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DESIRABILITY STATE BANK MEMBERSHIP in the FEDERAL RESERVE SYSTEM An address by MARSHALL COUSINS, Commissioner of Bankingfor Wisconsin, before the Convention of the National Associa tion of Supervisors of State Banks, at Seattle, Washington, fuly 6, 7, 8 and 9, 1920. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis . president and MrGENTLEMEN: Our President has honored me by assigning a very important subject: “The Desirability of State Bank Membership in the Federal Reserve System.” I question the wisdom of our good Presi dent in detailing me to talk to you on this topic, although ordinarily I am willing to concede that he is a man of discretion and exercises the best of judgment. I have endeavored to treat the matter fairly and to bring out objections as well as points in favor of membership. I trust I may advance some thoughts which may be of interest and assistance in consideration of the question. No body of men in the country have greater interest in laws, legislation, and policies that will promote the strengthen ing of our banking institutions, than the members of this National Association of Supervisors of State Banks. It is im material to us whether the legislation is by Congress or by the legislature of one of the states; if it is beneficial to banking and strengthens and makes more useful the banking institutions, it is welcome legislation to us. Notwithstanding the majority of the banks under the super- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 vision of the members of this association are not members of the Federal Reserve System I am glad to be able to state that every member of this association is a believer in the value of the Federal Reserve System, although we may differ in some respects from the policies of administration inaugurated by the officials at the present time in control and as to the wisdom of some of the provisions of the law as it is today. N February 28,1920 there were 21,961 state banking institutions with a total Ocapital of $1,402,365,014.88; with deposits of $24,189,608,399.21; and total resources of $29,024,095,838.83. At the same date the Comptroller of the Currency in his report lists 7,933 National banks with total deposits of $16,965,122,000; and total resources of $21,862,540,000. The number of State banks in the country exceeded the number of National banks by 14,028. The de posits in the State banks exceeded the deposits of the National banks by $7,224,486,399.21. We, as the Supervisors of the banks holding the larger share of the deposits of the nation, of necessity are as thor oughly in sympathy with all legislation and policies for the betterment of banking as is the Federal Reserve Board or the Comptroller of the Currency; and in the paper that follows, I have endeavored to bring out suggestions which may result in the strengthening of the law, making it more productive of greater benefit to all banks and consequently to the commercial interests of our country. Under the original provisions of the Federal Reserve Act, membership by the National banks was compulsory. State banks were given the privilege of joining the System providing they voluntarily submitted to the same laws and depart- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 ment regulations governing the National banks. As the conditions under which they could become members of the System proposed to deprive the State banks of many privileges which experience had demonstrated were entirely consistent with good banking, few State banks ap plied for admission. With conditions brought about by the war, and by the long delayed official entry of the United States into the struggle, the necessity for the mobilization of our resources became extremely important, especially as concerned our banking resources. It was then Congress amended the Federal Reserve Act so that State banks having the same required capital as National banks might become member institutions and still retain their charter rights and the privileges granted by their own state banking laws. As a result many State banks joined and this added about fifty per cent of the state banking power to the System. In arriving at a fair conclusion as to the advisability of State banks taking membership, it appears a brief review of our old banking system and what has been accomplished by the new should be a logical basis for our decision. HE financial disturbances of the early 90’s and the money panic of 1907 are Trecent history. Many authorities felt these situations arose from the feeling of a lack of confidence in the banks to meet sudden and great emergencies. The fact that the panic of 1907 was met and handled by the banks and financial in terests of the country did not do away with the lack of confidence in the then prevailing system. The movement which had been gradually forming to seek a new and better financial system and one that would more completely meet the needs of our great and rapidly growing nation, continued. Leading bankers and states men had already given the matter serious study and consideration. The Congress in 1910 appointed a commission, of which Senator Nelson W. Aldrich was chairman, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 for the purpose of gathering information, formulating a report, and presenting the matter to Congress. This commission, known as the “National Monetary Com mission,” called to its assistance the best talent of this and other nations along banking and financial lines. After an exhaustive study of conditions, at home and abroad, a report was submitted, fill ing some twenty-six volumes, known as the “National Monetary Commission’s Re port.” Out of this study of the subject grew several bills, none of which became laws other than the “Emergency Currency Act.” The movement for legislation did not cease, however. Congress and the bankers of the country continued their study of the question, conflicting opinions were gradually reconciled and on De cember 23, 1913, the Federal Reserve Act became a law. The Act contains practically the fundamental principles as originally proposed. Any bill that becomes a law, if it be important, has more or less of a political aspect. Both of the dominant political parties proposed banking legislation in their 1912 platforms. Whatever claim may be made by politicians or political parties, it may fairly be said that the Federal Reserve Act had its inception in the minds of bankers and of statesmen whose motives were higher than petty politics or selfish interests. NDER the old system, reserves were not available when most needed. UReserve city banks were unable to extend credit or financial accommodation and business was stagnated and hard times ensued. Thus far the Federal Reserve System has made a creditable record and justified in a measure the fondest dreams of its founders. Through its help, the United States Government floated some twenty-five billion dollars of loans and https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 the banks were able to meet all demands for money and to extend the necessary credit to keep business on an even level under the trying conditions which re quired the use of double and triple the normal capital. The benefits were general, extending beyond the member bank to the non-member bank, and to every American business man and business enterprise. It is questionable, however, whether the Federal Reserve System is entitled to all the credit claimed for it. It is entitled to its full share of credit, but it must not be forgotten that practically every bank in the country—member and non-member—state, national, and private —and the vast majority of the business and financial corporations and individual citizens, exerted themselves to co-operate with the Government in the financing of the war. But wherever the credit be longs is immaterial. The Government was successful in bringing about the termination of the war waged by the Central Powers against the world, which threatened the destruction of all that had been gained in two thousand years of Christian civilization. The System has demonstrated its value. It has met with criticism and some of those criticisms are possibly well founded. An investigation of the System has been frequently suggested during the past year and such action might prove a benefit, in that it may bring about a strengthening of the System and a safe guarding of the banking and commercial interests. But I will venture it as my opinion, the business interests of the coun try and the banks themselves will not for a moment consider taking a backward step and a return to the condition pre vailing prior to 1914. We should en courage any investigation or movement which has the possibility of strengthening the System and bringing about changes which are fundamentally sound. And this can best be accomplished by friendly counsel and suggestion. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 O, with this spirit in mind let us view some of the objections which have been raised and which are of importance to the banks for whose policy of manage ment we are inalarge measure responsible. S First:—In the very beginning, a feeling of distrust of the administration of the System was awakened by the absolute and studied disregard of a very important provision of the act by “The Reserve Bank Organization Committee,” com posed of the Secretary of the Treasury, Mr. McAdoo, the Comptroller of the Currency, Mr. Williams, and the Sec retary of Agriculture, Mr. Houston. Had these men not nullified and violated the requirement of the law that the districts shall be apportioned with due regard to the convenience and customary course of business, many state banks would have promptly applied for membership. And I believe the same reason which kept them from joining the System at its in ception, keeps many of them out today. But this condition can be remedied by legislation. Second:—The lines of operation of member banks are expected and required to be largely those in vogue in the Na tional System. This is not as unreason able as might at first seem apparent, for that System spreads over the entire country, is admittedly well supervised and maintained at a high degree of effi ciency. Each state has its own code of banking laws, some of them outgrown and inadequate, and not reposing the power in the supervising authority to properly administer them. Others are complete in their provisions, modern, and as efficiently administered as is the Na tional banking law. There is no uni formity, however, and no body of law makers at Washington could be reasonably expected to compile a code which would operate in perfect harmony and completely function with the diverse systems and laws of forty-eight sovereign states. This condition can be partly remedied https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 by the law makers of the several states, and partly by the granting of additional powers to the Reserve Banks to deal with the state member banks in their districts as conditions may require. Third:—Unfortunately in the discus sions of the bill both in Congress and in the newspapers while it was still under consideration, the relations of the State banks to the System appear to have been a secondary consideration, and this has given rise to a feeling with many state bankers, that the Reserve System is solely intended for the National banks, and that the admission of the banks created by the States was a matter largely of tolerance. E know it was the desire and intention of the Congress that the System should serve all banks, and yet in the very law itself may be found at least one strong argument against this view, and this argument has influenced some State banks. The Comptroller of the Currency is made a member of the Federal Reserve Board. He is the supervising authority of the National banks, and naturally may be expected to favor such policies as may best promote the interests of the National banks. W The Comptroller of the Currency has lost no opportunity to belittle the State banks, and the supervision of the State banks. He has by unfair comparison with the record of the National banks, sought to create a public distrust of the State banks. This has not served to promote the taking of membership by such banks. Nor has the Comptroller’s assertion, in official reports, that certain legislation recommended by him would bring about the nationalization of the State banks served to create a more friendly feeling toward the Reserve System. And further, with all due respect to the wisdom of the appointing power, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 State banks have not had representation on the Board until recently, when a country state banker was named for a vacancy, the unexpired term having only a year to run. On the District boards it appears State banks have had but scant recogni tion. The Federal Reserve Bank of Chicago has never had a state banker on the board. I cannot speak as to other District banks. No suggestion as to a remedy of this condition is necessary. Fourth:—The fear that the establish ment of the Federal Reserve System will in time result in legislation prohibiting the existence or operation of banks chartered by the States, thus leaving only National banks to serve the commercial interests, is responsible for the failure of many banks to take membership. I feel this fear is without foundation, notwith standing the advocacy of this course by prominent officials of the System and by some of the officials of the Reserve Banks. Those who advocate but one system will have been gathered unto their fathers for many years before financial conditions will be such as to cause the Congress to seri ously contemplate such legislation. HERE is a place in our commercial life for National banks and a place for State banks. Both systems are of value to the nation, and each has its special sphere of usefulness. The exist ence of two systems is a safeguard and a check upon the Congress and the State Legislative bodies, and the public is ac cordingly protected and benefited. Should it come to pass the Congress endeavors to inflict unjust legislation upon the Na tional banks they can surrender their National charters and organize under the law of the State in which they are located. Should the legislature of any State inflict unjust legislation upon the banks operat ing under the laws of that State, the banks can surrender the State charter and take out a National charter. Under the law, T https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 a National bank is required to remain in the Reserve System, but the State banks are not so bound. Should the Congress enact unjust or hampering laws, or the powerful Federal Reserve Board become unjust or over-arbitrary, the State bank can withdraw from the System. This power, reserved to the State banks, is a most wise provision of the Reserve Act. Fifth:—There are operating objections also rendering membership impracticable, especially in the case of the smaller banks. Many of our State banks have not suffi cient capital, for the minimum capital requirement is $25,000. The loan limit on eligible paper is ten per cent of capital and surplus. Now it is a fact that in any small bank, the financing of one car of prime beef cattle would at the present time exhaust the borrowing limit of any one farmer, while the country grain mer chant who faces an unexpected delivery in cars, would find himself unable to finance even one car load of wheat, assuming that he had to depend on the borrowing capacity of the bank. As the greater part of my state is in the Seventh District, I am more familiar with conditions in that district and will use them in illustration. A forceful illustration is that of the cheese factories and fruit canning factories so numerous in Wisconsin and other parts of the Chicago District. These concerns are usually owned by local people and often constitute the only leading industry in the community. They are only seasonal borrowers, but during the season their needs are larger than any local or nearby bank can supply, if loaning power is limited to ten per cent. In all of the specific cases mentioned, the transaction has to do with the pro ducing or marketing of an essential com modity, the paper representing such transactions being in essence that which is considered most desirable by the Fed eral Reserve Board and Reserve Bank, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 yet notwithstanding this fact, not a dollar of such paper is eligible for redis count with the Federal Reserve Bank if the line exceeds ten per cent of the capital and surplus of the local bank as it usually will during the season. If that bank joins the Federal Reserve System and maintains its lawful reserve with that institution, it cannot carry a large enough average balance with any large com mercial bank to justify the latter in carry ing the excess line of its best and most liquid paper. Both the customer and the bank in such case are barred from the use of the banker’s acceptances—used so effectively, but possibly, in some instances, not wisely, in the cities for enlarging credit—as neither is strong enough to warrant the offering of such paper in the open market. T DO not desire it to be assumed this 1 statement is made with the intent of arguing for an indiscriminate increase in the loaning limit. At this time in many states, notably I regret to say in my own state of Wisconsin, the limit permitted under the state laws is far too large. The limitation placed by the Congress on the loans of the National banks has been one of the greatest safeguards of that System. At the same time, espe cially as regards the production of food stuffs and more particularly in the period of packing and shipping, some means should be, and surely can be, provided whereby the local bankers may, under proper safeguards, legally handle a larger line than is at present possible. Until this is done, membership will not be at tractive or profitable for the average small bank in an agricultural section. . Sixth:—With some State banks there appears to be an objection to that pro vision of the law permitting the Reserve Bank to examine the member banks. I do not consider this an objection worthy of consideration. No properly conducted institution should object to examinations. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 If the same system prevails in other dis tricts as that prevailing in the Chicago district, this objection would soon cease to exist. The Chicago bank co-operates with the state departments in the exam ination of member banks. They send their representatives who participate and co-operate with our examiners in the exam ination. Our examiners are in charge. The Reserve Bank examiner prepares his own report and a copy is forwarded by the Reserve Bank to the Department. No charge is made against the member bank for the examination by a Federal Reserve representative. In my own state we welcome this co operation of the Federal Reserve Bank and have found it of material assistance and value. In cases where criticism of the bank appears necessary the officers of the Chicago bank suggest that the criticism be made by the State Banking Depart ment. By this policy the influence of the State Department with the bank is maintained. Seventh:—We now come to an ob jection raised by State banks to member ship, namely, the loss of interest on bal ances. To many bankers, who have not made a thorough and conscientious study of the question, this appears to be a vital objection. Possibly many of them have not looked at both sides of it. From the very beginning the Federal Reserve Banks have declined to pay interest on balances. During the first two years the net earnings of the banks were not sufficiently large to fully provide for their statutory divi dend requirements. This gives good color to their claim that when normal conditions again obtain, their earnings will cease to be of the present volume and, if under such conditions they undertook to allow interest, they would be obliged to enter the open market for investments in com petition with the member banks, thus forcing a lowering in market rates to the detriment of the earning power of member https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 13 banks—to say nothing of rendering less liquid the reserves of the Federal Reserve Banks. R. HEATH, Chairman of the Fed eral Reserve Bank of Chicago, in a public declaration on the question, states that had that institution paid interest at the rate of 2 per cent on reserve balances from the day of opening down to January 1st of the present year, it would have had remaining a surplus of but a little over one million dollars. This would inevit ably have forced the calling in of the un paid balance of 50 per cent on all stock subscriptions. Certainly it is more satis factory to the member bank to have the Reserve Bank strengthen, through the accumulation of a large surplus, than to contribute such strength through addi tional payments to the capital stock. At the same time it is not out of reason that after the accumulation of the full statutory surplus the member bank should consider it is entitled to a larger share in the earnings than they now receive. Undoubtedly, and I believe that it is desirable it be done, the day will come when banks will receive returns in the form of special or extra dividends, de clared and distributed only in such years and in such amounts as are warranted by the year’s showing. Such a course should encourage more banks to enter the System and would promote more cordial relations between the Federal Reserve Bank and its members. M Eighth:—We now come to the much discussed question as to the right of a bank to charge exchange or make a serv ice charge in the clearing of checks. For many years this has been a source of irritation, controversy, annoyance, and misunderstandings to the business in terests and the banks of the country. The banker of today was born into the banking business with the idea that the charging of exchange is legitimate and proper; it is difficult for him to compre- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 14 hend why a charge which was recognized as legitimate for his predecessors is not equally as proper for him. In the past, the city correspondent has handled the out of town items without charge and gave immediate credit for them. The inauguration of the par clearance pro vision of the law by the Federal Reserve Board and the Federal Reserve Banks has occasioned much criticism of the Federal Reserve System and has resulted in many banks completely passing by all other features of the Federal Reserve law and condemning the law as unjust and vicious. "OUT is it fair to blame the Federal Re O serve Banks or the Federal Reserve Board for the inauguration of the par clearance system? Have not many of the banks been unjust in their complaints against the Federal Reserve Banks be cause of the effort of the banks to comply with the provisions of the Federal Re serve Act? Permit me to quote from a letter writ ten by the Governor of the Federal Re serve Board on April 12, 1920, to a mem ber of the House of Representatives. The Governor said:— “The situation regarding the Federal Reserve clearing system can be summed up in a very few words. There are certain clauses in sections 13 and 16 of the Fed eral Reserve Act which seem to require the Federal Reserve Board to establish a system for the clearing by the Federal Reserve Banks of all checks payable upon presentation within their respective dis tricts, regardless of whether the checks are drawn upon member or non-member banks. It appears also that the Federal Reserve Banks are required to receive these checks when tendered them for deposit by member banks at par—that is, without making any deduction from the face amount for collection or exchange charges. Section 13 empowers the Fed- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 eral Reserve Board to fix reasonable charges, not to exceed 10 cents per $100, which may be made by one bank against another bank for remitting in exchange or otherwise for checks received for col lection, but there is a proviso that ‘no such charges shall be made against Fed eral Reserve Banks? “Upon being asked for an opinion, the Attorney General of the United States has construed this provision literally and has advised the Board that Federal Re serve Banks can not lawfully pay any charge or fee to a bank for remitting to the Federal Reserve Bank for checks drawn upon the payer bank which have been sent to it by the Federal Reserve Bank for payment in exchange or other wise. “It is evident, therefore, that a Federal Reserve Bank receiving checks on non member banks for deposit must proceed to collect these checks, and that if the banks upon which they are drawn will not remit at par the Federal Reserve Bank is obliged to provide itself with some other means of making the collection. The Federal Reserve Banks therefore have called the attention of non-member banks to these provisions of law and have stated that stamped envelopes will be sent in each case to the remitting bank, in order that there may be no actual expense incurred by the payer bank in making the remit tance and that, if it is more convenient, remittance may be made in currency at the expense of the Federal Reserve Bank. All non-member banks have been advised that if they do not care to remit to the Federal Reserve Banks at par, collection will be made through some outside agency by having the checks presented at the bank counters for payment.” T would appear banks have been un and unjustly criticising the Fed IeralfairlyReserve Banks for complying with the law as it has been pointed out to them https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 16 by the Attorney General of the United States. The complaint of the banks should be against the Hardwick Amend ment to the Federal Reserve Act and not against the act as a whole, the Federal Reserve Board, or the Federal Reserve Banks. A mistake was undoubtedly made by the Federal Reserve Board in not insti tuting this policy from the beginning. When it was finally put into operation, it came at a time when every bank in the country was burdened with war work, short of help, and chafing under the red tape methods of the Treasury Depart ment in floating war bonds. Upon the District Banks fell their wrath and they unjustly blamed those banks for doing what the Federal Reserve Board and the Secretary of the Treasury required them to do. I believe this par clearance question has served to irritate to a greater extent the ill feelings of the average banker to ward the Federal Reserve Bank than any other provision of the Federal Reserve Act. It is to be regretted the Federal Reserve Board could not have withheld application of the par requirements until banking and financial conditions had been restored to a situation more nearly normal. I have consumed considerable of your time in reviewing some of the reasons why State banks have withheld joining the System. I will now attempt to give some of the reasons why membership is desirable and should appeal to them. ASIDE from the economic and patri_OL otic reasons for membership, there are very good specific benefits which accrue and amongst them are the fol lowing: First:—The certainty of securing rea sonable and seasonable rediscount accom- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 modations. The right to this is inherent to membership. They are relieved from depending upon the ability of another larger commercial bank to care for their needs and the requirements of its own customers at one and the same time. Second:—The non-member banks now share in the benefits of the System through being helped by a member bank. They have placed their bills payable and their rediscounts with the member bank and frequently these demands upon the member bank are so great that a bank is in turn compelled to rediscount with the Federal Reserve Bank. A large percent age of the loans made by the banks in the large cities acting as reserve banks for country correspondents is caused by their lending funds to the smaller bank. Through this indirect avenue the non member bank draws on the financial life blood from the arteries of the System. They benefit but they contribute nothing directly to its support. In a spirit of fairness they should be willing to contri bute. The State banks responded cheer fully, willingly, and earnestly to the call of the Government to assist in financing the war. The State banks are not “slackers.” They should as willingly contribute to the support of the System as they did to the support of the Govern ment during the war period. Third:—Immediate credit for redis counts and the ease with which they can be negotiated providing the member bank takes the pains to learn how it should be done and follows the simple rules of procedure required. Fourth:—The direct collection of out of town checks instead of by the old method of indirect routing which often caused long delays in final payment, in volved liability as endorser and occa sioned loss of funds owing to deposit being withdrawn before final collection was advised. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 18 Fifth:—Shipment of currency with out cost, either to or from the Reserve Bank. Sixth:—Telegraphic transfer of funds without cost to the member bank. Seventh:—Safe keeping of securities without cost. Eighth: — Reduced reserves under which a member bank may operate as compared with a non-member bank. This reason, however, does not apply in all the states. It appears to me, Mr. Chairman and Gentlemen, that the benefits to be de rived by members more than offset the objectionable features. There may still be some drawbacks to membership which Congress will in time remove. Conces sions have already been made to the State banks, but it is hardly fair to expect further concessions if the banks withhold joining the System and criticise and pro test from the outside. I believe it is a reasonable and fair suggestion that com mercial banks with assets of, we will say, one million dollars and upwards, be en couraged to take membership, and that the smaller institutions be left to their own discretion in the matter until such time as changes may be made better fitting their conditions. N closing permit me to say a few words. as to my experience with the Federal IReserve Bank of the Seventh District and its officials. We have found the bank ever ready to co-operate with us in whatever was for the advancement of good banking. We do not hesitate to confer with them upon financial policies particularly affecting our state. Expe rience has demonstrated the Federal Re serve Banks and the state banking depart ments can operate side by side without conflict or friction, each in their own field. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 I believe we will more closely approach an ideal situation when, for the welfare of nation-wide credit and trade and of national solvency, the two banking sys tems, the State and the Federal, each supreme and useful in its own functions, can yet be as one in matters of mobiliza tion of reserve, currency supply, and efficient supervision. A step in this direc tion, I believe, would be an amendment to the present Congressional laws trans ferring the direct control of the National banks to the Federal Reserve Board and the supervision of those banks to the Federal Reserve Agents of the districts in which the banks are located. Such a step, I believe, would certainly tend to a better state of mind amongst the National banks' generally. It would promote in creased efficiency, for the Federal Reserve Agent must be under the law a man of tested banking experience. He is in closer touch with conditions in his dis trict than any official at Washington, however earnest and energetic he may be. The Federal Reserve Agent is in a better position to have the personal knowledge and touch necessary to determine proper procedure and policy. I believe such an amendment to the laws would be con ducive to a much closer and more effective co-operation between the Federal Reserve Banks and the various State Banking Departments. - The members of this Association, chiefs of the State Banking Departments, can perform for our common country and their respective commonwealths no greater service than to unite their efforts to bring to pass this condition. . https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 20