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FOR RELEASE IN MQBK1H6 PAPERS THURSDAY. SEPTEMBER 27. 1917 STATE BANK MEMBERSHIP IN THE FEDERAL RESERVE SYSTEM Address by W. P. G- HARDING, GOVERNOR OF THE FEDERAL RESERVE BOARD Before the STATE BANK SECTION AI.IERICAN BANKERS ASSOCIATION, ATLANTIC CITY, N.J., Wednesday afternoon, September 26th X-400 The double entiy principle is the foundation of the science of accounting. There must be an alignment of debits qnd credits, and on all balance sheets resources are grouped on one side and liabilities on the other. In considering the merits of any banking system we must observe* this prin ciple of debit and credit. The advantages and the draw backs must all be taken into account, — a balance brought down, and its amount and the side upon which it falls will determine the merits of the system. The Federal Reserve Act is the fourth important banking law of wide application, which lias been enacted by Congress. At the outset, bank charters were granted by the states and not by the general government. Centralized control of credits X-400 - 2- was recognized to be dangerous and was regarded as being contraiy to the spirit of our institutions. Yet the need for a strong bank with extended powers of note issue and of discount, was felt so keenly, that as early as 1791, congress granted a charter to a dominant banTHng institution owned in part by the government, known in history as the first Bank of the United States. This bank appears to have been wisely managed and it undoubtedly served a useful function. There is no evidence of any flagrant abuse of its powers, but it was unable to secure an extension of its charter and was obliged to go into liquidation at the end of twenty years. The demand for a large bank of discount and issue how ever, continued to find expression, and five years later the second Bank of the united States was chartered by Act of Congress. The s t o n y career of this institution is familiar X-400 — 3— to all students of financial history; and vhile it afforded through its note issues, a satisfactory Circulating medium, and was useful in many respects, its arbitrary control of credits and i4c participation in politics created so strong a prejudice against it in the public mind that upon the expira tion of its charter, it too was unable to SOciiTe ah extension, and after a few years additional of existence as a state bank it was finally forced into liquidation. In the ledger of public opinion the balance was found to be on the wrong side,— the evils connected with the bank exceeded the good. so strong were the prejudices \nhich it aroused that no bank modeled upon similar lines has since been allowed to exist in this country and probably none will ever be. For more than twenty-five years after the fall of the second Bank of the United States, the state institutions in X-400 this country had the financial field to themselves. Most of them were permitted to issue circulating notes under the laws of their respective states but these laws were not uniform, and in most cases were entirely inadequate for the protection of the note holder. State bank currency was local in its character, and when circulated away from its place of issue the discount upon it increased in a degree corresponding to the distance, and no financial authority has ever contended that the experience of this country with' state bank notes was qt all satisfactory. In 1863 Congress legislated for the third time in a comprehensive way on the subject of banking, and the National Banking system was the result. One of the underlying principles of this Act was the diffusion of banking power — X-400 -5- the absolute autonoby of each bank chartered. "A national currency, with localized banking,” Was the theory of the system’s sponsors. The ls&v subjected the banks to whole some restrictions and regulations, and required that their operations be supervised by a bureau chief of the Treasury Department, known as the Comptroller of the Currency. The national banks were authorized, upon the security of united States bonds, to issue circulating notes, which were free from the principal objections to state bank notes, in that adequate provision was made for their redemption, they were receivable at par in all parts of the United States , and their value was not affected by the insolvency of the issuing bank. A dual system of reserves was established for these banks, the law providing that part be kept in lawful money in the vaults of X-4Q0 the hanks and that part he kept with other hanks approved as reserve agents. Experience has shown that the national banking system was defective in three vital particulars: (1) The currency provided hy the hanks while sound and stable, was absolutely inelastic; its volume did not depend upon the needs of trade, hut was regulated rather hy the price of the government bonds against which the national hank notes were issued. (2) weakness. The pyramiding of reserves was another source of Banks in the larger cities acting as reserve agents for the countiy hanks would have a plethora of funds at certain seasons of the year, while at other times, es pecially when crops were moving, their deposits would decrease X-400 ~7- and they would be called upon to rediscount heavily for their country bank correspondents. There was no rediscount market in this country available to the larger banks, nor was there any way of making adequate additions to the volume of currency in times of stress. (3) A third defect in the national banking system lay in the lack of coordination and cooperation. There were no means of compelling banks to stand together for the common welfare, to mobilize their resources; and in all of-our fi nancial crises the trouble was aggravated by the desire of frightened banks to build up their own reserves without regard for commercial needs, and without any thought for the general banking situation. The state banks and trust companies were affected in the same way as the national banks. X-400 -8- These defects in the banking system were painfully evident during the severe financial panics of 1873, 1693, and 1907; and while perhaps not entirely responsible for the weakness of our credit structure, they rendered it impossible to restore confidence, to provide for the requirement of business, or to minimize the effects of too drastic liquida tion. After the memorable panic of 1907, serious consideration was given to the subject of banking and currency reform, and the law which was approved on December 23, 1913, known as the Federal Reserve Act, the,result of an arousod public sentiment sensed by a few strong personalities, was the outcome. In stead of one central bank, provision was made for the division of the country into twelve districts and the establishment of a Federal Reserve bank in each. This law has been amended X-400 -9- in certain important particulars which the experience of actual operation has shown to be desirable; and, without at tempting to discuss the reasons for the changes which have been made, let us consider some features of the Act as it stands today. The Federal Reserve banks are owned by the national and state banks which constitute their membership. Each member bank is required to subscribe an amount equal to six per cent of its own capital and surplus to stock of the Federal Reserve bank of its district. One-half of the amount subscribed must be paid in, the other half being subject to call. After all necessary expenses of a Federal reserve bank Jjave been provided for, the stockholder;.? banks are entitled to receive an annual dividend of six per cent on the paid-in capital stock, which dividend is cumulative. After dividend claims, have X-400 - 10- be en fully met all the net earnings must be paid to the United States as a franchise tax, except that one-half of the net earnings must be paid into a surplus fund until that fund amounts to forty per centum of the paid-in capital stock of the Federal reserve bank. Stock in a Federal reserve bank is not transferable, but upon the liquidation or retire ment ef a member bank, its stock must be surrendered to the Federal reserve bank for cancellation, and payment will be made to the retiring bank equal to its cash pain-in subscrip tions on the shares of stock surrendered, plus one-half of one per centum per month from the period of the last dividend, provided the payment does not exceed the book value of the stock. While profit is a minor consideration with the Federal reserve banks, their current earnings are such that they will X-400 -11before a great while be able to pay all accumulated dividends. Although carlying reserves of about 60 per cent against all deposit and note liabilities, the average net earnings of the twelve banks for the first eight months of the present year have been at the rate of 12.1 per cent per annum. The average net earnings for the month of August of the present year were at the rate of 17.3 per cent. The objection therefore, which was raided frequently during the first year of the operation of the Federal Beserve banks, that the stock would prove to be a dead investment, is no longer a valid one. Each Federal Be serve bank is an autonomous institution, with nine directors, six elected by the stockholding banks, and three appointed by the Federal Beserve Board. one of these three is chairman of the board and Federal Beserve agent. the law to appoint one He is authorized under X-400 *•12- oi* more assistants, subject to the approval of the Board. With this exception, all officers and employes of Federal re serve banks are chosen by thoir own directors, the Federal Beserve Board being given power to approve salaries and to make removals for cause# The Federal Beserve banks do not come into competition for deposits with the commercial banks which conpose their membership. They are not allowed to receive deposits from individuals, firms, corporations, or municipalities. While they may receive United States deposits, they are given no monopoly of such deposits. They receive deposits from their member banks and from such non-member banks as may desire to carry balances with them for exchange or collection purposes, and ne interest is paid by Federal reserve banks on deposits. X-400 -13- A glance at the statements which have "been issued by national banks during the past two years — enormous gains in deposits — which show generally will demonstrate the absurdity of the fears formerly expressed so often that the Federal Re serve banks would reduce the deposits of their member banks. There is no occasion here for an extended review of the powers of the Federal reserve banks, or for a discussion in detail of rediscounts, open market operations, and note issues. It is now admitted by all, except a few irreconcil- ables, that the Federal Reserve banks do furnish an elastic currency, one capable of responding to the needs of the country by expanding in times of stress or of great commercial and industrial activity, and by contracting in periods of dullness, the limitations being the amount of gold obtainable X-400 -14- for reserves against the notes outstanding and the eligible paper available as security for the notes* Even though there may be no reduction in the amount Of Federal reserve notes outstanding, actual contraction may be effected by increasing the gold reserve held against them. The gold reserve against the Federal Reserve notes now outstanding is 81 per cent, al though the normal reserve required by law is 40 per cent. The operations in which the banks can engage are clearly de fined by law, and there is no centralization of credits. Discount rates are fixed by the Board of directors of each Federal Reserve bank, subject to the approval of the Federal Reserve Board, and applications for rediscounts of eligible paper are passed upon at each bank without reference to any other authority. One Federal Reserve bank mey rediscount X-400 ~ 15- paper for another, either voluntarily, or by direction of the Federal Reserve Board upon the affirmative vote of five members. In this way we have a diffusion of credit but a concentration of resources^ All national banks were required by the law to become members and only a very few of them chose as an alternative to surrender their charters. The original Act provided for the admission of state banks as members, but during the first two years of the operation of the system few chose to exercise this privilege. The Act did not state in sufficient detail the terms and conditions for state tank membership, but left much to regulation by the Federal Reserve Board; and vdiile the Board’s interpretation wf the section relating to state bank membership was satisfactory to officials of most of the state banks which contemplated becoming members, it was r X-400 -16- felt that the banks would, be on safer ground if the terms were stated more clearly and definitely .in the Act itself. The Adt approved June 31, 1917, amended in several particulars the Federal Reserve law, and one of the most important amend ments is. that relating to the admission of state banks and trust companies. Section 9, as amended and reenacted pro vides that "any bank becoming a member of the Federal Reserve system shall retain its full charter and statutoiy rights as a state bank or trust company, and may continue to exercise all corporate powers granted it by the state in which it was created, and shall be entitled to all privileges of member banks.'* So fully does this clause protect the charter powers of a state bank that the Attorney General of the United states has recently ruled that it exempts a state bank from tho re- X-400 -17- strictions of Section 8 of the Clayton Act which relates to interlocking directors. Other clauses of Section 9 as amended provide that IVhile state hank members shall be sub ject to examinations made by direction of the Federal Reserve Board or of the Federal reserve bank by examiners selected or approved by the FederalReserve Board, incases where the di rectors of Federal reserve banks shall approve the examinations made by state authorities, such examinations and reports may be accepted in lieu of examinations made by examiners selected or approved by the Federal Reserve Board. This removes the objection that state banks are subject to double examinations» Another objection frequently urged, was that the law made no provision for the retirement of a state bank from the Federal Reserve system unless it should be expelled for X-400 -18- violation of sotee regulation. The Act as amended provides that "aiy State batik or trust cotepany desiring to withdraw from membership in a Federal reserve batik taay do so, aftei* six months’ written notice shall haVe beefa filed with the Federal Reserve Board, ppon the stirrender and cancellation of all of its holdings of capital stock in the Federal Reserve bank; Provided, however. That no Federal Reserve bank shall, fexcept tinder express authority of the Federal Reserve Board, cancel within the same calendar year more than twenty-five per centum of its capital stock for the purpose of effecting voluntary withdrawals during that year.” Many state banks otherwise favorably inclined toward membership, have been deterred from making application because of the limitations upon their loans which would be imposed. The Act now provides that a state bank or trust company which X-400 -19- becomes a member of the Federal reserve system, shall retaih the full statutory rights which it eh joys under the laws of its own state, so that the question of excess loans is deter mined entirely by state law. But, in order to avoid giving state bank members an undue advantage over national banks, it is provided that "no Federal Beserve bank shall be permitted to discount for any state bank or trust company notes, drafts or bills of exchange of any #ne borrower who is liable for borrowed money to such state bank or trust company in an amount greater than ten per centum of the capital and surplus of such bank or trust company, but the discount of bills of exchange drawn against actually existing value and the discount of commercial or business paper actually owned by the person negotiating the same shall not be considered as borrowed money within the meaning of X-400 - 20- this section. The Federal Reserve hank, as a condition of the discount of notes, drafts * and bills of exchange for such state bank or trust company, shall require a certificate or guaranty to the effect that the borrower is hot liable io such bank in excess of the amount provided by this section, and will not be permitted to become liable in excess of this amount while such notes, drafts, or bills of exchange are under discount with the Federal Reserve bank.” Therefore, should a state bank member have in its portfolio large loans which would be excessive for a national bank, but which are permitted under the laws of its state, no objection can be raised from the standpoint of amount, by the Federal Reserve bank against such a loan; but in offer ing rediscounts to a Federal Reserve bank, the member bank should offer paper vhich comes within the 10 per cent limit. X-400 - 21- Our countiy is now passing through one of the most critical periods of its existence. It is engaged in the most frightful and costly war of all history. Totally unprepared sir months ago for a serious conflict, it has now in training a vast army, and within the span of a few months will have completed preparat i o n s for war on land and sea, beneath the sea, and in the air, which ordinarily would have required years. It is advancing enormous sums to other nations with vhich it is associated in this war. The amounts necessary for financing our undertakings and for taking care of our conmitments will aggregate £18,©60,008,000 for the first year, — day. $1,500,000,000 a month, or £50,©00,00® a Our actual expenditures since last April have far ex ceeded the total for the four years of the Civil war. In such circumstances our old banking system would have proved totally X-400 -22- inadequate. It could not, 5,n point of fact, have withstood the shock which we felt in 1914 when the war broke out between three great European powers on one side, and two on the other. The Federal Reserve Act, even before the Federal Reserve barks were fully organized, was the means of carrying us safely through that crisis, for the Act extended for one year the life of the Aldrich-Vreeland notes and made their issue practicable. Revival of confidence and a return to normal conditions were coincident with the establishment of the Federal Reserve banks. Their operation has given to every element in this country, — - the national banks, the state banks, the manufacturers, the merchants, and the individual depositors, — a sense of security which otherwise would have been totally lacking. Within a few months four million subscribers have absorber!, an issue of $2 ,000,000,000 of 3-1/2 per cent government bonds. X-400 - 23- the most gigantic financial operation this country has ever known. Yet there has been no financial stringency, iio violent fluctuations in call money rates nor ih discount rates; there has been no general calling of loans, no forced liquidation. At a crucial time during the month of June, the Federal Reserve „ banks discounted $663,196,000 0f member banks’ short time col and bankers' acceptances, lateral notes/and the money situation was kept completely under control. The country is now about to engage in a campaign for the sale of the second issue of United States Liberty bonds. The amount of the offering will be, at the very lowest, 50 per cent greater than the first. The crops of the country will be moving at the same time, and we should remember that before the establishment of the Federal Reserve banks money stringency dur ing the crop moving period was a matter of annual recurrence. The twelve Federal Reserve banks are the fiscal agents of the X-400 -24- go verncent . Through the facilities afforded by them and by means of the organizations which they have effected, the Govern ment of the United States expects to gather up the funds necessary for its support in the present crisis, and by reason of their knowledge of the ability of the Federal reserve banks to rediscount for them, the member banks look forward without fear to the impending demands upon them. More than 7600 national banks are members of the Federal Reserve system, — members perforce at first, but most of them now by choice, and of the 20,000 state banks and trust companies in the United States, of which perhaps eight or nine thousand are eligible for membership, how many are standing shoulder to shoulder with the national banks in sustaining these Federal Reserve banks v.hich all agree are our financial bulwarks in the present emergency? Just eighty-four; but in this number are X-400 ~25and more important included many of the larger/state banks and trust companies. The capital of the state bank and trust company members of the Federal Be serve systeia amounts to more than $61,000,000; their surplus to more than $62,000,000, and their to$ol resources to more than $1 ,200 ,000,000 , and new applications for membership are being received every day, from small banks as well as large. The following table shows the movement of state banks into the system has not been confined to localities, but that their membership has extended to all Federal Beserve districts except the third. The banking laws of Pennsylvania formerly prohibited the stock ownership which is necessary for the ad mission of a .bank, but they have very recently been amended in this respect; X-400 -26- state DISTRICTS HUMBER BANKS member BANKS. TOTAL RESOURCES CAPITAL Boston 7 $ 10,300,000 $10,275,000 $232,528,223 New York 5 5,600,000 8,246;165 199,490,595 Cleveland 3 4 ,?oo*obo 4;700,0b0 112,078,100 Richmond 8 1,740,700 412,90® 8,572,391 Atlanta 6 2,405,300 2, 309,750 33,219,162 Chicago 24 20,485,00® 18, 647,000 393,981,964 St. Louis 6 10,750,000 14,500,00® 149,087,326 Minneapolis 7 1,825,0®0 543,50® 13,919,808 Kansas City 7 2,855,000 2,310,000 63,975,595 10 835,000 155,650 9,117,321 1 50.000 100.000 1,493,790 84 $61,545,700 $62,199,965 $1,217,464,272 Dallas San Francisco TOTALS X-400 -27- I am confident that in few a/~weeks more the resources of the state member banks and trust companies will amount to more than £2 ,000,000,000, and I cannot but feel that if the state banks and trust companies of America will give earnest consideration Jo the contingencies ahead of us, motives of self-interest, as well as a patriotic desire to cooperate will determine them to apply for membership, and that ' in time _the number of state bank members will be nearer eighty-four hundred than eighty-four. In making up your balance sheet on the Federal Beserve system, in grouping the assets and liabilities of membership, ask yourselves these questions:- worth while? Are the Federal Beserve banks Would you care to have them abolished ? If they are worth sustaining, should they be supported almost entirely by one class of banks, or should all unite upbuilding them? Will their strength be augmented, and the financial welfare of X-400 the country further safeguarded, by your membership? Ash those state banks which are already members whether their charter powers have been hampered or curtailed by their membership; whether the regulations of the Federal Reserve Board have inter fered with their business or methods of doing business; ■whether the Federal reserve banks have been arbitrary in their dealings; ask them if they have had difficulty in getting from the Federal reserve banks any accommodations to which they were entitled, or if they have had no occasion to ask for accommoda tion, what the knowledge is worth that the accommodation can be had when wanted. The answer to these questions I have no doubt must be placed on the asset side. balance sheet make this entry:— balances carried, — On the liability side of your loss of interest on reserve and there is another entry which may appear on both sides of the sheet, — the effect of the Federal Reserve collection system, for some of the banks will object to the loss # X-400 -29- of earnings Occasioned, by remitting for checks at par to the Federal Eeserve bank. Others, and a constantly growing number, will make this entry on the asset side because of the facility which the Federal Beserve bank offers for the collection of their own outside items* And make this extension on the asset side:- Every dollar of reserves carried with the Federal Reserve banks adds to their power to maintain sound and healthy banking con ditions, to respond to any demands which may be made upon them, and to help our country win its fight for liberty and a safe and lasting peace. Then add 15) the figures, - strike a balance, and your application for membership will follow! Ex-Opficio Members W . P. G. HARDING. GOVERNOR P A U L m . WARBURG, v ic e Go v e r n o r FREDERIC A. DELANO ADOLPH C. M ILLER CHARLES S. HAMLIN W ILLIAM G. McADOO SECRETARY OF THE TREASURY CHAIRMAN JOHN SKELTON W ILLIAM S COMPTROLLER OF THE CURRENCY FEDERAL RESERVE BOARD WASHINGTON H. PARKER W ILLIS . SECRETARY SHERMAN P. ALLE N . ASST. SECRETARY a n d F is c a l A g en t ADDRESS REPLY TO FEDERAL RESERVE BOARD September 22, 1917. Dear Mr. The Treasury Department is retiring gold certificates in de nominations smaller than $50., and the Treasurer of the United States has advised the Board that he is desirous of obtaining from time to time Federal Reserve notes in five and ten dollar de nominations (mostly tens) for use by the cashier of the Treasury in making ordinary payments. An opportunity is thus afforded of increasing the gold holdings Of the Federal reserve banks by mak ing this exChahgd of Federal reserve notes for gold* and the Board feels that all the Federal reserve banks should participate pro rata, in their proper proportion. There will be available eventual ly about $300*006*000 of ten and twenty dollar gold certificates which can be exchanged for Federal reserve notes ih this way. The Board understands that these exchanged will be made at the rate of about $3,000*000 per week. BO faf* one million dollars each for districts One* two* three and fourj have been exchanged* The Treasurer has not yet advised the Board of the atoouht of certificates that he will have available for exchange during the coming week, but the Board will advise you as soon as an allotment is made your bank. Upon receipt of the Board’s advice a telegram as follows should be sent to the Board: Federal reserve bank has deposited $________________ as collateral for issue of Federal reserve notes, please request Comptroller of the Currency to deliver to the Treasurer of the United States Federal reserve notes aggregating $____________ in _____________________denominations, such delivery to be made upon deposit by Treasurer of the united states of $_________ in gold settlement fund to credit of Federal Reserve Bank of Signed _________________________ Federal Reserve Agent. Your bank can deposit with the Federal reserve agent coin,gold certificates or eligible commercial paper as may be most convenient. Very truly yours, Governor
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