Federal Reserve Bank Services, 63592-63608 [07-5602]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 72, Number 217 (Friday, November 9, 2007)]
[Notices]
[Pages 63592-63608]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 07-5602]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1299]


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 private sector adjustment factor 
(PSAF) for 2008 of $113.1 million and the 2008 fee schedules for 
Federal Reserve priced services and electronic access. 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 and earnings credit rate become effective 
January 2, 2008.

FOR FURTHER INFORMATION CONTACT: For questions regarding the fee 
schedules: Jack K. Walton II, Associate Director, (202/452-2660); 
Jeffrey S.H. Yeganeh, Manager, Retail Payments, (202/728-5801); Edwin 
J. Lucio, Senior Financial Services Analyst, (202/736-5636), 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 Senner, Senior 
Financial Analyst, (202/452-2042), 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 2008 fee 
schedules for the check service are available from the Board, the 
Federal Reserve Banks, or the Reserve Banks' financial services Web 
site at https://www.frbservices.org.

SUPPLEMENTARY INFORMATION: 

I. Private Sector Adjustment Factor and Priced Services

    A. Overview--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 the 
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. Similarly, investment 
income is imputed and netted with related direct costs associated with 
clearing balances to estimate net income on clearing balances (NICB). 
From 1997 through 2006, the Reserve Banks recovered 99.0 percent of 
their total expenses (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\ The ten-year recovery rate is based upon the pro forma 
income statement for Federal Reserve priced services published in 
the Board's Annual Report.
    Effective December 31, 2006, the Reserve Banks implemented 
Financial Accounting Standards No. 158: Employers' Accounting for 
Defined Benefit Pension and Other Postretirement Plans (FAS 158), 
which resulted in recognizing a reduction in equity related to the 
priced services' benefit plans. Including this reduction in equity 
results in cost recovery of 95.5 percent for the ten-year period. 
This measure of long-run cost recovery is also published in the 
Board's Annual Report.
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    Table 1 summarizes 2006, 2007 estimated, and 2008 budgeted cost 
recovery rates for all priced services. Cost recovery is estimated to 
be 101.5 percent in 2007 and budgeted to be 101.1 percent in 2008. The 
check service accounts for approximately 80 percent of the total cost 
of priced services and thus significantly influences the aggregate cost 
recovery rate. The electronic services (FedACH[supreg], 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\
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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]
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                                                                                                          5e
                                                                              3  Net                   Recovery
                                                               2c  Total      income     4d  Target   rate after
                      Year                       1b  Revenue    expense     (ROE)  [1-      ROE       target ROE
                                                                                2]                    [1/(2+4)]
                                                                                                      (percent)
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2006...........................................      1,031.2        875.5        155.7         72.0        108.8
2007 (estimate)................................      1,015.1        920.0         95.1         80.4        101.5

[[Page 63593]]

 
2008 (budget)..................................        897.1        821.3         75.8         66.5        101.1
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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. Clearing balances are assumed to be invested in a broad
  portfolio of investments, such as short-term Treasury securities, government agency securities, commercial
  paper, long-term corporate bonds, and money market 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.
e The recovery rates in this and subsequent tables do not reflect the unamortized gains or losses that must be
  recognized in accordance with FAS 158. Including these gains or losses, the recovery rate would have been 79.9
  percent for 2006 and is estimated to be 103.0 percent for 2007. Future gains or losses, and their effect on
  cost recovery, cannot be projected.

    Table 2 presents an overview of the 2006, 2007 budgeted, 2007 
estimated, and 2008 budgeted cost recovery performance by priced 
service.

                                     Table 2.--Priced Services Cost Recovery
                                                    [percent]
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                                                                               2007         2007         2008
                       Priced service                             2006        Budget      Estimate     Budget a
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All services................................................        108.8        101.9        101.5        101.1
Check.......................................................        109.3        101.8        100.4        100.3
FedACH......................................................        104.3        102.5        105.8        102.0
Fedwire Funds and NSS.......................................        111.4        102.5        107.0        105.5
Fedwire Securities..........................................        104.5        101.9        103.5       105.0
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a 2008 budget figures reflect the latest data from the Reserve Banks. The Reserve Banks will transmit final
  budget data to the Board in November 2007, for Board consideration in December 2007.

    1. 2007 Estimated Performance--The Reserve Banks estimate that they 
will recover 101.5 percent of the costs of providing priced services, 
including imputed expenses and targeted ROE, compared with a budgeted 
recovery rate of 101.9 percent, as shown in table 2. The Reserve Banks 
estimate that they will again exceed $1 billion in revenue and that all 
services will achieve full cost recovery. The Reserve Banks also 
estimate that they will fully recover actual and imputed expenses and 
earn net income of $95.1 million, compared with the target of $80.4 
million. The greater-than-targeted net income is largely driven by the 
performance of the check service, which had greater-than-expected 
volumes of paper return items and Check 21 substitute checks.
    The Reserve Banks have continued their efforts to downsize their 
paper check processing infrastructure as paper check volumes continue 
to decline nationwide. The Reserve Banks have already reduced the 
number of sites at which they process checks from forty-five in 2003 to 
nineteen in 2007 and have announced that they will consolidate to four 
check processing offices by early 2011. These check restructuring 
efforts have helped the Reserve Banks to maintain full cost recovery by 
reducing costs in line with the decline in revenues associated with 
paper check processing.
    2. 2008 Private Sector Adjustment Factor--The 2008 PSAF for Reserve 
Bank priced services is $113.1 million. This amount represents a 
decrease of $19.4 million from the 2007 PSAF of $132.5 million. This 
reduction is primarily the result of decreases in both the amount of 
imputed equity and in the cost of equity.
    3. 2008 Projected Performance--The Reserve Banks project a priced 
services cost recovery rate of 101.1 percent in 2008. The 2008 fees for 
priced services are projected to result in a net income of $75.8 
million compared with the target of $66.5 million. The major risks to 
the Reserve Banks' ability to achieve their budgeted targets are 
higher-than-expected declines in paper check volume as well as 
increased competition from correspondent banks and other service 
providers. Other risks include lower-than-expected electronic payments 
volumes, and costs associated with unanticipated problems with check 
office restructurings or technological upgrades. In light of these 
risks, the Reserve Banks will continue to refine their business and 
operational strategies to improve efficiency and reduce costs and 
excess capacity. These efforts should position the Reserve Banks to 
achieve their financial and other payment system objectives and 
statutory requirements over the long run.
    4. 2008 Pricing--The following summarizes the Reserve Banks' 
changes in fee schedules for priced services in 2008:
Check
     The Reserve Banks will raise the fees for paper forward 
collection check products 12.1 percent, paper return check products 
12.5 percent, and payor bank check products 13.8 percent.
     The Reserve Banks will decrease Check 21 fees for 
FedForward products delivered to electronic endpoints 3.2

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percent and increase Check 21 fees for FedForward products delivered to 
substitute check endpoints 10.3 percent. The Reserve Banks also will 
increase the FedReceipt Forward deposit discount by $0.001 for each 
check presented through FedReceipt products.
     With the 2008 fee changes, the price index for the check 
service will have increased 75.4 percent since 1998.
FedACH
     The Reserve Banks will eliminate the input file processing 
fee.
     With the 2008 fee change, the price index for the FedACH 
service will have decreased 61.7 percent since 1998.
Fedwire Funds and National Settlement
     The Reserve Banks will decrease the online transfer fee by 
three cents in the highest-priced tier, two cents in the midpriced 
tier, and one cent in the lowest-priced tier and increase the volume 
thresholds for each tier.
     With the 2008 fee changes, the price index for the Fedwire 
Funds and National Settlement Services will have decreased 51.6 percent 
since 1998.
Fedwire Securities
     The Reserve Banks will not change prices.
     The price index for the Fedwire Securities Service will 
have decreased 44.4 percent since 1998.
    5. 2008 Price Index--Figure 1 compares indexes of fees for the 
Reserve Banks' priced services with the GDP price index. Compared with 
the price index for 2007, the price index for all Reserve Bank priced 
services is projected to increase 2.7 percent in 2008. The price index 
for electronic payment services is projected to decrease 8.3 percent in 
2008. The price index for paper check services is projected to increase 
11.7 percent in 2008. This increase mainly reflects the Reserve Banks' 
continued efforts to encourage a shift from paper check services to 
Check 21 products. For the period 1998 to 2008, the price index for all 
priced services is expected to increase by 35.4 percent. In comparison, 
from 1998 through 2007, the GDP price index increased 24.3 percent.
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    B. Private Sector Adjustment Factor--The method for calculating the 
financing and equity costs in the PSAF requires determining the 
appropriate

[[Page 63596]]

levels of debt and equity to impute and then applying the applicable 
financing rates. In this process, a pro forma balance sheet using 
estimated assets and liabilities associated with the Reserve Banks' 
priced services is developed, and the remaining elements that would 
exist if these priced services were provided by a private business firm 
are imputed. The same generally accepted accounting principles that 
apply to commercial-entity financial statements also apply to the 
relevant elements in the priced services pro forma financial 
statements.
    The portion of Federal Reserve assets that will be used to provide 
priced services during the coming year is determined using information 
on actual assets and projected disposals and acquisitions. The priced 
portion of these assets is determined based on the allocation of the 
related depreciation expense. The priced portion of actual Federal 
Reserve 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, long-
term liabilities, and equity 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 by more than two 
percentage points.\3\ 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. Imputed equity meets the 
FDIC requirements for a well-capitalized depository institution for 
insurance premium purposes and represents the market capitalization, or 
shareholder value, for Reserve Bank priced services.\4\
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    \3\ 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, which are 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.
    \4\ 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, (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 priced 
services balance sheet has no components of Tier 1 or total capital 
other than equity; therefore, requirements 1 and 2 are essentially 
the same measurement.
    As used in this context, the term ``shareholder'' does not refer 
to the actual member banks of the Federal Reserve System, but rather 
to the implied shareholders who would have an ownership interest if 
the Reserve Banks' priced services were provided by a private firm.
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    The equity financing rate is the target ROE rate produced by the 
capital asset pricing model (CAPM). 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 the CAPM, the risk-free rate is based 
on the three-month Treasury bill; the beta is assumed to equal 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.
    For simplicity, given that federal corporate income tax rates are 
graduated, state income tax rates vary, and various credits and 
deductions can apply, an actual 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.\5\ To the extent that actual performance results are 
greater or less than the targeted ROE, income taxes are adjusted using 
an imputed income tax rate. Because the Reserve Banks provide similar 
services through their correspondent banking activities, including 
payment and settlement services, and the amount of imputed equity meets 
the FDIC requirements for a well-capitalized depository institution, 
the imputed income tax rate is the median of the rates paid by the top 
fifty bank holding companies (BHCs) based on deposit balances over the 
past five years adjusted to the extent that they invested in tax-free 
municipal bonds.
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    \5\ Other taxes, such as sales taxes, are included in priced-
services actual or imputed costs.
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    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 based on current FDIC rates and projected 
clearing balances held with the Reserve Banks.
    1. Net Income on Clearing Balances--The NICB calculation is 
performed each year along with the PSAF calculation and is based on the 
assumption that the Reserve Banks invest clearing balances net of 
imputed reserve requirements and balances used to finance priced-
services assets. Using these net clearing balance levels, the Reserve 
Banks impute a constant spread, determined by the return on a portfolio 
of investments, over the three-month Treasury bill rate.\6\ 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.\7\ 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.
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    \6\ 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 7 for 
the investments imputed in 2008.
    NICB is projected to be $125.8 million for 2008 using a constant 
spread of 26 basis points over the three-month Treasury bill rate 
and applying this rate to the clearing balance levels used in the 
2008 pricing process. The 2007 NICB estimate is $135.7 million.
    \7\ July 2007 rates and balances were used to project 2008 NICB.
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    2. Analysis of the 2008 PSAF--The decrease in the 2008 PSAF is 
primarily due to an overall reduction in imputed equity and a slight 
decrease in the required ROE result provided by the CAPM.
    Estimated 2008 Federal Reserve assets, reflected in table 3, have 
decreased $2,279.8 million, mainly due to a decline in items in process 
of collection of $1,977.2 million. This reduction largely stems from 
the accelerated collection of items processed in the Check 21 
environment.
    As shown in table 4, the portion of assets financed with clearing 
balances has increased. Short-term assets funded with clearing balances 
total $4.2 million. This figure represents a $6.0 million decline from 
the short-term assets funded in 2007, a decrease that results from the 
reduction in estimated short-term receivables. The amount of core 
clearing balances used to fund long-term assets has increased $68.5 
million primarily because of an increase in long-term assets and a 
lower amount of imputed equity, which also is used to fund long-term 
assets.
    As previously mentioned, clearing balances are available as a 
funding source for priced-services assets. Table 4 shows that $72.7 
million in clearing balances is used to fund priced-services

[[Page 63597]]

assets in 2008. The interest rate sensitivity analysis in table 5 
indicates that a 200 basis point decrease in interest rates affects the 
ratio of rate-sensitive assets to rate-sensitive liabilities and 
decreases cost recovery by 1.5 percentage points, while an increase of 
200 basis points in interest rates increases cost recovery by 1.4 
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.
    As shown in table 3, the amount of equity imputed for the 2008 PSAF 
is $628.9 million, a decrease of $114.0 million from the imputed equity 
for 2007. In accordance with FAS 158, this amount includes an 
accumulated other comprehensive loss of $328.4 million. The capital to 
total assets ratio and the capital to risk-weighted assets ratio both 
meet or exceed the regulatory requirements for a well-capitalized 
depository institution. Equity is based on 5 percent of total assets, 
and capital to risk-weighted assets is 10.1 percent.\8\ Following the 
final FDIC regulations regarding the assessment of insurance premiums, 
the Reserve Banks imputed a one-time priced services assessment credit 
of $16.6 million. In 2007, this imputed credit fully offset the imputed 
assessment for the priced services. For 2008, the net FDIC assessment 
is imputed at $0.4 million.\9\
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    \8\ In December 2006, bank regulators (the Board of Governors of 
the Federal Reserve System, the FDIC, the Office of the Comptroller 
of the Currency, and the Office of Thrift Supervision) announced an 
interim ruling that excludes FAS 158-related accumulated other 
comprehensive income or losses from the calculation of regulatory 
capital. The Reserve Banks, however, elected to impute total equity 
at 5 percent of assets, as indicated above, until the regulators 
announce a final ruling.
    \9\ Per FDIC rules, any remaining portion of the one-time 
assessment credit can offset up to 90 percent of the assessment 
amount in subsequent years. For 2008, 90 percent of the total 
imputed assessment of $4.1 million was offset by the remaining 
assessment credit, resulting in a net assessment of $0.4 million.
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    Table 6 shows the imputed PSAF elements, the pretax ROE, and other 
required PSAF costs for 2007 and 2008. The $20.7 million decrease in 
ROE is primarily caused by a lower amount of imputed equity and a 
slight decrease in the risk-free rate of return. Sales taxes increased 
from $8.5 million in 2007 to $8.9 million in 2008. The effective income 
tax rate used in 2008 decreased to 31.2 percent from 31.5 percent in 
2007. The priced-services portion of the Board's expenses increased 
$0.5 million from $6.7 million in 2007 to $7.2 million in 2008.

              Table 3.--Comparison of Pro Forma Balance Sheets for Federal Reserve Priced Services
                                [Millions of dollars--projected average for year]
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                                                                      2008            2007            Change
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Short-term assets:
    Imputed reserve requirement on clearing balances...........          $799.7          $823.4          $(23.7)
    Receivables................................................            64.3            70.1            (5.8)
    Materials and supplies.....................................             2.0             1.1             0.9
    Prepaid expenses...........................................            29.3            30.2            (0.9)
    Items in process of collection \10\........................         3,411.7         5,388.9        (1,977.2)
                                                                ------------------------------------------------
        Total short-term assets................................         4,307.0         6,313.7        (2,006.7)
Imputed investments............................................         7,124.5         7,444.5          (320.0)
Long-term assets:
    Premises \11\..............................................           393.9           395.2            (1.3)
    Furniture and equipment....................................           131.0           138.7            (7.7)
    Leasehold improvements and long-term prepayments...........            86.7            56.6            30.1
    Prepaid pension costs......................................           384.2           349.1            35.1
    Deferred tax asset.........................................           150.0           159.3            (9.3)
                                                                ------------------------------------------------
        Total long-term assets.................................         1,145.8         1,098.9            46.9
                                                                ------------------------------------------------
            Total assets.......................................        12,577.3        14,857.1        (2,279.8)
                                                                ================================================
Short-term liabilities:\12\
    Clearing balances..........................................         7,683.9         8,322.7          (638.8)
    Deferred credit items \10\.................................         3,724.7         5,300.3        (1,575.6)
    Short-term payables........................................            91.4            91.2             0.2
                                                                ------------------------------------------------
        Total short-term liabilities...........................        11,500.0        13,714.2        (2,214.2)
Long-term liabilities:\12\
    Postemployment/postretirement benefits liability...........           448.4           400.0            48.4
                                                                ------------------------------------------------
        Total liabilities......................................        11,948.4        14,114.2        (2,165.8)
Equity \13\....................................................           628.9           742.9          (114.0)
                                                                ------------------------------------------------
        Total liabilities and equity...........................        12,577.3        14,857.1        (2,279.8)
                                                                ================================================
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\10\ Represents float that is directly estimated at the service level.
\11\ Includes the allocation of Board of Governors assets to priced services of $1.2 million for 2008 and 2007.
\12\ No debt is imputed because clearing balances are a funding source.
\13\ Includes an accumulated other comprehensive loss of $361.0 million for 2007, which was reduced to $328.4
  million for 2008 to reflect the ongoing amortization of the accumulated loss in accordance with FAS 158.
  Future gains or losses, and their effects on the pro forma balance sheet, cannot be projected.

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[[Page 63599]]



                             Table 5.--2008 Interest Rate Sensitivity Analysis \16\
                                              [Millions of dollars]
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                                                                                       Rate
                                                                 Rate  sensitive    insensitive        Total
----------------------------------------------------------------------------------------------------------------
Assets:
    Imputed reserve requirement on clearing balances...........  ...............          $799.7          $799.7
    Imputed investments........................................        $7,124.5   ..............         7,124.5
    Receivables................................................  ...............            64.3            64.3
    Materials and supplies.....................................  ...............             2.0             2.0
    Prepaid expenses...........................................  ...............            29.3            29.3
    Items in process of collection \17\........................          (313.0)         3,724.7         3,411.7
    Long-term assets...........................................  ...............         1,145.8         1,145.8
                                                                ------------------------------------------------
        Total assets...........................................         6,811.5          5,765.8        12,577.3
                                                                ================================================
Liabilities:
    Clearing balances \18\.....................................         5,851.6          1,832.3         7,683.9
    Deferred credit items......................................  ...............         3,724.7         3,724.7
    Short-term payables........................................  ...............            91.4            91.4
    Long-term liabilities......................................  ...............           448.4           448.4
                                                                ------------------------------------------------
        Total liabilities......................................         5,851.6          6,096.8        11,948.4
----------------------------------------------------------------------------------------------------------------


 
                                             200 basis       200 basis
                                          point decrease  point increase
                                             in rates        in rates
------------------------------------------------------------------------
Rate change results:
    Asset yield ($6,811.5 x rate change)         (136.2)           136.2
    Liability cost ($5,851.6 x rate              (117.0)           117.0
     change)............................
                                         -------------------------------
        Effect of 200 basis point change          (19.2)            19.2
                                         ===============================
    2008 budgeted revenue...............           897.1           897.1
    Effect of change....................          (19.2)            19.2
                                         -------------------------------
        Revenue adjusted for effect of             877.9           916.3
         interest rate change...........
                                         ===============================
    2008 budgeted total expenses........           770.5           770.5
    2008 budgeted PSAF..................           117.3           117.3
    Tax effect of interest rate change             (6.0)             6.0
     ($ change x 31.2%).................
                                         -------------------------------
        Total recovery amounts..........           881.8           893.8
                                         ===============================
    Recovery rate before interest rate            101.1%          101.1%
     change.............................
    Recovery rate after interest rate              99.6%          102.5%
     change.............................
    Effect of interest rate change on             (1.5)%            1.4%
     cost recovery \19\.................
------------------------------------------------------------------------
\16\ The interest rate sensitivity analysis evaluates the level of
  interest rate risk presented by the difference between rate-sensitive
  assets and rate-sensitive liabilities. The analysis reviews the ratio
  of rate-sensitive assets to rate-sensitive liabilities and the effect
  on cost recovery of a change in interest rates of up to 200 basis
  points.
\17\ The amount designated as rate-sensitive represents items collected
  prior to providing credit according to established availability
  schedules.
\18\ The amount designated as rate-insensitive represents clearing
  balances on which earnings credits are not paid.
\19\ The effect of a potential change in rates is less than a two
  percentage point change in cost recovery; therefore, no long-term debt
  is imputed for 2008.


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   Table 7.--Computation of 2008 Capital Adequacy for Federal Reserve
                             Priced Services
                          [Millions of dollars]
------------------------------------------------------------------------
                                                       Risk      Weight
                                           Assets    weighted    assets
------------------------------------------------------------------------
Imputed reserve requirement on clearing     $799.7        0.0       $0.0
 balances..............................
Imputed investments:
    1-year Treasury note \25\ \26\.....    2,475.5        0.0        0.0
    Commercial paper (3-month) \25\....    4,249.5        1.0    4,249.5
    GNMA mutual fund \27\..............      399.5        0.2       79.9
                                        --------------------------------
        Total imputed investments......    7,124.5  .........    4,329.4
Receivables............................       64.3        0.2       12.9
Materials and supplies.................        2.0        1.0        2.0
Prepaid expenses.......................       29.3        1.0       29.3
Items in process of collection.........    3,411.7        0.2      682.3
Premises...............................      393.9        1.0      393.9
Furniture and equipment................      131.0        1.0      131.0
Leasehold improvements and long-term          86.7        1.0       86.7
 prepayments...........................
Prepaid pension costs..................      384.2        1.0      384.2
Deferred tax asset.....................      150.0        1.0      150.0
                                        --------------------------------
        Total..........................   12,577.3  .........    6,201.7
                                        ================================
Imputed equity for 2008................      628.9  .........  .........
Capital to risk-weighted assets........      10.1%  .........  .........
Capital to total assets................       5.0%  .........  .........
------------------------------------------------------------------------
\25\ The imputed investments are assumed to be similar to those for
  which rates are available on the Federal Reserve's H.15 statistical
  release, which can be located at https://www.federalreserve.gov/
releases/h15/data.htm.
\26\ Includes estimated amounts arising from the collection of items
  prior to providing credit according to established availability
  schedules. These amounts are assumed to be invested in a short-term
  Treasury security.
\27\ The imputed mutual fund investment is based on Vanguard's GNMA Fund
  Investor Shares fund, which was chosen based on the investment
  strategies articulated in its prospectuses. The fund returns can be
  located at https://personal.vanguard.com/VGApp/hnw/FundsByType.

    C. Earnings Credits on Clearing Balances--The Reserve Banks will 
maintain the current rate of 80 percent of the three-month Treasury 
bill rate to calculate earnings credits on clearing balances.\28\
---------------------------------------------------------------------------

    \28\ 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 depository institution (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 Banks.
    The ``marginal reserve requirement'' adjustment accounts for the 
fact that the respondent can deduct balances maintained at a 
correspondent, but not at 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
    [ 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.
---------------------------------------------------------------------------

    Clearing balances were introduced in 1981, as 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. The earnings credit calculation uses a percentage 
discount on a rolling thirteen-week average of the annualized coupon 
equivalent yield of three-month Treasury bills in the secondary market. 
Earnings credits, which are calculated monthly, can be used only to 
offset charges for priced services and expire if not used within one 
year.\29\
---------------------------------------------------------------------------

    \29\ A band is established around the contracted clearing 
balance to determine the maximum balance on which credits are earned 
as well as any deficiency charges. The clearing balance allowance is 
2 percent of the contracted amount or $25,000, whichever is greater. 
Earnings credits are based on the period-average balance maintained 
up to a maximum of the contracted amount plus the clearing balance 
allowance. Deficiency charges apply when the average balance falls 
below the contracted amount less the allowance, although credits are 
still earned on the average maintained balance.
---------------------------------------------------------------------------

    D. Check Service--Table 8 shows the 2006, 2007 estimated, and 2008 
budgeted cost recovery performance for the commercial check service.

[[Page 63602]]



                         Table 8.--Check Service Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                      5 Recovery
                                                                              3 Net                   rate after
                     Year 1                       1 Revenue     2 Total       income      4 Target    target ROE
                                                                expense    (ROE) [1-2]      ROE       [1/(2+4)]
                                                                                                      (percent)
----------------------------------------------------------------------------------------------------------------
2006...........................................        845.7        716.9        128.7         57.1        109.3
2007 (estimate)................................        815.2        748.5         66.7         63.2        100.4
2008 (budget)..................................        701.5        647.2         54.4         51.9        100.3
----------------------------------------------------------------------------------------------------------------

    1. 2007 Estimate--For 2007, the Reserve Banks estimate that the 
check service will recover 100.4 percent of total expenses and targeted 
ROE, compared with the budgeted recovery rate of 101.8 percent. The 
Reserve Banks expect to recover all actual and imputed expenses of 
providing check services and earn net income of $66.7 million (see 
table 8).
    The lower-than-budgeted cost recovery is the result of costs that 
were $40.3 million greater than budgeted and are primarily attributable 
to the accrual of one-time costs associated with the next phase of 
check restructuring. Revenue was $29.7 million higher than expected, 
reflecting additional revenue associated with Check 21 deposits 
presented to non-electronic endpoints using substitute checks and 
helped to offset the unbudgeted costs.
    The number of checks deposited electronically has grown rapidly in 
2007 (see table 9). Year-to-date through September, 37.9 percent of the 
Reserve Banks' volume was deposited through Check 21 products. Year-to-
date figures, however, understate the current penetration rate of Check 
21 products because volume has increased throughout 2007. In the month 
of September, for example, the proportion of checks deposited 
electronically with the Reserve Banks for collection rose to about 50.6 
percent of total check deposits.
    The number of checks presented electronically using Check 21 
products has also grown steadily in 2007 (see table 9). Year-to-date 
through September, 18.6 percent of the Reserve Banks' volume was 
presented using Check 21 products, compared with a rate of 26.7 percent 
for the month of September. Before the end of the year, the Reserve 
Banks expect that nearly a third of all checks will be presented using 
Check 21 products. Depository institutions have been slower to accept 
check presentments electronically because financial incentives are 
generally stronger for electronic check deposit and because integrating 
electronic presentments into back-office processing and risk-management 
systems can be a complex and expensive undertaking.

            Table 9.--Check 21 Product Penetration Rates \a\
                              [Percent] \b\
------------------------------------------------------------------------
                                                 September
                                       2006      2007 Year-   September
                                                  to-date        2007
------------------------------------------------------------------------
Deposit:                                  12.0         38.8         51.7
    FedForward...................         11.4         37.9         50.6
    Paper to Check 21............          0.6          1.0          1.1
Presentment:                               4.1         18.6         26.7
    FedReceipt...................          0.1          1.1          1.5
    FedReceipt Plus..............          4.0         17.5         25.2
Return:                            ...........  ...........  ...........
    FedReturn....................         12.0         36.0        39.4
------------------------------------------------------------------------
\a\ The Reserve Banks' Check 21 product suite includes FedForward,
  FedReturn, FedReceipt, and FedReceipt Return. FedForward is the
  electronic alternative to forward check collection; FedReturn is the
  electronic alternative to paper check return; FedReceipt is electronic
  presentment with accompanying images; and FedReceipt Return is the
  electronic return of unpaid checks. Under FedReceipt, the Reserve
  Banks electronically present only the checks that were deposited
  electronically or that were deposited in paper form and converted into
  electronic form by the Reserve Banks. Under FedReceipt Plus, the
  Reserve Banks electronically present all checks drawn on the customer.
 
\b\ Deposit and presentment statistics are calculated as a percentage of
  total forward collection volume. Return statistics are calculated as a
  percentage of total return volume.

    For full-year 2007, the Reserve Banks estimate that their total 
forward check volume will decline 8 percent.\30\ Paper forward-
collection volume is expected to decline 35.3 percent for the full year 
compared with a budgeted decline of 21.3 percent as more volume is 
deposited electronically (see table 10). This greater-than-expected 
decline in paper check volume is a result of more checks being 
deposited electronically. The Reserve Banks estimate that paper return 
volume will decline at a slower pace than forward paper volume, 27.1 
percent for the full year compared with a budgeted decline of 31.7 
percent.
---------------------------------------------------------------------------

    \30\ Total forward Reserve Bank check volumes have dropped from 
roughly 11.0 billion in 2006 to 10.1 billion in 2007 and are 
expected to fall to 9.2 billion in 2008.

[[Page 63603]]



              Table 10.--Paper Check Product Volume Changes
                                [Percent]
------------------------------------------------------------------------
                                                   Change
                                     Budgeted     through     Estimated
                                   2007 change   September   2007 change
                                                    2007
------------------------------------------------------------------------
Total forward collection.........        -21.3        -35.7        -35.3
Returns..........................        -31.7        -23.4        -27.1
------------------------------------------------------------------------

    2. 2008 Pricing--In 2008, the Reserve Banks project that the check 
service will recover 100.3 percent of total expenses and targeted ROE. 
Revenue is projected to be $701.5 million, or about a $114 million 
decline from 2007. This decline is driven by a $142 million drop in 
paper check and payor bank fee revenue that is partially offset by a 
$43 million increase in Check 21 fee revenue. Total expenses for the 
check service are projected to be $647.2 million, or about a $101 
million decline from 2007. A key driver in the reduction of local check 
costs is the continued planned restructuring of the Reserve Banks' 
check-processing sites, including a reduction in staff of approximately 
20 percent.\31\
---------------------------------------------------------------------------

    \31\ In February 2003, the Reserve Banks announced an initiative 
to reduce the number of sites at which they process checks from 
forty-five to thirty-two. The Reserve Banks announced further rounds 
of restructurings in August 2004, May 2005, and May 2006. As of 
October 2007, there are nineteen Reserve Bank check processing 
offices. The Reserve Banks have announced plans to consolidate to 
four check processing sites by early 2011.
---------------------------------------------------------------------------

    For 2008, the Reserve Banks estimate that their total forward check 
volume will decline 9 percent. The Reserve Banks project that paper 
check volume for forward products will decrease about 44 percent, 
volume for paper check return products will decrease 33 percent, and 
volume for payor bank products will decrease 45 percent. These expected 
volume declines will be offset by a projected increase in Check 21 
volumes as the shift from paper to electronic check volume continues. 
The Reserve Banks project that FedForward volume will increase 42 
percent, FedReceipt Plus volume will increase 87 percent, and FedReturn 
volume will increase 39 percent (see table 11). The Reserve Banks' 
projected increase in Check 21 volume will result in a more modest 17 
percent increase in Check 21 product revenue as the share of Check 21 
deposits presented to FedReceipt electronic endpoints grows. Board and 
Reserve Bank staff believe that the key to realizing Check 21 cost 
efficiencies for the System continues to be the widespread acceptance 
of electronic check presentments by paying banks, and by year-end 2008, 
the Reserve Banks expect that 75 percent of their check volume will be 
deposited using Check 21 services and that 55 percent of their check 
volume will be presented using Check 21 services.

                       Table 11.--Check 21 Volume
------------------------------------------------------------------------
                                                     2008
                                                   Budgeted     Growth
                                                    volume     from 2007
                                                   (millions   estimate
                                                   of items)   (percent)
------------------------------------------------------------------------
FedForward......................................       5,842          42
FedReceipt Plus.................................       3,841          87
FedReturn.......................................          60          39
------------------------------------------------------------------------

    The Reserve Banks expect to see continued growth in their Check 21 
volumes in 2008, as market participants continue to replace their 
existing traditional check infrastructure to take advantage of more 
cost-effective electronic clearing. The Reserve Banks project volume 
losses from large banks that are expected to increase the number of 
check images exchanged among themselves. This volume loss, however, is 
expected to be offset through the expansion of customers using existing 
Check 21 products and the introduction of new Check 21 products. In 
addition, the Reserve Banks will further standardize their product 
offerings and will eliminate products that generate little volume. 
These actions will help the Reserve Banks achieve a more uniform 
product suite, leading to greater operational efficiencies.
    For 2008, the Reserve Banks are targeting an overall price increase 
for traditional check services of 12.5 percent, including a 12.1 
percent increase in forward check collection fees, a 12.5 percent 
increase in return service fees, and a 13.8 percent increase in payor 
bank services fees.\32\ For Check 21 services, the Reserve Banks will 
decrease by 3.2 percent the fees for Check 21 deposits that are 
presented electronically. The fees for Check 21 deposits that are 
presented as substitute checks, however, will increase 10.3 percent. 
There will be no change in fees charged for the Check 21 FedReturn 
product (see table 12).
---------------------------------------------------------------------------

    \32\ In 2007, the Reserve Banks announced a sunset strategy for 
payor bank services. The Reserve Banks will discontinue offering 
these services by the end of 2009.

                       Table 12.--2008 Fee Changes
                                [Percent]
------------------------------------------------------------------------
                          Product                             Fee change
------------------------------------------------------------------------
Traditional Check..........................................         12.5
  Forward collection.......................................         12.1
  Returns..................................................         12.5
  Payor bank services......................................         13.8
Check 21:
  FedForward (electronic endpoints)........................         -3.2
  FedForward (substitute check endpoints)..................         10.3
  FedReturn................................................       (\B\)
------------------------------------------------------------------------
\a\ FedReceipt customers currently receive a $0.003 discount per check
  presented electronically, which will increase to a $0.004 discount in
  2008. This discount can be used to offset fees for checks deposited
  electronically with the Reserve Banks.
\b\ No changes.

    The major risks to meeting the Reserve Banks' budgeted 2008 cost 
recovery are higher-than-expected declines in paper check volume as 
well as increased competition from correspondent banks and other 
service providers as they expand their Check 21 service offerings. The 
Reserve Banks may also suffer greater Check 21 volume losses if large 
banks exchange images among themselves more quickly than anticipated. 
Other risks include unanticipated problems with check restructurings or 
other major initiatives that may result in significant cost overruns.
    E. FedACH Service--Table 13 below shows the 2006, 2007 estimated, 
and 2008 budgeted cost recovery performance for the commercial FedACH 
service.

[[Page 63604]]



                        Table 13.--FedACH Service Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                      5 Recovery
                                                                              3 Net                   rate after
                      Year                        1 Revenue     2 Total       income      4 Target    target ROE
                                                                expense    (ROE) [1-2]      ROE       [1/(2+4)]
                                                                                                      (percent)
----------------------------------------------------------------------------------------------------------------
2006...........................................         91.4         80.1         11.3          7.5        104.3
2007 (estimate)................................        101.7         87.3         14.3          8.8        105.8
2008 (budget)..................................         99.1         89.6          9.5          7.6        102.0
----------------------------------------------------------------------------------------------------------------

    1. 2007 Estimate--The Reserve Banks estimate that the FedACH 
service will recover 105.8 percent of total expenses and targeted ROE, 
compared with the budgeted recovery rate of 102.5 percent. The Reserve 
Banks expect to recover all actual and imputed expenses of providing 
FedACH services and earn net income of $14.3 million. Year-to-date 
through September, FedACH commercial origination volume is 13.6 percent 
higher than during the same period last year, compared with a budgeted 
full-year growth of 12.4 percent. For full-year 2007, the Reserve Banks 
estimate that FedACH commercial originations will grow 13.1 percent 
because some of their customers will have migrated their business to 
EPN, the other automated clearing house (ACH) operator.
    2. 2008 Pricing--The Reserve Banks project that the FedACH service 
will recover 102.0 percent of total expenses and targeted ROE in 2008. 
Total revenue is budgeted to decrease $2.6 million from the 2007 
estimate, primarily as the result of the elimination of the input file 
processing fee. Total expenses are budgeted to increase $2.3 million 
from the 2007 estimate. This increase reflects the additional resources 
needed to support the multiyear technology transition plan from a 
mainframe-computer to a distributed-server processing environment.
    The Reserve Banks expect FedACH commercial origination volume to 
grow 11.2 percent in 2008. This expected growth is largely attributable 
to volume increases associated with electronic check conversion 
applications, including checks converted at lockboxes and at the point 
of sale.
    The Reserve Banks will also change their pricing approach for two 
existing ACH products. The first, FedEDI[reg] Plus, offers depository 
institutions the ability to provide corporate-level payment data to 
their customers.\33\ The second, FedACH risk management services, 
provides depository institutions the ability to better monitor the 
risks of their ACH transactions. Beginning in 2008, the subscription 
fee for FedACH risk management services will be eliminated, and fees 
for monitoring criteria will be reduced and tiered. In addition, access 
to FedACH risk management services, along with FedEDI Plus, will be 
bundled with FedLine Web connectivity. Separate fees will also be 
charged for FedEDI Plus scheduled, secure delivery, and on demand 
reports.\34\
---------------------------------------------------------------------------

    \33\ FedEDI is a registered servicemark of the Reserve Banks.
    \34\ Depository institutions that use FedLine Advantage, FedLine 
Command, and FedLine Direct will also have access to FedEDI Plus and 
FedACH risk management services because FedLine Web functionality is 
included in these electronic access packages.
---------------------------------------------------------------------------

    The primary risk to meeting the Reserve Banks' budgeted 2008 cost 
recovery is the loss of large ACH originators to EPN. Other risks 
include the potential growth of direct ACH exchanges that bypass the 
ACH operators and unanticipated problems with technology upgrades that 
may result in significant cost overruns.
    F. Fedwire Funds and National Settlement Services--Table 14 below 
shows the 2006, 2007 estimated, and 2008 budgeted cost recovery 
performance for the Fedwire Funds and National Settlement Services.

        Table 14.--Fedwire Funds and National Settlement Services Pro Forma Cost and Revenue Performance
                                                  [$ millions]
----------------------------------------------------------------------------------------------------------------
                                                                                                     5  Recovery
                                                                              3  Net                  rate after
                      Year                        1  Revenue    2  Total      income     4  Target    target ROE
                                                                expense     (ROE)  [1-      ROE       [1/(2+4)]
                                                                                2]                    (percent)
----------------------------------------------------------------------------------------------------------------
2006...........................................         72.3         59.3         13.0          5.6        111.4
2007 (estimate)................................         74.8         63.6         11.2          6.3        107.0
2008 (budget)..................................         72.9         63.8          9.0          5.3        105.5
----------------------------------------------------------------------------------------------------------------

    1. 2007 Estimate--The Reserve Banks estimate that the Fedwire Funds 
and National Settlement Services will recover 107.0 percent of total 
expenses and targeted ROE, compared with a 2007 budgeted recovery rate 
of 102.5 percent. The greater-than-expected recovery rate is primarily 
attributed to higher-than-expected electronic connection and fee 
revenues and lower-than-budgeted operating costs. Year-to-date through 
September, online funds volume was 1.4 percent higher than during the 
same period last year. For full-year 2007, the Reserve Banks estimate 
that online funds volume will grow 1.4 percent, compared with a 
budgeted flat growth. With respect to the National Settlement Service, 
the Reserve Banks estimate that the volume of settlement entries 
processed during 2007 will be 7.0 percent higher than the 2007 budget 
projection of flat growth. The higher-than-budgeted National Settlement 
Service volume is due primarily to the Depository Trust & Clearing 
Corporation subsidiaries' greater use of the National Settlement 
Service for settlement activity.

[[Page 63605]]

    2. 2008 Pricing--In 2008, the Reserve Banks expect the Fed