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FEDERAL RESERVE BANK
OF NEW YORK
[
Circular No. 9568 ~|
October 20, 1983
PRIVATE SECTOR ADJUSTMENT FACTOR
Proposed Changes in Calculation of the PSAF for 1984
To All Depository Institutions in the Second
Federal Reserve District, and Others Concerned:
The following statement was issued by the Board of Governors of the Federal Reserve System:
The Federal Reserve Board has requested comment on proposed revisions to its procedure for calculation of the pri
vate sector adjustment factor (PSAF). As provided in the Monetary Control Act of 1980, the PSAF is an allowance for the
taxes that would have been paid and a return on capital had the Federal Reserve’s priced services been furnished by a
private sector firm.
The Board requested comment by November 30, 1983.
The proposed revisions to the procedure used in calculating the PSAF for 1984 include:
• Use of data directly linking single-purpose assets to Federal Reserve services.
• Expansion of the sample used to calculate the PSAF from 12 to the 25 largest bank holding companies.
• Calculation of the Federal Reserve’s asset base to reflect the value of assets expected to be acquired and disposed of
in 1984.
• Removal of the financing costs of net adjustment float from the asset base.
• Recovery of the estimated sales taxes that would have been paid on the purchases of certain goods and services if
the Reserve Banks were subject to such taxes.
• Recovery of expenses incurred by Board staff working directly on the development of priced services and inclusion
of the portion of the Board’s assets employed in this specific activity in the PSAF asset base.
In addition to these revisions, the Board is requesting comment on an alternative method of determining the income
tax rate used in calculating the PSAF.
Enclosed, for depository institutions in this District, is a copy of the Board’s official notice in this matter. It will
be printed in the F e d e r a l R e g i s t e r and additional copies will be furnished upon request directed to our Circulars
Division. Comments should be submitted by November 30, 1983, and may be sent to our Planning and Control
Function.
A
nthony
M . Solom on,
P r e s id e n t.
FEDERAL RESERVE SYSTEM
[Docket No. R-0485]
Private Sector Adjustment Factor
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Request for comments.
SUMMARY:
The Board of Gove rnors is requesting p u blic comment
on the m e t h o d o l o g y for calcu l a t i n g the Private Sector
Adjustment Factor ("PSAF") for 1984.
DATE:
Comments must be received b y November 30, 1983.
ADDRESS:
Comments, which should refer to Docket No. R-0485,
may be mailed to Mr. W i l l i a m W. Wiles, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and
C o nstitution Avenue, N . W . , Washington, D.C. 20551, or d e l i v e r e d
to Room B-2223 betw e e n 8:45 a.m. and 5:15 p.m.
Comments
received may be inspected at Room B-1122 b e t w e e n 8:45 a.m. and
5:15 p.m., except as provi d e d in § 261.6(a) of the Board's
Rules Regarding the A v a i l a b i l i t y of Information,
12 CFR
§ 261.6(a).
FOR F U R T H E R INFORMATION CONTACT:
Earl Hamilton, Assistant
Director (202/452-3874), D i v i s i o n of Federal Reserve Bank
Operations; Gilbert T. Schwartz, Ass o c i a t e General Counsel
(202/452-3625) or Robert G. Ballen (202/452-3265), Attorney,
Legal Division, Board of Governors of the Federal Reserve
System, Washington, D.C. 20551.
S U P P L E M E N T A RY INFORMATION:
The M o n e t a r y Control Act of 1980
(Pub. L. 96-221) p rovides that over the long run, fees for the
Federal Reserve's priced services are to be bas e d upon costs,
including the "taxes that would h a v e b e e n paid and the return
on capital that would have b e e n p r o v i d e d had the services been
furnished b y a p r i v a t e busi n e s s firm."
Accordingly, the PSAF
should be thought of as a financial or a c c o u n t i n g y a r d stick
that facilitates the imputation of capital costs and taxes to
the Federal Reserve.
Over time, however, the pricing process
more g e n e r a l l y should seek to ensure that econ o m i c resources
are a l located and p ayments services are p r o v i d e d in the most
efficient ways possible.
The Board has examined the issues relating to the
current methodology that has been used in calculating the PSAF
and requests comment on the following:
[Enc. Cir. No.
9568]
-2-
a.
Choice of M o d e l . Since Federal Reserve Banks
unique organizations, it is not p o s s i b l e to find tota l l y
comparable p r i v a t e sector firms to use as a model for imputing
the cost of capital and taxes.
In view of the u nique nature of
the Federal Reserve, the PSAF could be c a l c u l a t e d b y a b a n d o n i n g
reference to the actual ex p e r i e n c e of any p r i v a t e sector firm,
and judgments could be made regarding the Federal Reserve's
cost of capital and taxes had it b e e n a p r i v a t e firm.
However,
in view of the fact that there would be no basis upon whi c h to
deter m i n e the a ppropriat e ne s s of any judgments made among the
infinite number of costs of capital and tax possibi l i t i es , the
Board p roposes that those e n tities most c l o s e l y c o m p a r a b l e to
the Federal Reserve with regard to its p riced services cont i n u e
to be used as a model for p u r p o s e s of c a l c u l a t i n g the PSAF.
In reaching this d e c i s i o n four a l t e r n a t i v e types of
entities were analyzed:
p u b l i c utilities, g o v e r n m e n t - s p o n s o r e d
o r g anizations
such
as
the
Federal.
National
Mortgage
Association, nonbank data p r o c e s s i n g companies,
and bank
hold i n g companies.
Bank h o l d i n g companies are c u r r e n t l y used
as the model for the PSAF.
The Board rejected p u blic utilities as a model b e c a u s e
services p rovided by these entities g e n e r a l l y do not r e semble
those of the Federal Reserve.
Moreover, their capital costs
and structure are such as to result in a PSAF that p r o b a b l y
would be lower than that deri v e d from a bank h o l d i n g c o m p a n y
model.
G o v e r n m e n t - sp o n s o r e d entities also were d e t e r m i n e d not
to be a p p r opriate as a model be c a u s e their services g e n e r a l l y
are not comparable to those of the Federal Reserve.
The
services
prov i d e d
by
government-sponsored
entities
p r e d o m i n a n t l y relate to e x tensions of credit, rather than to
p a y m e n t s - r e la t e d services of the Federal Reserve.
In addition,
the cost of capital of g o v e r n m e n t - s p o n s o r e d entities, in part
because of their governm e n t sponsorship, w o u l d result in a
lower cost of capital for the PSAF c a l c u l a t i o n than using the
bank h o l d i n g company model.
While use of nonbank data p r o c e s s i n g c o m panies as a
model was c o nsidered and p r e v i o u s l y rejected,
a more
c o m p r e h e n s i ve review of the data p r o c e s s i n g c o m p a n y model was
undertaken in view of the su g g e s t i o n that such c o m panies
prov i d e the a p p r opriate model for the PSAF.
The Board
continues to b e l i e v e that data p r o c e s s i n g c o m p a n i e s do not
p r o vide the a ppropriate model given the d i s s i m i l a r i t y b e t w e e n
their services and those of the Federal Reserve.
Although both
the Federal Reserve and data p r o c e s s i n g com p a n i e s use
computers, a detai l e d ana l y s i s of the serv i c e s of six d a t a
are
-3processing companies that others h a v e suggested be used as a
model for the PSAF indicated that their service offerings are
significantly different from the p r iced services activities of
the Reserve Banks and that they are not the a p p r o p r i a t e model.
First, the prospec t s of these data proces s o r s are tied
to d e v e l opments in activities far removed from those of the
Federal Reserve.
Second, the different services p r o v i d e d by
the Federal Reserve and these data p r o c e s s o r s necessi t a t e d
different inputs into the p r o d u c t i o n process.
For example, the
data processors specified do not collect checks like the
Federal Reserve and other d e p o s i t o r y institutions.
Third, to
the limited extent to which the activities of the data
processors are at all compar a b l e to those of the Federal
Reserve, the data processor s gen e r a l l y only p e r f o r m a po r t i o n
only one step in the paym e n t s p r o c e s s — the recording and
transfer of payments information.
The Federal Reserve, in
contrast, performs many, and in some cases all, of the steps
that take place as payments are made.
Finally, none of these
six data proc e s s i n g companies that others h a v e suggested be
used as a model included the Federal Reserve as a competitor in
its discu s s i o n of competitors in its 1982 Form 10-K filings
with the Securities and Exchange Commission.
Further, only one
of the six has commented on a single o c c a s i o n on the Federal
Reserve's pricing proposals, and that comment was limited to a
narrow point.
It has been suggested that since large bank h o l d i n g
companies engage in a number of activ i t i e s other than
correspondent banking, their capital costs do not p r o vide an
appropriate model for the Federal Reserve.
Clearly, large
bank i n g
organizations
engage
in
a
wide
range
of
a c t i v i t i e s - -m a n y of which are related to the activities of
correspondent divisions.
The fact that the correspondent
banking d i v i s i o n does not raise capital on its own and
interacts with the totality of the b a n k i n g organiz a t i o n
gene r a l l y reinforces the logic of using the bank h o l d i n g
company model.
Thus, taking into account the services offered, and
the obvious fact that large b a n k i n g o r g a n i z a t i o n s are the
competitors of the Federal Reserve, the Board proposes that
large bank h o l d i n g companies continue to be the appropriate
model upon which to construct the PSAF.
The Board is also c o n s i d e r i n g the risk that might be
associated with the corres p o n d e nt opera t i o n s of the b a n king
o r g a n i z a t i o n on a stand-alo n e basis and, in turn, what that
might imply for the discount or pr e m i u m of the market price of
its stock relative to book value.
Unfortunately, there is
-4 -
virtually no reasonable bas i s for d e t e r m i n i n g whether, in fact,
correspondent services would be p e r c e i v e d as more or less risky
by the market than other b a n k i n g o p e r a t i o n s - - i n p a r t b e c a u s e
the correspondent services are tied together w ith the entire
bank.
Moreover, even if that d e t e r m i n a t i o n could b e made,
there is no way to anticipa t e ho w the market wou l d respond.
The Board also co n s i d e r e d the issue of the se l e c t i on
of the specific bank h o l d i n g companies to be i ncluded wi t h i n
the PSAF model.
Currently, the model is c o m p r i s e d of the 12
largest bank holding companies in the United States.
These
institutions were chosen p r i m a r i l y b e c a u s e of their size and
their importance in the cor r e s p o n d e nt b a n k i n g business.
It has
been suggested that this sample is i n a p p r o p r i a te b e c a u s e it is,
in general, too small and b e c a u s e the market value of the stock
of these companies may be m a t e r i a l l y b e l o w b o o k value, w h i c h in
turn lowers the cost of e q u i t y capital in the P SAF calculation.
The Board b elieves that the s u g g e s t i o n to e xpand the
size of the sample has merit.
Such an e x p a n s i o n w o uld reduce
the poten t i a l that overall results will be b i a s e d b y individual
institutions, and provide greater g e o g r a p h i c repre s e n t a t io n .
Accordingly, he Board p ropo s e s to expand the sample to include
the 25 largest bank hold i n g companies.
W i t h regard to the su g g e s t i o n that the m arket value of
the stock of the bank h o l d i n g companies in the sample is too
low relative to book value, the Board not e d that the stock of
very few large bank h o l d i n g c o m p anies c u r r e n t l y is selling at
or above book value.
However, using the p r o p o s e d sample of 25
large bank h o l d i n g companies does raise the m a r k e t - t o - b o o k
ratio of the sample.
For example, as of mid-1983, the
market - t o - b oo k ratio for the 25 companies was about 83 p e r c e n t
versus about 75 percent for the smaller sample of 12 h o l d i n g
companies.
On balance, there is no basis for judging why these
firms' stock sells b e l o w book, or for k n o w i n g w h e t h e r their
c o r respon dent d ivisions on a s t a n d - a l o n e b a sis (to the extent
they could be segregated from the rest of the company) could
command a stock market val u a t i o n at or near book.
Similarly,
there is no b asis for judging h o w the mar k e t would value the
Federal Reserve's p ayments services b u s iness.
The Board
believes that the m a r k e t - b o o k r e l a t i o n s h i p in the p r o p o s e d
sample of the 25 largest h o l d i n g c o m panies would p r o v i d e a
reasonable b a s i s for esti m a t i n g the cost of e q u i t y in the PSAF
calculation.
Accordingly, for p u r p o s e s of the PSAF model, the
Board p r o p o s e s to use the cost of e q u i t y of the 25 largest b a n k
h o l d i n g companies, w h ich are the major a l t e r n a t i v e suppliers of
the p r i c e d services offered b y the Fed.
-5-
b.
Long- T e r m A s s e t s . The Federal Reserve faces
same judgments as other firms in apporti o n i n g the cost of
shared assets (primarily l o n g-term assets such as property#
buildings and equipment) among different operations.
The Federal Reserve cur r e n t l y a p portions long-term
assets on the basis of the ratio of o p e r a t i n g expenses for
priced services to total o p e r a t i n g expenses.
This expense
ratio is a p p roximately 40 percent.
While this expense ratio
provides a reasonable p r o x y for the assets e m ployed in p riced
services and is a d m i n i s t r a t i v e l y simple to implement# direct
dete r m i n a t i on of the uses of assets b a s e d upon the Federal
Reserve's Planning and Control System ("PACS") would more
prec i s e l y identify the assets used in the p r o v i s i o n of pr i c e d
services.
Accordingly# the Board p roposes that the expense
ratio method for asset d e t e r m i n a t i o n be r e placed b y the direct
determ i n a t i on method.
The proposed direct d e t e r m i n a t i on method would use the
PACS accounting system# whi c h prov i d e s data that can d i r e c t l y
link single-purpose assets to either p r iced or non-priced
services.
In addition# PACS prov i d e s the same information for
assets# such as buildings and cent r a l i z e d computers# that are
used jointly in the p r o v i s i o n of p r i c e d and non-priced
services.
For example# dep r e c i a t i o n is a component of total
o c c u p a n c y costs#
which are r e d i s t r i b u t ed to all PACS
activities.
Since this de p r e c i a t i o n is linked dire c t l y to
assets carried on the Federal Reserve's b a l a n c e sheet# the
assets can be linked to the p r o d u c t i o n of p r i c e d and no n - p r i c e d
services.
The Board b eliev e s this p r o c e d u r e would result in a
more precise dete r m i n a t i on of the asset b ase than the current
method.
As indicated in Tables 1 and 2, the total value of
assets a t t r ibutable to p r i c e d services decl i n e s under the
direct dete r m i n a t i on method.
A l t h o u g h the value of furniture
and equipment increases under the p r o p o s e d methodology# the
increase is more than offset b y a d e c line in the value of
buil d i n g s allocated to p r i c e d services.
This occurs beca u s e
the p e r c e n t a g e of b uilding space d i r e c t l y and indirectly used
by priced services is, in fact# smaller than that which was
estimated using the 40 pe r c e n t expense ratio for priced
services.
In part# this is b e c a u s e staff of the System's data
collection activities in support of m o n e t a r y and economic
p o l i c y and supervision and re g u l a t i o n functions# as well as
bank e x a mination and other non-p r i c e d and central bank
functions o c c u p y space a rr a n g e d in the tradi t i o n a l office
setting.
On the other hand# check p r o c e s s i n g and other p riced
services
functions
predominantly
occupy
p r o d u c t i o n - ty p e
facilities and make intensive use of space and other
the
- 6 -
resources.
In particular, check o p e r a t i o n s use less floor
space per p e rson and use equipment and space 24 h o u r s a da y as
compared with a normal eight h o u r da y in most n o n - p r i c e d
areas.
Further, fiscal ag e n c y and cash operations, w h i c h are
non-priced services, occup y a s ignificant amount of space.
c.
The Tax Rate Used in the PSAF C a l c u l a t i o n . The
tax rate c u rrently used for the PSAF c a l c u l a t i o n is bas e d on
the ratio of current taxes to total taxable income of the
hold i n g companies included in the sample.
Defe r r e d taxes are
excluded from this ratio.
In addition, an a d j u s t m e n t is made
to add the tax effect of t a x-free interest income from state
and municipal securities.
Deferred taxes are not factored into
the ratio beca u s e they do not represent taxes p a i d d u r i n g the
current year and are likely not to be paid until far into the
future.
The adjustment for tax-free income is m ade b e c a u s e it
is b e l i e v e d that h o l d i n g such securities is related to he
investment strategy of the organization.
The Board prop o s e s that the current m ethod of
c a l c u l a t i n g the tax ratio with an a d j u s t m e n t to eli m i n a t e
e x t r a o r d i n a ry gains and losses, be used to c a l c u l a t e the 1984
PSAF.
This method is inco r p o r a t e d into the c a l c u l a t i o n s shown
in Table 2.
W ith no changes in methodology, the 1984 tax rate
for the original sample of 12 b ank h o l d i n g c o m p a n i e s would be
35.1 p e r c e n t - - d o w n from 38.1 pe r c e n t in 1983.
For the p r o p o s e d
larger sample, the 1984 tax rate would be 35.8 percent.
The Board is also r e questing p u b l i c comment on an
alternative tax rate c a l c u l a t i o n method.
The a l t e r n a t i v e tax
rate would be b ased upon the financial s t a t ement p r o v i s i o n for
income taxes w hich takes into account d e f e r r e d taxes.
It has
been suggested that from an a c c o u n t i n g p e rspective,
the
inclusion of defer r e d taxes w o uld p r o v i d e a more useful
rep r e s e n t a t io n of the overall tax lia b i l i t y of a firm.
Under
this method, the e ffectiv e tax rate for 1984 wou l d be
a p p r o x i m a t e l y 40 percent and the p r e - t a x rate on eq u i t y would
be a p p r o x i m a t e l y 23 percent, thus add i n g about $2 m i l l i o n to be
recovered from the PSAF.
d.
Date for the Asset Base E s t i m a t e .
The current
m e t h o d o l o g y uses the average asset base for the p r e v i o u s year,
altho u g h estimated expenses are bas e d on the year in w h ich the
PSAF is to be applied (e.g. the 1983 c a l c u l a t i o n used assets as
of September 29, 1982.)
The Board p r o p o s e s that the asset b a s e
for the year in w h i c h the PSAF would a p p l y be adju s t e d to
reflect the value of assets e xpected to be acqu i r e d and
disp o s e d of in that year.
Since the a ssets of the Reserve
- 7 -
Banks are expected to be h i g h e r in 1984 than in 1983, this
change would increase PSAF recoveries by a p p r o x i m a t e l y $1.6
million.
e.
Sales T a x e s .
The current m e t h o d o l o g y does
include an imputation for the sales taxes that would have b e e n
paid by the Reserve Banks if they were like other private
firms.
The Board proposes that the e s t imated sales taxes that
would have been paid were it not for the Reserve Banks'
statutory exemption be recovered as part of the PSAF for 1984.
This amount is tentatively estimated at a p p r o x i m a t e ly $4.9
million.
f.
Board of
Governors
Assets
and
Expenses.
Currently, Board staff expenses are not subject to recovery and
Board assets are not included in the PSAF asset base.
The
Board proposes that the expenses incurred by Board staff
working dire c t l y on the development of prices be subject to
recovery.
Similarly, the Board p r oposes that the assets
e mployed in this specific a c t i v i t y be included in the PSAF
asset base.
It is estimated that in 1984, about $1.9 m i l lion
in o p erating expenses at the Board of G o v ernors would be
included in expenses subject to recovery and that the asset
base would be raised by about $0.5 million to take account of
fixed assets of the Board of Governors used for this purpose.
g.
Shipping E x p e n s e s .
Shipping expenses c u r r ently
are excluded from the PSAF c a l c u l a t i o n b e c a u s e the assets
employed in the production of shipping services are not Federal
Reserve assets, but rather are owned b y the various carriers
with whom the Reserve Banks deal.
It has b een suggested that
this treatment is inappropriate, but the c r iticisms of this
treatment has been in the context of PSAF m e t h o d o l o g y in which
the PSAF asset base is dete r m i n e d on an expense ratio method.
W hen priced service assets are determ i n e d d i r e c t l y as the Board
is p r o p o s i n g instead of on an expense ratio basis, the removal
of shipping expenses from the calcu l a t i o n has no effect on
total recoveries.
Including shipping e x penses in the PSAF
d enominator w ould result in a lower PSAF bei n g applied to a
higher expense base with the p r o duct of the two remaining
unchanged.
As a result, the Board has d e t e r m i n e d that the
original basis for excludi n g shipping e xpenses from the
c a l c ulatio n remains correct, and proposes no change in this
area.
h.
Leased A s s e t s . Currently, leases for space and
equipment b y the Federal Reserve Banks are not capitalized and
the value of such leases are not included in the asset base
used to calculate the PSAF.
not
-8 -
Specific criteri a h a v e b e e n e s t a b l i s h e d b y the
Financial A c c ounting Standards Board (F A S B ) in its Rule 13 for
d e t e rmining w h ich leases should be capitalized.
The Federal
Reserve c urrently does not make a c a s e - b y - c a s e d e t e r m i n a t i o n as
to which of its leases meet FASB Rule 13.
However, in view of
the rule, it has b e e n suggested that the Federal Reserve
capitalize its leases for p u r p o s e s of d e t e r m i n i n g the PSAF.
Accordingly, the Board proposes that all leases that be c o m e
effective on or after Jan u a r y 1, 1984, that meet FASB Rule 13
be capitalized.
In addition, the Board p r o p o s e s that current
leases be examined to d e t e r m i n e if any a d j u s t m e n t s are needed.
However, as indicated below, even if some such leases would be
capitalized, it is very u n l i k e l y that this w o u l d h a v e an effect
on the dollars to be recovered via the PSAF.
Lease payments c u r r e n t l y made b y the R e s erve Banks
include the implicit financing costs that are incurred by the
lessors for a c quiring the assets.
If the value of leases were
capitalized and included in the PSAF, the f i n a ncing costs wou l d
be d o u b l e - c o u n t e d — once in expenses to be r e c o v e r e d and o nce in
the cost of capital asso c i a t e d with the asset base.
Thus, to
avoid such double-counting , these leases should not be in the
asset b ase even if they meet FASB Rule 13.
As a result,
c a p i t alizing leases would h a v e no effect on the PSAF.
The
p a t t e r n of expenses, however, might be affected, to a l i m ited
extent, over the term of the leases b e c a u s e the p r o p o r t i o n of
interest to p r incipal included in the amount a m o r t i z e d is
higher in the early years and lower in the later years of the
lease.
i . Book Value of Physical A s s e t s .
Currently, for
purposes of calculating the PSAF, the Federal Reserve uses b o o k
value--as opposed to some estimate of market v a l u e - - f o r Federal
Reserve physi c a l assets such as b u i l d i n g s and equipment.
The
Board p r o p o s e s to continue to use the b o o k value of fixed
assets in the calcu l a t i o n of the PSAF.
The use of book values
is universal in p r i v a t e business.
Furthermore, it is the
actual h i s t o r i c a l cost of a c q u i r i n g assets that must be
financed--not their value at some later date.
The p r a c t i c e of
using book value for buildings, equipment, and p r o p e r t y is
consistent with b a n k i n g industry p r a c t i c e s and consi s t e n t with
g e nerally a c c e p t e d acco u n t i n g p r i n ciples.
D e t e r m i n i n g a normal
rate of return on the basis of h i s t o r i c a l cost is the
p r e v a i l i n g p r a c t i c e throughout the p r i v a t e sector.
In
particular, the assets of the large b ank h o l d i n g c o m panies used
as the source of the cost of capital are r e p o r t e d at b ook value.
A decision to value assets at market would essentially
require using a market value accounting system since it would
be necessary to take into account the income created by
-9
increases in asset values.
Such an ac c o u n t i n g system does not
now exist.
If such an acco u n t i n g system were developed, the
capital a s s ociated with increases in asset values would be
generated automatically.
In this event it would not be
n ecessary to raise new funds to support the hig h e r asset values.
Judging the relat i o n s h i p b e t w e e n market and book
values is not easy.
However, in consi d e r i n g the Federal
Reserve's equipment (which is a p p r o x i m a t e l y $75 m i l lion or
almost 30 percent of total long-term assets),
it seems
reasonable to conclude that market value is not likely to
exceed book value and, in fact, book values might exceed market
values.
This would follow from the fact that such equipment is
p r e d o m i n a n t l y proc e s s i n g equipment where d e c l i n i n g prices for
new equipment and technolog i c al changes may reduce the market
value of e xisting equipment at a faster rate than is prov i d e d
for in the relevant d e p r e c i a t i o n schedules.
With regard to bu i l d i n g assets, there is little
ques t i o n that, in the aggregate, the market value of Federal
Reserve buildings is great e r than adju s t e d book value.
However, when c o n s idering the value of the space used b y the
Reserve Banks for priced service activities, it is important to
recognize that the porti o n s of the b u i l d i n g s used for p r i c e d
services are not considered p r e m i u m space.
Therefore, the test
of whether the book value of space devoted to Federal Reserve
priced services is s i g n i f i c a n t l y at odds with market value
cannot be judged b y looking at the book v a lue/market value
relationship for the b u i l d i n g as a whole, but rather should be
judged b y looking at the market value of the specific space
used for priced services versus its a djusted b ook value.
Even
this more limited compa r i s o n is not easy to make.
However, in
looking at the p r e v a i l i n g rents charged by some of the Reserve
Banks to outside tenants in r e l a t i o n s h i p to the PACS charges
for space devoted to priced services, it appears that such PACS
charges are, on average, in line w ith this p r o x y for the market
value of such space.
On this basis, it would appear that market values of
space in Federal Reserve b u i l d i n g s d e v oted to p r i c e d service
activities are a p p r o x i m a t e l y in line with the adjusted book
values of such space.
However, even if they were out of line,
it is not c l e a r — even from the p e r s p e c t i v e of overall economic
e f f iciency as opposed to a c c o u n t i n g n o r m s - - t h a t market values
should be used in c a l c ulati n g the cost of capital for Federal
Reserve p r i c e d services.
That is, if the Federal Reserve used
market values and its c o m p e t i t o r s did not (assuming the market
value of the competitors' assets also exce e d e d book value), all
other things b e i n g equal, this could p r o d u c e a less efficient
a l l o c a t i o n of societal resources.
-10-
It is because neither economics nor a c c o u n t i n g can
provide perfect guidance on these issues that the a p p r o a c h
taken with regard to the a c q u i s i t i o n of new a ssets takes on
special importance.
That is, decisions to a c q u i r e or not to
acquire a p a r t i c u l a r asset must be u n d e r t a k e n w i t h i n the
context of rigorous capital b u d g e t i n g procedures.
The Federal
Reserve has had such p r o c e d u r e s in p l a c e for a n umber of
years.
However, in view of their increased i m portance in the
proceed service environmen t and to ensure that such p r o c e d u r e s
are consistent with the PSAF calculation,
it has been
d e termined to undertake a review of all such p r o c e d u r e s to
ensure that the methods used are a p p r o p r i a t e and are
cons i s t e n t l y applied in all cases.
j.
Short-Term A s s e t s . For 1982 and 1983, the largest
component (about $60 million) of short term assets was net
adjustment float, which was included in the PSAF c a l c u l a t i o n as
a proxy for liquid assets that the R e s erve Banks wou l d use for
priced services.
Since the value of all Federal Reserve check
f l oat--including net adjus t m e n t float--will be rec o v e r e d t hough
service fees in 1984, the Board p r o p o s e s to remove the
financing costs of net ad j u s t m e n t float from the asset b a s e
that is used to calculate the PSAF.
It should be c l e a r l y
emphasized that the effect of this change is e s s e n t i a l l y a
shift from one class of re covery to another, whi c h has o n l y a
small effect on the total dollars to be recovered.
As in past years, Federal Reserve s h o r t - t e r m assets
will include receivables, supplies, and d e f e r r e d charges.
In
1984 these items aggregate to about $27 m i l l i o n as o p p osed to
about $20 million in 1983.
Under the propo s e d methodology, c l e a r i n g b a l a n c e s that
d e p o s i t o r y institutions m a i n t a i n at the Rese r v e Banks to p a y
for services would be c o n s i d e r e d a short term asset.
During
the past year, the amount of clea r i n g b a l a n c e s has g r own
considerably.
Total clear i n g b a l a n c e s a v e r a g e d $978 m i l l i o n
b e t w e e n July 20 and August 10, 1983.
The g r o w t h in c l e a r i ng
b a l a n c e s can be a t t ribute d to two factors.
First, more
d e p o s i t o r y institutions are finding c l e a r i n g b a l a n c e s a
convenient way of c o m p e n s a t i n g for services and i n t e r t e r r i t or y
check
float.
Second,
the n umber of small d e p o s i t o r y
institutions using Federal Reserve services has increased and
many of them p r efer to c o m p e n s a t e for s e rvices w i t h c learing
balances.
Because of the significant g r o w t h
in clea r i n g
balances, the financing aspe c t s of c l e a r i n g b a l a n c e s and the
m e t h o d o l o g y used to calcu l a t e earnings c r e dits on clea r i n g
balances were reevaluated.
In general, the income earned by
-li
the assets a ttributable to clearing bala n c e s should be at least
equal the earnings credits pro v i d e d on these balances.
Using
the average three-month U. S. T r easury bill rate over the first
half of 1983 and assuming clearing bal a n c e s in 1984 average
$1 billion, the total income earned for 1984 would be $82.5
million.
Under current p o l i c y the Reserve Banks app l y earnings
credits o n l y to the required clearing b a l a n c e level, not the
actual level.
The earnings credits are ca l c u l a t e d at the
federal funds rate.
For 1984, it is est i m a t e d that about $800
m illion of the a p p r o x i m a t e ly $1 b i l l i o n in c l earing balances
would be required balances.
Excess bala n c e s arise in part
b ecause of sharp short run swings and seasonal peaks in the use
of Federal Reserve services.
Using the aver a g e federal funds
rate for the first half of 1983 and a s s u m i n g $800 m i l lion in
required clearing balances in 1984, the cost of such bala n c e s
to the Federal Reserve would be $69.3 million.
Thus, the
System income on clearing b a l a n c e s is a n t i c i p a t e d to exceed
expenses by $13.2 million ($82.5 m i l lion - $69.3 million).
The Board also studied the m e t h o d o l o g y used by
c orrespondent banks to calculate the rate of return they
p rov i d e on c o r respondent balances, w h i c h are a n a l y t i c a l l y
similar to clearing balances.
If a c o r r e s p o n d e nt b a l a n c e is
maintained at a c o r respondent bank, the corre s p o n d e nt would be
required to m aintain reserves on the b a l a n c e s held.
In most
cases, the correspondent would be at a marg i n a l reserve
requirement rate of 12 percent.
Generally, the c o r r e spondent
bank takes this factor into c o n s i d e r a t i on w hen it calculates
the rate paid on the balance.
Because c o r r e s p o n d e nt banks
g ener a l l y adjust the earnings rate b y the m a rginal reserve
requirement, maint a i n i n g clea r i n g b a lances at a Reserve Bank
m ay be more attr a c t i v e to a r e spondent bank.
However, when
m a i n t a i n i n g a bala n c e at a c o r r e s p o n d e nt bank, the respondent
bank is p e r m i t t e d to deduct the ba l a n c e from its reservable
liabilities.
Therefore, the di f f e r e n c e b e t w e e n the rate the
Reserve Banks a pply is not the 12 p e r c e n t m a rginal reserve
r equirement rate but rather the d i f f e r e n c e b e t w e e n this 12
p ercent rate and the respo n d e n t banks ' mar g i n a l reserve
r equirement rate, which is a "due from" d e d u c t i o n for the
respondent.
It has b e e n e s t i m a t e d that the e a rnings rate
a pplied by Reserve Banks should be reduced by about 7 percent
on average for it to be co m p a r a b l e to the value g e n e r a l l y
received b y respondent banks on clearing balances.
Had this
adjustment b e e n made, the earnings credit rate would h a v e b e e n
reduced a p p r o x i m a t e l y 7 perc e n t on average.
This reduction
would result in revenues b e i n g $5 m i l l i o n less than the $13.2
million net interest revenue from clea r i n g b a l a n c e s (see
-1 2-
Table 4).
Acco r d i n g l y , the B o a r d p r o p o s e s that the rate the
Reserve Banks a p p l y to c l e a r i n g b a l a n c e s be a d j u s t e d to r e f l e c t
the net v a l u e of the b a l a n c e s to the resp o n d e n t , w h i c h takes
into a c c o u n t the c o r r e s p o n d e n t ' s m a r g i n a l r e s e r v e r e q u i r e m e n t
and the r e s p o n d e n t ' s due from ded u c t i o n .
The a m o u n t of excess c l e a r i n g b a l a n c e s are e x p e c t e d to
be re d u c e d in 1984 b e c a u s e of ne w p r o c e d u r e s b e i n g a d o p t e d b y
the R e s e r v e Banks.
R e s erve Banks are in the p r o c e s s of
developing
a
new
se r v i c e
that
will
allow
depository
i n s t i t u t i o n s to trans f e r their e x cess b a l a n c e s m o r e r e a d i l y to
other institutions, w h i c h c o u l d then invest t h e m in the federal
funds market.
If the exce s s b a l a n c e s are r e d u c e d to the p o i n t
that the S y s t e m income on such b a l a n c e s w ill b e less than
expenses, the rate p aid on such b a l a n c e s m a y be a d j u s t e d .
One
a d j u s t m e n t u n der c o n s i d e r a t i o n in that e v e n t w o u l d be to
c a l c u l a t e the e a r n i n g s c r edit at the U. S. T r e a s u r y b i l l rate
r a ther than at the federal funds rate.
In a n y event, c l e a r i n g
b a l a n c e s and their c o r r e s p o n d i n g a s s e t s c o u l d be m a n a g e d such
that the total income to the Federal R e s e r v e at least e q u a l s
the cost of such b a l a n c e s to the Fe d e r a l Reserve.
Net E f fect of P r o p o s e d C h a r g e s .
The net e f f e c t of the a b o v e
p r o p o s e d c h a n g e s on the e s t i m a t e d d o l l a r s w h i c h mus t be
r e c o v e r e d via the P SAF is modest.
As i n d i c a t e d in T a b l e 2, if
the 1984 c a l c u l a t i o n s w e r e m a d e u s i n g the p r e s e n t m e t h o d o l o g y ,
the p e r c e n t a g e of these costs to c a p i t a l w o u l d be 15.9 percent,
the d o l l a r s to be r e c o v e r e d via the PSA F w o u l d be $ 5 9.4 m i l l i o n
and the r a tio of the d o l l a r s to be r e c o v e r e d to e s t i m a t e d
expenses
w o u l d be
15.34
p e r cent.
Using
the
proposed
m e t h o d o l o g y , these m a g n i t u d e s are 18.86 percent, $56.2 million,
and 14.51, p e r c e n t r e s p e c t i v e l y .
By o r der of the B o a r d of Governors,
(Signed)
October
12,
1983.
W i l l i a m W. W i l e s
W i l l i a m W. W i l e s
S e c r e t a r y of the Board
[SEAL]
TA B L E 1
Pro Forma Balance Sheet
Priced Services
1984
(in millions)
Current
Method
Proposed
Method
Assets
Current Assets
Recei vables
Adjustments, Net
Suppli es
Deferred Charges
Government Securities
$ 23.6
45.5
3.9
2.0
$ 75.0
$
$
23.6
—
1.9
1.6
27.1
—
1,000.0
$220.5
78.2
$298.7
$ 183.2*
87.7
$ 270.9
Long-Term Assets
Bank Premises
Equipment and Furniture
Total Assets
$373.7
$1,298.0
Liabilities and Equities
Liabi1ities
Clearing Balances
Short-Term Debt
Long-Term Debt
Total Liabilities
Equity
Total Liabilities and Equities
*
% 75.0
101.9
$1,000.0
27.1
79.1
$176.9
$1,106.2
196.8
191.8
$373.7
$1,298.0
Includes an allocation of space for the Board building
TABLE 2
Private Sector Adjustment Factor
1983
1984
Estimated
Current
Proposed
$ 80.3
$288.5
$ 75.0
$298.7
$ 27.1
$270.9
Assets to be Financed (mil lion)
I.
*
II.
Current
Long-Term
Cost of Capital
Short-Term Debt Rate
Long-Term Debt Rate
Pre-Tax Equity Rate
Weighted Average Cost
of Capital
13.06%
10.63%
20.53%
9.63%
10.33%
21.17%
9.48%
10.01%
21.25%
16.35%
15.90%
17.20%
III.
Tax Rate
38.1 %
35.1 %
35.8 %
IV.
Capital Structure
21.8 %
25.8 %
52.4 %
20.0 %
27.3 %
52.7 %
9.1 %
26.5 %
64.4 %
Short-Term Debt
Long-Term Debt
Equity
PSAF
Recovery (millions)
As Percent of Capital
As Percent of Expenses
$60.3
16.35
16.01
$ 59.4
15.90
15.34
$ 56.2
18.86
14.51
TABLE 3
PSAF and Other Recoveries
Calendar Year 1984
(mil lions)
I.
PSAF Recoveries
1984
Current
Total PSAF Recoveries
Proposed
$ 59.4
Changes Due To:
-
Explicit Pricing of Adjustments, Net
Direct Determination of Assets
Changes in the Sample
Use of Prospective Assets
Sales Taxes
Allocation of Board Assets
-4.4
6. 8
+1.4
+1.6
+4.9
-
+
.1
Net Changes
-3.2
Total PSAF Recoveries
II.
$56.2
Other Recoveries
- Estimated Expenses
- Board of Governors Expenses
- Transportation Expenses
$387.3
78.8
Total Other Revenues
III.
$387.3
1.9
78.8
$466.1
$468.0
Float Recovery
- Value of "Residual Float"
- Value of Adjustments, Net
Total Float Recoveries
Grand Total of Recoveries
$39.3
$ 39.3
4.0
$39.3
$43.3
$564.8
$567.5
TA B L E 4
Clearing Balance Revenue and Expense
(millions)
1984
Total Clearing Balance Income
$82.5
Total Clearing Balance Credits Used
-69.3
Net Revenue from Clearing Balances
13.2
Adjustments for Reserve Requirements
-5.0
Net Clearing Balance Income
$8.2
@FedFRASER