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January, 12, 1979
Successful
Year
Last year's rapid changes in financial
markets and increasingly restrictive
monetary action$ did not prevent the
nation's commercial banks from having
a prosperous year. A robust 11 -percent
gain in bank credit provided strong
financial support for an aging, but still
viable, economic expansion. Loans
accounted for almost the entire $96billion increase in bank credit, as mortgage and consumer lending continued
at near-record volume and as businessloan demand became more broadly
based to include large corporations.
Banks again reduced their holdings of
U.S. Treasury securities, but offset this
decline somewhat by adding Federal
Agency and municipal securities to their
portfolios.
In 1978's environment of skyrocketing
interest rates, banks were relatively successful in maintaining favorable.spreads
between their return on assetsand their
cost of funds. However, the adoption of
several new deposit innovations built in
a higher future cost structure. Moneycenter banks improved their profit performance significantly, and regional
banks continued to achieve exceptionally high earnings.
Other suppliers of funds also increased
their volume of activity during 1978.
Total funds raised in financial markets
reached $458 billion (annual rate) in the
first three quarters of the year - roughly
15 percent ahead of the 1977 pace. Net
Treasury borrowings fell significantly
below previous years, due to both an
increase in government receipts and a
short-fall in expenditures. Furthermore,
heavy foreign investment in Treasury
issues reduced the share of the deficit
which had to be financed by domestic
markets ..In contrast, net offerings by
Federally sponsored agencies tripled
over their 1977 levels, reflecting heavy
borrowing by housing-related agencies.
Municipal-bond financing also exceeded
the previous record set in 1977.Corporations were less active in the capital
markets than they had been during the
earl ier stages of the expansion, but they
again relied heavily on the commercialpaper market for funds. Consequently,
banks failed to win back all ofthe ground
which they had lost earl ierto these other
competitors for corporate business.
Escalatingrates
Credit became increasingly costly as
interest rates soared to record or nearrecord levels, reflecting tighter policy
measu res in the midst of growi ng market
pressures, along with the effects of inflationary expectations. The Federal
Reserve raised the discount rate - the
rate charged by Federal Reserve Banks
on member-bank borrowings - in a
series of five steps between January and
October, from 6 to 8112percent, and then
boosted the rate to a record 9112percent
on November 1.At the same time, the
Fed imposed a 2-percent supplemental
requirement on all large time deposits of
$1 00,000 and over (including negotiable
CD's) and on certain other bank sources
of funds.
Short-term interest rates rose by more
than 3112percentage points during the
course of the year, with the sharpest
increase occurring after the Federal
Reserve's November 1 credittightening moves. Treasury bill yields
(continued on page 2)
§CE\f('u IPrr ©)jr)\cc11 CC
(Q)
Opinions expressed in this newsletter do not
necessarily reflect the views of the rnanagenlentof the
Federal Reserve Bankof San Francisco,nor of the Board
oi Governors of the Federa! Reserve System.
rose at a somewhat slower pace because
of heavy foreign purchases. But rates on
commercial paper, large CD's and
Federal funds climbed steeply to levels
not far below the record highs experienced in mid-1974. Banks attempted to
maintain their profit margins by raising
the prime rate for their top-rated corporate borrowers 15 times during the year, to
a near-record 11% percent - up four
full percentage points from a year earlier.
Strongloandemand
Tightening monetary actions moderated
bank-credit expansion in the fourth
quarter, but total !'oans still rose a record
$91 billion for the year. A $27-billion
increase in business loans was noteworthy because many large corporations
returned to the banks for some of their
borrowi ng needs. As a consequence,
money-center banks recorded far more
substantial gains than they did in 1977,
when business borrowing was largely
confined to the regional banks patronized by smaller firms with few alternative
credit options.
Nonetheless, the consumer sector again
accounted for the major part of the total
loan increase. Real-estate loans rose 19
percent, reflecting the seemingly insatiable demand for residential property,
both as a place to live and as an inflation
hedge. Consumer instalment loans also
escalated further, particularly for auto
loans, credit-card debt and home-equity
borrowing.
More costlydepositsDuring the first three quarters of 1978,
increases in both demand and time
deposits supplied funds for the strong
bank-loan expansion, but these sources
dwindled late in the year. Roughly twofifths of the increase in time and savings
deposits occurred in the form of large
($100,000 and over) negotiable time
certi fi cates.
Following Federal Reserve approval,
banks introduced in mid-1978 a noteworthy deposit innovation - moneymarket certificates tied to the 26-week
Treasury bill rate. The availability of
these certificates enhanced banks' ability
to retain funds which otherwise might
have been lost through disintermediation
into market instruments. In November,
banks began to offer automatic transfers
from, savings aCCOl:lnts,-and this innova-,tion also helped banks retain their
deposits.
'
High profits
According to preliminary data, bankprofits reached a new peak in 1978. The
large increase in earning assets, heavily
weighted toward mortgage and consumer loans, boosted income from
interest payments. Banks generally
maintained a profitable spread between
thei r retu rn on loans and thei r cost of
funds, by making quick adjustments in
loan rates whenever money-market
rates increased. This was particularly
true in the latter part of the year. Net
income also improved, accordingto
preliminary data, as banks experienced
proportionately fewer loan losses. Earnings from foreign operations also apparently increased, as a result of higher loan
volume as well as generally profitable
foreign-exchange operations.
On the other hand, expenses soared as
banks shifted from less costly sources of
funds (those subject to deposit-rate ceilings) to more expensive sources acquired
2
BANK CREDIT - Three Years of Recovery
-5
I
.
Real
BUSiness Estate Consumer
Loans &
Investments
Investments
Source: Federal Reserve Board of Governors
at accelerating money-market rates.
Savings deposits increased only modestly
in comparison with the previous year's
$1 8-billion increase, partly because
many savers transferred their funds
during the summer and fall to the new
T-bill certificates, which were not
sub ject to rate cei lings. These certificates became a relatively costly source
of funds in the latter part of the
when Treasury-bill and other moneymarket rates skyrocketed.
Again, as in earlier high-rate periods,
banks reliedheavily for funds on large
CD's, which increased by $22 billion double the previous year's gain. These
funds became even more costly in
when the 2-percentsupplemental reserve requirement became
effective. Another late-year cost increase
resulted from the implementation of
automatic-transfer accounts, which
involved heavy start-up costs in addition
to the 5-percent interest expense on
individual funds that had formerly been
held in interest-free checking accounts.
Temperedoutlook
Late 1978's restrictive monetary actions
already have materially affected the
banking outlook for 1979. Bank-asset
growth slowed significantly in the fourth
quarter from the rapid pace of the last
two years. Yet the past year's steep rise in
loan rates has provided banks with very
attractive loan portfolios - in business
loans as well as mortgages and new
longer-maturity consumer loans. Since
reductions in the prime rate traditionally
lag declines in other interest rates, bank
spreads should become more favorable
once market rates begin to decline.
Bank-loan demand from the business
sector could remain relatively strong at least in the short-run - because of
3
inflation-generated needs and the reluctance of corporations to finance longterm at current rate levels. However,
mortgage demand shou Id weaken if
home construction declines as expected,
Also, consumer instalment borrowing
cou Id become less exuberant because of
economic uncertainties and higher
consumer-debt ratios.
More importantly, banks are are likely to
suffer from the high cost of funds which
has now been built into their liability
structure. The new T-bill certificates,
being issued at Treasury bill rates near
1974-peak levels, carry 6-rrionth maturities. Many large negotiable CD's, which
are now a major source of new funds,
also have extended maturities. Although
banks carefully'costed-out their plans
before offering the new automatictransfer accounts last November, their
earnings could still be affected by this
innovation. On the other hand, banks
should experience a new flow offunds
into cheaper depos it categories if the
economy slows down and interest rates
decline. Butthere may be a lag in recovering those deposits lost through disintermediation, because many of these funds
are locked into other investment
instruments for some periods of time.
In addition, banks face increased
competition from other financial insti- '
tutions, not only in the lending area but
also in the fight for demand balances
and savings and time deposits. On
balance, then, banks will not have an
easy job matching last year's profit
performance in 1979.
Ruth Wilson
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BANKING DATA-TWELfTH fEDERALRESERVE
DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
large Commercial Banks
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 (less cash items) - total*
Demand deposits (adjusted)
U.s. Government deposits
Time deposits - total*
States and political subdivisions
Savings deposits
Other time depositsl
Large negotiable CD's
Weekly Averages
of Daily Figures
Member Bank Reserve Position
ExcessReserves(+)/Deficiency (-)
Borrowings
Net free( + )/Net borrowed (-)
Federal Funds-Seven large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales(-)
Transactions with U.s. security dealers
Net loans (+ )/Net borrowings (-)
Amount
Outstanding
Change
from
12/27/78
12/20/78
124,347
101,042
1,776
29,064
35,324
19,039
8,452
14,853
117,473
31,597
311
83,655
7,235
31,422
42,548
20,646
201
131
- 351
17
99
128
44
26
- 215
- 249
285
528
68
208
296
164
Change from
year ago
Dollar
Percent
-
-
Week ended
Week ended
12/27/78
12/20/78
11
108
119
+
+
39
13
26
17,523
18,531
97
3,622 .
7,969
4,360
978
30
12,030
2,167
411
10,554
567
32
10,535
5,750
16.40
22.46
5.18
J4.24
29.13
29.70
- 10.37
0.20
11.41
7.36
- 56.93
14.44
8.50
0.10
32.91
38.60
Comparable
year-ago period
+
+
58
25
33
+ 694
+ 721
-
+ 369
+ 398
+ 176
414
*Includes items not shown separately. llndividuals, partnerships and corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author . . ..
Free copies of this and other Federal Reserve pUblications can be obtained by calling or writing the Public
Infonnation Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone
(415) 544-2184.
@FedFRASER