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FEDERAL RESERVE BANK
OF NEW YORK
Fiscal Agent of the United States
Circular No. 1939
February 17, 1918

Public Notice of Offering of $100,000,000, or thereabouts, of Treasury Bills
Dated February 23, 1939
Maturing May 24, 1939

To all Incorporated Banks and Trust Companies in the
Second Federal Reserve District and Others Concerned:

Following is the text of a notice today made public by the Treasury Department with respect to a new
offering of Treasury bills payable at maturity without interest to be sold on a discount basis to the highest
bidders.

_
^

The Secretary of the Treasury gives notice that tenders are invited for Treasury bills to the amount of $100,000,000,
or thereabouts. They will be 90-day bills; and will be sold on a discount basis to the highest bidders. Tenders will be
received at the Federal Reserve Banks, or the branches thereof, up to two o'clock p.m., Eastern Standard time, on
Monday, February 20, 1939. Tenders will not be received at the Treasury Department, Washington.
The Treasury bills will be dated February 23, 1939, and will mature on May 24, 1939, and on the maturity
date the face amount will be payable without interest. They will be issued in bearer form only, and in amounts or
denominations of $1,000, $10,000, $100,000, $500,000, and $1,000,000 (maturity value).
It is urged that tenders be made on the printed forms and forwarded in the special envelopes which will be supplied
by the Federal Reserve Banks or branches upon application therefor.
No tender for an amount less than $1,000 will be considered. Each tender must be in multiples of $1,000. The
price offered must be expressed on the basis of 100, with not more than three decimal places, e. g., 99.125. Fractions
must not be used.
Tenders will be accepted without cash deposit from incorporated banks and trust companies and from responsible
and recognized dealers in investment securities. Tenders from others must be accompanied by a deposit of 10 per cent
of the face amount of Treasury bills applied for, unless the tenders are accompanied by an express guaranty of payment
by an incorporated bank or trust company.
Immediately after the closing hour for receipt of tenders on February 20, 1939, all tenders received at the
Federal Reserve Banks or branches thereof up to the closing hour will be opened and public announcement of the
acceptable prices will follow as soon as possible thereafter, probably on the following morning. The Secretary of the
Treasury expressly reserves the right to reject any or all tenders or parts of tenders, and to allot less than the amount
applied for, and his action in any such respect shall be final. Those submitting tenders will be advised of the acceptance
or rejection thereof. Payment at the price offered for Treasury bills allotted must be made at the Federal Reserve Banks
in cash or other immediately available funds on February 23, 1939.
The Treasury bills will be exempt, as to principal and interest, and any gain from the sale or other disposition
thereof will also be exempt, from all taxation, except estate and inheritance taxes. (Attention is invited to Treasury
Decision 4550, ruling that Treasury bills are not exempt from the gift tax.) No loss from the sale or other disposition
of the Treasury bills shall be allowed as a deduction, or otherwise recognized, for the purposes of any tax now or
hereafter imposed by the United States or any of its possessions.
Treasury Department Circular No. 418, as amended, and this notice prescribe the terms of the Treasury bills
and govern the conditions of their issue. Copies of the circular may be obtained from any Federal Reserve Bank or
branch thereof.
In accordance with the above announcement tenders will be received at the Securities Department of
this bank (2nd floor, 33 Liberty Street, New York City) or at the Buffalo Branch of this bank (272 Main
Street, Buffalo, New York) until two o'clock p.m., Eastern Standard time, on Monday, February 20, 1939.
It is requested that tenders be submitted on special form and in special envelope enclosed herewith.
Attention is invited to the fact that payment for the Treasury bills cannot be made by credit through the
War Loan Deposit Account. Payment must be made in cash or other immediately available funds.
GEORGE L. HARRISON,

"N




President.

T

No

TENDER FOR 90-DAY TREASURY BILLS
Dated February 23,1939.

Maturing May 24,1939.
Dated at

T o THE FEDERAL RESERVE BANK OF N E W YORK,

1939

Fiscal Agent of the United States,
New York City, N. Y.
Pursuant to the provisions of Treasury Department Circular No. 418, as amended, and to
the provisions of the public announcement on February 17, 1939, as issued by the Secretary of the
Treasury, the undersigned offers to pay

* for a total amount
(Rate per 100)

of $

(maturity value) of the Treasury bills therein described, or for any less

amount that

may be allotted, payment

therefor

to be made at your bank in cash or other

immediately available funds on the date stated in the public announcement.
The Treasury bills for which tender is hereby made are to be dated February 23, 1939,
and are to mature on May 24, 1939.
This tender will be inserted in special envelope entitled "Tender for Treasury bills."
IMPORTANT INSTRUCTIONS:
1. No tender for less than $1,000 will be considered, and each tender must be for an amount in multiples
of $1,000 (maturity value). Also, if more than one price is offered, a separate form must be executed at each
price.
2. If the person making the tender is a corporation, the form should be signed by an officer of the corporation authorized to make the tender, and the signing of the form by an officer of the corporation will be
construed as a representation by him that he has been so authorized. If the tender is made by a partnership, it
should be signed by a member of the firm, who should sign in the form "
,a
copartnership, by
, a member of the firm."
3. Tenders will be accepted without cash deposit from incorporated banks and trust companies and from
responsible and recognized dealers in investment securities. Tenders from others must be accompanied by a
deposit of 10 per cent of the face amount of Treasury bills applied for, unless the tenders are accompanied by
an express guaranty of payment by an incorporated bank or trust company.
4. If the language of this form is changed in any respect, which, in the opinion of the Secretary of the
Treasury, is material, the tender may be disregarded.
Payment by credit through War Loan Deposit Account will not be permitted.

Before signing fill in all required spaces.
Name of Subscriber

..
(Please print)

By

,
(Official signature)

(Title)

Street Address

-

City, Town or Village, and State
SPACES BELOW ARE FOR THE USE OF THE FEDERAL RESERVE BANK
Carded

Examined

Allotment

Received

Classified

Figured

Checked

TENTB-451-a




Checked

Ledger

Advised

Recorded

Acknowledged

Method of Payment

Window

Disposition

Amount

Custody

* Price should be expressed on the basis of 100, with not more than
three decimal places, e.g., 99.125. Fractions must not be used.

Date Released

Mail

By

Other DepartmentB

FEDERAL RESERVE BANK
OF NEW YORK

February 20, 1939.

ANNUAL REPORT OF THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM

We are sending to you, herewith, a pamphlet containing excerpts from
the Twenty-fifth Annual Report of the Board of Governors of the Federal
Reserve System. While it may be that you have received a copy of the
complete Annual Report, or of this pamphlet, direct from the Board of
Governors, the character of the information which it contains makes it
seem desirable to us to run the risk of duplication in bringing it to your
attention.
That part of the Annual Report of the Board of Governors, contained
in the accompanying pamphlet, discusses what the Board deems to be major
problems in the field of banking and credit administration. It contains no
specific recommendations for new legislation or for administrative changes,
but it points to the desirability of thorough and intensive study of these
and related problems, by those who are interested in our banking and
credit system.
We believe that a widespread knowledge of these problems is essential
to success in their solution.




GEORGE L. HARRISON,

President.

PROBLEMS
OF

BANKING AND BANK SUPERVISION

EXCERPTS FROM 1938 ANNUAL REPORT OF THE

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM




UNITED STATES OF AMERICA
WASHINGTON: 1939

PROBLEMS
OF

BANKING AND BANK SUPERVISION

EXCERPTS FROM 1938 ANNUAL REPORT OF THE

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM




UNITED STATES OF AMERICA
WASHINGTON: 1939

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
December 31, 1938
MARRINER S. ECCLES, Chairman

RONALD RANSOM, Vice

Chairman

M. S. SZYMCZAK
J O H N K. M C K E E

CHESTER C. DAVIS
ERNEST G. DRAPER

LAWRENCE CLAYTON, Assistant

to the

ELLIOTT THURSTON, Special Assistant
CHESTER MORRILL,

Chairman

to the Chairman

Secretary

LISTON P. BETHEA, Assistant

Secretary

S. R. CARPENTER, Assistant Secretary
J. C. NOELL, Assistant Secretary
WALTER WYATT, General

Counsel

J. P . DREIBELBIS, Assistant General Counsel
GEORGE B. VEST, Assistant General Counsel
B. MAGRUDER WINGFIELD, Assistant General Counsel
LEO H. PAULGER, Chief, Division of Examinations
R. F . LEONARD, Assistant Chief, Division of Examinations
C. E. CAGLE, Assistant Chief, Division of Examinations
E. A. GOLDENWEISER, Director, Division of Research and Statistics
WOODLIEF THOMAS, Assistant Director, Division of Research and Statistics
LAXJCHLIN CURRIE, Assistant Director, Division of Research and Statistics
EDWARD L. SMEAD, Chief, Division of Bank Operations
J. R. VAN FOSSEN, Assistant Chief, Division of Bank Operations
J. E. HORBETT, Assistant Chief, Division of Bank Operations
CARL E. PARRY, Chief, Division of Security Loans
PHILIP E. BRADLEY, Assistant Chief, Division of Security Loans
O. E . FOULK, Fiscal Agent
JOSEPHINE E. LALLY, Deputy Fiscal Agent




CONTENTS
PAGE

Foreword
Summary
Composition of the Banking System and Trends in Banking
Public Supervision of Banks
Relation Between Supervisory and Credit Policies
Nature and Function of Bank Reserves
The Banking System Today
Composition of the Banking System
,
Changes in Character of Banking
Laws and Jurisdictions to Which Banks Are Subject
Discriminatory Federal Laws
Bank Supervision
Allocations of Authority
Confusion and Conflict of Authority
Relation Between Supervisory and Credit Policies
The Problem of Reserves
Reserves and Credit Regulation
Sources of Reserves
Long-view Problem Raised by Excess Reserves

1
2
2
2
4
4
6
6
7
8
10
11
11
12
16
18
18
19
21

APPENDIX
Comparison of Some of the Federal Statutory Provisions Regulating the Business of Different Classes of Banks
25
Revision in Bank Examination Procedure
27
Revised Regulation Issued by the Comptroller of the Currency on Purchases of
Investment Securities
31




m

PROBLEMS OF BANKING AND BANK SUPERVISION

FOREWORD

The present, when our banking system is under no stress, is an appropriate time to present to Congress a picture of the banking problems of
today. The Board is convinced that it would be derelict in the discharge
of its responsibilities if it failed to call to the attention of Congress such
defects in our banking machinery, from the monetary, credit, and supervisory point of view, as still exist, notwithstanding the important improvements that have been made by Congress in recent years. This is
a necessary first step in preparing the ground for such further improvements, within the general framework of our State and national banking
systems, as Congress may deem advisable in order to enable the
banking mechanism better to withstand stresses and strains to which it
may be subjected in the future as it has been in the past. This report
is confined to a discussion of major problems in the banking field and
no attempt has been made to cover all the matters in this field that
require consideration at this time. The Board stands ready to offer all
the assistance in considering this subject that Congress may desire and
that the Board is able to contribute.
Banking is a business vested with a public interest. The current financial needs of commerce, industry, and agriculture are met largely through
the individual actions of the 15,000 separate banks in operation in this
country. The volume of their loans and investments has a direct relationship to the volume of business activity, and the deposits created by
these loans and investments, as they pass from hand to hand, are the
mer?"im through which the bulk of the nation's payments are made.
Successful operation of our banking institutions is, therefore, necessary
to the orderly functioning of the nation's business. It is not merely the
concern of those who have invested their money in the banking business,
nor merely of those who have entrusted their deposits to the banks. It is
also a matter of public concern, both because of the importance of safeguarding deposits and because of the part that the banks play in maintaining the flow of goods and services through the channels of production
and distribution, from the farm, the forest, and the mine to the ultimate
consumer. Interference with the orderly functioning of banks, whether
through bank failures or otherwise, results in the elimination of an



Z

ANNUAL REPORT OP BOARD OP GOVERNORS

habitual source of financial assistance on which the banks' customers
have relied, and in the loss or tying up of deposits belonging to the depositors who have made their business and personal plans in the assurance that they have this money at their disposal. The degree of eagerness
of banks to extend credit and their ability to do so have an important
influence on the course of business, because these factors result in an
expansion or a contraction of loans and investments, and in changes in
the volume of deposits, which are the country's principal medium of
exchange.
SUMMARY

Composition of the Banking System and Trends in Banking.—At the
present time our banking system, as considered in this report, consists
of about 15,000 banks. National banks, which are chartered by the
Federal Government, constitute about one-third of the number, and
nearly all the rest are chartered by the forty-eight State authorities. All
of the national banks and about 10 percent of the State banks are members of the Federal Reserve System, and these members hold 70 percent of total bank deposits and 85 percent of deposits at commercial
banks. All but about 1,500 banks are insured by the Federal Deposit
Insurance Corporation, which covers deposits up to $5,000 for each depositor. Of the total of approximately $60,000,000,000 of bank deposits
at the present time, 45 percent is at national banks, 25 percent
at State member banks, and the remainder at nonmember banks.
Although about 85 percent of all bank depositors are protected in whole
or in part by Federal deposit insurance, only about 38 percent of the
aggregate amount of deposits is covered.
Since 1921 the number of banks has been approximately cut in two,
principally by bank failures, which have resulted in losses to depositors
of over $2,000,000,000. While the amount of bank deposits at present is
larger than it has been at any previous time, and while in general the
country has ample and in some localities excessive banking facilities,
there may be some localities that do not have adequate banking service.
The nature of bank operations and the composition of bank assets
have been greatly changed in recent years. Commercial borrowing at
banks has declined. In the last decade, with the growth of the public
debt, securities of the United States Government have become an increasingly important part of bank portfolios and now constitute over
one-third of their total earning assets.
Public Supervision of Banks.—Its Growth and Pattern.—Recognition
of the public interest in banking is indicated by the fact that banks have
been subject to public supervision for nearly a hundred years. Banking
legislation, State and national, has reflected the cumulative results of
attempts by various governmental authorities to meet competitive conditions and specific situations and emergencies. As a consequence, the



FEDERAL RESERVE SYSTEM

3

development of the mechanism of supervision has been piecemeal in
character and not in accordance with comprehensive plans made with
reference to the country's banking needs taken as a whole. From this
process the banking picture emerges as a crazy quilt of conflicting powers
and jurisdictions, of overlapping authorities and gaps in authority, of
restrictions making it difficult for banks to serve their communities and
make a living, and of conditions making it next to impossible for public
authorities to apply adequate restraints at a time and in conditions when
this may be in the public interest. A chart showing the confusion of
jurisdictions under which the banks function appears on page 9.
Discriminations.—Different classes of banks are subject to different
laws and jurisdictions, and these differences in many cases constitute
competitive disadvantages, particularly for national banks and other
members of the Federal Reserve System. The Board of Governors and
the officers of the Federal Reserve banks strive to encourage eligible nonmember banks to become members of the Federal Reserve System, yet
there are provisions of law that tend to discourage membership since
they apply to member and not to nonmember banks. Among such provisions, for example, are those that restrict banks in charging exchange,
prescribe the minimum capital for the establishment of banks and
branches, establish requirements for reserves against deposits, and limit
the character of bank investments.1
Supervisory Responsibility Diffused.—Forty-eight State authorities
and the Federal Government share the responsibility for bank supervision. Within the Federal Government authority over the banks is scattered among several agencies. The Comptroller of the Currency has the
responsibility for the chartering and closing of national banks and the
primary responsibility for their examination and supervision. The Federal Reserve System has some degree of supervision over all member
banks, but in matters relating to national banks the primary responsibility is with the Comptroller, and in those pertaining to State member
banks it is with State supervisory authorities. The Federal Deposit
Insurance Corporation has definite responsibilities in regard to all insured banks, and exercises its supervisory powers particularly in the case
of insured banks which are not members of the Federal Reserve System.
The Treasury Department, under the emergency laws of 1933, still has
the responsibility for licensing member banks and for approval of the
purchase of bank stock by the Reconstruction Finance Corporation. This
Corporation, because of its authority to make loans to banks and to purchase preferred stock and debentures from them, has proprietary and
contractual powers of supervision over such banks as receive loans or
capital from the Corporation.
As a consequence of this diffusion of authority, the banks themselves
1
Provisions of law that also result in discrimination include restrictions on interlocking directorates,
on loans to officers, and on other matters discussed on pages 10 and 11.




4

ANNUAL REPORT OP BOARD OF GOVERNORS

are frequently confused about the agency with which they must deal and
by the variety of regulations. While cooperative arrangements have been
worked out among the various governmental agencies by which banks
are generally not subjected to separate examinations by more than one
authority, the power to examine banks is possessed by several agencies
and this power can be used. There are many regulations relating to
various banking operations, the responsibility for which is divided between several authorities. For example, the power to determine maximum rates of interest to be paid on time deposits is divided between the
Board of Governors of the Federal Reserve System and the Federal
Deposit Insurance Corporation. The same division exists in connection
with enforcement of the law prohibiting the paying of interest on demand
deposits. The power of granting and supervising the exercise of trust
powers by national banks is divided between the Board of Governors and
the Comptroller of the Currency. There are many other similar instances.
As a consequence of the diffusion of responsibility and diversity of
authority over the banks there is often uncertainty of decision and delay
in action where promptness is important in the public interest.
Problem of Uniformity in Examination Policy.—Diffusion of authority
has also been responsible for difficulties in establishing uniform policies
in connection with bank examinations. While a voluntary agreement has
been worked out between the three principal Federal supervisory agencies—the Comptroller of the Currency, the Federal Deposit Insurance
Corporation, and the Board of Governors—the permanence of this arrangement depends on continuous agreement between the agencies on the
policies involved, and its effectiveness depends on a uniform interpretation of the policies adopted. The interpretation, however, may vary
from time to time in accordance with the points of view of those responsible for the policies of the three agencies.
Relation Between Supervisory and Credit Policies.—The Board wishes
to raise a broad question as to the relationship that should exist between
general credit policies and policies pursued in the examination and supervision of banks. There have been times in the past when these policies
have worked in opposite directions, with a consequent aggravation of
deflationary and inflationary trends.
This report presents for consideration the problem whether and, if so,
by what method examination policies could be so harmonized with credit
policies as to become jointly a stabilizing force in the national economy.
Nature and Function of Bank Reserves.—The Federal Reserve System's power to influence credit conditions as an aid to greater economic
stability arises largely out of its ability to regulate the volume of member bank reserves. This subject was discussed at length in the Annual
Report for 1936.
To state it briefly, under our system member banks are obliged to keep
reserves in amounts equal to a definite proportion of their deposit lia


FEDERAL RESERVE SYSTEM

5

bilities. Consequently, in order to extend more credit, a bank must have
reserves in excess of its existing requirements or be able to obtain such
reserves. By increasing or decreasing the amount of reserves available
to the banks, the Federal Reserve authorities may encourage or discourage the expansion of bank credit, particularly at times when the
banks have a limited amount of unused reserves. Changes in the amount
of unused reserves of member banks can be effected by the System
through purchases or sales of United States Government securities in
the open market, through discounts for member banks at the discount
rate, and through changes in reserve requirements.
Growth of Reserves in Recent Years.—Bank reserves, however, are
influenced also by developments over which the System has no control,
such as gold imports and issues of silver certificates by the Treasury.
Since the amount of money that remains in circulation is determined by
the people's habits and needs for cash and not by the amount of currency issued, currency of any kind issued not in direct response to current
needs of the public is deposited in the banks and is added to bank
reserves.
In considering the problems of credit regulation in the future, the
banking authorities are faced with the effects of the rapid growth of
bank reserves in recent years. In the five years from 1933 to 1938 this
growth has amounted to $6,000,000,000, due to additions to the gold
stock and the issuance of silver certificates by the Treasury. When gold
comes into the country and the Treasury purchases it, the funds thus
released by the Treasury come into possession of the banks and become
bank reserves, and when silver certificates are issued by the Treasury
this also adds an equivalent amount to the reserves of member banks.
The amount of reserves needed by banks has been augmented by the
increase in reserve requirements and by the growth in deposits, but their
reserves now exceed requirements by $3,600,000,000. This amount of excess reserves can be more than doubled, even without further gold imports or silver purchases, through disbursement by the Treasury of
amounts equivalent to the gold it holds in the Stabilization Fund and
elsewhere, by a reduction of its unusually large balances with the Federal Reserve banks, and by the issuance of silver certificates against the
free silver bullion now in the Treasury's possession. This leaves out of
consideration the Treasury's authority to issue United States notes. The
Treasury can also absorb member bank reserves by increasing its cash
holdings and its Federal Reserve balances. Under existing conditions
the Treasury's powers to influence member bank reserves outweigh
those possessed by the Federal Reserve System.
System's Powers to Control Excess Reserves.—Under the present law
the Federal Reserve System can absorb excess reserves only to the extent
of approximately $800,000,000, the amount by which it can increase



6

ANNUAL REPORT OF BOARD OF GOVERNORS

member bank reserve requirements, and the additional amounts that
could be taken up by such sales out of its portfolio of $2,560,000,000 of
Government securities as may be in the public interest. After the System had done all in its power to absorb excess reserves, a considerable
amount would remain at the disposal of the banks. In view of the
many changes in bank assets and in money market conditions that have
occurred in recent years, only experience can determine at what level
of excess reserves banks will be responsive to Federal Reserve policy.
It is clear, however, that the present and prospective volume of excess
reserves may at some time become the basis of an injurious credit expansion. If this should develop, the Federal Reserve System with its
present powers might not be in a position to carry out the mandate of
Congress to prevent such an expansion.
The Board is convinced that there is no immediate prospect of excessive expansion of bank credit and no reason to change the present
policy of monetary ease adopted for the purpose of facilitating recovery.
It believes, however, that the present is an appropriate time to review
our banking, credit, and monetary system in order that Congress may
consider such changes and improvements as appear desirable.
THE BANKING SYSTEM TODAY

Composition of the Banking System.—A brief statement about the
number and size of the different types of banks that exist today, and the
changes that have occurred in recent years in the character of the banking business, will supply a background for the banking picture with
reference to which banking laws and banking administration will be
considered in this report.
Our banking system is the result of an evolutionary development. At
the time of the passage of the National Bank Act in 1863, all incorporated banks were under State authority. After establishment of the
national banking system, supervision of a large part of the country's
commercial banking resources passed to the Federal Government. Upon
this composite structure of national and State banks was superimposed
in 1913 the Federal Reserve System, which extended Federal supervision
to such State banks as joined the System. In 1933 the organization of
the Federal Deposit Insurance Corporation extended Federal supervision
to all banks having Federal insurance of deposits.
The number and deposits of the principal groups of banks as of
June 30, 1938, are shown in the following table. The total includes all
commercial banks and trust companies in the United States and some
private banks, as well as mutual and stock savings banks and a few
so-called industrial banks. The figures do not include institutions which
may engage in some banking operations but which are not generally considered as being primarily banks. For example, security brokers^ land



FEDERAL RESERVE SYSTEM
BANKING STRUCTURE OF THE UNITED STATES

June 30, 1938

Number
of
banks

All banks
Insured b a n k s :
National
Insured nonmember
SToninsured banks
1

Gross
deposits 1
(in millions
of dollars)

15,287
5,242
1,096
7,437
1,512

Percent of total
Number
of
banks

Deposits

59,044

100

100

26,763
14,546
7,123
10,612

34
7
49
10

45
25
12
18

Include interbank deposits.

banks, building and savings and loan associations, mortgage companies,
finance companies, and credit agencies owned in whole or in part by the
Federal Government are not included.
In this table, so arranged as to show the four principal groups of
banks from the supervisory point of view, the first two groups together
comprise all member banks of the Federal Reserve System, and the first
three together all represent banks insured by the Federal Deposit Insurance Corporation. The table shows that 41 percent of all banks are
members of the Federal Reserve System, that they hold 70 percent of
deposits, that 90 percent of all banks are insured, and that these insured banks hold 82 percent of all deposits. Of the total amount of
bank deposits about 38 percent is covered by Federal deposit insurance.
Ten percent of the banks with 18 percent of deposits are noninsured
banks. Most of the deposits of noninsured banks are in about 600
mutual savings and private banks. Leaving these out, all but 900 commercial banks with $900,000,000 of deposits are covered by Federal deposit insurance.
The number of banks in operation at present is only about one-half
as large as in 1921. Through failures and consolidations the number of
banks has been reduced from 30,000 to 15,000. The banks which suspended held deposits of about $8,500,000,000, of which about one-fourth
has been lost to depositors. The aggregate volume of deposits of the
banking system, however, has generally grown, except in the three years
from 1930 to 1933, and at the end of 1938 was larger than at any previous time.
Changes in Character of Banking.—The character of the banking
business has undergone considerable change in the past twenty years.
Increasing use of the corporate form of business enterprise, together with
the growth in the importance of large concerns and in the custom of
meeting corporate financial needs through security issues or out of retained earnings, has resulted in a decline in the extent to which business



8

ANNUAL REPORT OF BOARD OF GOVERNORS

relies upon banks for commercial loans. There has also been in recent
years an increase in the amount of savings deposited in banks, which has
placed on the banks the responsibility for the investment of these funds.
During recent years, with the decrease in demand for commercial loans
and the increase in funds held by banks, there has been a pronounced
change in the nature of bank assets. Holdings of Government and other
securities and loans on real estate have increased, while commercial
loans have diminished in importance. Banks have been forced to find
outlets for the funds through channels other than those which were
customary in former days and this has been reflected in revisions of
banking laws relating to mortgages, of regulations applicable to bank
investments, and a liberalization of the basis of borrowing from the
Federal Reserve banks.
Laws and Jurisdictions to Which Banks Are Subject.—As has been
pointed out above, the banks of the country, viewed in relation to the
laws and supervisory authorities to which they are subject, can be divided
into four groups: (1) National banks; (2) State bank members of the
Federal Reserve System; (3) Nonmember State banks covered by Federal deposit insurance; and (4) Noninsured State banks. Of these four
groups of banks the first three are covered by Federal deposit insurance.
The network of laws and regulations to which these banks are subject is
illustrated by the chart on page 9.
Summarizing the matter briefly, and in reverse order, noninsured State
banks are subject to only a few Federal banking laws and are almost
entirely controlled by State laws and authorities.
Insured nonmember banks are subject to State laws and to such
Federal banking laws as apply to all banks whose deposits are covered
in whole or in part by Federal deposit insurance.
State bank members of the Federal Reserve System are subject to
Ihree sets of laws: State laws; Federal laws connected with Federal
deposit insurance; and other Federal laws applicable to members of the
Federal Reserve System.
National banks are governed by Federal banking laws, some applicable to them as banks chartered by the Federal Government, some as
members of the Federal Reserve System, and some because they are
insured by the Federal Deposit Insurance Corporation.
Out of this complicated network of independent laws and overlapping
jurisdictions and authorities arise many discriminations against one or
another group of banks. When national laws are compared with State
laws the comparison has to be made with 48 different sets of laws. It
is obvious that such a comparison cannot be made in detail within the
scope of this report. Some of the outstanding differences between the
various laws in effect have to do with capital requirements for the organization of banks, with the character of loans and investments permitted, with amounts permissible to be loaned to an individual, with



PRINCIPAL BANK SUPERVISORY RELATIONSHIPS

MONETARY

CONTROLS

FISCAL POLICY OPEN MARKET
OPERATIONS
GOLD ANO
SILVER POUCY
STABILIZATION
OPERATIONS

MAJOR

RESERVE
REQUIREMENTS
REDISCOUNT
POLICY

RELATIONSHIPS

INCIDENTAL

RELATIONSHIPS




10

ANNUAL REPORT OP BOARD OF GOVERNORS

the establishment of branches, and with the charging of exchange on
checks.
Discriminatory Federal Laws.—Some of the principal laws that result
in competitive advantages for one group of banks as compared with the
others may be mentioned. The statements refer only to discriminations
in the Federal laws between member banks and nonmember insured
banks. There may be cases where laws in some States provide for restrictions on State banks similar to those imposed by Federal laws on member banks.
Member banks are required by statute to remit at par to the Federal
Reserve bank for all checks drawn against the member bank and collected through the Federal Reserve bank. Nonmember banks can make
exchange charges on checks forwarded to them for collection. In many
cases such exchange charges constitute an important source of revenue
for small banks.
Member banks are required to have a fixed minimum capital in accordance with the size of the town in which they are located, while
for insured nonmember banks there is no fixed Federal requirement
and each case is considered on its merits by the Federal Deposit Insurance Corporation. There is also an important discrimination against
member banks in the matter of capital requirements in connection with
authority to establish branches.
Member banks must keep with the Reserve banks reserve balances
against their deposit liabilities in proportions determined by the Federal
Reserve Act and the Board of Governors, while nonmember banks are
governed in this matter by State laws which in most cases require
smaller reserves.
The character of investments eligible for purchase by member banks
is subject to Federal regulation while nonmember banks are not subject
to this particular regulation.
Provisions in the Clayton Act which regulate and restrict the service
of persons in various capacities in more than one bank with a view to
preventing concentration of banking power are applicable to member
banks but not to nonmember banks. In view of the fact that obtaining
the services of influential and capable directors is an important and a
difficult task for banks, the greater freedom of choice in this respect
possessed by nonmember banks works to the disadvantage of membership in the System.
Member banks are subject to many restrictions and regulations, not
applicable to other banks, in respect to the affiliates with which they
may be connected. This is a matter of importance principally in connection with membership in banking groups controlled by holding
companies.
Member banks, but not other banks, are also subject to Federal laws
by authority of which officers and directors may be removed by the



FEDERAL RESERVE SYSTEM

11

Board of Governors in cases of continued violation of law or continued
unsafe or unsound practices. This provision of law was designed to
strengthen the hand of supervisory authorities in promoting sound banking conditions, short of taking steps that would result in the suspension
of the bank.
Member banks, but not other banks, are subject to Federal restrictions
and limitations regarding loans to officers.
A list of all Federal statutory provisions that do not apply uniformly
to all banks subject to Federal supervision is too lengthy for the report.
A partial list appears in the Appendix.
The application of some of these laws singly or in combination tends
to discourage membership in the Federal Reserve System. Specific instances have come to the attention of the Board of Governors during the
past year.
A number of national banks have recently surrendered their national
charters and taken State charters because they can operate branches with
less capital under State law; a number of State banks which desire to
join the Federal Reserve System have been prevented from doing so
because they have branches and do not have the capital required by Federal law for the operation of branches by State member banks; and a
number of banks have threatened to withdraw from the System rather
than give up valued directors because of the provisions of the Clayton
Act. Many State banks in the Mississippi Valley and the South Atlantic
States refrain from joining the Federal Reserve System because members
of the System are required to be members of the par clearance system
while nonmember banks may deduct exchange charges. There have been
withdrawals from the Federal Reserve System for which the same reason
was given.
These are but a few illustrations of the many ways in which the Federal banking laws discourage membership in the Federal Reserve System
and encourage banks to continue to operate as nonmember banks.
BANK SUPERVISION

Allocations of Authority.—Not only do laws regulating bank operations differ for different groups of banks, but banks are also subject to
a number of different supervisory authorities and to diverse regulations
issued and enforced by such authorities.
Supervision and regulation of banks differ materially from State to
State as well as between banks that are chartered by States and those
that are chartered by the Federal Government. Even within the Federal
Government there is extensive diversity, overlapping, and confusion of
jurisdiction in the regulation and supervision of different groups of banks.
There are five Federal agencies engaged in bank supervision. Prior to
1933, Federal supervision of the commercial banking system, in so far as
it was subject to such supervision, was in the hands of the Comptroller



12

ANNUAL REPORT OF BOARD OF GOVERNORS

of the Currency and the Federal Reserve Board. Since 1933 there has
been added the Federal Deposit Insurance Corporation, which exercises
broad supervisory powers. Certain powers of the Reconstruction Finance
Corporation also give it a measure of responsibility for the operation of
banks, and the Secretary of the Treasury, through the exercise of authority under the President's emergency powers, licenses the operation of
member banks and has authority to exercise other regulatory powers.
Broadly speaking, the function of the Comptroller of the Currency is
to charter and supervise national banks and, when necessary, to appoint
conservators or to close and supervise the liquidation of national banks.
When the Comptroller closes a bank, however, on account of its inability
to meet the demands of its depositors, he is required to appoint the Federal Deposit Insurance Corporation as receiver.
The Federal Reserve System has authority to supervise and examine
all banks that are members of the System and to lay down requirements
for admission of State banks to membership. But in relation to national
banks its authority is parallel to a considerable extent with that of the
Comptroller of the Currency, and in regard to State banks with those of
State supervisory authorities. When banks receive national charters from
the Comptroller, they become members of the Federal Reserve System,
without any action by the Board of Governors, and State banks, while
they can join the System only with its approval, bring with them charter
rights obtained from State authorities.
The supervisory functions of the Federal Deposit Insurance Corporation revolve around the insurance of deposits of banks that are insured
and the termination of this insurance. Supervisory functions of the Federal Deposit Insurance Corporation relating to State insured banks
parallel to some extent the functions exercised by State authorities and
as to national banks and State member banks duplicate to some extent
the functions of the Comptroller of the Currency and the Federal Reserve System. National banks chartered by the Comptroller of the
Currency and State banks admitted to membership in the Federal Reserve System are all insured by the Federal Deposit Insurance Corporation.
The supervisory activities of the Reconstruction Finance Corporation
occur in connection with the purchase and ownership of preferred stock
and capital notes and debentures of banks. These activities are not
based directly on legal requirements but indirectly on the proprietary
and contractual relationships between the Corporation and the banks.
Confusion and Conflict of Authority.—In many matters there are
divisions of authority, both in the law vesting the authority and in its
exercise.
For instance, the Comptroller of the Currency issues regulations defining and governing the purchase of investment securities by national
banks. The regulations, however, are applicable also to State member



FEDERAL RESERVE SYSTEM

13

banks but not to insured nonmember banks. The Comptroller of the
Currency enforces the regulations with respect to national banks and
the Reserve System enforces them with respect to State member banks.
A similar situation exists in relation to the exercise of trust powers
by national banks. Authority to grant trust powers and to issue regulations rests with the Board of Governors. Supervision over the exercise
of these powers and over compliance with these regulations, however, is
in the hands of the Comptroller of the Currency.
Confusion and conflict of authority exist also in the matter of regulation of interest to be paid by banks on deposits. Payment of interest on
demand deposits is prohibited for all insured banks, including national
banks, State member banks, and insured nonmember banks. This would
appear to be a simple matter. But application of the definition of interest to particular cases is not simple and has many implications. It has,
for example, an important bearing on the practice of city banks in
absorbing expenses and exchange charges on items collected for country
correspondents in return for the maintenance of balances. There is,
however, no single authority having power to administer this law. In
regard to member banks it is administered by the Board of Governors
and in regard to nonmember insured banks by the Federal Deposit Insurance Corporation. The Federal Deposit Insurance Corporation enforces
its own regulation, but the Board's regulation, in so far as it applies to
national banks, is administered by the Comptroller of the Currency.
Determination of the maximum rate of interest to be paid on time
deposits is made for member banks by the Board of Governors and for
nonmember insured banks by the Federal Deposit Insurance Corporation.
The Federal Reserve System is charged wTith the administration of
the law regarding holding company affiliates of member banks; but the
same holding company sometimes controls national banks supervised
primarily by the Comptroller of the Currency, State member banks supervised principally by the States and the Federal Reserve System,
nonmember insured banks supervised principally by the States and the
Federal Deposit Insurance Corporation, and non-banking corporations
which are required to submit to examinations and to furnish reports of
condition to the Federal Reserve System or the Comptroller of the Currency but usually are not subjected to any further supervision by bank
supervisory agencies. Such situations involve additional overlapping,
conflicts, and gaps in authority.
The conflicts of authority in bank supervision cause much confusion
and delay and not infrequently prevent prompt action in cases where
quick decision is necessary to prevent losses to the public and to remedy
critical situations.
In one case, for example, an excessively long period of time elapsed
between initiation of negotiations and the final consummation of a plan



14

ANNUAL REPORT OF BOARD OF GOVERNORS

for the relief of a dangerous banking situation in an overbanked community in which were located two State member banks and a national
bank, all in an unsatisfactory condition. The lapse of time was largely
due to the fact that the plan for working out the situation had to be
satisfactory not only to the local interests and to the State banking
authorities, but to the following Federal agencies: the Reconstruction
Finance Corporation, which purchased preferred stock in the new bank
organized to succeed the three; the Secretary of the Treasury, who had
first to request the Reconstruction Finance Corporation to subscribe to
the preferred stock and then had to license the new bank; the Federal
Deposit Insurance Corporation, which made a loan to the national bank;
the Comptroller of the Currency, whose cooperation was necessary in
order that the national bank might be included in the program; and the
Federal Reserve bank of the district and the Board of Governors, in
connection with the admission of the new bank to membership in the
System. Officials and examiners of all these agencies were participants in
numerous conferences, both at Washington and in the field.
In the case of another national bank, while the Federal Deposit Insurance Corporation was preparing to institute proceedings to terminate
the bank's insurance, which might be expected to end in the appointment
of the Federal Deposit Insurance Corporation as receiver, the Comptroller of the Currency filed a certificate with the Board of Governors
instituting proceedings against the president of the bank to remove him
from office under authority granted by the Banking Act of 1933. The
Board then initiated a hearing but, while this proceeding was under way,
the Comptroller of the Currency found it necessary to appoint a conservator. After the conservator was appointed, the Board proceedings
were concluded and the president of the bank was removed from office.
Subsequently the conservator was supplanted by the Federal Deposit
Insurance Corporation as receiver.
There are cases of banks threatening to give up national charters in
order to escape regulation and supervision by the Comptroller of the
Currency; of other banks threatening to retire from the Federal Reserve
System in order to escape regulation and supervision by the Reserve
System; and of still other banks threatening to join the Federal Reserve System in order to escape some requirements or conditions imposed
by the Federal Deposit Insurance Corporation.
In practice there is less confusion in many of the supervisory activities
of the Comptroller of the Currency, the Federal Reserve System, and
the Federal Deposit Insurance Corporation than in the authority under
which these agencies act. Bank examinations are an example. Generally
speaking, national banks are examined only by the Comptroller of the
Currency; the Federal Reserve System has power to examine all member
banks but does not examine national banks and examines State member
banks in cooperation with State authorities, and State member banks



FEDERAL RESERVE SYSTEM

15

are not examined by either the Comptroller of the Currency or the Federal Deposit Insurance Corporation; the Federal Deposit Insurance Corporation in cooperation with State authorities examines the insured State
banks which are not members of the Reserve System. The Federal
Deposit Insurance Corporation has power to examine national banks,
with the permission of the Comptroller of the Currency, and State member banks, with the permission of the Board of Governors. Such examinations, however, are seldom made. State banks belonging to the
Reserve System and insured nonmember banks are examined by Federal,
as well as by State, authorities but the extent of duplication in this
respect is reduced through arrangements for joint or alternating examinations. In practice, therefore, the effect of these conflicting authorities
to examine banks has been minimized by agreement by which the Federal agencies accept each other's examinations, but the authority, nevertheless, exists and can be used.
Somewhat the same situation exists as regards condition, dividend,
and other reports, and their publication. The Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Reserve
System all have powers and responsibilities in this field. They all maintain, in addition to examination departments, statistical organizations,
and here again only agreements moderate the bad effects of duplicate
and conflicting requirements.
While duplication in reports and examinations by different Federal
agencies is largely avoided by cooperative arrangements, nevertheless
delays and difficulties arise from the overlapping of responsibility. Even
after an agreement is reached, there may be, and in fact, there are, differences of interpretation of the procedure, formula, or policy agreed
upon.
For example, after lengthy negotiations a voluntary agreement between the agencies in connection with examination policy was reached
last summer.1 The effectiveness of this agreement, however, depends, in
the first place, on the continuance of cooperation between the agencies
and, in the second place, on the nature of interpretations placed by the
different agencies on the agreed principles of examination. A similarity
of interpretation is difficult to attain because the agencies have different
responsibilities and, therefore, different approaches to the problem. The
Comptroller of the Currency is primarily a supervisory and examining
agency and is interested principally in matters affecting the status of
individual banks. The Federal Deposit Insurance Corporation is primarily an insurance agency and is, therefore, primarily concerned about
the protection of the insurance fund. The Board of Governors, in addition to its supervisory responsibilities, is concerned with national credit
and monetary policies, and is, therefore, interested in supervisory policies
1

See Appendix.




16

ANNUAL REPORT OF BOARD OF GOVERNORS

that are in conformity with credit policies. Such policies must look not
only to the status of individual banks and the safeguarding of the interests of depositors, but also to the maintenance of sound credit conditions
in the aggregate and a sound banking system, without which credit
IKilicies cannot be effectively put into operation.
While the ultimate objective of all the agencies concerned is a sound
banking condition and an unimpeded flow of funds to finance commerce,
industry, and agriculture, the different points of approach to the problem
by the different agencies inevitably lead to differences in emphasis in the
interpretation of principles of policy.
RELATION BETWEEN SUPERVISORY AND CREDIT POLICIES

The agreement upon examination procedure which has been mentioned
marks a cooperative forward step by the agencies concerned. The fundamental question as to what should be the relationship between the administration of national credit policies and of bank examination and
supervision, however, still remains and is of so vital importance as to
deserve careful consideration by Congress.
Criticism has been directed in recent years at supervising authorities
for the influence they have exercised towards the curtailment of credit
at times when such curtailment has been contrary to prevailing national
credit policies and has tended to retard economic recovery. There are
wide differences of opinion on this subject and it deserves full and fair
exploration and consideration.
Some of the questions that may be considered in this connection are
here presented:
What effect does bank supervision have on changes in the outstanding volume of bank credit?
What influence do examinations have on the expansion or contraction of credit during the different phases of the business cycle?
Should examination policy be so directed as to contribute to the
protection of the general economy from the effects of undue expansion or contraction of credit?
What distinction, if any, exists between the considerations upon
which a sound national credit policy should be based and the measures that should be taken to insure the soundness of individual
banks?
Is harmony between examination policies and credit policies necessary to the discharge of the responsibilities of the agencies vested
with authority to determine these policies?
Consideration should be given to the question whether examiners'
appraisals of loans and investments based on current conditions and
market quotations may at times accelerate the downward spiral of a
depression or delay recovery; also whether at other times examiners,



FEDERAL RESERVE SYSTEM

17

in passing on loans which may be currently collectible, fail to take into
consideration the existence of a tendency towards unsound credit conditions and to exert a restraining influence on boom conditions. This may
result from the fact that in a period of decline current quotations may
merely reflect the temporary absence of a fair market, and may understate intrinsic values, while in a boom period market quotations may
reflect speculative expectations rather than true values.
May efforts of supervisory agencies to produce increased bank liquidity at times of low business activity and depressed markets have unanticipated and unintended adverse effects upon the local community,
and may these local effects, when aggregated, exert a general deflationary
influence on business and credit conditions in the country as a whole?
In considering relationships between examination policies and general
credit policies, it would be desirable to determine whether bank supervisory authorities should exert their influence to encourage extension of
sound credit by banks at times when they have funds available and
when such extension of credit may be helpful to the national economy;
and, on the other hand, whether at times of unduly rapid growth of bank
credit the influence of these agencies should be exerted to discourage
banks from freely making loans, even of the kinds that ordinarily could
be made with apparent safety by a particular bank. This question involves consideration of the relationship between the extension of credit
at certain times by particular banks and the broader and longer-range
problem of nationwide credit expansion.
Consideration might also be given to the possible effect on the general
economy of rigid definitions of the character of loans and investments
that may be made by banks. May such definitions cause unnecessary
liquidation at certain times and result in the holding of idle funds at
other times? Has the problem of definition of assets that banks may
acquire been affected by changes that have been made in recent years
in the laws, regulations, and conditions governing assets on which banks
can borrow from the Federal Reserve banks? Can agencies charged with
the responsibility of determining general policies that affect the extension of credit by banks discharge this responsibility unless examinations, which affect the policies and practices of individual banks, are in
harmony with these general credit policies?
The bank examiner in the field deals with local situations. He attempts to appraise assets in the light of such information as is available
to him and values must be determined in many cases by local conditions.
These conditions may relate to the position of the particular bank being
examined or of the particular community. It is a problem of great complexity to find means by wrhich this local procedure, when multiplied by
the thousands of banks throughout the country, can be brought into conformity with national policies.
Can the examination policies of the several Federal supervisory agen


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ANNUAL REPORT OF BOARD OF GOVERNORS

cies be further coordinated to promote effective functioning of the entire
banking system, making it a force toward increased national economic
stability? Furthermore, can the responsibilities vested in the Federal
agencies and the agencies of the 48 States charged with the examination
and supervision of their respective State banks also be properly coordinated to the same end?
It seems hardly possible to consider any of these questions singly. If
they are considered as a whole and studied in the light of the past
history of bank examination, of existing banking and credit conditions,
and of the objectives to be sought, answers should be found which will
go far toward producing a sounder and more flexible banking system.
THE PROBLEM OF RESERVES

Reserves and Credit Regulation.—The Federal Reserve System's power
to influence the volume and cost of bank credit arises largely out of its
authority over member bank reserves.
Under our system member banks are obliged to keep an amount equal
to a prescribed proportion of their deposit liabilities in the form of reserve balances with the Federal Reserve banks. Reserve requirements
for nonmember banks are determined by State authorities and are generally lower in effect than those prescribed for member banks. In order to
extend more credit without themselves borrowing, member banks must
have reserves in excess of their legal requirements. By increasing or
decreasing the amount of reserves available to the banks, therefore, the
Federal Reserve System can encourage or discourage the expansion of
bank credit and bank deposits, particularly at a time when banks have
little or no unused reserves. For a complete exposition of the functions
of reserves and of reserve requirements, reference is made to the Board's
Annual Report for 1936.
The usual situation in years gone by, when the pressure for credit
expansion was considerable and the volume of reserves limited, was for
the banks generally to have no reserves in excess of legal requirements.
In other words the banks were at all times practically loaned up. An
aggregate increase in their loans and investments, therefore, involved
borrowing from the Federal Reserve banks in order to acquire additional
reserves. When the banks are borrowing, they are less willing to make
loans and they become subject to the discount rate and to other measures
of regulation of their operations under provisions of the Federal Reserve
Act. When the System wished to encourage the expansion of bank credit,
it could take the initiative in increasing bank reserves by buying Government securities in the open market, which would place at the disposal
of banks funds with which to pay off debt at the Reserve banks or to
expand their own credit. On the other hand, when the System wished
to restrain expansion, it could sell Government securities, thereby taking
money out of the market and reducing reserves to the point where banks



FEDERAL RESERVE SYSTEM

19

would have to borrow in order to expand. By further sales the System
could reduce member bank reserves even below the amount needed to
maintain the existing aggregate volume of loans and investments, and
put the banks in a position of having the alternative of borrowing from
the Reserve banks or contracting their loans and investments.
This was the main line of action in encouragement and restraint as
long as the banks did not have a volume of reserves far in excess of
their current needs. In recent years banks have had continuously a large
amount of excess reserves. This is true at present, notwithstanding the
fact that, in accordance with authority under the Banking Act of 1935,
reserve requirements have been increased by approximately 75 percent
above the percentages stated in the statute.
The entire technique of influencing changes in the volume of bank
credit needs to be reconsidered in the light of changed banking and
money market conditions. It is probable that the increased importance
of holdings of Government securities and the shrinkage of the Streetloan account, through which individual banks were in the habit of making adjustments in their position in response to changing commercial
demands, as well as other changes in the situation, have made the banking system more responsive than formerly to measures of restraint. One
influence in this direction would come from the fact that sales of Government securities by the Reserve System, in addition to their effects on
bank reserves, would have a direct effect on the capital market of which
these securities now constitute an important part. The large holdings
by the banks of such securities make the banks more sensitive to changes
in bond prices. For these reasons it may not prove necessary in the
future, as it has been in the past, for banks to be without excess reserves and actually to be borrowing from the Reserve banks in order to
make them responsive to restraining influences.
Only experience can determine to what extent these changes in conditions have altered the effectiveness of existing methods of regulation.
There is no doubt, however, that such a volume of excess reserves as is
held by the banks today and as is likely to be at their disposal in the
near future presents an important problem to the country's credit and
monetary authorities.
Sources of Reserves.—Since the end of 1933 reserve balances of member banks have increased three-fold and at the end of 1938 totaled
$8,700,000,000, of which $3,200,000,000 were excess reserves. As shown
in the table, this growth in reserves has been due principally to the
extraordinary inflow of gold from abroad. The country's monetary gold
stock in dollars has increased during the five years by $10,500,000,000,
of which $2,800,000,000 represents the effect of revaluation and $7,700,000,000 additions of new gold from abroad and from domestic mines.
A portion of this additional gold is still held by the Treasury in the



20

ANNUAL REPORT OF BOARD OP GOVERNORS

Stabilization Fund and otherwise and some of it was used to retire national bank notes in a manner that did not add to member bank reserves.
FACTORS OF CHANGE IN MEMBER BANK RESERVES

December 30, 1933, to December 31, 1938
(Approximate figures, in millions of dollars)
Additions due to:
Gold operations
7,422
Issue of silver certificates
1,221
Total additions
8,643
Deductions due to increase in money in circulation, growth in Treasury and
nonmember deposits at Federal Reserve banks, etc
2,648
Total increase in member bank reserves
Increase in required reserves due to:
Increase in percentage requirements
Increase in member bank deposits
Increase in excess reserves
Changes in reserve position from December 30, 1933, to December 31. 1938:
Total reserves
. Increased from 2,729 to
Required reserves
Increased from 1,870 to
Excess reserves
Increased from 859 to

5,995
2,342
1,307
2,346
8,724
5,519
3,205

Of the inflow of gold from abroad, about two-thirds has resulted
from the movement of foreign capital to the United States. Large and
erratic movements of floating capital from country to country at a time
of political uncertainty and financial disorganization have been one of
the most disturbing factors in the financial fabric of post-war years.
Such movements are not like capital movements for long-term investment or seasonal movements in connection with foreign trade, nor like
movements in response to differences in interest rates, which have long
been a part of the international financial mechanism. Large and
sudden capital withdrawals tend to cause contraction of credit and
to retard business activity in the country from which the capital is
withdrawn. At the other end, accumulation of foreign funds in the money
market which appears for the time to offer the best security or -the
greatest opportunity for profit is disturbing to the monetary and credit
systems of the country where this market is located. These movements
accentuate speculative changes in the security market and create either
a condition of artificial monetary ease or the need of absorbing excess
reserves at public or private expense. International capital movements
account for the greater part of the reserve problem with which this
country has to contend.
In addition to the gold inflow another source of reserves amounting
to $1,200,000,000 has been the issuance by the Treasury of silver coin
and certificates in connection with domestic and foreign silver purchases.
Additions to member bank reserves from the above sources have been
absorbed to the extent of $2,600,000,000 by increases in the demand for
currency and through growth of Treasury and nonmember bank deposits
at the Federal Reserve banks.



FEDERAL RESERVE SYSTEM

21

As a net result of all these developments and transactions, $6,000,000,000 was added to member bank reserves in the five years 1934-1938.
Of this amount $3,650,000,000 was absorbed by increases in required
reserves, due both to the increase in the prescribed ratios of reserves to
deposits and to the growth in the banks' deposit liabilities. Excess
reserves of member banks increased by $2,350,000,000 and at the end
of 1938 were $3,200,000,000. In the early weeks of 1939, with a return
How of currency from circulation and a decline in Treasury balances,
excess reserves increased to $3,600,000,000. A continuation of gold inflow
and of silver purchases would further add to excess reserves.
The volume of excess reserves now in existence, furthermore, can be
greatly increased by actions of the United States Treasury. By disbursements of funds equivalent to the gold held in the Stabilization
Fund and elsewhere, by reduction of its unusually large balances with the
Federal Reserve banks, and by the use of its authority to issue silver
certificates against silver bullion now in its possession, the Treasury
could more than double existing excess reserves of member banks. In
addition, the Treasury has authority to issue up to $3,000,000,000 of
United States notes which would also be added to member bank reserves.
The Treasury also has power to absorb member bank reserves; it can
do so by increasing its cash holdings and Federal Reserve balances. With
these powers and the general gold and silver policies in the hands of
the Treasury, its power to influence the volume of member bank reserves
under existing conditions outweighs that of the Federal Reserve System.
Long-view Problem Raised by Excess Reserves.—In considering the
problem of reserves at this time the Board wishes to emphasize that the
long-view problem created by the existing large volume of bank deposits
and bank reserves is distinct from the immediate problem of making
ample bank credit available for the expansion of business from current
levels.
In recent years it has been the policy of the Government and of the
Federal Reserve System to encourage the expansion of credit. This has
constituted the so-called policy of monetary ease, which has been directed at keeping banks supplied with an abundant volume of reserves,
so as to encourage them to expand their loans and investments. This
policy has been one of the factors in the creation of the existing large
volume of deposits in the hands of business enterprises and of individual
and corporate investors, and has resulted in reducing interest rates to
the lowest level in history. It has been reflected in a decline in the carrying charges on mortgage debt for farmers and urban householders, has
enabled many corporations to refund their debt at lower rates, and has
lightened the cost of current financing to commerce, industry, and
agriculture.
Nor is there any immediate reason for considering a reversal of this



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ANNUAL REPORT OF BOARD OP GOVERNORS

policy. There is nothing in the present monetary or banking situation
that would point to a proximate danger of injurious credit expansion. It is
in such a period as this, however, when there is no call for quick action
to meet emergency situations, that problems that may arise in the future
should be analyzed and the efficiency of existing machinery appraised.
It is from this point of view that the System's existing powers to
absorb excess reserves should be considered. Member banks at present
have excess reserves of $3,600,000,000, and this total may be doubled in
the future. To absorb these reserves the System has the power to raise
reserve requirements by $800,000,000 and to make sales out of its portfolio of United States Government obligations, which amounts to $2,560,000,000. The use of these available means of absorbing reserves, to the
extent that it may be in the public interest to do so, would still leave
the banks with a volume of excess reserves upon which it would be possible for an injurious credit expansion to develop.
The ability of the banks greatly to expand the volume of their credit
without resort to the Federal Reserve banks would make it possible for
a speculative situation to get under way that would be beyond the power
of the System to check or control. The Reserve System would, therefore,
be unable to discharge the responsibility placed upon it by Congress or
to perform the service that the country rightly expects from it.
In view of this situation the Board has deemed it its duty to point
out to Congress the present and prospective reserve position of our banking system and the limitations on the powers of the System to regulate it.







APPENDIX

23




COMPARISON OF SOME OF THE FEDERAL STATUTORY
PROVISIONS REGULATING THE BUSINESS OF
DIFFERENT CLASSES OF BANKS l
I. Federal statutory provisions applicable to national banks ONLY.

Restrictions on real estate loans.
Regulations governing exercise of trust powers.
Restrictions on acting as insurance agent.
Restrictions on acting as real estate loan broker.
Requirement that one-tenth of earnings be transferred to
surplus until surplus equals common capital.
Prohibition against holding "other real estate" for more
than five years.
Limitations on total loans to one borrower.2
Restrictions on absorption of another bank.
Limitations on indebtedness which bank may incur.
II. Federal statutory provisions applicable to all member banks, but NOT to
nonmember insured banks (standards not necessarily uniform between
national banks and State member banks).

Regulations governing purchase of investment securities.
Prohibition against purchasing stocks and engaging in
underwriting of investment securities and stocks.
Restrictions on loans to executive officers.
Restrictions on dealings with directors.
Prohibition against paying preferential rate of interest on
deposits of directors, officers, etc.
Restrictions on interlocking directorates or other interlocking relations with other banks.
Restrictions on interlocking directorates or other interlocking relations with securities companies.
Prohibition against bank having less than 5 or more than
25 directors.
Provision authorizing supervisory authority to remove officers or directors for continued violations of law or continued unsafe or unsound practices.
Prohibition against affiliation with securities company.
Restrictions on holding company affiliates.
Restrictions of bank stock representing stock of other corporations.
Limitations on loans to affiliates.
Limitations on investment in bank premises.
Minimum capital requirements.
Minimum capital requirements for branches.
!
There are a few Federal banking laws -which apply to all banks including noninsured banks. Among
them are provisions of law restricting the receipt of deposits by nonbanking institutions, including securities companies; those regulating loans for the purpose of purchasing or carrying securities registered on national securities exchanges; and those granting certain tax advantages in connection with the operation of
a common trust fund if operated in conformity with the regulations of the Board of Governors.
2
Loans in excess of the limit fixed by the National Banking Act may not be discounted with a Federal Reserve bank by a State member bank but that part of a loan which is not excessive may be discounted by a
national bank.




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ANNUAL REPORT OF BOARD OF GOVERNORS

Prohibition against loaning on or purchasing own stock.
Restrictions on withdrawal of capital and payment of unearned dividends.
Requirement that reserves specified in Federal Reserve Act
be maintained.
Prohibition against making loans or paying dividends while
reserves deficient.
Requirements in connection with par clearance collection
system.
Prohibition against false certification of checks.
Limitations on acceptance powers.
Prohibition against acting as agent for nonbanking institutions in making loans to brokers or dealers in securities.
Limitations on loans to one borrower on stocks or bonds.
Limitations on aggregate loans to all borrowers on stocks
or bonds.
Limitations on deposits with nonmember banks.
III. Federal statutory provisions applicable to member banks and to nonmember insured banks (standards not necessarily uniform between
national banks, State member banks, and insured nonmember banks).

Restrictions on establishment of branches.
Restrictions on consolidating or merging with noninsured
bank, assuming liability for such bank's deposits, or
transferring assets to such bank for assumption of deposits.
Restrictions on payment of interest on deposits.
Restrictions on paying time deposits before maturity or
waiving notice before payment of savings deposits.
Prohibition against payment of dividends while delinquent
on deposit insurance assessment.
Prohibition against loans or gratuities to bank examiners.
Provision authorizing supervisory authority to publish examination report if bank does not follow recommendation
based thereon.
Provision authorizing supervisory authority to require that
bank provide protection and indemnity against burglary,
defalcation and similar insurable losses.




REVISION IN BANK EXAMINATION PROCEDURE
An important development during the year in the field of bank examination and supervision was the revision of procedure in bank examinations agreed to by the Secretary of the Treasury, the Board of
Governors of the Federal Reserve System, the Directors of the Federal
Deposit Insurance Corporation, and the Comptroller of the Currency.
The agreement was reached in the summer and the revised procedure was
made effective in September after the examination report forms had been
revised to give effect to the changed procedure. Representatives of the
National Association of Supervisors of State Banks were consulted in
regard to the program and the Executive Committee of the Association
agreed in principle with the program as adopted. The revised procedure
has been made effective in many States and is being made effective in
whole or in part in others.
The principal changes in the examination procedure were the abandonment of the "slow" classification of assets and recognition of the
principle that bank investments should be considered in the light of
inherent soundness rather than on the basis of day-to-day market
fluctuations.
The "slow" classification had long been a source of irritation, complaint, and misunderstanding. By its very name it emphasized liquidity
but the term was a misnomer inasmuch as the "slow" classification did
not include all loans of longer maturities. The exact meaning of the
term was not clear, nor could a substitute term be found to express
clearly what was intended by the classification. Accordingly the old
classifications of "slow," "doubtful," and "loss" as used in reports of
examinations were discontinued and numerical classifications were
adopted with the reports of examination containing definitions of the
types of assets to be included in each classification. Under the new
designations the principle is clearly recognized that in making loans
banks should be encouraged to place emphasis upon soundness and intrinsic value rather than upon liquidity or quick maturity, and the examiners are expected to follow this principle in their examinations.
With respect to the appraisal of investment securities, the revised
examination procedure is based on the view that the soundness of the
banking system depends in the last analysis upon the soundness of the
country's business and industrial enterprises and should not be measured
by current market quotations which often fail to reflect true appraisals
of intrinsic worth. Under the revised procedure, as formerly, stocks and
defaulted securities are grouped separately and net depreciation in such
issues based on current market prices is classified as loss to be charged
off. Other securities, however, are divided into two groups which might
be considered, broadly, as (1) securities of investment character, and
(2) securities having distinctly or predominantly speculative character


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ANNUAL REPORT OF BOARD OF GOVERNORS

istics. Appreciation or depreciation in securities in the first group is
disregarded, and banks are permitted to carry these securities at book
value with proper provision for amortization of premiums. Banks are
also not required to charge off on their books any depreciation in securities in the second group. Such securities, however, are appraised in
the report of examination on the basis of the average market price for
18 months preceding examination and in the computation of adjusted
capital account of the bank, as shown in the report of examination, 50
percent of the net depreciation figured on such average basis is deducted.
By separating appraisal of bank investments from current market
quotations it was hoped that banks would be encouraged to purchase
securities for true worth. The revised procedure also recognized the need
for conservation of profits from the sale of securities, emphasized the
necessity for the maintenance of adequate reserves to provide for possible losses in securities and other assets, and reaffirmed the position
against the practice of speculation in securities.
In considering the question of bank examination and supervision
recognition was given to the great changes which have occurred during
the past 20 years in the composition and character of bank assets, the
substantial decrease in the holdings of short-term, self-liquidating commercial paper, and the great increase in the holdings of investment
securities, both in aggregate amount and as compared with total assets.
As a result of these developments, banks find it necessary to look, to a
considerable extent at least, for other forms of loans to replace the lost
volume of short-term commercial loans and to treat the security account
more as a permanent investment account than as a means for the
temporary investment of idle funds. Changes made by the Banking
Act of 1935 in the law regarding advances by Federal Reserve banks and
the revised regulation on this matter issued in 1937 by the Board of
Governors were designed to assist banks to meet these changed conditions. The new policies with respect to bank examination and supervision were framed with the same end in view. The revised examination procedure does not represent a relaxation of standards. It was
worked out as a measure which, with its emphasis upon fundamental
soundness of assets of every type, would further the maintenance of a
sound banking system and enable banks better to serve their depositors
and their communities.
Following is a description of the revision of procedure in bank examinations as agreed to by the Secretary of the Treasury, the Board of
Governors of the Federal Reserve System, the directors of the Federal
Deposit Insurance Corporation, and the Comptroller of the Currency:
The Classification of Loans in Bank Examinations.—The present captions of the classification units, namely, "Slow," "Doubtful," and "Loss"
are to be abandoned.



FEDERAL RESERVE SYSTEM

29

The classification units hereafter will be designated numerically and
the following definitions thereof will be printed in examination reports:
I. Loans or portions thereof the repayment of which appears
assured. These loans are not classified in the examination report.
II. Loans or portions thereof which appear to involve a substantial and unreasonable degree of risk to the bank by reason of
an unfavorable record or other unsatisfactory characteristics noted
in the examiner's comments. There exists in such loans the possibility of future loss to the bank unless they receive the careful
and continued attention of the bank's management. No loan is so
classified if ultimate repayment seems reasonably assured in view
of the sound net worth of the maker or endorser, his earning capacity
and character, or the protection of collateral or other security of
sound intrinsic value.
III. Loans or portions thereof the ultimate collection of which is
doubtful and in which a substantial loss is probable but not yet
definitely ascertainable in amount. Loans so classified should receive the vigorous attention of the management with a view to
salvaging whatever value may remain.
IV. Loans or portions thereof regarded by the examiner for
reasons set forth in his comments as uncollectible and as estimated
losses. Amounts so classified should be promptly charged off.
Present practice will be continued under which the totals of II, III
and IV above are included in the recapitulation or summary of examiners' classifications.
Fifty percent of the total of III above and all of IV above will be
deducted in computing the net sound capital of the bank.
The Appraisal of Bonds in Bank Examinations.— Neither appreciation nor depreciation in Group I securities will be shown in the report.
Neither will be taken into account in figuring net sound capital of the
bank.
Group I securities are marketable obligations in which the investment characteristics are not distinctly or predominantly speculative. This group includes general market obligations in the four
highest grades and unrated securities of equivalent value.
The securities in Group II will be valued at the average market price
for eighteen months just preceding examination and 50 percent of the net
depreciation will be deducted in computing the net sound capital.
Group II securities are those in which the investment characteristics are distinctly or predominantly speculative. This group includes general market obligations in grades below the four highest,
and unrated securities of equivalent value.
Present practice will be continued under which net depreciation in the
securities in Group III and Group IV is classified as loss.
Group III securities: Securities in default.
Group IV securities: Stocks.
Present practice will be continued under which premiums on securities
purchased at a premium must be amortized.



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ANNUAL REPORT OF BOARD OF GOVERNORS

Present practice of listing all securities and showing their book value
will be continued.
The Treatment of Securities Profits in Bank Examinations.—Until
losses have been written off and adequate reserves established, the use
of profits from the sale of securities for any purpose other than those,
will not be approved.
Present practice will be continued under which estimated losses must
be charged off.
Present practice will be continued under which the establishment and
maintenance of adequate reserves, including reserves against the securities account, are encouraged.
Present practice will be continued under which speculation in securities is criticised and penalized.




REVISED REGULATION ISSUED BY THE COMPTROLLER OF
THE CURRENCY ON PURCHASES OF INVESTMENT
SECURITIES
By virtue of the authority vested in the Comptroller of the Currency
by paragraph Seventh of Section 5136 of the Revised Statutes, the following regulation is promulgated:
SECTION I

(1) An obligation of indebtedness which may be purchased for its own
account by a national bank or State member bank of the Federal Reserve
System, in order to come within the classification of "investment securities" within the meaning of paragraph Seventh of said Section 5136, must
be a marketable obligation, i.e., it must be salable under ordinary circumstances with reasonable promptness at a fair value; and with respect to
the particular security, there must be present one or more of the following characteristics:
(a) A public distribution of the securities must have been provided for or made in a manner to protect or insure the marketability
of the issue; or,
(b) Other existing securities of the obligor must have such a public distribution as to protect or insure the marketability of the issue
under consideration; or,
(c) In the case of investment securities for which a public distribution as set forth in (a) or (b) above cannot be so provided, or so
made, and which are issued by established commercial or industrial
businesses or enterprises, that can demonstrate the ability to service
such securities, the debt evidenced thereby must mature not later
than ten years after the date of issuance of the security and must be
of such sound value or so secured as reasonably to assure its payment; and such securities must, by their terms, provide for the amortization of the debt evidenced thereby so that at least 75 percent of
the principal will be extinguished by the maturity date by substantial periodic payments: Provided, That no amortization need be required for the period of the first year after the date of issuance of
such securities.
(2) Where the security is issued under a trust agreement, the agreement must provide for a trustee independent of the obligor, and such
trustee must be a bank or trust company.
(3) All purchases of investment securities by national and State member banks for their own account must be of securities "in the form of
bonds, notes, and/or debentures, commonly known as investment securities"; and every transaction which is in fact such a purchase must,
regardless of its form, comply with this regulation.
SECTION II

(1) Although the bank is permitted to purchase "investment securities" for its own account for purposes of investment under the provisions



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ANNUAL REPORT OF BOARD OF GOVERNORS

of Revised Statute 5136 and this regulation, the bank is not permitted
otherwise to participate as a principal in the marketing of securities.
(2) The statutory limitation on the amount of the "investment securities" of any one obligor or maker which may be held by the bank, is to
be determined on the basis of the par or face value of the securities, and
not on their market value.
(3) The purchase of "investment securities" in which the investment
characteristics are distinctly or predominantly speculative, or the purchase of securities which are in default, either as to principal or interest,
is prohibited.
(4) Purchase of an investment security at a price exceeding par is
prohibited, unless the bank shall:
(a) Provide for the regular amortization of the premium paid so
that the premium shall be entirely extinguished at or before the
maturity of the security and the security (including premium) shall
at no intervening date be carried at an amount in excess of that at
which the obligor may legally redeem such security; or
(b) Set up a reserve account to amortize the premium, said account to be credited periodically with an amount not less than the
amount required for amortization under (a) above.
(5) Purchase of securities convertible into stock at the option of the
issuer is prohibited.
(6) Purchase of securities convertible into stock at the option of the
holder or with stock purchase warrants attached is prohibited if the price
paid for such security is in excess of the investment value of the security
itself, considered independently of the stock purchase warrants or conversion feature. If it is apparent that the price paid for an otherwise
eligible security fairly reflects the investment value of the security itself
and does not include any speculative value based upon the presence of a
stock purchase warrant or conversion option the purchase of such a security is not prohibited.
(7) As to purchase of securities under repurchase agreement, subject to the limitations and restrictions set forth in the law and this regulation:
(a) It is permissible for the bank to purchase "investment securities" from another under an agreement whereby the bank has an
option or a right to require the seller of the securities to repurchase
them from the bank at a price stated or at a price subject to determination under the terms of the agreement, but in no case less than
the value at the time of repurchase.
(b) It is permissible for the bank to purchase ''investment securities" from another under an agreement whereby the seller or a
third party guarantees the bank against loss on resale of the securities.
(c) It is not permissible for the bank to purchase "investment
securities" from another under an agreement whereby the seller reserves the right or the option to repurchase said securities itself or
through its nominee at a price stated or at a price subject to deter


FEDERAL RESERVE SYSTEM

33

mination under the terms of the agreement, notwithstanding the fact
that the bank may also, under such agreement, have the right or
option to compel the seller to repurchase the securities at a price
stated or at a price subject to determination under the terms of the
agreement.
(8) As to repurchase agreements accompanying sales of securities,
(a) It is permissible for the bank selling securities to another to
agree that the bank shall have an option or right to repurchase the
securities from the buyer at a price stated or at a price subject to
determination under the terms of the agreement, but in no case in
excess of the market value at the time of repurchase.
(b) It is not permissible for the bank selling securities to another
to agree that the purchaser shall have the right or the option to require the bank to repurchase said securities at a price stated or at a
price subject to determination under the terms of the agreement,
notwithstanding the fact that the bank may also, under such agreement, have the right or option to repurchase the securities from the
buyer at a price stated or at a price subject to determination under
the terms of the agreement.
In view of the fact that some banks may have bought or sold securities
under a form of agreement which is prohibited by this regulation, the
bank should either terminate or modify same so as to conform to this
regulation, where such action may lawfully be taken. Existing agreements of the prohibited type must not be renewed.
EXCEPTION

The restrictions and limitations of this regulation do not apply to
securities acquired through foreclosure on collateral, or acquired in good
faith by way of compromise of a doubtful claim or to avert an apprehended loss in connection with a debt previously contracted, or to real
estate securities acquired pursuant to Section 24 of the Federal Reserve
Act, as amended.
This regulation supersedes prior regulations governing the purchase of
"investment securities" and is effective from and after July 1, 1938.
Signed and promulgated this 27th day of June, 1938.




MARSHALL R. DIGGS

Acting Comptroller of the Currency


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102