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March-April 1965 ON~·BLY REVIEW NEBR . COLO. KANS . Growth and Transition of District Small Cities . . . . . . . . . . page 3 Correspondent Banking . . . . . . . . . . . page 9 FEDERAL RESERVE RANK OF KANSAS EITY Subscriptions to th e MONTHLY REVIEW are available to the public without charge. Additional copies of any issue may be obtained from the R esearch D epartment, Federal Reserve Bank of Kansas City, Kansas City, Missouri 64106. Permission is granted to reproduce any material in this publication. Growth and Transition of District Small Cities r(-., HROUGHO UT the hi tory o f the United . States, the proce o f urban growth ha p roceeded w itho ut interruptio n. It has been, and rema in s, a co nco mita nt of eco nomi c growth . The diminishing ru ral charac ter of the United States was d ra ma ticall y pointed u p in th e 1920 Ce n us whe n, fo r th e first time in ou r hi sto ry, th propo rti o n o f peop le living in x d cl th os in rura l ~W' a s. By 1960 , rn o r th an 60 pe r ce nt f the U . . popul ati o n r sided in 2 12 sta nd a rd metropo li ta n stati sti ca l areas (S MSA 's ). To a large exte nt, a co unte rpa rt of thi s deve lo pment ca n be fo und in the T enth F ederal R eserve Distri ct. The trend tow a rd concentra tio n in the Di strict's la rge metropolitan areas during the 20th ce ntury was a nalyzed at length in earli er issues of the M onthly R eview and req uires no addit ional comment. ' Thi s a rti cle will foc us o n a d imensio n o f urban growth th a t was excluded in th e ea rli er a rti.cl es , nam e ly, th e growth o f small cities in th T enth Di tri ct. and will dea l with deve lo pme nts betwee n th e 1950 and 1960 Census da tes ." The a na lysi is direc ted a t small incorporated c ities within the District havi ng a popul ation o f between 10,000 and 50 ,000 which we re located outside SMSA's . The di fficulty in obtaining mea ningful data on cities 1 See, "T he Grow th of Me t ro p o lita n Areas in the Te nth Distric t," Mn 111/,/y Re 1•ie 11', e pte m be r 30, 195 1. See a l. o, "Sta nd a rd M et ro po lit a n S ta ti sti c a l Areas in the Ten th Distri c t,• · M o 11tlil.1· R e ,·iew, M ay-J une 1964, an d , " D ist ric t M e tro po lit an Area - T he ir In di v i dua l x pe riences, " Mo nth!)' R e ,·ie11', July-A ug ust 1964 . " T he M o 111/il;• R e ,·ie w o f Ma rc h 3 1, 1952 , ca rri ed a n a r ti cl e e ntitl ed , "The G ro wt h o f m a ll ities in the T e nth Di stric t," ' whi l.: h t raced the g row t h o f sm a ll c it ies th roug h the 1950 Ce nsus d a te. A purpose of th e c u r re n t a rt ic le is to p rov ide for co nt inui ty wi th th e ea rlie r stud y . Monthly Review • March -April 1965 of fewe r th a n I 0 ,000, a well a consideration s of space, p reclude the ir be ing ana lyzed , a ltho ugh the ir impo rt ance in a n a rea such a th e T enth District sho uld no t be minimi zed . A BROAD LOOK AT POPULATION GROWTH Ta bl e de c ribes the growth in po pul atio n betwee n 1950 a nd 1960 in District sta te . In addi tio n , it sp c ifi s th di tri buti n o f p pul a tion amo ng th D istrict M A ' · a nd sma ll citi s d uring thi s p ri I. O n the basis o f the I 950 e nsus, it may be see n th a t metropolita n areas a nd small cities accounted for approxima te ly 54 pe r ce nt of the 8. 3 million total District po pul ation . The metropolitan a reas were res ponsible for a little more th a n 41 per cent and the small cities' share of the total was 12 .4 per cent. The results of the 1960 Census showed th at District SMSA's and incorporated cities with a popul ati on o f betwee n 10,000 a nd 50 ,000 loca ted o utside SM SA 's conta ined mo re th a n 62 pe r ce nt o f th e Di stri c t' s 9 .6 milli o n Table l TENTH DISTRICT POPULATION 1950 Actual Number Per Cent of Total Population Colorad o Kans as Missouri ·' Nebra ska Ne w Me xi co * Oklahoma * W yom in g 1,325,089 1,905,299 984,4 16 1,325,510 379,485 2 ,099,248 290,529 15.9 22 .9 11.8 16 .0 4 .6 25 .3 3.5 1960 Percentage Per Cent Change in Actual of Total Population Number Popuiation 1950 -1960 1,753,947 2,178,611 l, 104,069 1,411 ,330 555,378 2,221 ,778 330,066 18.4 22 .8 11.6 14.8 5.8 23.3 3 .5 32.4 14.3 12.2 6 .5 46 .4 5.8 13.6 Di stric t To ta l 8 ,309,576 Dis t r ict SMS A ' s 3 ,423,04 4 4 1. 2 9 ,555, 179 4,703,377 49 .2 37.4 15.0 Dis tr ic t Sma ll Cit ies 1,027,869 12.4 1,2 42 ,838 13.0 20 .9 Dis trict SMSA ' s and Sma ll Cit ies 4 ,450,913 53 .6 5 ,946,215 62 .2 33 .6 ' Te nt h Dis t r ict p ort io n only . SOURCE : U. S. Burea u of the Cen sus , Census of Population 1960. 3 District Small Cities people . J t is interesting to note th at the ri se in total population during this period-1.25 million-was actually exceeded by the popul ation gain recorded by the District SMSA's-1.28 million. Also, while the percentage rise in Tenth District population- 15 pe r cent-fell short of the 18.5 per cent gain for the Nation as a whole, the SMSA population advanced at a rate of more than twice that of the District or th e United States. It should not be co ncluded , however, th at the District's entire population ga in was wholly attributable to th e SMSA 's. During the I 950's , the mall citie did record a population increase of abou t 2 15,000- albeit less than o ne fifth as much as th e la rg r mctrop titan areas. In that am span of tim e, though , the rural areas suff red a p pulation los of approx ima tely a quarter of a million. The sha rp increase in population of the SMSA 's raised their share of total District population from 41 per cent in 19 50 to 49 per cent in 1960. In contrast, the small cities' share rose by little more than one half of one percentage point-from 12.4 per cent to 13 per cent. Thus, in the face of increasing concentration in the large metropolitan a reas, mall ci ties in the aggregate barely have managed to hold th eir gro und in terms of relative population ga ins. The extent to which thi was a genera lized phenomeno n, or more or less regional, is di scussed in the rema inder of thi s article . GROWTH BY REGIONS States in the Tenth District contain several regional transitions. At the time of the 1960 Census, there were 64 incorporated cities in t_h e District having a popul a tion of betwee n I 0 ,000 and 50,000, a nd located outside District SMSA's. This co mpares with a tota l of 63 mall cities which wer no ted in the 1950 Ce n us. The imilarity in the number of small cities a t th e two Census dates sho uld not be interpreted as mea ning that little change oc4 curred in the Di strict's smaller urban areas. On the contrary, the composition of the small c1t1e changed appreciably over the decade. The 64 small cities in the 1960 Census included nine new entries , while eight cities which had been listed in the 1950 Census no lo nger appea red in the later Census data. The signifi ca nce of thi s changed composition· will be di cus ed later in the article. The 64 small cities have been assigned to five major geographic regions , parts of which fal l within the Tenth District. These regions have varying socio-economic characteristics; although , withi n a ny given region , simila r types of farming act ivities u ually predominate." These areas a nd th e cities they enco mpass arc shown o n the acco mpanying map. In th North enter ( o rn Belt ) region , 12 citie of eas tern Nebraska a nd north eastern Kan sas are fou nd. The principal agricultural activity is livestock farm ing for the production of meat anim als. As might be expected, corn is the leading agricultural crop and much of it is fed to cattle and hogs. Manufacturing activities are related primarily to the processing of farm products. Four principal SMSA's are found in thi s regio n, which erve as centers for marketing, proce sing, a nd transs hipping of farm prod ucts , a nd are so urces of farming equipme nt and suppli es. The Di strict portion of the Centra l Pl ains region is bounded by th e om Belt on the east. and the Rocky Mountains on the west. T he primary economic activities are agricultu ral, with wheat production and cattle "See, Bogue, D o na ld J. , and Bea le , Calvin L., Eco11omic Areas of rh e Un ir ed Srates, Nev.: York : The Free Press of Glencoe, Inc., 1961, pp . xxxix-x lvi. This class ificat ion sys tem- using cou nti es as the bas ic unit- has, in la rge part, been accep ted by th e U. S. Burea u of the Census. ~ hi!e questions rega rdin g delimitation o f the reg io ns are 111ev 1t ab le, the pla cement of Sherid a n, W yo ., and Trinid ad, o lo ., in the Cen tra l Pla ins reg io n seems espec ia ll y tenu ous. On the basis of phy ica l consid era ti o ns, both c ities might more logic_ally b~ placed in the Roc ky M o untam a nd lnt ermounta rn region ; howeve r, the eco no mic cha rac teri stics of the counties in whi ch these c ities a rc loca ted appea r to rese mble mo re closely those of th e Centra l Plains regi on. LOCATION OF SMALL CITIES BY GEOGRAPHIC REGION IN THE TENTH DISTRICT e D D SHERIDAN North Center (Co rn Belt) Region Central Plains Region Cen tro I and Eastern Upland Reg ion D D D NEBRASKA South Center and Southwe st Plains Region Rocky Mountain and lntermountoin Region Standard Metropolitan Statistical Areas • Small Cities NORFOLK• • SCOTTSBLUFF _____ FdN T • COLLINS ) STERLING . • GREELEY BEATRICE • KANSAS ST. ATCHI LEAVEN WO MANHA TTA N •TOPEKA"HAYS ✓UNCTION• e • C I TY S A LINA GREAT BE NO GA ROEN CITY • e e HUTCHINSON• • DODGE CITY LIBERAL < Y LJ L AWRENC EMPORIA e B '. -/ NE WTO N WICHITA 0 EL DORA nr CHANUT PARSO WINFIELD ARKANSAS CIT Y OKLAHOMA g ra zing taking precedenee o ve r the grow ing of corn and fattening of cattle and hog , which are characteristic of the orn Belt to the ea t. Petrol eum also plays an important econo mic role in thi s reg ion , which encompasses 30 of the District's 64 small cities and includes cities from Kansa s, Oklahoma, Nebraska, Colorado , and Wyoming. Three principal SMSA 's also a re found in the District portion o f thi s region . South of th e Centra l Pl ain li es th e South Ce nte r a nd Southwest Plains region . Within th e District portion of thi s region, cotton grow ing ha bee n supplant d by live tock fa rming as a principal agricultura l activity. Oil and na tural gas pl ay a large economic rol e in the li velihood of thi s portion of the District. This area inMonthly Review • March -April 1965 eludes IO small c ities- all within the state of Oklahoma- as well as o ne o f the la rge r SMSA's in the Di trict. The District portion of the Central a nd Eastern Upland region is the smallest of the five regions which describe the District. It contains no SMSA's and only three small cities, two in southwestern Missouri and o ne in sou theaste rn Oklahoma. The rema ining economic region , contain ing nine District small citie in Colorado, New Mex ico, and Wyoming, i th e Rocky Mo untai n and I ntermountain region . One o f th e Di strict's fastest growing me tropolita n areas-Albuquerque -is found in thi area . T able 2 provides inform ation o n the changes in population and total employment which oc5 Table 2 POPULATION AND EMPLOYMENT GROWTH OF DISTRICT SMALL CITIES 1950-1960 curred in each of the 64 small cities of the District's five economic regions between 1950 and 1960. It present imilar data for the Di trict' s 13 SMSA's and for the United States, for purpo e of comparison with the rates of cha nge for the small c1t1e of the Di trict. During the I 9 50' , the Di trict' 64 sma1l cities, ta ken as a whole, recorded ra tes of advance in both popul ation and e mploym ent cess of th a t for the Nation littl e more th a n ha lf the rat vance sho wn for th e M A 's. th e rapid inc reas ·s in pl oy m ·nt and p pulati a lly a nd Di tri ct-wid - ha v n well doc ument d in prcviou i u s of the R eview, th fa ilure of the small cities to advance as rapidly as the SMSA's m th e Di strict is not surprising. What does appear somewhat surprising is that the 64 small cities taken as a whol e showed better relative ga ins m popul ation and empl oym ent betwee n I 950 a nd 1960 th an did th e N ati o n. T he e xt nt to whic h thi s p henomen n was indige nou s to on or mor reg ion , or Di trict-widc in nature, may be see n in T a bl e 3 . This tabl e compares, in a implified form , regio nal percentage changes in population and employment with simil ar average changes for the United States , D istrict SMSA's, a nd the aggregate of District small citie for the p riod 1950-1960. If the popul ation data in Tabl 3 ·u xamined , th · ge ne ra ll y favorabl performanc of the 64 mall cities relative to the na tional rate of advance is not readily di cerned. In onl y two region - th e entral Plain , and 6 POPULATION 1960 North Center (Corn Belt) Reg ion Atch ison, Kan s. 12,529 Lawrence, Kans . 32,858 Leavenworth, Kans. 22,052 Ottawa , Kans . 10,673 Beatrice, Neb r. 12,132 Columb us, Nebr. Fremont, Nebr. Grand hlond, Nebr. Hasting s, Ne br. Kearn ey , Nebr. Norfolk, Nebr . North Pla tt e, Nebr . Total 12 District Cities Central Pia ins Region Fort Collins: Colo. Greeley, Colo. Sterling, Colo. Trinidad, Colo. Arkansas City , Kans . Chanute, Kan s. Coffeyvi lle, Kans. Dodge City , Ka ns. El Dorado, Kan s. Emp o ria , Kan s. Gard n City, Kan s. Gr at B nd, Kan s. Hay s, Kan s. Hutchin son , Kan s. Independe nce, Kan s. Junction City, Kan s. liberal , Kans. Manhattan, Kans . Newton, Kans. Parsons, Kans . Pittsbu q:i, Ka ns. Salina, Kans. Winfield, Kans . Scottsbluff, Nebr . Bartlesville, Okla . Enid, Okla . Miami, Okla . Ponca City, Okla . Cheyenne, Wyo. Sheridon, Wyo. EMPLOY Change 1950- 1960 Number Per Cen t Change 19S0-1960 Number Per Cent - 313 4,717 590 - 12 56 1,400 1,871 978 972 1, 143 1,034 130 - 6 .3 60.7 8.2 - 0.3 1.2 38.3 31.0 11 0 12.7 25 .3 23 .4 2.1 12,566 18 .0 3,600 2,564 965 - 557 511 340 61 919 497 1,019 451 1,348 1,564 1,264 83 817 2,417 1,762 901 - 505 - 156 4,1 77 621 400 2,454 622 145 981 5,217 - 100 67.4 35.3 32 .0 - 15.7 11 .0 9.2 1.0 21.4 11.7 16.4 10.7 25 .8 48 . 9.5 2.0 21.6 82 .9 27 .3 19.6 - 9.7 - 2.2 40.9 15.3 7.8 29 .9 4.6 3.3 12.2 42 .2 - 2.2 34,382 19 .2 - 2.1 40.7 7.2 25,742 21,412 14,210 13,640 17,184 - 263 9,507 1,473 592 319 3,592 4,936 3,060 1,201 2,095 2,305 1,751 2 14,606 30,568 16.6 25,027 26,314 10,751 10,691 14,262 10,849 17,382 13,520 12,523 18, 190 11 ,811 16,670 11 ,947 37,574 11 ,222 18,700 13,813 22,993 14,877 13,929 18,678 43,202 11 , 117 13,377 27,893 38,859 12,869 24,411 43 ,505 11,651 10,090 5,960 3,217 - 1,513 1,359 740 269 2,258 1,486 2,521 906 4,005 3,322 3,999 - 113 5,238 6,679 3,937 3,287 - 821 - 663 17,026 853 519 8,665 2,842 1,068 4,231 11,570 151 103,088 67.6 29.3 42.7 - 12.4 10.5 7.3 1.6 20.0 13.5 16. 1 8.3 31.6 38 .5 11 .9 - 1.0 38.9 93 .6 20.7 28 .4 - 5.6 - 3.4 65 .0 8.3 4.0 45 . 1 7.9 9. 1 21.0 36.2 1.3 21.7 8,945 9,818 3,980 2,996 5,175 4,053 6,076 5,222 4,727 7,216 4,649 6,577 4t7 88 14,613 4,239 4,599 5,331 8,222 5,495 4,708 6,786 14,394 4 ,685 5,538 10,670 14,145 4 ,509 9,013 17,570 4,369 213,108 - 294 - 281 - 290 - 865 - - 561 1,408 820 - 9.8 40 .6 12.6 12,476 19,698 Total 30 District Cities 578,607 Central and Eastern Upland Region 5 .9 2.7 40.4 33.4 13.5 5 .9 17.3 20.3 11.3 4,668 12,494 7,772 3,897 4,883 5,055 7,904 9,882 8,601 5,658 5,458 6,255 82,527 Ca rtha ge, Mo. Joplin, Mo. McAI ster, Okla . 11 ,264 38,958 17,419 76 247 - 459 0.7 0.6 - 2.6 - 136 Total 3 District Cities 67,64 1 South Center and Southwest Plains Region - 0.2 3,962 14,078 5,-461 23,501 Ada, Okla . Altus, Okla. Ardmore, Okla . Chickasha , Okla . Duncan, Okla . Muskogee, Okla . Okmulgee, Okla. Seminole, Okla . Shawnee, Okla . Stillwater, Ok la . 14,347 21 ,225 20,184 14,866 20,009 38 ,059 15,951 11,464 24,326 23,965 - 1,648 11,490 2,294 - 976 4,684 770 - 2,366 - 399 1,378 3,727 - 10.3 118 .0 12.8 - 6.2 30.6 2. 1 - 12.9 - 3.4 6 .0 18.4 18,954 204,396 Total 10 District Cities Rocky Mountain and lntermountain Region 10.2 5,154 4,875 7,309 5, 320 7,513 13,322 5,104 3,811 8,651 8,-416 69,475 1 1,617 - 603 - 718 - 219 320 1,202 3,267 6.9 2.0 5.0 3.6 . 27.4 - 4.3 - 12.3 - 5.4 3.8 16.7 4.9 34 .9 993 3,071 41.2 3,841 10,530 Durango, Colo. 31.9 1,739 28 .9 4, 190 7,186 18,694 Grand Junction, Colo . 554.9 6,947 8, 199 20,149 554.0 23,786 Farm ington, N. Mex. 56 .8 1,765 4,870 54.3 4,956 14,089 Gallup, N. Mex . n.o n.a . 3,-451 8,023 356.4 10,274 Grants , N. Mex . 31.0 2,699 19.3 11,395 5,396 33,394 Santa Fe, N. Mex . 47.4 4,841 64.4 15,052 15,257 38,930 Cosper, Wyo . 8.9 525 6,413 12.4 1,939 17,520 Laramie, Wyo. - 11.6 - 496 - 4.5 - -486 3,765 10,371 Rock Springs, Wyo. 4S.6 .. 19,013** 54 .3 60,721 ** 62 ,495 177,588 Total 9 District Citi es District's 64 17.9*' 449,332 ** 68,363 ** 20.9 1,242 ,838 214,969 Small Cities 30.8 1,746,650 411 ,396 37 .4 4,703,377 1,280,333 District' s 13 SMSA 's 14 .5 64,639,247 8,203,974 18.S 179,323,175 27,997,377 United States • less than .05 per cent. •• Excludes Grants, New Mexico, since employment data are unavailable for 1950. SOURCE : U. S. Bu reau of the Census, Census of Population 1960. District Small Cities the Rocky Mounta in a nd lntermounta in region - did the pe rcentage change in popul ation exceed the U . S. average for the period . Both region a lso recorded relative population ga in s grea ter than the average for the Di strict small cities . In th e case of the Rocky Mountai n a nd I ntcrmounta in region , the rate of advance in population exceeded the average for the 13 Distri ct SM A 's as we ll. It is worth noting that the ri c in population in Di st rict SMSA 's was at a ra te more th an twi ce as high as the United State during th e I 950's. Th us, th e perform ance of th e Rocky Mounta in and Intermou nta in region, in ter ms o f popu latio n ga in , appear. a ll th mo re imprc.-s iv . Ncvc rth cl ss, ·vc n th ou rh th ' re rio ns sh wing stro ng popu 1:ltio n advanc s ac ·o unt cd for n 'a rl y two third s of a ll sma ll c iti s in th Di tri ct, the r lativc populatio n strength of the mall cities- when vi wed o n a regional ba is-was more or less a confined phenomenon rathe r th an a gene ral occurrence. Thi s will be seen even more clearly when th e performance of the individual cities is considered. Turning to a consideration of comparative regio na l employm ent changes , results shown in T able 3 arc quite simil a r to th ose for regional pop ul atio n cha nges . Only th e North enter ( o rn Belt) regio n diverges from th e pattern of popul a ti o n c h·rnges. Once aga in , the Centra l Pl ai n and R oc ky Mountai n and Jnte rm ounta in regions show greater relative growth th a n th e United States or th e District small cities, with the latter region gaining em ployment at a rate even in excess of th at for the Dist rict SMSA 's. The percentage change in employment for both th e Central and E astern Upland region a nd the South Center and Southwest Pl a in w re le th a n for th e U nited States, the sma ll cities' average, o r the Di strict SMSA average a nd co rres ponded with the reco rd of population changes for th ese region . Thus, the table shows a rema rkable symmetry between popul atio n a nd employment developments in th e various Distri ct regio ns during 1950-1960. Monthly Review • March-April 1965 Table 3 COMPARISON OF PER CENT CHANGES IN POPULATION AND TOTAL EMPLOYMENT 1950-1960 - - -- - ----+------,I---+----+- Total Population : U. S. Average District SMSA Averag e District Small City Average * To ta l Employment : U. S. Av erag e District SMSA Av era g Di strict Sma ll C ity Av erage * + + + + NOTE : equa ls grea te r than ; - equals less than . * Excludes Grants, New Mexico, since emp loyment data for 1950 are unavailable. S0 ~:~.E: U. S. Bu reau of th e Census, Census of Population , 1 A LOOK INSIDE THE REGIONS Population a nd employment d ata for individual cities show n in Table 2 strongly corroborate the regional observations summ arized in Tabl e 3. Fir t, population a nd employment cha nges for th e individu a l c itic moved in a nea rly parallel fa hion . Secondly, when rates of c hange in population a nd total empl oyment for th e various regions are meas ured aga inst the average rate of c hange for the United Sta tes, the Di strict SMSA's, or the 64 sm all cities, it was usua11y the case th at a majority of the individual cities within each region experienced rates of change corresponding to that for the regio n as a whol e. For exa mpl e, the Rocky Mo unta in and fntermountai n region expe ri enced popul a tion a nd empl oyment ga ins betwee n 1950 a nd 1960 a t ra tes which e xceeded th e average ra tes of adva nce for either the Na tio n, th e Di stri ct SMSA 's, or the 64 small cities . Thus, approxima tely two thirds of the cities in th at regio n showed a simil ar pattern o f adva nce . At the othe r end of the spect rum , 7 District Small Cities the South Cent r a nd Southwes t Pl a ins region and th e Cent ra l a nd E aste rn upl a nd s reg ion tra iled b e hind the N a ti o n , District SMSA's, a nd 64 ma ll c ities' a verage ga in in popul a tio n and employme nt. Within those reg io ns, nea rly all th e ma ll c itie du pli ca ted the regio nal pe rform ance. The pe rfor ma nce of the indi vidu a l cities in th e N o rth e nte r a nd e ntra l Pl a ins regio n vi s-a-vi s th e o ve r-a ll reg io na l pe rce ntage c ha nges in po pul ati o n a nd e mpl oy ment also lends s up po rt to th e o bserva ti o n th a t the regio nal pe rfo rm a nces we re hi ghly represe ntati ve o f the pe rform a nce o f a majo rity of the citi es w ithin a g iv n reg i n, rat her th a n th e con equ e nce o f a few ex tre mely fav rab le o r unfavo rable show in gs by ind ivid ua l ·iti ·s . The ha n , , d ·omp siti o n o f th e Dis tri t small c iti es in the J 9E0 e ns us re lat ive to th 1950 e ns u e num era tio n was me nti o ned ea rl ier in the study . An exa min at io n of the c ha nges sheds added light o n the viability of the D is t rict's small c ities during a perio d w hen me tro polita nization was proceeding a t a ra pid pace . T he ve ry fact th at nine new small District cities we re listed in the I 960 Censu s i itself a significa nt fact alo ngs ide th e fa vo ra bl e growth reco rd o f num e rou sma ll c ities whi c h h ad bee n o n th li st IO y ars ea rli e r. It ma y b a rg ued th a t th I ss o f e ight fo rm e r small c itie , whil e ga ining nine new o nes, simply inc reased th e to ta l numbe r o f Di stri ct sma ll cities by a ne t o f o ne. Howeve r, a n exa mination o f those cities which we re dele ted from the 1960 Census list is ve ry instructive in providing a prope r pe rspective fo r a ny judgme nt o n the growth capacities of sm all cities. The e ight m aJI citie no lo nger pre e nt at th e time o f th e 1960 e n u include E l R e no, No rm a n, Sa pulpa, Lawto n, a nd Guthri e, Okl aho ma, as well as Fort Scott, Ka nsas, a nd Bo ulde r a nd o lo rado Springs, o lo rado. It sho uld be reca lled th at " mall c ities" ha ve been defined as a n incorpo ra ted e ntity ha ving a popul a ti on of be tween I 0 ,000 and 50 ,000, a nd lo8 ca ted o ut ide the limits of a sta nda rd metropo lita n stati sti ca l a rea . Thu s, of these eight small c ities, o nl y two- Fort Scott a nd Guthrie - we re a bse nt in the 1960 Census list as a re ult of a dec line in popul a tion to below I 0 ,000. Lawto n , o n the othe r ha nd , wa de ig na ted a n SMSA a a co n eque nce o f it rap id g row th , as was Colo ra do Springs . Of th e re ma ining fo ur c ities, E l R e no a nd Norm a n w re absorbed into th e Okl a hom a ity SMSA ; Sa pul pa beca me a n integ ral pa rt of th e Tulsa SMSA ; a nd Bo ulder was jo ined to th e D enve r SMSA. In li ght o f th ese develo pme nts, it see m inappro1 ria te to rega rd the ne t ga in o f o ne sma ll D istrict ci ty as th signifi ca nt occ urr nee in the 1 row th pa tt rn o f th Di stri t's small c ities betwee n I :J50 and 1960. The rea l signifi a nc' appears to li e in th dyna mi grow th f s ma ll ci ti s suc h a Law t n a nd lo rado pr ings, with the ir re ulting t ra n fo rm a ti o n in to larger self-co nta in d me tropolita n a reas. Simil a rl y, the merg ing o r a bsorption o f El Re no, Norma n, Sa pulpa, a nd Boulde r into me t ropo lita n areas signifi es the inc reased inte rdepende ncy whic h has evolved between the la rge r c itie a nd adj ace nt mall urba n ce nte rs. In no se nse, th e refore, should one vi ew th e experie nce o f the sma ll c ities in th e T e nth District b twe n 1950 a nd 19 60 a nd conclud that a sim pl proce s o f attrition a nd equiva le nt replace me nt was a t wo rk . R a the r, a dyna mic proc ss o f grow th was in e vide nce with a tra nsfo rm ati o n o f sm all e r urba n ce nte rs into mo re complex a nd integra ted la rge r me tropolita n areas. This " loss" of small cities, through growth, was fu lly compe nsated for by the introduction of new small cities in the T e nth Di strict . Altho ugh thi s g rowth process was mo re in ev ide nce in o me Di trict regio ns th a n in ot he r , its xiste nce is unde ni a ble a nd it , uggests tha t mall c itie , suc h as tho e di . cu s ed in th i article, m ay repre e nt a way sta ti o n in the process o f urba n growth , ra the r th a n sim ply a n a nac hroni m in the face o f in c reasing me tropolita n a rea growth . Correspondent Banking BANKS sell their se rvices to individua ls, bu sinesses, a nd governmental units. Among th e bu inc customers of m a ny bank s arc o the r comme rcial banks. A s custome rs, commercial bank purch ase th e same gene ral types of se rvices- clearing, de pository, c redit advi ce a nd suppl y, ctc .- as no nbank busin esses and indi vidu a ls. Like other c ustome rs, banks pay fo r th ese se rvi ces by maintain in r balances with th e sclkr <1s well as by making exp li c it mo ney pay ments. Howeve r, th e re la tion hip be twee n ba nks as produce rs of se rvi ces and ot he r commercial banks as purchasers of bank output is thought to have spec ial importance because of its possible implications for question s o f ba nking structure as well as moneta ry policy. Apart from its special importance , correspondent ba nking is highly complex. Small country ba nk commonly m a intain co rre pondc nt re lat io ns with 5 or 6 ba nk , wherca larger bank s may mainta in balances with 30 or more banks. Flows of se rvi ces arc fr equ e ntly r c iproca l and at times quite c ircuito us. N c ve rth ele s, the flow o f correspo ndent se rvices through th e banking syste m traces a perceptible hi era rchica l structure of banks. Small country ba nks ge ne rally maintain balances with a se ri es of la rger ba nks in regional financia l centers. Banks in regional financial centers m a intain b alances with other banks in regional fin a ncial centers, as well as with bank s in New York and/or C hicago. New Yo rk and hicago ba nks will , in turn , m a intain balances with ba nk s in the natio na l fi nancial cente rs and also with banks in variou s reg ional centers. The intricacy of thi s network indica tes th e d g rce o f indirection a nd compl ex ity that inte rba nk se rvice flows ca n assume . C OMMER C IAL Monthly Review • March -April 1965 PRODUCTION VERSUS PURCHASE OF BANK SERVICES The basic reason for the fl ow of se rvices ,1mo ng banks is th at in o me insta nces comme rc ia l banks find it e ither impossibl e or relati ve ly cos tly to produce certain serv ices required by th e ir custo me rs. Wh en a profitco nsc io us ba nk finds it cheape r to purcha c ;1 sc rvic , from anoth e r bank than to pr duce thi1l Sl,;rv ic' it se lf, it will r sor t to ;1 co rrespond e nt. In d te rmining whic h banks ar t prod uce a give n typ of se rvice a nd which arc to purchase the e rvice, ba nk size a nd locat ion appea r to be of para mount importa nce. These two factors, it m ay be noted , are not entirely independent of each other, since banks rarely grow to g rea t size. in sparsely populated or commerc ially re mote a reas. The importance of bank location is, perhaps, best e xe mplifi ed by clearing se rvices. A bank rece iving a c hec k d raw n on a not he r bank mu st ar range for tra nsportation of th e c hec k to e ith e r th e paying bank's pre mi ses or to some loca ti o n wh ere the paying ba nk ma inta in an acco unt. 1f a co untry bank regul a rl y rece ives a substa nti a l numbe r of items draw n on a city bank, it m ay become convenient to maintain an account with the paying bank and u se its clearing facilities. Since the volume of clearing flows betwee n banks generally is influenced by the pattern of commerce in a n a rea, the dec i ion to mainta in a correspondent relationship der ives partly fr o m th e geog raphic location of pa rtic ipa nt . Ba nk size, the seco nd m ajor c le me nt ra tion alizing th e production of ba nk services, appears to have es pecially pervasive implications for th e structure of correspondent relationship . The impo rta nce of bank size derives 9 Correspondent Banking la rgely from the connection between size and divi sion of labo r. B ecause b a nks produce such diverse financial services, substa ntial size is necessary to permit th e specializa tion required to ga in experti se in all phases of the business. If the required volum e of busines is unatta in a bl e, it becomes cheaper for a ba nk to purcha e servic s from o the r ba nk with more highl y developed faciliti . Co rrespondent banking thu s may be viewed as a mea ns for c ircu mve nting so me of the di sadva ntages inhe rent in sma ll size. In effect, th e la rger bunk sta nd s ready to se ll or rent fac to rs of producti on r se rvi ces fl ow ing from these factors to small e r bank s in small r amo unts th a n ar othe rwi se ava ilabl e . T he fo ll ow ing c ursory desc ripti n of selected type of co rres p nde nt s rvic s is mea nt to co nvey an impress io n of the scope a nd variety of suc h ervices, but is not a n exh a ustive listing of type of corres ponde nt services . Following the descriptive m a terial are sections devoted to interpretation of the meaning and importance of correspondent banking. Mos t of the discu ss ion is focused upon the relation ship betwee n the small cou ntry membe r bank a nd la rge r bank s in region al financial centers; howeve r, parts o f the di sc uss ion a rc equ ally relevant to co rrc pondent relationships a mo ng thcr types o f bank . or responde nt se rvi ces will be conve ni ently , a lbe it so mewhat arbitrarily, gro uped under three hea ding : clea ring se rvices, asse t ma nagement se rvice , and other mi scellaneous se rvices. CLEARING SERVICES It is significa nt that a siza bl e proportion of Fede ral Rese rve me mbe r ba nk s prefer to susta in th e ex pe nse o f cl ea ring through correspondents, eve n though Federal Reserve Ba nk provide clea ring se rvice at no add itio nal co t, o nce me mbe rship has been e tabli shed . Banks in reg ion al financial center actively solicit this type of bu siness with not abl e success. For exampl e, less th a n one fourth 10 of the me mber ba nk s in the T enth Federal Re e rve Di strict cleared directly throug h the Rese rve Bank during I 964. It may be assumed th at the remainder rely prim a rily o n the faciliti es of co rre pondents. On th e o th e r hand , ci ty correspo nde nts will ubmit ma ny of the ite ms orig in ati ng with the ir re ponde nt to the Federal Re se rve Bank. Thu s, th e practice of clearing throu gh corres po nde nts will no t necessaril y res ult in a mate ri al reduction in the vo lume o f clearings handl ed by the Federal Reserve Sy te rn , but an e leme nt o f indirecti o n i. int roduced into the clea ring proces . The abi lity of city corr ponde nts to sell clc~1ri ng s rv ices to me mb r banks is partl y ·xp la in ·cl hy th e incl us io n f th sc s rvices as an intc 1 ral part o f a I a kag f hi ghl y di v rse . e rvices that co mpri se th typical corresp ndent rela tio nship. H owever, it is al o true that clearing serv ice provided by correspondents are diffe re nti ated from tho e offered b y Federal R eserve B anks. For exampl e, the Federal Rese rve Bank may require some so rting o f items submitted for collection, whereas correspo nden ts commonly acce pt clea ring items un so rted. Federal Rese rve B a nks will not gene rally accept no npa r o r foreign ite ms, whil e corr spo ndc nts do no t usually impo e uch re st n c t1 ns. In additi o n , co rres po nd nts freq u ntl y provide immediate c redit for a ll ca h item , whereas the Federal Re e rve Ba nk give immediate, I-day, o r 2-day credit depe nding upo n th e location of the paying b a nk. The point to be em ph asized is that city correspondents a ugme nt th e clea ring se rvices offered member banks by the Federal Reserve System . ASSET MANAGEMENT SERVICES With rega rd to portfolio man age ment , the sma ll bank face two m ajor proble m . F ir t, it does not ge nera te suffici e nt ex per t information inte rn a ll y, a nd second , it i fore d to tra de in re latively small unit . In helping the sma ll ba nk circ umve nt the e inhe re nt disadva ntages, the city cor res po nde nt promotes two socially Correspondent Banking u cful ends. Inter-area capita l mobility is enhanc d and the di emi nation of eco nomically valuable in formatio n i. facilitated. Expert inform at ion , purchased from a corre pondent, may relate to pr blems a broad as th e over-a ll tructure of a bank 's portfolio, or it may be confined to th e merit. of a pecific municipal s c urity. The intricaci s o f Trea ury advance rcfundings and th e e r ditw rthiness o f out-of-area loa n applicants al o se rve as bases for exc ha nges of information . The ci ty co rrespo ndent's hi ghl y specialized orga nization. as well as its numerous co ntacts with banks 1mg' and small, provide it with uniqu e c red ' ntial s ;i s ;1 purveyor o f wi lc -rn ngi n, ex pert is'. The importance of tradin g units cxpr sses itse lf in two w·iys. ir. t, sma ll er bank occa ionall y arc co nfronted by va lued cu tomer. who wi h to negotiate larger loa n th an these banks can lega lly or prudently make to any inglc borrower. The e same bank , when in need of funds or outl ets for the employment of idl e funds, often find th at th e size of trading units in organized markets precl ude their participation . The first type of contin ge ncy is often solved with a loa n participation , whereby th e c ity co rres pondent shares in th e ov rsize loa ns originated by co rrespo nd nts. The second type o f problem may be dealt with by providing loa ns in which sma ller ba nk s may pa rti cipate . In ad diti o n, corrc po ndcnt. may lend or borrow, u ing federal fund s or other instrum ent , or they may buy or ell various type of ea rning assets. In effect, the city correspondent " makes a market" in various types of debt in trum ents de igned to erve th e needs o f small er bank s. Dep nding on the n eds and tastes of participants, the city c rrcspondcnt may act as d al r, broker, r both . The importance o f . uch a relatio nship is mor fully apprec iated by r cogni zing that a sets flowin g among banks arc at times those for which th ere arc no o r ga ni ze d se condary market . Monthly Review • March April 1965 MISCELLANEOUS SERVICES In add ition to th e serv ice · al ready discussed, co rrespo ndent provide a group of miscellan ou ervice. . ome of which arc used infreyu entl y but remain crucia l to th e efficient oprati o n o f smnll cr bank . . . . xamples of such serv i cs include tru st and intern at ional bank ing. and co nsultatio n o n manage ment problem s. Per. onncl probl ems o f smaller. remotely itu ated bank s arc often I a rti cul arly difficult. Co rre pondcnts comm only se rve as a cl ea ring house for hi gher level job app lica nts and ope nin 1 s at such bank s. In addit ion. so me small r hanks rarti c ipatc in th e 1 roup insuranc and rctircm ' Ill pro 1 ra ms o f ·it y c )rr ·s pondent s. ' it y ' orr s1 ond nts alsc fa ·ilitat th e cx chang f equity in small r bnn ks by bringing toge th er pr . pccti vc buy r. and clle r and by fin a ncing th e purch a of stock . An indication of th e importance f corre pondents in financing equity tran sfe rs is ugges ted by a re cent study don e under the ausp ices of the Ho use Committee on Banking and Currency. A questionna ire addressed to 6,200 member bank s in 1962 revealed that 2, 166 Joans made by th e e banks w re secured with IO per cent or more o f the equ ity in oth er banks. Th prepo nde rant majority o f these loa ns was made in area s with larg conce ntratio n of r latively small bank s. or example, banks within th e Tenth Di trict had 4 70 loa ns o ut ta nding th at we re sec ured by IO per cent or more of the tock of bank s withi n the Kan as City District . Assuming no duplication , the banks whose tock se rved as collateral constituted more than one fourth of all comm ercial bank in the area. Th purposes for which th e e loa ns were m ade wcr not di clo ed, but it sc ms rca o nab le to cx1 ec t th at th e bor r w r · had a wid vari ty of purposes. On th e other hand, th ere is no reaso n to doubt that th acqui iti n of bank equity was one re a on for borrowing. Th e ge neral acceptability of bank stock as coll atera l for bank loa ns ha mea ning beyond 11 Correspondent Banking facilitating th e transfe r of equity. Since the market for the stock of sm a ll ba nks is not highl y d eveloped , owners m ay find it difficult to dispose of such assets on short notice witho ut accepting sizabl e losses. So long as loa ns a re readil y ava il a ble to those able to hypothecate ba nk stock, di sposa l of the stock on short notice beco mes unnecessary. The rea dy ava il ability of such loa ns may thu s b e viewed as e nh a ncing the rea l rate o f re turn o n in ves tm ents in bank stock . Still othe r se rvices com monly provided through corres ponde nt rela tion ships might be di scu sed in so me detail. Th e provi sion of co in , I ctro ni c data proc ss in g se rvices, a nd advice o n building d s i ,n and equ ipm e nt a r ju st a few . Howeve r, th c r ~ is little point in tryi n, to ma k thi s disc uss io n xha ustiv . Th fi Id is far too broa I a nd impl c enum eratio n of se rvices conveys littl e in ight. AN INTERPRETATION OF CORRESPONDENT BANKING The foregoing di scuss ion s uggested that the importance of correspondent ba nking results la rgely from economies of scale in the production of b a nking se rvices. Since large banks can produce some types of b a nk output a t lower cost than th e ir small e r co unte rparts, the sm a ll e r bank ca n fr que ntl y purch a c ba nk c rvi ce at I we r cost th a n it ca n produce the m . Vi ewed in thi way , inte rbank s rvicc flow s become a type of " inte rm edi a te product," a na logo us to th e se mi-processed good s purchased by a m a nufacturer. A measure of the importa nce of interbank service flows and a possible measure of economies of scale may be obtained by relating ba nk purchases of correspondent services to a le . D riving such a m eas ure i , howeve r, co mplica ted by . a number o f con idera tion s. Fi rst, the r arc difficulties in meas uring th e volum e of inte rb a nk se rvice fl ows beca use payment for th ese se rvices arc mad e by explicit money transfe rs as we ll as by m a intaining balances with the bank s upplying serv ices. The 12 balances re prese nt a type of payment "in kind " in which the medium of exchange is a factor of production , a n in gredient used by th e rece iving ba nk in th e further production of output. Surpri singly, " in kind " payments are easily es tim a ted , but ex plicit inte rb a nk money payments a rc not. Thi s stems from th e fact that interba nk bal a nces arc shown in Re ports of Co ndition , but inte rbank payments are not ge ne ra lly how n, as such , in I nco mc a nd Divi dend Reports. H owever, th e inability to m easure exp li c it inte rba nk paym e nts may not be a m ajo r problem s ince they a re ge ne ra ll y far less importa nt th a n " in kind " payme nts. A di stin c ti o n mu st be made be twee n Federa l Rese rve mc mb ·,· ,ind nonm e mbe r bank s in th e int ·rprc tati o n or th e ir interbank bal ,in ·cs. The ·o rrcspo ncl nt bank rece iving ba lances inves ts th e fund , allowing for rese rve require me nts, and th e ea rnings o n such investme nts con titutc th e pay me nt received from its res ponde nt for se rvices re nde red . Th e m ember bank maintaining correspondent ba la nces could a lte rn atively withdraw these fund s a nd purchase earning assets itself, th e reby augmenting its income. Thus, inte rbank bal a nces re present forgon e in co me to the member ba nk maintaining the m, as we ll as a so urce of income to th e de pository bank. Th ese bala nces a rc maintain d in co nsidera ti o n o f serv ices rece ived a nd , provided re pondcnt arc profit con cious, th e amo unt o f in co me forgone by th e me mbe r bank main taining such ba la nces should not te nd to be greater than its es timate of the value of services provided by th e depository bank . In the case of nonmembe r b anks, however. it is important to recognize that their corresponden t ba la nces may serve as legal rese rves. A nonm e mbe r ba nk th a t is fully " loa ned up" -without e xec s rese rve - will not effective ly have th opt io n of withdrawing its co rrespondent balances for th e purchase of e arn ing assets. It is reaso nab le to a um e th at these de posits wou ld be maintained eve n in the a bse nce of se rvices provided by the depos itory Correspondent Banking bank. Thus , the nonmember bank holding interbank balances for rese rve purposes does not the reby sustain an opportunity cost in the same way as the membe r bank . 1 Of course, in choosing among poss ible depositories, the nonmembe r bank will attempt to select the bank making the mo t ge nerou offe r of corre pondent se rvices . However, there is no co mpelling reason to expect the va lue o f these ervices to equ a l th e forgone income, a m easured by the member bank ho lding such balances, unl ess the selle rs of bank services are in hi ghly competitive ma rket . If strong competition is absent, depository ba nk s need not pay as muc h- in se rvi ces- for th e corres po nd ent balances o f nonme mbe r b·rnks as th ey would for th e balances o f memb r bank s. Wh eth e r d posito ry ba nk s in fac t pay more or less for the e deposits is not known. Howe ve r, it seems reasonable to assume th at the ea rnings a member bank might have obtained by investing its interbank balances, again allowing for rese rve requirements , may be used as a meas ure of the lower limit of the value of services the bank receives from correspondents. On the other hand, such an ass umption does not appea r warra nted wh en applied to nonm embe r banks. A second probl em in d riving a meas ure of the relationship betwee n sa les a nd co rres pondent s rvices purchased r !ates to the meas urement of bank sales . The maj o r difficulty encountered here relates to problems of asse t valuation-the treatment of capital ga ins and losses. However, detailed discussion of thi s problem is beyond the scope of this article. Current operating revenu e-mainly interest and service charge income -will be u sed as a measure of sales, whil e recognizing that th e measure i not uniquely correct. 'Thi s a rgum ent is predica ted on the ass um p tio n tha t the m a rginal return o n va ult cas h is zero a nd th at ba nk s do not have the opti o n o f ho lding their rese rves in the form of ea rning assets. In cases where these two assum ptio ns a re no t sa tisfi ed , the distincti o n between member a nd no nm embe r ba nks can be wea kened o r nullified . Monthly Review • March -April 1965 Chart 1 SALES AND CORRESPONDENT SERVICES PURCHASED RELATED TO TOTAL DEPOSITS Thousands of Dollars Mi llions of Dollars 2 .5 2.0 1.5 1.0 100 80 60 .5 40 20 5 Deposits in Millions of Dollar s NOTE: The relationship Setween correspondent services purchased and total deposits was obtained in three steps. First, a statistical technique-least squares re gression-was used to estimate the relationship between demand balances with correspondents and total deposits . The fitted equation-shown · in Technical Note 2-was then multiplied by a constant-1 minus the legal reserve requirement against demand de?osits for country member banks (l.0- 0 . 12 = 0 .88)- in order to transform the equa tion into a relationship between the invest ible portions of correspondent balances and deposit size. (Co rrespondent balances are treated as de ductions from tota l demand deposits in the computation of required reserves .) The final step involved multiplying the re sulting equation by a second constant- 3 .5 per ce nt- which was on assumed value for the rate of return on highly liquid bank invest ments . This multiplication further transformed the equation into a relationship between forgone income, or corres pondent services purchased, and deposit size . C ha rt 1 shows an estimated relationship between correspondent services purchased , or forgone income on interbank balances, and deposit size, for a sampl e of 602 country member banks in th e T enth F ederal Rese rve Di stri ct. Banks in the sa mple ranged from approxim ately $0 .5 million to $34.2 million in deposit size . The cha rt indicates th at th e small est bank in th e sa mple purchase about $ 1,400 pe r yea r in corre pondent se rvices . This value increases at a dimini shing rate as de13 Correspondent Banking posits grow, and reaches a maximum of $38 ,500 for ba nks with deposits of $26.8 mil1ion. Thereafter, forgo ne incom e falls as deposits ri se a nd at $34.2 million , th e m aximum deposit size in the sa mpl e, banks purch ase approximately $35 ,600 wort h of correspondent se rvices per year. The rema ining line in ~ h art I dep icts th e estimated re la ti o nship between sa t s- current opera ting re venue- and de po it size . (See T ec hnica l Note 2.) Sal es ri se at a n increasing rate as bank depo sits g row. A ba n k with $0.5 million in total deposits has esti mated sa le of $22,900 per year a nd b a nks of maximum depo it sizc- $34.2 millionshow sa les of $2.07 milli o n . Chart 2, w hi ch is d riv d fr m the equa ti o ns d ·pic t ·d in ' hart I , show · for one in ·om a nd sal es as ;1 per c nt of de posit , and forgo ne incom i a lso shown as a per c nt of sales . The chart indicates that forgo ne inco me declines as a pe r cent of deposits as bank size increases. Fo r the sm all est banks in th e sa mpl e, forgone income on correspondent balances, or correspondent serv ices purchased, a mounts to 0.29 per cent of tota l deposits and for the largest banks the value is 0.10 per cent. In co ntrast , sa les, as a per ce nt of deposits, ri se co nsi tcntly w ith bank grow th , from a low o f 4.6 per ce nt to a hi gh of 6 . I p r c nt. Th e line ma rk ed "corres pondent se rvices purcha cd/s·1 les" is a lowe r limit es timate of the per ce nt of sa les w hic h arc inte rmediate product- the resold o utput of ot her producers -fo r bank of varying de posit size. The equation unde rlying the charted relationsh ip was obtained by dividing th e correspondent services purch ased rela tion ship of Chart 1 by the sa les relationship also show n in C hart I. The resulting eq ua ti o n indica tes that correspond e nt ·c rvices becom e less importa nt relative to sale. a depo it size of bank inc r ases . However, th rat io of forg nc inco m e to ales fa ll at a declining rate- the re is a tendency for the line to flatte n o ut- as depos its grow . Fo r the sm all e t ba nk s in th e sa mpl e, 6.2 per ce nt of 14 Chart 2 RELATIONSHIPS DERIVED FROM EQUATIONS UNDERLYING CHART 1 Per Cent 7 6 5 4 3 / Correspondent Servic es Purchased/ / Soles 2 Corresponde nt Services Purchased/ / / Deposits 0 J 0 5 1 -1. ----1- 20 25 30 10 15 Deposits in Millions of Dollars 35 sa les are intermediate product in the form of co r responde nt services, but only 1.7 pe r cent of sa les of the la rgest banks a re acco unted for by purchased corresponde nt services. This relationship prov ides te nta tive corroboration for th e economics of scale e xplanation for the im portance of correspo nde nt banking. A s b a nk s beco me larger, they prod uce a n e ver g rea te r perce ntage of the ir a le . The der ived rela tion ship i a lso signifi ca nt in th a t it provides a mea s ure of the q ua ntitative importa nce of corre spo nde n t banking for m a ll ba nk s in a unit ba nking enviro nme nt. On the other hand, it may be worth repeating th a t the measure of co rrespondent se rvice flows covers only that po rti on of cor responde nt se rvices which are paid for by th e mainte na nce of inte rba nk b a lances among th . a mpl bank . In add iti o n , th e ra t o f return u ·ed in de riving the forgone income m ea ure was se lected so m e wh a t arbitrari ly, and the mea sure of a les is not c ntir ly unambiguou s . T hese sho rtcomings are, however, judged to be of rel atively mino r im - Correspondent Banking portance, a nd the contour of the derived relationship appea rs quite plausible. EXPLICIT SERVICE CHARGES VERSUS T E MAI E A To thi s point, the qu estion of why banks appa rently prefer to receive and/or make payment for co rre pondent se rv ices in the form of inte rba nk bala nc s has not been co n idered. If ex plicit and implicit payme nts were equa l. banks might be expected to be indiffere nt to the for m of payment. H owever, payment in the form of bala nces is rather general in banking. S rvices provided the U . S. Treasury are paid for by maintaining tax and loa n accou nt balan s, a nd stat' a nd local gov ·rnmcnts mmon ly use th e sam means to ·ompe nsat · co mm rcial ba nks. T he ro l of mpcnsating ba lance req uir ment. in co nnecti o n with loans is al o a nalogous to the part played by interba nk balances in connec tion with correspondent relationships. Thus any explanation of implicit payments in correspondent banking may be expected to have wider relevance. Any one or a combination of three explanations may acco unt for the use of implicit payments in corres pondent relati onsh ips. F irst, the lega l prohibition of inte rest payment o n demand dep its xerts a n impo rtant influe nce. Since depos its rep rese nt a productive input to the individu al ba nk. banks seek to purchase them. Prohibition of intere t payments precludes effecting suc h tra n actio n in the conventional manne r- through money payments -and thu s bank s remunerate their supplie rs with services. A second explanation , suggested by bankers. relates to th e importance of deposits, apart from th e considerations of hort-run profit max imi za tion . Some bankers argue that given the choice betwc n implic it a nd ex plicit payments in eq ual a mo unt , they wou ld prefer implicit payment because it fost rs deposit growth. The importance of deposit growth stem from its conventional use as a measure Monthly Review • March-April 1965 of management acume n. Jt u e as such m ay be rationalized by a rgui ng that deposit growth provides a foundation for the futu re growth of earn ings. B a nks may even trade off current ea rnings to ac hieve a desirable rate of deposit grow th , in which case the supplie rs of deposits co uld benefit from th e use of a n implicit payment system. Correspondent se rvices may be obta ined at lowe r cos t to the respo nde nt tha n would be the ca c under a system of explicit payments. On th e o ther hand, in the absence of the lega l prohibition of interest payment o n depo its, interest rates presumably would refl ect the pecia l value of deposits to bank . A third r a ·o n for implicit payment may be foun I in bankers' pr fcrc ncc f r nonp ri ce fo rm s o f co mp ti lio n. It has be ·n argued that unbridl ' d pri c comp tition imparts a destabilizing influence to th banking system , and thus has genera lly deleterious implications for the economy. Setting aside the question of the validity of such argument , implicit payments can be explained by a general aversion to price competition . Although all three suggested explanations for implicit payments are potentially impo rtant, th e first- the legal prohibition of inte rest payment on de ma nd depos its-appears most com pelling beca u c of its obvious impact. Th ac tual relevance of the other xpla nat ions is more ope n to ques tion . Co n. ider the ca e of nonmembe r banks where the opportunity cost of maintaining interbank balance i zero, assuming such deposits are used to sa tisfy legal reserve requirements. lf correspondents ea rn 4 per cent on such deposits , they will be able to provide se rvices worth any amount between zero and 4 per cent of balances and both banks will find the relationship profitable. A sume, for the purpose of di scus ion. th at th corre pondcnt pays the respondent 2 .5 per cent- in the form of s rvice - on int rba nk balances. The re pondent is thu ea rning 2.5 per c nt on its legal reserves which, in effect, have no ea rning power in alte rn ative u es. The cor15 Correspondent Banking res ponde nt al so find s thi s a rrangem e nt adva ntageo us in th a t it profits to th e exte nt of the sprea d b e twee n th e earni ng power of th e deposits -4 pe r ce nt- a nd th e co t of providing correspondent se rvices-2 .5 pe r ce nt- to its responde nt. In hi g hly competitive m arkets th e va lu e of corres ponde nt se rvice would be expecte d to approximat 4 pe r ce nt o n b a lances. whi le in other circums ta nces so me inte rmedi a te va lu e mi g ht be arrived at through nego ti at ion . In a ny ca se, th e va lu e o f corresponde nt se rvices mi ght be ex pec ted to re ma in m ea ningfull y a bove th e zero floor beca use sm a ll e r sta te ba nks have th e a lte rna tive o f me mbe rship in th e Federal R ese rve . T h s ituati o n o f m mbc r b;tnk s is ;dt e rcd in de tail, but re main s ess ·nti;ill y th ' s;1111 c . Th liff rc n c s t ms from the fa t that int rbank ba la nces of me mbe r bank se rve as seco nd a ry re rves a nd th e oppo rtunity co t o f ma inta in ing inte rba nk b ala nces thu approaches the yield on hi ghly liquid ea rning assets, say 3 .5 per ce nt. Thi s mea ns the m e mbe r respondent mu st rece ive se rvices worth in excess of 3.5 p r cent on ba lances to m a ke th e corresponde nt relation ship a ttractive, wh e reas any no nzero re turn m ay sa ti fy th e no nm e mbe r respondent. On th e o th e r hand , in hi ghly com pe titive marke ts all r sponde nts wi ll be o ffe red approximate ly 4 pe r ce nt- th e ass um ed va lu e o f s uch balances to c ity correspondents- and th e m e mbe r- nonm e mbe r di stincti o n will be in consequ e nti a l. But if such c ircum sta nces do not pre va il a nd corresponde nts a re a bl e to trea t diffe re nt customers differe ntl y, th e m embe r ba nk m ay be able to command a so mewh at hi ghe r re turn on its inte rba nk b a la nces. CONCLUSION Th e di c us io n pre c nted thu s far has uc he d m a ny ba . cs , se veral o f them so mewhat tec hni ca l. In co ncluding, a few broad ge nera li za ti o ns may be useful. M a ny stude nts o f b a nkin g structure have argued th e a dva ntage of branch ba nking by a lluding to economie of sc a le in the p roduction of comme rcial ba nk e rvices. Much of th e fo rego ing di scus ion sugges ts that correspo ndent ba nkin g i a potenti a ll y e ffective mea ns fo r circ umventing th ese inh ere nt di adva ntages o f s ma ll -s ize ba nking firm . T o th e ex te nt tha t co rres po ndent ba nkin g i a n effici ent sy te rn for the productio n a nd di tribu tion of bank o utput. th e advantages f branch banking attributable to eco nomic. of sca le m ay be . c ri o us ly weake ned . In serving co mm e rc ia l bank s, corres pondent ba nkin g mobilizes inte r-;:u ec1 flow s of ca pital. o th e r factors o f productio n, a nd inform a ti o n. It e ffect ive ly inte~ ratcs th e ba n kin 1 sys te m a nd in clo in , thi s it re rrcse nt s a ·o 1 c nt alt e rnati ve to hr;1nch, !.!, roup , or c h;1in b;1nkin 1 • On th e other ha nd , th e r is rca s n t qu sti o n th e viability o f unit banking in th e abs nc o f we ll deve loped co rr p nde nt b a nking in tituti o ns. TECHNICAL NOTES 1. The sample of banks employed in the regression eq u a tio n s consists of all (602 ) country member banks in the Kansas City Federal Reserve District with correspondent deposit liabilities of less than $100,000 . Earnings data were taken from individual bank Incom e e nd Dividend Reports for the year, 1963. Deposits data came from Reports of Condition for year end 1963 . 2. The regression equations used in Chart I w e re as fo llo ws: C .2766 ( 10") -I .9342 (lO - ') D - .1744 (lO -") D 2 (.2483 (1 0 ")) (.6770 ( JO · ")) (.2875 (10 · 7 )) R" - .4423 E-= .7678 (10 ") I .4567 (lO · ') D -j- .4345 (10 · 7 ) D 2 (.4816 (10")) (.1313 (lO -")) (. 5575 (lO -h)) R" .9506 where C is demand balances with banks in the United St a tes (ex cluding reciproca l balances ), E is current operating reven ue, and D is total deposits. R" is the coefficie nt of d e termination adjusted for degrees of freedom . Values in parentheses below the regression coefficients are standard errors of the coefficients. Neithe r intercept is significantly different from zero at the 10 per cent level. They were consequently assumed to b e zero in plotting the e quations in Charts l and 2 . 3 . Th e cubic form of deposits was tested as an ex planatory va r iab le but it s co e fficient wa s not significa ntly di ffere nt from z ero . 4 . Th e re la tionship betw ee n C/ E and D as shown in Chart 2 was d eriv ed from th e two eq uations show n in not e 2 . C/ E was a lso ind e pend e ntly re gressed upon d e posits . Th e res ultan t eq uation was cubic in depo si ts. C / E f e ll at a falling rate and th e n a t an increasing rate as deposits gre w . This e quation indicated C / E w as slig htly higher at low le ve ls of D and slightly lo wer at high le ve ls of D than is th e case in Chart 2 .
@FedFRASER