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Form F. R. 131

BOARD O F G O V E R N O R S

/U

OF THE

FEDERAL RESERVE

SYSTEM

Office Correspondence
•pQ
p
r

Subject:

Chairman Eccles
i

Lauchlin Currie
——

Future T^nd of Ttank A i l t f ffp.i

•

In accordance with your suggestions I have considerably enlarged
my previous note on the trend of bank assets in the next few years•
I should be grateful for any further comments or criticisms. Do you
think it would be a useful thing to send to the Board and, perhaps,
Presidents of the Open Market Committee?
I am now engaged on a memorandum on the monetary situation in
relation to excess reserves, attempting among other things to work
out a criterion of the "adequacy" or "excessiveness" of the money
supply.







LC: R & S.
Confici ential
Nov.11, 1956.

THE TREND OF BANK ASSETS IN THE NEXT FEW YEARS

Statement of the Problem
Although it is not possible to be very explicit on this
subject its importance in various connections justifies a
consideration of the evidence bearing on it. Some people
feel that in order to meet the demand for commercial loans
on the part of their customers that is anticipated with
further recovery, banks will dispose of their holdings of
Governments and this will exert pressure on the Government
bond market• Of even more importance, the rapidity and extent
to which banks expand loans may determine in large part the
rapidity and extent to which it may prove desirable to take
action with regard to excess reserves.
Conclusion
A survey of the previous experience in this and other
countries, and a consideration of the effect of more recent
developments, suggests that ?/hile the probable increase in
the demand for unsecured and secured loans may very well be
in excess of the amount by which it is thought desirable to
let total earning assets and, hence, deposits, expand, it wall
probably not be greatly in excess. This view rests on the
assumption that the recovery movement will continue to be
orderly and will not be characterized by rapid advances in

commodity prices* Even the anticipated excess in the demand
for loans over the amount by which it is thought desirable to
permit total earning assets to increase need not entail a
liquidation of bank holdings of Government bonds because (a)
a substantial portion of bank holdings is in notes and bills
and (b) it is to be expected that the Government will retire
and refund a portion of the short-term debt*
Considerations Leading Up to the Conclusion
It would appear, in the first place, that there will be
little necessity or disposition to liquidate Governments in
order to meet the demand for other types of loans so long as
member banks possess an abundance of excess reserves. In view
of the magnitude of the expansion of circulating deposits plus
outside currency that has occurred since 1933, it is questionable
whether it may not be thought desirable to prevent further
expansion of the volume of money• If such should prove to be
the case, action would have to be taken to return to the condition that prevailed up to 1932 of no excess reserves• The
question would then arise as to whether and to what extent banks
would liquidate their Governments in order to increase other




types of earning assets»
In addition to the expansion of other assets that is possible
so long as banks possess excess reserves, there is the expansion
that will be possible on the basis of reserves released by a

shift from demand to time deposits and on the basis of additional
capital and surplus. It is apparent, therefore, that considerable
expansion of loans is possible before any necessity would arise
for a liquidation of Governments.
We may now look at the matter from the banks1 point of view.
Banks are as a rule anxious to meet any requirements for loans
of their customers which they consider safe. The rates are generally
higher than on other assets and the goodwill and maintenance of
the customer relationship is a factor. On the other hand, banks
have always the problem of liquidity to bear in mind. They feel
they need a substantial portion of assets they can realize on
quickly without loss of principal or of goodwill.
It is of interest to compare the proportion of earning assets
of member banks represented by Governments, call loans to brokers
in New York, and acceptances and commercial paper, of 18.6 percent
in 1929 with 41 percent in 1956. If, on the latter date, Government guaranteed issues are included, the proportion becomes 47
percent. If only Government notes, bills and certificates are
included in each case, the proportions were 10 percent in 1929
and 24 percent in 1956. Even allowing for some increase in liquidity
requirements resulting from the experience in the depression, it
is apparent that, judged by pre-depression standards, banks have
a large portion of their earning assets in liquid form and could
well afford to increase their customer loans at the expense of
liquid earning assets.



-4-

It would appear, therefore, that the amount of expansion
of customer loans to be expected becomes more largely a question
of the probable demand for such loans than of reluctance of
banks to make loans. In approaching this problem it will be
helpful to compare the earning assets of member banks in 1955
with the earning assets in 1929. This is done in the following
table:

1/

Member Bank Loans and Investments. June 1929-56.(In millions of dollars)
1929

Percent

1956

Percent

Government Obligations
Bills, Certificates
1,150
5,005
4*155

Total
Guaranteed
Total direct and
guaranteed

.28
5,
8.
.58
,86
11,

6 ,426
5 ,295
11 ,721

19.
.97
16.
,46
56.
.45

1 ,951

and Notes
Bonds

6.
.06

4.155

,86
11.

15 ,672

42, 49
r

Other Securities

5.898

16.
.85

6 ,045

.79
18.

Total Securities

10.055

28.
.69

19 ,717

61.
.28

2,025
7,754
9,759

5.
.78
22,
.07
.85
27,

1.
,079
,150
5,
,209
4,

525
9 .75
15 .08

3,164

.05
9.

,540
2j

7 .27

447

1.
.28

557

1 .75

All Other Loans

11,618

55.
.16

,555
5,

16 .64

Total Loans

24,988

.51
71.

,461
12,

58 .72

Total Loans & Investments

55,041 100,,00

,178
52,

100 ,00

Loans on Securities
To brokers in New York
To others
Total
Loans on Real Estate
Acceptances & commercial paper

1/ Exclusive of interbank loans.




-5-

This table serves the purpose of bringing out the absolute
and percentage changes in the composition of the earning assets
of member banks since 1929 and indicates the magnitude of changes
the restoration of the 1929 composition would entail. The big
changes, of course, have been the increase in Government direct
and guaranteed issues and the declines in loans on securities
and "All Other Loans". It is interesting, however, to note that
Government bonds are only $2.5 billion in excess of 1929, although
if guaranteed issues are included the increase is $4.2 billion.
The big increase in Governments has been in bills and notes.
Non-member insured banks on June 50, 1956, held approximately
$500 million of Government bonds and $500 million of guaranteed
issues. The figures would be still further increased by the
inclusion of non-member non-insured banks.
It is now proposed to examine separately the prospects of
expansion in the various types of earning assets. We will then
be in a better position to weigh the probabilities of a decline
in bank holdings of Governments.
Unsecured Loans
1. Movement of "All Other Loans". 1921-29* 1955-56. From
June 1921 to June 1925 the index of production rose from 65 to 106.
In the same period national bank loans other than on securities
and real estate declined $607 million, and holdings of Government
securities increased $570 million.




-6-

Froia June 1923 to June 1929 the index of production rose from
106 to 125. Loans other than on securities and real estate of
national banks decreased by $714 million, or 9 percent. Their
holdings of Government securities increased $110 million. In
the same period the Government debt outstanding decreased by $5,369.
In interpreting these facts a plausible explanation appears to be
as follows:
New loans were undoubtedly being made in the sharp recovery
from 1921 to 1923. The total outstanding declined, however, as a
result of the heavy liquidation of loans that had been carried over
from the peak of 1920. Moreover, the price level stabilized at
a considerably lower level than prevailed in 1919-20, and the
requirements for working capital were lower on this account. From
1923 to 1929 unsecured los-ns continued to decline, although the
index of production rose. This behavior appears to be in large
part attributable to the lessening economic importance of those
individuals and concerns that comprise the bulk of borrowing customers, and in part to the increasing ability to finance expansion in
ways other than by bank loans. I may quote what I have said
i/
elsewhere on this subject:
!!

Upon the basis of an investigation into the accounts of
729 companies, divided into 30 groups, for which comparable
balance sheet© were available from 1922 to 1928 inclusive, the
writer sought to explain the decline in bank loans as due to a
recognition of the extent to which loans intensify the dangers

1/ The Supply and Control of Money in the United States, p. 41.






-7-

of a drastic decline in net earnings and of insolvency, should
gross earnings decline.1/ Although only the larger companies
were studied it is highly significant, in view of the apparent
trend toward large scale enterprise, that the companies that
were growing most rapidly and should on that account require
larger loans, actually reduced them to a nominal figure, while
companies whose earnings were low or declining were carrying
heavy bank loans and in some cases actually increasing them.
It appeared that the desire to liquidate loans pervaded all
industry, since in those cases where loans were still relatively
heavy in 1928 the ability to liquidate was lacking. It was
inferred, moreover, from this study that the great bulk of
commercial loans were being made to farmers and relatively small
business concerns. If economic progress continues to be associated with the increasing importance of the larger corporations
having access to the stock and bond markets, there is a strong
probability that the commercial loan will continue to decline
in the future.11
1/ The Decline of the Commercial Loan* Quarterly Journal of
Economics, August, 1931, pp. 698-709.
Our past experience appears to have some relevance to recent
developments and future prospects. During the recovery from 19S5
to 1955, the volume of liquidation and write-offs of old loans of
member banks exceeded the volume of new loans made, so that the
total declined by $23 million despite an expansion of business activity.
In 1935, however, new loans being made began to exceed old loans
paid or written off, and the total for reporting member banks increased $693 million from October 1935 to October 1936. The fact
that all other loans have begun to expand before full recovery is
achieved, which was not true in 1921-23, is perhaps partly attributable to the extremely heavy liquidation that had already occurred




-8-

in the period 1929-33, and partly to the relatively more favorable
recovery of agriculture in the present movement.
The trend noticeable in the Twenties, where it appeared that
broadly speaking only those industrial and commercial concerns
that could not easily raise money elsewhere borrowed from banks,
may be expected to continue. In fact the experience of the
depression has served to emphasize anew the dangers associated
with short-term indebtedness. From the point of view of this
long-term trend, therefore, we would expect the proportion of
other loans to total loans and investments to be less in the
future than in the Twenties.
2. Bank Loans and the Recovery in Other Countries. The
co-existence of increasing business activity and declining bank
loans experienced in this country from 1921 to 1923 and from
1933 to 1955 is not peculiar to this country. As the following
table indicates, the same divergent movements took place in
the United Kingdom, Canada, and Sweden in recent years, though
in the past year an upturn in loans has occurred in the United
Kingdom.
In interpreting these figures it should be borne in mind
that the decline from 1929 was far less steep in England and
Sweden, and hence that the percentage rate of decline and recovery
in the United States is much greater. Another factor was the
decline and subsequent increase in bank loans in the United States




-9-

attributable to bank closings and the subsequent taking over
in part of loans from closed banks. We should, therefore,
expect loans to decline more rapidly in the United States
and show a greater degree of recovery.

-10Bank Loans in United Kingdom, Canada, Sweden and the United States. 1929-56, and Yearly Average
Index of Production.

United
Loans to
customers
(millioas
of L)
1929. ,
1950. ,
1931. ,
1952. ,
1935. .
1936. .

m
976
926
856
780
852

KingdomIndex of
Production
100.0
92.5
83.8
83.5
88.2
115.1 1/

1/ Second quarter.
2/ June.




Canada
Loans & disIndex of
counts other
than on secur. Produc(mill.of Canad.i tion
1,434
1,425
1,263
1,211
955
777

100.0
84.8
71.0
58.1
60.3
87.6 2/

Sweden
Loans &
overdrafts Index of
(millions Producof kronor) tion
3,203
3,409
•5,392
3,031
2,763

100.0
99.3
95.4
90.1
126.9
135.8 2/

United States
All other
loans
Index of
(millions
Producof dollars) tion
11,618
10,349
8,744
6,892
4,834
5,355

100.0
80.7
68.1
53.8
63.9
86.6 2/

-11-

5. Other Considerations Bearing on the Future Movement of
1
1

All Other Loans".
American industry as a whole appears to have more cash and

be in a more liquid position than in 1929. A considerable expansion
of activity could, therefore, be financed without entailing the
necessity of raising new money. Too much emphasis should not be
put on this factor, however, since, for one thing, industry may
prefer to remain more liquid than heretofore and, for another, a
general condition of liquidity is quite compatible with the existence
of a shortage of working capital on the part of small manufacturers,
merchants, and farmers, who make up so large a proportion of the
borrowers from banks. The requirements of farmers, on the other
hand, are likely to be met more largely by agencies other than
commercial banks than was true formerly.
It is reasonable to assume that the future character of the
recovery movement will have an important influence on the demand
for commercial loans. If the movement is steady and orderly in
character and is not accompanied by any marked rise in prices,
working capital requirements will be less than they would be if
the movement assumes the proportions of a boom and rapid increases
in prices occur. This reasoning receives some confirmation from a
contrast of the 1917-20 experience, which was a commodity and
general business boom, with that of 1923-29. Loans of national







-12-

banks other than on securities increased #3.8 billion, or
59 percent, in the earlier period as contrasted with a
decrease of $714, or 9 percent in the period 1923-29 in
such loans.
To this point most of the considerations mentioned appear
to suggest that on balance a moderate expansion only of "All
Other Loans" is to be anticipated if the recovery movement
continues orderly and rapid price advances are avoided. There
are two considerations, however, which point in the opposite
direction. One is an increase in "All Other Loans" of reporting
member banks in the past year. If the same amount of expansion
took place in the next four years this would mean an increase
of $2.8 billion. If, however, the same rate of increase occurs,
the expansion would be $4.5 billion. It would be very helpful
if more were known of the nature of the increase that has
occurred. It may in part represent the taking over of existing
loans by member banks, in part an expansion in installment
selling, and in part loans for capital purposes which are
expected to be refunded. The trend in the next six months in
comparison with the trend in the previous year should afford
some clue as to the permanence and strength of the recent movement.




-13-

A factor which is now present but which was lacking in the
Twenties is a tax on undistributed earnings. While it is not
expected to induce the larger companies having access to the stock
and bond markets to borrow from banks, it may very well have this
effect on the intermediate-sized corporationswhich have no access
to the capital markets and which may experience some difficulty
in getting some two or three hundred shareholders to take up
rights to subscribe for new stock. In such cases there is an
added inducement to distribute earnings in dividends ana finance
working capital requirements by means of bank loans.
Eespite the increase that has occurred in the past year and
the uncertain effect of the new tax on undistributed earnings,
previous experience in this and other countries would appear to
suggest that "All Other Loans" will not regain the proportion of
total loans and investments they represented in 1929 and that it
is doubtful if they will regain the absolute level then prevailing.
In other words, assuming the absence of rapid price advances,
it seems more likely that "All Other Loans" will expand some
$3 or $4 billion, rather than by the $6 billion necessary to
restore the 1929 level.
Security Loans»
The only comparable series of loans on securities covering
the post-war decade is that for national banks. This type of
loan increased from $2.7 billion in 1921 to $5.5 billion in 1929,




-14-

or by $2.8 billion. In 1921 they comprised 17 percent of
national bank loans and investments, in 1925 eighteen percent
and in 1929 twenty-five and a half percent.
It appears improbable that security loans will increase as
rapidly in the next few years. For one thing, many people of
this generation have had a disastrous experience with margin
trading and the caution thus engendered may be expected to last
for some time. Of more importance, however, is the requirement
for higher margins than prevailed in the Twenties. It is perhaps
not unreasonable to expect that any tendency toward a rapid
increase in security loans will be checked by higher margin
requirements. On the other hand, there may be more of a tendency
for commercial loans to be backed by collateral.
Loans on Seal Estate.
Although the increase in residential building has not as yet
been reflected in any increase in bank loans, this is probably
owing to the continuance of liquidation of old loans. It is to
be anticipated, however, that loans on real estate will experience
considerable rise in the next few years. Various factors should
contribute to this end. In the first place, there are the new
provisions of the Banking Act of 1955, and the new opportunities
to assure against loss afforded by the Federal Housing Administration. The latter are of particular importance in the case of

-15-

thinly-margined mortgages*

Secondly, the probable continuance

of low yields on securities, acceptances, commercial paper and
call loans, and the present strong liquid position of banks
will combine to enhance the attractiveness of real estate loans.
Thirdly, there appears to be a strong likelihood of a very
heavy volume of building construction in the next few years.
While, therefore, it is to be expected that the bulk of
mortgage lending will continue to be handled by agencies other
than commercial banks, there is a possibility that loans on real
estate by commercial banks may double in the next few years.
With reference to our main problem, however, it may be pointed
out that this would mean an increase of only two billions.
Acceptances and Commercial Paper.
It appears unlikely that the growth on these types of
loans will be of quantitative significance. Even if the total
of acceptances rises to the level of the late Twenties, this would
mean a net expansion of only some $700 million.
Other Securities.
Member banks hold slightly more other securities than they
did in 1929 and the proportion of earning assets represented by
other securities has increased from 17 percent to 19 percent.
It seems probable, therefore, that banks will be somewhat
reluctant to increase their holdings by any substantial amount




-16-

unless they have excess reserves which they can utilize in no
other manner. The more stringent definition of investment
securities may also be a factor.
Government Securities
Total holdings of Government securities, direct and guaranteed, increased from 12 percent of member bank loans and
investments in 1929 to 42§ percent on June 50, 1956. Long-term
Governments, direct and guaranteed, showed a much less rapid
increase. They amounted to 22§ percent of member bank earning
assets on June 30, 1936, as compared with

percent in 1929.

In view of the magnitude of the increase, the prospects of
little additional increase in the Federal debt, and the signs
of an upturn in the demand for bank loans, it is likely that
member bank holdings of Government securities are now at or
near their peak. If they do not increase further, the proportion
they represent of member bank loans and investments will decline
as other earning assets increase.
Whether bank holdings of Governments will experience an
absolute decline and if so, by what amount, appears to depend
more largely on the rapidity of debt retirement by the Government
and the policy with regard to funding short-term issues than on
the pressure to liquidate arising from the expansion in the demand
for other types of loans. This conclusion is based on (a)
the probable moderate expansion in the demand for other types







-17-

of loans, (b) the possibility of increasing total earning
assets and (c) the scarcity of other types of liquid earning
assets. While the probable increase in the demand for
unsecured and secured loans may be in excess of the amount
by which it is thought desirable to permit total earning
assets and, hence, deposits to expand, it will probably not
be greatly in excess. In the meantime it is to be expected
that a portion of bank holdings of short-term Governments
will be retired and refunded, so that the total bank holdings
of all Governments will decline. In other words, there
appears little likelihood that banks will be under the
necessity of liquidating their holdings of Government bonds
in order to satisfy local requirements for loans.
If the expansion in the demand for loans is less than
anticipated, if substantial debt retirements by the Federal
Government are not effected and if a substantial part of the
short-term debt is not converted into long-term issues, it
is quite possible that banks will retain the bulk of their
present holdings of Governments. This may even prove to be
the case if some 20 or 30 percent of the notes are retired or
converted into long-term issues*

All insured banks now hold

only 46 percent of the total of notes outstanding and even
including the Federal Reserve Banks they hold less than 60
percent. The liquid character of such notes may lead banks




-18-

to increase the proportion of the total outstanding they now hold.
A table showing the proportions of the total of various classes
of Government direct and guaranteed issues held by the member
banks, insured banks, and Federal Reserve banks is appended.
Another factor that has a bearing on this subject is the
possible liquidation of a substantial amount of notes and bills
held by the Federal Reserve banks. Member banks may be expected
to absorb a portion of such notes and bills and this would tend
to keep up their total holdings of Governments.
Still another factor of uncertain effect would be a rise
in long-term interest yields and a fall in bond prices. This
might induce a certain amount of liquidation of bonds by banks.
It is interesting to note, however, that banks maintained their
holdings of Governments in 1928-29 despite the rise in interest
rates and the active demand for loans that prevailed at that
time.
The preceding discussion serves, among other things, to
indicate the important bearing of refunding operations on monetary
policy. If, for example, it is found that the conversion of
notes and bills into long-term issues leads to a substantial
decline in the total holdings of Government securities of banks,
such operations would serve to offset an expansion of loans which
would otherwise result in an expansion of total deposits. On
the other hand, in so far as banks decline to convert short into

-19-

long-term issues, the rate of interest at which the short-term
debt can be converted into long-term debt will be higher than
it otherwise would be. Individuals and agencies other than banks
must be induced to increase their total holdings of Governments
and this will absorb financial deposits otherwise available for
investment elsewhere.
A table showing the holdings of Government securities,
other securities, and loans of commercial banks in England, Canada
and Sweden, is also appended. This table indicates that to date
there has been no reduction in the commercial bank holdings of
Government securities in these countries.




AMOUNT AND PROPORTIONS OF VARIOUS CLASSES OF THE PUBLIC DEBT HELD
BY VARIOUS CLASSES OF BANKS. 1954-1956.
Jane 50
1955
Total direct outstanding
27.645
Member banks
9,871
Percent
35.7
Insured banks
10,470
Percent
37.9
Federal Reserve banks
2,432
Percent
8.8

1956

28^989
11,721
35.5
12,515
37.9
2,430
7.4

Bonds
Member banks
Percent
Insured banks
Percent
Federal Reserve banks
Percent

16,510
4,838
29.3
5,210
31.6
468
2.8

14.936
4,458
29.8
4,889
32.7
317
2.1

18.628
5,295
28.4
5,817
31.2
316
1.7

Notes
Member banks
Percent
Insured banks
Percent
Federal Reserve banks
Percent

6.932
2,871
41.4
3,047
44.0
605
8.7

10.501
4,313
41.1
4,476
42.6
1,511
14.4

11.861
5,160
43.5
5,428
45.8
1,494
12.6

Certificates
Member banks
Percent
Insured banks
Percent
Federal Reserve banks
Percent

l t 635
637
39.0
656
40.1
265
16.2

156

146

Bills
Member banks
Percent
Insured banks
Percent
Fed.Reserve bks .bills &
certificates 1934
Percent

1.404
791
56.3
794
56.6

2.053
1,099
53.5
1,105
53.8

2.354
1,266
53.8
1,270
54.0

477
34.0

604
29.4

620
26.3

681
276
40.5
298
43.8

4.123
1,558
37.8
1,882
45.6

4.718
1,950
41.3
2,257
47.8

Lly guaranteed outstanding
Member banks
Percent
Insured banks
Percent




-

—

-

—

—

—

—

—

—

—

-

-

COM^ICIAL BANKS' EARNING ASSETS. CANADA. SWEDEN. UNITED KINGDOM.
Canada

ff

1929. lP£5-55.

(Money figures in millions of Canadian dollars)

Year
June
30
1929
1933
1934
1935

Dominion &
Provincial
Government
Securities
% to
Amount Total
13
552
28
639
29
654
56
839

Other
Securities
% to
Amount
Total
175
6
222
10
185
8
8
179

Other loans
& discounts
% to
Amount Total
1,434
51
1,057
46
1,018
45
954
41

Other earning
assets
% to
Total
Amount
861
31
383
17
398
18
356
15

Total
% to
Total
Amount
100
2,820
100
2,301
100
2,253
100
2,508

—

Sweden
(Money figures in millions of kronor)

Year
Dec.
31
1929
1933
1934
1955

Total
Securities
% to
Total
Amount
9
595
462
10
640
14
648
14

Loans
outstanding
& overdrafts _
_
% to
Total
Amount
5,203
69
65
2,803
2,750
61
2,765
61

Other earning
assets
% to
Total
Amount
25
1,047
26
1,166
25
1,117
25
1,140

Total
Amount
4,645
4,431
4,507
4,551

% to
Total
100
100
100
100

United Kingdom
(Money figures in millions of t)
Other earning
Other
Loans to
Govt. Secur.&
Securities
Treas.Notes 1/
Total
assets
customers 2/
Year
% to
% to
% to
% to
% to
June
Total
Total
Amount
Amount Total
Amount
Total
Amount Total
30
Amount
,278
1,625
61
100
17
513
19
2
996
1929
58
-255
14
1,776
44
100
35
2
779
1933
707
40
1954
625
57
46
3
45
761
245
15
1,677
100
41
1955
727
44
53
3
231
779
15
1,790
100
1/ Includes British Government bonds and Treasury bills, estimated for the 10 London clearing banks*
2/ Advances & items in transit,
of data from the banks making such reports. The estimates for
!
S3 & f 34 are less reliable than !35,tho all estimates t^nt^tlve