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l l5K

Federal Reserve Bank
of Dallas

HELEN E. HOLCOMB
DALLAS, TEXAS
75265-5906

FIRST VICE PRESIDENT AND
CHIEF OPERATING OFFICER

November 19, 2001
Notice 01-84

TO: The Chief Operating Officer of each
financial institution and others concerned
in the Eleventh Federal Reserve District
SUBJECT
Modifications to the Method for Calculating
the Private Sector Adjustment Factor
DETAILS
The Board of Governors of the Federal Reserve System has approved modifications
to the method for calculating the Private Sector Adjustment Factor (PSAF). The PSAF imputes
the cost that would have been incurred and profits that would have been earned had the Federal
Reserve Banks’ priced services been provided by a private firm.
The Board considered several alternatives for calculating components of the PSAF
and is modifying the current method for imputing debt and equity, enhancing the method for
determining the target rate of return on equity, and continuing to use the fifty largest bank holding companies’ financial data as a proxy for Federal Reserve priced services activities. In a
change from the proposal and current practice, the peer group will be selected based on total
deposits rather than the size of asset balances.
The revised method will be used to determine the PSAF and fees for Federal Reserve
priced services beginning with the 2002 price setting.
ATTACHMENT
A copy of the Board’s notice as it appears on pages 52617–23, Vol. 66, No. 200 of the
Federal Register dated October 16, 2001, is attached.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

-2MORE INFORMATION
For more information, please contact Bill Green, Payments Services Department,
(214) 922-5490. For additional copies of this Bank’s notice, contact the Public Affairs
Department at (214) 922-5254 or access District Notices on our web site at
http://www.dallasfed.org/banking/notices/index.html.
Sincerely,

Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices
SUPPLEMENTARY INFORMATION:

FEDERAL RESERVE SYSTEM
[Docket No. R–1095]

Federal Reserve Bank Services;
Private Sector Adjustment Factor
AGENCY: Board of Governors of the
Federal Reserve System.
ACTION: Notice.
SUMMARY: The Board has approved
modifications to the method for
calculating the Private Sector
Adjustment Factor (PSAF), which
imputes the costs that would have been
incurred and profits that would have
been earned had the Federal Reserve
Banks’ priced services been provided by
a private firm. The Board considered
several alternatives for calculating
components of the PSAF and is
modifying the current method for
imputing debt and equity, enhancing
the method for determining the target
rate of return on equity, and continuing
to use the fifty largest bank holding
companies’ financial data as a proxy for
Federal Reserve priced-services
activities. In a change from the proposal
and current practice, the peer group will
be selected based on total deposits
rather than the size of asset balances.
The revised method will be used to
determine the PSAF and fees for Federal
Reserve priced services beginning with
the 2002 price setting.
FOR FURTHER INFORMATION CONTACT:
Gregory L. Evans, Manager (202/452–
3945) or Brenda L. Richards, Sr.
Financial Analyst (202/452–2753),
Division of Reserve Bank Operations
and Payment Systems. For users of
Telecommunication Device for the Deaf
(TDD) only, please call 202/263–4869.
Copies of a research paper describing
the theoretical basis and detailed
application of each of the models (‘‘The
Federal Reserve Banks’ Imputed Cost of
Equity Capital’’) may be obtained from
the Board through the Freedom of
Information Office (202/452–3684) or at
the Board’s web site at http://
www.federalreserve.gov/boarddocs/
press/boardacts/2000/200012212/
researchpaper.pdf.

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I. Background
As required by the Monetary Control
Act of 1980, fees for Federal Reserve
priced services provided to depository
institutions are set at a rate to recover
all direct and indirect costs of providing
the services actually incurred and
imputed costs. Imputed costs include
financing costs, return on equity (also
referred to as profit), taxes, and certain
other expenses that would be incurred
if a private business firm provided the
services. The imputed costs and
imputed profit are collectively referred
to as the private-sector adjustment factor
(PSAF). In a comparable fashion,
revenue is imputed and netted with
actual related direct costs through the
net income on clearing balances (NICB)
calculation.
Calculating the PSAF involves
projecting the level of priced-services
assets and determining the financing
mix used to fund them and the rates
used to impute financing costs. In the
current method, the financing rates, the
combination of financing types, and an
income tax rate are based on data
developed from the ‘‘bank holding
company (BHC) model,’’ a model that
contains consolidated financial data for
the nation’s fifty largest (based on asset
balances) BHCs. Imputed taxes are
captured using a pre-tax return on
equity (ROE). The current methodology
assumes that the Reserve Banks invest
all clearing balances net of imputed
reserve requirements in three-month
Treasury bills. The net earnings or
expense attributable to the imputed
Treasury-bill investments and actual
earnings credits granted to clearing
balance holders based on the federal
funds rate are considered income or
expense for priced-services activities.
The net income or expense is referred to
as net income on clearing balances
(NICB).
To evaluate the effect of changes that
may have occurred in Reserve Bank
priced-service activities, accounting
standards, finance theory, regulatory
practices, and banking activity, the
Board periodically reviews the methods
for calculating the PSAF and the NICB.
To ensure that the method remains
current and consistent with sound
business management, the Board
requested comments on a proposal to
modify certain elements of the
calculations (65 FR 82360, December 28,
2000). Specifically, the Board requested
comment on the following changes to
the PSAF:
• Imputed debt and equity: The Board
proposed initially designating $4 billion
of clearing balances as core deposits for

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potential use as a financing source for
priced-services assets, thereby reducing
the funds available for imputing
investment income. The Board also
proposed imputing equity at the
minimum requirements for a wellcapitalized institution as defined by the
FDIC for purposes of assessing
insurance premiums.
• Target return on equity (ROE): The
Board proposed enhancing the method
for determining the target rate of return
on equity by combining the rate
resulting from the current BHC model,
one example of the comparable
accounting earnings model (CAE), with
rates derived from a discounted cash
flow (DCF) model and a capital asset
pricing model (CAPM). The Board
proposed a risk-free rate and using
specific data for determining the average
risk premium for the market and the
beta in the CAPM. For the DCF, the
Board proposed using commercially
available consensus forecasts to measure
future dividends and long-term growth
rates. The Board also proposed equal
weights within the CAE model, weights
based on market capitalization for the
DCF and CAPM models, and a
combined ROE measure based on equal
weighting of the results of the three
models.
• Peer group: The Board proposed
continuing the current practice of
selecting the largest fifty BHCs based on
asset balance size as the Reserve Bank
peer group.
II. Priced Services Balance Sheet
Table 1 represents the elements of the
priced-services balance sheet and how
they will be derived. All actual assets
and liabilities presented on the pricedservices balance sheet are based on
projected average daily balances.
III. Summary and Analysis of
Comments
The Board received ten responses to
its request for comment, including
responses from two Reserve Banks.
Overall, eight commenters supported
and two commenters opposed the
Board’s proposal. Those supporting the
proposal represented credit unions,
smaller depository institutions, and
Reserve Banks. The Association of Bank
Couriers and Fiserv, Inc. opposed the
proposal. The Board received no
comments from large banks or bank
holding companies.
Those supporting the proposal believe
that the proposed changes to the PSAF
methodology are appropriate and will
provide a better basis on which to
impute the expenses and income used
in setting Federal Reserve fees. Those in
opposition object to using clearing

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Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices

balances to finance priced services
assets, the imputed equity level, certain
aspects of the economic models, and the
basis for selection of a peer group.
A. Imputed Debt and Equity
Currently short-term debt, long-term
debt, and equity are imputed to the
extent necessary to finance short-term
and long-term assets without
consideration of the Reserve Banks’
clearing balance liability.1 The cost for
debt financing is determined using the
short- and long-term debt rates from the
BHC model. The apportionment of longterm asset financing between long-term
debt and equity is based on the debt-toequity ratio derived from the BHC
model. The Board believes that these
practices unnecessarily impute larger
amounts of certain assets and liabilities
and equity along with their related
income and expenses to priced services.
Considering the growth in the size of
clearing balances since the inception of
the NICB and the stable nature of the
majority of the balances, the Board
believes that rather than incur
additional debt costs, a private business
firm would use a portion of these
balances to finance its capital needs.
In its request for comment, the Board
proposed that initially $4 billion of
clearing balances be designated as
‘‘core’’ and that these core balances be
made available to finance long-term
assets. The use of core clearing balances
will effectively eliminate debt and
reduce imputed investments in Treasury
securities. The Board requested
comment on whether this was a
reasonable use of these balances, and
asked that commenters who opposed
initially establishing the $4 billion as
core balances to suggest an alternative
portion of the balances and a method for
deriving the acceptable balance. In
addition, the Board proposed basing the
Reserve Bank priced-services equity
balance on that required by the FDIC to
be considered a well-capitalized
institution.
One commenter challenged the
Federal Reserve’s statutory authority to
integrate the PSAF and NICB
calculations. Two commenters,
including the commenter who
challenged the Board’s statutory
authority, objected to the proposed use
of core clearing balances to fund long1 Depository institutions may hold both reserve
and clearing balances with the Federal Reserve
Banks. Reserve balances are held pursuant to
regulatory requirements and are separate from the
Reserve Banks’ priced-services activities. Clearing
balances, based on contractual agreements with
Reserve Banks, are held to settle transactions arising
from use of Federal Reserve priced services. In
some cases, depository institutions hold clearing
balances in excess of contractual agreements.

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term assets. Another commenter stated
that the $4 billion was too conservative
and offered an alternative method for its
calculation. Two commenters supported
the Board’s proposal to evaluate the
balance of the core deposits annually,
and one expressed support for the
proposal provided that clearing balance
requirements were not adjusted to
facilitate the use of this core balance.
The basis for the objection of two
commenters to the use of core clearing
balances was essentially that clearing
balances are short-term liabilities and
should be used to finance only shortterm assets. One comment stated that
the Federal Reserve controls these
balances based on the rate it offers to
compensate depositors. Another offered
that banking organizations attribute
extended maturities to a portion of their
core deposits, but the deposits are
considered to finance longer-term
financial assets, not prepaid pension
assets and long-term fixed assets such as
buildings, check sorters, and leasehold
improvements. The commenter stated
that these assets are typically financed
with equity capital and long-term debt.
This commenter also expressed concern
with the proposal’s creation of a
negative working capital position
(current assets minus current liabilities)
for the priced-services balance sheet.
Support for this concern was based on
an analysis of six non-bank publicly
held payments processors and their
positive working capital positions.
One commenter objected to the
Board’s proposal to impute only the
equity sufficient to meet the FDIC
requirements to be considered a wellcapitalized institution. The objection is
based on the contention that this level
of equity would not be acceptable and
that bank holding company
management maintains capital well
above regulatory minimums. The
commenter believes that the equity of
the Federal Reserve priced services
balance sheet should be closer to or
should match that of commercial banks,
which they estimate as close to 8
percent.
The Board has concluded that
initially classifying $4 billion as core
clearing balances to fund long-term
priced services assets is a practical
approach that treats these balances in a
way private-sector providers would treat
them. In addition, the Board has
concluded that imputing equity based
on FDIC requirements to be considered
a well-capitalized institution provides
adequate protection against
uncertainties and is a prudent use of
this financing source.
The Board considered the stability of
clearing balances and the current level

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of priced-services assets. The balances
have not dropped below $4 billion since
1992. In addition, the structure of the
current priced-services balance sheet
requires that only an insubstantial part
of the balances be used to finance
longer-term assets leaving the majority
of these balances for investment in
financial assets. A portion of all assets
will be financed with equity. In
considering how private business firms
would use these balances, the Board
believes that cash would be considered
a fungible resource, but only after
considering the interest rate risk
presented by financing long-term assets
at short-term rates. To address this risk
and avoid inappropriate volatility in
earnings, the Board will review the
interest rate risk of long-term pricedservices asset financing each year. The
Board will evaluate the level of interest
rate risk by reviewing the ratio of ratesensitive assets to rate-sensitive
liabilities and the effect on cost recovery
of an increase or decrease in interest
rates of up to 200 basis points. To
control interest rate risk within
acceptable levels, long-term debt will be
imputed when the risk is estimated to
exceed a change in cost recovery of
more than two percentage points.
Although the amount of initial core
balances may appear very conservative
to some commenters, this level is more
than sufficient to finance the current
level of assets. The Board expects to
review clearing balance trends
periodically and the core amount will
be adjusted if necessary. Consistent with
current practice, the size of contracted
clearing balances established by the
Federal Reserve and depository
institutions will be based on the level
necessary for clearing and paying for
services and will not be changed in
order to increase the size of core
balances in order to finance long-term
assets.
The level of clearing balances
maintained by depository institutions
with the Reserve Banks increases or
decreases based on the funds needed to
process transactions. The compensation
provided to depositors, earnings credits
available to apply to future services, is
based on these contracted balances and
the federal funds rate. Although the rate
is targeted by the Federal Reserve
without consideration of the cost of
earnings credits, it is set by the
marketplace demand for short-term
funds.
The Board’s proposal for financing
long-term assets with core clearing
balances does, as a commenter
indicated, create a negative working
capital position. The commenter
believes if the priced-services activities

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Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices
were a private-sector company,
regulators would not look favorably on
this position. A working capital
comparison is not typically used in
analyzing the financial condition of a
depository institution. The liquidity of a
depository institution is commonly
reviewed using other measures that
quantify the amount of cash or liquid
assets and other funding sources (e.g.,
borrowings) available to meet expected
cash demands at given time frames.
Regulators define an entity’s liquid
assets as ‘‘those assets which are readily
available as cash or which can be
converted into cash on an ‘‘arm’slength’’ basis without considerable
loss.’’ 2 The Board believes that the
priced-services assets on the balance
sheet, specifically the three-month
Treasury securities, are sufficient to
meet the liquidity needs of priced
services.
When it requested comment, the
Board noted the necessary integration of
the PSAF and NICB calculations. The
imputed income or expense resulting
from the NICB calculation has
historically been and will continue to be
a part of determining priced-services
revenue. Integration is necessary to
reflect the reduction of clearing balances
available for investment and the
resulting reduction of the imputed
income. The MCA states that fees must
incorporate ‘‘an allocation of imputed
costs’’ and that ‘‘pricing principles shall
give due regard to competitive factors.’’
To consider the PSAF along with the
cost of earnings credits included in the
NICB without including the revenue
from imputed investments would result
in non-competitive pricing.
In evaluating the need for equity
financing, one must consider the risk
inherent in the assets being financed.
Ignoring risk and imputing equity equal
to the average equity of commercial
banks, as proposed by one commenter,
would be contrary to sound business
decision-making. Equity dollars,
typically the most expensive of
financing sources, are actively managed
by financial institutions. Regulators
require a minimum level of capital to
protect against insolvency or failure by
offsetting or absorbing potential loses in
the value of bank loans and
investments, to protect against
temporary losses of liquidity, and to
ensure public confidence in the bank’s
ability to respond to shifts in economic
conditions. Imputing equity to meet
regulatory requirements for a wellcapitalized institution results in a
proposed capital to risk-weighted assets
2 BHC Supervision Manual, December 1992,
Section 4010.2.

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ratio of 27.7 percent for the pricedservices balance sheet. The capital to
risk-weighted ratios for the sample fifty
BHCs are significantly lower, with none
being greater than 15 percent. This ratio,
combined with the liquidity of the
imputed Treasury investments, is
sufficient to protect against potential
losses arising from changes in economic
conditions or shifts in the value of
investments. In general, the Board
believes that a higher leverage ratio for
BHCs reflects the increased risk
experienced by these entities because of
the financing activity in which they
engage and that targeting an equity-toasset ratio somewhat lower than the
peer group average is appropriate for
Federal Reserve priced services.
B. Imputed Return on Equity
Currently, the target return on equity
is calculated based on the ROE results
from the BHC model as an average of the
ratios of the BHCs’ net income and
average book value of equity. This
model can be duplicated and is readily
accepted in industry practice. Its
shortcomings, however, are that it uses
historical data from the two to seven
years before the target year to predict
future earnings and it is based on book
rather than market values.
The Board proposed that the PSAF
target ROE be calculated using a
combination of the current CAE model
and two additional economic models, a
capital asset pricing model and a
discounted cash flow model. The Board
requested comment on the economic
models, their elements, the proposed
methods for weighting and averaging
them, and whether they are theoretically
sound and should be used to calculate
the PSAF.
The response from commenters was
mixed regarding the theory, use, and
components of each of the models.
Although most commenters supported
the use of the three models, the
proposed weightings within the models,
and the averaging of their outcomes, one
commenter believes that the CAE
should be weighted by organization size
and another believes that it should be
weighted by service revenue. One
commenter criticized the CAE model
because it could be distorted by credit
losses unrelated to BHC processing
activities. This same commenter
believes that the thirty-year Treasury
bond rate rather than three-month
Treasury-bill rate should be used for the
risk free rate in the CAPM. One
commenter believes that the DCF should
receive greater weight in the
computation, while another believes
that it is inappropriate to use the DCF
in the calculation due to a perception

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52619

that it ignores capital appreciation.
Although there was support for the use
of the CAE and CAPM models in the
calculation, two commenters objected to
using BHCs as the comparable group.
The Board has concluded that the
three models will be used to calculate
its priced-services target ROE and the
calculation will be based on the
proposed method. The models have a
solid foundation in economic and
finance theory and are regularly used in
industry practice. This approach to
calculating the target ROE is based on
an understanding that each of the three
models uses different information and
has different strengths and weaknesses.
Together the three models provide a
measure that is more reliable,
consistent, and forward-looking than
using the CAE model alone. In addition,
the proposed method brings in factors
that affect competitors’ return on equity
that had not been previously considered
with the CAE model, such as the results
of changes in market conditions and
risk.
The Board considered several
methods for weighting within the
models. The Board believes that the best
and most common method is to weight
based on market capitalization in the
DCF and CAPM models and to maintain
the current method of equal weighting
for the CAE model. Weights based on
organization size do not provide a more
appropriate ROE than that provided
with the equally weighted CAE. Weights
based on service revenue could distort
the resulting ROE because service
revenue includes income from many
activities that Reserve Banks do not
provide and because depository
institutions differ in the degree to which
they use fees or balances to obtain
compensation. For example, in
comparable entities, payment for
services can be assessed based on
holding compensating balances rather
than explicit fees. These varied
approaches to assessing service revenue
could affect the comparability of this
information and could result in an
inconsistent ROE measure over time.
The financial results used in the CAE
model are obtained from publiclyavailable financial statements based on
objective criteria. Availability and
credibility of the financial data are
important considerations in determining
the structure of and peer group included
in the model. If the data-gathering
process included subjectively
identifying and adjusting the financial
results of each BHC in the model for
activities that are not exactly
comparable to priced services, the
credibility of the calculation could be
diminished. After careful consideration

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of the comments, the Board believes that
the BHC results as presented in audited
financial statements provide a
reasonable proxy for Federal Reserve
priced services activities.
It is standard academic practice to use
short-term Treasury rates, such as the
three-month Treasury bill rate, in the
implementation of the CAPM model.
Any short-term rate chosen must be
adjusted based on the time horizon of
the analysis. A one-year rate is
appropriate for the PSAF calculation
because the implicit horizon of analysis
is one year. Whether this one-year rate
is based on the average of monthly,
three-month, or one-year Treasury bill
rates is insignificant because the market
for Treasury securities is typically
efficient enough to remove major
pricing anomalies between securities of
different maturities. This efficiency
results in little difference between
yields in the short term. Adopting a
longer-term risk-free rate, such as the
thirty-year Treasury rate, however,
could not be supported given the oneyear time horizon.
The contention that the DCF does not
consider capital appreciation has been
refuted in economic literature. The DCF
does consider capital appreciation in its
assumption that dividends will grow
over time. The present value of a finite
stream of dividends plus the present
value of a future price of the stock is
mathematically equal to the present
value of an infinite stream of
dividends.3 The Board will include the
DCF model in the PSAF calculation as
proposed and weight it equally with the
two other models.
C. Peer Group
The Board proposed maintaining the
currently used BHC sample of the
largest fifty, based on the size of asset
balances, but asked whether this sample
size continues to be a reasonable data
peer group for Reserve Bank pricedservices activities. In addition, the
Board requested commenters’ views on
whether BHC data could be adjusted to
resemble more closely the Reserve Bank
priced-services activities.
Two commenters objected to the use
of BHCs as the peer group and suggested
using data processing and check
processing organizations as the peer
group. Two other commenters suggested
that fewer BHCs would provide an
adequate sample for the model and one
suggested that a subgroup from the top
fifty BHCs based on the relative
importance of certain income accounts
3 Sergei P. Dobrovolsky, The Economics of
Corporation Finance, (New York: McGraw Hill
Book Company, 1971), 81.

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to total net income would provide a
better proxy. One commenter suggested
selecting the peer group based on
service revenue.
The Board acknowledges that BHCs
are an imperfect proxy for Federal
Reserve priced services. The Board
considered several alternatives and
concluded that the services provided by
data processing and check processing
companies are not sufficiently
analogous to priced-services activities of
the Reserve Banks largely because they
do not provide settlement services or
hold correspondent or clearing balances.
Although, in some cases it may be a
small part of their overall business,
BHCs do provide similar payment
services, including settlement, and hold
correspondent balances. Like BHCs,
data processing and check processing
companies also derive substantial
income from lines of business in which
Reserve Banks do not engage. In
addition, obtaining the information for
these processing companies necessary to
compile the data needed in the three
economic models would be difficult for
the Board and for the public.4 Use of
non-audited financial information
provided by these entities in the models
could diminish the credibility of the
results and create omissions or
inconsistencies. In addition, there are
significantly fewer data processors and
check processors than BHCs, which
would make it difficult to mitigate the
effects of extreme financial performance
of a few companies in the peer group.
Although reducing the sample size
could reduce time and effort required
for data gathering, the risk that the
performance of a few BHCs could skew
the model’s results increases. Selecting
the peer group based on service revenue
would not create a better sample
because, as noted, service revenue
includes income from many activities
that Reserve Banks do not provide.
Further, in comparable entities,
payment for services can be received
based on holding compensating
balances rather than assessing an
explicit fee. These varied approaches to
assessing service revenue could affect
the comparability of this information.
After careful consideration of these
and other alternatives, the Board
concluded that the fifty largest BHCs
provide a reasonable peer group for
priced services. In a change from the
4 One commenter believes that verifiable financial
information for these entities could be obtained
through industry associations. This would require
the Federal Reserve to rely on data that has not been
audited and to provide such financial information
to the public. Further, consensus forecasts, used in
the DCF model, are not available for entities that are
not publicly held.

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proposal and current practice, the peer
group will be selected based on total
deposits rather than asset balance size.
A peer group based on total deposits
maintains the focus on the largest
banking entities and avoids the
distortion that could result from
including financial holding companies
on the basis of their other financial
service activities and assets necessary to
provide these services. Because of the
changes in BHC structure made with the
Gramm-Leach-Bliley Act of 1999, BHCs
may engage more extensively in nonbanking service activities than in the
past.5
IV. Effects of New PSAF Methodology
The combination of the current
equally-weighted CAE and the marketweighted DCF and CAPM models
produces the following pre-tax ROE
(pre-tax profit as a percent of imputed
equity) based on the BHC performance
data used for the 2001 PSAF:

PRE-TAX RETURN ON EQUITY
[In percent]
CAE

DCF

23.8 .......

CAPM

22.1

23.3

Combined
23.1

From year to year, the combined
model for calculating ROE can yield a
target ROE that is higher or lower than
the current method. On the average
during the period from 1983 to 2001, the
combined model yielded a pre-tax ROE
that is 230 basis points higher than the
current method.
Using core clearing balances as a
source of financing for actual pricedservices assets reduces imputed shortand long-term debt and imputed
investments in marketable securities. As
a result, the income and expenses
associated with these imputed elements
are reduced as well. Establishing equity
at the level required by FDIC
requirements for a well-capitalized
institution results in setting equity equal
to five percent of total assets, which is
a slight reduction from the level
planned in 2001 under the current
methodology (5.3 percent). Applying the
new PSAF methodology to the 2001
priced-services balance sheet reduces
PSAF costs $53.3 million or 26 percent
and reduces net income on clearing
balances $33.8 million or 90 percent.
This results in a net reduction of costs
5 Selecting the BHC sample based on total
deposits rather than assets results in the change of
two BHCs in the ranking. As these entities become
more involved in providing non-banking services,
the Board anticipates that the sample comparability
will become more divergent.

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Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices
to priced services of $19.5 million or
slightly more than 2 percent of total
actual and imputed costs, including the
target ROE of $138.2 million.6 Table 2
illustrates the effects of the changes on
the various elements of the PSAF and
NICB calculations.
V. Competitive Impact Analysis
All operational and legal changes
considered by the Board that have a
substantial effect on payment system
participants are subject to the
competitive impact analysis described
in the March 1990 policy statement
‘‘The Federal Reserve in the Payments
System.’’7 Under this policy, the Board
assesses whether the change would have
a direct and material adverse effect on
the ability of other service providers to
compete effectively with the Federal
Reserve in providing similar services
because of differing legal powers or
constraints or because of a dominant
market position of the Federal Reserve
deriving from such legal differences. If
the fees or fee structures create such an
effect, the Board must further evaluate
the changes to assess whether their
benefits—such as contributions to
payment system efficiency, payment
system integrity, or other Board
objectives—can be retained while
reducing the hindrances to competition.
Because the PSAF includes costs
(with an adjustment for NICB net
revenues or expenses) that must be
recovered through fees for priced

services, changes made to the method
may have an effect on fees. This
proposal is intended to refine the PSAF
to resemble more closely the costs and
profits of other service providers as
required by the MCA. Consequently, the
fees adopted by the Reserve Banks
should be based on the costs and profit
targets that are more comparable with
those of other providers. Accordingly,
the Board believes this proposal will not
have a direct and material adverse effect
on the ability of other service providers
to compete effectively with the Federal
Reserve in providing similar services.
VI. Conclusion
The Board has adopted the following
modifications to the method for
calculating the private sector adjustment
factor (PSAF):
• An initial core amount of $4 billion
of clearing balances will be available to
finance priced-services assets. In the
current environment, this eliminates the
need to impute long-term debt. An
interest risk sensitivity analysis will be
performed each year and the Board will
impute long-term debt if the results of
the analysis indicate that an increase or
decrease in interest rates of up to 200
basis points results in a reduction in
cost recovery of more than two
percentage points. In addition, the
Board will annually review clearing
balance trends and the core amount will
be adjusted, if necessary.

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• Equity will be imputed to meet the
FDIC definition of a well-capitalized
institution in its classification for
assessing insurance premiums.
Currently, this is five percent of total
assets.
• The target return on equity will be
determined using the results of three
economic models.
—The results of the current CAE model
will be combined with the results of
the capital asset pricing model and
the discounted cash flows model.
—A short-term Treasury-bill rate will be
used as the risk-free rate and
historical stock market data with a
rolling ten-year period will be used in
implementing the CAPM model.
—Commercially available consensus
forecasts will be used to determine
the expected future dividends and
long-term growth rates in the DCF
model.
—Within the CAPM and DCF models,
the ROE will use weights based on
market capitalization and within the
CAE model, the ROE calculation will
be based on equal weights. The results
of the three models will then be
averaged to derive the PSAF ROE.
• A peer group of the fifty largest
bank holding companies based on total
deposits will be used in each of the
models.
• The revised method will be used to
determine the 2002 PSAF and fees for
Federal Reserve priced services.

TABLE 1.—PRICED-SERVICES BALANCE SHEET
[Projected average daily balance]
Assets

Type

Description

Required reserves ...........

Imputed ......

U.S. Treasury securities ..

Imputed ......

Short-term assets ............

Actual .........

Cash items in process of
collection.

Actual .........

Pension assets. ...............

Actual .........

Long-term assets .............

Actual .........

Intended to simulate commercial bank reserve requirements.
Represents the portion of clearing balances not
required for reserves or to finance other actual
or imputed priced-service assets.
Accounts receivable, prepaid assets expenses,
and materials and supplies reported on the
Federal Reserve Banks’ balance sheets that
are attributed to priced services.
Transactions credited to the accounts of depository institutions, but not yet collected by the
Federal Reserve Banks that are attributed to
priced services.
Prepaid pension costs reported on the Federal
Reserve Banks’ balance sheets that are attributed to priced services.
Premises, furniture and equipment, leases, and
leasehold improvements reported on the Federal Reserve Banks’ and Board of Governors
balance sheets that are attributed to priced
services.

6 Under this proposal, priced-services revenue
would be $944.7 million and expenses would be
$951.5 million, resulting in a budgeted cost

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10 percent of total clearing balances.
Total liabilities plus equity less other assets.

7 FRRS

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Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices
TABLE 1.—PRICED-SERVICES BALANCE SHEET
[continued]

Liabilities and equity

Type

Description

Method for computing

Core clearing balances ....

Actual .........

The portion of clearing balances considered stable and available to finance long-term pricedservice assets.

Non-core clearing balances.

Actual .........

Short-term payables ........

Actual .........

Deferred credits ...............

Actual .........

Postemployment/Postretirement liability.

Actual .........

Long-term debt ................

Imputed ......

Equity ...............................

Imputed ......

Deposits of financial institutions maintained at
Federal Reserve Banks for clearing transactions. Available to finance short-term priced
service assets..
The portion of sundry items payable, earnings
credits due depository institutions, and accrued
expenses unpaid reported on the Federal Reserve Banks’ balance sheets that is attributed
to priced services.
The value of checks deposited with the Federal
Reserve Banks, but not yet credited to the accounts of the Reserve Banks’ depositors.
The portion of post-retirement benefits due reported on the Federal Reserve Banks’ balance
sheets that is attributed to priced services.
An amount imputed when equity and core clearing are not sufficient to finance long-term
priced-services assets.
The minimum level of equity necessary to meet
FDIC requirements for a weighted well-capitalized institution.

Total clearing balances required for financing
long-term assets. Maximum core amount initially set at the lesser of $4 billion, which is the
estimated amount of actual contracted clearing
balances that have historically been stable, or
the maximum amount available based on an
analysis of interest rate risk sensitivity.
Equal to total clearing balances used for financing long-term assets

Equal to the larger of zero or long-term and pension assets postemployment/postretirement liability, core clearing balances, and equity.
The greater of five percent of total assets or 10
percent of risk-weighted assets.

BILLING CODE 6210–10–P

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Federal Register / Vol. 66, No. 200 / Tuesday, October 16, 2001 / Notices

By order of the Board of Governors of the
Federal Reserve System, October 9, 2001.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 01–25833 Filed 10–15–01; 8:45 am]
BILLING CODE 6210–01–C

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