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?. R. 131
BOARD OF GOVERNORS
OF THE

FEDERAL RESERVE SYSTEM

Office Correspondence
To

Chairman Eccle.S-

From

Date — J u n e 2, 1957,
Subject .-Proposal to give the Board
discretionary power over reserve requirements against foreign deposits.

Attached is a memorandum on the proposal to give the Board discretionary
power over the reserve requirements against foreign deposits, together with
a statement by Mr. Test op the legal aspects of the proposal*




June 2, 1937.

DISCRETIONARY PO1ER OVER RESERVE REQUIBT*MFOTS AGAINST FOREIGN DEPOSITS
IN AMERICAN BANKS
The following arguBients can be urged in favor of a grant of broad
discretionary power to the Board of Governors to determine reserve
requirements against deposits held by or on behalf of non-resident aliens
in American banks:
1.

Such power could be used as a deterrent to the inflow of short-

term capital. If reserve requirements were raised sufficiently, banks
would be reluctant to accept foreign deposits and would certainly not
solicit them.
2.

In so far as capital inflows take the form of deposits, and to

the extent to which reserves were required against such deposits, the
Treasury would be relieved of the necessity of increasing the public debt
and sterilizing incoming gold. From the end of 1933 to May of this year
foreign deposits increased by nearly a billion dollars.
3f

If high reserve requirements were in force against foreign

deposits, this would minimize the extent to which banks would be forced
to liquidate their loans or to borrow from the Federal Reserve in the
event of a sudden withdrawal. From the end of 1929 to the end of 1933
foreign deposits were drawn down by $1.3 billion. In addition, other
short-term balances declined $1.5 billion. The worst period of bank
deflation, that of late 1931, was associated with withdrawal of foreignheld deposits in this country.

Conditions have changed since then but

a large withdrawal of foreign-held deposits would still result in some
liquidation^




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4#

Discrimination could be exercised as between a net increase

in foreign deposits arising from an inflow of capital and a net increase
arising from stock market liquidation.

In the latter case reserve

requirements need not be raised and might actually be lowered or the
increased requirements might be supplied by open market purchases*
5. Ability to vary reserve requirements against foreign deposits
would afford a valuable additional power to operate on the volume c
f
reserves of the New York banks,
6. Such a grant of power would constitute the strongest grounds
for testing our authority to determine reserve requirements for nonmember banks. The main non-member bank affected would be J, P. Morgan
and Company.

The addition of this power to our existing power to

determine margin requirements for nonHnamber banks would constitute
another step toward bank unification*

As against these advantages may be contrasted the following disadvantages:
1. Haising reserve requirements against existing foreign deposits
would tend to absorb excess reserves, force liquidation or cause
borrowing from the Federal Reserve, and would therefore be restrictive
in nature.

(This disadvantage could be met by confining an increase

in requirements to a future increase in deposits until such time as it
is desired to exercise some general measure of restraint).
2. New York banks would be exposed to an element of uncertainty
with respect to reserve requirements against their foreign deposits.




-3-

3*

Foreigners could evade service charges, if any were imposed,

by withdrawing cash or by investing in Treasury bills and acceptances.
If invested in Treasury bills, there would be a tendency to convert
inactive deposits into active deposits, which at times may not be
desirable on general monetary grounds*

(The withdrawal of cash would

be equivalent to the imposition of 100 percent reserves and the purchase
of Treasury bills could be met by the imposition of moderate transfer
taxes*

In any case, it is doubtful if service charges would be imposed

and an increase in the withholding tax rate would diminish the attractiveness of Treasury bills)*
4*
deposits

If higher reserve requirements were in force against foreign
and such deposits were drawn down for the purpose of buying

securities, reserve requirements of banks as a whole would be reduced
and an expansion of loans and deposits made possible*

(This could be

counteracted by open-market sales of securities or by Treasury absorption
of excess reserves)*
5. If the Treasury did not sterilize gold that resulted in an
increase in foreign-held deposits on the grounds that the higji reserve
requirements constituted the sterilization, excess reserves would be
increased when, as, and if these deposits were drawn down for the
purchase of securities*

(The Treasury might undertake to absorb excess

reserves arising from this source*)

A grant of power should be broadly discretionary, so as to permit
of discrimination as between ordinary working balances and other deposits*



-4-

Beserves for foreign-held deposits in non-member banks should take
the foim of deposits in the Federal Reserve banks*
For the particular purpose at hand it appears proper to require
high reserve requirements against foreign-held time deposits as well
as demand deposits*
The problem of enforcement should not prove unduly difficult*
The bulk of foreign-held deposits are now known to and reported by banks*
A general notice to the effect that all deposits held by or on behalf
of non-resident aliens mast be reported to the banks, with penalties
provided for failure to report, should be all that is needed. There will
be very little inducement not to report such deposits, as the service
charges, if any are imposed, would be small relative to the penalties*