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F E D E R A L R E S E R V E BA N K O F NEW YO R K r Circular No. 5 7 6 4 1 I~ January 20, 1966 J NOTICE OF PROPOSED RULE MAKING Definition of “Deposit” in Regulations D and Q To A ll B anks, and Others Concerned, in the Second F ederal Reserve D istrict: The following statement was made public today by the Board of Governors of the Federal Reserve System: The Board o f Governors today announced proposed amendments to its Regulation D, relating to reserve requirements o f member banks, and its Regulation Q, relating to the payment o f interest on deposits by member banks. The amendments would in effect define “ deposits” for purposes o f those regulations as including prom is sory notes and other forms o f indebtedness o f member banks with certain exceptions. In general, the exceptions would exclude from coverage (1 ) borrowings from Federal Reserve Banks, (2) borrowings from other banks, including so-called “ Federal funds transactions,” (3) borrowings in the form o f transfers o f United States obligations under repurchase agreements, and (4 ) borrowings with maturities o f more than two years that are subordinated to claims o f depositors and general creditors. The proposed amendments have been prom pted by the development over the past year of the practice among some banks o f issuing short-term promissory notes to corporate customers and others in order to obtain loanable funds. This practice has tended to lessen the effectiveness o f provisions of the Federal Reserve A ct that prohibit the payment o f interest on demand deposits, limit the rate o f interest payable on time deposits, and require reserves against deposits. The proposed amendments would apply to any indebtedness within their coverage that is incurred after today (January 20, 1966) and that is outstanding after the effective date. Comments on the proposed amendments should be submitted by February 25, 1966. The amendments would not be made effective until approxim ately 60 days after their adoption b y the Board. The text o f the notice regarding the proposed amendments, as it has been sent to the F ederal R egister, is printed below. The notice includes illustrative examples o f the manner in which the amendments would affect particular types o f transactions. FEDERAL RESERVE SYSTEM [ 12 CFR Parts 2 0 4 , 217 Regs. D, Q 1 J RESERVES OF MEMBER BAN KS; PA Y MENT OF INTEREST ON DEPOSITS Notice of Proposed Rule M aking The Board of Governors is considering amending section 204.1 of Regulation D ( “ Reserves of Member Banks” ) and section 217.1 of Regulation Q ( “ Payment of Inter est on Deposits” ) by inserting at the begin ning of each the following new paragraph: “ (a ) Deposit. — The term ‘deposit’ means any indebtedness of a member bank that arises out of a transaction in the or dinary course of its business with respect to either funds received or credit extended by the bank, except (1 ) indebtedness due to a Federal Reserve Bank, (2 ) indebtedness due to another bank for its own account that is not reflected on books or reports of the debtor as a deposit or of the creditor as a bank balance, (3 ) indebtedness arising from a transfer of direct obligations o f the United States that the bank is obligated to repurchase, and (4 ) indebtedness subordi nated to the claims of depositors and general creditors that has an original maturity of more than two years; provided, however, that this paragraph shall not affect the status, for purposes of this part, of any indebtedness incurred prior to January 20, 1966.” The present paragraphs ( a ) , ( b ) , ( c ) , ( d ) , ( e ) , ( f ) , ( g ) , ( h ) , and (i) of section 204.1 would be redesignated as paragraphs (over) ( b ) , ( c ) , ( d ) , ( e ) , ( f ) , ( g ) , (h ), ( i ) , and ( j ) , respectively. The present paragraphs ( a ) , ( b ) , ( c ) , ( d ) , and (e) of section 217.1 would be redesignated as paragraphs ( b ), ( c ) , ( d ) , ( e ) , and ( f ) , respectively. I f adopted by the Board, it is contem plated that the amendments would be made effective approximately 60 days after the date of their adoption. The amendments would apply not only to any indebtedness within their coverage incurred after the effective date but also to any such indebted ness outstanding on the effective date that was incurred after January 20, 1966. During the past year, a number of banks have issued promissory notes as a means of obtaining additional funds. It is now ap parent that this practice results in avoid ance of laws and regulations governing payment of interest on deposits and main tenance of reserves against deposits. The proposed amendments to Regula tions Q and D are designed to prevent eva sions of those laws and regulations and are based upon the premise that, with few ex ceptions, indebtedness of member banks must be considered and treated as deposits subject to Regulations Q and D in order to effectuate congressional directives and poli cies, as expressed in section 19 o f the F ed eral Reserve A ct. The amendments are intended princi pally to bring promissory notes within the definition of deposits. However, the Board would be prepared to adopt similar amend ments with respect to other forms of indebt edness that were being used as a means of avoiding laws or regulations relating to pay ment of interest on deposits and mainte nance by member banks of reserves against deposits. The following are illustrations of the effects of the presently proposed definition of deposits, from the standpoint of rules governing payment of interest on deposits: (1 ) In consideration of the receipt of funds, a member bank issues its promissory note (either negotiable or nonnegotiable) to mature in six months. The bank’s liability would be a deposit. Consequently, the rate of interest on the note could not lawfully exceed that permitted on a certificate of deposit. (2 ) A member bank issues its note pay able on demand or within less than 30 days, either negotiable or nonnegotiable. The bank’s liability would constitute a demand deposit, and it could not law fully pay any interest thereon. (3 ) A member bank purchases station ery and office supplies on credit. Such in debtedness would not arise from “ funds received or credit extended by the bank,” and consequently it would not be a deposit. (4 ) A member bank borrows funds on its note, secured by a mortgage on the bank premises, and uses the proceeds to pay for renovation. Although this indebtedness would arise from “ funds received” by the bank, the transaction would not be “ in the ordinary course o f its business,” and there fore the indebtedness would not constitute a deposit. (5 ) A member bank lends funds to a customer and credits the proceeds to his account. The amount so credited would, as heretofore, be a deposit. (6 ) A member bank receives funds, in the ordinary course o f its business, from a correspondent bank — whether member or nonmember, domestic or foreign. Consistent with traditional practice and understanding of the parties, the liability of the recipient bank would be a deposit. The proposed definition of “ deposit,” however, would ex cept from its coverage an interbank indebt edness that is entered and reported by both banks as a loan transaction. A loan of what are commonly termed “ Federal funds” is an example of an indebtedness that wrould fall within such exception. (7 ) A member bank issues debentures or notes to provide additional “ capital” funds. B y contract, the claim of the secur ity holders against the assets of the bank is subordinated to the claims of depositors and all other creditors. Such notes are excepted from the definition of deposit if they have an original maturity of more than two years. This notice is published pursuant to section 4 of the Administrative Procedure A ct and section 1 (b ) of the Rules of P ro cedure of the Board of Governors o f the Federal Reserve System (12 CFR 2 6 2 .1 ( b ) ) . To aid in the consideration o f this matter by the Board, interested persons are invited to submit relevant data, views, or arguments. A ny such material should be submitted in writing to the Secretary, Board of Governors of the Federal Reserve System, Washington, D . C., 20551, to be received not later than February 25, 1966. Dated at Washington, D .C., this 20th day of January, 1966. B oard of G overnors T h e F ederal S ystem of R eser ve M e r r it t S h e r m a n , Secretary. Additional copies of this circular will be furnished on request. A lfred H ayes, President.