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Federal Reserve Bank of St. Louis
Collection: Paul A. Volcker Papers
Call Number: MC279
Box 8
Preferred Citation: NOW Accounts [Folder 1], 1973-1976; Paul A. Volcker Papers, Box 8; Public
Policy Papers, Department of Rare Books and Special Collections, Princeton University Library
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Federal Reserve Bank of St. Louis
AMERICAN
BOARD OF (111'4- Tit:CRS
OF ièk
FEDEUI. RESEriVE
BANKERS
ASSOCIATION
1976 NOV 12 M110: 36
EXECUTIVE VICE rRESIDENT
RECEIVED
OFFICE OF THE CHAIRMAN
\NiIlisW Alexander
202/467-4211
kokii 4,c
11 November 1976
1120 Connecticut Avenue, N V.
Washington, D.C.
10036
/ 2g
The Honorable Arthur F. Burns
Cha'irman
Board of Governors of the
Federal Reserve System
20th & Constitution Avenue, N. W.
Washington, D. C. 20551
Dear Chairman Burns:
I am writing because of concerns expressed by several bankers about a Federal
Reserve Board staff study, "Effects of NOW Accounts on 1974-1975 Commercial
Bank Costs and Earnings," by John Paulus. We realize the paper is merely a
study by one of your staff economists and does not represent an official
position of the Board. Nevertheless, the wide publicity given the study by
the press, Senator McIntyre, and others, has prompted me to express our concern
about its cursory treatment of some important policy issues.
Specifically, the opening section of the paper says that given "the accumulating evidence that NOWs have not significantly reduced commercial bank market
shares, or after tax earnings at the aggregate level, it would appear that
the NOW account program has been an almost unqualified success." The paper
goes on to say "some weaker banks could experience serious financial difficulLies if NOW pressures on costs and revenues continue. In the event such
difficulties disrupt financial markets, the final verdict on NOWs may be less
optimistic." Thus, the attitude of the author seems to be that statewide
market shares and the stability of financial markets are the only criteria 1
that should be used to evaluate the NOW account program. We disagree.
The cost burden of NOW accounts is particularly heavy on smaller consumer
oriented banks whose market area typically is smaller than that encompassed
by statewide boundaries. The aggregation of all markets in a state would
give adequate information about local markets only if NOW accounts impinged
equally on all banks in all markets, and the innovation had, in fact, spread
throughout the state. Neither of these conditions holds.
More importantly, we do not think the problems of individual smaller banks
that are hurt by NOW accounts can be summarily dismissed. The banks affected
are managed by people who made decisions to serve the needs of their communities under a given set of rules and regulations. They are not responsible
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Federal Reserve Bank of St. Louis
AMERICAN
BANKERS
ASSOCIATION
vse
r4l1ING uo
11 November 1976
SHEET NO.
TWO
for changing the rules, policymakers are. Failure of such institutions for
reasons beyond managerial control would be a disservice to the management
of these banks and the communities they serve. We believe these institutions deserve due consideration.
We shall continue our own evaluation of the NOW account program. As the
Board undertakes its evaluation, we hope it will make a balanced consideration
of the problems encountered by all financial institutions and their customers.
Sincerely,
Willis
Ale ander
WWA:mfc
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Federal Reserve Bank of St. Louis
S.
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Federal Reserve Bank of St. Louis
0-13- 7LBOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYST
EM
Mr. Chairman---
Paul Nelson, chief of staff of House banking
called to indicate that Reuss has now received
letters from three Reserve Bank presidents and
that
the letters are almost identical.
Paul put forward the thesis that we were
co-ordinating the replies and indicated --"w
e are
going to blast you people':
Ken G.
cc--Joe Coyne
DRAFTED BY:
Ea( sari,
A. atut-wva_
REVIEWED BY:
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Federal Reserve Bank of St. Louis
T,
QkL-
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Federal Reserve Bank of St. Louis
September 10, 1976
The Honorable Henry S. Reuss
Chairman
Committee on Banking, Currency
and Housing
House of Pepresentatives
•ashington, D. C. 20515
Dear Mr. Chairman:
In accordance with the request in your letter of
April 19, I am pleased to enclose a paper prepared by a
member of the Board's staff entitled "Effects of NOV
Accounts on 1974-75 Commercial Bank Costa and Earnings.
This study analyzes the effects of the introduction of NOV
accounts in Massachusetts and New Hampshire on bank
profits and market shares. It also contains some comments
on the characteristics of the possible long-run balance that
might be achieved with the continued payment of interest on
transactions balances, and the transition problems that would
be associated with such a development.
I hope that you will find the study helpful. As
indicated, it expresses staff judgments, which have not been
reviewed or approved by the Board of Governors.
cAncerely yours,
Arthur F. Burns
Enclosure
EE:ja
cc: Ed Ettin
HOUSE
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Dixon
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2129 RHOB
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212 HOB Annex* Lewis
B-371A RHOB
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3156-HOB-Annex-2-**
3154 HOB Annex 2**
605 HOB Annex*
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2129 RHOB
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2129 IT
3154 HOB Annex
2129 RHOB
* N.J. Avenue & C Streets, S.E.
** Independence Avenue & 2nd Street, S.W.
SENATE
5300 DSOB
5310
5230
Abshire
A-522, 119 D St., N.E.
Henderson 5300 DSOB
Mar inaccio 5300 DSOB
Rohner
A-524, 119 D St., N.E.
Kuttnex„, 5300 DSOB
JEC
Stark
G-133 DSOB
Krumbhaar
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Federal Reserve Bank of St. Louis
G-133 DSOB
Karl ::Th
C-133 DSOB
(House Gov't. °pers.)
B-350A RHOB
House BUDGET
Gross
Teeters
Miller
Jewell
5226 DSM
456 R;;33
A-719 Annex 3, 119 D St.
1251 PSOT,',
5300 "
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Senate BUDGET
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T.'
-
EFFECTS OF NOW ACCOUNTS ON
1974-75 COMMERCIAL BANK COSTS AND EARNINGS
BY
JOHN D. PAULUS
August 1976
Staff, Board of Governors of the Federal Reserve System
This study represents a joint effort of several members of the Federal
Reserve System staff. First, Ralph Kimball of the Federal Reserve
Bank of Boston deserves a special thanks. His assistance was invaluable
on matters ranging from defining marginal bank groups to conducting bank
interviews. At the Board, Edward Ettin, James Kickline, John Mingo
and Perry Quick made particularly valuable contributions and improvements to the final draft. Others who read an earlier draft and made
valuable coullitents include David Lindsey, Ray Lombra and John Williams
from the Board and Paul Anderson, Robert White and Mary Chamberlain
from the Boston Fed. Jeff Susskind and Rebekah Wright assisted in
gathering data and preparing tables, and Mary McLaughlin and Denise
Lancaster typed the final as well as earlier drafts. Despite the
assistance of these people, I alone am responsible for any remaining
errors of judgment or analysis.
NOTE: The judgmentsand conclusionsof this paper are not necessarily those
of the Board of Governors of the Federal Reserve System.
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Federal Reserve Bank of St. Louis
V
CONTENTS
I.
II.
III.
IV.
V.
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Federal Reserve Bank of St. Louis
INTRODUCTION
Regulation and Growth
Purpose and Scope
Summary and Conclusions
1
FLOWS OF FUNDS AND MARKET SHARES
Source of NOW Funds
Market Shares of Total Deposits
7
EFFECTS OF NOW ACCOUNTS ON AGGREGATE COMMERCIAL
BANK COSTS AND EARNINGS
Incremental Costs of NOWs
Reductions in Earnings from Demand Deposit Outflows
After Tax Reduction in Earnings
15
ADJUSTMENT PROBLEMS OF INDIVIDUAL BANKS
High Ratio Banks
Runoff Banks
Low Income Banks
Summary of Marginal Bank Earnings
Portfolio Adjustments by Marginal Banks
24
THE LONG RUN ADJUSTMENT PROBLEM OF COMMERCIAL BANKS
Characteristics of the Steady State
Transtion to the Steady State
36
APPENDIX A
Removal of Interest Rate Constraints, Bank
Costs of Acquiring Funds, and Portfolio Risk
42
APPENDIX B
Short-Run Profit Maximization as a Sub-Optimal
Criterion When the Long-Run Supply of Funds Depends on
Market Shares Established During a Transition Period
47
•
I.
INTRODUCTION
In May 1972 the Massachusetts Supreme Court ruled that state
law did not prohibit mutual savings banks from offering negotiable
orders of withdrawal (NOW) from savings accounts.
Following this
ruling several state chartered mutual savings banks (MSBs) in Massachusetts began to issue NOW accounts, and, in September, a savings
I.nk in New Hampshire began offering NOWs after determining that New
Hampshire law was similar to that of Massachusetts.
Although these
rulings allowed state-regulated MSBs to participate in the NOW market,
federally chartered or insured depository institutions could not-under federal regulations--offer NOWs.
The resultant controversy led
to congressional legislation--Public Law 93-100--signed on August 16,
1973, authorizing all depository institutions (except credit unions)
in Massachusetts and New Hampshire to offer interest bearing deposits
on which withdrawals by negotiable order could be made.
This legis-
lation thus established a formal experiment in the two states in which
limited demand deposit powers were extended to thrifts and the payment
of interest on
transactions balances was authorized for the first
tiII_ since 1933.
Regulation and Growth
Regulation of NOW accounts was divided between the Federal
Reserve Board, the Federal Home Loan Bank Board, and the Federal Deposit
Insurance Corporation.
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Federal Reserve Bank of St. Louis
All institutions were authorized to begin offering
•
-2-
NOWs on January 1, 1974, but NOW accounts were to be issued exclusively
to individuals, non-profit organizations and sole proprietorships.
Partnerships, corporations, state and local governments, and financial
institutions were prohibited from holding NOWs.
Because eligible
individuals and institutions held an estimated one-third of the $6
billion in demand deposits in Massachusetts and New Hampshire in 1974,
this prohibition limited to about $2 billion the maximum level of conversions from commercial bank (CB) demand balances to NOW accounts; of
course, NOWs could also attract funds from other financial assets,
especially savings deposits.
The three federal agencies imposed an interest rate ceiling
of 5 per cent on NOW accounts offered by all institutions, the same as
on savings deposits at CBs but one-fourth of a point less than thrifts
are permitted to pay on savings deposits.
At the end of 1975, 97 per
cent of all institutions offering NOWs were paying this 5 per cent
ceiling rate of interest.
Congress did not include in the law uniform reserve requirements against NOWs.
Because NOWs are technically savings accounts,
members of the Federal Reserve System must hold 3 per cent in required
reserves against NOW balances, as compared to reserve requirements
averaging about 10 per cent
on demand deposits.
Nonmember banks and
thrifts in Massachusetts and New Hampshire hold negligible reserves in
non-interest bearing form against both demand deposits and NOW accounts.
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Federal Reserve Bank of St. Louis
-3-
The popularity of NOWs with consumers is evidenced by the
rapid and steady growth of these accounts.
In the first two years of
the experiment, NOW balances grew at an average rate of 7-2/3 per cent
per month, advancing from $143 million to $839 million.
As shown in
Figure 1, the monthly growth rates over this period have been quite
stable, although during the last half of 1975 the rate of NOW growth
declined somewhat, averaging just under 6 per cent per month.
FIGURE 1
NOW BALANCES ON RATIO SCALE
($ millions)
Purpose and Scope
NOW accounts have evolved into a very close substitute for
personal checking accounts, thereby eroding CBs traditional monopoly
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
-4position in the issuance of such
accounts.
With such erosion,CBs
in Massachusetts and New Hampshire have lost the exclusive claim to
offering "one-stop banking" to individuals who, for convenience, might
be willing to maintain a time or savings account, even at relatively
unfavorable interest rates, at an institution that provides checking
services.
Moreover, the payment of interest on NOW accounts, many
of which represent direct conversions of zero-interest demand
deposits, has raised the average costs to CBs of acquiring funds.
These factors suggest that NOW accounts could affect the
stability and the viability of coluutercial banking in Massachusetts
and New Hampshire as CBs attempt to adjust to the new, more competitive
environment.
This issue--the stability of commercial banking in
the two states during the adjustment period--is the subject of the
remainder of this study.
to analyze
the
Both aggregate and micro data are used
ongoing adjustment of banks in the two states.
In Sections II and III, a broad view is taken of industry wide
developments in banking in 1974 and 1975.
Shifts in market shares
are reviewed, and the hypothesis that the spread of one-stop banking
to thrifts might cause CBs to lose significant amounts of demand
related funds--especially small time and savings deposits--is examined.
Rough estimates of the direct effect of NOW accounts on CB costs
and earnings since January
1974 are also developed and discussed.
In Section IV the emphasis shifts to the adjustment
problem of selected individual CBs.
In any industry, it is the
-5-
Itmarginal" firms--those firms with relatively high costs, or inadequate
revenues--that determine the flexibility of the industry in adjusting
to changes in the competitive and regulatory environment.
The effect
of NOW accounts on costs and earnings of 40 such marginal banks in the
two states are therefore analyzed for 1974 and 1975.
Moreover, adjustments
in asset portfolios are considered to determine whether these banks have
attempted to offset lower earnings by undertaking more risky investments.
In Section V, characteristics of the steady state--the period
after which the industry has had ample time to adjust fully to NOW accounts--are discussed, including implications for increased efficiency
in the allocation of resources and the extent to which the public
S.nefits, on balance, from the issuance of NOW accounts.
In addition,
future CB adjustment problems are considered as NOW balances continue
to grow toward some equilibrium level.
Summary and Conclusions
Although NOWs represent a relatively expensive source of funds,
banks began to compete aggressively for such deposits in 1975, despite low
rates of return on money market instruments and weak demand for business
loans.
As a result, NOW related flows of funds have had only amodest effect
on the CB share of total deposits in Massachusetts and New Hampshire.
By
the end of 1975, two full years after the NOW experiment began, households
in the two states had converted an estimated $370 million in CB demand
S.lances to NOW accounts at thrifts.
However, there is no evidence that
significant flows of time and savings deposits have accompanied this demand
outflow from CBs.
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Federal Reserve Bank of St. Louis
Thus, NOW induced shifts in deposit flows, confined
mainly to demand deposits, appear to have reduced the CB share of
deposits in the two states--which total nearly $40 billion--by about
one percentage point.
The effects of NOWs on aggregate CB costs and earnings are
limited by the relatively small size of the NOW market in the two states-demand balances eligible for conversion to NOW accounts, for example,
represent less than 15 per cent of total deposits at CBs.
In 1974,
higher costs and deposit outflows associated with NOWs reduced aggregate
CB after tax earnings an estimated 2-1/2 per cent.
Heightened consumer
awareness of NOWs by 1975 caused an acceleration in the growth of these
deposits, resulting in substantial increases in bank costs of funds.
As
a result, the estimated earnings reduction attributable to NOWs in 1975
was more than twice that of 1974.
It is argued in the final section that after all adjustments
are complete--a process that may take several more years--CB costs of
acquiring transactions balances could ultimately decline as a result of
removing the restriction against the payment of interest on such funds.
Given this expectation--which implies that both consumers and banks will
be better off in the long run--and the accumulating evidence that NOWs have
not reduced significantly either CB market shares or after tax earnings at
the aggregate level, it would appear that the NOW experiment has been an
almost unqualified success to date.
However, an examination of the earnings of those banks that
appear to be most vulnerable to competitive pressures from NOWs--the
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Federal Reserve Bank of St. Louis
-7-
"marginal" banks--revealed that the earnings performance of such banks
deteriorated significantly in 1975 relative to that of other banks in
the two states.
In the next few years the earnings prospects for many
marginal banks in Massachusetts and New Hampshire, which tend on average
to be relatively small, may worsen as conversions and outflows of demand
deposits continue.
Though NOWs may be only one of many contributing
factors, some weaker banks could eventually experience serious financial
difficulties if NOW pressures on costs and revenues continue.
In the
event such difficulties should disrupt financial markets, the final
verdict on NOWs may be less optimistic than the 1974-75 aggregate figures
would suggest.
However, the likelihood of such disruptions is probably
small because the link between the disappearance or enforced merger of a
limited number of weak banks, which is an uncertain event itself, and
the stability of financial markets, is very difficult to establish.
II.
FLOWS OF FUNDS AND MARKET SHARES
The share of the NOW market held by CBs, shown in Table 1,
has risen steadily since the beginning of the NOW experiment, reaching
43 per cent by the end of 1975.
MSBs held 46 per cent of all NOW
balances at that time, while savings and loan associations and cooperative banks (S&Ls and Coops) held the remaining 11 per cent.
During 1974,
CBs and MSBs each captured 41 per cent of net new NOW balances, with S&Ls
and Coops attracting 18 per cent.
In contrast, in 1975 CBs acquired 56
per cent of the increase in NOWs, while MSBs and S&Ls and Coops received
33 and 11 per cent, respectively, of net new inflows.
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Federal Reserve Bank of St. Louis
•
TABLE 1
WITHDRAWAL (NOWs)
OUTSTANDING BALANCES AND SHARES - NEGOTIABLE ORDERS OF
(in thousands of dollars)
COMMERCIAL BANKS
MONTH
ENDED
1972--Sept.
Oct.
Nov.
Dec.
1973--Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
1974--Jan.
Feb.
Mar.
Apr.
MaJue
July
Aug.
Sept.
Oct.
Nov.
Dec.
175--Tan.
,Pb.
Mar.
Apr.
May
Jiine
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Federal Reserve Bank of St. Louis
Aug.
Sept.
Oct.
Nnv.
Dec.
TOTAL OF ALL
OFFERING
INSTITUTIONS
11.094
22,386
34,823
45,272
60,726
73,451
86,118
94,606
102,045
108,381
113,418
117,005
120,223
130,361
136,872
143,254
143,190
150,447
165,157
174 682
180,637
191,229
204.646
232.386
249,033
270,813
293,305
312,576
339,982
385,190
449,638
472,864
514,018
580,331
630,402
670,790
713,419
761,967
796,533
839,339
TOTAL
2,556
4,338
6,588
9,689
11,052
13,771
17,919
32,955
39.253
46,776
55,994
65,249
82,861
107,481
137,519
150.999
172,653
210,838
233,513
256,992
289,308
305,214
325,519
359,023
MASS.
2,274
3,857
5,916
8,458
9,296
11,156
14,175
28,450
33,597
40,245
48,563
56,989
73,517
96,647
124,706
136,165
155,318
185,923
201,607
217,936
235,029
254,821
271,691
302,112
N.H.
282
481
672
1,231
1,756
2,615
3,744
4,505
5,656
6,531
7,431
8,260
9,344
10,481
12,813
14,834
17,335
24,195
31.096
39,056
45,279
50,393
53,828
56,911
SHARE
OF
TOTAL
NOWS
.02
.03
.04
.06
.06
.07
.09
.14
.16
.17
.19
.21
.24
.28
.31
.32
.34
.36
.37
.38
.39
.40
.41
.43
MUTUAL SAVINGS BANKS
TOTAL
11,094
22,386
34,823
45,272
60,726
73,451
86,118
94,606
102,045
108,381
113,418
117,005
120,223
130,361
132,872
143,254
139,779
143,764
154,007
157,412
159,591
164,733
171,503
180,335
187,721
197,758
206,764
213,661
220,725
236,580
262,797
268,571
283,322
304,633
327,417
337,684
351,612
368,271
378,792
386,560
MASS.
N.H.
11,094
22,386
460
34,363
750
44,522
1,065
59,661
1,476
71,975
1.956
84,162
2,265
92,341
2,412
99,633
2,693
105,688
2,932
110,486
3,153
113,852
3,964
116,259
4,488
125,873
5,077
131,795
5,226
138,028
4,947
134,832
5,311
138,453
6,162
5
147,84
7,103
150,309
8,081
0
151,51
8,787
155,946
9.959
161,544
11,216
169.119
175,340 12,381
184,830 12,928
192,577 14,187
200,083 13,578
206,797 13,928
221,506 15,074
246,259 16,538
250,780 17,791
263,978 19,344
283,134 21,499
303,805 23,612
213,117 25,567
324,005 27,607
338,580 29,691
347,145 31,647
356,319 30,241
SHARE
OF
TOTAL
NOWS
SAVINGS & LOAN ASSOCIATIONS SHARE
OF
TOTAL
NOWS
N.H.
MASS.
TOTAL
a
CO
.98
.96
.93
.90
.90
.86
.84
.78
.75
.73
.71
.68
.65
.61
.58
.57
.55
.53
.52
.50
.49
.48
.48
.46
855
2,345
4,562
7,581
9,994
12,725
15,224
19,096
22,059
26,279
30,547
33,666
36,396
41,482
49,322
53,294
58,043
64,860
69,472
76,114
81,499
88,482
92,222
93,756
855
2,345
4,325
6,913
8,351
11,089
13,223
16,781
19,314
23,316
26,689
29,747
32,369
37,215
43,980
47,185
51,388
57,315
61,554
67,519
72,407
78,785
81,863
84,168
237
' 668
1,143
1,636
2,001
2,315
2,745
2,968
3,858
3,919
4,027
4,267
5,342
6,109
6,655
7,545
7,918
8,595
9,092
9,697
10,359
9,598
.01
.02
.03
.04
.05
.07
.07
.08
.09
.10
.10
.11
.11
.11
.11
.11
.11
.11
.11
.11
.11
.12
.12
.11
•
-9-
The success of CBs in 1975 in attracting
or retaining NOW
funds can be attributed in part to the large increase in the number of
offering institutions relative to that of MSBs.
In 1975, the number of
CBs offering NOW accounts increased from 64 to 134, while the number of
offering MSBs rose only from 157 to 175.
Though a large number of S&Ls
and Coops entered the NOW market in 1975, their ability to attract NOW
balances has been limited by the relatively small size of these institutions in the two states.
Source of NOW Funds
Establishing the source of NOW funds--whether demand deposits,
time and savings deposits, or other--is of considerable importance in
examining NOW related market share developments and, as will be shown in
Section III, in estimating the aggregate earnings impact of NOWs on CBs.
One important type of evidence on this matter concerns the behavior of
active NOW accounts and the proportion of NOW funds in active and inactive
accounts.
Draft activity against active NOW accounts (i.e., those with at
least one draft drawn in a given month) has increased gradually during the
experiment and now averages about 11 drafts per month.
Since the average
number of checks written against personal checking accounts in New England
in 1974 was about 14, this suggests that active NOW accounts are being
used primarily as checking accounts.
As a first approximation it thus seems reasonable to assume
that funds in active NOW accounts were acquired largely from demand deposit balances.
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If, as seems plausible, inactive NOW funds originated
-
primarily in sources other than demand deposits--especially time and
savings deposits--then total active NOW balances can serve as an
estimate of the amount of NOW funds that were converted, or diverted,
from demand deposits.
Though there are no data on active and inactive balances,
estimates can be obtained from data on the number of active and inactive
NOW accounts in the two states.
In December 1975, there were 764,984
NOW accounts at banks and thrifts in Massachusetts and New Hampshire,
of which 157,136--or 21 per cent--were inactive.
If the average
balance in these inactive accounts was equal to the average balance in
savings accounts in CBs in New England, which is $1100, then inactive
balances totaled some $170 million in December, or about 20 per cent of
2/
total NOW balances.
This leaves
$670 million, or about 80 per cent,
1/
Of course, the 157,136 inactive accounts include some that were
active in earlier months; likewise, some of the accounts that
were active in December were inactive in one or more previous
months. However, it is believed that the number of drafts
written against each account is relatively stable from month-tomonth, so that membership in the two classes of accounts--active
and inactive--is also relatively stable. A necessary (though
not sufficient) condition for stable membership in the two
classes is that the percentage of inactive accounts must be
relatively stable. This condition is satisfied adequately in the
two states where the percentage of inactive accounts has
fluctuated narrowly from month-to-month while declining from 26
per cent in mid-1974 to 20 per cent in December 1975.
2/
Passbook savings balances in thrifts average between $2000 and
$3000 in Massachusetts and New Hampshire. However, those savings
balances that were converted to NOWs can be expected to be much
smaller than this average because of the one-fourth percentage
point loss in earnings which becomes significant for large accounts.
Moreover, many of the larger savings accounts at thrifts are held
by businesses and are therefore ineligible for conversion to N0Ws.
Thus, the $1100 figure is applied to both thrifts and CBs.
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Federal Reserve Bank of St. Louis
-11--
in active balances.
This estimate of the proportion of NOW balances
attracted from demand deposits is similar to those offered by banking
industry representatives in Massachusetts.
In Table 2, estimated active and inactive balances are shown
for CBs and thrifts in December 1975.
As shown in column 3, thrifts
held an estimated $370 million in active NOW balances in December.
These funds, serving largely as checking balances,-'
been obtained primarily from CB demand balances.
appear to have
Of the $110 million
in inactive accounts at thrifts, an undetermined part was no doubt
obtained from CB time and savings deposits, with most of the remainder
representing conversions from time and savings at thrifts.
This
TABLE 2
ESTIMATED ACTIVE AND INACTIVE NOW BALANCES
($ in millions)
December 1975
Massachusetts
and
New Hampshire
359.0
61.4
297.6
MSBs
386.6
89.6
296.9
93.8
21.8
71.9
839.3
172.8
666.5
TOTAL
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Federal Reserve Bank of St. Louis
Estimated
Active
Balances
CBs
S&Ls & Coops
3/
NOW
Balances
Estimated
Inactive
Balances
Draft activity against active NOW accounts at thrifts averages about
9% in the two states, only slightly below the average at CBs.
-12-
suggests that approximately $400 million of NOW balances currently
held by thrifts originated in CB deposits.
Market Shares of Total Deposits
The direct effect of NOW accounts on market shares in the
two state area, where deposits at CBs and thrifts total nearly $40
billion, thus amounts to a one percentage point reduction in the
45 per cent share held by CBs.
Although this represents a relatively
modest reduction in the market share of CBs, the indirect effect of
NOWs on such shares must also be considered before any judgment can
I- reached on whether major shifts are under way.
This indirect effect involves the spread of convenient one
stop banking to thrifts.
By permitting thrifts to issue what is
essentially a demand deposit, CBs could conceivably lose large amounts
of time and, especially, savings deposits as demand deposit funds are
S iverted to thrifts.
Commercial bankers are particularly worried
about this possibility in view of the one-fourth percentage point
advantage thrifts can offer on passbook savings.
The evidence on this issue indicates that no such shift in
deposits between institutions has occurred, as yet.
In the upper half
of Table 3 market shares of passbook savings excluding NOWs are shown
for the last four Call Report dates, beginning in DecemI,•fore the NOW experiment began.
the passbook
As shown in the table, CBs' share of
savings market, in as
Massachusetts and New Hampshire,
has actually grown during the NOW experiment.
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Federal Reserve Bank of St. Louis
In MassachusetLs the
-13-
TABLE 3
MARKET SHARES OF DEPOSITS HELD BY MAJOR DEPOSITORY
INSTITUTIONS IN MASSACHUSETTS AND NEW HAMPSHIRE
June
1970
Dec
June
Dec
June
1974
1974
1973
1972
PASSBOOK SAVINGS EXCLUDING NOWs
June
1975
Massachusetts (dollars
in ii.,,
13,605
13,815
12,906
13,680
12,882
13,695
Percentage held by
CBs
MSBs
S&Ls
11.9
79.5
8.6
15.5
75.2
16.7
73.8
16.5
74.6
17.7
73.3
19.1
72.6
1,632
1,702
1,784
1,835
1,807
1,937
16.7
68.3
15.0
24.7
59.9
15.4
27.1
57.8
15.1
29.0
55.9
15.1
29.5
55.4
15.1
30.0
54.9
15.1
New Hampshire (dollars
in millions)
Percentage held by
CBs
MSBs
S&Ls and coops
TOTAL DEPOSITS
(dollars
in millions)
ffT,
Percentage held by
CBs
MSBs
S&Ls
New Hampshire (dollars
in millions)
21,886
26,856
30,771
31,302
31,819
32,273
43.8
49.6
6.6
43.0
50.3
6.7
45.8
47.8
6.4
46.4
47.2
6.5
46.5
47.1
6.4
43.7
49.5
6.8
2,242
2,850
3,326
3,430
3,462
3,685
36.5
50.3
13.2
41.3
44.9
13.8
42.5
43.7
13.9
42.7
43.3
14.1
42.9
42.8
14.3
41.9
43.5
14.6
Percentage held by
CBs
MSBs
S&Ls and coops
NOTE:
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Federal Reserve Bank of St. Louis
MSB and CB data are from Assets and Liabilities of Commercial and Mutual
Savings Banks (FDIC) with the exception of Massachusetts MSB data which
are from Monthly
were obtained from the NAMSB in New York. S&L.i.
Financial Data (FSLIC).
-14-
share of passbooks held by CBs increased from 16.7 to 19.1 per cent
between December 1973 and June 1975, while New Hampshire CBs have increased their share of this market from 27.1 to 30.0 per cent during
this period.
CBs have made significant gains in the passbook savings
market during the last twenty years, and this evidence suggests that
NOW accounts have not significantly retarded this progress.
Comparisons of total market shares are of limited value, since
CBs, unlike thrifts, obtain a relatively large and variable part of their
deposits from the issuance of large Certificates of Deposit.
Data on
total deposits are, nevertheless, presented in the bottom half of Table 3.
Although the CB share of total deposits declined from 46.4 to 43.7 per cent
between mid-1974 and mid-1975, this share remains nearly a percentage point
above its June 1972 level--recall that NOW accounts have been issued by
MSBs in the two states since mid-1972.
In New Hampshire, the market
share of CBs has remained relatively stable over the 1974-75 period, as
CBs in that state have successfully protected the gains made in market
shares in the early seventies.
On the basis of this evidence it appears that, to date, no
significant shifts have occurred in market shares beyond those arising
directly from transfers of CB deposits into active NOW accounts at
thrifts.
delayed
However, the possibility of such a shift, occurring on a
basis, cannot be totally ruled out, particularly if consumers
adjust slowly to changing conditions in financial markets.
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III. EFFECTS OF NOW ACCOUNTS ON AGGREGATE
COMMERCIAL BANK COSTS, EARNINGS, AND PORTFOLIOS: 1974-1975
In attempting to establish a permanent share of the NOW
market, CBs in Massachusetts and New Hampshire have absorbed higher
costs through the conversion of demand deposits to NOW accounts and
have thus experienced a reduction in net earnings.
Moreover, CB
net earnings have been further reduced by the loss of relatively
profitable demand deposit funds to thrifts offering NOWs.
Estimates
of the effect of NOWs on aggregate CB earnings must therefore include
both the inhouse cost of converting noninterest bearing demand deposits
to NOWs, as well as earnings reductions associated with NOW related
outflows of demand deposits.
In the remainder of this section rough estimates are
produced which, it should be emphasized, are indicative only of basic
magnitudes.
For reasons to be discussed later, these estimates are
probably biased in the sense that the true depressing effect of NOWs
on CB earnings is more likely to be smaller than the estimates, rather
than larger.
Incremental Costs of NOWs
In estimating the added costs to CBs of acquiring and
retaining NOW funds, costs of converting time and savings deposits
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
-16-
to NOWs are ignored, since such costs are likely to be small.
Thus
incremental costs are calculated by multiplying estimated NOW balances
at CBs which were converted from demand deposits by the difference
between the average cost of NOW funds and that of demand deposit
funds.
For this purpose, active NOW balances at CBs, as calculated
in Section II, will be used to estimate the level of conversions
from demand deposits to NOWs.
For nonmember banks the average cost of NOW funds is equal
approximately to the sum of the interest payment, which averages
4/
In equating conversions of demand deposits to estimated active
NOW balances, the consolidation of savings and demand deposit
accounts into one active NOW account creates a minor problem,
since treating the balance in the active NOW account as originating
in a demand deposit causes an upward bias in the estimated level
of demand deposit conversions. Because average NOW balances at CBs
significantly higher than at thrifts--$1600 at CBs to $900 at
thrifts--it might appear that the effect of account consolidation
on average NOW balances at CBs is large. However, this is somewhat misleading, since NOW accounts at CBs include conversions of
so called D/B/A--"doing business as"--demand deposit accounts of
sole proprietorships. These accounts typically carry very large
balances ranging up to $50,000 and more. According to knowledgable observers, most of these D/B/A accounts have been
converted to NOWs, thereby raising NOW average balances relative
to those of demand deposits. For a few CBs whose D/B/A accounts
were examined, average NOW balances after excluding D/B/A
accounts were much smaller and more consistent with average
demand deposit balances. Thus, the effect on average balances
of consolidating savings and demand deposit accounts into one
active NOW account may be quite small, and active NOW balances,
as calculated in Section II, probably serve as a reasonably
accurate, though slightly biased estimate of demand deposit
conversions.
ii
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Federal Reserve Bank of St. Louis
-17nearly 5 per cent, and the net cost of servicing NOW accounts.
This
latter cost consists mainly of expenditures on account maintenance
(statement preparation, etc.) and costs associated, to a lesser
extent, with clearing drafts and handling deposits to NOW accounts.
For Federal Reserve members, the NOW cost is equal to this sum, less
the earnings from funds released by the lower required reserve ratio
on NOWs relative to demand deposits.
The per dollar marginal cost of demand deposit funds is
approximately equal to the net cost of servicing demand deposit accounts.
This service cost is similar to that of NOW accounts, though
probably slightly smaller because a higher proportion of CBs offer
free checking than offer free NOWs.
If the service cost differential
is ignored because of its relative smallness, the incremental cost of
NOW funds converted from demand deposits is equal to the rate of
interest on NOWs minus, where applicable, the additional earnings
frS m lower reserve requirements against NOWs.
In calculating incremental costs, the interest rate on
NOWs is set at 5 per cent and the 3 month Treasury bill rate is used
to measure earnings from lower reserve requirements for member banks.
These estimated costs are presented in Table 4 on a monthly basis
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Federal Reserve Bank of St. Louis
-18-
1/
beginning in January 1974.
For 1974, the estimated incremental cost
of NOWs totaled $830,000, while for 1975, this total is $9.3 million,
reflecting the large growth in NOW balances at CBs this past year.
In 1974, before tax CB earnings in Massachusetts and New Hampshire
totaled $194 million, while in 1975 such earnings totaled $124 million;
thus estimated incremental costs were about equal to one-half per
cent of 1974 earnings, while 1975 incremental costs are estimated to
I- about 7/
1
2 per cent of such earnings.
incremental costs were equal
By 1975 year-end, moreover,
to about $14 million at an annual rate
($1.182 million times 12), or about 11 per cent of 1975 earnings.
As noted earlier, however, there are several reasons
why these estimates probably overstate actual incremental costs.
First, the small savings on service charges of NOWs relative to
demand deposits are ignored and, second, active balances are used
to estimate demand deposit conversions and this estimate is biased
upward.
Also, the consolidation of savings and demand deposit
accSunts into a single NOW account reduces CB's costs, since the
I.intenance cost of a NOW account is smaller than the sum of the
costs of maintaining separate demand and savings deposit
accounts.
5/ Syillmbolically, the per dollar NOW cost for a Federal Reserve member
bank can be expressed as:
wherethe interest rate paid on NOWs, sn is the annual cost
per dolar
of servicing a NOW account, r is rate of interest on
Y
some asset into which the funds derived from the lower NOW reserve
requirements will be invested, and the constant .07 is the difference
between the average reserve requirement against demand deposits and
NOW accounts. If s is ignored on the grounds that NOW service
cS sts are similar t8 those of demand deposits, the incremental cost
of NOW funds is equal to in - .07 r for Federal Reserve members,
and to i for nonmembers. These expressions are used in calculating
estimateR c5sts in Table 4.
-19TABLE 4
ESTIMATED INCREMENTAL COSTS TO CBs OF NOW ACCOUNTS
(in thousands 0
1974-Jan
MEMBER BANKS
Monthly
Incremental IncreActive
mental
Cost
Balances per Dollar Cost
1,215.5
4.5
.00371
NONMEMBER BANKS
Monthly
TOTAL
Incremental IncreCB
Cost
mental Incremental
Active
Cost
Cost
Balances per Dollar
6.7
'2-.2
.00417
519.9
Feb
1,129.5
.00375
4.2
1,412.2
.00417
5.9
10.1
Mar
2,010.1
.00370
7.4
2,685.9
.00417
11.2
18.6
Apr
2,770.8
.00369
10.2
4,392.6
.00417
18.3
28.5
May
3,148.1
.00367
11.6
4,704.0
.00417
19.6
31.2
Jun
4,279.7
.00360
15.4
5,691.9
.00417
23.7
39.1
Jul
6,783.7
.00371
25.2
7,032.3
.00417
29.3
54.5
Aug
12,588.0
.00366
46.1
7,838.6
.00417
32.7
78.8
Sep
11,554.0
.00368
42.5
16.528.0
.00417
68.9
111.4
Oct
11,524.0
.00374
43.1
18,815.0
.00417
78.5
121.6
Nov
15,756.0
.00372
58.6
21,449.0
.00417
89.4
148.1
Dec
19,994.0
.00375
75.0
25,168.0
.00417
104.9
179.9
828.9
1975-Jan
31,248.0
.00379
118.4
29,175.0
.00417
121.7
240.1
Feb
46,098.0
.00384
177.0
34,810.0
.00417
145.2
322.2
Mar
62,754.0
.00384
241.0
45,720.0
4.00417
190.7
431.6
Apr
70,121.0
.00383
268.6
51,462.0
.00417
214.6
483.2
May
80,021.0
.00386
308.9
60,001.0
.00417
250.2
559.1
Jun 103,083.0
.00386
397.9
68,747.0
.00417
286.7
684.6
Jul 118,220.0
.00381
450.4
75.699.0
.00417
315.7
766.1
Aug 127,962.0
.00379
485.0
83,326.0
.00417
347.5
832.5
Sep 140,017.0
.00379
530.7
92,286.0
.00417
384.8
915.5
Oct 153,315.0
.00381
584.1
99,918.0
.00417
416.7
1,000.8
Nov 163,813.0
.00385
630.7
107,302.0
.00417
447.4
1,078.1
Dec 183,221.0
.00385
705.4
114,385.0
.00417
477.0
1,182.4
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Federal Reserve Bank of St. Louis
9,325.0
-20--
Reductions in Earnings from Demand Deposit Outflows
The second way in which NOW accounts can reduce CB earnings
is through the loss to thrifts of funds which would otherwise have
provided positive net earnings for CBs.
As noted earlier, the major
identifiable loss of CB funds amounts to about $370 million in demand
deposit balances through December 1975.
In attempting to estimate earnings reductions at CBs attributable to NOW induced outflows of funds, active NOW balances at thrifts
are used to approximate demand deposit outflows.
Savings deposit out-
flows, which are essentially unknown, are ignored because the earnings
from such funds would have been small, especially in 1975 when market
interest rates were low, relative to those of demand deposits.
For nonmember banks, per dollar earnings on demand deposits
are equal to the average yield on invested funds minus the net cost of
acquiring such funds (in the case of demand deposits, the cost of servicing an average account).
/
For Federal Reserve member banks, net
earnings on demand deposit funds are equal to the average yield on
invested funds multiplied by 0.9 (the proportion, on average, of each
demand deposit dollar that can be invested after reserve requirements
are met) minus the net cost of acquiring funds.-'
6/
7/
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Federal Reserve Bank of St. Louis
Of course, nonmember banks maintain small precautionary reserves
against deposits. Since such reserves are negligible, they are
ignored in all calculations
Symbolically, net demand deposit earnings for member banks are
expressed by rD(1 -rr) -sD = [r(1 - rr) -s]D, where r is the yield
on invested funds, rr is the average reserve requirement against
demand deposits, s is the service cost per dollar of demand balances,
and D is the stock of demand deposits. This expression also holds
for nonmember banks, of course, with rr = 0.
-21-
Studies by Donald Hester and James Pierce indicate that a
high proportion of demand deposit funds are invested in short-term
market securities; thus the Treasury bill rate was used to measure
13!
the yield on demand deposit funds lost to thrifts.
The average cost
of servicing a demand deposit account was, somewhat arbitrarily, set
at 3 per cent of the average balance.
This rough estimate is based on
functional cost data from the Federal Reserve Bank of Boston.
These
data indicate the cost of servicing a checking account in New England
averages between 3 and 4 per cent.
Since a substantial portion of CBs
in Massachusetts and New Hampshire offer free checking (implying only
a small part of servicing costs are born by customers), 3 per cent was
chosen as the average net cost of servicing such deposits.
Estimates of the earnings reduction attributable to NOW
induced demand deposits outflows are presented in Table 5.
For each
month the estimated total outflow is shown for both member and nonmember
banks.
These outflows are cumulative--that is, they include all funds
lost in previous months as well as those lost in the current month.
For both member and nonmember banks, estimated outflows are multiplied
by monthly per dollar earnings on demand deposit funds to obtain an
8/
9/
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Federal Reserve Bank of St. Louis
See Hester, Donald and James L. Pierce, Bank Management and Portfolio
Behavior, Yale University Press, 1975.
This method of calculating demand deposit earnings implies the
marginal return on demand balances exceeds the average return on all
balances. Although for a hypothetical bank issuing only one type of
deposit, the marginal return should be below the average return,
such a relationship need not hold for any particular type of deposit
for banks issuing more than one type of deposit.
-22TABLE 5
ESTIMATED LOST EARNINGS FROM DEMAND DEPOSIT OUTFLOWS
(in thousands $)
1974-Jan
Feb
MEMBER BANKS
CB EARNINGS
NONMEMBER BANKS
Monthly
Monthly
Cumulative
Cumulative
Reduction
Lost
from
Earnings
Estimated
Lost
Earnings
Estimated
Outflows Per Dollar Earnings Outflows Per Dollar Earnings Outflows
94,209
17,735
.00396
.00332
312.4
70.3
382.7
95,314
.00279
266.4
60.8
17,959
.00338
327.2
Mar
103,085
.00349
359.7
19,456
.00415
80.8
440.6
Apr
105,906
.00367
388.9
20,026
.00436
87.3
476.1
May
107,994
.00382
412.8
20,478
.00453
92.7
505.5
Jun
111,187
.00361
401.3
21,121
.00429
90.6
491.8
Jul
116,941
.00331
387.5
22,264
.00396
88.2
475.7
Aug
122,692
.00406
497.9
23,404
.00479
112.0
609.9
Sep
127,487
.00377
480.9
24,368
.00447
108
91:4
9
4
58
89
7,8
9
Oct
135,191
.00293
396.5
25,838
.00354
Nov
143,460
.00319
457.5
27,469
.00382
104.9
562.4
Dec
151,598
.00288
437.2
28,949
.00348
100.8
538.1
5,887.6
1975-Jan
155,605
.00237
368.7
28,376
.00291
Feb
170,420
.00169
287.5
31,075
.00215
Mar
195,432
.00166
324.0
35,646
Apr
206,168
.00177
365.0
May
219,731
.00149
Jun
236,247
Jul
82.6
451.3
.00212
676:96
5
59
416
4
39
37,647
.00225
84.5
449.5
326.6
40,128
.00193
77.4
404.0
.00139
329.5
43,193
.00183
78.9
408.4
252,305
.00212
535.6
46,079
.00264
121.5
657.1
Aug
257,973
.00235
605.5
47,222
.00289
136.3
741.8
Sep
276,384
.00229
632.2
50,622
.00282
142.7
774.9
Oct
293,152
.00206
604.1
53,729
.00257
137.9
742.1
Nov
303,838
.00160
A86.4
55,725
.00206
114.6
601.1
Dec
311,801
.00163
507.6
57,082
.00209
119.1
626.7
6,611.0
NOTE:
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Federal Reserve Bank of St. Louis
Outflows from memb2r and nonmember CBs are assumed to be proportional to
market shares of demand deposits (averaged over each year) of these banks.
For example, if member CBs held 80 per cent of demand deposits in a given
year, then 80 per cent of active balances at thrifts for that year are
assumed to have come from member banks and the remaining 20 per cent from
nonmembers.
-23-
estimate of earnings lost each month.
For 1974, these estimated earnings
reductions totaled $5.9 million, which is much larger than the 1974 estimate of incremental costs from Table 4.
This, of course, reflects the
fact that thrifts--especially MSBs--held a large percentage of active
NOWs in 1974.
The 1975 estimated earnings reduction from demand deposit
10
outflows, shown at the bottom of Table 5, totaled $6.6 million.--I
After Tax Reduction in Earnings
Adding the estimates of incremental costs of conversion of
demand deposits to NOWs at CBs to the reduced earnings from demand deposit
outflows from CBs to thrifts yields a rough estimate of the total before
tax reduction in earnings attributable to NOW accounts.
For 1974 this
total was $6.7 million, while for 1975 the total was $15.9 million.
To obtain an after tax reduction in earnings it is necessary
to reduce these figures by the amount of the tax savings accruing from
lower CB earnings.
In 1974 more than 90 per cent of Massachusetts and
New Hampshire CBs had before tax earnings exceeding $25,000.
The mar-
ginal tax rate for these banks was therefore 48 per cent, while for the
remaining banks the marginal rate was either 25 or zero per cent,
depending on whether earnings were positive or negative.
10/
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Federal Reserve Bank of St. Louis
The weighted
Concerning the robustness of these estimates to changes in the
assumed average balance in inactive accounts, if instead of $1100
this average was twice as large--$2200--the earnings reduction
from demand deposit outflows would have been about 30 per cent
smaller. For example, assuming a $2200 average balance in inactive
accounts at thrifts reduces estimated active balances from $370
million to $260 million in December 1975. Thus, earnings reductions from demand deposit outflows would be only 26/37, or about
70 per cent, of those shown in Table 5 for that month.
-24-
average of these marginal rates, with weights equal to the proportion
of banks in each class, is equal to about 44 per cent.
Reducing the
estimated $6.7 million 1974 earnings reduction by this amount produces
an after tax reduction in earnings of $3.8 million.
Since after tax
profits in Massachusetts and New Hampshire totaled $142 million in 1974,
this represents a reduction in total after tax earnings of a little
over 2% per cent.
For 1975 the weighted average marginal tax rate for Massachusetts and New Hampshire banks was 40 per cent.
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Reducing the $15.9
milliS n 1975 before tax earnings reduction by this factor thus produces
an after tax reduction of $9.5 million.
Total after tax earnings in
the two NOW states declined by $35 million to $107 million in 1975.
NOWs thus appear to account for a little more than one-quarter of the
earnings drop in the two states last year.
IV.
ADJUSTMENT PROBLEMS OF INDIVIDUAL BANKS
Analysis of aggregate data suggests that at worst, industrywide earnings in Massachusetts and New Hampshire may have been depressed
by a few percentage points in 1974 and 1975 by the introduction of NOW
accounts.
Consequently, the industry IS
I.rticularly serious adjustment problems.
often conceal important information.
not appear to be experiencing
However, aggregate data can
In particular, when an industry
is adjusting to a change in basic costs or revenues, certain segments
S f that industry--those so-called marginal firms--may suffer disproportionately high losses of earnings and capital.
The adjustment
A
-25-
experience of these firms can often reveal far more about the stability
of the industry than aggregate S.
The remainder of this section is therefore devoted to a study
of costs, earnings, and portfolio adjustments of selected banks whose
earnings and capital positions appear to be most vulnerable to NOW
related changes in costs and revenues.
The banks selected for special
attention--40 of the 226 banks in the two states--belong to at least
one of the following categories:ratio" banks, defined as
those banks having 10 per cent or more of total deposits in NOW accounts
in June 1975, (2) "runoff" banks, defined as those banks not offering
NOWs in mid-1975 and experiencing significant losses of demand deposits
between January 1974 and June 1975, and
earnings" banks, defined
as those banks offering NOWs in mid-1975 with 1974 before tax earnings
to total deposit ratios in the lowest 20 percentile in the two states.
These 40 banks tend to be relatively small--the median bank having only
million in deposits--and include only one very large bank.
High Ratio Banks
In June 1975, there were eight "high ratio" CBs--banks with
more than 10 per cent of total deposits in NOW accounts.
Five of these
I.nks were either established banks with a history of aggressive management prior to the introduction of NOW accounts, or were new banks.
In interviews conducted by the Federal Reserve Bank of Boston, it was
found that the former group of banks tended to be aggressive in offering
NOWs, often introducing them before their competitors and promoting them
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Federal Reserve Bank of St. Louis
A
-26-
heavily through advertising.
In general, the management of these banks
viewed NOW accounts as a means of increasing their market shares by
attracting new customers.
For these banks, the high proportion of NOWs
resulted from a deliberatet aggressive policy by the banks' management.
The remaining three banks tended to be older banks which
introduced NOW accounts as a defensive measure.
These banks, for one
reasS n or another, found themselves under severe competitive pressures
and were forced to introduce NOWs to maintain their deposit base.
Two of these banks have an abnormally high ratio of personal demand
deposits to total deposits, and thus were particularly vulnerable
to competition from thrifts offering NOWs.
Table 6 displays the recent aggregate earnings pattern of six
of the eight "high ratio" banks--those six that have been in operation
since 1973.
The largest of the six banks had negative earnings in
the 1972-1973 base period, and positive but low earnings in 1974 and
1975.
On balance, the remaining five banks
in 1974, but suffered substantial earnings
increased their earnings
declines in 1975 relative
tS the 1972-1973 pre-NOW base period.
Of the six banks in Table 6, three indicated that their high
cS ncentration of NOWs reflected a deliberate policy of attempting
to increase market shares.
S efensively.
The remaining three banks were acting
It is dcult to judge for any of these banks the
relative importance of NOW costs in the 1975 overall reduction in
high ratio bank earnings.
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Federal Reserve Bank of St. Louis
However, calculations similar to those
-27-
of Section III suggest that one large bank experienced an increase
in NOW costs exceeding $600,000 in 1975, while two other banks lost
at least 10 per cent of 1975 income due to higher NOW costs and outflows of demand deposit funds.
It seems reasonable to surmise that the six high ratio banks-at least in the short run--probably suffered the largest earnings reductions from the NOW experiment.
The three banks that acted defensively
appear to have had little choice in the matter of whether to offer NOWs;
their earnings problems could be severe and could well continue for some
time.
The remaining three banks were also hard hit by higher NOW costs;
however, their aggressive strategies may prove successful in the longer
run.
TABLE 6
SUMMARY OF HIGH RATIO BANK EARNINGS
Average Size
1974 Assets
(in $ Millions)
40.3
Average Ratio
of NOWs to
Deposits
Dec 1975
1972-73 Average
After Tax Earnings per Bank
(in $ Thousands)
23.7
139
Per Cent Change
from 1972-73
After Tax Earnings
1974
1975
42.0
-28.2
Runoff Banks
In contrast to the "high ratio" banks that had a high ratio
of NOWs to total deposits, 16 so-called "runoff" banks lost at least
10 per cent of their demand deposit base between January 1974 and
June 1975 and did not offer NOW accounts over this period.
Of the
16 runoffs, all but three indicated in interviews that they believed
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-28-
demand deposit outflows were at least partly attributable to NOWs.
However, four of the 13 banks that blamed NOWs for demand outflows also
inI icated that their demand deposit losses due to NOWs were very small.
Most of the 16 runoff banks cited added costs as the reason
for not introducing NOWs.
Some banks also indicated that they lacked
necessary computer facilities required to handle NOW accounts and one
S.nk, which IS
not pay the ceiling interest rate on savings accounts,
expressed concern that offering NOWs would cause added expenses by
forcing the savings rate to the ceiling.
Table 7 displays separately the average earnings of those nine
I.nks that felt that NOWs had contributed to demand deposit runoffs
and of the seven banks that believed that NOWs had contributed little
if anything to runoffs.
The earnings records of the two groups of
runoff banks in 1975 are quite similar, with both groups of banks
experiencing one to two per cent increases in 1972-1973 average
earnings.
Over the two years, five banks in each category experienced
lS wer earnings relative to 1972-1973 in at least one year, with one
bank in the latter category suffering lower earnings in both years.
Again it is difficult to judge how much of the earnings impact
of "runoff" banks was due to NOWs.
Generally, the earnings of these
I.nks held up better than those of "high ratio" banks that aggressively
sS ught NOWs or defensively acquiesced in offering NOWs.
However, the
lS ng run earnings potential of runoffs could still be less favorable
than that of the high ratio banks.
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TABLE 7
RUNOFF BANK EARNINGS
1972-73
Per Ceut
Avera8e
Averdge
Size
Reduction After Tax
1974
in Demand
Earnings
Per Bank
Deposits
Assets
12/73-12/75 ($000s)
% Change From
1972-73 After
Tax Earnings
1975
1974
Attributed to NOWs
13.5
22.6
41.2
110.6
1.8
Not Attributed to
NOWs
26.2
19.5
351.0
23.5
1.5
Total
19.0
20.9
176.8
34.9
1.5
Low Income Banks
Low income banks are defined as those banks offering NOWs
in June 1975 whose ratio of 1974 before tax earnings to total deposits
falls in the lowest 20 percentile for the two states.
There were 18
banks in this category, with 13 in Massachusetts and five in New
Hampshire.
These banks all had ratios of before tax earnings to
deposits below 0.7 per cent in 1974, a year in which the two-state
average for all banks was about 1.2 per cent.
As shown in Table 8, the low earnings banks suffered substantial
reductions in earnings in IS
1974 and 1975.
In 1974, 11 of the 18
lS w earners experienced a drop in earnings from 1972-1973, while in 1975
the earnings of 14 of these banks were lower than in 1972-1973.
However,
it cannot be concluded that NOWs were primarily responsible for this
sharp decline in earnings for the low earners, because many of these
S.nks, which were selected precisely because their 1974 earnings were
-3I-
low, suffered from relatively large loan losses in 1974 and 1975.
Generally low 1975 earnings, moreover, appear to reflect a continuation
of 1974 earnings problems as well as increased pressures from NOWs.
TABLE 8
LOW INCOME BANK EARNINGS
Average Size
1974 Assets
(in $ Millions)
Average Ratio
of NOWs to
Deposits
Dec 1975
1972-73 Average
After Tax Earnings per Bank
(in $ Thousands)
141.£3
2.5
657
Per Cent Change
from 1972-73
After Tax Earnings
1974
1975
-26.7
-103.1
* excludes earnings record of largest bank in "low income" group
Summary of Marginal Bank Earnings
Table 9 compares the 1974-75 earnings of the 40 Massachusetts
and New Hampshire marginal banks to those of the remag 186 CBs in
the two states,to CBs in the four other New England states,and to CBs in
the balance of the nation.
From this table it is seen that in 1975
even banks in Massachusetts and New Hampshire not included in the marginal bank category generally performed more poorly than other New England
S. nks.
Part of this poor earnings performance is attributable to NOWs,
since nearly all banks in the two states were affected adversely to varying
degrees by NOW pressures in 1975.
However, as noted in Section III, NOWs
can account for only a small part--an estimated one-fourth--of the drop in
after tax earnings in the two states last y--r.
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Other factors, including
-31-
TABLE 9
Weighted Average Changes
in Earnings
Category
High Ratio Banks
Per Cent Change
in Earnings from
1972-73
1974
1975
42.0
-28.2
Run-off Banks
Runoff attributed to NOWs
Runoff not attributed to NOWs
34.9
110.6
23.5
1.5
1.8
1.5
Low Earnings Banks
Low Earnings Banks - adjusted*
-26.7
-46.2
-103.1
-62.8
All Marginal Banks
All Marginal Banks - adjusted*
-11.8
-10.3
-80.0
-37.8
9.2
-16.6
CB's in Other 4 New England States
16.7
9.8
CB's in 44 Other States
18.5
19.5
Other Banks
186 Other CB's in Massachusetts
and New Hampshire
Excludes earnings record of largest bank in "low income" group
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-32-
large loan losses resulting from the depressed economies of the two
states, presumably account for the remainder of the drop in earnings.
It is clear from Table 9 that the earnings performance of
the 40 marginal banks, particularly in 1975, was significantly worse
than that of other banks, including the 186 Massachusetts and New
Hampshire banks not included in the marginal bank category.
However,
it would be incorrect to attribute this poor earnings performance totally or even largely to NOWs.
According to reports of bank examiners,
the major problem for the low income banks has been excessive loan
losses and inefficient management.
In no case was it concluded in
bank examination reports that NOWs were a principal contributor to the
earnings problems of low earnings banks.
The examiners reports also
indicate that NOWs played a relatively minor role in the overall
earnings reductions of "high ratio" and "runoff" banks.
Indeed, NOWs
were mentioned in only a few of the latest examination reports of the
40 marginal banks and in most cases, the examiner's comments were
limited to factual observations on NOW growth.
More generally, while earnings were clearly lower for the 40
banks selected for special analysis, it does not appear that NOWs
have as yet had a significant adverse effect on the soundness of the
Massachusetts and New Hampshire marginal banks.
However, NOW-related
problems could become severe for some of these banks in the future,
particularly those that, for reasons unrelated to NOWs, are presently
experiencing earnings difficulties.
Reduced revenues from demand
deposit outflows or higher costs associated with conversions of demand
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-33--
balances to NOWs could threaten the already weakened condition of
these banks.
Indeed, although evidence suggests that NOWs per se
did not cause the problems of any of these 40 banks, the NOW experiment appears to have, in the short run at least, exacerbated more
basic problems faced by several banks.
Such banks clearly present
the most difficult problem for the banking system in adjusting to
financial innovations and regulatory changes.
Portfolio Adjustments by Marginal Banks
to offset higher NOW
CBs with earnings problems can attempt
costs and lower earnings in two basic ways:
by lowering costs by
accounts, and by raising
imposing relatively high service charges on NOW
revenues in any number of ways.
As indicated briefly in Section III,
there is limited evidence, mostly of a
judgmental nature, that CB
average than those imposed
service charges on NOW accounts are higher on
small, of increased NOW costs
on demand deposits; thus a part, probably
charges.
are being recovered through higher service
CBs can attempt to increase revenues by raising loan rates.
However, in Massachusetts and New Hampshire, where stiff competition
exists from banks in neighboring states and from money market instruments--including commercial paper--such a strategy would likely be
counterproductive.
CBs can also attempt to raise earnings by including
in their portfolios more risky, higher yielding assets. For example,
a CB can usually increase revenues by selling short-term, highly liquid
•
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Federal Reserve Bank of St. Louis
-34-
assets such as Treasury bills, and using the proceeds to acquire nonprime business or real estate loans.
The problem with this strategy
is that the acquisition of more loans increases both the level of
average earnings and the variation of these earnings.
Increased
variation in earnings, moreover, generally increases the probability
of bank failure.
Thus, portfolio adjustments by CBs attempting to
maintain a target level of earnings are of considerable importance
in examining the stability of commercial banking.
Before reviewing empirical evidence on this matter, it should
be
noted that, on theoretical grounds, costs and portfolio risk
will, under some conditions, be directly related.
11/ Portfolio theory
as developed in the last 25 years, however, suggests that rational
wealth holders seek to balance benefits of higher rates of return
against the disadvantages of additional risk when selecting an
optimal portfolio of assets.
This behavior, though implying under
some conditions that somewhat more risk will be assumed when the return
on bank capital declines, is generally incompatible with attempting to
maintain a target level of earnings independent of portfolio risk
whenever costs or revenues change.
This suggests
a willingness of
bank shareholders to accept somewhat lower earnings in the event of a
temporary increase in costs; thus only modest increases in the riskiness of the bank portfolio may result.
11/
See Carl Gambs, "Interest Bearing Demand Deposits and Bank
Portfolio Behavior", Southern Economic Journal, July 1975.
-35-
The hypothesis that the 40 marginal banks in Massachusetts
and New Hampshire have increased portfolio risk in order to offset
NOW related lower earnings can be examined by using the ratio of loans
to total assets as a very rough measure of risk for each bank.
In the
left panel of Figure 2, ratios of loans to total assets are shown for
each of the three classes of marginal banks.
Since early 1974 these
ratios have been gradually declining, and this would appear to contradict the "target rate of earnings" hypothesis of CB behavior.
However, the economies of Massachusetts and New Hampshire were
depressed during the 1974-75 period, and loan demand was generally weak.
Therefore, a comparison of loan ratios of marginal banks relative to
FIGURE 2
High ratio
Industry less
marginal banks
IMINOT
4
Low income
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Margin 1 banks I/
/\/
—
Runoffs
gn
:1 7
•
-36-
all other Massachusetts and New Hampshire banks is shown in the right
panel of Figure 2.
Because marginal banks experienced greater than
average NOW related earnings losses, it might be conjectured that under
the target rate of return hypothesis their loan to asset ratios might
decline less than that of the industry.
Instead, since late 1974 the
aggregate marginal bank ratio, as shown in the right panel of Figure 2,
has declined more than the industry ratio.
Based on this evidence, the
40 marginal banks IS not appear to have increased the riskiness of their
portfolios, as measured by the ratio of loans to assets, as a result of
the NOW experiment.
V.
THE LONG-RUN ADJUSTMENT PROBLEM OF COMMERCIAL BANKS
Conversion of time and savings deposits to NOW accounts causes
negligible cost increases for CBs.
Thus, the problem banks face in the
long run is that of absorbing, or offsetting, higher costs associated
with conversions from demand deposits to NOWs, and the loss of funds to
thrifts.
Because CBs have become quite successful in retaining NOW
funds, and hence face escalating costs of acquiring funds
in the short
run, the problem of absorbing such costs will be examined in some detail
in the remainder of this section.
Characteristics of the Steady State
The Federal Reserve Board's Demand Deposit Ownership Survey indicates that one-third of all demand deposits are held by households; thus
only about $2 billion of the $6 bon in demand balances in Massachusetts
and New Hampshire could ultimately be converted to NOWs.
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Federal Reserve Bank of St. Louis
In Table 2 it
-37-
was shown that an estimated $670 million of demand depo
sits had been
converted to NOWs as of December 1975.
Thus, approximately one-third
of all eligible transactions balances were at that
time in NOW accounts.
It would be grossly incorrect, however, to attempt to obta
in
an estimate of the effect of NOWs on CB profits in
the steady state-that period after which NOW market shares have stabilized
and CBs have
made all desired adjustments--by multiplying the Dece
mber 1975 estimated
earnings reductions (Tables 4 and 5) by some number such
as 3.
Such a
calculation would be misleading because it ignores
potential adjustments
that CBs can make in competing for NOW funds.
Before the payment of interest on NOWs was permitte
d, CBs
competed for transactions balances by offering supplier
s of funds various
nonpecuniary services, such as free checking, branch
banking, longer hours
of operation, and larger numbers of tellers to redu
ce waiting time.
At
the margin, however, the cost of providing such services
generally exceeds
the value attached to these services by customers.
It is a widely accepted
proposition, for example, that whenever the price
of a service is set at
zero, that service will be consumed by customers
until the value to the
customer of the last unit is zero.
However, there is a positive cost
associated with providing, or producing each service
unit (e.g., the cost
of clearing checks written against a "free" chec
king account is positive
for each check).
Thus, the provision of such services is ineffici
ent in
the sense that valuable resources are used up in prod
ucing services which,
on the margin, have relatively low value.
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By substituting pecuniary returns--the payment of interest
on NOWs--for nonpecuniary services, CBs can eliminate the waste
, or
inefficiencies, associated with providing nonpecuniary services that
have low marginal values relative to cost.--
Indeed, by permitting
the payment of interest on NOW balances, both customers and banks
can
be expected to benefit.
This can be shown by supposing that banks
initially offer free checking services to the public and pay no
interest
on demand deposit balances.
The total return on demand funds derived
by customers is thus equal to the value of check cashing services,
while
the cost to the bank of acquiring demand balances is equal to the cost
of servicing their customers' free checking accounts.
If banks are
allowed to make explicit interest payments to customers with deman
d
funds on deposit, customers will be better off even if they are requi
red
to pay for check cashing services as long as the interest rate
is set
high enough.
Moreover, bank costs can be lowered due to reduced costs
of servicing checking accounts--which are no longer "free" to
customers-if the interest rate is not set too high.
Indeed, it can be shown--see
Appendix A--that there is a range of interest rates for which
both customers and banks are better off--i.e., the total value of
bank services
to the customer, including interest earned, is higher, while
bank costs
of providing these services are lower.
12/
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For the pre-1933 period, when CBs were permitted to pay
interest
on demand balances, banks with higher average interest payme
nts
tended also to have lower average expenses other than inter
est.
This presumably reflects the substitution of pecuniary
for nonpecuniary services by banks offering higher rates of
in-_erest on
deposits. See George Benston,"Interest Payments on Deman
d Deposits
and Bank Investment Behavior," Journal of PitiL1
Ecolomvs.
October, 1964.
-39-
One very important implication of this result--as shown in
Appendix A--is that the cost to CBs of acquiring transactions balances
can conceivably decline if banks are permitted to pay interest on such
balances.
This paradoxical result arises from the fact that removing
a constraint on the way in which banks can compete for transactions
balances allows CBs to select a more efficient (lower cost) strategy
for attracting such funds.
Transition to the Steady State
As previously noted, banks began to compete aggressively for
NOW funds in 1975.
As also noted, continuing competitive pressures may
l
make the transition to the steady state a long, and for many margina
banks, a difficult process.
However, after NOW growth begins to moderate
the aggresand NOW market shares of individual CBs and thrifts stabilize,
sive competition for NOW funds should gradually disappear.
This will prob-
ably occur through a reduction in the level of free nonpecuniary services.
To establish that rational pricing of NOW balances will indeed
occur at some future date, it is necessary to show that the pricing
(including
policy now in effect of offering relatively high rates of return
ty such as a NOW
both pecuniary and nonpecuniary returns) on a new liabili
n
account is neither surprising nor irrational, but represents a short-ru
ted
strategy consistent with maximizing the sum of current plus discoun
future earnings.
13/
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Indeed, it can be shown--see Appendix B--that when the
Early evidence on service charges on NOWs in Vermont, Rhode Island,
Connecticut, and Maine, which began issuing such accounts in March
1976, indicates that depository institutions in those states are
pricing NOWs more in accordance with long-run profit maximizing
criteria. For example, while in Massachusetts and New Hampshire
over half of all issuing institutions offer free NOWs, only about
one-quarter of the issuing institutions in the remaining four New
England states are similarly offering free NOWs.
-40-
future supply of funds arising from a new liability is related positively
to market shares established during the transition period before such
shares have completely stabilized, a bank seeking to maximize the value
of stockholder's equity will temporarily
pay higher rates for these
funds than is consistent with short-run profit maximization.
As market
shares begin to stabilize, moreover, the rate of return offered will
decline to the profit maximizing level.
This implies that current CB
behavior in competing aggressively for NOW funds is not inconsistent
with stockholder objectives, and more important, as the NOW market
settles down", total rates of return offered on NOW accounts will decline.
The major type of nonpecuniary return offered by CBs which
can be easily adjusted is free checking, including free drafts and free
account maintenance.
In table 10, estimates of NOW costs based on
Functional Cost Data from the Federal Reserve Bank of Boston are shown.
Table 10
NOW COSTS FOR A $1000 ACCOUNT
Item
Cost
Number of items
per Month
Monthly
Cost
Annual
Cost
$.09
11
.99
11.88
Deposits made
.15
2
.30
3.60
Outside checks
Handled
.04
4
.16
1.92
2.00
1
2.00
24.00
Total servicing cost per
account
3.45
41.40
Interest cost, $1000.00
Account
4.17
40.00
.,.62
$91.40
Drafts
Account Maintenance
(Statements, etc.)
Total cost per account
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Federal Reserve Bank of St. Louis
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The total annual cost of servicing a NOW account with a $1000 average
balance is about $90, of which nearly half ($41.40) is attributable to
non-interest related costs.
If a 10 cent charge were imposed on drafts,
the cost of servicing an average NOW account would decline to about $80.
Moreover, if account maintenance charges were introduced, this cost would
drop further to about $55.
Since the cost of servicing a free checking
account averages about $40, CBs offering such accounts would thus experience, as the transition period proceeds, only moderate increases in costs
Of acquiring transactions balances if customers are required to absorb
draft and account maintenance charges.
Other adjustments which take longer to make--such as reducing
the number of branches, constructing less elaborate bank buildings, and
the like--will be made later as competitive pressures force CBs to
adopt more efficient strategies for acquiring deposits.
These adjust-
ments, as noted earlier, will lower CB costs and thereby provide a net
gain to the economy through more efficient resource utilization.
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APPENDIX A
REMOVAL OF INTEREST RATE CONSTRAINTS,
BANK COSTS OF ACQUIRING FUNDS, AND
PORTFOLIO RISK*
Suppose that banks can initially offer only non pecuniary
services--free checking, long hours, impressive buildings, etc.--in order
to attract transactions deposits.
The demand for these services is given
by the curve DD in figure A-1, while the MC curve represents the marginal
cost to the bank of providing such services.
Price
FIGURE A-1
A
Quantity
0
Q0
Qi
If the price of non pecuniary services is set at zero--as it is
for all banks that offer free checking--the quantity demanded of such
services will be 0Q1.
The area under the DD curve--the area of triangle
ODQ --thus represents the total value of these services to the customer.
1
The
cost of providing this level of services, ignoring fixed costs, is equal to
the area under the MC curve--the area of OAEQ1.
* It is assumed throughout this appendix that bank customers are relatively
homogenous and that the number of checks written is positively related to
the average balance of each account.
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From figure A-1 it is clear that the cost of providing services
beyond 0Q0 exceeds the value attached to such services by customers.
If
permitted to pay interest on these funds, banks can eliminate this inefficiency, and still provide customers with the same or greater level of
total--pecuniary plus nonpecuniary--services.
Moreover, the cost of
providing this level of services will be lower.
For example, suppose banks charge customers Po for nonpecuniary
services (e.g., check cashing and statement preparation).
The level of
such services "purchased" by customers will then drop to 0Q0, which yields
a net return to customers equal to the area of the triancle PoDB (which
is equal to the area under the demand curve between 0 and Q0 less the
cost paid for services--equal to OP0BQ0).
Suppose further that the
interest rate is set at a level to yield customers a pecuniary return
equal to the area of OP0CQ1.
The total return to customers is then equal
to the area under the demand curve between 0 and Q1 plus the area of the
triangle BCQ1.
The area of BCQ1 thus represents a net gain to customers.
The cost to the bank of providing this higher level of services is equal
to the area under the marginal cost curve between 0 and Q0 plus the area
of the rectangle BCQ1Q0.
This is less than the area under MC between 0
and Q1--the original cost of nonpecuniary services--by the area of BEC.
Thus, by paying this particular interest rate on funds, total returns to
customers are increased, while bank costs have declined.
Moreover, any
interest payment greater than OP0BQ1 but less than OP0BEQ 1 will similarly
raise total returns to customers while lowering bank costs.
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•
-44-
This result can be easily extended to show that the cost of
funds will decline if banks are permitted to pay interest on deposits.
In the northeast quadrant of figure A-2, let the curve CR describe the
relationship between bank costs of providing services and the valuation
of those services by customers.
Next, in the southeast quadrant, let
the curve S represent the customers' supply function of deposits.
This
curve has the usual property that as total returns offered by banks
increase, the supply of funds rises.
C
figure A-2
total Cost
C
CR
CR
a
Co
a
Ds
R
o
Valuation of
Services
(Net Return)
45°
D
o
Ds
The cost of acquiring funds is depicted by the curve C in the
northwest quadrant of figure A-2.
This curve is derived from the CR
and S curves by use of the 45 degree translation line in the southwest
quadrant.
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For example, if bank costs are Co' thc level of services
-45-
offered to customers will be R . According to the supply function S,
o
s .
customers will then supply Do in funds. Thus, deposits totaling D:
as indicated by the point a in the
are supplied when bank costs are C,
S
northwest quadrant.
The payment of interest on deposits shifts the CR curve to
the right to
since, as shown, a higher return to customers can be
achieved by a given expenditure of bank funds.
figure A-2
It is easily seen from
that this shift causes the C curve to shift downward to
Thus, by removing the constraint against the payment of interest on
transactions balances--and thereby permitting banks to adopt a more
efficient strategy for attracting funds--the cost to banks of acquiring
funds will decline.
Finally, the lowering of the C curve has implications for the
amount of portfolio risk a bank will undertake.
1/
It has been shown- in
2J
that if bank owners
the context of a mean-variance portfolio model
have a quadratic utility functiodj the amount of portfolio risk a bank
will undertake rises whenever the risk-return curve shifts downward,
and declines when an upward shift occurs.
The lowering of the C curve
in the steady state would tend to raise the mean-variance curve.
1/
2/
3/
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Thus,
See Carl Gambs, op. cit.
The mean-variance portfolio model was developed by Harry Markowitz,
Portfolio Selection, Efficient Diversification of Investments, New
quidity Preference
York: John Wiley & Sons, 1959 and James Tobin,
as Behavior Towards Risk", Review of Economic Studies, February 1958.
For a comprehensive review of portfolio theory including recent
I- velopments, see Michael Jensen, "Capital Markets: Theory and
Evidence
Bell Journal of Economics and Management Science, 1972.
Quadratic, that is, in the mean and variance of the distribution of
expected returns.
-46-
in the long run, bank portfolio risk might be lowered as a result of
the payment of interest on transactions balances.
In the short run,
the C curve is raised and the mean-variance curve is lowered, thus
implying that portfolio risk might increase.
However, as noted in
Section IV, there is no evidence as yet of such a change in the riskiness of bank assets in Massachusetts and New Hampshire.
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Federal Reserve Bank of St. Louis
p
-47-
APPENDIX B
SHORT-RUN PROFIT MAXIMIZATION AS A SUB-OPTIMAL
CRITERION WHEN THE LONG-RUN SUPPLY OF FUNDS DEPENDS ON
MARKET SHARES ESTABLISHED DURING A TRANSITION PERIOr
Suppose a new bank liability is introduced and that the long
run supply of funds to each bank depends positively on the market share
established during a transition period.
Suppose further that the bank
wishes to maximinize the sum of current plus future discounted profits.
For a two-period world the formal problem is:
maximinimize
where
H
t
H
W = H
t
+ 1
—
H
s
= (i - r ) D
t
t
t
profits during the transition period
= (i - r ) D
s
S
s
profits in the steady state
p is a discount rate
i is the rate earned on investments during the transition period.
t
r
t
is the offering rate on the new liability (including both
pecuniary and nonpecuniary services) during the transition
period
i is the rate earned on investments in the steady state
s
r is the offering rate (also includes both pecuniary and nons
pecuniary services) in the steady state (rs < is)
The deposit supply functions are of the forms:
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D
t
(Supply function
during transition)
= D (r )
t t
t
S
= D (r , D )
s s
t
s
S
31)
s
3D
t
>0
(Supply function
in steady state)
1
•
-48-
Note that the supply of funds during the transition period depends positively
on the offering rate, while the supply in the steady state, or long run,
depends positively on the market share--D --established during the transition
t
period in addition to the offering rate.
To maximinize W (wealth), we differentiate with respect to r
t
and r and set both expressions to zero:
s
311
3r
1
@il
3r
t
II
0
0
t
an
s
3r
s
= o
Rs with respect to rt yields
Differentiating
WOO
(i - r ) 3D
s
s
s
3D
t > 0
Because 311 /3r is positive, the partial derivative 311 /3r must be negative
t
t
t
s
if the first order profit maximinization conditions are to be satisfied
(first equation above).
This implies that if the first period profit
function is concave with respect to r , as is usually assumed, then the
t
rate r
t
that maximizes wealth is greater than the first period profit
maximizing rate.
This is shown in figure B-1, where rP and rw
are the transition period profit and wealth maximizing prices,respectively.
w
Notice that r --the rate offered by a bank maximizing wealth (or
equiva-
lently, stockholders equity)--is higher than rt; this follows from 3y9rt
being negative.
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-49-
Figure B-1
rP
t
r
t
r
t
Finally, the condition ails/ars = 0 implies that in the steady
state, after market shares have stabilized, rate setting will be based
on traditional profit maximizing considerations.
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BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
To
Chairman Burns
Date
August 30, 1976
Subject:
,A
FronL_Theodore E. Allison,
By letter of April 19, 1976, Congressman Reuss requested copies
of any studies or analyses prepared by the staff on NOW account developments.
Members of our Research Division
(His letter and your response are attached.)
subsequently indicated to the House Banking Committee staff that it might be
late summer before such a study was available, and the Banking Committee
staff was agreeable with that timetable.
I have enclosed for your review a study that has been prepared by
Mr. Paulus and reviewed by Governor Partee.
Governor Partee's suggestions
have been fully incorporated into the final draft, and he had no objection
to sending the study to the Congress.
Ken Guenther wants you to know that this study could figure in
discussion of the "Williams amendment" (which would extend the NOW account
experiment to New York and New Jersey), but that doesn't concern him; Reuss'
office calls regularly to inquire about the study, and he thinks it should
be sent.
If you concur in the sending of this study, the attached letter to
Congressman Reuss may be used to transmit it.
appropriate distribution among staff of k
Ken's office will make an
f the House and Senate.
Governor Gardner will send the study to the other members of the Interagency
Coordinating Committee.
Also, given the relatively large numbers of requests
for copies of studies of NOWs, the staff has suggested that the paper be
released to the general public as one of a series of "staff studies,"
Attachments
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DRAFTED BY:
Lyle Gramley
Normand Bernard
REVIEWED BY:
Ken Guenther
Gov.
Parteer-lep
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-15f/
April 26, 1976
The donoreble Henry S. Reuss
Chairman
Committee on Banking Currency
and Housing
douse of Representative
Washington, D.C.
20515
Dear Mr. Chairman:
A Board staff study of the NOU account experiment in
Mossachusetts and New nampshiro has been underway for several
months, but it has not yet been completed. I hope the study
will be of sufficient interest, and of high enough cuality, to
merit distribution, but that has not yet been Pacertained.
Our awn staff work on the NOW account experiment has
been independent of the work done at the Federal Reserve r.ank
of Boston. We have been in touch with the &fink and they will
send otudies published by their staff directly to your office.
Please let me know if I can be of further assistance.
Sincerely yours,
Arthur F. Burns
Arthur P. 'urns
bee: Mr. risenmenger—Boston Fed
LLG:UB:pjt (#B-154)
bcc: Mr. Gramley
Mrs. Mallardi (2)
FR-7 (Rev. 9/75)
Daee. 747/77
cc/BOAR2
F
Control No.
GOVERNORS
OF THE
FEDERAL
13 -/sV
RESERVE
SYSTEM
MAIL
CONGRESSIONAL
HANDLING
PRIORITY
To:
Please review promptly he attached correspondence
_...
and let
s-manfrom
me have your suggestions in rough draft.
In order to meet the Chairman's requirement for a
response within five (5) working days, it will be
q
necessary for me to have your reply by
The final letter will be signed by:
Chairman Burns
Governor
Mr. Guenther or Mr. Brenneman
Please indicate below the name and extension of the
person who drafts the reply. When reviews are required
within your Division, please complete these before forwarding the draft reply to me.
Reply drafted by:
Ext.
If there are any problems or questions please give
me a call; otherwise, please return this form directly
to me with the draft reply and any attachments that are
appropriate. Many thanks.
Carol O'Brien
Room B-2214
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Ext. 2735
..
.USS, WIS.. CHAIRMAN
S. "."A
WRIGHT PA...MAN, TEX.
WILLIAM A. BARRETT, PA.
6p".ir,O.Z ". tf:IRS. JOHN B.) SULLIVAN, MO.
ASHLEY, OHIO
THOMAS
WILLIAM S. MOORHEAD, PA.
ROBERT G. STEPHENS. JR., GA.
FERNAND J. ST GERMAIN. R.I.
HENRY B. GONZALEZ, TEX.
JOSEPH G. MINISH, N.J.
FRANK ANNUNZIO, ILL.
THOMAS M. REES, CALIF.
JAMES M. HANLEY, N.Y.
pARREN J. MITCHELL. MD.
WALTER E. FAUNTROY. D.C.
LINDY (MRS. HALE) BOGGS,LA.
STEPHEN L. NEAL, N.C.
JERRY M. PATTERSON, CALIF.
JAMES J. BLANCHARD, MICH.
CARROLL HUBBARD. JR., KY.
JOHN J. LAFALCE, N.Y.
GLADYS NOON SPELLMAN, MD.
LES AuCOIN, OREG.
PAUL E. TSONGAS, MASS.
BUTLER DERRICK, S.C.
PHILIP H. HAYES, IND.
MARK W. HANNAFORD, CALIF.
DAVID W. EVANS, IND.
CLIFFORD ALLEN, TEN N.
U.S. HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, CURRENCY AND HOUSING
NINETY-FOURTH
2129 RAYBURN
CONGRESS
HOUSE OFFICE BUILDING
WASHINGTON, D.C.
20515
ALBERT W. JOHNSON.PA.
J. WILLIAM STANTON, OHIO
GARRY BROWN. MICH.
CHALMERS P. WYLIE, OHIO
JOHN H. ROUSSCLOT, CALIF.
EWART B. McKINNEY, CONN.
JOHN B. CONLAN, ARIZ.
GEORGE V. HANSEN, IDAHO
RICHARD T. SCHULZE, PA.
WILLIS D. GRADISON, JR., OHIO
HENRY J. HYDE. ILL.
RICHARD KELLY, FLA.
CHARLES E. GRASSLEY, IOWA
MILLICENT FENWICK, N.J.
22$-4247
April 19, 1976
Honorable Arthur F. Burns
Chairman
Board of Governors
Federal Reserve System
Washington, D.C. 20551
Dear Mr. Chairman:
As you know, P.L. 93-100 which was signed into law on August
16, 1973, provided for the issuance of NOW accounts in the States
of Massachusetts and New Hampshire. It is my understanding that
the Federal Reserve Bank of Boston, along with the staff of the
Board of Governors of the Federal Reserve System, have been engaged
in a detailed economic study of the so-called NOW account experiment.
1(
I would appreciate it if you could send us any studies or
analyses which the Boston Fed or your staff has completed on the
subject, or any studies that might be available in the near future.
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Federal Reserve Bank of St. Louis
Sincerely,
Henry S. Reuss
Chairman
•
.4•
-411
If •
•-••
,
0•••
40/0
•
August 24, 1976
President Volcker -- N.Y.
President Morris -- Boston
Subject:
Senate Banking Committee Language Re-NOW Accounts for
New York and New Jersey
H.R. 12934 (Federal Reserve Reform Act) and H.R. 3035
(Payment of Interest on Public Demand Deposits) have now been
reported.
Both bills contain identical language extending a mini-
NOW account experiment to New York and New Jersey.
Langunge of the bill as reported states:
"Section 2(a) of Public Law 93-100 is amended-(1) by inserting "(1)" immediately after "(a)";
(2) by inserting "New York, New Jersey," immediately after
"Vermont,"; and
(3) by adding at the end thereof the following new paragraph:
"(2) Notwithstanding paragraph (1)--
"(A) a federally chartered depository institution (other than
a national bank) which is located in
New
York or New Jersey may allow
the owner of a deposit or account tomake withdrawals by negotiable or
transferable instruments for the purpose of making transfers to third
parties if all depository institutions which are chartered by the same
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••
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Federal Reserve Bank of St. Louis
PAGE 2
State in which that federally chartered depository institution is
located are authorized by or under State law to allow such withdrawals or to pravide checking accounts; and
federally chnrtered depository institution which is
located in New York or New Jersey may pay interest or dividends on
such a deposit or account if all such State-chartered depository institutions are authorized by or under State law to pay interest or dividends
°a such a deposit or account."
la strongly stated additional 7iews Senators McIntyre and
Brooke crcized Committee action as "unnecessary and undesirable."
They object to the "attitude that the Federal Government should only
go so far as the States, and no farther in granting new powers to
financial institutions chartered under Federal Law," 'note that the
Committee action
es in the face of action taken by the Senate last
December" when it passed the FIA, and contend that this actionrepresents
an inexcuaable step backward in terms of the public interest."
McIntyre and Brooke indicate that when either bill is
considered on the floor that they "intend to support an amendment to
incorporate the proposal originally offered in Committee to do the
same for New York and New Jersey, with a one year delay in the ability
of NOW accounts in New York and New Jersey to pay interest."
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Federal Reserve Bank of St. Louis
4
PAGE 3
They note that in the absence of such an amendment "that
the Congress would better refrain from taking any action with respect
to New York and New Jersey at the present time."
Copy of bill and report is being airmailed.
K. Guenther
• .
-1
".;X4--. •'
•
. •‘.'A :16*
.
IPA".
%Too;
•
••••
•
-1...OF to.""Mr7
"%t411. 45,fr
.• • . -
•,••
•
• ..,••• • ,
Vv.•••• •
------... MOM
.1
CHAIRMAN OF THE BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
June 30, 1976
The Honorable William Proxmire
Chairman
Committee on Banking, Housing and
Urban Affairs
United States Senate
20510
Washington, D. C.
Dear Mr. Chairman:
Thank you for the opportunity to comment on the proposed
amendment to legislation extending the moratorium on the authority of
States and localities to levy "doing business" taxes on out-of-state
financial depositories. The proposed amendment would make many of the
provisions of the Financial Institutions Act (S. 1267) applicable to
eight Northeastern States.
The Board has not had an opportunity to consider carefully
the ramifications of applying a modified FIA to one region of the United
States and consequently has no overall position on this proposed amendment at this time. However, the Board believes that careful consideration
should be given to certain problems raised by regional application of
the FIA.
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One such problem results from the authorization, in one area
of the country only, for corporations and State and local governments,
as well as individuals, to maintain NOW accounts. In the Board's view,
this authorization has the potential of inducing substantial flows of
deposits into the affected region. For example, even with the proposed
geographic restrictions, national corporations with headquarters in
one of the Northeastern States, such as New York, would be likely to
shift demand balances held outside the region into NOW accounts. Such
shifts could have a serious detrimental effect on banks in other areas
of the country.
The Board is also uncertain about the implications of including
State officials in deliberations of the Federal regulatory agencies
on matters relating to interest on deposits. The difficulties raised
by such a required procedure could significantly impede the ability
of the Federal regulators to deal effectively with financial issues
of national significance.
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.•
The Honorable William Proxmire
- 2
The Board notes that the provision contained in S. 1267 that
would remove the current prohibition on the payment of interest on demand
deposits has been deleted from the current proposal. The Board regards
this change as a prudent step and is prepared to conduct further study
on the effects of permitting interest to be paid on demand deposits.
We stand ready to assist the Congress in any way that we can
in the course of its consideration of this legislation.
Sincerely yours,
Arthur F. Burns
•
March 5, 1976
TO:
Eisenmenger,Kimball, Basch,
SUBJECT:
Andersen and White (FRB of Boston)
NOW Accounts
Kichline
Mingo
Boltz
Quick
Lindsey
Salop
Williams
Susskind
Winn
Gunther
FROM:
EDWARD C. ETTIN
Attached is a draft of Paulus' paver on NOW accounts.
Lyle
Gramley has not yet seen it.
Would you please send any conuaents you may have directly
to Paulus no later than March 15.
A final version will them be
sent to Lyle with a recommendation that it, and the attached
covering memo, be sent to the Board.
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Federal Reserve Bank of St. Louis
•
To: Board of Governors
Subject:
From: Lyle Gramley
NOW Accounts
The attached staff memorandum,prepared by Mr. Paulus,
analyzes the effect of the NOW experiment on commercial bank market
shares, costs, earning, and portfolios.
His conclusions are summarized
on pages 5-7.
In testimony before the Subcommittee on Financial Institutions, Supervisors, Regulations, and Insurance of the House Banking
Committee, Governor Mitchell irdicated last fall to Congressman St.
Germain that it was time for such a study to be prepared.
may wish to transmit
.p.uus
The Board
paper to the appropriate Congressional
Committee as staff views regarding the impact of the NOW experiment on
cS mmercial banking in Massachusetts and New Hampshire
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S
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DRAFT
February, 1976
EFFECTS OF NOW ACCOUNTS
ON
GOMMEE=4:AAKE CCZ:5 An EARNINGS
by
• ,
I.
INTRODUCTION
In June 1972 the Massachusetts Supreme Court ruled that
state law did not prohibit negotiable orders of withdrawal (NOW)
from savings accounts.
Following this ruling, several State chartered
Mutual Savings Banks (MSBs) in Massachusetts began to issue NOW
accounts, and, in September, a savings bank in New Hampshire began
offering NOWs after determining that New Hampshire law was similar
to that of Massachusetts.
Although these rulings allowed state-
regulated MSBs to participate in the NOW market, federally chartered
or insured depository
offer NOWS.
institutions
could
not—uncle,-
The resultant controversy led to congressional legislation--
public law 93-100--signed into law on August 16, 1973, authorizing
all depository institutions (except credit unions) in Massachusetts
and New Hampshire to offer interest bearing deposits on which withdrawals by negotiable order could be made.
This legislation thus
established a formal experiment in the two states in which limited
demand deposit powers were extended to thrifts and the payment of
interest on transactions balances was authorized for the first time
since 1933.
*
Acknowledgments: Ralph Kimball, Edward Ettin, Jeff Suskind,
Rebecca Wright, John Williams, Paul Boltz, Perry Quick.
•
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- 2 Regulation and Growth
Regulation of NOW accounts was left to the Federal Reserve
Board, the Federal Home Loan Bank Board, and the Federal Deposit
Insurance Corporation.
All institutions were authorized to begin
S ffering NOWs on January 1, 1974, and NOW accounts were to be issued
exclusively to individuals, non-profit organizations and sole
proprietorships--partnerships, corporations and financial institutions
were prohibited from holdings NOWs.
Because eligible individuals
and institutions held an estimated one-third of the $6 hillion in
demand deposits in Massachusetts and New Hampshire in 1974, this
prohibition limited to about $2 billion the maximum level of conversions from commercial bank (CB) demand balances to NOW accounts.
The three agencies imposed an interest rate ceiling of 5
per cent on NOW accounts, the same as on savings deposits at CBs
but one-fourth of a point less than thrifts are permitted to pay on
savings deposits.
Presently, nearly 98 per cent of all institutions
offering NOWs pay this 5 per cent ceiling rate of interest.
Congress did not include in the law uniform reserve requirements against NOWs.
Thus, members of the Federal Reserve System
treat NOWs as savings deposits for purposes of calculating required
reserves.
Member banks must therefore hold 3 per cent in required
reserves against NOW balances, as compared to reserve requirements
averaging 10 per cent on demand deposits.
Nonmember banks and
thrifts in Massachusetts and New Hampshire essentially hold no
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Federal Reserve Bank of St. Louis
- 3 reserves in non-interest bearing form against either demand deposits
or NOW accounts.
The popularity of NOWs with consumers is evidenced by the
rapid and steady growth of these accounts.
In the 20 months between
January 1974 and September 1975, NOW balances grew at an average
rate of about 7 per cent per month, advancing from $143 million to $713
million.
As shown in Figure 1, the monthly gcoith rates over this
period have been quite stable, though during August and September,
the last two months for which data are available, the rate of NOW
growth declined slightly to 6-1/2 per cent per month.
However, there
is no reason to expect a significant slowing in NOW growth in the
next
few months.
figure ]
NOW BALANCES
($ Millions)
Now Balances
(Ratio Scale)
707
500
354
6.9 per cent trend
line
NOW Balances
250
177
125
time
1974
Purpose and Scope
NOW accounts have evolved into a very close substitute for
personal checking accounts, thereby eroding CBs traditional monoply
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Federal Reserve Bank of St. Louis
- 4 position in the issuancP. pi 4ese o.counts.
in Massachusetts and Neufl'a
With such erosion,CBs
ave lost the exclusive claim to
offering "one-stop banking" to customers who, for convenience, might
be willing to maintain a time or savings account, even at relatively
unfavorable interest rates, at an institution that provides checking
services.
Moreover, the payment of interest on NOW accounts, many
of which represent direct conversions of zero-interest demand
deposits, has raised the average costs to CBs of acquiring funds.
These factors suggest that NOW accounts could affect the
stability and the viability of commercial banking in Massachusetts
and New Hampshire as CBs attempt to adjust to the new, more competitive
environment.
This issue--the stability of commercial banking in
the two states during the adjustment period--is the subject
of the remainder of this memorandum.
Both aggregate and micro
data are used to study the adjustment of banks in the two states.
In Sections II and III, a broad view is taken of industry wide
developments in banking in 1974 and 1975.
Shifts in market shares
are reviewed, and the hypothesis that the spread of one-stop banking
to thrifts might cause CBs to lose significant amounts of demand
related funds--such as small time and savings deposits--is examined.
Rough estimates of the direct effect of NOW accounts on CB's costs
and earnings since January
1974 are also developed and discussed.
In Section IV the emphasis shifts to the adjustment
problem of selected individual CBs.
In any industry, it is the
•
-5
"marginal" firms--those firms with relatively high costs, or
inadequate revenues--that determine the capability of the indus
try
to adjust to changes in the competitive and regulatory envir
onment.
The effect of NOW accounts on costs and earnings of 39 such banks
are therefore analyzed for 1974 and 1975.
Moreover, adjustments to
asset portfolios are considered to determine whether these banks
have attempted to offset lower earnings by undertaking more risky
investments.
In Section V, characteristics of the steady st(:te--the
period after which the industry has had ample time to adjust fully
to
NOW accounts--are discussed, including implications for the allocation
of resources and the extent to which the public benefits, on
balance, from the issuance of NOW accounts.
In addition, future
CB adjustment problems are considered as NOW balances continue
to
grow toward some steady state value.
Summary and Conclusions
NOW related flows of funds have had only a modest effect
on the CB share of total deposits in Massachusetts and New Hampshire.
By September 1975, some 20 months after the NOW experiment
began, households in the two states had converted an estimated $330 million
in
CB demand balances to NOW accounts at thrifts.
However, there is no
evidence that significant flows of time and savings deposits have
accompanied this demand outflow
from CBs.
Thus, NOW induced shifts
in deposit flows, limited mainly to demand deposits, appear to have
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a
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•
Federal Reserve Bank of St. Louis
- 6 reduced the CB share of deposits in the two states--which total
nearly $40 billion--by about one percentage point.
The effects of NOWs on CB costs and earnings are limited
by the relatively small size of the NOW market in the two
states.
Demand balances eligible for conversion to NOW
accounts represent less than 15 per cent of
total deposits
at CBs.
Higher costs and deposit outflows associated
with
NOWs reduced CB after tax earnings an estimated 2.5 per cent in
1974.
In 1975, heightened consumer awareness of NOWs caused an accelerati
on
in the growth of these deposits, resulting in substantial incre
ases in
bank costs of funds.
For the first nine months of the year, the
estimated earnings reduction attributable to NOWs is more than
twice
that ot 1974.
An examination of those banks that appear to be most
vulnerable to competitive pressures from NOWs revealed that, altho
ugh
a few--perhaps a half dozen--are suffering from significant earni
ngs
reductions due to NOWs, most so called marginal banks are not exper
iencing
severe adjustment problems.
Although NOW funds remain relatively expensive, banks and
thrifts continue to compete aggressively for such deposits, despite
low rates of return on money market instruments and continuing weak
demands for business loans.
Over the longer term, however, such
competition should diminish as NOW growth moderates and market
shares stabilize.
It seems plausible, moreover, that this stability
will produce more rational pricing of NOW funds, including the
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Federal Reserve Bank of St. Louis
I
- 7 imposition of higher servirr Jaanger,rthat should help to relieve cost
pressures on CBs.
Finally, it is argued that after all adjustments are
complete--a process that might take several years --CB costs of
acquiring transactions balances could ultimately decline as a result
of removing the restriction against the payment of interest on such
funds.
By permitting banks to select a more efficient strategy in
competing for funds--i.e. by permitting banks to substitute pecuniary
for lower valued nonpecuniary services as a means of attracting deposits
--it is shown that the allocation of resources in banking will
improve.
II.
FLOWS OF FUNDS AND MARKET SHARES
The share of the NOW market held by CBs, shown in Table 1,
has risen steadily since the beginning of the NOW experiment, reaching
39 per cent last September.
MSBs now hold 49 per cent of all NOW
balances, while savings and loan associations and cooperative banks
(S&Ls and Coops) hold the remaining 11 per cent.
During 1974, CBs
and MSBs each captured 41 per cent of net new NOW balances, with
S&Ls and Coops attracting 18 per cent.
In contrast, in the first
9 months of 1975, CBs acquired 53 per cent of the increase in NOWs,
while MSBs and S&Ls and Coops received 35 and 12 per cent, respectively,
of net new inflows.
The success of CBs in 1975 in attracting, or retaining NOW
funds can be attributed in part to the large increase in the number
TABLE 1
OUTSTANDING BALANCES AND SHARES - ECOTIABLE ORDERS OF WITHDRAWAL (NOWs)
(in thousands of dollars)
'
MONTH
ENDED
COMMERCIAL BANKS
TOTAL OF ALL
OFFERING
INSTITUTIONS
TOTAL
MASS.
N.H.
1972--Sept.
Oct.
Nov.
Dec.
1973--Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
1974--Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct..
Nov.
Dec.
1975--Jan.
Feb.
Mar.
11,094
22,386
34,823
45,272
60,726
73,451
86,118
94,606
102,045
108,381
113,418
117,005
120,223
130,361
136,872
143,254
143,190
150,447
165,157
174,682
180,637
191,229
204,646
232,386
249,033
270,813
293,305
312,576
339,982
385,190
449,638
2,556
4,338
6,588
9,689
11,052
13,771
17,919
32,955
39,253
46,776
55,994
65,249
82,861
107,128
137,519
2,274
282
481
3,857.
5,916
672
8,458
1,231
9,296
1,756
11,156
2,615
14,175
3,744
28,450
4,505
33,597
5,656
40,245
6,531
7,431
48,563
56,989
8,260
73,517
9,344
96,647 10,481
124,706 12,813
Apr.
May
June
July
Aug.
Sept.
472,864
514,018
580,331
630,402
670,790
713,419
150.999
172,653
210,838
233,513
256,992
280,308
136 165
155,318
185,923
201,607
217,936
235,029
14,834
17,335
24,195
31,906
39.056
45,279
SHARE
OF
TOTAL
NOWS
MUTUAL SAVINGS BANKS
TOTAL
MASS.
SAVINGS & LOAN ASSOCIATIONS
TOTAL
MASS.
N.H.
SHARE
OF
TOTAL
NOWS
.02
.03
.04
.06
.06
.07
.09
.14
.16
.17
.19
.21
.24
.28
.31
11,094
22,385
34,823
45,272
60,725
73,451
86,118
94,605
102,045
108,381
113,413
117,005
120,223
130,361
132,872
143,254
139,779
143,764
154,307
157,412
159,591
164,733
171,503
180,335
187,721
197,758
206,764
213,561
220,725
236,80
262,797
11,094
22,386
34,363
44,522
59,661
71,975
84,162
92,341
99,633
105,688
110,486
113,852
116,259
125,873
131,795
138,028
134,832
138,453
147,845
150,309
151,510
155,946
161,544
169,119
175,340
184,330
192,577
200,083
206,797
221,506
246 259
460
750
1,065
1,476
1,956
2,265
2,412
2,693
2,932
3,153
3,964
4,488
5,077
5,226
4,947
5,311
6,162
7,103
8,081
8,787
9,959
11,216
12,381
12,928
14,187
13,578
13,928
15,074
16,538
.98
.96
.93
.90
.98
.86
.84
.78
.75
.73
.71
.68
.65
.61
.58
855
2,345
4,562
7,581
9,994
12,725
15,224
19,096
22,059
26,279
30,547
33,666
36,396
41,482
49,322
855
2,345
4,325
6,913
8,351
11,089
13,223
16,781
19,314
23,316
26,689
29,747
32,369
37,215
43,980
--237
668
1,143
1,636
2,001
2,315
2,745
2,968
3,858
3,919
4,027
4,267
5,342
.01
.02
.03
.04
.05
.07
.07
.03
.09
.10
.10
.11
.11
.11
.11
.32
.34
.36
.37
.38
.39
268,571
283 322
304,533
327,417
337,584
351,612
250,780
263,978
283,134
303,805
213,117
324,005
17,791
19,344
21,499
23,612
25,567
27,607
.57
.55
.53
.52
.50
.49
53,294
58,043
64,860
69,472
76,114
81,499
47,185
51,388
57,315
61,554
67,519
72,407
6,109
6,655
7,545
7,918
8,595
9,092
.11
.11
.11
.11
.11
.11
Statistical Section, Research Department, Federal Reserve Bank of Boston.
Prepared by:
Includes three member commercial banks.
The above adjustments were made to insure the confidentiality of individual tnstitution data.
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Federal Reserve Bank of St. Louis
N.H.
SHARE
OF
TOTAL
NOWS
.
•
.
A
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Federal Reserve Bank of St. Louis
9
of offering institalrianclative to that of MSBs.
September, th
In 1975, through
marthomm b,L -,,;itt;Wifering NOW accounts increased from 64
to 123, while the number of offering MSBs rose only from 157 to
173.
Though a large number of S&Ls and Coops entered the NOW market in
1975, their ability to attract NOW balances has been limited by
their relatively small size.
Source of NOW Funds
Establishing the source of NOW funds--whether demand
deposits, time and savings deposits, or other--is of considerable
importance in examining NOW related market share developments and,
it will be shown in Section III, in estimating the earnings impact
of NOWs on CBs.
One important type of evidence on this matter
concerns the behavior of active NOW accounts and the proportion of
NOW funds in active and inactive accounts.
Draft activity against
active NOW accounts (i.e. those with at least one draft drawn in a
given month) has increased gradually during the experiment, and now
averages about 10-1/2 drafts per month.
Since the average number of
checks written against personal checking accounts in New England in
1974 was about 14, this suggests that active NOW accounts are being
used primarily as checking accounts.
As a first approximation it thus seems reasonable to assume
that funds in active NOW accounts were acquired largely from demand
deposit balances.
If, as seems plausible, inactive NOW funds originated
primarily in other sources--presumably time and savings deposits--
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Federal Reserve Bank of St. Louis
- 10 then total active NOW balances can serve as an estimate of
the
amount of NOW funds that were caPnvarte
diverted, from demand
deposits.
Though there are no data on active and inactive balances,
estimates can be obtained from data on the number of
active and
inactive NOW accounts in the two states.
In September, 1975, there
were 656,000 NOW accounts at banks and thrifts in Massa
chusetts and
:/
New Hampshire, of which 140,000, or 21 per cent were inact
ive)
If
the average balance in these inactive accounts were equal to
the average
balance in savings accounts in CBs in New England, which
is $1100,
then inactive balances totaled some $154 million in September,
or
2/
about 20 per cent of total NOW balances.—
This leaves $559 million,
or about 80 per cent, in active halnnees.
Evidence on growth rates of demand and savings deposits in
New England supports the credibility of these figures as estimates
1/
Of course, the 140,000 inactive accounts include some that were
active in earlier months; likewise, some of the accounts that
were active in September were inactive in one or more previous
months. However, it is believed that the number of drafts
written against each account is relatively stable from month
-tomonth, so that membership in the two classes of accounts--active
and inactive--is also relatively stable. A necessary (through
not sufficient) condition for stabile membership in the two
classes is that the percentage of inactive accounts must be
relatively stable. This condition is satisfied adequately in
the
two states where the percentage of inactive accounts has
fluctuated narrowly from month -to-month while declining from 26
per cent in mid-1974 to 20 per cent in September
1975.
2/
Passbook savings balances in thrifts average between $2000 at
$3000 in Massachusetts and New Hampshire. However, those savin
gs
balances that were converted to NOWs can be expected to be much
smaller than the average because of the one-fourth percentage
point loss in earnings which becomes significant for large accou
nts.
Moreover, many of the larger savings accounts at thrif
ts are held
by businesses and are therefore ineligible for conversion
to NOWs.
Thus, the $1100 figure is applied to thrifts as well as
to CBs.
A
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Federal Reserve Bank of St. Louis
- 11 of the share of NOW funds attracted from demand relative to other
types of deposits.
Since January
1974, demand deposits have declined
relatively more in Massachusetts and New Hampshire than in neigh
boring
New England states, while savings deposits have continued to grow
at
rates similar to those of Connecticut, Maine, Rhode Island,
and
Vermont.
In fact, after adjustment for cyclical and regional factors,
demand deposits in Massachusetts and New Hampshire appear to have
been reduced since January 1974, by an amount which is about
equal
to the growth in NOWs.
This suggests that some high proportion of
NOWs, perhaps three-fourths or more, has been attracted from deman
d
2/
deposits.
In Table 2, estimated active and inactive balances are
slInwn for clIQ and thrifts In Scptcabcr 1975.
As showa in Column 3,
TABLE 2
ESTIMATED ACTIVE AND INACTIVE NOW BALANCES
September, 1975
Massachusetts and
New Hampshire
IS in millions)
CBs
I
MSBs
S&Ls and Coops
Total
NOW
Balances
Estimated
Inactive
Balances
Estimated
Active
Balances
280.308
48.005
232.303
351.612
86.598
265.014
81.499
19.507
61.992
731.419
154.110
559.309
For details on demand and savings deposits growth in Massachuse
tts
and New Hampshire relative to other New England states, see
Appendix A.
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Federal Reserve Bank of St. Louis
- 12 thrifts held an estimated
in September.
$330 million in active NOW balances
These_iiinfic, serving largely as checking accou
nts,
appear to have been obtained primarily from CB deman
d balances.
Of
the $100 million in inactive accounts at thrif
ts, an undetermined
part was no doubt obtained from CB time and savin
gs deposits, with
most of the remainder representing conversions from
time and savings
at thrifts.
This suggests that between $300 and $400 million of
NOW
balances currently held by thrifts originated in CB
deposits.
Market Shares of Total Deposits
The direct effect of NOW accounts on market shares in
the
two-state area, where deposits at CBs and thrifts
total nearly $40
billion, thus amounts to, perhaps, a one percentage
point reduction
in the 45 per cent share held by (1
- 3.
9111rNi7gh
a
relatively modest reduction in the market share of CB's,
the indirect
effect of NOWs on such shares must also be considered
before any
judgment can be reached on whether major shifts are under
way.
This indirect effect involves the spread of convenient
one
stop banking to thrifts.
By permitting thrifts to issue what is
essentially a demand deposit, CBs could lose large amoun
ts of time
and, especially, savings deposits as demand deposit funds
are diverted
to thrifts.
Commercial bankers are particularly worried about this
possibility in view of the one-fourth point advantage thrif
ts can
offer on passbook savings.
4/
Draft activity against active NOW accounts at thrifts
averages
about 9-1/2 in the two states, only slightly below the avera
ge
at CBs.
- 13 The evidence on this issur, indicates that no such shift
in
deposits between instita
ii
as yet.
In the upper
half of Table 3, market shares of passbook savings are shown
for
the last four call report dates, beginning in December
1973--just
before the NOW experiment began.
As shown in the table, CBs share of
the passbook savings market, in both Massachusetts and
New Hampshire,
has actually risen during the NOW experiment.
In Massachusetts the
share of passbooks held by CBs increased for 16.7 to 19.1
per cent
between December 1973 and June 1975, while New Hampshire CBs
have
increase their share of the market from 27.1 to 31.1 per
cent during
this period.
CBs have made significant gains in this market during
the last 20 years, and this evidence suggests that
NOW accounts have
not retarded this progress.
Comparisons of total market shares are of limited value,
since CBs, unlike thrifts, obtain a relatively large and
variable part of
their deposits from large Certificates of Deposit.
Data on total deposits are,
nevertheless, presented in the bottom half of Table 3.
Though the
CB share of total deposits declined from 46 to 44 per cent betwe
en
mid -1974 and mid-1975, this share remains a percentage point
above
its June 1972 level (recall that NOW accounts have been issue
d by
MSBs in the two states since mid-1972).
In New Hampshire, the market
share of CBs has remained relatively stable over the last year,
as
CBs have successfully protected the gains in market shares made
in
the early seventies.
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Federal Reserve Bank of St. Louis
- 14 TABLE 3
MARKET SHARES OF DEPOSITS HELD BY MAJOR
DEPOSITORY INSTITUTIONS IN MASSACHUSETTS AND NEW HAMPSHIRE
June
1970
June
1972
Dec.
1973
June
1974
Dec.
1974
June
1975
PASSBOOK SAVINGS EXCLUDING NOWs
Massachusetts (dollars in
millions)
12,906
13,680
12,883
13,695
CBs
16.7
16.5
17.7
19.1
MSBs
73.8
74.6
73.3
72.6
9.5
8.9
8.9
8.3
1,781
1,824
1,806
1,930
CBs
27.1
79.2
29.5
30.1
MSBs
57.1
55.6
55.3
54.8
S&Ls and coops
15.2
15.1
15.2
15.1
Percentage held by
S&Ls and coops
New Hampshire (dollars in
(millions)
Percentage held by
TOTAL DEPOSITS
Massachusetts (dollars in
millions)
21,952
26,956
CBs
43.6
43.0
46.0
44.0
MSBs
49.8
50.3
47.6
49.2
6.0
6.7
6.4
6.8
2,234
2,840
3,425
3,693
CBs
36.7
41.4
42.8
42.3
MSBs
50.1
44.7
43.1
43.1
S&Ls and coops
13.2
13.9
14.1
14.6
31,563
32,426
Percentage held by
S&Ls and coops
New Hampshire (dollars in
millions)
Percentage held by
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
- 15 On the basis of this evidence it appears that, to date, no
significant shifts have occurred in market shares beyon
d those arising
directly from transfers of CB deposits into active
NOW accounts at
thrifts.
However, the possibility of such a shift, occurring on
a
delayed basis, cannot be totally ruled out, particular
ly if consumers
adjust slowly to changing conditions in financial marke
ts.
III. EFFECTS OF NOW ACCOUNTS ON AGGREGATE
COMMERCIAL BANK COSTS AND EARNINGS: 1974-1975
In attempting to establish a permanent share of the NOW
market, CBs in Massachusetts and New Hampshire have absor
bed higher
costs through the conversion of demand deposits to
NOW accounts and
have thus experienced a reduction in net earnings.
Moreover, CB
net earnings have been further reduced by the loss of relat
ively
profitable demand deposit funds to thrifts offering
NOWs.
Estimates
of the effect of NOWs on aggregate CB earnings must there
fore include
both the cost of converting noninterest bearing deman
d deposits to
NOWs and earnings reductions associated with NOW related outfl
ows of
demand deposits.
In the remainder of this section rough estimates are
produced which, it should be emphasized, are indicative
only of basic
magnitudes.
For reasons to be discussed later, these estimates are
probably biased in the sense that the true depressing effec
t of NOWs
on CB earnings is more likely to be smaller than these
estimates,
rather than larger.
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Federal Reserve Bank of St. Louis
- 16 Incremental Costs of NOWs
In estimating the added costs.,to CBs of acquiring and
retaining NOW funds, costs of converting time and savings deposits
to NOWs are ignored, since such costs are likely to be small.
Thus,
incremental costs are calculated by multiplying estimated NOW balanc
es
at CBs which were
converted from demand deposits by the difference
between the average cost of NOW funds and that of demand deposit
funds.
For this purpose, active NOW balances at CBs, as calculated
in Section II, will be used to estimate the level of conversions
from demand deposits to NOWs.
For nonmember banks the average cost of NOW funds is equal
approximately to the sum of the interest payment, which averages
In equating conversions of demand deposits to estimated active
NOW balances, the consolidation of savings and demand deposit
accounts into one active NOW account creates a minor problem,
since treating the balance in the active NOW account as originating
in a demand deposit causes an upward bias in the estimated level
of demand deposit conversions. Because NOW balances at CBs are
significantly higher than at thrifts--$1600 at CBs to $900 at
thrifts--it might appear that the effect of account consolidation
on average NOW balances at CBs is large. However, this is somewhat misleading, since NOW accounts at CBs include conversion of
so called D/B/A--"doing business as"--demand deposit accounts of
sole proprietorships. These accounts typically carry very large
balances ranging up to $50,000 and more. According to knowledgable observers, most of these D/B/A accounts have been
converted to NOWs, thereby raising NOW average balances relative
to those of demand deposits. For a few CBs whose D/B/A accounts
were examined, average NOW balances after excluding D/B/A
accounts were much smaller and more consistent with average
demand deposit balances. Thus, the effect on average balances
of consolidating savings and demand deposit accounts into one
active NOW account may be quite small, and active NOW balances,
as calculated in Section II, probably serve as a reasonably
accurate, though slightly biased estimate of demand deposit
conversions.
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Federal Reserve Bank of St. Louis
a
- 17 nearly 5 per cent, and the net cost of servicing NOW accounts.
This
latter cost consists mainly of expenditures on account maintenance
(statement preparation, etc.) and costs associated, to a lesser
extent, with clearing drafts and handling deposits to NOW accounts.
For Federal Reserve members, the NOW cost is equal to this sum, less
the earnings from funds released by the lower required reserve ratio
on NOWs relative to demand deposits.
The per dollar marginal cost of demand deposit funds is
approximately equal to the net cost of servicing demand deposit
accounts.
This cost is similar to that of NOW accounts, though
probably slightly smaller because a higher proportion of CBs offer
free checking than offer free NOWs.
If this service cost differential
is ignored because of its relative smallness, the incremental cost of
NOW funds converted from demand deposits is equal to the rate of
interest on NOWs minus, where applicable, the additional earnings
from lower reserve requirements against NOWs.
In calculating incremental costs, the interest rate on
NOWs is set at 5 per cent and the Treasury bill rate is used
to measure earnings from lower reserve requirements for member banks.
These estimated costs are presented in Table 4 on a monthly basis
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Federal Reserve Bank of St. Louis
- 18 beginning in January 1974.
For '1974, the estimated incremental cost
of NOWs totaled $8201thour-ffnd.
For the first 9 months of 1975, this
total is $50 2 million, reflecting the large growth in NOW balanc
es
at CBs this past year.
In 1974, before tax CB earnings in Massachusetts
and New Hampshire totaled $
costs were about equal to
million; thus estimated incremental
per cent of 1974 earnings, while
1975 incremental costs for the first 9 months of the year are
estimated to be about
per cent of such earnings.
As noted
earlier, however, there are several reasons why these estimates
probably overstate actual incremental costs.
First, the small savings
on service changes of NOWs relative to demand deposits are ignored
and, second, active balances are used to estimate demand deposit
conversions and this estiiAate is biased upward.
Also, the con-
solidation of savings and demand deposit accounts into a single NOW
account reduces CB's costs, since the maintenance cost on a NOW
account is smaller than the sum of the costs of maintaining separate
demand deposit accounts.
6/
Symbolically, the per dollar NOW cost for a Federal Reserve bank
can be expressed as:
c = i + s
n
11
- .07 r
where in is the interest rate paid on NOWs, sn is the annual
cost per dollar of servicing a NOW account, r is rate of interest
on some asset into which the funds derived from the lower NOW
reserve requirement will be invested, and the constant .07
is
the difference between the average reserve requirement against
demand deposits and NOW accounts. If sn is ignored on the
grounds that NOW service costs are similar to those of demand
deposits, the incremental cost of NOW funds is equal to in .07 r for Federal Reserve members, and to in for nonmembers.
These expressions are used in calculating estimated costs in
Table 4.
- 19 TABLE 4
ESTIMATED INCREMENTAL COSTS TO CBs OF NOW ACCOUNTS
(in thousands $)
Active
Balances
1974:Jan.
1,159.0
MEMBER BANKS
Monthly
Incremental
Cost
Incremental
Per Dollar
Cost
NONMEMBER BANKS
Monthly
Incremental IncreActive
Cost
mental
Balances Per Dollar
Cost
TOTAL
CB
Incremental
Cost
.00371
4.3
575.5
.00417
2.3
6.7
Feb.
.00375
6.1
1,271.0
.00417
5.3
11.4
Mar.
.00370
9.0
2,278.2
9.5
18.4
Apr.
.00369
12.5
3,765.0
15.7
28.2
May
.00367
13.8
4,076.7
17.0
30.9
June
.00360
17.8
5,155.9
21.5
39.3
July
.00371
27.0
6,546.8
27.3
54.3
Aug.
.00366
47.4
7,506.6
31.3
78.7
Sept.
.00368
51.0
14,220.6
59.3
110.3
Oct.
.00374
59.2
14,508.4
60.5
119.7
Nov.
.00372
74.8
31,390.9
130.9
205.6
Dec.
.00375
92.6
20,479.6
85.4
178.0
1975:Jan.
.00379
134.0
25,083.9
.00417
104.6
881.5
238.5
Feb.
.00384
190.3
31,366.9
.00417
130.8
321.0
Mar.
.00384
255.9
41.822.5
174.4
430.3
Apr.
.00383
283.2
47,649.9
198.7
481.9
May
.00386
324.6
55,947.2
233.3
557.9
June
.00386
407.6
66,235.0
276.2
683.8
July
.00381
455.5
74,364.5
310.1
765.6
Aug.
.00379
489.9
82,278.2
343.1
832.0
Sept.
.00379
533.8
91,438.8
381.3
915.1
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Federal Reserve Bank of St. Louis
5,226.1
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Federal Reserve Bank of St. Louis
- 20 Reductions in Earnings from Demand Deposit Outflows
The second way in which NOW accounts can reduce CB earnings
is through the loss to thrifts of funds which would otherwise have
provided positive net earnings for CBs.
As noted earlier, the major
identifiable loss of CB funds amounts to about $330 million in demand
deposit balances through September, 1975.
In attempting to estimate earnings reductions at CBs
attributable to NOW induced outflows of funds, active NOW balanc
es
at thrifts are used to approximate demand deposit outflows.
Savings
deposit outflows, which are essentially unknown, are ignored becaus
e
the earnings from such funds would have been small, especially
in
1975 when market interest rates were low, relative to those of demand
deposits.
For nonmember banks, per dollar earnings on demand deposits
are equal to the average yield on invested funds minus the net cost
of acquiring such funds (in the case of demand deposits, the cost
of servicing an average account).
For Federal Reserve member banks,
ITt earnings on demand deposit funds are equal to this amount
multiplied by 9, the proportion, on average, of each demand deposit
dollar that can be invested after reserve requirements are met.
Studies by Donald Hester and James Pierce indicate that a high
proportion of demand deposit funds are invested in short term market
securities; thus the Treasury bill rate was used to measure the yield
- 21 TABLE 5
ESTIMATED LOST EARNINGS FROM DEMAND DEPOSIT OUTFLOWS
($ thousands)
MEMBER BANKS
Cumulative Monthly
Estimated
Earnings
Outflows Per Dollar
NONMEMBER BANKS
Lost
Earnings
Cumulative Monthly
Estimated
Earnings
Outflows Per Dollar
Lost
Earnings
CB
EARNINGS
Reduction
from
Outflows
1974:Jan.
94,831.5
.00356
337.6
17,121.2
.00396
67.8
405.4
Feb.
95,953.4
.00304
291.7
17,337.3
.00338
58.6
350.3
Mar.
103,663.1
.00374
387.7
18,750.0
.00416
78.0
465.7
Apr.
106,607.1
.00392
417.9
19,311.9
.00436
84.2
502.1
May
108.725.5
.00408
443.6
19,735.1
.00453
89.4
533.0
June
111,631.7
.00429
478.9
20,272.5
.00477
96.7
575.6
July
117,752.8
.00356
419.2
21,439.4
.00396
84.9
504.1
Aug.
122,573.1
.00431
532.6
22,526.1
.00479
107.9
640.5
Sept.
128,408.0
.00402
516.2
23,445.2
.00447
104.8
621.0
Oct.
136,175.5
.00319
434.4
24,858.8
.00354
88.0
552.4
Nov.
144,505.8
.00344
497.1
26,361.3
.00382
100.7
597.8
Dec.
154,568.7
.00313
483.8
27,844.8
.00348
96.9
580.7
6,298.6
1975:Jan.
155,610.7
.00262
407.7
28,384.9
.00291
82.6
490.3
Feb.
170,412.4
.00194
330.6
31,064.8
.00216
67.1
397.7
Mar.
195,418.7
.00203
396.7
35,663.7
.00226
80.6
477.3
Apr.
206,157.6
.00203
418.5
37,654.9
.00226
85.1
503.6
May
219,712.6
.00174
382.3
40,103.6
.00193
77.4
459.7
June
236,242.4
.00165
389.8
43,169.4
.00183
79.0
468.8
July
252,310.9
.00238
600.5
46,098.5
.00264
121.7
722.2
Aug.
257,961.5
.00260
670.7
47,231.8
.00289
136.5
807.2
Sept.
276,378.0
.00254
702.0
50,638.3
.00282
142.8
844.8
5,171.6
NOTE: Outflows from member and nonmember CBs are assumed to be
proportional to market
shares of demand deposits of these banks. For example, if member CBs held 80 per cent
of demand deposits in a given month, than 80 per cent of active balances at thrifts are
assumed to have come from member banks and the remaining 20 per cent from nonmembers.
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Federal Reserve Bank of St. Louis
- 22 on demand deposit funds lost to thrifts.
'
The average cost of
servicing a demand deposit acr....out-q- mr.a,
',ret at 3 per cent of the
average balance.
This estimate is based on functional cost data from
the Federal Reserve Bank of Boston.
These data indicate the cost of
servicing a checking account in New England averages
between 3 and 4
per cent; since a substantial portion of CBs in Massachuse
tts and
New Hampshire offer free checking, 3 per cent was chosen as
the
average net cost of servicing such deposits.
Estimates of the earnings reduction attributable to NOW
induced demand deposit outflows are presented in Table
5.
For any
given month, the estimated total outflow is shown for
both member and
nonmember banks.
These outflows include all funds lost in previous
months as well as those lost in thp current month.
-re-NY
1‘,,41,..
.
•...4
1lA.N...11LLI
.L
and nonmember banks estimated outflows are multiplied by
monthly per
dollar earnings on demand deposit funds to obtain an estim
ate of
earnings lost each month.
For 1974, these estimated earnings reductions
total $6.2 million, which is much larger than the 1974 estim
ate of
incremental costs from Table 4.
This, of course, reflects the fact
that thrifts--especially MSBs--held a large percentage of
active
NOWs in 1974.
The 1975 estimated earnings reduction from demand
deposit outflows, which covers only the first 9 months
of this year,
7/
See Hester, Donald and James L. Pierce, Bank Management
and
Portfolio Behavior, Yale University Press, 1975.
- 23 8/
totaled $5.4 million.—
After Tax Reduction in Earnings
Adding the estimates of incremental costs of shifts from
demand deposits to NOWs at CBs and reduced earnings
from demand
deposit outflows from CBs to thrifts yields a rough
estimate of the
total before tax reduction in earnings attributable
to NOW accounts.
For 1974 this total is $7.2 million, while for the first
nine months
of 1975, the total is $10.4 million.
To obtain an after tax reduction in earnings it is necessary
to reduce these figures by the amount of the tax savin
g accruing
from lower CB earnings.
In 1974 more than 90 per cent of Massachusetts
and New Hampshire CBs had before tax earnings excee
ding $25,000.
The
marginal tax rate fnr these banks were therefore 48 per
euilL, while
for the remaining banks the marginal rate was 25 per
cent.
The
weighted average of these marginal rates, with weights equal
to the
proportion of banks in each class, is thus equal to about
46 per
cent.
Reducing the estimated $6.8 million 1974 earnings reduction by
this amount produces an after tax reduction in earnings
of $3.7
million.
Since after tax profits in Massachusetts and New Hamsphire
totaled $142 million in 1974, this represents a reduction
in total
after tax earnings of about 2-1/2 per cent.
8/
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Federal Reserve Bank of St. Louis
Concerning the robustness of these estimates to changes in
the
assumed average balance in inactive accounts, if instead
of
$1100 this average was twice as large--$2200--the earni
ngs
reduction from demand deposit outflows would have been about
30
per cent smaller. For example, assuming a $2200 avera
ge balance
in inactive accounts at thrifts reduces estimated activ
e balances
from $330 million to $230 million in September, 1975. Thus,
earnings reductions from demand depos
it outflows would be only
23/33, or about 70 per cent, of those shown in Table
5 for that
month.
a
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Federal Reserve Bank of St. Louis
-24Since no income figures are yet available for 1975, a
similar calculation cannot be made for that year.
However, if the
1974 tax reduction is applied to the $10.4 million in reduced 1975
earnings, the after tax reduction in earnings attributable to
NOWs for the
first 9 months of the year is $5.6 million.
IV.
ADJUSTMENT PROBLEMS OF INDIVIDUAL BANKS
Analysis of aggregative--industry wide--data suggests that,
at worst, aggregate CB earnings may have been depressed by a few
percentage points in 1974 Pnd 1975.
These data, therefore, do not
indicate that the industry is experiencing particularly serious
adjustment problems.
However, aggregative data can often conceal
important information.
In particular, when an industry is adjusting
to a change in basic costs or revenues, certain segments of the
industry--those so called marginal firms--may suffer disproportionat
ely
high losses of earnings and capital.
The adjustment experience of
these firms can often reveal far more about the stability of the
industry than aggregative data.
The remainder of this section is therefore devoted to a
study of costs, earnings, and portfolio adjustments of several
such
banks in Massachusetts and New Hampshire.
Each of these banks belongs
to one of the following categories; (1) "high impact" banks
having
10 per cent or more of total deposits in NOW accounts in June
1975,
(2) banks having low earnings in 1974, or (3) banks not offering
NOWs, but experiencing significant losses of demand deposits betwe
en
I
•
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Federal Reserve Bank of St. Louis
- 25 January 1974 and June 1975.
W-1-,y-rdnine,cf).the
states fall into one or more df-tkestomitiegories.
banks in the two
Obviously, the
earnings and capital positions of these banks are especially
vulnerable to NOW related changes in costs and revenues.
To estimate the cost and earnings impact of NOWs it is first
necessary to project for each bank a level of demand deposits that
would have been observed in the absence of NOWs.
After this projection
is made, actual demand deposits are compared to projected balances.
Then, if the actual demand deposit balances of a bank offering NOWs
exceed projected deposits, the earnings reductions for that bank
from the advent of NOWs is zero, since all NOW balances are, in
effect, net new funds.
However, for a CB offering NOWs and having
actual demand deposits below the projected level, the cost of
converting demand balances to NOWs and, possibly, the earnings
reduction from an outflow of demand funds both will reduce total
earnings.
For banks not offering NOWs but experiencing large run-
offs of demand balances (category 3), the earnings reduction
attributable to NOWs is calculated as the lost earnings from NOW
induced outflows of funds as measured by the difference between
projected and actual demand deposits.
To illustrate, assume in the absence of NOWs demand
deposits are projected to grow from do to d
suppose deposits actually grow to da.
in Figure 2, and
If NOW balances at this bank
- 26 deposits
figure 2
do
time
to
are equal to the distance dp - b at time t, then NOW conversions
from demand deposits are assumed to total dp - d , which is, of
a
course, the amount by which projected deposits exceed actual demand
deposits.
The remaining NOWs--d a - b--are thus assumed to have been
attracted from other institutions.
of NOW accounts is equal to d
- a.
Alt
sl_ippncn
the level
This amount is then assumed to
represent inhouse conversions from demand deposits.
However, in this
case, NOW balances are less than the "deficiency" in demand deposits
as measured by d
d
a
The difference, a - d
a) is assumed to
represent demand balances lost to another institution offering NOWs,
and the earnings reduction from this outflow is added to the direct
cost of converting demand deposits to NOWs.
Actual projections of demand deposits were based on a
comparison of demand deposit growth for each bank relative to the
average growth in demand deposits in Maine, Connecticut, Vermont,
and Rhode Island during 1972 and 1973.
This established a differential
between the demand deposit growth rate of each bank and the average
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
- 27 growth rate of demand deposits in these four New Engla
nd states not
affected by NOWs.
During 1974 and 1975 projected demand deposit
growth for each bank was set equal to the average
growth in these
deposits in the four New England states plus the 1972-73 differential.
This method of projection thus assumes that demand depos
its of those
banks that were growing more rapidly than the average
rate in the
four New England states in 1972-73 would continue to
do so in the
absence of NOWs, while those banks whose demand deposit
growth was
below that of the average would continue to exper
ience slower growth.
As in Section III, the per dollar cost of converted demand
deposits is assumed to equal the interest payment on
NOWs less,
where applicable, the increased earnings from released
reserves.
The per dollar earnings reduction from lost funds
is also calculated
as the difference between the Treasury bill rate and
the average
cost of servicing demand deposits-- which is
assumed, again, to be 3
per cent.
High Impact Banks—
In June 1975, there were 8 CBs with more than 10 per cent
of total deposits in NOW accounts.
Five of these banks were either
established banks with a history of aggressive management
prior to
the introduction of NOW accounts or new banks.
In interviews
conducted by the Federal Reserve Bank of Boston, it was
found
-9/
See Ralph C. Kimball,"
Federal Reserve Bank of Boston, for a similar analysis
of high
impact, low income, and run-off banks.
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Federal Reserve Bank of St. Louis
- 28 that the former group of ,b.alaks terA-? .t-ck..e aggressive in offering
NOWs, often introducing them bt:t± competitors and promoting
them heavily through advertising.
In general the management of these
banks viewed NOW accounts as a means of increasing their market
shares by attracting new customers.
For these banks, the high
proportion of NOWs resulted from a deliberate aggressive policy by
the banks' management.
The remaining three banks tended to be older banks which
introduced NOW accounts as a defensive measure.
These banks, for
one reason or another, found themselves under severe competitive
pressures and were forced to introduce NOWs to maintain their deposit
base.
Two of these banks have an abnormally high ratio of personal
demand deposits to total deposits, and thus were particularly vulnerable to competition from thrifts offering NOWs.
Individual bank names and data are not reported in this
study.
Instead, the number of banks whose before tax income was
reduced by various percentages is given in Table 6.
Of the eight
high impact banks, only five have been in operation long enough to
permit a projection of the level of demand deposits which is
required to make the cost and earnings reduction calculations.
Of
these five banks, it is estimated that four had their earnings reduced
by less than 10 per cent in 1974, while one had a percentage reduction
of about 50 per cent.
- 29 In 1975, two of the banks are expected to continue to
experience income reductions of less than 10 per cent, two are
projected to suffer 10 to 20 per cent reductions, while NOW related
changes in costs and revenues are expected to produce negative net
earnings in 1975 for one bank.
However, it should be noted that this
bank is one of the five "high impact" banks whose management was
classified as very aggressive.
This bank has experienced impressive
growth over the past decade and does not appear to be endangered by
the added costs from NOW accounts.
Low Income Banks
Low income banks are defined as those banks offering NOWs
whose ratio of 1974 before tax earnings to total deposits falls in
the lowest 10 per cent for the
this category, with 13 being
New Hampshire.
below
two
ctnta.c.
10
4J_LL
Massachusetts CBs and five operating in
These banks all had earnings to deposit ratios
per cent in 1974, while the two-state average for all
banks was about
per cent.
As shown in. the "low earnings" columns of Table 6, about
one-half of these banks had 1974 earnings reduced by less than 20
per cent.
One bank had negative earnings in 1974 on account of NOW
related costs; however, this bank would have had very low earnings-less than $5 thousand--even without added NOW costs which were
estimated at about $10 thousand.
In 1975, about half of the low income banks are expected to
experience earnings reductions from NOWs of less than 10 per cent,
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Federal Reserve Bank of St. Louis
-30 TABLE 6
EARNINGS REDUCTIONS FROM NOW ACCOUNTS:
Income Reduced by
(per cent)
High Impacts
1974
1975
Low Earnings
1974
1975
MARGINAL BANKS
Runoffs
1974
1975
Total
1974
1975
0-10
4
2
5
9
7
7
16
18
10-20
0
2
4
3
4
4
8
9
20-30
3
2
1
0
4
2
30-40
1
0
1
1
2
1
40-50
1
2
3
1
4
3
1
2
2
2
60-70
1
0
1
1
1
70-80
1
0
1
1
1
80-90
0
0
0
90-100
0
0
0
50-60
1
100
Total
NOTE:
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Federal Reserve Bank of St. Louis
5
1
1
5
18
18
16
1
1
2
16
39
39
One bank belonged to both the "high impact" and the "low earnings" group.
This bank is included only in the high impact category in the Table.
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Federal Reserve Bank of St. Louis
- 31 while four banks are projected to lose about one-half of their 1975
earnings.
Since many of the low income banks are probably experiencing
temporarily low earnings, these banks can be expected to show significantly improved earnings in the next few years even after NOW
related costs are fully absorbed.
Thus, even the distribution of
earnings reductions shown in Table 6, which do not appear to indicate
widespread and serious adjustment problems among these banks,
probably overstates the impact of NOWs on basic--or permanent-earnings for such banks.
Runoff Banks
Runoff banks are defined as those banks
not offering NOWs
that lost 10 per cent or more of their demand deposit base between
January 1974 and June 1975.
Of the 16 runoff banks, only about one half
believe that demand deposit outflows are at least partly caused by
competitors offering NOW accounts.
Most of these banks cited
added expenses as the reason for not introducing NOWs.
Some banks
also indicated that they lacked necessary computer facilities
required to handle NOW accounts and one bank, which does not pay
the ceiling interest rate on savings accounts, expressed concern
that offering NOWs would cause added expenses by forcing the savings
rate to the ceiling.
Although about half the runoff banks do not believe that
competition for NOW accounts is responsible for their demand deposit
- 32 outflows, earnings reduction estimates are shown for all 16 banks
in Table 6.
Runoff banks have no conversion costs, so the percent
earnings reduction estimates shown in Table 6 are based strictly on
earnings losses from NOW induced demand deposit outflows.
Of the 16
runoff banks, 11 experienced estimated earnings losses from NOWs
of less than 20 per cent of total earnings in both 1974 and 1975.
In 1975, earnings reductions exceeding 50 per cent of total earnings
are projected for three banks, with one of these banks suffering
greater than a 100 per cent reduction.
Summary of Marginal Bank Earnings Reduction&
As shown in the last two columns of Table 6, about 40 per
cent of the 39 marginal banks experirnrPa NOW related earningQ
reductions of less than 10 per cent in 1974, and 60 per cent suffered
less than 20 per cent reductions.
Five banks--or less than 15 per
cent of the 39 banks--are estimated to have lost 50 per cent or
more of 1974 earnings, including one bank which lost more than 100
per cent.
However, as noted, this bank had only small NOW costs,
but suffered from abnormally low earnings even without the NOW
offset.
In 1975, about two-thirds of the 39 banks are estimated to
have suffered relatively modest--less than 20 per cent--earnings
reductions.
Many banks experienced healthy demand deposit growth in
1975, thus helping to reduce estimated NOW losses.
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Federal Reserve Bank of St. Louis
Also, Treasury
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Federal Reserve Bank of St. Louis
- 33 bill rates--which are used to measure earnings losses from outflows-have been significantly lower in 1975 than in 1974.
Six CBs, however,
are projected to lose 50 per cent or more of 1975 earnings, and of
these, two could lose more than 100 per cent.
The distribution of earnings reductions in these two
columns suggests that even within the class of marginal banks, only
a small number, perhaps 15 per cent, are presently experiencing significant adjustment problems.
Of these, some may continue to experience
severe adjustment problems, while others, such as those with
temporarily low income due to other causes, many recover from NOW
related earnings reductions without further problems.
In addition,
several runoff banks, by their own admission, have not really suffered
NOW related deposit and earnings losses, but rather have lost demand
deposits for other reasons.
10
Portfolio Adjustments by Marginal Banks---/
CBs an attempt to offset higher NOW costs and lower
earnings in two basic ways; by lowering costs by imposing relatively
Itigh service charges on NOW accounts, and by raising revenues
in any number of ways.
As indicated briefly in Section III, there
is limited evidence, mostly of a judgmental nature, that CB service
charges on NOW accounts are higher on average than those imposed
on demand deposits; thus a part, probably small, of increased
NOW costs are being recovered through higher service charges.
10/
For a discussion of portfolio adjustments of thrifts, see
Appendix B.
-34 -
CBs an attempt to increase revenue by raising loan rates.
However,
in Massachusetts and New Hampshire, where stiff competition exists from banks
in neighboring states and from money market obligations, such as strategy
would likely be counterproductive.
CBs can also attempt to raise
earnings by including in their portfolios more risky, higher yielding assets.
For example, a CB can usually increase revenues by selling short-term highly
liquid assets such as Treasury bills, and using the proceeds to acquire nonprime business or real estate loans.
The problem with this strategy is that
the acquisition of more loans :!ncreases both the level of average earnings
and the variation of these earnings.
Increased variation in earnings, moreover,
increases the probability of bank failure.
Thus, portfolio adjustments by
CBs attempting to maintain a target level of earnings are of conRiderahlP,
importance in examining the stability of commercial banking.
Before reviewing empirical evidence on this matter, it should be
noted that, on theoretical grounds, costs and portfolio risk should be directly
11/
related.
Portfolio theory as developed in the last 25 years, however, suggests
that rational wealth holders seek to balance benefits of higher rates of
return against the disadvantages of additional risk when selecting an optimal
portfolio of assets.
This behavior, though implying somewhat more risk will
be assumed when the return on bank capital declines, is generally incompatible
with attempting to maintain a target level of earnings independent of portfolio risk whenever costs or revenues change.
This suggest a willingness of
bank shareholders to accept lower earnings in the event of a temporary
increase in cost; thus only modest increases in the riskness of the bank
11/
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Federal Reserve Bank of St. Louis
See Ralph Gambs, "Interest Bearing Demand Deposits and Bank Portfolio
Behavior", Southern Economic Journal, July 1975.
- 35 -
portfolio may result.
The hypothesis that the 39 marginal banks in Massachusetts
and New Hampshire have attempted to increase portfolio risk in order
to offset NOW related lower earnings can be examined by using the
ratio of loans to total assets as a rough measure of risk for each
bank.
In the left panel of Figure 39 ratios of loans to total
assets are shown for each of the three classes of marginal banks.
Figure 3
Pct.
High Impact
Pct.
`ma
65
65 -
1
60-
60
rr
55F
Low income
5
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Federal Reserve Bank of St. Louis
f7/
."7"1
Marginal)'
banks//
'
50
Runoffs/
'Industry less
ginal
45
. 1W
19/3
1974
7547-5
1973
1974
1975
Since early 1974 these ratios have been gradually declining, and this
would appear to contradict the "target rate of earnings" hypothesis
of CB behavior.
However, the economies of Massachusetts and New
Hampshire were depressed during the 1974-75 period, so that loan
demand was generally weak.
Therefore, a comparison of loan ratios
of marginal banks relative to all other Massachusetts and New
Hampshire banks is shown in the right panel of Figure 3.
Because
the marginal banks experienced greater than average NOW related earnings
losses, it might be expected that under the target rate of return
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Federal Reserve Bank of St. Louis
- 36 hypothesis
their loan to asset ratios might decline less than
that of the industry.
Instead, since late 1974, the aggregate
marginal bank ratio, as shown in the right panel of Figure 3,has
declined more than the industry ratio.
Based on this evidence, the
39 marginal banks do not appear to have increased the riskiness of
their portfolios, as measured by the ratio of loans to assets, as a
result of NOW accounts.
V.
THE LONG RUN ADJUSTMENT PROBLEM OF COMMERCIAL BANKS
Conversion of time and savings deposits to NOW accounts
causes negligible cost increases, so the problem CBs face in the
long run is absorbing, or offsetting, higher costs associated with
conversions from demand deposits to NOWs and the loss of funds to
thrifts.
Because CBs have become quite successful in retaining NOW
funds and hence face escalating costs of acquiring funds, the problem
of absorbing such costs will be examined in some detail in the
remainder of this section.
Characteristics of the Steady State
The Federal Reserve Board's Demand Deposit Ownership Survey
indicates that 1/3 of all demand deposits are held by households; thus
only about $2 billion of the $6 billion in demand deposits in Massachusetts
and New Hampshire could therefore be converted to NOWs.
In Table 2
it was shown that an estimated $550 million of demand deposits had been
converted to NOWs as of September 1975.
Thus, between 25 and 30 per
cent of eligible transactions balances were at that time in NOW accounts.
•
-37 -
It would be grossly incorrect, however, to attempt to
S.in an estimate of the effect of NOWs on CB profits in the steady
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Federal Reserve Bank of St. Louis
state--that period after which NOW market shares have stabilized and
CBs have made all desired adjustments--by multiplying the September 1975
estimated earnings reductions (Tables 4 and 5) by some number such
as 3 or 4.
Such a calculation would be nisleading because it ignores
potential adjustments that CBs can make in competing for NOW funds.
Before the payment of interest on NOWs was permitted, CBs
competed for transactions balances by offering suppliers of funds
various non pecuniary services such as free checking, branch banking,
lS nger hours of operation, and larger numbers of tellers to reduce
waiting time.
At the margin, however, the cost of providing such services
exceeds the value attached to these services by custamers.
It is a
widely accepted proposition, for example, that whenever the price
a service is set at zero, that service
of
will be consumed by customers
untilthe value of the last unit is zero.
However, there is a positive
cost associated with providing, or producing each service unit (e.g.
the cost of clearing checks written against a "free" checking account is
positive for each check).
Thus, the provision of such services is
inefficient in the sense that valuable resources are used up in producing
serices which, on the aargin, have relatively low value.
By substituting pecuniary returns--the payment of interest on NOWs-for non pecuniary services, CBs can eliminate the waste, or inefficiencies,
associated with providing non pecuniary services that have low marginal
'
values relative to cost. *Indeed, by"permktting the payment of interest
on NOW balances, both customers and banks can be expected to benefit.
This can be shown by supposing that banks initially offer free checking
services to the public and pay no interest on demand deposit balances.
The total return on demand funds derived by customers is thus equal to the
value of check cashing services, while the cost to the bank of acquiring
demand balances is equal to the cost of servicing their customers' free
checking accounts.
If banks are allowed to make explicit interest
payments to customers with demand funds on deposit, customers will be
better off even if they are required to pay for check cashing services
as long as the interest rate is high enough.
Moreover, bank costs can
be lowered due to reduced costs of servicing checking accounts if the
interest rate is not set too high.
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Federal Reserve Bank of St. Louis
Indeed, it is shown in Appendix
C
that there is a range if interest rates for which both customers--suppliers
of demand deposits--and banks are better off--i.e. the total value of
bank services to the customer, including interest earned, is higher
and bank costs of providing these services are lower.
One important implication of this result--also discussed in
Appendix C -- is that the cost to CBs of acquiring transactions balances
will decline if banks are permitted to pay interest on such balances.
This paradoxical result arises from the fact that removing a constraint
on the way in which banks can compete for funds allows CBs to select a
more efficient strategy for attracting funds.
-3I -
Transition to the Steady State
Competitive pressures may make the transition to the steady
state a long, and for some banks, a difficult process.
However, after NOW
growth begins to moderate and NOW market shares of individual CBs and thrifts
stabilize, the aggressive competition for NOW funds should gradually disappear as the level of non pecuniary services is reduced.
To establish that rational pricing of NOW balances will indeed
occur at some future date, it is necessary to show that the pricing policy
now in effect of offering relatively high rates of return (including both
I-cuniary and non pecuniary returns) on a new claim
such as a NOW account
is neither surprising irrational, but represents a short run strategy
consistent with maximizing the sum of current plus discounted future earnings.
In Appendix D, a formal argument is presented showing that when the future
suIIly of funds arising
from a new claim is related positively to market
shares established during the period before such shares have completely
stabilized, a bank seeking to maximize the value of stockholder's equity
will temporarily pay higher rates for these funds than is consistent with short
run profit maximization.
As market shares begin to stablize, moreover, the
rae of return offered will decline to the profit maximizing level.
This
implies that current CB behavior in competing aggressively for NOW funds is not
inconsistent with stockholder objectives, and more important, as the NOW market
settles down"
total rates of return offered on NOW accounts will decline.
The major type of non pecuniary return offered by CBs which can
be easily adjusted is free checking, including free drafts and free account
maintenance.
In table 7, estimates of NOW costs based on Functional
Cost Data from the Federal Reserve Bank of Boston -are shown.
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The
•
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Federal Reserve Bank of St. Louis
total annual cost of servicing a NOW account with a $1000 average balance
is about $90, of which nearly half ($41.40) is attributable to non interest
related costs.
If a 10 cent charge were imposed on drafts, the cost
of servicing an average NOW account would decline to about $80.
TABLE 7
NOW COSTS FOR A $1000 ACCOUNT
Item
Cost
Number of items
per Month
Monthly
Cost
Annual
Cost
$.09
11
.99
11.88
.15
2
.30
3.60
.16
1.92
2.00
24.00
Total cost per account
3.45
41.40
Interest cost, $1000.00
Account
4.17
50.00
$7.62
$91.40
Drafts
Deposits made
Outside checks
Handled
Account Maintenance
(Statements, etc.)
2.00
1
Total cost per month
Moreover, if account maintenance charges were introduced, this cost
would drop to about $55.
Since the cost of servicing a free checking
account averages about $40, CBs offering such accounts would thus
experience, as the transition period proceeds, only moderate increases
in costs of acquiring transactions balances if customers are required
to absorb draft and account maintenance charges.
Other adjustments which take longer to make—such as reducing
the number of branch banks, constructing less elaborate bank buildings and
the like--will be made
later .as competitive pressures force CBs to
adopt more efficient strategies far-mequiring deposits.
as noted earlier, will lower CB
These adjustments,
costs and thereby provide a net
gain to the economy through more efficient resource utilization.
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-42 APPENDIX A
EVIDENCE ON THE SOURCE OF NOW DEPOSITS
If a substantial portion of NOW balances represent conversions
from demand deposits, then demand deposit levels in Massachusetts and
New Hampshire should have been lowered by NOW accounts.
Similarly,
savings deposits, being only marginally affected, should have grown at
normal rates during the last two years.
As shown in columns 1 and 2 of
Table A-1, demand deposit balances in Massachusetts and New Hampshire
did decline some $300 million in 1974.
Moreover, balances in savings
accounts increased about $300 million over this period.
Part of the decline
in demand deposits and part of the increase in savings, however, can
be attributed to cyclical and regional economic factors.
An attempt
to adjust for these factors is therefore made in column 3 where projections
of demand and savings deposit growth are shown.
These projections are
based on the assumption that in the absence of NOWs, demand and savings
balances would have grown at the same rate as the average of those two
series in the four neighboring New England states which did not offer
NOWs.
Thus, the projected levels represent an estimate of demand and
savings balances that would have occurred had NOWs not been introduced, and
the difference between columns 2 and 3 represents a rough estimate of
the effect of NOW accounts on demand and savings deposit balances.
-43 TABLE A-1
SOURCE OF NOW DEPOSITS
($ billions)
JIMMOOPOINI1
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Federal Reserve Bank of St. Louis
IPC demand
Savings deposits
excluding NOWs
NOW accounts
(1)
1973.4
(2)
Actual
1974.4
(3)
Proj.
1974.4
6.329
6.025
6.244
13.885
14.160
14.194
.143
.340
(5)
(4)
Diff. Actual
(2)-(3) 1975.2
(6)
(7)
Diff.
Proj.
1975.2 (6)-(7)
6.280
5.853
-.427
-.028 15.268
15.100
-.168
-.219
.197*
.437*
.580
* Actual growth.
This difference, as shown in column 4, indicates that actual demand
deposit growth in 1974 was some $220 million less than projected in Massachusettz,
and New Hampshire.
Moreover, balances in savings accounts were only abouL
$30 million below expected levels.
The $220 million reduction in demand
deposits in 1974 is almost completely offset by the $197 million increase
in NOW balances, shown in the last row of Table A-1, suggesting that a
significant portion of NOWs originated in CB demand deposits.
Similar
calculations, appearing in columns 6 and 7, for the 18 month period from
January 1974 to June 1975 also indicate that, over the longer period,
demand deposits have probably been the major source of funds for new
NOW balances.
APPENDIX B
PORTFOLIO ADJUSTMENTS BY THRIFTS
Several important-impld,cations for thrift asset management
arise from permitting MSBs and S&Ls to issue NOW accounts.
Since they
have developed as a very close substitute for checking accounts, NOW
accounts should have short run and cyclical stability characteristics
similar to those of demand deposits.
Specifically, NOWs can be expected
to be relatively more stable over the business cycle than time and savings
deposits.
For example, figure 4 presents some evidence on the cyclical
Seasonally Adjusted
Annual Rates
20
FIGURE B-1
-10
1975
1970
stability of demand deposits relative to that of time and savings deposits
at CBS and thrifts.
Comparing the movements of the two series over the period
shown, there is a clear indication that demand deposits are more stable over
long periods of time than time and savings deposits.
This evidence is
supported by econometric studies which indicate that the sensitivity of time
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Federal Reserve Bank of St. Louis
-45--
and savings flows to changes in market interest rates is much greater
than that of demand deposits.
The acquisition of transactions balances by thrifts in the form
of NOW accounts should, therefore, reduce the severity of the so-called
disintermediation problem usually experienced by these institutions during
periods of high market interest rates and, thereby, reduce the variation
of earnings over the business cycle.
However, the implications of thrift
issuance of NOWs for mortgage lending are less clear.
Research by Hester
and Pierce-'suggests that depository institutions tend to allocate a
significantly larger proportion of time and savings funds to real estate
loans than demand funds.
For example, using a model of CB asset management,
Hester and Pierce estimate that approximately 30 ccnts
.L
aLL ctuu.L.
dollar derived frOm time and savings deposits will be invested in real
estate loans, while only 5 to 10 cents of an additional dollar of demand
deposits will be similarly invested.--' Permitting thrifts to issue NOW
accounts should, therefore, result in greater diversification of thrift
asset portfolios as relatively large proportions of NOW funds are invested
in short-term assets such as Treasury bills and consumer loans.
1/ Hester, Donald and James Pierce, op. cit.
2/ Though demand deposits are more stable than time and savings deposits over
the business cycle, they are much more volatile over shorter periods of time
such as a week. Thus, portfolio managers are reluctant to invest large
proportions of demand funds in mortgages, since a demand deposit run-off within
a few weeks might require that such assets be sold at a loss.
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Federal Reserve Bank of St. Louis
-46-
Total mortgage lending by all depository institutions might still
increase, however, as a result of permitting thrifts to issue NOW accounts.
The net effect on such lending of flows of funds between CBs and thrifts,
through small, should be positive, since thrifts have a comparative advantage
in mortgage lending.
More important, however, is the extent to which CB
tiLa and savings deposit funds accompany the outflows of demand funds from
CBs to thrifts.
If, through the issuance of NOWs, thrifts are able to
increase their share of the time and savings market, the net effect on
mortgage lending could be significant, since thrifts invest more than 70
per cent of such funds in mortgages, compared to perhaps 30 per cent by
CBs.
As noted in Section II, there is no,evidence, as yet, of such a
shift in market shares in Massachusetts and New Hampshire; thus there is no
reason to expect that major changes in mortgage lending are imminent.
However,
if the present 1/4 point differential on passbook savings between CBs and
thrifts is maintained, large outflows of CB savings funds associated with
demand deposit flows might occur after the adjustment to NOWs is complete.
Such a change in market shares could then significantly increase mortgage
lending at the expense of other types of loans traditionally provided by CBs.
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APPENDIX C
REMOVAL OF INTEREST RATE CONSTRAINTS,
BANK COSTS OF ACQUIRING FUNDS, AND
-PORTFOLIO RISK*
Suppose that banks can initially offer only non pecuniary
services--free checking, long hours, impressive buildings, etc.--in order
to attract transactions deposits.
The denand for these services is given
by the curve DD in figure C-1, while the MC curve represents the marginal
cost to the bank of providing such services.
Price
FIGURE C-1
Quantity
0
Qo
Qi
If the price of non pecuniary services is set at zero--as it is
for all banks that offer free checking--the quantity demanded of non pecuniary
services will be 0Q1.
The area under the DD curve--the area of triangle
ODQ --thus represents the total value of these services to the customer.
1
The
cost of providing this level of services, ignoring fixed costs, is equal to
the area under the MC curve--the area of OAEQ1.
* It is assumed throughout this appendix that bank customers are relatively
homogenous and that the number of checks written is positively_related to ,
the average balance of each account.
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Federal Reserve Bank of St. Louis
-48—
FrSm figure C-1 it is clear that the cost of providing services
I- yond OQ
S
exceeds the value attached to such services by customers.
If
permitted to pay interest on these funds, banks can eliminate this
inefficiency, and still provide customers with the same or greater level
of total--pecuniary plus non pecuniary--services.
Moreover, the cost of
providing this level of services will be lower.
For example, suppose banks change customers P for non pecuniary
o
services.
be OQ
S
The level of such services "purchased" by customers will then
which yields a net return to customers equal to the area.of the
triangle PDBn
o
(which is equal to the area under the demand curve be twee
0 and Q less the cost paid for services--equal to OP BQ ).
S o
o
Suppose
further that the interest rate is the set at a level to yield customers
a pecuniary return equal to the area of OPCQ . The total return to
S 1
customers is then equal to the area under the demand curve plus the
area of the triangle BCQ1.
The cost to the bank of providing these
services is equal to the area under the marginal cost curve between 0
o. This is le ss than the
C
and Q plus the area of the rectangle By
o
'arela under MC between 0 and Q --the original cost of non pecuniary ser1
vices--by the area of BEC.
Thus, by paying this particular interest
rate on funds, total returns to customers are increased, while bank
costs have declined.
Moreover, any interest payment greater than
OPBQ but less than OPBEQ will similarly raise total returns to
1
o 1
o
customers while lowering bank costs.
This result can be easily extended to show that the cost
Sf funds will decline if banks are permitted to pay interest on
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Federal Reserve Bank of St. Louis
-4S -
deposits.
In the northeast quadrant of figure C.2, let the curve CR
describe the relationship between bank costs of providing services and
the valuation of those services by customers.
Next, in the southeast
figure C-2
total Cost
Ds
Valuation of
Services
(Net Return)
Ds
quadrant, let the curve S represent the customers' supply function of
funds.
This curve has the usual property that as total returns offered by
S.nks increase, the supply of funds rises.
The cost of acquiring funds is depicted by the curve C in the
northwest quadrant of figure C-2.
This curve is derived from the CR and
S curves by use of the 45 degree translation line in the southwest quadrant.
For example, if bank costs arelevel of services offered
O
to customers will be R .
o
According to the supply function S, customers
o in funds.
will then supply Ds
s
Thus, deposits totaling D are supplied
when bank costs are C , as indicated by the point a in the northwest
o
quadrant.
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Federal Reserve Bank of St. Louis
-50-
The payment of interest on deposits shifts the CR curve to the
sbowri a higher return to customers can be achieved
right to C R, since, as,
by a given expenditure of bank funds.
It is easily seen from figure C-2
that this shift causes the C curve to shift downward to C'.
Thus, by re-
moving the constraint against the payment of interest on transactions
balances--and thereby permitting banks to adopt a more efficient strategy
for attracting funds--the cost to banks of acquiring funds will decline.
Finally, the lowering of the C curve has implications for the
amount of portfolio risk a bank will undertake.
1/
It has been shown- in the
/
context of a mean-variance portfolio model that if bank owners have a
3/
quadratic utility function , the amount of portfolio risk a bank will undertake rises whenever the risk-return curve shifts downward, and declines
when
an
nnranl-r1
shift
The
lnwerinq of the C curve in
state would tend to raise the mean-variance curve.
the stendy
Thus, in the long
run bank portfolio risk might be lowered as a result of the payment of
interest on transaction balances.
In the short fun, the C curve is raised
1/See Ralph Gambs, 22. cit.
2/The mean-variance portfolio model was developed by Harry Markowitz,
Portfolio Selection, Efficient Diversification of Investments, New
York: John Wiley & Sons, 1959 and James Tobin,"Liquidity Preference
as Behavior Towards Risk", Review of Economic Studies, February 1958.
For a comprehensive review of portfolio theory including recent developments, see Michael Jensen, "Capital Markets: Theory and Evidence", Bell
Journal of Economics and Management Science, 1972.
3/Quadratic, that is, in the mean and variance of the distribution of
expected returns.
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Federal Reserve Bank of St. Louis
„
- 51 -
and the mean-variance curve is lowered, thus implying that portfolio risk
might increase.
However, as noted in Section IV, there is no evidence
yet of such a change in the riskiness of bank assets.
4
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Federal Reserve Bank of St. Louis
as
APPENDIX ,D
PROFIT MAXIMIZATION AS A SUB-OPTIMAL CRITERION
WHEN THE LONG RUN SUPPLY OF FUNDS DEPENDS ON
MARKET SHARES ESTABLISHED DURING A TRANSITION
PERIOD
Suppose a new bank liability is introduced and that the long
run supply of funds to each bank depends positively on the market share
established during a transition period.
Suppose further that the bank
wishes to maximinize the sum of current plus future discounted profits.
For a two period world the formal problem is:
maximinimi4eW=E+11I
t
—
s
where
t
r )D
t
t
H = (i - r ) D
s
s
s
s
profits during the transition period
profits in the steady state
p is a discount rate
i is the rate earned on investments during the transition period.
t
is the offering rate on the new liability during the transition
t
(r < i )
period
t
t
r
i is the rate earned on investments in the steady state
s
r is the offering rate in the steady state (r < i )
s
s
s
The supply functions have the forms:
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Federal Reserve Bank of St. Louis
D = D
)
tt
t
D = D (r , D )
s
s s
t
(Supply function
during transition)
ar
t
DD
s
Dr
s
2
aps >o
3D
t
(Supply function
in steady state)
-53-
,;-titt.. -LIansition period depends positively
Note that the supply of funds duon the offering rate, while the supply in -the steady state, or long run,
depends positively on the market share--D --established during the transition
t
in addition to the offering rate.
To maximinize W (wealth), we differentiate with respect to r
t
and r and set both expressions to zero:
s
t+
@r
t
Differentiating
1
Hs
Dr
t
= 0
H with respect to r
s
(i
s
r)
s
s
yields
0
t > 0
Because DR /@r is positive, the partial derivative
s
t
/3r must be negative
t
t
if the first order profit maximinization conditions are to be satisfied
(first equation above).
This implies that if the first period profit
functiSn is concave with respect to r , as is usually assumed, then the
t
rate r
t
that maximizes wealth is greater than the first period profit
maximizing rate.
This is shown in figure D-1, where rP and rw
are the transition period profit and wealth maximizing prices respectively.
w
Notice that r --the rate offered by a bank maximizing wealth (or, equivalently, stockholders equity)--is higher than rP; this follows from nt/rt
being negative.
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Federal Reserve Bank of St. Louis
an'
it-
-54Figure D-1
nt
,
D
rt
w
r
t
r
t
Finally, the condition all2/rs = 0 implies that in the steady
state, after market shares have stabilized, rate setting will be based
on triditional profit maximizing considerations
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•••oF GOved
•i•
• 0
FEDERAL
4,
press
RESERVE
release
LI
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Federal Reserve Bank of St. Louis
March 1, 1976
For immediate release
The Board of Governors of the Federal Reserve System
today amended its Regulation Q to permit member commercial banks
throughout New England to offer NOW accounts to their customers.
The action was taken in light of legislation effective
February 27, 1976,authorizing NOW accounts in four additional New
England States.
Congress previously authorized NOW accounts in
Massachusetts and New Hampshire on an experimental basis.
A customer holding a NOW account may write Negotiable
Orders of Withdrawal (NCIWs) against the account and at the same
time receive interest on the funds retained in the account.
Attached is a copy of the amendment to Regulation Q,
which governs the payment of interest on deposits by member
S.nks.
- 0 -
11,
TITLE 12--BANKS AND BANKING
CHAPTER II--FEDERAL RESERVE SYSTEM
SUBCHAPTER A--BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
[Regulation Q]
Part 217--Interest on Deposits
Technical Amendments for Deposits
Subject to Negotiable Orders of Withdrawal
The Board of Governors of the Federal Reserve System has
amended Regulation Q (12 CFR 217) in light of recent legislation
(P.L. 94-222)
authorizing negotiable orders of withdrawal (NOW)
accounts in the States of Maine, Connecticut, Rhode Island, and Vermont.
The amendments are technical in nature and are intended only to extend
the existing provisions of Regulation Q regarding the offering of
NOW accounts to member banks in those States in which Federal law
permits such accounts.
The amendments also clarify the types of
depositors that may be offered NOW accounts by member banks.
The first amendment adds a sentence to
217.1(e)(3) to
make clear the fact that NOW accounts may not be maintained where
any beneficial interest is held by a corporation, partnership, association,
or other organization operated for profit or not operated primarily
for religious, philanthropic, charitable, educational, fraternal,
or other similar purposes.
In addition, the provision relating to
maintenance of NOW accounts established prior to May 16, 1975, by
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Federal Reserve Bank of St. Louis
-2-
certain governmental units has been eliminated because all such accounts
were required to have been terminated by December 31, 1975 (see 40
FR 17885).
The second amendment eliminates the reference to the States
of Massachusetts and New Hampshire contained in
217.5(c)(3) to
provide that the restrictions relating to manner of payment of savings
deposits do not apply to deposits subject to negotiable orders of
withdrawal, the issuance of which is
authorized by Federal law.
The final amendment modes
5
217.6(i) to limit NOW account
advertising of member banks, to the extent practicable, to media
directed toward residents of the States in which Federal law authorizes
such accounts and eliminates references to Massachusetts and New Hampshire.
The provision also restricts all other solicitations of NOW accounts,
to the extent practicable, only to persons residing or employed in
the States in which Federal law authorizes such accounts and to persons
who are customers of member banks in those States on the effective
S.te of this amendment.
This action was taken pursuant to the Board's authority
unS.r
q
19 of the Federal Reserve Act371b) to prescribe
rules governing the payment and advertisement of interest on deposits.
Because these amendments are technical in nature only and
do not result in any substantive changes to the provisions of Regulation Q,
the Board finds that good cause exists for dispensing with notice
and public participation referred to in
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Federal Reserve Bank of St. Louis
5
553(b) of Title 5 of the
-3-
United States
Coc!-
with respect to these amendments.
The Board has
determined that such procedures are unnecessary in view of the nature
of the amendments.
In addition, in view of the technical nature of
the amendments and in order to enable member banks to offer NOW accounts
to the public as soon as possible, the Board finds good cause to make
the amendments effective immediately.
Pursuant to
effective
.arch 1,
5 19 of the Federal Reserve Act (12 U.S.C. 371b)
1976,
5 217 of Regulation Q (12 CFR 217) is
amended to read as follows:
5 217.1--DEFINITIONS
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Federal Reserve Bank of St. Louis
(e)
Savings deposits
(3) In those States where banks are permitted
to offer deposits subject to negotiable orders
of withdrawal, such deposits may be maintained
if such deposits consist of funds deposited to
the credit of or in which the entire beneficial
interest is held by one or more individuals, or
- corporation, association, or other occlization
operated primarily for religious, philanthropic,
charitable, educational, fraternal, or other similar
purposes, and not operated for profit. Deposits
in which any beneficial interest is held by a
corporation, partnership, association or other
organization operated for profit or not operated
primarily for religious, philanthropic, charitable,
educational, fraternal, or other similar purposes
may not be classified as deposits subject to
negotiable orders of withdrawal.
-49 217.5—WITHDRAWAL OF SAVINGS DEPOSITS
(c)
Manner of payment of savings deposits
(3) The provisions of this paragraph do not apply
to deposits subject to negotiable orders of withdrawal
-Ar Federal
that are authorized '
217.6--ADVERTISING OF INTEREST ON DEPOSITS
(i) Negotiable orders of withdrawal.
In addition to compliance with the other paragraphs
of this section, member banks offering accounts
subject to negotiable orders of withdrawal, to
the extent practicable, shall limit every advertisement, announcement or solicitation made in any
newspaper, magazine, radio, television or other
media to such facilities directed toward residents
of the States in which Federal law authorizes
the issuance of such accounts. All other advertisement,
announcements and solicitations of such accounts,
including direct mailing, circulars, and notices,
whether written or oral, to the extent practicable,
shall be directed only to persons residing or
employed in the States in which Federal law authorizes
the issuance of accounts subject to negotiable
orders of withdrawal and to persons who are customers
of member banks in those States on the effective
date of this amendment.
By order of the Board of Governors, effective Mrch 1,
1976.
(Signed) Theodore E. Allison
Theodore E. Allison
Secretary of the Board
[SEAL]
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
February 10, 1976
To:
Board of Governors
From:
Don Winn
The House has now given final approval to S. 2672 thereby
clearing the measure for the President. This is the bill which
extends the moratorium on the interstate taxation of depository
institutions, allows NOW accounts in all six New England States,
and makes certain changes in the Fair Credit Billing Act. The NOW
account provision goes into effect immediately upon date of enactment.
cc:
Messrs. Allison, Garwood, Coyne, O'Brien, Hawke, Gramley, Raiken,
F. Solomon, Kluckman, Kichline, Eckert, Ettin, and Ms. Hart
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Federal Reserve Bank of St. Louis
•
•
February 9, 1976
To:
From:
Board of Governors
\tt
Don Winn
On Friday, February 6, the Senate, after adding minor
amendments, agreed to the House version of S. 2672, the bill which
would extend the moratorium on interstate taxation of depository
institutions to September 12, 1976.
This bill would also allow all Federal financial institutions in the 6 New England states to offer NOW accounts.
It is the third section of the bill with its provisions
amending the Fair Credit Billing Act that has been the subject of
disagreement between the House and Senate.
•••
•••
MR Mil
The Senate has now agreed to the House provision
authorizing the Federal Reserve Board to delegate
to staff the authority to issue binding interpretations
and approvals.
The Senate has also agreed to the House provision to
specifically prohibit the imposition of surcharges on
credit card customers. The Senate, however, has added
the modification that the ban on surcharges would be
limited to a 3 year period so that Congress would
review the matter at a later time.
The House bill would have eliminated the 5 per cent
limitation on permissible cash discounts. The Senate
disagreed with this provision and has added an amendment
to reinstate the 5 per cent limit.
The bill naw returns to the House for final approval, which
is expected without further changes.
cc:
Messrs. Allison, Garwood, Coyne, O'Brien, Hawke, Gramley, Raiken,
Kichline, Eckert, Ettin, and Ms. Hart
k
F. Solomon, Klucman,
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Federal Reserve Bank of St. Louis
b 4.10
December 8, 1975
To:
Board of Governors
From:
Don Winn
The Senate today approved an extension of the moratorium
on interstate taxation of national banks from December 31, 1975,
to September 12, 1976. It also accepted by a voice vote an amendment by Senator Brooke authorizing NOW accounts in all the New
England states.
Also, the Senate passed legislation repealing provisions
of the Real Estate Settlement Procedures Act. An amendment
recommended by the Board was adopted to allow advance disclosure of
credit costs. The language of the amendment reads as follows:
(c) For the purposes of subsection (a), the Board is
authorized to require by regulation the disclosure of all or part
of the information required to be disclosed under this Chapter at
the time a creditor makes a written commitment with respect to a
consumer credit transaction involving real property which is used
or is expected to be used as the principal residence of the person
to whom the credit is extended.
cc:
Messrs. Allison, Garwood, Coyne, O'Brien, Hawke, Solomon,
Raiken, Kluckman, Kichline, Ettin, Boltz, Eckert,
and Ms. Hart.
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Federal Reserve Bank of St. Louis
November 18, 1975
To:
Thru:
From:
Chairman Burns
Ken Guenther
Don Winn
At your request I have talked to Governor Mitchell about the
possible McIntyre legislation to extend NOW account powers to Federal
S&L's in states like Maine and Connecticut which are giving demand
deposit powers and NOW account powers to state chartered thrift
institutions.
Governor Mitchell feels that in New fngland the S&L's are A
relatively small part of the market so that extending NOW account powers
to Federal S&L's would not have an important effect on commercial banks
and it would equalize the Federal S&L's with the state chartered thrifts.
He feels that it would be entirely different if the extension were to
ppply to states outside New Lngland where S&L's have a much larger
market share.
Attached is a table showing market shares in Connecticut and
Maine, which Governor Mitchell referred to.
Governor Mitchell also suggested that we say to McIntyre that
we would have to consider remavims the differential if the change were
to result in a worsening of competitive positions.
Shall I indicate to McIntyre's staff (and this would be off
the record) that the Board would not object to extending NOW account
powers to Federal S&L's in New England, but that the Board would take
a different position if the legislation affected other saographic
areas?
Yes
No
4.41111.111.111.6.1111.0
take the position that
I asked Governor Mitchell if we should
to commercial banks. He did not
NOW account powers should also be given
the commercial bank share of
think this was necessary. He said that
there was no evidence they would
the market was increasing and that
be hurt.
Attachment
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
To
From
Board of Governors
Date
Subject:
February 20, 1975
NOW account developments in
Paul W. _Boltz
December 1974
After one full year of the Congressionally-mandated NOW account
experiment in Massachusetts and New Hampshire, outstanding balances in NOW
accounts in the two states have more than doubled to $313 million, and the
pace of growth accelerated in the second half of the year.
At the present
rate, outstanding NOW account balances will double approximately every 8
months.
However, although they have spread at a rapid rate, they still are
less than 1 per cent of total deposits and less than 4 per cent of demand
deposits at depository institutions in the two states.
At the end of the year, 75 per cent of the 201 mutual savings
banks in the two states were offering NOW accounts, up from 50 per cent at
the beginning of the year.
Savings and loan associations entered the field
very rapidly in 1974, and at the end of December over 40 per cent of the
197 S&L's in the two states were offering NOW accounts.
Commercial banks
have not matched the aggressive entry of the S&L's into the NOW market, and
at the close of the year only 28 per cent of banks had NOW accounts.
Altogether, 47 per cent of the 627 depository institutions in the two states
were offering NOW accounts as of December 31, 1974.
The more rapid entry
of thrift institutions into the NOW market likely reflects their desire to
compete with commercial banks in the payments market.
Since banks already
had demand deposits, their slower entry may reflect their prior position of
'1
strength in this market.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-2-
Activity levels at NOW accounts gradually rose over the year.
New
Hampshire MSB's, which pioneered NOW accounts with no-charge drafts that
paid low interest, had the highest average level of NOW account activity
in January 1974 when data were first collected.
At that time, 75 per cent
of New Hampshire's MSB's that offered NOW accounts provided free drafts,
and tne proportion of other institutions offering free NOW drafts in the
two states was much lower.
Other institutions switched to free drafts as
the year progressed or offered them when they first entered the NOW market.
Most institutions switching to free drafts continued paying the ceiling rate
of 5 per cent, and to compete with them, institutions just entering the
field also paid the ceiling rate on their free-draft NOW accounts.
Consequently,
the accounts have evolved into very attractive accounts for transactions
balances.
As the following table shows, NOW account activity at New Hampshire
MSB's is being approached at other institutions.
1974 NOW Account Activity in Massachusetts and New Hampshire
Average number of
Percentage of NOW
NOW drafts per
accounts with over
account
20 drafts
January
December
January
December
Massachusetts
Commercial banks
MSB's
S&L's
Total Massachusetts
6.8
6.8
4.9
6.8
8.5
9.2
10.6
9.3
0.0
3.8
0.0
3.7
11.0
7.8
10.8
8.7
4.1
11.0
0.0
15.5
12.6
**
12.2
10.3
11.7
25.0
**
16.6
14.0
16.0
New Hampshire
Commercial banks
MSB's
S&L's
Total New Hampshire
12.6
24.6
Total Massachusetts
and New Hampshire
7.3
5.4
9.5
9.4
** In January, only one S&L in New Hampshire was offering NOW accounts, and its
data were included with data on MSB's in New Hampshire by the Boston Federal
Reserve Bank to protect the confidentiality of the report.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-3Interest Rates and Charges for Drafts on Now Accounts in
Massachusetss and New Hampshire, 1974
Percentage of
institutions at
ceiling rate
January December
Percentage of
institutions with
free NOW drafts
January
December
Massachusetts
Commercial banks
MSB's
S&L's
Total Massachusetts
100.0
100.0
100.0
100.0
98.0
100.0
100.0
99.6
27.3
25.9
36.4
27.1
19.6
70.2
78.6
62.3
66.6
13.3
0.0
75.0
21.0
83.3
45.0
90.9
67.4
63.2
50.0
70.0
45.4
58.1
88.1
94.9
32.5
61.7
New Hampshire
Commercial banks
MSB's
S&L's
Total New Hampshire
Total Massachusetts
and New Hampshire
**
**
**
In January, only one S&L in New Hampshire was offering NOW accounts, and
its data were included with data on MSB's in New Hampshire by the Boston
Federal Reserve Bank to protect the confidentiality of the report.
One feature of the NOW accounts which has remained relatively stable
over the year is the predominant method of interest calculation--from day of
deposit to day of withdrawal.
Almost all the mutual savings banks offering
NOW accounts in January 1974 calculated interest in this way, and since then
over 90 per cent of the institutions which began offering NOW's also calculated
interest from day of deposit to day of withdrawal.
Most institutions also
cS mpound the interest either continuously or daily, but the proportion has
been falling slightly as the number of institutions compounding quarterly or
monthly has grown.
At the end of December about 70 per cent of the offering
institutiS ns compounded continuously or daily.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
TABLE 1
NUMBER OF INSTITUTIONS OFFERING NOWS AND NOW BALANCES AS OF
DECEMBER 319 1974
RS )
( DOLLAR AMOUNTS IN 1tuIIMI!J.']'I'1ILII
I
I
I
I
I
I
I
I
I
I
I
I
--- .... -I
I
I MASSACHUSETTS
I
I
COMMERCIAL BANKS
I
MEMBERS
NON—MEMBERS
I
I
I
MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED — MEMBERS FHL8
I
STATE INSURED — MEMBERS FHLB
I
STATE INSURED — NON—MEMBERS FHLB
I
I
TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
I
COMMERCIAL BANKS
I
I
I
I
MUTUAL SAVINGS BANKS
I
I
SAVINGS E. LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED — MEMBERS FHL8
STATE INSURED — MEMBERS FHLR
STATE INSURED — NON MEMBERS FHLB
TOTAL
NEW HAMPSHIRE
I TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
TRANSACTIONS DURING MONTH
I
I
I-NOW
I
I
I BALANCES 1 AMOUNT I
OF
I DEPOSIT I ALL WITH—
I
I PREVIOUS I
I INTEREST I INFLOWS I DRAWALS
I OFFERING I MONTH
I
I CREDITED I
I
NOWS
I
NUMBER OF
INSTITUTIONS
TOTAL
I
I
I
NOW
I
I BALA^!CES I
I CURRENT I
I
MONTH I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
153
92
61
51
33
18
489563
239876
249687
188
71
117
459870
21 9504
249366
379626
16,482
21,144
6
5
1
569989
28,964
28,025
167
131
1929577
787
1139401
1069656
26
2009083
179
35
28
116
70
21
11
38
269689
119534
59639
99516
116
63
21
32
249894
129018
4,510
89366
219952
109409
49264
79279
0
0
0
0
299747
13,206
5,906
109b35
499
252
2679829
19091
1849165
1669234
32
2869819
76
12
79431
27
69104
59302
0
89260
34
20
149187
42
129716
139366
1
139578
18
0
0
11
0
0
39858
0
0
16
0
0
39312
0
0
39267
0
0
0
0
0
128
43
259476
85
229132
219935
1
259757
I
627
295
2939305
19176
2069297
1889169
33
3129576
I
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMENT+ FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
I
I SERVICE
I CHARGES
I
1
39
I'I'JLI?IIIIIIIII
0 1
0 I
TABLE 2
NUMBER OF NOW ACCOUNTS AT OFFERING INSTITUTIONS
AS OF
I
NUMBER OF
I NOW ACCOUNTS
I
PREVIOUS
MONTH
DECEMBER 31' 1974
I NEW ACCOUNTS OPENED DURING MONTH I
I
I
BY EXISTING
I
BY NEW
I
CUSTOMERS MI
CUSTOMERS
NUMBER OF
ACCOUNTS CLOSED
DURING
MONTH
NUMBER OF
NOW ACCOUNTS
CURRENT
MONTH
MASSACHUSETTS
COMMERCIAL BANKS
MEMBERS
NON-MEMBERS
MUTUAL SAVINGS RANKS
SAVINGS 6. LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON-MEMBERS FHLB
TOTAL MASSACHUSETTS
39,986
18,550
21,436
3,637
1,783
1,854
2,718
2,005
713
673
544
129
45,668
21,794
23,814
196,125
6,583
5,422
2,426
205,704
34,048
16,283
6,329
119436
1,967
988
175
804
1,587
712
281
594
354
187
50
117
379248
179796
6,7_35
12,717
270,159
12,187
9,727
3,453
288,6e0
4,991
319
156
70
5,3(o6
18,475
662
224
166
199195
3,586
0
0
194
0
0
232
0
0
48
3,964
0
0
27,052
1,175
612
284
28,555
13,362
10,339
3,737
317,175
NEW HAMPSHIRE
COMMERCIAL BANKS
MUTUAL SAVINGS RANKS
SAVINGS Fs LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON MEMBERS FHLB
TOTAL
NEW HAMPSHIRE
TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
297,211
(1) EXISTING CUSTOMERS ARE DEFINED AS THOSE HAVING
AN ACCOUNT AT THE INSTITUTION AT THE TIME THE NOW
ACCOUNT WAS OPENED.
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMEN
T, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
TABLE 3 A
NOW ACCOUNT ACTIVITY
DURING THE MONTH OF
DECEMBER 319 1974
NUMBER OF NOW ACCOUNTS WITH ACTIVITY
DECEMBER 319 1974
DURING MONTH OF:
I
NO DRAFTS
I
1-9
DRAFTS
I 10-20 DRAFTSI
I
> 20 DRAFTS I
TOTAL
NUMBER OF
NOW
DRAFTS
AVERAGF
I
NUMBER CF
I
NOW DRAFTS I
I
I PER ACCOUNT(2)I
I MASSACHUSETTS
I
COMMERCIAL BANKS
MEMBERS
NON-MEMBERS
17,279
139050
49229
169142
49920
119222
79204
29264
49940
59043
1,560
3,483
2419438
96,328
145,110
8.5
11.0
7.3
I
I
I
I
MUTUAL SAVINGS BANKS
489551
1029171
389840
169142
194559646
9.2
I
I
SAVINGS & LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON-MEMBERS FHL8
89442
59112
19240
29090
159578
69964
29983
59631
99193
39769
19720
39704
49035
19951
792
19292
3069140
1459919
599822
1009399
10.6
11.5
10.8
9.4
I
I
I
I
749272
1339891
55,237
259220
290039224
9.3
I
982
29425
19154
835
489591
11.0
I
39075
79956
4,987
3,177
1979175
12.2
I
641
19905
0
0
863
555
0
0
349302
0
0
10.3
0.0
0.0
I
I
49698
129286
79004
49567
280,068
11.7
I
789970
1469177
629241
299787
292839292
9.5
I
I
TOTAL MASSACHUSETTS
I NEW HAMPSHIRE
I
COMMERCIAL BANKS
I
MUTUAL SAVINGS BANKS
I
SAVINGS & LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON MEMBERS FHL8
I
TOTAL
NEW HAMPSHIIl
RE
TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
w•Ron•••••=....orms
(2) AVERAGE EXCLUDES THOSE ACCOUNTS WHICH HAD NO ACTIVITY DURING THE MONTH.
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
TABLE 3 B
NOW ACCOUNT ACTIVITY
DURING THE MONTH OF
DECEMBER 31, 1974
,11•1114•=11,
I
I
I
I
I
I
I
I
PERCENTAGE OF NOW ACCOUNTS WITH ACTIVITY
DURING MONTH OF: DECEMBER 31, 1974
NO DRAFTS
I
1-.9
DRAFTS I 10-20 DRAFTS I
I NUMBEk OF
I NOW ACCOUNTS
CURRENT
I
MONTH
> 20 DRAFTS I
(3)
1
1
I
I
AVERAGE
BALANCE
PER
ACCOUNT
I
I
I
I
I MASSACHUSETTS
I
COMMERCIAL BANKS
MEMBERS
NONMEMBERS
37•8
59.9
17.7
35.3
22.6
47.0
15.8
10.4
20.7
11.0
7.2
14.6
45,668
21,794
23,874
I
MUTUAL SAVINGS BANKS
23.6
49.7
18.9
7.8
205,704
I
SAVINGS I. LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON-MEMBERS FHLB
22.7
28.7
18.4
16.4
41.8
39.1
44•3
44.3
24.7
21.2
25.5
29.1
10.8
11.0
11.8
10.2
37,248
17,796
6,735
12,717
I
1,247.90 I
1,328.99 I
1,173.87 I
I
972.67 I
I
I
798.62 I
742.08 I
878.91 I
836.28 I
TOTAL MASSACHUSETTS
25.7
46.4
19.1
8.7
288,620
993.76 I
I
I NEW HAMPSHIRE
I
COMMERCIAL BANKS
18.2
44.9
21.4
15.5
5,396
1,530.76 I
I
MUTUAL SAVINGS BANKS
16.0
41.4
26.0
16.6
19,195
707.37 I
I
SAVINGS & LOAN ASSOCIATIONS AND
COOPERATIVES
FSLIC INSURED - MEMBERS FHLB
STATE INSURED
MEMBERS FHLB
STATE INSURED - NON MEMBERS FHLB
16.2
0.0
0.0
48.1
0.0
0.0
21.8
0.0
0.0
14.0
0.0
0.0
3,964
0
0
988.65 I
0.00 I
0.00 I
TOTAL
16.5
43.0
24.5
16.0
28,555
902.01 I
24.9
46.1
19.6
9.4
317,175
985.50 I
I
NEW HAMPSHIRE
I TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
(3) PERCENTAGES MAY NOT TOTAL EXACTLY 100
PERCENT DUE TO ROUNDING
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
S
TABLE 4 A
RATES PAID ON NOW ACCOUNTS
AS OF
DECEMBER 31' 1974
( DOLLAR AMOUNTS IN THOUSANDS OF DOLLARS )
I
I
I
I
I
I
I
I
I
I
I
I MASSACHUSETTS
I
COMMERCIAL BANKS
I
MEMBERS
I
NON-MEMBERS
I
I
I
MUTUAL SAVINGS BANKS
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON-MEMBERS FHLB
I
I
I
TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
I
COMMERCIAL BANKS
1
I
MUTUAL SAVINGS BANKS
I
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
STATE INSURED - NON MEMBERS FHLB
I
I
I
NEW HAMPSHIRE
TOTAL
I
I TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
I
3.0%
NO OF
INST
I
I
DOLLAR
AMOUNT
I
I
I
I
I
OVER 3.0% AND
LESS THAN 4.0%
NO OF
INST
I
I
DOLLAR
AMOUNT
I
1
I
I
I
I
I
I
I
I
4.0%
NO OF
INST
I
I
DOLLAR
AMOUNT
NO OF
INST
I
I
DOLLAR
AMOUNT
0
0
0
0
0
0
0
0
0
0
0
0
1
0
1
316
0
316
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
316
0
0
0
0
0
0
2
569
0
0
4
1,806
0
0
7
5,046
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
0
0
160
0
0
0
0
0
0
0
0
4
1,806
0
0
10
5,775
0
0
4
1,806
0
0
11
6,091
0
0
Immlommlm
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
I
I
I
I
OVER 4.0% AND
LESS THAN 4.'30%
.IM.M.OIMA.M.imwd.mmOmMe.mmomeninaso
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
F
TABLE 4 El
RATES PAID ON NOW ACCOUNTS
AS OF
DECEMBER 319 1974
( DOLLAR AMOUNTS IN THOUSANDS OF DOLLARS )
.....m.......m...m...
gmliam...........m,
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4.50%
NO OF
INST
1
I
DOLLAR
AMOUNT
OVER 4.5% AND
LESS THAN 5.0%
NO OF
INST
I
I
DOLLAR
AMOUNT
I
I
I
I
I
5.0%
NO OF
INSTS
I
I
DOLLAR
AMOUNT
I
I
I
I
I
WEIGHTED
AVERAGE
RATE (4)
..1......01•
I
I MASSACHUSETTS
I
I
COMMERCIAL BANKS
I
MEMBERS
I
NON-MEMBERS
I
I
MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON-MEMBERS FHLB
I
I
TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
I
COMMERCIAL BANKS
I
I
I
I
MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON MEMBERS FHLB
1
I
TOTAL
NEW HAMPSHIRE
I
I TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
I
I
mor
(4)
•=.111•01,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
molm.......
I
I
I
I
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
I
0
0
0
0
0
0
0
0
0
0
0
0
50
33
17
56,673
28,964
27,709
4.994
5.000
4.988
0
o
o
o
131
200,083
5.000
0
0
0
0
o
o
o
0
0
0
0
0
0
0
0
0
70
21
11
38
29,747
13,206
5,906
10,635
5.000
5.000
5.000
5.000
0
0
0
0
251
286,503
4.998
o
o
o
o
10
7
7,691
4.931
o
0
o
o
9
6,726
4.362
0
0
0
0
0
0
0
0
0
0
0
0
10
0
3,759
0
4.959
.000
o
0
.000
0
o
o
o
1
1
29
18,176
4.635
0
o
o
o
280
304,679
4.968
I
I
1
I
I
...NI
.....1.410,
WEIGHTED BY DOLLAR AMOUNT
PREPARED
I
I
I
I
1
By STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
TABLE 5
METHOD OF INTEREST RATE CALCULATION
AS OF
DECEMBER 31, 1974
( NUMBER OF INSTITUTIONS )
•=1•NII.
I
INTEREST CALCULATED ON:
I
I AVG DLY
MIN DAY OF DEP DAY OF DEP
TO DIV DT
BAL
BAL
TO WITH
I
I
I
I
I
I
I MASSACHUSETTS
I
COMMERCIAL BANKS
I
I
MEMBERS
NON-MEMBERS
I
I
MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON-MEMBERS FHLB
I
I
TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
COMMERCIAL BANKS
I
I
I
I
I
MUTUAL SAVINGS RANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON MEMBERS FHLB
I
I
TOTAL
NEW HAMPSHIRE
I
I TOTAL MASSACHUSETTS AND NEW HAMPSHIRE
I
I
I
I
OTHER I
I
DAILY
CONT
MONTHLY
QTERLY
OTHER
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
8
5
3
2
0
2
40
27
13
0
0
0
1
1
0
11
7
4
11
6
5
17
11
6
12
9
3
0
0
0
3
1
126
0
1
86
27
13
4
1
3
1
0
2
0
0
0
0
65
19
11
35
1
0
0
1
1
1
0
0
37
10
6
21
13
7
1
5
9
1
2
6
11
0
3
0
I
2
6
0
0
14
3
231
1
3
134
51
39
27
1
0
1
10
0
1
0
2
10
0
0
0
0
19
0
1
18
0
2
0
0
0
0
0
1
0
0
10
0
0
0
0
0
0
0
0
5
0
0
4
0
0
2
0
0
0
0
0
0
0
0
0
2
39
0
2
23
6
14
0
0
14
5
270
1
5
157
57
53
27
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
PREPARED BY STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
FREQUENCY OF COMPOUNDING
•
TABLE 6
SIZE DISTRIBUTION BY NUMBER OF INSTITUTIONS
AS OF
DECEMBER 31. 1974
( BASED ON TOTAL ASSETS )
I
I
I
I
I
I
I
I MASSACHUSETTS
I
I
COMMERCIAL BANKS
I
MEMBERS
NON-MEMBERS
I
I
I MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLB
I
STATE INSURED - MEMBERS FHL9
I
STATE INSURED - NON-MEMBERS FHLB
1
I
TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
I COMMERCIAL BANKS
I
I
I
I MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHL3
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON MEMBERS FHLB
I
I
TOTAL
NEW HAMPSHIRE
I
ITOTAL MASSACHUSETTS AND NEW HAMPSHIRE
I
I
< $50 m
ALL INSTITUTIONS
I
I
I
S50-250 M
I
> $250 m
INSTITUTIONS OFFERING NOWS
I
I
< $50M
$50-250 m
I
I
> $250 M
101
57
44
41
25
16
11
10
1
21
12
9
23
15
8
7
6
1
69
84
14
43
74
14
156
22
25
109
22
12
3
7
1
1
0
0
51
10
7
34
18
10
4
4
1
1
0
0
326
147
26
115
115
e2
71
5
0
12
0
0
22
11
1
9
10
1
16
0
0
2
0
0
0
0
0
10
0
0
1
0
0
0
0
0
109
18
1
31
11
1
435
165
27
146
126
23
PREPARED By STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
I
I
I
TABLE 7
SOURCE OF NEW ACCOUNTS AND CHARGES PER DRAFT
AS OF
DECEMBER 31, 1974
( DOLLAR AMOUNTS IN THOUSANDS OF DOLLARS )
DEPOSITS TO NEW
NOW ACCOUNTS FROM: (5)
I DEM DEPOSITS I
I
I MASSACHUSETTS
I
I COMMERCIAL BANKS
I
MEMBERS
I
NON-MEMBERS
I
I MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
COOPERATIVES
I
I
FSLIC INSURED - MEMBERS FHLR
I
STATE INSURED - MEMBERS FHLB
I
STATE INSURED - NON-MEMBERS FHLB
I
I TOTAL MASSACHUSETTS
I
I
I NEW HAMPSHIRE
I
I COMMERCIAL BANKS
I
I
I
I MUTUAL SAVINGS BANKS
I
I
SAVINGS & LOAN ASSOCIATIONS AND
I
COOPERATIVES
I
FSLIC INSURED - MEMBERS FHLR
I
STATE INSURED - MEMBERS FHLR
I
STATE INSURED - NON MEMBERS FHLB
I
NEW HAMPSHIRE
I TOTAL
I
ITOTAL MASSACHUSETTS AND NEW HAMPSHIRE
I
I
TIME & SAV
I
I
I
FREE
I
CHARGES
PER
DRAFT
$.10
1
1.15
OTHER (6)
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
272
132
140
350
272
78
10
6
4
10
6
4
12
8
4
19
13
6
0
1,849
92
13
13
13
0
0
0
0
337
178
16
143
55
15
6
34
7
4
2
1
2
0
0
2
6
2
3
1
272
2,536
157
30
27
38
21S
39
6
0
6
0
0
78
14
1
0
5
0
87
5
1
0
4
0
1
0
1
I
I
I
I
I
I
I
I
0
0
0
0
0
0
0
0
0
215
204
25
2
10
6
487
2,740
182
32
37
44
(5) THESE ARE TRANSFERS TO NEW NOW ACCOUNTS OPENED DURING THE MONTH FROM THE INSTITUTIONS OWN DEMAND DEPOSITS OR
TIME AND SAVINGS DEPOSITS.
(6) "OTHER" INCLUDES INSTITUTIONS USING A COMBINATION OF FREE DRAFTS PLUS A
CHARGE FOR EACH DRAFT OVER A SPECIFIED NUMBER.
PREPARED By STATISTICAL SECTION, RESEARCH DEPARTMENT, FEDERAL RESERVE BANK OF BOSTON
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
Table 8
OUTSTANDING BALANCES - NEGOTIABLE ORDERS OF WITHDRAWAL (NOWs)
(in thousands of dollars)
MONTH
ENDED
1972 Sept.
Oct.
Nov.
Dec.
1973 Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
1974 Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
TOTAL OF ALL
OFFERING
INSTITUTIONS
11,094
22,386
34,823
45,272
60,726
73,451
86,118
94,606
102,045
108,381
113,418
117,005
120,223
130,361
136,872
143,254
143,190
150,447
165,157
174,682
180,637
191,229
204,646
232,386
249,033
270,813
293,305
312,576
TOTAL
2,556
4,338
6,588
9,689
11,052
13,771
17,919
32,955
39,253
46,776
55,994
65,249
COMMERCIAL BANKS
MEMBER
MASS.
N.H.
1,511
2,060
2,882
3,638
3,891
4,587
6,511
13,707
14,837
18,969
23,876
28,964
---------
---
MUTUAL SAVINGS BANKS
NON-MEMBER
MASS.
N.H.
763
1,797
3,034
4,820
5,405
6,569
7,664
14,743
18,760
21,276
24,687
28,025
282
481
672
1,231
1,756
2,615
3,744
4,505
5,656
6,531
7,431
8,260
TOTAL
MASS.
N.H.
11,094
22,386
34,823
45,272
60,726
73,451
86,118
94,606
102,045
108,381
113,418
117,005
120,223
130,361
136,872
143,254
139,779
143,764
154,007
157,412
159,591
164,733
171,503
180,335
187,721
197,758
206,764
213,661
11,094
22,386
34,363
44,522
59,661
71,975
84,162
92,341
99,633
105,688
110,486
113,852
116,259
125,873
131,795
138,028
134,832
138,453
147,845
150,309
151,510
155,946
161,544
169,119
175,340
184.830
192,577
200,083
460
750
1,065
1,476
1,956
2,265
2,412
2,693
2,932
3,153
3,964
4,488
5,077
5,226
4,947
5,311
6,162
7,103
8,081
8,787
9,959
11,216
12,381
12,928
14,187
13,578
.,
....
. _
rueparea
y. -tatisticaj
bection, Kesearch
Department, Federal Reserve Bank of Boston
*Includes three member commercial banks.
The above adjustments were made to insure the confidentiality
of individual institution
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
data.
SAVINGS & LOAN ASSOCIATIONS
I MASSACHUSETTS
TOTAL
COOPS
S&Ls
855
2,345
4,562
7,581
9,994
12,725
15,224
19,096
22,059
26.279
30,547
33,666
470
1,315
2,340
3,374
4,045
4,843
5,446
7,313
8,044
9,979
11,534
13,206
385
1,030
1,985
3,539
4,906
6,246
7,777
9,468
11,270
13,338
15,155
16,541
N.H.
--237
668
1,143
1,636
2,001
2,315
2,745
2,963
3,858
3,919
'''411411
Table 9
NUMBER OF INSTITUTIONS OFFERING NEGOTIABLE ORDERS OF WITHDRAWAL (NOWs)
MEINTH
ENDED
1972 Sept.
Oct.
Nov.
Dec.
1973 Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
1974 Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
TOTAL OF ALL
OFFERING
INSTITUTIONS
23
35
52
59
63
67
69
69
69
69
70
72
74
80
86
90
126
141
171
188
204
227
238
248
257
277
285
295
TOTAL
TOTAL
14
15
21
24
26
35
37
41
42
53
58
63
MUTUAL SAVINGS BANKS
COMMERCIAL BANKS
NON-MEMBER
MEMBER
N.H.*
MASS.
N.H.
MASS.
5
5
8
9
9
14
15
18
18
28
31
33
1
1
3
3
4
7
8
8
9
9
9
9
6
7
8
10
11
12
12
13
13
14
16
18
2
2
2
2
2
2
2
2
2
2
2
3
TrIlk23
35
52
59
63
67
69
69
69
69
70
72
74
80
86
90
100
104
114
121
126
133
137
140
142
148
148
151
Prepared by: Statistical Section, Research Department, Federal Reserve Bank of Boston
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
MASS.
23
35
46
50
53
55
57
57
57
57
58
60
61
66
71
75
85
89
98
104
108
114
118
120
122
128
128
131
N.H.
_
-6
9
10
12
12
12
12
12
12
12
13
14
15
15
15
15
16
17
18
19
19
20
20
20
20
20
SAVINGS & LOAN ASSOCIATIONS
N.H.
MASS.
COOPS
S&Ls
TOTAL
12
22
36
43
52
59
64
67
73
76
79
81
4
6
9
12
12
15
17
18
20
20
21
21
7
15
23
27
35
38
39
41
45
46
48
49
1
1
4
4
5
6
8
8
8
10
10
11
MR. RIPPEY
FOR INFORMATION PRIOR TO CONSIDERATION
AT A BOARD MEETING
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
•
February 4, 1975
To:
hoard of Governors
From:
Legal Division
(Messrs. Raiken
and Schwartz)
ACTION_REQUESTED:
Subject: Summary of Comments on the
Board's proposed amendment to prohibit
governmental NOW accounts.
None at this time.
This memorandum is a summary of the
coments received in response to the Board's publication of a
proposed
amendment to Regulation Q to prohibit member banks from conti
nuing to
offer governmental NOW accounts.
BACKGROUND:
On November 26, 1974 the Board (and the FDIC) amended
Regulation Q to permit member banks to off-r savings accounts
to governmental units.
That action also had the effect of permitting governmental
units in Massachusetts and New Hampshire to obtain NOW accounts.
After
reviewing requests from the ABA, the Massachusetts Bankers Associatio
n
and Senator iicIntyre, the Board and the FDIC agreed to reconsider
that
part of the amendment which permitted governmental units to hold NOW
accounts.
COMMENTS RECEIVED:
The comment period expired on January 20, 1975.
Approx-
imately 145 comments have been received on the subject proposal as of
January 29, 1975.
Comments were received from four groups:
(1) commercial
banks throughout the United States, (2) bankers associations, (3)
Federal
Reserve Banks and (4) other interested parties including government
al
treasurers, Congressmen, and the Public Interest Research Group.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
2-
These groups expressed the following positions:
Number of
Respondents
I.
II.
III.
IV.
Commercial Banks
Bankers Associations
Federal Reserve Banks
Others
TOTAL
124
10
6
6
146
Favor
Proposal
120
7
4
___ 1_
132
Against
Proposal
4
3
2
5
14
Attachment A presents the major comments received and the number of times
mentioned by members of the above groups.
I. cPRIPLqYCAR1 13..4nk§.
Of 124 banks commenting on the proposal, 120 were in favor of
the Board prohibiting governmental NOW accounts and 4 were opposed.
1ost
of the comments (77) came from the First Federal Reserve District, which
Includes the States of -plassachusetts and rew Lampshire
all 77 banks were
in favor of prohibiting governmental NOWs.
The most frequently cited reason by banks for their position was
that governmental NOWs would result in commercial banks losing a substantial
amount of governmental deposits to thrifts.
The resulting loss would affect
bank liquidity and result in a depression of bank earnings.
This comment
was mentioned by 73 banks.
Fifty-seven banks stated that it was their belief that the NOW
experiment was originally authorized solely for individuals.
Forty-nine banks noted that governmental NOWs would result in a
lessening in the support they provide to the governmental securities
markets, with the result that governments will incur an increase in the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
3
interest rates they must pay on such aligations. lany of these respondents stated that they would aIiilso eliminate
,%IL4
banking services they now
provide without charge to governmental bodies.
Ten respondents mentioned that it would be improper to authorize
NOWs in light of the severe economic hardship which the Northeast is
undergoing at present.
Nine banks cited their belief that governmental NOW deposits
would not result in an increase in mortgage funds because governmental NOW
funds would be essentially transactional in nature.
Those banks in favor of governmental NO-Cs (4) expressed their
belief that NOW accounts would assist public treasurers in obtaining a
higher return on their money and that governmental NOWs are a logical
1/
extension to the basic NOW experiment.
II.
Banker'
Associations
Ten bankers associations commented on the proposal.
Those
organiW ations representing commercial banks were in favor of the proposed
amendment to prohibit governmental NOWs.
•
•
•
•
•
•
•
These groups included:
American Bankers Association
Long Island Bankers Association
Massachusetts Bankers Association
New liampshire tankers Association
New York State Eankers Association
Massachusetts Independent tankers Association
Pennsylvania Bankers Association
1/ First National City Bank; Peoples Trust of New Jersey, Iowa-Des Noines
National Bank; First National Bank of Clayton, Hissouri.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
These associations stressed their belief that Congress intended NOWs to be
available solely to individuals and that governmental NOWs would adversely
affect bank liquidity.
The Massachusetts Bankers Association
particularly vocal, having submitted a 25 page comment.
CMBA ) was
The MBA contends
that it was the intent of Congress that NOWs be made available to
viduals, not corporations or governmental bodies.
They also cite
adverse competitive effect governmental NOWs would have upon commercial
banks, especially in light of the severe economic hardships which the
thTI
northeastern U.S. is undergoing at present.
The National Association of Mutual Savings Banks, the Savings
Bank Association of Nassachusetts and the Nassachusetts Co-operative Bank
League oppose the proposed amendment, and express the belief that governmental NOWs would aid the investment programs of government treasurers,
stimulate competition for public funds among the various financial institutions, and would serve the public interest by providing additional interest
revenue to governments.
III.
Federal Reserve Banks
Comments in favor of the amendment to prohibit governmental NOW
accounts were received from the Atlanta, Dallas, Philadelphia and Richmond
Reserve Lanks.
These banks believe that NO0 accounts are intended to be
solely for individuals.
Two of these Reserve Banks also expressed their belief that
governmental NOUs would adversely affect bank liquidity.
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Federal Reserve Bank of St. Louis
5
•
IMO
The New Yorir Reserve Bank is opposed to the adoption of the
amendment, contending that extension of the experiment would provide
useful data for analysis purposes as well as stimulate competition for
governmental deposits.
The Chicago Reserve Bank also opposes the amend-
ment, stating that governmental NOWs would, after consideration of the
negative and positive effects, be in the public interest.
IV.
Other Respondents
Senators IlcIntyre and Proxmire have commented on the concept
of governmental NOW accounts.
Senator McIntyre stated his belief that
L
ret_e
NOWs were never intended to be available to Imoi-iy'itittirks
while Senator
Proxmire opposed the amendment, stating that the extension of the NOW
experiment to governmental deposits would have a number of significant
or beneficial results, not the least of which would be increased interest
earned by governmental bodies.
Senator Proxmire sees nothing in the law
to prohibit governmental NOWs.
The Treasurers of the States of Illinois and Iowa as well as
the Treasurer of the City of Rockford, Illinois expressed opposition to
the proposed amendment, contending that governmental 1;0Ws would aid
governmental investment programs.
Other comments opposinE the proposed amendment were received from
the Public Interest Research Group which, although in favor of governmental NOWs, alleged that the Board may not adopt the proposed amendment
because the original amendments authorizing governmental savings accounts
were adopted in violation of the public notice requirements of the
Administrative Procedure Act.
Attachment
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Federal Reserve Bank of St. Louis
ATTACHMENT A
COillEiiTS BY RESPONDUTTS
(Number of times mentioned)
Commercial
Banks
1.
2.
3.
4.
5.
6.
Lankers
Associations
Federal Reserve
111.11.gi
Others
1
NOW account experiment was originally authorized by Congress to be offered exclusively to
individuals.
57
5
2
If governmental NOI• accounts are authorized,
commercial banks may incur a substantial loss of
governmental deposits to thrifts, thereby adversely
affecting bank liquidity and resulting in a
depression of bank earnings.
73
3
2
Loss of governmental deposits by banks will result
in decreased bank participation in governmental
securities markets, increases in rates of interest
governments must pay; elimination of free banking
services being offered to governments, and increased
service charges and loan rates to other bank
customers.
49
2
Governmental NOW account balances will be transactional in nature and are maintained for too short a
period of time to be invested in long-term mortgages.
Lxpansion of NOWs to governmental units is unwise
in light of severe economic hardships which NEUS
is undergoing at present.
Governmental NOWs will assist the investment programs
of public treasurers and are a logical extension to
the NOW experiment.
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Federal Reserve Bank of St. Louis
•
•
10
1
3
3
1
5
Return this py to
Legal Division as soon
as origind is maiied
showing on copy the date
of moiling.
NMI
irs=-0-cT?
DE.0 2 17 1974
The Honorable Thomas .I. te.Intyre
United States Senate
Washinzton, D. C.
20510
Dear Senator McIntyre;
Thank you for your letter of December 20, 1974, in which
you urge the Locrd to modify its ref;ulatiolis on governmental unit
scvings deposits to continue to prohibit member banks from offeriug
NOW accounts to such entitif:s. The hoard and the FDIC have received
several request that their respective rezulations be nedified in
the manner you recommend.
As a result of receipt of theso comments, the Lord has agreed
to reconsider this matter. On Decelber 23, 1974, the Board issued the
enclosed press release and Federal Register notice soliciting public
conts until Januziry 20, 1975, on the question of whether member banks
should continue to be able to offer E01:s to goverment/21 units. The
Board's announcement also advises that until a final determination is
wide by the board, rerber banks should not offer EOW eccouets to
governmental units.
The Board wv4.314 welcome any further comments you might
have on this Datter.
Sincerely,
W. rItchell
George W. Mitchell
Enclosures
• ALR:iks
12/26/74
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Federal Reserve Bank of St. Louis
JOHN SPARKMAN, ALA., CHAIRMAN
WILL.1•M PROXMIRE WIS.
HARRISON A. WILLIAMS, N.J.
THOMAS J. MC ITFYRE, N.H.
vr.ALAN CrfANSTON, CALIF.
ADLAI E. STEVENSON III, ILL.
J. BENNETT JOHNSTON, JR., LA.
WILLIAM D. HATH‘WAY, MAINE
O
JOHN TOWER, TUX.
WALLACE F. UNNE
AN
EDWARD W. BROOKE,
SS.
RODERT W. PACKWOOD, OREG.
BILL BROCK, TENN.
LOWELL P. WEICKER, JR.. CONN.
JOSEPH R. BIDEN, JR., DEL.
DUDLEY L. O'NEAL, JR.
STAFF DIRECTOR AND GENERAL COUNSEL
WM. HOWARD BEASLEY III, DIRECTOR OF MINORITY
STAFF
OTHELLA C. POM PIER, CHIEF CLERK
?JCI-rifeb
Zertate
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
WASHINGTON,D.C.
20510
December 20, 1974
The Honorable George Mitchell
Vice Chairman
Board of Governors
Federal Reserve System
20th and Constitution Avenue Northwest
Washington, D. C. 20551
Dear Governor Mitchell:
It has come to my attention that the Federal Reserve and the other
financial regulatory agencies are contemplating permitting the
acceptance
of public unit deposits in the form of NOW accounts by commercial
banks
and thrift institutions in the States of Massachusetts and New Hamps
hire.
This development arises from efforts to implement Section 101 of
the
"Depository Institutions Amendments of 1974", Public Law 93-495.
I
believe that this development is unwarranted and that regulation
s should
continue to insure that NOW accounts are confined to individual
s and nonprofit corporations.
The legislative history is clear that Congress' intent was to
limit
NOW accounts to individuals. These are family financial accou
nts. While
their ownership by non-profit groups is deemed to be a permissible
extension
of this purpose, there is no mention of authorizing NOW accounts
for
governmental entities or public units, and, in fact, Congress'
intent was
exactly to the contrary. Moreover, nothing in the legislative histo
ry
surrounding Public Law 93-495 alters this result.
Congress labored long and hard during the NOW account controversy,
and finally adopted a compromise providing for the experimental use of
NOW accounts in the States of Massachusetts and New Hampshire. In both
the Committee report and debate on the Senate floor, it was made clear that
NOW accounts were intended to benefit consumers; and therefore, they shoul
d
be limited solely to individuals. In the Committee report itself, the
following language appears: "The Committee, however, is convinced that
such accounts should only be offered and limited solely to individual
persons." This position was maintained throughout Congress' consideration
of this legislation; and the action contemplated by your agency and the
other bank regulatory agencies in expanding the NOW account service to
governmental entities is directly contrary to the stated purpose of the
legislation.
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Federal Reserve Bank of St. Louis
P
VO
The Honorable George Mitchell
December 20, 1974
Page 2
It should be noted that this issue arose earlier this 7.ear when the
Federal Home Loan Bank Board sought to allow savings and loan associations
in Massachusetts and New Hampshire to accept NOW deposits from governmental
entities. At that time, I raised similar objections, and the Board
subsequently modified its regulations to prohibit the acceptance of NOW
accounts from governmental bodies by such savings and loan associations.
I urge you to conform your regulations on public unit savings accounts
to continue the prohibition on the acceptance of NOW deposits from
governmental entities by commercial banks and thrift institutions in
Massachusetts and New Hampshire. The concept of permitting public unit
depositors to have NOW accounts should be given serious consideration at
the appropriate time. Such accounts may very well be in the public interest.
However, since NOW accounts are still in an experimental stage, that
experiment should be left as it is until an overall policy on NOW accounts
is established. Just such a policy is contained, for example, in the
Financial Institutions Act. Therefore, it would be inappropriate for the
regulatory agencies to broaden the base of NOW accounts in this manner at
this time.
Your prompt attention to this matter will be appreciated greatly, and
I hope to have a response from you at your earliest convenience.
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Federal Reserve Bank of St. Louis
Sin
/444este
omas J. Mein Irte
te"
Chairman
Subcommittee on Financial
Institutions
.1•••
••'of GOv ••.
ti?4,•.
0
••q-
FEDERAL
•P
It.,•..0
ESERVE
October 17, 1974
For Immediate Release
The Board of Governors of the Federal Reserve System today
s of
removed the 150-item limitation on the number of Negotiable Order
Massachusetts
Withdrawal (NOWS) that may be accepted by a member bank in
and New Hampshire in any one year.
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Federal Reserve Bank of St. Louis
A copy of the Board's order in this matter is attached.
- 0 -
•
TITLE 12--BANKS AND BANKING
CHAPTER II--FEDERAL RESERVE SYSTEM
[REG. Q]
PART 217--INTEREST ON DEPOSITS
Negotiable Orders of Withdrawal
Effective January 1, 1974, the Board of Governors amended
Regulation Q (Interest on Deposits) to prescribe rules governing the use
of Negotiable Orders of Withdrawal (NOWs) within Massachusetts and New
Hampshire as authorized by section 2(a) of P.L. 93-100.
These rules include
a limitation on the number of NOWs that may be accepted by a member bank
from a customer to 150 per year.
NOW accounts in other institutions have
not been made subject to an item limitation.
Since the adoption of NOW account amendments to Regulation Q,
the Board of Governors and the other Federal financial supervisory agencies
have conducted a surveillance program designed to monitor NOW account activity.
Data received for the first eight months of NOW activity in Massachu-
setts and New Hampshire since Federal regulations were adopted indicate
that NOW account activity has developed in a gradual manner without the
wholesale conversion of checking accounts to NOW accounts.
On the basis
of its evaluation of current NOW account data and pursuant to P.L. 93-100
and the Board's authority under section 19 of the Federal Reserve Act to
prescribe rules governing the payment of interest on deposits, the Board
has amended Regulation Q to remove the 150 per year limitation on the number
of NOWs that may be accepted from a customer by a member bank.
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Federal Reserve Bank of St. Louis
As a result
-2-
of this action, member banks and NOW depositors will be permitted to amend
existing NOW account deposit agreements to remove item limitation provisions.
There was no notice, public participation and deferred effective
date with respect to this amendment because such procedure would result in
delay that would be contrary to the public interest and serve no useful
purpose.
See § 262.2(e) of the Board's Rules of Procedure (12 CFR
§ 262.2(e)).
Effective immediately, the Board has amended section 217.5(c)
of its Regulation Q (12 CFR Part 217) to read as follows:
§ 217.5
Withdrawal of Savingp Deposits
(c) Manner of payment of savings deposits
(1) Subject to the provisions of subparagraphs (2) and (3) of
this paragraph, *
(3) The provisions of this paragraph do not apply to deposits
subject to negotiable orders of withdrawal authorized by Federal law to
be issued in the states of Massachusetts and New Hampshire.
(4)
By Order of the Board of Governors, October 17, 1974.
(Signed) Theodore E. Allison
Theodore E. Allison
Secretary of the Board
[SEAL]
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Federal Reserve Bank of St. Louis
BOARD OF GOVERNORS
Or THE
•
FEDERAL RESERVE SYSTEM
Office Correspondence
To
From
Board
Date October 8, 1974
Subject:
of Governors
NOW accounts data for
August 1974
Bankihg Section
(Paul W. Boltz)
This memorandum is for information only and concerns developments
in NOW accounts in New Hampshire and Massachusetts in August 1974.
Inflows to NOW accounts at member banks were up sharply in August,
principally due to a single bank's transferring a block of its savings accounts
to NOW status.
The Third National Bank of Hampden County, Springfield,
Massachusetts, began offering NOW accounts by notifying the holders of over
4,000 savings accounts representing deposits of $6.3 million that they
could write NOW drafts on their accounts.
The bank is one of 10 weekly
reporting banks in Massachusetts and has total deposits of over $200 million.
The Boston Federal Reserve is investigating the unorthodox method of
introducing NOW accounts by the Third National Bank, but there appears to
be nothing illegal in the procedure and other banks may follow.
Another large member began offering NOW's on October 1 and
initiated a heavy statewide advertising campaign in Massachusetts.
The
Shawmut Association with nine banks (total deposits $1.7 billion) is
promoting its new NOW accounts as part of a marketing strategy that includes
a package of services of free checking, free checks, and over-draft
privileges for a flat monthly fee.
This is the first time a commercial
bank has advertised NOW accounts statewide in either New Hampshire or
Massachusetts.
In contrast, the largest banking organization in
Massachusetts, First National Bank of Boston, has been advertising locally
against NOW accounts.
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Federal Reserve Bank of St. Louis
-2the
With the sharp growth of NOW balances associated with
r banks in
Third National Bank of Hampden County, NOW balances at membe
small initial
Massachusetts more than doubled during August, given their
size.
tts
However, the growth of NOW deposits at MSB's in Massachuse
banks.
still nearly equaled the expansion of balances at commercial
The
tutions in the two
10 percent rate of growth of NOW balances at all insti
states in August was the highest of the year.
Three commercial banks,
in New Hampshire
three MSB's and three S&L's began offering NOW accounts
70 percent of
and Massachusetts in August, and by the end of the month
for S&L's
the MSB's were offering NOW accounts, while the proportion
was 34 percent and for banks 18 percent.
ficantly
NOW accounts at commercial banks continue to be signi
activity appears
larger than accounts at competing institutions, and their
thrift institutions.
to be declining relative to the activity of accounts at
nt at commercial banks
In August, the average number of drafts per NOW accou
at the Hampden
was likely lowered by the sudden creation of such accounts
but a declining
County bank for depositors unfamiliar with the account,
banks has been
average level of activity of NOW accounts at commercial
observed since May.
The 150 item limitation may be responsible for the
available data.
lower level of drafts, but this has not been confirmed by
have had a
At other institutions in Massachusetts, the MSB's accounts
accounts have
relatively stable level of activity, but the S&L's NOW
the most active accounts.
become progressively more active and in August were
New Hampshire, the NOW accounts at the MSB's had
the highest average
.
number of drafts, followed by the accounts at S&L's and banks
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Federal Reserve Bank of St. Louis
In
APR
-3There has developed a noticable and predictable relationship
the
between level of activity of accounts at the competing institutions and
proportion of such institutions offering free draft privileges.
In the
two states, the highest level of activity is found in NOW accounts at
the
MSB's in New Hampshire, three-quarters of which offer free drafts; at
ial
other end of the scale, the lowest level of activity is found at commerc
banks in Massachusetts where only 17 percent of the banks offer free
drafts.
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Federal Reserve Bank of St. Louis
•
BOARD OF GOVERNORS
OF T}-4E
FEDERAL RESERVE SYSTEM
Office Correspondence
To
Board of Governors
From
Banking Section (Paul W, Boltz)
Dee
Subject:
September 6, 1974
NOW account data for
July 1974
This memorandum is for information only and concerns developments
in NOW accounts in New Hampshire and Massachusetts in July 1974.
Net inflows into NOW accounts at all offering institutions continue
at a rapid pace in the two states.
Deposits in NOW accounts at commercial
banks increased 30 per cent in July, although only two more commercial
banks began offering NOW accounts for the first time during the month,
and NOW deposits at savings and loan associations expanded by 20 per cent,
as 5 additional S&L's began offering such accounts during July.
The NOW
balances at mutual savings banks grew at the lower rate of 7 per cent in
July, but in spite of the competition from banks and S&L's, NOW balances
at MSB's accounted for almost 84 per cent of all NOW balances in the two
states in July, seven months after competing institutions were allowed to
offer NOW accounts.
In fact, since January 1 of this year, more mutual
savings banks have begun offering NOW's than commercial banks (47 versus 37),
and at the end of July almost 70 per cent of all mutual savings banks were
offering NOW accounts.
The fastest spread of the NOW accounts, however,
has been at the S&L's in 1974.
At the end of July, 64 S&L's--almost one-
third of all the S&L's in the two states--were offering NOW accounts.
Nonbank financial institutions are moving much more quickly into NOW
accounts than commercial banks.
(Tables 1 and 9)
In July, commercial banks offering NOW accounts were more successful in attracting new customers through NOW accounts.
Almost 60 per cent
of NOW accounts opened at commercial banks during the month were opened
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Federal Reserve Bank of St. Louis
- 2 -
by new customers.
In recent months, the proportion of new customers
opening accounts had tended toward about 45 per cent at all types of
NOW-offering institutions, and in July the proportion of new customers
opening NOW accounts at S&L's was slightly higher than this, and at MSB's
was slightly lower.
(Table 2)
Member bank NOW accounts
continue to be larger and less actively
used than NOW accounts at competing institutions, including nonmember
commercial banks.
And although member bank NOW accounts are gradually
becoming more active, the differential between the average balance in
member bank NOW accounts and other NOW accounts widened in July.
Commercial
S. nks, member and nonmembers alike, encourage the use of their NOW accounts
as.savings accounts by placing charges on drafts and paying the ceng
rate on the deposits.
While well over one-third of the
and MSB's
that offer NOW accounts have free draft privileges, at the end of July
only 16 per cent of commercial banks offering NOW's provided free drafts.
Moreover, a majority of banks compound interest on NOW accounts monthly
or quarterly, rather than continuously or daily as most competing institutions
do.
One-fourth of the NOW-offering member banks IS not pay interest from
day of deposit to day of withdrawal while only 5 per cent of competing
instititions pay interestway other than from day of deposit to day
of withdrawal.
Thus, the commercial banks have been slow to offer NOW
accounts and, when
offered, have tended to adopt a combination of charges
on drafts and interest calculations that induce the use of NOW accounts
as a savings accounts. (Tables 3A, 3B, 4A, 4B, and 5)
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Federal Reserve Bank of St. Louis
I
A
- 3_
Over 90 per cent of all NOW-offering institutions pay the ceiling
rate of 5 per cent.
The major exceptions are the mutual savings banks in
New Hampshire which have a history of low interest rates with no charges
for drafts.
Almost 70 per cent of them pay at or below 4 per cent on
NOW balances.
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Federal Reserve Bank of St. Louis
•
...41114
BOARDOFGOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Dee
July 15, 1974
Subject: NOW Account data for May
To
Board of Governors
From
Banking Section (Paul W. Boltz)
This memorandum is for information only and
suIII. rizes developments in NOW accounts in New Hampshire and
Massachusetts during May 1974.
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Federal Reserve Bank of St. Louis
3s5ciations continue to
--Savings and loan 3,
move aggressively into offering NOW accounts.
S&L's accounted for 9 of the sixteen institutions which began offering NOW accounts
in May, along with 2 commercial banks and 5
I utual savings banks.
At the end of May more
than a quarter of the S&L's were offering NOW
accounts in the two states, while less than
one out of eight commercial banks were offering
NOW's.
Relatively few member banks have begun
to offer NOW's; at the end of May only 13
out of the 143 member banks in the two states
were offering such accounts.
Thus, the 63
I- r cent of mutual savings banks that offer
NOW's continue to hold the large majority of
NOW deposits--88 per cent of the total.
(Tables 1 and 8)
--Outstanding balances of NOW accounts grew
3.4 per cent in May, the slowest rate since
January.
However, the not seasonally adjusted
annual rate of growth of NOW account balances
%
Alkv
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Federal Reserve Bank of St. Louis
_
2
-
at all institutions in the first five months
of 1974 was almost 50 per cent.
Though the
MSB's did not maintain the extremely rapid
pace of growth of 1973 (over 300 per cent), in
the first five months of 1974 their NOW
balances grew at a not seasonally adjusted annual
rate of 27 per cent.
(Table 8)
--Commercial banks were more successful than
MSB's or S&L's in attracting new customers
to their NOW accounts.
Less than half the new
accounts in May at S&L's and MSB's were opened
by new customers, while almost 60 per cent
of accounts opened at commercial banks in May
were opened by new customers.
(Table 2)
--The level of activity of NOW accounts at
member commercial banks is far less than
activity at other institutions, including
nonmember commercial banks.
Over 70 per cent
of NOW accounts at member banks in Massachusetts
had no drafts written on them in May.
At all
other NOW-offering institutions in Massachusetts,
the proportion was less than 30 per cent.
Also,
the balances in accounts at member banks are
considerably larger than balances in accounts
at competing institutions, and thus the NOW
accounts at member banks appear to be used
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Federal Reserve Bank of St. Louis
3
as savings accounts, rather than as demand
deposits.
The sharpest contrast to this are
the NOW accounts at mutual savings banks in
New Hampshire where the balances are on average
less than half the balances at member banks in
Masachusetts and the level of activity makes
the accounts appear to be checking accounts.
These institutions offer low rate,no service
charge NOW accounts.
(Tables 3A and 3B)
--The proportion of institutions offering free
draft privileges on NOW accounts has been
gradually increasing, and most of the increase
has been due to more MSB's offering free drafts.
Since January, the proportion of S&L's
and commercial banks offering free draft
privileges has been relatively volatile, but
as the number of S&L's and CB's offering NOW's
becomes larger, the trend will become clearer
and not so easily affected by small changes
at the margin.
By the end of May, 55 per cent
of NOW-offering institutions in New Hampshire
were offering free drafts and 32 per cent in
Massachusetts.
BOARD OF GOVERNORS
•
OF THE
3„p
FEDERAL RESERVE SYSTEM
'.Office Correspondence
To
Board of Governors
Date
June 5, 1974
Subject: NOW Account data for April
From. Banking Section (Paul W. Boltz)
This memorandum is for information only and summarizes
developments in NOW accounts in New Hampshire and Massachusetts
during April 1974.
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Federal Reserve Bank of St. Louis
IMMO
In April, 17 more institutions began offering NOW
accounts in New Hampshire and Massachusetts--3
commercial banks, 7 mutual savings banks, and 7
savings and loan associations.
Savings and loan
associations have moved very quickly into offering
NOW accounts.
Although there are fewer S&L's than
either CB's or MSB's, the number of S&L's which began
offering NOW accounts since the end of January equals
the number of CB's and MSB's combined which began
offering NOW's in the same period.
At the end of April,
more than 20 per cent of S&L's was offering NOW's
in the two states, compared to about 10 per cent of the
commercial banks.
Mutual savings banks continue to
dominate the field with 60 per cent of them offering
NOW accounts and holding 90 per cent of total NOW
deposits.
IMMO
(Tables 1 and 8)
NOW balances at all institutions in the two states
grew 5.8 per cent in April, with more than half
the growth occurring at CB's and S&L's.
Except for
an unexplained spurt of growth in March, NOW accounts
- 2 at MSB's have been growing at depressed rates since
commercial banks and S&L's began offering NOW accounts
in January 1974.
(Table 8)
About 45 per cent of NOW accounts opened in April
were opened by new customers at commercial banks
and mutual savings banks.
S&L's did not attract
as many new customers, as only 35 per cent of their
new accounts were opened by new customers.
mately 20 per cent of the
Approxi-
al NOW deposits at
commercial banks made by existing customers were
from time and savings deposits.
(Tables 2 and 7)
NOW accounts at commercial banks continued to be less
actively used on average than NOW accounts at competing
institutions.
Commercial banks have a relatively
large proportion of accounts that have no activity,
S
17-
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Federal Reserve Bank of St. Louis
ut the average number of drafts of accounts at
commercial banks that have any activity is rising.
In Massachusetts, the average approached the level of
activity of comparable accounts at MSB's in April.
same is true
The
of the NOW accounts atMassa-
chusetts, which like the commercial banks have a large
S roportion of completely inactive accounts.
On the
other hand, in New Hampshire the NOW accounts at
and commercial banks with any activity are less active
by a good margin than NOW accounts at the MSB's.
(Tables apt and 3B)
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Federal Reserve Bank of St. Louis
3
Almost all institutions offering NOW accounts in
Massachusetts were paying the ceiling rate of
5 per cent, and all the banks and S&L's in New
Hampshire were paying the ceiling rate in April.
But
only 2 of the 17 mutual savings banks in New Hampshire
offering NOW accounts were at this rate, and the
others were paying 4 per cent or below.
The majority
of institutions were paying interest from day of
deposit to day of withdrawal.
(Tables 4A and 4B)
In April the number of CB's offering free drafts
did not change, but two MSB's and two S&L's began
offering free drafts.
Thus, while 17 instituitions
began offering NOW accounts in April, only 4 additional
institutions provided free draft privileges.
Of all
institutions offering NOW accounts, the proportion with
free drafts at the end of April was 34 per cent.
The
trend is uncertain in this regard, however, since the
proportion of NOW-offering institutions with free draft
privileges had risen noticeably in the previous month.
(Table 10)
•
•
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
Office Correspondence
To
Board of Governors
From
Frederic Solomon
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Federal Reserve Bank of St. Louis
•Areft--3
Date
Subject: Spread
May 29, 1974.
of NOW-type Accounts.
For Information Only
There appears to be a growing tendency fcr NOW-type accounts
to spread to areas beyond New England.
The attached clipping from the New York Times of Monday,
May 27, describes such accounts being offered by certain mutual
savings banks in New York.
One of these mutual savings banks called
its accounts WOW accounts, standing for "Written Order of Withdrawal."
Mr. Piderit, Vice President of the Federal Reserve Bank of
New York, indicated that these accounts are offered under c long
neglected provision of law and that the State Banking Department has no
plans to discourage them.
Also attached is a copy of an advertisement forwarded by Senior
Vice President Morrison of the Chicago Reserve Bank.
This advertisement,
issued by First Federal Savings and Loan Association of Wisconsin, offers
what it calls a "telephone savings account," which pays 5 1
cS mpounded daily.
interest
The S&L has established procedures by which the customer
can telephone at any time and have funds transferred to his bank to meet
checks which he has drawn.
While the approach is not new, it might have
increased appeal at the present time and could be available to anyone,
including corporations.
•
,
FEISTJEDERAL
MIAS
OHIISCONSIN
• •,1
••• Oa• suot•.1.4re us
Manitowoc 0flic•
••0 Noar. AT.. A
May 8, 1974
wore
VOSraEf TS
•••••••TCA,04:. W.SCONS.N )./20
0114i NU Qui
Wisconsin Aluminum Foundry Co., Inc.
836 So. 16th St.
Manitowoc, Wisconsin
Dear Mr. Schwartz:
We would like to introduce you to a new plan offered by First Federal
Savings and Loan of Wisconsin for corporations, mall businesses, and
the self-employed. It's called our "Telephone Savings Account."
It was designed with several objectives in mind:
To provide a temporary and liquid short term investment for
cash balances which earn no interest in checking accounts.
To provide with this service, the convenience of handling your
transactions by telephone.
The Telephone Savings Account will pay 57, interest, compounded daily
on all funds, from the date of deposit to the date of withdrawal.
Deposits may be made by simply drawing a check payable to First Federal
Savings and Loan, for credit to the account of
(name)
(account number) , and mailing it to First Federal Savings and Loan,
724 - York Street, Manitowoc, Wisconsin.
When you need funds to cover checks drawn on your checking account, call
the First Federal "Telephone Savings Account Teller" any time between
10:00 A.M. and 3:00 P.M., at 682 - 6812 and give her the following
information:
Your Name (Authorized Person)
Account Number
Name of Firm
Amount of Withdrawal
A check for the withdrawal will be personally delivered to your bank the
following morning. The monthly statement furnished will itemize each
transaction and state current balance of your account following posting of
all transactions for the month.
We welcome an opportunity to further discuss with you interest dollars you
can earn with our Telephone Savings Account.
Very truly yours,
FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION
of WISCONSIN
•
LJ
Beatrice E. Klein,
Branch Manager
Enc:
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Federal Reserve Bank of St. Louis
Removal Notice
The item(s) identified below have been removed in accordance with FRASER's policy on handling
sensitive information in digitization projects due to copyright protections.
Citation Information
Document Type: Newspaper article
Citations:
Number of Pages Removed: 1
Cole, Robert J. "Personal Finance: Savings Banks' 'Checks.'" New York Times, May 7, 1971.
Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
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BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
To
From
Board of Governors
Mae April 30, 1974
Subject:
NOW Account data for March
Banking Section (Paul Boltz)
This memorandum is for information only and summarizes the
major developments regarding NOW accounts in March 1974.
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Federal Reserve Bank of St. Louis
During March, 30 additional institutions began offering
NOW accounts in Massachusetts and New Hampshire (6
commercial banks, 10 mutual savings banks, and 14 saving
and loan associations).
By the end of the month, 9.2
per cent of the commercial banks, 18.7 per cent of the
savings and loan associations, and 56.7 per cent of the
mutual savings banks were offering NOW's (Table 1).
a die
NOW balances at all institutions increased 9.7 per cent
in March and reached $165.2 million.
Of that total
only 4 per cent were deposits at commercial banks and
2.8 per cent were deposits at S & L's, but deposits at
these institutions are growing very rapidly in percentage terms
ONION
(Tables 1 and 8).
The increase of NOW account balances at mutual savings
banks in the first quarter of 1974 was sharply below
the average quarterly increases in 1973.
However, the
total quarterly increase of NOW accounts balances at all
offering institutions was almost as high as the 1973
average.
The first quarter rise in NOW balances at
all institutions was $21.9 million, of which $10.8 million
was the mutual savings banks' share of the increase.
The
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Federal Reserve Bank of St. Louis
•
2
average quarterly increase of NOW balances in 1973,
when only MSB's offered NOW's, was $24.5 billion.
While part of this reduced rate of growth at MSB's can
be attributed to one-time portfolio adjustments which
were occurring during the early part of 1973, part should
also be attributed to the introduction of competition
from other depository institutions.
Slightly more than 40 per cent of the NOW accounts opened
at commercial banks in March were opened by existing
customers.
About 55 per cent of the initial deposits
in NOW accounts were from time and savings deposits,
up sharply from January and February when less than onethird of new deposits by existing customers were from
time and savings deposits (Tables 2 and 7).
••••=1.
Commercial bank NOW balances continued to be both larger
and less actively used than NOW accounts at competiting
institutions
(Tables 3A and 3B).
The average NOW account
balance in March at commercial banks was $1786
($2008
for members and $1623 for nonmembers), far higher than the
average of $1295 at MSB's and the average balance of $852
at S&L's.
The accounts at both S&L's and commercial banks
are becoming more active as each month passes, but slightly
less than half (46.6 per cent) of NOW accounts at commercial
banks had no activity in March, with most of the inactive
accounts at member banks.
In contrast, only 26 per cent
Amok
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Federal Reserve Bank of St. Louis
- 3
of NOW accounts at MSB's and 36 per cent of NOW accounts
at S&L's had no activity.
The most active accounts are
those at mutual savings banks in New Hampshire; 19 per
cent of these had more than 20 drafts written on them in
March.
--
As in earlier months, virtually all NOW-offering institutions
in Massachusetts were paying the ceiling rate of 5 per cent
(Tables 4A and 4B).
In New Hampshire, however, while all
commercial banks and S&L's were at the ceiling rate only
2 of the 16 mutual savings banks ofeering NOW's were at
that rate, and the others were paying 4 per cent or
below.
The majority of institutions are paying interest
from day of deposit to day of withdrawal (Table 5).
--
About one-third of the MSB's and S&L's in Massachusetts
offering NOW accounts provide unlimited free draft
privileges to depositors.
This proportion is up from
January and may reflect competition to attract depositors.
The large majority
of MSB's in New Hampshire (81.3 per cent)
also offer free drafts, and this high proportion may
account for the considerable activity reported for these
accounts.
Less than 15 per cent of the banks offering
NOW's in the two states offer free drafts (Table 10).
A111
,
•
April 29, 1974
To:
Board of Governors
From:
Legal Division
(Messrs. Nicoll
and Raiken)
BANK REQUEST:
Subject: Request by First National Bank
of Boston to suspend Regulation Q limitation:
on transfers from savings accounts.
The First National Bank of Boston ("Bank") has requested
Q
that the Board suspend operation of section 217.5(c)(2)(i) of Regulation
the
in the States of Massachusetts and New Hampshire in conjunction with
1/
States.
operation of the NOW account experiment currently underway in those
h payment
This paragraph prohibits withdrawals from savings deposits throug
same
to the bank or transfer of credit to another deposit account of the
authorizing
depositor made pursuant to an advertised plan or agreement
or
such payments as a normal practice to cover the depositor's drafts
checks.
RECOMMENDED ACTION:
It is recommended that the requested suspension of
s summarized
the savings deposit transfer limitations be denied for the reason
as follows:
1.
A question exists as to the Board's legal authority to
non-NOW accounts
suspend (or amend) the present transfer limitations as to
only in Massachusetts and New Hampshire.
2.
of
Removal of the transfer limitations would permit use
accounts and
savings deposits to cover drafts drawn on token checking
t of interest
thereby, for all practical purposes, result in the paymen
on demand deposits.
President Morris
1/ A copy of Bank's request is attached as Attachment A.
22 recommends
of the Federal Reserve Bank of Boston by letter of April
The General Counsel
approval of the requested suspension (Attachment B).
request (Attachment C).
of the Boston Reserve Bank recommends denial of Bank's
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Federal Reserve Bank of St. Louis
46.
S
•
2
3.
Removal of the transfer limitations would result in a major
change in the character of savings deposits in Massachusetts and New
rized
Hampshire and thereby alter the environment in which Congress autho
a limited experiment to be conducted.
4.
mers
Bank presently has the ability to offer NOWs to its custo
the Board's
and has not presented any evidence supporting its contention that
market NOWs.
150 item limitation is seriously inhibiting its ability to
rized as follows:
Arguments in favor of Bank's proposal may be summa
1.
NOW experThe suspension action may be taken as part of the
sustainable
iment authorized by Congress and therefore would be legally
accounts.
under the Board's authority to issue regulations for NOW
2.
more to permit
The suspension of transfer limitations will do no
nt NOW account
the payment of interest on demand deposits than the prese
as sanctioned by Congress.
3.
banks to
Removal of transfer limitations will permit member
which does not
offer a comparable alternative to NOW accounts, but one
not result in additional
require the creation of an additional account and does
items entering the payments mechanism.
COORDINATING CONIITTEE CONSIDERATION:
At a recent meeting of the Inter-
informed the representatives
agency Coordinating Committee, Governor Mitchell
ved and would
of the other agencies that the subject request had been recei
be considered by the Board in the near future.
No objections were expressed
ng Committee.
regarding Bank's request by members of the Coordinati
Chairman
is apparently attempting
Bomar of the FHLBB expressed the view that since Bank
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Federal Reserve Bank of St. Louis
3
to develop a means to offer services similar to NOWs but without the Board's
150 item limitation, if the Board is inclined to grant relief, such action
should more appropriately take the form of a removal or modification of
the item limitation itself.
It was also confirmed at this meeting that
the FDIC, without formal announcement, has for more than a year permitted
withdrawals or transfers from a savings deposit to a depositor or to another
2/
account of the same depositor by means of telephone requests.
DISCUSSION:
Bank states that suspension of the transfer limitations would
(1) enhance deposit experiments currently in progress regarding NOW accounts
3/
and automatic withdrawals from S&L savings deposits and (2) enable commercial
banks to compete on a more equal basis with thrift institutions which offer
NOW accounts.
The requested action appears related to the effect of the 150
item limitation contained in the Board's NOW account regulations.
In its
advertising copy (Attachment B) the Bank has stressed the concept of an
account for saving and an account for spending.
The proposed arrangement
would enable it to offer both types of accounts with a link to cover overdrafts or excessive balances in the "spending" account.
2/ A memorandum from the Legal Division recommending reconsideration of the
Board's 1936 interpretation against telephone transfers will be presented to
the Board within the next few weeks.
3/ The FHLBB has authorized a cash dispensing deposit-withdrawal "POS"
pilot project to be conducted in Lincoln, Nehraska. In addition, FriLBB
regulations permit preauthorized payments to third parties from savings
accounts to (1) purchase U.S. obligations, (2) purchase mortgagor or savings
member insurance, (3) transfer funds to a relative of the depositor, (4)
purchase a housing or housing-related item, pay loans for such items,
including real estate mortgages, taxes and insurance, rent, utilities,
home improvements, fixtures, home furnishings or major appliances and
similar items (12 C.F.R. 545.4(2)).
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Federal Reserve Bank of St. Louis
k
•
-4
Origin of Present Transfer Limitations:
/ID
The present savings deposit transfer
limitations that Bank requests be suspended were adopted in January 1962
primarily in view of the practice developed by Citizens Bank and Trust
Company of Park Ridge Illinois, whereby that bank permitted a depositor
maintaining a savings account to draw checks against the bank.
Under the
agreement between the bank and the depositor, checks not covered by remittance
from the depositor within seven days would be covered by the bank's automatic
withdrawal of sufficient funds from the depositor's savings account.
The
Board considered that such a practice constituted misuse of savings deposits
and involved a payment of interest on a demand deposit in contravention of
section 19 of the Federal Reserve Act.
The Board therefore adopted the
transfer limitations to preserve a meaningful difference between demand
deposits and savings deposits.
Board Authority to Remove Transfer Limitations in Two States:
Absent a
clearer showing of the relevance and benefit of removal of transfer limitations
to the current NOW experiment (or some exigent circumstances necessitating
Board action to protect the public) we believe there exists a significant
question as to whether the Board's authority under section 19 of the Federal
Reserve Act (to define various deposits and prescribe regulations as it
may deem necessary to effect the purposes of that section), also includes
authority to establish withdrawal or transfer rules in two states different
from those applied in the rest of the country.
The Board has the authority to establish different interest rate
limitations for different classes of deposits
. . according to the nature
and location of member banks or their depositors' but no such specific
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Federal Reserve Bank of St. Louis
5
authority to establish different rules applicable to savings accounts is
contained in the Act.
Clearly, uniformity of System rules and regulations
regarding various types of deposits held by member banks was one of the
intended goals of Congress when it placed authority in the Board to define
various types of deposits for member banks.
Legislative history relevant to NOW account legislation (and the
bulk of public comment on NOW accounts) indicates a desire for uniformity
of NOW regulations among institutions in the experiment area.
In our view,
removal of the present transfer limitations will create disequbrium
among institutions by restructuring all savings deposits held at member
banks in Massachusetts and New Hampshire.
Such action at this time may have a disruptive rather than beneficial
effect on the NOW experiment.
Suspension of transfer limitations is not
essential to the experiment commissioned by Congress.
Because such action
II.y in fact impede the NOW experiment through the introduction of transfer
privileges for all savings deposits four months after NOW authorization by the
agencies, we believe that amendment of Regulation Q only in the two state ar -is
S tnecessary and therefore may be subject to successful challenge in
the courts.
We believe the likelihood of a disruptive effect on the NOW
experiment outweighs the possibly valid assertion that making all savings
accounts in the test area subject to some form of transfer procedure may
provide a clearer indication of the consequences of removal on a nationwide
S.sis of the prohibition on the payment of interest on demand deposits.
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Federal Reserve Bank of St. Louis
•
6
Payment of Interest on Demand Deposits:
The Board's notice of adoption of
the present savings deposit transfer limitations (effective January 15, 1962)
stated that,
"the purpose of the amendment is (1) to prevent certain
practices that facilitate the use of a savings deposit
as a regular means of drawing checks on the depository
bank . .
Board action removing or suspeLding savings deposit withdrawal limitations
from Regulation Q would not in itself constitute authorization for Bank
to pay interest on demand deposits.
Such action would, however, have
the practical effect of permitting the use of savings deposits in a manner
closely resembling demand deposits.
Prior to adoption of the present transfer limitations it was the
view of the Legal Division that a deposit may be classified as a savings
deposit if (in addition to meeting requirements such as depositor eligibility)
It was subject to an agreement under which the depositor is or may be required
by a bank to give notice in writing of an intended withdrawal not less than
4/
30 days before the withdrawal is made.
We concur with the Division's previously expressed view that
limitations on transfers from savings deposits are not essential for maintaining the statutory distinction between savings and demand deposits.
effect
However, because removal of the limitations would have the practical
recommend
of permitting payment of interest on funds used to cover checks, we
face of
that such action not be taken during the NOW experiment in the
recent Congressional consideration of NOW legislation.
Reference to that
Payment of Interest
4/ Memorandum, "A Legal History of Federal Regulation of
on Demand Deposits," by Howard H. Hackley, September 30, 1955.
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Federal Reserve Bank of St. Louis
•
-7
consideration indicates a reluctance on the part of Congress to remove the
distinction between demand and savings deposits without first reviewing
the effects of the NOW experiment which, in the form approved by Congress,
falls short of permitting the payment of interest on demand deposits.
Now Experiment:
Bank contends that such action would "enhance" the exper-
iment, presumably by permitting member banks to more easily compete with
institutions which can offer NOWs without a 150 item limitation
As
recognized by the Boston Reserve Bank, if savings deposits were made automatically transferable to a demand deposit by prior agreement, such action
would provide the convenience of the NOW account without requiring the
creation of a separate account.
It can be expected, however, that altering
the character of savings accounts to provide transfer privileges similar
to NOWs would convince many potential NOW customers not to open a NOW account.
An element of the NOW experiment--to determine the appeal of NOWs over
present savings accounts--would be lost.
It can be argued however, that
making all savings accounts as convenient as NOWs may enhance the results
of the experiment by providing a more accurate indication of the extent
of depositor willingness to convert from demand deposit to interest bearing
accounts subject to either transfer or negotiable order.
As noted by President Morris, suspension of transfer limitations
will provide depositors with a convenient means to write drafts while
maintaining separate interest bearing thrift accounts.
consistent with the NOW rationale.
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Federal Reserve Bank of St. Louis
This result appears
On balance, however, we believe that
S
-8 the NOW experiment, as authorized by Congress and as currently in process,
should remain undisturbed at least during the remainder of this year to
provide Congress an opportunity to review the acceptance and effect of NOW
accounts in the form originally authorized by the agencies.
This review
can be expected later this year when agency interest rate control authority
is again considered by Congress.
Confining the suspension of transfer limitations to the present
NOW account area in order to "enhance" that experiment is certain to be
labeled discriminatory and unreasonable by member banks in other states.
NOW accounts are prohibited in all states except Massachusetts and New
Hampshire, therefore, the Board is directed by statute to limit NOWs to
those states.
No such limitation exists on the Board's authority to amend
its rules regarding savings deposits to permit transfers.
Judging from
comments received when the Board considered NOW regulations, commercial
banks throughout the country and especially those in states bordering
Massachusetts and New Hampshire which have been seeking methods to offer
more convenient thrift accounts will urge strongly that the suspension
action apply System-wide.
Application of the proposed suspension to all member banks
nationwide, during the NOW experiment, would subject the Board to Congressional criticism for taking action which may have the effect of permitting
savings accounts to be used in a manner resembling NOWs before Congress
and the agencies have seen the results of the NOW experiment.
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Federal Reserve Bank of St. Louis
-9 CONCLUSION:
For the reasons discussed above we believe Bank's request
should be denied.
Bank is able to offer NOWs and as indicated in the
attached draft response (Attachment D), the Board has previously expressed
its willingness to review the 150 item limitation should current monitoring
efforts indicate that member banks are unable to compete on an equal basis
with other institutions offering NOWs.
1
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Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
ATTACHMENT A
, .
TON
HE \FIRST NATIONAL BANK
OIROS
RICHARD D. HILL
Chairman of the Board
February 19, 197)
!
111•••••••••
•
•
Board of Govern
ors
Federal Reserve
System
Washington, D.
C.
20551
Attention:
Mr. Chester L.
Feldberg, Secret
ary
Gentlemen:
/In recent mont
hs changes have
taken ph-Ice in th
regulations whic
e Federal
h apnly to the sa
vings deposits
deposits of fina
and demand
ncial institutions
For example, ne
in
th
e
Un
ited States.
w legislation ha
s permitted bank
institutions in
s and thrift
New Hampshire an
d Massachusetts
negotiable orders
to offer
of withdrawal an
d the Board of Go
has issued regu
vernors
lations covering
the NOV account
in those states
exneriment
. Automatic wi
thdrawals from sa
in Federal Savi
vings accounts
ngs and Loan As
sociations have al
authorized, on
so been
an interim basi
s. In order to
experiments, the
enhance these
following reques
t is made.
EV this letter
The First Nation
al Bank of Boston
requests the Bo
respectfully
ard to suspend
the operation of
(c)(2)(i) of Re
Se
ction 217.5
gulation Q. The
Regulation curr
as follows:
ently provides
"(2) Notwiths
tanding the prov
isions of subnar
(1) of this pa
agraph
ragraph, no with
di.awal shall be
mitted by a memb
perer bank to be ma
de from a saving
deposit, throug
s
h payment to the
bank itself or
transfer of cred
through
it to a demand or
other deposit ac
of the same depo
count
sitor (other than
of interest on th
savings deposit)
e
if such payment
or transfer is ma
pursuant to any
de
advertised plan
or any agreemen
ten or oral,
t, writ(i) which auth
orizes such 'pay
ments or transfer
. of credit tr
s
be made as a no
rmal practice in
to cover checks
:.-der
or drafts drawn
by the deposi:D
upon the bank."
r
•
The purpose to
be served by
suspension of
Is to enable
subsection (c)(
co=ercial blinks
2)(1)
to co2pete on a
with thrift in
more even foot
stitutions which
ing
offer I:0Y acco
In such an in
unts. A deposi
stitution is no
tor
t bound rigidly
by the concept
of
Boston, Massachusetts 02
110
•
THE FIRs r NATIONAL BANK OF BOSTON
iroseP
••••
Board of Governors
February 19, 1974
-2-
•
genuine thrift, 1-,ut rathr is permitted to take advantage
of the time value of money drawing interest on his balance
in savings, but able to make tranfers to third persons
periodically without „presenting a signed withd2aval order
in person or by mail. The same, functional result .should,
we feel, be allowsd to customers of commercial banks who
have both savings and checking accounts in the same bank.
With the suspension of the provision cited above, a commercial
bank; upon receipt of checks, could dcbit the customer's
checking account in the normal way and then when insufficient
funds remain in his checking account automatically move funds
from his savings account to his demand deposit account. Such
autbmatic transfers would be made pursuant to an agreement
with each participating customer.
We believe that this request is fully in the public interest,
since it would permit com-nercial banks to offer, on a fair
competitive basis, benefi.tc to the public. .The proposed suspension of the subsection would simplify the customer's
bookkeeping since he would receive one .tatement for his
checking account and savings account. Furthermore, by
permitting commercial banks to make transfers between the
accounts automatically, the efficiencies of their computer
operations could be more fully realized.
This should amount to a significant improvement in the payments
mechanism.
st,
If we can furnis.h further information in support of this reque
please let me know.
Yours truly
„.
/,,
47
/
L
•
-4-4•
Richard D. Hill k
Chairman
Copy to:
Mr. Frank Morris, President
Federal Reserve Bank of. Bo_,ton
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Federal Reserve Bank of St. Louis
•
ATTACHMENT B
FEDERAL RESERVE BANK
OF BOSTON
FRANK E. MORRIS
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Federal Reserve Bank of St. Louis
PRESIDENT
BOSTON, MASSACHUSETTS 02106
TELEPHONE (617) 426-7100
April 22, 1974
Mr. Chester B. Feldberg, Secretary
Board of Governors of the
Federal Reserve System
Washington, D. C. 20551
Dear Mr. Feldberg:
The First National Bank of Boston has requested suspension of Regulation Q prohibitions on transfers from a savings
account to a demand deposit account of the same depositor as
a normal practice in order to cover checks drawn by the depositor. This Bank believes that the requested suspension is
warranted, subject to qualifications discussed below which
relate to the NOW account experiment.
The proposed change in Regulation Q would permit
commercial banks to offer their customers checking accounts
in combination with savings accounts so that an overdraft of
the depositor's checking account would be covered by automatic
transfer from the depositor's savings account. First National
argues that commercial banks would then be able "to compete on
a more even footing with thrift institutions which offer NOW
accounts." Since banks in Massachusetts may themselves offer
NOW accounts on an exactly equal footing with thrift institutions, First National's request really signals a preference
fS r an alternate form of account arrangements. The customer
would benefit since there would be no need to open a separate
NOW account; instead, savings and demand accounts would be
combinedsingle statement account. From the banks' point
of view, it is argued that computer handling of combination
accounts would be more efficient.
The computer efficiency argument is more pertinent to First
National's present circumstapces than to commercial banks generally. In recent advertising, the bank has aggressively
promoted free checking accounts tied to savings accounts
(minimum balance $5.00; see attachment.) Thus, its computer
operations are presently set up with the capacity to handle
demand and savings accounts in combination. If an automatic
transfer provision were permitted and the bank continued to
offer the combination free of charge, the resulting package
would represent the functional equivalent of no-service-charge
NOW accounts, which are offered in Massachusetts by 3 commercial banks and 31 thrift institutions (as of March 29.)
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Federal Reserve Bank of St. Louis
•
Mr. Chester B. Feldberg
-2-
April 22, 1974
We see no compelling reason to deny the requested change
in Regulation Q, provided that the suspension is effected
explicitly as part of the NOW account experiment in Massachusetts and New Hampshire. Therefore, we would not favor the
suspension if it could not be limited to the two states.
Similarly, in the event that commercial banks' savings account
interest rate ceilings are increased in the future, we would
require that interest on savings deposits in a combination
account with automatic transfer provisions be paid at a rate
no higher than the permissible rate payable on NOW accounts.
Sincerely,
Frank E. Morris
Attachment
Removal Notice
The item(s) identified below have been removed in accordance with FRASER's policy on handling
sensitive information in digitization projects due to copyright protections.
Citation Information
Document Type: Advertisement
Citations:
Number of Pages Removed: 1
The First National Bank of Boston. "What's the Quickest Way to Spend Away Your Savings
Account?" 1974.
Federal Reserve Bank of St. Louis
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Federal Reserve Bank of St. Louis
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F2DEAAL RESERVE BANK
F BOSTON
•
Date
EMORANDUM
Mr. Morris
):
om:
ATTACHMENT C
Subject
March 14, 1974
Request re Reaulation Q from
First National BankcZ Boston
Mr. Stone
By letter of February 19 to the Board of Governors, copy to
you, The First National Bank of Boston requested suspension of that
portion of Regulation Q that prohibits transfers from a savings deposit to a demand deposit of the same depositor if such transfer is
made pursuant to any advertised plan or any agreement which authorizes
such transfers 4„..„ be made as a normal practice in order to cover checks
drawn by that depositor.
. In my opinion that request should be denied.
The section of Reaulation Q in question is sometimes referred
to as the Park Ridge section, designed to prevent the regular use of
savings deposits and withdrawals therefrom to cure deficits in demand
deposits, as had been proposed in the early 1960's by the Citizens
Bank and Trust Company, Park Ridge, Illinois. As you know, the
Regulation Q section in question was a compromise of what the Park
Ridge Bank first proposed; and that bank, at the present time, markets
a deposit plan that takes full advantage of that compromise provision.
The request of the First does not limit itself to Massachusetts
tnd New Hampshire; I recommend denial of the request whether it is
construed as limited to those two states or to the nation as a whole.
The general thrust of the First's position in support of its
request is that commercial banks should be able to compete on a more
equal footing with thrift institutions which offer NOW accounts. It
points out, quite correctly, that the depositor in a commercial bank
may not arrange for transfers to be made from his savings deposit to
his demand deposit, and when coupled with the statutory prohibition
against the payment of interest on demand deposits, the commercil bank
is placed at a competitive disadvantage vis-a-vis the savings -a_ :ks
offering a NOW account. You will recall that this disadvantage was a
major point in the brief by the Massachusetts Bankers Association in
presenting its views during the period Congress was wrestling with the
question of what to do with NOW accounts.
The clearest answer tc :he First is to suggest that it might
compete with the thrift institutions by offering NOW accounts. It
.> could not do .so prior to the federal legislation that permits the
regional experiment, hut it is cuite clear that both under the statute
and under the amended. Regulation Q a commercial bank in the two states
can offer NOW accounts and provide for automatic transfers therefrom
to a checking account of the same depositor.
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Federal Reserve Bank of St. Louis
•
•
page
It is clear that a suspension of the ReglIktion Q provision
as requested by the First would mean that the member banks would, in
effect, be able to pay interest on demand deposits. Removal of the
statutory prohibition aq-ainst that practice may be forthcoming,and
Governor Mitchell may be quite right in suggesting a "family account"
that would permit easy transfers to and from checking accounts--but
until those changes take place, it is premature to grant the request
of the First.
yb
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Federal Reserve Bank of St. Louis
ATtACHMENT D
Mr. Richard D. Hill
Chairman of the Board
The First National Bank of Boston
Boston, Massachusetts 02100
Dear Mr. Hill:
This responds to your letter of February 19, 1974, requesting
that the Board suspend the operation of Section 217.5(c)(2)(1) of Regulation Q which provides limitations on the transfer of funds from a savings
deposit to the depository bank or through transfer of credit to a demand
or other deposit account of the same depositor.
The Board has reviewed your request in light of the NOW experiment presently being conducted in Massachusetts and New Hampshire and has
determined that such action to suspend the present transfer limitations
should not be taken at this time.. As you know the Board and the other
Federal financial supervisory agencies have jointly instituted a monitoring program to enable these agencies and Congress to assess the acceptance and financial effects of the use of NOWS in the experiment area.
Because the NOW experiment as authorized by Congress and the
agency monitoring effort have been in place for only four months, data
thus far received are inadequate to permit accurate assessment of the
use of NOWS in the form existing in the two States at the time Congress
considered NOW legislation and authorized continued NOW usage under experimental conditions.
Removal of the transfer limitations as to all sav-
ings deposits at this time would significantly change the NOW experiment
environment and thereby may make more difficult accurate evaluation of
the date received thus far.
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Federal Reserve Bank of St. Louis
,•••
2
IMMO
These considerations, in addition to the fact that data thus
far available do not indicate that the Board's item limitation is inhibiting member banks' ability to offer NOW services on an equal footing with
other financial institutions, convince the Board that the suspension of
transfer limitations for all savings deposits is not warranted at this
time.
The Board is continuing to monitor closely the use of NOWS and is
prepared to review its present regulatory requirements should data indicate that additional regulatory actions appear necessary.
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Federal Reserve Bank of St. Louis
Very truly yours,
Chester B. Feldberg
Secretary of the Board
@FedFRASER