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MARCH 1977

Farm Real Estate ValuesSome Important Determinants ........ page 3
Comparative Burdens of Federal Reserve
Member and Nonmember Banks ..... page 13

UNEMPLOYMENT INSURANCE:
PROGRAMS, PROCEDURES, AND PROBLEMS

A new booklet, Unemployment Insunmce: Programs,
Procedures, and Problems, 'which incorporates material
from three articles published in the Monthly Review in
1976, is now available from the Research Division.
The nation's Federal-state system of unemployment
compensation has grown in size and scope far beyond that
envisioned by its creators. The booklet reviews the origins
and objectives of the program, examines disparities among
states in regular benefit programs, and analyzes the UI
system in the context of recent economic research.
Copies are available from the Research Division, Federal
Reserve Bank of Kansas City, Kansas City, Missouri
64198.

Subscriptions to the Monthly Review are
available to the public without charge.
Additional copies of any issue may be obtained
from the Research Division, Federal Reserve
Bank of Kansas City, Kansas City, Missouri
64198. Permission is granted to reproduce any
material in this publication provided the source
is credited.

Farm Real Estate ValuesSome Important Determinants
By Marvin Duncan
value of all farm assets has grown
T hemarkedly
since 1940, increasing from $53
billion to a total of $585 billion on January 1,
1976. Though all asset categories have increased
sharply, none has grown faster than real estate.
The value of real estate in the farm sector
balance sheet has grown from $34 billion in 1940
to $422 billion in 1976-over 12.5 times its 1940
value. By comparison, total assets less land have
increased from $19 billion in 1940 to $163
billion in 1976-just under 8.5 times its 1940
value. By another standard of comparison , real
estate represented 64 per cent of the total assets
of the farming sector in 1940. By 1976, the
proportion had risen to 72 per cent. Total
liabilities have also grown , from $10 billion to
$91 billion , during that period. However, the
proportion of total liabilities accounted for by
real estate debt has decreased over that period
from 66 per cent to 56 per cent.
Over the past 36 years, farm real estate has
accounted for an increasing proportion of
proprietors' equities (net worth) in the farming
sector (Chart 1). For example, while proprietors'
equities increased 13 per cent during 1975, farm
real estate values increased 14 per cent. It is not
surprising that farmers and ranchers have
become increasingly interested in the land as an
asset and in the factors affecting land values.
Farmers , ranchers , nonfarm investors , and
lenders are asking if the mix of factors affecting
Monthly Review • March 1977

land values has changed-and if present rates of
increase in property values are sustainable in the
future.
VARIABLES AFFECTI NG LAND VALUES

Many variables may affect farm real estate
values. For practical purposes, however, it is
necessary to reduce the number of factors to be
considered in any analysis. Furthermore,
variables considered must be consistent with
economic theory and adequate data must be
available to test the impact of the variables
selected on farm real estate values. Another
constraint concerns the statistical relationships
among the variables considered. For example, if
explanatory variables are too closely related
(correlated) , it may be necessary to let one serve
as a proxy variable explaining its own effect, as
well as the effect of the others, in the statistical
analysis. Finally, using only a few variables
believed to have major impact on farm real
estate values simplifies the analysis and
interpretation of the results.
The following variables are often considered
to be major determinants of farm real estate
values .
Inflation
Chart 2-in which the indexes charted have
1940 base values of 100-indicates the
movements of indexes of farm real estate values
3

Farm Real Estate Values-

Chart 1
BALANCE SHEET OF FARMING SECTOR

Billions of Dollars

600

500 -

400 ,_

300 -

Total Assets in 1972 Dol lars

i
200 ._

Total Assets

- t

100

Equity

L(!!ld

Assets Less Land
,

--L.10 bT
.t
11t1es

0
1940

I
1

·-

I
1

SOURCE: U.S. Department of Agriculture (USDA) .

and the implicit price deflator for GNP during
the 1940-76 period. 1 With the exception of 1940
through 1944, the farm real estate price index
has been above the GNP deflator index and
since 1955 has risen at an increasingly faster
rate. Those who contend that land is a good
hedge against inflation appear to be correct.
Except for a few relatively short periods of time ,
farm real estate price changes have generally

1 The implicit price deflator for gross national product
(GNP) , which adjusts nominal gross national product data
for inflation , is the broadest measure of change in the
general price level.

moved in the same direction as the GNP deflator
since 1925. Percentage land price changes have
often been greater, however, both on the up and
down sides, than percentage changes in the
GNP deflator. Correlation analysis of the two
indexes indicates a correlation coefficientadjusted for autocorrelation-of .37 (on a scale
of 0 to 1.0) and one that differs significantly
from zero. While this does not mean that 37 per
cent of farmland price increases are due to
inflation--correlation does not imply causation
-it does mean that the indexes have exhibited
approximate harmony over the past half
century.
~ra Res rve BanK of Kansas C

Some Important Determinants

Chart 2
LAND PRICES AND FARM INCOME
(1940 = 100)

Index
1400 - - - - - - - - - - - - - - - - - - - I

I
I
I

1200

I
I
I

1000

I
I

Land Prices
800

/
I _,,,

\ 1/ / / /
Personal Income From
/ /
/
Nonfarm Sources \
//
/

600

Net Farm Income
(Including Gov't. Pay)

400

/
/

----

✓-- ✓

/
,/

200

GNP Def lotor

0 .__.......__._ _.__._____.___________________
1940

SOURCE: U.S. Department of Agriculture .

Farm Income
The value of land is ultimately determined by
the value of products produced on the land or
uses to which the land can be put (coal mining,
urban development, recreation , etc.). 2 Farm
real estate values maintained a fairly stable
relationship to farm income trends from the
mid- l 920's to the mid-1950's. Since then ,
however , farmland values have increased at an
2 Marvin Duncan, "Farm Real Estate Values," Federal
Re serve Bank of Kansas City Monthly Review (January
1977), pp . 13-20.

Monthly Review • March 1977

increasingly rapid rate that has outstripped
increases in net farm income-except during the
1971-73 period when rapid increases in farm
income were accompanied by rapid increases in
land values.
A partial explanation for this apparent
paradox may be found in the trend of personal
income of the farm population from nonfarm
sources (Chart 2). This index has increased at a
rate almost comparable to the rate of increase in
land prices from 1961 to 1975-land prices
increased 225 per cent and personal income
from nonfarm sources increased 199 per cent.
By 1975 , personal income of the farm
5

Farm Real Estate Values-

population from nonfarm sources totaled $22. 7
billion and was equal to the realized net income
from farming. When inventory adjustments
were included, however, net income from
farming totaled $25.6 billion. Income from
nonfarm sources has enabled many farm
families-particularly new entrants-to meet
the cash flow requirements of farm real estate
purchases.
Government Payments

Government payments to farmers have been a
factor in farm income since the mid-1930's. In
1935, these payments accounted for almost 7.5
per cent of cash receipts to farmers. However,
such payments declined in importance until
1955, when they accounted for less than 1 per
cent of cash receipts. Begin ning in 1956 , that
proportion rose again, reaching a range of 6 per
cent to 7. 3 per cent of cash receipts in the late
1960's and early 1970's, before declining to very
low levels after 1973.
Farm real estate values have increased
because of the lowered risk level in farming
resulting from the income maintenance aspects
of government farm programs. It has been
suggested that capitalization of farm program
benefits into land values quite directly leads to
the need for more benefits-resulting in higher
land values and again the need for more
benefits. 3 Others note that the proportion of the
payments actually capitalized into land values is
moderated because of uncertainty over the
duration of such payments. 4 Thus, future buyers
of farm real estate need not lose all the
additional income flowing from government
payments if an appropriate discount rate is used
in determining the property value.
3 Walter E. Chryst and John F . Timmons, "The Economic
Ro le of Land Resource Institutions in Agricultural
Adjustment ," Dynamics of Land Use : Needed Adjustment
(Ames : Iowa State University Press, 1961), pp . 252-77 .
4 Robert D . Reinsel and Ronald D. Krenz , Capitalization of
Farm Program Benefits into Land Values (Economic
Research Service , U.S. Department of Agriculture , October
1972).

Capital Gains

With the exception of only 3 years since 1950,
holders of farm real estate in the aggregate have
enjoyed capital appreciation of that asset (Chart
3) . The annual rate of capital appreciation has
been as high as 25.2 per cent. In fact , when the
rates of income earnings of land 5 are compared
to the capital appreciation rates, the latter could
be expected to have had a more profound
impact on farm real estate value changes than
the former. Thus, expectation of capital
appreciation can result in increased farm real
estate values.
Alternative Investment Opportunities

Rational investors make investments that are
expected to maximize their total net return over
time. Both annual rates of return and rates of
capital appreciation must be considered. When
returns are higher in agricultural investments
than elsewhere, it is reasonable to expect asset
prices in the farm sector to be bid up relative to
prices of nonfarm assets. Conversely, higher
rates of return outside of agriculture would
cause investors to shift out of agricultural
investments. Between 1940 and 1975, rates of
return on common stocks, for example, were
below the total rates of return on farm real
estate about half the time (Chart 3). On
balance, increased profitability of alternative
investment opportunities should have a
depressing effect on farm real estate values as
funds that formerly bid for real estate are
invested elsewhere.
Transfers of Farmland

The total number of voluntary farmland
transfers is generally taken to represent the
supply of farmland on the market during a given
time. Farm enlargement demand and the
demand for nonfarm uses imply increasing
5 Income earnings of land is realized gross farm income
including government payments less production costs,
family labor costs , and a man ageme nt charge of 10 per cent
of cash receipts.

Federal Reserve Bank of Kansas City

Some Important Determinants

Chart 3
RATES OF RETURN ON FA RM REAL ESTATE AND COMMON STOCKS
Per Cent

- Return on Income Earnings ~
- Capital Appreciation - - ~ ~ Total Return on Real Estate
-Return on Stocks
Rate of Change In GNP Deflator

52.6

60
30

43.4

---

25 20
15
10

5
0

-5

[

-8.7

-10.8
I

1951

I1 I
55

I1 I
60

-10.0

I1 I
65

,..
-8.4

I1 I
70

-147-26.4

]

SOURCES: U.S. Department of Ag riculture .
The common stock return is based on the Standard and Poor's Composite Index and is from Roger G . Ibbotson
and Rex A . Sinquefield, " Stocks , Bonds , Bills, and Inflation : Year-by-Year Returns (1926-1974), " The Journal
of Business (J anuary 1976), pp . 11-47. Gross farm income less production costs , costs of family labor, and a
management charge (10 per cent of cash receipts) divided by the total value of farm real estate yields the rate
of ret urn on incom e earnings .

competition for the available farmland. Thus, a
decrease in voluntary transfers (supply) should
increase the sale price of farmland.
Farm Enlargement

Land purchases by farmers and ranchers to
increase the size of their operations have been a
persistent and important factor affecting farm
real estate values. A remarkably constant
stream of new technology has enabled farmers
Monthly Review • March 1977

and ranchers to handle ever increasing acreage
with less manpower. While this technology has
generally reduced the per unit cost of production
it has frequently been available only in large,
discrete units such as four-wheel drive tractors.
Thus, to achieve the potential efficiencies
resulting from technology, it has often been
necessary to expand the scale of farm and ranch
enterprises. Average farm size in the United
States increased from 145 acres in 1926 to 206
7

Farm Real Estate Values-

acres in 1950. By 1975, the average farm size
had increased to 387 acres. Since 1940, farm
size and farm real estate values have both
increased-almost without hesitation.
From the individual operator's point of view,
technology which reduces costs and increases
output enables him to pay higher prices for land
needed to expand his operation. However, when
many farmers and ranchers follow this strategy
they frequently find aggregate output has
increased as a result of widespread adoption of
the new technology. Because demand is inelastic
for most agricultural products, 6 product prices
may decline enough to cause lower gross
revenues per acre than prevailed before the
adoption of new technology. Thus, technology
alone should then result in decreasing land
prices. However, as population and per capita
income increase, demand for farm products
increases. Furthermore, government farm
programs support farm income levels and
reduce uncertainty associated with agricultural
production. Thus, increasing demand, along
with the interaction of technology and
government farm programs , makes farm
enlargement profitable-adding upward thrust
to farm real estate values.
MODELS OF FARM
REAL ESTATE VAL

Researchers have used a variety of approaches
in formulating econometric models of farm real
estate values ranging from very simple single
equation models with few explanatory variables
to complex multiequation models employing
sophisticated statistical techniques for their
solutions. A brief discussion of three different
models for predicting land prices offers insight
into the approaches used. 7
Tweeten and Nelson explained 95 per cent of
the variation 1n land prices during the 1923-63
6 For a given level of demand, a production increase of a
given percentage results in a product price decline such that
gross revenue is lower than before the production increase.
8

period, using a five equation model that posited
land price as a function of land in farms, farm
transfers , the number of farms, last year's net
farm income, rate of return on nonfarm
investment, and last year's land price. 8 They
concluded that farm enlargement pressure was
the most important cause of increase in
farmland values during the 1950-63 period.
This model has good predictive qualities: A
simplified one equation version of the
model-using 1925-75 data-explained 98.8 per
cent of the variation in land prices during that
time period.
Herdt and Cochrane developed a simultaneous equation model of the farm real estate
market in an effort to explain rising farmland
prices in the face of constant income per acre. 9
They hypothesized that technological advance
played an important role in the price increases.
Study results indicated that technology (the
USDA productivity index), the ratio of prices
paid to prices received, and the general price
level were primary determinants of farmland
prices.
Robert Reinsel, using a different approach,
predicted land price as a function of U.S.
population and the money supply (including
time deposits). 10 The model explained 99.8 per
cent of the variation in land prices from
1947-70. Reinsel concluded that inflationary
pressures in the economy and increased
population pressures were the dominant factors
7 Apparently, neither Tweeten and Nelson nor Herdt and
Cochrane corrected for possible serial correlation in their
model solutions . Reinsel used a generalized least squares
approach to correct for serial correlation in his model
solution.
8 Luther G. Tweeten and Ted R. Nelson , Sources and
Repercussions of Changing U.S. Farm Real Estate Values
(Technical Bulletin T -120, Oklahoma State University ,
April 1966).
9 Robert W. Herdt and Willard W . Cochrane, "Farm Land
Prices and Farm Technological Advance," Journal of Farm
Economics (May 1966), pp. 243-63.
10 Robert D. Reinsel , "The Aggregate Real Estate
Market" (Unpublished Ph.D. Thesis, Michigan State
University, 1973), pp. 107-36.

rederal Reserve Bank of Kansas c,ty

Some Important Determinants

affecting farm real estate values. Although the
model accurately predicts land price, it cannot
explain the impact of other important
determinants of land values.
A SIMPLE MODEL OF THE FARM
RE
E TATE AR FT

A single ~quation econometric model of the
farm real estate market at a national level has
been constructed. Although the model is
primarily a predictive one, it also has some
capability to explain the impact of certain
explanatory variables generally agreed to be
important determinants of value. Additionally,
some insight into the more important questions
currently being raised about farm real estate can
be gained by analyzing the model results.
It is reasonable to expect that farmers and
ranchers, as well as non farm investors,
determine what they will bid for farm real estate
based on an expected level of realized net
income , capital gains, or returns on alternative
investments. For this model, the expected values
are based on a weighted average of the actual
values for the past 3 years. 11 Table 1 indicates
the variables used in the model. All variables,
except voluntary transfers (T) and average farm
size (F), are adjusted for inflation using the
GNP price deflator. Thus, the real impact
(inflation adjusted) of the explanatory variables
on farm real estate values can be determined. 12

Model Results

The empirical results of the land price model
are summarized in Table 2. Equation 1 is solved
using 1929-75 data. Equation 2 is solved using
1937-75 data in order to include the impact on
11 Expected value

3Vt-1 + 2Vt-2 + Vt-3
6

12 The model is of the form:
P = /j 0 + ENFI/A + EPINF/ A +GPL/A + Cge +
Se+ T + F.
13 The reader who is not interested in the detailed
econometric findings may wish to go directly to the
Summary and Conclusion section, p . 11 of this article.

Monthly Review • March 1977

Table 1
IDENTIFICATIO, OF VARIABLES
USED IN MODEL*
Designation

Description

Value of land per acre

ENFI/A

Expected farm operators' realized
net farm income/acre

EPINF/A

Expected personal income of the
farm population from nonfarm
sources/acre

GPL/A

Government payments /a cre

Cge

Expected return - earnin gs plus
capital gains- on farm real estate

Voluntary transfers of farmland
per 1,000 farms

Expected returns on common
stock

Average farm size (acres) t

• All monetary variables and common stock returns
are def lated by the GNP price def lator. Expected
values , where used, are calculated from deflated
values.
tThis variable represents farm enlargement
pressures .

land prices of nonfarm income sources of the
farm population. All regression coefficients for
the explanatory variables have the expected
signs, with the possible exception of government
payments (GPL/ A).
Government payments (GPL/ A) has a
statistically significant coefficient in equations 1
and 2. However , the coefficient sign is negative,
meaning an increase in the size of government
payments is associated with a decrease in the
price of land. Since government payments is
usually considered to be an income component,
a positive coefficient sign is normally expected.
The negative relationship can be partially
9

Farm Real Estate Values-

Table 2
ESTIMATED FARM RE
Eqtn.
No.
1
2

Data
Pe riod

D .W.

R hoa

1929-75
.989
4.211
level of si gni ficanceb

1.912

.930

1939-75
.991
4.025
level of significance

1.826

S.E.

.808

f3o
-95.813
-75 .163

E VALUE EQUATIONS
Va ri ables

EN FI / A

EPI N F / A

GPL/A

Cge

Cge60-75

T 42-49

1.38 1

-8 .131

.078

.706

-.047

-.084

.062

.669

-.001

-. 127

.089

.522

1.239

3 .066
§

-7 .857

t
-.312

.963

a A generalized least squares (Cochrane-Orcutt) procedure was used to correct for the first order serial correlation. Rho (p )
is the correcting factor in the general regression equation of the form Y = X/j + 2:t + p'I, t-1 ·
b *significant
tsignifican t
;significant
§sign ificant

at 1 % level
at 5% level
at 10% level
at 20% level.

explained by looking at the (GPL/ A) and land
va lue data series, adjusted for inflation.
Apparently, the variability in government
payments during the periods for which
equations 1 and 2 are solved--compared to the
continued increase in land values-results in a
negative relationship. This is particularly
evident in the latter part of the data period,
when government payments fell to low levels as
land values were increasing rapidly.
The most important determinants (statistically significant) of farm real estate values are
found to be farm enlargement pressures (F) and
expected realized net farm income (ENFI / A).
Capital gains expectations were significantly
greater during the 1960-75 period (Cge60-75)
than previously. Expected personal income by
farmers from nonfarm sources (EPINF / A) is a
significant determinant in equation 2-but at a
lower level of significance. The highly significant
positive coefficient for farm enlargement (F) in
both equations indicates that variable continues
to be a very important factor in explaining
increased land values.
The model solutions (Table 2) indicated that
expected returns on common stock (Se) and
voluntary transfers of farmland (T), though
statistically insignificant, are of the expected
negative sign. Improved returns from stocks will
10

bid investment funds away from land . Increased
supply of farmland for sale, indicated by more
transfers , can be expected to result in a lower
equilibrium price for farmland. The (T42-49)
variable accounts separately for a period of
unusually large voluntary farm transfers and
rising land values and had been expected to have
a positive sign. Despite the positive sign , the net
impact of farm transfers between 1942 and 1949
(adding the coefficients for T and T 42-49) is still
negative.
The elasticities 14 for the variables in equation
2 were calculated using 1975 data. A 1 per cent
increase in the value of each variable in the
equation would be expected to change land price
by the following percentage value:
ENFI/A
EPINF / A
GPL/A
Cge
Cge60-75
Se
T
F

+0.23
+0.23
- 0.01
-0. 04
+0.13
0.00
-0.02
+ 0.90

14 e =
where fJ is the regression coefficient , x is the
independent variable , and y is the dependent variable .
Federa Reserve Bank of Kansas City

Some Important Determinants

PER CENT CHANGE IN AVERAGE VALUE PER ACRE
OF FARM REAL ESTATE, MARCH 1971-FEBRUARY 1976

l::J. BASEO ON INDEX NUM BERS OF AVERAGE VA LUE PER A CRE

SOURCE: U.S . Department of Agriculture.

Generally, most of the same variables important
in determining national land values are assumed
to be important at a state level , also. However,
increases in state land values (Chart 4) will
reflect the profitability of agriculture within
each state , as well as the impact of such
variables as government payments , expected
capital gains, and farm enlargement pressures.
SUMMARY AND CONCLUSION

Population and income growth in the United
States have increased demand for agricultural
products and nonfarm uses of land, providing
support for higher farm real estate values.
Monthly Review • March 1977

Increases in land value have also more than kept
pace with changes in the general price level (as
measured by the GNP deflator). In general, the
view that farm real estate is a good hedge
against inflation is not unreasonable.
Analysis of real changes-Le., with the
impact of inflation removed-in farm real estate
values indicates farm enlargement pressure,
farm income, and capital gains expectations
continue to be the most important determinants
of land prices. Farm enlargement pressure has
been a major determinant for at least 35 years.
As long as present trends in agricultural
technology continue, farm enlargement pressure
11

Farm Real Estate Values- Some Important Determinants

will provide an upward thrust to farm real estate
values.
Increases in farm real estate values continue
to outpace increases in realized net farm
income. This situation presents a particularly
difficult barrier to new entrants into farming
who must amortize large land indebtedness out
of current earnings. However, income to farm
families from nonfarm sources has been steadily
increasing and now is approximately equal to
realized net farm income. Consequently,
nonfarm income provides an increasingly
important cash flow source to service farm real
estate debt.
The increased importance, since 1960, of
capital gains expectations in determining farm
real estate values is not surprising. However,
those who expect capital gains to v~lidate land
purchase decisions should realize that (1) such
expectations do not provide cash flow to service
the real estate debt, (2) capital gains may be
realized only by sale or refinancing of the land,
and (3) present capital gains expectations may
be based on short-term farm income and price
inflation experience that may not be supported
in the future.
On balance, farmland and ranchland will
continue to be good long-term investments when
realistically priced and when a purchaser can

realistically expect to generate a cash flow
sufficient to service the real estate debt-as well
as other production costs, debt service, and
living expenses. It is quite likely, however, that
the rate of increase in farm real estate values
(both nominal and real) will decrease
substantially over the next few years as a result
of lower rates of price inflation, possible
reductions in net farm income, and probable
reductions in capital gains expectations. While
long-term declines in farm real estate values are
unlikely-unless the U.S. economy experiences
price deflation-short periods of very low capital
appreciation or even absolute price declines in
some areas (such as major grain producing areas
of the Great Plains and the Middle West) are
distinct possibilities. On the other hand, largescale government subsidies for farmers or a
return of weather-induced world crop shortfalls
would support present land values. Those
circumstances would also prevent, or at least
moderate, the substantial slowdown in the rate
of increase of farm real estate values that market
forces appear to dictate. As a result of the
uncertain future, farm real estate lenders may
increasingly rely on the income earning capacity
of land as a measure of collateral value, rather
than the previously popular comparable sales
approach to determining value.

Federal Reserve Bank of Kansas C,ty

Comparative Burdens of Federal Reserve
Member nd Nonm mber Banks

By Robert E . Knight
n a recent report the Conference of State
Bank Supervisors (CSBS) investigated the
relative burdens and benefits of Federal
Reserve member and nonmember banks.' The
study argues that while member banks hold
greater amounts of "nonearning" assets, their
direct access to Federal Reserve services allows
them to serve as correspondents. Consequently,
the member bank burden of "nonearning"
assets should be adjusted for the benefits
derived from performing correspondent
activities. When such calculations are
performed, the study finds the net burden
ratios for the two groups of banks are quite
similar, with member banks actually having a
lower overall burden than nonmembers. Based
on these results the study draws several policy
conclusions:

(1) Subjecting all banks to the Federal

Reserve's reserve requirements is not
necessary to achieve equitable treatment of member and nonmember
banks;
(2) To the extent any inequities exist,
they are as great among member
banks as between member and nonmember banks; and
Monthly Review • March 1977

(3) Any inequities between members and
nonmembers are so minor that they
could be corrected by altering the
reserve requirements of member
banks.
In the first portion of this article, the CSBS
report is reviewed and evaluated. Subsequently,
an alternative approach for measuring the net
burdens or benefits of membership to banks is
suggested. The .alternative method yields
estimates of the net "burden/benefit" ratios
that vary sharply from those in the CSBS
report. In particular, they imply that member
banks in all but the largest deposit size
category experience a net burden associated
with membership.
A REVIEW AND EVALUATION
OF "iE CSBS S. UDY

A summary of the figures analyzed by the
CSBS to derive the "burden/benefit" ratios for
member and nonmember banks is presented in
Table 1. The data are from the December 1973
call report, and all figures are presented as
1 Lawrence E. Kreider, "Optional Affiliation with the
Federal Reserve System for Reserve Purposes Is Consistent
with Equitable Treatment Between Banks" (Washington,
D .C.: Conference of State Bank Supervisors, 1976).

Comparative Burdens of Federal Reserve

Table 1
OUTLINE OF CSBS APPROACH FOR DERIVING NET BURDEN RATIOS
OF INSURED MEMBER AND NONMEMBER BANKS
(All figures are for December 31, 1973, and are expressed as a
percentage of total deposits less cash items in process of collection)
MEMBER
BANKS

Cash Assets
1. Reserves.· with Federal Reserve Banks . . . . . . . . .... .
2.
3.

Demand Balances Due from Commercial Banks ..... .
Vault Cash . . . . . . . . . . . . . . . . . .. .... . . . ..... .
4.
Tota l Cash Assets (= lines 1+2+3) .. .. ..... .

NONMEMBER
BANKS

0.0572
0.0383
0.0168
0.1124

0.0760
0.0172
0.0932

0.0340 *

0.0042

0.0019

0.0005

0.0149

0.0092

0.0239

0.0315

0.0748

0.0456

0.0224

0.0137

Correspondent-Type Liabilities
5.
6.
7.
8.

Coll ected Demand Balances Due to Commercial
Bank s (= 57 .5% of gross balances) . . . . . . . . . . .. . . .
Collected Demand Balances Du e to Mutual
Sav ings Banks (= 87.6% of gross balances ) .. . . . ... .
Collected Demand Balances Due to U.S. Govern ment (= 87.6% of gro ss balances) . ... .. .... .... .
Collected Demand Balances Due to States and
Political Subdivisions (= 87 .6% of gross balances) ....
9.
Total Collected Correspondent-Type
Liabilit ies (= lines 5+6+7+8) ... .. .. . . .. . .

Net Correspondent-Type Balances Available to Yield Profits
10. Net Balances for Prof its (= 30% of I ine 9) .... .... .
Nonearning Reserve Assets
11 . Nonearning Reserves at Federal Reserve Banks
Member Banks: 68.2% of line 1
12.

13.

15.

Nonmembe r Banks: None
Nonearn in g Demand Balances Due from Co rrespon dents
Member Banks : 14.9% of line 2
Nonmember Banks : 52.2% of line 2
Nonearning Vault Cash . . . . . . .. .. ... . .... . ... .
Member Banks : 20.2% of line 3
Nonmember Banks : 24.3% of line 3
14. Total Nonearning Assets (= lines 11+12+13) .. .
Net Burden Ratios (l in e 14-10) . . . . . ... .. . . . .. .

0.0390

0.0057

0.0396

0.0033

0.0041

0.0481
0.0257

0.0438
0.0301

·1n Table 7 of the CSBS study , this figure was incorrectly listed as .0366. The totals reported in the study
were , however, correct.
14

Federal Reserve Bank of Kansas City

Member and Nonmember Banks

ratios to total deposits adjusted (total deposits
less cash items in process of collection).
Although the balance sheet items excluded
from cash assets or included with
correspondent-type liabilities could be questioned , the conclusions of the study hinge
primarily on the proportions of alternative
types of assets and liabilities assumed to
represent a net burden or benefit to banks. For
example , the CSBS assumes that 30 per cent of
the collected correspondent-type balances are
available to correspondents to yield net benefits
or profits (line 10). On the cost or burden side,
the report stipulates that for member banks
14.9 per cent of the gross demand balances due
from correspondents are in excess of those
required to compensate correspondents , while
the comparab le percentage for nonmembers is
52.2 per cent (line 12). In the case of vault cash
(line 13), the nonearning or nonproductive
portion for members is judged to be 20.2 per
cent , and for nonmembers, 24.3 per cent.
Similarly, 68 .2 per cent of the reserves member
banks maintain at the Federal Reserve are
assumed to be nonearning (line 11). The ratio
of total nonearning or nonproductive assets is
then computed (line 14) and reduced by the
ratio of benefits banks are presumed to derive
from their correspondent business (line 10) . On
balance, the figures suggest that members and
nonmembers , respectively , have net burdens
equal to 2.57 per cent and 3.01 per cent of total
deposits adjusted (line 15) .
Despite these summary ratios , the analysis in
the report is conducted mainly by comparing
the behavior of member and nonmember banks
in different deposit size categories. On this
level , the study indicates that nonmember
banks with total deposits under $25 million or
over $200 million experience greater burdens
than member banks. To the extent these
figures are valid , they imply that the 7,040
nonmember banks in these size categories
should have an incentive to join the Federal
Reserve to lower their net burden. These
'V1onthly A

• Mar n 9/

conclusions, however, are suspect. The burden
ratios estimated in the study are frequently at
variance with the common belief that Federal
Reserve membership entails a net burden for
banks, particularly smaller ones.
Although the CSBS report is presented as an
objective research effort, the approach appears
arbitrary. In several instances the percentages
used to calculate the net "burden/ benefit"
ratios do not appear to be based on
independent analysis or study. The fact that no
sources and little justification are given for the
more controversial estimates makes their
confirmation extremely difficult. Moreover,
some of the figures are even inconsistent within
the report.
Before turning to the inconsistencies ,
however, several broader issues raised by the
report need to be considered. First, the CSBS
study implicitly assumes that the costs of
membership are largely offset by the ability of
member banks to function as correspondents.
The validity of this assumption, though, is
uncertain. On the one hand, some observers
feel that member banks experience a
competitive adva~tage in the offering of
correspondent services because they have direct
access to the free services provided by the
Federal Reserve, such as check collections.
This advantage , moreover, is felt to give them a
lead in competing for all correspondent
business , even when the services are in no way
related to membership status. The fact that
member banks hold by far the largest share of
balances due to other banks is often cited as
proof of this view .
Critics, on the other hand, tend to argue that
only large banks are able to offer a full range of
correspondent services. In their opinion the fact
that larger banks are generally members of the
Federal Reserve is irrelevant. To support this
hypothesis , the critics maintain that
nonmembers are frequently able to obtain
acces s to Federal Reserve services of an
operational nature on nearly the same terms as
15

Comparative Burdens of Federal Reserve

members. 2 In addition, they feel that the large
number of nonmember banks with "due to"
balances is important evidence that the
nonmembers are a significant competitive force
in the market for correspondent banking. 3
Under these circumstances, the critics argue
that it makes little sense to consider
correspondent business a benefit of a System
2 Member bank correspondents, for example , may
experience an advantage in soliciting correspondent
business because the Federal Reserve accepts cash letters
from member banks and collects them without charge.
Providing assistance with check collections is one of the
most important correspondent services , but correspondents
need not be members to gain access to the Federal
Reserve's check collection facilities. In the case of regional
check processing centers operated by the Federal Reserve,
nonmember banks may deposit items drawn on other
participating banks . In addition , some nonmember
correspondents have d~veloped arrangements whereby they
are able to deposit any item for collection directly at a
Federal Reserve Bank . A nonmember bank engaging in
such practices normally uses a split endorsement, which
contains both its name and the name of a member bank.
Technically, items are deposited in the name of a member
bank which in turn makes funds available to the
nonmember as they become collected.
The extent of such practices is presently unknown , but
the result is clearly to reduce the need of a correspondent
bank to be a member of the Federal Reserve. Moreover,
many fundamental correspondent services , such as
providing data processing , assisting with loan
participations and international transactions, arranging
purchases and sales of Federal funds , offering advice and
consulting expertise, etc ., have little or no relationship to
Federal Reserve membership .
Another advantage to member banks offering
correspondent services may occur from the restrictions
placed on interbank deposits of member banks. Section
19(e) of the Federal Reserve Act limits a member bank's
deposit with any nonmember bank to 10 per cent of the
member bank's paid up capital and surplus. If this
provision were rigidly enforced , member banks would
frequently be unable to use nonmember banks as their
principal correspondents . In the past, however, this
limitation has at times been evaded by obtaining the
participation of a third bank. If the member bank's
account at the nonmember were to exceed the limit , the
nonmember would credit the excess to the account of a
third bank . The third bank in turn would simultaneously
credit the account of the member bank and debit the
account of the nonmember. Thus the nonmember in effect
would retain total use of the member bank's funds . In late
1976 the Federal Reserve proposed a regulation to close this
loophole.

membership. While this article does not
attempt to resolve this debate, one point does
require mention. Even if the CSBS argument is
accepted, in June 1975 there were 3,272
member banks with no demand balances due to
other commercial banks. These banks clearly
received no offset to the gross cost of System
membership. Computing ratios of the average
"burden/benefit" for all member banks in a
given deposit size category could seriously
distort the situation for individual banks.
A second difficulty with the report involves
the use of the call report statistics for
estimating the net "burden/benefit" ratios.
The correspondent balance figures reported on
call report dates are often subject to substantial
"window dressing, " and can yield unrepresentative results. In fact , if the June 1974 call
report figures had been used rather than those
for December 1973, the study would have
concluded that member banks on average
experienced a greater burden than nonmembers, just the opposite of what the
December 1973 figures suggested. Furthermore, some of the inferences drawn in the
report are clearly the result of overinterpreting
the 1-day call report figures. For example, the
inequity between the treatment of state
chartered member banks and national banks is
stressed by showing that state chartered
member banks with deposits over $5 billion had
a ratio of reserves on deposit at Reserve Banks
that was 72 per cent above the ratio for
national banks of the same size.~ The charge ,
however , is invalid. Abstracting from
differences in holdings of vault cash or in
reservable liabilities, the ratios for both groups
would tend to be identical over a statement
week since both are subject to the same reserve
3 For example, the June 1975 call report statistics indicate
that there were 2,522 member banks and 2,235 nonmember
banks with demand balances due to domestic commercial
banks. In fact , all commercial banks , both member and
nonmember, with total deposits over $500 million showed
demand balances due to other commercial banks.
4 Kreider , pp. 10-13 .
Federal Reserve Bank of Kansas City

Member and Nonmember Bank

requirements. The 72 per cent difference
merely demonstrates the magnitude of the
distortion that can arise when call report
figures are used to compare the relative
burdens of reserve requirements . 5
A third problem with the study is that it
contains several methodological inconsistencies
which influence the conclusions . For instance ,
in calculating the b enefits correspondents
derive from the sale of services , the gross " due
to" balances are adjusted for uncollected funds
or float. However, in measuring the cost to
respondent banks of purchasing correspondent
services, the total of "due from" balances is
assu med to be collected. Certainly " due to"
b alances which are uncollected are a lso
uncollected on the " due from" side. In recent
yea r s correspondent ba nks have devoted
con siderable effort to obtai ning a cc ur ate
measures of collected balances, mainly in an
attempt to prevent respondents from seeking to
sell uncollected correspondent balances in the
Federal funds market . Since nonmember banks
tend to maintain larger " due from " accounts
than members, this inconsistency results in
overstating the relative reserve burden of the
nonmembers . 6
Another inconsistency concerns the profitability of providing correspondent services. In
particular, the report assumes that the cost of
5 One way to minimize , although not eliminate, such
prob lems is to analyze only deposit size groups containing
sizable numbers of banks. If the figures for any individual
ban k or small group of banks are not permitted to
dominate the averages for a deposit size category, the
likelihood of obtaining representative estimates is greatly
improved .
6 Using data derived from the annual account analysis
su rveys of the Federal Reserve Bank of Kansas City, the
report assumes th at 42 .5 per cent of correspondent
balances due to banks are uncollected. Wh ile this figure is
probab ly va lid for larger co r res pon de nts, smalle r
correspondents have never been included in the survey. The
app licability of this figure to smaller correspondents,
consequently , is uncertain . In any event, the adj ustment
made for float is sizable, and the fact that " due from"
balances are not corrected for float leads to a significant
distortion.

providing correspondent services is equal to 70
per cent of the income produced by "due to"
balances and that the remaining 30 per cent is
net profit. 7 On the other hand, 52.2 per cent
and 14. 9 per cent of the "due from" balances
held by nonmember and member banks,
respectively, are stipulated to be in excess of
that required to compensate correspondents for
services. However, the balances which are
assumed to generate profits to correspondents
are significantly different under the two
estimates. On the respondent side, profits to
correspondents would be equal to the interest
on $8.8 billion of "due from " balances ; on the
correspondent side , profit would be equal to
the in terest on $5.2 billion of " due to"
balances, a difference of 70 per cent. 8 This
d isc re pan cy is mainl y attributable t o the
nonuniform treatment of collected balances.
However , it results either in understating the
profitability of correspondents or overstating
the net burden to respondents of holding
nonproductive "due from " balances. Since
nonmembers are assumed to be the major
holders of such nonearning balances, the
tendency in the latter case would be to overstate
the burden of state' reserve requirements.
Although the CSBS report rarely discusses
the comparative implications of the nonproductive or nonearning compensating balances
assum ed in the study, the figures raise a
number of interesting questions. For instance,
7 Kreider , p. 22 .
8 The average member and nonmember bank percentages
of " due from" balances that are assumed to be in excess of
the amou nt required to compensate correspondents for
services are calculated in Table 14 of the CSBS study. The
table shows that $8. 776 billion of such balances are
available to correspondents to yield profits . In contrast ,
Table 7 shows the collected demand balances due to
commercial banks . Using th e 30 per cent profitability ratio
stipulated in the study, the figures in Table 7 imply that
interest received on $5 .151 billion of collected " due to"
balances is available to correspondents as profit. Thus, the
report implies respondent banks have provided about 70
per cent more in nonearn ing fu nds at correspondents than
correspondents are assumed to have received .
17

Comparative Burdens of Federal Reserve

why should the nonproductive fraction of a
member bank's vault cash ever be less than for
a nonmember bank? Why should any bank
hold more than the maximum amount of vault
cash expected to be required for normal
operating needs? Nonmember bank reserve
requirements may explain a tendency for
nonmember banks to hold large amounts of
excess or nonearning balances at correspondents, but why should member banks have
such balances? On the other hand , why should
the average total demand of member banks for
correspondent-type services exceed that of
nonmembers by about 40 per cent? 9 Do the
extra services that member banks receive from
the Federal Reserve require the members to
9 The as sumed compensating balances required for
correspondent-type services can be derived from Tables 1,
2, 13, and 14 of the CSBS study. Specifically, Table 1
indicates that member banks have 5. 72 per cent of total
deposits adjusted in reserves at the Federal Reserve . Table
13 states that 3.90 per cent of total deposits adjusted or
about 68 per cent of these balances are nonearning or
nonproductive. Therefore, about 32 per cent of the funds
member banks have on deposit at Reserve Banks, equalling
1.82 per cent of total deposits adjusted, are earning assets.
Similarly, Table 2 indicates that member banks hold
3.83 per cent of total deposits as demand balances due
from correspondents , but the figures in Table 14 show that
14.9 per cent of these funds are nonproductive, making the
remainder, or 3.26 per cent of total deposits adjusted, the
earning or productive compensating balances at
correspon dents. Total earning balances at both
correspondents and the Federal Reserve, therefore, are
equal to 5.08 per cent of total deposits adjusted.
By comparison , nonmember banks are assumed to
obtain correspondent-type services only from correspondent
banks. Similar calculations indicate that the report implies
that nonmembers on average maintain 3.63 per cent of
total deposits adjusted in compensating earning balances at
correspondents. Thus, per dollar of deposits, member
banks are assumed to keep nearly 40 per cent more earning
compensating balances at correspondents than are kept by
nonmembers.
Comparison of the additional percentages of
correspondent services utilized by member banks in
different deposit size categories reveals that the small and
the largest member banks are presumed in the CSBS study
to require the greatest "extra" correspondent assistance.
For instance, member banks with deposits under Sl million
and with deposits between Sl and $3 billion are assumed to
require 79 per cent and 98 per cent, respectively, more

hold this much more in compensating
balances? Member banks, of course, have
access to the discount window, but
compensating balances are not required for
borrowings and direct interest payments are
required on any amount borrowed. Access to
the discount window, therefore, cannot serve
as a justification for the comparatively greater
demand for correspondent-type services of
member banks. Moreover, since both member
and nonmember banks function as correspondents , further study would be required to relate
the 40 per cent difference to any derived
demand for correspondent-type services which
may exist as a result of the provision of these
services.
Although evidence is sketchy, the relatively
greater demand by member banks for
correspondent-type services does not appear to
be supported by previous studies. Several years
ago the Federal Reserve Bank of Kansas City
conducted a small study regarding the demand
for transit-type services from correspondents.
While large variances were evident among
similarly sized banks and while urban banks
experienced comparatively greater demands ,
the analysis was unable to find any regular
difference between member and nonmember
banks. 10 The study, however, was limited to a
comparison of banks with under $30 million in
total deposits. Clearly the difference in the
relative demand for correspondent-type services
assumed in the CSBS report requires an
explanation, but none is provided. The results

correspondent assistance than comparably sized
nonmember banks. Although the implied demand by
member banks for correspondent-type services in the
medium sized deposit categories tends to be closer to that
of nonmembers, the figures for the "extra" services
required present an irregular pattern .
10 Robert E. Knight, "The Impact of Changing Check
Clearing Arrangements on the Correspondent Banking
System," Monthly Review. Federal Reserve Bank of Kansas
City, December 1972, pp. 14-24.

Federal Reserve Bank of Kansas City

Member and NonlT'ember Banks

of the assumptions in the CSBS study, though,
are to lower the estimated cost of Federal
Reserve membership and to raise the estimated
burden experienced by nonmember banks.
The overall approach and the questionable
ratios of earning and nonearning assets are the
most important issues in an evaluation of the
CSBS report, but a variety of less significant
questions also exist. Why does the study
consider that balances due to the Federal
government, states, and political subdivisions
are the functional equivalent of correspondent
balances? Governmental units certainly require
the use of banking services, but the magnitude
of government deposits h as ra rely been
det ermined by the amount necessary to
compensate banks for services . Why is no
allowance made in the report for the services
the Federal Reserve provides to nonmember
banks without charge, such as access to
region al check processing centers and
automated clearinghouses and some security
safekeeping? Are member banks in these
instances expected to pay the cost for both
grou ps? Why does the report treat cash items
in process of collection as a deduction from
deposits, as would be the case for member
banks, but ignore the fact that in most states
nonmembers may count cash items toward
m eeting rese rve require m ents? Why are
differences in the composition of deposits
betw een member and nonmember banks
ign ored in the report? In recent years
nondeposit liabilities have become a major
source of loanable funds to banks. Would the
conclusions in any way be changed if the
estimated burdens were related to total assets
rather than a measure of adjusted deposits?
Such questions warrant further inquiry, but
they ignore the fundamental issue that the
ratios of nonearning or nonproductive assets
stipulated in the report are quite arbitrary. The
following sections of this article reestimate the
compa rative burden of member and
nonmember banks using a slightly different
Monthly Review • Md ..ch 1917

approach. Under the assumption that similarly
sized banks have the same total demand for
correspondent-type services , the data indicate a
cost of Federal Reserve membership for banks
in most size categories.
A

ALTERNATIVE APPROACH FOR
MEASURING THE COSTS AND
BENEFITS OF FEDERAL RESERVE
MEMBERSHIP

An OvervJew of the Model

The approach used in this article to measure
the comparative burdens of member and
nonmember banks is similar in spirit to that in
the CSBS study. Holdings of net earning and
nonearn ing assets and liabilities are estimated
as a percentage of deposits for both member
and nonmember banks. The first step is to
determine the nonearning portion of
nonmember bank balances due from
correspondents. Since Illinois nonmembers are
not subject to any formal reserve requirements
and since the " due from" balances maintained
by nonmembers n~tionally are essentially equal
to that of the Illinois nonmembers, it is
concludeJ that state reserve requirements on
average impose no burden on nonmember
banks. The " due from " balances maintained
by nonmembers can be considered to be the
amount required to compensate correspondents
for services.
The second step in the calculation of the
burden ratios involves the derivation for
member banks of the excess correspondenttype balances due from other banks. In
contrast to nonmember banks which generally
obtai n correspondent services only from
correspondents, member banks receive such
services from both the Federal Reserve and
correspondents. Moreover, the sum of balances
member banks keep at correspondents and the
Federal Reserve substantially exceeds the
balances nonmembers have at correspondents.
19

Comparative Burdens of Federal Reserve

The article assumes that similarly sized
member and nonmember banks have the same
total demand for correspondent-type services
and that member banks strive to hold no more
at correspondents than is required to
compensate them fully for services. Therefore,
the excess of the sum of balances held by
member banks at correspondents and the
Federal Reserve over the balances held by
nonmembers at correspondents can be taken as
indicative of the cost to member banks of
System reserve requirements. This excess is
considered to be nonearning balances of
member banks at the Federal Reserve.
The third step is determining the nonearning
portion of vault cash for both member and
nonmember banks. Although it is not clear why
any bank would choose to hold more vault cash
than required for operating purposes , the
nonearning portions stipulated in the CSBS
study are sufficiently small that they have
relatively little effect on the estimated burden
ratios. As a result, the CSBS estimates are used
without modification. Thus, the major factors
creating burdens for banks are the nonearning
portions of vault cash and balances held at the
Federal Reserve. This sum is then reduced by
the proportion of balances due to respondent
banks that are in excess of that required to
compensate correspondents for performing
services. In other words, the benefit ratio is
equal to the proportion of "due to" balances
that is assumed to yield profits to
correspondents.
The next section of the article describes the
data used to generate the estimates of the
"burden/benefit" ratios. In the succeeding
section, the "burden / benefit" ratios are
derived.

The Data
In the model developed here the data
analyzed are from the June 1975 call report,
rather than the December 1973 call used by the
CSBS. The alternate date has been selected
20

because the figures are more recent and
because correspondent balance totals are often
subject to less window dressing on the June
call. The shift of dates , however, does not
significantly affect the results. Had the CSBS
used the same ratios to analyze the June 1975
data as were used for December 1973, the
report would have found that both member and
nonmember banks experienced slightly lighter
burdens of nonearning assets than were
suggested by the 1973 figures. The relative
burden of nonmember banks, though, would
have appeared greater in 1975 than in 1973.
Specifically, for 1973 the CSBS found that the
proportion of total deposits adjusted that was
nonearning was 2.57 per cent for member
banks and 3.01 per cent for nonmembers, a
difference of .44 per cent. By comparison, the
1975 data suggest figures of 2.45 per cent for
members and 3.00 per cent for nonmembers ,
thus implying an even greater disparity .
Several other slight modifications are also
made in the analysis of the data. In this article,
the net "burden/benefit" ratios are expressed
as a fraction of total deposits, rather than of
total deposits minus cash items in process of
collection. This alteration does not modify any
of the basic conclusions, although since
member banks have a higher ratio of cash
items in process of collection the change tends
to lower the "burden/ benefit" ratio relatively
for member banks. A second modification
involves the exclusion of demand balances due
to government units from correspondent totals.
The reason the CSBS considers these deposits
to be in the same category as correspondent
balances is not clear. These funds are often
allocated among banks in proportion to their
deposit sizes and Federal Reserve membership
is rarely of any direct significance in the
?. llocation. Moreover, few governmental units
make frequent use of many correspondent
services other than check collections.
Regardless, since nonmem her banks had
slightly greater ratios of these deposits on both
Federal Reserve Bank of Kansas City

Member and Nonmember Banks

call dates, their exclusion from the present
analysis has the relative effect of understating
the profits nonmember banks derive from these
deposits. The overall effect of these
modifications, therefore, is to raise the "net
burden" ratio for nonmember banks relative to
that of member banks. Consequently, to the
extent any biases have been introduced in these
modifications , they are all in the direction of
confirming the hypotheses in the CSBS report.
A comparison of member and nonmember
bank holdings of cash assets-vault cash,
correspondent balances , cash items in process
of collection, and deposits at the Federal
Reserve--is shown in Table 2. Since both
member and nonmember banks utilize many
services of the correspondent banking system,
b o th groups hold large balances with
cor respond e nts as compensation. When
deflated by deposits, however, the table shows
that smaller banks place between 5 and 9 per
cent of total deposits in correspondent
balances . The percentage generally declines as
bank size increases , although banks in the
largest deposit size category evidence some
increase. Member banks , moreover, regularly
hold smaller balances with correspondents than
do nonmembers. The lower average of member
bank " due from" balances undoubtedly reflects
the facts that member bank reserves partly
satisfy a need for liquidity and that the Federal
Reserve performs some services for members
which might otherwise be handled by
correspondents. The additional fraction of
deposits maintained in correspondent balances
by nonmember banks averages between 1.2 and
8.4 per cent of total deposits, with the largest
differential by far occurring for banks with
total deposits over $1 billion.
Cash items in process of collection rise
rapidly with bank size for both member and
nonmember banks. The relatively low fraction
of deposits represented by cash items at smaller
banks is probably not very meaningful since
most small banks tend to classify cash items as
Monthly Review • March 1977

"due from banks" immediately upon dispatch
of a cash letter. As a result, a tendency exists to
understate cash items and to overstate "due
from" balances. Normally this misclassification
is of no significance. Member banks are
permitted to deduct the total of cash items and
"due from" balances in computing deposits
subject to reserve requirements, while
nonmember banks are generally allowed to
meet state reserve requirements with holdings
of either of these assets. By comparison, the
table also shows that member banks in each
deposit size category regularly hold a slightly
larger fraction of deposits in vault cash.
If bank reserves at the Federal Reserve are
included with other cash assets , member banks
in all deposit size categories hold a higher
percentage of deposits in cash assets. Member
banks with deposits under $100 million tend to
have between 2.2 and 3.8 per cent of deposits
more in cash assets than do comparably sized
nonmember banks. For larger member banks
the additional fraction of deposits held as cash
assets rises sharply, varying between 5.4 and
7.6 per cent of total deposits. In part, this
tendency is attri~utable to the progressive
nature of System reserve requirements. In
contrast, if cash items in process of collection
are excluded from cash assets, the figures in
the table could still be used to show that
member banks in all but the largest deposit size
category hold higher amounts of cash asssets,
although the differences are not so pronounced.
Demand balances due to mutual savings
banks and domestic commercial banks are also
shown in Table 2. In all size groupings,
member banks have a higher proportion of
total deposits in "due to" balances than do
nonmembers. As would be expected, the
relative importance of these types of deposits
tends to rise with the size of the reporting
bank. However, even if "due to" balances are
netted against total cash assets, member banks
in all but the largest deposit size category still
hold greater fractions of deposits in cash assets.
21

Comparative Burdens of Federal Reserve

Table 2
CASH ASSETS PER $1,000 OF TOTAL DEPOSITS
June 30, 1975
ALL INSURED COMMERCIAL
BANKS IN THE
UNITED STATES

TOTAL DEPOSIT SIZE IN MILLIONS OF DOLLARS
LESS
THAN $5

$5 TO
$10

$10 TO
$25

$25 TO
$50

$50 TO
$100

$100 TO
$500

$500 TO
$1,000

1$1 ,000 AND
MORE

All Member Banks

Vault Cash . . . . . .

. .

22.54

17 .80

17 .00

17.04

17.39

17.85

16.10

9 .26

Reserve with Federal Reserve .

33 .67

34 .64

34.96

38 .84

42.33

42.7 5

37.48

53 .61

56.21

52.44

51.96

55 .88

59.73

60.60

53 .57

62 .87

75.34

60.62

50.19

45.20

36 .91

31.13

21 .66

33.65

. .

Total Reserves .. . . . ..
Dema nd Balances Due from
Correspondents . . . . . .
Cash Items in Process of
Collection . . . . ..

9.66

8.35

12.00

16.89

30.23

60 .79

90 .51

115.38

Total Cash Assets .. .

141 .21

121.41

114.15

117 .97

126.87

152.52

165 .75

211 .90

Demand Bal ances Due to
Domestic Commercial Banks .

5.99

3.33

2.87

5.48

12.84

38.19

46.49

86 .72

Demand Balances Due to
Mutual Savings Banks . . . . .

1.65

1.18

1.30

0 .64

1.16

1.36

1 .41

2.43

Total Due to Demand
Balances . . . . . . . ..

7.65

4.52

4 .17

6.12

14.00

39 .55

47.89

89 .15

...

16.75

14.70

15.40

14.99

13.67

14.19

14.83

8.99*

Demand Balances Due from
Correspondents . . . .. . ..

86.84

76.41

71 .33

68.35

65.40

67 .92

52 .13

118.12*

All Nonmember Banks

Vault Cash . . . . . . ..

Cash Items in Process of
Collection .. . . . ..
..

2.51

3.64

5.40

7.23

9.89

16.03

22.61

30 .35 *

Total Cash Assets .. . . .

106.10

94.75

92.13

90 .57

88 .96

98.14

89 .57

157.46*

Demand Balances Due to
Domestic Com merc ial Banks .

2.54

1.48

1.66

3.14

11.02

16.87

7.4 0

13 .74*

Demand Balan ces Due to
Mutua l Savings Banks . . . . .

0 .09

0.25

0.31

0 .33

0.40

0.94

1.97

Total Due to Demand
Ba lances. . . . . . . . .

2.63

1.74

1.97

3.47

11.42

17.81

9 .37

13 .74 *

443.86

394.67

360.13

361.29

364.03

403.93

437 .3 9

452 .61 *

Nonmember Banks

406.23

362.07

358.63

358 .36

359 .68

374.71

360.71

409.45 *

MEMO :
Demand Deposits Per $1 ,000
of Total Deposits
Member Banks
Number of Banks
Member Banks

Nonmember Banks .

526

931

1,985

1,11 0

621

462

2,063

2,239

2,694

970

351

191

NOTE: Details may not add to totals due to rounding.
*Sample contains three or fewer banks.

Federal Reserve Bank of Kansas City

Member and Nonmember Banks

Table 3
CASH ASSETS PER $1,000 TOTAL DEPOSITS FOR
INSURED NONMEMBER BANKS IN ILLINOIS
June 30, 1975

LESS
THAN $5

TOTAL DEPOSIT SIZE IN MILLIONS OF DOLLARS
$5 TO
$10

$10 TO
$25

$25 TO
$50

$50 TO
$100

$100 TO
$500

$500 TO 1$1,000 AND
$1,000
MORE

Vault Cash . . . . . . . . . . . .

16.52

12.16

13.23

12.26

9.50

7 .09

Demand Balances Due
from Correspondents .. .

86.76

73.38

61 .24

55.62

57 .70

57.30

.. .
.. .. .

2.36

3 .25

3.39

5.78

4.96

5.22

105.63

88.79

77.87

73.65

72.16

69 .61

Dema nd Balances Due to
Domestic Commerc ial Banks .

0.48

0 .75

0.45

1.76

4 .63

9.40

Demand Bal ances Due to
Mutual Savings Bank s . . . .

0.48

0 .75

0.45

1.76

4 .63

9.40

Demand Depos its Per $1,000
of Total Deposits . . . . . .

399 .67

345.35

329.14

319.78

306.25

265.95

Number of Ban ks . .. . .. ..

149

198

207

102

Cash Items in Process of
Collect ion ..... ...
Total Cash Assets

Total Due to Demand
Balan ces . . . . . . . .

. .

MEMO :

NOTE: Details may not add to totals due to rounding.

ESTIMATED BURDENS OF MEMBER
AND NONMEMBER BANKS
Nonearning Member Bank Balances at
Reserve Banks

Previous studies of the comparative burden
of state nonmember reserve requirements have
generally focused on nonmember banks in
Illinois . Although Illinois nonmembers are
expected to maintain prudent levels of
liquidity, they are not subject to any statutory
reserve requirement. The "due from" balances
maintained by these banks, consequently, are
often assumed to be equal to the amount
nonmemb ers must hold to compensate
correspondents for services. Cash asset holdings
of these Illinois banks on June 30, 1975, are
shown in Table 3. A comparison of these
figures with those for all nonmember banks in
Monthly Review • March 1977

Table 2 reveals that Illinois nonmembers in the
smallest deposit size category had virtually the
same relative amount of "due from" balances
as all nonmember banks, but in larger deposit
size categories held slightly smaller amounts of
these balances. The tendency for larger Illinois
nonmembers to maintain relatively smaller
"due from" accounts could be attributed to the
absence of reserve requirements or the fact that
demand deposits at these banks comprise a
smaller share of deposits than at nonmembers
generally. This conclusion, however, may not
be warranted. An identical comparison based
on the June 30, 1973, call report figures
produced nearly the opposite picture. 11 At that
11 Robert E. Knight , "Reserve Requirements : Comparative Reserve Requirements at Member and Nonmember
Banks," Monthly R eview, Federal Reserve Bank of Kansas
City, April 1974, p. 11.

Comparative Burdens of Federal Reserve

time Illinois nonmembers with total deposits
under $10 million held slightly smaller amounts
of "due from" balances than did all
nonmember banks, while larger Illinois
nonmembers had somewhat larger amounts of
"due from" balances.
While these comparisons demonstrate the
magnitude of fluctuations that can occur in
"due from" balances on call report dates, the
tendency for the Illinois nonmember " due
from" ratio to fluctuate closely about the ratio
for all nonmember banks suggests two
conclusions. The first is that state reserve
requirements have a relatively insignificant
effect on the "due from" balances maintained
by nonmember banks on average. The second
conclusion follows from the first and is that the
"due from" balances of nonmembers are
roughly equal to the amount required to
compensate correjpondents for services. 12
Ascertaining the demand of member banks
for services from correspondents and the
Federal Reserve is more difficult. However, it
seems reasonable to presume as a first
approximation that banks of similar sizes
should on average have the same needs for
correspondent-type services. Moreover, since
there is no requirement that member banks
maintain any correspondent accounts, the
balances these banks maintain should be
a relatively accurate reflection of the amount
member banks must hold to compensate
correspondents. The figures in Table 2 indicate
that member banks tend to have smaller ratios
12 The second conclusion must be viewed from the
standpoint of a respondent bank. Correspondent banks , of
course, earn profit from the provision of services and
frequently find in an account analysis that excess balances
have been maintained . However , the account analysis rarely
includes all correspondent services rendered, and thus may
understate the total cost of providing services. Moreover , a
respondent bank would normally strive to maintain
sufficient excess balances at a correspondent to serve as a
justification for a future call on services. In this sense,
therefore , "due from" balances can be considered as the
amount respondent banks feel must be provided to ensure
adequate compensation to correspondents for services.

of "due from" balances at correspondents than
do nonmember banks. Given these facts and
assumptions, the com pens a ting balances
member banks would be required to maintain
with the Federal Reserve, if the Federal Reserve
priced its services like correspondents, can be
calculated. Required compensating balances
for services provided member banks by the
Federal Reserve would be equal to the
difference between member and nonmember
bank collected balances at correspondents. In
other words, the excess of the sum of balances
held by member banks at correspondents and
the Federal Reserve over balances held by
nonmembers at correspondents can be taken as
indicative of the cost to member banks of
System reserve requirements. This excess is
considered to be nonearning balances of
member banks at the Federal Reserve.
In contrast with the approach of the CSBS
study, this analysis implies that the holding of
demand balances at correspondents entails no
real loss to either members or nonmembers.
Member banks, however, experience a burden
to the extent that the total of their collected
"due from" demand balances at correspondents and their balances at Reserve Banks
exceeds the collected "due from" demand
balances maintained by nonmembers. If the
"due from" figures in Table 2 are adjusted for
uncollected funds ' 3 and the com pu ta tions
described are performed, the burden ratios
shown in line 2 of Table 4 are obtained. ' 4 The
results suggest that the reserve requirement
burden is higher for smaller banks and
ultimately declines as deposit size expands. On
average, member banks with total deposits
under $1 billion appear to experience a burden
from balances at Reserve Banks of 2. 7 to 2.0
per cent of total deposits. In contrast, at 0.6
per cent the ratio is substantially lower for
member banks with deposits over $1 billion.
Although this pattern is nearly the reverse of
that obtained in the CSBS study, it appears
reasonable . Many small banks make almost no
Federal Reserve Bank of Kansas City

Member and Nonmember Banks

Table 4
COMPARATIVE BURDENS OF NET NONEARNING ASSETS FOR MEMBER AND
NONMEMBER BANKS
(All figures are shown per $1,000 of total deposits)
June 30, 1975
INSURED COMMERCIAL BANKS
IN THE UN ITED STATES

LESS
TH AN $5

TOTAL DEPOSIT SIZE IN MILLIONS OF DOLLARS
$5 TO
$10

$10 TO
$25

$25 TO
$50

$50 TO
$100

$100 TO
$500

$500 TO
$1,000

$1 ,000 AND
MORE

Insured Member Banks

1. No nearning Vau lt Cash
2. Nonearning Bal ances at
Federal Reserve Banks .

5.634

4.449

4 .251

4.260

4.261

3 .838

2.9.78

1.482

27.242

25.813

23 .143

25.899

26.404

22 .184

20.447

6 .391

3. (l ess ) "Due to" Balances
Available for Profi t .. .

0.989

0.582

0 .530

0. 773

1.746

4 .885

5.859

10.563

4. Net Bu rden (+)/Benefit (-)

31 .887

29 .680

26 .864

29 .386

28 .91 9

21 .137

17 .566

-2.690

5. Nonearning Vault Cash .

4.187

3.675

3.850

3.748

3.383

3 .299

3.225

1.888

6. (less) "Due to" Balances
Avail ab le for Profit . ..

0.368

0.243

0.275

0.485

1.596

2.489

1.309

1.920

7. Net Burden(+)/Benefit(-)

3.819

3.432

3.575

3.263

1.787

0.810

1.916

-0 .032

Insured Nonmember Ba nks

13 To obtain an esti ma t e of collecte d balances at
correspondents, the interbank deposit totals shown in
Table 2 have been reduced by 44 .1 per cent. This figure
was obtained from the 1975 account analysis survey of
major correspondents an d a·p pears to be relatively robust.
However , the app licability of th is percentage to the " due
from" deposits or to smalle r correspondents which are less
active in offering check collection services is unknown .
Following the CSBS approach , the percentage is assumed
to be invaria nt throughout the analysis .
For a description of the 1975 account analysis survey
resu lts see Robert E. Knight , " Account Analysis in
Correspo nd ent Bank ing ," Monthly R eview, Federal
Reserve Bank of Kansas City, March 1976.
Interestingly, use of the 44.1 per cent figure for the
uncollected portion of demand balances is consistent with
the assumption that member and nonmember banks with
under $50 million in deposits have the same ratios of total
un collected funds (u ncollected " due from" balances plus
cash items in process of collection). For larger banks the
percentage results in a higher total of uncollected funds for
member banks , which could be attributable to the fact that
these banks perform clearing services for smaller members
and nonmembers .
14 A numerical example may help to clarify the proced ure

1 Rev1e

• Marct-i 1917

used to derive the figures in Table 4 which show
nonearning balances of member banks at Reserve Banks.
Table 2 indicates that member banks in ·the smallest
deposit size category have balances due from the Federal
Reserve and correspondents, respectively, of 33.67 and
75.34, where both figures are expressed per $1,000 of total
deposits . Balances at Reserve Banks represent collected
funds , but balances at correspondents include both
collected and uncollected funds. Since uncollected funds
cannot be used to compensate co rre spo ndents for
performing services , collected balances must be estimated.
Thus , collected balances of members at correspondents are
equal to 75.34 times 55.9% , or 42.115. Therefore, total
collected balances of members at correspondents and the
Federal Reserve are equal to 42 .115 plus 33.67, or 75.785.
Similarly , collected funds of nonmembers at
correspondents are equal to the "due from " deposits of
86 .84 times 55.9% , or 48 .543. If both groups of banks have
the same demand for correspondent-type services, the
compe n sating balances of each would be identical.
However , since member banks are holding 27.242
(= 75 . 785 minus 48.543) more in correspondent-type
balances th an nonmembers, this figure is used in Table 4
as a measure of the nonearning balances at the Federal
Reserve of member banks in the smallest deposit size
category.

Comparative Burdens of Federal Reserve

use of Federal Reserve services, while large
banks are usually the major depositors of cash
letters, initiate by far the majority of wire
transfers, often make the most frequent
demands upon the Fed to supply currency and
coin both for their own use and for
respondents, etc.
In any event, these burden ratios should be
viewed in a relative sense rather than as a
precise measure of the actual burden .
Implicitly the figures assume that about 31 per
cent of the total balances member banks keep
at Reserve Banks are nonearning asssets.
Earning balances, therefore, are equal to about
69 per cent of t he total. By comparison, if the
yield on the total of member bank balances at
the Federal Reserve were equal to the average
Treasury bill rate in 1975, only about 35 per
cent of the income generated would be required
to pay the total cost the Federal Reserve
actually experienced in providing services to
member banks. However, correspondents are
not able to earn interest on the total of deposit
funds they receive and would normally include
an allowance for profit in the cost of services. If
the Federal Reserve's compensating balance
requirements were established in the same
fashion as a correspondent , between SO and 55
per cent of the member bank reserves at the
Federal Reserve would be required to cover the
System's costs of providing services to banks.
Window-dressing tendencies or unanticipated
movements in interbank balances could easily
account for the remaining difference in these
two estimates.
A word of caution is in order. The relative
burden ratios could be significantly distorted by
window dressing. The tendency for window
dressing to occur on call report dates suggests
that the estimated burden experienced by
member banks may be understated. If all
banks were to increase their "due from" totals
by an equal percentage on call report dates, the
fact that nonmember banks have larger "due

from" balances would lead in this model to an
overstatement of earning or productive reserves
of member banks at Reserve Banks. These
considerations suggest that the relative burden
ratios are probably representative, but that the
actual figures may be biased downward.

Nonearning Vault Cash
The CSBS study assumes that certain
portions of vault cash for both member and
nonmember banks are nonearning. In the case
of members, the nonearning fraction is
assumed to fall from 25 per cent for banks with
deposits under $75 million to 15 per cent for
banks with deposits over $5 billion. For
nonmember banks the ratio falls from 25 per
cent for the smallest to 20 per cent for the
largest. Although it is not clear why any bank
would hold vau lt cash that exceeded its
maximum likely operating needs, vault cash
comprises a relatively small percentage of cash
assets. The nonearning component, therefore,
has relatively little impact on the burden ratios
which are expressed as a fraction of total
deposits. Under these circumstances, the
nonearning percentages suggested by the CSBS
report have been used to estimate the
nonearning vault cash ratios for member and
nonmember banks. The estimated burden
figures for vault cash are shown in lines 1 and 5
of Table 4 .

Earning "Due to" Balances
The CSBS study, as mentioned previously,
calculates the earning portion of demand
balances due to banks and government units by
adjusting ledger balances for float and then
assuming that 30 per cent of the interest earned
on the remaining collected balances represents
profit. This approach tends to be overly
simplistic. Account analysis surveys have
generally found that correspondent banks
incorporate a substantial profit margin into
their analysis. In 1975, the most common

Federal Reserve Bank of Kansas City

Member and Nonmember Banks

pretax allowa nce was 25 per cent. 15
Correspondents, though, rarely realize profits
of this magnitude. The primary reason is that
the account analysis usually lists only those
services that are easily quantifiable-number of
items deposited, ledger entry credits or debits ,
wire t ransfers , etc.-but rarely covers
intangible services such as consulting advice ,
customer referrals, and loan participation
assistance . By seeking a relatively high profit
on listed services, correspondents hope to cover
the costs and earn a reasonable profit on all
services. Either a 25 or 30 per cent figure would
tend to overstate actual profits, but for the sake
of comparability the 25 per cent figure has been
used in the calculations of net benefits.
T he treatment of required reserves also
demands special mention. Since member banks
must hold reserves against demand deposits
either in vault cash or in a noninterest earning
deposit at the Federal Reserve, the total of
collected "due to" balances is not available to
generate an interest return. For member banks
the investable funds represented by correspondent balances are computed in this study by
reducing gross "due to" balances by float and
by an allowance for the reserves banks must
maintain. Of the remaining balances, 25 per
cent is assumed to be available to yield profits
to correspondents. In the case of nonmember
banks a slightly different approach is utilized.
Nonmember banks are also expected to hold
reserves agai nst deposits , but these are
generally held in correspondent balances which
are a form of earning asset. As a result, no
deduction was made for the reserves of
nonmember correspondents. Ignoring any
reserves nonmember banks maintain for "due
to" balances may result in overstating the net
benefit nonmember banks experience from
providing cor res pondent services, but the
magnitude of this bias would be small.
15 Robert E. Knight, "Account Analysis in Correspondent
Banking, " Monthly R eview, Federal Reserve Bank of
Kan sas City, March 1976 .

Monthly Review • March 1977

The estimated benefits member and
nonmember banks derive from serving as
correspondents are shown in lines 3 and 6 of
Table 4. As can been seen, member banks in
all deposit size categories have higher benefit
ratios, but the magnitude of the ratios is quite
small for member banks with deposits under
$100 million. This pattern, of course, reflects
the fact that the major correspondent banks are
often large member banks.
CONCLUSION
The alternative approach used in this article
for measuring the net burden to banks of....
reserve requirement s and the partially
offsetting benefits of serving as correspondents
implies on balance t hat mem ber banks
experience a burden not borne by nonmembers.
The net "burden/benefit" figures in lines 4 and
7 of Table 4 indicate that only in the largest
deposit size category does the profit
experienced by member banks as correspondents offset the nonearning portion of cai;h
assets. Member banks with total deposits undei:
$100 million experience a net burden equal. to
foregone interest on about 3 per cent of total
deposits, while the burden for those with
deposits between $100 million and $1 billion is
somewhat less . In contrast, banks with total
deposits over $1 billion appear to experience a
net benefit from System membership. Despite
the fact that System reserve requirements are
quite progressive, these estimates suggest that
smaller member banks may operate at a
competitive disadvantage relative to the larger
ones. The figures further imply that if the
Federal Reserve wished to eliminate a cost to
membership, it would be necessary to reduce
average reserve requirements on total deposits
by about 3 percentage points for banks with
deposits under $100 million and by about 2
percentage points for banks with deposits
between $100 million and $1 billion.
By comparison, the lowest burdens among

Comparative Burdens of Federa Reserve> Memoer ar.d Nonrrernber Barks

nonmembers are also experienced by the largest
banks. The most outstanding feature of the
figures, however, is the relatively low burden
ratios for nonmembers in all deposit size
categories. In all but the largest deposit group,
the estimated burden for nonmembers is 13 per
cent or less of the burden experienced by
similarly sized member banks.
These conclusions are nearly the opposite of
those of the CSBS report which indicated that
on average nonmember banks experienced a
heavier burden than members. However, unlike
the CSBS report, the figures in this study are
consistent with the Federal Reserve's
experiences in which the smaller member banks
have shown the greatest desire to withdraw
from System membership . Nevertheless, a word
of caution is in order. While the figures appear
to be indicative of relative burdens, they should
not be interpreted literally. In the first place,
no consideration has been given in the analysis
to differences in the deposit composition of
member and nonmember banks. The fact that
demand deposits comprise a smaller share of
total deposits at nonmembers could imply that
member banks should normally experience
greater comparative burdens. Differences of
these magnitudes in relative burdens , however,
could not be completely explained by this
factor. In addition , no allowance has been
made for differences among similarly sized
banks in the demand for correspondent
services. Factors such as a bank's location, the
nature of its business, its liquidity , and the
aggressiveness of its management could affect
the need for such services. Membership status
could also have an impact. Further research
would be necessary to determine whether the
omission of these factors had introduced any

systematic bias in the calculations. Regardless ,
the estimated burden figures are at best
applicable only to broad classes of banks and
may not be representative of the situation at
any individual bank. The qualification is
significantly reinforced by the fact that all
banks have balances due from other banks, but
less than half have balances due to other
banks .
Secondly, the computations are based on
1-day figures rather than daily averages . The
extent to which this may bias the results is
unknown, but evidence considered earlier
suggested that window dressing at the time of
the call was significant. Thirdly, the model
requires fewer assumptions about the earning
or nonearning components of balance sheet
items than did the CSBS analysis, but to the
extent the assumed proportions are wrong, the
net burden ratios would be biased. Finally, the
issue has not been resolved as to whether the
ability to serve as a correspondent bank should
be considered a benefit of Federal Reserve
membership. If any large bank, member or
nonmember, can function effectively as a
correspondent, the overall model may be
invalid. A number of alternative approaches for
measuring the burden of Federal Reserve
membership could be used , but these generally
tend to arrive at the same conclusion as this
article.
In conclusion, the model in this article
suggests that even under the type of
assumptions introduced by the CSBS study , the
burden of nonmember banks is not heavier
than that of members. Nonmember banks
appear to have a significant competitive
advantage over member banks, particularly in
the smaller size groupings .

Federal Reserve Bank of Kdnsas C t v

Full text of Economic Review (Federal Reserve Bank of Kansas City) : March 1977

FRASER