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F r n R K 11
aj.i. 3

BOARD OF GOVERNORS
O F THE

FEDERAL RESERVE SYSTEM

Office Correspondence
To

Chairman Eccles

Subject:.

R^^

Lauchlin Gurrie

from a rise in reserve requirements




In the light of the discussion on Tuesday I have written
up my proposal. I think: I have met all the .objections and
have made out a stronger case than I made ivn the meeting.

?5^

Confidential
January 21, 1937.
L. B. Currie

^

PROPOSAL TO EXEMPT TIME DEPOSITS FROM A RISE IN RESERVE
REQfflREfrlKNTS
The problem
It is the duty of the Board to prevent an injurious expansion of credit.
There are strong arguments^ that will not be entered upon here^for doing this
by absorbing excess reserves through raised reserve requirements before engaging in open-market sales. Raising reserve requirements, however, has the
disadvantage of lessening the attractiveness of membership in the System and
of making it difficult to secure unification, or at least uniformity in reserve
requirements as between member and non-member banks. The problem, therefore,
is to raise reserve requirements in such a way as to minimise the worsening
of the competitive position of member banks.
The competitive -position of country member banks
There appears to be little danger of defection of city member banks
because of increased reserve requirements.
clear in the case of country banks*

The question, however, is not so

A comparison of the legal reserve re-

quirements of country member and non-member banks is not unduly unfavorable
to member banks*

The fact, however, that almost all States permit legal

reserves to be held in the form of vault cash and balances with other banks
radically changes the picture. All country banks find it necessary to hold
assets in the form of vault cash and bankers* balances.

Inmost cases, there-

fore, legal reserves on deposit with the reserve banks are a net addition
to the amount of non-earning assets country member banks must hold in comparison with country non-member banks*




-2-

It is difficult to assess the importance of this factor.

The fact

that there is little correlation between the proportion of member to
non-member banks and the relative reserve requirements in various States
suggests that other factors have been more important in the past in affecting
decisions to join or not to join the System.

On the other hand, the doub-

ling of previous country member bank reserve requirements would unquestionably
tend to make this factor a more important consideration in the future. That
country member banks are alive to the issue is indicated by the letters of
protest the Board has recently received.
A possible solution
It has been suggested that if a compromise is made it should take the
form of a complete exemption of country banks from increased reserve requirements.
1.

Such a course, however, appears to be open to very serious objections;
Since country member banks have a higher percentage of excess re-

serves than city banks their complete and explicit exemption would be interpreted as a sign of weakness on the part of the Board, and its prestige would
thereby suffer.
2.

By resulting in a greater spread between the reserve requirements

against demand deposits in city and country banks, the shift of deposits
and reserves from city to country banks that noiraally occurs in the upswing
would permit a further expansion of demand deposits, or means of payment.
3.

It would prove very difficult at a later date to raise the reserve

requirements of country banks alone.




-3-

Suggested solution
It is suggested that the problem could be most effectively met
by exempting time deposits from a rise in requirements.
1.

Substantial relief will be afforded country banks with little

diminution in the net effectiveness of action if the rise in reserve
requirements were confined to demand deposits.

On the basis of the

November 1-15 figures and in comparison with the rise of 33 l/3 percent
against all deposits, it would reduce the increase in requirements for
country banks by one-third*

The net difference for all banks, however,

would be only §160million, or ten percent.

This follows from the

facts that demand deposits in the System are more than double time deposits,
that a 33 l/3 percent rise in the already relatively high requirements
against demand deposits amounts to many more percentage points than an
equal percentage rise against time deposits, and that city banks hold
80 percent of the demand deposits while country banks hold 50 percent
of the time deposits. The absolute and percentage differences for various
classes of banks are indicated in the following table:

Amount that would
Percent that would
be absorbed by
be absorbed by
Excess
33 1/3
33 1/3
percent
Classes of banks reserves
percent
Flat
Flat
increase 33 1/3
(First half 33 1/3
increase
on deman(1 percent
of Nov.) percent
on demand
increase deposits increase deposits
alone
alone
Central reserve city bks.
734
88.1
646
New York City
636
86.8
143
216
Chicago
137
63.2
66*1
Reserve city banks
720
487
421
58.5
67.7
244
163
30.8
529
Country b n . s
aJc
46.1
1,521 1,357
All member banks
2,199
69.1
61.7



-4-

2.

In addition to country banks, substantial relief will be

afforded reserve city banks in the San Francisco district whose time
deposits are large relative to their demand deposits.

On the basis

of the November 1-15 figures a uniform 33 l/3 percent increase would
absorb 107 percent of the excess reserves of these banks, whereas a
33 1/3 percent increase against demand deposits alone would absorb
only 78 percent. As pointed out below, these percentages will probably
be higher by the time action is taken,
3.

It is to be anticipated that the $160 million difference would

result in less utilization of bankers* balances and hence would afford
some relief to the New York banks.
4. The effectiveness of action would not be impaired by a reduction of $160 million in the excess reserves absorbed. Up until recently
it was anticipated that the exercise of the full remaining power would
leave banks with $700 million excess reserves, and that member banks
would receive further accessions of reserves from declining currency
and inflowing gold.
change.

The picture has recently undergone considerable

The Treasury proposes not only to prevent further inflows of

gold from creating excess reserves but, by its action, will undertake
to reduce excess reserves. Moreover, by making its action in effect
retroactive it apparently proposes to reduce excess reserves by some
$•150 million more than we

anticipated.

Finally, it now appears that

currency in circulation will continue to increase. Kence, there is a




-5-

likelihood that if full action is taken soon,banks will he left not
with $700 million, but with nearer $500 million excess reserves, and
there appears to be good reason to believe that unless the reserve
banks buy bills or securities the excess reserves will be absorbed and
banks will be forced to borrow before the year end.
Since, therefore, the picture has undergone such a drastic change,
there would appear to be good reason for lowering somewhat the amount
of absorption originally contemplated at this time.

It would be undesir-

able to do this by exempting a particular class of bank or by lowering
the percentage rise against all deposits.

It could be accomplished,

however, by exempting tine deposits.
5.

It would not appear unduly difficult to raise reserve require-

ments against time deposits at some time in the future if it should
be thought desirable.

The point has been made that the same difficulty

would arise as would attend an attempt to raise reserve requirements
for country banks alone.

There is a significant difference, however,

between explicitly singling out a particular class of bank and a particular
type of deposit. So far as I know, nobody has made the point that the
determination of the maximum rate of interest payable on time deposits
is directed at country banks.

If it were desired to raise reserve

requirements against time deposits in the future it would presumably
be done at a time when time deposits were explanding or interest rates
were rising, and it would either reinforce or serve as an alternative
to a rise in the maximum rate of interest payable on time deposits.




-6-

In this connection it is worth pointing out that very few people
are aware of the distribution of deposits or of the incidence of the
burden of raised reserve requirements against time deposits.

In any

case, city banks hold as many time deposits as do country banks.
6. The specific proposal under discussion impinges on the broader
problem of the advisability of differencesin reserve requirements as
between time and demand deposits.

As reasons for not widening the present

spread in requirements it has been claimed that this course would increase
the inducement for classifying active deposits as time deposits and
would result in numerous attempts at circumvention, that time deposits
are in effect payable on demand and hence should carry the same requirements as demand deposits, and that lower reserve requirements against time
deposits uermit a greater expansion of total bank deposits.

I shall take

up these points in order.
a.

Inducement for reclassifying deposits.

the force of this contention.

It is difficult to see

Bankers pay no interest on demand deposits

and there would be no point in a person carrying a time deposit rather
than a demand deposit unless he received interest.

In the specific case

at point the additional inducement to the bankers would be the interest
they can secure on the released reserve that amounts to 1 J percent of the
-deposit.

It is obvious that the additional interest banks would, have to

earn on this 1 g percent in order to pay interest to the depositor on the
-total deposit would be impossible to secure.

The same is true if the

released reserve amounts to 9§ percent (14 - 4k) or 15^ percent or even
percent.




In the last instance, the rate of interest that would have

-7to be earned on the released reserve would have to be five times the
rate paid on time deposits.
If, of course, it were a case of the demand depositor removing
his deposit altogether from the bank in order, for example, to buy
securities, it would probably be to the bankers* interest to solicit
the deposit as a time deposit.

This, however, is quite different from

reclassifying existing deposits that would not otherwise be withdrawn
from the bank.

Finally, in this connection it is worth pointing out

that the regulations now in force against checking against time deposits
appear to be fairly strictly enforced.
b.

Time deposits payable on demand.

It is now generally agreed

that the purpose of legal reserves is not to provide liquidity but to
furnish a means of contro}.

For liquidity banks must rely on their

secondary reserves. Moreover, time deposits normally increase steadily
and are drawn out only in a severe depression.

Even in 1930 they

increased.
c.

Greater expansion of total deposits permitted. While this is

true, the further inference that this is a bad thing should not be drawn.
In terms of the flow of money, savings that take the form of increased
time deposits result in a diminished flow and lower incomes than savings
that take the form of direct investment.

In the former ease not all

the savings of the individual are passed along by the banker to the
ultimate borrower to be disbursed.




In the latter case all the savings

-8-

are passed along.

The danger lies in concentrating on banking figures

alone and overlooking the total community flow of money. Raising
reserve requirements against time deposits, by impeding the expenditure
of current savings, would run counter to our attitude on the tax on
undistributed earnings and on social security taxes, an attitude that
is based on our fear that over the longer term savings may be excessive
relative to the opportunities for investment in durable goods,.
7.

The press statement could explain an exemption of time deposits,

if it were thought necessary to make an explanation, in terms of the fact
that it is desired to leave banks with over $600 million excess reserves
so that they can meet the currency needs, etc., of the remainder of the
year without borrowing or without reserve banks buying securities.

It

is thought undesirable to exempt any class of bank or to leave a small
part of the power to raise reserve requirements against all deposits
unexercised.

By confining the rise to reserve requirements against

demand deposits, an amount of absorption of excess reserves which is
thought about right in the present circumstances would be achieved.

It

might possibly be mentioned that time deposits have experienced little
expansion as yet.




January 25, 19371

EXA1IPLBS ILLtJSmCTIHa TSE KESTBICTITO EFFECT OF KES5KVS BEQUIB^MENTS
AGAINST TIME DEPOSIT

Example I ~ Assume #1 billion of savings out of current income go axmaally
into savings or time deposits*

Assume reserve requirements against time

deposits to b© 6 percent and the average against demand deposits to be
20 percent*
On #x billion shift from demand deposit® to time deposits represented
by current savings, the released reserve, emounts to fl4Q million* (#g00
million minus $60 million)*

Banks can expntid tbeir loans and investments

by |700 million {#3,40 million multiplied by 5, the ratio of expansion of
demand deposits)*

Hnnce, out of #1 billion saved only #700 million is

passod along to borrowers to be disbursed*

If, instead of increasing

their time deposits, savers had invested their savings directly, a full
$1 billion would heve been passed along to borrowers, etc*

lb offset

this diminution in the flow of money additional reserves of #60 million
dollars would have to be furnished banks so that they ean increase their
loans end investments by an additional #300 million (#60 multiplied by 5}*

Example II
Sane assumptions as before, except that reserve requirements against
time deposits remain at

percent*

Oi\#l billion shift from demand deposits, the released reserve
amounts to #155 million (#200 million minus #45 million}*

Banks can

expand their loans and Investments by #775 million {#155 multiplied by 5}*




To ensure that the full amount of savings are passed along to borrowers
additional reserves of #45 million w o l d have to be furnished banks so
that they could eap&nd their loans and investments by an additional
#225 million {#45 million multiplied by 5 h

Conclusion
Trous the point of view of maintaining t e flos? of purchasing power
t
reserve requirements against time deposits should be kept as low as
possible.

Ideally they should be zero, so that the full amount of savings

would be passed along whether the saver bought a bond, etc*, directly or
increased his time depositsm