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a n e c o n o m ic re v ie w b y th e F e d e ra l R eserve B a n k o f Chicago Bank holding company review 1973/74 - P a r t i Contents The pace o f holding com pany expan sion experienced a m ild setback in 1974 after more than doubling in | 1973. The reduced level o f holding com pany activity can be attributed largely to the Board o f Governor's increased denial rate and to depressed prices o f bank stocks. 1974 disinterm ediationdistrict impact Regulatory changes designed to reduce the m agnitude o f disinterm ediation undoubtedly facilitated a reversal o f the process in late 1973 and early 1974. 3 11 Subscriptions to Business Conditions are available to the public free of charge. For information concerning bulk mailings, address inquiries to Research Department, Federal Reserve Bank of Chicago, P. 0. Box 834, Chicago, Illinois 60690. Articles may be reprinted provided source is credited. Please provide the bank’s Research Department with a copy of any material in which an article is reprinted. Business Conditions, February 1975 3 Bank holding company review 1973/74 - Part I For word: The historical developm ents leading to the 1970 am endm ents to the B ank H olding C om pany A ct o f 1956—and the consequences that flowed from the Federal Reserve S ystem ’s im plem entation o f the am endm ents as o f year-end 1972 — are discussed in detail in “B ank holding com panies: a n o v erview ,” B u sin e ss C o n d itio n s , A ugust 1973. This article traces m ajor developm ents in hank holding com pany activity in 1973 and 1974. Part II is scheduled to appear in the April issue o f B usiness Conditions. The last few years have witnessed not only an increase in the number o f bank holding com panies and their dom ination o f Am erican banking, but also a substan tial increase in the number o f financially related fields that bank holding companies have entered. A s the bank holding com pany m ovem ent has matured, however, some fundam ental changes in the direc tion and speed o f holding com pany expan sion have becom e apparent. A reduction in bank holding com pany activity occurred in 1974 and was due largely to the im plementation o f a “ go slow ” policy by the Board o f Governors—a policy reflected in the increased number o f denials o f holding com pany applications issued by the Board last year—and to a drastic decline in the price o f bank stock, which presumably added to the difficulty o f acquiring other banks and bank-related companies. P e r m is s ib le n o n b a n k a c tiv itie s One o f the forem ost responsibilities o f the Board o f Governors o f the Federal R eserv e System in regulating bank holding com panies is determining which nonbank activities are “ closely related to banking” as specified in Section 4(c)(8) o f the 1970 amendments to the Bank Holding Com pany Act. A s 1973 opened, the Board had approved 16 general classes o f non bank activities as being permissible for bank holding companies, had denied seven specific activities, and was still weighing the merits o f five activities. In late 1973 and early 1974, three o f the “ pending” ac tivities were added to the permissible list. C o u r ie r s e r v ic e . In November 1973 the Board permitted holding companies to perform courier services under an exten sive set o f limitations and conditions specifically designed to enhance competi tion. Bank holding com panies are now allowed to transport materials o f limited intrinsic value for which the time element is critical (such as cancelled checks) provided that the services are performed on an explicit fee basis, are profit oriented, are paid for directly by the customer, and are made available to the holding com pany’s competitors at the same rates the h o ld in g com p a n y charges its other customers. Without restrictions, some bank holding com panies m ight have been able to offer courier services free or below cost in an effort to promote other profitable services. This practice could have driven existing courier firm s out o f business and w o u l d h a v e c o n s t i t u t e d u n fa ir competition—unfair in the sense that ex isting firms would have lost customers for reasons other than their econom ic efficien cy or the pricing and quality o f their product. In the same order, the Board stated that the evidence submitted in support o f 4 allowing holding com panies to provide ar m ored car service was inconclusive. However, the Board left open the possibili ty that new or additional evidence m ight be persuasive enough to warrant adding armored car services as a permissible ac tivity at a later date. M a n a g e m e n t c o n s u l t i n g . By statute, bank holding com panies have been permitted to provide m anagem ent consulting services to their affiliated banks since 1956. Section 4(a)(2) o f the original Bank H olding Com pany A ct per mitted a bank holding com pany to furnish or perform services for any bank o f which the holding com pany owned or controlled at least 25 percent o f the voting shares. Effective February 26,1974, the Board ex panded this activity by am ending Regula tion Y to permit bank holding com panies to provide m anagem ent consulting services for nonaffiliated banks. In two orders on June 5,1972, the Board ruled that the per form ance o f general m anagem ent con sulting was not a proper incident to bank ing and added that activity to the proscrib ed list. Several restrictions were placed upon the w ay in w hich m anagem ent consulting services m ight be provided to nonaffiliated banks so as to minimize, if not eliminate, the potential for unfair competitive prac tices. Holding com panies m ight provide managem ent consulting advice to banks on a n o n co n tin u in g basis provided that: neither the holding com pany nor its subsidiaries had an equity interest in the client bank; no interlocking officer, direc tor, or employee relationship existed with the client bank; the m anagem ent advice is rendered on an explicit fee basis; and the names o f all banks affiliated with the holding com pany and all clients that m ay compete with the potential client bank be disclosed. In the absence o f these restric tions, it m ight have been possible for a bank holding com pany to exercise control over banks without any ownership interest Federal Reserve Bank of Chicago and without prior Board approval, as re quired by the act. L e a s in g o f r e a l p r o p e r t y . In April 1974, when the Board added leasing real property to its permissible list, it also amended the existing restrictions on the leasing o f personal property in order to make all leasing restrictions more com parable. The m ain purpose o f the restric tions is to make the holding com pany’s ownership o f the leased property inciden tal to the credit transaction, thus m ain taining the holding com pany’s role as a financial intermediary. Restrictions com mon to both types o f leasing include the stipulations that: the lease be the func tional equivalent o f an extension o f credit; the property be acquired for this or an earlier lease; the property be leased on a nonoperating basis; the lease be o f the full payout type; the maxim um term be 40 years; the property be re-leased within two years o f the expiration o f the lease; and the lessor not retain any interest in the proper ty for a total o f more than 50 years. P e n d in g a c tiv itie s Late in 1974 the Board determined th a t tw o oth er a ctivities—m ortgage gu a ra n tee in su ra n ce a n d operating savings and loan associations—should re main on the “ pending” list although they were closely related to banking. Both o f these activities had been under considera tion for a rather long period o f time, and in each instance the Board did not specifical ly proscribe the activity. In fact, the Board declared both activities to be closely related to banking within the m eaning o f Section 4(c)(8), but said that the public in terest would not be served by permitting bank holding com panies to perform these activities “at this tim e” (emphasis added). The Board’s reluctance to approve ac tivities that it had determined were closely related to banking and that m ight produce net public benefits if performed by bank Business Conditions, February 1975 holding com panies represented a definite departure from previous Board attitudes. It is interesting to compare the concluding statement in the Board’s order declaring th a t the u n d erw ritin g o f m ortgage guarantee insurance would not be an ap propriate activity at that time with an earlier statement by the Board regarding bank holding com pany expansion and diversification. In its September 9, 1974 order focusing on m ortgage guarantee in surance, the Board stated: . . . the Board believes that these are times when it would be desirable for bank holding com panies generally to slow their present rate o f expansion and to direct their energies principal ly to w a rd stron g and efficient op e ra tio n s within their existing modes, rather than toward expansion into new activities. This is particular ly true with regard to expansion into a new area such as private m ortgage in su ra n ce in v o lv in g uncertainties which are sufficient in the Board’s view to outweigh at the present time the public benefits that m ight be ex pected to result from this proposal. While not representing a 180-degree turn in position, this statement does represent a very different philosophy from that ex pressed in the Board’s Statement o f Prin ciples o f February 20, 1969: . . . consistent with continued growth and developm ent o f a dynam ic and in c r e a s in g ly co m p le x econ om y, banks should be granted greater freedom to innovate new services and p roced u res, either directly, . . . or through affiliates in a holding com pany system. . . . Bank holding com panies should be allowed to enter cer ta in n o n -b a n k in g areas o f ac tiv ity . . . w h ich would facilitate broader services for the public. . . . The 1970 amendments to the Bank 5 H olding Com pany A ct brought about a fundamental change in the nature o f bank ing [and in regulators’ views o f banking] since they created the “ need for bank m anagem ent to m ove away from thinking altogether like bankers, and to think, in stead, like corporate m anagers looking out over a related set o f businesses which in cludes one or more banks . . -” 1 Recently, however, views expressed by the Board suggest that bankers should devote more time to the business o f banking and, at least in the near future, give reduced priori ty to expansion into new areas. This does not im ply that the Board has closed the permissible list to new additions; indeed, in September 1974, the operation o f travel agencies was added to the list o f activities under consideration. But until the Board signals that conditions have improved suf ficiently to warrant a resumption o f bank holding com pany expansion, the banking industry will have little incentive to ex plore new fields o f activity. F u tu re p e r m is s ib le a c tiv itie s A prediction o f how much time will elapse before the Board shifts its stance on new holding com pany activities is com plicated by the fact that some disagree ment exists am ong Board members as to whether expansion by all bank holding companies should be constrained because o f the growth-oriented nature and finan cial philosophy o f some. The dispute centers upon whether the permissible list should be closed to new activities until an e m e r g in g i n d u s t r y tr e n d tow a rd deteriorating capital ratios is clearly reversed. Alternatively, in ruling on new activities, the Board could discriminate against just those holding companies that have significantly leveraged their equity 'J e ffre y M. B ucher, “ B an kers and the B a n k H o ld in g C o m pa ny,” speech before the 79th A n n u a l C o nve ntion o f the F lo rid a B an kers A ssociatio n, B a l H a rb o r, F lo rid a , Jun e 23, 1973. Federal Reserve Bank of Chicago 6 capital position through heavy reliance on debt, particularly short-term debt. In a landm ark denial, the Board, con ceding that operation o f a savings and loan association was closely related to banking, concluded that bank holding companies should avoid adding to their debt burden by acquiring leveraged com panies requiring periodic infusions o f capital. Two Governors, while concurring in that specific denial, said that the Board was espousing too broad a principle in im posing such a requirement on all holding companies. More specifically, Governor Philip E. Coldwell stated: . . . conservatively-m anaged bank holding com panies without signifi cant debt should n o t . . . be denied op portunities for expansion o f which they have not previously availed themselves. The Board apparently chooses to apply its so-called “ go slow ” policy across the board without discrim inating between leveraged and n on-leveraged holding com panies in order to avoid confusion in the industry as to the scope o f the policy. In m y view, it is our respon sibility to examine each holding com pany’s application on a case by case basis and to acknowledge differences am ong non-leveraged and leveraged holding com panies.2 If the Board were to adopt Governor Coldwell’s more lenient view as an induce ment to highly leveraged holding com panies to augment their equity capital, the number o f permissible nonbank activities should continue to grow. Nevertheless, the growth rate would be m uch slower than in the past because all o f the obviously per missible activities have been approved. ^“Concurring Statement of Governor Coldwell,” Board Order of November 4, 1974 denying the application of American Fletcher Corporation, In dianapolis, Indiana, to acquire the Southwest Savings and Loan Association, Phoenix, Arizona. Activities A PPR O VED by the Board 1. Dealer in bankers’ acceptances 2. Mortgage company 3. Finance company 4. C redit card company 5. F actoring company 6. O perating an in d u s tria l bank 7. Servicing loans 8. T rust company 9. A dviser to real estate investm ent trusts and other investm ent companies 10. General economic in fo rm a tio n and advice 11. Portfolio investm ent advice 12. F ull pay-out leasing o f personal property 13. F u ll pay-out leasing o f real property 14. C om m unity welfare investm ents 15. Bookkeeping and data processing services 16. Insurance agent or broker in connection w ith credit extensions 17. U n d e rw ritin g credit life and credit accident and health insurance 18. Courier service 19. M anagem ent banks consulting to n o n a ffilia te d 20. Sale o f travelers checks 21. B ullion broker Activities DENIED by the Board 1. E qu ity fun din g (combined sale o f m utual funds and insurance) 2. U n d e rw ritin g general life insurance 3. Real estate brokerage 4. Land development 5. Real estate syndication 6. General m anagement consulting 7. Property management Activities UNDER CONSIDERATION by the Board 1. Arm ored car services 2. Mortgage guarantee insurance 3. Savings and loan associations 4. T ravel agencies 5. U n d e rw ritin g and dealing in U.S. G overn m ent and certain m u n icip a l securities Business Conditions, February 1975 Slower holding company expansion After m ore than doubling in 1973, the pace o f bank holding com pany expansion across the nation experienced a mild set back in 1974. Much the same experience h eld for th e Seventh District. The diminished volume o f holding com pany ac tivity can be attributed largely to the Board’s increased denial rate and depress ed stock prices. The total number o f bank holding com pany and merger applications acted upon by the Federal Reserve System in 1974 fell slightly—from 717 in 1973, to 671 in 1974, a 6.4 percent decline.3 In the latter period the proportion o f bank holding com pany and merger applications denied by the Board— the “ denial rate” —increased significantly, up from 4.3 percent in 1973, to 7.1 percent in 1974.4 The denial rate o f bank holding com pany form ations rose dram atically, from less than 1 percent in 1973 to more than 10 percent in 1974; for acquisitions o f an ad ditional bank the denial rate was virtually unchanged, declining from 4.5 percent in 1973 to 4.4 percent in 1974. For nonbank a c quisitions the Board’s denial rate in creased slightly, from 6.9 percent in 1973 to 8.6 percent in 1974. Careful analysis o f the orders issued by the Board in 1973 and 1974 reveals noticeable changes in the Board’s attitude concerning two issues: capital adequacy and potential competition. Largely as a result o f the Board’s increasingly strict views on these two matters, the denial rate 'The number of applications processed by the System includes applications acted on by the Board or by the Reserve banks under delegated authority un der Sections 3(a)(1), 3(a)(3), 3(a)(5), 4(c)(8), and 4(d) of the Bank Holding Company Act and under the Bank Merger Act. Excluded from the totals shown are Reserve bank actions on 4(c)(8) de novo notifications and System actions on 4(c)(12) notifications. 'The 4.3 percent denial rate in 1973 was unusual ly low by historical standards. In 1966 and 1967, the Board’s denial rate exceeded 10 percent; from 1968 to 1970, the denial rate rose from 5.1 to 6 percent, rising again in 1971 to 7.9 percent, and in 1972 to 9 percent. 7 has increased, m any applications have been withdrawn prior to Board action, and an unknown number o f applications that might otherwise have been filed have never been written. The issue o f “ capital adequacy,” rais ed by the continuing decline in the capital ratios o f banks and bank holding com panies, has alw ays been o f m ajor concern to the Board. This concern has led to the Board’s recent implementation o f a “ go slow ” policy—a policy that has been effec tive in slow ing all forms o f holding com pany expansion by sharply reducing the probability o f approval o f any acquisition that would add significantly to a holding com pany’s debt burden. Not only has the Board’s attitude shifted with regard to banking factors—in particular, the issue o f capital adequacy— but the Board appears to have revised its treatment o f competitive factors as well. In 1973 and 1974, the Board demonstrated substantial concern with potential and probable future competition. The Board recently denied several applications where no existing com petition existed between the applicant and the bank or nonbank com pany to be acquired but where, it believed, potential and probable future competition would be adversely affected. W holly aside from these changes in the Board’s attitudes, holding com pany ac tivity declined in 1974 for another reason— the decline in the price o f bank stock. The magnitude o f the decline in the value o f holding com pany shares, especially those o f the nation’s largest bank holding com panies, is evidenced by the 40 percent decline in the Salom on Brothers 22-Bank Index in 1974. During the same period, the Standard and P oor’s Index o f 425 in dustrials declined 30 percent. For the purpose o f comparison, an un weighted index o f bank stock prices was compiled for 33 banks having deposits on June 30, 1974 o f less than $100 million. In 1974 the price o f these banks’ shares 8 declined 15.4 percent, which suggests that on average, the shift in the relative price o f stocks o f large and small banks made the latter feel worse o ff at the originally agreed-upon exchange ratio. This evidence supports frequently made statements that applications were withdrawn or not filed when the relative change in stock prices made it im possible to renegotiate ex change ratios which would satisfy both the buyer and seller. Indeed, in a few in stances, transactions were not consum mated even though the applications had been approved by the Board o f Governors. In 1974, 46 applications to acquire banks and bank-related com panies and 34 de novo notifications to enter nonbank ac t iv it ie s w ere w ith d ra w n .5 N ot all withdrawals were the consequence o f changes in the price o f holding com pany stock. Some applications were withdrawn when it becam e obvious that the Board w ou ld d en y them b e ca u se sim ilar a p p lic a tio n s h a d been denied. The withdrawal o f applications that have a very high probability o f being denied tends to hold down the Board’s denial rate. This rate would be expected to decline over time as holding com panies learn by experience w hat factors the Board considers adverse and thus avoid the time and expense o f fil ing applications deemed to have a high likelihood o f denial. It is only recently that the im portance o f changes in Board policy—which caused some applications to be withdrawn and discouraged others from being filed—has been realized. R ecogni tion o f the im portance o f this effect should serve as a w arning against relying solely upon the denial rate as an index o f the restrictiveness o f Board policy. Nonbank acquisitions There was a m odest shift in 1974 in the im portance o f certain nonbank activities 5Data from the Board’s H.2 release, “Applications and Reports Received or Acted on by the Board.” Business Conditions, February 1975 Federal Reserve Bank of Chicago entered by the acquisition o f going con cern s. W h erea s fin a n c e co m p a n ie s overw helm ingly dominated nonbank ac quisitions in the nation in 1973, such a c quisitions m aintained their lead position by only a slight margin last year. Com m ercial and consumer finance are areas obviously ripe for bank holding com pany participation. Banks typically con centrate extensions o f business and con sumer credit at the short and intermediate range o f the maturity spectrum, just as fin a n ce com panies do. The primary difference between banks and finance com panies is with respect to the creditworthiness o f the customers they serve, with finance com panies specializing in higher risk loans. Historically, it has been considered inappropriate for banks to utilize depositors’ funds to make high risk loans o f the type that would be made by finance com panies. A finance com pany subsidiary o f a bank holding com pany usually relies upon the resources o f its parent com pany or upon its own nonbank resources to supply its w orking capital; thus, it can extend riskier loans than its bank affiliate w ithout arousing regulatory concern. Through its finance com pany subsidiary, the holding com pany is able to increase its share o f the consumer or business credit market by developing relationships with clients that its bank subsidiary formerly had turned away. Thus, the finance com pany industry has proven to be a natural extension o f the activities performed by holding companies. Acquisitions o f m ortgage banking firms accounted for the second largest proportion o f nonbank acquisitions in 1973. In 1974 m ortgage banking fell to third place, while insurance agencies took over second place am ong acquisitions re quiring Board approval. The increase in the number o f insurance agency ac quisitions reflects two unrelated forces. First, m any holding com pany form ations and bank acquisitions in 1974 involved small banks in rural communities. In m any instances these banks had an in surance agency affiliate—often the only local source o f insurance. A s these banks were acquired by holding com panies, the insurance agency was acquired also. The second factor was that a large number o f insurance agency cases had been held in abeyance (since early 1972) pending the outcome o f hearings requested by the N ational A ssociation o f Insurance Agents 9 and others. Applications that the Board (or in these instances, the appropriate Reserve bank) otherwise would have acted upon in 1972 and 1973, had no objections been rais ed by third parties, were not approved by the Board until 1974.H District developments Within the five states o f the Seventh Federal Reserve District—Illinois, In diana, Iowa, M ichigan, and W isconsin— M ichigan alone accounted for slightly more than one-third o f all bank holding co m p a n y fo r m a tio n s and bank ac quisitions in 1974. (M ichigan law forbade corporations from ow ning banks until April 1971.) Probably due to an increased number o f denials, the number o f applications from holding com panies in the district ceased to accelerate in 1974. The denial rate on applications filed by holding com panies in th e d i s t r i c t in cre a s e d ev en m ore fiMany of the insurance agency applications acted on by the Board in 1974 involved de novo entry. The Board decides such cases, rather than the Reserve bank acting under delegated authority, whenever substantive objections are raised by a member of the public. Number and deposits of banks in holding companies in the Seventh District 1972 1971 Number o fb a n k s 135 Illinois 22 Indiana 147 Iowa Michigan 19 127 Wisconsin *As of June 30,1974. Total deposits (billion dollars) 19.9 3.5 2.8 0.8 5.3 Share o f state deposits (percent) 50.1 29.3 37.2 3.7 49.6 Number - ofb a n k s mk 143 23 157 35 136 Total deposits (billion dollars) 25.8 4.4 3.3 5.8 6.1 1974* 1973 Share o f state deposits (percent) 55.9 32.3 38.9 22.7 50.0 Number o fb a n k s 146 27 168 71 144 Total deposits (billion dollars) 30.9 5.2 3.8 18.3 6.6 Share o f state deposits (percent) 58.7 34.0 39.1 67.6 50.4 Number o fb a n k s 149 28 171 81 150 Total deposits Share o f state deposits 32.2 5.3 4.0 19.6 6.8 59.4 33.7 40.7 70.4 50.4 (billion dollars) (percent) j 10 dramatically than for the nation. In 1973, 42 holding com pany form ations and 42 holding com pany acquisitions o f ad ditional banks were approved. None was denied. In 1974, however, seven o f 42 applications for holding com pany for mations and one o f 37 holding com pany ac quisitions o f additional banks by district holding com panies were denied. In the district, as in the nation, finance companies were the m ost popular nonbank activity for holding com panies in 1974, with consumer finance holding a slight edge over com m ercial finance. The second most com m only entered activity was leas ing o f both personal and real property. A c ting as an insurance agent ranked third. An analysis o f the number o f Seventh District holding com panies that have begun to perform nonbank activities since passage o f the 1970 amendments shows that last year’s pattern w as not unusual. The most frequently entered nonbank ac tivity over the last four years (1971-74) was personal property leasing. For all intents and purposes, a full payout lease is the functional equivalent o f a credit extension to a business for ac quiring capital equipment, one o f the primary lending activities o f commercial banks. In the last few years, moreover, both the lessee and lessor have accrued ad vantages from leasing not present in an or dinary loan. The leased equipment ties up none o f the lessee’s w orking capital and does not appear as debt on his balance sheet. The lessor (i.e., the bank or bank holding com pany), being the owner o f the equipment, benefits from being able to lessen its tax burden since it is allowed to apply the depreciation o f the equipment against its tax liabilities. These side benefits have been sufficient to induce a s i g n i f i c a n t s h ift to le a sin g from traditional form s o f credit extension. If proposed changes in accounting principles requiring leases to be capitaliz ed on the balance sheet were adopted, it Federal Reserve Bank of Chicago would reduce leasing’s attractiveness to the lessee, thus tending to m itigate the growth o f leasing in the future. It is noteworthy that although real property leasing has been permissible for less than one year, seven holding com panies in the district are engaged in this activity; presumably, real property leasing would have ranked higher had it been per m issible for a longer period. While the number o f banks affiliated with holding companies in the district states continued to expand in 1974, the rate o f expansion trailed that o f previous years. The rate o f growth o f the number o f holding com pany banks increased from 5.4 percent in 1971, to 9.8 percent in 1972, to 12.6 percent in 1973. Last year, however, the acceleration in the rate o f expansion came to a halt as the number o f bank sub sidiaries o f holding companies in the five states increased at an annual rate o f just under 10 percent. More than 40 percent o f the expansion in the number o f banks af filiated with holding companies in the five states during the first h a lf o f 1974 took place in M ichigan. The im portance o f holding com pany banks in M ichigan’s banking structure cannot be overstated. At year-end 1971, the 5.7 percent o f M ichigan banks that were subsidiaries o f holding com panies controlled less than 4 percent o f state deposits; by mid-1974, alm ost onefourth o f all M ichigan banks—accounting for over 70 percent o f state deposits—were subsidiaries o f bank holding com panies. At the opposite extreme were Indiana and W isconsin. In both states the propor tion o f commercial bank deposits con trolled by subsidiaries o f holding com panies declined in the first h a lf o f 1974, while the number o f banks affiliated with holding com panies increased slightly. This indicates that Indiana and W isconsin banks not affiliated with holding com panies had a faster deposit grow th rate than holding com pany banks. H arvey Rosenblum Business Conditions, February 1975 11 1974 disintermediation— district impact The distortions in savings flows that result when high market interest rates attract funds away from financial intermediaries has becom e a fam iliar phenomenon. In late 1966 and again throughout 1969, time and savings deposits left commercial banks and thrift institutions only to return at a record-breaking pace when interest rates subsequently dropped. Early in 1973 efforts to restrain ex cessive credit expansion in the face o f accelerating business credit demands again drove market interest rates to levels that threatened disintermediation. To allow more effective competition for funds, the regulatory authorities modified the rules relating to time and savings deposits. Ceiling rates were suspended on large denom ination time deposits ($100,000 or more) and were raised on smaller deposits and longer maturities. Although these changes did not prevent disintermediation in the summer o f 1973 and for several m onths during 1974, they undoubtedly reduced its m agnitude and facilitated a quicker reversal o f the process. Reports by district com m ercial banks and savings and loan associations (S&Ls) indicate that in the year ending October 31, 1974: • Both banks and S&Ls realized an overall net inflow o f time and savings deposits although less than normal. • Com m ercial banks enjoyed a better and more sustained rate o f growth than S&Ls. • Large banks (total deposits $100 million or more) had more rapid growth in total time and savings deposits than smaller banks. • Expansion was m ainly in big de nom ination deposits at large banks and in consumer-type accounts at smaller banks. • A s m ark et in terest rates rose, depositors shifted small denomination time deposits out o f shorter-maturity, lower-rate accounts into longer-term, higher-yield accounts. Market yields and deposit rates Market yields have been very attrac tive relative to rates paid by banks and S&Ls on consumer-type deposits (pass b ook savings and time deposits in denom inations less than $100,000) over much o f the past two years. In early 1973 the Federal Reserve’s Regulation Q and equivalent rules for insured nonmember banks allowed a maximum o f 4V2 percent on passbook savings, and rates ranging from 5 to 5% percent on time deposits in de nom inations less than $100,000. S&L ceilings were generally V2 percent higher. By mid-1973 the market yield on 3-month Treasury bills exceeded 7 percent and was still rising. To give the financial in termediaries greater leeway to bid for funds, the authorities raised rate ceilings on most time and savings deposits. (See box.) At the same time the difference between the maximum rates S&Ls could pay over what banks could pay was re duced to V4 percent for most maturity categories. (Higher ceilings on six-year and governm ent unit deposits were not authorized until November 1974.) These adjustments in regulations still left deposits at a disadvantage relative to competing outlets for savings. Treasury Federal Reserve Bank of Chicago 12 M axim um interest rates payable on time and savings deposits, January 31, 1975 Type of deposit Banks S&Ls(l) Savings deposits 5 5 V4 Other time deposits: Less than $100,000: 30 - 89 days 5 (2) 5 l/2 90 days to 1 year 5 -'A 1 year to 2 '/i years 6 6 '/a (3) 2 '/-i years or more 6 Vi 6 :,A (3) 7 'A (3) 7 '/2 (3) 4 to 6 years 7 -A (3) 6 years or more (4) 7 '/2 (3) 7 'A 7 ■'/<(3,6) Govt, units (5) $100,000 or more No maximum No maximum (1) Some geographic variations; (2) Not permitted; (3) Minimum $1,000; (4) Effective December 23,1974; (5) Authorized November 27,1974; (6) 30 days or more. bill rates peaked at near 9 percent in 1973, receded to only about 7 percent early last year and then rebounded to a late August record near 10 percent. The summer o f 1974 also saw the emergence o f “ floating rate” notes sold by bank holding com panies, the development o f m oney market mutual funds, and high grade corporate bonds with coupons above 9^2 percent. Large certificates o f deposit (CDs over $100,000) are competitive with other money market instruments, such as un secured notes issued by large corporations (commercial paper). Ceilings on CDs maturing in less than 90 days were suspended in June 1970 to enable banks to help finance businesses unable to sell com mercial paper in the wake o f the Penn Cen tral bankruptcy. By the spring o f 1973, the banks could not compete with other money market instruments in maturity areas longer than 89 days and the rem aining rate limits on the large CDs were sus pended. (An increase in reserve re quirements to discourage excessive credit expansion financed by CDs accom panied the suspension order. These requirements were not removed until the fall o f 1974.) S&Ls also issue large denom ination CDs, but their access to such funds has been severely restricted by legal limi tations on the total amount that can be out standing and by the fact that S&L CDs have only recently become marketable. The interest-sensitivity o f deposit customers, the credit needs o f borrowers, the degree o f institutional dependence on consumer-type savings, and the aggres siveness o f competition for higher-cost money were the important factors affec ting time and savings deposit growth in this environment. The evidence on bank experience cited below is based on responses o f district member banks to the Federal Reserve’s regular surveys o f time and savings deposits on October 31, 1973 and October 31, 1974. How smaller banks fared Time and savings deposits represent about two-thirds o f total deposit liabilities at member banks in the district. A t smaller banks (total deposits less than $100 million) consumer-type deposits comprise 85 percent o f total time and savings deposits. The ability o f these banks to at tract and hold such deposits within legal rate limitations is, therefore, a m ajor factor in bank growth. A s o f last October 31, the large majority o f these banks were offering the best terms permitted under the regulations on consumer-type deposits, as indicated below: Percent o f Percent o f banks issuing issuing banks various accts. paying ceiling Passbook 99 83 O ther tim e: O rig in a l m a tu rity Less th a n 1 year 1 - 2 V i years 2 V i - 4 years 4 years or more 96 98 87 83 90 92 97 72 Business Conditions, February 1975 Despite the record interest rates available on credit market instruments, total time and savings deposits at these banks rose 11 percent in the year ending October 31,1974, compared to 7 percent in the prior 12 months. More than two-thirds o f the gain w as in consumer-type accounts. There were wide differences am ong banks, with roughly 8 percent reporting net declines in those accounts. Passbook savings kept pace with the higher paying consumer-type time de posits—each rose 9 percent. For m any savers the liquidity and convenience o f passbook savings outweigh the higher yields available on longer-term time ac counts. Outstanding consumer-type sav ings are about evenly divided between passbook savings and other time de posits—certificates and open accounts. In 1974 consumer-type time deposits with original maturities under two and one-half years declined 14 percent while those with maturities from two and oneh a lf up to four years rose 72 percent. The biggest gains were in the four-year cer tificates. These accounted for 10 percent o f all consumer-type savings at the smaller banks by the end o f October 1974—up from 4 percent a year earlier. Although big CDs rose 20 percent at the smaller banks in the 12 m onths ending October 31, 1974, they contributed only 8 percent o f the total increase in time and savings deposits during that time. More over, large deposits were less available when conditions were tightest. When big CDs were expanding strongly at larger banks, growth w as insignificant at the smaller banks, m ost o f which were unable to earn enough to cover the cost o f CD money. “ All other” time deposits, primarily owned by state and local governments, registered a 26 percent increase at the smaller banks in the year ending October 1974. The survey did not show what proportion o f these accounts were large 13 enough to be exempt from rate ceilings. In Indiana and Illinois such deposits were an important source o f growth, contributing 40 percent and 25 percent, respectively, o f the increase in total time and savings deposits. Large banks rely on CD market At member banks with total deposits o f $100 m illion or more, time and savings deposits increased 15 percent in the year ending October 31, 1974. More than twothirds o f this gain was attributable to large denom ination CDs exempt from rate ceilings. Most o f the increase occurred in the six months, M arch through August, when business loans were expanding strongly. A t the time o f the October survey, out s ta n d in g la rg e d e n o m in a tio n tim e deposits at district member banks totaled $13 billion. More than four-fifths o f these deposits are liabilities o f the very large banks in Chicago and Detroit. The slowdown in savings was most severe at large banks Deposit size Change in _ (m consumer-type Under 2550100 deposits* 25 50 100 & over (percent) (percent of member banks) Decline 5 10 13 30 Increase: 0 -5 8 18 25 29 5 - 10 20 25 37 26 10 - 15 27 27 17 11 15 - 20 14 13 6 3 20 and over 26 7 2 1 *Twelve months ended October 31,1974. Federal Reserve Bank of Chicago 14 About h a lf o f total time and savings deposits at large banks last October were consumer-type, but this proportion ranged from 34 percent in Illinois to 71 percent in Iowa and M ichigan. Branch banks, w hich are prohibited in Illinois, attract more con sumer deposits reflecting more office locations. The incentive for larger banks to pay the 5 percent m axim um rate on passbook savings appears to be related to the impor tance o f consumer-type savings in total time and savings deposits as well as by competitive conditions, other sources o f time deposits, and the interest returns available on loans. By last October 31, almost all the large Illinois and Iowa banks were paying the maxim um pass book rate compared with only h a lf o f the larger banks in Indiana and M ichigan. Many banks with a high proportion o f deposits in passbook savings form are reluctant to raise the cost o f these accounts across the board, especially when even the ceiling rate provides little deterrent to the loss o f interest-sensitive money, given the higher yields available elsewhere. Essentially all o f the larger member banks in the district were offering a full S&L deposit gains were nearly all in high-yield accounts Percent change in deposits, year ended October 3 1 , 1974 A rea Regular passbook Chicago -3 -3 Other Illinois -2 Indianapolis -2 Other Indiana + 3* Des Moines Other Iowa Detroit +1 Other Michigan - 5 Milwaukee - 1* Other Wisconsin *Less than .5 percent. SOURCE: FSLIC H igher-rate accounts +9 +15 +6 +13 +23 +20 +25 +12 +12 +19 Total +3 +8 +4 +6 +16 +12 +13 +3 +6 +10 maturity spectrum o f time certificates and open account deposits in denom inations o f less than $100,000. M ost were paying the ceiling rates on maturities up to four years. About four-fifths were paying the m axi mum allowable on four-year certificates. Total consumer-type deposits rose only 2 percent at the large banks in the year ending October 31, and provided 7 per cent o f the overall time deposit growth. In Iowa and Indiana, however, they con tributed 46 and 32 percent, respectively. The poorer experience in the m ajor finan cial centers in part reflects the greater availability o f alternative investments in those centers. As at the smaller banks, increases in “ all other” time deposits at Indiana and Il linois banks made a significant contribu tion to time and savings deposits there. Savings and loans hit harder Deposits at savings and loan asso ciations are comparable to consumer-type time and savings deposits at banks. Despite the rate edge S&Ls hold over com mercial banks, S&Ls in m ost district areas suffered substantial net outflows for several consecutive m onths o f 1974 after good gains in the first quarter. For the year ending last October, insured savings and loan associations in the five Seventh Federal Reserve District states reported a net savings gain o f 6 percent com pared to increases o f 10 percent and 15 percent in the tw o previous 12-month periods. All o f the S&L growth was in accounts paying more than the regular passbook rate. Savings in the higher rate accounts rose 14 percent. But outstandings in the regular passbook accounts declined 2 per cent, in contrast with the 5 percent com mercial bank gain. These com parisons suggest that S&L savers are somewhat m o re in te re st-se n sitiv e th a n b a n k customers. Eleanor Erdevig Business Conditions, February 1975 15 Interest-bearing deposits of individuals, partnerships, and corporations in denom inations of less than $100,000 at Seventh District m em ber banks October 31, 1974 SMSA1 Total weighted Certificates and average rate2 __________Savings__________ _______ open accounts October 31 Amounts Change from Amounts Change from outstanding year ago outstanding 1973 1974 year ago (p e r c e n t) (m illio n s) (p e r c e n t) (m illio n s) (p e r c e n t) Illinois B lo o m in g to n C h a m p a ig n -U r b a n a C h ic a g o R o ck Is la n d -M o lin e D ecatu r P e o ria R o c k fo r d S p r in g fie ld O th er S ta te tota l 5.39 5.55 5.36 5.29 5.44 5.29 5.48 5.53 5.47 5.38 5.57 5.67 5.43 5.66 5.58 5.44 5.57 5.64 5.61 5.47 36 51 5,120 133 57 146 168 126 551 6,388 +14.1 +14.4 + 1.8 + 9.9 + 6.2 + 2.1 + 4.2 + 7.5 +13.0 + 3.2 35 65 3,333 204 86 114 152 157 933 5,079 +15.8 +21.1 + 2.0 + 5.6 + 3.9 +10.9 + 3.4 + 8.0 +10.1 + 4.3 5.45 4.87 5.41 5.42 5.36 5.36 5.33 5.55 5.25 5.58 5.58 5.54 5.64 5.56 214 270 473 142 87 500 1,686 + 8.0 +31.1 + 3.3 +11.6 +23.9 + 9.8 +11.3 213 234 754 151 69 940 2,361 + 8.3 -1 2 .4 + 9.2 +11.6 +16.0 +13.6 + 8.4 5.13 5.52 5.50 5.58 5.56 5.54 5.52 5.69 5.66 5.79 5.72 5.67 5.71 5.71 54 157 51 68 41 486 857 +21.7 + 11.4 +12.2 +13.9 +16.9 +23.5 +19.1 66 154 66 85 53 1,027 1,451 + 7.2 .6 + 6.1 +18.3 + 1.9 +11.6 + 9.7 4.82 4.88 5.32 4.94 5.05 5.05 5.38 4.93 5.10 5.24 5.22 5.33 5.12 5.45 5.11 5.62 5.16 5.37 5.46 5.30 5.48 5.43 170 44 3,638 433 359 108 173 484 106 785 6,300 + + + + + + + + .6 8.8 1.9 1.9 1.6 5.9 .4 .5 1.7 6.9 1.8 105 30 2,955 184 458 65 142 384 61 742 5,126 + 3.6 + 7.2 ♦ 5.55 5.25 5.39 5.47 5.40 5.53 5.48 5.66 5.42 5.46 5.49 5.54 5.67 5.58 99 68 35 650 79 480 1,411 + 5.9 + 6.8 + 4.3 + 4.7 + 8.0 +11.6 + 7.3 120 56 62 442 71 734 1,485 + + + + + + 5.33 5.50 16,642 + 4.5 15,502 Indiana F ort W ay n e G a r y -H a m m o n d I n d ia n a p o lis S ou th B en d T err e H au te O th er S ta te tota l Iowa C e d a r R a p id s D es M o in e s D u bu qu e S io u x C ity W a te rlo o O th er S ta te tota l Michigan A n n A rb or B attle C reek D etroit F lin t G r a n d R a p id s Jackson K a la m a z o o L a n s in g S a g in a w O th er S ta te tota l +34.7 +10.6 +17.6 + 7.7 - 2.5 + 9.6 +10.8 + 3.7 Wisconsin A p p le to n -O s h k o s h K en osh a M a d is o n M ilw a u k ee R a c in e O th er S ta te tota l Seventh District 3.8 9.9 .5 1.3 1.6 4.5 3.2 + 5.1 *Less than .05 percent. '“ Other cities” include SMSAs in which there are less than three banks. Davenport-Rock IslandMoline SMSA data were disaggregated in order to include Davenport banks in the Iowa data. '^Calculated by weighting each bank’s reported offering rate by the dollar amount of outstanding balances in its corresponding deposit category. If a bank did not offer a particular type of contract on October 31, any outstanding balance in that category was excluded in calculating the weighted rate.
@FedFRASER