View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.




Office Correspondence

HhA-tTTOftn Itealag


Date_gctober 25 1 1946.
Subject I

Mr* Knapp
Probably the principal subject for discussion at the joint N*A.CAldrich Committee meeting on Monday afternoon will be the flotation of International Bank debentures, and in particular the participation of commercial
banks in this process, whether as investors or depositors* Mr* Collado would
like if possible to talk to you on Monday morning on these subjects* I am
attaching some material which you may want to look over in preparation for
these meetings*
Attachments 3



Dffice Correspondence

Chairman E c c l e s


Date ontoiw as

Mr. Knapp
Attached are two documents wMoli have just been received as
background for the meeting with the Aldrich Cosmiittee Monday afternoon.
(1) The first document is a reprint of a recent speech delivered by Mr* Aldrich, setting forth his general views on international
economic policy. The speech is almost a model of the ^liberal approach11;
Mr. JU.drich favors reduction of trade barriers, stabilization of exchanges,
abolition of exchange control on current transactions, free flow of international investment, etc. He endorses the objectives of the International
Trade Organization and of the International Monetary Fund (stating that
his earlier objection to the Fund was based on the feeling that the
British problem had to be solved first). He also emphasizes the importance
of reducing fluctuation in business activity in the United States both
in order to maintain our demand for imports and in order to avoid •erratic
fluctuations in capital export&m.
Turning to the work of his Committee, Mr. Aldrich states that
^Government or Government-sponsored loans should be supplemented and
eventually replaced by private international f inane ing*, and adds that
*the time is now ripe for the transition from Government to private international lending*. He expresses the hope for an early expansion of direct
investment abroad, pointing out that such investment does not burden the
international balance of trade with contractual interest payments. He
points out that the U. S. investor must receive assurance of fair treatment from foreign countries, but adds that the investor "must be willing
to enter into partnership with local capital* in the foreign country.
(2) The second attachment is an internal memorandum prepared
in the International Bank which has been forwarded to the national Advisory
Council by Mr. Collado. It deals with the progress made in making the
securities of the Bank eligible for investment by various classes of
institutions. It reviews the early spadework done at the beginning of
this year by the H.A»C. Technical Committee under Harry White, which produced the one tangible result of getting legislation in Hew York State
making the securities eligible for investment by savings banks. It reviews the progress which has been made since that time in the education
of various investment groups and various State supervisory authorities.
All of this does not add up to very much in terms of concrete progress.
The paper then sets forth plans for action between now and
next January when the more important State legislatures will again be in
session. It explains that Mr. Oollado has taken over the leadership in

-2tiiis campaign, and that he will make personal visits in several of the
leading States to ^lobby* for appropriate legislation* It is hoped that
as far as possible leading institutions or institutional groups will take
the initiative in proposing legislation, bub in many cases it may be
necessary to work directly upon the State supervisory authorities* Other
groups which may prove helpful are the Brett on Woods Committee of the
American Bar Association and the Aldrich Committee*
A few references are made in the memorandum to the problem of
action by the Comptroller of the Currency declaring International Bank
securities eligible for investment by national banks and to the problem
of amending national laws and regulations to permit participation by commercial banks in the distribution of these securities. In this connection
it is stated that '•the National Advisory Council is planning to establish
a small working committee to investigate and correlate the activities of
principal Federal agencies having to do with the Bank's securities*. At
Mr. Colladofs request, this committee (on which we are represented by Mr.
Dembitz) has now been formed and is preparing some factual memoranda on
the subjects mentioned above. I have asked that the existence of this
committee and a statement of its functions be brought to the attention
of the National Advisory Council.

Attachments 2

Distribution of International Bank
Securities by Commercial Banks

Several commercial bankers, in discussing the market for
International Bank securities, have suggested that Section 5136 of
the Revised Statutes be amended to allow banks to act as distributors
and dealers in these securities. At present, tho law forbids such
transactions by corrjmercial banks excopt in the securities of the U.S.
Government and certain of its agencies, and in State and municipal
bonds. Since the performance of these functions by banks in relation
to International Benk securities could conceivably be of great assistance to the Bank, the question of such an amendment needs to be given
serious consideration.
There are three different functions which commercial banks
could be asked to undertake in this field. They are (1) underwriting,
or assumption of the risk that a given issue of International Bank
securities will be successfully sold; (2) the distribution of new
issues of the Bank on a commission basis without assuming the underwriting risk, and (3) dealing in the securities to maintain a market
after thoy have been distributed. It is highly unlikely that the
International Bank will seek underwriting services, but it will
probably desire assistance from the market in promoting the sale of
new issues and in developing an orderly market. The Bank will become
in time the largest single issuer of securities in our market, aside
from the Governmant itself, and broad distribution among investors
will be necessary to assure successful flotation of its issues.
The present law on this subject was enacted as part of
the Banking Act of 1933> and it appears to have had two principal
purposes. One purpose was to add to the protection of the banks1
creditors by preventing commercial banks from assuming undue risks
in connection with security market operations. This, however, was
clearly not tho sole purpose, since even where a bank is permitted
to buy given blocks of securities for investment, it is not permitted
to buy the same securities for reso.le as underwriter or distributor.
The other purpose was to assist in rationalizing our financial structure by separating functions that were considered incompatible. Thus
it was desired to insure that the nature of a bankrs investment portfolio would be determined by investment considerations rather than by
the exigencies of a securities underwriting or distributing business;
and to insure that customers who might cipply to a bank for investment
counsel or for credit accommodation would not find consideration of
their case prejudiced by the bank's position as a seller of securities.
The State and municipal securities and securities of Federal Government agencies which are exempted from the lawfs limitations

have two characteristics which seirved to justify this exemption:
First, they are typically securities of relatively high investment
quality; this tends to minimize underwriting risks, and it also tends
to cause the underwriters1 and distributors1 "spreads" to be low, thus
minimizing the incentive to a bank to indulge in undesirable practices
in order to push sales. And second, the issuers of these securities
are governmental as distinguished from private, so that there is no
possibility that a bank might abuse its underwriting functions to
assist an issuer in which officers of the bank had a personal financial
These same characteristics would apply to International Bank
securities, and might justify an amendment that would permit a bank to
purchase these securities for distribution or dealing purposes up to
the amount that the bank could legally hold for investment purposes.
On the other hand, in view of the importance of the principles embodied
in the present law, a departure in favor of International Bank securities should hardly be considered unless very important benefits to that
Bank can be expected from it.
It is difficult to estimate how important it would be to the
Bank to have the assistance of commercial banks as distributors and
dealers in its securities. The existing investment securities houses
already have widespread systems of branch offices, correspondents, and
salesmen, which have proved adequate for the distribution of very large
volumes of domestic corporate bonds, while the bond departments of banks
(dealing in the restricted list of securities permitted by the present
law) have few salesmen and reach a much smaller number of investors.
The large banks point out, however, that they give investment information and assistance to great numbers of local banks, which in turn give
information and assistance to their customers. The placing of adequate
information in the hands of prospective purchasers is of great importance
in the sale of securities of a new type, such as International Bank obligations, which conscientious managers of investment accounts will
refuse to buy (regardless of pric^, yield or sponsorship) unless they
feel that they fully understand them. While the banks might do much in
disseminating such information even if they could not participate in
distributing the securities, they would naturally do much more if they
could also earn commissions as distributors. Probably only tiirn will
show how important this difference vail become. Unfortunately, however,
it is on the very first issue or issues that full scale commercial bank
participation may be of tho most importance, since these issues will
probably bo undertaken before most institutional investors have been
authorized by State laws to invest in the International Bankfs securities.
A few bankers have stated that their ability to act also as
dealers, making a market for International Bank securities after they are
issued, would assure a more orderly market for the securities, and thereby encourage both them and their correspondent banks to make investments
in the securities. As dealers they would assist not only in the initial

-3distribution of each issue but also in the subsequent process of directing the floating supply into the hands of strong permanent holders.
It is again difficult to judge the extent to which the International
Bank would benefit if banks as well as security houses were permitted
to perform this function.

October 14,

Investment in International Bank Securities
by .Commercial Banks

When International Bank securities appear o t the market,
commercial banks will be able • under present Federal laws - to
invest in such securities up to 10 per cent of their capital and surplus • Some banks will decide to invest in the early issues, perhaps
up to the full 10 per cent limitation, while many banks may wish to
wait until the new securities become more "seasoned*" Some banks may
hesitate to invest at first because of their uncertainty as to whether
the securities will be considered by the Comptroller of the Currency
to be eligible for bank investment.
The total volume of securities to be issued by the International Bank over the next five years may approach $7 billion• If
the Bank adopts a policy of arranging the maturities of its obligations
in a pattern corresponding roughly to the pattern of repayments due
to the Bank from borrowers, most of the Bank's obligations will be
long temu However, a very substantial amount (perhaps $ 2 billion)
may have maturities of 10 years or less, and thus fall within the
category of investments ordinarily considqred appropriate for commercial banks• Under present laws, not more than |700 million could
be taken up by the commercial banking system, even in the unlikely
event that each bank bought the maximum permitted •
In connection with the present Federal bank regulations,
there are two questions that will require the attention of the bank
supervisory agencies -


When the first issue of International Bank
obligations is about to be floated, the
Comptroller of the Currency will undoubtedly
be asked by some bankers whether he considers
the obligations to bo securities that are
"not distinctly or predominantly speculative"
and thus eligible for investment by momber
banks under the Comptroller's regulations«
There seoms to be no question but that the
securities will meet this requirement; the
question is whpthor the Comptroller should
clarify the situation by answering such


There may be proposed an amendment of the law
to exempt International Bank securities from
the 10 per cent limitation on bank investments •
Congress has already given such exemptions to
securities of such agencies as the Federal
Land Banks and Home Loan Banks. The question
will arise of the attitude the bank supervisory
agencies should take toward such an amendment.

In connection with both questions it will be necessary,
of course, to consider the relation of bank investment in these
securities to the more general questions of the expansion and control of bank credit in the United State6 • A separate memorandum on
this and related subjects is being prepared*
Statement by Comptroller on Eligibility*
It seems evident that the new International Bank securities
will not be "predominantly speculative"; they will therefore be
eligible for bank purchases under the Comptroller's regulation* As
a practical matter, however, since the securities will be of a new
and unfamiliar type, many bankers may tend to take a conservative
attitude, and if there is any doubt as to whether purchases are permitted under the regulation, some prospective purchasers will defer
This subject has been discussed informally with representatives of the Comptrollers office, who agreed that the Comptroller
could hardly object to bank purchases of the securities* The Comptroller would not want to issue any kind of public statement that
might seem to be a recommendation of these securities* However, if
a banker should make an appropriate inquiry when the securities
are about to be issued, the Comptroller would probably give an answer
to it, and his answer would undoubtedly spread rapidly among the
After the first issue has appeared, the Comptroller cannot
avoid letting bankers know that he considers the securities to be
eligible, since the securities will appear in banks1 portfolios,
and the fact that their apearance there was not objected to by
examiners will soon become known to bankers in general* Thus, on
the great majority of the Bankfs issues, commercial banks will not
be in any doubt as to their eligibility; it is only the initial issue on which clarification by the Comptroller would affect the amount
of bank purchases* The market reception of the first issue, however,
will have a disproportionate effect in determining the atmosphere for
the reception of subsequent issues* If there exists doubt among
bankers as to eligibility, which affects the volume of bank investment in the first issue, it might lead to much greater adverse effects upon the future operations of the Bank*
If the rating agencies gssign ratings to these bonds, that
would assist bankers in determining their eligibility* However,
there is not yet any indication whether or not the agencies will assign ratings initiallyf and there appear good reasons why the
agencies should not be pressed to do so* The basis on which the
rating system is founded is well designed for distinguishing between
the quality of one railroad or industrial bond and another, or one
municipal or foreign government bond and another, but it is not well
suited for comparing bonds of entirely different kinds of institutions*

HYhile there seems no questions that the new bonds of the Bank will
be ftnot distinctly or predominantly speculative* it would be very
difficult to determine exactly which one of the first four quality
ratings is fairly applicable to them at this stage in the Bankfs
Relaxation of 10 per cent lAmit on Bank Investment*
Section 5136 of the Revised Statutes prohibits any national
bank from investing more than 10 per cent of its capital and surplus
in securities of any one obligor, and the Federal Reserve Act
(Sec* 9) applies this same rule to state member banks• The purpose
of the limitation was to protect a bankfs creditors by preventing
the bank from risking an undue amount, in relation to its capital funds,
in any one situation. The statute exempts United States Government
bonds, general obligations of states and political subdivisions and
securities of certain Federal agencies such as the Federal Land Banks*
The question arises whether the statute should be further amended to
give a similar exemption to obligations of the International Bank*
Obligations of the United States Government are exempted
because they involve no risk of the obligor1s failure to make repayment when due* Exemptions are also provided for obligations of
the Federal Land Banks and certain other Federal Government agencies
and for State an£ municipal obligations; these exemptions might be
justified on several different grounds: (l) they are the obligations
of issuers Whom Congress, in the public interest, desired to help;
(2) the exempted securities are generally of comparatively high investment quality; and (3) since issuers of those securities are
governmental as distinguished from private, there is no danger of
improper use of banks1 assets on behalf of particular private interests*
These grounds for the existing exemptions would also seem
applicable to securities of the International Bank* An additional
reason for special treatment of the International Bank securities
lies in the nature of the assets behind them*
In the first place, while the 10 per cent limitation was
intended to insure that the risk elements in a member bankfs investment portfolio would be diversified rather than concentrated in
issues of a single obligor, it should be observed that the International Bank represents in itself a diversification of risks. Each
dollar of the Bank's liabilities will be covered in effect by two
different sets of Governmental liabilities, since the liabilities
of the Bank must be fully covered (l) by the Bank*s assets in the
form of loans, each made to a foreign government or to a borrower
with foreign government guarantee, and also (2) by the subscriptions
of the member Governments, 80 per cent of which can be called only
when needed to meet the Bank's liabilities•

Furthermore, the United States subscription is large and
amounts in effect to a United States Government guarantee of the
principal of the Bankfs securities up to at least 35 per cent of
their aggregate principal amount* This percentage nay be reduced by
the admission of additional member countries, but can never be less
than 27 per cent, and under certain circumstances, night prove to be
considerably more than 35 per cent* For the remainder not covered by
this U % S« guarantee, the liability of other member countries as subscribers to the Bankfs capital will bo divided among numerous countries
with none having more than 16 per cent of the total, while the liability
of member countries as obligors (or guarantors) on the Banlcfs loans
will also undoubtedly show a wide diversification among borrowing
For these reasons an amendment on behalf of these securities
seems justifiable in principle* Instead of exempting these securities
entirely from any limitation, it might be preferable merely to raise
the figure from 10 per cent to some higher figure such as 20 or 25 or
50 per cent* A figure of 20 per cent would almost be justified by
the U* S* Government guarantee alone; if a bank invested up to 20 per
cent of its capital and surplus, the part of its investment not covered
by the U* S* Government guarantee could not in any circumstances
greatly exceed 10 per cent*
It may be possible to defer any decision on the matter, at
least until the summer of 1947, because in the beginning the 10 per
cent limitation will not exert any significantly restrictive effect
on the International Bankfs sale of its securities* Pew banks would
consider investing above the 10 per cent limit before the securities
have begun to be "seasoned11, and since the securities will be issued
gradually, rather than in very large volume at any one time,a year
or more may elapse before the 10 per cent limitation, becomes seriously

October 14, 1946 •

Inflationary Implications of International
Bank Operations in U. S.
The activities of the International Bank in lending dollars abroad
will undoubtedly have inflationary effects in this country during the next
year* However, we must accept most of these effects if we are to give timely
aid to foreign countries in their efforts to reconstruct and stabilize their
economies. And we should be clear on how much of them are fairly attributable
to the existence of the Bank, and how much would have manifested themselves if
the cad had been financed in other ways.
The most direct and important inflationary effect of the Bankfs operations will arise from the additional demand for exports which will be stimulated
by its dollar loans to foreign countries. Although in general these dollars
will be free for expenditure in any currency area,l/ it is certain, in-view of
the present world supply situation, that the bulk of them will be spent directly
on U. S. exports of goods and services. Even to the extent that in the first
instance they are spent elsewhere and become accretions to the dollar reserves
of foreign countries, the some world supply situation is likely to result in
their expenditure in this market vathin a relatively short period. In short,
directly or by a somewhat delayed indirect process, any dollars lent by the
Bank will enter our market in competition for domestic production of goods and
But the lending operations of the Bank can be fairly said to have had
direct inflationary consequences in our markets only when they have stimulated
additional exports, i.e. exports which foreign countries would not have bought
in any case under alternative financing methods. In the absence of the Bank,
some countries which will use its facilities would have floated their own dollar loans in our market (though at higher interest rates). Others would have
drawn more heavily on their existing gold and dollar reserves. Badly needed
goods would have been acquired, however great the immediate sacrifice. However, in the case of loans from the Bank which displace the liquidation of
foreign gold and dollar reserves, while no immediate net inflationary effect
ensues, it should be noted that the higher level of reserves remaining in foreign hands contains a possible inflationary threat for the future.
The Baiikfs operations may also havo effects tending to increase inflationary potential in. our domestic money market. A detailed statement is
appended showing the effects on commercial bank deposits and reserves of various
types of Bank operations. More concretely, a picture might be drawn of the development over the next year based on the following simplified assumptions:
1. The Bank makes direct dollar loan commitments of $2,000 million
of which f1,200 million is disbursed to foreign borrowers. (No guarantee
1/ As an exception, the U.S. is authorized to require that loans made from 18
per cent out of its 20 per cent paid-in subscription to the Bank be utilized
only for U.S. exports, but it is not expected to insist on such a condition.

-22. Foreign borrowers disburse the full $1,200 million, but $250
million is spent in third countries; these countries respend $200 million in
the United States during the period, and are temporarily holding $50 million
in their dollar reserves with the Federal Reserve Banks.
3. The Bank's loan commitments are fully covered by itc paid-in
dollar capital ($635 million from the 20 per cent paid-in U. S. subscription
and about $90 million from the 2 per cent dollar subscriptions by foreign
countries) and by debentures outstanding in this market of $1,275 million, of
which $275 million has been taken by commercial banks.
4. Disbursements on the Bank f s loans have been made out of its paidin capital, and to the extent necessary ($475 million) out of the proceeds from
debentures. The remaining $800 million of debenture money is invested in U. S.
Government securities.
On these assumptions, the effects on commercial bank deposits and reserves over the year as a whole may be summarized as follows:
(a) Deposits will have increased by $315 million ($275 million of
bank subscriptions to debentures, plus $90 million of foreign government subscriptions drawn from foreign accounts at the Federal Reserve Banks, less $50
million accumulated in accounts at the Federal Reserve Banks by foreign countries
in which part of loan proceeds are spent).
(b) Required reserves will have increased by $160 million ($55 million to cover the increase in deposits and $105 million to cover the shift from
war loan account to ordinary deposits of the dollars represented by tho TJ. S.
paid-in subscription).
(c) Reserves will have increased by $40 million ($90 million added to
market from funds subscribed by foreign governments less $50 million withheld
from market by foreign countries).
(d) The net reduction in excess reserves (or the need for additional
reserves) would therefore have been $120 million.
It is important to point out, however, that this analysis proceeds on
the assumption of "other tilings being equal"; in particular it assumes that the
$635 million to be paid in on the U. S. subscription to the Bank would have remained in the Treasury1 s war loan account if not used for this purpose. In
view of the Treasury's current debt redemption program, it may be more reasonable
to assume that this money would have been used to retire bank-held debt, in
which case an equivalent amount of deposits would have been extinguished.
Allowing for this factor, the Bank's operations over the coming year may cause
commercial bank deposits to be $950 million higher than they would otherwise
have been. No amendment is necessary in the reserve calculations.
On the other hand, once the assumption of "other things being equal"
is abandoned, attention should be directed to the inflow of foreign gold and
dollar reserves which might have occurred over the next year in the absence of
the Bank. If the $1,150 million of exports from the United States wore purchased

-3here in any case and financed through the liquidation of foreign countries1
gold and dollar reserves, not only would there be an increase in commercial
bent deposits greater than that attributed to the Bank's operations in the
preceding paragraph, but commercial bank reserves v/ould rise correspondingly.
Actually the additional liquidation of foreign reserves which might occur in
the absence of the Bank would not doubt be considerably smaller than this,
but it would certainly be an important inflationary influence on our money

In conclusion, it is repeated that the most important inflationary
impact on our economy of the International Bankfs operations arises from ito
financing of additional exports. The more rapidly the Bank raises and disburses funds, r n tho more the Bank directs its lonns toward countries which
without such assistance could not buy in this market, the more serious this
impact will become. These arc matt era over whicli the National Advisory Council
has control and the decisions of that body on the Bank's borrowing and lending
operations will largely determine tho extent to which inflationary consequences
By comparison, the particular mathods by which the Bank raises dollar funds in this :a?aia;t aro •unimportant. It is true that it would be preferable to hcVG pll of the- Bankfs debentures placed in tho hands of "genuine" investors without participation by the commercial banking system. However, even
to the extent that banks do buy them, the result would be far preferable to
the inflow of foreign gold and dollar reserves which might occur in the absence
of Bank financing.
Furthermore it should bo borne in mind that any move to discourage
commercial bank purchases of International Bank debentures within the present
legal limits would bu sure to have wide repercussions on the markot for those
securities. The singling out of these particular securities for unfavorable
comment in connection with bank investment would inevitably have an adverse
effect on their reception by those classes of investors (insurance companies,
savings banks, trustees, individuals, etc.) who arc regarded as tho preferable
reuositories for them.

October 17, 1946.

Note on Effects of International Bank
Operations Upon U.S. Money Market

The following note traces the technical effects which the
International Bank's U. S. dollar operations would have on the U. S.
money market during the initial stages of the Baiikfs development, i.e.
during the period that it is building up its borrowings and its loan
portfolio. The main text proceeds on the supposition that these operations will involve raising funds in the market only by the issuance of
the Bank's debentures; the effects of operations by the Bank in guaranteeing issues by foreign obligors (now considered quite unlikely to attain
substantial volume) are covered in brackets.
Let us make initially the simplifying assumption that dollar
funds are concurrently raised by the Bani:, disbursed by the Bank to foreign borrowers, and disbursed by the loreign borrowers in this market
(directly, or indirectly via transactions with third countries), /in
the case of guaranteed issues, it is assumed that the raising of the
funds and their disbursement in this market is concurrent^/ The money
market effects of the BankTs operations may then be analyzed according
to tho source of the dollar funds which it uses for foreign loans.
(a) Use of dollars paid in on U, S. Government subscription
(20 per cent of subscription) !T~In view of the way in which these dollars
will have been raised (i.e. by Treasury draft on war loan deposits), the
net effect of their use would be deflationary in the narrow money market
sense. The volume of bank deposits would remain unchanged, but deposits
would have shifted from \var loan account to the account of American suppliers of the export market, involving an increase of required reserves
not accompanied by any increase in member bank reserves. If all of the
dollars to be paid in by the U. S. Government ($635 million due in installments through next May) were lent out, the increase in required reserves (reduction in excess reserves) would be a little over $100 million.
(b) Use of dollars peiid in on foreign government subscriptions
(2 per cent of subscriptions) .1/ In general these funds will be provided
by draft on foreign accounts with the Federal Reserve Banks, and their
transfer to American suppliers of the export market would increase both
deposits and member bank reserves by the same amount, and also fractionally
increase required reserves. If all dollars to be paid in on foreign government subscriptions were lent out, there would be an increase of about
$90 million in commercial bank deposits and a net increase of about #75
million in excess reserves, largely offsetting the reduction of excess
reserves under (a).
1 / A few small countries have paid in gold instead of dollars or have
deferred payment, but the results are unimportant.

-2(c) Use of dollars raised from sale of debentures to individual
or institutional investors* The transfer of these funds from investors to
American suppliers of the foreign market would produce no change in the
volume of commercial bank deposits or reserves. /Same is true in case
of sale of guaranteed
(d) Use of dollars raised from sale of debentures to commercial banks. The provision of funds from this source would involve a
corresponding expansion of commercial bank deposits and a fractional increase in required reserves. The theoretical maximum of commercial bank
purchases of debentures is about $700 million under present laws, so that
deposits might conceivably rise by this amount and required reserves by
something over $100 million. To the extent that purchases were made by
banks not holding excess reserves, the necessary reserves might be built
up through sales of short-tprm Governments to the Federal Reserve Banks
up to somo fraction of the $100 million (plus) figure. /Same is true in
case of sale of guaranteed
Let us now assume that lags occur between the raising of funds
by the Bank, the disbursement of the funds by the Bank to the foreign
borrower, and the disbursements by the foreign borrower (directly or indirectly) to suppliers in the U. S. market. Such lags would tend to
create an accumulation of funds at the Federal Reserve Bank of New York
in the accounts of the International Bank or of foreign countries,1/ affecting the results stated above by correspondingly reducing commercial
bank deposits and commercial bank reserves and hence causing pressure on
the reserve position of the banks. /Same results follow in case of a lag
between the raising of funds on guaranteed issues and their disbursement
in this market^ However, while some such lags are likely to occur, in
most cases where they are of substantial duration, they will probably be
offset through action by the holder of the resulting balances (i.e. the
Bank or foreign monetary authorities) to place them in short-term investments in the market• The conclusions stated above therefore remain substantially unaffected.
The Ba&k has already adopted the policy of iijvesting in shortterm Governments the 2 per cent payable in dollars on the capital subscriptions of all member countries, pending ths use of such dollars on foreign loans. The other dollars which the Bank will receive from capital
subscriptions (the remaining 18 per cent of the paid-in U. S. subscription)
must be placed by the Bank for the most part in non-interest-bearing demand notes of the U. S. Treasury if they are not required for foreign
loans (the Bank can reserve a small amount of these dollars for working
purposes). In raising funds by the sale of debentures, the Bank will seek
so far as possible to match the inflow of debenture proceeds against its
disbursements on loans, possibly by making the purchase price of debentures
payable in installments over a period of time. However, the avoidance of
some lag may be very difficult, especially if the Bank feels that its
1/ Ignoring the possibility that to some minor extent the funds might
accumulate in foreign deposits with U. S. commercial banks.

-3loan commitments must at all times be covered by firm borrowings plus
paid-in capital. While substantial lags may therefore occur, the Bank
will undoubtedly seek to minimize its loss of interest from holding idle
borrowed funds by investing in short-term Governments any balances which
tend to accumulate.^/
No question arises of a lag between disbursement of funds by
the Bank to foreign borrowers, and i-edisbursement by the borrowers, since
under its Articles of Agreement the Bank can advance funds under its
credits "only to meet expenses as they are actually incurred11.
/Tn the case of guaranteed issues, lags are quite likely to
occur between the raising and disbursement of funds by the foreign borrower,
and precedent indicates much less likelihood that resulting temporary
balances would be employed in short-term investment in this market. However, aside from the fact that the volume of guaranteed issues will not
be large in this particular case there is a relatively good chance that
any accumulated bdences will b.e held by the foreign borrower with commercial banks rather than with the Federal Reserve Bank, thus leaving
undisturbed the money morket effects stated at the outset of this
Probably the most serious possibility of an uncompensated lag
arises in the case of dollar funds disbursed by the Bank to foreign borrowers
and spent by thorn in third countries. At the present time, in view of the
world supply situation, the bulk of such funds would probably be spent
fairly rapidly on U. S. escports of goods end services. However, as time
goes on, increasing proportions of such funds may tend to remain for
longer periods of time in the dollar reserves of foreign countries. To
this extent, as noted above, a movement of funds would occur out of the
market and into the Federal Reserve Bank, bringing pressure on the reserve
position of commercial banks.
/Fhe same holds true in case proceeds from guaranteed issues
are initiaTly spent by the borrowers in third countries^

If Another way of eliminating the effects of such a lag on the money
market would be for the Bank to leave the proceeds of debenture issues
with the commercial banks rather than transferring them to its account at
the Federal Reserve Bank. While this device would also promote the Bank's
good relations with commercial banks, it appears not to be permissible
under the Bank's Articles of Agreemejrfc and its adoption would involve
sacrifice of the earnings which the Bauk might make by short-term investment
of its funds.