Board of Governors of the Federal Reserve System

Federal Reserve Banks

The Federal Reserve Banks provide payment services to depository and certain other institutions, distribute the nation's currency and coin to depository institutions, and serve as fiscal agents and depositories for the U.S. government and other entities. The Reserve Banks also contribute to setting national monetary policy and supervision of banks and other financial entities operating in the United States (discussed in sections 2 through 4 of this annual report).

Federal Reserve Priced Services

Reserve Banks provide a range of payment and related services to depository and certain other institutions; these "priced services" include collecting checks, operating an automated clearinghouse (ACH) service, transferring funds and securities, and providing a multilateral settlement service.¹

The Reserve Banks have been engaged in a number of multiyear technology initiatives that will modernize their priced-services processing platforms. These investments are expected to enhance efficiency, the overall quality of operations, and the Reserve Banks' ability to offer additional services, consistent with the longstanding principles of fostering efficiency and safety, to depository institutions. The Reserve Banks continued to enhance the resiliency and information security posture of the Fedwire Funds, National Settlement Service, and Fedwire Securities Service through the Fedwire Resiliency Program, a multiyear initiative to respond to environmental threats and cyberthreats. The Reserve Banks are also developing and planning to implement a new FedACH-processing platform to improve the efficiency and reliability of their current FedACH operations. In September 2016, the Reserve Banks implemented the first of three phases of the SameDay ACH service in support of a National Automated Clearing House Association (NACHA) operating rule change; the new SameDay ACH service enhances the existing Reserve Bank SameDay ACH product by enabling time-critical payments via the ACH network and improving the availability of funds to end users. The first phase enables same-day ACH credits, and the second phase, which is expected to be implemented in the second half of 2017, will enable same-day ACH debits.²

Cost Recovery

The Monetary Control Act of 1980 requires that the Federal Reserve establish fees for priced services 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.³ The imputed costs and imputed profit are collectively referred to as the private-sector adjustment factor (PSAF). From 2007 through 2016, the Reserve Banks recovered 101.8 percent of the total priced services costs, including the PSAF (see table 1).⁴

Table 1. Priced services cost recovery, 2007-16

In 2016 specifically, Reserve Banks recovered 104.7 percent of the total priced services costs, including the PSAF.⁵ The Reserve Banks' operating expenses and imputed costs totaled $410.6 million. Revenue from operations totaled $434.2 million, resulting in net income from priced services of $23.7 million. The commercial check-collection service and the Fedwire Funds and National Settlement Service achieved full cost recovery; however, the FedACH Service and the Fedwire Securities Service did not achieve full cost recovery because of investment costs associated with the multiyear technology initiatives discussed above. Greater-than-expected check volume processed by the Reserve Banks has been the single most significant factor in greater than full cost recovery overall.

Commercial Check-Collection Service

The commercial check-collection service provides a suite of electronic and paper processing options for forward and return collections. In 2016, the Reserve Banks recovered 112.7 percent of the total costs of their commercial check-collection service, including the related PSAF. Revenue from operations totaled $154.2 million, resulting in net income of $18.6 million. The Reserve Banks' operating expenses and imputed costs totaled $135.6 million. Reserve Banks handled 5.2 billion checks in 2016, a decrease of 3.9 percent from 2015 (see table 2). The average daily value of checks collected by the Reserve Banks in 2016 was approximately $32.2 billion, a decrease of 0.3 percent from the previous year.

Table 2. Activity in Federal Reserve priced services, 2014-16

Commercial Automated Clearinghouse Service

The commercial ACH service provides domestic and cross-border batched payment options for same-day and next-day settlement. In 2016, the Reserve Banks recovered 98.8 percent of the total costs of their commercial ACH services, including the related PSAF. Revenue from operations totaled $131.0 million, resulting in net loss of $0.3 million. The Reserve Banks' operating expenses and imputed costs totaled $131.4 million. The Reserve Banks processed 13.0 billion commercial ACH transactions in 2016, an increase of 5.4 percent from 2015 (see table 2). The average daily value of FedACH transfers in 2016 was approximately $86.7 billion, an increase of 5.9 percent from the previous year.

Fedwire Funds and National Settlement Services

In 2016, the Reserve Banks recovered 103.3 percent of the costs of their Fedwire Funds and National Settlement Services, including the related PSAF. Revenue from operations totaled $123.0 million, resulting in a net income of $5.3 million. The Reserve Banks' operating expenses and imputed costs totaled $117.8 million in 2016.

Fedwire Funds Service

The Fedwire Funds Service allows its participants to send or receive domestic time-critical payments using their balances at Reserve Banks to transfer funds in real time. From 2015 to 2016, the number of Fedwire funds transfers originated by depository institutions increased 4.0 percent, to approximately 152 million (see table 2). The average daily value of Fedwire funds transfers in 2016 was $3.1 trillion, a decrease of 7.7 percent from the previous year.

National Settlement Service

The National Settlement Service is a multilateral settlement system that allows participants in private-sector clearing arrangements to settle transactions using their balances at Reserve Banks. In 2016, the service processed settlement files for 17 local and national private-sector arrangements. The Reserve Banks processed 8,329 files that contained about 501,000 settlement entries for these arrangements in 2016 (see table 2). Settlement file activity in 2016 was roughly the same as in 2015, and settlement entries decreased 1.4 percent.

Fedwire Securities Service

The Fedwire Securities Service allows its participants to transfer electronically to other service participants certain securities issued by the U.S. Treasury Department, federal government agencies, government-sponsored enterprises, and certain international organizations.⁶ In 2016, the Reserve Banks recovered 99.2 percent of the costs of their Fedwire Securities Service, including the related PSAF. Revenue from operations totaled $25.9 million, resulting in a net income of $0.0 million. The Reserve Banks' operating expenses and imputed costs totaled $25.8 million in 2016. In 2016, the number of non-Treasury securities transfers processed via the service decreased 8.0 percent from 2015, to approximately 3.9 million (see table 2). The average daily value of Fedwire Securities transfers in 2016 was $1.1 trillion, a decrease of 2.7 percent from the previous year.

Float

In 2016, the Reserve Banks had daily average credit float of $334.4 million, compared with daily average credit float of $193.2 million in 2015.⁷

Currency and Coin

The Federal Reserve Board issues the nation's currency (in the form of Federal Reserve notes) to
28 Federal Reserve Bank offices. The Reserve Banks, in turn, distribute Federal Reserve notes to depository institutions in response to public demand. The Reserve Banks also distribute the nation's coin to depository institutions on behalf of the U.S. Department of the Treasury.⁸ Together, the Board and Reserve Banks work to maintain the integrity of and confidence in Federal Reserve notes. In 2016, the Board paid Treasury's Bureau of Engraving and Printing (BEP) $660.0 million for costs associated with the production of nearly 7.3 billion Federal Reserve notes.

In 2016, the Reserve Banks distributed 36.3 billion Federal Reserve notes into circulation, a 1.4 percent decrease from 2015, and received 34.7 billion Federal Reserve notes from circulation, a 1.2 percent decrease from 2015. In 2016, the Reserve Banks also distributed 73.4 billion coins into circulation, a 2.8 percent increase from 2015, and received 58.2 billion coins from circulation, a 4.1 percent increase from 2015.

The value of Federal Reserve notes in circulation increased nearly 6.0 percent in 2016, to $1,463 billion at year-end. The Board estimates that as much as two-thirds of the value of Federal Reserve notes in circulation is held abroad, mainly as a store of value. The 2016 increase in value is attributable largely to increased demand for $100 notes; however, demand for transactional denominations also increased. The volume of $1 and $20 notes in circulation increased 3.3 percent in 2016, compared with 6.7 percent growth in the volume of $100 notes in circulation.

U.S. Currency Education Program

The U.S. Currency Education Program (CEP) is an interagency program managed by the Board in partnership with the United States Secret Service and the BEP. The CEP is responsible for ensuring that users of U.S. currency around the world have access to education, training, and information about all designs of Federal Reserve notes, from 1914 to the present.

Education and training includes conducting domestic and international training seminars for staff at the Federal Reserve Banks, financial institutions, law enforcement agencies, the gaming industry, and government entities. During 2016, the CEP conducted outreach in the United States, Thailand, Cambodia, Guatemala, and Argentina, which included training for more than 600 key stakeholders. The CEP launched two new hard-copy materials in 2016, "Dollars in Detail" and "Know the $20," which are available on the educational website www.uscurrency.gov.

Other Improvements and Efforts

During 2016, the Reserve Banks began implementation of a new cash automation platform (CashForward) to replace legacy software applications, automate business concepts, and processes, and to employ technologies to meet the cash business's current and future needs more cost effectively. The new cash platform also will facilitate business continuity and contingency planning and enhance the support provided to Reserve Bank customers. Deployment of CashForward began in June 2016, with 10 offices successfully deploying the platform by year-end. Implementation for the remaining 18 offices will be completed in 2017.

The Federal Reserve also has initiated a program to replace the aging high-speed currency-processing equipment at all Reserve Banks by 2026. In 2016, the Federal Reserve issued a request for proposal for new equipment and related maintenance services and used a comprehensive scoring process to evaluate the proposals. The Federal Reserve expects to negotiate terms for contract award in 2017.

During 2016, the Board and the BEP continued to build on the improved quality assurance processes established to date at the BEP. The Board and BEP continued to reclaim $100 notes using single note inspection equipment, which allowed the Board to avoid nearly $25.4 million in variable production costs. During 2017, the Board and BEP will develop and implement processes and procedures to reclaim additional denominations using single-note inspection equipment, which will reduce overall spoilage and variable printing costs. In addition, the Board and BEP agreed on a long-term capital equipment replacement strategy to modernize and replace aging production equipment at the BEP that has exceeded its useful life; the replacement will improve production efficiency and reduce spoilage.

Fiscal Agency and Government Depository Services

As fiscal agents and depositories for the federal government, the Reserve Banks auction Treasury securities, process electronic and check payments for Treasury, collect funds owed to the federal government, maintain Treasury's bank account, and develop, operate, and maintain a number of automated systems to support Treasury's mission. The Reserve Banks also provide certain fiscal agency and depository services to other entities, typically other government instrumentalities at the request of Treasury; these services are primarily related to book-entry securities. Treasury and other entities fully reimburse the Reserve Banks for the expense of providing fiscal agency and depository services.

In 2016, fiscal agency expenses increased to $677.0 million (see table 3), primarily as a result of requests from Treasury's Bureau of the Fiscal Service and an increase in Reserve Bank pension costs to be reimbursed by Treasury and other entities.⁹ Support for Treasury programs accounted for 94.0 percent of expenses, and support for other entities accounted for 6.0 percent.

Table 3. Expenses of the Federal Reserve Banks for fiscal agency and depository services, 2014-16

In April 2014, as part of the federal government's effort to increase operational efficiency and effectiveness, Treasury announced the consolidation of the fiscal agency services provided by the Reserve Banks. Although Treasury expects long-term savings by reducing the number of Reserve Banks that provide fiscal agency services, the Reserve Banks are experiencing an increase in expenses during the consolidation process, which will continue over the next several years. In 2016, total consolidation expenses amounted to $20.9 million as a result of the eight Reserve Bank business lines that transitioned and preparations for the upcoming transitions.¹⁰ Consolidation expenses are included in the line items for Payment, Collection, and Cash-management services in table 3.

Treasury Securities Services

The Reserve Banks work closely with Treasury's Fiscal Service in support of the borrowing needs of the federal government. The Reserve Banks auction, issue, maintain, and redeem securities; provide customer service; and operate the automated systems supporting U.S. savings bonds and marketable Treasury securities (bills, notes, and bonds). Treasury securities services consist of retail securities programs, which primarily serve individual investors, and wholesale securities programs, which serve institutional customers.

Retail Securities Programs

Reserve Bank operating expenses for the retail securities program decreased to $50.2 million in 2016, largely because of the shift in telephony infrastructure costs to the Fiscal Service. Program expense drivers included the Reserve Banks' operation of a virtual case-file system and a virtual contact center to support retail securities services, as well as increased staffing to manage the savings-bond transaction workload.

The Reserve Banks also provided support to Treasury's Retail Program Review initiative, which may shape the retail securities program's future mission, vision, and operating model. Operating expenses to support this effort were $2.3 million in 2016.

Wholesale Securities Programs

The Reserve Banks support wholesale securities programs through the sale, issuance, safekeeping, and transfer of marketable Treasury securities for institutional investors.¹¹ The Reserve Banks conducted 266 Treasury securities auctions in 2016. Of the 266 auctions, 12 auctions were for Floating Rate Notes.¹²

In 2016, Reserve Bank operating expenses to support Treasury securities auctions increased to $42.5 million. Operating expenses were driven by upgrades to the auction application, which receives and processes bids submitted primarily by wholesale securities auction participants, and by modernization of the application infrastructure.

Operating expenses associated with Treasury securities safekeeping and transfer activities increased to $22.9 million in 2016 as a result of the Reserve Banks' effort to migrate the securities services from a mainframe system to a distributed computing environment.¹³

Payment Services

The Reserve Banks work closely with Treasury's Fiscal Service and other government agencies to process payments to individuals and companies. The Reserve Banks process federal payroll payments, Social Security and veterans' benefits, income tax refunds, vendor payments, and other types of payments.

Reserve Bank operating expenses for payments-related activity decreased to $159.3 million in 2016, primarily because consolidation activities ended for International Treasury Services (ITS) and Automated Standard Application for Payments (ASAP). These decreases were partially offset by increased consolidation expenses and increased program expenses associated with Post Payment System (PPS), Invoice Processing Platform (IPP), and Stored Value Card (SVC).

The Reserve Banks operate the ITS application, which provides cross-border payment and collection services as well as cash-management functions on behalf of Treasury. U.S. government agencies use ITS to issue international benefit, payroll, and vendor payments in 100 currencies to recipients in established and emerging markets. ITS expenses in 2016 decreased to $15.5 million primarily because consolidation activities came to an end.

The ASAP application enables federal agencies to electronically disburse funds to recipient organizations. Expenses for ASAP decreased 35.5 percent from 2015, to $9.1 million in 2016, because of the completion of consolidation activities.

The Reserve Banks continued work on the PPS initiative, a multiyear effort to modernize several of Treasury's legacy post-payment processing systems into a single application to enhance operations, reduce expenses, improve data analytics capabilities, and provide a centralized and standardized set of payment data. In 2016, program expenses for PPS increased to $18.8 million as the result of greater system development expenses and $2.6 million in consolidation expenses.

The IPP is part of Treasury's all-electronic initiative--an electronic invoicing and payment information system that allows vendors to enter invoice data electronically, through either a web-based portal or electronic submission. The IPP accepts, processes, and presents data from supplier systems related to all stages of a payment transaction, including the purchase order, invoice, and other payment information. In 2016, the Reserve Banks' IPP expenses increased to $24.5 million, primarily because of increased staffing to support consolidation efforts.

The SVC program comprises three military cash-management programs: EagleCash, EZPay, and Navy Cash. These programs provide electronic payment methods for goods and services on military bases and Navy ships, both domestic and overseas, to reduce costs and increase convenience for the military and service members. The Reserve Banks, as fiscal agent, currently operate EagleCash and EZpay and will assume responsibility for Navy Cash in 2017. In 2016, Reserve Bank operating expenses for Treasury's SVC business increased to $24.4 million, largely because of $10.8 million in expenses associated with the transition of the Navy Cash program from a third-party financial agent.

Collection Services

The Reserve Banks also work closely with the Fiscal Service to collect funds owed to the federal government, including various taxes, fees for goods and services, and delinquent debts. In 2016, Reserve Bank operating expenses related to collection services increased to $66.4 million, largely because of greater operating expenses for Pay.gov, eCommerce, and the Collections Information Repository (CIR).

The Reserve Banks operate Pay.gov, an application that allows the public to use the Internet to authorize and initiate payments to federal agencies. During the year, the Pay.gov program expanded to include more than 140 new agency programs and processed more than 177 million online payments totaling $152 billion. Pay.gov expenses increased to $20.1 million in 2016, primarily because of software amortization expenses.

The Reserve Banks also continued supporting Treasury's electronic commerce initiative (eCommerce) to expand ways for agencies and the public to do business with Treasury through online banking solutions, mobile technologies, and other payment methods. Program expenses for eCommerce increased to $5.3 million in 2016 because of expenses associated with developing a new mobile payment platform that will facilitate more-efficient federal revenue collections and because of increased vendor fees for the program.

In 2016, the Reserve Banks transitioned the CIR application from a third-party financial agent. The CIR application enables the Fiscal Service to standardize the availability of financial information, furthering transparency goals and enabling federal agencies to improve cash-management decisions and performance. Expenses for CIR totaled $7.7 million in 2016 and were primarily attributable to transition expenses and application development.

Treasury Cash-Management Services

The Reserve Banks maintain Treasury's operating cash account and provide collateral-management and collateral-monitoring services for those Treasury programs that have collateral requirements. The Reserve Banks also support Treasury's efforts to modernize its financial management processes by developing software, operating help desks, and managing projects on behalf of the Fiscal Service.

In 2016, Reserve Bank operating expenses related to Treasury cash-management services increased to $82.2 million, of which $5.1 million was attributable to the consolidation. The increase was primarily due to significant application development efforts for Bank Management System and the G-invoicing system. The Bank Management System application determines commercial bank compensation for depository services provided to Treasury, and G-invoicing provides electronic intragovernmental invoicing processing. These increased expenses were partially offset by decreased expenses associated with the end of consolidation activities for the Treasury Cash Management System and Direct Voucher Submission applications.

Services Provided to Other Entities

When permitted by federal statute or when required by the Secretary of the Treasury, the Reserve Banks provide fiscal agency and depository services to other domestic and international entities.

Reserve Bank operating expenses for services provided to other entities increased to $37.3 million in 2016. Book-entry securities issuance and maintenance activities account for a significant amount of the work performed for other entities, with the majority performed for the Federal Home Loan Mortgage Association (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), and the Government National Mortgage Association (Ginnie Mae).

Use of Federal Reserve Intraday Credit

The Board's Payment System Risk policy governs the use of Federal Reserve Bank intraday credit, also known as daylight overdrafts. A daylight overdraft occurs when an institution's account activity creates a negative balance in the institution's Federal Reserve account at any time in the operating day. Daylight overdrafts enable an institution to send payments more freely throughout the day than if it were limited strictly by its available intraday funds balance, increasing efficiency and reducing payment system risk. The Payment System Risk policy recognizes explicitly the role of the central bank in providing intraday balances and credit to healthy institutions; under the policy, the Reserve Banks provide collateralized intraday credit at no cost.

Before the 2007-09 financial crisis, overnight balances were much lower and daylight overdrafts significantly higher than levels observed since late 2008. The use of daylight overdrafts spiked amid the market turmoil near the end of 2008 but dropped sharply as various liquidity programs initiated by the Federal Reserve, all since terminated, took effect. During this period, the Federal Reserve also began paying interest on balances held at the Reserve Banks, increased its lending under the Term Auction Facility, and began purchasing government-sponsored enterprise mortgage-backed securities. These measures tended to increase balances institutions held at the Banks, which decreased the demand for intraday credit. In 2007, for example, institutions held, on average, less than $20 billion in overnight balances, and total average daylight overdrafts were around $60 billion. In contrast, institutions held historically high levels of overnight balances at the Reserve Banks in 2016, while daylight overdrafts remained historically low, as shown in figure 1.

 

Daylight overdraft fees are also at historically low levels. In 2016, institutions paid about $48,100 in daylight overdraft fees; in contrast, fees totaled more than $50 million in 2008. The decrease in fees is largely attributable to the elevated level of reserve balances that began to accumulate in late 2008 and to the 2011 policy revision that eliminated fees for daylight overdrafts that are collateralized.

 

FedLine Access to Reserve Bank Services

The Reserve Banks' FedLine access solutions provide financial institutions with a variety of alternatives for electronically accessing the Banks' payment and information services. For priced services, the Reserve Banks charge fees for these electronic connections and allocate the associated costs and revenue to the various services. There are currently five FedLine channels through which customers can access the Reserve Banks' priced services: FedMail, FedLine Web, FedLine Advantage, FedLine Command, and FedLine Direct. These FedLine channels are designed to meet the individual connectivity, security, and contingency requirements of depository institution customers.

Between 2007 and 2016, Reserve Bank priced FedLine connections decreased nearly 18 percent, and the number of depository institutions in the United States declined 30 percent.¹⁴ During this same period, the number of employees within depository institutions who have FedLine credentials increased 23 percent, reflecting in part the expansion of value-added services provided and use of the network for central bank applications. As of December 2016, more than 45,000 individuals had access to value-added services (Accounting Management Information, FedTransaction Analyzer, and ACH Risk Services) and more than 35,000 individuals had access to central bank applications for regulatory reporting purposes.

The Reserve Banks continue to maintain their focus on security and resiliency by upgrading critical elements of the FedLine solutions. Enhancements to the FedLine Advantage and FedLine Command access solutions were deployed to approximately 4,500 financial institutions, and enhancements to the FedLine Direct solution, used by approximately 210 of the largest financial institutions, were completed in 2016.

Information Technology

The improvement of efficiency, effectiveness, and security of information technology (IT) services and operations continued to be a focus for the Reserve Banks in 2016. Led by the Federal Reserve System's National IT organization, the Reserve Banks approved the System IT Strategic Plan to reduce the complexity and risk involved in the delivery of technology services. The plan focuses on IT productivity, simplicity, accountability, and stewardship across the System. National IT is guiding the plan's implementation and tracking progress toward the plan's goals. This effort is scheduled to be completed in 2020.

The Reserve Banks remained vigilant about their cybersecurity posture, investing in risk-mitigation initiatives and programs and continuously monitoring and assessing cybersecurity risks to its operations. The Federal Reserve implemented several cybersecurity initiatives that enable threat-driven analysis; increase the ability to respond to evolving cybersecurity threats with agility, decisiveness, and speed by streamlining decisionmaking during a cybersecurity incident; and continue to improve its continuous monitoring capabilities of key systems.

Examinations of the Federal Reserve Banks

The combined financial statements of the Reserve Banks as well as the financial statements of each of the 12 Reserve Banks are audited annually by an independent public accountant retained by the Board of Governors.¹⁵ In addition, the Reserve Banks are subject to oversight by the Board of Governors, which performs its own reviews.

The Reserve Banks use the 2013 framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to assess their internal controls over financial reporting, including the safeguarding of assets. Within this framework, the management of each Reserve Bank annually provides an assertion letter to its board of directors that confirms adherence to COSO standards.

The Federal Reserve Board engaged KPMG LLP (KPMG) to audit the 2016 combined and individual financial statements of the Reserve Banks.¹⁶

In 2016, KPMG also conducted audits of the internal controls associated with financial reporting for each of the Reserve Banks. Fees for KPMG's services totaled $6.7 million. To ensure auditor independence, the Board requires that KPMG be independent in all matters relating to the audits. Specifically, KPMG 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 2016, the Reserve Banks did not engage KPMG for significant non-audit services.

The Board's reviews of the Reserve Banks include a wide range of offsite and onsite oversight activities, conducted primarily by its Division of Reserve Bank Operations and Payment Systems. Division personnel monitor on an ongoing basis the activities of each Reserve Bank, National IT, and the System's Office of Employee Benefits (OEB). They conduct a comprehensive onsite review of each Reserve Bank and OEB at least once every three years and review National IT, the System Open Market Account (SOMA), and Fedwire annually.

The comprehensive onsite reviews include an assessment of the internal audit function's effectiveness and its conformance to the Institute of Internal Auditors' (IIA) International Standards for the Professional Practice of Internal Auditing, applicable policies and guidance, and the IIA's code of ethics.

The Board also reviews SOMA and foreign currency holdings to

1. determine whether the New York Reserve Bank, while conducting the related transactions and associated controls, complies with the policies established by the Federal Open Market Committee (FOMC); and
2. assess SOMA-related IT project management and application development, vendor management, and system resiliency and contingency plans.

In addition, KPMG audits the year-end schedule of participated asset and liability accounts and the related schedule of participated income accounts. The FOMC is provided with the external audit reports and a report on the Board review.

Income and Expenses

Table 4 summarizes the income, expenses, and distributions of net earnings of the Reserve Banks for 2016 and 2015. Income in 2016 was $111.7 billion, compared with $114.2 billion in 2015.

Table 4. Income, expenses, and distribution of net earnings of the Federal Reserve Banks, 2016 and 2015

Expenses totaled $19,269 million:

1. $12,044 million in interest paid to depository institutions on reserve balances and term deposits;
2. $4,205 million in Reserve Bank operating expenses;
3. $1,122 million in interest expense on securities sold under agreements to repurchase;
4. $565 million in net periodic pension expense;
5. $709 million in assessments for Board of Governors expenditures;
6. $701 million for the cost of producing, issuing, and retiring currency;
7. $596 million for Consumer Financial Protection Bureau costs; and
8. $4 million in other costs.

The expenses were reduced by $677 million in reimbursements for services provided to government agencies. Net deductions from current net income totaled $114 million, which includes $103 million in unrealized losses on foreign currency denominated investments revalued to reflect current market exchange rates, $15 million in realized losses on Treasury securities, and $19 million in realized gains on federal agency and government-sponsored enterprise mortgage-backed securities (GSE MBS). Dividends paid to member banks for 2016 totaled $711 million. Effective January 1, 2016, the Fixing America's Surface Transportation Act (FAST Act) changed the dividend rate for member banks with more than $10 billion of consolidated assets to the smaller of 6 percent or the rate equal to the high yield of the 10-year Treasury note auctioned at the last auction held prior to the payment of the dividend. The FAST Act did not change the 6 percent dividend rate for member banks with $10 billion or less of total consolidated assets.

Net income before remittances to Treasury totaled $92,178 million in 2016 (net income of $92,361 million, decreased by other comprehensive loss of $183 million). Earnings remittances to the Treasury totaled $91,467 million in 2016. The FAST Act, which amended section 7(a) of the Federal Reserve Act, requires that any Reserve Bank capital surplus in excess of $10 billion be transferred to Treasury.¹⁷ The Reserve Banks reported comprehensive income of $711 million in 2016 after providing for remittances to Treasury.

Section 11 of this report, "Statistical Tables," provides more detailed information on the Reserve Banks. Table 9 is a statement of condition for each Reserve Bank; table 10 details the income and expenses of each Reserve Bank for 2016; table 11 shows a condensed statement for each Reserve Bank for the years 1914 through 2016; and table 13 gives the number and annual salaries of officers and employees for each Reserve Bank. A detailed account of the assessments and expenditures of the Board of Governors appears in the Board of Governors Financial Statements (see section 12, "Federal Reserve System Audits").

SOMA Holdings and Loans

The Reserve Banks' average net daily SOMA holdings during 2016 amounted to $4,071 billion, a decrease of $83 billion from 2015 (see table 5).

Table 5. System Open Market Account (SOMA) holdings of the Federal Reserve Banks, 2016 and 2015

SOMA Securities Holdings

The average daily holdings of Treasury securities decreased by $18 billion, to an average daily amount of $2,570 billion. The average daily holdings of GSE debt securities decreased by $11 billion, to an average daily amount of $25 billion. The average daily holdings of federal agency and GSE MBS increased by $9 billion, to an average daily amount of $1,802 billion.

The increases in average daily holdings of federal agency and GSE MBS are due to reinvestment of principal payments from other SOMA holdings in federal agency and GSE MBS. The average daily holdings of GSE debt securities decreased as a result of maturities.

There were no significant holdings of securities purchased under agreements to resell in 2016 or 2015. Average daily holdings of foreign currency denominated investments in 2016 were $20,713 million, compared with $19,846 million in 2015. The average daily balance of central bank liquidity swap drawings was $933 million in 2016 and $209 million in 2015. The average daily balance of securities sold under agreements to repurchase was $347,496 million, an increase of $63,911 million from 2015.

The average rates of interest earned on the Reserve Banks' holdings of Treasury securities increased to 2.48 percent, and the average rates on GSE debt securities increased to 3.79 percent in 2016. The average rate of interest earned on federal agency and GSE MBS decreased to 2.57 percent in 2016. The average interest rates for securities sold under agreements to repurchase increased to 0.32 percent in 2016. The average rate of interest earned on foreign currency denominated investments decreased to -0.03 percent, while the average rate of interest earned on central bank liquidity swaps increased to 0.96 percent in 2016.

Lending

In 2016, the average daily primary, secondary, and seasonal credit extended by the Reserve Banks to depository institutions decreased by $24 million, to $101 million. The average rate of interest earned on primary, secondary, and seasonal credit increased to 0.62 percent in 2016, from 0.28 percent in 2015.

ML is a lending facility established in 2008 under authority of FRA section 13(3) in response to the 2007-09 financial crisis. Net portfolio assets of ML decreased from $1,778 million in 2015 to $1,742 million in 2016, and liabilities decreased from $57 million to $33 million. ML net loss of $12 million in 2016 comprised interest income of $9 million, loss on investments of $19 million, and operating expenses of $2 million.

Federal Reserve Bank Premises

Several Reserve Banks took action in 2016 to maintain and renovate their facilities. The multiyear renovation programs at the New York, Richmond, Kansas City, and San Francisco Reserve Banks' headquarters and Los Angeles Branch building continued. All Reserve Banks continued to implement projects to maintain building systems to ensure efficient and reliable operations. The New York Reserve Bank continued repairs and renovations to the 33 Maiden Lane building. In 2016, the St. Louis Reserve Bank expanded its leased office space to accommodate increased Treasury services.

For more information on the acquisition costs and net book value of the Reserve Banks and Branches, see table 14 in section 11 ("Statistical Tables") of this annual report.

Pro Forma Financial Statements for Federal Reserve Priced Services

 

Table 6. Pro forma balance sheet for Federal Reserve priced services, December 31, 2016 and 2015

 

 

Table 7. Pro forma income statement for Federal Reserve priced services, 2016 and 2015

 

 

Table 8. Pro forma income statement for Federal Reserve priced services, by service, 2016

 

Notes to Pro Forma Financial Statements for Priced Services

(1) Short-Term Assets

Receivables are composed of fees due the Reserve Banks for providing priced services and the share of suspense- and difference-account balances related to priced services.

Items in process of collection are gross Federal Reserve cash items in process of collection (CIPC), stated on a basis comparable to that of a commercial bank. They reflect adjustments for intra-Reserve Bank items that would otherwise be double-counted on the combined Federal Reserve balance sheet and adjustments for items associated with nonpriced items (such as those collected for government agencies). 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. Investments of excess financing derived from credit float are assumed to be invested in federal funds.

(2) Long-Term Assets

Long-term assets consist of long-term assets used solely in priced services and the priced-service portion of long-term assets shared with nonpriced services, including a deferred tax asset related to the priced services pension and postretirement benefits obligation. The tax rate associated with the deferred tax asset was 21.6 percent and 22.4 percent for 2016 and 2015, respectively.

Long-term assets also consist of an estimate of the assets of the Board of Governors used in the development of priced services.

(3) Liabilities and Equity

Under the matched-book capital structure for assets, short-term assets are financed with short-term payables and imputed short-term debt, if needed. Long-term assets are financed with long-term liabilities, imputed long-term debt, and imputed equity, if needed. To meet the Federal Deposit Insurance Corporation requirements for a well-capitalized institution, in 2016 equity is imputed at 5.0 percent of total assets and 10.9 percent of risk-weighted assets, and in 2015 equity is imputed at 6.4 percent of total assets and 10.0 percent of risk-weighted assets.

In 2014, the Board approved revisions to the Payment System Risk policy to reflect the new international standards for financial market infrastructures developed by the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions in the Principles for Financial Market Infrastructures. The policy retains the expectation that the Fedwire Services will meet or exceed the applicable risk-management standards. Effective December 31, 2015, the Reserve Banks' priced services imputed six months of the Fedwire Funds Service's current operating expenses as liquid net financial assets and equity on the pro forma balance sheet. The imputed assets held as liquid net financial assets are cash items in process of collection, which are assumed to be invested in federal funds.

In accordance with Accounting Standards Codification (ASC) Topic 715 (ASC 715), Compensation-Retirement Benefits, the Reserve Banks record the funded status of pension and other benefit plans on their balance sheets. To reflect the funded status of their benefit plans, the Reserve Banks recognize the deferred items related to these plans, which include prior service costs and actuarial gains or losses, on the balance sheet. This results in an adjustment to the pension and other benefit plan liabilities related to priced services and the recognition of an associated deferred tax asset with an offsetting adjustment, net of tax, to accumulated other comprehensive income (AOCI), which is included in equity. The Reserve Bank priced services recognized a pension liability, which is a component of accrued benefit costs, of $33.2 million in 2016 and $26.2 million in 2015. The change in the funded status of the pension and other benefit plans resulted in a corresponding increase in accumulated other comprehensive loss of $12.9 million in 2016.

(4) Revenue

Revenue represents fees charged to depository institutions for priced services and is realized from each institution through direct charges to an institution's account.

(5) Operating Expenses

Operating expenses consist of the direct, indirect, and other general administrative expenses of the Reserve Banks for priced services and the expenses of the Board related to the development of priced services. Board expenses were $5.0 million in 2016 and $3.3 million in 2015.

In accordance with ASC 715, the Reserve Bank priced services recognized qualified pension-plan operating expenses of $34.4 million in 2016 and $33.7 million in 2015. Operating expenses also include the nonqualified net pension expense of $4.9 million in 2016 and $3.2 million in 2015. The adoption of ASC 715 does not change the systematic approach required by generally accepted accounting principles to recognize the expenses associated with the Reserve Banks' benefit plans in the income statement. As a result, these expenses do not include amounts related to changes in the funded status of the Reserve Banks' benefit plans, which are reflected in AOCI.

The income statement by service reflects revenue, operating expenses, imputed costs, other income and expenses, and cost recovery. The tax rate associated with imputed taxes was 21.6 percent and 22.4 percent for 2016 and 2015, respectively.

(6) Imputed Costs

Imputed costs consist of income taxes, return on equity, interest on debt, sales taxes, and interest on float. Many imputed costs are derived from the PSAF model. The 2016 cost of short-term debt imputed in the PSAF model is based on nonfinancial commercial paper rates; the cost of imputed long-term debt is based on Merrill Lynch Corporate and High Yield Index returns; and the effective tax rate is derived from U.S. publicly traded firm data, which serve as the proxy for the financial data of a representative private-sector firm. The after-tax rate of return on equity is based on the returns of the equity market as a whole.¹⁸

Interest is imputed on the debt assumed necessary to finance priced-service assets. These imputed costs are allocated among priced services according to the ratio of operating expenses, less shipping expenses, for each service to the total expenses, less the total shipping expenses, for all services.

Interest on float is derived from the value of float to be recovered for the check and ACH services, Fedwire Funds Service, and Fedwire Securities Services, through per-item fees during the period. Float income or cost is based on the actual float incurred for each priced service.

The following shows the daily average recovery of actual float by the Reserve Banks for 2016, in millions of dollars:

Float that is created by account adjustments due to transaction errors and the observance of nonstandard holidays by some depository institutions was recovered from the depository institutions through charging institutions directly. Float subject to recovery is valued at the federal funds rate. Certain ACH funding requirements and check products generate credit float; this float has been subtracted from the cost base subject to recovery in 2016 and 2015.

(7) Other Income and Expenses

Other income consists of income on imputed investments. Excess financing resulting from additional equity imputed to meet the FDIC well-capitalized requirements is assumed to be invested and earning interest at the 3-month Treasury bill rate.

(8) Cost Recovery

Annual cost recovery is the ratio of revenue, including other income, to the sum of operating expenses, imputed costs, imputed income taxes, and after-tax targeted return on equity.

Footnotes