[Federal Register Volume 68, Number 208 (Tuesday, October 28, 2003)]
[Notices]
[Pages 61418-61444]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-27123]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1165]


Federal Reserve Bank Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has approved the 2004 fee schedules for Federal 
Reserve priced services and electronic connections and a private-sector 
adjustment factor (PSAF) for 2004 of $179.7 million. These actions were 
taken in accordance with the requirements of the Monetary Control Act 
of 1980, which requires that, over the long run, fees for Federal 
Reserve priced services be established on the basis of all direct and 
indirect costs, including the PSAF. The Board has also approved 
changing the earnings credit rate on clearing balances from the federal 
funds rate to 90 percent of the three-month Treasury bill rate, and 
changing the limit on the frequency of changes to contracted clearing 
balances from once per month to as often as each maintenance period.

DATES: The new fee schedules become effective January 2, 2004. The 
change in the earnings credit rate on clearing balances, and the change 
to how often depository institutions can change contracted clearing 
balances becomes effective January 8, 2004.

FOR FURTHER INFORMATION CONTACT: For questions regarding the fee 
schedules: Jack K. Walton II, Assistant Director, (202/452-2660); 
Gregory E. Cannella, Financial Services Analyst, (202/530-6214), 
Division of Reserve Bank Operations and Payment Systems. For questions 
regarding the PSAF and earnings credits on clearing balances: Lezell 
Murphy, Senior Financial Analyst, (202/452-3758); or Brenda Richards, 
Senior Financial Analyst, (202/452-2753); or Gregory Evans, Manager, 
Financial Accounting, (202/452-3945), Division of Reserve Bank 
Operations and Payment Systems. For users of Telecommunications Device 
for the Deaf (TDD) only, please call 202/452-3544. Copies of the 2004 
fee schedules for the check service are available from the Board, the 
Federal Reserve Banks, or the Reserve Banks' financial services Web 
site at http://www.frbservices.org.

[[Page 61419]]


SUPPLEMENTARY INFORMATION:

I. Priced Services

    A. Discussion--From 1993 through 2002, the Reserve Banks recovered 
98.8 percent of their total costs for providing priced services, 
including special project costs, imputed expenses, and targeted after-
tax profits or return on equity (ROE).\1\
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    \1\ These imputed expenses, such as taxes that would have been 
paid, and the return on equity that would have to be earned had the 
services been furnished by a private business firm, are referred to 
as the private-sector adjustment factor (PSAF). The ten-year 
recovery rate is based upon the pro forma income statements for 
Federal Reserve Banks' priced services published in the Board's 
Annual Report. Beginning in 2000, the PSAF has included additional 
financing costs associated with pension assets attributable to 
priced services. This ten-year cost recovery rate has been computed 
as if these costs were not included in the PSAF calculations prior 
to 2000. If these costs were included in the calculations, and 
assuming that the Reserve Banks would not have made any 
contemporaneous cost or revenue adjustments, the 10-year recovery 
rate would be 97.8 percent.
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    Table 1 summarizes the priced services' actual, estimated, and 
budgeted cost recovery rates for 2002, 2003, and 2004, respectively. 
Cost recovery is estimated to be 85.6 percent in 2003 and budgeted to 
be 93.6 percent in 2004. The aggregate cost recovery rates are heavily 
influenced by the performance of the check service, which accounts for 
approximately 83 percent of the total cost of priced services. The 
electronic services (FedACH, Fedwire funds and national settlement 
(NSS), and Fedwire securities) account for approximately 17 percent of 
costs, while noncash and special cash services represent a de minimis 
amount.
[GRAPHIC] [TIFF OMITTED] TN28OC03.002

    Table 2 presents an overview of the 2002, 2003 budget, 2003 
estimate, and 2004 budget cost recovery performance by category of 
major priced service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.003


[[Page 61420]]


    1. 2003 Estimated Performance--In 2003, the Reserve Banks estimate 
that they will recover 85.6 percent of the costs of providing priced 
services, compared with the budgeted recovery rate of 93.7 percent. The 
Reserve Banks do not expect to recover fully actual and imputed 
expenses, incurring an overall net loss of $44.4 million, which is 
$87.3 million less than the budgeted net income of $42.9 million. This 
shortfall is largely driven by lower-than-expected net income from 
clearing balances (NICB) and increased pension costs, as well as lower-
than-expected check service revenues and one-time costs associated with 
check restructuring.\2\
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    \2\ The Reserve Banks' check restructuring initiative will 
reduce Federal Reserve check processing locations from 45 to 32 
sites and will streamline check adjustments by 2004. (See http://www.frbservices.org/Retail/pdf/CheckRestructure-CustomerLetter.pdf.)
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    Two primary factors are contributing to the check service's 
underrecovery. First, higher-than-anticipated volume declines, as well 
as a shift by customers to lower priced check products as a result of 
low interest rates, have resulted in check service operating revenues 
in 2003 running $26.9 million below budget. The Federal Reserve 
System's recent retail payments research, along with more recent 
anecdotal information from the industry, indicates that check use in 
the United States is continuing to decline.\3\ The deterioration in the 
Reserve Banks' check volume is consistent with this nationwide trend. 
Second, while the Reserve Banks have reduced operating costs in 
response to the volume declines, one-time costs associated with the 
check restructuring initiative have contributed to significantly lower-
than-budgeted check service cost recovery.
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    \3\ See Gerdes, Geoffrey R. and Jack K. Walton II, ``The Use of 
Checks and Other Noncash Payment Instruments in the United States,'' 
Federal Reserve Bulletin, August 2002, pp. 360-374. (See http://www.federalreserve.gov/pubs/bulletin/default.htm.)
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    2. 2004 Projected Performance--For 2004, the Reserve Banks project 
a priced services cost recovery rate of 93.6 percent, with net income 
of $48.2 million, as compared to target net income of $112.4 million. 
The primary factors affecting 2004 cost recovery are the one-time costs 
associated with planned and potential further restructuring of the 
Reserve Banks' check operations and the continued decline in check 
volume.
    The primary risks to the Reserve Banks' ability to achieve their 
budget targets are greater-than-expected costs associated with the 
restructuring initiative and a steeper decline in the Reserve Banks' 
check volume than the projected 8.9 percent decrease. Additionally, the 
Check Clearing for the 21st Century Act (Check 21) presents risk to 
existing volumes, pricing, and product strategies. To address the 
continuing decline in check volumes, the Reserve Banks will continue to 
implement a business and operational strategy that will improve 
efficiency, reduce excess capacity and other costs, and position the 
service to achieve its financial and payment system objectives over the 
long term.
    3. 2004 Pricing--The following summarizes the Reserve Banks'' 
changes in fee structures and levels for priced services in 2004, along 
with an indication of overall experience with prices in each service 
line since 1996:\4\
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    \4\ Data elements used in calculating the price index for 2002 
and prior years include explicit fee revenue from priced services 
and volumes associated with those services. For 2003 and 2004, the 
year-over-year percentage changes are based on comparisons of the 
2002 results, 2003 estimates, and 2004 projections.
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Check
    [sbull] The Reserve Banks will raise fees for forward-collection 
check products 5.8 percent, return check products 6.1 percent, and 
payor bank check products 0.7 percent compared with January 2003 fees.
    [sbull] The price index for the check service has increased about 
37 percent since 1996.
FedACH
    [sbull] The Reserve Banks will reduce the input file processing fee 
from $5.00 to $3.75, and will retain all other fees at their current 
levels.
    [sbull] The price index for the FedACH service has decreased about 
66 percent since 1996.
Fedwire Funds and National Settlement
    [sbull] The Reserve Banks will retain fees at their current levels.
    [sbull] The price index for the Fedwire funds and national 
settlement service has decreased about 62 percent since 1996.
Fedwire Securities
    [sbull] The Reserve Banks will reduce the on-line transfer 
origination and receipt fee from $0.40 to $0.32 and will reduce the 
claim adjustment fee from $0.38 to $0.30. The Reserve Banks will 
increase the off-line surcharge from $25 to $28 and will increase the 
joint custody surcharge from $22 to $30. The Reserve Banks will retain 
all other fees at their current levels.
    [sbull] The price index for the Fedwire securities service has 
decreased about 39 percent since 1996.
    4. 2003 Price Index--Figure 1 compares indices of fees for the 
Federal Reserve's priced services with the GDP price deflator. Since 
1995, the price index for all priced services has increased a total of 
about 3.6 percent. The price index for electronic payment services 
(FedACH, Fedwire funds and national settlement, Fedwire securities, and 
electronic check products), as well as electronic access to Federal 
Reserve Banks' priced services, is projected to decrease 1.2 percent in 
2004. The price index for paper-based payment services (check and 
noncash collection) is expected to increase about 5.9 percent in 2004. 
Compared with the price index for 2003, the price index for all Federal 
Reserve Bank priced services is projected to increase approximately 3.9 
percent in 2004.

[[Page 61421]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.004

    B. Earnings Credits on Clearing Balances--The Board has approved 
changing the rate used in calculating earnings credits on clearing 
balances from the federal funds rate to 90 percent of the three-month 
Treasury bill rate, effective January 8, 2004. The ``marginal reserve 
requirement'' adjustment in the earnings credit calculation will 
continue to be made using the federal funds rate.
    Clearing balances were introduced in 1981, as a part of the Board's 
implementation of the Monetary Control Act, to facilitate the access to 
Federal Reserve priced services by institutions that either did not 
have an account at a Reserve Bank or did not have a sufficient required 
reserve balance to support the settlement of their payment 
transactions. Reserve Banks have calculated earnings credits based on 
the effective federal funds rate since the inception of the clearing 
balance program over twenty years ago. Earnings credits can be used 
only to offset charges for priced services, are calculated monthly, and 
expire if not used within one year.\5\
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    \5\ A band is established around the contracted clearing balance 
to determine the maximum balance on which credits are earned as well 
as any deficiency charges. The clearing balance allowance is 2 
percent of the contracted amount, or $25,000, whichever is greater. 
Earnings credits are based on the period-average balance maintained 
up to a maximum of the contracted amount plus the clearing balance 
allowance. Deficiency charges apply when the average balance falls 
below the contracted amount less the allowance, although credits are 
still earned on the average maintained balance.
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    The most common practice at private-sector correspondent banks is 
to calculate earnings credits on compensating balances using a rate 
discounted from the lagged three-month Treasury bill rate. Discounts 
are expressed either as a percentage reduction or a level (basis-point) 
reduction from the base rate. Even so, almost one-quarter of large 
correspondent banks no longer explicitly tie the earnings credit rate 
to an external benchmark. Correspondent banks generally do not 
establish required compensating balance levels and they generally do 
not allow earning credits to accumulate to future months, like the 
Federal Reserve.\6\ Earnings credits on balances held at correspondent 
banks generally must be used in the month earned.
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    \6\ A minimum balance may be established in specific cases, 
depending on the creditworthiness of the customer.
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    Under current procedures, the earnings credits on clearing balances 
held at the Federal Reserve are based on the average effective federal 
funds rate, the average clearing balance maintained, the imputed 
reserve requirement adjustment, and the marginal reserve requirement. 
These two adjustments are applied so that the return on clearing 
balances at the Federal Reserve is comparable to what the depository 
institution would have earned had it maintained the same balance at a 
private-sector correspondent.\7\
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    \7\ The ``imputed reserve requirement'' adjustment is made 
because a private-sector correspondent would be required to hold 
reserves against the respondent's balance with it. As a result, the 
correspondent would reduce the balance on which it would base 
earnings credits for the respondent because it would be required to 
hold a portion, determined by its marginal reserve ratio, in the 
form of non-interest-bearing reserves. For example, if a depository 
institution held $1 million in clearing balances with correspondent 
bank and the correspondent had a marginal reserve ratio of 10 
percent, then the correspondent bank would be required to hold 
$100,000 in reserves, and it would grant credits to the respondent 
based on 90 percent of the balance, or $900,000. This adjustment 
imputes a marginal reserve ratio of 10 percent to the Reserve Bank.
    The ``marginal reserve requirement'' adjustment accounts for the 
fact that the respondent can deduct balances maintained at a 
correspondent, but not the Federal Reserve, from its reservable 
liabilities. This reduction has value to the respondent when it 
frees up balances that can be invested in interest-bearing 
instruments, such as a federal funds. For example, a respondent 
placing $1 million with a correspondent rather than the Federal 
Reserve would free up $30,000 if its marginal reserve ratio were 3 
percent.
    The formula used by the Reserve Banks to calculate earnings 
credits can be expressed as e = [ b * (1-FRR) * r] + [ b * (MRR) * 
f] where e is total earnings credits, b is the average clearing 
balance maintained, FRR is the assumed Reserve Bank marginal reserve 
ratio (10 percent), r is the earnings credit rate (currently equal 
to f), MRR is the marginal reserve ratio of the depository 
institution holding the balance (either 0 percent, 3 percent, or 10 
percent) and f is the average federal funds rate. A depository 
institution that meets its reserve requirement entirely with vault 
cash is assigned a marginal reserve requirement of zero.

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[[Page 61422]]

    By using the federal funds rate, the Reserve Banks are calculating 
earnings credits using a rate that is higher than typical market 
practice. The Reserve Banks could better align their rates with those 
of the marketplace and lower their cost of clearing balances, which 
must be recovered via fees, by changing to a Treasury-bill-based rate. 
The Board has approved that the earnings credit rate be changed to 90 
percent of a rolling 13-week average of the annualized coupon 
equivalent yield of three-month Treasury bills in the secondary market 
to better align Federal Reserve policy with market practice.
    The Board also approved changing its policy on the frequency with 
which depository institutions can change their contracted clearing 
balances. The new policy will permit changes more frequently, as often 
as each maintenance period. Under this new policy, any change would 
still need to be made before the beginning of the reserve maintenance 
period to which it applies. Advance agreement on the amount of the 
contracted balance ensures that variations in contracted clearing 
balances are not a source of uncertainty for the conduct of open market 
operations during a reserve maintenance period. Depository 
institutions, through the Reserve Banks, have expressed interest over 
the years in being able to make more frequent changes to their 
contracted level.
    C. Check--Table 3 below shows the 2002, 2003 estimate, and 2004 
budgeted cost recovery performance for the check service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.005

    1. 2002 Performance--The check service recovered 91.7 percent of 
total costs in 2002, including imputed expenses, and a portion of 
targeted ROE, which was less than the targeted recovery rate of 95.5 
percent. The volume of checks collected decreased 1.9 percent from 
2001, consistent with nationwide trends away from the use of paper 
checks and toward greater use of electronic payment methods. Revenue 
fell from 2001 levels primarily due to declining volume combined with a 
customer shift to lower priced products. Customer demand for these 
lower priced products grew and the value of premium priced accelerated 
availability products diminished as interest rates declined. Revenue 
was $44.3 million less than budget. Costs were $13.6 million less than 
budget due to local cost reductions, which were largely offset by 
lower-than-budgeted pension credits.
    2. 2003 Estimate--Through August 2003, the check service has 
recovered 84.3 percent of total costs, including imputed expenses, and 
targeted ROE. For the full year, the Reserve Banks do not expect to 
recover fully their costs of providing check services. Specifically, 
the Reserve Banks estimate that the check service will recover 83.2 
percent of its total costs for the full year compared with the budgeted 
2003 recovery rate of 92.5 percent, for an operating loss of $61.2 
million. The lower-than-budgeted recovery rate is driven by lower-than-
anticipated NICB and pension credits, which account for $59.4 million 
of the financial shortfall. Additional contributing factors include 
costs of $39.0 million associated with the check restructuring and 
check modernization initiatives that were not included in the original 
budget, and less-than-budgeted operating revenue of $26.9 million.\8\ 
The service revenue shortfall reflects a continued trend of customers 
towards the use of lower priced products, which are more attractive in 
a low interest rate environment. The budget variances are summarized in 
table 4.
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    \8\ The check modernization initiative, which is largely 
completed, is comprised of four individual projects to standardize 
the Reserve Banks' hardware and software platforms for check 
processing and adjustments, for check imaging and archiving, and to 
develop a Web-based delivery platform.

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[[Page 61423]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.006

    The volume of checks handled by the Reserve Banks has declined (as 
shown in table 5), reflecting the broader market trend in which the use 
of checks continues to decline. Forward-collection check product volume 
through August, excluding electronic fine sort volume, declined 4.8 
percent.\9\ For the full year 2003, the Reserve Banks estimate that 
forward-collection volume will decline 4.8 percent, compared with a 
budgeted decline of 1.9 percent. Return check volume has increased 0.4 
percent through August 2003. The Reserve Banks, however, anticipate 
that return check volume will decline 0.2 percent for the full year, 
compared with a budgeted decline of 3.3 percent.
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    \9\ Two Reserve Banks offer an electronic fine-sort product, 
which allows depository institutions to exchange fine-sort 
information electronically between themselves with paper checks to 
follow.
[GRAPHIC] [TIFF OMITTED] TN28OC03.007

    Electronic check presentment volumes are projected to decline for 
full-year 2003, as summarized in table 6. Reserve Banks provide paying 
banks with electronic check data or images for approximately 40 percent 
of the checks they collect. Image volumes are projected to increase 8.8 
percent to approximately 1.5 billion check images, which represent 
about 9.8 percent of all checks collected by the Reserve Banks. While 
the total number of images increased, the increase was below the 
budgeted growth rate of 14.9 percent.

[[Page 61424]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.008

    3. 2004 Projection--For 2004, the Reserve Banks will focus largely 
on opportunities to streamline further check processing and adjustment 
activities across the System. The multi-year check modernization 
project will be largely completed by the end of 2003 and will result in 
a standard operating platform in all remaining Reserve Bank check 
processing offices. In 2004, the Reserve Banks plan to reduce check 
costs by $21.2 million as the check modernization management and 
implementation teams are phased out. As the Reserve Banks complete 
their transitions to the standard check platform, they will reduce 
operating costs further. For example, through August 2003, the Reserve 
Banks have reduced check operating costs $13.2 million because of the 
greater efficiencies resulting from the check modernization projects. 
In addition to these anticipated cost savings, the transition to a 
common operating platform also will enable the Reserve Banks to improve 
their operating efficiency further by providing them with additional 
flexibility to adjust their check processing infrastructure.
    Check restructuring allows the Reserve Banks to address ongoing 
volume changes by reducing excess capacity across the Federal Reserve 
System. The Reserve Banks will begin implementing the restructuring 
initiative this year and will continue the restructuring through 2004. 
While most of the one-time costs for this initiative will be accrued in 
2003, significant costs also will be incurred in 2004. Check 
restructuring is expected to improve Reserve Bank cost effectiveness 
over the long term, with the current initiative reducing steady-state 
production costs by $60 million in 2005. The Reserve Banks will 
continue to assess the potential for further changes to their check 
processing infrastructure. Given the expected continued volume decline 
in the interbank check collection market and the industry's excess 
processing capacity, the Reserve Banks anticipate further changes to 
their infrastructure in 2005. As a result, the Reserve Banks' 2004 
budget includes the accrual of expenses associated with further changes 
in their check processing infrastructure in 2005, and potential 
expenses for operational changes related to Check 21 in 2004. The 
Reserve Banks are currently developing products as well as making 
changes to operational workflows to address Check 21.
    In addition to the operational initiatives for improving efficiency 
and reducing ongoing costs, the Reserve Banks will modify the price of 
selected products in 2004 to enhance service revenue. The Reserve Banks 
will increase certain fees to collect and return checks drawn on 
depository institutions that are distant from Federal Reserve check 
processing offices to reflect the Reserve Banks' costs more accurately 
in providing these products. Most of the price increases are targeted 
at markets that have become increasingly costly for the Reserve Banks 
to service. Depository institutions collecting checks drawn on and 
returning checks to depository institutions located in these markets 
may see a substantial increase in their check collection and return 
fees.
    There is also a significant effort in 2004 to continue setting fees 
to achieve greater pricing consistency for key products across the 
Reserve Banks. In addition, a number of high-value products have been 
selected for moderate price increases for 2004. The fee changes will 
enhance the Reserve Banks' ability to recover costs, while maintaining 
the competitiveness of these products.
    For 2004, the Reserve Banks are targeting an overall price increase 
of 5.2 percent, as shown in table 7. This increase consists of a 5.8 
percent increase in forward check-collection fees, comprised of a 6.9 
percent increase in forward cash letter fees and a 5.4 percent increase 
in per-item fees. Fees for return services will increase by 6.1 
percent, which is composed of a 7.5 percent increase in return cash 
letter fees and a 5.1 percent increase in per-item fees. The average 
volume-weighted fees for payor bank services will increase 0.7 percent 
compared with current fees.

[[Page 61425]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.009

    Table 8 below summarizes ranges of selected check fees for 2003 and 
2004, and shows 2004 price changes in bold type.

[[Page 61426]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.010

    4. 2004 Cost Recovery--For 2004, the Reserve Banks project that the 
check service will recover 91.9 percent of total costs, including 
imputed expenses, and targeted ROE. The Reserve Banks expect to recover 
all direct and indirect operating costs and all imputed costs of 
providing check services, but only a portion of the targeted return on 
equity.
    Total adjusted costs before taxes are projected to decrease 
approximately $87.1 million, or 9.1 percent, from estimated 2003 
expenses. The largest factor contributing to the decline is local 
operating costs, which are expected to decrease by $64.9 million, or 
11.4 percent. This decline reflects significant reductions in personnel 
costs and partial year savings associated with discontinuing the 
processing of checks at thirteen Federal Reserve offices. Additional 
reductions include lower check modernization expenses and the 
consolidation of some local administrative functions into national 
support centers.
    Total check revenue is projected to increase $31.6 million, or 4.2 
percent, compared with the 2003 estimate. The revenue growth is driven 
largely by a $44.6 million increase in NICB. This increase associated 
with the change in methodology to calculate imputed investment income 
and payments of earnings credits to depository institution holders of 
clearing balances. Partially offsetting this increase is a projected 
$15.2 million, or 2.1 percent, decline in service revenue. This decline 
is largely attributable to a projected acceleration of the downward 
trend in the Reserve Banks' check volumes. The price changes will 
partially offset the effect of volume losses on check revenue.
    In 2004, forward-processed check volume is projected to be 12.8 
billion, a decrease of 8.9 percent compared with the 2003 estimate. The 
overall decline of paper check volume in the United States is the 
predominant factor for the loss of forward volume; however, the Reserve 
Banks also are projecting volume losses resulting from check 
restructuring

[[Page 61427]]

(which accounts for 2 percentage points of that decline) and price 
increases. Fine-sort check volume is expected to decline by 8.1 percent 
from the 2003 estimate. Return volume is projected to decrease by 7.0 
percent compared with the 2003 estimate, a somewhat slower rate than 
forward volume. The difference in the rates of decline for forward and 
return volumes is a result of an increase in the Reserve Banks' share 
of the market for returned check processing in 2003 that is expected to 
continue into 2004.
    The Reserve Banks expect a slight decrease in payor bank service 
volumes. Electronic presentment volume is expected to decline 0.8 
percent in 2004. Image volume is projected to grow 5.1 percent in 2004, 
compared with estimated 2003 volumes. Image volume growth is expected 
to be driven by the increased functionality of FedImage services (for 
example, electronic access to archived check images using web 
technology).
    The Board believes that the greatest risks to achieving the 
projected cost recovery rate for the check service are volume declines 
and associated revenue losses beyond System budget projections, and 
greater-than-expected costs associated with the check restructuring 
initiative.
    The Board believes that the cost, volume, and revenue projections 
are reasonable and has approved the price changes for the Reserve 
Banks' check service.
    D. Automated Clearinghouse (FedACH)--Table 9 below shows the 2002, 
2003 estimate, and 2004 budgeted cost recovery performance for the 
commercial FedACH service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.011

    1. 2002 Performance--In 2002, the FedACH service recovered 104.1 
percent of total costs, including imputed expenses, and targeted ROE, 
compared with a targeted recovery rate of 101.4 percent. The greater-
than-budgeted cost recovery was due mainly to higher-than-expected 
volume. The commercial ACH origination volume processed by the Reserve 
Banks was 12.1 percent higher than in 2001, compared with the 7.3 
percent decrease reflected in the 2002 budget. This reflects lower-
than-expected volume shift to a private-sector ACH operator.
    2. 2003 Estimate--The Reserve Banks estimate that the FedACH 
service will recover 101.6 percent of total expenses in 2003, compared 
with the budgeted recovery rate of 100.3 percent. The greater-than-
budgeted cost recovery is attributable mainly to lower-than-expected 
information technology support costs. Although the Reserve Banks 
estimate that 2003 volume will be 13.7 percent higher than in 2002, 
they estimate that revenue will be $3.2 million lower, primarily 
because of price reductions that became effective January 2, 2003. 
Through August 2003, the Reserve Banks' FedACH volume has increased 
13.2 percent over the same period in 2002.
    3. 2004 Pricing--The Reserve Banks project that the FedACH service 
will recover 101.8 percent of its costs in 2004, including imputed 
expenses, and targeted ROE. The Reserve Banks are keeping fees 
unchanged except for a decrease in the input file processing fee from 
$5.00 to $3.75. Ceteris paribus, the lower per-file fee would reduce 
the Reserve Banks' FedACH revenue by about $4 million annually. The 
budgeted $6.2 million increase in revenue reflects 8.7 percent growth 
in anticipated FedACH processed origination volume, increased 
electronic connection revenue, and increased NICB as a result of the 
Reserve Banks' change in the NICB computation methodology. The year-
over-year cost increase is due primarily to projects related to 
FedLine[reg] for the Web and to the development of new 
FedACH services, including risk management and international ACH 
services. The Reserve Banks generally believe that nationwide ACH 
volume will grow somewhat faster than FedACH volume as large depository 
institutions continue to shift their volume to the other ACH operator.
    The Board believes that the cost, volume, and revenue projections 
are reasonable and has approved the price changes for the Reserve 
Banks' FedACH service.
    E. Fedwire Funds and National Settlement Service--Table 10 below 
shows the 2002, 2003 estimate, and 2004 budgeted cost recovery 
performance for the Fedwire funds and national settlement service.

[[Page 61428]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.012

    1. 2002 Performance--The Fedwire funds and national settlement 
service recovered 99.6 percent of total costs in 2002, including 
imputed expenses, and targeted ROE, less than the budgeted recovery 
rate of 101.1 percent. Expenses for 2002 were $3.6 million more than 
original budget projections, primarily because of unbudgeted costs 
associated with the FedLine for the Web project and a FedLine for 
Windows write-off. Service revenue was $2.6 million greater than 
budget.
    2. 2003 Estimate--For 2003, the Reserve Banks estimate that the 
Fedwire funds and national settlement service will recover 98.0 percent 
of total expenses, including imputed expenses, and target ROE, compared 
with a budgeted recovery rate of 101.8 percent. The underrecovery is 
attributed primarily to significantly lower-than-expected pension 
credits. Funds transfer volume through August 2003 has increased 9.4 
percent relative to the same period in 2002. For the full year, the 
Reserve Banks estimate that volume will increase 7.3 percent compared 
with 2002, based on the expectation that volume growth will be flat for 
the remainder of the year. The Reserve Banks had originally projected 
zero volume growth for 2003, which was based on historical growth 
levels combined with anticipated losses of volume to a competitor. This 
shifting of volume to the competitor, however, did not materialize and, 
in fact, the Reserve Banks gained market share in 2003. With respect to 
the national settlement service, the Reserve Banks estimate that 2003 
volume will be less than budget due to continued consolidations among 
check clearinghouses.
    3. 2004 Pricing--The Reserve Banks are keeping fees for the Fedwire 
funds and national settlement service unchanged from 2003.
    The Reserve Banks project that the Fedwire funds and national 
settlement service will recover 103.3 percent of total costs in 2004, 
including imputed expenses, and targeted ROE. Total costs, including 
imputed expenses, and targeted ROE are expected to increase $5.2 
million from the 2003 estimate because of higher costs related to the 
FedLine for the Web project, higher data communications costs, and a 
higher PSAF. Funds transfer volume for 2004 is expected to increase 6.8 
percent compared with the 2003 estimate. National settlement volume is 
expected to remain flat. The Reserve Banks project total revenue to 
increase by $8.2 million over the 2003 estimate primarily because of 
continued strong volume growth, an increase in NICB attributable to the 
change in the calculation methodology, and higher electronic access 
revenue.
    The Board believes that the cost, volume, and revenue projections 
are reasonable and has approved the price changes for the Reserve 
Banks' Fedwire funds and national settlement service be approved.
    F. Fedwire Securities Service--Table 11 below shows the 2002, 2003 
estimate, and 2004 budgeted cost recovery performance for the Fedwire 
securities service.\10\
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    \10\ The Reserve Banks provide transfer services for securities 
issued by the U.S. Treasury, federal government agencies, 
government-sponsored enterprises, and certain international 
institutions. The priced component of this service, reflected in 
this memorandum, consists of revenues, expenses, and volumes 
associated with the transfer of all non-Treasury securities. For 
Treasury securities, the U.S. Treasury assesses fees for the 
securities transfer component of the service. The Reserve Banks 
assess a fee for the funds settlement component of a Treasury 
securities transfer; this component is not treated as a priced 
service.

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[[Page 61429]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.013

    1. 2002 Performance--The Fedwire securities service recovered 100.1 
percent of total costs in 2002, including imputed expenses, and 
targeted ROE. Total costs and service revenue for 2002 were greater 
than budget by $1.1 million and $1.0 million, respectively.
    2. 2003 Estimate--Through August 2003, the Fedwire securities 
service recovered 107.4 percent of total costs, including imputed 
expenses, and targeted ROE. For full-year 2003, the Reserve Banks 
estimate that the Fedwire securities service will recover 106.0 percent 
of total costs, compared with a budgeted recovery rate of 100.6 
percent. The overrecovery is attributed primarily to higher-than-
expected volume growth.
    Through August 2003, total Fedwire securities transfer volume has 
increased 23.7 percent relative to the same period in 2002.\11\ For the 
full year, the Reserve Banks estimate that total Fedwire securities 
volume will increase 21.9 percent from 2002, compared with a budgeted 
4.3 percent increase. The significantly higher-than-expected volume 
growth is due primarily to the continued strength of the residential 
mortgage financing market. The Reserve Banks expect that volume growth 
experienced year-to-date will level off in the remaining months of the 
year.
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    \11\ Part of this increase is due to the full-year effect of the 
addition of Ginnie Mae securities to the Fedwire Securities Service, 
which was completed in March 2002.
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    3. 2004 Pricing--The Reserve Banks are reducing the on-line 
transfer origination and receipt fees from $0.40 to $0.32 and reducing 
the claim adjustment fee from $0.38 to $0.30.\12\ The Reserve Banks 
will increase the off-line surcharge from $25 to $28 and increasing the 
joint custody surcharge from $22 to $30. The Reserve Banks will retain 
all other fees at their current levels.
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    \12\ In 2002, the Reserve Banks implemented a new automated 
claim adjustment feature for mortgage-backed securities. The 
automated claim adjustment process (ACAP) supports the settlement of 
claims related to failed securities transactions, interim accounting 
for securities with an accrual date different than the record date, 
and repurchase agreements. ACAP allows participants to add 
information to transfer messages that the Fedwire securities service 
can use to calculate cash payments owed to counterparties involved 
with related transfers.
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    The Reserve Banks project that the Fedwire securities service will 
recover 104.7 percent of costs in 2004, including imputed expenses, and 
targeted ROE. Total costs, including imputed expenses, and targeted ROE 
are expected to increase $0.7 million from the 2003 estimate.
    The Reserve Banks project that total securities volume in 2004 will 
increase 6.8 percent from the 2003 estimate. Total revenue is projected 
to increase slightly from the 2003 estimate, as the expected decrease 
in revenue from price reductions is offset by a higher NICB 
attributable to the changes in calculation methodology.
    The Board believes that the cost, volume, and revenue projections 
are reasonable and has approved the price changes for the Reserve 
Banks' Fedwire securities service.
    G. Noncash Collection--Table 12 below shows the 2002, 2003 
estimate, and 2004 budgeted cost recovery performance for the noncash 
collection service.
[GRAPHIC] [TIFF OMITTED] TN28OC03.014


[[Page 61430]]


    1. 2002 Performance--The noncash collection service recovered 100.6 
percent of total expenses in 2002, including imputed expenses, and 
targeted ROE, exceeding the budgeted recovery rate of 94.3 percent. 
Volume for 2002 declined 19.2 percent from 2001 levels, as expected.
    2. 2003 Estimate--Through August 2003, the noncash collection 
service recovered 131.5 percent of its costs. For full-year 2003, the 
Reserve Banks estimate that the noncash collection service will recover 
118.9 percent of costs, including imputed expenses, and targeted ROE, 
compared with the budgeted recovery rate of 110.9 percent. This 
overrecovery is attributed to higher-than-expected revenues, as volume 
has not decreased from 2002 as much as anticipated. Noncash volume 
through August has decreased 13.1 percent compared with volume during 
the same period in 2002. For the full year, the Reserve Banks estimate 
that 2003 volume will decrease 18.9 percent from 2002, compared with a 
budgeted decline of 21.0 percent.
    3. 2004 Pricing--The Reserve Banks are keeping fees for the noncash 
collection service unchanged from 2003. As the number of outstanding 
physical municipal securities continues to decline, the volume of 
coupons and bonds presented for collection also will decline. New 
issues of bearer municipal securities effectively ceased in 1983 after 
the Tax Equity and Fiscal Responsibility Act of 1982 removed tax 
advantages for investors. In 2004, the Reserve Banks project that the 
noncash collection service will recover 113.3 percent of total costs, 
including imputed expenses, and targeted ROE. The Reserve Banks project 
that volume will decrease 18.9 percent from the 2003 estimate.
    The Board believes that the cost, volume, and revenue projections 
are reasonable and has approved the price changes for the Reserve 
Banks' noncash collection service.
    H. Special Cash--Special cash services represent a de minimis 
portion (less than one tenth of one percent) of overall priced services 
provided by the Reserve Banks to depository institutions. In 2002, 
special cash services included wrapped coin, nonstandard packaging of 
currency orders and deposits, and, for part of the year, registered 
mail shipments of currency and coin. The offices that offered 
registered mail shipments discontinued this service in mid to late 
2002. In 2003, special cash services consisted of wrapped coin for half 
of the year and nonstandard packaging of currency. The Helena office 
discontinued its wrapped coin service in June 2003, and the Seventh 
District will discontinue its nonstandard packaging service in December 
2003. With the Helena office and the Seventh District exiting these 
businesses, the Reserve Banks will not provide any special cash 
services in 2004. Table 13 below shows 2002 and estimated 2003 cost 
recovery performance for special cash services.
[GRAPHIC] [TIFF OMITTED] TN28OC03.015

    1. 2002 Performance--Special cash services recovered 94.8 percent 
of total expenses, including imputed expenses, and targeted ROE in 
2002, compared with a targeted recovery rate of 103.4 percent. The 
underrecovery was due primarily to the Kansas City District and the 
Helena office discontinuing registered mail shipments of currency 
earlier than budgeted in 2002, but continued to incur support charges 
throughout the year.
    2. 2003 Estimate--Through August 2003, special cash services has 
recovered 72.1 percent of total expenses, including imputed expenses, 
and targeted ROE. For full-year 2003, the Reserve Banks project that 
special cash services will recover 71.9 percent of costs, compared with 
a targeted recovery rate of 77.3 percent. Compared with 2002, total 
expenses are projected to decrease $0.9 million, or 65.6 percent, and 
revenue is expected to decrease $1.0 million, or 70.5 percent.
    3. 2004 Pricing--There is no special cash service planned for 2004, 
and no costs will be allocated to this service.

II. Private-Sector Adjustment Factor

    A. Background--Each year, as required by the Monetary Control Act 
of 1980, the Reserve Banks set fees for priced services provided to 
depository institutions. These fees are set to recover, over the long 
run, all direct and indirect costs and imputed costs, including 
financing costs, taxes, and certain other expenses that would have been 
incurred, as well as return on equity (profit) that would have been 
earned, if a private business firm provided the services. These imputed 
costs are based on data developed in part from a model comprising 
consolidated financial data for the nation's fifty largest bank holding 
companies (BHCs).\13\ The imputed costs and imputed profit are 
collectively referred to as the PSAF. In a comparable fashion, 
investment income is imputed and netted with related direct costs 
associated with clearing balances to estimate NICB.\14\
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    \13\ The peer group of the fifty largest bank holding companies 
is selected based on total deposits.
    \14\ See companion notice, Federal Reserve Bank Services, 
elsewhere in today's Federal Register, on the change to the imputed 
investment income on clearing balances method for 2004. Using the 
average spread of 35 basis points over the three-month Treasury bill 
rate, applied to the clearing balance levels and rate assumptions 
used in the 2004 pricing process, NICB is projected to be $52.7 
million.

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[[Page 61431]]

    The method for calculating the financing and equity costs in the 
PSAF requires determining the appropriate levels of debt and equity to 
impute and then applying the applicable financing rates. This process 
requires developing a pro forma priced services balance sheet using 
actual Reserve Bank assets and liabilities associated with priced 
services and imputing the remaining elements that would exist if the 
Reserve Banks' priced services were provided by a private-sector 
business firm.
    The amount of the Reserve Banks' assets that will be used to 
provide priced services during the coming year is determined using 
Reserve Bank information on actual assets and projected disposals and 
acquisitions. The priced portion of mixed-use assets is determined 
based on the allocation of the related depreciation expense. The priced 
portion of actual Reserve Bank liabilities consists of balances held by 
Reserve Banks for clearing priced services transactions (clearing 
balances), estimated based on historical data, and other liabilities 
such as accounts payable and accrued expenses.
    Long-term debt is imputed only when core clearing balances and 
long-term liabilities are not sufficient to fund long-term assets or if 
the interest rate risk sensitivity analysis indicates that estimated 
risk will exceed a change in cost recovery of more than two percentage 
points.\15\ Short-term debt is imputed only when short-term liabilities 
and clearing balances not used to fund long-term assets, together, are 
not sufficient to fund short-term assets. Equity is imputed to meet the 
FDIC definition of a well-capitalized institution, which is currently 5 
percent of total assets and 10 percent of risk-weighted assets.
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    \15\ A portion of clearing balances is used as a funding source 
for priced services assets. Long-term assets are partially funded 
from core clearing balances, currently $4 billion. Core clearing 
balances are considered the portion of the balances that has 
remained stable over time without regard to the magnitude of actual 
clearing balances. The PSAF methodology includes an analysis of 
interest rate risk sensitivity, which compares rate-sensitive assets 
with rate-sensitive liabilities and measures the effect on cost 
recovery of a change in interest rates of up to 200 basis points.
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    1. Financing Rates--Equity financing rates are based on the average 
of the return on equity (ROE) results of three economic models using 
data from the BHC model.\16\ For simplicity, given that federal 
corporate tax rates are graduated, state tax rates vary, and various 
credits and deductions can apply, a specific tax rate is not calculated 
for Reserve Bank priced services. Instead, the use of a pre-tax ROE 
captures imputed taxes. The resulting ROE influences the dollar level 
of the PSAF and Federal Reserve price levels because this is the return 
a shareholder would expect in order to invest in a private business 
firm. The use of the pre-tax ROE assumes 100 percent recovery of 
expenses, including the targeted ROE. The recommended PSAF is, 
therefore, based on a matching of revenues with actual and imputed 
costs and imputed profits. Should the pre-tax earnings be less than the 
targeted ROE, as projected, imputed expenses would be adjusted for the 
tax savings associated with the adjusted recovery. The imputed tax rate 
is the median of the rates paid by the BHCs over the past five years 
adjusted to the extent that BHCs have invested in municipal bonds.
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    \16\ The pre-tax return on equity (ROE) is determined using the 
results of the comparable accounting earnings model (CAE), the 
discounted cash-flow model (DCF), and the capital asset pricing 
model (CAPM). Within the CAPM and DCF models, the ROE is weighted 
based on market capitalization, and within the CAE model, the ROE 
calculation is equally weighted. The results of the three models are 
averaged to impute the PSAF pre-tax ROE. When needed, to impute 
short- and long-term debt, the debt rates are derived based on the 
short-term debt and long-term debt elements in the BHC model.
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    2. Other Costs--The PSAF also includes the estimated priced 
services-related expenses of the Board of Governors and imputed sales 
taxes based on Reserve Bank expenses. An assessment for FDIC insurance, 
when required, is imputed based on current FDIC rates and projected 
clearing balances held with the Federal Reserve.
    B. Discussion--The increase in the 2004 PSAF is primarily due to a 
significant increase in clearing balances on which investments are 
imputed and the resulting increase in total assets. Because required 
imputed equity is based on five percent of total assets, priced 
services equity and cost of equity increased.
    1. Asset Base--The total estimated cost of Federal Reserve assets 
to be used in providing priced services is reflected in table 14. Total 
assets have increased $1,704.6 million, or 11.0 percent from 2003. 
Growth of $1,283.0 million in imputed investments, growth of $131.8 
million in imputed reserve requirements, which are based on the level 
of clearing balances, and an increase of $308.4 million in cash items 
in process of collection explains the majority of this increase. As 
shown in table 15, the assets financed through the PSAF have decreased, 
primarily due to the decrease in prepaid pension costs. Short-term 
assets funded with short-term payables and clearing balances total 
$102.0 million. This amount represents a decrease of $1.8 million, or 
1.7 percent, from the short-term assets funded in 2003. Long-term 
assets funded with long-term liabilities, equity, and core clearing 
balances are projected to total $1,520.6 million. This amount 
represents a decrease of $16.8 million, or 1.1 percent, from the long-
term assets funded in 2003. A decrease of $17.8 million in prepaid 
pension costs explains the majority of the decrease. The decrease of 
$15.0 million in furniture and equipment is offset by an increase in 
bank premises and leasehold improvements and long-term prepayments of 
$3.9 million and $12.1 million, respectively.
    2. Debt and Equity Costs and Taxes--As previously mentioned, core 
clearing balances are available as a funding source for priced services 
assets. Table 15 shows that $407.2 million in clearing balances are 
used to fund priced services assets in 2004. The interest rate 
sensitivity analysis in table 16 indicates that the ratio of rate-
sensitive assets to rate-sensitive liabilities and the effect on cost 
recovery of an increase in interest rates of 200 basis points produces 
a decrease in cost recovery of 1.3 percentage points. The established 
threshold for change to cost recovery is two percentage points; 
therefore, interest rate risk associated with using these balances is 
within acceptable levels and no long-term debt is imputed.
    Table 17 shows the imputed PSAF elements, the pre-tax ROE, and 
other required PSAF recoveries for 2003 and proposed for 2004. The 
significant increase in clearing balances from which the investments 
are imputed increases total assets. An increase in total assets, and 
the resulting increase in imputed equity, increases targeted ROE. 
Although the pre-tax ROE rate decreased from 19.4 percent for 2003 to 
18.6 percent for 2004, with increased imputed equity, the pre-tax ROE 
increased $9.6 million. As indicated previously, the pre-tax ROE is 
calculated using the combined results of three models. The effective 
tax rate used in 2004 also decreased to 29.8 percent from 30.4 percent 
in 2003. Sales taxes decreased $2.8 million from $14.8 million in 2003 
to $12.0 million in 2004. Offsetting this is a $1.2 million increase in 
Board of Governors expenses.
    3. Capital Adequacy and FDIC Assessment--As shown in table 14, the 
amount of equity imputed for the proposed 2004 PSAF is $860.8 million, 
an increase of $85.2 million from imputed equity of $775.6 million in

[[Page 61432]]

2003. As noted above, equity is based on 5 percent of total assets, as 
required by the FDIC for a well-capitalized institution in its 
definition for purposes of assessing insurance premiums. In both 2004 
and 2003, the capital to risk-weighted asset ratio and the capital to 
total assets ratio both exceed regulatory guidelines. As a result, no 
FDIC assessment is imputed for either year.

III. Analysis of Competitive Effect

    All operational and legal changes considered by the Board that have 
a substantial effect on payments system participants are subject to the 
competitive impact analysis described in the March 1990 policy 
statement, ``The Federal Reserve in the Payments System.'' \17\ Under 
this policy, the Board assesses whether the change would have a direct 
and material adverse effect on the ability of other service providers 
to compete effectively with the Federal Reserve in providing similar 
services because of differing legal powers or constraints or because of 
a dominant market position deriving from such legal differences. If the 
change creates such an effect, the Board must further evaluate the 
change to assess whether its benefits `` such as contributions to 
payment system efficiency, payment system integrity, or other Board 
objectives--can be retained while minimizing the adverse effect on 
competition.
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    \17\ Federal Reserve Regulatory Service (FRRS) 9-1558.
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    The 2004 fees result in a projected ROE less than the target 
established using a model that is based on the consolidated results 
over time of the largest fifty BHCs. To the extent that these BHCs 
expect a mature declining business, such as check processing, to have 
the same ROE as the organization as a whole, the Reserve Banks' failure 
to set fees to achieve the target ROE could adversely affect the 
ability of other service providers to compete with the Reserve Banks. 
Based upon discussions with the industry and other anecdotal 
information, the Board does not believe that BHCs have such an 
expectation. Moreover, given the current market environment, greater 
fee increases are not likely to improve the Reserve Banks' cost 
recovery materially and might even reduce the revenue that the Reserve 
Banks receive as depository institutions seek lower cost alternatives. 
Overall, the Board believes that the fee changes and the changes to 
earnings credits on clearing balances are reasonable.

BILLING CODE 6210-01-P

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[GRAPHIC] [TIFF OMITTED] TN28OC03.024

BILLING CODE 6210-01-C

Electronic Connection Fee Schedule

    There are four types of electronic connections through which 
depository institutions access the Reserve Banks' priced services: 
FedLine[reg], FedMail[reg], FedPhone[reg], and computer interface

[[Page 61442]]

(mainframe to mainframe).\46\ The Reserve Banks allocate costs and 
revenues associated with these electronic connections to the various 
priced services.
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    \46\ These connections may also be used to access non-priced 
services provided by the Reserve Banks. No fee is assessed if a 
particular connection is used only to access non-priced services.
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    In 2004, the Reserve Banks are offering a new bundled electronic 
access package for a monthly fee of $150 that includes one DOS-based 
FedLine dial connection and one FedLine for the Web institution-level 
connection with three digital certificates for individual 
subscriptions. This package supports the Reserve Banks' strategic 
direction of moving to web-based electronic access, consistent with, 
and in response to, customers' preferences. The Reserve Banks are 
increasing the monthly fee for additional DOS-based FedLine dial 
connections from $75 to $100. This increase, the first since 1993, 
reflects the cost of maintaining and updating FedLine connectivity. The 
Reserve Banks are retaining the connection fees for FedLine for the Web 
access and the other existing connection fees at current levels.
BILLING CODE 6210-01-P

[[Page 61443]]

[GRAPHIC] [TIFF OMITTED] TN28OC03.026



[[Page 61444]]


    By order of the Board of Governors of the Federal Reserve 
System, October 22, 2003.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 03-27123 Filed 10-27-03; 8:45 am]
BILLING CODE 6210-01-C