[Federal Register Volume 70, Number 98 (Monday, May 23, 2005)]
[Notices]
[Pages 29512-29526]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10168]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1229]


Federal Reserve Bank Services Private Sector Adjustment Factor

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice with request for comments.

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SUMMARY: The Board requests comment on potential modifications to the 
method for calculating the target return on equity (ROE) in the 
private-sector adjustment factor (PSAF). The PSAF imputes the costs 
that would have been incurred and profits that would have been earned 
had the Federal Reserve Banks' priced services been provided by a 
private firm. The Monetary Control Act of 1980 (MCA) requires that the 
Federal Reserve set fees for its services to recover, over the long 
run, its actual costs of providing the services, as well as the imputed 
costs and profits. The Board reviews its method for calculating the 
PSAF periodically to assess whether it is still appropriate in light of 
the changing business and regulatory environment, industry practices, 
and accounting standards.
    Specifically, the Board requests comment on possible changes to the 
current method to compute a target rate of return on equity capital, 
including changes to the analytical models and peer group institutions 
used. The Board's method for setting its overall level of equity 
capital would continue to be based on the Federal Deposit Insurance 
Corporation (FDIC) guidelines for a well-capitalized institution for 
insurance premium purposes.

DATES: Comments must be submitted on or before July 22, 2005.

ADDRESSES: You may submit comments, identified by Docket No. OP-1229, 
by any of the following methods:
     Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: [email protected]
     FAX: 202/452-3819 or 202/452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, except as necessary for technical reasons. Accordingly, your 
comments

[[Page 29513]]

will not be edited to remove any identifying or contact information. 
Public comments may also be viewed electronically or on paper in Room 
MP-500 of the Board's Martin Building (20th and C Streets, NW) between 
9 a.m. and 5 p.m. on weekdays.

FOR FUTHER INFORMATION CONTACT: Gregory L. Evans, Assistant Director 
(202/452-3945), Brenda L. Richards, Financial Project Leader (202/452-
2753), or Jonathan Mueller, Financial Analyst (202/530-6291); Division 
of Reserve Bank Operations and Payment Systems. Telecommunications 
Device for the Deaf (TDD) users may contact 202/263-4869.

SUPPLEMENTARY INFORMATION:

I. Background

    The MCA requires that the Board establish fees for ``priced 
services'' provided to depository institutions at a level necessary to 
recover all direct and indirect costs actually incurred and imputed 
costs. Imputed costs include financing costs, return on equity capital 
(profit), taxes, and certain other expenses that would be incurred if a 
private business firm provided the services. The imputed costs and 
imputed profit are collectively referred to as the private sector 
adjustment factor (PSAF). In establishing fees, the Board considers the 
objectives of fostering competition, improving the efficiency of the 
payments mechanism, and providing an adequate level of services 
nationwide.
    The methodology underlying the PSAF is reviewed periodically to 
ensure that it is appropriate and relevant in light of changes that may 
have occurred in Reserve Bank priced-services activities, accounting 
standards, finance theory, and regulatory and business practices.\1\ 
The Board considers four principles when reviewing the PSAF 
methodology: (1) Providing a conceptually sound basis for efficient 
pricing in the market for payments services, (2) maintaining 
consistency with actual Reserve Bank financial information and 
practice, (3) maintaining consistency with private-sector practice, and 
(4) using data in the public domain in order to make the PSAF 
replicable. In addition, the Board seeks to balance the cost, 
complexity, and accuracy of the PSAF methodology in implementing 
theoretically sound approaches.\2\
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    \1\ During the development of this proposal, the Federal Reserve 
worked with a consulting firm specializing in capital allocation and 
risk management and four finance professors from U.S. academic 
institutions to obtain information about current private-sector 
practices.
    \2\ The previous review of the PSAF was completed in 2001 (65 FR 
82360, October 10, 2001) and changes were implemented for the 2002 
PSAF.
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    The Board seeks to establish fees for priced services to recover 
projected costs and the PSAF over the long run. Because the Board does 
not believe that price volatility increases efficiency in payment 
systems, it has been wary of cost-recovery models that produce volatile 
results from year to year. For this reason, fees for each year are not 
set to offset any previous or subsequent years' overrecovery or 
underrecovery. Moreover, other providers of payment services do not 
typically establish prices in order to eliminate surpluses or 
shortfalls incurred in previous years. A highly volatile PSAF applied 
mechanically to the fee-setting process could also result in 
unnecessarily volatile prices, which, in turn, could adversely affect 
the efficient operations of the Reserve Banks and other payment service 
providers. As a result, the Board has preferred, when appropriate, to 
adopt PSAF methods that provide for stable rather than volatile 
returns.

II. Private Sector Adjustment Factor

    The current method for calculating the PSAF includes determining 
the book value of Federal Reserve assets and liabilities to be used in 
providing priced services during the coming year, and the rates used to 
impute financing costs. The Board's method involves developing an 
estimated Federal Reserve priced-services pro forma balance sheet using 
actual priced-services assets and liabilities. The remaining elements 
on the balance sheet, such as equity, are imputed as if these services 
were provided by a private-sector firm. To satisfy the FDIC requirement 
for a well-capitalized institution, equity is imputed at 5 percent of 
total assets.\3\ In 2005, assets are projected to total $16.2 billion, 
resulting in imputed equity capital of $808 million.
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    \3\ Equity is imputed based on the FDIC definition of a ``well-
capitalized'' institution for insurance premium purposes. The FDIC 
requirements for a well-capitalized financial institution are (1) a 
ratio of total capital to risk-weighted assets of 10 percent or 
greater; and (2) a ratio of Tier 1 capital to risk-weighted assets 
of 6 percent or greater; and (3) a leverage ratio of Tier 1 capital 
to total assets of 5 percent or greater. The Federal Reserve priced-
services balance sheet total capital has no components of Tier 1 or 
total capital other than equity; therefore, requirements 1 and 2 are 
essentially the same measurement. Because risk-weighted assets are 
considerably below actual assets, only requirement 3 is binding for 
the Federal Reserve priced services.
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    A target ROE is estimated and applied to the equity capital on the 
pro forma balance sheet to determine the priced-services cost of 
equity.\4\ Currently, the ROE is calculated by averaging the results of 
three analytical models: The comparable accounting earnings (CAE) 
model, the discounted cash flow (DCF) model, and the capital asset 
pricing model (CAPM). The top fifty bank holding companies (BHCs) based 
on deposit balance serve as the peer group for Federal Reserve priced 
services and the peer group's financial data is used to estimate the 
target ROE. Selecting the BHCs based on deposit balances was intended 
to maintain the focus on the largest banking entities because they 
process transactions and perform settlement services comparable to 
those provided by the Reserve Banks.
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    \4\ For the 2005 PSAF, the target ROE of 18.1 percent is 
multiplied by the equity capital of $808 million to get the priced 
services cost of equity of $146 million.
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    The CAE model uses historical BHC accounting information to 
estimate ROE. The ROE for an individual BHC in the peer group is 
calculated as the ratio of the firm's net income before taxes to its 
book value of equity and is averaged with other BHCs to determine the 
peer group ROE. The DCF model takes a forward-looking approach to 
estimating ROE. It assumes that a firm's stock price is equal to the 
discounted present value of all expected future dividends. The CAPM 
captures the risk--return relationship that rational investors require 
in efficient markets. The underlying theory of the model assumes that 
investors demand a premium for bearing risk; that is, the higher the 
risk of the security, the higher its expected return must be to attract 
investors to buy it. The basic principle of CAPM is that the required 
rate of return on a firm's equity is equal to the return on a risk-free 
asset plus a risk premium.
    The PSAF also includes imputed taxes, which are captured using a 
pretax ROE. A pretax ROE assumes that a 100 percent recovery of 
expenses, including the targeted ROE, is achieved. The PSAF tax rate is 
the median of the rates paid by the fifty BHCs in the peer group over 
the past five years. Finally, the PSAF includes the estimated share of 
the Board of Governors' expenses that supports priced services, imputed 
sales tax, and an imputed assessment for FDIC insurance.

III. Discussion

A. Overview

    The Board is considering changes to the methodology used to 
estimate the target ROE for priced services. The table below summarizes 
the current methodology and the changes

[[Page 29514]]

considered, which are discussed in more depth in subsequent sections of 
the notice.
[GRAPHIC] [TIFF OMITTED] TN23MY05.000

B. Imputed Return on Equity

    The target ROE for Reserve Bank priced-services activities is 
established at the entity level rather than by developing an ROE for 
each service. Conceptually, the ROE is developed with a shareholder's 
perspective in mind and considers whether shareholders are adequately 
compensated in the form of average equity returns given the overall 
risk of the business activities.
    Current Three-Model Approach. As discussed earlier, the Board 
targets an ROE using the average of the results of the CAE, DCF, and 
CAPM models. The three economic models use different inputs and provide 
different outlooks when determining a unique target ROE.
1. Comparable Accounting Earnings Model
    The CAE model's sole source of data is peer group historical 
accounting information. The annual ratios of net income before taxes to 
equity of the individual BHCs are averaged to determine the peer group 
ROE. The arithmetic average of the last five years' individual ROEs is 
the CAE ROE.
    This model is appealing because it is directly related to the 
published financial statements of BHCs. Because the priced-services ROE 
is applied to the book value of equity, the CAE is also the only model 
that is consistent with the pro forma presentation that is used to 
measure cost recovery and compliance with the MCA. The CAE model's 
primary shortcomings are that it relies exclusively on historical data 
reported on a book value basis to project an expected market rate of 
return and does not incorporate future earnings expectations. The ROE 
results for any point are substantially anchored in past accounting 
book values, and book values can be less relevant to investors than 
market-based measures of a firm's financial condition. The CAE results 
can be particularly unrealistic during periods when there are large 
fluctuations in business cycles. These shortcomings were identified 
when the three-model approach was adopted in 2001; however, the Board 
believed the CAE results complemented the market-driven results of the 
DCF and CAPM models when the results of all three models were averaged.
2. Discounted Cash Flow Model
    The DCF approach requires as inputs the BHC peer group stock prices 
as well as forecasts of future dividends and long-term dividend growth 
rates.\5\ The implied discount rate of a firm can be calculated and 
considered the firm's estimated ROE in the DCF model if the stock price 
and expected future dividends are known. The ROEs for individual BHCs 
are combined using a

[[Page 29515]]

weighted average based on each BHC's equity market capitalization. The 
formula for the DCF model is
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    \5\ Consensus earnings forecasts and long-term growth rates (as 
published by the Institutional Brokers Estimate System) are 
translated into future dividend cash flows.
[GRAPHIC] [TIFF OMITTED] TN23MY05.001

    The DCF model was adopted for the ROE calculation because it 
incorporates projections of future shareholder market returns, which 
are not reflected in the CAE or CAPM models. The DCF model can be a 
powerful valuation tool; however, meaningful results depend on 
analysts' ability to project cash flow and dividend growth rates 
accurately. Financial market history has shown the inherent difficulty 
faced by analysts in developing accurate financial projections given 
the rapid shifts in business activities as a result of increased 
competition, changes in the regulatory environment, technological 
obsolescence, and other forces.
3. Capital Asset Pricing Model
    CAPM's basic principle is that the required rate of return on a 
firm's equity is equal to the return on a risk-free asset plus a risk 
premium. The risk premium is a measurement of the expected excess 
return on a market portfolio of equities (the expected market risk 
premium) and the correlation of the firm's returns to the market 
returns (beta).
[GRAPHIC] [TIFF OMITTED] TN23MY05.002

    The CAPM requires judgment in determining
     The risk-free interest rate or the rate of return on an 
investment with no or low risk, typically measured using a Treasury 
rate.
     The method, data, and period used for estimating the beta. 
The beta measures the market risk of a particular company relative to 
the risk of the overall market. A beta of 1.0 signifies that a firm's 
returns will be perfectly correlated with the market and move up or 
down with the market's return (dividends and capital gains and losses). 
A beta of less than 1.0 indicates that a firm's returns fluctuate less 
than the market (less risky); while a beta greater than 1.0 indicates 
that a firm's returns tend to vary more than the market (more risky).
     The market risk premium, which estimates the additional 
return investors require to forgo the safety of investing in no or low-
risk assets to bear the higher risk of common stock.
    The CAPM provides a framework to determine the risk-return 
relationship required by investors. Because CAPM measures the relevant 
market risk of a firm's stock and the contribution of the firm's stock 
to the market risk of a well-diversified portfolio, CAPM can be applied 
to many business decisions. For example, investors, who are concerned 
with market risk when holding diversified portfolios, can use CAPM to 
make portfolio management decisions and balance the risk-return 
tradeoff. Business managers, who are concerned with maximizing the 
return to shareholders, can also use CAPM to make financing decisions 
because CAPM produces the required rate of return expected by the 
market. As a practical matter, not all financial models, including 
CAPM, will necessarily produce accurate estimates unless the 
decisionmaker exercises some judgment to adjust for risks that

[[Page 29516]]

the models do not measure. In addition, CAPM can produce varying 
results that may not accurately predict future performance, depending 
on the formula inputs. Nevertheless, CAPM is a useful conceptual tool 
because it represents the way rational people would behave when 
managing risk and making financing decisions.
    Because the results of the CAPM are sensitive to the inputs, they 
are critical to the model's usefulness. The risk-free rate is a 
significant factor because it both is used to determine the market risk 
premium and also is added to the risk premium of the peer group in the 
CAPM calculation. Currently, the Board uses the constant maturity yield 
on the one-year Treasury bill as the risk-free rate. The monthly stock 
returns over a rolling ten-year period are used in a linear regression 
technique to estimate the peer group beta.\6\ To capture each BHC's 
involvement in similar service activities, the returns of each BHC in 
the peer group are weighted by market capitalization. The market risk 
premium is estimated using the monthly excess return of the market over 
the risk-free rate since 1927, which is standard finance practice.\7\
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    \6\ Linear regression uses variables, such as the BHCs' equity 
returns and the market's return, and estimates a relationship 
between them in the form of a straight-line.
    \7\ The market risk premium data are found on the Kenneth R. 
French website (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french). Stock return data are obtained from the Center for 
Research in Security Prices.
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4. Results of the Current Three-Model Approach
    The following table shows Reserve Bank priced services pretax and 
after-tax ROE targets from 2001 to 2005 using each of the three models. 
Table 2 highlights the CAPM's sensitivity to interest rates, which has 
made it much more variable from year to year than the other two models. 
As rates fell from 2001 to 2005, the CAPM produced an ROE that is much 
lower than the ROEs produced by the CAE or DCF models. Conversely, 
during periods of higher interest rates such as the 1980s, the CAPM 
produced higher ROE results than the CAE or DCF. Over the eighteen-year 
period of 1983-2000, the average ROE of the CAPM was the highest of all 
three models at 15.1 percent, followed by the CAE at 11.4 percent and 
the DCF at 13.0 percent.
[GRAPHIC] [TIFF OMITTED] TN23MY05.003

    The three models for calculating the target ROE are based on 
different assumptions, analytical approaches, and data sources. Because 
each of the three models brings a different perspective to a firm's 
cost of equity capital, the Board concluded that a simple average of 
the three was a better measure of the peer group's ROE than any single 
model by itself. Support for this approach was found in academic 
studies that demonstrated that the use of multiple models can improve 
estimation techniques when each model provides new information. Taking 
the average of the three models was seen as a way to minimize the 
effect of unusual data and provide a less-volatile ROE over time. In 
recent years, however, academic, market, and financial services 
industry practices have evolved, and the weaknesses of the CAE and DCF 
have become more widely recognized. As a result, reliance on the CAE 
and DCF for targeting a firm's ROE has declined.
    The Board requests comment on alternative methods to calculate the 
target ROE. Are there models, other than the three in use, that the 
Board should consider? What is considered to be a reasonable target ROE 
for institutions that provide services similar to those provided by the 
Reserve Banks?
    Possible change to the imputed ROE methodology. To implement the 
principle of maintaining consistency with private-sector practice, the 
Board reviewed current finance theory and practice to determine whether 
the current PSAF methodology, and in particular the three-model 
approach, is the most appropriate method for

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computing the ROE. When the Board adopted the current three-model 
approach, there was evidence that multiple models were being used by 
academics and professionals to estimate ROE.\8\ Current information 
suggests, however, that CAPM has continued to evolve and is used more 
in practice than the CAE and DCF methods.\9\ Specifically, the CAE 
method, while not widely used at the time of the last study, has 
continued to wane in use. Similarly, the effectiveness of the DCF as a 
tool for estimating ROE has also been questioned based on recent 
research findings that analysts' dividend projections can be upwardly 
or downwardly biased.\10\ Although some public utilities still use the 
results of the DCF model together with CAPM for developing ROE targets, 
it is not used by many larger financial institutions.\11\ With 
information suggesting that two of the three models that are used in 
the current ROE method might not be in line with common practice, the 
Board is considering discontinuing using the average of the results of 
three models and use CAPM only to calculate the target ROE. While CAPM 
has the virtue of being a forward-looking, market-based measure of ROE 
that incorporates the fundamental risk'return relationships required by 
rational investors and is the most widely accepted and used model for 
calculating ROE, it also continues to be the most volatile of the 
methods, as shown in table 2. The volatility comes from the estimates 
and assumptions required to calculate the ROE.
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    \8\ For example, when the current method was adopted, the New 
York State Public Service Commission was considering using an 
average of different ROE measures to determine the cost of equity 
capital for utilities it regulates.
    \9\ R.F. Bruner, K.M. Eades, R.S. Harris, and R.C. Higgins, 1998 
``Best Practices in Estimating Cost of Capital: Survey and 
Synthesis,'' Financial Practice and Education, and J.R. Graham, and 
C.R. Harvey, 2001 ``The Theory and Practice of Corporate Finance: 
Evidence from the Field,'' Journal of Financial Economics, find that 
CAPM is the dominant model for estimating cost of equity. In 
addition, most textbook treatments of equity cost of capital 
calculations are based on the CAPM model (for example see 
www.Damodaran.com).
    \10\ Louis K.C. Chan, Jason Karceski, and Josef Lakonishok, 
``Analysts'' Conflict of Interest and Biases in Earnings Forecasts' 
March 2003, NBER Working Paper 9544, find evidence that analysts 
manipulate forecasts downward so that firms are positioned for 
positive earnings surprises at announcement dates. Patricia M. 
Deschow, Amy Hutton, and Richard Sloan, ``The Relation between 
Analysts'' Forecasts of Long-term Earnings Growth and Stock Price 
Performance Following Equity Offerings' Contemporary Accounting 
Research, Spring 2000, find that analysts' projections may be overly 
optimistic because fees paid to analyst's firms are correlated to 
optimistic projections.
    \11\ J.H. Vander Weide, 2004. Prepared Testimony for the Pacific 
Gas and Electric Company Cost of Capital 2004 and 2005 Submission to 
the California Public Utilities Commission.
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    The Board requests comment on whether the CAPM methodology is 
appropriate to rely on to estimate a target ROE. What important 
elements of the ROE calculation might be excluded if the Board adopts 
the CAPM-only method? Are there considerations that do not support the 
use of CAPM to impute the Reserve Banks' target ROE? Is the DCF model 
used to estimate a target ROE? What earnings estimates are the most 
useful? Are recent published accounting earnings relevant when 
estimating a target ROE? Is the volatility of the CAPM-only method 
acceptable? Should CAPM-only be viewed as a method to develop an ROE 
that may be modified; if so, why and how would one modify the model?

C. Possible CAPM Methodology Modifications

    Regardless of whether a CAPM-only method for ROE is adopted, the 
Board is considering whether the current CAPM methodology should be 
modified to better reflect comparably positioned service providers, the 
aims of the MCA, and current academic and professional practice.\12\ As 
previously noted, CAPM requires judgment to determine the inputs that 
should be used for each aspect of model. The Board is considering 
modifying the risk-free investment horizon and the beta assumptions, 
including the peer group used to estimate beta, the beta estimation 
period, and the weighting of the peer group betas in CAPM.
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    \12\ As part of the current review, the Board examined whether 
economic factors other than the overall market return significantly 
affect the stock returns of the BHC peer group. In the analysis, 
alternative multifactor CAPMs that included BHC payments-related 
revenue shares and macroeconomic interest rate spreads were 
analyzed. The analysis suggests that the current standard CAPM and 
equity betas used to estimate ROE are reasonable. See ``Alternative 
Measures of the Cost of Equity Capital for the Federal Reserve 
Banks'' Payments Services: Technical Supplement to the 2004 PSAF 
Review'' by Barnes and Lopez (http://www.federalreserve.gov/boarddocs/press/other/2005/20050518/supplement.pdf).
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    Risk-free investment horizon. The CAPM risk-free parameter in the 
Board's current method for calculating the target ROE is based on a 
one-year Treasury bill rate. The Treasury security is considered to be 
risk-free, and this short-term rate was chosen to match the time 
horizon of the target ROE.\13\ There are competing views about whether 
a short-term or long-term risk-free rate is more appropriate in the 
CAPM. One point of view is that a short-term risk-free rate is 
consistent with an underlying tenet of CAPM that suggests that the 
market for a security is liquid and matches the time horizon of a 
short-term investor. This approach is consistent with the yearly price-
setting for Federal Reserve services. Another point of view advocates 
using a long-term risk-free rate, such as the ten-year Treasury bond 
rate, because it more closely matches the duration of investments, the 
duration of stock market indexes used to estimate a beta, and the 
investment horizon of a long-term investor. It may also be considered 
to be more in line with the MCA's requirement for the Federal Reserve 
to recover all costs of providing its services over the long run. In 
this approach, a target ROE should represent return that the firm hopes 
to achieve on average over the fluctuations of the business cycle. When 
considering what risk-free rate term to use, generally the time horizon 
of the investor is matched with term of the risk-free security. If 
investment in the Reserve Banks' activities is assumed to be long term, 
this approach would support using the yield on a longer-term Treasury 
instrument as the risk-free rate in the CAPM to calculate the Reserve 
Banks' priced-services target ROE.
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    \13\ Although the priced-services ROE is recomputed each year, 
the Board considered the difference between a one-year rate based on 
the average of monthly, three-month, or one-year Treasury bill rate 
insignificant because Treasury securities do not have significant 
pricing anomalies across short-term maturities.
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    Rates on short-term Treasury bills are subject to more volatility 
than longer-term Treasury securities because they are more sensitive to 
economic conditions. Historically, the yields on short- and long-term 
Treasury securities generally move in the same direction, with long-
term securities offering higher yields, on average, than the yields 
provided by short-term securities. Volatility of the short-term 
Treasury rate could produce widely-varying CAPM ROE estimates and 
adversely affect the pricing of the Federal Reserve's services. To the 
extent that the Reserve Banks adjust prices each year to recover a 
fluctuating ROE, a more-stable ROE may lead to more-stable prices, 
which is consistent with the Federal Reserve's objective to promote 
efficient payments operations.
    As mentioned earlier in this notice, the expected market risk 
premium (E(Rm-Rf)) data are gathered from a third-party source. This is 
a widely accepted and easily accessible source, and the data are 
calculated with short-term risk-free rates, which is standard practice 
because investors can buy or sell securities in the short term. Because 
the risk-free rate is used in two parts of the CAPM equation, however, 
inconsistency is introduced in the

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equation when a long-term investment horizon is combined with the 
short-term expected market risk premium from the third-party source. To 
maintain consistency, the constant maturity yield on the ten-year 
Treasury bond, less a term premium, could be used as an estimate of the 
risk-free rate (Rf). Empirical analyses show that, on average, longer-
term Treasury securities have higher yields. This term premium, 
estimated using the historical difference between short- and long-term 
Treasury securities, would be used to adjust a long-term rate in order 
to reflect an average expected short-term risk-free rate over a ten-
year horizon.\14\ \15\
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    \14\ As reported in the H.15 Historical Releases report 
published by the Board of Governors. The H.15 provides the constant 
maturity yield (annualized) for various term Treasury securities on 
a monthly basis.
    \15\ The term premium is estimated at 1.34 percent, which is the 
arithmetic average of the difference between the ten-year Treasury 
bond yield and the one-month Treasury bill yield from 1959-2003 
based on data from the Federal Reserve Board H.15 statistical 
release and Ibbotson Associates.
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    Table 3 compares the ROEs that result from using the one-year 
versus the ten-year risk free rate in the CAPM calculation. For 
illustrative purposes, the beta is assumed to equal 1.0 to isolate the 
effect of using a short- and longer-term rate on the current 
methodology. For 2005, there is a different of 1.6 percentage points 
between the after-tax ROE calculated when using a short-term risk-free 
rate and a long-term free rate adjusted by the term premium.
[GRAPHIC] [TIFF OMITTED] TN23MY05.004

    The Board requests comment on the time horizon for estimating a 
target ROE. Should the Federal Reserve's priced-services target ROE for 
the upcoming year be based on a short-term rate, which might reflect 
what the market expects its peers to deliver in the upcoming year, or 
should the target ROE be calculated using a long-term rate, which might 
better reflect the return that the market expects its peers to deliver, 
on average, over time? The Board also requests comment on the 
reasonableness of incorporating a ten-year Treasury bond less a term 
premium to reflect an expected average short-term risk-free rate over a 
ten-year horizon. What are other factors that could be used to 
incorporate a long-term time horizon?
    Beta assumptions. A beta measures the sensitivity of the peer group 
returns to the overall market's returns. In order to calculate a beta 
representative of the Federal Reserve priced-services activities, a 
comparable peer group is needed. When the peer group is identified, the 
most relevant and appropriate methods to use for the beta calculation 
can be determined.
1. Peer Group
    Although BHCs' activities are not a perfect proxy for Reserve Bank 
priced-services activity, they provide similar services through their 
correspondent banking activities, including payment and settlement 
services. They also hold respondent (``due-to'') balances, which are 
similar to depository institution balances held by Reserve Banks, and 
have publicly available information; therefore, they are the most 
reasonable alternative.\16\ One drawback to using BHCs as the proxy is 
that they offer diverse services with different risk profiles that 
reach well beyond the payment services that are provided by the Reserve 
Banks, such as consumer and corporate lending and investment services. 
To reduce the effect on the ROE of these noncomparable services in 
which BHCs are involved, the Board is also considering looking at the 
level of a BHC's involvement in correspondent banking activity, its 
capital structure, and its solvency ratings in refining the BHC peer 
group to better match the Federal Reserve priced-services activities.
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    \16\ BHC due-to balances are bank deposits reported on the books 
of the individual institutions that make up the BHC, which originate 
from other banks and represent respondent balances held to provide 
transaction processing and settlement services.
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    To choose peers whose activities are more comparable to the Federal 
Reserve priced services, the Board is considering a peer group that 
meets all of the following criteria.
    1. The BHCs among the top fifty publicly traded BHCs based on 
deposit balances.
    2. The BHCs among the top fifty publicly traded BHCs based on their 
level of due-to balances. By using deposit and due-to balances, the 
peer group would represent publicly traded entities that provide 
correspondent banking services and have several years of financial data 
available in the public domain.\17\ This selection criteria may result 
in a peer group of BHCs that hold both retail and correspondent 
deposits and are more involved in transaction processing and settlement 
services.
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    \17\ Choosing BHCs that have been traded for five years allows 
the Federal Reserve to use BHC market returns in the other models 
used to determine a target ROE. The number of years in the selection 
criteria would change if more or fewer market data observations were 
needed.
---------------------------------------------------------------------------

    3. To more closely relate the peer group members' capital structure 
and risk-weighted asset ratios to the Federal Reserve's priced-services 
imputed capital structure, the Board is considering further refining 
the selection process by choosing BHCs that have a ratio of Tier 1 
capital to risk-weighted assets similar to Reserve Bank

[[Page 29519]]

priced-services activities (plus or minus 20 percent).\18\
---------------------------------------------------------------------------

    \18\ The Tier 1 capital to risk-weighted assets ratio for the 
2005 PSAF was 10.8 percent. Choosing a BHC within +/-20 percent of 
the capital to risk-weighted asset ratio (8.6 percent to 13.0 
percent for the 2005 PSAF) would capture a reasonable number of BHCs 
with similar capital structures and risk-weighted assets.
---------------------------------------------------------------------------

    4. To create a peer group that has a solvency rating similar to 
that of the Federal Reserve's priced-services activities if the Federal 
Reserve were a private firm, the peer group could be further narrowed 
by including only the BHCs that have an investment-grade solvency 
rating.
    Attachment I shows the resulting peer group (cross-matched peer 
group) of twenty BHCs that results from these selection criteria using 
publicly available data as of December 2003.\19\ To minimize the 
complexity involved in capturing the due-to balances for the peer 
group, the Board is considering assuming that the largest three hundred 
BHCs by deposit balance includes the top fifty BHCs by due-to 
balance.\20\
---------------------------------------------------------------------------

    \19\ The PSAF calculation uses data from audited financial 
statements of the peer group. The data used for the 2005 PSAF 
calculation is based on year-end 2003 data because this is the most 
recent publicly available information at the time of the 
calculation.
    \20\ Due-to balance data are available only at the bank level 
and must be aggregated to get to the BHC level.
---------------------------------------------------------------------------

    An alternative the Board is also considering could eliminate 
deposit balances as a selection criterion and use the three remaining 
criteria to select a peer group, while limiting to twenty-five the 
number of institutions to which it would be applied. Choosing the peer 
group by the largest due-to balances and not considering their level of 
deposit balance may result in a peer group that is more focused only on 
correspondent banking activities. When the peer group is composed of 
the top twenty-five institutions based on their level of due-to 
balances that also meet the Tier 1 capital to risk-weighted assets 
ratio and solvency rating filtering criteria, the peer group is 
narrowed to seventeen of the twenty institutions that resulted from the 
cross-matching of deposit and due-to balances.\21\
---------------------------------------------------------------------------

    \21\ Of the top twenty-five institutions based on due-to 
balances, three are not publicly traded and five do not have a Tier 
1 capital to risk-weighted asset ratios similar to Reserve Bank 
priced services.
---------------------------------------------------------------------------

    Although the cross-matched peer group is smaller than the top fifty 
BHC peer group by deposit balance, the majority of the top fifty BHCs 
by deposit and due-to balances is accounted for in the cross-matched 
peer group. For example, the cross-matched peer group consists of 67 
percent of the deposits of the top fifty BHCs by deposit and 59 percent 
of the due-to balances of the top fifty BHCs by due-to balance.
    The Board requests comment on this modified approach to selecting a 
peer group, and in particular on the following questions. What factors 
should be considered when determining the Federal Reserve's priced-
services peer group? Is selecting a peer group based on deposit 
balances, due-to balances, or a combination of both an appropriate peer 
group selection criterion? Is there other criteria the Board should 
consider? Do the Tier 1 capital-to-risk-weighted assets ratio and 
solvency rating filters improve the selection method?
2. Beta Estimation Period
    In the current method, the beta is estimated from a rolling ten-
year period of monthly stock returns for each BHC in the peer group. 
Different sample periods result in different betas, with a longer 
period producing a beta that is less sensitive to unusual market 
variations and a shorter period having an opposite effect. The rolling 
ten-year period was adopted because it provides a sufficient number of 
market observations to mitigate the effect of market variations on the 
calculation.
    The Board is considering calculating the beta using monthly returns 
from the market over a rolling five-year period rather than a rolling 
ten-year period. Some financial sources suggest that using more years 
of historical data to calculate the beta may be less relevant to the 
firm's future returns than fewer years would be, because the nature of 
business risks undertaken by firms may have changed significantly over 
ten-years. The shorter period is less likely to distort ROE results 
because it excludes some past structural changes in the banking 
industry and in the financial markets that no longer reflect current 
BHC peer group risk profiles. In addition, a five-year data period 
could provide a reasonable number of observations to estimate the peer 
group beta. Table 4 compares the 2005 CAPM ROEs of the current peer 
group to the CAPM ROEs of the cross-matched peer group using a long-
term risk-free rate less a term premium.\22\ Using the five-year 
rolling period results in a lower ROE for both peer groups because the 
peer group BHCs' returns compared to the market's returns have been 
less volatile over the five-year period than over the ten-year period.
---------------------------------------------------------------------------

    \22\ For ease in illustration, only the cross-matched peer group 
of due-to/deposit balances will be compared to the current peer 
group throughout the remainder of this notice.
[GRAPHIC] [TIFF OMITTED] TN23MY05.005


[[Page 29520]]


    The Board requests comment on the beta estimation period. Does a 
rolling five-year period or a rolling ten-year period better capture 
elements that are relevant to calculating a meaningful beta for 
estimating the Reserve Bank priced-services ROE?
---------------------------------------------------------------------------

    \23\ A minor modification to calculate beta produces slightly 
different ROE results when comparing the current CAPM calculation, 
shown in the first row, with the current 2005 CAPM calculation shown 
in table 2.
---------------------------------------------------------------------------

3. Weighting of the Peer Group Betas
    In the current method to determine the priced-services beta in 
CAPM, the returns of each BHC in the peer group are market-value 
weighted and are compared with the overall market returns. In effect, 
value weighting assumes that a firm's payments business is proportional 
to its market capitalization level. As BHCs become more involved in 
nonpayment-related businesses, however, the extent to which market 
capitalization is representative of a BHC's payments activities and its 
usefulness to weight the betas is uncertain. Value weighting, 
therefore, may not produce an appropriate beta to serve as the proxy 
for the Reserve Banks' priced-services activities.
    The Board is considering calculating the priced-services beta using 
the equal-weighted returns of each BHC in the peer group rather than 
value-weighted returns as a better approximation of the appropriate 
peer group. Equal-weighted and value-weighted averages of betas from 
2001 to 2005 for each BHC in the cross-matched peer group are shown in 
attachment II. The difference between the betas, using equal-weighting 
or value-weighting, with the cross-matched peer group of twenty BHCs, 
varies. For 2001 and 2005, equal-weighting are .12 and .20 lower than 
value-weighting, respectively.
    Table 5 compares the ROEs that result from applying the two 
different weighting schemes with the returns for each peer group using 
a long-term risk-free rate less a term premium. For the 2005 CAPM 
after-tax ROE using the cross-matched peer group, the difference 
between equal-weighting and value-weighting is 2.0 percent.
[GRAPHIC] [TIFF OMITTED] TN23MY05.006

    The Board requests comment on what weighting method is appropriate 
to best capture the business risk of a peer group. Is equal-weighting 
or value-weighting the returns of each BHC in the peer group preferable 
when estimating beta? Should an alternative weighting process, such as 
by deposit or due-to balances, be used? What are the strengths and 
weaknesses of each weighting method?
4. Beta of 1.0
    Historical betas use past returns of a firm and the market to 
estimate the firm's beta for the future. Historical betas, however, may 
not be a good predictor of the future risk for a firm because it may be 
facing different risks than it did in the past. Finance literature 
suggests that betas, as an empirical rule, move towards 1.0 over time. 
Assigning a beta of 1.0 for a firm assumes that the firm will achieve 
the same returns as the market over time, and therefore carries the 
same risk as the market in the long run.
    To simplify the beta estimation process, the Board is considering 
assigning the Federal Reserve's priced services a beta of 1.0. When 
using a beta of 1.0, a peer group is no longer needed to estimate the 
target CAPM ROE.
    An alternative way to incorporate the concept that all firm betas 
will revert to 1.0 is to weight the historical beta and the beta of 1.0 
to determine the firm's adjusted beta. For example, financial 
literature suggests and financial firm practice support applying a two-
thirds weight on the historical beta and a one-third weight on the beta 
of 1.0. The adjusted beta will reduce volatility and be a truer measure 
of risk over the long run while moving the beta estimate closer to 1.0.
    The Board requests comment on incorporating the concept that all 
firm betas will be 1.0 over time in the priced-services beta 
calculation. Is a beta equal to 1.0 for Federal Reserve priced services 
a reasonable simplifying assumption when computing CAPM? Are important 
elements that should be factored into the CAPM equation eliminated with 
this assumption? If an adjusted beta should be considered, what is the 
best method for implementing it?
    In addition, the Board requests comment on the overall CAPM 
methodology changes it is considering. Are the after-tax and pretax ROE 
results of the CAPM-only method reasonable? In what ways, if any, does 
this methodology oversimplify the calculation? In what ways, if any, is 
the methodology overly complex?

D. Effect of Different PSAF Methodologies

    Table 6 shows the effect on the beta of changes to the CAPM factors 
being considered.

[[Page 29521]]

[GRAPHIC] [TIFF OMITTED] TN23MY05.007

    As shown in rows one and two, the reduction in the peer group size 
from fifty to twenty BHCs, which results when applying the filters 
described in the peer group section of the notice, causes the 
historical beta for the sample group to rise slightly. The rise in 
historical beta is attributable to the increased weight of the larger 
BHCs in the cross-matched peer group because the smaller BHCs in the 
current peer group of fifty dropped out. In general, the smaller BHCs 
have lower betas, which may result, in part, from a greater reliance on 
more-traditional and less-risky core banking activities. The weighting 
of the historical beta and the beta of 1.0 cause the adjusted beta to 
be closer to 1.0.
    The change in historical beta between rows two and three reflects 
the change in the rolling beta estimation period from ten to five 
years. This change produces a notable drop in the historical beta. The 
reduction in the beta from .98 to .82 demonstrates that the cross-
matched peer group has been less volatile than the market over the last 
five years than over the last ten years.
    Lines three and four show that the historical beta for the cross-
matched peer group declines significantly when moving from value-
weighting to equal-weighting. The two largest BHCs based on market 
capitalization have substantially higher betas than the other BHCs in 
the peer group, with five-year averages of 1.5 and 1.2. With the 
exception of two midsize-to-small BHCs, the remaining BHCs in the peer 
group all have a five-year average betas of less than 1.0.\24\ The two 
largest BHCs account for more than 60 percent of the sample group's 
historical beta under value-weighting, while they make up just 24 
percent of beta under equal-weighting.
---------------------------------------------------------------------------

    \24\ The five-year average betas less than 1.0 range from 
.48-.85.
---------------------------------------------------------------------------

    Combining the peer group historical betas from table 6 above with 
the appropriate interest rate and market data, the pretax return on 
equity and the cost of equity\25\ for Reserve Bank priced services in 
2005 are shown in table 7:\26\
---------------------------------------------------------------------------

    \25\ A minor modification to calculate beta produces slightly 
different ROE results when comparing the current CAPM calculation, 
shown in the first row, with the current 2005 CAPM calculation shown 
in table 2.
    \26\ The estimated ROE is applied to the priced services 2005 
book value equity balance of $808 million to derive the cost of 
equity shown in the table.
[GRAPHIC] [TIFF OMITTED] TN23MY05.008


[[Page 29522]]


    In 2005, a 100 basis point change in the pretax ROE increases or 
decreases the imputed costs to priced services by about $8.1 million. 
This is approximately 1.1 percent of priced-services expenses.\27\
---------------------------------------------------------------------------

    \27\ System 2005 budgeted priced services expenses less shipping 
are $724.8 million.
---------------------------------------------------------------------------

IV. Broader Issues in the Implementation of Target ROE

    As noted earlier in this notice, the Board seeks to fully recover 
the costs of its priced-services operations, including the PSAF, over 
the long run. To limit unnecessary and potentially disruptive 
volatility in its pricing, the Board does not require priced services 
to offset previous years' overrecoveries or underrecoveries. 
Accordingly, a target ROE for priced services is calculated each year 
by the method described in this notice, and that target is factored 
directly into product pricing decisions for the upcoming budget year.
    The Board notes that among some companies the current practice is 
to establish a multiyear ROE target, to be achieved over a strategic 
planning horizon. Budget models may focus on specific project and 
business line targets or on maximizing profit from year to year. 
Strategic ROEs could take a longer-term view and consider changes in 
the marketplace and technology and how the firm would respond to them, 
along with planned capital investment. Companies may intentionally set 
prices in a way that would result in actual ROE performance deviating 
from the target year to year; however, they expect to achieve the 
target on average over the planning horizon.
    The Board would consider adopting a longer-term view if a case 
could be made that it would significantly improve the efficiency of the 
payments systems. Implementing a less mechanical approach would require 
the Board to devise a transparent and replicable method to adjust the 
annual ROE targets built into the Reserve Bank priced-services' budget 
so as to achieve the long-term objective. The Board seeks comment on 
the following questions.
    Do firms target a different ROE for near-term budgeting purposes 
than for multiyear, longer-term, strategic planning? What advantages or 
disadvantages are there to the Federal Reserve setting a PSAF, 
including the priced-services ROE, more or less frequently than 
annually? What, if any, are the implications if a longer-term approach 
to setting the ROE is adopted?
    Under the MCA, the fees the Reserve Banks charge for priced 
services are to be set to fully recover the costs that a private-sector 
provider would incur in providing them over the long run. As the 
payments system evolves from paper-based transactions to electronic 
forms, the Board will be setting a target ROE for the Reserve Banks 
priced-services activities in the context of declining volumes for its 
check service line. The Board seeks comment on the following questions.
    What are the advantages and disadvantages to the Board changing its 
current practice of setting the target ROE for priced services at an 
entity level and begin developing target ROEs for each service line? In 
what way should the Board adjust the target ROE to consider the decline 
in use of paper-based check products, given that the check service 
represents a majority of priced-services activities?

V. Looking Ahead

    While the Board considers the changes to the current PSAF 
methodology discussed above, it recognizes that the changes under way 
in the payments industry and regulatory practices will, in all 
likelihood, lead to the consideration of more changes to the PSAF model 
in the longer term. Historically, the Board considered BHCs a proxy for 
the Reserve Bank priced-services peer group because correspondent banks 
are the Reserve Banks' primary competitors in providing check services, 
which comprises more than 80 percent of the cost of Reserve Bank 
priced-services activities. Competitors in the electronic payment 
services, however, have typically been market utilities. Market 
utilities, such as the Clearing House Interbank Payment System (CHIPS), 
which is the primary competitor for Fedwire funds transfer services, 
and the Electronic Payments Network (EPN), which is the only private-
sector automated clearinghouse (ACH) operator, are both member-owned 
clearinghouses. As paper check volume continues to decline and as the 
check service increasingly becomes electronic, market utilities may 
replace correspondent banks as the Reserve Banks' primary priced-
services competitor.
    Similarly, proposals developed by the Basel Committee on Banking 
Supervision (Basel II), once adopted, to improve capital regulations 
internationally, make regulatory capital more risk sensitive, include 
an explicit operational risk capital charge, and promote enhanced risk-
management practices among large, internationally active banking 
organizations may affect the capital structure of the Reserve Banks' 
priced-services peer group and warrant consideration in developing the 
PSAF equity costs.
    The Board would welcome any comments on the possible implications 
of these and other environmental changes for the appropriate approach 
to calculate the PSAF.

VI. Competitive Impact Analysis

    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.'' \28\ 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 of the Federal Reserve deriving from such 
legal differences. If the fees or fee structures create such an effect, 
the Board must further evaluate the changes to assess whether their 
benefits--such as contributions to payment system efficiency, payment 
system integrity, or other Board objectives--can be retained while 
reducing the hindrances to competition.
---------------------------------------------------------------------------

    \28\ FRRS 9-1558.
---------------------------------------------------------------------------

    Because the PSAF includes costs that must be recovered through fees 
for priced services, changes made to the method may have an effect on 
fees. The Board is considering changes that may refine the PSAF peer 
group and ROE methodology to resemble that of other service providers 
as required by the MCA. Consequently, the fees adopted by the Reserve 
Banks should be based on the cost and profit targets that are 
comparable with those of other providers of services similar to Reserve 
Bank priced services. Accordingly, the Board believes that if it 
determines to adopt some or all of these changes, the changes will not 
have a direct and material adverse effect on the ability of other 
service providers to compete effectively, due to legal differences, 
with the Federal Reserve in providing similar services.

VII. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
ch. 3506; 5 CFR Part 1320 Appendix A.1), the Board has reviewed the 
proposal under the authority delegated to the Board by the Office of 
Management and Budget. No collections of information pursuant to the 
Paperwork Reduction Act are contained in the proposal.

[[Page 29523]]

VIII. Summary of Comments Requested

A. Imputed ROE

    The Board requests comment on alternative methods to calculate the 
target ROE.
    1. Are there models, other than the three in use, that the Board 
should consider?
    2. What is considered to be a reasonable target ROE for 
institutions that provide services similar to those provided by the 
Reserve Banks?
    The Board requests comments on whether the CAPM methodology is 
appropriate to rely on to estimate a target ROE.
    3. What important elements of the ROE calculation might be excluded 
if the Board adopts the CAPM-only method?
    4. Are there considerations that do not support the use of CAPM to 
impute the Reserve Banks' target ROE?
    5. Is the DCF model used to estimate a target ROE? What earnings 
estimates are the most useful?
    6. Are recent published accounting earnings relevant when 
estimating a target ROE?
    7. Is the volatility of the CAPM-only method acceptable?
    8. Should CAPM-only be viewed as a method to develop an ROE that 
may be modified; if so, why and how would one modify the model?

B. CAPM Methodology

Risk-Free Investment Horizon
    The Board requests comment on the time horizon for estimating a 
target ROE.
    1. Should the Federal Reserve's priced-services target ROE for the 
upcoming year be based on a short-term rate, which might reflect what 
the market expects its peers to deliver in the upcoming year, or should 
the target ROE be calculated using a long-term rate, which might better 
reflect the return that the market expects its peers to deliver, on 
average, over time?
    2. Is it reasonable for the Board to incorporate a ten-year 
Treasury bond less a term premium to reflect an expected average short-
term risk-free rate over a ten-year horizon?
    3. What are other factors that could be used to incorporate a long-
term time horizon?
Peer Group
    The Board requests comment on the modified approach to selecting a 
peer group, and in particular on the following questions.
    4. What factors should be considered when determining the Federal 
Reserve's priced-services peer group?
    5. Is selecting a peer group based on deposit balances, due-to 
balances, or a combination of both an appropriate peer group selection 
criterion?
    6. Is there other criteria the Board should consider?
    7. Do the Tier 1 capital-to-risk-weighted assets ratio and solvency 
ratings filters improve the selection method?
Beta Estimation Period
    The Board requests comment on the beta estimation period.
    8. Does a rolling five-year period or a rolling ten-year period 
better capture elements that are relevant to calculating a meaningful 
beta for estimating the Reserve Bank priced-services ROE?
Weighting of the Peer Group Betas
    The Board requests comment on what weighting method is appropriate 
to best capture the business risk of a peer group.
    9. Is equal-weighting or value-weighting the returns of each BHC in 
the peer group preferable when estimating beta?
    10. Should an alternative weighting process, such as by deposit or 
due-to balances, be used?
    11. What are the strengths and weaknesses of each weighting method?
Beta of 1.0
    The Board requests comment on incorporating the concept that all 
firm betas will be 1.0 over time in the priced-services beta 
calculation.
    12. Is a beta equal to 1.0 for Federal Reserve priced services a 
reasonable simplifying assumption when computing CAPM?
    13. Are important elements that should be factored into the CAPM 
equation eliminated with this assumption?
    14. If an adjusted beta should be considered, what is the best 
method for implementing it?
    In addition, the Board requests comment on the overall CAPM 
methodology changes it is considering.
    15. Are the after-tax and pretax ROE results of the CAPM-only 
method reasonable?
    16. In what ways, if any, does this methodology oversimplify the 
calculation?
    17. In what ways, if any, is the methodology overly complex?

C. Broader Issues in the Implementation of the Target ROE

    The Board seeks comment on the following questions.
    1. Do firms target a different ROE for near-term budgeting purposes 
than for multiyear, longer-term, strategic planning?
    2. What advantages or disadvantages are there to the Federal 
Reserve setting a PSAF, including the priced-services ROE, more or less 
frequently than annually?
    3. What, if any, are the implications if a longer-term approach to 
setting the ROE is adopted?
    4. What are the advantages and disadvantages to the Board changing 
its current practice of setting the target ROE for priced services at 
an entity level and begin developing target ROEs for each service line?
    5. In what way should the Board adjust the target ROE to consider 
the decline in use of paper-based check products, given that the check 
service represents a majority of priced-services activities?

D. Looking Ahead

    The Board requests comment on the possible implications that 
payment industry and regulatory changes may have on the approach to 
calculate PSAF.

    By order of the Board of Governors of the Federal Reserve 
System, May 17, 2005.
Jennifer J. Johnson,
 Secretary of the Board.
BILLING CODE 6210-01-P

[[Page 29524]]

[GRAPHIC] [TIFF OMITTED] TN23MY05.009


[[Page 29525]]


[GRAPHIC] [TIFF OMITTED] TN23MY05.010

     
---------------------------------------------------------------------------

    \29\ Differences in calculation timing result in slightly 
different value- and equal-weighted betas than shown in Attachment 
III.

---------------------------------------------------------------------------

[[Page 29526]]

[GRAPHIC] [TIFF OMITTED] TN23MY05.011

     
---------------------------------------------------------------------------

    \30\ A minor modification to claculate beta produces slightly 
different ROE results when comparing the current CAPM calculation, 
shown in the first row, with the current 2005 CAPM calculation shown 
in table 2.
---------------------------------------------------------------------------

[FR Doc. 05-10168 Filed 5-20-05; 8:45 am]
BILLING CODE 6210-01-C