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FEDERAL RESERVE BANK OF NEW YORK [ Circular No. 10730 August 24, 1994 1 PROPOSAL TO CHANGE THE METHOD FOR IMPUTING INCOME ON CLEARING BALANCES FOR PRICED SERVICES Comments Requested by September 21, 1994 To All Depository Institutions in the Second Federal Reserve District, and Others Concerned: The following statement has been issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board has requested public comment on a proposal to modify the methodology for imputing clearing balance income to more closely parallel the practices of a private sector provider. Comment is requested by September 21, 1994. Specifically, the Board is requesting comment on changing the rate used to impute clearing balance income from the 90-day Treasury bill coupon equivalent yield to a longer term Treasury rate based on the earning asset maturity structure of the largest bank holding companies (BHCs). The intended effect of the proposal is to promote competitive equity with private sector practices by matching the maturity structure for investment of clearing balances to the structure revealed in bank holding company data on investments. The Monetary Control Act requires the Federal Reserve Banks to establish fees for their services similar to those of private-sector service providers. In establishing fees, the Board considers the objectives of fostering competition, improving the efficiency of the payments mechanism, and providing financial services nationwide. Printed on the following pages is the text of the Board’s official notice in this matter, which was published in the Federal Register of August 19. Comments thereon should be submitted by September 21, and may be sent to the Board of Governors, as specified in the notice, or to our Management Information Department. W il l ia m J. M cD o n o u g h President. , /o V 3 d 42832 Federal Register / Vol. 59, No. 160 / Friday, August 19, 1994 / Notices Constitution Avenue, N.W., Washington, D.C. 20551. Comments also may be delivered to Room B-2222 of the Eccles Building between 8:45 a.m. and 5:15 p in. weekdays, or to the guard station in the Eccles Building courtyard on 20th Street NW. (between Constitution Avenue and C Street) at any time. Comments may be inspected in Room MP-500 of the Martin Building between 9:00 a.m. and 5:00 p.m. w-eekdays, except as provided in 12 CFR 261.8 of the Board’s rules regarding availability of information. FOR FURTHER INFORMATION CONTACT: Greg Evans, Manager (202/452-3945), or Gwen Mitchell, Senior Accounting Analyst (202/452-3841), Division of Reserve Bank Operations and Payment Systems, Board of Governors of the Federal Reserve System. For the hearing im paired only: Telecommunications Device for the Deaf, Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: The Monetary Control Act (MCA) requires the Federal Reserve Banks to establish fees for their services on a basis similar to private sector service providers. In establishing fees, the Board considers objectives of fostering competition, FEDERAL RESERVE SYSTEM improving the efficiency of the payments mechanism, and providing [Docket R-0846] financial services nationwide. Accordingly, the Federal Reserve Federal Reserve Bank Services: Imputed Income ort Clearing Balances im putes costs in the private sector adjustment factor (PSAF) that are AGENCY: Board of Governors of the intended to mirror private sector sales Federal Reserve System. taxes, income taxes, cost of funds, and ACTION: Request for comment. FDIC assessments. Capital structure, equity and debt rates, and an income tax SUMMARY: The Board is requesting rate are derived from a model of the comment on a proposal to modify the largest (in asset size) 50 bank holding m e t h o d o l o g y fo r i m p u t i n g c l e a r i n g companies. The Federal Reserve uses balance income to more closely parallel the bank holding company model to the practices of a private sector service place Reserve Bank payment service provider. Specifically, the Board is costs on an equal footing with those requesting comment on a proposal to costs incurred by the private sector. The change the rate used to impute clearing banking industry has accepted the BHC balance income from the 90-day model as a proxy for determining Treasury bill coupon equivalent yield to Federal Reserve imputed costs. a longer term Treasury rate based on the In February 1981, the Federal Reserve earning asset maturity structure of the established procedures to assist largest bank holding companies (BHCs). depository institutions with clearing The intended effect of the proposal is to arrangements at Reserve Banks, promote competitive equity with private recognizing that the maintenance of an sector practices by matching the account relationship is necessary for (a) maturity structure for investment of depository institutions that do not clearing balances to the structure maintain reserve accounts but desire revealed in bank holding company data direct access to some or all Federal on investments. Reserve priced services and (b) DATES: Comments must be submitted on depository institutions that do maintain or before September 21, 1994. a reserve account but find the reserve ADDRESSES: Comments, which should balance inadequate for their refer to Docket No. R-0846, may be transactions. Because clearing balances w'ere mailed to William VV. Wiles, Secretary, established as a result of depository Board of Governors of the Federal institutions wanting access to Federal Reserve System, 20th Street and Reserve priced services, it was determined that investment earnings attributable to clearing balances should be ascribed to the System’s priced service operations, comparable to the use of these balances by other service providers. The 1982 annual financial report of the Federal Reserve reflected these earnings. This priced service revenue factor, net income on clearing balances (NICE), is the difference between the income the Federal Reserve im putes on clearing balances held with the Federal Reserve System, less im puted reserve requirements, and the priced services cost of earnings credits granted to depository institutions, net of expired earnings credits. (Appendix A illustrates the current NICB calculation.) The private sector recognizes revenue from these balances in a similar wav. In 1982, under its delegated authority rules, the Board approved a rate of return equivalent to the yield on the short-term assets included in the System Open Market Account portfolio for calculating clearing balance income. The Federal Reserve selected the 90-day Treasury bill coupon equivalent yield to impute income on clearing balances. A primary benefit of the 90-day Treasury rate, wrhich is still used today, is that its yield is equivalent to the yield on short-term assets currently included in the Federal Reserve’s System Open Market Account (SOMA) portfolio. Additionally', use of the short-term 90day rate was viewed as more closely approximating what would have been realized had clearing balance funds been held and invested by a private business firm. Lastly, Treasury yield data are available to the public. This allows the earnings calculation to be replicated by the private sector. The Reserve System recently reviewed the methodology used to impute income on clearing balances to determine the comparability of Federal Reserve practices in this area with practices of correspondent banks. A telephone survey of bank holding companies was conducted to determine the types of assets in which correspondent banks invest clearing balance funds. Survey results showed that, although correspondent banks pay earnings credits based on a short-term rate (90day Treasury bill), their investment of clearing balance funds is determined by the economic environment, their risk policies, and investment opportunities available. The survey participants identified a range of investment options including, loans, securities, and overnight funds. Federal Register / Vol. 59, No. 160 / Friday, August 19, 1994 / Notices It was observed that correspondent banks may exercise a broad range of investment opportunities whereas the Federal Reserve has adopted a more restrictive practice. Since Reserve Bank im puted investments do not reflect correspondent bank practices, the approach is inconsistent w ith other areas of priced service accounting. Other areas of priced service accounting either draw on actual Reserve Bank costs, or are im puted based on BHC data. More important, over time, by computing clearing balance income in the current fashion, the Federal Reserve may be understating clearing balance revenue, increasing costs of Federal Reserve priced services, and setting prices higher than necessary to promote effective competition and efficient payment services. The proposal under consideration by the Board of Governors is to determine the maturity structure of short-, intermediate-, and long-term securities assets from the BHC model and impute income based on published matching term Treasury yields. The Board is considering the BHC structure/Treasury yields method because it promotes competitive equity w ith private sector practices by matching the maturity structure for investment of clearing balances to the structure revealed in bank holding company data on investments. One problem with attempting to match the earnings realized by bank holding companies is that the risk premium for the private sector is difficult to manage and approximate. Also, the Federal Reserve could not determ ine administrative costs from available data. Therefore, the Board believes that the Treasury rate provides a reasonable proxy for the actual rate realized by bank holding companies on clearing balances, without the risk premium associated with holding com pany investments and adm inistrative costs incurred managing portfolio risk. Bank holding company maturity structures and Treasury yields are publicly available so that the NICB calculation can be replicated by the private sector. The recommended approach provides longer term investments, which would produce higher earnings, assuming an upward sloping yield curve. Proposed NICB Computation An estimate of NICB is prepared annually. Under the recommended methodology, selected earning assets include Federal funds, repurchase agreements, and securities. These investments were chosen because they most closely represent the Treasury function investments of the private sector. The earning assets maturity structure of the BHC model would be defined as follows: less than one year (short-term), one -to -five years (intermediate-term) and greater than five years (long-term). The maturity structure would be calculated from the most recent four quarters of Y9 data. The Y9 is a quarterly BHC report filed with the Federal Reserve and is generally available to the public 50 to 60 days after the close of the quarter. For example, four quarters for 1992 would be used for the 1994 earnings rate estimate, which would be calculated in the fall of 1993. Similarly, 1992 BHC data are used for the 1994 PSAF calculation. Historical rates are used because the Board has decided in previous instances to avoid the appearance of forecasting interest rates. Published matching-term Treasury yields would be applied to the maturity percentages and summed to develop the earnings rate. The Board intends initially to use shorter term Treasury rates. In this regard, a three-month Treasury yield would be used for the short-term rate maturity portion. A oneyear Treasury yield would be used for the intermediate-term, and a five-year Treasury yield would be applied for the long-term portions. Current year-to-date (approximately four months) week ending average Treasury yields from the Federal Reserve H.15 Statistical Release w ould be used for the estimate. The recommended m aturity structure and applicable Treasury yields are shown below. 42833 The following table illustrates the result of this recommendation compared with the current methodology using 1994 projections. 1994 NICB Estimate ($ M illions) Current Method Clearing balance income: Investable funds Earnings ra te .... Earnings on in vested portion of clearing bal ances ............ Cost of earnings credits: Cost (Fed funds rate) .............. Net cost of earn ings credits .... Net Income on clearing bal ances ................ BHC struc ture and treasury yield $5,417.8 3.0877% $5,417.8 4.1109% 167.3 222.7 3.0079% 3.0079% 141.9 141.9 $25.4 $80.8 Had the recommended approach been in place for the 1994 estimate, clearing balance earnings would have increased $55.4 m illion or 33.1 percent, from $167.3 m illion using the current method to $222.7 million. This is due to a 102 basis points increase in the earnings rate, from 3.0877 percent in the current m ethod to 4.1109 p ercent1. NICB would have increased from $25.4 m illion in the current m ethod to $80.8 million. Moreover, the Board believes that investm ent decisions made by BHCs are not static. Instead, these decisions are the result of several considerations, BHC Treasury maturity struc Weighted aver including the economic environment, ture yield (B) age rate (AxB) their risk policies, and investment (A) opportunities available. Consequently, the Board recognizes that the % Investment Three% recom m ended methodology may require < 1 year. month ..... further adjustment based on economic % Investments One% situations or new investment year ........ 1-5 years. opportunities. Prudent private sector % Investment Five- ....... % investors would be aware of changing year ........ 5+ years. T o ta l........... Weighted aver variables and would make the necessary age esti investm ent changes to reflect market mated rate. conditions. Accordingly, the Board would Actual NICB results are im puted propose to make such adjustments, monthly. Under the recommended w ithout public comment, unless the methodology, the maturity structure adjustm ent entails a change in the developed in the calculation of the methodology. Therefore, imputed estimate would be held constant for the investm ent income would be subject to year; however, current monthly the Board’s approval as are fee Treasury yields would be applied to the schedules for Federal Reserve priced percentages to develop the weighted services and the PSAF. average earnings rate. The week-ending average yields, as published in the 1 T h e im p u ted w eig h ted average earnings rate is Federal Reserve H.15 Statistical Release, d eriv ed as f o llo w s (short, in term ed ia te, a n d lo n g would be used to calculate the monthly term , re sp ectiv ely ): ((32.67% * 3.0 8 7 7 % ) + (27.58% rate. * 3 .3 8 8 9 % ) + (39.75% * 5.4 5 2 6 % )) = 4.1109% 42834 * Federal Register / Vol. 59, No. 160 / F riday, A ugust 19, 1994 / N otices In summary, the current short term nature of Federal Reserve clearing balance income is not representative of the behavior of most correspondent banks. Although the recom m ended methodology still does not purely match BHC activity, the Board believes that it more closely parallels the practices of a private sector service provider. The recommended methodology also complies with Federal Reserve pricing principles The Board also believes that the Treasury rate provides a reasonable proxy for the actual rate realized by bank holding companies on clearing balances. The Treasury rate is simpler to adm inister because it does not incorporate a risk premium or administrative costs of managing portfolio risk. The Board requests comments on the proposal to: (a) change the methodology for imputing clearing balance income to more closely parallel the practices of a private sector service provider and (b) change the rate used to impute clearing balance income from the 90-day Treasury bill coupon equivalent yield to a longer term Treasury rate based on the earning asset maturity structure of the largest BHCs. By order o f the Board of G overnors of the Federal R eserve S ystem , A ugust 12,1-994. William W. Wiles, S e c r e ta r y o f th e B o a rd . BILLING CODE 6210-01-P Estimated Clearing Balances - Float CIPC Estimated Clearing Balances - Required Reserves Earnings on Invested Portion of Clearing Balances Investable Funds x 3 month T-Bill Coupon Equivalent Rate Clearing Balances Subject to Imputed Reserve Requirements x 10.0% Reserve Requirements Required Reserves Earnings on IPCB Less: Projected Clearing Balances Eligible for Earnings Credits x 90 0 % Reserve Adjustment Factor Priced Earnings Credits J Cost Adjusted Clearing Balances Eligible for Earnings Credits x Fed Funds Rate - Estimated Unused Earnings Credits Priced Earnings Credits Cost > ► d Federal Register / Vol. 59, No. 160 / Friday, August 19, 1994 / Notices [FR Doc. 94-20408 Filed 8-18-94; 8:45 am) BILUNG CODE 6210-01-C Net Income on Clearing Balances X > 42835 NICB ESTIMATION CALCULATION
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