Financial Update (July-Septemer 1997)

Federal Reserve System Payments
Services Priced to Cover Costs

M any people, even bankers and others in the financial services industry who are most knowledgeable about the Federal Reserve, often have misperceptions about how the Fed sets its prices for the payments services it provides to financial institutions. The process is not as complicated or mysterious as some might think.

The Federal Reserve System sets its prices annually to recover its actual and imputed costs for each payment service provided to depository institutions, based on an assessment of forecast volumes. Based on its 1996 experience and its projections for 1997, the Fed was able to reduce its prices across all services by 3.4 percent over 1996 prices, largely because of its ongoing efforts to efficiently consolidate operations. The Federal Reserve System is projecting that it will recover all of its total operating costs this year for priced services.

Providing Financial Services

Sometimes called "the banker's bank," the Fed provides an array of payments services that include check collection, automated clearinghouse services, funds transfer and net settlement, book-entry securities, noncash collection and special cash services.

Each year the Reserve Banks recommend price levels for the upcoming year based essentially upon estimations of cost, volume and revenue. Final prices are then approved by the Board of Governors in Washington, D.C. All prices are set at the same level for all depository institutions throughout the nation with the exception of most check and special cash services fees. These prices vary from District to District because of costs specific to each region of the country.

By law, costs for each service must include those directly associated with providing a service, such as personnel and equipment. Among the other costs are indirect costs, which include support costs, such as automation and building expenses, as well as overhead costs, such as marketing, legal, auditing and the human resources function.

Additionally, the Fed also is required to recover float, the Fed funds value of money lost on a day when credit is given before the item is collected, and a private sector adjustment factor (PSAF). The PSAF takes into account the return on capital, taxes, insurance and other imputed expenses that would be incurred by a private-sector service provider.

The PSAF is calculated using five-year historical data from the 50 largest bank holding companies as well as Federal Reserve Bank and Board of Governors information, such as asset levels and Treasury and federal funds rates. The bank holding company data include each company's short- and long-term debt rates, pre-tax return on equity and the percent of each company's long-term assets financed by debt. Adding these factors into the pool of costs that Federal Reserve services income must cover in essence levels the playing field with private-sector providers.

Charging for Services

Prior to 1980 the Fed did not charge fees for the services it provided to financial institutions, and only member banks had access to the System's services. At that time, nonmember institutions had to go through a correspondent member bank for service access. In 1980 Congress passed the Monetary Control Act, which, among other provisions, required the Fed to make its services available to all depository institutions and to charge these institutions for payments services. This change was intended to encourage competition between the Fed and private-sector providers of payment services.

Whether providing services at no charge, as the Fed did prior to 1980, or charging customers for payments services, the Fed has played a vital role in the successful operation of the U.S. payments system, which is the largest in the world. For the future, while the payments system and the Fed's role in it may change, the Fed will continue to work to make the nation's payments system as efficient, reliable and accessible as possible.

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