DEFINITION of 'Private Sector Adjustment Factor - PSAF'

Private sector adjustment factor (PSAF) is a method used by the Federal Reserve Board (Fed) for calculating the costs of Federal Reserve banks providing certain services to depository institutions. The services provided include checks, Automated Clearing House (ACH), Fedwire funds and Fedwire securities. The Monetary Control Act of 1980 requires the Fed to recover both the direct and indirect costs of providing these services plus the imputed costs that would have been incurred if the services were provided by the private sector. The fees are set each year and are meant to recover at least 100% of these expenses.

BREAKING DOWN 'Private Sector Adjustment Factor - PSAF'

The Fed reviews its PSAF methodology periodically to make sure it is current with changes in the banking industry. In 2005, the Fed changed its price-setting methodology so that only the capital asset pricing model (CAPM) is utilized to determine a return on equity (ROE); previously, results of three models, including CAPM, were averaged to calculate ROE, which is the underlying basis of the annual fee.

PSAF Methodology

The Federal Reserve Board uses data from publicly traded banks and other corporations, where relevant, to formulate its PSAF models. The method involves estimating imputed levels of debt and equity and then applying applicable financing rates. The annual PSAF model is a pro-forma balance sheet of approximated assets and liabilities, with other inputs imputed as if the Fed-provided services listed above were offered by private sector entities. The same generally accepted accounting principles (GAAP) used by private sector firms are applied by the Fed to develop the financial statements in its model. For the CAPM calculation, the three-month Treasury bill rate is the risk-free rate, the beta is assumed to be 1.0, and the market risk premium is based on 40-year historical monthly returns over risk-free rates. With the derivation of an estimated ROE, the Fed then can calculate the fee for its services to depository institutions. The ROE is a reflection of the expected return of shareholder in a private enterprise. The PSAF model calculates the amount of fees it charges to reach this ROE.

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