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FEDERAL RESERVE BOARD WASHINGTON ADDRESS OFFICIAL CORRESPONDENCE T O T H E FEDERAL RESERVE BOARD X-6892 May 14, 1931. SUBJECT: P r o g r e s s i v e P e n a l t i e s on D e f i c i e n t R e s e r v e s . Dear S i r : The a t t a c h e d memorandum, a d d r e s s e d t o t h e Governor of t h e F e d e r a l Reserve Board by t h e Chief of t h e D i v i s i o n of Bank O p e r a t i o n s , on t h e s u b j e c t " P r o g r e s s i v e P e n a l t i e s on D e f i c i e n t Reserves of Member Banks" was r e a d t o t h e r e c e n t " C o n f e r e n c e of Governors which r e q u e s t e d t h a t t h e F e d e r a l Reserve Board f o r w a r d a copy t o each F e d e r a l r e s e r v e bank which now" a p p l i e s p r o g r e s s i v e p e n a l t i e s f o r continued d e f i c i e n c i e s i n r e s e r v e s . I t i s b e i n g forwarded t o t h e o t h e r F e d e r a l r e s e r v e banks a s a m a t t e r of i n f o r m a t i o n . The s u g g e s t i o n has been made t h a t t h e F e d e r a l Reserve Board amend i t s R e g u l a t i o n D, so a s e i t h e r ( a ) t o a b o l i s h t h e p r o g r e s s i v e p e n a l t y a l t o g e t h e r , or (b) t o make i t mandatory and a p p l i c a b l e u n i f o r m l y t o a l l F e d e r a l r e s e r v e d i s t r i c t s . A c c o r d i n g l y , t h e Board has r e q u e s t e d t h e System Committee on Reserves t o make a s p e c i a l s t u d y and r e p o r t a s t o t h e e f f e c t i v e n e s s and d e s i r a b i l i t y of assessing progressive penalties. Very t r u l y y o u r s , E. M. McClelland, Assistant Secretary. Enclosures. TO GOVERNORS OF ALL F . R. BANKS. X-6892-a CQPY April 25, 1931. TO Governor Meyer SUBJECT: Progressive penalties on FROM Mr. Smead deficient reserves of member banks. Section 19 of the Federal Reserve Act provides that the required reserve "balance carried by a member "bank with a Federal reserve "bank may, under the regulations and subject to such penalties as may he prescribed by the Federal Reserve Board, be checked against and withdrawn by such member bank for the purpose of meeting existing l i a b i l i t i e s . In accord- ance with this section the Federal Reserve Board has provided i n Regulation D that a penalty on the amount of the deficiency in reserves shall be assessed at a basic rate of 2 per cent per annum above the Federal reserve bank discount rate on 90 day commercial paper, also that upon the application of a Federal reserve bank the Board w i l l approve progressive penalties for continued deficiencies in reserves, the t o t a l penalty not to exceed 10 per cent. At the present time 7 Federal reserve banks apply progressive penalty rates on continued deficiencies in reserves, s i x of them having a maximum penalty rate of 10 per cent, and one 8 per cent. In order to compare the deficiencies i n the d i s t r i c t s which apply progressive penalties with def i c i e n c i e s in d i s t r i c t s which do not apply progressive penalties, we have prepared the attached table showing: 1. 2. Average number of member banks in operation in 1930. Number of member banks subject to basic and to progressive penalties,for deficiencies in reserves. 3. Uumber of banks out of each 1,000 in operation that were subject to basic and to progressive penalties on deficiencies. 4. Ratio of average deficiencies to average reserve balances of a l l member banks. From an examination of the table i t appears that the Federal reserve banks that apply progressive penalty rates have r e l a t i v e l y more banks with X-6892-a 655 2 — continued d e f i c i e n c i e s , t h a n do t h e r e s e r v e banks t h a t do not a p p l y p r o gressive penalty r a t e s . This r a i s e s t h e q u e s t i o n whether t h e p r o g r e s s i v e p e n a l t i e s a r e p a i d by ( a ) Member banks which, owing t o t h e i r overextended c o n d i t i o n , a r e u n a b l e t o m a i n t a i n t h e i r r e q u i r e d r e s e r v e s , or (b) Member banks which a r e i n a r e a s o n a b l y s a t i s f a c t o r y cond i t i o n b u t , t h r o u g h n e g l i g e n c e or o t h e r w i s e , make no attempt to maintain t h e i r required r e s e r v e s . The F e d e r a l Reserve Banks of Chicago, Minneapolis and D a l l a s , which a ( one time a p p l i e d p r o g r e s s i v e r a t e e , have d i s c o n t i n u e d them. The r e a - sons g i v e n f o r d i s c o n t i n u i n g t h e p r o g r e s s i v e p e n a l t i e s a r e a s f o l l o w s : Governor Young of Minneapolis - " A f t e r a thorough i n v e s t i g a t i o n of t h e s i t u a t i o n , we a r e convinced t h a t t h e banks t h a t pay a t e n p e r cent p e n a l t y r a t e do not do so because of t h e i r u n willingness to carry s u f f i c i e n t reserve with us, but solely b e c a u s e of t h e i r u t t e r i n a b i l i t y t o do s o . " Mr. Walsh of D a l l a s - "The p r o g r e s s i v e r a t e does not i n i t s e l f a c t a s a d e t e r r e n t t o member b a n k s , and t h o s e banks t h a t have p a i d t h e i n c r e a s e d r a t e , even t o t h e maximum, a l t h o u g h h a v i n g every d e s i r e t o do s o , have been u n a b l e t o m a i n t a i n t h e i r r e q u i r e d r e s e r v e by r e a s o n of h a v i n g r e a c h e d t h e i r maximum ability." Mr. Heath of Chicago - "Our o b s e r v a t i o n i s t h a t by f a r t h e g r e a t e r number of member banks whose r e s e r v e s a r e c o n t i n u a l l y d e f i c i e n t , a r e u n a b l e t o m a i n t a i n such r e s e r v e s w i t h o u t r e d i s c o u n t i n g f u r t h e r , and t h a t t h e i r c o n d i t i o n a s a r u l e i s not such a s t o j u s t i f y further increase in rediscounts." Data a v a i l a b l e i n t h i s o f f i c e i n d i c a t e t h a t d u r i n g t h e p a s t two y e a r s , 286 member banks have been s u b j e c t t o t h e maximum p e n a l t y r a t e s of 10 p e r c e n t , or would have begn s u b j e c t t o such r a t e s had t h e y b e e n a p p l i e d i n a l l districts, Of t h e s e 286 b a n k s , 163 a r e s t i l l members,' 79 have suspended, 29 have been a b s o r b e d by o t h e r b a n k s , 8 have been r e o r g a n i z e d or succeeded by new b a n k s , 6 have withdrawn from t h e System, and 1 has gone i n t o v o l u n tary liquidation. X-6893-a k gu ^ 656 The f a c t t h a t F e d e r a l r e s e r v e "banks t h a t a p p l y p r o g r e s s i v e p e n a l t i e s have r e l a t i v e l y more member hanks w i t h continued, d e f i c i e n c i e s t h a n F e d e r a l r e s e r v e hanks t h a t do not a p p l y p r o g r e s s i v e p e n a l t i e s , and t h a t a r e l a tively large p e r c e n t a g e of t h e member hanks t h a t pay t h e p r o g r e s s i v e p e n a l t i e s a r e i n an overextended c o n d i t i o n , r a i s e s t h e q u e s t i o n a s t o whether t h e a p p l i c a t i o n of p r o g r e s s i v e p e n a l t i e s does n o t , i n most c a s e s , p l a c e a d d i t i o n a l b u r d e n s on t h o s e member hanks which a r e l e a s t a h l e t o h e a r them. I t occurs t o me t h a t you may wish t o d i s c u s s t h i s q u e s t i o n w i t h t h e Governors a t t h e i r c o n f e r e n c e next week. ' e •Wttiil»ciEr^'iB3gmEaw'tm5®-''33kaBS"iraRiirG 1930 federal Beserve District Average number of member banks i n district Average number of t a n k s s u b j e c t t o Total At maximum r a t e of 10 p e r cent* At lower progressive rates* At normal rate Number of banks, out of each 1000 i n o p e r a t i o n , t h a t were — Subject Subject Deficient Subject t o lower t o maximum p r o g r e s - t o normal in penalty reserves penalty sive (total) of 1056 penalties F.R.SiueiS TKfiT APPLY PROGRESSIVE PSKALTI5S Boston Philadelphia Cleveland San F r a n c i s c o Richmond Atlanta Kansas C i t y Total 400 756 125 153 386 123 .085# .111 .201 .070 .589 .576 .195 20 39 6 53 51 16 254 241 156 63,713 61,648 87,741 754 8 23 175 865,385 375 355 171 1,688 4 24 233 206 257 210 8 4 a 252 182 981,690 344,423 476 574 .048 .167 16 18 16 78 177 91 106 813 361 172 179 230 9 9 7 6 29 27 22 20 323 138 148 204 76,220 51,086 60,289 287 126 245 1,708 •377 .247 .4o6 .113 885 160 136 158 10 lo _ 1 14 a 125 99 138 4,321 887 35 99 492 147,066 137,819 191,745 175,653 325 331 179 205 4ll 1 l4o 139 132 215 4 2 3 594 ( I n thousands of d o l l a r s ) 158 234 5 19 10 56 105 103 124 139 783 Average daily deficiencies 10 7 24 17 4 60 110 Average daily reserves of a l l member banks 3-32% R a t i o of average deficiencies to average r e s e r v e s of a l l member banks 26 128 mm .195 F.R.BAKSS THAT DO HOT APPLY PROGRESSIVE PENALTIES Hew York Chicago 923 1,132 237 238 St. Louis Minneapolis Dallas 548 662 716 3,981 198 114 128 915 Total I_5_ 25 1,513,708 •For t h e l a s t f i v e d i s t r i c t s , columns 3 and 4 r e p r e s e n t t h e member banks which would have been s u b j e c t t o p r o g r e s s i v e r a t e s i f such r a t e s had been a p p l i e d by t h e r e s p e c t i v e F e d e r a l r e s e r v e b a n k s . I n t h e A t l a n t a d i s t r i c t t h e maximum r a t e i t 8 p e r c e n t . NOTE: T o t a l number of member b a n k s , a s shown i n column 1, i s t h e average of 12 end-of-month d a t e s ; t h e number of bz nke d e f i c i e n t i n r e s e r v e s i s t h e a v e r a g e of q u a r t e r l y r e p o r t s ; d a i l y d e f i c i e n c i e s a r e a l s o a v e r a g e s of q u a r t e r l y r e p o r t s . FEDERAL RESERVE BOARD DIVISI01T OF 3AM OPERATIONS APRIL 24, 1931 01