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FEDERAL RESERVE BANK
OF NEW YORK
[
Circular No. 9659 1
March 27, 1984
PRIVATE SECTOR ADJUSTMENT FACTOR
Revised Procedure for Calculating the PSAF
T o A ll D e p o s i t o r y I n s titu tio n s in th e S e c o n d
F e d e r a l R e s e r v e D i s t r i c t , a n d O th e r s C o n c e r n e d :
The following statement has been issued by the Board of Governors of the Federal Reserve System:
The Federal Reserve Board has approved revisions to its procedure for calculation of the private sector adjustment
factor (PSAF). The PSAF is an allowance for the taxes that would have been paid and the return on capital that would have
been provided had the Federal Reserve’s priced services been furnished by a private sector firm.
The revisions to the procedure used in calculating the PSAF for 1984 will be as follows:
© Expansion of the sample used to calculate the PSAF from the 12 to the 25 largest bank holding companies. The
bank holding companies with the highest and the lowest return on equity in the sample will be excluded.
Q Employment of the direct determination methodology for establishing the asset base used for computing the
PSAF.
© Inclusion of the net effect of those assets expected to be acquired and disposed of during 1984 in the priced
services 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.
© Inclusion of those portions of expenses and fixed assets of the Board of Governors related to the development of
priced services.
© Inclusion of an imputation for FDIC insurance assessment.
© Removal of the financing costs of net adjustment float from the asset base because such float is now priced explic
itly.
In addition, the tax rate used in the PSAF calculation will be based on the ratio of current Federal, state, and local
income taxes to total taxable income of the bank holding companies included in the sample.
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 , single copies will be furnished to others upon request directed to our Circulars
Division. Questions thereon may be directed to Robert M. Abplanalp, Vice President (Tel. No. 212-791-5349).
A nthony M . S o lo m o n ,
P r e s id e n t.
FEDERAL RESERVE SYSTEM
[Docket No. R-0485]
Private Sector Adjustment Factor
AGENCY:
Board of Governors.
ACTION:
Approval
of methodology for
calculating
the Private
Sector Adjustment Factor for 1984*
SUMMARY:
The
calculating
1984o
Board
the
has
Private
approved
Sector
the
methodology
Adjustment
Factor
for
(PSAF)
for
The PSAF is a recovery of the imputed costs which takes
into account the taxes that would have been paid and the return
on
capital
that
would
have
been
provided
had
the
Federal
Reserve's priced services been furnished by a private business
firm.
The estimated recovery through the PSAF in 1 9 8 4 will be
$ 5 8 . 8 million.
EFFECTIVE DATE:
January 1, 1984
FOR FURTHER INFORMATION CONTACT:
Director
(202/452-3806)
(202/452-3874),
Gilbert T.
Division
Schwartz,
Daniel L. Rhoads,
Attorney
David
L. Robinson,
Associate
or Earl G. Hamilton, Assistant Director
of
Federal
Reserve
Bank
Associate General Counsel
Attorney
Operations;
(202/452-3625),
(202/452-3711), or Robert G. Ballen,
(202/452-3265), Legal Division,
Board of Governors of
the Federal Reserve System, Washington, D.C. 20551.
SUPPLEMENTARY
Act of 1980
INFORMATION:
Background.
(Title I of Pub.
L. 96-221)
The
Monetary
Control
provides that over the
long run, fees for the Federal Reserve's priced services are to
be based upon costs,
[Enc, Cir. No. 9659]
including the "taxes that would have been
-2 -
paid and the return on capital that would have been provided
had the services been furnished by a private business
The Private
that
Sector Adjustment
facilitates
the
Factor
imputation
of
("PSAF")
these
firm.”
is the vehicle
taxes
and
capital
costs to the Federal Reserve,,
In
proposal
for 1984,
October
1983
the
Board
requested
comment
on
a
to revise the methodology used to calculate the PSAF
The proposed revisions included:
Use of the direct determination method for
establishing the asset base used for computing the
PSAF »
Expansion of the sample used to calculate the PSAF
from the 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 because such float is
priced explicitly.
Recovery of the estimated sales taxes rthat 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
assets employed in this specific activity in the
PSAF asset base.
Capitalization of Federal Reserve leases that
become effective on or after January 1, 1984? that
meet the criteria for capitalization as set forth
in FASB Statement 13,
“ 3
In addition to these revisions,
the Board requested comment on
an alternative method of determining the income tax rate used
in calculating the PSAF„
of these proposed
approximately
It was estimated that the net effect
changes would be to require
$56„2
million
through
Board also requested comment
the
a recovery of
PSAF
in
19840
on a proposed adjustment
The
to the
method for calculating earnings credits on clearing balances to
take into account reserve requirements
the Reserve Banks would
be subject to if they were subject to reserve requirements.
Analysis
of
Comments,
A
total
of
45
responded to the Board’s request for comment,
Reserve Banks.
including
Of the 38 non-Reserve Banks comments,
received from banks and bank holding companies,
banking
commenters
industry
trade groups0
Responses
commenters
proposals
method,
discussing
concerning
calculation
the
of
specific
use
the
of
issues
the
were
also
Federal
received
A majority of
agreed
direct
32 were
and four from
from one thrift institution and one congressman.
the
seven
that
the
determination
Reserve’s asset
base
to
reflect the value of assets to be acquired and disposed of in
1984, recovery of estimated sales taxes,
expenses
incurred
development
of
by
Board
priced
staff
services,
recovery of estimated
working
and
the
directly
on
inclusion
the
of
capitalized leases in the asset base used to calculate the PSAF
were appropriate0
The majority of
commenters
also
supported
the exclusion of shipping expenses from the PSAF calculation,.
Commenters
were
divided
on
the
issues
of
the
bank
holding
-4-
company model
and
its
expansion
largest bank holding companies,
continued
use
of
book
values
from
the
twelve
to
the
25
the tax rate methodology,
as
the
basis
of
asset
the
base
calculation, and the exclusion of net adjustment float from the
short-term asset base.
Objections
opposition
companies
capital,
to
as
the
the
to
the
Federal
model
proposal
Reserve’s
for
stemmed
use
estimating
of
an
mainly
bank
imputed
from
holding
cost
of
tax rate, and the short term assets to be included in
the PSAF calculation
Ac
the
Choice of Model - Thirty-four commenters discussed
Board’s proposal
to
continue
using
large
bank
holding
companies as the model upon which to construct the PSAF and to
expand
the sample
size
from the twelve
largest
bank
companies to the 25 largest bank holding companies.
holding
Seventeen
commenters supported the use of the bank holding company model
on the basis that the model represented those institutions that
the Federal Reserve directly competed with in the provision of
priced
services.
Several
commenters
supported
expanding
sample size from the 12 largest bank holding companies
25 largest bank holding companies,
stating that
the
to the
the expansion
would present a more accurate representation of the market.
Seventeen commenters were opposed to the use of bank
holding companies as the model and stated that data processing
corporations were the most appropriate model.
These commenters
-5-
believe that the priced service business of the Federal Reserve
Banks
most
closely
resembles
processing corporations.
the
services
offered
data
They also believe that using a large
bank holding company model
is inappropriate because
majority of a bank holding company's activities
to the services
by
the large
are unrelated
the Federal Reserve Banks offer,,
Many of the
commenters who opposed the proposal stated that if the Federal
Reserve was going to continue the use of bank holding companies
as the model,
it would have to include more assets
and cash items
forma balance
in the process of collection
sheet of the Federal Reserve
like cash
to make
the pro
System consistent
with consolidated bank holding company balance sheets,,
The Board carefully considered alternative models such
as
utilities,
companieSc
bank
holding
companies,
Determining whether
Federal Reserve would actually
higher
or
companies,
lower
or
than
any
that
other
Federal
Reserve's
incur
characteristicsc
industry
blend
The Board believes
with
model,
bank
that
the
would
be
holding
involves
the
particularly in view of
of
public
and
private
that an analysis
reasonable alternatives strongly reinforces
bank holding company model
processing
in the market
associated
unique
data
the cost of capital
consideration of a number of factors,
the
and
of all
the view that
the
is the most reasonable and logical
choice o
The Board recognizes,
as some commenters pointed out,
that bank holding companies engage in numerous activities other
-6-
than correspondent bank
services
services,
However,
of bank holding companies most
priced services
activities
the
only
Reserve.
--
Therefore,
correspondent
closely resemble
of the Federal Reserve,
banking organizations are the major
virtually
the
direct
since
—
and
competitors
and
the
large
for many services
of
the correspondent
the
Federal
operations
of
a
bank holding company have the same cost of capital that accrues
to the bank holding company as a whole,
the Board believes
it
is appropriate to impute capital costs to the Federal Reserve
based
on
the
capital
costs
and
structure
of
bank
holding
companies.
Certain aspects of the Federal Reserve's provision of
priced
services
are
more
analogous
government-sponsored enterprises,
capital
to
utilities
which have a
lower
than that implied by the bank holding
or
cost
of
company model.
The Federal Reserve was directed by the Congress to provide an
adequate level of service nationwide and must,
all
depository
Moreover,
reflecting
should not be
entity0
institutions
the
regardless
Federal
an aggressive,
of
Reserve's
high
growth,
therefore,
size
or
public
profit
serve
location.
role,
it
maximizing
It should, of course, earn a reasonable rate of return
-- a test that seems more than adequately provided for
in the
use of the bank holding company m o del„
The principal alternative to the bank holding company
model suggested by a number of commenters is the use of a model
based on data processing companies,,
The argument that nonbank
-7-
data processors would provide a better model
companies rests on two major assumptions^
provide
payments
Reserve
Banks;
services
and,
that
second,
are
a
than bank holding
first,
similar
to
stand-alone
priced service entity would have
these
those
Federal
the financial
firms
of
the
Reserve
characeristics
of those data processing companies.,
Given
the
disparities
between
the
services
of
processing companies and the services provided by the
data
Federal
Reserve, data processors are not the appropriate model for the
PSAFo
A
thorough
processors
indicates
review
suggested
that
the
of
by
some
assertion
supported by the facts.
the
of
of
activities
the
removed
from
processors
are
the
data
clearly
activities
is
not
All six of these firms provide a wide
to the financial industry,,
processors
six
commenters
similar
variety of computer-related services
data
of
tied
unrelated
As a result, the fortunes of these
to
Federal
in many fields
developments
Reserve.
in
activities
Moreover,
incur none of the basic costs
the
far
data
associated with
the
business of banking, such as the cost of associated vault space
or protection
or
the
cost
equipment
of
for securities
specialized
equipment
safekeeping operations
and
transportation
necessary for processing and delivering checks.
To the very limited extent that the activities of the
data processors are at all comparable to those of the Federal
Reserve, they generally only perform a portion of the services
provided
by
the
Federal
Reserve,,
For
example,
the
data
-8-
processors perform only one step in the payments process -- the
recording and
Reserve?
the steps
transfer
of payments
information.
The
Federal
in contrasty performs many? and in some cases all?
that
take place
as payments
are made.
The
of
large
banks that are subsidiaries of bank holding companies?
either
directly
every
or
through
joint
ventures?
provide
virtually
service offered by the Federal Reserve.
Finally?
the
six
data
processors
specifically
suggested by some commenters apparently do not subscribe to the
view that their activities are similar to those of the Federal
Reserve.
None of these six firms includes the Federal Reserve
as a competitor in the discussion of competitors section of its
Form 10-K filed with
Further?
the Securities
and
only one of the six has ever
occasion on any of
the
Federal
Exchange Commission.
commented on a single
Reserve's
pricing
proposals?
with that comment limited to a narrow point
unrelated
PSAF.
on
Finally?
no
data processor
1984 PSAF methodology.
commented
on
commented
The one bank service
the proposal
supported
the
to the
the proposed
corporation
use
of
large
that
bank
holding companies as the appropriate model.
The second argument
model
is
that
the
companies
should
operating
targets.
high-growth?
capital
the
structure
constitute
It
for
is
technologically
the
data
and
Federal
clear
that
oriented
processing
returns
Reserve's
these
of
these
financial
firms
operations
company
--
are
a
fact
suggested by the variability of their stock prices relative to
-9-
stock
that
prices
generally.
it should
be
However,
the objective
the Board does
of
the
Federal
not believe
Reserve
mirror the performance of these specialized firms;
that
the
Federal
with
a view
Reserve
toward
should
achieving
conduct
financial
its
to
to suggest
priced
services
objectives
of
that
nature would seem to be in conflict with the very essence of
the Federal Reserve’s historical
and public
interest payments
mechanism operations.
With
regard
company models
to
the
application
of. the bank
holding
twelve commenters supported expanding the model
size to include the 25 largest bank holding companies, but some
suggested that the sample include those bank holding companies
that are most
business.
heavily
involved
An analysis
in
indicates
the
that
correspondent
the
use
of
banking
a sample
comprised of the 25 largest correspondent banks ranked by ”due
tow balances has virtually no impact on the PSAF.
Another issue raised by some commenters stems from the
fact that the market price of the stock of certain bank holding
companies
used in the model
such stock.
As a result,
is well below the book value
of
suggestions have been made that the
return on equity implied for the Federal Reserve by this model
is too low.
Specifically,
and after-tax
result
from an
income
some commenters argued that pre-tax
targeted
income stream
by
the
that would
equate market and book value of stock.
Federal
be
Reserve
large
should
enough
to
-10-
In
component
response
to
this
of the PSAF was
comment, the
calculated
bank holding companies with
for
differing
cost
of
several
equity
samples
relationships
of
of market
value to book value for their stock.
The calculations indicate
that
highest
the
holding
companies
with
the
market-to-book
ratios had higher returns on equity than the companies with the
lowest
ratiosc
Overall,
however,
the absolute amount of
differences were relatively small.
regionally diverse sample
calculation
due
to
and
In order
avoid
institutions
at
to create a more
distortions
the
the
in
extremes,
the
the
PSAF
Board
believes it is reasonable to use the sample of the 25 largest
bank holding companies.
the bank
holding
However,
companies
to avoid unusual distortions,
with
the
lowest
and
the
highest
returns on equity will be eliminated from the 25 company sample
before
the
actual
calculations
are
made.
Should
changing
market-to-book relationships imply any material affect on PSAF
recoveries,
the choice of the 25 largest bank holding companies
as the basis for the PSAF calculation will be reevaluated.
There
stream
are
generated
operations.
other
by
that
Federal
the
factors
constrain
Reserve's
the
priced
service
The most significant of these is that the Federal
Reserve does not have the same "profit maximization"
as a private firm.
For example,
service
have
operations
Specifically,
assumption,
income
the
limited
Federal
to
limited
the Federal Reserve's priced
investment
Reserve's
Treasury
objectives
opportunity.
investments
bills,
whereas
are,
any
by
profit
-11-
maximizing
firm
would
hold
a
substantial
portion
of
its
investments In higher yielding instruments,,
Bo
Book
Value
of
Physical
Assets
-
Twenty-five
commenters discussed the use of book value of physical
in the calculation of the PSAP0
assets
Thirteen commenters supported
the use of book value to determine the value of physical assets
as being consistent with
the practices
in the private
sector
and among bank holding companieSc
Twelve
supported
the
commenters
use
of
opposed
current
the use of book
market
value
value and
to determine
the
value of physical assets^ many stating that a book value system
used
for
accounting
pricing^
or
investment^
tax
or
purposes
is
production
inappropriate
decisions,,
for
Several
commenters noted that the use of book value causes geographic
distortions
between
Federal
Reserve
Districts
with
new
buildings and those with old buildings^ and suggested that the
Federal
Reserve
follow
Financial
(FASB) Statement number 33 which
Accounting
requires
Standards
Board
reporting of assets
at current value,,
The Board continues
to believe that
using book value for physical asset valuation
The practice
of
using
book
value
for
the practice of
Is appropriate,,
property^
plant,
and
equipment is consistent with banking industry practice and with
generally
accepted
establishing
accounting
financial
principles,,
performance
standards
Moreover^
based
upon
historical costs is a prevalent practice throughout the private
sector.
Furthermore^
under
the provisions
of
FASB
Statement
-12-
number 33 (the accounting profession's current methodology for
supplementary disclosure of inflation-adjusted financial data)?
if assets were revalued to reflect market value rather than
book value?
income.
an adjustment would also have
to be made
in
Finally? since a market value accounting system does
not exist? the Federal Reserve -- like all other entities
has no practical choice other than the use of net book values.
The use of market
theoretical
Federal
appeal because
Reserve
or
the
valuation
of
physical
the use of net book
banking
industry
assets
has
value by the
could
result
in
distortions and inefficiencies if book values were far removed
from market values.
Such does not appear to be the case with
respect to the Federal Reserve.
Approximately one-third of the physical assets used by
the
Federal
equipment.
Reserve
The
in
great
the
bulk
provision
of
such
of
priced
assets
is
services
computers
is
and
related equipment for which the market value does not appear
greater than its book value -- in fact? the book value appears
to be much greater
than market value for this equipment.
For
example? there are two computer models owned by the Federal
Reserve that?
as a result of technological
market value
that
values
is
$9-10
million
less
innovation?
than
their
have a
book
1/
1/
The Reserve Banks intend to use this equipment for the
length of time originally contemplated in the depreciation
schedules.
-13-
With respect to Reserve Bank buildings,
for
market
value
available
alternative use of space?
to
the
Federal
the best proxy
Reserve
is
the
that is, what rent could the Federal
Reserve obtain for its space or what would the Federal Reserve
have to pay if the priced service operations were moved out of
a Federal
Reserve Bank's building
The Federal Reserve
making
comparisons
because,
in
to other
faces a practical
of book
general,
only
and
a
problem*,
market
portion
comparable
however,
values
of
a
space.
of
its
Reserve
when
space
Bank's
facility is used for priced service operations and space costs
are charged through the Federal Reserve's Planning and Control
System
(PACS)
at one rate
for
all
activities
-- priced
nonpriced within a building -- regardless of location,.
prime space,
which
and
Thus,
is typically not used for priced services,
may tend to be undervalued whereas less
than prime
space for
priced service activities may tend to be overvalued.
Analysis
imposes
on
its
of
the
internal
space
2/
costs— 7
operations
the
(based
Federal
on
PACS
Reserve
standard
rates) and prevailing commercial space rentals in all cities in
which the Federal Reserve maintains operations shows that there
are Reserve offices with PACS space costs above and below local
market
rates.
However,
basis, the PACS charge
on
an overall
weighted
average
cost
(including PSAF) per square foot
2/ Cost of space to be recovered through pricing includes
utilities, depreciation, taxes, housekeeping and building
maintenance labor, the supervision of that labor, and the PSAF.
-14-
for Reserve Banks is $16.83, well within the weighted average
market range of $13,41 to $20,90,
Further,, of the nearly one
million square feet in the Federal Reserve devoted to check
operations, approximately 30 percent is rented -- primarily for
RCPC5s -- thus explicitly reflecting the market rate in these
locations.
It therefore appears that continued use of book
value for calculating the PSAF is reasonable.
Board staff will
continue to monitor this matter closely,
C,
Income Taxes - The Board requested public comment
on whether to use an income tax rate based on taxes actually
paid, or a tax rate which takes into account deferred taxes,
3
for the income tax rate used in the PSAF calculation.— /
Three commenters supported the Board5s present methodology.
Ten commenters supported inclusion of deferred taxes as being a
better
representation of
the
tax
liability
of
a private
company, if effective tax rates for bank holding companies were
used.
Twenty-three commenters stated that marginal tax rates
were more appropriate.
Deferred
depreciation.
taxes
arise
principally
from
accelerated
Including the effect of deferred taxes would
In the past, the tax rate used in the PSAF calculation
was based on the ratio of current income taxes (Federal, state,
and local) to total income of the bank holding companies
included in the sample.
Deferred taxes were excluded from this
ratio. An adjustment was made to the tax rate to exclude any
benefits that banks derive from holding tax exempt state and
local government securities.
-15-
increase the tax rate used for purposes of the PSAF in some
years and decrease the tax rate in other yearsD
(The effect of
excluding deferred taxes for 1984 is to increase the dollars to
be recovered through the PSAF by $1„3 million).
Over time, it
is likely that the effect of using deferred taxes would balance
outo
Because
deferred
it
taxes
in
is
administratively
the
PSAF
complex
calculation,
to
(e0g„,
include
separate
depreciation schedules would have to be developed),
reasonable that the PSAF computation not take
it
is
into account
deferred taxes,
With regard to the use of marginal tax rates,
the
taxes actually paid by the bank holding companies in the model
-- or by most other firms -- are not at the maximum marginal
tax rate.
Therefore, while the Federal Reserve would use the
marginal tax rate for prospective investment analysis purposes,
it would not be appropriate to use the marginal tax rate for
purposes of calculating the PSAF„
In order to judge the reasonableness of the tax rate
developed from the model, the income taxes the Federal Reserve
would actually pay in 1984 if the Federal Reserve was subject
to income taxes was approximated„
even without the benefits of
any year
other
calculated,
(2)
than the year
tax benefits
This analysis suggests that
(1) investment tax credits from
for which
taxes
from accelerated
applicable to the Federal Reserve,
and
(3)
are being
depreciation
the normal
tax
minimization efforts that businesses follow, a 38a6 percent tax
rate appears appropriate,,
If any allowance for
the three
-1 6 -
factors cited above were made, the actual tax rate might be
considerably lower than 38 06 percent,,
Some commenters suggested the Federal Reserve look at
domestic tax rates of bank holding companies for purposes of
determining
its assumed
tax
liability because
the Federal
Reserve's priced services are entirely domestic,,
A study on
financial institutions prepared by staff of the Joint Committee
on Taxation showed that, for 20 large commercial banks,
the
average U.S.
effective tax rate for the most recent year
4
studied, 1981, was 2„7 percent.— / The corresponding foreign
and worldwide
average
effective
rates were
38.1
and
2405
respectively.
The 2.7 percent and 24c5 percent effective tax
rates are significantly lower than the 38.6 percent effective
tax rate in the PSAF calculation.
Do
Direct
Determination
of
Assets
-
Seventeen
commenters supported the proposal to replace the expense ratio
method for asset determination with the direct determination
method based on PACS, stating that it would be a more precise
measurement of the assets used in the production of priced
services.
Concern was expressed by six commenters over the
data structure of PACS, and the allocations of assets between
priced and non-priced services,,
These commenters urged the
A/
Staff of Joint Committee on Taxation, Committee on
Finance, Taxation of Banks and Thrift Institutions, 12 (Joint
Comm. Print, March 11, 1983).
"“17Board to make available to the public details of the asset
allocation between priced and non-priced services embodied in
PACSo
One commenter opposed the proposal stating that PACS
would underallocate assets to the priced services.
The
original
long-term assets^
and
PSAF
methodology
certain
short-term
apportioned
assets
such
all
as
materials and supplies^ deferred charges and other receivables
on the basis of the ratio of operating expenses for priced
services
(less
shipping)
to
total
operating expenses (less shipping).
priced
and
non-priced
This approach resulted in
apportioning approximately 40 percent of the total book value
of assets to the priced service asset base to be financed via
the PSAFo
It is important, however, that shared (joint-purpose)
assets and single-purpose assets be precisely linked to priced
services so that a priced service asset base accurately and
fully identifies assets employed in the provision of priced
services.
The direct determination method relies essentially
on PACS cost accounting to link single-purpose assets directly
to priced
and
non-priced
services,
thus
precisely the priced service asset base.
determining
In addition,
more
PACS
provides the same information for assets, such as buildings and
centralized computers, that are used jointly in the provision
of priced and non-priced services.
For example, depreciation
is included in total occupancy costs, which are redistributed
to
all
PACS
activities.
Because
depreciation
Is
linked
“ 1 8 =
directly to assets carried on the Federal Reserve's balance
sheets the assets can be linked to the production of priced and
non-priced services.
For
illustrative
purposes,
the
check
processing
operation currently occupies approximately 13 percent of total
System floor space.
value
of buildings
service.
Therefore,
13 percent of the net book
is directly attributable
to the
check
In addition, the amount of space occupied by each
support activity and each overhead service whose costs are
redistributed or allocated to the check
service
is known.
Since the percentage of expenses that each support and each
overhead service redistributed or allocated to check
as a
percentage of total expenses is also known, that percentage
rate can be used to determine the additional building values to
be attributable to the check service.,
As a result, a total of
22 percent of the net book value of building assets can be
attributed to the check service and included in the priced
service asset base.
long-term assets.
Similar calculations are rhade for other
This process,
followed for each
of
the
Federal Reserve's priced services, ultimately produces a priced
service asset base that includes all assets directly identified
with a priced service and the appropriate portion of shared
assets that relate to priced services.
E.
proposed
that
development
Board of Governors Assets and Expenses - The Board
of
expenses
prices
incurred
be
subject
by
to
Board
staff
recovery.
in
the
Nineteen
■19'
commenters supported this proposal.
Eight of these commenters
stated that the allocation should also include expenses and
assets indirectly related to priced services, such as planning,
budgeting,
review,
monitoring,
policy
making
and
control.
Several commenters noted that the proposal paralleled private
sector practiceSo
The
Board
believes
it
is
appropriate
to
include
expenses incurred by Board staff working on the development of
priced services
($1.9
million)
in the expense
subject
to
recovery and the Board assets employed in this activity ($<,5
million) in the PSAF asset base, beginning in 1984*
However,
the Board believes it would be inappropriate to impose expenses
associated with the Board8s supervisory responsibilities over
Reserve Banks when the Federal Reserve does not assess charges
on member banks and bank holding companies for other types of
supervisory activities0
F0
Sales Taxes - Twenty-seven comments were received
on the proposal to include in the PSAF an estimate of sales
taxes that would have been paid by the Reserve Banks had they
not
had
a
statutory
supported the proposal*
exemption*
Twenty-five
commenters
Two commenters opposed including sales
taxes on the basis that sales tax is not a cost incurred by
Reserve Banks*
The Board believes that an allowance for sales taxes
the Federal Reserve Banks would have paid were they subject to
such taxes should be included as a cost of providing priced
-20
services.
For
1984 , the total
Federal
Reserve
sales
tax
attributed to priced services is approximately $4.9 millionc
G.
Shipping Expenses - Thirteen commenters discussed
the proposal
to exclude
calculation.
shipping
Eleven commenters
shipping expenses,
expenses
supported
from
the
PSAF
the exclusion
and two commenters stated that
of
shipping
expenses should be included.
The assets employed in the production of shipping
services are not Federal Reserve assets, but rather are owned
by the various carriers with whom the Reserve Banks deal.
When
priced service assets are determined directly instead of on an
expense ratio basis, the removal of shipping expenses from the
calculation has no effect on total recoveries.
Staff expenses
of managing shipping services are recovered through overhead
allocations as well as direct allocations to priced service
activities.
Accordingly, the Board determined not to include
shipping expenses in the calculation of the PSAF.
H.
Date for
the Asset
Base
Estimate
- Eighteen
respondents discussed the Board’s proposal that the asset base
for the year in which the PSAF would apply be adjusted to
reflect the value of the assets expected to be acquired and
disposed of in that year.
proposal,
Seventeen commenters supported the
stating that it would be an improvement over the
current method
of using
the average asset base
from the
previous year and would be more consistent with private sector
practices.
Two commenters opposed the proposal; one commenter
-21-
stated it was inconsistent with cost theory used in the private
sector c
The Board has determined that adjusting the asset base
used in applying the PSAF for the value of assets expected to
be acquired or disposed of in the year for which the PSAF would
apply better reflects the actual assets used to provide priced
services,
Further*, it appears that this modification would
parallel private sector practices.
Accordingly, the Board has
adopted the procedure as proposed,
I.
Leased Assets - Fourteen commenters supported the
proposal that all leases becoming effective on or after January
1 , 1984*, and meeting criteria of FASB Statement number 13 be
capitalized for purposes of determining the PSAF,
commenters stated the proposal was
in accord with
Several
industry
practice and generally accepted accounting standards.
Other
commenters discussed leased assets in terms of the impact of
leases on capital structure.
They stated that leased assets do
not appear on the Federal Reserve's books*, but*, that
if a
private entity were to issue debt*, lenders would regard lease
obligations as if they were debt and adjust
capital structure accordingly.
that entity's
In their opinion*, high levels
of leases preclude high levels of debt.
The Board has determined to include the value of all
Federal
Reserve
leases
that become
effective
on or after
January 1, 1984, that meet the criteria for capitalization as
*
set forth in FASB Statement number 13 in the calculation of the
22-
PSAF,
amount^
This amount is expected to be $1.5 million.
it is anticipated
that $0.9 million
priced service activities,,
Of this
is related to
Since the financing costs (interest
payments) associated with these leases are explicitly reflected
in the operating expenses to be recovered through pricing,
there would be no effect upon the PSAF or the costs to be
recovered if these leases were capitalizedo
Furthermore, these
leases would not affect the Federal Reserve's debt/equity ratio
as asserted by some of the commenters in view of the d _ minimus
e
level of capitalized leases.
The amount of leases entered into
prior to January 1, 1984, that satisfy the requirements of FASB
Statement
number 13
is
small
and
no
adjustments
appear
necessary.
J.
Short-Term Assets - 1.
Float.
Sixteen commenters
discussed the proposal to remove the financing costs of net
adjustment
float
calculation.
from the
asset
base
used
for
the
PSAF
Ten commenters supported the proposal in view of
the fact that the value of all Federal Reserve check float will
be recovered through service fees in 1984.
opposed to the proposal.
Six commenters were
A few commenters suggested that float
be financed at either the short-term rate applicable to the
bank holding companies in the model or the rate equivalent to
the imputed weighted average cost of capital computed in the
PSAF calculation.
The Board determined that it is appropriate to remove
the financing costs of net adjustment float from the asset base
-2 3 “
to be financed via the PSAF since the value of Federal Reserve
check float will be recovered fully through explicit pricing in
19840
In view of the self-financing characteristics inherent
in recovering float value through explicit pricing^
inclusion
of financing costs for net adjustments float in the Federal
Reserve's asset base would result in a double recovery0
With
regard to the suggestion that float be financed by alternative
rates, the MCA requires interest on items credited prior to
collection to be charged at the Federal funds rate0
20
Cash ItemSo
Several commenters stated that
the level of short-term assets was too low and that a large
short-term asset,
cash items
in the process
of collection
(CIPC), has been omitted from the pro forma balance sheeto
These commenters
also
tied
the
inclusion
of CIPC
to the
requirement that commercial banks must maintain 5 percent of
assets as capital^ stating that a bank holding company models
if applied consistently, would require the Federal Reserve to
comply with
capital
guidelines
established by
the
Federal
Reserve and the Comptroller of the Currency for large banks and
bank holding companies0
The Federal Reserve, by virtue of its check processing
operations^ has large amounts of cash items in the process of
collection each dayD
The difference between cash items in the
process of collection and deferred availability items is float,
the value of which must be recovered under the Monetary Control
Acto
Cash items in the process of collection that are offset
-24-
by deferred availability items are costless and thus need not
be financed by the PSAF or otherwise,
Therefore, insofar as
the Federal Reserve's overall net income is concerned, the only
Rcostw associated with cash items in the process of collection
arises from the net balances created which, in accordance with
the MCA, are effectively priced at the Federal funds rate 0
As several commenters stated, the gross amount of cash
items
typically
is
included
on
the balance
sheet
of
a
commercial bank, and a commercial bank's gross cash items are
subject to regulatory capital guidelines0
By extension, it was
suggested that a five percent primary capital ratio, if applied
to a Federal Reserve balance sheet that included the gross
amount of cash items, would require considerably more capital
than provided for in the PSAF calculation.
The Federal Reserve does not believe this conclusion
is warranted.,
First, cash items are not a risk asset -- a fact
that is implicitly recognized in the development of regulatory
capital
guidelines,,
Second,
cash
items
represent
only
4
percent of the total assets of the banking organizations in the
sample,,
If these items were removed from the total assets of
commercial banks, the resulting primary capital ratio guideline
would be increased to about 5 „2 percent,,
The comparable ratio
of equity to total assets on the Federal Reserve's pro forma
balance sheet
is about
9 percent „
Consequently,
when
the
primary capital ratio is adjusted to take account of cash items
in the process of collection,
it appears
that the Federal
“ 25■
Reserve 5s capital provided for in the PSAF
calculation
is
reasonable.
3°
Clearing
Balances,
,
The
Board
also
proposed to adjust the method for calculating earnings
had
credits
on clearing balances to take into account reserve requirements
applicable had similar balances been held at a correspondent
bank.
Thirteen commenters supported the proposals
If
a
respondent's
balance
is
maintained
at
a
correspondent bank,- the correspondent would be required
maintain reserves on the balances held.
In most cases,
to
the
correspondent would be at a marginal reserve requirement ratio
of 12 percento
Generally,- the correspondent bank takes its
marginal reserve requirement into account when it calculates
the
earnings
credit
on
the
respondent's
balances.
The
respondents however, would receive an additional benefit from
being able to deduct balances held at the correspondent from
its
reservable
transaction
accounts.
Accordingly,
it
is
appropriate to take this into account in calculating earnings
credits on clearing balances.
The Board has determined to adjust the method used for
calculating
earnings
credits
to
reflect
the
reserve
requirements that would apply if the balances had been held
with a correspondent bank.
Each respondent's balance would be
reduced by an imputed net interbank reserve requirement.
This
would be calculated as the 12 percent
a
requirement
that
correspondent would be subject to, less the reserve saving to
-2 6-
the respondent if it could deduct the balance from reservable
transaction accounts.
Preliminary estimates indicate that this
would reduce the rate at which depository institutions are paid
earnings credits on clearing balances by about 7 percent.
At
the same time,, an imputed reserve burden of 12 percent would be
imposed
upon
the
Federal
Reserve’s revenues
from clearing
balances.
K,
District vs. National PSAF -- Three commenters
advocated that the Federal Reserve use a district rather than a
national PSAF,
These commenters argued that such a policy
would more directly and fully recognize differences in costs
among
Reserve
cities,
and
thus
help
to
promote
a
more
competitive environment.
The Federal Reserve believes that a national PSAF is
appropriate for several reasons.
First, the Federal Reserve's
electronic payment services are priced on a national basis to
recognize the national nature of such services.
This approach
has broad support among private banking organizations.
Thus, a
district PSAF would be incompatible with the underlying nature
of these services and the current approach to the pricing of
such services.
Second,
while
check
processing
and
definitive
securities operations are priced at the district level, even
these services are,
in many ways,
national
in nature.
For
example, almost 50 percent of the checks and 70 percent of the
-27-
coupons processed by the Federal Reserve are handled by more
than one office„
Thirds where district prices are used*, such prices
already reflect the effect of local costs for wages*, utilities*,
property taxes,, and other factors of production,,
Moreover, the
costs of capital to the Federal Reserve (as, for example*, the
interest rates it would pay on debt) would be uniform and
national.
Thus,
the use
practical
matter,
mean
quantity of
change.
capital
of a district PSAF would,
only that
among
Federal
the
distribution
Reserve
as a
of
the
Districts would
Such a change would not have a material impact on
actual prices but would introduce a major element of complexity
into pricing and price schedules.
Indeed, under this approach,
the quantity of capital first would have to be divided among
national and district services and then, for district services,
be determined for each of the Federal Reserve's 48 offices.
The result would be a massive matrix of PSAFs, which would be
an administrative nightmare.
Fourth, as best can be judged, private organizations
-- including banks -- typically do not vary their prices on the
basis of the specific capital
resources used to produce a
specific service at a specific location.
The
fees
for
a
checking account, for example, generally do not vary depending
on whether the account is held at a very high-rent central city
location or a suburban or rural branch.
Thus, the local PSAF
would imply a standard of performance in the Federal Reserve
-28-
which
appears
to be
at
odds
with
conventional
business
practices.
Finally* the characteristics of many capital assets
used by Federal Reserve Banks are fixed by national policies
and standards.
automation
For example* security standards for buildings*
standards*
and
standards
calling
for
redundant
back-up operating systems influence the capital base at all
Federal
Reserve
offices
in ways
that
result
in
capital
resources that are different than might be the case if each
Federal Reserve office were a stand-alone entity.
because the Federal Reserve Banks are part
In short*
of a national
system* many of their activities are national in scope and are
influenced by national policies.
Consequently* reflecting this
reality* it is appropriate to have a single* uniform PSAF for
all Reserve Banks.
L.
FDIC Insurance -- Several commenters expressed the
view that the PSAF should include the Federal deposit insurance
assessment that would apply to the Federal Reserve if its
deposits were Federally insured.
A review of the pro forma
balance sheet for Federal Reserve priced service operations
shows
that approximately $1.7 billion of clearing balances
would be subject to the Federal deposit insurance assessment if
the
Federal
Reserve were
a member
of
the FDIC.
Because
virtually all correspondent banks are members of the FDIC* it
is reasonable for the Federal Reserve to add to the PSAF the
deposit
insurance
expense
that
incurred by the Federal Reserve.
otherwise
would
have
been
-2 9 “
Applying
the
formula
for
calculating
the
Federal
deposit insurance assesssment based on the Federal Reserve's
pro forma balance sheet results in a Federal deposit insurance
assessment of $102 million0
Board Action
After
analysis
of
the
comments
received
on
the
proposed modifications to the methodology for calculating the
PSAF
for
1984,
the
Board
has
determined
that
the
most
appropriate model from which to impute taxes and the costs of
capital for Reserve Banks consists of a sample of large bank
holding companies0
The Board has also decided to expand the
sample size of the model from the 12 largest bank holding
companies to the 25 largest bank holding companies0
However,
to prevent distortions, the Board has determined that the best
performing bank holding company and the worst performing bank
holding company of the 25 in the sample should be excluded from
the calculations.
The Board has also approved the following adjustments
to the methodology for calculating the PSAFi
Employ the direct determination methodology for
establishing the asset base used for computing the
PSAF o
Include in the priced services asset base for 1984
the net effect of those assets expected to be
acquired and disposed of during the year.
Recover the estimated sales taxes that would have
been paid on the purchases of certain goods and
services were Reserve Banks subject to such taxes.
-3 0-
Include those portions of expenses and fixed assets
of the Board of Governors related to the
development of priced services.
Include an imputation for FDIC insurance assessment.
Remove the financing costs of net adjustment float
from the asset base because such float is now
priced explicitly,,
As
a result
of
these
changes,
the
estimated
dollars
to
be
recovered through the PSAF in 1984 will be $58.8 million.
the current methodology were used for 1984,
If
the PSAF recovery
would be $53,6 million.
The Board has also adopted the proposed adjustment to
the
method
for
calculating
earnings
credits
on
clearing
balances to take into account reserve requirements the Reserve
Banks
would
be
requirements.
subject
This
to
they were
adjustment,
substantial modifications
Therefore,
if
subject
however,
will
to
reserve
require
to Reserve Banks” existing software.
implementation of this action will take place when
the necessary modifications have been made later this year.
Factors bearing on the calculation of the PSAF such as
capital structure changes
in the large bank holding companies
or changes in their cost of capital will be closely monitored
and changes to the methodology for calculating the PSAF to take
such changes into account will be considered where appropriate.
By order
of
the
Board
of
Governors
of
the
Federal
Reserve System, March 20, 1984.
(s ig n e d )
W il l i a m W. W i l e s
William W. Wiles
Secretary of the Board
Table
1
Summary of Changes from Proposed 1984 PSAF
Total PSAF Recoveries - October public comment
$56*2
Change Due To:
- - R ec la s s if ic a ti o n of Board
of Governors expenses
+1=9
-= Inclusion of Federal deposit
insurance assessment
+lo2
--
+0*2
Updating prospective evaluation
of assets f o r 1984
- - Change in treatment of leasehold
improvements
+0ol
- - Inclusion of prepaid expenses
other
+0*4
- - Change in value of materials and
supplies
+0*3
--
Updating cap ita l s tr u ctu re
=0*8
--
Updating financing rates through
3rd Quarter 1983
PSAF Recoveries For 1984
=0*7
_____
$58*8
Table
2
Derivation of the 1984 PSAF
A
o
Assets to be Financed V
Short-Term
Long-Term
Total
Bo
32o 3
273o 8
2/
$306o1
Weighted Average Cost of
lo
20
3o
Capital Structure £ /
Short-Term Debt
Long-Term Debt
Equity
28 o4%
61 o0%
Financing Rates/Costs £ /
Average rates paid by the
bank holding companies
included in the sample
Short-Term Debt
Long-Term Debt
Pre-Tax Equity £ /
9o 23%
10.14%
20o 90%
Elements of Capital Costs
Short-Term Debt
Long-Term Debt
Equity
Other Required PSAF Recoveries
Sales Taxes
Federal Deposit Insurance Assessment
Board of Governors Expenses
D
o
$
Total PSAF Recoveries
As a percent of capital
As a percent of expenses £ /
10.6%
$
32.3
8701
186.7
409
1.2
1.9
X
3/
3/
X
X
9 c23% = $ 3.0
10o14% =
8o8
20o 90% =
39o 0
$ 50o8
8.0
$58o 8
19o 21
15o 25
1/ Priced service asset base is based on d i r e c t determination of assets methodo
2/ Consists of t o t a l long-term assets less capital leases which are s e l f - f i n a n c i n g .
3/ All short-term assets are assumed to be financed by short-term debto Of the t o t a l
long-term as se ts, 3108 percent are assumed to be financed by long-term debt, and
6802 percent by e q u i t y c
_ / The pre-tax rate of return on equity is based on average a f t e r - t a x rates of
4
return on equity f o r the bank holding company sample, adjusted by the e f f e c t i v e
tax rate to y i e l d the pre-tax rate of return on e q u ity .
j>/ Systemwide 1984 budgeted priced service expenses less shipping were $385o6
mi 11 iono
1984 PSAF
Revi sed
I.
Preliminary
Assets to be Financed
(m illion)
Current
Long-term
$ 32.3
$ 273.8
$ 27.1
$ 270.9
Cost of Capital
Short-Term Debt Rate
Long-Term Debt Rate
Pre-Tax Equity Rate
Weighted Average Cost of Capital
Tax Rate
IVo
9.23%
10.14%
20.90%
16.61%
9.48%
10.01%
21.25%
17.20%
38.6%
35.8%
Capital Structure
Short-Term Debt
Long-Term Debt
Equity
10.6%
28.4%
61.0%
9.1%
26.5%
64.4%
PSAF
Recovery
As Percent of Capital
As Percent of Expenses
$58.8
19.21%
15.25%
$56.2
18.86%
14.51%
Table
4
Changes between 1984 Preliminary and 1984 Revised Balance Sheet
Revi sed
1984
Short-term assets
Imputed reserve requirements
on clearing balances
Investment in marketable s e c u ri ti e s
Receivables
Materials and supplies
Prepaid expenses
Net items in process of
collection (flo a t)
Total short-term assets
Long-term assets
Premises 1/
Furniture and equipment
Leases and leasehold improvements
Total long-term assets
Long-term l i a b i l i t i e s
Obligation under capital leases
Long-term debt 2/
Total long-term l i a b i l i t i e s
Total l i a b i l i t i e s
Equity 2/
Total l i a b i l i t i e s and equity
$
1,000.0
23.6
1.9
1.6
$147o4
l s080.6
23.7
4.3
4.3
477.0
$1,737,3
$1,027.1
183.2
87.7
176.7
95.6
2.4
274.7
270.9
$2,012.0
Total assets
Short-term l i a b i l i t i e s
Clearing balances
Balances a r i s i n g from early
c r e d i t of uncollected items
Short-term debt 2/
Total short-term l i a b i l i t i e s
Prelimi nary
1984
$1,298.0
1s228.0
19000.0
477.0
32.3
27.1
1s737.3
0.9
87.1
1s027.1
79.1
88.0
79.1
1s825.3
l s106.2
186.7
191.8
$2,012.0
$1,298.0
_1/ Includes an a l lo c a t i o n of $ 0o5 m i l l i o n in Board of Governors' assets to
priced services.
2 J Imputed figures representing the means through which c e r ta in priced service
assets are financed,,
@FedFRASER