President's Message

This year's annual report focuses on the nation's payments system, most particularly, retail payments. The astonishing advances we've seen lately in technologies like smart cards and electronic cash have thrust the payments system, typically an invisible dimension of the economy, onto the front page of the newspaper. Simultaneously, these developments have made life more interesting for the Federal Reserve.

Why? Because the Federal Reserve is responsible for ensuring the payments system's integrity and efficiency. This important role is one of the three main responsibilities assigned to us by the Federal Reserve Act--the others are conducting monetary policy for the United States and regulating banking organizations. Throughout history, the Fed has approached all three roles with the same broad goal in mind:  to provide a stable monetary environment in which the economy can achieve its maximum sustainable rate of economic growth. Inflation, banking failures and unreliable payments mechanisms all serve to distort the public's financial decisions and lead to an underachieving economy.

Not surprisingly, the Federal Reserve's three responsibilities are also inextricably linked in an operational sense. Changes in the Fed's monetary liabilities--currency in circulation and bank reserves--are the principal instruments of monetary policy. At the same time, these liabilities constitute the only means of final settlement of transactions in our payments system. Because commercial banks and other depository institutions are the only ones permitted to maintain reserve accounts at Federal Reserve Banks, they alone are in a position to extend final settlement services directly to their customers. Accordingly, they are regulated, not only to protect consumer deposits, but also to ensure the integrity of our nation's payments system.

The payments technologies being introduced today have pushed to the forefront a host of public policy questions that cut across the Fed's range of responsibilities. As payment options become more electronically based, for example, how will monetary policy be affected? Does the current structure of payments regulation adequately address transactions in cyberspace? Should nonbank issuers of smart cards be subject to banking regulations? How should virtual banks be supervised? And so on

Right now, there are more questions than answers. To me, however, this is only appropriate:  When markets are exploring new ideas, as they certainly are today, a central banker's primary task is to consider whether these ideas will serve the public good. At the same time, we must be patient, allowing the marketplace, as appropriate, to devise the answers.

The Federal Reserve will, of course, share its considerable expertise and provide guidance, if necessary, to nudge the market in a positive direction. But we must not act prematurely to impose rules or to inhibit innovations that might prove to strengthen the payments system. The best solutions will arise from experimentation, collaboration and the joint efforts of parties working together to set common standards and workable safeguards. In the end, if we have properly focused on the goals of a secure, efficient and accessible payments system, our nation will reap tremendous economic rewards.

John F. McDonnell Chairman of the Board Thomas C. Melzer President and Chief Executive Officer

Before we begin our report, I would like to express my thanks to Bob Quenon for his excellent leadership and guidance over the past three years as chairman of the board. Equal thanks are due also to departing directors Daniel Ash and Laura Douglas at the Louisville Branch; Mahlon Martin at the Little Rock Branch, who died unexpectedly in 1995; and Andy Craig of Boatmen's Bancshares for his three years of service as our Federal Advisory Council member.

Finally, I want to give special recognition to First Vice President James R. Bowen, who retired after 31 years with the Federal Reserve. Jim joined the St. Louis Fed in 1987, building on a successful career at the Federal Reserve Bank of Kansas City. All of us at the Bank benefited from Jim's unparalleled insight and wisdom, both on day- to-day operations and long-range issues. At the same time, we are fortunate to have attracted W. LeGrande Rives to take Jim's place. He has a wealth of banking experience at Liberty National Bank in Louisville and Centerre Bank in St. Louis. We welcome LeGrande to our management staff.

THOMAS C. MELZER President and Chief Executive officer