Federal Register, Volume 60 Issue 217 (Thursday, November 9, 1995)

[Federal Register Volume 60, Number 217 (Thursday, November 9, 1995)]
[Notices]
[Pages 56591-56600]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27631]

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FEDERAL RESERVE SYSTEM

[Docket No. R-0899]

Federal Reserve Bank Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has approved a private sector adjustment factor
(PSAF) for 1996 of $85.8 million, as well as fee schedules for Federal
Reserve priced services and electronic connections. 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.

DATES: The PSAF and the fee schedules become effective January 2, 1996.

FOR FURTHER INFORMATION CONTACT: For questions regarding the private
sector adjustment factor: Elizabeth Tacik, Accounting Analyst (202/452-
2303), Division of Reserve Bank Operations and Payment Systems; for
questions regarding fees schedules: Scott Knudson, Senior Financial
Services Analyst, ACH Payments (202/452-3959), Michele Braun, Senior
Financial Services Analyst, Check Payments (202/452-2819), Darrell Mak,
Financial Services Analyst, Funds Transfer and Book-Entry Securities
Services, (202/452-3223), Ken Buckley, Manager, Information Technology
(electronic connections), (202/452-3646), Michael Bermudez, Financial
Services Analyst, (202/452-2216), or Marianne Hansberry, Financial
Services Analyst, Cash Section, (202/452-2760), Division of Reserve
Bank Operations and Payment Systems. For users of Telecommunications
Device for the Deaf only, please contact Dorothea Thompson (202/452-
3544).
Copies of the 1996 fee schedules for the check, automated clearing
house (ACH), funds transfer and net settlement, book-entry securities,
noncash collection, and special cash services, as well as electronic
connections to Reserve Banks, are available from the Reserve Banks.

SUPPLEMENTARY INFORMATION:

I. Private Sector Adjustment Factor

A. Overview--The Board has approved a 1996 PSAF for Federal Reserve
priced services of $85.8 million. This amount represents a decrease of
$8.9 million or 9.4 percent from the PSAF of $94.7 million targeted for
1995.
As required by the Monetary Control Act (MCA) (12 U.S.C. 248a), the
Federal Reserve's fee schedules for priced services include ``taxes
that would have been paid and the return on capital that would have
been provided had the services been furnished by a private business
firm.'' These imputed costs are based on data developed in part from a
model comprised of the nation's 50 largest (in asset size) bank holding
companies (BHCs).
The methodology first entails determining the value of Federal
Reserve assets that will be used in producing priced services during
the coming year. Short-term assets are assumed to be financed by short-
term liabilities; and long-term assets are assumed to be financed by a
combination of long-term debt and equity derived from the BHC model.
For 1995, the mix of long-term debt and equity was modified slightly to
ensure an imputed equity to asset ratio of 4 percent as required for
adequately capitalized institutions under provisions of Regulation F
(12 CFR 206.5). This was not necessary for 1996.
Imputed capital costs are determined by applying related interest
rates and rates of return on equity (ROE) derived from the BHC model to
assets used in providing priced services. The rates drawn from the BHC
model are based on consolidated financial data for the 50 largest BHCs
in each of the last five years. Because short-term debt, by definition,
matures within one year, only data for the most recent year are used
for computing the short-term debt rate.
In addition to capital costs, the PSAF includes imputed sales
taxes, expenses of the Board of Governors related to priced services,
and an imputed Federal

[[Page 56592]]
Deposit Insurance Corporation (FDIC) insurance assessment on clearing
balances held with the Federal Reserve to settle transactions.
B. Asset Base--The estimated value of Federal Reserve assets to be
used in providing priced services in 1996 is reflected in table A-1.
Table A-2 shows that the assets assumed to be financed through debt and
equity are projected to total $637.3 million. As shown in table A-3,
this represents a net increase of $14.4 million or 2.3 percent from
1995. This increase results primarily from a higher priced asset base
at the Reserve Banks. A decrease of $10.6 million or 14.3 percent in
the FRAS priced asset base due to a reduction in capital purchases and
a reduction in the FRAS priced percentage sightly offset the increase
in Reserve Bank asset levels.
C. Cost of Capital, Taxes, and Other Imputed Costs--Table A-3 shows
the financing and tax rates, as well as the other required PSAF
recoveries proposed for 1996, and compares the 1996 rates with the
rates used for developing the PSAF for 1995. The pre-tax return on
equity rate increased from 12.1 percent in 1995 to 14.2 percent for
1996. The increase is a result of stronger 1994 BHC financial
performance included in the 1996 BHC model, relative to the 1989 BHC
financial performance in the 1995 BHC model.
The decrease in the FDIC insurance assessment from $19.0 million in
1995 to $2.2 million in 1996, as shown in table A-3, is attributable to
the impact of the new lower rate for deposit insurance and lower
clearing balances. The FDIC rate of $0.26 for every $100 in clearing
balances was reduced to $0.04 as of June 1, 1995.
D. Capital Adequacy--As shown on table A-4, the amount of capital
imputed for the proposed 1996 PSAF totals 34.4 percent of risk-weighted
assets, well in excess of the 8 percent capital guideline for state
member banks and BHCs.

II. Priced Services

A. Overview--Over the period 1985 through 1994, the Reserve Banks
recovered 100.7 percent of the total costs of providing priced
services, including special project costs that were budgeted for
recovery and targeted ROE.\1\ Table 1 summarizes the cost and revenue
performance for priced services since 1985.

\1\ Certain offsets to costs and certain costs are treated
differently in the pro forma income statement for Federal Reserve
priced services that is published in the Board's Annual Report than
they are for purposes of setting fees. For example, off-sets to
costs associated with the transition to and retroactive application
of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 87 (SFAS 87), pension accounting, and SFAS
106, other post-retirement employee benefits accounting, have not
been considered in setting fees for priced services. Under the
procedures used to prepare the pro forma income statement, the
Reserve Banks recovered 101.4 percent of the expenses incurred in
providing priced services, including targeted ROE, from 1985 through
1994.
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B. 1995 Performance--The 1995 fees approved by the Board were
expected to recover 100.6 percent of the costs of providing priced
services, including imputed expenses, automation consolidation special
project costs budgeted for recovery, and targeted ROE. Through August
1995, the System recovered 98.7 percent of total priced services
expenses, including automation consolidation special project costs and
targeted ROE. The Reserve Banks now estimate that priced services
revenues will yield a net income of $25.8 million for the year,
compared with a targeted ROE of $31.5 million. The recovery rate after
ROE is expected to be 99.3 percent. Approximately $19.8 million in
automation consolidation special project costs will be recovered in
1995, leaving $36.0 million in accumulated costs to be financed and
recovered later.\2\

\2\ In 1981, the Board adopted a policy that permits the Reserve
Banks to defer and finance development costs if the development
costs would have a material effect on unit costs, provided a
conservative time period is set for full cost recovery and a
financing factor is applied to the deferred portion of development
costs.
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The variation in the cost recovery performance from the original
1995 projections can be attributed to the following major factors.
First, the pre-tax credits arising from accounting for pensions under
the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 87 (SFAS 87) were revised downward by $16.1
million from the estimate used to set 1995 fees. This reduction was due
primarily to a lower return on assets in 1994 and a slightly lower
discount rate for valuing pension plan assets. On the other hand, the
FDIC insurance assessment was reduced, which lowered imputed expenses
by $9.4 million. If these two changes had not occurred, the Reserve
Banks' estimated 1995 recovery rate would have been 99.8 percent, or
0.5 percentage points higher than now forecast.

Table 1.--Pro Forma Cost and Revenue Performance (a)
[$ millions]

8 Special
2 3 Special 7 Recovery project
Operating project 4 Total 5 Net 6 Target rate after costs
Year 1 Revenue costs and costs expense income ROE target ROE deferred
imputed recovered (ROE) (percent) and
expenses financed
(b) (c) (d) [2+3] [1-4] (e) [1/(4+6)] (f)
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1985............................................ 613.8 555.3 0.0 555.3 58.5 23.9 106.0 0.0
1986............................................ 627.7 571.6 0.0 571.6 56.1 27.3 104.8 0.0
1987............................................ 649.7 598.2 0.0 598.2 51.5 29.3 103.5 0.0
1988............................................ 667.7 641.1 3.2 644.3 23.4 32.7 98.6 0.0
1989............................................ 718.6 692.1 4.6 696.7 21.9 32.9 98.5 0.0
1990............................................ 746.5 698.1 2.8 700.9 45.6 33.6 101.6 0.0
1991............................................ 750.2 710.0 1.6 711.6 38.6 32.5 100.8 0.0
1992............................................ 760.8 731.0 11.2 742.2 18.6 26.0 99.0 1.6
1993............................................ 774.5 722.4 27.1 749.5 25.0 24.9 100.0 12.5
1994............................................ 767.2 748.3 8.8 757.1 10.1 34.6 96.9 33.9
1995 (Est)...................................... 757.7 712.1 19.8 731.9 25.8 31.5 99.3 36.0

[[Page 56593]]

1996 (Bud)...................................... 791.6 723.7 25.5 749.3 42.3 36.7 100.7 33.1
(a) Details may not sum to totals because of rounding. The revenues and expenses for 1985 through 1993 include the definitive safekeeping service, which
was discontinued in 1993. The table includes revised revenue and expense data for 1992 and 1993.
(b) Beginning in 1987, net income on clearing balances is included in revenue.
(c) Imputed expenses include interest on debt, taxes, FDIC insurance, and the cost of float. Credits for prepaid pension costs under SFAS 87 and the
charges for post-retirement benefits in accordance with SFAS 106 are included beginning in 1993.
(d) Special project costs include Electronic Payment System (EPS) costs from 1988 through 1990, check image project costs from 1988 through 1993, and
certain categories of automation consolidation costs from 1992 through 1996.
(e) Targeted ROE is based on the ROE included in the PSAF and has been adjusted for taxes, which are included in column 2. Targeted ROE has not been
adjusted to reflect automation consolidation special project costs deferred and financed. The Reserve Banks plan to recover these costs in the future.

(f) Totals are cumulative and include financing costs.

Second, for the second year, the check service's volume losses were
greater than anticipated, reflecting increasing use of direct
presentments and continuing consolidation in the banking industry. The
Reserve Banks' current estimates indicate that check revenues will be
about $10.0 million lower than original projections. Conversely, ACH
volume has grown more rapidly than the Reserve Banks initially
projected and revenues are nearly $4.0 million higher than anticipated.
C. 1996 Projection--In 1996, all priced services expect to recover
operating costs and imputed expenses, including targeted ROE. Total
revenues in 1996 are projected to increase 4.5 percent compared with
1995 estimated revenues.^{3 Based on the Reserve Banks' budgeted
costs, volumes, and revenues, the proposed 1996 fees will yield net
income of $42.3 million for the year, compared with a targeted ROE of
$36.7 million. These estimates result in a 100.7 percent cost recovery
rate, including automation consolidation special project costs budgeted
for recovery and targeted ROE. Priced services expenses before special
project costs are projected to increase 1.6 percent compared with
estimated 1995 levels. Approximately $25.5 million in automated
consolidation special project costs will be recovered, leaving $33.1
million of accumulated special project costs to be recovered in the
future. The following sections discuss the 1994 and 1995 year-to-date
performance for each priced service, as well as the changes to fees
that were approved by the Board.

\3\ The projected revenues include net income on clearing
balances.
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D. Check--Table 2 presents the actual 1994, estimated 1995, and
projected 1996 cost recovery performance for the check service.

Table 2.--Check Pro Forma Cost and Revenue Performance
[$ millions]

--------------------------------------------------------- ----------- ----------- --------[2+3]--------[1-4]----------- ----[1/(4+6)]-----------
1994............................................ 582.4 579.8 0.0 579.8 2.6 26.3 96.1 11.3
1995 (Est)...................................... 569.2 548.9 5.3 554.2 15.0 24.0 98.4 12.0
1996 (Bud)...................................... 595.0 561.3 5.6 566.9 28.1 28.0 100.0 10.9

1. 1994 Performance--The check service recovered 96.1 percent of
total expenses in 1994, including targeted ROE. The volume of checks
collected decreased 13.3 percent from 1993 levels as a result of the
implementation of the same-day settlement regulation, as well as bank
consolidation and merger activity. Return item volume decreased 1.7
percent.
2. 1995 Performance--Through August 1995, the check service
recovered 98.2 percent of total expenses, including automation
consolidation special projects costs and targeted ROE, compared with
the targeted 1995 recovery rate of 100.0 percent. The volume of checks
collected decreased 7.0 percent from 1994 levels, reflecting a 3.7
percent decrease in processed volume and a 19.2 percent decrease in
fine sort volume. Return item volume increased 2.6 percent.
The Reserve Banks now estimate that 1995 net income will amount to
$15.0 million, compared with the $24.0 million budgeted. Two
significant factors contribute to the variation. First, the decline in
check collection volume experienced through August is expected to
accelerate. The Reserve Banks now expect volume to decline by 9.3
percent for the year, versus the budgeted volume loss of 2.4 percent.
As a result, check revenues are expected to be

[[Page 56594]]
approximately $10 million lower than the Reserve Banks' original
projections. Second, although the Reserve Banks took steps to reduce
production costs, those steps were largely offset by a net increase in
other expenses of $5.2 million. This increase is due to a $12.4 million
pre-tax reduction in pension credits, which increased expenses, offset
by a $7.2 million reduction in the FDIC insurance assessment. As a
result, several Reserve Banks implemented selective price increases
during the year to address the revenue shortfall. On a volume-weighted
average basis, forward collection and return check fees were increased
by about 1.5 percent and about 9.5 percent, respectively, since January
1995.
In addition, the Federal Reserve Bank of Chicago opened a new check
processing facility in Peoria, Illinois in September, which is expected
to contribute to processing efficiency over the long run.
3. 1996 Issues--As in 1995, the Reserve Banks will be challenged by
the changes occurring in the check processing environment. In
particular, the evolution to interstate banking is likely to lead to
significant changes in the interbank check collection market. To ensure
that the Reserve Banks will be able to provide efficient, fairly priced
check services and to contribute to improving the efficiency of the
payments system, the Banks will (1) emphasize the use of electronic
check products that increase the efficiency of the check collection
process, (2) introduce a set of consistent national products, and (3)
continue to pursue operational efficiencies.
To encourage the use of electronics, the Reserve Banks will
continue to promote electronic check presentment (ECP) products. In
addition, by year-end 1996, all Reserve offices will offer electronic
cash letter (ECL) deposit products. These products reduce Reserve Bank
operating costs by reducing manual processing. As a result, the Reserve
Banks will offer ECL deposit products at lower per-item fees or later
deposit deadlines than traditional check deposit products. The Reserve
Banks believe that widespread use of ECL and ECP products ultimately
will reduce the costs incurred in transporting and handling paper
checks and, thus, will reduce the total costs of the check collection
system.
To address the needs of multi-district depository institutions, the
Reserve Banks will implement a set of national core check products. The
core products will have identical features and names, although fees for
the products will be set at the local office level to reflect the
difference in the Reserve Banks' cost structures. In addition, Reserve
Banks are expanding the use of tiered prices to ensure that fees take
into consideration the cost of collecting checks drawn on various
paying institutions, adding low-priced group sort products to provide
depositing institutions increased options for reducing check collection
costs, and improving deposit deadlines to improve funds availability.
Several Reserve Banks are also introducing digital image technology
into their commercial check operations and offering image-enhanced
check products to payor banks. The use of image technology has the
potential to reduce Reserve Banks' operating costs and increase the
acceptance of ECP and check truncation.
Total check service operating costs plus imputed expenses are
projected to increase by $12.4 million, or 2.3 percent above estimated
1995 expenses. Total check collection volume is expected to decline by
1.1 percent in 1996. The Reserve Banks project an increase of
approximately 0.7 percent in processed volume, a decrease of 9.5
percent in fine sort volume, and a decrease of 1.1 percent in return
item volume.
4. 1996 Fees--The check fees approved by the Board reflect more
accurately the fixed and variable costs of providing check services. In
addition, the fees reflect the Reserve Banks' continued efforts to
encourage the use of electronics to improve the efficiency of the check
collection mechanism.
Overall, 1996 fees for forward collection products will increase by
about 1.8 percent on a volume-weighted average basis, compared with
current prices.^{4 The most significant increases are in processed
cash-letter and fine sort per-item fees, which are increasing 10.6
percent and 5.9 percent, respectively. Forward processed per-item fee
increases are modest. Of the 2,166 forward collection and fine sort
fees, about 69 percent will remain unchanged, 22 percent will increase,
5 percent will be for new products, and 4 percent will be reduced.
About 125 fees that were in place in 1995 will be discontinued.

\4\ Selected price increases were implemented during 1995.
Combining the Reserve Banks' recommended price changes for January
1996 with the price increases that were implemented since January
1995, the volume-weighted average increase in fees for forward
collection products is approximately 3 percent.
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Compared with current prices, the volume-weighted average increase
in fees for return item products will increase approximately 4.0
percent.^{5 Of the 1,442 return item fees, 63 percent will remain
unchanged, 34 percent will increase, 2 percent will be for new
products, and 1 percent will decline. About 76 fees that were in place
in 1995 will be discontinued. No changes in the fees for the
Interdistrict Transportation Service (ITS) are recommended.

\5\ Combining the Reserve Banks' recommended price changes for
January 1996 with the price increases that were implemented since
January 1995, the volume-weighted average increase in return fees is
about 14 percent.
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Table 3 highlights selected 1995 and 1996 check fees.

Table 3.--Selected Check Fees
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Products 1995 price ranges 1996 price ranges
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Items: (per item) (per item)
Forward processed
City.......................... $0.003 to 0.049.................... $0.003 to 0.080
Regional Check Procesing 0.003 to 0.069..................... 0.003 to 0.079
Center (RCPC).
Fine Sort
City.......................... 0.002 to 0.012..................... 0.003 to 0.012
RCPC.......................... 0.002 to 0.017..................... 0.002 to 0.017
Qualified return items
City.......................... 0.100 to 0.740..................... 0.100 to 1.110
RCPC.......................... 0.120 to 1.040..................... 0.120 to 1.560
Raw return items
City.......................... 0.580 to 2.180..................... 0.580 to 4.000
RCPC.......................... 0.800 to 2.180..................... 0.900 to 4.000

[[Page 56595]]

Cash letters: (per cash letter) (per cash letter)
Forward processed................. $1.50 to 8.00...................... $1.50 to 9.00
Forward fine-sort package......... 2.50 to 11.00...................... 2.50 to 11.00
Return items: raw and qualified... 1.50 to 8.00....................... 1.50 to 8.00
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Payor bank service revenue is expected to grow by approximately 22
percent in 1996, primarily due to more widespread acceptance of the
Reserve Banks' electronic presentment and image-enhanced check
products.
The Reserve Banks project that the check service will recover 100
percent of total costs, including $5.6 million in automation
consolidation special project costs and targeted ROE. Approximately
$10.9 million in automation consolidation special project costs will be
deferred and financed for recovery in future years.
While most Reserve Banks' plans for 1996 are conservative, several
Reserve Banks have adopted fairly aggressive pricing and product
development strategies and plan significant operational changes aimed
at improving efficiency and reducing costs. Because of the
aggressiveness of some plans, the Board believes that there are risks
in achieving the Reserve Banks' aggregate volume projections, in
particular. Because additional steps could be taken during 1996 to
reduce operating costs if volume projections were not met, the Board
approved the 1996 check fees proposed by the Reserve Banks.
E. Automated Clearing House (ACH)--Table 4 presents the actual
1994, estimated 1995, and projected 1996 cost recovery performance for
the commercial ACH service.

Table 4.--ACH Pro Forma Cost and Revenue Performance
[$ millions]

8 Special
2 Operating 3 Special 7 Recovery project
costs and project 4 Total 5 Net 6 Target rate after costs
Year 1 Revenue imputed costs expenses income ROE Target ROE deferred
expenses recovered (ROE) (percent) and
financed
[2+3] [1-4] [1/(4+6)]
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1994............................................ 66.9 64.6 0.0 64.6 2.3 3.4 98.3 19.6
1995 (Est)...................................... 74.7 66.3 4.0 70.2 4.5 3.1 101.9 21.5
1996 (Bud)...................................... 78.9 66.0 9.2 75.2 3.6 3.6 100.0 17.3

1. 1994 Performance--Revenues from the ACH service recovered 98.3
percent of total expenses, including targeted ROE, during 1994. The
factors contributing to the net revenue shortfall included the costs
associated with the transition to FRAS and Fednet and the expenses
associated with the development of the new Fed ACH application
software. Commercial ACH volume increased by 16.8 percent over the 1993
volume level.
2. 1995 Performance--Through August 1995, the ACH service recovered
103.2 percent of total expenses, including automation consolidation
special project costs and targeted ROE, compared with the targeted 1995
recovery rate of 100.0 percent. The higher cost recovery rate is due
primarily to a higher than expected commercial volume growth rate.
Year-to-date commercial ACH volume increased 18.4 percent over the 1994
level, compared with the projected 1995 increase of 12.9 percent. The
Reserve Banks now project net income of $4.5 million, compared with the
$3.1 million budgeted for 1995. Commercial ACH volume is expected to
increase 17.5 percent over the 1994 level.
3. 1996 Issues--During 1996, the Reserve Banks plan to complete
implementation of the Fed ACH application software, which was developed
over the last several years. Because no Reserve Banks had completed
their transition to Fed ACH when the 1996 budgets were prepared, there
is some uncertainty about the ongoing costs of operating the new
software in the FRAS automation environment. The projected commercial
volume growth rate of 17.5 percent may be aggressive in light of the
continuing consolidation in the banking industry. The Reserve Banks
believe, however, that their marketing efforts with the National
Automated Clearing House Association have the potential to spur volume
growth.
4. 1996 Fees--The ACH service is capital intensive and demonstrates
increasing returns to scale over wide volume ranges. As a result, the
volume growth realized over the last several years has resulted in
declining per-item processing costs. The Board anticipates that per-
item costs will decline further after all ACH processing is
consolidated, following the implementation of Fed ACH. The Board has
approved several modifications to the current ACH fees for 1996. These
modifications are shown in table 5.

Table 5
------------------------------------------------------------------------
Fees as
Current of
Fee category fees January
1996
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Interdistrict Items............................... $0.014 $0.012
Presorted Items................................... $0.012 $0.010
Interdistrict Addenda............................. $0.005 $0.004
Account Servicing Fee............................. $20.00 $25.00
Nonautomated Services............................. $10.00 $15.00
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As table 5 indicates, the Board has approved per-item fees
reductions for unsorted and presorted interdistrict transactions of
$0.002. In addition, the interdistrict fee for addenda items, which
provide supplementary payment-related data, will be reduced by $0.001,
eliminating the differential between local and interdistrict addenda
items. Because of the high fixed costs

[[Page 56596]]
associated with providing the ACH service, the Board has approved an
increase of $5.00 per month in the account servicing fee. Finally, the
Board has approved a $5.00 increase in the fees for paper return items
and notifications of change (NOC), government paper NOCs, telephone
return items, and telephone advices to reflect the labor intensive
nature of processing, and to provide an incentive for depository
institutions to automate these processes.
After the Reserve Banks have fully implemented Fed ACH, they plan
to propose further reductions in per-item fees and to offer a number of
new products, including products designed to assist receiving
institutions, as well as products designed to permit high-volume
originating institutions to obtain lower fees by sorting transactions
before transmitting them to the Federal Reserve. The Board anticipates
that it will be requested to approve additional fee reductions and
service enhancements in mid-1996.
Based on the fee schedule proposed by the Reserve Banks, they are
projecting that the ACH service will recover 100.0 percent of costs,
including $9.2 in automation consolidation special project costs and
targeted ROE. Approximately $17.3 million in automation consolidation
special project costs will continue to be deferred and financed for
recovery in future years. The Board has approved the 1996 fees proposed
by the Reserve Banks.
F. Funds Transfer and Net Settlement--Table 6 presents the actual
1994, estimated 1995, and projected 1996 cost recovery performance for
the funds transfer and net settlement service.

Table 6.--Funds Transfer Pro Forma Cost and Revenue Performance
[Dollars in millions]

1. 1994 Performance--For 1994, the funds transfer and net
settlement service recovered 101.7 percent of total expenses, including
automation consolidation special project costs and targeted ROE. The
net revenue surplus was largely due to lower data communications and
accounting overhead costs. Funds transfer volume increased 3.4 percent
over the 1993 volume level.
2. 1995 Performance--Through August 1995, the funds transfer and
net settlement service recovered 99.2 percent of total expenses,
including automation consolidation special project costs and targeted
ROE, compared with the targeted 1995 recovery rate of 106.5 percent.
The lower cost recovery rate is due in part to the lower than expected
pension credit and delays in the conversion of several Reserve Banks to
the centralized funds transfer application software. This conversion
has now been completed. The Reserve Banks now project net income of
$6.1 million, compared with the $8.2 million budgeted for 1995. Funds
transfer volume is expected to increase 3.1 percent over the 1994
volume level, which is consistent with the growth rate through August.
3. 1996 Issues--The Reserve Banks expect continuing consolidation
of the banking industry to affect funds transfer volume growth. For
1996, an increase of 2.1 percent over the 1995 level is projected,
which is somewhat lower than historical trends. The Reserve Banks
project that operating costs will decline modestly, reflecting the full
year effect of consolidated processing.
4. 1996 Fees--Based on retaining the 1995 fee schedule, the Reserve
Banks project that revenues will recover 106.6 percent of total
expenses, including $9.3 million in automation consolidation special
project costs and targeted ROE. Although the Reserve Banks' net income
projection exceeds the targeted ROE by $5.6 million, lower than
projected volume growth could reduce revenues significantly. The Board
has approved retaining the 1995 funds transfer fees for 1996.
G. Book-Entry Securities ^{6--Table 7 presents the actual 1994,
estimated 1995, and projected 1996 cost recovery performance for the
book-entry securities service.

\6\ Includes Purchase and Sale Activity.

Table 7.--Book-Entry Securities Pro Forma Cost and Revenue Performance
[In millions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
8 Special
2 Operating 3 Special 7 Recovery project
costs and project 4 Total 5 Net 6 Target rate after costs
Year 1 Revenue imputed costs expense income ROE target ROE deferred
expenses recovered (ROE) (percent) and
financed
[2+3] [1-4] [1/(4+6)]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1994............................................ 15.8 13.7 1.7 15.4 0.4 0.7 98.1 1.2
1995 (Est)...................................... 15.8 14.2 0.9 15.1 0.7 0.7 100.1 2.5
1996 (Bud)...................................... 15.8 13.6 1.4 15.0 0.7 0.8 100.0 4.5
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[[Page 56597]]

1. 1994 Performance--Revenues from the book-entry securities
service recovered 98.1 percent of total expenses, including automation
consolidation special project costs and targeted ROE during 1994. Book-
entry securities transfer volume increased only 1.6 percent over 1993
levels due to a sharp decline in trading activity associated with
increasing mortgage interest rates in mid-1994.
2. 1995 Performance--Through August 1995, the book-entry securities
service recovered 99.3 percent of total expenses, including automation
consolidation special project costs and targeted ROE, compared with the
targeted 1995 recovery rate of 100.1 percent. During the same period,
book-entry securities transfer volume decreased 4.2 percent compared
with the 1994 level, reflecting the continuing decline in the volume of
mortgage-backed securities activity. Although operating expenses are
now expected to be slightly higher than originally projected, the
Reserve Banks expect to achieve their targeted recovery rate for 1995.
This projection is based on two factors. First, the volume of book-
entry securities transfers, which declined through mid-1995, has begun
to increase over 1994 levels. The Reserve Banks now project a decrease
in book-entry securities transfers of only 0.8 percent for the year.
Second, the number of accounts maintained and securities issues held,
as well as the volume of off-line transfers, are expected to be higher
than budgeted.
3. 1996 Issues--The Reserve Banks expect book-entry securities
transfer volume to remain at approximately the 1995 level. Participants
Trust Company (PTC) announced its intent to expand its mortgage-backed
securities business to include securities issued by the Federal Home
Loan Mortgage Corporation and the Federal National Mortgage
Association. PTC, however, has not indicated when these securities will
be included in their system. The Reserve Banks anticipate that the
effect on 1996 volume will be minimal, but the effect on volume levels
in the future could be substantial.
The Reserve Banks plan to begin their conversion to the National
Book-Entry System (NBES) in April 1996. Once the conversion is
complete, the Reserve Banks expect to reduce data processing costs
substantially. Unlike the current system, the NBES requires that
securities held as collateral be held in separate securities accounts,
rather than combined into one account. The Reserve Banks plan to
analyze the effect of this change and recommend that the Board approve
a modified fee in mid-1996.
4. 1996 Fees--Although there are uncertainties with respect to
volume projections beyond 1996, based on the approved fee schedule, the
Reserve Banks project that the book-entry securities service will
recover 100.0 percent of costs, including $1.4 million in automation
consolidation special project costs and targeted ROE. The Board has
approved retaining the 1995 book-entry securities fees for 1996.
H. Electronic Connections--The Federal Reserve Banks charge fees
for the electronic connections used by depository institutions to
access priced services. The costs and revenues associated with
electronic connections are allocated to the various priced services
based on the relative number of connections that are used to access
each service.
In 1995, the Federal Reserve Board increased fees for several types
of electronic connections due to the increasing costs of implementing
Fednet. The Board also approved two new categories of electronic
connections--(1) high-speed dedicated leased-line connections of 128
kilobits per second (kbps) and 256 kbps and (2) standard dedicated and
shared options to support contingency testing by depository
institutions with dedicated leased-line connections.
The Board has approved retaining the 1995 fees for electronic
connections during 1996.
I. Noncash Collection--Table 8 presents the actual 1994, estimated
1995, and projected 1996 cost recovery performance for the noncash
collection service.

Table 8.--Noncash Collection Pro Forma Cost and Revenue Performance
[$ millions]

8 Special
2 Operating 3 Special 7 Recovery project
costs and project 4 Total 5 Net 6 Target rate after costs
Year 1 Revenue imputed costs expense income ROE target ROE deferred
expenses recovered (ROE) (percent) and
financed
[2+3] [1-4] [1/(4+6)]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1994............................................ 4.1 4.9 0.0 4.9 (0.8) 0.2 80.1 0.2
1995 (Est)...................................... 3.8 4.2 0.0 4.2 (0.4) 0.2 86.3 0.2
1996 (Bud)...................................... 4.8 4.5 0.0 4.5 0.2 0.2 100.0 0.2

1. 1994 Performance--Revenues from the noncash collection service
recovered 80.1 percent of total expenses, including targeted ROE, in
1994. The revenue shortfall is attributed to the costs associated with
consolidating operations and a volume decline of approximately 37
percent from 1993 levels.
2. 1995 Performance--Through August 1995, the noncash collection
service recovered 81.8 percent of total expenses including targeted
ROE, compared with the targeted 1995 recovery rate of 91.4 percent. The
volume of noncash collection items increased 12.2 percent, compared
with the projected 1995 increase of 21.6 percent. A recovery rate of
86.3 percent is now projected for 1995. The improvement compared with
year-to-date performance reflects the Reserve Banks' projection of
higher volume levels during the fourth quarter of 1995 because one of
the major noncash collection service providers withdrew from the
business in August. In addition, the consolidation of noncash
collection operations at the Cleveland and Jacksonville offices was
completed in July and should assist in controlling operating costs.
3. 1996 Issues--The Reserve Banks are projecting an increase of
22.5 percent in noncash collection volume for 1996. Several factors may
affect 1996 volume growth. All of the major service providers
discontinued providing noncash collection services during 1995. At the
same time, several smaller entities continue to provide noncash
collection services. In addition, the Depository Trust Company (DTC),
the largest national securities depository, has proposed to collect
municipal

[[Page 56598]]
coupons on behalf of its participants. While some volume may shift to
the Reserve Banks, the DTC's potential presence complicates forecasting
1996 volume levels.
Because of the changing environment, the Board believes that the
Reserve Banks' presence in the business provides a degree of stability.
In early 1996, the Reserve Banks plan to modify the geographical areas
serviced by the two processing sites to increase processing efficiency
and maintain high quality.
4. 1996 Fees--The Reserve Banks proposed adoption of a national fee
schedule for the noncash collection service. To standardize fees, the
local and interregional coupon fees assessed by the Cleveland office
will be increased by $0.50. In addition, to reflect more accurately the
cost of collecting matured bonds, the bond collection fee will be
increased from $40 to $50. Based on the proposed fee schedule, the
Reserve Banks are projecting that the noncash collection service will
recover 100.0 percent of total costs, including targeted ROE. The Board
has approved the national fee schedule proposed by the Reserve Banks
for the noncash collection service.
J. Cash Services--Cash services provided by the Federal Reserve
Banks include cash transportation, coin wrapping, nonstandard packaging
of currency orders and deposits, and nonstandard frequency of access to
cash services.
Table 9 presents actual 1994 performance, estimated 1995, and
projected 1996 cost recovery performance for the priced cash services.

Table 9.--Cash Pro Forma Cost and Revenue Performance
[$ millions]

8 Special
2 Operating 3 Special 7 Recovery project
costs and project 4 Total 5 Net 6 Target rate after costs
Year 1 Revenue imputed costs expense income ROE target ROE deferred
expenses recovered (ROE) (percent) and
financed
[2+3] [1-4] [1/(4+6)]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1994............................................ 6.4 6.0 0.0 6.0 0.4 0.2 102.6 0.0
1995 (Est)...................................... 5.2 5.1 0.0 5.1 0.1 0.1 99.5 0.0
1996 (Bud)...................................... 6.7 6.3 0.0 6.3 0.4 0.2 102.2 0.0

The Reserve Banks expect that 1996 revenues will recover all costs
for cash services, including targeted ROE. Projected revenues and costs
are higher for 1996 because the San Francisco District will begin to
charge fees for access to cash services beyond the basic service level.

III. Competitive Impact Analysis

All operational and legal changes considered by the Board that have
a substantial effect on payment system participants are subject to the
competitive impact analysis described in the March 1990 policy
statement ``The Federal Reserve in the Payments System.'' In this
analysis, the Board assesses whether the proposed 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 due to differing legal powers or constraints, or due
to a dominant market position of the Federal Reserve deriving from such
legal differences.
The Board believes that the recommended price and service level
changes would not have a substantial effect on payments system
participants, and would not have a direct and material effect on the
ability of other service providers to compete effectively with the
Federal Reserve in providing similar services. The 1996 fees approved
by the Board result in a projected return on equity that meets the
target return on equity based on the 50 bank holding company model.
Therefore, the Board believes that approval of the proposed fees would
not have an adverse effect on the ability of other service providers to
compete with the Reserve Banks.

Attachments

Table A-1.--Comparison of Pro Forma Balance Sheets for Federal Reserve
Priced Services
[Millions of dollars--average for year]
------------------------------------------------------------------------
1996 1995
------------------------------------------------------------------------
Short-term assets:
Imputed reserve
requirement on clearing
balances............... $ 409.6 $ 619.8
Investment in marketable
securities............. 3,686.7 5,577.9
Receivables \1\......... 64.4 62.8
Materials and supplies
\1\.................... 8.6 5.7
Suspense & Difference
\1\.................... 0.0 0.1
Prepaid expenses \1\.... 13.9 16.1
Items in process of
collection............. 2,413.2 2,592.5
----------- -----------
Total short-term
assets............... ......... $6,596.4 ......... $8,874.9
Long-term assets:
Premises \1\ \2\........ $ 346.4 $ 337.7
Furniture and equipment
\1\.................... 189.4 187.8
Leasehold improvements
and long-term
prepayments \1\........ 14.6 12.6
Capital leases.......... 2.3 3.8
----------- -----------

[[Page 56599]]

Total long-term assets ......... 552.7 ......... 541.9
----------- ----------
Total assets.......... ......... $7,149.1 ......... $9,416.8
=========== ==========
Short-term liabilities:
Clearing balances and
balances arising from
early credit of
uncollected items...... $4,096.3 $6,197.7
Deferred credit items... 2,413.2 2,592.5
Short-term debt \3\..... 86.8 84.7
----------- -----------
Total short-term
liabilities.......... ......... $6,596.3 ......... $8,874.9
Long-term liabilities:
Obligations under
capital leases......... $ 2.3 $ 3.8
Long-term debt \3\...... 182.7 161.6
----------- -----------
Total long-term
liabilities.......... ......... 185.0 ......... 165.4
----------- ----------
Total liabilities..... ......... $6,781.3 ......... $9,040.3
Equity \3\............ ......... 367.8 ......... 376.5
----------- ----------
Total liabilities and
equity............... ......... $7,149.1 ......... $9,416.8
=========== ==========
------------------------------------------------------------------------
\1\ Financed through PSAF; other assets are self-financing.
\2\ Includes allocations of Board of Governors' assets to priced
services of $0.5 million for 1996 and $0.4 million for 1995.
\3\ Imputed figures represent the source of financing for certain priced
services assets.

Note: Details may not add to totals due to rounding.

Table A-2.--Derivation of the 1996 PSAF
[Millions of dollars]
------------------------------------------------------------------------

------------------------------------------------------------------------
A. Assets to be Financed: \1\
Short-term..................... $86.9
Long-term \2\.................. 550.4 $637.3
------------
B. Weighted Average Cost:
1. Capital Structure \3\
Short-term Debt.............. 13.6%
Long-term Debt............... 28.7%
Equity....................... 57.7%
2. Financing Rates/Costs \3\
Short-term Debt.............. 3.9%
Long-term Debt............... 7.6%
Pre-tax Equity \4\........... 14.2%
3. Elements of Capital Costs
Short-term Debt.............. $86.9 x 3.9% = $3.4
Long-term Debt............... 182.7 x 7.6% = 13.8
Equity....................... 367.8 x 14.2% = 52.3
-----------
$69.5
C. Other Required PSAF Recoveries:
Sales Taxes.................... $11.3
Federal Deposit Insurance
Assessment.................... 2.2
Board of Governors Expenses.... 2.8 $16.3
-----------
D. Total PSAF Recoveries........... .......... ........... $85.8
------------ -----------
As a percent of capital........ .......... ........... 13.5%
As a percent of expenses \5\... .......... ........... 14.1%
------------------------------------------------------------------------
\1\ Priced service asset base is based on the direct determination of
assets method.
\2\ Consists of total long-term assets, including the priced portion of
FRAS assets, less self financing capital leases.
\3\ All short-term assets are assumed to be financed by short-term debt.
Of the total long-term assets, 33 percent are assumed to be financed
by long-term debt and 67 percent by equity.
\4\ The pre-tax rate of return on equity is based on the average after-
tax rate of return on equity, adjusted by the effective tax rate to
yield the pre-tax rate of return on equity for each bank holding
company for each year. These data are then averaged over five years to
yield the pre-tax return on equity for use in the PSAF.
\5\ Systemwide 1995 budgeted priced service expenses less shipping are
$610.3 million.

[[Page 56600]]
Table A-3.--Comparison Between 1996 and 1995 PSAF Components
------------------------------------------------------------------------
1996 1995
------------------------------------------------------------------------
A. Assets to be Financed (millions of dollars):
Short-term.................................. $86.9 $84.7
Long-term................................... 550.4 538.2
-----------------------
Total..................................... $637.3 $622.9
B. Cost of Capital:
Short-term Debt Rate........................ 3.9% 3.5%
Long-term Debt Rate......................... 7.6% 8.2%
Pre-tax Return on Equity.................... 14.2% 12.1%
Weighted Average Long-term Cost of Capital.. 12.0% 10.9%
C. Tax Rate..................................... 29.9% 31.0%
D. Capital Structure:
Short-term Debt............................. 13.6% 15.4%
Long-term Debt.............................. 28.7% 25.4%
Equity...................................... 57.7% 59.2%
E. Other Required PSAF Recoveries (millions of
dollars):
Sales Taxes................................. $11.3 $11.3
Federal Deposit Insurance Assessment........ 2.2 19.0
Board of Governors Expenses................. 2.8 2.7
F. Total PSAF:
Required Recovery........................... $85.8 $94.7
As Percent of Capital....................... 13.5% 15.2%
As Percent of Expenses...................... 14.1% 15.7%
------------------------------------------------------------------------

Table A-4--Computation of Capital Adequacy for Federal Reserve Priced
Services
[millions of dollars]
------------------------------------------------------------------------
Risk Weighted
Assets weight assets
------------------------------------------------------------------------
Imputed reserve requirement on
clearing balances.................... $409.6 0.0 $0.0
Investment in marketable securities... 3,686.7 0.0 0.0
Receivables........................... 64.4 0.2 12.9
Materials and supplies................ 8.6 1.0 8.6
Suspense & Difference................. 0.0 0.2 0.0
Prepaid expenses...................... 13.9 1.0 13.9
Items in process of collection........ 2,413.2 0.2 482.6
Premises.............................. 346.4 1.0 346.4
Furniture and equipment............... 189.4 1.0 189.4
Leases & long-term prepayments........ 16.9 1.0 16.9
------------ ----------
Total........................... $7,149.1 $1,070.7
Imputed Equity for 1995............... $367.8
Capital to Risk-Weighted Assets....... 34.4%
Capital to Total Assets............... 5.1%
------------------------------------------------------------------------

By order of the Board of Governors of the Federal Reserve
System, November 2, 1995.
William W. Wiles,
Secretary of the Board.
[FR Doc. 95-27631 Filed 11-8-95; 8:45 am]
BILLING CODE 6210-01-P}}}}