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Business Review


Seeding Science-Based Industry


Pressing Against the Ceiling?
How High Can the Loan/Deposit Ratio Go?








Seeding Science-Based Industry
. . . New research-oriented firms are difficult to nurture at best. Often in the past,
they have found the environment in the Delaivare Valley less than best, but deeds and
attitudes are changing in this respect, and the changes are all for the better.

Pressing Against the Ceiling?
. . . Credit demands in our full-employment economy are boosting the ratio of loans
to deposits in commercial banks. Trend is likely to continue, but at a slower pace.


is produced in the Department of Research. Donald R. Hulmes prepared the layout and art­
work. The authors will be glad to receive comments on their articles.
Requests for additional copies should be addressed to Bank and Public Relations, Federal Reserve Bank of Philadelphia,
Philadelphia, Pennsylvania 19101.

A report on interviews with scientist-businessmen on problems of . . . .

by Elizabeth P. Deuterm ann

The young engineer looked his visitor squarely

one. Behind the teak desk sits the engineer. Facing

in the eye. “ Yes,” he said, “ Government contracts
were essential when we started the firm. In 1957

window frames an almost rural panorama. To his

almost a hundred per cent of our work was with
the Pentagon. Not now, though. Today it’s only
42 per cent. Our research and development led to
so many commercial applications we hadn’t ex­
pected.” With computer-like speed he ticked off
new patents, products, and industrial customers,
just as he had answered the previous questions.

him is his visitor. To the engineer’s left a large
right is the closed glass door providing a mirror
image of the word President.
The president of this company is one of three
engineers who started their own business after
leaving a larger firm. He was anxious to tell how
they did it. For three hours he drew on his per­

“ How did I get initial financing? It wasn’t

sonal experience to explain what made it easy or
difficult to form his science-based firm.

easy. It never is for a firm whose stock-in-trade
is new technology. But I’ll tell you this. Financing
a venture like ours is a lot easier here in Boston

Why did he bother? Really, for the same rea­
son a golfer talks golf, or a skier, skiing. He was
discussing something dear to his heart.

than in many other places.” An hour passed be­

More to the point, why did the interview occur

fore the engineer was asked if there were any ties

at all? The answer lies in the intense contem­

between area universities and his company. “ Of
course if it hadn’t been for Graduate School at

porary concern with regional economic growth,

M.I.T., I wouldn’t have come here from Texas in

dustry will stimulate it.

and the widespread hope that science-based in­

the first place. And that goes for a lot of our staff.
We always know we can get good technical peo­

Home-grown R & D

ple from local schools when we need them.”
The scene of this questioning is an electronics

From New York City to Sacramento, California,

plant in suburban Boston. An interview is under­

work to increase jobs in their communities. Two

way in one of the offices— a handsomely modern

questions loom large in their minds. What indus­

thousands of private citizens and public officials


b usiness re v ie w

tries will be the big employers of tomorrow? How

engineer or scientist with an idea for a better

can they get more of those industries in their

mousetrap. Second, the man with the idea must

regions? In response to question one, a number
of major cities expect future jobs to be generated

where he is employed must show receptiveness

by research and development activities. R & D,

to new ideas by tangible support of fledgling

undoubtedly, is one of the nation’s most rapidly

R & D companies.

growing businesses. And it tends to concentrate

want to start his own firm. Third, the community

Take Philadelphia as an illustration. Some­


where in the area an engineer is contemplating
his resignation from a large company. He has

growth, the urban developer’s prime concern is
how his area can capitalize on it. A region can

worked for years in computer research. He has
not one, but ten ideas for improving a company

increase its R & D activities in different ways.
A popular and well-publicized approach is to

product. And he strongly believes their adoption
will boost sales tremendously. Since manage­
ment doesn’t agree, he is considering two alterna­

in large urban areas. So far, so good.
But having identified an opportunity

look outside the region for help— specifically, to
lure a large Government laboratory. A more
fundamental approach is to look inward and
create the kind of community which stimulates

tives. Should he go with another company or
spin-off and start his own firm? Personally, he
is eager to be his own boss. But something holds

and supports the formation of new science-based

him hack. Long hours of conversation with engi­
neer friends who started their own companies
have planted doubts in his mind.

Soil testing

From their experience, he has formed an

What does it take for a community to be a good

attitude that Philadelphia is not the best place

place to start a science-based firm? A number of

to start a new science-based firm. Whether this

people think they know. But actually very little

attitude is based on myth or reality, the image

fact-finding has been done to answer this ques­

itself can be the determining factor in the birth

tion. Hence the investigation reported here.
The approach was through case studies of firms

of a new company in the area. And the image
apparently does exist.

in two metropolitan areas:

Boston. Philadelphia is the largest metropolitan

The attitudes of company founders interviewed
in Philadelphia suggest the Delaware Valley is

Philadelphia and

area in the Third Federal Reserve District. Bos­

not regarded as an outstandingly good area in

ton has an outstanding reputation as a research

which to launch a new R & D-oriented business.

and development center. It is alleged to be a

Scientist-businessmen frequently cited Boston,

community where science-based firms find it easy
to take roots and grow.

with envy, as a case in contrast. Is it possible that
if another group had been studied, their feelings

Is it really easier to start a research-oriented
business in one community than in another?
And if so, why?

evidence points to such attitudes being wide­

Germination and climate

would have been different? Probably not; the
spread among scientists and engineers.* And the
mere fact that they are held is important; in itself,
it can inhibit growth.

There are three basic requirements for starting a
science-based company. First, there must be an


*This question is discussed in detail on pp. 9-10.

b usin ess re v ie w

These are summary evaluations. On what are

munity is able and willing to help him. A strong

they based? What do the Boston founders think

communication network in financing circles leads

they have going for them that their Philadelphia

the money-seeking scientist to a local source of

counterparts find lacking? The answer is in the

Interviewees point to commercial banks in

financial climate and the university complex.

Boston as an important link in this network. If

banks cannot supply the seed money, they know

To begin operating, the science-based firm natu­

who can. They know because they’ve made

rally needs seed money. The founder first looks

science-based industry a specialty. As a result,

around the home territory where he lives and has

the engineer-turned-entrepreneur who seeks fi­

worked. How expeditiously he obtains funds

nancing can sit down to discuss his needs with

varies with his financial sophistication. Those less

an engineer-turned-banker. The latter, a vice-

knowledgeable eventually discover that personal

president at one bank, is dramatically advertised
in local news media as the man who “ finances
the frontiers of science.”
Promotion is one thing. Delivery is what
counts. From the interviewees’ viewpoint, Boston
banks deliver. This holds both for initial financ­
ing and for sustaining financing over the difficult
first five years— at which time the company is
considered to have come of age and finds financ­

resources or wealthy friends, rather than financial
institutions, most frequently give the breath of
life to the infant industry. Risk capital for a
venture based on new technology— say, solid
state physics— is not readily available any place
in the country.

ing less of a headache. The responses strongly
suggest that this rapport with the scientific com­
munity and financial support of banks is a great
asset to the growth of new R & D industry.
Entrepreneurs interviewed in the Delaware
Valley do not find their banking community
quite so understanding. They think local banks

Nevertheless, such risk capital does appear

could be of much greater assistance— indirectly,

less difficult to obtain if financiers are scientif­

if not directly— in getting a fledgling off the

ically sophisticated. The scientist-businessmen we

ground. This attitude, whether justified or not,

talked with find this sophistication in the Boston

can inhibit growth not only in R & D but also in
local banking itself. If the scientist seeking funds

financial community. Financiers, they say, be­
lieve that a high proportion of new jobs in the
next ten years will be in industries growing out of

initially assumes local banks can’t or won’t help

current research and development. A high pro­

in turn, may assume this indicates a lack of

him, he won’t knock on their doors. The banker,

portion of future profits for lenders will have the

demand for R & D financing. The scientist-execu­

same root. Because Boston bankers believe this,

tives interviewed felt that when banks cannot

one company president noted, the financially

directly finance a risky business, they can func­

ignorant scientist-entrepreneur can readily learn

tion as important intermediaries. They can bring
eager risk-takers and scientists together.

of sources of venture capital. The financial com­


b usin ess r e v ie w


In this sequence of events, an obvious question

Founders of science-based firms strongly be­

arises. What holds the future entrepreneur to an

lieve local universities are vital to company for­
mations— and to their futures. The Boston cor­

area between graduation and groundbreaking?
The same answer applies both to Philadelphia

porate heads think their area’s graduate schools

and Boston. In every case in our study, a primary

play a fundamental role in the growth of the
region’s R & D companies. The Philadelphia

reason for locating new companies in their respec­
tive areas was that it was home for one or more

executives interviewed do not believe local uni­
versities provide as much stimulation to growth

of the founders. It was not necessarily the home
of birth. In many instances it had become home

of their industries. This is the second major way
in which Boston and Philadelphia scientists view

during the long time spent in graduate school or
working in the region.

their communities differently as seed-beds for
R & D firms.

Lengthy residence in an area gives a new entre­

How can universities stimulate the growth of
science-based industry? A direct way is by spin­
ning-off companies. For example, a professor may
be a frustrated businessman at heart. If he also is
bursting with ideas for marketable new products,
he may form his own firm. More likely, however,
the university’s role in initiating corporations
takes a less direct route.

preneur a necessary knowledge of territory. He
feels more confident in taking a chance on a
company of his own on home ground. Experience
has given him contact with local competitors. He
can put his finger on local sources of supplies and
business services peculiar to his specialized needs.
So the thought of starting a company any place
other than home is rarely considered. This is
quite unlike the large corporation which hires

One path is through high-quality graduate
training in engineering and physical sciences.
Universities which offer outstanding opportunities
for study and research act as magnets to attract
the nation’s most talented students to a region.
Let’s assume one of these men takes a job with a
local company when his graduate study is com­
pleted. Time passes before he is ready to start his
own firm— if that is his goal. Rarely does the
scientist jump straight from the laboratory to
executive row. First he must acquire some knowl­
edge of final products and markets— knowledge
which he doesn’t gain in the laboratory. He gets
this education in a position above the starting

ideal branch location. Only on one occasion did

one. Having acquired it, he departs and forms his

we encounter a spin-off that did a location survey
beyond home base. Even in this exception, the

own local company. The community has a new
economic asset— a job producer, a tax source, a
corporate headquarters. It must give some of the
credit to the top-notch graduate school which first
attracted the company founder to the region.

Digitized for 6

site chosen was influenced by the desire of one
founder to go back home.
Many science-based firms in the Delaware
Valley and in Boston were started by professors

b usiness re v ie w

and by their graduate students. Whether one area


produces more firms than the other by these

School graduates who court the “ innovation”





means, no one really knows. However, it may be

market. They actively seek out scientists with

significant that university offshoots were much

new ideas to back financially.

easier to track down in Boston than in Philadel­

Men who have organized science-based firms

phia. In addition, the founders contacted in both

point to other ways the university community aids

regions think Boston has the lead. For Boston,

their growth. Consulting is one of them. The

this is another stimulant for a scientist to start a

small, new company depends on university per­

company. Seeing one’s colleagues succeed as

sonnel to solve technical problems. Having such

company founders encourages one to try it him­

consultants readily available is an asset to the

Apparently the big era for attracting the future

Professors of engineering and science also act

corporate head to Philadelphia via the graduate

as consultants to Boston banks investing in new

school was in the ’forties. One reason, undoubt­

R & D ventures. For example, the future profit­

edly, was the outstanding reputation of the Moore

ability of an innovation in chemical process con­

School of Engineering in computer research. The

trol may be hard for a banker to evaluate. There­

Philadelphia scientist-executives interviewed be­

fore, he turns to a consulting professor he knows

lieve this type of graduate school pull has greatly

who specializes in the same research field as the

diminished in the last twenty years. Indicative of

bank’s client. This practice tends to ease financing

Boston’s greater attraction today is that it pro­
duces nine doctorates in engineering and physics

for new firms with growth potential in technical

to every one coming out of universities in the
Philadelphia area.

Furthermore, many Boston professors actively

The university graduate school is not only a
source of tomorrow’s corporate heads, but of men
who will work for young research firms today.

serve on boards of directors of both science-based
firms and area banks. This has generated greater
rapport among financiers, universities, and the

Interestingly, not one Philadelphia executive sug­

R & D industry. The founder of the Boston sci­
ence-based firm feels he profits from the resulting

gested that a good reason for being in the area
was the availability of technical talent. Only one

increase in mutual understanding and cooperation.
This type of understanding is felt to be seri­

failed to stress this in Boston. There, new science-

ously lacking in Philadelphia. It grows in Boston

based firms depend more heavily on local grad­
uate schools for employees than is the case in the

the university complex and scientists in business.

Delaware Valley. The demand is not just for engi­

Such ivy-industry ties are considered to be weak

neers and scientists. It particularly includes grad­
uates of the Harvard Business School.

in the Delaware Valley.

The Business School graduates have shown

from the many ties described which exist between

The other side of the fence

considerable interest in new R & D ventures in the
Boston area. For many young firms, a very fruit­

These attitudes of would-be entrepreneurs toward

ful merger of business and scientific training has

sities are the factors most frequently cited as

resulted. In addition, Boston executives frequently

inhibiting growth of new science-based firms in

mentioned a number of local venture capital

the Delaware Valley. In other important respects,

availability of financing and the role of univer­


business r e v ie w

entrepreneurs view spin-off influences as equally
favorable in both regions.
For example, one requirement is that sufficient
low-cost space be available for incubation. In both
regions such space is available where the tech­
nology-based firm wants it— in the suburban
ring surrounding the old core city. Founders of
new firms in Philadelphia and Boston agree that
low-cost space is no problem— “ except in the
city.” Costs are lower in the suburbs. But this
is not the foremost reason why they distinctly
prefer a suburban location. Aesthetic appeal and
numerous conveniences weigh much more heavily.
Hence, abandoned textile plants, for instance, in
the older sections of the two cities don’t attract
incubating R & D firms. City slums, traffic con­
gestion, distance from home to work, and inade­

in Philadelphia or Boston did not give the com­

quate parking space repel new companies. In both

pany any particular advantage in receiving needed

core cities where redevelopment efforts are geared

Government support.

to attract R & D firms, overcoming suburban pref­
erences and finding means to reduce space costs

Shade and sunlight

present a real challenge.

The preceding

If science-based firms are to attract and hold
technical personnel in a region, it must rate high

science-based firms are easier to start in Boston



that new

than in Philadelphia. Therefore, one would ex­

as a desirable place to live. Both Philadelphia

pect to find more new R & D companies blossom­

and Boston rate high. The scientist or engineer

ing in the former region. Experience does seem

prefers to live in a major metropolitan area. He

to indicate that R & D spin-offs are easier to locate

wants as many advantages of the country as pos­

in Boston than in Philadelphia.
Other evidence indicates that special char­

sible, without losing those which only the big
city provides. Some companies interviewed con­

acteristics of the Boston scientific community

sidered, as they grew, establishing branches in

make it a more probable spin-off producer than

rural areas to lower costs. They didn’t do it.

the Delaware Valley. Compared to the Philadel­

Strong staff resistance to isolation from the urban

phia area, Boston employs more scientists. A

scene killed expansion into rural areas.
Another aid to successful spin-offs is often a

higher proportion of them are working in re­
search and development. By contrast, scientists

Government contract to support R & D until the

in the Philadelphia area are more production-

firm’s reputation is established. In the majority
of the case studies, Federal customers were essen­

oriented. In addition, those in the Boston area
have a higher degree of educational attainment

tial at the start of the company. But company

than scientists working in Philadelphia.

founders did not feel that contract awards were
influenced by their addresses. That is, just being

in Philadelphia are engaged more heavily in

Digitized for 8

The story is similar for engineers. Engineers

b usiness re v ie w

production, sales, and marketing than in Boston,

to attract outstanding professors of engineering

where they are employed to a greater extent di­

and science to the faculty.

rectly in research and its management. This con­

In addition, universities of the region are

centration of high-quality brainpower, oriented

working in concert to develop the University

toward research and development, is the basic

City Science Center. One specific goal of the

source of new ideas which lead to new companies.

Science Center Corporation is to assist the incu­

Nevertheless, the Philadelphia region does have

bation of science-based firms. This is also the

a strong resource of technical manpower for

objective of the Regional Development Labora­

seeding new science-based industry. Among the

tory— a brainchild of the West Philadelphia Cor­

nation’s major metropolitan areas, Philadelphia


ranks seventh as an employer of scientists. There

Economic Development Corporation.

are 29,000 engineers and physicists living in the
Philadelphia region compared to 21,000 in Bos­
ton. In addition, the number of engineers in both

fruitful way of improving the region’s environ­

areas grew at about the same speed between
1950 and 1960. This manpower pool is potentially





These community efforts are aimed at the most
ment for formation of new firms. They are be­
ginnings in the opening of new channels of com­
munication among the scientific, university and

a valuable source of scientific entrepreneurs and

financial communities of the area. A better under­

of new R & D firms in the Delaware Valley.

standing and appreciation of the symbiotic rela­

In the past few years the Philadelphia com­

tionship of these three groups can provide the

munity has become increasingly aware of the
importance to its economy of home-grown sci­

stimulating and supportive environment Philadel­
phia needs to become a more fertile seed-bed of

ence-based companies. The area’s banks are
demonstrating greater interest in supporting new

science-based industry.

R & D enterprises. Bankers’ initiative helped lead
to the formation of the Southeastern Pennsyl­
vania Development Fund to fill a financing gap
for neophyte firms. A formal program is under­
way to educate local bankers in new technologies
which promise industrial growth in the region.
Recently, a number of universities in the area
have stepped up their drive for better graduate
programs in science and engineering. One ex­
ample is the program of the new Laboratory for
Research on the Structure of Matter at the Uni­
versity of Pennsylvania. This will attract grad­
uate students to the area for research into the
science of materials. The Drexel Institute of Tech­
nology is in the process of greatly strengthening
its graduate program— having received permis­
sion last year to grant doctoral degrees. The
Institute also is moving actively and successfully

The Delaware Valley firms whose founders were
interviewed in this investigation were selected by
carefully reviewing all available sources of infor­
mation on research-oriented companies. The
firms themselves then were contacted, to iden­
tify those formed during the postwar years by
persons from local universities or companies.
When such a firm was identified, arrangements
were made to interview one of its founders. No
firm refused an interview.
The Boston firms were selected similarly, but
those actually interviewed were chosen so as to
approximate the Delaware Valley firms in age,
size, industry and origin of founder— whether
from a university or a research-oriented industry.
One firm contacted refused an interview without
prior high-level contacts being established. The
required entree then was obtained prior to fur­
ther requests for interviews, and there were no
more refusals. In one case, the founder had left
to form another new firm, but granted an inter­
view nevertheless.
To insure comparability, each person inter­
viewed was asked the same questions. However,


b usin ess r e v ie w

interviews were open-ended; they averaged three
hours in length. Questions asked were based on
a thorough review of suggested hypotheses as to
why new science-based firms are established.
The questionnaire served to test the hypotheses
themselves and to determine where responses
differed between Boston and Philadelphia.
Answers to the majority of the questions did
not differ very much between the two areas. But
with respect to two questions, responses differed
strikingly. The two questions concerned the im­
portance of local universities in the formation of
new science-based firms, and the attitude of
local banks to the financing of the small sciencebased firm.
On the first issue, the interviews in every case
took off from the question, “ Do local universities
play any role in stimulating new science-based
firms?” All 13 company founders responded, as


Universities play an
important role
Universities play small role
It is possible, of course, to pick from two
areas, where opinion really does not differ on a
subject, 13 people (7 from Area 1; 6 from Area
2) whose opinions differ in such a way that all
those from Area 1 react negatively and all those
from Area 2 react positively. The probability of
this occurring accidentally (that is, solely as a
chance event) is .00058. In other words, in 13
cases, chance alone would produce so violent
a difference, when in reality opinions in each
area were split the same way, only once in 1716
tries (58 times in 100,000 tries).
The financing issue was opened with the ques­
tion, “What is the attitude of local banks to
financing for the small, science-based firm?” One
company founder in Boston disclaimed current
knowledge on the subject; accordingly, there
were 12 responses, as follows:


Attitude “good” or
Attitude “ unreceptive,”
“ poor” or “bad.”
The probability of accidentally picking 12 peo­
ple from two areas where opinion really does not


differ on a subject (7 from Area 1; 5 from Area
2) and finding that all those from Area 1 react
negatively and all those from Area 2 react posi­
tively, is .00126. That is, chance alone would
produce so violent a difference in 12 cases, when
in reality opinions in each area were split the
same way, only once in 792 tries (126 times in
100,000 tries).
The probability that these findings are acci­
dental manifestly is extremely small; they are
one-in-a-thousand cases. Therefore, in all prob­
ability they reflect either real differences of opin­
ion on these points in the two areas, or else they
reflect bias either in the selection of firms or in
the way the interviews were conducted.
The method of selecting firms has been out­
lined; lists were assembled, firms were contacted,
and when one met the criterion of being a spin­
off from a Delaware Valley university or industry
its founder was interviewed. Boston firms were
selected by trying to match characteristics of the
local firms that had been interviewed. These
selection procedures were imposed by the diffi­
culty of enumerating the total population of spin­
off firms in each area. This selection method
does not satisfy all the conditions of a random
procedure, so it is possible that it favored “ nega­
tives” in Philadelphia and “ positives” in Boston.
There is nothing in the way firms were selected
to support such a contention, however. Arguing
against it is the fact that on all issues except
universities and financing, the responses from
the same persons failed to show statistically sig­
nificant differences; that is, such differences as
did materialize between the two areas were well
within the range expected on the basis of chance
The interviews were kept comparable by em­
ploying the same questionnaire and interviewer
in each. Company founders expressed them­
selves freely and at length. It is possible that
they were led to express opinions contrary to or
more highly colored than their real ones— nega­
tively colored on the one hand and positively on
the other. The investigation was so designed as
to guard against this happening, however.
The findings, therefore, probably did not arise
by accident or from controlled selection or con­
trolled responses, though this is not certain. If
none of these factors determined the results,
then they reflect real differences between the
areas on the two questions.

by David P. Eastburn

As credit demands press harder and harder on

on the same basic forces that have shaped its past.

supplies, a recurring question in board rooms

As chart 1 also shows, putting the question in

and executive dining rooms of commercial banks
is “ how high can the loan/deposit ratio g o ? ”

investments gives the same general picture as

Bankers look at a ratio of 62 per cent for all

loans as a percentage of total deposits. This is a

commercial banks and ratios of 70 per cent and
above for many individual banks and conclude
that the ceiling can’t be very far away.*

much more fruitful way of looking at the question
because the most important factor determining

terms of loans as a percentage of total loans and

Older bankers with long memories, of course,
may recall even higher ratios back in the 1920’s. As


chart 1 shows, the ratio for all commercial banks
was just under 80 per cent early in the twenties,
and at the end of the decade was still as high as

The LOAN/DEPOSIT RATIO has experienced two
broad swings in the past 45 years— declining
from 1920 to 1944, and then rising since World
War II. The ratio of loans to loans and invest­
ments has moved generally the same way.

70 per cent. But memories tend to be short, and
as top positions of more and more banks are


taken by younger men whose experience is limited
to post-Depression years, the present ratio is, to
all intents and purposes, a new peak. The broad
rise from 17 per cent in 1944 to 62 per cent today
seemingly just can’t continue at the rate it has
been going.
What has moved the ratio in the past?

The future of the loan/deposit ratio will depend
*Some calculate the ratio by deducting uncollected
items from deposits and expressing loans as a percentage of
“ adjusted” deposits. This produces a ratio for all com­
mercial banks of 67 per cent.


b usin ess r e v ie w



MERCIAL BANKS help to explain ups and downs
in the loan/deposit ratio. The rise in the ratio
in recent years results from the increase in loans
relative to Governments and municipals held by

Changes in earning assets of banks are strongly in­
fluenced by changes in NET PRIVATE AND PUBLIC
DEBT OUTSTANDING. As private debt has expanded
in recent years relative to Federal and state and
local government debt, much of this private debt
has found its way into bank portfolios in the form
of loans.

Billions of Dollars

*“ Other securities.”











e— estimated.

the loan/deposit ratio is the kinds of assets bank­
ers decide to put their funds into. As chart 2
shows, bankers ever since World War II have

commercial banking. But in a broad sense, their

chosen to acquire loans rather than Federal

which they have little or no control. Among these

Government securities. This accounts for the

are wars and the general state of the economy.
These affect the banker’s decisions by influenc­

broad rise in the loan/deposit ratio during that

decisions are made for them by events over

period. The broad decline through the 1930’s and

ing the kinds of instruments available for him to

World War II was caused by the opposite move­

acquire. Trends in major types of debt outstand­

ment—acquisition of Government securities at a

ing in the economy, presented in chart 3, show a

rate greater than loans. Bank holdings of munic­

striking similarity to trends in bank assets in

ipal securities were a relatively neutral factor
during most of the earlier period, but after World

chart 2. During the Depression and World War

War II began to become more important and in

rapidly than private and state and local govern­

the last five years have really spurted.*

ment debt. As bankers took large amounts of
Federal Government securities into their port­

Individual bankers consider many things in
deciding the kinds of assets to acquire, and in
this, of course, lies much of the art and skill of

II, Federal Government debt increased more

folios, this kind of instrument became a much
larger proportion of total earning assets.
In the postwar period, on the other hand,

* Throughout this article, data on municipal securities
actually are “ other” (i.e., other than Federal Government)
securities held by banks. Municipals constitute the great
bulk of “ other securities.”


bankers have responded to, and indeed contrib­
uted to, the tremendous surge of the private
economy. Their acquisitions of loans have been

b usin ess re v ie w

part of the process which has generated such a

The picture is much more complicated than

rapid increase in private debt. In contrast, growth

this, of course, but here let’s consider only one

of Federal debt has been relatively limited and

refinement. This has to do with the share of out­

helps to explain the decline in bank holdings of

standing debt which commercial banks, vis-d-vis

Government securities. The expansion in state

other investors, acquire. Chart 4 shows commer­

and local government debt has offered more

cial banks’ share of outstanding debt since 1920.

opportunities for hanks to acquire this type of

It indicates that banks in recent years have


acquired a rising share of private debt, but a

In broad terms, then, the types of assets which

declining share of Federal Government debt. An­

bankers decide to hold have been influenced

other way of putting this is that the ratio of loans

strongly by the types of debt instruments avail­

to loans and investments and the ratio of loans to

able. When Federal Government debt has risen

deposits have grown even faster than one would

more rapidly than state and local and private

expect simply on grounds of the growth in out­

debt, banks have acquired Government securities

standing debt; bankers have hurried the trend

relative to other assets. When, as in the postwar

along in recent years by acquiring an increasing

period, private debt has risen more rapidly than

share of outstanding private debt.



banks have increased the

importance of loans relative to investments. This
fact, probably more than anything else, explains
the behavior of both the ratio of loans to loans
and investments and the ratio of loans to deposits.

Outlook for 1970

This review of forces at work in the past brings
us back to the question posed at the outset: how
much higher can the loan/deposit ratio go? With­
out making any predictions, it is possible to figure


how high it might go by, say, 1970, assuming cer­

DEBT also helps to explain behavior of the loan/deposit ratio. In the past few years, banks have ac­
quired a larger share of outstanding private debt,
thus pushing up the loan/deposit ratio even faster
than would have resulted from shifting debt patterns

tain conditions. These conditions involve: (1)
trends in the various kinds of debt outstanding;


(2) commercial banks’ share of that debt. Some
of the many possible assumptions that could be
made are shown in the table on the next page.
In the first column, we assume simply that
trends continue as they have been going in recent
years. Private debt would keep rising very rapidly
and commercial banks would continue to get
a rising share of it. State and local government
debt also would rise rapidly, and the commercial
bank share would expand at the exceptionally
fast rate of recent years. While Federal Govern­
ment debt also would rise, commercial banks
would reduce their share, as they have been doing

e— estimated.
* Ratio of “ other securities” to state and local govern­

ment debt.

for some time.
Any banker who expects things to keep going
as they have been, in other words, can get an


b usiness r e v ie w

O utstanding debt—

trend of
recent years

Federal Governm ent
State & local
ern m ent

tren d


C om m ercial bank share
Private debt
Federal G overnm ent
State & local gov’t



fa st as in
fa st as in
fa st as in

3 as

assumed to keep growing at the recent rate and
commercial banks do not reduce their share of
it quite so rapidly. State and local government
debt would also continue to rise as fast as it
has been, but commercial banks would not in­
crease their share of it quite so rapidly. Given
these assumptions, the loan/deposit ratio would

fa st as in
fast as in
fa st as in

3 as
A as
3 as

Ratio of lo an s/lo a n s &
investm ents
7 0%
Ratio of loans/deposits*
* Estim ated from relationship to ratio of lo an s/lo a n s &
investm ents in recent years.

come out to about 64 per cent.
Bankers who foresee other possibilities will
get other loan/deposit ratios. More extreme
assumptions would tend to produce more extreme
results. But the odds are against either extreme
— either a very high, or very low ratio-—as we
look ahead. A very high ratio would suggest
boom conditions in the private economy until
1970, with commercial banks extending their

idea of the loan/deposit ratio in 1970 by looking
at the bottom of the first column. This shows a

competitive position; at the same time, municipals
and Governments held by banks would have to

ratio of about 66 per cent. This, of course, is

increase much more slowly or decline relative to

higher than the ratio today. But it is not as high
as one would expect simply by projecting the

loans. While these conditions are possible, they
don’t appear to be the most likely.

trend of the loan/deposit ratio in recent years.
The reason, primarily, is the very rapid growth

of any size is quite remote. As chart 1 shows,

It seems still clearer that a decline in the ratio

to continue for the next several years, municipals

the ratio has not dropped consistently and sub­
stantially since the 1930’s and World War II.

would become an increasingly important part of

The only developments which could bring about

of municipals in bank portfolios. If this were

bank earning assets and tend to hold down the

such a drop would seem to be an international

rise in the loan/deposit ratio.*

crisis or a depression. Either of these would

The second column is intended for those
bankers who may not be content to assume

require a major step-up in Federal Government
spending which would produce a large flow of

simply a continuation of recent trends. In this

Government securities into commercial banks.

column, we assume that private debt will not rise

The greater likelihood is that the loan/deposit

as rapidly as it has been, nor will commercial

ratio will rise higher by 1970 than it is now, but

banks increase their share of it as rapidly. On

not as fast as it has in recent years.

the other hand, Federal Government debt is
In the shorter-run
* Municipals would rise from 14.7 to 18.0 per cent of

total earning assets. The importance of assumptions
about the behavior of municipals is illustrated by the
fact that if all trends are assumed to continue as in
recent years except that commercial banks’ share of
municipals is assumed to level off at the present per­
centage, then the loan/deposit ratio would rise to 68.5
per cent.


Of course, 1970 is still some time away. In
shorter periods the loan/deposit ratio responds,
more than anything else, to fluctuations of the
business cycle. As chart 5 shows, the ratio rises
during economic expansions and declines during

b usin ess re v ie w

ness cycles explain short-run changes in the
loan/deposit ratio. Banks move into Governments
when loan demand falls off in recessions (shaded
portions) and out of Governments when loans pick
up again.






Their holdings of municipals have tended to grow
more steadily, picking up in recent years as
banks have sought higher-yielding investments.
What this look at cycles indicates is that on
top of the longer upward drift of the loan/deposit

Per Cent

ratio are superimposed particularly rapid spurts
during periods of strong credit demand, such as
the present. It is during these periods that con­
cern about the ratio mounts. Bankers see their
holdings of more risky and less liquid assets
rising and their holdings of less risky and more
liquid assets declining. As they look ahead to
still further demands on their resources, they
examine their risk and liquidity positions more
and more closely and. tend to become more selec­
tive in meeting further demands.
Bankers may not find much comfort, there­
fore, in the longer-run projections presented
above. Nor are they urged to. Sometime in the
future they may look back on today’s ratio and
regard it as fairly comfortable. Bankers have
changed their views about customary levels

Shaded areas represent periods of recession.

of the ratio in the past and may well change
them again in years to come.
But right now, and looking to the immediate

(shaded portions). The reason, of

future, they feel squeezed by the rising ratio.
To the extent this feeling induces them to look

course, is that loan demand is strong when busi­
ness is good. At the same time, supplies of funds

twice at demands for credit, it serves a useful
purpose of relieving pressures in our current

get tight and, in order to meet needs of their

full-employment economy.






Third Federal
Reserve District

Per cent change


United States

Per cent change


Mar. 1966



Mar. 1966





+ 2
Electric power consumed + 10
Man-hours, total* .......... + 1
+ l
+ l
CONSTRUCTION** .............. +46

+ 8
+ 5
+ 4
+ 9
+ 3



+ 9


Per cent
March 1966

Per cent
March 1966







Per cent
March 1966

Per cent
March 1966





+ 9
Wilmington .....



+ 4

Trenton ............
+ 11
+ 10

(All member banks)
Deposits ............................... — 1
Loans ..................................... + 2
Investments ....................... - 2
U.S. Govt, securities .... — 4
Other ................................... + 1
Check payments*** ........ + 4f

+ 4
+ 10
- 1
+ 12



+ 2
- 2
— 4
+ 4

+ 6
+ 14
- 9
+ 11
+ 16



+ 4

-1 6



+ 8


+ 1

+ 3




+ 8


+ 1

+ 10

+ 3

+ 11

— 2

+ 13

+ 1

+ 7

+ 1

+ 3

+ 2

+ 9

+ 4

+ 15

+ 1

-3 1

+ 1

+ 1

+ 4

+ 2

+ 4

+ 9

— 1

+ 2

Lancaster ..........

+ 1

+ 7

+ 2

+ 14

+ 9

+ 17

+ 1

+ 10

Lehigh Valley ..

+ 1

+ 1

+ 4

+ 4

+ 3



+ 5


Philadelphia .....


+ 4

+ 1

+ 10

+ 7

+ 19

Reading ............


+ 4

+ 1

+ 9



+ 12


+ 6


+ 6
+ 10



‘ Production workers only
“ Value of contracts
‘ “ Adjusted for seasonal variation

+ 3t

+ 2f


+ 4
+ 3

+ 4
+ 2

tl5 SMSA’s

Scranton ..........


+ 5

+ 3

+ 12



+ 15

— 1

Wilkes-Barre ....


Altoona ............

+ 16
+ 18

Johnstown ........

+ 12
+ 14



Harrisburg ........

+ 5



+ 1

+ 2

Atlantic City ....

+ 2

+ 4

+ 2

+ 10

— 2

+ 14

+ 1

+ 9

York ..................


+ 5

+ 1

+ 13


+ 8


+ 4


‘ Not restricted to corporate limits of cities but covers areas of one
or more counties.
“ All commercial banks. Adjusted for seasonal variation.
‘ “ Member banks only. Last Wednesday of the month.

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