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NET CORPORATE SAVING IN THE 1970’s
Timothy Q. Cook
The period since the beginning
has been one of low net corporate

of the 1970’s
saving rela-

penses on plant and equipment.
JVhile this first
step seems straightforward,
costs for accounting

tive to previous periods. 1 This is shown in Chart
1, which compares
the movement
of the three

purposes
can be determined
The measurement
of material

major components
of gross private saving-corporate saving, personal saving, and capital consumption allowances-over
the last twenty years.

ation, in particular, has been a matter
able controversy
in recent years.

On an annual basis corporate saving in the 197075 period averaged 3.9 percent of gross private
saving compared to an average
of 12.1 percent
the previous fourteen years.
Personal saving, on
the other hand, was unusually high over the same
period compared
to typical
levels in previous
years.
Also shown in Chart 1 is the saving (or
surplus) of the U. S. Government
as a percentage
of gross private saving.
It has generally
been
negative throughout
the 1970’s to date, acting as
a drain on gross private saving.
While the unusually
high levels of personal
saving and the long p eriod of continued
U. S.
Government
dissaving are of considerable
interest, the primary concern of this article is the behavior of net corporate
saving in the 1970’s and
the consequences
of that behavior for the aggregate corporate balance sheet.
The first two sections of the article look at the determinants
of
corporate
saving
and consider
various
factors
that underlie
its weakness
in the 1970’s.
The
next two sections consider the impact of corporate saving over the period on corporate borrowing requirements
and interest rates and its cumulative effect on the corporate balance sheet. The
last section looks briefly at the role of corporate
saving in the “capital crisis” debate.

in different
ways.
costs and depreciof consider-

Corporate
revenue remaining
after the deduction of these costs is divided into two parts: net
interest payments
to holders of financial claims
against
corporate
income and reported
profits.
The sum of these two items is generally
called
property income.
The major distinction
between
the two types of property
income is that net
interest
payments
are treated
as an expense.
Consequently
profit taxes are paid on reported
profits but not on net interest payments.
The third step shown in Table I is perhaps the
most difficult to understand
but in recent years
has been very important.
It consists of making
two adjustments
to reported profits to take into
account
the distorting
effects
of inflation
on
profits when costs are measured on an historical
basis.
Until recently the vast majority
of corporations computed reported profits by deducting
the historical
costs of inputs from the current
value of output. In a period of inflation a portion
of profits computed in this way essentially
represents capital gains on inventories
as they are
going through
the production
process.
These

Net Corporate
Saving
Net corporate
saving is
calculated as the residual after all other claims on
gross corporate income have been paid. Table I
outlines the items that are deducted from gross
corporate income to obtain net corporate
saving.
The first step shown in Table I is to deduct
costs from total revenues.
These costs include
labor costs, material costs, and indirect business
taxes.
In addition corporations
deduct capital
consumption
allowances to cover depreciation
ex-

Table

MEASURES OF CORPORATE INCOME,
PROFITS, AND SAVING
GROSS REVENUES
Labor Costs
-

FEDERAL RESERVE BANK

Material
Costs
Tax Depreciation
indirect Business Taxes

=
-

PROPERTY INCOME
Net Interest Payments

+

REPORTED PROFITS
(WA + CCAA)

=
=
-

OPERATING
PROFITS
Profit Taxes

-

AFTER-TAX OPERATING
Dividends

=
’ In this article “corporations” refers only to domestic nonfinancial
corporations.
Unless otherwise noted, the data cited in the text
and in the charts exclude profits arising in the “rest of the world”
and profits of financial institutions.

I

=

NET CORPORATE

OF RICHMOND

PROFITS

SAVING
3

Capital Consumption Allowances

Net Corporate Saving

U. S. Government surplus

I

\

-

inventory
profits cannot be used for taxes, dividends, or expansion of plant and equipment since
they must be used to purchase
new inputs at
current higher nominal prices; that is, they must
be used simply to maintain
the scale of operations of the firm.
For this reason
reported
profits should be reduced by the amount of these
inventory
profits to get a truer measure of operating profits-profits
that result from operations
rather than from inflation.
The national income
and product accounts
(NIA)
take this approach
by adding to reported
profits
an adjustment,
equal to the negative of inventory profits, called the

Another
problem with the measame amount.
surement
of economic
depreciation
is the possirules that do nolt
bility of changin g depreciation
reflect the true rate at which capital
is being
consumed.
In recent years more liberal depreciation formulas
allowing
quicker
write-offs
of
plant and equipment
have been introduced.
Before 1976 the NIA corporate profit statement
reflected tax depreciation.
The NIA have just undergone a major revision, however, and now economic capital consumption
figures are based on
an unchanging formula applied to replacement costs.:!
The corporate profit statement
has not only art

inventory

IVA adjustment
but also a capital consumption
allowance
adjustment
(CCAA)
to reflect
the
difference between tax depreciation
and economic
depreciation
as computed by the Commerce
Department
on the basis of replacement
costs.
As
will be shown below, the IVA has been much
larger than the CCAA in the 1970’s, although the
CCAA has been steadily increasing.3

valuation

A second
between
a period

that

tax

lowances)

for tax

(IVA).

may create

profits

of inflation

preciation
figure

factor

reported

adjustment

is the

(capital

of historical

behind

true

economic

tax

depreciation

must

consumption

depreciation

costs.

alIn a

might
based

in

of de-

Corporations

depreciation

of inflation,

profits

computation

purposes.

on the basis

period

a divergence

and operating

lag

on re-

placement
costs of plant and equipment
at current prices.
In such a case reported profits are
overstated
by the difference
between
economic
depreciation
and tax depreciation.
Alternatively,
the cost of capital consumed is understated
by the

4

ECONOMIC

REVIEW,

?The procedure is described in [ZO].
3 Of course, the size of the CCAA depends upon the formula that is
used to determine economic capital consumption. Young [ZO] con..
tains a discussion of the reasons behind the choice of the formula
to be used by the Department of Commerce in the NIA.
Terborgb
[IS] has argued that the straight-line write-off assumption used by
the Department of Commerce is “in most applications a grievously
retarded measure of capital consumption” and has used an alterna..
tive formula that results in a capital consumption adjustment that
is a larger offset to reported profits.

MAY/JUNE

1976

The

last

deduction

two

steps

of profit

shown

taxes

in Table

I are the

and dividends.

It should

be emphasized
that profit taxes are based on
reported
profits
rather
than operating
profits.
Consequently,
in a period of rising inflation inventory profits and profits due to under-depreciation of plant and equipment
are both taxed at
the same rate as operating
profits.
The consequences of this procedure
will be shown below.
The Decline in Net Corporate
Saving
‘The five
measures
of corporate
income discussed
in the
previous section are shown in Chart 2, all relative
to gross corporate product.
Net corporate saving
in the 1970-75 period averaged
1.1 percent
of
gross corporate
product compared to an average
of 3.4 percent
in the previous
fourteen
years.
Several factors have contributed
to the prolonged
relative
weakness
in corporate
saving
in the
1970’s. First, the period included two recessions,
the latter of which was very severe.
As the chart
demonstrates,
property
income and profits typically
fall relative
to gross corporate
product
during recessions,
pulling
down net corporate

saving.

Explanations
for this phenomenon
are of
are viewed as
two types. 4 First, prices generally
being set at a markup over normal long-run costs.
In recessionary
times output and productivity
fall, with the result that current unit costs exceed
normal unit costs.
Consequently,
the difference
between current revenues and current costs declines. The second type of explanation,
not necessarily incompatible
with the first, is that price
behavior relative to costs reflects
demand pressures.
As these pressures
decline in a recession
and excess capacity develops, the spread between
prices and costs tends to fall, resulting
in lower
profits and saving.
A second factor that has had an adverse effect
on profits, and hence net corporate saving, in the
1970’s to date is the substantial
rise in the percent
of property
income going to net interest
payments.
As shown in Table II, this rose from
about 10 percent in the mid-1960’s
to around 23
percent in 1970 and has remained near that level.
in subsequent
years.
The rising share of prop’ A review of price determination studies is contained in [IS].

Accounts.

FEDERAL RESERVE BANK OF RICHMOND

5

erty income going to interest
payments
was a
result both of the changing financial structure of
the corporate sector as firms relied more heavily
on debt to raise funds and the strong rise in interest rates in the latter half of the 1960’s.
ACcording
to most views of price determination
relative to costs, the shift to a greater reliance on
debt financing
would necessarily
exert a downward pull on profits, since a greater proportion
of property
income has to be directed to debtholders. (The factors underlying
the rise in net
interest payments will be discussed in more detail
below.)
As shown in Chart 2, property income
in the 1970’s, compared
to previous years, has
held up better than reported profits.
The third factor that clearly has contributed
to
the weakness in corporate saving in the 1970’s is
inflation.
Chart 2 shows the widening
gap between reported profits and operating
profits as
inflation
accelerated.
The IVA and the CCAA
are shown in Table III.
The IVA rose sharply
in 1973 and 1974 due to large increases
in inflation and substantial
inventory accumulation.
The
CCAA has been small in comparison
to the IVA
because
the rising divergence
between
replacement costs and historical costs of plant and equipment as inflation accelerated
has generally
been
offset, or more than offset, by the impact on tax
depreciation
of liberalized
depreciation
formulas.
The CCAA increased
operating
profits slightly
from the mid-1960’s to 1973 and decreased operating profits in 1974 and 1975. As can be seen
from Table III and Chart 2, the combined effects
of the IVA and the CCAA rose throughout
the
1966-75 decade, jumpin g sharply in 1973 and 1974.

Table

II

SHARES OF PROPERTY INCOME
($ Billions)

Net

Interest

Reported
- Profits

-

Property
Income

Net Interest
QS a Percent
of Property
Income

1966

7.4

69.5

76.9

9.6

1967

8.7

65.4

74.1

11.7
12.3

1968

10.1

71.9

82.0

1969

13.1

68.4

81.5

16.1

1970

17.0

55.1

72.1

23.6

1971

17.9

43.3

81.2

22.0

1972

19.1

75.9

95.0

20.1

1973

24.5

92.8

117.3

20.9

1974

31.7

103.8

135.5

23.4

1975

34.3

95.1

129.4

26.5

Bureau
of Economic
Source:
product Accounts.

6

Analysis,

National

income

ECONOMIC

and

REVIEW,

In 1974 inventory
under-depreciation
percent
The
saving

of reported

profits
and profits
due to
of capital assets rose to 39
profits.

adverse impact
was accentuated

of inflation
on corporate
by the fact that, as indi,-

cated above, corporate
profit taxes are paid on
the basis
of reported,
rather
than operating,
Consequently,
when inventory
profits
profits.
and/or profits due to under-depreciation
of capital
assets cause reported
profits
to be overstated,
tax rates on operating profits rise. This phenomenon is shown in Table IV, which compares
the
effective
tax rates on aggregate
corporate
reported and operating
p rofits over the last ten
The effective
tax rate on reported
coryears.
porate profits rose in 1968 due to the tax surcharge imposed that year and rose further in 19653
due to the suspension
of the investment
tax
The effective
rate subsequently
fell folcredit.
lowing the removal of the surcharge
in 1970 and
the reinstitution
of the investment
tax credit in
the second half of 1971. The fall in the effective
rate from 1972 through
1974 resulted
from the
liberalization
of depreciation
rules in 1971, while
the decline in 1975 was primarily
due to the increase in the investment
tax credit that year.
The effective
tax rate on operating
profits
looks quite different.
In particular,
effective tax
rates on operating
profits rose sharply over the
1973-74 period, despite the fact that effective tax
rates on reported profits were fairly low by historical standards,
as the difference
between
reported profits and operating profits widened.
On
the other hand, in 1975, when inventory
profits
fell sharply, very low effective tax rates (by postwar standards)
on reported profits were matched
by low effective tax rates on operating
profits.
The share of operating
profits going to dividends has also been unusually high in the 1970’s.
The reasons for this are not clear.
Dividends
tend to adjust slowly to changing profits;
consequently, fluctuations
in the ratio of dividends to
reported and operating profits are largely due to
short-run
fluctuations
in profits.
In particular,
when profits fall in recessionary
times, the dividends to profits ratio tends to rise. However, an.other possible factor contributing
to the unusu.ally high ratio of dividend payments to operating
profits SO far in the 1970’s could be that firms
were focusing on reported, rather than operating,
profits.
This focus, combined with the growing
gap between reported profits and operating
pro-fits as inflation accelerated,
would tend to raise
MAY/JUNE

1976

Table

111

ADJUSTMENTS TO REPORTED PROFITS
($ Billions)

IVA

CCAA

Total
Adjustments

Percent of
Reported
Profits

1966

-2.1

3.8

1.7

-2.5

1967

-1.7

3.6

1.9

-2.9

1968

- 3.4

3.6

.2

-.3

1969

-5.5

3.5

- 2.0

2.9

1970

-5.1

1.5

-3.6

6.5

1971

- 5.0

1972

-6.6

.5

-4.5

7.1

2.7

-3.9

5.1

1.6

1973

-18.4

-16.8

18.1

1974

- 38.5

-2.1

-40.6

39.1

1975

-10.8

-4.1

- 14.9

15.7

Source:
Bureau
of Economic
Product Accounts.

Analysis,

National

Income

and

the share of operating profits going to dividends
and decrease the share going to net saving.”
Some observers
have, in fact, argued that as
late as 1974 most corporations
were still focusing
on reported rather than operating profits in their
decision-making
process and that this focus, combined with accelerating
inflation,
was a factor
contributing
to the falloff in operating profits in
the 1970’s and especially in 1973 and 1974. There
are two types of evidence supporting
this view.
The first comes from a study by ru’ordhaus [14]
in which he compares pricing equations based on
historical
costs to pricing
equations
based on
replacement
costs.
The
latter,
which
would
correspond
to pricing
to maintain
operating
profit margins, did a much poorer job of explainthan did the former.
ing the pricin, Q decision
Consequently,
Nordhaus
concluded,
using data
through
1973, that “It appears very likely that
‘WA illusion’ constitutes
a very large fraction
of the current profit squeeze”
[II, p. 1911. The
second type of evidence is that numerous voices
within
the nonfinancial
corporate
sector have
acknowledged
the continued
focus on reported
profits into 1974.
An example is the statement
by George Terborgh : ‘(It is clear that American
business
has not yet learned
to protect
itself
against inflation”
[ 181.
In any case, by the second half of 1974 widespread attention
was being given to the distortional impact of inflation on reported profits, and

increasing
focus was being given to the matter
of accounting
methods in an age of inflation.6
A
major consequence
has been the switch by many
corporations
from First In, First Out (historical
cost) to Last In, First Out (replacement
cost)
accounting
methods. Under the latter, latest costs
become expenses.
Therefore,
end-of-period
inventory is valued at the cost of the first units
purchased durin g the period (or the cost of units
purchased
in previous
periods).’
The
consequence is that in a period of rising prices the
reported value of end-of-period
inventory
assets
are lower, reported
profits
are lower, and the
wedge between reported and operating
profits is
diminished.
As shown in Table III, the IVA fell sharply
in 1975.
The switch by many firms to LIFO
accounting
methods undoubtedly
played a role in
its fall.
Other important
factors were the substantial fall in the rate of inflation
and the net
reduction
in inventories.
Business
management
can do nothing at present to remedy the problem
of a growing
discrepancy

between

since

they

ances

on the basis

must

less, the switch

economic

and tax depreciation,

determine

depreciation

of historical

by the Commerce

costs.

Department

in

“Good examples of this attention are IS] and 1111. The distinction
between operating profits and reported profits has also resulted in
the introduction of a new term-quality
of earnings-into
the
stock market lexicon. “Good” earnings are those related to operating profits.
7 This is an oversimplification.
The major problems with the use
of LIFO methods are those associated with the valuation of inventories and the consequent difficulties in interpreting profit statements, and balance sheet ratios that depend on inventory levels.
Nelson [12] contains a discussion of these difficulties.

Table IV

EFFECTIVE TAX RATES ON AGGREGATE
CORPORATE REPORTED AND OPERATING PROFITS
(Percent)
Reported
Profits

Operating
Profits

1966

42.4

41.4

1967

42.4

41.2

1968

46.7

46.6

1969

48.7

50.2

1970

49.5

52.9

1971

47.2

50.9

1972

44.1

46.5

1973

42.1

51.5

1974
j Unfortunately nothing conclusive can be said by looking at the
aggregate corporate data because the dividend figures in the NIA
beginning in late 19’78 are not comparable with earlier yearn. The
reason for this is the changed status of some multinational COYporations-Aramco.
in particular-in
the accounts due to increased
foreign ownership.

allow-

Neverthe-

41.1

47.6

1975

38.0

45.6

Source:
Bureau of Economic Analysis,
ond Product Accounts.

FEDERAL RESERVE BANK OF RICHMOND

National

Income

7

its treatment
of capital consumption
in the NIA
is a major step in recognizing
this danger.
A fourth factor that almost certainly
had an
adverse
effect on corporate
profits and saving
during part of the 1970’s was price controls.
The
evidence from several studies [4; 14; 161 shows
that, given previous
relationships,
prices were
unusually low relative to costs in 1971 and 1972
during Phase I and Phase II of price controls.
As a consequence,
profits failed to rebound as
sharply in the years following the 1970 recession
as they had following other postwar recessions.
In summary, the weakness in corporate saving
in the 1970’s to date was the result of several
factors
including
two recessions,
high rates of
inflation, the increased share of property income
going to net interest payments,
and, at least in
1971 and 1972, the experiment with price controls.
The Corporate
Financing
Gap
Net corporate
saving can be combined with tax depreciation
and
foreign branch profits to get a measure of gross
internally
generated
funds.
The difference
between total capital investment
and gross internal
funds-sometimes
called the corporate
financing
gap-corresponds
fairly closely to the net funds
that corporations
have to raise in financial
markets.
Chart 3 shows that corporate
investment
was a fairly stable fraction
of GNP from the
mid-1960’s
through
1974, although
generally
at
higher levels than in previous years.
Gross internal funds relative to GNP, however, fell over

that period,’ primarily
due to the decline in corporate saving.
As a result the ratio of the corporate financing
gap to GNP rose to very high
levels by the end of the period, almost twice the
previous postwar peaks.
Many observers
have argued that the rise in
the corporate financing gap over this period wa.s
a major

determinant

[5; 71.

Their

Market
mand

of the rise in interest

reasoning

interest

rates

for and supply

is fairly

are determined
of debt

financing
od, rising

interest

competing
rates

loanable
Chart

whose
The

results

were

REVIEW,

higher

greater

the

corporate

the corporate

financing

4 compares
of GNP

long-term

interest

the view that

to an average
rates

and provides

on interest

rates

factor putting
in recent

inof

sector.
gap as

support

the rise in the corporate

gap was an important

share

of short-

and
for

financing

upward pres-

years.s

S Certain comments relating to Chart 3 and Chart 4 are in order.
First,
the numbers are divided by GNP so that they can be compared
over time. Second, corporations raise funds in both the long- and
short-term debt markets.
The use of the simple average of the
short- and long-term interest rates is intended to capture overall
interest rate pressures.
Third, the graphs and the accompanying
discussion are not meant to imply that corporate financing repuir+
ments are the only determinant of the level of interest rates; they
are simply intended to provide support for the view that the rising
level of these requirements was an important factor underlying the
increase in interest rates.

Financ;ng Gap

ECONOMIC

is more

goin g to

Gross Internal Funds

8

to outbid

borrowing

and a significantly

funds

a percent

sure

As the

rose over the peri-

rates were necessary

borrowers,

interest-sensitive.
terest

by the de-

securities.

gap of corporations

rates

straightforward..

MAY/JUNE

1976

4

Corporate
Saving, the Corporate
Balance
Sheet,
and Balance
Sheet Drag
The weakness
of corporate saving has also been a factor contributing
to two ongoing debates.
The first of these debates relates to the significance
of the state of
the corporate balance sheet as a factor affecting
economic activity.
The discussion over the state
of the corporate
balance
sheet has focused on
certain liquidity and leverage ratios of categories
of items from the aggregate
corporate
balance
Liquidity
ratios provide rule-of-thumb
sheet.
measures of a firm’s ability to meet its maturing
obligations
when it is subjectkd
to unexpected
variations in income. Two of the most commonly
cited aggregate
liquidity ratios are the ratio of
current assets (less inventories)
to current liabilities-the
quick ratio-and
the ratio of short-term
debt to long-term
debt.
The higher the quick
ratio and the lower the ratio of short-term
debt
to long-term
debt, the more liquid is the aggregate corporate balance sheet.
Leverage
ratios measure the relative contribution of creditors versus owners to the financing of
a firm. Two commonly cited aggregate
leverage
measures
are the ratio of equity to total assets
and the ratio of net interest payments to property
income.
The lower the ratio of equity to assets
and the higher the ratio of net interest payments

Interest Rote

to property
income, the greater
is the claim
creditors to corporate
income and the greater
the risk of bankruptcy.

of
is

What are the appropriate
levels of these ratios?
Economic
and finance theory has very little to
Nevertheless,
there is a
say about the matter.
widespread belief among members of the financial
and business communities
that these ratios as a
group reached dangerous
levels by the end of
1974. The state of the aggregate
corporate
balance sheet at that point was alternatively
described as “fragile,” “impaired,”
“overburdened,”
The
“imbalanced,”
and “illiquid.”
“unstable,”
behavior over rime of the four ratios cited above
is shown in Chart 5.g Two developments
are parFirst,
all the measures
ticularly
noteworthy.
have been deteriorating
since the mid-1960’s. TWO
of the four ratios were fairly stable before that
time while the other two-equity
to total assets
and current
assets
to current
liabilities-were
continuing
trends that began earlier.
0 These ratios while aidely cited, frequently use aggregate balance
The
sheet categories that include different balance sheet items.
consequence is that the same ratio can look quite different from
source to source. For example. all bank loans are frequently included in the short-term debt category, whereas in Chart 5 long-term
If they had been
bank loans are excluded from that category.
included, the ratio would have been higher but would still show
It should also be noted that current assets and
the same trend.
current liabilities in Chart 5 exclude trade credit and trade debt
since they largely net out for the corporate sector as a whole.

FEDERAL RESERVE BANK

OF RICHMOND

9

between
investment
and internally
generated
funds, one or more of the balance sheet ratios
shown in Chart 5 will deteriorate.
Corporations,

Second, the ratios moved fairly closely with the
rise in the corporate
financing
gap, which in
turn was closely related to the decline in corporate profits and corporate saving. In particular,
the ratios deteriorated
most sharply in 1966, 1969,
and 1973 when the financing
gap rose most rapidly, and deteriorated
least or improved when the
financing
gap declined
during 1967, 1971, and
1975. The extraordinary
fall in the financing gap
in 1975, in particular,
was accompanied
by a substantial improvement
in all the ratios.
The

observed

relationship

between

in fact, have been reluctant to issue new stock in
Table
V shows the net funds
recent
years.
raised by corporations
through stock sales as a
percent of total net funds raised by the corporate
To some extent,
sector in financial
markets.
especially
1974, the reluctance
to sell stock was a
result of the poor performance
of stock prices.
Similarly,

in some years,

rising stock prices have induced the corporate
sector to rely more heavily on stock sales.
By
itself,
however,
the performance
of the stock
market cannot explain the dearth of new stock
issues in the period covered in Table V. There
are several
other possible
contributing
factors.
The most important
is probably the differential

the rise in

the corporate financing gap through 1974 and the
deterioration
of the aggregate
balance
sheet
ratios results from the fact that a financing
gap
must be financed by depleting liquid assets, increasing short- and long-term debt, or selling new
stock. If new stock is not sold to finance the gap

Current Assets/Current

Equity/Total

Liabilities

Assets

-------------

--z-

-

---------

Proportion

----------

of Bond Offerings

Rated Baa or Lower

Short-Term/long-Term
‘.C-.-,N+--./-*---

Interest

2-r
,,e-N#,,,‘t

Debt

Payments/Property

/---

-

,.4---\
--x-c.,/

\
\

.e’-NL.rC-------~,4

10

1

0-0

income
-4-

ECONOMIC

such as 1971 and 1972,

/w---e-

REVIEW,

-I4

MAY/JUNE

/

1976

,‘\
‘4’

.--em\
\

v-e

d--n,

tax treatment of dividends and interest payments.
Interest payments by corporations
to debtholders
are not subject
to the corporate
income
tax,
while dividend
payments
to stockholders
are.
Consequently,
a smaller before-tax
share of corporate income is needed to give an equal after-tax
rate of return to a new debtholder than to a new
stockholder.
Thus, it is in the interest of existing
stockholders, up to a point, for the firm to fund its
financing gap through debt rather than equity.lO
Another factor contributing
to the relationship
between
the rise in the financing
gap and the
deterioration
of the balance sheet ratios was the
simultaneous
rise in interest rates. It was argued
earlier that the financing gap was probably a major
determinant
of this rise in interest rates.
Whatever the cause, rising interest rates contributed
to
the deterioration
of the ratios in two ways. First,
they increased the incentive to finance short-term
rather than long-term-thereby
adversely affecting the liquidity ratios-and
second, they directly
contributed
to the proportion of property income
going to net interest payments.
An additional
factor, unrelated
to the rise in
the financing
gap, that had an adverse effect on
the liquidity ratios in recent years is the greater
reliance of corporations
on liability management
as a hedge against financial uncertainty.
According to a recent study [ 171, beginning in the mid1960’s corporations
sharply increased their use of
bank loan commitments.
Clearly, with a guaranteed commitment
of funds as protection
against
unexpected
fluctuations
in income, the perceived
need for a “liquid” balance sheet is lessened.
Aside from the widespread talk of financial instability,
two concrete consequences
of the deterioration of the balance sheet ratios are identifiable.
First, as the aggregate
ratios deteriorated,
a greater number of corporate credit ratings were
lowered by the rating agencies [ 11. These ratings
are a significant
determinant
of the cost of borrowed funds for these corporations.
Second, the
deterioration
in the ratios contributed
to the development
of a two-tier
market
for long-term
funds in which lower-rated
companies
had an
increasingly
difficult time raising funds even at
an increasingly
higher rate. The downward movement in the proportion of publicly-offered
straight
bond offerings by corporations with a credit rating of
Baa or lower during the 1966-74 period is shown in
lo Several plans have been proposed to deal with this problem.
plan proposed by Henry Wallich [19], which could be implementeRd
without the major complication of an abrupt change in after-tax
profits, would be to place
an equal tax burden on all types of
property income: interest, dividends, and retained earnings.

Table

V

NET FUNDS RAISED THROUGH STOCK SALES
AS A PERCENT OF
TOTAL NET FUNDS RAISED BY THE
CORPORATE SECTOR IN FINANCIAL MARKETS
(Percent)
1960

11.8

1968

1961

17.2

1969

8.7

1962

3.2

1970

14.4

1963

-2.4

-.6

1971

24.4

1964

7.4

1972

19.7

1965

0.0

1973

11.0

1966

5.1

1974

5.3

1967

8.1

1975

27.8

Source:
Board of Governors
Flow of Funds.

of the Federal

Reserve System,

Chart 5 along with the balance sheet ratios. The net
result of these two factors was that more companies received lower credit ratings and a smaller
percentage
of that growing group were able to
raise long-term
funds.
A third consequence
of the behavior of the balance sheet ratios was increasing
debate over their
impact on the rate of growth in the economy following the 1974 recession.
Many observers
feel
that the state of the corporate balance sheet is a
factor inhibiting
rapid economic growth, at least
in the near-term,
because many corporations
are
still in the process of restructuring
their balance
sheets. Typical statements
(made in the summer
of 1975) from two of the most well-known
proponents of this view are:
Currently, the financial
base of business corporations needs substantial repair before this sector will be ready to take a fling at inventory
speculation and at spending huge sums for plant
and equipment [Henry Kaufman, 71.
Given the scare that households, firms and financial institutions had in 1973-75, we can expect that
these cash flows will be used initially to increase
the robustness of balance sheets, rather than as a
basis for continuing the trends [similar to those
shown in Chart 51 exhibited in the charts [Hyman
Minsky, lo].

Many of these same commentators
argue not
only that the recovery will be moderate but also
that it should be moderate.
Their reasons for this
view stem from the behavior of the ratios shown
of slow growth in recent
in Chart 5. Periods
years have been periods of decline in the corin the
porate financing
gap and improvement
ratios, while periods
of more rapid expansion
have been periods of increase in the financing gap
and deterioration
of the ratios.
These observers

FEDERAL RESERVE BANK OF RICHMOND

11

fear the consequences
of continuing
the long-run
trends shown in Chart 5. As Kaufman puts it,
let us recognize that a quick and spectacular
advance in economic activity would have terribly
adverse implications
for the financial position of
business.
This is because efforts to improve cor-

porate liquidity would have to be shoved aside in
order to meet the enlarged new demand for inventory and other real assets [7].

They

also note

that

even though

the top tier of

higher-rated
corporations
accomplished
substantial improvements
in their balance sheets in 1975,
the second tier of lower-rated
firms made much
less progress.
Parenthetically
it should be noted
that from the point of view of these observers the
best possible
circumstance
would be a continuation of the rebound in corporate
saving shown
in 1975, which would allow a greater part of expansion of real assets to be financed
internally
than has generally
been the case in recent years.
A central idea in the above discussion
is that
the state of the balance sheet can be a determinant, aride from its impact on current borrowing
Perhaps
costs, of a firm’s investment
decisions.
no other idea is so widespread
in business and
financial
circles and given so little attention
in
academic
circles.ir
The corollary
to this idea is
that overburdened
balance
sheets can exert a
drag on economic activity as corporations
reduce
investment
expenditures
in an effort to improve
In the
the condition
of their balance
sheets.
extreme,
widespread
efforts to restructure
balance sheets could result in a self-defeating
decline
in income and prices and a rise in real debt burdens. While modern balance sheet watchers have
generally
not raised this specter in the inflationary environment
of recent years, it has in the
past been a matter of genuine concern.
As Irving
Fisher put it 44 years ago:
When a whole community is in a state of overindebtedness, the dollar reacts in such a way that
the very act of liquidation may sometimes enlarge
the real debts instead of reducing
them!
Nominally, of course, any liquidation must reduce debts,
but really . . . it may swell the rreall
uxmaid
balance 03 every debt in the country, : . . ~caus!ng]
a vicious spiral downward-a
tailspin-into
the
trough of depression 13, p. 251.12

Corporate
Saving, Capital Crunch, and the Capital Shortage
Debate
The terms capital crunch,
capital
shortage,
and capital
crisis have been
lIThat is not to say that the idea has never been considered.
M&lam [9] has a discussion of the limited role balance sheets have
played in theoretical economic discourses in the past.
12Fisher’s main prescription for preventing cyclical fluctuations in
debt from becoming depressions was. of course, to maintain a
stable real value of the dollar through a stable money supply.

12

ECONOMIC

REVIEW,

widely used the last couple of years in many
senses, which can be broadly broken up into two
general categories : near-term and long-term. The
weakness in corporate saving plays a role in both
The weakness
in corporate
profits
discussions.
and

saving

in recent

years

is the

crux

of the

whole near-term
issue.
As has been shown in
this article, the weak state of corporate
saving
combined with fairly steady (and relatively
high)
corporate
investment
expenditures
to create an
ever-widening
financing
gap.
These
events
played an important
role in generating
concern
over deteriorating
balance
sheets,
the development of the two-tier
bond market, and rising
The combined
effects
of these
interest rates.
developments

created

a growing

concern

about

the ability and/or willingness
of corporations
to
continue to raise funds to finance real investment.
The longer-term
use of the term capital crisis
concerns itself with the adequacy of the projected
saving of various
sectors
of the economy
for
financing
projected
investment
needs.
It is beyond the scope of this article to dwell at length
on the numerous
recent studies of the issue.l’l
Suffice it to say that predictions
concerning
the
behavior of corporate
and U. S. saving generally
play a major role in the determination
of the
likelihood
of a long-term
capital crisis.
Specifically, these studies generally require that to avoid
a capital shortage corporate
saving must return
to levels more characteristic
of the pre-1970 peri-,
od and that, within a couple of years, the U. S.
Government
budget deficit must be transformed
into a budget surplus.
Although no attempt to predict the future be-,
havior of corporate
saving will be made here, it
can be pointed out that four factors were already
at work in 1975 to increase corporate
saving sigThe two most important
developnificantly.
ments were the rebound in economic activity and
the significant
deceleration
in the rate of inflation.
The third factor was the decline in the
effective tax rate on corporate
operating
profits.
As indicated earlier, the rise in the effective
tax
rate on aggregate
corporate
operating
profits in
the 1970’s was largely an unintended
result of the
not conscious
government
impact of inflation,
policy.
The effective
tax rate on aggregate
reported profits has declined every year since 1970.
In 1975 the effective
tax rates on both reported
and operating profits were at low levels by post13See [2] for a study that concluded with the instantly famous line
that “We can afford the future, but just barely” and [13] for a
more pessimistic conclusion.

MAY/JUNE

1976

war

standards.

The

fourth

factor

working

“Profits,
Share Prices,
5. Hendershott,
Patric H.
Interest Rates, and Inflation,” memorandum, September 1974. Revised version forthcoming, University of Michigan Business Review, University of
Michigan Graduate School of Business Administration, Ann Arbor, Michigan, September 1976.

to

expand
on the

corporate saving was the increasing
focus
impact of inflation
on operating
profits
The switch by many firms
and corporate saving.
to LIFO
accounting
methods, the change in the
treatment
of capital
consumption
in the NIA,

Studies of Invest
6. Jorgenson, D. W. “Econometric
ment Behavior: A Survey.” Journal of Economic
Literature,
(December 1971), pp. 1111-47.

and to some extent, the increase
in the investment tax credit in 1975 n-ere all a result of that
changing
focus.

7. Kaufman, Henry. “Liquidity
It Will Delay the Recovery.”
(June 9, 1975), pp. 25-8.

8. Lintner, John. “Saving and Investing for Future
Answers
to Inflation
and Recession:
Growth.”
Economic Policies for a Modern Society, Edited by
Albert T. Sommers. The Conference Board, Inc.,
1975.

In summary,
several
factors
comSummary
bined in the 1970’s to cause a prolonged
weakThis weakness
in
ness in net corporate
saving.
con junction with relatively
high capital expenditures created unusually
large external
financing
requirements,
which, along with other factors,
contributed
to the deterioration
of the aggregate
corporate
balance
sheet and helped
spur the
capital shortage debate.
Last year saw a strong
resurgence
of corporate
operating
profits
and
saving, an extraordinary
decline in external financing requirements,
and a significant
improvement
in the aggregate
corporate
balance sheet ratios.
A consequence
of these developments
has been a
marked decline in the intensity
of the debates
over the state of the corporate balance sheet and
If the factors
the presence
of a capital crisis.
that contributed
to the deterioration
of corporate
saving reappear, however, a resurgence
of these
debates can be expected.

References

“Inflation,
Recession and the
9. M&lam,
W. D.
Burden of Private Debt.” Banca Nazionale Del
Lavoro Quarterly Review, 113 (June 1975), 145-71.
“Financial
Resonrces in a
10. Minsky, Hyman P.
Fragile
Environment.”
Challenge,
(July/August
1975)) pp. 6-13.
11. Morgan Guarantee Trust Company. “Profitability
and Investment.”
The Morgan Guarantee Survey,
(September 1974), pp. 4-13.
12. Nelson, Car1 L. “The
Journal of Commercial
1975), pp. 31-9.

2. Bosworth,
Barry,
James
S. Duesenberry,
and
Andrew S. Carron. Capital Needs in the Seventies,
Institution,
Washington,
D. C.: The Brookings
1975.
3. Fisher, Irving. Booms and Depressions, Some First
Princivles. Binchamton. New York: Adelnhi Company, -1932.
.
4. Gordon, Robert J. “The Response of Wages and
Prices to the First Two Years of Controls.”
Brookings
Papers
on Economic
Activity,
(3rd
quarter, 19’73), pp. 765-80.

Big Rush to LIFO.”
The
Bank Lending,
(December

13. New York Stock Exchange.
The Capital Needs
and Savinas Potential of the U. S. Economu.
New
”
York- Stock Exchange, inc., 1974.
“The Falling Share of
14. Nordhaus,
William D.
Brookings Papers on Economic Activity,
Profits.”
(1st quarter, 1974)) pp. 169-217.
15. Nordhaus, William D.
“Recent Developments in
Price Dynamics.”
The Econometrics
of Price
Determination.
Conference
sponsored by Board
of Governors of the Federal Reserve System and
Social Science Research Council.
Washington,
D. C., October 30-31, 1970.
16.

1. Board of Governors of the Federal Reserve System.
“Recent
Developments.
in Corporate
Finance.”
F;deral
Reserve Bullet%, (August 19’75), pp. 463-

Repair Essential, But
The Money Manager,

Schultze, Charles L. “Falling Profits, Rising Profit
Margins, and the Full-Employment
Profit.” Brookings Papers on Economic Activity,
(2nd quarter,
1975), pp. 449-72.

1’7. Summers, Bruce J. “Loan Commitments to Business in United States Banking History.” Economic
Review, Federal Reserve Bank of Richmond, 61
(September/October
1975)) 15-23.
18. Terborgh, George. “Inflation and Profits.” Financial Analysts Journal, (May/June 1974)) pp. 19-23.
19. Wallich, Henry C. “Is There a Capital Shortage?”
Challenge,
(September/October
1975)) pp. 30-6.
20. Young, Allan H. “New Estimates of Capital Consumption Allowances
Revision of GNP in the
Survey of Current Business, Vol. 55,
Benchmark.”
No. 10 (October 1975)) 14-16.

FEDERAL RESERVE BANK

OF RICHMOND

13

REGULATIONS
BETWEEN

AFFECTING COMPETITION

BANKS AND THRIFT INSTITUTIONS
IN THE FIFTH DISTRICT
Bruce

J. Summers

Over the past several years readers of this Revieul
have been exposed to a number of articles dealing
with the concept of banking structure
and, more
with the structure
of geographic
specifically,
banking
markets
in the Fifth Federal
Reserve
District.
These articles are listed in the accompanying bibliography
[3 ; 6; S; 111. The approach
generally
taken has been to examine
banks as
single product firms, with the institutional
scope
of competition
limited to banks themselves.
Until
recently
this has in fact been the standard
apstudies, not only in
proach to bankin g structure
purely economic literature
but also in court antitrust decisions
involving
banking
competition.’
however,
banks
can be
For
some purposes,
thought
of as multiproduct
firms offering
an
array of distinct
services,
or as “financial
department
stores” [ 1, p. 3621.
It has become increasingly
evident that banks enter into direct
competition
with nonbank
financial
institutions
for some of these products.
This article briefly reviews the concept of competition
between
banks and nonbank
financial
Its major purpose is to review and
institutions.
compare the regulations
governing
market entry
and branching
by banks and competing
nonbank
financial
institutions
(thrift institutions)
in the
Fifth District.
This approach expands an earlier
treatment
of the subject
that appeared
in this
Review [ 31.
Competition
Between
Banks and Thrifts
Both
commercial
banks and thrift institutions
offer a
wide array of services.
On what basis, then, can
a determination
be made as to the extent and
degree of competition
between
these different
In certain
types of financial
intermediaries?
product lines, for example demand deposits, there
is generally no overlap, and the question of competition
is, therefore,
moot.”
In other product
1 In a seminal merger case involving two Philadelphia banks, the
Supreme Court decided that competition should be examined solely
in Q banking institutions context. See United States Y. Philadelphia
National Bank. 33, S.Ct. 1715 (1963).
‘Mutual savings banks in Maryland and several other states. however, have demand deposit powers.

11

ECONOMIC

REVIEW,

lines, however, there is a great deal of similarity
between the offerings
of banks and thrifts, and
there is some reason to expect that competition
may exist for these services.
The primary area
of overlap for banks and thrift institutions
is in
the increasingly
important field of retail banking
services.
Although
this is a broad field, most
research
has been centered
on competition
for
A review of this particuretail savings deposits.
lar product market is interesting
for the insight it
gives into the nature of and methods for determining competition.
An economic test of the degree of competition
between organizations
offering similar products
would focus upon the degree of substitutability
between the respective
product offerings.
In the
case of savings
deposits, the assets offered by
commercial
banks and thrift institutions
would
be considered good substitutes
if an increase (decrease)
in the rate of return on one produced a
significant
decrease (increase)
in the amount held
of the other. If a change in the rate of return paid
on one resulted in a proportionate,
hut negative,
change
in the amount
held of the other, the
products could be considered identical.
An independent
relationship
would exist if one asset
failed to respond to changes in the interest rate
paid on the other.
There are, of course, several
dimensions
to the return from holding savings
deposits.
These
include liquidity,
safety,
convenience,
and explicit interest return.
With respect to the first two, there is virtually no difference between bank and thrift institution
savings
deposits.
Banks, however, due to their ability to
offer a wider array of complimentary
services,
have an edge with respect to convenience.
Thrift
institutions,
which can offer a g percent differential over bank rates, have an edge with respect
to interest return.
These four factors all influence the degree to which bank and thrift deposits
are substitutes.
A number of attempts have been made to measure the degree of substitutability
between sa\-ings deposits offered by commercial
banks and 1))
MAY/JUNE

1976

thrift

institutions.

niently

These
attempts
are convein a number of studies
[9;

summarized

10; 121. In one of these summaries,
Gilbert and
Murphy conclude that evidence from various time
series and cross section studies shows that the
savings deposit services offered by thrift institutions, specifically
savings and loan associations
and mutual savings banks, are close substitutes
for commercial
bank savings deposit services
[9,
pp. 10 and 171. They also indicate that competition for savings deposits between these institutional types has increased
in recent years
[9,
p. 141. These conclusions
suggest that, for completeness, any consideration
of the structure
of a
market for savings
deposits must include both
commercial
banks and thrift institutions.
There are other, although less well researched,
product markets where the potential for competition between banks and thrift institutions
is high.
Due to recent regulatory
changes, for example,
banks are now allowed to offer business savings
accounts up to $150,000 per customer,
something
that increases their potential for competition
with
thrift institutions.3
Also, both banks and thrifts
offer mortgage loans to consumers.
In a related
lending area, both make construction
loans to
builders.
To a limited degree, they may also
compete for consumer
instalment
loans.
While
the number of product markets where banks and
thrift institutions
offer similar services is limited,
competition
within any given market
may be
intense, just as it is in the case of savings deposits.
Furthermore,
with the nation’s financial
structure
closer than ever to reforms that could
dramatically
alter the scope of activities for thrift
institutions,
the areas of competitive
overlap
could expand and intensify. These considerations
argue for an approach
to “banking
structure”
studies
that takes
into account
interindustry
competition.
The institutional
structure
of a given market
strongly
influences
the degree
of competition
among financial
intermediaries;
this in turn influences the availability
and cost of products or
services
in that market.4
To a very important
extent, the structure of financial markets is determined by regulations
governing market entry and
branching.
These regulations
may be explicitly
:’ Effective November 10, 1975, the Board of Governors
of the Federal
Reserve System amended Regulations D and Q to permit profitmaking organizations to hold savings accounts at member banks.
The FDIC took similar action regarding state nonmember banks.
See “Amendments to Regulations D and Q.” Federal
Reserve
Bulletin.

(October

1975).

p.

708.

4 See reference 141 fur a detailed dhcuasion of thr impo&ance UT
market structure.

based on statutory provisions or may be the result
of discretionary
action exercised
by particular
regulatory
authorities.
Furthermore,
the regulations that apply to the various competing organizations may be different.
Regulations
may differ
for the same types of institutions
that have different charters
(Federal
or state),
and they may
differ among the several institutional
types. Any
given
market
will have a structure
that
is
uniquely influenced,
depending on the combination of regulations
under which its participants
operate.
The rest of this article will focus on the
regulatory
makeup
of Fifth
District
financial
markets, with special attention given to the major
financial
intermediaries
that operate in the District.
In addition to commercial
banks, these include savings
and loan, or building
and loan,
associations
(S&L’s)
and mutual savings banks
(MSB’s) .6
Market Entry
Entry into Fifth District markets
by the financial
intermediaries
under consideration here is regulated by both the various states
and by either the Comptroller
of the Currency or
the Federal Home Loan Bank Board for Federally chartered banks or S&L’s, respectively.
The
only exception
to the dual chartering
system is
the District
of Columbia,
the laws of which require all banks and S&L’s to obtain the approval
of the Federal
regulatory
agencies
before they
commence business.
The various chartering
authorities
consider a
number of factors
in reviewing
applications
to
establish
new financial organizations.
These include needs of the community,
quality of proposed management,
impact upon existing institutions, and capital adequacy.
Capital adequacy is
the most objective
of these factors and therefore
is the easiest to measure.
It also, of course, can
be interpreted
in different ways and can mean a
great deal in terms of relative difficulty in gaining access to a market.
Minimum capital requirements for market entry by banks are specified in
the laws of each District state and in Federal law
for national
banks.6
For S&L’s,
a distinction
must be made between stock and mutual associations.
Mutual charters
are available
in every
District
state and from the Federal Home Loan
Bank Board.
Virginia
is the only state that
grants stock charters for S&L’s.
The stock form
I,Among the Fifth District states, only
Maryland
charters.
Federal charters are not available.

grants

MSB

“The minimum statutory capital requirements. which have non
changed for a number of years. are summarized in 13, PP.
S-91.

FEDERAL RESERVE BANK

OF RICHMOND

15

of organization
is not available
to S&L’s
that
desire Federal
charters.
Minimum
financial
requirements
governing
market entry, expressed in
terms of initial deposit subscriptions
and general
reserve and/or expense funds, are specified in the
laws of Maryland and Virginia.
North Carolina,
South Carolina, and West Virginia
requirements
are determined
as a matter of policy by the state
regulatory
authorities.
For Federally
chartered
S&L’s, minimum capital requirements
are established by the Federal
Home Loan Bank Board.
Maryland law requires that newly formed MSB’s
have a minimum guaranty
fund equal in amount
to the minimum capital stock required of newly
formed state banks.

Table

MINIMUM

CAPITAL REQUIREMENTS

Applicants

for Federal
March

Population
of Area*

Below 10,000

Total: PermanentStack and
Paid-In Surplus;
$

I

Charter

or Insurance

1976
Withdrawable

Caoital

Stock
Applicant
-

Mutual
Applicant
-

150,000(

30)

$225,000(225)

10,001-25,000

200,000(

40)

300,000(250)

400,000(300)

$

300,000(250)

25,001-50,000

300,000(

60)

375,000(275)

500,000(350)

50,001-100,000
Downtown
Other Areas

400,000(
300,000(

80)
60)

400,000(300)
375,000(275)

550,000(400)
500,000(350)

100,001-200,000
Downtown
Other Areas

500,000(100)
400,000(
80)

450,000(325)
400,000(300)

600,000(450)
550,000(400)

200,001-350,000
Downtown
Other Areas

600,000(120)
500,000(100)

525,000(375)
450,000(325)

700,000(550)
600,000(450)

350,001-500,000
Downtown
Other Areas

700,000(140)
600,000(120)

600,000(450)
525,000(375)

800,000(650)
700,000(550)

500,001-750,000
Downtown
Other Areas

800,000(
700,000(

160)
140)

675,000(525)
600,000(450)

900,000(700)
800,000(650)

750,001-1,000,000
Downtown
Other Areas

900,000(180)
800,000( 160)

750,000(600)
675,000(525)

1,000,000(750)
900,000(700)

950,000(725)
750,000(600)

1,250,000(850)
1,000,000(750)

Over 1.OOO,OOO
Downtown
Other Areas

1,000,000(200)
900,000(180)

*In determining
population,
the basic criterion of measurement
is
the aggregate
metropolitan
area.
In applying
the concept to
specific cases, consideration
is given to community characteristics,
trade patterns, and the nature and degree of real estate development.
fGenerally,
the amount of paid-in surplus should approximate
percent of the amount of permanent
stock.

20

( ) = Minimum number of subscribers.
Minimum number of subscribers to withdrawable
capital
of stock applicant
may be
reduced by number of others subscribing to permanent stock.
Source:

16

Federal

Home

Loan

Bank of Atlanta.

ECONOMIC

REVIEW,

Although
state laws and policies
are rather
specific with regard to the minimum financial requirements
that must be met by newly formed
state chartered banks and S&L’s, in practice the)
are of limited

significance.

This

is so because

of

the widespread
additional requirement
that Fed-era1 deposit insurance be obtained before a state
charter
can be granted.
Every
District
state,
either as a matter of law or policy, requires that
banks
organizing
under
state
charter
obtain
FDIC
insurance.
South Carolina
and Virginia
require FSLIC
insurance
as part of the charter.ing process for S&L’s, and Maryland
and North
Carolina require either FSLIC
insurance
or deposit protection
from a state chartered
savings
share association.
Only West Virginia
has no
insurance requirement
for state chartered S&L’s.;’
Maryland requires that MSB’s be insured by the
FDIC.
Federal
deposit insurance
is required
of all
Federally chartered institutions.
FDIC insurance
qualification
is an automatic
part of the chartering process
for national
banks.
The Federal
Home Loan Bank Board administers
the FSLIC
program,
and the financial
requirements
for
S&L’s
organizing
under a Federal
charter
are
identical
to those
for associations
organizing
under state charter
and seeking
FSLIC
insur.ante.
FDIC
ganizing
financial

standards
of capital adequacy
for orbanks, therefore,
constitute
the effective
requirements
governing
market
entry

throughout
the Fifth District.
FDIC capital ade-.
quacy standards
are arrived at on the following:
basis.
An organizing
bank’s deposit growth is
projected
three years into the future, and initial.
capitalization,
in the form of stock and surplus,,
must equal 10 percent of the projected
deposit
figure.
In no event, however, can initial capitali-.
zation fall below $ZSO,OOO. Effective financial re-.
quirements
governing
market entry by S&L’s in.
South Carolina and Virginia are those established.
by the Federal Home Loan Bank Board and are
listed in Table I. These requirements
also apply
to FSLIC
insured S&L’s in Maryland and North
Carolina;
associations
in these states opting for
savings
share association
insurance
must meet
financial
requirements
established
by the states.
Maryland
law requires
S&L’s to have an initial
deposit subscription
of $100,000, a general reserve
7 It should be noted. however. that there have been no S&L applications for state charters in West Virginia for a number of years.
The reasons for this will become clear shortly. West Virginia industrial loan companies must qualify for FDIC insurance before a
rlxle charter is aranted.

MAY/JUNE

1976

Table

II

REGULATIONS GOVERNING
Fifth Federal

BRANCHING

Reserve District

March

1976

North Carolina

Sou+h Cmolino

Pcrmi++rd statewide.
Prior e+,prova, by
Commi‘%io”er of eunkr
required.

P.,m;,ted .t.+owide.
Prior .pp,wol
by Bmk
Commi,rioncr reqvired.

Prohibited.

Permitted rtatewid..
Prior .app’o*ol of
Adminirtrator of S.vin+,r
and Low Divirion
required.

Not opplic.blo.

Pcrmincd stotevridc.
P,ior approval by Board
of Bclnk cc.ntro,
required.

Pmnintd
rtotwidt.
Priw ~pprord by Bard
of Sank Control
rcqui,cd.

F’rohibitrd.

Not applimbk.

No, appli<able.

Not opplicoblc.

Pemittcd throughw, +hr
Dh‘,ilf. Prior oppmd
by Cmptroller
of the
Currcnry required.

No+ applicable.

I

Soune:

Fadarol and r+o,o s+a+u+c~.

fund equal to 6 percent of the initial subscription,
and an expense fund equal to 25 percent of the
initial subscription.
North Carolina requires an
initial subscription
of $750,000 and a reserve fund
of $50,000.
As already mentioned,
MSB’s chartered by the state of Maryland must conform to
the FDIC standards specified above.
It wouId appear that in those states where not
only banks but also S&L’s
must meet Federal
deposit
insurance
financial
standards,
namely
South Carolina
and Virginia,
the relative
difficulty of market entry is about equal.
The same
is true for banks and Federally
insured S&L’s
in North
Carolina;
and for banks,
Federally
insured
S&L’s,
and MSB’s
in Maryland.
In
these two states market
entry by state chartered S&L’s
that elect savings
share association insurance,
however, is considerably
easier
than for banks or Federally
insured S&L’s.
Inasmuch as no statutory
provision or policy governing Federal deposit insurance or minimum financial requirements
exists in West Virginia,
it
is difficult to judge what standards would apply
to S&L’s seeking a state charter.
Branching
State laws govern the branching
activities
of both Federally
and state chartered
commercial
banks.
This exception
to the dual
banking system has as its origin the McFadden
Act of 1927, which gave national banks explicit
sanction to establish full service branches in their
home office cities but only in states where state

chartered banks were permitted to branch.
Subsequently,
the Bankin, e Act of 1933 allowed national banks to branch anywhere
in their home
office state subject to the restrictions
imposed on
state chartered
banks by state law. Table II, a
summary
of state branching
laws in the Fifth
District, shows that statewide de novo bank branching is permitted in Maryland, North Carolina, and
Virginia allows limited de novo
South Carolina.
bank branching
and statewide
branching
by
merger, while branchin g is prohibited
in West
Virginia.
Federal
law permits
citywide
bank
branching
in the District of Columbia.
The branching
regulations
that apply to Federally and state chartered S&L’s, unlike commercial banks, are not uniform by state.
This is bespecified
for Federcause branchin g privileges
ally chartered associations
are not constrained
by
Federal chartering
of mutual S&L’s
state laws.
was established
by the Home Owner’s Loan Act
of 1933, which gave the Federal
Home Loan
Bank Board general statutory
authority
for the
incorporation,
supervision,
and regulation
of
From the outset, the Bank
these instituti0ns.s
Board interpreted
the Act as giving it discretionary authority
to authorize
branching
by Feder*The Federal Home Loan Bank Board came into bein% as part of
the Federal Home Loan Bank System, with passage of the Federal
Home Loan Bank Act in 3932. As initially established, the System’s
primary responsibilities were to provide added liquidity to member
associations through direct advances and to meet recurriw needs
for more loanable funds than the immediate inflow of deposits
might suppls’.

FEDERAL RESERVE BANK

OF RICHMOND

17

ally chartered
S&L’s
been challenged,
but

This
the

interpretation

Federal

courts

has
have

ruled that the Bank Board does have such discretionary
authority
and, furthermore,
that this
authority
is not limited by the extent to which
allowed
to
state
chartered
associations
are
branch.
Also, a number of unsuccessful
attempts
have
Loan

been made to amend the Home Owner’s
Act of 1933 by making
state branching

laws the
Federally
Current

ultimate
constraint
on branching
by
chartered S&L’s.
Federal Home Loan Bank Board regu-

lations permit
ate branches,

Federally
including
General

chartered S&L’s to opermobile facilities,
virtuapplication
can be made

ally statewide.
to establish branches within a 100 mile radius of
the home office but not, in any event, across state
lines.
A recently
adopted regulation,
effective
March 12, 1976, allows Federally
chartered S&L’s
to establish branches or mobile facilities
in rural
areas without restriction
on distance from home
office. Federal associations
may conform to state
branching
laws if these permit greater branching
freedom
than the Federal
Home
Loan
Bank
Board regulations.
The laws of four Fifth District
states, Maryland, North Carolina,
South Carolina,
and Virginia, provide for statewide branching
by S&L’s.
In these states Federally
chartered
associations
also branch statewide.
West Virginia
law prohibits branching
by S&L’s, and Federally
chartered associations
operating
in the state conform
to the more liberal
Federal
Home Loan Bank
Board
regulations.
All District
of Columbia
S&L’s
operate
under
Federal
charters,
and
branching
is permitted
citywide.
Maryland
MSB’s are allowed to branch statewide.
With
regard to branching
privileges,
banks
and nonbank
thrift
institutions
are
treated
equally in three District
states, Maryland,
North
Carolina, and South Carolina, and in the District
of Columbia.
In Virginia S&L’s enjoy somewhat
greater
branching
privileges
in comparison
to
those under which banks operate.
In West Virginia there exists a direct asymmetry
between
banks and state chartered S&L’s on the one hand,
which are prohibited from branching,
and Federally chartered
S&L’s on the other, which enjoy
what amounts to statewide
branching.

Conclusion
ing market

In reviewing the regulations
entry and branching by Fifth

governDistrict

financial intermediaries,
this article has described
one set of factors that influence market structure.
It is clear that these regulations
often differ
among states and sometimes
among institutional
The regulatory
types within any given state.
setting, therefore, must be given explicit attention
in market structure
studies that consider competition between
banks and thrift institutions.

References
1. Alhadeff, David A. “Monopolistic Competition and

Banking
Markets.”
Monopolistic
Competition
Theory:
Studies in Impact.
Edited by Robert El.
Kuenne. New York: John Wiley & Sons, Inc., 1967.

2. Baxter, Nevins D., David McFarland, and Harold
T. Shapiro. “Banking Structure and Nonbank Financial Intermediaries,”
National Banking Review,
(March 1967)) pp. 305-16.
3. Broaddus, J. Alfred, Jr.
“Regulations
Affecting
Bankina Structure in the Fifth District.” Monthlu
Review, Federal Reserve Bank of Richmond, (Dd:
cember 1970), pp. ‘7-11.
4.

.
“The Banking Structure:
What It
Means and Why It Mat&,”
Monthly Review,
Federal Reserve Bank of Richmond, . (November
.
1971), pp. 2-10.

5. Cohen, Bruce C. and George G. Kaufman. “Factors
Determining
Bank Deposit Growth by State: An
Empirical Analysis,”
Journal of Finance,
(March
1965), pp. 59-70.
6. Coleman, Thomas Y. and Bradley H. Gunter. “Recent Developments
in Fifth
District
Banking,”
Monthly Review, Federal Reserve Bank of Richmond, (December 1972), pp. 9-14.
7. Ettin, Edward
sumer Savings

C. and Barbara Negri Opper. Conand Thrift Institutions.
Staff Eco-

nomic Study No. 56.

ernors of the Federal

Washington:

Reserve

Board of Gov-.

System, 1970.

8. Farnsworth,
Clyde H., Jr. “Sources of Bank Exuansion in the Fifth District:
Internal and External Growth,” Monthly Review, Federal Reserve
Bank of Richmond, (June 1973)) pp. 2-5.
9. Gilbert, Gary G. and Neil B. Murphy.
“Competition Between Thrift Institutions and Commercial
Banks: An Examination of the Evidence,” Journal
of Bunk Research,
(Summer 1971), pp. 8-18.
10. Jackson, William.
Thrift Institution
Competition
With Commercial
Banks : Empirical
Evidence.
Working Paper No. 74-l. Federal Reserve Bank of
Richmond.
11. Snellings,
Aubrey
N.
“The
Changing
District
Banking Structure,” Monthly Review, Federal Reserve Bank of Richmond, (July 1969), pp. 2-5.
12. Yesley, Joel M. “Defining the Product Market in
Commercial Banking,” Economic
Review, Federal
Reserve Bank of Cleveland,
(June/Julv
1972),
pp. 17-31.

The ECONOMIC
REVIEWis produced by the Research Department
of the Federal Reserve Bank of RichAddress inquiries
to Bank and Public
mond. Subscriptions
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Relations, Federal Reserve Bank of Richmond, P. 0. Box 27622, Richmond,
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