CRITERIA FOR EVALUATING PROPOSED PAYMENTS-SYSTEM CHANGES

In offering payment services, the Federal Reserve must satisfy the cost-recovery objective of the Monetary Control Act: in the long run, aggregate revenues should match costs. The pricing principles adopted by the Board of Governors in 1980 added to the aggregate cost-recovery objective specified in the Monetary Control Act the more stringent objective of full-cost recovery (including all operating and float costs and imputed taxes and return on capital) for each service line.¹ This internal objective of cost recovery for each service line was subsequently modified to provide that revenues for each service line must cover all operating costs, float costs, and certain imputed costs, such as the cost of interest on short- and long-term debt, as well as make some contribution to the pre-tax return on equity. Thus, each service line must be at least marginally “profitable” and all service lines combined must, in the aggregate, cover all production costs, float costs, and the private-sector adjustment factor.

The Federal Reserve establishes cost-recovery objectives, rather than targeted volume objectives, for its services. In a dynamic payments environment, circumstances might arise, such as changes in technology or banking structure, that could jeopardize the Federal Reserve’s ability to meet its cost-recovery objectives in a particular service. If a service experiencing such developments can be improved to be responsive to the market, it would continue to be offered. If it becomes clear, however, that the service cannot be expected to meet cost-recovery objectives, the Federal Reserve would reassess the appropriateness of continuing to provide the service after taking into account its other objectives, including the requirement to provide equitable access and an adequate level of services nationwide. For example, several Reserve Banks have stopped offering cash transportation in areas where an adequate level of this service is otherwise provided by the private sector.

More efficient operations or aggressive pricing by other service providers could also result in the Federal Reserve’s failing to meet cost-recovery objectives. Because the Monetary Control Act directs the Federal Reserve to give due regard to competitive factors, a decision would have to be made whether the public benefits of continuing to offer the service justify the shortfall. The Federal Reserve might also continue to provide a service that did not meet cost-recovery objectives if the revenue shortfall were caused by a temporary situation that could be corrected. In any event, a decision to continue to provide a service that could not reasonably be expected to meet cost-recovery objectives would be made by the Federal Reserve Board only after seeking public comment and only where there were clear public benefits to such a course of action. Similarly, any decision to withdraw from a particular service line would have to be undertaken in an orderly way, giving due regard to the transition problems associated with the discontinuation of a service.

The Federal Reserve’s operational presence in the payments system can be expected to change as the payments system evolves. Increased interstate banking activity, technological developments, developments in law and regulation, and the entry of new participants in the payments system will all influence the evolution of the Federal Reserve’s role.

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

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.