Federal Reserve's Key Policies for the Provision
of Financial Services

Frequently Asked Questions about the Federal Reserve's Roles in the Payment System

1. What are the Federal Reserve's roles in the payment system?

In summary, the role of the Federal Reserve in providing payment services is to promote the integrity and efficiency of the payments mechanism and to ensure the provision of payment services to all depository institutions on an equitable basis, and to do so in an atmosphere of competitive fairness. Given the size, speed, and interdependencies of payments, this mission is, and will likely continue to be, even more important than it was when the Federal Reserve was established in 1913.

The Role of the Federal Reserve
Background

Since the Federal Reserve's inception, its active involvement in payments processing has been an integral part of the development of the nation's financial system. The Congress, responding in part to the breakdown of the check-collection system in the early 1900s, made the Federal Reserve an active participant in the payments system when it established the Federal Reserve in 1913. At that time the Congress envisioned that the Federal Reserve would play a dual role as an operator and a regulator of the payments system. The Congress has reaffirmed its commitment to this dual role for the Federal Reserve in the Monetary Control Act of 1980 and the Expedited Funds Availability Act, enacted in 1987.

The Federal Reserve has a wide-ranging participatory role in the payments system. Reserve Banks process checks and provide a nationwide network for the collection of items ineligible for processing through normal check-collection channels, such as matured coupons, bonds, and banker's acceptances. The Federal Reserve assisted in developing the automated clearinghouse system for small-dollar electronic payments and now provides a nationwide electronic ACH network. Depository institutions transfer large-dollar payments over the Federal Reserve's nationwide wire transfer system (Fedwire). The Federal Reserve also operates a book-entry securities service for the safekeeping and transfer of United States Treasury and agency securities. Finally, the Federal Reserve supports a variety of private clearing arrangements by providing settlement services through its nationwide network of account relationships.

This participatory role has served the nation well, contributing directly and indirectly to widespread public confidence in a payments system that is quick, sure, and efficient. The Federal Reserve's participatory role is well suited to the structure of the United States' financial industry. This country has a highly fractionalized banking system spread over wide areas with different types of institutions having differing payments needs. As interstate banking spreads, the underlying public-policy rationale for the Federal Reserve's operational presence in the payments system will continue to be an important consideration. The Federal Reserve will continue to bring to payments markets an overall concern for safety and soundness, promotion of operating efficiency, and equitable access. Indeed, those considerations relating to integrity, efficiency, and access to the payments system will remain at the core of the Federal Reserve's role and responsibilities regarding the operation of the payments system.

From The Federal Reserve in the Payments System, issued 1984; revised 1990.

2. Who oversees the Federal Reserve Banks?

Externally, the safeguards include congressional oversight, directly and through the General Accounting Office, and statutory controls. An additional level of external review is provided by the public through the opportunity to comment on all significant Board proposals. The internal safeguards include oversight by the Board of Governors and Reserve Bank boards of directors through various means, including use of the Board examiners and Reserve Bank internal auditors. Finally, the Federal Reserve itself imposes restrictions upon the conduct of its employees--restrictions intended to avoid even the appearance of impropriety.

From Standards Related to Priced-Service Activities of the Federal Reserve Banks, issued 1984.

Since 1997, an external audit firm has performed an annual audit of the combined Reserve Bank financial statements and the financial statements of each of the twelve Reserve Banks.

3. How does the Federal Reserve avoid conflicts among its many roles?

The Federal Reserve has exercised care to avoid actual or apparent conflict between its role as a provider of services and its role as a regulator, supervisor, and lender. . . . [T]here are in place external and internal safeguards that ensure that these objectives are achieved. Externally, the safeguards include congressional oversight, directly and through the General Accounting Office, and statutory controls. An additional level of external review is provided by the public through the opportunity to comment on all significant Board proposals. The internal safeguards include oversight by the Board of Governors and Reserve Bank boards of directors through various means, including use of the Board examiners and Reserve Bank internal auditors. Finally, the Federal Reserve itself imposes restrictions upon the conduct of its employees--restrictions intended to avoid even the appearance of impropriety. . . .

1. No Reserve Bank personnel with responsibility for priced services, unless acting in the capacity of president or first vice president, will also be responsible for monetary policy, bank supervision, or lending areas. Priced-service personnel will not make policy decisions affecting monetary policy, bank supervision, or lending matters.
2. Branch managers may administer policy decisions of a Reserve Bank in the lending area but may not make policy decisions in this area.
3. Federal Reserve actions relative to a depository institution in the monetary policy, supervisory, or lending functions involving a particular depository institution will be made without regard as to whether that institution is a user of Reserve Bank services or is an alternative provider of such services.
4. Except for the president, first vice president, branch manager, or persons acting in these capacities, Reserve Bank personnel involved in monetary policy, bank supervision, or the lending function may discuss Federal Reserve priced services with a depository institution only where necessary to carry out their responsibilities. With the exceptions noted above, personnel involved in priced services may discuss matters relating to monetary policy, bank supervision, or lending with a depository institution only where the information discussed is general in nature or is public.
5. Reserve Bank personnel involved in monetary policy, bank supervision, or the lending function may provide confidential information obtained in the course of their duties to Reserve Bank priced-services personnel only where such action fulfills an important supervisory objective, preserves the integrity of the payment mechanism, or protects the assets of the Reserve Banks. In such cases, information will be provided on a need-to-know basis and only with the approval of senior management.

4. Under the Monetary Control Act, for what services are the Federal Reserve Banks required to charge fees?

The services which shall be covered by the schedule of fees under subsection (a) are--

1. currency and coin services;
2. check clearing and collection services;
3. wire transfer services;
4. automated clearinghouse services;
5. settlement services;
6. securities safekeeping services;
7. Federal Reserve float; and
8. any new services which the Federal Reserve System offers, including but not limited to payment services to effectuate the electronic transfer of funds.

5. What is the process through which the Federal Reserve Banks review their prices every year?

All Federal Reserve fees are reviewed annually and revised, if necessary. The annual review takes place during the fourth quarter of the year. Each Reserve Bank forecasts its costs and volumes for each priced service for the upcoming year. Included in the cost estimate are all direct, support, overhead, and float costs that are to be allocated to each priced service. The cost and volume estimates are based on a combination of historical experience and projections. At the same time, the Federal Reserve calculates a proposed PSAF for the year. Aggregate cost and volume estimates for nationally priced services are based on estimates made by the individual Reserve Banks.

The proposed Reserve Bank fees are reviewed by the System's Financial Services Policy Committee, the staff of the Board of Governors, and the Committee on Federal Reserve Bank Affairs. The purpose of the review is to ensure that the cost and volume estimates are reasonable, that the PSAF calculation is consistent with System guidelines, and that proposed prices meet the cost-recovery policies of the Board of Governors. Finally, the Board of Governors reviews and approves the proposed prices and PSAF.

From The Federal Reserve in the Payments System, issued 1984; revised 1990.

6. What costs are the Federal Reserve Banks required to recover through their fees?

Over the long run, fees shall be established on the basis of all direct and indirect costs actually incurred in providing the Federal Reserve services priced, including interest on items credited prior to actual collection, overhead, and an allocation of 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 services been furnished by a private business firm, except that the pricing principles shall give due regard to competitive factors and the provision of an adequate level of such services nationwide.

From Statutory Authority for Services Pricing Policy, Monetary Control Act of 1980.

7. What are the guiding principles under which Federal Reserve Banks provide financial services to depository institutions?

The Board has adopted the following pricing principles, which incorporate both the specific statutory requirements of the Monetary Control Act and provisions intended to fulfill its legislative intent:

1. All Federal Reserve Bank services covered by the fee schedule shall be priced explicitly.
2. All Federal Reserve Bank services covered by the fee schedule shall be available to nonmember depository institutions, and such services shall be priced at the same fee schedule applicable to member banks, except that nonmembers shall be subject to any other terms, including a requirement of balances sufficient for clearing purposes, that the Board may determine are applicable to member banks.
3. Over the long run, fees shall be established on the basis of all direct and indirect costs actually incurred in providing the Federal Reserve services priced, including interest on items credited prior to actual collection, overhead, and an allocation of imputed costs that takes into account the taxes that would have been paid and the return on capital that would have been provided had the services been furnished by a private business firm, except that the pricing principles shall give due regard to competitive factors and the provision of an adequate level of such services nationwide.
4. Interest on items credited prior to collection shall be charged at the current rate applicable in the market for federal funds.
5. The Board intends that fees be set so that revenues for major service categories match costs (inclusive of a private-sector markup). During the initial start-up period, however, new operational requirements and variations in volume may temporarily change unit costs for some service categories. It is the System's intention to match revenues and costs as soon as possible, and the Board will monitor the System's progress in meeting this goal by reviewing regular reports submitted by the Reserve Banks. If, in the interest of providing an adequate level of services nationwide, the Board determines to authorize a fee schedule for a service below cost, it will announce its decision.
6. Service arrangements and related fee schedules shall be responsive to the changing needs for services in particular markets. Advance notice will be given for changes in fees and significant changes in service arrangements to permit orderly adjustments by users and providers of similar services.
7. The structure of fees and service arrangements may be designed both to improve the efficient utilization of Federal Reserve services and to reflect desirable longer-run improvements in the nation's payment system. Public comment will be requested when changes in fees and service arrangements are proposed that would have significant longer-run effects on the nation's payment system.

8. What criteria does the Federal Reserve consider before introducing a new service or major service enhancement?

As the Federal Reserve considers the introduction of new services or major service enhancements, all of the following criteria must be met:

• The Federal Reserve must expect to achieve full recovery of costs over the long run.
• The Federal Reserve must expect that its providing the service will yield a clear public benefit, including, for example, promoting the integrity of the payments system, improving the effectiveness of financial markets, reducing the risk associated with payments and securities-transfer services, or improving the efficiency of the payments system.
• The service should be one that other providers alone cannot be expected to provide with reasonable effectiveness, scope, and equity. For example, it may be necessary for the Federal Reserve to provide a payment service to ensure that an adequate level of service is provided nationwide or to avoid undue delay in the development and implementation of the service.

9. When might the Federal Reserve Board request public comment on a priced service?

The Committee on Federal Reserve Bank Affairs (Committee) has considered guidelines that could be used by Board staff and the Committee as input to their assessment of whether a proposal related to Federal Reserve priced services should be subject to public comment before adoption. These guidelines help ensure greater consistency in interpreting the Board's pricing principle requiring public comment "when changes in fees and service arrangements are proposed that would have significant longer-run effects on the nation's payments systems."

Public comment on matters related to Reserve Bank priced service should be requested in the following circumstances:

1. The Board proposes changes to its pricing principles.
2. A Federal Reserve Bank plans to enter a new priced service line or significantly expand or modify an existing service line.
3. All Federal Reserve Banks plan to withdraw from a current service line.
4. The Federal Reserve Banks plan to recover less than the short-run average variable cost for a service line over an extended period.
5. The Reserve Bank's planned action is likely to have direct and material adverse effect on the ability of other service providers to compete effectively in providing similar services due to differing legal powers or constraints or due to a dominant market position of the Federal Reserve deriving from such legal differences.
6. The Federal Reserve proposes a significant modification to the methodology for calculating imputed priced services costs or revenue.
7. The contemplated action would (or is intended to) result in a significant long-term structural change in the payments system.

10. How does the Federal Reserve Board review and approve new priced-services products or changes to existing product fees and services?

The Board establishes prices for Reserve Bank services, pursuant to section 11A of the Federal Reserve Act. In certain circumstances, the Board has delegated its authority in this area to the Director of Reserve Bank Operations and Payment Systems (RBOPS) or to the Financial Services Policy Committee (FSPC). The FSPC may further delegate its authority to the appropriate financial services product director. Four categories of price and service change proposals have been defined: non-routine, routine, accelerated, and pre-approved. The product director will inform the Director of RBOPS of a proposed change to a nationally priced service before approval. The Director of RBOPS will determine the classification of the proposal.

From Price- and Service-Change Proposals, issued 1981; revised 1999.

11. When does the Federal Reserve Board conduct competitive-impact analyses? What is considered?

The Board will also conduct a competitive-impact analysis when considering an operational or legal change, such as a change to a price or service, or a change to Regulation J, if that change would have a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services due to differing legal powers or constraints or due to a dominant market position of the Federal Reserve deriving from such legal differences. All operational or legal changes having a substantial effect on payments-system participants will be subject to a competitive-impact analysis, even if competitive effects are not apparent on the face of the proposal.

In conducting the competitive-impact analysis, the Board would first determine whether the proposal has a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services. Second, if such an adverse effect on the ability to compete is identified, the Board would then ascertain whether the adverse effect was due to legal differences or due to a dominant market position deriving from such legal differences. Third, if it is determined that legal differences or a dominant market position deriving from such legal differences exist, then the proposed change would be further evaluated to assess its benefits, such as contributing to payments-system efficiency or integrity or other Board objectives, and to determine whether the proposal's objectives could be reasonably achieved with a lesser or no adverse competitive impact. Fourth, the Board would then either modify the proposal to lessen or eliminate the adverse impact on competitors' ability to compete or determine that the payments-system objectives may not be reasonably achieved if the proposal were modified. If reasonable modifications would not mitigate the adverse effect, the Board would then determine whether the anticipated benefits were significant enough to proceed with the change even though it may adversely affect the ability of other service providers to compete with the Federal Reserve in that service.

From The Federal Reserve in the Payments System, issued 1984; revised 1990.

12. How can payment system participants express concerns about the Federal Reserve priced-services policies or practices?

If a depository institution or other payments-system participant believes that the Federal Reserve's priced-services policies or practices are not in accord with the competitive analysis or other criteria described above, it should communicate its concerns to the first vice president of the local Federal Reserve Bank. If the institution wishes to pursue the matter further after discussing the issue with the Reserve Bank staff, it may address its concern to the Board member designated as chairman of the Board's Committee on Federal Reserve Bank Affairs.

From The Federal Reserve in the Payments System, issued 1984; revised 1990.