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'W THE BUSINESS REVIEW .Wg-J r«sa -*'^*a.' »«Vi*^SSS FEDERAL RESERVE BANK OF PHILADELPHIA SEPTEMBER 1, 1945 * Transition from War to Peace The sudden ending of the war against Japan on August 14 changed the whole as pect of reconversion overnight. The Government was faced with a choice of imme diately cancelling contracts or gradually tapering off war production. The first al ternative Involved an abrupt dislocation in employment but the second meant a needless tying up of scarce materials which could only prolong the process of re conversion and inject uncertainty into the timing of the transition. The decision was to cancel all contracts except those which were needed to supply the occupation forces abroad and the troops undergoing demobilization. In the first week after V-J Day, the Army and Navy cancelled $30 billion in war contracts in addition to pre vious cancellations of $14 billion between V-E Day and V-J Day. This action precip itated an immediate shift from war to peacetime activity. Philadelphia in Transition This area undoubtedly has a less difficult Against this background a complete reap praisal was needed of the reconversion picture problem of reconversion than many other cen in the Philadelphia-Camden industrial area, the ters throughout the country. Although it was major war production center of the Third Fed the fourth largest war production center in the eral Reserve District. In the week following United States, most of its facilities can be Japan’s surrender, the Philadelphia Committee readily converted to peacetime production. for Economic Development, through the facili Relatively few new plants were constructed in ties of this bank, made a new survey of manufac the area during the war and most of the war turing plants in this area comprising eight coun time increase in capacity, as shown in the chart, ties—Bucks, Chester, Delaware, Montgomery resulted from expansion in existing plants to and Philadelphia in Pennsylvania, and Burling produce the same products as in peacetime. New ton, Camden and Gloucester in New Jersey. The aircraft facilities formed a small percentage of survey showed that manufacturers expect to em total increase in capacity, and synthetic rubber, ploy in mid-November 98 per cent as many explosive, and aluminum plants were relatively workers as they had on their payrolls the day unimportant. Shipbuilding is the major problem industry for the reconversion period. The the war ended. Page One ment is likely to be somewhat greater than is indicated by the net changes. But this type of rapid turnover within the short period of a month constitutes no major problem. WARTIME PLANT EXPANSION PER CENT 100 r iit The First Month—Declining Employment 75 • □ 50 • EXPANSION TOTALS 25 ■ O CONVERSION UNITED STATES $24326 MILLION PHILADELPHIA AREA $622 MILLION UNITED STATES PHILADELPHIA 8-COUNTY AREA SOURCE-US. WAR PRODUCTION OOWO Philadelphia area has the third largest concen tration of shipbuilding facilities in the coun try, and many of the ways will not be needed after the war. Fortunately, it has a large pre dominance of consumer goods industries which can be counted on to absorb many of the workers laid off by the shipyards. Textiles, food, tobacco, printing establishments, and paper mills have little or no reconversion problem and are re stricted only by temporary shortage of raw materials. Reconversion Prior to V-J Day A large contraction in manufacturing em ployment in the Philadelphia area had already occurred by the time Japan surrendered. As shown by the accompanying table, manufac turing employment declined from a wartime peak of 640,000 in June 1943 to about 560,000 in August 1945. Of the net decline of approxi mately 80,000 workers nearly three-quarters were released from the transportation equip ment, iron and steel, and machinery industries, indicating that reconversion was already under way. However, unemployment was not serious because the total civilian labor force declined as a result of continued inductions into the armed forces. The sizeable shift in the working force which has already occurred should ease the transition now taking place. Manufacturers estimate that in the first month of reconversion the net release of men and women from manufacturing estab lishments will total only 27,000. Many more will be laid off for short intervals and imme diately re-employed, so that the total adjust Page Two The greatest declines in employment in the first month after the war are expected to occur in the transportation equipment industry, and in the electrical and nonelectrical machinery groups which anticipate a net loss of 20,000 workers by the middle of September. In view of the fact that almost 200,000 workers were em ployed in these industries at the time the war ended, the decline of only ten per cent is not large. Several shipbuilding establishments ex pect to continue work on ships now on the ways or to retain a large number of employees for re pair work. Other transportation equipment in dustries were already partially converted by V-J Day, and were not severely affected by con tract terminations. Employment in these indus tries will undoubtedly continue well above the eventual peacetime level during September and as far ahead as November. Textile and apparel establishments also ex pect a further decline in employment of about 7,000 beyond that which has already occurred over the war period. The principal difficulty of textile and apparel firms is a shortage of mate rials. Although raw cotton and raw wool are abundant, the yarn manufacturers have had difficulty getting adequate labor and equipment in the past year so that supplies of finished yarn are not now available. Rayon is still being used in the manufacture of tires; and nylon, although it is being turned out in considerable quantity, will not be available in sufficient amounts to satisfy the famished market for several months. The War Production Board has not yet removed restrictions on most textile yarns which are scarce. A few industries such as printing, rub ber, petroleum, shoes, and food are already absorbing additional labor. The chief problem emphasized by manufac turers is the difficulty of getting materials for processing and materials for new construction. The War Production Board has largely elimi nated the Controlled Materials Plan and relaxed restrictions on many major raw materials includ ing steel, aluminum, copper, and chemicals, but a number of important items such as lumber, paper, rubber, and textile yarns continue to be scarce. The need for skilled labor to assist in ESTIMATES OF EMPLOYMENT IN THE PHILADELPHIA EIGHT-COUNTY AREA 1940 1943 (a) Aug. 14, 1945 (b) Sept. 15, 1945 (b) Nov. 15, 1945 (b) 194X (in thousands) Total manufacturing........... Food................................................ Tobacco......................................... Textiles........................................... Apparel........................................... Lumber & lumber products.. . Paper.............................................. Printing.......................................... Chemicals & petroleum prods. Rubber........................................... Leather........................................... Stone, clay & glass..................... Iron and steel............................... Nonferrous metals..................... Machinery (except electric). . . Electrical machinery................. Transportation equipment. . . . Miscellaneous............................... 425 35 639 35 561 37 534 38 9 50 41 549 39 512 41 11 12 68 Total nonmanufacturing. .. Transportation, communica tions, utilities............................. Trade............... ................. ............. Finance & business services. . . Personal services......................... Other*............................................ June 10 10 8 65 46 9 16 27 34 3 58 58 9 17 28 42 5 9 9 85 53 45 (a) 8 8 17 29 43 5 9 17 31 44 57 40 9 18 33 45 6 10 6 11 22 41 39 161 27 72 5 32 33 128 29 7 70 5 29 25 119 25 7 70 5 30 27 117 24 9 59 5 24 33 72 25 740 765 736 747 754 804 82 219 168 116 155 94 100 222 149 99 152 103 170 98 229 155 107 165 95 242 176 201 216 149 99 172 100 222 1,404 1,297 1,281 1,303 1,316 11 8 46 5 22 23 43 Grand Total................................. 1,165 6 8 51 9 18 31 39 4 12 121 170 ♦Includes agriculture, mining, construction, government, and miscellaneous (a) Based on first C. E. D. manufacturing survey made in 1943-44. (b) Based on C. E. D. manufacturing survey made in August 1945. retooling was also mentioned by manufacturers as an obstacle to reconversion. Some lowerpaying industries will have difficulty getting workers in the immediate transition period. Workers Reabsorbed Reconversion in the Philadelphia area is ex pected to be virtually completed in three months, and out of the total of 27,000 workers released in the first month after V-J Day nearly 15.000 will have been reabsorbed in manufac turing by November. The net decline in manufacturing employ ment in the transition period will be only about 12.000 in the eight-county area around Phila delphia, if present estimates of manufacturers are correct. This in itself would constitute but a small addition to unemployment even if no workers are absorbed by nonmanufacturing industries. Obviously, many persons will be needed by the nonmanufacturing industries which have had to carry on with a reduced labor force during the war period. The construction industry alone will need several thousand more workers in order to provide new housing, new plants for civilian production, and much-needed repair work on offices, homes, and highways. The service industries, including business, finan cial, personal, and domestic services, have greatly reduced employment since 1940. All of these nonmanufacturing industries may be expected to expand as soon as labor becomes available. It is estimated that nonmanufacturing industries might absorb as many as 18,000 per sons in three months which would mean that total employment in all industries might accord ingly be higher in November than it was in August. Unemployment Low in November The effect of these changes on unemployment can only be estimated in a very general way. Immediate layoff of workers at the end of August probably swelled the ranks of job hunters to a fairly high level but many plants expected to rehire employees within a few weeks or days when plans could be completed for the changeover. This initial unemployment is but temporary and not indicative of conditions by November. If we assume no increase in job opportunities in nonmanufacturing, unemploy ment in this area could be as high as 60,000 or 70,000 workers but if nonmanufacturing lines absorb even a moderate number of workers, un employment would be about 46,000 in November —no higher than on V-J Day. Either of these es timates would be negligible in comparison with the 1940 unemployment level of 243,000 workers. As shown by the table below, both of them are close to the irreducible minimum prevailing in 1943. The return of veterans to the labor force will probably have no great effect on the Philadel phia labor market at least for the present since it will be largely offset by the retirement of women and older workers and the out-migration of workers to other areas. In-migration, how ever, might be a factor in increasing unemploy ment since a number of workers from Bucks County have commuted to Trenton during the war and many from Philadelphia and Delaware Counties have been employed in Wilmington. If sharp reductions should occur in these nearby cities, they might well affect the local labor mar ket situation. ESTIMATES OF THE CIVILIAN LABOR FORCE PHILADELPHIA EIGHT-COUNTY AREA (in thousands) U nemployment........................................ 1940 June 1943 Aug. 1945 Nov. 1945 1,408 1,165 243 1,437 1,404 33 1,343 1,297 46 1,349 1,303 46 Page Three Declining Incomes The significance of transitional unemployment lies in its effect on incomes and purchasing power. Any major increase in the number of persons without jobs, especially if prolonged, would tend to reduce the demands for goods and services and this in turn might affect deci sions of manufacturers with regard to employ ment. The decline in income during reconversion will be considerably greater than the decline in employment because of shifts to lower-paid industries, reductions in the number of hours worked per week, and reduction of over time pay. To some extent, these declines in “take home’' pay may be offset by increases in basic wage rates, now that the War Labor Board has abandoned the “little steel formula”. Such increases, however, may be limited ulti mately by ceiling prices on manufacturers’ goods. Unemployment compensation benefits paid to workers will help to maintain pur chasing power during the period of transition. In the state of Pennsylvania benefits of $20 a week are payable for twenty weeks according to a recent revision in the provisions of the state law; a $600 million fund is available for taking care of a large volume of transitional unemploy ment in the state. Savings of Individuals The chief offset, however, to the decline in income during reconversion is the large backlog of personal savings built up by individuals dur ing the war period. Total liquid asset holdings of individuals in the Third Federal Reserve Dis trict at the present time are estimated at be tween $7% and $8'4 billion including demand deposits, time deposits, currency, and Govern ment securities. Although it is difficult to esti mate the increase in such holdings over the war period, a reasonable assumption would be that between $4 and $5 billion of the present total holdings constitute a net gain over 1939. Prior to the war, liquid assets were held pri marily for everyday transactions, but as a result of increased earnings there exists today a large volume of potential purchasing power in the form of readily available funds which could be drawn upon at any time and will encourage spending out of current income. What per centage of these funds are owned by persons who might be unemployed or might suffer a sharp reduction in income during the transition to peacetime production it is impossible to say. Page Four A wide redistribution of income has occurred as a result of the war, and lower income groups undoubtedly hold a greater percentage of sav ings than they did six years ago. Expenditures for Construction Not only have individuals built up a large accumulation of savings which will help to tide them over the transition, but state and city gov ernments and business corporations are plan ning to spend a large volume of funds, which can be put to work immediately to employ workers on necessary construction. The state of Pennsylvania has appropriated $75 million for public works projects of one kind or another, and an additional $100 million is now available for road improvements in the next two years. The city of Philadelphia is planning to spend an estimated $34 million on waterworks, sewage plants and street repairs in the immediate future, apart from several long-term projects still under consideration. Camden has available approximately $6 million for immediate con struction and highway repair. Manufacturers in the Philadelphia area have accumulated funds to finance a fair-sized pro gram of plant construction and equipment as soon as labor and materials become available. In a survey conducted by the Philadelphia Com mittee for Economic Development early this year, manufacturing plants in the city estimated that they would spend $100 million for new construction and new equipment, of which nearly 70 per cent would be financed out of their own funds and the remaining 30 per cent would be obtained from banks and other sources. Some estimates indicate that the need for construction and equipment expenditure will be much larger if industries bring their facilities up to date. The Danger of Inflation The existence of a large volume of savings serves to counterbalance declines in income dur ing reconversion and encourages manufacturers to expand production, but it also constitutes a potential threat of inflation. Consumers have built up a large backlog of demand in the last four years for all types of durable goods. If they endeavor to spend large amounts of money be fore goods return to the markets in sufficient quantities, we face the possibility of an upward spiral in prices and wages. Up until the present time war bond redemptions by individuals in the Philadelphia area have not risen seriously, al though marked increases have been noted in the past two weeks. The whole question of convert ing savings into purchasing power, however, is not a local problem but a national one; the an swer to it depends largely on the behavior of consumers generally. The general consensus seems to be that, until the flow of goods meas ures up to the purchasing power, appropriate restraints or controls are inescapable in order to prevent a spiral of inflation such as followed the first World War. Conclusion The immediate outlook for a rapid reconver sion of industry in the Philadelphia-Camden industrial area is extremely favorable because of—first, the ease with which war plant facil ities can be converted to civilian use; second, the extent to which reconversion had already taken place before the surrender of Japan; and third, the number of consumer goods industries and nonmanufacturing lines which can absorb labor rapidly. The collapse of demand for war goods will be replaced to a large extent by the accumulated pressure for construction and other durables backed up by huge savings in the hands of individuals and businesses. The exist ence of these sources of purchasing power to gether with the knowledge of a great backlog of demand for durable goods is encouraging manufacturers to formulate extensive plans for a high level of production. Post-war goals of manufacturers in the Phila delphia area call for an increase in employment from 425,000 in 1940 to 512,000 in 194x, the first year after reconversion. This was the con clusion of the first survey of 1943 made by the local Committee for Economic Development. This goal will not absorb all of the employable workers in the area unless new job opportunities are opened up in other lines. The ease with which the Philadelphia indus trial area expects to make the transition to peace should not obscure the fact that over a long-run period the city and its environs face a number of difficult problems. A sizeable portion of its industrial plant and equipment is old and in need of renovation. Technological improvements have been developed which can well be applied to various lines of industry. Only an intelligent and imaginative application will enable Phila delphia to maintain its position as a leading in dustrial area. $ Page Five Bank Capital and Bank Risks The primary purpose of bank capital is to protect creditors, chiefly depositors, against loss. It can serve this purpose only if it is large enough and sound enough so that losses will not impair the claims of creditors. How to measure ade quacy of capital in relation to possible losses is the question that has perplexed bankers and supervisory authorities for many years. Up to the present no single factor or formula has given a satisfactory answer. Experience and study of the problem, however, have emphasized (a) the complete inadequacy of the traditional ratio based on the relationship between capital funds and deposits, and (b) the necessity for consid ering a complex of factors such as the amount and character of deposit liabilities, the char acter and quality of assets, the quality of man agement, the corporate powers exercised, and current and prospective conditions of the econ omy within which a bank operates. Bank capital in relation to total resources has been declining over a long period of time. In the early days of American banking the capital account was not uncommonly as large as notes and deposit liabilities combined, although “cap ital” frequently consisted more of stockholders’ promises than of actual investment. The Na tional Banking Act, which in 1865 restricted bank note issues and provided substantial re quirements for paid-in capital, not only was an important stabilizing factor but ushered in a new era of deposit banking in the United States. At the end of 1866 the proportion of capital ac counts to deposit liabilities of national banks was 72 per cent, but by 1900 the ratio had fallen to 28 per cent. This decline continued from a ratio of 25 per cent at the outbreak of the First World War to 12 per cent at the begin ning of the present war, and had reached a low of 6.3 per cent by the end of 1944. What has happened is that with temporary interruptions bank liabilities have continued to expand rapidly while capital accounts have generally expanded at a much slower pace. What is the significance of this trend? Does it mean a progressive deterioration in the cap ital position of banks, or does it merely reflect a fundamental change in the structure and magnitude of bank assets and liabilities? Our banking system probably was never stronger than it is at present, yet the proportion of cap ital funds to deposits is the lowest on record. Page Six Some of the strongest banks show the smallest ratios. Obviously, the traditional ratio of tento-one has outlived its usefulness, and no com petent student of banking will use it even as a benchmark in measuring the adequacy of bank capital. Records also show that the character and composition of bank assets and liabilities, as well as their inter-relationship, have changed enormously in recent decades. Sources of bank earnings likewise have been changing from loans to investments, so that at present over one-half of bank income is derived from secur ities, most of which are Government obligations. Capital Adequacy Depends Primarily Upon Asset Quality Adequacy of capital is purely a relative matter and depends upon the amount of bank capital in relation to the risk of loss on bank assets, rather than upon any fixed ratio between capital and liabilities. Most commercial bank liabilities, however, are demand claims and banks must be prepared to meet them as they arise. Their character should determine the character of assets as well as the relative amounts of each asset held. For this reason, liquidity of assets is a factor in determining the risk of loss. Unless a bank has sufficient cash and assets which can readily be turned into cash, it may be forced to sacrifice otherwise good assets at a loss. Rela tively risk-free assets, therefore, include only those that at any time either can be sold in the market without substantial loss or can be used at their full value to obtain funds from the Federal Reserve Banks, the nucleus of our credit system. The convertibility of assets into cash at the Federal Reserve Banks through discounting or borrowing is the most important source of liquidity in times of unsettled markets and wide spread pressure on banks. Access to a central banking system having excess reserves and legal authority to create cash assures both bank liquidity in the sense of supplying cash immediately and bank solvency in the sense of protecting the value of sound assets. The ability of banks to shift assets to central institutions, such as the Federal Reserve Banks, meets critical needs of the moment by preventing panicky liquidation of loans and securities and helps conserve asset values by moderating the pressure and eventually restor ing orderly conditions in the money market. This facility, as strengthened by legislation since the early 1930’s, is probably the most significant development in our banking during the past three decades, and obviously no capital ratio can measure its full effectiveness in meeting crises affecting individual banks or the banking system as a whole. No one would question that banks were stronger and deposits safer at the end of 1944 when the capital-deposit ratio was 6.3 per cent than in June 1932 when, as banking approached its greatest crisis, the ratio was over 20 per cent. The reason for present banking strength lies in the relatively risk-free nature of bank assets generally. Government securities and cash held by member banks at present aggre gate 85 per cent of their total deposits, so that their other assets could depreciate by almost 30 per cent of book values and still be sufficient to cover the remaining liabilities. What the future market for Government securities is likely to be no one of course can predict with absolute certainty. It will depend on many circumstances, important among which is the extent to which banks expand their loans and other investments beyond the scale pre vailing in recent years. Recognition also must be given to the fact that most Government se curities held by banks are of short maturities, ten years or under. Any change in interest rates would have relatively little effect on the intrinsic value of such assets. Monetary policy designed to stabilize money markets and to aid in keeping economic activity on an even keel will be a factor as important as it has been during the war. There is at present no prospect for any substantial change in inter est rates in the near future. Still another im portant aspect is the fact that supervisory authorities appraise Government securities for examination purposes at amortized cost or book value, whichever is the lower, so that no ques tion of bank solvency can arise on account of such securities. These considerations, together with their usefulness as collateral for Federal Reserve credit, make Government securities held by banks as riskless as any bankable asset can be under present or anticipated conditions. It would of course be very convenient for bankers and supervisory authorities if some effective formula could be devised to measure accurately the adequacy of a bank’s capital. Attempts in fact have been made to measure the sufficiency of capital in relation to the degree of risk exposure that may confront a bank. Three ratios which have been suggested for this purpose deserve consideration, what ever may be their shortcomings. If they do not provide an answer to our problem, they at least suggest a more'objective approach than does the conventional ratio of capital to deposits. They may be stated as follows: Capital 1. ---------------Risk assets “Net capital” 2. 3 Deposits less cash and Governments “Net capital” _ ' Risk assets less fixed assets Risk assets are defined as total resources less cash and Government security holdings. It has sometimes been suggested that among Govern ment securities only those of short maturity— say under one year or even five years—should be included with risk-free assets, but under prevailing conditions it is reasonable to include all Governments in that category. Net capital, as used in two of these ratios, is ascertained by subtracting fixed assets from total capital accounts. It should not be con fused with the more familiar term “net sound capital” which is determined by adjusting book capital for assets adversely “classified” by bank examiners. Net sound capital should be used when considering capital adequacy of an indi vidual bank, but information of this type is not available for measuring changes in the bank system over long periods. When net capital is compared with assets it is necessary to deduct fixed assets from total assets, since the former have already been offset by an equal amount of capital. The ratio of capital accounts to risk assets is an improvement over the ratio of capital to de posits because it relates capital to the function it is expected to perform, namely, to absorb losses which may arise. But this ratio makes no allow ance for the differences in risk that actually exist among assets which are not risk-free. The ratio of net capital to deposits less cash and Governments goes one step further by elimi nating fixed assets and a corresponding amount of capital on the assumption that such assets are of limited liquidating value. In effect, fixed Page Seven assets are entirely written off the balance sheet. The remaining capital is then related to the amount of deposits not covered by risk-free assets. The ratio of net capital to risk assets is similar except that the net capital is here related to the source of losses—namely, assets which may shrink—instead of to liabilities. These two ratios share, although in lesser degree, the weakness in the total capital to risk assets ratio. Although they eliminate fixed assets, they make no distinction in degree of risk among other risk assets. The accompanying charts show these ratios, together with the traditional capital-deposit ratio, for key dates since the beginning of the Federal Reserve System. Bank failures per hun dred member banks also are shown as a basis for judging the effectiveness of the ratios in meas uring adequacy of capital. An appropriate measure, reflecting all risks to which bank assets might be exposed, would be expected to decline before a rise in bank failures takes place. Cer tainly when such a ratio was high, fewer bank failures might be expected to occur. Obviously these ratios have not allowed for all banking risks since no such inverse correla tion between bank failures and any of these ratios is apparent over most of the period. The capital-deposit ratio is, as might be expected, the least reliable. The high point reached by this ratio since 1916 was in June 1932. This was the last call date preceding the final wave of bank failures which ended in the collapse of our banking system less than nine months later. The ratio has declined rapidly and continu ously since 1933, while member bank failures have almost reached the vanishing point. The other three ratios, while reflecting the risk situation more accurately since 1933, follow a pattern very similiar to the outmoded capitaldeposit ratio during the preceding eighteen years. They seem to have been particularly significant only in periods of heavy excess re serves or of bank credit expansion stimulated almost entirely by Government deficit financing —in other words, in times of relatively risk-free banking. From 1919 through 1921, all four ratios rose sharply but were accompanied by rising bank failures and followed by several years of still higher failure rates. The ratios were at approximately the same levels in 1929 as at the end of 1921, and in fact fluctuated by only a few percentage points at intervening Page Eight dates not shown on the chart. During this pe riod, however, there was a prolonged bulge in bank failures with a relative decline in 1928 and 1929. During the liquidation spiral of the next two and a half years, which accompanied our greatest economic decline, all of these cap ital ratios rose sharply although bank failures were soaring. This was due to rapidly declining deposits rather than increased capital. The absence of consistent inverse correlation between these capital ratios and bank failures prior to 1933 was to a considerable extent the result of inherent defects in our banking struc ture. Banking theory and practice had long emphasized the importance of self-liquidating bank loans, but provisions for assuring liquidity in a large part of bank assets had not kept pace with the changing nature of bank portfolios. Many failures were due to lack of assets which could be liquidated to meet deposit drains rather than to a lack of sound assets. These defects have been largely remedied by (a) more liberal lending powers of the Federal Reserve Banks; (b) the confidence engendered by insuring de posits under the Federal Deposit Insurance Cor poration; and (c) adoption of uniform and more objective methods for appraisal of assets by supervisory authorities. If these conditions had prevailed in earlier years, bank failures would probably have been greatly reduced, and perhaps no bank with in herently sound assets would have failed because of temporary pressure for liquidity. The point remains, however, that as long as banks assume risks under changing banking and economic cir cumstances, a capital ratio which might be ade quate to avoid all failures under a given set of circumstances might be entirely inadequate as conditions fluctuate, unless so designed as to reflect all risk factors. At the heart of the problem is the fact that the degree of asset exposure is frequently determined by broad national and international economic conditions over which individual banks have no control. Dynamic changes in these conditions inevitably influence intrinsic values of bank assets as well as their liquidity. Complex of Factors in Measuring Capital Adequacy The insuperable difficulty in developing an adequate capital ratio lies in the large number of factors which influence the adequacy of cap ital as a protection to bank creditors. The MEMBER BANK CAPITAL RATIOS * SELECTED DATES 1914-1944 PERCENT CAPITAL TO DEPOSITS CAPITAL TO RISK ASSETS 1 NET CAPITAL TO DEPOSITS LESS CASH AND GOVERNMENTS 'NET CAPITAL TO RISK ASSETS FAILURES PER IOO MEMBER BANKS PER CENT 1914-1920 INCLUSIVE,BASED ON NATIONAL BANK FIGURES. __ OR LESS 1914 ’16 '18 ’20 ’22 ’24 ’26 '28 '30 '32 ’34 '36 38 '40 '42 '44 Page Nine tangible factors alone could be measured only by a ratio of formidable complexity, but more important is the fact that many intangible fac tors could not be. accurately evaluated by any mathematical formula. Tangible factors upon which the adequacy of a bank’s capital depends would include: 1. Accurate evaluation of each asset under existing conditions. 2. Type, quality, and distribution of assets, as well as their convertibility into cash without substantial loss. 3. Degree of risk inherent in individual assets. This is in part dependent on their sensitiveness to chang ing economic conditions. 4. Total deposits and relative importance of the differ ent types of deposits. 5. Scope of corporate powers exercised by the bank, such as trust powers, title guarantee, and the like, which may involve contingent liabilities. 6. Earning power of the bank. Perhaps even more important are the in tangible factors which influence a bank’s pros pects. These would include: 1. The management of the bank—its general com petency, speculative or conservative tendencies, and likelihood of change in management personnel. 2. Fluctuations in general economic conditions with particular stress on the cyclical phase in which the test is being made. 3. The kind of community in which the bank is lo cated; the nature of and trends in population; and the types, diversification, and degree of stability to be found in its industries. 4. The character of the bank’s clientele, both borrow ers and depositors; their economic level and sources of income. Any formula designed to reflect, even approxi mately, the influence of all these factors would be too complicated to be useful. The human factor becomes the real determinant when these influences are evaluated, and any purely mech anistic approach is likely to be more misleading than enlightening. A formula could perhaps be designed to fit a given situation, but it is very unlikely that any capital ratio can be developed to fit all banks under all economic conditions. In any event a rigid standard probably would be unwise and'would produce undesirable and perhaps unexpected results over a period of .time. It might force .liquidation..or .sacrificing Page Ten of otherwise good assets at the very time when contraction of bank credit would be most harmful to our economy. If based on risk assets, such a formula might also encourage banks to avoid all risk lending and to depend on various service charges to supplement any deficiency in income to be derived from assets consisting of cash and practically risk-free investments such as Governments. * The lack of a satisfactory measure does not , mean that the importance of adequate capital should be ignored. While the present capital position presents no important problem for banks in general, because of the dominance of relatively riskless assets among bank resources, the situation may change considerably in the years following the war. When banks expand private lending and security investment many of them may need more capital to provide a satisfactory margin of safety and enable them * to serve their communities effectively. It is greatly to be desired that banks assume neces sary risks inherent in financing private indus try and trade as we return to a peacetime econ omy. They will be expected to provide agricul tural credit, inventory and receivables financing, term loans for equipment, and mortgage credit, as the needs of our economy dictate. The same will be true of investments in corporate liens 4 and other types of domestic or even international securities according to the dictates of good investment practice. No matter how skillful a bank may be in selecting good loans and invest ments, these assets involve risks greater than a portfolio of Government securities and Govern ment-guaranteed loans. As is well known, two methods are available for increasing bank capital. Banks have been ^ adding to capital by retaining about two-thirds of their earnings. Although earnings are rela tively high, and probably will remain so, this method alone is slow to meet the situation satis factorily, especially since banks may have to face increased expenses. Adjustments of salary schedules and pension provisions may be neces sary if banks expect to attract and retain desir able personnel, particularly in view of the ..present .attempts to promote effective relations y with customers and the public. It is also possible that some adjustment in interest rates may have to be made on time deposits if banks expect to compete with other savings "channels after the war; - Many bankers are already giving serious ..attention.jto the.se. possibilities, The second method of increasing capital is by • selling additional stock. But general popularity of bank stock will require maintenance of earn ings and possibly somewhat higher dividends than some banks are now paying. The consid erable number of banks in this area which recently have offered new shares, either to re tire outstanding preferred stock or to increase total capital, have encountered favorable response by the investing public. Additional v stock, of course, will dilute the earnings on existing shares, but increased capital may well justify the acquisition of more risk assets whose volume and higher yields may more than sup port existing dividend rates. This analysis has been concerned with aggre gate or average capital ratios of member banks. Individual banks, naturally, vary widely from the average; and the immediate problem of , supervisory authorities is usually concerned with individual cases. Whatever method is used in appraising the adequacy of an indi vidual bank’s capital, satisfactory results will depend upon accurate evaluation of all factors affecting the particular bank, rather than on the application of some formal minimum ratio. Competent and constructive analysis of a bank’s problem probably will gain the cooperation of its management in correcting a weak situation *- more effectively than pointing to some rule-ofthumb minimum capital ratio. Over-simplified ratios are not accurate guides in themselves, and even reasonably good ratios would of neces sity be so complicated that they would result in misunderstanding and bad relations between supervisory authorities and management of banks. group an exposure rating representing the maxi mum percentage loss which might be anticipated from the group as a whole. The adjusted value of each group could then be multiplied by its exposure rating, and the results added to give the total amount of asset exposure. This amount should be less than net sound capital or the latter is not adequate to protect creditors against potential risks. Concluding Comments The foregoing analysis of our experience over a long period demonstrates that it is unrealistic to place faith in any single minimum capital ratio as a yardstick of capital adequacy. The traditional ratio of capital to deposits is partic ularly unreliable and should be constantly minimized, if not entirely discarded. Capital ratios are useful in measuring general trends in the banking system, and as indicators of need for further analysis of individual banks which vary too widely from the general average. Even here it should be remembered always that cap ital ratios may fail to measure either individ ual or general banking conditions accurately. Adequate protection of depositors is of pri mary importance, but a dynamic banking sys tem must do more than provide safekeeping for depositors’ funds. Attention also must be di rected to the equally important function of financing productive enterprise. Without sacri ficing the necessary safety of deposits, a suc cessful banking system also serves the credit needs of the community and justifies the invest ment of stockholders’ funds. Probably the most effective approach would r be to stress “net sound capital” and its relation to the risk inherent in a bank’s assets. Net sound capital is measured by the excess of assets, whose book values have been adjusted to reflect intrinsic values, over liabilities. To determine the degree of risk, each asset should be treated independently in the light of tangible and intangible risk factors. Under a system of risk-free banking, capital adequacy would cease to be a problem; but risk-free banking is hardly banking at all and would be difficult to justify in a progressive economy based on private initiative. Until recent years, risk assets comprised the bulk of banking resources, and the interests of the com munity and of stockholders alike will best be served as banking again assumes its role of financing private enterprise. In practical application of risk rating, it might be necessary to group assets according to degree of risk regardless of their other char acteristics, but these groups should not be too limited in number. The same type of asset— mortgages for example—might appear in sev eral groups since risk may vary widely among mortgage loans. A bank could assign to each Bank capital should be adequate to permit banks to perform this function without endan gering depositors’ claims, but a given minimum ratio of capital to risk may be attained either by increasing invested capital or by reducing risk assets. Too much stress on a mathematical formula may result only in banks avoiding nor mal risks in the future. Page Eleven BUSINESS STATISTICS Production Employment and Income in Pennsylvania Philadelphia Federal Reserve District Industry, Trade and Service Adjusted for seasonal variation Indexes: 1923-5 =100 July June July 1945 1945 1944 INDUSTRIALPRODUCTION 129p 130 MANUFACTURING............... 131 p 132 187p 189 92p 92 Metal products....................... 159* 161r Textile products..................... 68p 66 Transportation equipment. . 421 430 Food products......................... 123p 124 Tobacco and products.......... 78 89 Building materials.................. 37 38 Chemicals and products.... 177 170 Leather and products........... 80p 81 100 Paper and printing................ 106 Individual lines Pig iron..................................... 102 101 Steel........................................... 133 128 Silk manufactures................. 88 84 Woolen and worsteds............ 64p 64 Cotton products..................... 49 46 Carpets and rugs.................... 56p 56 66 Hosiery...................................... 76 Underwear................................ 155 135 Cement...................................... 36 40 Brick.......................................... 52 51 Lumber and products........... 32 28 147 152 237 94 186 70 597 127r 80 34 170 105 98 - 1 - 1 - 1 0 - 1 + 3 - 2 0 -12 + + 3 4 1 6 __ Indexes: 1932 =100 21 2 _ — 14 — 3 — 29 — 3 — 2 + 8 + 4 — 24 + 9 124p 128 126p 130 2 8 6 155 63p 409 llOp 84 40 174 73p 103 — — — 23 0 — 1 + 2 + 5 — 18 + 3 + 2 + 5 - 4 — 6 — 5 — 2 + 2 — 8 + 3 — 9 — 6 + ii + + 163r 181 64 64 430 580 112 118r 86 96 37 41 170 167 79 95 95 99 96 130r 83 84 r 61p 62 43 44 53p 55 65 62 129 135 46 44 1 50 53 2 30 33 r 3* 126 127 23 83 107 55 7 56 10 130p 129 2 95 83 0 85 83 3 107 102 86 14 99 24 60p 59 5 93 93 4 162 159 16 76 83 17 74 81 10 96 100 r 12 332 336 2 415 427 0 414 433 2 345 344 94 121 Slaughtering, meat packing. Sugar refining.......................... — Canning and preserving.... + Cigars......................................... — Paper and wood pulp............ Printing and publishing........ + Shoes.......................................... — Leather, goat and kid........... — Paints and varnishes............. — Coke, by-product................... — COAL MINING........................ — Anthracite................................... _ Bituminous............................... — CRUDE OIL............................... ELECTRIC POWER............... + Sales, total................................ Sales to industries.................. — BUILDING CONTRACTS 66 TOTAL AWARDSt.................. 78 -16 15 60 57 + + 41 Residential!............................. 8 7 4 28 _ 78 9 +53 Nonresidentialf....................... 109 72 91 +52 + 20 + 34 100 Public works and utilities!-. 142 334 120 -57 + 18 +161 122 * Unadjusted for seasonal variation. p—Preliminary, t 3-month moving daily average centered at 3rd month, r—Revised. 142 146 80 5 73 317 Allentown........... Altoona............... Harrisburg.......... Johnstown.......... Lancaster............ Reading............... Scranton.............. Wilkes-Barre. ... York..."................ Factory employment Fact ory payr oils Buil iing peri nits val ue 123 130r 85 82 97 101 340 404 417 363 52 De nts June 1945 July 1944 June 1945 July 1944 June 1945 July 1944 - 3 - 1 - 1 - 4 -10 - 2 - 7 + 9 - 4 -13 -13 - 9 + 70 +165 - 45 + 90 +478 - 7 - 77 - 58 +114 -22 + 7 +26 +19 +13 -12 + 7 -15 +22 -20 —22 +11 +20 + 36 +834 - 19 - 22 + 40 + 86 +579 +183 + 38 + 17 -16 -17 -23 -15 - 4 + 7 -19 + 8 +19 + 14 +4io - 4 0 - 2 - 3 - 2 —12 0 0 - 4 - 2 — 4 0 - 5 8 3 6 8 0 -12 - 3 + 6 0 -10 - 9 +11 0 -25 - 5 - 4 - 2 - 7 -32 - 2 * Area not restricted to the corporate limits of cities given here. Page Twelve - 9 -14 -14 -15 -21 +21 +18 — 7 + 8 -10 0 -12 - 2 0 0 0 + 2 - 3 + + - 0 +1 101 0 97 - 3 9 1 4 5 - 3 - 5 - 5 - 8 -10 +14 - 9 - 8 - 4 + 3 + 2 + 8 + 6 -18 0 - 3 - 2 + 2 0 + 2 + 3 -10 +12 - 1 + 1 - 4 +10 Payrolls* Indexes: 1923-5=100 TOTAL..................................... Iron, steel and products.... Nonferrous metal products. Transportation equipment.. Chemicals and products___ Leather and products.......... Others: Musical instruments.......... 107 114 214 132 75 69 98 118 80 49 113 72 103 99 - 2 - 2 - 2 - 4 - 1 - 1 - 1 - 2 - 2 - 4 -1 46 136 81 - 5 - 5 - 1 0 + 2 + 3 - 9 -11 + 6 -18 - 5 - 5 - 7 — 5 - 6 - 6 - 3 - 3 + 2 + 5 -12 — 7 - 6 180 240 437 230 118 110 156 190 126 82 211 121 — _ — - 5 -10 6 -14 + 3 4 9 -21 3 3 5 + 2 + 3 2 — 2 + 2 - 4 4 6 0 0 0 160 147 - 1 + 2 + 5 + 4 + 9 +13 71 305 113 - 5 - 1 + 5 - 4 + 1 -20 * Figures from 2801 plants. Hours and Wages July 1944 4 4 3 302 440 93 299 117 248 255 152 165 157 193 184 185 10 June 1945 - - 5 - 9 + 8 83 103 July 1944 0 2 2 2 Per cent Per cent July change from July change from 1945 1945 index June July index June July 1945 1944 1945 1944 110 80 98 169 r 77 74 + Employment* 121 June 1945 - 7 - 2 -15 166 50 69 49 76 131 98 117 103 107 Manufacturing Factory workers Averages July 1945 and per cent change from year ago Re ail saJ es 124 66 Local Business Conditions* Percentage change— July 1945 from month and year ago Per cent Per cent July change from July chang from 1945 1945 index June July index June July 1945 1944 1945 1944 GENERAL INDEX........... Manufacturing...................... Anthracite mining............... Bituminous coal mining. . . Building and construction.. Quar. and nonmet. mining.. Crude petroleum prod......... Public utilities....................... Retail trade............................ Wholesale trade.................... Hotels...................................... Laundries................................ Dyeing and cleaning............ 98 136 r 79 59 47 54 136 33 48 33 125 IJay rolls Employment July June July 1945 1945 1944 - 10 — 10 15 - 13 - 14 _ 4 — 11 + 5 +1 + 4 + 7 — 9 + 1 — 1 + 15 — 6 + 15 — 5 + 9 + 42 + 3 + 5 -15 7 - 1* o* 111 138 -19 — 34 91 54 52 121 + 4 — 55 187p 179 163r + 5 + 15 88 77 79 -13 — 3 86 85 + 1 + 2 87 110 103 100 + 7 + 10 92 104 118 -12 — 22 69p 59 91 +16 — 25 100 105 + 10 — 5 91 165 159 172 + 4 — 4 85 78 - 8 — 1 78 0 74 81 74 - 9 109 114r 114 - 4 — 4 332 323 340 + 3 - 2 446 449 434 - 1 + 3 440 446 444 - 1 _ 1 338 341 336 - 1 — 5 107 150r 81 62 54 56 81 164 28 50 30 Not adjusted Per cent change July 1945 1945 fr orn from 7 Mo. Year mos. 1944 ago ago -14 -18 -28 -14 -22 -11 -10 - 6 —25 -15 +10 - 1 +18 + 7 + 3 + 4 +n TOTAL............................. Iron, steel and prods.. . Nonfer. metal prods.. . Transportation equip.. Textiles and clothing. . Textiles........................ Clothing....................... Food products............... Stone, clay and glass. . Lumber products......... Chemicals and prods... Leather and prods........ Paper and printing.. . . Printing........................ Cigars and tobacco... Rubber tires, goods. . Musical instruments. Wee tly working tim 3* Hou rly earnir gs* Week ly earnin gs! Aver age Ch’ge Aver Ch’ge Aver hours age age Ch’ge 43 4 - 2 $1,075 +1 $46.52 -1 44.2 - 4 1.142 +1 50.49 - 3 43.5 - 3 1.013 + i 44.07 - 2 0 44.6 - 4 1.255 55,90 - 4 .815 + 7 31.83 + 9 39.1 + 2 40.2 + 2 .827 + 6 33.25 + 8 0 .783 +10 28.80 +10 36.3 0 .840 + 4 37.51 + 3 44.3 40.4 + 2 .967 + 6 39.05 + 8 43.1 - 2 799 + 5 33.92 + 2 46.7 + 2 1.082 + 2 50.39 + 4 .790 + 5 33.82 + 7 42.9 + 2 .947 + 5 41.93 + 8 44.1 + 3 42.6 + 5 1.095 + 4 46.82 +10 42.4 45.7 40.6 * Figures from 2657 plants. + 2 + 5 .664 + 7 28.16 1.090 + 4 49.76 .896 - 4 36.34 f Figures from 2801 plants. -11 + 9 + 9 -15 Distribution and Prices Per cent change Wholesale trade Unadjusted for seasonal variation July 1945 Month Sales Total of all lines... Drugs..................... Dry goods............. Electrical supplies Groceries............... Hardware.............. Jewelry.................. Paper...................... + + 5 5 7 4 + -2 Inventories Total of all lines... Dry goods............. Electrical supplies Groceries............... Hardware.............. Jewelry................... Paper............... .. . . + + 45 +41 +20 +10 +10 +10 +15 - 9 - 5 -14 + +1 8 - 9 -43 +28 - 9 - 7 - 4 0 - 7 - 5 +6 RETAIL TRADE Sales Department stores—District........................ Philadelphia............... Women’s apparel.............................................. Men’s apparel........................................... Shoe.......................................... 198 188 226 152 181 185 176 198 157 r 157 169r 156 r 192 146 163 + 7 + 6 + 14 - 3 +15 -17* +17 +20 +18 + 5 +11 +14* July June July 1945 1945 1944 +12 +10 136 +19 +14 + 8 127 139 167 153 171 175r 168 156 149 167 61 156 138r 151 r 131 r 189 66 75 150 134 150 136 89 163 290 193 120 101 116r lOOr 108 97 126 Inventories 0 164 162 223 70 - 9 -21 0 Not adjusted Per cent ch ange July 1945 July June July fro m 1945 1945 1945 1944 from 7 Month Year mos. 1944 ago ago Indexes: 1935-1939 =100 8 + -184 -21 -11 -11 Adjusted for seasonal variation 1945 from 7 mos. 1944 Shoe.................................................... Furniture.................................................... Source: U. S. Department of Commerce. 165r 146 161 143 232 219 68 87 0 + 1 - 4 + 3 0* +13 +14 + 2 -19 + 8* Per ceiit chanf efrom Prices Basie commodities (Aug. 1939 =100).... Wholesale (1926=100)................. Farm............................. Food.............................. Other............................ Living costs (1935-1939=100) United States............. Philadelphia............... Food............................ Clothing..................... F uels........................... Housefurnishings. . . Other.......................... July 1945 Month Year ago ago 0 184 106 129 107 - 1 - 1 100 0 129 128 139 146 113 143 0 0 0 0 Aug. 1939 +1 0 + + + + + 84 2 + 41 4 +111 1 1 + 59 + 24 + 3 + 3 + 3 + 5 + 3 + 4 - 1 + 3 121 0 + 1 Source: U. S. Bureau of Labor Statistics. + + + + + + + 31 31 50 47 17 42 FREIGHT-CAR LOADINGS Total........................................................... Merchandise and miscellaneous................... Merchandise—l.c.l.......................................... Coal............................................................. Ore............................................................. Coke..................................................................... Forest products............................................... Grain and products....................................... Livestock............................................................. MISCELLANEOUS Life insurance sales..................................... Business liquidations Number........................................................... Amount of liabilities....................................... Check payments................................................. 20 * Computed from unadjusted data. 147 134 86 165 204 221 99 146 123 133 199 146 133 89 181 198 207 97 171 150 138 87 166 215 233 121 132 234 - 2 - 3 - 1 - 2 0 111 111 -28 - 9 + 2 - 7 -18 + 5 -15 157 305 203 171 +1 +1 - 3 - 8 + 3 + 7 + 2 -14 +1 196 105 148 110 153 138 87 158 322 214 134 164 147 122 + 1 + 9 +11 127 135 116 187 —33* —73* -15 62* 62* + 9 189 252 178 120 122 - 5 - 5 -17 +20 75* + 7 0 0 86 r—Revised. BANKING STATISTICS MEMBER BANK RESERVES AND RELATED FACTORS Reporting member banks (Millions $) Changes in— Aug. 22, 1945 Assets Commercial loans................... $ 214 44 Other loans to carry secur... 64 33 Other loans............................... 1 122 Total loans............................ $ 478 Government securities.......... $2007 Four weeks One year +$10 + — - $24 + 8 2* + 50 — 4 — 1 2* + 19 +$10* + 48 6 +$295 - 55 + 22 Total investments............... $2191 -163 +$262 Total loans & investments. $2669 Reserve with F. R. Bank.. . 425 29 Balances with other banks.. 83 Other assets—net................... 49 —$53 + 10 +$310 + 49 + + + - Other securities....................... i84 Liabilities Demand deposits, adjusted. $1781 Time deposits.......................... 213 U. S. Government deposits. 611 Interbank deposits................. 378 Borrowings............................... 6 17 Capital account...................... 249 * Revised. * —$69 + 6 3 +$43 + 3 - 97 + 12 + 3 + 2 5 Aug. 1 Aug. 8 Aug. 15 Aug. 22 Changes in four weeks Sources of funds: Reserve Bank credit extended in district............................ Commercial transfers (chiefly interdistrict)....................... Treasury operations................................................................... - 5.1 +31.7 -14.2 +18.8 +38.7 -46.8 -12.1 +39.6 - 4.2 +28.5 +14.7 -37.3 + 30.1 +124.7 -102.5 +12.4 +10.7 +23.3 + 5.9 + 52.3 + + + + +11.8 + 0.1 - 1.3 + 0.1 + 4.0 +19.4 - 0.1 + 0.0 +10.6 - 5.3 + 0.7 - 0.1 + 31.8 + 19.8 + 0.2 + 0.5 Uses of funds: Member bank reserve deposits............................... “Other deposits” at Reserve Bank..................................... Other Federal Reserve accounts................. 5.4 5.5 1.0 0.5 4-19 Member bank reserves (Daily averages, dollar figures in millions) Re Held quired Ex cess 8 +$184 + 29 + 93 + 28 + 4 + 1 + 18 Ch anges in w eeks ended— Third Federal Reserve District (Millions of dollars) Phila. banks 1944: Aug. 1-15 . . 1945: July 1-15 .. July 16-31. . Aug. 1-15.. $357 407 403 407 $349 394 394 397 $ 8 13 9 Country banks 1944: Aug. 1-15.. 1945: July 1-15. July 16-31. . Aug. 1-15. . 284 339 331 332 226 262 268 273 58 77 63 59 10 Ratio of excess to re quired + 52.3 A Federal Reserve Bank of Phila. (Dollar figures in millions) Changes in— Aug. 22, 1945 Disc, and advances.. $ 10.8 Industrial loans........ 2.4 2% U. S. securities.......... 1584.4 3 2 Total......................... $1597.6 2 Note circulation. . . . 1566.9 Member bk. deposits 747.2 U. S. general account 49.4 26 Foreign deposits. . . . 98.1 29 Other deposits.......... 3.5 Gold certificate res... 23 860.6 22 Reserve ratio............. 34.9% Four weeks year +$ 7.4 + 0.4 + 26.0 +$ 5.6 1.7 + 463.0 +$33.8 + 31.8 + 19.8 - 1.3 + 4.8 + 0.2 + 23.3 + 0.2% +$466.9 + 271.6 + 105.9 + 14.3 - 28.0 3.4 - 101.7 - 10.8% Page Thirteen
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