Statement by Wayne D. Angell and Edward W. Kelley, Jr., members, Board of Governors of the Federal Reserve System, before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs of the U.S. House of Representatives, May 27, 1992.

1. The attachments to this statement are available on request from Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551.

Statement by Wayne D. Angell and Edward W. Kelley, Jr., Members, Board of Governors of the Federal Reserve System, before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs of the U.S. House of Representatives, May 27, 1992

It is a pleasure for Governor Kelley and me to visit with this subcommittee today to discuss and review the Federal Reserve System's expenses and budget. Today, as we look at the Federal Reserve System's budget for 1992, Governor Kelley will discuss the Board's budget and major initiatives, and my comments will focus on the Reserve Bank budgets, as well as on major System initiatives.

The Board has recently made available to the public and to this subcommittee copies of our publication, Annual Report: Budget Review, 1991-92, which presents detailed information about spending plans for 1992. The attached tables have been updated for 1991 actual experience, and, therefore, some variations exist from data in that document. (1)

The actual increase in Federal Reserve System expenses from 1986 to 1991 has been 5.2 percent. This increase is not a cost increase for a constant basket of services but reflects our response to supervision and regulation initiatives, expedited funds availability (EFA) legislation requirements, contingency planning initiatives, and several major initiatives for the U.S. Treasury.

For 1992, the Federal Reserve System has budgeted operating expenses of $1.7 billion, an increase of 6.9 percent over the 1991 budget and 7.4 percent above 1991 actual expenses. From 1990 to 1991, expenses were up 6.3 percent, reflecting a O. 5 percent underspending of the 1991 budget. Before getting to the details of our 1992 plans, I would remind the subcommittee of two aspects of Federal Reserve System operations that affect our budget in unusual ways. First, 45 percent of System expenses ($786 million) was recovered through priced service revenues. All increases in costs of priced services result in increased earnings returned to the U.S. Treasury. Second, 9 percent ($158 million) of our expenses is for fiscal agency operations provided to the Treasury Department and other agencies on a reimbursable basis. About 40 percent of total reimbursable expenses was actually reimbursed in 1991. Altogether, about 55 percent of our total expenses is either recovered through pricing or is reimbursable. On a net basis the cost to the public of the Federal Reserve System's operations is $776 million of the total $1.7 billion budgeted for 1992. Besides priced service revenues the System has very large earnings on the System's portfolio of assets that are derived directly from required bank reserves, currency issuance activities, and foreign exchange activities that enabled the Federal Reserve Banks to pay $21 billion to the Treasury in 1991.

HISTORICAL OVER VIEW

It might be helpful to put the budget for 1992 in perspective by sketching the most recent tenyear history of System expenses. Between 1981 and 1991, Federal Reserve System expenses increased at an average annual rate of 5.4 percent; System employment decreased at an average annual rate of 0.1 percent; and volume in measured operations increased 30 percent over the ten-year period. Unit cost did increase in some services in the early eighties as Federal Reserve Bank volumes fell after the implementation of pricing under the Monetary Control Act. However, after the transition to pricing was completed in 1983, the composite unit cost for all functions has increased only 0.3 percent on an annual basis, even while improvements have been made in the quality of services.

For priced services, a decline in unit cost has been particularly noticeable in the electronic payment areas. Automated clearinghouse (ACH) unit cost has decreased 7.7 percent per year (1981-91), and funds transfer unit cost has decreased 1.4 percent per year during this same time period; since 1986, the decreases per year have been 11.4 percent for ACH and 1.9 percent for funds. Volume growth has averaged almost 8 percent per year for funds transfer and 23 percent per year for ACH transactions (1981-91). In our large check processing operation, on the other hand, where there has been a significant effort to improve the quality of service through increased availability and improved deposit deadlines, unit cost has increased an average of 1.9 percent per year since 1983. Many of these initiatives have resulted in reducing Federal Reserve float. The daily average level of Federal Reserve float has been reduced from $1.5 billion in 1983 to $348 million in 1991.

For our nonpriced cash operations--involving the distribution of currency and coin--unit costs have also been declining. Since 1983 the decline has averaged about 1.2 percent per year, with volumes increasing 4.4 percent per year. However, in our fiscal agency operations, also nonpriced, unit costs have increased 4.8 percent per year since 1983, reflecting new operations and services for the Treasury. In this area, the Federal Reserve System has managed several initiatives for the Treasury to improve long-term efficiency in Treasury securities and savings bonds and to improve the quality of service to the public. Through 1991 the Federal Reserve has added 468 staff members and spent a cumulative $96 million on these Treasury initiatives.

It is difficult to measure productivity improvements in the supervision and regulation area, and these activities have required significant increases in resources over the last ten years. We do not have good data regarding the benefit to the banking system and the insurance fund regarding the efficiency of additional supervision and regulation expenditures. Between 1981 and 1991, the number of staff members for supervision and regulation increased 610, and annual expenditures increased $137.5 million. These resources have been employed to strengthen the ability of the Reserve Banks to identify and address problems in the banking organizations under their jurisdiction. Obviously, the Reserve Banks have had to deal with greatly increasing work loads in the past several years as reflected in the record number of bank failures and problem banks, as well as in the increasingly complex issues they have had to face in reviewing and processing regulatory applications and in developing supervisory policies to deal with new and changing banking risks.

In presenting our spending plans for 1992, I would like to mention that both the Reserve Bank budgets and the Board's budget must be approved by the Board of Governors. Reserve Bank budgets are first approved by the Banks' boards of directors and then reviewed by the Committee on Federal Reserve Bank Activities before submission to the Board of Governors. Governor Kelley oversees the Board's budget, and I will turn to him for that discussion.

BOARD OF GOVERNORS BUDGET

The 1992 budget of the Board of Governors comprises three parts: a Board operations budget of $123.6 million, an extraordinary items budget of $3.2 million for special projects of a unique or one-time nature, and an Office of Inspector General budget of $2.0 million. The operations budget of $123.6 million is 12.5 percent greater than 1991 expenses. Increases in salaries and benefits for current personnel and in the price of goods and services account for 51 percent of the rise. Initiatives to increase staffing and improve automation, largely in the supervision and regulation and monetary and economic policy operational areas, account for the remaining 49 percent.

The Board authorized 1,608 positions for the operational areas and 21 for the Office of Inspector General; no positions were required for the extraordinary items budget. The budget added a total of 39 positions for the operational areas; of this total, 25 were for the supervision and regulation function. Coupled with positions added during 1991 and fewer vacancies, the new positions will enhance the Board's ability to manage a growing work load in international supervision, enforcement, and litigation. The remaining 14 positions were added for the monetary and economic policy function to strengthen and expand long-term research, to help in a nationwide effort to improve the quality of government economic statistics, and to enhance analytical capabilities through additional automation.

The budget did not fund any requirements that might result from a proposed special investigative unit, pending further review of the requirements and estimates of necessary resources.

Operations Budget by Operational Area

Monetary and Economic Policy. The budget for the monetary and economic policy area is $59.5 million, which is $4.5 million, or 8.2 percent, more than 1991 expenses. The budget provided an increased level of funding for the divisions that support this function to meet an increasing work load, expand long-term research, and improve the quality of economic data. Automation initiatives, including continuation of the phased development of the research computing system, were key elements of the divisions' plans to manage the work load. Because productivity improvements alone were not sufficient to support these initiatives, fourteen positions were added.

Investments in research automation have produced productivity gains that, combined with adjustments in priorities and reductions in long-term research, have limited expenses and the degree of staff growth for the monetary policy function over the last five years. The greater 1992 personnel authorizations, in large measure driven by an effort to meet analytical requirements at the Board, also reflect increased requirements for support from the supervision and regulation operational area. Questions on such topics as the farm credit system, insurance companies, interest-rate risk, capital standards, and regulation of government-sponsored enterprises have added to the work load. Studies on banking legislation, deposit insurance, and consolidation in the banking industry are typical of areas requiring increased attention. The additional staff resources will slow continued growth in the volume of uncompensated staff overtime and will allow for a moderate increase in long-term research.

Supervision and Regulation. The budget for the supervision and regulation area is $38.5 million; this amount is $6.4 million, or 19.9 percent, over 1991 expenses. As noted earlier, twenty-five positions were added, which, in conjunction with positions added during 1991, caused the majority of the increase. The additional positions were required to meet continued growth in the work load, particularly in international supervision, policy analysis, applications, and litigation and enforcement.

Besides costs associated directly with new initiatives, the budget funded the Board's share of the automation costs for development of the National Information Center (NIC). The NIC is the sole source of consolidated banking structure and financial data for bank holding companies. When the entire NIC is established, complete with national structure, supervisory, and certain financial data for financial and other related institutions, it will be of major benefit to the supervision and regulation operational area. The 1992 funding was approved to continue the scheduled transition from existing software to software that can access the NIC database. The completed NIC will reduce Systemwide costs, improve data integrity, and lead to more timely and more meaningful analysis of applications, merger requests, and other actions.

Substantial resources were also approved for the rewrite of the programming that produces the Bank Holding Company Performance Report (BHCPR), an analytical tool used by all Reserve Banks and Board staff members. This report is utilized for determining the financial condition of Bank Holding Companies in connection with offsite analysis, on-site inspections, and reviews of proposed mergers and acquisitions.

Finally, resources were approved for enhanced software to access the Home Mortgage Disclosure Act (HMDA) database to provide improved analysis of the data used in the examination, applications, and research areas. On an annual basis, HMDA requires lending institutions that have more than $10 million in assets, and offices in metropolitan statistical areas, to compile data regarding applications for origination and purchases of mortgage and home improvement loans. These data are then submitted to the supervisory agencies and processed by the FFIEC to produce a disclosure statement that the FFIEC must make available to the public.

Automation enhancements were approved to replace obsolete equipment with equipment capable of greater interaction with the BHCPR, NIC, HMDA, and other critical databases. The upgraded equipment improves the staff members' ability to meet tight deadlines with high-quality analyses and finished products.

Services to Financial Institutions and the Public. Services to financial institutions and the public, which includes the payments function, has a budget of $3.3 million, an increase of $0.5 million, or 15.8 percent, over 1991 expenses. The increase was necessary to fund both improvement of cash tracking for the System and a lower level of staff vacancies.

System Policy Direction and Oversight. The budget for System policy direction and oversight is $22.2 million, an increase of $2.4 million, or 12.0 percent, over 1991 expenses.

The increase in this budget was tied to a lower level of vacancies, a new position, and the development of mainframe software to provide improved financial information. This budget also funded continued upgrading of office automation systems and the expansion of network facilities.

Operations Budget by Object of Expense

The most significant expense item in the Board's budget is for personnel, which accounts for about 75 percent of operating expenses. The 1992 increase in the salary budget, $6.4 million, or 8.7 percent, includes not only annual salary increases for current personnel (4.9 percentage points) but also salaries for new positions (3.8 percentage points), both those added in late 1991 and the thirty-nine positions added for 1992. A lower vacancy rate also contributed to the increase.

Retirement costs for 1992 are $0.8 million, or 16.3 percent, greater than 1991 expenses, primarily because of increases in the Board's matching contribution to the thrift plan and in the wage base subject to social security and medicare taxes.

Insurance costs are $0.3 million, or 4.8 percent, greater than 1991 expenses. The rate increase for the health insurance plans, combined with a higher level of staffing for new positions and fewer vacancies, produced $0.5 million of increase. Partially offsetting these increases was a $0.2 million decrease in workers compensation, reflecting a large one-time payout in 1991.

The cost of goods and services accounted for 25 percent of the budget. To keep permanent staff increases to a minimum, the budget funded increased use of contractual professional services to provide software development support for important projects as well as expert advice for data improvement and examiner training initiatives. The travel budget increased because of higher airfares, a greater volume of travel to resolve supervisory issues, and relocation costs for new staff members. Software expenses are higher as a result of rate increases for mainframe software and the changing technological needs of the Board.

Capital Budget

The capital budget for 1992 is $5.0 million, which is $54,600 greater than 1991 expenditures. The budget provided for requirements in the areas of automation and telecommunications and improvements to facilities.

Continued investment by all the Board's divisions in workstation, network, and office automation systems amounted to $3.3 million. The budget includes funds for a premises-wide network, a document-management system, and a network for the administrative systems using off-the-shelf software.

Facilities improvements include a multiyear effort to repair concrete slabs in the parking garage and a new air handler to improve heating, ventilation, and air conditioning in the data center. Capital funds will also be required for the reconfiguration of office space.

Trends

The increase in the 1992 operations budget of the Board over 1991 expenses, 12.5 percent, was significantly greater than the 7.8 percent average annual rate of increase for the past five years and the 7.1 percent increase for the past ten years. The larger increase reflects the surge in work load that has exceeded the ability of managers to absorb through improved productivity.

The average annual increase in Board costs since 1982 has been 6.3 percent. Although this figure is low relative to the substantial growth in work load, the annual rate of increase has been rising. For example, in the ten years ending in 1990 the average annual increase was 6.0 percent. The recent rise is attributable to a higher level of staffing, adjustments of salaries resulting from a revised employee compensation program, and sharp increases in benefit costs, particularly for health insurance. The salary and benefit changes have had a particularly noticeable impact because 75 percent of the Board's budget is for staffing. For the first time since 1988, the goods and services budget increased at a faster pace than the personnel budget. The shift is a result of depreciation expenses on a larger stock of capitalized automation equipment, costs of maintaining the Board's facilities and providing additional office space, and a decision to satisfy software requirements through temporary contractual arrangements rather than hiring additional permanent staff. The latter decision was made in recognition of the temporary nature of the increased requirement for software development for major projects such as the NIC and HMDA.

Personnel costs have been affected by the increase in the total number of positions and the decline in the number of position vacancies. The 1992 increase in positions, to a total of 1,608, returns the Board to the same number as in 1985. In recent years, increases in the supervision and regulation operational area were offset by decreases elsewhere. Between 1985 and 1991, the number of positions directly supporting the supervision and regulation function increased from 242 to 293, although the overall number of positions at the Board declined. The 1992 budget provided an additional 25 positions in this area to a new total of 318.

The combined effects of the revised employee compensation program and the slowdown in the economy have resulted in a reduced rate of staff turnover and a lower level of vacancies. Turnover in 1991 was the lowest in many years, and a low rate was projected in the 1992 budget. This is proving extremely important to the Board in meeting key requirements without further increases in the number of positions.

The 1992 rate increase for the Board's health insurance plan, 6.3 percent, is significantly below the 22 percent average annual rate of increase in the previous five years. The lower rate of increase reflects some reductions in the plan's benefits, necessary in light of the large and continuing increases that were projected to continue indefinitely without management action.

Extraordinary Items

Three projects are covered by the extraordinary items budget. The first is the 1992 Survey of Consumer Finances, which will collect important financial data used for a wide variety of policy analysis and monetary policy purposes. The project reflects the Board's interest in enhancing the quality of economic data by obtaining information on income, assets, debts, pensions, employment, use of financial services, savings behavior, and other characteristics of U.S. households. Cross-categorization of the data will allow important statistical observations that are useful in a wide variety of economic studies.

The second project is an audit of the Federal Reserve Bank of Kansas City by a public accounting firm, which was originally scheduled to be performed in 1991. Because more lead time was needed for procurement, the project was rescheduled for 1992. The financial examinations program in the Division of Reserve Bank Operations and Payment Systems will audit the other Reserve Banks as usual. The objective of the outside audit is to provide assurance that internal audits at the Reserve Banks achieve desired controls and standards consistent with those applied by the accounting profession.

The third project covered by the extraordinary items budget is a study by an outside consultant to ensure the security of the transfer of funds and securities via Fedwire. The study will focus on additional security enhancements that should be incorporated into the Federal Reserve System information security architecture to ensure security of the Fedwire system.

Office of Inspector General

The 1992 Office of Inspector General (0IG) budget of $2.0 million was $0.4 million, or 28.0 percent, higher than 1991 expenses. The increase was due largely to the addition of two new audit manager positions and related expenses. The office's goods and services expenses decreased slightly, primarily because of a one-time software purchase in 1991 and reduced use of external legal services.

Governor Angell will now discuss the Reserve Bank budgets.

RESERVE BANK BUDGETS

The Reserve Banks' 992 expenses--both priced and nonpriced--were budgeted at 6.4 percent above the 1991 budget; the actual increase in expenses between 1990 and 1991 was 6.2 percent. Eight major initiatives account for almost a third of the budgeted increase in Reserve Bank expenses.

The initiative with the largest expense impact is facility improvements, which will add $18.7 million to operating expenses in 1992, or 1.2 percent of the operating budget. Expenses associated with two building projects account for nearly all of the increase: New York's East Rutherford Operations Center, $9.2 million, and Dallas's new building, $7.9 million.

Initiatives in supervision and regulation are expected to increase expenses by $8.5 million and employment by 108. A majority of the Reserve Banks see a need for additional staff members because of increased work loads, increased examination of foreign banks, and more problem institutions. Additional pressures result from the 1991 passage of the FDIC Improvement Act. Travel and automation costs add to the salary expense burden for the additional staff members.

Nine Banks collectively have budgeted $2.8 million to improve the efficiency of check collection systems. Most of these projects are continuing efforts and are contributing to a reduction in check-staff levels.

Expenses for fiscal initiatives, which are reimbursable, are expected to add $2.4 million. Most of this increase is for the final phase of the Regional Delivery System, which involves centralized issuance of over-the-counter savings bonds. Another savings bond initiative, known as Masterfile, provides for centralized processing of payroll deductions and will also add expenses. These projects are being implemented at the request of the Treasury Department to bring operating efficiencies to the savings bond program.

Reserve Bank operations in today's environment require more reliable and secure computer systems, more office automation, and more communication networks. These needs are met partly through the initiative for automation and contingency projects ($2.0 million).

The remaining initiatives include $4.6 million for the last year of the plan to increase the employer's share of the matching contribution to the thrift plan: In 1992 the employer's share will increase from 70 cents to 80 cents on the dollar up to 6 percent of salary. An additional $1.0 million is budgeted for currency processing equipment and personnel to handle currency volume growth on the West Coast.

Partially offsetting the above increases are initiatives that will result in savings of $3.4 million. These savings are being achieved by increased productivity and consolidation of certain operations in four Districts.

Expenses by Service Line

Besides these major initiatives, it may be helpful to look at 1992 budgeted expenses on the basis of our four service lines.

Services to Financial Institutions and the Public. Expenses for services to financial institutions and the public, which include all of the priced services and some of the nonpriced services, are budgeted at $1,042.1 million and account for two-thirds of total expenses. These expenses are increasing by $61.7 million, or 6.3 percent, over 1991. Staffing for services to financial institutions and the public is budgeted at 8,974, a decrease of 70, or 0.8 percent. Expenses of priced services (all of which are within this service line) are budgeted at $672.3 million, an increase of 4.0 percent; these services, incidentally, are expected to generate revenues of about $786 million. Nonpriced services within this service line are budgeted at $369.8 million, an increase of 7.5 percent.

Commercial check processing is by far the largest component in this service line ($504.9 million); it accounts for 48.5 percent of the service line's expenses and employs 5,480 people. The anticipated increase in expenses is $22.2 million, or 4.6 percent, and employment is expected to decline by 60, or 1.1 percent. The reduction in staff members results from continued automation in adjustments, conversion to optical disk storage systems, and improvements in return-item processing. Commercial check volume is budgeted to decrease 0.2 percent, and unit costs are budgeted to increase 4.2 percent. Continuing efforts to increase automation in the commercial check service should continue to lower unit costs in the future.

Our other large operations in this service line are currency ($157.2 million and 1,524 people), automated clearinghouse ($89.5 million and 361 people), and funds transfer ($75.7 million and 158 people). Currency expenses are expected to increase 10.8 percent over 1991 because of rising volumes and implementation of new high speed equipment. In automated clearinghouse, a 10.9 percent increase in expenses reflects an anticipated volume increase of 15.9 percent. Funds transfer is expecting stable growth and a decrease of 2 in its average number of personnel; expenses will be up 8.8 percent primarily because of increased data processing costs.

Supervision and Regulation. Expenses for supervision and regulation, budgeted at $261.2 million for 1992, are expected to increase $23.9 million, or 10.1 percent, over 1991. This service line has been the fastest growing of the four and now constitutes 16.4 percent of total System expenses, compared with 14.3 percent in 1987. The budgeted level for staff members is 2,477, an increase of 135, or 5.8 percent, over 1991.

The expense increase for supervision and regulation is concentrated in the salary and benefit object for new and ongoing staff members as well as for travel, training, and automation (primarily laptop computers). Demands on the Federal Reserve Banks' examination staff members include more examinations of broader scope, increased emphasis on Bank Secrecy Act issues, and the need to monitor compliance with and pursue enhancements to international risk-based capital standards. Also, our examination staff members must handle a large number of organizations that continue to require special attention in the form of extended examinations. The expense increase is also affected by initiatives for payment system risk and daylight overdraft pricing. In addition, the passage of the FDIC Improvement Act of 1991 will require additional resources in 1992 mainly for the examination of branches of foreign banks operating in this country.

Services to the U.S. Treasury and Other Government Agencies. Expenses for services to the U.S. Treasury and other government agencies are budgeted at $180.1 million, an increase of $10.6 million, or 6.2 percent, over 1991. These expenses continue at about 11 percent of total expenses in 1992. Staffing levels are budgeted to increase by thirty-two, or 1.7 percent. Operationally, the most significant development in this area is the continuing conversion of over-the-counter savings bonds to the Regional Delivery System, which is the main reason for the net staff increase. Savings bond volume is expected to increase 9.0 percent, and unit costs are budgeted to decrease by 0.4 percent.

Monetary and Economic Policy. Expenses in 1991 for the conduct of monetary and economic policy at the Federal Reserve Banks total $113.0 million and account for about 7 percent of the total budget. An increase of $6.3 million, or 5.9 percent, is anticipated in 1992. Employment, budgeted at 794, reflects an employment increase of 11 over actual 1991. Besides providing for the staff additions, the expense increase represents salary administration actions and increased equipment and data processing costs associated with automation initiatives.

Budgets by Object of Expense

Reserve Bank expenses on an object of expense basis also might be useful to the subcommittee.

Personnel. Operating expenses for personnel comprise officer and employee salaries, other compensation to personnel, and retirement and other benefits. Total personnel costs account for 65.0 percent of Reserve Bank expenses and are expected to increase 7.2 percent in 1992.

Salaries and other personnel expenses account for about 52 percent of 1992 Reserve Bank budgeted expenses and are expected to be $47.5 million, or 6.1 percent, above 1991 expenses. Salaries alone are budgeted to increase by $50.3 million, or 6.5 percent, and will be partially offset by a decline in other personnel expense of $2.8 million, or 22.2 percent. The decrease in other personnel expenses results from a declining use of temporary help. Merit pay increases of $37.1 million, or 4.8 percent, account for about 74 percent of salary expense growth. Staffing level increases, promotions, reclassifications, and structure adjustments account for about 26 percent of salary expense growth. These increases are partially offset by position vacancies and reduced overtime.

Expenses for retirement and other benefits, which account for 13.0 percent of Reserve Bank budgets, are anticipated to increase $22.3 million, or 12.1 percent, in 1992. This increase is the result of continued escalation in hospital and medical costs, a rise in social security, and an increase in the thrift plan match in 1992.

Nonpersonnel. Nonpersonnel expenses account for 35.0 percent of Reserve Bank expenses and are projected to increase 6.2 percent in 1992.

Equipment expenses are expected to increase 8.1 percent and to account for 11.3 percent of total expenses in 1992. Most of the increase is in depreciation expenses resulting from acquisitions to expand data-processing and data-communications capabilities because of increased work loads.

Shipping costs (primarily for check operations) account for 5.7 percent of the 1992 budget and are projected to increase 3.5 percent in 1992. This relatively small increase is due primarily to savings in postage costs as a result of the implementation of the Regional Delivery System for savings bonds.

Building expenses, which account for 9.2 percent of total expenses, are expected to increase 10.3 percent in 1992 because of higher real estate taxes in several Districts and the full-year effect of recently completed capital projects. New York's East Rutherford Operations Center and the Dallas building project contribute heavily to the large increase in building expenses.

By their nature, capital outlays vary greatly from year to year. These expenditures are greatly affected by the near-completion of the Dallas building and New York's East Rutherford Operations Center--and by outlays for dataprocessing and data-communications equipment.

SPECIAL BUDGET EMPHASIS

The Board of Governors has continued to approve two research and development projects and has added a third project in the 1992 budget. These projects will provide long-range benefits to the Federal Reserve and the banking industry and ultimately the American public. Because spending on such projects is relatively high and short-term, the Federal Reserve accounts for them separately from its operating expenses. The budget for these special projects in 1992 is $20.1 million. This amount includes $4.3 million for check image processing, $9.3 million for currency authentication sytems, and $6.5 million for the new project in 1992 automation consolidation.

The check image processing project will continue to build on previous years' research---the central concept is to test digital technologies to record images for use in processing checks. The focus in 1992 will be in three areas: (1) preparing for sustained tests of high-speed image capture systems for the government check application; (2) developing low-speed personal computerbased systems for the return-item application; and (3) leading efforts to develop industry standards for interchange of check images between banks.

The primary concept of the second project, currency authentication systems, is to improve capabilities for detection of counterfeit notes in the processing of incoming currency deposits at the Reserve Banks--and thereby promote the integrity of U.S. currency in circulation. These efforts should lead to effective counterfeit detector devices that will be attached to the Federal Reserve's high-speed currency processing equipment.

In 1992, the System will incur its first expenditures for automation consolidation. This project involves the consolidation of all mainframe computer operations at three sites within the System--Richmond, Dallas, and New York. The 1992 project budget covers staffing of the project team and development of a detailed plan for achieving a consolidated automation environment within the Federal Reserve System.

Governor Kelley and I thank you for this opportunity to address the subcommittee on the Federal Reserve System budget. The existing budget processes are working well in controlling costs while at the same time encouraging quality improvements. We welcome your comments and would be pleased to address any questions you may have on our budget.

TESTIMONY ON H.R. 4398

You have also asked for our assessment of H.R.4398, the Federal Reserve Bank Branch Modernization Act, a bill introduced by Mr. Erdreich on March 5, 1992. This much-needed action would remove outdated limitations on the acquisition or construction of branch buildings and should result in the least costly provision of space for Federal Reserve operations.

The construction, expansion, or moderuization of Branch Federal Reserve Bank Buildings is authorized in section 10 of the Federal Reserve Act. Statutory limitations included in the act place an accumulative ceiling on branch construction. As most recently amended in 1974, the act places an aggregate cumulative limitation of $140 million on fonds that may be expended on Branch construction. Recently completed Branch buildings have exhausted the fund, and as a result, the Federal Reserve is unable to pursue needed branch construction projects.

A few of our Branch buildings need attention not just because they are more than thirty years old, but more important because they do not provide adequate types or amounts of space for check and cash or provide efficient building support systems. The Federal Reserve has experienced significant changes in facility requirements in recent years, primarily related to automation of check and cash, that have exacerbated the situation. Because many of the affected areas do not lend themselves to renovation--vaults and delivery courts, for instance-efforts by Branch management to obtain needed space through leasing and renovating have provided only temporary relief. Although the Federal Reserve does lease space, experience has indicated that the long-term costs of leasing are higher than the costs of ownership. Before making any decisions related to the provision of space, I want to assure you that we thoroughly analyze the discounted life-cycle costs of several alternatives.

The latest analysis of projected building needs from the Reserve Banks suggests that either renovations, additions, or new facilities may be required in Birmingham, Nashville, Houston, San Antonio, and El Paso in the next five to ten years. The remaining balance in the Branch fund prohibits us from addressing these needs. A brief description of each Branch's needs follows.

Birmingham Branch

It is projected that the facility, constructed in 1927 with an addition constructed in 1959, will soon be unable to accommodate the anticipated demands and occupancy levels. The most significant deficiencies are related to inadequate and inefficient operations facilities that include the vault, the cash and check processing areas, and the secure and general delivery areas. Also, in recent years the basement has been damaged from a continuous influx of subsurface ground water that necessitates continuous operation of a sump pump.

Nashville Branch

The 1958 building will soon be inadequate to accommodate facility and occupancy demands. Specifically, the vaults and secure delivery court are, or will soon be, inadequate to accommodate volume levels.

Houston Branch

The 1958 building is inadequately sized for the long-term requirements. Specifically, the vault, cash processing, and delivery court areas are not adequate to allow efficient operations. In addition, should the Houston economy rebound to near previous levels, the Branch's activities and subsequent facility demands will further increase the pressure on the building.

San Antonio Branch

Although the building, constructed in 1956, has been well maintained, the facility does not provide adequate vault, cash processing, and delivery court areas. A significant upturn in the Texas economy will require that additional space be provided.

El Paso Branch

The 1957 building exhibits deficiencies similar to those identified in the other Branch buildings. Those deficiencies are related to vault, operations areas, and delivery courts.

Branches, even more so than head offices, are primarily engaged in providing services to financial institutions and the U.S. Treasury. These services include check collection, currency and coin processing and distribution, funds transfer' services, processing of government payments, and other services. All costs to provide these services (including building costs) are recovered either as reimbursable expenses (in the case of U.S. Treasury services) or by pricing the services.

To continue providing quality financial services in the most efficient manner, it is important that our facilities remain efficient. The provisions in the proposed amendment to section 10 would enable us to provide facilities for delivering services efficiently to the nation's financial institutions and the Treasury. Therefore, we encourage passage of H.R.4398.