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President's Message

In response to dramatic shifts in the payment landscape, the Federal Reserve in 2003 made some tough decisions regarding the offices in which it will continue to process checks. In the Eighth District, such decisions have had a ripple effect, prompting us to shut down our operational role in cash processing and vacate branch buildings in Little Rock and Louisville. By the end of 2004, the Little Rock and Louisville branches will no longer process any form of payment.

For an institution like the Fed, these changes were seismic. If you searched for a single word to sum up what the Fed is all about, the word stability would do a pretty good job. Our primary mission is to maintain price stability. Stability also defines the Fed’s goals since 1913 for supervising and regulating the nation’s banking system, as well as safeguarding the nation’s payments system. Finally, our employees have always regarded the Fed as a stable place to come to work each day.

In the wake of decisions that will reduce staff in Little Rock and Louisville to fewer than 10 each, we have pondered the question: What’s a Fed branch for anyway? Have branch offices served their time? The essay in this annual report answers the latter question with a resounding no.

We will detail the critical significance of the St. Louis Fed’s regional presence in cities around its district. Simply put, we cannot afford to lose or lessen the importance of the network of economic information-gathering resources we’ve established, the critical input we get from our branch boards of directors on the regional economy, and the one-on-one relationships we’ve nurtured among the region’s bankers, teachers, community development agencies and university professors. Indeed, we plan to expand these networks, as this report will discuss.

Our renewed efforts will result in a greater public and intellectual presence in branch cities than we’ve had. Even as we reduce our role as an employer of workers, we expect to be increasing our visibility in the community.

Our new branch direction marks a new era. At the same time, we should not forget the tremendous contributions of the employees who are leaving us. Our employees in Little Rock and Louisville are some of the finest in the Federal Reserve System, and we will miss them. They routinely have led the System in measures of productivity and cost recovery, and I am saddened by the decisions that have cost them their jobs. As we say goodbye to these employees during the second half of 2004, I will do my best to pay tribute to their dedication, excellence and customer service, for they deserve whatever thanks we can give them.

William Poole
PRESIDENT AND CEO

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Branching Out: The St. Louis Fed's Three Branches Expand Beyond Bricks and Mortar

The first thing they’ll have to do is order new business cards. That’s because their titles will change from “branch manager” to “senior branch executive.” And that is just the first of a multitude of changes the Federal Reserve Bank of St. Louis’ three branch managers will encounter in the second half of 2004. New title. New mission. New era.

Indeed, everything will change in the Eighth District’s Little Rock, Louisville and Memphis branches starting later this year. If you live in these communities, expect to read, see and hear more about the Fed’s expanded role in a number of local initiatives. One might envision this involvement manifesting itself in a number of ways:

• Robert Hopkins, Little Rock senior branch executive, welcoming attendees to a Fed-sponsored urban planning conference;
• Tom Boone, Louisville senior branch executive, addressing high school seniors about the Federal Reserve’s role in monetary policy and the payments system;
• Martha Perine Beard, Memphis senior branch executive, making TV and radio appearances to discuss economic and banking trends affecting the Mid-South;
• a St. Louis Fed economist appearing at a chamber of commerce luncheon to present her research on employment trends in the community;
• a Fed-sponsored speaker’s program attracting high-profile business leaders from around the country; or
• more meetings between lenders and community development groups—meetings that are hosted by local Fed representatives and that address key issues related to credit access.

“I think those of us in the Eighth District branches have a great opportunity in our communities to make our presence felt more broadly than ever before,” Boone says.

Following a year in which national and local consolidation decisions led the Bank to change the role of its branches dramatically, the St. Louis Fed will draw upon its intellectual capital in areas such as community affairs, economic education, research and monetary policy to increase its contributions to the branch cities and surrounding regions.

This annual report will examine the decisions that prompted the St. Louis Fed to redefine the traditional role of its branches to focus more on outreach and less on operations. In addition, it will review the evolving functions of the branch offices since their inception. Finally, it will discuss in greater detail the branches’ new and expanded responsibilities and functions.

CHECK: THE TRANSITION FROM PAPER TO ELECTRONICS
What the Federal Reserve announced on Feb. 6, 2003, is the type of news that has become commonplace in most of the business world. At the Fed, however, it was a jolting, paradigm-shifting event. The Fed announced a consolidation of its check operations, resulting in the elimination of 1,300 positions by the end of 2004.

Smaller consolidations in the past, in response to market conditions, had resulted in some degree of employment shrinkage at the Fed. A sweeping, nationwide wave of job cuts, however, was not something common to the Fed or its employees.

To understand why the Fed is consolidating from 45 check-processing sites to 32 and streamlining its check-adjustment functions from 43 locations to 12 is to understand the decline of checks themselves.1 It is nothing short of precipitous.

Even though checks remain the most popular form of retail payment outside of cash, they make up only 60 percent of all noncash retail payments today compared with 85 percent in 1979. Federal Reserve studies suggest that roughly 40 billion checks were written in the United States in 2002, down from about 50 billion in 1995. Federal Reserve banks handle about 16.5 billion of these checks annually, and this volume is expected to decline as well. But the bad news for the Fed’s check operations is actually evidence of success given the Fed’s long-standing push for more electronic payments.

On the day of the Fed’s check announcement, Cathy Minehan, president and CEO of the Federal Reserve Bank of Boston and, at the time, chair of the Fed’s Financial Services Policy Committee, explained: “Nationwide, consumers and businesses have made a significant shift in how they make payments, substituting electronic payments for checks. This development is good news for the nation’s payments system, and the Federal Reserve has strongly supported this shift. But declining check volumes are requiring the Reserve banks to make changes in their check operations to address the challenges posed by the changing market. The changes we are announcing today will help us meet these challenges.”

In light of the increased popularity of electronic payments at the expense of check growth, the Federal Reserve had no choice but to take action. Because the Fed has a goal to recover its check costs (as stipulated in the Monetary Control Act of 1980), Reserve banks must continually balance revenue and expenditures in its financial services. With check volumes declining across the nation, however, the Federal Reserve System has missed its cost-recovery targets in recent years. The Fed’s Check Re-engineering Initiative was launched to get the cost recovery effort back on track.

The initiative is expected to reduce the Fed’s operating costs for check services by about $60 million in 2005 and about $300 million over the next five years. The Eighth District is projected to save $5 million annually.

THE IMPACT ON THE EIGHTH DISTRICT
The ramifications of the Fed’s check announcement were more severe in the Eighth Federal Reserve District than in most other districts in the Fed System. As a result of the decision, the following actions will occur:

• In Little Rock, all of Check Operations will shut down, with processing moving to the Memphis office in July 2004;
• In Louisville, all of Check Operations will shut down. In August 2004, Check processing will move to Cincinnati, and Check adjustments will move to Cleveland.
• In Memphis, Check processing will expand with the addition of Little Rock’s check volume.
• St. Louis will maintain its check-processing function.
• Management of Check adjustments in Little Rock, Memphis and St. Louis will be consolidated in Memphis.

About 160 Check employees, mainly in Little Rock and Louisville, will lose their jobs once the consolidations are complete. Their departure has nothing to do with performance. As St. Louis Fed President Bill Poole and First Vice President LeGrande Rives were quick to point out, the decision was primarily “a fact of geography.” The city of Louisville sits only 100 miles from Cincinnati. Little Rock is only 120 miles from Memphis.

“We are not blessed in the Eighth District with a branch infrastructure that supports the kinds of changes we’ve seen,” Rives says. “When these branches were established, it probably made sense to have branches that were only 120 miles apart, in terms of transportation, the banking environment, the way checks were handled. ... But, obviously, a lot has changed in terms of technology, transportation, economic conditions and population growth. When you look at these changes since the 1920s and where the population is now, it becomes very difficult for us to maintain operations at branches that are only 120 miles apart.”

TAKING IT ONE STEP FURTHER
For some Federal Reserve offices that are losing their Check operations—Little Rock and Louisville among them—the announcement would translate into the exodus of the majority of staff. At the time of the decision in early 2003, Little Rock and Louisville each employed about 130 people, roughly two-thirds of whom worked in the Check Department. The remaining operation function, Cash processing, employs far fewer people than Check. Other employees work in support functions such as protection, building maintenance, food services and housekeeping. Each branch also has a Community Affairs representative.

With the absence of the main revenue generator, Check, the cost of running the Little Rock and Louisville branches would be shouldered almost entirely by Cash. To avoid shifting these costs to the U.S. Treasury and to maintain the efficiency of operations, the District made the following Cash restructuring decisions in July 2003:

• Cash operations and support services, including protection, building and food services, would close in the Little Rock and Louisville branches in late 2004.
• The night shift Cash operation in Louisville would move to Memphis on Jan. 1, 2004.

Reflecting the reduced staffing, the Bank will also sell the Little Rock and Louisville buildings. A small staff consisting of a senior branch executive, community affairs representatives, economic education specialists and support staff will be working in leased space and maintaining contact with local banks, organizations and officials. In addition, each branch will continue to have its own board of directors to gather regional economic information.

Rives says: “We considered all kinds of alternatives that could possibly either put in new operations or shore up how we distributed costs at those branches. And, really, none of them made good economic sense.

“We asked ourselves, ‘Is there anything on the horizon that would make the answer different two years from now, or five years from now?’ And the answer was, ‘no.’”

ORIGINS OF THE EIGHTH DISTRICT
The St. Louis Fed, importantly, is not closing its Little Rock and Louisville branches. The current events represent the latest in the evolution of the Eighth District branches, albeit the most dramatic changes in the nearly 90-year history of the three branches.

To learn how the branches came into existence, one must go back nearly a century to the creation of the Eighth District. When the Federal Reserve Act was enacted in 1913, St. Louis was the fourth-largest city in the United States. In addition to being a major railroad hub, St. Louis was the world’s largest fur market, the nation’s third-largest manufacturing city, a major livestock market, a brewing center, a leading distributor of dry goods, as well as a leading banking center.

The Federal Reserve Act called for between eight and 12 Reserve districts. Competition among cities was fierce. A total of 37 cities made formal pitches to the Federal Reserve Bank Organizing Committee. Because of St. Louis’ size and economic significance to the nation, city representatives were confident that St. Louis would be selected. What concerned officials more was the size of the territory St. Louis would be granted. They sought to be awarded one of the four largest regional banks, hoping for all or parts of 12 states to be within its boundaries, according to one newspaper report.

In the book A Foregone Conclusion: The Founding of the Federal Reserve Bank of St. Louis, the St. Louis contingent was said to be pushing for “a long north-and-south axis to ensure a balance of economic interests. The cotton-belt bankers from Tennessee through Arkansas, Mississippi and Louisiana to Texas, with their heavy seasonal demands for credit, should press the Organizing Committee to give St. Louis a self-sufficient district with a variety of economic interests, such as mining and manufacturing, and enough banking resources to absorb seasonal credit demands.”

Within the large territory St. Louis envisioned for its district, eight other cities also were seeking selection: Kansas City, Memphis, New Orleans, Indianapolis, Nashville, Dallas, Houston and Fort Worth. In an attempt at gentle persuasion, those hoping to land a Reserve bank in St. Louis sent a letter to bankers in many of these cities to inform them that there would more than likely be 10 to 15 branches in a St. Louis district, each with local control through a seven-member board.

Eighteen banks signed the letter, which was sent to their correspondent banks. The bankers said that in a 12-state district headquartered in St. Louis, “every point could be served more satisfactorily through the branches of the St. Louis Reserve Bank than through smaller banks or through banks located in districts not so diversified. It is the evident and proper intent of the law to allow the free use of branches so that all privileges could be carried near to all the people, no matter where the district bank be located.”

In January 1914, St. Louis made its case to Organizing Committee members William G. McAdoo, the secretary of the Treasury, and David Houston, the secretary of Agriculture. In an ambitious proposal—though one scaled back from the previously reported version—Festus Wade, president of the St. Louis Clearing House Association, presented St. Louis as “District Five” of a Federal Reserve consisting of eight districts.

When the Organizing Committee made its announcement on April 2, 1914, 12 districts—the maximum allowed by the Federal Reserve Act—were created, with St. Louis named as head office of the Eighth District. The inclusion of districts headquartered in Kansas City and Dallas cut into the west and southwest areas that St. Louis desired for its district. Mainly, that included Texas, Oklahoma and western Missouri. The Eighth District’s size, nearly 150,000 square miles, was the fourth smallest among all districts, behind Philadelphia, New York and Boston.

ALONG CAME THE BRANCHES
The notion of 10 to 15 branches sprinkled throughout the St. Louis Federal Reserve District never materialized. But within four years of the St. Louis Fed’s swinging open its doors in November 1914, three branches were established. They were located in Little Rock, Louisville and Memphis.

Louisville was the first branch to open, in December 1917. The St. Louis Fed’s Board of Directors heard arguments from the Louisville Clearing House Association for the establishment of a branch in Louisville back in September 1916. Not until the following summer did the board approve the establishment of the branch. The Memphis Clearing House Authority petitioned the Bank to establish a branch in that city in the spring of 1918. The St. Louis Board approved the request in June 1918. Just a few weeks later, the directors approved a request from Arkansas bankers to establish a branch in Little Rock.

Before any of the branches could begin functioning, final approval was needed from the Federal Reserve Board in Washington, D.C. Once granted, the St. Louis Board could authorize the branches to perform formal functions, which it did during board meetings in September 1918. The branches’ powers were heavy on the operational side and included clearing checks, processing cash and handling credit applications and wire transfers. The seven branch functions and duties spelled out were:

1. To receive from any member or clearing member bank in its territory for collection and credit with it checks drawn on any bank on the par list of the Federal Reserve banks.
2. To receive from any member or clearing member bank or Federal Reserve bank or branch thereof for collection and credit with or through the head office checks on any bank in its territory on the par list of the Federal Reserve banks.
3. To receive from any member or clearing member bank in its territory for collection and credit when paid, notes, drafts, coupons and other legitimate collection items.
4. To receive from any member or clearing member bank or Federal Reserve bank or branch thereof for collection and credit when paid with or through the head office, notes, drafts, coupons and other legitimate collection items which are payable within its territory.
5. To receive and pass on applications for rediscount and transmit such applications to the head office for approval.
6. To receive and make wire transfers for the member and clearing member banks in its territory.
7. To receive and transmit by wire to the head office for their approval and advice of rate of discount, all applications of member or clearing member banks to buy or sell mail transfers.

ROLE OF THE BRANCHES: HELPING TO KEEP THE STOOL STEADY
The Federal Reserve is often referred to as a three-legged stool, performing functions and offering expertise in three distinct areas:

• MONETARY POLICY – Basing its decisions on hard data and anecdotal evidence, the Fed acts to keep the level of overall prices stable and the economy growing at a sustainable rate without igniting inflation.
• SUPERVISION AND REGULATION OF FINANCIAL INSTITUTIONS – The Fed is one of several regulators monitoring the banking industry. Fed examiners identify areas of risk that could affect a bank’s safety and soundness, and ensure compliance with consumer regulations.
• PROVIDING FINANCIAL SERVICES – A component of the Fed’s mission is to foster the integrity, efficiency and accessibility of the payments system. To support its mission, the Fed offers financial services to banks and the U.S. government to encourage competition, innovation and efficiency in the marketplace.

Since the early days of the Eighth District, the Little Rock, Louisville and Memphis branches have played a significant role in the monetary policy and financial services arenas while supervision and regulation functions have been carried out through the St. Louis office.

MONETARY POLICY: A branch’s contribution to the monetary policy leg of the stool comes primarily from its board of directors. The Federal Reserve Act stipulates that each Reserve bank branch be operated by a board whose members possess the same qualifications as directors of the head office. The seven directors who serve on each branch board represent the interests of agriculture, commerce, industry, labor and consumers. Current branch board members in the Eighth District hail from sectors of the economy as diverse as banking, academia, health care, manufacturing and affordable housing.

Like the St. Louis board, each branch board generally meets monthly. The directors report on the latest developments in the local economy, and those reports are shared with the Bank president and Bank economists. The president then weighs this information with hard data before attending meetings of the Federal Open Market Committee (FOMC). The FOMC, which determines the target level of the federal funds rate, meets eight times a year to review economic and financial conditions, determine the appropriate stance of monetary policy and assess the risks to its long-run goals of price stability and sustainable economic growth.

St. Louis Fed President Bill Poole regards as critical the anecdotal information provided by sources like board members because it is more timely than formal data such as Gross Domestic Product (GDP) or unemployment statistics. Quantitative measurements that are released monthly or quarterly tend to lag current economic conditions.

“Anecdotal information helps us to see what is going on in the economy almost as it is happening,” Poole says. “Also, because it is collected from the people who are actually making day-to-day decisions, it helps us to understand why trends in the data are occurring.”

As an example, Poole describes the case of a branch director who in the summer of 2000 reported that loan demand at his bank was falling and that other firms in his area were beginning to experience problems. At the time, the economy seemed to be growing rapidly, and nearly all forecasts indicated that rapid growth would continue. Reports of this sort surfaced throughout the rest of 2000 and into 2001, helping the Fed to get ahead of the recession by lowering its federal funds rate target in early 2001, even though current GDP data suggested that the economy was still growing.

Poole also notes that while most of the anecdotal information collected by the Fed supplements other information at the Fed’s disposal, the anecdotal reports at times become the primary source of information. Tried and true standard data are not reliable guides whenever history has not recorded a pattern for how the economy is likely to respond. The Sept. 11, 2001, terrorist attacks, for example, had immediate and dramatic economic consequences, but nothing in history could be used to predict the consequences of such an event. The Fed was able to use its network of contacts to get a good idea of the sectors that were affected the most, weeks before any formal data were available.

Poole says: “We found out very quickly that the Fed’s injection of liquidity into the banking system had been successful, in that few banks reported having liquidity problems despite the near-complete shutdown of financial markets. We also found that retail sales came to a halt in the two to three days after the attacks but surged back to near-normal levels by the weekend and that manufacturers in the District were anticipating that they would be reducing their output by an average of 10 percent.

“All of this information was vital in the weeks immediately following the attacks, when the Fed had to react very quickly while navigating the uncharted waters of September and October. Indeed, based on anecdotal reports and experience, but without any substantial amount of formal data applying to the period after Sept. 11, the FOMC cut the intended federal funds rate on Sept. 17 and again on Oct. 2.”

Information from directors and sources is compiled and shared with the public in a special report—informally called the Beige Book—which is issued about two weeks before each FOMC meeting.

FINANCIAL SERVICES: Fewer than 30 employees were on hand to open each of the St. Louis Fed’s three branches. Quickly and steadily, however, the need for more workers and larger facilities at each branch became obvious to accommodate the branches’ main function, providing financial services to depository institutions.

The Louisville Branch moved into a new building less than two years after opening its doors. The Branch stayed in growth mode for many years to come: taking over check clearing on city banks from the Louisville Clearing House Association in 1920; installing machines for counting currency in 1928; taking over the issuance and redemption of Defense Bonds (later known as War Bonds and Savings Bonds) from the St. Louis office in the 1940s; moving again into its current building in 1958; and installing an electronic check-handling system in the 1960s.

In Memphis, the Branch’s employees moved to expanded offices in 1920. During the decade, the Branch grew to serve 61 banks in eastern Arkansas, northern Mississippi and western Tennessee. Business growth necessitated the construction of a new two-story building before the end of the decade. Even though a third story was added in 1944, by the mid-’60s the building became increasingly inadequate to serve the needs of Memphis financial institutions. In 1972, the Branch moved to a new, four-story downtown building from which it continues to serve more than 400 financial institutions in its zone.

The Little Rock Branch exhibited similar growth since its inception. On the first day the Branch opened in January 1919, clerks processed 750 checks. By December, the quantity had grown to more than 12,000 daily. Employees moved to a new building in 1925 and would stay there for 42 years. With the number of member banks rising to 67 and check volume surging, the Branch moved into its current building in 1967.

Employment at each branch peaked at more than 200 in the early 1970s. Trends such as interstate banking and advancements in technology hastened the movement toward consolidated financial services among Reserve banks. Since then, branch functions have gradually been consolidated, culminating with the check and cash announcements of 2003. (See chart.)

In 1980, Congress passed the Monetary Control Act, which required the Fed to begin charging for its financial services. The act also opened the Fed’s services to all depository financial institutions. Previously, only member banks had direct access to Fed services.

“The Monetary Control Act was clearly a watershed event,” says Karl Ashman, senior vice president, Administration, and Little Rock branch manager between 1990 and 1995.

Louisville Branch Manager Tom Boone adds, “From an operations perspective, the Monetary Control Act pushed us into the real world. Not only did we quickly and dramatically improve our efficiency and productivity, but we also began thinking strategically in terms of competing for business.”

Now, in the midst of another historic turn of events, the St. Louis Fed prepares to begin a new chapter.

A NEW FED IN TOWN
Barring consumers en masse holstering their debit and credit cards, logging off banking and commercial web sites, and canceling their direct payment accounts, the large check-processing operations employing scores of people will never return to Little Rock and Louisville. Consumers have made it clear: They are increasingly comfortable with electronic forms of payment. What’s more, recent legislation like Check 21 is expected to push the electronic payments trend further.

What is not certain at this point is how successful the District’s new branch model will become. Can offices that once employed more than 200 people make viable contributions to their communities and the Fed with drastically reduced staffs?

Mary Karr, senior vice president of Legal, Public and Community Affairs, is in charge of the effort to establish a new model for an Eighth District branch office. If history is a barometer, Karr believes the transition will be a success:

“The St. Louis Fed has a great tradition of conducting research that supports monetary policy decisions,” Karr says. “We are excited to build on that reputation as we strengthen our intellectual presence in our branches. Shifting our focus from operations will give us an opportunity to be more visible in programs designed to increase the public’s understanding of monetary policy and the economy.”

Little Rock Branch Manager Robert Hopkins is fully aware that his branch is about to sail in uncharted waters.

“For the Little Rock and Louisville offices, outreach is going to be the primary mission,” Hopkins says. “Memphis will still have a huge operations facility, so that branch will be important regardless of what happens on the outreach side.”

Many companies use the term outreach to mean charitable contributions or employee volunteerism. What the Fed means by outreach is different. Indeed, while plans for expanded outreach in the St. Louis Fed’s branch cities continue to evolve, the outlines of the effort are already taking shape:

EXPANDED EMPHASIS ON MONETARY POLICY: The St. Louis Fed will deepen its knowledge of economic developments across the District, with the effort managed from the four District offices. Equally important, the Bank will increase its efforts to communicate policy issues to improve general understanding of how policy is made and its effects on the economy.

EXPANDED RESEARCH INTO REGIONAL ECONOMIC ISSUES: To further aid in monetary policy research, the St. Louis Fed will hire additional economists who will specialize in studying regional issues affecting the District and later present their findings to academic, business and community audiences.

EXPANDED ECONOMIC EDUCATION PROGRAMS: These programs demystify the Fed and explain money, banking and the Fed in simple language for teachers and their students. With dedicated economic education staff members located at a branch, the St. Louis Fed will be able to work more effectively with teachers and students in the branch cities. The Fed has a tremendous range of resources available for use by teachers and students.

EXPANDED COMMUNITY AFFAIRS PROGRAMS: The Bank’s Community Affairs Office links lenders with community development organizations. By facilitating partnerships within communities, employees in this department foster dialogue and understanding on issues such as the Community Reinvestment Act, economic development, affordable housing, and fair and equal access to credit. Community Affairs publishes numerous materials on these topics and also hosts or sponsors forums throughout the District. The St. Louis Fed will expand Community Affairs’ role in all three branches by increasing staff and sponsoring additional programs.

THE ADDITION OF A SUPERVISORY PRESENCE IN MEMPHIS: Experienced examiners will relocate to Memphis from St. Louis. Julie Stackhouse, the St. Louis Fed’s senior vice president over Banking Supervision and Regulation, plans for the operation to grow to about 10 members over time. Stackhouse says, “Our reason for establishing this satellite office is simple: We want to become more accessible. I believe we can be more effective as a Mid-South banking supervisor if we establish a physical presence in Memphis.”

A COMMITTED AND PROFESSIONALLY DIVERSE BOARD OF DIRECTORS AT EACH BRANCH: Maintaining a strong board is perhaps the most critical piece of the new branch model, for the District will need engaged directors to make these ideas successful. Hopkins, for one, is optimistic that business and community leaders will continue to want to serve on a branch board, saying, “I think the directors are tied to the Federal Reserve System more than they are to these large buildings.“

All of the evidence presented here indicates that the St. Louis Fed’s branches had momentum in several areas of outreach and monetary policy, even before last year’s decisions were made. An intellectual presence at each branch was already in place, co-existing as an essential element of a branch’s makeup, along with operational services. By the end of 2004, however, an intellectual presence will be what remains in two of the three branches.

“Time will tell as to whether we’ll be successful,” Hopkins says. “It depends on what we do and how we do it.”

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Check 21: The Check Stops Here

To enhance efficiency and foster innovation in the payments system, the Federal Reserve System sponsored the Check Clearing for the 21st Century Act (Check 21), which will go into effect Oct. 28, 2004. Check 21 facilitates the use of check electronification to help promote a more efficient system of check collection and processing. It also reduces legal impediments to check truncation that exist under current law.

It works like this: Currently, when you deposit a check at your bank, the bank must present the original paper check to the paying bank, unless there is an agreement in place between the banks. Under Check 21, the paying bank is also required to accept presentment of a substitute check—a paper reproduction of the original check that contains an image of the front and back of the original check, including its magnetic ink character recognition (MICR) information.

As a result of Check 21, banks may choose to truncate original paper checks, process and deliver checks electronically, and print substitute checks at a location near the paying bank for presentment. The act does not require banks to accept checks in electronic form, nor does it require banks to create substitute checks. But it does require banks to accept substitute checks, which will serve as the legal equivalent to the original check.

How quickly banks will adopt all of the provisions of Check 21 is unknown. While all banks will need to ensure they can process substitute checks, they will need to determine whether they can make a business case for investing in the systems and processes necessary to implement check electronification. Some banks will quickly see the advantages for their business, while for other banks it may not make sense immediately.

Overall check volumes have declined over the past several years. About 40 billion checks continue to be written annually in the United States, and the Federal Reserve processes 16.5 billion of those checks. So while checks may be in decline, it is clear they are not going away overnight.

What Check 21 may mean for the Federal Reserve banks is fewer checks to process and reduced costs associated with the relatively slow and expensive check transportation network. The act may also result in an increased share of check- processing resources devoted to receiving, sorting and delivering check data and images electronically.

Says Timothy C. Brown, vice president, Check, at the St. Louis Fed: “This legislation facilitates check electronification while allowing consumers and businesses to continue using paper checks. With Check 21, we can accelerate the check-clearing process, reduce some of the risks associated with ground and air transportation, and reduce operating costs.”

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Branch Manager Quotes

As the Eighth District's branch managers prepare for major changes to their offices' roles and responsibilities, they share their thoughts on the challenges that lie ahead:

“Change is always a challenge, and the extent to which we are reducing our physical presence will be a very difficult transition. But on the other side of that transition, I see opportunities to make our presence felt in a very positive and meaningful way. For example, by opening new dialogues and forging new partnerships in our communities, we will be able to improve the exchange of economic information and, I hope, make some inroads in promoting economic education and financial literacy.”
Tom Boone LOUISVILLE

“The Memphis office will be challenged to achieve some very aggressive productivity measures. Overnight, we will leap from being the smallest to the largest operations office in the District. Our operations in Check and Cash will double. Memphis’ employees, however, are eager to face the challenge. Although the Memphis office will have a strong operations presence, I am excited about the expansion that will occur with regard to our intellectual presence in the community.”
Martha Perine Beard MEMPHIS

“The redesigned mission of the Little Rock Branch affords us the opportunity to expand our existing relationships with bankers, educators and other business leaders across the state, making relevant contributions to economic research, education and community service. We at Little Rock look forward to building on our years of service to the people of Arkansas.”
Robert Hopkins LITTLE ROCK

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Little Rock Board of Directors

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Louisville Board of Directors

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Memphis Board of Directors

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St. Louis Board of Directors

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Thank You Retiring Board Members

We would like to express our deepest gratitude to those members of our Eighth District boards of directors who retired in 2003.

Our appreciation and best wishes go out to:

• Vick M. Crawley from the Little Rock Board,
• Frank J. Nichols from the Louisville Board,
• E.C. Neelly III from the Memphis Board and
• Robert L. Johnson from the St. Louis Board.

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The Economic Outlook Through the Eyes of Our Board Members

What challenges does your organization or industry face in 2004 and beyond?

“Challenges that face the banking industry, inclusive of our organization, continue to be the shrinking margin due to the competitive nature in the commercial lending arena, plus the unprecedented low interest rates. It is also very difficult to gather deposits due to lack of attractive rates and the availability of alternative investments that currently exist.”
Raymond E. Skelton, REGIONAL PRESIDENT
U.S. BANK, NORTH LITTLE ROCK, ARKANSAS

“The energy industry’s emphasis today is on going back to basics—investing in bread-and-butter energy distribution assets and building financial strength. While more than 85 percent of all customers surveyed express strong satisfaction with our service, my utility company and the entire industry must respond to customer demand for even higher levels of service quality—near-flawless energy delivery—in the face of constrained resources. Our focus must continue to be on diversifying our fuel sources, employing technology to keep our operations clean and efficient, and relentlessly cutting costs where we can.”
Charles W. Mueller
AMEREN CORP., ST. LOUIS, MISSOURI

“The ability to consistently grow earning assets will remain a challenge to banks in areas that do not provide a steady supply of good loans. Sensitivity to interest rate risk can be an added challenge to these banks when funds are placed into extended investment portfolio maturities to generate more profitable margins.”
Lewis F. Mallory Jr., CHAIRMAN AND CEO
NATIONAL BANK OF COMMERCE, STARKVILLE, MISSISSIPPI

“I am in the philanthropic world. … Our challenge in 2004 and the future is to keep to our missions and assure our communities that the investments we make through grants to improve the quality of life are effective, and that we are accountable in how we use these funds.”
Marjorie Z. Soyugenc, EXECUTIVE DIRECTOR AND CEO
WELBORN FOUNDATION, EVANSVILLE, INDIANA

“Our greatest challenge will be getting accurate market information from China, which has become the major customer for our product. Our industry is having to shift from a U.S. market to an export market, primarily China.”
Meredith Baird Allen, VICE PRESIDENT, MARKETING
STAPLE COTTON COOPERATIVE ASSOCIATION
GREENWOOD, MISSISSIPPI

“Small and/or independent banks face the same old challenges—primarily, training new personnel and retaining experienced personnel in this era of advanced technology and specialization.”
Gordon B. Guess, CHAIRMAN, PRESIDENT AND CEO
THE PEOPLES BANK, MARION, KENTUCKY

“The confidence of builders in Louisville metro is high. A strong housing market and stable interest rates will result in healthy choice and pricing options for first-time home buyers. However, in the affordable housing arena, the challenge of delivering attractive mortgage products, with fair and affordable rates and fees, will be great. First-time home buyers, as well as those homeowners who have earned equity, will continue to be offered subprime mortgage packages that may not be in their long-term interest.”
Maria Gerwing Hampton, PRESIDENT
THE HOUSING PARTNERSHIP INC., LOUISVILLE, KENTUCKY

“I think that the greatest challenge to the banking industry will come from nonbank financial institutions. Community banks in particular will continue to face strong competition from credit unions. Community banks will also find it difficult to keep up with new technology trends and will have trouble in continuing to find new products to increase noninterest income.”
James A. England, CHAIRMAN, PRESIDENT AND CEO
DECATUR COUNTY BANK, DECATURVILLE, TENNESSEE

“The construction industry will be impacted by the budget deficits faced by state, local and federal legislative bodies. Highways, bridges, water and sewage treatment facilities and government offices funded by federal, state and local tax dollars make up a large percentage of dollars spent on construction. Construction projects are normally the first items to be cut during budget crunches. The impact will be felt in the next few years.”
J. Stephen Barger, EXECUTIVE SECRETARY-TREASURER
KENTUCKY STATE DISTRICT COUNCIL OF CARPENTERS
FRANKFORT, KENTUCKY

“Over the course of the next few years, the overall automobile market in the United States should increase. With the number of new drivers that will come of driving age from the ‘Y Generation’ and longer life spans, some are predicting that annual sales could reach 20 million units within the next five years. The effects of this should have an impact over the short run looking ahead in 2004. However, the industry as a whole is suffering from the loss of pricing power and the high cost of incentives, which will remain the biggest obstacles facing the automobile market.”
Russell Gwatney, PRESIDENT
GWATNEY COMPANIES, MEMPHIS, TENNESSEE

Are there any new trends or business processes that you expect will have a major impact on your organization or industry in the near future?

“The most immediate impact to my industry will be the impact of Check 21. I believe new alliances will be made in the banking industry, and small banks will need to unite and be nimble in the market in order to compete. I further believe that five years from now, the banking landscape will look nothing like it does today.”
Bradley W. Small, PRESIDENT AND CEO
THE FARMERS AND MERCHANTS NATIONAL BANK
NASHVILLE, ILLINOIS

“Driven by changes in consumer preference and innovations in food production and processing technology, the structure of agriculture is evolving from one of small independent farmers producing for open markets into a vertically coordinated agribusiness system. The transformation will significantly impact food manufacturers, consumers and farmers. Consumers will benefit from a wider selection of food products and possibly lower prices. Farmers may gain or lose depending on their size, location and skill in negotiating with integrated food companies.”
Bert Greenwalt, PARTNER
GREENWALT CO., HAZEN, ARKANSAS

“Both consolidation and expansion in the banking industry create activity in the commercial real estate sector. The merger and acquisition of larger old-line banks has opened the door for the formation of new community banks. The former often puts space/property on the market, and the latter often takes it. This trend should continue.”
Everett Tucker III, CHAIRMAN
MOSES TUCKER REAL ESTATE INC., LITTLE ROCK, ARKANSAS

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A Message from Management

As this year’s annual report clearly illustrates, the Federal Reserve Bank of St. Louis is undergoing considerable change. A new model for how we operate our branches is just one indication—though a significant one—that the phrase business as usual no longer applies to the Eighth District.

Thus, for 2004 we deemed it necessary to write a new vision statement for the Bank, which reads: The Federal Reserve Bank of St. Louis will be recognized as a leader in shaping the future of the Fed’s business and support functions, and as a benchmark provider of services among Federal Reserve banks. Looking back on 2003, we are encouraged to see that in many aspects, we are already fulfilling these critical roles.

Many of our employees—like those who support the Fed’s important relationship with the U.S. Treasury—exhibit leadership on a daily basis. As home to the Treasury Relations and Support Office, the St. Louis Fed oversees the full range of projects and services that Reserve banks around the country provide to the Treasury. In addition, the District continued its leadership and operational support of the Treasury’s cash management, tax collection and collateral monitoring business. Year-end feedback from Treasury senior executives indicated a high level of satisfaction with our performance at both the District and System level.

The District’s Banking Supervision and Regulation Division displayed leadership in a number of areas. Division management either chairs or participates on several critical System-level committees and work groups. On behalf of the Federal Reserve System, the consumer compliance function developed a web site to train bankers on significant changes to Regulation C. The web site received national acclaim across the banking community. The Center for Online Learning, one of the division’s unique offerings, continued to grow as the System leader in web-based training, resulting in a savings in time and money for learners.

Our Research Division continued to be a leader in the electronic transmission of economic data and Bank-related information via the Internet. After 38 years, the printing of U.S. Financial Data was discontinued and successfully transitioned to electronic distribution. Federal Reserve Electronic Data (FRED) traffic increased 79 percent over 2002, and the Research function’s web pages received 18.8 million hits during 2003, a 65 percent increase over 2002. St. Louis Research economists realized substantial increases in productivity last year, with 43 articles published or accepted for publication in refereed journals, 20 more than in 2002. Also, Bank economists made 118 presentations at System meetings, professional conferences and university-sponsored seminars, double the amount from 2002.

In partnership with the Fourth Federal Reserve District, the Bank pioneered the first regional approach to financial services sales and marketing. This endeavor resulted in a savings of approximately $2 million in the two districts as productivity was improved and redundancies eliminated. The collaborative approach may serve as a template for similar sales and marketing consolidations in other districts.

Continuing to place a high priority on the Bank’s public presence, the Community Affairs Office sponsored 42 meetings for District audiences on topics such as serving immigrant markets, community investment opportunities and personal financial education. Our economic education efforts drew more than 900 people to 34 events throughout the year. The Bank’s tour program attracted 255 groups for a total attendance of 5,359. The St. Louis Fed led a System work group to create a single web page from which visitors can link directly to all regional and national Fed web sites, as well as other selected Fed resources. The page is located at www.federalreserveonline.org.

To explain what it means to be a benchmark provider of services, one need only look at the Bank’s Check and Cash departments. During a year of uncertainty, these departments performed in an outstanding manner. All four District check operations areas met their net revenue, cost and productivity targets. Cash exceeded its bundles-per-hour target, as well as the System average. In Treasury services, the District achieved 18 of 19 operational/service quality measures in 2003, and a formal customer satisfaction survey conducted in late 2002 showed that 94 percent of Treasury Tax and Loan (TT&L) customers are “very satisfied” or “satisfied” with the District’s services.

Our bank examiners met nearly all examination, inspection and applications processing mandates. The Credit/Payments Risk and Statistics function achieved all of its operating mandates, even during a year in which the functions were reorganized to realize efficiencies and enhance cross-functional communications and staff development. Staff members in these areas participated in new outreach programs to educate bankers on reporting requirements, account management practices and new credit facilities.

In 2004, the District’s primary challenge will be the check and cash consolidation efforts and the concurrent efforts to implement a new model for the branch offices. At the same time, District management will continue to look for opportunities to assume System leadership responsibilities while striving to remain a benchmark provider of services. In order to meet System security requirements and add some additional office space, last spring we announced a multiyear, multimillion-dollar strategy to renovate and expand our existing downtown St. Louis office. In addition to the extensive security improvements, we will add 54,000 square feet of office space by 2007.

The St. Louis Fed is poised to face a set of challenges never encountered before. Our staff’s continued high level of performance indicates that we are well-positioned to meet the expectations and needs of the System, our customers and our constituents.

William Poole
PRESIDENT AND CEO

W. LeGrande Rives
FIRST VICE PRESIDENT AND COO

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Summary of Operations

Summary of Key Operation Statistics for Services Provided to Depository Institutions and the U.S. Treasury (The following schedule is unaudited and has been included as supplemental information.)

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Bank Officers

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Credits

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