1996 Annual Report

Highlights of 1996

Keeping the nation's payments system operating smoothly and efficiently continues to be a challenge to the regional Reserve Banks as the needs of our customers change and expand rapidly. We are developing new technologies and customized solutions to creatively tailor the banking services we offer to depository institutions and the federal government. There were several notable milestones in 1996.

It's our job to make sure there is enough coin and currency in circulation to meet the public's demand. In fact, the warehousing, shipping, processing, and handling of currency are major functions of the Reserve Banks. This was an especially notable challenge in 1996 as we introduced the redesigned $100 bill to the public in March. The redesigned bills include new or modified features to improve security and stay ahead of counterfeiters and advances in technology which make it easier to reproduce currency. A seamless introduction of the new currency into the money stream was essential.

We began storing the new notes at all of our five offices as early as January to make sure we had enough on hand to release the end of March. But before that, in the third quarter of 1995, we held 20 customer education seminars in seven states throughout the Twelfth District. In addition to the seminars, we distributed information kits; circulated an informational video with reasons for the redesign, circulation plans, and recognizable features of the redesigned currency; and staffed an information desk to assist customers with any questions regarding the new currency.

To facilitate the smooth rollover of $100s in foreign markets, Extended Custodial Inventories (ECIs) were established and managed by the Federal Reserve Bank of New York in London, Frankfurt, and Zurich. These ECIs strategically stockpiled inventories in key markets and geographic redistribution centers to minimize inventory limitations imposed by flight schedules and in-transit insurance ceilings.

Were we successful? Currently, approximately 60 percent of all $100s flowing back to our Bank are the newly designed notes, and they now make up 32.7 percent of the 2.6 billion notes in circulation.

But all transactions are not handled in cash. In fact, check volume, contrary to forecasters' predictions, continues to increase, and handling paper checks and the related movement of funds remain costly and labor intensive. Approximately 63 billion checks are written each year in the United States, a number which is expected to continue to grow over the next several years.

Converting these paper checks to electronic data is one way to expedite check clearing. Electronic Check Presentment (ECP), for example, provides financial institutions with an electronic file of check data in advance of the delivery of the physical checks from the Federal Reserve, allowing earlier identification of fraud, decreased clearing times, and reduced reliance on transportation.

During 1996, the Bank introduced check imaging as a complement to such electronic products as ECP. Check imaging takes a digital picture of a check and saves it in digital, computer-file form for retrieval when needed. This process, in essence, turns a paper check into an electronic "picture" which is easier to organize, distribute, store, and access. ECP, together with check images, allows banks and their cash management customers to address fraud and risk concerns up to 12 hours earlier than if they had to wait for the arrival of physical checks. Retrieving check images from computer storage systems also speeds response time in handling customer balance inquiries, requests for check clearing information, and requests for check copies, resulting in operational efficiencies and improved customer service. The Bank's check image product line is flexible and can be easily customized to meet a variety of needs.

Electronic funds transfer is a faster and more secure method of payment than either cash or check. The automated clearing house (ACH) is an electronic funds transfer system. This nationwide network processes electronically originated credit and debit transfers such as direct deposit payroll payments and corporate payments to contractors and vendors. During 1996 the Federal Reserve System converted to a new centralized ACH application software, Fed ACH. This software enabled us to significantly reduce fees and provide depository institutions with greater control over how they access, process, and settle ACH transactions. Because ACH transactions are processed from one central computer site within the Federal Reserve System, items no longer have to be transmitted from one Federal Reserve district to another.

In addition, customers have expanded file delivery options and enhanced on-line access. This means they can have greater processing flexibility and provide their customers with time-critical ACH payments more quickly.

The Federal Reserve also holds U.S. government securities in safekeeping as book entries --electronic records rather than paper certificates--for depository institutions. During 1996, the Federal Reserve Bank of San Francisco also installed new software in this service. This software, which is referred to as NBES (New Book-Entry System), provides for centralized computer processing at a single site with standardized services to depository institutions. NBES offers an increased number of accounts available to users; improved contingency and disaster recovery capabilities; quick wire transfers for all transactions; and enhanced reporting features.

Operational controls in the Los Angeles Branch Cash area received an unusual amount of scrutiny in 1996. As a result of an internal compliance team's findings of errors in a Los Angeles Cash administrative report, the General Accounting Office reviewed the department's statistical reporting processes and noted possible concerns regarding the integrity of cash accounting and financial controls. By year-end, results of an internal audit, a Board of Governors examination, an unannounced vault count, and an independent, external accounting firm's review all pointed to the soundness of our operational controls and the integrity of our overall cash operation.

Economic Research

Research during 1996 addressed policy-related issues, including U.S. monetary policy, international topics, and the effects of banking industry restructuring. Staff published extensively both in Bank publications and outside academic journals.

Monetary policy studies covered such topics as the effect of policy on the economy, indicators of future inflation, and the way in which the Fed sets the stance of monetary policy in response to economic developments. International topics included monetary policy targets in the United Kingdom, New Zealand, and Japan; exchange rate risk and trade flows; and exchange rate exposure and crises. Banking studies looked at efficiency, the pricing of financial services, and the availability of credit. This research formed the basis for extensive briefings of senior management on monetary and regulatory policy, as well as economic developments in the western United States and the Pacific Basin.

Furthering the Bank's ongoing efforts to promote cooperation and share research among Pacific Basin countries, our Center for Pacific Basin Monetary and Economic Studies held a conference, "Managing Capital Flows and Exchange Rates: Lessons from the Pacific Basin." The department also co-hosted an academic conference with the Center for Economic Policy Research at Stanford University. Papers at that conference examined the measurement and management of monetary policy.

Banking Supervision and Regulation

The supervision and regulation function in 1996 was significantly affected by rapid changes in the industry brought on by increased industry consolidation, interstate branching and banking, and the development of electronic banking products and services. Specific emphasis was placed on risk management, concentrating on increasing the value of the supervisory process and ensuring its efficiency and effectiveness for our customers.

To achieve delivery of a more effective, risk-focused, and seamless supervisory approach, the Consumer Compliance and Community Affairs and Bank Supervision and Regulation departments were merged into one division.

At year-end there were 62 state member banks in the District. There were also 210 holding companies with assets totaling $522 billion, 120 branches and agencies of foreign banks, 8 Edge and Agreement corporation offices, and 40 representative offices.

Overall applications activity declined as the total number of applications filed during 1996 reached 291 as compared to 310 in 1995. This level, while slightly reduced from the prior year's activity, continues to reflect the expansion and consolidation of the industry. Applications to form bank holding companies declined from 54 during 1995 to 26 in 1996, and merger applications by state member banks declined by half in 1996.

The Twelfth District continued to provide guidance and direction on community reinvestment throughout the nine Western states. Community Affairs co-sponsored, with the American Bankers' Association and the Small Business Administration, the 1996 National Community Development Lending Conference. Later in the year, the unit sponsored its annual Community Reinvestment conference, entitled "The New CRA: Focus on the Future." It also sponsored two one-day small business lending conferences and a conference on electronic banking and its implications for consumers, and facilitated numerous other meetings. Staff also coordinated a series of seven public meetings on the proposed merger between First Interstate Bank of California and Wells Fargo Bank, with approximately 550 individuals providing their comments on CRA activity of these banks.

In the area of community development, the Bank provided leadership to the Association of Reinvestment Consortia for Housing, and consulted with Seattle-based banks on the formation of the Seattle Small Business Lenders Association's "One Stop Capital Shop." To assist banks in identifying local investment opportunities, the unit held bi-monthly roundtables in Boise, Las Vegas, Los Angeles, Salt Lake City, San Francisco, and Seattle.