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Economic Brief

February 2016, EB16-02

The Cost of Fed Membership
By Helen Fessenden and Gary Richardson

Since the Federal Reserve’s founding, it has paid a regular dividend to banks
that are Fed members in exchange for those banks holding stock in Federal
Reserve Banks. Recent transportation legislation reduced these dividends
and used the savings to help fund the bill. While this move provided a shortterm financing fix, it also raised a bigger question of whether banks will want
to remain members of the Fed.
Federal transportation legislation may seem like
an unusual place to address the Federal Reserve’s
functions and operations, including its relationship with member banks. But that is what happened last December, when President Barack
Obama signed a comprehensive transportation
bill that boosted funding substantially across
many categories. On the one hand, the law was
good news for the nation’s aging highways, tunnels, and bridges. But it also tapped an unorthodox source for some of its financing: the Federal
Reserve System. Rather than raise the gas tax, the
traditional source of highway funding, lawmakers
opted to take some money that the Fed would
otherwise have paid to its member banks in the
form of dividends. They also took a much bigger
sum from the Fed’s surplus account. Over the
legislation’s five-year authorization, the amount
from the Fed surplus account will total $33 billion, while the dividend-payment savings will
come to $2.7 billion—together financing more
than 10 percent of the highway law’s total cost.
Outside the banking industry, many Americans
had been unaware that the Fed paid dividends
to banks until the highway bill hit the news. In
fact, these payments have been central to the

EB16-02 - Federal Reserve Bank of Richmond

relationship between the Federal Reserve System
and commercial banks since the Fed’s founding
in 1913. The dividend was a key part of a bundle
of benefits and costs that came with Fed membership. Under this arrangement, the Reserve
Banks paid member banks a dividend amounting to 6 percent on the stock that the Federal
Reserve Act required member banks to pay in to
the Reserve Bank in their district.
Under last year’s law, however, Congress cut the
dividend from 6 percent to the current 10-year
Treasury rate (now less than 2 percent) for banks
with assets more than $10 billion; smaller banks
continue to receive the historical return. This
measure marked a compromise over an earlier
draft of the bill, which had cut the dividend to
1.5 percent and exempted only banks with assets
less than $1 billion. In that version, the total fiveyear savings from the dividend cut would have
come to $17 billion instead of $2.7 billion. Amid
heavy lobbying by banks, Congress scaled back
the scope of the dividend provision and found
an alternative financing source in the Fed surplus
account.1 These moves drew criticism from senior
Fed officials for setting a poor precedent on fiscal
policy and impinging on Fed independence.2

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Given the relatively small sum of the dividend provision, it may be tempting to dismiss its significance.
But a closer look at the history of the Fed-bank
relationship shows that the value of these dividends
is greater—and more complicated—than just the
dollar amount. These payments are part of a longrunning story: the Fed’s challenge, over time, to encourage banks to join and stay in the Federal Reserve
System to reduce the risk of what is now known as
“shadow banking.”
Shadow banks perform similar functions as commercial banks without joining the Federal Reserve System
or being regulated by it. In the 1920s, this financial
activity was concentrated in the state-chartered bank
and trust companies, which declined to join the
Federal Reserve; in the 1980s, it took off in the savings and loan institutions and money market mutual
funds; and most recently, it was seen in the explosive
growth of mortgage lending and the securitization
boom ahead of the 2007–08 financial crisis. In effect,
the dividend payments are one piece of a larger
debate: how much financial activity will take place in
institutions regulated by the central bank, and how
much will occur outside that regime?
Costs Versus Benefits?
Of all the challenges facing the Fed’s founders, one of
the toughest was how to bind all commercial banks
together in a nationally supervised organization that
would be responsive to different regional needs. During the rapid economic growth before World War I,
banking activity sharply increased, especially among
small banks that took a state, rather than national,
charter. From 1906 to 1913, the number of state
banks grew 65 percent while their combined assets
rose 46 percent; among national banks, by contrast,
that growth was only 24 percent and 42 percent,
respectively. State banks enjoyed several advantages
over national banks that drove this surge, including
the ability to make real estate loans, fewer restrictions
on branching, lower capital requirements, and more
relaxed supervision.3
Most of the drafters of the 1913 Federal Reserve Act
believed the United States would be better off if all
commercial banks belonged to the Federal Reserve

System. However, they were also political realists
and did not believe that Congress would compel all
banks to join. In addition, the Fed’s founders had to
find a way to finance the establishment of 12 regional
Reserve Banks without using taxpayer dollars, which
would have been politically unpopular. Finally, they
had to figure out how to collect enough gold to back
Federal Reserve notes (dollars).
Congress settled on a voluntary membership model:
nationally chartered banks were required to join,
state-chartered banks were not, and national banks
that did not want to join were allowed to switch to
state charters. Banks that wanted to join the Fed
had to purchase stock in their district’s Reserve Bank
equal to 3 percent of their capital and surplus. An
equal amount was placed “on call” at the behest of
the Federal Reserve Board, which, at any time it believed necessary, could compel commercial banks to
double their stock holdings.
This stock served as the initial capital for the regional
Reserve Banks. It also paid the Fed’s operating expenses for its first few years, until the Reserve Banks
earned sufficient amounts to pay for themselves.
Another important requirement was that commercial banks had to pay for their stock subscriptions in
gold. This provision transferred much of the nation’s
gold reserves from commercial banks to the Fed,
enabling it to issue notes backed by gold, as federal
law demanded.
Meanwhile, commercial banks that joined the Fed received a dividend on the stock that they purchased.
The annual dividend was set at 6 percent and was
cumulative, meaning that if a Reserve Bank did not
earn enough to pay dividends to member banks in
one year, it could make up the missed payments in
future years. Congress set the dividend rate comparable to the rate of return on similar investments,
which had some risk in the short run, but which
seemed like a reasonably good bet in the longer
term. This rate was comparable to European central
banks, which had raised capital for their operations
using a similar model and generally offered returns
on their stock of 4 percent or 5 percent. The dividend
was also close to the rate of return on the gold with

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which banks were compelled to make the purchase.
From 1913 to 2013, in fact, gold earned an average
annual return between 4 percent and 5 percent.
The only problem was that this idea didn’t work once
the Fed was up and running. To be sure, the Fed succeeded on other core mandates, including establishing a national payments system and creating a
market for bank assets. But it failed to attract state
banks as members in significant numbers. At the end
of the Fed’s first decade, fewer than 8 percent of state
banks had joined the System. Over the years, subsequent laws tried to make Fed membership more attractive by cutting the amount of notice a state bank
had to give if it wanted to leave the System (from 12
to six months), among other inducements. Still, most
state banks opted out of the Fed through the 1920s,
and most new banks chose to be state, rather than
national, institutions. Most of the growth in lending
was concentrated in state banks as well.
To Paul Warburg, the German-American financier
who was one of the intellectual framers of the Fed,
this risk of a dual banking system threatened to undermine broader financial stability.
How can non-member banks “justify themselves in
staying out the system and in throwing the entire
responsibility and burden upon the shoulders of the
national banks and those few trust companies and
state banks that have become members?” asked Warburg, speaking to a bankers’ group in 1916. “They do
not contribute their fair share of gold to the general
reserve fund of the nation, nor do they provide their
share of the capital to the Federal Reserve Banks.”

requirements and couldn’t earn interest on those
reserves, whereas non-members could hold less in
reserves and earn up to 2 percent interest. Nonmembers could charge for check-clearing, whereas
members could not. In addition, Fed regulation was
often seen as more onerous than state regulation. As
for the discount window, many non-member banks
were able to access it indirectly through their ties
with correspondent banks that were members, so
they viewed formal Fed membership as unnecessary.5
The imbalance between incentives and disincentives
meant that the banks that did join the Fed tended to
be large institutions that were attracted to discount
window access as a way of getting more deposits
from non-member banks; these banks tended to be
big enough to absorb the extra compliance costs,
and were well-positioned in the interbank network.
Membership also was compelling to banks that had
great fluctuations in seasonal loan demand from
farmers because the discount window eased their
liquidity risk. But small banks that encountered less
seasonal loan fluctuation, and that were close to Fed
member banks that could provide discount window
access, could easily borrow from the latter and were
less likely to join.6

“Not only do they fail to contribute their share of
strength to the system, but, unconsciously perhaps,
they become forces that make for the direct weakening of its strength and efficiency,” he warned.4

As for the dividends, they didn’t have a big role during the banking debates of the day once they became routine for member banks. But they indirectly
played into the broader issue of low membership
rates among state banks as concerned policymakers sought ways to address the Fed’s poor record in
encouraging universal bank membership. In 1928,
one of those policymakers, Sen. Carter Glass (D-Va.),
tried to advance a measure that would raise the annual dividend payments to banks from 6 percent to
10 percent to 15 percent (depending on the Reserve
Bank) with the difference coming out of the Fed surplus account. His measure failed, however.

The Rise of Shadow Banking
Among the banks that opted out, the belief was that
the advantages of Fed membership—namely, the
dividend payments and access to the Fed discount
window—weren’t enough to offset the costs. For example, Fed members had to adhere to higher reserve

Fifteen years after Warburg’s warning, the Fed’s failure to attract state-bank members played a part in
the collapse of the financial system during the Great
Depression. The commercial banking crises that
prolonged the initial contraction began among nonmember banks. At the time, the Federal Reserve Sys-

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tem was unable to craft a unified response that could
have helped all institutions, such as rediscounting
and open market operations. Instead, Fed leaders
disagreed on the extent to which the Fed could and
should aid non-member banks.7 These debates partly
reflected concerns about the System’s obligations
to financial institutions that did not contribute to its
upkeep or submit to its regulations. As non-member
banks failed in greater numbers than member banks,
the portion of all commercial banks that were members increased from less than 34 percent in 1930 to
nearly 49 percent in the 1940s. (See Figure 1.)
The bank membership divide affected another
debate: whether collateral originating at or passing through non-member banks was eligible at the
Reserve Banks’ discount windows or for purchase

on the open market. The legality of this practice was
questionable. Some Reserve Banks — particularly
Atlanta and New York—occasionally accepted collateral originated by non-member institutions. Other
Reserve Banks and the Federal Reserve Board, however, did not.8 In turn, contagion among non-member banks eventually afflicted Fed members. But by
then, the Fed lacked the resources, and perhaps the
will or knowledge, to prevent a complete collapse.
A Bigger Club
Since the Great Depression, the banking industry has
undergone profound changes. In 1933, the Roosevelt
administration established the Federal Deposit Insurance Corporation, which expanded federal supervision to most commercial banks. Later, in 1980, the
Monetary Control Act allowed the Fed to open its

1: Federal
Member Banks
as a Percent
of All
1: Federal
a Percent
of All

Commercial Banks





Percent of All Commercial Bank Assets Held By Members

Percent of All Commercial Banks That Are Members












Sources: Member-bank data for 1915 through 1970 come from the Board of Governors of the Federal Reserve System, Banking and Monetary
for through
1915 through
the Board
of the
Statistics. Non-member-bank
for 1915
1970 come1970
from the
U.S. Census
of the United
1977 come
Reserve System, Banking and Monetary Statistics. Non-member-bank data for 1915 through 1970
from the Board of Governors, E.3.4 Domestic Offices, Insured Commercial Bank Assets and Liabilities Consolidated Report of Condition (various
from the U.S. Census Bureau, Historical Statistics of the United States, Colonial Times to 1957,
issues). Data for 1978 through 1979 come from FDIC annual reports, and data for 1980 through 2014 come from annual reports of the Federal
reports of
the Board of Governors and the Federal Deposit Insurance Corp. Data for
Financial Institutions
the Board
of Governors,
E.3.4 commercial
Notes: Beginning
data are
for insured
banks, but uninsured
held only
a tiny percentage
of commercial bank
assets by
Data from the
Board of Governors’
only include
sheet for
so reported
total assets
of non-member banks suffer some downward bias from 1958 through 1968.

1979 come from FDIC annual reports, and data for 1980 through 2014 come from annual reports of
the Federal Financial Institutions Examination Council.
Notes: Beginning with 1980, data are for insured commercial banks, but uninsured commercial banks
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held only a tiny percentage of commercial bank assets by 1980. Data from the Board of Governors'
annual reports only include principal balance sheet items, so reported total assets of non-member
banks suffer some downward bias from 1958 through 1968.

discount window to all banks, not just member banks.
The Act also required all depository institutions, not
just member banks, to set aside reserves. In 2008, the
Fed began paying interest on all bank reserves as well.
Due to such changes, the formal distinction between
membership and non-membership matters less today
than it used to. At the same time, the federal government’s scope of banking supervision and regulation is
far wider, due to the FDIC and subsequent legislation
such as the 2010 Dodd-Frank reforms.
While much has changed, however, some things
remain the same. Today, only about one-third of
the nation’s 6,348 banks, including the 10 biggest
institutions, are members of the Federal Reserve.
Furthermore, a substantial share of banking activity
has migrated to institutions such as money market
mutual funds, which act in many ways like commercial banks but operate outside of the supervision of
the Federal Reserve and other bank regulators.
Throughout the decades, however, the dividends
paid to member banks have been a constant and,
for the most part, unchallenged component of the
relationship between the Fed and commercial banks.
Between Glass’s proposal in 1928 and the 2015 highway legislation, there is only one case on the record
where Congress considered a measure regarding
Fed dividends. In 1964, Rep. Wright Patman (D-Texas)
unsuccessfully proposed to discontinue the dividends
and send the savings to Treasury. Fed Chairman
William McChesney Martin Jr. spoke out against the
idea, arguing that the bank stock contribution, while
not “indispensable” to the Fed, helped integrate
banks into the System. If the dividends ceased, he
added, some might view the change “as a step
toward nationalization of the banking system” or as
“significant portent of basic monetary changes.”
Today’s political environment is a far cry from the
1960s, however. By the summer of 2015, as Senate
negotiators were looking for a way to fill a financing
gap in the long-stalled highway bill, they came across
an idea that some House Democrats had first pitched
a year earlier—to cut the Fed dividend to 1.5 percent
for most banks and divert the savings to help fund
the legislation. The lawmakers pointed out that in

2014 the Fed paid dividends totaling $1.7 billion, with
the lion’s share going to big banks such as Bank of
America ($310 million) and Citi ($250 million) – banks
that, by virtue of their size, are the biggest stockholders in the Fed. Banks lobbied against the proposal,
and Congress responded by cutting the dividend by
a lesser amount and exempting far more small banks
than originally proposed. Lawmakers, reluctant to
raise the gas tax or look to other sources of revenue,
found the remainder of the money needed to fund
the transportation bill from the Fed’s surplus account.
At the end of the negotiations, the amount of money
at stake with the dividend cut was small. But the
impact is still being played out as many banks are
reconsidering the broader Fed-bank arrangement
that was set up in 1913. Indeed, just as Fed officials
had warned of “unanticipated consequences” of the
highway bill, shifts in this relationship may already
be underway.
As a case in point: just days after the highway legislation was enacted, as Congress took up a year-end
spending bill to fund government agencies, banks
pushed a measure to cut the amount of stock that
large banks would have to hold at the Fed in “paid in”
capital, from 3 percent to 0.5 percent. The proposal’s
financial effect would have been far bigger than
the dividend cut, sending about $25 billion back to
banks and leaving about $5 billion at the Fed. The
proposal also would have limited the Fed’s ability to
demand the full 6 percent of capital, and it would
have allowed small banks to choose whether they
wanted to follow the example of their larger counterparts and take back their Fed stock.
The measure was shelved, but it may return this
year. Just as importantly, it has prompted new
questions from the banking industry. As one bank
lobbyist recently told the Wall Street Journal, “This is
not something that we … even thought about until
the highway bill passed. If we’re not getting the
dividend we signed up for … do we need this entire
system anyway?”
Indeed, the lobbyist’s question of Fed membership
remains relevant more than 100 years after the Fed’s

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founding. There is no modern example to shed light
on what might happen if banks decide Fed membership is no longer worth it. Nor is it clear what the
consequences—intended as well as unintended—
may be if member banks start leaving the System in
substantial numbers. But what is clear is that a large
decline in membership would directly challenge
Warburg’s prediction that “the future will belong to
those banks—national or state—that are members
of the Federal Reserve System.”
Helen Fessenden is an economics writer in the
Research Department of the Federal Reserve Bank
of Richmond, and Gary Richardson is the Federal
Reserve System historian.

F or a more detailed discussion of the history and purpose of
the Fed surplus account, please see the upcoming issue of the
Richmond Fed’s Econ Focus magazine. For an analysis of the
transportation law, also known as the Fixing America’s Surface
Transportation (FAST) Act, see Robert Jay Dilger, “Federalism
Issues in Surface Transportation Policy: A Historical Perspective,” Congressional Research Service, December 8, 2015.


F ed Chair Janet Yellen commented on the financing provisions
of the transportation bill as she spoke during congressional
testimony; see Vicki Needham, “Yellen Concerned About Use
of Fed Surplus for Highway Bill,” The Hill, December 3, 2015. As
the bill was advancing, Vice Chair Stanley Fischer called those
measures “dangerous”; see David Harrison, “House Highway Bill
to Use Fed Surplus Account for Funding,” Wall Street Journal,
November 5, 2015. And former Fed Chair Ben Bernanke called
the measures “budgetary sleight of hand” in his Brookings
Institution blog post on November 9, 2015.


I n the early 1930s, the Federal Reserve Committee on Branch,
Group, and Chain Banking prepared a report on the rise of
state-chartered banks, “The Dual Banking System in the United
States,” which is available on the Federal Reserve Archive at


S ee Paul M. Warburg, “The Federal Reserve System and the
Banks,” Address prepared for the New York State Bankers Association Convention, June 9, 1916.


S ee Charles W. Calomiris, Matthew Jaremski, Haelim Park, and
Gary Richardson, “Liquidity Risk, Bank Networks, and the Value
of Joining the Federal Reserve System,” National Bureau of
Economic Research Working Paper No. 21684, October 2015.


S ee Calomiris et al.


S ee Gary Richardson and William Troost, “Monetary Intervention Mitigated Banking Panics during the Great Depression:
Quasi-Experimental Evidence from the Federal Reserve District
Border, 1929 to 1933,” Journal of Political Economy, December
2009, vol. 117, no. 6, pp. 1031–1073.


T he Federal Reserve Board did not directly make discount
window loans, but under the Federal Reserve Act, it had the
authority to determine whether Reserve Banks could accept
paper originated by non-members as collateral. In effect, in
this one small area of discount lending in the Fed’s early
years, the Reserve Banks and the Board had joint decisionmaking authority.

This article may be photocopied or reprinted in its
entirety. Please credit the authors, source, and the
Federal Reserve Bank of Richmond and include the
italicized statement below.
Views expressed in this article are those of the authors
and not necessarily those of the Federal Reserve Bank
of Richmond or the Federal Reserve System.

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