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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 C hicago Toward more uniform reserve requirements Banking developments m a rc h 1974 Toward more uniform reserve requirements 3 Opposition to the Board o f G overnors' efforts to achieve greater uniformity o f reserve requirements in the banking s y s tem often appears to be based on misunderstandings o f how re quired reserves serve as a link between mem ber bank reserves and the quantity o f m oney in the econom y, how the central bank determines the quantity o f assets that are specified as member bank reserves, and w hy the p res ent structure o f reserve require ments effectively im pose a tax on membership. Banking developments 13 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. O. 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, March 19 7 4 3 oward more uniform reserve requirements Late in Jan u ary, the Board o f Governors o f the Federal Reserve System submitted to the Congress a proposal that would require all types o f financial institutions whose deposits are used by the public in making m oney paym ents to hold reserves against those deposits in accordance with a schedule specified by the Board. This re quest to extend reserve requirements to n o n m e m b e r in s titu tio n s reflects in creasing difficulties in exercising effective control over the monetary aggregates in the face o f accelerated growth o f moneytype deposits at such institutions. T h e B o a r d ’s legislative proposal would require all but the smallest non m em ber co m m e rcia l banks to hold reserves against their demand deposits in the same form and am ount as banks that are m embers o f the Federal Reserve System. Savings and loan associations and mutual savings banks, as well as com m ercial banks, would be subject to reserve requirements on accounts subject to N egotiable Orders o f W ithdrawal (NOWs) w h e r e p e r m it t e d ( c u r r e n t l y o n ly M assachusetts and New Hampshire). The B oard’s proposal also asks for wider ranges within which it would have authority to change required reserve-todeposit ratios. A ll institutions meeting Federal Reserve requirements would be eligible to borrow at the discount window. Except for the inclusion o f the NOW accounts, w hich have only recently emerg ed as a means by which depositors can make paym ents directly from savings-type deposits, the proposal is a replay o f a theme that has been repeated again and again over the past 20 years. In addition to urgings by the Board, recommendations fo r a p p ly in g the sam e reserve re quirements to all banks were made by the Com m ission on M oney and Credit in 1961, by the President’s Committee on Financial Institutions in 1963, and b y the Hunt Com mission in 1971. These groups advocated more uniformity in reserve requirements because their studies convinced them that such uniformity is a necessary precondi tion to effective monetary control. Purposes The stated purposes o f the Board’s proposed legislation are “ to achieve better m anagem ent o f m oney and credit, to provide a more equitable system o f reserve requirements am ong financial institutions that offer similar deposit services, and to permit Federal Reserve lending assistance to a broader range o f financial institutions when and as they come under unusual li quidity pressures.” Within the United States, the Federal Reserve System has sole responsibility for monetary control. The principal reason for the System ’s reserve requirements is to serve as a lever by w hich it can carry out this primary central banking function— control over the quantity o f money and credit. M ost state authorities also impose reserve requirements, but the assets that satisfy m ost state requirements are not in a suitable form to serve monetary control purposes. All com m ercial banks are chartered either by the Comptroller o f the Currency (national banks) or by the banking a u th orities o f the individual states. M em bership in the Federal Reserve System is required for national banks but voluntary for state-chartered banks. Both federal and state banking authorities regulate the banks under their respective jurisdictions in the interests o f sound Federal Reserve Bank of Chicago ly large, accounting for roughly another 20 banking practices and the protection o f percent o f all com m ercial bank demand depositors. O f over 14,000 commercial banks in the United States, over 8,400, or deposits. While it seems unlikely that the very largest state banks (including some about 60 percent, were not members o f the Federal Reserve System at the end o f last multi-billion dollar institutions) would leave the System, m any banks with more year. The average nonmember is relatively than $100 million in total deposits have small, however, so that this three-fifths o f the bank population accounted for only 25 a lrea d y d on e so. W hen one bank percent o f the deposit com ponent o f the withdraws, pressure is transferred to com money supply and 22 percent o f all com peting members as they try to protect their mercial bank credit. competitive positions. I f these proportions remained con Thus, shrinkage in the proportion o f stant or changed in some stable and pre deposits directly influenced by Federal dictable way, the problem posed for Reserve action can be expected to continue. monetary control would not be significant. From 83 percent in 1960, this proportion The evidence o f the past few years, declined to 75 percent in 1973. Even if the however, indicates that the nonmember very large state banks remain members, sector is not only grow ing faster, but its this share can be expected to shrink growth is more erratic than the trend for further, as the competitive advantage en joyed by nonmembers enables them to member banks. Since 1960, about 750 grow faster and as few new banks elect to banks have left the System through withdrawal or merger. O f the roughly 1,850 new Member and nonmember banks— state-chartered banks es number and demand deposits tablished since 1960, less U nited States Seventh District than 150 have elected to 6 /1 5 /6 0 6 /3 0 /6 7 6 /3 0 /7 3 6 /1 5 /6 0 6 /3 0 /6 7 6 /3 0 /7 3 join the System. This (n u m b e rs) trend has accelerated Num ber o f banks over the past six years, Mem ber 6 ,2 1 4 6 ,1 0 7 5 ,7 0 5 1,004 990 93 2 with an annual growth National 4 ,5 4 2 4 ,6 2 9 581 66 4 4 ,7 8 0 650 1,672 State 1,327 1,0 76 42 3 34 0 268 in net demand deposits Nonm em ber 7,2 77 7,6 37 8,341 1 ,4 70 1,5 57 1,705 at nonmembers o f 10 All commercial 13,491 13 ,744 14 ,046 2 ,4 7 4 2 ,5 4 7 2 ,6 3 7 percent—double the pace (p e r c e n t) at member banks on Nonmembers as percent average, and three times o f all commercial banks as great in some years. 53.9 5 9 .4 59 .4 55.6 61.1 64 .7 I f potential shifts (b illio n d o lla rs) from national to state Private demand deposits* charters(relatively easy Member 134.9 107.0 1 8 7.0 15.4 18.9 25 .8 National 67 .8 9 4 .3 139.5 11.4 14.2 2 0 .0 to effect) are ignored, State 39.2 4 0 .6 4 7 .5 4.0 4 .6 5.8 further attrition can be Nonm em ber 19.4 2 8 .8 55 .2 3.3 5.1 8.5 expected from am ong the All commercial 126.3 163.7 2 4 2 .2 18.8 2 4 .0 34.3 more than 1,000 state (p e r c e n t) banks in the United Nonmembers as percent States th a t are still o f all commercial banks 15.3 2 2 .8 17.6 2 1 .2 24.7 17.6 members o f the Federal Reserve System. These Does not include deposits of the U. S. G overnm ent or interbank deposits. banks tend to be relative Business Conditions, March 19 74 becom e members. In addition to the basic problem, new developments, exemplified by the NOW ac counts, are bestowing more and more o f the characteristics o f m oney on financial assets other than com m ercial bank check ing accounts. A parallel development is the grow ing acceptance o f the view that con trol over the rate o f growth in the monetary aggregates is crucial to the health o f the econom y. Thus, the need for arrangements that will broaden the scope o f the System ’s effective control over money is sure to becom e increasingly urgent. Closely related to the concern with m onetary objectives, the B oard’s proposal aims to spread the costs that monetary control imposes on member banks more equitably am ong financial institutions that offer sim ilar deposit services. Since this would mean a reduction in the com petitive advantage nonmembers now en joy, it is understandably opposed by them. A s a partial offset to the loss in advantage that would accom pany the equalization o f reserve burdens, however, are the benefits o f access to funds at the discount window. Som e o f the opposition a n d /or in difference toward efforts for greater unifor mity o f reserve requirements, however, appears to be based on a misunderstand ing o f how the reserve ratio specified by the System serves as a link between member bank reserves and the quantity o f money, how the central bank determines the quan tity o f the assets that are specified as reserves o f member banks, and why the present structure o f reserve requirements effectively imposes a tax on membership. Reserves and money Reserve requirements were written into m ost banking laws and regulations to assu re liqu idity to meet depositors’ withdrawals. State laws vary with respect to both the percentage o f deposits banks are required to hold as reserves and the 5 types o f assets that are reserve-eligible. Il linois law has no requirements what soever. In m any states, the percentage re quirements (required ratios o f reserves to deposits) are not significantly different from those imposed by the Federal Reserve, but the form is different. Only vault cash and collected deposit balances at Federal Reserve banks qualify as reserves for Federal Reserve members. State nonm em ber banks, however, can count correspondent balances (collected or uncollected), and in m any states, U.S. securities and even their home state’s securities also count in partial fulfillment o f requirements. Actual liquidity is supplied, o f course, by a variety o f short-term assets and also through liability management. Legal reserves provide liquidity only to a very limited degree—w hat must be held cannot be paid out to depositors. However, it has long been recognized that the main func tion o f cash reserve requirements is to limit monetary expansion. M oney is anything that can be used as a means o f payment. But for econom ic policy purposes, the U. S. m oney stock is usually defined to include currency and bank checking accounts held by the public. Deposit balances o f the U. S. Government and other banks are excluded. To the ex tent savings deposits, either at banks or at other financial institutions, can give rise to check-like instruments, such as the NOWs, they too are money. The distribution o f the m oney supply between deposits and c u r r e n c y is determ in ed by p u b lic demand—one being freely exchangeable into the other. Therefore, the capacity o f the banking system to expand deposits is the real objective o f monetary control. How do reserve requirements affect this? In a “ fractional reserve” money system such as ours, deposit expansion in the banking system is a multiple o f the quantity o f reserves. The size o f that mul tiple is determined basically by thepercen- 6 tage requirement. For every $1 increase in reserves, a 20 percent requirement permits deposits to rise $5, while a 10 percent re quirement permits deposits to rise $10. To achieve its deposit growth target, the cen tral bank must be able to control, or at least be able to predict, both the quantity o f reserves and the reserve ratio. Given a fixed reserve requirement ratio, control over the growth in deposits is exercised by control over the volume o f reserves. This is why the kind o f assets that can be counted as reserves is so important. The Federal R eserv e S ystem cannot control the a g g re g a te v o lu m e o f correspondent balances and governm ent securities. It can control the total am ount o f cash balances that banks hold in Federal Reserve banks. These balances are in fact created by the Federal Reserve, largely through its open market operations. A s a base for money, they are equivalent to the gold against which bankers issued notes a century ago, but unlike that gold, the supply is deter mined in accord with the econom y’s needs. How money grows It is often difficult for observers, and sometimes even for bankers themselves, to understand the critical role o f the central bank as the source o f new funds to the banking system. With deposits constantly shifting am ong thousands o f banks, a single institution is not able to see the mul tiple expansion process taking place. Sup pose, for example, the Federal Reserve wants to provide additional monetary growth. It is likely to do this by purchasing governm ent securities in the open market. Paym ent for the securities is made with a check on the Federal Reserve Bank o f New York, which acts as an agent for the System’s open market account. This check is deposited by the seller o f the securities in a commercial bank, adding to the deposit liabilities o f that bank and to its reserve balance at its Federal Reserve bank. This Federal Reserve Bank of Chicago is a net addition to existing reserve balances that has resulted from the open market purchase. Deposits o f the commer cial banking system can continue to ex pand through the process o f m aking loans and investments until total deposits reach the maximum amount that can be sup ported by the increase in member bank reserve balances. To illustrate, in the abstract, suppose the reserve requirement were 15 percent and there were only one bank. T hat bank could immediately increase its earning assets and deposits by m aking loans until the initial increase in reserves generated by the open market purchase is supporting an increase in aggregate deposits almost seven times its size. (With a reserve require ment o f 15 percent, $100 in new reserves will support a maximum o f $667 in ad ditional deposits.)The loan proceeds would be credited to the borrowers’ deposits, but withdrawals by the borrowers from their deposits would merely appear in some other customers’ deposits. In a banking system with m any banks, however, the deposits created by new loans to borrowers are likely to be shifted to other banks, with a corre sponding drain on the lending bank’s reserve account, which gets charged when checks drawn on that bank are paid. The process can be repeated until all o f the new reserves have been absorbed as required reserves against expanded deposits in the banking system as a whole. A n individual bank, therefore, can increase its earning assets by only the difference between in creases in its deposits and the reserves necessary to support those increases. Customer transactions shift deposits from bank to bank. As the deposits shift, the reserve base for them also shifts to the receiving bank. It should be noted that the Federal Reserve’s ability to purchase securities is totally independent o f previously existing m em ber ban k reserve deposits. But Business Conditions, March 19 74 because the banker cannot distinguish between a deposit inflow that results from the System ’s purchase and any other credits to its reserve balance in paym ent for checks deposited by customers in the norm al course o f business, it m ay appear to him that the reserve balance he has to keep at the Reserve bank finances the Federal Reserve’s purchase o f securities rather than the reverse. The System ’s ability to control money stems from the fact that money consists o f either the System ’s liabilities (nearly all currency is Federal Reserve notes), or has a d ire ct re la tio n s h ip to the System’s liabilities (deposits must be supported by member bank reserves). It is by increasing (by buying securities) or reducing (by sell ing securities) the reserve base o f the bank ing system that the Federal Reserve im plements its m onetary objectives. While there are other factors that influence the reserve base supporting deposits—drains to meet currency demands o f the public being the largest—Reserve bank security purchases are in the long run the major source o f bank reserves. Over the past ten years, Federal Reserve holdings o f U .S. securities have increased by alm ost $40 billion. O f this amount, about threefourths has been passed through the banks to the public in the form o f currency (Federal Reserve notes). The rest has in creased member bank reserves, providing the base for multiple deposit expansion. Slippages Even if reserve requirement percen tages remain unchanged, the relationship between the am ount o f reserves supplied a n d th e m o n e y s to c k —the reserve multiplier—is not constant for a number o f reasons: (1) currency paid out to the public absorbs reserves on a dollar-for-dollar basis, (2) reserves must be held against some bank liabilities other than checking accounts o f the public (U. S. Government 7 balances, deposits o f other banks, time d e p o s i t s , a n d c e r t a in n o n d e p o s it liabilities) and different percentage re quirements apply to some o f these, (3) deposits m ay shift am ong member banks with different average reserve re quirements (the schedule o f graduation results in a higher average ratio for large banks than for small ones), (4) excess reserves m ay increase or decrease, and (5) deposits m ay shift to nonmember banks where the im pact o f Federal Reserve actions is greatly diluted. The first three o f these factors are reasonably easy to ascertain at any given time. Their effects can be estimated and allowed for in the effort to determine the volume o f reserves necessary to achieve target growth rates in money, although ad mittedly they can give rise to some slip page in control in the short run. Excess reserves tend to be erratic from week to week but have little effect on the multiplier over longer periods o f time. Deposit shifts to nonmembers have much bigger effects on the reserve multiplier and are more difficult to offset, partly because they are difficult to predict and partly because offsetting action imposes costs on member banks. Those w ho contend that the applica tion o f Federal Reserve requirements to nonmembers is unnecessary for effective monetary control point out that because nonmember banks hold reserves in the form o f correspondent balances at member banks, against w hich member banks must in turn hold cash reserves, System reserve action does affect nonmember deposits. Clearly, however, the same amount o f member bank reserves will support far more customer deposits at nonmember banks than at members. Under a 15 per cent requirement, $1 o f member bank reserves will support $6.67 in deposits o f a nonmember bank which, in turn, will sup port (in a state with a 15 percent require ment) alm ost $45 o f deposits at the non 8 member. Such “ pyram iding” o f reserves was a m ajor shortcom ing o f the old national banking system that the Federal Reserve A ct was designed to correct. The vastly increased leverage entailed in deposit shifts from members to non m e m b e r s a lt e r s s ig n ific a n t ly the relationship between the amount o f reserves supplied to the banking system and the overall rate o f expansion in money. What if reserve requirements were eliminated? The second argument offered by those who oppose the B oard’s latest proposal is that open market operations, not reserve requirements, provide the m ajor thrust o f the System ’s control and that such operations have an im pact on all banks. Without question, open market operations are the means by which the System con trols the quantity o f bank reserves. With or without reserve requirements, open market purchases o f securities increase the total am ou n t o f outstanding currency or deposits at the Reserve banks (together called “ high-powered m oney” ), while sales reduce this total. What would the elimination o f legal reserve requirem ents imply for the System ’s open market operations, for monetary control, and for banks? First, the bank assets that now serve as “ reserves” would not entirely disappear. A ll banks would still need to hold vault cash to meet customer demands, and m any would con tinue to keep working balances at Federal R e s e r v e b a n k s . W ith o u t requ ired minimums, however, average balances would be smaller. Federal Reserve note liabilities would continue to rise in keeping with the public’s needs, but Federal Reserve deposit liabilities to member banks would be reduced to a “ desired” rather than a “ required” level. The im pact o f the initial elimination o f required ratios would be to release a large Federal Reserve Bank of Chicago amount o f funds for loan and deposit ex pansion. To prevent the inflationary effects o f such expansion, the Federal Reserve would have to absorb these “ ex cess” reserves by selling U. S. securities in the open market. Thereafter, the Federal Reserve would continue to provide for renewed expansion from this lower level in its note and deposit liabilities by purchas ing securities in the open market. In the absence o f a legally prescribed minimum o f reserves in relation to deposits, however, there would be greater uncertainty about the volume o f deposits resulting from the System ’s open market operations. The multiplier would be a larger and a more unstable number, likely to be biggest under conditions when restraint on money growth is called for. In order to slow m oney growth, the Federal Reserve would have to restrict its open market purchases so as to cut the banks’ balances at the Reserve banks below the “ d e sire d ” level, th u s reducing the willingness o f banks to expand loans and deposits under conditions o f strong loan demand. For the banks, the absence o f reserve requirem ents would mean somewhat larger earning assets for a given deposit level and therefore increased earnings, at least in the short run. As a result o f com petition, however, this earnings impact could be much less than expected. Higher profit potential would cause banks to bid up deposit interest rates and lower loan rates in their search for more business. With required reserve ratios, however, there is less room for deposit variation resulting from variation in the reserve mul tiplier. The actual level o f the reserve ratio is less important than the fact that a specific requirement exists. However, the lower the ratio, the larger the im pact on deposits o f unintended changes in the reserve base. Thus, the weakness o f the link between reserves and deposits at non member banks, com bined with the grow- Business Conditions, March 19 7 4 ing proportion o f these deposits in the total m oney supply, has a tendency to weaken the System ’s control. The im portance o f the System ’s ability to change required reserve ratios is a separate matter. Such changes have been made rather infrequently, partly because even a sm all change has a large and per vasive im pact on potential deposit expan sion or contraction. But there are times when such an im pact is consistent with policy aims. Use o f this tool, especially to increase the required ratio, has been limited in large part because increases raise m em bers’ costs—worsening their competitive position, increasing the incen tive for banks to drop out o f the System, and thus further eroding monetary control. In fact, it is the cost disadvantage s p e c i f i c a l l y — a n d it s e f f e c t s on m em bership—that poses the greatest threat to the effectiveness o f monetary con trol because it drives more and more o f the n ation’s m oney supply into banks where the relation between deposits and the reserve base is very loose. The matter of equity Reserve requirements are a cost im posed on the banking system by the necessity for m onetary control. Federal Reserve member banks are disadvantaged only to the extent this cost is greater for them than for com peting nonmembers. Aside from the ability o f nonmembers to count as reserves governm ent securities that are clearly earning assets, from what sources do differences in costs arise? Vault cash held to meet operating needs can be counted as reserves by both m em b ers a n d nonm em bers. Reserve balances that members maintain at the Fed are w orking balances and serve some o f the same purposes as deposits o f non members with correspondents—entitling the member to such services as check clear ing, safekeeping, and m oney transfer 9 facilities. In addition, member banks have access to the discount window. To a large extent, however, the average cash reserve balance is a nonearning asset. Member banks also must keep balances with cor respondents, though often smaller than those maintained by nonmembers, to pay for services not provided by the Federal Reserve, such as loan overlines, and in vestment services. Nonmembers, on the other hand, earn a full return in services on their collected deposits with correspondents—deposits that a lso s a tis fy th eir reserve re quirements. In addition, items still in the process o f collection, classified as “ due from ” banks, can be counted as legal reserves in m ost states even though they are only claim s to assets that are still in the possession o f another bank. Such un collected balances may be h a lf as large as a bank’s required reserves. As a result, non member banks generally do not need to hold for reserve purposes more correspon dent balances than are necessary for operating needs. There have been some attempts to measure the differential cost burden for members—that is, w hatportion o f required reserves is over and above the amount these banks would have to hold for operating purposes. One Federal Reserve official estimated the extra burden for a bank with a 13 percent requirement at about 7 percent o f demand deposits. Whatever the differential, when translated into earnings it has increased over the years as interest rates have risen. Profit potential is thus greater for nonmembers, giving them an edge over members in at tracting capital and com peting for both loan and deposit business. More convincing than any statistical estimate o f the reserve burden, however, is the steady exodus from membership and the small percentage o f new banks that become members. Moreover, to the extent deposit expansion outside member banks 10 accelerates, members have to bear the im pact o f System efforts to control expansion for the banking system as a whole. In view o f the inequity, w hy is there not solid member bank support for the Board’s proposal? The explanation lies m ainly in the concern felt by large- and medium-size member banks about the possible im pact on their correspondent business. The overall reduction in cor respondent balances would seem likely to be quite m odest since not much change in the use o f correspondent services would be expected. But any correspondent bank that supported a proposal that would increase costs for an im portant segment o f its customers m ight expect to lose some o f those customers to a more discrete com petitor. This is particularly true for medium-large banks in cities outside the major m oney market centers where inter bank deposits constitute a large portion o f total sources o f funds. It is within this group o f banks that nonm em ber com peti tion is felt m ost acutely, and where the failure to equalize costs is m ost likely to result in further loss o f members. Not compulsory membership! The Board’s current proposal does not re quire membership, nor does it threaten the authority o f the state bank supervisory agencies with respect to chartering or regulatory functions. The Board is seeking the control o f all m oney—not the control o f all banks. Moreover, Federal Reserve re quirements would apply only to those ac counts that are directly involved in mak ing money paym ents—demand deposits and the NOW-type accounts. Time deposits and other types o f liabilities subject to reserve requirements at member banks would be exempt. In order to restrict the change to the minimum consistent with m onetary needs and to moderate the adverse earnings im pact, especially on small banks, the Federal Reserve Bank of Chicago proposal would exempt the first $2 million o f nonmember net demand deposits and NOWs. This provision would effectively exempt m ost banks with total deposits o f $4 million or less. There are more than 3,000 o f these small banks but they account for less than 3 percent o f the nation’s de mand deposits. A four-year phase-in provi sion would cushion the im pact on the qualifying banks. Thus, it is not proposed that there should be complete uniformity. But because demand deposit requirements are the most burdensome to m ost banks, adoption o f the proposal would go a long way toward equalizing costs while plug ging a grow ing leak in m onetary control. Operating vault cash would continue to serve as reserves. A t present percentage requirements, the increase in required reserves under the proposal would exceed vault cash by an estimated $2.3 billion. These additional reserves would have to be supplied by the System gradually, in line with the transition schedule, but they would not have any further expansion potential since the deposits they would support already exist. The proposal to widen permissible ranges o f reserve requirements would allow the Board som ewhat more flexibility in using variable reserve requirements as a policy tool and would permit lower re quirements on savings accounts with third-party transfer privileges than are applied to regular checking accounts. A lower minimum on members’ time and savings deposits would permit further flex ibility on passbook savings deposits, already at the low end o f the reserve re quirement range. The proposal does not specify the terms and conditions under w hich non member institutions could borrow at the d isco u n t window. Extension o f this privilege is not just a trade-off for more onerous reserve requirements but to provide greater assurance to communities served by nonmember institutions that Business Conditions, March 19 7 4 1 Federal Reserve System reserve requirements—present and proposed Present Proposed Institutio ns covered Federal banks. Reserve member A ll commercial banks; other fina ncial in s titu tio n s th a t accept demand deposits or interest bearing deposits from which the depositor is allowed to make w ithdraw als by negotiable or transferable instrum ent for the pur pose o f m aking payments to th ird per sons (NOWs). L iab ilities subject to reserve requirements For member banks, a ll net demand deposits, a ll time deposits, and certain non deposit lia b ilitie s (net de mand deposits are demand deposits less cash items in process of collection and “ due from banks’’). No change for members. For non members, only net demand deposits and NOWs. Exemptions None for banks covered. None for members. F irs t $2 m illio n for nonmembers on both net demand deposits and NOWs. Range w ith in which Board can change reserve requirements N e t d e m a n d deposits: Reserve city banks 10-22% Country banks 7-14% Time deposits (including NOWs) 3-10%. Net demand deposits NOWs or sim ila r accounts Time and savings deposits o f member banks Reporting Federal Reserve members re p o rt as requested by Board. A ll in stitu tion s receiving demand deposits or offering NOWs required to report deposit lia b ilitie s and required reserves, as requested by Board. C redit available throu gh Federal Reserve discount w indow To Federal Reserve member banks. Other institutions eligible only in emergency. Im plem entation 5-22%. 3-20%. 1-10%. Expanded to nonmember institutions required to m aintain Federal Reserve reserve requirements, Provides for four-year transition period w ith respect to amount of demand deposits held by nonmember in stitutions a t the time o f enactment of the new law. On base period deposits, the percent o f required reserves tha t would have to be carried during the firs t year second year th ird year fourth year thereafter 20% 40% 60% 80% 100%. Additions to demand deposits over base am ount subject to fu ll reserve re quirement when law becomes effective. 12 their credit needs can be accom m odated in times o f stress. District impact There are more than 1,700 nonmember banks in the Seventh Federal Reserve D is trict— one-fifth o f all nonmember banks in the nation. Deposit data as o f mid-1973 indicate that the $2 m illion ex emption o f net demand deposits would make the proposal inapplicable to more than 700 o f these banks, including h a lf or more o f the nonmembers in Iowa and the district portion o f W isconsin, and 37 per cent in the district portion o f Illinois. Membership experience in this district has been fairly typical, with attrition in creasing with interest rates. In the six years ending December 31,1973,67 district banks with total deposits o f more than $1 billion withdrew from m em bership.Of 131 new state-chartered banks, only four join ed the System. In 1973 alone, none o f 27 new banks-joined. In the six-year period, 35 new national banks offset part o f the decline in state members. District data also indicate a trend toward greater attrition am ong larger in stitutions. O f all withdrawals since 1967, roughly one-third were below $5 million in total deposits and h a lf were below $10 million. In 1973 alone, 12 banks with more than $400 m illion o f deposits converted to nonmember status. None was smaller than $5 million, and only one-fourth was in the below $10 million group. Two o f the withdrawals were banks with over $100 million in deposits, one o f w hich involved conversion from a national to a state charter. Now or when? Change from established patterns is always difficult to accom plish. This is es Federal Reserve Bank of Chicago pecially true in situations where the change imposes costs on some groups or reduces their advantage relative to others. Moreover, it is easy for the opposition to point to other factors that m ay cause even more trouble for the Federal Reserve in its efforts to implement monetary policy. But while no one can say at exactly what point the rising share o f money-type liabilities not subject to central bank reserve rules will cause a significant dilu tion in monetary control, the trend toward reduced co n tro l is cle a r, and the groundwork is already laid for accelera tion in this trend. The time to take correc tive action is before the problem becomes critical. The reserve requirement issue is not a matter o f infighting between regulatory agencies. If the central banking concept is valid, it must apply to all types o f liabilities that serve as m oney regardless o f the in stitution involved. There is no other m ajor country where part o f the banking system is not subject to the central ban k ’s reserve requirement. The Board’s proposal, though a com promise with complete uniformity, would be a move in the right direction. It would in crease the capability o f the System to a c h i e v e m o n e t a r y o b je c t i v e s b y eliminating one source o f slippage between its control variable, reserves, and the quan tity o f money and credit that is considered consistent with the nation’s econom ic goals. This is a matter in w hich the public interest has a high stake. Sooner or later, the changing structure o f the payments mechanism, combined with the ravages o f an inflation that m ay be at least in part traceable to monetary control problems, will overcome the inertia and the political pressures that delay reform and place an unfair burden on member banks. D orothy M. Nichols Business Conditions, March 19 74 13 Banking developments Consumer-type time and savings accounts total deposits o f less than $100 million were paying the maximum allowable rate on passbook savings (the same proportion as a year earlier). Larger banks, however, with a higher proportion o f consumer savings in these accounts, were slower to raise their rates. O nly 66 percent were pay ing the ceiling rate on passbook savings by October 31 (compared to 74 percent a year earlier). Some o f these banks may have decided that m oving from 4x/i percent to the new 5 percent ceiling would increase the cost o f these accounts while providing little deterrent to the loss o f interest-sensitive money, given the much higher yields available elsewhere. According to the October survey, almost all banks were offering time cer tificates and open account deposits in denom inations o f less than $100,000 with A com parison o f the results o f the Federal Reserve’s annual survey o f time and savings deposits at all member banks on October 31,1973 with the quarterly sample survey on July 31 indicated that Seventh District member banks were able to m ain tain, but not expand, the total amount o f their savings and small-denomination time deposits follow ing last summer’s changes in interest rate ceilings. Other findings in the annual survey o f all 935 dis trict member banks were: • A bout three-fourths o f the banks had m oved to the higher maximum savings rate by October 31. • About 70 percent o f the banks were issuing four-year, no-ceiling certificates. • Three-fourths o f the issuing banks were paying 7*4 percent or Consumer-type time and savings deposits less on these certificates. Seventh District member banks • M ost o f the increase in four- October 31,1973 year certificates appeared to be Percentage paying m axim um M aturity accounted for by shifts out o f Savings Less than 1 to lower-yielding accounts. 1 year 2V* years Size of bank accounts • L a r g e -d e n o m in a tio n tim e tal deposits less deposits, other than negotiable than $ 1 0 0 m illion certificates o f deposit, continued 82 Illinois 78 83 to expand at a rapid rate. 84 Indiana 80 69 The Federal Reserve System 84 Iowa 85 85 and the Federal Deposit Insurance Michigan 54 70 68 Wisconsin 78 82 82 Corporation announced a new s ch e d u le o f m a xim u m rates 74 Total 80 80 payable on time and savings ac tal deposits $ 1 0 0 counts at the start o f the third m illion or over quarter. By J uly 31, over one-half o f 92 Illinois 92 95 the member banks in the district 44 83 Indiana 83 had raised their rates to the new Iowa 100 67 100 Michigan 41 79 89 m aximums. By October 31, accord Wisconsin 80 100 90 ing to the annual survey, about Total 66 89 90 three-fourths o f these banks with rate 2'A to 4 years 95 97 98 94 95 96 97 100 83 93 100 96 14 original maturities up to two and one-half years. About 81 percent o f the smaller rep ortin g bank s were offering time deposits with maturities o f two and oneh a lf to four years, and 89 percent o f the larger banks were offering them at that time. Under the revised regulations, banks could issue ceiling-free certificates requir ing deposits o f at least $1,000 with maturities o f four years or more as o f July 1, 1973. In this district, 69 percent o f member banks with total deposits o f less than $100 m illion and 93 percent o f district banks with total deposits o f $100 m illion or more were offering these certificates at the end o f October. A bout three-fourths o f all issuing banks—large and sm all—were paying l lA percent or less. Effective N o vember 1,1973, a ceiling rate o i l lA percent was established for these four-year time certificates. From the end o f July to the end o f O c to b e r 1973, tota l o u ts ta n d in g s in consumer-type time and savings accounts at the reporting banks declined less than 1 percent. There was, however, a change in the distribution o f funds am ong the v a rio u s types o f deposits. Passbook savings at both large and smaller banks declined by about 2 percent. Substantial declines were reported in time certificates and open account deposits with maturities o f less than two and one-half years. The sum o f these losses, however, was about equal to the total gains registered in the Federal Reserve Bank of Chicago Four-year time deposit certificates less than $100,000 without interest ceiling Seventh District member banks October 31,1973 Percentage paying Percent issuing 7.25% or less Illinois 65 90 7 Indiana 77 64 33 3 Iowa 51 67 33 0 Michigan Wisconsin 82 81 91 29 6 61 3 10 Total 69 73 23 4 95 83 11 20 60 11 13 83 78 67 40 100 90 100 44 0 56 0 0 93 78 16 6 Size of bank 7.50% Over 7.50% Total deposits less than $ 1 0 0 m illion 3 Total deposits $ 1 0 0 m illion or over Illinois Indiana Iowa Michigan Wisconsin Total 0 h ig h e r-y ie ld in g tim e d ep osits with maturities o f two and one-half to four years and the ceiling-free, four-year certificates. Time deposits over $100,000, other than negotiable certificates o f deposit, ex panded rapidly as banks continued to offer attractive rates to their customers. In July, amounts outstanding at the large banks were almost seven times the am ounts out standing during the October 1972 survey. From July to October 1973, these deposits rose another 23 percent. ■ Business Conditions, March 19 7 4 15 Interest-bearing deposits of individuals, partnerships, and corporations denominations of less than $100,000 at Seventh District member banks SMSA1 Total wei ghted average rate2 October 31 1972 1973 (percent) in October 31. 1973 Savings Certificates and open accounts Amounts Amounts Change from Change from year aqo year ago outstanding outstanding (millions) (percent) (millions) (percent) Illinois Bloomington 4.87 5.39 31 + 7.8 4.98 5.55 31 44 + 3.3 Champaign-Urbana + 6.5 53 - 1.4 Chicago 4.77 5.36 5,021 - 3.8 3,247 - .3 Rock Island-Moline 4.76 5.29 121 Decatur 4.90 5.44 53 + 5.3 83 Peoria 4.77 5.30 143 + 1.3 103 + .9 193 +15.2 - .7 + 3.1 Rockford 4.88 5.48 161 + 5.4 147 + 5.4 Springfield 4.88 5.51 112 + 2.6 129 + 5.0 Other 4.96 5.48 498 + 9.7 871 +13.0 4.80 5.38 6,184 - 2.1 4,857 + 2.8 + 9.4 State total Indiana Anderson 5.00 5.56 18 +23.7 22 Gary-Hammond 4.53 206 + 9.0 259 + 8.2 Indianapolis South Bend 4.90 4.84 5.26 5.42 457 692 + 7.5 5.42 127 + 7.5 + 9.1 136 + 16.6 Terre Haute 4.88 5.36 71 + 8.0 60 +13.3 Other 4.86 5.38 676 + 8.6 1,050 +11.1 4.83 5.38 1,555 + 8.5 2,219 + 9.3 - 2.3 State total Iowa Cedar Rapids 4.72 5.13 44 + 5.0 62 Des Moines 4.95 5.25 157 +12.2 155 Dubuque 5.06 5.50 48 + 13.9 60 Sioux City 4.95 5.58 60 + 7.6 72 + 9.6 Waterloo 5.00 5.56 35 +17.7 52 +12.2 Other State total - .9 + 8.4 5.04 5.08 393 5.01 5.18 737 +21.0 + 16.2 918 1,319 +13.3 + 9.4 - 2.6 101 +35.1 Michigan Ann Arbor 4.40 4.82 169 Battle Creek 4.82 4.85 32 Detroit 4.69 5.32 .8 24 +44.1 3,505 + 2.5 2,877 + 1.8 - Flint 4.76 4.97 467 + 8.8 171 Grand Rapids 4.64 5.05 396 - 3.2 437 + 12.1 * Jackson 4.46 5.05 102 + 4.8 56 + 7.0 Lansing 4.59 4.93 479 - 2.8 384 + 3.0 Saginaw 4.73 5.12 105 + 2.2 +21.5 4.79 5.25 955 + 10.5 56 844 4.69 5.22 6,210 + 3.1 4.950 + 2.3 Appleton-Oshkosh 4.99 5.54 5.25 + 6.9 + 7.3 + 4.2 4.86 91 64 111 Kenosha 51 +13.3 Madison 5.05 4.80 5.39 32 - 2.1 60 + 5.45 608 + 1.2 423 + 4.8 4.96 5.41 58 + 3.2 63 - 1.6 5.04 5.52 431 +10.1 702 + 8.3 4.93 5.47 1,284 + 4.7 1,410 + 6.6 4 79 5.32 15,969 + 2.2 14,755 + 4.5 Other State total + 7.4 Wisconsin Milwaukee Racine Other State total Seventh District •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 for the area. .4
@FedFRASER