At this time, the act required the Federal Reserve to begin  charging all institutions for such services. Federal Reserve Uses a Detailed System for Accounting for the Full Costs Associated with Its Payment Services

The Federal Reserve Banks use a detailed cost accounting system that  helps them meet several requirements relating to how to set the fees  charged for payment services and account for and recover the costs  incurred in providing them. In addition, our analysis indicated that the Federal Reserve’s cost  accounting practices aligned with broad cost accounting standards for  federal entities. As previously discussed, the Monetary Control Act requires  the Federal Reserve to establish fees on the basis of direct and indirect  costs, including 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 a private firm had provided the services. Federal Reserve’s Process for Capturing Its Payment Services Costs Has Not Been Externally Reviewed in Decades

Although the Federal Reserve appears to have a sound system for  capturing its payment services costs, it has not obtained an independent  review involving detailed testing of the accuracy of its cost accounting  process in more than 30 years. Although staff from the  independent public accounting firm that conducted the Federal Reserve’s  financial audit in 2014 told us that the Federal Reserve Banks have  thorough processes, their audits did not include steps to review payment  services costs and revenues because these costs were not in the scope  of the audit. Customers Generally Were Satisfied with Federal Reserve Services, but Some Competitors Questioned the Fairness of Some Practices

Reserve Bank customers with whom we spoke generally were satisfied  with the services and pricing they received, but some competitors raised  concerns about the fairness of a number of pricing practices. Representatives  from one institution said that the Federal Reserve and private-sector  pricing was similar for checks and wire payments, but not for ACH  payments, where they said the Federal Reserve had better prices. Federal Reserve  staff and some market participants cited the Federal Reserve’s role in  multiple market innovations. Representatives from TCH said that increased regulatory costs along with  what they see as the unfair way that the Federal Reserve is competing in  payment services is creating difficulties for the long-term viability of  private-sector operators. While the Monetary Control Act requires the Federal Reserve to give due  regard to competitive factors and the provision of an adequate level of  such services nationwide when pricing its payment services, the act does  not address the preferred type or extent of private-sector competition in  the payments industry. The Federal Reserve also has a process for addressing complaints about  its payment system activities. These entities included:
12 financial institutions and nonbank entities that compete with the  Reserve Banks to provide payment services; and
12 banks and credit unions that were end-user customers of private- sector providers, the Reserve Banks, or both (including 6 also  supervised by the Federal Reserve). Market participants also  generally supported having the Federal Reserve continue to play multiple  roles in the payment system. Recommendations for Executive Action

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. Periodically obtain independent testing of the methods the Federal  Reserve uses to capture its actual costs and simulate those of the  private sector. This report examined (1) how  effectively the Federal Reserve captures and recovers its payment  services costs; (2) the effect of the Federal Reserve’s practices on  competition in the payment services market; (3) how the Federal Reserve  mitigates the inherent conflicts posed by its various roles in the payments  system; and (4) market participant viewpoints on the future role of the  Federal Reserve in the payments system. We also analyzed Federal Reserve pricing and revenue data for each of  these services, including examining trends in service prices over time. We also  reviewed additional guidance the Federal Reserve provided to its staff on  the conduct of its payment services activities. To help ensure that it is complying with its pricing policies and effectively  assessing its competitive impact, the Federal Reserve conducts various  internal reviews.
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 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.

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.