Federal Reserve's Competition with Other Providers Benefits Customers, but Additional Reviews Could Increase Assurance of Cost Accuracy
GAO-16-614: Published: Aug 30, 2016. Publicly Released: Sep 29, 2016.
What GAO Found
The Federal Reserve Banks are authorized to provide payment services—such as check clearing and wire transfers—to ensure continuous and equitable access to all institutions. The Depository Institutions Deregulation and Monetary Control Act of 1980 (Monetary Control Act) requires the Federal Reserve to establish prices for its payment services on the basis of the costs incurred in providing the services and give due regard to competitive factors and the provision of an adequate level of services nationwide. GAO found the Federal Reserve had a detailed cost accounting system for capturing these costs that generally aligned with federal cost accounting standards. Although this system was evaluated and found effective by a public accounting firm in the 1980s, it has not undergone a detailed independent evaluation since then. In addition to the actual costs it incurs in providing services, the Federal Reserve also must include 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 if the services had been furnished by a private firm. Although its processes for simulating the imputed costs generally were reasonable, the Federal Reserve did not impute certain compliance costs private-sector firms can face—such as for planning for recovery and orderly wind down after financial or other difficulties. Including additional simulated costs competitors can incur and obtaining periodic external evaluations of its cost accounting practices would provide greater assurance that the Federal Reserve fully includes appropriate costs when pricing its services.
Since the mid-2000s, the effects of Federal Reserve participation in the payment services market have included lower prices for many customers; overall market share for competitors also increased. Although some competitors raised concerns about some Federal Reserve pricing practices, customers GAO interviewed generally were satisfied with its services and prices. The Federal Reserve also has a process for assessing its pricing and products to help ensure it is not unfairly leveraging any legal advantages. Since 2005, the Federal Reserve lowered prices for checks and smaller electronic payments while increasing prices for wire transfers. During this time, private-sector competitors' market share expanded overall. But the Federal Reserve's only competitor in small electronic payments and wire transfers told GAO that increased regulatory costs and competitive pressure from the Federal Reserve creates difficulties for the long-term viability of private-sector operators.
Most market participants GAO interviewed were satisfied with how the Federal Reserve performed various regulatory and service provider roles in the payments system. Most of the 24 participants GAO interviewed had no concerns over how the Federal Reserve separated its supervisory activities from its payment services activities. The Federal Reserve also has begun collaborating with market participants to pursue improvements to the safety, speed, and efficiency of the payment system. Although some competitors said the Federal Reserve should reduce its payment services role, many participants supported having the Federal Reserve remain an active provider. Federal Reserve staff indicated that these activities provide the Federal Reserve with sufficient revenue to enable it to provide ubiquitous access at affordable prices.
Why GAO Did This Study
Federal Reserve Banks compete with private-sector entities to provide services while Federal Reserve Board staff also supervise the Reserve Banks and other service providers and financial institution users of these services. The Monetary Control Act requires the Federal Reserve to establish fees for its services on the basis of costs, including certain imputed private-sector costs. GAO was asked to review issues regarding the Federal Reserve's role in providing payment services. Among other objectives, GAO examined (1) how well the Federal Reserve calculates and recovers its costs, (2) the effect of the Federal Reserve on competition in the market, and (3) market participant views on the Federal Reserve's role in the payments system.
GAO analyzed cost and price data trends; reviewed laws, regulations, and guidance related to Federal Reserve oversight and provision of payment services; and interviewed Federal Reserve officials, relevant trade associations, randomly selected payment service providers, customer financial institutions, and other market participants.
What GAO Recommends
GAO recommends that the Federal Reserve consider ways to incorporate, where appropriate, additional costs faced by private-sector competitors in its simulated cost recoveries and periodically obtain an external audit that tests the accuracy of the methods it uses to capture and simulate its costs. The Federal Reserve noted steps they will take to address GAO's recommendations.
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Recommendations for Executive Action
Status: Closed - Implemented
Comments: After we issued our report, the Federal Reserve agreed to consider ways to incorporate the cost categories identified by GAO in the Board's imputed private sector cost methodology. In a letter dated December 21, 2017, the Board provided GAO with information on how staff have considered ways to incorporate these additional costs into its methodology for pricing check clearing and other services to banks. The staff provided us with a 15-page analysis documenting their consideration of how to incorporate the costs associated with integrated planning for recovery and wind down and compliance with antimoney-laundering requirements. As a result of this analysis, the Board staff concluded that no sound, transparent, and replicable approach could be used to practicably incorporate these costs in its imputed private-sector cost methodology without introducing undue cost, complexity, and potential errors in the Board's calculation.
Recommendation: To provide greater assurance that the Federal Reserve is complying with the Monetary Control Act's requirement to establish fees on the basis of costs actually incurred and an allocation of imputed private-sector costs, the Chair of the Federal Reserve Board of Governors of the Federal Reserve System should consider ways to incorporate the costs related to integrated planning for recovery and wind down and compliance with antimoney-laundering requirements, to the extent practicable, in its imputed private-sector cost methodology.
Agency Affected: Federal Reserve System: Board of Governors
Status: Closed - Implemented
Comments: In response, the Federal Reserve Board engaged Deloitte & Touche LLP to review the methods currently employed for capturing actual and imputed costs related to Reserve Bank priced services. Over the course of the engagement, Deloitte reviewed the cost accounting policies established by the Federal Reserve, including comparing the policies to industry standard practices, evaluating the effectiveness of the policies in meeting the Monetary Control Act's requirements, and identifying gaps or opportunities to improve the efficiency and effectiveness of the policies. In addition, Deloitte reviewed the Board's Principles for the Pricing of Federal Reserve Bank Services to assess their relevance in meeting the objectives of the act, performed testing of the Federal Reserve's cost allocation methods for compliance, and interviewed management regarding the adequacy of the cost accounting policies and procedures. After completing its review in January 2018, Deloitte's overall conclusion was that cost allocations to the Reserve Banks' priced services are consistent with regulatory requirements and are effective in meeting the requirements of the act. The Federal Reserve staff also noted that the audit confirmed the existence of improvement opportunities that will allow them find efficiencies in their processes and additional transparency in their data reporting. The staff also indicated that they will periodically evaluate the appropriateness and timing of obtaining independent testing, taking into account any changes and the length of time since previous independent testing was conducted.
Recommendation: To provide greater assurance that the Federal Reserve is complying with the Monetary Control Act's requirement to establish fees on the basis of costs actually incurred and an allocation of imputed private-sector costs, the Chair of the Federal Reserve Board of Governors of the Federal Reserve System should periodically obtain independent testing of the methods the Federal Reserve uses to capture its actual costs and simulate those of the private sector.
Agency Affected: Federal Reserve System: Board of Governors