Full text of Economic Quarterly (Federal Reserve Bank of Richmond) : September 1966

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r F in s T N a t io n a l b a n k
S T A T E S T R E E T A T C IR C L E
SOM EW HERE, U . S . A -

_
•hot day of day* for which
*h« balance »rom »h* do.ly

i Thursday after the close of the n

The trend is toward more careful reserve management
at Fifth District Banks.

Reserve Management at Fifth District
Banks, like other businesses, strive to make profits.
In basic terms, banking consists of attracting funds
and allocating them, subject to various constraints,
among a wide variety of assets. H ow successful a
banker is in selecting a proper distribution of assets
determines in large part the level of his institu
tion’s profits.
One aspect of asset selection is reserve manage
ment, which involves, among other things, keeping
reserves at a minimum necessary to satisfy legal re
quirements. Failure to achieve this objective results
in unnecessary costs. Banks are charged for de
ficiencies in excess of 2 % of required reserves at
a rate 2 percentage points above the discount rate.
Excess reserves, on the other hand, are nonearning
assets, the implicit cost of which is the income which
could have been earned on an interest-bearing asset.
Reserve Requirements
Congress has defined
legal reserves for member banks and has empowered
the Board of Governors of the Federal Reserve
System to set reserve requirements within prescribed
limits. Since 1960 legal reserves have been defined
to include both vault cash and deposits with the Fed
eral Reserve. Presently, reserve requirements against
net demand deposits are 12% for Country banks and
16^2% for Reserve City banks. Net demand de
posits are total demand deposits minus cash items
in process of collection and balances due from do
mestic commercial banks. Reserve requirements on
time and savings deposits are the same for both
classes of banks. The requirement is 4 % on all
savings deposits and on all time deposits up to $5
million. According to a recent ruling by the Board
of Governors, time deposits in excess of $5 million in
any bank are subject to a reserve requirement of 6 % .
While many banks find it advantageous to try to
maintain reserves at the required level on a daily
basis, daily reserve balancing is not required.
Present regulations permit Reserve City banks to
average reserves over a one-week period and Country
banks to average over a two-week period. This ar
rangement gives banks considerable flexibility in
meeting reserve requirements, since deficits early in
the reserve period can be made up later. Reserve
averaging periods begin on Thursday and end the
next Wednesday for Reserve City banks, and end on
the second Wednesday for Country banks. Thus,
settlement dates for Reserve City and Country banks
coincide every other week.
Digitized for 2FRASER

The Process of Reserve Adjustment T h e p ro
cess of reserve adjustment involves three essential
activities: (1 ) keeping close tab on the timing and
magnitude of various entries affecting the reserve
account, (2 ) projecting movements in loans and de
posits with reasonable accuracy, and (3 ) acquiring
additional reserves or disposing of excess reserves as
the situation demands.
Keeping close track of the entries affecting the
reserve account requires a thorough understanding
of reserve accounting and a systematized accounting
procedure. If a bank frequently has large deficits or
persistently runs large excess reserves, it is prima
facie evidence that a re-examination of reserve ac
counting procedures is in order.
T o help banks develop more efficient reserve ac
counting techniques, the Federal Reserve Bank of
Richmond is preparing a manual which should be
very useful to banks not already using an effective
system. Designed especially for the use of Country
banks, the manual will contain, among other things,
a guide to reserve computation and a year’s supply
of a form entitled “ Report of Deposits and R e
quired Reserves.” T o each copy of this report a
worksheet has been attached for the bank’s use in
computing its reserve position. Effective use of this
worksheet should enable a bank to know each day
its cumulative reserve excess or deficiency with
reasonable accuracy. The manual should be available
for distribution in September.
In order to match reserves as closely as possible
with legal requirements, it is necessary to know not
only the current reserve position of the bank but
what it is likely to be a few days hence. For this
reason, some banks make fairly elaborate projections
of deposit flows and loan demand. These estimates
are normally based on knowledge of seasonal fluctua
tions and general economic conditions and on analysis
of such special factors as Treasury calls on tax and
loan accounts, spending patterns of large corporate
customers and state and local governments, securities
transactions, and anticipated extensions and retire
ments of large loans.
W hile the Federal Reserve Bank of Richmond
does not make projections for individual banks, it
does offer a service which may be useful in recogniz
ing patterns of some of the variables that determine
seasonal reserve needs.

This Bank will make avail

able to any member bank a computer printout and a

Member Banks
chart of monthly data on its loans, time deposits, and
“ other” demand deposits which are defined as total
demand deposits minus Government and interbank
deposits. These data, which are presented as cumu
lative absolute changes from the beginning of the
three most recent years, provide a good picture of the
bank’s seasonal pattern of loans and deposits. This
is useful in that it gives some idea of the timing and
magnitude of seasonal reserve needs and permits the
bank to make advance preparations.
In addition to knowledge of the bank’s current
reserve position and what it is likely to be in the
near future, effective reserve management also re
quires skill in disposing of excess reserves and in
acquiring additional reserves on advantageous terms.
This in turn necessitates an understanding of money
market processes and the various alternative means
of reserve adjustment.

the banker may take action which will provide re
serves on a more permanent basis.
As a rule, very short-term reserve needs are likely
to be covered in the Federal funds market, by bor
rowing, or, in the case of large banks, by raising
dealer loan rates. Transactions in marketable se
curities to meet very short-term needs are quite ex
pensive because dealers in these instruments must
be compensated for their role in providing a market.
As a rule, the longer the maturity or the less readily
marketable the paper the more significant this cost
becomes. But even with Treasury bills, the most
readily marketable of the liquid assets held by banks,
the cost is by no means a minor consideration.
As an illustration, consider the cost of a one-day
turnaround (sell one day, repurchase the next),
using three-month Treasury bills at the rates which
prevailed on July 29. T o gain reserves for one day,
the bank would have been required to sell bills at
$98.8075 per $100 of face amount and buy them
back the following day at a price of $98.8175, a loss
of $.01 per $100.

Expressed in percentage terms

this amounts to 3.65% per year which, in making
Instruments of Reserve Adjustment W h ile the
number of alternatives tends to vary directly with
size of bank, each bank, even the smallest, has several
choices open to it. Actually, any manipulation of
assets or liabilities which is designed to affect the re
serve position of the bank on a short-term basis can
be thought of as a means of reserve adjustment. The
most common methods are trading in Federal funds,
trading in Government securities, making repurchase
agreements with Government securities dealers,
making outright loans to dealers, and borrowing from
the Federal Reserve and from correspondents. Trad
ing in short-term municipal bonds has apparently as
sumed increased importance as a means of reserve
adjustment in recent years.
Selection of the appropriate alternative hinges on
a number of considerations, but certainly relative
cost is one of the most important. Presumably, a
banker will choose the method which is least costly,
but this involves more than a simple comparison of
rates. H ow long the reserves are likely to be in
excess or deficit is an important factor bearing on
relative cost because in some cases it is expensive
to reverse transactions quickly.
On the basis of past experience a banker can some
times judge whether or not a given reserve situation
is likely to continue or to be quickly reversed. If past
experience indicates that a bank is entering a period
of seasonal deposit losses or strong loan demand,
there is reason to believe that reserve pressures will
continue for some time to come. In such a situation,

cost comparisons with other means of reserve ad
justment, must be added to the interest which could
have been earned on the bill had it been held. A s the
span of time between sale and repurchase lengthens,

the cost of the turnaround in percentage terms de
clines sharply as the constant cost of $.01 per $100 is
spread over more days. A t the rates used in this
example, the cost of a one-week turnaround would
amount to only .52% at an annual rate.
Another important factor bearing on choices
among alternatives is Federal Reserve administration
of the discount window. Since borrowing from the
Federal Reserve is a privilege and not a right, relative
cost cannot be a principal determinant. Evidence
that it has not been is the fact that banks have been
buying Federal funds at rates in excess of the dis
count rate for many months. Recently, this premium
over the discount rate has risen as high as lj^ per
centage points, proving beyond doubt that relative
cost has not been a controlling factor. This is as
it should be. Regulation A , which governs dis
counting, makes it very clear that borrowing is to
be relied upon only as a temporary source of funds
and that borrowing to profit from rate differentials
is inappropriate use of the discount window. The
regulation reads in part as follow s: “ Under ordinary
circumstances, the continuous use of Federal Reserve
credit by a member bank over a considerable period
of time is not regarded as appropriate. In con
sidering a request for credit accommodation, each
Federal Reserve Bank . . . considers whether the
bank is borrowing principally for the purpose of
obtaining a tax advantage or profiting from rate
differentials. . . .” This regulation has been in effect
since February 1955, and on the whole, banks have
come to understand rather well the distinction be
tween appropriate and inappropriate borrowing.
Success of Reserve Management

One measure

of good reserve management is the extent to which
banks succeed in keeping their total reserves equal
to their required reserves.
a perfect measure.

This, of course, is not

One limitation is the fact that

while two banks may have identical ratios, one may
have been more skillful in its choice of alternative
means of reserve adjustment or may have been more
successful in keeping balances with correspondents
at minimum working levels.

Still, it is a good

measure because banks which are successful in one
aspect of reserve management are likely to be suc
cessful in the others also.
The chart on page 3 shows the ratio of required
reserves to total reserves by deposit size of selected
Fifth District banks.

Use of ratios improves the

meaningfulness of comparisons from one size class
to another.

The magnitude of the ratio indicates

the degree of success in minimizing excess reserves.
Digitized for 4
FRASER

A ratio of 1, for example, indicates zero excess
reserves.
The chart illustrates vividly a number of interest
ing facts. (1 ) The degree of success of reserve
management tends to vary directly with bank size.
(2 ) Large banks have been consistently successful
over a prolonged period. (3 ) Banks under $100
million in deposits have become increasingly suc
cessful over time with smaller banks showing the
most improvement. (4 ) The ratio of required re
serves to total reserves at small banks tends to
fluctuate with the business cycle.
Greater success in reserve management at the
larger banks has been due to a number of factors.
In the first place, amounts involved are large in
absolute terms and management readily recognizes
the earnings potential of efficient reserve use. For
example, with Federal funds trading at 5 ^ % , $1 mil
lion left uninvested for a single day costs the bank
$150.68. Secondly, large banks can generally af
ford to hire a specialist whose principal function is
to look after the bank’s money position. It is not
surprising that such a person can do a more ef
ficient job than the executive officer of the typical
small bank who must of necessity devote his atten
tion to the whole range of management problems.
Finally, as already mentioned, large banks tend to
have a wider array of reserve adjustment media open
to them. Until the past few years, the Federal funds
market was confined almost exclusively to large
banks which could trade in denominations of
$500,000 or more. Banks in the two largest size
classifications have shown no trend toward increased
efficiency since 1958, partly because the effect of the
above factors on large banks has been unchanged
over the period in question.
A number of developments account for the in
crease in the ratio of required reserves to total re
serves at banks under $100 million. One is the
higher cost of letting funds lie idle. W hile interest
rates have fluctuated over the course of the business
cycle, the general trend has been upward, and during
most of this year the three-month bill rate has been
about 25 basis points higher than at the peak yields
in early 1960. As rates rose over the period, bankers
felt constrained to put their excess reserves to work.
Bankers have also been induced to strive for
greater efficiency in an effort to compensate for rising
costs. Costs as a fraction of current operating in
come have risen rather steadily at Fifth District
banks, from 70.5% in 1958 to 73.9% in 1965. This
has been due in large part to rapidly rising interest
costs on time and savings deposits. These deposits
as a fraction of total deposits rose from 27.3% in

1958 to 39.1% in 1965. This changing deposit mix
combined with rising rates resulted in sharply rising
total interest payments. A s a per cent of current
operating income, these payments rose from 21.1%
in 1958 to 28.6% in 1965. T o help cover these
added costs, banks have instituted various economiz
ing measures, including better reserve management.
Finally, there are various institutional changes
which help account for the trend toward more ef
ficient reserve utilization. Probably the most im
portant of these is the growth and development of
the Federal funds market. Because of the increas
ing willingness of large banks to buy and sell Fed
eral funds in small blocks, sometimes as small as
$25,000, the Federal funds market has become avail
able to small banks as an alternative means of re
serve adjustment for the first time. A second in
stitutional change, already alluded to, has been the
growth of time deposits which are generally less
volatile than demand deposits.
The drop in the ratio of required to total reserves
in 1960-61 at banks under $25 million in deposits
was probably due in large part to the 1960-61 re
cession. As the demand for funds declined with
the decline in business activity, the Federal Reserve
injected reserves into the banking system and market
rates of interest fell. Some bankers probably de
cided that at the lower rates of interest close reserve
management was not worth the trouble. For the
most part, however, the decline was probably unin
tentional and resulted from a failure to respond
quickly to changing conditions. Excess reserves
simply piled up as bankers failed to take on invest
ments in sufficient volume to compensate for the de
cline in loan demand and the injection of new re
serves by the Federal Reserve.
Variation in Reserve Management Practices R e
serve management practices vary considerably from
bank to bank. This is due in part to the fact that
different banks face different situations which call
for tailor-made reserve policies. More important is
the fact that bankers have different attitudes toward
the importance and techniques of reserve manage
ment. Some insist that their institutions stay on
top of reserve developments and scrutinize carefully
the relative cost of alternatives. Others take a more
relaxed attitude, and rely on custom and habit instead
of rigorous cost comparisons.

posit category operated in some years with ratios
around the 50% level. A t the opposite extreme, a
number of the small banks operated consistently with
ratios which compared favorably with banks in the
largest size class. This suggests that efficient re
serve management need not be the exclusive preserve
of large institutions.
The range of variation in the ratios at the large
banks was very small, suggesting that such banks
uniformly attached considerable importance to re
serve management. The actual means of reserve ad
justment varied widely from bank to bank, however,
proving once again the old adage that a cat can be
skinned in more than one way.
This was evident from an examination of 1965
data at large Fifth District banks on loans, deposits,
Federal funds transactions, borrowings from the Fed
eral Reserve, and holdings of short-term Govern
ments. Some banks apparently relied primarily on
one or two methods while others used all of the con
ventional methods more or less continuously. Some
banks never borrowed from the Federal Reserve
while other banks borrowed intermittently. Some
banks maintained their holdings of short-term G ov
ernments at fairly constant levels. A t other banks
these holdings fluctuated with the longer term move
ments of loans and deposits. Some banks apparently
used the Federal funds market as a permanent source
of funds as well as a means of reserve adjustment.
These banks were rather consistent net buyers of
Federal funds throughout the year. Other banks,
however, remained rather consistently on the selling
side, their net sales fluctuating with the degree of
pressure on their reserve positions. Other banks
operated on both sides of the Federal funds market,
switching from a position of net buyer to net seller
several times during the course of the year. The
analysis of the data did not indicate which approach
was best, but it did show that a number of different
approaches can be utilized to accomplish the objective
of operating with minimal excess reserves.
One other conclusion emerges from the examina
tion of individual bank data.

They indicate that re

serve management is a problem which lends itself
to

the

scientific approach.

Those

banks

which

operated with high ratios of required to total re
serves in one year tended to do so in all the others,
and those which operated with a low ratio in one

The average ratios of required reserves to total

year tended to have low ratios throughout the period.

reserves presented in the chart do not tell the whole

This was even true of the largest banks where the

story by any means.

Deviations from the average

range of variation from bank to bank was quite small.

ratios can be quite large, especially at the smaller

This suggests very strongly that successful reserve

banks.

management is a matter of design and not of chance.

Some banks in the under $25 million de

SELECTED STA TISTICS WITH

RECENT A V ER A G E AN N U A L GROW TH
A n nual G ro w th Rates
1960- 1965
Richmond

RATES

Richmond SM SA

U. S.

1965

Population

2.2

1.6

486,800

C ivilian Labor Force

4.9

2.1

231,600

N onagricultural Employment

3.4

2.9

196,800

Estim ated Total Personal Income

8.4

5.9

$1,452,000,000

V a lu e of Retail Sales

5.1

6.7

V a lu e o f W holesale Trade

5.2

4.7

$1,798,000,000

756,000,000

Total Construction

15.5

6.8

Total Deposits of Com m ercial Banks

11.1

10.9

$1,337,465,000

Savin gs and Loan Shares

14.6

12.2

Sources:

134,427,000
253,924,000

Board of G o vernors of the Federal Reserve System ; Federal Savin gs and Loan Insurance
C orp.; Richmond C ham ber of Com m erce; U. S. Departm ent of Com m erce, Bureau of the
C ensus; U. S. Departm ent of Labor, Bureau of Labor Statistics.

“ ten
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j
tut**

facial

icn m o n a O Tan aara /v\erropoiiTan OTansTicai /\rea

the in d e p e n d e n t city o f Richm ond a n d the co unties o f H en rico , s te rfie ld , a n d H a n o v e r,
o f 1737 C o lon el W illia m B yrd selected a site on the f a ll lin e of Ja m e s R ive r
e a l lo catio n fo r a to bacco m a rk e t.
W a re h o u se s s p ra n g up aln im m e d ia te ly ,
y e a rs la te r Richm ond w a s in co rp o rate d a s a to w n .
T o d a y th«y is the hom e
le a d in g b ra n d s o f cig a re tte s a n d p ip e to b acco .
If the cigaret-nade in Richm ond last y e a r
iced end-to-end, th ey w o u ld e n circle the w o rld 2 0 0 tim e s. T w the most im p o rta n t a n d fa ste st g ro w in g ol
u rg eo nin g a re a a re ch e m icals a n d m etal prod ucts.
H Richm on o ne of 12 cities in the n atio n h a v in g a Fe
m a jo r fin a n c ia l cen ter. The m etro p o litan a r e a h as 12 b a n k s aiV b ra n ch e s fo r a to tal o f 81 b a n k in g o ffice
i f V ir g in ia 's la rg e st co m m e rcia l b a n k s a n d in su ra n c e co m p a n ie s 1 th e ir h e a d q u a rte rs h e re .
reed $ 1 .5

b illio n .

B an k deb its to to tal d e m an d d e p o sits, a n 'fa t o r o f b u siness a c tiv ity ,

M 0 .8 b illio n fo r the firs t h a lf o f 1 9 6 6 .
a n y other city in V ir g in ia .

T h is is o v e r 2 V i timesger

P u rch a ses o f s a v in g s a n d lo an s h a ia v e g ro w n

e ra g e a n n u a l ra te of 1 4 .6 per cent o ve r the p ast fiv e y e a rs to a I o f $ 2 5 3 .9 m illio n
|

Richm ond's c iv ilia n la b o r fo rce is g ro w in g r a p id ly .

d a p p ro x im a te ly 2 3 8 ,0 0 0 , up 3 .4 % fro m last y e a r.
•ar, the u n e m p lo yed a s a per cent o f the la b o r fo rce
ed fo r se a so n a l v a ria tio n in the R ichm ond S M SA
2 .3 % .

This com D ares to 3 .4 %

In Ju n e w o rk fo rce

T o tal assets of

“ The Federal funds market is a market for im
mediate balances in or claims on a Federal Reserve
Bank. . . . Loans are generally made . . . in units
of one million dollars. . . . The daily volume often
runs as high as a billion dollars . . . the upper limit
of the interest rate on Federal funds is generally the
Federal Reserve discount rate . . .”
W hen the book quoted above was published in
1959 its description of the Federal funds market
was entirely accurate, but changes have occurred
rapidly and only the first statement is descriptive of
the market today. The market is still the mechanism
through which member banks in need of additional
reserves borrow the excess reserves of other member
banks on a short-term basis, but Federal funds
transactions now take place in amounts much smaller
than one million dollars and daily volume sometimes
exceeds $5 billion in the New York market alone.
Interest rates on Federal funds have exceeded the
discount rate by wide margins in recent months— as
much as 1 ^ % on several occasions. Recent studies
by several Federal Reserve Banks indicate that the
Federal funds market has changed over the past few
years from a rather small, highly specialized portion
of the New York money market to a nationwide
market in which banks of all sizes participate.
Extent of Participation T h e Federal Reserve
Bank of Richmond recently completed a survey of
all member banks in the Fifth Federal Reserve
District. The survey revealed that 168 of the 405
banks responding to the questionnaire were active
traders in Federal funds. O f the 168 traders, 61
were sellers only, 11 were buyers only, and 96
traded from time to time on both sides of the
market. O f course many of the transactions were
with other banks outside the Fifth District, and so

FIFTH DISTRICT BANKS
FUNDS MARI

FEDERAL

1960-1966

Per Cent

Both Sellers and Buyers
Buyers O nly
Sellers Only

Federal Funds ir
no match between purchases and sales by District
banks is to be expected.
Participation in the market was related directly to
bank size, with the proportion of banks that trade
Federal funds increasing with each size classification
up to the $50 million level. All banks with deposits

TYPICAL SIZE OF FEDER
DISTRIBUTED

25-50

50-100
I

I Under $100,000

100 and Ovsr
[2 ]

$100,000-$500,000

temporary reserve deficiencies, 142 of the 298 non
purchasers said yes. Those answering yes included
46 of 61 traders in Federal funds which have been
sellers only and 96 of 237 banks which do not trade
in the market.

FIFTH DISTRICT BANKS DEALING
IN FEDERAL FUNDS
Num ber

1960-1966

Number of Fifth D istrict Banks in Federal Funds Market
February 1966
$ 1 0 - $ 1 0 0 M il.*

D eposit
Size
($ mil.)
Under 2
2-5
5-10
10-25
25-50
50-100
100-250
Over 250
Total

Under $10 Mil. *

Number of
Member
Banks1 Total
21
100
129
83
36
14
8
14
405

Number of Traders
Sellers
Buyers
Sellers
Only
Only & Buyers

2
22
33
45
30
14
8
14
168

2
13
13
20
9
3
1
0
61

0
3
5
3
0
0
0
0
11

0
6
15
22
21
11
7
14
96

1 Excludes four nonrespondents.

Growth of the Market

A lth ou gh m any small

and medium size banks now trade in Federal funds,
most of them have entered the market within the
■

1962

1960

past five years.

1964

* Deposit Size of Banks
Note:

The larger banks which developed

the market have been buying and selling reserve

1966 figures a re only through February.

balances for a considerably longer period.

O f the

22 trading banks with deposits over $100 million,

the Fifth District
of $50 million or over were either sellers or buyers
of Federal funds, and all those over $250 million
were active on both sides of the market.
Many banks have not yet entered the market only
because the need has not arisen. When asked if
they would buy Federal funds in the future to meet

19 were in the market prior to 1960, and two began
trading Federal funds in 1960.

Only nine of the 89

banks in the $10-$ 100 million range were trading
Federal funds before 1960, and most of the smaller
banks entered the market much later. Only one
bank under $10 million was in the market before
1962, when it was joined by a second. But in the
next three years, the total jumped to 54, and at the
time of the survey, 57 of the under $10 million banks

UNDS TRANSACTIONS
E OF BA N K-1965
PURCHASERS

Under $5 Mil.

$500,000-$!,000,000

25-50
□

100 and O ver

O ver $1,000,000

had begun to buy and sell Federal funds. The chart
on page 9 illustrates the dramatic increase in the
number of $10-$100 million banks in the market
after 1960, and the sharp upturn among those under
$10 million beginning in 1962.
Most of the smaller banks have entered the Federal
funds market through their larger correspondents.
The city correspondents have faciliated small bank
entry by soliciting funds in units as small as $25,000
at some banks, and to some extent, by making rel
atively small advances to their country bank cor
respondents. Rising interest rates and heavy loan
demand have provided a strong incentive for many
banks to borrow from their correspondents.
Size of Transactions T he pie charts across the
bottom of the two previous pages show the relation
ship between bank size and the size of Federal funds
transactions. The smallest banks naturally bought
and sold funds only in relatively small quantities, and
the statistics indicate that the largest banks typically
confine their operations to large transactions. The
close correlation between size of bank and size of
transaction suggests that most Federal funds transac
tions take place between banks of the same size or
those near the same size.
Apparently the largest
banks usually do not deal with the smallest banks

FIFTH DISTRICT BANKS BORROWING IN THE
FEDERAL FUNDS MARKET AND AT
THE DISCOUNT WINDOW
Per Cent

1965

100

Agents for Transactions T he recent entry o f
large numbers of relatively small banks into the Fed
eral funds market has had a significant effect on the
structure of the market and the ways in which pur
chases and sales are made. Before 1960, almost all
transactions were handled through brokers. Today,
many banks, especially the larger ones, still rely on
brokers but by far the largest number of Fifth Dis
trict banks in the market buy and sell primarily
through correspondent banks. Of the 157 sellers of
Federal funds replying to the survey, 145 typically
sold through correspondent banks, seven through
other commercial banks, and only five through
brokers. Of the 107 purchasers, 96 usually bought
funds through correspondents, six through other
commercial banks, and five through brokers.
Frequency of Transactions The survey revealed
that, as might be expected, large banks were much
more active in the Federal funds market than small
banks in 1965. The average number of sales per
month did not exceed 4.5 for banks under $25 mil
lion, but for the $25-$50 million size class, the
average jumped sharply to 10. Banks in the $50-

Federal Funds Market
80

unless there is a direct correspondent relationship.
All of the sales at banks under $5 million and
nearly nine tenths of those at $5-$ 10 million banks
were in amounts under $500,000, but no bank larger
than $50 million typically made such small purchases.
Transactions of less than half a million dollars ac
counted for only 6 % of all purchases by banks in
the $25-$50 million class. Many of the larger banks
occasionally bought or sold Federal funds in units
of less than $100,000, but banks of $25 million or
over concentrated their buying in units of $1,000,000
or more. The smaller banks may have sold Federal
funds in small amounts to large banks outside the
Fifth District, but it seems likely that most of their
transactions were with banks of their own size or
slightly larger, typically their correspondents.

Discount W indow
Both

A verage Number of
Federal Funds Transactions per Month
By D eposit Size of Bank
1965

D eposit Size
($ m illions)

5-10

10-25

25-50

50-100

Deposit Size of Banks-$ Mil.

Digitized for 10
FRASER

O ve r

100

Under 5
5-10
10-25
25-50
50-100
Over 100
Total
Less than one.

Sales

Purchc

4
4
4.5
10
8
11
6.5

1.5
*
3
1.5
2
17
2

$100 million range averaged eight sales per month
and those over $100 million averaged 11. Purchases
were concentrated in the large banks to an even
greater extent than sales. A t the banks with less
than $100 million of deposits, the largest average
number of purchases per month for any size category
was three. The average jumped to 17 per month for
those banks over $100 million, and these were the
only ones for which purchases exceeded sales.

from 12% of the smallest banks to 86% of the largest.
The combination of those buying funds only and those
utilizing both sources also grew steadily with bank
size, ranging from 5% to 9 1% .

Thus, the larger

the bank, the stronger the tendency to borrow. Pre
sumably this is because larger banks, with a wider
array of loan opportunities, operate with a smaller
margin of excess reserves and are more likely to
incur deficits requiring some adjustment.

Federal Funds vs. Discounting M ost banks meet
reserve deficiencies in the short run primarily by
buying Federal funds or borrowing from the Federal

and since they are also more active in the market,

Reserve.

dollar volume of Federal funds traded.

Large banks tend to incur reserve defi

Since the larger banks deal in larger transactions,
it is to be expected that they account for the largest
The Report

ciencies more frequently than small banks, and there

of Condition of 408 Fifth District Banks for Decem

fore rely more heavily on both sources of funds. This

ber 31, 1965, indicates that on that day, at least,

is illustrated by the chart on page 10.

O f the 120

banks in the survey with deposits of less than $5

such was the case.

Total transactions at the smallest

banks were only $1.6 million, while banks in the

million, 4 % bought Federal funds and 12% borrowed

largest size classification purchased $24.8 million

at the discount window in 1965, but less than 1%

and sold $49.1 million of Federal funds.

tapped both sources.

tinuation of the trend of recent years would change

In the next size classification,

A con

$5-$10 million, only 2 % of the 129 banks used both

that relationship significantly, however,

sources, while 13% bought Federal funds and 17%

creased

borrowed from the Federal Reserve.

The proportion

Trading in Federal funds by small banks has been

using both sources rose rapidly to 8% in the $10-

stimulated by strong loan demand pressures, and in

$25 million range, 14% in the $25-$50 million range,

recent months, by a restrictive monetary policy.

29% of the $50-$100 million banks, and 82% of the

entry into the market is not solely the result of a

banks with deposits over $100 million.

small bank participation

scarcity of reserves.

The proportion of banks buying Federal funds
but not borrowing at the discount window also rose

with in

in the market.

But

Federal funds sales, and to

some extent, purchases, also represent for many banks
more careful reserve management.

with bank size up to the $100 million level, then
dropped sharply from 43%

to 9 % .

Borrowing

through the discount window only was heaviest in

Federal Funds Sold and Purchased
By Fifth D istrict Banks
On Decem ber 31, 1965

the $50-$ 100 million class and in the three smallest
classes.
The correlation between borrowing and bank size
is much closer for both sources of funds when all of
the banks borrowing from each source are considered.
The total of banks borrowing at the discount window
only plus those utilizing both sources grew steadily

Total Borrowing by Size of Bank
1965
Deposit
Size
($ m il.)

Percentage
of all banks
discounting

Percentage of
all banks buying
Federal funds

Under 5

5-10

10-25

25-50

50-100

Over 100

D eposit
Size
($ mil.)
Under 5

Total
Sold
Purchased
number
Banks Amount Banks Am ount
of banks (N um ber) ($ m il.) (N um ber) ($ mil.)

5-10

120
131

7
14

1.6
8.9

0
0

1
2

2.7
0.7

10-25

11.6

25-50

15.6

50-100

3.8

100-250

0.4

49.1

24.8

408

91.0

28.8

Over 250
Total

0.6

N ote: Four banks in the over $250 million deposit class
both sold ($30.6 m illion) and purchased ($17.0 m illion).
T hese amounts are included in the above table. The re
maining banks were either on the selling or on the pur
chasing side.

THE FIFTH DISTRICT
BANKING DEVELOPMENTS
The rate of total credit expansion at Fifth District
member banks has been slower this year than in
1965, and the pattern of growth shows the effects of
the Federal Reserve’s policy of monetary restraint
in the face of intense loan demand. Total loans have
grown less rapidly so far this year than in the same
months of the past two years, but growth of dif
ferent types of loans has varied widely. Business
loans have expanded at an unprecedented pace,
especially in June and July, while consumer, real
estate, agricultural, and other loans have moved up
at a slower rate than in other recent years.
Fifth District banks have acquired a part of their
funds for loan expansion by liquidating invest
ments— U. S. Government securities in particular.
The dollar volume of Governments held by District
member banks declined over 13% in the first half
of 1966. In spite of higher interest rates on time

and savings deposits, deposit expansion provided a
smaller portion of reserve growth this year than in
other recent years. District member banks turned
to the discount window of the Federal Reserve Bank
for a larger amount of reserves than in any of the
past five years. Borrowing was concentrated pri
marily at reserve city banks in the first quarter, but
in the second quarter country bank borrowing in
creased rapidly and reached record levels in some
periods. Total bank reserves have continued to
grow in the District, rising from $1.11 billion on
July 28, 1965 to $1.20 billion on July 26, 1966, but
record-smashing increases in interest rates indicate
that the demand for credit has risen much more
rapidly than the supply. Many District banks are
now finding it necessary to ration credit and are
denying loans for speculative purposes, inventory
expansion, and some types of construction.