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Facing Change,
Managing Risk

President’s Message..........................................2
Santomero’s Reflections on Greenspan and
The Transition to a New Chairman.....................7
Evolution of Payments in the U.S......................12
Fed’s Role in a Changing Banking Industry.....16
Preventing Check Fraud...................................20
Managing Risk at the Bank and
	 Across the System......................................22
Protecting Our Information Systems.................24
Helping Consumers Make Better
	 Financial Decisions.....................................26
Board of Directors............................................28
Advisory Councils.............................................30
Executive Committee........................................33
Current Officers................................................34
Operating Statistics..........................................35
Statement of Auditor Independence.................36
Financial Reports.............................................37
Notes to Financial Statements.........................44
Remembering David Eastburn.........................59

President’s Message

Facing Change and Managing Risk
Change and risk are words that are inextricably linked, and nowhere is
this more evident than in the financial system. As markets grow more
complex, as technology advances, as customers demand more services,
the financial system must adapt to meet the needs of this ever-changing
environment. Every step of the way, we must consider how to balance risk
with the benefits and necessity of progress.

The Philadelphia Fed’s 2005 annual report,
“Facing Change, Managing Risk,” examines
this concept in detail. After all, as stewards of
the financial system, it is the responsibility of
the Federal Reserve System to navigate these
changes, helping to ensure a thriving and prosperous economy for our nation.
This particular annual report is special to
me because it covers my last year as president
of the Federal Reserve Bank of Philadelphia. I
have been part of this Bank for nearly six years,
including two years as a voting member of the
Federal Open Market Committee. I am honored
to have had the opportunity to lead such a prestigious institution as the Philadelphia Fed and
to have worked with so many talented and dedicated people.

Leading Change
Our Bank has adapted to the changing
times and has emerged as an even stronger and
more vital institution. When I took office, my viAnthony M. Santomero, President

sion was for the Philadelphia Bank to be known
as an important center of central bank knowledge and capability. I believe this vision has been
achieved in ways that have touched on virtually every aspect of the Fed. In my final
message as president, I would like to share with you some highlights of the Philadelphia
Bank’s accomplishments here in our District as well as in the Federal Reserve System.
The Philadelphia Fed has long been a System leader in providing financial services to depository institutions. This is perhaps most evident in check operations. In 2005,
we further solidified our position of strength when the Philadelphia Fed was selected to

Federal Reserve Bank of Philadelphia

become a System consolidation site for check processing, absorbing New York’s East
Rutherford Operations Center, known as EROC. The Federal Reserve System chose
Philadelphia based on its overall productivity and efficiency, its ability to handle the total
check volume of both Districts, and its proximity to New York financial institutions. This
new responsibility will mean additional equipment and space renovations to accommodate the increased workload. Furthermore, in the second half of 2006, we expect to create a substantial number of new positions to help process the additional volume.
The Philadelphia Fed has also played a key role in providing financial services to
the U.S. Treasury. We are now one of only two sites in the System that clear government-issued checks, and we have been actively engaged in modernizing the way the
federal government makes these payments.
At the same time, we have been involved in the ongoing monitoring of the
nation’s financial and payment systems. Studies produced here and throughout
the Federal Reserve System have emphasized the remarkable evolution taking
place in U.S. payments. Later in this book, First Vice President Bill Stone elaborates on just how pervasive payment changes have become.
We have advanced the System’s knowledge of evolving payments mechanisms as the first Federal Reserve Bank to establish a dedicated Payment
Cards Center. In 2005, the Center produced papers and conducted conferences and workshops on a number of important topics to provide meaningful
insights into developments in consumer credit and payments.
Indeed, we are a palpable presence in the research and policy arena,
which is perhaps most visible to the general public in our annual Philadelphia
Fed Policy Forum. In 2005, we looked at “Fiscal Imbalance: Problems, Solutions,
and Implications.” As in past years, the event brought together leading academics, policymakers, and market economists for debate and discussion of relevant
macroeconomic and monetary policy issues.

“Tony Santomero is an
accomplished leader
and talented economist.
We at the Federal
Reserve have greatly
benefited from his
perspective and keen
insights. He has been a
valued voice of wisdom
at our meeting table.
We will miss him.”
— 	Former Chairman
		 Alan Greenspan

Managing Risk
In central bank administration, 2005 was an important year as well. Over
the past several years we have carved out a role in the “knowledge and information” sector of the Fed’s infrastructure. We now lead the System in the
challenging area of Enterprise Risk Management (ERM). Our Bank’s ERM group, as
well as our well-regarded accounting professionals, has furthered our reputation as
an extremely efficient, high-quality organization with a strong focus on controls and

risk management. In 2005, we developed a relationship with the central bank of Spain,
which wants to implement an ERM program. As a result of this contact, our chief financial officer has been asked to co-chair a consortium of central banks—from Europe
and elsewhere—that will meet annually to discuss common risk-management concerns.
In an environment of high loan growth in 2005, our Supervision, Regulation and
Credit (SRC) Department continued working with banks to ensure that credit quality

was never compromised. As the banking industry becomes more complex and competitive, the tenets of capital adequacy and risk management are more important than
ever before. At the Philadelphia Fed, we recognize this and have established a unit in
SRC to analyze retail credit risk. Now the System has charged us with developing the
strategy for implementing this part of the new Basel II capital requirements. We are
also home to the System’s Subcommittee on Credit, Reserves, and Risk Management,
known as SCRRM. Our Bank has led the way here by coordinating System policies to
supply depository institutions with needed liquidity, implement new discount window
policies, and direct the upgrade of supporting System technology.

Sharing Knowledge

The Philadelphia
Fed is an
with a powerful
niche in
public service
and a stellar
reputation for
quality and

As important as it is to have knowledge and expertise, it is just as important to
share it. Therefore, we have made strong contributions to our community and our
country in the area of economic outreach. In 2005, our Bank offered a number of programs to promote knowledge and share resources concerning personal finance and
the U.S. economy.
We produced the educational consumer video, “Buried by Debt: The Dangers of
Borrowing,” which offers at-risk consumers real-life examples of lending abuses and
offers tips to avoid falling victim to such abuses. Philadelphia is a System leader in
economic education and has developed financial literacy curriculums used both locally
and nationally. In addition, our programs to promote financial literacy, improve access
to credit, end predatory lending, and foster urban development continue to make a real
difference in our District’s communities.
Indeed, not only has the Bank become an even more important part of the Philadelphia community but also of economic policy discussions in our District. Our participation
in these discussions has affirmed the Philadelphia Fed’s expertise in monetary policy.

Board of Directors
Of course, all of this would not be possible without the leadership and support of
our board of directors, who guide us in all our accomplishments. It is only fitting that we
recognize our debt to them for their service. These nine individuals play an important
role in keeping us in touch with our District and by performing the oversight role of directors everywhere.
We offer our sincere thanks to two members of our board who have completed
their terms of service with us: Robert E. Chappell, chairman and CEO of The Penn
Mutual Life Insurance Company, and Kenneth R. Shoemaker, president and CEO of
Orrstown Bank. Each was a valuable contributor to our board and helped immeasurably in our attempts to maintain close contacts with all sectors within the District.
We offer special thanks to our outgoing chairman of the board, Ron Naples. His
leadership, keen insights into the regional, national, and global economy, and his corporate governance skills will be missed—as will his good humor.
I am pleased to report that Doris M. Damm, president and CEO of ACCU Staffing
Services, has been appointed chairman of the board of directors, and William F. Hecht,

Federal Reserve
Reserve Bank
Bank of
of Philadelphia

chairman and CEO of PPL Corporation, has been appointed deputy chairman
of the board of directors. I leave my position with the knowledge that the Bank’s
board has strong leaders at the top.
At the same time, we welcome our newest board members and look forward
to their counsel and guidance. John G. Gerlach, president and CEO of Pocono
Community Bank; Audrey S. Oswell, president and CEO of Resorts Atlantic City;
and Charles P. Pizzi, president and CEO of Tasty Baking Company, joined the
board on January 1, 2006. On behalf of all of us here at the Philadelphia Fed, I
thank our board for its valuable contributions.
Let me also acknowledge the contribution of Bruce L. Hammonds, president
and CEO of MBNA Corporation, who has completed his term as a
member of the Federal Advisory Council (FAC), and welcome Ted
T. Cecala, chairman and CEO of Wilmington Trust Company, who
has been appointed to represent the Third District on the FAC.

Closing Thoughts

Santomero has made
significant contributions to
the Bank, the Federal Reserve
System, and our region. We will
miss his outstanding leadership
and knowledge. We have full
confidence in the leadership
team Tony helped build that will
continue to manage the Bank .”

The world has changed a great deal in just the first few years
of this new millennium and so, too, has the Philadelphia Reserve
Bank. We are strongly connected to the financial industry and engaged in our community. We have increased our visibility in our
District on many fronts. We contribute to and lead many System
initiatives. I am confident this tradition of excellence will carry on
as the Philadelphia Fed continues to be a high-quality provider of
financial services and a leader in the Federal Reserve System.
As part of the nation’s central bank, the Philadelphia Fed is
an organization with a powerful niche in public service and a stellar
—	 Ronald J. Naples
reputation for quality and credibility. Our Bank will continue to move
		 2005 Chairman, Board of Directors
forward under its new leadership and will remain steadfastly committed to the strength and growth of the Third District’s economy.
In closing, I would like to express my gratitude for having had
the pleasure of national service in a truly outstanding institution and
for the opportunity to work under Alan Greenspan, a Chairman who was universally regarded as America’s and the world’s finest central banker. At the same time, I
applaud the President’s choice of Ben Bernanke as the 14th Chairman of the Board
of Governors. The Federal Reserve is in good hands.

Anthony M. Santomero
March 2006

Santomero’s Reflections on Greenspan and Bernanke
Alan Greenspan
How did Alan Greenspan accomplish so much?
Everyone wants to know the answer to this and there is
no shortage of explanations. But from my vantage point
the answer is rather clear.
Alan Greenspan is first and foremost an extraordinary economist. As a professional economic forecaster,
he has an uncanny ability to project our economy’s
course. His almost total recall of even the most obscure
statistics is unparalleled. As a result, he has shown the
most remarkable ability to adapt to the pervasive, ongoing changes in the economy while still standing strong
against inflation.
But while Alan Greenspan is an extraordinary
Former Chairman Alan Greenspan
economist, he is also an extraordinary leader. He will be
remembered as a consensus builder and a developer of
talent. It shows in the strength of the organization and the strong consensus that has
been achieved at our monetary policy meetings. Unanimity has been the rule, not the
exception, in spite of strong voices and difficult circumstances. This is a testament to
his leadership.
Yet, historians will probably most remember Greenspan and the Greenspan era
for the changes made to transparency in Fed policymaking over the past decade. This
openness has been the defining aspect of monetary policy under Greenspan. Information about the Fed’s policy goals, its assessment of the current economic situation, and
its strategic direction are increasingly part of the public record.
Ben Bernanke
Chairman Bernanke has close ties to the Philadelphia Bank. He served as
a visiting scholar in our Research Department, a participant in our annual Policy
Forum, and a neighbor during his time at Princeton.
I came to know Ben quite well when he was on the Board of Governors
in 2003 and 2004, and I always appreciated his collegiality and insight. He is
scholarly and unassuming — a true intellectual. He is a man of impeccable
credentials and sound policy judgment. His reputation is one of intellectual rigor
and integrity.
Ben is considered one of the finest monetary economists of our time, with
a gift for understanding how economic concepts apply to real world markets.
This allows him to neatly bridge the gap between sound ideas and good policies. He questions the status quo and offers fresh interpretations of the data.
As chair of Princeton’s Economics Department, Bernanke described his
managerial style as “primus inter pares” (first among equals). He has said,
“We’re all the same rank. I’m just the one sitting in the chair.” This approach
could also serve him well as Chairman of the FOMC, where all participants contribute to the outcome and policy action.

Chairman Ben Bernanke

Federal Reserve Bank of Philadelphia

The Transition to a New Chairman

Facing Change,
Managing Risk

By Anthony M. Santomero

The prospect of a new Chairman at the helm of the Federal Reserve has
always caused anxiety from Wall Street to Main Street. Here President
Anthony Santomero shares his thoughts on the Fed’s transition to a
new Chairman, bidding farewell to the venerable Alan Greenspan and
welcoming a new era under Chairman Ben Bernanke.

The Changing of the Guard
When Alan Greenspan was
nominated to replace Paul Volcker
as head of the Federal Reserve
in June 1987, the world’s financial markets collectively held their
breath. Skepticism was rampant as
to whether Greenspan would be
able to do as good a job as Volcker.
A New York Times article expressed these concerns, saying:
“The markets had incredible
confidence in Paul. Investors saw
him as the one guy with the knowledge, guts and skill to stop inflation
and hold the system together…
Indeed, some economists are saying that one reason there is growing
fear of an economic catastrophe is
that the Reagan administration let
Volcker go, replacing him with the
less-experienced and less-wellknown Alan Greenspan.”
Barron’s also opined on the

Federal Reserve Chairman Ben Bernanke, former Chairman Paul Volcker, and
former Chairman Alan Greenspan at a reception in January 2006.

transition, calling Volcker “a legend
in his own time,” and comparing him to
Greenspan, who was “a relatively un-

The Volcker Legacy
Before Greenspan, Paul Volcker

known quantity.” Little did they know at

earned quite a reputation — for him-

the time, they were referring to the man

self and for the Federal Reserve as an

who would come to be known as “the

institution. When he assumed office in


1979, Volcker also assumed the burden

of double-digit inflation. It was the most

up or down, he decided the Fed should

sustained period of inflation post-WWII

focus on controlling the money supply

America had ever faced—rising at annu-

and be committed to slowing monetary

al rates of over 10 percent and up to 14

growth to beat inflation. To achieve its

or 15 percent in some months. As Fed

money growth targets, the Fed would

Chairman, Volcker devised a strategy

have to allow interest rates to rise, and

that would crush inflation and change

they rose dramatically. The fed funds

the face of central banking.

rate reached 19 percent in 1981 and

Rather than follow the Fed’s traditional practice of nudging interest rates

held fast despite the ensuing recession.
But the policy proved effective,
and within three years, inflation had
been tamed. By 1983, Volcker’s policy
succeeded in bringing the inflation rate
down to around 4 percent, and the
economy was on the path to a sustained
expansion. Volcker was lauded as a genius, and his powerful policy changes
earned the Fed an unprecedented level
of credibility and prestige.

Greenspan’s Tenure
At his confirmation hearing before
the Senate Banking Committee, Greenspan spoke of the same Fed goals
Volcker had advocated. He too recognized and argued forcefully that to create
an environment for solid, sustained economic growth, it was absolutely crucial
that the Fed focus on containing inflation.
As the expansion of the 1980s matured, the Chairman remained true to his
words. However, only two months after
he took office, Greenspan was faced
with the biggest stock market crash since
the Great Depression. On October 19,
1987—Black Monday—the Dow Jones
Industrial Average plummeted nearly 23
Chairman Bernanke and former Chairman Greenspan at the public swearing-in
ceremony on February 6, 2006.

percent, its greatest loss ever in percentage terms. Amid widespread fears of
a recession, Greenspan acted quickly
to provide liquidity to financial markets
and calm investors. His quick response

Federal Reserve Bank of Philadelphia

and competent leadership shaped his

Supported by strong monetary

reputation and earned him high marks

stimulus, the economy proved surpris-

from his peers and the public. The Fed’s

ingly resilient—indeed, more so than

actions under Greenspan helped secure

most had believed possible. Despite an

public confidence in future price stability,

unprecedented series of disturbances

though not without a period of recession

—the declining stock market, a terrorist

as the new decade began.

attack on American soil, two wars, nu-

It was during the expansion of the

merous financial scandals, skyrocketing

1990s that Chairman Greenspan put

oil prices, and even natural disasters

his own unique stamp on the conduct

—the economy recovered and again

of monetary policy. In the first half of

embarked on a path of sustainable

the decade, the economy moved from

expansion. Indeed, under Chairman

recession to recovery, and the Fed re-

Greenspan’s leadership, the 21st cen-

moved the monetary accommodation

tury began with the Fed providing the

it had provided. Then, mid-decade, the

economy with unprecedented monetary

economy began to boom. Growth accel-

support during a difficult downturn and,

erated, and unemployment began falling

at the same time, preserving public con-

to levels not seen in 30 years. The ortho-

fidence in its commitment to long-term

dox monetary policy prescription was to

price stability.

tighten. But Greenspan veered from the

Alan Greenspan served as Fed

orthodox view. He believed that the rules

Chairman for more than 18 years. The

of the game had changed. In a new era

second longest-serving Chairman in the

of accelerating productivity growth and

history of the Fed, he was appointed or

increased competition, he believed it

reappointed by four different Presidents.

was possible to run the economy on all

During his tenure, the U.S. economy

cylinders and close to full employment,

achieved both strong growth and stable

without undue inflationary pressures.

prices. Inside the Fed, Greenspan, like

With the Fed ever-vigilant, the expansion

Volcker, exerted a powerful influence

went on to become the longest in U.S.

and fundamentally altered the way we


think about policymaking.

“The Fed’s job
is to take away
the punch bowl
just when the
party really gets

Still, Greenspan knew that all was
not perfect. In 1996, he gave his famous
“irrational exuberance” speech, allud-

Bernanke at the Helm
In February 2006, Ben Bernanke

ing to concerns about a stock market

succeeded Alan Greenspan as Fed

bubble. When the bubble finally burst

Chairman. Again, there is some appre-

and the economy fell into recession, the

hension because a relative unknown is

Federal Reserve responded aggressive-

following a celebrated success. Again,

ly. Short-term rates were slashed nearly

the incoming Chairman has stated pub-

5 percent in one year and brought down

licly his commitment to pursuing the

to a mere 1 percent by 2003. The U.S.

Fed’s fundamental goals, in particular,

financial markets had not seen rates so

preserving a stable price environment.

low in nearly 50 years.

If history is a guide, circumstances will

— Former Chairman 		
William McChesney Martin

challenge the new Chairman to meet
that commitment and offer him opportu-

policy only enhances its effectiveness.

nities to put his own stamp on the con-

Indeed, the financial markets begin

duct of monetary policy.

building anticipated policy actions into

On a personal level, Chairman

Ben Bernanke is
an accomplished
scholar in
the field of

ally implemented. Thus, the response

to serve well as the head of the nation’s

to Fed policy in the financial sector, and

central bank. He is an accomplished

in the economy as a whole, is swifter,

scholar in the field of monetary econom-

smoother, and stronger than it would

ics, a former Fed Governor and econom-

otherwise be.

ic advisor to the President, and widely

porter of transparency, and, as a Gover-


nor, he had often spoken in support of a

Beyond that, Ben Bernanke has

instance, he has already indicated that

FOMC in monetary policy matters. All

he would like to see more consideration

seven Fed Governors and 12 Reserve

of an explicit inflation target. So, indica-

Bank presidents participate in FOMC

tions are that the Fed may well consider

meetings, collectively assessing the

additional steps toward transparency

economy, discussing policy alternatives,

under Chairman Bernanke.

Chairman Bernanke has in making


Among the most powerful allies

The Chairman’s Leadership
Looking back, Paul Volcker and

effective monetary policy is one his

Alan Greenspan came to the Fed

predecessor helped to create: greater

Chairmanship with a strong sense of

transparency. Greater openness about

the Fed’s mission, keen insight into

monetary policy decisions was a defin-

the workings of the economy, and the

ing aspect of the Greenspan Fed, and it

confidence to act decisively in the face

was an important means through which

of challenging circumstances. During

Greenspan built the Fed’s reputation

their tenures, they advanced the Fed’s

and influence.

capabilities and instilled strong public

Prior to 1994, there was no direct
communication between the FOMC and

Sharing their strengths and build-

the markets. Today, the FOMC issues

ing on their legacy, Ben Bernanke now

press releases after each meeting, stat-

leads the way as Fed Chairman. We

ing its near-term fed funds target, with

will all be watching to see how the new

an explanation of the action and an

leader of the Fed changes the System’s

indication of the likely future course of

approach to monetary policy and builds

policy. The release also summarizes the

on its strong legacy.

FOMC’s outlook for growth and inflation.


more open Federal Reserve System. For

the support of his colleagues on the

and widely

and clear

Our new Chairman is a strong sup-

recognized as a deep thinker and clear

and ultimately selecting a policy action.

a deep thinker

asset prices even before they are actu-

Bernanke has the talent and expertise

recognized as

This transparency in monetary

Federal Reserve Bank of Philadelphia

Facing Change,
Managing Risk
“Facing Change, Managing Risk” aptly describes the work of the Federal
Reserve Bank of Philadelphia in 2005. We have even recently seen change at the
highest level as the Federal Reserve System welcomed new Chairman Ben Bernanke.
The Philadelphia Bank is expecting to soon have a new president as well.
Without question change has been an integral part of the financial services
landscape over the last several years. For the nation’s central bank, managing the
risks inherent in this evolution is always a top priority.
In this report, we have highlighted the Philadelphia Reserve Bank’s role in
both meeting the needs of the ever-changing banking environment and addressing
the associated risks.


Facing Change,
Managing Risk

Evolution of Payments in the U.S.
By William H. Stone, Jr.

The 2004 Federal Reserve Payments Study asserted that electronic
payments, for the first time ever, had trumped paper checks in number
of total transactions. First Vice President William Stone discusses the
major changes faced by our nation’s payments system and shares how
the Federal Reserve is managing the risks inherent in this evolution.
The Federal Reserve is highly
vested in the evolution of payments. Our
role encompasses both the responsibility
to maintain the integrity of the payments
system and participation in new innovation as a financial services provider.
According to the Fed’s most recent
study, only about 45 percent of all U.S.
noncash retail payments are made by
paper check, with payment cards and
ACH accounting for much of the remainder. At current growth rates, credit cards
and debit cards will both individually
surpass the paper check in terms of total
annual transactions by 2007.
From the early days of banking until
quite recently, checks had maintained
dominance as our nation’s noncash payment of choice. Then, in the early 1970s,
the Fed introduced its automated clearinghouse (ACH) and began an evolution

William H. Stone, Jr., First Vice President

of electronic payments that would replace transactions traditionally made via

rolls, quickly followed, as did other forms

checks. ACH grew quickly by distributing

of debit and credit payments.

various U.S. Treasury credit payments,


Financial institutions continue to

such as armed services payrolls and

find innovative uses for ACH, spanning

Social Security payments, to name just a

a broad range of retail transactions and

few. Commercial bank credit payments,

shifting substantial volumes to this sys-

such as direct deposit of employers’ pay-

tem, primarily at the expense of check

Federal Reserve Bank of Philadelphia

volume. A relatively recent variation

to-person payments supported by credit

even allows merchants to convert paper

cards. In addition, some banks and

checks to electronic payments through

other card issuers even offer online con-

the ACH at the point of purchase. Anoth-

solidated bill payment on their websites.

er variation, known as ARC, for accounts

The second most popular elec-

receivable conversion, allows billers such

tronic instrument for making retail pay-

as utilities and credit card issuers to con-

ments today is the debit card. It arrived

vert checks that are sent to pay monthly

on the scene relatively recently—during

bills. These new uses have increased

the 1980s—but its growth in usage has

substantially as of late.

already been dramatic.

But despite innovations in ACH,
the greatest driver of change in our
nation’s payments system has been

Payment Card Growth
At first, the debit card emerged

payment cards. The credit card was the

as a result of automated teller machine

first ubiquitous consumer-based elec-

(ATM) systems, but it then moved be-

tronic payments instrument to emerge,

yond being solely a mechanism to ac-

and it was the credit card that proved

cess currency. Now, bank customers

most instrumental in moving payments

have the option to simply present the

from paper to electronics at the point

card to the merchants and have their

of sale. Credit cards began as offline

bank account directly debited.

travel and dining cards in the 1960s,

The greatest
driver of change
in our nation’s
system has been
payment cards.

The Fed’s payment study found

grew to become more general-purpose

that debit payments had the largest

purchasing cards in the 1970s, and then

compound annual growth rate, at 24

increased vastly in usage in the 1980s.

percent. Indeed, the growing popularity of debit cards seems to be part of a

Technology Boom
In the 1990s, when the technology

broader phenomenon. Last year, Visa
announced that for the first time ever,

boom made information processing and

its global debit transaction volume sur-

telecommunications more powerful and

passed its credit transaction volume.

less expensive, credit card companies

The last decade has marked a

were poised to gain. Low-cost telecom

clear turning point in our payments

has made real-time, point-of-service

system. From that time on, Federal Re-

verification of cardholders and their

serve research has indicated a steady

credit availability widespread, speeding

decline in check usage. While the num-

transactions and curtailing fraud. Of sig-

ber of checks written remains large, the

nificance for the future, this technology

majority of noncash payments in the

has made the credit card a viable means

U.S. are now initiated electronically. In

of payment for e-commerce as well. We

fact, since their peak a decade ago,

have also seen a rise in Internet person-

checks are not only losing market share,


they are actually declining in absolute

for the 21st Century Act, or Check 21, it


became even easier to move toward a

The last few years, in particular,
have marked dramatic change for the in-

banks have additional options for hand-

dustry. While the 37 billion checks writ-

ling image-based payments.

ten in the U.S. in 2003 were down more

The Philadelphia
Fed has earned
the distinction
of being the
largest producer

more electronic check process because

As a provider of financial services,

than 12 percent from their 2001 levels,

the Fed has been actively engaged in

electronic transactions over that period

bringing a whole array of new products

totaled over 44 billion, representing an

to market to enable banks to more fully

increase of roughly 45 percent.

take advantage of Check 21 benefits.

Looking forward, the share of re-

Our business has been enhanced in a

tail transactions handled by cards, both

number of ways to encourage the new

debit and credit, will continue to grow,

image technology the act allows. To

particularly at the point of sale. In ad-

cite just a few: We have established an

dition, organizations other than banks,

image archive for electronic items; we

especially retailers, will expand their role

have modified deposit deadlines and en-

in the payments system.

hanced clearing times; and we have en-

But the question remains: How

hanced our ability to produce substitute

quickly will the move from paper to elec-

checks, the intermediate step toward a

tronics occur? The transition depends

full image-exchange environment. In

on both the evolution of our payments

fact, the Philadelphia Fed has earned

system’s capabilities and consumer

the distinction of being the largest pro-

Federal Reserve

acceptance. Consumer habits tend to

ducer of substitute checks in the Federal

change gradually. People will only ac-

Reserve System.


cept a payment structure in which they

of substitute
checks in the

have the utmost confidence. As a result,
the paper check is likely to be with us for
some time.

Evolution in Efficiency
With the evolution of the payments
system accelerating, the Federal Reserve System has made major adjust-

Future of Check Clearing
In the meantime, the Fed has been


ments to both its physical infrastructure
and its payments services. Our program

trying to maximize the efficiencies af-

of aggressive electronification of retail

forded by electronic processing of pay-

payments will facilitate Check 21 and

ments, whether that transaction is initiat-

allow us to identify new processing effi-

ed electronically or by paper check. For

ciencies. The ongoing shift to electronic

the latter, the Fed is doing what it can to

payments has also profoundly affected

foster check truncation and electronifica-

our check processing operations. The

tion as early as possible in the payment

Fed currently clears about one-third of

process. Under the Check Clearing

all checks written in the U.S. Still, the

Federal Reserve Bank of Philadelphia

number of checks collected annually

Bank in the future, as this Systemwide

through the Reserve Banks has fallen

leadership role solidifies our position of

nearly 20 percent since 1999, and the

strength in check processing efficiency.

decline continues to accelerate.
Consequently, the Fed has had to
consolidate its operations, closing down

Future of Electronic Payments
As the check continues to be re-

processing sites where appropriate. Yet,

placed by more efficient payment types,

we still maintain national service levels

new technologies continue to help curtail

by re-routing checks to nearby sites. To

check fraud. The Federal Reserve and,

illustrate the scale of this effort, consider

in particular, the Philadelphia Fed have

that two years ago the Fed had 45 check

been industry leaders in identifying tech-

processing sites. By mid-2006 we will be

nology to help reduce fraud in the check

down to 22. This downsizing helps us fill

payment system. These efforts have

our traditional role of payments proces-

constrained the $5 billion annual fraud

sor while at the same time maintaining

losses that burden financial services in-

efficiency in this new environment.

stitutions and their customers.

The Philadelphia Fed has been

To address the evolution taking

selected to become a System consolida-

place in the payments system, in 2000,

tion site for check processing, absorbing

the Philadelphia Fed established its Pay-

New York’s East Rutherford Operations

ment Cards Center. The Center’s work

Center — known as EROC. The Federal

has been instrumental in enhancing our

Reserve System chose us based on

understanding of electronic payment ve-

our overall productivity and efficiency,

hicles, their use by consumers, and their

ability to handle total check volume for

broader impact on the financial system.

both Districts, and our proximity to New

The Federal Reserve System en-

York financial institutions. The Phila-

courages the market to drive checks to-

delphia Fed has long been a leader in

ward electronics. The Philadelphia Fed

the System with a premier check opera-

will play a key leadership role in manag-

tion, but new responsibility will mean

ing check payments as they morph into

additional employees, equipment, and

new payment forms. We will also con-

space renovations to accommodate the

tinue to develop our unique expertise in

increased workload. In the second half

understanding and tracking the payment

of 2006, we expect to create approxi-

card industry as new payment vehicles

mately 60 new positions to help process

evolve in both market share and com-

the additional volume. These changes


The Federal
Reserve and, in
particular, the
Fed have been
industry leaders
in identifying
technology to
help reduce
fraud in the
check payment

should have positive implications for our


Fed’s Role in a Changing
Banking Industry

Facing Change,
Managing Risk

For Supervision, Regulation and Credit, facing change and managing risk
are all in a day’s work. Senior Vice President and Chief Lending Officer
Michael E. Collins talks about the dynamic nature of the banking industry
and how the Fed is adapting to changing times.

Q: How is the banking industry faring
in today’s economy?
Collins: In 2005, the industry delivered
strong performance, smoothly adapting
from a benign economic environment to
one of rising interest rates and stronger
growth. Throughout this transition, the
nation’s financial institutions have been
able to successfully deal with changing
circumstances while still generating
healthy profits. Going forward, we
believe the U.S. banking industry is well
positioned to support a thriving and
prosperous U.S. economy.
Our banking system is truly the
nexus of our economy. It supports a
dynamic and competitive financial
services market while still encouraging
innovation and responsiveness. The
industry’s central role in allocating

Michael E. Collins, Senior Vice President
and Lending Officer

resources, pooling capital, and funding
economic growth has continued to grow

Q: So, adapting to change is an im-

and change as its complexity evolves.

portant aspect of the banking busi-

Technological advances, combined

ness. How does this affect SRC?

with new products and markets,


have changed the financial services

Collins: Our supervisory practices have

landscape, creating opportunities and

become geared more toward evaluation

challenges for both financial institutions

of risk management and less toward

and industry supervisors.

point-in-time financial assessments.

Federal Reserve Bank of Philadelphia

Supervision itself is a preventative

out shocks and risks, ideally with mini-

and collaborative practice, intended to be

mal regulatory involvement. Effective

flexible and designed to identify and as-

market discipline gives banks strong

sess risk. Our approach to supervision

incentives to conduct their business in a

focuses on a bank’s systems, policies,

safe, sound, and efficient manner.

and internal controls. This helps us en-

However, since we can never ex-

sure that appropriate procedures are in

actly duplicate the market’s discipline,

place to contain risk and, importantly, that

we must depend on supervisory guid-

bank management adheres to them. Our

ance, rules, and procedures to ensure

goal is to ensure public confidence and a

safety and soundness in our institutions.

sound banking and financial system.

Also, financial institutions may not al-

Regulation, on the other hand, is

ways objectively consider the broader


largely responsive. Regulation typically

implications of their decisions on other

grows from fraud and abuse, disrup-

stakeholders in the marketplace. So, it is

tive technologies, and rapidly evolving

incumbent upon the Fed and other regu-

social trends. It establishes rules and

latory agencies to work with financial in-

directives, with due consideration to past

stitutions and help them achieve optimal

events, and should be an ongoing pro-

outcomes without stifling their innovation.


Q: Credit risk has historically been


cess aligned with strategy.
In both supervision and regulation,
we always strive to avoid unintended

the leading cause of bank failures.

consequences and excessive burden.

What is the industry doing to protect

Supervisory processes and regulations

assets and ensure against undue

and guidelines undergo periodic evalua-

credit risk?

itself is a
preventative and

intended to
be flexible and
designed to

tion to ensure their continued effectiveness. We believe governance is a fluid

Collins: Imbalances and undue risk can

process, which should encompass best

build on a bank’s balance sheet as a re-

practices and guidance.

sult of the growth in nontraditional mortgage products, the rise in commercial

Q: How do you balance your supervi-

real estate concentrations, and the in-

sory and regulatory duties while still

creased use of leverage. We expect in-

encouraging banks to sort out their

stitutions with higher risk profiles to have

own best practices?

more robust risk management systems.

identify and
assess risk.

As such, institutions increasingly manCollins: Given the increasing scale and

age risk on a portfolio basis, conduct-

diversity of financial institutions and the

ing stress testing and using secondary

rapid pace of change, it is important for

markets to mitigate risk. They also price

supervision and regulation to try to mir-

for risk to ensure a balanced risk-reward

ror the discipline the market itself would

equation. Such risk-based pricing is con-


sistent with expanding access to credit.

Markets are remarkably resilient
and have an inherent capacity to sort

Banks are willing to take on riskier
loans because they can hedge away


some risk by issuing asset-backed secu-

prudent lending and adherence to good

rities. These markets are sophisticated

credit fundamentals.

and complex, allowing many individual

Our supervisory
practices have
adapted to
a changing
becoming geared

investors to purchase a portion of the

ing these loans to ensure that borrowers

loans, which have been “bundled” for

have the capacity to repay them, thereby

diversification purposes. The situation is

sustaining the expansion of homeown-

win-win. The bank is rendered less vul-

ership these products make possible.

nerable to the risk of the original loans,

This is an area of increasing sensitivity

and the investors are willing to bear that

in regulatory circles, largely because of

risk for the chance to earn higher poten-

the newness of these types of products.

tial returns.

Risk management procedures must

While we recognize that credit con-

of risk

loan types. Borrowers must be able to

excessive levels may expose an insti-

sustain their investment and repay these

tution to high credit loss volatility and,

new loans. And underwriters must have

when unchecked, can be an unsafe and

systems in place to ensure that they will.

unsound strategy. Banks have implemented in-house limits and strength-

Q: What is the Fed doing to protect

ened their oversight of concentrations by


improving portfolio stratification. Nevertheless, regulators have released draft

Collins: As an agency charged with

guidance related to commercial real

banking supervision and regulation, the

estate concentrations given the historic

Fed has a responsibility to ensure that

adverse impact on the industry.

banks follow safe and sound management practices and serve all segments

Q: What is the Fed’s position on the

of their community. People must have

use of more exotic instruments, such

access to a sound banking system

as interest-only loans?

where their money can be invested productively with minimal risk.

Collins: The Fed understands the need

The Federal Reserve writes

for innovation in the financial services

regulations to implement many of the

industry to ensure we have a vibrant

major consumer protection laws. These

banking system. Innovation is good,

include the Truth in Lending Act, which

but, as with anything new, we must be

ensures consumers receive adequate

careful about how these instruments

information about credit, and the Truth

are used. We must also ensure that the

in Savings Act, which requires banks

public is sufficiently financially literate

to disclose certain information about

to choose and use these instruments

deposit accounts. The Federal Reserve


also has responsibility for reviewing

Of course, despite these solutions,


consider the unique nature of these new

centrations can be effectively managed,

more toward

It is incumbent upon bankers mak-

banks’ compliance with its regulations. In

the competitive drive to win customers

addition, the Federal Reserve responds

should not supersede the discipline of

to inquiries and investigates complaints

Federal Reserve Bank of Philadelphia

from the public regarding the institutions

Consolidation can improve ef-

it supervises and refers other inquiries/

ficiency and scale while still allowing

complaints to the appropriate regulatory

the benefits of local banking. Through


branch networks, institutions build not
only their reputation and brand but also

Q: What is the purpose of the new

the ability to expand distribution chan-

Bank Secrecy Act manual?

nels and delivery networks. However,
despite ongoing consolidation among

Collins: The new interagency Bank Se-

larger institutions, there continues to be

crecy Act examination manual, released

a steady level of requests for new bank

in June, was a collaborative effort of the

charters, which indicates that strong

federal banking agencies and the U.S.

consumer and investor demand for com-

Department of the Treasury’s Financial

munity banks still exists.

Crimes Enforcement Network. It intro-

The vast array of opportunities and

duces no new rules or guidance, but

risks likely means there will be no pre-

rather it is a compilation of existing regu-

eminent model for the successful bank-

latory requirements, supervisory expec-

ing organization of the future. Rather,

tations, and sound practices designed

several models will likely thrive and sur-

to ensure that the banking system is not

vive. The proper execution of the model

used to finance illicit activities.

and unparalleled attention to customers

Now, more
than ever
before, capital
adequacy, risk

will determine its success.

and effective

Q: What is the status of Basel II?


its operations from money laundering or

Collins: Capital adequacy is an ongoing

are of critical

terrorist financing.

concern for bank supervisors. The U.S.

Sound Bank Secrecy Act/antimoney laundering risk management
enables an organization to identify risks
and better direct resources to safeguard

is striving to implement the proposed
Q: Why do you think the industry has

international regulatory framework of

continued toward consolidation?

Basel II by 2009. This framework will
better align regulatory capital with risks

Collins: The trend toward nationwide

and represent a vast change in how

banking and the desire to leverage in-

banks determine capital adequacy. Un-

vestments in technology have contrib-

der its advanced approaches, banks will

uted to banks’ desire to consolidate. In

be required to adopt more formal, quan-

addition, some consolidation activity has

titative risk measures and risk manage-

been the result of competitive changes

ment procedures. Essentially, Basel II

that allowed financial institutions to cross

strengthens the link between regulatory

lines of business and break into new

capital and risk management.

importance to
maintaining a
safe and sound
financial system.

markets. In turn, such activity has imposed significant change on the industry.


Preventing Check Fraud

Facing Change,
Managing Risk

Paper checks are still a major player in the payment system, and
managing risk includes finding ways to prevent check fraud. Here’s what
the Philadelphia Fed is doing in this area.

Estimates of check fraud’s cost to
consumers, merchants, and the financial
services industry range from $5 billion
to $10 billion a year. Whatever the actual number, check fraud is a costly and
growing problem in the United States
and around the world.
In 2005, the Philadelphia Fed undertook several efforts to prevent check
fraud, such as promoting the exchange
of technologies and data throughout
the payments system. The Bank also
encouraged collaboration in the financial services industry to address certain
challenges. But before we talk about
that, some history is in order.
For many years, the Federal Reserve Bank of Philadelphia, along with
the Treasury, tested technologies that
would help the financial services industry
deter check fraud. The Treasury made a
logical partner because it issues approximately 250 million checks a year for payments such as Social Security benefits
and tax refunds.
In 2003, after testing several
technologies, the Philadelphia Fed and
the Treasury adopted one for use with
Treasury checks. This application allows
the Treasury to encrypt a code on each
check at the time of issue. The code
describes the dollar amount, the date of


Federal Reserve Bank of Philadelphia

Blake Prichard, Executive Vice President

issue, the account number, and so forth,
and it is invisible to the human eye. But
when the check is digitally imaged, this
technology survives the imaging and
allows the hidden data to be compared
against the information written on the
check, then confirms whether the check
is genuine. The Philadelphia Fed found
it to be effective in identifying altered

checks and payment and processing errors. Today, all Treasury checks include
this technology.
Blake Prichard, executive vice
president, Retail Payments, points out
that an important aspect of this partnership between the Philadelphia Fed and
the Treasury is that “none of this would
have happened without the perceptive
leadership here at the Bank and the industry focus that has long been emphasized by top management at Treasury.” 	

Role of Check 21
Another motivation for implementing such new technology was Check 21.
This law allows a substitute check, created from an electronic image, to serve
as the legal equivalent of the check itself.
A collecting bank can create an electronic image of a check, transmit the image
to the paying bank’s location, and then
present the paying bank with a paper
reproduction or with the electronic image.
Philadelphia Fed management
anticipated that this law would bring
special concerns: Once banks started
electronic imaging of checks and truncating the original paper checks, how
could the industry adapt to the loss of
the anti-check fraud features on the
originals? The concern was that Check
21 might unwittingly invite greater check
fraud unless the industry could find new
technologies that would render fraud
prevention measures “image survivable.”
That’s why the Philadelphia Fed
addressed this issue well in advance of
Check 21’s implementation. The technology chosen by the Philadelphia Fed
and the Treasury has solved this “survival” problem. Now, Prichard states, “Using this technology, we detect fraudulent

checks almost every day in this Bank.”

Recent Events
In 2005, the Bank took the next
steps in fighting check fraud: promoting
standards for the exchange of check
fraud technologies and encouraging
the broad adoption of these standards
throughout the payments system. Prichard notes, however, that “the Fed doesn’t
plan to impose standards. Rather, we
support efforts to create new technologies, and we want the marketplace to
evaluate them.”
To further support the development
of new technologies, the Bank joined
forces with the Financial Services Technology Consortium (FSTC), a research
organization based in New York. FSTC
encourages collaboration among various
players in the financial services industry
to find solutions to challenges facing the
The Bank and FSTC launched a
project to create interoperability standards for fraud detection applications.
Right now, if one bank uses, say, bar
codes to verify a check’s authenticity, it
may not be able to verify a check issued
by a bank that relies on other types of
check fraud technologies. An interoperable system would allow any financial
institution—and eventually merchants
and others—to verify a check regardless
of who issued it and what type of security measures were used. One of the biggest benefits is that fraudulent checks
will be intercepted much earlier in the
payments stream.
In 2006 and beyond, the Philadelphia Fed will continue to support efforts
to develop new and better ways to detect
fraudulent checks.

In 2006 and
beyond, the
Philadelphia Fed
will continue to
support efforts to
develop new and
better ways to
detect fraudulent


Facing Change,
Managing Risk

Managing Risk at the Bank and
Across the System
When you’re the nation’s central bank, effectively managing risk throughout
the organization is a top priority. Indeed, managing risk from a broader
perspective has become a hot topic both inside and outside the Fed.

Managing risk is not a
new concept for companies
and corporations. However,
lately, risk management
has taken on a new aspect:
incorporating risk management principles across the
entire organization. Donna
Franco, chief financial officer
at the Philadelphia Fed, puts
it this way: “Corporations
have been managing risk
for many years. What ERM
adds is an organization-wide
view.” A large institution like
the Federal Reserve System
is no exception. Like other
organizations, the Fed is
subject to operational, credit,
market, strategic, and reputational risks. To deal with
risk issues, the System developed an ERM framework
several years ago, and two
years ago, the Federal Re-

Donna Franco, Chief Financial Officer, and Spyro Karetsos, Assistant Vice
President, Enterprise Risk Management

serve Bank of Philadelphia
established the Enterprise

Philadelphia Reserve Bank led a System

Risk Management (ERM) Department.

work group that produced a white paper

The Philadelphia Fed’s and the System’s involvement with ERM dates back
to 2002, when the general auditor of the


Federal Reserve Bank of Philadelphia

that became the basis for implementing
ERM in the Federal Reserve System.
Why is managing risk at a broader

level so important? The interconnected

best practices across the System. One

nature of the Fed is one reason. If a

venue for doing so is the System’s an-

risk-related issue arises at one Reserve

nual ERM meeting, which Philadelphia

Bank, it may well have implications for

has hosted for the past three years.

the other Reserve Banks.

Importantly, at the 2005 meeting, it was

Spyro Karetsos, assistant vice

clear that a “community of interest” has

president, Enterprise Risk Manage-

emerged within the Federal Reserve.

ment, notes that sometimes company

One piece of evidence is that these

managers and officers have made deci-

meetings no longer rely on outside

sions about risk-taking informally. By

speakers to fill the agenda; presenters

formalizing the decision-making pro-

now come from within the System in ad-

cess, Karetsos says, ERM “increases

dition to external presenters.

the awareness of risk and the potential

For the Philadelphia Bank, sharing

impact certain decisions may have.” Fur-

ERM ideas sometimes means moving

thermore, he says, it allows managers

beyond the Fed’s walls and even beyond

and others to understand a decision’s

U.S. borders. In August 2005, Karetsos

effect not just on one business area but

published an article on the topic in the

on other stakeholders as well.

RMA Journal, a publication of the Risk
Management Association. ERM has also

Other Aspects of ERM
Another valuable aspect of ERM,

taken on an international scope. In 2005,
the central bank of Spain toured various

Karetsos observes, is that “it compels

central banks because it wants to imple-

entities to develop a common language.

ment an ERM program. As a result of its

Having everyone use the same terminol-

contact with the Philadelphia Fed, the

ogy to talk about risk reduces the need

Banco de España has developed a rela-

to ‘translate’ risk concepts.” Karetsos

tionship with the ERM staff here. In early

adds that a formal ERM program also

2006, Franco flew to Madrid to share

gives organizations a tool for monitoring

ideas with her peers from other central

risk: “Initially, a company may determine

banks. She has also been asked to co-

the amount of risk associated with a cer-

chair a consortium of central banks that

tain action. But ERM gives you ways to

will meet annually to discuss common

monitor your actual risk level after you’ve

risk-management concerns.

carried out the decision. It’s really a system of checks and balances.”
One good feature about the Sys-

are and align
we can reduce
inherent risks
to a level within
our tolerance
— Spyro Karetsos

covers an organization’s activities and
business lines. ERM also acts as a lens
that allows a company to view existing

Karetsos says. It provides standards

information from a risk perspective. No

that allow a Systemwide perspective,

organization can entirely eliminate risk,

but each Bank’s ERM processes can be

Karetsos notes, but “if we know what the

customized to fit that Bank’s culture.

risks are and align resources appropri-

ERM programs, and one goal is to share

what the risks

Ultimately, ERM is an umbrella that

tem’s ERM framework is its flexibility,

Other Reserve Banks also have

“If we know

ately, we can reduce inherent risks to a
level within our tolerance range.”


Facing Change,
Managing Risk

Protecting Our Information Systems
Many of the biggest risks facing the Federal Reserve Bank of Philadelphia
come from cyberspace. Threats to the security of the Bank’s information
networks—for example, from the Internet or e-mail—are almost
constant. The Information Technology Services Department has primary
responsibility for managing the risk posed by these threats.

Fending off attacks from cyberspace may have a “Star Wars” sound to
it, but it’s a task that the Bank’s Information Technology Services (ITS) Department deals with every day. According
to Pat Regan, vice president, ITS, “The
Federal Reserve System takes very seriously the establishment of information
security standards for all of the Fed’s
To protect computer systems from
intruders, the Federal Reserve uses
intrusion detection technology. According to Regan, the technology “senses”
certain types of unauthorized activity and
reports it to a group that analyzes the information and, if necessary, takes action.
The Philadelphia Fed also uses
technology to look for vulnerabilities in
its computing systems. Keith Morales,
information security manager, notes
that assessing vulnerability is one of

Pat Regan, Vice President, ITS, and Keith Morales,
Information Security Manager

the first steps in learning how to protect

it before the bad guys can exploit it. But

industry has noted a dramatic increase

it doesn’t take long before the bad guys

in the number of exposures and the

have another virus or worm to spread.”

number of computer hacking attempts.


vulnerability,” he says, “our goal is to fix

Regan points out that the security

The Philadelphia Fed is also the

He describes the Bank’s information

site for the Federal Reserve System’s

security situation as a “punch/counter-

Groupware Leadership Center (GLC).

punch” problem. “When we learn of a

The GLC provides e-mail, desktop con-

Federal Reserve Bank of Philadelphia

ferencing, instant messaging, document

As Regan notes, “We have a high level

management, and self-service team

of security awareness at the Bank. But

website capabilities for almost 20,000

an important element in protecting the

customers across all 12 Reserve Banks.

Bank’s—and the System’s—computer

To protect the System’s computers, the

network is training our employees and

GLC employs rigorous security safe-

relying on them to follow security pro-

guards that act as a layer of defense

cedures.” Internal audits help to ensure

against numerous threats from a variety

that employees develop and use good

of sources. Such safeguards include fil-

security habits.

tering spam, which actually exceeds the
total volume of delivered e-mail.

In addition to the endeavors listed
above, Philadelphia’s ITS Department is
involved with many other ongoing proj-

System Architecture
Morales says many of the Bank’s

ects related to information security. For
example, the Bank is leading an initiative

information security measures are de-

to look at how the Fed handles compli-

signed to fit the System’s security archi-

ance with legislation such as the Federal

tecture, which focuses on finding solu-

Information Security Management Act

tions to information security risks. This

(FISMA). FISMA defines what actions

architecture sets security standards from

federal agencies need to take to be

the standpoint of risk management rath-

deemed appropriately secure. Morales

er than risk avoidance. “Because we’re

says, “It’s the government’s version of

such a large organization,” Morales

the Federal Reserve’s security architec-

observes, “we have multiple layers of

ture and risk management.” So although

defenses in place. However, no layer is

the Reserve Banks are not federal

perfect. So the System’s security archi-

agencies, the Board of Governors and

tecture helps us look at the solutions we

the U.S. Treasury are; so any systems

have in place and figure out if they’re the

developed for use by the Board or the

right ones. The Fed’s computer network

Treasury need to comply with FISMA.

is so interconnected that a weakness in

Mike Ram, senior information security

one area may create weaknesses else-

consultant, is playing a leadership role


supporting some of the Fed’s initiatives

Another ITS effort involves the con-

with FISMA.

tainment of malicious software, or “mal-

Ultimately, Morales summarizes

ware”—for example, spyware or adware

the Bank’s security position this way:

that websites download onto computers

“The Fed wants security at an appropri-

that connect to them. This effort also en-

ate level. We’re not trying to build 80-foot

compasses potentially harmful elements

walls around all of our computer sys-

distributed through e-mail attachments

tems. But it may be appropriate to have

and embedded links to “bad” websites.

300-foot walls around Fedwire, which is

A final factor that helps ITS staff
keep computer systems safe is the

To protect
the Fed’s
computers, the
GLC employs
rigorous security
safeguards that
act as a layer of
defense against
threats from
a variety of

a significant part of our nation’s payment

Bank’s own internal audit procedures.


Facing Change,
Managing Risk

Helping Consumers Make Better
Financial Decisions
Since the early 1980s, the Community Affairs Department has helped
financial institutions understand the credit needs of low- and moderateincome people and communities. As a result, these people and communities
have experienced a significant increase in their ability to build wealth and
access credit, particularly for homeownership or home repair.
In 2005, the Community Affairs Department offered a variety of programs
to help students and adult consumers
become more knowledgeable about
personal finance and the U.S. economy.
One major project was creating a video
about lending abuses. In “Buried by
Debt: The Dangers of Borrowing,” people
tell true stories about how they were
taken in by unscrupulous lenders and

Why a Video?
The idea for the video first surfaced
in November 2003 when 11 ministers
from large congregations throughout
Philadelphia were meeting at the Bank
to launch a financial education program
for their congregants. “We asked the
ministers what we could do to help them
reach their communities,” says Dede
Myers, vice president and community
affairs officer. “They told us that many
of their congregants were victims of
unscrupulous lenders and asked if we

Dede Myers, Vice President and Community Affairs Officer

could produce a video that would help
educate people about lending practices.”
Myers and Marvin M. Smith, com-


Smith, “The challenge was to make a
video that would still be useful five years

munity development research advisor,

from now. We started by doing back-

set the process in motion. According to

ground research to discover the most

Federal Reserve Bank of Philadelphia

common problems people encountered.

it or housing counselor attended all the

We focused on balloon loans, unreason-

showings and encouraged employees to

ably high interest rates, loan flipping,

ask questions. The sessions were very

prepayment penalties, and contractor

popular and lasted nearly 90 minutes.

To make the video, Community Affairs enlisted the help of Irv Ackelsberg

Other Efforts
To further help employees, Com-

and Brian Mildenberg, two attorneys

munity Affairs also offered a five-week

who have had a lot of experience hand-

homeownership program, and several

ling consumer credit cases. In fact, they

of the participants have since bought

asked several of their clients to be in the

houses. Other consumer education proj-

video. Smith recalls that it took a lot of

ects included offering a training session

convincing to get the local residents to

for faith-based organizations and provid-

appear. But, finally, they understood that

ing space and staff support for quarterly

by participating in the video, they could

meetings of the Financial Education

help others avoid some of the problems

Support Network of Southeastern Penn-

they had experienced.


was to make
a video that
would still

Additional endeavors by the

How the Video Was Used

“The challenge

department’s economic education unit

The resulting 14-minute tape has

involved enhancing the curriculum of an

been in great demand by various audi-

existing financial literacy program, which

ences. More than 3,000 copies were

had met with great success in Delaware,

distributed in 2005, including a Spanish

and promoting it to teachers in Penn-

version. The department posted informa-

sylvania and New Jersey. The unit also

tion about the video and an order form

held a number of financial education

on its website, which resulted in many

seminars for teachers around the Third

requests. Furthermore, other Federal


be useful five
years from now.
We started by
discovering the
most common
problems people

Reserve Banks
have asked for


copies to dis-

— Marvin M. Smith

tribute to their
as well.
To help
the Bank’s staff,
Community Affairs also offered
employees on all
shifts a chance
to see the video.
Smith and a cred-


Standing left to right: Kenneth Shoemaker, Wayne Weidner, Garry Maddox, and Coleman Townsend. Seated left to right: William
Hecht, Robert Chappell, Ronald Naples, Eugene Rogers, and Doris Damm.

Federal Reserve Bank of Philadelphia

Board of Directors

Federal Reserve Bank of Philadelphia

Robert E. Chappell
Board member since January 2000.
Chair, Budget and Operations Committee and Member, Personnel Committee. Chairman and CEO of Penn
Mutual Life Insurance Company.
Board member Insurance Federation
of Pennsylvania. Member of Taxation and Financial Services Steering
Committee for American Council of
Life Insurers. Serves on boards of
Quaker Chemical Corporation, South
Chester Tube Company, and Wharton Financial Institutions Center at
University of Pennsylvania.
Doris M. Damm
Deputy Chairman, Federal Reserve
Bank of Philadelphia Board of Directors. Board member since January
2001. Chair, Personnel Committee
and Member, Budget and Operations
Committee. President and Chief
Executive Officer of ACCU Staffing
Services. Other affiliations include
Cerebral Palsy of New Jersey, Our
Lady of Lourdes Medical Center, Our
Lady of Lourdes Foundation, and
Cherry Hill Regional Chamber of
William F. Hecht
Board member since January 2004.
Member, Research and External
Affairs and Budget and Operations
committees. Chairman and CEO of
PPL Corporation. Member of Executive Committee of Edison Electric
Institute. Director of Nuclear Energy
Institute, Edison Electric Institute,
Lehigh Valley Hospital and Health
Network, Dentsply International and
RenaissanceRe Holdings, Ltd. President of Lehigh Valley Partnership.
Garry L. Maddox
Board member since January 2003.
Member, Audit and Personnel committees. President and CEO of A.

Pomerantz & Company. Founding
President of World Wide Concessions, Inc. Founder and Executive
Director of LPGA Urban Youth Golf
Program of Greater Atlantic City.
Founder and President of Youth Golf
and Academics Program. Serves
on boards of Boys and Girls Club of
Camden County, Corporate Alliance
for Drug Education, Greater Philadelphia Chamber of Commerce, Fairmount Park Commission, Neumann
College, Philadelphia Sports Congress, Operation Good Neighbor, St.
Christopher’s Hospital for Children,
and Shippensburg University. Director Emeritus of Philadelphia Child
Guidance Center. Member of Board
of Governors of National Adoption
Ronald J. Naples
Chairman, Federal Reserve Bank
of Philadelphia Board of Directors.
Board member since January 2001.
Chairman and Chief Executive Officer of Quaker Chemical Corporation.
Chairman of Board of University of
the Arts. Serves on boards of Glatfelter, NCO Group, Philadelphia Museum of Art, Franklin Institute, Foreign Policy Research Institute, Rock
School of the Pennsylvania Ballet,
and American Red Cross - Southeastern Pennsylvania Chapter.
Eugene W. Rogers
Board member since January 2004.
Member, Audit and Personnel committees. CEO of Newfield Bancorp,
Inc., CEO of Newfield National Bank,
and Director of FNBN Investment
Corp. Director of Atlantic Central
Bankers Bank. Member of Kennedy
Hospital Advisory Board and New
Jersey Bankers Association. Serves
as Chairman of the South Jersey
Community Bankers Association.

Kenneth R. Shoemaker
Board member since January 2003.
Chair, Audit Committee and Member, Research and External Affairs
Committee. President and CEO of
Orrstown Bank, President and CEO
of Orrstown Financial Services.
Chairman of Council of Trustees of
Shippensburg University. Serves on
boards of Cumberland Valley School
of Music, Carlisle Regional Medical
Center and Pennsylvania Bankers
Association. Founding President of
Mainstreet Non-Profit Redevelopment Corporation.
P. Coleman Townsend, Jr.
Board member since January 2002.
Chair, Research and External Affairs Committee and Member, Audit
Committee. Chairman and CEO of
Townsends, Inc. Member of Board
of Trustees of University of Delaware
and Winterthur Museum. Member
Winterthur Museum Garden, Collections and Library committees.
Serves on the Council of Advisors
for Delaware Center of Horticulture.
Advisory Board Member for Liberty
Mutual and Lehman Art Center Brooks School. Active participant on
Delaware Art Museum Collections
Wayne R. Weidner
Board member since January 2005.
Member, Budget and Operations
and Research and External Affairs
committees. Chairman National
Penn Bank. Chairman & CEO of
National Penn Bancshares. Serves
as a director of National Penn Investors Trust Company, Link Financial
Services, Penn 1st Financial Services, National Penn Life Insurance
Company, NPB Delaware, and Hawk
Mountain Council Boy Scouts of


2005 Business Advisory Council
Federal Reserve Bank of Philadelphia

Reneé Amoore

Robert L. Gronlund

Melinda K. Holman

President & CEO

Chairman & CEO


The Amoore Group

Wood Mode Inc.

Holman Enterprises

King of Prussia, PA

Kreamer, PA

Pennsauken, NJ

Daniel Blaschak


Eric May


Douglass C. Henry, Jr.

President & Owner

Blaschak Coal Corp.


Pen Fern Oil Co., Inc.

Mahanoy City, PA

Henry Molded Products, Inc.

Dallas, PA

Lebanon, PA
Keith Campbell*

Albert Morrison, III*


Chairman, President, & CEO

Mannington Mills, Inc.

Burnham Holdings

Salem, NJ

Lancaster, PA
Mark S. Stellini
President & CEO
Wilmington, DE
Kenneth L. Tuckey
Chairman, President, & CEO
Tuckey Mechanical Services,
Carlisle, PA
Rodman Ward
Speakman Company
Wilmington, DE
David C. Wenger
President & CEO
RoadLink USA East
Philadelphia, PA

Standing left to right: Melinda Holman, David Wenger, Robert Gronlund, Daniel
Blaschak, and Kenneth Tuckey. Seated left to right: Rodman Ward, Reneé Amoore,
Mark Stellini, Douglass Henry, and Eric May.
* Not pictured

Federal Reserve Bank of Philadelphia

2005 Community Bank Advisory Council
Federal Reserve Bank of Philadelphia

John W. Adonizio

Mark E. Huntley

William F. Snell*



President & CEO

Landmark Community Bank

Delaware National Bank

Farmers and Merchants

Pittston, PA

Georgetown, DE

Trust Co.

Thomas A. Bracken*

John T. Parry*

President & CEO

President & CEO

Peter C. Zimmerman

Sun National Bank

First National Bank & Trust

President & CEO

Vineland, NJ

Co. of Newtown

First National Bank of

Newtown, PA


Chambersburg, PA

Donna M. Coughey*

Newport, PA

President & CEO

Michael M. Quick*

First Financial Bank


Downingtown, PA

Susquehanna Patriot Bank
Marlton, NJ

Allan R. Dennison
President & CEO
AmeriServ Financial
Johnstown, PA
Robert E. Forse
Chairman, President, & CEO
Woodlands Bank
Williamsport, PA
Mark D. Gainer*
President & CEO
Union National Community
Mt. Joy, PA
Aaron L. Groff
Chairman, President, & CEO
Ephrata National Bank
Ephrata, PA

Clockwise left to right: Allan Dennison, Peter Zimmerman, Robert Forse, Aaron
Groff, John Adonizio, and Mark Huntley.

* Not pictured


2005 Credit Union Advisory Council
Federal Reserve Bank of Philadelphia

David W. Clendaniel*

Alfreda A. Earnest


President & CEO

President & CEO

Louise P. Lingenfelser

Dover FCU

Deepwater Industries FCU

President & CEO

Dover, DE

Deepwater, NJ

UGI Employees FCU
Wyomissing, PA

Eileen Crean

James E. Everhart, Jr.

President & CEO

President & CEO

Jeff March*


Louviers FCU

President & CEO

Vineland, NJ

Newark, DE

Citadel FCU

Maurice Dawkins

Dorothy A. Fox

President & CEO

President & CEO

Robert L. Marquette

American Spirit FCU

NE PA Community FCU

President & CEO

Newark, DE

Stroudsburg, PA

Members 1st FCU

Thorndale, PA

Mechanicsburg, PA
Larry D. Miller
President & CEO
Mennonite Financial FCU
Lancaster, PA
Larry L. Stoner
President & CEO
Susquehanna Valley FCU
Camp Hill, PA
Edwin L. Williams
President & CEO
Discovery FCU
Wyomissing, PA

Clockwise standing from left: Maurice Dawkins, Edwin Williams, Larry Miller, Robert
Marquette, and Eileen Crean. Clockwise seated from bottom left: Alfreda Earnest, Dorothy
Fox, Louise Lingenfelser, James Everhart, and Larry Stoner.
* Not pictured

Federal Reserve Bank of Philadelphia

Executive Committee
Federal Reserve Bank of Philadelphia

The Bank’s Executive Committee consists of the president, first vice president, and the key senior officers who report directly
to them. They meet regularly to discuss important issues facing the Bank or the Federal Reserve System. Pictured clockwise
from left are Milissa Tadeo, Senior Vice President; Michael Collins, Senior Vice President; Blake Prichard, Executive Vice
President; Richard Lang, Executive Vice President; Anthony Santomero, President; and William Stone, First Vice President.


Current Officers

Federal Reserve Bank of Philadelphia

Anthony M. Santomero
William H. Stone, Jr.
First Vice President
Richard W. Lang
Executive Vice President
D. Blake Prichard
Executive Vice President
Michael E. Collins
Senior Vice President
and Lending Officer
Supervision, Regulation and
Loretta J. Mester
Senior Vice President and
Director of Research
Milissa M. Tadeo
Senior Vice President
Cash Services and Treasury
John G. Bell
Vice President
Financial Statistics
Robert J. Bucco
Vice President
Wholesale Product Office
Peter P. Burns
Vice President and Director
Payment Cards Center
Theodore M. Crone
Vice President and

Michael Dotsey
Vice President and Senior
Economic Policy Advisor
Richard A. Elliott
Vice President
Facilities Management,
Records, and Document


John D. Ackley
Assistant Vice President
Treasury Services

Mary Ann Hood
Vice President
Human Resources

Mitchell S. Berlin
Assistant Vice President and

Camille M. Ochman
Assistant Vice President
Cash Services

Donna Brenner
Assistant Vice President
Accounting Services

Anthony T. Scafide, Jr.
Assistant Vice President
Customer Relations

Jennifer E. Cardy
Assistant Vice President and
Assistant General Auditor

Stephen J. Smith
Assistant Vice President and
Assistant Counsel

Shirley L. Coker
Assistant Vice President and

Eric A. Sonnheim
Assistant Vice President
Supervision, Regulation and

Cynthia L. Course
Assistant Vice President
Supervision, Regulation and

C. Danny Spriggs
Assistant Vice President

Arun K. Jain
Vice President
Retail Payment Services
William W. Lang
Vice President
Supervision, Regulation and
Edward M. Mahon
Vice President and General
Stephen A. Meyer
Vice President and Senior
Economic Policy Advisor
Mary DeHaven Myers
Vice President and
Community Affairs Officer
Community Affairs
A. Reed Raymond, III
Vice President and Chief
Administrative Officer
Supervision, Regulation and
Patrick M. Regan
Vice President
Information Technology
Michelle M. Scipione
Vice President
Cash Services

John J. Deibel
Vice President and Chief
Examination Officer
Supervision, Regulation and

Donna L. Franco
Vice President and
Chief Financial Officer

Faith P. Goldstein
Vice President
Public Affairs

Richard A. Sheaffer
Vice President and General
Herbert E. Taylor
Vice President and Corporate
Vish P. Viswanathan
Vice President and Discount
Supervision, Regulation and
Kei-Mu Yi
Vice President and

Frank J. Doto
Assistant Vice President
Supervision, Regulation and
Michael T. Doyle
Assistant Vice President
Technical Services Officer
Information Technology
William L. Gaunt
Assistant Vice President
Supervision, Regulation and
Stephen G. Hart
Assistant Vice President
Human Resources
Spyro Karetsos
Assistant Vice President
Enterprise Risk Management
John P. Kelly
Assistant Vice President
Check Operations
Retail Payment Services
Elisabeth V. Levins
Assistant Vice President
Supervision, Regulation and

Alice Kelley Menzano
Assistant Vice President
Information Technology

Marie Tkaczyk
Assistant Vice President
Information Technology
Todd Vermilyea
Assistant Vice President
Supervision, Regulation and
Constance H. Wallgren
Assistant Vice President
Supervision, Regulation and
Aileen C. Boer
Research Support Officer
Maryann T. Connelly
Assistant Counsel
Gregory Fanelli
Treasury Payments Officer
Retail Payments
Suzanne W. Furr
Wholesale Product Officer
Wholesale Product Office
Wanda Preston
Check Adjustments Officer
Retail Payment Services

Includes promotions through March 2006

Federal Reserve Bank of Philadelphia

Operating Statistics
Federal Reserve Bank of Philadelphia


In 2005, Philadelphia’s total volume of commercial checks processed de-

creased 14 percent and the dollar value of transactions increased 13 percent. The
volume of U.S. government checks increased 4 percent in 2005, but the dollar value
decreased 6 percent. In November, the Philadelphia Bank permanently assumed the
processing of U.S government checks previously processed in Atlanta due to arrangements made in the wake of Hurricane Katrina.

The Philadelphia Bank continued to be a major processor of cash in the Fed-

eral Reserve System in 2005. While the volume of currency processed remained fairly
constant in 2005, due to the processing of a significantly higher proportion of ones, the
actual dollar value of currency processed decreased by 19 percent. In 2005, one of
our larger customers began depositing coin directly to an off-site terminal; therefore,
the volume of coin bags processed declined by 22 percent and the processed coin
value decreased by 7 percent.
In 2005, both the number and value of loans to depository institutions were
lower than in the previous year.








Dollar Value	


Dollar Value

Check processing:

Commercial checks	

969.0 million checks	 $2,256.4 billion	 1,129.4 million checks	 $2,001.8 billion


U.S. government	

84.9 million checks	

$103.2 billion	

82.0 million checks	

$109.6 billion	

Cash operations:

Currency processed	

2,351.4 million notes	

$36.1 billion	

2,358.1 million notes	

$44.3 billion	

Coin paid and received	

587.8 thousand bags	

$225.5 million	

756.3 thousand bags	

$242.7 million	

Loans to depository institutions	

110 loans	

$823.6 million	

120 loans	

$1,393.6 million


during the year


Statement of Auditor Independence

The firm engaged by the Board of Governors for the audits of the individual and combined financial statements of the Reserve Banks for
2005 was PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $4.6 million. To ensure auditor independence, the Board
of Governors requires that PwC be independent in all matters relating
to the audit. Specifically, PwC may not perform services for the Reserve Banks or others that would place it in a position of auditing its
own work, making management decisions on behalf of the Reserve
Banks, or in any other way impairing its audit independence. In 2005,
the Bank did not engage PwC for any material advisory services.


Federal Reserve Bank of Philadelphia

Financial Reports

Letter to Directors.............................................38
Report of Independent Accountants.................39	
Report of Independent Auditors.......................40
Statements of Condition...................................41
Statements of Income......................................42
Statements of Changes in Capital....................43
Notes to Financial Statements.........................44


Letter to Directors
Federal Reserve Bank of Philadelphia



Federal Reserve Bank of Philadelphia

Report of Independent Accountants
Federal Reserve Bank of Philadelphia



Report of Independent Auditors
Federal Reserve Bank of Philadelphia


Federal Reserve Bank of Philadelphia

Statements of Condition
Federal Reserve Bank of Philadelphia
As of December 31, 2005 and December 31, 2004 (in millions)





Gold certificates	





Special drawing rights certificates		






Items in process of collection		



Loans to depository institutions		



U.S. government securities, net		



Investments denominated in foreign currencies		



Accrued interest receivable		



Interdistrict settlement account		



Bank premises and equipment, net		



Interest on Federal Reserve notes due from U.S. Treasury		



Other assets		



Total assets	







Federal Reserve notes outstanding, net	


Securities sold under agreements to repurchase		




Depository institutions		



Other deposits		



Deferred credit items		



Interest on Federal Reserve notes due U.S. Treasury		



Accrued benefit costs		



Other liabilities		



Total liabilities		



Capital paid-in		






Total capital		





Total liabilities and capital	




The accompanying notes are an integral part of these financial statements.



Statements of Income
Federal Reserve Bank of Philadelphia
For the years ended December 31, 2005 and December 31, 2004 (in millions)



Interest income:			
Interest on U.S. government securities	





Interest on investments denominated in foreign currencies		



Total interest income		







Interest expense:
	 Interest expense on securities sold under agreements

to repurchase		

Net interest income		
Other operating income (loss):			
Income from services		


Compensation received for check services provided		



Reimbursable services to government agencies		









Foreign currency gains (losses), net	


Other income		
Total other operating income (loss)	



Operating expenses:			
Salaries and other benefits		



Occupancy expense		



Equipment expense		



Assessments by the Board of Governors		



Other expenses 		



Total operating expenses		





Net income prior to distribution	



Distribution of net income:			
Dividends paid to member banks	


Transferred to surplus 		










Payments to U.S. Treasury as interest on Federal Reserve

Total distribution	

The accompanying notes are an integral part of these financial statements.


Federal Reserve Bank of Philadelphia



Statements of Changes in Capital
Federal Reserve Bank of Philadelphia
For the years ended December 31, 2005 and December 31, 2004 (in millions)

Capital Paid-in	

Total Capital


Balance at January 1, 2004
(5.2 million shares)	



Transferred to surplus		


Net change in capital stock issued


(0.7 million shares)		












Balance at December 31, 2004
(5.9 million shares)	



Transferred to surplus		


Net change in capital stock issued

(9.0 million shares)		












Balance at December 31, 2005
(14.9 million shares)	





$	 1,488

The accompanying notes are an integral part of these financial statements.


Notes to Financial Statements

Federal Reserve Bank
of Philadelphia

1. Structure
The Federal Reserve Bank of Philadelphia (“Bank”) is part of the Federal Reserve System
(“System”) and one of the twelve Reserve Banks (“Reserve Banks”) created by Congress under
the Federal Reserve Act of 1913 (“Federal Reserve Act”), which established the central bank of
the United States. The Reserve Banks are chartered by the federal government and possess a
unique set of governmental, corporate, and central bank characteristics. The Bank in Philadelphia
serves the Third Federal Reserve District, which includes Delaware and portions of New Jersey
and Pennsylvania.
In accordance with the Federal Reserve Act, supervision and control of the Bank are exercised by a Board of Directors. The Federal Reserve Act specifies the composition of the Board
of Directors for each of the Reserve Banks. Each board is composed of nine members serving
three-year terms: three directors, including those designated as Chairman and Deputy Chairman,
are appointed by the Board of Governors, and six directors are elected by member banks. Banks
that are members of the System include all national banks and any state-chartered banks that
apply and are approved for membership in the System. Member banks are divided into three
classes according to size. Member banks in each class elect one director representing member
banks and one representing the public. In any election of directors, each member bank receives
one vote, regardless of the number of shares of Reserve Bank stock it holds.
The System also consists, in part, of the Board of Governors of the Federal Reserve System
(“Board of Governors”) and the Federal Open Market Committee (“FOMC”). The Board of Governors, an independent federal agency, is charged by the Federal Reserve Act with a number of
specific duties, including general supervision over the Reserve Banks. The FOMC is composed
of members of the Board of Governors, the president of the Federal Reserve Bank of New York
(“FRBNY”), and on a rotating basis four other Reserve Bank presidents.

2. Operations and Services
The System performs a variety of services and operations. Functions include formulating
and conducting monetary policy; participating actively in the payments system including largedollar transfers of funds, automated clearinghouse (“ACH”) operations, and check processing;
distributing coin and currency; performing fiscal agency functions for the U.S. Treasury and certain
federal agencies; serving as the federal government’s bank; providing short-term loans to depository institutions; serving the consumer and the community by providing educational materials and
information regarding consumer laws; supervising bank holding companies, state member banks,
and U.S. offices of foreign banking organizations; and administering other regulations of the Board
of Governors. The System also provides certain services to foreign central banks, governments,
and international official institutions.
The FOMC, in the conduct of monetary policy, establishes policy regarding domestic open
market operations, oversees these operations, and annually issues authorizations and directives
to the FRBNY for its execution of transactions. FRBNY is authorized to conduct operations in domestic markets, including direct purchase and sale of U. S. government securities, the purchase
of securities under agreements to resell, the sale of securities under agreements to repurchase,


Federal Reserve Bank of Philadelphia

and the lending of U.S. government securities. FRBNY executes these open market transactions
and holds the resulting securities, with the exception of securities purchased under agreements to

Federal Reserve Bank
of Philadelphia

resell, in the portfolio known as the System Open Market Account (“SOMA”).
In addition to authorizing and directing operations in the domestic securities market, the
FOMC authorizes and directs FRBNY to execute operations in foreign markets for major currencies in order to counter disorderly conditions in exchange markets or to meet other needs
specified by the FOMC in carrying out the System’s central bank responsibilities. The FRBNY is
authorized by the FOMC to hold balances of, and to execute spot and forward foreign exchange
(“F/X”) and securities contracts for nine foreign currencies and to invest such foreign currency
holdings ensuring adequate liquidity is maintained. In addition, FRBNY is authorized to maintain
reciprocal currency arrangements (“F/X swaps”) with two central banks, and “warehouse” foreign
currencies for the U.S. Treasury and Exchange Stabilization Fund (“ESF”) through the Reserve
Banks. In connection with its foreign currency activities, FRBNY may enter into contracts that
contain varying degrees of off-balance-sheet market risk, because they represent contractual
commitments involving future settlement and counter-party credit risk. The FRBNY controls credit
risk by obtaining credit approvals, establishing transaction limits, and performing daily monitoring
Although Reserve Banks are separate legal entities, in the interests of greater efficiency and
effectiveness, they collaborate in the delivery of certain operations and services. The collaboration
takes the form of centralized competency centers, operations sites, and product or service offices
that have responsibility for the delivery of certain services on behalf of the Reserve Banks. Various
operational and management models are used and are supported by service agreements between
the Reserve Bank providing the service and the other eleven Reserve Banks. In some cases, costs
incurred by a Reserve Bank for services provided to other Reserve Banks are not shared; in other
cases, Reserve Banks are billed for services provided to them by another Reserve Bank.
Major services provided on behalf of the System by the Bank, for which the costs were not
redistributed to the other Reserve Banks, include: Collateral Management System, Electronic
Cash Letter System, Groupware Leadership Center, Subcommittee on Credit, Reserves, and Risk
Management Administration Office, and Treasury Direct Central Business Administration Function.
Beginning in 2005, the Reserve Banks adopted a new management model for providing
check services to depository institutions. Under this new model, the Federal Reserve Bank of Atlanta (“FRBA”) has the overall responsibility for managing the Reserve Banks’ provision of check
services and recognizes total System check revenue on its Statements of Income. FRBA compensates the other eleven Banks for the costs incurred to provide check services. This compensation is reported as “Compensation received for check services provided” in the Statements of
Income. If the management model had been in place in 2004, the Bank would have reported $29
million as compensation received for check services provided and $38 million in check revenue
would have been reported by FRB Atlanta rather than the Bank.

3. Significant Accounting Policies
Accounting principles for entities with the unique powers and responsibilities of the nation’s
central bank have not been formulated by the various accounting standard-setting bodies. The
Board of Governors has developed specialized accounting principles and practices that it believes
are appropriate for the significantly different nature and function of a central bank as compared


Federal Reserve Bank
of Philadelphia

with the private sector. These accounting principles and practices are documented in the Financial Accounting Manual for Federal Reserve Banks (“Financial Accounting Manual”), which is issued by the Board of Governors. All Reserve Banks are required to adopt and apply accounting
policies and practices that are consistent with the Financial Accounting Manual and the financial
statements have been prepared in accordance with the Financial Accounting Manual.
Differences exist between the accounting principles and practices in the Financial Accounting Manual and those generally accepted in the United States (“GAAP”) primarily due to the
unique nature of the Bank’s powers and responsibilities as part of the nation’s central bank. The
primary difference is the presentation of all security holdings at amortized cost, rather than using
the fair value presentation requirements in accordance with GAAP. Amortized cost more appropriately reflects the Bank’s security holdings given its unique responsibility to conduct monetary
policy. While the application of current market prices to the securities holdings may result in values
substantially above or below their carrying values, these unrealized changes in value would have
no direct affect on the quantity of reserves available to the banking system or on the prospects for
future Bank earnings or capital. Both the domestic and foreign components of the SOMA portfolio
may involve transactions that result in gains or losses when holdings are sold prior to maturity.
Decisions regarding security and foreign currency transactions, including their purchase and sale,
are motivated by monetary policy objectives rather than profit. Accordingly, market values, earnings, and any gains or losses resulting from the sale of such securities and currencies are incidental to the open market operations and do not motivate its activities or policy decisions.
In addition, the Bank has elected not to present a Statement of Cash Flows because the
liquidity and cash position of the Bank are not a primary concern given the Bank’s unique powers and responsibilities. A Statement of Cash Flows, therefore, would not provide any additional
meaningful information. Other information regarding the Bank’s activities is provided in, or may
be derived from, the Statements of Condition, Income, and Changes in Capital. There are no
other significant differences between the policies outlined in the Financial Accounting Manual and
The preparation of the financial statements in conformity with the Financial Accounting
Manual requires management to make certain estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Unique accounts and significant accounting
policies are explained below.
a. Gold and Special Drawing Rights Certificates
The Secretary of the U.S. Treasury is authorized to issue gold and special drawing rights
(“SDR”) certificates to the Reserve Banks.
Payment for the gold certificates by the Reserve Banks is made by crediting equivalent
amounts in dollars into the account established for the U.S. Treasury. These gold certificates
held by the Reserve Banks are required to be backed by the gold of the U.S. Treasury. The U.S.
Treasury may reacquire the gold certificates at any time and the Reserve Banks must deliver
them to the U.S. Treasury. At such time, the U.S. Treasury’s account is charged, and the Reserve
Banks’ gold certificate accounts are lowered. The value of gold for purposes of backing the gold
certificates is set by law at $42 2/9 a fine troy ounce. The Board of Governors allocates the gold
certificates among Reserve Banks once a year based on the average Federal Reserve notes
outstanding in each Reserve Bank.


Federal Reserve Bank of Philadelphia

Special drawing rights (“SDRs”) are issued by the International Monetary Fund (“Fund”) to its
members in proportion to each member’s quota in the Fund at the time of issuance. SDRs serve

Federal Reserve Bank
of Philadelphia

as a supplement to international monetary reserves and may be transferred from one national
monetary authority to another. Under the law providing for United States participation in the SDR
system, the Secretary of the U.S. Treasury is authorized to issue SDR certificates, somewhat like
gold certificates, to the Reserve Banks. At such time, equivalent amounts in dollars are credited
to the account established for the U.S. Treasury, and the Reserve Banks’ SDR certificate accounts
are increased. The Reserve Banks are required to purchase SDR certificates, at the direction of
the U.S. Treasury, for the purpose of financing SDR acquisitions or for financing exchange stabilization operations. At the time SDR transactions occur, the Board of Governors allocates SDR
certificate transactions among Reserve Banks based upon Federal Reserve notes outstanding in
each District at the end of the preceding year. There were no SDR transactions in 2005 or 2004.
b. Loans to Depository Institutions
All depository institutions that maintain reservable transaction accounts or nonpersonal time
deposits, as defined in regulations issued by the Board of Governors, have borrowing privileges at
the discretion of the Reserve Bank. Borrowers execute certain lending agreements and deposit
sufficient collateral before credit is extended. Loans are evaluated for collectibility, and currently all
are considered collectible and fully collateralized. If loans were ever deemed to be uncollectible,
an appropriate reserve would be established. Interest is accrued using the applicable discount
rate established at least every fourteen days by the Board of Directors of the Reserve Bank, subject to review by the Board of Governors.
c. U.S. Government Securities and Investments Denominated in Foreign Currencies
U.S. government securities and investments denominated in foreign currencies comprising
the SOMA are recorded at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a straight-line basis. Interest income is accrued on a straightline basis. Gains and losses resulting from sales of securities are determined by specific issues
based on average cost. Foreign-currency-denominated assets are revalued daily at current foreign currency market exchange rates in order to report these assets in U.S. dollars. Realized and
unrealized gains and losses on investments denominated in foreign currencies are reported as
“Foreign currency gains (losses), net.”
Activity related to U.S. government securities, including the related premiums, discounts,
and realized and unrealized gains and losses, is allocated to each Reserve Bank on a percentage
basis derived from an annual settlement of interdistrict clearings that occurs in April of each year.
The settlement equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding in each District. Activity related to investments in foreign-currency-denominated assets
is allocated to each Reserve Bank based on the ratio of each Reserve Bank’s capital and surplus
to aggregate capital and surplus at the preceding December 31.
d. U.S. Government Securities Sold Under Agreements to Repurchase and Securities
Securities sold under agreements to repurchase are accounted for as financing transactions
and the associated interest expense is recognized over the life of the transaction. These transactions are carried in the Statements of Condition at their contractual amounts and the related accrued interest is reported as a component of “Other liabilities.”


Federal Reserve Bank
of Philadelphia

U.S. government securities held in the SOMA are lent to U.S. government securities dealers
and to banks participating in U.S. government securities clearing arrangements in order to facilitate the effective functioning of the domestic securities market. Securities-lending transactions
are fully collateralized by other U.S. government securities and the collateral taken is in excess of
the market value of the securities loaned. The FRBNY charges the dealer or bank a fee for borrowing securities and the fees are reported as a component of “Other Income” in the Statements
of Income.
Activity related to U.S. government securities sold under agreements to repurchase and
securities lending is allocated to each Reserve Bank on a percentage basis derived from the
annual settlement of interdistrict clearings. Securities purchased under agreements to resell are
allocated to FRBNY and not to the other Banks.
e. Foreign Currency Swaps and Warehousing
F/X swap arrangements are contractual agreements between two parties to exchange specified currencies, at a specified price, on a specified date. The parties agree to exchange their
currencies up to a pre-arranged maximum amount and for an agreed-upon period of time (up to
twelve months), at an agreed-upon interest rate. These arrangements give the FOMC temporary
access to the foreign currencies it may need to intervene to support the dollar and give the counterparty temporary access to dollars it may need to support its own currency. Drawings under the
F/X swap arrangements can be initiated by either FRBNY or the counterparty (the drawer) and
must be agreed to by the drawee. The F/X swaps are structured so that the party initiating the
transaction bears the exchange rate risk upon maturity. FRBNY will generally invest the foreign
currency received under an F/X swap in interest-bearing instruments.
Warehousing is an arrangement under which the FOMC agrees to exchange, at the request
of the U.S. Treasury, U.S. dollars for foreign currencies held by the U.S. Treasury or ESF over a
limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar
resources of the U.S. Treasury and ESF for financing purchases of foreign currencies and related
international operations.
Foreign currency swaps and warehousing agreements are revalued daily at current market
exchange rates. Activity related to these agreements, with the exception of the unrealized gains
and losses resulting from the daily revaluation, is allocated to each Reserve Bank based on the
ratio of each Reserve Bank’s capital and surplus to aggregate capital and surplus at the preceding
December 31. Unrealized gains and losses resulting from the daily revaluation are allocated to
FRBNY and not to the other Reserve Banks.
f. Bank Premises, Equipment, and Software
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over estimated useful lives of assets ranging from two to
fifty years. Major alterations, renovations, and improvements are capitalized at cost as additions
to the asset accounts and are amortized over the remaining useful life of the asset. Maintenance,
repairs, and minor replacements are charged to operating expense in the year incurred. Capitalized assets including software, building, leasehold improvements, furniture, and equipment are
impaired when it is determined that the net realizable value is significantly less than book value
and is not recoverable.
Costs incurred for software, either developed internally or acquired for internal use, during
the application development stage are capitalized based on the cost of direct services and materi-


Federal Reserve Bank of Philadelphia

als associated with designing, coding, installing, or testing software. Capitalized software costs
are amortized on a straight-line basis over the estimated useful lives of the software applications,

Federal Reserve Bank
of Philadelphia

which range from two to five years.
g. Interdistrict Settlement Account
At the close of business each day, each Reserve Bank assembles the payments due to or
from other Reserve Banks as a result of the day’s transactions that involve depository institution
accounts held by other Districts. Such transactions may include funds settlement, check clearing, and ACH operations. The cumulative net amount due to or from the other Reserve Banks is
reflected in the “Interdistrict settlement account” in the Statements of Condition.
h. Federal Reserve Notes
Federal Reserve notes are the circulating currency of the United States. These notes are
issued through the various Federal Reserve agents (the Chairman of the Board of Directors of
each Reserve Bank) to the Reserve Banks upon deposit with such agents of certain classes of
collateral security, typically U.S. government securities. These notes are identified as issued to a
specific Reserve Bank. The Federal Reserve Act provides that the collateral security tendered by
the Reserve Bank to the Federal Reserve agent must be equal to the sum of the notes applied for
by such Reserve Bank.
Assets eligible to be pledged as collateral security include all Bank assets. The collateral
value is equal to the book value of the collateral tendered, with the exception of securities, whose
collateral value is equal to the par value of the securities tendered. The par value of securities
pledged for securities sold under agreements to repurchase is deducted.
The Board of Governors may, at any time, call upon a Reserve Bank for additional security
to adequately collateralize the Federal Reserve notes. To satisfy the obligation to provide sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks have entered into an
agreement that provides for certain assets of the Reserve Banks to be jointly pledged as collateral
for the Federal Reserve notes of all Reserve Banks. In the event that this collateral is insufficient,
the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien
on all the assets of the Reserve Banks. Finally, as obligations of the United States, Federal Reserve notes are backed by the full faith and credit of the United States government.
The “Federal Reserve notes outstanding, net” account represents the Bank’s Federal Reserve notes outstanding, reduced by the currency issued to the Bank but not in circulation, of
$6,130 million, and $7,973 million at December 31, 2005 and 2004, respectively.
i. Items in Process of Collection and Deferred Credit Items
The balance in the “Items in process of collection” line in the Statements of Condition primarily represents amounts attributable to checks that have been deposited for collection by the
payee depository institution and, as of the balance sheet date, have not yet been collected from
the payor depository institution. Deferred credit items are the counterpart liability to items in process of collection, and the amounts in this account arise from deferring credit for deposited items
until the amounts are collected. The balances in both accounts can fluctuate and vary significantly
from day to day.
j. Capital Paid-in
The Federal Reserve Act requires that each member bank subscribe to the capital stock of


Federal Reserve Bank
of Philadelphia

the Reserve Bank in an amount equal to 6 percent of the capital and surplus of the member bank.
These shares are nonvoting with a par value of $100 and may not be transferred or hypothecated.
As a member bank’s capital and surplus changes, its holdings of Reserve Bank stock must be
adjusted. Currently, only one-half of the subscription is paid-in and the remainder is subject to call.
By law, each Bank is required to pay each member bank an annual dividend of 6 percent on the
paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable for
Reserve Bank liabilities up to twice the par value of stock subscribed by it.
k. Surplus
The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount
of capital paid-in as of December 31. This amount is intended to provide additional capital and
reduce the possibility that the Reserve Banks would be required to call on member banks for additional capital. Pursuant to Section 16 of the Federal Reserve Act, Reserve Banks are required
by the Board of Governors to transfer to the U.S. Treasury as interest on Federal Reserve notes
excess earnings, after providing for the costs of operations, payment of dividends, and reservation
of an amount necessary to equate surplus with capital paid-in.
In the event of losses or an increase in capital paid-in at a Reserve Bank, payments to the
U.S. Treasury are suspended and earnings are retained until the surplus is equal to the capital
paid-in. Weekly payments to the U.S. Treasury may vary significantly.
In the event of a decrease in capital paid-in, the excess surplus, after equating capital paidin and surplus at December 31, is distributed to U.S. Treasury in the following year. This amount is
reported as a component of “Payments to U.S. Treasury as interest on Federal Reserve notes”.
l. Income and Costs Related to U.S. Treasury Services
The Bank is required by the Federal Reserve Act to serve as fiscal agent and depository of
the United States. By statute, the Department of the Treasury is permitted, but not required, to
pay for these services.
The Treasury and other government agencies reimbursement process for all Reserve Banks
is centralized at the Bank. Each Reserve Bank transfers its Treasury reimbursement receivable
to the Bank. The reimbursement receivable is reported in “Other assets” and totaled $67 million
and $53 million at December 31, 2005 and 2004, respectively. The cost of unreimbursed Treasury
services, is reported in “Other expense” and totaled $19 thousand and $10 thousand at December
31, 2005 and 2004, respectively.
m. Assessments by the Board of Governors
The Board of Governors assesses the Reserve Banks to fund its operations based on each
Reserve Bank’s capital and surplus balances. The Board of Governors also assesses each Reserve Bank for the expenses incurred for the U.S. Treasury to issue and retire Federal Reserve
notes based on each Reserve Bank’s share of the number of notes comprising the System’s net
liability for Federal Reserve notes on December 31 of the previous year.
n. Taxes
The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real
property. The Bank’s real property taxes were $2 million for both years ended December 31, 2005
and 2004 and are reported as a component of “Occupancy expense.” 	


Federal Reserve Bank of Philadelphia

o. Restructuring Charges
In 2003, the System began the restructuring of several operations, primarily check, cash,

Federal Reserve Bank
of Philadelphia

and U.S. Treasury services. The restructuring included streamlining the management and support structures, reducing staff, decreasing the number of processing locations, and increasing
processing capacity in the remaining locations. These restructuring activities continued in 2004
and 2005.

4. U.S. Government Securities, Securities Sold Under Agreements to
Repurchase, and Securities Lending
The FRBNY, on behalf of the Reserve Banks, holds securities bought outright in the SOMA.
The Bank’s allocated share of SOMA balances was approximately 3.547 percent and 2.974 percent at December 31, 2005 and 2004, respectively.
The Bank’s allocated share of U.S. Government securities, net, held in the SOMA at December 31, was as follows (in millions):



Par value:		
U.S. government:	















Total par value		



Unamortized premiums		



Unaccreted discounts		




Total allocated to Bank	



$	 21,581

The total of the U.S. government securities, net held in the SOMA was $750,202 million and
$725,584 million at December 31, 2005 and 2004, respectively.
At December 31, 2005 and 2004, the total contract amount of securities sold under
agreements to repurchase was $30,505 million and $30,783 million, respectively, of which $1,082
million and $916 million, were allocated to the Bank. The total par value of the SOMA securities
pledged for securities sold under agreements to repurchase at December 31, 2005 and 2004 was
$30,559 million and $30,808 million, respectively, of which $1,084 million and $916 million was
allocated to the Bank.


Federal Reserve Bank
of Philadelphia

The maturity distribution of U.S. government securities bought outright and securities sold
under agreements to repurchase, that were allocated to the Bank at December 31, 2005, was as
follows (in millions):	



U.S. Government 	

Securities Sold Under 	


Maturities of	


Agreements to Repurchase


Securities Held	

(Par value)	

(Contract amount)


Within 15 days	






16 days to 90 days		




91 days to 1 year		




Over 1 year to 5 years		




Over 5 years to 10 years		




Over 10 years		









At December 31, 2005 and 2004, U.S. government securities with par values of $3,776
million and $6,609 million, respectively, were loaned from the SOMA, of which $134 million and
$197 million, respectively, were allocated to the Bank.

5. Investments Denominated in Foreign Currencies
The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign
central banks and the Bank for International Settlements and invests in foreign government debt
instruments. Foreign government debt instruments held include both securities bought outright
and securities purchased under agreements to resell. These investments are guaranteed as to
principal and interest by the foreign governments.
The Bank’s allocated share of investments denominated in foreign currencies was
approximately 2.497 percent and 2.923 percent at December 31, 2005 and 2004, respectively.
The Bank’s allocated share of investments denominated in foreign currencies, including
accrued interest, valued at current foreign currency market exchange rates at December 31, was
as follows (in millions):


European Union Euro:	



Foreign currency deposits	



Securities purchased under agreements to resell		




Government debt instruments		



Japanese Yen:	







Foreign currency deposits 		



Government debt instruments		






Federal Reserve Bank of Philadelphia



Total System investments denominated in foreign currencies were $18,928 million and
$21,368 million at December 31, 2005 and 2004, respectively.

Federal Reserve Bank
of Philadelphia

The maturity distribution of investments denominated in foreign currencies which were
allocated to the Bank at December 31, 2005, was as follows (in millions):

Maturities of Investments	


Denominated in 	




Foreign Currencies	





Within 15 days	


16 days to 90 days		




91 days to 1 year		





Over 1 year to 5 years		





Over 5 years to 10 years		







Total		 $







200 		 $


At December 31, 2005 and 2004, there were no material open or outstanding foreign
exchange contracts.
At December 31, 2005 and 2004, the warehousing facility was $5,000 million, with no
balance outstanding.

6. Bank Premises, Equipment, and Software
A summary of bank premises and equipment at December 31 is as follows (in millions):

Useful Life Range


(in Years)	




Bank premises and equipment:














Building machinery and equipment	





Construction in progress	





Furniture and equipment	












Accumulated depreciation			



Bank premises and equipment, net		






Depreciation expense, for the years ended		






Federal Reserve Bank
of Philadelphia

The Bank leases space to an outside tenant with a lease term of 5 years. Rental income
from such lease was $1 million for both years ended December 31, 2005 and 2004. Future
minimum lease payments under the noncancelable agreement in existence at December 31,
2005, were (in millions):







The Bank has capitalized software assets, net of amortization, of $10 million and $8 million
at December 31, 2005 and 2004, respectively. Amortization expense was $1 million for both years
ended December 31, 2005 and 2004. Capitalized software assets are reported as a component of
“Other assets” and related amortization is reported as a component of “Other expenses.”
Assets impaired either as a result of the Bank’s restructuring plan, as discussed in footnote
10, or the Bank’s decision to increase efficiency, included equipment. Asset impairment losses of
$466 thousand for the period ending December 31, 2005 was determined using fair values based
on quoted market values or other valuation techniques and are reported as a component of “Other
expenses.” The Bank had no impairment losses in 2004.

7. Commitments and Contingencies
At December 31, 2005, the Bank was obligated under noncancelable leases for premises
and equipment with terms of approximately one year. These leases provide for increased rental
payments based upon increases in real estate taxes, operating costs, or selected price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data
processing and office equipment (including taxes, insurance and maintenance when included in
rent), net of sublease rentals, was $1 million for both years ended December 31, 2005 and 2004.
Certain of the Bank’s leases have options to renew. The Bank has no capital leases.
Future minimum rental payments under noncancelable operating leases with terms of one
year or more, at December 31, 2005, were not material.
At December 31, 2005, the Bank, acting on behalf of the Reserve Banks, had a contractual
commitment extending through the year 2008 totaling $7 million. As of December 31, 2005, $7
million of this commitment was recognized. This commitment represents software licenses and
maintenance. The fixed payments under this commitment are $2 million for both years 2006 and
Under the Insurance Agreement of the Federal Reserve Banks, each Reserve Bank has
agreed to bear, on a per incident basis, a pro rata share of losses in excess of one percent of
the capital paid-in of the claiming Reserve Bank, up to 50 percent of the total capital paid-in of all
Reserve Banks. Losses are borne in the ratio that a Reserve Bank’s capital paid-in bears to the


Federal Reserve Bank of Philadelphia

total capital paid-in of all Reserve Banks at the beginning of the calendar year in which the loss is
shared. No claims were outstanding under such agreement at December 31, 2005 or 2004.

Federal Reserve Bank
of Philadelphia

The Bank is involved in certain legal actions and claims arising in the ordinary course of
business. Although it is difficult to predict the ultimate outcome of these actions, in management’s
opinion, based on discussions with counsel, the aforementioned litigation and claims will be
resolved without material adverse effect on the financial position or results of operations of the

8. Retirement and Thrift Plans
Retirement Plans
The Bank currently offers three defined benefit retirement plans to its employees, based on
length of service and level of compensation. Substantially all of the Bank’s employees participate
in the Retirement Plan for Employees of the Federal Reserve System (“System Plan”). Employees
at certain compensation levels participate in the Benefit Equalization Retirement Plan (“BEP”) and
certain Bank officers participate in the Supplemental Employee Retirement Plan (“SERP”).
The System Plan is a multi-employer plan with contributions fully funded by participating
employers. Participating employers are the Federal Reserve Banks, the Board of Governors of
the Federal Reserve System, and the Office of Employee Benefits of the Federal Reserve System.
No separate accounting is maintained of assets contributed by the participating employers. The
FRBNY acts as a sponsor of the System Plan and the costs associated with the Plan are not
redistributed to other participating employers. The Bank’s benefit obligation and net pension costs
for the BEP and the SERP at December 31, 2005 and 2004, and for the years then ended, are
not material.
Thrift Plan
Employees of the Bank may also participate in the defined contribution Thrift Plan for
Employees of the Federal Reserve System (“Thrift Plan”). The Bank’s Thrift Plan contributions
totaled $3 million for both years ended December 31, 2005 and 2004 and are reported as a
component of “Salaries and other benefits.” The Bank matches employee contributions based on
a specified formula. For the years ended December 31, 2005 and 2004, the Bank matched 80
percent on the first 6 percent of employee contributions for employees with less than five years of
service and 100 percent on the first 6 percent of employee contributions for employees with five
or more years of service.

9. Postretirement Benefits Other Than Pensions and Postemployment
Postretirement Benefits Other Than Pensions
In addition to the Bank’s retirement plans, employees who have met certain age and length
of service requirements are eligible for both medical benefits and life insurance coverage during
The Bank funds benefits payable under the medical and life insurance plans as due and,
accordingly, has no plan assets.


Federal Reserve Bank
of Philadelphia

Following is a reconciliation of beginning and ending balances of the benefit obligation (in


Accumulated postretirement benefit obligation at January 1	





Service cost-benefits earned during the period		



Interest cost of accumulated benefit obligation		



Actuarial (gain) loss		



Contributions by plan participants		



Benefits paid		



Plan amendments		



Accumulated postretirement benefit obligation at December 31	 $	




At December 31, 2005 and 2004, the weighted-average discount rate assumptions used
in developing the postretirement benefit obligation were 5.50 percent and 5.75 percent, respectively.
Discount rates reflect yields available on high quality corporate bonds that would generate
the cash flows necessary to pay the plan’s benefits when due.
Following is a reconciliation of the beginning and ending balance of the plan assets, the
unfunded postretirement benefit obligation, and the accrued postretirement benefit costs (in millions):


Fair value of plan assets at January 1	


Actual return on plan assets		






Contributions by the employer		



Contributions by plan participants		



Benefits paid		



Fair value of plan assets at December 31	





Unfunded postretirement benefit obligation	





Unrecognized prior service cost		


Unrecognized net actuarial loss		


Accrued postretirement benefit costs	





Accrued postretirement benefit costs are reported as a component of “Accrued benefit


Federal Reserve Bank of Philadelphia

For measurement purposes, the assumed health care cost trend rates at December 31 are
as follows:


Health care cost trend rate assumed for next year	

Federal Reserve Bank
of Philadelphia


9.00 %	

9.00 %

Rate to which the cost trend rate is assumed to decline
(the ultimate trend rate)	

5.00 %	

4.75 %

Year that the rate reaches the ultimate trend rate	



Assumed health care cost trend rates have a significant effect on the amounts reported for
health care plans. A one percentage point change in assumed health care cost trend rates would
have the following effects for the year ended December 31, 2005 (in millions):

One Percentage	 One Percentage


Point Increase	

Point Decrease

Effect on aggregate of service and interest cost components
	 of net periodic postretirement benefit costs	


Effect on accumulated postretirement benefit obligation		





The following is a summary of the components of net periodic postretirement benefit costs
for the years ended December 31 (in millions):


Service cost-benefits earned during the period	





Interest cost of accumulated benefit obligation		



Amortization of prior service cost		



Recognized net actuarial loss		





Total periodic expense	



Curtailment gain		



Net periodic postretirement benefit costs (credit)	





Net postretirement benefit costs are actuarially determines using a January 1 measurement
date. At January 1, 2005 and 2004, the weighted-average discount rate assumptions used to
determine net periodic postretirement benefit costs were 5.75 percent and 6.25 percent, respectively.
Net periodic postretirement benefit costs are reported as a component of “Salaries and
other benefits.”


Federal Reserve Bank
of Philadelphia

A plan amendment that modified the credited service period eligibility requirements created
curtailment gains in 2004.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established
a prescription drug benefit under Medicare (“Medicare Part D”) and a federal subsidy to sponsors
of retiree health care benefit plans that provide benefits that are at least actuarially equivalent to
Medicare Part D. The benefits provided by the Bank’s plan to certain participants are at least actuarially equivalent to the Medicare Part D prescription drug benefit. The estimated effects of the
subsidy, retroactive to January 1, 2004, are reflected in actuarial gain in the accumulated postretirement benefit obligation and in actuarial loss in the net periodic postretirement benefit costs.
Following is a summary of expected benefit payments (in millions):


Expected benefit payments:	

Without Subsidy	





























With Subsidy



Postemployment Benefits
The Bank offers benefits to former or inactive employees. Postemployment benefit costs
are actuarially determined using a December 31, 2005 measurement date and include the cost
of medical and dental insurance, survivor income, and disability benefits. The accrued postemployment benefit costs recognized by the Bank at December 31, 2005 and 2004 were $5 million
and $6 million, respectively. This cost is included as a component of “Accrued benefit costs.” Net
periodic postemployment benefit costs included in 2005 and 2004 operating expenses were $20
thousand and ($1) million, respectively and are recorded as a component of “Salaries and other

10. Business Restructuring Charges
In 2005, the System announced plans for consolidation and restructuring to streamline operations and reduce costs, including consolidation of operations and staff reductions in various
functions of several Banks. The Bank’s costs associated with the restructuring were not material.


Federal Reserve Bank of Philadelphia

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102