[Federal Register Volume 59, Number 160 (Friday, August 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20408]


[[Page Unknown]]

[Federal Register: August 19, 1994]


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FEDERAL RESERVE SYSTEM

[Docket R-0846]

 

Federal Reserve Bank Services: Imputed Income on Clearing 
Balances

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comment.

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SUMMARY: The Board is requesting comment on a proposal to modify the 
methodology for imputing clearing balance income to more closely 
parallel the practices of a private sector service provider. 
Specifically, the Board is requesting comment on a proposal to change 
the rate used to impute clearing balance income from the 90-day 
Treasury bill coupon equivalent yield to a longer term Treasury rate 
based on the earning asset maturity structure of the largest bank 
holding companies (BHCs). The intended effect of the proposal is to 
promote competitive equity with private sector practices by matching 
the maturity structure for investment of clearing balances to the 
structure revealed in bank holding company data on investments.

DATES: Comments must be submitted on or before September 21, 1994.

ADDRESSES: Comments, which should refer to Docket No. R-0846, may be 
mailed to William W. Wiles, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, N.W., 
Washington, D.C. 20551. Comments also may be delivered to Room B-2222 
of the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to 
the guard station in the Eccles Building courtyard on 20th Street NW. 
(between Constitution Avenue and C Street) at any time. Comments may be 
inspected in Room MP-500 of the Martin Building between 9:00 a.m. and 
5:00 p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's 
rules regarding availability of information.

FOR FURTHER INFORMATION CONTACT: Greg Evans, Manager (202/452-3945), or 
Gwen Mitchell, Senior Accounting Analyst (202/452-3841), Division of 
Reserve Bank Operations and Payment Systems, Board of Governors of the 
Federal Reserve System. For the hearing impaired only: 
Telecommunications Device for the Deaf, Dorothea Thompson (202/452-
3544).

SUPPLEMENTARY INFORMATION: The Monetary Control Act (MCA) requires the 
Federal Reserve Banks to establish fees for their services on a basis 
similar to private sector service providers. In establishing fees, the 
Board considers objectives of fostering competition, improving the 
efficiency of the payments mechanism, and providing financial services 
nationwide.
    Accordingly, the Federal Reserve imputes costs in the private 
sector adjustment factor (PSAF) that are intended to mirror private 
sector sales taxes, income taxes, cost of funds, and FDIC assessments. 
Capital structure, equity and debt rates, and an income tax rate are 
derived from a model of the largest (in asset size) 50 bank holding 
companies. The Federal Reserve uses the bank holding company model to 
place Reserve Bank payment service costs on an equal footing with those 
costs incurred by the private sector. The banking industry has accepted 
the BHC model as a proxy for determining Federal Reserve imputed costs.
    In February 1981, the Federal Reserve established procedures to 
assist depository institutions with clearing arrangements at Reserve 
Banks, recognizing that the maintenance of an account relationship is 
necessary for (a) depository institutions that do not maintain reserve 
accounts but desire direct access to some or all Federal Reserve priced 
services and (b) depository institutions that do maintain a reserve 
account but find the reserve balance inadequate for their transactions.
    Because clearing balances were established as a result of 
depository institutions wanting access to Federal Reserve priced 
services, it was determined that investment earnings attributable to 
clearing balances should be ascribed to the System's priced service 
operations, comparable to the use of these balances by other service 
providers. The 1982 annual financial report of the Federal Reserve 
reflected these earnings.
    This priced service revenue factor, net income on clearing balances 
(NICB), is the difference between the income the Federal Reserve 
imputes on clearing balances held with the Federal Reserve System, less 
imputed reserve requirements, and the priced services cost of earnings 
credits granted to depository institutions, net of expired earnings 
credits. (Appendix A illustrates the current NICB calculation.) The 
private sector recognizes revenue from these balances in a similar way.
    In 1982, under its delegated authority rules, the Board approved a 
rate of return equivalent to the yield on the short-term assets 
included in the System Open Market Account portfolio for calculating 
clearing balance income. The Federal Reserve selected the 90-day 
Treasury bill coupon equivalent yield to impute income on clearing 
balances.
    A primary benefit of the 90-day Treasury rate, which is still used 
today, is that its yield is equivalent to the yield on short-term 
assets currently included in the Federal Reserve's System Open Market 
Account (SOMA) portfolio. Additionally, use of the short-term 90-day 
rate was viewed as more closely approximating what would have been 
realized had clearing balance funds been held and invested by a private 
business firm. Lastly, Treasury yield data are available to the public. 
This allows the earnings calculation to be replicated by the private 
sector.
    The Reserve System recently reviewed the methodology used to impute 
income on clearing balances to determine the comparability of Federal 
Reserve practices in this area with practices of correspondent banks. A 
telephone survey of bank holding companies was conducted to determine 
the types of assets in which correspondent banks invest clearing 
balance funds.
    Survey results showed that, although correspondent banks pay 
earnings credits based on a short-term rate (90-day Treasury bill), 
their investment of clearing balance funds is determined by the 
economic environment, their risk policies, and investment opportunities 
available. The survey participants identified a range of investment 
options including, loans, securities, and overnight funds.
    It was observed that correspondent banks may exercise a broad range 
of investment opportunities whereas the Federal Reserve has adopted a 
more restrictive practice. Since Reserve Bank imputed investments do 
not reflect correspondent bank practices, the approach is inconsistent 
with other areas of priced service accounting. Other areas of priced 
service accounting either draw on actual Reserve Bank costs, or are 
imputed based on BHC data. More important, over time, by computing 
clearing balance income in the current fashion, the Federal Reserve may 
be understating clearing balance revenue, increasing costs of Federal 
Reserve priced services, and setting prices higher than necessary to 
promote effective competition and efficient payment services.
    The proposal under consideration by the Board of Governors is to 
determine the maturity structure of short-, intermediate-, and long-
term securities assets from the BHC model and impute income based on 
published matching term Treasury yields. The Board is considering the 
BHC structure/Treasury yields method because it promotes competitive 
equity with private sector practices by matching the maturity structure 
for investment of clearing balances to the structure revealed in bank 
holding company data on investments.
    One problem with attempting to match the earnings realized by bank 
holding companies is that the risk premium for the private sector is 
difficult to manage and approximate. Also, the Federal Reserve could 
not determine administrative costs from available data. Therefore, the 
Board believes that the Treasury rate provides a reasonable proxy for 
the actual rate realized by bank holding companies on clearing 
balances, without the risk premium associated with holding company 
investments and administrative costs incurred managing portfolio risk. 
Bank holding company maturity structures and Treasury yields are 
publicly available so that the NICB calculation can be replicated by 
the private sector. The recommended approach provides longer term 
investments, which would produce higher earnings, assuming an upward 
sloping yield curve.

Proposed NICB Computation

    An estimate of NICB is prepared annually. Under the recommended 
methodology, selected earning assets include Federal funds, repurchase 
agreements, and securities. These investments were chosen because they 
most closely represent the Treasury function investments of the private 
sector. The earning assets maturity structure of the BHC model would be 
defined as follows: less than one year (short-term), one -to -five 
years (intermediate-term) and greater than five years (long-term). The 
maturity structure would be calculated from the most recent four 
quarters of Y9 data. The Y9 is a quarterly BHC report filed with the 
Federal Reserve and is generally available to the public 50 to 60 days 
after the close of the quarter. For example, four quarters for 1992 
would be used for the 1994 earnings rate estimate, which would be 
calculated in the fall of 1993. Similarly, 1992 BHC data are used for 
the 1994 PSAF calculation. Historical rates are used because the Board 
has decided in previous instances to avoid the appearance of 
forecasting interest rates.
    Published matching-term Treasury yields would be applied to the 
maturity percentages and summed to develop the earnings rate. The Board 
intends initially to use shorter term Treasury rates. In this regard, a 
three-month Treasury yield would be used for the short-term rate 
maturity portion. A one- year Treasury yield would be used for the 
intermediate-term, and a five-year Treasury yield would be applied for 
the long-term portions. Current year-to-date (approximately four 
months) week-ending average Treasury yields from the Federal Reserve 
H.15 Statistical Release would be used for the estimate. The 
recommended maturity structure and applicable Treasury yields are shown 
below. 

------------------------------------------------------------------------
 BHC maturity structure                            Weighted average rate
          (A)               Treasury yield (B)             (AxB)        
------------------------------------------------------------------------
% Investment < 1 year..  Three-                   %                     
                         month..................                        
% Investments 1-5 years  One-                     %                     
                         year...................                        
% Investment 5+ years..  Five-..................  %                     
                         year...................                        
  Total................  .......................  Weighted average      
                                                   estimated rate.      
------------------------------------------------------------------------

    Actual NICB results are imputed monthly. Under the recommended 
methodology, the maturity structure developed in the calculation of the 
estimate would be held constant for the year; however, current monthly 
Treasury yields would be applied to the percentages to develop the 
weighted average earnings rate. The week-ending average yields, as 
published in the Federal Reserve H.15 Statistical Release, would be 
used to calculate the monthly rate.
    The following table illustrates the result of this recommendation 
compared with the current methodology using 1994 projections. 

                    1994 NICB Estimate ($ Millions)                     
------------------------------------------------------------------------
                                                                  BHC   
                                                               structure
                                                    Current       and   
                                                    Method     treasury 
                                                                 yield  
------------------------------------------------------------------------
Clearing balance income:                                                
  Investable funds..............................    $5,417.8    $5,417.8
  Earnings rate.................................     3.0877%     4.1109%
  Earnings on invested portion of clearing                              
   balances.....................................       167.3       222.7
Cost of earnings credits:                                               
  Cost (Fed funds rate).........................     3.0079%     3.0079%
  Net cost of earnings credits..................       141.9       141.9
Net Income on clearing balances.................       $25.4       $80.8
------------------------------------------------------------------------

    Had the recommended approach been in place for the 1994 estimate, 
clearing balance earnings would have increased $55.4 million or 33.1 
percent, from $167.3 million using the current method to $222.7 
million. This is due to a 102 basis points increase in the earnings 
rate, from 3.0877 percent in the current method to 4.1109 percent\1\. 
NICB would have increased from $25.4 million in the current method to 
$80.8 million.
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    \1\The imputed weighted average earnings rate is derived as 
follows (short, intermediate, and long-term, respectively): ((32.67% 
* 3.0877%) + (27.58% * 3.3889%) + (39.75% * 5.4526%)) = 4.1109%
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    Moreover, the Board believes that investment decisions made by BHCs 
are not static. Instead, these decisions are the result of several 
considerations, including the economic environment, their risk 
policies, and investment opportunities available. Consequently, the 
Board recognizes that the recommended methodology may require further 
adjustment based on economic situations or new investment 
opportunities. Prudent private sector investors would be aware of 
changing variables and would make the necessary investment changes to 
reflect market conditions.
    Accordingly, the Board would propose to make such adjustments, 
without public comment, unless the adjustment entails a change in the 
methodology. Therefore, imputed investment income would be subject to 
the Board's approval as are fee schedules for Federal Reserve priced 
services and the PSAF.
    In summary, the current short term nature of Federal Reserve 
clearing balance income is not representative of the behavior of most 
correspondent banks. Although the recommended methodology still does 
not purely match BHC activity, the Board believes that it more closely 
parallels the practices of a private sector service provider. The 
recommended methodology also complies with Federal Reserve pricing 
principles. The Board also believes that the Treasury rate provides a 
reasonable proxy for the actual rate realized by bank holding companies 
on clearing balances. The Treasury rate is simpler to administer 
because it does not incorporate a risk premium or administrative costs 
of managing portfolio risk. The Board requests comments on the proposal 
to: (a) change the methodology for imputing clearing balance income to 
more closely parallel the practices of a private sector service 
provider and (b) change the rate used to impute clearing balance income 
from the 90-day Treasury bill coupon equivalent yield to a longer term 
Treasury rate based on the earning asset maturity structure of the 
largest BHCs.

    By order of the Board of Governors of the Federal Reserve 
System, August 12, 1994.
William W. Wiles,
Secretary of the Board.
BILLING CODE 6210-01-P




E:\GRAPHICS\EN19AU94.034

[FR Doc. 94-20408 Filed 8-18-94; 8:45 am]
BILLING CODE 6210-01-C