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Federal Reserve Bank of Minneapolis 1981 Annual Report Priced Services To Depository Institutions in the Ninth Federal Reserve District: I am pleased to transmit to you the Federal Reserve Bank of Minneapolis' first Annual Report for Priced Services. In a meaningful way, this report is symbolic of one of the major changes and challenges this Bank experienced in 1981. Indeed, infrequently have the products and services of a public instrumentality been priced and offered in the marketplace in direct competition with similar services offered by private firms. The results have been encouraging to me in a number of important respects. First, I take some considerable pride in the manner in which my associates and colleagues in the Bank have begun the transition initiated by the Monetary Control Act. I take equal satisfaction from the cooperation we have received from depository institutions—large and small—throughout the Ninth District. Even though there were some missteps on our part, when I look at the magnitude of this initial task and the manner in which it was completed, I can't help but conclude that we are now well positioned to assist in the further evolution of the payments mechanism in the District. Second, and more importantly, I have come to realize more fully that the Federal Reserve Bank of Minneapolis does indeed have an important role to play in contributing to the efficiency and the effectiveness of the payments mechanism in the District. To some extent that role is simply a direct extension of the fact that we have been in the business for a long time. But, there is more to it than that. I have, for example, been struck by the frequency with which bankers and others tell me how much they value Fed services and Fed prices as a standard for the marketplace. Similarly, it is also clear that the Fed is viewed by bankers and others as something of a "trusted intermediary." Finally, there is also, it seems to me, a recognition of the fact that we can and should play a role as a catalyst for constructive change and innovation. All of these things, of course, bode well for achieving the fundamental intent of the MCA—greater efficiency, integrity, and cost effectiveness in the delivery of payment services. In the light of all of this, we look to our future in the priced service business with confidence and enthusiasm. The building blocks are now in place, but the greatest challenges lay ahead. We must now become more responsive, more flexible, and more effective in anticipating and meeting the needs of our customers. Quality, efficiency, and responsiveness will be our guideposts. In that spirit, we look forward to better serving the depository institutions and the financial community of the Ninth Federal Reserve District. E. Gerald Corrigan, President Federal Reserve Bank of Minneapolis • • • Introducing Customer Services Shifting from a framework of providing services only to member banks at no explicit charge to offering services to all depository institutions at an explicit price offered a new challenge to us in 1981. And, if we are to achieve the efficiencies intended by the framers of the Monetary Control Act, it is essential that every depository institution, large or small, have the best information possible in order to select its best alterna tive for obtaining needed services. Accordingly, in 1981, we formed a Customer Services Department—with a staff responsible for ensuring that depository institutions have a good understand ing of the nature of Fed services, their prices and how to use them effectively. , In Customer Services we pay attention to the needs of all Ninth Dis trict customers, from the largest to the smallest. Our District is large and diverse and includes fi nancial institutions that differ greatly . . . . We have to be aware of those differences in order to be sure that the services we provide do, in fact meet the individual institu tion's needs. , Stan Medina Pricing is new to us> but we have been a major supplier of payment services for a long tim e . . . . We have a system firmly established to provide needed financial services . . . . We recognize that the Federal Reserve has a lot to offer because it is a national system with na tional communication and transportation net works, but at the same time; we feel it is im portant to emphasize the characteristics that dis tinguish the needs of in stitutions in the Ninth Federal Reserve District from others in the coun- try. Bob Brandt Ours may have been a no-frills approach in the past but that is not our intent for the future. We have special strengths and considerable exper tise in our traditional service lines.. .we plan to build on those strengths and find better ways to serve the needs of our customers. , Ray "Buzz" Hulctt We are concerned. . . very concerned . . . about our customers' needs. 3 Directors of the Federal Reserve Bank of Minneapolis William G. Phillips Chairman and Federal Reserve Agent John B. Davis, Jr. Deputy Chairman Class A Elected by Member Banks Henry N. Ness (1982) Senior Vice President Fargo National Bank and Trust Company Fargo, North Dakota Vern A. Marquardt (1983) President Commercial National Bank LAnse, Michigan Dale W. Fern (1984) President and Chairman First National Bank Baldwin, Wisconsin Class B Elected by Member Banks Joe F. Kirby (1982) Chairman Western Surety Company Sioux Falls, South Dakota Harold F. Zigmund (1983) President Blandin Paper Company Grand Rapids, Minnesota William L. Mathers (1984) President Mathers Land Company Miles City, Montana February 1 , 1982 Directors of the Helena Branch Ernest B. Corrick Chairman Gene J. Etchart Vice Chairman Appointed by Board of Directors Federal Reserve Bank of Minneapolis Harry W. Newlon (1982) President First National Bank Bozeman, Montana Jase O. Norsworthy (1982) President The N R G Company Billings, Montana Fern, Zigmund, Mathers Roger H. Ulrich (1983) President First State Bank Malta, Montana Appointed by Board of Governors Ernest B. Corrick (1982) Vice President and General Manager Champion International Corporation Timberlands-Rocky Mountain Operations Milltown, Montana Gene J. Etchart (1983) Past President Hinsdale Livestock Company Glasgow, Montana Member of Federal Advisory Council Sister Generose Gervais, Phillips, Marquardt Class C Appointed by Board of Governors Sister Generose Gervais (1982) Administrator Saint Mary's Hospital Rochester, Minnesota Clarence G. Frame Vice Chairman First Bank System, Inc. Minneapolis, Minnesota John B. Davis, Jr. (1983) President Macalester College St. Paul, Minnesota William G. Phillips (1984) Chairman International Multifoods Minneapolis, Minnesota Term Expires D ecem ber 31 of Indicated Year 4 Newlon, Kirby, Davis, Ness Officers of the Federal Reserve Bank of Minneapolis Februan/ 1, 1982 E. Gerald Corrigan President Thomas E. Gainor First Vice President Melvin L. Burstein Senior Vice President and General Counsel Richard K. Einan Assistant Vice President and Assistant Secretary Leonard W. Fernelius Senior Vice President Caryl W. Hayward Assistant Vice President Gary H. Stem Senior Vice President and Director of Research Richard C. Heiber Assistant Vice President Sheldon L. Azine Vice President and Deputy General Counsel Ronald O. Hostad Assistant Vice President Lester G. Gable Vice President Phil C. Gerber Vice President Bruce J. Hedblom Vice President Douglas R. Hellweg Vice President Ronald E. Kaatz Vice President Howard L. Knous Vice President and General Auditor William B. Holm Assistant Vice President Ray L. Hulett Assistant Vice President Roderick A. Long Assistant Vice President James M. Lyon Secretary and Assistant Counsel Gerald J. Mallen Assistant Vice President Susan J. Manchester Assistant Vice President Preston J. Miller Assistant Vice President Ruth A. Reister Assistant Vice President David R. McDonald Vice President Charles L. Shromoff Assistant General Auditor Clarence W. Nelson Vice President and Economic Adviser Kenneth C. Theisen Assistant Vice President Arthur J. Rolnick Vice President and Deputy Director of Research Colleen K. Strand Vice President James R. Taylor Vice President Robert W. Worcester Vice President Robert C. Brandt Assistant Vice President James U. Brooks Assistant Vice President Marilyn L. Brown Assistant Vice President Evelyn F. Carroll Assistant Vice President Gainor, Corrigan Theodore E. Umhoefer, Jr. Assistant Vice President Joseph R. Vogel Chief Examiner Norma J. Wuertz Assistant Vice President William G. Wurster Assistant Vice President Fernelius, Stern, Burstein Officers of the Helena Branch Betty J. Lindstrom Vice President G. Randall Fraser Assistant Vice President Robert F. McNellis Assistant Vice President 5 Our Services. . . The Federal Reserve Bank of Minneapolis continued to achieve higher levels of productivity and efficiency in 1981. And we also introduced a number of changes to our services, illustrating our desire and ability to respond to the challenges of a competitive environ ment. Some highlights follow: http://fraser.stlouisfed.org/ 6 Federal Reserve Bank of St. Louis Check Processing Services T h e head office of the Minneapolis Federal Reserve Bank is the second largest check processing operation in the Federal Reserve System—clearing approximate ly three million checks or check-like instruments each day. Over the past several years, we have made a sizable investment in upgrading every phase of that opera tion. New high-speed equipment has been installed which processes more than 90,000 items per hour per and significantly reduces the number of Digitizedmachine for FRASER missorted items. While that installation entailed some of the inevitable disruptions that occur during any conversion, the payback associated with the invest ment in terms of higher efficiency and quality are now being realized. Productivity has increased sharply, float has been reduced to a frictional level, and the number of outstanding adjustment cases has been reduced from more than 8,500 at the beginning of 1981 to only 1,300 by year end. 7 Check Processing Services But, more importantly, we now have a foundation in place that will permit us to diversify and tailor our check services to better meet the needs of our cus tomers as well as contribute to a more viable and efficient payments mechanism in the Upper Midwest. Consistent with that objective, in 1981 we: □ Engaged an outside consultant to conduct market research and analysis regarding the needs and priorities of our customers and to recommend changes and enhancements to our service lines. □ Entered into an agreement with the Twin City Clearinghouse to offer a "settlement" service where by this Bank will provide transportation and net settlement services for fine sort packages drawn on banks in the Twin Cities clearing territory which are not members of the clearinghouse and do not use a member of the clearinghouse for their demand deposit accounting. □ Initiated the Montana Expedited Check Clearing Arrangement (MECCA) to provide overnight check clearing services to a large number of Montana institutions. Through the use of a dedicated air charter service, MECCA checks deposited with Helena at midnight are in the hands of the paying bank later in the morning. □ Began offering a "calculated availability" option at our Helena office. This option enables depositors with a daily average volume of 15,000 items or less to deposit unsorted cash letters on which the Helena Branch calculates credit availability based on the items contained in the cash letter. □ Continued to support the direct exchange of items through local clearing arrangements. MECCA uses Capital Arrow, Inc., an air char ter service in Helena, Montana. Our accomplishments in 1981 are but a beginning toward meeting our goals of quality, efficiency, and responsiveness. In 1982, further improvements to our check processing services are already underway at our Minneapolis office. Dollar amount encoding has been added to our array of check clearing services for those financial institu tions that, because of volume, cannot justify acquisi tion of their own encoding equipment. And we also plan to offer a "calculated availability" option for in zone and out-of-zone items, to raise the daily average volume limit for unsorted items and to provide additional transportation lines to other Federal Re serve offices to improve credit availability. Automated Clearinghouse i_yevelopments in com puter and communica tions technology over the last few years have en abled the Federal Re serve System to augment its conventional check clearinghouse with an electronic means for ex changing paperless debit and credit entries be tween financial institu tions for customer ac counts—the Automated Clearinghouse (ACH). Through ACH, a finan cial institution can origi nate and receive certain payments automatically and efficiently, thereby reducing the number of checks that otherwise would be written and processed. Currently, both credit and debit pay ments such as govern ment payments, commer cial payrolls, mortgage payments, insurance pre miums, and utility bills can be processed through the ACH. Since its inception, im provements in the sys tem have continued to be developed. For example, in 1981 we began com bined processing of gov ernment and commercial files in order to improve the efficiency of ACH op erations, particularly in the area of delivery to receivers. In 1982 we will begin to transmit ACH data via tape to tape data links. This service enhancement will be more efficient and reliable, and will offer re mote financial institutions the same delivery dead lines as our local cus tomers. 9 Funds Transfer Service FEDWIKE 10 — F e DWIRE, the Federal Reserve's nationwide tele communications network, is a unique feature of the Fed's service package. It is the only such facility that permits the irrevocable same day transfer of funds. Through this service, the receiving institution has absolute assurance that the funds received are final payment in "same day" funds. This has proved to be an invaluable service for depository institutions in effectively managing their cash and reserve account positions. In addition, fi nancial institutions can make transfers through FEDWIRE on behalf of their customers—again in immediately available funds. Although transfers can be made either "on-line" or "off-line," the immediate effect of pricing this service in January 1981 was to increase the demand for on line transfer services nationwide. This increased de mand for on-line transfers is due in part to the 11 Funds Transfer Service—FEDWJRE difference in pricing—on-line transactions are less expensive because they eliminate the manual process ing required in off-line telephone communications. To update its nationwide communication capacity, the Federal Reserve System is replacing its current com munications network with FRCS-80—a new com munications system that will provide additional flexi bility, security, and capacity. FRCS-80 has been de signed with the flexibility to accommodate multiple connections with a variety of terminals and other communications systems. It also provides enhanced speed and efficiency through its packet switching technology. And it will eventually allow another Fed eral Reserve Bank to receive and process communi cations for this Bank if our computers are inoperative. The network is expandable to meet volume increases created by additional connections to financial institu tions through low-cost, dial-up alternatives to more costly sophisticated computer-to-computer links. This Bank's portion of the FRCS-80 system will become operational in mid-1982. 12 / / 'l m\ \ / K ( Recognizing the advantage to our customers of the improved productivity and cost effectiveness of this advanced technology, we began in 1981 to investi gate a dial-terminal network to provide low-cost, on line capabilities. The dial terminal (called FED link 1) is being offered to institutions through a lease ar rangement or through direct purchase and will allow institutions that have a fairly low volume of funds transfers to justify the cost of operating on-line. FED Link 1 will not only permit sending and receiving on line funds and securities transfers, but will also pro vide the capability for the following services: □ □ □ □ □ □ □ □ net settlement notification of large dollar return items money market and deposit interest rate ceilings advice of ACH cash concentration items reserve account balances and related information advice of cash letter credits financial institution name and ABA number changes "flash" reports of important financial and economic information We anticipate offering more services as we explore new ways to better meet customer needs. In this regard, we plan in 1982 to form a "user group" of depository institutions who can help us determine which service offerings would be most beneficial to depository institutions. Although FED link 1 will initially be limited to the first 150 subscribers, we plan to expand the network to as many as 500 institutions by the end of 1983. F E D im 13 Cash Services http://fraser.stlouisfed.org/ 14 Federal Reserve Bank of St. Louis T h e Federal Reserve's services relating to the provi sion of an "elastic" supply of currency and coin to the public through the network of depository institutions represent a mix of activities. Currency and coin process ing operations, for example, are public goods. Thus, activities such as the issuance of new currency and coin, the sorting of fit and unfit currency, and the destruction of unfit notes are essential central bank functions and are not priced. 15 Cash Services Only the cost of transporting coin and currency to depository institutions is subject to pricing. This is the only phase of our currency operations where compe tition in the marketplace can produce the efficiencies and economies contemplated by the drafters of the Monetary Control Act. and insurance costs. Although it is too soon to judge the effects of pricing of our cash transportation serv ices, early results suggest that a number of non member banks and thrift institutions have decided to participate in our transportation arrangements. Pricing of our cash transportation services began in January 1982. Initially, the price is based on a volume charge and a per stop charge associated with the cost of shipping currency and coin by armored courier from the Fed to individual depository institutions. Where institutions wish to receive currency by reg istered mail, the fee includes registered mail postage During 1982, we will closely examine our methods of cash transportation and related services. We plan to rearrange some of the armored courier routes to provide better service. And we will explore the possi bility of establishing currency depots to serve institu tions in the outlying areas of the Ninth District more economically. http://fraser.stlouisfed.org/ 16 Federal Reserve Bank of St. Louis With regard to our processing operations, we have entered into a program which, over time, is designed to upgrade the quality of currency in circulation. It should also complement efforts of some institutions to make more widespread use of automated teller machines (ATMs). As part of this program, we have installed two high speed automated currency-processing systems known as CVCS (currency verification, counting, and sorting sys tem). These systems perform all of the basic currencyprocessing functions formerly done manually—includ ing counting, sorting and verifying note denominations, detecting counterfeits, and destroying unfit notes or packaging fit notes for further circulation. Currently, about 98 percent of our currency is processed on these high-speed machines. This new technology has had several benefits. It pro vides a higher and more dependable level of quality control regarding the condition of currency which is put back into circulation by the Fed. In addition, it has significantly reduced processing time which has allowed us to reduce staff and realize substantial cost savings. And it has improved counterfeit detection and reduced costly, labor-intensive currency verification and destruc tion procedures. 17 18 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis O n e of the major securities services we offer is the maintenance of accounts and the electronic transfer of securities held by depository institutions in bookentry form—an example where innovation and leader ship by the Federal Reserve System has resulted in major efficiencies in the payments system. Not surprisingly, pricing has had little or no effect on the volume of operations in this area of our securities function. Moreover, steps we have taken in 1981 and others planned for 1982 should make this highly valuable service more attractive and more accessible to depository institutions in the District. For example, with the expansion of our direct on-line communica tions network in 1981, 92 percent of all securities transfers are now on-line. The adoption of FED link 1 in 1982 and the introduction of the FRCS-80 module planned for 1982 will further increase the efficiency, security, and flexibility of our book-entry processing. 19 Securities Services Historically, this Bank's definitive securities opera tions were limited to providing safekeeping services for government and agency security holdings of mem ber banks. Pricing of these services has resulted in a substantial decline in the volume of such securities held in our vaults. To some extent, this decline can be attributed to higher costs related to our philosophy of control and security as the nation's Central Bank. Nevertheless, the volume of such securities held in our vaults remains substantial, and we are looking at ways to make these services more attractive. For example, around midyear, we anticipate reducing the number of days required to pass credit to our depositors for coupons. In addition, we plan to offer the holding of municipal and corporate securities, certificates of deposit, and corporate stock for cus tomers of financial institutions. We have also identified several other changes to our safekeeping and noncash collection services that we will be pursuing in 1982. 20 fro \m\m issuance m ,000 ftHCE, PUOlr-o KT BOHD&I35I inclusive. o ! Princ5»n rity ftrnowtj $005651 400,o w l 425,0001 425,0001 t--s 450,0001 | : 5 450,(HO 1 Is 7 500,0001 b £3 h 1: mm pi 500,«« I'n |c : 500,000l 500,005! m cs to opinion luHding Bed y o\District unty, Miwi jchool Distr I w e have fcen prelim . Scho o l Di< 12, all yean® e years 1981 ,redemption■ jtrict In Invt* 198I and Km nd accrued M It respectivt® lie rates per I L at 3.25%, fis at 3.60%. 1 E at 3.70%, 1 E at 3.75V i4 p$ at 3.80'/:, 1 | | b e a rs § 9 6 7 to M tegregate c ! ‘J ■tesented I , 1968 w ig Kjary 1 ins4| B | e a t the n&j Bjust Comp;-'!1 Min n e s o t a : S tate B uild in g w h a t we K e d and e«^ K n , It Is o'-S K sh o w la**- i and btojjj I N T E R E S T P A Y A iB I P R IN C IP A L DU! trlct In to both P'i yhich Hthin the^ >r am ount I I Ofiiii 21 Our Challenge... 22 1 he transition to pricing required us to make some basic changes in the way we operate. Our entire management process and structure were examined and modified to position us to operate in this new environment. We acquired new expertise to market our services and design products to meet the needs of customers in a competitive environment. Pricing also necessitated changes to our operating climate and organizational culture. Extensive resources were re quired to modify and install new accounting, billing, and related operating systems. Those "mechanical" aspects of the implementation of pricing of our serv ices have been completed in a timely and effective manner. In 1982, we must move forward and confront more effectively the fundamental challenges created by the pricing environment. In doing that, we must be sensitive to our overall posture. Obviously, we cannot approach the issue of competitive posture in precisely the same manner that a private corporation would. We have public and statutory responsibilities relating to the payments and banking systems that transcend our role as a competitor in the market. And these public responsibilities may, in certain instances, come into conflict with competing in the market, or at least competing in the more traditional ways that private !&**>■ institutions might compete. Our overriding concern must be to ensure that payment services are provided in the most efficient manner and that the confidence in the payments mechanism is preserved. Therefore, the bottom line is clear. We must not only outline our strategic plans with enough flexibility to be responsive to our customers' needs, but we must act in a fashion that is consistent with the goal of promoting efficiency in the market. To further complicate matters, we must meet these objectives within the framework of statutory language that imposes constraints on us that would be quite foreign to a private corporation. Obviously, during any initial start-up period such as this, new opera tional requirements and shifts in volumes and usage patterns will temporarily affect unit costs. But once we have moved through that initial adjustment period, we must diligently chart a course of action that will ensure that our goal of matching revenues and costs is met. The challenge is not simply a matter of changing prices to bring them in line with our costs. To the contrary, we must develop a strategy of pricing— including price changes—that is compatible with our product development and enhancement programs and is also consistent with our cost containment efforts. In turn, the latter requires that we vigorously and systematically examine each aspect of our resource base. We must make sure that all parts of the pro ductivity equation have been scrutinized. And we must balance short-term productivity gains with invest ments that will help us realize our long-term goals. We need to continue to minimize costs, while search ing for new service enhancements to improve reve nues. And we must ensure that we are realizing all of the cost efficiencies of electronic technology. That technology must be designed to accommodate future growth without proportional increases in operations personnel. So, the challenge is clear: we must take a hard look at our services to ensure that they do, in fact, meet the needs of all institutions in the District. We must continue to examine our costs, and we must work toward efficiencies in the overall market. But we are excited and confident about our new role. The challenges that this Bank has met in the past year reflect the maturitv j and dedication of our staff. We appreciate their past accomplishments and look to them for future achievements. We also appreciate the support of our customers as we continue to search for ways to better fulfill our role in the financial community. 23
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