing for the 21st Century Act (Check 21) presents risk to
existing volumes, pricing, and product strategies. To address the
continuing decline in check volumes, the Reserve Banks will continue to
implement a business and operational strategy that will improve
efficiency, reduce excess capacity and other costs, and position the
service to achieve its financial and payment system objectives over the
long term.
3. 2004 Pricing--The following summarizes the Reserve Banks''
changes in fee structures and levels for priced services in 2004, along
with an indication of overall experience with prices in each service
line since 1996:\4\
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\4\ Data elements used in calculating the price index for 2002
and prior years include explicit fee revenue from priced services
and volumes associated with those services. For 2003 and 2004, the
year-over-year percentage changes are based on comparisons of the
2002 results, 2003 estimates, and 2004 projections.
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Check
[sbull] The Reserve Banks will raise fees for forward-collection
check products 5.8 percent, return check products 6.1 percent, and
payor bank check products 0.7 percent compared with January 2003 fees.
[sbull] The price index for the check service has increased about
37 percent since 1996.
FedACH
[sbull] The Reserve Banks will reduce the input file processing fee
from $5.00 to $3.75, and will retain all other fees at their current
levels.
[sbull] The price index for the FedACH service has decreased about
66 percent since 1996.
Fedwire Funds and National Settlement
[sbull] The Reserve Banks will retain fees at their current levels.
[sbull] The price index for the Fedwire funds and national
settlement service has decreased about 62 percent since 1996.
Fedwire Securities
[sbull] The Reserve Banks will reduce the on-line transfer
origination and receipt fee from $0.40 to $0.32 and will reduce the
claim adjustment fee from $0.38 to $0.30. The Reserve Banks will
increase the off-line surcharge from $25 to $28 and will increase the
joint custody surcharge from $22 to $30. The Reserve Banks will retain
all other fees at their current levels.
[sbull] The price index for the Fedwire securities service has
decreased about 39 percent since 1996.
4. 2003 Price Index--Figure 1 compares indices of fees for the
Federal Reserve's priced services with the GDP price deflator. Since
1995, the price index for all priced services has increased a total of
about 3.6 percent. The price index for electronic payment services
(FedACH, Fedwire funds and national settlement, Fedwire securities, and
electronic check products), as well as electronic access to Federal
Reserve Banks' priced services, is projected to decrease 1.2 percent in
2004. The price index for paper-based payment services (check and
noncash collection) is expected to increase about 5.9 percent in 2004.
Compared with the price index for 2003, the price index for all Federal
Reserve Bank priced services is projected to increase approximately 3.9
percent in 2004.
[[Page 61421]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.004
B. Earnings Credits on Clearing Balances--The Board has approved
changing the rate used in calculating earnings credits on clearing
balances from the federal funds rate to 90 percent of the three-month
Treasury bill rate, effective January 8, 2004. The ``marginal reserve
requirement'' adjustment in the earnings credit calculation will
continue to be made using the federal funds rate.
Clearing balances were introduced in 1981, as a part of the Board's
implementation of the Monetary Control Act, to facilitate the access to
Federal Reserve priced services by institutions that either did not
have an account at a Reserve Bank or did not have a sufficient required
reserve balance to support the settlement of their payment
transactions. Reserve Banks have calculated earnings credits based on
the effective federal funds rate since the inception of the clearing
balance program over twenty years ago. Earnings credits can be used
only to offset charges for priced services, are calculated monthly, and
expire if not used within one year.\5\
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\5\ A band is established around the contracted clearing balance
to determine the maximum balance on which credits are earned as well
as any deficiency charges. The clearing balance allowance is 2
percent of the contracted amount, or $25,000, whichever is greater.
Earnings credits are based on the period-average balance maintained
up to a maximum of the contracted amount plus the clearing balance
allowance. Deficiency charges apply when the average balance falls
below the contracted amount less the allowance, although credits are
still earned on the average maintained balance.
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The most common practice at private-sector correspondent banks is
to calculate earnings credits on compensating balances using a rate
discounted from the lagged three-month Treasury bill rate. Discounts
are expressed either as a percentage reduction or a level (basis-point)
reduction from the base rate. Even so, almost one-quarter of large
correspondent banks no longer explicitly tie the earnings credit rate
to an external benchmark. Correspondent banks generally do not
establish required compensating balance levels and they generally do
not allow earning credits to accumulate to future months, like the
Federal Reserve.\6\ Earnings credits on balances held at correspondent
banks generally must be used in the month earned.
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\6\ A minimum balance may be established in specific cases,
depending on the creditworthiness of the customer.
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Under current procedures, the earnings credits on clearing balances
held at the Federal Reserve are based on the average effective federal
funds rate, the average clearing balance maintained, the imputed
reserve requirement adjustment, and the marginal reserve requirement.
These two adjustments are applied so that the return on clearing
balances at the Federal Reserve is comparable to what the depository
institution would have earned had it maintained the same balance at a
private-sector correspondent.\7\
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\7\ The ``imputed reserve requirement'' adjustment is made
because a private-sector correspondent would be required to hold
reserves against the respondent's balance with it. As a result, the
correspondent would reduce the balance on which it would base
earnings credits for the respondent because it would be required to
hold a portion, determined by its marginal reserve ratio, in the
form of non-interest-bearing reserves. For example, if a depository
institution held $1 million in clearing balances with correspondent
bank and the correspondent had a marginal reserve ratio of 10
percent, then the correspondent bank would be required to hold
$100,000 in reserves, and it would grant credits to the respondent
based on 90 percent of the balance, or $900,000. This adjustment
imputes a marginal reserve ratio of 10 percent to the Reserve Bank.
The ``marginal reserve requirement'' adjustment accounts for the
fact that the respondent can deduct balances maintained at a
correspondent, but not the Federal Reserve, from its reservable
liabilities. This reduction has value to the respondent when it
frees up balances that can be invested in interest-bearing
instruments, such as a federal funds. For example, a respondent
placing $1 million with a correspondent rather than the Federal
Reserve would free up $30,000 if its marginal reserve ratio were 3
percent.
The formula used by the Reserve Banks to calculate earnings
credits can be expressed as e = [ b * (1-FRR) * r] + [ b * (MRR) *
f] where e is total earnings credits, b is the average clearing
balance maintained, FRR is the assumed Reserve Bank marginal reserve
ratio (10 percent), r is the earnings credit rate (currently equal
to f), MRR is the marginal reserve ratio of the depository
institution holding the balance (either 0 percent, 3 percent, or 10
percent) and f is the average federal funds rate. A depository
institution that meets its reserve requirement entirely with vault
cash is assigned a marginal reserve requirement of zero.
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[[Page 61422]]
By using the federal funds rate, the Reserve Banks are calculating
earnings credits using a rate that is higher than typical market
practice. The Reserve Banks could better align their rates with those
of the marketplace and lower their cost of clearing balances, which
must be recovered via fees, by changing to a Treasury-bill-based rate.
The Board has approved that the earnings credit rate be changed to 90
percent of a rolling 13-week average of the annualized coupon
equivalent yield of three-month Treasury bills in the secondary market
to better align Federal Reserve policy with market practice.
The Board also approved changing its policy on the frequency with
which depository institutions can change their contracted clearing
balances. The new policy will permit changes more frequently, as often
as each maintenance period. Under this new policy, any change would
still need to be made before the beginning of the reserve maintenance
period to which it applies. Advance agreement on the amount of the
contracted balance ensures that variations in contracted clearing
balances are not a source of uncertainty for the conduct of open market
operations during a reserve maintenance period. Depository
institutions, through the Reserve Banks, have expressed interest over
the years in being able to make more frequent changes to their
contracted level.
C. Check--Table 3 below shows the 2002, 2003 estimate, and 2004
budgeted cost recovery performance for the check service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.005
1. 2002 Performance--The check service recovered 91.7 percent of
total costs in 2002, including imputed expenses, and a portion of
targeted ROE, which was less than the targeted recovery rate of 95.5
percent. The volume of checks collected decreased 1.9 percent from
2001, consistent with nationwide trends away from the use of paper
checks and toward greater use of electronic payment methods. Revenue
fell from 2001 levels primarily due to declining volume combined with a
customer shift to lower priced products. Customer demand for these
lower priced products grew and the value of premium priced accelerated
availability products diminished as interest rates declined. Revenue
was $44.3 million less than budget. Costs were $13.6 million less than
budget due to local cost reductions, which were largely offset by
lower-than-budgeted pension credits.
2. 2003 Estimate--Through August 2003, the check service has
recovered 84.3 percent of total costs, including imputed expenses, and
targeted ROE. For the full year, the Reserve Banks do not expect to
recover fully their costs of providing check services. Specifically,
the Reserve Banks estimate that the check service will recover 83.2
percent of its total costs for the full year compared with the budgeted
2003 recovery rate of 92.5 percent, for an operating loss of $61.2
million. The lower-than-budgeted recovery rate is driven by lower-than-
anticipated NICB and pension credits, which account for $59.4 million
of the financial shortfall. Additional contributing factors include
costs of $39.0 million associated with the check restructuring and
check modernization initiatives that were not included in the original
budget, and less-than-budgeted operating revenue of $26.9 million.\8\
The service revenue shortfall reflects a continued trend of customers
towards the use of lower priced products, which are more attractive in
a low interest rate environment. The budget variances are summarized in
table 4.
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\8\ The check modernization initiative, which is largely
completed, is comprised of four individual projects to standardize
the Reserve Banks' hardware and software platforms for check
processing and adjustments, for check imaging and archiving, and to
develop a Web-based delivery platform.
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[[Page 61423]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.006
The volume of checks handled by the Reserve Banks has declined (as
shown in table 5), reflecting the broader market trend in which the use
of checks continues to decline. Forward-collection check product volume
through August, excluding electronic fine sort volume, declined 4.8
percent.\9\ For the full year 2003, the Reserve Banks estimate that
forward-collection volume will decline 4.8 percent, compared with a
budgeted decline of 1.9 percent. Return check volume has increased 0.4
percent through August 2003. The Reserve Banks, however, anticipate
that return check volume will decline 0.2 percent for the full year,
compared with a budgeted decline of 3.3 percent.
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\9\ Two Reserve Banks offer an electronic fine-sort product,
which allows depository institutions to exchange fine-sort
information electronically between themselves with paper checks to
follow.
[GRAPHIC] [TIFF OMITTED] TN28OC03.007
Electronic check presentment volumes are projected to decline for
full-year 2003, as summarized in table 6. Reserve Banks provide paying
banks with electronic check data or images for approximately 40 percent
of the checks they collect. Image volumes are projected to increase 8.8
percent to approximately 1.5 billion check images, which represent
about 9.8 percent of all checks collected by the Reserve Banks. While
the total number of images increased, the increase was below the
budgeted growth rate of 14.9 percent.
[[Page 61424]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.008
3. 2004 Projection--For 2004, the Reserve Banks will focus largely
on opportunities to streamline further check processing and adjustment
activities across the System. The multi-year check modernization
project will be largely completed by the end of 2003 and will result in
a standard operating platform in all remaining Reserve Bank check
processing offices. In 2004, the Reserve Banks plan to reduce check
costs by $21.2 million as the check modernization management and
implementation teams are phased out. As the Reserve Banks complete
their transitions to the standard check platform, they will reduce
operating costs further. For example, through August 2003, the Reserve
Banks have reduced check operating costs $13.2 million because of the
greater efficiencies resulting from the check modernization projects.
In addition to these anticipated cost savings, the transition to a
common operating platform also will enable the Reserve Banks to improve
their operating efficiency further by providing them with additional
flexibility to adjust their check processing infrastructure.
Check restructuring allows the Reserve Banks to address ongoing
volume changes by reducing excess capacity across the Federal Reserve
System. The Reserve Banks will begin implementing the restructuring
initiative this year and will continue the restructuring through 2004.
While most of the one-time costs for this initiative will be accrued in
2003, significant costs also will be incurred in 2004. Check
restructuring is expected to improve Reserve Bank cost effectiveness
over the long term, with the current initiative reducing steady-state
production costs by $60 million in 2005. The Reserve Banks will
continue to assess the potential for further changes to their check
processing infrastructure. Given the expected continued volume decline
in the interbank check collection market and the industry's excess
processing capacity, the Reserve Banks anticipate further changes to
their infrastructure in 2005. As a result, the Reserve Banks' 2004
budget includes the accrual of expenses associated with further changes
in their check processing infrastructure in 2005, and potential
expenses for operational changes related to Check 21 in 2004. The
Reserve Banks are currently developing products as well as making
changes to operational workflows to address Check 21.
In addition to the operational initiatives for improving efficiency
and reducing ongoing costs, the Reserve Banks will modify the price of
selected products in 2004 to enhance service revenue. The Reserve Banks
will increase certain fees to collect and return checks drawn on
depository institutions that are distant from Federal Reserve check
processing offices to reflect the Reserve Banks' costs more accurately
in providing these products. Most of the price increases are targeted
at markets that have become increasingly costly for the Reserve Banks
to service. Depository institutions collecting checks drawn on and
returning checks to depository institutions located in these markets
may see a substantial increase in their check collection and return
fees.
There is also a significant effort in 2004 to continue setting fees
to achieve greater pricing consistency for key products across the
Reserve Banks. In addition, a number of high-value products have been
selected for moderate price increases for 2004. The fee changes will
enhance the Reserve Banks' ability to recover costs, while maintaining
the competitiveness of these products.
For 2004, the Reserve Banks are targeting an overall price increase
of 5.2 percent, as shown in table 7. This increase consists of a 5.8
percent increase in forward check-collection fees, comprised of a 6.9
percent increase in forward cash letter fees and a 5.4 percent increase
in per-item fees. Fees for return services will increase by 6.1
percent, which is composed of a 7.5 percent increase in return cash
letter fees and a 5.1 percent increase in per-item fees. The average
volume-weighted fees for payor bank services will increase 0.7 percent
compared with current fees.
[[Page 61425]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.009
Table 8 below summarizes ranges of selected check fees for 2003 and
2004, and shows 2004 price changes in bold type.
[[Page 61426]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.010
4. 2004 Cost Recovery--For 2004, the Reserve Banks project that the
check service will recover 91.9 percent of total costs, including
imputed expenses, and targeted ROE. The Reserve Banks expect to recover
all direct and indirect operating costs and all imputed costs of
providing check services, but only a portion of the targeted return on
equity.
Total adjusted costs before taxes are projected to decrease
approximately $87.1 million, or 9.1 percent, from estimated 2003
expenses. The largest factor contributing to the decline is local
operating costs, which are expected to decrease by $64.9 million, or
11.4 percent. This decline reflects significant reductions in personnel
costs and partial year savings associated with discontinuing the
processing of checks at thirteen Federal Reserve offices. Additional
reductions include lower check modernization expenses and the
consolidation of some local administrative functions into national
support centers.
Total check revenue is projected to increase $31.6 million, or 4.2
percent, compared with the 2003 estimate. The revenue growth is driven
largely by a $44.6 million increase in NICB. This increase associated
with the change in methodology to calculate imputed investment income
and payments of earnings credits to depository institution holders of
clearing balances. Partially offsetting this increase is a projected
$15.2 million, or 2.1 percent, decline in service revenue. This decline
is largely attributable to a projected acceleration of the downward
trend in the Reserve Banks' check volumes. The price changes will
partially offset the effect of volume losses on check revenue.
In 2004, forward-processed check volume is projected to be 12.8
billion, a decrease of 8.9 percent compared with the 2003 estimate. The
overall decline of paper check volume in the United States is the
predominant factor for the loss of forward volume; however, the Reserve
Banks also are projecting volume losses resulting from check
restructuring
[[Page 61427]]
(which accounts for 2 percentage points of that decline) and price
increases. Fine-sort check volume is expected to decline by 8.1 percent
from the 2003 estimate. Return volume is projected to decrease by 7.0
percent compared with the 2003 estimate, a somewhat slower rate than
forward volume. The difference in the rates of decline for forward and
return volumes is a result of an increase in the Reserve Banks' share
of the market for returned check processing in 2003 that is expected to
continue into 2004.
The Reserve Banks expect a slight decrease in payor bank service
volumes. Electronic presentment volume is expected to decline 0.8
percent in 2004. Image volume is projected to grow 5.1 percent in 2004,
compared with estimated 2003 volumes. Image volume growth is expected
to be driven by the increased functionality of FedImage services (for
example, electronic access to archived check images using web
technology).
The Board believes that the greatest risks to achieving the
projected cost recovery rate for the check service are volume declines
and associated revenue losses beyond System budget projections, and
greater-than-expected costs associated with the check restructuring
initiative.
The Board believes that the cost, volume, and revenue projections
are reasonable and has approved the price changes for the Reserve
Banks' check service.
D. Automated Clearinghouse (FedACH)--Table 9 below shows the 2002,
2003 estimate, and 2004 budgeted cost recovery performance for the
commercial FedACH service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.011
1. 2002 Performance--In 2002, the FedACH service recovered 104.1
percent of total costs, including imputed expenses, and targeted ROE,
compared with a targeted recovery rate of 101.4 percent. The greater-
than-budgeted cost recovery was due mainly to higher-than-expected
volume. The commercial ACH origination volume processed by the Reserve
Banks was 12.1 percent higher than in 2001, compared with the 7.3
percent decrease reflected in the 2002 budget. This reflects lower-
than-expected volume shift to a private-sector ACH operator.
2. 2003 Estimate--The Reserve Banks estimate that the FedACH
service will recover 101.6 percent of total expenses in 2003, compared
with the budgeted recovery rate of 100.3 percent. The greater-than-
budgeted cost recovery is attributable mainly to lower-than-expected
information technology support costs. Although the Reserve Banks
estimate that 2003 volume will be 13.7 percent higher than in 2002,
they estimate that revenue will be $3.2 million lower, primarily
because of price reductions that became effective January 2, 2003.
Through August 2003, the Reserve Banks' FedACH volume has increased
13.2 percent over the same period in 2002.
3. 2004 Pricing--The Reserve Banks project that the FedACH service
will recover 101.8 percent of its costs in 2004, including imputed
expenses, and targeted ROE. The Reserve Banks are keeping fees
unchanged except for a decrease in the input file processing fee from
$5.00 to $3.75. Ceteris paribus, the lower per-file fee would reduce
the Reserve Banks' FedACH revenue by about $4 million annually. The
budgeted $6.2 million increase in revenue reflects 8.7 percent growth
in anticipated FedACH processed origination volume, increased
electronic connection revenue, and increased NICB as a result of the
Reserve Banks' change in the NICB computation methodology. The year-
over-year cost increase is due primarily to projects related to
FedLine[reg] for the Web and to the development of new
FedACH services, including risk management and international ACH
services. The Reserve Banks generally believe that nationwide ACH
volume will grow somewhat faster than FedACH volume as large depository
institutions continue to shift their volume to the other ACH operator.
The Board believes that the cost, volume, and revenue projections
are reasonable and has approved the price changes for the Reserve
Banks' FedACH service.
E. Fedwire Funds and National Settlement Service--Table 10 below
shows the 2002, 2003 estimate, and 2004 budgeted cost recovery
performance for the Fedwire funds and national settlement service.
[[Page 61428]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.012
1. 2002 Performance--The Fedwire funds and national settlement
service recovered 99.6 percent of total costs in 2002, including
imputed expenses, and targeted ROE, less than the budgeted recovery
rate of 101.1 percent. Expenses for 2002 were $3.6 million more than
original budget projections, primarily because of unbudgeted costs
associated with the FedLine for the Web project and a FedLine for
Windows write-off. Service revenue was $2.6 million greater than
budget.
2. 2003 Estimate--For 2003, the Reserve Banks estimate that the
Fedwire funds and national settlement service will recover 98.0 percent
of total expenses, including imputed expenses, and target ROE, compared
with a budgeted recovery rate of 101.8 percent. The underrecovery is
attributed primarily to significantly lower-than-expected pension
credits. Funds transfer volume through August 2003 has increased 9.4
percent relative to the same period in 2002. For the full year, the
Reserve Banks estimate that volume will increase 7.3 percent compared
with 2002, based on the expectation that volume growth will be flat for
the remainder of the year. The Reserve Banks had originally projected
zero volume growth for 2003, which was based on historical growth
levels combined with anticipated losses of volume to a competitor. This
shifting of volume to the competitor, however, did not materialize and,
in fact, the Reserve Banks gained market share in 2003. With respect to
the national settlement service, the Reserve Banks estimate that 2003
volume will be less than budget due to continued consolidations among
check clearinghouses.
3. 2004 Pricing--The Reserve Banks are keeping fees for the Fedwire
funds and national settlement service unchanged from 2003.
The Reserve Banks project that the Fedwire funds and national
settlement service will recover 103.3 percent of total costs in 2004,
including imputed expenses, and targeted ROE. Total costs, including
imputed expenses, and targeted ROE are expected to increase $5.2
million from the 2003 estimate because of higher costs related to the
FedLine for the Web project, higher data communications costs, and a
higher PSAF. Funds transfer volume for 2004 is expected to increase 6.8
percent compared with the 2003 estimate. National settlement volume is
expected to remain flat. The Reserve Banks project total revenue to
increase by $8.2 million over the 2003 estimate primarily because of
continued strong volume growth, an increase in NICB attributable to the
change in the calculation methodology, and higher electronic access
revenue.
The Board believes that the cost, volume, and revenue projections
are reasonable and has approved the price changes for the Reserve
Banks' Fedwire funds and national settlement service be approved.
F. Fedwire Securities Service--Table 11 below shows the 2002, 2003
estimate, and 2004 budgeted cost recovery performance for the Fedwire
securities service.\10\
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\10\ The Reserve Banks provide transfer services for securities
issued by the U.S. Treasury, federal government agencies,
government-sponsored enterprises, and certain international
institutions. The priced component of this service, reflected in
this memorandum, consists of revenues, expenses, and volumes
associated with the transfer of all non-Treasury securities. For
Treasury securities, the U.S. Treasury assesses fees for the
securities transfer component of the service. The Reserve Banks
assess a fee for the funds settlement component of a Treasury
securities transfer; this component is not treated as a priced
service.
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[[Page 61429]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.013
1. 2002 Performance--The Fedwire securities service recovered 100.1
percent of total costs in 2002, including imputed expenses, and
targeted ROE. Total costs and service revenue for 2002 were greater
than budget by $1.1 million and $1.0 million, respectively.
2. 2003 Estimate--Through August 2003, the Fedwire securities
service recovered 107.4 percent of total costs, including imputed
expenses, and targeted ROE. For full-year 2003, the Reserve Banks
estimate that the Fedwire securities service will recover 106.0 percent
of total costs, compared with a budgeted recovery rate of 100.6
percent. The overrecovery is attributed primarily to higher-than-
expected volume growth.
Through August 2003, total Fedwire securities transfer volume has
increased 23.7 percent relative to the same period in 2002.\11\ For the
full year, the Reserve Banks estimate that total Fedwire securities
volume will increase 21.9 percent from 2002, compared with a budgeted
4.3 percent increase. The significantly higher-than-expected volume
growth is due primarily to the continued strength of the residential
mortgage financing market. The Reserve Banks expect that volume growth
experienced year-to-date will level off in the remaining months of the
year.
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\11\ Part of this increase is due to the full-year effect of the
addition of Ginnie Mae securities to the Fedwire Securities Service,
which was completed in March 2002.
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3. 2004 Pricing--The Reserve Banks are reducing the on-line
transfer origination and receipt fees from $0.40 to $0.32 and reducing
the claim adjustment fee from $0.38 to $0.30.\12\ The Reserve Banks
will increase the off-line surcharge from $25 to $28 and increasing the
joint custody surcharge from $22 to $30. The Reserve Banks will retain
all other fees at their current levels.
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\12\ In 2002, the Reserve Banks implemented a new automated
claim adjustment feature for mortgage-backed securities. The
automated claim adjustment process (ACAP) supports the settlement of
claims related to failed securities transactions, interim accounting
for securities with an accrual date different than the record date,
and repurchase agreements. ACAP allows participants to add
information to transfer messages that the Fedwire securities service
can use to calculate cash payments owed to counterparties involved
with related transfers.
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The Reserve Banks project that the Fedwire securities service will
recover 104.7 percent of costs in 2004, including imputed expenses, and
targeted ROE. Total costs, including imputed expenses, and targeted ROE
are expected to increase $0.7 million from the 2003 estimate.
The Reserve Banks project that total securities volume in 2004 will
increase 6.8 percent from the 2003 estimate. Total revenue is projected
to increase slightly from the 2003 estimate, as the expected decrease
in revenue from price reductions is offset by a higher NICB
attributable to the changes in calculation methodology.
The Board believes that the cost, volume, and revenue projections
are reasonable and has approved the price changes for the Reserve
Banks' Fedwire securities service.
G. Noncash Collection--Table 12 below shows the 2002, 2003
estimate, and 2004 budgeted cost recovery performance for the noncash
collection service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.014
[[Page 61430]]
1. 2002 Performance--The noncash collection service recovered 100.6
percent of total expenses in 2002, including imputed expenses, and
targeted ROE, exceeding the budgeted recovery rate of 94.3 percent.
Volume for 2002 declined 19.2 percent from 2001 levels, as expected.
2. 2003 Estimate--Through August 2003, the noncash collection
service recovered 131.5 percent of its costs. For full-year 2003, the
Reserve Banks estimate that the noncash collection service will recover
118.9 percent of costs, including imputed expenses, and targeted ROE,
compared with the budgeted recovery rate of 110.9 percent. This
overrecovery is attributed to higher-than-expected revenues, as volume
has not decreased from 2002 as much as anticipated. Noncash volume
through August has decreased 13.1 percent compared with volume during
the same period in 2002. For the full year, the Reserve Banks estimate
that 2003 volume will decrease 18.9 percent from 2002, compared with a
budgeted decline of 21.0 percent.
3. 2004 Pricing--The Reserve Banks are keeping fees for the noncash
collection service unchanged from 2003. As the number of outstanding
physical municipal securities continues to decline, the volume of
coupons and bonds presented for collection also will decline. New
issues of bearer municipal securities effectively ceased in 1983 after
the Tax Equity and Fiscal Responsibility Act of 1982 removed tax
advantages for investors. In 2004, the Reserve Banks project that the
noncash collection service will recover 113.3 percent of total costs,
including imputed expenses, and targeted ROE. The Reserve Banks project
that volume will decrease 18.9 percent from the 2003 estimate.
The Board believes that the cost, volume, and revenue projections
are reasonable and has approved the price changes for the Reserve
Banks' noncash collection service.
H. Special Cash--Special cash services represent a de minimis
portion (less than one tenth of one percent) of overall priced services
provided by the Reserve Banks to depository institutions. In 2002,
special cash services included wrapped coin, nonstandard packaging of
currency orders and deposits, and, for part of the year, registered
mail shipments of currency and coin. The offices that offered
registered mail shipments discontinued this service in mid to late
2002. In 2003, special cash services consisted of wrapped coin for half
of the year and nonstandard packaging of currency. The Helena office
discontinued its wrapped coin service in June 2003, and the Seventh
District will discontinue its nonstandard packaging service in December
2003. With the Helena office and the Seventh District exiting these
businesses, the Reserve Banks will not provide any special cash
services in 2004. Table 13 below shows 2002 and estimated 2003 cost
recovery performance for special cash services.
[GRAPHIC] [TIFF OMITTED] TN28OC03.015
1. 2002 Performance--Special cash services recovered 94.8 percent
of total expenses, including imputed expenses, and targeted ROE in
2002, compared with a targeted recovery rate of 103.4 percent. The
underrecovery was due primarily to the Kansas City District and the
Helena office discontinuing registered mail shipments of currency
earlier than budgeted in 2002, but continued to incur support charges
throughout the year.
2. 2003 Estimate--Through August 2003, special cash services has
recovered 72.1 percent of total expenses, including imputed expenses,
and targeted ROE. For full-year 2003, the Reserve Banks project that
special cash services will recover 71.9 percent of costs, compared with
a targeted recovery rate of 77.3 percent. Compared with 2002, total
expenses are projected to decrease $0.9 million, or 65.6 percent, and
revenue is expected to decrease $1.0 million, or 70.5 percent.
3. 2004 Pricing--There is no special cash service planned for 2004,
and no costs will be allocated to this service.
II. Private-Sector Adjustment Factor
A. Background--Each year, as required by the Monetary Control Act
of 1980, the Reserve Banks set fees for priced services provided to
depository institutions. These fees are set to recover, over the long
run, all direct and indirect costs and imputed costs, including
financing costs, taxes, and certain other expenses that would have been
incurred, as well as return on equity (profit) that would have been
earned, if a private business firm provided the services. These imputed
costs are based on data developed in part from a model comprising
consolidated financial data for the nation's fifty largest bank holding
companies (BHCs).\13\ The imputed costs and imputed profit are
collectively referred to as the PSAF. In a comparable fashion,
investment income is imputed and netted with related direct costs
associated with clearing balances to estimate NICB.\14\
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\13\ The peer group of the fifty largest bank holding companies
is selected based on total deposits.
\14\ See companion notice, Federal Reserve Bank Services,
elsewhere in today's Federal Register, on the change to the imputed
investment income on clearing balances method for 2004. Using the
average spread of 35 basis points over the three-month Treasury bill
rate, applied to the clearing balance levels and rate assumptions
used in the 2004 pricing process, NICB is projected to be $52.7
million.
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[[Page 61431]]
The method for calculating the financing and equity costs in the
PSAF requires determining the appropriate levels of debt and equity to
impute and then applying the applicable financing rates. This process
requires developing a pro forma priced services balance sheet using
actual Reserve Bank assets and liabilities associated with priced
services and imputing the remaining elements that would exist if the
Reserve Banks' priced services were provided by a private-sector
business firm.
The amount of the Reserve Banks' assets that will be used to
provide priced services during the coming year is determined using
Reserve Bank information on actual assets and projected disposals and
acquisitions. The priced portion of mixed-use assets is determined
based on the allocation of the related depreciation expense. The priced
portion of actual Reserve Bank liabilities consists of balances held by
Reserve Banks for clearing priced services transactions (clearing
balances), estimated based on historical data, and other liabilities
such as accounts payable and accrued expenses.
Long-term debt is imputed only when core clearing balances and
long-term liabilities are not sufficient to fund long-term assets or if
the interest rate risk sensitivity analysis indicates that estimated
risk will exceed a change in cost recovery of more than two percentage
points.\15\ Short-term debt is imputed only when short-term liabilities
and clearing balances not used to fund long-term assets, together, are
not sufficient to fund short-term assets. Equity is imputed to meet the
FDIC definition of a well-capitalized institution, which is currently 5
percent of total assets and 10 percent of risk-weighted assets.
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\15\ A portion of clearing balances is used as a funding source
for priced services assets. Long-term assets are partially funded
from core clearing balances, currently $4 billion. Core clearing
balances are considered the portion of the balances that has
remained stable over time without regard to the magnitude of actual
clearing balances. The PSAF methodology includes an analysis of
interest rate risk sensitivity, which compares rate-sensitive assets
with rate-sensitive liabilities and measures the effect on cost
recovery of a change in interest rates of up to 200 basis points.
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1. Financing Rates--Equity financing rates are based on the average
of the return on equity (ROE) results of three economic models using
data from the BHC model.\16\ For simplicity, given that federal
corporate tax rates are graduated, state tax rates vary, and various
credits and deductions can apply, a specific tax rate is not calculated
for Reserve Bank priced services. Instead, the use of a pre-tax ROE
captures imputed taxes. The resulting ROE influences the dollar level
of the PSAF and Federal Reserve price levels because this is the return
a shareholder would expect in order to invest in a private business
firm. The use of the pre-tax ROE assumes 100 percent recovery of
expenses, including the targeted ROE. The recommended PSAF is,
therefore, based on a matching of revenues with actual and imputed
costs and imputed profits. Should the pre-tax earnings be less than the
targeted ROE, as projected, imputed expenses would be adjusted for the
tax savings associated with the adjusted recovery. The imputed tax rate
is the median of the rates paid by the BHCs over the past five years
adjusted to the extent that BHCs have invested in municipal bonds.
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\16\ The pre-tax return on equity (ROE) is determined using the
results of the comparable accounting earnings model (CAE), the
discounted cash-flow model (DCF), and the capital asset pricing
model (CAPM). Within the CAPM and DCF models, the ROE is weighted
based on market capitalization, and within the CAE model, the ROE
calculation is equally weighted. The results of the three models are
averaged to impute the PSAF pre-tax ROE. When needed, to impute
short- and long-term debt, the debt rates are derived based on the
short-term debt and long-term debt elements in the BHC model.
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2. Other Costs--The PSAF also includes the estimated priced
services-related expenses of the Board of Governors and imputed sales
taxes based on Reserve Bank expenses. An assessment for FDIC insurance,
when required, is imputed based on current FDIC rates and projected
clearing balances held with the Federal Reserve.
B. Discussion--The increase in the 2004 PSAF is primarily due to a
significant increase in clearing balances on which investments are
imputed and the resulting increase in total assets. Because required
imputed equity is based on five percent of total assets, priced
services equity and cost of equity increased.
1. Asset Base--The total estimated cost of Federal Reserve assets
to be used in providing priced services is reflected in table 14. Total
assets have increased $1,704.6 million, or 11.0 percent from 2003.
Growth of $1,283.0 million in imputed investments, growth of $131.8
million in imputed reserve requirements, which are based on the level
of clearing balances, and an increase of $308.4 million in cash items
in process of collection explains the majority of this increase. As
shown in table 15, the assets financed through the PSAF have decreased,
primarily due to the decrease in prepaid pension costs. Short-term
assets funded with short-term payables and clearing balances total
$102.0 million. This amount represents a decrease of $1.8 million, or
1.7 percent, from the short-term assets funded in 2003. Long-term
assets funded with long-term liabilities, equity, and core clearing
balances are projected to total $1,520.6 million. This amount
represents a decrease of $16.8 million, or 1.1 percent, from the long-
term assets funded in 2003. A decrease of $17.8 million in prepaid
pension costs explains the majority of the decrease. The decrease of
$15.0 million in furniture and equipment is offset by an increase in
bank premises and leasehold improvements and long-term prepayments of
$3.9 million and $12.1 million, respectively.
2. Debt and Equity Costs and Taxes--As previously mentioned, core
clearing balances are available as a funding source for priced services
assets. Table 15 shows that $407.2 million in clearing balances are
used to fund priced services assets in 2004. The interest rate
sensitivity analysis in table 16 indicates that the ratio of rate-
sensitive assets to rate-sensitive liabilities and the effect on cost
recovery of an increase in interest rates of 200 basis points produces
a decrease in cost recovery of 1.3 percentage points. The established
threshold for change to cost recovery is two percentage points;
therefore, interest rate risk associated with using these balances is
within acceptable levels and no long-term debt is imputed.
Table 17 shows the imputed PSAF elements, the pre-tax ROE, and
other required PSAF recoveries for 2003 and proposed for 2004. The
significant increase in clearing balances from which the investments
are imputed increases total assets. An increase in total assets, and
the resulting increase in imputed equity, increases targeted ROE.
Although the pre-tax ROE rate decreased from 19.4 percent for 2003 to
18.6 percent for 2004, with increased imputed equity, the pre-tax ROE
increased $9.6 million. As indicated previously, the pre-tax ROE is
calculated using the combined results of three models. The effective
tax rate used in 2004 also decreased to 29.8 percent from 30.4 percent
in 2003. Sales taxes decreased $2.8 million from $14.8 million in 2003
to $12.0 million in 2004. Offsetting this is a $1.2 million increase in
Board of Governors expenses.
3. Capital Adequacy and FDIC Assessment--As shown in table 14, the
amount of equity imputed for the proposed 2004 PSAF is $860.8 million,
an increase of $85.2 million from imputed equity of $775.6 million in
[[Page 61432]]
2003. As noted above, equity is based on 5 percent of total assets, as
required by the FDIC for a well-capitalized institution in its
definition for purposes of assessing insurance premiums. In both 2004
and 2003, the capital to risk-weighted asset ratio and the capital to
total assets ratio both exceed regulatory guidelines. As a result, no
FDIC assessment is imputed for either year.
III. Analysis of Competitive Effect
All operational and legal changes considered by the Board that have
a substantial effect on payments system participants are subject to the
competitive impact analysis described in the March 1990 policy
statement, ``The Federal Reserve in the Payments System.'' \17\ Under
this policy, the Board assesses whether the change would have a direct
and material adverse effect on the ability of other service providers
to compete effectively with the Federal Reserve in providing similar
services because of differing legal powers or constraints or because of
a dominant market position deriving from such legal differences. If the
change creates such an effect, the Board must further evaluate the
change to assess whether its benefits `` such as contributions to
payment system efficiency, payment system integrity, or other Board
objectives--can be retained while minimizing the adverse effect on
competition.
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\17\ Federal Reserve Regulatory Service (FRRS) 9-1558.
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The 2004 fees result in a projected ROE less than the target
established using a model that is based on the consolidated results
over time of the largest fifty BHCs. To the extent that these BHCs
expect a mature declining business, such as check processing, to have
the same ROE as the organization as a whole, the Reserve Banks' failure
to set fees to achieve the target ROE could adversely affect the
ability of other service providers to compete with the Reserve Banks.
Based upon discussions with the industry and other anecdotal
information, the Board does not believe that BHCs have such an
expectation. Moreover, given the current market environment, greater
fee increases are not likely to improve the Reserve Banks' cost
recovery materially and might even reduce the revenue that the Reserve
Banks receive as depository institutions seek lower cost alternatives.
Overall, the Board believes that the fee changes and the changes to
earnings credits on clearing balances are reasonable.
BILLING CODE 6210-01-P
[[Page 61433]]
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[[Page 61434]]
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[[Page 61435]]
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[[Page 61436]]
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[[Page 61437]]
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[[Page 61438]]
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[[Page 61439]]
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[[Page 61440]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.023
[[Page 61441]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.024
BILLING CODE 6210-01-C
Electronic Connection Fee Schedule
There are four types of electronic connections through which
depository institutions access the Reserve Banks' priced services:
FedLine[reg], FedMail[reg], FedPhone[reg], and computer interface
[[Page 61442]]
(mainframe to mainframe).\46\ The Reserve Banks allocate costs and
revenues associated with these electronic connections to the various
priced services.
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\46\ These connections may also be used to access non-priced
services provided by the Reserve Banks. No fee is assessed if a
particular connection is used only to access non-priced services.
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In 2004, the Reserve Banks are offering a new bundled electronic
access package for a monthly fee of $150 that includes one DOS-based
FedLine dial connection and one FedLine for the Web institution-level
connection with three digital certificates for individual
subscriptions. This package supports the Reserve Banks' strategic
direction of moving to web-based electronic access, consistent with,
and in response to, customers' preferences. The Reserve Banks are
increasing the monthly fee for additional DOS-based FedLine dial
connections from $75 to $100. This increase, the first since 1993,
reflects the cost of maintaining and updating FedLine connectivity. The
Reserve Banks are retaining the connection fees for FedLine for the Web
access and the other existing connection fees at current levels.
BILLING CODE 6210-01-P
[[Page 61443]]
[GRAPHIC] [TIFF OMITTED] TN28OC03.026
[[Page 61444]]
By order of the Board of Governors of the Federal Reserve
System, October 22, 2003.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 03-27123 Filed 10-27-03; 8:45 am]
BILLING CODE 6210-01-C