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931 E x OFFICIO MEMBERS ... _ W . P . 6 . H A R D I N G , GOVERNOR CASTER A L B E R T S T R A U S S , VICE GOVERNOR SECRETARY OP THE TREASURY ADOLPH C. MILLER CHAIRMAN C H A R L E S S . HAMLIN FEDERAL RESERVE BOARD — ADDRESS REPLY TO FEDERAL RESERVE BOARD WASHINGTON W . T . C H A P M A N , SECRETARY R . G . E M E R S O N , ASSISTANT SECRETARY W . M. I N L A Y , FISCAL AGENT November 29,1919* Subject: X-1738 Balances of Non-Member Clearing Banks. Dear S i r r * Some question has been raised, a s t o the method, of computing the amount and c h a r a c t e r of the balances to be maintained with t h e i r r e s p e c t i v e Federal Reserve Banks by non-meitiber c l e a r i n g banks, t h a t i s , banks which have made d e p o s i t s with the Federal Reserve Banks f o r the purpose of exchange or c o l l e c t i o n under the p r o v i s i o n s of Section 1J of the Federal Reserve Act. On pages 617 and 6lS of the August 1917 B u l l e t i n there i s published an opinion of counsel t o the e f f e c t t h a t the purpose of the proviso i n the s o - c a l l e d Hardwick amendment t o Section 13 i s to a f f o r d p r o t e c t i o n to the Federal Reserve Banks a g a i n s t any p o s s i b l e l o s s r e s u l t i n g from c l e a r i n g t r a n s a c t i o n s with non-member banks and t h a t the Federal Reserve Banks are t h e r e f o r e authorized t o r e q u i r e and should r e q u i r e a c l e a r i n g non-member bank to maintain a balance s u f f i c i e n t i n the judgment of the o f f i c e r s of the Federal Reserve Bank to o f f s e t checks or other items drawn a g a i n s t the d e p o s i t i n g bank and presented by the Federal Reserve Bank f o r payment as well as items r e c e i v e d from the d e p o s i t i n g bank. There i s quoted below f o r your information a l e t t e r addressed to one of the Federal Reserve Banks under date of October 2g, 1919, which i s not intended in any way t o amend the opinion above r e f e r r e d to b u t which i s merely f o r the purpose of d e f i n i n g , f i r s t , the amount t h a t i s necessary to c o n s t i t u t e an " o f f s e t " f o r checks d e p o s i t e d by a non-member bank w i t h the Federal Reserve Bank and s t i l l i n the process of c o l l e c t i o n , and second, the c h a r a c t e r of the "balance s u f f i c i e n t " to make the o f f s e t . "Dear Sir " I have received your l e t t e r of October 2 1 s t , suggesting some m o d i f i c a t i o n s of the B o a r d ' s a t t i t u d e upon t h a t p o r t i o n of Section 13 of the Federal Reserve Act which r e f e r s t o the c l e a r i n g accounts of nonmember banks. "The language of Section 13, which i s r e p e a t e d i n Regulation J , p r o v i d e s , in connection with the e s t a b lishment of c l e a r i n g accounts by non-member banks and t r u s t companies t h a t , 1 such non-member bank or t r u s t company m a i n t a i n with the Federal Reserve Bank of i t s . -2- X-173S 922 d i s t r i c t a balance s u f f i c i e n t t o o f f s e t t h e items i n t r a n s i t h e l d f o r i t s account by the Federal Reserve Bank. 1 "Before d i s c u s s i n g whether a ' b a l a n c e 1 means a book balance or a c o l l e c t e d b a l a n c e , i t would be well to throw some l i g h t upon the meaning of the word ' o f f s e t ' • In c a s e s where a non-member bank c o l l e c t s items through a Federal Reserve Bank and r e c e i v e s d e f e r r e d c r e d i t only a f t e r the items have a c t u a l l y been c o l l e c t e d , i t i s c l e a r t h a t no balance whatever i s n e c e s s a r y to o f f s e t items i n t r a n s i t h e l d f o r account of the non-member bank by the Federal Reserve Bank. The B o a r d ' s c o n s t r u c t i o n of the word ' o f f s e t ' , t h e r e f o r e , i s that i t must apply to the l a b o r performed and the expense i n c u r r e d by the Federal Reserve Bank i n c o l l e c t i n g the items f o r t h e non-member bank. I t seems, t h e r e f o r e , in determining wnat balance w i l l be s u f f i c i e n t t'o o f f s e t items i n t r a n s i t h e l d f o r account of a non-member bank by the F e d e r a l Reserve Bank where c r e d i t i s n o t given u n t i l the items a r e a c t u a l l y •collected c o n s i d e r a t i o n should be given t o the average volume of c o l l e c t i o n s made by the Federal Reserve Bank f o r the non-member bank and the p r o p o r t i o n borne by such b u s i n e s s t o the t o t a l c o l l e c t i o n b u s i n e s s of t h e Federal Reserve Bank. I t w i l l be found i n many c a s e s t h a t the value of a small a c t u a l balance w i l l be s u f f i c i e n t to compensate the Federal Reserve Bank f o r i t s work i n h a n d l i n g c o l l e c t i o n s f o r a non-member bank and t h a t the amount of balance r e q u i r e d w i l l be l e s s than the average d a i l y volume of c o l l e c t i o n s r e c e i v e d from the non-member bank. "While the Board has made no formal r u l i n g covering i t s i n t e r p r e t a t i o n of the words 1 a balance s u f f i c i e n t ' i t has, n e v e r t h e l e s s , construed these words to mean a c o l l e c t e d b a l a n c e . I f a non-member bank should be p e r m i t t e d t o maint a i n only an u n c o l l e c t e d balance a g a i n s t i t s items i n process of c o l l e c t i o n by the Federal Reserve Bank, i t i s l i k e l y t h a t the F e d e r a l Reserve Bank would be l e f t most of the time with only an u n c o l l e c t e d balance on i t s books, r e p r e s e n t i n g no a c t u a l f u n d s a v a i l a b l e t o the end of compensating i t s e l f f o r ' the work and expense involved. No commercial bank, having r e g a r d f o r good banking p r a c t i c e , would t o l e r a t e such a s i t u a t i o n . I f the p r i v i l e g e you suggest were accorded to member banks, the Federal Reserve System might a t times have no u s a b l e f u n d s , and the g r a n t i n g of i t to c l e a r i n g nonmember banks would make i t t o the i n t e r e s t of a s t a t e bank to become a c l e a r i n g non-member r a t h e r than a r e g u l a r member. Such a bank could, i n v a r i o u s ways, do i t s borrowing through i t s correspondents, and a t the same time u s e the c o l l e c t i o n f a c i l i t i e s of the Federal Reserve System w i t h o u t c o n t r i b u t i n g one penny t o the upkeep of t h a t System. "This problem would appear t o solve i t s e l f , if the bank commissioners of the v a r i o u s s t a t e s , i n d e s i g n a t i n g the Federal Reserve Bank a s a r e s e r v e agent f o r s t a t e banks, should s t i p u l a t e ( as they probably w i l l and as I think they s h o u l d ) , t h a t the r e q u i r e d r e s e r v e must be c a r r i e d i n c o l l e c t e d f u n d s as i n the case of n a t i o n a l banks. -3- 3-17)6 , 923 "The opening of c l e a r i n g accounts by non-member banks w i l l undoubtedly accrue t o the advantage of the Federal Reserve System, and w i l l m a t e r i a l l y add to the service i t r e n d e r s . Success i n a t t r a c t i n g such accounts w i l l , a s you s t a t e , f a c i l i t a t e the a c q u i s i t i o n of par p o i n t s , and such a c q u i s i t i o n of par p o i n t s w i l l encourage member banks to send a l l miscellaneous items d i r e c t t o the Federal Reserve Banks and branches, with the i d e a of checking a g a i n s t excess r e s e r v e s i n f a v o r of correspondents with whom i n t e r e s t - b e a r i n g balances are d e s i r e d . In a d d i t i o n , the opening of c l e a r i n g accounts by non-member banks w i l l a l s o very l i k e l y give impetus t o the proper r o u t i n g of items, because these banks, i f the volume of t h e i r b u s i ne ss j u s t i f i e s , can be authorized to send items d i r e c t to t h e Federal Reserve Banks and branches f o r the c r e d i t of t h e i r c i t y correspondent. I t seems to me, however, t h a t the Board should continue f o r the presegat, to construe the words 1 balance s u f f i c i e n t ^ to mean a c o l l e c t e d balance. "Your information as to the a c t i o n which w i l l be takenby the s t a t e bank commissioners in your d i s t r i c t i s very i n t e r e s t i n g . I t would be e x c e l l e n t if these commissioners, i n d e s i g n a t i n g the Federal Reserve Bank as a r e s e r v e agent f o r s t a t e banks, could be p r e v a i l e d upon to make the conditions and requirements covering such reserve b a l a n c e s uniform. I s h a l l be pleased to have you keep me posted on t h i s phase of the s i t u a t i o n a s i t develops." As i n d i c a t e d above where a non-member bank c l e a r s items through a Federal Reserve Bank and r e c e i v e s a c r e d i t only a f t e r the items have been c o l l e c t e d , i t i s evident t h a t no balance whatever i s necessary to o f f s e t items i n t r a n s i t in order to p r o t e c t the Federal Reserve Bank a g a i n s t any p o s s i b l e l o s s r e s u l t i n g from the t r a n s a c t i o n . The Board has r u l e d t h e r e f o r e t h a t i n such a case t h e reserve bank might r e q u i r e the non-member bank to maintain a balance s u f f i c i e n t to o f f s e t the expense i n c u r r e d by the Federal Reserve Bank in nuking the c o l l e c t i o n s . I t should be noted, however, t h a t t h i s should not i n any way i n t e r f e r e with the c a l c u l a t i o n of the amount of deposit which must be maintained i n accordance with the opinion published i n the B u l l e t i n i n order to p r o t e c t the Federal Reserve Bank a g a i n s t any p o s s i b l e l o s s in the case of items drawn a g a i n s t the non—member bank which are b e i n g c o l l e c t e d through the Federal Reserve Batik. Very t r u l y yours, Governor. To Governors and Chairmen of a l l F.R, Banks.
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