a

GAO

United States General Accounting Office

Report to Congressional Requesters

September 2002 FEDERAL RESERVE 

SYSTEM

Update on GAO’s 1996 

Recommendations

GAO-02-774
Page i GAO-02-774 Federal Reserve System

Contents

Letter 1

Results in Brief 1

Background 2

The Federal Reserve Has Taken Steps to Address Systemwide 

Mission and Management Issues 5

The Federal Reserve Has Strengthened Its Control and Oversight 

Mechanisms 8

The Federal Reserve Has Consolidated Some of Its Administrative 

Functions 10

The Federal Reserve Has Continued Its Policy of Not Charging for 

Bank Examinations 13

Scope and Methodology 17

Agency Comments 17

Appendix

Appendix I: Comments from the Federal Reserve System 19

Tables Table 1: Charges and Assessments on Banks, by Charter, as of 

September 2002 15

Figures Figure 1: Federal Reserve Employment from 1995 to 2001 3

Figure 2: Federal Reserve Operating Expenses from 1993 to 2001 4

Figure 3: 1996 Recommendations Affecting Federal Reserve 

Systemwide Mission and Management Issues 6

Figure 4: 1996 Recommendation Affecting Federal Reserve Control 

and Oversight Mechanisms 8

Figure 5: 1996 Recommendations Affecting Federal Reserve 

Administrative Functions 12

Figure 6: Recommendation Regarding Charging for Bank 

Examinations 14

Abbreviations

FDIC Federal Deposit Insurance Corporation

DRR Designated Reserve Ratio

OCC Office of the Comptroller of the Currency

PSDC Payments System Development Committee
Page 1 GAO-02-774 Federal Reserve System

United States General Accounting Office

Washington, D.C. 20548

A

September 25, 2002 Letr

The Honorable Harry Reid

The Honorable Byron Dorgan

United States Senate

Our June 1996, report,1

 which we prepared at your request, made a number 

of recommendations to the Board of Governors of the Federal Reserve 

System (the Board) for reducing spending and improving the operations of 

the Federal Reserve System (Federal Reserve). This report responds to 

your request that we review the status of the Federal Reserve’s response to 

our recommendations, which fall into four broad categories: (1) 

systemwide mission and management issues, (2) control and oversight 

mechanisms, (3) administrative functions, and (4) funding the cost of bank 

examinations. For each category, we briefly review the report’s findings 

and recommendations and then describe related actions taken by the 

Federal Reserve following publication of the 1996 report. 

The 1996 report also made a recommendation regarding the Federal 

Reserve’s practice of maintaining a surplus account to protect the Federal 

Reserve from losses. We address this issue in a separate report.2

Results in Brief The Federal Reserve has taken actions responsive to most of the 1996 

report’s recommendations. The Federal Reserve has retained its structure 

but has sought to consolidate operations and bring common management 

practices to the 12 Federal Reserve District Banks (Reserve Banks). In 

particular, the Federal Reserve now manages the payments services it 

provides to banks on a systemwide basis. The Federal Reserve has also 

changed its budgeting, internal oversight, and cost accounting processes in 

an effort to increase accountability. It has taken other steps to decrease 

costs in areas identified by our 1996 report. For example, the Reserve 

Banks have consolidated their purchases of some services, such as 

prescription drug coverage, to take advantage of volume discounts, rather 

than continuing with the former practice of each individual Reserve Bank 

1

U.S. General Accounting Office, Federal Reserve System: Current and Future Challenges 

Require Systemwide Attention, GAO/GGD-96-128 (Washington, D.C.: June 17, 1996).

2

U.S. General Accounting Office, Federal Reserve System: The Surplus Account, GAO-02-

939 (Washington, D.C.: Sept. 18, 2002).
Page 2 GAO-02-774 Federal Reserve System

purchasing services separately. The Federal Reserve, however, continues 

not charging for bank examinations. Federal Reserve officials explained 

that they continue to believe that charging for bank examinations would tip 

the current balance against state charters for banks, and thus be 

inconsistent with maintaining the dual banking system of state and 

nationally chartered banks. While we continue to believe that a strong 

argument exists for industry funding of federal supervision and regulation, 

we also recognize the benefits of the dual banking system. Ultimately, it is 

up to Congress to decide how to fund federal regulation and to balance the 

differences among the different bank regulators.

Background The Federal Reserve Act of 1913 established the Federal Reserve System as 

the country’s central bank. The act made the Federal Reserve an 

independent, decentralized bank to better ensure that monetary policy 

would be based on a broad economic perspective from all regions of the 

country. The Federal Reserve System consists of the Board of Governors 

located in Washington, D.C., and 12 Reserve Banks, with 25 branches, 

located throughout the nation. 

Each Reserve Bank is a federally chartered corporation with a Board of 

Directors representing the public and member banks in its district. Under 

the Federal Reserve Act, Reserve Banks are subject to the general 

supervision of the Board. The Board is a federal agency, responsible for 

maintaining the stability of financial markets, supervising financial and 

bank holding companies and state-chartered banks that are members of the 

Federal Reserve and the U.S. operations of foreign banking organizations, 

and overseeing the operations of the Reserve Banks. The Board has 

delegated some of these responsibilities, including bank examinations, to 

the Reserve Banks, which also provide payment services, such as check 

clearing and wire transfers, to depository institutions and government 

agencies. 

In 2001, there were approximately 25,000 staff in the Federal Reserve with 

about 93 percent of these employees working at the Reserve Banks. From 

1995 to 2001, Federal Reserve employment decreased by 482 employees. 

Employment for 2002 is projected to grow by 314, largely because of plans 

to increase security staff. Figure 1 shows Federal Reserve employment 

from 1995 to 2001.
Page 3 GAO-02-774 Federal Reserve System

Figure 1: Federal Reserve Employment from 1995 to 2001 

Source: Federal Reserve Board staff.

In the 1996 report, we noted that the Federal Reserve is self-financed, and 

that the income it collects but does not use to fund its operations is turned 

over to the U.S. Treasury.3

 In 2001, the Federal Reserve had a total income 

of $31.9 billion and expenses of approximately $2.1 billion; it subsequently 

transferred $27.1 billion to the U.S. Treasury.4

Since 1993, the operating expenses of the Federal Reserve have increased 

an average of 4.2 percent per year (2.2 percent when adjusted for inflation). 

According to its 2002 Budget Review, the Federal Reserve’s operating 

3

The Federal Reserve earns most of its income from its portfolio of Treasury securities. It 

also receives revenue for payment services that it provides to financial institutions.

4

The remaining $2.7 billion comprised net deductions from income resulting primarily from 

unrealized losses on assets denominated in foreign currencies revalued to reflect current 

market exchange rates; assessments by the Board for its expenses and cost of currency; and 

other distributions, which included dividends paid to member banks and transfers to the 

surplus account.
Page 4 GAO-02-774 Federal Reserve System

expenses are budgeted at $2.8 billion, an increase of 4.5 percent from the 

estimated 2001 expenses. Figure 2 shows the Federal Reserve’s operating 

expenses from 1993 to 2001.

Figure 2: Federal Reserve Operating Expenses from 1993 to 2001

Source: Federal Reserve budget review.

Our 1996 report identified several inefficiencies in the Federal Reserve’s 

policies and practices that had increased the cost of providing its services, 

including its costs for travel, personnel benefits, and contracting and 

procurement. Many of these inefficiencies related to the decentralized 

nature of the Federal Reserve, which allowed each Reserve Bank to set 

many of its own policies, and to the absence of traditional cost-minimizing 

forces, such as competition or appropriations, that are commonplace in 

entities that are either purely private or public sector in nature. With this in 

mind, we suggested that the Federal Reserve could do more to increase its 

cost consciousness and ensure that it is operating as efficiently as possible. 

The 1996 report concluded that major cost reductions ultimately depended 

on the Federal Reserve’s carefully reexamining its mission, structure, and 

work processes. The report identified areas that had potential for reducing 
Page 5 GAO-02-774 Federal Reserve System

the Federal Reserve’s costs. The recommendations from the report fall into 

four broad categories: 

• systemwide mission and management issues,

• control and oversight mechanisms, 

• cost of specific Federal Reserve administrative functions, and

• charging banks for the costs associated with bank examinations.

The Federal Reserve 

Has Taken Steps to 

Address Systemwide 

Mission and 

Management Issues 

In 1996, we noted that the Federal Reserve 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 included (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) continuing rapid consolidation of the banking 

industry, which could affect both the need for and the distribution of bank 

examination staff. Because these areas accounted for the largest part of the 

Federal Reserve’s expenses and staffing, we believed that addressing these 

challenges effectively would likely result in major changes in how the 

Federal Reserve operated. 

The Federal Reserve’s strategic plans and programs under development at 

the time of the 1996 report generally focused on individual divisions, 

Reserve Banks, or functions. While these plans served an important 

purpose in defining the direction of these Federal Reserve entities, we also 

believed that the emerging issues and challenges facing the Federal 

Reserve would necessitate strategic planning focused on the system as a 

whole. We also found that each of the Reserve Banks administered various 

functions independently, rather than as a single entity that could operate 

more efficiently or possibly command more advantageous prices. These 

findings led to the recommendations in figure 3.
Page 6 GAO-02-774 Federal Reserve System

Figure 3: 1996 Recommendations Affecting Federal Reserve Systemwide Mission 

and Management Issues

Source: U.S. General Accounting Office, Federal Reserve System: Current and Future Challenges 

Require Systemwide Attention, GAO/GGD-96-128 (Washington D.C.: June 17, 1996).

Since 1996, the Federal Reserve has consolidated the management of the 

services provided by the individual Reserve Banks, particularly payment 

services. For example, payment system products and new technologies are 

now managed on a systemwide basis. The Federal Reserve also has 

undertaken an assessment of its role in providing payment services.

In January 1998, the Committee on the Federal Reserve in the Payments 

Mechanism, chaired by the Vice Chair of the Board of Governors, issued its 

report entitled The Federal Reserve in the Payments Mechanism. The 

study examined the payment services provided by the Federal Reserve in 

light of the rapid changes occurring in the financial services and technology 

sectors. These services include check clearing and automated 

clearinghouse services such as direct deposits. The committee undertook a 

fundamental review of the Federal Reserve’s role in the payments system 

and considered how alternative roles for the Federal Reserve might 

enhance or undermine the integrity, efficiency, and accessibility of the 

payments system. It concluded that the Federal Reserve’s current role, or 

even a slightly enhanced role, in fostering technical change was preferred 

by most payment system participants. 
Page 7 GAO-02-774 Federal Reserve System

In July 1999, the Federal Reserve formed the Payments System 

Development Committee (PSDC) to advise the Board and system officials 

on medium- and long-term public policy issues surrounding developments 

in the retail payments system.5

 This committee, which includes two 

Federal Reserve Board Governors, a Reserve Bank President, and a 

Reserve Bank First Vice President, was intended to follow up on the work 

of the Committee on the Federal Reserve in the Payments System. PSDC’s 

work has included the Check Truncation Act, proposed legislation 

designed to remove certain legal impediments to check truncation and 

enhance the overall efficiency of the nation’s payments system. It has also 

worked with payments industry officials to develop standards to facilitate 

increased use of electronic check processing. The Federal Reserve has 

introduced new payment products, such as its imaging service, to recognize 

the increasing role that image-based services are playing in the evolution of 

the U.S. payments system and the migration toward more electronic 

payments. 

The Federal Reserve has also undertaken numerous initiatives to 

streamline management structures, consolidate operations, and apply 

emerging technologies to the Reserve Banks’ business processes in order 

to improve quality and reduce costs. Federal Reserve officials explained 

that many of their initiatives have the effect of consolidating functions of 

the Federal Reserve without consolidating the 12 Reserve Banks. For 

example, in 1999, the Treasury Direct customer support function was 

consolidated so that only 3 Reserve Banks are providing customer service 

support to individuals who purchase Treasury securities directly from the 

Treasury. From 1999 to 2002, the Federal Reserve consolidated several 

aspects of Fedwire funds and securities transfer operations. Similarly, in 

2000, the Treasury Investment Program was implemented, centralizing 

services that the Federal Reserve provides to the Treasury Tax and Loan 

Program.

The Federal Reserve continues to standardize and centralize the 

management of computer applications used for common business needs. It 

has selected a central site to develop and implement a centralized 

application for the Reserve Bank Planning and Control System. The 

Federal Reserve estimates that the centralization of applications such as 

5

PSDC is cochaired by the Vice Chairman of the Federal Reserve Board and the President of 

the Federal Reserve Bank of Boston.
Page 8 GAO-02-774 Federal Reserve System

the budget application will result in systemwide savings of $2.6 million over 

a 5-year period. 

The Federal Reserve 

Has Strengthened Its 

Control and Oversight 

Mechanisms

In 1996, we noted a number of weaknesses in the Federal Reserve’s 

budgeting and internal oversight processes. In reviewing the budgeting 

process for both the Board and Reserve Banks, we found that it was based 

on a current services approach that assumed both that existing functions 

would be retained and that the budget would continue to grow 

incrementally. We concluded that such an approach did not adequately 

support top management in controlling costs and imposing the internal 

self-discipline necessary for the Federal Reserve to respond effectively to 

future priorities. We found that internal oversight processes, such as 

performance measurement, internal audit, and financial audits, either did 

not support performance evaluation from a systemwide perspective or 

were becoming increasingly inappropriate in the changing environment. 

We also noted that the Office of Inspector General was authorized to 

review the activities of the Board, but not the Reserve Banks. As a result, 

we concluded that the Federal Reserve might not be making the most use 

of its resources devoted to Federal Reserve oversight. These findings led to 

the recommendation in figure 4. 

Figure 4: 1996 Recommendation Affecting Federal Reserve Control and Oversight 

Mechanisms

Source: GAO/GGD-96-128.

In addition to incorporating systemwide business strategies and resource 

needs into the Federal Reserve Bank budget planning process, the Federal 

Reserve Banks have changed their cost accounting system and have altered 

their internal and external auditing practices.

The Federal Reserve recognized that its budget process required too much 

effort and yielded an unrealistic spending outlook. Therefore, the Federal 
Page 9 GAO-02-774 Federal Reserve System

Reserve’s Financial Support Office proposed changes to the budget process 

in which system budget targets would be based on systemwide guidance 

rather than on Reserve Bank projections of their expenses. Banks provided 

their expense information later in the process when their budget 

development would be further along—an approach that also could help 

align budget planning with goal-setting for business strategies. In 2001, the 

Federal Reserve’s Conference of First Vice Presidents recommended 

incorporating this guidance to align the Reserve Bank budget projections 

more closely with business strategies. The conference identified “national 

business leaders,” that is, Federal Reserve staff with responsibility for most 

Reserve Bank functions. These leaders provide business guidance as input 

to the Reserve Banks as they prepare their Reserve Bank Budget Outlook. 

They are responsible for almost 90 percent of the total Reserve Bank 

spending. (The remaining 10 percent of spending is largely in support of 

Federal Reserve monetary policy formulation and is not covered by 

systemwide budget goals.)

The Board of Governors has also redefined its strategic plan and has now 

implemented a more rigorous 4-year planning process and a 2-year budget 

process. With this new plan in place, the Board has consolidated overhead 

and several support functions to reduce costs.

In March 2000, the Conference of First Vice Presidents approved 

recommendations designed to improve the cost-accounting practices of the 

Federal Reserve Banks. Board staff told us that Reserve Bank staffs have 

implemented these recommendations. Changes, according to Board staff, 

include the following: 

• Simplifying expense allocation by tying expenses to departments and 

organizational units in Reserve Banks rather than to specific activities. 

This change will eliminate a major portion of the manual process 

currently in place, and in turn, will reduce the opportunity for erroneous 

activity charges.

• Shifting some expenses from overhead to the service line that they 

support to reflect expenses more accurately.

• Eliminating sharing of costs among Reserve Banks for all services and 

operations that are provided centrally. Instead, the Reserve Bank that 

provides the service will now report associated expenses in an effort to 

enhance accountability.
Page 10 GAO-02-774 Federal Reserve System

The Board adopted several new policies aimed at safeguarding the 

independence of its external auditor. An external auditor, under a contract 

administered by Board staff, reviews each Reserve Bank’s financial 

statements. To enhance independence, in May 2002, the Board placed 

restrictions on Reserve Banks’ ability to contract with the Board’s external 

audit firm or to hire an auditor that has worked on the audit of a Reserve 

Bank. The Board currently requires that the external auditor of the Reserve 

Banks remain independent of Reserve Bank management, and that it 

provide a written statement to the Board delineating all relationships 

between the external auditor and the Reserve Banks. 

In 2001, the Board revised its policy on Reserve Bank audit committee 

duties and responsibilities, requiring that (1) audit committees adopt 

formal written charters, (2) audit committee members be independent and 

financially literate, and (3) audit committees meet with external auditors to 

discuss the Reserve Bank’s financial statements and issues arising from the 

annual external audit. The audit authority of the Inspector General remains 

unchanged.

The Federal Reserve 

Has Consolidated 

Some of Its 

Administrative 

Functions

In 1996, we concluded that opportunities existed to reduce the Federal 

Reserve’s spending in a number of different administrative areas. We found 

in 1996 that Federal Reserve personnel compensation (pay and benefits) 

varied within the Federal Reserve and included benefits that were 

relatively generous compared with those of government agencies with 

similar responsibilities. 

We also found that the Federal Reserve’s health care benefits were 

managed on a decentralized basis, with each Bank negotiating its own 

health care coverage. We noted that although the Reserve Banks had 

individually made efforts to reduce health care costs, the Reserve Banks 

had not worked together to determine whether their combined bargaining 

powers would further reduce these expenses. 

We found in 1996 that travel policies differed between the Board and the 

Reserve Banks and among the Reserve Banks. Therefore, the same trip 

could present different costs to different Reserve Banks. The differing 

travel policies made it necessary for each Reserve Bank to manage its own 

travel costs rather than allowing the Federal Reserve to manage travel 

costs on a centralized basis.
Page 11 GAO-02-774 Federal Reserve System

We also found in 1996 that the Board and the Reserve Banks used different 

procurement guidelines. The Board, while not specifically directed to do so 

by the Federal Reserve Act, followed the spirit of the federal government 

contracting rules. The Reserve Banks were required to follow Uniform 

Acquisition Guidelines, which were adopted by the Reserve Banks in 1985. 

These guidelines 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 attempted to 

ensure that Reserve Banks treated sources fairly and impartially. By 

fostering competition in the procurement process, Reserve Banks would 

have greater opportunity to realize cost savings through lower competitive 

pricing. Despite the Uniform Acquisition Guidelines, we observed instances 

in which

• practices at individual Reserve Banks differed significantly and some 

practices favored certain sources over others and 

• proper controls over conflict of interest were not followed at certain 

Reserve Banks. 

Practices at certain Reserve Banks lacked independent checks and 

reconciliations, and best practices used by certain Reserve Banks were not 

disseminated among the Reserve Banks. These findings led to the 

recommendations in figure 5.
Page 12 GAO-02-774 Federal Reserve System

Figure 5: 1996 Recommendations Affecting Federal Reserve Administrative 

Functions 

Source: GAO/GGD-96-128.

The Federal Reserve has taken or begun a number of actions in response to 

the findings and recommendations in our 1996 report. These actions 

include reassessing the compensation approach for the Federal Reserve, 

consolidating health insurance for the Reserve Banks, and changing its 

travel and acquisition practices. 

A work group of senior Reserve Bank and Board officials was established 

to reassess the compensation philosophy within the Federal Reserve 

System. The Board approved a new Reserve Bank total compensation 

philosophy on June 18, 1997. The philosophy provided broad principles for 

the design of benefit plans that were intended to be competitive within 

relevant labor markets and sufficiently flexible to attract, retain, and 

motivate the staff and officers required to fulfill the mission of the Federal 

Reserve. The policy indicates the purpose and objectives of Reserve Bank 

compensation and benefit programs as well as relevant labor markets and 

competitive position. In 1999, the Board approved in concept a Reserve 

Bank strategic benefits plan, which was developed to be a more specific 

plan for ensuring that benefits will be appropriately competitive into the 

future.

The Federal Reserve is in the process of consolidating the administration 

and selection of health benefits so that all Reserve Banks have similar plans 
Page 13 GAO-02-774 Federal Reserve System

that are administered uniformly. Initiatives in managing benefits also have 

led to the consolidation of the administration and record keeping of several 

other benefits, including the Thrift Plan, retirement plans, retiree 

prescription plans, and worker’s compensation plans. According to Federal 

Reserve staff, the thrift and retirement plans were consolidated a number 

of years ago and are fully outsourced to a single vendor. Moreover, the 

Board’s Office of Employee Benefits projects that it will save $4 million 

from implementing the consolidated health care plans. 

In 2001, the Reserve Banks began a plan to reduce travel costs by 

upgrading videoconferencing capabilities. A vendor for this system was 

selected in the first quarter of 2002, and Federal Reserve officials said 

installation of new facilities has been completed in offices that previously 

had videoconferencing. The next phase of this effort will include installing 

videoconferencing facilities in offices that did not previously have them. 

The Board has also encouraged travel savings through pursuing 

government discounts and traveling at nonpeak hours. 

In March 1997, the Federal Reserve completed a fundamental review of its 

Uniform Acquisition Guidance. As part of this effort, it reviewed 

benchmarking and best practices efforts to determine if any changes were 

necessary. In July 1998, a new Model Acquisition Guideline was approved, 

replacing the 1985 Uniform Acquisition Guidelines. The Federal Reserve 

has continued to engage in its benchmarking process. Federal Reserve staff 

said that this process has revealed continued declines in the cost of 

providing procurement services through the use of streamlined purchasing 

procedures. Benchmarking studies have concluded that the Federal 

Reserve’s enhanced use of the System Purchasing Service to gain 

economies of scale has resulted in significant savings. Board staff 

explained that, where it makes sense, the Board uses procurement 

resources available to government agencies, such as the General Services 

Administration. However, they said that in some cases, such as in their 

procurement of telecommunication services, the Board and the Reserve 

Banks might negotiate together to enhance their bargaining position.

The Federal Reserve 

Has Continued Its 

Policy of Not Charging 

for Bank Examinations

Our 1996 report noted that 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 
Page 14 GAO-02-774 Federal Reserve System

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 federal bank examinations are borne by the 

taxpayers, while for national banks, the costs of examination 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, for the state member banks it examines. In 

addition, the Federal Reserve inspects bank holding companies but does 

not charge the institutions for those inspections. Similarly, FDIC is 

authorized to charge for bank examinations but it does not do so. These 

findings led to the recommendation in figure 6.

Figure 6: Recommendation Regarding Charging for Bank Examinations

Source: GAO/GGD-96-128.

The Federal Reserve continues to believe that it should not charge for bank 

examinations. Federal Reserve officials told us that, since state member 

banks already pay state banking commissions for examinations, an 

additional charge for a Federal Reserve examination would increase the 

cost and lessen the value of a state banking charter, thus compromising the 

nation’s dual banking system.6

 Banks pay an array of annual charges and 

assessments associated with their charters, as table 1 indicates.

6

The actual cost of bank regulation includes the cost of complying with regulation as well as 

any direct charges. Compliance costs, however, are difficult or impossible to observe or 

measure, while any direct costs are reflected in a bank’s accounting records. This 

measurement issue is discussed in G. Elliehausen, The Cost of Bank Regulation: A Review 

of the Evidence, Federal Reserve Board Staff Study, April 1998.
Page 15 GAO-02-774 Federal Reserve System

Table 1: Charges and Assessments on Banks, by Charter, as of September 2002

Note: Since the Bank Insurance Fund balance exceeded the Designated Reserve Ratio (DRR) target, 

1.25 percent of deposits, in 1995, FDIC is not currently charging insurance premiums except for banks 

that are considered to pose particular risk of imposing charges on the Bank Insurance Fund. The 

Federal Deposit Insurance Corporation Improvement Act of 1991 established the DRR target.

Source: GAO analysis of banking data.

All three federal bank regulators are self-funded. Differences in their 

funding mechanisms, however, may lead to differences in who ultimately 

pays the costs of supervision and regulation, even if the supervisory and 

regulatory actions serve the common purposes of ensuring that banks are 

operated in a safe and sound manner. The Federal Reserve funds its 

operations from the earnings on its portfolio of Treasury securities, as 

previously noted. Since the Federal Reserve’s transfers to the Treasury are 

reduced by the expenses of its bank supervisory and regulatory activities, 

the taxpayer ultimately pays for Federal Reserve activities. FDIC may fund 

its operations from the premiums that banks pay for deposit insurance. 

However, since the Bank Insurance Fund is 1.25 percent of bank deposits, 

which it has been since 1995, FDIC generally does not charge banks 

premiums for deposit insurance. If FDIC were to begin charging insurance 

premiums, then either the bank’s owners or customers, including 

depositors, would be paying for FDIC examinations. OCC is funded by 

assessments on the assets held by national banks and fees for services. 

Under this arrangement, the owners or customers of national banks pay for 

OCC operations. The differences among the funding approaches of the 

federal bank regulators continue to raise questions about whether these 

Bank charter

Primary 

federal 

supervisor

Annual fees and 

assessments 

(federal/state)

Federal 

Reserve 

Bank 

capital

Federal 

deposit 

insurance 

premiums

State-chartered 

member of the 

Federal Reserve 

System

Federal 

Reserve

Federal: No

State: Yes—states 

charge a variety of 

fees and 

assessments

Yes Yes

State-chartered 

nonmember banks

FDIC Federal: No

State: Yes—states 

charge a variety of 

fees and 

assessments

No Yes

National banks OCC Federal: Yes

State: No

Yes Yes
Page 16 GAO-02-774 Federal Reserve System

impose unequal burdens on banks—varying with their charter—and their 

customers. 

Bank decisions to select (or maintain) one charter over the alternatives 

depend on the relative advantages of the charters as well as the associated 

costs. Federal Reserve officials argue that the dual banking system has 

worked well historically, allowing banks to choose the charter that best 

serves their business plan and, thus, has promoted innovation and a wider 

array of services for bank customers. In a 1997 speech, Federal Reserve 

Chairman Alan Greenspan commented: 

“The dual banking system not only fosters and preserves innovation but also constitutes our 

main protection against overly zealous and rigid federal regulation and supervision. A bank 

must have a choice of more than one federal regulator, and must be permitted to change 

charters, to protect itself against arbitrary and capricious regulatory behavior. Naturally, 

some observers are concerned that two or more federal agencies will engage in a 

‘competition in laxity,’ and we must guard against that; but the greater danger, I believe, is 

that a single federal regulator would become rigid and insensitive to the needs of the 

marketplace.”7

Further, Federal Reserve officials note that the roughly even shares of 

banks across the charters, and consistent shares of deposits among the 

charters, suggest that the relative costs and benefits of the charters 

balance. National banks, they believe, see a value in their charter that at 

least offsets any additional costs. 

OCC, however, has argued that the current fee structure may distort the 

dual banking system:

“Healthy competition in the quality of supervision and innovation in meeting the needs of 

banks and their customers should lie at the heart of our dual banking system. Unfortunately, 

today a primary focus of this competition is on price. Because state banks receive a federal 

subsidy for the predominant part of their supervision, there is a cost incentive for banks to 

avoid or depart from the national charter in favor of the heavily subsidized state charter. 

This inevitably tends to undermine a vigorous and healthy dual banking system.”8

OCC has proposed that the costs of supervising national banks (which OCC 

performs) and state supervision of state-chartered banks be paid from 

FDIC insurance funds. This approach would attempt to provide 

7

Remarks by Chairman Alan Greenspan, Federal Reserve Board, at the Annual Convention 

of the Independent Bankers Association of America, Phoenix, Arizona, March 22, 1997.

8

OCC Quarterly Journal, vol. 20, no. 4, December 2001, p. 32.
Page 17 GAO-02-774 Federal Reserve System

consistency at the federal regulator-level by having the costs of regulation 

borne by taxpayers or depositors. We have generally favored an approach 

in which regulated entities pay for their own federal regulation. 

Since the Federal Reserve continues to strongly disagree with our 

recommendation regarding charging for bank examinations, actions to 

implement the recommendation are unlikely. While we continue to believe 

that a strong argument exists for industry funding of federal supervision 

and regulation, we also recognize the benefits of the dual banking system. 

Ultimately, however, it is up to Congress to decide how to fund federal 

regulation and to balance the differences among the different bank 

regulators.

Scope and 

Methodology

To review the Federal Reserve’s actions in response to our 

recommendations, we interviewed staff from the Federal Reserve Board’s 

Division of Reserve Bank Operations, Division of Banking Supervision and 

Regulation, Office of Inspector General, as well as the Board’s Staff 

Director for Management. We reviewed relevant policies and other Board 

actions and documents. We did not visit any Reserve Banks to verify or 

review implementation of these new policies.

We conducted our work in Washington, D.C., between April and August, 

2002, in accordance with generally accepted government auditing 

standards. 

Agency Comments We requested comments on a draft of this report from the Board. In these 

comments, the Director of the Division of Reserve Bank Operations and 

Payment Systems agreed with the information presented in this report; the 

comments are reprinted in appendix I. We incorporated the Board’s 

technical comments where appropriate.

As agreed with your offices, unless you publicly release its contents earlier, 

we plan no further distribution of this report until 30 days from its date. At 

that time, we will send copies of this report to the Chairmen and Ranking 

Minority Members of the Senate Committee on Banking, Housing, and 

Urban Affairs, and the House Committee on Financial Services. We will 

also send copies to the Chairman of the Board of Governors of the Federal 

Reserve System, and we will make copies available to others on request. In 
Page 18 GAO-02-774 Federal Reserve System

addition, this report is available at no charge on our Web site at 

http://www.gao.gov.

Please contact me or James McDermott, Assistant Director, at 

(202) 512-8678 if you or your staff have any questions concerning this 

report. Other key contributors to this report were Thomas Conahan and 

Josie Sigl.

Thomas J. McCool

Managing Director, Financial Institutions and 

Community Investment
Page 19 GAO-02-774 Federal Reserve System

Appendix I

Comments from the Federal Reserve System AAppenednxidexiIs

(250071)
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