Full text of Annual Report of the Federal Reserve Bank of Philadelphia : Strategy for Changing Times : 2002 Annual Report

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CONTENTS
2

President’s Message

Targeting Quality and Efficiency

Operating Statistics

Quantifying Retail Credit Risk

Investigating Check Fraud

Studying Payment Cards

Promoting Economic Education

Establishing Strong Controls

Board of Directors

Advisory Councils

Current Officers

Statement of Auditor Independence

Financial Reports

Key Bank Phone Numbers

MISSION
The Federal Reserve Bank of Philadelphia is one of 12 regional Reserve
Banks in the United States that, together with the Board of Governors in Washington, D.C., make up the Federal Reserve System – the nation’s central bank. The
System’s primary role is to ensure a sound financial system and a healthy economy.
To foster this goal, the Federal Reserve Bank of Philadelphia helps formulate
and implement monetary policy, supervises banks and bank holding companies, and
provides financial services to depository institutions and the federal government. The
Philadelphia Fed serves the Third District, which is composed of eastern Pennsylvania, southern New Jersey, and Delaware.

“STRATEGY FOR CHANGING TIMES” is
more than the theme of this year’s annual report. It is a basic tenet for how we do business.
What worked yesterday may not be as effective
tomorrow. The current business environment
requires adaptation and flexibility to prepare
for future needs. At the Federal Reserve Bank
of Philadelphia, we adhere to a strategy that
reveres stability yet allows for change, seeks innovation yet inspires confidence.
This year’s annual report theme, “Strategy
for Changing Times,” outlines our moves to
strengthen our overall position. We trust you
will find “Strategy for Changing Times” informative. As always, our strategy begins with our
president…

PRESIDENT’S MESSAGE

Our strategies
evolve, but
our focus
on excellence
remains constant.

Dr. Anthony M. Santomero, President

O U R

S T R AT E G Y

he year 2002 was a challenging one for our

is straight

TO LEARN

country, filled with financial uncertainty

The cornerstone of our strategy is to con-

and geopolitical turmoil. Economically, the rise

tinue to build upon our knowledge of the finan-

from recession was slower and more difficult than

cial services industry and the economy at large.

initially anticipated. Indeed, the future course

Rapid change is a fact of life; so we constantly

of the economy is still very much on everyone’s

strive to develop new knowledge and new ca-

mind.

pacity to ensure financial system integrity and

Times such as these challenge the Federal

economic stability.

Reserve in all its dimensions — as monetary poli-

One example is the recent establishment of

cymaker, as regulator, and as payments provider.

the Payment Cards Center. The Center engages

I am proud of the contributions the Philadelphia

in intense study of evolving techniques in retail

Reserve Bank makes to meet those challenges.

payments. Use of credit cards, debit cards, and

Our strategy for facing these trying times is

other new methods of payment is growing rapidly,

straightforward: to learn and to lead. Though

and the Center provides meaningful insights into

simple, it serves us well as a “Strategy for Chang-

payments innovations and the issues they raise.

ing Times.”

To help build knowledge and capability in the

processing network that positions the Fed to

regulatory arena, we recently began a project to

continue delivering check services at reasonable

quantify the impact of growth in retail credit on

prices to its customers all across the country.

the overall safety and soundness of the financial

On the more technical side, the Bank

system. This project leverages the expertise we

continues to lead System efforts to combat check

developed in our extensive analysis of consumer

fraud. In partnership with both industry groups

credit risk and the credit card industry concen-

and the U.S. Treasury, we are finding ways to turn

trated in our District.

new technologies into workable solutions to this
serious problem.

As part of our effort to build knowledge as
monetary policymakers, we held our second an-

Behind the scenes, our Bank also helps the

nual Policy Forum last year. The Forum brought

Federal Reserve System maintain and enhance

together central bankers and policy experts from

the application of technology to its business pro-

around the world to debate the value of interna-

cesses. We oversee the System’s infrastructure for

tional coordination in setting domestic monetary

e-mail, videoconferencing, collaborative systems,

policy.

and important aspects of information security.

forward: to learn and to lead
TO LEAD

In 2002, we also expanded
our outreach to consumers of

As we increase our knowledge, we increase
our capacity and propensity to lead. The Philadel-

financial services in the District.

phia Fed has taken a leadership role in a number

Educational programs developed

of important Federal Reserve System initiatives,

and promoted by the Philadelphia

as well as pursuing some initiatives of its own here

Fed help consumers make better

in the District.

financial decisions. In low- and
moderate-income communities

This past year, our Bank had the opportunity

— often targets of unscrupulous

to help develop and implement major changes in the

business practices — we help

Fed’s discount window facility. These changes make

people understand risks and

it easier for banks in sound financial condition to

evaluate alternatives. In District

obtain short-term loans from the Federal Reserve.

classrooms, we help young people

We also contributed to a broad review of

understand the workings of the

the Fed’s check clearing operations that led to

economy and the financial system

a substantial restructuring and consolidation of

in which they are just beginning

processing sites. The result is a more efficient

to participate.

STRATEGY FOR CHANGING TIMES
Through learning and leadership, we
will do our part to advance the Fed’s
mission of fostering a sound financial
system and a healthy economy.

In addition, we started a new project to

our District has evolved into a microcosm of the

broaden our public outreach, taking advantage of

national economy, and it now tracks national eco-

our unique location on Independence Mall. Our

nomic developments quite closely. So, I expect

financial exhibit, Money in Motion, will open

our region to be a full participant in the national

in July 2003. Using technology and interactive

economic expansion that lies ahead.

displays, visitors will learn about the country’s

The banks of the Third District are posi-

financial history, as well as the history of the

tioned to support that growth. They fared well

Federal Reserve System and its unique role in the

through the recession and the early stages of this

nation’s economy.

recovery. Through prudent risk management and
responsiveness to shifting customer demands,
they have performed admirably in very challeng-

LOOKING AHEAD

ing times. I am confident they have the capacity

As we move into 2003, I am optimistic about

to meet District demands for credit and other

the future. I see this year as one in which the

financial services in the months and years ahead.

economic recovery gains momentum, position-

Here at the Philadelphia Fed, we look for-

ing our nation for a period of sustained economic expansion. Indeed, the ultimate drivers of

ward to the new challenges and new opportunities

healthy growth — technology, productivity, and

changing times will bring. Through learning and

globalization — are very much in place. Despite

leadership, we will do our part to advance the

near-term uncertainty, people have confidence in

Fed’s mission of fostering a sound financial system

our economy’s long-term potential. Indeed, this

and a healthy economy.

confidence itself bolsters growth and ensures our
ability to reach that potential.

BOARD OF DIRECTORS

The future of the Third District economy is

Recent events remind us about the important

equally promising. Over the past several decades,

role that boards of directors play in guiding organ-

CLOSING THOUGHTS

izations. Reserve Bank boards of directors not
only oversee the operations of the Reserve Bank,

In closing, and in light of our country’s

but they also contribute to the formulation of Fed

continued state of heightened security aware-

policy on behalf of the District. It is a responsi-

ness, it is important to stress that we stand ready

bility they take seriously and perform admirably.

to maintain the integrity of the financial system

So, I want to acknowledge recent changes to the

— to supply liquidity, assist financial institutions

board of directors of the Federal Reserve Bank of

in need, and maintain the payments system.

Philadelphia:

As part of the Federal Reserve System, the

Glenn A. Schaeffer, president emeritus of the

Philadelphia Fed is an organization with a clear

Pennsylvania Building and Construction Trades

calling to public service. We remain a high quality

Council, has been appointed chairman of the

provider of central bank services and continue our

board, and Ronald J. Naples, chairman and CEO

quest to be broadly recognized as an important

of Quaker Chemical Corporation, was appointed

center of central bank knowledge and capability.

deputy chairman.

As the year 2002 so clearly demonstrated,

We are grateful for the guidance provided

times change and our strategies must evolve. But

by two directors who completed their terms of

our focus on excellence remains constant. Look-

service last year: our former chairman, Charisse R.

ing ahead, we will continue to foster an environ-

Lillie, partner at Ballard Spahr Andrews & Inger-

ment of strength and growth for our region’s

soll, and Frank Kaminski, Jr., chairman, president,

economy.

and CEO of Atlantic Central Bankers Bank.
We welcome our two new board members:
Garry L. Maddox, CEO of A. Pomerantz & Company, and Kenneth R. Shoemaker, president and
CEO of Orrstown Bank. We look forward to the

Anthony M. Santomero

insights they will surely provide.

President

In addition, Rufus A. Fulton, Jr., chairman

April 2003

and CEO of Fulton Financial Corporation, has
been reappointed to represent the Third District
on the Federal Advisory Council to the Board of
Governors.
On behalf of all of us here at the Philadelphia
Fed, I thank them for their leadership and their
commitment to public service.

TARGETING QUALITY AND EFFICIENCY

s the financial environment evolves and

Philadelphia area researchers are more interested

new technologies emerge, the Federal

in factors influencing the health-care industry and

Reserve focuses on the most efficient and ef-

payment card providers because of the predomi-

fective ways to fulfill its missions. First Vice

nance of these activities in the District.

President Bill Stone offers his insights on the

Financial institutions, too, have specialized

evolution of the Federal Reserve System and

and expanded into new financial vehicles. From

the Philadelphia Fed’s key role.

a supervision and regulation perspective, uniform
expertise is not required in every Federal Reserve

SPECIALIZATION AND EFFICIENT

District. Rather, sharing expertise across District

USE OF RESOURCES

lines ensures we are using resources effectively to

Each of the 12 Reserve Banks in the Federal
Reserve System expends great effort on issues

best serve our financial institutions.
In providing services to the financial com-

concerning national monetary policy. Each

munity and the U.S. Treasury, we have found

Reserve Bank also does specialized research

that not all aspects of a service can be provided

unique to its regional environment. For example,

efficiently on a local basis. This is particularly true

CHANGING TIMES demand new
with changes in technology and the reduced reliance on paper transactions and documents.
An example of this is the Fed’s participation
in the ownership of government securities by
individuals. U.S. Treasury securities are often purchased by consumers through TreasuryDirectSM,
the first Systemwide consolidation of services,
which found its home at the Philadelphia Fed
back in the mid-1980s. Holding these securities
in book-entry form made maintaining accounts at
a single site a logical option.
Payments activities have also been in transition. As large-dollar payments and automated
clearinghouse payments have become more
electronic, geographic proximity has become less
important. This consolidated processing brings
significant improvements in efficiency.

William H. Stone, Jr., First Vice President

CHANGES IN CHECK INFRASTRUCTURE

them electronically, and create

During the early 1970s check payments were

machine-readable substitute

being influenced by a strong set of demands. Faster

checks that would be the legal

funds availability led to an expansion in Federal Re-

equivalent of the original checks.

serve facilities as regional check processing centers

The act, now in Congress waiting

opened to offer later deposit deadlines and improved

consideration, would remove

funds availability. Despite predictions of their

certain legal impediments and

demise, check payments increased at a brisk pace.

would enhance the efficiency of
the payments system.

Then, the mid-1980s ushered in electronic
means for banks to provide information about
check payments prior to processing the physi-

OPPORTUNITIES

cal paper. Customers gained the advantage of

FOR LEADERSHIP

earlier quality information, while banks avoided

When consolidation and

the demands of expensive additional processing

centralization take place, they of-

equipment.

fer the opportunity for leadership

strategies for quality and efficiency
In the late 1990s, image processing furthered

and capitalization on special capabilities. This has

the decline in reliance on the physical check. In

been the case for a number of Fed services, such

addition, the accelerating growth of electronic

as collateral management for financial institutions

payments has led to declines in check volumes.

and special payments applications for the U.S.

Consequently, the Federal Reserve is re-examin-

Treasury.

ing its check infrastructure and reducing the

Within the Federal Reserve System, the

number of processing sites.

Philadelphia Fed has an outstanding reputation

The changes in check infrastructure are still

for leading System projects and an impressive

limited by geographic constraints. Check service

portfolio of current leadership assignments. For

levels must be maintained, and the requirements

example, we have earned a central role in the

for physical delivery of checks, although lessen-

Fed’s technology initiatives through our oversight

ing, are still the primary limiting factor. Passage

of the planning, implementation, and functional

of the Check Truncation Act would open many

enhancements to the shared technology — or

additional opportunities for innovation in check

Groupware — for the entire Federal Reserve

processing and remove many of the geographic

System. Philadelphia also was asked to provide

restraints. Banks would then be able to trun-

analysis on how to improve the effectiveness

cate — or stop the flow of — checks, process

and efficiency of information security across our
7

distributed processing platforms.

ties with the entire Fed System. When financial
institutions access the services of their regional

As the largest single Fed site for check pro-

Reserve Bank, they do so with the confidence

cessing and also one of the most sophisticated and

that the full arsenal of Fed resources and capabili-

efficient operations in the System, Philadelphia

ties is behind them. This way, the power of shar-

is a major source of innovation and leadership.

ing best practices is put to use to deliver superior,

Philadelphia was asked to lead the effort and

high quality customer service.

make recommendations on check infrastructure,
leading to the decisions announced in early 2003.

Our goal is to continue to provide the highest

We are currently engaged in research for the

quality service in the most efficient and effective

System and the U.S. Treasury to combat check

manner possible. We at the Federal Reserve Bank

fraud. In addition, we are working to develop a

of Philadelphia are committed to quality, innova-

new check information and reconcilement system

tion, and responsiveness. We will strive to make

for the U.S. Treasury.

strategic investments that allow us to contribute

At the Philadelphia Fed, we take advan-

to the System and serve our Third District stake-

tage of change to leverage our strengths, pursue

holders.

leadership opportunities, and share our capabili-

At the Philadelphia Fed
We take advantage of change to leverage
our strengths, pursue leadership opportunities, and share our capabilities with the
entire Fed System.
8

OPERATING STATISTICS

n 2002, Philadelphia’s total volume of com-

cessed increased 3 percent while the related dollar

mercial checks processed decreased 4 percent.

value increased 12 percent, both attributable to

Conversely, the dollar value of transactions

normal growth. The substantial decrease in coin

increased 4 percent. Beginning in January 2002,

processed was the result of the August 2002 elimi-

the Bank started phasing in its newly assumed re-

nation of some processing of lower denominations

sponsibility for processing all government checks

of coin. The substantial decrease in food coupons

for the First, Second, Third, and Fourth Federal

processed was a result of the consolidation of this

Reserve Districts.

function in January 2002.

The Philadelphia Bank continued to be a

In 2002, both the number and value of loans

major processor of cash in the Federal Reserve

to depository institutions were lower than in the

System in 2002. The volume of currency pro-

previous year.

2002
Volume

2002
Dollar Value

2001
Volume

2001
Dollar Value

$64.5 billion

40.9 million checks

$37.1 billion

$2,594.7 billion

1,339.8 million checks

$2,501.3 billion

SERVICES TO DEPOSITORY INSTITUTIONS
Check processing:
U.S. government

52.8 million checks

Commercial checks 1,282.6 million checks

Cash operations:
Currency processed

2,116.7 million notes

$41.2 billion

2,053.8 million notes

$36.8 billion

Coin processed

23.8 thousand bags

$16.4 million

52.5 thousand bags

$29.9 million

68 loans

$210.3 million

96 loans

$503.3 million

$2.8 million

6.4 million coupons

$34.3 million

Loans to
depository institutions

SERVICES TO U.S. TREASURY
Food coupons processed 551 thousand coupons

Note: Because of the consolidation of Federal Reserve System wire transfer of funds and electronic book-entry transfer operations
to other Federal Reserve offices, related statistics are no longer shown here.

QUANTIFYING RETAIL CREDIT RISK

s our nation’s central bank, the Federal

sophisticated credit-scoring models for measuring

Reserve is responsible for the integrity

retail risk.

of the financial system and views risk management as a key element of bank supervision.

DEVELOPING RETAIL CREDIT RISK MODELS

Mike Collins, senior vice president, Supervi-

The revolution in information and commu-

sion, Regulation and Credit, tells how Phila-

nications technology has led to the emergence

delphia is establishing advanced approaches to

of consumer credit-scoring models as a mainstay

quantifying retail credit risk.

technique. As a result, we now have more efficient means to slot individual loans into appropri-

As a regulator and supervisor of financial

ate risk classes. This has led to greater potential

institutions, the Fed must expand its knowledge of

for risk-based pricing and targeted marketing in

the broad financial industry to ensure its integrity

retail lending; however, there is much ground still

and stability. The Philadelphia Fed is leading a

to be covered.

Systemwide effort to develop a supervisory frame-

While the sophistication of automated credit

work to evaluate bank practices in retail credit risk

scoring has increased, only recently have some

management, including internal risk rating systems.

institutions put resources into advanced methods

CHANGING TIMES mean improved
This project, which will enhance the Federal

of retail portfolio credit risk modeling. Addition-

Reserve’s ability to assess banking organizations’

ally, quantifying the risk in retail portfolios places

retail credit risk quantification methods, responds

an even greater premium on a bank’s ability to

to gaps in the Basel II framework. Basel is a land-

accurately differentiate the credit quality of bor-

mark international agreement on bank capital

rowers. It also requires an acute understanding

standards and risk-based regulation. Until quite

of the contributions of retail credit to both risk

recently, bank and supervisory resources have

and return. For example, problems in accurately

concentrated on credit risk modeling of commer-

predicting performance in sub-prime portfolios

cial and industrial portfolios, with fewer resources

proved detrimental to some institutions’ overall

devoted to understanding risk in the retail credit

level of risk, as we have seen in 2002.

area, which includes such common consumer
instruments as mortgages, credit cards, and auto

THE PHILADELPHIA FED’S PROJECT

loans.

Given the recent developments in the retail

However, despite the emphasis on the com-

sector, regulators must gain a greater understand-

mercial side, retail credit is a substantial part of

ing of current industry practices and areas for

the risk borne by the banking industry. Recogniz-

potential improvement. The Philadelphia Fed has

ing this, the industry has begun to develop more

distinguished itself as an expert hub of emerging

industry issues and a vital resource in identifying
and implementing industry best practices. Consequently, we have the important System responsibility to expand the Fed’s knowledge of advanced
approaches to quantifying retail credit risk. Our
efforts focus on three main goals:
First, we document existing policies and practices among institutions capable of effectively measuring retail credit risk. Toward this goal, we have
joined with other U.S. regulators in conducting
interviews at several large banking organizations.
These interviews help us identify current practices
in evaluating retail credit risk and improve our
knowledge of current industry practices. We are
using this information to compare banks’ current

Michael E. Collins, Senior Vice President
and Lending Officer

practices with the Basel II proposal for an internal

practices and increased responsibilities
ratings-based (IRB) approach to retail credit.

strengths and weaknesses of existing retail risk

Our second goal is to analyze the reliability

quantification standards at large U.S. banks. Our

of current practices and assess their weaknesses

findings will be presented at various forums to

or gaps. That way, we can spot problems supervi-

educate the industry on these issues. We will also

sors need to address in assessing internal risk and

lead efforts of the Federal Reserve System and

capital adequacy in the retail credit area.

other U.S. banking regulators to develop training

Our third goal is to identify major analytical is-

curricula for supervisory staff on IRB standards

sues in quantifying retail credit risk and to generate

and examination guidance.

relevant research. In this way, we can identify pri-

Constructive dialogue between financial

ority policy issues for the Federal Reserve and other

institutions and their regulators means standards

banking regulators and make recommendations

progress and practices improve. With more ex-

on how to tackle them. Philadelphia’s work is the

perience and better information, risk parameters

beginning of a necessary and important long-term

will change and models will get stronger and

effort in the retail credit arena.

more efficient. Rather than a uniform regulatory

Throughout 2003, Philadelphia will develop

standard, financial institutions will develop their

a research agenda on retail credit risk quantifica-

own assessments and procedures that accurately

tion. We are now preparing research analyzing

capture retail credit risk.

INVESTIGATING CHECK FRAUD

hile technology has brought about

Basically, detecting check fraud has two

innovations in the financial services

facets: the application of fraud-prevention tech-

industry, it has also enabled more sophisticated

nology and machines that can read new security

methods of fraud. Consequently, we need

features. Right now, there are four types of tech-

increasingly sophisticated technology to detect

nologies in this area: laser ink, two-dimensional

fraud. That’s why the Retail Payments Office

barcodes, seal encoding, and digital watermarking.

(RPO) asked Philadelphia to lead an investiga-

Our pilot programs involved these last two tech-

tion into ways to prevent check fraud. Arun

nologies. Initially, we used test checks from the

Jain, vice president, Retail Payments, talked

Treasury. The seal encoding pilot used produc-

about the Bank’s role in two pilot programs.

tion checks issued by the Federal Reserve Bank of
Philadelphia for Treasury-related payments, and

Since Philadelphia has a close working rela-

the digital watermarking pilot used simulated test

tionship with the Treasury Department, it made

checks.

sense for us to jointly undertake this project.

Seal encoding technology conceals informa-

Furthermore, Treasury checks are a major target

tion (for example, the dollar amount, account

for fraud.

number, payee name, or issue date) within the

CHANGING TIMES mean new ways
body of the check in order to detect altered or
counterfeit checks. It’s similar to two-dimensional
barcoding, but not as visible. (See sidebar.) For
instance, you can hide data in a corporate logo on
a check. Someone looking at the check may not
see a difference, but the right detection software
can read the hidden information and match it to
what is on the magnetic ink character recognition
(MICR) line that’s printed on the bottom of a
check. The pilot showed that seal encoding works
in some situations, but not all.
The second pilot applied a digital watermark to the body of the check. The idea is that
photocopiers and high-resolution scanners won’t
pick up and subsequently print the watermark,

High speed sorters
such as this one process
checks using magnetic ink
character recognition.

thus making it harder for counterfeiters to copy
checks.

One advantage here is that digital watermarking can cover a wide area of the check.
Since checks can be mishandled and mutilated,
it’s better to have the fraud-detection feature in
more than one part of the check. One problem
with both of these technologies is that good

Chemical Inks and
Two-Dimensional Barcodes

checks are sometimes flagged as altered or
counterfeit, and it costs both time and money
to verify the so-called false positive checks.
RESULTS
Working with other Reserve Banks, we
tested seal encoding and digital watermarking
on both IBM and Unisys sorters. That way, we
could note differences between the types of
sorters.

of detecting fraud
These pilots involved true research and development work. Although these technologies
are used for fraud detection in other industries,
we are trying to validate their applicability in
the checks arena. Cost/benefit analyses will be
important determinants of which technologies
are finally adopted.
Our initial report of the outcome will go
to the RPO and Treasury. Subsequently, we’ll
share the outcome with the banking industry.
The results for these various pilot programs will
determine if Treasury is ready to adopt one or
both of these technologies.
Our goal is to aid the banking industry by
helping to develop new methods for reducing
fraud, which costs the industry — and consumers — millions of dollars every year.

Chemical Inks. The idea behind chemical inks is
to invent a process that places an invisible mark on
a check that cannot be reproduced and is manufactured only in secure printing arrangements.
Testing for the chemical ink would be accomplished via special scanning devices licensed by
the technology owner. Low-cost scanners would
shine a special ultra-violet or laser light spectrum
onto the paper to test for reflection from the
chemicals. Checks expected to have this invisible
chemical ink would be considered genuine if the
test is positive and assumed to be counterfeit if
the test fails.
Two-Dimensional Barcodes. Two-dimensional
barcodes are the modern equivalent of the universal product code (UPC) found on most products
in grocery stores and other retail outlets. But unlike the long, varying-width lines that code eight
to 12 digits of product code data, 2-D barcodes
can carry a payload of hundreds of bytes of data.
Low-cost digital scanners and decoding software would be used to test the 2-D barcode.
Existing digital scanners on high-speed checkprocessing equipment could be used to test for the
existence of a 2-D barcode and to compare it with
the MICR line at the bottom of the check and
visual data.

STUDYING PAYMENT CARDS

ver the past decade, consumers have

since 1979, consumer electronic payments have

moved away from paper forms of pay-

grown from approximately 5 billion transactions

ment — checks and cash — to payment cards

a year to about 30 billion. The pace of change is

and other electronic methods. Acknowledging

further accelerating as consumers become increas-

this shift in consumers’ behavior, the Phila-

ingly comfortable with these new payment mecha-

delphia Fed established the Payment Cards

nisms.

Center to serve as a source of expertise on this
important segment of the financial system. The

USING NEW PAYMENT METHODS

Center’s director, Peter Burns, elaborated on

After cash and checks, credit cards are prob-

the Center’s mission and achievements to date.

ably the most familiar method of payment and the
payment vehicle of choice for many consumers.

Although cash and checks remain popular

Right now, about 80 percent of Americans use

methods of payment, consumers are turning more

credit cards, and most carry several different cards

frequently to electronic methods, such as credit

in their wallets. At the same time, use of debit

cards, debit cards, smart cards, stored-value cards,

cards, which are directly linked to consumers’

and other emerging payment technologies. In fact,

bank accounts, is growing even faster than credit

CHANGING TIMES mean new
Paper to Electronic Payments

cards. Simultaneously, banks,
retailers, and other businesses
are experimenting with various other electronic payment
vehicles that add convenience

Migration from paper
to electronic payments
will drive investments in
product development,
operations, technology,
marketing, and business
infrastructure.

and efficiency to the retail payments arena.
HIGHLIGHTS IN 2002
To carry out its mandate to
monitor trends in the industry
and provide insights into this
evolving field, the Payment
Cards Center has launched a
variety of projects over the past
two years.
In 2002, we held a series

Jeanne M. Hogarth (left), program manager, and Marianne A. Hilgert, research assistant, Consumer
Policies Section, Board of Governors of the Federal Reserve System, participated in the Payment Cards
Center’s workshop “Voting with Your Feet: Consumers’ Problems with Credit Cards and Exit Behaviors.”

ways of making payments
of workshops featuring industry experts on a

Center’s web site, allowing even wider distribu-

wide range of topics, including the role of credit

tion. Furthermore, the Center is committed to

reporting agencies, financial privacy, and credit

supporting academic research on payment-card

risk management practices. We also co-sponsored

topics and works with the Bank’s Research De-

three major conferences: one with the Bank’s

partment in fulfilling this part of its mission. In

Research Department, one with the Wharton

addition, the Center’s visiting scholars program

Financial Institutions Center, and one with the

brings academic researchers to the Bank, usually

Electronic Funds Transfer Association’s E-Com-

for one or two academic semesters, so they can

merce Payments Council. These conferences

pursue their research interests.

brought together representatives from the aca-

This past year, we expanded our programs

demic, industry, and policy communities to debate

and honed our expertise. Now it’s time to look

critical issues in consumer payments.

ahead. In the coming year, we will work to further

Discussion papers, which offer business analy-

engage industry practitioners and academic and

ses of issues related to payment cards, constitute

consumer representatives in our activities and

another aspect of our work. These papers, which

design programs that effectively address their

are available in hard copy, are also posted on the

concerns.

PROMOTING ECONOMIC EDUCATION

asier access to credit and increased in-

TEACHING THE TEACHERS

stances of predatory lending have created a

In our economic education program, we want

greater need to educate the public about finan-

to make people aware of the Federal Reserve

cial services. To meet this need, the Commu-

System and the workings of the economy in

nity Affairs Department at the Philadelphia Fed

general. We’re also developing financial literacy

has expanded its programs in economic educa-

programs that target both young people and low-

tion and financial literacy. The department’s

and moderate-income adults. We want to keep

economic education specialist, Andrew Hill,

young people from getting into financial trouble

described some of the new ventures.

and help adults find their way out of it. So we
teach them about credit, bank services, and saving. Also, we introduce such economic concepts

Financial literacy is an important topic these

as the allocation of scarce resources and the idea

days. The headlines tell the story: Americans hold

that a choice they make today may mean giving

more debt than ever before, personal bankruptcies

up something later.

are at an all-time high, and people continue to fall

Some states mandate economic education

victim to financial scams and predatory lenders.

at the high school level; other states voluntarily

CHANGING TIMES mean a greater
The proliferation of check cashing outlets has

include it in their curricula. But, unfortunately,

had an effect. In many low- and moderate-income

many high school teachers are ill-equipped to

neighborhoods, these outlets offer convenient

teach economics and finance. That’s where we

locations and hours. People use them in spite of

hope to have an impact. We’re following a train-

the very high fees they charge. Also, many people

the-trainer model. Rather than being directly

in our society have no regular relationship with

involved with students, we’re providing significant

a financial institution. Consequently, the people

training to teachers so they can get the message

who can least afford it are being hit with high

across.

fees, and sometimes high interest rates, from tax
preparers, check cashing facilities, payday lenders,

OUR SUCCESSES

and rent-to-own furniture stores.

To date, our biggest success has been in Dela-

As these problems have become more

ware, where a financial literacy program intro-

prevalent, there has been a push to do something

duced in one high school has now spread to seven

about them. In response, the Community Af-

other schools. Fortunately, we’ve built strong

fairs Department has renewed its commitment to

partnerships with the Delaware Bankers Associa-

increasing financial literacy and has created some

tion, the Consumer Credit Counseling Services

new initiatives in economic education.

of Maryland and Delaware, and the University of

Delaware’s Center for Economic Education and

conferences. In fact, we’ve already hosted several

Entrepreneurship. Although we lit the fire, our

events. Last summer, the department presented

partners did 95 percent of the work.

day-long programs to students in the Pennsylvania

We’re hoping to replicate our Delaware suc-

Governor’s School for Entrepreneurship and to

cess in Pennsylvania and New Jersey. To that end,

teachers as part of the Summer Institute of the

we’re building relationships with state councils on

South Jersey Chamber of Commerce. In October,

economic education and with economic educa-

teachers from Philadelphia and its suburbs came

tion centers at colleges and universities.

to the Bank for a seminar called “Hot Topics in
Economics.”

COURSES AND OTHER PLANS
This summer, we’ll offer teachers a gradu-

Thus far, our programs have been well received by Third District teachers and consumers.

ate-level course on money and banking. We’ll

Our efforts also support the Bank’s goal of making

also participate with the University of Delaware

the Philadelphia Fed known as a center of central

and Millersville University in a separate graduate

bank knowledge and capability.

course for teachers.
Other plans include holding workshops and

need for economic education

Andrew Hill, economic education specialist, Federal Reserve Bank of Philadelphia,
17
talks to a group of teachers about the importance of economic
education.

ESTABLISHING STRONG CONTROLS

aving a solid financial base is crucial to

controls are. Bear in mind that many of the initia-

the work of the Federal Reserve Bank of

tives you’ve read about in this report are possible

Philadelphia. Donna Franco, vice president and

because strong internal controls are in place.

chief financial officer, tells why strong internal
controls are an essential part of that base.

REINFORCING CONTROLS
How do we reinforce such controls? First, the

Strong internal controls are important to the

Bank’s senior management sets the tone that is

financial soundness and integrity of any orga-

crucial to the control environment. Since strong

nization. But when you’re the entity that sets

controls are an integral part of the Bank’s strategic

monetary policy and fosters the integrity of the

direction, there are well-documented policies and

nation’s payments system, such controls are vital.

procedures in place, which serve as ready references

The Philadelphia Fed’s stability – indeed, that

for control questions that arise.

of the Federal Reserve System – is underlined by
stringent internal controls.

Second, in addition to our own controls, which
are guided by the precepts of the Board of Governors

In fact, we believe the more creative and

in Washington, D.C., we also benefit from periodic

innovative we want to be, the more crucial these

reviews by the Board. Having dual controls gives us

C H A N G I N G

T I M E S

m e a n

a definite advantage over other organizations.
Third, and equally important, is the ongoing
cooperation and communication among the various departments at the Bank. For example, the
Bank’s chief counsel and ethics officer provides
valuable insight and support in maintaining the
ethical standards so important to strong internal
controls.
OTHER RELATIONSHIPS
Furthermore, Audit and Accounting have an
important relationship. This liaison is particularly
valuable when the Bank goes through its yearly
evaluation process, which assesses the effectiveness of the Bank’s internal controls. It also comes
into play during the year-end financial audit with
the Bank’s accounting firm.

Donna L. Franco, Vice President
and Chief Financial Officer

Internal Control System Components
• Control Environment — sets the tone and serves as a
foundation for internal controls
• Risk Assessment — identifies and analyzes relevant risks to
achievement of objectives
• Control Activities — includes policies and procedures that
help ensure execution of management’s directives
• Information and Communication — identifies and captures
pertinent information and communicates it to relevant parties
• Monitoring — incorporates ongoing and periodic reviews of
quality of internal controls

e v e n

s t r o n g e r

c o n t r o l s

Another important area of cooperation is

tarnishing our image. With our reputation intact,

between the Bank’s Board of Directors and the

we can move forward and take on new strategic

Bank’s management. Our Board’s Budget and Op-

initiatives.

erations Committee receives regular reports and

Quality is another key feature of strong fun-

periodic presentations, and we use these opportu-

damentals. When an organization lacks quality, it

nities to address financial and operational issues.

spends too much time and money fixing mistakes.

Similarly, the Audit Committee receives reports

A lot of an organization’s success depends on

on the effectiveness of controls throughout the

having the right people with the right skills in the

Bank.

right job.

RISK AND QUALITY

THE BOTTOM LINE
So what’s the bottom line? The Bank makes

Of course, cooperation forms only part of the
controls story. Controlling risk and promoting

sure that all employees recognize their respon-

quality are also critical aspects.

sibilities in maintaining strong internal controls
in their areas. Controls are a part of our normal

On the risk side, a potential pitfall we face
as a Federal Reserve Bank is reputational risk.

routine — not a once-a-year checklist that we

We must be vigilant in all our activities to avoid

complete.

6
8

BOARD OF DIRECTORS
Robert E. Chappell (4)
Federal Reserve Bank of Philadelphia Board of
Directors member since 2000. Member Budget and
Operations and Personnel committees. Chairman
and Chief Executive Officer of Penn Mutual Life
Insurance Company. Member Insurance Federation
of Pennsylvania and Taxation and Financial Services
Steering Committee for American Council of Life
Insurance. Serves on boards of Glatfelter, Quaker
Chemical Corporation, South Chester Tube Company,
LOMA, and Wharton Financial Institutions Center at
University of Pennsylvania.

on numerous boards, including Juvenile Law Center,
Friends Select School, Franklin Institute, and Leadership, Inc.
Ronald J. Naples (2)
Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and
Research and External Affairs committees. Chairman
and Chief Executive Officer of Quaker Chemical Corporation. Chairman of the Board of the University of
the Arts. Serves on boards of Glatfelter, Philadelphia
Museum of Art, Franklin Institute, Foreign Policy
Research Institute, Rock School of the Pennsylvania
Ballet, and Greater Philadelphia First.

Walter E. Daller, Jr. (9)
Federal Reserve Bank of Philadelphia Board of Directors member since January 2002. Member Budget and
Operations and Personnel committees. Chairman,
President & CEO of Harleysville National Corporation. Chairman of Harleysville National Bank and
Trust Company. Member of Board of Directors of Independent Community Bankers of America and TCM
Bank of Tampa, Florida. Serves on boards of North
Penn United Way, Lower Salford Historical Society,
Muhlenberg House, Montgomery County Lands Trust,
and Perkiomen Valley Watershed. Previously served as
Federal Reserve Bank of Philadelphia’s representative
to Federal Advisory Council.

Glenn A. Schaeffer (7)
Deputy Chairman, Federal Reserve Bank of Philadelphia Board of Directors. Board member since
1998. Member Budget and Operations and Research and External Affairs committees. President
Emeritus Pennsylvania Building and Construction
Trades Council, Harrisburg. Co-founder Capital
Area Labor Management Committee. Coordinator,
Capital Area Labor Management Construction Partnership Coordination Project. Member of Executive
Committee of Pennsylvania AFL-CIO, Governor’s
Committee on Economic Development through
Labor Management, Pennsylvania Prevailing Wage
Advisory Board, and Keystone Commission on Education and Employment in the 21st Century. Serves
on Capital Blue Cross board.

Doris M. Damm (3)
Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and
Personnel committees. President and Chief Executive
Officer of ACCU Staffing Services. Other affiliations
include Cerebral Palsy of New Jersey, Cherry Hill Economic Development Council, Our Lady of Lourdes
Medical Center, Our Lady of Lourdes Foundation,
and Cherry Hill Regional Chamber of Commerce.

P. Coleman Townsend, Jr. (8)
Federal Reserve Bank of Philadelphia Board of Directors member since January 2002. Member Budget and
Operations and Personnel committees. Chairman
and CEO of Townsends, Inc. Member of Board of
Trustees of University of Delaware and Winterthur
Museum. Serves on Council of Advisors for Delaware
Center for Horticulture, Lehman Art Center Advisory
Committee, Liberty Mutual Advisory Committee, and
Board of Overseers for Delaware College of Art and
Design.

Frank Kaminski, Jr. (1)
Federal Reserve Bank of Philadelphia Board of
Directors member since 2000. Member Audit and
Research and External Affairs committees. Chairman of Atlantic Central Bankers Bank. Professional
affiliations include Pennsylvania Bankers Association, Independent Bankers Association of America,
Pennsylvania Association of Community Bankers, and
Bankers Bank Council.

Robert J. Vanderslice (5)
Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and
Research and External Affairs committees. President
and Chief Operating Officer of Pennsville National
Bank. Vice President of Penn Bancshares, Inc.
Professional affiliations include Federal Reserve Relations Committee of New Jersey Bankers Association,
Pennsville Economic Development Coalition, Penns
Grove Rotary Club, and Salem County Chamber of
Commerce.

Charisse R. Lillie (6)
Chairman, Federal Reserve Bank of Philadelphia
Board of Directors. Board member since 1996.
Chairman of litigation department of law firm of
Ballard Spahr Andrews & Ingersoll, LLP. Member of
Labor and Employment Law Group of firm’s litigation department. Chair of American Bar Association
Commission on Racial and Ethnic Diversity. Serves

ADVISORY COUNCILS

2002 BUSINESS COUNCIL

CHAIRMAN
John K. Ball (11), Chairman, President & CEO
R.M. Shoemaker Co., West Conshohocken, PA

Sandra F. Holsonback,* Director
Small Business Development Center
Lehigh University, Bethlehem, PA

Lynn Banta (12), Owner
Twin Stacks Development Co. Inc., Dallas, PA

Dennis E. Klima (2), President & CEO
Bayhealth Inc., Dover, DE

Michael F. Camardo (6), Executive Vice President
Lockheed Martin Technology, Cherry Hill, NJ

Warren B. Matthews (3), M.D., President
Wyncote Family Medicine, Wyncote, PA

Chloe R. Eichelberger (9), Owner,
President & CEO
Chloe Eichelberger Textiles, Inc., York, PA

John Milligan (10), President
Milligan & Company LLC, Philadelphia, PA
Mitchell L. Morgan (7), President
Morgan Properties, King of Prussia, PA

David J. Freschman (8), President
Delaware Innovation Fund, Wilmington, DE
1 2

4
9

5 6

7
10

Audrey S. Oswell (4), President & COO
Resorts Atlantic City, Atlantic City, NJ

Jeffrey J. Trester (5), Director and Co-CEO
PriceSCAN.com, Inc., Malvern, PA

William L. Wilson (1), Principal-in-Charge
Synterra, Philadelphia, PA

* Not pictured

2002 COMMUNITY BANK COUNCIL

Thomas J. Bisko,* President
The Quakertown National Bank, Quakertown, PA

George W. Nise (7), President & CEO
Beneficial Savings Bank, Philadelphia, PA

Joseph E. Chippie,* President & CEO
First National Bank of Wyoming, Wyoming, DE

John W. Ord (5), President & CEO
Peoples National Bank, Hallstead, PA

Thomas W. Cook,* Executive Vice President
& CEO
The Bank of Landisburg, Landisburg, PA

Frederick C. (Ted) Peters II (2), President & CEO
The Bryn Mawr Trust Company, Bryn Mawr, PA
Patrick M. Ryan (3), President and CEO
The Yardville National Bank, Hamilton, NJ

John G. Gerlach (1), President & CEO
& Director
Pocono Community Bank, Stroudsburg, PA

Wayne R. Weidner,* Chairman, President & CEO
National Penn Bancshares, Inc., Boyertown, PA

CHAIRMAN
Robert H. King (6), President,
Sterling Bank, Mount Laurel, NJ

William Leandri (4), President & CEO
Luzerne National Bank, Luzerne, PA

* Not pictured

ADVISORY COUNCILS

2002 CREDIT UNION COUNCIL

Paula M. Albanese (5), President
Diamond State FCU, New Castle, DE

Thomas A. Phillips (3), General Manager
Lakehurst Naval FCU, Lakehurst, NJ

Barbara Arrowsmith (1), Manager
New Castle County Delaware Employees FCU
New Castle, DE

Diana L. Roberts,* President & CEO
Hershey FCU, Hershey, PA
C. Kipp Stecher,* President & CEO
AmeriChoice FCU, Mechanicsburg, PA

CHAIRMAN
Jo Ann Broderick,* President
First Commonwealth FCU, Lehigh Valley, PA

Judith M. Supplee (6), President & CEO
Keystone FCU, West Chester, PA

L. Edward Brzozowski (2), President
MON-OC FCU, Toms River, NJ

Virginia F. Williams (7), CEO
FAA Technical Center FCU, Northfield, NJ

Dennis Flickinger (4), President & CEO
First Capital FCU, York, PA
1

John LaRosa (8), COO & Treasurer
Police and Fire FCU, Philadelphia, PA

* Not pictured

4
7

6
5

James F. McCaw,* President & CEO
K of C FCU, Philadelphia, PA

CURRENT OFFICERS
Anthony M. Santomero
President
William H. Stone, Jr.
First Vice President
Donald F. Doros
Executive Vice President
Richard W. Lang
Executive Vice President
Michael E. Collins
Senior Vice President and
Lending Officer
Loretta J. Mester
Senior Vice President and
Director of Research
John B. Shaffer
Senior Vice President and
General Auditor
Milissa M. Tadeo
Senior Vice President
Human Resources and
Treasury Services
John G. Bell
Vice President
Financial Statistics
Robert J. Bucco
Vice President
Wholesale Product Office
Peter P. Burns
Vice President and
Director
Payment Cards Center
Theodore M. Crone
Vice President and
Economist
Dean Croushore
Vice President and
Economist
John J. Deibel
Vice President and Chief
Administrative Officer
Supervision, Regulation
and Credit
Patrick L. Donahue
Vice President
Customer Relations
Michael Dotsey
Vice President and Senior
Economic Policy Advisor

Herbert E. Taylor
Vice President and
Corporate Secretary

William Evans, Jr.
Vice President
Information Technology
Services

Vish P. Viswanathan
Vice President and
Discount Officer
Supervision, Regulation
and Credit

Donna L. Franco
Vice President and
Chief Financial Officer
Joanna H. Frodin
Vice President
Supervision, Regulation
and Credit
Faith P. Goldstein
Vice President
Public Affairs
Arun K. Jain
Vice President
Retail Payment Services
Henry T. Kern
Vice President
Cash Services
Thomas P. Lambinus
Vice President
Facilities, Records,
Purchasing,
Transportation, and
Document Services

Bernard M. Wennemer
Assistant Vice President
Supervision, Regulation
and Credit

Shirley L. Coker
Assistant Vice President
and Counsel

Anthony J. White
Assistant Vice President
Customer Relations

William L. Gaunt
Assistant Vice President
Supervision, Regulation
and Credit

Michael P. Zamulinsky
Assistant Vice President
Supervision, Regulation
and Credit

Stephen G. Hart
Assistant Vice President
Human Resources

Mitchell S. Berlin
Research Officer and
Economist

Mary Ann Hood
Assistant Vice President
Human Resources

Aileen C. Boer
Research Support Officer

John P. Kelly
Assistant Vice President
Retail Payment Services

Edward M. Mahon
Vice President and
General Counsel

Elisabeth V. Levins
Assistant Vice President
Supervision, Regulation
and Credit

Stephen A. Meyer
Vice President and
Senior Economic Policy
Advisor

Alice Kelley Menzano
Assistant Vice President
Information Technology
Services

Mary DeHaven Myers
Vice President and
Community Affairs
Officer

Patrick M. Regan
Assistant Vice President
and Information Security
Officer

A. Reed Raymond, III
Vice President
Supervision, Regulation
and Credit

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

Richard A. Sheaffer
Vice President
Treasury Services

Ronald R. Sheldon
Assistant Vice President
Retail Payment Services

Includes promotions through March 2003

Richard A. Valente
Assistant Vice President
and Assistant General
Auditor

Eileen P. Adezio
Assistant Vice President
Supervision, Regulation
and Credit

Howard M. James, Jr.
Assistant Vice President
Supervision, Regulation
and Credit

William W. Lang
Vice President
Supervision, Regulation
and Credit

Marie Tkaczyk
Assistant Vice President
Information Technology
Services

Donna L. Brenner
Budget Officer and
Assistant Secretary
Accounting Services
Michael T. Doyle
Business Planning and
Analysis Officer
Linda K. Kirson
Office Automation
Support Officer
Information Technology
Services
Joseph L. McCann
Administrative Services
and Security Officer
Edward C. Morrison
Operations Officer
Information Technology
Services
Michelle M. Scipione
Cash Services Officer
Stephen J. Smith
Assistant Counsel

S TAT E M E N T O F A U D I T O R I N D E P E N D E N C E
The firm engaged by the Board of Governors for the audits of the individual and combined financial statements of the Reserve Banks for 2002 was PricewaterhouseCoopers
LLP (PwC). Fees for these services totaled $1.0 million. In order to ensure auditor independence, the Board of Governors requires that PwC be independent in all matters
relating to the audit. Specifically, PwC may not perform services for the Reserve Banks
or others that would place it in a position of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit
independence. In 2002, the Bank did not engage PwC for advisory services.

Letter to Directors

Report of Independent Accountants

Statements of Condition

Statements of Income

Statements of Changes in Capital

Notes to Financial Statements

FINANCIAL REPORTS

CONTENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

LETTER TO DIRECTORS

FEDERAL RESERVE BANK OF PHILADELPHIA

REPORT OF INDEPENDENT ACCOUNTANTS

FEDERAL RESERVE BANK OF PHILADELPHIA

REPORT OF INDEPENDENT ACCOUNTANTS

As of December 31, 2002 and December 31, 2001 (in millions)
2002

2001

ASSETS
Gold certificates
Special drawing rights certificates
Coin
Items in process of collection
U.S. government and federal agency securities, net
Investments denominated in foreign currencies
Accrued interest receivable
Bank premises and equipment, net
Other assets

Total assets

430
83
61
494
24,576
510
210
73
96

454
83
44
526
23,071
481
234
70
91

$ 26,533

$ 25,054

$ 18,624
811

$ 21,773
–

577
3
556

413
2
100

47
5,391
51
7

29
2,239
51
5

Total liabilities

26,067

24,612

Capital:
Capital paid-in
Surplus

233
233

221
221

466

442

$ 26,533

$ 25,054

LIABILITIES AND CAPITAL
Liabilities:
Federal Reserve notes outstanding, net
Securities sold under agreements to repurchase
Deposits:
Depository institutions
Other deposits
Deferred credit items
Interest on Federal Reserve notes
due U.S. Treasury
Interdistrict settlement account
Accrued benefit costs
Other liabilities

Total capital
Total liabilities and capital

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

FEDERAL RESERVE BANK OF PHILADELPHIA

STATEMENTS OF CONDITION

FEDERAL RESERVE BANK OF PHILADELPHIA

STATEMENTS OF INCOME
For the years ended December 31, 2002 and December 31, 2001 (in millions)

Interest income:
Interest on U.S. government and federal agency securities
Interest on investments denominated in foreign currencies

2002

2001

984
8

$ 1,219
11

992

1,230

–

991

1,230

46
20
62
3
3

47
20
(47)
13
4

134

81
9
13
21
29

79
9
13
24
32

153

157

972

$ 1,110

14
12

Total interest income
Interest expense:
Interest expense on securities sold under agreements to
repurchase
Net interest income
Other operating income:
Income from services
Reimbursable services to government agencies
Foreign currency gains (losses), net
U.S. government securities gains, net
Other income
Total other operating income
Operating expenses:
Salaries and other benefits
Occupancy expense
Equipment expense
Assessments by Board of Governors
Other expenses
Total operating expenses
Net income prior to distribution
Distribution of net income:
Dividends paid to member banks
Transferred to (from) surplus
Payments to U.S. Treasury as interest on Federal
Reserve notes
Total distribution

14
(7)

946

1,103

972

$ 1,110

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

For the years ended December 31, 2002 and December 31, 2001 (in millions)

Capital Paid-in

Balance at January 1, 2001
(4.6 million shares)

228

Net income transferred from surplus
Net change in capital stock redeemed
(0.2 million shares)
Balance at December 31, 2001
(4.4 million shares)

Surplus

228

Total Capital

456

–

(7)

–

(7)

221

442

Net income transferred to surplus

–

Net change in capital stock issued
(0.2 million shares)

–

Balance at December 31, 2002
(4.6 million shares)

233

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

233

466

FEDERAL RESERVE BANK OF PHILADELPHIA

STATEMENTS OF CHANGES IN CAPITAL

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

1. STRUCTURE

by member banks, three represent the public and
three represent member banks. Member banks

The Federal Reserve Bank of Philadelphia

are divided into three classes according to size.

(“Bank”) is part of the Federal Reserve System

Member banks in each class elect one director

(“System”) created by Congress under the Federal

representing member banks and one represent-

Reserve Act of 1913 (“Federal Reserve Act”)

ing the public. In any election of directors, each

which established the central bank of the United

member bank receives one vote, regardless of the

States. The System consists of the Board of

number of shares of Reserve Bank stock it holds.

Governors of the Federal Reserve System (“Board

2. OPERATIONS AND
SERVICES

of Governors”) and twelve Federal Reserve Banks
(“Reserve Banks”). The Reserve Banks are
chartered by the federal government and possess a

The System performs a variety of services and

unique set of governmental, corporate, and central
bank characteristics. The Bank in Philadelphia

operations. Functions include: formulating and

serves the Third Federal Reserve District, which

conducting monetary policy; participating actively

includes Delaware and portions of New Jersey

in the payments mechanism, including large-dol-

and Pennsylvania. Other major elements of the

lar transfers of funds, automated clearinghouse

System are the Federal Open Market Committee

(“ACH”) operations and check processing; distrib-

(“FOMC”) and the Federal Advisory Council.

uting coin and currency; performing fiscal agency

The FOMC is composed of members of the

functions for the U.S. Treasury and certain federal

Board of Governors, the president of the Federal

agencies; serving as the federal government’s

Reserve Bank of New York (“FRBNY”) and, on a

bank; providing short-term loans to depository

rotating basis, four other Reserve Bank presidents.

institutions; serving the consumer and the com-

Banks that are members of the System include all

munity by providing educational materials and

national banks and any state chartered bank that

information regarding consumer laws; supervising

applies and is approved for membership in the

bank holding companies and state member banks;

System.

and administering other regulations of the Board
of Governors. The Board of Governors’ operating costs are funded through assessments on the

Board of Directors

Reserve Banks.

In accordance with the Federal Reserve Act,
supervision and control of the Bank are exercised

The FOMC establishes policy regarding open

by a Board of Directors. The Federal Reserve Act

market operations, oversees these operations, and

specifies the composition of the Board of Direc-

issues authorizations and directives to the FRBNY

tors for each of the Reserve Banks. Each board

for its execution of transactions. Authorized

is composed of nine members serving three-year

transaction types include direct purchase and sale

terms: three directors, including those designated

of securities, matched sale-purchase transactions,

as Chairman and Deputy Chairman, are appoint-

the purchase of securities under agreements to

ed by the Board of Governors, and six directors

resell, the sale of securities under agreements to

are elected by member banks. Of the six elected

repurchase, and the lending of U.S. government

securities. The FRBNY is also authorized by

tions as separate sales and purchases, rather than

the FOMC to hold balances of, and to execute

secured borrowings with pledged collateral, as

spot and forward foreign exchange (“F/X”) and

is generally required by GAAP. In addition, the

securities contracts in, nine foreign currencies,

Bank has elected not to present a Statement of

maintain reciprocal currency arrangements

Cash Flows. The Statement of Cash Flows has

(“F/X swaps”) with various central banks, and

not been included as the liquidity and cash posi-

“warehouse” foreign currencies for the U.S.

tion of the Bank are not of primary concern to

Treasury and Exchange Stabilization Fund

the users of these financial statements. Other

(“ESF”) through the Reserve Banks.

information regarding the Bank’s activities is provided in, or may be derived from, the Statements

3. SIGNIFICANT ACCOUNTING
POLICIES

of Condition, Income, and Changes in Capital.
Therefore, a Statement of Cash Flows would not
provide any additional useful information. There

Accounting principles for entities with the

are no other significant differences between the

unique powers and responsibilities of the nation’s

policies outlined in the Financial Accounting

central bank have not been formulated by the

Manual and GAAP.

Financial Accounting Standards Board. The

Effective January 2001, the System

Board of Governors has developed specialized

implemented procedures to eliminate the sharing

accounting principles and practices that it

of costs by Reserve Banks for certain services

believes are appropriate for the significantly

a Reserve Bank may provide on behalf of the

different nature and function of a central bank as

System. Major services provided for the System

compared to the private sector. These accounting

by the Bank, for which the costs will not be

principles and practices are documented in the

redistributed to the other Reserve Banks, include:

Financial Accounting Manual for Federal Reserve

Collateral Management System, Electronic Cash

Banks (“Financial Accounting Manual”), which

Letter System, Groupware Leadership Center,

is issued by the Board of Governors. All Reserve

Subcommittee on Credit Reserves and Risk

Banks are required to adopt and apply accounting

Management Administrative Office, Treasury

policies and practices that are consistent with the

Direct Central Business Administration Function.

Financial Accounting Manual.

The preparation of the financial statements

The financial statements have been prepared

in conformity with the Financial Accounting

in accordance with the Financial Accounting

Manual requires management to make certain

Manual. Differences exist between the account-

estimates and assumptions that affect the reported

ing principles and practices of the System and

amounts of assets and liabilities, disclosure of

accounting principles generally accepted in the

contingent assets and liabilities at the date of the

United States of America (“GAAP”). The prima-

financial statements, and the reported amounts of

ry differences are the presentation of all security

income and expenses during the reporting period.

holdings at amortized cost, rather than at the fair

Actual results could differ from those estimates.

value presentation requirements of GAAP, and

Unique accounts and significant accounting

the accounting for matched sale-purchase transac-

policies are explained below.

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS
a. Gold Certificates

SDR certificate acquisitions or for financing

The Secretary of the Treasury is authorized

exchange stabilization operations. At the time

to issue gold certificates to the Reserve Banks to

SDR transactions occur, the Board of Governors

monetize gold held by the U.S. Treasury. Payment

allocates SDR certificate transactions among

for the gold certificates by the Reserve Banks is

Reserve Banks based upon Federal Reserve notes

made by crediting equivalent amounts in dollars

outstanding in each District at the end of the

into the account established for the U.S. Treasury.

preceding year. There were no SDR transactions

These gold certificates held by the Reserve Banks

in 2002.

are required to be backed by the gold of the U.S.
Treasury. The U.S. Treasury may reacquire

the gold certificates at any time and the Reserve

Loans to Depository Institutions
The Depository Institutions Deregulation

Banks must deliver them to the U.S. Treasury. At

and Monetary Control Act of 1980 provides

such time, the U.S. Treasury’s account is charged

that all depository institutions that maintain

and the Reserve Banks’ gold certificate accounts

reservable transaction accounts or nonpersonal

are lowered. The value of gold for purposes of

time deposits, as defined in Regulation D issued

backing the gold certificates is set by law at $42

by the Board of Governors, have borrowing

2/9 a fine troy ounce. The Board of Governors

privileges at the discretion of the Reserve Banks.

allocates the gold certificates among Reserve

Borrowers execute certain lending agreements

Banks once a year based upon average Federal

and deposit sufficient collateral before credit is

Reserve notes outstanding in each District.

extended. Loans are evaluated for collectibility,
and currently all are considered collectible and

Special Drawing Rights Certificates

fully collateralized. If loans were ever deemed to

Special drawing rights (“SDRs”) are issued

be uncollectible, an appropriate reserve would

by the International Monetary Fund (“Fund”)

be established. Interest is accrued using the

to its members in proportion to each member’s

applicable discount rate established at least every

quota in the Fund at the time of issuance. SDRs

fourteen days by the Boards of Directors of the

serve as a supplement to international monetary

Reserve Banks, subject to review by the Board of

reserves and may be transferred from one national

Governors. Reserve Banks retain the option to

monetary authority to another. Under the law

impose a surcharge above the basic rate in certain

providing for United States participation in the

circumstances. There were no outstanding loans

SDR system, the Secretary of the U.S. Treasury

to depository institutions at December 31, 2002

is authorized to issue SDR certificates, somewhat

and 2001, respectively.

like gold certificates, to the Reserve Banks. At
such time, equivalent amounts in dollars are

credited to the account established for the U.S.

and Investments Denominated in Foreign Currencies

Treasury, and the Reserve Banks’ SDR certificate

U.S. Government and Federal Agency Securities
The FOMC has designated the FRBNY to

accounts are increased. The Reserve Banks are

execute open market transactions on its behalf

required to purchase SDRs, at the direction of

and to hold the resulting securities in the portfolio

the U.S. Treasury, for the purpose of financing

known as the System Open Market Account

(“SOMA”). In addition to authorizing and

between two parties to exchange specified

directing operations in the domestic securities

currencies, at a specified price, on a specified

market, the FOMC authorizes and directs the

date. Spot foreign contracts normally settle two

FRBNY to execute operations in foreign markets

days after the trade date, whereas the settlement

for major currencies in order to counter disorderly

date on forward contracts is negotiated between

conditions in exchange markets or to meet

the contracting parties, but will extend beyond

other needs specified by the FOMC in carrying

two days from the trade date. The FRBNY

out the System’s central bank responsibilities.

generally enters into spot contracts, with any

Such authorizations are reviewed and approved

forward contracts generally limited to the second

annually by the FOMC.

leg of a swap/warehousing transaction.

In December 2002, the FRBNY replaced

The FRBNY, on behalf of the Reserve

matched sale-purchase (“MSP”) transactions with

Banks, maintains renewable, short-term F/X

securities sold under agreements to repurchase.

swap arrangements with two authorized foreign

MSP transactions, accounted for as separate sale

central banks. The parties agree to exchange

and purchase transactions, are transactions in

their currencies up to a pre-arranged maximum

which the FRBNY sells a security and buys it back

amount and for an agreed upon period of time

at the rate specified at the commencement of the

(up to twelve months), at an agreed upon interest

transaction. Securities sold under agreements

rate. These arrangements give the FOMC

to repurchase are treated as secured borrowing

temporary access to foreign currencies that it may

transactions with the associated interest expense

need for intervention operations to support the

recognized over the life of the transaction.

dollar and give the partner foreign central bank

The FRBNY has sole authorization by the

temporary access to dollars it may need to support

FOMC to lend U.S. government securities held in

its own currency. Drawings under the F/X swap

the SOMA to U.S. government securities dealers

arrangements can be initiated by either the

and to banks participating in U.S. government

FRBNY or the partner foreign central bank, and

securities clearing arrangements on behalf of

must be agreed to by the drawee. The F/X swaps

the System, in order to facilitate the effective

are structured so that the party initiating the

functioning of the domestic securities market.

transaction (the drawer) bears the exchange rate

These securities-lending transactions are fully

risk upon maturity. The FRBNY will generally

collateralized by other U.S. government securities.

invest the foreign currency received under an F/X

FOMC policy requires FRBNY to take possession

swap in interest-bearing instruments.

of collateral in excess of the market values of

Warehousing is an arrangement under which

the securities loaned. The market values of the

the FOMC agrees to exchange, at the request of

collateral and the securities loaned are monitored

the Treasury, U.S. dollars for foreign currencies

by FRBNY on a daily basis, with additional

held by the Treasury or ESF over a limited period

collateral obtained as necessary. The securities

of time. The purpose of the warehousing facility

loaned continue to be accounted for in the

is to supplement the U.S. dollar resources of the

SOMA.

Treasury and ESF for financing purchases of foreign

F/X contracts are contractual agreements

currencies and related international operations.

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS
In connection with its foreign currency

agency securities” or “Interest on investments

activities, the FRBNY, on behalf of the Reserve

denominated in foreign currencies,” as

Banks, may enter into contracts which contain

appropriate. Income earned on securities lending

varying degrees of off-balance sheet market risk,

transactions is reported as a component of “Other

because they represent contractual commitments

income.” Gains and losses resulting from sales of

involving future settlement and counter-party

securities are determined by specific issues based

credit risk. The FRBNY controls credit risk

on average cost. Gains and losses on the sales of

by obtaining credit approvals, establishing

U.S. government and federal agency securities

transaction limits, and performing daily

are reported as “U.S. government securities gains,

monitoring procedures.

net”. Foreign-currency-denominated assets are

While the application of current market

revalued daily at current foreign currency market

prices to the securities currently held in the

exchange rates in order to report these assets in

SOMA portfolio and investments denominated

U.S. dollars. Realized and unrealized gains and

in foreign currencies may result in values

losses on investments denominated in foreign

substantially above or below their carrying values,

currencies are reported as Foreign currency gains

these unrealized changes in value would have no

(losses), net. Foreign currencies held through F/X

direct effect on the quantity of reserves available

swaps, when initiated by the counter-party, and

to the banking system or on the prospects for

warehousing arrangements are revalued daily,

future Reserve Bank earnings or capital. Both the

with the unrealized gain or loss reported by the

domestic and foreign components of the SOMA

FRBNY as a component of “Other assets” or

portfolio from time to time involve transactions

“Other liabilities,” as appropriate.

that can result in gains or losses when holdings

Balances of U.S. government and federal

are sold prior to maturity. Decisions regarding

agency securities bought outright, securities

the securities and foreign currencies transactions,

sold under agreements to repurchase, securities

including their purchase and sale, are motivated

loaned, investments denominated in foreign

by monetary policy objectives rather than profit.

currency, interest income and expense, securities

Accordingly, market values, earnings, and any

lending fee income, amortization of premiums

gains or losses resulting from the sale of such

and discounts on securities bought outright, gains

currencies and securities are incidental to the

and losses on sales of securities, and realized

open market operations and do not motivate its

and unrealized gains and losses on investments

activities or policy decisions.

denominated in foreign currencies, excluding

U.S. government and federal agency

those held under an F/X swap arrangement, are

securities and investments denominated in foreign

allocated to each Reserve Bank. Income from

currencies comprising the SOMA are recorded

securities lending transactions undertaken by the

at cost, on a settlement-date basis, and adjusted

FRBNY are also allocated to each Reserve Bank.

for amortization of premiums or accretion of

Securities purchased under agreements to resell

discounts on a straight-line basis. Interest income

and unrealized gains and losses on the revaluation

is accrued on a straight-line basis and is reported

of foreign currency holdings under F/X swaps and

as “Interest on U.S. government and federal

warehousing arrangements are allocated to the

FRBNY and not to other Reserve Banks.

of collateral security, typically U.S. government
securities. These notes are identified as issued

Bank Premises, Equipment, and Software

to a specific Reserve Bank. The Federal Reserve

Bank premises and equipment are stated at

Act provides that the collateral security tendered

cost less accumulated depreciation. Depreciation

by the Reserve Bank to the Federal Reserve agent

is calculated on a straight-line basis over

must be equal to the sum of the notes applied

estimated useful lives of assets ranging from

for by such Reserve Bank. In accordance with

2 to 50 years. New assets, major alterations,

the Federal Reserve Act, gold certificates, special

renovations and improvements are capitalized

drawing rights certificates, U.S. government and

at cost as additions to the asset accounts.

federal agency securities, securities purchased

Maintenance, repairs and minor replacements

under agreements to resell, loans to depository

are charged to operations in the year incurred.

institutions, and investments denominated in

Costs incurred for software, either developed

foreign currencies are pledged as collateral for

internally or acquired for internal use, during the

net Federal Reserve notes outstanding. The

application development stage are capitalized

collateral value is equal to the book value of

based on the cost of direct services and materials

the collateral tendered, with the exception of

associated with designing, coding, installing, or

securities, whose collateral value is equal to the

testing software.

par value of the securities tendered, and securities
purchased under agreements to resell, which are

Interdistrict Settlement Account

valued at the contract amount. The par value

At the close of business each day, all Reserve

of securities pledged for securities sold under

Banks and branches assemble the payments due

agreements to repurchase is similarly deducted.

to or from other Reserve Banks and branches as a

The Board of Governors may, at any time, call

result of transactions involving accounts residing

upon a Reserve Bank for additional security to

in other Districts that occurred during the day’s

adequately collateralize the Federal Reserve

operations. Such transactions may include

notes. The Reserve Banks have entered into

funds settlement, check clearing and ACH

an agreement which provides for certain assets

operations, and allocations of shared expenses.

of the Reserve Banks to be jointly pledged as

The cumulative net amount due to or from other

collateral for the Federal Reserve notes of all

Reserve Banks is reported as the “Interdistrict

Reserve Banks in order to satisfy their obligation

settlement account.”

of providing sufficient collateral for outstanding
Federal Reserve notes. In the event that this

Federal Reserve Notes

collateral is insufficient, the Federal Reserve Act

Federal Reserve notes are the circulating

provides that Federal Reserve notes become a

currency of the United States. These notes

first and paramount lien on all the assets of the

are issued through the various Federal Reserve

Reserve Banks. Finally, as obligations of the

agents (the Chairman of the Board of Directors

United States, Federal Reserve notes are backed

of each Reserve Bank) to the Reserve Banks

by the full faith and credit of the United States

upon deposit with such agents of certain classes

government.

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS
The “Federal Reserve notes outstanding, net”

costs of operations, payment of dividends, and

account represents the Bank’s Federal Reserve

reservation of an amount necessary to equate

notes outstanding, reduced by its currency

surplus with capital paid-in.

holdings of $6,893 million, and $6,562 million

In the event of losses or a substantial increase

at December 31, 2002 and December 31, 2001,

in capital, payments to the U.S. Treasury are

respectively.

suspended until such losses are recovered through
subsequent earnings. Weekly payments to the

Capital Paid-in

U.S. Treasury may vary significantly.

The Federal Reserve Act requires that
each member bank subscribe to the capital

stock of the Reserve Bank in an amount equal

Income and Costs related to Treasury Services
The Bank is required by the Federal Reserve

to 6 percent of the capital and surplus of the

Act to serve as fiscal agent and depository of the

member bank. As a member bank’s capital

United States. By statute, the Department of the

and surplus changes, its holdings of the Reserve

Treasury is permitted, but not required, to pay for

Bank’s stock must be adjusted. Member banks

these services. Beginning January 1, 1998, the

are those state-chartered banks that apply and

reimbursement process for all Reserve Banks was

are approved for membership in the System and

centralized at the Bank that included the transfer

all national banks. Currently, only one-half of

of each Reserve Bank’s Treasury reimbursement

the subscription is paid-in and the remainder is

receivable to the Bank. The centralized portion

subject to call. These shares are nonvoting with

of the Bank’s reimbursement receivable, reported

a par value of $100. They may not be transferred

in “Other assets,” totaled $73 million and

or hypothecated. By law, each member bank

$70 million at December 31, 2002 and 2001,

is entitled to receive an annual dividend of

respectively.

6 percent on the paid-in capital stock. This
cumulative dividend is paid semiannually. A

member bank is liable for Reserve Bank liabilities

Taxes
The Reserve Banks are exempt from federal,

up to twice the par value of stock subscribed by it.

state, and local taxes, except for taxes on real
property, which are reported as a component of

Surplus

“Occupancy expense.”

The Board of Governors requires Reserve

4. U.S. GOVERNMENT AND
FEDERAL AGENCY
SECURITIES

Banks to maintain a surplus equal to the amount
of capital paid-in as of December 31. This amount
is intended to provide additional capital and
reduce the possibility that the Reserve Banks
would be required to call on member banks for

Securities bought outright are held in the

additional capital. Pursuant to Section 16 of the

SOMA at the FRBNY. An undivided interest

Federal Reserve Act, Reserve Banks are required

in SOMA activity and the related premiums,

by the Board of Governors to transfer to the U.S.

discounts and income, with the exception of

Treasury excess earnings, after providing for the

securities purchased under agreements to resell, is

allocated to each Reserve Bank on a percentage
basis derived from an annual settlement of

Maturities of Securities Held

Par value
Total

Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years

$ 1,055
5,930
5,455
6,643
2,050
3,070

interdistrict clearings. The settlement, performed
in April of each year, equalizes Reserve Bank
gold certificate holdings to Federal Reserve notes
outstanding. The Bank’s allocated share of
SOMA balances was approximately 3.845 percent
and 4.107 percent at December 31, 2002 and
2001, respectively.

Total

The Bank’s allocated share of securities held
in the SOMA at December 31, that were bought

$ 24,203

As mentioned in footnote 3, in December

outright, was as follows (in millions):

2002, the FRBNY replaced MSP transactions with
securities sold under agreements to repurchase.

2002
Par value:
U.S. government:
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated
to Bank

At December 31, 2002, securities sold under

2001

agreements to repurchase with a contract
amount of $21,091 million and a par value of
$21,098 million were outstanding, of which $811

8,717
11,455
4,031

$ 7,479
10,923
4,258

24,203

22,660

414
(41)

464
(53)

$ 24,576

$ 23,071

million and $811 million, respectively, were
allocated to the Bank. At December 31, 2001,
MSP transactions involving U.S. government
securities with a par value of $23,188 million were
outstanding, of which $952 million was allocated
to the Bank. Securities sold under agreements to
repurchase and MSP transactions are generally
overnight arrangements.
At December 31, 2002 and 2001, U.S.
government securities with par values of $1,841
million and $7,345 million, respectively, were
loaned from the SOMA, of which $71 million and

Total SOMA securities bought outright

$302 million were allocated to the Bank.

were $639,125 million and $561,701 million at
December 31, 2002 and 2001, respectively.

5. INVESTMENTS
DENOMINATED IN
FOREIGN CURRENCIES

The maturity distribution of U.S. government
and federal agency securities bought outright,
which were allocated to the Bank at December 31, 2002, was as follows (in millions):

The FRBNY, on behalf of the Reserve Banks,
holds foreign currency deposits with foreign
central banks and the Bank for International
Settlements, and invests in foreign government

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS
debt instruments. Foreign government debt

million at December 31, 2002 and 2001,

instruments held include both securities

respectively.

bought outright and securities purchased under

The maturity distribution of investments

agreements to resell. These investments are

denominated in foreign currencies which were

guaranteed as to principal and interest by the

allocated to the Bank at December 31, 2002, was

foreign governments.

as follows (in millions):

Each Reserve Bank is allocated a share of

Maturities of Investments Denominated
in Foreign Currencies

foreign-currency-denominated assets, the related
interest income, and realized and unrealized

Within 1 year
Over 1 year to 5 years
Over 5 years to 10 years

foreign currency gains and losses, with the
exception of unrealized gains and losses on
F/X swaps and warehousing transactions. This

Total

allocation is based on the ratio of each Reserve
Bank’s capital and surplus to aggregate capital

were no open foreign exchange contracts or

The Bank’s allocated share of investments

outstanding F/X swaps.

denominated in foreign currencies was

At December 31, 2002 and 2001, the

approximately 3.015 percent and 3.305 percent at

warehousing facility was $5,000 million, with zero

December 31, 2002 and 2001, respectively.

balance outstanding.

The Bank’s allocated share of investments
denominated in foreign currencies, valued at

6. BANK PREMISES AND
EQUIPMENT

current foreign currency market exchange rates at
December 31, was as follows (in millions):

European Union Euro:
Foreign currency deposits
Government debt
instruments including
agreements to resell
Japanese Yen:
Foreign currency deposits
Government debt
instruments including
agreements to resell
Accrued interest
Total

$ 510

At December 31, 2002 and 2001, there

and surplus at the preceding December 31.

2002

$ 471
27
12

A summary of bank premises and equipment

2001

at December 31 is as follows (in millions):
$ 168

$ 152

186

176

$ 510

$ 481

2002
Bank premises and equipment:
Land
$ 2.6
Buildings
66.2
Building machinery and
equipment
10.8
Construction in progress
1.3
Furniture and equipment
63.6

Total investments denominated in foreign
currencies were $16,913 million and $14,559

2001
$ 2.5
65.8
9.6
.5
59.1

144.5

137.5

Accumulated depreciation

(72.0)

(67.8)

Bank premises and
equipment, net

$ 72.5

$ 69.7

Depreciation expense was $9 million for both

Federal Reserve Banks dated as of March 2, 1999,

years ended December 31, 2002 and 2001.

each of the Reserve Banks has agreed to bear,

The Bank leases unused space to an outside

on a per incident basis, a pro rata share of losses

tenant. This lease has a term of 2 years. Rental

in excess of one percent of the capital paid-in

income from such lease was $1 million for both

of the claiming Reserve Bank, up to 50 percent

years ended December 31, 2002 and 2001. Future

of the total capital paid-in of all Reserve Banks.

minimum lease payments under the noncancel-

Losses are borne in the ratio that a Reserve Bank’s

able agreement in existence at December 31,

capital paid-in bears to the total capital paid-in of

2002 were $3 million for years 2003 through

all Reserve Banks at the beginning of the calendar

2004.

year in which the loss is shared. No claims were
outstanding under such agreement at December

7. COMMITMENTS AND
CONTINGENCIES

31, 2002 or 2001.
The Bank is involved in certain legal
actions and claims arising in the ordinary course

At December 31, 2002, the Bank was

of business. Although it is difficult to predict

obligated under noncancelable leases for premises

the ultimate outcome of these actions, in

and equipment with terms ranging from 1 to

management’s opinion, based on discussions with

approximately 3 years. These leases provide for

counsel, the aforementioned litigation and claims

increased rentals based upon increases in real

will be resolved without material adverse effect on

estate taxes, operating costs or selected price

the financial position or results of operations of

indices.

the Bank.

Rental expense under operating leases for

8. RETIREMENT AND
THRIFT PLANS

certain operating facilities, warehouses, and data
processing and office equipment (including taxes,
insurance and maintenance when included in
rent), net of sublease rentals, was $1 million and

Retirement Plans

$658 thousand for the years ended December

The Bank currently offers two defined

31, 2002 and 2001, respectively. Certain of the

benefit retirement plans to its employees, based

Bank’s leases have options to renew. The Bank

on length of service and level of compensation.

has no capital leases.

Substantially all of the Bank’s employees

Future minimum rental payments under

participate in the Retirement Plan for Employees

noncancelable operating leases with terms of one

of the Federal Reserve System (“System Plan”)

year or more, at December 31, 2002, were $560

and the Benefit Equalization Retirement Plan

thousand, $300 thousand, and $50 thousand for

(“BEP”) and certain Bank officers participate

the years 2003, 2004, and 2005, respectively.

in a Supplemental Employee Retirement

At December 31, 2002, the Bank has no

Plan (“SERP”). The System Plan is a multi-

other commitments and long-term obligations in

employer plan with contributions fully funded by

excess of one year.

participating employers. No separate accounting

Under the Insurance Agreement of the

is maintained of assets contributed by the

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS
9. POSTRETIREMENT BENEFITS
OTHER THAN PENSIONS AND
POSTEMPLOYMENT BENEFITS

participating employers. The Bank’s projected
benefit obligation and net pension costs for the
BEP at December 31, 2002 and 2001 and for the
SERP at December 31, 2002, and for the years
then ended, are not material.

Postretirement benefits other than pensions
In addition to the Bank’s retirement plans,

Thrift Plan

employees who have met certain age and length of

Employees of the Bank may also participate

service requirements are eligible for both medical

in the defined contribution Thrift Plan for

benefits and life insurance coverage during retirement.

Employees of the Federal Reserve System (“Thrift

The Bank funds benefits payable under the

Plan”). The Bank’s Thrift Plan contributions

medical and life insurance plans as due and,

totaled $3 million for each of the years ended

accordingly, has no plan assets. Net postretirement

December 31, 2002 and 2001 and are reported as

benefit costs are actuarially determined using a

a component of “Salaries and other benefits.”

January 1 measurement date.

Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions):
2002

2001

Accumulated postretirement benefit obligation at January 1
Service cost-benefits earned during the period
Interest cost of accumulated benefit obligation
Actuarial loss (gain)
Contributions by plan participants
Benefits paid
Plan amendments (curtailments, special termination benefits)

$ 37.2
0.7
2.2
(2.6)
0.2
(2.4)
(0.2)

$ 33.4
0.7
2.4
2.1
0.3
(1.5)
(0.2)

Accumulated postretirement benefit obligation at December 31

$ 35.1

$ 37.2

Following is a reconciliation of the beginning and ending balance of the plan assets, the unfunded
postretirement benefit obligation, and the accrued postretirement benefit costs (in millions):
2002

2001

Fair value of plan assets at January 1
Actual return on plan assets
Contributions by the employer
Contributions by plan participants
Benefits paid
Fair value of plan assets at December 31
Unfunded postretirement benefit obligation
Unrecognized initial net transition asset (obligation)
Unrecognized prior service cost
Unrecognized net actuarial gain (loss)

–
–
2.2
0.2
(2.4)
$
–
$ 35.1
–
14.3
(6.2)

–
–
1.2
0.3
(1.5)
$
–
$ 37.2
–
16.0
(8.9)

Accrued postretirement benefit costs

$ 43.2

$ 44.3

Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs.”
44

At December 31, 2002 and 2001, the

expected to decrease gradually to 5.0 percent by

weighted average discount rate assumptions used

2008, and remain at that level thereafter.

in developing the benefit obligation were 6.75

Assumed health care cost trend rates have

percent and 7.00 percent, respectively.

a significant effect on the amounts reported for

For measurement purposes, a 9.0 percent

health care plans. A one percentage point change

annual rate of increase in the cost of covered

in assumed health care cost trend rates would

health care benefits was assumed for 2003.

have the following effects for the year ended

Ultimately, the health care cost trend rate is

December 31, 2002 (in millions):

One Percentage
Point Increase
Effect on aggregate of service and interest cost components
of net periodic postretirement benefit costs
Effect on accumulated postretirement benefit obligation

One Percentage
Point Decrease

0.3
3.0

$ (0.3)
(3.4)

The following is a summary of the components of net periodic postretirement benefit costs for the
years ended December 31 (in millions):
2002
Service cost-benefits earned during the period
Interest cost of accumulated benefit obligation
Amortization of prior service cost
Recognized net actuarial loss
Net periodic postretirement benefit costs

0.7
2.2
(1.9)
0.1
$
1.1

2001
$

0.7
2.4
(1.8)
0.2
$ 1.5

Net periodic postretirement benefit costs are reported as a component of “Salaries and other
benefits.”

costs. The accrued postemployment benefit costs

Postemployment benefits

recognized by the Bank at December 31, 2002

The Bank offers benefits to former or inactive
employees. Postemployment benefit costs are

and 2001, were $7 million for both years. This

actuarially determined and include the cost of

cost is included as a component of “Accrued

medical and dental insurance, survivor income,

benefit costs.” Net periodic postemployment

and disability benefits. Costs were projected using

benefit costs included in 2002 and 2001 operating

the same discount rate and health care trend

expenses were $1 million for both years.

rates as were used for projecting postretirement

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

FEDERAL RESERVE BANK OF PHILADELPHIA

NOTES TO FINANCIAL STATEMENTS

10. SUBSEQUENT EVENT

locations. The restructuring, which is expected to
begin in 2003 and conclude by the end of 2004,
will have no significant effect on the Bank. At

In January 2003, the System announced plans
to restructure its check collection operations.

this time, the Reserve Banks have not developed

The restructuring plans include streamlining

detailed estimates of the cost of the restructuring

the check management structure, reducing staff,

plan in the aggregate or for the individual Reserve

decreasing the number of check-processing loca-

Banks affected.

tions, and increasing processing capacity in other

he Federal Reserve Bank of Philadelphia’s web site is our electronic front door.
A visit to our site allows you to keep up with the latest information on the re-

gional and national economy and consumer issues. You can also find links to employment opportunities, educational and consumer resources, and the latest consumer
and research publications from the Federal Reserve Bank of Philadelphia. Our new
e-mail service notifies you of web updates for subscription topics you choose, including circular letters, news releases, speeches, Payment Cards Center information, and
more. Visit us at www.phil.frb.org to learn more.

V I S I T w w w. p h i l . f r b . o rg
KEY FEDERAL RESERVE
BANK OF PHILADELPHIA
PHONE NUMBERS
Business Planning and Analysis
215-574-6564
Community Affairs
215-574-6458
Financial Statistics/Regulatory
Reporting
215-574-6455
Human Resources
215-574-6150
Library & Research Center
215-574-6540
Payment Cards Center
215-574-7220
Public Affairs
215-574-6113
Research
215-574-6448
Supervision, Regulation and Credit
215-574-6480
Consumer Complaints
1-800-372-1220
Treasury Services
215-574-4332

Full text of Annual Report of the Federal Reserve Bank of Philadelphia : Strategy for Changing Times : 2002 Annual Report

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