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Consideration of the Federal Reserve System From the Standpoint of the Trust Company or State Bank https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis An Address by Breckinridge Jones President Mississippi Valley Trust Company St. Louis Before the Trust Company Section of the American Bankers’ Association at Atlantic City, N. J. Sept. 25th, 1917 - https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The writer claims no special originality for views expressed in this paper, as be fore writing it he had quite extensive correspondence concerning the subject, and has not hesitated to utilize any suggestions (and there were very many) that he thought deserved a place in the consideration of the subject. He takes this opportunity to express his thanks to those who were helpful in the matter. Consideration of the Federal Reserve System from the Standpoint of the Trust Company or State Bank By BRECKINRIDGE JONES In May last the Trust Company with which I am con nected joined the Federal Reserve System. We received dozens of inquiries from other State institutions—Trust Companies and Banks—asking the reasons why we had joined. To save duplication of work, I had printed the substance of the answer in a pamphlet entitled: “Why One State Institution Joined the Federal Reserve System,” and sent it to our correspondents and some others. Then came your President’s request for me to speak here. I consented, thinking I could use the meat of that pamphlet, but before I knew it—being on my vacation—the pamphlet was reprinted in the Federal Reserve Bulletin and Trust Companies Magazine, so I must shift the kaleidoscope. Before an audience such as this it would be a waste of time to recur to the defects of our old currency system, or to treat as a debatable question now the fundamental value of the Federal Reserve Act. It is now conceded everywhere that the new system is a masterful improvement over the old. No one would return to the old. In the last campaign not one candidate for public office, anywhere, even as much as suggested a repeal of the Federal Reserve Act. It has come to stay, and is justly popular with the general public. It has already aided in a great public ser vice. It is everywhere admitted to be a comprehensive, compact, strong, efficient banking system, even though not perfect. Universally, bankers admit its prime value in pre venting panics, stabilizing commerce, protecting the banker, facilitating his customers, and above all, in aiding the Gov ernment to finance the war. Every financial institution in the United States, whether a member or not, has been, and is, a beneficiary of its operations. But Mr. Warburg, the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis very able Vice-Governor of the Federal Reserve Board, will discuss before the General Convention the merits of the Act and what it has accomplished. I refer to it only to voice the thought that as the efficiency of the Act will be the more accentuated as the number of members is greater, as the gold reserve is larger, and as the collection system is more comprehensive, there is a distinct patriotic duty on the part of every eligible Trust Company and State Bank to join the System. That is the conclusion when viewing the subject* from a national standpoint. While I will leave for Mr. Warburg’s facile pen the discussion of the national viewpoint of the System, I can not refrain from attaching as an addendum to this paper an illuminating letter of re cent date from our old friend in the Trust Company Sec tion, the Chairman of the Federal Reserve Bank in New York, Mr. Pierre Jay, as it is too valuable not to be read and put in the record. . But, what are the benefits ? I speak now not of the gen eral benefits that come from the fact that the System is in successful and efficient operation—benefits which every in stitution will receive, whether it is a member or not—but of the benefits. which, when looked at from a selfish standpoint, would influence a State Bank to join the Sys tem. (The term “State Bank” as herein used will be under stood to include Trust Companies.) What are the express provisions of the law relating to a State Bank that becomes a member, and what are the practical considerations inci dent thereto? Legal and Practical Advantages and Disadvantages of State Bank and Trust Company Membership Section 9 of the Federal Reserve Act, as amended June 21, 1917, provides among other things: “Subject to the provisions of the Act and the regu lations of the Board made pursuant thereto, any bank https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 becoming a member of the Federal Reserve System shall retain its full charter and statutory rights as a State Bank or Trust Company, and may continue to exercise all corporate powers granted it by the State in which it was created, and shall be entitled to all privileges of member banks.” Under this provision it becomes material to inquire: First: What are the results of this new enactment providing that a State Bank entering the System shall retain all its charter and statutory rights ? Second: What are the provisions of the Act and the regulations of the Board to which such right will be subject? Third: What are the privileges of a member bank to which it will be entitled ? First: As to Retaining All of Its Charter and Statutory Powers. The Federal Reserve Board at first claimed for itself the right to prescribe what part of the char ter powers of a State Bank or Trust Company an in stitution should exercise if it became a member of the Fed eral Reserve System. That position was fundamentally objectionable to the State Banks and Trust Companies, and, upon a thorough presentation of the matter to the Federal Reserve Board, the Board, by regulation, practically aban doned that position and left the matter with a declaration that if the charter powers of a State Bank or Trust Com pany were such as, in the opinion of the Board, would interfere with the liquid condition of the State Bank or Trust Company, there might be a limitation put on the State Bank’s facilities in re-discounting. But State Banks, and especially Trust Companies, feared that after they had come in the Board might change those regulations (having the same right to change as to make), and so in terfere with the Bank’s powers, especially those that were https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 not enjoyed by national banks. That objection has been removed entirely by the recent Congressional amendment. Under the amendment the Federal ,Reserve Board is given the power to make rules and regulations as to the right of a State Bank to become a member, and in acting on the application, shall consider the financial condition of the applying bank, the general character of its management, and whether or not the corporate powers exercised are con sistent with the purposes of the Act. Thus, if there is any question as to whether the Bank’s condition, management or corporate powers are not con sistent with the purpose of the Act, that question will be settled before the Bank becomes a member, and there will be no chance afterwards for embarrassment on that account. The conditions under which the Bank enters can be covered by the terms of its application, which, when granted, may amount to a contract. An important result is that a Trust Company will pre serve intact all its trust powers. (a) Loans in Excess of Ten Per Cent, of Capital and Surplus Under the original Act, the restrictions applicable to National Banks as to lending not over ten per cent, of their capital and surplus (Section 5200 National Bank Act), were made to apply to State Banks joining the System. Under the amendment that application was repealed, and a State Bank retains all its charter and statutory rights as to the amount it may lend to any one borrower. This ten per cent, limit on loans was a subject of great objection on the part of many State Banks. Whether their objection was well taken is not now important. (b) Usury Under the original Act, the Usury Laws that applied to National Banks were made to apply to State Banks be- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 coming members. Many State Banks preferred to operate under their State Laws, under which they had built up their business, and with which they were familiar. The amend ment repeals the application of that Section so that now a State Member Bank, in the matter of usury, will be sub ject only to the law of its own State, unless the statutes of the State in which the Bank isjocated, in terms make a Bank joining the Federal Reserve System subject to the Federal usury laws. (c) Clayton Act—Interlocking Directors— Private Banks There is an interesting, and to many, I am sure, an un expected, result of the amendment. The Clayton Act (Sec. 8), prohibits interlocking directors and also prohibits a private banker, under certain limitations, from being “a director, or other officer or employee in any bank or bank ing association organized or operating under the laws of the United States.” Under the original Act the Federal Reserve Board con strued that a State Bank becoming a member was “operat ing under the laws of the United States,” but on the 10th of this month the acting Attorney-General of the United States, in an opinion to the Secretary of the Treasury in construing this amendment, said: “Section 9 as amended goes further, and by positive provision declares that State member banks shall retain their Tull charter and statutory rights’ as State banks, ‘subject to the provisions of this Act and to the regu lations of the Board made pursuant thereto.’ Since the rights existing under State laws as to selection of directors seem clearly among the ‘charter and statutory rights’ thus retained in full by State member banks, they must be held free in that regard from the restric tions imposed by Section 8 of the Clayton Act.” This opinion, which, without doubt, will be followed by the Federal Reserve Board, removes the main objection that https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 a number of the large State Banks and Trust Companies had to entering the System. Many of their directors are directors of other State Banks and Trust Companies, or are “private bankers,” and these last words have practically been construed to include not those who deal entirely on commission, but every broker or bond dealer who makes a business of buying and selling securities for his own ac count. Heretofore, if they had become member banks they would have lost from their boards all these interlocking di rectors and private bankers—a very serious loss, and in many instances a controlling factor in keeping them out of the system. Many State institutions did not object to this restriction because they rather liked the idea of having directors whose only affection was for them, and not divided with a com petitor. Note also that while the Clayton Act in the particulars mentioned does not apply to State Banks and Trust Com panies, it does apply to National Banks, because they are distinctly “organized and operating under the laws of the United States.” Second: What are the Provisions of the Act and the Regulations of the Board to Which Such Right Will Be Subject? Note that the amendment specifies eleven special pro visions that shall apply; and, by specifying these eleven, under the accepted rules of construction, all others are ex cluded. True, the amendment makes a member State Bank sub ject to the regulations of the Federal Reserve Board, but, again under the recognized rules of construction, these regulations will be applied to the administration and or derly carrying out of the law as enacted by Congress, and will not give the Board the power to make the State Banks https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 subject to specific provisions of the law other than those here now set out: 1. A State Bank must comply with the reserve and capital requirements of the Act, being the same as applied to National Banks. there is no particular disadvantage in this. I believe (a) The reserve requirements now are : For country banks 7% of demand deposits and 3% of time deposits. For Reserve city banks 10% of demand deposits and 3% of time deposits. For Central Reserve city banks 13% of demand de posits and 3% of time deposits. These reserves must be kept in the Reserve Banks and no interest is allowed thereon, whereas now a large part of these balances of non-member banks are kept with city correspondents at, say, two per cent, interest. This is the one objection that is the most often urged, especially by the smaller banks. As a Member Bank can get currency as a matter of legal right and without delay from the Federal Reserve Bank, either from balances or from re-discounts, many member banks need to keep practically only till money in their offices. As a matter of fact, they do run on much lower .cash reserves than formerly, and this dif ference is of such an amount that the interest earned from loaning it, nearly, if not entirely, offsets the loss of interest on the balance with the Reserve Bank. In our case, most of our required balance for the Federal Reserve Bank was taken from our vaults, where it had earned no interest, and now we lend down much nearer to our required reserve, and at the same time are better pro tected and feel more secure than before we joined. If a State Bank reserve has been (which is seldom the case) and is to continue to be (which is improbable) main- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 tained constantly at the minimum, upon entering the System such bank would be required to transfer from its deposi taries, which pay two per cent., to the Federal Reserve Bank, which pays no interest, and the loss of interest would be of considerable moment. As a matter of fact, however, its reserves for the greater part of the year have been con siderably in excess of the legal minimum. Should it con tinue this practice, a large portion of these funds now with depositaries could be continued with them, and this loss of interest would be small. If, on the other hand, by reason of its facility for getting currency and its re-discount privi leges, it can run on less balances than heretofore, then this difference could be loaned out at more than double the two per cent, it has been getting, and there would be likely be no loss, but a profit. Should a State Bank join the System, it would not be compelled to maintain much excess cash reserves when anticipating stringent money conditions, or when providing the financing of large transactions, either alone, or when it participates with other banks. It could, therefore, employ to greater advantage its excess reserves by applying them in the usual channels which yield a higher return than the interest received from its city depositaries. (b) State Bank Members must have a capital at least equal to that required for a National Bank in the same place. This is reasonable, and certainly there can be no objection to it on the part of the banks that are of the size required. 2. State Banks must conform to the legal pro visions imposed on National Banks: (a)Prohibiting such banks from loaning on, or purchasing their owri stock; (b) Relating to the withdrawal or impairment of capital; (c) Relating to the payment of unearned dividends. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 These provisions make for good banking and are found in substance in the laws of most of the States. There is no disadvantage in conforming to them. The original Act put each of these matters under the Comptroller, whereas this amendment puts them, as to State Members, entirely under the Federal Reserve Bank. 3. State Bank Members are made subject to the provisions and penalties of the U. S. Revised Statutes, Section 5209, which relates to embezzle ment, abstraction, misapplication of funds, false entries, and issuing obligations or disposing of assets without authority from the Directors. These provisions are wholesome and above objection. The enforcement of the penalties under this section was never under the Comptroller, but for the National Banks has always been, and now for all members is, in the courts. 4. At least three reports of condition and of pay ment of dividends must be made each year on call of the Federal Reserve Bank on dates fixed by the Federal Reserve Board. The original Act provided for these reports to the Comp troller ; but the amendment requires them only to the Fed eral Reserve Bank on dates fixed by the Federal Reserve Board. Under the regulations, if the call is made as of the same day as the call of the State, as is usually the case, a copy of the statement made to' the State will be sufficient. The laws of most of the States require at least two state ments for State Banks, while under the National Bank Act, National Banks must make five. Moreover, many of the clearing houses require all of their members—including the State institutions—to make statements whenever the Na tional Banks are called for a statement. There may be some little added labor and some slight additional expense under this requirement, but I have heard of no Bank making https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 this an objection. Most State Banks prefer to make state ments when their competitors make them. 5. State Bank Members under the amended law are subject to examinations made by direction of the Federal Reserve Board, or of the Federal Reserve Bank, instead of by the Comptroller, as required by the original Act. But if the Directors of the Federal Reserve Bank approve the examinations made by the State authorities, such examinations may be accepted in lieu of the Federal Reserve Bank ex aminations. This approval is usually given where the State examina tions are considered worthy. The Board may also order special examinations, and if made, State Banks must pay the expense of such examinations. This is a wholesome provision: the tendency of it is to make the State Exam iners more careful. No State Banking Department would like to have its examinations turned down. Every State Member Bank will aid in making the State examinations so thorough that a Federal examination will not he required. This will tend to hold to a high standard all State exam inations, whether of member banks or not, as the examiners will likely use the same yardstick everywhere. It is material to note here that these provisions entirely exempt State Bank and Trust Company members from ex aminations by, or reports to, the Comptroller of the Cur rency under the provisions of Section 5240, U. S. Revised Statutes, or otherwise. In other words, since the recent amendment to the Federal Reserve Act, a Member Trust Company or State Bank is not in any way subject to the Comptroller of the Currency; and so far as the Federal Re serve Act is concerned, it is subject to examinations and reports of condition only to the Federal Reserve Bank of its district. And note further, that the officers and directors of the district bank are residents of the district, familiar with local conditions, accessible to personal acquaintance, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 and two-thirds of them are chosen by the stockholding banks of the district, the other third being selected by the Federal Reserve Board. The two-thirds chosen by the stockholding banks can elect all the officers except the Federal Reserve Agent and his deputy, and can in general control the management of the District Board. 6. Non-compliance with the provisions of said Section 9 of the Act, or the regulations of the Federal Reserve Board, made pursuant thereto, subjects State Bank Members to surrender of stock and forfeiture of privileges of membership. This penalty can be imposed, not by the Comptroller, as before the amendment, but only by the Federal Reserve Board, and only after a hearing, and the Board may restore membership upon proof of compliance with the Act. With out meaning to imply that it would have been otherwise under the Comptroller, it is meet to say that this insures that there will be no spasmodic, supercritical, or unreason able enforcement of the Act, and that a Bank will have its attention drawn to any alleged violation and will have ample time to explain or reform its conduct. Thus, insofar as the Federal Reserve Act is concerned, this provision amounts to giving to the Federal Reserve Board about the same right as to controlling membership in the System that each State reserves to itself as to all corporations—namely: the right to forfeit a charter by qtio warranto proceedings where a corporation violates the law. 7. Under the original Act there was no express provision for a State Bank’s getting out of the Sys tem, if it were once in. In answer to that objection—frequently and forcefully urged—the Federal Reserve Board made a regulation pro viding for withdrawal on twelve months’ notice; but now, under the amendment, State Banks may voluntarily with- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 draw upon six months’ written notice. There is, however, a limitation that the aggregate withdrawals in any one year shall not be more than one-quarter of the capital of the Federal Reserve Bank. 8. State Bank Members are made subject to all the provisions of the Act which relate specifically to member banks, except that State Bank Members are not subject to examination by the Comptroller, as above mentioned. (See 1st and 2nd paragraphs of Section 5240, as amended by Section 21 of the Act as amended June 21st.) In this connection, Section 22 of the Federal Reserve Act should be mentioned, as it is the only section that need be discussed in this connection as affording grounds for objec tion to entering the System. It will be hereafter discussed. 9. While State Bank Members are not limited by the Act in the amount of loans to any one bor rower, they can not procure re-discount of paper by any one borrower beyond ten per cent, of capital and surplus, with the usual exception that discount of bills drawn against actually existing value, and all business paper actually owned by the person negotiating the same, shall not be considered as bor rowed money. In connection with re-discounts a certificate of non-excess must be furnished. There would seem nothing objectionable in this pro vision. 10. There is a further prohibition against over certification by an officer or clerk of a State Bank Member analogous to the similar provisions of the National Bank Act. However, the penalty is to be imposed, not by the Comp troller, as before the amendment, but only by the Federal https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 Reserve Board after a hearing. this. There is no objection to 11. A State Bank must subscribe six per cent, of its capital and surplus to the capital stock of the Federal Reserve Bank. One-half of this is payable immediately, and the balance is subject to call of the Federal Reserve Board. In no instance as yet has this last one-half been called. The Federal Reserve Bank is required to pay, when earned, [cumulative] dividends of six per cent, on the amount paid in. Some of the Federal Reserve Banks have not yet made such earnings. As a whole, however, they have earned over 5%' on their stock, and from this time on it seems evi dent that they will each earn the required six per cent. If they do this, there is no loss to the subscribing bank, except to those banks where the earnings on all its assets are in excess of this. No bank could be much hurt by putting 3% of its capital and surplus in such a 6% investment. But even if there should be some little loss here and some little loss on the interest on balances carried with the Federal Reserve Bank, this loss may be considered as premium paid for insurance. Those in the System are not making any complaint along this line. The suggestion has been made that it would be wise to eliminate the requirement of subscription to the capital stock of the Federal Reserve Banks, as this stock serves no particular function in the Federal Reserve System. In other words, the Federal Reserve Banks do not require any capital stock, and if the stock were entirely eliminated, or reduced to a very small amount, the various Federal Re serve Banks would not be obliged to earn money in order to pay dividends, and this would tend to keep the Federal Re serve Banks out of the open market and out of competition with the member banks. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 13 Third: What are the Privileges of a Member Bank to Which It Will Be Entitled? (a) Acceptances and Discounts. The acceptances of a member bank can be sold on the open market at a rate estimated at between % and ^2 of one per cent, lower -than the similar obligations of a non-member bank. It appears that banks generally concede this additional credit to a member bank. This is demonstrated by the daily quo tations as to acceptances of the higher class of members and non-members. The advantages, however, are not to be measured solely by present business. As acceptance business grows more general, a bank is likely to have more business and more prestige if it can offer more favorable rates than other banks' who are not members of the System. A member should be able to maintain not only its present prestige, but materially increase it. Non-members are limited in trading in acceptances and deprived of fair profits derived therefrom by reason of the fact that they have no fixed channel by means of which they can dispose of their acceptances, except in the open dis count market, which is limited and precarious in times of firm money rates. The regulations' of the Federal Reserve Board defining eligible paper are liberal. From month to month accept ances are coming into greater use and the discount market is broadening. By amendment of the Act, acceptances can be made against domestic, as well as foreign, shipments; but State Banks are not limited by the Federal Reserve Act in the character of drafts which they now have the power to accept under their State charters and statutory rights. A State Bank, however, is limited by the Act in certain respects as to the quantity that it can accept for one bor rower or in the aggregate. But such limitations relate en- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 14 tirely to drafts or bills of exchange which grow out of transactions involving the importation or exportation of goods or which grow out of transactions involving the do mestic shipment of goods, provided shipping documents conveying or securing title are attached at the time of ac ceptance, or which are secured at the time of acceptance by a warehouse receipt or other document conveying or secur ing title, covering readily marketable staples; and does not anywhere refer to or affect a State Bank’s right, if it has it under State charter or statutory powers, to accept plain finance bills which may have no documents attached. And the limitations that are given in the Act (when it says that no Member Bank shall accept, whether in a foreign or domestic transaction, for any one person, etc., to an amount equal to more than 10 per centum of its capital and surplus, and when it says that no bank shall accept such bills to an amount equal at any time in the aggregate to more than fifty per cent, of its capital and surplus, with the privilege, upon approval of the Federal Reserve Board, of increasing to one hundred per cent, on foreign drafts alone, or on foreign drafts and domestic drafts together, provided that such domestic drafts shall not exceed 50% of such aggre gate) are limitations upon the amount of drafts or bills, of exchange just above mentioned and have no reference to ordinary drafts that may be accepted by a State Bank under its statutory rights. There is also the right to accept drafts drawn for the purpose of furnishing dollar exchange up to an additional 50 per cent. (See Section 13 of the Act as amended.) Let me repeat, there is no limit, so far as the Act is con cerned, on the character of acceptances a State Bank can make, nor as to the quantity except as above mentioned. My prediction is that the large Trust Companies will find a very large increase in their business along this line, and especially https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 when they know that they have a fixed right to discount with the Federal Reserve Bank. (&) Commercial Paper and Bills Purchased. In addition to the re-discounting privilege in the handling of acceptances, a State Bank going into the System will have the privilege of re-discounting with the Federal Re serve Bank eligible commercial paper and bills of exchange in such an amount “as may be safely and reasonably made with due regard to the claims and demands of other banks.” The Federal Reserve Bank’s rate of re-discounting this class of paper will usually be from % to 1% under the rate which the particular paper yields to the Member Bank offering it for re-discount. A State Bank will be limited in a large expansion of its commercial business unless it has re-discounting facilities, such as are afforded by the Federal Reserve System. It must have facilities as good as those of its competitor. No restrictions are imposed by the Federal Reserve Act on a State Bank’s present powers to make loans under the State Law—its full charter and statutory rights in this particular remain intact. (c) Accounts erom Member Banks and Accounts Carried by State Banks with Depositaries. At the present time a National Bank, or a Member State Bank, having excess reserves, can not deposit an amount greater than 10% of its capital and surplus with a non member bank and many banks at various times wish to have more than this with their city depositaries. The recent amendment having removed nearly all the fair objections a State Bank could raise against joining the System, a large number of Trust Companies and State Banks are now prepared to join, and they, therefore, would be subject to the same restrictions. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 16 If a State Bank in a reserve or central reserve city wishes to have large deposits from member correspondents it should join the System. It should then be able to ma terially increase the amount of deposits from Member Banks, and with such increase there would naturally follow an increase of deposits from non-member banks. (d) Collateral Loans from Federal Reserve Bank. To borrow money from the Federal Reserve Banks for a period not exceeding fifteen days on the member’s own promissory note, secured by commercial paper or govern ment bonds or notes. This is an important privilege and can be used on a mo ment’s notice to enable a bank to protect its reserve against sudden or unexpected large withdrawals of deposits, or calls for funds. It gives an opportunity to use as collateral for the time specified, bonds or notes of the United States and paper that might not be eligible for dis count, that is, such drafts, bills of exchange or bankers’ ac ceptances as might not be eligible for re-discount, but would be eligible for purchase by it. (^) Federal Reserve Notes and Other Currency. To obtain Federal Reserve notes and other currency as needed from the Federal Reserve Bank. Here again, a member is relieved from dependence on the convenience or ability of its city correspondent. You know the Reserve Bank always has the goods, and always finds it convenient to deliver them. (/) To Receive Deposits oe Postal Savings and Other Government Funds. The law requires now that new or additional pos tal savings shall be deposited with member banks only. Thus, where a Member Bank loses deposits to the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 Postal Savings, and in troublous times this may be quite worth noting, the money may at once come back by the bank’s being a Postal Savings Depositary. (#) To Have Checks and Drafts Drawn Upon it Re ceived at Par by all Federal Reserve Banks. (&) To Make Its Drafts on the Federal Reserve Bank Available for Immediate Credit at Any Federal Reserve Bank. (i) To Participate in the Check Clearing and Col lection Facilities of the Federal Reserve System. A member is not required to use these facilities, but has the privilege. In passing, it may be well to remark that a number of clearing houses are settling their clearing house balances by check on the Federal Reserve Bank, and under the amend ment permitting this, non-member banks are keeping bal ances there for that purpose. Note that these non-member banks consider the benefits such as to justify them in keep ing balances there without interest. Moreover, doing business with the Federal Reserve Bank is a great convenience in buying and selling New York Ex change. Hereafter, in the large cities, I think it will soon be almost impossible to do this economically without being a member. The collection system developing under the Federal Reserve Board can not be equalled by any other method. Under the amendment, banks can charge for the collection of checks drawn on them, except when presented by a Federal Reserve Bank. In the course of time, this will develop a monopoly of the collection business through the Federal Reserve Bank. There will be great advantage here from being a member. Each of the last three (g), (h) and (f), deserves ex tended attention, but time will not permit; each is worthy https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 18 of consideration in a separate paper, and the more each of them is considered, the more distinctly will appear the ad vantages a member has over a non-member. Section 11 (k)—Trust Powers to National Banks Since the Supreme Court of the United States has decided that Section 11 (^), giving National Banks certain Trust powers, is constitutional, it is likely that in due course many of these banks will develop Trust departments, and if they do, then they will advertise their Trust departments as under Federal supervision, and, therefore, entitled to greater favor from the public. They now do this in their Savings departments. There will then be the same reasons of pres tige to come up for consideration with the Trust Companies. These Trust Companies that are members will likely be advertising that they can give to their patrons the additional protection of Federal supervision, and in addition will make to the public a plea for more patronage, or more support, because they stand before the public with every possible element of public supervision and public protection that is afforded under the law, either State or Federal. I think this may be an additional reason for Trust Companies to come into the System, and may, in some communities where competitors are aggressive, be sufficient, along with the other general considerations, to induce a Trust Company that does no commercial business to join the system. Section 22 of the Federal Reserve Act The most serious objection to the Act, from the stand point of the State Banks and Trust Companies, was that they found that Section 22 of the Federal Reserve Act prac tically prohibited an officer or employe, director or attorney, of a Member Bank from transacting any business with the bank. This may be stating the matter too broadly, but the general effects only are in contemplation. The penalties in https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 this Section No. 22 are fine and imprisonment. It is thought that the Federal Reserve Board has had more trouble over this section than any other section of the Act. The Board did not feel that it had any right, by regulation, to modify or define the express Act of Congress, but upon the whole subject being fully presented to the Board, the result was that the main objections were met by the Board’s recommending an amendment to the Act, providing that interest might be allowed on balances of directors, officers, employees, and attorneys, and loans made to directors and attorneys on the express written authority of a majority of the Board of Directors. The Federal Reserve Board has ruled that this can be accomplished by a general resolu tion. While the prohibitions of this section apparently are not receiving special notice from the authorities at this time, yet it would be wise for any State Bank or Trust Company, before it enters the System, to have Section No. 22 referred to its attorney for a report. This section needs further amendment, so that without at all lowering the standards, its prohibitions will not unduly interfere with very many reasonable and proper transactions. Membership gives a State Bank or Trust Company added prestige. The general public has confidence in the Federal Reserve System, and feels that banks that have the benefits of membership, and are subject to Federal supervision, are being managed safely, and are in a stronger position to take care of themselves and their customers under any and all circumstances. It is no answer to this to say that the size and growth of State Institutions show that they are popular with the people, and that a State Bank can always expect to get assistance from its city correspondent, which it knows is strong—and this, whether that correspondent is a member or not—and that it has always been liberally treated by that correspondent. It is well known that there have been many times when the city correspondent, whether State or Na- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 20 tional, under the old law, could not get currency and when it could not lend money to its country bank customers, and that the tendency is, in general tight money times, for the city bank to be famishing for funds at the same time that its country correspondent is hungry for money. On which of two correspondents would you prefer to have to rely in times of stress—the member that you know has the right to re-discount with the Federal Reserve Bank and get needed money for you, or a non-member, who has no such right, and who may have to depend on the courtesy of one of its correspondents or depositaries who is a member? I believe it true that practically every large Trust Company keeps the majority of its reserve accounts with National Banks, or with State Banks who are members. This is not alone for the reasons of reciprocal business, but because those large institutions realize that they need the protection of the Federal Reserve System, indirectly, at least. It seems rea sonable that customers, especially those whose business re quires large lines of credit, should do business with a bank which, in times of drought, has the right to go direct to the reservoir. Before we became members, we certainly felt that way. I could not answer the argument. We thought that in the long run our customers would arrive at the same conclusion, so we joined the System, and ever since have been glad that we did. It is generally admitted that the Federal Reserve Board is made up of men who are competent, prudent, reasonable, approachable and patriotic, and who do not play politics. The same may be said of the Boards of the several Federal Reserve Banks. The public knows this; the public believes in the System; the public understands the benefits that will accrue to a bank from joining the System; and it will not be very long before there will begin to be an opinion that if an eligible State Bank or Trust Company does not join the System, it is because the character of its business, or the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 21 condition of its business, is such that it would not be per mitted to join. The advantages of membership are distinct, important, and cumulative. The disadvantage that is most often as serted is that the Federal Reserve Bank does not allow in terest on balances. As a nation, we are giving liberally our blood, and our treasure, to this gigantic struggle. We send our boys to the front—we kiss them good-bye with valiant hearts. Will we then falter at so paltry a sacrifice, if it be one, as losing a little interest on our balances ? Our country needs credit, and as more billions are required, more credit will be required to protect those boys, to absorb the financial shock during the war—to win the war—and after the war to be in shape for a rapid convalescence. The best way to make the foundation for more credit is to corral the gold of the country in Federal Reserve Banks and have the banks of the country present a united, co-operating force. Will you do your part ? https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 22 ADDENDUM Letter from Pierre Jay Chairman Federal Reserve Bank In New York Buckman, New Mexico, September 18, 1917. The Stabil ity of the Federal Reserve System. Dear Mr. Jones:— I regret that, through illness, I have been unable before to answer your letter of August 27th asking for my views as to the advantages and disadvantages of membership in the Federal Reserve System. It gives me pleasure to answer, but instead of presenting a sort of ledger account with the debits to membership on one side and the credits on the other, I should rather leave this to be figured out by each individual Trust Com pany, and to suggest to you certain benefits from the System both to business and to banks, which may seem too intangible or remote to enter in a balance sheet, yet which constitute the really important services which the System is rendering the country. We are midway in the transition from a system of scat tered reserves to a system of concentrated reserves. The system we are leaving behind was a fair weather system; it would not work in bad weather. It was all right when the winds were light and credit was moving at its normal velocity, but when the winds suddenly freshened, and the velocity of credit movements increased, it failed to work, for it had no way of suddenly manufacturing the new credit required by the increased velocity except by drawing on its own reserves, which inevitably meant withdrawing credit already extended in other directions, thereby chilling our whole industrial fabric. The banks in the various reserve cities which carried the banking reserves of the country, and which were ex Marginal notes added in publishing. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 23 Elasticity of Credit Manufac turingPower. pected to furnish the new credit when needed, were com mercial banks operated for profit and carrying reserves relatively little larger than those of the banks for which they were expected suddenly to manufacture the larger addi tional credits. Theoretically, they were habitually near the end of their credit manufacturing power. In practice, they could not produce the required amount of new credit. Many country banks have referred to the ease with which they came through the various panics from which we have suffered, saying that their city correspondents have taken good care of them. This is undoubtedly true, but the city correspondents were often able to do so only by weakening their own position to such an extent as to bring about either suspension of payment typified by clearing house certificates, or by such a readjustment of their other credits as to cause a paralysis- or slowing up of industry which has caused the loss of untold millions to the customers, employers and employees of the country banks which have expressed such satisfaction at the way they have gotten through past panics. The whole trouble came because the reserves of the country were kept in institutions keeping commercial bank reserves, instead of reserve bank reserves. A commercial bank carrying from fifteen per cent, to twenty-five per cent, reserve is not an institution to which one can safely look to manufacture suddenly, any large additional amount of credit. It is already using its credit nearly to the limit. The Federal Reserve Banks, on the other hand, normally carry reserves of from 70% to 80%; their ability suddenly to manufacture credit is very large. They are like a large reservoir of unused credit which may be drawn upon at any moment without causing financial strain or disturbing ex isting credits. As I have said, we are midway in the transition from the old way of keeping our bank reserves, to the new way. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 24 Federal Reserve System has Stood the Test. Half the banking resources of the country have adjusted themselves to the new way and have affiliated themselves with this new, efficient and smooth working credit factory; the other half cling to their old system with all its rigidity and inelasticity, and its inability to give them the credit facilities they need unless it falls back on the Fed eral Reserve System. They have postponed the de cision as to joining the Reserve System for one reason or another, the reason most generally as signed being that they wished to wait until the system had come into action and had been tested. Well, the sys tem came into action and was tested last June. Under the enormous transactions of war financing, the wheel of credit suddenly began to revolve with a. velocity never before known in the country. As usual the strain was felt most acutely in New York, the money center. Funds on deposit in New York began to be withdrawn to other parts of the country in enormous volume to pay for treasury certificates of indebtedness and Liberty Loan bonds. As fast as prac ticable the Treasury transferred these funds back to New York to make advances there to the various foreign gov ernments. To maintain their reserves during this period the New York banks had recourse, freely, to the Federal Reserve Bank. On June 1st, its loans and discounts were Sixty-two Millions, representing the extent to which its credit was in use. They had stood at about this sum during the two preceding months. On June 19th its loans and discounts were Two Hundred and Seventy-four Millions, or an increase of Two Hundred and Twelve Millions in nineteen days in the extent to which its credit was required by the local banks. A month later its loans and discounts had fallen to Seventythree Millions, showing the temporary nature of the demand and the ability of the Reserve Bank to contract as quickly as it expanded its credit. Furthermore, besides supplying https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 25 Necessity for Unity Among. Financial Institutions of the Country. this vast amount of credit to fill the vacuum caused by the withdrawal of funds from New York, the Federal Re serve System supplied the machinery to transfer hun dreds of millions of dollars every week back and forth across the country without the shipment of a dollar of currency or coin and presumably without a dollar of cost to the banks making the transfer. The figures for the rest of the country are not so striking but Two Hundred and Twelve Million Dollars is an amount of credit far exceeding the largest amount of clearing house certificates ever issued in any year by the New York banks. What would have happened if the Federal Reserve Bank had not been there to provide this sudden and press ing demand for credit no one, of course, can say, but I am convinced that it would be utterly impracticable to carry on the Government’s war financing on the large scale necessary without the existence of the Federal Reserve System. But the Federal Reserve System, with one-half of the banking resources of the country behind it, might well prove unable to supply the credit required by all of the banks of the country, should the strain become too severe. It, therefore, seems to me that the Trust Companies and the other State institutions, now that the system has had its test, the severity of which is perhaps not generally ap preciated, owing to the steadiness of the conditions it pro duced, and now that the laws have been amended in so fa vorable a way to the State institutions, should consider the question of entrance to the System, not solely on the basis of whether they will suffer an immediate loss or show an immediate profit from membership, but on the far broader basis of public policy and of what will be the best for them selves and their customers in the long run; whether their reserves will be used in such a way as to be an element of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 26 Improve ment in Collection System. Saving in Domestic Exchange Transac tions. strength to the financial business of the country, or whether as an element of weakness. One of the things for which the country banks have criticized the Federal Reserve System has been the par col lection system. The criticism is a perfectly natural one, but it fails to recognize the broader aspects of this manda tory provision of the Act. In 1863 the volume of bank notes was 60% of the volume of bank deposits. Now bank notes equal only 6% or 7% of the deposits of the national banks. Deposit currency now completely overshadows bank note currency. In 1863 the National Bank Act was passed to standardize bank note currency. One of the objects of the Federal Reserve Act was to standardize deposit cur rency. Just as it took some years to effect the standardization of bank notes a half century agd, so it will now take some time to standardize bank checks, but I venture to say that a few years hence we would no more revert to the un scientific method of dealing with check collections and do mestic exchange which prevailed up to 1914, than we would be willing to go back to the system of bank notes prevailing prior to 1863. The Federal Reserve System is eliminating from our domestic exchange transactions that element of cost sup posed to arise from the shipment of currency to make ex change, by itself absorbing the cost of shipping currency whenever this is necessary. At a cost which is negligible and assumed in the public interest, the system has been able, through the medium of its gold settlement fund, to make transfers and settlements at par between all twelve Federal Reserve Banks and the districts they represent. Any mem ber choosing to use its facilities may make settlements at par in any part of the country. Bankers and business men do not generally understand that the country is thus on a par basis for the remittance of funds, but members of the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 27 Benefits Accruing from Federal Reserve System’s Building up Large Gold Reserve. Trust Company Section will not be slow to grasp its sig nificance. It would be difficult for members to figure any direct profits from the administration of the gold reserve of the country by the Federal Reserve System, yet this is one of its functions which, if properly exercised, should, when the exchanges become normal, prove of immense benefit in steadying the credit conditions of our country. During the past three years the System has accumulated over $500,000,000 of gold in exchange for Federal Exchange notes, in addition to the gold provided by the deposits of its member banks, its total gold holdings now being about $1,398,737,000. ' There is still over $500,000,000 of gold and gold cer tificates in circulation as pocket and till money, a consider able portion of which should also gradually find its way into the Federal Reserve Banks. If they should be able, through this means, and through the entrance of a consider able number of State institutions to the System, to accumu late a fund of $2,000,000,000- gold, there would still be left about $1,000,000,000’ of gold in bank vaults and elsewhere, yet the System would have the largest gold fund in the world, and would be put in the strongest possible position not only to deal effectively with international gold move ments, but to assume successfully the responsibility which must inevitably fall to its lot of constituting the first line of defence of our Government in maintaining the gold standard of this country. I have written you about intangible, rather than tangible, advantages of the Federal Reserve System, because I be lieve that, in the long run, they are the ones that count most. I have felt also that the country was in a mood to consider intangible things just now, since it has entered the war with no thought of profit or gain for itself, but to help “make the world safe for Democracy.” For this purpose, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 28 which seems somewhat remote from us, we are preparing to make colossal sacrifices of men and money. Is it too much to ask the State Institutions to consider membership in the Federal Reserve System in this same spirit, even though no immediate profit may be figured therefrom, and even though it may possibly entail some sacrifice, in order that our banking system may be made safe for that larger participation in the world’s commerce and finance which we are being irresistibly called upon to assume. Very truly yours, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis (Signed) 29 Pie)rre) Jay.