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F R P R IN T 2 2 7 4 Circular N o. 2 2 Series of 1 9 2 0 FEDERAL RESERVE BANK OF D AL L A S Dallas, Texas, June 12th, 1920. TO T H E PR E SID E N T O F TH E B A N K A D D R E S S E D : There appeared in the Dallas News of June nth, 1920, an editorial on the subject of The Advancing Cost of Bank Credit, which, while apparently directed to the people, carries with it a message of such great importance to the banking fraternity that we have obtained some reprints of it and I am taking the liberty of inclosing one herewith for your informa tion. The soundness of the views expressed in this editorial are unquestioned and bear out, to a certain extent, the views expressed by us in our Circular No. 17, under date of May 7 th, 1920, wherein we urged our member banks to curtail their borrowings from the Federal Re serve Bank and elsewhere, for what might be termed non-essential purposes, in order that all available and necessary credit might be extended to encourage and aid the agricultural and live stock production of this district. It is generally recognized that both money and market conditions are such as to warrant or justify some increase over pre-war rates on loans, but we feel sure that the thoughtful banker will see the utter unwisdom of imposing any undue burden on the industry and com merce of the country. His own interest, and that of the community in general, will best be subserved by an attitude o f friendly consideration for the productive interests of the District. Only through increased production of the necessities can we hope for any reduction, or even stabilization, of our present high prices o f food and clothing, or for any increase in the actual wealth of our nation, for in its last analysis all wealth has its origin in nature and its products. On the banker, because of his far-reaching influence, devolves the greatest responsibility in connection with the stimulation of increased production, and we earnestly urge you to co operate with us and to use that influence whenever and wherever possible. The war is over, but we still have before us, to as great or even greater extent than ever before, the patriotic duty of producing food, clothing and other necessities for our people. May we not count upon your assistance? Yours very earnestly, vz-cc Governor. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) The Dallas Morning News Friday, June 11, 1920. T H E A D V A N C IN G COST OF B A N K C R ED IT. It seems to have become the pol icy of banks to advance their dis count rates commensurately with the advances made in the redis count rates of the Federal Reserve Banks. Some o f them seem not to have been content to limit their advances to the advances made by the Federal Reserve Banks,, but to have made the action of the Fed eral Reserve Banks a pretext to widen the previously existing dif ference between the discount and the rediscount rates. W e use the word pretext for the reason that the action of a Federal Reserve Bank in increasing its rediscount rates does not necessarily warrant member banks in making any in crease, whatever. The idea that it does, which idea seems to govern the policy of member banks, be trays a most surprising misconcep tion of the purposes and functions of the Federal Reserve System. It was not the purpose in creat ing the Federal Reserve System to enable the member banks to make a profit out o f their rediscount op erations. Nor was it the purpose even to enlarge their opportuni ties for increasing their earnings in any way. The salient purpose was to create and maintain a reser voir of credit for use in times of stress. Whenever rediscount rates are advanced, therefore, it is done chiefly to husband the resources of the Federal Reserve Banks. U n der normal conditions, the rates of a central bank, in countries which have long had them, are higher than the open market rates, so that banks which rediscount lose instead o f gain by the operation; and properly so, since the effect is to restrict the use of credit, which is the purpose of the central bank in advancing its rediscount l’ates. It is obvious that if member banks are to make a profit on their re discount operations they will be under no inducement to contract the volume of credit, and hence the purpose of the Federal Reserve Bank in advancing its rediscount rates will be somewhat balked,, if not defeated. That there is a species of profi teering in advancing discount rates on no other warrant than the fact that the Federal Reserve Banks have advanced their rediscount rates will become apparent on a moment’s reflection. For it is but a small percentage— about 12 per cent, we believe— of the loans made by member banks are rediscounted at the Federal Reserve Banks. In other words, about 88 per cent of their loans are made from their own funds, so that when they ad vance their discount rates commen surately with an advance made in the rediscount rates of the Federal Reserve Banks they are merely in creasing their profits on nearly 90 per cent of the loans they make at the advanced rates . Thus what they in reality do is to put a “ re placement value” on their funds, but without, however, always re placing them; so that they have even less excuse than the dealers in sugar for adopting .that thrifty rule of pricing. I f the member banks had all of their loanable funds outstanding, or even any very large percentage of them, it might be both just and expedient to make additional loans at the rates of the Federal Reserve Banks, or even at rates higher than those of the Federal Reserve Banks. But when they make their rates ad vance with those of the Federal Re serve Banks without being under the necessity of rediscounting the loans made at those advanced rates, it is evident that they are merely exploiting an opportunity which arises from an unhealthful condi tion of finance and industry. There is the less excuse for doing this in the fact that the Federal Reserve A ct has freed for use a great deal of the money which the old law re quired them to keep in their vaults. Since a greater percentage o f their funds is thus made available for lending, they can make their rates lower and still make their discount operations as profitable as they were before the institution of the Federal Reserve System. The action of the banks through out the country in advancing their discount rates has engendered no little dissatisfaction, and that dis satisfaction vents itself in com plaints against the Federal Re serve Banks. That this is an in justice to those institutions is made clear by what has been said.
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