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CHAIRMAN O F T H E B O A R D O F G O V E R N O R S FEDERAL R E S E R V E SYSTEM W A S H IN G T O N , D. C . 2 0 5 5 1 November 15, 1972 The Honorable Herbert Stein, Chairman Council of Economic Advisers 314 Executive Office Building Washington, D. C c 6 ^ ^ ^ Dear Mr,. Chairman: ^ Ip. For several years the Board of Governors has sought Congressional approval of legislation which would make Federal Reserve reserve requirements applicable to all Federally insured banks, rather than to member banks alone. Last year, in its annual report, the Board stated its belief that reserve requirements should apply to all deposits subject to withdrawal by check in any type of financial institution. These proposals are related to developments in Federal Reserve System mem bership over the past decade and to the evolution toward use of check-like .transfer at nonbank savings institutions. Since 1960, 675 banks have left y the System through withdrawal (including converting from national to State charters) and mergers. During the same period, 102 State-chartered banks ^/voluntarily joined the System, while 1,483 newly State-chartered banks opted not to do so. Banks withdrawing in 1971 (41) averaged about $16 million in deposits, although there were several in the $20-$80 million range (Attachment 1). Thus far during 1972, three banks with deposits of $100 million or more have withdrawn, and most recently one bank -- the Wilmington Trust Company -- having deposits in excess of $500 million has withdrawn. There is no great mystery about the reason why banks withdraw or remain outside the Federal Reserve System. There are some supervisory restric tions on members which may be significant in certain cases; but by far the most important reason for electing nonmember status is the difference xJ in reserve requirements between member and nonmember banks and its effect on bank earnings. Virtually every State has reserve requirements which permit lower levels of non-earning assets for nonmembers and most States can and do reduce their requirements when the Federal Reserve does so. As banks strive for greater earnings, there is increasing incentive for them to withdraw from the System, and less incentive for new banks to join. This change in Federal Reserve System membership has resulted in a declining proportion of deposits subject to Federal Reserve requirements. I attach a brief memorandum and tables tracing these changes over the past several years (Attachment 2). As the Annual Report of the Board of Gover nors for 1971 states, demand deposits held by any institution — nonmember banks, savings banks, or any other — are logically part of the country1s m iS a $C$C/\>C- Sy$rlci/ *0 ^6X 3 3 The Honorable Herbert Stein - 2 - money supply, just as are those in member banks. Applying the same demand-deposit reserve requirements to all such institutions would facil itate the effective implementation of monetary policy0 In lesser degree, the same might be said about time deposits0 In fact, for monetary policy purposes, the distinction between demand and time deposits is being blurred, not only by the "Negotiable Order of Withdrawal" mentioned below, but also by new financial services which allow quick transfers from one type of deposit to another. The proposal to extend reserve requirements to others than commercial banks has become increasingly pertinent as savings banks, credit unions, and other institutions have sought and, in some cases, have obtained the right to engage in third-party transfers of funds. In the State of Massachusetts for example, savings banks have instituted a controversial form of interest bearing account subject to a "Negotiable Order of Withdrawal" -- an arrange ment which is tantamount to a checking account. Issues of interest payment on demand deposits and competitive equity aside, this adds to the effective money supply outside the direct control of the monetary authority. The Federal Reserve System, by administrative rule, recently restructured its reserve requirements for member banks in such a way that required reserves are a function of bank size alone, rather than relocation, and so that there is a smoother progression of requirements against increasing deposit-size categories. The System would be prepared to make other types of changes should nonmember banks and other financial institutions be sub ject to its reserve requirements, to the end that the transition to a new situation be smooth and that equity among institutions be improved. Accompanying its recommendation on reserve requirements, the Board has proposed that the privilege of borrowing from Federal Reserve Banks be extended to all institutions subject to its reserve requirements. The Federal Reserve, as lender of last resort, must stand ready to make funds available in emergencies to the entire banking system regardless of mem bership status. As in the case of the recent changes in the payment echanism, the Federal Reserve, in the public interest, cannot exclude nonmember institutions. Legislation is required to insure that this vital service is available in timely fashion to all depository institutions, and that all institutions share equitably in the System1s costs. The Board hopes that the Council of Economic Advisers will see fit, in its forthcoming report, to recommend legislation designed (1 ) to apply a flex ible system of reserve requirements to the deposits of all depository institutions that accept deposits subject to transfer to third parties on The Honorable Herbert Stein - 3 - demand and (2) to authorize the Reserve Banks to extend credit to such institutions on the same basis as they extend credit to member banks. The need for such legislation is of long standing, and it is becoming a matter of urgency. The future effectiveness of monetary policy, and of financial institutions as a whole, depend on it. Sincerely yours, Arthur F . Burns Enclosures cc: The Honorable George P. Shultz Attachment 2 Effects of Changes in System Membership on Deposits Subject to Reserve Requirements Member bank demand deposits as a component of total money supply (M^) have declined steadily from 65 „4 per cent at the end of 1960 to 58«6 per cent at the end of 1971, During the same period, demand deposits in nonmember banks as a percentage of total money supply increased from 14e3 per cent to 1806 per cent (Table l)c Looking at a broader definition of money supply (M3 ), member bank demand deposits declined from 23,3 per cent of the total in December 1965 to 19 per cent in December 1971 while the percentage of nonmember bank demand deposits remained practically unchanged. These movements reflected to some extent a shift in the form in which liquid assets are held, from demand to time deposits; member bank time and savings deposits as a per centage of total increased from 2 2 c2 per cent to 24 per cent, nonmember time and savings deposits from 5 C7 to 8e5 per cent0 Deposits at nonbank thrift institutions remained relatively unchanged at 35 per cent, by far the largest component of M 30 In effect, virtually one-half of the money supply, as broadly defined, was outside the direct control of the monetary authorities at the end of 1971 (Table 2). TABLE 1 Components as a Percentage of Total Money Supply - 1960-19712/ Last-monthof-year Member bank demand deposits Nonmember bank demand deposits Currency and coin I960 65.4 14.3 20.3 1961 65.4 14.5 2 0. 1 1962 64.6 14.9 20.5 1963 63.7 15.3 21.0 1964 63.2 15.7 21.2 1965 62.3 16.2 21.4 1966 61.4 16.4 22.1 1967 61.6 16.6 21.8 1968 61.1 17.1 21.8 1969 59.7 17.9 22.4 1970 59.5 17.9 2 2. 6 1971 58.6 18.6 22 . 8 17 Based on last-month-of-year not seasonally adjusted data0 Attachment 1 BANK MEMBERSHIP STATUS _____Newly Formed Banks State State Nonmember Member National Voluntarily Joining State National Members (Converted) Withdrawals_____ Merged Out of System State National State Members (Converted)^ Member National I960 98 4 33 6 6 26 9 5 3 1961 84 2 24 5 5 17 1 2 6 1962 116 5 62 5 7 23 5 2 16 1963 133 3 163 5 15 22 16 4 8 1964 133 3 200 4 19 19 5 1 7 1965 106 4 88 1 13 22 7 4 10 1966 88 5 25 3 10 32 7 2 12 1967 81 3 18 1 7 21 5 3 11 1968 72 1 17 4 8 39 11 0 17 1969 111 6 17 2 8 42 27 7 11 1970 137 8 40 0 4 38 38 2 11 1971 155 9 37 4 7 20 21 1 11 1972* 169 _7 36 2 60 760 42 10 119 27 348 11 1,483 163 3 36 5 128 ^Through September TABLE 2 Components as a Percentage of M3 — Member Demand December A v era g e 1965 1966 1967 1968 1969 1970 1971 of M M3 100.0 100.0 100.0 100.0 100.0 100.0 100.0 * D e t a i l may n o t add to 1 Nonmember Demand o fM 2 3 .3 2 2 .4 2 1 .8 2 1 .5 2 1 .1 2 0 .6 1 9 .0 t o t a l due t o r o u n d in g . 1 6 .0 6 .0 5 .9 6 .0 6 .3 6 .2 6 .1 1965-1971' C o m 'l Bank Tim e and S a v in g s C u r re n c y and c o in 8 .0 8 .1 7 .7 7 .7 7 .9 7 .8 7 .4 Bank Member Nonmember 2 2 .2 2 3 .0 23.7 2 4 .1 2 3 .3 2 3 .6 2 4 .0 5 .7 6 .1 6.5 7 .0 7 .4 8 .1 8 .5 D e p o s it s o f Nonbank T h r ift I n s t it u t 3 4 .8 34.5 3 4 .4 33.7 3 4 .0 33.7 3 5 .0 CHAI RMAN O F T H E B O A R D O F G O V E R N O R S FEDERAL R E SE RVE SYSTEM W A S H IN G T O N , D. C . 2 0 5 5 1 D e c e m b e r 13, 1972 Dear Herb: A s I told you the other day, the B o a r d continues to be deeply concerned about the attrition being experienced in Sy s t e m m e m b e r s h i p . A n article in the N e w Y o r k T i m e s of D e c e m b e r 5 reported the withdrawal of two m o r e large m e m b e r banks--one in N e w Jersey and one in Maine--each of which had deposits in the neighborhood of $ 2 00 million. O u r internal statistics s h o w that 51 banks have withdrawn f r o m m e m b e r s h i p this year through m i d - N o v e m b e r , 10 m o r e than in all of 1971. M o s t of these w e r e small institutions, but several w e r e in the class above $100 million. This continuing-and even accelerating--rate of withdrawal weakens the S y s t e m and the basis for effective monetary control. It emphasizes the need for a p r o m p t and equitable restructuring in the burden of reserve requirements, along the lines of the proposal set forth in m y letter of N o v e m b e r 15. Sincerely yours Arthur F. Burns The Honorable Herbert Stein Chairman Council of E c o n o m i c Advisers Executive Office Building Washington, D. G. 20501
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