[Federal Register Volume 68, Number 198 (Tuesday, October 14, 2003)]
[Notices]
[Pages 59176-59182]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-25901]



[[Page 59176]]

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FEDERAL RESERVE SYSTEM

[Docket No. OP-1164]


Federal Reserve Bank Currency Recirculation Policy

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comment; notice.

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SUMMARY: The Board is requesting comment on proposed changes to its 
cash services policy to reduce depository institutions' overuse of 
Federal Reserve Bank cash processing services, which will affect 
approximately 100 institutions with large cash businesses. The Board 
proposes revising its policy by adding two elements: (1) A custodial 
inventory program that provides an incentive to depository institutions 
to hold currency in their vaults to meet customers' demand, and (2) a 
fee to depository institutions that deposit currency to and order 
currency from Reserve Banks within the same week instead of 
recirculating currency deposited with them among their customers. The 
Board has authorized Reserve Banks to conduct a proof-of-concept 
program during 2004 to provide information about the proposed custodial 
inventory program.

EFFECTIVE DATE: Comments must be received by January 15, 2004.

ADDRESSES: Comments should refer to Docket No. OP-1164 and may be 
mailed to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551. However, because paper mail in the Washington 
area and at the Board of Governors is subject to delay, please consider 
submitting your comments by e-mail to [email protected], 
or faxing them to the Office of the Secretary at 202/452-3819 or 202/
452-3102. Members of the public may inspect comments in Room MP-500 of 
the Martin Building between 9 a.m. and 5 p.m. on weekdays pursuant to 
Sec.  261.12, except as provided in Sec.  261.14, of the Board's Rules 
Regarding Availability of Information, 12 CFR 261.12 and 261.14.
    Comments on the collections of information under the Paperwork 
Reduction Act should be sent to the Secretary, with copies of such 
comments sent to the Office of Management and Budget, Paperwork 
Reduction Project (7100--to be obtained), Washington, DC, 20503.

FOR FURTHER INFORMATION CONTACT: Eugenie E. Foster, Project Leader 
(202/736-5603), or Michael Lambert, Manager (202/452-3376), Cash 
Section, Division of Reserve Bank Operations and Payment Systems; for 
the hearing impaired only: Telecommunications Device for the Deaf, 
Dorothea Thompson (202/452-3544).

SUPPLEMENTARY INFORMATION: 

1. Background

    The Federal Reserve Banks (Reserve Banks) supply genuine (new and 
fit) currency and coin to depository institutions throughout the nation 
to meet the public's cash demand. Historically, Reserve Banks have 
removed unfit notes from circulation and served as intermediaries among 
depository institutions, accepting deposits from those with a surplus 
of fit notes and providing currency to those with a shortfall.\1\ 
Depository institutions, in turn, have acted as intermediaries among 
their customers, recirculating currency from merchant customers, for 
example, to meet the cash demands of households and other customers.
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    \1\ Fit notes are of acceptable quality for circulation, whereas 
unfit notes are unacceptable. For example, unfit notes are often 
soiled, torn, or defaced. New notes are previously uncirculated 
notes that Reserve Banks issue.
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    These traditional patterns have been changing as depository 
institutions have used fewer fit notes deposited by customers to fill 
other customers' orders. Today, depository institutions often order 
currency directly from Reserve Banks to fill their customers' orders 
and deposit notes received from their customers directly with Reserve 
Banks. A number of depository institutions, for example, have 
reorganized their businesses to distribute currency to ATMs separately 
from currency distributed to large retail customers or to the 
institution's branches. Each of these depository institutions' business 
lines withdraws currency from Reserve Banks without first exhausting 
currency that its other business lines may accumulate from customer 
deposits within the same geographic area.
    Further, actions taken by many depository institutions to reduce 
their required reserves may have permitted them to reduce their 
holdings of vault cash.\2\ Depository institutions with vault cash in 
excess of that needed to satisfy reserve requirements have an incentive 
to economize on holdings of currency in their vaults, particularly by 
increasing the size and frequency of their deposits of currency to and 
orders of currency from Reserve Banks.\3\
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    \2\ Depository institutions can satisfy their reserve 
requirements with vault cash, or with reserve balances held at a 
Reserve Bank either directly or through a pass-through 
correspondent. Since the mid-1990s, however, many depository 
institutions have sharply reduced their reserve requirements by 
sweeping balances held by retail customers in deposit accounts that 
are reservable into deposit accounts that are not reservable. For 
some institutions, the reduction in required reserves left them with 
more vault cash than necessary to meet requirements.
    \3\ Vault cash holdings do not earn interest. If an institution 
deposits currency with a Reserve Bank, it receives credit to its 
account at the Federal Reserve. The depository institution can then 
earn a positive return on those funds by lending them to another 
institution, such as in the federal funds market.
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    Reserve Banks' order and deposit activity during 2002 indicates 
that deposits of nearly 6.7 billion $5 through $20 notes were followed 
or preceded by orders of the same denomination by the same institution 
in the same business week.\4\ This pattern suggests that some 
depository institutions are relying on Reserve Banks to recirculate a 
substantial amount of currency within the depository institutions' own 
organizations and that this currency makes up a significant portion of 
their cash deposits to Reserve Banks. Further, this activity is 
primarily concentrated in 100 depository institutions with large cash 
businesses. Underpinning depository institutions' decisions to use--and 
overuse--Reserve Bank cash processing services is the fact that Reserve 
Banks offer basic currency processing services without charge.
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    \4\ This amounts to 35 percent of notes deposited in these 
denominations, or 20 percent of total deposits in 2002.
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2. Current Policy

    Reserve Banks' Operating Circular 2, Cash Services, states:

    If you deposit fit currency with us, you may not order currency 
of the same denomination within five business days prior to or 
following the deposit of that denomination. This practice, known as 
``cross-shipping,'' is not permitted at the depositing office level. 
When practicable, cross-shipping should be minimized or eliminated 
at the depositing institution level.\5\
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    \5\ Federal Reserve Operating Circular 2, January 2, 1998, 
section 3.3. http://www.frbservices.org/Cash/index.cfm.

    This policy has proven ineffective in reducing or preventing cross-
shipping for several reasons. The direction to depository institutions 
to minimize cross-shipping at the institution level (instead of the 
branch or business-unit level) ``when practicable'' does not provide 
sufficient guidance to depository institutions or Reserve Banks with 
respect to the circumstances under which cross-shipping should not 
occur. More fundamentally, the only tool Reserve Banks currently have 
to enforce

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the policy is to deny currency services to depository institutions that 
do not comply with the operating circular requirement. Denial of 
service would be highly disruptive to the businesses of both the 
depository institutions and their customers. In addition, Reserve Banks 
have not had systematic tools for monitoring the quality of specific 
currency deposits, making the process of identifying cross-shipping 
cumbersome and costly.

3. Proposed Recirculation Policy

    The Board believes that to minimize the societal cost of providing 
currency to the public, depository institutions should resume their 
traditional role of supplying fit currency from their customers' 
deposits to meet other customers' needs before turning to Reserve Banks 
to obtain currency. To provide incentives for depository institutions 
to adopt the least costly means of recirculating currency to their 
customers, the Board proposes to implement a policy that has two inter-
related components: a custodial inventory program and a fee that would 
be assessed on deposits of cross-shipped currency.

Custodial Inventory Program

    One reason that depository institutions engage in cross-shipping is 
to avoid incurring opportunity costs of holding currency, which earns 
no interest income. To mitigate these costs associated with holding 
currency long enough to facilitate its recirculation, the Board 
proposes to allow the depository institutions to transfer into 
custodial inventories $5, $10, and $20 notes that they might otherwise 
cross-ship. A custodial inventory is currency owned by a Reserve Bank 
but located within a depository institution's secured facility and 
segregated from the depository institution's currency. To be eligible 
to hold a custodial inventory under the proposed program, a depository 
institution must be capable of, and commit to, recirculating 
substantial amounts of currency in the $5 through $20 denominations in 
order to justify the administrative costs and the risks to Reserve 
Banks of allowing depository institutions to hold Reserve Bank currency 
in their vaults. Under the custodial inventory program, depository 
institutions could move to Reserve Banks' accounts currency that is 
temporarily surplus but that the institutions expect to pay to 
customers within the same business week. The Board understands that 
custodial inventories may facilitate smoother use of depository 
institutions' processing equipment by allowing them to store peak-day 
deposits of unprocessed currency for handling later in the week. 
Custodial inventories also may allow depository institutions to avoid 
the costs of preparing and transporting their temporarily surplus 
currency to and from Reserve Bank cash offices. For years, central 
banks in some other G-10 countries have used custodial inventory 
programs to increase recirculation by depository institutions.
    While the Board intends for the custodial inventory program to 
provide an incentive to depository institutions to avoid cross-
shipping, institutions should continue to maintain on their own books 
sufficient currency inventories to meet normal currency operations and 
contingency needs. Depository institutions could transfer to a 
custodial inventory no more than 25 percent of the value of their total 
holdings in the $5 through $20 denominations. In addition, any 
institution that uses a custodial inventory to circumvent the intent of 
the recirculation policy, for example, by alternating the weeks in 
which it orders and deposits currency to a Reserve Bank, would lose its 
eligibility to participate in the program.

Custodial Inventory Proof-of-Concept Program

    Before undertaking a permanent custodial inventory program, the 
Board has authorized Reserve Banks to implement during 2004 a one-year 
proof-of-concept program. The purpose of the proof-of-concept program 
is to allow Reserve Banks to evaluate how custodial inventories 
influence depository institutions' patterns of depositing and 
withdrawing currency, while allowing depository institutions to assess 
the costs and benefits of participating in the program. Reserve Banks 
also need to evaluate more fully the costs as well as the operational 
risks and risk management procedures for the custodial inventory 
program before undertaking a permanent program. Reserve Banks would 
select approximately 15 proof-of-concept sites from depository 
institution applications. Throughout the proof-of-concept program, 
Reserve Banks would monitor the order and deposit activity of 
participating institutions to determine whether they have recirculated 
more currency within their organizations than they did before the 
establishment of the custodial inventory.
    Reserve Banks will select proof-of-concept sites from a cross-
section of depository institutions that are high volume users of 
Reserve Bank cash services. At a minimum, proof-of-concept program 
participants must demonstrate that they will recirculate at least 200 
bundles of currency per week in a Reserve Bank zone or sub-zone.\6\ An 
institution that currently cross-ships at least 200 bundles of currency 
per week in a zone or sub-zone would meet the recirculation threshold 
for a custodial inventory proof-of-concept. Alternatively, an 
institution could meet the threshold for a proof-of-concept site by 
providing deposit and payment records demonstrating that it 
recirculates at least 200 bundles of currency weekly among its 
customers. After reviewing the results of the proof-of-concept program, 
Reserve Banks will determine the minimum bundles of currency a 
depository institution must recirculate weekly to qualify for a 
custodial inventory. Thereafter, Reserve Banks would review annually 
the minimum bundles required to support a custodial inventory.
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    \6\ A bundle of currency is a standard package of 1,000 notes. A 
zone is the area to which a Reserve Bank office provides currency 
services. Under this proposed policy, Reserve Banks may establish 
sub-zones for large metropolitan areas at a significant distance 
from the nearest Reserve Bank office. Deposits and orders by 
institutions with branches and vaults in a sub-zone would be 
assessed cross-shipping fees separately from the institutions' 
activities in the rest of the zone.
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    The Board will review and use the results of the proof-of concept 
program to develop an inventory cap formula for determining the amounts 
of currency that depository institutions may transfer to Reserve Bank 
books. Each proof-of-concept custodial inventory will be subject to an 
inventory cap of either (1) 25 percent of average closing balances of 
currency during the previous week at that location (including both 
depository institution and Reserve Bank balances) in the $5 through $20 
denominations, or (2) 25 percent of average daily closing balances of 
currency for the four previous same days of the week in the $5 through 
$20 denominations at that location.\7\ Reserve Banks will test both 
formulas to enable the Board to determine the inventory cap percentage 
that allows the proper balance between providing an incentive to 
depository institutions to recirculate and limiting the transfer of 
inventory to Reserve Bank accounts. The Reserve Banks will also 
evaluate whether one inventory cap better promotes efficiency and 
administrative convenience for the

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depository institutions and Reserve Banks.
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    \7\ For example, under alternative 1, a depository institution 
that had daily balances averaging $100 million during the previous 
week would be subject to an inventory cap of $25 million. Under 
alternative 2, Monday's cap would be based on the average of the 
previous four Mondays, Tuesday's cap would be based on the average 
of the previous four Tuesdays, and so forth.
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    Reserve Banks will select proof-of-concept program participants to 
include depository institutions that:
    (1) Deposit more than they order, order more than they deposit, and 
deposit and order in roughly balanced amounts;
    (2) Are located a range of distances from the nearest Reserve Bank 
office;
    (3) Serve differently sized markets; and
    (4) Use a range of currency processing equipment and engage in a 
variety of currency handling practices, including, for example, 
outsourced or consortium arrangements.
    The Board will begin to evaluate the results of the proof-of-
concept program after six months of operation and will measure the 
success of the program to the extent that:
    (1) Proof-of-concept participants significantly reduce cross-
shipping or recirculate significant amounts of currency within the 
Reserve Bank zone or sub-zone in which the proof-of-concept site is 
located; and
    (2) Deposits received from proof-of-concept participants contain a 
higher proportion of unfit notes than the average for all deposits in 
the same denominations in the Reserve Bank zone or sub-zone in which 
the proof-of-concept site is located.
    Based on the public comments and the results of the proof-of-
concept program, the Board will determine whether to implement a 
permanent custodial inventory program. If a program is implemented, 
proof-of-concept participants will have the opportunity to continue 
operating custodial inventories consistent with the final requirements.
    Proof-of concept applications and the custodial inventory contract 
will be accessible through the Federal Reserve System Financial 
Services Web site, http://www.frbservices.org, beginning on January 29, 
2004. Reserve Banks expect to accept applications between January 29, 
2004, and March 15, 2004, for proof-of-concept sites located in the 
areas currently served by the following Federal Reserve offices: 
Boston; Charlotte; Chicago; Cleveland; Denver; Detroit; East 
Rutherford; Houston; Kansas City; Los Angeles; Miami; Minneapolis; 
Nashville; Oklahoma City; Philadelphia; San Francisco; Seattle; and St. 
Louis.

Recirculation Fee

    Because the Board expects that custodial inventories alone will not 
substantially reduce cross-shipping, it proposes to establish a 
recirculation fee to provide further incentive for depository 
institutions to recirculate currency. Based on current levels of 
Reserve Bank costs, the fee would be $5 to $6 per bundle of cross-
shipped currency. Depository institutions would pay the fee when they 
deposit fit currency and order the same denomination within the same 
business week in a Reserve Bank zone or sub-zone. The fee would not be 
assessed on deposits of unfit or surplus fit currency, where surplus is 
defined as currency that is not needed by the depository institution 
within the business week of its deposit. The fee also would not be 
assessed on deposits of $50 and $100 notes because these notes are a 
relatively minor component of cross-shipped currency and, more 
importantly, because of the risk that depository institutions might 
recirculate high-denomination counterfeit notes. The Reserve Banks 
estimate that the recirculation fee would affect approximately 100 of 
the Reserve Banks' largest cash customers.
    The Board proposes initially to exclude one-dollar notes from the 
recirculation policy. Because of the relatively low incidence of 
counterfeiting and the low value of one-dollar notes, depository 
institutions handle them differently from higher denominations in 
various ways that minimize costs. The incremental costs to depository 
institutions of sorting and recirculating fit one-dollar notes instead 
of ordering them from Reserve Banks would likely be greater than the 
costs for higher denomination notes. Reserve Banks are working with the 
banking industry with the goal of achieving net savings comparable to 
those that Reserve Banks could realize by including one-dollar notes in 
the recirculation policy. If this collaborative effort fails to yield 
comparable savings to those achieved by Reserve Banks through 
implementation of this policy within two years of the effective date of 
the permanent custodial inventory program, the Board proposes to apply 
the recirculation policy to one-dollar notes.
    The Board proposes to set the recirculation fee to recover Reserve 
Banks' costs that vary with the quantity of currency that they process. 
The recirculation fee would not be subject to the pricing requirements 
of the Monetary Control Act (MCA). The MCA applies to currency and coin 
services such as transportation and coin wrapping, but not to services 
``of a governmental nature, such as the disbursement and receipt of new 
or fit coin and currency.'' \8\ The Board determined, in the 
development of its pricing principles, that ``currency and coin 
processing (paying, receiving, and verifying both coin and currency, 
and issuing, processing, canceling, and destroying currency) are 
governmental functions and would not be considered priced services 
subject to MCA.'' \9\ The proposed recirculation fee is not for priced 
cash services subject to MCA; rather, it is a recovery of costs 
intended to encourage private-sector behavioral changes that would 
lower the overall societal costs of cash processing and distribution by 
curtailing overuse of a free governmental service.
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    \8\ 126 Cong. Rec. S3168 (March 27, 1980) (statement of Senator 
Proxmire).
    \9\ 45 FR 56893, September 4, 1980.
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De minimis Exemption

    The Board proposes to exempt de minimis levels of cross-shipped 
currency from the recirculation fee. Depository institutions would not 
pay a recirculation fee for the first 1,000 bundles of currency cross-
shipped in a zone or sub-zone each quarter for three reasons.\10\ 
First, the exemption would compensate for minor differences between 
currency fitness determinations made by depository institutions and 
Reserve Banks in processing these notes.\11\ Second, the exemption 
would limit the effect of the policy on institutions whose small scale 
of currency operations may not justify investments in sorting 
equipment. Third, the exemption would allow depository institutions 
experiencing unanticipated swings in customer demand to order or 
deposit currency without incurring a fee. The proposed exemption would 
not have a material effect on Reserve Bank processing volumes, but 
would reduce or eliminate the cost of the policy for a large number of 
depository institutions.
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    \10\ Reserve Banks will review the level of the de minimis 
exemption annually. The 1,000-bundle exemption excludes one-dollar 
notes.
    \11\ Because Reserve Banks would assess the recirculation fee 
for all fit notes deposited above the de minimis exemption, 
depository institutions would have an incentive to ensure that their 
fitness determinations are comparable to those of Reserve Banks.
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    A Reserve Bank would apply the de minimis exemption to currency 
that a depository institution cross-ships in a zone or sub-zone during 
each quarter. Depository institutions could not transfer a de minimis 
exemption from one zone or sub-zone to another. All or part of an 
exemption that a depository institution did not use during a quarter 
would expire at the end of that quarter. Reserve Banks would apply the 
exemption against depository

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institutions' total volumes of cross-shipped currency, not against each 
individual denomination.

Cost Analysis of the Recirculation Policy

    During 2002, Reserve Banks processed 34.2 billion notes, with total 
costs of approximately $342 million. This number includes 19.4 billion 
$5 through $20 notes, 6.7 billion of which depository institutions 
cross-shipped. Curtailing current cross-shipping and its expected 
future growth would reduce Reserve Banks' expenses by enabling them to 
scale down currency processing operations and delay future capital 
investments in equipment and facilities. The Board estimates that by 
implementing the proposed recirculation policy, Reserve Banks could 
avoid currency processing costs of up to $35 million per year based on 
2002 expense data.\12\
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    \12\ This estimate includes costs that vary with the volume of 
currency processed, including labor, materials, and equipment. The 
amount by which Reserve Banks are able to reduce costs would depend 
on the actual decline in volumes because of this proposed policy. 
This decline would depend on the extent to which: (1) Depository 
institutions elect to pay the fee instead of recirculating; (2) 
depository institutions take full advantage of the de minimis 
exemption; and (3) depository institutions alter their handling of 
denominations not covered by the proposed policy.
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Custodial Inventory Program

    Reserve Banks would incur approximately $400,000 per year in 
operating costs to administer the proposed custodial inventory program, 
including auditing the custodial inventories, managing the overall 
program, and amortizing an investment to develop software to monitor 
Reserve Bank currency in custodial inventories. The Reserve Banks 
estimate that during the first year of the program their costs would 
total approximately $600,000 because of one-time charges for training 
and site evaluations.
    The Board believes that depository institutions also may incur some 
additional costs in operating a custodial inventory. For example, 
depository institutions may have to modify their facilities to 
segregate Reserve Bank currency or to enhance their physical security, 
perhaps by installing surveillance equipment. They may also have to 
enhance physical- and procedural-access controls and engage in 
additional sorting and other handling of the notes held in a custodial 
inventory.
Recirculation Fee
    Most of the depository institutions with the largest cash 
operations have reported that, whether or not the Board adopts this 
recirculation policy, by 2006 they will use medium- or high-speed 
sorting equipment to process much of the currency deposited to Reserve 
Banks. Most of these depository institutions would need only 
inexpensive modifications to their processing equipment to recover fit 
currency for recirculation. The Board estimates that the total annual 
incremental expense would be approximately $2 million for all 
institutions using automated equipment to identify notes that are fit 
to recirculate.\13\
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    \13\ The Board assumes that depository institutions that use or 
acquire medium- or high-speed sorting equipment would use it to 
process all but one-dollar notes for quality. This estimate also 
assumes that under the proposed policy those depository institutions 
would process most of the $5 through $20 notes that they deposited 
with Reserve Banks during 2002.
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    With the recirculation fee at $5 to $6 per bundle of cross-shipped 
currency, the Board projects that depository institutions would incur 
up to $18 million in fees annually where it is not economical for them 
to install currency fitness sorting equipment.\14\ Instead of paying a 
recirculation fee to cross-ship this currency, however, the Board would 
expect depository institutions to explore lower-cost alternatives, such 
as having tellers manually sort currency at the point of receipt, 
paying currency to customers without fitness sorting when a range in 
the quality of notes is acceptable to customers, or obtaining currency 
processing services from other local institutions or armored carriers 
able to offer pricing that reflects economies of scale.\15\ The Board 
would expect, therefore, that altogether depository institutions would 
incur total costs of approximately $20 million annually for 
recirculating most of the $5 through $20 denomination notes they 
currently cross-ship.
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    \14\ This is the total estimated recirculation fee that 
depository institutions would incur if they cross-shipped 50 percent 
of $5 through $20 notes.
    \15\ Depository institutions indicate that their customers are 
willing to accept a wider range in the quality of $5 notes than for 
the higher denominations.
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Conclusion
    The Board projects that the societal benefits of implementing the 
recirculation fee would outweigh the societal costs by up to $15 
million per year.\16\ For the most part, the benefits would accrue from 
avoided operating expenses at Reserve Banks. Greater recirculation by 
depository institutions would reduce the growth of Reserve Bank 
currency receipts and processing, and delay expansion of publicly owned 
and operated currency-processing infrastructure. Depository 
institutions may incur increased costs if they elect to participate in 
the custodial inventory program, take actions to avoid paying fees, or 
choose to pay fees. Any costs incurred by depository institutions are 
estimated to be significantly smaller than the costs that Reserve Banks 
will avoid if the institutions reduce or cease cross-shipping currency.
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    \16\ The incremental costs to Reserve Banks to implement the 
recirculation fee will be minimal--primarily costs associated with 
amortizing a $600 thousand software development investment that will 
allow Reserve Banks to track cross-shipping systematically.
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Phased Implementation

    The Board proposes to implement the recirculation policy in phases. 
If the Board approves implementation of the custodial inventory program 
following the proof-of-concept program, the first phase will expand the 
program to all eligible participants. In the second phase, which will 
begin approximately one year after the effective date of the permanent 
custodial inventory program, Reserve Banks will begin assessing the 
cross-shipping fee.\17\ In the third phase, which will begin two years 
after the effective date of the permanent custodial inventory program, 
the Board would extend the recirculation policy to one-dollar notes if 
the Reserve Banks' net savings from collaborating with depository 
institutions is not comparable to those resulting from the 
implementation of this policy for $5 through $20 notes.
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    \17\ If the Board decides not to implement the custodial 
inventory program, it will implement the recirculation fee one year 
after termination of the proof-of-concept program.
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5. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (PRA) \18\, 
the Board reviewed the proposed rule under the authority delegated to 
it by the Office of Management and Budget (OMB). The proposed rule 
contains requirements that are subject to the PRA and required to 
obtain a benefit. The respondents/recordkeepers are for-profit 
financial institutions. The Board may not conduct or sponsor, nor is an 
organization required to respond to, this information collection unless 
it displays a currently valid OMB control number. The Board will obtain 
an OMB control number.
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    \18\ 44 U.S.C. 3506; 5 CFR 1320 Appendix A.1.
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    In 2003, the Board authorized Reserve Banks to implement a one-year 
proof-of-concept program starting in 2004. The proof-of-concept program 
would allow Reserve Banks to evaluate how custodial inventories 
influence depository institutions' patterns of depositing and 
withdrawing currency, while allowing

[[Page 59180]]

depository institutions to assess the value of participating in the 
program. To initiate the proof-of-concept program, Reserve Banks would 
select 15 depository institution sites from applications submitted via 
the Internet. The Board estimates that it would take a depository 
institution, on average, 12 hours (ranging from 8 and 16 hours) to 
complete and submit an application. The application would request 
information such as: A description of the vault and vault security; 
contact person information; prior year's loss history for the proposed 
vault; volume, amount, and daily averages of vault holdings; personal 
computer availability and Internet access; and certification of 
insurance coverage. After being accepted into the proof-of-concept 
program, depository institutions would be required to use an Internet-
based inventory tracking system that would take each institution 
approximately 15 minutes per day (excluding weekends and holidays) to 
track cash inventory.
    The Board would begin to evaluate the results of the proof-of-
concept program after six months of operation. Based on the public 
comments and the results of the proof-of-concept, the Board would 
determine whether to implement a permanent custodial inventory program.
    If the Board implements a permanent program, the 15 proof-of-
concept participants would have the opportunity to continue operating 
custodial inventories, and Reserve Banks would select up to 135 
additional sites. These new participants would be required to submit an 
application and, if accepted into the program, use the Internet-based 
inventory system.
    The Board will review and, if needed, revise the following burden 
estimates after the first six months of the proof-of-concept program:
    (1) Number of proof-of-concept program sites: 15.
    (2) Number of custodial inventory sites: 150.
    (3) Response time: 12 hours per application submitted; 15 minutes 
per day for inventory tracking; estimated total annual burden: 11,175 
hours.
    The Board requests comment on how many depository institutions will 
complete and submit the application to partake in the proof-of-concept 
program or the custodial inventory program, including:
    (1) Whether the proposed collection of information is necessary for 
the proper performance of the Board and Reserve Banks' functions; 
including whether the information has practical utility;
    (2) The accuracy of the Board's estimate of the burden of the 
proposed information collection, including the cost of compliance;
    (3) Ways to enhance the quality, utility, and clarity of the 
information to be collected; and
    (4) Ways to minimize the burden of information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology.

6. Comments

    The Board requests comments on all aspects of the proposed 
recirculation policy as described below, on the benefits and drawbacks 
of implementing it, and, in particular, on the following questions:
    (1) How effective will the proposed custodial inventory program and 
the recirculation fee be in reducing or eliminating cross-shipping? 
What are the major benefits and drawbacks of custodial inventories and 
the recirculation fee?
    (2) Are there effective alternate approaches that the Board should 
consider to increase depository institutions' recirculation of 
currency?
    (3) Are there factors not described in this notice that would 
affect a depository institution's decision to pay a recirculation fee 
or undertake greater recirculation of currency within its organization? 
What are the benefits and drawbacks of allowing a de minimis exemption 
of 1,000 bundles of currency per depository institution per quarter for 
a zone or sub-zone? Is there an alternative approach to administering 
the de minimis exemption that would address identified drawbacks and 
still achieve the intended objectives of reducing the burden of 
complying on depository institutions with small currency operations 
while ensuring that most cross-shipping activity is governed by the 
policy?
    (4) Under what circumstances would it be reasonable and practical 
for depository institutions to adopt lower-cost alternatives to the 
recirculation fee, such as having tellers manually sort currency at the 
point of receipt, paying currency to customers without fitness sorting 
when a range in the quality of notes is acceptable to customers, or 
obtaining currency processing services from other local institutions or 
armored carriers able to offer prices that reflect economies of scale?
    (5) Are there alternative approaches that could be used to improve 
the efficiency of handling one-dollar notes other than applying the 
cross-shipping fee? What savings would an institution expect to realize 
from these alternative approaches?
    (6) What costs would a depository institution anticipate incurring 
for operating a custodial inventory? How should Reserve Banks calculate 
the cap on the amount of currency that a depository institution may 
deposit in a custodial inventory? How many bundles of currency should 
Reserve Banks require a depository institution to recirculate per week 
to qualify for a custodial inventory?
    (7) What would be the effects of the program, if any, on depository 
institutions' customers, on armored carriers, or on other parties?

7. Proposed Federal Reserve Cash Recirculation Policy

    The Board proposes the following policy to promote depository 
institution recirculation of currency.

Policy

    Reserve Banks' role in the distribution of currency is to make 
available to depository institutions a supply of genuine (new and fit) 
currency sufficient to meet the public's cash demand. Reserve Banks 
remove unfit notes from circulation and act as intermediaries between 
depository institutions, accepting notes from those that have a surplus 
and providing currency to those with a shortfall. Depository 
institutions act as intermediaries to recirculate fit currency among 
their customers. Cross-shipping occurs when an institution deposits fit 
currency and orders currency of the same denomination, above the de 
minimis exemption, within the same week, in a Reserve Bank zone or sub-
zone.

Custodial Inventory Program

    The Board proposes to establish a custodial inventory program to 
promote currency recirculation by reducing depository institutions' 
opportunity costs for holding currency. Participants in the custodial 
inventory program would hold, in their vaults, currency on the books of 
the Reserve Banks that they otherwise might have shipped to, and then 
ordered from, Reserve Banks during a business week. This program would 
include the following elements.
    (1) Only depository institutions are eligible to participate in the 
custodial inventory program; however, depository institutions that 
outsource their currency vault(s) to a third party would also be 
eligible.
    (2) A depository institution must be able to recirculate among its 
customers a substantial volume of eligible denominations of currency in 
the zone

[[Page 59181]]

or sub-zone of a proposed custodial inventory site. If the Board 
approves implementation of a permanent custodial inventory program, 
Reserve Banks will determine the minimum bundles of currency that 
depository institutions must be able to recirculate on a weekly basis 
to qualify for the custodial inventory program. Thereafter, Reserve 
Banks will review annually the minimum bundles required for depository 
institution participation in the custodial inventory program.
    (3) Depository institutions may deposit into custodial inventories 
notes that they sort by denomination, count, and package in bundles. 
Depository institutions may deposit notes of any denomination that is 
subject to the recirculation fee.
    (4) Depository institutions may deposit currency into or withdraw 
currency from custodial inventories at any time during the local 
Reserve Bank's business day.
    (5) Depository institutions may maintain currency in custodial 
inventories on the Reserve Bank's books during fitness sorting or re-
packaging.
    (6) After reviewing the results of the proof-of-concept program, 
the Board will establish the inventory cap for currency that depository 
institutions may deposit into custodial inventories.
    (7) Depository institutions that operate custodial inventories may 
continue to order currency from and deposit currency to Reserve Banks, 
which will monitor the activity for cross-shipping.
    (8) Reserve Banks will require depository institutions to account 
for custodial inventory transactions via a Reserve Bank-provided, 
Internet-based accounting and inventory tracking system, to allow both 
Reserve Banks and the depository institutions to monitor the Reserve 
Bank-owned currency.
    (9) Depository institutions that operate custodial inventories must 
agree to requirements that mitigate the risks that Reserve Banks incur 
by allowing the institutions to hold their currency. These measures 
include the following:
    (a) A depository institution that operates a custodial inventory 
must indemnify the Reserve Bank against theft or loss of Reserve Bank 
currency. As provided in Reserve Banks' Operating Circular 1, Account 
Relationships, any such obligation is secured by all of the 
institution's assets in the possession of, or maintained with, any 
Reserve Bank, including its Federal Reserve account.
    (b) Potential custodial inventory sites must comply with Reserve 
Bank physical security guidelines for vaults, access control, and 
camera coverage.
    (c) Depository institutions proposing potential custodial inventory 
sites must agree to operate their facilities in accordance with Reserve 
Bank guidelines for access and control.
    (d) Depository institutions that operate custodial inventories must 
segregate Reserve Bank currency from other currency.
    (e) Depository institutions that operate custodial inventories must 
allow full access to Reserve Banks, the Board, the General Accounting 
Office, and their agents for unannounced audits of Reserve Bank 
currency.
    (f) To qualify for a custodial inventory, a depository institution 
must be financially sound, as determined by its administrative Reserve 
Bank.
    (10) Any depository institution that uses a custodial inventory to 
circumvent the intent of the recirculation policy will lose its 
eligibility to participate in the program.

Recirculation Fee

    (1) Fee. Reserve Banks will charge depository institutions a 
recirculation fee to recover currency processing costs for every 1,000 
fit notes that a depository institution cross-ships, above a de minimis 
exemption. A Reserve Bank will assess a recirculation fee if a 
depository institution deposits fit currency and orders the same 
denomination within the same business week, within a Reserve Bank zone 
or sub-zone. This policy does not apply to $50 and $100 notes.\19\ 
Based on current costs, Reserve Banks project that the recirculation 
fee will be in the $5 to $6 range for every 1,000 notes of currency 
that a depository institution cross-ships. Reserve Banks will announce 
the amount in the quarter before implementing the fee.
---------------------------------------------------------------------------

    \19\ Initially, Reserve Banks will also not assess a 
recirculation fee for one-dollar notes.
---------------------------------------------------------------------------

    (2) Recirculation fee components. The recirculation fee will be 
based on those Reserve Bank costs that vary with the quantity of 
currency processed. Such costs include personnel, materials, and 
equipment. The fee will not include overhead costs such as facilities, 
legal, business development, audit, and protection services that 
Reserve Banks incur to meet their central bank cash services 
responsibilities.
    (3) Recirculation fee de minimis exemption. Reserve Banks will 
allocate recirculation de minimis exemptions to depository institutions 
for each zone or sub-zone where they do business. Reserve Banks will 
apply the exemptions to depository institutions' total cross-shipped 
volume; exemptions will not be denomination specific. De minimis 
exemptions may not be transferred from one zone or sub-zone to another. 
Unused de minimis exemptions will expire at the end of each quarter. 
Initially, the de minimis exemption would be 1,000 bundles per quarter. 
Reserve Banks will review the level of the de minimis exemption 
annually.
    (4) One-dollar notes. Initially, Reserve Banks will not assess a 
recirculation fee for one-dollar notes. Reserve Banks will work with 
the banking industry to achieve, within two years of the effective date 
of the permanent custodial inventory program, Reserve Bank net savings 
comparable to those that could be realized by including one-dollar 
notes in the policy. Reserve Banks will review one-dollar recirculation 
annually for the duration of the collaborative program. If this 
collaborative effort fails to yield savings comparable to those 
achieved by Reserve Banks through implementing this policy to the $5 
through $20 denominations, the Board will include one-dollar notes 
under the recirculation policy.
    (5) Reserve Bank zones and monitoring. Reserve Banks will monitor 
currency orders and deposits for all endpoints of depository 
institutions in each Reserve Bank office service area (``zone'') for 
recirculation. Reserve Bank zones with large metropolitan areas located 
at a significant distance from a Reserve Bank office may be divided 
into smaller service areas (``sub-zones''). Reserve Banks will monitor 
together endpoints located in and near a sub-zone under the 
recirculation policy. Reserve Banks will monitor endpoints in other 
parts of a zone as a group separate from the endpoints in the sub-zone. 
Customers may choose the zone or sub-zone in which to include border 
endpoints. The criteria for establishing sub-zones balance the size of 
a metropolitan area against its distance from the Reserve Bank office. 
The table below outlines proposed sub-zone criteria, as well as the 
cities that would currently qualify. Reserve Banks will review sub-zone 
criteria annually.

[[Page 59182]]



                                        Table 1.--Reserve Bank Sub-Zones
----------------------------------------------------------------------------------------------------------------
                                                 Distance from
                                                 reserve bank     Metropolitan statistical area     Population
                                                    office                    (MSA)                    \20\
----------------------------------------------------------------------------------------------------------------
MSAs  1000 miles from RB with                 2,387  Honolulu, HI....................         876,156
 population  250,000.                         1,448  Anchorage, AK...................         260,283
MSAs  250 miles & with population               275  Las Vegas, NV...................       1,563,282
  500,000.                                      270  Albuquerque, NM.................         712,738
                                                           270  Sarasota--Bradenton, Orlando,          4,630,517
                                                                 Tampa, FL.
                                                           278  McAllen--Edinburg--Mission, TX..         569,463
                                                           260  Charleston, SC..................         549,033
MSAs  125 miles & with population               125  San Diego, CA...................       2,813,833
  1,000,000.                                    168  Raleigh--Durham--Chapel Hill, NC       1,187,941
                                                           156  Grand Rapids, MI................       1,088,514
MSAs  100 miles & with population               114  Indianapolis, IN................       1,607,486
 1,500,000.                                     111  Columbus, OH....................      1,540,157
----------------------------------------------------------------------------------------------------------------
\20\ Census Bureau Ranking Tables for Metropolitan Areas: Population in 2000, and Population Change from 1990 to
  2000, number PHC-T-3.http://www.census.gov/population/www/cen2000/tablist.html.

    (6) Weekly monitoring. Reserve Banks will monitor depository 
institutions' order and deposit activity weekly for cross-shipping 
(Monday through Friday). If a depository institution circumvents the 
recirculation policy, for example, by alternating the weeks in which it 
orders and deposits currency, Reserve Banks will apply the 
recirculation fee to fit notes in such deposits.
    (7) Monthly reports. Beginning February 2004, each Reserve Bank 
will make available to any depository institution, upon request, a 
monthly report showing that institution's order and deposit activity, 
and an estimate of recirculation fees in each Reserve Bank zone and 
sub-zone where it does business in that district.
    (8) Zone quarterly average fitness rate. To calculate an 
institution's recirculation fee for a zone or sub-zone, Reserve Banks 
will determine the number of fit notes deposited as a percentage of 
total notes deposited during each quarter. Reserve Banks will then 
apply this quarterly average fitness rate by zone or sub-zone to an 
institution's deposits during the following quarter to determine how 
much currency it cross-shipped.\21\
---------------------------------------------------------------------------

    \21\ For example, if an institution's deposits in a zone or sub-
zone included 80 percent fit currency during the period January 
through March, the Reserve Bank would apply an 80 percent zone or 
sub-zone quarterly average fitness rate to deposits from that 
depository institution during the April through June period. The 
Reserve Bank would apply the depository institution's zone or sub-
zone quarterly average fitness rate for second-quarter deposits of 
each denomination in determining the recirculation fee for its 
third-quarter deposits, and so forth.
---------------------------------------------------------------------------

    (9) Fitness criteria. By December 31, 2003, Reserve Banks will 
provide fitness sorting guidelines and equipment calibration standards.

    By order of the Board of Governors of the Federal Reserve 
System, October 7, 2003.
Robert deV. Frierson,
Deputy Secretary of the Board.
[FR Doc. 03-25901 Filed 10-10-03; 8:45 am]
BILLING CODE 6210-01-P