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Eecles -

Gov. Vardaman called me and asked me to
call you/attention to the draft of the memorandum
regarding Responsibilities of Directors of Federal
Reserve Banks, which is to be taken up at the Board
meeting this morning. He thinks the entire letter
is very weak and that some one like Mr. Thurston,
who understands public relations, should be requested
to redraft it and put it in better language.
He especially vvants you to read paragraphs
2 and 3 of Section I on Page 3—this he thinks is
bad presentation. And on Section U on Page 4>
Examination of Member Banks—he feels this is



APR - 6 1948
When a new director takes his place upon the Board of a Federal Reserve Bank he naturally does so with a desire to make as substantial a contribution as possible to that undertaking. How effeotive
his initial efforts may be will depend to a large extent upon how
familiar he is with the operations of a Federal Reserve Bank, both as a
separately chartered institution and as an integral part of a nationwide
central banking system. Experience has demonstrated that a new director
takes some time to familiarize himself with the many important differences
between the overall functions of a Reserve Bank directorate and that of an
ordinary oommercial bank or other business enterprise. For that reason
this memorandum has been prepared and is being sent out by the Board of
Governors with a view to directing your attention to some of the important
national aspects of System operations and the part which you can play in
shaping the course of these operations. It is intended to give you a
"birdfs eye view" of the System as the nation's central banking organisation.
A supplemental statement prepared at your Federal Reserve Bank
will be given you by the Bank, which discusses the internal organization
and affairs of the Bank.
The Federal Reserve Act, passed in 1913» created the Federal
Reserve System which is presently comprised of the Board of Governors,
the Federal Open Market Committee, the Federal Advisory Council, the
twelve Federal Reserve Banks, and nearly 7f000 member banks. As the core
of the System, Congress required every national bank to become a member
stockholder and depositor in the Federal Reserve Bank of its district.
State banks and trust companies may become members voluntarily, with the
approval of the Board, by subscribing to the capital stock of the Federal
Reserve Banks the same amount in proportion to their capital and surplus
as is required of national banks as members.
The role of the Board of Governors in the Federal Reserve System
is largely policy making and supervisory in character. Among the major
powers granted to the Board are the supervision, regulation and examination
of the twelve Federal Reserve Banks and their branches; the supervision and
regulation of the issue of Federal Reserve notes, which comprise the
principal part of the volume of money in circulation; the admission of
State banks to membership in the System, the granting of trust powers to
national banks, and the examination of member banks; the determination of
the amount of reserves that shall be held by member banks and the approval
of the discount rates at Reserve Bonks; the determination of the amounts
which banks, brokers and others may lend on listed stocks; the fixing of
the interest rates that member banks may pay on time and savings deposits;
and the removal, upon proper citation and prooedurt, of any person as an
officer or director of any member bank for continued violation of banking

- 2 -

laws or unsafe or unsound banking practices. In addition to these
instances of particular regulatory authority, the Board has, in the field
of national credit policy, an even more general and comprehensive responsibility for contributing to the maintenance of sound monetary and
credit conditions.
The twelve Federal Reserve Banks are the functional units for
accomplishing the broad objectives of the Federal Reserve Act. By virtue
of their strategic location in the money markets of the United States
they are in a position to exert important influences over the member banks
indeed over all banks — in their districts through the dissemination of
information and advice on matters involving national monetary and credit
policy. Particular examples of their specific responsibilities include
the accommodation of the local credit needs of the district through advances and discounts for member banks. They are also empowered to lend
directly to business organizations under certain conditions. In addition
they are the medium for supplying the member banks of their districts with
Federal Reserve notes and other currency. They act as the fiscal agent of
the United States and this phase of their activities covers many phases of
the Government's business. They hold the reserve deposits of their member
banks, and they act as clearing houses and collecting agents in the nationwide collection of checks and other instruments.
The Federal Advisory Council is composed of a representative of
each of the Federal Reserve districts, twelve in all, who are elected by
the boards of directors of the Reserve Banks. The Council meets with the
Board several times each year to discuss and advise with the Board on
important matters of System policy.
The Federal Open Market Committee is composed of all the members
of the Board and five of the presidents of the Reserve Banks. The latter,
with the exception of the President of the Federal Reserve Bank of New
York, are on a rotating basis. The function of the Open Market Committee
is to direct the purchase and sale of Government securities held by the
Federal Reserve Banks.
The principal purposes of the Federal Reserve System are:
(l) the accommodation of commerce, industry and agriculture through the
exercise of the Systemfs influence upon the general credit situation of
the country; (2) the issuance and retirement of Federal Reserve notes to
meet the currency needs of the country; (3) operation of an efficient
system for the clearing and collection of checks; (l\) a more effective
supervision of banks; and (5) to act as fiscal agent of the United States.
A detailed discussion of the means by which these objectives were intended
to be accomplished is contained in a booklet entitled "The Federal Reserve
System, Its Purposes and Functions", and a larger volume entitled "Banking

- 3Studies", copies of which are being placed in your hands. However, it
may be helpful here briefly to outline the basic System activities which
underlie each of these purposes*
(1) The System's Credit Controls. The most important function
which the System was designed to* perform is that of helping to stabilize
the economy at the highest sustainable levels of production and employment
so far as that national objective may be accomplished through exercise of
monetary or credit influence. The tools which Congress fashioned for
System use, with respect to this objective, were powers to fix discount
rates, to fix reserve requirements of member banks (within certain statutory
limitations), and to make open market purchases and sales of Government
Events beyond the control of the System have done much to nullify
these powers as instruments for influencing the volume of bank credit. This
is due principally to the tremendous increase in the amount of Government
securities outstanding, particularly those held by the banks, which resulted from the Governments financing of World War II and the need for
the System to provide an orderly market and support for marketable bonds.
Today, with the economy of the country threatened by dangerous postwar
inflationary influences, the banks are in a position to expand credit almost at will by selling Government bonds and converting the proceeds into
loans and discounts. So long as the System remains committed to the
support of the Government long-term bond market — a commitment which
seems hardly likely to be withdrawn in the near future -- the banks are
thus free to expand credit without restraint, since discount rates and reserve requirements under existing law are not effective deterrents.
This is one of the most important problems which face the
System today. It challenges the best thinking in all of the System's
units. If the Federal Reserve System is to continue as the nation's
principal agency for combating economic instability, it behooves all who
are connected with the System to come to grips with the problem in a
realistic and objective manner in seeking solutions based on a broad oonception of the national interest.
(2) The Issuance and Retirement of Federal Reserve Notes.
The issuance and retirement of Federal Reserve notes is largely an automatic, although entirely elastic, process. Federal Reserve notes are
paid out by the Reserve Banks to member banks on request. Any Federal
Reserve Bank can obtain the notes from its Federal Reserve agent upon
pledging gold certificates, eligible paper or any United States Government obligations. The only limitation is that the Reserve Banks must have
in their own hands or pledged with a Federal Reserve agent gold certificates
amounting to not less than 25 per cent of the Federal Reserve notes in
circulation in addition to having in their own possession gold certificates
amounting to not less than 25 per cent of their deposit liabilities. Under
this system the currency tide of the nation simply ebbs and flows as the
needs of the member banks in each district may dictate.

-k(3) The System^ Nationwide Clearing Houses The clearing
house function o£ the Federal Reserve System is also largely a mechanical
operation. Member banks send to their Reserve Banks checks which they
have received for deposit and which are drawn on banks both within and
without their Federal Reserve district. Each Reserve Bank in turn sends
checks drawn on member banks in its district to such banks, charging
their accounts for the proceeds; checks drawn on banks located out of
such district are forwarded to the Federal Reserve Bank or branch in such
district and a similar process is followed. Thus, the great bulk of the
nation's checking business is accommodated without the physical transfer
of any currency; the Federal Reserve Banks clearing with each other and
the member bank accounts being charged and credited in offsetting amounts,
(U) Examination of Member Banks. Each Federal Reserve Bank
is responsible for the examination of the State member banks in its
district. While under the law the System is authorized to examine all
member banks, in practice these examinations are conducted only of State
member banks and do not include examinations of national banks. The
latter are examined by the Comptroller of the Currency and his reports
of examination are accepted by the System rather than having a duplication
of suoh functions* As a rule, the State member banks are examined at
least once each year by the Reserve Bank of that district.


(5) The Fiscal Service Function. The Federal Reserve Banks
act as fiscal agents, custodians and depositaries for -the Treasury Department and certain other Government agencies such as the Reconstruction Finance and Commodity Credit corporations. For the Treasury, the principal
operations performed are those in connection with the issue, exchange and
redemption of Government securities and the handling of Government checks,
coupons and receipts covering withheld taxes. For the RFC, CCC and other
Government agencies the principal operation now performed is the acceptance, custody and release of securities and other valuable documents.
About one-third of the total personnel of the Reserve Banks is engaged in
fiscal agency operations.
As indicated above, the function of the Board of Governors is
largely supervisory and policy making in character. To the Board has
been delegated the responsibility for integrating and coordinating the
operations of the System as a whole to the end that the System may
produce maximum results in the publio interest. In order that the Board
might effectively discharge this responsibility Congress has vested in it
a number of general and specific powers which bring the Board and the Federal Reserve Banks into a variety of important day to day working relationships. A few examples of these powers and the manner of their exercise may
assist a new director more quickly to understand the division of responsibilities as between the Board and the Reserve Banks.


-5 Thus, the Board was granted the power to "exercise general
supervision over (the) Federal Reserve Banks", to "examine at its discretion the accounts, books, and affairs of each Federal Reserve Bank",
and to "require such statements and reports as it may deem necessary"
from time to time* Such an examination is made at least once each year
and the results are brought to the attention of the Bank's board through
its ohairman. In fulfilling its responsibility of "general supervision"
the Board has also acted in numerous ways to protect the proprietary
interest of the United States in the Reserve Banks. As you are no doubt
aware, upon liquidation of a Reserve Bank the member banks in that
district are entitled only to receive the par value of their shares, with
accrued dividends, any surplus of such Bank being made the property of the
United States Government by the Federal Reserve Act, Even now, approximately ninety per cent of the net earnings of the Reserve Banks over and
above the statutory dividends payable to the member banks are channeled
into the United States Treasury through an interest charge levied by the
Board on the amounts of Reserve Bank notes in circulation after deducting
gold certificates held as collateral security.
In addition, the Board exercises certain supervisory powers with
respect to the appointment of official personnel, salaries and expenses at
the Federal Reserve Banks. In this connection the Board and the Banks have
recently revised the personnel classification plans for the grading of
Bank personnel below the officer level, which plans also fix appropriate
salary limitations within each grade. The salaries of officers are reviewed by the Board on an individual basis, with a view to maintaining
such salaries on a reasonably comparable basis at all of the Federal Reserve Banks. In addition, the Board has recently reestablished the
arrangement (largely discontinued during the war) under which annual
budgets are submitted to it by the Federal Reserve Banks.
Other important aspects of the Board's relationships with the
Federal Reserve Banks include its statutory duty to appoint three of the
nine directors of each Bank; its duty to designate the chairman and
deputy chairman of the board of directors at eaoh Bank; its responsibility for approving the appointment of the president and first vice
president at each Bank; its authority to remove any director, officer or
employee at any Bank for cause; and its authority to suspend the operation and take possession of any Federal Reserve Bank that violates the
provisions of the Federal Reserve Act. In addition, the Board is required to exercise special supervision over the foreign relationships and
transactions of the Reserve Banks; The responsibility for policy with
respect to the establishment, operation and discontinuance of branches of
the Reserve Banks rests in the first instance with the Board. And the
Board may also regulate the transfer of funds by the Federal Reserve Banks
and their branches.
Then, too, the Board exercises certain authority over the
credit functions of the Federal Reserve Banks. For example, the discounts.

-6 advancements and accommodations extended to member banks are subject to
the orders and regulations of the Board. The discount rates charged by
the banks are subject to the BoardTs approval. And the Board may also
require a Reserve Bank to rediscount at rates fixed by the Board paper
acquired by other Reserve Banks and to write off doubtful or worthless
assets* The issuance and retirement of Federal Reserve notes are also
under the supervision and regulation of the Board,
These are some, b,ut not all, of the Boardfs statutory responsibilities for the conduct of System affairs. Merely to enumerate them is
to emphasize the basic need for the constant interchange of intelligence
and ideas between the Board and the Federal Reserve Banks. Fortunately,
however, this need is being met in a satisfactory and practical manner.
For example, the presidents of the Federal Reserve Banks meet with the
Board several times each year, both in their Presidents' Conference and
as rotating members of the Federal Open Market Committee. These meetings
are devoted to full discussions of matters affecting monetary and credit
policy as well as of various problems affecting the operations of the
Reserve Banks themselves. There are also a number of committees of the
Presidents1 Conference, in some of whose discussions members of the Boardfs
staff participate, which are devoted largely to discussions of operating
problems. In addition, "the chairmen of the Federal Reserve Banks meet with
the Board twice each year to discuss similar topics. Then there are the
various conferences which are held at the Board between certain of the
operating staffs of the Banks and the members of the Board1s staff. These
include periodic conferences relating to member bank examinations, auditing,
legal matters, research programs, and such other special topics as from
time to time may require special discussion.
Each director of a Federal Reserve Bank has a position of vital
public responsibility, and each is chosen especially for his ability to
fulfill that responsibility. Although the term of all the directors is
three years and although their responsibilities are alike, the manner of
their selection, which is provided by law, is based on their being
divided into three classes. The purpose of this arrangement is to obtain
a wide representation of public, banking, agricultural, commercial, and
industrial interests. Class A and B directors are chosen by member banks;
the three Class A directors are usually member bank officers, and the three
Class B directors, who may not be officers and employees of any bank, must
be actively engaged in their district in commerce, agriculture or some
other industrial pursuit. The three Class C directors are selected by the
Board of Governors. Each Class C director must have been for at least two
years a resident of his district, and he may not be an officer or employee
of any bank.
The primary responsibility of a Reserve Bank director is, of
course, to the Reserve Bank itself. By making available to the Bank his


-7 seasoned experience in business and public affairs, and with his broad
knowledge of regional conditions he can help guide the Bank wisely* His
board prescribes the bylaws under which the Bankfs general business is
conducted and the privileges granted to it by law are exercised. It is
responsible for the general conduct of the Bank's affairs, including the
election of officers, being required to administer these affairs "fairly
and impartially and without discrimination in favor of or against any
member bank or banks".
But a Reserve Bank director has an even broader responsibility.
Because of the breadth of his experience he is in a position to make
valuable contributions to the formulation of System policies and their
effective application in his district. Furthermore, when System policy
decisions have been made, the directors are able to explain and thereby
bring about an understanding and acceptance of them in their various communities. There is a widespread feeling that fiscal and monetary programs
and procedure are difficult, if not impossible, for the average individual
to understand. However, actions taken by the Government and its central
bank in this field are of the utmost importance to the public generally,
and it is desirable that an understanding of them be as widespread as
possible. And this will be particularly true in future years, which will
be characterized by a large national debt, a large federal budget, and increased importance of fiscal and monetary policies in the economic life of
the country. Although the System has no direct responsibility for fiscal
policy, that problem is so closely related to the System and its responsibilities that the directors, through the information developed by the
System, should keep in touch with it as it affects the System and the Federal Reserve Banks and be prepared to advise regarding the policies that
might be followed.
Much has been said in recent years about the Federal Reserve
Banks as centers of information and leadership and it is believed that the
directors can play a most effective part in bringing this about. In this
connection the following is a nummary of a statement made by the chairmen
at their conference in April
"There should be no limit to the work of the Federal Reserve
Banks in the field of cooperation, education, and leadership. The
good that the Banks can do is limited only by the intelligence,
courage, and leadership of their directors and officers. On the
other hand, we must not underestimate the routine or operating
functions and responsibilities of central banking as they form a
vital part of the System. On the assumption that there will be
further centralization with respect to fiscal and monetary policy
and that the objectives of that policy will be different and
novel involving measures which will take on an increasing explicit regional differentiation, it seems desirable that the
Reserve Banks be firmly established as centers of information,
enlightenment, and leadership. They must be able to submit



*acomprehensive information wisely interpreted on economic problems
and regional trends. They must be able to act as centers for
interpretation in their districts of national policy and methods
in the fiscal and monetary area. They must be able to assume
leadership in times of emergency and to exert proper influence
on national policy especially from the point of view of regional
This assignment is one to challenge the abilities of the best
qualified men ^° §©rve as directors of Federal Reserve Banks.