[Federal Register Volume 70, Number 216 (Wednesday, November 9, 2005)]
[Notices]
[Pages 68049-68069]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-22224]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1241]


Federal Reserve Bank Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has approved the 2006 fee schedules for Federal 
Reserve priced services and electronic access and a private-sector 
adjustment factor (PSAF) for 2006 of $117.7 million. These actions were 
taken in accordance with the requirements of the Monetary Control Act 
of 1980, which requires that, over the long run, fees for Federal 
Reserve priced services be established on the basis of all direct and 
indirect costs, including the PSAF. The Board has also approved 
maintaining the current earnings credit rate on clearing balances.

DATES: The new fee schedules become effective January 3, 2006, except 
the FedLine Select electronic connection fees, which become effective 
April 1, 2006.

FOR FURTHER INFORMATION CONTACT: For questions regarding the fee 
schedules: Jack K. Walton II, Associate Director (202/452-2660); Jeremy 
R. Mandell, Financial Services Analyst (202/452-2842), Division of 
Reserve Bank Operations and Payment Systems. For questions regarding 
the PSAF and earnings credits on clearing balances: Gregory L. Evans, 
Assistant Director, (202/452-3945); Brenda L. Richards, Manager, 
Financial Accounting (202/452-2753); or Jonathan Mueller, Financial 
Analyst (202/530-6291), Division of Reserve Bank Operations and Payment 
Systems. For users of Telecommunications Device for the Deaf (TDD) 
only, please call 202-263-4869. Copies of the 2006 fee schedules for 
the check service are available from the Board, the Federal Reserve 
Banks, or the Reserve Banks' financial services Web site at 
www.frbservices.org.

SUPPLEMENTARY INFORMATION: 

I. Priced Services

A. Discussion

    From 1995 through 2004, the Reserve Banks recovered 97.5 percent of 
their total expense (including special project costs and imputed 
expenses) and targeted after-tax profits or return on equity (ROE) for 
providing priced services.\1\
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    \1\ These imputed expenses, such as taxes that would have been 
paid, and the return on equity that would have to be earned had the 
services been furnished by a private business firm, are referred to 
as the PSAF. The ten-year recovery rate is based upon the pro forma 
income statements for Federal Reserve Banks' priced services 
published in the Board's Annual Report.
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    Table 1 summarizes 2004, 2005 estimated, and 2006 budgeted cost 
recovery rates for all priced services. Cost recovery is estimated to 
be 103.6 percent in 2005 and budgeted to be 102.5 percent in 2006. The 
performance of the check service heavily influences the aggregate cost 
recovery rates and accounts for approximately 80 percent of the total 
cost of priced services. The electronic services (FedACH<SUP>SM</SUP>, 
the Fedwire[supreg] funds service and national settlement service 
(NSS), and the Fedwire[supreg] securities service) account for 
approximately 20 percent of total costs.\2\ The noncash collection 
service represents a de minimis amount of total costs and, by year-end 
2005, the Reserve Banks will exit the service.
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    \2\ FedACh and Fedwire are registered servicemarks of the 
Reserve Banks.

                  Table 1.--Aggregate Priced Services Pro Forma Cost and Revenue Performance a
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                    5 Recovery
                                                     2c  Total     3  Net income    41d  Target     rate after
              Year                  1b  Revenue       expense       (Roe) [1-2]         ROE       target ROE [1/
                                                                                                      (2+4)]
----------------------------------------------------------------------------------------------------------------
2004............................           914.6           842.6            72.0           112.4           95.8%
2005 (estimate).................           958.2           821.8           136.4           102.9          103.6%
2006 (budget)...................           911.1           817.1            94.0            72.0         102.5%
----------------------------------------------------------------------------------------------------------------
a Calculations in this table and subsequent pro forma cost and revenue tables may be affected by rounding.
b Revenue includes net income on clearing balances (NICB). Clearing balances are assumed to be invested in a
  broad portfolio of investments, such as Treasury securities, government agency securities, commercial paper,
  municipal and corporate bonds, and money market and mutual funds. To impute income, a constant spread is
  determined from the historical average return on this portfolio and applied to the rate used to determine the
  cost of clearing balances. NICB equals the imputed income from these investments less earnings credits granted
  to holders of clearing balances. The cost of earnings credits is based on the discounted three-month Treasury
  bill rate.
c The calculation of total expense includes operating, imputed, and other expenses. Imputed and other expenses
  include taxes, FDIC insurance, Board of Governors' priced services expenses, the cost of float, and interest
  on imputed debt, if any. Credits or debits related to the accounting for pensions under FAS 87 are also
  included.
d Target ROE is the after-tax ROE included in the PSAF. The 2006 target return on equity is lower than it has
  been historically because of a Board-approved change to the method used to calculate the targeted return on
  equity.

    Table 2 presents an overview of the 2004, 2005 budget, 2005 
estimate, and 2006 budget cost recovery performance by priced service.

[[Page 68050]]



                                     Table 2.--Priced Services Cost Recovery
                                                    [percent]
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                 Priced service                        2004         2005 Budget    2005 Estimate   2006 Budgeta
----------------------------------------------------------------------------------------------------------------
All services....................................            95.8           100.1           103.6           102.5
Check...........................................            94.6           100.3           104.0           102.3
FedACH..........................................           103.0           100.4           102.2           101.0
Fedwire funds and NSS...........................            99.4           100.1           101.4           105.6
Fedwire securities..............................           102.6           102.8           101.3           105.9
Noncash collection..............................           120.3            76.7            90.9           n.a.
----------------------------------------------------------------------------------------------------------------
a 2006 budget figures reflect the latest data from Reserve Banks. The Reserve Banks will transmit final budget
  data to the Board in November 2005, for Board approval in mid-December 2005.
n.a.--not applicable

1. 2005 Estimated Performance
    In 2005, the Reserve Banks estimate that they will recover 103.6 
percent of the costs of providing priced services, including imputed 
expenses and targeted ROE, compared with a budgeted recovery rate of 
100.1 percent, as shown in table 2. The Reserve Banks estimate that all 
services will achieve full cost recovery with the exception of the 
noncash collection service, from which the Reserve Banks will exit by 
year end. The Reserve Banks estimate that they will fully recover 
actual and imputed expenses and earn net income of $136.4 million 
compared with the target of $102.9 million. This greater-than-expected 
net income is largely driven by greater-than-expected (1) check 
volumes, (2) cost savings associated with the Reserve Banks' check 
restructuring efforts, and (3) net income on clearing balances (NICB).
    The decline in paper check volume continues to have a significant 
effect on the Reserve Banks priced services.\3\ Check use nationwide 
has been declining, in part because of the increased use of debit and 
credit cards, as well as the growing trend for merchants, billers, and 
others to covert checks into automated clearinghouse (ACH) 
transactions. These factors have led to a general decline in the 
interbank clearing of checks, including clearings through the Reserve 
Banks. In this environment, to meet their cost recovery objectives, the 
Reserve Banks have undertaken efforts to reduce the costs associated 
with the check service, including reducing the number of check 
processing sites from forty-five in 2003 to twenty-two by the end of 
2006.
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    \3\ The Federal Reserve's 2004 retail payments research 
indicated that the total number of checks paid declined at an 
average annual rate of 4.3 percent from 2000 to 2003. This rate of 
decline is greater than 3.3 percent average annual rate estimated to 
have occurred from 1995 to 2000. See Gerdes, Geoffrey R. and Jack K. 
Walton II, ``Trends in the Use of Payment Instruments in the United 
States,'' Federal Reserve Bulletin, Spring 2005, pp. 180-201. (See 
http://www.federalreserve.gov/pubs/bulletin/2005/spring05_payment.pdf.)
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2. 2006 Projected Performance
    For 2006, the Reserve Banks project a priced services cost recovery 
rate of 102.5 percent. The 2006 fees for priced services are projected 
to result in a net income of $94.0 million, or $22.0 million more than 
needed to achieve full cost recovery. The major risks to the Reserve 
Banks' ability to achieve their budget targets are a greater decline in 
the Reserve Banks' check volume than the projected 13.8 percent, 
unanticipated problems with check office restructurings that could 
result in significant cost overruns, and greater-than-expected 
electronic payments volume loss to competitors. In light of these 
risks, the Reserve Banks will continue to refine their business and 
operational strategies to improve efficiency and reduce excess capacity 
and other costs. These strategies will position the Reserve Banks to 
achieve their financial and payment system objectives and statutory 
requirements over the long run.
3. 2006 Pricing
    The following summarizes the changes in the Reserve Banks' fee 
schedules for priced services in 2006:
    Check
    <bullet> The Reserve Banks will raise paper check fees for forward-
collection check products 5.3 percent, return-check products 5.4 
percent, and payor bank check products 5.3 percent.
    <bullet> The Reserve Banks will decrease Check 21 fees for 
FedForward products 13.8 percent and to offer incentives to customers 
to use FedReceipt products.
    <bullet> With the 2006 fee change, the price index for the check 
service will have increased 49 percent since 1997.
    FedACH
    <bullet> The Reserve Banks will reduce the input file fee one-third 
and the FedLine Web origination returns and notification of change fee 
40 percent.
    <bullet> With the 2006 fee change, the price index for the FedACH 
service will have decreased 63 percent since 1997.
    Fedwire funds and national settlement
    <bullet> The Reserve Banks will raise the surcharge for offline 
funds transfers by one-third.
    <bullet> With the 2006 fee change, the price index for the Fedwire 
funds and national settlement services will have decreased 57 percent 
since 1997.
    Fedwire securities
    <bullet> The Reserve Banks will raise the surcharge for offline 
securities transfers 51.5 percent and the joint custody fee 14.3 
percent.
    <bullet> With the 2006 fee change, the price index for the Fedwire 
securities service will have decreased 47 percent since 1997.
4. 2006 Price Index
    Figure 1 compares indexes of fees for the Reserve Banks' priced 
services with the GDP price deflator. Compared with the price index for 
2005, the price index for all Reserve Bank priced services is projected 
to increase 3.0 percent in 2006. The price index for electronic payment 
services, as well as electronic access to Reserve Banks' priced 
services, is projected to decrease 1.0 percent in 2006. The price index 
for the paper-based payments services is projected to increase 5.4 
percent in 2006. When projecting out to 2006, the price index for all 
priced services has increased a total of 12.1 percent since 1997. In 
comparison, from 1997 through 2004, the GDP deflator increased 14.4 
percent.

BILLING CODE 6210-01-P

[[Page 68051]]

[GRAPHIC] [TIFF OMITTED] TN09NO05.053

B. Earnings Credits on Clearing Balances

    The Board has approved maintaining the current rate of 80 percent 
of the three-month Treasury bill rate to calculate earnings credits on 
clearing balances.\4\ The Reserve Banks will continue to calculate 
earnings credits for the marginal reserve requirement adjusted portion 
of clearing balances at the federal funds rate.\5\
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    \4\ Two adjustments are applied to the earnings credit rate so 
that the return on clearing balances at the Federal Reserve is 
comparable to what the DI would have earned had it maintained the 
same balances at a private-sector correspondent. The ``imputed 
reserve requirement'' adjustment is made because a private-sector 
correspondent would be required to hold reserves against the 
respondent's balance with it. As a result, the correspondent would 
reduce the balance on which it would base earnings credits for the 
respondent because it would be required to hold a portion, 
determined by its marginal reserve ratio, in the form of non-
interest-bearing reserves. For example, if a DI held $1 million in 
clearing balances with a correspondent bank and the correspondent 
had a marginal reserve ratio of 10 percent, then the correspondent 
bank would be required to hold $100,000 in reserves, and it would 
typically grant credits to the respondent based on 90 percent of the 
balance, or $900,000. This adjustment imputes a marginal reserve 
ratio of 10 percent to the Reserve Bank.
    The ``marginal reserve requirement'' adjustment accounts for the 
fact that the respondent can deduct balances maintained at a 
correspondent, but not the Federal Reserve, from its reservable 
liabilities. This reduction has value to the respondent when it 
frees up balances that can be invested in interest-bearing 
instruments, such as federal funds. For example, a respondent 
placing $1 million with a correspondent rather than the Federal 
Reserve would free up $30,000 if its marginal reserve ratio were 3 
percent.
    The formula used by the Reserve Banks to calculate earnings 
credits can be expressed as
    e = [ b * (1-FRR) * r] + [ b * (MRR) * f]
    Where e is total earnings credits, b is the average clearing 
balance maintained, FRR is the assumed Reserve Bank marginal reserve 
ratio (10 percent), r is the earnings credit rate, MRR is the 
marginal reserve ratio of the DI holding the balance (either 0 
percent, 3 percent, or 10 percent), and f is the average federal 
funds rate. A DI that meets its reserve requirement entirely with 
vault cash is assigned a marginal reserve requirement of zero.
    \5\ This calculation adjusts earnings credits as though account 
holders could adjust their reserve requirement for a ``due from 
deduction'' for clearing balances held with a Reserve Bank.
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    Clearing balances were introduced in 1981, as a part of the Board's 
implementation of the Monetary Control Act, to facilitate access to 
Federal Reserve priced services by institutions that did not have 
sufficient reserve balances to support the settlement of their payment 
transactions. Beginning in 2004, the earnings credit calculation was 
changed from using the federal funds rate to using a percentage 
discount on a rolling thirteen-week average of the annualized coupon 
equivalent yield of three-month Treasury bills in the secondary market 
to better align Federal Reserve policy with market practice. Earnings 
credits can be used only to offset charges for priced services, are 
calculated monthly, and expire if not used within one year.\6\
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    \6\ A band is established around the contracted clearing balance 
to determine the maximum balance on which credits are earned as well 
as any deficiency charges. The clearing balance allowance is 2 
percent of the contracted amount, or $25,00, whichever is greater. 
Earnings credits are based on the period-average balance maintained 
up to a maximum of the contracted amount plus the clearinig balance 
allowance. Deficiency charges apply when the average balance fals 
below the contracted amount less the allowance, although credits are 
still earned on the average maintained balance.
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C. Check Service

    Table 3 below shows the 2004, 2005 estimate, and 2006 budgeted cost 
recovery performance for the check service.

[[Page 68052]]



                             Table 3.--Check Pro Forma Cost and Revenue Performance
                                                  [$ millions]
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                                                                                                    5  Recovery
                                                     2  Total      3  Net income                    rate after
              Year                  1  Revenue        expense       (ROE) [1-2]    4  Target Roe  target ROE [1/
                                                                                                      (2+4)]
----------------------------------------------------------------------------------------------------------------
2004............................           760.2           709.6            50.2            93.6           94.6%
2005 (estimate).................           786.4           673.9           112.5            82.0           104.0
2006 (budget)...................           732.9           659.6            73.4            57.0           102.3
----------------------------------------------------------------------------------------------------------------

1. 2005 Estimate
    For 2005, the Reserve Banks estimate that the check service will 
recover 104.0 percent of total expenses and targeted ROE, compared with 
the budgeted recovery rate of 100.3 percent. The Reserve Banks expect 
to recover all actual and imputed expenses of providing check services 
and earn net income of $112.5 million (see table 3).
    The higher-than-budgeted cost recovery is the result of higher-
than-expected revenue of $53.7 million that was partially offset by 
higher-than-expected expenses of $24.0 million. The higher revenue is 
due to greater-than-budgeted check volumes, customer use of a higher 
priced product mix, greater-than-expected NICB, and explicit float 
revenue. The higher costs were largely due to the cost of processing 
greater-than-expected paper check volume and higher personnel costs 
related to Check 21 substitute check printing.
    The greater-than-expected paper check volume can be attributed to 
the slower-than-expected adoption of Check 21 products and lower-than-
anticipated volume losses resulting from check office restructurings. 
For full-year 2005, the Reserve Banks estimate that paper forward-
collection check volume will decline 12.0 percent, compared with a 
budgeted decline of 14.6 percent. The Reserve Banks expect that paper 
return check volume will decline 24.4 percent for the full year, 
compared with a budgeted decline of 27.0 percent.

                                  Table 4.--Paper Check Product Volume Changes
                                                    [percent]
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                                                                                   Actual change
                                                                   Budgeted 2005      through     Estimated 2005
                                                                      change        August 2005       change
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Total forward-collection a
    Forward-processed...........................................          (14.7)          (11.2)          (10.9)
    Fine-sort a.................................................          (10.1)          (21.6)          (31.9)
Returns.........................................................          (27.0)          (19.5)         (24.4)
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a These rates exclude electronic fine-sort volume. Including the electronic fine-sort product, fine-sort volume
  was budgeted to decline 42.6 percent in 2005 and is now estimated to decline 33.7 percent.

    While electronic check presentment volumes are expected to decline 
for full-year 2005 (see table 5), the share of electronic checks that 
the Reserve Banks present is expected to increase. Through August 2005, 
the Reserve Banks presented approximately 26.2 percent of their checks 
electronically, which represents an increase from 24.6 percent in 2004. 
In addition to electronic check presentment, through August 2005, the 
Reserve Banks captured images for about 12.3 percent of all checks they 
collected.

                                    Table 5.--Electronic Check Product Share
                                                    [percent]
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                                                                                    2005 actual
                                                                       2004       through August  2005 estimated
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Truncation a....................................................             5.8             6.7             6.2
Non-truncation (Electronic Check Presentment) a.................            18.8            19.5            19.3
Electronic check information....................................             6.3             6.0             6.1
Images..........................................................            11.0            12.3           12.1
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a ECP consists of truncated and non-truncated checks. Non-truncated checks include checks presented through the
  MICR presentment and MICR presentment plus products.

2. 2006 Pricing
    In 2006, the Reserve Banks project that the check service will 
recover 102.3 of total expenses and targeted ROE.
    The Reserve Banks plan to maintain full cost recovery by continuing 
to streamline check processing and administrative activities across the 
System as well as by increasing Check 21 volume. A number of cost 
reduction initiatives have been identified and are currently in various 
stages of implementation. These initiatives include eliminating six 
more check processing sites by the end of 2006 and working to reduce 
various check support functions such as check adjustments and check 
automation

[[Page 68053]]

services in response to the declining volume.\7\
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    \7\ In February 2003, the Reserve Banks announced an initiative 
to reduce the number of check processing locations from forty-five 
to thirty-two. In August 2004 and May 2005, the Reserve Banks 
announced two further rounds of restructurings. By the end of these 
announced restructurings in 2006, the Reserve Banks will have 
twenty-two check processing locations.
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    Total expenses are projected to decline by $14.3 million, a decline 
of 2.1 percent when compared with the 2005 estimate. This decline is 
primarily attributable to lower local operating costs due to efficiency 
improvements at restructuring sites and declines in projected 2006 
volumes. These lower costs are partially offset by higher temporary 
costs associated with further check restructuring and additional costs 
to support Check 21 products.
    Revenue is projected to be $732.9 million, a decline of 6.8 percent 
compared to the 2005 estimate. This decline is driven by a $75.9 
million, or 10.7 percent, decline in fee revenue that is offset by a 
$22.3 million increase in NICB. In 2006, the Reserve Banks project that 
paper check volume for forward products will decrease 13.9 percent, 
volume for return products will decrease 23.9 percent, and volume for 
payor bank products will decrease 20.4 percent. These expected volume 
declines will be partially offset by a projected increase in Check 21 
volume.
    Check 21 products have been offered for about one year, and the 
Reserve Banks anticipate significant growth in 2006 (see table 6).\8\ 
The Reserve Banks project that FedForward volume will more than double, 
FedReturn volume will more than triple, and FedReceipt volume will 
increase almost twelvefold. The Reserve Banks have projected an 
increase in the 2006 Check 21 volume that will result in a doubling of 
Check 21 product revenue, to about $44 million. Board and Reserve Bank 
staff believe that the key to realizing Check 21 cost efficiencies for 
the System is the widespread acceptance of FedReceipt by paying banks.
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    \8\ The Reserve Banks' Check 21 product suite includes 
FedForward, FedReturn, and FedReceipt. FedForward is the electronic 
alternative to forward check collection; FedReturn is the electronic 
alternative to return items; and FedReceipt is electronic receipt of 
Check 21 items.

                        Table 6.--Check 21 Volume
------------------------------------------------------------------------
                                           2006 Budgeted
                                              volume        Growth from
                                           [millions of    2005 estimate
                                              items]         [percent]
------------------------------------------------------------------------
FedForward..............................           431.8           138.5
FedReturn...............................            15.2           206.7
FedReceipt..............................            57.5         1,084.3
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    In 2006, the Reserve Banks will continue to encourage the adoption 
of electronic check collection and presentment alternatives through 
modest price increases to paper check products and price reductions for 
some electronic products. The price increases for paper products 
generally are expected to be distributed across most product 
categories, with generally higher price increases for nonstrategic 
product lines. The Reserve Banks will also narrow the price ranges for 
similar products across the System. In addition, the Reserve Banks will 
offer depository institutions (DIs) greater incentives to deposit 
checks electronically and to accept image presentments. Longer term, as 
the use of Check 21-related products increases, the pricing of paper 
products may be strategically raised to encourage further adoption of 
electronic check collection and presentment alternatives.
    For 2006, the Reserve Banks are targeting an overall price increase 
for paper check services of 5.3 percent (see table 7). This increase 
consists of a 5.3 percent increase in forward check-collection fees, 
which is composed of a 4.9 percent increase in forward cash letter fees 
and a 5.4 percent increase in per-item fees. Fees for return services 
will increase by 5.4 percent, which is composed of a 5.9 percent 
increase in return cash letter fees and a 5.3 percent increase in per-
item fees. The average volume-weighted fees for payor bank services 
will increase 5.3 percent.

                       Table 7.--2006 Fee Changes
                                [percent]
------------------------------------------------------------------------
                         Product                            Fee change
------------------------------------------------------------------------
Paper Check.............................................             5.3
    Forward-collection..................................             5.3
        Cash Letter.....................................             4.9
        Item............................................             5.4
    Returns.............................................             5.4
        Cash Letter.....................................             5.9
        Item............................................             5.3
Payor bank services.....................................             5.3
    Truncation..........................................             1.8
    Non-truncation (electronic check presentment).......            14.5
    Electronic check information........................            13.8
    Images..............................................           (1.0)
Check 21
    FedForward..........................................          (13.8)
    FedReturn...........................................             0.0
    FedReceipt..........................................      ($.002) a
------------------------------------------------------------------------
a FedReceipt customers will receive a $0.002 discount per check
  presented. The discount can be used to offset other check service fees
  incurred by FedReceipt customers.

    The primary risk to meeting the budgeted 2006 cost recovery is 
higher-than-expected paper check volume declines. Other risks include 
unanticipated problems with check office restructurings or other major 
initiatives that may result in significant cost overruns.

D. FedACH Service

    Table 8 below shows the 2004, 2005 estimate, and 2006 budgeted cost 
recovery performance for the commercial FedACH service.

[[Page 68054]]



                             Table 8.--FedACH Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                    5  Recovery
                                                     2  Total      3  Net income                    rate after
              Year                  1  Revenue        expense       (ROE)[1-2]     4  Target roe  target roe [1/
                                                                                                      (2+4)]
----------------------------------------------------------------------------------------------------------------
2004............................            75.1            64.0            11.1             8.9          103.0%
2005 (estimate).................            84.7            72.8            11.8            10.0           102.2
2006 (budget)...................            86.7            78.3             8.4             7.6           101.0
----------------------------------------------------------------------------------------------------------------

1. 2005 Estimate
    For 2005, the Reserve Banks estimate that the FedACH service will 
recover 102.2 percent of total expenses and targeted ROE, compared with 
the budgeted recovery rate of 100.4 percent. Total revenue is estimated 
to be $2.6 million greater than the amount budgeted, and total expenses 
exceed budget by about $1.3 million. Through August, FedACH commercial 
origination volume is 14.5 percent higher than the same period last 
year. For full-year 2005, the Reserve Banks estimate that FedACH 
originations will grow 12.7 percent, compared with the budgeted growth 
of 7.7 percent.
2. 2006 Pricing
    The Reserve Banks will reduce the input file fee one-third, from 
$3.75 to $2.50. This change is consistent with the Reserve Banks' long-
term strategy to decrease file fees. In addition, the Reserve Banks 
will reduce the FedLine Web notification of change fee 40 percent, from 
$0.50 to $0.30, to better align the fee with that of similar products.
    The Reserve Banks project that the FedACH service will recover 
101.0 percent of total expenses and targeted ROE in 2006. Total revenue 
is budgeted to increase $2.1 million from the 2005 estimate, despite 
$1.6 million less in fee revenue. The decrease in fee revenue is offset 
by NICB revenue, which is $3.2 million larger than the 2005 estimate. 
Based on industry projections, the Reserve Banks estimate national ACH 
commercial origination volume will grow approximately 18 percent in 
2006. This growth is largely attributable to volume increases 
associated with electronic check conversion applications, including 
checks converted at lockboxes, and internet initiated payments. The 
Reserve Banks, however, have projected FedACH commercial origination 
volume growth of 7.6 percent in 2006 to reflect continued volume shifts 
to the private-sector ACH operator.
    Total expenses and targeted ROE are budgeted to increase $3.1 
million over the 2005 estimate. The Reserve Banks have budgeted 
increased costs for product development and service initiatives, such 
as FedACH risk management services.

E. Fedwire Funds and National Settlement Services

    Table 9 below shows the 2004, 2005 estimate, and 2006 budgeted cost 
recovery performance for the Fedwire funds and national settlement 
services.

         Table 9.--Fedwire Funds and National Settlement Services Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                    5  Recovery
                                                     2  Total      3  Net income                    rate after
              Year                  1  Revenue        expense       (ROE) [1-2]    4  TABOET ROE  Target ROE [1/
                                                                                                      (2+4)]
----------------------------------------------------------------------------------------------------------------
    2004........................            57.1            50.6             6.5             6.8           99.4%
    2005 (estimate).............            64.9            56.1             8.8             7.9           101.4
    2006 (budget)...............            69.3            60.0             9.3             5.6           105.6
----------------------------------------------------------------------------------------------------------------

1. 2005 Estimate

    For 2005, the Reserve Banks estimate that the Fedwire funds and 
national settlement services will recover 101.4 percent of total 
expenses and targeted ROE, compared with a 2005 budgeted recovery rate 
of 100.1 percent. Fedwire funds achieved full cost recovery despite 
lower-than-budgeted fee revenue. Although the Reserve Banks have 
experienced higher-than-expected growth for online funds volume for 
2005, most of the growth has been in the lowest-priced tier. Through 
August, online funds volume is 5.7 percent higher than it was for the 
same period last year. For full-year 2005, the Reserve Banks estimate 
that online funds volume will grow 5.3 percent, compared with a 
budgeted growth of 2.8 percent. Also offsetting the lower-than-budgeted 
fee revenue is higher electronic connection revenue and NICB, as well 
as lower operating costs. With respect to the national settlement 
service, the Reserve Banks estimate that the volume of settlement 
entries processed during 2005 will be 1.4 percent higher than the 2005 
budget projection.
2. 2006 Pricing
    The Reserve Banks will raise the surcharge for offline transfers 
one-third, from $15 to $20. The surcharge increase more closely aligns 
the fee with the costs of providing offline access to the Fedwire funds 
service.
    In 2006, the Reserve Banks project that Fedwire funds and national 
settlement services will recover 105.6 percent of total expense and 
targeted ROE. The Reserve Banks project 2006 total revenue to increase 
by $4.4 million over the 2005 estimate primarily because of the 
projected higher funds transfer volume and higher NICB and electronic 
connection revenue. Total expenses for 2006 are expected to increase 
$3.9 million from the 2005 estimate primarily because of security and 
technology investments, including the cost to migrate from legacy 
systems to Internet protocol-based systems, and further enhance 
resiliency. Online funds transfer volume for 2006 is expected to 
increase 3.0 percent compared with the 2005 estimate. National 
settlement

[[Page 68055]]

service volume for 2006 is expected to remain flat compared with the 
2005 estimate.

F. Fedwire Securities Service

    Table 10 below shows the 2004, 2005 estimate, and 2006 budgeted 
cost recovery performance for the Fedwire securities service.\9\
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    \9\ The Reserve Banks provide transfer services for securities 
issued by the U.S. Treasury, federal government agencies, 
government-sponsored enterprises, and certain international 
institutions. The priced component of this service, reflected in 
this memorandum, consists of revenues, expenses, and volumes 
associated with the transfer of all non-Treasury securities. For 
Treasury securities, the U.S. Treasury assesses fees for the 
securities transfer component of the service. The Reserve Banks 
assess a fee for the funds settlement component of a Treasury 
securities transfer; this component is not treated as a priced 
service.

                  Table 10.--Fedwire Securities Service Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                    5  Recovery
                                                     2  Total      3  Net income                    rate after
              Year                  1  Revenue        expense       (ROE)[1-2]     4  Target ROE  target ROE [1/
                                                                                                      (2+4)]%
----------------------------------------------------------------------------------------------------------------
2004............................            20.4            17.0             3.4             2.9           102.6
2005 (estimate).................            21.0            17.9             3.1             2.9           101.3
2006 (budget)...................            22.1            19.1             3.0             1.8           105.9
----------------------------------------------------------------------------------------------------------------

1. 2005 Estimate
    For 2005, the Reserve Banks estimate that the Fedwire securities 
service will recover 101.3 percent of total expenses and targeted ROE, 
compared with a 2005 budgeted recovery rate of 102.8 percent. The 
lower-than-budgeted recovery is primarily attributable to $0.6 million 
in lower-than-expected fee revenue associated with lower-than-expected 
transaction volume. Through August, online securities volume was flat 
compared to the same period last year. For full-year 2005, the Reserve 
Banks estimate that online securities volume will grow 1.1 percent, 
compared with a budgeted growth of 2.0 percent. The shortfall in fee 
revenue was offset by higher-than-expected NICB revenue.
2. 2006 Pricing
    The Reserve Banks will raise the offline transfer origination and 
receipt surcharge from $33 to $50, and the joint custody origination 
surcharge from $35 to $40. The Reserve Banks will retain all other fees 
at their current levels. The surcharge increase more closely aligns the 
fees with the costs of processing these transactions.
    The Reserve Banks project that the Fedwire securities service will 
recover 105.9 percent of total expense and targeted ROE in 2006. Total 
revenue is projected to increase $1.1 million from the 2005 estimate 
primarily because of higher NICB. Online securities volume in 2006 is 
budgeted to be flat against the 2005 estimate. Offline securities 
volume is projected to fall 9.0 percent against the 2005 estimate. 
Total expenses are expected to increase $1.2 million from the 2005 
estimate. In 2006, the Reserve Banks plan to continue to invest in 
security and technology projects to enhance resiliency, migrate from 
legacy systems to Internet protocol-based systems, and implement 
changes in payment system risk policy.

G. Noncash Collection Service

    Table 11 below shows the 2004 and 2005 estimated cost recovery 
performance for the noncash collection service.

                      Table 11.--Noncash Collection Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                    5  Recovery
                                                     2  Total      3  Net income                    rate after
              Year                  1  Revenue        expense       (ROE) [1-2]    4  Target ROE  target ROE [1/
                                                                                                      (2+4)]%
----------------------------------------------------------------------------------------------------------------
2004............................             1.9             1.4             0.5             0.2           120.3
2005 (estimate).................             1.2             1.1             0.1             0.2            90.9
----------------------------------------------------------------------------------------------------------------

1. 2005 Estimate
    For 2005, the Reserve Banks estimate that the noncash collection 
service will recover 90.9 percent of total expenses and targeted ROE, 
compared with the budgeted recovery rate of 76.7 percent. This greater-
than-expected recovery is due to lower-than-expected costs of 
withdrawal. The Reserve Banks estimate that, in 2005, noncash 
collection volume will be 16.1 percent lower than expected. Effective 
September 30, 2005, the Reserve Banks stopped accepting deposits of 
definitive municipal securities from DIs. The Reserve Banks plan to 
complete withdrawal from the service effective December 30, 2005.
2. 2006 Pricing
    The Reserve Banks will no longer offer the noncash collection 
service in 2006.

H. Electronic Access

    The Reserve Banks allocate the costs and revenues associated with 
electronic access methods to the Reserve Banks' priced services.\10\ 
There are four types of electronic access methods through which DIs can 
access the Reserve Banks' priced services: FedLine[reg], FedMail[reg], 
FedPhone[reg], and computer interface (mainframe to mainframe).\11\ 
There are three ways DIs currently use FedLine to

[[Page 68056]]

access the Reserve Banks' services: FedLine Web, FedLine Advantage, or 
FedLine DOS. Information services are available through FedLine Web, 
while transaction services are available through FedLine Advantage or 
FedLine DOS. For 2006, the Reserve Banks will change to the FedLine DOS 
connection fees as well as ancillary changes to frame relay spare parts 
and training fees.
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    \10\ Certain electronic access fees are recorded as recoveries 
that offset the cost of providing these services. These fees are for 
ancillary services, such as training and vendor pass-through 
charges. Therefore, these fees are not listed in the electronic 
access 2006 fee schedule below.
    \11\ Fedline, FedMail, and FedPhone are registered servicemarks 
of the Reserve Banks. These connections may also be used to access 
non-priced services provided by the Reserve Banks.
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    The Reserve Banks will discontinue access to their services via 
FedLine DOS effective September 30, 2006. The Reserve Banks are 
migrating their customers to a tiered, web-based access structure. This 
migration is scheduled to be completed by September 30. At that time, 
FedLine customers will only be able to access Reserve Banks services 
via FedLine Web or FedLine Advantage. In the interim, those customers 
that have not yet migrated to web-based access can continue to use 
FedLine DOS. For those customers, the Reserve Banks bundle a FedLine 
DOS connection and a FedLine Web connection into a single FedLine 
Select package. In this arrangement, customers use their FedLine DOS 
connection to access transaction services and FedLine Web to access 
information services. The Reserve Banks will increase the fee for 
FedLine Select from $200 to $400 per month, beginning April 1, 2006, to 
encourage customers to move to FedLine Advantage before the September 
30, 2006, sunset date.
    The Reserve Banks will also increase the frame relay spare parts 
set fee and in-person and over-the-phone training fees. The fee 
increase for the frame relay spare parts set, from $155 to $175, is 
intended to ensure fee consistency with the complete 56 kbps frame 
relay product.\12\ The fee increase for over-the-phone and in-person 
training, from $100 to $150 per session and $800 to $1,000 per session 
respectively, is intended to encourage the use of online training 
options that are offered at no cost.
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    \12\ The fee for the computer interface frame relay 56 kbps 
product is $1,000 per month. The fee for the full circuit backup 
single equipment set is $825 per month which, when combined with the 
$175 per month spare parts set fee, is consistent with the complete 
frame relay product.
---------------------------------------------------------------------------

II. Private-Sector Adjustment Factor

A. Background

    Each year, as required by the Monetary Control Act of 1980, the 
Reserve Banks set fees for priced services provided to depository 
institutions. These fees are set to recover, over the long run, all 
direct and indirect costs and imputed costs, including financing costs, 
taxes, and certain other expenses, as well as return on equity (profit) 
that would have been earned if a private business firm provided the 
services. The imputed costs and imputed profit are collectively 
referred to as the PSAF. In a comparable fashion, investment income is 
imputed and netted with related direct costs associated with clearing 
balances to estimate NICB.

B. Private Sector Adjustment Factor

    The method for calculating the financing and equity costs in the 
PSAF requires determining the appropriate levels of debt and equity to 
impute and then applying the applicable financing rates. In this 
process, a pro forma priced services balance sheet using estimated 
Reserve Bank assets and liabilities associated with priced services is 
developed and the remaining elements that would exist if the Reserve 
Banks' priced services were provided by a private business firm are 
imputed.
    The amount of the Reserve Banks' assets that will be used to 
provide priced services during the coming year is determined using 
Reserve Bank information on actual assets and projected disposals and 
acquisitions. The priced portion of assets is determined based on the 
allocation of the related depreciation expense. The priced portion of 
actual Reserve Bank liabilities consists of balances held by Reserve 
Banks for clearing priced services transactions (clearing balances), 
and other liabilities such as accounts payable and accrued expenses.
    Long-term debt is imputed only when core clearing balances and 
long-term liabilities are not sufficient to fund long-term assets or if 
the interest rate risk sensitivity analysis, which measures the 
interest rate effect of the difference between interest rate sensitive 
assets and liabilities, indicates that a 200 basis point change in 
interest rates would change cost recovery more than two percentage 
points.\13\ Short-term debt is imputed only when short-term liabilities 
and clearing balances not used to finance long-term assets are 
insufficient to fund short-term assets. Equity is imputed to meet the 
FDIC definition of a well-capitalized depository institution for 
insurance premium purposes.\14\
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    \13\ A portion of clearing balances is used as a funding source 
for priced services assets. Long-term assets are partially funded 
from core clearing balances, currently $4 billion. Core clearing 
balances are considered the portion of the balances that has 
remained stable over time without regard to the magnitude of actual 
clearing balances.
    \14\ The FDIC requirements for a well-capitalized depository 
institution are 1) a ratio of total capital to risk-weighted assets 
of 10 percent or greater; and 2) a ratio of Tier 1 capital to risk-
weighted assets of 6 percent or greater; and 3) a leverage ratio of 
Tier 1 capital to total assets of 5 percent or greater. The Federal 
Reserve priced-services balance sheet total capital has no 
components of Tier 1 or total capital other than equity; therefore, 
requirements 1 and 2 are essentially the same measurement.
---------------------------------------------------------------------------

1. Financing rates
    Equity financing rates are based on the target ROE result of the 
capital asset pricing model (CAPM).\15\ In the CAPM, the required rate 
of return on a firm's equity is equal to the return on a risk-free 
asset plus a risk premium. To implement CAPM, the risk-free rate is 
based on the three-month Treasury bill, the beta is assumed to be equal 
to 1.0, which approximates the risk of the market as a whole, and the 
monthly returns in excess of the risk-free rate over the most recent 40 
years are used as the market risk premium. The resulting ROE influences 
the dollar level of the PSAF because this is the return a shareholder 
would expect in order to invest in a private business firm.
---------------------------------------------------------------------------

    \15\ In October, the Board approved changes to the methodology 
used to derive the pretax ROE from using the average of the results 
of three analytical models, the comparable accounting earnings model 
(CAE), the discounted cash-flow model (DCF), and the CAPM, to using 
only the CAPM (70 FR 60341, October 17, 2005).
---------------------------------------------------------------------------

    For simplicity, given that federal corporate income tax rates are 
graduated, state income tax rates vary, and various credits and 
deductions can apply, a specific income tax expense is not calculated 
for Reserve Bank priced services. Instead, the Board targets a pretax 
ROE that would provide sufficient income to fulfill its income tax 
obligations.\16\ To the extent that the actual performance results are 
greater or less than the targeted ROE, income taxes are adjusted using 
an imputed income tax rate. The imputed income tax rate is the median 
of the rates paid by the top fifty bank holding companies (BHCs) based 
on deposit balance over the past five years adjusted to the extent that 
they invested in tax-free municipal bonds. Because the Reserve Banks 
provide similar services through their correspondent banking 
activities, including payment and settlement services, and equity is 
imputed to meet the FDIC requirements of a well-capitalized depository 
institution, using a tax rate based on the top fifty BHCs by deposit 
balance continues to be an applicable and reasonable approach.
---------------------------------------------------------------------------

    \16\ Other taxes are included in price-services actual or 
imputed costs.
---------------------------------------------------------------------------

2. Other Costs
    The PSAF also includes the estimated priced services-related 
expenses of the Board of Governors and imputed sales taxes based on 
Reserve Bank estimated expenditures. An assessment for FDIC insurance, 
when required, is imputed

[[Page 68057]]

based on current FDIC rates and projected clearing balances held with 
the Federal Reserve.

C. Net Income on Clearing Balances

    The NICB calculation is made each year along with the PSAF 
calculation and is based on the assumption that Reserve Banks invest 
clearing balances net of imputed reserve requirements and balances used 
to finance priced-services assets. Based on these net clearing balance 
levels, Reserve Banks impute a constant spread, determined by the 
return on a portfolio of investments, over the three-month Treasury 
bill rate.\17\ \18\ The calculation also involves determining the 
priced services cost of earnings credits (amounts available to offset 
service fees) on contracted clearing balances held, net of expired 
earnings credits, based on a discounted Treasury bill rate. Rates and 
clearing balance levels used in the NICB estimate are based on the most 
recent rates and clearing balance levels.\19\ Because clearing balances 
are held for clearing priced services transactions or offsetting priced 
services fees, they are directly related to priced services. The net 
earnings or expense attributed to the investments and the cost 
associated with holding clearing balances, therefore, are considered 
net income for priced services activities.
---------------------------------------------------------------------------

    \17\ The investment portfolio is composed of investments 
comparable to a BHC's investment holdings, such as short-term 
Treasury securities, government agency securities, commercial paper, 
long-term corporate bonds, and money market funds. See table 16 for 
the investments imputed in 2006.
    \18\ NICB is projected to be $102.8 million for 2006 using a 
constant spread of 35 basis points over the three-month Treasury 
bill, and applying this rate to the clearing balance levels used in 
the 2006 pricing process. The 2005 NICB estimate is $73.8 million.
    \19\ July 2005 rates and balances were used to estimate the 2006 
NICB.
---------------------------------------------------------------------------

D. Discussion

    The decrease in the 2006 PSAF is primarily due to the decrease in 
ROE, which results in a decrease in the cost of equity. Although 
clearing balances on which investments are imputed decreased, a similar 
offsetting increase in items in process of collection results in a 
small increase in total assets. Because equity is imputed at 5 percent 
of total assets, this small change in assets causes equity to remain 
unchanged from 2005.
1. Asset Base
    The estimated 2006 Federal Reserve assets, reflected in table 12, 
have increased $0.3 million. The decline in imputed investments in 
marketable securities of $546.0 million and in imputed reserve 
requirements of $69.7 million, which are imputed based on the estimated 
level of clearing balances held, are offset by an increase in items in 
process of collection due to higher estimated float receivables. As a 
result of consolidation and restructuring of several System priced 
services functions, furniture and equipment and bank premises assets 
are expected to decrease $59.5 million in 2006.
    As shown in table 13, the assets financed through the PSAF have 
decreased. Short-term assets funded with short-term payables and 
clearing balances total $28.4 million. This represents a $10.5 million 
decrease from the short-term assets funded in 2005 due to an increase 
in expected short-term payables. Long-term assets funded with long-term 
liabilities, equity, and core clearing balances are projected to total 
$291.1 million. This represents a decrease of $70.6 million from the 
long-term assets funded in 2005 because long-term assets have 
decreased.
2. Debt and Equity Costs and Taxes
    As previously mentioned, core clearing balances are available as a 
funding source for priced service assets. Table 13 shows that $319.5 
million in clearing balances is used to fund priced services assets in 
2006. The interest rate sensitivity analysis in table 14 indicates that 
a 200 basis point decrease in interest rates affects the ratio of rate-
sensitive assets to rate-sensitive liabilities and produces a decrease 
in cost recovery of 1.2 percentage points, while an increase of 200 
basis points in interest rates increases cost recovery by 1.1 
percentage points. The established threshold for a change in cost 
recovery is two percentage points; therefore, interest rate risk 
associated with using these balances is within acceptable levels and no 
long-term debt is imputed.
    Table 15 shows the imputed PSAF elements, the pretax ROE, and other 
required PSAF costs for 2005 and 2006. The decrease in ROE lowers the 
estimated cost of equity in 2006. Sales taxes decreased from $8.2 
million in 2005 to $7.7 million in 2006. The effective income tax rate 
used in 2006 increased to 29.8 percent from 29.6 percent in 2005. The 
priced service portion of the Board's expenses increased $0.9 million 
from $6.6 million in 2005 to $7.5 million in 2006.
3. Capital Adequacy and FDIC Assessment
    As shown in table 12, the amount of equity imputed for the 2006 
PSAF is $808.0 million, unchanged from the imputed equity in 2005. As 
noted above and shown in table 16, equity is based on 5 percent of 
total assets and is greater than 10 percent of risk-weighted assets, as 
required by the FDIC definition of a well-capitalized depository 
institution for insurance premium purposes. In 2006, the capital to 
total assets ratio and the capital to risk-weighted asset ratio both 
meet or exceed regulatory guidelines. As a result, no FDIC assessment 
is imputed for 2006.

III. Analysis of Competitive Effect

    All operational and legal changes considered by the Board that have 
a substantial effect on payments system participants are subject to the 
competitive impact analysis described in the March 1990 policy, ``The 
Federal Reserve in the Payments System.'' \20\ Under this policy, the 
Board assesses whether the proposed change would have a direct and 
material adverse effect on the ability of other service providers to 
compete effectively with the Federal Reserve in providing similar 
services because of differing legal powers or constraints or because of 
a dominant market position deriving from such legal differences. If the 
change creates such an effect, the Board must further evaluate the 
change to assess whether its benefits--such as contributions to payment 
system efficiency, payment system integrity, or other Board 
objectives--can be retained while minimizing the adverse effect on 
competition.
---------------------------------------------------------------------------

    \20\ Federal Reserve Regulatory Service (FRRS) 9-1558.
---------------------------------------------------------------------------

    The Board believes that the 2006 fees, fee structures, or changes 
in service will not have a direct and material adverse effect on the 
ability of other service providers to compete effectively with the 
Reserve Banks in providing similar services. The changes will permit 
the Reserve Banks to earn an ROE that is comparable to the returns of 
the overall market.
BILLING CODE 6210-01-P

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[[Page 68069]]


    By order of the Board of Governors of the Federal Reserve 
System, November 2, 2005.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 05-22224 Filed 11-8-05; 8:45 am]
BILLING CODE 6210-01-C