CUNA Regulatory Comment Call


February 6, 2001

Price Change In Federal Reserve Payments Services

(NOT A MAJOR RULE)

EXECUTIVE SUMMARY

The Federal Reserve System (Board) has published a request for comments on proposed changes to modify the Federal Reserve Banks’ (Reserve Banks) pricing for payments services, . Comments are due by April 6, 2001. Please submit your comments to CUNA by March 20, 2001. The Board is conducting this review as part of its routine assessment of whether its payments services are competitive. This proposal impacts credit unions because it may change the cost of payments services provided by the Reserve Banks.

Please feel free to fax your responses to CUNA at 202-371-8240; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com or to Assistant General Counsel Michelle Profit at mprofit@cuna.com; or mail them to Mary or Michelle c/o CUNA’s Regulatory Advocacy Department, 805 15th Street, NW, Suite 300, Washington, DC 20005. This notice was published in the Federal Register on December 28, 2000. A copy of the notice is here http://www.access.gpo.gov/su_docs/fedreg/a001228c.html.

CUNA attended a meeting hosted by the Board on this notice on February 2, 2001.

  • This proposal modifies the formula for calculating the private sector adjustment factor (PSAF) which affects the prices that Reserve Banks charge for payments services such as check collection and ACH processing. The Monetary Control Act of 1980 requires that the Reserve Banks set fees for their services that recoup their actual costs and their imputed costs and profits, known as the PSAF. The PSAF is equivalent to the costs the Reserve Banks would have incurred and the profits that they would have retained had they been a private sector firm. The fees of the Reserve Bank must recover the PSAF and actual costs, so altering the PSAF affects fees.

  • According to the Board, the proposed changes in the PSAF formula would produce no significant change (less than 2 percent) in the Reserve Banks' prices for payment services.

  • The Federal Reserve proposes to alter calculation of the PSAF by modifying the method for imputing debt and equity; changing the method for determining the target rate of return on equity, and continuing its use of data from the fifty largest bank holding companies as a proxy.

BRIEF BACKGROUND

The current PSAF formula is based on the following calculations and projections:

  • actual assets are projected;
  • short-term assets are assumed to be financed with short-term liabilities and long-term assets are assumed to be financed with a combination of long-term debt and equity;
  • the financing rates and the combination of financing types are based on data developed from the financial data for the nation's fifty bank holding companies (BHCs) with the largest asset size;
  • imputed taxes are captured using a pre-tax return on equity (ROE);
  • the PSAF is adjusted for the tax expense or savings associated with the adjusted recovery;
  • the variable PSAF tax rate is the median of the rates paid by the BHCs over the past five years adjusted to the extent that the BHCs invest in municipal bonds;
  • the PSAF includes the estimated priced-services expenses of the Board of Governors, imputed sales taxes, and an assessment for FDIC insurance; and
  • the net income on clearing balances (NICB) assumes that the Reserve Banks invest the clearing balances net of imputed reserves, and imputes an equal investment in three-month Treasury bills.

RULE

The Board has proposed the following modifications to the PSAF formula.

  • Overall, the new formula for calculating the PSAF for 2001 would reduce it. As a result, the change on payments services prices would be negligible or within the margin of error. The net effect would be to reduce the price model by about 2 percent.
  • Under the proposal, a portion of the contracted clearing balances would be considered "core deposits," in other words, deposits that will remain stable without clearing balances. According to the Federal Reserve, this use is consistent with a deposit organization's use of deposits. These core deposits are stable enough, so that a substantial portion of the balances can be used to fund longer-term assets.
  • The proposal recommends that $4 billion of clearing balances (out of more than $7 billion clearing balances currently maintained) could initially be considered available to finance long-term assets.
  • The Board proposes targeting an equity level sufficient to satisfy the FDIC requirement for a well-capitalized institution, which is currently 5 percent of total assets and 10 percent of risk-weighted assets. This proposal is consistent with how the Board believes rational bank management would target its equity level.
  • The target return on equity for Reserve Bank priced services is based on the average of three methods. The first model is the comparable accounting earnings (CAE) model. The shortcomings to this model are that it uses historical data from the two to seven years before the target year to predict future earnings and is based on book values rather than market values. The Capital Asset Pricing model (CAPM) estimates the imputed BHC ROE from the return on a stock portfolio of the fifty largest BHCs over a one-year period. The Discounted Cash Flow model (DCF model) assumes that a firm's stock price is equal to the present discounted value of all expected future dividends. If the stock price and expected future dividends are known, the implied discount rate for the firm can be calculated and is considered to be the firm's equity cost of capital.
  • The proposed model for calculating ROE would have produced a pre-tax ROE that was on average 230 basis points higher than the ROE produced from the current method for the years from 1983-2001.

QUESTIONS REGARDING THE SYSTEM

  1. The Board requests comment on its proposal to create a priced-services balance sheet that resembles that of a private business firm, using real assets and liabilities, imputing liabilities and equity only to the extent necessary, and more appropriately reflecting the risk inherent in priced-service activity. Do you agree with this approach?









  2. The Board requests comment on the benefits and drawbacks of using core-clearing balances as a source of financing long-term assets. The Board is also interested in opinions on whether establishing an initial level of core balances of $4 billion is reasonable. Is there another way core balances should be calculated? Please explain.









  3. Are the CAE, DCF, and CAPM economic models theoretically sound and should they be used to calculate the PSAF? Does a simple average of the results of the three economic models provide an appropriate ROE?









  4. Is the three-month Treasury-bill rate an appropriate Treasury maturity for use as the risk- free rate in the CAPM? In determining the average risk premium for the market in the CAPM model, is stock market activity since 1927 an appropriate source for data? Does using a rolling ten-year average of bank holding company data provide a reasonable beta for use in the CAPM? Are commercially available consensus forecasts an appropriate measure of future dividends and long- term growth rates for use in the DCF economic model?









  5. Does an equally weighted average of the results of the CAE result in a reasonable ROE? Does a market-weighted average of the results of the CAPM result in a reasonable ROE? Does a market-weighted average of the results of the DCF result in a reasonable ROE?









  6. The Board requests comment on whether the fifty largest (in asset size) bank holding companies continue to be a reasonable data peer group for Reserve Bank priced services activities. The Board would like commenters' views on whether there are ways to adjust BHC data to resemble more closely the Federal Reserve Banks priced-service payment activities. Should any other peer groups be used?









  7. Should the Board change the PSAF if it will likely raise prices for payments services? Should the Board only change the PSAF if it will be price neutral or result in a price decrease?









  8. Should CUNA support this proposal in its entirety or only specific aspects? Are the proposed changes in the PSAF methodology appropriate?









  9. Other comments?









    Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
    Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com
    Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
    Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com
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