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FE D E R A L R E S E R V E B A N K OF D A L L A S
S t a t i o n K, D allas, T e x a s 7 5 2 2 2

C i r c u l a r No. 84-49
April 5,1984

TO:

All d e p o s i t o r y i n s t i t u t i o n s
Reserve D i s t r i c t

ATTENTION:

Chief Executive O f f i c e r

SUBJECT:

Private sector adjustment factor

SUGARY:

The Board o f Governors o f th e Federal Reserve System
has
approved
revisions
to
its
procedure f o r
c a l c u l a t i o n of the p r i v a t e s e c t o r a dj us t me nt f a c t o r
(PSAF) f o r 1984.

ATTACHMENTS:

A copy o f t he Bo ar d' s p r e s s r e l e a s e and n o t i c e as
p ub li s he d in t he Federal R e g i s t e r

MORE INFORMATION:

Lyne H. C a r t e r , (214)
Tu r ne r , (214) 651-6460

ADDITIONAL COPIES:

P ubl i c A f f a i r s Department, Extension 6289

in the Eleventh Federal

651-6175

or

Michael

Banks and others are encouraged to use the follow ing incom ing W A TS numbers in contacting this Bank: 1-800-442-7140
(in trastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the extension referred to above.

N.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

---

FEDERAL RESERVE pressrelease
For immediate r e l e a s e

March 21, 1984

The Federal Reserve Board has approved r e v i s i o n s t o i t s procedure f o r
c a l c u l a t i o n of t h e p r i v a t e s e c t o r a d j us t me nt f a c t o r (PSAF).

The PSAF i s an

allowance f o r t h e t a x e s t h a t would have been paid and t h e r e t u r n on c a p i t a l t h a t
would have been provided had t h e Federal R e s e r v e ' s p r i c e d s e r v i c e s been f u r n i s h e d
by a p r i v a t e s e c t o r f i r m .
The r e v i s i o n s t o t h e proc edure used in c a l c u l a t i n g t h e PSAF f o r 1984
will be as f ol l ows :
•

Expansion of t h e sample used t o c a l c u l a t e t h e PSAF from t h e 12 t o
t h e 25 l a r y e s t bank holding companies. The bank holding company
with t h e h i g h e s t and t h e lowest r e t u r n on e q u i t y in t h e sample
w i l 1 be e xcl uded.

•

Employment of t h e d i r e c t d e t e r m i n a t i o n methodology f o r e s t a b ­
l i s h i n g t h e a s s e t base used f o r computing t h e PSAF.

•

I n c l u s i o n of t h e n et e f f e c t of t h o s e a s s e t s expected to be ac­
q u i r e d and di sp ose d of d ur in g 1984 in t h e p r i c e d s e r v i c e s a s s e t
base.

•

Recovery o f t h e e s t i m a t e d s a l e s t a x e s
on t h e pu rc ha se s of c e r t a i n goods and
Banks were s u b j e c t t o such t a x e s .

•

I n c l u s i o n of t h o s e p o r t i o n s of expenses and f i x e d a s s e t s of t h e
Board of Governors r e l a t e d t o t h e development of p r i c e d s e r v i c e s .

•

I n c l u s i o n of an imput at io n f o r FDIC i n s u r a n c e a s s e s s m e n t .

§

Removal of t h e f i n a n c i n g c o s t s of n et a dj us t me nt f l o a t from t h e
a s s e t base because such f l o a t i s now p r i ce d e x p l i c i t l y .

t h a t would have been paid
s e r v i c e s i f t h e Reserve

In a d d i t i o n , t h e t a x r a t e used in t h e PSAF c a l c u l a t i o n wi l l be based
on t h e r a t i o of c u r r e n t F e d e r a l , s t a t e , and l o c a l income t a x e s to t o t a l t a x a b l e
income of t h e bank ho ld ing companies i n c l ud e d in t h e sample.
The B oar d' s n o t i c e i s a t t a c h e d .
Attachment

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices

11251

FEDERAL RESERVE SYSTEM
[D o ck et No. R-0485]

Private Sector Adjustment Factor
Board of Governors.
Approval of methodology for
calculating the Private Sector
Adjustment Factor for 1984.

agency:
a c t io n :

The Board has approved the
methodology for calculating the Private
Sector Adjustment Factor (PSAF) for
1984. The PSAF is a recovery of the
imputed costs which takes into account
the taxes that would have been paid and
the return on capital that would have
SUMMARY:

11252

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices

been provided had the Federal Reserve’s
priced services been furnished by a
private business firm. The estimated
recovery through the PSAF in 1984 will
be $5.8 million .
EFFECTIVE d a t e : January 1,1984.
FOR FURTHER INFORMATION CONTACT:

David L. Robinson, Associate Director
(202/452-3806) or Earl G. Hamilton,
Assistant Director (202/452-3974),
Division of Federal Reserve Bank
Operations; Gilbert T. Schwartz,
Associate General Counsel (202/4523625), Daniel L. Rhoads, Attorney (202/
452-3711), or Robert G. Ballen, Attorney
(202/452-3265), Legal Division, Board of
Governors of the Federal Reserve
System, Washington, D.C. 20551.
SUPPLEMENTARY INFORMATION:

Background
The Monetary Control Act of 1980
(Title I of Pub. L. 96-221) provides that
over the long run, fees for the Federal
Reserve's priced services are to be
based upon costs, including the “taxes
that would have been paid and the
return on capital that would have been
provided had the services been
furnished by a private business firm.”
The Private Sector Adjustment Factor
(“PSAF") is the vehicle that facilitates
the imputation of these taxes and
capital costs to the Federal Reserve.
In October 1983 the Board requested
comment on a proposal to revise the
methodology used to calculate the PSAF
for 1984. The proposed revisions
included:
—Use of the direct determination method for
establishing the asset base used for
computing the PSAF.
—Expansion of the sqmpie used to calculate
the PSAF from the the 12 to the 25 largest
bank holding companies.
—Calculation of the Federal Reserve’s asset
base to reflect the value of assets expected
to be acquired and disposed of in 1984.
—Removal of the financing costs of net
adjustment float from the asset base
because such float is priced explicitly.
—Recovery of the estimated sales taxes that
would have been paid on the purchase of
certain goods and services if the Reserve
Banks were subject to such taxes.
—Recovery of expenses incurred by Board
staff working directly on the development
of priced services and inclusion of the
portion of the Board assets employed in
this specific activity in the PSAF asset
base.
—Capitalization of Federal Reserve leases
that become effective on or after January 1,
1984, that meet the criteria for
capitalization as set forth in PSAF
Statement 13.

In addition to these revisions, the Board
requested comment on an alternative
method of determining the income tax
rate used in calculating the PSAF. It was

estimated that the net effect of these
proposed changes would be to require a
recovery of approximately $56.2 million
through the PSAF in 1984. The Board
also requested comment on a proposed
adjustment to the method for calculating
earnings credits on clearing balances to
take into account reserve requirements
the Reserve Banks would be subject to if
they were subject to reserve
requirements.
Analysis o f Comments. A total of 45
commenters responded to the Board’s
request for comment, including seven
Reserve Banks. Of the 38 non-Reserve
Banks comments, 32 were received from
banks and bank holding companies and
four from banking industry trade groups.
Responses were also received from one
thrift institution and one congressman.
A majority of the commenters discussing
specific issues agreed that the proposals
concerning the use of the direct
determination method, calculation of the
Federal Reserve’s asset base to reflect
the value of assets to be acquired and
disposed of in 1984, recovery of
estimated sales taxes, recovery of
estimated expenses incurred by Board
staff working directly on the
development of priced services, and the
inclusion of the capitalized leases in the
asset base used to calculate the PSAF
were appropriate. The majority of
commenters also supported the
exclusion of shipping expenses from the
PSAF calculation. Commenters were
divided on the issues of the bank
holding company model and its
expansion from the twelve to the 25
largest bank holding companies, the tax
rate methodology, the continued use of
book values as the basis of asset base
calculation, and the exclusion of net
adjustment float from the short-term
asset base.
Objections to the proposal stemmed
mainly from opposition to the Federal
Reserve’s use of bank holding
companies as the model for estimating
an imputed cost of capital, tax rate, and
the short term assests to be included in
the PSAF calculation.
A. Choice o f Model—Thirty-four
commenters discussed the Board’s
proposal to continue using large bank
holding companies as the model upon
which to construct the PSAF and to
expand the sample size from the twelve
largest bank holding companies to the 25
largest bank holding companies.
Seventeen commenters supported the
use of the bank holding company model
on the basis that the model represented
those institutions that the Federal
Reserve directly competed with in the
provision of priced services. Several
commenters supported expanding the
sample size from the 12 largest bank

holding companies to the 25 largest bank
holding companies, stating that the
expansion would present a more
accurate representation of the market.
Seventeen commenters were opposed
to the use of bank holding companies as
the model and stated that data
processing corporations were the most
appropriate model. These commenters
believe that the priced service business
of the Federal Reserve Banks most
closely resembles the services offered
by data processing corporations.They
also believe that using a large bank
holding company model is inappropiate
because the large majority of a bank
holding company’s activities are
unrelated to the services the Federal
Reserve Banks offer. Many of the
commenters who opposed the proposal
stated that if the Federal Reserve was
going to continue the use of bank
holding companies as the model, it
would have to include more assets like
cash and cash items in the process of
collection to make the pro forma
balance sheet of the Federal Reserve
System consistent with consolidated
bank holding company balance sheets.
The Board carefully considered
alternative models such utilities, bank
holding companies, and data processing
companies. Determining whether the
cost of capital that the Federal Reserve
would actually incur in the market
would be higher or lower than that
associated with bank holding
companies, or any other industry model,
involves the consideration of a number
of factors, particularly in view of the
Federal Reserve’s unique blend of public
and private characteristics. The Board
believes that an analysis of all
reasonable alternatives strongly
reinforces the view that the bank
holding company model is the most
reasonable and logical choice.
The Board recognizes, as some
commenters pointed out, that bank
holding companies engage in numerous
activities other than correspondent bank
services. However, the correspondent
services of bank holding companies
most closely resemble the priced
services activities of the Federal
Reserve, and large banking
organizations are the major—and for
many services virtually the only—direct
competitors of the Federal Reserve.
Therefore, since the correspondent
operations of a bank holding company
have the same cost of capital that
accrues to the bank holding company as
a whole, the Board believes it is
appropriate to impute capital costs to
the Federal Reserve based on the capital
costs an structure of bank holding
companies.

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices
Certain aspects of the Federal
Reserve’s provision of priced services
are more analogous to utilities or
government-sponsored enterprises,
which have a lower cost of capital than
that implied by the bank holding
company model. The Federal Reserve
was directed by the Congress to provide
an adequate level of service nationwide
and must, therefore, serve all depository
institutions regardless of size or
location. Moreover, reflecting the
Federal Reserve’s public role, it should
not be an aggressive, high growth, profit
maximizing entity. It should, of course,
earn an reasonable rate of return—a test
that seems more than adequately
provided for in the use of the bank
holding company model.
The principal alternative to the bank
holding company model suggested by a
number of commenters is the use of a
model based on data processing
companies. The argument that nonbank
data processors would privide a better
model than bank holding companies
rests on two major assumptions: First,
these firms provide payments services
that are similar to those of the Federal
Reserve Banks; and, second, a stand­
alone Federal Reserve priced service
entity would have the financial
characteristics of those data processing
companies.
Given the disparities between the
services of data processing companies
and the services provided by the Federal
Reserve, data processors are not the
appropriate model for the PSAF. A
thorough review of the activities of six
data processors suggested by some of
the commenters clearly indicates that
the assertion of similar activities is not
supported by the facts. All six of these
firms provide a wide variety of
computer-related services in many fields
unrelated to the financial industry. As a
result, the fortunes of these data
processors are tied to developments in
activities far removed from the Federal
Reserve. Moreover, the data processors
incur none of the basic costs associated
with the business of banking, such as
the cost of associated vault space or
protection equipment for securities
safekeeping operations or the cost of
specialized equipment and
transportation necessary for processing
and delivering checks.
To the very limited extent that the
activities of the data processors are at
all comparable to those of the Federal
Reserve, they generally only perform a
portion of the services provided by the
Federal Reserve. For example, the data
processors perform only one step in the
payments process—the recording and
transfer of payments information. The

Federal Reserve, in contrast, performs
many, and in some cases all, of the steps
that take place as payments are made.
The large banks that are subsidiaries of
bank holding companies, either directly
or through joint ventures, provide
virtually every service offered by the
Federal Reserve.
Finally, the six data processors
specifically suggested by some
commenters apparently do not subscribe
to the view that their activities are
similar to those of the Federal Reserve.
None of these six firms includes the
Federal Reserve as a competitor in the
discussion of competitors section of its
Form 10-K filed with the Securities and
Exchange Commission. Further, only one
of the six has ever commented on a
single occasion on any of the Federal
Reserve’s pricing proposals, with that
comment limited to a narrow point
unrelated to the PSAF. Finally, no data
processor commented on the proposed
1984 PSAF methodology. The one bank
service corporation that commented on
the proposal supported the use of large
bank holding companies as the
appropriate model.
The second argument for the data
processing company model is that the
capital structure and returns of these
companies should constitute the Federal
Reserve’s financial operating targets. It
is clear that these firms are high-growth,
technologically oriented operations—a
fact suggested by the variability of their
stock prices relative to stock prices
generally. However, the Board does not
believe that it should be the objective of
the Federal Reserve to mirror the
performance of these specialized firms;
to suggest that the Federal Reserve
should conduct its priced services with a
view toward achieving financial
objectives of that nature would seem to
be in conflict with the very essence of
the Federal Reserve’s historical and
public interest payments mechanism
operations.
With regard to the application of the
bank holding company model, twelve
commenters supported expanding the
model size to include the 25 largest bank
holding companies, but some suggested
that the sample include those bank
holding companies that are most heavily
involved in the correspondent banking
business. An analysis indicates that the
use of a sample comprised of the 25
largest correspondent banks ranked by
“due to” balances has virtually no
impact on the PSAF.
Another issue raised by some
commenters stems from the fact that the
market price of the stock of certain bank
holding companies used in the model is
well below the book value of such stock.

11253

As a result, suggestions have been made
that the return on equity implied for the
Federal Reserve by this jnodel is too
low. Specifically, some commenters
argued that pre-tax and after-tax income
targeted by the Federal Reserve should
result from an income stream that would
be large enough to equate market and
book value of stock.
In response to this comment, the cost
of equity component of the PSAF was
calculated for several samples of bank
holding companies with differing
relationships of market value to book
value for their stock. The calculations
indicate that the holding companies with
the highest market-to-book ratios had
higher returns on equity than the
companies with the lowest ratios.
Overall, however, the absolute amount
of the differences were relatively small.
In order to create a more regionally
diverse sample and avoid distortions in
the PSAF calculation due to institutions
at the extremes, the Board believes it is
reasonable to use the sample of the 25
largest bank holding companies.
However, to avoid unusual distortions,
the bank holding companies with the
lowest and the highest returns on equity
will be eliminated from the 25 company
sample before the actual calculations
are made. Should changing market-tobook relationships imply any material
affect on PSAF recoveries, the choice of
the 25 largest bank holding companies
as the basis for the PSAF calculation
will be reevaluated.
There are other factors that constrain
in the income stream generated by the
Federal Reserve’s priced service
operations. The most significant of these
is that the Federal Reserve does not
have the same “profit maximization”
objectives as a private firm. For
example, the Federal Reserve’s priced
service operations have limited
investment opportunity. Specifically, the
Federal Reserve’s investments are, by
assumption, limited to Treasury bills,
whereas any profit maximizing firm
would hold a substantial portion of its
investments in higher yielding
instruments.
B. Book Value o f Physical Assets —
Twenty-five commenters discussed the
use of book value of physical assets in
the calculation of the PSAF. Thirteen
commenters supported the use of book
value to determine the value of physical
assets as being consistent with the
practices in the private sector and
among bank holding companies.
Twelve commenters opposed the use
of book value and supported the use of
current market value to determine the
value of physical assets, many stating
that a book value system used for

11254

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices

accounting or tax purposes is
inappropriate for pricing, investment, or
production decisions. Several
commenters noted that the use of book
value causes geographic distortions
between Federal Reserve Districts with
new buildings and those with old
buildings, and suggested that the
Federal Reserve follow Financial
Accounting Standards Board (FASB)
Statement number 33 which requires
reporting of assets at current value.
The Board continues to believe that
the practice of using book value for
physical asset valuation is appropriate.
The practice of using book value for
property, plant, and equipment is
consistent with banking industry
practice and with generally accepted
accounting principles. Moreover,
establishing financial performance
standards based upon historical costs is
a prevalent practice throughout the
private sector. Furthermore, under the
provisions of FASB Statement number
33 (the accounting profession’s current
methodology for supplementary
disclosure of inflation-adjusted financial
data), if assets were revalued to reflect
market value rather than book value, an
adjustment would also have to be made
in income. Finally, since a market value
accounting system does not exist, the
Federal Reserve—like all other
entities—has no practical choice other
than the use of net book values.
The use of market valuation of
physical assets has theoretical appeal
because the use of net book value by the
Federal Reserve or the banking industry
could result in distortions and
inefficiences if book values were far
removed from market values. Such does
not appear to be the case with respect to
the Federal Reserve.
Approximately one-third of the
physical assets used by the Federal
Reserve in the provision of priced
services is equipment. The great bulk of
such assets is computers and related
equipment for which the market value
does not appear greater than its book
value—in fact, the book Value appears
to be much greater than market value for
this equipment. For example, there are
two computer models owned by the
Federal Reserve that, as a result of
technological innovation, have a market
value that is $9-10 million less than their
book values.1
With respect to Reserve Bank
buildings, the best proxy for market
value available to the Federal Reserve is
the alternative use of space; that is,
what rent could the Federal Reserve
1 The Reserve Banks intend to use this equipment
for the length of time originally contemplated in the
depreciation schedules.

obtain for its space or what would the
Federal Reserve have to pay if the
priced service operations were moved
out of a Federal Reserve Bank’s building
to other comparable space. The Federal
Reserve faces a practical problem,
however, when making comparisons of
book and market values of its space
because, in general, only a portion of a
Reserve Bank’s facility is used for priced
service operations and space costs are
charged through the Federal Reserve's
Planning and Control System (PACS) at
one rate for all activities—priced and
nonpriced within a building—regardless
of location. Thus, prime space, which is
typically not used for priced services,
may tend to be undervalued whereas
less than prime space for priced service
activities may tend to be overvalued.
Analysis of the space costs 2 the
Federal Reserve imposes on its internal
operations (based on PACS standard
rates) and prevailing commercial space
rentals in all cities in which the Federal
Reserve maintains operations shows
that there are Reserve offices with
PACS space costs above and below
local market rates. However, in an
overall weighted average cost basis, the
PACS charge (including PSAF) per
square foot for Reserve Banks is $16.83,
well within the weighted average
market range of $13.41 to $20.90. Further,
of the nearly one million square feet in
the Federal Reserve devoted to check
operations, approximately 30 percent is
rented—primarily for RCPC’s—thus
explicitly reflecting the market rate in
these locations. It therefore appears that
continued use of book value for
calculating the PSAF is reasonable.
Board staff will continue to monitor this
matter closely.
C. Income Taxes—The Board
requested public comment on whether to
use an income tax rate based on taxes
actually paid, or a tax rate which takes
into account deferred taxes, for the
income tax rate used in the PSAFF
calculation.3 Three commenters
supported the Board’s present
methodology. Ten commenters
supported inclusion of deferred taxes as
being a better representation of the tax
liability of a private company, if
effective tax rates for bank holding
companies were used. Twenty-three
2 Cost of space to be recovered through pricing
includes utilities, depreciation, taxes, housekeeping
and building maintenance labor, the supervision of
that labor, and the PSAF.
JIn the past, the tax rate used in the PSAF
calculation was based on the rato of current income
taxes (Federal, state and local) to total income of
the bank holding companies included in the sample.
Deferred taxes were excluded from this ratio. An
adjustment was made to the tax rate to exclude any
benefits that banks derive from holding tax exempt
state and local government securities.

commenters stated that marginal tax
rates were more appropriate,
Deferred taxes arise principally from
accelerated depreciation. Including the
effect of deferred taxes would increase
the tax rate used for purposes of the
PSAF in some years and decrease the
ta* rate inother years. (The effect of
excluding dererred taxes for 1984 is to
increase the dollars to be recovered
through the PSAF by $1.3 million). Over
time, it is likely that the effect of using
dererred taxes would balance out.
Because it is administratively complex
to include deferred taxes in the PSAF
calculation, (e.g., separate depreciation
schedules would have to be developed),
it is reasonable that the PSAF
computation not take into account
deferred taxes.
With regard to the use of marginal tax
rates, the taxes actually paid by the
bank holding companies in the model—
or by most other firms—are not at the
maximum marginal tax rate. Therefore*
while the Federal Reserve would use the
marginal tax rate for prospective
investment analysis purposes, it would
not be appropriate to use the marginal
tax rate for purposes of calculating the
PSAF.
In order to judge the reasonableness
of the tax rate developed from the
model, the income taxes the Federal
Reserve would actually pay in 1984 if
the Federal Reserve was subject to
income taxes was approximated. This
analysis suggests that even without the
benefits of (1) investment tax credits
from any year other than the year for
which taxes are being calculated, (2) tax
benefits from accelerated depreciation
applicable to the Federal Reserve, and
(3) the normal tax minimization efforts
that businesses follow, a 38.6 percent
tax rate appears appropriate. If any
allowance for the three factors cited
above were made, the actual tax rate
might be considerably lower than 38.6
percent.
Some commenters suggested the
Federal Reserve look at domestic tax
rates of bank holding companies for
purposes of determining its assumed tax
liability because the Federal Reserve’s
priced services are entirely domestic. A
study on financial institutions prepared
by staff of the Joint Committee on
Taxation showed that, for 20 large
commercial banks, the average U.S.
effective tax rate for the most recent
year studied, 1981, was 2.7 percent.4The.
4Staff of Joint Committee on Taxation, Committee
on Finance, Taxation of Banks and Thrift
Institutions, 12 (Joint Comm. Print. March 11,19831.

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices
corresponding foreign and worldwide
average effective rates were 38.1 and
24.5 respectively. The 2.7 percent and
24.5 percent effective tax rates are
significantly lower than the 38.6 percent
effective tax rate in the PSAF
calculation.
D. Direct Determination of Assets —
Seventeen commenters supported the
proposal to replace the expense ratio
method for asset determination with the
direct determination method based on
PACS, stating that it would be a more
precise measurement of the assets used
in the production of priced services.
Concern was expressed by six
commenters over the data structure of
PACS, and the allocations of assets
between priced and non-priced services.
These commenters urged the Board to
make available to the public details of
the asset allocation between priced and
non-priced services embodied in PACS.
One commenter opposed the proposal
stating that PACS would underallocate
assets to the priced services.
The original PSAF methodology
apportioned all long-term assets, and
certain short-term assets such as
materials and supplies, deferred charges
and other receivables on the basis of the
ratio of operating expenses for priced
services (less shipping) to total priced
and non-priced operating expenses (less
shipping) to total priced and non-priced
operating expenses (less shipping). This
approach resulted in apportioning
approximately 40 percent of the total
book value of assets to the priced
service assets base to be financed via
the PSAF.
It is important, however, that shared
(joint-puropse) assets and single­
purpose assest be precisely linked to
priced services so that a priced service
asset base accurately and fully
identifies assets employed in the
provision of priced services. The direct
determination method relies essentially
on PACS cost accounting to link single­
purpose assets directly to priced and
non-priced services, thus determining
more precisely the priced service asset
base. In addition, PACS provides the
same information for assets, such as
buildings and centralized computers,
that are used jointly in the provision of
priced and non-priced services. For
example, depreciation is included in
total occupancy costs, which are
redistributed to all PACS activities.
Because depreciation is linked directly
to assets carried on the Federal
Reserve’s balance sheet, the assets can
be linked to the production of priced and
non-priced services.
For illustrative purposes, the check
processing operation currently occupies
approximately 13 percent of total

System floor space. Therefore, 13
percent of the' net book value of
buildings is directly attributable to the
check service. In addition, the amount of
space occupied by each support activity
and each overhead service whose costs
are redistributed or allocated to the
chech service is known. Since the
precentage of expenses that each
support and each overhead service
redistributed or allocated to check as a
percentage of total expenses is also
known, that percentage rate can be used
to determine the additional building
values to be attributable to the check
service. As a result, a total of 22 percent
of the net book value of building assets
can be attributed to the check service
and included in the priced service asset
base. Similar calculations are made for
other long-term assets. This process,
followed for each of the Federal
Reserve's priced services, ultimately
produces a priced service asset base
that includes all assets directly
identified with a priced service and the
appropriate portion of shared assets that
relate to priced services.
E. Board of Governors Assets and
Expenses—The Board proposed that
expenses incurred by Board staff in the
development of prices be subject to
recovery. Nineteen commenters
supported this proposal. Eight of these
commenters stated that the allocation
should also include expenses and assets
indirectly related to priced services,
such as planning, budgeting, review,
monitoring, policy making and control.
Several commenters noted that the
proposal paralleled private sector
practices.
The Board believes it is appropriate to
include expenses incurred by Board
staff working on the development of
priced services ($1.9 million) in the
expense subject to recovery and the
Board assets employed in this activity
($.5 million) in the PSAF asset base,
begining in 1984. However, the Board
believes it would be inappropriate to
impose expenses associated with the
Board's supervisory responsibilities over
Reserve Banks when the Federal
Reserve does not assess charges on
member banks and bank holding
companies for other types of supervisory
activities.
F. Sales Taxes—Twenty-seven
comments were received on the
proposal to include in the PSAF an
estimate of sales taxes that would have
been paid by the Reserve Banks had
they not had a statutory exemption.
Twenty-five commenters supported the
proposal. Two commenters opposed
including sales taxes on the basis that
sales tax is not a cost incurred by
Reserve Banks.

11255

The Board believes that an allowance
for sales taxes the Federal Reserve
Banks would have paid were they
subject to such taxes should be included
as a cost of providing priced services.
For 1984, the total Federal Reserve sales
tax attributed to priced services is
approximately $4.9 million.
G. Shipping Expenses—Thirteen
commenters discussed the proposal to
exclude shipping expenses from the
PSAF calculation. Eleven commenters
supported the exclusion of shipping
expenses, and two commenters stated
that shipping expenses should be
included.
The assets employed in the production
of shipping services are not Federal
Reserve assets, but rather are owned by
the various carriers with whom the
Reserve Banks deal. When priced
service assets are determined directly
instead of on an expense ratio basis, the
removal of shipping expenses from the
calculation has no effect on total
recoveries. Staff expenses of managing
shipping services are recovered through
overhead allocations as well as direct
allocations to priced service activities.
Accordingly, the Board determined not
to include shipping expenses in the
calculation of the PSAF.
H. Date for the Asset Base Estimate—
Eighteen respondents discussed the
Board’s proposal that the asset base for
the year i n , hich the PSAF would apply
w
be adjusted to reflect the value of the
assets expected to be acquired and
disposed of in that year. Seventeen
commenters supported the proposal,
stating that it would be an improvement
over the current method of using the
average asset base from the previous
year and would be more consistent with
private sector practices. Two
commenters opposed the proposal; one
commenter stated it was inconsistent
w ith cost theory used in the private
sector.
The Board has determined that
adjusting the asset base used in
applying the PSAF for the value of
assets expected to be acquired or
disposed of in the year for which the
PSAF would apply better reflects the
actual assets used to provide priced
services. Further, it appears that this
modification would parallel private
sector practices. Accordingly, the Board
has adopted the procedure as proposed.
I. Leased Assets —Fourteen
commenters supported the proposal that
all leases becoming effective on or after
January 1,1984, and meeting criteria of
FASB Statement number 13 be
capitalized for purposes of determining
the PSAF. Several commenters stated
the proposal was in accord with

11256

Federal Register / Vol. 49, No. 59 / Monday, March 26, 1984 / Notices

industry practice and generally accepted
accounting standards. Other
commenters discussed leased assets in
terms of the impact of leases on capital
structure. They stated that leased assets
do not appear on the Federal Reserve’s
books, but, that if a private entity were
to issue debt, lenders would regard
lease obligations as if they were debt
and adjust that entity’s capital structure
accordingly. In their opinion, high levels
of leases preclude high levels of debt.
The Board has determined to include
the value of all Federal Reserve leases
that become effective on or after
January 1,1984, that meet the criteria for
capitalization as set forth in FASB
Statement number 13 in the calculation
of the PSAF. This amount is expected to
be $1.5 million. Of this amount, it is
anticipated that $0.9 million is related to
priced service activities. Since the
financing costs (interest payments)
associated with these leases are
explicitly reflected in the operating
expenses to be recovered through
pricing, there would be no effect upon
the PSAF or the costs to be recovered if
these leases were capitalized.
Furthermore, these leases would not
affect the Federal Reserve’s debt/equity
ratio as asserted by some of the
commenters in view of the de minimus
level of capitalized leases. The amount
of leases entered into prior to January 1,
1984, that satisfy the requirements of
FASB Statement number 13 is small and
no adjustments appear necessary.
J. Short-Term Assets —1. Float.
Sixteen commenters discussed the
proposal to remove the financing costs
of new adjustment float from the asset
base used for the PASF calculation. Ten
commenters supported the proposal in
view of the fact that the value of all
Federal Reserve check float will be
recovered through service fees in 1984.
Six commenters were opposed to the
proposal. A few commenters suggested
that float be financed at either the short­
term rate applicable to the bank holding
companies in the model or the rate
equivalent to the imputed weighted
average cost of capital computed in the
PASF calculation.
The Board determined that it is
appropriate to remove the financing
costs of net adjustment float from the
asset base to be financed via the PSAF
since the value of Federal Reserve check
float will be recovered fully through
explicit pricing in 1984. In view of the
self-financing characteristics inherent in
recovering float value through explicit
pricing, inclusion of financing costs for
net adjustments float in the Federal
Reserve’s asset base would result in a
double recovery. With regard to the

suggestion that float be financed by
alternative rates, the MCA requires
interest of items credited prior to
collection to be charged at the Federal
funds rate.
2. Cash Items. Several commenters
stated that the level of short-term assets
was two low and that a large short-term
asset, cash items in the process of
collection (CIPC), has been omitted from
the pro forma balance sheet. These
commenters also tied the inclusion of
CIPC to the requirement that
commercial banks must maintain 5
percent of assets as capital, stating that
a bank holding company model, if
applied consistently, would require the
Federal Reserve to comply with capital
guidelines established by the Federal
Reserve and the Comptroller of the
Currency for large banks and bank
holding companies.
The Federal Reserve, by virtue of its
check processing operations, has large
amounts of cash items in the process of
collection each day. The difference
between cash items in the process of
collection and deferred availability
items is float, the value of which must
be recovered under the Monetary
Control Act. Cash items in the process
of collection that are offset by deferred
availability items are costless and thus
need not be financed by the PSAF or
otherwise. Therefore, insofar as the
Federal Reserve’s overall net income is
concerned, the only "cost” associated
with cash items in the process of
collection arises from the net balances
created which, in accordance with the
MCA, are effectively priced at the
Federal funds rate.
As several commenters stated, the
gross amount of cash items typically is
included on the balance sheet of a
commercial bank, and a commercial
bank’s gross cash items are subject to
regulatory capital guidelines. By
extension, it was suggested that a five
percent primary capital ratio, if applied
to a Federal Reserve balance sheet that
included the gross amount of cash items,
would require considerably more capital
than provided for in the PSAF
calculation.
The Federal Reserve does not believe
this conclusion is warranted. First, cash
items are not a risk asset—a fact that is
implicitly recognized in the development
of regulatory capital guidelines. Second,
cash items represent only 4 percent of
the total assets of the banking
organizations in the sample. If these
items were removed from the total
assets of commercial banks, the
resulting primary capital ratio guideline
would be increased to about 5.2 percent.
The comparable ratio of equity to total

assets on the Federal Reserve’s pro
forma balance sheet is about 9 percent.
Consequently, when the primary capital
ratio is adjusted to take account of cash
items in the process of collection, it
appears that the Federal Reserve’s
capital provided for in the PSAF
calculation is reasonable.
3. Clearing Balances. The Board also
had proposed to adjust the method for
calculating earnings credits on clearing
balances to take into account reserve
requirements applicable had similar
balances been held at a correspondent
bank. Thirteen commenters supported
the proposal.
If a respondent’s balance is
maintained at a correspondent bank, the
correspondent would be required to
maintain reserves on the balances held.
In most cases, the correspondent would
be at a marginal reserve requirement
ratio of 12 percent. Generally, the
correspondent bank takes its marginal
reserve requirement into account when
it calculates the earnings credit on the
respondent’s balances. The respondent,
however, would receive an additional
benefit from being able to deduct
balances held at the correspondent from
its reservable transaction accounts.
Accordingly, it is appropriate to take
this into account in calculating earnings
credits on clearing balances.
The Board has determined to adjust
the method used for calculating earnings
credits to reflect the reserve
requirements that would apply if the
balances had been held with a
correspondent bank. Each respondent’s
balance would be reduced by an
imputed net interbank reserve
requirement. This would be calculated
as the 12 percent requirement that a
correspondent would be subject to, less
the reserve saving to the respondent if it
could deduct the balance from
reservable transaction accounts.
Preliminary estimates indicate that this
would reduce the rate at which
depository institutions are paid earnings
credits on clearing balances by about 7
percent. At the same time, an imputed
reserve burden of 12 percent would be
imposed upon the Federal Reserve’s
revenues from clearing balances.
K. District vs. National PSAF—Three
commenters advocated that the Federal
Reserve use a district rather than a
national PSAF. These commenters
argued that such a policy would more
directly and fully recognize differences
in costs among Reserve cities, and thus
help to promote a more competitive
environment.
The Federal Reserve believes that a
national PSAF is appropriate for several
reasons. First, the Federal Reserve’s

11257

Federal Register / VoL 49, No. 59 / Monday* March 26* 1984 / Notices
electronic payment services are priced
on a national basis to recognize the
national nature of such services. This
approach has broad support among
private banking organizations. Thus, a
district PSAF would be incompatible
with the underlying nature of these
services and the current approach to the
pricing of such services.
Second, while check processing and
definitive securities operations are
priced at the district level, even these
services are, in many ways, national in
nature. For example, almost 50 percent
of the checks and 70 percent of the
coupons processed by the Federal
Reserve are handled by more than one
office.
Third, where district prices are used,
such prices already reflect the effect of
local costs for wages, utilities, property,
taxes, and other factors of production.
Moreover, the costs of capital to the
Federal Reserve (as, for example, the
interest rates it would pay on debt)
would be uniform and national. Thus,
the use of a district PSAF, would, as a
practical matter, mean only that the
distribution of the quantity of capital
among Federal Reserve Districts would
change. Such a change would not have a
material impact on actual prices but
would introduce a major element of
complexity into pricing and price
schedules. Indeed, under this approach,
the quantity of capital first would have
to be divided among national and
district services and then, for district
services, be determined for each of the
Federal Reserve's 48 offices. The result
would be a massive matrix of PSAF’s,
which would be an administrative
nightmare.
Fourth, as best can be judged, private
organizations—including banks—
typically do not vary their prices on the
basis of the specific capital resources
used to produce a specific service at a
specific location. The fees for a checking
account, for example, generally do not
vary depending on whether the account
is held at a very high-rent central city
location or a suburban or rural branch.
Thus, the local PSAF would imply a
standard of performance in the Federal
Reserve which appears to be at odds
with conventional business practices.
Finally, the characteristics of many
capital assets used by Federal Reserve
Banks are fixed by national policies and
standards. For example, security
standards for buildings, automation
standards, and standards calling for
redundant back-up operating systems
influence the capital base at all Federal
Reserve offices in ways that result in
capital resources that are different than
might be the case if each Federal
Reserve office were a stand-alone

entity. In short, because the Federal
Reserve Banks are part of a national
system, many of their activities are
national in scope and are influenced by
national policies. Consequently,
reflecting this reality, it is appropriate to
have a single, uniform PSAF for all
Reserve Banks.
L. FDIC Insurance—Several
commenters expressed the view that the
PSAF should include the Federal deposit
insurance assessment that would apply
to the Federal Reserve if its deposits
were Federally insured. A review of the
pro forma balance sheet for Federal
Reserve priced service operations shows
that approximately $1.7 billion of
clearing balances would be subject to
the Federal deposit insurance
assessment if the Federal Reserve were
a member of the FDIC. Because virtually
all correspondent banks are members of
the FDIC, it is reasonable for the Federal
Reserve to add to the PSAF the deposit
insurance expense that otherwise would
have been incurred by the Federal
Reserve.
Applying the formula for calculating
the Federal deposit insurance
assessment based on the Federal
Reserve's pro forma balance sheet
results in a Federal deposit insurance
assessment of $1.2 million.
Board Action
After analysis of the comments
received on the proposed modifications
to the methodology for calculating the
PSAF for 1984, the Board has
determined that the most appropriate
model from which to impute taxes and
the costs of capital for Reserve Banks
consists of a sample of large bank
holding companies. The Board has also
decided to expand the sample size of the
model from the 12 largest bank holding
companies to the 25 largest bank holding
companies. However, to prevent
distortions, the Board has determined
that the best performing bank holding
company and the worst performing bank
holding company of the 25 in the sample
should be excluded from the
calculations.
The Board has also approved the
following adjustments to the
methodology for calculating the PSAF:
—Employ the direct determination
methodology for establishing the asset base
used for computing the PSAF.
—Include in the priced services asset base
for 1984 the net effect of those assets
expected to be acquired and disposed of
during the year.
—Recover the estimated sales taxes that
would have been paid on the purchases of
certain goods and services were Reserve
Banks subject to such taxes.
—Include those portions of expenses and
fixed assets of the Board of Governors

related to the development of priced
services.
—Include an imputation for FDIC insurance
assessment.
—Remove the financing costs of net
adjustment float from the assel base
because such float is now priced explicitly.

As a result of these changes, the
estimated dollars to be recovered
through the PSAF in 1984 will be $58.8
million. If the current methodology were
used for 1984, the PSAF recovery would
be $53.0 million.
The Board has also adopted the
proposed adjustment to the method for
calculating earnings credits on clearing
balances to take into account reserve
requirements the Reserve Banks would
be subject to if they were subject to
reserve requirements. This adjustment,
however, will require substantial
modifications to Reserve Banks’ existing
software. Therefore, implementation of
this action will take place when the
necessary modifications have been
made later this year.
Factors bearing on the calculation of
the PSAF such as capital structure
changes in the large bank holding
companies or changes in their cost of
capital will be closely monitored and
changes to the methodology for
calculating the PSAF to take such
changes into account will be considered
where appropriate.
By order of the Board of Governors of the
Federal Reserve System, March 20,1984.
William W. Wiles,

Secretary o f the Board.
T a b l e 1 .—Summary o f Changes

From

Proposed 1984 PSAF
Total PSAF recoveries—October public comment......... $56 2
Change due to:
Reclassification of Board of Governors e x p e n s e s 4-1.9
Inclusion of Federal deposit insurance assess­
m ent............ _............................................................. 4- 1.2
Updating prospective evaluation of assets for
1964........................................................................... + 0.2
Change in treatment of leaseholdimprovements.... fO.1
Inclusion of prepaid expenses other......................... -4-0.4
Change in value of materials and supplies.............. + 0.3
Updating capital structure........................................... -0 .8
Updating financing rates through 3rd quarter
1983.................. ................................................... ... - 0 7
PSAF recoveries for 1984.....................................

T a b le 2 .— Derivation

58 8

o f the 1984 PSAF

A. Assets to be financed:1
Short-term...................................................................

$32 3

Long-term......................................................... ’ 273.8
Total.................. ................................................... 306.1
B Weighted average cost of:
1. Capital Structure:3
Short-term debt (percent)..................................
Long-term debt (percent)............. .....................
Entity (percent)..................................................
2. Financing rates/costs:1
Average rate* paid by the bank holding
companies included in the sample:
Short-teon debt (percent)........... ..............
Long-term debt (percent)...........................

10.6
28.4
61.0

9.23
10.14

11258

Federal Register / Vol. 49, No. 59 / Monday. March 26, 1984 / Notices

T a b le 2.— Derivation

o f the 1984 PSAF—

T a b l e 4.— C h a n g e s B e t w e e n 1984 P r e l im i ­
n a r y a n d 1984 R e v is e d Ba l a n c e S h e e t —

Continued
Pre-tax equity (percent)4........................... . 20.90
3. Elements of capita) costs:
Short-term debt $ 3 2 .3 x 9 .2 3 % ........................
Long-term debt $87.1 *x 10.1456.......................
Equity $186.7 3X 20.90%....................................

$3.0
8.6
39.0

Total..............................................................

50.8

C. Other required PSAF recoveries:
Sales Taxes................................................................
Federal deposit insurance assessment..................
Bosrd of Governors expenses.................................

4.9
1.2
1.9

Total.....................................................................
D. Total PSAF recoveries........................ .......................

8.0
58.8

As a percent of capital.................... .............................. .. 19.21
As a percent of expenses *........................................ ..
15.25

Continued
Re­
vised
1984

Prelimi­
nary
1984

Short-term deb! * .... ...............................

323

27.1

Total short-term liabilities..............

1,737.3

1,027.1

Long-term liabilities:
Obligation under capital leases..... .......
Long-term debt * ........... ................. - .....

0.9
87.1

79.1

Total long-term liabilities.................

88.0

79.1

1,625.3
186.7

1,106.2
191.8

Total liabilities and equity.™— .... 2,012.0

1.298.0

Total llaWlftJes.............................................. -

1 Includes an allocation of $0.5 million In Board of Gover­
‘ Priced service asset base is based on direct determina­
nors' assets to priced services.
* Imputed figures representing the means through which
tion of assets method.
* Consists of total long-term assets less capital leases certain priced service assets are financed.
which are self-financing.
’ A ll short-term assets are assumed to be financed by
|FR Doc. 84-7971 Filed 3-23-84; 8:45 am]
short-tem debt. O f the total long-term assets, 31.8 percent
are assumed to be financed by long-term debt, and 68.2
BILLING CODE 8210-01-M
percent by equity.
‘ The pre-tax rate of return on equity is baaed on
average after-tax rates of return on equity for the bank
holding company sample, adjusted by the effective tax rate
to yield the pre-tax rate of return on equity.
1Systemwide 1984 budgeted priced service expenses less
1
shipping were $365-6 million.

T able

3.—1984 PSAF
Re­
vised

Prelimi­
nary

$32.3
S273.8

$27.1
$270.9

9.23
10.14
20.90

9.48
10.01
21.25

16.61
38.6

17.20
35.8

10.6
28.4
61.0

9.1
26.5
64.4

$58.8
19.21
15.25

$56.2
18.86
14.51

1 Assets to be financed (million):
.

II. Cost of capital:

Weighted average cost of capital (per­
il!. Tax rate (percent)
IV. Capital structure:

PSAF:

T a b l e 4.— C h a n g e s B e t w e e n 1984 P r e l im i ­
n a r y a n d 1984 R e v is e d B a l a n c e S h e e t
Re­
vised
1984

Prelimi­
nary
1984

Short-term assets:
Imputed reserve

requirements on
$147.4
Investment in marketable securities..... 1.080.6 $1,000.0
23.7
23.6
1.9
4.3
1.6
4.3
Net Items in process of collection
477.0
(float)....................................................
1.737.3

1,027.1

183.2
87.7

Leases and leasehold improvements...

176.7
95.6
2.4

Total long-term assets...................

274.7

270.9

Total assets..................................... 2,012.0

1.298.0

Total short-term assets...........
Long-term assets:

Short-term liabilities:
1,228.0
Balances arising from early credit of
uncollected items...............................

477.0

1,000.0

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