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Resesurdb Depairtaeiraft January 18,1974 EaimMiniff Se©ir@e&ffdl Last year was a busy year for the nation's bankers— too busy in some respects, because of the very high interest rates they had to pay for the deposits needed to satisfy a soaring loan demand. Yet most banks experienced record or near record levels of net income, as rec ord loan rates were collected on the very large increase in loan assets. This year may be somewhat dif ferent, however, with a slowdown in the pace of business expansion. One good thing about such a showing is that it may give banks a chance to restore a better balance among both their assets and liabil ities; for example, by rebuilding their security portfolios and reducing their dependence on CD money. Scorecard results Financial activity moved at a fren zied pace in the first half of 1973, and slowed to a more sustainable pace during the second half as mon etary policy became less expansive. In this respect, the Federal Reserve made a number of restrictive moves. The discount rate was raised seven times, from 4V2 percent at the beginning of the year to 71/2 percent in August. At midyear, reserves on demand deposits were increased V 2 percentage point, and marginal reserve requirements were placed on large denomination CD's and certain other liabilities. (A further increase in margin requirements was applied in September, but lowered toward the end of the year.) In May, all rate ceilings on Digiti^ted for FRASER large CD's were suspended, per mitting banks to bid competitively for such funds. In the face of restrictive policy moves and record high levels of loan rates, commercial-bank credit expanded $71 billion (12.6 percent) to a year-end total of $630 billion. At that point, commercial bank loans totaled $449 billion and in vestments totaled $181 billion. Unlike the previous year, the in crease was concentrated almost entirely in loans, since security port folios grew only modestly with a sharp reduction in Treasury secu rity holdings. The boom in bank lending to busi ness dominated the credit scene; this loan category rose 21 percent over the year, almost twice as fast as in 1972 and four times the 1971 pace. However, business lending ex hibited sharp fluctuations over the course of the year. The volume of business loans rose at a 38-percent annual rate in the first quarter, as credit needs were boosted by both the booming domestic economy and the international monetary crisis, and also by a shift of bor rowers from the commercial paper market to the banks. Business loan growth later slackened to only a 41/2-percent rate in the fourth quarter, partly reflecting the re channeling of loan demand to the commercial-paper market as bank lending rates regained their traditional differential over paper rates. (continued on page2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. The bank prime business-loan rate reached 10 percent in September, following 16 separate upward adjustments, and then began to ease off in the fall months. Indeed, short-term rates generally rose in a spectacular fashion, reflecting the overwhelming strength of the econ omy and the near-record price in flation. The three-month Treasury bill rate jumped over 316 percent age points to a level of more than 816 percent in August, but then fluc tuated at lower levels during the rest of the year. Finding funds A major development last year was the banks' heavy reliance on large negotiable CD's as a source of funds to support the massive loan expan sion. The largest increases in CD's occurred early in the spring, and again in mid-summer after the re moval of rate ceilings, when aggres sive bidding for such funds pushed offering rates to a record 11 percent. The role of CD's in this expansion differed from the situation in the similar 1969 boom, when existing rate ceilings held CD rates below competitive money-market rates, forcing banks to turn to such alter native sources of funds as Eurodollars and commercial paper issued through bank holding companies. In the severely restric tive atmosphere of 1969, CD's declined by $12 billion, whereas in 1973 they rose $1916 billion (43 percent). The cost of bank funds rose last year in tandem with the soaring rise of money-market rates. As a reflection of the removal of rate ceilings, of fering rates on large CD's ranged from a low of 516 percent to a peak of 11 percent, with the year-end rate hovering around 916 percent. The effective rate on Federal funds (interbank loans of unused bal ances with the Federal Reserve) fol lowed essentially the same path, al though ending the year just below 10 percent. Also, member-bank bor rowings from the Fed became more expensive as the discount rate rose from 416 percent in January to a final level of 716 percent in August. Profit margins were reduced early in the year by the limitation on loan rates imposed by the guidelines of the Committee on Interest and Div idends. In the first quarter, the pre vailing prime business-loan rate rose only from 6 to 616 percent, while market rates generally rose a full percentage point or more. This situation helped trigger a strong shift of borrowers from the commercial-paper market to the banks. However, the situation changed considerably following the CID's development of the two-tier rate system in April. Thereafter, banks had more flexibility for adjusting the rates charged large borrowers, in exchange for continuation of rel atively stable rates on loans to small businesses and households. The prime rate thus rose rapidly to a 10-percent peak in late September, and has held close to that level ever since. Higher loan rates, when applied to the huge increase in loan assets, produced a strong level of earnings for most (but not all) banks. Some large banks with international operations benefitted from the boom conditions overseas, aug mented by the favorable earnings impact of the revaluation of major foreign currencies. However, those banks that relied heavily on large CD's and borrowings to finance their expanded assets were not nearly as well off. • Uncharted territory Bankers, like everybody else, are starting the New Year with many un answered questions about the course of the economy in 1974. With the continuation of inflation, the general consensus is that inven tories will be more costly to finance, creating increased loan demand. Also, with the shortage-imposed need for new business investment, the belief is that financing require ments will expand for both long term and short-term loans, although some of this demand probably will be met by increased reliance on the capital markets. Digitize^! for FRASER Mortgage lending likely will suffer substantially from energy and other shortages, while the pace of con sumer lending should lag in re sponse to rising unemployment, rising prices of necessities, and the very heavy debt obligations of many households. As overall loan demand decelerates, however, banks should be able to rebuild their depleted security portfolios. In view of the expectation of more moderate loan demand, loan rates may move down from their record highs of 1973. The cost of funds for banks also should fall if consumers expand their savings flows in antic ipation of a softening economic situation. On the other hand, cor porate treasurers may be less able to put money into CD's, partly be cause of their need for funds for capital-goods purchases, but mostly because of the impact of a sluggish economy on corporate profits. The slowdown in the economy iron ically could benefit banks during 1974, according to most market ob servers. The slowdown should ease loan demand enough to permit banks to pay lower prices for de posit and other funds. This could mean improved profit positions be cause of a wider spread between what banks pay for money and what they charge for their funds. Ruth Wilson u o » 3u !q s e /v \ • q e in • u o i i a t o • e p e ^ N • o q e p i M BM PH . P |U J O p |B 3 . PUOZUV • i- J I|B J 'O J S O U E J j U B S I ZSi ON ilWH3d aivd 3D ViSO d s n ! 1IVW SSV13 1SJH3 BANKING DATA— TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Loans adjusted and investments* Loans adjusted— total* Securities loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Government deposits Time deposits— total* Savings Other time I.P.C. State and political subdivisions (Large negotiable CD's) Weekly Averages of Daily Figures Member Bank Reserve Position Excess reserves Borrowings Net free (+ ) / Net borrowed (— ) Federal Funds— Seven Large Banks Interbank Federal funds transactions Net purchases (+ ) / Net sales (— ) Transactions: U.S. securities dealers Net loans (+ ) / Net borrowings (— ) Amount Outstanding 1/2/74 Change from 12/26/73 80,049 61,151 1,276 21,154 18,297 9,128 6,136 12,762 76,154 22,977 1,299 50,137 17,758 22,435 7,194 10,525 + 747 + 744 - 109 + 146 + 52 + 32 - 173 + 176 + 1,134 + 519 + 285 - 216 + 201 - 370 13 - 358 Week ended 1/2/74 - 31 217 186 Change from year ago Dollar Percent +10,827 + 10,477 23 + 3,282 + 3,195 + 1,322 - 1,106 + 1,456 + 7,501 + 1,047 + 122 + 6,163 557 + 5,491 + 805 + 3,948 Week ended 12/26/73 - 115 172 57 + + + + + + + + + + + + + 15.64 20.68 1.77 18.36 21.16 16.94 15.27 12.88 10.93 4.77 10.37 14.02 3.04 32.41 12.60 60.03 Comparable year-ago period - 123 129 6 +1,852 + 1,804 + 179 + + + 225 348 491 •Includes items not shown separately. Information on this and other publications can be obtained by calling or writing the Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, Digitized for FR^SfiFfrancisco, California 94120. Phone (415) 397-1137. http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis B )jS B |V
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