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July 21, 1978
Mem bersh ip 1 - The Background
Over the past decade, the Federal Reserve System has experienced an accelerating withdrawal of member
banks and a consequent decline in the
amount of banking-system deposits
subject to Federal Reserve requirements. To help stop this attrition, the
Board of Governors this month released proposals to reduce the burden on Federal Reserve member banks
and simultaneously move toward
competitive equality among financial
institutions generally. In this first of
two articles, we discuss the background to the problem and outline the
Fed's proposed solution. Next week,
we will describe the Fed's proposals in
greater detail.
Membership dedine
A total of 551 banks have withdrawn
from the Federal Reserve System over
the past decade, and the majority of
newly-formed banks have chosen to
remain outside the System. As a result,
the proportion of commercial-bank
deposits held by member banks has
declined sharply, from 83 percent in
1965 to about 73 percent today. In
earlier years, most banks that withdrew were smaller banks, for whom
the System provided less attractive
services than those available through
correspondent banks. More recently,
however, the withdrawals have included an increasing number of larger
banks. In 1977, for example, 15 of
the 69 banks that left the System
had deposits of over $100 million.
The end result could be a strikingly different Federal Reserve System, composed primarily of large banks and
lacking direct ties to the rest of the
banking system. Such a development
would eliminate the Fed's unique character as a decentralized central bank
serving institutions of many sizes all
over the nation. In the Board's words,
the erosion of membership and of
member-bank deposits
to
weaken the nation's financial system as
more and more of the nation's payments and credit transactions are handled outside the safe channels of the
Federal Reserve, as fewer and fewer
banks have immediate access to the
Federal Reserve Bank credit facilities, as
a national presence in bank sU'pervisory and regulatory functions becomes
increasingly diluted, and as implementation of monetary policy becomes
more difficult.
N
Rising rates, dual system
The decline in membership can be
traced to the rising trend of market interest rates, which has increased the
implicit cost of assets frozen in the
non-earning reserves required of
member banks. Many banks have
concluded that the benefits of Federal
Reserve membership do not offset
the cost of System reserve require-
(continued on page 2)
m0)17
Opinions expressed in this newsletter do not
necessarily reflect the vievl/s of the management of the
Federal Reserve Bankof SanFrancisco, nor of the Board
of Governors of the Federal Reserve Systenl.
ments. In the U.s., the dual-banking
system of national and state chartering
gives banks the option of withdrawing
from membership and choosing nonmember status, because state-chartered banks need not become System
members.
State non-member banks are subject
to state reserve requirements, which
vary from state to state but are usually
effectively lower than System requirements, whatever the formal level of reserve ratios. This is so because many
states allow U.s. government securities
to serve as reserves, which pay interest directly. Again, most states permit
reserve assets to be held as balances
at (correspondent) banks, which earn
an indirect return in the form of various banking services provided by the
correspondents. Thus, non-member
banks gain access to the national payments mechanism through member
correspondent banks, and pay a lower
net cost in the process.
In contrast, member-bank reserves are
limited to cash and deposits at Federal
Reserve Banks. These assets bear no
2
interest, and their indirect value depends on what each bank receives in
the form of Federal Reserve services - check clearing, funds transfer,
provision of coin and currency, securities safekeeping, access to credit, and
so on. Up until about the 1950's, the
value of these services more than
matched alternative market yields, but
the picture has changed considerably
.with the inflation-caused upsurge in
market rates of the past decade or so.
Instead of market yields of 1 -to- 2
percent, banks are now able to earn
rates of 5-to-7 percent on their earning reserves, so that a net benefit from
System membership has turned to a
net burden for many banks. According
to some estimates, the aggregate burden could exceed $650 million.
The problem of membership, moreover, involves not only non-member
commercial banks but also a wider
group of non-bank financial institutions. Savings-and-Ioan associations,
mutual savings banks and credit unions
boast even lower reserve requirements than non-member banks, and
are beginning to take on many of the
characteristics of commercial banks. In
the Northeast, many of these thrift institutions have begun to offer N OW
accounts, which are deposits combining the 'interest-bearing features of savings accounts and the third-party
transactions features previously limited
to commercial-bank demand deposits. N OW accounts as such are still
limited to that one part of the country,
but transactions-type accounts have
been appearing elsewhere, in the
form of S&L remote-payments terminals and credit-union share drafts.
Proposed solution
Under existing arrangements, Federal
Reserve member banks bear a
in
the form of non-interest-bearing reserves - a tax which is not paid by nonmember b?nks and which frequently
is not offset by the value of System services a bank receives. The Fed's ability
to act on its own to reduce this burden
is limited. The ability to reduce reserve
requirements is limited by statute and
by monetary-policy considerations.
The Fed's proposals thus include two
major packages. The first package is
embodied in proposed legislation, submitted to Congress in the form of the
Reserve Requirements Act of '1978.
This legislation would require all institutions offering transactions-type deposits to maintain appropriate
reserves with the Federal Reserve System, but would grant them access to
certain Fed services as compensation.
The second package involves Federal
Reserve actions to lower reserve requirements on demand deposits, impose fees on certain services and
broaden access to those services, and
pay interest on reserve balances. In
conjunction with this package, the
Board submitted to Congress the Interest on Reserves Act of 1978. As introduced, this bill would establish a ceiling
on the payment of interest on reserve
balances.
3
The Fed's proposals are directed not
only at arresting the decline in membership but also at restoring competitive equality with non-member banks
as well as other institutions now providing transactions-type accounts. The
introduction of service charges can be
seen as a means of encouraging more
efficiencies in the functioning of the
nation's financial sector.
The Federal Reserve can act under existing authority to lower reserve requirements on member-bank demand
deposits, but it needs Congressional
approval for imposing uniform reserve requirements on all transactions
deposits. The Fed does not contemplate introducing pricing of services unless interest is paid on reserves, so
several parts of the package depend
on Congressional action. Hearings are
scheduled for late this month, but it is
difficult to predict when final legislative action will occur. Nonetheless, the
Fed's action shows its intention to reduce the burden borne by member
banks and thereby slow the exodus
from the System.
Robert Johnston
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BANKiNGDATA-TWELFTH FEDER.Al
RESERVE
DISTRICT
(Dollar amounts in millions)
Selected Assets and liabilities
large Commercial Banl(s
Amount
Outstanding
Change
from
Change from
year ago
Dollars
Percent
7/5178
6128178
Loans (gross, adjusted) and investments*
Loans (gross, adjusted)- total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.s. Treasury securities
Other securities
Deposits (lesscash items)- total*
Demand deposits (adjusted)
U.s. Government deposits
Time deposits- total*
States and political subdivisions
Savingsdeposits
Other time deposits:j:
Large negotiable CD's
114,566
92,630
3,043
27,859
30,893
16,379
8,149
13,787
112,427
31,248
464
78,283
6,565
31,778
36,711
18,309
+ 1,091
+ 1,615
+ 1,052
84
+ 156
+ 122
371
- 153
+ 1,644
+ 1,419
- 116
95
102
+ 123
45
3
+
Weekly Averages
of Daily Figures
Week ended
Week ended
7/5178
6/28178
Member Bank Reserve Position
ExcessReserves(+)/Deficiency (-)
Borrowings
Net free(+ )/Net borrowed (-)
Federal Funds-Seven Large Banks
Interbank Federalfund transactions
Net purchases(+ )/Net sales(
-)
Transactionswith U.s. security dealers
Net loans (+ )/Net borrowings (-)
+
+
82
44
38
+
15
74
59
15.71
21.57
23.15
17.24
26.42
27.93
10.82
0.82
14.42
10.51
- 11.79
+ 16.57
+ 14.93
0.53
+ 34.32
+ 76.29
+
+
+
+.
+
+
+
+
+
Comparable
year-ago period
+
+
860
1,608
324
+ 15,557
+ 16,434
572
+
+ 4,097'
+ 6,457
+ 3,576
989
112
+
+ 14,173
+ 2,972
62
+ 11,129
853
+
169
+ 9,381
+ 7,923
+
440
33
1
32
725
+
19
*Includes items not shown separately. :j:lndividuals,partnerships and corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author . ...
Free copies of this and other Federal ReservepUblications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone
(415) 544-2184.
@FedFRASER