    Federal Reserve System: Current and Future Challenges Require Systemwide
    Attention (Chapter Report, 06/17/96, GAO/GGD-96-128).

    Pursuant to a congressional request, GAO reviewed the operations of the
    Federal Reserve System, focusing on: (1) its finances and levels of
    spending; (2) areas where spending could be reduced; and (3) actions the
    Federal Reserve could take to meet future challenges in systemwide
    management.

    GAO found that: (1) Federal Reserve operating expenses increased from
    $1.36 billion in 1988 to $2 billion in 1994; (2) the most significant
    operating cost increases were for bank supervision and regulation,
    personnel pay and benefits, and extensive modernization and
    consolidation of information systems; (3) operating costs vary among
    reserve banks because the Federal Reserve has not established consistent
    policies; (4) the Federal Reserve could reduce its personnel benefits
    and travel-related reimbursements, and realign its contracting and
    procurement practices; (5) a reduction or elimination of the Federal
    Reserve surplus account, which increased from $2.1 billion in 1988 to
    $3.7 billion in 1994, would increase federal budgetary receipts in the
    year that the reduction or elimination occurs; (6) major developments
    such as increased competition from private-sector suppliers, use of
    electronic banking, and consolidation of the banking industry, are
    likely to affect the Federal Reserve's operations, future role, and
    management structures; and (7) the Federal Reserve must eliminate the
    weaknesses in its planning, budgeting, oversight, and audit processes
    that impede its cost control efforts.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  GGD-96-128
         TITLE:  Federal Reserve System: Current and Future Challenges
                 Require Systemwide Attention
          DATE:  06/17/96
       SUBJECT:  Federal reserve banks
                 Financial institutions
                 Administrative costs
                 Cost control
                 Federal agency reorganization
                 Strategic information systems planning
                 Internal controls
                 Bank examination
                 Banking regulation
                 Monetary policies
    IDENTIFIER:  International Monetary Fund
                 Exchange Stabilization Fund
                 Gramm-Rudman
                 Social Security Program
                 Federal Reserve Board Retirement System
                 Civil Service Retirement System
                 Federal Employees Retirement System
                 FEDNET
                 Federal Reserve Financial Examination Program

    Federal Reserve System: Current and Future Challenges Require Systemwide
    Attention (Chapter Report, 06/17/96, GAO/GGD-96-128).

    Pursuant to a congressional request, GAO reviewed the operations of the
    Federal Reserve System, focusing on: (1) its finances and levels of
    spending; (2) areas where spending could be reduced; and (3) actions the
    Federal Reserve could take to meet future challenges in systemwide
    management.

    GAO found that: (1) Federal Reserve operating expenses increased from
    $1.36 billion in 1988 to $2 billion in 1994; (2) the most significant
    operating cost increases were for bank supervision and regulation,
    personnel pay and benefits, and extensive modernization and
    consolidation of information systems; (3) operating costs vary among
    reserve banks because the Federal Reserve has not established consistent
    policies; (4) the Federal Reserve could reduce its personnel benefits
    and travel-related reimbursements, and realign its contracting and
    procurement practices; (5) a reduction or elimination of the Federal
    Reserve surplus account, which increased from $2.1 billion in 1988 to
    $3.7 billion in 1994, would increase federal budgetary receipts in the
    year that the reduction or elimination occurs; (6) major developments
    such as increased competition from private-sector suppliers, use of
    electronic banking, and consolidation of the banking industry, are
    likely to affect the Federal Reserve's operations, future role, and
    management structures; and (7) the Federal Reserve must eliminate the
    weaknesses in its planning, budgeting, oversight, and audit processes
    that impede its cost control efforts.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  GGD-96-128
         TITLE:  Federal Reserve System: Current and Future Challenges
                 Require Systemwide Attention
          DATE:  06/17/96
       SUBJECT:  Federal reserve banks
                 Financial institutions
                 Administrative costs
                 Cost control
                 Federal agency reorganization
                 Strategic information systems planning
                 Internal controls
                 Bank examination
                 Banking regulation
                 Monetary policies
    IDENTIFIER:  International Monetary Fund
                 Exchange Stabilization Fund
                 Gramm-Rudman
                 Social Security Program
                 Federal Reserve Board Retirement System
                 Civil Service Retirement System
                 Federal Employees Retirement System
                 FEDNET
                 Federal Reserve Financial Examination Program

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    Cover
    ================================================================ COVER

    Report to Congressional Requesters

    June 1996

    FEDERAL RESERVE SYSTEM - CURRENT
    AND FUTURE CHALLENGES REQUIRE
    SYSTEMWIDE ATTENTION

    GAO/GGD-96-128

    Challenges Require Systemwide Attention

    (233416)

    Abbreviations
    =============================================================== ABBREV

      ACH - automated clearinghouse
      A&E - architecture and engineering
      ATM - Automated Teller Machine
      BEA - Budget Enforcement Act of 1990
      CBD - Central Business District
      COFVP - Conference of First Vice Presidents
      COP - Conference of Presidents
      CSRS - Civil Service Retirement System
      DBS&R - Division of Banking Supervision and Regulation
      DHRM - Division of Human Resources Management
      DRBOPS - Division of Reserve Bank Operations and Payment Systems
      EBT - Electronic Benefits Transfer
      FAR - Federal Acquisition Regulations
      FDIC - Federal Deposit Insurance Corporation
      FDICIA - Federal Deposit Insurance Corporation Improvement Act of
         1991
      FEPCA - Federal Employees Pay Comparability Act
      FERS - Federal Employees' Retirement System
      FIRREA - Financial Institutions Reform, Recovery, and Enforcement
         Act of 1989
      FOMC - Federal Open Market Committee
      FRAS - Federal Reserve Automation Services
      FRBRS - Federal Reserve Board Retirement System
      GRH - Gramm-Rudman-Hollings Act
      GS - general schedule
      IMF - International Monetary Fund
      NPR - National Performance Review
      OCC - Office of the Comptroller of the Currency
      OIG - Office of the Inspector General
      PAYGO - pay-as-you-go
      POS - point-of-sale
      SDR - special drawing rights
      SEC - Securities and Exchange Commission
      SPCG - Strategic Planning Coordination Group
      UAG - Uniform Acquisition Guidelines

    Letter
    =============================================================== LETTER

    B-259961

    June 17, 1996

    The Honorable Harry Reid
    The Honorable Byron L.  Dorgan
    United States Senate

    This report responds to your request asking us to review the
    operations of the Federal Reserve System (Federal Reserve).  The
    report discusses the Federal Reserve's finances, including levels of
    spending and factors that could affect its finances.  We also
    reviewed the Federal Reserve's major expenditures and discussed areas
    where spending may possibly be reduced.  Additionally, the report
    discusses how the Federal Reserve's unique structure presents
    challenges in systemwide management.  The report contains matters for
    congressional consideration and recommendations to the Board of
    Governors of the Federal Reserve System for reducing Federal Reserve
    spending and improving operations.

    We are sending copies of this report to the Chairman of the Board of
    Governors of the Federal Reserve System, the other Governors, and the
    Presidents of the Federal Reserve Banks.  We are also sending copies
    to members of the banking committees and other interested parties.

    Major contributors to this report are listed in appendix VI.

    James L.  Bothwell
    Director, Financial Institutions
     and Market Issues

    EXECUTIVE SUMMARY
    ============================================================ Chapter 0

       PURPOSE
    ---------------------------------------------------------- Chapter 0:1

    The Federal Reserve System (Federal Reserve or System), our nation's
    central bank, is unique among governmental entities in its mission,
    structure, and especially its finances.  Unlike federal agencies
    funded through congressional appropriations, the Federal Reserve is a
    self-financing entity that deducts its expenses from its revenue and
    transfers the remaining amount to the U.S.  Department of the
    Treasury.  Although the Federal Reserve's primary mission is to
    support a stable economy, not to maximize the amount transferred to
    Treasury, System revenues contribute to total U.S.  revenues and
    deductions from System revenues thus represent a cost to U.S.
    taxpayers.  In view of today's constrained budget environment,
    Senators Reid and Dorgan requested GAO's assistance in analyzing
    Federal Reserve finances, including levels of spending; factors that
    could affect Federal Reserve finances in the future; and mechanisms
    used to control the cost of the Federal Reserve to taxpayers.

    Specifically, GAO sought to (1) analyze trends in the cost of Federal
    Reserve operations during 1988 to 1994 and the System's management
    processes for controlling spending and overseeing operations, (2)
    identify opportunities to increase the System's efficiency without
    adversely affecting its effectiveness, (3) identify ongoing and
    future developments that could significantly affect the Federal
    Reserve's mission and finances, and (4) assess the System's strategic
    management processes and identify actions the Federal Reserve could
    take to successfully meet future challenges and ensure the efficiency
    and effectiveness of its operations.

       BACKGROUND
    ---------------------------------------------------------- Chapter 0:2

          THE FEDERAL RESERVE'S
          MISSION AND STRUCTURE
    -------------------------------------------------------- Chapter 0:2.1

    The Federal Reserve is responsible for conducting monetary policy,
    maintaining the stability of financial markets, providing services to
    financial institutions and government agencies, and supervising and
    regulating banks and bank-holding companies.  The Federal Reserve Act
    of 1913 established the Federal Reserve as an independent,
    decentralized central bank to better ensure that monetary policy was
    based on a broad economic perspective from all regions of the country
    and was not unduly influenced by political pressures.

    One major component of the System's structure is a federal agency in
    Washington, D.C.--the Board of Governors of the Federal Reserve
    System.  The top officials of the Board are seven Board members who
    are appointed by the president and confirmed by the U.S.  Senate.
    Although the Federal Reserve is required to report to Congress on its
    activities, its decisions do not have to be approved by either the
    president or Congress.

    The other major components are 12 federally chartered corporations
    located throughout the United States, which are known as the Federal
    Reserve Banks.  The Reserve Banks, with a total of 25 branches, are
    not federal agencies and are structured to function with a measure of
    autonomy.  The stock of the Reserve Banks is held by those commercial
    banks that are members of the Federal Reserve, but that stock does
    not carry all of the usual incidents of stock ownership.  Each
    Reserve Bank has its own management structure and board of directors.
    The Board of Governors appoints three of the nine directors of each
    Reserve Bank, including the Chairman, and approves the appointments
    and salaries of each Reserve Bank president and first vice president.

    The Reserve Banks are also subject to the "general supervision" of
    the Board.  With certain exceptions, such as a requirement that the
    Board order an annual financial examination of each Reserve Bank, the
    Federal Reserve Act does not specifically define this general
    supervisory authority.  The Federal Reserve Act also limits this
    authority in certain ways.  For example, the Board cannot close a
    Reserve Bank or establish a new one without congressional approval.
    Generally, the Board exercises its supervisory role through
    operations reviews, financial examinations, budget reviews and
    approvals, and year-end evaluations.

          THE FEDERAL RESERVE'S
          FINANCES
    -------------------------------------------------------- Chapter 0:2.2

    Over the 1988 to 1994 period, the Federal Reserve's annual revenue
    averaged $22.0 billion and greatly exceeded its average annual
    expenses and other deductions of $2.5 billion.  Consequently, the
    annual amount returned to Treasury during this period ranged from
    about $16 billion to $24 billion.  The return of these remaining
    revenues to Treasury is in accordance with a policy established by
    the Board of Governors, and is not required by statute.

    The most significant source of Federal Reserve revenue each year is
    the interest earned on U.S.  securities held by the Reserve Banks as
    backing or "collateral" for the Federal Reserve notes that circulate
    as paper money.  It is this revenue, which accounted for almost 90
    percent of the total Federal Reserve revenue in 1994, that virtually
    guarantees a substantial annual "profit" for the System.  The second
    largest source of revenue is the fees that the Federal Reserve
    charges banks and other financial institutions for providing "priced
    services," such as check-clearing and electronic funds transfers.  As
    required by the Monetary Control Act of 1980, the Reserve Banks are
    to assess fees on the basis of, among other things, all direct and
    indirect costs incurred in providing such services.  The Federal
    Reserve is reimbursed, in part, by Treasury and in full by other
    agencies for the services the System provides to them.

    The most significant deduction from its revenue that the Federal
    Reserve makes each year is for the operating expenses of the Reserve
    Banks and the Board.  The amount of this deduction, which is the
    major focus of this report, totaled $2.0 billion in 1994.  About 70
    percent of these operating expenses is for payment system and other
    financial services provided to banks and agencies, about 20 percent
    is for supervision and regulation, and about 10 percent is for
    monetary policy activities.  Pay and benefits for the Federal
    Reserve's workforce of over 25,000 employees accounted for almost 70
    percent of its total operating expenses in 1994.

       RESULTS IN BRIEF
    ---------------------------------------------------------- Chapter 0:3

    The Federal Reserve has unquestionably played a major role in
    promoting the nation's economic well-being.  Although the Federal
    Reserve's cost of operations has rarely emerged as a visible public
    issue because of its self-financing nature, increasing constraints on
    the federal budget require increased scrutiny of this cost, just as
    all costs that affect U.S.  taxpayers.  Over the 7-year period of
    1988 to 1994, the cost of Federal Reserve operations increased
    steadily and substantially.  Specifically, operating expenses for the
    Board and Reserve Banks increased by about 50 percent, with the
    greatest increases occurring in the areas of bank supervision,
    personnel costs, and data-processing modernization.  The costs of
    providing priced services have been rising faster than the
    corresponding revenues received.  Overall, these cost increases
    exceeded the 25-percent inflation that occurred during this period.

    With the current budgetary climate, the Federal Reserve could do more
    to increase its cost consciousness and ensure that it is operating as
    efficiently as possible in its day-to-day operations.  GAO's review
    identified several inefficiencies in the Federal Reserve's policies
    and practices that have increased the cost of providing its current
    services, including its costs for travel, personnel benefits,
    building acquisition, and contracting and procurement.  Many of these
    inefficiencies relate to the decentralized nature of the Federal
    Reserve, which allows each Reserve Bank to set many of its own
    policies, and to the absence of traditional cost-minimizing forces
    that are commonplace in entities that are either purely private or
    public sector in nature.  The Federal Reserve also retains a $3.7
    billion surplus account that GAO believes could be safely reduced or
    returned to the Treasury.  While many of these areas have some
    potential for reducing its costs, GAO believes that achieving major
    cost reductions ultimately depends on the Federal Reserve's carefully
    reexamining its mission, structure, and work processes.

    The need for such a reexamination is underscored by a number of major
    legislative, technological, and marketplace developments that could
    profoundly affect the nature, size, and distribution of the Federal
    Reserve's activities and resources.  For example, the Reserve Banks
    are facing a major challenge in the form of increasing competition
    from private sector suppliers of financial services.  In addition, a
    continuing switch from paper-based to electronic payment services and
    the rapid consolidation that is currently occurring in the banking
    industry could significantly affect both the magnitude and
    distribution of the Reserve Banks' workloads and resources.  Since
    almost 90 percent of the Reserve Banks' costs is currently associated
    with the delivery of payment system and other financial services and
    bank supervision, these developments raise important questions
    regarding the future role of the Reserve Banks, their management
    structures, and their locations.

    For the Federal Reserve to most effectively meet these challenges and
    streamline its operations, the Board and Reserve Banks must work
    together to strategically plan for the future.  Prior GAO reviews of
    public and private sector organizations, which have successfully
    faced similar challenges, indicated that these organizations
    effectively implemented initiatives to focus on their primary
    missions and business lines, realign their structures to fit their
    missions, and apply technology to streamline their work processes.
    If the Federal Reserve is to effectively follow this strategy, it
    will need the Board's sustained leadership and the Reserve Banks'
    commitment.  The Federal Reserve will also need to address certain
    weaknesses that GAO identified in its existing oversight and
    budgetary processes.  Such weaknesses include a budgetary process
    that assumed continued incremental growth and oversight mechanisms
    that appeared fragmented, inefficient, or lacking in independence.
    The Federal Reserve has begun to show that it can address operational
    issues strategically and work in a systemwide manner when necessary.
    As the Federal Reserve enters the next century, it is vital that it
    continues such efforts so that it can accomplish its mission as
    efficiently and effectively as possible.

       PRINCIPAL FINDINGS
    ---------------------------------------------------------- Chapter 0:4

          FEDERAL RESERVE OPERATING
          COSTS HAVE INCREASED RAPIDLY
    -------------------------------------------------------- Chapter 0:4.1

    Federal Reserve operating expenses increased from $1.36 billion in
    1988 to $2.00 billion in 1994, or 48 percent.  This represents a
    significant increase in the real cost of Federal Reserve operations
    as it exceeded the 25-percent inflation that occurred during this
    period.  In addition, as shown in figure 1, the 48- percent increase
    in the Federal Reserve's operating costs from 1988 to 1994 was also
    greater than the 17-percent increase in overall federal discretionary
    spending and somewhat less than the 51-percent increase in federal
    discretionary spending adjusted to exclude the effects of the "peace
    dividend."

       Figure 1:  Cumulative Increases
       in Federal Reserve Expenses,
       1988-1994

       (See figure in printed
       edition.)

    Sources:  Federal Reserve Board and the budget of the United States.

    The most significant increases occurred in expenses for bank
    supervision and regulation, personnel costs, and an extensive
    automation modernization and consolidation effort.  The number of
    Federal Reserve staff increased 4 percent over this period, rising
    from 24,829 staff in 1988 to 25,744 in 1994.  The largest increase in
    staffing was in bank supervision and regulation and, according to
    Federal Reserve officials, resulted from changes in bank supervision
    mandated by banking reform laws.  System personnel expenditures
    accounted for about two-thirds of the Federal Reserve's total
    operating costs and increased by about 53 percent during the period.
    This increase was due to rising salary and benefit costs, staffing
    levels, and the changing composition of the Federal Reserve
    workforce.

    The Federal Reserve's capital expenditures during the 1988 to 1994
    period totaled about $1.7 billion, resulting from (1) a more than
    doubling of the book value of the System's data-processing and other
    equipment and capitalized leases and (2) the construction of a new
    Reserve Bank building in Dallas.  Much of the investment in
    data-processing equipment was incurred as a part of a large-scale
    project to consolidate Reserve Bank mainframe computer services into
    a centrally managed facility known as Federal Reserve Automated
    Services.

          OPPORTUNITIES EXIST TO
          REDUCE COSTS
    -------------------------------------------------------- Chapter 0:4.2

    With the current budgetary climate, the Federal Reserve could do more
    to increase its cost consciousness and ensure that it is operating as
    efficiently as possible in its day-to-day operations.  For example,
    personnel benefit packages varied among Reserve Banks and certain
    benefits--such as leave policies and savings plans--were generous
    compared to those of federal financial regulatory agencies with
    similar personnel requirements.  To some extent, these benefit
    packages could be necessary to recruit and retain highly skilled
    professional staff, such as lawyers, economists, and financial
    analysts.  However, more than half of the Federal Reserve's staff
    were administrative and clerical employees providing support services
    to financial institutions and government agencies.

    Travel-related reimbursement policies also varied among Reserve
    Banks, resulting in significant differences in the reimbursable
    amounts allowed for lodging and meals.  In addition, contracting and
    procurement practices at some Reserve Banks that GAO reviewed favored
    certain sources over others, despite Systemwide guidance that
    prohibits these practices.  Such practices raise concerns about
    conflicts of interest and favoritism and about whether the Federal
    Reserve is receiving the most favorable prices.  Innovative methods
    of managing and controlling contracting and procurement costs, which
    GAO identified as "best practices" at some Reserve Banks, had not
    been formally disseminated among the other Reserve Banks.  For
    example, GAO found that one Reserve Bank, in negotiating the award of
    large contracts, provided refined contract specifications on major
    contract components that, according to Reserve Bank officials, helped
    the Reserve Bank better negotiate the bids.

    Any downward adjustment to the size of the Federal Reserve's surplus
    account--or perhaps its elimination--while not representing a
    reduction in the real cost of the Federal Reserve to taxpayers, would
    result in an increase in federal budgetary receipts in the year that
    the adjustment or elimination occurs.\1

    Although the surplus account is intended to absorb possible losses,
    the Federal Reserve has recorded substantial net profits for 79
    consecutive years.  Even though the likelihood of the Federal
    Reserve's incurring losses exceeding its revenues appears remote, the
    total surplus increased 79 percent during 1988 to 1994, rising from
    $2.1 billion to $3.7 billion.

    --------------------
    \1 The Joint Explanatory Statement accompanying the Fiscal Year 1996
    Budget Resolution directed the Congressional Budget Office not to
    score for fiscal year 1996 any savings for new legislation that might
    affect the Federal Reserve's transfer of the surplus account to the
    U.S.  Treasury.  (H.R.  Rep.  No.  104-159 at 51 (June 26, 1995).)
    Accordingly, if such legislation had been passed, the transfer would
    not have been counted for purposes of determining compliance with the
    Budget Enforcement Act for Fiscal Year 1996.

          MAJOR DEVELOPMENTS LIKELY TO
          AFFECT THE FEDERAL RESERVE'S
          MISSION AND FINANCES
    -------------------------------------------------------- Chapter 0:4.3

    A number of major legislative, technological, and marketplace
    developments could profoundly affect the nature, size, and
    distribution of the Federal Reserve's activities and resources.
    About 90 percent of the Reserve Banks' operating expenses in 1994
    were associated with the delivery of payment system and financial
    services and bank supervision--the two areas that are most likely to
    be affected by these developments.

    For example, as a result of increased competition from private sector
    suppliers and a continued shift to electronic banking, the Federal
    Reserve has experienced a decline in the volume of its check-clearing
    activity.  The Federal Reserve's costs have been rising faster than
    corresponding revenues in several of its other service lines as well,
    and, in 1994, the System did not meet its cost recovery target for
    its priced services overall.  If these trends continue and the
    Federal Reserve is not able to recover all of its costs over the long
    run, it could be compelled to pursue other options.  These options
    may include the Federal Reserve's (1) reducing its uneconomical
    activities--perhaps by establishing a separate, private corporation
    to provide those priced services--and focusing more on regulation and
    standard-setting in many areas of the payments system or (2)
    subsidizing operations deemed essential to provide adequate
    nationwide service.

    A major consolidation is also currently occurring in the banking
    industry that could significantly affect the magnitude and
    distribution of the Federal Reserve's supervisory activities.  In
    particular, changes in the number and location of the bank-holding
    companies the Federal Reserve examines could require adjustments in
    the examination staffs of the various Reserve Banks.  Current
    legislative proposals could also require the Federal Reserve to
    charge banks fees to cover the cost of its examinations.  Although
    the Federal Reserve Act authorizes the System to charge fees for bank
    examinations, the Federal Reserve has decided not to do so because it
    would impose additional costs on state-chartered member banks.  Thus,
    taxpayers in effect bear the cost of these examinations, which
    totaled $368 million in 1994.

    Collectively, these developments present significant challenges to
    the Federal Reserve to rethink many aspects of its operations and
    raise important questions regarding the future role of the Reserve
    Banks, their management structures, and locations.  Such a rethinking
    is also needed because the Federal Reserve's basic structure of 12
    Reserve Banks and 25 branches has changed remarkably little since it
    was first established in 1913, despite the significant shifts in
    demographics and economic activity that have occurred since then.

          FEDERAL RESERVE COULD
          BENEFIT FROM MAJOR
          SYSTEMWIDE REVIEW OF
          OPERATIONS
    -------------------------------------------------------- Chapter 0:4.4

    Congress and the administration are pursuing efforts to reduce
    federal government discretionary spending, an effort that parallels
    corporate restructuring developments in banking and other industries.
    GAO's prior work in public and private-sector management reform
    showed that organizations that have been successful in improving
    their efficiency have done so by effectively implementing certain
    initiatives.  These organizations' initiatives were implemented to
    focus on their primary missions and business lines, realign their
    structures to fit their mission, and apply technology to streamline
    their work processes.  The Board's sustained leadership and the
    Reserve Banks' commitment will be needed if the Federal Reserve is to
    effectively follow such a strategy.

    Without strong external pressure to minimize overall costs, the
    Federal Reserve must create the necessary self-discipline for the
    institution to adequately control its costs and respond effectively
    to future challenges.  However, GAO found weaknesses in the planning
    and budgeting processes that are key mechanisms for helping
    accomplish these goals.  The Federal Reserve requires Board divisions
    and Reserve Banks to set priorities and prepare plans, and the System
    has recently formed a strategic planning coordination group.
    However, the Federal Reserve did not have an integrated, systemwide
    strategic plan that identified the emerging issues and challenges
    affecting the entire System and how to effectively address them.  In
    addition, the Federal Reserve's budgeting process assumed continued
    incremental growth in the Federal Reserve's budget and, thus, did not
    help contain costs as much as it could have.

    GAO also found weaknesses in some of the Federal Reserve's oversight
    processes.  The Federal Reserve had many oversight tools that were
    used to monitor and evaluate Reserve Bank activities.  However, the
    combination of the Board's general supervisory responsibilities for
    Reserve Bank operations and the autonomy of the Reserve Banks has
    resulted in oversight that, in some areas, appears fragmented,
    inefficient, or lacking in independence.  For example, GAO found
    issues that were either not adequately covered or were reviewed by
    both the Board's and the Reserve Banks' oversight organizations.
    Furthermore, some Systemwide internal auditing lacked clear
    independence.  The Board's Office of the Inspector General, while
    independent, is not authorized to directly audit Reserve Bank
    operations.  However, the Federal Reserve has recently decided to
    contract out for independent audits of its combined financial
    statements for the years 1995 through 1999.  GAO commends this
    approach and urges that it be permanently instituted.

    A major effort to review the Federal Reserve's operations could
    present it with profound challenges in planning and confronting
    possible changes.  The essential missions as well as the locations of
    the Reserve Banks are set by law, and the autonomy of the Reserve
    Banks generally necessitates a consensus-oriented decisionmaking in
    systemwide planning.  However, despite its unique structure, the
    Federal Reserve has begun to show that it can address operational
    issues strategically and work in a systemwide manner when necessary.
    This is evidenced by the recent establishment of a new Financial
    Services Committee to examine priced services and the consolidation
    of its data-processing facilities.  As the Federal Reserve enters the
    next century, it is vital that both the Board and the Reserve Banks
    continue to foster a systemwide focus so that the Federal Reserve can
    fulfill its mission in an efficient and effective manner.

       RECOMMENDATIONS AND MATTERS FOR
       CONSIDERATION
    ---------------------------------------------------------- Chapter 0:5

    In analyzing opportunities to reduce the cost of Federal Reserve
    operations to the taxpayer, any potential adverse impact on the
    independence of monetary policy or on the Federal Reserve's ability
    to meet its key responsibilities should be considered carefully.
    However, GAO sees no inherent conflict between the Federal Reserve's
    independence or effectiveness and efforts to improve efficiency.
    Many of the functions performed by the Federal Reserve have little
    direct relation to monetary policy, and the Board, working with the
    Reserve Banks, has the authority and ability to take many cost-saving
    actions without jeopardizing the System's mission effectiveness.
    However, any decision to close Reserve Banks or establish a separate
    corporation for priced services would require congressional approval.
    Thus, GAO makes recommendations to the Board and suggests several
    matters for congressional consideration.

          RECOMMENDATIONS TO THE BOARD
          OF GOVERNORS
    -------------------------------------------------------- Chapter 0:5.1

    GAO recommends that the Board undertake a fundamental review of
    Federal Reserve operations focusing on the primary mission, business
    lines, and structure that would best support its overall mandate.
    Such an organizational review should include an assessment of

      -- the Federal Reserve's role in providing financial services to
         banks and government agencies and an analysis of the costs and
         benefits to the System and the taxpayers of various options for
         delivering such services (such options could include:
         discontinuing delivery of certain priced services to financial
         institutions; privatizing the delivery of other services by
         establishing a private corporation for delivering such services;
         or retaining responsibility for being the primary service
         provider);

      -- cost-saving opportunities that could result from streamlining
         its existing management structures and consolidating Federal
         Reserve operations, including possible mergers among the 12
         Reserve Banks and 25 branches; and

      -- the potential for technology to support streamlined work
         processes in the Reserve Banks and reduce costs and improve
         quality.

    In addition, GAO recommends that the Board

      -- strengthen its existing control and oversight mechanisms by,
         among other things, (1) reviewing the appropriateness of current
         budget assumptions that assume steady annual growth; (2) taking
         steps to better ensure the independence of the Federal Reserve's
         internal audit function and to expand the scope of its Inspector
         General's authority; and (3) ensuring that an independent
         financial audit of the Reserve Banks' combined financial
         statements is conducted every year;

      -- review benefit levels at the Board and the Reserve Banks to
         determine if these levels can continue to be justified,
         considering today's environment of increased governmental and
         private-sector cost containment and the composition of the
         Federal Reserve's workforce;

      -- assess whether there is any compelling need for the surplus
         account and whether the size of the account can be safely
         reduced; and

      -- reconsider its policy not to charge for bank examinations.

    GAO is also making additional recommendations concerning the Federal
    Reserve's policies on travel, contracting, procurement, and other
    operational matters.

          MATTERS FOR CONGRESSIONAL
          CONSIDERATION
    -------------------------------------------------------- Chapter 0:5.2

    Congress should consider the results of the Federal Reserve's
    assessments and determine

      -- whether it would be desirable to merge or close any of the 12
         Reserve Banks or 25 branches;

      -- whether there is a continued need for the Federal Reserve's
         surplus account and, if so, what the appropriate amount of the
         account should be; and

      -- which of the various options for delivering priced services to
         financial institutions are in the best interests of public
         policy and represent the best balance between achieving cost
         savings and serving the nation's financial interests.

    Congress should also consider

      -- requiring an annual independent audit of the Reserve Banks'
         combined financial statements;

      -- requiring the Federal Reserve to charge for bank examinations;
         and

      -- establishing a statutory requirement that the Federal Reserve
         annually return its remaining revenues to the Treasury.

       FEDERAL RESERVE'S COMMENTS AND
       GAO'S EVALUATION
    ---------------------------------------------------------- Chapter 0:6

    GAO requested comments on a draft of this report from the Federal
    Reserve Board of Governors.  GAO's responses to the Board's comments
    on the specific recommendations contained in this report appear at
    the end of the chapters where those recommendations are made.
    Additional responses are contained in appendix V.  In addition, the
    staff of the Board of Governors provided technical comments that were
    incorporated in this report as appropriate.

    The Board took exception to what it termed the broad implication of
    the draft report that the Federal Reserve has not exercised
    appropriate budget constraint and has not adequately addressed the
    changing technological and financial environment within which it
    operates.  The Board stated its belief that the Federal Reserve had
    exercised diligence in managing the cost of the System, and the
    System was as cost effective as the most efficient public and private
    sector institutions.  As evidence of its cost control, the Board
    noted that, despite an increase in its supervisory responsibilities
    and a costly computer upgrade, its cost growth over the period of
    1988 to 1994 was somewhat less than the increase in federal
    nondefense discretionary expenditures that occurred over the same
    years.  This was one of the three standards of comparison that GAO
    used in this report.  The Board also stated that the Federal
    Reserve's revenues from the provision of financial services to
    depository institutions consistently exceeded its direct and indirect
    costs, and thus earned money for the Treasury.

    The Board recognized that the Federal Reserve could be made more
    efficient and effective, and stated that it would evaluate and
    implement some of GAO's specific cost-saving recommendations where
    appropriate.  However, the Board noted that while some activities
    appear to be more cost effective if consolidated, deciding on the
    appropriate degree of consolidation was a difficult issue.
    Specifically, the Board agreed with GAO's recommendations to review
    the Federal Reserve's policies and practices regarding travel,
    contracting, and procurement, and agreed to consider managing health
    care benefits on a systemwide basis.  The Board did not agree with
    GAO that it has significant opportunities to reduce its costs in such
    areas as personnel compensation and its management of large-scale
    building projects.

    The Board also did not agree with most of GAO's broader
    recommendations, including the recommendations to assess whether
    cost-saving opportunities exist in streamlining its current
    management structure and consolidating Federal Reserve operations; to
    take steps to strengthen existing oversight and control mechanisms
    and improve its budgetary processes; to assess the costs and benefits
    of various options for providing financial services; and to
    reconsider its policy not to charge for bank examinations.  With
    regard to the surplus account, the Board agreed that the appropriate
    level of the surplus is open to debate, but did not agree to consider
    reducing or eliminating the surplus, arguing in part that such a
    transfer would have no economic impact.

    The Board believed that the Federal Reserve adequately planned for
    future significant changes affecting financial services and bank
    supervision.  With regard to opportunities for streamlining
    operations, the Board stated that savings were most likely in the
    consolidation of electronic financial services, and that paper-based
    services offered only modest potential savings.  Concerning
    consolidation of Reserve Banks and branches, the Board noted that
    their locations would likely be different if established today, but
    stated that relocations or realignments would have to result in
    substantial long-term savings to offset high transition costs.

    GAO continues to believe that the Federal Reserve has significant
    opportunities to reduce its costs, that the major technological and
    marketplace developments discussed in this report are likely to have
    profound implications for the System's activities, and that the
    Federal Reserve could benefit from a major Systemwide review of its
    operations and structure.  GAO agrees that such an undertaking would
    be difficult, but believes that a broad rethinking of the Federal
    Reserve's mission, structure, lines of business, and its strategic
    management processes is needed for the Federal Reserve to be as
    efficient and effective as it can be in fulfilling its critical role
    as our nation's central bank.  GAO believes that without such a
    systemwide review, the Federal Reserve will be increasingly less
    competitive with private sector suppliers of financial services and
    less cost effective in its overall operations.

    GAO commends the Federal Reserve for taking actions to consolidate
    some of its operations, such as its mainframe computer operations and
    its savings bond program, and to consider other potential cost-saving
    opportunities, such as managing health care benefits on a systemwide
    basis.  However, GAO notes that these efforts fall far short of the
    broad rethinking GAO believes is needed and are unlikely to yield the
    truly significant savings that could result from such an effort.  In
    particular, while GAO agrees that realigning and consolidating
    facilities would involve short-term transition costs, GAO believes
    that such costs could be outweighed by long-term savings from having
    a more rational and efficient structure.

    INTRODUCTION
    ============================================================ Chapter 1

    The Federal Reserve System (Federal Reserve or System), our nation's
    central bank, is unique among governmental entities in many respects,
    particularly in its finances.  Unlike many government agencies whose
    operations are funded through the Congressional appropriations
    process, the Federal Reserve deducts operations and other expenses
    from its revenues and transfers the remaining amount to the U.S.
    Department of the Treasury (Treasury).  Although the primary mission
    of the Federal Reserve is to support a stable economy, not to make a
    profit or maximize its transfer to Treasury, System revenues
    contribute to total U.S.  revenues; thus, deductions from System
    revenues represent a cost to U.S.  taxpayers.  In today's constrained
    budget environment, Congress seeks to be well informed on all
    activities that affect the government's finances.  For this reason,
    Members of Congress have requested our assistance in providing
    information about the revenues and costs of the Federal Reserve,
    factors that could affect Federal Reserve finances, and about the
    mechanisms used to control costs and conduct strategic planning.

       THE FEDERAL RESERVE'S UNIQUE
       STRUCTURE REFLECTS EFFORTS TO
       BALANCE DIFFERING INTERESTS
    ---------------------------------------------------------- Chapter 1:1

    The Federal Reserve was created by the Federal Reserve Act of 1913
    ".  .  .  to provide for the establishment of Federal reserve banks,
    to furnish an elastic currency, to afford means of rediscounting
    commercial paper, to establish a more effective supervision of
    banking in the United States, and for other purposes."

    The Federal Reserve's basic structure includes a federal agency in
    Washington, D.C.--the Board of Governors of the Federal Reserve
    System (Board), whose seven members are appointed by the president
    and confirmed by the Senate.\1 Figure 1.1 shows the organizational
    structure of the Board.  The structure also includes 12 federally
    chartered corporations, located in various regions of the country
    (Federal Reserve districts), known as Federal Reserve Banks (Reserve
    Banks).  Figure 1.2 shows the boundaries of the Federal Reserve
    districts.

    The Federal Reserve is unusual in many respects compared to other
    entities established to carry out public purposes.  It is a federal
    system that is part public and part private; although the Board is a
    government agency, the Reserve Banks are not.  Also, the Federal
    Reserve does not follow the familiar federal structure of a
    "top-down" hierarchy, with all policymaking powers centralized in
    Washington, D.C.  Instead, the Board and the Reserve Banks have
    shared responsibilities and policymaking authority in many areas of
    operation.

       Figure 1.1:  Organizational
       Chart of the Federal Reserve
       Board

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

    Note 1:  The Federal Reserve officially identifies districts by
    number and by Reserve Bank city.

    Note 2:  In District 12, the Seattle Branch serves Alaska, and the
    San Francisco Bank serves Hawaii.

    Source:  Federal Reserve System.

       Figure 1.2:  Map of the Federal
       Reserve Districts

       (See figure in printed
       edition.)

       Source:  Federal Reserve Board.

       (See figure in printed
       edition.)

    --------------------
    \1 Each of the seven Governors is appointed to serve all or the
    expired portion of staggered 14-year terms.  No 2 members can be from
    the same region of the country, as defined by the boundaries of the
    12 Federal Reserve districts.

          THE FEDERAL RESERVE IS PART
          PUBLIC, PART PRIVATE
    -------------------------------------------------------- Chapter 1:1.1

    The Federal Reserve's part-public, part-private composition evolved
    from efforts to ensure our central bank's balanced consideration of
    public and private interests at national and regional levels.  A
    related feature is the Federal Reserve's structural independence from
    political influence and direct taxpayer support.  The Federal
    Reserve's budget is not subject to the approval of Congress or the
    administration, and the central bank receives no government
    appropriations.  The Reserve Banks are structured as self-supporting
    corporations, and the Board is financed by a levy on the Reserve
    Banks.

    The Reserve Banks are federally chartered corporations wholly owned
    by private-sector commercial banks (which, as members of the Federal
    Reserve, are known as member banks.)\2 In terms of assets and
    personnel, most of the Federal Reserve is in the Reserve Banks:
    virtually all of the Federal Reserve's assets, liabilities, revenues,
    and expenses are carried on the books of the Reserve Banks, and 94
    percent of the over 25,000 employees of the Federal Reserve are
    employed by the Reserve Banks.  As of December 31, 1994, the assets
    of the Reserve Banks were $437.0 billion, and their liabilities and
    equity were $429.5 and $7.4 billion, respectively.

    Although the Reserve Banks are privately owned corporations, they
    differ from most such entities in important ways.  The ownership of
    all stock of the Reserve Banks confers on member banks only some of
    the typical attributes of control and financial interest.  For
    example, member banks receive dividends on Federal Reserve stock, but
    these dividends are set by law at 6 percent of paid-in capital.
    Member banks may not sell the stock or pledge the stock as collateral
    for loans.  Also, member banks elect six directors of the Reserve
    Banks' boards of directors; the Board appoints three directors and
    designates one of these as chairman and another as deputy chairman of
    the board.\3 Finally, the Reserve Banks have been considered
    instrumentalities of the federal government in at least one
    context.\4

    --------------------
    \2 At year-end 1994, the member banks of the Federal Reserve numbered
    4,115.  These banks accounted for about 80 percent of the assets of
    the U.S.  banking system.

    \3 Member banks in each district elect three Class A directors, who
    represent member banks, and three Class B directors, who represent
    the public.  The Board appoints three Class C directors who also
    represent the public.  Each of the 25 branch offices of the Reserve
    Banks also has its own board of directors.

    \4 For example, in Brink's, Inc.  v.  Board of Governors of the
    Federal Reserve System, 466 F.  Supp.  116 (D.  D.C.  1979), the
    Federal District Court held that certain "governmental" functions
    exercised by the Federal Reserve Bank of Richmond rendered the
    Reserve Bank a government entity for purposes of the Service Contract
    Act, 41 U.S.C.  section 351 et seq.

          THE BOARD AND THE RESERVE
          BANKS SHARE RESPONSIBILITIES
          AND DECISIONMAKING
    -------------------------------------------------------- Chapter 1:1.2

    Although the Federal Reserve must report to Congress annually on its
    operations, decisions of System policymakers generally are not
    subject to ratification by the president or any presidential
    appointees in the executive branch or by Congress.  The Federal
    Reserve Act not only gives the board of directors at each of the
    Reserve Banks powers of supervision and control over the Reserve
    Bank, but it also grants the Board of Governors the power to exercise
    general supervision over the Reserve Banks.  For example, the board
    of directors at each Reserve Bank appoint and determine the
    compensation of the top official of each Reserve Bank; however, the
    Board of Governors is authorized to approve or disapprove these
    decisions.  The Federal Reserve Act does not specifically define the
    general supervisory responsibilities of the Board of Governors.

          THE FEDERAL RESERVE USES A
          CONFERENCE SYSTEM TO
          COORDINATE DECISIONMAKING
    -------------------------------------------------------- Chapter 1:1.3

    To help systemwide planning and decisionmaking in a system of shared
    responsibilities, the Board and the Reserve Banks participate in
    systemwide conferences.  In 1994, the conference structure consisted
    of three major conferences:\5 the Conference of Presidents (COP), the
    Conference of First Vice Presidents (COFVP), and the Conference of
    General Auditors, as described in table 1.1.  Each of these
    conferences is supported by committees, subcommittees, and task
    forces, involving many Federal Reserve officials and staff.

                                        Table 1.1

                         Three Conferences of the Federal Reserve
                                        as of 1994

    Conference          Members             Purpose
    ------------------  ------------------  ----------------------------------------
    Conference of       Presidents of the   The Conference is to consider managerial
    Presidents          Reserve Banks       matters of common interest to Reserve
                                            Banks and consult with and advise the
                                            Board on these matters. These managerial
                                            matters include discounts and audits,
                                            management systems and budgets,
                                            strategic planning, personnel,
                                            legislation and regulations,
                                            supervision, and research.

    Conference of       First vice          The Conference is to consider and
    First Vice          presidents of the   coordinate Reserve Bank operations.
    Presidents          Reserve Banks

    Conference of       General auditors    The Conference is to enable general
    General             of the Reserve      auditors to discuss matters of mutual
    Auditors            Banks               concern and to adopt uniform policies
                                            and solutions to problems.
    --------------------------------------------------------------------------------
    Source:  Federal Reserve Board.

    In 1995, a new management structure for financial services took over
    many of the duties of the COFVP that were related to priced services.
    The new committee was established to streamline the Federal Reserve's
    decisionmaking process and to make the Reserve Bank first vice
    presidents more accountable for strategic planning of major business
    lines throughout the entire System.  This new structure and details
    on the Federal Reserve's decisionmaking authority are discussed
    further in chapter 5.

    --------------------
    \5 The conference structure also includes the Conference of Chairmen,
    which is composed of the chairman of each Reserve Bank.  However,
    according to a Board official, the powers of this conference are
    limited.

       THE MISSION OF THE FEDERAL
       RESERVE
    ---------------------------------------------------------- Chapter 1:2

    Many, but not all, of the responsibilities of the Federal Reserve are
    shared by the Board and the Reserve Banks.  This is perhaps best
    explained in the context of a discussion of the basic mission of the
    Federal Reserve.

    The mission of the Federal Reserve today, which is critical to the
    nation's economy, can be generally described in terms of four major
    functions or responsibilities:  conducting monetary policy;
    maintaining the stability of the financial system and containing
    systemic risk that may arise in financial markets; providing services
    to financial institutions and other governmental agencies; and
    supervising and regulating banks and bank-holding companies.  Table
    1.2 briefly describes the basic responsibilities of the Federal
    Reserve and explains how these responsibilities are shared by
    components of the System.

                                        Table 1.2

                         The Basic Mission of the Federal Reserve
                            System by Major Lines of Business

                                                            How responsibilities are
    Responsibility                Explanation               carried out
    ----------------------------  ------------------------  ------------------------
    Conduct monetary              The Federal Reserve       The Federal Reserve's
    policy                        influences the money      Federal Open Market
                                  supply and credit         Committee (FOMC) makes
                                  conditions in the         monetary policy. Voting
                                  economy in pursuit of     members are the seven
                                  full employment and       Board members and five
                                  stable prices. For        Reserve Bank presidents,
                                  example, the System       including the president
                                  affects the money supply  of the Reserve Bank of
                                  by buying and selling     New York, a permanent
                                  U.S. securities in the    member of the committee.
                                  open-market (known as     Other Reserve Bank
                                  open-market operations).  presidents are voting
                                  The Federal Reserve also  members on a rotating
                                  buys and sells foreign    basis. All Reserve Bank
                                  currencies and            presidents participate
                                  securities to affect the  in FOMC meetings. Staff
                                  dollar's exchange rate    support is provided by
                                  and help stabilize        Board and Reserve Bank
                                  financial markets         employees.
                                  internationally.

    Maintain stability of         The Federal Reserve       FOMC carries this out
    financial markets             increases the liquidity   through open-market
                                  of markets by             operations.
                                  temporarily supplying
                                  extra reserves to the     Discount window
                                  banking system through    operations are carried
                                  open-market operations.   out by each of the
                                                            Reserve Banks in
                                  The Federal Reserve       accordance with policies
                                  lends to financial        approved by the Board.
                                  entities through
                                  discount window
                                  operations. To stabilize
                                  markets, the Federal
                                  Reserve can lend
                                  reserves directly to
                                  certain entities in
                                  financial difficulty by
                                  making discount window
                                  loans.\a

    Provide services to           The Federal Reserve       Each of the Reserve
    financial                     provides "priced          Banks provides check-
    institutions                  services" to financial    clearing and funds
                                  institutions, including   transfers, subject to
                                  check-clearing and        the Board's supervisory
                                  processing and            powers.
                                  electronically
                                  transferring funds        Subject to the Board's
                                  between financial         supervision, each
                                  institutions.             Reserve Bank issues
                                                            Federal Reserve notes
                                  The System also           and coins; verifies
                                  distributes and receives  deposits of financial
                                  Federal Reserve notes     institutions; replaces
                                  (paper money) and coins   and destroys unfit
                                  and holds U.S.            currency; and identifies
                                  securities to back        counterfeit currency.
                                  issued Federal Reserve
                                  notes. The System
                                  ensures that enough
                                  currency and coins are
                                  in circulation to meet
                                  public demand.

    Provide services to           The Federal Reserve       The Reserve Banks
    Treasury and other            issues and redeems        provide various services
    government agencies           government securities     to Treasury and other
                                  and performs other        government agencies
                                  services for Treasury;    subject to the Board's
                                  also, the System          supervision.
                                  provides services to
                                  other government
                                  agencies. For example,
                                  the Federal Reserve
                                  processes food coupons
                                  for the U.S. Department
                                  of Agriculture.

    Supervise and                 The Federal Reserve       The Reserve Banks
    regulate banks and            supervises all U.S.       perform many supervisory
    bank-holding                  bank-holding companies,   duties--such as bank-
    companies                     state-chartered banks     holding company
                                  that are members of the   inspections and bank
                                  Federal Reserve, all      examinations--subject to
                                  Edge Act\b and agreement  the Board's
                                  corporations, the         supervision.
                                  foreign activities of
                                  member banks, and the     The Board is responsible
                                  U.S. operations of        for establishing theses
                                  foreign banks.            standards through
                                                            relations, rules, policy
                                  The System establishes    guidelines, or
                                  standards designed to     supervisory
                                  ensure the safe and       interpretations, which
                                  sound operation of        may be established under
                                  financial institutions.   specific provisions of a
                                                            law or under more
                                                            general legal
                                                            authority.

    --------------------------------------------------------------------------------
    \a Any institution holding deposits subject to reserve requirements
    (such as transaction accounts and nonpersonal time deposits) has
    access to the discount window, subject to technical restrictions
    imposed by the Federal Deposit Insurance Corporation Improvement Act.

    \b Edge Act corporations are corporations chartered by the Federal
    Reserve to engage in international banking.  The Board Of Governors
    acts on applications to establish Edge Act corporations and also
    examines the corporations and their subsidiaries.

       THE FEDERAL RESERVE'S INTERNAL
       BUDGETARY CONTROLS AND
       OVERSIGHT REFLECT THE SYSTEM'S
       STRUCTURE
    ---------------------------------------------------------- Chapter 1:3

    The budgetary controls and oversight structures internal to the
    Federal Reserve reflect the fact that each of the Reserve Banks has
    its own management structure in addition to being supervised by the
    Board.  Concerning budget controls--the primary control over
    spending--the Reserve Banks and the Board have similar, but separate,
    processes, and the Board approves all final budgets.  The Federal
    Reserve's internal oversight structure includes general auditors at
    each of the Reserve Banks and the Office of the Inspector General
    (OIG) at the Board.  The OIG is authorized to audit activities for
    which the Board has primary responsibility.  In addition, some Board
    divisions, such as the Division of Reserve Bank Operations and
    Payment Systems (DRBOPS), Division of Human Resources Management
    (DHRM), and Division of Banking Supervision and Regulation (DBS&R),
    conduct operations reviews using the Board's delegated authority to
    supervise the Reserve Banks.  DRBOPS also conducts financial
    examinations, operational audits, and annual performance evaluations
    of the Reserve Banks.  The budgetary controls and oversight
    structures of the Federal Reserve are discussed further in chapter 5.

    The Reserve Banks use accrual accounting to track expenses.  For this
    reason, the Reserve Banks' operating expenses reflect only the
    depreciation costs of capital acquisitions.  Each major unit of the
    Reserve Banks has an operations budget and a capital asset budget,
    and each is controlled by the same process.

       THE FEDERAL RESERVE FINANCES
       ITS OPERATIONS FROM CURRENT
       REVENUE AND RETURNS REMAINING
       REVENUE TO TREASURY
    ---------------------------------------------------------- Chapter 1:4

    Each year, the Federal Reserve deducts operations and other expenses
    from current revenue and transfers the remaining amount to Treasury.
    For example, in 1994, the Federal Reserve deducted about $3.5 billion
    from the current revenue of about $24 billion and returned about
    $20.5 billion to Treasury.  The amount returned to Treasury has
    varied during the period of 1988 to 1994, as shown in table 1.3.  The
    return of these remaining revenues to Treasury is in accordance with
    a policy established by the Board of Governors, and is not required
    by statute.

                                   Table 1.3

                     The Amount Returned to Treasury by the
                           Federal Reserve, 1988-1994

                             (Dollars in billions)

    Year                                                           Payment
    ----------------------------------------  ----------------------------
    1998                                                             $17.4
    1989                                                              21.6
    1990                                                              23.6
    1991                                                              20.8
    1992                                                              16.8
    1993                                                              16.0
    1994                                                              20.5
    ----------------------------------------------------------------------
    Source:  Federal Reserve System.

    The amount that the Federal Reserve transfers to Treasury each year
    is a function of the amount of System revenues and deductions, which
    are affected by a variety of factors.

       SOURCES OF FEDERAL RESERVE
       REVENUE
    ---------------------------------------------------------- Chapter 1:5

    The Federal Reserve has three major sources of recurring revenue:
    interest on U.S.  securities held primarily to collateralize currency
    (currency-related securities), other interest earned, and fee income.
    Table 1.4 briefly identifies the sources of revenue and briefly
    describes the primary factors that determine the amounts received
    from each source.  As detailed in this table, only in the case of
    priced services and net payments for fiscal agent services can the
    Federal Reserve set fees in response to fluctuations in the costs it
    incurs.

                                        Table 1.4

                          Primary Sources of Current Revenue of
                                   the Federal Reserve

                    Amount in
                    1994 (in
                    thousands)
                    and
                    percentage
    Source of       of total                                Primary influences on
    revenue         revenues      Definition                amount of income
    --------------  ------------  ------------------------  ------------------------
    U.S.            $18.4         Interest paid by          Public demand for
    securities      billion       Treasury and other U.S.   currency and
    held            (87.3%)       agencies on securities    fluctuations in interest
    by Federal                    held by the Federal       rates.
    Reserve to                    Reserve to collateralize
    collateralize                 the currency.
    currency

    Other interest income
    --------------------------------------------------------------------------------
    Noncurrency-    $829.8        Interest paid by          Actions taken to
    related         million       Treasury and other U.S.   implement monetary
    U.S.            (3.9%)        agencies on securities    policy and fluctuations
    securities                    held by the Federal       in interest rates.
                                  Reserve that are not
                                  used to collateralize
                                  the currency.

    Interest on     $894.5        Interest earned on        Fluctuations in the
    foreign         million       account balances          value of the dollar
    securities      (4.2%)        maintained with foreign   exchange rates and
                                  banks. The accounts are   interest rates paid by
                                  used to stabilize         foreign banks.
                                  fluctuations in
                                  international flows and
                                  exchange values of
                                  currencies.

    Interest on     $34.7         Interest paid by          Changing market
    loans           million       financial institutions    conditions and
                    (0.2%)        on loans granted by       fluctuations in interest
                                  Reserve Banks because of  rates.
                                  liquidity needs,
                                  financial trouble, or to
                                  comply with reserve
                                  requirements.

    Fee income
    --------------------------------------------------------------------------------
    Priced          $734.4        Fees financial            Costs Reserve Banks
    services        million       institutions pay for      incur to provide
                    (3.5%)        services such as          institutions these
                                  clearing checks,          services and the
                                  electronic transfers of   competition from private
                                  funds, and safekeeping    sector vendors offering
                                  securities.               similar services.

    Net payments    $176.9        Fees Treasury and other   Costs Reserve Banks
    for             million       government agencies pay   incur to provide
    fiscal agent    (0.8%)        for services needed.      agencies these services.
    services

    ================================================================================
    Total           $21.1         n/a                       n/a
                    billion
    --------------------------------------------------------------------------------
    Legend:  n/a = not applicable.

    Source:  Federal Reserve System.

          REVENUE IS DOMINATED BY
          INTEREST INCOME, PRIMARILY
          INTEREST ON SECURITIES
    -------------------------------------------------------- Chapter 1:5.1

    Most Federal Reserve revenue comes from interest earned on U.S.
    government securities that are held by Reserve Banks and used to
    back, or collateralize, Federal Reserve notes.  The Federal Reserve
    Act introduced Federal Reserve notes--the "paper money" that we use
    today.  Before being issued to the public, Federal Reserve notes must
    be secured by legally authorized collateral--gold certificates,
    special drawing rights (SDR),\6 and U.S.  Treasury and federal agency
    securities purchased through open- market operations.\7 About $381.5
    billion in Federal Reserve notes were in circulation as of December
    31, 1994, and as shown in table 1.4, the assets that collateralized
    those notes accounted for about 87 percent of the Federal Reserve
    assets at that time.  Those assets represented mainly U.S.  Treasury
    and federal agency securities.  Throughout the 1988 to 1994 period,
    interest received on such currency-related securities ranged from 79
    to 87 percent of all System revenues.

    --------------------
    \6 SDRs are created by the International Monetary Fund (IMF), after
    agreement by a majority of the IMF members, to serve as a supplement
    to the international monetary reserves of IMF members.  SDRs are
    allocated to the members in accordance with the size of the members'
    quota, but without any payment.  SDRs received by the U.S.
    government are, by law, held by the Secretary of the Treasury for the
    account of the Exchange Stabilization Fund.

    \7 Almost all of the government securities held by the Federal
    Reserve are Treasury securities purchased in the open market, but the
    Federal Reserve also has purchased some agency securities that
    comprise less than 2 percent of the government securities portfolio.

             OTHER INTEREST INCOME
    ------------------------------------------------------ Chapter 1:5.1.1

    Interest on noncurrency-related U.S.  securities refers to interest
    earned on securities purchased to implement monetary policy.  The
    Federal Reserve influences the economy mainly through a system of
    managed reserves.\8 The Monetary Control Act of 1980 requires all
    depository institutions to hold reserve balances in accounts with the
    Reserve Bank for their Federal Reserve districts or other designated
    institutions or, as permitted by Board regulations, in the form of
    cash in their vaults.  The Federal Reserve sets reserve requirements
    for depository institutions and determines the total of reserves for
    the banking system.  By purchasing securities in the market, the
    Federal Reserve expands reserves when it wants to lower interest
    rates and encourage more credit in the economy.\9 Conversely, by
    selling securities, the Federal Reserve reduces reserves when it
    wants to raise interest rates and restrict the amount of credit.

    The Federal Reserve's control over bank reserves enables it to play a
    major role in protecting the economy against systemic risk--that is,
    excessive disruption from financial market disturbances.  In the
    event of a financial crisis, such as a plunge in stock prices, the
    Federal Reserve may increase the liquidity of markets by temporarily
    supplying extra reserves to the banking system through open-market
    operations.

    Interest on foreign securities was an additional source of revenue.
    In 1994, the Federal Reserve held $20.5 billion in foreign
    securities.  The Federal Reserve also has a reciprocal swap network
    with different central banks, which is not included on the balance
    sheet.\10 The Federal Reserve earns interest on foreign-denominated
    assets, but also faces risks in that it can gain or lose on trades.

    The Federal Reserve earns interest on loans provided to depository
    institutions through its discount window.  Through the discount
    window, commercial banks and other depository institutions may borrow
    reserves from the Federal Reserve.  These institutions are expected
    to draw on all other reasonably available sources of funds before
    coming to the discount window.  The loans are made at a rate of
    interest--the discount rate--set by the Reserve Banks and approved by
    the Board.

    --------------------
    \8 To a lesser extent, the Federal Reserve also influences the amount
    of reserves through adjustments to the discount rate (which affects
    the cost of borrowing) and, on occasion, changes in reserve
    requirement ratios.

    \9 For example, to expand reserves, the Federal Reserve buys
    government securities through its open-market operations, which adds
    to reserves.  When the Federal Reserve purchases securities, it pays
    by issuing a check on itself, in effect.  On receipt of the check,
    the seller's bank presents it to the Federal Reserve for payment.
    The Federal Reserve honors the check by increasing the reserve
    account at the Reserve Bank of the seller's bank.  The reserves of
    the seller's bank rise with no offsetting decline in reserves
    elsewhere; thus, the total volume of reserves increases.  By adding
    to bank reserves, the Federal Reserve can seek to lower interest
    rates and expand the supply of money and credit available in the
    economy.

    \10 The swap network consists of reciprocal short-term arrangements
    (comparable to repurchase and matched sale-purchase agreements in the
    domestic government securities market) among the Federal Reserve,
    other central banks, and the Bank of International Settlements.
    These arrangements, which have been used infrequently in recent
    years, give the Federal Reserve temporary access to the foreign
    currencies it needs for intervention operations to support the dollar
    and give the partner foreign central banks temporary access to
    dollars they need to support their own currencies.

          THE FEDERAL RESERVE IS
          REQUIRED TO SET FEES FOR
          PRICED SERVICES TO RECOVER
          COST OF SERVICES
    -------------------------------------------------------- Chapter 1:5.2

    The Monetary Control Act requires the Federal Reserve to charge
    depository institutions for its services to financial institutions,
    setting fees in such a way that, over the long run, the revenues from
    these services will recover the costs of providing them.  The act
    also requires all depository institutions to meet the Federal
    Reserve's reserve requirements and grants these same institutions
    access to System services at market prices as well as access to
    short-term or discount loans.\11 In addition to the services
    mentioned in table 1.2, the Federal Reserve provides securities
    safekeeping and transfer and noncash collection services.  Services
    to financial institutions and Treasury constitute a large portion of
    the Federal Reserve expenses.

    --------------------
    \11 Before 1980, only banks that were members of the Federal Reserve
    had access to Federal Reserve services and discount loans at
    subsidized prices and interest rates.  Nonmember banks, which had no
    direct access to System services and loans, could receive such
    services only by maintaining correspondent relationships with
    commercial banks that belonged to the System.

       FEDERAL RESERVE EXPENSES AND
       OTHER DEDUCTIONS
    ---------------------------------------------------------- Chapter 1:6

    From current revenues, the Federal Reserve deducts the cost of
    operating the 12 Reserve Banks and the Board and other expenses
    before transferring the remaining revenues to Treasury.  Generally,
    these deductions can be categorized as expenses; other deductions;
    and losses, gains, and other adjustments.  Table 1.5 briefly
    describes these deductions.  For purposes of this report, operating
    expenses of the Federal Reserve include the cost of operating the
    Reserve Banks and the Board.

                                        Table 1.5

                           Deductions the Federal Reserve Makes
                                      From Revenues

                                     1994 Amount
    Deduction                      (000 omitted)  Definition
    ----------------------------  --------------  ----------------------------------
    Operating expenses
    --------------------------------------------------------------------------------
    Operating expenses of            -$1,858,319  Under limits set by the Board,
     Reserve Banks                                 operating expenses for Reserve
                                                   Banks' personnel, materials and
                                                   supplies, equipment/software,
                                                   shipping, travel, communications,
                                                   and building depreciation.
    Assessments for Board               -146,866  Expenses of the Board of Governors
     expenditures                                  are financed through an
                                                   assessment levied on the Reserve
                                                   Banks.
    ================================================================================
    Total                             -2,005,185  n/a

    Other deductions
    --------------------------------------------------------------------------------
    Interest on required                -223,623  The Federal Reserve pays interest
     clearing balances                             on the clearing balances that
                                                   financial institutions maintain
                                                   at Reserve Banks to protect
                                                   against settlement risk. The
                                                   Federal Reserve pays interest in
                                                   the form of credits that
                                                   financial institutions may use to
                                                   defray check-clearing and other
                                                   costs.
    Purchase of currency from           -368,187  In response to public demand for
     Treasury                                      currency and the need to replace
                                                   unfit currency, the Federal
                                                   Reserve pays Treasury for
                                                   printing Federal Reserve notes.
    Transfer to surplus                 -282,122  At the discretion of the Board,
                                                   the Reserve Banks retain from
                                                   their net earnings amounts that
                                                   would adjust their surplus
                                                   account to equal their Paid-in
                                                   Capital Account.
    Dividends to stockholders           -212,090  As established by statute, the
                                                   Federal Reserve pays an annual
                                                   dividend of 6 percent to member
                                                   banks that own Federal Reserve
                                                   stock. The amount of dividends
                                                   paid automatically increases when
                                                   member banks' equity increases.
    ================================================================================
    Total                            -$1,086,022  n/a
    --------------------------------------------------------------------------------
    Legend:  n/a = not applicable

    Note:  Deductions from revenues are shown as negative numbers.

    Source:  Federal Reserve System.

          ADJUSTMENTS TO CURRENT
          REVENUE MAY INCREASE OR
          DECREASE TOTAL CURRENT
          REVENUE
    -------------------------------------------------------- Chapter 1:6.1

    As shown in table 1.6, the Federal Reserve makes other adjustments to
    current revenue.

                                        Table 1.6

                            Losses, Gains, and Adjustments to
                            Federal Reserve Revenue as of 1994

    Losses, gains, and other         1994 amount
    adjustments                    (000 omitted)  Definition
    ----------------------------  --------------  ----------------------------------
    Sales of U.S. Treasury and          -$24,286  As the result of actions taken to
     agency securities                             implement monetary policy,
                                                   respond to public demand for
                                                   currency, and fluctuations in
                                                   interest rates, the net profit
                                                   (or loss) resulting from FOMC
                                                   trading of U.S. government
                                                   securities.
    Sales or changes in value of      +2,422,626  As the result of actions taken to
     foreign exchange or assets                    stabilize U.S. and foreign
     denominated in foreign                        currencies, the net profit (or
     currency                                      loss) resulting from the trading
                                                   or holding of assets denominated
                                                   in foreign currencies, as
                                                   authorized by FOMC. Trading gains
                                                   or losses occur when assets
                                                   denominated in foreign currencies
                                                   are sold. Reserve Banks also
                                                   record translation gains or
                                                   losses when fluctuations in
                                                   exchange rates change the value
                                                   of assets denominated in foreign
                                                   currencies.
    Adjustment to revenue for            +75,246  In response to changes in
     accounting rule changes and                   accounting principles or other
     other items                                   items, additions and subtractions
                                                   to current revenue.
    ================================================================================
    Total                            +$2,473,586  n/a
    --------------------------------------------------------------------------------
    Legend:

    FOMC = Federal Open Market Committee
    n/a = not applicable

    Note:  Deductions from revenues are shown as negative numbers.  In a
    few cases, adjustments may either be deductions from or additions to
    revenues, depending on Federal Reserve actions and market conditions
    during the year.  These items are shown as negative or positive
    numbers, as appropriate.

    Source:  Federal Reserve System.

    For example, gains and losses resulting from sales of U.S.  Treasury
    and agency securities or changes in value of foreign exchange or
    assets denominated in foreign currencies are accounted for in
    adjustments to current revenue.  Other gains or losses, such as those
    realized as the result of changes to accounting rules, are also
    accounted for in this way.  In 1993, the Federal Reserve experienced
    a significant one-time deduction to revenues, primarily the result of
    the initial accrual of postretirement employee benefits required by a
    change in accounting rules.\12 In recent years, adjustments have been
    volatile because of gains or losses on assets denominated in foreign
    currencies, both from actual transactions and from revaluation to
    dollars of assets held in portfolio.

    --------------------
    \12 This change was the adoption of the Statement of Financial
    Accounting Standards No.  106, "Employers' Accounting for
    Postretirement Benefits Other Than Pensions."

       OBJECTIVES, SCOPE, AND
       METHODOLOGY
    ---------------------------------------------------------- Chapter 1:7

    Our objectives were to (1) analyze trends in the cost of Federal
    Reserve operations during 1988 to 1994 and the System's management
    processes for controlling spending and overseeing operations, (2)
    identify opportunities to increase the System's efficiency without
    adversely affecting its effectiveness, (3) identify ongoing and
    future developments that could significantly affect the Federal
    Reserve's mission and finances, and (4) assess the System's strategic
    management processes and identify actions the Federal Reserve could
    take to successfully meet future challenges and ensure the efficiency
    and effectiveness of its operations.

    To analyze trends in the Federal Reserve's spending during 1988 to
    1994, we developed a 7-year trend analysis on the expenses of the
    Federal Reserve.  In addition, we examined the Reserve Banks' and the
    Board's cost-accounting systems to identify trends in the Federal
    Reserve's operating expenses by mission-related activity (such as
    services to financial institutions and Treasury) and types of expense
    (such as salaries, benefits, and travel).  However, we did not audit
    these numbers and did not verify their accuracy.  We reviewed a
    variety of financial-accounting, cost- accounting, staffing, and
    budgetary reports prepared by the Board and the individual Reserve
    Banks.  To analyze the Federal Reserve's spending trends, we compared
    the System's levels of spending to inflation and levels of
    discretionary spending of the federal government during the same
    period.  Due to the limitations of our audit authority, we did not
    analyze direct costs relating to the buying, selling, and holding of
    securities and foreign currency or other valuables in connection with
    the implementation of monetary policy.

    To identify opportunities that exist to increase the System's
    efficiency without adversely affecting its effectiveness, we
    concentrated our work on personnel compensation, travel, and
    procurement and contracting.  More specifically, we

      -- reviewed Board and Reserve Bank personnel compensation data and
         policies, travel policies, and samples of travel vouchers;

      -- compared personnel compensation policies and regulations to
         those of selected federal agencies;

      -- developed and mailed a standardized data collection instrument,
         or questionnaire, to obtain pay and benefits information from
         the human resource officers at the eight Reserve Banks where we
         did not do detailed audit work in these areas;\13

      -- contacted questionnaire respondents by telephone to further
         clarify questionnaire responses;\14

      -- did an in-depth review of the procurement process at the San
         Francisco Reserve Bank, focusing on items with a cost of more
         than $25,000; and

      -- interviewed officials at three Reserve Banks who were
         responsible for procurement, reviewed procurement guidance,
         traced purchases through the payment process, and reviewed
         selected contracts.

    To identify ongoing and future developments that could significantly
    affect the Federal Reserve's mission and finances, we

      -- analyzed studies, data, and other information and interviewed
         knowledgeable officials of the Federal Reserve on issues related
         to check clearing, currency processing, and bank supervision and

      -- interviewed officials and analyzed supporting documentation from
         the Federal Reserve Bank of Kansas City to determine how the
         automation consolidation project, the Federal Reserve Automation
         Services (FRAS), had affected its check-clearing priced service.

    To assess the System's strategic management processes and identify
    actions the Federal Reserve could take to successfully meet these
    challenges and ensure the efficiency and effectiveness of its
    operations in the future, we

      -- reviewed and analyzed current and potential future trends in the
         workload of, and the cost of operating, the System's major
         services and lines of business;

      -- reviewed Federal Reserve planning documents and interviewed
         System officials about planning and management processes;

      -- reviewed the Federal Reserve's budgeting process, including the
         various budget proposals made throughout the budgeting cycle at
         the Board and the Reserve Banks (Chicago, Dallas, New York, and
         San Francisco) for the years 1988 through 1993;

      -- compared each of the Banks' budget proposal within a cycle to
         the previous proposal to determine whether the process promoted
         reduction in the size of the budget proposals;

      -- compared the Federal Reserve's actual expenses to the operating
         budgets and actual expenditures to capital budgets for the years
         reviewed to determine whether the System operated within its
         approved spending limits;

      -- obtained an understanding of the controls on major capital
         acquisitions by reviewing the process the Reserve Bank of Dallas
         used to obtain approval from the Board to construct its new bank
         building and compared the results of the process to the
         initially approved plans;

      -- conducted interviews focused on oversight with officials from
         the Board's OIG and DRBOPS;

      -- reviewed a number of OIG reports and analyzed the Federal
         Reserve Act and the Inspector General Act of 1978 and its
         subsequent amendments;

      -- interviewed Board officials who managed the Financial
         Examination Program and the Annual Performance Evaluation;
         DRBOPS managers who oversee the operating areas at the Reserve
         Banks; and the general auditors of the Reserve Banks at Chicago,
         Dallas, New York, San Francisco, and Richmond;

      -- reviewed the 1989 to 1993 financial examination reports and the
         1989 to 1993 annual performance evaluation reports for the
         Reserve Banks of Chicago, Dallas, New York, and San Francisco;
         and

      -- reviewed the operations review reports conducted by DRBOPS,
         DHRM, and DBS&R.

    We did our work in accordance with generally accepted government
    auditing standards at the Board of Governors in Washington, D.C., and
    at the Federal Reserve Banks in Chicago; Dallas; Kansas City, MO; New
    York; Richmond; and San Francisco from January 1994 through September
    1995.  We obtained written comments on a draft of this report from
    the Federal Reserve Board of Governors.  The comments are discussed
    at the ends of chapters 3 and 5 and reprinted in appendix V.  Staff
    of the Federal Reserve Board provided additional technical comments
    on the draft report, which were incorporated as appropriate.

    --------------------
    \13 We obtained data and information for the Reserve Banks only.  In
    some cases, the 25 branch banks may have had different benefits, such
    as different cafeteria or mass transit subsidies.

    \14 The questionnaires and interviews were completed in June and July
    1994, and the information collected was for the calendar year 1993.
    In some cases we asked for cost estimates for various benefits.
    Where we were able to update these cost figures using the System's
    cost-accounting information for calendar year 1994, we did so.

    THE FEDERAL RESERVE HAS BECOME
    INCREASINGLY EXPENSIVE TO OPERATE
    ============================================================ Chapter 2

    In the 7-year period from 1988 to 1994, as many commercial banks
    restructured to reduce operating costs and increase revenues and
    Congress and the Executive Branch acted to constrain discretionary
    federal spending,\1 the cost to operate the Federal Reserve has
    increased steadily and substantially--from $1.36 billion in 1988 to
    $2.00 billion in 1994, or 48 percent.  This percentage increase
    exceeded the 25-percent inflation that occurred during the same
    period, was also greater than the 17- percent increase in overall
    federal discretionary spending, and was almost the same as the
    51-percent increase in federal nondefense spending.  The growth in
    Federal Reserve expenses was caused by significant increases that
    occurred in expenses for bank supervision and regulation, personnel
    compensation, and extensive automation modernization and
    consolidation.

    --------------------
    \1 Discretionary spending is that spending controlled through the
    appropriations process.  It excludes interest on the national debt
    and entitlement programs.  Examples of entitlement programs are
    Social Security, Food Stamps, and Medicaid.

       IN RECENT YEARS, CONGRESS HAS
       ACTED TO CONTROL SPENDING AND
       BANKS HAVE SOUGHT TO INCREASE
       EFFICIENCY
    ---------------------------------------------------------- Chapter 2:1

    Since the early 1980s, federal budgeting has been dominated by
    concern about the budget deficit.  In the mid-1980s, the deficit was
    greater than $200 billion; in the early 1990s, the deficit approached
    $300 billion.  By 1985, the high deficit prompted the enactment of
    the Gramm-Rudman-Hollings Act (GRH), which established deficit
    targets for each year through fiscal year 1991, when the budget was
    to be balanced.  GRH was amended in 1987.  In 1990, Congress revised
    the GRH process with the Budget Enforcement Act of 1990 (BEA).
    Rather than focusing on fixed deficit targets, BEA was designed to
    limit legislative actions by limiting appropriations and restricting
    the creation or expansion of any entitlement program or tax cut.

    BEA categorizes all federal spending as either discretionary (funded
    through annual appropriation acts) or direct (entitlements or
    spending that results from laws other than appropriation acts).  BEA
    set discretionary spending limits--called caps--to control the
    aggregate amount that can be appropriated and expended for all
    discretionary programs in a fiscal year.  Thus, all discretionary
    programs compete with each other within the caps.  Direct spending
    programs are controlled by BEA's pay-as-you-go (PAYGO) rules.  The
    main PAYGO requirement is that legislation enacted during a session
    of Congress which increases direct spending or decreases revenues,
    must be offset by revenue increases or a cut in another direct
    spending program.  If the legislative action increases the deficit
    for a fiscal year, a sequestration from certain direct spending
    accounts occurs.

    In addition to these budgetary control mechanisms, the administration
    and Congress are attempting to make the federal government smaller
    and more cost efficient by reforming or "reinventing" its agencies
    and work processes.  For example, the National Performance Review
    (NPR), under the direction of the Vice President, is an
    administration initiative that seeks to propose recommendations on
    how the federal government could work better and cost less.

    Throughout the 1980s and into the 1990s, many U.S.  banks also made
    strategic decisions to restructure their activities, cut operating
    costs, and generally develop more efficient operations.  The U.S.
    banking system underwent this transition in response to intense
    domestic and international competition, technological and financial
    innovations, and changing market conditions.\2

    For several reasons, the Federal Reserve is not subject to the same
    cost-reduction pressures that are affecting both public agencies and
    private sector firms.  The Federal Reserve, for example, is not
    subject to BEA, primarily because it operates without congressional
    appropriations and funds its operations and pays other expenses from
    the current revenue of the Reserve Banks.  Also, unlike private
    firms, the Federal Reserve does not have a profit incentive to lower
    costs and increase efficiency.

    --------------------
    \2 Throughout the 1980s and into the 1990s, many U.S.  banks faced
    serious asset quality problems resulting from problem loans to
    developing countries, excessive commercial real estate lending, and
    an economic recession and other factors.

       THE INCREASE IN THE COST OF THE
       FEDERAL RESERVE OUTPACED
       INFLATION AND TOTAL FEDERAL
       DISCRETIONARY SPENDING
    ---------------------------------------------------------- Chapter 2:2

    From 1988 to 1994, as shown in figure 2.1, Federal Reserve operating
    expenses increased from $1.36 billion to $2.00 billion.  This was an
    increase of about twice the amount of inflation and about 3 times the
    increase in overall federal discretionary spending that occurred in
    that period.  During this same period, Federal Reserve operating
    expenses increased at about the same rate as the percentage increase
    for nondefense federal discretionary spending.

       Figure 2.1:  Cumulative
       Increases in Federal Reserve
       Operating Expenses, 1988-1994

       (See figure in printed
       edition.)

    Sources:  Federal Reserve Board and the budget of the United States.

          THE FEDERAL RESERVE
          ALLOCATES ITS OPERATING
          BUDGET TO MISSION-RELATED
          AREAS AND EXPENSE CATEGORIES
    -------------------------------------------------------- Chapter 2:2.1

    The Federal Reserve uses cost-accounting systems that allocate
    operating budget expenditures to both mission-related categories and
    expense categories.  For budgeting purposes and accounting,
    expenditures of the Federal Reserve are accounted for in five major
    mission-related areas of the System:  monetary policy, supervision
    and regulation, services to financial institutions and the public,
    services to Treasury and other government agencies, and System policy
    and oversight.  Costs of support and overhead, including Board
    expenditures for System policy direction and oversight, are allocated
    to each Federal Reserve mission activity.\3 The costs are distributed
    to the Federal Reserve mission activities in accordance with
    predetermined ratios derived by estimated usage.  The Federal Reserve
    also categorizes operating expenses by expense categories.  These
    categories include personnel compensation, equipment and software,
    buildings, travel, shipping, materials and supplies, and
    communication.

    --------------------
    \3 Support and overhead costs include, among other things, data
    communication and data-processing expenses, and legal and accounting
    expenses.

       SUPERVISION AND REGULATION AREA
       EXPERIENCED THE HIGHEST GROWTH
       OF ALL THE FEDERAL RESERVE'S
       MISSION-RELATED ACTIVITIES
    ---------------------------------------------------------- Chapter 2:3

    As shown in table 2.1, although spending in all five of the Federal
    Reserve's mission-related activities increased during 1988 to 1994,
    the supervision and regulation area experienced the highest spending
    growth.  The rate of spending increases in mission-related activities
    ranged from 34 percent (services to financial institutions and the
    public) to 102 percent (supervision and regulation).  The growth in
    the supervision and regulation area resulted from staff increases in
    the area.  Services to financial institutions and the public,
    services to government agencies, and bank supervision and regulation
    accounted for almost 90 percent of the Federal Reserve's costs.
    Within the services to financial institutions activity, expenses for
    priced services increased substantially less than those for nonpriced
    services.  Priced services expenses increased the least of any
    mission-related activity.

    According to Federal Reserve officials, growth in supervision and
    regulation expenditures was driven primarily by staff increases.
    These staff increases resulted from the implementation of the
    regulatory requirements mandated by banking reform laws, such as the
    Federal Financial Institutions Reform, Recovery and Enforcement Act
    of 1989 (FIRREA) and the Federal Deposit Insurance Corporation
    Improvement Act (FDICIA) of 1991.\4 The supervision and regulation
    area increased its staff over 42 percent during 1988 to 1994 from
    2,456 to 3,498.\5 During the same period, both the Office of the
    Comptroller of the Currency (OCC) and the Federal Deposit Insurance
    Corporation (FDIC) had increased the size of their bank supervision
    and regulation staff by about 24 percent and 45 percent,
    respectively.

    As shown in table 2.1, costs related to priced services rose by the
    smallest rate of growth during 1988 to 1994.  The Federal Reserve has
    a significant incentive to restrain priced services costs because
    under the Monetary Control Act, fees for services are to be based on
    the recovery of expenses, and the System competes with the private
    sector in providing services to financial institutions.  The Monetary
    Control Act requires the Federal Reserve to charge financial
    institutions for priced services, such as check processing, and to
    recover its costs.  In addition, the Federal Reserve competes with
    private check clearinghouses and automated clearinghouse (ACH)
    networks in processing checks and conducting ACH transactions.

                                   Table 2.1

                        Federal Reserve's Calendar Year
                       Operating Costs by Mission-Related
                           Categories, 1988 and 1994

                                              1988        1994  Percentage
    Activities                          (millions)  (millions)      change
    ----------------------------------  ----------  ----------  ----------
    Monetary and economic                   $134.0      $185.4        38.4
     policy
    Supervision and                          208.0       420.7       102.3
     regulation

    Services to financial institutions
    ----------------------------------------------------------------------
    Priced services\a                        559.2       712.3        27.4
    Nonpriced services\b                     296.3       436.9        47.4
    ======================================================================
    Subtotal                                 855.5     1,149.2        34.3
    Services to government agencies          141.5       218.2        54.2
    System policy and                         18.4        29.6        60.9
     direction
    ======================================================================
    Total                                 $1,357.5    $2,003.1        47.6
    ----------------------------------------------------------------------
    \a Priced services include Automated Clearinghouse, Fedwire, check,
    and book entry securities.

    \b Nonpriced services are those services for which the Federal
    Reserve does not charge financial institutions, such as currency
    processing and the lending of the discount window.

    Source:  Federal Reserve System.

    --------------------
    \4 According to Federal Reserve officials, about 200 examiners were
    hired just to implement the Foreign Bank Supervision Enhancement Act,
    Title 2 of FDICIA.

    \5 The number of staff is derived from the average number of
    personnel, which measures the number of employees in terms of
    full-time positions for the time period.

       FEDERAL RESERVE OPERATING COSTS
       INCREASED SIGNIFICANTLY, WITH
       PERSONNEL COMPENSATION
       ACCOUNTING FOR MOST OF THE
       INCREASE
    ---------------------------------------------------------- Chapter 2:4

    As shown in table 2.2, the three Federal Reserve expense categories
    with the largest growth rates were equipment and software (85
    percent), travel (66 percent), and personnel compensation\6 (53
    percent) during 1988 to 1994.  The percentage growth in Federal
    Reserve expenses for personnel compensation, equipment and software,
    building, and travel all exceeded the amount of inflation (25
    percent).

                                   Table 2.2

                    Federal Reserve Expenditures by Expense
                     Categories for Calendar Years 1988 and
                    1994 and Percentage Change During 1988-
                                      1994

                             (Dollars in thousands)

                                                     Amount of  Percentage
    Expense category              1988        1994    increase      change
    ----------------------  ----------  ----------  ----------  ----------
    Personnel                 $858,311  $1,314,200    $455,889       53.11
     compensation
    Equipment and              157,016     290,962     133,946       85.31
     software\a
    Building\a                 120,564     170,364      49,800       41.31
    Travel                      28,519      47,238      18,719       65.64
    Other\b                    193,061     180,366     -12,695       -6.58
    ======================================================================
    Total                   $1,357,471  $2,003,130    $645,659       47.56
    ----------------------------------------------------------------------
    \a The amounts and rates shown in these categories are derived from
    amounts in the Federal Reserve's operating expenses, which, for
    capital acquisitions, recognize only the cost of depreciation.

    \b The "Other" category includes expense categories for shipping,
    materials and supplies, and communication.

    Source:  Federal Reserve System.

    The most significant expense category during the period of 1988 to
    1994 was personnel compensation, which accounted, in 1994, for nearly
    two-thirds of the Federal Reserve's operating budget and over 70
    percent of the total growth in the System's operating budget.  (See
    fig.  2.2.) Personnel compensation expenses increased from $858
    million in 1988 to $1.3 billion in 1994--an increase of $456 million,
    or about 53 percent.

       Figure 2.2:  Federal Reserve's
       1994 Operating Expenses, by
       Expense Category

       (See figure in printed
       edition.)

    Source:  Federal Reserve System.

    Thus, any increase in personnel compensation costs would have a
    disproportionate impact on the overall increase in Federal Reserve
    spending.  As shown in table 2.2, the overall increase in Federal
    Reserve operating expenses from 1988 to 1994 was about $646 million;
    personnel compensation accounted for about $456 million, or 71
    percent, of this increase.  Figure 2.3 shows the contributions (by
    percentage) of each major expense category to this $646 million
    increase.

       Figure 2.3:  Contributions of
       Expense Categories to the
       Overall Increase in System
       Expenses

       (See figure in printed
       edition.)

    Source:  Federal Reserve System.

    --------------------
    \6 Personnel compensation includes salaries; medical, dental, and
    life insurance; retirement contributions; and other benefits, such as
    transportation subsidies.

          THREE FACTORS CONTRIBUTED TO
          THE INCREASE IN FEDERAL
          RESERVE PERSONNEL
          COMPENSATION COSTS
    -------------------------------------------------------- Chapter 2:4.1

    Increases in staffing levels and in the overall cost of benefits as
    well as the changes in the workforce composition of the Federal
    Reserve contributed to the rising cost of System personnel
    compensation in the 1988 to 1994 period.  The percentage increases
    for the Federal Reserve's staffing levels and its overall cost of
    benefits exceeded the comparable percentages for the federal
    government (see table 2.3).  Salary growth in the Federal Reserve and
    the federal government was comparable during the period.

                                   Table 2.3

                      Percentage Increases in Staffing and
                     Overall Costs of Salaries and Benefits
                           in the Period of 1988-1994

                                       Federal Reserve
    Factors                                     System  Federal government
    ------------------------------  ------------------  ------------------
    Staffing levels                                 4%                 -2%
    Benefits, per employee                        96\a                  62
    Salaries, per employee                          39                  36
    ----------------------------------------------------------------------
    \a To compare the cost of Federal Reserve benefits with the federal
    government, we adjusted the data for the System benefits for
    accounting standards not followed by the federal government.

    Source:  Federal Reserve System and the U.S.  budget.

    More specifically, System benefits have been adjusted to account for
    the Federal Reserve's decision to start, in 1987, to amortize the
    overfunded portion of its pension plan.  The effect of this action
    has been to reduce the Federal Reserve's expenses.  In addition, the
    Federal Reserve started in 1993 to accrue the cost of health benefits
    for its retired employees.  The federal government's employee pension
    program is prefunded, but it and postretirement health benefits have
    an unfunded liability.

             STAFFING AND SALARY
             LEVELS
    ------------------------------------------------------ Chapter 2:4.1.1

    While the federal government's overall staffing level declined by 2
    percent, the overall staffing level of the Federal Reserve increased
    from 24,829 to 25,744, or by about 4 percent.  This percentage
    increase is about the same as employment growth in the federal
    government outside the Department of Defense.\7 Viewed in terms of
    mission-related activities, the level of staffing shifted
    considerably from 1988 to 1994, as shown in table 2.4.

                                   Table 2.4

                     Changes in Federal Reserve Staffing by
                              Activity, 1988-1994

                                                                Percentage
    Category                            1988           1994         change
    -------------------------  -------------  -------------  -------------
    Board of Governors\a               1,484          1,635            +10

    Reserve Banks, by activity
    ----------------------------------------------------------------------
    Monetary and economic                766            729             -5
     policy
    Services to Treasury and           1,819          1,754             -4
     other agencies
    Services to financial              9,033          8,302             -8
     institutions
    Supervision and                    2,209          3,079            +39
     regulation
    Support                            4,562          5,062            +11
    Overhead                           4,956          5,183             +5
    Total Reserve Bank
     staffing                         23,345         24,109             +3
    ======================================================================
    Total                             24,829         25,744             +4
    ----------------------------------------------------------------------
    Note:  Table staffing numbers reflect the average number of persons.

    \a System accounting does not allocate Board staffing by
    mission-related activity.

    Source:  Federal Reserve System.

    The largest increase in staffing occurred in supervision and
    regulation, whose staff tend to be white-collar employees, primarily
    bank examiners.  The second-largest increase occurred in support, due
    primarily to new, automated data-processing professionals, also
    white-collar staff.  The largest decrease in staffing occurred in
    services to financial institutions, which is an area of activity with
    a larger proportion of blue-collar workers who handle functions in
    check and currency processing.

    Federal Reserve salary costs, which amounted to a total of about $1
    billion in 1994, constituted 79 percent of System personnel
    compensation costs in 1994.  During 1988 to 1994, the Federal Reserve
    salary costs increased by 44 percent compared to an increase of 33
    percent for the federal government.  Adjusting for the Federal
    Reserve's increase in staffing, we compared the salary costs of the
    System and the federal government on a per employee basis for the
    period of 1988 to 1994.  The results showed that the 39-percent
    increase in the per employee cost of Federal Reserve salaries was
    slightly higher than the 36-percent increase in the per capita salary
    cost in the federal government.  The growth in the Federal Reserve's
    overall salary costs can be attributed to the increase in new
    professional positions created by the Federal Reserve during 1988 to
    1994.

    --------------------
    \7 The decrease in federal government civilian employment reflects
    primarily a 14-percent decrease in the Department of Defense.
    Employment in the rest of the government increased by 4 percent over
    the 1988 to 1994 period.  (Federal government employment is measured
    on a full-time equivalent basis.)

             COST OF BENEFITS
    ------------------------------------------------------ Chapter 2:4.1.2

    During 1988 to 1994, the cost of benefits represented an increasingly
    larger share of the Federal Reserve's personnel compensation
    costs--16 percent in 1988 and 21 percent in 1994.  During this same
    period, the cost of Federal Reserve benefits increased by 98 percent
    compared to an increase of 59 percent for the federal government.
    Again, adjusting for the Federal Reserve's increase in staffing, we
    compared the benefit costs of the System and the federal government
    on a per employee basis for the period of 1988 to 1994.  The results
    showed that the increase in the per employee cost of Federal Reserve
    benefits (96 percent) was higher than the increase for the federal
    government (62 percent).  The difference in the growth of Federal
    Reserve and federal government benefits can be attributed to (1)
    higher costs for benefits offered to existing staff and (2) the
    additional cost of benefits for new positions created by the Federal
    Reserve in the period.

          TRAVEL AND EQUIPMENT AND
          SOFTWARE HAD THE GREATEST
          GROWTH IN THE FEDERAL
          RESERVE'S OPERATING EXPENSES
    -------------------------------------------------------- Chapter 2:4.2

    Although travel and equipment and software expenses constituted a
    small portion of the System's operating expenses, during 1988 to
    1994, these expenses had the highest growth rates in operating
    expenses.  As previously mentioned, equipment and software and travel
    expenses increased by 85 percent and 66 percent, respectively.  The
    growth in the equipment and software expenses primarily resulted from
    the depreciation/amortization expenses in equipment, including
    computers and software.

    The cost of the Federal Reserve's travel expenses increased
    significantly more than the federal government's travel expenses
    during 1988 to 1994.  The Federal Reserve's travel expenses increased
    by 66 percent compared to 26 percent for the federal government.
    This may be due, in part, to differences in the travel policies of
    the Federal Reserve and the federal government.

       AUTOMATION AND CONSTRUCTION
       PROJECTS ACCOUNTED FOR MUCH OF
       THE RESERVE BANKS' CAPITAL
       EXPENDITURES
    ---------------------------------------------------------- Chapter 2:5

    During 1988 to 1994, the Reserve Banks spent about $1.7 billion on
    capital acquisitions.  Costs for capital expenditures are allocated
    to a budget separate from the Reserve Banks' operating budget.
    During 1994, the Reserve Banks spent approximately $270 million to
    acquire capital assets, such as computer equipment and software for
    the Federal Reserve's automation and consolidation project, which is
    known as FRAS.  The Reserve Banks' 1994 capital expenditures
    represented a 60-percent increase from the 1988 expenditures.
    However, unlike operating expenses, which increased steadily every
    year, the growth in the capital expenditures was somewhat sporadic,
    increasing in some years and decreasing in other years.  We did not
    compare the Reserve Banks' capital acquisitions to the federal
    government's capital acquisitions because of the differences in the
    way capital spending is tracked.

    As previously mentioned, the large growth in the Reserve Bank's
    capital expenditures was partially the result of FRAS.  Three
    automation consolidation centers will consolidate most of the
    independent mainframe operations of the 12 Reserve Banks, providing
    consolidated mainframe and contingency support for, among other
    things, the Federal Reserve's mission-critical payments system.  The
    three FRAS centers are at the Dallas and Richmond Reserve Banks and
    the East Rutherford Operations Center of the New York Federal
    Reserve.  As of December 31, 1994, the total capital acquisition
    cost, primarily for computer and software, was $242 million.

       CONCLUSIONS
    ---------------------------------------------------------- Chapter 2:6

    While many commercial banks were downsizing their organizations and
    the federal government was constraining spending, the Federal
    Reserve's costs were steadily increasing.  During 1988 to 1994, the
    cost of operating the Reserve Banks and the Board increased by 48
    percent--nearly twice the amount of inflation.  The growth in the
    Federal Reserve's operating budget was primarily produced by cost
    increases in the supervision and regulation area and in the expense
    categories of personnel compensation, travel, and equipment.

    Although the Federal Reserve's expenditures increased in all five
    mission-related areas, supervision and regulation experienced the
    most growth during 1988 to 1994.  The priced services area--where the
    Monetary Control Act requires the Federal Reserve to recover costs
    and the Federal Reserve competes with the private sector in providing
    services to financial institutions--had the lowest cost growth.
    Thus, where the System had significant incentives to constrain costs,
    it appeared to have done so.

    Personnel compensation costs, accounting for nearly two-thirds of the
    operating budget, grew by 53 percent during 1988 to 1994.  Also,
    personnel compensation costs represented over 70 percent of the
    growth in the Federal Reserve's operating budget.  The growth in
    Federal Reserve benefits and the increase of professional employment
    at the Reserve Banks contributed to the rise in the Federal Reserve
    personnel compensation costs.

    OPPORTUNITIES EXIST TO REDUCE
    FEDERAL RESERVE OPERATING EXPENSES
    ============================================================ Chapter 3

    The results of our review of many policies and practices of the Board
    and Reserve Banks indicated that opportunities exist to reduce the
    Federal Reserve's spending.  Federal Reserve personnel compensation
    (pay and benefits) varied within the Federal Reserve and included
    benefits that were relatively generous compared to those of
    government agencies with similar responsibilities.  We also found
    that improvements and greater uniformity in Reserve Bank policies and
    practices relating to travel reimbursements, contracting and
    procurement, and construction planning could reduce operating and
    capital spending costs and reduce the Reserve Banks' risk of
    potential conflict of interest and favoritism.  For example, we found
    that the Federal Reserve overlooked opportunities to reduce costs in
    planning and managing the design of the new Dallas Reserve Bank
    building.  Finally, we found that a reduction in annual Federal
    Reserve transfer to its surplus account, while not representing a
    direct reduction in Federal Reserve expenditures, would have a
    positive budgetary impact in the year that any such reductions
    occurred.

       THE FEDERAL RESERVE'S PERSONNEL
       COMPENSATION SYSTEM SEEKS TO
       COMPENSATE EMPLOYEES ON THE
       BASIS OF THE LOCAL LABOR
       MARKETS
    ---------------------------------------------------------- Chapter 3:1

    The boards of directors of the 12 Reserve Banks supervise and control
    the Reserve Banks, subject to the general supervision of the Board of
    Governors.  The Board employs individuals who are necessary to
    conduct the business of the Board.  It also sets employee salaries
    and benefits; approves compensation paid by Reserve Banks to their
    employees; and establishes regulations, policies, and practices
    covering employee benefits.  The Reserve Banks and Board have
    established differing employee pay levels and benefits.  Except for
    the salaries of the Chairman and members of the Board, Federal
    Reserve salaries are not limited by ceilings established by the civil
    service pay system.  Salaries at some other federal financial
    regulators, notably OCC and FDIC, also have not been limited by civil
    service pay rules.\1

    Two important objectives of the Federal Reserve's compensation system
    are to (1) attract, retain, and motivate qualified employees at all
    levels of responsibility and (2) be externally competitive with local
    and/or regional labor markets.  To accomplish these objectives, the
    Board and 12 Reserve Banks conduct individual salary surveys of
    private and public institutions with related job positions in local
    labor markets.  The Board and Reserve Banks also survey other
    organizations periodically as they make benefit decisions.  While we
    sought to understand the nature and scope of the Federal Reserve's
    surveys, we did not verify or analyze the data and methodology used
    in these surveys.

    To determine whether opportunities exist to reduce the Federal
    Reserve's costs of operation, we reviewed personnel pay and benefits
    at the Reserve Banks and Board.  We compared the general procedures
    for setting Reserve Board and Banks' salaries to those of the federal
    government.  We compared the specific benefits offered Board and
    Reserve Bank employees to those of federal financial regulatory
    agencies with responsibilities analogous to some responsibilities of
    the Federal Reserve.  The federal agencies whose salaries and
    benefits served as comparisons were FDIC, OCC, and the Securities and
    Exchange Commission (SEC).  OCC and FDIC generally are not subject to
    civil service limitations in providing salaries and benefits to their
    employees, while SEC is subject to such limitations.  We did not
    attempt to analyze differences in employee responsibilities when we
    compared Federal Reserve salary levels and benefits to those of FDIC,
    OCC, and SEC.

    --------------------
    \1 For example, FDIC is not bound by either the Classification Act or
    the general schedule (GS) pay scale.  It can administratively
    establish its own salary structure.  The fifth paragraph of section
    1819 of Title 12, the FDIC Act of 1950, grants authority to the FDIC
    Board of Directors to fix compensation.

          FEDERAL RESERVE SALARY
          LEVELS WERE ADJUSTED TO BE
          COMPETITIVE WITH LOCAL LABOR
          MARKETS
    -------------------------------------------------------- Chapter 3:1.1

    The Federal Reserve attempts to offer salaries competitive with
    private sector organizations.  The Federal Reserve is not constrained
    by maximum limits when setting its salaries for most positions.  (The
    notable exceptions are the salaries for the Governors of the Board,
    including the Chairman.)\2 In addition, both Board and Reserve Bank
    salaries are based on independent salary surveys of organizations
    that have similar local labor forces.  As a result, the Federal
    Reserve offers salaries that are competitive with private sector
    organizations in a given locality.  In contrast, most civil service
    salaries are subject to maximum levels, the highest of which is level
    IV of the executive pay schedule, which was $115,700 in 1994.

    In 1990, Congress passed the Federal Employees Pay Comparability Act
    (FEPCA), which provided for a comprehensive, long-term pay reform
    program designed to ultimately make federal salaries more competitive
    with the private sector.  Under FEPCA, locality pay adjustments were
    to be phased in over a 9-year period beginning in 1994.  The goal was
    to reduce pay disparities between federal white-collar workers and
    nonfederal workers to no more than 5 percent by the year 2002.
    However, budget constraints have already resulted in reductions of
    scheduled locality pay adjustments for federal workers for 1995 and
    1996.  Thus, in contrast to the Federal Reserve, civil service
    agencies, including SEC, have been unable to offer their employees
    salaries comparable to those in local labor markets.

    Other federal financial regulators do not face these constraints.
    FDIC employees received salaries with geographic differentials that
    amounted to up to 31 percent more than civil service basic pay
    levels.  OCC's salary structure, which had a maximum base salary of
    $166,400, also provided employees with geographic pay differentials
    of up to 34 percent of OCC's base salary levels.  FDIC and OCC
    salaries are, with some exceptions, not limited to ceilings
    established by the civil service pay system; notable exceptions are
    the salaries of members of FDIC's board of directors and the salary
    of the Comptroller of the Currency.

    One interesting result of the statutory limits on the Governors'
    salaries, coupled with the ability of the Federal Reserve to set
    competitive salaries for other positions, is that a substantial
    number of Federal Reserve employees are paid more than the Chairman
    of the Board.  Specifically, 120 top-level Federal Reserve officials,
    including all Reserve Bank presidents, earned more in 1994 than the
    Chairman.  In 1994, the annual salaries of Reserve Bank presidents
    ranged from $159,600 to $229,600, while the Board Chairman's salary
    was $133,600 (the maximum allowed), and each of the other Board
    members' salary was $123,100.  Appendix III provides the titles and
    the number of Federal Reserve employees who earn more than the Board
    Chairman and also shows the 1994 salaries for the presidents of the
    12 Reserve Banks.

    --------------------
    \2 Salaries of the Chairman and other Board members are established
    by law (5 U.S.C.  5313 and 5314) under the Federal Executive Pay
    Schedule.

          THE BOARD AND RESERVE BANKS
          OFFERED A VARIETY OF
          BENEFITS
    -------------------------------------------------------- Chapter 3:1.2

    Although employee benefits at the Board and Reserve Banks differed in
    many respects, some Federal Reserve benefits were systemwide and
    available at the same levels to all Federal Reserve employees.
    Systemwide benefits included retirement plans, the thrift savings
    plan, business travel/accident insurance, life and survivor
    insurance, and a long-term disability income plan.  Other benefits
    not offered on a systemwide basis included mass transit subsidies and
    leave granted for marriage, bereavement, family care, and floating
    holidays.

    From our review of the Federal Reserve's personnel policies and
    practices, we found that a few Federal Reserve benefits were more
    generous than those available to OCC and FDIC and many were more
    generous than civil service benefits, such as those available to SEC.
    Also, the Federal Reserve provided additional benefits to some
    high-level officials, including home security systems, bodyguards,
    and home-to-work transportation in Federal Reserve- owned vehicles.

          FEDERAL RESERVE HEALTH CARE
          BENEFITS WERE MANAGED ON A
          DECENTRALIZED BASIS
    -------------------------------------------------------- Chapter 3:1.3

    All 12 Reserve Banks offered their employees comprehensive health
    insurance packages.  Although the Board paid the same health care
    premiums as other federal agencies (payments that ranged from about
    60 to 75 percent) the percentage of premiums paid by Reserve Banks
    differed.  Most Reserve Banks paid 75 to 90 percent of health
    insurance premiums.  Appendix III shows the percentage of health
    insurance premiums paid by the Reserve Banks, the Board, FDIC, OCC,
    and SEC.  The total health care cost paid by the Board and the
    Reserve Banks in 1994 was $7.5 million and $64.9 million,
    respectively.

    Recognizing that health care costs are escalating, Reserve Banks are
    attempting to reduce health plan costs.  Federal Reserve health care
    benefits were managed on a decentralized basis, with each Bank
    negotiating its own health care coverage.  One Reserve Bank
    eliminated its preferred provider option previously available to
    employees, replaced it with a managed care network, and reduced the
    number of available health maintenance organizations.  Federal
    Reserve officials estimated that health care costs would have been
    about $900,000 more for 1993 without these changes.  Another Reserve
    Bank reduced the number of health care plans available to employees
    to two effective in April 1994; officials estimated resulting savings
    of about $2.3 million over the following 3 years.  Although the
    Reserve Banks have individually made efforts to reduce health care
    costs, the Reserve Banks have not worked together to determine
    whether their combined bargaining powers would further reduce these
    expenses.

          SOME FEDERAL RESERVE LEAVE
          POLICIES DIFFERED FROM THOSE
          OF OTHER FEDERAL FINANCIAL
          REGULATORS AND CIVIL SERVICE
    -------------------------------------------------------- Chapter 3:1.4

    The number of days allowed for annual and sick leave differed
    significantly among the Reserve Banks and between the Reserve Banks
    and the Board.  The Board, along with FDIC, OCC, and SEC, followed
    the civil service guidelines, which provide between 13 and 26 days
    for annual leave and 13 days for sick leave each year.  The number of
    annual leave days available to Reserve Bank employees ranged from 10
    to a maximum of 23 to 32 days per year, depending on length of
    service.  Thus, relatively junior Reserve Bank employees were granted
    fewer annual leave days than civil service permits, but more senior
    employees could accrue more annual leave days each year than civil
    service permits.  However, some Reserve Banks offered additional paid
    leave for certain purposes, such as bereavement or marriage, which
    was in addition to annual leave.  Among the Reserve Banks, the number
    of sick days employees accrue varied considerably.  Six Reserve Banks
    offered fewer sick leave days annually than civil service employment
    (ranging from 8-1/4 to 12 days), while two others offered sick leave
    in the range of 15 to 18 days.  Other Reserve Banks appeared to offer
    more generous sick leave policies.  Tables III.7 and III.9 in
    appendix III show the leave benefits available at the Reserve Banks,
    the Board, FDIC, OCC, and SEC.

          COMPARISON OF FEDERAL
          RESERVE AND OTHER FEDERAL
          EMPLOYEE RETIREMENT PROGRAMS
    -------------------------------------------------------- Chapter 3:1.5

    Federal Reserve Board and Bank employees do not participate in the
    retirement programs that cover most federal civilian employees.
    Separate retirement programs apply to Board and Reserve Bank
    employees.

    Before 1983, Board employees, along with federal employees in
    general, were not covered by the Social Security program.  Board
    employees were under the Federal Reserve Board Retirement System
    (FRBRS), and other federal employees were under the Civil Service
    Retirement System (CSRS).  Even though they were separate, the two
    systems' provisions were virtually identical.  In contrast, Reserve
    Bank employees were not considered to be employed by the federal
    government.  They were covered by Social Security and a separate
    retirement system designed to complement their Social Security
    benefits.

    The Social Security Amendments of 1983 required all federal
    employees, including Board employees, first hired after December 1983
    to participate in Social Security.  Accordingly, new retirement
    systems had to be developed to recognize the availability of Social
    Security benefits for the covered employees.  The Federal Employees'
    Retirement System (FERS) was developed to cover federal employees in
    general.  However, rather than develop a new retirement system for
    future Board employees, the Federal Reserve decided that they would
    be covered by the retirement system already in place for Reserve Bank
    employees.

    In addition to the pension benefits available from the FRBRS and
    Reserve Bank retirement systems, Board and Reserve Bank employees can
    earn additional retirement income through participation in a thrift
    plan sponsored by the Federal Reserve.  The thrift plan includes two
    components--a savings account and a deferred compensation account.
    Employees may contribute to either or both accounts.  Employee
    contributions to the savings account are made with after-tax dollars,
    and contributions to the deferred compensation account are made with
    pretax dollars.  For each dollar an employee contributes to the
    thrift plan, up to 6 percent of salary, the Federal Reserve matches
    80 percent of the employee's contributions.  Thus, the maximum
    employer contribution to any employee's thrift plan is 4.8 percent of
    salary.  Employees may contribute additional amounts to the thrift
    plan with no matching contributions by the Federal Reserve.

    Even though the pension benefits available to other federal employees
    in CSRS and Board employees in FRBRS are the same, Board employees
    have the distinct advantage of being eligible to participate in the
    thrift plan and receive matching contributions from the Federal
    Reserve.  Employees in CSRS may contribute to a thrift plan, but
    receive no contributions from their employing agencies.

    The Reserve Bank pension plan differs from the FERS pension plan that
    applies to federal employees in general.  Some of the features of the
    Reserve Bank plan are less generous than the counterpart features of
    FERS.  For example, Reserve Bank plan's benefits are based on
    employees' average salaries earned during their 5 highest-paid years,
    while FERS' benefits are based on employees' average salaries earned
    during their 3 highest-paid years.  Also, Reserve Bank employees must
    be at least age 60 with 30 years of service to retire with unreduced
    retirement benefits, while FERS provides unreduced benefits as early
    as age 55 with 30 years of service.\3 However, these FERS advantages
    are more than offset by a number of significant features of the
    Reserve Bank plan that are superior to FERS.  Some of the features
    where the Reserve Bank plan is more generous than FERS are as
    follows:

      -- The Reserve Bank plan is free to employees; FERS requires
         employees to contribute .8 percent of their salaries toward plan
         costs.

      -- The Reserve Bank plan's benefit calculation formula provides
         considerably greater benefits than the FERS formula.  In the
         Reserve Bank plan, benefits are equal to 1.3 percent of average
         salary up to the Social Security integration level and 1.8
         percent of average salary over the integration level multiplied
         by total years of service.  (The integration level is the
         average of the maximum amounts of salary covered by Social
         Security from 1959 through the year of retirement.  For
         employees retiring in 1995, the integration level was $24,312).
         In the FERS plan, the formula for each year of service is 1.1
         percent of average salary for retirees who are at least age 62
         with 20 years of service.  For retirees who are younger than age
         62, the FERS benefit formula is 1 percent of average salary for
         each year of service.

      -- The Reserve Bank plan allows employees as young as age 50 to
         voluntarily retire early with reduced benefits.  FERS does not
         have a similar provision.  Under FERS, employees cannot
         voluntarily retire before age 55 unless they or their agencies
         are facing involuntary employee separations.

    FERS also includes a thrift plan to which covered employees and their
    agencies can contribute to increase retirement income.  The FERS
    thrift plan is designed somewhat differently from the Federal Reserve
    thrift plan; overall, it provides slightly greater benefits to
    participating employees.  Unlike the Federal Reserve thrift plan, all
    employees in FERS receive agency contributions equal to 1 percent of
    their salaries regardless of whether the employees make any
    contributions.  The agencies then match, dollar-for-dollar, employee
    pretax contributions of up to 3 percent of salary and 50 cents on the
    dollar for the next 2 percent of salary that employees contribute to
    the thrift plan.  Thus, compared to the maximum 4.8 percent of salary
    the Federal Reserve will contribute to an employee's thrift plan,
    employing agencies will contribute as much as 5 percent of employees'
    salaries to the FERS thrift plan.  Also, to receive the maximum
    employer contribution of 4.8 percent of salary, Board and Reserve
    Bank employees must contribute 6 percent of their salaries.
    Employees in FERS can receive employer contributions of 5 percent of
    salary by contributing 5 percent of their salaries to the FERS thrift
    plan.

    --------------------
    \3 Under provisions of the FERS Act, the FERS retirement age
    advantage will be less in the future.  Retirement eligibility at age
    55 is available under FERS only to employees who were born before
    January 1, 1948.  The age requirement gradually increases until it
    reaches age 57 for employees born after December 31, 1969.

          A NUMBER OF OTHER FEDERAL
          RESERVE BENEFITS WERE NOT
          AVAILABLE TO CIVIL SERVICE
          EMPLOYEES
    -------------------------------------------------------- Chapter 3:1.6

    As shown in table 3.1, the Federal Reserve offered a few benefits to
    its employees that are generally not offered to civil service
    employees.  These benefits included separate dental insurance,
    subsidized employee cafeterias, premium conversion accounts, flexible
    spending accounts, matching contributions for savings accounts, and
    mass transit subsidies.  In addition, some banks offered marriage,
    bereavement, parental care, and floating holiday leave as leave
    categories separate and distinct from the usual annual and sick leave
    offered.  Appendix III provides a full description of these selected
    Federal Reserve benefits and their availability at FDIC, OCC, and
    SEC.

                                        Table 3.1

                          Benefits Available to Federal Reserve,
                         FDIC, OCC, and SEC Employees During 1993

                                   Number of
                  Board of     Reserve Banks                              SEC (civil
    Benefits      Governors       (12 total)  FDIC          OCC           service)
    ------------  ----------  --------------  ------------  ------------  ----------
    Health        Yes                     12  Yes           Yes           Yes
    insurance

    Dental        Yes                     12  Yes           Yes           No
    insurance

    Subsidized    Yes                     12  Yes           Yes           \a
    cafeteria/
    Dining room

    Premium       Yes                     12  Yes           Yes           No
    conversion
    account

    Flexible      Yes                     11  Yes           Yes           No
    spending
    account

    Thrift        Yes                     12  Yes           Yes           Yes
    savings plan

    Savings plan  Yes                     12  Yes           Yes           No

    Annual leave  Yes                     12  Yes           Yes           Yes

    Sick leave    Yes                     12  Yes           Yes           Yes

    Marriage      No                       4  No            No            No
    leave

    Bereavement   No                      11  No            No            No
    leave

    Family care   No                       3  No            No            No
    leave\b

    Floating      No                      10  No            No            No
    holidays

    Mass transit  Yes                      4  No            No            Yes
    subsidy

    Home          Yes                      8  No            No            No
    security      (for the            (for 8
    systems       Chairman)      presidents,
                                 5 first VP,
                                 1 executive
                                     VP, and
                                1 senior VP)

    Home-to-      Yes                     12  No            No            No
    Work          (Chairman   (59 employees,
    transportati  only)        including all
    on in agency                 presidents)
    vehicle

    Employee      Yes                      6  No            No            No
    store

    Employee      No                      10  No            No            No
    lounge

    On-site       Yes                     11  Yes           Yes           Yes
    exercise
    facility

    Employee      Yes                     12  Yes           Yes           Yes
    parking

    Tuition       Yes                     12  Yes           Yes           Yes\c
    assistance
    program

    Business      Yes                     12  Yes           Yes           No
    travel/                                                               (covered
    Accident                                                              by credit
    insurance                                                             card)

    Civil         Yes                     \d  Yes           Yes           Yes
    Service
    Retirement
    System

    FERS          Yes                     \d  Yes           Yes           Yes

    Other         Yes                     12  No            No            No
    agency-
    managed
    retirement
    plan

    Long-Term     Yes                     12  Yes           Yes           Yes
    Disability

    Life          Yes                     12  Yes           Yes           Yes
    insurance
    --------------------------------------------------------------------------------
    Legend:

    FDIC = Federal Deposit Insurance Corporation
    OCC = Office of the Comptroller of the Currency
    SEC = Securities and Exchange Commission
    VP = Vice President
    FERS = Federal Employees' Retirement System

    \a SEC has no cafeteria.

    \b The Federal Reserve Board of Governors, some Federal Reserve
    Banks, FDIC, OCC, and SEC allow their employees to use annual or sick
    leave for family care.

    \c Available only to employees in grades GS-8 and below.

    \d The Reserve Banks are not covered under these plans.

    Sources:  GAO analysis of information provided by the Federal Reserve
    Board; 12 Federal Reserve Main District Banks; and FDIC, OCC, and SEC
    headquarters.

       FEDERAL RESERVE BANK TRAVEL
       POLICIES ARE NOT UNIFORM AND
       REPRESENT AN OPPORTUNITY TO
       REDUCE COSTS
    ---------------------------------------------------------- Chapter 3:2

    To determine whether opportunities existed to reduce the Federal
    Reserve's operational costs, we also reviewed travel reimbursement
    policies within the Federal Reserve.  Each year, the Board and the
    Reserve Banks spend millions of dollars for employee travel.  In
    1994, for example, the total of travel expenditures for the Federal
    Reserve was $42 million.  According to Board officials, Board
    personnel are authorized to use government rates for lodging and
    airfare.  Some Reserve Bank officials we interviewed stated that
    Reserve Bank employees are ineligible for government rates for
    lodging and airfare because the Reserve Banks are not federal
    agencies.\4 However, one Bank official disagreed, stating that
    Reserve Bank employees can request government rates for lodging, but
    cannot insist on receiving government rates.

    --------------------
    \4 Reserve Bank employees performing Board-delegated duties, such as
    financial institution examinations, are reimbursed on the basis of
    the Reserve Bank's travel policies, not the Board's.  Bank examiners
    at FDIC and OCC are able to take advantage of Federal airfare and
    lodging rates.

          TRAVEL REIMBURSEMENT
          POLICIES VARIED WITHIN THE
          FEDERAL RESERVE
    -------------------------------------------------------- Chapter 3:2.1

    Under regulations comparable to those for other federal employees,
    Board employees are reimbursed for lodging and meal expenses on a per
    diem basis.  However, members of the Board are permitted to receive
    reimbursement for domestic lodging and meals on either an actual
    expense or per diem basis, when deemed appropriate.  The Board's
    general policy directive for Reserve Bank travel expenditures allows
    for variations in Reserve Bank reimbursement procedures.  These
    differences can result in additional expenditures.  One Reserve Bank
    we reviewed had maximum lodging reimbursement rates, while another
    Reserve Bank had recommended reimbursement rates.\5 However, two
    Reserve Banks reimbursed at cost without maximum or recommended
    rates.  As a result of these policy differences, two travelers'
    overnight lodging allowances for the same city could vary widely,
    depending on each traveler's Reserve Bank.

    In addition to the differences noted in lodging costs, Reserve Banks
    reimbursed employees for meals using varying schedules and rates.
    Two Reserve Banks reimbursed travelers for meals on the basis of a
    schedule that divided the day into four quarters, while another
    Reserve Bank used a more narrowly defined schedule that aligned with
    typical meal times.  Additionally, another Reserve Bank reimbursed
    travelers for meals depending on whether they were traveling to a
    Federal Reserve System entity versus other locations.  Of the Reserve
    Banks we reviewed, two also allowed employees to choose actual cost
    reimbursement rather than a flat per diem rate.  As a result of these
    policy differences, the total meal reimbursement for a 3-day trip to
    the Board in Washington, D.C., could range from $76 to $105.

    We believe making travel policies uniform within the Federal Reserve
    could provide an opportunity to reduce Federal Reserve expenses,
    particularly if caps on reimbursements were set below current levels.
    In addition, more uniform policies could result in some
    administrative costs reductions, particularly if common travel
    policies would enable travel expenses to be managed on a more
    centralized basis, thus reducing the need for staff time devoted to
    travel administration at each Reserve Bank.

    --------------------
    \5 The maximum lodging rate is a set dollar amount above which the
    employee will not be reimbursed, except in special, approved
    circumstances.  On the other hand, the recommended reimbursement rate
    is a suggested dollar amount used by employees as a guideline when
    making travel arrangements.

       IMPROVED CONTRACTING AND
       PROCUREMENT PRACTICES COULD
       RESULT IN COST EFFICIENCIES
    ---------------------------------------------------------- Chapter 3:3

    To determine whether opportunities existed to reduce the Federal
    Reserve's operational costs, we also reviewed procurement and
    contracting practices at several Reserve Banks.  Unlike personnel
    costs that remain relatively stable, expenses associated with capital
    acquisitions can vary significantly from year-to-year, offering
    additional opportunities for controlling and reducing procurement
    costs.  The 12 Reserve Banks spent more than $560 million in 1994 to
    acquire buildings, equipment, supplies, and services.  Nearly half of
    the total ($267 million) was used to buy capital items (buildings and
    equipment) and fund building projects.  As discussed in chapter 1,
    only depreciation costs of capital assets are accounted for in annual
    operating budgets.

    Because the Board and Reserve Banks spend millions each year for
    goods and services, certain controls should be in place to ensure
    that those dollars are spent wisely.  For example, the Reserve Banks
    should have an effective procurement and control process in place to
    ensure that they receive goods and services at the most reasonable
    cost.  Moreover, to prevent fraud and abuse, the procurement
    practices should also preclude potential conflicts of interest
    between the Reserve Banks and contractors.

    The Board and the Reserve Banks used different procurement
    guidelines.  Although not specifically directed to do so by the
    Federal Reserve Act, a spokesman for the Board told us that the Board
    follows the spirit of the federal government contracting rules, which
    are contained in the Federal Acquisition Regulations (FAR).  Reserve
    Banks are not required to follow these rules.

    However, each Reserve Bank is required to follow general procurement
    guidance, called Uniform Acquisition Guidelines (UAG), which were
    adopted by the Reserve Banks in 1985.  The UAGs were developed by the
    Reserve Banks in conference committees.  They were designed to
    provide minimum requirements for Reserve Bank procurement activities.
    By providing opportunities for all interested bidders to become a
    selected source, the guidelines attempt to ensure that Reserve Banks
    treat sources fairly and impartially.  By fostering competition in
    the procurement process, Reserve Banks will also have a greater
    opportunity to realize cost savings through lower competitive
    pricing.

    Despite the UAGs, we observed the following:

      -- Practices at individual Reserve Banks differed significantly and
         some practices favored certain sources over others.  For
         instance, some Reserve Banks did not allow an equal opportunity
         for new bidders to bid for large procurements and limited
         bidders lists to sources with which the Reserve Banks had
         traditionally done business.  This practice existed even though
         other equally qualified sources were both available and
         interested.  Furthermore, some Reserve Banks retained incumbent
         contractors for certain services for years without recompeting
         the award, thus precluding other firms from competing for those
         services.  At one of the four Reserve Banks we visited, the
         records indicated that the cafeteria contract was last competed
         over 9 years ago.  At another Reserve Bank we visited, personnel
         could not locate documentation of their last cafeteria contract
         negotiations, which they believed occurred in the late 1980s.
         By limiting the ability of other sources to compete for a
         contract, Reserve Banks tend to reduce competition, thereby
         missing opportunities to reduce procurement costs.

      -- Proper controls over conflict of interest were not followed at
         certain Reserve Banks.  For instance, the UAGs prohibit
         disclosure of specific information contained in bids or
         proposals to anyone except Reserve Bank personnel before
         awarding the contract.  However, two of the four Reserve Banks
         we visited transferred almost all functions leading up to the
         award of major building contracts to architecture and
         engineering (A&E) firms.  A&E firms receive and evaluate bids
         and recommend the source that should receive the award.  In
         contrast, at the other two Reserve Banks we visited, only
         Reserve Bank personnel were allowed to receive and evaluate the
         bids or proposals and choose the successful source.  The
         building department's vice president at one of the four Reserve
         Banks told us that the larger the role the A&E firm plays, the
         greater the potential for favoritism and conflict of interest.

      -- Practices at certain Reserve Banks lacked independent checks and
         reconciliations.  Although each Reserve Bank should have
         controls for independent checks and reconciliations of voucher
         payments, at two of the four Reserve Banks we visited, only the
         building department was responsible for authorizing progress
         payments made to construction contractors.  At both Reserve
         Banks, officials responsible for the payment function, where the
         reconciliation should take place, did not track payment amounts
         against the total available contract dollars.  Instead, when
         vouchers were received that showed the approval of the building
         department, the vouchers were paid.

      -- Noteworthy practices used by certain Banks were not disseminated
         among the Reserve Banks.  Several Reserve Banks had procedural
         strengths or notable practices that were missing in others.
         Building department officials at one of the four Reserve Banks
         requested and analyzed various elements of cost included in
         construction proposals, which enabled them to evaluate the
         proposed prices.  They had found that challenging the
         bids/proposals from construction contractors resulted in
         improved understanding of what is required, as well as better
         quality and lower prices.  However, we found no evidence that
         information about these "best practices" was being disseminated
         within the Federal Reserve.  Specifics on these practices are
         described in appendix IV.

       THE FEDERAL RESERVE COULD BE
       MORE COST CONSCIOUS WHEN
       PLANNING AND MANAGING
       LARGE-SCALE BUILDING PROJECTS
    ---------------------------------------------------------- Chapter 3:4

    To determine whether opportunities exist to reduce the Federal
    Reserve's operational costs, we also reviewed decisions related to
    the construction of the Dallas Reserve Bank facility.  Even though
    the cost of the Dallas building project was $8 million less than the
    initially approved budget and construction was completed ahead of
    schedule, opportunities existed for the Federal Reserve to reduce
    costs.  In two areas, we found that the Reserve Bank could have cut
    costs approved by the Board.  First, the Dallas Reserve Bank building
    was larger than the plan initially specified; second, the Reserve
    Bank purchased more land than necessary.  Since the building
    contained enough square footage to meet the projected space-study
    needs through 2017, the purchase of additional acreage for expansion
    purposes had questionable value.

          THE DALLAS RESERVE BANK
          OUTGREW ITS ORIGINAL BANK
          BUILDING
    -------------------------------------------------------- Chapter 3:4.1

    By July 1988, the Dallas Reserve Bank had outgrown its original
    building.  The building could not house all employees, no longer
    complied with the evolving building codes, and contained many space
    deficiencies.  Faced with these problems, Dallas Reserve Bank
    officials commissioned a study, to identify alternatives that would
    resolve the space problems.

    As a result of that study, in November 1988, the Dallas Reserve Bank
    recommended that the Board:

      -- approve a space plan for a building with 540,334 net usable
         square feet, which would satisfy the Reserve Bank's projected
         needs through 2017;

      -- locate the new building on land within the Central Business
         District (CBD), which would provide the most effective and
         appropriate solution for satisfying the Reserve Bank's space
         needs over the long term;

      -- approve a target budget of $171.8 million for the construction
         of a new building on a new site; and

      -- authorize the Reserve Bank to proceed with a site selection and
         conceptual design for a new building.

          THE BOARD APPROVED THE COST
          OF A NEW DALLAS RESERVE BANK
          BUILDING
    -------------------------------------------------------- Chapter 3:4.2

    In January 1989, the Board approved the Dallas Reserve Bank's
    proposal to construct a new building at a new location within the
    Dallas CBD.  The Board-approved plan had a target budget of $171.8
    million and a target completion date of August 1992.  In July 1990,
    the Board authorized the Dallas Reserve Bank's proposal to follow an
    expedited (or "fast track") construction plan.  This approach allowed
    the Reserve Bank to begin construction with incomplete construction
    drawings and without finalized subcontract agreements.  Additionally,
    the Board lowered the final budget for the land purchase and new
    building design and construction to $164.5 million.  The expedited
    construction plan also allowed occupancy 3 months ahead of schedule.

          THE FACILITY WAS OVERBUILT
    -------------------------------------------------------- Chapter 3:4.3

    The proposal submitted by the Dallas Reserve Bank to the Board called
    for the construction of a 540,334 square foot building.  The building
    requirements for the Reserve Bank's new facility were based on the
    Board's projected space requirements.  The Board requires that new
    building projects allow for 15 years of personnel growth and 25 years
    of vault and other space growth.  The Dallas Reserve Bank hired a
    consultant to determine the projected space needs on the basis of the
    Board criteria.  The space study found that 540,334 square feet would
    allow for 15 years of personnel growth through 2007 and that 580,093
    square feet would allow for 25 years of equipment growth though 2017.

    The completed building contains 595,385 square feet, which is 55,051
    square feet more (about 10 percent) than the initially approved
    square footage.  In addition, the new building's square footage was
    more than the 580,093 square feet the bank is projected to need in
    2017.  The two areas most overbuilt, in terms of total square feet
    and percent authorized, were the data services and lobby areas.  In
    the data services area, 70,167 square feet were authorized by the
    Board.  However, in the completed building, the final square footage
    for data services was 90,860, or 29 percent more than was authorized.
    The building's two lobby entrances called for 7,800 in total square
    feet, while the actual square footage on completion was 27,369, or an
    increase of 250 percent.

    According to a Reserve Bank official, the architect's plan provided
    for more space than was approved by the Board.  However, the
    additional space did not cause concern since the design and
    construction costs for the plan were less than the budgeted amount
    approved by the Board.

          LAND PURCHASED WAS
          UNNECESSARY
    -------------------------------------------------------- Chapter 3:4.4

    The Dallas Reserve Bank purchased, with the Board's approval, 8.02
    acres of land for $27.7 million, or $79.30 per square foot.  They
    needed 6.02 acres for new building construction and purchased the
    additional 2 acres for future building expansion or sale.  Since the
    building design exceeded projected space needs through 2017, the need
    for additional land was redundant.  According to a senior official at
    the Dallas Reserve Bank, the Bank could have purchased only the 6.2
    acres for approximately $20.7 million and foregone the additional 2
    acres for a total savings to the Federal Reserve of $7 million.

       OPPORTUNITIES MAY EXIST TO
       REDUCE OR ELIMINATE THE SURPLUS
       ACCOUNT
    ---------------------------------------------------------- Chapter 3:5

    Downward adjustments to the surplus account, or its elimination,
    would have a positive budgetary impact by increasing the amounts
    returned to Treasury in the years that they occur.  The current
    formula for calculating the amounts to be contributed to surplus
    accounts is as follows.  Each Reserve Bank's capital stock is by law
    equal to 6 percent of the paid-in capital and surplus of its member
    banks.\6 Annually, as banks' paid-in capital and surplus grow or
    shrink, member banks are required to adjust the amount of their
    Federal Reserve Bank stock to equal 6 percent of their paid-in
    capital and surplus.  The Reserve Banks then contribute, out of
    Federal Reserve earnings, amounts to their surplus accounts so that
    the surplus balances are equal to the amount of paid-in capital.
    During 1988 to 1994, the total of the surplus accounts systemwide
    increased 79 percent, from $2.1 billion in 1988 to $3.7 billion in
    1994.

    The Federal Reserve has stated in its publications that the purpose
    of the surplus accounts is to ensure that adequate capital is
    available to absorb possible losses.  In its monetary policy, lender
    of last resort, and payment system activities, the Federal Reserve is
    exposed to risks that could potentially generate large losses.
    However, because the Federal Reserve's interest income so far exceeds
    its expenses, we believe it is highly unlikely the Federal Reserve
    will ever incur sufficient annual losses such that it would be
    required to use any funds in the surplus account.  In the years 1914
    and 1915, the first 2 years of its operations, the Federal Reserve
    experienced net losses.  However, every year since then, for 79
    years, the Federal Reserve has recorded substantial net profits.  The
    profits for 1994 were $20 billion and expenses, including losses,
    were about $3 billion.

    We could find no criteria to use in assessing the amount held in
    surplus.  According to Federal Reserve officials, the methodology for
    deciding that amount has changed and is somewhat arbitrary.
    Currently, and in the past, the levels of the surplus account have
    been discretionary because the requirement to have the surplus
    account equal to paid-in capital has been a matter of Federal Reserve
    policy; it was not required by law.  However, in a provision of the
    Omnibus Budget Reconciliation Act of 1993, Congress required the
    Federal Reserve, in fiscal years 1997 and 1998 only, to calculate the
    surplus account using the current formula and then to reduce the
    account by $106 million in fiscal year 1997 and $107 million in
    fiscal year 1998.  Although the law did not specifically state the
    purpose of those transfers, its effect was to reduce the federal
    government's projected deficit in those years.  Considering that this
    provision only applies to fiscal years 1997 and 1998 and the general
    lack of criteria for assessing surplus amounts, Congress may wish to
    determine whether these surplus accounts are necessary and, if so,
    set permanently in law an appropriate amount for these accounts.

    --------------------
    \6 Member banks must subscribe to stock equal to 6 percent of their
    paid capital and surplus.  However, only half of this amount (3
    percent) must actually be paid; the remaining amount, 3 percent, is
    subject to the call of the Reserve Bank.

       CONCLUSIONS
    ---------------------------------------------------------- Chapter 3:6

    Because the Federal Reserve's spending represents a cost to U.S.
    taxpayers, the Federal Reserve should operate as efficiently as
    possible.  Our review indicates opportunities exist to reduce Federal
    Reserve spending.  Federal Reserve expenditures for personnel
    benefits varied among Reserve Banks and some benefits were generous
    compared to those of federal agencies with similar responsibilities.

    Also, we believe that opportunities exist for reductions in
    discretionary spending for health care and travel costs through the
    systemwide management of these areas.  Although several Reserve Banks
    have undertaken efforts to reduce their health care costs, we believe
    that centralized management of the Federal Reserve's health care
    plans could further reduce health care costs.  Furthermore, we
    believe travel expenses could be reduced by adopting the most
    cost-effective "best practices" in travel reimbursement policies.
    Although instituting uniform, cost-conscious practices at all Reserve
    Banks may appear contrary to the tradition of independently managed
    Reserve Banks, the Reserve Banks have adopted uniform policies and
    procedures in many areas of operation.

    Our review of contracting and procurement practices at some Reserve
    Banks also indicate opportunities to reduce discretionary spending
    for goods and services.  We believe that the Federal Reserve could
    better ensure the purchase of goods and services at reasonable cost
    through increased compliance with UAG as well as systemwide adoption
    of "best practices" in procurement and contracting.  Moreover, in its
    planning and management of the Dallas Reserve Bank construction
    project, the Reserve Bank overlooked opportunities to reduce spending
    that the Board had approved.

    Downward adjustments to the surplus account, or its elimination,
    would have a positive budgetary impact by increasing the Federal
    Reserve's annual transfer to Treasury in the years that any such
    reductions occur.\7 Federal Reserve deductions would have to exceed
    the billions of dollars transferred to Treasury annually before the
    Federal Reserve's use of the account would be necessary.  Since the
    chances of an occurrence of such an event are extremely remote, we
    believe that capping, reducing, or even eliminating the surplus
    account represents an opportunity to decrease deductions to the
    amount transferred to Treasury each year.

    --------------------
    \7 The Joint Explanatory Statement accompanying the Fiscal Year 1996
    Budget Resolution directed the Congressional Budget Office not to
    score for fiscal year 1996 any savings for new legislation that might
    affect the Federal Reserve's transfer of the surplus account to the
    U.S.  Treasury.  (H.R.  Rep.  No.  104-159 at 51 (June 26, 1995).)
    Accordingly, if such legislation had been passed, the transfer would
    not have been counted for purposes of determining compliance with the
    Budget Enforcement Act for Fiscal Year 1996.

       RECOMMENDATIONS TO THE BOARD OF
       GOVERNORS OF THE FEDERAL
       RESERVE
    ---------------------------------------------------------- Chapter 3:7

    We recommend that the Board of Governors

      -- review pay and benefits levels at the Board and the Federal
         Reserve Banks to determine if current levels can continue to be
         justified in today's environment of increased governmental and
         private-sector cost containment;

      -- assess whether managing the Federal Reserve's health care
         coverage on a systemwide basis could reduce health care costs;

      -- review travel policies at the 12 Reserve Banks and change those
         policies that increase costs;

      -- review contracting and procurement practices at the 12 Reserve
         Banks to ensure that these practices are in compliance with the
         system acquisition guidelines and result in cost-effective
         contracts;

      -- ensure that the "best practices" in contracting and procurement
         at the 12 Reserve Banks are regularly identified, disseminated,
         and adopted by the Reserve Banks; and

      -- review policies regarding the size of the surplus account and
         determine if opportunities exist to decrease the amount held in
         the account.

       MATTER FOR CONGRESSIONAL
       CONSIDERATION
    ---------------------------------------------------------- Chapter 3:8

    Congress should consider the results of the Board's review and decide
    if there is a continued need for the Federal Reserve's surplus
    account and, if so, what the appropriate amount of the account should
    be.

       FEDERAL RESERVE'S COMMENTS AND
       OUR EVALUATION
    ---------------------------------------------------------- Chapter 3:9

    In written comments on a draft of this report, the Federal Reserve's
    Board of Governors did not agree with our recommendations that they
    review pay and benefits levels and consider reducing or eliminating
    the surplus account.  The Board stated that the Federal Reserve
    strives to provide salaries and benefits competitive with local
    private sector markets and that its current pay and benefits levels
    are necessary to attract and retain skilled employees.  The Board
    agreed that the appropriate level of the surplus account is open to
    debate, but it did not agree to consider reducing or eliminating the
    surplus account.  The Board stated that reducing the surplus account
    would have no real economic impact and cited the possibility that,
    without the surplus account, temporary short-term losses could lead
    to a perceived impairment of its capital that could raise investors'
    concerns about the System's ability to conduct sound monetary policy.
    The Board agreed with our recommendations concerning the Federal
    Reserve's policies and practices regarding travel, contracting, and
    procurement.  The Board also agreed with our recommendation
    concerning the management of health care benefits.

    Because personnel costs accounted for almost 70 percent of the
    Federal Reserve's total operating costs and increased by over 50
    percent in the 1988 to 1994 period, we believe these costs should be
    one of the first areas to be examined for potential savings.  We
    acknowledge that certain benefit levels may be necessary for the
    Federal Reserve to attract and retain a skilled workforce.  However,
    we do not believe the Board has made a convincing case that these
    benefits need not be reexamined with a view toward greater cost
    containment.  In addition to the private sector, the Federal Reserve
    also competes with public sector employers, and its benefits are
    clearly more generous than those of the federal government overall.
    In some cases, the Federal Reserve's benefits are more generous than
    those of the other financial industry regulators who are the major
    employer-competitors in areas such as bank supervision.  Moreover, we
    note that less than half of the Federal Reserve's total workforce is
    highly skilled professional staff, such as lawyers, economists, and
    financial analysts.

    We maintain, and the Board agreed, that reducing or eliminating the
    surplus account, by transferring these funds to Treasury, would
    increase overall government receipts and reduce the unified budget
    deficit in the year that any such transfer occurred.  We also agree
    with the Board that reducing or eliminating the surplus account would
    be offset by a reduction in subsequent years of interest payments to
    Treasury that the Federal Reserve would have otherwise earned by
    investing these funds in government securities.  However, we believe
    Congress has a legitimate interest in deciding whether it would be
    more appropriate to have these funds returned immediately, either to
    reduce the outstanding public debt or for other purposes, rather than
    to receive them over a longer period of time.  To allow for the
    possibility that a small, temporary loss could raise investor
    concerns about the Federal Reserve's ability to conduct sound
    monetary policy, we suggested that Congress may wish to set an
    appropriate level for the surplus account as an alternative to its
    elimination.

    THE FEDERAL RESERVE SYSTEM FACES
    MAJOR MISSION- RELATED CHALLENGES
    ============================================================ Chapter 4

    The Federal Reserve System faces major challenges in its mission and
    lines of business, particularly in services to depository
    institutions and government agencies and in bank supervision.  These
    challenges include (1) increased competition from the private sector
    and increasing difficulties in recovering costs in priced services,
    (2) increasingly widespread use of electronic transactions in the
    financial services industry, and (3) the continuing rapid
    consolidation of the banking industry, which could affect both the
    need for, and the distribution of, bank examination staff.  Because
    these areas account for the largest part of the Federal Reserve's
    expenses and staffing, addressing these challenges effectively will
    likely result in major changes in how the Federal Reserve operates.
    As the Federal Reserve undertakes to meet these challenges, it is
    also likely to find that its current structure, established in 1913
    when the nation's financial industry was much less complicated, is
    increasingly inappropriate for the fast-paced, global financial world
    of today and the next century.  However, if major changes to the
    Federal Reserve's structure are to be made to promote increased
    efficiency and competitiveness, such changes will need to be
    carefully weighed against any potential effects on the independence
    of our nation's central bank.

       CHALLENGES FACING THE FEDERAL
       RESERVE WILL LIKELY AFFECT MOST
       OF THE WORKLOAD AT THE RESERVE
       BANKS
    ---------------------------------------------------------- Chapter 4:1

    The overwhelming majority of the workload and expenses incurred at
    the Reserve Banks is related to three lines of business--services to
    depository institutions, services to government agencies, and bank
    supervision and regulation.  These lines of business account for over
    90 percent of all Federal Reserve Bank expenses, as shown in table
    4.1.

                                   Table 4.1

                     Federal Reserve Banks' Operating Costs
                    by Mission-Related Categories, Calendar
                                   Year 1994

                                                          1994  Percentage
    Activities                                      (millions)    of total
    ----------------------------------------------  ----------  ----------
    (1) Monetary and economic policy                    $125.5        6.75
    (2) Services to depository institutions            1,146.5       61.70
    (3) Services to Treasury and other government        218.2       11.74
     agencies
    (4) Supervision and regulation                       368.1       19.81
    Subtotal: (2)+(3)+(4)                             $1,732.8       93.25
    ======================================================================
    Total                                             $1,858.3      100.00
    ----------------------------------------------------------------------
    Source:  Federal Reserve System.

    Except for bank supervision, most of this workload is production-
    oriented, whether paper driven, such as processing currency for banks
    and clearing checks, or electronic in nature, such as running the
    automated clearinghouse and funds transfer systems.  In these areas,
    employees often work in shifts, under fairly rigid deadlines and
    production expectations.  These three lines of business are precisely
    the areas subject to an increasing variety of external and internal
    environmental pressures and challenges.

          THE FEDERAL RESERVE FACES
          MAJOR COMPETITION, WORKLOAD
          REDUCTIONS, AND COST
          PRESSURES IN DELIVERING
          SERVICES TO DEPOSITORY
          INSTITUTIONS
    -------------------------------------------------------- Chapter 4:1.1

    In providing services to depository institutions, the Federal Reserve
    faces its most immediate and significant challenges to its mission.
    The Monetary Control Act of 1980 requires that the Federal Reserve
    base its fees for certain services--check processing, automated
    clearinghouse (ACH) transactions, Fedwire, securities transfers,
    etc--on, among other things, the costs of providing such services.
    At the same time, the Federal Reserve is required to promote the
    accessibility and efficiency of the nation's payments system, a role
    that may make it difficult for the Federal Reserve to raise prices
    sufficiently to recover its costs.  Because services to depository
    institutions represent over 61 percent of all Federal Reserve Bank
    expenses and employ the largest part of Reserve Bank staffing, these
    changes are likely to have a dramatic effect on the size of the
    Reserve Banks' expenses, workload, and staffing needs.

          THE FEDERAL RESERVE FACES
          INCREASING COMPETITION IN
          PRICED SERVICES
    -------------------------------------------------------- Chapter 4:1.2

    The Federal Reserve faces intense competition in check clearing.  In
    1993, for the first time in a number of years, the actual volume of
    checks handled by the Federal Reserve declined, albeit by a modest
    0.2 percent.  The Federal Reserve reported that the total volume of
    commercial checks for 1994 declined by almost 15 percent from 1993
    levels.  The implementation of same-day settlement rules\1

    by the Federal Reserve, beginning on January 3, 1994, is partly
    responsible for this declining trend.  Federal Reserve officials told
    us they expect further declines in the years ahead.

    A significant factor in the Federal Reserve's loss of volume and
    market share in check clearing is the growth of private
    clearinghouses.  The nation's check-clearing volume is still growing
    slowly, but on a per capita basis, the volume is stagnant.  At the
    same time, private clearinghouses competing with the Federal Reserve
    have grown.  The California Bankers Clearing House, the Chicago
    Clearing House, and the Clearing House Association of the Southwest
    reported increases in the numbers of member banks in 1994.  The
    California Bankers Clearing House also reported that it is delivering
    checks to 200 nonmember banks for same-day settlement and, in the
    process, saving its member banks $3.2 million a year in fees these
    banks would have had to pay the Federal Reserve for these services.

    Other factors promise even further reductions in check-clearing
    volume for the Federal Reserve.  These factors include

      -- electronic check presentment, in which only the essential check
         data are recorded and transmitted to the payor bank so that
         payment or return decisions can be accelerated;

      -- check imaging, which involves the use of digitized images of
         entire checks to perform processing operations;\2

      -- banking consolidation and increased interstate banking,
         resulting in the increase of "on us" checks, which will not need
         to go through a clearinghouse, and

      -- electronic banking, which is now being offered by some banks,
         could, in the long term, make paper checks an anachronism.

    In combination, these factors indicate a continued and perhaps
    accelerating decline in the Federal Reserve's check-clearing
    business.  About 22 percent of all Reserve Bank employees were
    involved in check clearing in 1994.  As volume declines, the Federal
    Reserve will need to prepare for reductions in staff required for
    cost-competitive services.

    In other priced services, the Federal Reserve is also likely to face
    increased competition.  The market share of private ACH providers,
    such as the New York Automated Clearinghouse, the Arizona
    Clearinghouse Association, and VISA will likely increase.  Even in
    book-entry securities transfer services, an area where the Federal
    Reserve currently faces only nominal competition, the Federal Reserve
    is anticipating that future developments could lead to increased
    competition.

    --------------------
    \1 Beginning in January 1994, an addendum to Regulation CC requires
    the Federal Reserve and banks engaged in private check-clearing
    arrangements to return or refund, by the end of the same business
    day, checks presented for interbank settlement before 8 a.m.  In
    addition, the clearing organization cannot charge an additional fee
    for this service.

    \2 Since March 1994, the Minneapolis Federal Reserve Bank has offered
    check imaging to its customers.

          POTENTIAL REVENUE SHORTFALLS
          PRESENT CHALLENGES IN
          MEETING PRICING PROVISIONS
          OF THE MONETARY CONTROL ACT
    -------------------------------------------------------- Chapter 4:1.3

    The Federal Reserve is facing increased difficulty in recovering its
    costs for priced services.  As shown in table 4.2, costs have
    outpaced revenues since 1990 in three of the Federal Reserve's priced
    services.

                                   Table 4.2

                       Percentage Changes in Revenue and
                       Expenses for Payments for Federal
                          Reserve Services, 1990-1994

    Service                                    Revenue            Expenses
    ------------------------------  ------------------  ------------------
    Check clearing                                -.2%               13.8%
    ACH                                           22.0                41.1
    Fedwire                                       12.0                25.8
    ----------------------------------------------------------------------
    Legend:  ACH = automated clearinghouse.

    Source:  Federal Reserve System.

    Some of the difficulties in recovering costs stem from higher than
    anticipated automation consolidation costs associated with the
    Federal Reserve Automation Services (FRAS).  (See chs.  2 and 5 for
    details on the FRAS project.) These costs have been a particular
    problem in check clearing.

    In recent times, the Federal Reserve has been able to mitigate the
    effects of these trends in several ways:

      -- The Federal Reserve has simply deferred certain automation
         consolidation costs to future years.

      -- The Federal Reserve has reduced its targeted return on equity.\3

    In 1993 and 1994, the target rate of return was about 5 percent,
    which was historically a low rate of return, primarily because of
    losses that bank-holding companies experienced in 1989 and 1991.

      -- Past overfunding of the Federal Reserve's pension plans has
         enabled the Federal Reserve to offset some additional costs of
         providing priced services by allocating a portion of the
         overfunding to priced services, resulting in a decrease in
         expenses for those services.  In 1993, for example, the amount
         of the overfunded plan allocated to priced services was $36.7
         million.  Even so, the impact of the overfunded pension plan was
         not sufficient to enable the Federal Reserve to meet its
         targeted return on equity in 1994.  The overfunding will be
         completely amortized in the year 2002.

    These conditions are all temporary.  The Federal Reserve will be
    faced with increasing pressures on its pricing policies.  For
    example, with regard to the return on equity, median rates of return
    on equity among large bank-holding companies are now in the 15- to
    16-percent range, so the target rate of the Federal Reserve may have
    to move toward that number.  Meeting a 15-percent target rate of
    return on equity would require the Federal Reserve to increase its
    revenue by about $50 million, which amounts to about a 7-percent
    across-the-board price increase.

    --------------------
    \3 The Monetary Control Act requires the Federal Reserve to include
    in its costs a private-sector adjustment factor, which contains
    adjustments for taxes and a return on equity similar to those that
    would be factored into private sector institutions' pricing policies.
    The Federal Reserve has adopted a formula that calculates the return
    on equity as the average after-tax rate of return over the preceding
    5 years by the top 25 bank-holding companies.

          THE FEDERAL RESERVE COULD
          FACE MAJOR WORKLOAD
          REDUCTIONS IN PROVIDING
          SERVICES TO THE DEPARTMENT
          OF THE TREASURY AND OTHER
          GOVERNMENT AGENCIES
    -------------------------------------------------------- Chapter 4:1.4

    Several changes in services to Department of the Treasury and other
    government agencies, and depository institutions, could have a
    significant impact on Federal Reserve costs as well as on staffing
    levels and alignment.  These changes include consolidation of U.S.
    savings bonds operations,\4 increased government use of electronic
    benefit transactions, and changes in the U.S.  currency.

    Treasury, which directs the U.S.  government's savings bonds program,
    ordered the Federal Reserve to consolidate its savings bonds
    operations to five locations.\5 This consolidation has resulted in
    the need to relocate staff at Reserve Banks that were losing savings
    bonds operations.  Most of the savings bonds employees at
    nonconsolidation Reserve Bank locations have been relocated to other
    departments at their respective Reserve Banks.  However, one Reserve
    Bank could not relocate all of its savings bonds employees to other
    departments and was forced to lay off some of those employees.

    An increased use of electronic payments in services provided to
    Treasury and other government agencies may also result in
    realignments or reductions in staff at Reserve Banks.  The National
    Performance Review's (NPR) recommendation that the U.S.  Department
    of Agriculture distribute food stamp benefits through Electronic
    Benefits Transfer (EBT) may result in the realignment of Reserve Bank
    staff.  EBT uses an automated financial transaction process and card
    access technologies to electronically deliver federal and state
    benefits to recipients via point-of-sale (POS) terminals and
    Automated Teller Machines (ATM).  Currently, the Federal Reserve
    receives the paper coupons deposited by merchants at their financial
    institutions, confirms the totals, checks for counterfeit coupons,
    destroys the coupons, credits the sending institution's account, and
    debits the U.S.  Treasury account for the value of the food coupons.
    Under the EBT system, funds would be transferred electronically from
    the U.S.  Treasury's bank account to the retailer's depository
    account via the automated clearinghouse (ACH).

    Recently, Texas converted its food-stamp operations to an EBT
    arrangement.  This necessitated the Dallas Federal Reserve Bank's
    eliminating 22 positions in its food-stamp processing area.

    Introduction of a 1-dollar coin, which is currently being considered
    by Congress, could result in dramatic staffing reductions in Reserve
    Banks' currency processing operations.  Many nations use a coin for
    monetary transactions at, and in many cases well above, the level for
    which the United States uses a paper dollar.  Although the Susan B.
    Anthony 1-dollar coin was not accepted by the public when it was
    introduced in 1979, a switch to a 1-dollar coin, particularly if the
    paper dollar were withdrawn from circulation, could nevertheless
    reduce Federal Reserve expenses and result in savings to the
    taxpayers.

    One-dollar paper notes make up approximately 40 percent of the
    currency processed by Federal Reserve Banks.  Officials told us that
    if the 1-dollar coin were introduced and the 1-dollar bill were
    removed from circulation, substantial reductions in currency
    processing staff would need to be made, perhaps resulting in the
    elimination of the second shift processing at many Reserve Banks.

    --------------------
    \4 The Reserve Banks issue, service, and redeem U.S.  savings bonds
    on behalf of Treasury.

    \5 The following are the consolidated locations:  (1) Buffalo branch
    of the New York Reserve Bank, (2) Pittsburgh branch of the Cleveland
    Reserve Bank, (3) Richmond Reserve Bank, (4) Minneapolis Reserve
    Bank, and (5) Kansas City Reserve Bank.

          CHANGES IN BANK SUPERVISION
          AND REGULATION COULD AFFECT
          STAFFING ALIGNMENTS AND
          REVENUES
    -------------------------------------------------------- Chapter 4:1.5

    The continuingly intense banking industry consolidation would likely
    affect the locations and need for Federal Reserve bank examination
    staff.  As banks merge or are acquired, the Federal Reserve will face
    the need to reexamine its current distribution of examination staff.
    Some Reserve Banks may see a need for increased staffing; others may
    find that they must radically reduce their examination staffs.  As an
    example, figure 4.1 shows the percentage changes in the number of
    state-member banks by Federal Reserve district for the period of 1990
    to 1995.

       Figure 4.1:  Percentage Change
       in State- Member Banks by
       Federal Reserve District,
       1990-1995

       (See figure in printed
       edition.)

    Note:  Data are as of December 1990 and as of June 1994.

    Source:  Federal Reserve System.

    Less certain are the potential effects of any bank regulatory
    consolidation Congress may enact.  Differing consolidation proposals
    have been made to consolidate federal financial institutions'
    regulatory responsibilities.  Some proposals would provide for the
    complete consolidation of all regulation into a single federal
    regulator.  Other proposals envision retaining or even increasing the
    responsibilities of the Federal Reserve in bank supervision.

    Some proposed changes to the banking regulatory structure have raised
    policy issues about the Federal Reserve's role in bank regulation.
    The Federal Reserve has raised strong objections to a new regulatory
    system in which its role in direct bank supervision would be
    eliminated or substantially reduced.  Federal Reserve officials argue
    that the System's ability to conduct monetary policy and operate the
    payments system and the discount window would be greatly impaired by
    the removal of its responsibilities for regulating and supervising
    bank-holding companies and state- member banks.  Likewise, those who
    support maintaining the Federal Reserve's involvement in bank
    regulation argue that if the Federal Reserve is to be responsible for
    forestalling financial crises and effective as the "lender of last
    resort," the Federal Reserve must have direct experience with at
    least a portion of the depository institutions.  On the other hand,
    others argue that the Federal Reserve can obtain information needed
    for monetary control through other means, such as reports from other
    agencies or Board representation on other agencies.

    Because supervision and regulation activities account for
    approximately 20 percent of Federal Reserve Bank operating expenses,
    a reduction in the central bank's direct role in bank supervision and
    regulation could have a significant impact on the Reserve Banks.
    Conversely, if the Federal Reserve were given responsibility for some
    or all of the largest banks, the percentage of the banking system
    assets for which the Federal Reserve would be the primary regulator
    could increase.  While assigning large banking organizations to the
    Federal Reserve would address concerns about systemic risk, this
    could change the geographic distribution of Federal Reserve
    supervisory responsibilities.  Such a redistribution would, of
    course, affect expenditures at individual Reserve Banks.

    The Federal Reserve's revenues, and hence its return to the
    taxpayers, would be enhanced by charging fees for bank examinations.
    Federal bank regulators differ in their policies regarding the
    assessment of fees for bank examinations.  The Office of the
    Comptroller of the Currency (OCC) charges national banks for
    examinations that it conducts.  In contrast, state-chartered banks,
    which are supervised by either the Federal Reserve or the Federal
    Deposit Insurance Corporation (FDIC) in conjunction with state-
    banking agencies, are charged fees by those state-banking agencies
    but not by their federal regulator.  Thus, the costs of the Federal
    Reserve's bank examinations--$368 million in 1994--are borne by the
    taxpayers, while for national banks, the costs of examinations are
    borne by the banks that are examined.  The Federal Reserve Act
    authorizes the Federal Reserve to charge fees for bank examinations,
    but the Federal Reserve has not done so, either for the state-member
    banks it examines or the bank-holding company examinations it
    conducts.  Similarly, FDIC is authorized to charge for bank
    examinations but does not do so.  The administration's fiscal year
    1996 budget includes provisions for both FDIC and the Federal Reserve
    to charge for bank examinations.

    The Federal Reserve is concerned that if it instituted charges for
    its bank examinations it could create incentives for state-member
    banks, who are already charged for state examinations, to either
    change their charters to national charters or resign membership in
    the Federal Reserve (opting to be supervised by FDIC as
    state-nonmember banks), to avoid paying fees for both state and
    federal examinations.  Such incentives, the Federal Reserve believes,
    would have major disruptive effects on the dual banking system.

    We believe any disruption would be small.  At the end of 1994, there
    were 3,078 national banks with 56 percent of total bank assets, 6,398
    state-chartered nonmember banks with 23 percent of total bank assets,
    and only 974 state-chartered member banks with 21 percent of total
    bank assets.  Thus, the number of banks that would be affected is
    relatively small.  If the FDIC also adopted examination fees,
    incentives for banks to become state-nonmember banks to avoid such
    fees would be eliminated.  With respect to double-charges for bank
    examinations, we believe an equitable fee-sharing arrangement with
    state agencies that is based on the division of supervisory
    responsibility seems possible.  Moreover, charging for bank-holding
    company examinations would not present such possible disruptions
    because the Federal Reserve is their federal regulator, regardless of
    whether the subsidiary banks are chartered by OCC or the states.
    Charging holding company examination fees might also encourage
    greater efficiency in supervising banking organizations.

       MISSION-RELATED CHALLENGES AND
       EFFORTS TO REDUCE EXPENSES ARE
       LIKELY TO RAISE QUESTIONS ABOUT
       THE STRUCTURE OF THE FEDERAL
       RESERVE SYSTEM
    ---------------------------------------------------------- Chapter 4:2

    Addressing the challenges discussed above will likely result in
    dramatic changes in staffing and how work is done at the Reserve
    Banks.  In addition, continuing pressures to contain costs, in part
    fueled by the increasing competition from the private sector in
    priced services, may result in changes in how Federal Reserve
    programs are managed.  Taken together, such changes will likely call
    into question the continuing appropriateness of the Federal Reserve's
    current structure.

          EFFECTIVELY ADDRESSING
          CHALLENGES WILL LIKELY
          RESULT IN SMALLER RESERVE
          BANKS
    -------------------------------------------------------- Chapter 4:2.1

    Changes that can affect many of the Federal Reserve's lines of
    business--particularly those concentrated at the Reserve Banks, such
    as check clearing, currency processing, and bank supervision--may
    result in substantial reductions in staffing at the Reserve Banks in
    the years ahead.  These trends are already beginning to occur.
    Overall staffing at the Reserve Banks has declined modestly by 1.4
    percent from the first quarter of 1994 to the first quarter of 1995.
    And staffing in the line of business, services to financial
    institutions and the public, which includes priced services, declined
    somewhat more--by 2.2 percent.  Some Reserve Banks have offered
    "early out" retirements to some employees to encourage reductions
    during 1988 to 1994.

    As Reserve Banks contract in size, the continuing justification for
    the overhead structure, replicated at 12 Reserve Banks, will be
    called into question.  Federal Reserve overhead expenses rose from
    $355 million in 1988 to $564 million in 1994, an increase of about 59
    percent.  This is one of the greatest increases among the Federal
    Reserve's lines of business for this period.  As the Federal Reserve
    faces the challenges we have just described, it will have significant
    opportunities to reduce staffing and, therefore, costs, particularly
    at the Reserve Banks.  As this occurs, the Federal Reserve should
    plan to reduce overhead expenses comparably.

          COST MINIMIZATION PRESSURES
          COULD RESULT IN MORE
          CENTRALIZED MANAGEMENT OF
          FEDERAL RESERVE PROGRAMS
    -------------------------------------------------------- Chapter 4:2.2

    Increased competition from the private sector and the continuing need
    to make governmental functions as cost efficient as possible will
    likely require that the Federal Reserve achieve significantly greater
    efficiencies in its operations--for example, in personnel pay and
    benefits, travel costs, procurement, and other areas.  Systemwide
    management of many Federal Reserve activities has the potential to
    reduce costs to taxpayers, the government, and financial
    institutions.  The Federal Reserve has often chosen in the past to
    manage programs on a systemwide basis for reasons of efficiency and
    to ensure effective operations of Reserve Bank programs.  For
    example, some Federal Reserve benefits are established systemwide and
    are available at the same levels to all employees, regardless of
    where they work.  In this regard, the Board of Governors sets
    benefits for all Federal Reserve employees.  These systemwide
    benefits include retirement plans, thrift savings plans, business
    travel/accident insurance, life and survivor insurance, and a
    long-term disability income plan.  Benefits that are not established
    systemwide include health benefits and various types of leave, such
    as marriage leave and bereavement leave (see app.  III).

    For large System projects, the Federal Reserve has often taken a
    systemwide approach to procurement and management.  When the Federal
    Reserve determined the need for a new generation of currency
    processing equipment, a single contract was used to purchase all 132
    machines from a single vendor.  According to the Board's Division of
    Reserve Bank Operations and Payment Systems' (DRBOPS) Cash Manager,
    this helped ensure a better price compared to prices resulting from
    the Reserve Banks' purchasing the machines individually.  When the
    Federal Reserve determined the need for the Federal Reserve's data
    processing and communications to have improved reliability, risk
    management, and security, among other things, Reserve Bank and Board
    decisionmakers chose to centralize those operations at three centers
    rather than continue separate operations at each of the Reserve
    Banks.

    Finally, when the Office of the Inspector General (OIG) criticized
    the individual ethics programs at the Reserve Banks, the Federal
    Reserve responded by establishing uniform ethics standards (the
    Uniform Code of Conduct) and standardizing financial disclosure and
    other ethics-related forms throughout the Federal Reserve.

    We have also identified several opportunities for the Federal Reserve
    to better control costs and increase efficiencies through increased
    systemwide management.  These include the Federal Reserve's taking
    the following steps:

      -- review benefits programs at the 12 Reserve Banks to reduce or
         eliminate benefits that are not necessary to attract and retain
         a quality workforce;

      -- manage other benefits--such as health plans--on a cost-effective
         systemwide basis, utilizing the combined bargaining power of the
         12 Reserve Banks;

      -- standardize travel policies and procedures to eliminate
         anomalies among the Reserve Banks that may result in unnecessary
         expenditures; and

      -- review contracting and procurement practices at the 12 Reserve
         Banks to (1) eliminate practices that could result in excessive
         costs and (2) promote and publicize "best practices" that are
         identified.

    As more centralized management is instituted, the continuing need for
    separate management structures at the 12 Reserve Banks may
    increasingly be called into question.  For example, increasingly
    uniform Reserve Bank personnel policies would reduce the need for 12
    separate Reserve Bank personnel departments.  Similarly, if travel
    policies are made more consistent, travel may be able to be managed
    more efficiently on a systemwide basis.

          MANY ASPECTS OF THE
          RATIONALE FOR THE FEDERAL
          RESERVE'S STRUCTURE ARE
          OUTMODED
    -------------------------------------------------------- Chapter 4:2.3

    The structure of the Federal Reserve was shaped when the U.S.
    economy was much more regional in nature.  For example, during
    congressional debate on establishing the Reserve Banks, a Member of
    Congress said that the numbers and locations of the Reserve Banks
    should be such that
    ".  .  .  no bank be more than an overnight's train ride from its
    Reserve Bank." Today, the increased use of electronic funds and
    securities transfers make the geographical location of Reserve Banks
    irrelevant for many functions.

    Demographics that shaped decisions about the location of Reserve
    Banks have also changed profoundly.  Except for minor boundary
    changes, the geographical structure of the Federal Reserve has
    remained unchanged since 1914, while the nation's population has
    shifted dramatically.  Although population statistics are an inexact
    proxy for all matters considered in the original decisionmaking, they
    have rough parallels in bank assets, check- clearing volume, currency
    needs, and other factors that have an impact on the Federal Reserve's
    lines of business.

    Since 1914, population growth and shifts have resulted in increasing
    disparities in population in the 12 Reserve districts, which were
    fairly similar in size in 1914.\6 For example, the San Francisco
    Reserve Bank in 1914 served 6 percent of the nation's population; the
    St.  Louis Reserve Bank served almost 10 percent.  As of 1990, the
    San Francisco Bank served almost 20 percent of the population, while
    the St.  Louis Bank served just 5 percent.  Overall, in 1914, the
    populations served by the Reserve Banks represented a range of 5 to
    14 percent of the nation's population.  By 1990, the range had spread
    to 3 to 19 percent of the nation's population, as shown in table 4.3.

                                        Table 4.3

                          A Comparison of the Population Within
                         Federal Reserve Districts, 1910 v. 1990

                    1910                                1990
    District  population     Percent        Rank  population     Percent        Rank
    --------  ----------  ----------  ----------  ----------  ----------  ----------
    Boston     6,307,000           7           8  12,378,000           5          10
    New York  11,329,000          12           2  20,514,000           8           5
    Philadel   5,953,000           6           9  11,506,000           5          11
     phia
    Clevelan   8,375,000           9           5  16,108,000           7           7
     d
    Richmond   8,479,000           9           4  23,305,000          10           4
    Atlanta    9,094,000          10           3  31,833,000          13           2
    Chicago   13,114,000          14           1  30,601,000          12           3
    St.        8,273,000           9           6  12,528,000           5           9
     Louis
    Minneapo   4,432,000           5          12   7,574,000           3          12
     lis
    Kansas     6,899,000           7           7  13,541,000           6           8
     City
    Dallas     4,539,000           5          11  18,467,000           8           6
    San        5,434,000           6          10  46,500,000          19           1
     Francis
     co
    ================================================================================
    Total     92,228,000                          244,855,00
                                                           0
    --------------------------------------------------------------------------------
    Source:  U.S.  Bureau of the Census.

    Further changes in the nation's population, coupled with reduced
    staffing at the Reserve Banks and increasing systemwide management of
    the Federal Reserve, call into question the continuing need for 12
    Reserve Banks.

    In addition, an examination of the continuing need for maintaining 25
    branch banks may be appropriate.  Although the Board has authority to
    open or close branch banks, it has not done so frequently.
    Twenty-four of the current 25 branch banks were established by 1927.
    Since then, the Board has opened only one additional branch bank--the
    Miami branch of the Atlanta Federal Reserve Bank in 1975.  The Board
    has only closed one branch bank in the Federal Reserve's history; the
    Spokane branch of the San Francisco Reserve Bank was closed in 1938.
    Considering the substantial changes in the nation and its financial
    system since most of the branches were established, an overall review
    of the branch bank structure would seem appropriate.

    --------------------
    \6 The 1910 census data were the closest to 1914, which was the year
    the Federal Reserve opened for business.

       ANY STRUCTURAL CHANGES WILL
       NEED TO BE WEIGHED AGAINST
       CONCERNS ABOUT THE INDEPENDENCE
       OF OUR NATION'S CENTRAL BANK
    ---------------------------------------------------------- Chapter 4:3

    The Federal Reserve's structure, established in 1913, was the end
    result of many compromises designed to promote Federal Reserve
    accountability to the public, and, at the same time, to maintain
    Federal Reserve independence from the nation's political processes.
    The importance of the banking industry was acknowledged by
    establishing member banks as owners of Reserve Bank stock.  At the
    same time, representation from the public was ensured through the
    membership of the Reserve Banks' Boards of Directors, which are
    chosen to include a diverse representation from agriculture,
    commerce, industry, services, labor, and consumers across each
    Reserve Bank's district.  The importance of money centers, such as
    New York and San Francisco, was geographically balanced through the
    creation of 12 Reserve Banks--the maximum allowed under the Federal
    Reserve Act--thus ensuring that both rural and urban interests would
    be represented in the work and the deliberations of our central bank.
    In the same way, the power of the Board was tempered by establishing
    the Reserve Banks as independent entities subject only to the
    "general supervision" of the Board.  Finally, while the Federal
    Reserve was created by an act of Congress and is required to report
    periodically to Congress, its actions do not need to be ratified by
    Congress or the president and, as explained in previous chapters, it
    is funded independently from the congressional appropriations
    process.

    In many ways, these compromises have served the nation well and have
    created additional benefits for the Federal Reserve perhaps not fully
    envisioned when the Federal Reserve Act was passed.  Federal Reserve
    officials believed that the broad geographic diversity represented by
    the Reserve Banks aids in the conduct of monetary policy by ensuring
    that various regional perspectives on the nation's economy are heard.
    A total of 281 individuals, many of whom are prominent leaders of
    industry, the financial services community, labor groups, and
    consumer interests, serve as directors of the Reserve Banks and their
    branches.  These directors provide both a sounding board for Federal
    Reserve policies as well as an established "community of interest" to
    support the Federal Reserve when challenges to its independence
    arise, as they have from time to time in the past.  Federal Reserve
    officials also feel that this community of directors provides a very
    useful network of relationships for the nation's economy during times
    of financial crisis.

    We are not in a position to fully evaluate the merits of these
    benefits for the Federal Reserve or the nation.  If, because of the
    major challenges facing the Federal Reserve, changes to the Federal
    Reserve's structure are contemplated, these issues would need to be
    carefully evaluated when doing so.  As to the benefit of having
    diversity of economic information for monetary policy purposes, in
    today's information age, it is likely that sufficient quality
    economic information could be gathered in some manner, even if the
    number of Reserve Banks were reduced.  As to the benefits of its
    directors' network of support, the effects of a reduction in the
    numbers of Reserve Banks or a diminution of their responsibilities is
    less clear.  If some Reserve Banks were to become, in effect, merely
    payments system processing centers, for example, the ability of these
    banks to attract prominent directors might be jeopardized.  Any
    actual or perceived effects this might have on the independence of
    the Federal Reserve would need to be weighed carefully against any
    potential improvements in efficiency and cost savings that such
    changes would yield.

       CONCLUSIONS
    ---------------------------------------------------------- Chapter 4:4

    In this and previous chapters we have discussed a number of changes
    facing the Federal Reserve.  These are summarized below in table 4.4.

                                        Table 4.4

                          Impact of Changes in Lines of Business
                         on Federal Reserve Staffing and Finances

                                                                    Actual or
                                                                    potential impact
                                                                    on Reserve
                                                                    Banks' staffing
    Change/Potential change                 Status                  and/or finances
    --------------------------------------  ----------------------  ----------------
    Changes affecting priced services
    --------------------------------------------------------------------------------
    Automation consolidation--FRAS          Under way               Some reduction
                                                                    in personnel who
                                                                    run mainframe
                                                                    operations;
                                                                    increasing costs
                                                                    for priced and
                                                                    other financial
                                                                    services

    Check imaging; growth of electronic     In process              Reduced need for
    payments                                                        personnel who
                                                                    process checks

    Growth of private check clearinghouses  In process              Reduced need for
                                                                    personnel who
                                                                    process checks

    Same-day settlement rules               Implemented             Has already
                                                                    resulted in
                                                                    decreased check
                                                                    volume; may
                                                                    contribute to
                                                                    further
                                                                    reductions of
                                                                    staff who
                                                                    process checks

    Interstate banking                      In process              Further
                                                                    reduction in
                                                                    personnel who
                                                                    process checks
                                                                    due to increase
                                                                    of "on us"
                                                                    checks;
                                                                    uncertain
                                                                    effects on bank
                                                                    examination
                                                                    staff

    Revenue shortfalls in priced services   Currently occurring     Threatens cost
                                                                    recovery mandate
                                                                    of the Monetary
                                                                    Control Act

    Changes affecting services to Treasury and depository institutions
    --------------------------------------------------------------------------------
    Savings bond consolidation              Completed               So far has
                                                                    resulted in
                                                                    staff
                                                                    realignments,
                                                                    but no major
                                                                    reductions, at
                                                                    Reserve Banks
                                                                    and branches

    1-dollar coin                           Proposed                May reduce need
                                                                    for staff who
                                                                    process
                                                                    currency;
                                                                    reduced currency
                                                                    costs for the
                                                                    Federal Reserve

    Electronic food stamps/EBT              Under way               Some net
                                                                    reduction in
                                                                    personnel who
                                                                    process paper
                                                                    food stamps

    Changes affecting bank supervision and reserves
    --------------------------------------------------------------------------------
    Bank regulatory consolidation           Congress must enact     Uncertain, but
                                            law                     could result in
                                                                    reductions in
                                                                    bank examination
                                                                    staff

    Charging for bank examinations          Federal Reserve         Increases in fee
                                            currently has           income of
                                            authority               approximately
                                                                    $300 to $400
                                                                    million per year

    Banking industry consolidation          Under way               Changes in
                                                                    distribution of,
                                                                    if not
                                                                    reductions in,
                                                                    bank examination
                                                                    staff

    Changes in managing the System as a whole
    --------------------------------------------------------------------------------
    Systemwide approaches in personnel      May be inevitable       Reductions in
    (e.g., health benefits, travel, etc.)                           overhead-bank
                                                                    administration

    Reduction of Federal Reserve overhead   Should occur as other   Reduced Federal
                                            expenses are reduced    Reserve costs
    --------------------------------------------------------------------------------
    Legend:

    EBT = Electronic Benefits Transfer
    FRAS = Federal Reserve Automation Service

    Source:  GAO analysis.

    Taken together, these changes will likely result in substantial
    reductions in staffing at the Reserve Banks, which will likely call
    into question the continued appropriateness of the Federal Reserve's
    current structure.  We believe that responding to these challenges
    and making any accompanying structural changes that may become
    desirable can best be effectively accomplished through strategic
    management and planning by both the Reserve Banks and the Board
    working together for the System.  In chapter 5, we focus on strategic
    planning and how the Federal Reserve can take steps to proactively
    manage for these current and future challenges.

    GREATER SYSTEMWIDE FOCUS WOULD
    STRENGTHEN STRATEGIC MANAGEMENT
    PROCESSES
    ============================================================ Chapter 5

    If the Federal Reserve is to effectively meet the challenges it faces
    and streamline operations, the Board and the Reserve Banks must work
    together to strategically plan for the future.  Our prior work in
    public- and private-sector management reform showed that
    organizations that have been successful in improving their efficiency
    have done so by effectively implementing initiatives to focus on
    their primary missions and business lines, realign their structures
    to fit their mission, and apply technology to their work processes.
    Without strong external pressure to minimize overall costs, the
    Federal Reserve must create the necessary self-discipline for the
    institution to adequately control its costs and respond effectively
    to future challenges.  However, we found weaknesses in the planning,
    budgeting, and internal oversight processes that are key mechanisms
    for helping accomplish these goals.  A fundamental review of the
    Federal Reserve's missions, structure, and use of technology would
    present the Federal Reserve with profound cultural challenges;
    however, the Federal Reserve has begun to show that it can address
    operational issues strategically and work in a systemwide manner when
    necessary.  As the Federal Reserve enters the next century, it is
    vital that both the Reserve Board and the Banks continue to foster a
    systemwide focus so that the Federal Reserve can fulfill its mission
    in an efficient and effective manner.

       PUBLIC AND PRIVATE
       ORGANIZATIONS ACHIEVED SUCCESS
       THROUGH MANAGEMENT REFORM
    ---------------------------------------------------------- Chapter 5:1

    On the basis of our earlier work in public- and private-sector
    management reform, we found that leading organizations were able to
    effectively adapt to changes and challenges in their environment by
    planning strategically for the future.\1 These organizations had the
    management processes in place--strategic planning, budgeting, and
    performance measurement--that supported their top leadership in
    setting strategic direction and establishing organizationwide
    priorities.  Through strategic planning, organizations were able to
    better identify emerging issues and challenges and posture themselves
    to address these changes proactively.  Successful organizations also
    integrated their planning processes with budgeting and performance
    management.  With sound budgeting processes, these organizations were
    better able to weigh the priorities of the moment against those of
    the future.  These organizations were also able to identify mistakes
    and make the appropriate adjustments by linking their budgeting
    processes to performance management.

    Our work has also shown that public and private sector organizations
    that were able to achieve significant cost reductions while improving
    performance and service delivery did so by fundamentally rethinking
    their mission, strategic goals, lines of business (products and
    services), and customer needs.  As a result of these reassessments,
    organizations sometimes found it necessary to redefine all or part of
    their missions, set new strategic goals, and modify their lines of
    business.

    In redefining their missions and strategic goals, organizations
    sometimes found that a fundamental rethinking and radical redesign of
    their key business and work processes was needed.  Known as business
    process reengineering, this fundamental rethinking seeks to achieve
    dramatic improvements in critical performance measures.  In reviewing
    their core management and business processes, these leading
    organizations identified those that were highest in cost, were most
    customer sensitive, and presented the most significant opportunities
    and risks for improvement.  They then considered the full range of
    information technology alternatives and information needs to
    determine how information technology could simplify and reduce the
    time and cost of carrying out these work processes.  After
    considering the range of needs and available alternatives, these
    organizations radically redesigned these work processes to better
    carry out their core missions.

    --------------------
    \1 See Executive Guide:  Improving Mission Performance Through
    Strategic Information Management and Technology (GAO/AIMD-94-115, May
    1994); Managing for Results:  State Experiences Provide Insights for
    Federal Management Reforms (GAO/GGD-95-22, Dec.  21, 1994); Managing
    for Results:  Experiences Abroad Suggest Insights for Federal
    Management Reforms (GAO/GGD-95-120, May 2, 1995); and Government
    Reform:  Goal-Setting and Performance (GAO/AIMD/GGD-95-130R, Mar.
    27, 1995).

       STRATEGIC PLANNING PROCESSES
       COULD BENEFIT FROM GREATER
       SYSTEMWIDE FOCUS
    ---------------------------------------------------------- Chapter 5:2

    As discussed in chapter 4, the Federal Reserve faces major challenges
    to its business lines, particularly in the delivery of priced
    services to financial institutions.  To effectively address these
    challenges, the Board and Reserve Banks need to work together to
    strategically plan for the future.  We found that the Federal Reserve
    had a range of strategic plans and strategic planning initiatives in
    place or under development.  For example, Board divisions and Reserve
    Banks had strategic planning processes that supported the formulation
    of strategic plans.  According to Federal Reserve planning documents,
    the strategic planning process is to be linked to the Federal
    Reserve's budgeting and resource allocation process.  In addition to
    these strategic plans, strategic plans at the System-level had been
    adopted, or were being developed, for Financial Services and
    Information Technology.  However, the Federal Reserve did not have a
    process for integrating these individual planning processes and
    providing a systemwide focus for assumptions involving the future
    environment and relationships among functions.  As a result, the
    Federal Reserve may not be making the best use of its many strategic
    planning processes to prepare for the future and undertake the bold
    thinking that is needed to address current and future challenges.

          CHAIRMAN, BOARD, AND RESERVE
          BANKS HAVE ROLES IN
          STRATEGIC PLANNING
    -------------------------------------------------------- Chapter 5:2.1

    Strategic planning within the Federal Reserve is carried out by the
    Chairman, the Board, and the Reserve Banks.  As the chief executive
    officer of the Board, the Chairman is responsible for, among other
    things, providing (1) overall leadership and organizational direction
    to help establish major policy goals of the Federal Reserve and (2)
    administrative direction to the other Governors, the Board staff, and
    Reserve Banks.  In his leadership capacity, the Chairman is involved
    in key decisions relating to major organizational structure changes
    that are designed to achieve strategic goals.  The Chairman also
    conveys his views on the future direction, goals, and objectives of
    Federal Reserve policy through participation in meetings with the
    chairmen of Reserve Banks' boards of directors and various Federal
    Reserve conferences.

    The Board, which sets policy for the Federal Reserve, also has a role
    in strategic planning.  The Board carries out its work through
    regular meetings and is assisted by standing committees and ad hoc
    committees.  The standing committees perform a range of functions.
    The committees help formulate policy, review annual budgets for the
    relevant Board staff units, and monitor the performance of Board
    staff units or Reserve Banks against the approved budget.  One of the
    standing committees, the Committee on Reserve Bank Activities, is
    responsible for overseeing the administrative operations of the
    Federal Reserve.  Its purview includes general supervision over
    Reserve Bank operations, budgets, and planning activities and
    oversight of DRBOPS.

    Each of the Reserve Banks has a strategic planning process that
    establishes goals and direction for the Reserve Bank.  Because of the
    independent structure of the Reserve Banks and shared supervisory
    authority within the Federal Reserve, the Reserve Banks have
    established a conference structure, composed of the Conference of
    Presidents (COP) and the Conference of First Vice Presidents (COFVP),
    to help develop systemwide consensus on issues and proposals that
    affect all Reserve Banks.  COP, representing the Reserve Bank
    presidents, focuses on issues related to discounts and credits,
    management systems, strategic planning, personnel, legislation and
    regulations, supervision, and research.  COFVP, representing the
    Reserve Bank first vice presidents, focuses on operational issues
    affecting the Reserve Banks.  The conferences are supported by
    committees and subcommittees that administer the bulk of the
    conferences' work and often initiate projects.  The organizational
    structures of COP and COFVP are shown in figures 5.1 and 5.2.

       Figure 5.1:  Organization of
       the Conference of Presidents

       (See figure in printed
       edition.)

    Source:  Federal Reserve System.

       Figure 5.2:  Organization of
       the Conference of First Vice
       Presidents

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

    Source:  Federal Reserve System.

    In late 1994, a new management structure was installed to streamline
    the decisionmaking process and increase the accountability of Reserve
    Bank first vice presidents for strategic planning of financial
    services--which are priced services and other services, such as cash
    operations--provided to financial institutions.  Under the new
    structure, the Financial Services Policy Committee, which is composed
    of two presidents and three first vice presidents, is responsible for
    the overall direction of financial services and related support
    functions.  Furthermore, the committee serves as the vehicle for
    conveying major issues to the Board for discussion and actions.

    The new structure has dramatically altered the responsibilities of
    COFVP.  COFVP maintains responsibility over the budget process.  The
    Financial Services Management Committee is composed of six first vice
    presidents--the chairperson, four product group directors, and the
    director of automation services.  The management committee is
    responsible for developing and implementing business plans for the
    financial services and monitoring budgets and projects.  The
    Financial Services Operations Council is responsible for coordination
    and provides advice to the management committee.  The product offices
    are responsible for planning the future direction of each service
    area and receive support from their respective advisory groups.  To
    carry out the Board's supervisory role, DRBOPS staff serve as
    liaisons to the various groups in the new structure.

    Figure 5.3 illustrates the new structure for financial services
    management.

       Figure 5.3:  Organization of
       Financial Services Management

       (See figure in printed
       edition.)

    \a The Business Development Advisory Group reports to the Management
    Committee Chair.

    \b The Automation/Communications Advisory Group will work with both
    FRAS and Support Services.

    Source:  Federal Reserve System.

          PLANNING PROCESSES FOCUSED
          ON INDIVIDUAL GOALS AND
          OBJECTIVES
    -------------------------------------------------------- Chapter 5:2.2

    Although the Federal Reserve has a range of strategic planning
    processes or programs in place or under development, we found these
    processes were not designed to address, on behalf of the Federal
    Reserve, the critical challenges raised by an increasing need to
    constrain costs, likely changes for System business lines, or the
    possible implications of those changes on the Federal Reserve's
    structure.  In reviewing the Federal Reserve's strategic plans and
    strategic programs under development, we found that they were
    generally focused on the strategic goals and objectives of individual
    divisions, Reserve Banks, or functions.  While we believe these plans
    serve an important purpose in defining the direction of these Federal
    Reserve entities, we believe that the emerging issues and challenges
    facing the Federal Reserve will necessitate bold strategic planning
    focused on the System as a whole.  For example, the Federal Reserve
    may find the System's long-term interest better served, both from a
    cost-reduction and performance perspective, by a review of (1) the
    System's mission and business lines; (2) the need for all Reserve
    Banks to perform many of the same functions; and (3) the potential
    for further consolidation or centralization of certain missions and
    functions.  Determining the future direction of the Federal Reserve
    and what is best for the System overall, will require the Chairman,
    the Board, and the Reserve Banks to make hard decisions that will
    raise further issues and concerns regarding their impact on the
    Federal Reserve's system of shared leadership and control.

          LIMITED AUTHORITY MAY HAMPER
          RECENTLY ESTABLISHED FEDERAL
          RESERVE PLANNING
          COORDINATION GROUP
    -------------------------------------------------------- Chapter 5:2.3

    The Federal Reserve recently took action toward achieving greater
    integration of its strategic planning processes.  Recognizing the
    need for a more systemwide focus, the Board, in mid-1995, chartered
    the establishment of a new planning entity known as the Federal
    Reserve System Strategic Planning Coordination Group (SPCG).  In
    assembling SPCG, the Federal Reserve put together an organizationally
    diverse group whose membership includes the Chairman of the Board
    (who serves as an ex officio member) and representatives of the
    Board, and the Reserve Banks, and all major functional and support
    areas.  SPCG is to provide a common framework for the development and
    refinement of the many individual strategic plans and action plans
    within the Federal Reserve.  According to Federal Reserve planning
    documents, several Board members and Reserve Bank presidents believed
    that the discrete strategic planning processes within the Federal
    Reserve would benefit from greater coherence, especially in terms of
    assumptions about the future environment and interrelationships among
    functions.

    While we believe the establishment of SPCG is a positive step for the
    Federal Reserve, we are concerned that SPCG's scope of responsibility
    and authority may be too limited.  Specifically, SPCG was tasked to
    develop for senior management (governors, presidents, first vice
    presidents, and certain Board division directors) a document setting
    forth a common

      -- view of the mission, vision, values, and priorities of the
         Federal Reserve;

      -- view of, and assumptions about, the future environment in which
         the Federal Reserve will operate;

      -- understanding of the strengths and opportunities, as well as the
         weaknesses and vulnerabilities, of the Federal Reserve; and

      -- recognition of major challenges or redirections facing the
         Federal Reserve.

    In describing the scope of SPCG's work, the Board also identified the
    following four important issues that the group might address.

      -- How can the Federal Reserve Board and Reserve Banks work better
         as a System rather than as 13 separate entities?

      -- How can the Board and Reserve Banks achieve better coordination
         across functional areas within units and within the Federal
         Reserve?

      -- How can the Board and Reserve Banks achieve better coordination
         across units within functional areas?

      -- Are there changes or innovations in the structure or governance
         of the Federal Reserve that would make it work better?

    If the Federal Reserve is to more fully use SPCG, it may need to (1)
    broaden the group's responsibilities to specifically include a
    fundamental review of Federal Reserve operations focusing on the
    primary mission, business lines, and structure that would best
    support the Federal Reserve's overall mandate in an environment of an
    increasingly constrained federal budget and (2) better empower the
    group to have an impact by changing expectations throughout the
    Federal Reserve about the nature of the changes that could result
    from the group's work.  The SPCG Chairman and Vice Chairman have
    stated that SPCG is not intended to develop new specific action plans
    or objectives or to override plans or objectives already in place,
    for either functional areas or organizational units.  Rather, the
    results of the planning coordination process would be the common
    framework for developing and refining constituent strategic plans and
    action plans.  Minutes of a September 1995 SPCG meeting indicated the
    group's concern about its limited authority.  The minutes identified
    several important questions as being planned to be addressed by the
    group.  Two of these questions were (1) how the group could guide
    organizational decisionmaking, help set priorities for the Federal
    Reserve, and drive the System's budget processes and (2) how the
    group could strike an appropriate balance between a system framework
    and the system strength derived from district/functional autonomy.

       BETTER LINKAGE OF INFORMATION
       TECHNOLOGY PLANNING TO
       STRATEGIC DECISIONMAKING NEEDED
    ---------------------------------------------------------- Chapter 5:3

    Beginning in the latter 1980s, information technology within the
    Federal Reserve underwent a profound change.  Between 1988 through
    1994, the Federal Reserve spent hundreds of millions of dollars on
    information technology.  By late 1995, according to Federal Reserve
    planning documents, most mission-critical applications had been or
    were being completely rewritten; a new network, FEDNET,\2 had been
    built and was being deployed; and the FRAS organization, established
    to consolidate the mainframe processing function, had assumed
    responsibility for most mainframe processing.

    While we did not do an in-depth review of FRAS, we believe that such
    an approach makes sense.  However, Reserve Banks have remaining
    concerns about the spillover implications of a systemwide approach to
    mainframe processing consolidation for the System's future.  Because
    of the size of the information technology investment and the
    potential that such technology holds for providing higher quality
    services at a faster and lower cost, it is critical that the Federal
    Reserve ensures that its strategic information technology planning is
    an integral part of the Federal Reserve's strategic planning process
    and business planning and that assumptions about the future
    environment are fully considered.

    --------------------
    \2 FEDNET is the Federal Reserve's communications network connecting
    all Reserve System offices and depository institutions.

          FEDERAL RESERVE ADOPTED
          SYSTEMWIDE APPROACH TO
          MAINFRAME CONSOLIDATION
    -------------------------------------------------------- Chapter 5:3.1

    In the 1980s, several Reserve Banks, primarily seeking cost
    efficiencies, proposed that their Reserve Banks consolidate mainframe
    processing.  On the basis of this effort, the Board later established
    a committee to study the feasibility of consolidation for the Federal
    Reserve as a whole.  This committee proposed that the Federal Reserve
    replace the independent mainframe operations of the 12 Reserve Banks
    and consolidate these operations into 3 automation centers.\3 This
    proposal also included a unique organizational structure for
    overseeing mainframe computer operations, placing the responsibility
    for the consolidated operations under a Senior Automation Executive
    located within the Richmond Reserve District as a separate
    organizational entity called FRAS.  In 1990, the Board and the
    Reserve Banks adopted this proposal, setting a new precedent for a
    systemwide approach to an important operational function.  The
    Federal Reserve's approach to implementing FRAS represented a major
    departure from the decentralized approach traditionally used by the
    Federal Reserve to carry out its operational functions.

    The objectives of automation consolidation, in descending order of
    importance, were to

      -- improve reliability and disaster recovery,

      -- increase control of payment system risk in a national banking
         environment,

      -- improve security of the total automation environment,

      -- enhance responsiveness to changing business requirements, and

      -- improve efficiency.

    The Federal Reserve anticipates that FRAS will be responsible for
    operating mission-critical systems, such as Fedwire (which handles
    more than $1 trillion in transactions each business day from almost
    every U.S.  financial institution) and key information systems, such
    as the Federal Reserve's bank statistics database and payroll system.

    The systemwide approach to automation consolidation prompted concerns
    about the control of automation resources and the impact of this
    approach on the Reserve Bank autonomy and the future of the Federal
    Reserve.  These concerns were twofold:  (1) that the consolidation of
    this activity would lead to the consolidation of other activities and
    (2) that the Reserve Banks would lose control of the automation
    resources.

    The Reserve Banks worried whether they would continue to manage the
    automation resources or whether the Board's staff would become more
    involved in the planning and day-to-day management of automation
    resources.  Concerns were also expressed that, as consolidation
    progresses, a few "significant" Reserve Banks would emerge.  The
    emergence of such Reserve Banks could cause other Reserve Banks to
    have a harder time recruiting prestigious directors, thereby
    diminishing the regional character and local support of the Federal
    Reserve.

    --------------------
    \3 Before FRAS, each of the Reserve Banks operated its own data
    processing mainframe operations, including system applications.  Over
    the years, some Reserve Banks modified their applications to suit
    their own designs.  The modifications created the potential for 12
    different applications being operated nationally for the same
    function.

          SCOPE OF FRAS GREW
    -------------------------------------------------------- Chapter 5:3.2

    As originally conceived, FRAS was to be a system to provide cheaper
    mainframe processing support for the delivery of services to Treasury
    and the financial institutions.  However, as is often the case with
    major information technology projects, the scope of the project grew
    to include applications not originally envisioned in the original
    plans for FRAS.

    Planning for FRAS could have taken into greater account the needs of
    the Reserve Banks.  Some Reserve Bank officials told us that the
    growth in scope of FRAS, particularly to include check processing,
    had made it difficult for them to comply with the requirement in the
    Monetary Control Act that service fees should recover the costs of
    priced services.

    As the Federal Reserve proceeds in the implementation of FRAS, it
    needs to better identify the Federal Reserve's overall mission needs,
    the needs of the Reserve Banks, and those work processes that hold
    the most promise for improved service delivery through information
    technology.  While we did not do an in-depth review of FRAS, it
    appears that the design of FRAS assumes the retention of all key
    missions and business lines.  Furthermore, we did not observe an
    identification of those work processes that could be reengineered and
    that hold the most promise and risk for the application of
    information technology.  If the Federal Reserve revises its
    assumptions about the future environment and the Federal Reserve's
    core missions and business lines, it must ensure that these decisions
    are well integrated with its information technology strategic
    planning.

          STRATEGIC INFORMATION
          TECHNOLOGY PLAN UNDER
          DEVELOPMENT
    -------------------------------------------------------- Chapter 5:3.3

    The Federal Reserve is currently working on a strategic plan for
    Federal Reserve information technology.  The plan seeks to lay out a
    planning horizon for the Federal Reserve through the year 2000.  As
    of February 1996, the strategic plan was still in draft.  In
    reviewing the draft plan, we observed that it lays out the strategic
    goals and strategies by mission.  The draft plan also assumed the
    retention of all missions, business lines, and operating structures.
    As the Federal Reserve refines its information technology strategic
    plan, it is vital that the Federal Reserve continually checks its key
    strategic assumptions and makes sure that the information technology
    strategic goals keep pace with key strategic decisions.

       BUDGETING PROCESS CAN BETTER
       SUPPORT COST CONSTRAINT
    ---------------------------------------------------------- Chapter 5:4

    An effective budget process should support top management in
    constraining costs, weighing current priorities against future
    priorities, and allocating resources according to organizational
    priorities.  For an institution such as the Federal Reserve, it is
    especially important that there be a rigorous budget formulation and
    execution process in place to constrain cost and foster the internal
    self-discipline necessary to periodically reassess its strategic
    goals and priorities.  The Federal Reserve's budget process seeks to
    ensure that overall Federal Reserve objectives are accomplished
    efficiently and effectively.  In reviewing the budgeting process for
    both the Board and Reserve Banks, we found that the Federal Reserve
    had a budgeting process that imposed some discipline in that there
    was no material overspending of approved budgets.  However, we found
    the Federal Reserve's budget process had a weakness in that it used a
    current services approach that assumed existing functions would be
    retained and that assumed continued incremental budgetary growth.
    Such an approach, we believe, did not adequately support top
    management in constraining costs and imposing the internal
    self-discipline necessary for the Federal Reserve to respond
    effectively to future priorities.

          THE BOARD AND RESERVE BANKS
          USED CURRENT SERVICES
          APPROACH
    -------------------------------------------------------- Chapter 5:4.1

    In reviewing the budgeting process for 1988 to 1994, we found the
    operating budgets of the Board and the Reserve Banks were formulated
    on the basis of the assumption that existing units would generally
    continue to perform their required functions and their budgets would
    increase from year-to-year to account for expected increases in
    inflation and salaries.  With no formal constraints on overall
    spending, the extent of increases in unit budgets was left ultimately
    to the discretion of the Board.

          FORMULATION AND APPROVAL OF
          THE BOARD'S BUDGET
    -------------------------------------------------------- Chapter 5:4.2

    The formulation of the Board's budget was overseen by the
    administrative governor under authority delegated by the Chairman of
    the Board and managed by the Board's Office of the Controller.  The
    process began in the spring of each year with the development of a
    budget guideline and extends through November.  In the spring, each
    Board division developed a strategic plan, which identified and
    prioritized objectives, and a proposed budget.\4

    Next, the Board Governor (or Governors) with administrative
    responsibility for the division reviewed the plans and commented on
    the merit of the proposed budget.  The divisions had the opportunity
    to revise their strategic plans on the basis of those comments.

    The Program Analysis and Budgets section of the Controller's Office
    then developed a proposed budget guideline, or acceptable percentage
    increases in Board expenses for the upcoming year.  According to
    officials we interviewed, the percentage increases were based on such
    factors as inflation and the expected cost of programs and
    initiatives identified in strategic planning sessions.  The proposed
    percentage increases were first reviewed by the administrative
    Governor and the Board Chairman; if they were satisfied, the Board
    received the proposal for approval during the summer.

    Each Board division used the approved percentage increase to prepare
    a revised budget proposal that they submitted to the Controller in
    the fall.  After reviewing the budget proposals and making any
    necessary adjustments, the Controller coordinated meetings to discuss
    the budget proposal with each division and the appropriate
    administrative Governor(s).  On the basis of these meetings, the
    Controller could make additional adjustments before consolidating the
    division budgets.  The consolidated budget was then given to the
    Administrative Governor for review and presentation to the Board
    Chairman.  After all appropriate adjustments had been made, the
    Administrative Governor presented the consolidated budget to the full
    Board for approval at a public meeting shortly before the new budget
    year, which began in January.

    --------------------
    \4 These sessions helped to develop the Board's long-term direction,
    according to the Board officials we interviewed.

          FORMULATION AND APPROVAL OF
          RESERVE BANK BUDGETS
    -------------------------------------------------------- Chapter 5:4.3

    Percentage increases and proposed Reserve Bank budgets were
    formulated and approved in a process separate from formulation and
    approval of the Board's increases and budget.  The Reserve Banks'
    process generally took 6 months, culminating in the Board's approval
    of the proposed increase in late spring of the year before the
    subject budget year.  During 1988 to 1994, the Federal Reserve's
    conferences--COP and COFVP--along with their supporting committees,
    subcommittees, and task forces, provided a systemwide mechanism for
    the development and sequential review at many System levels of
    budgetary proposals and objectives that affect all Reserve Banks.
    Various data were considered in developing the percentage increase
    proposal, including volume and cost projections for priced services,
    Federal Reserve project cost projections, and information on Reserve
    Bank initiatives affecting expenses.

    Shortly after the Board's approval of the allowed increase in Reserve
    Bank budgets, each Reserve Bank developed budget documents and
    materials, including a proposed budget.  These proposals were
    initially reviewed by COFVP and then forwarded to COP for review.
    The COP's budget recommendations were then reviewed and approved, in
    turn, by DRBOPS, the Board's Reserve Bank Activities Committee and,
    finally, by the full Board shortly before the start of the budget
    year.

          BOARD AND RESERVE BANK
          BUDGETS WERE MONITORED
          THROUGHOUT THE YEAR
    -------------------------------------------------------- Chapter 5:4.4

    The budgets for the Reserve Banks and the Board were monitored
    throughout the year.  For example, the Board's actual expenditures
    were compared to the budget plan throughout the year to ensure
    compliance with approved budget and program plans.  The Office of the
    Controller had lead responsibility for monitoring the Board's budget.
    The Controller submitted quarterly reports to the Board that compared
    each division's performance with its expenses and conducted midyear
    reviews with each division to control costs and provide a baseline
    for analyzing the upcoming year's budget request.  Generally, if the
    Reserve Banks and the Board did not deviate from their respective
    budgets by more than 1 percent, they were allowed to reprogram funds
    from one spending category to another without seeking Board approval.

    Reserve Bank budgets were also monitored throughout the year--both at
    the Board and Reserve Banks.  These budgets were monitored mainly
    through the Reserve Bank's cost-accounting system by the individual
    Reserve Bank controller and staff of DRBOPS.  The cost-accounting
    system facilitated the comparison of the financial and operating
    performance at Reserve Banks individually and as a whole.

    In exercising its statutory authority to generally supervise the
    Reserve Banks, the Board required the Reserve Banks to submit budgets
    annually and to seek approval, on an ad hoc basis, for large
    purchases (capital acquisitions).  In addition to the budget approval
    process, the Board established various levels of approvals for
    Reserve Bank operations for expenditures related to buildings,
    equipment acquisitions, and price changes for Reserve Bank services.
    Over certain dollar amounts, these proposed expenditures must be
    approved by the Board.  For proposals that fell below the specified
    threshold, the Board delegated its approval authority to DRBOPS or
    the Reserve Banks.  In addition, DRBOPS may forward Reserve Bank
    proposals that may have systemwide policy implications to the Board.
    According to a DRBOPS official, proposals approved at the Reserve
    Bank-level are routinely forwarded to the Board as an information
    item.

          BUDGETARY COMPLIANCE
          DIFFERED BETWEEN OPERATING
          AND CAPITAL BUDGETS
    -------------------------------------------------------- Chapter 5:4.5

    In reviewing the execution of the Federal Reserve's budget between
    1988 and 1994, we observed that the budget processes of the Board and
    the Reserve Banks resulted in budgets that increased each year.
    However, amounts finally approved were generally lower than those
    initially requested.  As a whole, we found that Reserve Banks and the
    Federal Reserve sometimes exceeded the initially approved operating
    budgets, but generally by amounts that were less than 1 percent of
    the approved operating budget.

    Concerning the Federal Reserve's capital budget, we found that in
    every year except 1992, the Federal Reserve spent less than was
    budgeted.  In most years, the underspending was primarily related to
    data processing and data communications equipment.  However, in 1992,
    the Federal Reserve overspent its data processing and data
    communications budget by almost $52 million.  In that year, the
    Federal Reserve's initial capital budget did not call for purchasing
    any computer equipment for FRAS.  However, in 1992, the Federal
    Reserve began FRAS-related acquisition and development; by year-end,
    the Federal Reserve had spent nearly $96 million to purchase computer
    equipment.

       SYSTEMWIDE PERSPECTIVE NEEDED
       IN INTERNAL OVERSIGHT PROCESSES
    ---------------------------------------------------------- Chapter 5:5

    Internal oversight processes, such as performance measurement,
    internal audit, and financial audits, can and should play key roles
    in assisting management in achieving its strategic vision for the
    organization.  The Federal Reserve had many oversight mechanisms in
    place.  However, we found that these mechanisms either did not
    support performance evaluation from a systemwide perspective or were
    becoming increasingly inappropriate in the changing environment.  As
    a result, the Federal Reserve may not be making the most use of its
    resources devoted to Federal Reserve oversight.

          FEDERAL RESERVE HAD A
          VARIETY OF OVERSIGHT
          MECHANISMS
    -------------------------------------------------------- Chapter 5:5.1

    The Board and Reserve Banks had a variety of mechanisms to oversee
    many activities.  Oversight of Board programs and operations is
    provided by the Board's OIG.\5 The various oversight mechanisms of
    the Federal Reserve are summarized in table 5.1.

                                        Table 5.1

                          Major Oversight Mechanisms Within the
                         Federal Reserve, by Major Components of
                         the System, the Board, and Reserve Banks

    Federal Reserve         Explanation of oversight mechanisms
    ----------------------  --------------------------------------------------------
    Oversight of the Board
    --------------------------------------------------------------------------------
    OIG audits and reviews  Operating under the authority of the Inspector General
                            Act of 1978, as amended, the OIG is to audit and review
                            Board programs, including the Board's examinations and
                            programs for overseeing Reserve Bank activities and
                            Board-delegated programs carried out by the Reserve
                            Banks, such as bank supervision and regulation. The OIG
                            is also to report to Congress on its findings twice a
                            year. The OIG is required to follow generally accepted
                            government auditing standards, which require that
                            auditors be independent of the entities they are
                            auditing.

                            The OIG is not authorized to directly audit Reserve Bank
                            activities.

    Oversight of Reserve Banks
    --------------------------------------------------------------------------------
    Annual performance      Under delegated authority of the Board, DRBOPS is to
    evaluations             evaluate each Reserve Bank's operational areas on their
                            unit costs and quality measures and review cost-
                            accounting and cost data.

                            The performance ratings are used in determining the
                            salaries for each Reserve Bank president and first vice
                            president.

    Financial examinations  Under delegated authority of the Board, DRBOPS is to
                            ensure the accuracy and reliability of each Reserve
                            Bank's balance sheet, propriety and adequacy of
                            supporting documentation of expenditures, and review
                            procedures and controls for compliance with system
                            policies and applicable regulations and procedures.\a

    Operations reviews      Under delegated authority of the Board, DRBOPS is to (1)
                            review certain Reserve Bank functions to ensure
                            compliance with Federal Reserve policies and standards
                            and (2) promote effective and efficient Reserve Bank
                            operations.\b

                            Other divisions of the Board also conduct operations
                            reviews under delegated authority. For example, the
                            Board's Division of Human Resources Management reviews
                            human resources operations at each of the Reserve Banks.

    Internal audits         Reporting to the Reserve Bank's board of directors
                            through the directors' audit committee, each Reserve
                            Bank has a general auditor and staff that are to
                            evaluate internal control systems and determine the
                            Reserve Bank's compliance with applicable policies and
                            regulations.

    External audits         Under a contract with the Board, an independent public
                            accounting firm is scheduled to audit the combined
                            financial statements of the Reserve Banks for each year
                            from 1995 through 1999. During these years, the
                            financial statements of each individual banks will also
                            be audited.
    --------------------------------------------------------------------------------
    Legend:

    ACH = automated clearinghouse
    DRBOPS = Division of Reserve Bank Operations and Payment Systems
    OIG = Office of the Inspector General

    \a We agree with a recent OIG's recommendation that the Financial
    Examination Program should become organizationally independent from
    DRBOPS and report directly to the Board.  The OIG concluded that the
    financial examination program, as currently organized within DRBOPS,
    presents the appearance that it may not be fully independent.

    \b DRBOPS conducts operations reviews on, among other things, check,
    cash, fiscal agency, ACH, electronic processing, and cost-accounting
    operations.

    Source:  Federal Reserve System.

    --------------------
    \5 Offices of the inspector general were established by the Inspector
    General Act of 1978, as amended, to create independent and objective
    units to (1) conduct and supervise audits and investigations relating
    to programs and operations of the various agencies; (2) provide
    leadership and coordination and recommend policies to promote
    economy, efficiency, and effectiveness and prevent and detect fraud
    and abuse in agency programs and operations; and (3) provide a means
    for keeping the head of the establishment and Congress fully and
    currently informed of such issues.

          DEVELOPMENT OF JOINT
          PERFORMANCE MEASUREMENT
          INDICATORS IS NEEDED
    -------------------------------------------------------- Chapter 5:5.2

    Through involving key stakeholders in developing performance
    measurement systems keyed to organizational goals, performance
    measurement can be used to assess how all parts of the organization
    are contributing to overall effectiveness in achieving the
    organization's key goals.  In conducting our work, we noted that the
    evaluation and assessment of Reserve Bank performance had received
    considerable attention from both Reserve Bank management and the
    Board.  DRBOPS conducted annual assessments of Reserve Bank
    operations in various areas.  Reserve Bank management tracked
    performance on a variety of measures on an ongoing basis.  And other
    oversight mechanisms--internal and external financial examinations,
    operations reviews, and OIG evaluations--provided other information
    on performance.  However, many of these current performance measures
    were too narrowly focused on such Bank-specific measures as the
    numbers of checks processed or the amount of fees collected for ACH
    processing.  In the context of the Federal Reserve's new efforts on
    systemwide planning for the Board and the Reserve Banks together, the
    Federal Reserve would appear to lack major systemwide benchmarks to
    measure how effectively the Federal Reserve--as a whole--is meeting
    its new challenges.

    Concerning systemwide goals and objectives, it may now be appropriate
    for the Federal Reserve to redesign its key performance indicators to
    more accurately reflect overall organizational goals and objectives.
    As a part of this new strategy, outcome-linked performance measures
    should be developed, for both the Board and Reserve Banks, that show
    how organizational components can best contribute to overall
    organizational effectiveness.

          EXISTING OVERSIGHT
          STRUCTURES LIKELY TO BECOME
          INCREASINGLY INAPPROPRIATE
          FOR RESERVE BANK OPERATIONS
    -------------------------------------------------------- Chapter 5:5.3

    Even given the numbers of oversight mechanisms available to the
    Federal Reserve, we identified specific problems--the coverage of
    audit and evaluations, the potential for the lack of independence,
    and possible audit reporting problems--that all could be improved
    with certain changes in Federal Reserve oversight.  These problems
    stemmed in part from the unique structure of the Federal Reserve and
    the authority provided to those entities supporting the Board.  For
    example, the Inspector General is authorized to review only the
    activities of the Board while DRBOPS is responsible for overseeing
    the Reserve Banks and for developing policies.  As the Federal
    Reserve increases systemwide projects and consolidations, the need
    for stronger, comprehensive Federal Reserve oversight is likely to
    increase.  With improved oversight, the Federal Reserve can better
    identify areas where efficiencies can be achieved, particularly areas
    with reengineering potential, and ensure that organizational results
    are both outcome-linked and responsive to multiple organizational
    priorities that may cut across various parts of an organization.

             IMPROVEMENTS NEEDED IN
             AUDIT AND EVALUATION
             COVERAGE
    ------------------------------------------------------ Chapter 5:5.3.1

    The lack of a systemwide perspective has affected the audit and
    evaluation coverage within the Federal Reserve.  Until recently, the
    Federal Reserve's oversight mechanisms did not include an independent
    audit of the combined financial statements of the Reserve Banks.
    DRBOPS, which lacks clear independence, conducted individual
    financial examinations of each Reserve Bank on behalf of the Board.
    In November 1994, the Board awarded a contract to have an independent
    public accounting firm audit the combined financial statements of the
    Federal Reserve Banks for the years 1995 through 1999.  We believe
    this would be helpful toward improving financial auditing within the
    Reserve.  However, we also believe that a permanent policy to require
    an annual independent financial audit of the combined Reserve Banks'
    financial statements is needed.  We recommended that this be done in
    some of our previous work.\6 Government experience has shown that
    emphasis on financial management and oversight can change with agency
    leadership.  Therefore, legislating an annual audit requirement, as
    was done by the Government Management Reform Act of 1994, which
    expanded the Chief Financial Officer Act's requirements to the 24
    largest executive agencies to obtain annual financial statement
    audits, would ensure that emphasis on financial management is
    continued.

    We also noted in our review that some areas were the subject of
    possibly redundant audit attention.  For example, at the time of our
    review, we observed separate evaluations of various aspects of work
    on the Federal Reserve Automation Services project at the Richmond
    Reserve Bank being conducted by the Richmond General Auditor, the
    OIG, and DRBOPS staff.  While we did not do an in-depth analysis of
    areas of overlap in these audits, we nevertheless found possible
    areas of overlap.  At the same time, in our review of a sample of
    contracting and procurement practices at selected Reserve Banks, we
    found potential for possible conflicts of interest within the bid
    selection processes and some lax practices in ensuring that correct
    payments were being made on contracts.  Yet despite the fact that
    contracting received some audit attention at the Reserve Banks we
    visited, these problems were not identified.

    --------------------
    \6 Federal Reserve Banks:  Internal Control, Accounting, and Auditing
    Issues (GAO/AIMD-96-5, Feb.  9, 1996).

             POSSIBLE REPORTING
             PROBLEMS IN SYSTEMWIDE
             AUDITS
    ------------------------------------------------------ Chapter 5:5.3.2

    The use of the existing oversight structure to conduct systemwide
    audits may not be appropriate because the general auditors do not
    report to a systemwide board of directors.  At the time of our
    review, one General Auditor was serving as the head of the systemwide
    audit of the ISS-3000 currency processing equipment.  The General
    Auditor was to report the audit findings to that Reserve Bank's Audit
    Committee even though this review was conducted for the Federal
    Reserve as a whole.  In our view, the findings of an audit of a major
    systemwide project should be reported directly to the Board, which
    has direct fiscal responsibility for the project.

          OVERSIGHT CONCERNS COULD BE
          ADDRESSED THROUGH BETTER
          FOCUS
    -------------------------------------------------------- Chapter 5:5.4

    We believe that the Federal Reserve could alleviate some, if not all,
    of these problems by providing a more focused and efficient approach
    to Federal Reserve oversight.  The Federal Reserve could accomplish
    this by taking steps to better ensure the independence of its
    internal audit function and to expand the scope of the OIG's
    authority to include responsibility for auditing the Reserve Banks
    and systemwide projects.  As Reserve Banks are moving toward more
    systemwide projects and more centralized decisionmaking, the Federal
    Reserve's fragmented oversight structure is increasingly
    inappropriate to provide adequate oversight of centralized Reserve
    Bank operations.  If the OIG's authority was expanded, the problems
    of redundant audits would be addressed.  The expansion of the OIG's
    authority would necessitate both an increase in staff and spending
    for the OIG.  However, it may be possible to simultaneously reduce
    staffing in other oversight mechanisms.

       CONCLUSIONS
    ---------------------------------------------------------- Chapter 5:6

    We believe that the Federal Reserve, to effectively plan for the
    future, needs to conduct a fundamental assessment of its operations
    focusing on its missions, strategic goals, and structure.  Such an
    assessment should also include a review of the Federal Reserve
    strategic management processes.  We believe that the Federal Reserve
    faces some difficult constraints in conducting such an effort.  For
    example, the Board will need to work with the Reserve Banks to
    rethink their mutual roles in the shared leadership of the system.
    Furthermore, they will face profound challenges in planning and
    confronting possible changes.  Planning deliberations related to
    redefining core missions and business lines and realigning the
    Federal Reserve's structure and governance would require strategic
    planners to "think beyond" the statutory powers of the Board and
    Reserve Banks.  The essential missions as well as the locations of
    the Federal Reserve's Reserve Banks are set by law, and the autonomy
    of the Reserve Banks generally necessitates consensus-oriented
    decisionmaking in systemwide planning.  For example, the Federal
    Reserve is required by law to develop and implement monetary policy,
    supervise and regulate banks, regulate and provide payments system
    services, and provide fiscal agency services to government agencies
    upon request.

    In rethinking its mission and business lines, the Federal Reserve may
    face conflicts and difficult policy choices, which may require that
    it consult with Congress for help in resolving them.  For example,
    the Federal Reserve is required to base check- clearing fees on the
    recovery of its costs; at the same time, it must also function as the
    "clearer of last resort" and promote the safety and soundness of
    financial institutions.  In addition, neither the Board nor the
    Reserve Banks is authorized to change the numbers or locations of
    Reserve Banks or essential elements of Federal Reserve governance.
    Changes that might be considered in the context of a fundamental
    assessment of Federal Reserve operations could require legislative
    action to accomplish.

    Because it lacks the cost minimization pressures common to most
    public and private entities, the Federal Reserve must work extra hard
    to overcome internal pressures for budgetary increases.  As discussed
    in chapter 1, the Board is a government agency and provides Congress
    with an annual report of the Federal Reserve's operations; however,
    the Federal Reserve is not subject to the congressional
    appropriations process that serves as a constraint on spending by
    federal entities.  Furthermore, because the Federal Reserve Act sets
    dividends to member banks at 6 percent and prohibits them from
    selling their shares, shareholders, who are member banks, do not have
    the usual financial incentives to encourage cost-efficient
    operations.  Additionally, the amount of interest the Federal Reserve
    receives on securities acquired through the issue of Federal Reserve
    notes is so great that it tends to mask the net decline of all other
    revenue sources that occurred over the 1988 to 1994 period.
    Therefore, it is especially important for the Federal Reserve to have
    management processes that support top management in constraining
    costs and that instill a high level of internal self-discipline that
    would allow the Federal Reserve to overcome institutional resistance
    to major management reform.

    However, despite its unique structure, the Federal Reserve has begun
    to show that it can address operational issues strategically and work
    in a systemwide manner when necessary, as evidenced by the recent
    establishment of a new Financial Services Committee to examine priced
    services and by the consolidation of its data-processing facilities.
    The Board and the Reserve Banks must work together to meet the
    emerging challenges and to ensure that the nation's central bank
    keeps pace with the changing environment and remains a strong and
    competitive institution.

       RECOMMENDATIONS AND MATTERS FOR
       CONSIDERATION
    ---------------------------------------------------------- Chapter 5:7

    In analyzing opportunities to reduce the cost of Federal Reserve
    operations to the taxpayer, any potential adverse impact on the
    independence of monetary policy or on the Federal Reserve's ability
    to meet its key responsibilities should be considered carefully.
    However, we see no inherent conflict between the Federal Reserve's
    independence or effectiveness and efforts to improve efficiency.
    Many of the functions performed by the Federal Reserve have little
    direct relation to monetary policy, and the Board, working with the
    Reserve Banks, has the authority and ability to take many cost-saving
    actions without jeopardizing its mission effectiveness.  However, any
    decision to close Reserve Banks or establish a separate corporation
    for priced services would require congressional approval.  Thus, we
    make recommendations to the Board and suggest several matters for
    congressional consideration.

          RECOMMENDATIONS TO THE BOARD
          OF GOVERNORS
    -------------------------------------------------------- Chapter 5:7.1

    We recommend that the Board of Governors undertake a fundamental
    review of Federal Reserve operations focusing on the primary mission,
    business lines, and structure that would best support its overall
    mandate.  Such an organizational review should include an assessment
    of the following:

      -- the Federal Reserve's role in providing financial services to
         banks and government agencies and an analysis of the costs and
         benefits to the Federal Reserve and the taxpayers of various
         options for delivering such services (such options could include
         discontinuing delivery of certain priced services to financial
         institutions, privatizing the delivery of other services by
         establishing a private corporation for delivering such services,
         or retaining responsibility for being the primary service
         provider);

      -- cost-saving opportunities that could result from streamlining
         the Federal Reserve's existing management structures and
         consolidating Federal Reserve operations, including possible
         mergers among the 12 Reserve Banks and 25 branches; and

      -- the potential for technology to support streamlined work
         processes in the Reserve Banks and to reduce costs and improve
         quality.

    In addition, we recommend that the Board strengthen its existing
    control and oversight mechanisms by, among other things, (1)
    reviewing the appropriateness of current budget assumptions, which
    assume steady annual growth; (2) taking steps to better ensure the
    independence of the Federal Reserve's internal audit function and to
    expand the scope of its OIG's authority; and (3) ensuring that an
    independent financial audit of the Reserve Banks' combined financial
    statements is conducted every year.

          MATTERS FOR CONGRESSIONAL
          CONSIDERATION
    -------------------------------------------------------- Chapter 5:7.2

    Congress should consider the results of the Federal Reserve's
    assessments and determine

      -- whether it would be desirable to merge or close any of the 12
         Reserve Banks or 25 branches and

      -- which of the various options for delivering priced services to
         financial institutions are in the best interests of public
         policy and represent the best balance between achieving cost
         savings and serving the nation's financial interests.

    Congress should also consider

      -- requiring an annual independent audit of the Reserve Banks'
         combined financial statements;

      -- requiring the Federal Reserve to charge for bank examinations;
         and

      -- establishing a statutory requirement that the Federal Reserve
         annually transfer its remaining revenues to the Treasury.

       FEDERAL RESERVE'S COMMENTS AND
       OUR EVALUATION
    ---------------------------------------------------------- Chapter 5:8

    The Federal Reserve's Board of Governors did not agree with any of
    our recommendations to the Board or with our suggestions to Congress.
    The Board did not agree to undertake a fundamental review of the
    Federal Reserve System's operations, because it believes such reviews
    are an ongoing and integral part of the Board's oversight of the
    System.  The Board stated that the Federal Reserve's role in
    providing financial services to depository institutions is constantly
    being tested in the marketplace, and the Board noted that the System
    is consolidating the management of some financial services.  The
    Board stated its belief that most savings from such consolidation
    efforts would be possible in electronic payment functions, such as
    Fedwire, with lesser savings possible in paper-based financial
    services, such as check clearing.  The Board also did not agree to
    consider alternatives to the current way the System provides priced
    services.

    Concerning merging or closing any of its 12 Reserve Banks or 25
    branches, the Board stated that, while the Federal Reserve's
    structure would likely be different if established today, any such
    realignments or relocations would have to yield substantial long-term
    savings to offset the transition costs.  Concerning the potential for
    technology to support streamlined work processes in the Reserve
    Banks, the Board stated that the Federal Reserve routinely assesses
    technologies for their ability to reduce costs and improve the
    quality of its services.

    Concerning our recommendations to improve the Federal Reserve's
    control and oversight mechanisms, the Board did not agree with our
    characterization of the System's budget process as one that assumed
    continuous growth.  The Board also did not agree that the
    independence of its internal oversight would be strengthened by
    expanding the authority of the Board's OIG to the Reserve Banks.  The
    Board believed that the current audit process ensured adequate
    independence and that expanding the OIG's authority could integrally
    involve the inspector general in the Board's oversight process and
    raise questions about the inspector general's "arm's length" ability
    to audit such processes.  The Board did not comment on our
    recommendation to institutionalize an annual external audit of the
    combined financial statements of the Reserve Banks.

    Finally, the Board did not agree with our suggestion that Congress
    may want to consider requiring the Federal Reserve to charge for bank
    examinations.  The Board noted that, currently, the states charge
    examination fees that, on average, are approximately half of those
    charged by OCC for national bank examinations.  The Board believed
    that if the Federal Reserve and FDIC were to charge for their
    examinations of state-chartered banks, such fees could tip the scales
    toward national charters and call into question the long-term
    viability of a valuable dual banking system.

    We continue to believe that the major technological and marketplace
    developments that are currently affecting the financial services
    industry have profound implications for the activities and operations
    of the Federal Reserve and require the System to have a strong,
    systemwide strategic management process.  We acknowledge that the
    Federal Reserve has a range of strategic planning processes and
    programs in place or under development.  And we recognize and commend
    the Federal Reserve's efforts to provide a more systemwide focus for
    its strategic planning efforts through the recent creation of the
    Federal Reserve System Strategic Planning Coordination Group.
    However, we are concerned that these strategic planning efforts are
    not sufficiently integrated and thus may be too limited and
    insufficient to effectively address the major challenges the Federal
    Reserve is facing, given the potential implications of these
    developments for the Federal Reserve's business lines and
    organizational structure.

    Leading private and public institutions have found that truly
    significant savings often come only when, as a part of a
    comprehensive strategic planning process, they have rethought their
    basic missions and lines of business and reengineered their work
    processes to streamline operations.  The Federal Reserve's plans to
    consolidate some of its operations in financial services, while
    commendable, fall far short of the broad rethinking that we believe
    is necessary if the Federal Reserve is to be as efficient and cost
    effective as it can be in fulfilling its critical role as our
    nation's central bank.

    As a part of this broad rethinking, we also believe the Federal
    Reserve should consider consolidating some Reserve Banks and
    branches.  We agree with the Board that such consolidation would
    result in transition costs but we believe that these costs could be
    offset by longer-term savings.  We also note that consolidating banks
    and branches is not without precedent among central banks.  For
    example, before the reunification of the former East and West
    Germany, the German central bank, the Deutsche Bundesbank (which was
    established by the Allies after World War II and modeled on the
    Federal Reserve System), had a presence in the form of Landesbanks in
    each of the 11 West German states.  If it chose to keep intact the
    same structure after reunification, the Bundesbank was faced with the
    possibility of establishing five additional Landesbanks, one in each
    of the states of the former East Germany.  Instead, the German
    government reduced the total number of Landesbanks serving the
    reunified 16 states to 9 Landesbanks and significantly reduced the
    number of central bank branches as well.  The chief reasons given for
    these consolidation efforts were to promote efficiency and cost
    savings.  Between January 1, 1995, and January 1, 1996, the
    Bundesbank reported that it was able to reduce its staff by 6
    percent.

    Our recommendation that the Federal Reserve consider alternatives to
    the current way it delivers priced services to depository
    institutions is another example of the broad rethinking of mission
    and lines of business that we believe the Federal Reserve should
    undertake.  When institutions carefully reexamine their missions and
    lines of business, they often determine that some lines of business
    are no longer profitable or no longer fit with the strategic
    direction they wish to take.  For example, observers in the private
    sector have questioned whether it is appropriate for the Federal
    Reserve to continue to be both a provider and regulator of priced
    services, particularly in light of the growth of private-sector
    service providers.  Some top officials within the Federal Reserve
    have, in the past, also suggested alternative ways to provide these
    services, such as by establishing a separate corporation.

    Regarding the use of technology to streamline work processes, our
    reviews of leading organizations that have sought to improve
    performance through strategic information management and technology
    have shown that accomplishing order-of-magnitude improvements in
    performance nearly always requires streamlining or redesigning
    critical work processes.\7 Consequently, we believe information
    systems initiatives must be focused on process improvement.  Using
    business process reengineering to drive information systems
    initiatives can lead to these order-of-magnitude savings, rather than
    the marginal efficiency gains normally associated with initiatives
    that use technology to do the same work, the same way, only faster.
    We acknowledged in several sections in this report that the Federal
    Reserve's automation consolidation efforts (under the FRAS system)
    were designed to promote more efficient operations and to ensure
    increased security in the nation's payments system.  However, we are
    concerned that the Federal Reserve's automation consolidation efforts
    may not have involved sufficient reengineering of existing work
    processes.  Because of the size of the information technology
    investment and the potential that such technology holds for providing
    higher quality services faster and at lower cost, we believe that it
    is critical that the Federal Reserve ensures that its strategic
    information technology planning is an integral part of its strategic
    and business planning processes.

    We continue to believe that the concerns we raised about the Federal
    Reserve's oversight and control mechanisms are valid.  Although the
    Federal Reserve does not view its budget process as having a built-in
    assumption of annual growth, we note that, for each year from 1988 to
    1994 and for each Reserve Bank, annual budget targets have been
    expressed as percentage increases from the previous year's budgets.
    The budget did not reflect a decrease in budget authority in any year
    for any Reserve Bank despite the fact that during this period many
    Reserve Banks consolidated their savings bonds programs and mainframe
    computer operations.

    With regard to expanding the OIG's authority to directly audit the
    Reserve Banks, we believe the inspector general can perform these
    functions while also retaining the ability to provide arm's length
    reviews of the Board's oversight processes.  In an increasingly
    consolidated Federal Reserve System, retaining the Reserve Banks'
    general auditors to do systemwide reviews seems increasingly
    inappropriate.  And reliance on DRBOPS to do such reviews leads to
    questions about the independent nature of such reviews, particularly
    since this division also sets policy for the Reserve Banks and has
    approval authority over certain Reserve Bank purchases and decisions.
    Such problems and questions could be resolved by expanding the OIG's
    authority and by taking steps to better ensure the independence of
    the Federal Reserve's internal audit function.  In addition,
    centralizing reviews of Reserve Bank programs would make more
    apparent any overlapping and redundant reviews and would more clearly
    highlight areas receiving insufficient audit attention.

    Finally, we found no reason to suggest that having the Federal
    Reserve charge for its bank examinations would threaten our valuable
    dual banking system.  Currently, the Federal Reserve is the only one
    of five federal regulators of depository institutions where
    taxpayers, and not the industry, bear the cost of supervision.  As we
    noted in this report, the Federal Reserve supervises less than 1,000
    state-member banks, or about 9 percent of all banks, and evidence
    from recent mergers indicates that state charters are being
    considered more desirable than national charters.  The Federal
    Reserve could also take steps through arrangements with state banking
    regulators to reduce any undue competitive effects of charging for
    bank examinations.  In addition, our recommendation is not meant to
    be limited to charging state-member banks.  The Federal Reserve's
    response does not address charging for its other examinations--those
    for foreign banks and bank-holding companies--where the possibility
    of charter switching is not an issue.

    (See figure in printed edition.)Appendix I

    --------------------
    \7 See GAO/AIMD-94-115, May 1994.

    DETAILED STATEMENT OF CONDITIONS
    OF ALL FEDERAL RESERVE BANKS
    COMBINED, DECEMBER 31, 1994
    ============================================================ Chapter 5

    (See figure in printed edition.)

    (See figure in printed edition.)Appendix II
    INCOME AND EXPENSES OF FEDERAL
    RESERVE BANKS, 1994
    ============================================================ Chapter 5

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    PERSONNEL COMPENSATION INFORMATION
    FOR THE FEDERAL RESERVE SYSTEM
    ========================================================= Appendix III

    This appendix includes information on personnel compensation within
    the Federal Reserve.  Where appropriate, we also compared the Federal
    Reserve's personnel practices to other federal agencies with
    analogous regulatory responsibilities.  Table III.1 shows the number
    and title of Federal Reserve employees who earned more than the Board
    Chairman during 1994.  Tables III.2 through III.5 contain 1994 salary
    information for personnel at various levels within the Federal
    Reserve.  Table III.6 shows the percentage of health insurance
    subsidies paid in 1993 by the Reserve Banks, the Board, and other
    regulatory agencies.  Table III.7 shows the 1993 employee annual and
    sick leave eligibility levels for the Reserve Banks, the Board, and
    other regulatory agencies.

    In addition, this appendix includes a description of the several
    benefit programs offered to Federal Reserve employees that, in many
    cases, were not provided to employees of the Securities and Exchange
    Commission (SEC), FDIC, or OCC.  These benefits included dental
    insurance; a subsidized employee cafeteria; premium conversion
    accounts; flexible spending accounts; matching contributions for
    savings accounts; and separate leave categories for bereavement,
    marriage, and family care.

                                  Table III.1

                     Federal Reserve Officials Earning More
                      Than the Board Chairman During 1994

                             Number of  Typical      Number of  Typical
                               Federal  Federal        Federal  Federal
                               Reserve  Reserve        Reserve  Reserve
    Salary range ($000           Board  Board             Bank  Bank
    omitted)                 employees  titles       employees  titles
    ----------------------  ----------  ----------  ----------  ----------
    />133.6 to 140                   9  Associate           15  First VP,
                                        director                Senior VP

    />140 to 150                    11  Associate           24  First VP,
                                        director,               Senior VP
                                        Deputy
                                        director

    />150 to 160                     4  Deputy              23  President,
                                        director                First VP,
                                                                Senior VP

    />160 to 170                    12  Director             8  President,
                                                                First VP,
                                                                Executive
                                                                VP, Senior
                                                                VP

    />170 to 180                     0  N/A                  3  President,
                                                                Executive
                                                                VP

    />180 to 190                     0  N/A                  4  President,
                                                                Executive
                                                                VP

    />190 to 200                     0  N/A                  3  President,
                                                                Executive
                                                                VP

    />200 to 210                     0  N/A                  1  President

    />210 to 220                     0  N/A                  1  President

    />220 to 230                     0  N/A                  2  President

    ======================================================================
    Total                           36  N/A                 84  N/A
    ----------------------------------------------------------------------
    Legend:

    /> = Greater than
    N/A = Not applicable
    VP = Vice president

    Source:  Federal Reserve Board.

                                  Table III.2

                    1994 Reserve Bank President and Federal
                      Reserve Board Chairman and Members'
                                    Salaries

    Reserve Bank and Board                                          Salary
    ----------------------------------------  ----------------------------
    Atlanta                                                       $212,000
    Boston                                                         177,600
    Chicago                                                        221,700
    Cleveland                                                      165,500
    Dallas                                                         161,500
    Kansas City                                                    159,800
    Minneapolis                                                    175,200
    New York                                                       205,000
    Philadelphia                                                   184,500
    Richmond                                                       159,600
    St. Louis                                                      190,900
    San Francisco                                                  229,600
    Board Chairman                                                 133,600
    Board members                                                  123,100
    ----------------------------------------------------------------------
    Source:  Federal Reserve Board.

                                  Table III.3

                      1994 Federal Reserve Bank First Vice
                         President Salary Scale Ranges

    Reserve Bank                        Minimum salary      Maximum salary
    ------------------------------  ------------------  ------------------
    New York                                  $140,500            $224,500
    San Francisco                              130,500             209,500
    Atlanta                                    121,500             194,500
    Chicago                                    121,500             194,500
    All other Reserve                          110,000             176,000
     Banks
    ----------------------------------------------------------------------
    Source:  Federal Reserve Board.

                                  Table III.4

                      1994 Federal Reserve Bank and Board
                          Officer Salary Scale Ranges

    Reserve Bank and Board              Minimum salary      Maximum salary
    ------------------------------  ------------------  ------------------
    Atlanta                                    $57,500            $157,000
    Boston                                      57,500             157,000
    Chicago                                     57,500             157,000
    Cleveland                                   52,500             151,000
    Dallas                                      57,500             157,000
    Kansas City                                 52,500             151,000
    Minneapolis                                 57,500             157,000
    New York                                    63,500             204,000
    Philadelphia                                57,500             157,000
    Richmond                                    52,500             151,000
    St. Louis                                   52,500             151,000
    San Francisco                               66,500             175,000
    Federal Reserve Board                       63,500             161,800
    ----------------------------------------------------------------------
    Note:  This table excludes president and first vice president
    salaries.

    Source:  Federal Reserve Board.

                                  Table III.5

                     1994 Bank and Board Nonofficer Salary
                                  Scale Ranges

    Reserve Bank and Board              Minimum salary      Maximum salary
    ------------------------------  ------------------  ------------------
    Atlanta                                    $11,000             $83,600
    Boston                                       9,530              87,980
    Chicago                                     13,585              79,580
    Cleveland                                   12,340              81,600
    Dallas                                      11,900              82,900
    Kansas City                                 11,964              82,116
    Minneapolis                                 11,000              80,700
    New York                                    12,475             103,800
    Philadelphia                                 9,770              81,600
    Richmond                                    12,300              76,068
    St. Louis                                   10,700              75,200
    San Francisco                               13,500              88,700
    Federal Reserve Board                       15,380             123,470
    ----------------------------------------------------------------------
    Note:  The time frame during 1994 in which these ranges were in
    effect varied.  For example, one bank's 1994 salary scale was
    effective from October 1, 1993, to September 30, 1994.

    Source:  Federal Reserve Board.

                                  Table III.6

                      Percentage of 1993 Health Insurance
                                   Subsidies

                                               Percentage of premiums paid
    Entity                                                       by entity
    ----------------------------------------  ----------------------------
    Atlanta                                                         76 -94
    Boston                                                              70
    Chicago                                                         75 -90
    Cleveland                                                           78
    Dallas                                                              72
    Kansas City                                                         80
    Minneapolis                                                     81 -87
    New York                                                            85
    Philadelphia                                                    83 -90
    Richmond                                                        67 -90
    St. Louis                                                       75 -90
    San Francisco                                                       80
    Federal Reserve Board                                           60 -75
    FDIC                                                                85
    OCC                                                             74 -76
    SEC                                                             60 -75
    ----------------------------------------------------------------------
    Sources:  Federal Reserve Board; 12 Federal Reserve Banks; and the
    headquarters of FDIC, OCC, and SEC.

                            Table III.7

                1993 Employee Annual and Sick Leave
                         Eligibility Levels

                              Annual leave  Sick leave
    Entity                       (in days)  (in days)
    ------------------  ------------------  ------------------
    Atlanta                         10 -32  15
    Boston                          10 -25  18 at full pay and
                                             18 at half pay
    Chicago                         11 -23  10
    Cleveland                       10 -28  12
    Dallas                          10 -23  12
    Kansas City                     10 -30  12 to 260,
                                             depending on
                                             length of service
    Minneapolis                     10 -27  8-1/4
    New York                        10 -30  10 full pay and
                                             120
                                             60-percent pay
                                             during first year
                                             to 260 full pay,
                                             depending on
                                             length of service
    Philadelphia                    10 -25  12
    Richmond                        10 -27  20 -75, depending
                                             on length of
                                             service
    St. Louis                       10 -25  18
    San Francisco                   10 -25  9 -12, depending
                                             on length of
                                             service
    Federal Reserve                 13 -26  13
     Board
    FDIC                            13 -26  13
    OCC                             13 -26  13
    SEC                             13 -26  13
    ----------------------------------------------------------
    Sources:  The Federal Reserve Board; 12 Federal Reserve Banks; and
    the headquarters of FDIC, OCC, and SEC.

          A NUMBER OF FEDERAL RESERVE
          BENEFITS WERE NOT AVAILABLE
          TO CIVIL SERVICE EMPLOYEES
    ----------------------------------------------------- Appendix III:0.1

    The Federal Reserve offered benefits that are not generally offered
    to civil service employees, although many of the benefits are
    available to employees of FDIC and OCC.  These benefits included
    separate dental insurance, subsidized employee cafeterias, premium
    conversion accounts, flexible spending accounts, matching
    contributions for savings accounts, and mass transit subsidies.  In
    addition, some banks offered marriage, bereavement, parental care,
    and floating holiday leave.

          SUBSIDIZED CAFETERIAS
    ----------------------------------------------------- Appendix III:0.2

    The Board and the Reserve Banks pay a subsidy to reduce the cost of
    employee cafeteria meals.  The Board offers subsidized employee meals
    in its cafeteria, seven dining rooms, and three meeting rooms.  The
    Board's subsidy in 1993 was 45 percent and cost about $741,000.  Each
    of the Reserve Banks also have subsidized cafeterias, but the level
    of subsidies and number of cafeterias and dining rooms differed.  As
    shown in table I.7, in 1993, the total cost of cafeteria subsidies
    for the 12 Reserve Banks was about $8.4 million.  Most Reserve Bank
    cafeterias were privately run, with the Reserve Bank paying subsidies
    ranging from 19 to 55 percent.  FDIC and OCC provided cafeteria
    subsidies of 40 and 19 percent, respectively; SEC did not have a
    cafeteria.

                                  Table III.8

                    1993 Cafeteria and Dining Room Subsidies
                     for the Federal Reserve System, FDIC,
                                  OCC, and SEC

                                                                Percentage
    Entity                          Total subsidy cost        subsidized\a
    ------------------------------  ------------------  ------------------
    Atlanta                                   $632,747                  45
    Boston                                     680,729                  52
    Chicago                                  1,101,062                  49
    Cleveland                                  280,773                  50
    Dallas                                     651,928                  43
    Kansas City                                500,808                  50
    Minneapolis                                321,644                  37
    New York                                 2,500,000                  55
    Philadelphia                               519,108                  40
    Richmond                                   545,457                  52
    St. Louis                                  445,603                  45
    San Francisco                              174,866                  19
    Federal Reserve Board                      740,900                  45
    FDIC\b                                     246,420                  40
    OCC\c                                       83,322                  19
    SEC                                            n/a                 n/a
    ----------------------------------------------------------------------
    Legend:  n/a = not applicable.

    \a When separate percentages were provided for the cafeteria and
    dining room subsidies, we combined the employee cafeteria and
    executive dining room subsidy cost and divided by the total cost for
    both facilities to calculate the percentage subsidized.  Percentages
    were rounded to the nearest whole number.

    \b Information is for the 12-month period from June 1, 1993, to May
    31, 1994.

    \c OCC indicated that its cafeteria contractor is expected to operate
    on a break-even basis.  However, in 1993 the contractor experienced a
    loss of $83,322, which was subsidized by OCC.

    Sources:  The Federal Reserve Board; Federal Reserve District Banks;
    and the headquarters of FDIC, OCC, and SEC.

             DENTAL INSURANCE
    --------------------------------------------------- Appendix III:0.2.1

    While the Federal Employees Health Benefits Program does not offer
    employees separate subsidized dental insurance, the Board subsidizes
    its employees' dental plan, paying approximately 80 percent of the
    premium.  Reserve Bank subsidies ranged from 65 to 95 percent.  In
    1993, the dental subsidy cost the Board about $518,000 and the 12
    Reserve Banks, a total of more than $6.8 million.  To reduce this
    cost, one Reserve Bank negotiated a new dental plan that froze
    premiums for 1993 and 1994.  Officials estimated that this would save
    the Reserve Bank $200,000 over those 2 years.  FDIC and OCC pay the
    full cost of their employee dental insurance.  In keeping with the
    Federal Employees Health Benefits Program, SEC does not offer this
    benefit.

             MARRIAGE, BEREAVEMENT,
             FAMILY CARE, AND FLOATING
             HOLIDAY LEAVE
    --------------------------------------------------- Appendix III:0.2.2

    In addition to annual and sick leave, many Reserve Banks offered
    separate leave categories for bereavement, marriage, family care, and
    floating holidays that are not generally offered to civil service
    employees.  The Board, FDIC, OCC, and SEC do not offer any of these
    four leave programs.  Their employees must use their annual or sick
    leave, in lieu of these other leave benefits.  Table III.9 shows the
    number of banks offering these leave categories and the number of
    days offered.

                                  Table III.9

                    Marriage, Bereavement, Family Care, and
                             Floating Holiday Leave

                                       Number of banks      Number of days
    Leave category                    offering benefit             offered
    ------------------------------  ------------------  ------------------
    Bereavement                                     11                3 -7
    Marriage                                         4                1 -5
    Family care                                     \3                0 -5
    Floating holidays                               10                1 -2
    ----------------------------------------------------------------------
    Source:  Federal Reserve Banks.

    Bereavement leave provides extra days off for an employee to grieve
    the loss of a family member.  In 1993, 2 of the 11 banks that offered
    bereavement leave did not keep records of the number of days
    provided.  The remaining nine banks granted a total of about 4,200
    days for bereavement leave.  The cost to one bank that granted about
    1,500 days of bereavement leave was $245,000.

    Marriage leave is provided to employees who are marrying.  One of the
    four banks that granted such leave in 1993 did not track the number
    of days provided.  The other three banks granted a total of 546 days
    for marriage leave.  The cost to one bank granting 394 days of such
    leave was about $64,000.

    Family care leave is provided to employees to care for sick family
    members.  Three banks offered paid family care leave and granted a
    total of about 2,900 days in 1993.  We did not determine the cost of
    family care leave.  Floating holidays are given to employees to use
    to take care of personal matters.

             MASS TRANSIT SUBSIDY
    --------------------------------------------------- Appendix III:0.2.3

    Four of the 12 Reserve Banks offered employees a monthly mass transit
    subsidy.  Some restricted the subsidy to employees who did not use
    the Reserve Banks' parking facilities.  The subsidies ranged from $4
    in Kansas City to $30 in St.  Louis.  Both the Board and SEC offer
    employees up to $21 in monthly mass transit subsidies, while FDIC and
    OCC do not offer this benefit.\1 Under section 629 of the Treasury,
    Postal Service and General Government Appropriations Act of 1991,
    Public Law 101-509, federal government agencies may offer monthly
    mass transit subsidies to their employees.

    --------------------
    \1 At the time our survey, the Board was unable to provide us
    information about the total cost of the mass transit subsidy.

             HOME SECURITY SYSTEMS
    --------------------------------------------------- Appendix III:0.2.4

    Home security systems are provided to the Chairman of the Board,
    eight Reserve Bank presidents, five first vice presidents, one
    executive vice president, and one senior vice president.  We were
    told that the Board Chairman's system cost approximately $2,500, and
    the cost to install four of the Reserve Bank Presidents' systems
    ranged from $2,500 to $8,000.  FDIC, OCC, and SEC do not provide home
    security systems for officers or employees.

             HOME-TO-WORK
             TRANSPORTATION
    --------------------------------------------------- Appendix III:0.2.5

    At the Board, only the Chairman regularly receives home-to-work
    transportation authorized under Public Law 99-550.\2 At the Reserve
    Banks, six other Reserve Bank presidents drive themselves from home
    to work in Federal Reserve-owned vehicles.  In addition, 47 other
    Reserve Bank personnel use bank vehicles to travel from home to work,
    and some can also use the cars for personal reasons, although they
    must claim a taxable benefit.  As of January 1996, three banks
    indicated they will limit the use of bank-owned vehicles for
    home-to-work transportation to presidents and first vice presidents.
    This will result in about 12 fewer employees' using these vehicles
    for home-to-work travel.  The FDIC, OCC, and SEC Washington, D.C.,
    offices do not regularly provide home-to-work transportation to their
    officials.

    --------------------
    \2 The Chairman is the only Board member who is assigned a
    chauffeured vehicle.  The 6 remaining Board members have access to a
    motor pool of 14 vehicles that is used for business-related trips.

    PROCUREMENT PRACTICES DIFFER AND
    EFFECTIVE CONTROLS ARE OFTEN
    MISSING
    ========================================================== Appendix IV

    As discussed in chapter 3, despite the Federal Reserve's attempt to
    provide a framework for uniform procurement policies, Reserve Banks
    have differing procurement practices.  Although the guidance used by
    each Reserve Bank is intended, among other things, to ensure fair and
    equitable treatment of prospective sources, Reserve Bank practices
    appear to favor certain sources over others.  We found that some
    Reserve Banks comply closely with Uniform Acquisition Guidelines
    (UAG), while others use practices that limit competition.  At some
    Reserve Banks, new bidders were not provided an equal opportunity to
    bid for large procurements, and bidders lists at three Reserve Banks
    were limited to sources with which the Reserve Banks traditionally
    have done business, although other equally qualified sources were
    available and interested.

    Some practices/procedures at individual Reserve Banks are
    commendable, yet noteworthy procedures were not being disseminated
    among the Reserve Banks.  None of the Reserve Banks uses commendable
    procedures in every area.  For instance, although the procurement
    process at one Reserve Bank appeared to be in compliance with the
    intent of the UAGs, it lacked appropriate controls over its voucher
    payment function for major construction contracts.  Moreover, some
    Reserve Banks use practices that restrict full and open competition,
    by limiting bidders lists to sources with which the Reserve Bank
    traditionally does business, although we were told that other sources
    were available and interested.

       CERTAIN BIDDERS FAVORED IN
       SOURCE SELECTION
    -------------------------------------------------------- Appendix IV:1

    According to the UAGs, invitations to bid and requests for proposals
    should be sent to as many interested suppliers as possible to ensure
    competition.  Interested suppliers should not be excluded from
    receiving a solicitation, unless they are clearly unable to fulfill
    the basic requirements of the solicitation.  Yet, new sources were
    excluded from receiving awards for large, complex, and costly
    procurements at most of the Reserve Banks we visited, since Reserve
    Banks restricted lists of potential bidders to sources with which
    they have had previous experience, giving new sources smaller, less
    complex orders.  Furthermore, several Reserve Banks restricted the
    number of potential bidders by forwarding invitations to bid and
    requests for proposals to a limited number of bidders.  For example,
    the building department at one Reserve Bank selected the sources and
    limited the number of sources to a maximum of five bidders for
    construction/building alteration projects.

    In contrast, another Reserve Bank solicited bids/proposals from a
    large number of sources.  To prepare for the award of its travel
    contract, the Reserve Bank combined information from a list of the
    top travel agencies in the area with names from their vendor database
    to identify potential sources.  The Reserve Bank invited a total of
    14 sources to a meeting to discuss Reserve Bank requirements.  The
    Reserve Bank also forwarded copies of questions and answers from the
    meeting to the 11 firms attending the meeting.  Proposals were
    subsequently received from six firms.  The successful firm was
    selected on the basis of the best overall financial cost to the
    Reserve Bank.

       CONTRACT EXTENSION PRECLUDES
       COMPETITION
    -------------------------------------------------------- Appendix IV:2

    The UAGs encourage competition and restrict the use of sole/single
    source awards to situations where (1) no other source of supply is
    available, (2) the urgency of the Reserve Bank's need does not permit
    the delay involved in using more formal methods of acquisition, or
    (3) senior officials deem it necessary.  However, two of the four
    Reserve Banks we reviewed have retained incumbent cafeteria
    contractors for years without recompeting the award, thus precluding
    other firms from competing for those services.  Officials at one of
    the Reserve Banks were unable to locate documentation in support of
    the last contract competition, which they believed occurred in the
    late 1980s.  Furthermore, at the other Reserve Bank, records
    indicated that the cafeteria contract was last competed in 1986,
    about 10 years ago.  In contrast, two Reserve Banks competed their
    cafeteria contract awards within the last 2 years.  One Reserve Bank
    invited six firms to submit bids for cafeteria operations and
    performed an extensive analysis of the four bids received to
    determine which firm should receive the award, including an analysis
    of the possibility of using one source to operate the Reserve Bank's
    cafeteria, as well as the cafeterias at each branch office.  Our
    review showed that the other Reserve Bank invited 14 firms to submit
    bids and performed an extensive analysis of the 11 bids received to
    select the firm to operate the cafeteria.

       WIDE DISCRETION IN NEGOTIATIONS
    -------------------------------------------------------- Appendix IV:3

    In addition to competitive bidding, in which the award goes to the
    low bidder after the bids are opened, the UAGs provide for the use of
    competitive proposals.  The competitive proposal method permits
    discussions with offerors after proposals have been opened to allow
    clarification and changes in proposals.  However, adequate
    precautions are to be taken to treat each offeror fairly and to
    ensure that information gleaned from competing proposals is not
    disclosed to other offerors.

    Our work indicated that wide discretion exists among Reserve Banks in
    the latitude under which they negotiate with competitive sources.
    For example, in negotiating the competitive award of a network server
    and peripherals at one of the four Reserve Banks, negotiations were
    conducted only with the low bidder after bid opening, despite the
    fact that the system configuration (i.e., type, size, and
    sophistication of server) had been totally changed.  Other firms were
    not given the opportunity to offer competing bids.  In contrast, when
    a design change occurred after bid opening, one Reserve Bank's legal
    department required that the contract be recompeted and did not allow
    negotiations with bidders.

       BID EVALUATION DELEGATED
       OUTSIDE THE RESERVE BANK
    -------------------------------------------------------- Appendix IV:4

    Although the UAGs prohibit disclosure of specific information
    contained in bids or proposals to anyone except Reserve Bank
    personnel directly involved in the selection process, two Reserve
    Banks transferred most functions associated with the award of major
    construction/building alteration contracts to architecture and
    engineering (A&E) firms.  Both Reserve Banks used A&E firms for
    source selection, receipt and evaluation of bids, and selection of
    the successful bidder.  The amount of responsibility passed from the
    hands of Reserve Bank personnel to the A&E firm is demonstrated by
    the fact that the Reserve Bank officials at one of the two Reserve
    Banks were not aware that the award may not have been given to the
    low bidder.  The department vice president assured us that he was
    certain that the A&E firm could justify the award to the selected
    source.

    In contrast, one Reserve Bank building department's vice president
    cautioned against delegating bid evaluation functions to A&E firms,
    commenting that the larger the role the A&E firm plays, the greater
    the potential for favoritism.  At another Reserve Bank, personnel
    also retained source selection functions for large construction
    contracts.  Moreover, they told us they found that the process of
    evaluating cost information provided by potential sources leads to a
    better understanding of the sources' knowledge of the area and their
    technical capability.  An official from the Reserve Bank summarized
    the benefits of evaluating proposals as follows:  challenging the
    bids/proposals from construction contractors results in improved
    understanding of what is required, better quality, and lower prices.

       INDEPENDENT CHECKS AND
       RECONCILIATION LACKING
    -------------------------------------------------------- Appendix IV:5

    Although the UAGs do not address payments, the American Institute of
    Certified Public Accountants defines a desirable control environment
    as one in which duties should be segregated to reduce opportunities
    for any person to be in a position to perpetuate or conceal errors or
    irregularities in the normal course of his or her duties.  Therefore,
    different people/organizations should have the responsibility for
    authorizing transactions, recording transactions, etc.  Another
    control procedure is ensuring that the procedures contain independent
    checks and reconciliations.

    Two Reserve Banks had a system of internal checks over the voucher
    payment process for progress payments associated with construction
    contracts.  The organization responsible for the paying of invoices
    at each Reserve Bank maintained a separate clerical
    check/reconciliation system to ensure that contract dollar amounts
    were not exceeded.  However, two other Reserve Banks did not have
    systems that ensured separation of duties or independent checks.  The
    individual responsible for the payment function at one Reserve Bank
    explained that when an authorization to pay an invoice for a progress
    payment is received from the building department, it is paid.  At the
    other Reserve Bank, officials responsible for the payment function
    explained that, while they tracked payments to each source by year,
    they did not track progress payments on each contract.

    In contrast, at another Reserve Bank, payments to construction
    contractors were closely controlled.  As a control mechanism for the
    payment authorization from the Building Department, another
    department tracked progress payments using a spreadsheet.  When a
    payment authorization was received, the spreadsheet maintained for
    each construction contract was updated to accumulate a running total.
    This practice ensured that construction contractors did not receive
    more funds than the Reserve Bank was obligated to pay.  This control
    system served as an independent check and reconciliation.

    (See figure in printed edition.)Appendix V
    COMMENTS FROM THE BOARD OF
    GOVERNORS OF THE FEDERAL RESERVE
    SYSTEM
    ========================================================== Appendix IV

    See comment 1.

    (See figure in printed edition.)

    See comment 2.

    See comment 3.

    (See figure in printed edition.)

    See comment 4.

    See comment 5.

    (See figure in printed edition.)

    See comment 6.

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 7.

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 8.

    (See figure in printed edition.)

    See comment 9.

    The following are GAO's comments on the Board of Governors of the
    Federal Reserve System's letter dated April 11, 1996.

       GAO COMMENTS
    -------------------------------------------------------- Appendix IV:6

    1.  The Federal Reserve Board commented that the cost increases we
    reported were related to a number of new initiatives in expanded
    supervision and technology and personnel enhancements necessary to
    keep pace with developments in private financial markets.  The Board
    also commented that some redundancy of resources was necessary to
    limit the risk of systemic crises.  We acknowledge that the growth in
    Federal Reserve expenses that occurred during 1988 to 1994 was
    caused, at least partially, by significant increases in expenses for
    bank supervision and regulation, personnel compensation, and an
    extensive automation modernization and consolidation effort.
    However, we note that bank supervision accounted for only about 20
    percent of total Reserve Bank expenses in 1994.  We also note that
    the Federal Reserve's computer hardware and software expenses are
    largely capitalized, with their costs being spread out over many
    years through charges to depreciation.  Finally, we note that the
    rapid rise in personnel compensation costs, which affected all lines
    of business and accounted for about two-thirds of total Federal
    Reserve operating costs in 1994, was by far the most significant
    contributor to the Federal Reserve's cost increases during the 1988
    to 1994 period, representing over 70 percent of the total growth in
    the System's operating expenses.

    2.  The Board commented that the overall growth in their costs during
    the 1988 to 1994 period was lower than the comparable growth in
    federal nondefense discretionary expenditures.  We used three
    different baselines as standards of comparison in this report.  As
    the Board noted, the growth in the Federal Reserve's operating costs
    was somewhat less than the growth in federal nondefense discretionary
    expenditures over the 1988 to 1994 period.  However, it was
    substantially greater than both the amount of inflation and the
    increase in total federal discretionary expenditures that occurred
    over these same years.  We also noted in this report that Federal
    Reserve employment increased approximately 4 percent during the 1988
    to 1994 period.  To compensate for differences in changes in
    employment levels, we computed personnel costs on a per capita basis.
    These calculations showed that the 39-percent increase in the per
    employee cost of Federal Reserve salaries was slightly higher than
    the 36-percent increase in the per capita salary cost in the federal
    government.  However, the increase in the per employee cost of
    Federal Reserve benefits (96 percent) was substantially higher than
    the increase for the federal government (62 percent).

    3.  The Board commented that, while some opportunities for
    consolidation of activities may exist, the benefits of the autonomy
    and competitiveness of the Reserve Banks in attracting highly
    qualified staff must be balanced against the expected savings from
    consolidation.  We agree that a competitive, internal environment can
    help attract highly qualified staff.  However, our findings raise
    questions about the extent to which the Federal Reserve is able to
    capture the benefits of internal competition.  One measure of
    effective competition within a cost-conscious, decentralized
    organization would be the extent to which proven or potential
    cost-saving strategies developed by one or more of the autonomous
    units is shared with, and embraced by, the others.  We found mixed
    evidence of this at the Federal Reserve.  For example, we noted that
    the systemwide automation consolidation effort began as a proposal by
    several Reserve Banks that they consolidate their mainframe
    processing.  This effort led the Board to establish a committee to
    study the feasibility of consolidation for the Federal Reserve as a
    whole.  However, in other activities--such as contracting and
    procurement and management of health care benefits--we identified
    cost-saving strategies that had not been shared, at least formally,
    among the Reserve Banks.  Furthermore, we do not believe that
    consolidating activities is necessarily inconsistent with maintaining
    a competitive, internal environment.  For example, a systemwide
    activity performed by fewer than 12 Reserve Banks could still provide
    opportunities for internal competition.

    4.  The Board noted that its financial services, especially its
    priced services, are competitively tested by the marketplace.  We
    noted in the report that private sector competition is increasing in
    payments services.  Still, in many areas, competition is limited and
    many financial institutions have no alternative to the Federal
    Reserve for some services.  For example, private check clearinghouses
    often only cover certain geographical areas or handle only certain
    types of payments, such as those for large dollar amounts.

    5.  The Board commented that the Federal Reserve fully recovers its
    costs of providing services to depository institutions in the long
    run.  The Board noted that, from 1986 through 1995, it recovered 101
    percent of its costs, including a targeted return on equity and other
    imputed costs.  We noted that the most recent data showed a trend of
    Federal Reserve expenses for providing priced services rising much
    faster than the revenues received.  For example, from 1990 to 1994,
    Federal Reserve revenues from check clearing actually declined by 0.2
    percent, while expenses increased 13.8 percent.  Similarly, automated
    clearinghouse revenues increased during the period by 22 percent,
    while expenses increased 41.1 percent.  Thus, we continue to believe
    that the Board should undertake a review of the Federal Reserve's
    provision of these services.

    6.  The Board noted that the decline in the Reserve Banks' check
    volume was largely attributable to the Board's adopting a same day
    settlement rule, and that staffing reductions were made to adjust to
    those declines in volume.  We noted in this report that the growth in
    expenses for priced services to financial institutions was the
    smallest for any line of business during the 1988 to 1994 period.
    However, we also noted that the Federal Reserve has a significant
    incentive to restrain increases in these costs because the System
    competes with the private sector in providing these services and is
    legally required to charge fees that recover its costs.  We also
    noted that, in other service areas not subject to these constraints,
    Federal Reserve staffing and expenses have increased despite
    Systemwide efforts to consolidate and increase efficiency.  For
    example, in the savings bonds program, Treasury directed the Federal
    Reserve to consolidate its savings bonds operations from 12 to 5
    locations.  Despite this consolidation, staffing in the program
    increased slightly.  When Treasury announced the selection of the 5
    Reserve Bank locations in June 1992, there were 913 employees in the
    savings bonds departments of the Reserve Banks and branches.  In
    1994, there were 918 employees.  Automation costs for the program
    also increased, from $6.7 million in 1992 to $12.7 million in 1994.

    7.  The Board stated that our finding that the increase in Federal
    Reserve benefits from 1988 to 1994 was significantly higher than
    benefit increases for the federal government did not appear to be
    correct.  They calculated the benefit increase to be 64 percent for
    the Federal Reserve, comparable to our reported increase in the
    federal government's benefits of 62 percent.  Their calculation was
    based on a different methodology than ours.

    Although there are several ways to present the increases in the cost
    of benefits for the Federal Reserve, we believe our methodology is
    the best way to facilitate comparison with the federal government.
    The Board's annual reports, which are done on an accrual basis,
    showed a 176-percent increase in per capita benefits over this
    period.  However, to facilitate comparison with the federal
    government, it was necessary to take out certain accruals because the
    federal government accounts are done primarily on a cash basis.  In
    our calculations, we (1) reduced the Board's reported amounts by a
    measure of the accrual for additional postretirement benefit
    expenses; (2) increased these amounts by a measure of the accrual for
    the Federal Reserve's overfunded pension fund; and (3) added back in
    amounts representing payments for the Federal Reserve's early
    retirements in 1988, 1989, and 1994.  In calculating its 64-percent
    estimate, the Federal Reserve has made the first two adjustments, but
    not the third.  As a result, the Federal Reserve numbers do not
    include early retirement payments, but these costs are included in
    the federal government's benefits costs and are clearly a cost
    incurred by the Federal Reserve.  We believe that comparability would
    be more properly maintained by including these costs in the Federal
    Reserve measures as well.

    8.  The Board noted that the planning and design phase of the Dallas
    Federal Reserve Bank building predated certain decisions concerning
    computer facility consolidation, but included sufficient flexibility
    in design to accommodate the decision made later to house a
    consolidated data center.  While recognizing the need for some
    flexibility to accommodate changes in function or design, we continue
    to believe that such major construction projects may offer
    opportunities to reduce costs.  Such opportunities appear to have
    been available in the Dallas Reserve Bank building and some could
    still be available if, as the Federal Reserve suggests, they were to
    sell off unneeded land.  In addition, after making what turned out to
    be overestimates of staffing growth for the Dallas Reserve Bank
    building, the Federal Reserve has subsequently made more conservative
    projections in connection with a new bank building and a major
    renovation of an existing bank building.

    9.  The Board stated that the Federal Reserve System has engaged in a
    variety of strategic planning efforts for many years.  In addition,
    the Board noted that it had recently established a Federal Reserve
    System Strategic Planning Coordination Group (SPCG) to coordinate
    various strategic planning efforts within the System.

    We acknowledged that the Federal Reserve had established SPCG, which
    includes representatives from the Reserve Banks and the Board of
    Governors.  SPCG is to provide a common framework for the development
    and refinement of the many individual strategic plans and action
    plans within the Federal Reserve.  According to Federal Reserve
    planning documents, several Board members and Reserve Bank presidents
    believed that the discrete strategic planning processes within the
    Federal Reserve would benefit from greater coherence, especially in
    terms of assumptions about the future environment and
    interrelationships among functions.  In our report, we characterized
    the establishment of SPCG as a positive step for the Federal Reserve,
    but we expressed concern that its scope of responsibility and
    authority may be too limited.  While doing the bold strategic
    planning we envision may be difficult to accomplish in a system of
    shared responsibilities, we continue to believe it is essential for
    the Federal Reserve to adopt such an approach to effectively meet the
    challenges of the future.

    MAJOR CONTRIBUTORS TO THIS REPORT
    ========================================================== Appendix VI

       GENERAL GOVERNMENT DIVISION,
       WASHINGTON, D.C.
    -------------------------------------------------------- Appendix VI:1

    Helen H.  Hsing, Associate Director, Financial Institutions and
     Markets Issues
    Thomas J.  McCool, Associate Director, Financial Institutions and
     Markets Issues
    Stephen C.  Swaim, Assistant Director (retired)
    Charles G.  Kilian, Project Manager
    Vanessa Y.  Adams, Evaluator
    Nancy M.  Eibeck, Evaluator
    Carl M.  Ramirez, Technical Advisor
    Desiree W.  Whipple, Reports Analyst
    Charlotte Moore, Reports Analyst
    Yolanda Riley, Information Processing Assistant
    Phoebe Jones, Information Processing Assistant

       CHICAGO FIELD OFFICE
    -------------------------------------------------------- Appendix VI:2

    Susan R.  Bradshaw, Evaluator
    Cristine M.  Marik, Evaluator

       DALLAS FIELD OFFICE
    -------------------------------------------------------- Appendix VI:3

    John V.  Kelly, Senior Evaluator
    Ellen G.  Thompson, Evaluator

       KANSAS CITY FIELD OFFICE
    -------------------------------------------------------- Appendix VI:4

    Marshall S.  Picow, Senior Evaluator
    Karl G.  Neybert, Evaluator

       NEW YORK FIELD OFFICE
    -------------------------------------------------------- Appendix VI:5

    Raymond L.  Gast, Evaluator
    Despina Hatzelis, Evaluator

       SAN FRANCISCO FIELD OFFICE
    -------------------------------------------------------- Appendix VI:6

    Ruth Ann Hijazi, Senior Evaluator
    Julie M.  DeVault, Evaluator

       OFFICE OF THE GENERAL COUNSEL
    -------------------------------------------------------- Appendix VI:7

    Paul Thompson, Attorney

    *** End of document. ***