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FEDERAL RESERVE BANK OF RICHMOND MONTHLY DECEMBER 1970 THE MONETARIST-NONMONETARIST DEBATE Some 19th Century Controversies Revisited Standing on opposite sides of the current debate over monetary theory and policy, and delineating the major issues, are a monetarist group and a non monetarist or credit school contingent. Generally, the monetarists: (1 ) make a sharp distinction be tween money and other liquid assets; (2 ) argue that the money stock determines total spending, the price level, and the nominal level of national incom e; (3 ) believe that the central bank can control the money supply by controlling a narrowly defined m onetary base (cu rren cy plus bank reserves) ; (4 ) are critical of the central bank’s past performance in controlling the money supply and argue that in appropriate policies may have been the source of economic disturbances; and (5 ) wish to replace the central bank’s discretionary powers with rules. The nonmonetarists, on the other hand, generally: (1 ) view money merely as a component of a broad spectrum of liquid assets that have an important bearing on total spending; (2 ) argue that the money supply is largely an endogenous variable, i.e., de termined primarily by (instead of itself determining) the level of economic activity and by the public’s preferences for money and other types of liquid as sets; (3 ) hold that, in the short run at least, the slippage between the monetary base and the money supply renders the central bank’s control over the latter weak and uncertain ; (4 ) believe that economic disturbances stem chiefly from nonmonetary factors instead of from inappropriate central bank policies; and (5 ) defend the central bank’s discretionary powers by alleging that rules are too simple and too narrowly circumscribed to handle all contingencies. The intensity of the current monetarist-nonmonetarist debate tends to obscure its origins and its lineage. The current controversy is the latest re currence of a debate that has been going on for a long time. The essentials of the debate can be traced back to the Bullionist-Antibullionist and Cur rency-Banking School controversies that took place in Britain in the 19th century. This article traces the development of the controversy and shows how similar in essentials are the prevalent monetary doctrines of today and their counterparts in the 1800’s. 2 T h e B u llio n is t - A n t ib u llio n is t C on troversy In 1797, under the stress of the Napoleonic Wars, Britain departed the gold standard for an incon vertible paper standard. A series of poor harvests, necessitating extraordinary wheat im ports, had weakened England’s trade balance. The tradebalance deterioration combined with heavy military expenditures abroad had depleted the Bank of E ng land’s gold holdings and had forced suspension of specie payments, i.e., bank notes and deposits were no longer automatically convertible into gold. The suspension of specie payments and the corresponding increase in the stock of paper money was followed by a rise in the paper pound price of bullion, foreign exchange and commodities. A debate arose between the Bullionists and the Antibullionists centering on two questions: W as there inflation in Britain? If so, what was its source? The Bullionists argued that inflation did exist, that overissue of banknotes by the Bank of England was its cause, and that the premium quoted on bul lion (the difference between the market and the mint price of gold in terms of paper money) was the proof. Price indexes were not in use then. The Bullionists used the gold premium as we use price indexes today to measure the extent of inflation. The Antibullionists denied the existence of infla tion. The premium on gold, they said, was not due to note overissue and rising domestic prices, but to the unfavorable balance of payments that had lowered the exchange rate of the British pound relative to gold and foreign currencies. The Bul lionists replied that the cause of the persistent un favorable trade balance had to be currency inflation rather than the commodity-sector disturbances cited by the Antibullionists. This was an early example of monetarist-nonmonetarist disagreement over the source of economic disequilibrium, the monetarists (Bullionists) finding it in the inappropriate actions of the central bank and nonmonetarist (Antibul lionists) in monmonetary factors, notably crop failures and heavy military outlays abroad. Indicting the Bank of England for its tendency to overissue notes, the Bullionists stressed several points that thereafter became key components of monetarist doctrine. First, they stated that the money supply is the major determinant of the price level and that changes in the money stock cause price level changes. The Bullionists may have had a fairly refined and subtle theory of money, but, when discussing policy matters or interpreting events, they resorted to the simplistic notion that prices always vary directly and proportionally with changes in the money supply. Second, the Bullionists implied that the Bank of England had the power to control the money supply within close limits via control of a narrowly defined monetary base. This point was brought out in their treatment of the relation between the volume of Bank of England notes and the volume of notes issued by country banks. The money supply at that time in cluded gold and banknotes both of the Bank of Eng land and country banks. The link between the entire money supply and the Bank of England note com ponent might have appeared tenuous because of the possibility of the country bank note component ex panding and contracting independently of the be havior of Bank of England notes. But the Bul lionists denied this possibility on two grounds. First, the country banks tended to keep as a reserve Bank of England notes equal to a relatively constant percent of their own note liabilities. Second, any overissue of country bank notes (and consequent rise in local prices relative to London prices) would drain Bank note reserves from the countryside to London via a regional balance of payments mecha nism, thereby forcing the country banks to contract their note issue. Because of the foregoing reasons, asserted the Bullionists, country bank notes would be passively tied to Bank of England notes by a virtually rigid link and could expand or contract only if the Bank’s issues did. Third, the Bullionists felt that the Bank of E ng land’s discretionary policy should be limited and the conduct of monetary policy prescribed by a rigid rule. In this case, the rule prescribed was that the Bank should limit its issues of inconvertible paper to the volume that would exist if the notes were con vertible into gold, i.e., that the bank limit its note issue to the amount consistent with equality between the mint and market price of bullion. Defending the Bank of England against the Bullionist charge of note overissue, the Antibullionists employed the real-bills doctrine which, thereafter, oc cupied a vital position in nonmonetarist thought. Overissue of inconvertible paper currency would be impossible, argued the Antibullionists, as long as new notes were issued only on the discount of sound com mercial paper. The rationale of the real-bills doctrine was that the creation of money would be tied to the production of additional output and that the money would be extinguished as the paper was redeemed with the sales proceeds. Since money creation would be limited to the expansion of goods, no inflation would occur. T he C urrency-B anking School C ontroversy The m onetarist-nonm onetarist con troversy flared up again in the discussion surrounding the Bank Charter A ct of 1844. The protagonists at this time were known as the Currency School and the Banking School, but they were the intellectual heirs of the Bullionists and Antibullionists. The Bullionists, in their search for a rule limiting the discretionary powers of the Bank of England, had established a precept which was adopted by the Currency School. A ccording to this precept, a mixed gold-paper currency should be made to behave e x actly as would a purely metallic currency. The Bullionists had thought that convertibility as such would be sufficient to insure that the paper currency would respond automatically to gold flows consistent with this precept. Convertibility alone, they thought, would be sufficient to prevent currency overissue, to keep the foreign exchanges at par, and to maintain equality between mint and market price of gold. Thus, the Bullionists were satisfied when England resumed specie payments, i.e., went back on the gold standard in 1821. T o members of the Currency School, however, the requirement of convertibility was not sufficient, by itself, to prevent overissue. They feared that even a legally convertible currency could be issued to excess with the fo llo w in g co n se q u e n ce s: rising British prices relative to foreign prices, unfavorable balance of payments, gold outflow, depletion of gold reserves, and, ultimately, suspension of converti bility. The rate of reserve depletion would be ac celerated, they noted, if the external gold drain coincided with an internal drain as domestic resi dents, pessimistic about the maintenance of con vertibility in the future, sought to convert paper cur rency into gold. The apprehensions of the Currency School were well founded. Experience following the 1821 re sumption of specie payments had demonstrated to the Currency School that mere convertibility was not enough to preserve the gold standard (the primary policy objective in those days). In the three decades following resumption, British financial history was punctuated by frequent external gold drains— some so severe as to endanger convertibility— and by periodic overexpansion of credit followed by panics 3 and liquidity crises. Moreover, to many members of the Currency School, it appeared that the actions of the Bank of England had been sluggish, perverse, and destabilizing during these periods. It seemed that the Bank’s reactions to external drains were often too late to protect the gold reserve and served instead to weaken public confidence in the Bank’s ability to maintain convertibility. Furtherm ore, when the Bank finally did apply restrictive policies to stem the gold losses, these policy actions tended to coincide with and to exacerbate the domestic liquidity crises. W hat was needed to prevent the recurrence of gold drains, exchange depreciation, and dom estic liquidity crises, the C urrency School thought, was convertibility plus strict regulation of the volume of Bank notes. The Currency School was successful in enacting its ideas into legislation. The Bank Charter A ct of 1844 embodied its prescription that, except for a fixed amount of notes which the Bank could issue against government securities, new notes could only be emitted if an equivalent amount of gold or silver was brought to the Bank. In modern parlance, the Charter A ct established a marginal gold reserve re quirement of 100% behind note issues. W ith notes tied to gold in this fashion, external gold drains would be accompanied by reduction of a like amount of notes domestically. change and demand deposits (now , but not then, de fined as part of the money supply)— from their policy analysis. They thought that the entire credit superstructure could be controlled by control of the note base. In particular, they thought that the note issue set a limit on the creation of deposits so that control of the former implied control of the latter. This argument bears some resemblance to the modern monetarist doctrine that control of a narrowly-defined stock of “ high powered money” implies virtual control of the money supply. In justification of the sharp distinction they made between money and near money, they pointed out that in crises near moneys were poor substitutes for money strictly speaking (gold and notes), because only the latter would be accepted in final payment. Third, the Currency School wanted the Bank’s discretionary powers in policy making severely con strained. The Charter A ct’s provision for tying note issues to gold instead of to the discretion of the Bank’s officers was intended to serve this purpose. Monetarist Doctrines of the Currency School It is easy to detect the monetarist doctrines in the Cur rency School’s arguments. First, of course, was the Currency School’s prescription for stabilizing prices, securing convertibility, and preserving the gold standard by tying the note issue to gold. This pre scription was based on the monetarist notion that money stock changes cause price level changes. The Currency School held that the channel of influence ran from domestic note overissue to rising prices to a weakened trade balance and deterioration of the foreign exchanges and ultimately to gold outflows. Similarly, domestic price rises would be reversed and the foreign exchanges strengthened by reducing the note issue. By tying notes to gold with a 100% re serve requirement, stability of the foreign exchanges would be achieved automatically. Second, the Currency School displayed monetarist traits in focusing on a narrow concept of money. Real Bills and the Commercial Loan Theory In contrast to the Currency School, members of the Banking School thought that convertibility was suf ficient to assure monetary stability. They thought that no further regulation of note issue was needed. Their arguments relied on the real bills doctrine and the law of reflux. A s noted earlier, the real bills doctrine asserts the impossibility of note overissue as long as banks restrict their loans to self-liquidating commercial or agricultural paper. The Banking School advocated discretionary control of bank notes by banks themselves. Banks, they thought, could judge the volume of notes required to meet the legitimate needs of trade. But Banking School ad vocates went further, noting that, even if the real bills criterion was violated, the law of reflux would operate to prevent overissue. If notes were emitted in excess of legitimate working capital needs, the public would not wish to hold the excess notes, and the notes would flow back to the banks. Because of this reflux mechanism, convertibility alone was suf ficient insurance against overissue. Accordingly, the central bank did not need to be constrained by a rigid rule because the supply of money and credit would regulate itself automatically through the force The strict separation of money from “ near money” of people’s self-interest. is a monetarist characteristic. fluenced later antimonetarist opposition to monetary A t a time when bills of exchange and demand deposits were being em ployed increasingly as exchange media, the Currency This notion probably in “ rules.” The Banking School never explained adequately School advocates concentrated on notes only. They the rationale of the law of reflux. felt justified in excluding near money— bills of ex consisted of little more than the notions that (1 ) the 4 Apparently, it public determines the amount of currency it needs to make purchases at current prices, and (2 ) if the currency in existence exceeds the desired amount, the public would return the excess to the banking system. The banks were viewed as being entirely passive. They could not force an excess issue on the public. The current price level and the volume of transactions were treated as given data (instead o f as variables determ ined within the econom ic system) by the Banking School in its discussion of the reflux. tivity precede money supply changes, (2 ) the supply of circulating media is not independent of the de mand, and (3 ) the central bank is often not an active controller of the money supply but, instead, is an agency responding to prior changes in the demand for money. Nonmonetarist Doctrines of the Banking School Like present-day nonm onetarists, the Banking School emphasized the overall structure of credit rather than a narrowly defined money supply. It criticized attempts to make a watertight distinction between money and near money. The Banking School argued that the use of bank deposits, bills of exchange, and other forms of credit (i.e., money substitutes) would defeat the Currency School’s ef forts to control the credit superstructure via control of the banknote base. The Banking School thought that the volume of credit that could be erected on a given monetary base was extremely variable and un predictable. Here is the nonmonetarist notion that the volume of credit is independent of, as well as quantitatively more significant than, the money stock. It should be noted that in the Banking School’s terminology the word credit was largely synonomous with the term means of payment. Today a distinction is drawn between the two concepts: bank credit refers to the earning assets of banks whereas deposit and note liabilities of banks serve as means of pay ment. However, the tendency to meld or fuse the two concepts persists in banking circles and may ac count for the central bank’s emphasis on qualitative control of loans in the 1920’s and for its primary policy focus, until quite recently, on credit and creditmarket conditions instead of on the money supply. Contrary to the Currency School’s contention that the channel of influence runs from money to prices, the Banking School argued that the channel of causation runs in the opposite direction. That is, when prices, total money income, and aggregate de mand are increasing, the demand for loans would in crease and the banking system would respond to the increased loan demand by supplying additional credit Outcome of the Currency-Banking Debate W h at was the outcome of these 19th century debates? It was largely a standoff. Although the Currency School’s prescription of fixed exchanges, maintenance of the gold standard, currency convertibility, and strict control of notes (but not of deposits) became part of British monetary orthodoxy in the second half of the 19th century, the Currency School’s once dominant position had eroded significantly by the turn of the century. It was clear by then that the Currency School had grossly underestimated the significance of deposits. The Currency School wanted monetary control to be automatic, but the failure of the 1844 Bank Charter A ct to regulate deposits permitted the Bank of England to exercise discretionary control over this part of the money supply. Growing recognition of the Bank’s responsi bility as a lender of last resort, together with the Bank’s successful use of its discount rate in pro tecting its gold reserve, further strengthened the case for discretionary control. In addition, attention was swinging away from the Currency School’s concern with maintaining stability in the external exchanges to the problem of domestic price level stability. It is also true that the Bullionists’ and Currency School’s quantity theory of money had gained wide spread acceptance among academic economists by the end of the century. But this advantage was offset by the survival in banking circles of the Anti bullionists’ and Banking School’s real bills doctrine. The real bills doctrine had been subjected to sus tained criticism throughout the 19th century. The monetarists had demonstrated that as long as the loan rate of interest is below the expected yield on new capital projects, the demand for loans would be insatiable. In such a case the real bills criterion would not effectively limit the quantity of money in existence. Despite this and other criticisms, the real bills doctrine survived in banking tradition and was incorporated as a key concept into the Federal R e serve A ct of 1913. The A ct provided for the ex and circulating media. In the determination of the tension of reserve bank credit (chiefly loans to mem volume of currency in existence, the public (b or ber banks) via the Federal Reserve’s rediscounting rowers) played an active role and banks (issuers) of eligible (short-term, self-liquidating) commercial a passive role. The volume of currency was demand paper presented to it by member banks. determined. Here is the origin of three more non monetarist doctrines: (1 ) changes in economic ac In summary, the dominant position that mone tarists had gained by their initial victories had de 5 teriorated by the turn of the century. A s evidence that the monetarists did not gain the upper hand, we may cite the Stabilization Hearings before the U. S. Congress in the 1920’s. American monetarists, wishing to limit the discretion of the central bank, proposed the adoption of a legislative mandate re quiring the Federal Reserve to stabilize the price level as measured by a price index. Federal Reserve officials employed Banking School arguments in their opposition to the proposal. The proposal was not enacted into law. T h e Current D ebate T h e main lines of the 19th century debates remain essentially unchanged up to the present time, and the debate today is a standoff just as it was at the turn of the century. Today’s monetarists are no less critical of the central bank than their Bullionist forebears were of the 19th century Bank of England. Some modern mone tarists attribute both the Great Depression of the 1930’s and the inflation of the late 1960’s to inap propriate central bank policies. Monetarists still ad vocate that the central bank’s discretionary mone tary management be replaced by a rule— in this case a rule fixing the annual growth rate of the money stock at a steady figure roughly corresponding to the long-term trend growth rate of output. M one tarists still argue that money-stock changes precede and cause changes in national income. They still argue that the central bank has full control over a well defined monetary base which is sufficient to enable it to control the money supply. On the other side of the debate nonmonetarist doctrines are still very much in force. A large body of literature questions the distinction between money and other liquid assets and belittles the efficacy of actions to control the stock of money in a financial system that can produce an endless variety of money substitutes. Similar issues were, of course, raised by the Banking School. Moreover, the monetarist conception of the money supply as an exogenous variable under the control of an independent central bank is being questioned. Countering the monetarist conception is the Banking School notion of the money supply as an endogenous variable, determined 6 by the level of economic activity and by the public’s preferences for money as against other financial as sets. Even the old law of reflux has reappeared in a new version which holds that the public will adjust its volume of deposits so as to eliminate any excess. In addition, while the central bank no longer adheres to the real bills principle, until fairly recently it still defined its actions and formulated its policies largely in terms of Banking School concepts (e.g., credit market conditions) instead of in terms of the money supply. In the past year, the central bank has given greater consideration to the money supply as a policy target. But it still uses credit-market conditions as supplementary policy guides, and some monetarists charge that it continues to give too much weight to the objective of credit-market stabilization. Finally, nonmonetarist interpretations of economic distur bance are frequently heard. Inflation is said to result from cost-push forces, administered prices, sectional demand shifts, and bottlenecks in the econom y’s structure rather than from an oversupply of money. Nonmonetarist explanations of the cause of the Great Depression, e.g., vanishing investment opportunities, collapse of confidence, and the stock-market crash, compete with monetarist explanations. C onclusion T h e lon gevity of the m onetaristnonmonetarist controversy is remarkable. Despite two centuries of innovations in monetary thought, policy, and institutions, the two sides still argue over basically the same issues. One can only speculate as to why the debate has not long since been laid to rest. Maybe it is because some of the commentators have not been sufficiently aware of the work of their predecessors. Or perhaps it is because until very recently statistical analysis was not sufficiently ad vanced to permit rigorous testing of the opposing theories. M ore likely it is because neither side has a monopoly on the truth. If this is the case, it is unlikely that the controversy will be resolved in the near future. Even with sophisticated empirical techniques, it will probably take a long time to identify conclusively the valid elements of each position. Thomas M . Humphrey REGULATIONS AFFECTING BANKING STRUCTURE IN THE FIFTH DISTRICT A major determinant of the structure of the bank ing industry is the set of regulations governing bank formation, branching, mergers, and bank holding companies. In the Fifth Federal Reserve District, as elsewhere in the United States, this regulatory environment is complex. Federal regulations differ among the several classes of banks. Three federal agencies (the Comptroller of the Currency, the Fed eral Deposit Insurance Corporation, and the Federal Reserve System) share supervisory responsibility among themselves and with state regulatory au thorities. State laws vary widely from one state to another. The purpose of this article is to summarize and compare regulations affecting the banking structure in the states of the Fifth District. The Fifth Dis trict presents a particularly interesting sample for such a comparison, since each of the principal types of bank law environment found in the United States is represented by at least one state in the District. The accompanying table outlines current federal and state restrictions having the greatest impact on the banking structure. The remainder of this article discusses each section of the table in turn. statutory minima probably give some indication of the relative stringency of actual requirements in par ticular states. W ith the exception of Virginia, mini mum capital set by Fifth District state laws varies depending on the population of the city or town in which the new bank intends to establish its home office.1 The considerable variety of requirements which arises under this scheme makes generalization difficult; however, as the first row of the table indi cates, North Carolina minima appear to be relatively high and South Carolina requirements comparatively low for most population categories. The relative position of the other states varies from one popula tion range to another. DOMESTIC BRANCH AND MERGER REGULATION (Rows 2 and 3 of Table) The regulation of bank branching and bank mer gers significantly influences the banking structure in any state, since these activities directly affect both the number and size distribution of banks. In general, a bank can, where permitted, establish a branch by either of two procedures: (1 ) creation of a new fa cility ( de novo branching), or (2 ) conversion of an ENTRY REQUIREMENTS (Row 1 of Table) Requirements for the establishment of new banks are given by federal law for national banks and by state law for state chartered banks. Minimum capital requirements are of special significance for the banking structure. These requirements can af fect the number of banks operating in a given state, since they are an important determinant of the ease with which a new bank can be formed. Moreover, since bank size, as measured by total assets or total deposits, is related to capital, these requirements can also affect the size distribution of banks in a given state. Federal and state statutes establish minimum standards respecting bank capital. Actual capital re quirements, however, are determined for each po tential entrant by the relevant chartering authority and often exceed statutory minima. Nonetheless, existing facility acquired by merger. In the vast majority of cases, the object of a merger is the es tablishment of a branch by the acquiring bank. Con sequently, laws regulating branching and mergers are intimately related and are discussed together in this section. The intermingling of federal and state jurisdic tions is particularly complex in the area of branch ing and mergers. In general, however, state laws provide the ultimate constraint in that individual states can prohibit or restrict branching by both national and state banks within their respective boundaries even though branching is permitted state wide by federal statutes. The simplest procedure in approaching this subject is to consider the situation prevailing in each District state in turn. 1 In states where branching is permitted, m inim um additional capital required to establish a branch in a given location is identical to or close to the requirement for a new bank in the same location. 7 FEDERAL AN D STATE REGULATIO N S AFFEC TIN G THE B AN KIN G STRUCTURE FIFTH FEDERAL RESERVE DISTRICT AU GU ST, 1970 FEDERAL REGULATION S N ational Banks State M em ber Banks STATE REGULATION S Insured N onm em ber Banks M ary lan d 1. Entry Requirements 0 — 15,000: 0- a. M inimum C ap ital (require ments for each population range) 6,000: $50,000 6.000 - 50,000: $100,000 50.000 + : $200,000 b. Paid-in Surplus 20% 2. Domestic Branches $25,0 0 0 1 5 .0 0 0 - 5 0 ,0 0 0 : $75,000 5 0 . 0 0 0 - 1 5 0,000: $1 0 0 ,0 0 0 150,000 + : $500,000* 20% of capital stock Permitted. Prior a p proval by Com ptroller required Permitted. Prior a p proval by Board of G overnors required Permitted. proval by quired Prior a p FDIC re South C aro lin a North C aro lin a 0 - 3,000: $25,000 3 , 0 0 0 - 10,000: $50,000 10,000 + : $1 0 0 ,0 0 0 0 - 3,000: $100,0 0 0 3 ,0 0 0 — 10,000: $1 5 0 ,0 0 0 10,000 — 2 5 ,000: $ 2 0 0,000 25,0 0 0 — 50,000: $250,0 0 0 50 ,0 0 0 + : $300,0 0 0 10% of capital stock 50% of cap ital stock Permitted statew ide. Permitted statew ide. Prior a p p ro val by .prior a p p ro v al by Bank Com m issioner Com m isioner of Banks required required W est V irg in ia V irg in ia District of Colum bia 3 Uniform $ 5 0 ,0 0 0 2 0 - 3,000: $50,0 0 0 3 .000 - 6,000: $75,000 6.000 - 2 5 ,000: $1 0 0 ,0 0 0 2 5 ,0 0 0 - 5 0 ,0 0 0 : $ 1 2 5,000 5 0 .0 0 0 + : $ 1 5 0 ,0 0 0 1) De novo branch ing permitted: a) w ithin the city, tow n, or county of parent ban k Prohibited Permitted throughout the District of Colum bia. Prior a p p ro val by Com ptroller re quired of cap ital stock Permitted statewide. Prior ap p ro val by Board of Bank Con trol required Federal la w does not geo grap hically restrict branching. Each bank, including each national bank, is subject to the geographic restrictions on branching imposed by the state in w hich it operates. b) w ithin a city con tiguous to the city or county of parent bank c) w ithin a county contiguous to the city of parent bank up to 5 miles from city limit Prior ap p ro val by State Corporation Com m ission required 2) De novo branching permitted statew ide at certain fed eral and state installations. Prior a p p ro v al by Com m ission required 3) Branching by m er ger permitted state w ide. Prior ap p ro val of Com m ission re quired 3. M ergers Permitted. Prior a p proval by Com ptroller required if resulting bank is a national bank Permitted. Prior a p proval by Board of G overnors required if resulting bank is a state m em ber bank Permitted. Prior a p proval by FDIC re quired if resulting bank is an insured nonm em ber bank Permitted. Prior ap- Permittec|. Prior a p proval by Bank Com- p ro va| by Commism issioner required i f sioner Gf Banks reresulting bank is a quired if resulting state bank bank is a state bank Permitted. State a p proval not required Permitted. Prior a p proval by State C o r poration Com m ission required No statutory provi sions regulating bank m ergers specifically No statutory provi sions regulating bank m ergers specifically No statutory p ro v i-No statutory provisions regulating b a n k sjons regulating bank holding com pany fo r-fo ld in g com pany for m ations, acquisitions% T,a jjonS( acquisitions or m ergers or m ergers Prior ap p ro val by Board of Bank Con trol required for bank holding com pany form ations, a cq u isi tions and m ergers No statutory provi sions regulating bank holding com pany for m ations, acquisitions or m ergers Prohibited No statutory provi sions regulating bank holding com pany fo r m ations, acquisitions or m ergers M ergers involving a n y insured bank a re subject to the Bank M erger Act of 1960 w hich: 1) prohibits m ergers resulting in a monopoly, and 2) prohibits m ergers w hich lessen competition unless the anti competitive effects a re clearly outweighed by increased public convenience. 4. Bank Holding Com panies Bank Holding C om p any Act of 1956 defines a bank holding com pany as a n y com pany controlling 25% or more of the voting stock of 2 or more banks or w hich controls the election of a m ajority of the di rectors of 2 or more banks. W ithin the limits of this definition, prior appro val by the Board of Governors is required for: 1) the form ation of a bank holding com pany, 2) the acquisition by a bank holding com pany of 5% or more of the voting stock of an y bank, and 3) the m erger of a bank holding com pany w ith another bank holding com pany. The Board receives recom m endations of the Com ptroller and state banking authorities regarding bank holding com pany acquisitions which affect national and state banks, respectively. The Board must not approve: 1) 2) acquisitions resulting in a monopoly, or acquisitions w hich lessen competition, unless the anticom petitive effects a re clearly outweighed by increased public con venience. Subject to certain detailed provisions, bank holding com panies m ay not en gag e in business unrelated to banking. Source: Relevant Federal and state statutes. Requirements given here are fo r all banks. 1 3The Requirements for banks intending to engage in trust activities are higher. law s of the District of Columbia do not provide fo r the chartering of commercial banks by the Government of the District of Columbia. The Government of the District o f Columbia can, however, charter trust companies which may perform • ■ ■ ■• r ___ ti •• _____ ___ ? i _ •_ r _ _ iL _ _ _ _ ___ l _ ._ _ _ _ _ i _ _ . • _ _ _ _ _ there was chartered by the Comptroller in accordance with an Act of Congress. _i_ ±_ t r\ n n r\ _ _ r\ r\ _ t t...— U_______ L , Maryland, North Carolina, and South Carolina all permit statewide branching either de novo or by merger with prior approval by state banking au thorities. A s the first three columns of rows 2 and 3 area of the acquired bank then remains possible.4 W est Virginia law prohibits bank branches al together, and W est Virginia remains the only unit banking state in the District. of the table indicate, insured banks operating in these BANK HOLDING COMPANIES areas must also obtain approval of one of the three (Row federal agencies regulating banks, the particular agency depending on the classification of the bank in question.2 District of Columbia banks can branch throughout the city with prior approval by the Comp troller. Federal and state laws contain general guidelines (pertaining to com petitive and con venience effects) which are designed to assist in the disposition of individual applications. In practice, both federal and state regulatory agencies possess considerable discretionary authority in specific cases that can, over a period of time, significantly affect the actual banking structure in each of these states. It is with respect to this dis cretionary power that the major practical distinction between de novo and merger branching in these states arises; namely, branching by merger does, but de novo branching does not, eliminate existing bank organizations. Therefore, speaking generally, mer ger branching is more likely to affect competition adversely in a given market area than de novo branching, a fact which may influence agency rulings. Prior to 1962, Virginia law permitted banks to branch either de novo or by merger, but only in the geographic vicinity of the home office. In 1962, the law was revised to permit statewide branching by merger. D e novo branching, however, remains re stricted to the local area of the home office. The revised law has stimulated the growth of statewide banking organizations in V irginia; however, the con tinued ban on nonlocal de novo branching has en couraged several large banks to expand via the hold ing company route.3 This preference results from the fact that nonlocal branching by merger eliminates the home office of an acquired bank and hence pre cludes further branching on a de novo basis in the new location. In contrast, holding company acquisi tion of a bank does not eliminate the existing home office. Further branching on a de novo basis in the 2 In general, federal authority over banks is divided among the three federal agencies as follow s: the Comptroller regulates national banks, the Board of Governors of the Federal Reserve System regu lates state-chartered banks which are members of the System, and the Federal Deposit Insurance Corporation regulates insured statechartered banks which are not members of the System. Each agency must seek the advice of the other two agencies when reaching merger decisions within their respective jurisdictions. 3 Virginia law does not restrict bank holding company acquisitions. 10 4 of Table) Federal and state laws restricting bank holding company activity stem from two separate areas of concern: (1 ) fear that the growth of large holding companies will reduce competition in the banking industry, and (2 ) fear that the close association of banks with nonbank holding company affiliates will lead to unsound banking practices. The first area of concern, related specifically to the banking struc ture, is essentially the same one motivating the regu lation of bank branching and focuses attention pri marily, but not exclusively, on multiple-bank holding companies. The latter apprehension, generated by the experience of the Great Depression, currently extends to both multiple-bank and one-bank holding companies. In the Fifth District, W est Virginia prohibits multiple bank holding companies Elsewhere in the District, the legal foundation for bank holding com pany regulation is the federal Bank Holding Com pany Act of 1956 (row 4, column 1). This statute applies to “ registered” bank holding companies only, i.e., to holding companies controlling two or more banks. Under this law, the Board of Governors of the Federal Reserve System must approve registered bank holding company formations, acquisitions, and mergers. The statute explicitly requires that non banking subsidiaries of registered bank holding com panies be “ . . . so closely related to the business of banking. . . as to be a proper incident thereto . . . .” District of Columbia, Maryland, North Carolina, and Virginia laws do not contain provisions for bank holding company regulation. Therefore, the Board of Governors exercises exclusive legal authority in these states, although, under the 1956 statute, state banking authorities submit recommendations to the Board regarding holding company acquisitions of state banks. South Carolina law requires prior ap proval by the State Board of Bank Control of registered holding company formations, acquisitions, and mergers, regardless of whether the banks in volved in these transactions are state or national banks. 4For a comprehensive description of banking developments in V ir ginia during the past decade see Robert G. Murphy, The Virginia Banking Stru ctu re: Changes Since 1962. Unpublished thesis, The Stonier Graduate School of Banking, R utgers: The State U n i versity, N ew Brunswick, N ew Jersey, 1969. Currently, one-bank holding companies are subject only to federal and state laws applicable to all (fi nancial and nonfinancial) holding companies. Until recently, the majority of one-bank holding companies in the United States controlled relatively small banks. During the past three years, however, the number of one-bank holding companies has increased were the lead institutions of one-bank holding com panies. By state, the two largest banks in Maryland, the three largest banks in North Carolina, two of the three largest banks in South Carolina, and the second largest bank in Virginia were one-bank hold ing company subsidiaries on the same date. sharply, and such companies now list several of the nation’s largest banks as subsidiaries. CONCLUSION Most of these companies were initiated and are controlled by the Federal and state laws regulating bank entry, managements of the participating banks themselves. branching, mergers, and holding companies signifi Congress is currently considering several bills im cantly affect the structure of the banking industry posing varying degrees of restriction on one-bank in each of the Fifth Federal Reserve District states. holding company activities. This article has attempted to summarize the principal In general, these pro posals would give either the Board of Governors or features of these regulations. all three federal greater detail should consult the relevant statutes regulatory agencies supervisory The reader who seeks powers over one-bank holding companies comparable themselves. to the authority presently exercised by the Board of laws grant considerable discretionary powers to fed Further, since both federal and state Governors over registered bank holding companies. eral and state banking authorities, the interested If such legislation is enacted, the effect on the Fifth reader should familiarize himself with recent de District banking industry could be considerable. On cisions of these agencies in specific cases. June 30. 1970, the four largest banks in the District / . Alfred Broaddus, Jr. 11 MONTHLY REVIEW FEDERAL RESERVE BANK OF RICHMOND Table of Contents—1 970 Ja n u a ry Economic Review of 1969—The Fifth District Federal Housing Agencies and the Residential M ortgage M arket State and Local Governm ent Debt W illiam H. W allace Ja n e F. Nelson Ja n e F. Nelson Feb ruary Forecasts 1970 Construction Costs Farm Financial and Credit Conditions W illiam E. Cullison Ja n e F. Nelson S a d a L. C la rke March Perspective on M onetary Policy The Agricultural Outlook for 1970 Bank Credit Proxy J. Dew ey Dane S a d a L. C larke Jim m ie R. Monhollon April Forecasting Accuracy in the Sixties Survey of Time and Savin g s Deposits Clyde H. Farnsw orth, Jr. Jim m ie R. Monhollon and Ja n e F. Nelson M. G ra ce Haskins The Fifth District (Personal Income) M ay The Evolving Payments System The Federal Reserve's Com m unications Center and the Paym ents System The W ashington-Baltim ore Regional C heck C learin g Center A ubrey N. Snellings W illiam H. W alla ce M obile and M odular Housing H. Lee Boatw right, III and C . P. K ahler The Flow-of-Funds Accounts C lyd e H. Farnsw orth, Jr. and H. Su zan ne Jones W ynnelle W ilson and M arjorie Solomon Sum iye O kubo July Regulation Q : An Instrument of M onetary Policy The Public Inform ation Function Jim m ie R. Monhollon C a rla R. G rego ry August A Seaso n ally Adjusted W orld Federal O u tlays in the Sixties C ontainer Shipping W illiam E. Cullison W ynnelle W ilson Robert W . Cham berlin Septem ber M easuring Price C hang es C orpo rate Financing in the Sixties A N ew Look at Counterfeiting W illiam H. W allace Philip H. Davidson C a rla R. G rego ry O ctober M easuring Price C hang es Parity, Support Prices, Direct Paym ents, and All That W illiam H. W alla ce Thom as E. Snider Novem ber M easuring Price C hang es Foreign Autom obile Sa les in the United States Personal Income in the Fifth District M obile Home Financing W illiam H. W allace Sum iye Okubo W illiam E. Cullison C lyd e H. Farnsw orth, Jr. December The M onetarist-N onm onetarist Debate Regulations Affecting Banking Structure in the Fifth District Thom as M. Humphrey J. Alfred Broaddus, Jr. June Fifth District Investors and the Bill M arket 12