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BOARD OF GOVERNORS OF THE FEDERAL Date To RESERVE SYSTEM November 25, 19k7 Chairman Ecclos Woodlief Thomas MESSAGE: This i s a r e v i s e d copy. Copies are b e i n g h e l d pending a u t h o r i t y t o \ release* Q Message d e l i v e r e d b y F.R. 468 Digitized R e vfor . FRASER 1/47 November 25 # 19k7 PROPOSAL FOR A SPECIAL RESERVE REQUIREMENT AGAINST THE DEMAND AND TIME DEPOSITS OF BANKS I n order t o p r o v i d e a more e f f e c t i v e means o f r e s t r a i n i n g infla- t i o n a r y expansion o f bank c r e d i t , the Board o f Governors o f the Federal Reserve System proposes t h a t the Congress pass l e g i s l a t i o n g r a n t i n g the System's Federal Open Market Committee temporary a u t h o r i t y t o impose g r a d u a l l y as c o n d i t i o n s may warrant a requirement t h a t a l l commercial banks h o l d a s p e c i a l r e s e r v e . This reserve should be i n a d d i t i o n t o reserves r e q u i r e d under e x i s t i n g laws and an average amount o f o p e r a t i n g funds c u s t o m a r i l y h e l d by the banks, and c o n s i s t o f cash o r cash i t e m s , inter- bank balances, balances w i t h t h e Federal Reserve Banks, and Treasury b i l l s , c e r t i f i c a t e s , or n o t e s . L e g i s l a t i o n should p r o v i d e t h a t t h i s a u t h o r i t y be granted f o r a t h r e e - y e a r p e r i o d # The Federal Open Market Committee should have a u t h o r i t y t o vary t h e requirement i n accordance w i t h t h e needs pf the s i t u a t i o n and w i t h i n the l i m i t s o f a maximum f i x e d by l a w . Need f o r the proposed measure,—This s p e c i a l requirement i s necessary t o enable the Federal Reserve System t o l i m i t the a b i l i t y o f banks t o o b t a i n a d d i t i o n a l reserves by s e l l i n g p a r t o f the l a r g e holdings o f Government s e c u r i t i e s and t o reduce o r o f f s e t t h e i n f l a t i o n a r y e f f e c t s o f increased bank reserves r e s u l t i n g from t h a t source o r from g o l d o r currency movements• L i m i t a t i o n s on bank reserves are needed t o r e s t r a i n banks i n meeting excessive demands f o r bank c r e d i t . A t the present h i g h l e v e l o f employment and o u t p u t , f u r t h e r expansion o f the t o t a l volume o f bank c r e d i t i s i n f l a t i o n a r y because i t would add t o e x p e n d i t u r e s , which are a l r e a d y i n excess o f t h * p r o d u c t i v e c a p a c i t y o f t h i s c o u n t r y ^ e x i s t i n g s t r u c t u r e and l a b o r f o r c e . industrial - 2 - I n order t o meet p r i v a t e c r e d i t demands, banks have been s e l l i n g Government s e c u r i t i e s i n the m a r k e t • The F e d e r a l Reserve System, w h i c h p r o v i d e s t h e u l t i m a t e market f o r Government s e c u r i t i e s , has had t o purchase such s e c u r i t i e s # I n m a i n t a i n i n g o r d e r l y and s t a b l e market c o n d i t i o n s the F e d e r a l Reserve System must be prepared a t a l l times t o purchase t h e Government s e c u r i t i e s n o t absorbed by o t h e r i n v e s t o r s . Whenever t h o Federal Reserve purchases Government s e c u r i t i e s , a d d i t i o n a l bank reserves are thus c r e a t e d and these i n t u r n supply the b a s i s f o r an expansion i n bank c r e d i t o f many times t h e i r amount. I n t h i s s i t u a t i o n , the F e d e r a l Reserve System has no e f f e c t i v e powers t o p r e v e n t an i n c r e a s e i n bank reserves e i t h e r t h r o u g h g o l d a c q u i s i t i o n s o r t h r o u g h bank sales o f s e c u r i t i e s • Use o f t h e customary weapon o f open market o p e r a t i o n s would i n v o l v e the s a l e i n t h e market o f t h e Reserve System 1 s h o l d i n g s o f Government s e c u r i t i e s and, t h e r e f o r e , i s n o t a f e a s i b l e means o f o f f s e t t i n g increases i n bank r e s e r v e s • Under p r e s e n t conditions, such o p e r a t i o n s a r e i m p r a c t i c a l because o f t h e i r p o s s i b l e d i s r u p t i v e upon t h e Government s e c u r i t i e s market* effects O r d e r l y and r e l a t i v e l y s t a b l e con- d i t i o n s i n t h i s market are e s s e n t i a l t o M a i n t a i n t h e p u b l i c 1 s c o n f i d e n c e i n Government c r e d i t * F u r t h e r m o r e , avoidance o f any undue i n c r e a s e i n the i n t e r e s t c o s t on the Government's huge p u b l i c debt i s d e s i r a b l e as a m a t t e r o f n a t i o n a l p o l i c y and g e n e r a l p u b l i c interest. L i k e w i s e , h i g h e r F e d e r a l Reserve d i s c o u n t r a t e s would have little o£ no e f f e c t , because t h e banks themselves have no occasion t o borrow funds t o m a i n t a i n r e s e r v e p o s i t i o n s a s * l o n g as t h e y can s e l l Government s e c u r i t i e s f o r t h i s purpose« - 2 - Under the proposed a u t h o r i t y , banks could be l i m i t e d i n t h e i r a b i l i t y t o expand c r e d i t on the basis o f new reserves r e s u l t i n g from g o l d or currency movements, from sales o f t h e i r own h o l d i n g s o f Government s e c u r i t i e s , or f r o m Federal Reserve support o f the p r i c e s o f l o n g - t e r m Government securities. I n a d d i t i o n , i t would d i v o r c e the Government s e c u r i t i e s market from p r i v a t e c r e d i t and permit the Federal Reserve System t o use more efr f e c t i v e l y d i s c o u n t r a t e s and open market operations t o a f f e c t p r i m a r i l y c o n d i t i o n s i n the p r i v a t e c r e d i t markfet. Thus, the a u t h o r i t y would make i t p o s s i b l e t o l i m i t the volume and r a i s e the cost o f p r i v a t e c r e d i t w i t h o u t n e c e s s a r i l y i n c r e a s i n g the i n t e r e s t cost t o the Government on a l a r g e p a r t o f the v a s t p u b l i c debt o u t s t a n d i n g . Features o f the s p e c i a l reserve p l a n , — S a l i e n t f e a t u r e s o f the proposed temporary a u t h o r i t y may be b r i e f l y summarized as f o l l o w s : (1) The power t o impose and t o v a r y the s p e c i a l reserve requirement would bo vested i n the Federal Open Market Committee and would be l i m i t e d by law t o a temporary p e r i o d o f t h r e e y e a r s . (2) The requirement would apply t o a l l banks r e c e i v i n g demand d e p o s i t s , i n c l u d i n g member banks o f the Federal Re$erve System and nonmember banks—insured and noninsurea. I t would n o t a p p l y , however, t o banks t h a t do e x c l u s i v e l y a savings b u s i n e s s . (3) The s p e c i a l reserve requirement would apply t o b o t h demand and time deposits and would be s u b j e c t t o a maximum l i m i t f i x e d by s t a t u t e t A maximum o f 25 per cent o f gross demand deposits and a maximum o f 10 per cent o f time deposits w i l l probably be adequate f o r the temporary p e r i o d covered by the proposed s t a t u t e . (ll.) E l i g i b l e s p e c i a l reserve assets would includes (a) The excess o f s p e c i f i e d cash assets over an allowance f o r e x i s t i n g reserve requirements and an average o f customary o p e r a t i n g funds o f the banks; and (b) O b l i g a t i o n s o f the United States i n the form o f Treasury b i l l s , c e r t i f i c a t e s , and notes ( w i t h o r i g i n a l m a t u r i t i e s o f 2 years or l e s s ) . Cash assets e l i g i b l e f o r meeting the s p e c i a l reserve requirement would i n c l u d e ; (a) Balances w i t h Reserve Banks* (b) Coin and currency* ( c ) Cash items i n process of C o l l e c t i o n * (d) Balances due f r o m i n excess o f balances due t o banks i n U« S« Only t h e excess o f the sum o f these items over a s p e c i f i e d amount o f customary o p e r a t i n g funds, i n c l u d i n g the e x i s t i n g s t a t u t o r y allowance f o r r e q u i r e d r e s e r v e s , would be a v a i l a b l e f o r i n c l u s i o n i n the s p e c i a l r e s e r v e . The allowance f o r e x i s t i n g r e q u i r e d reserves and customary o p e r a t i n g funds would be f i x e d by s t a t u t e a t 20 per cent o f gross demand deposits plus 6 per cent o f time depos i t s . The requirement would be i n t r o d u c e d g r a d u a l l y as c r e d i t c o n d i t i o n s w a r r a n t * The a u t h o r i z i n g s t a t u t e could p r o v i d e t h a t , a f t e r a s p e c i a l reserve has been e s t a b l i s h e d o f 10 per cent a g a i n s t gross demand d e p o s i t s and 4 per cent a g a i n s t time d e p o s i t s , f u r t h e r changes would not exceed 5 P e r cent o f gross demand d e p o s i t s and 2 per cent o f time deposits a t one t i m e . Ample n o t i c e should be g i v e n b e f o r e the e f f e c t i v e date o f such changes t o a l l o w banks adequate time t o make adjustments. The f o l l o w i n g c o n s i d e r a t i o n s should determine the t i m i n g o f the i n t r o d u c t i o n o f , or changes i n , the s p e c i a l reserve requirement: (a) The volume and ownership of special, reserve assets and o f o t h e r assets r e a d i l y con~ v e r t i b l e i n t o e l i g i b l e assets; (b) Past and prospective g o l d movements, currency f l u c t u a t i o n s , or o t h e r f a c t o r s causing changes i n the volume o f bank reserves; ( c ) Conditions i n the Government s e c u r i t i e s market; (d) The general c r e d i t s i t u a t i o n . S p e c i a l reserves and requirements would be computed on a d a i l y average basis f o r monthly periods* or f o r o t h e r periods by classes o f banks as the Open Market Committee might p r e s c r i b e . The p e n a l t y a g a i n s t average d e f i c i e n c i e s i n the requirement would be o n e - h a l f per cent per month, payable t o the United S t a t e s . The Federal Open Market Committee would be a u t h o r i s e d t o issue r e g u l a t i o n s governing the a d m i n i s t r a t i o n o f the requirement* t o r e q u i r e necessary r e p o r t s , and t o delegate a d m i n i s t r a t i o n w i t h respect t o nonmember banks t o o t h e r a p p r o p r i a t e Federal or State banking agencies. - 5 - Operation o f the proposal*—Establishment o f the s p e c i a l reserve requirement would accomplish two p r i n c i p a l purposes: ( l ) i t would reduce the amount o f Government s e c u r i t i e s t h a t banks would be w i l l i n g t o s e l l t o Obtain a d d i t i o n a l r e s e r v e s ; and (2) i t would decrease the r a t i o o f m u l t i p l e c r e d i t expansion on the b a s i s o f a g i v e n amount o f reserves• These r e s u l t s could be accomplished w i t h o u t reducing the volume o f earning assets o f banks* The s p e c i a l reserve requirement would n o t deprive banks of any earning assets b u t would reduce the a v a i l a b l e amount o f h i g h l y l i q u i d and r e a d i l y saleable assets which banks b o l d as secondary reserves t o meet losses o f deposits and new c r e d i t demands* Because o f the r e d u c t i o n i n a v a i l a b l e secondary reserves, banks would then be less w i l l i n g t p s e l l Government s e c u r i t i e s h e l d i n excess o f the requirement i n order to. acquire h i g h e r - y i e l d i n g l o a n or investment assets* Thus, an e f f e c t o f the s p e c i a l reserve requirement would be t o reduce the c r e a t i o n o f new reserves and expansion o f bank c r e d i t through m o n e t i z a t i o n o f the p u b l i c debt* Other instruments o f Federal Reserve p o l i c y could be so used as t o f a c i l i t a t e adjustment t o the new requirement and subsequently wpuld be employed t o apply such a d d i t i o n a l r e s t r i c t i o n s o r such easing as the general c r e d i t s i t u a t i o n might r e q u i r e * One o f the purposes o f the p r o - posed new requirement i s t o make p o s s i b l e the more e f f e c t i v e use o f the exis.ting instruments i n o f f s e t t i n g changes i n bank r e s e r v e s — p a r t i c u l a r l y open market operations and discount r a t e s - ^ w i t h p u t s e r i o u s l y u p s e t t i n g the Government s e c u r i t i e s market and unduly r a i s i n g the i n t e r e s t cost on the p u b l i c debt* - 6 - The F e d e r a l Open Market Committee, w h i c h w o u l d have a u t h o r i t y t o a p p l y and v a r y t h e r e q u i r e m e n t , i s composed o f a l l seven members o f t h e Board o f Governors o f t h e F e d e r a l Reserve System and f i v e t i v e s o f t h e F e d e r a l Reserve Banks. The Committee f s p r e s e n t representaauthority covers t h e System's Government s e c u r i t y and o t h e r open market o p e r a t i o n s . The use o f t h e proposed s p e c i a l r e s e r v e r e q u i r e m e n t w o u l d be c l o s e l y r e l a t e d t o these o p e r a t i o n s . R e d u c t i o n i n t h e r a t i o o f m u l t i p l e c r e d i t e x p a n s i o n on t h e b a s i s o f any a d d i t i o n t o t h e s u p p l y o f r e s e r v e s w o u l d be an e s p e c i a l l y e f f e c t of the special reserve requirement. important How g r e a t a r e d u c t i o n w o u l d r e - s u l t f r o m t h e p r e s e n t r a t i o o f s i x o r more t o one w o u l d depend on t h e percentage r e q u i r e m e n t e s t a b l i s h e d . The r a t i o m i g h t be l o w e r e d t o about two and o n e - h a l f t o one i f t h e maximum s p e c i a l r e s e r v e r e q u i r e m e n t s h o u l d be a u t h o r i z e d . The mere e x i s t e n c e o f power t o impose a s p e c i a l r e s e r v e require- ment w o u l d i t s e l f e x e r t a s t r o n g r e s t r a i n i n g i n f l u e n c e on bank c r e d i t expansion. Banks w o u l d need t o g u i d e t h e i r p o l i c i e s w i t h an eye t o t h e possible i m p o s i t i o n o f the requirement. The e x t e n t o f use o f t h e special r e s e r v e r e q u i r e m e n t w o u l d n e c e s s a r i l y depend on developments i n t h e g e n e r a l credit situation. R e s t r a i n t on f u r t h e r bank c r e d i t e x p a n s i o n by t h e proposed r e q u i r e m e n t , supplemented as t h e s i t u a t i o n may w a r r a n t by o t h e r credit c o n t r o l measures, w o u l d n o t p r e v e n t t h e accommodation by banks o f t h e economy's e s s e n t i a l c r e d i t needs. The a d d i t i o n a l r e s e r v e requirement, however, w o u l d impose on banks a g r e a t e r r e s p o n s i b i l i t y f o r m e e t i n g - 7 - e s s e n t i a l c r e d i t demands o u t o f e x i s t i n g l o a n a b l e f u n d s * t o expand l o a n s , banks w o u l d need t o s e l l s e c u r i t i e s o f types tbet m i g h t be bought by o t h e r i n v e s t o r s , r a t h e r t h a n s h o r t - t e r m Government s e c u r i t i e s w h i c h under p r e s e n t c o n d i t i o n s a r e purchased p r i n c i p a l l y b y t h e Reserve Banks* The major e f f e c t o f an a c t i v e program t o r e s t r a i n bank c r e d i t e x p a n s i o n , f o r w h i c h t h e sugg e s t e d r e s e r v e r e q u i r e m e n t i s needed, w o u l d be t o reduce m a t e r i a l l y the ready a v a i l a b i l i t y o f bank c r e d i t t o p r i v a t e b o r r o w e r s a t low i n t e r e s t rates• Advantages o f t h e p r o p o s a l . — T h e proposed measure has many i m p o r t a n t advantages o f a l t e r n a t i v e means o f c u r b i n g c r e d i t e x p a n s i o n . f u r t h e r bank c r e d i t e x p a n s i o n m i g h t be a t t e m p t e d by a l l o w i n g R e s t r a i n t on short-term i n t e r e s t r a t e s on b o t h p u b l i c and p r i v a t e c r e d i t t o r i s e s u b s t a n t i a l l y , thus i n c r e a s i n g t h e c o s t o f b o r r o w i n g and t h e r e b y s e e k i n g t o d e t e r b o r r o w i n g . Such a p o l i c y , however, w o u l d g r e a t l y i n c r e a s e t h e c o s t t o t h e Government o f c a r r y i n g t h e p u b l i c debt and have d i s r u p t i v e e f f e c t s on t h e Government s e c u r i t i e s market* Under t h e proposed a u t h o r i t y , i n t e r e s t on p r i v a t e c r e d i t c o u l d be r a i s e d w i t h o u t i n c r e a s i n g r a t e s on Government securities. I n o t h e r w o r d s , any p e n a l t y r a t e s w o u l d be p a i d by those who are currently r e s p o n s i b l e f o r i n f l a t i o n a r y b o r r o w i n g and who m i g h t be d e t e r r e d by t h e h i g h e r r a t e s and n o t by t h e Government, w h i c h i s r e d u c i n g indebtedness. I f i n f l a t i o n a r y e x p a n s i o n o f t o t a l bank c r e d i t t o p r i v a t e b o r rowers i s t o be r e s t r i c t e d , t h e r e s t r a i n t must be p l a c e d p r i m a r i l y on t h e lender* Under p r e s e n t c o n d i t i o n s , even such a s u b s t a n t i a l r i s e i n s h o r t - t e r m i n t e r e s t r a t e s as one o r two percentage p o i n t s w o u l d n o t d e t e r many b o r r o w e r s , and m i g h t encourage f u r t h e r l e n d i n g because o f t h e additional - 8 - p r o f i t inducement t o t h e l e n d e r * Under t h e proposed measure, t h e restraint i s p l a c e d p r i m a r i l y upon t h e l e n d e r w h i c h i n t h i s case i s t h e b a n k i n g system* The p r o p o s a l w o u l d t h u s have t h e e f f e c t o f r e t a r d i n g f u r t h e r bank c r e d i t e x p a n s i o n b y l i m i t i n g t h e a b i l i t y o f t h e banks t o make c r e d i t available. From t h e s t a n d p o i n t o f i t s e f f e c t on t h e e a r n i n g p o s i t i o n o f b a n k s , t h e p l a n i s s u p e r i o r t o an i n c r e a s e i n p r i m a r y r e s e r v e r e q u i r e m e n t s , because i t w o u l d enable banks t o r e t a i n e a r n i n g a s s e t s t h a t w o u l d have t o be s o l d t o meet an i n c r e a s e i n p r i m a r y r e s e r v e r e q u i r e m e n t s * A t t h e same t i m e i t w o u l d p e r m i t an i n c r e a s e i n i n t e r e s t r a t e s on p r i v a t e d e b t and w o u l d make p o s s i b l e an i n c r e a s e i n e a r n i n g s a t banks where i n t e r e s t on loans a r e e s p e c i a l l y low* This c o u l d be accomplished w i t h o u t t h e i n t e r e s t c o s t on t h e p u b l i c d e b t * rates increasing The c o n t i n u e d p r o f i t a b i l i t y o f bank o p e r a t i o n s i s e s s e n t i a l i f t h e banks a r e t o meet t h e i r i n c r e a s i n g c o s t s and b u i l d up adequate r e s e r v e s w h i l e s e r v i n g t h e i r communities constructively* The s p e c i f i c f o r m o f t h e proposed s p e c i a l r e s e r v e r e q u i r e m e n t , as more f u l l y d e s c r i b e d i n t h e n e x t s e c t i o n , i s designed t o f i t t h e sort o f banking system t h a t e x i s t s i n t h i s c o u n t r y w i t h o u t a l t e r a t i o n s i n its s t r u c t u r e o r d r a s t i c changes i n i t s customary methods o f o p e r a t i o n * Banka t h a t are n o t members o f t h e F e d e r a l Reserve System w o u l d have t o be included* L i m i t a t i o n s o f t h e r e q u i r e m e n t t o member banks o n l y w o u l d s e r i o u s l y weaken t h e F e d e r a l Reserve System by g i v i n g a g r e a t advantage t o nonmembership and t h e r e f o r e w o u l d make t h e measure i n e f f e c t i v e , as w e l l as i n e q u i t a b l e . I t w o u l d assure e q u i t a b l e t r e a t m e n t o f i n d i v i d u a l banks and groups o f banks w i t h o u t r e q u i r i n g t h a t a ^ l banks become s u b j e c t t o a s i n g l e authority* - 9 - The r e q u i r e m e n t w o u l d a l s o make use o f t h e p r a c t i c e o f d e p o s i t s w i t h o u t i n t e r f e r i n g w i t h t h e system o f c o r r e s p o n d e n t interbank relations. I t w o u l d r e q u i r e banks t o h o l d a l a r g e p o r t i o n o f t h e Government securities t h a t t h e y were encouraged and p e r m i t t e d t o buy t o a i d i n war f i n a n c e and a l l o w them t o meet a l l e s s e n t i a l c r e d i t needs o f t h e economy. still I t would assure t h e maintenance o f a h i g h degree o f l i q u i d i t y and s a f e t y i n t h e b a n k i n g system d u r i n g a p e r i o d o f r a p i d and u n c e r t a i n economic change. The Board b e l i e v e s t h a t t h e proposed p l a n i s t h e o n l y p r a c t i c a l method o f d e a l i n g w i t h t h e p r e s e n t monetary and c r e d i t s i t u a t i o n because i t assures t h a t t h e p r e s s u r e s w i l l be e x e r t e d a t t h e p l a c e s where r e s t r a i n t on bank c r e d i t expansion can b® e f f e c t i v e . A t t h e same t i m e t h e p l a n w i l l p r o t e c t t h e i n t e r e s t s o f t h e Government, t h e g e n e r a l p u b l i c , and t h e b a n k i n g system. Formula f o r computing1 t h e s p e c i a l r e s e r v e i i in 11 11 i' ii requirement.—The j II 11 i i 11 < ii' i a s s e t s t h a t w o u l d be counted as s p e c i a l r e s e r v e s i n c l u d e c e r t a i n s p e c i f i e d nonearning o r cash a s s e t s , as w e l l as Treasury b i l l s , certificates of i n d e b t e d n e s s , and n o t e s h a v i n g o r i g i n a l m a t u r i t i e s n o t exceeding two y e a r s . The e l i g i b l e cash a s s e t s i n c l u d e balances w i t h t h e F e d e r a l Reserve Banks, c o i n and c u r r e n c y , cash items i n process o f c o l l e c t i o n , and balances due f r o m , i n excess o f balances due t o , o t h e r banks i n t h e U n i t e d S t a t e s . Only t h e excess o f t h e sum o f t h e s e items o v e r an a l l o w a n c e f o r existing r e q u i r e d r e s e r v e s and o p e r a t i n g f u n d s c u s t o m a r i l y h e l d by banks w o u l d be counted i n t h e s p e c i a l r e s e r v e . I n o r d e r t o assure u n i f o r m i t y among banks, such a l l o w a n c e s h o u l d be f i x e d by s t a t u t e a t 20 p e r c e n t o f gross demand d e p o s i t s and 6 p e r cent o f t i m o d e p o s i t s * - 10 - To accomplish t h e purposes o f t h e s p e c i a l r e s e r v e a u t h o r i t y , it i s d e s i r a b l e t h a t t h e f o r m u l a i n c l u d e some m a r g i n o f cash a s s e t s as w e l l as t h e s p e c i f i e d s h o r t - t e r m Government s e c u r i t i e s * Confining the eligible s p e c i a l r e s e r v e a s s e t s t o Government s e c u r i t i e s w o u l d cause d i f f i c u l t i e s t o banks o b t a i n i n g new f u n d s and n o t h o l d i n g adequate amounts o f required securities* the A f o r m u l a l i m i t e d t o t h e s e e a r n i n g a s s e t s would a l s o be no more e f f e c t i v e i n r e s t r i c t i n g f u r t h e r i n f l a t i o n a r y c r e d i t expansion* O n l y T r e a s u r y b i l l s , c e r t i f i c a t e s . , and s h o r t - t e r m n o t e s are proposed f o r i n c l u s i o n i n t h e s p e c i a l r e s e r v e and o t h e r Government s e c u r i - * t i e s are e l i m i n a t e d f o r a number o f r e a s o n s . The volume o f b i l l s , certi- f i c a t e s , and n o t e s can be more e a s i l y l i m i t e d t o r e l a t i v e l y s t a b l e amounts. To i n c l u d e a l l Government s e c u r i t i e s w o u l d make necessary t h e o f a v e r y h i g h r e s e r v e r e q u i r e m e n t f o r i t t o be e f f e c t i v e * imposition Inclusion of Government bonds w i t h i n one o r two y e a r s o f m a t u r i t y o r c a l l d a t e s w o u l d cause sudden s u b s t a n t i a l i n c r e a s e s and decreases i n t h e amount o f reserve assets* eligible I t i s a p p r o p r i a t e f o r banks h o l d i n g d e p o s i t s s u b j e c t to w i t h d r a w a l t o m a i n t a i n a h i g h degree o f l i q u i d i t y , p r o v i d e d b y s h o r t - t e r m assets* I n c l u s i o n o f l o n g e r - t e r m h i g h e r - r a t e s e c u r i t i e s would n o t stop banks f r o m s h i f t i n g t h e i r l o w e r - r a t e i s s u e s t o t h e F e d e r a l and p u r c h a s i n g the higher-rate bonds i n t h e market* o u t s i d e t h e b a n k i n g system* More o f t h e l a t t e r are s t i l l held L i m i t a t i o n of the requirement t o the e s p e c i a l l y s h o r t - t e r m i s s u e s w o u l d improve t h e market demand f o r these i s s u e s and h e l p t o m a i n t a i n a l o w e r r a t e on s h o r t - t e r m Government b o r r o w ing without lowering long-term interest rates* F i n a l l y , banks w o u l d have t o s e l l t h e i r h i g h e r - r a t e i s s u e s i n o r d e r t o expand l o a n s and t h i s w o u l d be more o f a discouragement t o l e n d i n g t h a n s a l e o f s h o r t - t e r m l o w - r a t e issues* An e q u i t a b l e f o r m u l a s h o u l d a l l o w f o r t h e g r e a t v a r i a t i o n s among groups o f banks w i t h r e s p e c t t o b a s i c r e s e r v e r e q u i r e m e n t s and w i t h r e s p e c t t o h o l d i n g s o f d i f f e r e n t t y p e s o f cash a s s e t s , w i t h o u t i n t e r f e r i n g u n d u l y w i t h t h e s e r e q u i r e m e n t s and p r a c t i c e s * Reserve r e q u i r e m e n t s f o r nonmember banks n o t o n l y d i f f e r f r o m t h o s e f o r member banks b u t a l s o v a r y f r o m S t a t e t o State» Lfember banks may h o l d excoss r e s e r v e s w i t h F e d e r a l Reserve Banks and a l s o b a l a n c e s w i t h c o r r e s p o n d o n t b a n k s * Nonmember banks h o l d b o t h r e q u i r e d and secondary r e s e r v e s i n t h e f o r m o f b a l a n c e s w i t h c o r r e spondent banks and would no doubt p r e f e r t o c o n t i n u e h o l d i n g much o f their r e s e r v e s i n t h i s f o r m , even though p e r m i t t e d t o h o l d d e p o s i t s w i t h Reserve Banks* The f o r m u l a proposed f o r t h e c o m p u t a t i o n o f cash a s s e t s e l i g i b l e f o r s a t i s f y i n g the s p e c i a l reserve requirement takes these f a c t o r s into c o n s i d e r a t i o n and t h e r e f o r e makes use o f , w i t h o u t i n t e r f e r i n g w i t h , c o r r e s p o n d e n t bank r e l a t i o n s , b o t h f o r member and nonmember banks* the s p e c i a l r e s e r v e r e q u i r e m e n t w o u l d be i n a d d i t i o n t o a f i g u r e w h i c h t a k e s account o f t h e r e s e r v e r e q u i r e m e n t s under e x i s t i n g l a w and average o p e r a t i n g f u n d s c u s t o m a r i l y h e l d b y t h e banks* F o r purposes o f administrative s i m p l i c i t y , t h e proposed f o r m u l a w o u l d be u n i f o r m f o r a l l banks* A v a i l a b i l i t y o f s p e c i a l r e s e r v e a s s e t s * ~ T h e f o r m u l a and i t s a p p l i c a t i o n t o c e r t a i n b r o a d groups o f i n s u r e d banks, u s i n g aggregate f i g u r e s as o f June 3 0 , 19U7, i s i l l u s t r a t e d i n T a b l e 1 a t t a c h e d * The t a b l e shows t h a t each m a j o r group o f banks have mora t h a n enough s p e c i a l r e s e r v e a s s e t s a v a i l a b l e t o meet a r e q u i r e m e n t established a t 10 p e r c e n t a g a i n s t g r o s s demand d e p o s i t s and U p e r c e n t a g a i n s t t i m e deposits* A t t h e s t a t u t o r y maximum suggested f o r t h e r e q u i r e m e n t — n a m e l y - 12 25 p e r cent a g a i n s t demand d e p o s i t s and 10 p e r c e n t a g a i n s t t i m e d e p o s i t s — t h e d i f f e r e n t g r o u p s show d e f i c i e n c i e s i n h o l d i n g s o f e l i g i b l e a s s e t s o f v a r y i n g p e r c e n t a g e amounts. The v a r i a t i o n i n t h e p e r c e n t a g e s o f d e f i c i e n c y o r excess a t t h e s e l e c t e d l e v e l s i s s t i l l w i d e r , o f c o u r s e , when s t u d i e d b y groups o f batiks a c c o r d i n g t o F e d e r a l Reserve D i s t r i c t s , as i n T a b l e 2 , w h i c h shows h o l d i n g s o f s p e c i a l r e s e r v e a s s e t s and s h o r t - t e r m Government bonds as p e r c e n t a g e s o f g r o s s demand d e p o s i t s . A l l o f t h e s e groups w o u l d be a b l e t o meet t h e l o w e r l e v e l o f r e q u i r e m e n t s shown* even g r e a t e r Data b y i n d i v i d u a l banks would show differences. I n considering the d e f i c i e n c i e s i n e l i g i b l e special reserve a s s e t s t h a t banks m i g h t c o n f r o n t a t c e r t a i n r e q u i r e m e n t l e v e l s , i t must be remembered t h a t b a n k s , as Table 2 shows, h o l d s u b s t a n t i a l amounts o f s h o r t - t e r m Government bonds t h a t may be e v e n t u a l l y r e f u n d e d b y t h e T r e a s u r y i n t o e l i g i b l e a s s e t s o r t h a t c o u l d be c o n v e r t e d t h r o u g h t h e market i n t o such a s s e t s . I n a d d i t i o n t o 16 b i l l i o n d o l l a r s o f T r e a s u r y b i l l s , c e r t i f i c a t e s , and n o t e s , a l l commercial banks h o l d h b i l l i o n d o l l a r s o f bonds due o r c a l l a b l e w i t h i n one y e a r and 27 b i l l i o n due w i t h i n one t o f i v e y e a r s , and t h e s e a r e w i d e l y d i s t r i b u t e d among banks* As t h e s e bonds a r e r e t i r e d t h e y can be r e f u n d e d b y t h e T r e a s u r y t h r o u g h i s s u a n c e o f s p e c i a l r e s e r v e e l i g i b l e a s s e t s , depending on t h e need o f t h e b a n k i n g system and t h e demand f o r such a s s e t s . The F e d e r a l Reserve System, m o r e o v e r , h o l d s 20 b i l l i o n d o l l a r s o f T r e a s u r y b i l l s , certificates, and n o t e s , w h i c h banks c o u l d a c q u i r e b y s e l l i n g t o t h e System o t h e r Government securities. About 12 b i l l i o n d o l l a r s o f e l i g i b l e o b l i g a t i o n s are a l s o h e l d b y nonbank i n v e s t o r s . - 13 - Another source o f e l i g i b l e a s s e t s i s t h e c u r r e n t end p r o s p e c t i v e g o l d i n f l o w , and any o t h e r i n c r e a s e i n bank cash i n excess o f required r e s e r v e s and customary o p e r a t i n g funds w o u l d a l s o be e l i g i b l e t o a p p l y against the s p e c i a l reserve• I t i s c l e a r f r o m an a n a l y s i s o f t h e bank p o s i t i o n and t h e a v a i l a b l e r e s e r v e a s s e t s t h a t t h e b a n k i n g system w o u l d be a b l e t o meet any r e q u i r e m e n t s w i t h i n t h e l i m i t s o f t h e p r o p o s a l w i t h o u t severe a d j u s t m e n t s and w i t h o u t undue l i m i t a t i o n upon t h e i r a b i l i t y t o s u p p l y t h e c r e d i t needs o f t h e economy. A u t h o r i t y f o r t h e System t o v a r y t h e ments w o u l d p e r m i t any a l t e r a t i o n s needed t o meet changing essential require- situations. TABLE 1 ILLUSTRATIVE COMPUTATION OF SPECIAL RbSERVE ASSETS, JUNE 30, 1947 i(Based on aggregate f i g u r e s i n m i l l i o n s o f d o l l a r s , by groups o f banks) Assets 1 . Gross demand d e p o s i t s 2 . Time d e p o s i t s 3 . C o i n and c u r r e n c y u . Cash items i n process o f c o l l e c t i o n 5 . Excess o f demand balances due f r o m over demand d e p o s i t s due t o o t h e r banks i n U* S . * 6 . Balances w i t h F e d e r a l Reserve Banks Member banks Nonmember Central Reserve Country i n s u r e d reserve c i t y banks c i t y New XorkjChicago 22,683 1,459 5.037 87.1 31,983 11,269 27,659 li+,1+75 11,891 6,4+9 123 1,884 36 3U9 kio 2,623 780 84+ 395 12U 973 6,271+ 2,5146 4,628 2,765 4,166 6,173 1,357 9,36? 8,787 3,284 4,624 1,060 7,073 6,1+00 2,759 9 . Excfess cash a s s e t s * (7 - 8) 10. Treasury b i l l s , c e r t i f i c a t e s , and notes 1,549 2,015 298 606 2,29k k.&7h 2,387 5,191 525 2,932 11. T o t a l s p e c i a l r e s e r v e a s s e t s * ( 9 * 10) 3,564 90k 7,168 7,578 3,1+57 + + 5 + 6) 7 . Net cash a s s e t s * ( 3 4 8 . Deduct 20$ o f gross demand d e p o s i t s p l u s 6/o o f t i m e d e p o s i t s — — — tm — - lS^TCpecial reserve r e q u i r e d a t given percentages: a . 10/o a g a i n s t demand and l y i a g a i n s t time deposits b . Maximum o f 2$% a g a i n s t demand and 10/o a g a i n s t t i m e d e p o s i t s 1 3 . D e f i c i e n c y o r excess o f s p e c i a l reserve a s s e t s : * a . "vfith 10/o a g a i n s t demand and against time deposits b . W i t h 25/o a g a i n s t demand and 10/o against time deposits 1 k. Percentage d e f i c i e n c y o r excess o f s p e c i a l r e s e r v e a s s e t s t o demand deposits: a . W i t h 10/i a g a i n s t demand and 4/® against time deposits b . W i t h 25/o a g a i n s t demand and 10$ against time deposits 2,327 539 5,817 3,&+9 3,3l+5 1,14+3 9,123 8,^62 3,608 •1,237 +365 +3,519 -2,252 -14+3 -1,95k •5.5 +7.2 -8.8 +2,014 -784 -151 +11.0 +15.3 +16.9 -6.1 -2.8 -1.3 - -9.9 • F i g u r e s shown f o r t h e s e items are c o n f u t e d on t h e b a s i s o f aggregates by groups o f banks f o r t h e c o u n t r y as a w h o l e ; t o t a l s o f f i g u r e s computed s e p a r a t e l y f o r ^ I g l i v i d u a l banks o r f r o m aggregates by d i s t r i c t s would show somewhat d i f f e r e n t f g p b u n t s o f a v a i l a b l e cash assets f o r some o f t h e g r o u p s . RATIOS OF AVAILABLE SPECIAL RESERVE ASSETS AND SHORT-TERM TREASURY BONDS TO GROSS DEMAND DEPOSITS, ALL INSURED COMMERCIAL BANKS, JUNE 3 0 , 19^7 Per c e n t oi r gross demand d e p o s i t s D e f i c i e n c y o r excess T r e a s u r y bonds due of special reserve o r c a l lLab l e t / assets i f r e TreasuryTotal quirements a r e bills, Excess s p e c i a l 10% o f certifi2595 o f cash . demand reserve cates, demand assets?/ Within Within and assets and and 1 year 1 - 5 years 2$ of notes 10?* o f time time deposits deposits 0 Central reserve c i t y member banks New York Chicago 6.8 27.8 12.0 5.9 15.7 17.9 - 8.8 «• 5 . 5 + 7.2 5.7 1+.2 23.1+ 10.3 9.3 6.7 8.0 12.9 Huh 20.6 10.3 8.8 16.8 13.3 22.9 7a 9ih 8.3 6.i+ l.h 8; 7 7.1 6.3 7.3 6.0 6.1 7.6 17;5 18.7 lk.9 liuU 20.3 23.2 27.7 16.6 16; 1 22i7 19.U 30.5 - 8,6 -11.8 -11.3 -111. 2 - 7.0 - 3.9 - 2.7 -10.2 -10.7 - 3.7 - 7.1 .9 + 7.1 + 6.5 + luk + 3.0 + 9-h +12.3 +15.5 + 5-9 + 5.1+ +12.2 + 8.8 +17.9 5.1 3.5 1.5 7.1 2.5 3.5 5.9 5;i 3.7 it.8 2.2 6.1 I8.3 31^7 22.6 33.7 32.5 20.0 36.9 2^.2 28.0 19.1 18. U 31.3 15.2 7.2 22.U - 6.1 +11.0 li.9 27.8 12.6 12.7 18.7 17.8 17.0 19.7 21.6 21.7 23.8 26.1 21.3 17.6 6.h 9.3 10.1 11.1 8.5 5.1 10.5 3.8 6.U 9.6 11.1 7.9 18.9 21.9 28.8 28.9 25.5 2 M 32.1 25^5 30.2 35.8 32.U 25.5 -11.1 -11.5 5.0 h.3 5.0 37.3 1*5.7 + • + - 3.5 3.9 3;3 .6 3.2 .3 9.3 6.6 k-9 + 6.9 + 8.6 +15.5 +15.9 +13.8 +13.6 +19.5 +li|.0 +18.0 +25.2 +22.1 +13.3 k*3 3.9 5.9 h.0 7.3 3.2 2.9 6.9 la. 8 28.7 39.8 18.8 16.7 33.9 18.8 8.6 27.1+ - 2.8 +15.3 1+.7 3U.3 19.2 1.2 15.1 20.9 1.7 20.3 16.8 -15.8 -16.2 5.6 k.5 22; 0 1*8 .2 * 5.9 + 3.6 + 8.3 •13.5 + 8.7 +20.7 +22.2 +18.9 Ul.5 39.9 35.6 37.6 29.5 22.9 39.8 22.5 32.5 8.9 - 9.9 Reserve c i t y member banks Boston New York Philadelphia Cleveland Richmond Atlanta Chicago M l * Louis apmeapolis Kansas C i t y Dallas San F r a n c i s c o Total C o u n t r y member banks Boston New York Philadelphia Cleveland Richmond Atlanta Chicago S t . Louis Kinneapolis Kansas C i t y Dallas San F r a n c i s c o Total , 1*0.2 31.8 25.0 •Nonaeaber i n s u r e d ^ j j p e r c i a l banks ^roston New York Philadelphia Cleveland Richmond Atlanta Chicago S t * Louis Minneapolis Kansas C i t y JftkLlas ^ R n Francisco Total 20. I* 25.2 29.0 25.0 59.6 28.0 16.5 19.6 2i+.7 6; 8 5;9 1+.7 3.9 7.3 10.^ .6 U*k 21.2 26.8 20.6 32iO 3^9 29/7 itf.5 35.3 -11.1 - 6.3 - 9^2 + 3i8 + 3.1 + 2.7 +12.8 3.8 li.6 5.8 3.0 hi 6 2.2 +31.2 +2U.6 +16.5 + 5.5 2.9 .9 7-7 20.5 20.1 + .8 -16.6 29.1 - +16.9 it. 2 31.0 27.0 -h 8 . 6 1.3 18.3 39.3 0/ T o t a l o f ( 1 ) balances w i t h F e d e r a l Reserve Banks, ( 2 ) excess o f demand b a l a n c e s due f r o m over demand d e p o s i t s due t o banks i n U n i t e d S t a t e s , ( 3 ) c o i n and c u r r e n c y , and (J*) cash i t e m s i n process o f c o l l e c t i o n , l e s s ( 5 ) t h e sum o f 20 p e r c e n t o f demand d e p o s i t s and 6 p e r c e n t o f t i m e d e p o s i t s . b/ These r a t i o s are based on e s t i m a t e d h o l d i n g s o f sueh Treasury-bonds. BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, DIVISION OF BANK OPERATIONS, NOTEMBER 18, 19^7.
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