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176 FEDERAL RESERVE B O A R D WASHINGTON address official correspondence t o the federal reserve board X-7561 August 25, 1933. Dear Sir: There is attached hereto, for your information, a copy of a letter addressed by the Board to the Reconstruction Finance Corporation with regard to the question whether debentures issued by a bank under the provisions of the laws of the State of New York may be considered as capital in determining whether or not such bank has a capital sufficient to make it eligible for membership in the Federal Reserve System. Very truly yours, Chester Morrill, Secretary. TO ALL FEDERAL RESERVE AGENTS. 177 August 25, 1933. Reconstruction Finance Corporation, Washington, D. C. Gentlemen: Reference is made to the letter addressed "by your Counsel, Mr. James B. Alley to the Federal Reserve Board on August 5, 1933, requesting advice as to whether debentures issued by a bank under the provisions of the laws of the State of Hew York may be considered capital by the Federal Reserve Board in determining whether or not such bank has a capital sufficient to make it eligible for membership in the Federal Reserve System. It appears that the laws of the State of Hew York authorize a State banking institution "to issue by its board of directors capital notes or debentures when so specifically authorized by the superintendent of banks". The Hew York laws apparently do not in terms prescribe any of the qualities or rights and liabilities of such debentures or of the holders thereof. However, it is understood that under the provisions of the Constitution of the State of Hew York any stock issued by banks located in that State, including preferred stock, is subject to double liability and that the amendment to the laws of the State of Hew York authorizing banks to issue debentures was enacted in order to enable banks in that State to obtain funds for the protection of depositors without the holders of such debentures being subject to double liability as in the case of holders of capital stock of banks in that State. 178 X-7561-a Reconstruction Finance Corporation — 2 It has also "been noted that under the provisions of Section 304 of the Act of March 9, 1933, as amended, the Reconstruction Finance Corporation is not authorized to purchase preferred stock in a State banking institution if under the laws of the State in which such institution is located the holders of preferred stock are not exempt from double liability. However, in any State where a State "banking institution is not permitted to issue preferred stock exempt from double liability the Reconstruction Finance Corporation is authorized to purchase legally issued capital notes or debentures of State banking institutions located in such State. It has also been noted that under the provisions of R. F. C. From P. S. 2, Form of Bank Debentures, debentures which will be purchased by the Reconstruction Finance Corporation represent promises to pay on a specified date the amount of money paid in on such debentures and to pay the holders of the debentures a prescribed rate of interest semi—annually, and that so long as any of the debentures are outstanding the bank may not, except under certain circumstances, issue additional debentures or incur any "other indebtedness" except for certain specified purposes. Such Form further pro- vides that except under certain circumstances no debentures shall be called for redemption unless the unimpaired capital, surplus and undivided profits of the bank is in excess of a prescribed amount. Under the provisions of the laws of Hew York and the form of debenture prescribed by the Reconstruction Finance Corporation, the holders of such debentures apparently 179 X-7561-a Reconstruction Finance Corporation — 3 are not entitled to voting rights in the management of the corporation. In the circumstances described above, it seems clear that the New York law and the form of debenture prescribed by the Reconstruction Finance Corporation contemplate that such debentures shall represent borrowed money of the issuing bank and are not intended to represent a proprietary interest in the bank as is usually represented by capital stock of a bank or other corporation. Under the provisions of the Federal Reserve Act, banks become members of the Federal Reserve System through subscriptions for stock in a Federal reserve bank, and, except in the case of mutual savings banks or similar institutions which are not here involved, the Federal Reserve Act requires that the subscription for Federal reserve bank stock shall be made on the basis of the "paid-up capital stock and surplus" of the subscribing bank. The Federal Reserve Act also provides that a State bank shall not be admitted to membership unless it possesses "a paid-up unimpaired capital sufficient to entitle it to become a national banking association in the place where it is situated", except that banks located in a place having a population of not exceeding three thousand inhabitants may be admitted under certain circumstances with a capital of not less than $25,000. In this connection, attention is called to the fact that, under the provisions of Section 303 of the Act of March 9, 1933, the term "capital", as used in provisions of law relating to the capital of national banking associations X-7561-a^^Q Reconstruction Finance Corporation —r 4 "shall mean the amount of unimpaired common stock plus the amount of preferred stock outstanding and unimpaired." The term "capital", as used in connection with the capital requirements of national banks, therefore, includes only common and preferred stock, and, in view of the facts described above, this definition of "capital", applicable to national banks, is also applicable to capital requirements for admission of State institutions to membership in the Federal Reserve System. In view of the above circumstances and the provisions of law referred to, it seems clear that, vuder the provisions of the Federal Reserve Act, the eligibility of a State bank for membership in the Federal Reserve System depends upon the amount of its capital stock and cannot be determined upon the basis of its capital stock plus borrowed money obtained through the issuance of debentures or other methods. In this connection, it may be* noted that, under the law and the consistent position of the Board, the surplus of a bank is not included in determining whether the bank has sufficient capital to make it eligible for admission to membership. You are accordingly advised that, in the opinion of the Federal Reserve Board, debentures issued under the provisions of the laws of •the State of New York, as described above, may not be included in determining whether a State bank has a capital sufficient to make it eligible for membership in the Federal Reserve System. Very truly yours, (Signed) Chester Morrill Chester Morrill, Secretary.
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