[Federal Register Volume 59, Number 160 (Friday, August 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20408]
[[Page Unknown]]
[Federal Register: August 19, 1994]
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FEDERAL RESERVE SYSTEM
[Docket R-0846]
Federal Reserve Bank Services: Imputed Income on Clearing
Balances
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Request for comment.
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SUMMARY: The Board is requesting comment on a proposal to modify the
methodology for imputing clearing balance income to more closely
parallel the practices of a private sector service provider.
Specifically, the Board is requesting comment on a proposal to change
the rate used to impute clearing balance income from the 90-day
Treasury bill coupon equivalent yield to a longer term Treasury rate
based on the earning asset maturity structure of the largest bank
holding companies (BHCs). The intended effect of the proposal is to
promote competitive equity with private sector practices by matching
the maturity structure for investment of clearing balances to the
structure revealed in bank holding company data on investments.
DATES: Comments must be submitted on or before September 21, 1994.
ADDRESSES: Comments, which should refer to Docket No. R-0846, may be
mailed to William W. Wiles, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, N.W.,
Washington, D.C. 20551. Comments also may be delivered to Room B-2222
of the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to
the guard station in the Eccles Building courtyard on 20th Street NW.
(between Constitution Avenue and C Street) at any time. Comments may be
inspected in Room MP-500 of the Martin Building between 9:00 a.m. and
5:00 p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's
rules regarding availability of information.
FOR FURTHER INFORMATION CONTACT: Greg Evans, Manager (202/452-3945), or
Gwen Mitchell, Senior Accounting Analyst (202/452-3841), Division of
Reserve Bank Operations and Payment Systems, Board of Governors of the
Federal Reserve System. For the hearing impaired only:
Telecommunications Device for the Deaf, Dorothea Thompson (202/452-
3544).
SUPPLEMENTARY INFORMATION: The Monetary Control Act (MCA) requires the
Federal Reserve Banks to establish fees for their services on a basis
similar to private sector service providers. In establishing fees, the
Board considers objectives of fostering competition, improving the
efficiency of the payments mechanism, and providing financial services
nationwide.
Accordingly, the Federal Reserve imputes costs in the private
sector adjustment factor (PSAF) that are intended to mirror private
sector sales taxes, income taxes, cost of funds, and FDIC assessments.
Capital structure, equity and debt rates, and an income tax rate are
derived from a model of the largest (in asset size) 50 bank holding
companies. The Federal Reserve uses the bank holding company model to
place Reserve Bank payment service costs on an equal footing with those
costs incurred by the private sector. The banking industry has accepted
the BHC model as a proxy for determining Federal Reserve imputed costs.
In February 1981, the Federal Reserve established procedures to
assist depository institutions with clearing arrangements at Reserve
Banks, recognizing that the maintenance of an account relationship is
necessary for (a) depository institutions that do not maintain reserve
accounts but desire direct access to some or all Federal Reserve priced
services and (b) depository institutions that do maintain a reserve
account but find the reserve balance inadequate for their transactions.
Because clearing balances were established as a result of
depository institutions wanting access to Federal Reserve priced
services, it was determined that investment earnings attributable to
clearing balances should be ascribed to the System's priced service
operations, comparable to the use of these balances by other service
providers. The 1982 annual financial report of the Federal Reserve
reflected these earnings.
This priced service revenue factor, net income on clearing balances
(NICB), is the difference between the income the Federal Reserve
imputes on clearing balances held with the Federal Reserve System, less
imputed reserve requirements, and the priced services cost of earnings
credits granted to depository institutions, net of expired earnings
credits. (Appendix A illustrates the current NICB calculation.) The
private sector recognizes revenue from these balances in a similar way.
In 1982, under its delegated authority rules, the Board approved a
rate of return equivalent to the yield on the short-term assets
included in the System Open Market Account portfolio for calculating
clearing balance income. The Federal Reserve selected the 90-day
Treasury bill coupon equivalent yield to impute income on clearing
balances.
A primary benefit of the 90-day Treasury rate, which is still used
today, is that its yield is equivalent to the yield on short-term
assets currently included in the Federal Reserve's System Open Market
Account (SOMA) portfolio. Additionally, use of the short-term 90-day
rate was viewed as more closely approximating what would have been
realized had clearing balance funds been held and invested by a private
business firm. Lastly, Treasury yield data are available to the public.
This allows the earnings calculation to be replicated by the private
sector.
The Reserve System recently reviewed the methodology used to impute
income on clearing balances to determine the comparability of Federal
Reserve practices in this area with practices of correspondent banks. A
telephone survey of bank holding companies was conducted to determine
the types of assets in which correspondent banks invest clearing
balance funds.
Survey results showed that, although correspondent banks pay
earnings credits based on a short-term rate (90-day Treasury bill),
their investment of clearing balance funds is determined by the
economic environment, their risk policies, and investment opportunities
available. The survey participants identified a range of investment
options including, loans, securities, and overnight funds.
It was observed that correspondent banks may exercise a broad range
of investment opportunities whereas the Federal Reserve has adopted a
more restrictive practice. Since Reserve Bank imputed investments do
not reflect correspondent bank practices, the approach is inconsistent
with other areas of priced service accounting. Other areas of priced
service accounting either draw on actual Reserve Bank costs, or are
imputed based on BHC data. More important, over time, by computing
clearing balance income in the current fashion, the Federal Reserve may
be understating clearing balance revenue, increasing costs of Federal
Reserve priced services, and setting prices higher than necessary to
promote effective competition and efficient payment services.
The proposal under consideration by the Board of Governors is to
determine the maturity structure of short-, intermediate-, and long-
term securities assets from the BHC model and impute income based on
published matching term Treasury yields. The Board is considering the
BHC structure/Treasury yields method because it promotes competitive
equity with private sector practices by matching the maturity structure
for investment of clearing balances to the structure revealed in bank
holding company data on investments.
One problem with attempting to match the earnings realized by bank
holding companies is that the risk premium for the private sector is
difficult to manage and approximate. Also, the Federal Reserve could
not determine administrative costs from available data. Therefore, the
Board believes that the Treasury rate provides a reasonable proxy for
the actual rate realized by bank holding companies on clearing
balances, without the risk premium associated with holding company
investments and administrative costs incurred managing portfolio risk.
Bank holding company maturity structures and Treasury yields are
publicly available so that the NICB calculation can be replicated by
the private sector. The recommended approach provides longer term
investments, which would produce higher earnings, assuming an upward
sloping yield curve.
Proposed NICB Computation
An estimate of NICB is prepared annually. Under the recommended
methodology, selected earning assets include Federal funds, repurchase
agreements, and securities. These investments were chosen because they
most closely represent the Treasury function investments of the private
sector. The earning assets maturity structure of the BHC model would be
defined as follows: less than one year (short-term), one -to -five
years (intermediate-term) and greater than five years (long-term). The
maturity structure would be calculated from the most recent four
quarters of Y9 data. The Y9 is a quarterly BHC report filed with the
Federal Reserve and is generally available to the public 50 to 60 days
after the close of the quarter. For example, four quarters for 1992
would be used for the 1994 earnings rate estimate, which would be
calculated in the fall of 1993. Similarly, 1992 BHC data are used for
the 1994 PSAF calculation. Historical rates are used because the Board
has decided in previous instances to avoid the appearance of
forecasting interest rates.
Published matching-term Treasury yields would be applied to the
maturity percentages and summed to develop the earnings rate. The Board
intends initially to use shorter term Treasury rates. In this regard, a
three-month Treasury yield would be used for the short-term rate
maturity portion. A one- year Treasury yield would be used for the
intermediate-term, and a five-year Treasury yield would be applied for
the long-term portions. Current year-to-date (approximately four
months) week-ending average Treasury yields from the Federal Reserve
H.15 Statistical Release would be used for the estimate. The
recommended maturity structure and applicable Treasury yields are shown
below.
------------------------------------------------------------------------
BHC maturity structure Weighted average rate
(A) Treasury yield (B) (AxB)
------------------------------------------------------------------------
% Investment < 1="" year..="" three-="" %="" month..................="" %="" investments="" 1-5="" years="" one-="" %="" year...................="" %="" investment="" 5+="" years..="" five-..................="" %="" year...................="" total................="" .......................="" weighted="" average="" estimated="" rate.="" ------------------------------------------------------------------------="" actual="" nicb="" results="" are="" imputed="" monthly.="" under="" the="" recommended="" methodology,="" the="" maturity="" structure="" developed="" in="" the="" calculation="" of="" the="" estimate="" would="" be="" held="" constant="" for="" the="" year;="" however,="" current="" monthly="" treasury="" yields="" would="" be="" applied="" to="" the="" percentages="" to="" develop="" the="" weighted="" average="" earnings="" rate.="" the="" week-ending="" average="" yields,="" as="" published="" in="" the="" federal="" reserve="" h.15="" statistical="" release,="" would="" be="" used="" to="" calculate="" the="" monthly="" rate.="" the="" following="" table="" illustrates="" the="" result="" of="" this="" recommendation="" compared="" with="" the="" current="" methodology="" using="" 1994="" projections.="" 1994="" nicb="" estimate="" ($="" millions)="" ------------------------------------------------------------------------="" bhc="" structure="" current="" and="" method="" treasury="" yield="" ------------------------------------------------------------------------="" clearing="" balance="" income:="" investable="" funds..............................="" $5,417.8="" $5,417.8="" earnings="" rate.................................="" 3.0877%="" 4.1109%="" earnings="" on="" invested="" portion="" of="" clearing="" balances.....................................="" 167.3="" 222.7="" cost="" of="" earnings="" credits:="" cost="" (fed="" funds="" rate).........................="" 3.0079%="" 3.0079%="" net="" cost="" of="" earnings="" credits..................="" 141.9="" 141.9="" net="" income="" on="" clearing="" balances.................="" $25.4="" $80.8="" ------------------------------------------------------------------------="" had="" the="" recommended="" approach="" been="" in="" place="" for="" the="" 1994="" estimate,="" clearing="" balance="" earnings="" would="" have="" increased="" $55.4="" million="" or="" 33.1="" percent,="" from="" $167.3="" million="" using="" the="" current="" method="" to="" $222.7="" million.="" this="" is="" due="" to="" a="" 102="" basis="" points="" increase="" in="" the="" earnings="" rate,="" from="" 3.0877="" percent="" in="" the="" current="" method="" to="" 4.1109="" percent\1\.="" nicb="" would="" have="" increased="" from="" $25.4="" million="" in="" the="" current="" method="" to="" $80.8="" million.="" ---------------------------------------------------------------------------="" \1\the="" imputed="" weighted="" average="" earnings="" rate="" is="" derived="" as="" follows="" (short,="" intermediate,="" and="" long-term,="" respectively):="" ((32.67%="" *="" 3.0877%)="" +="" (27.58%="" *="" 3.3889%)="" +="" (39.75%="" *="" 5.4526%))="4.1109%" ---------------------------------------------------------------------------="" moreover,="" the="" board="" believes="" that="" investment="" decisions="" made="" by="" bhcs="" are="" not="" static.="" instead,="" these="" decisions="" are="" the="" result="" of="" several="" considerations,="" including="" the="" economic="" environment,="" their="" risk="" policies,="" and="" investment="" opportunities="" available.="" consequently,="" the="" board="" recognizes="" that="" the="" recommended="" methodology="" may="" require="" further="" adjustment="" based="" on="" economic="" situations="" or="" new="" investment="" opportunities.="" prudent="" private="" sector="" investors="" would="" be="" aware="" of="" changing="" variables="" and="" would="" make="" the="" necessary="" investment="" changes="" to="" reflect="" market="" conditions.="" accordingly,="" the="" board="" would="" propose="" to="" make="" such="" adjustments,="" without="" public="" comment,="" unless="" the="" adjustment="" entails="" a="" change="" in="" the="" methodology.="" therefore,="" imputed="" investment="" income="" would="" be="" subject="" to="" the="" board's="" approval="" as="" are="" fee="" schedules="" for="" federal="" reserve="" priced="" services="" and="" the="" psaf.="" in="" summary,="" the="" current="" short="" term="" nature="" of="" federal="" reserve="" clearing="" balance="" income="" is="" not="" representative="" of="" the="" behavior="" of="" most="" correspondent="" banks.="" although="" the="" recommended="" methodology="" still="" does="" not="" purely="" match="" bhc="" activity,="" the="" board="" believes="" that="" it="" more="" closely="" parallels="" the="" practices="" of="" a="" private="" sector="" service="" provider.="" the="" recommended="" methodology="" also="" complies="" with="" federal="" reserve="" pricing="" principles.="" the="" board="" also="" believes="" that="" the="" treasury="" rate="" provides="" a="" reasonable="" proxy="" for="" the="" actual="" rate="" realized="" by="" bank="" holding="" companies="" on="" clearing="" balances.="" the="" treasury="" rate="" is="" simpler="" to="" administer="" because="" it="" does="" not="" incorporate="" a="" risk="" premium="" or="" administrative="" costs="" of="" managing="" portfolio="" risk.="" the="" board="" requests="" comments="" on="" the="" proposal="" to:="" (a)="" change="" the="" methodology="" for="" imputing="" clearing="" balance="" income="" to="" more="" closely="" parallel="" the="" practices="" of="" a="" private="" sector="" service="" provider="" and="" (b)="" change="" the="" rate="" used="" to="" impute="" clearing="" balance="" income="" from="" the="" 90-day="" treasury="" bill="" coupon="" equivalent="" yield="" to="" a="" longer="" term="" treasury="" rate="" based="" on="" the="" earning="" asset="" maturity="" structure="" of="" the="" largest="" bhcs.="" by="" order="" of="" the="" board="" of="" governors="" of="" the="" federal="" reserve="" system,="" august="" 12,="" 1994.="" william="" w.="" wiles,="" secretary="" of="" the="" board.="" billing="" code="" 6210-01-p="">
E:\GRAPHICS\EN19AU94.034
[FR Doc. 94-20408 Filed 8-18-94; 8:45 am]
BILLING CODE 6210-01-C
