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Federal Reserve Banks

In addition to contributing to the setting of national monetary policy and supervising and regulating banks and other financial entities (discussed in preceding chapters), the Federal Reserve Banks operate a nationwide payments system, distribute the nation's currency and coin, and serve as fiscal agents and depositories for the United States.

Developments in Federal Reserve Priced Services

In operating a nationwide payments system, the Federal Reserve Banks provide numerous services to depository institutions, including collecting and processing checks, operating an automated clearinghouse service, transferring funds and securities, and providing settlement services. The Reserve Banks charge fees for providing these "priced services."

The Monetary Control Act of 1980 requires that the Federal Reserve establish fees for priced services provided to depository institutions so as to recover, over the long run, all direct and indirect costs actually incurred as well as the imputed costs that would have been incurred, including financing costs, taxes, and certain other expenses, and the return on equity (profit) that would have been earned if a private business firm had provided the services. The imputed costs and imputed profit are collectively referred to as the private-sector adjustment factor (PSAF). 1 Over the past ten years, the Reserve Banks have recovered 98.4 percent of their priced services costs, including the PSAF (table). In 2005, the Board approved changes, to be effective in 2006, to the method for calculating the target return on equity measure in the PSAF.

Overall, the price index for priced services increased 8.4 percent from 2004 to 2005. Revenue from priced services amounted to $901.0 million, other income was $93.7 million, and costs were $834.7 million, resulting in net income from priced services of $160.0 million. In 2005, the Reserve Banks recovered 106.1 percent of total costs of $937.7 million, including the PSAF. 2

Priced Services Cost Recovery, 1996-2005
Millions of dollars except as noted
Year Revenue from
services 1
expenses and
imputed costs 2
Targeted return
on equity
Total costs Cost recovery
(percent) 3
1996 815.9 746.4 42.9 789.3 103.4
1997 818.8 752.8 54.3 807.1 101.5
1998 839.8 743.2 66.8 809.9 103.7
1999 867.6 775.7 57.2 832.9 104.2
2000 922.8 818.2 98.4 916.6 100.7
2001 960.4 901.9 109.2 1,011.10 95.0
2002 918.3 891.7 92.5 984.3 93.3
2003 881.7 931.3 104.7 1,036.10 85.1
2004 914.6 842.6 112.4 955 95.8
2005 994.7 834.7 103 937.7 106.1
1996-2005 8,934.60 8,238.40 841.4 9,080.00 98.4

Note: Here and elsewhere in this chapter, components may not sum to totals or yield percentages shown because of rounding.
1. For the ten-year period, includes revenue from services of $8,606.3 million and other income and expense (net) of $328.3 million.   Return to table
2. For the ten-year period, includes operating expenses of $7,585.1 million, imputed costs of $341.4 million, and imputed income taxes of $312.0 million.   Return to table
3. Revenue from services divided by total costs.   Return to table

Commercial Check Collection Service

In 2005, operating expenses and imputed costs for the Reserve Banks' commercial check collection service totaled $688.6 million, of which $39.0 million was attributable to the transportation of commercial checks between Reserve Bank check-processing centers. Revenue amounted to $740.3 million, of which $42.9 million was attributable to estimated revenues derived from the transportation of commercial checks between Reserve Bank check-processing centers, and other income was $77.1 million. The resulting net income was $128.7 million. Check service revenue in 2005 increased $20.6 million from 2004, largely because of price increases and a slower-than-anticipated reduction of check-processing volume.

The Reserve Banks handled 12.2 billion checks in 2005, a decrease of 12.3 percent from the 13.9 billion checks handled in 2004 (table). The decline in Reserve Bank check volume is consistent with nationwide trends away from the use of checks and toward greater use of electronic payment methods. 3 Overall, the price index for check services increased 10.2 percent from 2004.

Activity in Federal Reserve Priced Services, 2003-2005
Thousands of items
Service 2005 2004 2003 Percent change
2004 to 2005 2003 to 2004
Commercial check 12,195,301 13,904,382 15,805,894 -12.3 -12
Funds transfer 135,227 128,270 125,936 5.4 1.9
Securities transfer 9,235 9,208 10,071 .3 -8.6
Commercial ACH 7,338,950 6,486,091 5,588,381 13.1 16.1
Noncash 117 211 280 -44.5 -24.7

Note: Activity in commercial check is the total number of commercial checks collected, including processed and fine-sort items; in funds transfer and securities transfer, the number of transactions originated online and offline; in commercial ACH, the total number of commercial items processed; and in noncash, the number of items on which fees were assessed.

In response to the continuing decline in check volume, the Reserve Banks in 2005 continued to reduce check service operating costs through a combination of measures, including closing some check-processing sites and increasing capacity at others. Checks that once would have been processed in Birmingham are now processed in Atlanta. Detroit check processing has been consolidated to Cleveland; Salt Lake City to Denver; Portland to Seattle; and Houston and Oklahoma City to Dallas.

Of all the checks presented by the Reserve Banks to paying banks in 2005, 25.2 percent (approximately 3.1 billion checks) were presented electronically, compared with 23.1 percent in 2004. The Banks captured images of 11.8 percent of the checks they collected, an increase from 10.4 percent in 2004. In 2005 the Banks presented approximately 241.5 million substitute checks, or 2.0 percent of the total number of checks they collected. (For more information on substitute checks, see the box "The First Full Year of Check 21.")

The First Full Year of Check 21

The United States is in the midst of significant change in the way payments are made. At one time, most noncash payments were made by paper check. Evidence of major change was seen in the results of the Federal Reserve's most-recent payments research, which found that in 2003, for the first time ever, businesses and consumers made more payments electronically (by debit and credit card, for example) than by paper check. The declining use of checks is only a part of the ongoing change within the payments system, however. The way in which checks are collected is changing as well, as a result of the Check Clearing for the 21st Century Act (commonly referred to as Check 21). Before implementation of the act in 2004, laws governing check collection allowed a paying bank to require that the original check be physically presented for payment. Check 21 was designed to facilitate the electronic processing of checks, with the goal of making check collection faster, more efficient, and less costly.

Under Check 21, while a paying bank may demand that presentment be in the form of a paper check, it may no longer require that the original check be presented. Instead, paying banks must accept a "substitute check," a special paper copy of an original check that can be processed in the same way as the original check. By authorizing this new, legally equivalent negotiable instrument, Check 21 facilitates, through the action of market forces, the adoption of check truncation and the electronic collection of checks. 1 As banks increasingly send and receive checks electronically, they will be able to reduce their infrastructure for processing paper checks and the cost of physically transporting original paper checks from the bank where they were deposited to the banks that pay them.

The Federal Reserve Banks have been leaders within the payments industry in making use of the authority granted by Check 21. They began offering Check 21 services as soon as the law became effective in October 2004. The services allow for the deposit of digital check images with the Reserve Banks and the truncation of paper-check deposits by the Reserve Banks. The check images are transmitted to the Reserve Bank closest to the paying bank, thereby eliminating the need to physically transport paper checks between the Banks. The receiving Reserve Bank either prints substitute checks from the check images for presentment to the paying bank or, if the paying bank accepts electronic presentment, provides the check information electronically.

Across the industry, banks have begun to take advantage of the opportunities created by Check 21. More than 500 depository institution customers were using Federal Reserve Check 21 services by year-end 2005. In December 2005, peak daily volume processed by the Reserve Banks exceeded 3 million substitute checks valued at more than $19 billion.

As with many significant operational and technological changes, adoption of the new check-processing methods made possible by Check 21 has been gradual. To fully realize the benefits of a faster, more efficient, less costly, and more resilient check-collection system envisioned when Check 21 was enacted, the banking industry will need to make changes to its current systems to support the exchange of digital check images. As technology improves and scale economies are realized, the cost of collecting checks electronically will decrease relative to the cost of collecting paper checks, and this decrease should eventually spur greater adoption of Check 21 technologies across the banking industry.

1. Check truncation is the removal of an original check from the check-collection system and the collection, instead, of a substitute check or, by agreement, information contained on the original check's magnetic ink character recognition (MICR) line, including the paying bank's routing number, the check writer's account number, the check serial number, and the amount of the check. Additional consumer information on Check 21 is available at . Banking industry educational and reference material on Check 21 is available at .   Return to text

Commercial Automated Clearinghouse Services

Reserve Bank operating expenses and imputed costs for commercial automated clearinghouse (ACH) services totaled $72.1 million in 2005. Revenue from ACH operations totaled $79.3 million and other income totaled $8.2 million, resulting in net income of $15.2 million. The Banks processed 7.3 billion commercial ACH transactions (worth $12.8 trillion), an increase of 13.1 percent from 2004. Overall, the price index for ACH services decreased 1.1 percent from 2004.

In 2005 the Reserve Banks conducted a pilot program of an ACH risk-management service that will be available to all depository institutions in 2006. The service will help originating institutions manage operational, credit, and third-party risk associated with originating ACH payments.

Fedwire Funds and National Settlement Services

Reserve Bank operating expenses and imputed costs for the Fedwire Funds and National Settlement Services totaled $55.3 million in 2005. Revenue from these operations totaled $61.0 million and other income amounted to $6.3 million, resulting in net income of $12.1 million.

Fedwire Funds Service

The Fedwire Funds Service allows participants to draw on their reserve or clearing balances at the Reserve Banks and transfer funds to other institutions that maintain accounts at the Banks. In 2005, the number of Fedwire funds transfers originated by depository institutions increased 5.4 percent from 2004, to approximately 135.2 million. The average daily value of Fedwire funds transfers in 2005 was $2.1 trillion.

National Settlement Service

Private clearing arrangements that exchange and settle transactions may use the Reserve Banks' National Settlement Service to settle their transactions. This service is provided to approximately fifty-five local and national private arrangements, primarily check clearinghouse associations but also other types of arrangements. In 2005, the Reserve Banks processed slightly more than 440,000 settlement entries for these arrangements.

Fedwire Securities Service

The Fedwire Securities Service allows participants to electronically transfer securities issued by the U.S. Treasury, federal government agencies, government-sponsored enterprises, and certain international organizations to other participants in the United States. 4 Reserve Bank operating expenses and imputed costs for providing this service totaled $17.4 million in 2005. Revenue from the service totaled $19.3 million, and other income totaled $2.0 million, resulting in net income of $3.8 million. Approximately 9.2 million transfers of Treasury and other securities were processed by the service during the year, almost unchanged from 2004. In 2005, the surcharge for offline transfers increased from $28 to $33.

Noncash Collection Service

At year-end 2005, the Reserve Banks withdrew from the noncash collection service, which collected and processed municipal bearer bonds and coupons issued by state and local governments (referred to as "noncash" items), because of a declining volume of coupons and bonds presented for collection. The service processed slightly fewer than 117,000 noncash transactions in 2005, representing a 44.5 percent decline in volume from 2004. Operating expenses and imputed costs for noncash operations totaled $1.1 million in 2005, and revenue and other income totaled $1.2 million, resulting in net income of approximately $0.1 million.


The Federal Reserve had daily average debit float of $133.4 million in 2005, compared with credit float of $76.4 million in 2004. 5

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Developments in Currency and Coin

The Federal Reserve Banks distribute the nation's currency (in the form of Federal Reserve notes) and coin through depository institutions and receive currency and coin from circulation. As currency flows into the Reserve Banks, the Banks inspect the notes and destroy those that are unfit for recirculation.

The Reserve Banks received 37.2 billion Federal Reserve notes from circulation in 2005, a 0.9 percent decrease from 2004, and made payments of 38.5 billion notes into circulation, a 1.6 percent increase from 2004. They received 56.1 billion coins from circulation in 2005, a 0.8 percent increase from 2004, and made payments of 72.1 billion coins into circulation, a 6.9 percent increase from 2004. 6

Because many depository institutions overuse Reserve Bank cash-processing services, the Board in 2003 requested comment on a policy of providing incentives to encourage depository institutions to recirculate fit currency to their customers rather than return it to the Federal Reserve for processing. Under the policy, the Federal Reserve would establish a custodial inventory program that allows depository institutions to transfer a portion of their cash holdings to the books of a Reserve Bank. Reserve Banks would charge fees to institutions that, within a one-week period, deposited fit currency and reordered currency of the same denomination within the same Reserve Bank office's service area. The Reserve Banks conducted a custodial inventory proof-of-concept program in 2004 to test the effectiveness of a program that supports the proposed policy and evaluated the program in 2005. The Reserve Banks believe that a permanent custodial inventory program, together with recirculation fees, would provide incentives to depository institutions to recirculate currency.

Study of the proposed policy's potential effects on the quality of currency in circulation continues. In 2005, the Federal Reserve worked with vending industry representatives to determine the effect of quality variance on machines' ability to accept currency. The Federal Reserve is also developing a technical definition of currency that is "fit for commerce" and a Reserve Bank program to monitor and control the quality of currency in circulation. The Board is expected to consider approval of a final recirculation policy in early 2006.

The Reserve Banks also continue to study cost-effective alternatives to the existing infrastructure for providing cash services. Earlier studies resulted in the elimination of cash operations at the Little Rock, Louisville, Buffalo, and Portland (Oregon) offices and the replacement of these offices with cash depots. In a cash depot arrangement, armored carrier facilities serve as collection and distribution points for depository institutions' currency deposits and orders. The deposits and orders are transported to and from a nearby Reserve Bank by armored carrier.

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Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2003-2005
Thousands of dollars
Agency and service 2005 2004 2003
Department of the Treasury  
Bureau of the Public Debt  
Treasury retail securities  
Savings bonds 59,624.0 72,385.1 66,403.7
TreasuryDirect and Treasury coupons 26,879.2 30,872.7 33,013.5
Treasury securities safekeeping and transfer 6,055.8 6,267.0 4,836.3
Treasury auction 17,553.5 17,159.5 16,802.6
Computer infrastructure development and support 2,575.5 5,935.1 7,836.7
Other services 1,806.5 1,709.8 1,460.7
Total 114,494.5 134,329.1 130,353.4
Financial Management Service  
Payment services  
Government check processing 20,988.0 24,245.4 25,624.7
Automated clearinghouse 5,709.5 5,352.9 6,253.9
Fedwire funds transfers 109.4 111.6 187.3
Other payment-related services 49,366.0 33,646.9 23,630.8
Collection services  
Tax and other revenue collections 39,736.0 34,248.4 29,782.9
Other collection-related services 14,354.2 12,922.8 12,532.6
Cash management services 40,496.7 21,835.8 18,227.8
Computer infrastructure development and support 67,703.3 52,673.3 24,575.3
Other services 2,332.2 6,931.6 6,666.2
Total 240,795.4 191,968.6 147,481.5
Other Treasury  
Total 15,726.7 15,106.1 13,913.5
Total, Treasury 371,016.6 341,403.7 291,748.5
Other Federal Agencies  
Department of Agriculture  
Food coupons 2,642.4 4,519.0 7,791.4
U.S. Postal Service  
Postal money orders 7,647.8 7,774.6 10,959.5
Other agencies  
Other services 14,870.2 16,104.0 16,508.2
Total, other agencies 25,160.4 28,397.5 35,259.2
Total reimbursable expenses 396,177.0 369,801.2 327,007.7

Developments in Fiscal Agency and Government Depository Services

As fiscal agents and depositories for the federal government, the Federal Reserve Banks provide services related to the federal debt, help the Treasury collect funds owed to the federal government, process electronic and check payments for the Treasury, maintain the Treasury's bank account, and invest excess Treasury balances. The Reserve Banks also provide limited fiscal agency and depository services to other entities.

The total cost of providing fiscal agency and depository services to the Treasury and other entities in 2005 amounted to $396.2 million, compared with $369.8 million in 2004 (table). Treasury-related costs were $371 million in 2005, compared with $341.4 million in 2004, an increase of 8.7 percent. The cost of providing services to other entities was $25.2 million, compared with $28.4 million in 2004. In 2005, as in 2004, the Treasury and other entities reimbursed the Reserve Banks for the costs of providing these services.

The most-significant development in the provision of fiscal agency services in 2005 was the Reserve Banks' consolidation of customer service and back-office operations that support the Treasury's retail securities programs, through which retail investors purchase and hold marketable Treasury securities and savings bonds. As the Treasury replaced paper processes in retail securities with more-efficient electronic processes, fewer operations sites were needed. The consolidation to two sites was completed in October 2005. The Banks expect that annual operating costs for retail securities operations will decline considerably in 2006 because of lower personnel costs.

Debt Services

The Reserve Banks auction, provide safekeeping for, and transfer Treasury securities. Reserve Bank operating expenses for these activities totaled $23.6 million in 2005, a slight increase from 2004. The Banks processed 245,000 tenders for Treasury securities, compared with 156,000 in 2004. They originated 12.6 million transfers of Treasury securities in 2005, an 18.6 percent increase from 2004.

The Reserve Banks also operate computer applications and provide customer service and back-office support for the Treasury's retail securities programs, including Treasury securities and savings bonds. Reserve Bank operating expenses for these activities were $86.5 million in 2005, compared with $103.3 million in 2004.

In addition, the Reserve Banks operate Treasury Direct, a program that allows investors to purchase and hold Treasury securities directly with the Treasury instead of through a broker. The program held $68.1 billion (par value) of Treasury securities as of December 31, 2005. Because the program was designed for investors who plan to hold their securities to maturity, it does not provide transfer services. Investors may, however, sell their securities for a fee through Sell Direct, a program operated by one of the Reserve Banks. Approximately 14,000 securities worth $874.8 million were sold through Sell Direct in 2005, compared with 15,000 securities worth $673.3 million in 2004. Fees associated with the sale of securities through Sell Direct totaled $566,000, an increase of 12.2 percent from the more than $504,000 in fees collected in 2004.

The Banks printed and mailed more than 32 million savings bonds in 2005, a 9.6 percent decrease from 2004. They issued more than 3 million Series I (inflation indexed) bonds and 12.6 million Series EE bonds. Reissued or exchanged bonds accounted for the remaining bonds printed. The Banks processed about 3.5 million redemption, reissue, and exchange transactions, a 9.6 percent decrease from 2004.

Payments Services

The Reserve Banks process both electronic and check payments for the Treasury. Reserve Bank operating expenses for processing government payments totaled $76.2 million in 2005, compared with $63.4 million in 2004. The Banks processed 981 million ACH payments for the Treasury, an increase of 4.4 percent from 2004, and more than 849,000 Fedwire funds transfers. They also processed 214.8 million paper government checks, a decline of 8.3 percent from 2004. In addition, the Banks issued more than 206,000 fiscal agency checks, a decrease of 25.9 percent from 2004.

In addition to processing payments, the Reserve Banks operate several programs to help the Treasury increase the use of electronic payments. One such program, the Automated Standard Application for Payment, enables recipients of federal grants to request payments using the Internet. This application processed $423.8 billion in Fedwire funds transfers and ACH payments in 2005, compared with $404.7 billion in 2004. Another such program, the stored-value card program, provides salary and benefit payments to military personnel, via a smart card, for use at military bases. In 2005, the Banks worked with the Treasury to plan a web-based application to allow federal agencies and vendors to exchange purchase orders and invoices and initiate ACH payments electronically. The operating costs for these three programs totaled $19.7 million in 2005, compared with $15.4 million in 2004.

Collection Services

The Reserve Banks support several Treasury programs to collect funds owed the federal government. Reserve Bank operating expenses related to these programs totaled $54.1 million in 2005, compared with $47.2 million in 2004. The Banks operate the Federal Reserve Electronic Tax Application (FR-ETA) as an adjunct to the Treasury's Electronic Federal Tax Payment System (EFTPS). EFTPS allows businesses and individual taxpayers to pay their taxes electronically. It uses the automated clearinghouse (ACH) to collect funds, so tax payments must be scheduled at least one day in advance. Some business taxpayers, however, do not know their tax liability until the tax due date. FR-ETA allows these taxpayers to use EFTPS by providing a same-day electronic federal tax payment alternative. FR-ETA collected $409.2 billion for the Treasury in 2005, compared with $344.8 billion in 2004.

In addition, the Reserve Banks operate, a Treasury program that allows members of the public to pay for goods and services offered by the federal government over the Internet. They also operate the Treasury's Paper Check Conversion and Electronic Check Processing programs, whereby checks written to government agencies are converted into ACH transactions at the point of sale or at lockbox locations. In 2005, the Reserve Banks originated more than 2.6 million ACH transactions through these programs, a 36 percent increase from the 1.9 million originated in 2004.

Cash Management Services

The Treasury maintains its bank account at the Reserve Banks and invests the funds it does not need for current payments with qualified depository institutions through the Treasury Tax and Loan (TT&L) program, which the Reserve Banks operate. Reserve Bank operating expenses related to this program totaled $40.5 million in 2005, compared with $21.8 million in 2004. The investments either are callable on demand or are for a set term. In 2005, the Reserve Banks placed a total of $8.8 billion in immediately callable investments and $574.1 billion in term investments. The rate for term investments is set at auction; the Reserve Banks held 104 such auctions in 2005, compared with 45 auctions in 2004. In 2005, the Treasury's income from the TT&L program was $597.4 million.

Services Provided to Other Entities

The Reserve Banks provide fiscal agency and depository services to other domestic and international entities when required to do so by the Secretary of the Treasury or when required or permitted to do so by federal statute. The majority of the work is securities-related.

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Electronic Access to Reserve Bank Services

The Federal Reserve Banks have been using a DOS-based platform, FedLine, to provide services and information to about seven thousand depository institution end points, mainly small and medium-sized institutions. A more-efficient replacement delivery channel, FedLine Advantage, which uses Internet web technologies to provide financial institutions with access to such critical payment systems as Fedwire Funds Service, Fedwire Securities Service, and FedACH Services, has been developed. Migration to FedLine Advantage began in 2005 and will be completed in 2006.

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The Federal Reserve System's Response to Hurricane Katrina

The damage from Hurricane Katrina's strike along the Gulf Coast on August 29, 2005, and the subsequent flooding of much of New Orleans when levees were breached, seriously affected the banking system's ability to provide financial services at a time when individuals and businesses needed access to their funds. Some depository institutions were flooded and unable to open. Others in the Gulf Coast region that were not severely damaged and might have opened were unable to do so because of interruptions to utility services or a shortage of employees. The transportation of cash for distribution to the public was impeded, and the process of presenting and collecting checks was disrupted.

These conditions presented challenges to the Federal Reserve, which is charged with distributing the nation's currency and coin and provides check-collection services to depository institutions. In the Gulf Coast region, the Federal Reserve conducts these operations through the New Orleans Branch of the Atlanta Federal Reserve Bank. The New Orleans Branch building was not flooded and sustained only minor damage from the hurricane. Only a few essential employees were able to remain in the building, however, so the Branch was unable to provide services as usual. Nonetheless, even before Hurricane Katrina struck, the Branch implemented its contingency operations plans by relocating certain essential employees from New Orleans to the Atlanta Bank's Birmingham, Alabama, Branch, and it quickly began providing services to depository institutions through other Federal Reserve offices. Recognizing that depository institutions faced gasoline shortages and could incur high costs to obtain cash from offices outside New Orleans, the Atlanta and Dallas Reserve Banks arranged for armored carriers to transport cash into the affected areas.

To further support recovery efforts, the Atlanta Reserve Bank also opened drop-off points for check deposits a few days after the hurricane. These deposits were then transported to the Bank's Atlanta office for processing. Staff from other Federal Reserve offices--and, subsequently, relocated New Orleans employees--have continued to process checks in Atlanta. The Atlanta Bank provided credit for deposited checks drawn on depository institutions in the New Orleans area even though it was initially unable to present checks to those institutions for collection, and it did not return the checks that it could not present. During the crisis, the number of checks drawn on New Orleans area institutions that cleared through the Federal Reserve rose significantly as checks that would normally have cleared through other channels were redirected through the Federal Reserve.

As depository institutions in the affected area began operating at contingency locations, the Atlanta Reserve Bank contacted those institutions to gather information on their situation, particularly on their liquidity and their ability to process payments. Reestablishing contact with depository institutions--an effort on which the Federal Reserve worked closely with other regulatory agencies--was critical, as some institutions had difficulty restoring their operations and were unable to retrieve their ACH (automated clearinghouse) files, which contained information on payroll, Social Security, and other credit payments that their customers needed in this time of crisis.

The Board also worked with key government finance and banking regulatory agencies to devise a strategy for restoring vital telecommunications services to affected institutions. The Board served as the central point of contact for management of the overall restoration effort under the Telecommunications Service Priority (TSP) program--a federal program that identifies and prioritizes those telecommunications services essential to national security and emergency preparedness. 1 Most institutions that were assigned high TSP priority had some measure of telecommunications services available within a matter of days.

1. The TSP program is administered by the National Communications System (NCS), an interagency group of federal departments and agencies that plans for and coordinates national security and emergency preparedness telecommunications, especially during crises. Return to text

Information Technology

In 2005, the Federal Reserve Banks completed projects to standardize local area network components and telephone private branch exchange systems and to implement reduced-cost wide area network telecommunications services. An initiative is now under way to strengthen information security controls across the System.

In partnership with the agencies that make up the Financial and Banking Information Infrastructure Committee, the Federal Reserve continued in 2005 to sponsor clearing and settlement utilities, key financial institutions, and key market participants in the national security and emergency preparedness programs offered by the Department of Homeland Security's National Communications System, which coordinates activities to ensure that critical telecommunications services are prepared to meet natural disasters and national emergencies. The Board's role in implementing one of these programs--the Telecommunications Service Priority program--to help restore telecommunications services to financial institutions in Mississippi and Louisiana in the wake of Hurricane Katrina and the subsequent flooding in New Orleans is described in the accompanying box.

In response to recommendations in the 2004 report of the Financial Services Task Force of the President's National Security Telecommunications Advisory Committee, the Federal Reserve in 2005 partnered with the Alliance for Telecommunications Industry Solutions (ATIS) on a collaborative project. The team assessed the ability to track changes in the way telecommunications circuits are routed to customer locations and determined that there is currently no commercially viable product that can be adopted to automate this process. The greater the number of carriers involved in providing services, the more difficult it becomes to track such changes. A diverse network provides more protection against disruption of service during contingencies, however, because diversity lessens the risk of a single point of failure. A report on this initiative, the National Diversity Assurance Initiative, was released in February 2006.

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Examinations of the Federal Reserve Banks

Section 21 of the Federal Reserve Act requires the Board of Governors to order an examination of each Federal Reserve Bank at least once a year. The Board engages a public accounting firm to perform an annual audit of the combined financial statements of the Reserve Banks (see the section "Federal Reserve Banks Combined Financial Statements"). The accounting firm also audits the annual financial statements of each of the twelve Banks. The Reserve Banks use the framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in assessing their internal controls over financial reporting, including the safeguarding of assets. In 2005, the Reserve Banks further enhanced their assessments under the COSO framework, strengthening the key control assertion process, consistent with the requirements of the Sarbanes-Oxley Act of 2002. Within this framework, management of each Reserve Bank provides an assertion letter to its board of directors annually confirming adherence to COSO standards, and a public accounting firm certifies management's assertion and issues an attestation report to the Bank's board of directors and to the Board of Governors.

The firm engaged for the audits of the individual and combined financial statements of the Reserve Banks for 2005 was PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $4.6 million. To ensure auditor independence, the Board requires that PwC be independent in all matters relating to the audit. Specifically, PwC may not perform services for the Reserve Banks or others that would place it in a position of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit independence. In 2005, the Reserve Banks did not engage PwC for non-audit services.

The Board's annual examination of the Reserve Banks includes a wide range of off-site and on-site oversight activities conducted by the Division of Reserve Bank Operations and Payment Systems. Division personnel monitor the activities of each Reserve Bank on an ongoing basis and conduct on-site reviews based on the division's risk- assessment methodology. The 2005 examinations also included assessing the efficiency and effectiveness of the internal audit function. To assess compliance with the policies established by the Federal Reserve's Federal Open Market Committee (FOMC), the division also reviews the accounts and holdings of the System Open Market Account at the Federal Reserve Bank of New York and the foreign currency operations conducted by that Bank. In addition, PwC audits the schedule of participated asset and liability accounts and the related schedule of participated income accounts at year-end. The FOMC receives the external audit reports and the report on the division's examination.

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Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2005 and 2004
Millions of dollars
Item 2005 2004
Current income 30,729 23,540
Current expenses 2,890 2,239
Operating expenses 1 2,677 2,123
Earnings credits granted 213 116
Current net income 27,840 21,301
Net additions to (deductions from, - ) current net income -3,577 918
Assessments by the Board of Governors 743 776
For expenditures of Board 266 272
For cost of currency 477 504
Net income before payments to Treasury 23,520 21,443
Dividends paid 781 582
Transferred to surplus 1,272 2,783
Payments to Treasury 2 21,468 18,078

1. Includes net periodic pension credit of $11 million in 2005 and $37 million in 2004. Return to table
2. Interest on Federal Reserve notes.   Return to table

Income and Expenses

The accompanying table summarizes the income, expenses, and distributions of net earnings of the Federal Reserve Banks for 2004 and 2005.

Income in 2005 was $30,729 million, compared with $23,540 million in 2004. Expenses totaled $3,633 million ($2,677 million in operating expenses, $213 million in earning scredits granted to depository institutions, $266 million in assessments for expenditures by the Board of Governors, and $477 million for the cost of new currency). Revenue from priced services was $901 million. The profit and loss account showed a net loss of $3,577 million. The loss was due primarily to unrealized losses on assets denominated in foreign currencies revalued to reflect current market exchange rates. Statutory dividends paid to member banks totaled $781 million, $199 million more than in 2004; the increase reflects an increase in the capital and surplus of member banks and a consequent increase in the paid-in capital stock of the Reserve Banks.

Payments to the U.S. Treasury in the form of interest on Federal Reserve notes totaled $21,468 million in 2005, up from $18,078 million in 2004; the payments equal net income after the deduction of dividends paid and of the amount necessary to equate the Reserve Banks' surplus to paid-in capital.

In the "Statistical Tables" section of this report, table 10 details the income and expenses of each Reserve Bank for 2005 and table 11 shows a condensed statement for each Bank for the years 1914 through 2005; table 9 is a statement of condition for each Bank, and table 13 gives number and annual salaries of officers and employees for each. A detailed account of the assessments and expenditures of the Board of Governors appears in the section "Board of Governors Financial Statements."

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Securities and Loans of the Federal Reserve Banks, 2003-2005
Millions of dollars except as noted
Item and year Total U.S. government
securities 1
Loans 2
Average daily holdings 3  
2003 683,438 683,294 144
2004 719,647 719,494 153
2005 761,509 761,295 214
Earnings 4
2003 22,598 22,597 1
2004 22,347 22,344 3
2005 28,966 28,959 7
Average interest rate (percent)  
2003 3.31 3.31 1.00
2004 3.11 3.11 1.74
2005 3.80 3.80 3.49

1. Includes federal agency obligations. Return to table
2. Does not include indebtedness assumed by the Federal Deposit Insurance Corporation. Return to table
3. Based on holdings at opening of business. Return to table
4. Earnings have not been netted with the interest expense on securities sold under agreements to repurchase. Return to table

Holdings of Securities and Loans

The Federal Reserve Banks' average daily holdings of securities and loans during 2005 amounted to $761,509 million, an increase of $41,862 million from 2004 (table). Holdings of U.S. government securities increased $41,801 million, and holdings of loans increased $61 million. The average rate of interest earned on the Reserve Banks' holdings of government securities increased to 3.80 percent, from 3.11 percent in 2004, and the average rate of interest earned on loans increased to 3.49 percent, from 1.74 percent.

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Volume of Operations

Table 12 in the "Statistical Tables" section shows the volume of operations in the principal departments of the Federal Reserve Banks for the years 2002 through 2005.

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Federal Reserve Bank Premises

In 2005, construction was completed on new buildings for the Dallas Federal Reserve Bank's Houston Branch and the Chicago Bank's Detroit Branch, and construction began on the Kansas City Bank's new headquarters building after the Board approved the project's final design. Design work continued, and site preparation work began, for the San Francisco Bank's new Seattle Branch building. The multiyear renovation program at the New York Bank's headquarters building continued, as did facility renovation projects at several Reserve Bank offices to accommodate the consolidation of check activities.

Security enhancement programs continue at several facilities. One such project is an ongoing external perimeter security improvement project at the Boston Bank. Another is taking place at the St. Louis Bank, where, as part of a long-term facility redevelopment program, construction of a new pedestrian entrance screening vestibule was completed and design work for an addition to the Bank's headquarters building continued. The St. Louis Bank also completed the purchase and renovation of a building to be used as a business-continuity relocation facility. In addition, the Richmond Bank completed renovation of a building to be used as a relocation site for critical staff and initiated construction of additional security improvements to the building. The Dallas Bank completed the purchase of property behind its headquarters building for the construction of a remote vehicle screening and shipping/receiving facility.

Also during 2005, the Board approved the Richmond Bank's purchase of property adjacent to its headquarters building for construction of a new parking garage, and the sales of the New York Bank's Buffalo Branch and the Kansas City Bank's headquarters building were finalized. Efforts to sell the Chicago Bank's Detroit Branch building, the St. Louis Bank's Little Rock Branch building, and the San Francisco Bank's Seattle and Portland Branch buildings continued, as did efforts by the Dallas Bank to sell excess land at its Houston Branch and to lease excess space in the Branch building.

Administrative activities for the Buffalo, Louisville, and Little Rock Branches were moved to leased facilities. Check operations formerly conducted at the San Francisco Bank's Seattle and Portland Branches were consolidated and relocated to a leased facility near the Seattle airport. The Portland Branch cash operation was relocated to the current Seattle Branch building until the new building is completed.

Although utility services were interrupted, the Atlanta Bank maintained the security and building systems operations of its New Orleans Branch building during Hurricane Katrina. Because the building sits several feet above flood level, it was not damaged by flooding.

Table 14 in the "Statistical Tables" section of this report details the acquisition costs and net book value of the Federal Reserve Banks and Branches.

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Pro Forma Financial Statements for Federal Reserve Priced Service

Pro Forma Balance Sheet for Priced Services, December 31, 2005 and 2004
Item 2005 2004
Short-term assets ( Note 1 )  
Imputed reserve requirements on clearing balances 993.2   1,115.7  
Imputed investments 8,626.4   9,691.9  
Receivables 77.0   75.8  
Materials and supplies 1.3   1.9  
Prepaid expenses 25.6   31.8  
Items in process of collection 5,934.4   6,107.1  
Total short-term assets   15,657.7   17,024.1
Long-term assets ( Note 2 )  
Premises 424.5   471.8  
Furniture and equipment 156.1   152.8  
Leases, leasehold improvements, and long-term prepayments 88.5   107.9  
Prepaid pension costs 796.8   795.4  
Total long-term assets   1,465.9   1,528.0
Total assets   17,123.6   18,552.1
Short-term liabilities  
Clearing balances and balances arising from early credit of uncollected items 10,703.2   11,909.5  
Deferred-availability items 5,163.0   5,354.3  
Short-term debt .0   .0  
Short-term payables 126.2   92.2  
Total short-term liabilities   15,992.4   17,355.9
Long-term liabilities  
Long-term debt .0   .0  
Postretirement/postemployment benefits obligation 275.0   268.6  
Total long-term liabilities   275.0   268.6
Total liabilities   16,267.4   17,624.5
Equity   856.2   927.6
Total liabilities and equity ( Note 3 )   17,123.6   18,552.1

Note: Components may not sum to totals because of rounding.
The accompanying notes are an integral part of these pro forma priced services financial statements.

Pro Forma Income Statement for Federal Reserve Priced Services, 2005 and 2004
Item 2005 2004
Revenue from services provided to depository institutions ( Note 4 )   901.0   865.9
Operating expenses ( Note 5 )   750.0   800.6
Income from operations   150.9   65.3
Imputed costs ( Note 6 )  
Interest on float 6.1   -.1  
Interest on debt .0   .0  
Sales taxes 11.3   11.6  
FDIC insurance    .0  17.4    .0  11.4
Income from operations after imputed costs   133.5   53.8
Other income and expenses ( Note 7 )  
Investment income 292.7   156.8  
Earnings credits -199.0  93.7 -108.1  48.7
Income before income taxes   227.2   102.5
Imputed income taxes ( Note 6 )    67.3    30.6
Net income   160.0   72.0
Memo: Targeted return on equity ( Note 6 )   103.0   112.4

Note: Components may not sum to totals because of rounding.
The accompanying notes are an integral part of these pro forma priced services financial statements.

Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2005
Item Total Commercial
Revenue from services ( Note 4 ) 901.0 740.3 61.0 19.3 79.3 1.1
Operating expenses ( Note 5 ) 750.0 619.0  49.3  15.5  65.1   1.1
Income from operations 150.9 121.3 11.7 3.8 14.1 .0
Imputed costs ( Note 6 )  17.4  15.5    .9    .3    .6    .0
Income from operations after imputed costs 133.5 105.7 10.9 3.4 13.5 .0
Other income and expenses, net ( Note 7 )  93.7  77.1   6.3   2.0   8.2    .1
Income before income taxes 227.2 182.9 17.2 5.4 21.6 .1
Imputed income taxes ( Note 6 )  67.3  54.1   5.1   1.6   6.4    .0
Net income 160.0 128.7 12.1 3.8 15.2 .1
Memo: Targeted return on equity ( Note 6 ) 103.0 82.0 7.9 2.9 10.0 .2

Note: Components may not sum to totals because of rounding.
     The accompanying notes are an integral part of these pro forma priced services financial statements.


Notes to Pro Forma Financial Statements for Priced Services

(1) Short-Term Assets

The imputed reserve requirement on clearing balances held at Reserve Banks by depository institutions reflects a treatment comparable to that of compensating balances held at correspondent banks by respondent institutions. The reserve requirement imposed on respondent balances must be held as vault cash or as non-earning balances maintained at a Reserve Bank; thus, a portion of priced services clearing balances held with the Federal Reserve is shown as required reserves on the asset side of the balance sheet. Another portion of the clearing balances is used to finance short-term and long-term assets. The remainder of clearing balances is assumed to be invested in a portfolio of investments, shown as imputed investments.

Receivables are (1) amounts due the Reserve Banks for priced services and (2) the share of suspense-account and difference-account balances related to priced services.

Materials and supplies are the inventory value of short-term assets.

Prepaid expenses include salary advances and travel advances for priced-service personnel.

Items in process of collection is gross Federal Reserve cash items in process of collection (CIPC) stated on a basis comparable to that of a commercial bank. It reflects adjustments for intra-System items that would otherwise be double-counted on a consolidated Federal Reserve balance sheet; adjustments for items associated with nonpriced items, such as those collected for government agencies; and adjustments for items associated with providing fixed availability or credit before items are received and processed. Among the costs to be recovered under the Monetary Control Act is the cost of float, or net CIPC during the period (the difference between gross CIPC and deferred-availability items, which is the portion of gross CIPC that involves a financing cost), valued at the federal funds rate.Return to table

(2) Long-Term Assets

Consists of long-term assets used solely in priced services, the priced-services portion of long-term assets shared with nonpriced services, and an estimate of the assets of the Board of Governors used in the development of priced services. Effective Jan. 1, 1987, the Reserve Banks implemented the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions (SFAS 87). Accordingly, the Reserve Banks recognized a credit to expenses for the qualified pension plan of $1.3 million in 2005 and a credit to expenses of $7.5 million in 2004 with a corresponding increase in this asset account.Return to table

(3) Liabilities and Equity

Under the matched-book capital structure for assets, short-term assets are financed with short-term payables and clearing balances. Long-term assets are financed with long-term liabilities and clearing balances. As a result, no short- or long-term debt is imputed. Other short-term liabilities include clearing balances maintained at Reserve Banks and deposit balances arising from float. Other long-term liabilities consist of accrued postemployment, postretirement, and nonqualified pension benefits costs and obligations on capital leases.

Equity is imputed at 5 percent of total assets based on the Federal Deposit Insurance Corporation's definition of a well-capitalized institution for deposit insurance premium purposes.Return to table

(4) Revenue

Revenue represents charges to depository institutions for priced services and is realized from each institution through one of two methods: direct charges to an institution's account or charges against its accumulated earnings credits.Return to table

(5) Operating Expenses

Operating expenses consist of the direct, indirect, and other general administrative expenses of the Reserve Banks for priced services plus the expenses for staff members of the Board of Governors working directly on the development of priced services. The expenses for Board staff members were $6.6 million in 2005 and $7.6 million in 2004. The net credit to expenses under SFAS 87 (see note 2) that includes the nonqualified pension expense of $1.0 million in 2005 is reflected in operating expenses.

The income statement by service reflects revenue, operating expenses, and imputed costs. Certain corporate overhead costs not closely related to any particular priced service are allocated to priced services in total based on an expense-ratio method, but are allocated among priced services based on management decision.

Corporate overhead was allocated among the priced services during 2005 and 2004 as follows (in millions):

2005 2004
Check........................................... 29.4 33.5
ACH............................................. 3.7 3.4
Fedwire funds.............................. 2.6 2.5
Fedwire securities....................... 1.3 1.3
Noncash services........................ .1 .1
Total............................................. 37.1 40.8
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(6) Imputed Costs

Imputed costs consist of income taxes, return on equity, interest on debt, sales taxes, the FDIC assessment, and interest on float. Many imputed costs are derived from the private-sector adjustment factor (PSAF) model, which uses bank holding companies as the proxy for a private-sector firm. The cost of debt and the effective tax rate from the PSAF model are used to impute debt and income taxes. The after-tax rate of return on equity is used to impute the profit that would have been earned had the services been provided by a private-sector firm.

Interest is imputed on the debt assumed necessary to finance priced-service assets; however, no debt wasimputed in 2005 or 2004. The sales taxes and FDIC assessment that the Federal Reserve would have paid had it been a private-sector firm are also among the components of the PSAF.

Interest on float is derived from the value of float to be recovered, either explicitly or through per-item fees, during the period. Float costs include costs for checks, book-entry securities, noncash collection, ACH, and funds transfers.

Float cost or income is based on the actual float incurred for each priced service. Other imputed costs are allocated among priced services according to the ratio of operating expenses less shipping expenses for each service to the total expenses for all services less the total shipping expenses for all services.

The following list shows the daily average recovery of actual float by the Reserve Banks for 2005 in millions of dollars:

Total float 134.3
Unrecovered float 11.9
Float subject to recovery 122.5
Sources of recovery of float  
    Income on clearing balances 12.3
    As-of adjustments -1.0
    Direct charges 837.7
    Per-item fees -728.4

Unrecovered float includes float generated by services to government agencies and by other central bank services. Float recovered through income on clearing balances is the result of the increase in investable clearing balances; the increase is produced by a deduction for float for cash items in process of collection, which reduces imputed reserve requirements. The income on clearing balances reduces the float to be recovered through other means. As-of adjustments and direct charges refer to float that is created by interterritory check transportation and the observance of non-standard holidays by some depository institutions. Such float may be recovered from the depository institutions through adjustments to institution reserve or clearing balances or by billing institutions directly. Float recovered through direct charges and per-item fees is valued at the federal funds rate; credit float recovered through per-item fees has been subtracted from the cost base subject to recovery in 2005.Return to table

(7) Other Income and Expenses

Consists of investment income on clearing balances and the cost of earnings credits. Investment income on clearing balances for 2004 and 2005 represents the average coupon-equivalent yield on three-month Treasury bills plus a constant spread, based on the return on a portfolio of investments. In both years, the return is applied to the total clearing balance maintained, adjusted for the effect of reserve requirements on clearing balances. Expenses for earnings credits granted to depository institutions on their clearing balances are derived by applying a discounted average coupon-equivalent yield on three-month Treasury bills to the required portion of the clearing balances, adjusted for the net effect of reserve requirements on clearing balances.Return to table

1. In addition to income taxes and the return on equity, the PSAF is made up of three imputed costs: interest on debt, sales taxes, and assessments for deposit insurance by the Federal Deposit Insurance Corporation (FDIC). Board of Governors assets and personnel costs that are related to priced services are also allocated to priced services; in the pro forma statements at the end of this chapter, Board expenses are included in operating expenses and Board assets are part of long-term assets. Return to text
2. Financial data reported throughout this chapter--revenue, other income, cost, net revenue, and income before taxes--can be linked to the pro forma statements at the end of this chapter. Other income is revenue from investment of clearing balances net of earnings credits, an amount termed net income on clearing balances. Total cost is the sum of operating expenses, imputed costs (interest on debt, interest on float, sales taxes, and the FDIC assessment), imputed income taxes, and the targeted return on equity. Return to text
3. The Federal Reserve System's retail payments research suggests that the number of checks written in the United States has been declining since the mid-1990s. For details, see Federal Reserve System, "The 2004 Federal Reserve Payments Study: Analysis of Noncash Payments Trends in the United States, 2000-2003" (December 2004). ( (223 KB PDF) Return to text
4. The expenses, revenues, and volumes reported here are for transfers of securities issued by federal government agencies, government-sponsored enterprises, and certain international organizations. The Treasury Department assesses fees on depository institutions for some of the transfer, account maintenance, and settlement services for U.S. Treasury securities provided by the Reserve Banks. For details, see the section "Debt Services" later in this chapter.    Return to text
5. Credit float occurs when the Reserve Banks receive settlement for items prior to providing credit to the depositing institution, and debit float occurs when the Reserve Banks credit the depositing institution prior to receiving settlement.    Return to text
6. Percentages reflect restatements of previously reported data.    Return to text

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