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H 2567 G S3A1 1984 - r ANNUAL REPORT 1984 FEDERAL RESERVE BANK OF SAN FRANCISCO .: / ) Table of Contents From the Boardroom 2 Setting the Pattern 4 The Western Regional Economy 6 Western Banking 9 Supervision, Regulation and Credit 12 Bank Administration LIBRARY 20 Directors R........ of San Ft--.o t~AR 111985 19 Priced Payments Services t;••lraI 14 Services to Government Agencies 25 The Federal Reserve Bank of San Francisco is one of twelve regional Reserve Banks which, together with the Board of Governors in Washington, D.C., comprise the nation's central bank . The Federal Reserve Bank of San Francisco serves the Twelfth Federal Reserve District, which includes Washington, Oregon, Califor nia, Arizona, Nevada, Utah , Idaho , Alaska, Hawaii, Guam and American Samoa. As the nation's central bank , the Federal Reserve is responsible for determining and carrying out our nation 's monetary policy. It also is a bank regulatory agency, a provider of wholesale priced banking services, and the fiscal agent for the United States Treasury. From the Boardroom pace in the first raised fears in some quarters that the recovery would falter in 1985. However, the failure of inflat ion in 1984 to acce lerate significantly as it typ ical ly does during an expans ion , and the shot-in-the arm given the economy by the fall in interest rates in the latter part of 1984, suggest that the economy will con tinue to expand in 1985. The closing months of 1984 marked the end of the second year of economic recovery for the United States and Twelfth District economies. The robust 5.9 percent growth of the national economy in 1984 was remarkably strong by historical standards for the second year of an economic expansion. Equally im pressive was the failure of inflation to pick up despite two years of healthy economic growth. To an important extent, this success was due to the Federal Reserve's continuing program of reducing growth in the monetary aggregates over the last five years. The diverse needs of the Twelfth District make special demands on the operations of the San Francisco Reserve Bank in its role in fostering an efficient pay ments mechanism. In 1984, the Bank implemented Systemwide and District programs to improve the qual ity and efficiency of its services. These programs included changes in check-depositing deadlines and check-sorting that resulted in an increased availability of funds and a 75-percent reduction in internally gener ated float. FedLine , a microcomputer-based funds trans fer service, was enhanced to allow customers to place orders for currency and coin , while automated clearinghouse services were enhanced on a System wide basis with an improved deposit and delivery schedu le, automation of paper return items , and expanded electron ic capabil ities. The economic expansion has been surprisingly strong given the persistence of high inflation-adjusted, or real, interest rates that to an important extent cou ld be traced to large ongoing federal budqet defic its. These high interest rates , and the related strength of the U.S. dollar overseas, showed up in an uneven pattern of economic development in different sectors of the economy, with industries vulnerable to either of the two factors generally failing to share fully in the eco nomic recove ry. Such a pattern also held for parts of the West and , in some instances, showed up in the performance of western banks significantly involved in lend ing to the affected industries, such as agriculture, real estate, and forest products. The Bank 's commitment to meet ing the future needs of the District was represented by groundbreaking ceremon ies for a new Los Angeles branch facility. The new building will accommodate all existing operational needs and their expansion in the foreseeable future. In 1984, the Bank also expanded its efforts to develop comprehensive disaster contingency plans to guard against the risk of ser ious financial loss. The plans provide detailed procedures for responding to and recovering from short -term disruptions and for main taining minimum levels of customer service . Cuts in personal taxes and added incentives for busi ness prov ided by the Econom ic Recovery and Tax Act of 1981 helped to offset much of the impact of high real interest rates on household spending on durables and business expenditures on plant and equipment. Indeed, plant and equipment spending enjoyed the biggest boom since the Korean War , a boom that was attr ibutable in part to a combination of new " high technology" investment opportunities and the efforts of business to modernize in the face of greater competi tion from abroad and deregulation at home . The Bank also pursued a cost-containment program aimed at controlling the costs of certain employee benefits and making broader use of automation . Automat ion of some services has the added benef it of improving serv ice delivery and meeting the chang ing needs of depos itory institutions in innovative ways . Together , cost-containment efforts held the Bank's 1984 expenses with in budget, and allowed the Bank to propose a 1985 budget only 5.3 percent higher than that of 1984. To an important extent, the burden of high interest rates fell heavily on industries strongly reliant on export markets, or that faced sign ificant competition from imports. The link was indirect: high interest rates helped attract a large influx of foreign capital , push ing up the value of the dollar on fore ign exchanges and thereby reducing the international competit iveness of U.S. business . As the year wore on, housing began to show signs that it too felt the pinch of higher interest rates , while agriculture struggled with the double burden of a strong dollar, which depressed overseas demand , and high borrowing costs. Management benef ited greatly during 1984 from the broad-based experience and judgment of the Bank 's Board of Directors at its headquarters office and at its four branches. The Directors provided guidance on major management decisions and planning goals . In addition, they supplied information and views on eco The significant deceleration in the rate of economic activity in the second half of 1984 from the heady 2 John J. Balles President Alan C. Furth Chairman (1985) Caroline Leonetti Ahmanson Chairman (1984) nom ic and financial conditions to support the Federal Reserve 's formulation of monetary policy. Fred W. Andrew Deputy Chairman (1985) Jack W. Gustavel (President and Chief Executive Offi cer , The First National Bank of North Idaho , Coeur D'Alene, Idaho), Wendell J . Ashton (Publisher, Deseret News, Salt Lake City, Utah), and G. Robert Truex, Jr . (Chairman, Rainier Bancorporation and Rainier Nation al Bank , Seattle , Washington); and to our Twelfth District Member of the Federal Advisory Council, Joseph J. Pinola (Chairman of the Board, First Inter state Bancorp , Los Angeles, California) . We especially appreciate the contributions of Caro line Leonetti Ahmanson , who retired as Cha irman of the Board of Directors of the San Franc isco Headquarters Office last year following 8112 years of service as a Director in this District. Her energy and devotion to the Federal Reserve System's goals provided an invalua ble source of counsel and inspiration to the Bank 's management and to its five Boards of Directors. We would like to extend our thanks and appreciation to other directors whose terms ended in 1984: the late Robert A. Young (Chairman of the Board and President, Northwest National Bank, Vancouver, Washington), Bruce M. Schwaegler (President, Bullock's-Bullocks Wilshire, Los Angeles, California), Finally , we wish to express our appreciation to the offi cers and staff whose efforts and dedication made 1984 an innovative and successful year. John J. Balles President 3 Alan C. Furth Chairman of the Board Setting the Pattern To a large extent, economic events in the Twelfth Dis trict in 1984 mirrored the forces shaping the national picture. Last year, the national economy was in the second year of a recovery noteworthy for both its overall strength and its very uneven pattern of devel opment across different sectors. The result of this un evenness was a dual economy in which export and import-competing firms and heavy industry were hurt by a strong dollar and high real interest rates. This dual economy showed up in the Twelfth District where the economic performance of regions with relatively high concentrations of affected industries lagged be hind that of other areas. In addition, a tapering-off of national economic growth in the second half of 1984 showed up in the District toward the end of the year. The pressure on interest rates became particularly acute in the first half of 1984 as robust 8.3 percent growth in the economy sent many households and businesses into the credit markets to borrow. However, a slowdown in the rapid pace of expansion in the latter half of the year, combined with actions taken by the Federal Reserve to support the economy's transition to a more sustainable rate of activity, allowed interest rates to retreat by year-end to approximately the same levels that prevailed at the beginning of the year. The high interest rates that have been one of the hall marks of this economic expansion would, by them selves, have significantly displaced, or "crowded out," household and business expenditures sensitive to in terest rate costs were it not for some offsetting influ ences. Last year was the third year of a plan, provided by the Economic Recovery and Tax Act of 1981, to phase in personal income tax cuts that boosted per sonal disposable incomes. As a result, consumer purchases of durable goods, such as automobiles, re mained strong despite high financing costs. Similarly, there is evidence that tax incentives for business pro vided by the 1981 Act have more or less fully offset the increased costs of issuing debt and equity caused by higher interest rates. Federal Deficits and High Real Rates Between 1981 and 1984, the U.S. federal budget defi cit rose from 2.2 percent to 4.8 percent of GNP. By 1984, the deficit was absorbing over half of the net savings of households, businesses, and state and local governments. The failure of the government deficit to shrink during the current economic expansion, which began at the end of 1982, combined with strong pri vate credit demands meant that the aggregate demand for funds greatly exceeded the supply of domestic saving. The result was unusually high levels of real, or inflation-adjusted, interest rates for this stage of a business expansion. Thus, it seems that the unusual strength in plant and equipment spending in the last two years was more likely due to the combination of new "high-technology" investment opportunities, particularly in the area of electronic equipment, and the need for business to modernize in the face of a more highly competitive at mosphere. The result has been the biggest boom in such spending of any economic expansion in the post-war period. High Employment Budget Deficit vs. Real After-Tax 6-Month Commercial Paper Rate Bi llions 01 Dollars Percen1 3 .5 150 Real Alter-Tax 6-Mo nl h Commercial Paper Rate ' (righ t sc ale) '" 120 Crowding out the Foreign Sector Because of offsetting factors, business investment has remained strong, at least in the aggregate. The sector affected most adversely by the deficit's impact on real interest rates has been the foreign sector, which con sists of industries that produce goods for export or that compete with foreign imports. A large U.S. federal budget deficit and high real interest rates, along with this country's political stability and strong economy, have attracted a large influx of foreign capital. The consequent heavy demand for U.S. dollars in foreign exchange markets has driven up the exchange value of the dollar. As a result, U.S. companies have found it difficult to compete abroad at the same time that imported goods have made large inroads into U.S . markets. 2.0 o 80 High Emplo yment • Budget Deficu (lett scale) 40 o 1979 1980 1981 198 2 1983 1984 - 4.0 . uSing average margina l ta x rate fOI mdivrduats 4 Mer cha nd ise Trade Deficit vs. Trade Weighted Value o f U.S Doll ar Billions oj DollatS 150 100 Mercha nd ise Trade Deficit 19130-82 • 100 The rate of inventory accumulation slowed to a more sustainable pace in the second half of 1984 and con tributed to a slowdown in production. In addition , the stimulatory effects of the Reagan Adm inistration 's personal income tax cuts on consumption had largely dissipated, while high real interest rates had started to take their toll on purchases of consumer durables and on residential construction. Furthermore, a tremendous surge in imports relative to exports, especially in the third quarter, reflected a substantial deflection of demand away from domestically produced goods. This switch in net foreign demand was four times as large in absolute terms during 1984 as the stimulatory effect of the change in the federal budget deficit. 150 125 Trade-Weighted Value of U.S. Dol lar (r ight scale) .... • pen sc ale) 50 o 100 1979 1980 1981 199 2 .983 1984 The weakening in overall demand , in conjunction with the first stages of an inventory correction , reduced the growth of real GNP from 8.6 percent in the first half of 1984 to 3.2 percent in the second half. By year-end , there was concern that the economic expansion was ending prematurely. Several signs, however, indicated differently. An increase in inflation typ ically has pre ceded the end of past recoveries, but, in the second half of 1984, the inflation rate remained low at around 3.5 percent. Consequently, by year-end , long-term in terest rates had fallen approximately 150 basis points from their highs in the summer, and promised to give a boost to interest-sensitive spending, such as hous ing and capital spending by business. In addition, new building permits for private housing were on the rise, while healthy growth in personal income at year-end raised hopes that household spending would pick up in the months ahead . Most important, growth in real economic activity accelerated in the fourth quarter from its third quarter slowdown . 75 The trade-weighted value of the U.S. dollar has risen over 50 percent since mid-1980, and it rose 13 percent in 1984 alone. As the dollar has risen, the U.S. mer chandise trade balance has deteriorated. Since mid-1980, when the dollar started to rise, the decline in the trade balance has been roughly $100 billion. For 1984, merchandise imports exceeded exports by $123 billion as a strong surge in imports outpaced a modest gain in exports. In addition , demand for U.S. ex ports has been reduced by relatively weak economic expansions abroad and by the debt burdens of lesser developed countries, which have forced them to cut back on their purchases from the U.S. Overall Overall, the economic expansion continued at an ex traordinarily strong pace through the first half of 1984. The sharp rise in production was due mainly to a re plenishing of real business inventories depleted at a record annual rate during the recession . In the begin ning of 1984, businesses were accumulating invento ries at a $30 billion annual rate , another record in the post-World War II period. This sharp swing away from a substantial run-off of inventories during the recession accounted for about 30 percent of the increase in pro duction during this expansion. Final sales-that is, GNP excluding inventory investment-have increased at about the same pace in this expansion as in past ones. 5 The Western Regional Economy Overall Measures of Recovery In keeping with its size and economic diversity, the West as a whole enjoyed an unemployment rate roughly equal to that of the nation. There was consid erable diversity in unemployment rates among western states, but even so, all of the nine states in the Twelfth District had unemployment rates at year-end below their December 1982 recession levels. The lowest rate at the end of the year was enjoyed by Arizona with 4.4 percent unemployment, while Alaska registered the highest rate at 9.6 percent. Like the national economy, the western economy enjoyed a broad-based, although uneven, expansion in the second year of the recovery. Economic develop ments in the Twelfth District, as in the nat ion, were driven mainly by growth in consumer spending and business investment. Highly expansionary fiscal policy, together with its effects on interest rates and the U.S. dollar, shaped the pattern of developments in the District, as did the boom in high-technology cap ital spending . Differences in economic performance among the states could be traced to an important extent to differ ences in their economic make-up. States with indus tries that relied heavily on government orders or that were part of the high-technology sector generally fared well , whereas states with industries significantly hurt by high interest rates and the strong dollar often suf fered by comparison. Also following the national pat tern , rapid economic growth in the beginning of 1984 slowed to a more sustainable pace in the second half of the year. Employment growth also varied widely across the states in the District. The most rapid employment gains were made in Utah and Arizona with annual growth rates of 9.6 and 8.1 percent respectively. In contrast, employment continued to grow sluggishly in Oregon and Washington . Growth in housing activ ity, another important barometer of regional conditions, also varied across states although it improved in most instances over 1983. The number of housing perm its issued increased most rapidly in Arizona and California and registered the slowest growth in Oregon and Idaho. Sources of Strength As in 1983, the prominence of the aerospace and elec tronics industries added vigor to a state's recovery . Both increased consumer spending and increased defense spending have buoyed the demand for these sectors' products. California, which received 23 per cent of all prime defense contracts in 1984, benefited most from the continued strength of defense spending. Employment in the aerospace industry in California rose by 7.2 percent in 1984, and employment in the electronics industries also increased sharply. The economies of Oregon, Utah and Washington received boosts from aerospace and electronics manufacturing activity as well. In fact, the strength of these sectors was crucial in offsetting some of the continued weak ness in the important forest products industry of the Pacific Northwest region. Unemployme nt Rates Twelfth Distri ct and the U.S. Percent 14 - 12 10 - - 8 - - - - 6 December 1982 • i1 - - - 4 - - - 2 - - - December 1984 • o C io " ~ l: ~. - - - - - - - - - - - - - - - - - - - .. - - J: ~: ~ Z i 0 ~ C g 6 Areas of Weakness Despite the generally good health of the western economy , there were some markedly weak areas. Agri culture, for example, suffered from the combined ef fects of continued high interest rates, the international strength of the dollar, and domestic and worldwide gluts in the markets for some products. Although interest rates declined toward the end of 1984, many western farmers were having difficulty with debt burdens they had accumulated over the past several years . The Federal Land Bank reported the highest rate of farm loan delinquencies in California in thirty years, and as many as 15 percent of California farmers left the industry in the past year. Weak foreign markets and the continued strength of the dollar overseas sharply reduced the demand for many of the West's key agricultural products. The value of California farm exports in 1984 fell to $3.0 billion from $3.3 billion in 1982 and $4.2 billion in 1981. Aerospace and Electronics Employment as a Proportion of Total Man ufacturing Employment-U .S. and Twelfth District 20 Pe rce nt 15 1984 u.s. • 10 12th District . 5 o Aerospac e Eteclronics As was true for the nation as a whole, the general in crease in consumer and business spending early last year also was a source of strength in the western economy. Employment in the serv ices and trade indus tries rose an average 5.0 percent from mid-1983 to June 1984 and was particularly important to the economies of Arizona, Utah and California. In Hawaii , for example , increases in tourism helped to offset the depressed pineapple and sugar industries. Farm problems have been compounded by unusually large harvests for some crops , most notably raisins, grapes and almonds. The combination of weak de mand and abundant supply of some crops depressed net farm income in most of the states in the District. In California, the deterioration in agriculture has caused as much as a 40-percent decline in certain agricultural land prices. In Idaho and Utah, however , net farm income weathered the difficult economic conditions and posted increases in 1984. Rapid rates of spending on consume r durables and new housing in the first half of 1984 also were sources of strength in the western economy, as they were in the national economy. In Arizona, construction activity was a particularly important contributor to the state's employment growth , which ranked as the most rapid in the nation in 1984. Toward year-end, however, key in dicators such as automobile sales and housing starts signalled that the economic slowdown observed nationally was occurring in the West as well. The wood products industry in the West also has re mained weak. Although home construction and other uses of wood products have grown significantly since the 1981-1982 recession , product prices remain de pressed because of weak export markets . Special regional circumstances also limit the recovery of this industry. Pacific Northwest producers face higher stumpage, labor and transportation costs compared to producers in the southeastern United States . They also suffer from proximity to Canadian producers, whose competitiveness has been helped by the weak ness of the Canadian dollar. As a result of these competitive disadvantages, production of some wood products at the end of 1984 remained below the levels of 1979. The boom in business capital spending nationwide during this recovery also is reflected in the District's economic performance . Districtwide employment gains of 2.5 percent in manufacturing were registered over the first half of the year, a rate only slightly below that of 1983, and nonresidential construction activity continued at high levels throughout 1984, particularly in Hawaii, Idaho and Nevada . 7 The weakness in the wood products industry signifi cantly detracted from the economic performance of Oregon and Washington in 1984. Despite strength in other industries in these states, the overall perform ance in both was lackluster. Oregon and Washington had the second and third highest unemployment rates in the Twelfth District and the slowest overall growth in employment during the year. The decline in short-term and long-term interest rates that occurred in the second half of 1984 will stimulate spending in the interest-rate sensitive sectors of consumer durables and housing. A strong revival in housing demand would be particularly welcome in the Pacific Northwest because it would provide the neces sary basis for a broad and sturdy recovery there. Recent passage of federal legislation affecting timber contracts on public lands also should help by reducing the average cost of harvested timber. The mining industry, concentrated mostly in the inter mountain states and Nevada, also was affected by low prices and foreign competition. The decline in inflation over the past two years has sharply reduced the de mand for the "inflation-hedge" metals, gold and silver. The subsequent fall in their prices has made much gold and silver mining in the West uneconomical. Copper mining continued to be plagued by weak world demand aggravated by a decline in international competitiveness due to the strong dollar. Disbursements from existing defense contract com mitments should strengthen the aerospace and electronics industries through 1986. Other high technology industries also can be expected to grow through the next two years . But the U.S. dollar's con tinued high value in foreign exchange markets will threaten to erode even the overseas demand for elec tronics products, and eventually cause some jobs in these industries to be moved to other countries. Despite the weakness in both mining and forest prod ucts, the economies of the intermountain states have been among the best performing in the District. In Utah, for example, the dampening effects of these weak sectors were more than offset by broad-based strength in the manufacturing and service industries and the general stimulus provided by defense expendi tures. Indeed, Utah enjoyed the third highest rate of employment growth in the nation during the first half of 1984. Agriculture also should be health ier in 1985 as the lower level of interest rates stemming from declines in the latter half of 1984 help relieve the current debt burden on farming operations. Export demand for agri cultural products would recover if foreign currencies regained some of their strength in relation to the U.S . dollar. Whether this occurs will depend importantly on the outcome of efforts to reduce the federal budget deficit. In any event, 1985 will be a critical year for western farmers generally, and California farmers in particular, as many farms already are in poor financial condition. The weakening of the OPEC cartel and the decline in world demand for oil were major causes of the contin ued poor performance of the Alaskan economy. Alaska depends strongly on oil revenues, to the extent that each one dollar decline in the price of a barrel of crude oil results in a decline of about $150 million in state revenues. For the state as a whole, employment growth in 1984 remained above national and District averages, and the unemployment rate, although still very high, remained stable in 1984. The economy of the Twelfth District should remain one of the most dynamic in the U.S. economy in 1985. Unlike much of the country, the western region does not depend on older, more vulnerable heavy industry. Rather, it harbors the largest concentration of high technology enterprise in the world and a diversity of other manufacturing, agricultural and raw materials industries. Such diversity gives the West the capacity to continue to grow through 1985. The Outlook Because the western economy is highly diversified, its overall performance next year should reflect that of the nation. Recovery should therefore continue, albeit at a slower pace . Some signs of a slowdown were evident before the end of 1984, but they did not indicate that the District's economy was heading toward a recession . This interpretation is reinforced by healthy Christmas retail sales activity and continuing declines in unem ployment rates at year-end. 8 Western Banking Because much of international debt is denominated in dollars, a stronger U.S. dollar means a higher debt repayment burden to a borrowing country in terms of its own currency. As a group, western banks posted their first year-over year increase in aggregate earnings since 1980. Nevertheless, just as in the last few years, their profita bility remained well below the national banking industry because of large loan losses suffered by a few large banks. Moreover, the unevenness of economic expansion which has characterized the current nation al and regional recoveries showed up in mixed performances across western banks in 1984. This problem is particularly acute for lesser developed countries (LDCs) with substantial amounts of interna tional debt. Because a solution to the economic prob lems of LDCs seems unlikely in the near future, large banks probably will be plagued for some time by their outstanding loans to these nations. The major drag on earnings for the banking industry, both nationally and in the West, continued to be relat ed to asset quality. A business expansion normally brings an improvement in bank loan quality by the end of its second year as it boosts the financial positions of bank borrowers. But despite an economic expansion that is strong by historical standards and which is now entering its third year, a significant improvement in the quality of bank assets does not seem imminent. One of the key reasons for this is the unevenness of the economic recovery in the District, a phenomenon shared with the national economy and shaped by some of the same developments-a reduction in infla tion, a persistence of high real interest rates and a strong dollar. The strong dollar also has contributed to weakness in several important segments of the domestic economy and thereby affected bank loan quality. It has curbed the overseas sales of many domestic firms while creat ing stiff competition for domestic industries competing against imported products. Reductions in international competitiveness, attributable in part to the strong dol lar, have weakened many export and import-competing industries in the West as elsewhere in the nation. The strong dollar along with high real interest rates have contributed to the unusually high default rates on bank loans to the troubled steel, mining and manufac turing industries, as well as to the agricultural and forest products industries. In a similar way, persistent weakness in the markets for petroleum products will continue to produce problems with loans to the energy industry. Furthermore, in many of the areas dominated by these depressed industries, both consumers and smaller businesses have suffered as well. Even a robust economy is not likely to improve the prospects of repayment by some firms in these industries unless the dollar loses some of its strength in international markets. High Interest Rates and a Strong Dollar The current expansion's high level of real interest rates has increased the real debt burden of many U.S. firms and raised the likelihood of defaults. It also has complicated the international debt repayment situation both directly by adding to the interest cost of financing debts and indirectly by being one factor that has driven up the foreign exchange value of the dollar. Problems with loan quality varied widely across banks in the West. For many, increases in provisions for loan losses due to bad loans resulted in weakened earn ings, while for some, they resulted in actual losses. Size, composition of loan portfolios, and location each played an important role in determining banks' loan quality. Multinationals were hurt by their problem LDC loans, while energy lenders continued to suffer from over-investment in the domestic petroleum industry. In California, some larger banks were also hurt by heavy losses on real estate and agricultural lending. In Ore gon, the smaller banks, lending in local markets, were hardest hit by the extended weakness in the forest products industry. Also, loan losses related to real estate were instrumental in the failure of several small western banks. Real Treasury Bill Rate Percent 8 6 4 2 o -2 -4 1969 1970 1972 1974 1976 1978 1980 1982 1984 9 I I. I Deposit deregulation has had still another important impact. Under the previous system of ceiling rates on retail deposits, large banks with access to national or international financial markets had substituted whole sale deposits, such as unregulated large CDs (that is, those over $100,000), for retail deposits. This response also was not as cost-effective in attracting deposits as direct price competition for retail deposits would have been. The shift from wholesale CDs to retail Money Market Deposit Accounts (MMDAs) that followed depos it deregulation appears to have had a beneficial impact on the earnings of large banks . It improved the ir competitive position for retail deposits in relation to their unregulated competitors , such as the money market funds, and allowed them to compete more efficiently against other banks for deposits. Deregulation This recovery is the first in 50 years to occur during a period in which depository institutions have been free from interest ceilings on most deposit accounts. De posit-rate deregulation has come essentially in two stages-first, on large-size business deposits in the late 1960s and early 1970s, and second , on retail con sumer deposits in the late 1970s and early 1980s. This deregulation has altered the way the financ ial and real sectors are affected by the business cycle. For exam ple, deregulation of deposit rates means that regulated depository institutions are no longer vulnerable to fi nancial disintermediation when market rates rise above ceiling levels. Thus, deregulation has eliminated the periodic shortages of loanable funds that used to oc cur when rates rose above ceiling levels , and thereby has ensured a good availability of bank loans and credit despite high interest rates. Not only has the economy benefited from the increased availability of bank credit during these episodes, but banks them selves are now able to compete much more effectively with financial institutions not subject to interest ceilings, such as money market funds, insurance companies, and the U.S . Treasury. The forces of deregulation were most evident in the pric ing of MMDAs-ceiling-free, insured, short-term re tail accounts offering limited check-writing privileges, and not subject to a reserve requirement on personal accounts. With the MMDA , institutions were able to at tract large quantities of funds (currently over $400 bil lion nationally), thus allowing large banks in particular to reduce their need for more expensive wholesale lia bilities, such as large CDs. During 1984, rates paid on MMDAs, which total over twenty percent of western banks' domestic deposits, were well below those paid on large CDs and rates paid by competing money market funds. While this pricing strategy for MMDAs tended to limit the total quantity of MMDA balances, it also resulted in a significant cost savings for many banks. Thus, banks' overall deposit versus lending interest margins widened as they took advantage of the lower costs of deposits. Under deposit-rate ceilings on retail accounts, banks and thrifts attracted core deposits, such as passbook savings, checking, and NOW accounts, by paying both explicit interest at the ceiling rate and by offering depositors a multitude of added conveniences and free or underpriced services, such as free checking privi leges and extensive branch office networks. In theory, this sort of noninterest or non price competition would be less efficient than direct competition using interest rates because depositors on average would value these additional services at less than their cost. Thus, under deposit deregulation, the explicit interest cost of attracting retail deposits would rise while the non inter est cost would decline as banks and thrifts cut back on some underpriced services and high-cost branches and begin charging explicitly for other services . Interest Rate s Percent 12 , 30-0 ay CO Rate 11 Particularly in the competitive bank and thrift markets that prevail in the West, it is likely that the rise in ex plicit interest costs actually would be less than the decline in noninterest costs. The total combined interest and noninterest costs might actually decline with deposit deregulation, although there could be a costly adjustment period. Therefore, a subtle but very important impact of deposit-rate deregulation is that it has offered the prospect of lowering the total cost of attracting retail deposits, particularly in competitive markets. 10 9 8 " - -.......,,, Money Markel Fund Rat e 7 10 ' 98 3 1984 .,. With the ability to engage in direct price competition, banks reduced nonprice forms of attracting deposits. They began to raise explicit fees for some previously underpriced banking services and to eliminate or cut back on others. The decline in some non priced ser vices resulted in cost savings that were supplemented by increased fee income from the explicit pricing of other services. Both changes contributed to lowering the noninterest costs of attracting deposits. Aggregate Net Income Twelfth District Banks Billions 2.25 2.00 1.50 1.00 One negative effect of deregulation on bank earnings has been the adjustments some banks have had to make in shifting from non price to price competition. For example, deregulation reduced the value of branches in attracting retail deposits and therefore im posed additional costs associated with reducing the number of such offices on banks, especially those with large branch networks. These losses associated with adjusting to a deregulated environment may have had short-run negative effects on some banks' earnings, but there is little evidence that the costs of deregula tion have substantially offset deregulation's positive effects on lowering total deposit costs and increasing fee income. The upturn in bank earnings and the rate at which new banks formed in the Twelfth District last year suggest that deregulation has not had a wide spread or lasting adverse impact on the industry. On the contrary, the impact appears to have been positive. .50 00 1975 1976 1977 1978 1979 1980 1981 1982 '983 1984 In addition, declining interest rates during the second half of 1984 had a positive impact on bank earnings because loan rates temporarily lagged behind the de cline in funding costs and because some banks still held substantial amounts of long-term fixed rate loans. Together, these positive factors offset the continued need to build up loan loss reserves, and resulted in an increase of over 30 percent in western banks' aggre gate net income for 1984 (net of extraordinary gains or losses). While earnings were well above 1983's de pressed $1.1 billion level, they were still far below the record $2.0 billion earned in 1980. For western banks in the aggregate, and for many individual institutions in the West as well, returns on equity and assets still are below the national averages. However, the turnaround in profitability in 1984 is important considering that banks probably will continue to face credit quality problems despite the advanced stage of the recovery. Improved earnings are essential if western banks are to generate much needed additions to their capital, and to continue to build cushions against potential losses. Performance Much of the improvement in aggregate western bank earnings resulted from a slight improvement in net in terest margins-the difference between interest earned on assets and interest paid on liabilities. Moreover, in the aggregate, dollar earnings also benefited from a moderate expansion in banks' assets despite a slight reduction in their foreign assets. Because of the unevenness of the current economic expansion, asset growth varied considerably across banks. The most rapid expansions were in some small er institutions that chose to increase their real estate and consumer lending. Consumers were eager to borrow, even at historically high real rates, to finance acquisitions of autos, other consumer durable goods and housing that had been postponed over the last several years. Weak loan demand from the corporate sector during much of the second half of 1984 slowed loan growth at the larger banks and led them to place more emphasis on their lending to the household sector. 11 Supervision, Regulation and Credit Close cooperat ion with other federal and state regula tors remained a key element in this Bank's effect ive . supervision of western depository institutions. The Bank continued successfully to coordinate examina tions of state member banks and offices of foreign banks on a joint or alternating basis with various state banking authorities, and scheduled bank holding com pany inspections to coincide, where possible, with the examination of the lead bank subsidiary by other fed eral agencies or the states. Cooperation extended to the implementation of formal corrective actions and the review of applications, and has resulted not only in more effective superv ision , but also economies in staffing and reduct ions in the burdens of examination for institutions. Developments in this Reserve Bank 's supervisory, regulatory and credit activ ities in 1984 confirmed the generally improving, although still spotty, condition of western banks and banking organizations. The balance sheets and earnings of individual banks reflected weaknesses in housing , energy, and certain agricultural products, while international loans created difficulties for multinational banks . Overall , most institutions experienced rising earnings and higher levels of capital, although poor loan quality and the economic sectors that did not share fully in the recovery harmed some institutions. The majority of weaker banking organizations did not warrant classification as problem institutions, but a small number required special supervisory attention . At the end of 1984, supervisory actions were outstanding or in process at 27 state member banks and bank hold ing companies out of a total of 350 such institu tions under this Bank's supervision . In addition, federal or state authorities closed 12 District commercial banks , compared to 10 in 1983. Most of these were small banks that failed because of problem real estate and agricultural loans. The Supervision, Regulation and Credit Department has a long-term objective, established in 1983, of improving the efficiency and quality of internal adm inis trative functions . In 1984, it made significant strides to ward automating its admin istrat ion with the use of new computer technology. On-line storage and retrieva l of collateral information for the cred it function were implemented , and automation projects affect ing the planning of examinations, examination records , and budgeting and management reports are in process . Other programming enhancements exped ited the processing of regulatory reports filed by District institutions and strengthened financial surve illance and analysis systems . These projects have improved the Bank's access to data and its ability to analyze the condition of supervised institutions. The lingering effects of the recession also were evident in record activity at the discount window. Dur ing 1984, both the number of loans granted and the number of borrowers reached new highs . The Bank extended 2,300 loans to 132 depository institutions, compared to 1,234 loans to 108 institutions in 1983. Furthermore, the number of institutions with liquidity problems that borrowed under the extended credit pro gram increased to 25 from 18 in 1983. A discount rate that was lower than market interest rates throughout 1984 also encouraged borrowers to seek temporary accommodation at the Federal Reserve. With the pros pect that their borrowing needs would grow through the year, institutions pledged $25.4 billion in collateral by year-end-up from $18 .5 billion in 1983. 12 District banks also expanded their international opera tions more cautiously in 1984 in view of the unsettled outlook for international lending. The applications for new offshore lending activities fell both in number and significance as banks exploited opportunities for financing trade instead. The long-run economic poten tial of Pacific Basin trade encouraged growth in the number of Edge Act international banking offices in the Twelfth District. These offices specialize in trade related banking transactions. Foreign banks' opera tions in the District also continued to grow, with the number of their branches and agencies increasing to about 150. Trade prospects also encouraged the ex pansion of Export Trading companies . By year-end, 9 were operating in the District and another had been approved . These companies were authorized by Con gress in 1982 to promote U.S. exports by providing specialized trade support services and financing beyond those permitted to Edge Act corporations and U.S. banks. Regulatory changes by the Federal Reserve System, as well as simplified application procedures, facilitated expansion by bank holding companies into such fields as securities brokerage, foreign exchange services and futures markets in 1984. Generally, banking orga nizations approached these activities with caution, although there was one striking exception-they rushed to form so-called "consumer banks." Such banks have bank charters, but they do not offer both demand deposits and business loans. By dropping one or the other activity, they cease to be "banks" for pur poses of the Bank Holding Company Act and become nonbank subsidiaries (hence the name "nonbank banks"), free from the barriers against interstate bank acquisitions. At year-end, this Reserve Bank had re ceived over 50 applications by District bank holding companies to establish such limited-purpose banks in 21 states plus the District of Columbia. The Board of Governors recently approved consumer bank applica tions in other Districts with expressed reluctance, but the future of these subsidiaries is unclear because of pending Congressional action , favored by the Board, to restrict them. The Federal Reserve's supervisory and requlatory re sponsibilities also include consumer education and protection . In 1984, the San Francisco Reserve Bank's consumer affairs staff continued its outreach activities by hosting two conferences for Neighborhood Housing Services and providing speakers for seminars and classes on consumer regulation for consumer groups and commercial bank training programs. Most con sumer complaints involving state member banks in 1984 concerned equal credit opportunities, although a growing number involved allegations of unauthorized withdrawals from automatic teller machines. To assist examiners in future evaluations of member bank pro grams under the Community Reinvestment Act, the Bank began to prepare a series of Community Profiles in 1984. These profiles are studies of demographic, ethnic, and housing patterns in metropolitan areas in the Twelfth District. Information from them will be made available to banks, governments and develop ment groups for use in their own planning . Profiles of Phoenix and Salt Lake City were completed in 1984. The composition of bank holding company applications reflected this push to form nonbank banks. In addition, there was a sharp jump in the number of notices filed under the Change of Bank Control Act. This Act requires individuals or groups of individuals to obtain approval prior to purchasing shares in banks or bank holding companies that affect the control of those organizations. In 1984, 25 change of control notices were processed, compared to 4 the previous year. In contrast, fewer new bank holding companies were formed. 13 Bank Administration The program to restructure the Bank 's telecommun ica tions network, begun in 1980, was completed in 1984. This project resulted in the consol idation and shar ing of telephone lines between the District's five offices and on-line depository financial institutions, thereby substantially reducing telecommunications costs asso ciated with current and future growth of the network. During 1984, the Federal Reserve Bank of San Francisco consolidated the delivery of certa in whole sale banking services and internal operations with the goal of improving their quality and efficiency. In addi tion , it developed and refined several products to meet the continually changing needs of the bank ing indus try. A cost-containment program was directed primarily toward controlling the costs of certain employee benefits and implementing an extensive automation strategy. Overall, the San Francisco Bank's cost-containment efforts held 1984 expenses to $120 .5 million (within budget) and allowed the Bank to propose a 1985 budget only 5.3 percent higher than that of 1984. The Bank continued a multi-year project of disaster contingency planning to ensure that critical customer services are maintained in emergencies. Perhaps the most prominent example of the Bank 's commitment to the efficient delivery of financial services was the start of construction on a new building for the Los Angeles Branch . The new fac ility is planned to meet the needs of the surrounding financial commun ity for decades to come . Disaster Contingency Planning In 1984, the Twelfth District expanded its major multi year effort to develop practical , well-tested, and com prehensive disaster cont ingency plans. These plans will promote staff safety and ensure that valuable items are protected. In addit ion, they guard against the risk of serious financ ial loss both to the Bank and Bank customers by specifying procedures to maintain minimum levels of customer service. Cost-Containment In 1984, the Bank developed a cost-conta inment strategy based on a reconfiguration of emp loyee bene fits and an intensified drive toward efficiencies from automation. The long-term strategy adopted for con trolling employee benefit costs emphasizes treatment alternatives and encou rages preventive health care . Treatment alternatives such as outpatient surgery and home health care should reduce the frequency and length of hospital admissions and thereby enable the Bank and its employees to realize lower medical premium costs. Operating departments with critical Reserve Bank functions have specified deta iled procedures for re sponse to and rapid recovery from short-term service disruptions. The overall Bank plan also will establish procedures for recovery from an emergency, such as provisions for emergency communications, back-up power for essential banking and building services, emergency medical care, and food storage . Twelfth District contingency plans for recovery from long-term service disruptions affecting the computer center (such as might be experienced during a major earthquake) will be initiated in 1985 in conjunction with Systemwide automation cont ingency efforts . The District's automation strategy exploits economies of scale by standardizing and centralizing large pro duction systems for several services. Furthermore, it stresses the use of microcomputers with in operating departments as complementary alternatives to higher cost data center fac ilities. For example, the conversion of check processing to identical systems in all five Reserve Bank offices in 1984 reduced prog ram main tenance costs and allowed for stronger contingency backup. Processing for the Automated Clearing House facilities at the Portland, Salt Lake City and Seattle offices will be centralized in San Franc isco in early 1985. In the Accounting area , both General Ledger and Billing Processing have been centralized in San Francisco in preparation for the new Integrated Accounting System which will be installed in all Federal Reserve Banks beginning in late 1985. Proposed new Los Angeles building 14 Facilities Planning Constructing a new building for the Los Angeles Branch was the chief focus of facilities plann ing efforts in 1984. The outdated Los Angeles facility, built in 1929 and expanded in 1953, cannot accommodate all existing operations, some of which are housed in nearby rented spaces . leading role in the System's resource-sharing automa tion program. This role dates back to the Bank 's devel opment of the first resource-shared application, SHARE, for automated securities handling. In 1984, the SHARE system was installed at three additional Reserve Banks , bringing the total to seven Banks at year-end; it is expected to be in production System wide (except at the New York Reserve Bank) in 1985. Direct participation in System automation efforts was complemented by the continued active participation of senior management in two national committees that set the long-range direction of Federal Reserve automation programs. The Board of Governors approved the conceptual de sign for the Los Angeles bUilding project in December 1983; the project architect is Daniel L. Dworsky. Con struction funding was approved in July 1984, and Swi nerton and Walberg, Inc. was engaged as the general contractor. Groundbreaking ceremonies were held last September on the building site adjacent to the existing facility. Other Systemwide automat ion efforts included imple mentation of Contemporaneous Reserves Reporting (CRR) in early 1984 and extensive systems planning and testing to support the installation of new Funds Transfer, Customer Information, Automated Clearing House (ACH) and Integrated Accounting System (lAS) software in 1985. The trans ition to new lAS software constitutes a multi-year, Systemwide effort that will standardize accounting systems at the same time that it centralizes the District's accounting system in the San Francisco headquarters office . The result should be improved accounting integrity over the Bank's assets and liabilities. The new building, scheduled for completion in 1986 will accommodate all existing operational needs and their expansion in the foreseeable future. It will have a back-up source of power and other systems critical to maintaining the delivery of services during emergen cies . In sum, the new facility will help the Branch meet the challenges of supplying efficient banking services to one of the nation's fastest growing communities. Automation Efforts The strategic objectives of the Bank's automation program support the Federal Reserve's multiple roles in making and implementing monetary and regulatory policy and in improving the efficiency of the payments mechanism through cost-effective services. Automation efforts therefore fall into several categories, including contributions to Systemwide efforts, internal enhance ments to make service delivery both more effic ient and responsive, and innovative programs to satisfy the changing needs of depository institutions. A second undertaking of the Bank's automation program has been to support Bank efforts to upgrade and expand electronic access for customers through out the Twelfth District. The basic components of this project are the increased use of microcomputers and the use of updated communications technology. In 1984, the Bank completed the new state-of-the-art intrad istrict communications network, SPINE, which expands electronic access capabilities and allows the Bank to contain communications costs. During the latter part of 1984, a major project was begun to up grade data communications, software and security fea tures for the Bank 's micro-computer based "FedLine" service, including the implementation of more compre hensive and reliable data encryption. In addition, the Bank prepared to provide electronic access to its Auto mated Clearing House services via dial-up telephone connection by early 1985. A major computer upgrade program for the Branch offices of the San Francisco Reserve Bank and a project to standardize the pro cessing of commercial checks throughout the District were other efforts successfully completed in 1984. Resource sharing efforts within the Federal Reserve's Systemwide automation program involve planning, testing, developing and implementing standard auto mated systems, the costs of which are shared by Reserve Banks. As represented by the Bank's involve ment in the joint development (with the Board of Gov ernors) of the Banking Statistics (STAT) application, these efforts continued to command a significant share of Bank resources last year. STAT, with initial availa bility planned for 1985, is an automated system designed to process data collected from depository institutions. The choice of the San Francisco Bank by the Board of Governors to co-develop STAT testifies to the Bank's 15 Boar d 01 Di rectors ORGANIZATION CHART JOhn J . Balles Presidenl and Chie l Ell6Cutive Officer March 1, 1985 Supervision, Regulation and Credit Law and Secretary's Office Eug ene A . Thomas Se nior Vic e President Superv ision. Regulation and Credit Louis E. Reilly Seni or Vice Presidant and Ge neral Cou nse l W. Gordon Smith VI~ President Credit and Co nsume r Al1airs Wayne L. Rickards Bank and Consumer Harry W. Green Vice President SHe and International Reg ulation Mer1e E. Barchan Vice President Bank Examlnaflons Donald R Lieb District Credit Oftlcer Robert D. M ullo rd Deputy General Cou nsel Regulation Offi cer Rod ney E. Reid Direc tor SHe and Interna tional Supervision Roben A. Johnston Ass!. Vice President Appl ica tiOns and Financial AnalysIs Kenneth R. Binning \ William L. Cooper Assccrat e General counset A p plicat io ns 0111cer Thomas P. McGrath Supervising O«icer Salt Lake City ) Dou glas R. Sha w Assccra te Genera! Counsel Eliza belh Fl. Pranymen Ass t. Vice Preeide nt and secreterv otme Boa rd Richard T. Griffith First VICe Prasrcant enc Chief Operahng Officer Thom as C. War re n Executive Vice Pres iden t I Statistical and Data Services Computer Serv ice s Finance and Product Manager Sara K. Garrison Vice President Statistical and Data Serv ices Wi llla mV. Ott Senior Vice Preside nt Computer Servi ces Car l E Pow ell Senior vlce President Fina nce and Produ ct Management G all A. Taylor Asst . vrc e Pr esident Monalary Aggr agat as and Reserves Lau rance Wash11en Vice President Systems and Communications Jud y A . Johnstone Vice Presiden t App lica tions SYSlems Eliot E. Gi uli Asst . VI~ Presic ent Intern ation al and Dom estic Financial Repo rts John Gleason Vice sreercent Prod uC1Managemen t Joan L. Moghad am Asst . vee Pres-den t Systems Jceech B. Fuchs Ass!. V~ s reeroent Syst ams Sa ndra E. Barggran Systems Officer vecent Pat rick Ton g Vice President Co mpuler Ooe reuo ne Rab en B. 0'0< Vice Presidem Product Management Asst . Vice Pr e s Adelle A . FOley Vice Presid ent Accou nt ing Electronic PaY' Tom Th aanu m Asst. VICe President Acco unting Gregory B. Wil liams ASS . Vice President I Fina ncial Plenn lng and Con trol San Franci sco Branch Portl l David J . c tmste-ecn Vice PreSiden t Angelo Senior Seattle Branch Salt Lake City Branch Gerald R. Kelly Senior vrce Presid ent E. Flonald Uggen Vic e President Kenn eth L. Peterson Ass t. vrce President Custody services Ger ald R. Dalhng Ass t. Vic e President An alysis and Control Asst. Vice Pres ident Payme nt setvcee M Tim Assl.V Admini' Gale P. Ans ell Asst. Vice preercem Analysis and Control Don W. Shee ts Asst. vee Pr esid ent Custody Control Manha F. Pen)' Asst . Vice President Financial Services Dean C Ass1.V Fayme Willia m C. Feran sen Assi . Vice Presiden t Fina nc ia l Serv ices Robert Fl . Richards Asst. Vice Pres idan t Paymen ts services Bruce H . Th ompson Ass t. Vic e Presidenl secwmes Services H.Wi(li ASS V 1. Cuslod Edwar d A. acone ur Check Office r And rea P. Wo lcott Finan cial Services Off ic er John H. Wo ng Ofhcer Cash Susan Asst.\j Fm anc J 16 Dougl as O. Knuds en servces ... Auditing BoaId a t Directors Roben l. Gatchell Genera l Audil or ...-1 Alan Blument hal Asslslant Gener al Audito r aM Chiel ExecutIVe Office r cna rtes O . eowc en Audit Officer Gary G. u oein AudJl Offic er Economic Research and Public Inlormatlon Joseph R. Bisig nano Semoe Vice Presid ent eno Direct or ot Research Jane W . Langhorne Ombudsmen John H. Beebe Vice President and Assoc . Duector 01 Research \ John P.Judd Vice President Demesne Macroeconomic Srudie s I Hang.-Sh eng Cheng Vic e Presldenl Intern at ional Studies Aldtard T. GriNith FIl'l t VICe Pres ident John L Scad ding VICe Presiden t Publi c Inlo rmatlOn anc Chiel Operating Offic e r :1ent anagemen l dent Rober1 B. O'ucncc nue Asst. Vice Preslden l Electroni c Paymenls Tom Tha anum A. S!.Vice Presid ent S ACl:Xlunting Sharo n Reisdo rf Asst. Vice President Accounnn c ! District Operations H. Peter Fran zel Senior Vice Pra ident Dist rict Opera Uons John F. Hoover Vice President Distr ict Financial Services Patricia K. Lang Vice Presldenl ccrporeie Perso nnel C. Kenneth Arnold Asst. Vice preetcerrt Data secu rity Sallie H. W eissinger Personn el Officer Oren L.Chri sten sen Vice President New BUilding Programs William K. Ginw Vic e PresIdent BUilding and Property Man agement J am es J. Tenge Asst . Vice Pres ident Admin istrat ive Servic es Williams President ~a nn i ng and Control \ Personnel and Administrative Services e ec rqe P. Ga lloway Vice President District securitylBtdg. note.on 'anagement " :oIey v ene B. .rcnnstcn Asst . vice Presid ent Legi slative Analyst Mic hael J. Murra y Sen.or VICe Preside nt Personnel and Admini stratrve Services and Product Management , Presidenl i Pe10 K. C. Hsieh r Audit ottcer John J. Balles Presid ent .." ! Gul Gidwan i Assistant Gene ral Au ditor SylVia A. Cu nningh am Procur ement serviCes Office r Portland Branch Los Angeles Branch Ang elo S. Ca rella Senior VI«l Presid ent RIchard C . Dunn Senior Vice Presid ent Rebert M. McGlII Senior Vice Presid 901 Mary Ellen Martin Asst. Vice President Financial Services Richard L. Rasmussen Vic e President Adm inistral lon M . Timoth y Carr Ass!. V1C e Presiden t Administretive Service s Dean C. Gonnerman Ass!. Vice Presiden t Payment s Service s Hector M . Manin Vice Presid ent Operation s Brent M. Duxbury Aut. Vice Pres ident AdministratI ve Servic eS Charles L. Huttst euer Asst . Vice President Cash Services Ross G. Ashman Ass\. Vice Presidem Paymerns Servi ces H. Willie m Penni ng ton Aser. Vice Preside nt CustOdy Cont rol susen L. acbert son Asst . Vic e President FinanCial Services 17 Theodore A. Schr oeder Securtties Servic es Officer Management Committee (From left to right) Michael J. Murray, Senior Vice President Richard T. Griffith, First Vice President and Chief Operating Officer Thomas C. Warren , Executive Vice President John J. Balles, President and Chief Executive Officer 18 Services to Government Agencies The Federal Reserve Bank of San Francisco is an important provider of fiscal and financial services to the United States Treasury and the public. Fiscal services include issuing government securities and savings bonds, and financial services include check collection and funds transfers for government agen cies, the processing of electronic payments and food coupons, and securities safekeeping . Another major government service provided by Reserve Banks is the distribution and recirculation of fit currency to depos itory financial institutions. The San Francisco Reserve Bank, with the second highest cash processing volume in the Federal Reserve System, uses high-speed processing machines to count, sort, cull and verify currency deposits. The Bank currently is working with other Reserve Banks to develop even more efficient and effective " second generation " cur rency processing equipment. In addition, the District is studying ways to automate various administrative and clerical cash operat ions, and is exploring more efficient ways to dispose of residue from destroyed unfit curren cy. For the cash customer, the San Francisco Bank published a Cash Services Customer's Guide to help Twelfth District depository institutions prepare currency orders and shipments, and joined with other Reserve Banks in establishing standards that would accommo date a wider range of cash orders. With branches in Los Angeles , Salt Lake City, Portland and Seattle, the San Franc isco Reserve Bank provides fiscal agent services to nine western states, including Alaska and Hawaii. Relat ively high interest rates in 1984 increased the attractiveness of Treasury secur i ties and led to a 35-percent increase in the commercial book-entry Treasury bill sales . In addition, the Bank 's intensive efforts to improve the efficiency of its savings bond services fostered an increase in the number of bonds issued that included a 14-percent increase in the number issued for corporate payrolls. In 1984, the unique circumstances surrounding the Games of the XXIII Olympiad created the need to meet increased currency demands in the Los Angeles area. The Los Angeles Branch of the San Francisco Reserve Bank formed a Task Force working with local banks and government agencies to ensure sufficient supplies of high quality currency for automated teller machines near the Olympic Stadium and the Olympic Village. The Task Force also worked with the Olympic Organiz ing Committee to study requirements for armored cash transportation and security precautions. These cooperative efforts successfully met the needs of the international event. The Federal Reserve Banks are the chief agents for relaying government transfer payments, such as social security payments, to individuals. These payments are made primarily through electronic transfers and/or Treasury checks. Electron ic payments through the Au tomated Clearing House (ACH) and "Fedwire" have grown in recent years and the upward trend continued in 1984. Last year, government payments constituted 38 percent of the Systemwide ACH volume. Reserve Banks also collect, sort, cancel, and truncate Treasury checks after circulation. Within the System, the San Francisco Bank is the largest processor of government checks in the United States, handling nearly 100 million such checks in 1984. 19 Priced Payments Services Growth of Payments Service s Through the Monetary Control Act (MCA) of 1980, Congress sought to promote greater competition in financial markets through deregulation and greater effi ciency in the payments mechanism. It did the latter by requiring all Federal Reserve Banks to provide open access to payments services at explicit prices for all depository institutions subject to reserve requirements and to set prices to fully recover the direct and indirect costs of these services. The Federal Reserve Bank of San Francisco has responded to the mandate by pur suing efficiencies from automation and by continually improving the quality of its services in response to the needs of the financial community in the nine western states it serves. Change (%) 50 , Aut omated Clearinghouse 40 30 20 10 o -10 The Twelfth District encompasses a highly populous and diverse area with a population of 38 million people spread over five time zones. To learn of and respond to the needs of more than 4,000 depos itory institu tions, the District Financial Services unit conducts market research and Districtwide service information programs. The District Product Management group, working with operations and automation staff, trans lates these needs into new or enhanced products. As a direct result of this program, a net increase of about 300 new customer relationships were established in 1984, and approximately 1,000 institutions in the Twelfth District now use Reserve Bank services. _ 20 1977 1978 1979 1980 1981 1982 1983 1984 By emphasizing improvements in the quality of check services that, for example, reduced internally generat ed float by 75 percent, the San Francisco Reserve Bank was able to hold the cost of check services steady throughout 1984. This commitment to price stability and rigorous cost-control will ensure a continuation of current product prices through 1985 with no more than minor adjustments. The Twelfth District's broad range of demographic and geographic conditions, in conjunction with its time dif ferences from eastern money markets, has dictated the most complex check transportation requirements in the System. In 1984, the Bank extended its transporta tion capability by joining with the System's Interdistrict Transportation Service (ITS) in delivering check collec tion services. The use of ITS charter service improved the availability of funds on many checks payable in other Federal Reserve Districts. Check Services The San Francisco Reserve Bank handles the largest volume of checks of any Reserve Bank in the Federal Reserve System. As a result, it aggressively pursues improvements in service levels and quality. In 1984, as part of a Systemwide plan, the Bank implemented later check deposit deadlines to improve the availability of funds . In addition, the Bank implemented the High Dol lar Group Sort service as part of a Systemwide effort to accelerate the collection of checks and offer cus tomers significant opportunities to obtain improved check availability and reduce transportation costs. Also, an enhanced national monitoring system to track delivery and credit performance on individual cash let ters improved the Bank 's ability to optimize check transportation arrangements as well as to assign check float to institutional depositors. Funds Transfer The Reserve Bank's online Funds Transfer service continued to grow in 1984 especially with the increas ing popularity of its microcomputer-based service FedLine. The total number of customers using FedLine doubled in 1984 to approximately 800. 20 Initially, the major goal of FedLine was to allow a wider range of subscribers to transfer funds directly through the Federal Reserve's communications system Fedwire. During 1984, the Bank expanded FedLine 's capabilities further to allow customers to place orders for currency and coin. In addition, the terminal device used for leased line electronic access was changed to a microcomputer for compatibility with FedLine and to provide better service. In early 1985, depository finan cial institutions will also have the option to receive electronic information on cash letters, debits, credits and adjustments, as well as daily accounting informa tion, through a new service, "FedLine-UpDate." Growth of Cash Services Change (% ) 25 20 15 10 5 o Automated Clearing House The bank's Automated Clearing House (ACH) facility remained an important and rapidly growing service in 1984. ACH consists of the exchange and del ivery of electronic payments items. While incentive pricing has been employed as a means to encourage rapid growth in this electronic service, the cost recovery target for this service has increased annually. In 1984, the ser vice was priced to recover 60 percent of expenses. By 1986, the Federal Reserve System plans to have phased in full cost recovery for ACH service. In coop eration with local Automated Clearing House Associa tions, the Bank continues to identify opportunities for stimulating wider acceptance of efficient electronic payments and for facilitating the entry of private sector processors into ACH service. 1977 1978 1979 • Does not inc lud e weighed 1980 CO in, 1981 1982 1983 1984 so 1977 figure is not com parable. •• Change in mint shipments. fit currency. The improved quality of currency helps accommodate the cash dispensing requirements of automated teller machines now abundant in the Twelfth District . Many Reserve Banks have elected to terminate their direct involvement in cash transportation. The San Francisco Bank , however , has opted to continue offer ing the service in the Twelfth District in response to increased customer demand. Since the inception of cash transportation pricing in 1982, the number of locations reached by the San Francisco Reserve Bank's cash delivery network has grown continuously. On a national scale, the ACH service was enhanced significantly by an improved SystemWide deposit and delivery schedule, new ACH software, the automation of paper return items, and substantially expanded electronic capab ilities. This Bank provides a variety of secur ities services to financial institutions in the Twelfth District, including transferring of book-entry securities, purchase and sale of government securities, and collection of noncash items. The pricing of System services for book-entry securities has prompted continuinq initiatives to reduce costs, including an evaluation of the effectiveness of centralizing the Twelfth District's service at San Fran cisco. In 1984, the bank's securities services staff collaborated with the Federal Reserve Bank of Minne apolis in an effort to improve the payment process for noncash collect ions sent to paying agents in the Twelfth District. This joint effort resulted in greater efficiency and a reduction of float. Cash and Securities Services Despite growth in alternative payments services, cash requirements throughout the Twelfth District were sub stantial in 1984. The Federal Reserve circulates new Federal Reserve notes, withdraws unfit bills from circu lation, and accommodates transfers of currency among financial institutions. Coin also is collected, counted and redistributed by the Federal Reserve System. While the transportation of currency and coin is priced, processing and related activities are provided as a government service. The quality of currency has been improved through the use of new high speed Currency Verification, Counting and Sorting (CVCS) machines that not only increase sorting speed but also provide for consistent control and adherence to standards for 21 Branch Operations (Shown from left to right, standing) David J . Christerson , Vice President, San Francisco Branch E. Ronald Liggett, Vice President, Salt Lake City Gerald R. Kelly , Senior Vice President , Seattle Richard C. Dunn, Senior Vice President, Los Angeles Angelo S. Carella, Senior Vice President, Portland (seated) H. Peter Franze l, Senior Vice President , District Operat ions A. Grant Holman , Senior Vice President (Retiring), Salt Lake City 22 Summary of Operations Volume (thousands) 1982 1983 ·· 1984 1,700,557 4,649 ,901 1,767 ,236 4,779,409 1,925,085 5,078 ,150 2,188,831 . 5,302,832 1,136 402 ,885 232 318,497 995 339 ,820 182 313,761 1,235 285 ,420 116 333 ,512 · 1,549 279 ,342 138 310,450 1,393,822 1,201,909 103,154 22,431 1,210,143 2,619,403 101,310 23,952 1,226,778 3,367,031 96,136 24,707 1,337 ,350 509 ,560 . 95 ,548 25,580 5,143 55,483 5,882 76,944 6,674 91 ,838 7,757 111,408 1,821 106 1,281 105 1,234 108 2,348 136 1981 J I I 1 Custody Services Cash Services Currency paid into circu lation Coin paid into circulation Securities Services Savings Bonds original issues Savings Bonds redemptions processed " Other Treasury orig inal issues Food coupons processed Payments Mechanism Services Check Processing Services Commercial checks processed Fine sort bundles processed " ! Government checks processed Return items processed Electronic Funds Transfer Services Wire transfers processed Automated clearinghouse transactions processed Discounts and Advances Total discounts and advances" Number of financial inst itutions accomrnodated ' • Number (not in thousands) , Reported in packages beg inning in 1984. 23 Twelfth Federal Reserve District " .. - ,JI•. Hawaii 24 Directors Directors of the Federal Reserve bring management ex pertise to the task of overseeing Reserve Bank opera tions. They provide information on key economic devel opments in various areas of the District, complementing the Bank's internal research. In addition , Board mem bers give advice on the general direction of monetary policy, especially with regard to the Bank's discount rate. Head Office Chairman of the Board and Federal Reserve Agent Alan C. Furth Vice Chairman Santa Fe Southern Pacific Corporation and President, Southern Pacific Company San Francisco, California Deputy Chairman Fred W. Andrew Chairman of the Board, President and Chief Executive Officer Superior Farming Company Bakersfield, California Carolyn S. Chambers President Chambers Cable Com., Inc. Eugene, Oregon Rayburn S. Dezember Chairman, President and Chief Executive Officer Central Pacific Corporation and Chairman, American National Bank Bakersfield, California Furth Andrew Chambers Dezember Eccles Gehb Hampton Tanaka Weyerhaeuser Spencer F. Eccles Chairman , President and Chief Executive Officer First Security Corporation Salt Lake City, Utah Donald J. Gehb President and Chief Executive Officer Alameda Bancorporation and Alameda First National Bank Alameda, California I ~ John C. Hampton Chairman, President and Chief Executive Officer Willamina Lumber Company Portland, Oregon Togo W. Tanaka Chairman Gramercy Enterprises, Inc. Los Angeles , California Federal Advisory Council Member G. Robert Truex, Jr. Chairman Rainier Bancorporation and Rainier National Bank Seattle, Washington George H. Weyerhaeuser President and Chief Executive Officer Weyerhaeuser Company Tacoma, Washington 25 Los Angeles Chairman of the Board Richard C. Seaver President and Chief Executive Officer Hydril Company Los Angeles, California Thomas R. Brown, Jr. Chairman of the Board Burr-Brown Corporation Tucson, Arizona Robert R. Dockson Chairman and Chief Executive Officer CalFed, Inc. Los Angeles, California Bram Goldsmith Chairman and Chief Executive Officer City National Bank Beverly Hills, California Lola McAlpin-Grant Attorney Inglewood, California Harvey J. Mitchell President and Chief Executive Officer Escondido National Bank Escondido, California William L. Tooley Chairman Tooley & Company, Investment Builders Los Angeles, California 26 Portland Chairman of the Board Paul E. Bragdon President Reed College Portland, Oregon Herman C. Bradley, Jr. President and Chief Executive Officer Tri-County Banking Company Junction City, Oregon John A. Elorriaga Chairman and Chief Executive Officer United States National Bank of Oregon Portland, Oregon William S. Naito Vice President Norcrest China Company Portland , Oregon J I I G. "Johnny" Parks Northwest Regional Director International Longshoremen's & Warehousemen's Union Portland, Oregon Sandra A. Suran Partner Suran and Company Beaverton, Oregon G. Dale Weight Chairman and Chief Executive Offic~r Benjamin Franklin Savings and Loan Association Portland, Oregon 27 Salt Lake City Chairman of the Board Don M. Wheeler President Wheeler Machinery Company Salt Lake City, Utah John A. Dahlstrom Chairman of the Board Tracy-Collins Bank and Trust Company Salt Lake City, Utah Lela M. Ence Executive Director University of Utah Alumni Association Salt Lake City, Utah Albert C. Gianoli President and Chairman of the Board The First National Bank of Ely Ely, Nevada Fred C. Humphreys Ch~rman, P~s~entand Chief Executive Officer The Idaho First National Bank and Moore Financial Group Boise, Idaho David Nimkin Financial Development Coordinator/Consultant Neighborhood Housing Services of America , Inc. Salt Lake City, Utah Robert N. Pratt Former President White River Shale Oil Corporation Salt Lake City, Utah 28 Seattle J I I Chairman of the Board John W. Ellis President and Chief Executive Officer Puget Sound Power & Light Company Bellevue, Washington I I Lonnie G. Bailey Executive Vice President Farmers and Merchants Bank of Rockford Spokane, Washington Carol Birkholz Managing Partner Laventhol & Horwath Seattle, Washington Byron I. Mallott President and Chief Executive Officer Sealaska Corporation Juneau, Alaska John N. Nordstrom Co-Chairman of the Board Nordstrom, Inc. Seattle, Washington W. W. Philip Chairman, President and Chief Executive Officer Puget Sound Bancorp Tacoma, Washington William S. Randall President and Chief Executive Officer First Interstate Bank of Washington, N.A. Seattle, Washington 29 Comparative Statement of Account (Thousands of Dollars) December 31, 1983 Assets Gold certificate account , Special Drawing Rights certificate account Other cash , , , ,., , . . . 1984 $ 1,182,000 $ 1',318,000 518 ,000 518,000 81,17894,148 Loans to depository institutions . 23,305 . 23,700 • Federal Agency obligations . 1,096,249 '. 1;075 ;682 , United States Government securities: Bills Notes Bonds . . . 8,345 ,211 . 9,108,176 8,107,233 " ' 8 ,364;689 2,639,318 " 2,942,780 , , Total United States Government securities Total loans and securities , Cash items in process of collection Bank premises Operating equipment , , , , , , , , Other assets: Denominated in foreign currencies , All other . , . , , , , , ,., , . . 19,091,762 20,211,316 ,20,415;645, 21,515;027 , . ,.,.. . 1,477,963 106,422 30,350 .692,624 110,613 " 31,319 608,520 438,043 ,, 589,744 . 690,995 ,. , , , , , " , .. , , , , ,., ,., ,., . . " Interdistrict Settlement Account , , , , . 1,273,9521,368,923 ". Total assets 25,927,744 ". ' 26,929,393 " Liabilities Federal Reserve notes 19,930,15121 ,048,999 Deposits: Total depository institutions-reserve accounts Foreign , Other deposits ,, , Total deposits , , . . . ,, , , .. , , Deferred availability cash items Other liabilities , , , ,.." Total liabilities , , , , .. , .. , , , ,., , , , .. , , ., ., , , ,., .. , , .,.,. , , , ., ,., 4,009,671 24,750 52,001 . , , 4,086,422 . . 1,130,877 298,710 . 25,446,160 , .. . 240,792 240,792 . 25,927,744 4,412,694 24,600 57,996 ' Capital Accounts Capital paid in Surplus , ' , Total liabilities and capital accounts , , ,.,. , , , , 30 , 255,490 ' 255,490 ,26,929,393 Earnings and Expenses (Thousands of Dollars) December 31, 1984 1983 Current Earnings . . . . . Total current earnings . 2,018,156 2,230,190 Total current expenses Less reimbursement for certain fiscal agency and other expenses . . 114,474 8,485 120;473 8,979 Net expenses Cost of earnings credit . . 105,989 4,554 111,494 8,799 Current net earnings Additions to current earnings Profit on sales of United States Government securities (net) All other . 1,907,613 2,109,897 . . 2,656 35,545 ·6,207 0 Total additions . 38,201 6,207 Deductions from current net earnings Loss on foreign exchange transactions (net) All other . . 75,289 0 74,590 447 Total deductions . 75,289 75,037 Net additions ( + ) deductions ( -) Assessments by Board of Governors Board Expenditures Federal Reserve currency cost Net earnings before payments to United States Treasury Dividends paid Payments to United States Treasury (interest on FR notes) . - 37,088 -68,830 . . . . . -11,734 -16,143 1,842,648 13,949 1,811,539 -13,406 . -20,624 2,007,037 14,816 1,977,523 Transferred to surplus Surplus January 1 Surplus December 31 . . . 17,160 223,632 240,792 14,698 240,792 255,490 $ 9,111 1,910,065 45,176 52,361 1,443 6,446 2,122,735 . 35,618 63,526 1,865 Discounts and advances United States Government securities Foreign currencies Income from services All other $ Current Expenses Profit and Loss 31 San Francisco Office P.O. Box 7702, San Francisco, California 94120 Los Angeles Branch P.O. Box 2077, Terminal Annex, Los Angeles, California 90051 Portland Branch P.O. Box 3436, Portland, Oregon 97208 Salt Lake City Branch P.O. Box 30780, Salt Lake City, Utah 84125 Seattle Branch P.O. Box 3567, Terminal Annex, Seattle, Washington 98124 This report was prepared by the staff of the Federal Reserve Bank of San Francisco: produced by Karen Rusk; graphics designed by William Rosenthal ; edited by John L. Scadding and Gregory J. Tong. Assistance provided by Economic Research; Supervision, Regulation and Credit; District Operations; Accounting; Personnel; and Computer Services . 32 Federal Reserve Bank of San Francisco P.O. Box 7702 San Francisco, California 94120 BULK RATE MAIL U.S . POSTAGE PAID PERMIT NO. 752 SAN FRANCISCO, CALIF.