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ECONOMIC

PERSPECTIVES
m

The Midwest prepares for
interstate banking
Regulatory innovation:
The new bank accounts

(bo)




BBS
KE

(

ECONOMIC PERSPECTIVES
March-April 1984
Volume VIII, Issue 2

^

E d ito ria l C o m m itte e

vice president and
associate director o f research
Randall C. Merris, research economist
Edward G. Nash, editor
Harvey Rosenblum,

graphics
typesetting
editorial assistant

Roger Thryselius,
Nancy Ahlstrom,
Gloria Hull,

Econom ic Perspectives is
published by the Research Department of
the Federal Reserv e Bank of Chicago. The
views expressed are the authors’ and do
not necessarily reflect the views of the
management of the Federal Reserve Bank
of Chicago or the Federal Reserve System.
Single-copy subscriptions are avail­
able free of charge. Please send requests
for single- and multiple-copy subscrip­
tions, back issues, and address changes to
Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois 60690, or telephone
(3 1 2 ) 322-5111.
Articles may be reprinted provided
source is credited and Public Information
Center is provided with a copy of the
published material.

___________ :_________________)

IS S N 0 1 6 4 -0 6 8 2




C o n te n ts
The Midwest prepares for
interstate banking

3

Regulatory innovation:
The new bank accou n ts

12

Midwestern bankers, quietly moinng into per­
missible areas of interstate banking, are
probably exporting more banking services
than the Midwest imports from other areas

As the dust settles after the introduction of
MMDAs and SNOWs, economists can more
clearly see what happened and what it means
for banking operations and monetary>
policy

T h e M idw est p re p a re s fo r in te rs ta te b an k in g
Sue F. G reg orash
Although interstate banking is not yet a nation­
wide reality and remains prohibited by the
McFadden Act and the Douglas Amendment to
the Bank Holding Company Act of 1956, many
have already begun to hail its arrival. A variety of
banking and related services are currently avail­
able on a multistate basis. For instance, a grow­
ing list of nonbanking activities permitted by
section 4 ( c ) ( 8 ) of the Bank Holding Company
Act of 1 9 5 6 —such as equity'financing, securities
brokerage services, and futures commission mer­
chant activities—may be offered by bank holding
com panies without geographical limitation.
Banks may also expand across state lines via loan
production offices, Edge Act corporations, and
electronic funds transfer (E F T ) networks. In
addition, the Garn-St Germain Depository Insti­
tutions Act of 1982 provides opportunities for
banking organizations to purchase failing finan­
cial institutions across state lines.
A question important to midwestem bank­
ing organizations and consumers in need of
financial services is whether the region is a net
supplier of such services to the rest of the coun­
try or a net importer of these services from outof-state institutions. The geographic source of
financial services becom es an increasingly im­
portant issue as banking regulations are relaxed
and as nationwide competition among banks and
nonbank financial institutions increases. Con­
sumers benefit, both in the availability and price
of services, when competition is keen.
This article analyzes Seventh District finan­
cial services to determine whether the District is
a net importer or exporter of financial serv ices.
After analyzing current interstate banking activ­
ity coming from, or directed toward, the five
Seventh District states, it is concluded that,
although the District is a net supplier of inter-*
Sue F. Gregorash is a regulatory economist at the Federal
Reserve Bank of Chicago. The author acknowledges a study
by David D. Whitehead,
Federal Reserve Bank of Atlanta ( 1983 ), upon which certain
portions of this article are based.

A Guide to Interstate Banking,

Federal Reserve Bank o f Chicago




state financial services, a great potential lies large­
ly untapped.
Examination of these activities is based
primarily on numbers of office locations for the
various services, not the dollar volume of activity
generated from these offices or their assets. The
bank-related activities of nonbanking firms will
not be examined here.1
Perm issible interstate activities
Bank holding companies are currently per­
mitted, under Section 4( c )( 8 ) of the Bank Hold­
ing Company Act of 1956 as amended and Regu­
lation Y, to engage in a broad scope of nonbank­
ing activities (Table 1). The offering of these
services is not subject to the geographical limita­
tions of banking; e.g., a bank holding company
located in Chicago may provide trust services
through an o ffice in Phoen ix, Miami, or
Anchorage.
The number of bank holding companies
headquartered in Seventh District states, along
with the number of their 4 ( c ) ( 8 ) subsidiaries
and offices is shown in Table 2. As of year-end
1981, Illinois, with 70 offices, led the District
states in number of 4 ( c ) ( 8 ) interstate subsidiar­
ies. Bank holding companies headquartered in
only three other states—New York, California,
and Pennsylvania—have established more of
these subsidiaries.
Even so. District states are net receivers of
4 ( c ) ( 8 ) services with 368 offices located inside
their boundaries, as opposed to 124 offices
'An interstate comparison based on total assets would
be valuable; however, the difficulty in obtaining asset break­
downs by type of activity precludes such a comparison here.
For an analysis of nonbank competition, see “Competi­
tion in Financial Services: The Impact of Nonbank Entry,” by
Harvey Roscnblum and Diane Siegel, Federal Reserve Bank of
Chicago,
and “Banks and Nonbanks: A Run
for the Money,"
, July/August 1983,
and Harvey Rosenblum and Christine Pavel, “Financial Ser­
vices in Transition: The Impact of Nonbank Entry,”
All of these publications are available from
the Chicago Fed’s Public Information Department.

Staff Study 83-1
Economic Perspectives

Memoranda 84-1.

Staff

3

T able 1

Permissible nonbank activities for bank holding companies under Section 4(c)(8)
of the Bank Holding Company Act and Regulation Y
(December, 1983)
A c tiv itie s p e rm itte d by re g u la tio n
1. Extensions of credit2
Mortgage banking
Finance companies: consumer, sales, and commercial
Credit cards
Factoring
2. Industrial bank, Morris Plan bank, industrial loan company
3. Servicing loans and other extensions of credit2
4. Trust com pany2

5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

Investment or financial advising2
Full-payout leasing of personal or real property2
Investments in community welfare projects2
Providing bookkeeping or data processing services2
Acting as insurance agent or broker primarily in connection with credit extensions2
Underwriting credit life and accident and health insurance
Providing courier services2
Management consulting to all depository institutions
Sale at retail of money orders with a face value of not more than $1000, travelers checks and savings bonds’ 2
Performing appraisals of real estate’
Issuance and sale of travelers checks
Providing securities brokerage services and related securities credit activities’
Arranging commercial real estate equity financing’
Underwriting and dealing in government obligations and money market instruments’
Foreign exchange advisory and transactional services’
Acting as a futures commission merchant’

A c tiv itie s p e rm itte d by o rd e r
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

Issuance and sale of travelers checks2 6
Buying and selling gold and silver bullion and silver coin2 4
Issuing money orders and general-purpose variable denominated payment instruments1,2,4
Futures commission merchant to cover gold and silver bullion and coins1,2 6
Underwriting certain federal, state and municipal securities’ 2,6
Check verification1 2' 4
,
Financial advice to consumers1 2
,
Issuance of small denomination debt instruments’
Arranging for equity financing of real estate6
Acting as futures commissions merchant6
Discount brokerage

emanating from bank holding companies located
in District states. Although the District states
house approximately 23 percent of the nation’s
bank holding companies, their 4 ( c ) ( 8 ) activi­
ties account for only about 11 percent of the
nation’s 4 ( c ) ( 8 ) interstate subsidiaries, and
only 2 percent of the number of interstate
offices.
Bank holding companies and their nonbank
subsidiaries may also participate in interstate
expansion via loan production offices and Edge
Act corporations. Eleven of the 13 Edge Act cor­

4




porations in the Seventh District are located in
Chicago; Detroit and Milwaukee have one each.
Twenty interstate Edges emanating from District
states are found in California, Massachusetts,
Minnesota, and New York.
Loan production office (LPO ) distribution
is shown in Table 3. The twenty-six interstate
LPOs are located in four of the five District states.
There is no LPO activity in Wisconsin. Banks
from Illinois and Michigan have originated 32
LPOs in 14 states outside their home states. In
this activity, the Seventh District (that is, Illinois

Economic Perspectives

T able 1 (cont.)
A c tiv itie s p e rm itte d by o rd e r (co n t.)
12.
13.
14.
15.
16.
17.
18.
19.
20.

Operating a distressed savings and loan association
Operating an Article XII Investment Co.
Executing foreign banking unsolicited purchases and sales of securities
Engaging in commercial banking activities abroad through a limited purpose Delaware bank
Performing appraisal of real estate and real estate advisor and real estate brokerage on nonresidential properties
Operating a Pool Reserve Plan for loss reserves of banks for loans to small businesses
Operating a thrift institution in Rhode Island
Operating a guaranty savings bank in New Hampshire
Offering information and transactional services for foreign exchange services.

A c tiv itie s d en ie d by th e Board
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.

Insurance premium funding (combined sales of mutual funds and insurance)
Underwriting life insurance not related to credit extension
Sales of level-term credit life insurance
Real estate brokerage (residential)
Armored car
Land development
Real estate syndication
General management consulting
Property management
Computer output microfilm service
Underwriting mortgage guaranty insurance14
3
*5
Operating a savings and loan association1 5
,
Operating a travel agency'■ 2
Underwriting property and casualty insurance1
Underwriting home loan life mortgage insurance1
Investment note issue with transactional characteristics
Real estate advisory services

1Added to list since January 1, 1975.
Activities permissible to national banks.
3Board orders found these activities closely related to banking but denied proposed acquisitions as part of its "go slow" policy.
4T o be decided on a case-by-case basis.
5Operating a thrift institution has been permitted by order in Rhode Island, New Hampshire, California, and Illinois.
Subsequently permitted by regulation.
SOURCE: Board of Governors of the Federal Reserve System

and Michigan) appears to be a net provider of
loan services to other parts of the country.
Table 4 lists the states whose banks and
holding companies have established interstate
offices in D istrict states, w hether through
4 ( c ) ( 8 ) activity, LPOs, or Edge Act corpora­
tions. New York, Massachusetts, Minnesota, and
California are the predominant states establish­
ing a presence in the Midwest.
The Garn-St Germain Depository' Institu­
tions Act of 1982 provides another interstate
opportunity. Banks and savings and loan associa­

Federal Reserve Bank o f Chicago




tions may acquire failing financial institutions
across state lines. The Act ranks these acquisi­
tions in order of preference, favoring combina­
tions between the same type of institution in the
same state. In considering out-of-state offers,
those institutions in adjoining states are to be
given priority over those from non-adjacent
states. Acquisitions by these favored parties,
however, do not always prevail. On January' 20,
1984, the Board of Governors approved an
application by Citicorp to acquire First Federal
Savings and Loan Association of Chicago and its

5

T able 2

Interstate 4(c)(8) activity of
Seventh District state bank holding companies
Holding companies with
interstate 4(c)(8) subsidiaries
Holding companies
with home
office in state

Holding company
home state

Holding
companies

Subsidiaries

Offices

Onebank
Illinois

Multi­
bank

Total

316

7

323

5

24

70

66

1

67

3

11

38

Indiana
Iowa

268

16

284

2

2

3

Michigan

18

24

42

1

3

6

Wisconsin

82

28

110

2

3

7

750

76

826

13

43

124

3201

430

3631

139

382

5500

23.4

17.7

22.7

9.4

11.3

2.3

District state
Total
U.S. total
District as a
% of U.S. total

SOURCE: Federal Reserve Board data as of December 31, 1981 and the Federal Reserve Bank of Atlanta. 4(c)(8)
refers to the section in the Bank Holding Company Act (together with Regulation Y) that permits bank holding companies
to engage in nonbank activities.

62 offices statewide under this provision of the
Garn Act.2
The most rapidly growing type of interstate
expansion is by means of EFT or automated teller
machine (ATM) networks. Each of the District
states is involved in some form of interstate EFT
network. Table 5 lists the EFT networks in each
District state and indicates those that are inter­
state. Note that the majority of EFT services
available in the District are provided by net­
works based in the District.
Often these regional systems will join to­
gether to form a national network. For instance,
four regional systems in the District have recently

Federal Reserve Bulletin

2See 70
157 ( February 1984).
Also, for a discussion of Citicorp’s acquisition of Fidelity
Federal Savings and Loan Association of San Francisco, sec 68
656 ( October 1982). Although this
acquisition was approved prior to the passage of the Garn-St
Germain Act, it generally complies w ith the procedure later
finalized.

Federal Reserve Bulletin

6




becom e members of Nationet, a national EFT
network tying 3,408 financial institutions in 26
states. In October 1983, when Nationet became
a nationwide network, it had a total of 12
member networks; the members from District
states include Iowa Transfer System, Des Moines,
Iowa; Magic Line, Detroit, Michigan; Electronic
Funds Illinois, Inc., Chicago, Illinois; and Tyme
Corporation, Browndeer, Wisconsin.3
In addition, the Board of Governors recently
granted approval for a joint venture—Money
Transfer System, St. Louis, Missouri—to begin
operating in Missouri and Kansas.4 This organiza­
tion plans to expand to Iowa, Illinois (which
requires an ATM reciprocity agreement), and
Kentucky'. This data processing network includes
a system of shared ATMs and will recruit savings

'Robert M. Garsson, “Nationet Launches 26-State ATM
Operation,”
October 14, 1983, pp 1, 15.
469

American Banker,
Federal Reserve Bulletin 643 (August

1983).

Economic Perspectives

Table 3

T able 4

Loan production office activity

Holding company activity in Seventh
District by state and type of activity

LPOs entering the District states
State

4(c)(8) Activity

States

Offices

Location in District
IA

21

Indiana

1

1

Iowa

2

2

Michigan

2

2

Wisconsin

0

0

IL

IN

Ml

Wl

X

X
X
X

X
X
X

X

X

X
X
X

X
X

8

Illinois

Total

10*

26

LPO activity originating from District states
States
State
Organizations
Offices
entered
Illinois

4

31

13

Michigan

1

1

1

5

32

14

Total

‘ This figure represents the total number of states outside
the Seventh District with an established LPO presence within the
District. Due to intradistrict movements and states with an LPO
presence in more than one District state, this figure does not
represent the sum of the numbers above it.
SOURCE: Federal Reserve Bank of Atlanta survey of the
top 200 banking organizations. 1983.

and loan associations as members as well as
banks.s

California
Connecticut
Delaware
Illinois
Indiana
Maryland
Massachusetts
Minnesota
New York
Oregon
Pennsylvania
Rhode Island
Wisconsin

X

X

X
X
X
X
X
X
X
X
X

X
X
X
X
X

X
X
X
X

X
X
X
X

LPO
California
Georgia
Illinois
Kentucky
Maryland
Massachusetts
Missouri
New Jersey
New York
North Carolina
Ohio
Pennsylvania
Washington

X
X
X
X
X

X
X

X

X
X
X
X
X
X
X

Interstate Edge

State banking laws
The banking laws of each of the Seventh
District states are summarized in Table 6. Multi­
bank holding companies, intrastate and inter­
state, are prohibited in Indiana. Only Iowa and
'One means of interstate expansion whose legality has
not yet been decided is proposed by Dimension Financial
Corporation. Dimension proposes to establish 31 “nonbank
banks” ( i.e., banks that do not issue commercial loans and
thus do not fall under the statutory definition of a bank in
section ( 2 ) of the BHCA) in 25 states nationwide. The
application was filed in March 1983 with the Comptroller of
the Currency and no ruling has been made to date. An Illinois
bank located near the site of a proposed Dimension “bank"
and several other banking associations are protesting the
application for two reasons. First, they assert that the
nationally-chartered “banks” to be acquired by Dimension
are subject to the Bank Holding Company Act and violate its
interstate banking prohibitions (section 3(d ), the so-called
Douglas Amendment). It has also been charged that Dimen­
sion itself would be a subsidiary of a savings and loan associa­
tion, causing further legal and regulatory' complications.

Federal Reserve Bank o f Chicago




California
Massachusetts
Minnesota
New York

X
X
X
X

SOURCE: Federal Reserve Bank of Atlanta survey
of the top 200 banking organizations. 1983.

Illinois allow grandfathered out-of-state bank
holding companies to continue expanding with­
in the state. None of the states currently has a
reciprocal interstate banking agreement with
another state. Illinois’s recently enacted law
allowing multibank holding companies restricts
their expansion to designated regions of the
state. These limitations are also imposed on the
grandfathered out-of-state holding companies.6
6Furthcr analysis of the Illinois multibank law may be
found in “First Year Experience: Illinois Multibanks Shop
Carefully,” by Sue F. Gregorash,
May/June 198.3.

Economic Perspectives,

7

Table 5

District participation in EFT networks
Interstate
(yes/no)

Number of
states
covered

Illinois
The Answer System
ATM Network Management Corp.
Cash Station
Computer Research Co.
Easy
‘ Electronic Funds Illinois, Inc.
Money Network
Shared Network Corp.
Yes

No
No
No
No
No
No
No
No
No

1
1
1
1
1
1
1
1
1

Ohio
Ohio

Ind iana
Access 24
Jeanie
The Owl Network

No
Yes
Yes

1
3
3

Iowa

Io w a
*lowa Transfer System

Yes

3

Wisconsin

M ich ig a n
Any Time Teller
Continet
•M agic Line
*Tyme Corporation

Yes
Yes
No
Yes

2
3
1
2

Wisconsin
Minnesota
Wisconsin

W iscon sin
A.O. Smith Data Systems Division
Continet
Fast Bank
*Tyme Corporation

No
Yes
Yes
Yes

1
3
5
2

State of origin
(if interstate)

Michigan
Wisconsin

Network

‘ Member of national EFT network (Nationet).
SOURCE: EFT Interchange: A Directory of Shared ATM Services, American Bankers Association,

1982.

These bank holding companies are exercis­
ing their opportunities to expand in Iowa and
Illinois, as seen in Table 7. General Bancshares
Corporation of St. Louis received Board approval
in August 1983 to add a fourth bank to its Illinois
holdings. Northwest Bancorp in Minneapolis
owns 11 banks in Iowa and is the largest bank
holding company in that state. Its most recent
Iowa acquisition was in 1980.
The only Seventh District bank holding
company to ow n banks outside of its home state
to date is Northern Trust Corporation of Chi­
cago. Within the past two years it has begun
acquiring banks in Florida pursuant to a grand­
father provision in Florida’s banking law. At yearend 1983, Northern Trust Corporation owned
four banks in Florida.

8




Since the passage of the Depository' Institu­
tions Deregulation and Monetary’ Control Act of
1980, the Garn-St Germain Act, and prior and
subsequent de jure and de facto deregulation of
the banking industry, banks and thrift institu­
tions are becoming more direct competitors. In
general, savings and loan associations are subject
to less restrictive state branching and expansion
laws than are banks. In Seventh District states,
savings and loan associations may branch state­
wide. Table 8 shows the interstate expansion of
savings and loan associations affecting the Sev­
enth District. As banks and savings and loan insti­
tutions begin to compete more and more for the
same customers, some form of parity should be
established regarding their respective expansion
powers.

Economic Perspectives

Table 6

Impediments to expansion: state banking laws

State

O ut-of-state entry
permitted

Reciprocity

Intrastate bank
holding company
expansion permitted

Branching

Illinois

Only permits
expansion of
grandfathered
companies'

None2

No branching;
limited service
facilities only

Within a designated
region or contiguous
region

Indiana

None

None

Limited

No multibank holding
companies permitted

Iowa

Only through
expansion of
grandfathered
companies'

None

Full-service
facilities permitted
within county of head
office or in a
contiguous county

Statewide; subject to
size limit of 8
percent of total state
deposits

Michigan

None

None

Same or adjacent county
as head office if within
25 miles; home office
protection

Statewide

Wisconsin

None

None

Same or adjacent county
as head office if within
25 miles; home office
protection

Statewide

'Iowa and Illinois allow expansion by companies with bank or trust company subsidiaries grandfathered by the 1956
Bank Holding Company Act. The Illinois multibank holding company law, effective January 1, 1982, grandfathered an
additional out-of-state holding company.
’Illinois law requires a reciprocity agreement for its interstate ATM network participants.

Table 7
Interstate bank activity
(August 31, 1983)*
Out-of-state banking
organizations having bank
subsidiaries in District states

Number of
organizations

Number of
banks

Number of
branch offices

Illinois

1

4

4

Iowa

1

11

50

Wisconsin

3

6

22

1

4

NA

District state banking
organizations with banking
activity outside home state
Illinois

•Branch office data as of December 31, 1981.
SOURCE: Board of Governors of the Federal Reserve System.

Federal Reserve Bank o f Chicago




9

wide. Out-of-state bank holding
companies own more subsidiary
Interstate savings and loan activity
banks inside Seventh District states
involving Seventh District states (March 1983)
than Seventh District bank hold­
Coverage
Name of institution
Home state
ing companies own in the rest of
the nation, primarily due to ac­
Ml, FL, NY, TX
1. Empire of America
Michigan
quisitions prior to the Douglas
Federal Savings Association
Amendment and the grandfather
California
CA, FL, IL, MO, TX
2. Home Savings of America,
provisions of Iowa and Illinois law.
Federal Savings and Loan
Most of the bank holding compan­
ies with a nationwide presence
Michigan
Ml, VA
3. Bay Savings Bank
have offices in Seventh District
Indiana
IN, KY
4. Union Federal Savings and
states. As with international bank­
Loan of Evansville
ing offices, many of these offices
SOURCE: Federal Home Loan Bank Board.
have been established as a conve­
nience to the banks’ current cus­
tomers and not for the purpose of
usurping market share from local banks.
Summary
Although the District is a net supplier of
interstate services, potential still exists for expan­
On the whole, the Seventh District states
sion. The Seventh District states house almost
are net exporters of interstate banking services,
one-quarter of the nation’s bank holding com ­
except for 4 ( c ) ( 8 ) activities. The District is well
panies, yet it does not provide a proportionate
covered with EFT networks, and the services
share of most interstate financial services. Furof four of these networks are available nation­
T able 8

10




Economic Perspectives

ther, it would seem that bank holding eompanies
in financial centers such as Chicago and, to a
lesser extent, Detroit, would be among the
nation’s leading innovators in interstate activity.
A possible explanation for this relative inactivity
is the restrictive state banking laws in Indiana
and Illinois that limit multibank holding com ­
pany expansion and thus encourage one-bank
holding company formations, accounting for the
District’s disproportionately large share of hold­
ing companies. Many of these one-bank holding
companies are small and have not yet diversified
into nonbanking activities even on a local basis,
much less an interstate one.
Unlike New England, neither the District
nor the Midwest has established any regional
cohesion, as is demonstrated currently by the
absence of reciprocity agreements in this area. In
fact, the limiting intrastate multibank holding
company laws of Illinois and Indiana tend to
discourage intra-regional support.
Future
Barring any blanket authority at the national
level for interstate acquisitions, development
will probably continue in the same areas of EFT,
4 ( c ) ( 8 ) activities, loan production offices, and
expansion by grandfathered bank holding com ­
panies. Now that some of the larger bank holding
companies have established themselves in major

Federal Resen'e Bank o f Chicago




metropolitan markets across the country, they
may seek to establish offices in smaller, regional
markets, and, conversely, regional bank holding
companies may establish themselves in metro­
politan areas. For instance, First Union Corpora­
tion of Charlotte, N.C., recently opened an office
in Chicago. Its purpose is not so much to com­
pete for Chicago business as it is to enhance its
image in its home region, the Southeast. NCNB
National Bank of North Carolina, also in Char­
lotte, and Wachovia Financial Corporation,
Winston-Salem, N.C., had previously established
Chicago offices.'7
Some banks and holding companies have
entered into contractual agreements to combine
should it ever becom e permissible by state or
federal law. Such a case exists in the Seventh
District, where First Bank System, Inc., Minne­
apolis, has announced an agreement to acquire
Banks of Iowa, Inc., Cedar Rapids, and its 11
subsidiary' banks. Other banks may be actively
developing their correspondent network and
enhancing services and computer hardware/soft­
ware compatibility' with their respondent banks
in hopes of cultivating potential marriage part­
ners. In most services, the Seventh District
appears to be among the leaders in interstate
banking activity.
"Steven L. Strahler, “Outsiders Grasp for Chicago’s Busi­
nesses,”
October 17, 1983, p. 29.

Crain ’s Chicago Business,

11

R eg u lato ry in n o v a tio n :
T h e n ew b an k a cco u n ts
G illian G arcia a n d A n n ie M cM ahon
Financial innovations are new ways to make
money. Many, and usually the most successful
innovations are initiated by the market. They are
introduced by financial firms in response to
opportunities to earn profits. Some innovations
take advantage of technical progress.
Others occur in response to government
regulation. Yet other innovations, such as the
money market deposit and Super NOW accounts,
are initiated by the regulators themselves.
Whatever their source, financial innovations
have repercussions for the management of
financial institutions. And they have important
implications for the conduct of monetary' policy.
Both of these topics are discussed in this paper.
The Money Market Deposit A ccount
In the Garn-St Germain Depository Institu­
tions Act of 1982, the Congress authorized an
account to provide depository institutions with
an instrument that is “directly equivalent to and
competitive with money market mutual funds.”
The result was the money market deposit account
( MMDA ). Money market mutual funds ( MMMFs )
had grown rapidly after their introduction in
1972 (Figure 1). They allowed the public to
earn market rates of interest, at times when Reg­
ulation Q was binding, and they offered limited
transactions features. This set of characteristics
proved very popular.
The MMDA offers these features and more.
It has been widely available since December 14,
1982. It is federally insured and pays an interest
rate that is restricted only by the discretion of
the institution ( on initial and maintained aver­
age balances of $2,500 or more ). Its features vary'
Gillian Garcia is a senior economist at the Federal
Reserve Bank of Chicago. Annie McMahon, a student intern
at the Chicago Fed when this article was written, is now a
banking associate at Continental Bank of Illinois. The authors
thank Thomas Gittings, Anne Marie Gonczy, Randall Merris,
and Harvey Rosenblum for helpful comments.

12




from institution to institution, but the authoriz­
ing act decrees some common denominators.
The account offers limited transaction features:
six transfers per month —pre-authorized, auto­
matic, or by telephone, of which no more than
three may be by check. Personal withdrawals are
unlimited, however. On personal accounts the
account carries no reserve requirements; a 3
percent reserve is imposed on nonpersonal
accounts. If the average balance falls below
$2,500, the NOW account ceiling com es into
effect.
The finer details of the account’s configura­
tion were established by the Depository' Institu­
tions Deregulation Committee (D ID C ).1 The
DIDC was so pleased with the press and financial
community’s enthusiastic response to the pend­
ing account that it was encouraged to quickly
authorize another account, the Super NOW
account (SNOW), that became available on Jan ­
uary 5, 1983The Super NOW Account
This account is a second regulatory' innova­
tion to help banks and thrifts to compete with
money market mutual funds. The SNOW account
clientele is more limited than that of the MMDA
(which is unrestricted). SNOWs are available to
households, government agencies, and nonprofit
organizations, as are NOW accounts in general.*
2
The SNOW account has unlimited transaction
features, and pays unregulated interest rates on
'The DIDC was established by the Depository Institu­
tion’s Deregulation and Monetary Control Act ( DIDMCA) of
1980, to co-ordinate the different federal regulators prog­
ress toward the deregulation of interest rates.
2
The NOW account was extended nationwide in Janu­
ary 1981, as authorized by the Depository Institutions
Deregulation and Monetary Control Act. At that time it was
available only to households and to nonprofit organizations.
Its clientele was extended by the Gam-St Germain Deposi­
tory Institutions Act, to include federal, state, and local
government deposits.

Economic Perspectives

Figure 1
Funds in M M M F s , M M D A s , and S N O W a c c o u n ts
$ billions

S O U R C E : B oard of G o vern o rs of the Federal Reserve.

initial and maintained balances of $2,500 or
more. But it carries reserve requirements as a
transaction account (currently at 12 percent).
Account e x p e rie n ce
The MMDA has been extremely popular to
date and has been a notable success in attracting
funds. As the data in Figure 1 show, it grew
rapidly after its introduction, surpassed MMMFs,
which were declining in volume, six weeks after
its introduction. After one more week, MMDAs
had exceeded the $242 billion peak that MMMFs
had attained in November 1982, ten years after
their introduction. By the end of May 1983,
MMDAs had reached $360 billion in value. They
are a success by any standard.
The SNOW experience has been less spec­
tacular. Its particular configuration of features
has proved less popular than that of the MMDA.
The account exceeded $25 billion after nine
weeks and had reached $38 billion by December
1983.
Effects on depository institutions
It is evident that the two accounts have
been successful and that MMMFs have suffered

Federal Reserve Bank o f Chicago




as a result. In an attempt to measure these
effects, a simple time series analysis of the behav­
ior of the three accounts was undertaken. The
motivation for this approach is described in the
box. The results of these analyses are reported in
the figures that follow.
C om m ercial banks:
The simple time series model that best fits
commercial bank savings and small time depos­
its was estimated from monthly data for the
period January’ 1959 through November 1981.
The data show that the model tracked the behav­
ior of the actual series so well that it is virtually
impossible to discern divergences between the
actual and model values in Figure 2. Based on
this past behavior, the series is extrapolated into
the period after November 1981 in the chart. It
shows that the regression model continued to fit
well, until the advent of the MMDA. Thereafter,
the series diverges noticeably from trend.
While MMDAs are considered to be primar­
ily a household sector savings vehicle, they have
some transactions features. For this reason, they
are excluded from Federal Reserve data on sav­
ings and small time deposits. Figure 2 shows that
funds in this small account series fell sharply

13

Figure 2
C o m m e r c ia l b a n k d e p o s its f o r e c a s t
deposits (log)

after November 1982. On the other hand, the
value of MMDAs p lu s savings and small time
deposits at commercial banks has risen sharply
since that time. These findings reinforce the
intuitive notion that some, but not all, of the
funds entering the new accounts have come
from in-house sources, such as passbook savings
deposits and six-month money market certifi­
cates.
The residuals, that is the differences between
the actual and the predicted values for commer­
cial bank combined deposits, are shown in Fig­
ure 3. The chart demonstrates that the introduc­
tion of the MMDA raised the growth rate of small
deposits far above the previously expected
experience. In short, the account’s introduction
dramatically raised the total value of funds that
commercial banks obtained from consumers
and small businesses.
Money Market Mutual Funds:
A similar simple representation of the expe­
riences of money market mutual funds is given in
Figure 4. The chart shows the deviations of the
actual from the predicted values for money
market mutual fund volumes. Here the predic­

14




tions arise from a time series regression equation
that is estimated through November 1982, just
prior to the advent of the new accounts. After
prediction difficulties during 1 9 7 4 —typical in
the period immediately following the introduc­
tion of a new financial instrument —the regres­
sion successfully tracks the behavior of MMMFs
until the advent of MMDAs. Thereafter, the
behavior of the money market mutual funds se­
ries stands in marked contrast to the experience
of banks’ consumer deposits. Actual growth
rates of MMMF assets in the post-November
1982 period fall substantially below those pre­
dicted by the pre-MMDA behavior.
To make sure that this finding did not arise
artificially as a result of ending the estimation
period for the regression immediately before the
introduction of the new account, another exper­
iment was conducted. The regression was recal­
culated with the estimation period ending twelve
months before the initiation of the new account.3
The conclusions are unchanged. This second
JThe commercial bank model was also estimated for
both periods. The commercial bank series produce undistinguishably simitar results regardless of whether the estima­
tion period runs through November 1981 or November
1982.

Economic Perspectives

Figure 3
B a n k s m a ll t i m e a n d s a v in g s d e p o s it s
in c lu d in g M M D A s — r e s id u a ls
rate of growth (percent)

Figure 4
M M M F s — re s id u a ls
rate of growth (percent)

Federal Resen e Rank o f Chicago




15

simple model is reasonably successful in estimat­
ing the behavior of MMMFs until December
1982. From that month on, as previously, the
regression substantially overestimates fund resid­
uals. This second MMMF regression, not repro­
duced in this article, highlights one new facet of
fund behavior. While the funds continued to
grow during 1982, their growth rate had begun
to decline even before the introduction of the
new accounts. However, the MMD account has
significantly worsened the environment for
money market funds.
Thrifts:
The results of similar experiments for thrift
savings and small time deposits do not produce
such unambiguous results. The reason is that in
December 1982, when the new accounts began
to be available, thrift deposit levels were already
substantially below' trend (Figure 5). This expe­
rience resulted partly from disintermediation,

partly from the recession that was then bottom ­
ing out, and partly also from some public loss of
confidence in the industry as a result of the S&L
crisis.4
The worst of the thrift deposit losses
occurred during 1982. Consequently estimating
a time series model through that year and pro­
jecting future deposit levels based on past, weak
experience shows the actual growth rates achieved
after the introduction of the new accounts to
have been substantially and beneficially affected.
This interpretation is shown in Figure 6 which
portrays regression residuals from the full period
(through November 1982) regression.
However, re-estimating the regression to
stop in November 1981 leaves the industry
expecting a more optimistic outcome for 1982
than, in fact, occurred. Predicting industry per­
formance beyond that year and comparing actual
experience with the projections show substan4The S&L crisis is described in Carron (1 9 8 2 ) and the
Federal Reserve Bank of Chicago 1983 a,b).

Figure 5

Thrift institution deposits fo re ca st
deposits (log)

16




Economic Perspectives

Figure 6

Thrift small time and savings deposits
including MMDAs—residuals
rate of growth (percent)

4 -

t r e n d line t h ro u g h 1982

3 -

2

-

1

-

1 I

i

1959

i

i

'61

i___i__ i___ i__ i___ i_ i_ l__ i___ i__ i___ i__ i___ i__ i___ i___i— i— i— i----1
_ _
___ i
'63

'65

'67

'69

tially negative residuals (Figure 7 ). The intro­
duction of the two new accounts a year later
reverses the deteriorating deposit position. The
actual growth rates early in 1983 are restored to
levels approaching those expected from expe­
rience through 1981. But they do not return the
industry near par for long—the early 1983 gains
are lost by the end of the year.

'71

'73

'75

'17

’79

'81

'83

commercial banks continued to grow, while
those at thrifts were declining.'5 Consequently,
while the total, combined value of bank and
thrift funds in MMDA accounts varied little in the
second half of 1983, their composition was
changing markedly—shifting from thrifts to
banks. In sharp contrast, MMMF levels were
seriously depleted following the introduction of
the two regulatory innovations.

Contrasting e x p erien ces
Im plications for m anagers
Thus, after November 1982, the values for
commercial bank and thrift savings and small
time deposits were raised substantially above
their earlier levels. Although both banks and
thrifts benefited from the two accounts, the two
residual series show some differences. Com­
mercial banks benefit unambiguously and more
than thrifts. Moreover, commercial banks account
growth was sustained after the initial spurt,
while thrifts relinquished some of their initial
gains as 1983 progressed. Indeed, during the
second half of 1983, the value of MMDA funds in

Federal Reserve Bank o f Chicago




The inflow of funds into banks and thrift
consumer-type accounts has the potential for
two effects upon operations. To the extent that
’ It is acknowledged that deposit flows are not totally
exogenous to banks and thrifts. In particular, where deposits
pay unregulated rates, institutions can influence their de­
posit flows by varying the rates they pay. Advertising and
other promotional activities are also relevant, as will be
discussed in a later article in this journal. Moreover, MMDAs,
which can be instantly withdrawn, are potentially more use­
ful to banks than to thrifts, because banks’ asset portfolios
have shorter maturity and duration than thrifts (Kaufman
1984).

17

Figure 7
T h r ift s m a ll t im e a n d s a v in g s d e p o s its in c lu d in g M M D A s — re s id u a ls
rate of growth (%)

®

L i—

i-------1
-------- 1
--------1
--------1
------- 1
--------1
------- 1
------- 1
--------1
------- 1
_____i_____ i_____ i_____ i_____ i_____ i_____ i_____i_____ i_____i_____ i_____ i_____ i_____ i

1959

61

'63

'65

'67

'69

the total volume of funds received by banks and
thrifts rises, they are in a position to increase
their lending activities. They can make more
mortgages, consumer, and business loans and/or
purchase more government securities. Profit­
able uses for the new funds must be found. Such
overall changes are expected to show up in the
data for the money aggregates. These will be
discussed in the following section.
On the other hand, the inflow in one area
may be counterbalanced by outflows elsewhere.
If MMDAs and SNOWs merely replace other
funds, the total value of bank and thrifts liabilities
(and, therefore, their assets) will not change.
But the composition of their liability portfolios
will be different.
In fact, both of these possibilities occurred
after the introduction of the new accounts. Total
resources available to depository institutions
rose and the composition of their portfolios
changed. Figure 8 shows these changes in total
volume and in composition for commercial
banks and thrifts.
During the first six months of the accounts,
the sum of the most important elements in
commercial bank liability portfolios rose 4.1
percent. It rose another 4.0 percent during the

18




'71

'73

'75

'77

'79

'81

'83

second half of 1983. Among the components,
commercial bank demand deposits rose lethar­
gically, while other checkable deposits (which
include SNOWs) continued the strong growth
that they have shown since NOW accounts first
became available nationwide in January' 1981.
The bank savings and small time deposit series
Figure 8
T h e c o m p o s itio n o f b a n k a n d t h r if t lia b ilitie s
$ billions

2,000

1,600

Banks
DD
ML
S D .S T D
MMDAs
OCD

December 1982

June 1983

Thrifts
FHLBA
ML
S D .S T D
MMDAs
OCD

December 1983

NOTE: DD. demand deposits; FHLBA, FHLB Advances; ML. managed liabilities;
including large CDs and RPs; SD, savings deposits; STD. small time deposits; OCD, other
checkable deposits.

Economic Perspectives

declined as did the major managed liabilities.
These declines are more pronounced in the first
half of the year than the second. Among the two
components of managed liabilities included here,
large time deposits declined, while RPs in­
creased.6
The level of the principal market sources of
thrift funds rose 9 0 percent in the first half of
1983 and 5.9 percent in the second half. Other
checkables gained strongly, but savings and
small time deposits declined significantly. RPs
increased and in contrast to banks, so did large
CDs, so that managed liabilities in general rose.7
However, S&L reliance on advances from the
Federal Home Loan Bank Board (FHLBB) was
substantially reduced. Consequently the semi­
annual increases in total thrift funds including
advances was smaller (at 7.2 percent in the first
half of the year and 5.3 percent in the second
half).
Im plications fo r th e m on etary aggregates
Particular caution must be exercised in ap­
plying the methodology described in the box to
any discussion of monetary' policy'. The monetary
6The large time deposit series most often quoted come
from Federal Reserve Release H.6, which provides time se­
ries data on the components of the monetary aggregates. The
M2 monetary aggregates include the majority’ of MMMF
funds. Consequently, to avoid double counting at the M3
level (where large CDs enter the monetary aggregates),
commercial bank sales of large CDs to MMMFs are excluded.
However, the data on the availability of funds to depository
institutions should include such CD holdings. These data are
provided in the Federal Reserve series G10. The G10 series
shows, as might be expected, sharper declines in large CD
holdings at banks:

Bank CD holdings
n.s.a. $ billions
December
1982
H.6 scries
G 10 series

June
1983

December
1983

270.0
3539

226.2
283.5

230.9
287.1

’The rise in the thrift holdings of large CDs may be a
reflection of the increase in brokered deposits. Federal
Home Loan Bank staff estimated that brokered deposits at
FSLIC-insured associations rose from
billion in Decem­
ber 1982 to S28.8 billion at the end of December 1983Brokered deposits present problems to the bank and thrift
deposit insurance agencies. (See Federal Home Loan Bank
Board, 1984).

$93

Federal Reserve Bank o f Chicago




aggregates are closely monitored by the Federal
Reserve. When it is clearly apparent that any
aggregate (M l, M2, M3 or total domestic nonfinancial credit) is deviating from the System’s
targeted ranges, remedial policy action is (n or­
mally) taken. For this reason, when a deviation
from trend occurs, it is not apparent whether
this has been engineered by the Fed in some
change in policy, or whether the deviation
results from some other event, such as the unex­
pected popularity of a financial innovation.
The Federal Reserve eased its policy stance
during the summer of 1982, and the growth rate
of the monetary' aggregates accelerated. Conse­
quently, to estimate the time series models for
the monetary aggregates with the date ending in
November 1981 would confuse the issue. By
1983 the growth rate would have increased both
in response to policy and possibly also because
of the innovation of the two new accounts. For
this reason, the estimation period ends in Novem­
ber 1982, immediately prior to the introduction
of the MMDA.
The time series models (Figures 9, 10, and
11) show that all three money aggregates were
affected by the new accounts. The relative
extent of the impact varies among the aggre­
gates, however.
Figure 9 shows that the level of Ml was
subjected to a positive shock during the first half
of 1983 This is an interesting finding, because it
was not known at that time whether the likely
positive inflows of funds into Ml from SNOWs
and expiring All Savers Certificates would be
counterbalanced by possible outflows to MMDAs
(w hich enter the aggregates first at the M2
level). Figure 11 shows that the inflows more
than compensated for the outflows, so that the
account grew rapidly.
By midyear 1983, the surge in Ml growth
was over. Since midyear 1983, Ml appears to be
growing at a rate parallel to that experienced in
late 1982, albeit at a higher level. This finding is
reassuring, for it suggests that it is now' more
feasible to return to using M 1 as the principal
monetary' target. Indeed, the Board has recently
announced that it will pay more attention to M1
during 1984 (Board of Governors, the Federal
Reserve, 1984, p. 7 2 ).

19

As expected, because MMDAs are included
first in the monetary' stock hierachy at the M2
level, this aggregate has been the most sharply
affected of the monetary aggregates ( see Figure
10). M2 has not yet returned to its pre-innovation
rate of growth.8
T h e conclusion is reinforced by the behavior of the
residual series, which is not shown in order to conserve
space.

The picture for M3 ( in Figure 11), however,
is different. An important part of the substitution
in depository’ institution portfolios has occurred
within the M3 level. For example, large time
deposits enter at this level. Thus the picture of
M3 behavior shows that this aggregate was only
slightly affected by the new accounts. This pic­
ture is also borne out by the behavior of the
residuals (not shown).

r
Tim e series forecasting
The methodology’ adopted in this paper in­
volves forecasting. The predictions, derived from
simple time series analysis, are then used in an
innovative way. The combined impact of the two
financial innovations is measured by comparing
what actually happened after the introduction of
the new accounts, with what is predicted to have
happened if the accounts had not been introduced.
The time series analy sis provides these predictions.
The method used for predicting what w'ould
have happened, absent the accounts, is intended to
be agnostic. That is, it bases the forecasts of the
future behavior of any economic variable at differ­
ent, regular intervals in time (a time series)
entirely on the past behavior of that series. No
information about the behavior of any other series
is needed for this kind of forecast. This simplifies
the forecasting process. Time series analysis says
essentially: there is a pattern to the behavior over
time of the series. Absent some innovation or other
disturbance, this pattern is expected to continue.
Computer programs exist for experimenting
with many different patterns and statisticians have
described ways to distinguish patterns that fit well
from those that do not. Some of the patterns that
might be observed result from seasonal variation in
the data. These patterns are eliminated when the
Federal Reserve seasonally adjusts its data. Conse­
quently, because seasonally adjusted data are used
(whenever available) in this study, only nonseasonal patterns were (in general) found in the
data.

The m odel ch o sen
The model that best fits the different series is a
simple one—an autoregressive, integrated, moving

average (ARIMA) of order (1 , 1 , 0 ) fitted to the
logarithms of the data. Further technical informa­
tion on forecasting using time series modeling can
be found in texts devoted to that subject (B o x and
Jenkins, 1976; Nelson, 1973).

Interpreting th e m odel
Essentially, an ARIMA of order ( 1 , 1, 0) applied
to log data says that the rate of growth of the time
series in this period is equal to some proportion, of
the previous period’s growth rate plus some error.
To estimate the impact created by the new'
accounts on any variable, the time series behavior
of that variable is estimated up to some time before
the new' account is introduced. Future behavior is
then forecast based on this past experience. Next,
the actual behavior is compared to that predicted.
The differences between the two series (called
the residuals) then estimate the effects of the
innovation on the series’ growth rates.

A caution
It must be emphasized that this technique is
not definitive. It can only be indicative of the effect
of the innovation. Other events, beyond the intro­
duction of the new accounts, have occurred and
these may have affected the behavior of the vari­
ables being studied. The present methodology
takes no explicit account of these other factors. It
should be used with appropriate caution, there­
fore. This caveat is particularly applicable to the
money stock data, whose behavior is responsive to
changes in Federal Reserve policy as w’ell as other
economic forces.

V_______________________________

20




Economic Perspectives

Figure 9
M l fo r e c a s t
$ billions

Figure 10

M2 fo re ca st
$ billions

Federal Reserve Bank o f Chicago




21

Figure 11

M3 fo re ca st
$ billions

Summary
The analysis in this paper shows that the
negative impact of the 1981-82 recession, disin­
termediation, and the S&L crisis on thrift deposit
levels were reversed by the introduction of the
new accounts. Thrift deposit levels were raised
above their 1982 trend during the early months
of the account and thereafter returned to trend.
The effects on bank consumer deposits were far
more positive. They were raised, and have re­
mained, substantially above trend. Money market
mutual funds have lost their earlier advantage.
Their strong pre-MMDA and SNOW growth has
been reversed and declines have continued into
January’ 1984.
The accumulation of funds in the new
accounts has been counterbalanced to a sub­
stantial extent by decreased depository7 institu­
tion reliance on other sources of funds, such as
savings and small time deposits. Banks, but not
thrifts, have decreased the levels of their large
CD liabilities. S&Ls rely less on FHLBB advances.

22




The changes have had implications for the
behavior of the monetary7aggregates. The level
and the growth rate of M 1 rose during the first
half of 1983 However, by the end of the 1983
the impact of the changes in the financial system
on M1 appeared to be over. Consequently, it is
now feasible to place increasing reliance on M 1
again in monetary7 policy determination and
implementation. M2 was the most affected of the
aggregates and M3 the least.
R eferences

Bulletin,

Board of Governors of the Federal Reserve,
“Monetary Policy Report To Congress,” February7
1984.

Time Series

Box, George E.P. and Gwilym M. Jenkins,
, Holden-Day
Inc., San Francisco, Revised Edition, 1976.

Analysis: Forecasting and Control

The Plight of the Thrift Institu­

Carron, Andrew S.,
\The Brookings Institution, Washington, D C.
1982.

tions

Economic Perspectives

Federal Home Loan Bank Board, “Report on Brokered
Deposits,” prepared by Representative Douglas
Barnard, Jr., and quoted in the American Banker,
March 26, 1984, pp. 5ff.

Kaufman, George G., “Measuring and managing inter­
est rate risk: A primer” Federal Reserve Bank of
Chicago, Economic Perspectives, January - Febru­
ary 1984.

The Federal Reserve Bank of Chicago, Economic Pers­
pectives, March - April 1983 a.

Nelson, Charles R.,

__________________, Leveling the Playing

Applied Time Series Analysis for
Managerial Forecasting. Holden-Dav Inc., San
Francisco, Ca., 1973-

Field. A Review of the DIDMCA of 1980 and the
Garn-St Germain Act of 1982, 1983 b.

Leveling the
Playing Field

A renew of the DIDMCA of I 'JHO and
the Garn-St Germain Act of V)H2
READINGS IN
ECONOMICS
AND
F IN A N C E fro m the Federal Reserve Bank o f Chicago

Leveling the Playing Field, the most recent publication in the Federal
Reserve Bank of Chicago’s series entitled ‘‘Readings in Economics and
Finance", summarizes the major provisions and explores the potential
ramifications of the Depository Institutions Deregulation and Monetary
Control Act of 1980 and the Garn-St Germain Depository Institutions Act
of 1982.
To order copies of this 55-page book, write: Public Information
Center, Publications Division, Federal Reserve Bank of Chicago, P.O. Box
834, Chicago, Illinois 60690, or call (312) 322-5112.

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