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Resesurdb Depairtaeiraft

January 18,1974

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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 percent
/2
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

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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

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