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O F C H IC A G O 1987Annual Report The Federal Reserve Bank of Chicago, as part of the nation’s central banking system, serves the Seventh District which includes major portions of Illinois, Indiana, Michigan, and Wisconsin plus all of Iowa. Its role is to foster a healthy financial system and economy through its monetary policy responsibilities, by examining and regulating banks and bank holding companies, and by providing banking services to depository institutions and the U.S. government. President's Message 1 The District Economy 4 Economic Research and Monetary Policy 8 Supervision and Regulation 10 Financial Services 12 Support Activities 14 Directors and Officers 16 Financial Statements 22 I am pleased to present the 1987 Annual Report of the Federal Reserve Bank of Chicago. As the report indicates, 1987 was a year of outstanding accomplishment for our Bank, due in large part to the efforts of our directors, officers and staff. I am proud of their achievements and I am grateful for their continued support and dedication. Nationally, 1987 was a year of remarkable economic progress. The economy entered its sixth year of uninterrupted growth, making this the longest peacetime expansion in the nation’s history. Buoyed by strong business investment and renewed growth in manufacturing exports, annual output grew by nearly 3 percent. By the end of 1987, unemployment had dropped to 5.7 percent, its lowest level since 1980. Happily, this growth was achieved while containing inflation to 4 percent—well above our longrun target but lower than might be expected at this phase of the economic cycle. The performance of the Midwest’s economy was the best of this decade. For the first time since 1983, manufacturing output in the Midwest grew more rapidly than for the nation as a whole, and for the first time since 1980, overall economic activity in the Midwest outpaced the rest of the nation. It is ironic that a year of healthy growth also should have witnessed the most notable financial disturbance of the last 50 years—the stock market correction of October 1987. The week of October 19 tested the capacity of our financial system to cope with destabilizing, shocks. The nation’s financial markets were subjected to dramatic price swings, massive trading volume, intermittent trading halts, and large flows of funds. The performance of these markets in the face of such shocks is testimony to their fundamental resilience. This resilience was made possible, in part, by excellent communication between all members of the financial community. This permitted regulators and market participants to deal with emerging problems in a timely and effective fashion. During this period the Federal Reserve sought to improve the economy’s ability to cope with the turmoil in the nation’s financial markets. The Federal Reserve accomplished this goal by providing additional liquidity to the financial markets through open market operations, by emphasizing its willingness to lend to banks through the discount window, and by extending the hours of operation on Fedwire, the Federal Reserve’s large-dollar payments system. With this vital support, the financial system proved equal to the week’s challenges. But while the financial system weathered the storm, it has become clear that institutional arrangements have not completely adjusted to the increasing importance of the options and futures markets. As the Report of the President's Task Force on Market Mechanisms makes clear, financial market regulation cannot ignore the fact that the stock, futures, and options markets are inextricably intertwined. Over the coming months regulators are going to be examining several ways of improving the performance of these markets including coordinated trading halts, unified clearing of financial contracts, and a strengthening of the specialist system on the nation's stock markets. As significant as these events are, I would like to devote the remainder of this letter to another financial event that has perhaps even greater implications for the future of the financial services industry. By the end of 1987, the chief federal bank regulators had each endorsed the relaxation of the Glass-Steagall and Bank Holding Company Acts—key laws restricting the types of financial services that can be offered by banking organizations. This consensus for change is the result of a number of factors including the growing importance of investment banking activities, the growth of broad-based financial services firms, an increase in competition for the traditional blue chip customers of money center banks, and a general recognition of the benefits that increased competition can bring to any industry. The primary goal of banking regulation should be to maintain an efficient financial system while assuring that the banking system does not become a source of overall economic instability. There is general agreement that the relaxation of the GlassSteagall and Bank Holding Company Acts is consistent with this goal. However, there remains considerable disagreement on how the components of a broad-based bank holding company should be regulated. The key challenge is to reconcile banking’s twin roles—competitor in the market for financial services and keystone of the nation’s monetary system. As part of its commitment to assure a stable monetary system, the Federal Reserve stands ready to provide liquidity to the entire financial system through open market operations. However, banks are beneficiaries of a “ safety net” that extends beyond the simple promise of a liquid financial system. Banks are permitted to borrow on a collateralized basis from the discount window and offer insured deposits. In addition, banks whose solvency is in question sometimes receive government assistance in restructuring their balance sheets. The design of a regulatory system that would permit banks to become a part of a diversified financial services firm while preserving those protections necessary for their special role in the monetary system is a difficult task. However, there are four principles that should be observed in constructing such a system. 1) The components of a broad-based financial services firm should be regulated in a consistent fashion. Today, each subsidiary of a financial services organization is regulated by its own industry regulator. Organizations operating in many different states may have to deal with a different regulator in each state. This fragmentation has made it difficult to effectively deal with problems that affect the entire organization. Such a system is particularly cumbersome when a major subsidiary of the organization faces doubts about its liquidity or solvency. 2 As bank holding companies make the transition to broad-based financial services holding companies, these problems will become more frequent and more complex. Prompt resolution of such problems will require, at a minimum, that regulators have free and easy access to information on the condition and operation of the various components of the holding company. 2) Any competitive advantage enjoyed by a financial institution should arise from greater efficiency or innovativeness, not from more favorable governmental treatment. As long as the safety net exists and banks have privileged access to the nation’s payments system, banks will retain certain unique advantages. At the same time, because of their key role in the monetary system, banks should always be subject to greater prudential regulation than other types of financial firms. This supervision will sometimes seem burdensome. However, the pursuit of an efficient financial system requires us to reduce the disparities between banks and nonbanks to the minimum level that is consistent with a safe and sound banking system. For the last decade, regulators have been successfully seeking to improve the capitalization of the U.S. banking system. These efforts have improved the safety and soundness of the banking system, reducing the ability of banks and their parents to gain an advantage from access to the safety net. The Basle Committee’s new agreement on bank capital regulation is an important step in the decade-long effort to improve bank capitalization. A result of discussions between the leading central banks, the agreement sets minimum capital requirements for banks in all signatory countries. By 1992, the agreement requires banks in these countries to have common equity equal to 4 percent of risk assets and total capital equal to 8 percent of risk assets. This will allow a further improvement in the capitalization of the U.S. banking system, while preventing U.S. banks from being disadvantaged relative to foreign competitors. However, higher capital requirements are only a partial solution. There is a limited but significant risk associated with off-balance sheet activities of the nation’s leading commercial banks. While these activities need to be recognized in assessing a bank’s capital adequacy, banks engaging in low-risk activities, on or off the balance sheet, should not be subjected to an unfair burden. The Basle agreement addresses this problem by introducing a system of risk-based minimum capital requirements that recognizes bank risk both on and off the balance sheet and weights different types of activities according to their risk. The implementation of this important proposal will be one of this year’s major challenges. The resulting improvements in bank capitalization will reduce the ability of banks and their holding companies to gain a competitive advantage as a result of their access to the safety net. This will ensure that banking organizations do not dominate other areas of the financial services industry simply as a result of this access. 3) Expanded powers for banking organizations should not automatically lead to an extension of the safety net beyond the banking system. Under the current system of regulation, this extension is prevented by limitations on bank ownership, bank services, and eligibility to borrow at the discount window. The relaxation of the Glass-Steagall and Bank Holding Company Acts will blur this clean demarcation. Many reform proposals attempt to limit the extension of the safety net by placing new activities in subsidiaries of the bank or of the holding company. By forcing this separation, proponents hope to erect so-called firewalls between the bank and the nonbank portions of the holding company. Restrictions on transactions between bank and nonbank components of the company would be used to reinforce this separation. If this approach is adopted, the holding company must have sufficient funding capability to support a troubled subsidiary without recourse to the bank. It also seems clear that if banks are going to be subject to limits on lending to nonbank affiliates and subsidiaries, most new activities should occur in subsidiaries of the holding company rather than in subsidiaries of the bank. While firewalls can be helpful, it is unlikely that they will, in all cases, prevent the rest of the organization from shifting losses to the bank and ultimately to the FDIC. The chances can be reduced by granting bank regulators access to information on the entire holding company, and by maintaining well-capitalized subsidiaries, particularly bank subsidiaries. 4) The expansion of powers for banking organizations should proceed in a cautious and deliberate fashion. While the preceding proposals will be useful in dealing with the problems that confront us, many issues have yet to be resolved and a few will only be identified the hard way, with experience. Until we have that experience, prudence dictates that the activities of companies owning banks should be confined to the financial sphere. The benefits derived from the formation of a diversified financial services firm are clear. On the other hand, the benefits from commingling banking and commerce are less clear. The relaxation of the Glass-Steagall and Bank Holding Company Acts would raise several new regulatory problems to which there does not appear to be any perfect solution. However, the best solution is offered by a regulatory system that gives regulators easy access to information, requires adequate bank capital, clearly defines the limits of the safety net, and expands the powers of banking organizations in a cautious and considered manner. With such a system in place, regulators can permit banking organizations to take advantage of opportunities previously foreclosed to them. The end result will be a less restrictive, more competitive, and more efficient financial services industry. Silas Keehn President - The Seventh District’s economy turned in strong performances across all its sectors in 1987, with signs of an even brighter future. iiiSSS 4 The 1980s have been a time for constructive change for the District’s economy— modernizing its manufacturing sector to meet global competition, expanding its service sector to absorb the spin-off of service activities from the manufacturing sector, and restructuring its farm sector to weather the far reaching problems in agriculture. Evidence is mounting that the economic changes that have taken place, while difficult for some, are leading to a healthier, more competitive District economy. With its most impressive economic performance of the decade in 1987, the District once again shows signs of becoming the engine of economic growth for the nation. Growth of manufacturing activity in the District outpaced the nation in 1987 for the first time in the decade other than the recovery year of 1983. The question is whether 1987 was an aberration or the beginning of an economic resurgence in the District. The performance of the major components of the District’s economy offers some insights. Manufacturing sector: building on trade-driven gains A major impetus to the growth of outputrelated activity in the District was the long awaited turnaround in foreign trade that began in 1987. The industrial structure of the District has a high concentration of tradesensitive industries that was bound to benefit eventually from the dollar’s steady decline since 1985. Once the lower dollar stimulated export activity and import competition eased, the region was well positioned to capture some of the growth in foreign and domestic demand for U.S. produced goods. A growth in trade-related activity was only part of the District’s story. Equally important was the fact that manufacturing activity in the District outperformed the nation in every major sector of manufacturing as shown by the Midwest Manufacturing Index (MMI). Constructed by the Chicago Reserve Bank’s Research Department, the MMI combines monthly labor and capital usage into a single comprehensive indicator of manufacturing activity. Growth in manufacturing activity: 1987 percent change (4Q/4Q) +10 Simply put, the region was not only expanding its manufacturing sector, but also increasing its share of the domestic and world markets in most sectors. Even the District’s machinery sector did better than its growth rate suggests, because the fourth quarter of 1986 on which its growth is based was exceptionally strong relative to the sector nationally. For some sectors, last year was the first time in many years that the District’s growth exceeded the national average. But for two sectors—metalworking and machinery— growth of manufacturing activity in the District has been outpacing the nation since as early as 1983 (i.e., the beginning of the current economic expansion). Moreover, these two sectors account for half of the region’s manufacturing activity. Of the District’s manufacturing sectors, only transportation declined throughout the 1980s (with the one exception of 1983, which was a recovery year led by that industry). Last year, an estimated 17,000 jobs were lost in Michigan as a direct and indirect result of auto plant closings and other cutbacks, and 38,000 more job losses are expected in 1988, according to an analysis by the University of Michigan. Nor will Michigan likely be alone; Chrysler’s plant in Kenosha, Wisconsin is also scheduled to be closed in 1988. Even in the transportation sector, however, there are positive signs for the future. It must be remembered that the auto industry currently has some of its most efficient auto plants located in the District (e.g., Ford Motor Company’s Torrence Avenue assembly operation in Chicago, General Motors’ truck plant in Fort Wayne, Indiana, and Chrysler's Belvidere, Illinois plant) and will have new state-of-the-art plants fully operating in 1988 (e.g., the new Diamond-Star Motors facility in Bloomington-Normal, Illinois and the Mazda 5 plant at Flat Rock, Michigan). Once restructuring is completed, the auto industry should join the District's other manufacturing industries in outperforming the nation. Index of manufacturing wages in the Seventh District percent of U.S. Rebuilding competitiveness: patience and commitment 1980 1982 1984 1986 Industrial research and development spending in the Seventh District billions of 1982 dollars Improvements in factor-cost differentials—the “cost of doing business” in the District as compared to elsewhere—have been important in achieving a stronger competitive position for the District. In a study undertaken by the Bank’s Research Department on determinants of metropolitan growth, costs associated with labor, taxes, and even access to technological resources, have been identified as important to growth. 12 9 6 3 1979 1981 1983 While the dollar’s decline was important in stimulating demand for manufactured goods, what underlies the sector’s strong performance in the District relative to the nation is a long-term process of rebuilding competitiveness. Inefficient plants and equipment are being modernized and replaced by new technologies to reduce production costs. 1985 Progress toward reducing costs in the District can be readily demonstrated. Manufacturing wages in the District relative to the nation have edged downward roughly 1 percent since the late 1970s. While such wage adjustments and their impact typically require decades to have their full effect on the region, the movement is in the right direction. Moreover, it should be noted that these wage declines have been standardized for differences in industrial structure so that the adjustments have not been realized solely because employment in the Distirct’s highwage industries has declined. Relative wage declines have, however, been concentrated in three states— Indiana, Wisconsin, and Iowa. The District's performance in 1987 was also based in part on its access to technology. Developing new technologies has been one aspect of the revival process. For example, the region has steadily increased its annual investment in research and development during the 1980s. Increased R&D spending in the 1980s has been particularly notable in the auto, electrical equipment, and chemical industries. 6 Applying new technologies is another aspect of the process. District manufacturers have been leaders in adapting new technologies to traditional industries. The fledgling robotics industry, for example, remains centered in the District where its primary market—the auto industry—is heavily concentrated. Service sector: steady, reliable growth The need to improve competitiveness in the manufacturing sector has often meant that, rather than expanding employment, manufacturers substituted capital for labor and purchased business services instead of supplying them internally. The service sector, therefore, becomes critical to the District’s long-run economic performance, as the primary source of new jobs. To be sure, the sector—defined here to include all serviceproducing industries except government— represents nearly 60 percent of the Distirct’s total employment. But, the service sector accounted for three-quarters of the 338,000 net increase in employment in the five District states during 1987. Employment growth, as a measure of economic activity in the service sector, can also provide a basis for measuring the sector’s performance in the District, relative to the nation. For example, is the District’s service sector keeping pace with the growth of the sevice sector nationwide? Unfortunately, service sector employment in the District grew by 3.0 percent in 1987, just under the national growth of 3.4 percent. While the District’s growth rate lagged the national sector slightly, however, the gap between the District’s and nation’s growth rate was the smallest it has been in the 1980s. Moreover, some segments within the service sector and some states within the District did exceed the pace set by the nation. Among industries within the service sector, for example, both retail and wholesale trade industries expanded their employment faster than the industries nationally. Somewhat troublesome is the fact that business-related services other than wholesale trade could not transfer the growth in the District’s manufacturing activity into above average service employment growth during 1987. To the extent that the two sectors are linked through manufacturing’s need for a variety of business services, manufacturing’s beneficial impact on business-service growth may yet become evident in 1988. One reason for the District’s poor performance in business services employment may be the uneven distribution of servicesector growth among the five states of the District. Service sector employment growth exceeded the national average in two states— Indiana and Wisconsin. In the case of Indiana particularly, service sector gains were pervasive, in large part associated with growth in the Indianapolis area. On the other hand, service sector growth in Michigan probably was depressed by developments in the auto industry. Farm sector: financial stress eases Last year also marked an upturn for the District’s farm sector. Improvements were evident in several broad measures of the farm sector’s performance in 1987, including farmland values, overall farm commodity prices, and—again—exports. In fiscal 1987, U.S. agricultural exports rose 18 percent in tonnage and 6 percent in value from the lows set the year before. Equally important to District farmers, farm sector earnings rose sharply to a new high, paced by another banner year for livestock producers. And evidence of financial stress among farmers and their lenders eased considerably, with further declines in outstanding debt and the upturn in farmland values. Indeed, considering the widespread financial stress that has affected agriculture in recent years, one of the most encouraging developments for District farmers was the indication that farmland values were starting to rise. Following a five-year slide that resulted in farmland values nationwide declining by a third, USDA analysts now estimate that farmland values in 1987 rose about 3 percent. The upturn was more pronounced in the District where earlier declines had eroded farmland values in some states by 50 to 60 percent. Farmland values, however, are still well below early 1980 peaks. Conditions in the farm sector remain vulnerable in both the District and the nation. The recovery in most measures of farm sector performance has been modest compared to earlier declines. And although most observers expect further recovery in the year ahead, those expectations hinge on continued large government farm programs and subsidies. Government farm programs underlie much of the recent prospects for a continuing recovery for U.S. farmers. The long-run health of the sector depends on achieving greater efficiency in agricultural production, while farmers must become less dependent on large government subsidies. Summing up: looking toward the 1990s Service sector employment growth: 1987 percent change (4Q/4Q) U.S. IL IN IA Ml Wl Farmland values index, 1976=100 190 With perhaps one notable exception—the auto industry—the District’s economy had every thing going for it in 1987. While one year does not make a trend, there is reason to be optimistic about the prospects for the District’s economy as it approaches the 1990s. If the dollar remains at current levels, more exports and less competition from imports should be a major benefit to both District manufacturers and farmers. The service sector should continue its trend growth and may get an additional boost from the District’s expanding manufacturing sector. And all signs from the farm sector point to improvement in the years ahead, which should also benefit the District’s service sector. Perhaps, the real test for the District’s industries in the remaining years of this decade will be their competitive performance—particularly whether District manufacturing activity can continue to outpace the growth of manufacturing activity in the nation as a whole. If so, 1987 may eventually be recognized as the turning point in the region’s economic fortunes. 7 Economic research and monitoring activities support the Bank's role in System monetary policy decisions which seek to foster a healthy, growing, and noninflationary economy. 8 The Bank's economic research efforts are aimed at gaining a better understanding of the workings of the national and District economy as well as the financial system. To further these efforts, the Bank placed special emphasis on three important goals during 1987: enhancing the analytical quality of the Bank’s economic research, strengthening the relevance of that research to policy decisions, and improving the two-way flow of information between the Bank and its various audiences. Economic policy analysis Three major lines of study anchored policy research efforts during 1987. The first provided useful insights into the fundamental causes of business fluctuations, including the role of financial markets in those fluctuations. The second explored the role of fiscal policy and its effects on the overall economy. The third focused on alternate measures of monetary policy in light of the large structural changes that have affected M1 and other monetary aggregates in recent years. Financial system research Regulatory research in 1987 continued to focus on public policy toward off-balance sheet activities in banking. These studies had two major facets: the role of regulation in stimulating the growth of off-balance sheet activities and the impact of these activities on bank risk. In addition, research on financial futures and options was emphasized. Because of this work—in particular, work on market regulation—the Bank was well prepared to analyze issues raised by the October 19th stock market decline. Regional studies Regional research activity emphasized a dual objective—cooperative efforts with public and private sector decision makers and basic research on the District economy. The Bank’s new Midwest Manufacturing Index, developed to monitor industrial activity in the District, was introduced during 1987. Other efforts stressed the evolving structure of the District’s economic base. The Department also worked on several joint regional efforts. including The Iowa Economy—Dimensions of Change, in conjunction with the Iowa Business Council; a cost-of-doing-business study for The Commercial Club of Chicago; and further work in cooperation with the Great Lakes Commission and the Detroit Financial Center Task Force. Information flows Critical to all research efforts is the flow of information—adequate and effective com munication between the Bank and the banking community, other regulatory bodies, the academic community, business and industry, the Federal Reserve Board and System, other central banks, and the public as a whole. The Bank’s understanding of economic conditions and relationships and its effectiveness as a participant in the monetary policy process depends on this input. An important component in the information flow is the enormous amount of data collected from District financial institutions by the Bank's Statistics Division. To improve the collection process, the handling of all data reports was converted in 1987 to STAT, a com prehensive and flexible data management soft ware system now used by all System Banks. As part of its outreach activities during the past year, the Bank hosted District-wide forums to discuss economic conditions with financial, business, and other community leaders. The Bank’s annual Conference on Bank Structure and Competition provided an opportunity for the discussion of critical issues facing the financial community both today and in the future. In 1987 the Bank inaugurated a macroeconomics seminar series in conjunction with the Northwestern University Economics Department. This past year the Bank also expanded its communications efforts through a new publication, Chicago Fed Letter, a monthly newsletter which focuses on economic topics of regional interest and features a special section on the Midwest Manufacturing Index. Through its supervisory, regulatory and lending activities, the Bank strives to ensure that the financial system is stable, competitive, and responsive to public needs. 10 Since the beginning of this decade, several trends have emerged which have made the supervisory, regulatory, and lending functions of the Bank more complex and more critical. Among these are the problems that financial institutions encounter in the midst of more volatile economic conditions and the blurring of market distinctions within the financial arena itself. The number of branches of foreign banks in the Seventh District continued to grow in 1987, reflecting the increasing globalization of banking and Chicago’s position as an international financial center. By the end of the year there were 52 foreign branches in Chicago, compared to 48 in 1986, with total assets of $29.3 billion compared to $21.9 billion in 1986. Bank supervision Merger and acquisition activities also continued at a rapid pace throughout 1987, in response to eased state banking restrictions on branching and interstate banking. Within the District, Illinois, Indiana, Michigan, and Wisconsin have passed reciprocal regional interstate banking legislation. During 1987 the Bank received, and was able to process in a timely manner, 510 domestic and foreign applications. Although merger and acquisition activity has decreased the overall number of banking organizations within the District, those that remain are larger and more complex, and present new supervisory challenges to the Bank. Thanks in large part to the improvement in the agricultural economy, the District experienced a reduction during 1987 in the number of banking organizations of supervisory concern. But despite this heartening news, the examination and surveillance activities of the Bank must continue to evolve to meet the ever-changing and complex challenges of the marketplace. In 1987, the Bank’s examination staff conducted 973 examinations and inspections—100 more than in 1986. Enhanced training efforts and the use of automation helped the division meet this increased workload. This past year the Chicago Reserve Bank supplemented the 30 different courses offered by the System and the Federal Financial Institutions Examination Council with monthly seminars for Bank staff on topics of special interest. Continuous change in the banking industry makes coordination with other bank regulatory agencies more critical than ever. Last year. Bank representatives increased the frequency of meetings with counterparts from the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, state regulators, and neighboring Federal Reserve Districts to discuss critical issues. These enhanced communications helped the Chicago Bank remain responsive to the banking community. Banking structure Globalization, changes in interstate banking laws, new bank powers and activities have each had a profound effect on the structure of today's banking system. And each contributes to the complexities the System and the Chicago Reserve Bank must sort out. Consolidation of Seventh Districtbased banking organizations number of banking organizations with assets over $1 billion 50 illlll number of commercial banks 3,000 1982 1983 1984 1985 19861987 Payment system risk During 1987, as in the previous year, efforts were made to reduce and control the risks inherent in the large-dollar wire transfer networks. Modifications to the payment system risk policy were adopted by the Board of Governors. The success of this program continued during 1987 thanks to the cooperative efforts of the Bank and senior management of Seventh District depository institutions. Additional initiatives Communication efforts were boosted this past year with the introduction of Banking Barometer, a quarterly analysis of banking conditions in the U.S. and the Seventh District. The Bank also conducted seminars for banking, regulatory agency, and general public audiences on a number of regulatory topics including Bank Secrecy Act requirements, capital guidelines, bank holding company requirements, capital market activities, and the Community Reinvestment Act. 11 Annual reports typically focus on one major factor when measuring success: the bottom line. Certainly on this basis, the Federal Reserve Bank of Chicago had another successful year as it fully recovered the costs of providing its priced financial services as required by the Monetary Control Act of 1980. Unlike a private corporation, however, the Bank's success cannot be fully captured in a dollar figure. While the bottom line is a key component, the Federal Reserve has a broader responsibility to foster a safe and effective financial system and payments mechanism. Check services For check services, 1987 was a year of increasing volumes, stable expenses, and unchanged prices. The Bank accomplished this by developing more efficient operations and enhancing services. For example, the Bank improved operations by “ repairing” high-dollar checks that could not be processed by its high-speed sorters. The repaired checks can then be processed by automated equipment and no longer require time-consuming manual sorting. Many of the Bank's service enhancements involved tailoring services to the specific needs of customers. Under the Streamlined Deposit Program, for example, the Bank offers standardized deposit requirements to all Chicago institutions. Similarly, the Bank initiated a program to encourage small depositors to consolidate their check deposits. Both programs increase productivity for the Chicago Reserve Bank and the depositor. The Bank also enhanced its payor information services, and established an internal inquiry unit that centralizes all telephone contact between institutions and the check adjustment area. develop the operational changes and service modifications that will enable District institutions to comply with the Act. Electronic services The Bank’s priced electronic services volumes rose sharply in 1987, with a 7 percent increase in wire transfer, a 38 percent increase in ACH, and a 27 percent increase in book-entry securities services. Contributing to these accelerating volumes was a variety of service improvements offered by the Bank. One major effort was the linkage of 268 dial-up personal computer terminals at District institutions to the Bank’s Connect 7/850 system. This network enables institutions to complete electronic transfers through the Federal Reserve by using their own personal computers rather than terminals leased from the Bank. Designed for institutions that do not need a high-speed computer connection for their electronic funds transfer volume, Connect 7/850 offers improved security, efficiency, and versatility. Improved data security was another major goal in the electronic services area in 1987. To help assure security, the Bank emphasized encryption—or coded text—for electronic payments. At year-end 1987, all computerlinked institution transfers were 100 percent encrypted. In all, 75 percent of wire transfer volume is now text-coded, while all the remaining electronic volume (which will be encrypted in 1988) is transfered through a secured authentication system. Another important 1987 effort was the Bank’s two-day Data Security Awareness Conference at which approximately 250 financial institution executives discussed topics such as fraud prevention and microcomputer security. Fiscal agency, cash, and securities services During 1987, the Federal Reserve initiated the long and complicated process of implement ing the Expedited Funds Availability Act. As part of this responsibility, the Federal Reserve Board proposed a series of regulatory initiatives and service modifications designed to speed both the check collection and return processes. To explain the proposals, the Chicago Reserve Bank conducted a series of 56 seminars which were attended by almost 2500 financial institution executives in early 1988. At the same time, the Bank began to Efforts in these areas focused on enhancing productivity and quality controls. One major project was completing the final stage of the Treasury Direct program for U.S. government securities. Under Treasury Direct, all govern ment securities are now issued in book-entry form. The new system simplifies recordkeeping, deposits payments automatically, and eliminates the possibility of lost or stolen securities. Providing for its human, physical and financial resources enables the Chicago Reserve Bank to meet its goals today and in the future. 14 For the Bank to successfully meet its responsibilities, considerable work and effort is required behind the scenes. One significant internal support activity in 1987 actually went beyond the Bank itself. Last year the Bank’s senior management chaired both the Conference of Presidents and Conference of First Vice Presidents within the Federal Reserve System. These two groups provide important coordination and future direction for all the System’s varied activities. Another major support project aimed at improving present and future operations was the implementation of the Integrated Accounting System. The system eliminates duplication of work and increases efficiency by enabling the Bank’s diverse operations units to directly enter any transaction, such as the deposit of checks by a financial institution, into the Bank’s central accounting system. Other support activities in 1987 were directed at enhancing each of the physical components that make up the Federal Reserve Bank of Chicago: its facilities, its equipment, and, most importantly, its staff. Building project The Bank’s renovation and expansion project was undertaken in 1986 to modernize its 65year-old headquarters building, which had become increasingly outdated as operations grew and became more complex and automated. When completed in 1989, the project will solve this problem and provide nearly a million square feet of space, compared to the current total of 650,000. The complex project continued on schedule in 1987. The 13th through the 16th floors—as well as the eastern half of the 12th floor— were redone, and departments were relocated to the new areas. The fifth floor was also renovated and a new employee cafeteria and a conference center were constructed after the Bank's library was moved to new quarters on the 11th floor. The renovation also affected the building’s exterior. Limestone facing was placed on the outside of a newly-constructed 14-story addition and on a previous addition built in 1957, matching these sections with the original building’s exterior. A less visible, but still extensive, effort was the installation of new mechanical, heating, ventilation, and air conditioning systems. Computer operations Computer operation improvements in 1987 included testing and implementing the Seventh District Communications Network. The network will enable institutions with high volumes of electronic funds transfers and other needs such as payor bank information to maintain a direct connection to their local Seventh District office. Because the network offers increased efficiency and enhanced security technology, it is a cost-effective solution to the Bank's current and future data communication needs. The Bank also developed a comprehensive plan for continuing essential computer operations in the event of a disaster. As part of this effort, the Bank successfully retested a computer relocation contingency site in Culpeper, Virginia. Additionally, the Chicago Office moved its electronic funds operations, and the computer support for them, to a nearby location in the South Loop. The move eliminates the risk of these services being disrupted during the Bank’s renovation. Human resources A less technological but surely as vital approach to preparing for tomorrow was the implementation of programs designed to develop the Bank’s future leaders. The Project in Management Excellence or PRIME program was developed and introduced to help highpotential employees enhance their abilities and management skills. During 1987, 31 employees were selected for the program, which consists of a comprehensive series of activities including workshops with senior officers. A very successful early retirement program was also developed and implemented in 1987. With 155 employees participating, cost savings objectives were exceeded and significant advancement opportunities were opened for the Bank's remaining staff. Deputy Chairman Marcus Alexis B. F. Backlund John W. Gabbert Charles S. McNeer Max J. Naylor Edward D, Powers Paul J. Schierl Barry F, Sullivan The nine-member Reserve Bank board has a general governance responsibility over Bank operations, acts on the discount rate, and contributes to monetary policy by advising on economic conditions. 16 Robert J. Day Chairman and Chief Executive Officer USC Corporation Chicago, Illinois Marcus Alexis Dean, College of Business Administration University of Illinois at Chicago Chicago, Illinois B. F. Backlund President and Chief Executive Officer Bartonville Bank Bartonville, Illinois John W. Gabbert President and Chief Executive Officer First O f America BankLa Porte, N.A. La Porte, Indiana Charles S. McNeer Chairman of the Board and Chief Executive Officer Wisconsin Electric Power Company Milwaukee, Wisconsin Max J. Naylor Crain and livestock farmer Jefferson, Iowa Edward D. Powers Chairman of the Board and Chief Executive Officer Mueller Company Decatur, Illinois Paul J. Schierl Chairman and Chief Executive Officer Fort Howard Paper Company Green Bay, Wisconsin Barry F. Sullivan Chairman of the Board The First National Bank of Chicago Chicago, Illinois Robert E. Brewer Senior Vice President (»>c-lif “ uy K mart Corporation Troy, Michigan Richard M. Gillett Old Kent Financial Grand Rapids, Michigan Richard T. Lindgren President and Chief Executive Officer Cross & Trecker Corporation Bloomfield Hills, Michigan Donald R. Mandich Chairman ana v^niet Executive Officer Comerica Bank-Detroit Detroit, Michigan Phyllis E. Peters Director, Professional Standards Review Touche Ross and Company Detroit, Michigan Thomas R. Ricketts Chairman of the Board and President Standard Federal Bank Troy, Michigan Ronald D. Story Chairman and President The Ionia County National Bank Ionia, Michigan The seven-member Branch board has a general oversight responsibility and provides additional information about regional conditions. 17 Advisory Council on Agriculture Federal Advisory Council Representative Charles T. Fisher III Chairman and President NBD Bancorp and National Bank of Detroit Detroit, Michigan The twelve-member Federal Advisory Council, with one representative from each District, meets quarterly with the Board of Governors to discuss business and financial conditions. The Chicago Reserve Bank’s two advisory councils serve to promote communication with the agricultural and small business sectors in the District. 18 Advisory Council on Small Business Ben Bement Dowagiac, Michigan Michigan Pork Producers Association Russell J. Clark Frankfort, Indiana Indiana Pork Producers Association David Conklin Corunna, Michigan Michigan Farm Bureau Kenneth Dalenberg Mansfield, Illinois Land of Lincoln Soybean Association Thomas Dorr Marcus, Iowa Iowa Corn Growers Association Gerald Elenbaum Owendale, Michigan Michigan Bean Commission James A. Grenlund Capron, Illinois Illinois Beef Association Robert R. Joslin Clarence, Iowa Iowa Farm Bureau Federation Jerry King Victoria, Illinois Illinois Pork Producers Association Anita Klein Plymouth, Wisconsin Women Involved in Farm Economics Wendel E. Shireman Columbus, Indiana Indiana Grange Gale Tigert Oshkosh, Wisconsin Wisconsin Soybean Association Frank A. Buethe Green Bay, Wisconsin Independent Business Association of Wisconsin James N. Farley Des Plaines, Illinois Independent Business Association of Illinois Enrique Loza Chicago, Illinois U.S. Hispanic Chamber of Commerce Cyril Ann Mandelbaum Des Moines, Iowa National Association of Women Business Owners/lowa Chapter Marilu B. Meyer Chicago, Illinois Illinois State Chamber of Commerce Michael J. Morton Southfield, Michigan The Small Business Association of Michigan Clifford A. Nederveld Lansing, Michigan National Federation of Independent Business Jeanne G. Paluzzi Livonia, Michigan National Association of Women Business Owners/Michigan Chapter James L. Siegmann Goshen, Indiana Indiana Chamber of Commerce John A. Travlos Ottumwa, Iowa Iowa Association of Business and Industry Directors The selection process for Reserve Bank directors assures broad representation across the District. Member banks, divided into size groups, elect three banker and three nonbanker directors. The Board of Governors in Washington, D.C., appoints the three remaining nonbanker directors. District member banks elected two new directors in 1987—B. F. Backlund and Paul J. Schierl. They replaced Leon T. Kendall, chairman of the board and chief executive officer of Mortgage Guaranty Insurance Corporation, Milwaukee, and O. J. Tomson, president of the Citizens National Bank of Charles City, Iowa. In addition, the Board of Governors appointed Robert J. Day to a second three-year term as a director and redesignated Mr. Day and Dr. Marcus Alexis as chairman and deputy chairman for 1987. At year-end 1987, Dr. Alexis was reappointed and Edward D. Powers and Barry F. Sullivan were re-elected as directors, to begin second three-year terms in 1988. Also, Mr. Day and Dr. Alexis were redesignated chairman and deputy chairman for 1988. Four of the seven Branch directors are appointed by the Chicago Reserve Bank board. The other Branch directors, all nonbankers, are selected by the Board of Governors. The Branch board selects its own chairman from among these three. In 1987, Richard T. Lindgren joined the Branch board and Ronald D. Story was reappointed to a three-year term. Mr. Lindgren replaced Karl D. Gregory, professor of economics and management, Oakland University, Rochester, Michigan. In addition, Robert E. Brewer was selected as board chairman for 1987. At year-end 1987, three new directors were named to join the Detroit Branch board in 1988: James A. Aliber, chairman and chief executive officer of First Federal of Michigan, Detroit; Beverly Beltaire, president of P. R. Associates, Detroit; and Frederik G. H. Meijer, chairman of Meijer Incorporated, Grand Rapids, Michigan. They replaced Robert E. Brewer, Richard M. Gillett, and Thomas R. Ricketts who completed their terms. Also effective in 1988 was the selection of Richard T. Lindgren as Branch chairman. The board of directors of each Reserve Bank names one representative to the System's Federal Advisory Council each year. Charles T. Fisher III served in that capacity during 1987 and was reappointed for 1988. Members of the Chicago Reserve Bank’s two advisory councils are selected from nominations by Seventh District small business and agricultural organizations. To provide the largest possible representation of various geographic areas and business activities, all new members were selected during 1987. Officers Appointments to a Federal Reserve Bank’s official staff are made by the Bank's board of directors. In 1987, the Board promoted William H. Gram to senior vice president, general counsel, and secretary, and designated Vice President David R. Allardice assistant director of research. Other 1987 promotions included James A. Bluemle to vice president in Financial Institution Accounts, David S. Epstein and Geoffrey C. Rosean to vice presidents in Supervision and Regulation, Teri J. Kurasch to vice president and associate general counsel, and Maria H. Coons to assistant vice president in Check Services. New officers named in 1987 included: A. Raymond Bacon, Robert A. Bechaz, and Barbara D. Benson, examining officers; Gay Whiting, applications officer; Brian W. Hausmann and Sheryn E. Bormann, personnel officers; and William J. O ’Connor, loans officer. Other new officers in 1987 were: Herbert L. Baer, research officer; Diane S. Noble, operations officer; and Margaret A. Koenigs, planning officer. Also in 1987, Vice President George W. Cloos and Assistant Vice President Rose M. Kubush retired after 38 years and 43 years of service respec tively. A sad note for 1987 was the death of Thomas P. Killeen who passed away while serving as vice president in charge of the Des Moines Office. He worked at the Bank for 26 years, including nine years of service as head of the Des Moines Office. Effective March 1, 1988, Assistant Vice President Edward Ketchmark was named to oversee that Office. 19 Services to Depository Institutions Operations and Check Services Charles W. Furbee, Senior Vice President Silas Keehn President Supervision and Regulation Franklin D. Dreyer, Vice President Roderick L. Housenga, Vice President Geoffrey C. Rosean, Vice President Nicholas P. Alban, Assistant Vice President John L. Bergstrom, Assistant Vice President Douglas J. Kasl, Assistant Vice President William H. Lossie, Jr., Assistant Vice President Patrick J. Tracy, Assistant Vice President Alicia Williams, Assistant Vice President A. Raymond Bacon, Examining Officer Robert A. Bechaz, Examining Officer Barbara D. Benson, Examining Officer Gay Whiting, Applications Officer Loans and Reserves Gerard J. Nick, Vice President William J. O ’Connor, Loans Officer Daniel M. Doyle First Vice President Economic Research and Information Services Karl A. Scheld, Senior Vice President and Director of Research Economic Research David R. Allardice, Vice President and Assistant Director of Research Gary L. Benjamin, Economic Adviser and Vice President Joseph G. Kvasnicka, Economic Adviser and Vice President . Larry R. Mote, Economic Adviser and Vice President Anne Marie L. Gonczy, Senior Economist and Assistant Vice President Herbert L. Baer, Research Officer Steven H. Strongin, Research Officer Information Services Nancy M. Goodman, Assistant Vice President Statistics Jean L. Valerius, Vice President 20 Cash, Fiscal Agency and Securities Services David R. Starin, Vice President Daniel P. Kinsella, Vice President Jerome D. Nicolas, Assistant Vice President Lawrence J. Powaga, Assistant Vice President Check Services Wayne R. Baxter, Vice President Paul J. Bettini, Vice President William A. Bonifield, Vice President Robert W. Wellhausen, Vice President Allen G. Wolkey, Vice President Maria H. Coons, Assistant Vice President Theodore E. Downing, Jr., Assistant Vice President Colleen M. Walsh, Assistant Vice President DeWayne W. Baker, Operations Officer Diane S. Noble, Operations Officer Automation and Electronic Services William C. Conrad, Senior Vice President Automation Support and Computer Operations Stephen M. Pill, Vice President Frank S. McKenna, Assistant Vice President Charles L. Schultz, Assistant Vice President James A. Suprinski, Assistant Vice President Electronic Services Glen Brooks, Vice President Kenneth R. Berg, Assistant Vice President James M. Rudny, Assistant Vice President Janet M. Terry, Assistant Vice President Leonard A. Lombardo, Operations Officer Linda B. Maschio, Operations Officer System Communications Center George E. Coe, Vice President Bonnie Bates, Assistant Vice President R. Steve Crain, Assistant Vice President Support Functions Financial and Management Services Carl E. Vander Wilt, Senior Vice President and Chief Financial Officer Financial Institution Accounts James A. Bluemle, Vice President Richard P. Anstee Financial Management and Management Services Glenn C. Hansen, Vice President Jerome F. John, Assistant Vice President Margaret A. Koenigs, Planning Officer Office of the General Auditor Richard P. Bush, General Auditor Angelina Chin, Auditing Officer Richard P. Bush Office of the General Counsel William H. Gram, Senior Vice President, General Counsel, and Secretary Legal Services Teri J. Kurasch, Vice President and Associate General Counsel Office of the Bank Secretariat Joan M. DeRycke, Assistant Vice President and Assistant Secretary Support Services Richard P. Anstee, Senior Vice President William C. Conrad Charles W. Furbee Administrative and General Services Robert A. Ludwig, Vice President Adolph J. Stojetz, Vice President Susan H. Riis, Assistant Vice President Facilities Improvement Robert D. Lauson, Vice President Human Resource Services Thomas G. Ciesielski, Vice President Gerald I. Silber, Assistant Vice President Sheryn E. Bormann, Personnel Officer Brian W. Hausmann, Personnel Officer District O ffices Detroit Branch Roby-L. Sloan, Senior Vice President and Branch Manager Frederick S. Dominick, Vice President and Assistant Branch Manager Joseph R. O'Connor, Assistant Vice President Richard L. Simms, Jr., Assistant Vice President F. Alan Wells, Assistant Vice President Yvonne H. Montgomery, Operations Officer William H. Gram James R. Morrison Karl A. Scheld Regional Offices Des Moines Edward Ketchmark, Assistant Vice President* Indianapolis Allen R. Jensen, Assistant Vice President Milwaukee Charles M. Lund, Assistant Vice President ^effective March 1,1988. Carl E. VanderWilt 21 Statement of Condition December 31,1987 Changes in Reserve Bank asset, liability and income items largely reflect economic developments and System monetary policy actions. Through securities purchases and loans to depository institutions, the Federal Reserve increases reserves, providing a base for monetary expansion in accord with the economy’s real growth. Assets Cold certificate account Interdistrict settlement account Special drawing rights certificate account Coin Loans and securities: Loans Federal agency securities U.S. government securities Total loans and securities Cash items in process of collection Bank premises December 31, 1986 $ 1,383,000,000 2,605,492,303 656,000,000 30,996,628 $ 1,394,000,000 2,974,753,447 656,000,000 28,851,439 19,275,000 875,886,823 25,385,206,512 26,280,368,335 88,875,000 873,140,707 22,039,465,372 23,001,481,079 619,910,166 70,486,933 1,012,503,507 43,165,213 2,623,471,867 1,617,504,999 4,240,976,866 Other assets: FDIC assumed indebtedness Other Total other assets Total assets $35,887,231,231 2,904,298,639 1,694,646,893 4,598,945,532 $33,709,700,217 Liabilities Federal Reserve notes $30,029,272,890 $27,063,964,386 4,324,615,741 5,008,402,617 Deposits: Depository institutions U.S. Treasury—general account Foreign Other Total deposits Deferred availability cash items Other liabilities Total liabilities Capital accounts Capital paid in Surplus Total capital Total liabilities and capital 22 0 0 20,400,000 145,421,015 4,490,436,756 20,250,000 102,368,860 5,131,021,477 522,129,789 322,785,696 $35,364,625,131 751,662,283 260,308,071 $33,206,956,217 261.303.050 261.303.050 522,606,100 $35,887,231,231 $ 251,372,000 251.372.000 502.744.000 $33,709,700,217 Stateme. 1986 1987 Current income Interest on loans Interest on government securities Interest on investments of foreign currencies Service fees All other Total current income Current expenses Operating expenses Other current expenses Total current expenses Less reimbursement for certain fiscal agency and other expenses Current net expenses Current net income Additions to (or deductions from) current net earnings Net profit (or loss) on sales of securities Net profit (or loss) on foreign exchange transactions Board of Governors assessment All other-net Net additions (or deductions) Net earnings available for distribution Distribution of net earnings Dividends paid Payments to U.S. Treasury (as interest on Federal Reserve notes) Transferred to surplus $ 179,483,497 1,858,905,221 46,776,722 85,444,353 2,439,365 $ 2,173,049,158 $ 206,123,740 1,782,213,012 53,106,506 84,722,988 1,712,351 $ 2,127,878,597 $ 142,027,683 22,891,037 164,918,720 $ 137,964,974 21,705,770 159,670,744 12,305,001 $ 152,613,719 12,795,133 $ 146,875,611 $ 2,020,435,439 $ 1,981,002,986 $ 4,853,276 $ $ 245,381,666 (34,556,202) (5,212,203) 210,466,537 266,035,104 (36,885,127) (7,541,544) $ 229,060,200 $ 2,230,901,976 $ 2,210,063,186 $ $ Reserve Bank income largely consists of interest on its share of the System’s securities portfolio purchased for monetary policy purposes. Almost all of this considerable income is returned to the Treasury after expenses and statutory dividends to member banks are paid. 15,356,719 2,205,614,207 9,931,050 $ 2,230,901,976 7,421,767 14,838,725 2,185,033,711 10,190,750 $ 2,210,063,186 23 Volume Dollar amount 1987 Check and electronic payments Checks, NOWs, and share drafts processed Fine sort and packaged checks handled U.S. government checks processed Automated clearinghouse (ACH) items processed Transfers of funds Cash operations Currency received and counted Unfit currency withdrawn Coin received and processed Securities services for depository institutions Safekeeping balance December 31: Definitive securities Book entry securities Purchase and sale Collection of securities and other noncash items Loans to depository institutions Total loans made Institutions accommodated Services to U.S. Treasury U.S. savings bonds issued, exchanged and redeemed Other government securities issued, exchanged and redeemed: Definitive securities Book entry securities Government coupons paid Federal tax deposits processed Food stamps processed 1986 1987 1986 2 .0 b illio n 1.9 billion 1.1 trillion 1 .0 t r illio n 150.6 billion 1 2 9 .4 b illio n 292.5 million 52.4 billion 5 5 .2 b illio n 63.8 million 750.9 billion 23.0 trillion 5 7 3 .7 b illio n 21.0 billion 3.2 billion 540.1 million 13.6 billion 192.7 billion 3.9 billion 146.1 m illio n 117.4 million 9.2 million 1 8 .4 b illio n 1.9 b illio n 2 .9 b illio n 4 7 6 .6 m illio n 4 7 8 .3 m illio n 4 .0 b illio n 1.8 billion 480.7 million 3.6 billion 1 4 .0 b illio n 0 .5 m illio n 0.5 million 19 .8 t h o u s a n d 13.7 thousand 2 7 6 .5 t h o u s a n d 278.3 thousand 2,353 1,840 207 2 0 .8 t r illio n 1 6 9 .9 b illio n 3 .2 b illio n 1.4 billion 4.7 billion 4 .5 b illio n 3.6 billion 3 .6 b illio n 1.7 billion 4.2 trillion 172.1 million 4 .2 t r illio n 1.2 m illio n 1 5 8 .6 m illio n 1 9 5 .0 t h o u s a n d 233.6 thousand 1.1 million 277.0 thousand 2 9 5 .0 m illio n 860.6 thousand 307.4 million 98.3 billion 1.4 billion 30.1 million 144.1 t h o u s a n d 9 2 .3 b illio n 1 .5 b illio n Federal Reserve Bank of Chicago Head Office 230 South LaSalle Street P.O. Box 834 Chicago, Illinois 60690 Detroit Branch 160 West Fort Street P.O. Box 1059 Detroit, Michigan 48231 Des Moines Office 616 Tenth Street P.O. Box 1903 Des Moines, Iowa 50306 Indianapolis Office 41 East Washington Street P.O. Box 2020B Indianapolis, Indiana 46206 Milwaukee Office 304 East State Street P.O. Box 361 Milwaukee, Wisconsin 53201 For additional copies of this report, contact the Public Information Center, Federal Reserve Bank of Chicago, at 312/322-5111.