[Federal Register Volume 74, Number 64 (Monday, April 6, 2009)]
[Notices]
[Pages 15481-15495]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-7473]
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FEDERAL RESERVE SYSTEM
[Docket No. OP-1354]
Federal Reserve Bank Services Private Sector Adjustment Factor
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice and request for public comment.
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SUMMARY: The Board requests comment on proposed modifications to its
method for calculating the private-sector adjustment factor (PSAF). The
PSAF is part of the Board's calculation, as required by the Monetary
Control Act of 1980 (MCA), to establish the fees that Federal Reserve
Banks (Reserve Banks) charge for certain financial services provided to
depository institutions (DIs). Consideration of a new PSAF methodology
was prompted by the reduction in clearing balances held by DIs at
Reserve Banks following the Board's recent implementation of the
payment of interest on required reserve balances and excess balances
held at Reserve Banks, as well as by long-term changes in the structure
of the market for providing payment services to DIs. The existing PSAF
calculation model, which is built upon a correspondent bank framework,
is driven primarily by the level of clearing balances held by DIs at
Reserve Banks. The expected continued reduction in clearing balances
will make the current PSAF calculation methodology less meaningful.
Accordingly, the Board requests comment on the prospective need to
change its methodology and its proposal to replace the current
correspondent bank model for calculating the PSAF with a publicly
traded firm model as described in this notice. If approved, use of this
new model could be reflected in priced services fees as early as 2010.
DATES: Comments must be submitted on or before May 29, 2009.
ADDRESSES: You may submit comments, identified by Docket No. OP-1354,
by any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected].
FAX: 202/452-3819 or 202/452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available on the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted,
except as necessary for technical reasons. Accordingly, your comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or on paper in Room
MP-500 of the Board's Martin Building (20th and C Streets, NW.) between
9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Gregory L. Evans, Deputy Associate
Director (202/452-3945), Brenda L. Richards, Manager (202/452-2753),
Jonathan Mueller, Senior Financial Analyst (202/530-6253), or Rebekah
Ellsworth, Financial Analyst (202/452-3480); Division of Reserve Bank
Operations and Payment Systems. Telecommunications Device for the Deaf
(TDD) users may contact 202/263-4869.
SUPPLEMENTARY INFORMATION:
I. Background
Under MCA, the Federal Reserve Banks must charge fees to DIs for
certain financial services, known collectively as ``priced services,''
so as to recover, over the long run, all direct and indirect costs
actually incurred in providing these services as well as the imputed
costs that would have been incurred had the services been provided by a
private-sector firm.1 2 MCA specifically identifies certain
imputed costs that must be recovered via priced services fees,
including taxes and return on equity (profit).
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\1\ These priced services include the check, automated
clearinghouse, Fedwire[reg] Funds, and Fedwire[reg] Securities (for
activity not related to Treasury securities) services.
\2\ 12 U.S.C. 248a(c)(3).
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To set priced services fees in accordance with the requirements of
MCA, the Board not only must estimate all actual direct and indirect
costs incurred in providing priced services but also must impute costs
that the Reserve Banks do not incur but would incur as private-sector
entities. In determining a methodology for imputing these costs, the
Board recognizes that there is no perfect private-sector proxy for the
Reserve Bank priced services, but seeks a methodology that is
theoretically sound and represents a reasonable approximation of the
costs the Reserve Banks would incur if operating as private-sector
providers. Because of the similarity between the services provided by
Reserve Banks and many of the services offered by private-sector
correspondent banks, the Board historically has derived these imputed
costs, collectively known as the PSAF, and offsetting imputed revenue,
known as net income on clearing balances (NICB), using a correspondent
bank model. The PSAF and NICB are estimated annually, and the resulting
net cost is incorporated each year when
[[Page 15482]]
setting priced services fees and measuring cost recovery.\3\
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\3\ In 2008, actual direct and indirect costs represented
approximately 88 percent of total priced services costs and the PSAF
represented the remaining 12 percent. The PSAF constituted an
estimated $108.3 million of the overall costs recovered by priced
services activities, and was offset by approximately $101.7 million
of NICB.
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The Clearing Balance Program
The Reserve Bank clearing balance program was developed in
connection with the implementation of MCA's requirement to establish
fees for priced services. This program allows DIs to hold at Reserve
Banks an agreed-upon level of clearing balances which serve several
purposes, including facilitating settlement of transactions, protecting
against overnight overdrafts, and paying for priced services through
the generation of earnings credits. The Reserve Bank clearing balance
program is largely modeled after similar programs offered by private-
sector correspondent banks, wherein respondent banks maintain balances
with their correspondents for some or all of the purposes listed above.
Under the Reserve Bank clearing balance program, a participating DI
agrees to set and maintain a targeted minimum average clearing balance,
known as the DI's contractual clearing balance, over a set period. A DI
may hold balances in excess of its contractual clearing balance and is
charged for deficiencies below the contracted minimum.
A DI accrues credits, known as earnings credits, on its contractual
clearing balances (not on excess balances) held at a Reserve Bank at a
rate currently equal to 80 percent of the 13-week moving average of the
annualized coupon equivalent yield of the three-month Treasury bill.
Earnings credits can only be applied toward priced services fees, and
unused credits expire if not used within one year.
Calculating the PSAF
The Board's method for calculating the PSAF begins with developing
a pro forma priced services balance sheet based on the projected
average book value of Reserve Bank assets and liabilities to be used in
providing priced services during the coming year.\4\ Additional
elements on the priced services balance sheet are imputed as if the
priced services were provided by a hypothetical private-sector
correspondent bank. For example, a private-sector correspondent bank
would be able to use the balances that its respondents deposit with it
as a funding source for investments. Accordingly, the Board imputes
investment income on clearing balances held at Reserve Banks based on
an imputed portfolio of interest-bearing assets. Similarly, because
private-sector correspondent banks are required to hold some portion of
their deposit balances as vault cash or as balances at a Reserve Bank,
the Board imputes a reserve requirement as a percentage of clearing
balances. The imputed investment of clearing balances and the imputed
reserve requirement both appear as assets on the priced services
balance sheet.
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\4\ The 2007 priced services balance sheet can be found in the
Federal Reserve Board's 2007 Annual Report at http://www.federalreserve.gov/boarddocs/rptcongress/annual07/sec2/c3.htm#nl12.
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The liability and equity components of the priced services balance
sheet consist of clearing balances, short- and long-term liabilities
related to providing priced services, imputed debt (if necessary), and
imputed equity. The level of clearing balances on the priced services
balance sheet increases or decreases at the discretion of the DIs
maintaining those balances and provides a source of long-term financing
for priced services assets.\5\ Using the correspondent bank model
results in imputed debt only when core clearing balances, long-term
liabilities, and equity on the priced services balance sheet are not
sufficient to fund long-term assets; or when an interest rate
sensitivity analysis indicates that a 200 basis point change in
interest rates would change the percentage of priced services costs
recovered (cost recovery) more than 2 percentage points. To satisfy the
FDIC requirement for a ``well-capitalized'' institution, equity is
imputed at 5 percent of total assets.\6\
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\5\ Using clearing balances as a financing source is consistent
with private-sector correspondent banks' use of their respondent
balances to fund short- and long-term assets. In the correspondent
bank model only the portion of clearing balances that has remained
stable over time (core clearing balances), historically set at $4
billion, is used to fund long-term assets on the priced services
balance sheet.
\6\ Equity is imputed based on the FDIC definition of a well-
capitalized depository institution for insurance premium purposes.
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. Because the total
capital on the priced services balance sheet has no components of
Tier 1 or total capital other than equity, requirements 1 and 2 are
essentially the same measurement. In addition, because risk-weighted
assets have historically been considerably below actual assets on
the priced services balance sheet, typically only requirement 3 has
been binding for the priced services.
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The imputed costs of the PSAF are derived from the priced services
balance sheet. A target return on equity (ROE) rate is estimated and
applied to the equity on the priced services balance sheet to determine
the cost of equity. The ROE rate is estimated using the capital asset
pricing model (CAPM), which calculates a firm's required ROE rate as
the sum of a risk-free rate of return and a risk premium. In this
model, the risk premium is the product of a firm-specific sensitivity
factor, known as beta, which expresses the correlation of the firm's
returns to the return of the market as a whole, and the expected return
of the market in excess of the risk-free rate. In the PSAF calculation,
the risk-free rate of return is based on the three-month Treasury bill
rate, and the expected market risk premium is the average of the
monthly returns of the market as a whole in excess of the risk-free
rate over the most recent 40 years.\7\ The priced services beta of 1.0
assumes that, over time, priced services returns will be perfectly
correlated with those of the overall market.
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\7\ Data on market returns are based on the French data series,
which is the standard data series used to estimate the market risk
premium (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html).
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Given that Federal corporate income tax rates are graduated, State
income tax rates vary, and various credits and deductions can apply,
the correspondent bank model does not include an actual income tax
expense. Instead, the Board targets a pretax ROE that would provide
sufficient income for the priced services to fulfill their imputed
income tax obligation. The imputed income tax rate used to calculate
the pretax ROE is the median of the rates paid over the past five years
by the top 50 bank holding companies (BHCs) ranked by deposit balances,
adjusted to exclude any investment in tax-free municipal bonds. The
PSAF also includes the estimated share of Board expenses that supports
the priced services, imputed sales tax, and an imputed FDIC insurance
assessment based on current FDIC rates and the level of clearing
balances held at Reserve Banks.
Calculating NICB
The correspondent bank model includes imputed revenue, known as
NICB, which is calculated each year along with the imputed costs of the
PSAF. The NICB calculation assumes that, similar to a correspondent
bank, the priced services would invest clearing balances, net of the
imputed reserve requirement and balances used to finance priced
services assets, in interest-bearing assets. To impute investment
income, a rate of return
[[Page 15483]]
equal to the yield on the three-month Treasury bill plus a constant
spread is applied to the level of clearing balances available for
investment on the priced services balance sheet. The constant spread is
derived annually from a portfolio of investments comparable to the
investment holdings of BHCs.\8\ The NICB calculation nets this imputed
investment income against the actual cost of earnings credits, which
represent the cost to the Reserve Banks of holding clearing
balances.\9\
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\8\ These investments include short-term Treasury securities,
government agency securities, commercial paper, long-term corporate
bonds, and money market funds. For additional details on the
calculation of the constant spread, refer to the notice of approval
of modifications to the method for calculating the PSAF, 68 FR
61413-61418 (Oct. 28, 2003).
\9\ Because clearing balances are voluntary, set by priced
services customers, and held for clearing transactions or offsetting
priced services fees, they are directly related to the priced
services. The cost associated with holding clearing balances,
therefore, is appropriately attributed to the priced services.
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Calculating Cost Recovery
The Board incorporates the PSAF and NICB into the projected and
actual annual cost recovery calculations for Reserve Bank priced
services. Cost recovery measures the percentage of priced services
costs, including the PSAF, recovered through priced services fees and
NICB. In the fall of each year, the Board projects the PSAF and NICB
for the following year using the most recent clearing balance and rate
data available (typically July data) during the process of establishing
priced services fees. The Board also estimates cost recovery for the
coming year using projected direct and indirect costs, revenue, and the
net imputed cost generated from the estimated PSAF and NICB.
When calculating actual cost recovery for the priced services at
the end of each year, the Board historically has used the estimated
PSAF derived during the price-setting process with only minimal
adjustments for actual rates or balance levels.\10\ \11\ The Board
adopted this approach because the PSAF largely represents the fixed
financing costs associated with the assets on the priced services
balance sheet, which is updated annually. This method has proven to be
reasonable and transparent without being unduly complex or burdensome.
The Board updates NICB, however, to reflect actual interest rates and
clearing balance levels throughout the year when calculating actual
priced services cost recovery. Actual NICB, therefore, can vary from
the projected amount used to determine priced services fees for a given
year. For example, while the projected and actual PSAF for 2007
remained substantially unchanged at $132.5 million, actual 2007 NICB
decreased from its $139.6 million projection to $133.8 million.
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\10\ Although the largest portion of the PSAF, the target ROE,
is fixed, two minor elements of the PSAF calculation are variable.
The first adjusts the imputed income tax expense for the difference
between the projected and actual priced services net income by
applying the imputed effective income tax rate to any difference.
The second recalculates the imputed FDIC assessment using actual
clearing balance levels and assessment rates.
\11\ In light of the uncertainty about the long-term effect that
paying interest on required reserve and excess balances held at
Reserve Banks will have on the level of clearing balances, the Board
will adjust the PSAF used in the actual cost-recovery calculation
for 2009 using the actual clearing balance levels maintained
throughout 2009.
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The Interdependence of Clearing Balances, the PSAF, and NICB
Changes in clearing balance levels directly affect the imputed
costs and income that factor into priced services fees and cost
recovery. Clearing balances not only represent the largest component of
the priced services balance sheet but also drive the calculation of
nearly all imputed elements included in priced services fees, including
the financing costs, the cost of equity, and NICB. For example,
clearing balances provide a major source of short- and long-term
funding for the assets on the priced services balance sheet,
representing 74 percent of total financing in 2007. Clearing balances
thus reduce total imputed financing costs by eliminating the need to
impute more costly forms of financing, such as debt.\12\ Clearing
balances, in the form of imputed investments, also represent a
significant portion of total priced services assets. Total assets, in
turn, determine the level of imputed equity and the resultant imputed
cost of that equity. In addition, the level of clearing balances
influences the amount of funds available for investment in the imputed
portfolio of investments and the cost of earnings credits, both of
which are principal factors in the NICB calculation. These three
elements--financing costs, the cost of equity, and NICB--are included
in the net imputed cost that is recovered through priced services fees.
Any change in the level of clearing balances, therefore, has a
significant effect on the PSAF, NICB, and cost recovery.
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\12\ Historically, debt financing rates have been higher than
the earnings credit rate, making debt a more costly source of
financing for the priced services balance sheet. For the week ended
February 11, 2009, the earnings credit rate paid on clearing
balances held by DIs at the Reserve Banks was 0.09 percent versus
5.21 percent for the bond rate on Moody's Aaa-rated corporate bonds
for the week ended February 13, 2009 (see http://www.federalreserve.gov/releases/h15/20090105/).
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Interest on Balances Held at Reserve Banks
Title II of the Financial Services Regulatory Relief Act of 2006
granted the Reserve Banks authority to pay earnings (interest) on
balances maintained by or on behalf of DIs at Reserve Banks.
Originally, this authority was to become effective in 2011. Section 128
of the Emergency Economic Stabilization Act of 2008, enacted on October
3, 2008, made the authority effective upon enactment. On October 6,
2008, the Board published an interim final rule amending Regulation D
(Reserve Requirements of Depository Institutions). The interim rule
directed the Reserve Banks to pay explicit interest on balances held at
Reserve Banks to satisfy reserve requirements (required reserve
balances) and on balances held in excess of both required reserve
balances and contractual clearing balances (excess balances), effective
October 9, 2008.\13\
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\13\ 73 FR 59482-59486 (Oct. 9, 2008), as amended by 73 FR
65506-65507 (Nov. 4, 2008), 73 FR 67713-67714 (Nov. 17, 2008), and
73 FR 78616 (Dec. 23, 2008).
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The Board has observed a significant decline in the level of
clearing balances held at Reserve Banks following the implementation of
interest on required reserve balances and excess balances and
anticipates that this trend will continue. The daily average level of
clearing balances over the two-week reserve maintenance period ending
October 8, 2008 was $7.7 billion. As shown in figure 1, by the reserve
maintenance period ending February 11, 2009, the daily average level of
clearing balances had fallen to $4.6 billion. Over this period, the
rate of interest paid on both required reserve balances and excess
balances maintained at Reserve Banks was generally higher than the
earnings credit rate paid on clearing balances.\14\ The interest rate
on required reserve balances and excess balances as of March 2009 is 25
basis points, which is the top of the targeted range for the Federal
funds rate and higher than the concurrent earnings credit rate for
clearing balances. When the target Federal funds rate exceeds the
earnings credit rate (the typical historical
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scenario), and absent a significant preference by DIs for implicit
interest on clearing balances over explicit interest on excess balances
held at Reserve Banks, DIs will likely continue to reduce clearing
balances in favor of increasing excess balances to receive higher,
explicit returns.
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\14\ The recent plateau in clearing balance levels may be due to
the small difference (often of less than 15 basis points) between
the rates earned on excess balances and clearing balances in the
current low interest rate environment. In a more normal rate
environment, the absolute value of this difference will increase,
giving DIs more incentive to shift from maintaining contractual
clearing balances to maintaining interest-earning excess balances.
[GRAPHIC] [TIFF OMITTED] TN06AP09.000
The expected continued decline in clearing balance levels could
have significant implications for the imputed costs that factor into
the Board's price-setting methodology. If clearing balance levels
decline significantly, the priced services balance sheet will shrink
dramatically, and the priced services will lose a major source of both
funding and income. A continued reduction in clearing balance levels
will decrease the similarities between the financial characteristics of
the priced services and private-sector correspondent banks.
Specifically, with low to zero clearing balance levels, it will be more
difficult to draw the analogy between correspondent banks, whose
balance sheets include large levels of deposit balances and related
accounts, and the Reserve Bank priced services. Similarly, markedly
reduced clearing balance levels will call into question the use of the
FDIC's regulatory structure for well-capitalized depository
institutions as a determinant of equity capital on the priced services
balance sheet and will potentially nullify the calculation of an FDIC
insurance assessment based on clearing balance levels. All of these
factors challenge the continued applicability of a PSAF model based on
a correspondent bank framework.
The potential for such circumstances, in conjunction with the
ongoing changes in the nature of priced services competitors discussed
below, has prompted the Board to consider changes to its approach to
imputing the costs that MCA requires to be recovered through priced
services fees. If approved, these changes could be effective as early
as the 2010 pricing process. In determining the appropriate timing of
such changes, the Board will consider trends in the level of clearing
balances held at Reserve Banks and the extent to which the nature of
the Reserve Banks' competitors, particularly in the check service,
shifts away from correspondent banks.
The Board requests comment on the following:
If the explicit interest rate for required reserve balances and
excess balances continues to be higher than the implicit rate paid on
clearing balances in the form of earnings credits, is it reasonable to
assume that DIs will continue to reduce or eliminate their level of
contractual clearing balances in favor of holding additional excess
balances? If not, why might DIs choose to maintain their clearing
balances?
Will DIs raise and lower the level of clearing balances they hold
at Reserve Banks depending on whether the earnings credit rate is above
or below the rate on excess balances?
Are there any reasons why the Board should maintain its clearing
balance program if demand for clearing balances continues to decline
significantly?
Trends in the Banking and Payment Systems Industries
As noted above, when implementing the priced services provisions of
MCA in the early 1980s, the Board identified private-sector
correspondent banks as the most appropriate peer group for the priced
services in adopting key elements of the policy. The Board
[[Page 15485]]
considered correspondent banks to be a reasonable proxy for private-
sector providers of priced services because they are the primary
competitors of the Reserve Banks' check service, which historically has
comprised more than 80 percent of the cost of Reserve Bank priced
services activities. In doing so, the Board recognized that BHCs offer
diverse services that extend well beyond the payment services that are
provided by the Reserve Banks, and that these services largely drive
BHC financial results; however, given that Reserve Banks and BHCs both
hold customer balances that facilitate payment services, the Board
considered it a reasonable comparison.
Recently, however, the analogy between private-sector correspondent
banks and the priced services has become less applicable. The payment
systems industry has sharply decreased its use of traditional check
services and increased its use of electronic payment services. As a
result, user-owned utilities, the Reserve Banks' typical competitors in
electronic payment services, have increasingly replaced correspondent
banks as the predominant competitors of the Reserve Banks in providing
priced services. These user-owned utilities include such entities as
the Clearing House Interbank Payment System (CHIPS), which is the
primary competitor for Fedwire[reg] funds transfer services, and the
Electronic Payments Network (EPN), which is the only private-sector
automated clearinghouse (ACH) operator. Both of these entities are part
of a larger cooperative, The Clearing House Payments Company, LLC
(TCH), which is owned entirely by its principal users. Unlike private-
sector correspondent banks, user-owned utilities do not hold overnight
balances for their participants. As paper check processing volumes
continue to decline and the check service becomes more electronic,
utilities will likely increasingly be key competitors of the Reserve
Banks in providing priced services. These trends, in conjunction with
the potential continued significant decline in clearing balances
resulting from the ability of DIs to receive explicit interest on
balances held at Reserve Banks, raise questions about the continued
appropriateness of the correspondent bank model as the basis for the
imputed costs that factor into the Board's pricing methodology.
II. The Proposed PSAF Model
The Publicly Traded Firm Model
The Board seeks to replace the current correspondent bank model
with a model that is transparent, consistent with current financial
theory and practice, and conceptually sound as a basis for efficient
pricing in the market of payment services. To achieve these objectives,
and given the difficulty in identifying and obtaining data for an
applicable peer group, the Board proposes to replace the correspondent
bank model with a ``publicly traded firm model'' for calculating the
imputed costs that factor into priced services fees and cost recovery.
This model recognizes the shift, in the priced services' financial
characteristics and competitors, away from correspondent banks, as well
as the difficulties inherent in a user-owned utility model as discussed
below, and instead compares the priced services to the entire market of
U.S. publicly traded firms.
Under the publicly traded firm model, the asset side of the priced
services balance sheet would reflect only the projected portion of
actual Reserve Bank assets used to provide priced services; no
additional assets would be imputed. Any residual clearing balances
maintained by DIs at Reserve Banks would not be included in the priced
services balance sheet or in the calculation of the PSAF. Consequently,
imputed investments and NICB would be zero by definition, and the
priced services would impute additional equity and debt to meet the
funding need on the priced services balance sheet. The publicly traded
firm model would not include an imputed FDIC assessment, because the
priced services' peer group would no longer be limited to private-
sector correspondent banks and because, as noted above, any residual
clearing balances would not be included in the priced services balance
sheet or in the PSAF calculation. The imputed capital structure, debt
and equity financing rates, and effective income tax rate would be
based on data for the U.S. market as a whole and would be calculated
using the various market data sources and time frames discussed below.
The time frame selected for each of these imputed elements was chosen
to minimize volatility in the PSAF from year to year. A one-year time
frame was selected for elements that historically have been more
stable; a five-year average was selected when data were more volatile
historically or when changes in that element would have a larger impact
on the PSAF.\15\ When averaging data for individual U.S. firms, the
model would use value-weighted rather than equal-weighted averages.\16\
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\15\ Although MCA's requirement for cost recovery over the long
run allows the Board to set fees to over- or underrecover costs in a
given year to minimize price volatility, volatility in imputed costs
makes the pricing process more complex. As a result, the Board has
typically preferred to adopt PSAF methodologies that provide for
stable rather than volatile imputed costs.
\16\ Value-weighted averages assign equal weight to each dollar,
while equal-weighted averages assign equal weight to each firm. The
Board opted to use value-weighted averages to reflect more
accurately the financial characteristics of the market as a whole
rather than those of the ``average'' firm in the market.
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The priced services imputed capital structure would be based on the
most recent full-year value-weighted average capital structure (that
is, total long-term debt to total long-term debt plus equity) of all
U.S. publicly traded firms included in a commercially available
financial database. The Board initially proposes using Standard &
Poor's Compustat[supreg] database as the source for the capital
structure and effective income tax rate of all U.S. publicly traded
firms. The Standard & Poor's Compustat[supreg] database contains
information on more than 6,000 U.S. publicly traded firms, which
approximate the entirety of the U.S. market. Because of the timing of
the price-setting process and the availability of relevant data, there
would be a two-year lag in the data used in the PSAF calculation: for
example, 2010 priced services fees, set in late 2009, would be based
upon full-year 2008 data.\17\ Table 1 shows the value-weighted average
capital structures for all U.S. publicly traded firms in the Standard &
Poor's Compustat[supreg] database from 2003 to 2007. In 2007, based on
the foregoing, the value-weighted average capital structure was 54
percent.
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\17\ The two-year lag in the data used to calculate certain
imputed costs in the PSAF is characteristic of the current model as
well and is due in large part to the timing of the price-setting
process.
[[Page 15486]]
Table 1--Capital Structure (Capitalization Ratio) of U.S. Publicly Traded Firms
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Five-year Standard
2003 2004 2005 2006 2007 average deviation
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55% 53% 53% 52% 54% 53% 1.0%
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Source: Standard & Poor's Compustat[supreg] data.
Because the PSAF resulting from the publicly traded firm model is
not highly sensitive to capital structure and because the value-
weighted average capital structure does not vary significantly from
year to year, the Board believes that a one-year time frame is
appropriate when imputing the priced services capital structure. This
conclusion is supported both by financial theory, which states that
changes in capital structure should not significantly affect the value
of a firm, and by sensitivity analysis as shown in attachment 1.\18\
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\18\ F. Modigliani and M.H. Miller (1958), ``The Cost of
Capital, Corporation Finance, and the Theory of Investment,''
American Economic Review, 48, pp. 261-97. The Modigliani-Miller
Theorem states that under some conditions and in an efficient market
the value of a firm is unaffected by how that firm is financed.
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The imputed effective income tax rate would be the five-year mean
of the value-weighted average ratios of current tax expense to total
net income for all U.S. publicly traded firms in the financial
database. Table 2 shows the annual value-weighted average effective tax
rates for all U.S. publicly traded firms in the Standard & Poor's
Compustat[supreg] database from 2003 to 2007. For that period, the
five-year mean of these tax rates was 24 percent. A five-year mean
would be used because of the volatility of the annual effective tax
rate from year to year and the sensitivity of the PSAF to this input,
as shown in attachment 1.
Table 2--Effective Tax Rate of U.S. Publicly Traded Firms
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Five-year Standard
2003 2004 2005 2006 2007 average deviation
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19% 23% 27% 24% 29% 24% 3.4%
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Source: Standard & Poor's Compustat[supreg] data.
The imputed long-term debt financing rate under the publicly traded
firm model would be the five-year mean of an estimated average annual
bond yield for the market as a whole. The Board proposes to use a five-
year mean when imputing a long-term debt financing rate to be
consistent with the treatment of the tax rate (both of these inputs are
cost-related) and to reduce year-to-year volatility in the PSAF.\19\
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\19\ Although attachment 1 shows low levels of volatility in the
average Moody's bond rates from 2003 to 2007, this stability has not
been the historic norm. Given the PSAF's sensitivity even to small
changes in the debt financing rate, the Board plans to use a five-
year average to minimize volatility in the PSAF.
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The Board initially proposes calculating the imputed long-term debt
rate as the five-year mean of the Aaa and Baa Moody's bond yields
published on the Federal Reserve Board's H.15 Statistical Release.\20\
The inclusion of only investment-grade debt is based on analysis of
data on approximately 1,400 publicly traded firms in the Compustat
database for which bond rating data are available.\21\ Given that the
majority of outstanding debt for this population was investment grade,
the Board considered an average investment-grade bond yield to be a
reasonable proxy for the imputed priced services long-term debt
financing rate. The Board considered two averaging techniques to
determine the average investment-grade bond yield, which provided
nearly identical results. Of these two approaches, the five-year mean
of the Aaa and Baa Moody's bond yields was more simple and
transparent.\22\ Table 3 shows the annual average yield from 2003 to
2007 using this methodology. For this period, the five-year mean was
6.0 percent.
---------------------------------------------------------------------------
\20\ http://www.federalreserve.gov/releases/H15/data.htm.
Moody's Aaa and Baa bond ratings represent the upper and lower
limits of the range of investment-grade bonds.
\21\ While the firms in this sample included only approximately
20 percent of publicly traded firms in the database, they
represented more than 85 percent of the assets and debt of the
complete population of over 6,000 firms. Analysis of data for this
sample from 2003 to 2007 showed that 82 percent of outstanding long-
term debt (which represents over 70 percent of the outstanding long-
term debt for all firms in the database during that period) was
investment grade.
\22\ Alternatively, the Board could calculate an average
investment-grade bond yield using five-year average annual bond
yields for each investment grade, weighted by the relative
proportion of debt outstanding for each grade in the population of
approximately 1,400 firms. For 2003 to 2007, the weighted average
bond yield using this technique differed from the five-year mean of
the Aaa and Baa Moody's bond yields by 2 basis points.
Table 3--Average of Annual Moody's Aaa and Baa Bond Yields
----------------------------------------------------------------------------------------------------------------
Five-year Standard
2003 2004 2005 2006 2007 average deviation
----------------------------------------------------------------------------------------------------------------
6.2% 6.0% 5.7% 6.0% 6.0% 6.0% 0.2%
----------------------------------------------------------------------------------------------------------------
Using an average investment-grade bond yield as the imputed priced
services long-term debt financing rate, however, does not take into
account the effect of non-investment-grade debt on the average bond
yield for the market as a whole. Inclusion of non-investment-grade debt
would result in a somewhat higher imputed long-term debt financing
rate. Accordingly, the Board could also calculate an average bond yield
for U.S. publicly traded firms using five-year average yields for each
bond rating, weighted by the relative
[[Page 15487]]
proportion of debt outstanding in the market at each bond rating.\23\
---------------------------------------------------------------------------
\23\ The relative proportions of outstanding debt would be based
on the most recent five years of Standard & Poor's Compustat[reg]
data for which bond rating data are available.
---------------------------------------------------------------------------
If short-term assets exceed short-term liabilities on the priced
services balance sheet, short-term debt would be imputed at the average
of the three-month AA and A2/P2 nonfinancial commercial paper rates as
published on the Federal Reserve Board's Commercial Paper Release.\24\
This methodology is simple, transparent, consistent with the proposed
approach to calculating the long-term debt financing rate, and based on
publicly available data.
---------------------------------------------------------------------------
\24\ http://www.federalreserve.gov/releases/cp/. AA and A2/P2
ratings for commercial paper approximate the same credit ratings as
Moody's Aaa and Baa ratings for bonds. Since 2002, the priced
services short-term funding need has been met by clearing balances,
eliminating the need to impute short-term debt.
---------------------------------------------------------------------------
The Board considered other data sources for each of the imputed
elements discussed above. These sources include the Flow of Funds
Federal Reserve Board Statistical Release for capital structure,
general corporate income tax rates as found on Internal Revenue Service
(IRS) Form 1120 for the effective tax rate, and the ratio of ``interest
and related expense'' to total debt for all publicly traded U.S. firms
in the Standard & Poor's Compustat[reg] database for the long-term debt
financing rate.\25\ In each case, the Board considered the source set
forth in the current proposal to be the superior alternative. The Flow
of Funds release does not include data on U.S. publicly traded
financial firms and provides only approximate market-value equity data.
Use of the general corporate income tax rate published by the IRS would
inappropriately exclude the effect of State and local taxes. A long-
term debt financing rate calculated from the Standard & Poor's
Compustat[reg] database would be artificially high because of the
inclusion of ``related expense,'' which includes items such as interest
on deposits held at DIs, in the interest expense measure used in the
numerator.
---------------------------------------------------------------------------
\25\ Current corporate income tax rates can be found in the 2008
instructions for IRS Form 1120 at http://www.irs.gov/pub/irs-pdf/i1120.pdf.
---------------------------------------------------------------------------
Under the publicly traded firm model, the imputed ROE rate would
continue to be calculated using the CAPM with a beta of 1.0 and a 40-
year average historical market premium. Given the sensitivity of the
PSAF to the risk-free rate used in the CAPM, and because short-term
Treasury bill rates are generally more sensitive to interest rate
changes than longer-term rates, the Board considered replacing the
current short-term risk-free rate with a longer-term risk-free rate. As
shown in attachment 1, changes in the risk-free rate used in the
calculation of the target ROE rate affect the PSAF more than any other
imputed element. In 2005, the Board decided to use a three-month
Treasury bill rate as the risk-free rate to impute the target ROE
because this rate was consistent with that used to calculate NICB and
would help minimize volatility in the net imputed cost caused by
changes in interest rates.\26\ With the elimination of NICB under the
proposed publicly traded firm model, however, using a longer-term
Treasury rate, such as the 10-year Treasury bond rate, may be an
appropriate way to minimize volatility in the calculation of the target
ROE rate. A longer-term rate more closely matches the duration of stock
market indexes used to estimate a beta, the expected life of the assets
on the priced services balance sheet, and the investment horizon of a
long-term investor.
---------------------------------------------------------------------------
\26\ 70 FR 60347 (Oct. 17, 2005). NICB is based on an average
three-month Treasury bill rate, while the target ROE CAPM
calculation uses a current three-month Treasury bill rate for the
risk-free rate.
---------------------------------------------------------------------------
Table 4 compares certain components for 2009 derived under the
publicly traded firm model with the same components as derived under
the baseline case.\27\ Using the elements discussed above, the publicly
traded firm model returns a PSAF of $55.4 million compared with a
baseline PSAF of $62.2 million (NICB of $48.8 million, net imputed cost
of $13.4 million).
---------------------------------------------------------------------------
\27\ The baseline PSAF of $62.2 million, projected NICB of $48.8
million, and net imputed cost of $13.4 million are the Board-
approved projected 2009 values using the correspondent bank model.
73 FR 65329-65340 (Nov. 3, 2008).
---------------------------------------------------------------------------
The baseline net imputed cost reflects clearing balance levels and
interest rates as of July 2008. The correspondent bank model is highly
sensitive to both of these variables. For example, using the lower
clearing balance levels and interest rates from February 2009,
projected 2009 NICB is less than half the amount that was projected for
pricing purposes, leading to an increase in the 2009 net imputed cost.
If clearing balances continue to decline, the variance between the PSAF
calculated using the proposed methodology and the net imputed cost
using the correspondent bank model will likely be significantly smaller
than noted above. In contrast, as interest rates rise, the income
generated on each dollar of clearing balances in the NICB calculation
of the correspondent bank model will increase. Rising interest rates,
however, will widen the spread between the interest rate on excess
balances and the earnings credits rate, giving DIs more incentive to
shift from maintaining clearing balances to maintaining additional
excess balances. This expected reduction in clearing balances will
reduce NICB, counteracting the effect of higher per-dollar earnings and
likely leading to a net decrease in NICB. Consequently, rising interest
rates could cause an overall increase of the net imputed cost of the
correspondent bank model throughout the year. This increase could
substantially shrink the variance between the PSAF of the proposed
model and the net imputed cost of the current model.
Table 4--Comparison of Current and Proposed Model
--------------------------------------------------------------------------------------------------------------------------------------------------------
Balance sheet
assets Financing composition Financing cost Tax rate Debt rate PSAF NICB
(billions) (percent) (percent) (millions) (millions)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline case: correspondent bank $9.2 Equity per FDIC ROE of $46.2 M....... 32.6 \(1)\ $62.2 $48.8
model. guidelines.
Publicly traded firm model......... 1.3 54% long-term debt, $40.3M (ROE of 24 6.0 55.4 0
46% equity. $22.3M; debt cost of
$18.0M).
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ No debt.
[[Page 15488]]
The Board believes that the publicly traded firm model would be an
appropriate replacement for the current PSAF model for a variety of
reasons. The publicly traded firm model is relatively simple to
calculate and understand, easily replicable by the public, and uses
objective, publicly-available data for all imputed inputs. Unlike the
correspondent bank model, the publicly traded firm model is not linked
to the level of clearing balances held at Reserve Banks. This
characteristic is important given the uncertainty surrounding future
clearing balance levels. Substantially lower clearing balances would
not only affect the funding and income of the priced services but also
undermine the basis for the use of an FDIC-based regulatory structure
for depository institutions as a determinate of the priced services
capital structure. A model that is not dependent on clearing balance
levels is also appropriate in an environment where clearing balances
are not relevant to a growing proportion of the Reserve Banks'
competitors in providing priced services. Another advantage of the
publicly traded firm model is its independence from a narrowly defined
peer group, such as private-sector correspondent banks, that may become
less relevant to the priced services over time. Unlike other models
considered, the publicly traded firm model does not incorporate data
from a limited number of comparable firms but rather from the entire
U.S. market of publicly traded firms. This independence decreases the
risk of price volatility that could result from changes in the
characteristics or financial results of a limited peer group. The
publicly traded firm model also is consistent with financial theory
regarding capital structure and financing costs and is conceptually
sound. In addition, the publicly traded firm model is consistent with
the current approach to calculating the ROE using CAPM with a beta of
1.0, which compares the priced services to the market as a whole.
The publicly traded firm model also has a few drawbacks. If some
level of clearing balances persists at Reserve Banks over the long
term, excluding these priced-services-related balances from the
calculation of the PSAF would depart from the Board's past practice of
including all actual priced services assets and liabilities in the
calculation of the PSAF and would disregard potential imputed income
from these balances. A publicly traded firm model also departs from a
model based specifically on the banking industry. This change in
direction may conflict with the fact that the priced services are
provided by Reserve Banks, which are, by definition, banks.
The Board specifically requests comment on the following:
Is using the U.S. market as a whole as a basis for the imputed
capital structure, tax rate, and debt financing rates of the priced
services reasonable? Is discontinuing the use of a correspondent bank
model reasonable?
Are the proposed approaches to imputing the capital structure,
effective tax rate, and long- and short-term debt financing rates
appropriate?
Is it reasonable to include only investment-grade bond yields in
the calculation of the imputed long-term debt financing rate? If not,
what approach should the Board take to include other yields or rates in
the calculation? What publicly-available data sources are best suited
for obtaining data on non-investment-grade debt?
Is it reasonable to limit the calculation of the short-term debt
financing rate to include only rated commercial paper even if the long-
term debt financing rate calculation were expanded to include non-
investment-grade debt, given the expectation that the need for short-
term funding on the priced services balance sheet will be relatively
small? If not, what approach should the Board take to include other
rates in the calculation?
What publicly-available data sources are best suited for
determining the effective tax rate, capital structure, and short- and
long-term debt financing rates of the U.S. market?
Should the Board consider using a longer-term risk-free rate to
calculate the target ROE to decrease the ROE calculation's sensitivity
to changes in interest rates?
III. Other PSAF Models Considered
The User-Owned Utility Model
The Reserve Banks' major competitors in the provision of priced
services increasingly are user-owned utilities rather than traditional
correspondent banks. Accordingly, one approach to revise the
methodology for imputing costs might be to model the priced services
balance sheet and imputed capital structure, financing rates, tax rate,
and other applicable costs on a user-owned utility. Under this
methodology, the priced services balance sheet and imputed costs would
reflect either the financial characteristics of a peer group of user-
owned utilities currently existing in the market or theoretical
assumptions about the behavior and characteristics of this type of
organization.
A user-owned utility model is conceptually appealing because the
Reserve Banks' competitors in the Fedwire[supreg] Funds,
FedACH[supreg], and, to a lesser extent, check services are
increasingly user-owned utilities. Such a model also recognizes that,
as clearing balance levels decline, providing priced services to DIs
that do not maintain clearing balances could more closely resemble the
operation of a user-owned utility than that of a traditional
correspondent bank.
Selecting an appropriate peer group for this approach, however, is
challenging. User-owned utilities typically provide a diverse array of
services using various operational approaches. Although choosing a
narrowly defined peer group of user-owned utilities, specifically one
consisting of peers that provide services more closely resembling the
priced services, could provide a more-comparable peer group, this
approach may also introduce greater volatility in the PSAF because of
the dependence on data from a small number of firms.
A user-owned utility peer group could present other problems as
well. Publicly available financial data on user-owned utilities are
often not published. For example, CHIPS and EPN provide services that
compete with the priced services provided by Reserve Banks. These two
entities, however, are both components of TCH, which does not publicly
report its financial statements either by product line or in aggregate.
Although data are more readily available to the public from several
other user-owned utilities (such as SWIFT and the Depository Trust &
Clearing Corporation), the services provided by these firms are less
comparable to those provided by the Reserve Banks.
Basing this model on theoretical characteristics of user-owned
utilities rather than on the actual data of a specific peer group could
also prove challenging. User-owned utilities, by definition, lack
incentive for profit maximization because the owners of these utilities
are also their primary customers. Consequently, user-owned utilities
tend to seek to maximize the benefit afforded to their users by
providing low-cost services while remaining financially viable.
Although the assumption that this characteristic could result in a
lower required rate of return on equity is reasonable, establishing a
methodology to calculate that rate using the limited economic
literature available on the subject could be difficult. Further,
establishing the means to calculate the other requisite imputed
elements--capital structure,
[[Page 15489]]
debt financing rates, and income taxes--using theoretical assumptions
or academic studies could be similarly challenging.
The user-owned utility model exhibits some of the same drawbacks of
the publicly traded firm model that the Board is proposing. For
example, a user-owned utility model represents the same significant
departure from a model based specifically on the banking industry. A
user-owned utility model also would not include residual clearing
balances, which departs from the Board's past practice of basing the
PSAF on actual priced services assets and liabilities.
The Board specifically requests comment on the following:
Given that user-owned utilities reflect a significant portion of
the Reserve Banks' competitors in providing priced services, would a
user-owned utility model be more appropriate? If yes, are there
approaches the Board should consider that would address the identified
obstacles?
The Cost-Plus Model
In 2005, while commenting on proposed changes to the PSAF
methodology for calculating the ROE, two commenters suggested a cost-
plus model as a simple, straightforward method for calculating the
PSAF. Accordingly, the Board investigated the possibility of using a
cost-plus PSAF model based on priced services operating expenses. A
cost-plus PSAF model would add a markup to the priced services
operating expenses for the year. The markup would be calculated by
applying an internal benchmark or market rate of return to the level of
budgeted priced services operating expenses. Regardless of the method
used to calculate the markup, residual clearing balances held at
Reserve Banks would not be included in the calculation of net imputed
cost, and NICB would therefore be zero by definition.
Calculating the markup for a cost-plus model requires a data source
from which to develop the internal benchmark or market rate of return
to be applied to budgeted operating expenses. In the case of an
internal benchmark, the Board considered using an average of historical
PSAF values. Such values, however, would not take current data into
account and would reflect a correspondent bank model that is
increasingly inapplicable given recent trends in the payments
industries and the expected continued decline in the level of clearing
balances. In addition, a static internal benchmark based on historical
PSAF values would fail to reflect ongoing changes in the marketplace.
Alternatively, the Board could base the markup ratio applied to the
priced services operating expenses on an external benchmark, such as
the average markup over operating expenses for the U.S. market as a
whole.\28\ Specifically, the Board could calculate the markup as the
ratio of pretax income and interest expense to operating expense for
all U.S. publicly traded firms. This markup could then be applied to
the projected level of priced services operating expense, including
imputed operating expenses such as sales tax, to determine the value of
the imputed profit, debt financing cost, and income taxes to be
factored into priced services fees. Applying a markup over expenses
ratio based on value-weighted average data for all publicly traded U.S.
firms in the Standard & Poor's Compustat[supreg] database to the 2009
budgeted priced services operating expense yields a projected 2009 PSAF
of $157.5 million.\29\
---------------------------------------------------------------------------
\28\ The Board discarded the idea of basing the markup ratio on
data for more narrowly-defined peer groups because of the challenges
of comparability and data availability discussed previously.
\29\ The Board could calculate a markup over expenses ratio
using two averaging techniques: equal weighting and value weighting.
The Board believes value weighting is more appropriate because it
would yield less-volatile results and would better capture the
characteristics of the market as a whole.
---------------------------------------------------------------------------
Although a cost-plus model is simple, transparent, and replicable
by the public, it also has several weaknesses. A cost-plus model based
on historical PSAF values is static and assumes continued use of the
current correspondent bank model, which is increasingly inapplicable.
In addition, basing a cost-plus model on accounting-based values
captures only book, not market, values of financing and other costs.
Such a model is also not consistent with current finance theory. As
with the models discussed previously, a cost-plus model represents a
departure from a model based specifically on the banking industry.
The Board specifically requests comment on the following:
Should the Board consider implementing a cost-plus model?
Are there other sources of data that the Board should consider
using to calculate an appropriate markup over operating expenses or
over another financial characteristic of the priced services?
Are there other approaches that the Board should consider to
address the identified obstacles?
Continuation of the Current Correspondent Bank Model
The Board also considered the continued use of the current
correspondent bank model to impute costs, with minor modifications.
Using this model while also paying interest on required reserve
balances and excess balances would result in a significantly smaller
priced services balance sheet because of the anticipated decline in
clearing balances and the associated imputed investment assets. Equity,
which would still be imputed at the FDIC regulatory minimum for a well-
capitalized depository institution, would shrink because of the
reduction in size of the overall priced services balance sheet.
Residual clearing balances would continue to serve as a funding
source for the priced services. If residual balances were not
sufficient to meet the funding need, net of equity, on the priced
services balance sheet, debt would be imputed. The imputed short- and
long-term debt financing rates would be calculated using the same
methodologies outlined for the imputed debt financing rates of the
publicly traded firm model. Using average market debt financing rates
in the correspondent bank model recognizes that as clearing balances
fall and debt rises as a percentage of total priced services assets,
the priced services balance sheet would look increasingly like that of
a publicly traded firm and less like that of a correspondent bank.\30\
An average debt financing rate would also use readily-available public
data and could be calculated with greater administrative ease. If
residual clearing balances exceeded the funding need on the priced
services balance sheet, NICB would be imputed.
---------------------------------------------------------------------------
\30\ For example, if clearing balances fall to zero, applying
the FDIC regulatory structure to determine the capital structure on
the priced services balance sheet would result in a capitalization
ratio of over 85 percent.
---------------------------------------------------------------------------
Table 5 compares certain components for 2009 as derived under a
continuation of the current correspondent bank model, with assumed
residual clearing balance levels ranging from $0 to $4 billion, to the
same components as derived under the baseline case. Using the values
listed below, a continuation of the current correspondent bank model
would return a net imputed cost between $50.7 million (PSAF of $50.7
million, NICB of $0) and $19.5 million (PSAF of $40.6 million net of
$21.1 million in NICB).\31\
[[Page 15490]]
The increase in net cost is largely the result of the reduction or
elimination of NICB caused by the decline in clearing balances levels.
This increase is partially offset by a reduction in the cost of equity
as a result of the reduced level of total assets and, consequently, of
imputed equity on the priced services balance sheet.\32\
---------------------------------------------------------------------------
\31\ The results presented in Table 5 are based on a risk-free
rate as of July 2008 of 1.67 percent. As interest rates increase,
both the ROE costs of the PSAF and the earnings of the NICB
portfolio would increase. The net effect of this increase would
depend on the size and character of the priced services balance
sheet.
\32\ The decrease in total financing costs is offset in part by
the cost of financing priced services assets with higher-cost debt
instead of low-cost clearing balances.
Table 5--Correspondent Bank Model Under Different Clearing Balance Assumptions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Balance
sheet Tax rate Debt rate PSAF NICB Net imputed
Assumed clearing balance level assets Financing composition Financing cost percent percent (millions) (millions) cost
(billions) (millions)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline case: $7.4 B ($4 B in $9.2 Equity per FDIC ROE of $46.2 M...... 32.6 (\1\) $62.2 $48.8 $13.4
core clearing balances). guidelines;
remainder clearing
balances.
$4 B ($2 B in core clearing 5.0 Equity per FDIC ROE of $25.0 M...... 32.6 .......... 40.6 21.1 19.5
balances). guidelines;
remainder clearing
balances.
No clearing balances.............. 1.3 Equity per FDIC $35.6 M (ROE of $6.4 32.6 6.0 50.7 0 50.7
guidelines; M; debt cost of
remainder debt. $29.2 M).
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ No debt.
Continued use of the correspondent bank model for imputing costs
would provide several advantages. Among these is its ability to draw
upon a well-defined FDIC regulatory structure and a peer group with
readily available data when establishing key imputed elements such as
capital structure and rates. This model also would afford a means by
which possible residual clearing balances held at Reserve Banks could
continue to provide a low-cost funding source and potential source of
imputed income.
A principal disadvantage of this model is the decreasing similarity
between the financial and operational characteristics of the Reserve
Bank priced services and traditional correspondent banks if the level
of clearing balances held at Reserve Banks continues to fall.
Historically, the Board has recognized that the financial
characteristics of BHCs are not driven primarily by the payment
services that compete with those offered by Reserve Banks, but has
considered BHCs an appropriate peer group because they are the primary
competitors to the Reserve Banks' check services and because both
entities hold customer balances for the purpose of facilitating
payments services. If clearing balance levels approach zero and as the
check service declines as a percentage of priced services revenue and
expenses, comparing priced services to correspondent banks for the
purpose of establishing a PSAF model will be increasingly difficult.
Dramatically reduced clearing balance levels will also call into
question the applicability of an FDIC-based regulatory structure
designed for depository institutions as the determinant of the priced
services capital structure. Specifically, in an environment of low to
zero clearing balance levels, applying the FDIC's regulatory structure
could result in a priced services capitalization ratio of more than 85
percent, which seems unreasonable when compared to correspondent banks
that are primarily funded by balances rather than long-term debt.
The Board specifically requests comment on the following:
Would continued use of the correspondent bank model to calculate
the PSAF be appropriate given the expected reduction in clearing
balances and changes in priced services competitors? If so, is the
proposed approach for calculating a debt financing rate in the
correspondent bank model reasonable?
IV. Competitive Impact
In its March 1990 policy statement ``The Federal Reserve in the
Payments System,'' the Board stated that all operational and legal
changes considered by the Board that could have a substantial effect on
payment system participants are subject to a competitive-impact
analysis.\33\ Under this policy, the Board evaluates whether a proposed
change would 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. These effects could be caused by
differences in legal authority or constraints between Reserve Banks and
private-sector competitors or by a dominant market position that the
Reserve Banks might derive from such legal differences. If the proposed
change creates such an effect, the Board must further evaluate the
changes to determine whether its benefits--such as contributions to
payment system efficiency, payment system integrity, or other Board
objectives--can be retained while reducing the hindrances to
competition.
---------------------------------------------------------------------------
\33\ FRRS 9-1558.
---------------------------------------------------------------------------
The intent of the PSAF, and of setting priced services fees in
general to fully recover the costs (including imputed costs and
profits) to provide them, is to facilitate competition between Reserve
Banks and private-sector providers of payment services to foster a more
efficient payment system. Identifying a meaningful private-sector peer
group for the purpose of calculating the PSAF, however, has been
difficult given the specific nature of the priced services provided by
the Reserve Banks. The correspondent bank model historically has
provided a reasonable proxy for Reserve Bank priced services, although
the Board recognizes that correspondent bank balance sheets and ROE are
typically driven largely by services that are not similar to those
provided by the Reserve Banks. As the Reserve Banks' check service
becomes a smaller proportion of total priced services revenues and
costs, user-owned utilities are increasingly becoming the Reserve
Banks' key priced services competitors. Because correspondent banks
will no
[[Page 15491]]
longer represent the primary competitors of Reserve Banks in providing
priced services, and because no reliable comparative data are available
for the user-owned utilities, the Board believes modeling the PSAF on a
publicly traded firm model is appropriate. Accordingly, the Board
believes that such a change in the PSAF model, if made, would not have
a direct and material adverse effect on the ability of other service
providers to compete effectively with Reserve Banks in providing
similar services.
V. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
ch. 3506; 5 CFR 1320 appendix A.1), the Board has reviewed the proposal
under the authority delegated to the Board by the Office of Management
and Budget. The proposal contains no provisions subject to the
Paperwork Reduction Act.
By order of the Board of Governors of the Federal Reserve
System, March 30, 2009.
Jennifer J. Johnson,
Secretary of the Board.
BILLING CODE 6210-02-P
[[Page 15492]]
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[[Page 15493]]
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[[Page 15494]]
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[[Page 15495]]
[FR Doc. E9-7473 Filed 4-3-09; 8:45 am]
BILLING CODE 6210-02-C