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2003 Annual Report


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2003 Annual Report
Last Updated: 04/14/03
Message from the President

The first and second halves of 2003 were about as different as night and day. In February, as the conflict with Iraq grew more pressing, the economy hit a wall. Businesses took a "wait and see" attitude toward many investment and hiring decisions, pending the progress of the war. Consumers became more reluctant to spend, and investors moved away from equities and into safe-haven assets like Treasury securities — pushing long-term interest rates to unusually low levels.

 

In the midst of all this downbeat news, the groundwork was laid for improvement in the second half of the year. Businesses took advantage of low interest rates to restructure their balance sheets, and consumers refinanced their mortgages at lower interest rates. In June, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate to 1 percent, the lowest rate in over 40 years, in order to give the economy additional support.

 

By the time summer arrived, the situation in Iraq had ceased to weigh heavily on decisionmakers' minds, and the economy was ready to take off. Output growth in the third quarter was the fastest rate in nearly 20 years and, for the year, economic output grew 4.3%.

 

By most indications, the expansion should continue in 2004. With inflation low and expected to stay low, the FOMC can be patient in removing its policy accommodation. Moreover, favorable trends in productivity — the result of extensive technological innovation during the past decade or so — should allow for solid growth and price stability in the year ahead.

 

Changes Ahead for Payments System
Just as technological innovation has benefits in the macroeconomy, innovation is also having a positive impact in the payment system. As payment technology continues to evolve, banks and their customers are moving away from paper-based payments — like checks — toward electronic payments.

 

The Fed has encouraged this change because of its huge potential to eliminate inefficiencies in the payments system. Last year, the Fed partnered with commercial financial institutions to push for legislation that would accelerate the move to electronic payments. In October, Congress passed the Check Clearing for the 21st Century Act. The new law, more commonly known as Check 21, requires banks to accept electronic or paper images in place of original paper checks, but offers some flexibility for implementation.

 

With Check 21 as a backdrop, this year's annual report explores the incentives and obstacles that affect how the payments industry adopts new payment standards. The article also discusses the appropriate policy role of the Federal Reserve in facilitating the shift to new standards.

 

Review of 2003 Results
The move toward electronic payments has also had a significant impact on our day-to-day check-processing operations. In 2003, our check revenue fell short of its targets. In an effort to get our costs more in line with diminishing revenues, the Federal Reserve System began to implement plans to consolidate check-processing operations nationwide. At the same time though, the Financial Services group continued to serve our customers well through improved quality and efficiency.

 

In addition, the Economic Research department continued to make a significant contribution to policy debates through its conferences and academic research. And Supervision and Regulation strengthened its performance by improving its risk assessment processes.

 

I'd also like to highlight two specific initiatives we undertook last year. One is the effort to strengthen our internal controls. This effort will help us manage costs and deal with organizational risk in all of our business areas. The other is the construction of our new branch building in Detroit. We broke ground on February 9, 2004, and the project will be completed next year. The new facility will have the technology to provide secure cash handling and efficient check processing in a safer work environment.

 

Appreciation to Our Employees and Directors
As we increased our focus on cutting costs and improving efficiency, our employees approached their work with a spirit of innovation and dedication. They demonstrated all the qualities that make me proud to work with them, and I'd like to thank them all for their continued commitment to the bank's success.

 

Additionally, I'd like to thank the members of our Boards of Directors. Their guidance and insights were invaluable as we moved through the year. I'd specifically like to acknowledge the Directors who retired at the end of 2003: Bob Darnall, Jack Evans, and Bob Yohanan from the Chicago Board, and Tim Leuliette, and David Wagner from the Detroit Board. We owe a special note of gratitude to Bob Darnall, who served as chair of the Chicago Board for the past two years and led the Conference of Chairmen of the Federal Reserve System during 2003, as well as to Tim Leuliette, who served as chairman of the Detroit Board for the past four years.

 

In 2004, we welcomed five new members to our Boards. Joining the Chicago Board are John Canning, Jr., chairman and CEO of Madison Dearborn Partners, and Michael Kubacki, chairman, president and CEO of Lake City Bank and Lakeland Financial Corporation. Joining the Detroit Board are Ralph Babb, Jr., chairman, president and CEO of Comerica Incorporated; Roger Cregg, executive vice president and chief financial officer of Pulte Homes, Inc; and Linda Likely, executive director of the Kalamazoo Neighborhood Housing Service. In addition, Mark Gaffney, president of the Michigan AFL-CIO, left his seat on the Detroit Board to join the Chicago Board.

 

I learned early in my management career that the key to success is to surround yourself with the best people. With our talented staff at the Chicago Fed and the guidance of our Boards of Directors, we are well positioned for a successful year in 2004.



Michael H. Moskow
President and Chief Executive Officer
April 8, 2004