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FEDERAL RESERVE REQUIREMENTS ACT OF 1978
HEARINGS
BlllFORE THE
COMMITTEE ON
BANKING, HOUSING, A.ND URBAN AFFAIRS
UNITED STA.TES SENA.TE
NINETY-FIFTH CONGRESS
SECOND SESSION
ON
S. 3304
TO AMEND THE FEDERAL RESERVE ACT TO PROVIDE FOR THE
MAINTENANOE OF RESERVES FOR CERTAIN INSTITUTIONS; TO
REQUIRE THE IMPOSITION OF CHARGES FOR CERTAIN SERVICES
BY FEDERAL RESERVE BANKS; TO AUTHORIZE THE PAYMENT OF
INTEREST ON RESERVES HELD IN FEDERAL RESERVE BANKS;
AND FOR OTHER PURPOSES
AUGUST 14, 15, 16, AND 17, 1978
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
33-M7 0
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Federal Reserve Bank of St. Louis
WASHINGTON : 1978
COIQU'l'TEE ON BANKING, HOUSING, AND URBAN AFFAIRS
WILLI.ill PROXllmB, Wlaeonaln, OAllffllllffl
JOHN SPARKMAN, Alabama
EDWARD W. BROOD, Muaaehuaetta
HARRISON A. WILLI.AHS. Ja., New Jersey JOHN TOWER, Tens
THOJIU.S l. HcINTYRE, New Hampahlre
JAKE GARN, Utah
ALAN CRANSTON, California
H. ;JOHN HEINZ UI, PenDIJ'lv8.Dla
ADLAI E. STEVENSON, Wlnola
RICHARD G. LUGAR, Indiana
ROBERT MORGAN, North Carolina
HARRISON SCHMITT, New Mesteo
DONALD W. RIEGLE, la., Klchtpn
PAUL S. BARBA.NEB, Mar;vlaDd
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Federal Reserve Bank of St. Louis
KIINNIDTH
l■UIUAB
A. MCLIIAN, StafJ Director
s. BUCKL■l', Jlmont, Slalf Dmolor
STIIVIDN M. ROBIDBTS, OMef .li1oonom'8t
(U)
CONTENTS
s. 3304__________________________________________________________
Paire
47
LIST OF WITNESSES
MONDAY, AUGUST
14
G. William Miller, Chairman, Board of Governors, Federal Reserve Board_
George A. LeMaistre, Chairman, Federal Deposit Insurance Corporation_
Lawrence Connell, Administrator, National Credit Union Administration_
Kenneth
Biederman,
Director, Office of Economic Research, Federal Home_
Loan Bank
Board ______________________________________________
TUESDAY, AUGUST
3
67
78
81
15
Muriel
banking superintendent, New York State Banking Depart-_
ment Siebert,
_________________________________________________________
John H. Perkins, president, Continental Illinois National Bank and Trust
Co., Chicago, Ill., and president-elect, American Bankers Association;
by Charles F. Haywood, professor of economics, University
accompanied
of Kentucky ___________________________________________________
_
Thomas F. Bolger, president, McHenry State Bank, McHenry, Ill., and
second vice president, Independent Bankers Association of America;
accompanied by Richard Peterson, consultant _____________________ _
John L. Donovan, vice president and treasurer, Casco Bank & Trust Co.,
t:r:;\,~:;:,
president, First National Bank of Canton, Canton, Pa_
L.
Jeremiah P. Shea, president and chief executive officer, Bank of Delaware,
Wilmington, DeL ___ -------------------------------------------WEDNESDAY, AUGUST
115
121
140
159
162
172
16
192
Robert Carswell, Deputy Secretary, De_partment of the Treasury _______ _
John G. Heimann, Comptroller of the Currency ______________________ _
Carol
Greenwald, commissioner of banks, Commonwealth of Massachu-_
settsS.___________________________________________________________
204
Richard S. Ravenscroft, president; accompanied by George D. Norton,
executive vice president and cashier, Philadelphia National Corp _____ _
215
THURSDAY, AUGUST
17
Lester Chandler, professor of economics, Economics Department, Princeton University__________________________________________________
James Pierce, professor of economics, Economics Department, University of California-Berkeley_______________________________________
Jon Brown, staff attorney, Public Interest Research Group, Washington,
D.C--~--------,----------------------------------------------Leland S. Prussia, executive vice president, Bank of America____________
Dr. James J. O'Leary, vice chairman, United States Trust Co., New
York, representing the New York Clearing House Association, accompanied by John Lee, executive vice president, New York Clearing House
Association_____________________________________________________
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211
232
236
239
258
265
IV
i\.DDITIONA.L STATEMENTS A.ND DATA.
Page
American Bankers Association:
135
Analysis of S. 3304 ___ ----------------------------------------Outline
of services
project ____________________________________________
to estimate the impact of the pricing of Federal
Reserve
_ 137
Conference of State Bank Supervisors, letter from Lawrence E. Kreider,
executive vice president-economist ________________________________ _ 275
Congressional Record, reprint of Wil&on v. Allied Loans case ___________ _ 152
Federal Reserve System, Board of Governors:
Letter to Chairman Reuss, House Committee on Banking, Finance
and Urban Affairs, commenting on H.R. 13847 _________________ _
51
Preliminary proposal to promote competitive equality among member
banks and other financial institutions and to encourage membership
in the Federal Reserve System ___________________________ ::_ ___ _
34
Quotation from the Interpretation of the Board of Governors of the Federal
Reserve Systems, section 3175: Analysis of individual accounts _______ _ 156
Suggested amendments to H.R. 13847 ___________________________ _
54
Friedman, Milton, professor of economics, University of Chicago, statement
answering questions received in letter from Senator Proxmire ________ _ 280
Interbank Card Association, letter from Amy Topiel, associate counsel_ __
283
Migdail, Evan, reprint of paper written with cooperation of Steven M.
Roberts, committee chief economist, titled "Universal Reserve Requirements, Interest on Reserves~and Charges for Services: A Comparison of
12 Central Banks With the .l'·ederal Reserve System" _______________ _ 304
National Association of Mutual Savings Banks, letter with views on S.
3304 from Saul B. Klaman, president_ ____________________________ _ 287
Pa~:t~~:,dp;!!fa~:~~~~c__a_t~~~~-e~~~~~s-~~~~~-s:~~~-e~-t-~f-~~~~~~~-v:~
"Proposed Bank Regulatory Changes and Their Effects on Economic
Stability," position paper by Anthony M. Santomero and Jeremy J.
Siegel, Wharton School, University of Pennsylvania _________________ _
289
332
CHARTS AND TABLES
Annual loss of Federal Reserve revenues due to attrition occurring since
1970___________________________________________________________
Average interest rate on new issues of 91-day Treasury bills, and net new
savings receipts (seasonally adjusted) at FSLIC-insured savings associations, 1966-78, by quarter________________________________________
Comparison of bankwire and fedwire charges _________ _:_______________
Effective interest rate on conventional mortgages on newly build homes,
and private housing units started (seasonally adjusted annual rate),
1966-78, by quarter______________________________________________
Effect of member bank attrition on short-run predictability of monetary
aggregates______________________________________________________
Effects on earnings of the Federal Reserve System of universal reserve
requirement proposals, Aug. 14, 1978______________________________
Estimated burden of Federal Reserve membership_____________________
Estimated loss of Treasury revenues, net of taxes______________________
Federal Reserve payments to the Treasury as a percent of Federal budget
receipts________________________________________________________
Net new savings receipts (seasonally adjusted) at FSLIC-insured savings
associations, and private housing units started (seasonally adjusted
annual rate), 1966-78, by quarter__________________________________
NOW accounts as percentage of household deposit balances in New
England________________________________________________________
Percentage of banks, withdrawing from the Federal Reserve System, by
size of bank_____________________________________________________
Percentage of New England commercial banks and deposits in the Federal
Reserve System_________________________________________________
Percentage of U.S. commercial banks and deposits in the Federal Reserve
System_________________________________________________________
Private housing units started (seasonally adjusted annual rate), and change
in real gross national product (annual rates) 1966-78, by quarter______
Profitability of member and nonmember banks________________________
Relative cash asset positions of member and nonmember banks__________
Return on funds supplied by member institutions to the Federal Home
Loan banks and the Federal Reserve banks_________________________
Voluntary changes in Federal Reserve membership____________________
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97
294
99
32
63
29
33
133
98
31
24
26
25
100
28
27
134
23
FEDERAL RESERVE REQUIREMENTS ACT OF 1978
MONDAY, AUGUST 14, 1978
U.S. SENATE,
CoMMITrEE ON BANKING, HousING, AND URBAN AFFAIRS,
W asMngton, D.O.
The committee met at 10 :05 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire, chairman of the committee,
presiding.
Present: Senators Proxmire, Lugar, and Schmitt.
The CHAIRMAN. The committee will come to order.
Good morning, Mr. Chairman.
Mr. MILLER. Good morning, Mr. Chairman.
OPENING STATEMENT OF CHAIRMAN :PROXMIRE
The CHAIRMAN. Today we begin 4 days of hearings on matters
related to reserve requirements and affiliation with the Federal Reserve
System. The bill before the committee is S. 3304. I introduced the measure by request of the Federal Reserve Board. There are also other bills
on this same issue being considered by the House Banking Committee.
The legislation before us contains four parts:
1. The establishment of universal reserve requirements against
transaction accounts of all depository institutions;
2. Restructuring of reserve requirements including establishment of
reserves against transaction accounts with a range of 3 to 10 percent
and reducmg the lower limit of the reserve range against time and savings deposits to one-half percent from the present 3 percent;
3. The establishing of a rational pricmg system :for services currently_ provided free of charge by Federal Reserve banks; and
4. The congressional authorization of interest payment on reserves
held at Federal Reserve banks.
The objectives of the legisl,ll;tion according to the Federal Reserve are
to provide for greater competitive equality among financial institutions, to improve the conduct of monetary policy, t.o assure the safety
and soundness of the banking system, and t.o promote a sound and
efficient payments system.
The major thrust of the legislation is to find a solution to the Federal
Reserve's loss of members. Therefore, it is incumbent on the committee
to get answers to questions about the Federal Reserve's membership
problem and to understand the implications for this prdblem for Federal Reserve policy. The membership problem has been an overbearing concern of the Federal Reserve for some time. I fear that
the diversion of time devoted t.o this issue may be harmful to more
important monetary matters.
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It is difficult to believe that we should need to be concerned with
membership in the Nation's central bank. The Federal Reserve is
virtually alone among central banks throughout the world in its
reliance on membership. In almost all other nations all banks must
be related to the central bank at least for monetary control purposes
and most of the time for clearing and settlement of payments. Why
we should perpetuate the idea of "membership," as such, in the U.S.
central bank rather than mandating some affiliation for all banks is a
question that must be asked from the very start of these hearings. I£
mandatory universal reserve requirements can be esta.blished, the
issues raised by the Federal Reserve would be solved once and for
all and the Federal Reserve could get on with its important job of
being a central bank to the Nation rather than a "members only" club.
I would like to make a few observations about each of the parts of
S. 3304. The issues are not entirely new, but they are complex and
many of them are technical.
First, I think universal reserves on transaction balances is needed
and that we should work toward this basic change in order to blur
the distinction between members and nonmembers. But it must be
done in a fair manner and it must include a recognition of the costs
of reserves, especially to small banks; it must include access to the
discount window for all banks; and it must include access to the Federal Reserve's payments system for all depository institutions.
Second, since the cost of idle reserves and the complicated reserve
structu~ has been emphasized by the Federal Reserve it is important
to consider carefully both simplification and a reduction in required
reserves. However, reducing required reserves will result in lower
earnings to the Federal Reserve and thus will result in reduced revenue for the Treasury. The committee has an obligation to be mindful
of the potential cost to the Treasury and the taxpayers of this country
and to. guard against an outright granting of funds to the banks.
Reserve reductions need to be justified, especially the request made by
the Federal Reserve to reduce the lower limit on the time and savings
reserve range to 0.5 percent. That's a drastic reduction and it's one I
think we ought to look at very carefully.
Third, on almost every basis the char~ng for Federal Reserve
services at market-related prices makes g-ood e-conomic sense. It would
provide for a more efficient payments system by clearly indicating costs
and allocating services t<! users willing to pay. It would allow the P:ivate sector to compete w1th the Federal Reserve for payments service
bu~iness. They cannot do that effectively now because of the zero
prices set by the Federal Reserve and the monopoly that has been
created. Pricing would also allow for a rational and £air access policy.
Federal Reserve services are now basically available only to members.
Open access to all depository institutions willing to pay should be
sought.
Finally, the payment of interest on reserves must be examined with
utmost care. There is no precedent for this in the historv of t.he Federal
Reserve and there is no anthori:i;ation in the Federai'Reserve Act or
in its legislative hiRtory. I have opposed such interest payment.c; before
because even payment of a mooest nmonnt of interest would set a
preeedent that wonl<l be nn invitntion to lnrger and Jarg-er transfer
of funds from the Treasury to the banks. I remain skeptieal of the
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need for such payments. It seems to me the Federal Reserve's membership problem could be solved without cost to the Treasury simply by
requiring all institutions to keep reserves at the Federal Reserve
banks.
There are a lot of questions to be asked. I'd like to welcome you
ago.in, Chairman Miller. You have been an outspoken proponent of
getting something done about Federal Reserve membership. At this
point you must feel like the little Dutch boy holding his finger in
the dike waiting for someone to hold back the floodwaters. You want
Congress to stop the membership flood and have been determined in
your e:ffort. But, I must warn you that in another story Jason's job
was to guard .the golden fleece. The Congress must protect the
Treasury.
I hope that we can find a way to solve the membership problem
without large cost to the Treasury and I hope we can do it quickly
so you can ~et on with more pressing economic matters that are of
substantial significance to the Nation.
Go right ahead, sir. I apologize for taking so long in this opening
statement and I'm particularly aware of the irony of my asking you
now if you can present your statement orally in about 10 minutes
or so. The entire statement will be printed in full in the record, incJnding the additional matter that you add at the end, the 13-page
addendum and the 10 charts. I had a chance to study those carefully
over the weekend and I was very impressed by your statement.
STATEMENT OF G. WILLIAM MILLER, CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE BOARD
Mr. MILLER. Thank you very much, Mr. Chairman.
I appreciate the opportunity to be here. Let me say that I am well
aware of the difficulty of taking up legislation of this importance so
late in a busy session, so I'm doubly grateful-to you and the committee for allowing the legislation to be considered, and to you for
submitting the legislation for consideration a.t our request.
I know the issues a.re complex. Your introductory statement was
helpful in outlining the fundamental issues. I hope that as we explore
this question we do, in fact, address it in terms of the broader issues
of equity and fair competition among financial •institutions rather
than consider the more narrow issue of membership. As you point
out, membership in the central bank is not essential; it's a rather
unique concept in the United States in terms of the functioning of a
central bank. And so it would be appropriate for us to think in broader
terms.
I will briefly hit the highlights of my prepared testimony as you
suggest. While you have already looked° at the accompanying charts,
I might just use them as a means of calling attention to certain
points.
·whether we look at this as a broad issue or a narrow issue, the
reason for urgency is that, with the attrition of membership, the
eentral bank is, in fact, losing its influence over money and credits.
Chart I shows attrition in recent years. Over the Jast -8 years, 430
banks have left the System and 103 have joined. Mos.t of the banks
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that left the System some years ago were smnller banks. but more
recently we have seen a tendency for larger banks to leave the System.
We even hear rumblingR about verv substantial banks leaving. This
is illustrated in chart II: From 1970 to 1977 the size of banks leaving
the Svstem has tended to he,eome increasimdv larger.
Chart III shows the result of this attrition on the percentage of commercial banks and commercial bank deposits in the Federal Reserve
System. The slope of the deposits line is what is of concern "° us,
bE>,eause if that decline continues for another 10 vears the effectiveness
of the central bank will be greatly le..c;sened.
·
Chart IV makes a similar point but from a regional point of view.
For a number of reasons, withdrawal from the Svstem has been particularly dramatic in New England. Partlv that is because of the
competitive situation in New England: the NOW accounts have made
it important for banks there to look carefully at all their cost burdens,
and so there's been a particularlv rapid attrition in New England
as shown in chart IV. It wasn't long ago that New En.1rlano. had a
larger percentage of commercial bank deposits in the Federal Reserve
System than the Nat.ion at larP."e. b11t in 10 vears, that nim•.i>nta~e has
gone to substantially below the national average, which shows how
ouickly witho.rawals can accelerate.
· Chart V shows what this membership issue is all about: it's about
the burden of membership; it's about the cost of being a member. The
fundamental issue is that members are required to maintain reserve
balance..q with the Federal Reserve on which no earnings are realizeo.sterile balances. Nonmemhers, on the other hand, generally are able,
under State laws. to holo. reserves either in the ·form of assets or
deposits that would he held in the normal course of business. Chart V
shows tha,t members hold a higher percentage of 8$0ts in nonearning
form than nonmembers, and it illustrates the competitive advantage
that nonmembers have.
In terms of earnin!?S and profita.hilitv of members compareo. to nonmembers, chart VI shows nonmembers on the top, with consistently
hiaher earnings than members. This, again, illustrates the cost burden
of membership.
Chart VII i1lustratl's the estimated burden of Federal Re.serve membership. The aggrel!ll,tc burden is plotted in the upper panel of that
chart, which shows, by size of bank, the millions of dollars of burden.
The lower panel shows the burden as a percent of pretax earnings:
as a percent of earnings, the burden falls particularly heavily on
smaller ba.nks, which is why we have seen so many leaving the System.
Chart VIII shows the effect of the loss of membershin in terms of the
issue that yon mentioned, Mr. Chairman-loss of revenues to the
Treasury. Federal Reserve earnings are paid over to the Treasury
and represent a sonrce of revem1e, similar to taxes, which belongs
to the pubJic. In chart VIII, we show the Rnnual lnc;s of Federal Reserve revenues as a result of attrition. The cumnlative imna,et is such
that if today, we had the same membershin thnt we hn.d back in the
be~innin~ of this decade. the earninl!S of the Federal Reserve wonlo.
he $220 million highE>r. So the attrition we have already experienced
has cost the Federal Reserve earnings of $220 million and as a result,
cost the Treasury $100 million.
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Chart IX shows that NOW accounts in New England have grown
particularly rapidly, and this competitive pressure is one of the
factors that has accelerated withdrawals in New England.
What does all this mean in terms beyond simply the desirability
of membership in the central bank or of the central bank's encompassing a substantial share of the Nation's deposits 1 It affects, to a
great extent, the financial system itself and the monetary controls
that we might exercise. The declining trend in membership weakens
the financial system in several ways. The testimony sets this issue out
pretty thoroughly, and I would be happy to answer questions, about
the effects on the financial system.
I would like to call your attention, though, to chart X, which
illustrates one of the effects on monetary policy. This chart is particularly important because it shows the relationship between the
percent of bank deposits not subject to reserve requirements and the
predictability of the money supply. As you move to the right on this
chart----cas more and more deeosits are not subject to Federal Reserve
requirement&-the predictability of the money supply is weakened,
and this makes the operation of monetary policy very difficult. The
more unpredictable the money aggregates, the more imperfect the
fundamental data and the less control over the outcome of Federal
Reserve policies. Better monetary policy can obviously be exercised
when the predictability of our action is at a very high level for our
proposal.
Rather than go through the various arguments which are spelled
out in the testimony and which I think are well known to this
committee, I would, again, just touch on the question of cost to the
System. The proposal that we have submitted to you and that you
have introduced at our request for paying interest on reserves, charging for services, and reducing reserve requirements, would be phased
in to reduce impact on Treasury revenues.
Chart XI shows that, based on the assumption of continued attrition at the rate we have experienced nationally in recent years, there
would be another $100 million loss to the Treasury by 1983. That is the
cost of attrition. The cost of the Board's plan is about $300 million. So
the true cost of the plan, using those assumptions, is probably about
$200 million by 1983.
On the other hand, if attrition should accelerate to the level we
ha.ve experienced in New England-which is the more likely occurrence in my opinion-then we can see that the loss to the Treasury
from continued attrition would be over $250 million by 1983. The
cost of the Board's plan, again, is about $300 million. In the absence
of our program, we can expect an impact on Treasury revenues between
$100 million and $250 million.
I would like to make one other comment on a point you made in
your introductory statement. I would like to say that it seems to me
the ideal solution would be to have universal reserves on transaction
balances and, ideally, applied not only to banks but to all financial
institutions. As financial institutions other than banks gain the right
to handle transactions balances outside of the control of the central
banking system, what is being created is a very inequitable system.
~an~ a_re ~andicapped in their ability to compete with other finanmal mst1tutions, and member banks are handicapped more than other
banks. So if we could agree on universal reserves, as you point out,
that solution would be fair and it would provide broader access to
the Federal Reserve so that it can operate as a central bank for the
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Federal Reserve Bank of St. Louis
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nation rather than as a central bank for members. That solution
would be very desirable.
We also concur with your suggestion that we seek to find a simplification in the formula for reduction of reserve requirements. Again,
ideally, it would be well to work not only toward universal reserves,
but toward more uniform reserves. Then there would be less reason
for banks and other financial institutions to direct their energies toward choosing the form of deposits-toward avoiding requirements or
finding deposits that require less reserves. We would instead have a
system which, through its uniformity, allows institutions to opt for
the best service to their customers.
I will end my comments here, Mr. Chairman. I appreciate your
including this testimony in full in the record. I am prepared at this
time-unless you would like some additional presentation-to proceed to questions.
[ Complete statement of Chairman Miller and a copy of S. 3304, as
introduced, follow:]
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For release on delivery
Proposals on Financial Institution
Reserve Requirements and
Related Issues
Statement by
G. William Miller
Chairman, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing and Urban Affairs
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Federal Reserve Bank of St. Louis
U.S. Senate
August 14, 1978
8
It is a pleasure to testify today on behalf of the
Federal Reserve System on the bill before your Committee to promote
competitive equity between member banks and other depository
institutions and to strengthen the nation's financial system by
stemming the attrition of banks from the Federal Reserve.
We are
grateful to this Committee and to its distinguished Chairman for
considering such proposed legislation so late in the session,
Attrition of membership in the Federal Reserve System is
~ccurring because member banks are at a serious competitive'
disadvantage relative to other depository institutions,
This attrition,
as it continues, dilutes the effectiveness with which the Federal
Reserve can fulfill its monetary and other objectives.
Therefore,
I should like, first, to discuss the dimensions and effects of the
decline in membership, and then to offer comments on the specific
legislation you are considering.
MEMBERSHIP IN THE SYSTEM CONTINUES TO DECLINE
The problem facing us is the continuing decline in System
membership in recent years.
over the past 8 years 430 member banks
have withdrawn from the System, while only 103 nonmember banks have
joined, as is illustrated in Chart I,
give up their membership, and
half of 1978.
In 1977 69 banks chose to
39 more banks withdrew in the first
This last statistic probably understates the trend,
because many member banks appear to be delaying their plans for
withdrawal from membership until they see what action the System
takes to resolve the membership problem,
Most of the banks with-
drawing from membership have been small, with total deposits under
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Federal Reserve Bank of St. Louis
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-2$S0 million,
But a disturbing tendency has developed recently for
larger banks also to leave the System, as shown by comparing the
top and bottom panels of Chart II.
Fifteen of the sixty-nine banks
leaving the System in 1977 had deposits of more than $100 million,
a record number for that size of bank,
The steady downward trend in the number of member banks
has been accompanied, of course, by a decline in the proportion
of bank deposits subject to Federal Reserve reserve requirements, as
may be seen from Chart III,
As of the end of 1977, member banks
held less than 73 per cent of total comnercial bank deposits, down
about 8 percentage points in the last 8 years.
Thus, more than
one-fourth of cODDercial bank deposits--and over three-fifths of
all banks--are outside the Federal Reserve System.
In New England, where the development of NOW accounts in
the past S years has greatly sharpened competition among depository
institutions, the decline in membership and in deposits held ·by
member banks has been even more dramatic, as illustrated in Chart IV.
The share of deposits in New England held by member banks fell by 11
percentage points in the last three years alone--from 73 per cent at
the end of 1974 to less than 62 per cent at the end of 1977,
DUE TO THE EXCESSIVE COST OF MEMBERSHIP
The basic reason for the decline in membership is the
financial burden that membership entails,
Most nonmember banks and
thrift institutions may hold their required reserves in the form of
earning assets or in the form of deposits (such as correspondent
balances) that would be held in the normal course of business.
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-3-
Member banks, by contrast, must keep their required reserves entirely
in non-earning form.
In consequence, as may be seen in Chart V,·
member banks hold a greater percentage of their total assets in
non-earning form than do nonmembers.
The cost burden of Federal Reserve membership thus consists
of the earnings that member banks must forego because of the extra
amount of non-earning assets. that they are required to hold.
Of
course, member banks are provided with services by Federal Reserve
Banks, but the value of these services does not by any means close the
earnings gap between member and nonmember banks.
And, as a result, the
earnings rate for member banks runs persistently below that for nonmembers, as illustrated in Chart VI.
The Board staff estimates that the aggregate cost burden
to member banks of Federal Reserve membership may exceed $650 million
annually, based on data for the year ending in September 1977, or
about 9 per cent of member bank profits before income tax.
The burden
of membership is not distributed equally across all sizes of member
banks.
According to our estimates, shown in the lower panel of
Chart VII, the relative burden is greatest for small banks--exceeding
20 per cent of profits for banks with less than $10 million in deposits.
INEQUITY OF COST BURDEN BORNE BY MEMBER BANKS
The competitive inequality caused by sterile reserve balances
can be regarded as an additional "tax" levied upon member banks.
Thia
"tax" produces Federal Reserve earnings that are paid over to the
Treasury and thereby become additional revenue to the U.S. Government.
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But this "tax" is inherently unfair because it falls only on member
banks.
Nonmember banks and thrift institutions, both of which compete
with members in many of the same markets for deposits and loans, do not
bear this tax.
Member banks naturally attempt to minimize the added burden
of sterile reserves that they bear, but there are practical limitations
on their ability to do so.
Those banks most successful in taking such
steps are the very largest banks,
Because of their size, the characterof
their business, and their managerial resources, these bankshave access to
sources of funds and to activities--such as participation in international banking, making repurchase agreements with business corporations,
and borrowing Federal funds--that are either free of reserve require111ents
or involve relatively small reserve requirements.
Moreover, such banks
are usually large correspondents that provide services to smaller banks,
including those based on access to Federal Reserve facilities,
Furthermore, requiring sterile reserves only from member banks
is an inefficient way to raise revenue for the Treasury, because it leads
to withdrawals from the System, resulting in reduction in Treasury revenues.
For example, withdrawals since 1970 have reduced Federal Reserve
earnings in 1977 by nearly $220 million from what they would have otherwise been, as shown in Chart VIII, and have reduced net Treasury revenues by about $100 million,
INCREASED C<ltl'ETITION FQR DEPOSITS HEIGHrENS AWARENESS OF BURDEN
It is obvious from the continuing erosion in Federal Reserve
membership that more and more banks are becoming acutely aware of the
cost burden of membership and of the competitive handicap arising from
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Federal Reserve Bank of St. Louis
12
-5that burden.
The cost of membership is due in part to the high interest
rates induced by inflation in recent years.
With market interest
rates exceeding 5 per cent for much of the past decade, the earning
opportuni~ies foregone by holding required reserves at Reserve Banks
have become painfully clear to member banks.
At the same time, competitive pressures on banks have
increased.
Banks once had a virtual monopoly on transactions accounts
because of their ability to offer demand deposits.
position is being eroded.
But this unique
Financial innovations have led to wide-
spread use of interest-bearing accounts at nonbank depository
institutions as well as banks for transactions purposes.
Since 1970,
these innovations have included the following: limited pre-authorized
"bill-payer" transfers from savings accounts at banks and savings and
loan associations, NOW accounts at practically all depository institutions in New England, credit union share drafts, telephone transfers
from savings deposits, and the use of electronic terminals to make
immediate transfers to and from savings accounts.
Growth of these
transactions-related interest-bearing deposits has b~en most dramatic
in recent years.
For example, NOW accounts have grown from almost
zero in 1974 to nearly 8 per cent of household deposit balances in
New England in 1977, as shown in Chart IX.
There is no sign that the intense competition for trans:.
actions accounts will abate.
•
.J~• • •
These heightened competitive forces
are compelling all depository institutions to be more cost sensitive
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Federal Reserve Bank of St. Louis
13
-6-
and to seek ways to maintain their profitability.
Experience shows
that withdrawal from the Federal Reserve System is a strategy that
many bank managements have chosen in these circumstances.
REDUCED MEMBERSHIP IN THE FEDERAL RESERVE WEAKENS THE FINANCIAL
~
The declining trend in membership is of great·concern
because, as it continues, it will inevitably weaken our financial
system in a number of ways.
Declining membership threatens to alter the character of
the Federal Reserve System as an institution away from that which
Congress originally intended.
Congress intended the nation's
central bank to provide needed liquidity and to establish sn efficient
national payments system, among other purposes.
All eommercial
banks were made eligible to participate in the governance and the
services of the regional Reserve Banks.
Membership in the System
was not restricted to national banks alone, because the System's
designers considered broad representation from all classes of banks
located in every region of the nation to be essential to the System's
functioning in the public interest.
They especially wished to
avoid over-representation by the largest banks.
Moreover, in founding
the System, Congress hoped State-chartered banks would join
_,.
-~.;ti/I"~
·:ifi order to strengthen both the Syste~he ability of the State
banks to serve their coll'lllllnities.
These purposes are as valid today as they were 65 years
ago, but continued attrition of membership could defeat these
Congressional goals.
If current trends continue, membership in the
Federal Reserve will consist predominantly of the very largest bapks
33-587 0 • 78
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Federal Reserve Bank of St. Louis
• 2
14
-7and of the smaller national banks who might choose, for one reason
or another, not to convert to state charters.
The monetary and other
policies of the Federal Reserve would then have their most immediate
impact on a relatively small part of our financial system.
MONETARY MANAGEMENT 'WEAKENED
As fewer and fewer banks, and a smaller share of the
nation's deposits, remain with the Federal Reserve System, the
ability of the System to influence the nation's money and c~edit
becomes weaker.
The discount window provides an important safety-
valve function, which enables the Federal Reserve to conduct monetary
policy effectively,
Member bank attrition means that fewer banks
have inmediate access to the discount window on a day-to-day basis.
As attrition continues, we could reach the point where there would
be a significant reduction in the financial system's flexibility in
adapting to, for example, a tightening of credit policies.
The
discount window provides individual member banks with a reasonable
period of time to make orderly adjustments in their lending and
investment policies. The cushion provided by the window facilitates
implementation of a restrictive menetary policy in a period of
inflationary demands.
The attrition in deposits subject to reserve requirements
set by the Federal Reserve also weakens the linkage between bank
reserves and the monetary aggregates,
As a larger and larger
fraction of deposits becomes subject to the diverse reserve requirements
set by the
50 states rather than by the Federal Reserve, the
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Federal Reserve Bank of St. Louis
15
-8relationship between money supply and reserves provided by the
Federal Reserve becomes less and less predictable.
Our staff has attempted to assess the extent to which
growth in nonmember bank deposits would weaken the relationship
between reserves and money.
Their tentative results are shown
in Chart X, which depicts the greater range of short-run variability
in M•l and M-2, with a given level of bank reserves, that would
develop as the per cent of deposits held by nonmembers rises.
As
more and more deposits are held outside the System, this chart
suggests that control of money through the reserve base becomes
increasingly uncertain.
Finally, it should be pointed out that fewer banks within
the Federal Reserve means that fewer institutions can be influenced
by changes in reserve requirements set by the Federal Reserve.
Changes in reserve requirements have not been a very active instrument
of monetary policy in recent years, but this was in part because of
a desire to avoid worsening the membership problem if reserve requirements were to be raised.
If the membership ~roblem could be resolved,
possibly through universal reserve requirements, adjustments in
reserve ratios might be made more flexibly when needed to affect
bank credit throughout the· country, or to influence banks' efforts
to attract particular types of deposits.
market operations in
u.s.
Moreover, while open
Government securities provide the Federal
Reserve with a powerful policy instrument, it is possible that
conditions could develop in the future--such as a less active
market for U.S. Government securities in a period of reduced Federal
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Federal Reserve Bank of St. Louis
16
-9-
budgetary deficits--where more flexible adjustment of reserve requirements might be a desirable adjunct in efforts to control the monetary
aggregates.
ADVERSE IMPACTS ON QUALITY OF BANKING SYSTEM
Not only is monetary control made more difficult by membership
attrition, but the quality of the banking system is also adversely
affected.
The Federal Reserve Act authorizes Reserve Banks to discount
paper for nonmembers, but only under "unusual and exigent" circumstances.
By the time such an emergency loan were made, therefore, the bank
would have encountered serious difficulties, and more problems could
be expected as it became known that it was in an "emergency" condition.
As a member, on the other hand, the bank would have probably begun
to borrow under regular procedures, and the development of an
emergency might have been forestalled.
The presence of the Federal Reserve in the bank supervisory
and regulatory area--a presence that becomes diluted with membership
attrition--also enhances the quality of the banking system.
The
activities of the System in that area cannot be readily separated
from its job of conducting monetary policy.
Regulatory and super-
visory policies can have important implications for monetary policy
and credit flows.
Changes in the ceiling rate on time deposits
are only the most obvious of such policies; others conc,•rn capital
adequacy, bank liquidity, international banking, and the quality
of loan portfolios.
POTENTIAL DETERIORATION IN THE PAYMENTS SYSTEM
Attrition of membership, as it continues, also threatens
to lead to a deterioration in the quality of the payments mechanism
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Federal Reserve Bank of St. Louis
17
-10-
that underlies all of the nation's economic transactions.
Reserve
balances held at Federal Reserve Banks are the foundation of the
payments mechanism, because these balances are used for making payments
and settling accounts between banks.
banks can serve the same purpose,
bia-
Nonmember deposits at correspondent
as more and more of the deposits
used for settlement purposes are held outside the Federal Reserve, the
banking system becomes increasingly exposed to the risk that such
funds might be immobilized if a large correspondent bank experienced
substantial operating difficulties or liquidity problems.
A liquidity
crisis affecting a large clearing bank would have widespread damaging
effects on the banking system as a whole because smaller banks might
become unable to use their clearing balances in the ordinary course
of business.
The Federal Reserve. of course, is not subject to
liquidity risk and therefore serves, as Congress intended, as a
completely safe foundation for the payments mechanism.
These various problems that either cause or result from
member bank attrition could be solved in a variety of ways, but we
believe the general approach embodied ins. 3304, the Federal Reserve
Requirements Act of 1978, is the most effective one under existing
circumstances,
That bill combines, with certain modifications, the
two legislative proposals recommended by the Board for promoting
competitive equality and stemming membership attrition.
The proposals
encompass universal reserve requirements on transactions accounts and
enactment of a limitation on the Board's ability to pay interest on
bank reserves held at Federal Reserve Banks.
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Federal Reserve Bank of St. Louis
While the Board of
18
-11-
course supports the approach of
s.
3304, a few minor modifications
of the bill as introduced may be desirable,
UNIVERSAL RESERVE REQUIREMENTS
The Board believes that the universal reserve requirements
provision of Title I of S. 3304 would reduce competitive inequality
between banks and other institutions insofar as transactions accounts
are concerned and would lay the basis for more effective monetary
control.
Universal reserve requirements can eliminate th~ competitive
inequality by imposing a similar reserve requirements structure on
similar institutions,
Title I of S, 3304 imposes reserve requirements
set by the Federal Reserve on transactions balances at all depository
institutions.
The first $5 million of such balances would be exempt
from reserve requirements, although a relatively small requirement
could be imposed if it proved necessary in the public interest.
This
exemption would mean that about one-third of present member banks and
about two-thirds of nonmembers would not be subject to reserve requirements on transactions accounts.
This limited extension of universal
reserves would significantly reduce competitive inequality.
The Board favors universal reserve requirements for reasons
quite.apart from the membership problem.
Universal reserves would con•
tribute to improving monetary management and to enhancing the stability
of the payments mechanism.
But it should be stressed that, while
providing for universal reserves on transactions accounts, S, 3304
does not authorize any supervisory role for the Federal Reserve System
with respect to nonmembers.
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Federal Reserve Bank of St. Louis
Indeed, the bill does not even require
19
-12nonmember institutions to establish an account relationship with the
Reserve Bank.
A nonmember's reserves could be held at a corres-
pondent bank-•or at a Federal Home Loan Bank, in the case of savings
and loan associations••and merely passed through to the Fed on a oneto-one basis by the correspondent.
Nonmembers would, however, have to
report data on their deposits and certain other items to the local
Reserve Bank for monetary management purposes.
We realize that universal reserve requirements have been
proposed before, and that the proposal raises a number of difficult
problems.
The Board continues to believe, however, that they are
necessary to help correct the competitive imbalances in our financial
system and to assure an effective monetary policy.
OTHER PROGRAM ELEMENTS
In addition to universal reserves, the Board's proposal
to promote competitive equality and stem attrition of member banks
has four other major features: reduction and restructuring of demand
deposit reserve requirements, payment ·of compensation on required
reserve balances, charges for services provided by Reserve Banks
(along with slightly broadened access to those services), and transfer
of a portion of System surplus to the Treasury during the transition
period in order to preserve the Treasury's revenue position while the
plan is implemented.
All of the provisions of the Board's plans
are described in some detail in the "Preliminary Proposal" that is
attached to this testimony, and which we would appreciate having
made part of the record of these hearings.
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Federal Reserve Bank of St. Louis
20
-13nie reduction in reserve requirements, together with the
proposed payment of interest on reserves, would about offset the
membership burden as presently measured, after allowing for charges
for services to members,
nie net annual cost to the Treasury of
this program, in the absence of universal reserve requirements, would
be about $300 million, based on deposits and reserves in 1977,
lbis
figure, of course, assumes that part of the reduction in Federal
Reserve earnings is recouped by the Treasury from banks, tpeir
stockholders, and customers in the form of taxes on increased
earnings and capital gains,
During a three-year phase-in period for the program, there
would be no loss in Treasury revenues, since the System would
reimburse the Treasury from its accumulated surplus.
After that
period, the actual loss would be considerably less than the estimated
$300 million cost of the Board's plan.
Membership attrition would
continue in the absence of a program to resolve the problem,
As shown
in Chart XI, without the program, by the fourth year continued
attrition probably would be costing the Treasury between $80 and
$210 million as a result of further declines in member bank reserves
held at the Federal Reserve.
lbus, the true cost of the program
is considerably lower than $300 million.
Moreover, should the program
increase membership, the cost would be reduced even further,
INTEREST ON RESERVE BALANCES
Title III of S. 3304 would authorize the Board to pay
interest on reserves and would limit the amount of interest that can
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Federal Reserve Bank of St. Louis
21
-14-
be paid.
The Board had suggested a limitation on interest paid,
after deducting the total amount of charges imposed for services,
of no more than 7 per cent of net earnings of the Federal Reserve
Banks in any one year.
$6 billion.)
(During 1977, net earnings were about
Title III retains the 7 per cent limitation but con-
tains a provision--in subsection (A) of that title--whose intended
effect appears unclear and could be interpreted to require that
part of the interest paid must offset charges for services on a
bank by bank basis.
The Board believes that its proposed language--
which imposes an over-all limitation on the total amount of interest
that can be paid after deducting the total of service charges
imposed--would be simpler and administratively more flexible.
Within the ov~r-all 7 per cent limitation, the Board
proposes to pay close to a market rate of interest on required
reserve balances up to $25 million in size.
On the basis of current
conditions, the proposed rate would be\ percentage point below the
average return on the System's portfolio; in 1977, the return on
portfolio would have permitted a 6 per cent rate on such reserve
balances.
Larger balances would earn interest at a 2 per cent rate.
Title III as introduced would legislate a 2 per cent
limitation on reserve balances in excess of $25 million.
The Board
does not believe that the 2 per cent limitation should be written
into law.
The proposed bill in any event contains an over-all
percentage limitation on the amount of interest payments the Federal
Reserve can make, and it is essential to retain administrative
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Federal Reserve Bank of St. Louis
22
-15-
flexibility in setting interest rates within the over-all limitation,
so that adjustments can be made as circumstances change and experience
is gained.
Mr. Chairman, thank you for the opportunity to present
the Federal Reserve's views this morning.
The problems with which
your Committee is dealing this morning are of crucial importance to
the long-run viability of the nation's central bank and to the
health of the nation's depository institutions and indeed to the
national economy.
The problems are exceedingly difficult, but I am
confident we can together find solutions that will serve the public
interest well.
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Federal Reserve Bank of St. Louis
-o-
23
Oh11U
Voluntary Chana•• In Federal RaHnra Membership
-
-
Number of banks
JOINING
- -
-
-
- -
-
40
28
+
0
-
-
20
...
-
40
-
60
WITHDRAWING
...
I
I
1971
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Federal Reserve Bank of St. Louis
I
I
1973
I
I
1976
I
I
1977
80
24
Chart][
Percentage of Banks Withdrawing from the Federal Reserve System
By Size of Bank
1970-72
Per cent
80
40
20
0
1973-75
20
0
1976-77
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Federal Reserve Bank of St. Louis
60
40
20
0
10-50
50-100
Size class (total deposits, millions of dollars)
Over 100
25
Cbattll
Percentage of U.S. Commercial Banks and
Deposits In the Federal Reaerve System
Pscent
90
80
70
eo
50
40
0
1961
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Federal Reserve Bank of St. Louis
1965
1989
1973
1977
26
Chartm
Percentage of New England Commercial Banks and
Deposits In the Federal Reserve System
Percent
90
85
BO
70
65
60
55
50
45
1961
1963
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Federal Reserve Bank of St. Louis
1965
1967
1969
1971
1973
197.5
0
1977
27
ChlltY
Relative Cash Asset Positions of Member and Nonmember Banks
Average Ratio ol Caah Aaaeta 10 Total Aaaeta
-
Ratio
.14
.13
.12
''
''
___
'
''
,__,
.11
~
''
' , ____ ,
NONMEMBERS
''
.10
''
''
' ' ...... ___ _
'
_ _ __.__.....,._ _ _ ___..___ ___.__ _ _J-._ ___..___ _ _ _ _
1971
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1973
1975
1977
~
.09
28
Chart l!I
Protltablllty of Member and Nonmember Banks
Pre-Tax Profits a• a Par Cant of Total A1Hta
Per cent
1.4
.,.,
1.3
\
\
NONMEMBERS
\
'
\
1.2
\
''
\
\
\
I
\
1.1
✓
\
✓
\
✓✓
I
✓
\
'...----✓
1.0
MEMBERS
.9
.8
1971
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Federal Reserve Bank of St. Louis
1973
1975
1977
29
Chart'D
Estimated Burden of Federal Reserve Membership
-
AGGREGATE BURDEN
MIiiions of dollars
-
300
, _ 200
, _ 100
i.....
rmmn I
I
I
I
I
AGGREGATE BURDEN AS PERCENT OF
ESTIMATED 1977 DOMESTIC PRE-TAX EARNINGS
0
-
-
--
-
Per cent
,__
.....
-
.....
-
30
20
10
,_
i.....
I
0-10
33•587 0 • 78 - 3
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Federal Reserve Bank of St. Louis
I
10-50
I
I
50-100
100-500
I
500-1000
Bank size clas&(total deposits, millions of dollars)
0
Over 1000
30
~-m
Lou
Annual
of Federal Reserve Revanuea
Dua lo Attrition Occurring Since 1870
Mllllonaofdolllrll
240)
180
120
80
40
0
1971
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Federal Reserve Bank of St. Louis
1973
1975
1977
31
Chart~
NOW Accounts aa Percentage of
Household Deposit Balances In New England
8
6
4
2
1974
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Federal Reserve Bank of St. Louis
1975
1976
32
ClllrtJ:
Effect ol Member Bank Allrlaon On Short-Run Predlctablllty ol Monetary Aggregates
Range of Unpradlctallle Y■rllllllllty
. Pen:entag■ points
18
12
8
4
..o""·.._....__..._,___,2'""0_..._,___,.__&.-_._40__,.__&.-.._....__e._o_...--J~&.--'---1e'""o_..._...__J.__L-J100
Per cent of Bank Deposits Not SUbject to Reserve Requirements
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Federal Reserve Bank of St. Louis
°
33
Chortll
Estimated Loaa of Treasury Revenues, Net of Taxes
Millions of dollars
400
350
-----------------1300
COST OF BOARD PLAN
COST OF ATTRITION
250
200
150
100
50
+
0
1979
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Federal Reserve Bank of St. Louis
1881
1983
34
7 /6/78
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
PRELIMINARY PROPOSAL
To Promote Competitive Equality Among
Member Banks and Other Financial Institutions
and to Encourage Membership in the Federal Reserve System
The continuing decline of bank membership in the Federal
Reserve System and the increasing competition between banks and other
depository institutions i~ providing payments services require prompt,
responsive measures.
This preliminary proposal is intended as a means of submitting
a program for consideration and appropriate action by Congress.
Background of the Problem
Section 19 of the Federal Reserve Act provides that member
banks of the Federal Reserve System are required to maintain reserves
against their demand and time deposits in such ratios as shall be determined by the Board within specified legal ranges.
ln order to satisfy
these reserve requirements, member banks are required to maintain
reserves in the form of vault cash and balances held in Federal Reserve
Banks.
Such balances maintained by member banks do not earn any inte.rest
at present.
By contrast, most banks that are not members of the Federal
Reserve System are permitted by State law to hold a substantial part of
their required reserves in the form of earning assets, such as United
States Treasury obligations, or in the form of balances that would be
held in the ordinary course of business in any event.
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Federal Reserve Bank of St. Louis
Consequently,
35
-2-
member banks incur a burden in the form of foregone earnings on their
required reserve balances.
As a result of the inflation of recent years and the increased
competition between banks and other depository institutions in providing
payments services, more and more banks have become aware of the burden
of membership and have determined that the benefits associated with
remaining a member bank do not outweigh the costs.
Over the past ten
Although
years, a total of 551 banks have withdrawn from membership.
many of the banks that have left the System are small, there is a growing trend among larger member banks to become nonmembers.
Of the 69
banks that left the Federal Rc,serve in 1977, 15 banks possessed deposits
in excess of $100 million.
Because of the decline in membership, the
proportion of total commercial bank deposits held by member banks has
by now been reduced to about 72 per cent.
If corrective action is not taken, a continued, probably an
accelerated, eroaion oi membership and of deposits subject to regulation by the Federal Reserve can be expected.
This threatens to weaken
the nation's financial system, as more and more of the nation's pay-
ments and credit transactions are handled outside the safe channels of
the federal Reserve, as fewer and fewer banks have immediate access tc,
Federal Reserve Bank credit facilities, as a national presence in bank
supervisory and regulatory (unctions becomes increasingly Jiluteds and
as implementation of monetary policy t,ecomes more difficult.
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Federal Reserve Bank of St. Louis
36
-3-
Proposed Legislation for Universal Reserve Reguirm,nt•
In order to promote fair c0111petition among -ber banks and
other depository institutions and to stem the decline in deposits subject to reserve requirements of the Federal Reserve, the Board will
transmit to Congress proposed legislation that would require all depository institutions to maintain reserves against transactions accounts
in accordance with requirements set by the Federal Reserve.
If uniform,
universal reserve requirements on transactions balances become effective,
c0111petition among banks and other depository institutions would be on a
more nearly equal basis.
The Board's proposed legislation would make transactions
accounts--such as demand deposits and N<M (negotiable order of withdrawal) accounts--at all Federally insured depository institutions
subject to reserve requirements set by the Federal Reserve.
However, a
total of $5 million of transactions accounts at these institutions,
whether members or nonmembers of the Federal Reserve, would not be subject
to the basic reserve requirements.
The proposed legislation also
adjusts the existing 3 to 10 per cent statutory range for reserve ratios
on time and savings deposits at member banks.
A reduction in the range to 1/2
of 1 to 10 per cent is proposed for time and savings deposits other
than transactions accounts to provide needed flexibility that would
enable member banks to c0111pete in this area on a more nearly equal basis
with other depository institutions.
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Federal Reserve Bank of St. Louis
37
-4-
The Board simultaneously is considering a program, described
below, whereby the Federal Reserve would charge for certain of its
services and would pay some compensation for required reserve balances.
However, if Congress enacts a requirement for universal reserves, the
Board would need to reconsider whether, and to what extent, its
proposed program of service charges and reserve compensation might
need to be adjusted in light of the effects of such legislation on
Federal Reserve membership, operation of the payments system, and
monetary control.
Proposed Federal Reserve Program
In view of the increasingly acute problems associated with
the decline in membership in the Federal Reserve System that is
attributable to the bucden imposed on member banks by competitive
inequality, the Board is also considering a program with the following
principal elements:
(1) restructuring and reduction of demand deposit
reserve requirements, (2) charging for services provided by the Federal
Reserve, (3) compensating for required reserve balances held at
Federal Reserve Banks, and (4) transfe~ring part of Federal Reserve
surplus to Treasury during a transition period to offset any Treasury
revenue loss.
The program would provide time for Congress to consider
the iasue of payment of interest on required reaerve balances.
If
the Federal Reserve is not able to pay interest on reserves, or
otherwise remove the burden of membership, it would not be feasible
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Federal Reserve Bank of St. Louis
38
-5-
to charge for services offered by Federal Reserve Banks.
A portion
of reserve balances held by member banks with Federal Reserve Banks
in effect represents payment for these services under current circum•
stances.
Chargtng for the services, without compensating banks for
the reserves held, wo~ld simply increase the burden of membership
and exacerbate competitive inequality.
Reserve Requirement Actions.
Under the proposed program, the
Board would amend Regulation D (Reserves of Member Banks) to simplify
the structure of reserve requirements.
The proposal would also redefine
a reserve city and impose reserve city reserve requirements on member
banks with net demand deposits in excess of $600 million (compared
to $400 million at present).
The structure of reserve requirements
would be revised in two phases as follows:
Present
Proposed
First phase
Size Class
U million)
0-2
2-10
10-100
100-400
over 400
Reserve
Requirement
7%
9\%
11!%
12\%
16.\;%
Size Class
U million)
0-10
10-200
200-600
over 600
Second phase
Reserve
Requirement
7%
91,%
12\%
Reserve
Require•
Size Cla~s
!~ million)
__!!!!!L_
0-200
200-600
over 600
7%
10%
16\%
16\%
It is anticipated that these actions would have the effect of releasing
approximately $5 billion in reserves on an annual basis, with about
$2! billion released by the initial adjustment.
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Federal Reserve Bank of St. Louis
39
-6-
Charges for Federal Reserve Servieep,
in the program relates to charging for services rendered by the
Federal lleserve,
member banks for
'l'he Federal Reserve does not
service ■
generally charge
now
it renders in view of the 1ub1tantiel
burden of membership preaently incurred by banlta.
Mellber banks "pay"
for Federal haerve services through the uinteunce of reserve
balance ■
with Reserve Banks.
Nonmember beaks are now permitted to
use a limited number of Federal Reserve
service■
at no charge.
Competitive equity between member beaks and nonmellber
iutitution1 requires that all users of Federal Reserve service, be
subject to
charge■
established on the same ba•is;
Moreover, such
charges.might encourage more efficient use of check clearing
facilities and prnide incentives for innovations that reduce co1ta,
With explicit pricing, therefore, the
opportunitie■
of tbe private
sector to compete with and improve upon Federal Reserve services
-uld be enhanced,
In order to assure continued efficient functioning of the
payments mechanism and to avoid major diaruption during the
tran■ i
tiO'n to a more C0111petitive environment, the Board would follCllf •
couervative nd flexible approach in
aeaerve services,
charges
■hould
e■ tabliahiag charge■
Fner■ l
To thia end, the System haa concluded that its
be competitive with
tho■ e
(when available) in the private sector,
retain flexibility to alter charges or
Met its reaponaibilities to maintain a
1arvice for the ution
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Federal Reserve Bank of St. Louis
for
a,•
for co,.arable
■ervicea
However, the Board would
■ervice
policies in order to
■atisfactory,
whole and to encourage
basic level of
innovation■,
40
The Board would use the following general principles as
guidelines for establishing a price structure:
1.
Each Federal Reserve service category for which charges
are to be assessed would usually have separate prices
by geographtc area, activity, and class of work processed.
The price schedule would employ explicit per item charges
and be as simple as possible.
Prices would be adjusted
as the System gained experience with service charges and
observed their effects in the markets in which the System
operates.
2.
The System does not contemplate significant alterations
in services provided at the time charges initially are
imposed.
However, after charges are in place, some offices
might find it necessary to revise their opera~ing policies
and prices to maintain competitiveness and to enable the
System to maintain a basic level of service nationwide.
3.
All users in the same pricing zone (typically a Federal
Reserve Bank, Branch or office area) would pay the same
price for a given service.
However, identical services
might not be provided in all areas.
More specifically, guidelines established by the Board for
the pricing of Federal Reserve check and automated clearing house
(ACH) services would include the following:
a.
Charges for check services would be imposed on depositing
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Federal Reserve Bank of St. Louis
institutions.
41
-8-
b.
l'Tices for interoffice items deposited locally might
include both a local processing charge and a uniform
national charge.
c.
Charges for automated clearing house (ACR) itema could
either be imposed on ACR associations or directly on
financial institutions using the service.
d.
l'Tices for automated clearing house services would be
set to encourage the use of such services and to
reflect mature volume levels.
It is anticipated that schedules of charges for System
services would be announced for public co11111ents, and implemented
in two phases:
First phase:
Charges for Federal Reserve payments services,
including check processing, check transportation,
and automated clearing house services.
Second phase:
Charges for certain other services, including
shipping of coin and currency to member banks,
transfer and settlement of reserve baiances,
and purchase, sale, safekeeping and clearing of
securities.
Based on the present volume of Federal Reserve Bank activity,
and on the direct and indirect coats incurred by the System, it is
estimated that charges imposed for System services would result in
revenue to the Federal Reserve of approximately $225 million annually
in the first phaae and about $410 million annually thereafter. 'l'he
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Federal Reserve Bank of St. Louis
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-9Federal Reserve does not anticipate imposing charges for governmentaltype functions it performs, such as conducting bank examinations
and monetary policy and certain activities associated with issuance
and destruction of Federal Reserve notes.
Access to Federal Reserve Facilities.
At present, Federal
Reserve Banlcs maintain virtually no accounts for nonmember depository
institutions.
However, nonmember institutions may-have access to
Federal Reserve operated automated clearinghouse facilities (ACH's).
Nonmember commercial banks may also deposit intra-regional checks
and drafts at Federal Reserve regional check processing centers
(RCPC's).
When charges are imposed for payments services under the
proposed program, the Federal Reserve would permit all nonmember
depository institutions with third party payment powers to deposit
intra-regional checks and drafts at RCPC's.
Nonmembers would pay the
same charges as member banks for services rendered by the Federal
Reserve, and would continue to be required to settle through reserve
accounts of member banks.
Once the proposed program has been fully implemented, and
the Federal Reserve has evaluated the impact of the program on membership and on the functioning of the payments mechanism, the System
expects to provide direct and full access for nonmember depository
institutions to payments and other operational services provided by
Federal Reserve Banks.
Access would be provided on the basis of
equality of treatment with respect to balances held by members and
nonmembers; balances held by nonmembers would be equivalent to the
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Federal Reserve Bank of St. Louis
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-10-
reserve balances of members and such funds would receive similar
compensation.
Compensation for Maintenance of Reguired Reserves.
The
third element in the Federal Reserve's proposed program relate• to
compensating member banks for the maintenance of required reserve
balances with the Federal Reserve.
Member banks are at a clear
competitive disadvantage because nonmember banks generally may
satisfy reserve requirements by holding interest bearing assets
or balances that would be held in the ordinary course of business
in any event, and this disadvantage contributes substantially to the
erosion of membership.
In order to reduce this inequality and to
prevent further erosion in membership, the Federal Reserve believes
it would be appropriate to compensate member banks by paying interest
on required reserve balances.
However, in no case would the amount
of compensation paid to member banks after deducting service charges
collected exceed 7 per cent of the net earnings of Reserve Banks
(before payment of compensation).
Toe Board will submit to Congress
proposed legislation to formalize this limitation on the bank payment
of interest on required reserve balanc~s.
11te Board proposes to phase in the payment of interest
on required reserve balances of member banks concurrent with the
imposition of charges for System services in accordance with the
following schedule:
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-11First phase:
Payment of interest on all required reserve balances
maintained at Federal Reserve Banks at a rate of 2
per cent per annum.
Second phase:
Rate of interest payable would be increased to\
percentage point below the average return on the
Federal Reserve System portfolio, valued at book,
for the first $25 million of required reserve
balances at Federal Reserve Banks.
Based on the
1977 return on the Federal Reserve portfolio, the
rate of compensation on those balances would be 6
per cent per annum.
The rate of interest payable
on required balancee held at Federal Reserve Banks
in excess of $25 million would be 2 per cent per
annum.
The Board estimates that interest payments to member banks
would amount to about $430 million in the first phase and about
$765 million annually thereafter, based on the current level of
member bank deposits.
Effect on Treasury Revenues.
Since 1947, the Federal Reserve
has paid almost all of its net earnings to the United States Treasury.
A portion of these earnings are attributable to the non-interest
earning required reserve balances that member banks hold at Federal
Reserve Banks.
Nonmember institutions do not hold such balances and
thus their reserve holdings are not a source of Treasury revenue.
program being proposed by the Board would substantially reduce this
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Federal Reserve Bank of St. Louis
The
45
-12unequal "tax" borne by member banks.
At the same time the Board
recognizes the budgetary need to maintain Treasury revenues.
·The Board estimates that adoption of the proposed program,
in the absence of universal reserve requirements, would in itself
result in a cumulative net reduction in United States Treasury
revenues on the order of $575-million over a transition period of,
for example, about three years,until the program would be fully in
place.
To eliminate this anticipated loss of revenue during the
transition period, the Federal Reserve would transfer an equivalent
amount of its surplus to the Treasury.
The Federal Reserve's
program, therefore, would not result in any net reduction in the
level of revenues received by the Treasury during the iaiplementation
period.
With the program fully in place, the net cost to the Treasury
would be expected to be minimal, if there were any cost at all.
Although Treasury revenues would be reduced by about $300 million
per year as a consequence of the actions in this program, there would
have been, in any case, a substantial decline of Treasury revenues in
the absence of the program.
At a minimum, if attrition in deposits
subject to Federal Reserve reserve requirements continued over the
next four years at the average rate of the recent past, Treasury
revenues would be reduced by about $80 million in the fourth year
and would increase further thereafter.
If the rate of attrition
were at the more rapid pace experienced in New England in recent
year■,
the losa in Treasury revenues would be about $200 million by
the fourth year.
33-587 0 - 78 - 4
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Federal Reserve Bank of St. Louis
The program could be expected to reduce, 1f not
46
-13-
eliminate, such attrition in deposits.
There might even be a gain
in Treasury revenues if the program succeeds in increasing membership.
The gain in revenues would be more pronounced if Congress
enacted the Board's proposed universal reserve requirement legislation.
Result of the Proposal
The Board believes that implementation of the program
presented in this statement is essential to the continued maintenance
of a sound financial system.
Implementation of its various elements
should result in an environment in which financial institutions can
compete on a more equitable basis·, should arrest the decline of bank
membership in the Federal Reserve System, and should facilitate the
implementation of monetary policy.
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Federal Reserve Bank of St. Louis
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[S. 3304, 911th Cong., 2d sess.]
A BILL To amend the Federal Reserve Act to provide for the maintenance of reserves for
certain institutions ; to require the imposition of charges for certain services by Federal
Reserve banks; to authorize the payment of interest on reserves held in Federal Reserve
banks ; and for other purposes
Be it enacted, by the Senate and H01tse of Representatives of the United States
of America in Congress assembled, That this Act may be cited as the "Federal
Reserve Requirements Act of 1978".
TITLE I-RESERVE REQUIREMENTS OF MEMBER BANKS AND OTHER l>EPosITOBY
INSTITUTIONS
SEC. 101. The first section of the Federal Reserve Act, as amended (12 U.S.C.
221), is amended by adding at the end thereof the following new paragraphs:
"The term 'depository institution' means"(1) any insured bank as defined in section 3 of the Federal Deposit
Insurance Act ;
"(2) any mutual savings bank as defined in section 3 of the Federal
Deposit Insurance Act;
"(3) any savings bank as defined in section 3 of the Federal Deposit
Insurance Act ;
" ( 4) any insured credit union as defined in section 101 of the Federal
Credit Union Act;
"(5) any member as defined in section 2 of the ll'ederal Home Loan Bank
Act;
"(6) any insured institution as defined in section 401 of the National
Housing Act ; and
"(7) for the purpose of 11ection 13 and the fourteenth paragraph of section
16, any association or entity which is wholly owned by or which consists only
of institutions referred to in clauses (1) through (6).
"The term 'transaction account' means a deposit or account on which the
d·epositor or account holder is allowed to make withdrawals by negotiable or
transferable instrument or other similar item for the purpose of making payments to third persons or others. Such term includes demand deposit, negotiable
order of withdrawal, and share draft accounts.".
SEC. 102. Section 19(a) of the Federal Reserve Act, as amended (12 U.S.C.
461), is amended by adding at the end thereof the following: "In order to prevent
evasions of the reserve requirements imposed by this Act, after consultation
with the Board of Directors of the Federal Deposit Insurance Corporation, the
Federa,l Home Loan Bank Board, and the Administator of the National Credit
Union Administration, the Board of Governors of the Federal Reserve System is
further authorized to determine, by regulation or order, that an account or
deposit is a transaction account wihere such account or deposit may be used to
provide funds directly or indirectly for the purpose of making payments or
transfers to third persons or others.".
SEO. 103. The last sentence of subsection (b) of ·section 19 of the Federal
Reserve Act, as amended (12 U.S.C. 461), is designated as paragraph (7) and
that part of subsection (b) that precedes that sentence i8 amended to read as
follows:
"(b) (1) Except as provided in paragraph (4), every depository institution as
defined in section 1 of the Federal Reserve Act, as amended (12 U.S.C. 221), shall
maintain reserves against its demand deposits at such average ratio of not less
than 7 per centum nor more than 22 per centum, as shall be determined by the
Board.
"(2) Except as provided in paragraph (4), every depository institution as
defined in section 1 of the Federal Reserve Act, as amended (12 U.S.C. 221), shall
maintain reserves which shall be at the same level for all depository institutions
against all other transaction accounts at such average ratio of not less than 3
per centum nor more tll.an 12 per centum, as shall be determined by the Board.
"(3) Every member bank shall maintain reserves against its time deposits and
savings d-eposits (other than negotiable order of withdrawal accounts) at such
average ratio of not less than one-half of 1 per centum nor more than 10 per
centum, as shall be determined by the Board.
" (4) A total of $5,000,000 of transaction accounts of a depository institution
shall not be subject to the reserve requirements of this section, subject to such
rules and regulations as may be adopted by the Board. However, the Board
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Federal Reserve Bank of St. Louis
48
may impose reserve requirements on such transaction accounts at such average
ratio of up to 7 per centum if determined to be appropriate in light of general
liquidity, considerations of monetary policy, or other relevant conditions prevailing in the banking system.
"(5) Every depository institution as defined in section 1 of the Federal Reserve
Act (12 U.S.C. 221) shall make reports concerning its deposit liabilities and
required reserves at such times and in such manner and form as the Board may
require.
"(6) (a) For purposes of determining the reserve requirements of a depository
institution established after June 30, 1978, which is an affiliate of a depository
institution subject to the reserve requirements of this section, the transaction
accounts of such newly established depository institutions shall be added to
the total transaction accounts of such affiliated depository institution.
"(b) In addition to its authority under section 19(a), the Board is authorized
to determine, by regulation or order, the affiliated depository institution to
whose transaction accounts the transaction accounts of a depository institution
established after June 30, 1978, shall be added for purposes of this provision.".
SEC. 104. With respect to any depository institution that is not a member of
the Federal Reserve System on June 30, 1978, the required reserves imposed
pursuant to subsection (a) against its transaction accounts on the effective
date of this Act shall be reduced by 75 per centum during the first year that
begins after the effective date, 50 per centum during the second year, and 25
per centum during the third year.
SEO. 105. (a) Section 19(c) of the Federal Reserve Act, as amended (12
U.S.C. 461), is amended to read as follows: "Reserves held by any depository
institution to meet the requirements imposed pursuant to subsection (b) of
this section shall be in the form of" ( 1) balances maintained for such purpo!?es by such depository institution
in the Federal Reserve bank of which it is a member or at which it maintains an account. However, the Board may, by regulation or order, permit
depository institutions to maintain all or a portion of their required reserves
against their transaction accounts in the form of vault cash: Provided,
That such proportion shall be identical for all depository institutions ; and
"(2) balances maintained by a nonmember depo~itory institution in a
member bank or in a Federal home loan bank maintains such funds in the
form of balances in a Federal Reserve bank of which it is a member or at
which it maintains an account. Balances received by a member bank from
another depository institution that are used to satisfy the reserve requirements imposed on such depository institution by this section shall not be
subject to the reserve requirements of this section imposed on such member
bank and shall not be subject to assessment imposed on such member bank
pursuant to section 7 of the Federal Deposit Insurance Act, as amended
(12 U.S.C.1817) .".
(b) Section 19(f) of such Act, as amended (12 U.S.O. 464), is amended by
deleting "member bank" and inserting in lieu thereof "depository institution".
SEO. 106. (a) The Federal Reserve Act is amended by inserting after section 11
(12 U.S.C. 248) the following new section:
"SEo. 11A. (a) Not later than July 1, 1979, the Board of GovE-mors shall have
prepared and sh-all publish ~r public comment a set of pricing ·principles and a
propoi:;ed sehedule of fees for Federal Reserve System servicPs ; and not later
than July 1, 1980, the Board shall put into el'l'ect a schedule of fees for such services which is based on those principles. Except that the Boa-rd may put into pl'f'ect
fees for some of such services prior to July 1, 1980, but after July 1, 1979, if it
determines such action to be appropriate.
TITLE II-CONFORMING AMENDMENTS AND EFFECTIVE DATE
SEC. 201. Section 5A of the FPderRl Home Loan Bank Act. RR amended (12
U.S.C. 1425a), is amended by redesignating subsection (f) as subsection (g) and
by inserting before such subsection, as redesiguated, the following new
subsection:
"(f) Every institution which is a member or is an insured irn'!titution as defined
in section 401(a) of title IV of the National H,omdng Act (12 U.S.C. 1724(a))
shall maintain -reserves agRinst its transaction a<'COunts as defined in Rection 1 of
the Federal Reserve Act (12 U.S.C. 221) in accordance with the.provisions of section 19 of the Federal Reserve Act (12 U.S.C. 461) in amounts not less than such
percentages of its aggregate amounts of such deposits or accounts as may be
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Federal Reserve Bank of St. Louis
49
prescribed under section 19(b) of-the Federal Reserve Act (12 U.S.C. 461) by the
Board of Governors of the Federal Reserve System.".
SEc. 202. Section 116 of the Federal Credit Union Act, as amended (12 U.S.C.
1762), is amended by adding at the end thereof the following new subsection:
"(c) Each insured credit union shall maintain reserves against its transaction
aCC'Ounts as defined in section 1 of the Federal Reserve Act (12 U.S.C. 221) in
accordance with the provisions of section 19 of the Federal Reserve Act ( 12 U.S.C.
461) in amounts not less than such percentages of its aggregate amounts of such
deposits or accounts as may be prescribed under section 19(b) of the Federal
Reserve Act (12 U.S.C. 461) by the Board of Governors of the Federal Reserve
System.".
SEC. 203. (a) The first paragraph of section 13 of the Federal Reserve Act (12
U.S.C. 342) is amended as follows:
(1) by inserting after the words "member banks" the words "or other
depository institutions" ;
(2) by inserting after the words "payable upon presentation" the first and
third times they appear, the words "or other items, including negotiable
orders of withdrawal or share drafts" ;
(3) by inserting after the words "payable upon presentation within its
district," the words "or other items, including negotiable orders of with•
drawal or share drafts";
( 4) by inserting after the words "nonmember bank or trust company,"
wherever they appear the words ''or other depository institution" ;
(5) by striking the words "sufficient to offset the items in transit held for
its account lby the Federal Reserve bank" and inserting in lieu thereof the
words "in such amount as the Board determines taking into account items in
transit, services provided by the Federal Reserve bank, and other factors as
the Board may deem appropriate" ; and
(6) by inserting after the words "nonmember bank" after the second colon
the words "or other depository institution".
(b) The thirteenth paragraph of section 16 of the Federal Reserve Act (12
U.S.C. 360) is amended as follows:
(1) by striking out the words "member banks" wherever they appear and
inserting in lieu thereof "depository institutions" ;
(2) by striking out the words "member bank'! wherever they appear and
inserting in lieu thereof "depository institution" ; and
(3) by inserting after "checks" wherever it appears the words "and other
items, including negotiable orders of withdrawal and share drafts".
(c) The fourteenth paragraph of section 16 of the Federal Reserve Act (12
U.S.C. 248(0)) is amended by striking out "its member banks" and inserting in
lieu thereof "depository institutions".
SEc. 204. The provisions of this Act shall become effective one year after the
date of enactment.
TITLE Ill-AUTHORITY FOR PAYMENT OF INTEREST ON RF.SERVES
SEc. 301. Section 13 of the Federal Reserve Act ls amended by adding at the
end thereof the following new paragraph :
"Subject to such limitations, restrictions, and regulations as the Boa-rd of Governors may prescribe, the Federal Reserve banks are hereby authorized to pay
interest on balances held in any Federal Reserve bank pursuant to section 19(b)
of this Act. The total amount of such interest paid with -respect to any year shall
not exceed the sum of the following items computed with respect to the same
year:
"(A) total receipts by Federal Reserve banks from the recipients of such
interest fur services rendered to such recipients by such banks, and
"(B) 7 per centum of the total net earnings of the Federal Reserve banks
computed without regard to the payment of such interest.
The rate of interest paid under this section shall not. exceed 2 per centum per
annum with respect to required balance in excess of $25,000,000 held at Federal
Reserve banks.".
The CHAIRMAN. That's fine. I want t.o thank you very much for a
masterful summary of a complicated presentation. I very much appreciate it. Also the note on which you ended is most congenial.
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I agree with you wholeheartedly that mandatory reserves :for aJ.J
but smaller depository institutions makes sense. Incidentally, I have
here a letter from Secretary of the Treasury Blumenthal to the House
Banking Committee chairman who says, in part,
The Treasury believes that the requirement 9f mandatory reserves for all but
small depository institutions is ·the preferable method of dealing with that
problem.
Now, universal reserve requirements have been proposed before
sometimes with membership required and other times without mandatory membership. Your proposal is just for universal resel'Ve :requirements without membership. Why¥ Does this mea.n membership is not
essential to the Federal Reserve operations but universal reserves are¥
Mr. Mn.LER. Senator, what we are seeking is equity in financia'I
competition among fina.ncial institutions. We are aware that, in seeking that w>al, there is no reason for the Federal Reserve to preempt or
monopolize the process of bank examination or supervision which is
now ha.ndled by-, a dual ban'!rimr structure.
We were trying to preserve tne dual banking s;rstem and, at the same
time, to look at the problem from the point of view of both fairness in
competition a.nd the better monetary control that would result from
greater control over deposits. Membership, per se, is not an essential
concept. Central ba.nks m other parts of the world operate on the basis
that banks must conform to the central ba.nk's monetary control a.nd
monetary policy, and that the central ba.nk must be able to assure the
safeness and soundness of banks and other financial institutions and
the backup of liquidity in times of stress. Those functions ca.n be performed without requiring memberhi:p, a.nd they can be performed, in
this case, without in any way changmg the nature of the dual banking system.
The CHAIRMAN. I think that was an excellent a.nswer except for one
part of it, which I think was implied there. How about the very last
part-universal reserves you say would be essential. You implied that.
Mr. Mn.LER. Universal reserves is the only system I know of that
solves the problem of fairne:;s once a.nd for all. What we have n<>w of
course-as this committee well knows-is a logical trend of financial
institutions developing payment services and performing other functions that have, in the past, been restricted to banks. We have the new
development of NOW accounts. We have share drafts develo_ped by
credit unions, which means that credit unions are holding dema.nd
deposits and providing checking a.ccounts. Ma.ny mutual savings banks
are now authorized by State law to offer checking account services, and
we can expect savings and loans to begin to creep into these new areas
of service.
So the fairest system would be universal reserves. It's not the only
way to go, and I would not want to mislead you, Mr. Chairman, by
saying it is. The other way to go, if we maintain the concept of membership-and this was the alternate proposal by the Federal Reserve-is to reduce the burden of membershi,e so that members could compete
fairly with other institutions. That is the reason for the suggestion
of limited payment of interest on reserves, controlled by Congress.
If we do not have universal reserves, at least the cost or burden of
being a member as compared to a nonmember would be more equitable.
The CHAmMAN. By and large, interest on reserves would be a (ID.Ore
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Federal Reserve Bank of St. Louis
51
equitable way. Everybody would be treated alike and it would solve
the problem once and for all, as you say, because there would be no
question of the universality and any possible erosion of this degree
of monetary policy effect.
Mr. MILLER. The preferable solution, if at all possible, is universal
reserves. A fallback position or an alternate solution is workable,
but not as fair.
The CHAIRMAN. Now it's sometimes argued that the reserve requirements structure currently in place weakens monetary policy because
the reserve multiplier is difficult to predict. Your chart 10 indicates
that that might become increasingly the case as fewer and fewer institutions become subject to reserve requirements. Your proposal would
simplify the structure somewhat but not completely.
Why shouldn't reserve requirements on the same type of deposit
liabilities be the same for all banks and other depository institutions,
exept the small institutions i
Mr. MILLER. You're correct; there certainly would be merit in looking at ways to simplify the structure toward more uniform reserve
requirements as well as universal requirements. When we're talking
about uniform reserves, we mean that regardless of the size of institution, required reserves would be the same for the same class of
liability. I would agree with you on taking that direction.
The CHAIRMAN. Chairman Reuss has proposed another solution
to the Federal Reserve problem. His new bill would have universal
reserve requirements against all deposits at banks with total deposits
of $100 million or more and set that, as you know, at 6½ percent, and
for banks with less than $100 million the reserve requirements would
be set at zero percent..
Have you commented to Chairman Reuss on his proposal and, if
so, what 1s the Board's view of it i
Mr. MILLER. Senator, let me go back just a moment. On Friday afternoon we had a discussion with Chairman Reuss on his proposal. The
final version of his bill, I believe, was introduced on Friday, and we
had the benefit of an extended session with him on Friday. Over the
weekend, our staff studied his proposal; last night we held a meeting
of the Board of ·Governors; and this morning we submitted to the
House committee our comments on his proposal. We find a good
deal of merit in much of the proposal.
There R,re a few areas where we feel that it would be desirable-indeed, highly desirable--to make some further adjustments. If you
would like, I could tick those off. Otherwise, I can submit a copy of
our letter, which is just off the press, for the record.
[The letter and attachments follow:]
Fli:DERAL RESERVE SYSTEV,
HON. HENBY S. REUSS,
Washington, D.O., August 14, 1978.
Ohairma.n, Oomm,ittee on Banking, FinGnce and Urban Affairs,
House of Representam,es,
Washington, D.O.
DEAB CHAIIWAN REUSS: The Board believes that H.R. 13847 represents a
patentially constructive approach t.o promoting competitive equality among
banks and to facilitating implementation of monetary palicy. However, in our
view, certain modifications of the proposed bill are essential for reasons dis.cussed
below.
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SECTION 2 OF THE BILL ON REPORTING REQUIREMENTS
Certain minor changes in this section would be desirable. They are shown, in
attachment A, as copy in bold brackets for deletions and italic type for insertions.
SUBSECTION (r) (1) THROUGH (r) (4) QN RESERVE REQUIREMENTS AND EXEMPTIONS
These subsections of H.R. 13847 change the reserve requirement structure in
the Federal Reserve Act by placing the same reserve requirements on virtually
all domestic liabilities of banks, apply this reserve requirement to nonmember
banks, but exempt the first $100 million of these liabilities at each bank-member
or nonmember-from reserve requirements. Certain changes in these provisions,
however, would enhance the effectiveness of monetary policy.
For purposes of reserve requirement policy, it is essential to distinguish
between demand and savings deposits, on the one hand, and time deposits, on
the other. A shift to a uniform reserve requirement for demand and savings
deposits is reasonable at this time because savings deposits are beginning to be
employed more actively in the payments mechanism, and this tendency wHl
become much more marked after November 1, when automatic transfers from
savings deposits to demand deposits are permitted. However, a reserve requirement range and structure for time deposits different from demand and savings
deposits is needed for the following reasons:
("a) Time deposits, particularly shorter~term instruments, are used by banks
in liability management to expand or contract bank credit. Reserve requirement
flexibility in this area would permit the Board to affect the cost and volume
of bank credi.t without affecting expansion in the basic money supply. This
suggests the need for a fairly broad reserve requirement range on time deposits,
particularly for shorter-term time deposits.
(b) Longer-term time deposits are not transactions-type balances, but are more
in the nature of financial investments. Thus, for monetary policy purposes, the
reserve requirement can be relatively low ·and the range of permissible reserve
ratios limited.
(c) A reserve requirement on time deposits as low as 1 per cent-which is
the ratio that the Board would initially expect to impose-would wo_rk to offset
the increased reserve burden from raising the reserv:e ratio on savings deposits
as contemplated under thi~ bill
H.R. 13847 also requires that reserve requirements be imposed on "net Federal
funds and other borrowings" which mature in 48 hours. The Board currently has
authority to define such sources of funds as deposits for reserve requirement
purposes. The impact of such a change needs further study because imposing
reserve requirements on those borrowings would represent a drastic change in
banking practices and would also a1fect the U.S. Government securities market
( since a signifl.cant portion of these borrowings are repurchase agreements
against U.S. Government securities). Under these circumstances, it would not
seem desirable for the bill to require the imposition of reserves on such borrowings. However. if the bill did have such a requirement, it might best be confined
to borrowing by banks from sources other than commercial banks, and the
applicable ratio might be the same as that on time deposits. A reserve requirement on interbank borrowings would unduly inhibit the present institutions
arrangements for smoothly distributing available reserves through the banking
system.
The proposed bill exempts the first $100 million of reservable liabilities from
reserve requirements, and indexes the future level of exemption to the rate of
growth in nominal GNP. The Board is troubled by these provisions. With regard
to exemption level, the Board strongly urges a $25 million exemption for the
total of demand and savings deposits and another $25 million for time deposits-yielding a total exemption of $50 million. Such an exemption would mean that
74 per cent of total bank deposits would be at institutions required to hold
reserves set by the Federal Reserve, virtually the same as now. It would exempt
about 3.850 members from reserve requiremPnts and would impose requirements
on about 1.170 nonmembers. or 13 pei; cent of total nonmember banks.
Economic and monetary policy concerns argue strongly against indexing of the
exemption level, quite apart from the administrative complexity of an indexing
system. With an exemption totallini? $50 million the percPntage of deposits subject to reserve requirements would be at a barely satisfactory level for purposes
of monetary control. That exemption also increases the risk of disruptions in the
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Federal Reserve Bank of St. Louis
53
payments mechanism because of the sharp cut in the number of banks required
to hold cash reserves, and some of these banks are sizable enough to perform
clearing functions at least on a regional basis. While these risks might be acceptable initially to achieve the over-all benefits of the bill, the indexing proPoSal in
the bill would probably preclude any improvement over time. Indeed, dt may well
worsen the situation since reservable bank deposits could well grow less rapidly
than nominal GNP as a result of increased competition for transactions and other
balances from nonbank depository institutions, which have a higher interest rate
ceiling on deposits. However, if the Committee wishes to legislate some automatic
adjustment of the $25 million exemption level, that level migbt be indexed to the
rate of growth in real GNP, which would allow for future normal expansion in
the economy.
The Board suggests that section (b) (1) of the bill be amended to include only
demand and savings deposits as reservable liabilities for purposes of that section,
to remove the indexing of the exemption, and to set the size of the exemption at
$25 million for these liabilities. An amendment to this effect is shown as attachment B.
To provide some added flexibility for monetary policy, and to set the reserve
requirement ratio initially at a level that is not excessively costly to the Treasury,
given the proposal for time deposits to be described below, it is also suggested that
the language of aubsection (b) (4) (A) be amended in accordance with attach•
ment C. This amendment has the effect of imposing an 8 percent reserve require•
ment on the total of reservable demand and savings deposits, and provides :flexi•
bility to vary this ratio between 7 and 9 percent.
Attachment D suggests an amendment to subsection (b) (4) (B) that would
generalize the authority now contained in that subsection, which gives the Board
some added reserve requirement flexibility. In light of the Board's recommenda•tion to distinguish time deposits from demand and savings deposits for reserve
requirement purposes the proposed amendment is technically necessary to apply
the authority to all classes of liabilities subject to reserve requirements.
To allow for the separate reserve requirement on time deposits •the Board proposes a new subsection (b) (5)-with present subsection (b) (5) !being appropriately renumbered. This proposed subsection, shown in attachment E, would permit an average reserve requirement range of 1 to 6 percent for time deposits with
initial maturities of 179 days or less, and a range of 1 to 3 percent for longer-term
time deposits. Suggested language that would encompass borrowings other than
from commercial banks is shown in brackets, should the Oommittee wish to
legislate reserve requirements on such funds. The first $25 million of all lia•
bilities in this subsection would be exempt.
SUBSECTION (7) ON THE DISCOUNT WINDOW
A broader access to the discount window, as is contemplated in H.R. 13847, is
desirable because it would enhance the liquidity of the banking system. Subsection (7) of H.R. 13847 provides access to the discount window for nonmember
banks exempt from reserve requirements upon certification of the FDIC or appropriate State supervisory authorities that access is needed to enable the bank to
function on a safe and sound basis in meeting the needs of the local community.
'J'his proposal appears unnecessarily complex, and the Board suggests that nonmember ban.ks exempt from reserve requirements be given access to the discount .
window on the same basis as member banks and as nonmember banks not exempt
from reserve requirements, provided that access may be conditioned on a certification of solvency from the FDIC. A proposed amendment to that effect is shown
in attachment F.
TRANSACTIONS BALANCES AT NONBANK DEPOSITORY INSTITUTIONS
The Board believes that it is important for equity and monetary police purposes to impose reserve requirements on •transactions balances at nonbank depository institutions. Such balances are likely to become an increasingly large
proportion of the nation's basic money supply. It is more practical to place reserve requirements on such balances now, when very few institutions would have
to hold reserves,' than at a later point when the imposition of reserves would
place a substantial transition cost on the individual institutions. Proposed language that would accomplish 'this objective is shown in attachment G.
1 Only about ftve nonbank depository instltutlons would be subject, lf the exemption
were $25 million.
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PHASE-IN
To ease the transition to reserve requirements on existing nonmember banks,
a suggested ·amendment that would phase in reserve requirements over a four
year period is shown in attachment H.
AFFILIATED INSTITUTIONS
Exempting a total of $50 million in deposits from reserve requirements provides a particularly strong incentive for ,banks to form new, affiliated commercial
banking entities in order to avoid reserve requirements. A !bank as large as $50
million would already enjoy many of the economies of scale, ,and thus the cost
of creating new banks would be small relative to the benefit of avoiding reserve
requirements.
It is proposed, therefore, that affiliated commercial banks have only one
1•xemption for each category of deposits. Should the Committee adopt the proposal for transactions balances at nonbank depository institutions, a similar
limitation should be imposed. Attachment I provides such language.
If the Committee wishes to provide relief from this proposal for existing affiliated institutions, grandfathering proposals could be considered. The Board
urges that any such grandfathering provide that the total of exempt deposits
for an ,affiliated group •be equal to the number of similar affiliated depository
institutions as of August 1, 1978, times the dollar level of the exemption for each
category of deposits in the bill, provided that any individual affiliated institution
would be sulbject to reserve requirements whenever its liabilities subject to
reserves exceeded the exemption level of an individual institution. A proposed
amendment along these lines is shown as attachment J.
PASS-THROUGH
The Board also would propose for Committee consideration an amendment that
would permit nonmember institutions to hold reserves required !by the Federal
Reserve with member !banks, Federal Home Loan Banks (in the case of savings
nnd loan associations), or at a Central Liquidity Facility if established (in the
case of credit unions), provided that these institutions pass such reserves
through to a ,Reserve Bank on a dollar for dollar basis. Such an amendment,
shown in attachment K, would permit existing correspondent relationships to be
maintained.
I would like, once more, to extend my and the Board's appreciation for the
intensive efrort made •by you and your colleagues on this very important matter.
Sincerely,
BILL.
ATTACHMENT A
AMENDMENT TO
H.R. 13847
0FFEBED BY - - -
On page 1, 1beginning on line 6, strike all of Section 2 extending through line
19 on ,page 2, and insert in lieu thereof the following new ,Section 2.
"Sec. 2. ·section 10 of the Federal Reserve Act is •amended by adding at the
end thereof the following new ,paragraph :
''The Board may require any depository institution specified in this paragraph
to make, at such intervals as the Board may prescribe, such reports [of the
total amounts of such categories] of its liabilities and assets as the Board
may determine to be necessary or desirable to enable the Board to discharge
its responsibility. to monitor and control monetary and credit aggregates.
Such reports shall be made (1) directly to the Board in the case of member
banks an.a in the Ca.Be of other deporitort1 institutions for aZZ UabiUtie& subject to reserve requirements, and (2) for all other reports to the Board through
the (A) Federal Deposit Insurance Corporation in the case of insured
State nonmember banks, Savings B<fflks, an.a Mutual 8a'1Jings Ban'k:s, (B)
National Credit Union Administration in the case of insured credit unions, (C)
Federal Home Loan Bank Board in the case of any Institution insured by the
Federal 1Saving,s and Loan Insu-rance Corpor-ation or w'hich is a memlber as
defined in section 2 of the Federal Home Loan Bank Act, and ( D) such State
officer or agency as the Board may designate in the case of any other ty.pe of
hank, savings and loan association, or credit union. The Board shall endeavor
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Federal Reserve Bank of St. Louis
to the maximum extent feasible to avoid unnecessary burdens on reporting institutions and the duplication of other reporting requirements, and any data therefrom shall be made readily available to the Board. The Board may classify
depository institutions for the purposes of this paragraph, and may impose different requirements on each such class."
Explanation.-Provides for direct reporting to Federal Reserve concerning
reserve liabilities and covers savings banks and mutual savings banks.
B
ATTACHMENT
AMENDMENT TO H.R. 13847 OFFEBED BY - On page 2, strike line 23 and all that follows through line 14 on page 3 and
insert in lieu thereof the following:
" ( 1b) (1) For the purposes of this subsection-The term 'reservable liabilities'
means, in the case of any State or national bank, the amount by which the sum
of such ibank's demand ·and savings deposits liabilities exceeds $25 million."
Explanation.-Redefines "reservable liabilities" to include only demand and
savings deposits; esta'blishes a $25 million exemption from reserve requirements
for demand and savings deposits and eliminates indexing for such exemption.
-
C
A'l"l'ACHMENT
AMENTMENT TO
H.R. 13847
OFFERED BY - - -
On page 4, line 1 strike all th·at follows through line 7 and insert in lieu thereof
the following :
" (4) All banks subject to reserve requirements shall maintain reserves against
their reservable liabilities in the ratio of 8 per centum, or in such other ratio
not greater than 9 per centum and not less than 7 per centum as the Board may
by regulation prescribe solely for the purpose of implementing monetary policy."
Explanation.-Establishes 8 percent reserve ratio with 2 percent discretionary
range for demand and savings deposits.
·
D
A'l"l'ACHMENT
AMENDMENT TO
H.R. 13847
OFFERED BY - - -
On page 4, beginning on line 8, strike all of subparagraph (B) through line 16.
On page 5, after line 16, add a new subsection (8) as follows:
"(8) Upon a finding lby the Board that extraordinary circumstances require
such action, -the Board may impose reserve •requirements outside the limits otherwise prescribed by this 'Section •for a period not exceeding 30 days but which may
be extended for further ,periods not exceeding 30 days 1by affirmative action by
the Board in each instance. The Board shall promptly transmit to the Congress
a report of any exercise of its authority under this subsection and the reasons
for such exercise."
Explanation.-Authorizes Board to impose reserve requirements outside limits
otherwise prescribed for all classes of liabilities subject to reserve r0Q,uirements.
1
A'l"l'ACHMENT
AMENDMENT TO
H.R. 13847
E
OFFERED BY - - -
On page 4, after line 16, insert the following new subsection and renumber the
following subsections accordingly :
"(b) (5) Subject to the exemptions in paragraph (C) of this subsection, banks
other than savings banks and mutual savings banks shall maintain reserves
against t h e i r - - - - -
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•~{A) time deposits with initial maturities of 179 days or less [and against
borrowings from sources other than commercial banks with maturities of one
week or less and with such longer maturities as the Board may prescribe] in a
ratio not less than one per centum nor more than 6 per centum, as shall be specified
by the Board of Governors and t h e i r - - - - "(B) time deposits with initial maturities of 180 days or more in a ratio of not
less than one per centum nor more than 3 per centum, as shall be specified by the
Board of Governors.
"(C) Reserve requirements imposed by this sufJsection shall apply only to that
portion of the sum of the liabilities specified in paragraphs (A) and (B), regardless of maturity, which exceeds $25 million."
Explanation.-Establishes reserve requirements for bank time deposits in
excess of $25 million with different ratios for deposits with initial maturities of
179 days or less, and for deposits with longer maturities; establishes reserve
requirements at the short-term time deposit ratio for borrowings from nonbank
sources.
ATTACHKEl'fT
A:U:END:U:ENT TO H.R.
F
13847 OFFERED
BY - - -
On page 5, amend subsection (7) by striking the balance of the subsection after
"member banks" on line 10 and inserting in lieu thereof the following : "... except
that the Board as a condition of access to or maintenance of such privileges may
require a certification of solvency of such bank from the Federal Deposit Insurance Corporation."
Explanatlon.-Entitles any bank, whether or not it maintains reserves with the
Federal Reserve, to access to Federal Reserve discount and borrowing priv11eges
on the same basis as member banks; eliminates a need for FDIC or State supervisory agency certification as condition to such access and in lieu thereof authorizes the Board to require a certification of solvency from the Federal Deposit
Insurance Corporation of any such bank as a condition to such access.
ATTACHMENT
G
A:U:END:U:ENT TO H.R. 13847 OFFERED BY - - On page 5, at the end of Section 3, add the following new subsec.t:lon :
"(b)( )
"(A) The term reservable liabilities means, in the case of any depository
institution as specified in Section 10 of this Act, other than a bank subject to
reserve requirements under subsection (b) (2), the amount by which such institution's transactions deposit balances, as defined by the Board in consultation
with the appropriate Federal depository institution supervisory agencies, exceeds
$25 million.
"(B) Such depository institutions shall maintain reserves against their reservable liabilities in the ratio specified in subsection (b) ( 4) ."
Explanation.-Establlshes reserve requirements for transaction accounts in
excess of $25 million maintained at nonbank depository institutions in the same
ratio applicable to demand and savings deposits at banks.
ATTACHMENT
AMENDMENT TO
H.R. 13847
H
OFFERED BY - - -
On page 5, after line 16 at the end of Section 3, add the following subsection :
" ( ) With respect to any depository institution that is not a member of the
Federal Reserve System on August 30, 1978, the required reserves imposed pursuant to this section on the effective date of this Act shall be reduced by 75
per centum during the first year that begins after the effective date, 50 per centum during the second year, and 25 per centum during the third year."
Explanation.-Establishes a four year phase-in for reserve requirements imposed on nonmember institutions.
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ATTACHMENT I
AMENDMENT TO H.R. 13847 OFFERED
BY - - - -
On page 5, after line 16 at the end of Section 3, add the following subsection :
" ( ) The total deposit liabilities exempted from reserve requirements pursuant to subsection ( 1), ( 5), and ( ) [if nonbank transaction accounts are covered]
for each such exemption shall not exceed $25 million in the aggregate for affiliated
banks, [and $25 million in the aggregate for affiliated nonbank depository institutions.]
Explanation.-Provides that total deposits exempted from reserve requirements for all institutions in an affiliated group shall not exceed $25 million for
each category of deposits.
ATTACHMENT J
AMENDMENT TO H.R. 13847 OFFERED
BY - - - -
On page 5 at the end of Section 3, add the following new subsection:
" ( ) In the case of affiliated banks [and affiliated nonbank depository institutions,] the total deposit liabilities exempted from reserve requirements pursuant to subsection (1), (5), and ( ) [if nonbank transaction accounts are covered] shall not exceed in the aggregate for such affiliated groups the product
resulting from multiplying the number of institutions in such affiliated group on
August 1, 1978 by $25 million for each such exemption, provided that no more
than $25 million shall be exempted under each such exemption at any individual
bank [or nonbank depository institution]."
Explanation.-Provides that total deposits exempted from reserve requirement shall not exceed $25 million for each exemption in individual institutions,
and for affiliated groups shall not exceed the number of institutions in such
groups on August 1, 1978 times $25 million for each exemption.
ATTACHMENT K
AMENDMENT TO H.R. 13847 OFFERED BY - - On page 5, after line 16, add a new subsection as follows :
"( ) Section 19(c) of the Federal Reserve Act, as amended (12 U.S.C. § 461)
is amended to read as follows: "Reserves held by any depository institution
to meet the requirements imposed pursuant to subsection (b) of this section
shall be in the form of" (1) Balances maintained for such purposes by such depository institution in
the Federal Reserve bank of which it is a member or at which it maintains an
account. However, the Board may, by regulation or order, permit depository institutions to maintain all or a portion of their required reserves against their
transaction accounts in the form of vault cash: Provided, That such proportion
shall be identical for all depository institutions; and
"(2) Balances maintained by a nonmember depository institution in a member
bank, in a Federal Home Loan Bank, or in a central liquidity facility that may be
established for credit unions : Provided, That such member bank, Federal Home
Loan Bank, or central liquidity facility maintains such funds in the form of
balances in a Federal Reserve bank of which it is a member or at which it maintains an account. Balances received by a member bank from another deposltol'j
institution that are used to satisfy the reserve requirement imposed on such
depository institution by the section shall not be subject to the reserve require
ments of this section imposed on such member bank and shall not be subject to
assessment imposed on such member bank pursuant to section 7 of the Federal
Deposit Insurance Act, as amended (12 U.S.C. § 1817) ."
Explanation.-Specifics that reserves may be held in the form of balances at
Federal Reserve banks, or of vault cash, and that a nonmember institution may
hold reserves at a member bank, at a Federal Home Loan bank (in the case of
savings and loan associations), or at a central liquidity facility (in the case o1
credit unions), provided that these institutions pass the reserves through to a
Reserve bank on a one-for-one basis.
·
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The CHAIRMAN. We would appreciate that very much.
I'm concerned with the high level of the exemption, whether $100
million is desirable, necessary, fair; whether it shouldn't be a somewhat lesser amount. It seems to me maybe $50 million might be more
appropriate under present circumstances.
Mr. MILLER. Mr. Chairman, may I just tick off some of the major
a.reas that our Board of Governors thought should be modified. The
Board of Governors felt the exemption was too high. We also felt-and
I believe Chairman Reuss agrees with this-that while we should have
substantially uniform reserves, the reserves on demand and possibly
savings deposits should be set at a different level than those on time
deposits. I believe Chairman Reuss agrees with our suggestion.
Our suggestion is that there be an exclusion of demand and savings
deposits under $25 million and an exclusion of time deposits under $25
million, for a total exemption of $50 million, as compared to Chairman
Reuss' suggestion exclusion of $100 million.
The advantage of that structure is great. It would increase, substantially, the amount of deposits subject to reserve requirements-with
the benefit shown in chart x-and it would assure an adequate number of institutions maintaining reserves for an adequate involvement
by the Central Bank. Our estimate is that about 2,900 banks would be
subject to reserve requirements using that formula. As you know, right
now there are about 5,700 member banks. So, in a sense, the number of
banks subject to reserve requirements would change.
On the other hand, some larger institutions who are not now subject
to reserve requirements would be. Overall, we feel the formula would
work out well.
Our second comment is that while Chairman Reuss' proposal is a
very constructive one, it does limit universal reserves to banks. We
continue to feel that universal reserves is the solution if possible, but
it should be applied to all transactions balances-at S. & L.'s, mutual
savings banks, and credit unions. If this were done today, only five
additional institutions would be covered, but the principle would be
established so-The CHAIRMAN. You say if this were done, onlv five additional institutions would be added if you covered not only the banks but the nonbanks 9
Mr. MILLER. Yes, sir, with the $25 million exclusion.
The CHAIRMAN. With the $25 million limit~
Mr. MILLER. Yes.
Senator SCHMITT. Excuse me. Would the chairman yield~
The CHAIRMAN. Surely.
Senator SCHMITT. Does that include credit unions i
Mr. MILLER. Yes, sir, that would include credit unions. With a $25
mi!lio~ exclusion, no credit union would be covered right now. But the
pomt Is that the rules would then be known, and that as these institutions seek out and opt for transactions accounts, they would know the
ground rules. They would know that if they want to be like banks in
t~at area, they would have to compete like banks. We would very much
like to see that happen.
We have a few other suggestions. We are particularly concerned
about a _loophole in ~he case of the proposal as to multi bank holding
compames. 1V"e ce~amly wouldn't wa_!lt the .e~ect of the exclusion to
produce an mcentive for banks to begm to d1v1de up-for every insti
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Federal Reserve Bank of St. Louis
59
tution ·to become a series of banks small enough to be exempt from
reserve requirements. We would want to be sure to find a consolidated
approach and not let the divide and conquer principle creep in. We have
made a few technical suggestions about this and also some about time
deposits.
The letter that we submitted to Chairman Reuss this morning can be
made available to you, and I'd be happy to pursue this in more detail.
The CHAIRMAN. Currently, Federal Reserve policy, as we all know,
is implemented primarily through Open Market activities. That is, by
buying and selling Federal obligations. You do that rather than changing reserve requirements and there's obviously both :pressure to reduce
reserve requirements from the banking institutions-it's very profitable
to them if they are reduced-and pressure against it from Members of
the Congress and members of the public and others who feel this deprives the Treasury of revenue they otherwise would have.
But, at any rate, using open market operations doesn't seem to hurt
the effectiveness of your monetary policy. It seems to be able to work
rather well that way.
In light of this, why does the Federal Reserve continue to ask for
broad flexibility to change reserve requirements~ Do you really need
a range of 7 to 22 percent for demand deposits, 3 to 12 percent for
transactional accounts, and ½ percent to 10 percent for time deposits~
It's a tremendously broad range. It would seem there's no real congressional limitation at all, in effect.
Mr. MILLER. Mr. Chairman, in formulating our proposal we had
many things to consider. Of course, one was the cost im.Pact of the possible solutions. We proposed relatively modest reductions in reserves
and, of course, maintained the statutory concept of different sizes of
banks being treated in different ways.
My only answer is that if we can go to universal reserves, then the
degree of flexibility we need for changing reserve requirements could
be very substantially narrowed.
The proposal Chairman Reuss has made, as you mentioned, would
set reserve requirements at· 6½ percent, with the authority to move
them up or down half a point-a very narrow band. In our discussions
with him Friday, when pointing out the desirability of distinguishing
between demand and savings deposits on the one hand and time deposits on the other, we suggested a reserve requirement initially, of 8
percent on the former deposits, with authority to move from 7 to 9,
which is also very narrow. I believe Chairman Reuss feels that is quite
workable, at least that degree of flexibility. We might change the figures a little as we study the impact of narrowin~ the band.
On time deposits, it was our suggestion to his staff that we be given
a leeway of 1 to 6 percent on reserve requirements for short-term ·time
deposits-179 days or less-where more control through reserves mhrht
be desirable, and that the reserve requirements on longer term time
denosits-180 days or longer-be in a band of 1 to 3 percent.
The CHAmMAN. All this hinges on universal reserve requirements!
Mr.MILLER. Yes,sir.
The CHAmMAN. And if so, you sa:v we could limit the ranges and the
flexibility and that's very, very helpful.
Mr. Mrr.LER. There was another provision which we did not propose,
but which the chairman of the House committee did; that was, that
given so narrow a range, if there were unusual circumstances, the
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Federal Reserve Bank of St. Louis
60
Board would be given authority to set reserves outs~de the range for a
30-day period and then report to Congress on the circumstances. CongrMs then would be able to react-either to confirm the action or take
alternate action if it felt that reserves should be put back into the band.
It's a very workable kind of plan.
I must just caution that this limiting of ranges is based entirely on
the r.rospect of having universal reserves; that makes other things
possible. You're certainly correct in pointing out that the present
structure has a historical base, but it may not be the best solution for
the 1980's and 1990's or for the next century. You were also correct in
pointing out that given the burden on members and the competitive
advantage of nonmembers, the pressure on the Federal Reserve has
been to reduce reserve requirements in order to reduce inequalities.
Therefore, for some time, there hasn't been much use of reserve requirements as a monetary tooL But it's important to keep that flexibility, either by maintaining some band or for emergency conditions.
It's particularly important to keep some flexibility so that.we can affect
the cost and availability of short-term time deposits. There are times
when that flexibility would be desirable.
.
The CHAIRMAN. Senator Schmitt.
·
Senator ScHMITT. Thank you, Mr. Chairman.
in
came
I
testimony.
your
missing
for
apologize
I
Miller,
Chairman
as rapidly as I could.
I am concerned about two things I guess immediately that come to
mind. One is the relative effect of the proposals not only that you have
made but also ,that Congressman Reuss has made, and your response to
his proposals, on the small banks. I realize you're suggesting a cutoff
so that smaller banks are-very small banks are not impacted, but still
there are small banks, and where we have had universal anythingregulations or reserves or what have you-there still proportionately
seems to be an extra burden on small banks. Would you talk to that a
little biU Like State-chartered banks, for example. 'They would have
the reserve requirement nresumably but it would be at a cost.
Mr. MILLER. Senator Schmitt. the proposal that Chairman ReuRs has
made for a $100 million exclusion would virtnally exclude all banks
that could be classified as small. So there would, I think, be complete
relief for what we think of as small banks.
Our alternate proposal-to have a $25 million exclusion for demand
and savings deposits and a $25 million exclusion for time deposits for
a total of $50 million-would subject only abont 3,000 banks to reserve
requirements. Once again, I would have to say that no small bank~
would be subject to reserves. There are 14,395 banks and 11,470 would
not be reouired to maintain any reserves under our proposal. About
3,000 would. and, with the $50 million exclusion. they would have to be
very good-sized banks before reserves would be required. Of course.
once they are subject to reserves, the requirement would be satisfie<l
initially with vault caf<h, so it would have to be an even bigger bank
before there was actuallv an impact.
In terms of.the regulatory burden, there's also a lot of merit to the
proposal. While about 74 percent of total bank deposits would be subiect to the reserve req1iirement, we would virtually eliminate alJ small
·
banks from the requirement.
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I realize I'm talking about a new proposal that you pi:obably hav~n't
even seen; it's Chairman Reuss' proposal that I was JUSt d1scussmg
with Chairman Proxmire.
Senator SCHMITT. Now the other issue that I understand you did talk
to some that is of concern to both of us, because we have talked about it
both publicly and privately, and that is the ability to measure the
money supply.
Now presumably the unive:rsal deposits would improve the Fed's
capability to understand over a broad period of time just what is happening to the money supply. Is that correct j
Mr. MILLER. That's correct.
Senator ScHmrr. Would you expl•ain that summary again for us,
please~
Mr. MILLER. Let me make a couple of observations. One is that it
would be very helpful to the Federal Reserve to have current data on
the liabilities of banks. One proposal that has been made is for an
amendment to give us access to data through the other regulatory
agencies; that would be helpful. We have suggested that data collection be direct in the case of any institution that is required to maintain
reserves with the Federal Reserve, which would expedite our getting
current information and improve the predictability of our actions.
I don't know whether you have copies before you, but Chart 10
attached to my testimony (p. 32) illustrates the point better than any
statement I could give you. As you move from left to right along the
bottom scale of that chart, you are moving from zero to 100 percent on
bank deposits not subject to reserve reqmrements. Or, to make the reciprocal statement, on the left side 100 percent of deposits are subject
to reserve requirements and on the right side, zero. As you move from
left to right-covering less and less bank deposits with reserve requirements-the vertical scale shows you the increase in the degree of
unpredictable variability in M1 or M2 • This illustrates how important
it is for us to have, not only the data, but a substantial amount of
deposits subject to reserve requirements so that we have the leverage
to increase the predictability of the money supply. This, of course,
greatly enhances the probability that Federal Reserve policies will
accomplish what is intended; the more accurately we're able to predict the situation, the more likely monetary policy will have the predicted consequence. That's what we're after.
Senator SCHMITT. Short run means what, in terms of time frame j
Mr. MILLER. Short run, in this case, means a 2-month period.
Senator SCHMITT. Do you think the Fed, intending to focus on that
as a minimum time frame for any kind of predictability of the money
supply, is a usefulf redictability i
Mr. MILLER. 0 course we need to get much more predictability
over the long term; there's no doubt about that. But to handle the long
term, we first need to get control of the short term. If we can predict
what will happen in a 2-month cycle, I think we will be that much
farther along in being able to get inside the ranges of tolerance we are
seeking to achieve in the long terms.
Senator SCHMITT. But I believe you agree that you can get too
short.
Mr. MILLER. That's correct.
Senator SCHMITT. You can get too myopic.
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Mr. MILLER. You have to be extremely cautious about the volatility
of 1-week figures, and of 2-month and 3-month figures. While we don't
want to concentrate on the weekly figures, we need to know how the
weekly figures fit into a pattern in order to predict what will ha:r,pen
over a 3-month period. Once we get that better 3-month predictability.
we _won't have as many surprises popping up in the money supply and
we won't always be trying to -react qmckly to get back within our
:ranges. That's what gets us into trouble.
Senator .SCHMITT. Thank you, Mr. Chairman.
The CHAIRMAN. I have just a few more questions. I'd like to ask
about the surplus account. You talked in your presentation about the
fact that the cost to the Treasury in the first 3 years would be nothing because of the fact the Federal Reserve would cover it by returning surplus to the Treasury. You have over $1 billion in your surplus
account and,' as I say, your proposal includes a transfer of about half
of that to the Treasury to offset the cost of interest payments on reserves. In the past, part of the surplus has been transferred to the
Treasury simply because the surplus got too large.
What I want to know is why you need a surplus in the first place?
Why shouldn't the whole thing be transferred to the Treasury 9 That
would reduce the deficit, tend to reduce the national debt, $1 billion
isn't much, but if it's added up it comes to something.
Mr. MILLER. It does add up to a lot of money to me.
Mr. Chairman, I will give you several reasons why I think the Federal Reserve surplus might be desirable. One is that it's very helpful
to have a surplus in order to cushion any change in policy, such as
we're considering, that otherwise would have an immediate impact on
th~ . Treasury. It's helpful to have a surplus against any
contmgency-The CHAIRMAN. It's hard to imagine another contingency like this
coming along.
Mr. MILLER. Who knowsY A war, a national emergency, an international crisis. One could see the need for several hundred million
dollars.
The CHAIRMAN. The usual need for a surplus for a bank is, of conrse,
so it won't fail and so it won't have a liquidity problem; You have
nothing like that at all. Obviously you have no liquidity problem. The
Federal Reserve cannot fail, by definition almost.
Mr. M:w:..ER. One reason is for a contingency-Senator SCHMITT. I hope the chairman is right.
The CHAIBMAN. Well, I can't imagine a scenario. I'd like to hear one.
What other bank has a -positive cashflow of $6 billion -or earnings that
are six times its surplus 9
Mr. Mn.r.E.R. The second reason is that if we transfer the $1 billion
we let everybody off the hook on the deficit. But it's just a one-time
shot. We hope Congress will not want to take advanta,ie of a one-time
adjustment and is looking at the necessity for fiscal discipline and a
fiscal plan that doesn't rely on that.
I'm hoping we can manage the economic affairs of this Nation so that
interest rates will come down significantly, in which case our earnings
would shrink.
The CHAmMAN. Why wouldn't this help the intel'l"st rates come
down 1 It would mean the Trensnry would borrow $1 billion less.
Mr. MILLER. I would certainly be happy to discuss with the Governors whether they would like to declare a dividend.
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The CHAIBMAN. Let me ask you another one because this occurred to
us while you were discussing the Reuss proposal.
Do you have any preliminary estimates 0£ the net cost 0£ the Reuss
proposal or the net cost 0£ your counterproposal? Your counterproposal would cost less, as I understand it, substantially less.
Mr. MILLER. Yes. Our counterproposal, with certain adjustments
that we have suggested in handling £ederal :funds and repurchase
agreements, would reduce Federal Reserve earnings by about $675
million gross. I£ we charge £or service&--eharges on the order 0£
$400 million-the net reduction in Federal Reserve earnings would be
about $275 million.
The CHAmMAN. I was thinking 0£ the Reuss proposal which would
simply provide-Mr. MILLER. Yes, sir. The Reuss proposal, according to our
calculationsThe CHAIBMAN. Provide the universal reserves with a cutoff 0£ $100
million, and your counterproposal that goes to $50 million. So yours
would cost less because you would have reserves extend over more
banks.
Mr. MILLER. Without including the added revenues £rom pricing
Federal Reserve services it appears that the Reuss proposal would involve a reduction 0£ Federal Reserve earnings 0£ about $190 million;
our proposal would cost about $420 million. So you could compare $190
million against $420 million. But we also suggested a slig-htly different
treatment of Federal funds and repurchase agreements because of the
potential effect on the market in Government securities of requiring
reserves on repurchase agreements. With those adjustments our cost
goes up to $675 million as compared to about $500 million under the
Reuss proposal.
The CnAmMAN. Would you provide for the record the breakdown
of your analysis of the cost?
Mr. MILLER. Yes, sir; we would be very pleased to do so.
[Chairman Miller subsequently submitted the following information:]
EFFECTS ON EARNINGS OF THE FEDERAL RESERVE SYSTEM OF UNIVERSAL RESERVE REQUIREMENT PROPOSALS,
AUG. 14, 1978 I
[In million of dollars]
Chanee in reserves held at Federal Reserve banks:
Members _________________________ ·------------------------------------Nonmembers ______________ ------------------------------------_________
Total reserves released________________________________________________
Reduction in Federal Reserve earnings•----------------------------------------
Reuss proposal•
Board proposal 3
-4, 885
I, 929
-8, 964
2,494
192
420
----------6, 468
-2, 954
1 Based on Call Report and TEDS data, December 1977.
2 6½ percent reserve ratio against net demand deposits, Federal funds purchased, other liahilit1es for borrowed money,
Eurodollars, savings deposits, plus time deposits. after exempting the 1st $100,000,000 of such liabilities. (Non-.xempt
Federal funds purchased, other liabilities for borrowed money, plus Eurodollars, amount to about $87,000,000,000. If the
reserve ratio on these liabilities were lowered to 1 percent, Federal Reserve earnings would be reduced an additional
$311,000,000.)
• 8 percent reserve ratio against net demand deposits, Federal funds from nonbank sources, other liabilities for borrowed
money, Eurodollars, plus savings deposits, after exempting the ht $25,000,000 of such liabilities. I percent reserve ratio
against time deposits in excess of $25,000,000. (Nonexempt Federal funds from nonbank sources, other liabilities for
borrowed money, plus Eurodollars amount to about $56,000,000,000. If the reserve ratio on these liabilities were lowered
to 1 percent, Federal Reserve earnings would be reduced an additional $255,000,000.)
• Estimated as if reserves released would earn a 6½ percent rate of return. (Note that the net cost to the Treasuryafter taxes on income of banks and stockholders-would be aboul 45 percent of these figures.)
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The CHAIRMAN. It's not clear from the language of the bill whether
it's the Federal Reserve's intent to count vault cash as a reserve as they
are now. The legislation says the Board may permit all or a portion of
the required reserves against transaction accounts in the form of vault
cash. Do you intend to count vault cash as reserves~
Mr. MILLER. Yes; we intend to.
The CHAIRMAN. Why shouldn't the legislation be written to say that 9
Mr. MILLER. I see no objection to that.
The CHAIRMAN. The Federal Reserve has never been in favor of open
access to nonmembers and thrifts. If the membership problem is resolved by universal reserves, do you see any problems with open access 9
Mr. MILLER. No, sir. If we had universal reserves,· it would be desirable to look at universal access on the same terms and conditions as
members.
The CHAmMAN. Now in the 1974 Universal Reserve Requirement
bill, access to discount window would have been granted to the banks
holding reserves at the Federal Reserve banks. That feature is absent
from your current proposal and yet you express concern about safety
and soundness of banks because of lack of access to the discount
window.
Why shouldn't this legislation provide access to the discount window
for banks required to meet Federal Reserve requirements 9
Mr. MILLER. If we should have a universal reserve requirement, it
would be well to ,ro to more universal access to the window. As a matter of fact, in the letter we sent to Chairman Reuss we make an even
broader suggestion: If the universal reserve approach should be
enacted, we would suggest that all financial institutions with transactions balances have access to the window on the same terms and
conditions as members, with the provision that we would have the
right, if we felt it necessary, to ask the FDIC to give us a certification
of solvency of an institution. So we are moving in the direction you
indicate, and I think this is one area we should seek to perfect in this
leizi,slation.
·The CHAmMAN. I have just one more question. Your proposal indicates that should the Congress enact uniform reserve requirements,
the Board would need to reconsider whether and to what extent its proposal for service charges and interest on reserves might need to be
adjusted. I'm not sure I know the meaning of that statement. Do you
or do you not think that charging for Federal Reserve services and interest on reserves are a good idea in their own right first?
Mr. MILLER. Mr. Chairman, that statement was, as you say, based
on the assumption of universal reverses. There would no 1onger be any
burden, because there can be no burden if everybody is treated the
same. It's the discrepancy in reserve requirements that creates the
burden..
At that point, one could reexamine the desirability of charging for
services and simply decide that the Federal Reserve should provide
services to all institutions. While the Board didn't have time to
cross tJh11.t bridge, it serons to me that, even if we had universal reserves,
it would be de1rirable to have a system of charging for services because
that would create the discipline of choice, alternatives-c~mpetition-
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and it would be another contribution toward improving the whole
banking and financial structure.
The CHAmMAN. I agree with that wholeheartedly. Also, it mightas has been indicated by National City Bank and others-increase
competition. I think that would be 11, good thing.
Mr. MILLER. It seems to me it would be. Our services are not free;
they are in exchange :for maintaining reserve balances. But because
they are not explicitly priced, the tendency is to make them more
attractive in order to soften the reserve burden. The result quite often,
it seems to me, has been not to make the highest and best use of
resources. The better allocation of resources would be to have a competitive system. With due respect, Mr. Chairman, there must be some
basic services provided by the central bank so that rural or remote
areas aren't neglected because nobody is willing to serve them.
The CHAIRMAN. Would you put this into effect without a congressional mandate should universal reserve requirements be legislated i
Mr. MILLER. Yes, sir.
The CHAIRMAN. You would~
Mr. MILLER. The contemplated plan-if we should set universal
reserves, on the basis of the Board's meeting yesterday-would be to
go forward with a charge for services.
The CHAIRMAN. Senator Lugar.
Senator LuoAR. I have no questions.
The CHAIRMAN. Senator Schmitt.
Senator SCHMITT. Mr. Chairman, pursuing this topic that you just
jntroduced, I guess what the basic proposal then boils down to, is
what is commonly called a carrot ·and stick approach or the apple and
spur -approach, depending on what part of the country you come from,
where the spur is the universal reserves. That would be an increased
burden on some, but the anticompetitive aspect of it would disappear because it would be uniform. On the other hand, to balance tJhat,
you would favor paying interest on reserves that are required and I
guess a general lowering of reserve requirements. Is that a oorrect
assessment i
Mr. MILLER. Senator Schmitt, when our proposal first came forward
it had two pieces. They've been connected into one piece in the Senate
proposal, but we looked upon them as two separate proposals because
they could be handled discretely. If there were universal reserves, it
would not be necessary to pay interest on reserves because there would
be equal treatment. There would be no membership burden. Therefore interest on reserves would be a question of choice on which Congress might express an opinion. But our thought ·at the time we introduce our proposals was that, if universal reserves were enacted we
would not pay interest on reserves bee.a.uses th~re would be no need
for a carrot. Everybody would be on an equal baSis.
Senator SCHMITT. But at an extra cost; right!
Mr. MILLER. At an extra cost.
8Pm1.tor SoHMITT. For everybody.
Mr. MILLER. Yes; but we did think that if we were to stay within
the pre.o:ent reserve structure, if we wanted to char~e for services we
would need to pay interest on reserves to wash out the cost. I want to
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distinguish between a system of universal reserves and the present
reserve structure. Under the present structure, if we desire to charge
for services, then we need interest on reserves so as not to add additional
costs to banks which the consumer would ultimately pay. If, as the
chairman is now talking ,about, we have universal reserves with substantially reduced reserve requirements and more uniformity, then
the problem suddenly becomes a bit different: Interest on reserves
might become an unnecessary feature; there would be room to charge
for certain services.
The institutions that would face an additional cost burden would
be large nonmembers, who are not now subject to reserve requirements.
Under our proposal of a total $50 million exclusion, about 1,100 nonmembers would be required to maintain reserves. But those would be
large institutions competing with similarly lar,2'0 members and equity
would seem to me to say they should pl-ay by the same rules as their
competitors.
Senator ScHMrrr. But nevertheless, those 1,100 institutions that
would be covered would have for themselves some increased burden.
Mr. MILLER. No question about that.
Senator ScHMrrr. The reserves, plus the cost of services.
Mr. MILLER. That burden could be reduced to zero if interest were
paid on reserves. The problem is then one of how much it costs the
Treasury to pay interest on a large amount of deposits.
Senator ScHMrrr. I understand.
Mr. MILLER. That's the tradeoff we're trying to examine.
Senator ScHMI'IT. I g-uess I tend to agree in general, although we
might disagree in specifics, that if institutions are providing the same
general class of services they should be playing by the same rules. We
have discussed that already with respect to the foreign bank issue
as well as now discussing it with respect to domestic bank.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very, very much, Mr. Chairman.
Mr. MILLER. This has been a very, very helpful discussion for us,
and I appreciate it, Mr. Chairman.
The CHAIRMAN. It's very helpful testimony and we've made a fine
record.
I'm going to ask a panel to come forward, the panel of the Honorable George LeMaistre, Chairman of the Federal Deposit Insurance
Corporation; Lawrence Connel, Administrator.National Credit Union
Administration; and Dr. Kenneth Biederman, Director, Office of Economic Research, Federal Home Loan Bank Board.
Mr. LeMaistre, we are honored to have you. I understand this will
be your last appearance, your farewell appearance, before a con2Tessional committee, and in your honor I wore your tie. your FDIC tie
this morning, given to me by an FDIC staff member, I'll confess. But it
was at a Christmas party when the spirit of p:iving and receiving is I
think pretty plutonic. So go ahead. We are happy to have you.
For the convenience of you gentlemen and for the convenience of
the committee, we are going to see if we can confine the oral testimony,
if possible, to 10 minutes or less and then we will have some questions
for you.
Chairman LeMaistre, go right ahead, sir.
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STATEMENT OF GEORGE A. LeMAISTRE, CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Mr. LEMAISTRE. Thank you, Mr. Chairman. I will summarize the prepared statement which has been filed and I do appreciate the opportunity to testify before this committee and present our views on the
Federal Reserve Requirements Act of 1978, S. 3304. This bill deals
with attrition in Federal Reserve System membership and related matters by: ( 1) Establishing universal reserve requirements for all commercial banks and £or other depository institutions offering transaction accounts; (2) paying interest on reserves and reducing reserve
requirements; and ( 3) charging £or Federal Reserve services now provided free only to member banks or to institutions that belong to automated clearinghouses.
Let me begm by stating our view that the legal requirement that
Federal Reserve member banks maintain sterile reserves is inequitable
to them and inequitable to their customers. However, we strongly oppose the establishment of universal reserve requirements as a way of
removing this inequity. The payment of interest on reserves and pricing of services, however, are attractive and deserve thoughtful and
sympathetic consideration. In considering these ·proposals it must be
kept in mind that redressing the imbalance between member and nonmember banks raises many of the difficult issues with which the Congress has been wrestling, without resolution, for a number of years.
These include, notably, the effective conduct of monetary policy; the
balance between the State and national banking systems; the changes
in the Federal regulatory structure, particularly whether the Federal
Reserve should continue to exercise supervisory authority; and, regulatory reform, particularly whether interest rate ceilings and the prohibition of interest on demand deposits should be abolished.
The Federal Reserve has stated its belief that the decline in the proportion of deposits held iby member banks caused by membership attrition adversely affects the precision with which monetary policy can be
conducted. There have been a number of studies of monetary control in
this country that have concluded that increased Federal Reserve membership and legal reserve requirements are not important to the effectiveness o:f monetary policy. The studies are cited in my prepared
statement and in the interests of time I shall not discuss them except
to say that the evidence and opinions on this issue are distinctly onesided. Knowing the tendency for economists to disagree, the unanimity
·
in this case is impressive.
What the Federal Reserve does need to conduct monetary policy
effectively is timely and accurate information about monetary aggregates. S. 3304 would require depository institutions to report their
deposit lia;bilities and required reserves directly to the Federal Reserve.
We support making such information ·available to the Federal Reserve
and have no objection to the adoption of the proposal in S. 3304 that
would do this.
In this regard, the FDIC has already been providing its assistance
to the Federal Reserve. In the spring of 1976, the FDIC instituted a
special schedule in the quarterly call report for all nonmember banks
to provide the Federal Reserve with better information on the money
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supply. Also, beginning the first week of July 1977, a sample of 580
nonmember banks began reporting deposit and cash items on a regula.r
weekly basis, the same items as all :i;ionmember banks report
four times a year. The Fedeml Reserve has indicated that it expects
the data from these two surveys to enable significant improve...ents
in its estimates of the nonmember bank component of the Nation's
money supply. The FDIC and the Federal Reserve have agreed to review this program in mid-1979 to determine whether nonmember bank
data are necessary for monetary policy purposes and, if they are,
whether the sample of 580 nonmember banks is adequate. To date the
Federal Reserve has voiced no dissatisfaction with this arrangement.
In summary, we believe the need for legal reserve requirements for
monetary control purposes is not supported by the weight of avail.able evidence. The evidence to date suggests that monetary policy effectiveness depends on adequate data, proper estimation procedures, and
appropriate open market operations decisions, and not on reserve requirement jurisdiction.
We believe the dual system of State and national banks has been
a positive element in the American system of government and has contributed to a more innovative and responsive financial system. Accordingly, maintaining a balance between the State and national banking
systems is a desirable public policy. Nonetheless, we should not maintain a "balanee" for the sa.ke of balance. It is clear that Federal Reserve requirements bear heavily on member banks and result generally
in such banks carrying more cash than they otherwise would.
One solution to the problem of equity that we believe should be
resisted is the proposal to impose universal reserve requirements on
the transactions balances of nonmember depository institutions. If
nonmember banks have to maintain reserves at the Federal Reserve
just as member banks must do, but have no access or have limited access to the discount window and other system benefits, why not become
members i The assumption is that obligatory universal reserves would
not only make nonmenrbership unattractive, but many institutions
would also be inclined to convert to a national charter.
Indeed, even the payment of interest on and reduction of reserves
might result in a massive influx into the State member and national systems. If this occurred, many State systems would lose their viability,
and the F~deral Reserve's and the Comptroller's supervisory authority
would have grown substantially without the benefit of congressional
consideration. Mv point iR that the issue of Federal regulatory structure cannot be isolated from that of balance.
The impact of S. 3304 on the efficiency of the banking system also
should be considered. Market pricing of goods and services is vital
to their efficient allocation and use. Presently, pricing is absent in at
least three !treas ~hat bear directly or indirectly upon the legislation
under consideration : ( 1) the absence of interest payments on the
required reserves of member banks, (2) the provision of s~rvices by
the Federal Reserve to members banks, and (3) the prohibition of
interest payments on demand deposit balances and deposit interest
rate ceilings.
As a matter of principle, whether to pay interest on reserves should
not be an issue. Presently, failure to pay interest is tantamount to
the imposition of a tax on some of our banks without calling it that.
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However, structuring a procedure for paying interest on reserves has
raised difficult questions about the appropriate interest rate, concerns
about possible windfall gains to large banks, and controversy over
what percentage of the Federal Reserve System's revenues should be
avail~ble for interest payments. It seems to me that a simpler a:pproach would be to permit member banks to invest their reserves m
interest-bearill8: securities. The Federal Reserve could determine what
kinds of secul'lties should be eligible for this purpose based on considerations such as risk. This approach would permit each bank to
make its own choice and obviate ·the necessity of having the Federal
Reserve establish a rate. This issue could be the subject of a study
as Congressman Stanton has proposed in H.R. 12706.
Explicitly pricing Federal Reserve services should increase the efficiency of our financial system by allowing various financial institutions to purchase the services they desire either from the Federal Reserve or from private alternatives.
If interest were paid on member bank reserves, pricing of Federal
Reserve services would be essential to prevent discriminatory treatment of nonmember depository institutions. Pricing would also provide a better opportunity for the correspondent banking system to
compete with the Federal Reserve. Such competition, in turn, should
encoura.g-e the Federal Reserve to eliminate waste, to improve services
and to offer new ones.
Assuming that it is good pu'blic policy to maintain a significant
presence for the Federal Reserve in the payments mechanism, we feel
that the Federal Reserve should have some flexibility in setting prices.
The requirement that pricing principles be produced and published
at least a year before the fee schedule becomes effective assures that
the Federal Reserve will not take advantage of its unique position.
However, we would recommend that the matter of pricing guidelines
receive careful study prior to the enactment of legislation on the issue
of pricing to make sure that the Federal Reserve has pricing flexibility without unfair advantage.
Payment Qf interest on reserves of member banks potentially could
place nonmember banks as a disadvantage because the 40-year-old
prohibition against the payment of interest on demand deposits does
not permit member banks· to pay interest on correspondent 'balances.
These balances often serve as reserves for nonmember banks and serve
as well for check clearing operations and compensation for other correspondent services. If the principle o-f explicit pricing: were adopted
for member banks, then parallel treatment would dictate that correspondent banks should have the choice of paying interest on correspondent balances and levying explicit charges for correspondent services. The.re can be little doubt that this would increase the efficiency
of the financial system.
However, if the interest prohibtion is lifted for correspondent deposits, the principle of equity would dictate that it should be lifted for
all demand deposits. I have long supported elimination of the prohibition of interest payments on demand desposits and rate ceilings on
other kinds of desposits.
Finally, the last issue I would like to touch on concerns the discount
window:'Dhe Federal Reserve believes that the ability of the system
to cope with the kind of generalized liquidity crisis most of us are
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concerned about-in which the public demands more cash than the
banking system holds-aggressive open market operations and discount
window accommodation to members can provide cash sufficient to
meet the public's demand.
The decline in membership does impair the ability of the system to
minister to a localized liquidity squeeze involving one or a few institutions. In the past, the Federal Reserve has sometimes resorted to
conduit loans for nonmembers in sudh circumstances-that is, loans
to a member bank which in tum provides credit to a nonmeIIl'ber institution but has been reluctant to accommodate nonmembers directly
through the discount window.
We believe that emergency borrowings from the Federal Reserve
discount window should be available to member and nonmember banks
alike upon certification by the FDIC that they are in danger of failing
and that such assistance is necessary for a temporary period until a
merger, a receivership sale or some other orderl_y resolution of the
bank's problems is arranged. The FDIC, in tum, should be authorized
to guarantee the repayment of such borrowings out of the resources
of the deposit insurance fund. In connection with this authority, the
FDIC should be required by law to keep the Federal Reserve full)'
informed with up-to-date information as to the financial condition of
all banks certified to borrow from the discount window under this
provision.
The legislative proposals before the committee whicJh address the
issue of Federal Reserve membership attrition raise many of the other
difficult issues we have been facing for the past decade. The persistent
surfacing of these issues is a measure of the need to address them
and resolve them, and I concede that the job of the Congress in this respect is not easy. I hope that these comments will prove to be helpful.
The CHAIRMAN. Thank you very much, Mr. LeMaistre.
[Complete statement follows:]
STATEMENT OF GEORGE
A. LEMAISTBE, CHAmMAN, FEDERAL DEPOSIT INSURANCE
Colll'ORATION
Mr. Chairman, I appreciate the opportunity to testify before this Committee
and present the FDIO's views on the Federal Reserve Requirements Act of
1978 (S. 3304) which would amend the Federal Reserve Act to provide for the
maintenance of reserves by certain depository institutions, to require the Federal Reserve System to impose charges for its services, and to authorize the payment of interest on reserves held in Federal Reserve banks.
This bill and several under consideration by the House Committee on Banking,
Finance, and Ur,ban Affairs would deal with attrition in Federal Reserve System
membership and related matters. There has been a slow but steady erosion of
Federal Reserve membership over the last decade as banks have chosen to lea·ve
the System. Recently, this gradual decline accelerated. Since the beginning of
1977, 108 banks have withdrawn from membership. The percentage of total
deposits of commercial banks held by Federal Reserve members has decreased
from 83 percent in 1965 to nearly 73 percent ot the present time.
The Federal Reserve System has become increasingly concerned about the
attrition of membership and the declining proportion of deposits held -by member
banks. For many years it proposed mandatory membel"Ship as a solution. The
proposal never received a serious hearing in the Congress for various reasons,
primarily because of the concern expressed. by the States about the impact of
mandatory membership on the viability of State banking systems. More recently,
the Federal Reserve modified its proposal to provide for mandatory reserves and
membership privileges for nonmembers.
Last year, as the problem of membership attrition became more acute, the
System proposed payment of interest on required reserves and reductions in
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the minimum statutory reserve requirement limitations. Those proposals were
coupled with the Consumer Financial Services Act S. 2065) which would have
authorized depository institutions to offer NOW accounts. In my testimony on
this subject before the Subcommittee on Financial Institutions last year, I stated
that payment of interest on required, reserves and reduction of reserve requirements would have important implications for the competitive balance between
member and nonmember banks and for the structure of the banking system. I
indicated that, in my judgment, these issues are quite complex and are not related to permitting interest bearing NOW accounts on a national basis. Therefore, I recommended that these issues be dealt with separately and be subjected
to careful and reasoned study. These hearings and those recently held before
the House Committee on Banking, Finance and Urban Affairs provide the opportunity for the thorough consideration I think is essential.
Let me begin •by stating our view that the legal requirement that Federal
Reserve member banks maintain sterile reserves is inequitable to them and inequitable to their customers. In many States, it also places member banks at a
competitive disadvantage vis-a-vis nonmember banks. The bill under discWISion
proposes: (1) to establish universal reserve requirements for all banks or depository institutions; (2) to pay interest on reserves and to reduce reserve requirements; and (3) to charge banks for Federal Reserve services now provided free to
member banks.
For reasons I shall discuss, we strongly oppose the establishment of universal
reserve requirements for all commercial banks as well as all depository institutions. The payment of interest on reserves and pricing of services, however, are
attractive and deserve thoughtful and sympathetic consideration. The implementation would not ·be easy because a redressing of the imbalance between member
and nonmember banks raises many of the difficult issues with which the Congress
has been wrestling, without resolution, for a number of years. These include,
notably the issue of changes in the Federal regulatory structure, particularly
whether the Federal Reserve should continue to exercise supervisory authority ;
and the issue to regulatory reform, particularly whether interest rate ceilings
and the prohibition of interest on demand deposits should ·be abolished.
In the remainder of this statement I shall explain how we reached these conclusions by discussing how the proposals for dealing with the attrition of Federal
Reserve membership bear on _several important public policy considerations:
(1) the capability of the Federal Reserve System to conduct monetary policy
effectively, (2) the balance between the State and national banking systems,
(3) the efficiency and innovative capacity of the ·banking system, and (4) the
viability of the :banking system under liquidity pressures.
I. MONETARY POLICY EFFECTIVENESS
The Federal Reserve has stated its belief that the decline in the proportion of
deposits held by member banks caused by membership attrition adversely affects
the precision with which monetary policy can be conducted. The point is that as
a larger portion of deposits becomes subject to diverse State reserve requirements
the linkage between bank reserves and the money supply becomes less predictable.
Of course. estimating the impact on the monetary aggregates of a particular
change in reserves becomes more difficult when different banks are subject to
different reserve requirements. But this problem would exist even if all banks
were subject to universal reserve requirements or if all banks were member
banks. Under the present reserve structure of the Federal Reserve, time deposits
sue subject to different requirements than demand deposits and different size
elasses of member banks are subject to varying reserve requirements. Hence,
o1 shift of funds among mem-ber banks has precisely the same effect of blurring
the precision of monetary policy that disturbs the Federal Reserve when nonmember depository institutions are involved. It should be noted that S. 3304
would not alter this appreciably, because it would maintain the present system
of ditferent percentages of deposits set aside as reserves based on bank size.
There have been several studies of the mon,etary control issue by economists
outside the Federal Reserve. All of those that I am familiar with have concluded
that increased Federal Reserve membership is not important to the effective.
ness of monetary policy.
Two major statistical studies have attempted to ascertain the impact of
universal reserve requirements for member and nonmember banks on the implementation of monetary policy. The first was conducted by Clark Warburton for
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the Commission on Money and Credit. Warburton concluded that, nonmember
banks are affected by Federal Reserve monetary policy actions in approximately
the same way that member banks are. Another investigation was reported by
Dennis Starleaf of Iowa State University. In Starleaf's study the actual M,
money multiplier for the period 1962-1972 was compared with a money multiplier
series simulated under the assumption that all banks were subject to the reserve
requirements of the Federal Reserve. The simulation indicated that had non•
member banks been subject to such reserve requirements there would have been
even greater variations in the money stock. Starleaf thus rejected the argument
that equal Federal Reserve reserve requirments for member and nonmember
banks are necessary for the implementation of monetary policy.
There have also been a number of attempts to analyze the logical arguments
and the statistical data that exist on this issue. The Hunt Commission concluded
that "reserve requirements are unnecessary for open market operations j:o control
the monetary base effectively." Carter Golembe, after discussing the difficulties
in conducting monetary policy with precision, concluded that,
... So many factors contribute to the lack of precision and certainty that
simply changing the proportion of deposits subject to Federal Reserve
requirements from almost 80 percent to nearly 100 percent would be of
relatively minor importance.
In a 1974 study, Professors Ross Robertson and Almarin Phillips investigated
the argument that nonmember banks behave in a different manner from member
banks and that such behavior thwarts implementation of Federal Reserve
monetary policy. They concluded that these arguments have no validity. A
study conducted by Gary Gilbert and Manferd Peterson at the FDIC found
results similar to those of Robertson and Phillips.
Most economists regard reserve requirements as secondary to open market
operations in conducting monetary policy. The Federal Reserve has made minimal use of changes in reserve requirements in recent years, possibly owing to
its fear of aggravating the membership attrition problem. Nonetheless, the
limited use of this monetary tool has not had a noticeable impact on the ability
of the Federal Reserve to conduct monetary policy.
Furthermore, several studies have shown that open market operations have
a timely impact on all commercial bank reserves. These studies indicate that
the total impact is felt by banks in some regions within the first 2 weeks following open market operations. In most cases, the impact of open market operations
on reserves is completely transmitted within 6 weeks. Moreover, the length of
time for the impact of open market operations to be transmitted is not related
to the region's distance from money market centers.
What the Federal Reserve does need to conduct monetary policy effectively
is information about monetary aggregates. For the conduct of monetary policy,
the Federal Reserve should be permitted to obtain summary statistics on assets
and liabilities of all depository institutions from the appropriate Federal agency.
S. 8804 would require depository institutions to report their deposit liabilities
and required reserves directly to the Federal Reserve. We support making such
information available to the Federal Reserve and have no objection to the
adoption of the proposal in S. 3804.
Several years ago, the Federal Reserve became concerned about the adequacy
of its data on the money supply and established a committee chaired by Pro•
fessor George L. Bach of Stanford University to recommend changes in money
supply statistics. One of the major recommendations of the Bach Committee
was that better and more frequent data on nonmember bank deposits were
desirable. Following that report, the FDIC instituted a special schedule in the
quarterly call report for all nonmember banks to provide the Federal Reserve
with better information on the money supply. This schedule requires nonmember
banks to compute a 7-day average of deposits for the 7 days ending with the
date of call. This collection was initiated with the spring 1976 Call for Reports
of Condition.
A second step, also recommended by the Bach Committee, went into effect in
the first week of July 1977. A sample of 580 nonmember banks i.s reporting
deposit and cash items on a regular weekly, basis, the same items as all nonmember banks report four times a year. The Federal Reserve has indicated
that it expects the data from these two surveys to permit significant improvements in their estimates of the nonmember bank component of the Nation's
money supply. The FDIC and the Federal Reserve have _agreed to review this
program in mid-1979 to determine whether nonmember bank data are necessary
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for monetary policy purposes and, if they are, whether the sample of nonmember
banks is adequate. In the interest of improving the timeliness of the survey
data to the }'ederal Reserve, the FDIC intends to request the 580 banks participating in the program to submit the data directly to the Federal Reserve rather
than through the FDIC regional offices, which is the present procedure.
In summary, we believe the need for legal reserve requirements for monetary
control purposeel is not supported by the weight of available evidence. The
evidence to date suggests that monetary policy effectiveness depends on adequate
data, proper estimation procedures, and appropriate open market operations
decisions; and not on reserve requirement jurisdiction.
Bank supervision and the ea;ercise of monetary policy
Representatives of the }'ederal Reserve System have also argued that significant supervisory and regulatory responsibilities are required for the effective
conduct of monetary policy. In his testimony before the House Bankting Committee, Chairman Miller reiterated the Federal Reserve's belief that its activities
in the bank supervisory and regulatory area "cannot be readily separated from
its job of conducting monetary policy." In the past, representatives of the Federal Reserve have argued as well that an understanding of the nuances of monetary policy and of deYelopments in the economy facilitate bank supervision.
We feel there are two valid arguments why bank supervision and regulation
and the conduct of monetary policy should be separated. First, it has been argued that the Federal Reserve's responsibility for bank supervision diverts attention from monetary policy formation and that this diversion may reduce its
effectiveness in implementing monetary policy. Second, when the implementation
of monetary policy goals and bank supervision are combined, the former will
inevitably take precedence leading to inconsistent and inequitable bank supervision.
We believe some benefits will be gained from the functional separation of
supervision and monetary policy. Furthermore, it is our opinion that the attrition of members from the Federal Reserve System and, hence, a lessening of its
supervisory and regulatory presence has not interfered with the effective conduct of monetary policy. Based on the available evidence and experience, we
tentatively conclude that neither control of reserve requirements in nonmember
depository institutions nor supervisory jurisdiction is critical to the conduct of
monetary policy.
II. DUAL BANKING SYSTEM
Historically, our Nation's banking system has developed within the unique
Federal character of our State and national governments. Today this is
manifested in the ability of both the States and the Federal Government to
charter banks and other kinds of depository institutions. The vitality of this
dualism is maintained by permitting banks to convert from one chartering authority to another.
While some may disagree, we believe the dual system of State and national
banks has been a positive element in the American system of government and has
contributed to a more innovative and responsive financial system. Accordingly,
maintaining a balance bjltween the State and national banking systems is a desirable public policy.. The attrition in Federal Reserve membership gives some
credence to the argument that this balance is tilting toward the State systems.
However, despite the .decline of Federal Reserve membership, member banks
still hold about three-quarters of domestic deposits. Moreover, the largest banks
which depend on Federal Reserve clearing and_money transfer services represent
a hard core of membership and deposits not likely to leave the system.
Nonetheless, we should not maintain a "balance" for the sake of balance. It
is clear that reserve requirements of the Federal Reserve weigh heavily on
member banks and result generally in such banks carrying more cash than
they otherwise would. In direct competition with the nonmember bank, a member bank might be disadvantaged.
One solution to the problem of equity that we believe should be resisted is
the proposal in S. 3304 to impose universal reserve requirements on the transactions balances of nonmember depository institutions. As we explained above,
extension of universal reserve requirements to nonmember institutions is not
essential to conduct monetary policy effectively. While reserve requirements are
primarily responsible for the inequity of Federal Reserve membership, we believe that equity can be achieved in other ways-such as paying interest on re-
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serves, permitting reserves to be held in the form of marketable securities, or reducing reserve requirements-without the necessity of resorting to universal
reserves for all institutions.
Universal reserve requirements are perceived as a threat to the integrity of
State banking systems. If nonmember banks have to maintain reserves at the
Federal Reserve just as member banks must do, but have no access or have limited
access to the discount window and other System benefits, why not become
members? The assumption is that obligatory universal reserves would not only
make nonmembership unattractive, but many institutions would also be in~
clined to convert to a national charter. The result would be an imbalance in the
dual system in favor of membership and the national banking system.
We do not know whether this would occur. However, such a proposal should
not be accepted unless this danger is eliminated. If there were a massive influx
into the State member and national systems, many State systems would lose
their viability, ·and the supervisory authority of the Federal Reserve and the
Oomptroller of the Currency would grow substantially without the benefit of
Congressional consideration. My point is that the issue of Federal regulatory structure cannot be isolated from this issue of balance. The better of the
two proposals-the paymellt of interest on reserves and lowering of reserve
requirements-avoids some serious shortcomings of the universal reserve requirements propos·al, but it raises the possibility of weakening the State systems.
In summary, we cannot prove that universal reserve requirements would seriously damage the dual banking system. However, we feel this portion of S. 3304
should be eliminated unless sufficient safeguards for maintaining a balance in
the dual banking system are developed.
III. BANKING SYSTEM EFFICIENCY AND INNOVATIVENESS
Market pricing of goods and services is vital to the efficient allocation and
use of those goods and services. In the words of Milton Friedman, pricing is
highly desirable ". . . to prevent the waste that arises from the absence of
specific charges for them." Generally, market pricing encourages competition to
improve the quaM.ty of goods and services and to lower their cost. Presently,
pricing is absent in at least three areas that bear directly or indirectly upon the
legislation under consideration: (1) the absence of interest payment on the
required reserves of member banks, (2) the provision of services by the Federal Reserve to'member banks, and (3) the prohibition of interest payments on
demand deposit balances and deposit interest rate ceilings. I will address each
in turn.
Interest on reserves
.As a matter of principle, whether to pay interest on reserves should not be
an issue. Presently, failure to pay interest is tantamount to the imposition of
a tax without calling it that. A substantial amount of the revenue foregoing by
member banks is passed on ,to the Treasury Department by the Federal Reserve.
Some of the revenue is used by the System to offset the cost of providing "free"
services to member banks. If it were the national policy to tax banks, dt would be
preferable to levy the tax directly on all banks and other depository institutions
as well. Then all would be treated equally.
Concern has been raised about the adverse impact payment of interest on
reserves would have on Treasury revenues. This concern has led to attempts to
structure a procedure for paying interest while minimizing the loss in Treasury
revenues. However, structuring a procedure for paying interest bogs down in
questions about the appropriate interest rate, concerns about possible windfall
gains to large banks, and controversy over what percentage of the Federal Reserve System's revenues should be available for interest payments. We submit
that none of this is really necessary. It imposes the subjective judgment of men
in dealing with the cost of membership when the market system could probably
do better. Why not permit member banks to invest their reserves in interest bearing securities? In fact the percentage of assets held in cash would probably be
reduced by only a few percentage points. The Federal Reserve could determine
what kinds of securities should be eligible for this purpose based on considerations such as risk. It might even supply them from its portfolio. This approach
would permit each bank to make its own choice and obviate the necessity of hav-
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ing the Federal Reserve establish a rate. Presumably, 36 States allow State nonmember banks to hold li.t least part of their required reserves in the form of
U.S. Government securities. This issue should be the subject of a careful study
as Congressman Stanton has proposed in H.R. 12706. If either the loss of Treasury revenues or subsidization of small banks were felt to be important problems,
we would recommend that the Congress address these problems directly through
national tax policy.
To the extent that our faith in the efficacy of the market system might be
migplaced, we endorse the provision in Section 3 of H.R. 12706 that would require
the Board of Governors to prepare a study on permitting member banks to invest
their reserves in securities.
Pricing of services
Explicitly pricing Federal Reserve services should increase the efficiency of
our financial system by allowing various financial institutions to purchase the
services they desire from the Federal Reserve or private alternatives. Among the
Federal Reserve System's major service are: operation of the payments system,
including check processing and transportation and automated clearinghouse
services ; pickup and deli very of coLn and currency ; wire transfers ; purchase,
sale, safekeeping and clearing securities ; and operation of the discount window.
If interest were paid on member bank reserves, by whatever means, pricing
of Federal Reserve services would be essential to prevent discriminatory treatment of nonmember depository institutions. Pricing of services also is sound
policy because it would enhance the efficiency of the financial system. This would
provide a better opportunity for the correspondent banking system to compete
with the Federal Reserve. Such competition, in turn, should encourage the Fed·
eral Reserve to eliminate waste, to improve services and to offer new ones.
Assuming that it is good public policy to maintain a significant presence for
the Federal Reserve in the payments mechanism, we feel that the Federal Reserve should have some flexibility in setting prices. The requirement that pricing
principles be produced and published at least a year before the fee schedule
becomes effective assures that the Federal Reserve will not take advantage of
its unique position. In developing a set of principles, we would hope that consideration would be given to some of the following matters so that further Congressional action will not be necessary.
The costs of producing the same service for a variety of customers may differ
in various areas of the country because labor and capital costs are not equal.
Thus, it may be more efficient for the Federal Reserve to charge different prices
according to the costs of providing services to different customers. The cost of
providing a certain service to nonmember banks and nonbank depository insti•
tutions could be below the cost Qf providing the same service only to member
banks. This could result from the way in which a service were utilized. For
example, a credit union may not require daily pickup and delivery of coins or
currency, or a savings and loan association might not complete security transactions as often as a commercial bank.
To allow the Federal Reserve some flexibility in developing and implementing
a pricing system, the Federal Reserve should be permitted to price services
explicitly by broad service classes. One price schedule might be developed for
payments services, another for securities services, and another for transportation. Perhaps a cost-plus pricing system could be developed for the services now
provided by the Federal Reserve, and the markup over the cost of providing
the service might be limited to a fixed percentage.
There seem to be economies of scale associated with at least some services that
the Federal Reserve now provides. If these economies are pervasive, the Federal
Reserve will be able to offer the relevant service at a lower price than any
private competitor. There is nothing undesirable about this, but the result should
be determined by experience, not flat. It is not unlikely that the Federal Reserve
has a natural monopoly on some services because private competitors could not
attract sufficient volume to offer the same services at as low a price.
Aecording to materials that former Federal Reserve Chairman Bul'lns submitted, to Senator Proxmire on October 4, 1977, in recent years the per unit costs
of conventional check processing, return items, transfer of funds, and automated
clearinghouse activities have declined as volumes increased. If these trends continue, the private sector might not be able to offer competing services at costs
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that are as low as those incurred by the Federal Reserve. On the other hand,
the cash services offered by the Federal Reserve do not seem to show declining
costs with increasing volumes. In an electronic banking environment, it is not
clear that several payments systems can compete efficiently. However, in this
regard we point out that the private bank wire continues to compete with the
Federal Reserve wire, and networks of correspondent banks provide payment
services that are preferred by some member banks over Federal Reserve pay•
ment services.
Interest on demand deposits
Payment of interest on reserves of member banks potentially could place nonmember banks at a disadvantage because the 40-year old prohibition against the
payment of interest on demand deposits does not permit member banks to pay
interest on correspondent balances. These balances often serve as reserves for
nonmember banks and serve as well for check clearing operations and compensation for other correspondent services. If the principle of explicit pricing is
adopted for member banks, then parallel treatment would dictate that banks
should have the choice of paying interest on correspondent balances and levying
explicit charges for correspondent services. There can be little doubt that this
would increase the efficiency of the financial system.
As a matter of principle, if the interest prohibition is lifted for correspondent
deposits, it should be lifted for all demand deposits. I have long supported elimination of the prohibition of interest payments on all transactions balances as
well as removal of interest rate ceilings on other kinds of deposits. Economlsts
have demonstrated that there is no merit to the contention that competition
for demand deposits through the payment of interest led to bank failures during
the Depression as some contend. They have also demonstrated, at least to our
satisfaction, that competition for deposits through the pricing mechanism would
result in a more efficient allocation of resources than competition through indirect means involving the implicit payment of interest by building more
branches, keeping open longer hours, providing free checking services, offering
premiums and free travelers' checks, as well as a variety of other services. Such
competition would lead to substantial benefits for both financial institutions and
bank customers.
Under the present system of implicit interest payments on checking accounts,
depositors are denied the opportunity to determine for themselves how they wish
to spend their portion of the income the bank earns~on their deposits. If interest
were paid, a depositor might choose to consume the same services that banks
now offer in the course of competing with other institutions for accounts or a
depositor might choose to forego such services and spend interest income on
di:lferent goods and services. This is an important benefit--consumers would
decide how to spend their interest income, not the banks.
Free- or below-actual-cost checking encourages inefficient use of resources
because depositors have little or no incentive to economize on check writing, even
though check clearance costs are substantial. Direct charges for checks are likely
to prompt depositors to write fewer checks. Such fees should cover a substantial
cost of clearing checks. Management's adoption of pricing policies more nearly
in line with the costs of providing services to customers will enhance a financial
institution's capabildty of paying a competitive interest rate on deposit balances
without impairing earnings.
Payment of competitive interest rates will lower some operating costs by reducing the need for customers to transfer funds from noninterest bearing checking accounts to savings accounts. Thus depositors will no longer find it necessary
to maintain separate checking and savings accounts. Customers will not need to
spend as much time and effort in managing deposit balances, particularly when
interest rates are high. Also, existing inequities whereby some depositors pay Ie.ss
than the cost of servicing their accounts will be eliminated.
IV. BANKING SYSTEM VIABILITY AND LIQUIDITY PRESSURES
One of the important functions of the Federal Reserve System is to serve as
the Nation's lender of last resort. Through the vehicle of the discount window,
the Federal Reserve is able to provide liquidity when it is needed. The discount
window acts as a safety valve by permitting the Federal Reserve to cushion the
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impact of a tight monetary policy on individual institutions. It can also assist
member banks in meeting routine but unexpected loan demand or deposit withdrawals, seasonal liquidity requirements, and emergency liquidity needs. A member bank's first recourse is expected to be to the market. If sufficient funds are
not available in the market, the Reserve Bank might provide accommodation,
but it is understood that it is temporary. Each member bank must eliminate
its discount window borrowings within a reasonable period. Reserve Banks also
require member banks to pledge collateral, typically of high quality.
The Federal Reserve Act authorizes entities other than member banks to use
the discount window only under "unusual and exigent" circumstances. As a
result, Federal Reserve reports indicate that no nonmember bank has borrowed
from the discount window since 1966.
While nonmember banks also face unexpected needs for liquidity, they ordinarily cope with them with little difficulty by borrowing from correspondent
banks in much the same way that members do from the Federal Reserve. Indeed,
even when nonmember banks are 'in trouble, it is generally possible for them to
borrow from correspondents if they have sufficient and acceptable collateral.
To be sure, the lending bank may also impose special conditions on the borrowing bank. But in that regard, the Federal Reserve also behaves like a careful
creditor in accommodating a floundering bank. It makes sure such loans are
well collaterized, that its interest in the collateral is perfected. and that the
borrowing bank is solvent. Thus, the fact that nonmembers do not have window
accommodation is not seriously disadvantageous in most circumstances.
The Federal Reserve believes that the ability of the financial system to handle
liquidity "crunches" will weaken if membership attrition continues unabated.
It should be understood that the decline in Federal Reserve membership does
not impair the ability of the System to cope with the kind of generalized liquidity
crisis most of us are concerned about, in which the public demands more cash
than the banking system holds. Aggressive open market operations and discount
window accommodation to members can provide cash sufficient to meet the public's demand. The decline in membership does impair the ability of the system
to minister to a localized liquidity squeeze involving one or a few in_stitutions.
In the past, the Federal Reserve has sometimes resorted to conduit loans in such
circumstances-that is, loans to a member bank which in turn provide credit
to a nonmember institution. We think that the Federal Reserve should accommodate a nonmember bank directly in such special circumstances.
Indeed, we are concerned that membership attrition has contributed to a narrow interpretation of the words "unusual and exigent" by the Federal Reserve.
If experience is a guide, these words appear to be interpreted by the Board of
Governors as requiring a national emergency before a Reserve Bank would be
authorized to lend to a nonmember institution. The interpretation could be less
remrictive, but at the present time it does not appear that the Board of Governors is willing to interpret "unusual and exigent" circumstances as extending
to situations that are unique to an individual nonmember institution. The unwillingness of the Federal Reserve to open the discount window to Am.erican
Bank and Trust of Orangehurg, South Carolina, in September 1974 led to the
FDIC to take the unusual step of providing short-term liquidity directly to the
bank under Section 13(c) of the FDI Act. 1
In December 1975, former FDIC Chairman Frank Wille proposed that the
Federal Reserve make short-term, temporary loans available to nonmember
banks in such circumstances. We support Chairman Wille's proposal. We believe
that emergency borrowings from the Federal Reserve discount window should
be available to member and nonmember banks alike upon certification by the
FDIC that they are in danger of failing and that such assistance is necessary for
a temporary period until a merger, a receivership sale, or some other orderly
resolution of the bank's problems is arranged. The FDIC, in turn, should be authorized to guarantee the repayment of sU:ch borrowings out of the resources of
the deposit insurance fund. In connection with this authority, the FDIC should
be required by law to keep the Federal Reserve fully informed with up-to-date
information as to the financial condition of all banks certified to borrow from
the discount window under this provision.
Tho CHAIRMAN. Mr. Connell.
1
Two weeks later the bank was closed.
33-587 0 • 78 • 6
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STATEMENT OF LAWRENCE CONNELL, ADMINISTRATOR,
NATIONAL CREDIT UNION ADMINISTRATION
Mr. CONNELL. Mr. Chairman, members of the committee, I welcome
the opportunity to appear here this morning and present the views of
the ~ational C:rerl.it Union Administration on S. 3004, the Federal Reserve Requirements Act of 1978. This legislation, if properly modified,
would strengthen the Federal Reserve System, equalize the terms on
which depOSitory institutions compete, and assure an orderly development of future payments mechanisms.
My remarks will :be primarily directed toward those provisions in
the legislation which have application directly or indirectly to credit
unions. I would also offer some personal observations regarding the
proposal and its possible effect.s on the Federal Reserve System in
monetary policy implementation and payment system operations.
For the most part, the Federal Reserve membership problem appears to be caused by smaller banks ending their member relationship
with the System. As this increases the number of commercial banks
outside the Federal Reserve System, a number of undesirable effects
take place.
The first is clear-the Nation's central bank loses contact with
smaller communities in our country and thusly loses the benefit of input from these communities. The foundations of the payments mechanism are also weakened.
Some of the early thinking regarding the Federal Reserve System
incorporated a federation of clearinghouses whose liabilities were
guaranteed by the United States. From the foundation of the Nation's
central bank, the Federal Reserve ha&-since the second decade of this
century-provided the base for an accepto;ble payments mechanism
performance level which has been a public good of inestimable value to
American economic development.
I am not suggesting that clearing services should be provided primarily by the Federal Reserve. In fact, the prospect of service unbundling and explicit prices opens the way for assuring sound development of private electronic and paper funds transfer systems. I believe the private sector will, in the coming years, become increasingly
the predominant component of the payments system. This development, however, will not be sound if the Federal Reserve is unable to
assure an acceptable level of payments system performance in every
region and community in this country. There may be some areas in
which private sector systems cannot be operated profitably.
Another undesir~ble effect of the decline of the Federal Reserve
membership is a return to the practice of pyramiding reserves in banks
of increasing sire and proximity to money markets. Before the Federal
Reserve was established, banks maintained liquidity with hard currency and deposits in larger banks.
These larger regional banks, in turn, held liquidity in the form of
the liabilities of even larger money-center banks. When one of the
money-center banks failed, it took with it some of the smaller banks
that were depending on it. The more ba,nks there are 0utside the Federal Reserve, the greater will be the extent of liquidity pyramiding. It
was an unsafe practice in the 1800's, and it still is.
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A fourth unwanted effect of declining Federal Reserve membership
is a decline in the efficiency of the lender of last-resort function. With
member institutions in every community, there is a mechanism for
making funds available to a 'bank or nonbank institution which is
based on a financial intermediary familiar with the Federal Reserve
and its procedures. As Federal Reserve membership erodes and community representation becomes minimal, the providing of liquidity to
nonmoney market areas becomes steadily more difficult and Jess
efficient.
In summary, the decline in Federal Reserve membership brings with
it a number of unintended results.
One. It results in the central bank primarily serving the larger commercial banks, and it is perceived by the local community as a representative of the larger banks rather than serving a broad spectrum of
the community;
Two. It undermines the foundation of the payments system and restricts payments system developments to the large batrk members;
Three. It encourages a return to liquidity pyramiding; and
Four. It reduces the Federal Reserve's ability to serve as the lender
of last resort.
Nationwide reserve requirements on all depository institutions offering third-party payment services, coupled with interest payments on
reserves, unbundled services, and explicit pricing would prevent the
unintended effects of membership declines fr0m taking place.
Mr. Chairman, I believe that a further benefit is likely to occur with
the establishment of uniform reserves; namely, an increase in the
monetary control capability of the Federal Reserve Board.
· Aoourate control of the money supply requires among other thin.~
that the Federal Reserve know how many dollars of demand deposits
are likely to be created for each dollar added to the system through
open market operatioru,. The imposition of uniform reserves in conjunction with these open market operations can be viewed with respect
to its effect on monetary control. I recognize that strong economic arguments have been presented on both sides of this issue. My personal
experience leads me to believe that monetary control will be improved
by the imposition of these reserves. Additionally, I am persuaded by
the fact that the Federal Reserve itself is requesting this as a necessary
element in future monetary control operations.
In addition to possibly improving the Federal Reserve's ability to
control the money supply, uniform reserve requirements would
broaden the membership base of the central bank to include virtualty
every depository institution in the country. If the broader membership base were coupled with changes in the selection and tenure of
Federal Reserve Bank directors and Board members-proposals this
committee and its House counterpart have considered before-the
leadership of the Federal Reserve would become more renresentative
of its newly expanded base and of the economy as a whole. The Federal Reserve has already taken tentative steps in this direction.
As for credit unions, I believe those that offer transactions accounts
should be subject to the same reserve requirements and monetary
policy reporting requirements imposed on banks and other thirdparty paying thrift institutions. I feel strongly, however, that in-
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formation on credit unions should be J.>rovided by the National Credit
Union Administration. This legislat10n provides that the F~eral
Home Loan Bank System would receive and hold the required reserves of savings and loan associations. Similarly, I feel the National
Credit Union Administration through a .central liquidity facility
should be specified as the receiver and holder of credit union reserves.
The share draft accounts of federally chartered credit unions totaled
only $588 million as of June 30, 1978. Of that amount, $212 million
was held in the 19 credit unions which currtmtly have share draft
accounts totaling more than $5 million. If uniform reserves were imposed as the legislation provides, federally chartered credit unions
would have to set aside $25.4 million to meet the maximum requirement.
Credit-unions are becoming increasingly involved in the Nation's
developing payments mechanism. The explicit pricing proposal is
timely and necessary. It will strike a balance between the vast network which the Federal Reserve currently has in place and the multitude of private institutions which have come forth on the wave of
the new electronic technology.
Private initiatives will msure the Federal Reserv,, System runs
with maximum efficiency, taking advantage of in-place components
of the system which continue to be useful. The in-place system will
assure an acceptable level of payments system performance to every
consumer and even in the remote sections of the country.
I recognize that we must face the roblem of access to Federal Reserve services by nonmember financia institutions. I feel the direct access approach should be followed with some form of compensation
for the stock purchases required of member banks. I will be looking
forward to the Board's pricing recommendations which are scheduled
to be presented later this month.
The following comments are directed at specific sections of the bill.
Section 103(4) provides for an exemption for financial institutions
with transaction accounts of $5 million or less. It further provides
that this exemption may be waived by the Board under certain conditions. My concern here is to insure that any imposition of reserve requirements on this group of smaller institutions not be done in a sudden or precipitous manner.
Section 103 ( 5) would require a credit union to make reports concerning its deposit liabiHties to the Board. As I mentioned previously,
I feel strongly that this information should be supplied to the Board
by the National Credit Union Administration.
Mr. Chairman_, this con?ludes my testimony. I will be happy to
answer any questions you might have.
The CHAmMAN. Thank you very much, Mr. Connell.
Dr. Biederman.
·
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Federal Reserve Bank of St. Louis
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81
STATEMENT OF DR. KENNETH :BIEDERMAN, DIRECTOR, OFFICE OF
ECONOMIC RESE ...\RCH, FEDERAL HOME LOAN BANK :BOARD
TESTIMJNY CJ-I 5.3304
FEDERAL RESERVE REQUIRH,flNI'S ACT OF 19 78
By
Kenneth R, Biedennan
Director, Office of Econanic Research
Federal Home Loan Bank Board
SUMMARY OF BANK BOARD'S POSITION
The Bank Board does not believe that reserve requirements should
be made compulsory for thrift institutions on their transaction
accounts.
To the extent that reserves are required for S&Ls, !...:.2.,_
in connection with any nationwide extension of NOW accounts, such
reserves should be held at Federal Home Loan Banks, and the Bank Board
should play a more defined role in setting such reserve requirements.
The Bank Board believes that a better procedure than requiring
reserves is for Congress to consider permitting the explicit payment
of interest on reserves so as to induce ,broader membership in the Federal
Reserve System on the part of commercial banks.
Finally, the Bank Board holds that the payment of such explicit
interest can be justified on broader economic grounds. It would
make more feasible the pricing of Federal Reserve services and direct
access to such services by thrift institutions, a position that we
strongly endorse. The Bank Board would recommend, however, that the
bill require pricing based on comparability with the private sector.
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Federal Reserve Bank of St. Louis
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INTRODUCTION
Mr. Chairman and Me 1nners of the Committee, my name is Kenneth
Biederman.
I am Director of the Office of Economic Research at the
Federal Home Loan 83nk Board.
The Bank Board appreciates this
opportunity to present its views on S.3304,
This bill contains three propos,ls.
The first would require
savings and loan associations, mutual savings banks, credit unions,
and all commercial banks to hold reserves against transaction
accounts.
Reserve requirements for all depository institutions would
be determined within prescribed statutory limits by the Federal
Reserve Board.
Second, the bill would authorize the Federal Reserve System
to pay interest on reserve balances.
Third, the bill would require tne Federal Reserve Board to publish
for public comment a set of pricing 9rinciples and a pro~osed schedule
of fees for services that it provides, and to put fees for services
into effect by a certain date.
I wo~ld like to comment on each of
these three 9ropos3ls.
RESERVE REQUIREMENTS FOR ALL DEPOSITORY INSTITUTIONS
The Bank Board believes that requiring reserves to be held by
all major types of depository institutions against their transaction
accounts is an unnecessary step.
By far the dominant volume of
transaction accounts is held at commercial banks.
Based on a
definition that includes demand deposits, interest and non-interest
bearing NOW accounts, and share draft accounts, commercial banks hold
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99.2 percent of all transaction accounts, or about $256 billion.
To the extent that the lack of control over reserves on tran5action
accounts presents a problem in executing monetary policy, this results
almost entirely fr.01n the fact that State-cha,·tered commerci~l hanks
have the option of not belonging to the Federal Reserve System.
These
non-member banks have 30e5 percent of transaction accounts, compared
to .8 of 1 percent held at thrift institutions.
In terms of quantitative magnitude, the Bank Board sees little
to be gained by the Federal Reserve having authority to impose and
enforce reserve requirements for thrift institutions. The bill
provides that the first $5 million of transaction accounts for each
depository institution would not normally be subject to reserve
requirements.
A $5 million exemption would effectively eliminate
reserve requirements for almost all savings and loan associations at
this time.
However, the bill as drafted would permit the Federal Reserve
Board to impose reserve requirements of up to an average of 7 percent
on the first $5 million of transaction accounts if it determined
this "to be appropriate in light of general liquidity, considerations
of monetary policy, or other relevant conditions prevailing in the
banking system." The decision to do so would reside solely with the
Federal Reserve Board.
This part of the bill creates an ambiguity as
to how extensive would· be the imposition of reserve requirements on
S&Ls.
If and when S&Ls receive checking and NOW accounts nationally, and
assuming that reserves could be held at the Federal Home Loan Banks, the
Bank Board would agree that there is a need to consider the imposition
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Federal Reserve Bank of St. Louis
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- 4 -
of reserves on S&Ls.
The Bank Board's important role in moderatinq the
excessive im~act of monetary policy on housing credit implies that any
reserves eventually required of S&Ls be held at the Federal Home Loan
Banks and be determined by housing credit considerations as well as
considerations of general monetary policy.
Indeed, such rPst-rvf:'s could,
depending on future developments in this area, serve as a source
of loanable funds to implement housing goals.
There appear to be two arguments that underlie the proposal for
extending reserve requirements to all major depository institutions.
The first has to do with the impact on the effectiveness of monetary
policy, in particular, the control over monetary aggregates.
The second
has to do with competitive parity because of the alleged unfairness of
reserve requirements imposed only on member commercial banks, and not
on non-member commercial banks and other types of depository institutions.
With respect to the effectiveness of monetary policy, the Bank
Board recognizes that the Federal Reserve's viewpoint on this matter
must be given significant weight since it has the responsibility for
the implementation of monetary policy.
However, the Bank Board is
aware of differing points of view on the need for required reserves.
There is a body of opinion among some monetary economists t~at
required reserves are not necessary to permit Federal Reserve open
market operations to be an effective tool for controlling the
money supply.
There are many monetary economists who believe
that considerably less than all transaction accounts need to
be covered by reserve requirements in order for open market operations
to be able to meet monetary growth targets set by the Federal
Reserve System.
Even among those who argue for the need for
required reserves, there is no consensus on what the level
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5 -
of reserve requirements should be and, in particular, whether
it needs to be as high as the upper limit of the ranges within which
this bill would establish such requirements.
What is essential for an effective monetary policy is for the
Federal Reserve to have better infor~ation about transaction and
other deposits of non-member depository institutions, and the Bank
Board stands ready to provide the Federal Reserve with timely data
on deposits of S&Ls.
To the extent that the Federal Reserve Board feels strongly
that the erosion of its membership base is a significant deterrent
to effeCtive monetary policy, a promising approach, in our opinion,
is provided in Title III of this bill that would give the Federal Reserve
Board authority to pay interest on r~serves.
This would hopefully
be adequate to prevent further erosion in the membershi9 base of
the Federal Reserve System, and perhaps cause some non-me~ber banks
to convert to membership status.
It needs to be emphasized that S&L savings flows are very much
affected by Federal Reserve monetary policy actions, even though S&Ls
are not currently subject to reserve requirements.
The instability
in savings flows has been demonstrated in many studies and w~s documented in Chairman McKinney's testimony on the conduct of monetary
policy before the House Banking Committee on August 7.
As we have seen since 1966, Federal Reserve actions that push
up interest rates make it less advantageous for households and others
to hold savings accounts at S&Ls. The result is a sharp reduction
in savings flows at S&Ls that normally gets translated into a comparable
reduction in mortgage lending and housing.
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Federal Reserve Bank of St. Louis
Thus, monetary policy has
86
-6-
had a major impact on mortgage credit and on housing. This was brought
out in Charts 1-4 that Chairman McKinney presented in his testimony
noted above, which are attached to this presentation for reference.
fo
Cact, Feder,,! Reserve monetary pol icy act ions caust> a larger
adverse impact on
deposits at S&Ls and mutual savings banks
than they do on deposits at commercial banks.
This is illustrated
by data that show that the deposit growth rate for S&Ls slowed from
17.3 percent during mid-1976 to mid-1977, to 12.3 p~rcent during mid1977 to mid-1978.
banks rose from 9.1
In contrast, total deposit growth of commercial
percent to 10.7 percent during the same periods.
The fact is that monetary policy actions result in much greater
instability in savings flows than in transaction accounts, since
households and others have a wide variety of options with respect
to savings media, many of which are not in deposit form.
With respect to transaction accounts, howevet, there is little in
the way of options other than deposits, so that such accounts show
much less interest rate sensitivity.
Thus, the facts would indicate
that there is no need for reserve requirements against any types of
accounts held at S&Ls in order for monetary policy to affect deposits
and mortgage lending at such institutions.
As demonstrated above,
thrift institutions and mortgage markets already bear a relatively heavy
burden of the impact of monetary policy, and the Bank Board's major
role has been to soften and to diffuse the impact of monetary policy
more equitably.
The Bank Board submits that this bill ignores a development that
could have more far reaching implications than the limited volume of
transaction accounts that are held by thrift institutions.
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Federal Reserve Bank of St. Louis
This is
87
-7-
the Federal Reserve and FDIC's regul,,tion that would permit
the automatic transfer of funds from savings accounts to checking
accounts of
banks, with no required fees, effective November 1.
If and when this goes into effect, it would convert a large proportion
of savings accounts of banks into the equivalent of checking accounts.
There is nothing in this bill that would mandate the Federal
Reserve Board to require savings accounts linked to checkin3
accounts through the automatic transfer provision to bear reserve
requirements equal to that of checking accounts, or even to require
that they bear reserve requirements equal to that on transaction
accounts other than checking accounts.
The same applies to other third
party transfers, such as telephone bill paying services. It is our
position that any bill reported out should contain such provisions.
This brings us to the second argument that appears to be the
basis for the proposal that reserve requirements be imposed on
transaction accounts at all major depository institutions:
matter of equity and competitive parity.
The
The argument is ma1e here
that, even with the payment of interest on reserves, the inter.est
payments permitted under this bill would be below alternative rates on
other. assets. Thus, it would seem the Federal Reserve is arguing that
fairness requires that all depository institutions be subject to the
same drag on earnings as member commercial banks currently subject
to the Fed's reserve requirements.
In the Bank Board's opinion, this is not a tenable argu~ent.
In order to assess properly the equity-competitive arguments, one has
to look at the totality of constraints imposed on thrift institutions
relative to commercial banks.
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Federal Reserve Bank of St. Louis
In the case of savings and loan
88
-8associations, they are already subject to liquidity requirements
which, by statute, must range between 4 to 10 percent.
The ~urpose
of such liquidity requirements is to provide the Bank Board with
a policy tool to affect mortgage crerlit availability,
There are no similar liquidity requirements imposed by the Federal
Reserve Board upon commercial banks. While these liquidity r~quirements
can be met through interest earning liquid assets, the return on such
assets is normally significantly less than that on mortgage loans.
In
1977, for example, the average yield on liguid assets of S&Ls was
somewhat under 7 percent compared to an average yield of 8.2 percent on
the mortgage portfolio.
If liquidity rquirements were abolished and
liquid assets put into mortgage loans at their current rate of 9-1/2 to
10 percent, the result would be to add about $500 million to S&L earnings,
or about 15% of earnings in 1977.
Thus, S&Ls are already subject to
a drag on earnings from the need to hold liquidity requirements.
Liquidity requirements are only one part of the broader question
of competitive parity between S&Ls and commercial banks.
The fact
is that S&Ls still generally have asset and liability powers that
fall considerably short of those of commercial banks.
This gives
commercial banks a definite edge in the competition for deposits since
they can provide a complete range of financial services under one roof.
One •tudy has shown'that competitive parity would require up to a 3/4
of l percent interest rate differential in favor of S&Ls 1·elative to that
of commercial banks.
In addition, S&Ls also have a significantly higher average tax
rate than commercial bank competitors because of the qreater ability
of commercial banks to take
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Federal Reserve Bank of St. Louis
E
of various tax shelters.
89
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Thus, the Bank Board can see no justification for reserve requirements being imposed on S&Ls from the standpoint of the competitive
argument at this time.
To impose such requirements would not bring
about competitive parity as appears to be implied by proponents of
such requirements.
On the contrary, it would further aggravate the
competitive imbalance between S&Ls and commercial banks.
The Bank Board is also troubled by the degree of control of the
Federal Reserve Board under this proposal, and this appears to go well
beyond what is necessary for an effective monetary policy. Under
S.3304, the Federal Reserve would have sole authority to determine whether
a deposit may be considered a transaction account.
The Federal Reserve
would only be required t o ~ with certain other Federal financial
regulatory agencies when making this decision.
Since an increasing
proportion of savings accounts of S&Ls, as well as commercial
banks, are likely to be subject to preauthorized payments, telephone
bill paying services, debit cards, or other types of access, this
will give the Federal Reserve the latitude to include a large proportion
of savings accounts as transaction accounts, even though the volume
of transaction debits through such accounts may remain well below
that of checking or NOW accounts.
S. 3304 provides no guidelines for the Federal Reserve with respect
to the degree of transaction activity that needs to be exhibited in
savings and time accounts for these to be classified as transaction
accounts.
The Bank Board has no way of knowing to what exte~t the
Federal Reserve's power to define transaction accounts would provide
a backdoor means to impose reserve requirements on savings accounts
of S&Ls.
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Federal Reserve Bank of St. Louis
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In addition, within the ranges Get in this bill, the Federal
Reserve Board would have sole authority to determine reserves against
demand and other transaction accounts of thrift institutions.
Reserves
against demand deposits could be set anywhere between 7 and 22 percent,
while reserves against all other transaction accounts could be set
between 3 and 12 percent.
This means that the level of reserve
requirements would be determined entirely by considerations
that appear paramount to the Federal Reserve Board.
The level of
reserve requirements imposed on S&Ls would not have to reflect, for
example, concerns of the Bank Board about mortgage credit availability
and housing activity, or the impact that such reserve requirements might
have on the earnings position and viability of thrift institutions.
An important provision of this bill is that the portion of required
reserves not held in the form of vault cash by S&Ls would have to be
deposited ultimately in a Federal Reserve Bank.
A member commercial
bank or a Federal Home Loan Bank could only be a conduit through
which reserves required of an S&L are funneled to a Federal Reserve
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Federal Reserve Bank of St. Louis
91
-11Bank.
The Bank Board is quite concerned about this provision of the
bill, which is paralleled in a bill (S.2055) reported by this Committee
which would authorize NOW accounts nationally for thrift institutions
and commercial banks.
To repeat ourselves, we are concerned about the substantial power
that the Federal Reserve Board would have under this bill with respect
to depository institutions other than commercial banks.
The impact of
whatever level of reserves requirements is set by the Federal Reserve
Board should have to take into account legitimate objectives and concerns
of the Federal Home Loan Bank Board and other thrift institution regulators.
Failure to do so will constrain the ability of the Bank Board to deal
with the undue impact of monetary policy on housing.
Thus, while the issue of reserves against transaction accounts is
inconsequential in terms of dollar amounts at this time as far as S&Ls
are concerned, we wish to go on record that in the event of reserve
requirements being imposed on S&Ls against transaction accounts in
the future, the Bank Board would hold to the following position:
(1) Reserves required against these balances could be held
at District Federal Home Loan Banks and not simply
on a pass-through basis to Federal Reserve Banks.
To the
extent that such reserves were held at the District Banks,
these Banks should satisfy any interest on reserves requirements.
(2) The Bank Board and other oversight agencies impacted
by these proposals should have a definite and defined
role in the determination and setting of reserve
requirements.
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Federal Reserve Bank of St. Louis
92
-12IN'rEREST ON RESERVES
we would like to turn to the payment of interest on reserves
which would be permitted within constraints under this bill.
While we
oppose the extension of reserve requirements imposed by the Federal
Reserve Board to thrift institutions at this time, we agree that Congress
should consider giving the Federal Reserve Board the authority to pay
interest on reserves of its member institutions.
As we noted above,
the payment of interest on reserves represents a preferred means by
which the Federal Reserve Board could stem the erosion in membership
from the Federal Reserve System.
Moreover, we believe that the payment
of interest on such reserves has merit on economic grounds.
The fact that explicit interest is not paid on reserves of member
commercial banks does not mean that these reserves are totally nonproductive.
As the members of -this Committee know, the Federal Reserve
System provides many specific services to its members at no cost,
and such free services can be regarded as the equivalent of an implicit
payment in return for reserves held at the Federal Reserve eanks.
The fact that the Federal Reserve System has a problem of membership
attrition despite this indicates that the implicit return in the
form of services provided freely are not deemed to be an adequate
rate of return on these reserves.
Once we are aware that there is an implicit return already
being paid on reserves held by member banks at the Federal Reserve,
we are no longer dealing with the issue of whether interest should
be paid, The relevant questions become:
(1) What should be the rate
of interest? and, (2) Would explicit interest payments make better sense
than implicit interest?
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Federal Reserve Bank of St. Louis
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-13-
The Bank Board's position is that an explicit interest rate
makes better sense since it permits ,nember commercial banks to utilize
the resulting interest in any way th,,t it desires, rather than being
forced to accept the services provided free of cost by the Feder.al
Reserve System.
As the Bank Board sees it, the payment of an explicit
interest rate on reserves is an important precondition to the pricing
of services by the Federal Reserve System and the resulting stimulus
to greater competition in the private sector in providing these types
of services.
Why is there so much controversy generated by the guestion of
whether explicit interest should be ~aid on reserves?
This appears
to arise from the concern of some that the payment of explicit
interest on reserves would represent "windfall" profits to commercial
banks.
This is a difficult argument to evaluate for. a number of
reasons, and the Bank Board would merely like to lay out the issues
without claiming to know the answers.
Those who argue that there is no problem of windfall profits
could point out that the reserve requirements imposed by the Federal
Reserve Board may be unnecessary or, at least, higher than necessary
for purposes of effective monetary policy.
If so, this would mean that
member commercial banks are probably holding a larger volume of non-interest
earning assets than is needed.
In evaluating the windfall profits argument, it is useful to
view non-interest earning reserves as a tax on commercial banks by
the Federal Government. Such reserves also represent a non-interest
form of debt of the Federal Government which substitutes for debt
that would other.wise have to be issued to and held by the public
at a market interest rate paid by the Federal Government.
33-587 0 - 78 - 7
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Federal Reserve Bank of St. Louis
If we view
94
-14reserve requirements as a tax, we get into the familiar question of
who ultimately pays this tax,
Is it the commercial banks them-
selves, or is the burden shifted onto others?
The burden could possibly be absorbed through a lower interest
rate paid by commercial banks on their savings and time accounts,
or a higher interest rate or fees charged on various types of loans
or services.
It is not clear as to what extent the ultimate burden of
nonpayment of interest on reserves is shifted onto the member commercial
banks themselves or onto others.
Thus, if the Federal Reserve System
were permitted to pay explicit interest on reserves, we do not know
to what extent this would increase the profits of the commercial
banking system.
While the Bank Board can support the payment of interest by the
Federal Reserve System to member institutions, we do not believe that
we can comment at this time on how such interest should be computed
and what should be the maximum interest rate permitted on such reserves.
However, the Bank Board believes that the payment of interest on
bank reserves strengthens the case for removing the ban on explicit
interest on demand deposits, as well as the case for extending interest
bearing NOW accounts and demand deposits nationally to all depository
institutions.
FEES FOR FEDERAL RESERVE SERVICES
We turn now to the provision of the bill which would require
that:
(1) Not later than July 1, 1979, the Federal Reserve Board
shall have prepared and published for public comment, pricing principles
and a 9r.oposed schedule of fees for Federal Reserve System services;
and, ( 0
)
The Federal Reserve Board shall put into effect a schedule
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Federal Reserve Bank of St. Louis
95
- 15 of fees for such services no later than July 1, 1980, and any time
after July 1, 1979 if it determined such action to be appropriate.
The Bank Board welcomes the explicit pricing of Federal Reserve
services.
The Board, however, believes that savings and loan associa-
tions and other thrift institutions should obtain direct access to
these services under this bill at the published schedule of fees, as
is provided for in S2595, the Federal Reserve System Services Act.
Thrift institutions should be able to avail themselves of direct access
to such Federal Reserve services as check collection, wire transfers,
settlements, automated clearinghouses, and securities safekeeping.
In addition, at the time that direct access to Federal Reserve services
is provided, provisions need to be made for settlements, which may require
clearing balances at the Federal Reserve for S&Ls.
Access to Federal Reserve services will give S&Ls and other thrift
institutions the option of not having to use a correspondent commercial
bank to obtain use of these services. Indeed, S&Ls could themselves
provide correspondent services as commercial banks currently do.
Of course, direct access does not mean that Federal Reserve
services will necessarily be utilized.
An important aspect of explicit
pricing is that thrift institutions, as well as banks, will be in a
position to choose between the Federal Reserve payments mechanisms
and those that operate outside of the Federal Reserve System.
Private payments mechanisms should be stimulated as a result of
explicit pricing by the Federal Reserve Board. We could see considerably
more competition as groups of commercial banks and thrift institutions
find it advantageous to set up alternative payments mechanisms or
to utilize mechanisms of other private entities.
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Federal Reserve Bank of St. Louis
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-16At the present time, with Federal Reserve services offered free
to members, member banks have a strong incentive to take advantage
of these services, thus reducing the ability of others to compete even
if they can offer better services. The Bank Board would note that this
bill is not explicit on the pricing guidelines that would have to be
followed. We would like to see Federal Reserve pricing done on a private
sector entity basis, i.e. pricing which recognizes imputed costs of
capital and taxation.
Such pricing is necessary for private sector
competition with Federal Reserve services.
Thank you Mr. Chairman and Members of the Committee.
concludes our testimony.
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Federal Reserve Bank of St. Louis
This
will be happy to answer any questions.
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Federal Reserve Bank of St. Louis
Chart 1. Average Interest Rate on New Issues of 91-Day Treasury Bills.
and Net New Savings Receipts (Seasonally Adjusted) at FSLIC-Insured
SavJngs Assoclatlons--1966-1978, by Quarter
p""""" I
Bllk>M ol Doll. .
e.oot----------------------------------, 12.0
,,I
,,• ,'"'\ ''r\,,\
\
\
''•' 'I
8.0
I
I
'\ \
5.00
I
I
I
I
I
'
Ii
''
''
\
"-....,,,
,,"
I
I I
4.0
I
I
I I \
I I
I
'\I, ''' '
,
• ''
I
I
"
I\
I I
,I'
f Net New Savingo lleatlpt9
' . (right
I
I
I
\
I
,ca1e,
0
'•
\I
2.00
f
1-
1987
1988·
1989
1970
1971
1972
1973
1974
1976
1978
1977
·2.0
1978
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Federal Reserve Bank of St. Louis
Chart 2. Net New Savings Receipts (Seasonally Adjusted) at FSLIC-Insured
Savings Associations. and Private Housing Units Started
(Seasonally Adjusted Annual Rate)--1966-1978. by Quarter
BiUlono of Doi. . i
MHHons of Units
12.0.-----------------------------------~2.e
2.6
9.0
".I fI
\
I
_J
8.0
,,.., /
.,,
3.11
I
/
I
I
,
2.0
"'
l
I
-
1.0
0.5
0.0
1988,
1987
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Federal Reserve Bank of St. Louis
Chart 3. Effective Interest Rate on Conventional Mortgages on Newly-Built
Homes, and ,Private Housing Units Started (Seasonally Adjusted
Annual Ratel --1966-1978,.'By Quarter
9.40
Pen:ent
Units
r
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -MHllona
- -of~
2.8
2.6
I\ ,. .... ,
\
I ...,,
,,,'
I
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\
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7.90j
,I
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2.0
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f
I
1.6
,/
I
\
\.
..,I
,'
1.0
1.80
0.6
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Federal Reserve Bank of St. Louis
Chart 4.
Private Housing Units Started (Seasonally Adjusted Annual Ratei.
and Change In Real Gross National Product (Annual Rates)-1966-1978, by Quarter
Mltl..,,_ of Unlm
Oinlorw of Dollars
2.BOO'r--------------------------------,40.0
101
The CHAIRMAN. Thank you Dr. Biederman.
.
Senator Schmitt has to leave and he's asked if he could ask one
question. So I would ask Senator Lugar's permission if he could ask
that one question.
Senator LuGAR. Surely.
Senator SCHMITT. I appreciate the Senator's courtesy and am intrigued by this testimony, maybe even more than I was by Chairman
Miller's.
Underlying it, I think is a general belief that the dual banking
system and a multifaceted financial system are of value to the country, and have been a proven value for some time.
Now, if there were a system designed to preserve this multifaceted
character of our financial system that included a requirement for deposit reporting by all financial institutions, the option for maintaining reserves in order to obtain the Fed services, the availability of the
discount window for financing, and then the payment of interest on
reserves if in fact reserves were maintained, and maybe even along
the interest lines suggested, would that kind of a package protect
the kinds of interests that you all-I shouldn't say you have interests
that you're protecting-but would it tend to mitigate the problems you
see in the proposed bill ?
Mr. LEMMSTRE. Senator Schmitt, I think definitely it would. However, I would suggest that in furnishing these services the Fed ought
to furnish them on an explicit pricing basis, as your bill suggested,
and that the furnishing of services not be conditioned on the maintenance of reserves. It seems to me that the reserve balances at the moment are the basis for giving free services--free in quotes--to various
banks who are maintaining those balances. It would be fairer and perhaps more efficient. to say what each service will cost and let the bank
select which services it wants and either get them from the Fed or a
correspondent bank or wherever they may be available.
I think our whole system would be more efficient if that method were
pursued.
Senator SCHMITT. But you would not perceive any value in allowing
those services to be bought, if you agreed to maintain reserves upon
which you could get interest?
Mr. LEMAISTRE. You mean add pricing to what your first question
was and furnish them free if the balance was kept?
Senator SCHMITT. No. I would say, if you as a thrift institution
or otherwise, would maintain reserves, then you can have access to
the services but at the fee schedule. But you could also get interest.
Mr. LEMAIS'IIRE. Get return on your reserves? Certainly that makes
it a more equitable bill. I'm convinced that would be less potentially
h~rmful. Frankly, I'm at a loss ~o say exactly what the impact of this
bill would be on the dual bankmg system. It's because I'm worried
about what might happen to it is why I have raised that question.
Senator ScHMITT. You think there are too many incentives to~ into
national banks i
Mr. LEMAISTRE. I think you might find a sudden influx into the-Federal system from the State system, and there are a few States-moro
than a few-that probably couldn't operate without maintaining something like their present level of membership in the State system. So to
the extent that the dual system is beneficial-and I think it has been
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beneficial-it has produced innovations in banking which have been
helpful. Whether good or bad, it gives us a proving ground for certain
experiments, as is the case in New England. Furthermore, it seems to
me that it's definitely worthwhile to preserve it, and the caution I'm
raising here is that we ought not to let this bill be a means of lessening
its viability. Because of these fears I raise those questions.
I do think what you suiz;iz;est is probably the way to approach it, although I would say that if universal reserves are being required simply
because of the effect on monetary policy, that I haven't seen that the
need for that has yet been demonstrated.
Senator SCHMI'IT. You think deposit reporting would have at least
some of the effect of universal reserves i
Mr. LEMA.ISTRE. I think so.
Senator ScHMI'IT. Mr. Connell.
Mr. CONNELL. Senator, I have no fear that the dual banking system
would-or dual financial system will suffer because of universal reserves. As I understand tins proposal, it's strictly, monetary reserves
and doesn't propose a full thrust of membership ljegulation that now
exists under the membership system that's currently used. Therefore, a
bank or a credit union or a savings and loan assqbiation can choose its
charter depending probably upon the operating powers thait it has in
a particular jurisdiction.
Senator ScHMITT. There's always th~ old rl:omino theory, though.
Mr. CONNELL. We have had the dommo tr>mg the other way, Senator, for the last several years, and I think its begun to have its impact
on the effectiveness of morumi.ry policy, and that does concern me that
we have a number of evolutionary conditions going on right now mnging from freeing up of the controls of interest rates, for instance, that's
one of the Federal Reserve tools for the monetary policies, one orf the
lesser tools but nonetheless we are beginning to have a movement toward more market determination of interest rates. We have changing
or blurring of definitions of money itself which, of course, involves the
intermediaries that I regulate, and all these require, I think, a new look
at our structure of carrying out monetary policy. And so I'm in favor
of the Federal Reserve's policy, with some modifications that we have
in our testimony.
Mr. BIEDERMAN. Senator, I think we would consider all of those areas
that you mentioned as improvements on the current bill. But I think
one area you may have touched on that needs attention has to do with
the role of the Federal Home Loan Bank System and the Credit Union
Administration in terms of setting reserve requirements and the question of were these reserves could be held. They would have to be passed
through the Federal home loan banks or held at the Federal Reserve
banks. I think, in aiddition to what you mentioned, we feel these issues
should be addressed more clearly.
Senator Scuxrrr. Well, thank you very much. Thank you, Mr.
Chairman.
•
The CHAmMAN. Thank you.
I want to follow up what the distin~hed Senator from New
Mexico talked a:bout. What concerns me-it's easy to solve these problems just by paying out more public money, pay interest on required
reserves. We have never done it in the past. We start with an estimate of $300 million and we could end up with many billions of dollars
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before we're through a year. Of course, the people who get it are going
to be pushing for it and we know what happens when that develops.
We also reduce the earnings of the Federal Reserve and therefore the
earnings of the Treasury and the burden on the taxpayer by reducing
the reserve requirements. So I think we have to be cautious and careful
about that.
We are obviously g"Oing to get a push in that direction from the people who are going to benefit from it, but we represent the broad public
interest and we ought to be sensitive and aware of the cost of this.
Let me start with Mr LeMaistre. The main issue that we are confronted with is not membership, but rather, whether the central bank
should have all depository institutions under its direct or indirect jurisdiction for these purposes: (1) Mon~ry policy purposes; (2) to assure safety and soundness of the financial system; and (3) to provide
for an efficient payment system.
Do you think that universal r~rve requirements would accomplish
these objectives?
Mr. LdursTRE. I would have to say I'm not convinced that it would.
The CHAIRMAN. You're almost alone in taking thwt position.
Mr. LEMArsTRE. I think monetary control depends upon having immediately available the data relative to monetary aggregates, where
shifts of funds are going, that sort of thing, and I think the data are
available and there is no need for universal reserve requirements.
1'he CHAIRMAN. Well, how about the issue of equity and fairness that
Mr. Mil1er stressed so emphatically and so hard and I thought so well?
I didn't hear any answer to that in your testimony or in the questioning by those of us here in the committee. Why shouldn't all institutions
of the same size have the same reserve requirement mandated for them?
Why shou'ld you have one that can opt out from under reserve requirements by giving up their membership and becoming a nonmember ·and
get that advantage?
Mr. LEMAISTRE. Well, I would have to say I agree that the present
system is inequitable. It does favor the nonmembers.
The CHAIRMAN. Why shouldn't universal reserve requirements be
mandated at ·a moderate level?
Mr. LEMAISTRE. At a low enough level, I don't think it would hurt.
I think the present-well, I shouldn't say this bill because-but the
level in the Reuss bi'll-I think would increase the requirements in
about 10 percent o,f member banks with more than $100 million in reservable liabilities.
The CHAIRMAN. You wouldn't object to that? You wouldn't object to
universal reserve requirements if they were exempt for the first $100
million plus 6½ percent above that?
Mr; LEMArsTRE. I would say thn.Jt the level ought to be below 6½
percent.
The CHAIRMAN. It's a big loss to the Treasury if you do it that way.
Mr. LEMAISTRE. If you want to tax the banks, I think you ought to
tax them directly.
The CHAIRMAN. The banks have enormous privilegp,s. ThP> banks
aren't starving. I don't see many bankers who are on welfare.
Mr. LEMAISTRE. I'm not objecting to taxing the banks, but I do
think it is wrong to tax 40 percent of the banks as we are doing now.
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Forty percent of them are leaving money up there on which they earn
nothmg so the Federal Reserve can earn something.
The CHAIRMAN. We have been doing that for 200 years. We have
been mandating requiring reserves one way or another.
Mr. LEMAISTRE. Right, and we have been inequitable to members
for some time.
The CHAIRMAN. Well, Mr. Connell, let me ask you how you feel,
whether the central bank should have all depository institutions under its direct or indirect jurisdiction for monetary policy purposes to
assure safety and soundness and provide for an efficient system, and
whether or not the universal reserve requirements would accomplish
those objectives.
Mr. CONNELL. Mr. Chairman, as I mentioned in my remarks to
Senator Schmitt, for monetary policy purposes, very much so. The
reserve banking system is dealing with the high-powered money section in terms of money creation and in that area which the Federal
Reserve will probably ·have its most effective implementation.
In terms of safety and soundness, I guess the most graphic example
I could think of was in reviewing the Federal Reserve's recently
changed policies on sea90nal lending in the last few years anyway.
The Federal Reserve relaxed its policy and set up a s~parate structure
for seasonal lending in the agricultural areas. Well, if you don't have
lending in this kind of facility for banks say in the agricultural area
or any area that has high seasonal swings, then the financial institution
keeps a greater portion of its assets in a liquid, sterile form awaiting
the bad time of the year, and that means that for the 2 months that
liquidity demands are high, the rest of the year the people in the
community suffer from lack of financial resources in terms of credit.
For the individual bank to insure the safety and soundness it will
maintain a higher portion of its assets in liquidity and less in loans.
So from a safety and soundness standpoint, if the discount window
were available, then the safety and soundness criteria would be met
without a cost to the local community.
In terms of the payments mechanism again, as we had fewer members, then we have correspondent banking services offered by fewer
banks which lowers the number of alternative sources for payments
processing and that, too, is not in the public interest.
So, for all those three reasons, I favor the universal reserve concept.
The CHAIRMAN. Very good. Dr. Biederman.
Mr. BIEDERMAN. A couple of points. I'm a little confused on the
monetary policy question. Chairman Miller surprised me a little bit
this morning. They have argued in their testimony several times that
this is an important monetary policy tool, but yet there's an agreement
to cut the reserve requirements down. We've got to think a little bit
just what side they come out on as far as the monetary policy tool.
Basically, we agree with the provisions of the bill. I think to the
extent it would promote an effective monetary policy tool clearly is
good for the financial system. Our reservations are pretty much
oriented toward the question of control and the role of the Federal
Home Loan Bank System.
On the equity point, as somebody who has done a lot of work in the
tax area, equity is a strange word. You're always for equity. I would
submit, however, that when we start talking about whether this
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bill will increase fairness, we need to look at such questions as increased power, relative powers, and even taxation questions as well.
So I would be a little cautious on the equity argument. It has a real
nice ring, from the standpoint that everybody should pay the same,
but we need, to look at a broader perspective as to just what is equitable
and what is not.
The CHAIRMAN. If they are the same size institution and they are
competing in the same kind of area, it seems to me they should be
treated alike.
Mr. BIEDERMAN. If they are competing in the same area, that's right.
The CHAIRMAN. Or with respect to what they are competing in.
Let me ask another question. As Chairman Miller indicated, the
Federal Reserve has suggested to Chairman Reuss that $25 million in
demand and savings deposits and $25 million in time deposits be
exempted from universal reserve requirements.
Now Chairman Miller said that only five thrift institutions would
then be affected. I would assume that those five would not be greatly
affected because their transactions balances are probably low.
I'd like to get your reaction to that proposal.
Mr. BIEDERMAN. Our figures indicate under the $5 million exemption
there would be one S&L affected. Whether that one falls out under the
$25 million, I'm not sure.
The CHAIRMAN. He said five thrift institutions. He may be including others than S&Ls. He might be including mutual savings banks.
Mr. BIEDERMAN. From our standpoint, we have to agree with that.
The CHAIRMAN. Well, I would like to get your reaction under those
circumstances whether that Reuss proposal, we could put that into
effect now or if you wanted to wait. Why wait if the effect is so limited
and moderate i
Mr. BIEDERMAN. Well, I guess it's a question of which comes first
here. You're right in your observation that we're talking about a pretty
small potato from the standpoint of the savings and loan associations.
The CHAIRMAN. At the same time, things are changing.
Mr. BIEDERMAN. If indeed things are changing and we do see increased powers such as NOW account authority nationwide and checking accounts, perhaps they should be considered in tandem.
The CHAIRMAN. Why not put into effect now and as they change then
you catch the competition and put it on an equitable basis so everybody is treated alike i
Mr. BIEDERMAN. Well, that's a good suggestion. As I say, as long as
things are progressing, we would certainly go along with that. Ultimately we would like to see the question of control in the Federal
Home Loan Bank addressed also.
The CHAIRMAN. Senator Lugar.
Senator LuoAR. Mr. Chairman, I was intrigued by Mr. LeMaistre's
testimony starting where he says, as a matter of principle, whether to
pay interest on reserves should not be an issue. Presently, failure to
pay interest is tantamount to the imposition of a tax without calling
it that. This, of course, gets to some of the dialog that has transpired
as to whether if you were going to be equitable you would not simply
impose a tax on banks per se or financial institutions, go about it in a
straightforward manner as opposed to attempting to level out the circumstances that institutions find themselves in.
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But then, you point out, why not permit member banks to invest their
reserves in interest bearing securities. In fact, the percentage of assets
held in cash would probably be reduced by only a few percentage
points. The Federal Reserve could determine what kind of securities
would be eligible for this purpose based on considerations such as risk.
It might even supply them from its own portfolio. This approach
would permit each bank to make its own choice and obviate the necessity of having the Federal Reserve establish a rate. Presently 36 States
allow State nonmember banks to hold securities as part of their required reserves in the form of U.S. Government securities.
Now it seems to me this really gets to the heart of the matter. If in
fact we are attempting to provide through this legislation safety and
security, which the idea of reserves implies, and a certain degree of
equity with regard to member banks that have been holding reserves
and, others that are a~o;ut the same size that haven't been holding reserves and, even more importantly, we should rely upon the good judgment and the management of the financial institutions to determine
how they want to go about providing their reserves, provided they do
so within the parameters of safety as the Federal Reserve has
suggested.
In other words, let the market system work to the maximum amount
without imposing a tax which is going to be nonequitable on the face
of it, as you let some come in and some come out and ~ve some exemptions and what have you. Obviously, you have testified that you
think this is a pretty good idea or at least raised some questions as to
why we haven't considered it, but it clearly gets around the problem of
universial reserves in lieu of tax. There is a universal principle here,
that any financial institution would be providing some degree of reserves for purposes of safety. If a financial institution could continue
to do so and invest in Government bonds or some other security that
met the Federal Reserve Board's strictures, then it would earn income.
They are not dead reserves sitting around in various places.
Now this seems to me to be such a good idea. Let me ask you, as an
experienced man in Government, what is wrong with it i Why would
anybody oppose that idea@
Mr. LEMA.IsTRE. Senator, I think I should point out there is a body
of thought that a reserve as such cannot be held in any kind of earning instrument, that the only true reserve is something that is equivalent to cash. I must say most of the people who say they are Federal
Reserve economists, but the truth of the matter is I think it is a good
idea. I think it deserves considera.tion. The bank which chooses to us
this method obviously would not put all of its reserves in interest bearing securities. As Mr. Connell mentioned a moment ago, there are certain seasonal demands which require banks to have a great deal of
liquid~ty either in cash or short-term securities which obviously earn
less than the longer ones. So in that case they would tailor their portfolio in the reserve account to their own regional needs.
So it seems to me that it's worth exploring and that's why I brought
it up, because Congressman Stanton in his proposal asked. the Fed to
make a study and report on it and it seems to me this kind of study
would be very useful to us. At first blush it looks good to me.
Senator LuoAR. Mr. LeMaistre, are there any Federal Reserve economists or others who believe that a reserve must be something other
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than interest bearing, that problem or that idea is somewhat undercut
by the discussion we are having. In other words, it seems to me that
clearly Chairman Miller and others are suggesting that in fact interest
be paid on reserves. So that I appreciate the fact that that may be one
objection that. would have been lain against your idea before, but
clearly it's not one now. That's the nature of the argument we are having, how much the rate ought to be and where the incidence of this
ought to fall.
Chairman Proxmire has pointed out if the incidence falls in such a
way that the Treasury simply loses $200, $300, $400, or $700 million a
year transferred to bankers, then there are some objections to that idea.
Clearly the idea you have is one in which apparently bankers are not
obtaining any additional revenue from the Treasury via the Federal
Reserve Board. They are taking the chance in the market of whatever
rates of interest are available. As I say, I wanted to highlight this because it just seems ,to me to be commonsense. I'm opposed to an idea of
a tax under the guise of something else. I'm opposed to almost all ideas
that move away from the market when we really do not need to do so at
all. In other words, it became simply a bureaucratic strategy to gain
greater control, but before leaping at your testimony, I just simply
wanted you to explain while you're here as a witness what the pros and
cons were of the thing.
Mr. LEMA1sTRE. As I say, I think it deserves study. I'm not saying
it's the sole answer and I think it should be pointed out that in those
States where reserves are lield in interest bearing securities the entire
reserve is very seldom held in that sort of way. As I understand it, they
are usually rather small. Most of it is cash or correspondent balances
or something of that sort. But even so, that is the banker's decision and
I think he should be permitted to make that business decision for the
best interest of his own institution.
Senator Luo.AR. Mr. Connell or Mr. Biederman, would you have a
comment on this discussion¥
Mr. CONNELL. In comparing State reserve statutes to the Federal
Reserve System, I think there is a distinction 'between a regulatory
reserve set up under State law where the purpose of the reserve is to
provide liquidity for periods of stress and so on as a safety matter, and
a monetary reserve which is designed to remove money from the banking system and there is, as Chairman LeMaistre indicated, a body of
thought that if the reserves were kept in securities of some sort that
the ability of the central bank to exercise its monetary policy function
in a rational reserve concept is not achieved, and that's the principle
that's ;beihg questioned on this. Payment of interest on reserves, because if the reserves can be reinvested and they do not result in the
monetary policy objective of limiting Federal control, then it just
doesn't work. So that's essentially the way I see it. I thought about this
business of keeping reserves in securities, particularly with re-spect to
creq.it unions and that question arose, so I had to back off quite frankly.
Senator Luo.AR. Let m~ just pursue it for a moment. Let's say for purposes of monetary control as opposed to safety, I think that's an important distinction, that the Federal Reserve Board decided the type
that was required and therefore said through its guidelines what you
can do with your money as a hanker-you must rnvest w percentage
more in Treasury bonds. Now isn't this a degree of monetary control rn
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which clea.rly you can't invest in something else, and yet at the same
time you have to establish a rate and deprive the taxpayers money
circling back to the Treasury and so forth~
Mr. CoNNELL. That's how it appeared to me at first and then the
question arose whether in that proce.ss as the financial institutions purchase treasuries or whatever, whether they don't release moneys to be
reloaned or reinvested elsewhere, and I guess the question really being
that when the Federal Reserve withdraws the money into the Federal
Reserve System it's sterilized for monetary policy purposes and reinvestment but not so for-maybe n"Ot so if those reserves were kept in
some money market instrument, treasuries, or whatever. I guess the
question arose whether that could effectively sterilize reserves for
monetary purposes ·and that there is a body of thought that it doesn't
sterilize the money.
Senator LUGAR. Mr. Biederman, do you have any comment 1
Mr. CONNELL. I don't understand 1t quite frankly indepth, but the
question arose so we would recognize it.
~fr. BIEDERMAN. The problem here is, using Federal Reserve numbers, that you've got a situation where the banks are apparently being
taxed, if you will, some $650 million more money than they feel would
be fair, given the return they would be getting on their services. The
horn of the dilemma is do you address this by lowering the reserve requirements to make up this differenee because you've got the reserve
requirements down, and then reduce the monetary policy tools as a
consequence, or do you explicitly, as you would price the service, pay
interest, and take a market solution. I think I would tend to lean
toward the direction of the market solution to the extent you don't
get into a price-fixing situation.
On the other hand, and I can understand the chairman's viewpoints
on this particular point, you get into the question of "are you providing
some sort of windfall profit to the banks, would some banks be overcompensated, and so on 1" There are two basic sides to this argument
and it becomes a matter of ar,proach. Clearly you've got banks that
are saying these services aren t worth it and we're getting out of the
system that needs to be addressed in some way.
Senator LUGAR. Thank you.
The CHAIBMAN. I think Senator Lugar has characterized a very intelligent question and one that bothers many people, but I think Mr.
Connell gave a reasonably good am,wer. If you do permit everybody:......
and I thmk to be fair you would have to permit the Chase Manhattan
and National City and Bank of America to do the same thing-if you
permit everybody to put their reserves in earning assets, the Treasury
obligations, and there were no sterile reserves, then if the Federal
Reserve wanted to act to reduce or increase in the money supply it
would be impotent. They wouldn't be able to do it because just exactly
as you say, if these funds went into Treasury hills, for example,
Treasury bill interest rates would tend t.o fall. Then that would mean
that more money would be available elsewhere and you wouldn't have
an effective monetary policy. The notion that you shouldn't tax banks
unfairly is a very good pomt. On the other hand, there is a windfall
here--you know, banks alone are in a very, very advantageous position
with respect to Federal taxes. They pay something like 16 percent of
their net profit in taxes compared to over 32 or 33 percent for other
corporations on the average.
·
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So they do ha,ve tha,t big a,dvantage. They also are given a, moneta,ry
power to crea,te money tha,t is unique and unusual. Furthermore, the
proposal by both Chairman Reuss and Chairman Miller would moderate the effect on ba,nks by greatly reducing the reserve requirements
that they have to pa,y whether it's 6½ percent or 7 or 9 percent; it
would be less than it 1s now for the big banks, and zero for banks with
either $100 million or $50 million in deposits. So you would ha,ve a
great benefit to the banks to begin with. You would also, because
you would universalize reserve requirements, make it possible for
monetary policy to work effectively with a lower level of reserves.
It seems to me that's a reasonwbly equitable ap:proach. I don't mean
to put you in an embarrassing position, Mr. LeMa1stre, but you seem to
be the lone holdout today. I don't mean the lone holdout. Obviously
you have many, many supporters, but the witnesses this morning seem
to disagree with you.
Mr. LEMArsTRE. Mr. Chairman, I'm not holding out in the sense that
I sa,y there's no other way to do it, but I do think the matter deserves
considerable study. It is worth taking the time to see whether there's
any objection to universal requirements.
The CHAIRMAN. I don't want to be unfair to you, but let me put
it bluntly because sometimes when we get a little blunt we get a
better give and take here. You say universal reserve requirements might
cause a massive influx into State member ·and and national systems
and you say the supervisory authority of the Federal Reserve and the
Comptroller of the Currency would ~ow substantially without the
benefit of congressional consideration. Of course, this would also
mean that the supervisory authority of the FDIC would diminish.
Isn't that the real reason_ why the FDIC is against universal reserve
requirements~ It doesn't want to lose a part of its turf¥
Mr. LEMArsTRE. I'm not aware tha.t that's the reason. It's not my
reason. I'd have to say I'm not even sure that the FDIC needs to stay in
supervision. Our prima.ry purpose, of course, is somewhat like the
Fed's, to make sure of a constant safe money supply, and my only
reason for raising that point is that I don't think the dual banking
system can survive if half the States drop out of bank supervision. It
just seems to me we have to make sure that that doesn't happen and
whether we're the ones that a.re examining those State chartered institutions or the Fed or the Comptroller doesn't really make a lot of difference to me, but I don't thmk you can operat.e witJhout the State
system if you want to keep the benefits of the dual system.
The CHAIRMAN. Mr. Biederman, how many savings and loan associations would be affected by the universal reserve requirement imposed
by the bill this committee is now considering~
Mr. BIEDERMAN. I think as I mentioned earlier, one.
The CHAIRMAN. Now on that basis, how can you maintain that universal reserve requirements should not be applied to savings and loan
associations at this time i
Mr. BIEDERMAN. I guess I get back to my earlier p<>int. We are not
opposed to the concept as long as we also address S1IDultaneously the
question of the increased powers from the standpoint of NOW accounts and checking a,ccounts.
The CHAIRMAN. I want to be sure I understand. Did you say if
nationwide NOW accounts or something similar become authorized
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for savings and loan associations you would then not oppose the
reserve requirements~
Mr. BIEDERMAN. That they should be -addressed at tha.t time-the
Bank Board has been on record in the past that they would support the
concept of universal reserve requirements.
The CHAIRMAN. All right. Mr. Connell, in your testimony you said
that an undesirable effect of the decline of the Federal Reserve membership is the return to the practice of pyramiding reserves of banks
of increasing size in proximity to the money market. Membership itself is not the key to this, is it i Isn't the holding of reserves with
either the Federal Reserve or a correspondent the choice~
Mr. CONNELL. That's it and uncler the present system of course where
under State law a bank can hold its reserves with a correspondent and
it receives from the correspondent the implicit service payment, they
will then keep those reserves with the correspondent. As fewer banks
are members of the Federal Reserve System, there's greater depositing
in the money center banks as the correspondent left to do business. For
instance, in Connecticut, we had three or four medium-sized banks in
the $300 million-plus category that had been active in correspondent
banking withdraw from the system and that would leave only a handful of banks in the correspondent system. So this trend, if it continues,
and if the earnings pressure continues, we'd have more and more money
moving in that fashion in correspondent balances to the money center
banks and that is pretty much what happened in the late 1800s in
terms of the correspondent banking and the problems with the pyramiding phenomena.
The CHAIRMAN. Are you arguing that the reserves be kept with the
central bank i
Mr. CONNELL. Yes.
The CHAIRMAN. Mr. LeMaistre, you indicated in your statement that
economists reject the need for equal reserve requirements for members
and nonmembers and particularly you cite the work by Dennis Starleaf. Dr. Starleiaf commented on the NOW account bill and he mentioned the results you cite but he said, "One is tempted to conclude from
my study results that reserve requirements are not needed for money
stock and control. However, at this time I'm unwilling to draw such a
conclusion." He indicates a lack of nonmember data and lag of reserve
requirements influenced his results and the proposition would be consistent that the reserve requirements enhance monetary control without
these factors.
Do the other studies you rely on take these factors into account
and were they done by monetary policy experts sudh as Dr. Starlean
Mr. LEMArsTRE. I think so. I think that Prof. Robertson, Prof. Phillips and Carter Golembe speak to those issues.
The CHAIRMAN. If the Federal Reserve indicated that it needed
data on deposits at credit unions, Mr. Connell, both Federal and State,
on say a weekly basis, could you provide it~
Mr. CONNELL. Yes, we would. We could set up a weekly system. I
think we could set it up, particularly given the small number of credit
unions involved in the proposal.
The CHAIRMAN. Mr. Biederman, the question of what constitutes
a transaction account hasn't been resolved. Certainly, some savings
accounts at both banks and thrifts can be used for transaction pur-
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poses either directly or by telephone transfers and automatic transfers
will add to the usefulness o:f savings account purposes.
In your view, how should savings accounts be treated, as transaction
accounts or time deposits¥
Mr. BIEDERMAN. I think they should be treated like time deposits.
The CHAIRMAN. Without qualification¥ Would you explain why¥
Mr. BIEDERMAN. Well, when you say treated, you mean under this
current bill i
The CHAIRMAN. That's right.
Mr. BIEDERMAN. Savings deposits :for thrift institutions should not,
I don't believe, be included under any reserve requirements at this
time. Maybe perhaps I misunderstood your question, but I do believe that automatic transfer provision-that there should be some
sort o:f reserve requirements :for that.
The CHAIRMAN. How do you do that i:f it's not through an account¥
·Mr.BIEDERMAN. How do you do what¥
The CHAIRMAN. How do you treat the savings accounts?
Mr. BIEDERMAN. Currently?
The CHAIRMAN. Yes.
Mr. BIEDERMAN. We have a liquidity requirement against savings
accounts on short-term borrowing in the Federal Home Loan Bank
System. It varies :from 4 to 10 percent. It's a requirement that 4 to 10
percent o:f savings plus short-term borrowings be held in certain
short-term assets.
The CHAIRMAN. Let me ask Mr. Roberts, the committee's chief
economist, to :follow up on that. He has trouble with your answer.
Mr. ROBERTS. I'm concerned about the treatment o:f the savings
deposits that enter into the automatic transfer arrangement with demand deposits. How do you differentiate that type o:f savings deposit
:for transactional purposes, :from other types of savings deposits?
Mr. BIEDERMAN. Well, I think at this point it has to go through
the imthority in order to make the transfer. It has to deal with the
authority that the transfer can in :fact take place. In the case o:f
savings and loan associations no such authority exists.
The CHAIRMAN. Now, Mr. Connell, you mentioned that the committee should consider changes in the selection and tenure of Reserve
bank directors and Board members. What changes would you recommend? Shouldn't the Federal Reserve bank presidents be made more
accountable?
Mr. CoNNELL. Mr. Chairman, I go back about a year ago when I
was testifying on S. 2298, when I suggested that the membership
of both the Federal Reserve bank directorships be broadened to include a greater cross-section of the community, including representatives of State government, and I think I will continue with that.
Of course, with increased authority comes increased accountability
and so I would think that the Congress should consider again the
retainment and membership o:f the Board of Governors as well. I
don't have any specific suggestions at this time but my main concern
I think is with the local banks, particularly, that a broader crosssection of the community be included. Of course, as the Board impacts
other intermediaries, then a system of communication has to be set
up so that the impact on other intermediaries and the people that do
business with them are considered also.
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The CHAIRMAN. Senator Lugar.
Senator Luo.AR. Mr. Chairman, staff has provided with certain
information and just for the sake of argument let me cast these
figures for you. I think Mr. McLean, the committee staff director,
indicates that about $27 billion of sterile reserve accounts are in the
Federal Reserve Board jurisdiction now and essentially it's from this
money that the Federal Reserve Board makes some revenues that
are then turned over to the Treasury.
One of the problems of the dialog that I was having with Mr.
LeMaistre-1 supposed it would come down to the :point if in fact
$27 billion of sterile reserves was substantially dissipated, as it
might be-if member banks of all sizes, those now in and out and so
forth, make their investments on their own, maybe Mr. McLean
indicates $4 or $5 billion might be left over for clearing of transactions or other technical reasons, but maybe $20 billion, maybe $22
billion would disappear, which means that the Federal Reserve Board
would then not be making money on that money and the Treasury
would not receive that income.
Chairman Proxmire mentions a fact which is important in the equation; that is, that the banking system as a whole ma,y not pay in
terms of corporate taxes as high a rate as do some other firms. There
wou]d be different situations. To the extent that a fairly hefty income
tax is paid by banks, the question I suppose could be raised whether
this new-found income of banks receiving on their own in Treasury
securities would not lead to higher income which would in fact be
taxed and money derived to the Treasury in that respect.
I raise all of this not to try to resolve it, but to indicate that I
thinks we are onto an intriguing area in terms of the incidence of
taxation and the benefits or the losses to the Treasury and in fact
really who ought to be controlling the whole process. As I have admitted, I'm intrigued by the thought that probably rather than having an arbitrary situation by the Federal Reserve Board, banking
systems would be healthier if the Fed.era! Reserve Board set the
parameters of what was illeg-ible for reserves and let the banks
make their own decisions even if it meant the Federal Reserve Board
had $22 billion less to play around with in the process this is a very
1 lifferent sort of proposition from which we entered the discussion
•>f this legislation and it leads me to believe that before proceeding
very much further with the Jegislation we ought to begin taking
a look at how reserves and safety and monetary policy can in fact
occur with the strengtJ,ening of free market decisionmaking as opposed to taking for granted that sterile reserves per se are a good
thing, unless we take the proposition that Federal securities are inherently unsafe to the point that there is no portfolio parameter
that is possible, which of course poses a whole set of different
problems.
Trying again on this basis, does anybody have a comment i Mr.
Connell. your eyeia; seemed to li_ght up at the thought.
Mr. CONNELL. Well, the tough balancing act is really the impact on
the Treasury in terms of the loss of revenue versus the indirect tax
benefit on the financial institutions that are members or prospective
members and that's I g'lless one policy argnment. But the other, in
tel'IJlls of keeping reserves in money market instruments is being ques-
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tioned as to its effect on the availability of the Federal Reserve to
exercise monetary policy and I think I would want to feel very secure
that the Federal Reserve could 1achieve its monetary policy objectives
before I would recommend that the reserves be kept other than in the
sterile form.
I guess it really comes down to the issue of equity in terms of the
rost of membership and the big problem has been that years ago when
interest rates were relatively low, when access to the discount window
was an importiant business tool for the 1930's, times have changed
and interest rates are high and the services are not providing the
return comparatively speaking that are available in the marketplace
and the market system has resulted really in erosion of the Federal
Reserve membership to the point where it's reached public policy
concern to make the Federal Reserve Board request consideration by
the Congress.
Senator LUGAR. But indeed the erosion problem as far as public
policy, I think we got back to the chairman's thought that .we're
talking about an efficient payments system, safety and soundness and
the ability to effect monetary policy-that these are objectives that
we're trying to arrive at. Now Mr. LeMaistre has suggested that mone·tary policy is much less a consequence of having sterile reserves in
large bulk 1at least as I see it-he suggests other reasons-but obviously honest people can differ on what it takes to effect monetary
policy. Maybe you need $2'7 billion. Maybe you need more than that
plus a more universal access to the attention of financial institutions,
large and small.
Mr. CoNNELL. I guess, Senator, this is the place where Mr. LeMaistre and I differ. I feel that the too]s of the Federal Reserve to
implement monetary policy have seriously eroded over the last 10
years, again ranging from interest rate controls to the definition of
money, to the developing of the securities market and so on. It's a
very complicated situation, but it seems to be moving all against the
Federal Reserve's ability to carry out its fundamental purpose.
Senator LUGAR. I suppose the question then is raised as to how much
more control is to be obtained through what appears to be 1a fairly
narrow packa¢ng of prices for services and the additional universal
reserved reqmrements. Granted, there are all kinds of things going
on in the world monetary markets as well as our own, the securities
markets and what have you.
Dr. Biederman, do you have any comments~
Mr. BIEDERMAN. A' couple comments on your taxation observations.
I think you hit two points on the head here. There is a school of
thought that says, "there would be no real windfall profit, that the
burden of this extra cost is reaJly on the savers and on the borrowers,
it's been shifted forward, and if there was payment of interest on the
reserves, then they would benefit." I'm a little suspicious of that
argument.
I think, particularly, on the side of the savers, because of regulation Q ceiling, that one might have to contest whether, in fa~t, any
burden is shifted here. As to whether taxes would go up in the case
of commercial banks becaiuse earnings would go up, clearly they
would. However, I wouldn't bet the family jewels on just how much,
given the history of this thing in the past, and the tendency for com-
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mercial banks, quite legitimately, to make objections to reducing their
tax burdens.
Senator LUGAR. Well, yoµ would have maybe a part of the argument that surrounds it presently if you have a certain degree of liberation of opportunity o:f greater pursuit of enterprise and an expanding pie, but aside from that, of course, there are many reffsons why
banks don't pay as high a levy on the Federal level which is because
they invest in municipal securities. And so the question then, I suppose, is whether they ought to do that or not or it might be a good
question now as to if that is a pretty healthy thing as to the status
of local governments.
Do you have any further comment, Mr. LeMaistre !
Mr. LEMA.ISTRE. Senator, I would have to point out that banks pay
about 16-percent rate on their income tax because the Congress decrees
that's what they shall pay, and if you want to attack it to increase
the income of the Treasury, then that seems to me is a proper place
to do it.
Senator LUGAR.· It's more equitable thing than trying to fool around
with the universal requirements and ins and outs and this so.rt of
thing.
Mr. LEMA!STRE. I think a lot of people have the conception that
banks pay a very low rate of income tax and I think that probably
some of that is justified, but nobody ever considers what they forego
on their reserves, income which might otherwise be tai:able.
Senator LUGAR. So while we're involved in what amounts to sort
of a truth in packagin~ and truth in lending or truth in pricing, we
could get into a truth ·m taxing and see what the incidence is of the
flow.
The CHAIRMAN. I don't want to hold my breath until the banks
start to pay the same share as everybody else on their income.
Mr. LEMAisTJIB. I predict it would pass if you called it truth in
something.
Senator LUGAR. That may very well be.
The CHAIRMAN. Thank you gentlemen-very, very much. I think you
have been excellent witnesses and made a good record. Tomorrow we
are going to hear from -the State Bankers Association, the New York
Commissioner, American Bankers Association, the Independent
Bankers Association, a panel of three bankers representing smaller
banks.
The committee will stand recessed until 10 o'clock tomorrow morn1
1
ing.
LWhereupon, iat 12 :25 p.m., the hearing was recessed, to be reconvened at 10 a.m., Tue:!§day, August 15, 1978.]
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Federal Reserve Bank of St. Louis
FEDERAL RESERVE REQUIREMENTS ACT OF 1978
TUESDAY, AUGUST US, 1978
.
U.S. SENATE,
CoMMI'PI'EE ON BANKING, HousrNo, AND URBAN AFFAIRS,
W<JJJhington, D.O.
The committee met at 10 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire ( chairman of the committee},
presiding.
Present: Senators Proxmire and Riegle.
The CHAIRMAN. The committee will come to order.
Today we continue hearings on matters related to reserve requirements and affiliation with the Federal Reserve System.
Yesterday I indicated rthat I tend to favor the establishment of
universal reserve requirements as a way to solve, in a J>0rmanent manner, the problems raised by the attrition of membership in the Federal
Reserve. That problem is basically a matter of having the Nation's
central bank in a position where all commercial banks and all depository institutions with transaction accounts above a certain size maintain reserve requirements on the same basis, where all banks have
access to the discount window, and where all depository institutions
have acccess to payments services on the same basis.
I am skeptical about interest on reserves. As a way to solve this
problem it would not be a permanent solution, hurt ratlier a giveawa:y
of Treasury funds. The tendency over time would be for more and
more interest to be paid at tJhe expense of the Treasury and the public.
Moreover, this would increase the Federal deficit and, therefore, tend
to increase the inflationary impact of the Federal Government and,
of course, it's always easy to solve our problems by spending more
money. It's an easy solution, but I think this indicates it's not the preferred solution.
I would like to welcome our first witness, Muriel Siebert, banking·
superintendent of the State of New York. We are delighted to see you
again and go right ahead.
STATEMENT OF MURIEL S:mBERT, BANKING SUPERINTENDENT,
NEW YORK STATE BANKING DEPARTMENT
Ms. SIEBERT. I am Muriel Siebert, superintendent of banks of the
State of New York. I am grateful for the opportunity to appear today
before the Senate Committee on Banking, Housing, and Urban Affairs
on the subject of S. 3304.
This bill addresses itself to tJhe imposition of reserve requirements
on transaction accounts, the payment of interest on reserves held in
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116
. Federal reserve banks, and the imposition of charges for certain services offered by the Federal Reserve banks.
Let me speak briefly to each of these points.
The bill would require the maintenance of nni:fo...rn an<l 1miversal
reserve requirements on all transaction accounts held in all de~itocy
institutions where the transaction accounts total more than $5 million.
This would encompass demand accounts at nonmember banks, checking or NOW accounts at thrifts, and share drafts at credit unions. The
Federal Reserve Board would have discretion in setting the required
reserve ratio within statutory boundaries of 7 to 22 percent for demand
accounts and 3 to 12 percent for other transaotions accounts. Finally
with respect to reserve ratios, the statutory range of reserve ratios on
time and savings accounts for member banks would be broadened to
reduce the minimum from the current 3 percent to· one-half of 1
percent.
Reserve requirements perform two imp<>rtant economic functions.
The first is to assure a minimum level of hq_uiditv at all de~it-taking
institutions. This adds to the stability- of mdividual institutions and
of the financial intermediary system. I suspect that this was the motivation for the reserve reQuirement nroviRions of the New York bank~
ing law which date back decades before the establishment of the Federal Reserve System. It is also, I suspect, a part of the motivation for
the presence of requirement provisions in the banking statutes of every
State with the sole exception of Illinois.
The liquidity function of reserves is a matter which prudent bankers would see to on their own, and the statutory requirement is therefore intended to protect against the excessive!v speculative. But the
liquidity function of reserves clearly doeR not re<1uire that the reserves be held in the form of liabilities of a Federal Reserve bank. And
indeed almost all States permit their nonmember banks to hold reserves in the form of deposits at other banks, and many States allow
interest-bearing securities such as U.S. Government obligations as
e]igible assets for this purpose. I might add that English banks, which
are subject to reserve requirements, are permitted to hold at least a
portion of their reserves in the form of Government securities and
other earning assets.
Once reserves are established, competitive equality problems arise
among various classes of financial institutions. Thus, when New York
State-chartered thrifts received the new power to offer checking accounts in 1976, the banking department fe]t it appropriate to propose
legislation requiring them to maintain reserves at nonmember bank
levels. This legishttion, by the way, has not yet been adopted.
Moreover, the liquidity function of reserves can be fulfilled without
requiring that reserve ratios be uniform in different areas or for different classes of banking organizations. Indeed, the structure of bank
regulations, including the Federal Reserve Act itself, has alwavs recognized different needs for reserves for city banks and country· banks
and for bia banks and small banks.
The flexibilitv of permitting reserve requirements suitab]e to the
needs of individual financial systems, particularly for smaller and
country banks, seems, from this perspective, preferable to a uniform
national requirement. The bill before yon already recognizes the need
for some flexibility by permitting the ·Fed to set reserve requirements
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Federal Reserve Bank of St. Louis
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within fairly broad statutory ranges. I think that the Congress would
want to give some thought to giving explicit guidance to the F~d ?n
the possible desirability of taking regional and size characteristics
of banks into account in setting specific reserve requirements.
The second important function of reserve requirements within o~r
current economic structure is to facilitate the conduct of domestic
monetary policy by the Federal Reserve System.
. .
I want to state at the outset that the conduct of monetary policy is
not within the scope of responsibility of the New York State banking department. I am, however, aware that a number of acknowledged
experts have questioned whether reserves are a necessary, or even a
helpful, component of control over the money supply. Chairman
LeMaistre of the FDIC, in his August 4 testimony before the House
Committee on Banking, Finance, and Urban Affairs on similar legislative proposals, discussed in some' detail the studies of these experts.
I am sure that your committee will hear testimony from many economists on this question.
·
In preparation for my testimony I _reviewed the reserve requirement
practices of other major Western nations where New York banks operate branches and which have substantial foreign branch operations in
New York. My research revealed the interesting facts that B.elgium
and Switzerland do not have in place any reserve requirements at the
moment. I am not aware of any substantial concern that the Belgians
and the Swiss are unable to control their domestic money supplies.
I would not, however, conclude from this that reserve requirements
are unnecessary within the context of our institutional configuration
in the United States. The issue, as I understand it, is that the Fed needs
to have knowledge of the relationship between the volume of bank reserves and the supply of money. This relationship is less stable and
less well known in an environment where the money creation function is carried out by a large number of different banks, subject to
different reserve requirements, held in different forms, and reporting
on their activities on different schedules. Posed this way, the issue is
one of the Fed's access to accurate and timely information. I note that
Congressman Reuss shares this perception o·f the problem. There may
be less drastic and more democratic ways of resolving this issue than
forcing all depository institutions to kP,ep reserves essentially as if they
were Fed members.
I might add that this question is especially timely as we enter the
era of automatic transfers from savings to checking accounts, for this
program may cause a larget volume of consumer deposits to be maintained as lower reserve savings as opposed to higher reserve checking
balances. This will have the transitional effect of further blurring the
Fed's command over monetary statistics, and the long-term effect of
raising the money multiplier. So the issue of improving the Fed's control over monetary data is a worthwhile topic for discussion.
The second major item in the bill is the authorization of the Fed
to pay interest on reserve balances maintained at Federal Reserve
hanks. I support this proposal both because it is reasonable on its face
for bankine- orµ-anizations to have some return on these funds and because it will reduce the current disparity between member and nonmember banks.
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I note that there is some debate over what level of interest payments the Fed should be required or permitted to make on reserve
funds. The clo9e:r we get to unifo~ reserve requirements with reserves to be held m the form of deposits at a Federal Reserve Bank the
more the level of interest payments becomes an issue to be settled by
debate rather than by competition in the marketplace. To the extent
that reserves are held as correspondent bank balances, I think the
competitive factors of the marketplace will give good guidance on a
realistic rate of interest the Fed could pay.
As a bank regulator responsible for thrifts as well as for commer~
cial banks, I do want to emphasize that if a market rate of return on
mandatory reserves is not forthcoming, that this will have a substantially more severe negative impact upon the thrifts than upon commercial banks.
I might add at this point that some thought should be given to
permittmg explicit interest payment on interbank demand balances.
The historic compensating balance method of paying for correspondent services could, I think, be improved by an unbundling approach
similar to that contemplated for the Federal Reserve banks by this bill.
I think further study of this question is warranted, especially in view
of the concerns raised by recent events about the correspondent banking system.
The last part of S. 3304 would require the Federal Reserve, by
July 1, 1979, to distribute foi: comment a set of pricing principles and
a proposed schedule of fees for services offered by Federal Reserve
banks, and, by July 1, 1980, to put into effect a schedule of fees for
such services which is based upon those principles.
I strongly endorse the concept of unbundling and charging appropriate prices for the services the Federal Reserve banks provide to
commercial banking institutions. On the other hand, I recognize that
this concept raises many and difficult questions. I therefore note with
approval that the American Bankers Association has decided to undertake a major study of the potential impact upon the banking industry of the Fed proposal, particularly this part on the unbundling of
prices.
The pricing proposal will impact differently upon different categories of banking organizations. Correspondent bankers would probably support a system of pricing Fed services which would enable
them to compete more effectively with the Fed for provision of these
services. There is certainly much to be said in support of having the
Fed set fairly and state explicitly the :prices charged for various services. This should strengthen competition and be beneficial to buyers
and sellers of correspondent services, and it seems equitable where a
governmental entity is offering services in competition with the private
sector.
At the same time, I must say that I share the concerns expressed by
Federal Reserve Governor Philip E. Coldwell, for the smaller, rural
banks' problems which might result from this pricing proposal. At
present, the Fed subsidizes these banks by charging them less than
cost for provision of services. This pricing proposal might result in
the Fed ending this subsidy and charging the small, rural banks at
actual cost for these services. I, too, am eager to see the plans of the
correspondent banks for providing services for the smaller, rural
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Federal Reserve Bank of St. Louis
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banks. I think a hardheaded review of the American experience with
the postal monopoly will provide a valuable cautionary tale as we enter
the unchatted waters of explicit Fed pricing .in competition with
private clearing houses and correspondent banking institutions.
We will need the time provided for in this bill to sort out these
questions before a pricing system can be put in place.
I hope that these comments will assist you in your deliberations on
the reserve requirement and other Fed membership issues. I thank
you again for affording me this opportunity to share these comments
with you.
The CHAIRMAN. Thank you very much, Superintendent Siebert. You
have made a lot of very valuable and interesting points about reserve
requirements and the issue of universal reserve requirements proposed
by the Federal Reserve, but you haven't indicated whether you favor
universal requirements as an equitable way to solve once and for all
the problems.facing the Federal Reserve. That is: as we know, an erosion of their reserve base. That reserve base has implications for monetary policy control, for safety and soundness of the banking system,
and for the efficient functioning of the payments mechanism.
So where do you stand on that issue 1 Do you favor universal reserve
requirements or do you oppose them and why j
Ms. SIEBERT. I believe that the States can set reserve requirements.
We require reserves which are held as deposits. I don't think that they
have to be held at the Fed in a non-interest-bearing form. I believe
that we should permit interest-bearing certificates like Treasury bills.
The CHAIRMAN. Well, the argument that Chairman Miller made yesterday is this ought to be on an equitable basis. We ought to treat
everybody alike. If the States have one reserve requirement system,
either their reserve requirements are less or their reserve requirements
permit banks to put their reserves in earning assets, it's unfair competition with the banks that are members of the Fed and have their
reserves sterilized and get no return at all on them or have a higher
·
reserve required.
Why shouldn't institutions of equal size, engaged in the same business be treated equally i
Ms. SIEBERT. Well, I think most of our larger banks are members of
the Fed. It's the smaller ones that are pulling out of the system.
The CHAmM4N. As you know, the problem of the smaller banks
would be handled by both the Fed proposal and the chairman of the
House Banking Committee's proposal, by simply exempting the deposits-I think the Reuss proposal is to exempt the first $100 million.
The Fed would, as I understand, demand deposits would have a similar
exemption but would exempt $50 million.
Ms. SIEBERT. I think if you exempt the first $50 million you're not
going to hurt the smaller banks. I believe in New York State we have
10 nonmember banks above that level. The lar~st is the Bank of
Tokyo Trust which is a wholly owned New York State chattered
bank. It is owned by the Bank of Tokyo, and I believe it is the largest
bank in the country that is not subjected-the largest State-Chattered
bank-that is not snbiected to Fed reserve requirements.
The CHAIBMAN. Why wouldn't that meet your objection as far as
the smaller bnnks are concerned and also the desirability of treating
com.petitors alike by having, as the Federal Reserve Board proposed,
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a uniform level of reserves across the board with a uniform exemption
for the first $50 million or so on deposits j
Ms. SIEBERT. Well, $50 million, I could probably take. Although I
would like to review the incentive which would be created for Statechartered banks with under $50 million in reservable liabilities to convert to national charter since they would thereby avoid all reserve
requirements. I'd have to study the fi~res of the number of banks in
our State. I think we have only 10 commercial banks over $50 million
in deposits that are not members of the Fed. In our thrift institutions
it's a different situaiton and the thrifts would be penalized because they
are paying interest on deposits. They have no way to get public capital
in the State of New York. Our thrift institutions are mutuals. They
cannot go out and sell additional equity to the public. The credit unions
increase their capital by retained earnings. So if we put a reserve requirement on the entire accounts for those credit unions that offer
share drafts around the country you will be penalizing the earnin~ to
institutions that cannot legally go out and sell additional shares. They
have no way to increase their capital base. In New York State, all of
our savings banks-and we have about $80 billion of them-are all
mutually owned and they cannot sell additional capital stock.
The CHAIRMAN. As you know, the Fed proposal would only cover
the transaction accounts of the thrifts. It wouldn't be universal coverage. But I don't see any reason why they shouldn't be treated alike
with respect to their transaction accounts. That's in competition with
the commercial banks.
M.s. SIEBERT. With the checking accounts, yes.
The CHAIRMAN. That's what they would propose. I would agree with
you that they shouldn't cover the other accounts, the time and savingi:i
accounts.
Ms. SIEBERT. When they go into the credit unions which offer share
drafts, I believe they are suggesting that the entire account be included
because the share draft is against the entire account.
The CHAIRMAN. The share draft would have the same exemption I
underst.and. They wouldn't include it.
In your testimony you _say Belgium and Switzerland do not ha,ve ~n
place any reserve reqmrements at the moment. I note that m
both countries the central bank has the ability, if they wish to do so, to
apply mandatory reserve requirements on all banks.
Do you know of any central bank in any country anywhere that
doesn't have the ability to apply mandatory universal reserve requirements except the Federal Reserve in the United States 1
Ms. SrEBERT. I do. not know of any. Wait until I ask my counsel,
please. He doesn't know of any either.
The CHAIRMAN. So that the experience of other central banks is tha,t
they all have at least the authority to do so and the power to do so.
Last year this committee held hearings on both correspondent banking and the role of the Federal Reserve in the payments mechanism.
At that time I said I favor a,llowing- pa,yment of interest on interbank
correspondent bala,nces and unbundling of services. Do you think this
should be permitted separately from a resolution of the issue of interest -payment on all dema,nd deposits~
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Ms. SIEBERT. Yes; I think that the services should be unbundled. I
had occasion to study some of the reports of our major money market
banks, some of the internal reports we get through our examination
process, and I think the pricing should be separate so that they can
charge and be paid accurately and that the correspondent banks, the
smaller banks that use correspondents, have the ability to go out and
shop.
The CHAIRMAN. I think so, too. I. think this would add an element
of competition and efficiency. It has served our country very well and
I think we ought to apply it here. Interest payments on demand deposits are now, as you know, prohibited by law and have been for some
years, yet many banks allow both their correspondent bank and corporate customers an earnings credit on their demand balances. Are you
familiar with these practices and do you think they are a violation of
the prohibition against interest payments on demand deposits i
Ms. SIEBERT. We haven't seen any in our examination reports. I
think it would have been called to my attention pretty fast.
The CHAIRMAN. Earning credit on demand balances, you aren't
familiar with that~
Ms. SIEBERT. I can look into it, but I have not seen it.
The CHAIRMAN. We'd appreciate it if you would look into it because
we understand that has been in practice. Of course, New York being
such a big State and so particularly important in banking, if you
haven't seen any there it's very significant I think.
Well, I want to thank you very much, Ms. Siebert, for your excellent testimony. We appreciate it.
Ms. SIEBERT. Thank vou.
The CHAIRMAN. I'd.like to ask a panel of John H. Perkins, president, Continental Illinois National Bank and Trust Company, Chical?O, Ill., and president-elect of the American Bankers Association;
and Thomas F. Bolger, president, McHenry State Bank, McHenry,
Ill., and second vice president, Independent Bankers Association of
America to come forward. This is kind of an "Illinois day. Up in Milwaukee we have a State fair for Wisconsin and we have an "Illinois"
day at the State fair. So this is "Illinois" day at the Senate Banking
Committee.
We are delig-hted to have you. We have three other witnesses following you, so we would appreciate it if you could confine your remarks, if
possible, to 10 minutes or as close to that as you can. For your
guidance we are goinl? to flick on the 1ight over there. It will be green
for 9 minutes, then yellow for 1 minute, and red means that's it.
STATEMDT OF 100 JI. PERKINS, PRESIDENT, CONTINENTAL
ILLINOIS NATIONAL BANK AND TRUST COMPANY, CHICAGO, ILL.,
AND PRESIDENT-ELECT, AMERICAN BANKERS ASSOCIATION, ACCOMPANIED BY CHARLES F. HAYWOOD, PROFESSOR OF ECONOMICS, UNIVERSITY OF XDTUCXY
[ Complete statement follows: l
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Chai.i:man
Proxmire, and members of the Committee, I am John H. Perkins,
President of the Continental Illinois National Bank and Trust Company of Chicago, and President-Elect of the American Bankers Association, a trade association whose membership includes more than 92 per cent of the nation's
14,383 full-service banks.
Accompanying me is Charles F. Haywood, Professor
of Economics at the University of Kentucky and consultant to our Association.
We are delighted to be here today to testify on the important proposals
before your committee.
There are few absolute certainties in any of the argu-
ments pro and con to the proposals for change.
All of us are having to ~pecu-
late about living in a Federal Reserve operating environment none have experienced.
The first question for consideration should not be:
How do we maintain
a relatively high level of membership in the Federal Reserve System?
more fundamental objectives should be clearly stated.
Rather,
Our Association ~elieves
these objectives are paramount:
--To assure the continued independence and effectiveness of our
central bank in its management of monetary policy,
--To enhance the efficiency of the payments system, and
--To eliminate arbitrary forms of discrimination against particular
types of financial institutions which inhibit the delivery of
banking services at least possible ccst.
S.33O4 is a constructive attempt to deal with the first two concerns,
although we do have some disagreements with specific aspects of this proposal.
Our third ccnce_rn is barely addressed in the proposal.
There appears, in tact,
to be an attempt to justify discrimination against medium-sized and larger
banks on the grounds that they are not leaving the Federal Reserve as frequently
as smaller banks and, hence, do not deserve the same level of relief from the
excessive burdens of membership.
Even if this is accepted as valid at the
moment, ·it will I_1Ot be valid in the future as more and more banks examine the
value of membership •. There also appears to be a belief that such discrimination
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will mitigate Treasury revenue losses.
The first notion is simply unfair, and,
as we shall discuss below, the second is probably incorrect.
In discussing legislative and regulatory proposals, the policymaking
bodies of the ·American Bankers Association attempt to discipline their thinking
by asking four questions:
--How do bank customers benefit from the proposal?
--Will the proposal enhance the broad competitive environment?
--Is the proposal consistent with national economic and.social priorities?
--Does the propcsal achieve or maintain equal competitive ground rules
among various types of competing financial institutions, and does it
provide opportunity for competitive financial institutions to maintain
viability and profitability regardless of size?
we believe these questions should be asked of all banking legislation.
An attachment to this testimony attempts to provide answers to the questions as
they relate to S.3304.
our Association has been involved in research and discussion of the issues
raised in S.3304 for some time.
The following items have been submitted to this
Committee on previous occasions and should prove useful in your discussions of
this proposal.
1)
ABA test.iJDony before tho Subcommittee on Financial Insitutions of
the Senate Committee on Banking, Housing, and Urban Affairs, on June 21, 1977.
This testimony discusses NOW accounts, the Federal Reserve' s membership problem,
and S.1668, our Association's legislative proposal to deal with these issues.
2)
ABA testimony before the Senate Committee on Banking, Housing, and
Urban Affairs, on October 11, 1977, on the role of the Federal Reserve in providing payments services.
3)
A letter from ABA to Senator Richard Lugar dated November 4, 1977,
discussing the extent to which required reserves might be reduced for Federal
Reserve member banks without impairing the effectiveness of 1110netary policy.
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We have also attached to the testimony an outline of a research project
the ABA will undertake to determine the inpact of pricing of Federal Reserve
services on the structure of the banking industry.
This outline was part of
a request for proposals that was sent to various consulting firms.
We are
currently in the process of evaluating their proposals and hope to begin the
project soon.
The Central Bank and its Management of Monetary Policy
The need for inandatory universal reserve requirements on transaction
accounts held by all depository institutions in order to assure an effective
monetary policy has not been demonstrated.
We oppose this proposal as unjustified
and likely to harm our nation's innovative dual banking system.
The Fed has proposed universal reserve requirements on transaction accounts
as a means of increasing the effectiveness of its monetary management ..
Never-
theless, it should be noted that the Federal Reserve does not have universal
support for its view that reserve requirements are a necessary tool for monetary
policy.
It is our view that reserve requirements for existing Fed member banks
could be significantly lowered, and the membership burden concomitantly relieved,
without any significant diminution of the Fed's ability to conduct monetary
policy.
To achieve this within
a framework
in which the Fed retains maximum
flexibility to use reserve requirements for monetary policy purPQses,
that existing statutory minimum reserve requirements be eliminated.
we
propose
our views
on this point are amplified in the aforementioned letter to Senator Lugar.
It is true that the percentage of transaction accounts subject to reserve
requirements of the Federal Reserve is declining.
membership is only one factor accounting for this.
The decline of Federal Reserve
Another is the increasing
proportion of transaction accounts that are held outside the banking industry.
Differing levels of reserve requirements among member and non-member institutions
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can cause additional instability in the money supply as deposit shares of
these different categories of institutions change and money flows among them.
But economists in the banking industry believe a much greater.source of
instability is the graduated levels of reserve requirements among banks who
are already members of the Fed.
Elimination of these differences would be
a significantly greater contribution to monetary stability--and an act of
simple fairness to the institutions involved.
As already stated, we believe reduction in reserve requirements should
probably be the preferred method used to alleviate the current membership burden.
However, if it is administered fairly, we do support proposals calling for the
payment of interest on reserves.
Indeed, the two methods can be considered
complementary to each other,
Limiting the payment of interest on reserves to revenues received from
the pricing of services would not alleviate the Fed's membership problem.
"Free" services received by member banks now are only a very limited offset to
the excessive burden of reserve requirements.
If prices charged by the Fed
approximate the value of services received, and interest paid is limited to
revenues received from pricing, the excessive burden of reserve requirements
will not be eliminated,
The Fed could then try to alleviate its membership
problem by raising its prices in hopes of increasing the revenue it has available
to pay interest.
But if its customers were price sensitive and looked for
other.providers of paym~nts services, this probably would not work.
The gathering of additional infonnation from non-member institutions, has our
support·, provided the data are needed for monetary policy purposes and proper
safeguards are adhered tO.
In partic,,1 ar, the data gathering should be done in
such a way that minimizes the rep,
rden placed on those institutions, and
reasonable attention should be gi
realistic analysis of cost vs. benefits.
33-587 0 - 78 - 9
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-sWhile we do not agree with all of the specifics of the various proposals
to solve the Fed's membership problem, we continue to believe that,for the
foreseeable future, a strong membership base is very important to the development
of successful monetary policy and support for it.
The problem is urgent and
attention should be paid to it as soon as possible.
We are acutely aware that
the cost of Federal Reserve membership is an .important item on the current
agenda of bank board meetings all across the country.
As Chairman Miller recently
pointed out in hearings on this subject before the House Banking Conmittee, and
as Secretary Blumenthal pointed out in hearings last year on S.1664 and S.1668
which dealt with the membership problem, the longer the problem continues, the
more banks will withdraw from the system and Treasury revenues from that source
will decline anyway.
Limiting the options available to relieve the membership
burden because of concern over current Treasury revenues could be penny-wise
and pound-foolish.
By the Federal Reserve's own estimate, withdrawals from
the Fed since 1970 reduced Federal Reserve payments to the Treasury in 1977 by
nearly $200 million from what they otherwise would have been.
long run.
It is structural.
It is continuing.
The problem is
And it should be solved.
Enhancement of the Efficiency of the Payments System
We believe the efficiency of the payments system would be greatly enhanced
if the Federal Reserve charged for its services.
However, we must note that we
foresee several difficulties in pricing of existing Federal Reserve services and
the provision of new ones.
The problem of determining proper cost allocations
is difficult enough for private firms.
If the Fed decides to take into account
its own costs in setting its prices, as it most certainly should, the s1tuation
is substantially more difficult.
How•does one allocate overhead costs among
such diverse activities as the administration of ronetary policy through open
market operations, the provision of services as fiscal agent for the Federal
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Government, the supervision of state-chartered member banks, the regulation
of bank holding company activities, lll'ld the provision of payments services
which also can be provided by private banks?
Even if all the relevant data
were known, we can think of no way to do this on a rational basis.
Indeed, as
new payments systems evolve, it becomes more and more difficult to even know
the relevant data.
The provision of payments services is the main banking area in which the
Fed competes directly with the private banking system.
Yet with 12 regional
banks, each having several branches which serve primarily as operations centers,
the Fed already has a nationwide system of operations centers in place.
is no
There
way a single bank can match this capability under the current banking
structure.
This makes accurate comparisons of the public and private clearing
systems more tenuous.
The proposal to limit payment of interest on reserves to revenue received
from pricing could diminish rather than enhance the efficiency of the payments
system.
We have already discussed why it would not eliminate the Fed's member-
ship burden.
Under such a system, the Fed might attempt to become more aggressive
in providing new services in an
attempt to raise pricing revenue so as to be
able to alleviate more of the membership burden.
Alternatively, if it believed
its customers were price-elastic it could, to the extent Congress and its
auditors permit it, undercut the private sector in an attempt to raise its
revenues in order to pay more interest on reserves and achieve a greater alleviation of its membe%'ship burden.
Neither of these responses would enhance the
efficiency of the payments system, and it is not clear that either of them
could ever enable the Fed to achieve an effective elimination of its membership
burden.
We are somewhat dismayed by _the Federal Reserve's comment that if universal
reserve requirements were enacted the Board would have to reevaluate its program
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to reduce the cost burden of required reserves, and price its services.
We
believe the Fed should reduce the cost burden of reserves and price its services,
reqardless of the structure of reserve requirem~~ts amona denosito:z:y institutions.
Such a program, if properly constructed, would greatly enhance the efficiency
of the payments system without significantly diminishing its ability to conduct
monetary policy.
It is our belief that an efficient payments system will be maintained only
if there is a strong, healthy, market-oriented, private-sector alternative to
payments services provided by the Fed.
To insure this, we would propose two rules
to which the Federal Reserve should be bound in setting its prices:
1.
Fed prices should not be less than fully allocated costs, including
all items of cost such as rent, depreciation, management and operating
salaries, cost of capital, taxes, and the very significant cost of
float--an item often neglected in discussions of this issue.
2.
Fed prices should not be less than what the private sector would
charge for similar services.
Although these standards would be difficult to enforce, they are not mutually
exclusive, and both should be used in the evaluation of Fed prices.
If this is
done in a fair and impartial manner, the efficiency of the payments system will
be greatly enhanced.
Our testimony on this subject before your Committee on
October 11, 1977, elabdrates on this vi~w.
These standards will also insure the
existence of a viable private sector alternative for the users of payments
services, thereby enforcing market discipline and allowing for maximum innovation.
Because of the Fed's role as a government agency with privileges accorded
to no private institutions, and the conceptual and practical difficulties in
setting a price for its services, attention should also be paid to what services
should be provided by the Fed as well as the price that should be paid for them.
Only when this is clearly agreed upon and understood by the Fed, the Congress,
and the private sector, can a fair and sensible balance be achieved between the
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Federal Reserve and the private sector as providers of payments services.
Arbitrary Discrimination Among Financial Institutions
Chairman Miller has recognized the competitive inequity in the reserve
requirements structure of member and non-member institutions.
However, inequities
which are just as harmful exist in the reserve requirements structure for existing
member banks.
In his testimony on this problem before the House Banking Committee
Chairman Miller stated that his proposal for universal reserve requirements
would not increase regulatory burdens on non-member banks.
an important part of the picture.
This statement neglects
Many banks elect to have a state charter and
to be non-members purely to avoid the excessive burdens of the Fed's reserve
requirements--not because they dislike the regulatory administration of the Comptroller of the Cuurency or the Fed.
Should universal reserve requirements be
enacted, the ultimate value of many state bank charters would be substantially
diJDinished and many banks would over time opt to join the Fed as a national bank.
Rather than substantially change the relative value of state and national bank
charters, a more sensible approach is to extend reserve requirements on transaction
accounts to all federally chartered depository institutions, and to those state
chartered institutions that elect to join the Federal Reserve, or the Federal
Home Loan Bank Board.
in
This proposal was made by our Association in S. 1668,
testimony before your ·committee last year.
This alternative preserves
the relative value of state and national bank charters in line with our
Federal system.
It extends the dual banking concept, as it is known in the
banking industry today, to thrift institutions as they come into the payments
business.
Limitation on total interest that may be paid on reserves unnecessarily
restricts the Fed's options.
We caution the committee to be sure that any such
limitation is realistic, and does not excessively hamper the Fed in its attempt
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to effectively relieve its membership burden.
Setting a lower interest ceiling
on required reserves over $25 million is discriminatory and we oppose it.
Setting
the maximum rates that can be paid far below the market is also obviously
unrealistic.
These proposals seem to be inspired by the view that interest on required
reserves would be a "raid on the Treasury" and would, unless controlled, consti-
tute an unnecssary subsidy to larger banks.
We disagree with both points.
Reserve requirements are a tool of monetary policy.
If they are to be
viewed as part of the Internal Revenue tax collection system, they should be
considered in that context.
The question of the in1Pact of reserve requirements
on Treasury receipts is a very complex subject.
It depends overall on the level
of the system holdings of earning assets in line with current monetary policy
goals.
Many other factors enter the picture, and have an in1Pact on these goals.
In the final. analysis, the Federal Reserve can control the level of system
reserves through open market operation.
Table 1 at the end of our testimony compares Federal Reserve payments to
the Federal Treasury with total Federal budget receipts in selected years.
Between 1957 and 1976 the percentage of Federal. budget receipts accounted for
by Federal payments to the Treasury rose over two hundred and forty per cent.
The contribution of sterile member banks reserves to
Federal Reserve earnings
constitutes a significant proportion of the total earnings.
The proportion
may have declined somewhat because of the lowering of reserve requirements since
1957.
But it has not declined significantly, and it seems safe to say that the
contribution of sterile member bank reserves to federal budget receipts has more
than doubled since 1957.
Proponents of the thesis that interest on reserves would be a "raid on the
Treasury" have on occasion, pointed to the low effective tax rate paid by banks.
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This emphasis is misplaced.
Those banks that pay effective tax rates substan-
tially below the statutory rate of forty-eight per cent do so because they take
advantage of specific tax incentives designed to influence the allocation of
their funds.
The most i~rtant example of this is the t~ ~xemption on muni-
cipal bonds--an exemption that has, for a long time, been basic to our constitutional system.
In responding to the objectives of this exemption, banks forego the
substantially higher income they might earn on taxable securities, and other
alternative investments.
In the process, however, these banks make a significant
contribution to financing the needs of state and local governments.
Another
example is the investment tax credit, an incentive specifically enacted into
law by the Congress for the purpose of job creation and capital formation.
Through
their leasing operations, banks make a significant contribution in this area.
Banks are proud of their record as taxpayers and deliverers of financial services.
There is no justification for discrimination against any size class of banks,
or against banks as institutions vis-a-vis their competitors.
Also, declines in Federal Reserve payments to the Treasury because of
reduced reserve requirements could easily be mitigated by a gradual phase-in
of the program to relieve the membership burden.
Of course, this would mean
that it might take longer to achieve a significant alleviation of the membership burden. Nevertheless, knowledge that positive steps are taken to relieve
this burden would probably stem the membership attrition in a substantially
sho±ter period of time.
The Federal Home Loan Ban1t Board is frequently vi:ewed by thrift ins·titutions,
who are major competitors of most banks, as its "central bank" which performs
many of the functions for it$ members that the Federal Reserve performs for its
members.
Members of both systems supply funds to the "central bank" and in
turn receive a return on funds supplied.
return.
Table 2 provides estimates of this
For banks in the Federal Reserve system the return is 2.0 per cent--
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mainly an imputed return from the cost of Federal Reserve services.
For
thrift institutions in the Federal Home Loan Bank System the return is 4.3 %.
Finally, we would like to note that, although we have no objections to
payments from the Fed's surplus to the Treasury, as proposed by the Fed, the
"sw:plus" does not represent idle ca~h or current earnings but merely an accounting
entry that arises because past ellr!'ings from the use of required reserves or the
provision of coin and currency have been retained and invested in other assets.
In summa.ry,
we
believe the current discriminatory aspects of the reserve
requirements structure are unfair and unnecessary.
We oppose the compounding
of this problem by additional discrimination in the interest rate paid on
reserves.
The emphasis being put on the relationship between Treasury revenues
and the membership burden in misplaced and, in the long run, will be detrimental
to both the Fed and the Treasury.
The efficiency of the payments system would
be greatly enhanced by explicit pricing of Federal Reserve services in a manner
that recognizes the constructive and innovative role played by the private
sector in the provision of payments services.
Such explicit pricing must be
accompanied by an effective alleviation of the Federal Reserve's membership
problem.
The most promising way to do this is to reduce reserve requirements.
We also support fair and impartial methods of allowing banks to earn interest
on their reserves.
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Table l
Federal ReseIYe Payments to the Treasury
as a Per Cent of Federal Budget Receipts
(2)
(3)
(4)
Payments to Treasury
bi: Federal ReseIYe
Federal Budget
ReceiEtS
Federal Reserve Payments
to Treasury as a Per cent
of Federal Budget ReceiEts
(1)
First Year
1957
543•
79,990
1962
718
99,676
. 72
1967
1,805
149,552
1.21
.67%
1972
3,252
208,649
1.56
1977
5,908
356,861
1.66
SoPr •· ·:
Treasury Bulletin
*Calendar Year 1957
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Table 2
Return on Funds Supplied by Member
Ins ti tut ions to the Federal Home Loan Banks
and the Federal Reserve Banks
F1mds Supplied by
Member Institutions
Capital Stock (millions)
Reserves
Deposits
(less float)
Return on F1mds
Federal Reserve
System
(Millions)
24,088
Bank System
(Millions)
7,438
1,029
26,709
0
3,650
490
Dividends
Interest on Deposits
Services (at cost)
Precentage Return on
Total Flmds Supplied
Federal Home Loan
3,295
0
4,143
321
60
0
430*
2.0%
146
175
0
4.3%
*Federal Reserve' s estimate of the cost of providing check clearing (including AOl)
and coin and currency services.
Source: Board of Governors of the Federal Reserve System, 64th Annual Report,
Federal Home Loan Bank System, Savings and Home Financing Source Book,
Federal Home Loan Bank Board of Journal, April, 1978.
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Analysis of S. 3304
How do bank customers benefit from the proposal?
Tlie extension of reserve requirements to non-member banks would hurt those
banks and diminish their ability to serve their customers,
Customers of banks
that achieved a significant relief from the membership burden would benefit.
Others would not.
The proposed limitation of interest on reserves to revenues
received from pricing would probably diminish the efficiency of the payments system
and ham bank customers.
Will the proposal enhance the broad competitive environment?
The pricing of payments services by the Fed would, if done properly, enhance
the efficiency of the payments system and the broad competitive environment
between public sector and private sector providers of payments services. However~ the
proposal to limit interest payments on reserves to revenue received from pricing
would diminish the efficiency of the payments system and detract from the broad
competitive environment by encouraging the Fed to pursue counter-productive
policies in the pricing and provision of payments services.
Is the proposal consistent with national economic and social priorities?
Tlie proposal would facilitate some alleviation of the Fed's membership problem
and give the Fed greater control of reserves for monetary policy purposes.
However,
our testimony elaborates on several undesirable aspects of the proposal, and we
believe there are more efficient ways to achieve the objectives of the bill.
Does the ro osal achieve or maintain e ual co eti ti ve rowid rules amon various
types of competing financial institutions, and does it provide opportunity or
competitive financial institutions to maintain viability and profitability
regardless of size?
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The ability of smaller non-member ban~• to compete would be diminished by
burdening them with excessive reserve requirement.s.
by exempting the first
SS
The bill recognizes this
million of transaction accounts from reserve requi.rements.
But there is still no reason to impose additional burdens on larger ilon~member
banks.
Some competitive inequities would be corrected by setting reserve require-
ments on transaction accounts at non-bank depository institutions.
The proposal
would discriminate against medium-sized and larger institutions on the payment of interess
-on
reserve.s and the substantial inequities in the existing reserve. requirements
structure would be continued.
resolve these difficult issues.
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Federal Reserve Bank of St. Louis
Our testimony SU&;llests some· equitable ways to
137
Outline of Project to Estimate the Impact
of the Pricing of Federal Reserve Services
I.
II.
Purpose - To develop alternative scenarios for the pricing
of Federal Reserve services and estimate their
impact on the Banking industry.
Parameters of the pricing process
A.
B.
Services to be priced. ABA task force says that all
Fed services should be priced. These would include
such things as:
l.
Check collection services
2.
Automated clearinghouse services
3.
Wire transfer services
4.
Coin and currency services
5.
Net settiement services
6.
Securities safekeeping services
7.
Bank examinations
8.
Services provided to other governmental agencios
9.
Any new services provided
Factors tc be considered in determining prices:
l.
2.
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What is to be done about membership burden
a.
Interest on reserves
b.
Reduction in reserve requirements
c.
Government securities held as reserves
d.
Nothing done to relieve membership burden
Cost factors
a.
Cost concept used
(l)
Fully allocated Federal Reserve costs, including cost of capital and taxes
(2)
Something less than fully allocated Fed cost
(a)
Marginal cost
(bl
Average operating cost, no allocation
of overhead
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2 -
(3)
Costs that would be incurred by the private
sector if they performed the service
(4)
Costs are ignored, membership burden is relieved
by one of the methods stated above, and prices
are set so as to have zero gain, or loss, to
Treasury
b.
Other cost distinctions
(1)
(2)
Fed district
(a)
Uniform price schedules in all
Fed districts
(b)
Price schedules depend on operating
costs of Fed district
Usage of services
(a)
(3)
3.
Volume discounts
(b)
No .volume discounts
(c)
Others--e.g., are there economies in
the joint usage of particular services?
Geographic location of bank
(a)
Prices uniform across country or, at
least, within Federal Reserve District.
(b)
Prices vary according to the location of
the bank
Other dimensions of pricing problem
a.
Access
(1)
Priced services available to all depository
institutions
(2)
Priced services available only to member
banks
(3)
Current access rules are maintained/i.e.,
services which are currently provided to
non-members will be provided to them under
a pricing regime. No new services will
be provided to non-members.
b.
Availability - i.e., how quickly is the service
provided
c.
Others?
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3 -
III. Factors affecting bank structure
IV.
A.
Ability of correspondents to pass on added costs to
respondents.
B.
Responses of respondent banks to the added costs that
are passed on.
c.
Extent to which measures taken to relieve membership
burden would offset added charges and negate the need
correspondent banks would feel to pass on added costs.
D.
Extent to which private sector will develop new payments
systems outside the Fed.
E.
Responses of member and non-member banks to the development
of such systems. How would these responses affect the
membership question?
What is to be done?
A.
A matrix of prices is to be developed.
The matrix should
show the prices for the services listed in part IIA under
the different pricing scenarios that could be delineated
using the factors listed in IIB.
Note: We understand that some of the data needed
to develop the cost estimates will be internal
Fed data that we do not have access to. However,
a fair amount of cost data is published by the
Fed. It will be the responsibility of the consultant to use this data in conjunction with
other available data to develop the best possible
estimate of the costs.
B.
The effect of each of the pricing scenarios on bank structure
is to be evaluated. Some possible factors to be considered
are listed in part III. The consultant may suggest other
factors.
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The CHAIRMAN. Thank you very much, Mr. Perkins.
Mr. Bolger.
STATEMENT OF THOMAS F. BOLGER, PRESIDENT, McHENRY STATE
BANK, McHENRY, ILL., AND SECOND VICE PRESIDENT, INDEPENDENT BANKERS ASSOCIATION OF AMERICA, ACCOMPANIED
BY RidHARD PETERSON, CONSULTANT
Mr. BOLGER. Mr. Chairman, my name is Thomas Bolger. I am second
vice president of the Independent Bankers Association of America,
and president of the McHenry State Bank, McHenry, Ill.
.
I appreciate the opportunity to appear before this committee on behalf of the 7,300 members of IBAA to present our views on the proposals relating to the payment of interest on reserves held by the Federal
Reserve banks and the explicit pricing of Federal Reserve System
services.
IBAA is comprised of a large number of relatively small community
banks. More than 80 percent of our banks have assets of $25 million
or less and over two-thirds are located in towns of under 5,000 population. Most of our members are found in the middle third of the country
comprising the major agricultural States, consequently our banks are
deeply involved in meetmg the credit needs of agriculture, small business, rural housing, and tlie consumer. In 1976, for example, commercial banks with assets of $25 million or less supplied almost half the
credit extended to agriculture by all of the Nation's commercial banks.
Thus, by supplying a major share of bank credit to rural communities,
our banks make a considerably larger contribution to the Nation's economic well-being than their size and share of commercial banking assets might suggest.
We appreciate the opportunity to testify on the proposed legislation
to enable the Federal Reserve Board to pay interest on reserves held
at Federal Reserve banks and to sanction the payment of explicit
charges rendered depository institutions by the Federal Reserve System. However, I should point out that the constraints imposed by the
timing of these hearings has limited our ability to assess fully the effectiveness of these proposals, in conjunction with the numerous proposals daily appearing in the House, in stemming the attrition of Federal Reserve System membership and their impact on the banks comprising our membership.
We share the concern of the Federal Reserve Board's chairman that
attrition of both banks and deposits of membership in the Federal Reserve System has accelerated in recent years and that the failure to
halt membership attrition may have severe implications for the ability
of the Federal Reserve Board to conduct monetary policy. However,
we are not persuaded that legislative remedies proposed by the Federal Reserve Board will provide the necessary inducements to attract
nonmembers to join the Federal Reserve System or persuade members
to remain in the system.
Let me turn, then, to the specifics of the legislation being considered
by: this committee. Title I would amend the Federal reserve Act to provide for the maintenance of reserves against transaction accounts in
Federal Reserve banks by all federally insured depository institutions.
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It is, in e:ffect, a mandatory universal reserves statute requiring commercial banks, mutual savings banks, savings and loan associations,
and credit unions to maintain reserves at Federal Reserve banks
against demand deposits and all other transaction accounts. The bill
would exempt from the reserve requirements, subject to such rules and
regulations as may be adopted by the Board, the first $5 million of
transaction acounts of a depository institution. Reserves meeting the
statute's requirements are to be in the form of balances in the Federal
Reserve bank of which it is a member or at which it maintains an account; or balances maintained by a nonmember depository institution
in a member bank or in a Federal home loan bank maintaining such
funds in the form of balances in a Federal Reserve bank of which it is
a member or at which it maintains an 'account.
IBAA has long been opposed to legislation which would make it
mandatory for all banks to maintain reserves in the Federal Reserve
System. Although national banks comprise about 27 percent of IBAA's
membership, 73 percent are State chartered banks, of which a small minority are members of the Fed. State chartered banks favor the freedom to join or not to join the Federal Reserve System. Furthermore,
the exemption purportedly provided for the first $5 million in transaction accounts is purely illustory in that there is broad statutory authority given the Board to impose reserves on even these deposits. It
is our deep concern that the mandatory reserve requirement would superimpose Federal regulation over State chartered depository institutions and so erode State regulations as to ultimately lead to complete
Federal control.
Momentarily, skipping over to title III, it would authorize the payment of interest on reserve balances held in any Federal Reserve bank.
It would authorize the Federal Reserve banks to pay a total amount of
interest in any 1 year up to the sum of: (a) total receipts from the
recipients of such interest for services rendered by Federal Reserve
banks; and (b) 7 percent of the total net earnings of the Federal
Reserve banks computed without regard to the payment of such interests; but with a ceiling rate of 2 percent per annum on reserve balance in excess of $25 million. As to the latter (b) the Board is now
seeking deletion of this section. The cost to the U.S. Treasury of such
interest payments could be a very high price to pay to induce State
chartered depository institutions to become members of the Federal
Reserve System. There is no assurance that the rate of interest to be
:paid on reserves will constitute sufficient inducement for nonmember
mstitutions to join the Fed or to enjoin Fed members from defecting. A
strong case has not been made to demonstrate that the payment of
interest on reserves as proposed will, in fact, solve the problem of
attrition.
Since the purpose of the payment of interest on reserves held at the
Fed is to make Fed membership more attractive and halt membership
attrition, the amount of income derived from such payment would
have to be equal to or exceed the earnings on reserves presently available under State reserve regulations. A recent study of the burden of
Fed membership revealed that the heaviest burden is borne by member
banks with deposits under $100 million and that banks with deposits
over $1 billion appear to experience a net benefit from system membership. Thus smaller member banks may operate at a competitive dis 33-587 0 - 78 - 10
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advantage relative to the larger olies. 1 This suggests that unless interest payments on reserves are equated with the burden of membership,
interest payments are not likely to be an effective instrument to attract
new members or in reducing membership attrition.
The lack of precise data on the net costs of this proposal to the
Treasury leads us to urge caution in setting the permissible interest
rate limits too high. On the other hand, the setting of rates of return
on reserves too low would make membership unattractive and thus defeat one of the basic purposes of the legislation.
To return to title I, it also requires the Board to prepare and offer for
public comment a set of pricing principles and a proposed sch~ule of
fees for Federal Reserve System services. The regulatory proposal to
make explicit charges for Fed services could create problems for small
member banks, that is, those with assets of $25 million or less. Most of
these banks would be exempt from the reserve requirements and presumably, under our reading of the statute, would not be receiving any
interest payment from the Fed on their transaction balances. How•
ever, they as members would be assessed charges for services provided
by the Fed. Under these circumstances small banks are not likely to be
attr!),Cted to membership in the Fed since they would probably opt for
obtaining these services through their correspondent banks. Fed services may be attractive but if a bank can obtain all of those services plus
many more from its correspondent it would be sacrificing earnings to
be in the system. 2 The only unique service offered by the Fed is access
to the discount window but a large number of banks have found that
this service is not an ad,:1quate inducement to remain members.
The effect of the payment of service charges on small banks is difficult to predict since it cannot be determined whether they would continue to obtain most of these services through their correspondent banks
as an offset against compensaiti~ balances or whether the correspondent banks would pass these explicit charges through to their respondents in addition to the income earned on compensating balances. It
seems ce~in that oorrespondent banks would be likely to adjust their
compensating balance requirements upward to, pass through some of
the explicit charges assessed against them by the Fed for services. Thus
small banks are not likely to obtain any benefits from the payment of interest on reserves but could be required to pay more for services pe.rformed by the Fed.
The thrust of the proposed legislation appears to be directed at holding in the Federal Reserve Svstem the 1,003 State chartered members
of the system and inducing the remaining 8,600 State chartered nonmember banks to join the system. Most nonmember State chartered
banks are relatively small institutions as revealed by the fact that in
1976 there were 11,800 banks with assets under $50 million accounting
for 82 percent of an banks in the United States. If, as some studies have
shown, small banks bear a heavier burden of Fed membership than
larger banks, the inducements offered to the smaller banks to join or
retain membership in the Fed should take account of these differences
1 Robert E. Knight, "Comparative Burdens of Federal Reserve Memher nnd Nonmember
Banks", Monthly Review. Federal Reserve Bank of Kansas City. March 11177. p. 27.
• Ronald D. Watson. Donald A. Leonald, Nariman Behravesh, "The DeclPlon to Withdraw: A Study of Why Banks J,eave the Feileral Reserve System," Federal Reserve Bank
of Philadelphia, Research Paper No. 30, September 1977.
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of membership burden. We do not believe the proposed legislation
moots this requirement.
Although we realize the Senate does not now have before it the alternates being oonsidered in the House, they will undoubtedly surface
here eventually and IBAA would like to take this opportunity to comment on several of them. First, H.R. 12706 which would provide for
the pricing of Federal Reserve System services and the payment of interest on reserves, attempts to give sufficient study to the proposal before putting it into effect-of course this implicitly precludes any prospoot of explicit pricing until the studies are concluded. While authorizing the Fed to pay interest or reserves the bill requires the Board to prepare a feasibility study and transmit it to Congress not later than July
1, 1981. We believe this is a constructive approach.
H.R. 12706 will hamstring the Fed in pricing services by mandating
explicit pricing to include both direct and indirect oosts. This could
make membership very uniattractive, especially if the Fed could not respond to market pressures caused by other correspondents providing
like services.
The amendments proposed by Chairman Reuss to H.R. 12706 seek to
address some of the concerns we have identified above. First. by reducing the amount of interest to be paid to income and earnin~, there
would be no drain on the U.S. Treasury. Second, there would be no
universal reserve requirements imposed on nonmember banks, and
there would be a statutory exemption of the first $10 million in transaction accounts, both consistent with the goal of reducing the burdens
of membership ,and enhancing the competitive posture of small independent banks. Third, a universal reporting requirement would be imposed to provide current and reliable information in order to effectrnate
ID01I1etary policy. We question whether or not an enhancement of the
current reporting program involving nonmember banks will provide
all the information necessary without imposing a new regulatory paperwork burden on small banks.
On the other hand, we believe more attention needs be given to the
proposed amendments whioh wrenches from the Fed the flexibility to
se,t reserve requirements and the discount rate.
Indeed, the proposals before this committee are a mixed bag of
monumental import.
On balance we cannot endorse S. 3304 since we are not convinced
that they will achieve the stated objectives. Furthermore, we are not
convinced that such legislation is necessary to prevent system attrition
or that the Fed's ability to manage monetary policv requires that all
depository institutions maintain reserves in the Fe<l. To improve the
Fed's capability to manage monetary policy it may only be necessary
to authorize it to obtain summary statistics on assets and liabilities of
all depository institutions as proposed in an amendment to H.R.12706.
Another proposal, short of the sweeping proposal of the Fed which
warrants consideration, is that offered by the Board of Directors of the
Federal Reserve Bank of Kansas City. This proposal would allow member banks to invest a portion of their required :reserves in Government
securities owned by the Federal Reserve. Individual banks would be allowed to choose specific issues from the variety of maturities in the
Federal Reserve's portfolio of U.S. Government securities. All pur-
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chases and sales of securities for reserve purposes would be made with
the Federal Reserve at money market prices. The securities would be
held by the Federal Reserve in a safekeeping account maintained for
reserve purposes. 3 The proposed amendment requiring a feasibility
study of such a proposal seems appropriate.
Another proposal suggested the creation of a new type of "affiliated"
membership, which would make membership more attractive particularly to smaller banks, by reducing some of the burdens of membership.
Under this proposal the requirement to purchase stock in the Fed
would be eliminated; access to the discount window would be provided at a raJOO above the charged full members; and the reserves required would be based on a clearing formula but not above those requirements for members.
At this juncture we feel that the point and counterpoint that seems
to be rushing this legislation along ought to be resisted. We feel the issues have been blurred and the net losers will be those who are intended
as beneficiaries important questions need to be asked such as whether
the immediate goal is to enhance Fed membership or to provide the
Fed with the tools necessary to effectua,te monetary policy. Some of ,the
proposals seem to be at cross purposes. In short, what 1s the rush i
H Congress is concerned that the Fed may take precipit:oo.s action
in the event no legislation passes before the end of the session, the
answer to us is to pass a resolution putting this first on next year's
agenda while prohibiting any implementation. There will be time to
have the Congress, the Fed and all the various interest groups analyze
the impacts and identify unreasonable courses of action.
We believe that if the Fed is sincere in enhancing membership, there
is one free way to do it. Over the years many members of our association have gotten the impression that there is a deep seated Fed attitude of disregard for the problems of small independent banks. These
attitudes have been manifested in a number of ways. In a study done by
the House Banking Committee it is clear, for instance, that the
boards of the district banks are heavily weighted in favor of individuals sensitized to big banks, rather than small banks. Furthermore,
historical review of the administration of the bank holding company
act suggests a non-recognition of the importance of this corporate
structure as a means of transferring small bank ownership from one
set of owners in a community to another set also in that community.
In shOl't, you can catch more flies with honey than with vinegar.
If there is any message that we urge on the members of the committee today, it is to go slow. Certainly, it is appealing to many of
our member banks to receive interest on reserves. Yet a concern of
the unknown-pricing-suggests caution. If the Congress would seek
to enhance membership rather than just give the Fed the tools necessary to effectuate monetary policy, .all the costs should be known. We
have not seen the specific proposals, and we understand the committee has not either. If a package of proposals will achieve the result, they
should all be carefully studied-not rushed through. The vast majority of our member banks are the purported beneficiary of these proposals. They have not had a chance to understand what has been pro• "A ~roposal for Enhancing the Attractiveness of Membership In the Federal Reserve
System. • A report by the Board of Directors of the Federal Reserve Bank of Kansas City,
June 1977.
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posed, much less respond to either us or the committee directly. In all
fairness, they need the chance to reflect and we urge you to give them
that opportunity.
Our doubts as to the efficacy of the proposed legislation in meeting
the attrition problem are heightened by the facts revealed in a study
analyzing ]federal Reserve l::,ystem attrition since 1960. That study
found the principal factors contributing to Fed attrition to be a tendency of de novo banks to remain outside the system; and a pattern of
more mergers and absorptions of member banks than nonmembers with
most of t.he merged and absorbed banks having been acquired by
other member banks. The bulk of deposit attrition has been due to a
more rapid rate of internal deposit growth on the part of the nonmember sector (including the growth of de novo nonmember banks
chartered since 1960), resulting in a relative increase in the average
size of nonmember banks.
The study concluded that without any reduction in the burden of
Fed membership, the pattern of net system withdrawals, as well as the
preference of de novo banks for nonmember status, may be expected
to continue. Moreover, recent withdrawals of member bank subsidiaries by several mu1tibank holding companies portend increased withdrawal activity on the part of multibank holding companies. Given the
larger size of multibank holding company member banks, such an
increase in withdrawal activity could mean a further acceleration of
deposit attrition. To slow and. possibly turn around the pace of aggregate deposit attrition the burden of System members.hip accordmg to the study must not only be eliminated but mus.t be converted to
a net benefit in order to encourage both ongoing nonmembers and de
novo banks to join the system.4 Uur analysis of the proposed legislation leads us to the conclusion that it will not meet this test.
The CHAIRMAN. Thank you, Mr. Bolger.
Mr. Perkins, your preferred solution to the Federal Reserve problem is to lower reserve requirements and to permit interest to be paid
on reserves. You oppose universal reserve requirements that many
people have endorsed and others believe would be a fair and equitable
solution.
If universal reserves carried with it a large exemp~ion for banks
below $50 million in deposits and if they also carried with it a reduction in the reserve requirements below what they are now, which
is what both Chairman Miller and others have proposed, would you
find them more attractive j
Mr. PERKINS. Well, obviously• they would be more attractive in a
sense. We have some trouble with the idea there should be size discrimination in reserve requirements, depending on the size of the
bank, but leaving that question out-The CHAIIWAN. Well, there is now. There has been consistently.
Mr. PEluuNs. I know there has.
The CHAIRMAN. We have always provided for lower reserve requirement.ls for smaller banks.
Mr. PERKINS, I think the point I made in the testimony is that we can
see some kind of a required reserves, interest on reserves, and pricing
• John T. Rose, "An Analysis of Federal Reserve System Attrition Since 1960," Federal
Reserve Board Stair Economic Study, December 1977.
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as a package for all federally chartered depository institutions as
being one way to get at the equity issue and the broader issue. We have
trouble with eliminating the alternative of the State charter, and this
goes back to the whole question of the dual banking system in this
country. It is based on the federal system we have, and we believe that
while you can argue for a perfect symmetrical equity, there's a lot to
be said for maintainhg the federal system in the country with its
checks and balances and its options.
The CHAIRMAN. V{ell, why would the universal reserves necessarily
do away with State charters i I can't understand why you can't have
a system in which you have the same reserves required for all banks the
same size, the same deposits, but that you have the State chartering
banks that choose to go that way and the supervision and examination
and so forth still lodged in the States so you still would have a dual
system.
Mr. PERKINS. Well, I think one answer would be very clear and that
is a lot of State-chartered banks wouldn't bother to be State chartered. They would switch to a national charter if they were exempt
from reserve requirements and they got some access to whatever services they wanted.
Mr. HAYWOOD. Mr. Chairman, if we take Mr. Miller's proposal of
yesterday of exempting banks under $50 million from reserve requirements, what State bank would then stay in its State system, where it
would have to meet State requirements, if it could get zero reserve
requirements by converting to a national charted Mr. Miller's proposal is really to nationalize the system, to provide inducement for all
hanks to convert to national charters.
The CHAIRMAN. Well, I don't know why they would necessarily
switch, to put it the other way. The State reserve requirements are
pretty gentle. They permit the reserves to be kept in earning assets,
as you know.
Mr. HAYWOOD. It varies from State to State.
The CHAIRMAN. Well, most States do. They don't all, that's true,
and I think there might well be a modification in the States that
permit that.
Mr. HAYWOOD. May I say we looked at this very quickly yesterday.
We looked at a few States in terms of their reserve requirements. The
association certainly intends to explore this most thoroughly in the
days that lie ahead, hut we came to a conclusion that there would be
substantial incentive to shift from State charters to national charters
because you would be shifting from something positive in the way of
reserve requirements to a zero reserve requirement.
The CHAIRMAN. Well, after all, shifting isn't just something you do
like that based on a theory or a whim, as you know. You do it with coni:::iderable concern. It's costly to shift. You have to change the name.
You have to print forms. That's minimum action. And I think you
find if you shift, you make a decision that would in most cases last for
a number of years. You wouldn't want to shift and then come back
again-that's like firing Billy Martin and saying, "Come back in 2
years."
Mr. HAYWOOD. Or Mr. Allen.
The CHAIRMAN. Or George Allen. That's right.
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Mr. HAYWOOD. He has suffered some of tha,t same thing.
The CHAIRMAN. Not only we in Washington but those in Los Angeles were concerned about George, but apparently that's more universal.
Well, as I say, I do think this is a matter that is much deeper than
simply allowing an advantage in reserves and, as I say, the advantage
would be pretty small and mild. I notice that the first witness we had
this mornmg, the hanking superintendent of New York, Ms. Siebert,
said-and she would have great concern and expertise in this areashe and the exl?ert who accompanied her agreed if you had the $50
million exemption, you wouldn't have very much trouble with this
with the universal reserves.
Mr. HAYWOOD. I think, with all due respect, sir, these proposals are
so new that very few people have had a chance to think through all the
implications, and the one we are emphasi,zing here this morning is the
one that concerns us most. We can't say how large that effect would
be, hut we do see that the direction of the effect would be to shift banks
from State charters to national charters. Quite frankly, we think that
our objective should not be to make large shifts in the structure of
our system today, but should be rather to look for improvements and
not disruptive things.
The CHAIRMAN. I agree with that. One of the other standards we'd
like to maintain is the one Mr. Perkins properly set forth in his statement when he said you want to do this with the lowest possible cost to
the public. The lowest possible cost to the public, of course, means
that we maintain to the extent we can the Federal Reserve's contribu,tion to the Treasury, that we don't erode that too much, and obviously
if we are going- to pay interest on reserves, that reduces the Federal
Reserve's earnmgs and it reduces what goes back to the Treasury. It
increases the general burden on the taxpayer and it gives banks an
advantage which-if I were a banker and if I were president-elect of
the American Bankers Association-I would be fighting for, too.
Mr. PERKINS. Well, it's an enormous penalty on member hanks and
it's much larger than often computed because it's not being computed
at the market rates. The point I was trying to make is that we never
thought of the Federal Reserve System as a tax collecting operation,
but when yo,µ get all done with the whole theory, the transitional
changes and the rest, the real income from the Federal Reserve comes
from the total earning assets they hold, total reserves in the system, and
it's the percentage o:f that that the Treasury gets as its receipts from the
Fed.
Certainly i:f you're going to pay interest on reserves, you're going
to have some increased cost. However, we are presuming a lot o:f that is
going to be offset by charges :for services, too.
The CHAIRMAN. Well, it's a step we should take with considerable
caution. We have never done it. We have been able to survive as a
Nation :for 200 years without it. The Federal Reserve System has been
in operation for 65 years without permitting interest to be paid on
reserves, and you can understand the very tempting populist appeal
for anybody in public office to say we don't want to give away the
public weal to the bankers. I mean, it's tough enough to resist wel:fare
payments and payments to :farmers and food stamps and so forth.
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When we have to have a food stamp program for bankers, that is hard
to support.
Mr. HAYWOOD. I tlhink we agree with a lot of that. That's why we
suggested lowering of reserve ratios over a period of time as an approach to solving the membership problem. We'd rather not get into the
payment of interest.
The ClIAIRMAN. I think that's much better.
Mr. PERKINS. And that's a phase-in operation.
The CHAIRMAN. And I would agree bank earnings have not been adequate. I think they should be improved. It's one of the problems we
have in this country. The capitalization of our banks, small and large,
is inadequate. We have to increase the profitability, but I think tliis
is probably the less sensitive thing to do politically. It's something
that's going to be very hard to sustain. You're going to be constantly
under attack by me and other guys.
Mr. PERKINS. We thought we were already.
The CHAIRMAN. Mr. Bolger, you said SO-percent of the IBAA members have assets of less than $25 million. If universal reserve requirements were legislated with an exemption of $25 to $50 million in deposits, most of your members wouldn '>t be affected. They wouldn't
be affected adversely. They would be benefited1 if anything.
What would ;your reaction be to that kind ot proposal i
Mr. BoLGER. Well, of course, this would be a personal observation
because these numerous proposals are just coming out, I think yesterday2 and our association has not been able to act on them. Yet on the
surtace some seem like great things. They might be ·a bonanza. But,
after all, bankers are people too. We must ask: Is it good for the country~ And I'm not so sure that eliminating all reserves for that big a
percentage of the banks is in the best interest of the country.
The CHAIRMAN. Would you be in favor of that kind of an exemptioni
Mr. BoLGER. I'm not sure that we would. Our association has not had
a chance to take a position. These proposals just came out. But I say
individually I think thatr-The CHAIRMAN. I'd be pretty surprised if on consideration that your
people wouldn't favor that exemption.
Mr. BOLGER. Well, my bank is a State Fed member. Our reserve requirement in the State of Illinois-Illinois has no State reserve requirements for State nonmember banks. We are required to keep a
balance of $3.6 million with tlhe Fed which at today's returns is probably $250,000 or $300,000 return.
In answer to your question, sure on the surface it sounds great;
but I think it would erode the dual banking system and I wouldn't
speak for the association and say that we would be entirely in support
of that proposal.
The CHAIRMAN. In your statement you said that interest on reserves
may not solve the membership problem and I agree. Can you explail].
that statement~ And also, what do you think would solve the membership problem for the Federal Reserve~
Mr. BoLGER. I really don't know what would solve it. I think the
thing that won't solve it is moving too quickly with legislation. I think
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there's too many new proposals. I don't think that there is any critical
necessity to enact legislation.
The CHAIRMAN. In your statement you indicate your sensitivity to
the pressure the Federal Reserve feels. They feel that their membership is dwindling and therefore their monetary policy power is eroded.
They feel they have to act and they are putting pressure on us. They
say if the Congress doesn't act they may decide to act or feel they can
act unilaterally. So that's the urgency involved. They are concerned
about our sitting and studying this for several years and finding their
membership has dropped so sharply that it's going to be very hard to
recover.
Mr. BoLGER. Let me refer to our legislative assistant.
Mr. PETERSON. Well, Senator, I thmk that what we are talking about
is a delay of some period so that people can conjugate what we're talking about. There are many, many J?itfalls that are involved.
The CHAIRMAN. How long a period would you say~
Mr. PETERSON. Well, I would say, first of all, we would like to get
some kind of an idea on all this explicit pricing business. Nobody has
seen word one yet and we get very, very concerned over the entire issue of explicit pricing. I know that Governor Coldwell has J?romised
Chairman Reuss to come up with some kind of a tentative pncing list
by the end of the month, but I will assure you that there's going to be
extensive debate over that.
The CHAIRMAN. I think you're right about the complications of the
pricing system, but that doesn't have to be part of this. That can be an
entirely separate issue._ I -think we all agree it's a healthy thing to
consider it and probably to move in that direction.
Mr. PETERSON. There is, I think, exactly what the American Bankers
Association said, and this is not an association position at aU, but I
think from my personal point of view it's transparent that the easy
way to solve this whole thing is simply to reduce the reserve range
and then tell the Fed to go ahead and do it. That's it. People will come
back in if they don't have that burden.
The CHAIRMAN. The statement by Chairman Miller indicated that
that wouldn't be a satisfactory solution. It doesn't give them enough
latitude now and if they simply had to work with the limited number
of members and their membership dwindling it would be much harder
to have an effective monetary policy. Reducing Federal Reserve reserve requirements would be, in his judgment, no comprehensive solution to this problem.
Mr. Bolger, universal reserve requirements need not mean mandatory membership or any change in supervision and regulation of nonmember banks. Would you agree that universal reserve requirements
need not change the current regulatory balance 1
Mr. BoLGER. I don't think I understand the question.
The CHAIRMAN. Well, the point Mr. Perkms made was that if we
have universal re~rve requirements there would be no real incentive
for the nonmember banks to remain outside the system. They could
switch to a Federal charter. They could join and be exempt from reserve requirements.
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Mr. BoLGER, I agree with that and that's one of the objections. It
would put a great strain on the dual banking system.
.
The CHAmMAN. Well, I'm not so sure why. The reserve reqmrements
are one element in their decision to be a member or nonmember. It's
certainly not the only element by any means. But you think this is
the decisive element?
Mr. BOLGER. Well, if we're eliminating so many banks, as some of
these proposals do, from any reserve requirements, and the way I
understand it the Federal Reserve requirements apply over the State
requirements, that it would certainly seem that many of the banks
would take out Fed membership. They would not have to chan~e their
name to do that. Nonmember banks can apply for membershi.P,
The CHAIRMAN. Mr. Perkins, you recommend payment of mterest
on reserves. If there were no membership problem this issue might
not arise at all except the reserves are partially clearing balances, like
balances banks hold with their correspondents. Why shouldn't this
issue be taken up in the context of removal of the prohibition against
interest on demand deposits and not until then? After all, when a
bank like the McHenry Bank-and you may be the correspondent for
them-when they put the correspondent balance on deposit with you,
you don't pay any interest on it.
Mr. PERKINS. No; that's true, but in return for the balances- and
I think this needs emphasis in connection with some of your previous questions-the balance is paid for by services rendered and those
services rendered are priced very explicitly and the balances, in most
cases, of most of those correspondent banks, corporations, and others
are very closely monitored to be sure they are paying enough for the
service.
The CHAmMAN. Whether they are closely monitored or not, there's
the same kind of situation with the Federal Reserve and that, I suppose, is a calculation that many bankers enter into to determine
whether or not they should contmue as members o:f the Federal Reserve. They, too, get services; do they not?
Mr. PERKINS. They get services, but I should say-I'll take my own
bank, for example. Our average reserve requirements run about $550
million and we think on average it would only take about $100 million to pay for the services at market rates that we are using of the
Fed and we are a very large user of the Fed system. I think one of the
comments, Mr. Chairman, on the question-The CHAmMAN. Nevertheless, don't you see the analogy? Why
shouldn't we consider this whole thing together i You're both cautioning that we take a little time with this and whv shouldn't we
consider this together with the removal of the prohibition against
interest on demand deposits? We're moving in that direction. We have
NOW accounts, as you know, in New England and moving across the
country.
Mr. PERKINS. Well, that's a possibility. On the other hand, I'm not
so sure that there aren't some interim solutions like reducing the level
of reserves and giving Chairman Miller a chance to find out whether
he is right or wrong in terms of what that would mean to membership
in the system, rather than just postulate the issue. But the fact is that
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people are very conscious of the cost of idle reserves at the Fed and
the problem is here and it's here now.
Mr. PETERSON. Senator, I think I'd like to interject on this point.
I think a great deal of the discussion that we're having and have been
having for the last several years centers on this matter of how efficient we're going to make the financial system by changing to an explicit price mode. All I can see down the road is an absolute morass.
The CHAIRMAN. H you have an explicit price system with competition, why~ You're the first witness who's indicated that. Every other
witness has indicated this would be desirable. You may be right, but
you're alone.
Mr. PETERSON. I have to say that the Independent Bankers Association-and I'm now speaking for the association-is very, very skeptical of explicit pricing. Right now the genius of the system is that it's
somewhat self-adjusting. We can adjust in terms of inflation and so
forth, and there's an inherent problem in the explicit pricing of money.
The CHAIRMAN. I can't understand why, if you have competition,
vigorous competition between the Fed and the big independent banksthe big banks who can offer services, too-why that competition
shouldn't result as it always has in this country in more efficient
operations and therefore lower cost operations, and I also can't understand why the bank shouldn't be charged full cost for their services.
Mr. PETERSON. But we do. I think we have a-The CHAIRMAN. What would be wrong with an explicit pricing
system~
Mr. PETERSON. It's an extraordinarily complicated thing. The financial industry has had experience with one mode of explicit pricing
so far and it's called the Truth in Lending Act.
The CHAIRMAN. You say that as if you had just had a spike driven
through your heart. I was author of the Truth in Lending Act.
Mr. PETERSON. Every day I feel the spike.
The CHAIRMAN. I thought that was·a pretty good bill. The Federal
Reserve study indicated our consumers are now far better informed
than they were before the Truth in Lending Act came into effect by
three or four times as informed-three or four times the people now
understand what the cost of credit is.
Senator RIEGLE. Mr. Chairman, would you yield at that point 1
The CHAIRMAN. Yes, indeed.
Senator RIEGLE. Not only that, but the banks have done very well.
They've got an enormous share of the market taken away from the
high-cost lenders that previously had that, so I would have thought
the banks would be here thanking us for that.
The CHAIRMAN. I wanted to oe the banks' pinup boy for that reason
but I haven't succeeded yet.
Senator RIEGLE. It's several billion dollars, not petty cash.
The CHAIRMAN. That's right.
Mr. PETERSON. Could we submit for the record a case that's recently
been decided in South Carolina, Wilson v. Allied Loams case j
The CHAIRMAN. Fine. I wish you would.
[The information follows:]
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[From the Congressional Record, J"uly 18, 1918)
HABBIET V. WILSON, PLAINTIFF,
"'·
ALLIED LoANS, INC., DEFENDANT
[Civ. A. No. 77--808]
United States District Court, D. South Carolina, Columbia Division, March 14,
1978.
Suit was brought by borrower alleging that forms used by lender violated
the federal Truth in Lending Act. On cross motions for summary judgment, the
District Court, Chapman, J., held that: (1) lender, which actually acquired
a security interest in any appliances or furniture acquired by the borrower
within ten days of the loan date, violated the regulations by failing to disclose
such interest; (2) since initial charge was not withheld from the amount
financed, that initial charge was not required to be labeled as a prepaid finance
charge," and (3) disclosure of $159.63 figure on form labeled "Net cash from
chart," representing $167.24, the amount financed, less payments for credit insurance policies and eight cents for documentary stamps, was not confusing,
misleading or inconsistent with disclosure requirements.
Judgment for plaintitr.
Marshall T. Walsh, Gaines & Walsh, Spartanburg, S.C., for defendant.
OBDEB
Chapman, District Judge.
Since Congress, in all of its wisdom, has determined that federal district
courts should preside over consumer complaints against finance companielil
relating to technicalities in language used in loan documents in which the
lofty sum of $100 is at issue, this Court must now proceed to wade through the
morass of technical regulations issued by the Federal Reserve Board in an
attempt to reach the merits of this case.
Defendants made two installment 'loans to the plaintitr in which she borrowed
$167.24 to be repaid in seven monthly payments of $28. Defendant secured this
loan by taking a security interest in a range and set of bunk beds owned by
plaintitr. In bringing this suit, plaintiff alleges that the forms used by defendant
violated the Federal Truth in Lending Act, 15 U.S.C. § 1601 et seq., and that
she is entitled under that Act to a judgment in the sum of double the amount of
the finance charge or $100,1 whichever is greater, plus costs and attorney fees.
u.s.c.
15
§ 1640.
[1] Plaintitr alleges that the disclosures made by the defendant on the loan
document violated the Act in three ways. First, p1.aintitr alleges that the defendant failed to disclose that it was taking a !'e<'urity ;nterest in after acquired
consumer goods. She bases this claim on 15 U.S.C. § 1639(a) (8) which states
that a creditor must disclose "a description of any security interest held or to
be . . . acquired by the creditor in connection with the extension of credit. and
a clear identification of the property to which the security interest relates."
PurFuant to 15 U.S.C. § 1604, the Federal Reserve Board promulgated the
following regulations governing disclosure of security interests :
"12 C.F.R. § 226.S(b) (5)-ln any transaction subject to this section, the following items, as applicable, shall be disclosed: (5) A description or identification
of the type of any security interest . . . acquired by the creditor in connection
with the extension of credit, and a clear identification of the property to which
the security interest relates. . . . If after-acquired property will be subject to the
security interest ... this fact shall be clearly set forth in conjunction with the
description or identification of the type of security interest . . . acquired."
"12 C.F.R. § 226.8(a)-All of the disclosures shall be made together on either
(1) the note ... on the same side of the page [as the creditors] signature; or
(2) one side of a separate statement which identifies the transactions."
In this case, all information relatln~ to each loan is contained on a single
document. This document contains the full text of the note and the full disclosure
of the loan terms on the front side. The text of the security agreement starts
on the bottom of the front page and continues on the back. The document clearly
discloses on the front page, in accordance with the statutes and regulations,
1
Thls matter is presently before the Court on cross motions for summary judgment.
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that a security interest is acquired in certain property identified as a range
and a set of bunk beds. The alleged defect in the form is the fact that terms
on the reverse side • of the form extend the security interest to "all other goods
of the same class now or hereafter acquired." Defendant argues in opposition
to plaintiff's motion for summary judgment that no interest was acquired in
after-acquired property because South Carolina law severely limits the effect of
after-acquired property clauses with respect to consumer goods. .S.O.Code Ann.
§ 36--9-204 ( 4)(b) (1976) provides:
"No security interest attaches under an after-acquired property clause to
consumer goods other than accessions when given as additional security unless
the debtor acquires rights in them within ten days after the secured party gives
value."
Defendant's argument would be correct but for the 10 1,1.ay provision. If state
law had totally invalidated after-acquired interest13 in consumer goods, the
language on defendant's form would have had no effect and no disclosure of a
security interest in after-acquired property would have been necessary because
no such interest would have been "acquired." Unfortunately for the defendant, since it actually acquired a security interest in any appliances or furniture
acquired by plaintiff within ten days of the loan date, it violated the regulations by failing to disclose this interest. See Eoenroae v. Household, Fin. Corp.
of South Dover, 422 F. Supp. 1327 (D. Del. 1976). Siflce this violation is apparent from the face of the loan document, there is no factual issue and
plaintiff is entitled to a summary judgment as to this claim.
Despite the fact that this Court feels compelled by the statutes and regulations
to award the plaintiff the penalty established by the Truth in Lending Act,
this result is absurd in light of the realities of this case. This barratrous legislation transforms loan documents into contest puzzles in which prizes are
awarded to those who can uncover the techuical defects. Unfortunately, these
prizes are not paid by the sponsor of the contest, the government, but by finance
companies who attempt to make a fair profit by loaning money while at the same
time trying to insure that the loans will be repaid. They must necessarily use
form documents which are sufficiently flexible to cover a wide variety of situations presented by both consumer and commercial loans. A penalty is imposed
on the defendant in this case even though it has acted in good faith and despite
the fact that plaintiff'. has sustained no damages. The violation in this case results
from a minor technicality which arises from the operation of the 10 day rule
relating to after-acquired security interests in consumer goods. The 10 day interest acquired was surely unwanted by the defendant, unimportant to the
plaintiff, and unexpected by both parties. It gave no meaningful security to
the defendant and its full disclosure to the plaintiff would undoubtedly have had
no effect on plaintiff's decision to obtain the loan from the defendant.
[2] Plaintiff's second complaint about defendant's form is that an initial
charge was withheld from the proceeds of the credit extended but was not
labeled with the term "prepaid finance charge" as required by the regulations.
The g1>neral disclosure requirements are set forth in 15 U.S.C. § 1689 and the
relevant requirements and defendant's compliance with them follow :
(a) Any creditor making a consumer loan or otherwise extending consumer
credit in a transaction * * * shall disclose each of the following items, to the extent applicable :
(1) The amount of credit of which the obllgor will have the actual use, or
which is or will be paid to him or for his account • • •. [Defendant disclosed this
amount to be $154.63.)
•
"(2) All charges, individually itemized, which are included in the amount of
credit extended but which are not part of the finance charge. [Defendant disclosed itemized charges made for various types of credit insurance and documentary stamps which totaied $7.61.)
"(3) The total amount to be financed (the sum of the amounts referred to in
paragraph (1) plus the amounts referred to in paragraph (2) ). [Defendant stated
that the amount financed was $167.24.)
"(4) • • • the amount of the finance charge. [The finance charge was stated
to be $28. 76.]"
The manner and specificity of the disclosures required by § 1639 are outlined in
12 C.F.R. § 226.8. After a circuitous jumping between paragraphs and subpara• So much information is required to be printed on the face of the instrument that notes
wm soon be printed and rolled up as a Roman scroll.
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graphs this regulation eventually establishes a requirement that any amount
withheld by the creditor from the "credit extended" be labeled with the term
"prepaid finance charge." The clarity of the explanation of this requirement is
apparent without a need for comment from the following quotations from§ 226.8:
" (c) In the case of a credit sale, in addition to the items required to be disclosed under paragraph (b) of this section, the followlng items, as applicable,
shall be disclosed :
"(6) Any amounts required to be deducted under paragraph (e) of this section
using, as applicable, the terms 'prepaid finance charge' and 'required deposit
balance' and, if both are applicable, the total of such items using the term
'total prepaid finance charge and required deposit balance.' "
(d) In the case of a loan or extension of credit which is not a credit sale, in
addition to the items required to be disclosed under paragraph (b) of this section, the following items, as applicable, shall be disclosed:
"(1) The amount of credit, excluding items set forth in paragraph (e) of this
section, which will be paid to the customer or for his account or to another
person on his behalf, inciuding all charges, individually itemized, which are
included in the amount of credit extended but which are not part of the finance
charge, using the term 'amount financed.'
"(2) Any amount referred to in paragraph (e) of this section required to be
excluded from the amount in subparagraph (1) of this paragraph, using, as
applicable, the terms 'prepaid finance charge' and 'required deposit balance,'
and, if both are are applicable, the total of such items using the term, 'total
prepaid finance charge and required deposit balance.' "
( e) The following amounts shall be disclosed and deducted in a credit sale in
accordance with paragraph (c) (6) of this section, and in other extensions of
credit hall be excluded from the amount disclosed under paragraph (d) (1) of
this section, and shall be disclosed in accordance with paragraph (d) (2) of this
section:
"(1) Any finance charge paid separately, in cash or otherwise, directly or
indirectly to the creditor or with the creditor's knowledge to another person, or
withheld by the creditor from the proceeds of the credit extended.''
As if this explanation of the "prepaid finance charge" requirement were not
confusing enough, the Federal Reserve Board made matters worse by issuing the
following "interpretation" of this requirement codified as 12 C.F.R. § 226.819:
"(a) Section 226.8(c) (6), 226.8(d) (2) and 226.8(e) (1) require that certain
finance charges be disclosed as "prepaid finance charges.'' They also require that
such prepaid finance charges be excluded or deducted from the credit extended in
arising at the "amount financed." The question arises whether add-on, discount
or other pre-computed finance charges which are reflected in the face amount of
the debt instrument as part of the customer's obligation, but which are excluded
from the "amount financed," must be labeled as "prepaid" finance charges.
"(b) The concept of prepaid finance charges was adopted to insure that -the
"amount financed" reflected only that credit of which the customer had the
actual use. Precomputed finance charges which are included in the face amount of
the obligation are not the type contemplated by the "prepaid" finance charge disclosure concept. Although such precomputed finance charges are not to be included
in the "amount financed,'' they need not be regarded as finance charges "paid
separately" or "withheld by the creditor from the proceeds of the credit extended"
within the meaning of§ 226.8(e) to require labeling "prepaid" under §§ 226.S(c)
(6) and 226.8(d) (2). They are "finance charges," of course, to be di_sclosed under
§§ 226.8(c) (8) and 226.S(d) (3).'"
This interpretation ~larifles the concept of prepaid finance charges like mud
clarifies water. The regulation and interpretation repeatedly use the phrase
"credit extended,'' as a starting point for determining whether a charge is a
"precomputed finance charge" or a "prepaid finance charge." The term "credit
extended,'' however, is never defined by the regulations. Only the terms "credit"
is defined as meaning "the right granted by a creditor -to a customer to defer
payment of debt, incur debt and defer its payment, or purchase property or services and defer payment therefor.'' 12 C.F.R. § 226.2(1). How is the lender to know
whether a part of the finance charge is withheld from the "pro<'eeds of the credit
extended" unless he knows what the term "credit extended" means? In the instant
8 Anyone capable of deciphering 12 C.F.R. 226.8 and its "Interpretation" should be workIng as a cryptographer at the Pentagon and not for a bank or loan company.
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case, if the credit extended is $196.00 (the total of the payments), then the
$10.03 initial charge is withheld from the proceeds of the credit extended and it
should have been labeled as a "prepaid finance charge." If, on the other hand, the
credit extended is $167.24 ( the amount financed), then the $10.03 initial charge
was not withheld from the proceeds of the credit extended and no "prepaid finance
charge" label was required. Since no definition of "credit extended" is contained in
the regulations, this Court defines the terms as it relates to this case to be synonymous with "amount financed." Accordingly, since the initial charge was not withheld from the amount financed, that initial charge was not required to be labeled
as a "prepaid finance charge." Defendant, therefore, is entitled to a summary
judgment as to this claim.
[3] Plaintiff's third complaint is that the loan documents contained "information which is confusing, misleading and inronsistent with the Disclosure requirements of 12 C.F.R. § 226.6(c)." That section of the regulations provides that any
additional information disclosed by the lender "[not] be stated, utilized, or
placed so as to mislead on confuse the customer...." Plaintiff contends that this
regulation was violated by the disclosure of the $159.63 figure labeled on the form
as "Net cash from chart." Plaintiff complains that the form gives "no explanation
as to what these figures . . . represent nor is it indicated as to how this might
he calculated." The Court does not understand why plaintiff is confused by the
$159.63 figure. The form clearly shows that the amount financed is $167.24. Plaintiff could have accepted that amount in cash; however, she elected to purchase
various credit insurance policies. These policies and the eight cents deducted for
documentary stamps totaled $7.61 which, when deducted from the amount financed
of $167.24, equals $159.63. It is quite clear that this figure results from the deduction of the insurance and stamps from the amount financed. Furthermore, there is
nothing confusing or misleading about the label "net cash from chart." The form
contains a chart showing, inter alia, the amount financed and the various in•
surance charges and the $159.63 net cash figure is clearly obtained from thE:
figures on this "chart." There is no merit to plaintiff's complaint about this
figure and the defendant is, accordingly, granted summary judgment on this
issue.
It is, therefore, ordered, in accordance with the foregoing discussion, that
judgment be entered in favor of the plaintiff in the amount of 100 plus costs of
this action plus a reasonable attorney fee of $150.00.
And it is so ordered.
The CHAIRMAN. Mr. Bolger, can you explain the IBAA affiliate
membership proposal for us i Please indicate what's similar to current
proposals either before this committee or the House Banking Committee1
Mr. BoLGER. Well, it would not require a stock ownership. It would
give them access to the window. They would be required to pay for
pricin<r as comparable to members but it would reduce somewhat tJhe
cost of membership. I think that the small bank mightThe CHAIRMAN. I can't see any difference in the way you describe
it and the Fed proposal.
Mr. BoLoER. Well, it's voluntary.
The CHAIRMAN. Very small banks would still be voluntary. With
the small banks it would still be voluntary both ways.
Mr. :BoLGER. Yes: it would still be voluntary.
The CHAIRMAN. Mr. Perkins, interest payments on demand deposits
is prohibited by law and yet it's well known that most banks allow their
correspondent bank and corporate customers implicit interest on their
demnnd deposits through mechanisms such as an earning credit or reduction in char~ for services. Are these practices widespread and do
you think that they are in viol-a.tion of the prohibition against interest
payments on demand deposits i
Mr. PERKINS. They are widespread. It's extremely well known and
I really have never heard the question raised as to whether they are
a violation of the law. I don't think they are. The prices a.re explicit.
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The earnings credit is explicit and when you price in the competitive
world you're pricing two sides of the cost.
The CHAIRMAN. Why isn't that a violation in view of the fact that
the law prohibits interest on demand deposits, and you say this is a
widespread practice, this earning .credit or reduction in charge for
services-why isn't that the same thing 9
Mr. PERKINS. I can't imagine, except for a token balance to take advantage of the settlement system, why anybody would keep demand deposits in the bank if they couldn't get any services for them.
The CHAIRMAN, I'm not challenging anybody's integrity on this
and I'm sure it's legal, but I'm just wondering why this isn't the same
kind of thing.
Mr. HAYWOOD. Mr. Chairman, may I suggest the answer may be in
the wording of the Federal Reserve regulations governing payment
of interest. That is, the law is very sweeping on this. It says payment
of interest in any form whatsoever.
The CHAIRMAN, Right.
Mr. HAYWOOD, It's kind of curious how NOW accounts got into the
picture with that kind of sweeping language in the Banking Act of
1933, but I believe that the Federal Reserve-that question has come
up again and again over the years in various ways and I don't have
the facts right here, but I think if we looked at the Federal Reserve
regulation on this we would find the answer there, that that credit
through services is exempted.
The CHAIRMAN, Will you give us what you can for the record on
that¥
Mr. HAYWOOD. Yes, sir. We will try to submit whatever we can
on that.
[The American Bankers Association submitted what follows for the
record. It is a quotation from the Interpretation of the Board of
Governors of the Federal Reserve Systems:]
1
SECTION
317'5:
ANALYSIS OF INDIVIDUAL AOQOUNTS
A member bank recently requested the Board of Governors of the Federal
Reserve System to consider whether the bank's practice of analyzing individual
accounts constitutes a "payment of interest" on demand deposits.
It appeared that the bank, in analyzing the accounts of depositors, uses a form
known as "Monthly Account Analysis." Use of the form involves the assessment
against the account of theoretical costs for certain services performed in connection with the account as follows: Checks paid at five cents each, transit items
at three cents each, clearinghouse items at one cent each, deposits at five cents
each, list checks at three cents each, return items at ten cents each, and overdrafts at fifty cents each. The total of these charges is designated in the analysis
as "Account Maintenance On Month" and to this total there is added 15 per cent.
At the same time, the theoretical earning value of the account for the month
is estimated by deducti\g from the avera-ge daily collected balance an amount
equal to the 18 per cent required reserves and treating the so-called "Net Earning Balance" as though the bank had it invested at a rate of 1 per cent a year.
If the cost of services, estimated in the above manner, exceeds the theoretical
earnings on the account, the difference is set up as "Cost of Services in Excess
of Earnings." Apparently, the customer may be charged this amount for the
services rendered by the bank. It is assumed, however, that in no case, as a result
of the analysis, is any payment made to the customer or any credit given which
increases the amount of his deposit balance.
The question raised by the correspondence involves the basic distinction between payments of "compensation· for the use of funds" and charges made for
keeping balances and performing other services for a customer. There is no
Federal law or regulation which prohibits a bank from imposing so-called "serv-
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Federal Reserve Bank of St. Louis
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ice charges" against a depositor-nor for that matter which requires it to receive
deposits at all. Its relations with a customer and the service charges which may
be imposed are matters of contract between the bank and the customer.
It is not unusual for the management of a bank to formulate some method of
internal accounting designed to enable the management to analyze individual
deposit accounts and determine the terms and conditions under which it will
keep and service such accounts for depositors. It is common for a bank using
an account analysis also to use as one of the factors in making the analysis
its estimate of the return it can obtain by investing the funds which the customer
has deposited with it. Likewise, it is common for such a bank to include in its
analysis estimated factors of cost in servicing the account. In some cases the
result is that the customer is charged by the book for keeping and servicing the
account. But the Board does not understand that in any case is a payment made
to or for the account of the customer as "compensation for the use of funds."
As the Board understands the facts, no payments are made at all. The analysis
is simply an internal arrangement to enable the bank to determine whether it
should make a charge. Under these circumstances, the Board was of the opinion
that, under the facts of the specific case, the use of the "Monthly Account
Analysis" is not a "payment of interest" and, accordingly, does not violate section 19 of the Federal Reserve Act or the provisions of the Board's Regulation Q.
Mr. BoLGER. Mr. Chairman, commercial banks who provide services
to our commercial customers provide more services based on their
deposit. It's really not much different than the service the correspondent banks provide a bank.
The CHAIRMAN. Well, that's a good point. Again, you're indicating
the great flexibility that the banks and the regulators have been able
to foresee in that law. It vrohibits interest on demand deposits, but
in effect a kind of interest 1s paid.
Mr. Perkins, you said that the Federal Reserve should not charge
less than the private sector for similar services. What if Federal
Reserve costs are less than the private sector's¥
Mr. PERKINS. By that statement we meant the costs should be fully
costed and have all of the cost in it including the cost of float.
The CHAmMAN. You wouldn't object if they're lower if their costs
were lower¥
Mr. PERKINS. No, sir. As far as being lower, if they are real, I think
that the private banking system and those of us who provide many
of these services can compete with them if the competition is fair and
based on the same ground rules as far as the pricing goes.
The CHAIRMAN. Mr. Bolger, you said the charges for Federal Reserve services could create problems for small banks. We have been
told that not many small banks use Federal Reserve services. If that's
true, what problem do you see with the pricing of Federal Reserve
services¥
Mr. BoLGER. Well, I think that that's if we do come to pricing of
services. I think distances-it's going to be rather difficult to fix a
price for services at a bank in Chicago, for instance, that's blocked
from the Fed, delivering currency or coin to somebody out in the
country. I think that could create a real problem to the dual banking system.
Mr. PERKINS. Our principal concern with pricing is that it be based
on fair and realistic prices and not some kind of marginal pricing
or something. There are lots of ways to price. To say the price is way
down here when the real price in the real world 'is somewhere up
here is wrong-and it's a very complica.ted subject and our aim is
that it be done fairly and be fu]ly understood when it's done. Many
33-587 0 • 78 • II
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of us know by experience it's a very difficult subject. It takes a lot of
work, a lot of experience, a lot of adjusting, constant work all the
time.
The CHAIRMAN. Mr. Perkins, you favor pricing the Federal Reserve
services. As you indicated, it would be a difficult task to set prices.
How do you propose to do it?
Mr. PERKINS. Well, I would think the prices would be set in the
same way that any of us in the business set prices. We try to look at
the whole question of what it costs us to do the services, what the
competitive market prices are.
The CHAIRMAN. Let me give you an example of what my problem is.
You include in your list of items to be included in pricing the cost
of float.
Mr. PERKINS. Sure.
The CHAIRMAN. Can you explain that cost to me and why and how
the Federal Reserve should charge for float?
Mr. PERKINS. Well, if we're going to have competition in the market,
with both the Federal Reserve and major suppliers in the banking
industry supplying the same services, the banking industry pays the
cost of float. In other words, it's a question of when money is collected
and when it isn't and when we compute what balances earn in terms
of what they are worth. If you have a $100 balance with us we don't
credit you for earnings of $100. Credit is given for earnings on $100
less the required reserves and then of that balance, only the money
that is collected. You may have a nominal balance of $100, but you
may have checks in process that haven't cleared yet, so the actual investable balance may be only $50. So you have to allow for the cost
of uncollected funds and the cost of reserve requirements in seeing
what you can earn on the money you have on depost, which is part
of your __price.
The CHAIRMAN. Thank you very much. That's a helpful answer.
Mr. HAYWOOD. I have one thing. The American Bankers Association has put out a request for proposal to leading accounting firms and
consulting firms and an outline of that is attached to our testimony, but
we have received proposals. We will be reviewing four firms on Thursday to make an award for a very, very detailed study on this very
question of pricing and the possible implication for our system.
The CHAIRMAN. I'd appreciate that very much. That's a great contribution to our understanding too. We would be looking forward to
getting that study.
Mr. PERKINS. It will be a very, very large study.
The CHAIRMAN. I want to thank you gentlemen very, very much for
your testimony. It's been most helpful and we very much appreciate it.
Our final panel consists of Mr. John L. Donovan, vice president and
treasurer, Casco Bank & Trust Co., Portland, Maine; L. Manley Preston, president, First National Bank of Canton, Canton, Pa,. ; and Jeremiah P. Shea, president and chief executive officer, Bank o:f Delaware,
Wilmington, Del.
Gentlemen, we appreciate your patience. We would appreciate it
a.lso if you could limit your oral rema,rks to 10 minutes or less and the
balance of your remarks will be put in the record. I'm going to have
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to leave shortly. Senator Don Riegle will take over the chair in a few
minutes, but proceed now. Mr. Donovan.
STATEMENT OF lOHN L. DONOVAN, VICE PRESIDENT AND TREASURER, CASCO BANK AND TRUST COMPANY, PORTLAND, MAINE
Mr. DONOVAN. Mr. Chairman, members of the committee, my name
is John L. Donovan. I am vice president and treasurer of Casco Bank
& Trust Co., Portland, Maine. It is indeed a pleasure to have this
opportunity to share with you some of my views on S. 3304 and the
companion bills which are being heard in the House.
By way of background, Casco Bank & Trust Co. was founded in
1933. Throughout all of its existence, it has been a State nonmember
insured bank. At June 30, 1978, we had total deposits of $318 million.
Transaction accounts as defined totaled $142 million of which demand
deposits were $102 million and NOW accounts were $40 million, retail
time and savings, $124 million and large C/D's were $52 million. We
operate 36 branches throughout the southern and western part of
Maine.
In regards to this legislation, I would like to concisely address four
major points: ( 1) the requirement that these reserves be kept at the
Federal Reserve Bank or a member bank; (2) the requirement for
uniform reserves for all depository institutions; (3) the payment of
interest on reserves held at Federal Reserve Banks; and (4) the imposition of charges for certain services provided by the Federal Reserve Banks.
Based upon published reports of testimony by other Federal regulators, trade groups and state regulators, m.y concerns with these four
points should not be too surprising. However, I hope to present persuasive arguments that in fact certain of these proposals will have a
permanent and not always beneficial effect to banks like Casco. I believe that the bill's inequities which are discussed below, seriously detract from the desirability for its passage in its present form.
(1) The requirement that reserves be kept at Federal Reserve Banks
or a member bank
In section 105, the bill requires that all depository institutions,
which term includes all commercial banks whether member or nonmember, all savings banks, savings and loans and credit unions, maintain their reserves on transaction accounts in one of four methods.
These are valult cash, balances at a Federal Reserve bank, balances at
a Federal Home Loan bank or balances at a member bank. This last
method, "balances at a member bank" will cause irreparable harm to
the ability of Casco and all nonmember banks to compete for business
on an equal basis with member banks. It is discrimintory, anticompetitive and unfair.
Presently, nonmember banks can equally compete for the accounts
of all types of depository institutions, with the exception of member
banks. These are usually working accounts, like most other businesf'!
accounts. In many cases, where required, they also double as reserve
balances for the depository.
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Federal Reserve Bank of St. Louis
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Now this bill would prohibit these accounts from being used to
satisfy the reserve requirements on transaction accounts. In this day
of high interest rates, the Treasurer cannot afford the luxury of idle
balances. In fact, isn't that what led to all this discussion about providing member banks with a method of earning interest on sterilized
reserve balances.
At Casco, for example, we have over 110 accounts from financial
institutions with average balances in excess of $8.5 million. In most
cases, these are both reserves and working balances. We stand to lose
those balances if they cannot be counted as reserves. At our current
earnings rate of 9.83 percent we will lose over $800,000 in pretax income when those balances are pulled. That is $400,000 after taxes or
almost 20 percent of 1977 earnings.
If section 105 is enacted in its present format, depository institutions will be forced to sever longstanding and mutually beneficial account relationships. Casco and all nonmember commercial banks will
be put in the posture of being a legislatively disadvantaged competitor. This can easily be corrected by amending the section and inserting
a comma and the words "nonmember bank or trust company" after
the words "member bank" throughout section 105(a) (2).
(~) The provision /Q'f' wniform reserves on transaction balances
Like most commentators, I object to the concept of a uniform reserve
requirement on transaction accounts for all depository institutions. Interestingly in Chairman Miller's letter and supporting documents, the
only justification for a "universal" reserve requirement is that it
"would place all depository institutions on a more nearly equal competitive basis." After my earlier remarks I respectfully disagree. Without commenting on the logic of a proposal for "universal reserves" on
d,eposits which excludes time and savings deposits, I suggest to this
committee and the Congress that the most effective method of placing
all depository institutions on a more equal competitive basis would be
~ eliminate the interest rate differential. However, that is not today's
issue.
It appears to me that the need for uniform reserve requirements
is needed only to simplify the District Reserve Banks' mathematical
computations. If the bill is amended both to permit interest passthrough and remove its anticompetitive sections, then I, for one, will
not object to uniform reserves.
(3) The payment of interest on reserves hel,d at the Federal Reserve
Barnlcs
I can appreciate the desirability of permitting the payment of interest on reserve balances. While it would be inappropriate to force
membership on a state-chartered bank in The Federal Reserve System,
it is clearly desirable that the number of such banks which become or
remain a Fed member be maximized to permit the most effective implementation of monetary policy.
This bank, from its inception in 1933, has never been a member of
the Federal Reserve System. However, there would be a very strong
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motivation for us to do so if interest were paid on reserve balances. I
believe similar motivations would apply to many other banks either
to join, rejoin, or remain a member of the System, if the legislation
were approved.
It is necessary that this section be adopted. In my opinion, it will
go a long way towards solving the membership problem. However,
before the issue is permanently lost in campaign rhetoric, and demagoguery over Treasury rip-o:lfs, I suggest that this committee give
favorable consideration to permit the interest payment to be tied to
market rate and without limitation on amounts of individual payments. Any other method would be artificial and result in someone
subsid,izing somebody.
( 4) The imposition of charges for certain services provided by Federal
Reserve Banks
I strongly support the concept of explicit pricing of Federal Reserve
services. 1 will ignore the philosophical debate as to whether or not the
Fed should be mvolved m the payments mechanism which enables
private citizens, businesses, and local governments, to make payments
for goods and services. The fact is that it is involved. The present
challenge is to maximize the opportunity to mold that involvement
into providing public benefits.
.At the present, most district Federal Reserve banks refuse access
to non1nembers on the theory that the noninterest-bearing reserves of
the members are providing payments for the services that the Fed
provides. However, if it was forced to explicitly price these services
on a fee basis without differentiating between member bank and nonmember status, then access and use of these services would be based on
a wilingness and ability to pay for the service and a desire for those
services. This voluntary access should commence on the effective date
of the pricing and not delayed as the Fed proposes.
In the documentation accompanying its legislative proposal, the
Fed outlined certain principles that it would use as guidelines for
establishing prices. To those I would add the ones outlined in S. 2595that is based upon fully allocated current costs, both direct and indirect, provisions for taxes and capital and based on known volumes.
To summarize, I feel that S. 3304 has the potential to resolve some
of the real banking problems of today. However, I caution this committee to examine its provisions and not permit a Fed drafted bill from
becoming anticompetitive and discriminatory to nonmember depository institutions.
Thank you for inviting me and I will be happy to respond
to questions.
Senator RIEGLE. Thank you very much.
I thing we'll listen to all three presentations before getting into
question~. So, Mr. Preston, do you want to proceed.
[ Complete statement follows:]
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STATEMENT OF L. MANLEY PRESTON, PRESIDENT, FIRST NA•
TIONAL :BANK OF CANTON, CANTON, PA.
August 15, 1978
Testimony of L. Manley Preston, President, The First National Bank of
Canton, Pennsylvania before The Senate C~nmittee on
Banking, Housing and Urban Affairs, August 15, 1978
INTRODUCTION
I appreciate the opportunity to give you
my
views on the problems
of retaining a dual system of banking in the United States and on
Senate Bill 3304.
I represent only myself, my bank, and its customers,
but I believe that other small Federal Reserve member bankers are in
substantial agreement with me on most points.
This legislation will, very likely, be seen as the "last hope" of
many small national and Federal Reserve member bankers.
If useful action
is not taken, the deterioration in the nationwide network of banks, large
and small, that are directly supervised and regulated by the Federal
Government and its agencies will continue.
I feel that time is running
out and that something should be done quickly.
I know that you need comments on the legislation being considered
and I wi 11 give them to you; but feei that there may have been too
little emphasis on the non-monetary effects of the departure of small
banks from the Federal Reserve System.
Sma 11 banks are leaving the Federal Reserve System because of an
unbalanced 11ationwide system of reserve requirements.
There may be
philosophical reasons also but no banker I have talked to left the Fed
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for any reason other than the opportunity to move into a system that had
lower or more liberal reserve requirements.
This attrition of banks is
well documented.
I am sure that you have heard or will hear testimony on the problems
that this gives the Fed as they set and carry out monetary policy.
I am
not so sure that much attention has been given to non-monetary considerations.
When the National Banking System was established by Congress, a
nationwide network of banks, large and small, was created.
These banks
were regulated, supervised and influenced by federal legislation.
In return, these banks have served the Federal Government as a window
into the communities they serve.
The national interaction between banker$,
examiners, and legislators has been valuable to the whole nation.
Except for the inequities in reserve requirements I like being a
national banker.
believe this nationwide system of banks, immediately
responsive to federal legislation, has served its customers and the
country well.
I believe that the help and regulation of the office of the
Comptroller of the Currency, especially as demonstrated in the last few
years, will create an exceptional net~ork of sound, well managed banks,
that will help us maintain a vigorous, efficient·econany.
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Back to the problem.
As a national bank we must belong to the Fed.
Because of this we must keep a non interest bearing reserve balance at a
Federal Reserve Bank.
$500,000.
We're a small bank.
Our reserve requirement is about
A correspondent bank would probably be delighted to give us the
same services that the Fed offers for a balance of $150,000.
The $350,000
difference less necessary vault cash, could be easily invested to earn
about $14,000 a year.
State banks that are non-members also have reserve requirements but
as I'm sure you know, these are often lower and can usually be placed
partly with correspondent banks of their choice and partly into interest
bearing securities.
I also understand that in some states, the enforce-
ment of these requirements is not stringent and that penalties are often
light or non existent.
Our bank is bearing a burden that is not being born by state banks
and others that are our canpetitors.
When I say our bank; I mean our
customers, our employees, and our shareholders.
say this because any
increased cost eventually hits each member of each of these groups.
THIS DOESN'T SEEM QUITE FAIR
This doesn't seem quite fair.
The Federal Reserve System is the
only organization in the United States that has a primary responsibility
to study and influence the economy so that individuals, businesses, labor
groups, farmers, consumers, foreign countries and our government wi 11
benefit.
All expenses incurred in this effort are paid from revenues generated
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by the operation of the Federal Reserve Banks.
Any profits generated go to the United States Treasury.
Income from other than earnings on securities is negligible.
National banks and Federal Reserve menber banks are the only
organizations that are required to keep sterile, non-earning (except for
services) reserves at the Federal Reserve Banks.
THEREFORE, only national banks and Federal Reserve member banks
directly support the nation's monetary regulatory sytem---to the
benefit of all others including their competitors. Additionally, the
excess funds generated by the use of their reserves is used to reduce
the tax load of the rest of the nation.
This doesn't seem quite fair.
If this isn't fair; if national banks and their customers are
bearing an extra burden that helps competing institutions directly and
indirectly--why don't they do something about it? They are.
They're
leaving the Fed.
Why does a bank stay? High hopes and inertia mostly (except for
large correspondent banks who wil I stay as long as banks are required to
keep correspondent balances with a Fed member).
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As a national banker I've learned the national laws.
and the examination system are familiar to me.
The regulations
To change means a new
charter, a new name, new fonns, new signs, explaining to custaners,
learning new ways.
Small bankers don't need this kind of 1~ork.
enough as it is, and lack the time and help to work on it.
They have
Still--they are
leaving.
I understand the problems the Congress has in bringing an equitable
solution to the problem.
I would urge you to listen to the reasons why
state bankers and others do not want a uniform reserve requirement.
With
a universal reserve requirement the problems they would have are the ones
we have now.
Can you blame us for leaving?
~_EGISLAJION UNDER CONSIUERATION.
To move on to the legislation being considered.
It's canplicated,
probably won't correct the problem, and still seems unfair; but it's a
start.
Uniform Reserve Requirements_
It is too bad that such a canplex bill is necessary to solve such a
simple problem.
If all financial institutions were required to help in the
nation's efforts to maintain good times by keepiny reserves at a Federal
Reserve Bank, the coo1plications of pricing and µdying interest on reserves
would be unnecessary and the Treasury would receive increased revenue fran
the Federal Reserve Banks!
This wou Id be coo1i ng out of the earnings of
those financial institutions that now get a free ride.
However that may be; any reduction in reservt!S will help and the
addition of other institutions even if limited to demand deposits and
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transaction accounts, will tend to ease the inequities we now bear.
I can
see that there will be pressure from non member institutions now and later,
to eliminate or water down this section.
Payment of Interest on Reserves
Paying interest on reserves is also an effective and simple way to
solve the problem; perhaps the simplest; but the reported amounts proposed
seem inadequate in todays market, especially when coupled with charges on
Fed service.
I feel that the exodus of small banks from the Fed would cease and
some might even return if interest paid on reserve accounts was at or near
market rates.
understand the concern of Congress that payment of interest would
reduce the amount the Fed turns over to the Treasury each year out of
their earnings.
to make this up.
I appreciate the concern for the taxpayer who would have
However; disregarding services, the amount paid to member
banks would be just about the amount that member banks are now subsidizing
the monetary contra 1 system of the country.
If the amount of this present subsidy was paid to member banks as
interest, it would eventually be distributed to stockholders in increased
earnings, to their employees in increased salaries, or to the cust~ners in
less expensive or imprGved service.
These are taxpayers too--in effect now
subsidizing their neighbors.
Charges for Service
Another part of the proposed bill calls for charges for service and
serving non-members.
Why not, if it's a fair charge for services rendered
and other factors are equitable?
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But--1 see no reason why my bank should pay penalties of membership
and also pay for service at the same rates as non-members.
There is no question that the services provided by the Fed to member
banks are valuable and well handled.
The problem arises when required
reserves that "pay" for these services are seen to be worth more in the
market place and in correspondent banks.
Another factor related to service that encourages inefficiency on
our part and in the operation of Federal Reserve Banks:
When you don't
have to pay extra for something that is offered, you may eat it, drink
it or use it even if you don't really need it.
Sane of the Fed services
(that are now the only non-legislative tools that can entice membership)
may be used simply because they are there, and have been more than paid
for.
A realistic service charge on services offered would probably weet~
out non-economic uses of Federal Reserve facilities and staff.
I have no objection to paying for service if everything else is equal
and I have a choice.
As it is now, we have no real choice and are in-
directly, through balances, paying far more than the going rate.
I can see pressure coming from correspondent banks and taxpayer groups
to keep these charges high.
ALTERNATIVES
lf a bill giving equity to member banks is passed, the Fed's problem
of attrition will be solved.
Anything less will allow the slow death of
national banking as we know it, and the Federal Reserve System will be made
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up of a few large banks and some weak, small ones that don't have the
gumption to leave or the knowledge that they are being taken advantage of.
CONCLUSION
The legislation being studied may be the "last hope" of small national
and member banks who want to remain in their system--we need action.
The bill takes a complex, still inequitable approach that is apparently
made necessary by the reluctance of non-member institutions to shoulder an
additional part of the nation's monetary regulation load.
If the bill pc1sses as proposed it may not stop menbership attrition.
To sum up my specific thoughts on Senate Bill 3304:
Reserve require-
ments will still be inequitable and member banks must subsidize their
c0npetitors and others.
Proposed payment of interest on reserves is not
enough to balance the remaining unfairness of preferential reserve requirements.
Charging for services would be a good idea except for the other
legislated inequities between users.
I am concerned that after the bill is passed there will be inexorable
pressure to reduce the interest paid on reserves to "protect the taxpayer",
and to increase the price of services to prevent "unfair competition" with
private enterprise.
This, combined with unequal reserve requirements,
makes the prospect for retaining Federal Reserve member banks dim, for
regaining them dismal, and for running one difficult.
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Even so it's a start.
I appreciate your efforts and hope you can
find a way to improve the bill now or later in a way that will restore
equity and help retain a strong, effective, nationally responsive central
banking system.
Thank you for the opportunity to express the views of a rural banker
on a very important problem.
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Senator RIEGLE. Well, thank you. Let me just ask one question before we go on and then we'll take our last witness here.
That is, how actively do you and others in the bank talk about the
decision as to stay in for a while longer or do you finally decide that
it's time to leave! How much.is that really an active topic of conversation, a pending decision that's in front of you i
Mr. Pm:sTON. In our board of directors meeting we have one director
that probably says, "Hey, how about being a State bank, what would
that do for our profits," probably about once every 6 weeks. It's the
same fellow and the others all nod.
Senator RIEGLE. But yet the step isn't taken, so something-Mr. PRESTON. High hopes and inertia-, I think, is the answer to that.
Senator RIEGLE. So the rest of the members, while they listen to what
he's saying, they may be getting nudged his way, but they still aren't
to the point where they are willing to follow his suggestion. Is that
the point!
Mr. PnsTON. I think they're ready. If I would nod my head yes,
they would say when can we start. I have enough to do without that.
Senator RIEGLE. So you're sort of the one who could in a sense cause
the board to make that decision!
Mr. PREsTON. Tomorrow morning.
Senator RIEGLE. And you're close to the point of throwing in the
towel but you're not quite there yet¥
Mr. PRESTON. High hopes and inertia. In our community they were
all national banks. By our community, I mean our area. We have lost
a few through mergers. We are about two national banks now instead
of eight.
Senator RIEGLE. But you would like to remain a national bank!
Mr. PRESTON. I like the system. I understand it. I think it's improving every day. The bank examination system especially will eventually,
in my opinion, create a chain of well-managed banks. In this new system, the Comptroller of the Currency is emphasizing management, not
Government control. I like that. I'd like to stay witb it. State systems
are fragmented probably. There are probably some great ones and
there are probably some that aren't so great. Also the continuity in the
State-I have seen in our own State good years, mediocre years, bad
years.
Senator RIEGLE. This is not exactly germane-that's sort of a term
of art around here-but how do you' feel about Bill Miller? How do
you think he's getting along!
Mr. PRESTON. He's getting some action. I like him. It's been too much
talk for the last 5 years.
Senator RIEGLE. So you feel pretty good about him so far!
Mr. PRESTON. So far.
Senator RIEGLE. Mr. Shea, why don't we hear from you!
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STATE?rlDT OF 1ERE?rlIAll P. SKEA, PRESIDENT ill> CHIEF EXECUTIVE OFFICER, BA:NX OF DELAWARE, WILJrtl:NGTO:N, DEL.
.Mr. SHEA, Thank you, Senator.
.My name is Jeremiah P. Shea. I'm president a.nd chief executive officer of the Hank of Delaware, Wilmmgton, Del. l don't intend to repeat the remarks submitted earlier but will briefly summarize and supplement those remarks.
Our bank is one of 17 commercial banks operating within the State
of Dela.ware. Of these 17 banks, only 5 are member oanks, and that by
reason of their national charter. They a.re small banks representing
only 2½ percent of the total banking resources within the State of
Delaware.
Our State is perhaps unique in having such a small Federal Reserve
presence. We are a publicly owned company, a local compa.ny with
5,700 stockholders, none of whom owns as much as 1 percent of our
stock. There is no controlling stockholder interest. We a.re something
over $600 million in total resources a.nd we operate 30 branches around
the State.
In 1972, as I outlined in my formal remarks, we gave up, and reluctantly I might add, a 54-year relationship with the Federal Reserve
System. Our bank then, as it is now, was strongly oriented to the
credit needs of our local community. Our loan-deposit ratio, as an indicator, has not been below 65 percent in my memory and usually in the
70-75 percent range, and currently it's running about 70 percent with
almost all lending being done to Delaware business.
We left the :Federal lieserve System because of the cost of continued
membership, because of the loss of lendable funds that this immobilization of reserves represented, and for competitive reasons as outlined in
my prepared remarks, in a community with four strongly competitive
banks, two of whom were members, two of whom were not.
The heavy demands of Federal Reserve membership siphoned funds
that we could lend and it reduced bank earnings substantially. We experienced a 35-percent share of saving in the first year after our departure or about 10 percent of our 1972 earnings or in terms of dollars,
about $450,000 saved after taxes.
As I understand Senate Bill 3304, it would essentially return us to
our pre-1972 condition. It would substantially increase our costs. It
would immobilize funds that we are now able to invest or otherwise
use to pay for services. It would enhance the competitive advantage
of noncommercial institutions over us and over other commercial banks
in the area.
A minor point perhaps, but the 25 percent per year phase-in referred
to with respect to the new reserve requirements is only a device that
would delay the day of reckoning.
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We don't believe that uniform reserve requirements are necessary
to achieve the Federal Reserve quest for greater monetary policy effectiveness. If the conditions of membership were more attractive, we
think that the tide would tum as nonmembers and former members
considered this situation, their cost-benefit ratio. If we are proven
wrong in this theory, if this did not produce the desired results, then
we would have to admit it and say that universal requirements would
appear to be the next logical step.
A plan acceptable to us, if universal requirements came into effect,
would allow vault cash to count as reserves, which it does now under
both State and Federal rules, but it would also allow correspondent
working balances to be counted as reserves which it does now under the
State but not under the proposed Fed rules. It would substantially reduce both the range and the rate of reserve requirements. It would
allow for the payment of interest at reasonable market rates on those reserves maintained in the Federal Reserve Bank of Philadelphia. It
would require the Fed to charge explicit rates and prices for services
rendered. It would make provision for inclusion in the total deposit
base of those savings and time deposits not confined to commercial
banks alone, but those in thrift institutions as well, referred to in the
proposed legislation as transaction accounts.
It would allow-and here I'm digressing to Congressman Reuss'
proposal of last week-that the rediscount rate would continue its
present function as a signal flag to the financial community.
Finally, we would strongly suggest separation of the consideration
of interest on reserves from the pricing of services. The Fed, through
S. 3304, is saying in effect that we will give you a dollar as long as we
are legislatively authorized to take it back, and in fact must take it
back because of Treasury financing requirements.
I agree with Mr. Perkins and others who have spoken here this
morning that the tie-in of pricing and reserves along with Federal
budget requirements is not or are not homogeneous considerations.
I would be pleased to answer any questions that you may have.
Senator RIEGLE. Thank you, Mr. Shea.
[Complete statement follows:]
33-687 0 • 78 - 12
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STATEMENT OF JEREMIAH P. SHEA, PRESIDENT AND CHIEF EXECUTIVE OFFICER
BANK OF DELAWARE, WILMINGTON, DELAWARE
TO:
SENATE COMMITTEE ON BANKING, HOUSING, AND ORBAN AFFAIRS
THE HONORABLE WILLIAM PROXMIRE, CHAIRMAN
AUGUST 15, 1978
In October, 1972, after fifty-four years of membership in the
Federal Reserve System, we reluctantly decided to withdraw and assume
the status ~fa state, non-member bank.
In arriving at this decision, we reviewed the benefits, obligations
and costs of membership in the Federal Reserve System. We also had to
deal with the, perhaps, emotional aspects of a long-term relationship
based on an endorsement of the idea--which we still promote--that a
strong, independent central bank is essential to the functioning of
government. Our Chairman is a former member of the Board of the Federal
Reserve Bank of Philadelphia.
I began my banking career as an employee
of that same bank.
So, you see, we were the victims of conflicting emotions in 1972,
when we decided that membership was a luxury we could no longer afford.
At that time, only 41% of all commercial banks were mefflbers of the
System, but they represented 79% of all commercial bank deposits.
In
1940, twenty-two years earlier, 46\ of all banks were members, representing 89% of commercial bank deposits.
Even then, the erosion of
membership was evident.
Why, then, did we leave?
There were two primary reasons.
First, we are
banks in the Delaware community.
Two were members,
non-members had a definite competitive advantage in
maintain fewer resources in cash/bank balances than
or Wilmington Trust, the other member.
one of four major
two were not.
The
that they could
Bank of Delaware
Cash and Bank Balances as% of Total Assets
Delaware Trust
Farmers Bank
Bank of Delaware
1971
6.2
10.6
14.6
Wilmington Trust
16.8
1970
6.9
10.2
16.8
18.3
1969
7.9
7.3
15.7
20.4
Second, as a non-member bank, we would have employed over $15
million more in earning assets, an increase of SI.
This difference is
accounted for by the fact that as a state non-member bank, correspondent
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Federal Reserve Bank of St. Louis
175
bank balances and cash would qualify as legal reserves.
Based on our
average deposits for the first eight months of 1972, the entire (noninterest bearing) balance at the Fed could be converted to earning
assets should we operate as a non-member bank.
This statement is based
on the then existing reserve requirements which are detailed below:
COMPARATIVE RESERVE REQUIREMENTS
(October, 1972)
~81
Net Demand De2osits
-
2 million
10 million
100 million
400 million
over 400 million
0
2
10
100
--
Delaware
81
81
81
101
121
131
17',1
101
101
Time Deposits
O 5 million
Over 5 million
Savings D~posits
31
51
31
31
31
31
composition of Legal Reserves:
Federal Reserve -
Vault cash and collected funds held in a
deposit account of Federal Reserve Bank of
Philadelphia.
(Correspondent bank balances
do not qualify.)
State of Delaware -vault cash and all bank balances, including
correspondent bank balances and items in
the process of collection.
* * *
Applying the reserve requirements outlined above to our average
demand and time deposits at that time, we made the following
comparison:
Reserve Requirements
(000 omitted)
~Required on Demand Deposit
"
"Time/Savings Deposits
Total Required Reserves
Less:
Average Vault Cash
Delaware
16,639
4,543
13,642
3,993
$ 21,182
17,635
4,379
~
Net Balance Requirements
FRB
Due from Banks, etc.
Averages Held
Excess Reserve
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Federal Reserve Bank of St. Louis
$ 16,803
13,256
19,520
16,803
-o-
$
6,264
176
Comments:
1)
The comparison made in the foregoing is based on total
deposits of $292.4 million (consisting of $159.3 million in
demand deposits, and $133.l million in savings and time deposits).
These figures are ~ypical of the second half of 1972.
2)
As a non-member bank, we released the entire $16.8 million
held at the Federal Reserve Bank of Philadelphia.
Approximately
$1.0 million of these funds were needed to compensate correspondent banks for added services, such as wire transfers, coin
and currency shipments, and custody of bank-owned securities.
3)
The remaining $15.8 million were employed in short-term
securities, mostly as a pledge against uninvested trust funds.
Earnings at a rate of 5.51 returned $869 thousand, worth 35¢
a share, after tax, in the first year after our departure.
4)
Bank balances were $6.2 million in excess of required
When deposit growth
legal reserves for a non-member bank.
absorbed this excess, the value was an additional $340
thousand, or 14¢ per share, after tax.
The statistical data reported above is based on our 1972 situation.
Today, based on current non-member reserve requirements, we must reserve
$22.5 million dollars against $162 million of demand deposits and $330
million of savings and time deposits.
Our available reserve, by definition, includes $5.4 million of cash and $24.1 of correspondent balances.
We could, if needed, also count our unpledged U.S. securities with a
maturity of five y~ars or less.
If Senate Bill 3304 is enacted, the cash and balances listed above
would continue to be needed but we would immobilize an additional $10-12
million in deposits at the Federal Reserve Bank of Philadelphia.
This
figure is b~sed on an assumed average reserve requirement of s, on $162
million of demand deposits with some offset ($1-2 million) for correspondent balances no longer required.
We made the change to non-member status without any loss of
liquidity and with an incremental improvement in the ratio of capital
to assets (by reason of increased earnings).
We actually improved the
speed of check clearance, because our correspondents, using round-theclock operations and direct sendings, had a faster availability schedule
than the Federal Reserve System.
Faster collection means savings (and
lower risk of loss) to us and our depositors.
Wire transfer services
were conducted outside the Federal Reserve System through correspondent
banks. With adequate balances at those banks (counted as reserves by
Delaware law), we anticipated and experienced no deterioration in
service.
Our greatest concern was the potential hazard posed by loss of
access to the "discount window." This, despite the fact that we had
only used the "window" nine times in ten years, for an average of four
days each time, and then only because the 11 window" was cheaper than
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4
other sources of funds.
To substitute for the "window" we arranged
substantial lines of credit with several correspondents, at rates
below the discount rate, to be used for reserve purposes.
In addition,
we can still borrow from Fed at a rate 2\ above the discount rate.
• • * * • * • • * * * *
If we are able to operate effectively without a direct association
with the Federal Reserve System, what should our position be on the
questions of
a)
I.
uniform reserve requirements?
b)
interest on reserves?
c)
pricing for services?
Uniform Reserve Requirements
If we believe--and we do--that the Fed should have adequate
control of monetary aggregates, we cannot dispute the concept
of uniform reserve requirements.
We would suggest, however,
the following limitations:
a.
Exclude, except in a nominal way, the smallest independent
banks.
b.
Include other financial institutions, savings banks,
savings and loan associations and credit unions, whose
deposits formerly constituted "M-3" but which now, by
reason of checking accounts, NOW accounts and share
drafts, are readily convertible to "M-1" deposits.
c.
Substantially reduce the rates and ranges of required
reserves, since a greater national deposit base would
be included under any uniform reserve requirement.
These limitations would reduce the earnings impact on all affected
institutions.
It would eliminate certain competitive disadvantages and
would ~eet the Fed's goal of controling a greater percentage of the
deposit base.
All of these were identified as desirable goals by
Congressman Reuss in his re~arks before the House on July 17.
Interest on Reserves
Please recognize that we approach this subject lacking the
scholarly historical perspective that you and your staff fflay share.
Our limited knowledge of the Federal Reserve System does not identify
bank reserves as an intended source of income to the Federal government.
Under the present system, reserves of member banks are non-income producing assets.
The income that results from their investment by the
Federal Reserve System is, by and large, contributed to the U.S. Treasury.
From our point of view, our assets are taken and invested and the income,
after Fed's e~penses, are passed to government and not back to the owners
of the funds.
rn other words, the income from our sequestered assets
represents a substantial hidden tax on the banking system.
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Feeling as we do, we must identify interest on reserves as an
overdue idea.
Our difficulty lies in the relating of these payments
to charges for service.
These are two different subjects, from where
we view it.
Interest should be paid; i t should be at a rate approaching
or equaling the return that the depositing bank could have obtained
through money market investment.
Or, as an alternative, stockholders
(members) of the Federal Reserve system could receive a fluctuating
dividend calculated by formula and based on the earnings of the Federal
Reserve Bank in their District.
This, in itself, would be an incentive
to membership.
Pricing for Services
The existence of Federal Reserve's nationwide operations network
is of the utmost importance to the banking system.
It should be
maintained.
Users of the network should expect to pay for it.
What price to charge? The answer to this can be found in the
same considerations a profit-oriented institution would consider,
i.e., direct costs, indirect costs and the cost of credit extended
through Federal Reserve "float.'' The cost of services rendered to
other agencies of government should be included in the formula, if
they are not already.
The pricing system we would suggest would be analogous to the system
we use in dealing with our corporate and commercial depositors.
Under
that method, an earnings credit on average deposits is calculated on the
basis of a money market indicator.
This number is used to calculate a
theoretical earnings credit.
The customer's use of services is charged
against this credit on the basis of an explicit price schedule for each
type and unit of service.
If he is a heavy user of service, there will
probably be a net charge that is billed or posted to his account.
Light
use of service usually results in a net earnings credit.
This net credit
is a consideration in the pricing of other bank services, such as use of
our loan facilities, etc.
Something along these lines might be the basis
on which Fed can deal with members and non-member depositors.
To say that interest paid on reserves cannot exceed income collected
for services places an aitificial barrier on a system that a) must
attract/retain members, b) must be competitive, c} must pay attention to
its "bottom line" and d} must maintain a level of financial service to
the nation.
The discount facility is the "emergency ward" of the banking system.
It should be available to all, but not necessarily without preferences.
Members, already accepting sub-normal returns on their deposited reserves,
should continue to enjoy a rate differential at the "window." Further,
anyone using the discount privilege mus~ expect to supply whatever information the lender may reasonably require.
Competition lies at the base of most of the improvements made in
the check-clearing system.
Subsidized pricing by an agency as large
as the Federal Reserve system would obviously endanger this multi-faceted
structure and should, therefore, be avoided.
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6
One of the House proposals would tie the discount rate to the
yield on 90-day Treasury Bills. Within the industry, most bankers
view the discount rate as a psychological weapon, infrequently considered except as a barometer of Federal Reserve attitude.
To change
its method of calibration would make it a mirror of the current market
rather than a signal of Federal Reserve analysis.
In other words, the
change in the discount rate mechanism as proposed would rob the discount rate of its peculiar value.
Also, there should be a survey to see how many states have tied
their usury rates to the discount rate.
This change could create a
great deal of turmoil for them.
It has been an honor for me to be able to present these obse~vations
and remarks to your Committee.
It is a complex subject and there is
no one correct answer.
I hope our views will be of some help.
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Senator RIEGLE. How much inflation are we seeing at the present
time and over the last 2 or 3 years in terms of bank services to customers j In other words, as you price out different aspects of what you
can do 'for somebody who banks with you, how much inflationary pressure are you experiencing and how much are you having to pass on to
your customers j Any of you can respond to that if you wish.
Mi". SHEA. The inflationary pressure is there. Obviously, we are in a
labor intensive industry that is trying to shift more toward a capital
intensive industry in an effort to contain those costs. I couldn~t put a
dollar figure on it because it's not that clear-cut. Where heavy labor use
is involved it's substantial and where we :have been able to automate we
have been able to fairly well hold the line.
Senator RIEGLE. How do you pass on costs to customers j What's the
most direct way that you can push a cost increase that you're experiencing on through to the user of your servioes j
Mr. SHEA. In the case of consumer depositors, checking accounts primarily. That's done through either the establishment of a balance requirement or the ~harging of a monthly fee or the two in concert; that
if a certain balance is not maintained that there is a monthly fee for
the handling of the account.
In the case of the commercial depositor, it's much like the system
that Mr. Perkins described earlier, where the customer is given a theo!etical earnings c~dit for tha.t part of ~is balance that we ~re able to
mvest after allowmg for reserve reqmrements and those items that
have not actually been collected. That figure is set to one side and is
used to offset the charges for the units of service made on the other side.
If the total earnings credit is consumed, then we make a direct charge
to the customer's account for any deficit in his balance or in his earnings
credit.
Senator RIEGLE. In a sense, then, you charge your customers for your
services. If you look at it over the l.ast 2 or 3 years, has there been a
measurable mcrease in what you are having to charge them for what
you do for them j
Mr. SHEA. Yes; there has been.
Senator RIEGLE. Could you express it in a percentage term roughly,
just to give us an idea j
Mr. SHEA. I'd say 25 to 50 percent and it would be considerably larger than that except for the impact of extremely competitive environment in the correspondent banking fraternity.
Senator RIEGLE. What's happened in your banks in this regard i
Mr. PRE.sroN. We have a little different philosophy. We don't feel
our service char~ is our income. These are service char~ on deposit
accounts. We feel that we are paying our customer for the money he lets
us use. In other words, if he has a balance of $100, we are paying him
a service of 20 checks a month and two deposits or whatever he uses on
his account. So this is a cost to us to get $100 to lend.
Our basic big-gest problem is the interest we pay on savings. There
are two kinds of costs for money. One is interest and the other is services, which amounts to telJers, capital facilities and so on. Our basic
business is making loans. We pay for money. That's a cost. We get our
money back by charging for it when we loan it out. So the basic place
we should recover any inflation or any other increased cost which
would include these implied costs of Federal Reserve membership
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would eventually go to our loan customers, I would say, in our
situation.
Senator RIEGLE. The loan customers in the sense that you would
charge them a higher interest rate~
Mr. PRESTON. It would be a higher interest rate basically, which is
a problem too because of unrealistic usury rates.
Senator RIEGLE. So let me ask, apart from the normal swings in interest rates, sort of the secular change in interest rates, are you finding in your bank that there's an upward creep in a sense in the cost
that you're charging your customers which is inflation related-and
I guess you're saying in effect that's showing up in the fact that the
interest rate, all other things being equal, is higher because built into
that is this increment.
Now~ i:f so, what would that percentage increase look like in your
bank over the last year or two~
Mr. PRESTON. I.think it would be almost exactly the same as the inflation rate in the economy-6 percent a year, 7 percent a year, 8 percent a year, 10 percent 1 year. Most of our cost is interest which is
affected definitely by inflation rates. The other costs are for people,
machinery, supplies. I'd say basically the inflation is the same for our
industry as any industry.
Senator RIEGLE. How about you, Mr. Donovan~ What would be your
experience there 1
Mr. DONOVAN. We have definitely factored inflation in the system.
About 18 months ago we discovered that after an attempt to raise our
prices back to 1973 that had been aborted by the wage and price controls that went in at that time we had forgotten about it and toward
1975 and we were looking at declining earnings and increasing costswe resurrected the pricing structure. At that time we instituted increases of roughly on the magnitude of 50 to 75 percent on specific
services. At the same time, we formed a committee of internal officers
connected with those areas that are cost sensitive and this committee
reviews our service charges covering the whole gamut periodically
and makes recommendations to management as to what we could do
to recapture those costs. We definitely factor inflation in. We have to
or we get killed.
Senator RIEGLE. So what would your cost increases over the last
year or two look like, would you say, percentagewise i
Mr. DoNOVAN. In the last 18 months we have increased costs probably after the initial jump somewhere on the magnitude of about 15
percent on some items over the last 2 years.
Senator RIEGLE. Now if we were to see a proposal passed then that
would allow banks that are in the Federal Reserve System to receive
a full interest payment, let's say at competitive rates, on their reserves
that are held by the Federal Reserve, that would give you all a shot
at additional money. I mean, it would be $14,000 in your case and
larger in terms of larger banks. Would this money be used to lower
the cost of services to customers~ What would you do with that money
or would that just be swallowed by the banks and make its way
through the additional net income and retained earnings or dividends, or would you use that as a way to roll back maybe some of the
price increases that you're having to pass on to people i What do you
think would happen to that if you had that windfall i
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Mr. SHEA. The 2-percent provision~
Senator RIEGLE. I'm saying we went to a competitive rate. We actually paid a higher percentage. Let's say you were paid a percentage
rate that-I don't know what that would be today, but 6 percent or
something in that range.
Mr. SHEA. Well, by and large, those dollars would be dollars that are
already invested at comparable rates. There would be a substitution
?f funds. I don't see there would be a net dollar improvement in our
mcome.
Senator RIEGLE. The Fed is not paying you interest now. If they
began to pay you interest on the money they are holding for you,
wouldn't that give you a sizableMr. SHEA. I think it would have an impact on Mr. Preston's bank
since he's a member.
Senator RIEGLE. I'm saying if you were a member. I guess I'm postulating it in that fashion. I'm saying maybe the question is not a good
one for you to deal with. I ought to be talking to somebody who's in
the Fed, but I'm wondering as a general proposition if the Fed were
doing that, and let's say you as a Fed bank were to become affiliated
with the Fed, if this would have the effect that it would be a large
enough item on a one-shot basis that it would actually benefit the consumer in the end in the sense the consumer would get a better break or
does it basically benefit owners of bank shares~ In other words, where
would the money go once the Fed gave it to the bank 1 And I'm
wondering if the competitive situation today and the anti-inflation
spirit is such that a lot of bankers would say this is a great chance for
us to roll back some of our recent price increases and get the cost of
our services down because we're not having to pay for somethingin a sense, we're not having to have our money sitting there idle and
therefore we can afford to preserve our profit margins and lower our
prices, or would the general response be inclined to be that this is a
windfall and this is something that the people who own and run the
bank get to keep i
Mr. SHEA. If we were subject to universal reserve requirements, it's
our calculation that we would have to add roughly $10 to $12 million of
reserves through the Federal Reserve which would be offset to some
extent by reduced requirements that we would have to keep at other
correspondent banks. I guess I'm getting back to my original point,
it would be a substitution of dollars and really no net gain of income
to us. There might be an income gain to the larger correspondent banks
that have these tremendous deposits on balance at the Fed and in fact
we would hope to see that and expect it would trickle through into the
pricing system for correspondent banking services.
Senator RIEGLE. I appreciate what you're saying with respect to
your banking situation. How would you see it 1
Mr. PRESTON. You've got me, because if you pass something like this,
I'm going to get some money and you want to know where it's going.
I think it will eventually get thrown into the pot. It will go everywhere eventually. Shareholders will get some of it and should in dividends. The bank will keep most of it, in my opinion, and it will be
part of our capital which increases our ability to serve the public with
more loans. We'll buy some machinery with it, automated tellers or
whatever comes down the line. We need this money in our bank to
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provide services and to provide extra profits. Eventually everybody
will benefit, including our employees.
Mr. DONOVAN. I think that's a fair assessment, Senator. I think it
will be spread among the various publics that a bank serves not only
its own shareholders but its employees, its customers, through either
reduced costs or improved services. I think one of the benefits that has
been somewhat ignored and was touched on earlier in the testimony
is capital ratios, that the banks will retain greater amounts of earnings
in their capital structures and that will benefit the community itself,
whether they're customers or not, because you will have a stronger community. Without earnings you can't have a strong bank, and I feel
that it's an idea whose time has come.
Senator RIEGLE. But if somebody were to ask us the question about
that we would not be able to say that that's necessarily the windfall to
the consumers. In other words, they are not necessarily going to be the
ones that end up in effect getting this on a passthrough.
Mr. PRESTON. You might think of it in terms of if we don't get it.
1'here's a certain level of profits that every industry, every business
must have. If we're $14,000 short somewhere, it would either come out
of dividends, capital, which will get the Comptroller of the Currency
on our neck, or we will have longer teller lines, old-fashioned systemspick up your statement instead of mailing it. Eventually the consumer
will suffer because after all stockholders and employees are consumers
too.
Mr. DoNOVAN. If it costs me 15 cents to process an item, whether I
get money on my reserve balance from the Fed or not get money on my
reserve balance from the Fed, it's going to cost me 15 cents to process
the item, and I'm going to pass that through. Now, competitive pressures might restrict the amount that I can pass through, but it's difficult
to make a categorical statement that the consumer will get all of it.
Senator RIEGLE. Apparently if the Fed were to pay competitive
rates on reserves that it holds and then price explicitly for services and
to do that properly, the revenue loss on paying competitive rates on
reserves would cost the Government $1.8 billion, and the offset in
pricing for services would be about $400 million. So if we were to
talk in terms of what might be a very clean way of doing it, you're talking about an initial shortfall in terms of the Federal budget of $1.4
billion, which is a pretty stiff one, and I think probably under our current conditions, even if one were to make an argument that that was
a theoretical desirruble way to start to reengineer the system, I'm not
sure that it's feasible or sound to take that kind of a shot. Although if
that were not a consideration, it certainly has some appeal to me, that
the idea that the funds kept ought to be paid at the competitive rate
and in turn whoever is using the services ought to pay the fair cost for
those serv~ces and people who take a lot pay for it and those who take
less get paid for what they take and we would have the thing on sort of
a rational :footing.
The problem is how we get from here to there, and that's sort of
where the debate seems to lie at the moment.
Let me pose some questions for you that Senator Proxmire is interested in having responses to.
Mr. Shea, you support universal reserve requirements with three
limitations: (1) an exclusion for small banks; (2) an inclusion of
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other.financial institutions with regard to their transaction accounts;
and ( 3) lower reserve requirements.
Let me ask you about all three of these. First, how big an exclusion
would you prefer would be the first $10,000, $25,000, $50,000 deposits
at each institution, or what figure 1
Mr. SHEA. I have no firm answer to that. I have been getting a
crash course in the intricacies of this subject in the last few weeks, and
I frankly wouldn't know where to draw the line other than state the
principle that the smaller banks should not have to bear the same kind
of burden or pressure that larger banks are subject to and are better
able to deal with.
Senator RIEGLE. Should all savings deposits be considered transaction accounts j If not, how do you differentiate 1
Mr. SHEA. I can only speak to our own area where a large savings
bank has a very widely distributed debit card which in essence opens
up some indeterminate portion of their savings accounts to transactional definition, and I think that's got to be looked at in terms of
just what the impact is within that bank's savin~ deposits. But this
is a card widely distributed, widely used, and is used as cash. There's
somewhat of a discount paid by the merchant and credited to the
depositor's account as an incentive for the depositor to use it, and it is
used. It's a very good plan and I have nothing but compliments for it,
but in looking at the other side of it, where do you draw the line between demand deposits and savings deposits 1
Really, I'm turning the question back because I don't know precisely
how to deal with that.
Senator RmoLE. What level of reserve requirements on transaction
accounts and time accounts do vou think is reasonable i
Mr. SHEA. We'll, the range -now is"{ to 22 percent. I think that the
range should be lowerod substantially, perhaps down to zero-I'm talking of range now, n~ the actual number-to give the Fed the right to
continue t.o move in a lower direction, and that the limit be brought
down from 22 percent to some other reasonable number, whether it
would be 8, 10, 12, I don't know. You ha.ve experts who have appeared
before you and who will probably appear later who would be able to
give you a better answer to that.
Senator RIEGLE. Mr. Preston, what is your reaction to a proposal to
exempt the first $50 millioo of deposits from reserve requirements to
lower the reserve requirements ratios and to make such requirements
mandatory and uniform for all depository institutions i
Mr. PRESTON. This would solve my problem. I see others though.
The American Bankers Association represent not only me but 60 percent of the banks in the country who are nonmember banks. They have a
real problem. You're changing the rule to help me. The other thing I
wonder about is: we're using reserve requirements here as a tool to
maintain Fed membership. Now, you can argue about reserve requirements, whether the Federal Reserve needs them or not in their
monetary policy, but you mav be giving up an important tool for the
wrong reason. At this time, if there was any reason to change tb.e reserve requirements, it would probablv be up, not down, as this tool is
used as a monetary oontrol method. That wou1d bother me a. little bit
on a nationwide-.ABA level, but speaking as a small member banker50 percent of the banks in the United States are under $25 million, and
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about 4 out of 10 of these a.re national banks or Federal Reserve member banks, it would solve our problem.
Senator RIEGLE. You said in yoor testimony, "If the bill passes as
proposed, it may not stop membership attrition." rm wondering, do
you believe that membership in the central bank is something that
should be continued, or should we attempt to get affiliation with the
Federal Reserve for all banks j
Mr. PREsToN. I think you should have a choice. The Federal Reserve
might do something that is counterproductive in our opinion, and we
should have a place to go. I think that State bankers are like I amthey believe in their system. They use it well and it's valuable to them.
They should have the choice as far as the regulatory part. As reserves
requirements go, it's too bad mandatory reserves weren't started 100
years ago. We wouldn't have this problem and the Fed would have
more interest.
Senator RIEGLE. Mr. Donovan, you argue in your testimony that nonmembers as well as members should be allowed to invest reserves in its
correspondent banks. Can you explain to us why you see this as being
importanti
Mr. DONOVAN. I think my testimony addressed that issue, Senator,
and to repeat it, the definition-we're throwing terms amund here that
•are confusing people, but the definition in the bill of the depository institution covers the whole gamut of what's nicely known as banks. It
covers commercial banks. It covers sa,vings banks, S. & L.'s, and ~t covers credit unions.
Now at the present time I have a su'bstantial number of savings
banks, credit unions, and S. & L.'s in the State of Maine as my customers. Now all of a sudden you're going to tell them that the balance
they maintain in Casco Bank, which is a nonmember, is a tainted balance because they cannot use that balance in oomputing their reserve
assets. So all of a sudden I'm discriminated against and, as I say in
there, we ha.ve 110 accounts in this category and we have $8.5 million
in balances which I stand the risk of losing, and I will lose overtime,
because it's not as attractive ·as a balance that they would have across
the street at Maine National which is a member bank.
Seniator RIEGLE. Is the lack of access to Federal Reserve services adversely affecting yorur bank~
Mr. DoNOVAN. No. We can obtain those services through our correspondent banks, and we are permitted, if we put the items in machine
form, to clear through the RPCP that the Fed maintains in Maine, but
we are not aJt a disadvantage.
Senator RIEGLE. If you had access to Fed services, do you think you
would use them j
Mr. DoNOVAN. There are certain services we would use certainly and
we pay a price for them now indirectly. We order currency and coin
through the Fed in Boston and the only difference between me and a
member bank is that I pay hard dollars for them to Brinks and they
get the Fed to pay for 1t. We maintain some safekeeping at Fed
through Fed member banks and if we had to pay :for it we probably
still would, and I think we would continue to use the services that we
use. We might consider whether we would send more items to the Fed
for collection as opposed to sending them to correspondents, but we'll
really get a ~ter availability of funds out of correspondents.
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Sen.itor RIEGLE. Mr. Shea, let me ask you the same question. Does
the lack of access to, Federal Reserve services adversely affect your
bank?
Mr. SHEA. Not at an. As I outlined in my remarks, this was a major
consideration before we made the move to be sure that we wouldn~t be
impacted •adversely in the availability of services and through the use
of correspondent banks we have been able to actually enhance the colleotion effectiveness. We have reduced costs in some areas. We were able
to substitute for the lack of access to the discount window through the
arrangement of large credit lines for reserve purposes with major correspondents and are satisfied that in every respect the service was as
good or perhaps even better than we had experienced as members of the
Federal Reserve. I'm talking about 1972 conditions.
Senator RIEGLE. Are you saying then that you're not necessarily in a
position to make a comparative assessment as to the efficiency now of
the Fed in providing the services versus the correspondent banks?
Mr. SHEA. No; for this reason: The operating procedures of the
Fed, as with all banks, change from time to time as new transportation schedules become available, and they offer you different options
as to how you break your work down before you send it to them or
whether it;s more advisable to send work directly to another bank,
and these operating circulars and manuals are constantly being rewritten to reflect these changes. But at that time the statement is true
that we could match and exceed the service we were getting.
Senator Rrnm,E. Mr. Donovan, commenting as a nonmember institution, should the discount window be open for all depositories and,
if so, what requirements should be established for that usage?
Mr. DoNOVAN. To Quote the Fed, the discount window is a privilege,
not a right. That's what they tell you when you go there, r:,nd the requirements of borrowing in the Fed are not any big deal. I mean, you
go in there and yon borrow for a short period of time and you pledge
liquid collateral. Now there is a certain mystique connected with the
fact that the Fed is the lender of last resort and you would like to think
y~m w:ould be_ able to get monev from them if it was that type of a
s1tuat1on. I thmk that presently I could go to the Fed today and I could
borrow provided they advanced the credit to me. What is my penalty
for not being a member? It's two points over the discount rate. I think
the thing that vou will never be able to legislate is the attitude that
the <listrict Federal Reserve bank has in welcoming nonmembers at
the discount window, and maybe if it's in the statute that they have to
nccept us as first class citizens then there might be an advantage to it.
But borrowing arrangements are available from correspondent banks.
"\Ve too have liquidity lines established that satisfy our needs if we
should ever have to use them, and so far we have not had to use them;
but we compensate the correspondent bank for those credit lines that
are available.
I think it would be nice to have the window, at least in theory, open
to all depository institutions, but it's really not that necessary.
Srnator Rri::o~E. Let me as~ any of ~ou that want to respond if there
should be a s1m1lar unbundlmg applied to correspondent services as
at least some people want Jo apply to Fed services and, if so, in what
manner could that kind of a project proceed?
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Mr. DONOVAN. Senator, I think there is unbundling now. I think
that's a misconception by whoever wrote the question. I know so. I
pay hard dollars for the services I get from correspondent banks. We
do get an earnings credit on the balance, but we keep our balances at
certain correspondents down to the bare minimum to cover items in
transit and we compensate them with a check at the end of the month.
Now assuming that the Fed unbundled, would my prices change'~ I
think there's a possibility that would happen. They might change by
increasing, only because the value of the balance might change. But
it's a mi8conception on somebody's part that there 1s this term unbundling between correspondents.
Senator RIEGLE. So you say it could be a much cleaner situation.
Mr. DoNOVAN. It's a whole lot cleaner in the private sector because
it is oompetitive. The Fed has no competitors. I mean, you belong,
you get to use what you want. If you don't, there's no benefit to you.
benator RIEGLE. I have noticed that they can be a bit highhanded. Do
either of the other two of you want to comment on that {
Mr. SHEA. Only to confirm what Mr. Donovan said.
Mr. PRESTON. I would confirm it. It's a difterent system but it's a
free choice. You don't pay dollars and get interest, b:it it's the same
effect.
Senator RIEGLE. We may have some additional questions that other
members of the committee would want to have you respond to for the
record, but I have nothing more now at this trme myself. So let me
thank each of the three of you for appearing today and for coming
and giving us your testimony. It's been very helpful to us and we appreciate it.
The committee stands in recess.
[Whereupon, at 12 :30 p.m., the hearing was recessed, to be reconvened at 10 a.m., Wednesday, August 16, 1978.]
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Federal Reserve Bank of St. Louis
FEDERAL RESERVE REQUIREMENTS ACT OF 1978
WEDNESDAY, AUGUST 16, 1978
U.S. SENATE,
Co:11,c:MITTEE ON BANKING, HousING, AND URBAN AFFAIRS,
W (l,8hington, D.O.
The committee met at 10 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire, chairman of the committee,
presiding.
Present : Senators Proxmire, Brooke, Riegle, and Sarbanes.
The CHAIRMAN. The committee will come to order. This is the committee's third day of hearings on proposals related to reserve requirements and Federal Reserve membership.
Thus far there is no clear consensus on a solution. There is agreement that the special problems on small banks and thrifts must be
recognized and that in general reserve requirements set by the Federal
Reserve should be lower than they are now.
The banks would like to receive interest on reserves, but that is not
seen as a permanent solution to the Federal Reserve's problem of attrition of members. Moreover, the precedent of some interest payment
would surely lead to additional demands for larger interest payment
in the future.
Our first witness today is the Honorable Robert Carswell, Deputy
Secretary of the Treasury. Mr. Carswell, I am sure that the Treasury
and the administration would be concerned if the Congress landed the
banking community $1.8 billion, which is the market return on reserves
at the .Federal Reserve. We will be especially interested in what you
may suggest as an alternative solution to help the Federal Reserve.
Mr. Uarswell, you may proceed as you like. We would appreciate
your taking about 10 minutes in your oral presentation.
Before you begin, Senator Brooke, the ranking member of the committee, has a statement. Both Senator Brooke and I are going to be
relieved by other Senators a, little later, because we both will be required in a markup of the De:ffnse appropriations bill this morning.
Senator Brooke.
STATEMENT OF SENATOR BROOKE
Senator BROOKE. Thank you, Mr. Chairman. Mr. Chairman, after
several years' discussion by the Federal Reserve Board Chairman and
others of the problem of declining Federal Reserve System membership, I am pleased that we are promptly holding these hearings on the
comprehensive proposal of the Board to resolve the membership problem. Furthermore, we should note that the Housing Banking Com(189)
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190
mittee has already begun markup of this proposal. In view of the importance of this legislative issuet I hope this committee will treat the
Federal Reserve Board proposal with promptness as well.
After more than a decade of decline in the number of banks that
are members of the Federal Reserve System, the need for attention to
this problem is quite obvious. The Board reports that in the last 10
years, 551 banks have withdrawn from membership. The proportion of
commercial bank deposits held by member banks has declined from 83
percent to 73 percent. We may not know the precise point at which
declining Federal Reserve System membership seriously weakens control over monetary policy, but in a period with deep problems in our
economy, we must maintain the strength of the Nation's central banking system.
To respond to this threat to the central banking system, the Federal Reserve proposes a four-part plan. First, interest would be paid
on required reserves.
Second, reserve requirements for member banks would be reduced
in two stages.
Third, explicit prices for Reserve System services would be imposed.
Finally, universal reserve requirements would apply to all demand
deposits, share drafts, and NOW accounts whether held by member banks or not.
I would like to discuss each of these elements of the Board's proposal
in turn.
First, I strongly support permitting banks to receive interest on
required reserves. This is clearly the most important element of the
Board's proposal to prevent further attrition from the Federal Reserve System. Member banks are now seriously disadvantaged by maintaining substantial non-interest-earning reserves. November :financial institutions generally are allowed to hold reserves in the form of
low risk, but nonetheless interest-earnin~ assets. The competitive disadvantage to member banks is apparent m the consistently lower average profits of member banks compared to nonmember banks.
This unequal treatment has become particularly important in recent years. ]first, persistent inflation and generally high interest rates
have increased the costs, in lost earnings, from keeping reserves in the
Federal Reserve System. Second, competition in banking has increased
dramatically, especially through the growth of the savings industry
and the credit unions. I would add that this heightened competition
is, to some degree, a direct result of congressional action encouraging
formation of these competing financial institutions. I am not suggesting that competition should be curtailed.. We must recognize, however, that our actions have increased the attention which the :financial
institutions must give fo earnings on all assets, including reserves.
Permitting banks to earn interest on required reserves can reverse this
unequal treatment of member banks, and significantly reduce the
·burden of membership in the Federal Reserve System.
As indicated in your opening statement yesterday, it is apparently
your view, Mr. Chairman, that the Treasury already gets the Reserve
System's earnings on these reserve deposits, so W'hy give any of it back
to the banks? The Chairman's view on this issue, in my opinion, could
not be more wrong. From this perspective, non-interest-bearing
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HH
reserves amount to little more than a hidden tax on some of the Nation's
banks. We must remember, though, that the Treasury has no claim
granted by Congress to take these funds from the banking system.
Furthermore, continued erosion of the membership is reducing the
Reserve System's payments to the Treasury.
I also support the second part of the Board's proposal whic'h would
gradually simplify and reduce reserve requirements for member banks.
This would further ease the burdens of membership, particularly for
smaller banks. I note that the Board would adjust open market operations to assure a neutral effect on monetary policy during the phasing
in of tJhese reserve requirement modifications.
With regard to pricing Federal Reserve System services, I am also in
basic sympathy with the Board's proposal. From the standpoint of
efficiency it certainly makP,s sense to me to charge for services used by
financial institutions. Furthermore, as check volume continues to grow
and new electronic funds transfer systems develop, this is a keytime to
encourage development of private sector alternatives to Reserve System
domination of payments-clearing functions. Private sector competition can only develop, however, in ·an environment of pricing by the
Federal Reserve that reflects all System costs for services.
Finally, the BoaPd proposes "universal reserve requirements" that
would apply to transaction accounts of all financial institutions,
whether member banks or not. This, I am sure, is the most contentious
element of the Board's proposal, because it removes from the majority
of the Nation's financial institutions the choice of whether to contribute
to the Federal Reserve System. Certainly legislation requiring de facto
participation in the Reserve System by all banks would substantially
solve the membership problem. However, it would also significantly
alter the basic structure of the banking system, and possibly tilt the
balance between State and National hank chartering too far against the
State system.
I will keep an open mind on this element of the Board's proposal, but
hope tJhat it proves to be unnecessary. A careful structuring of incentives for Reserve System membership through interest on reserves and
reduced reserve requirements should correct the problem of membership attrition. I believe we should authorize these incentives and the
rationalization of pricing for Reserve services. If these actions prove
insufficient to correct the memberahip problem, then we can reexamine
universal reserve requirements or other measures which by legislative
fiat insure adequate central banking system control over our monetary
policy.
Mr. Chairman, let me repeat that I appreciate these :prompt hearings
on this important legislation. The problem of declinmg Federal Reserve System membership should be resolved this year. The time is now
. ripe to resolve these significant banking issues, and I hope the committee will proceed quickly to formal consideration of the legislation.
I regret that I will not be able to stay through the competition of
your testimony, Mr. Carswell, and to ask questions. I would like to
submit some questions for the record, if I may.
I would also like to welcome the Comptroller. I always enjoy meeting with him and having an exchange with him. Of course I want to
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acknowledge the presence of our Banking Commissioner from the Commonwealth of Massachusetts, for whom I have the highest esteem, admiration, and respect.
Thank you, Mr. Chairman.
The CHAIRMAN. Before you depart, Senator Brooke, this is a very
interesting opening statement. The trouble is we can always solve
problems by spending money, the taxpayers' money. Here we go again.
If we are going to give the bankers something they have never had
before, ever, that is, interest paid by the Federal Government on the
reserves they are required to keep, it is a precedent that is going to be
very, very hard to hold down.
The Federal Reserve indicates the cost now would be relatively
modest, but it is likely to be a very heavy cost indeed. And to argue
that the banks have an absolute right because their reserves are sterilized doesn't make any sense on the basis of precedent or on the basis of
policy. The banks, after all, do ha,ve a great privilege, they are not
forced to be bankers, nobody forces a bank to be chartered. They do it
because they recognize it is a good thing, a very good thing. And the
requirement that they hold reserves is something we have had, as I
said, perpetually, and it is a system that has worked rather well.
For us to abandon that, especially in view of the fact that the consideration we can give to it in the closing days of this session would be
abbreviated, it seems to me is a profound step that we should be very,
very careful in taking, and recognize the serious cost that this may impose on the Treasury and ultimately, of course, on the general taxpayer.
Senator BROOKE. I recognize that. But you also recognize the erosion
of Reserve System membership. I ·am sure you are aware of it; you have
been concerned about it, as I have, and many others. The questions is:
What is a viable alternative~
. The CHAIRMAN. Well, I think there is a viable alternative, and the
alternaitive suggested by boith the House Banking Committee Chairma.n. ·and by the Chairman of the Federal Reserve as an alternative
would not, as I understand it, require interest to be paid on reserves,
but would require an exemption from having any reserve requirements
for small banks, No. 1, and, No. 2, would provide uniform reserve requirements on all banks of the same size, which it seems to me would be
equita;ble and fair. But that is something we can debate and discuss.
Senator Sarbanes i
Senator SARBANES. I have no comments at this time.
The CHAIRMAN. Mr. Carswell, I apologize for detaining you. Go
right ahead, sir.
STATEMENT OF ROBERT CARSWELL, DEPUTY SECRETARY,
DEPARTMENT OF THE TREASURY
Mr. CARSWELL, I am pleased to present the views of the administration on S. 3304, introduced at the request of ,the Federal Reserve Board.
That bill authorizes actio111S to eliminate the incentive for commercial
banks to withdraw from the Federal Reserve System.
Since June of last year, when this committee considered this problem, the trend toward lower Federal Reserve membership has continued, and in the last 12 months more than 60 commercial banks have
voluntarily withdrawn from the system.
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We understand that additional member banks are considering doing
so, but have delayed their decision until after the Congress responds
to the bills such as S. 3304, that are presently before it in this area.
Previous witnesses have reviewed the burden imposed on National
and State-chartered member banks by the requirement that they hold
non-interest-bearing reserves in the Federal Reserve System. The burden hes been heightened by the advent of high interest; rates, which
have increased the opportunity oost to member banks of reserves that
cannot be employed to generate income. As a result, the effective cost of
deposits to member banks is higher than for nonmembers.
The administration believes that the continuing attrition in Federal
Reserve System membership will endanger the pivotal role in our financial system played by the Federal Reserve. The Treasury believes that
requiring mandatory reserves for al'l but the smaller depository institutions is the preferable method of dealing witlh that problem.
If the Congress does not adopt that approach, the administration
supports the enactment of legislation that would, first, lower reserve
requirements, and second, explicitly grant to the Federal Reserve the
authority to pay interest on member bank reserve balances. The legislation should, however, limit the potential revenue-loss t.o the Treasury
and provide standards for the Federal Reserve to follow in setting the
appropriate levels of interest payments and reserve requirements.
The administration also agrees that the Federal Reserve should
move to impose explicit charges for each of its services, with appropriate safeguards to provide for an orderly transition from the present
system.
The role of the Federal Reserve System as the central bank has been
critical in this country, both as the overseer of tlhe money supply at the
discount window and as an institution that maintains close relations
with and provides counsel to a large spectrum of the banking community through its Federal Reserve banks, and also through the extension
of services to its members.
Each of these funotions plays a part in fulfilling the Federal Reserve's responsibilities for integrity and control of the monetary sys:
tern. Each is eroded by the continuing decline in membership.
While, as Senator Brooke said, none of us can pinpoint the moment
when a worrisome trend becomes an alarming event, it is clear that at
some point the stature and power of the central bank will become more
attenuated as the trend proceeds. This weakening of the role of the
Federal Reserve in our banking system should be arrested.
As I have said previously, the Treasury believes that the approach
of universal reserve requirements is the preferable one. The Federal
Reserve has proposed legislation that would require all depository institutions, whether or not members, to comply with mandatory Federal
Reserve requirements against transaction accounts. Nonmember reserves would be held at the Federal Reserve banks or at member banks,
which would in turn hold the reserve at a Federal Reserve bank.
The Treasury supports in principle the imposition of uniform reserve requirements on similar types of deposits at institutions of comparable size, regardless of the type of depositor,r institution holding
holding the deposits. The Federal Reserve's effectiveness in the conduct
of monetary control would be strengthened by requiring universal
reserves.
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This approach will provide a permanent solution to the impact of
the membership problem on the conduct of monetary policy. It severs
the link between Federal Reserve membership and the separate issue
of the appropriate level of reserve requirements necessary for the conduct of monetary policy. It avoids the necessity-which arises if tJhe
problem is to be met by the payment of interest on reserves-of requiring the Federal Reserve to compute the diffe.ring burdens of membership for different banks to insure that the interest payments and other
benefits are properly targeted.
Another advantage of a universal reserve requirement is that this
approach is signifi.oa.ntly less costly to the Treasury than the alternatives. Nevervheless, even under a universal reserve structure, a substantial reduction in reserve requirements, or even the payment of interest,
may be required to reduce the impact on smaller nonmembers of meeting reserve requirements.
Finally, it would eliminate the present inequities between treatment
of members and nonmembers with respect to reserves, while continuing
to vest responsibility for supervision and regulation of nonmembers
with. the FDIC and State bank supervisors.
Of course, there are a number of issues that remain to be resolved.
One very important question is the extent to which smaller institutions
may be exempted from reserve requirements in order to avoid the adverse impact on earnings that would flow from a change. Another is
whether the universal reserve requirement should extend to deposits
other than transaction accounts. In addition, the interaction of this
proposal with the separate questions of Federal Reserve membership
and access to Federal Reserve services must be closely examined.
Other issues include the place at which reserve balances should be
held, the form in which reserves are held, (some have argued in favor
of permitting Treasury securities to be used as reserves), the degree of
reduction in reserve requirements, the degree of uniformity in reserve
ratios, and the amount of interest, if any, paid on required reserves.
Despite these unanswered questions, this is a straightforward .and
workable approach to a complex problem. We would be glad to assist
you and your staff in seeking answers to these difficult questions.
However, if the Congress should decide that nonmember banks and
thrift institutions should continue to be exempted from reserve requirements of the Federal Reserve, then the administration supports
legislation to reduce the financial burden of membership on those
banks that would otherwise leave the system.
One approach contained in S. 3304 is to lower reserve requirements
and to permit the Federal Reserve to pay interest on its required reserves. This approach will initially be more costly than universal reserves. There is no reason to believe that the precise level of interest
payments and reserve requirements which serve to stabilize Federal
Reserve membership can be readily identified and it is likely that pressures for additional payments or reserve changes will build in the
future.
The Federal Reserve's proposal is similar in design and cost to the
program contained in title II of the NOW account bill introduced last
year. I will omit summarizing the proposal, because I am sure you
have heard it endlessly from previous witnesses, and go on to comment
on that proposal.
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Any payment by the Federal Reserve o:f interest on reserves, and
any reduced earnings :from lower reserve balances will, o:f course, result in the reduction o:f payments to the Treasury.
On the other hand, increased income received by member banks as
a result o:f such a program will lead to their paying additional taxes to
the Treasury. We estimate that over time the Treasury will recapture
approximately one-hal:f o:f these benefits through the tax system. Based
on the estimated cost o:f the Federal Reserve proposal o:f $675 million,
we estimate that the net cost to the Treasury, after tax recapture, will
be about $335 million per year.
When Secretary Blumenthal testified last year on .S. 1664, he stated
that the administration would accept a net revenue loss o:f some $200
to $300 million in order to solve the membership problem o:f the Federal Reserve.
As I noted, approaching the problem through the requirement o:f
universal reserves will reduce the cost to the Federal Government, but
we continue to believe that incurrence o:f a significant cost is warranted
to solve this problem.
The aggregate cost to the Treasury should, however, be subject to
an appropriate limit, and should also take into account that the loss
o:f revenue to Treasury can accrue :from a reduction in reserve requirements just as easily as :from the payment o:f interest on the
reserves.
We also believe that any plan based on the payment o:f interest on
reserves should take into account that different classes o:f banks receive
differing benefits :from Federal Reserve membership. Thus, use o:f
the discount window may well be more important to a lar~r than to a
smaller bank that may borrow in an emergency situation :from its
laraer correspondent.
There is considerable room :for debate about the appropriate amount
necessary to stem the membership loss and whether payments should
be the same to all banks or targeted to that class o:f bank where membership attrition is most probable.
We would be pleased to discuss with your staff :further possible
wavs to target payments to reduce the cost to the Treasury.
On the pricing issue, the administration believes that imposing explicit charges :for services rendered by the System will impose a use:ful
discipline on users o:f the service. It will also permit private vendors
o:f these services to compete on an equal basis. At the present time
private participation has been constrained by the difficulty o:f competing with a Government agency offering free services. We would suggest, however, the committee 'consider alternative methods by which
such pricing may be phased in, so that unnecessary disruption in the
system can be avoided.
The administration is, in principle, in :favor o:f open access to Fedl'ral Reserve services :for all nonmembers at nondiscriminatory prices.
That issue must be resolved, however, in the context o:f the effectivenPss o:f the steps taken to stem the reduction in membership. I:f acCl'SS to services is no longer an advantage o:f membership. then this
change may increase the outflow o:f members unless the other disadvnnt.ages have been :fu1ly offset.
'T'hat concludes my :formal testimony, Mr. Chairman.
[The complete statement o:f Mr. Carswell :follows:]
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STATEMENT OF ROBERT CARSWELL, DEPUTY SECRETARY OF THE TREASURY
I am pleased to present the views of the Administration on S. 3304, introduced at the request of the Federal Reserve Board. That bill authorizes
actions to eliminate the incentive for commercial banks to withdraw from the
Federal Reserve >System.
In June of last year, this Committee considered S. 1664, which had the dual
purpose (1) of authorizing financial institutions to maintain NOW accounts and
(2) of reducing-the cost of Federal Reserve membershi,p by lowering the range of
statutory reserve ratios and lby ,permitting the Federal reserve to pay interest on
required reserves. This Committee acted promptly, and favorably, on that legislative proposal, which Administration supported, and reported out a bill in midAugust of last year. No further action has been taken.
Since that time, the trend toward lower Federal Reserve membership has continued. In the last 12 months, more than 60 commercial 1banks have voluntarily
withdrawn from t'he System. We understand that additional member hank'S are
1•onsidering doing so, but have delayed their decision until after the Congress
responds to the bills, such as S. 3304, ·that are presently before it in this area.
Previous witnesses have reviewed the burden imposed on National and state
chartered member bank'S by the requirement that they hold non-interest bearing
reserves in the Federal Reserve System. The burden has been heightened by the
advent of high interest rates, which have increased the opportunity cost to member 1b anks of reserves that cannot be employed to generate income. As a result,
the effective cost of deposits to member banks is higher than for nonmembers.
1
SUMMARY OF CONCLUSIONS
The ,Administration believe that the continuing attrition in Federal Reserve
System membership will endanger the ,pivotal role in our financial system played
by the Federal Reserve. The Treasury ,believes that requiring mandatory reserves
for all 'but the smaller depository institutions is the preferable method of dealing
with that prO'blem.
If the Congress does not adopt that approach, the Administration supports the
enactment of legislation that would (1) lower reserve requirements and (2) explicitly grant to the Federal Reserve the authority to pay interest on member bank
reserve !balances. The legislation should limit the :potential revenue loss to the
Treasury ,and provide stand·ards for the Federal Reserve to follow in setting the
appropriate levels of interest payments and reserve requirements.
The Administration also agrees that the Federal Reserve should move to
impose eX'I)licit charges for each of its services, with appropriate safeguards to
provide for an orderly transition from the present system.
THE IMPACT OF A DECLINING MEMBERSHIP ON THE FEDERAL RESERVE
In the aftermath of the banking reforms that began with the Federal Reserve
Act in 1913 and continued after the Depression, the financial system of the United
States has 1become the strongest in the world. Bank regulators at the Federal and
state levels have played an important part in that development. The role of the
Federal Reserve System as the central bank has been critical-as the overseer .of
the money supply and discount window; as an institution that maintains close
relations with, and provides counsel to, a large spectrum of the banking community through its regional Federal Reserve Bank•s ; and through the extension
of its services to members.
Each of these functions plays a part in fulfilling the Federal Reserve's responsibility for the integrity and control of the monetary system. Each is eroded by
the continuing decline in members'hip. We cannot pinpoint the moment when a
worrisome trend 1becomes an alarming event. In all likelihood, there is no such
single point. But the stature and power of the central bank will become more
llttenuated as the trend proceeds. This weakening of the role of the Federal Reserve in our banking system should be arrested.
I would now like to turn to the specific legislative issues before this Committee.
UNIVERSAL RESERVES
The Federal Reserve has proposed legislation that would require all depository
institutions-whether or not members-to comply with Federal Rrserve requirements for reserves against tran&action accounts. Nonmember reserves would be
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Federal Reserve Bank of St. Louis
197
held at the Federal Reserve Ban.ks or at other member ban.ks which would, in
turn, hold the reserves at a Federal Reserve Bank.
The Treasury supports, in principle, the imposition of uniform reserve requirements on similar types of deposits at institutions of comparable size regardless of
the type of depository institution holding the deposits. The Federal Reserve's
effectiveness in the conduct of monetary control would be strengthened by requiring universal reserves.
This approach will provide a permanent solution to the impact of the membership problem on the conduct of monetary policy. It severs the link between
ll'ederal Reserve membership and the separate issue of the appropriate level of
reserve requirements necessary for the conduct of monetary policy. It avoids the
necessity-which arises if the problem is to be met by the payment of interest on
1 eserves---0f requiring the Federal Reserve to compute the differing burdens of
membership for different banks to intmre that the interest payments and other
benefits are properly targeted.
Another advantage of a universal reserve requirement is that this approach
is significantly less costly to the Treasury than the alternatives. Nevertheless,
even under a universal reserve structure, a substantial reduction in reserve requirements (or even the payment of interest) may be required to reduce the
impact on smaller nonmembers of meeting reserve requirements.
Finally, it would eliminate the present inequities between treatment of members
and nonmembers with respect to reserves while continuing to vest responsibility
for supervision and regulation of nonmembers with the FDIC and State bank
supervisors.
Of course, there are a number of issues that remain to be resolved. One very
important question is the extent to which smaller institution may be exempted
from reserve requirements in order to avoid the adverse impact on earnings that
would flow from a charge. Another is whether the "universal" reserve requirement should extend to deposits other than transaction accounts. In addition, the
interaction of this proposal with the separate questions of Federal Reserve membership and access to Federal Reserve services must be closely examined.
Other issues include the place at which reserve balances should be held, ·the
form in which the reserves are held (some have argued in favor of permitting
Treasury securities to be used as reserves), the degree of reduction in reserve
requirements, the degree of uniformity in reserve ratios, and the amount of
interest, if any, paid on required reserves.
Despite these unanswered questions, this is a straightforward ·and workable
approach to a complex ,prOlblem. We would ·be glad to assist you and your staff in
seeking answers to these difficult questions.
1
PAYMENT OF INTEREST ON RESERVES AND REDUCTION IN RESERVE REQUIREMENTS
If the Congress should decide that nonmem1ber banks and thrift institutions
should continue to be exempted from reserve requirements of the Federal
Reserve, then the Administration supports legislation to reduce the financial
burden of membership on those banks that would otherwise leave the System.
One approach, contained in •S. 8804, is to lower reserve requirements and to
permit the Federal Reserve to pay interest on its required reserves.
This approach will initially be more costlY than universal reserves. There is no
reason to believe that the precise level of interest payments and reserve requirements which serve to stabilize Federal Reserve membership can be readily identified and it is likely that pressures for additional payments or reserve changes
will build in the future.
The Federal Reserve's proposal is similar in design and cost to the program
contained in Title II of the Administration's NOW account bill introduced last
summer. The Federal Reserve Banks would begin paying interest on required
reserves and reserve requirements on demand deposits would be simplified and
reduced. Services now provided at no cost to member banks would begin to be
sold to members-and perhaps eventually to others-at prices set by the Federal
Reserve.
During the first phase, reserve requirements would be reduced to release approximately $8 billion in reserves. The Federal Reserve Banks would also begin
paying an interest rate of 2 percent on all required reserve balances held by
them. At present deposit levels, these payments would equal approximately $430
million.
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As the program becomes fully implemented, the interest rate paid on the first
$25 million of a bank's reserves will be raised to a level equal to one-half of 1 percent below the yield on the Federal Reserve's securities portfolio. Reserve requirements will be further reduced to release an additional $2 billion in reserves
to member banks.
Under present conditions, the Federal Reserve estimates that total interest
payments to member banks under the fully phased-in program would equal about
$765 million annually. The increased member bank earnings from the released
reserves will provide an additional $320 million in earnings, but member banks
will probably pay about $410 million to the Federal Reserve in service charges.
The net benefit to banks is therefore estimated to be approximately $675 million.
Interest payments would be limited to not more than the sum of the System's
receipts from charges for services purchased by members plus 7 percent of its
annual net earnings.
To reduce the initial impact of the program on the Treasury and the Federal
deficit during the transition period, the Jl'ederal Reserve will finance the program's estimated after-tax cost by paying the Treasury about $575 million from
its acr.umulated surplus.
THE COST TO THE FEDERAL GOVEBNM:ENT
Any payment by the Federal Reserve of interest on reserves, and any reduced
earnings from lower reserve balances, result in a reduction of payments to the
Treasury. On the other hand, the increased income received by member banks as
a result of such a program will lead to their paying additional taxes to the
Treasury. We estimate that over time the Treasury will recapture approximately
one-half of these benefits. Based on the estimated cost of the Jl'ederal Reserve
proposal of $675 million, we estimate that the net cost to the Treasury, after tax
recapture, will be about $335 million per year.
When Secretary Blumenthal testified last year on S. 1664, he stated that the
Administration would accept a net revenue loss of some $200-300 million in order
to solve the membership problem of the Jl'ederal Reserve. As I noted, approaching
the problem through the requirement of universal reserves will reduce the cost
to the Federal government, but we continue to believe that incurrence of a
significant cost is warranted to solve this problem.
The aggregate cost to the Treasury should, however, be subject to an appropriate limit and should also take into account that the loss of revenue to Treasury can accrue from a reduction in reserve requirements just as easily as from
the payment of interest on the reserves. We also believe that any plan based on
the payment of interest on reserves should take into account that different classes
of banks receive differing ,benefits ·from Federal Reserve membership. Thus use
of the discount window may well be more important to a larger than to a smaller
bank that may borrow in an emergency situation from its larger correspondent.
There is considerable room for debate about the appropriate amount necessary
to stem the membership loss and whether payments should be the same to all banks
or targeted to that class of bank where membership attrition is most probable.
We would be pleased to discuss with your staff further possible ways to target
payments to reduce the cost to the Treasury.
PRICING OF FEDERAL RESERVE SERVICES
Imposing explicit charges for services rendered by the System will impose a
useful discipline on the users of the services. It will also permit private vendors
of these services to compete on an equal basis. At the present time, private participation has been constrained by the difficulty of competing with a government
agency offering free services. We would suggest, however, that the Committee
consider alternative methods by which such pricing may be phased-in so that
unnecessary disruption in the system can be avoided.
The Administration is, in principle, in favor of open access to Federal Reserve
services for all non-members at nondiscriminatory prices. That issue must be
resolved, however, in the context of the effectiveness of the steps taken to stem
the reduction in membership. If access to services is no longer an advantage of
membership, then this change may increase the outflow of members unless the
other disadvantages have been fully offset.
That concludes my formal testimony, Mr. Chairman. I would be pleased to
answer any questions the Committee may have.
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The CHAIRMAN. Thank you, Mr. Carswell.
Mr. Carswell, when Chairman Miller appeared, he was very frank,
as is his manner, and he said that membership really isn't essential
and it is rather unique in the United States in terms of central bank
functions.
He admitted this was the only country he could think of in which
we have membership as a key, as it has been here, to monetary policy.
So he said it would be appropriate for us to think more broadly.
Do you agree that the concept of membership is an idea no longer
as essential as it seemed to be in the past?
Mr. CARSWELL, I think in general, yes. But there are things that the
Federal Reserve does, or has the power to do, that are identified in the
statutes with its powers over member banks, such as regulation Q, for
instance.
If we start divorcing the issue of a declining membership from reserve requirements, we will have to look at other sections of the
statute.
So there is some sorting out to do. But in principle there isn't any
real reason to identify the central bank's primary function of monetary
policy with a membership system. But in our present regulatory system, the two are interwoven. H you are going to separate the two,
you have to look at other ones as well.
The CHAIRMAN. I presume you have had a chance to look at both
Chairman Reuss' proposal and Chairman Miller's proposal.
Chairman Reuss, as I understand it, made a proposal for a universal
reserve at a certain specific level for everybody, with $100 million
exemption, and with the reserve requirement applied against time and
demand deposits.
The Federal Reserve proposal was for a $50 million exemption, but
with reserves applied apparently with a differential between time and
demand deposits.
Apparently they both would have about the same effect on the
Federal Reserve revenues.
Can you tell us which approach you prefer?
Mr. CARSWELL. I and our staff have looked at them both. We are
not satisfied that we have tlie final figures to be sure exactly what the
costs of the proposals are, and we really haven't had a chance to go
through all of the figures we have gotten so far. The Federal Reserve's
analysis of the two proposals has not been completed.
The CHAIRMAN. Are they roughly similar?
Mr. CARSWELL. They appear to be roughly similar in price. But it
depends on some subtleties which I don't think are clear yet.
The CHAIRMAN. They both would cost something more than the
present cost?
Mr. CARSWELL. Yes.
The CHAIRMAN. Therefore the implication of that is the banks would
gain from either of these proposals?
Mr. CARSWELL. They would gain, presumably.
The CHAIRMAN. They would gain as the Federal Reserve loses.
Mr. CARSWELL. That is correct. The cost to the Treasury would be
reduced by about half because of higher tax receipts.
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The CHAIRMAN. So this could not be considered any punitive action.
It would be a benefit to them, and wouldn't it seem in both cases it
would provide for a degree of equity among all banks of all sizes i
Mr. UARSWELL. Yes; we have advised Chairman Reuss that we are
in favor of pursuing his approach. I talked at length with Chairman
Miller about it, and there are elements of his proposal which we would
prefer to Chairman Reuss', because we think they would be more
equitable, and would better solve some of the problems. If you
applied a single reserve requirement to all time savings and demand
deposits, that will create problems of competitive inequities. We think
Chairman Miller's approach in -that respect would probably be better.
The CHAIRMAN. You_ heard Senator Brooke speak this morning
and yesterday Senator Lugar gave a similar view. I am concerned,
as l mdicated, that we may go the interest on reserves way, and there
may well be pressures from the banks and others to do this, I have
seen this happen in the past, this kind of thing.
The Federal Reserve proposal originally called for ·an artificial
2-percent rate, not the market rate. liut wouldn't such an artificial
arrangement designed at first to hold down the costs, wouldn't there
be great pressure to bring it up to the market rate, so that the market
rate would be paid on reserves eventually i
Couldn',t we expect under those circumstances ·a substantial loss i
I calculate about a $1.5 billion loss if you do it that way..
Mr. CARSWELL. As I said in my testimony, obviously we would
prefer a universal reserves approach. I am afraid if we go the payment of interest on reserves way, it will be reopened from time to
time as you suggest, because competitive forces will change, and
other differences will come into play.
There is no doubt that the Federal Reserve also will from time to
time run into situations where it would like to change the level of
reserve requirements. If it should increase reserve requirements, the
costs to the banks will rise, and that will lead to pressures on the
Federal Reserve to raise the interest rates, and so on.
I think in a fluid type of situation, that we can anticipate in the
.future, that as the Federal Reserve does its job of changing monetary
policy as necessary, there will be pressures to raise the subsidy provided by interest payments.
The CHAIRMAN. Let me ask for your judgment as an economist
on this: If we should adopt a policy of providing interest on reserves of several hundred million dollars,· who would benefit from
it in your judgment i Would it be the bank stockholders, or would
it be the people who use bank services, the customers, or would it be a
combination of the two, or is this not clear?
Mr. CARSWELL. I assume it would vary, depending on the bank and
what it did. There are banks that don't pay income taxes, for instance, because of tax loss carryforwards, and investments in municipal bonds ·and so on. For them you ·are going to get a different incidence of benefit from the payme;nt of interest than you would for a
bank which pays up to 50 percent of income in taxes.
. So I don't think you can be sure exactly what the benefits will be
m each class of bank. Obviously it will mean additional income to
the bank.
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What the bank does with the money depends on its management.
It may pay dividends, it may lower prices, it may refine services. I
suppose it depends on the competitive situation in the location.
I don't think you can generalize. Obviously some 0£ it would flow
through the bank stockholders in some situations.
The CHAIRMAN. I am not indicating it would be necessarily bad
£or the banks to increase their profits. I think bank profitability has
been too low. I think it would be desirable, certainly, to increase bank
capital. But I just would like to know i£ you have a judgment on
that.
The Federal Reserve bill would require that nonmember reserves
be held in Federal Reserve banks, member banks, or Federal home
loan banks. Presumably the member banks receiving the reserves
would already be correspondents 0£ the nonmembers. There are many
nonmembers that act as correspondent £or other nonmembers. Bo you
see any problem in having nonmember banks receive the reserves 0£
·
other nonmembers on the same passthrough basis as members?
Mr. CARSWELL. I don't know what technical problems 0£ identification that would raise. I suppose you would have to have an exemption
similar to the one that the Federal Reserve has in its bill now that says
that the member bank receiving a nonmember correspondent's· reserves must pass through the balances £or Federal Reserve Bank, but is
not required to hold reserves against the balances or include the
halances when computing its Federal deposit insurance assessment.
I assume vou would have to have a technical amendment to take
"are 0£ that situation. But it could be done that way.
The CHAIRMAN. Now the Federal Reserve has a surplus 0£ $1.1 billion. It is proposed to transfer about half 0£ this in the first 3 years 0£
this operation to alleviate the effect on the Treasury, or to cancel it.
I don't understand why they have to have a surplus.
Chairman Miller's response to that was i£ it is a bank you have to
liave a surplus. But it is not a bank, they have no liquidity problem,
no safety and soundness problem. Why shouldn't that be given to
the Treasury to reduce the deficit?
. Mr. CARSWE~. I read yesterday in the newspaper that you had asked
him that question, and had not received a comprehensive response.
Ro I looked into it as best I cou1d yesterday afternoon. I must say
tl1 at the history 0£ the surplus appe'ars to go back some way, and I
wasn't able to resolve the question 0£ why it shouldn't be transferred
to Treasurv.
The policv which the Fed has followed since at least 1960, appears
to be to maintain a surplus at the same level as the paid in capital
stock that it receives from member banks. That amount now is a little over $1 bilJion.
The CHAIRMAN. Now they propose to cut that in half by giving it
to the Treasury to make it easier to pay interest on reserves. Apparentlv that doesn't phase them. Shouldn't we wipe out the whole thing,
whether they pay interest on reserves or not?
Mr. CARSWELL. I wish I were clearer as to what the original reason
was £or that surplus. I don't think it has any particular effect on the
U.S. Cn>vernment, in the sense that it is circular. The Fed, I assume,
simply invests that surplus in U.S. Government securities. H the
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money were transferred to the Treasury, it would simply reduce the
debt and we wouldn't sell those securities. So in that sense it is circular.
There are a number of budgetary and accounting questions in this.
I assume the Fed holds the surpius because it has some reason to
think that there may be contingencies that it might face one day, where
it would have to reach into that surplus, such as foreign currency
swaps that went wrong, or whatever, but I just don't know.
The CHAIRMAN. Nobody can seem to come up with any reason why
they should have it.
Mr. CARSWELL. It has not been used, as far as we can tell, since the
early 1960's. But again it is not a matter of great moment in the sense
that it is circular. It is not lowering the revenue of the U.S. Government as such, because, as I say, the amounts involved are still invested
to the benefit of the Treasury.
The CHAIRMAN. Senator Sarbanes.
Senator SARBANES. Thank you, Mr. Chairman. Mr. Carswell, I guess
the underlying problem we are trying to get at is a sufficient number
of banks should remain within the order or influence of the Federal
Reserve so it can carry on monetary policy. Isn't that the basic
problem?
Mr. CARSWELL. Yes, sir.
Senator SARBANES. Now, isn't that problem analytically separate
from the question of payments to the bank to be members of the
System?
Mr. CARSWELL. Yes; I think it is analytically separate. As I said to
the chairman, it has unfortunately become tied to the membership
question. We have linked membership wtih other aspects of our banking system such as regulatory matters. But the problems of a central
bank with respect to reserves and monetary policy are clearly separable analytically from membership. To deal specifically with the monetary policy issue would require moving to a system of universal reserve requirements whether or not an institution is a member.
Senator SARBANES. Until you do that, you haven't really solved the
problem?
Mr. CARSWELL. I think that is correct. The ultimate solution to the
problem is to do that. That is why we prefer that approach.
Senator SARBANES. Is there any central bank in any other developed
country that permits its banks to take themselves out from under the
influence of the monetary policy set by the central bank?
Mr. CARSWELL. I have been told by the Fed staff that the answer to
that is no, there are none. e have not done an independent survey of
central bank requirements.
Senator ~ARBANES. If you start figuring out ways to, in effect, pay
them for bemg members, in order to keep them under the system, then
first of all you have no guarantee that that will keep enough of them
in to make the monetary policy work. I mean that is the problem you
are concerned about now?
Mr. CARSWELL. I think that is right.
Senator SARBANES. Is the Treasury more concerned about that problem, or the loss of revenue'?
Mr. CARSWELL. I don't know that I can rank them. I think the
Treasury has two concerns. One is that we have a central bank in this
country that is strong enough to conduct adequate monetary policy
in the country. Our second concern is revenue loss. The potential
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revenue loss in:volved in solving the membership problem may, as the
c:b.airman pointed out, be significant.
It does raise questions, I suppose, as to whether that has been considered in a discrete wa;y by the Congress. I don't know that there is
any necessary inequity mvolved in our efforts to minimize the payments to the· banks because as the chairman points out, banking is a
separate and unique kind of industry. The fact that banks are allowed to use other people's money has meant that they have always
been regulated by the Government. Therefore, the fact that banks
should have to pay for that privilege by maintaining reserves at the
Federal Reserve isn't necessarily eqmtable.
Senator SARBANES. For a properly functioning monetary system
with a central bank that can have an overall developed monetary
policy, that is the central framework for an individual bank really to
be able to operate. It would seem to me there is a strong rationale for
requiring the individual bank to be under the orbit of the central bank.
Otherwise you are not going to have a functioning monetary system.
Mr. CARSWELL. I agree.
Senator SARBANES. Is the run on membership and the number escaping the system now severe enough that you think the impact on
monetary policy has been weakened in a significant way?
Mr. CARSWELL. I think, to be candid, it hasn't happened yet. I
think one can overstate this problem in the sense that monetary policy
today is conducted primarily through open market operations, and
that is not analytically linked to membership.
On the other hand, there are problems with a monetary system that
isn't really aible to use reserve requirements as a tool of monetary policy, because it exacerbates the membership problem. What we have
done, really, is to deprive the central bank of an array of tools it probably should be using or considering using in some instances, but whfoh
are not now avaHable. On the other hand, we are getting by ce1tainly
with a monetary policy that is adequate.
But at some point, when the members leave in sufficient numbers,
you will really have deprived the central bank of, I think, the kind of
influence it ought to have in a properly functioning system.
Senator SARBANES. Thank you.
The CHAIRMAN. On that last point, I think Mr. Carswell made it
clear that his pre-ferred solution was universal reserve requirements.
In that event, you don't have to worry about the mem'bership problem
as far as monetary policy is concerned. If you impose universal re.serve
requirements across the board, that is. You have a completely effective
monetary policy as far as that particular instrument is concerned,
right?
·
Mr. CARSWELL. Yes.
The CHAmMAN. Thank you very much, Mr. Carswell. We appreciate
very much your testimony.
Next we have a panel of three witnesses: John G. Heimann, Comptroller of the Currency; Carol S. Greenwald, commissioner of
banks in Massachusetts; and Richard S. Ravenscroft, president of the
Philadelphia National Corp.
Mr. Heimann, we are honored and happy to have you here. We hope
you can confine your oral testimony to l O minutes or so. We will ask
the other witnesses to do likewise, so we have as much time as possible
for questions.
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STATEMENT OF lOHN G. HEIMANN, COMPTROLLER OF THE
CURRENCY
Mr. lIEIMANN. Thank you very much, Mr. Chairman. I have submitted t.estimony for the record, and this will be a brief summation.
I am honored to be here and pleased to be sharing the ta;ble with the
commissioner from ·Massaoh.usetts.
I welcome this opportunity to present the views of our office on
attrition of banks from the Federal Reserve System and proposals to
deal with that problem.
The recent upsurge in conversions of natio:q.al banks to State nonmembers reflects the financial burden and increasing unfairness built
into the present system of Federal Reserve membership.
In timM of low interest rates and high profits, institutions can ignore
this burden. In today's inflationary and highly competitive environment, many institutions cannot. If not corrected, the current trend may
have serious implications for our financial system and the governmental framework designed to insure its stability.
Accordingly, we view the proposals offered by the Federal Reserve
Board, S. 3304, and other similar proposals offered in the House of
Representatives, to be timely and constructive. In fashioning a solution to the attrition problem, we should seek to modify the existing
framework in a manner that will facilitate greater reliance on the
market, and less reliance on governmental decisions or restrictions.
In my judgment the broad outlines of the framework in which we
should work include reserve requirements which fall equally upon
comparable liabilities for all deposit-taking institutions, the receipt of
a rate of return appropriate under the circumstances on these reserve
balances, explicit pricing of Fedeml Reserve and correspondent services, open access to these services for all institutions which maintain
reserves, and payment of interest on demand balances.
At least three approaches to restructuring the reserve requirements
have been proposed. These include the imposition of at least some reserve requirements on nonmember institutions, the payments of interest
on required reserves or permitting member banks to hold reserves as
interest-bearing instruments, and the lowering of reserve requirements.
Any one or a combination of these might solve the problem of membership attrition.
In assessing various proposals, it seems to me certain considerations
should govern our action. We ought to seek a solution which most
likely will, (1) achieve substantial equity among competitors of comparable size and character, whether they be State or nationally chartered, members or nonmembers, thrifts, credit unions or commercial
banks.
(2) Maximize the efficiency and effectiveness of our control of monetary policy in the long run.
(3) Minimize the cost to the Treasury and hence most importantly
to the taxpayer.
( 4) Restore the balance between the State and national banking
system.
( 5) Minimize the difficulty of administering the system in a manner
to maintain equilibrium. And finally, (6) be most consistent with
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long-run change.a which will insure a more efficient financi,al system
which places maximum reliance on pricing and on competition, rather
than on governmental intervention.
We believe that the imposition of reserve requirements on member
and nonmember institutions represents the strategy for deterring withdrawal from system membership most nearly consis~nt with the.se six
principles, and this approach should be adopted by the Congre$.
Some have expressed the concern that this strategy would undermine
the viability of the dual banking system. In response, ·and lest anyone
think this judgment reflects a parochial point of view as the supervisor
of the national banking system, I would like to quo«j, from my own
testimony before another congressional committee in 1976.
There are those who fear that a system of mandatory reserves established. by
the Federal Reserve would be the death knell of the dual banking system. I reject
that notion. Moreover, from a public policy view, there is no advantage to a State
system which survives because it offers the regulated. institutions a bargain in reserve requirements.
As State regulators--
I might point out, Senator, that at the time I was a State supervisor
making this statementwe should be ready to compete with the Federal bank regulatory system by
offering high quality examination and supervision, speedy and even-handed handling of ,branch merger, chartering and acquisition applications, and a progressive
statutory and regulatory framework within which banking organizations can
compete.
My position today as Comptroller of the Currency is consistent with
my position as a State supervisor of banks. I am, of course, prepared
to address the issues raised by each of these proposals now before the
Congress, and have done so in our prepared testimony.
However, I would like to note a few specific points at this time.
First of all, it should be noted as a matter of fairness, reserve req_uirements should be imposed equally upon all depositing institutions which compete with one another. The case is especially strong
with respect to transaction accounts. However, although we support
the extension of reserve requirements to all institutions, we do not believe that the actions to address the attrition problem should necessarily
await the imposition of federally mandated reserve requirements
upon institutions other than commercial banks, which have heretofore
not been subject to such reserve requirements.
Second, we believe that the Federal Reserve System should move as
quickly as possible to provide its services, and we favor open access to
Federal Reserve services for all nonmembers, at nondiscriminatory
prices.
Third, the payment of market rates of interest on required reserves
should be linked to both the :r>hasing-in of Federal Reserve pricing
and the elimination of the prohibition of the payment of interest on
interbank demand balances.
Finally, we support legislation which expands the authority of the
Federal Reserve Board to require information to assist in the conduct
of monetary policy.
Thank you.
[The complete statement of Mr. Heimann follows:]
33-587 0 - 78 -14
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STATEMENT OF JOHN
G,
HEIMANN, COMPTBOLLEB OF THE CUB.BENOY
Mr. Chairman and members of the Committee: I welcome the opportunity to
present the views of our Office on attrition of banks from the Federal Reserve
System and proposals to deal with that problem. The recent upsurge in conversions of national banks to state nonmembers reflects the financial burden and
increasing unfairness built into Federal Reserve System membership. In times
of low interest rates and high profits, institutions can ignore this burden. In
today's inflationary and highly competitive environment, many institutions
cannot. If not corrected, the current trend may have serious implications for our
financial system and the governmental framework designed to assure its stability.
Accordingly, we view the proposals offered by the Federal Reserve Board, S. 3804,
and other similar proposals offered in the House of Representatives, to be timely
and constructive.
ATTRITION FBOM THE FEDERAL BESERVB SYSTEM A.ND THE NATIONAL BANKING SYSTEM
The Federal Reserve System has experienced a gradual decline in membership since World War II. In recent years, that trel).d has accelerated. The percentage of total deposits of commercial banks held by Federal Reserve member!!
has decreased from approximately 80 percent in 1970 to approximately 73 percent at present. During this period, there has been a net loss of 327 members
through conversion. Since the beginning of 1977, 108 banks have withdrawn, including 39 during the first half of this year. More disturbing than the numbers
themselves is the increased willingness of larger institutions to leave the System.
IDstorically, banks withdrawing from the System have almost always held
fewer than $50 million in deposits. In 1977, 15·of 69 converting banks held deposits amounting to more than $100 million.
During the 1960's only once did the national banking system experience withdrawal of more than 20 banks in a year. Since 1970, only once has this figure
dipped below 20. In 1977, 44 national banks withdrew and 24 have withdrawn
so far this year. Withdrawing national •banks have accounted for more than 50
percent of the total deposits lost by the Federal Reserve System in five of the
last eight years.
There is some evidence that these figures would be significantly larger but
for the willingness of a number of banks to await the results of these current
efforts to address the root cause of attrition from the System.
THE CAUSE OF MEMBERSHIP A'ITRITION
The conversion of banks from national to state charters and vice versa is not
new. The phenomenon is characteristic of our dual banking system. The reasons
for individual conversions have been as varied as the corporate strategies· one
would expect in a diverse banking system. Although objection can be raised to
the motivation to convert in a given case, on balance, the !possibility of conversion
has been a source of the system's vitality and has provided pressure for progressive reform.
The Comptrollership of James Saxon is illustrative. His liberal attitudes toward entry, branching and the powers of national banks greatly enhanced the
attractiveness of a national bank charter. While many state banks were placed
at somewhat of a disadvantage, the imbalance between the two systems was
soon corrected. As a result of action on the national level, many state11 revised
their laws and policies. Although Mr. Saxon's tenure was replaced by a more
cautious period in the Comptroller's Office, most observers believe that the balance which was struck was a _significantly more dynamic and innovative system.
A different factor has created the current disequilibrium. Its cause is not
obscure. No one seriously challenges the proposition that the current increase
in System withdrawals flows primarily from the fact that the cost of maintaining sterile reserves outweighs the benefits of membership for the vast majority
of institutions. As a result, there is a profound bottom line incentive for banks
with certain characteristics to leave the Federal Reserve System.
As I have suggested, the impact of the disparity of cost and benefits is amplified by our inflationary economy, as well as by increased competition from
nonmember banks and other deposit-taking institutions. This is demonstrated
dramatically in the New England states, where introduction of NOW accounts
and broadening thrift powers have greatly increased competition. As a result,
the share of deposits held by member banks in New England has fallen from
73 percent at the end of 1974 to less than 62 percent at the end of 1977.
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THE IMPACT OF A FAILURE TO ADDRESS THE PROBLEM
Failure to redress the inequitable burden of System membership in some
fashion will; in all likelihood, lead to further acceleration in the rate of withdrawals from membership. Included among these may be a significant number
of relatively large, complex institutions.
While I would not speculate ·at what level of withdrawal we would begin to
see serious consequenceR, I do fear that the increased rate of withdrawal from
membership which is likely will erode the role of the Federal Reserve as central
bank and eventually result in serious adverse consequences for the national banking system. The reasons for this concern are several.
UNFAIRNESS TO MEMBER BANKS
In my judgment, the most persuasive argument for reform is the subl!ltantial
inequity built into the existing structure of reserve requirements, exacerbated
by periods of inflation and high interest rates. For either a national bank or a
state member bank which does not obtain benefits (in the form of Federal Reserve services or profits from a correspondent banking relationship) adequate to
compensate it fairly for maintaining reserve balances, the difference between
the benefits actually received and a fair return on services constitutes a tax upon
the institution. The Federal Reserve System has estimated the aggregate burden
of membership to be on the order of $650 million, a tax that is borne ultimately
by customers and/or shareholders of member banks. There is a significant competitive disadvantage when nonmember banks operate free of this tax.
The inequity is compounded by the fact that the burden may not fall evenly,
even among member banks. According to Federal Reserve Board staff, the relative burden of membership is greatest for small banks. That burden is estimated
to exceed 20 percent of profit for banks with less than $10 million in deposits.
Thus, those institutions that make the least use of Federal Reserve services
must bear the tax most heavily.
IMPACT ON THE NATIONAL BANKING SYSTEM
Congress, for more than a century, has continued to support a dual federaVstate
system of commercial banking. The vitality, competitiveness and innovativeness of
our banking system bear witness to the wi.~dom of this approach. An important
principle underlying this policy has been that, over time, a 1"9ugh competitive
balance should be maintained between the two systems. This balance, or equilibrium, is necessary to maintain the viability of state banking systems and it
is e~sential to insure the appropriate role of federal policy in the banking system.
Congress has recognized that a viable system of federal chartering is a key to
the government's authority over a major portion of the banking system. This
authority has been important from the perspective of statutory limitations and
incentives to promote a sound, competitive and progressive banking structure.
With this perspective, it is particularly ironic that institutions with certain
characteristics are now being given a significant incentive to convert from a national charter to state charter by the federal government itself. To the degree
that significant numbers of banks leave the national system for state nonmember
status, the impact of federal law and policy on the banking system is necesi:=arily
diminished. In short, the inequitable impact of reserve requirements is serving to
undermine the purposes of the National Bank Act and to le~sen the role of Congressionally defined standards of conduct, prudence and diversification in the
nation's financial system.
In addition to lessening the impact of the National Bank Act and other legislation applicable to national hanks and other member institutions generally:, the
incremental effect of inequitable reserve requirements seems most likely to
discourage small institutions from seeking or retaining national charters. Although Rome have argued that the Comptroller of the Currency should be the regulator of large hanks, leaving the smaller institutions to the states, I would find
that result singularly unfortunate. My experience as Superintendent of Banks in
New York State underscored for me the importance of a supervisor having jurisdiction over a balanced range of different types and sizes of institutions. This is
necessary to maintain an appropriate understanding of the banking system and
may. from time to time. be instruments of federal policy, it is important that institutions of all sizes have a place in the system.
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l'OTENTIAL IMPACT ON SUPERVISION AND REGULATION
While conversions from the national banking system to date have not seriously
interfered with our ability to supervise and regulate banks, or threatened the
soundness of any individual bank, I believe that if this trend continues and accelerates, it will have an adverse impact on our supervisory capacity. The sources
of this concern are several.
The first arises out of problems associated with the transition which occurs as a
bank converts from primary supervision by the Comptroller's Office to primary
supervision by a state authority. The supervision of a large financial institution
is a complex task. Critical to performing that task effectively is the thorough
knowledge of the bank's personnel, policies and history. The new examination procedures recently adopted by the Comptroller of the Currency emphasize these
factors.
To the degree that this understanding of the institution is an important
aspect of supervision and regulation, the efficiency and efrectivenss of supervision
are damaged when a bank changes from one system to another. We view this
slippage as a price paid for the maintenance of a vital dual system, and needless
to say, we make every effort to minimize it through effective communication and
coordination among regulators.
Thus far, no major supervisory lapses have come to my attention as a result
of such a conversion. Nevertheless, the shift does place a strain on the supervisory
framework and consumes extra resources. Were the level of conversions to increase substantially and were those conversions to include a substantial number
of large institutions, it would surely have a significant impact on the efficiency
and effectiveness of our supervisory and regulatory efforts.
Second, to the degree that shifts occur from national to state charters, a commercial bank is leaving a framework of regulation which, in the aftermath of the
failures of U.S. National Bank and Franklin National Bank, has made enormous
strides in modernizing its approaches and policies to deal with large, complex
financial institutions. The process continues as we move in the coming months to
establish a multinational division which will focus specifically on the problem of
large national banks. Here again, significantly increased attrition, especially
among large banks, appears likely to lead, at least in the short-run, to a loss of
efficiency and effectiveness in supervision and regulation.
l:MPACT ON :MONETARY POLICY
The principal concern of the Federal Reserve Board has been the impact of
continued membership attrition on its ability to conduct monetary policy. Ohairman Miller has stated that "(a) s fewer and fewer banks, and a smaller share of
the nation's deposits, remain with the Federal Reserve System, the ability of the
System to influence the nation's money and credit becomes weaker." Three factors were cited by Chairman Miller in this regard, including the arguments : that
availability of the discount window as a "safety valve," allowing individual banks
to make adjustments during periods of restrictive action l!y the l'ederal Reserve,
provides needed flexibility which is diminished by attrition ; that attrition
within the System weakens the link between bank reserves and the monetary aggregates, thereby blunting the precision w_ith which monetary policy can be
exercised i and that while reserve requirements historically have not been an
membership consideration, especially during a period in which the efficacy of open
effective tool of monetary policy it could be used as an effective tool but for the
market operations is diminished.
Historically, critics of the Federal Reserve's position have countered the Federal Reserve System's proposals for solution of the membership problem with the
argument that neither reserve requirements nor membel'!Ship is necessary for the
effective conduct of monetary policy. They contend that open market operations
are the principal tool of monetary policy, and the Federal Reserve Board does
not need to maintain direct control over reserves, but only be assured of adequate
data.
The debate over the years indicates that reasonable people are divided on the
need for reserve requirements as a tool of monetary policy and the need for membership at all. It seems to me, however, that Chairman Miller placed his case in
the proper perspective by arguing, not that attrition necessarily destroys the
effectiveness of monetary policy, but that, as a practical matter, the current trend
may have the negative impact of reducing the System's flexibility and precision.
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Whether or not those who argue on the theoretical basis are ultimately correct,
I believe that the l'ederal Reserve's pragmatic concerns should be given great
deference.
In addition to the concerns I have outlined, two other factors seem relevant.
Apart from debates as to the optimal structure from the point of view of monetary
policy, the very state of flux resulting from continued and accelerating attrition
may well complicate the conduct of monetary policy, since ongoing adjustments
in tools of analysis and policy must be made to take into account the changing
system. Moreover, there can be little doubt that concern with the membership
problem is distracting and occupies valuable resources.
PROPOSED SOLUTIONS
The immediate task before us is to devise a strategy for restructuring reserve
requirements which will correct the disequilibrium resulting from the inequitable
burden of these requirements on some member institutions, thereby avoiding the
consequences of continued and accelerated attrition from Federal Reserve membership. Addressing this task, we should keep foremost in mind a long-run objective: the evolution of a financial system which is as efficient and flexible as
possible.
I am convinced that the most desirable financial system is one which relies to
the maximum degree possible on the market mechanism as the allocator of
resources. Of course, this is not our present system. The maintenance of sterile
reserves ; the prohibition of the payment of interest on demand deposits and
other interest rate restrictions; the absence of explicit pricing of Federal Reserve and correspondent services; and limitations on which institutions can use
these services; and limitations on which institutions can use these services represent interference with the market mechanism. As such, they are not necessarily
bad; at times, governmental intervention in the marketplace is appropriate. At the
same time, departures from a market system should be carefully examined and reexamined to see that they are warranted, that they do not lead to unintended
consequences, and that they have not outlived their usefulness. The existing disequilibrium, in my judgment, arises out of a framework of governmental action
and restrictions which has grown increasingly inappropriate.
Accordingly, in fashioning a short-run solution to the attrition problem, we
should seek to modify the existing framework in a manner that will facilitate
greater reliance on the market and less reliance on governmental decisions or restrictions. In my judgment, broad outlines 01' the framework which we should
work toward include: reserve requirements which fall equally upon comparable
liabilities for all deposit-taking institutions. In my judgment, broad outlines of
the framework which we should work toward include reserve requirements
which fall equally upon comparable liabilities for all deposit-taking institutions;
the receipt of a rate of return appropriate under the circumstances on these
reserve balances ; explicit pricing of Federal Reserve and correspondent services;
explicit pricing ·of Federal Reserve and correspondent services; open access to
the.se services for all institutions which maintain reserves; and payment of
interest on demand balances.
These changes cannot be implemented immediately or simultaneously. Even if
it were possible to do so, it might not be desirable, since immediate imposition of
such a revision would probably cause significant dislocations. Rather, a more
measured approach is appropriate. At the same time, in the context of action
to avoid the consequences of continued and accelerated attrition from the System, it is possible to take affirmative steps to move in the direction we have
outlined.
At least three approaches to restructuring of reserve requirements have been
proposed. These include: imposition of at least some reserve requirements on
nonmember institutions ; the payment of interest on required reserves or permitting member banks to hold reserves in interest-bearing instruments ; and the
lowering of reserve requirements. Any one or a combination of th"lse might solve
the problem of membership attrition.
In assessing various proposals, it seems to me that certain considerations
should govern our actions. We ought 1x> seek a solution which will be most likely
to:
Achieve substantial equity among competitors of comparable size and
characteristics, whether they be state or nationally chartered, members or
nonmembers, or thrifts or commercial banks ;
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Maximize the efficiency and effectiveness of our control of monetary policy
in the long-run ;
Minimize the cost to the Treasury and hence the taxpayer ;
Restore the balance between the state and national banking systems;
Minimize the difficulty of administering the system in a manner to maintain equilibrium; and finally,
Be most consistent with long-run changes which will insure a more efficient financial system which places maximum reliance on pricing and competition rather than governmental intervention.
,
We believe that the imposition of reserve requirements on member and nonmember institutions represents the strategy for stemming withdrawal from
System membership most nearly consistent with these principles and that this
approach should be adopted by this Congress.
Extension of reserve requirements to nonmembers is the preferred solution
for several reasons. First of all, the success of various proposals which have
focused upon the payment of interest on reserves to stem attrition would be
dependent on correct targeting of the benefits conferred. This would be difficult
to administer and might require constant adjustments in order to achieve the
desired effect. Second, precisely because targeting is required to stem attrition
at a minimum cost, the payment of interest on reserves would almost certainly
by itself fail to address the question of equity among comparable institutions.
Third, universal reserve requirements could involve the least cost to Treasury
and hence the taxpayers. Fourth, the imposition of some form of universal reserve requirements represents a step toward more effective control and flexibility over monetary policy-a step which might allow the Federal Reserve System to set reserve requirements at a relatively low level.
We have not attempted to address the specifics of various proposals in great
detail. I am, of course, prepared to address the issues raised by each of the proposals now before the Congress. A few specific points should be noted.
As a matter of logic and fairness, reserve requirements should be imposed
equally upon aZZ deposit-taking institutions which compete with one another.
The case is especially strong with respect to transactions account from the point
of view of both monetary policy and equity. Since other deposit-taking institutions are increasingly in direct competition with commercial banks to provide
this facility, it seems only fair that the burden of the tax-imposed by reserve requirements be shared by these institutions on an equitable basis. And, as other
deposit-taking institutions increasingly provide transactions accounts, these balances may become important in the exercise of monetary policy. S. 3304 recognizes these points.
However, although we support the extension of reserve requirements to all institutions, we do not believe that action to address the attrition problem should
necessarily await the imposition of federally-mandated reserve requirements upon
institutions other than commercial banks, which have heretofore not been subject
to such reserve requirements. It is possible, for example, to conceive of several
approaches which would involve a phasing-in of reserve requirements as other
deposit-taking institutions come into more direct competition with commercial
banks. One might, for example, key the imposition of reserve requirements to a
rather high level of transactions accounts.
Second. we believe that the Federal Reserve System should move as quickly
as possible to price its services, and we favor open access to Federal Reserve
services for all nonmembers at nondiscriminatory prices. Although not opposed
to legislation requiring pricing, we believe such legislation may not be necessary given the stated commitment of the Federal Reserve System to move to a
system of explicit pricing. In any event, legislation requiring the Federal Reserve System to price its services should allow for the orderly introduC'tion of
such a system-recognizing the task of pricing services heretofore without
charge will be difficult and that the transition period will n~sarily require a
complex series of adjustments on the part of many affected institutions and the
financial markets.
Third, the payment of market rates of interest on required reserves should be
linked to both the phasing-in of Federal Reserve System pricing and to elimination of the prohibition of the payment of interest on interbank demand balances.
The linkage between Federal Reserve services and the earning of interest on
reserves, of course, arises because free services now provide a substitute for
interest on these reserve balances. Thus, to the degree that banks are compensated for reserves, the services should no longer be provided without charge.
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Similarly, correspondent banks now provide free services as compensation for
balances. In order to maintain the viability of the correspondent system and to
provide yardstick competition for the Federal Reserve System, correspondents
should be allowed to pay interest on demand balances which are maintained with
them.
Finally, we support legislation which expands the authority of the Federal Reserve Board to require information to assist it in the conduct of monetary policy.
This provision is supported by scholars and practitioners of monetary policy,
and deserves enactment.
In conclusion, I would reiterate two points. Attrition from the Federal Reserve System is a problem which deserves a solution now before it causes serious
consequences and not after. In devising an immediate solution, we should seek
measures which facilitate and encourage ·evolution of the banking system in a
manner that involves greater reliance on the market mechanism and less. reliance on government prescription. We look forward to working with the Committee and its staff in this effort.
Senator RIEGLE. [presiding]. Thank you, Mr. Heimann. We are delighted to have you here, it is a pleasure seeing you again.
Ms. Greenwald, do you want to proceed next? It is a pleasure to
have you back here.
STATEMENT OF CAROL S. GREENWALD, COMMISSIONER OF BANKS,
COMMONWEALTH OF MASSACHUSETTS
Ms. GREENWALD. I welcome this opportunity to review and comment
on the appropriate role 0£ the Federal Reserve System. It is quite
clear the U.S. economy needs a central bank which can devote its attention to monetary policy and to preventing a liquidity crisis.
Although I have heard several comments this morning that tie
membership in the Fed.eral Reserve with the ability 0£ the Fed to conduct monetary policy, as an economist I believe that is not true.
However, I support legislation to allow the Fed to set universal
reserve requirements in the context 0£ universal non-membership in
the Federal Reserve System, because I do believe worrying about
membership has kept the Fed from spending all 0£ its time which it
desperately needs to devote to monetary policy. In that sense it diverts the attention 0£ the Board from important problems. Does membership at all impact on monetary policy? Let me explain what I mean
by universal reserve requirements in a system 0£ universal non-membership. I have no problem as a State regulator with having the Fed
set reserve requirements £or banks. In fact, right now the State Reserve requirements are approximately at the same level as the Federal
Reserve requirements on transaction accounts.
It is the composition 0£ those reserves that differs, but not the level.
:So there is no problem with that. We should have the Fed setting reserve requirements, but give up its authority in the area 0£ supervision.
The present State-chartered member banks would then be regulated
by FDIC. The Fed can set reserves in line with what it sees as the
needs 0£ monetary policy, and we would have access to the discount
window £or all depository financial institutions, access to the Fed's
services at £ull cost by all depository institutions, and the Fed setting
·
the required reserves.
I£ instead there has to be some compromise made with the dual banking system and we have to leave the Fed setting reserve requirements
only £or £ederally chartered institutions, then we are le£t with disadvantage 0£ having to pay interest on required reserves. It is a very
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costly solution, and you would have attrition of Fed membership because of the cost of belonging to the system, unless the Fed pays interest on reserves held at the Fed. I agree wth the Chairman that
eventually we will be paying interest at market rates, that will be the
only way to keep the members.
If the States allow reserves to be held in Treasury bills and market
bearing Government securities, to keep it competitive, you would have
to pay market rates of interest. That is a very big tax cut to give
the largest banks in this country.
I find it very difficult to think the Congress deliberated and came
up with the conclusion that the group most in need of a tax cut at this
time is the large banks.
My major I,>roblem with the Fed's proposal as opposed to my alternative for umversal nonmembership is that their proposal is really a
plan not only for universal reserve requirements, but for universal
membership. The way they have it set up, they will equalize the burden
among all financial institutions, but they won't quite equalize all of the
benefits. You must remember only members are going to have access to
the discount window. Everybody has the same burdens, but only members have access to the discount window. So obviously it is only sensible to end up being a member.
Although the Fed has said that universal reserve setting authority
has no regulatory aspects, that is not quite true, because 1t logically
leads to the universal membership.
I have testified on other occasions before this committee in favor
of the Federal Bank Commission, and I still believe you want to
separate bank supervision and the central bank authority. What we
would have now if we go along with the Fed's proposal is we will
have made the Federal Reserve the heir apparent to the Federal Bank
Commission, because it will be the only Federal regulatory authority
which will have regulatory control over all kinds of financial institutions.
And while I think it is right to centralize supervision, I think we
shold 'debate at this ;point whether we really want to merge the Federal
Bank Commission mto the Federal Reserve System.
It seems to me regardless of what we do with reserves, we really
want to answer the question of access to the discount window. It would
be absurd to say that the central bank is only willing to come to the
aid of a bank in terms of a liquidity crisis if it is a member of the Federal Reserve. We have managed to debase our central bank to the level
of a private club or trade association. That is certainly absurd. If you
want to make sure that banks only use the discount window when they
have liquidity problems, you could tie the discount rate at a quarter
of a point above the Federal funds or Treasury bill rate. Proposals to
make the discount rate a penalty rate have been around for a long time.
It could be enacted as part of the proposal for opening up access to
the discount window to all banks.
As I have said previously, paying interest on reserves is no longer
needed when you go to the universal reserve requirement, and since
going to the universal reserve requirement has the advantage of not
costing the Treasury and the U.S. taxpayers any money, plus it has
the advantage of ending the Federal Reserve wasting its time thinking about members, I would endorse and highly recommend that the
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Congress move toward the Federal Reserve having the authority to
set universal reserves in the context of universal nonmembership, so
that the Fed can be reoriented to being the central bank.
Finally, just to comment on Chairman Reuss' plan, I think it is an
excellent plan. It has only, I think, three minor disadvantages. One is
you still have the membership problem for banks with under $100
million in reserve liabilities and it won't solve access to the discount
window for those banks who are outside of the Fed, and you could
have a liquidity problem and a crisis created when some of those banks
needed funds.
Also the Chairman's proposal does not include NOW accounts, and
when we go to national NOW accounts, we would have to change his
definition of transaction account to include those thrift institutions
that would have the NOW accounts.
Finally, we are left with a situation of a central bank with members
and the central bank still worrying about its political position and its
constituency.
So I think the preferred way to go is universal reserve requirements and take them out of the supervision business entirely.
Thank you.
[The complete statement of Carol S. Greenwald; Commissioner of
Banks, follows:]
STATEMENT OF CAROL S. GBEENWALD, MASSACHUSETTS Co.M.MISSIONER OF BANKS
I welcome this opportunity to review and comment on the appropriate role of the
Federal Reserve System. The U.S. economy needs a central bank which can devote
its attention to monetary policy and to preventing liquidity crises. This can best
be accomplished if the Federal Reserve had no occasion to waste its time worrying
about a membership problem. The.obviou.s solution is to abolish membership, to
give every bank access to the discount window and to Federal Reserve services
at full cost and to allow the Fed to set required. reserves.
The Fed's plan for universal reserve requirements ts really a plan for universal
membership. To separate bureaucratic ambition from allegedly needed monetary
policy controls, the Fed should be given broader reserve setting authority, but
should give up the concept of membership and withdraw from the bank supervision area. This is a proposal for universal non-membership in a purified central
bank. Present state-chartered members would be regulated by the FDIC. The Fed
could set reserves in line with needed monetary policy goals. To do this, it does not
need to be the examining agency. With universal reserve setting authority, the
concept of membership lJecomes obsolete. '.rhe other side of the universal reserve
setting authority should be universal non-membership.
Whether the Fed sets the level of required. reserves for all depository institutions with transaction accounts or just for federally-chartered institutions does
not appear to be crucial for monetary policy. The symmetry of the dual banking
system would be preserved if the Fed set required reserve levels just for federallychartered institutions. Doing this in combination with legal authority to collect
asset and liability data from state-chartered institutions would amply meet
monetary policy needs. Required reserve levels are alJout the same whether set by
the Federal Reserve or the states, since they are set by what is considered
prudent liquidity requirements. The main difference is in the composition of the
reserves, not in the levels. The proposals to allow the l!'ed to pay interest on
reserves would remove an important element of difference.
The disadvantages of not having the Federal Re.serve set universal reserve
requirements are two:
First, federal reserve req¢.rements could be higher than some state requirements leaving a minor competitive disadvantage to federally-chartered institutions. But this is no way would be anything like the present disadvantage suffered
by members versus non-members. In fact, the relative burdens are likely to be very
much the same if federally-chartered institutions are paid the Treasury bill rate
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on reserves. Second, if the Fed in fact did decide at some point in the future to
revive changing reserve requirements as a monetary tool, the effectiveness of this
tool would be diluted somewhat by its limitation to federally-chartered institutions. The diluting effect would not be great, however, and, in fact, this is almost
a purely theoretical consideration since the Fed has used changing reserve requirements as a monetary tool so rarely. It has not been used because it is considered
a sledgehammer approach; and there are much more flexible instruments available, i.e., open market operations. Open market operations have been the operating
tool of monetary policy and its effectiveness is not affected by whether state law or
the Federal Reserve has set a given level of reserve requirements.
The major disadvantage of the Fed plan is that it is really a plan for universal
membership. Its proposal would allow it to set reserves for all institutions, pay the
same rate of interest on those reserves, and to offer all services but the discount
window to all banks at the same rate. Since the burdens are the same for membeni and non-members, but only members get access to the discount window, it
would only make sense in this setting to be a member. The Fed has said that universal reserve setting authority has no regulatory or supervisory aspect. That may
be true unless you look to see that it logically leads to universal membership.
And thus the Fed will be the logical heir apparent to become the Federal Bank
Commission, for only the Fed would then have federal regulatory responsibility
for all depository institutions.
We have previously testified that a unified federal bank supervisory agency is a
good idea. We argued, however, that this function should be separate from the
agency dealing with monetary policy. A plan for universal non-membership with
access to the discount window and Fed services for all depository institutions has
really the same long-run effects as the Fed's plan, only without the selfaggrandizement of the latter. Our proposal here for universal non-membership
would help create a pure central bank, i.e. one with responsibility for monetary
policy and a lender of last resort. These are the essential functions of a central
bank. The Fed's proposal for universal membership is one in which it would end
up as the superbanking agency, i.e. central bank and federal bank commission
combined. This degree of centralization may or may not be desirable, but it should
be debated now.
Regardless of who sets reserve requirements, the absurdity of access to the
discount window being limited to members must be dealt with. The Fed was
created as a result of a liquidity crisis to be a lender of last resort before anyone
ever tl:\ought of discretionary monetary policy. To limit the discount window to
members is to debase the central bank to the level of a trade association or private
club. We are proposing universal access to the discount window by all depository
institutions. To insure that the borrowing is used judiciously, I would tie the discount rate to a ¾ point above the federal funds rate or the Treasury bill rate.
Paying interest on reserves is not an essential feature of a universal non-membership system in which the central bank sets universal reserve requirements.
The Fed originally proposed paying interest on rese1-ves to solve a membership
problem, which is no longer a problem in a non-membership system. It would make
sense to let the Fed pay intereRt on reserves if the Fed only set reserve requirements for federally-chartered institutions because the states let state-chartered
banks hold reserves in government securities.
Paying interest on reserves is a tax cut for banks especially the largest and a
transfer to them of substantial proportion. To make more sense of this large tax
cut for banks, it should be shared with the public by lifting the prohibition of paying interest on demand deposits. Last year, this is just what the Fed proposedtying national NOW account availability to the Fed paying interest on reserves.
It was previously argued that not all the benefits of the tax cut would go to the
public even with NOW accounts, but some would have and now we have lost even
that much. I would find it hard to believe that the Congress has determined that
the largest banks are the elements in our society most in need of a tax cut.
I am tired of hearing about the Fed's membership "problem". You may be tired
of it too, as the American public and the medta are tired and confused by this obscure :tssue which, incredibly, is the number one priority of the distinguished new
chairman of the Federal Reserve System. The Fed's proposal. in its latest version,
is obscure to the public and laden with complex provisions only because it is designed principally to solve the membership problem. Cutting to the core of the
plan, I find merit in its basic reserve-setting component and would recommend
statutory changes to provide this authority to the Fed in the context of universal
non-membership and reorientation of the Fed's activities to focus on its essential
responsibilities as the central bank.
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ADDENDUM
The House Banking, Finance, and Urban Affairs Committee's recently proposed
plan to solve the ]'ed membership "problem" is clearly superior to the three alternatives previously presented. It is a very good plan.
I would only note three minor disavantages of this plan as compared to universal reserve setting on transaction account~ by the ]'ed in a system of universal
nonmembership:
1. It will not solve the membership problem for banks "ith under $100 million in
reserve liabilities which will continue to have an economic incentive for leaving
the system. The continued erosion of these banks could well precipitate a crisis if
access to the discount window continued to be limited to members.
2. When national NOW accounts are authorized, it will be necessary to change
the definition of reserve liabilities presently proposed to include all transaction
accounts at both commercial banks and thrifts.
3. The basic anomaly of having a central bank with members will remain and
the Fed still waste time worrying about its constituency and be heavily involved in regulatory matters rather than focusing attention more clearly on its
essential central bank responsibilities.
Senator RIEGLE. Thank you, Ms. Greenwald. Mr. Ravenscroft, we
know you come as an advocate of this approach, so we will be interested in hearing from you.
STATEMENT OF RICHARD S. RAVENSCROFT, PRESIDENT, ACCOMPANIED BY GEORGE D. NORTON, EXECUTIVE VICE PRESIDENT
AND CASHIER, PHILADELPHIA NATIONAL CORP.
Mr. RAVENSCROFT. Thank you, Mr. Chairman. I am Richard S.
Ravenscroft, president of the Philadelphia National Corp., a onebank holding company, whose principal subsidiary is the Philadelphia
National Bank.
Philadelphia National is the 28th largest U.S. commercial bank
based on deposits, with a full range of consumer and commercial banking business, including an extensive correspondent banking business
focused on clearing and payment services.
The corporation's other subsidiaries operate in the areas of mortgage banking, consumer and commercial finance, Government securities trading and investment advisory services and come within
the supervisory jurisdiction of the Federal Reserve System.
We want to thank you for the invitation to present our views here
today on S. 3304, the Federal Reserve Requirements Act of 1978.
We favor tlie legislation because it would improve, in our views, the
determination and execution of monetary policy, the soundness of
the banking system, and the efficiency of our national payments
system.
Further, it would end the abuse of the Federal Reserve's operating
services to fight the problem of membership attrition, which works to
the detriment of private competition and initiative.
We are a member of the Third Federal Reserve District. Within our
district we have seen 23 banks withdraw from the system from the end
o~ 1970 to the beginning of this year. More have left this year, and
still more appear on the brink of leaving, expecially in the present
climate of high inflation and interest rates. This experience parallels
the . nationwide trend reported by Chairman Miller in his recent
testimony.
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We are deeply concerned with the implications of this decline in the proportion of bank deposits subject to reserve requirements as it relates to the process of establishing and carrying out
monetary policy. This trend also restricts banks' access to the resources of the Nation's lender of last resort during periods of severe
economic stress. From our perspective of close da.y-to-day involvement with the Federal Reserve System, it is clear that the environment
in which we operate has changed considerably as the Federal Reserve's
membership problem has deepened and the Federal Reserve in turn
has used every ava.ilable mechanism in an unsuccessful effort to
respond.
The first and perhaps most controversial of the propose.ls in S. 3304
would require the establishment of reserve balances at the Federal
Reserve for all transaction accounts in depository institutions. By
defininp; transaction accounts to include such services as negotiable
order.of withdrawal or NOW accounts in thrift institutions and she.re
draft accounts in credit unions, this would extend reserve requirements not only to all but the smallest member and nonmember banks,
but also to certain deposits in other financial institutions.
There is strong logic to this provision. It would improve control
over monetary growth by brin¢ng more of the basic money supJ?lY
under the Federal Reserve's direct influer,ce. It would also provide
more uniform governmental treatment of deposits which perform
basically similar economic functions.
On the other hand, we recognize very practical problems with
passage of legislation bearing this provision and would recommend
its exclusion, if necessary, so as to not protract debate.
In the longer view, we see issues of regulatory supervision and
System membership as directly related to the major structural and
technological changes which have reshaped our financial system and
institutions. Today, commercial banks, like ourselves, compete for
sources of funds and for earning assets with a, host of other institutions,
thrifts, credit unions, foreign banks, some insurance companies and
brokerage houses, the commercial paper and capital markets, and the
financial services units of major commercial and retail companies.
So much for the monopoly of the banking industry. In view of the
urgency of correcting the membership problem, we feel that the issue
of evenhanded treatment of all types of financial institutions offering financial services should be set aside, but we do note that
the costs, restrictions, and inflexibilities of membership lie upon those
commercial banks, small, medium, and large, who have remained
within the System.
The most effective incentive to retain and build membership in the
Federal Reserve System lies in the payment of interest on reserve
balances. We oppose as discriminatory any propo0 nl to limit the rate
of ~nterest paid on reserve balances over $25 million, or any other
arbitrary amount.
We are aware that there are other ways to reduce the burden of
~e!llbership, f~r example, by red~ction of reserve levels, or by proVIsion for holdmg- some fixed portion of r<>servN1 in the form of Government securities. However, the payment of interest on reserves
seems to us to be the most straightforward and simple approach, and
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the one least encrusted with side issues related to the Federal Reserve's
monetary role.
The reserve requirement associated with Federal Reserve membership is in effect a special tax on member banks, or, more precisely,
a levy based upon the sum of deposits placed in those banks by individual customers.
Chairman Miller recently estimated the current level of that tax as
$650 million a year; we believe that is a most conservative estimate. We
recognize the concern of the Treasury about the impact of this proposal
on its revenues, particularly as it faces the prospect of financing budget
deficits of truly heroic dimension.
In turn, the Treasury should recognize that without prompt, decisive relief, membership will continue to erode, probably at an
accelerated rate.
In turn, reserve balances held by the Federal Reserve will decline,
and with them the Treasury's revenues.
Chairman Miller has estimated that these losses will grow by at
least $80 million for every year there is no relief. If memb&ship were
made attractive again, the reverse sequence could be expected. On
balance, it is misleading to characterize interest payme~ts as a. ''.raid
on the Treasury." To paraphrase one of the more promment mtizens
of our town, such a view simply is penny-wise and pound-foolish.
The effect of the tax represented by the reserve requirement becomes
almost diabolical as member banks are forced by competitive pressures
and economic reality to move toward paying interest even on customers' transaction balances, as thev have been for more than a decade
·
on temporarily idle balances.
It also has an effect on the lending side. It seems. curious that to
achieve the same effective margin on a loan to a commercial borrower,
U.S. commercial banks must charge roughly a half percent higher interest than that charged by a foreign bank or a nonregulated competitor
and that all of the markup flows through our coffers into those of the
U.S. Treasury.
It is in this context that I view comments that interest payments on
mandated reserves represent a gift to the largest banks. It should come
as no surprise that the largest banks receive the largest sums on their
reserves; they have more customers providing more deposits upon
which those reserves are based, and those idle sums currently provide
the largest share of the revenues turned over to the Treasury.
There is nothing illogical or unfair about returning interest payments to all banks, regardless of size, in proportion to the amount of
earning opportunities they are forced to forego by maintaining sterile
reserves at the Federal Reserve.
I don't see that any useful purpose is served by punitive or discriminatory provisions aimed at the 10 largest banks. or the 50 largest.
Our banking system is based on a diversity of institutions. We need our
large banks, which provide a breadth and sophistication of services
the small ones cannot, as well as our small banks, which provide more
convenient, often more personal services and attention.
A bank becomes and remains lart?e because individuals and businesses make a cumulative set of explicit decisions to place their deposits with that institution. It is an observable fact, however, to which
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the committee chairman alluded earlier, that many of our largest banks
are out adequately profitable today, judged by the standards of business enterprise in geenral, the performance level of their banking
peers, and the requisites of the capital markets. Because of domestic
branching and line-of-business restrictions, the direct operations of
many of the largest banks are confined to areas of declining economic
vitality. Because of their central urban locations they probably face
severe inflationary costs and growing local tax burdens. 'l'hey have felt
most directly competition from foreign banks not subject to the same
reserve requirements and restrictions, as well as from other nonregulated markets and institutions providing commercial and consumer
credit services.
Large banks bear a disproportionate share of the huge and still
growing cost of Government regulation, reporting, and examination.
They are already discriminated against in the progressive way in which
the required reserve balance is calculated. Any additional discriminatory provisions would tend to worsen a situation which has already
seen a number of major banks, weakened by these pressures, fall prey
to foreign opportunists.
Those who have suffered most from these circumstances have been
the shareholders who, by and large, are individuals or trusts and pension funds organized on behalf of individuals. About 80 percent of
Philadelphia National's stock is held by individuals or by fiduciary
intermediaries on behalf of individuals, with the average individual
holding less than $5,000 at current market value.
Acr~ the nation, in small banks and large, bank earnings provide
benefits of dividend income and capital appreciation to people of
ordinary means.
We have stated our philosophical basis for supporting interest payments on reserve balances. In my view, these reasons are fortified by
some very practical considerations which relate to the simultaneous
unbundling and explicit pricing of the Federal Reserve's operating
services. Our bank will send about 200 million checks through the
system this year, and thus faces substantial charges for such services.
However, we strongly favor this approach. An equitably structured
pricing system would permit private competition and innovation in
payment services, fostering a truly efficient, cost-effective national
payments system with immense public economic benefit.
Quite bluntly, existing Federal Reserve services need not meet any
marketplace test of economic efficiency. Member banks, faced with the
need to recover as much return as they can on their unproductive reserve balances, have a strong incentive to use any service the Federal
Reserve provides. Many banks are using services provided by the Federal Reserve that could be provided either at less cost or with greater
convenience or efficiency by the private sector.
What kind of a pricing system would provide the marketplace tests
needed to stimulate greater efficiencies in the payments system 1 We
recognize that the mechanics of pricing and cost allocation are complex, and for the Federal Reserve, the task will be extraordinarily difficult. Since the Federal Reserve's decisions have great consequence
for competition in payments services, it is important that the criteria
for pricing be open to public view and discussion.
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Prices charged banks for the Federal Reserve's services must reflect
the cost to the Federal Reserve, allocated fully and equitably among
all services. We believe that the service and pricing structure must incorporate the principle that availability of funds to banks will be based
uniformly on the Federal Reserve's actual collection patterns.
The American Bankers Association, recognizing the complexity of
this problem, has commissioned a further set of surveys and studies
on it. So far the Federal Reserve has not made public its own thoughts
on the subject in sufficient detail to permit useful analysis and
discussion.
We would anticipate that the payment of interest on reserves and
resultant relief of the membership problem would bring an end to the
perversion of the Federal Reserve's service role in the cause of aiding
membership retention. While we believe firmly in the value of Federal
Reserve independence in establishing monetary policy, we believe its
approach to operating services to be ·amenable to continuing public
discussion and debate.
In our view the worthwhile objective of arresting the decline in
membership has lured t:he Federal Reserve into adopting predatory
tactics in promoting its services, into arbitrary and discriminatory
subsidy of individual banks, and into an unhealthy bending of its own
service regulations and operating circulars.
I will cite a specific example from our own experience. In 1976,
Philadelphia National, as part of its competitive effort to obtain new
correspondent banking business, worked out an agreement with four
banks in the ,Johnstown, Pa., area to provide certain check-clearing
and check transportation services that were then unavailable from the
Federal Reserve and which other private institutions had chosen not to
offer competitively. After the agreement had been worked out in detail,
the Philadelphia Federal Reserve Bank, notified of it, intervened and
offered t:he identical service to the four banks at no direct cost to them.
Naturally, the banks chose the Federal Reserve's offer over ours. In
order to provide the service, the Federal Rese,rve had to incur costs
that I am convinced we could have met, had the Federal Reserve been
reQuired to charge a fair price for the service.
In this instance, the Federal Reserve directly undercut a private
initiative, presumably to engender the good will of four banks, and in
so doing, provided a de facto subsidy to those institutions funded by
the local Federal Reserve's profits on the investment of interest-free
reserve balances required to be maintained with it by district members,
including ourselves.
This and similar adventures raise serious public policy issues about
the current attitude of the Federal Reserve SyRtem toward ('Ompetition. We have done extensive analyses of the service pattern of the Federal Reserve, not only within the Third DiRtrict, but throughout the
Svstem. Our analvses clearlv show that the effect of variations in checkclearing schedules, sorting 'requirements, t.ransportation patte.rns, and
nolic:v on float throughout the System is to: (1) discriminate in services made a.vailable to banks in differe-nt diRtricts; (2) discriminate betwPen larrrer and smal1er banks: and on discriminate in effect by geography within a single district, the Third.
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We also have direct knowledge of instance.sin which the Federal Reserve has violated it.s own service regulations in individual cases; for
example, permitting a bank to receive service under the 5,000-unsorted
check program, even though its daily average considerably exceeded
5,000 items.
Our experiences with this kind of competition ha.ve increased, in our
minds, the need for prompt action such as proposed in the present bill
to alter this pattern of behavior by the Nation's central hank, principal
regulator and lender of last resort.
To summarize: (1) We believe that the membership problem of the
Federal Reserve System needs urgent action.
(2) We support the thrust of Senate bill 3304, with the comments
I have noted.
(3) Once we get past the immediate membership problem, we believe that the realistic and equitable pricing of the Fed's services will
encourage the development of flexible, efficient, and cost-effective national payments and aline the Federal Reffirve's orientation to the
achievement of those important interests.
Thank you, Mr. Chairman.
[Prepared statement of Mr. Ravenscroft follows:]
STATEMENT OF RICHARD
S.
RAVENSCROFT,
PRESIDENT PHILADELPHIA NATIONAL
CoRP,
Mr. Chairman and distinguished committee members: I am Richard S. Ravenscroft, president of the Philadelphia National Corporation, a one-bank holding
company whose principal subsidiary is the Philadelphia National Bank. Philadelphia National is the 29th largest U.S. commercial bank based on deposits, with
a full range of consumer and commercial banking business, including an extensive
correspondent banking business focused on clearing and payment services. The
corporation's other subsidiaries operate in the areas of mortgage banking, consumer and commercial finance, government securities trading and investment advisory services and come within the supervisory jurisdiction of the Federal Reserve System.
We want to thank you for the invitation to present our views here today on
Senate 3304, the Federal Reserve Requirements Act of 1978.
We favor the legislation because it would improve the determination and execution of monetary policy, the soundness of the banking system, and the efficiency
of our national payments system. Further, it would end the abuse of the Federal
H.eserve's operating services to fight the problem of membership attritiou, ,\'hich
works to the detriment of private competition and initiative.
We are a member of the Third Federal Reserve District. Within our District
we have seen 23 banks withdraw from the system from the end of 1970 to the
beginning of this year. More have left this year and still more appear on the brink
of leaving, especially in the present climate of high inflation and interest rates.
This experience parallels the nationwide trend reported by Chairman Miller in
his recent testimony.
We are deeply concerned with the implications of this decline in the proportion
of bank deposits subject to reserve requirements as it relates to the process of
establishing and carrying out monetary policy. This trend also restricts banks'
access to the resource of the nation's lender of the last resort during perwus of
severe economic stress. From our perspective of close day-to-day involvement
witib the Federal Reserve System, it is clear that the environment in which we operate has changed considerably as the Federal Reserve's membership problem
has deepened and the Federal Reserve in turn has used every available mechanism in an unsuccessful effort to respond.
The first and perhaps most controversial of the proposals in Senate 3304 would
require the establishment of reserve balances at the Federal Reserve for all
"transaction accounts" in depository institutions. By defining transaction accounts to include such services as negotiable order of withdrawal (NOW) accounts in thrift institutions and Slhare draft accounts in credit unions, this would
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Federal Reserve Bank of St. Louis
221
extend reserve requirements not only to all but the smallest member and nonmember banks but also to certain deposits in other financial institutions.
There is strong logic to this provision. It would improve control over monetary
growth by bringing more of the basic money supply under the Federal Reserve's
direct influence. It would also provide more uniform governmental treatment of
deposits which perform basically •similar economic functions. On the other hand,
we recognize very practical problems with passage of legislation bearing this
provision and would recommend its exclusion, if necessary, so as to not protract
deoate.
In the longer view, we see issues of regulatory supervision and system membership as directly related to the major structural and technological changes
which have reshaped our financial system and institutions. Today, commercial
banks compete for sources of funds and for earning assets with a host of other
institutions-thrifts, credit unions, foreign banks, some insurance companies and
brokerage houses, the commercial paper and capital markets, and the financial
services units of major commercial and retail companies. In view of the urgency
of correcting the membership problem, we feel that the issue of even-handed treatment of all types of institutions offering financial services should be set aside, but
we do note that the costs, restrictions, and inflexibilities of membership lie upon
those commercial banks---small, medium, and large----who have remained within
the system.
The most effective incentive to retain and build membership in the Federal
Reserve System lies in the payment of interest on reserve balances. We oppose
as discriminatory any proposal to limit the rate of interest paid on reserve balances over $25 million, or any other arbitrary amount.
We are aware that there are other ways to reduce the burden of membership,
for example by reduction of reserve levels or by provision for holding some fixed
portion of reserves in the form of government securities. However, the payment
of interest on reserves seems to us to be the most straightforward and simple
approach, and the one least encrusted with side issues related to the Federal
Reserve's monetary role.
The reserve requirement ,associated with Federal Reserve membership is in
effect a special tax on member banks or, more precisely, a levy based upon the
sum of deposits placed in those banks by individual customers. Chairman Miller
recently estimated the current level of that "tax" as $650 million a year; we believe that is a most conservative estimate. We recognize the con<>ern of the
Treasury about the impact of this proposal on its revenues, particularly as it
faces the prospect of financing budget deficits of truly heroic dimension. In turn,
the Treasury ·should recognize that without prompt, decisive relief, membership
will continue to erode, probably at an accelerated rate. In turn, reserve balances
held by the Federal Reserve will decline, and with them the Treasury's revenues. Chairman Miller has estimated that these losses will grow by at least
$80 million for every year there is no relief. If membership were made attractive
again, the reverse sequence could be expected. On •balance, it is misleading to
characterize interest payments as the most straightforward and simple approach,
and the one least encrusted with side issues related to the Federal Reserve's
monetary role.
The reserve requirement associated with Federal Reserve membership is in
effect a special tax on meID'ber banks or, more precisely, a levy based upon the
sum of deposits placed in those banks by individual customers. Chairman Miller
recently estimated the current level of that "tax" as $650 million a year; we
believe that Is a most conservative estimated. We recognize the concern of the
Treasury about the impact of this proposal on its revenues, particularly as it faces
the prospect of financing budget deficits of truly heroic dimension. In turn, the
Treasury should recognize that without prompt, decisive relief, membership will
continue to erode, probably at an accelerated rate. In turn, reserve balances held
by the Federal Reserve will decline, and with them the Treasury's revenues.
Chairman Miller has estimated that these losses will grow by at least $80 million for every year there is no relief. If membership were made attractive again,
the reverse sequence could be expected. On balance, it is misleading to characterize interest payments a "raid on the Treasury"; to paraphrase one of the more
,prominent citizens of our town such a view simply is penny-wise and poundfoolish.
The effect of the tax represented by the reserve requirement becomes almost
dia•bolical ,~s member banks are forced by competitive pressures and economic
reality to move toward paying interest even on customer's transaction balances,
33•587 0 • 78 •
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Federal Reserve Bank of St. Louis
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222
as they have ·been for more than a decade on tem'.l)Orarily idle balances. Its effect
is •also on the lending side. It seems curious that to achieve the same effective
margin on a loan to a commercial ·borrower, United ,states commercial banks
must charge roughly a half percent higher interest than that charged lby a
foreign bank or a nonregulated competitor •and that all of that mark-up flows
through our coffers into those of the United States Treasury.
It is in this context t'ha.t I view comment that interest payments on mandated
reserves represent a "gift" to the largest ,banks. It should come as no surprise
-that the largest banks receive the largest sums on their reserves: they have
more customers providing more deposits upon which those reserves are based,
and those idle sums currently provide the largest share of the revenues turned
over to the Treasury. There is nothing illogical or unfair •albout returning interest payments to all banks, regardless of size, in proportion to the amount of
earning opportunities they are forced to forego by maintaining sterile reserves at
the Federal Reserve.
I don't see that any useful public purpose is served 'by punitive or discriminatory ,provisions aimed at the 10 largest banks, or the fifty largest. Our banking
system is •based on a diversity of institutions; we need our large lbanks, which
provide a -breadth and sophistication of services the small ones cannot, as well as
our small •banks, which provide more convenient, often more personal services and
attention.
A bank becomes and remains large because individuals and businesses make a
cumulative set of explicit decisions to place their deposits with that institution. It
is an observable fact, however, that many of our largest banks are not adequately
profitable today, judged by the standards of business enterprise in general, the
performance level of the banking peers, and the requisites of the capital markets.
Because of domestic branching and line of business restrictions, the direct operations of many of the largest banks are confined to areas of declining economic
vitality. Because of their central urban locations they probably face severe inflationary costs and growing local tax burdens. They have felt most directly competition from foreign banks not subject to the same reserve requirements and restrictions, as well as from other nonregulated markets and institutions providing
commercial and consumer credit services. Large banks bear a disproportionate
share of the huge and still growing cost of government regulation, reporting and
exa,mination. They are already discriminated against in the progressive way in
which the required reserve balance is calculated. Any additional discriminatory
provisions would tend to worsen a situation which has aloady seen a number
of major banks, weakened by these pressures, fall prey to foreign opportunists.
Those who have suffered most from these circumstances have been the shareholders who, by and large are individuals or trusts or pension funds organized
on behalf of individuals. About 80 percent of Philadelphia National's stock is held
by individual's or by fiduciary intermediaries on behalf of individuals, with the
average individual holding less than $5,000 at current market value. Across the
nation, in small banks and large, bank earnings provide benefits of dividend and
capital appreciation to people of ordinary means.
We have stated our philosophical basis for supporting interest payments on reserve balances. In my view, these reasons are fortified by some very practical considerations which relate to the simultaneous unbundling and explicit pricing
of the Federal Reserve's operating services. Although Philadelphia National is a
heavy user of Federal Reserve services and thus faces substantial charges for
them, we strongly favor this approach. An equitably structured pricing system
would permit private competition and innovation in payment services, fostering
a truly efficient, cost-effective national payments system with immense public
economic benefit.
Quite bluntly, existing Federal Reserve services need not meet any marketplace test of economic efficiency. Member banks, faced with the need to recover
as much return as they can on their unproductive reserve balances, have a
strong incentive to use any services the Foreign Reserve provides. Many banks
are using services provided by the Federal Reserve that could be provided
either at less cost or with greater convenience by the private sector.
,What kind of a pricing system would provide the marketplace tests needed
to stimulate greater efficiencies in the payments system? We recognize that the
mechanics of pricing and cost allocation are complex ; for the Federal Reserve,
the task will be extraordinarily difficult. Since the Federal Reserve's decisions
have great consequence for competition in payments services, it is important
that the criteria for pricing be open to public view and discuosion.
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Federal Reserve Bank of St. Louis
228
Prices charged banks for the Federal Reserve's services must reflect the cost
to the Federal Reserve, allocated fully and equitably among all services. We
believe that the service and pricing structure must incorporate the principle that
availability of funds to banks will be based uniformly on the Federal Reserve's
actual collection patterns. The American Bankers Association recognizing the
complexity of this problem, has commissioned a further set of surveys and
studies on it. So far the Federal Reserve has not made public its own thoughts
on the subject in sufficient detail to permit useful analysis.
We would anticipate that the payment of interest on reserves and resultant relief of the membership problem would bring an end to the perversion of the
Federal Reserve's service role in the cause of aiding membership retention.
While we believe firmly in the value of Federal Reserve independence in setting
monetary policy, we believe its approach to operating services to be amenable to
continuing public discussion and debate.
In our view, the worthwhile objective of arresting the decline in membership
has lured the Federal Reserve into adopting predatory tactics in promoting its
services into arbitrary and discriminatory subsidy of individual banks, and into
an unhealthy bending of its own service regulations and operating circulars.
I will cite a specific example from our own experience. In 1976, Philadelphia
National, as part of its competitive effort to obtain new correspondent banking
business, worked out an agreement with four banks in the Johnstown, Pa., area
to provide certain check-clearing and check transportation services that were.
then unavailable from the Federal Reserve and which private institutions had
chosen not to offer competitively. After the agreement had been worked out in
detail, the Philadelphia Federal Reserve Bank, notified of it, intervened and
offered the identical service to the four banks at no direct cost to them. Naturally, the banks chose the Federal Reserve's offer over ours. In order to provide
the service, the Federal Reserve had to incur costs that I am convinced we
could have met-had the Federal Reserve been required to charge a fair price
for the service. In this instance, the Federal Reserve directly undercut a private initiative, presumably to engender the good will of four banks, and in so
doing, provided a de facto subsidy to those institutions funded by the local Federal
Reserve's profits on the investment of interest-free reserve balances required
to be maintained with it by district members, including ourselves.
This and similar adventures raise serious public policy issues about the current attitude of the Federal Reserve System towards competition. We have done
extensive analyses of the service pattern of the Federal Reserve not only within
the Third District but throughout the system. Our analyses clearly show that the
effect of variations in check-clearing schedules, sorting requirements, transportation patterns and policy on float throughout the system is to:
(1) Discriminate in services made available to banks in different districts;
(2) Discriminate between larger and smaller banks;
(3) Discriminate in effect by geography within a single district (the
Third).
We also have direct knowledge of instances in which the Federal Reserve has
violated its own service regulations in individual cases-for example, permitting
a bank to receive service under the 5,000-unsorted check program even though
its daily average considerably exceeded 5,000 items. Our experiences with this
kind of competition have increased, in our minds, the need for prompt action such
as proposed in the present bill to alter this pattern of behavior by the nation's
central bank, principal regulator and lender of last resort.
To summarize :
(1) We believe that the membership problem of the Federal Reserve System
needs urgent action.
(2) We support the thrust of Senate Bill 3304, with the comments I have
noted.
(3) Once we get past the immediate membership problem, we believe that
the realistic and equitable pricing of the Federal Reserve's services will encourage the development of flexible, efficient and cost-effective national payments and
align the Federal Reserve's orientation to the achievement of those important
interests.
Senator RIEGLE. Let me thank each of you for your testimony. Let
me move now to some areas of questioning. Let me direct the first question, if I may, to Mr. Heimann and Ms. Greenwald.
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Federal Reserve Bank of St. Louis
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There are several proposals now to have universal reserve requirements with a very high exclusion, so that small banks would not have
to bear the burden of reserves.
Chairman Reuss in the House bill has $100 million exemption, and
the :Federal Reserve says it favors a $50 million exemption.
My questions are two : .First, do you think there is any problem in
granting such a large exemption for reserve requirements i
And, two, several witnesses yesterday said that such a large exemption could induce State-chart~red banks to switch charters and become
.national banks. I wonder if either of you see this as a likely
possibility.
Ms. GREENWALD. I don't have any problem with a $100 million exemption. Certainly it is not too high for monetary policy. Moneta~
policy isn't operative through reserve requirements anyway, it has~ t
been for years and years, way before there ever was a membership
problem. The reason is that it is considered a very clumsy tool, a sledge
hammer approach, an open-market operation has been used extensively, and virtually exclusively for 40 years.
So I don't have to worry about a high exclusion for monetary policy.
I think it is a good idea because it excludes the very small banks,
who are very numerous, and. we have a financial burden placed on them
by having their rei,erves placed in non-interest-bearing securities.
So I think it is a good viable proposal for getting the Fed out of
worrying about the membership problem, and into finally getting on
with the work of being a central bank.
Mr. HEIMANN. We do not have a problem with an exclusion for
banks of a certain size. We believe that the burden on smaller banking institutions in this country, the regulatory burden itself, has to be
reexamined and reevaluated.
The question is what is the magic number. There is to some degree
an attempt by all parties to seek a correct sum, whether it is $50 million or $100 million, I don't think we really know. If this is to succeed, the conce:{>t will have to be flexible, predicated upon the experie;11ce of managi~g t~is ;11ew system of u~iversal reserves, with exclusions for certam mstitut10ns of a certam size.
Flexibility as to the amount would be key. There must be a methodology which will not discourage banks from growing over a certain size or finding techniques by which the institution's growth is
curtailed because of the limitation, be it $50 million or $100 million,
that makes them subject to reserves.
But I am sure the intelligent thought process of all parties involved
can come up with a plan that will solve the problem.
I would also like to say that part of what I have been hearing has
been that plan A or plan B or plan C will result in massive switching of charters, either from nationally chartered to State chartered,
or from State chartered to nationally cliartered.
I would suggest that is something of a bu_gaboo. I have been consistent as a State supervisor and as Comptroller of the Currency, and
I believe Commissioner Greenwald agrees with the thought process.
If, in effect, we have universal and uniform reserves, with open access,
then this question of pushing one system, forcing or making it terribly
attractive for banks to switch charters is not a real problem-it 1s
more of a strawman.
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Federal Reserve Bank of St. Louis
225
Ms. GREENWALD. Also I think the point we both made in 1976 in the
testimony is if, in fact, the State banking system is existing on a subsidy from the Federal Government, that is, it is cheaper to be a Statechartered bank, that is hardly any reason for the dual banking sy-stem. So if that is going to be the death knell for it, it probably should
goSenator RIEGLE. One of the questions that we would like to pin down
is whether the difference in reserve requirements between zero on the
one hand, versus whatever the States might require, wouldn't this still
induce some switching around? I gather you think not.
Ms. GREENWALD. No, I think if we are going to have this game that
everybody is going to have the same reserves, but only members get
access to ·the discount window, and only· members have access to the
Federal Reserve services, yes, then what is the point of not being
a member. You are crazy in that situation not to be a member, either
by becoming a State member or becoming a national bank, whatever
advantages there are in that sense.
So, yes, if you go to universal reserves and leave everything else
in place, you will end up with the Federal Bank Commission over
a,t the Federal Reserve System.
Mr. HEIMANN. I agree. Open access really solves the problems to
which we were addressing ourselves. If it is restricted, you could have
switching.
I might add, Senator, that everyone running a bank has reserves.
It is a question of where those reserves are held and whether they
earn interest. Imposition of reserves by .the Federal Reserve to Federal Reserve members is not a unique happening. I don't think there is
a bank supervisor in the world that doesn~t view reserves with peace
of mind and peace of heart. Reserves are a requirement. It is a question of the size of the reserves and how they are held, whether they
earn interest.
Ms. GREENWALD. They are a requirement of State law. It isn't simply that it is a well-run bank, State law requires reserves. I am familiar
with the Massachusetts reserves, and they are close to the Federal
reserve requirements. It is not the level of reserves that differs, it is
how you hold them. The State says if you hold say 20 percent for a
central city bank, you hold them in interest-bearing government securities. That is the difference.
Mr. HEIMANN. To be perfectly precise, in New York State reserves
are set at 1 percent below what the Federal Reserve sets them. In
other w;ords, the Federal Reserve sets them and the New York
Board adapts to it, so that is how the system works.
Senator RIEGLE. Mr. Ravenscroft, you said in your statement that
the most effective incentive to retain and build membership in the
Federal Reserve System lies, in the payment of interest on reserve
balances.
Each of our witnesses today disagrees. They think universal reserves would be better. I am wondering why you think interest payment on reserves would be more effective?
Mr. RAVENSCROFT. Obviously, the one is an order mandated by
legislative fiat, while the <;>ther is an economic incentive. If I were
to choose between a legislative stick and an economic carrot, I would
prefer the carrot. For one thing, I believe there is a certain public
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Federal Reserve Bank of St. Louis
226
benefit from permitting banks to walk out the door of a particular
regulatory agency if the manner in which that agency is conducting its
affairs is unreasonably oppressive.
That would not be the case if universal reserves led to de facto
supremacy of the Fed in the regulatory/supervisory junction. The
end of that road would be to cut off the opportunity for institutions
to express preferences in response to opportunities or perhaps inflexibilities among the Federal Reserve Board and its various districts.
So I think an economic incentive in this case would produce the
desired result. I know that legislative fiat would also. But I prefer
the one to the other.
Senator RIEGLE. I notice you are shaking your head, Mr. Heimann.
Mr. HEIMANN. I am afraid we may have apples and oranges mixed
in the same basket. I happen to believe in the dual banking system,
and that institutions should have some choice.
However, I don't think that the answer to the question would be
precisely the same, or vaguely the same as Mr. Ravenscroft's. At the
present time we are having changes in the dual banking system.
Those changes exist because 1t has become unprofitable for institutions
to remain in the Federal Reserve, the national banking system, simply
because of what is euphemistically called bottom line considerations.
So the changes that are taking place now are not predicated upon
the quality of supervision, State versus national supervision, they
are determined by very real and completely comprehensible economic
factors. That is, they affect the profit-ability of the individual institution and I may add, the board of director's liability as a board to try
to keep the profitability, for which they, representing the shareholders, are responsible at the highest degree consistent with safety
and soundness.
Again, I think it might be worth repeating what the Commissioner
and I have suggested, though we didn't prepare this ahead of timeI didn't know what her testimony was going to be, and she didn't know
what mine was going to be. If you have universal reserves and open
access, that means all like institutions can make the suggested change
Mr. Ravenscroft was talking about free of any extraneous factors,
such as profita.bility.
Then if the institution feels the quality of supervisor A is better or
more progressive or more compatible than supervisor B, then that
change can truly take place in the dual-banking system, without the
constraint as to whether or not it increases or decreases the profitability. So that I would argue, and intellectually it is perfectly consistent, that universal reserves with open access and of course pricing
of Federal Reserve service, all as one package, as has been suggested,
actually in many ways leaves the freedom of choice much more intellectually honest than it is at the present time.
Mr. RAVENSCROFT. If I may comment on that-Senator RIEGLE. Please.
Mr. RAVENSCROFT. I think that is all well and good in a closed system. But as I indicated in my testimony, we are not in a closed system.
We compete for earning assets and for sources of funds with other
institutions. You can impose universal reserves on all regulated institutions, and we are still going to have the problem as to the division
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of the financial system among regulated institutions and the nonregulated with which we must compete.
So I think in a narrow closed way that may be possible, it may snuff
out evidence of the problem. But we have got competitors enjoying
economic and operating advantage by not being regulated who would
not be regulated under any of these proposals.
Mr. HEIMANN. May I just continue this dialogi To the degree
stated, that is correct. It is closed to the commercial banking· system.
But as suggested by the Comptroller's Office and others, we believe
that universal reserves should be to all like deposit-taking institutions
and therefore in our testimony-and this has been set for some period
of time-we believe it should be extended to the thrift institutions and
the credit unions over a period of time, which partially answers the
problem Mr. Ravenscroft is talking about.
Second, with respect to the foreign banking institutions operating
in the United States today, a matter which he brought up in his testimony, we also believe that reserve requirements, the same level of
requirements-and we have so testified and so has the Fed-should
apply to those institutions.
Now when we get outside of these regulated areas of the commercial
and thrift industry, to such areas of activity as Sears Roebuck, which
is in the transaction business, or American Express, or others, to this
point Congress has not indicated its belief that there was a need or it
was in the public interest to regulate such industry.
So therefore I think that the conversation has to be delineated to
those industries or those areas of industry which have been placed
under regulation by the will of the Congress for good public purposes.
We support the extension of universality of reserves, uniformity of
reserves, to all of them, though I must put in the caveat that it would
have to be phased in over a period of time, it could not be done immediately because of the financial structure and the earning structure
of the thrift institutions, particularly.
Ms. GREENWALD. My testimony also talked about the Fed setting
levels of required reserves for all depository institutions with transaction accounts. I am supporting that in the setting of nonmembership.
It would be universal nonmembership, with the Fed setting universally required reserves for transaction accounts, any depository
institution.
Senator RIEGLE. Mr. Ravenscroft, you are president of a large correspondent bank, who compares with the Federal Reserve in supplying services to other banks. You favor pricing, so that you can more
eff~tively compete.
. A story in Business Week last February indicated that the Philadelphia Federal Reserve is doing everything it can to take your customers
away from you. As a matter of fact, you gave us one illustration today.
In your statement you said there was some, and I quote, "perversion of
the Federal Reserve's service role in the cause of aiding membership
retention."
I think it would be important for you to tell us in some detail exactly what the Philadelphia Federal Reserve is doing with its services to
aid membership, and I am wondering if you could give us further
examples of the Fed's changes in operations which you feel have been
made to influence membership.
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Mr. RAVENSOROIT. Senator, sitting immediately behind me is a colleague of mine, Mr. Norton, executive vice president of the bank, with
extensive experience through his career in operations, data processing,
and now the man to whom the entire correspondent banking function
reports.
I wonder if you would permit him to respond 9
Senator RIEGLE. Yes; why don't you come forward and bring your
chair up and share that microphone.
And would you repeat your name again for the record i
Mr. NoRTON. George D. Norton, executive vice president and cashier,
Philadelphia N ationaL
With regard to the areas of complaint that we have had with our
local Federal Reserve bank, it really stems, I believe, from their approach of trying to use the service route to try to stem the tide of attrition in membership.
And in the process we believe that there have been instances where
there has been a bending of the Federal Reserve regulations and operating rules in order to be able to accomplish these ends.
As a major correspondent bank within our district, we have had serious communications problems with the Federal lw,serve in that there
would be a change of operating rules and procedures that would be
communicated to smaller banks within the district, but would not be
adequately communicated to us through both were members of the
same system. One of the specific areas relates to an operating rule which
apparently originated sometimes in the late fifties or early sixties,
whereby the Federal Reserve b!lJlks would permit any member bank
that had an average of 350 checks per day or less to deposit these etb.ecks
with the local Federal Reserve, unsorted, so that the Federal Reserve
itself did the sorting.
Of course this was in direct competition with the services being provided by other large member correspondent banks.
That number was gradually increased, from 350 to 1,000, to 2,000,
and ultimately up to 5,000 checks per day. And in so doing, the level
of competition with correspondent b!lJlks continued to increase: 5,000
checks would take a bank into a size that would be approximately $75 to
$100 million. Our concern was that this limitation would rise and rise
without end.
The other consideration was also of significant importance to us because it got to the issue of implicit pricing. As you know, in the correspondent business there are explicit prices established for each type of
service, and this is equated to the level of balances tha,t must be maintained by either a member of the system or nonmember, that elects to
have a service.
In the third district, unlike all of the other district systems, under
the so-called 5,000 rule the Federal Reserve Bank of Philadelphia
elected not only to receive these checks unsorted, but also to give next.day immediate avaihtbility.
So therefore, as a matter of policy, they were making availability of
credit into reserve balances clearly in excess or faster than the checks
themselves could be collected and therefore increasing the total Federal
Reserve liability.
The Third District also has a very unique transportation system,
which is completely subsidized by the Federal Reserve bank. No other
Federal Reserve bank provides comparable service.
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All of these, I believe, are examples of the ways that the Federal Reserve is competing very effectively against its own members.
Senator RmoLE. I am wondering if you are a ware of any other part
of the :Federal Reserve System doing what you are experiencing in your
~j
.
Mr. RAVENSOROFr. I think our experience and information, based on
conversations witih banks around the country is that the Fed with
which we compete is surpassed by no other district in its aggressiveness.
Senato:i;· RIEGLE. Ms. Greenwald, what have you seen? From your
vantage point, have you seen this anywhere in New Englandi
Mr. RA.vENSCROFr. There are not thrilling issues in the political sense,
and they are not easy to describe. On the other hand, we certainly have
seen an erosion of potential markets. As I referred in my testimony,
we haven't seen any pickup in Federal Reserve membership, so we
think these actions are destined ,to mil. But it happens to raise very
serious questions as to the extent to which we can, for example, justify
investment in correspondent banking-the hardware and software and
people,-for the ensuing decade.
As I mentioned, we are not here rto get into a fight or to air our disputes with the Fed. We are here because we feel that the bill under consideration addresses in a very realistic sense the underlying problem,
and we have soon the effects of this on our volume, on our profits, on our
strategic plans.
They are not terribly exciting or easily described issues, but we
have learned what the rhinoceros looks and sounds like as it creeps up
on us.
Senator RIEGLE. Ms. Greenwald, did you want to comment i
Ms. GREENWALD. The Fed clearly has used these services as a means
of keeping members. The only example that comes to mind in New
England is the Fed's decision first not to let thri:llts into the automated
clearing house, and then to do so at a discriminatory pricing, until the
Justice Department intervened. Their motivation was to say, see, we
do something for our members.
Mr. HEIMANN. Senator, if I may, as you know, the Comptroller's
Office has felt for some period of time that this process, which has been
given the unlikely name of unbundl~, should apply in one form Oil'
another to the Federal Reserve and its system. Certainly since we are
supporters of the NOW accounts, it applies to the consumer receiving
interest on his demand deposit and paying for services.
Of course we have also felt quite strongly it should apply to the oorrespondent banking system. I assume that this follows that the Philadelphia National Bank would ascribe to the same theories as it follows
all of the way through. If you have unbundling, it should be an unbundling across tb.e board from the consumer to the bank.
Senator RIEGLE. Yesterday the members of a panel of bankers from
small banks said that correspondent banks have unbundled their services and ,are charging explicitly for services. They also said they receive
implicit interest on their demand deposits. Why aren't such implicit
payments a violation of the prohibition against payment on demand
deposits~
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Mr. HEIMANN. I frankly don't know what it means, an implicit payment on a demand deposit. There are examples of that in our society
which probably are bending the law. For example, giveaway programs; when you open a new account at a savings bank, those giveaways are a form of payment, even though they aren't calculated in
the rate of interest for regulation Q limitation purposes.
But I am not sure what they mean by implicit. I would say from the
supervisor's point of view, any supervisor, that he would prefer to
see explicit payment on demand deposits and explicit charge for
services. That is the only system by which we can calculate with a fair
degree of precision and accuracy whether the services of the institution
are being paid for directly or indirectly.
Senator RIEGLE. Ms. Greenwald, let me ask you, do you foresee any
problems for small Massachusetts banks if the Federal Reserve were
to price its services and compete with correspondent banks 1
Ms. GREENWALD. Do I see any problems 1
Senator RIEGLE. For the smaller banks in Massachusetts. Do you see
any adverse impact~
Ms. GREENWALD. No, especially if you f!O along with the Reuss plan
of exempting small banks from required reserves, that would have
more of an impact on them, if they had to suddenly become members of
the Fed and pay for services.
To go back, we have very few State-chartered members of the Fed
in Massachusetts. I believe we are down to six.
Senator RIEGLE. Let me ask one more question, if I may. If the Federal Reserve is to become a true central bank, with universal reserves,
open access to services and the discount window, the role of the regional
reserve banks may become more important.
Should steps be taken to make those reserve banks more accountable
to the Federal Government, perhaps by chan_ging the structure of the
boards of directors, and proving appointment of the presidents by say
the Federal Reserve Board, with confirmation by the Senate~
Ms. GREENWALD. I think that makes sense, regardless of what else
you do.
Senator RIEGLE. I like the idea, too. We just started a vote on the
floor:, which I must goto shortly, as I need to talk to some people before.
I know how I am going to vote. Also I want to talk to some other people
before they vote.
I appreciate very much your testimony today, and hope you see you
all again soon.
Mr. HEIMANN. Thank you, Senator.
Senator RIEGLE. The committee stands in recess.
[Thereupon, at 11 :45 a.m. the hearing was recessed, to reconvene at
10 a.m. the following day.]
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FEDERAL RESERVE REQUIREMENTS ACT OF 1978
TlllJ'BSDAY, AUGUST 17, 1978
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washing ton, D .0.
The committee met at 10 a.m. in room 5302, Dirksen Senate Office
Building, Senator William Proxmire ( chairman of the committee)
presiding.
Present: Senators Proxmire and Sarbanes.
STATEMENT OF CJIAmMAN PROXMmE
The CHAIRMAN. The committee will come to order. This is the
fourth and final day of hearings on reserve requirements and solutions
to the Federal Reserve's loss of membership.
On Monday Chairman Miller maintained that "Membership is not
essential, and it's rather unique in the United States in terms of central
bank functions, and so it would be appropriate for us to think broader."
I guess gramatically that should be "more broadly," but he said
"broader."
No Federal Reserve spokesman, according to the committee staff,
has ever gone that far before in explaining the problem the Federal
Reserves faces because of attrition of members.
What needs to be considered is to have the central bank in a position
to implement monetary policy, provide access to the discount window
and its payment services on a fair and equal bas1s for all banks, regardless of regulatory affiliation, and to do all this without the consequences of losmg membership if it makes a particular decision.
The Federal Reserve, the Treasury, the Comptroller of the Currency, among others, believe that universal reserve requirements of
some kind would be the best and most permanent solution to the problem facing the Federal Reserve. It would also allow the concept of
membership in the Federal Reserve to become a nonissue. Open access
to the discount window and to Federal Reserve services on the basis
of price rather than membership status would ·be possible. That would
be a major improvement to the present situation in which membership
considerations influence decisions.
The universal reserve requirement also would limit the exposure of
the Treasury to loss of revenues.
We have had a proposal, as you all know, to pay interest on reserves,
which has received the support of a number of Senators. Not this one.
It seems to me if we go that route, the cost to the taxpayers would be
very substantial inasmuch as the Federal Reserve revenues of course
are returned to the Treasury. If the market rate of interest is paid, and
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eventually we might get to that level on reserves, it is my understanding it would cost $1½ billion. At a time when a number of Senators,
including those in the forefront of advocating payment of interest on
reserves, are opposed to spending as much money as we are spending
on food stamps, and are cutting back in other areas, it seems to me it
is very very hard for us to maintain we should pay interest on reserves,
and benefit bankers.
Not that bankers don't need benefit, but their profits aren't too low.
I think it should be apparent to anybody who has any political understanding at all that this route is fraught with all kinds of difficulties.
If we try to change a policy that we have followed ever since the advent
of this country, and begin to pay interest on reserves, there will be
problems.
Our first panel of witnesses is a very distinguished group of economists, Lester Chandler from Princeton, James Pierce from the University of California at Berkeley, and Jon Brown, staff attorney for
the Public Interest Research Group.
If you gentlemen would come forward, we would be happy to hear
from you. So we will have time for questions, I am going to ask that
we run the time clock and everybody will have 10 minutes for his oral
statement. Anything you don't get a chance to say orally will be put in
the record and made available to the committee and to other Senators.
When you start, the green light will go on, it will stay on until you
have spoken for 9 minutes, then the yellow light will be on for 1 minute,
and then the red light, of course you know what that means.
Prefessor Chandler.
ST.ATEHENT OF PROFESSOR LESTER CHANDLER, ECONOM:ICS
DEP.ARTM:ENT, PRINCETON UNIVERSITY
Mr. CHANDLER. Thank you, Mr. Chairman, for the opportunity to
testify this morning. I wish to say that I endorse the proposed legislation, if, in your judgment, it is the most and best legislation on the
subject that can achieve adoption by Congress this year. Knowing the
disastrous fate of more comprehenfiive reform bills considered by Congress during recent years. I do not wish to urge extensions or amendments that would lead to no legislation at all.
Under these conditions, I approve the proposed legislation as a first
step toward reform of existing arrangements, which are highly discriminatory, distorting in their economic effects, and ill-designed to
facilitate monetary management.
At the heart of the present problem is the motley array of legal
reserve requirements that are highly discriminatory as between banks
that are members of the :Federal Reserve and those that are not. The
situation will be worsened if thousands of thrift institutions are permitted to create NOW aocounts and other transactions balances without meeting the same reserve requirements as those imposed on member
banks.
As you know, the only things countable as legal reserves for member
banks are cash in vault and deposits at the Federal Reserve, neither of
which pays any interest. Congress presumably ordered the imposition
of these requirements because it considered them necessary, or at least
useful, for purposes of monetary management, as a means of setting
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and stabilizing the size of the money multiplier. However, an incidental
effect of these reserve requirements is a tax on member banks. The tax
is in the form of the earnings that banks must forego in holding some of
their funds in the form of sterile required reserves instead of earning
assets. These tax revenues accrue in the .first instance to the Federal
Reserve in the form of interest on the earning assets acquired in supplying the required reserves, but a major part of these revenues is then contributed to the Treasury.
The reserve requirements on nonmember banks, as determined by the
various States, are far different and far less onerous. Illinois deals with
the matter in a refreshingly forthright manner; it has no reserve requirements at all. At least seven other States do impose reserve requirements, but permit all the requirements to be met with earning assets, such as Treasury securities, commercial paper, Federal funds and
negotiable certificates of deposit. A number of other States also permit
a part, in some cases a large part, in excess of 50 percent, or requirements to be met with such earning assets. Most of the remaining requirements can be met with deposits at other banks, many of which
would be held anyway for business reasons. Only a handful of States,
only three in fact, require that any fraction of reserves be held as cash
in vault, and this fraction is typically quite small, usually below one.fifth.
In short, the net cost to nonmemher banks of meeting their reserve
requirements is very small relative to the costs imposed on member
banks. In effect, banks that remain outside the Federal Reserve receive
a Federal subsidy in the form of exemptions from the tax that would be
imposed on them if they became members of the Federal Reserve.
My rough estimate is this subsidy is now costing the Treasury at
least $600 million a year.
Moreover, most of the reserve requirements applicable to nonmembers are of little or no use for the purpose of monetary management.
To be useful for this purpose, the supply of the things countable as
legal reserves must be subject to control by the Federal Reserve. The
latter can control the supply of cash plus deposits at the Federal Reserve. Hut neither the Federal Reserve nor any other central agency
can control the supply o:f the wide array of assets presently countable
as legal reserves :for nonmember banks.
Though I shall later criticize some of its details, I approve in principle the proposal that federally determined reserve requirements be
applied to transactions balances created not only by member banks, but
also by other insured commercial banks, and by thrift institutions, and
that the only assets countable as legal reserves be cash in vault and deposits at the Federal Reserve held directly or indirectly. Adoption of
this proposal would reduce markedly the present discrimmation against
member banks and would provide a set of reserve requirements more
helpful for purposes of monetary management.
If past experience provides any guide, this proposal will meet strong
opposition. Many will argue that it violates the principle of dual banking. This argument must be faced and should be rejected. There are, of
course, many aspects of bank regulation that are properly in the hands
of State legislatures and State banking authorities. But monetary
management is not one of these. The Constitution explicitly delegates
to Congress the exclusive power "to coin money and regulate the value
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thereof," and at least implies that Congress should take such actions
as are necessary or useful in meeting this responsibility. Congress has
decided that reserve requirements on member banks are necessary or
useful for this purpose. If this _is true for a small $20 million member
bank, why should a $100 million bank that elects to remain outside the
Federal Reserve be exempt~
I approve also the proposal that the Federal Reserve charge for the
services that it provides to financial institutions, instead of providing
them free, and that the prices charged for the various services be in
line with their costs of production. A large part of these charges will
probably be passed on to consumers in the form of higher prices for
financial services, but this is desirable in order to encourage economy
in the use of resources. Free services are invitation to waste. Consumers now receive large amounts of free services, partly because the
Federal Reserve provides free services to their banks, but more because
their banks provide free services in lieu of interest on demand deposits.
Specific pricing of Federal Reserve services would bring some economy in the use of resources, but much larger economies could be
achieved if banks were permitted to pay interest on demand deposits
and ~he banks were thus encouraged to make specific charges for their
services.
Charging specific prices for financial services by both the Federal
Reserve and other financial institutions takes on special importance
now because of the potentialities of the electronic funds transfer system now in process of development. This new system can be far more
efficient than the old system based on checks, but only if it can divert
consumers away from the use of checks and achieve a high volume of
transactions.
But the high costs of the paper-based system are not now apparent
to consumers who receive services free, so that incentives to shift to the
more efficient system are seriously weakened. The more efficient electronic fund transfer system will develop more rapidly if the services
of this system and the services of the paper-based system are priced
specifically in line with their relative costs of production.
The third title of the bill proposes that the Federal Reserve be authorized to pay interest on required reserves held in the form of balances at Federal Reserve banks. I approve this proposal in principle,
though I shall later criticize some of its details. I shall also contend
that if only some given amount of Treasury revenues can be sacrificed in the interest of reform, first priority should be given to reforming the reserve requirement themselves, and only a second priority to the payment of interest on required reserves.
Now for comments and criticisms of some of the details of the proposals, I do not like at all the distinction between demand deposits on
the one hand and NOW accounts and share draft accounts on the
other hand, for the purpose of fixing the level of reserve requirements. The bill proposes the range of requirements on demand deposits
be from 7 to 22 percent, while the range on the other types of transactions balances would be from 3 to 12 percent. This clearly presents the
possibility that actual reserve requirements will be set higher for
demand deposits than for NOW accounts and share draft accounts.
Yet all these types of transactions balances are functionally the same
and differ only in name. There seems to be no logical reason to treat
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them differently for reserve requirement purposes. We already have
one indefensible distinction between demand deposits and NOW accounts; interest on demand deposits remains prohibited but is permitted on NOW accounts. Why it is "unsound" to pay interest on demand deposits, but "sound" to pay interest on the same thing under
another name is beyond my comprehension. The prohibition of interest on demand deposits is a major reason for the shrinkage of demand deposits relative to the level of income and expenditures.
In 1950 business and households were willing to hold demand deposits equal to 30 percent of GNP; this ratio is now below 13 percent
and still declining. If reserve requirements on demand deposits are set
above those on other types of transactions belanaces, the tendency will
be to reduce still further the growth of demand deposits.
The present set of reserve requirements for member banks, especially those applicable to demand deposits, is faulty in at least two respects. These faults are of long standing and probably cannot be corrected at this time but they should be mentioned anyway. First, these
requirements are higher than necessary for monetary management
purposes. Before 1936 these requirements against demand deposits
ranged from 7 to 13 percent. They were raised above this level only
because of two historical episodes that have no relevance to present
conditions. First was the golden avalanche during the latter half of
the 1930s and second was the creation of huge amounts of bank reserves during World vVar II as the Federal Reserve purchased Government securities to aid in fianancing the war. There is no longer any
need for such high requirements. It is impossible to state precisely
what level of requirements is necessary for monetary management.
However it is certainly below present levels and is probably below
10 percent. Thus a reduction of the average level of reserve requirements could reduce the tax burden on members banks without damage
to monetary management.
The second fault of the present reserve requirements is that they
are graduated by the total amount of deposits in a bank. For example,
present requirements against demand deposits range from 7 percent
on the first $2 million of deposits to 16½ percent on deposits in excess
of $400 million. Such wide differentials can lead to slippages in the
conduct of monetary policy. A net shift of deposits from banks with
low requirements to banks with high requirements increases the average level of reserve requirements and tends to tighten monetary conditions whether or not that is desired. A net shift of deposits from
large banks to small banks has the opposite effect. Uniform requirements for all the banks would avoid this danger.
Moreover, the present graduated reserve requirements have the effect of imposing a graduated tax on banks, with the graduation based
on the volume of deJ?osits. The graduation is not based on
on net income, or the ratio of profits to capital, or benefits received, or
any other criterion ordinarily employed to justify ~aduation. The
bill before you would compound the inequity by paymg only a lower
rate of interest on the required reserves of large banks. As a general
rule, the rate of interest paid on required reserves would be tied to the
Federal Reserve's yield on its portfolio, but the rate paid on required
reserves in excess of $25 million would be limited to 2 percent. I can
find no justification for this.
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These faults of the existing system of reserve requirements provide
the reason for my earlier statement that if only some given amount of
Treasury revenue can be sacrificed to achieve reform, first priority
should be given to reforming reserve requirements and only a second
priority to the payment of interest on required reserves. ·
In conclusion, by far the most important part of this bill is that providing for the extension of federally determined reserve requirements
to transactions balances created by all types of depository institutions.
This reform is long overdue and urgently needed.
The CHAIRMAN. Thank you very much. Mr. Pierce.
STATEMENT OF PROF. 1Al'tlES PIERCE, ECONOMICS DEPARTl'tlENT,
UNIVERSITY OF CALIFORNIA, BERKELEY
Mr. PIERCE. I appreciate the opportunity to present my views on
S. 3304, a bill that imposes reserve requirements on nonmember depository institutions, that allows the Federal Reserve to pay interest on
reserves and that requires tllff Fed to charge for its services. I agree in
principle with these three reforms, yet disagree with the specific form
they take in S. 3304.
S. 3304 takes the valid issues of universal reserve requirements, interest payments on reserves and charging for services, and applies
them in support of a membership drive for the Federal Reserve. In the
hope of attracting members to the System, the bill would impose reserve requirements on all depository mstitutions with transactions accounts in excess of $5 million, it would reduce reserve requirements on
time deposits for member banks, and it would allow only member
banks to partake of Federal Reserve services, including access to the
discount window. This bill, if passed, would surely induce many nonmember banks, particularly large ones, to become members. After all,
if a bank is to have required reserves imposed against it, irrespective
of whether it, is a member or not, it mi~ht just as well become a member
and enjoy Fed services. The only additional cost would be to hold reserves against time deposits, which the bill reduces from present levels.
The inducement would be particularly strong because S. 3304 would
not require the Federal Reserve to charge full cost for its services. The
inducement to achieve membership would also grow over time for nonbank depository institutions as growth in their transactions accounts
would make low-cost Fed services and access to the discount window
increasingly attractive. I see no economic rationale for encouraging
Federal Reserve membership when reserve requirements are imposed
on transactions ·accounts of all kinds of depository institutions. However, I do see an economic rationale for allowing all de:pository institutions access to Fed services, including the discount wmdow, irrespective of membership in the Federal Reserve.
Membership dnves for the Fed are usually defended on the grounds
that the Federal Reserve needs members in order to execute monetary
policy effectively. The required reserves of members put a brake on the
expansion of money and credit. These requirements act to make the
relationship between open market operations and the monetary aggregates more predictable. Nonmembers do not hold idle reserves with the
Fed and it is often asserted that this missing link complicates mone-tary policy. It is further argued that nonmembers enjoy a competitive
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advantage over members because they can hold much of their "reserves" in interest-bearing liquid assets. J4'inally, member banks have
access to the discount window and nonmembers do not. As the number
of member banks shrinks, the efficacy of the discount window as the
ultimate source of liquidity diminishes and the "quality" of the banking system suffers.
On the surface, these arguments appear quite compelling. While
there is no evidence that the erosion of membership has hindered the
Fed's control over money and credit, if a large enough share of deposits
is with nonmembers, presumably this control will suffer. The degree of
suffering is unclear. It is crucial to note in this regard, that it is idle required reserves, not membership, that aids monetary control. The link
between idle required reserves and membership in the Federal Reserve
is a legal and historical one rather than an economic one. S. 3304 recognizes this distinction to a degree but then loses it. The bill would require nonmember depository institutions to hold idle reserves against
their transactions accounts; they would not have to become members.
From an economic point of view, transactions accounts such as NOW
accounts, automatic-transfer accounts and share draft accounts, are
sihiply demand deposits by another name. If reserve requirements on
demand deposits are needed ·for purposes of monetary policy, then they
are needed on all transactions accounts irrespective of where they reside-member bank, nonmember, savings and loan, mutual savings
bank or credit union. However, the bill authorizes lower reserve requirements for transactions accounts that are not demand deposits,
than it does for demand deposits themselves. This provision makes no
sense to me. S. 3304 tightens monetary control through universal reserve requirements and then turns around and loosens the control
through low reserve requirements for transactions accounts other
than demand deposits. This loosening can be justified only in
terms of maintaining or attracting members, not improving monetary
policy.
With the authorization of automatic transfers from savings to
checking accounts and with nationwide NOW accounts-or their equivalent-waiting in the wings there could be an explosion of nondemand
deposit transaction accounts in the near future. When and if this explosion occurs, these accounts with their relatively low reserve requirements could cause much greater problems for monetary control than
the gradual loss of member banks. In this bill, the Federal Reserve appears to be more interested in retaining members through low reserve
requirements on these accounts than it is in maintaining monetary control. The execution of monetary policy requires the same reserve requirements for all transactions accounts irrespective of their name.
The argument that members are needed because only they have
access to the discount window seems upside down to me. The discount
window can be an important source of liquidity to the entire banking
system. There is no reason to restrict its use to member banks. If the
safety of the banking system is weakened by having a shrinking number of banks eligible to use the discount wmdow, a simple solution is
!l,Vailable-allow universal access to the discount window for all depository institutions offering transactions accounts that have eligible paper
to discount. If universal reserve requirements are a good idea, then uni-
33-587 0 - 78 - 16
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versal access to the discount window is even a better one. This reform
would quickly solve the "quality:' of the banking system problem.
I would like to comment only briefly on the provisions of S. 3304 that
would require the Fed to charge for services and to pay interest on reserves. I support having the Fed charge for its services; the current
system is wasteful and it inhibits competition from the private sector.
I find the provisions in S. 3304 to be overly vague, however. Congress
should set the guidelines for the charging system. The Fed should
charge the full cost of providing all its services. The charges should
include indirect costs and allowance for the cost of capital and taxes
that would be paid by a private firm if it were to offer the services.
The Fed should be allowed, however, to phase in the full charge system over a number of years in order to ease the transition. I believe that
a market price should be charged :for the discount window as well. All
depository institutions with transactions accounts should have full access to Fed facilities, including the discount window and they should
all pay the same prices for these services.
I am in favor of paying interest on reserves but the situation is complicated by the prohibition of payment of interest on demand deposits
including correspondent balances. The case would be much stronger if
explicit interest were paid on these accounts. Just as banks should receive interest on their deposits-reserves-and pay for services received
from the Fed, so too should the public receive interest on its deposits
and pay for services received from banks. S. 3304 provides the first half
of this proposition and neglects the second.
The problem is also complicated by the current economic and budgetary situation. If tihe Nat.ion were enjoying price stability and if the
budget were balanced, the argument for paying interest on reserves
would be compelling. Required reserves levy a sort of tax on hanks. It
would be much easier to have universal reserve requirement set at le.vels
that are optimal for monetary policy, if the "tax" were eliminated.
This can be accomplished by paying a market interest rate on reserves.
Unfortunately, we have inflation and we have a Federal budget that is
badly in deficit. In this situation, tax cuts are not easy to achieve. There
have boon many proposals for tax cuts in this Congress ranging from
reductions in the individual and corporate income taxes to lowering
the capital gains tax. I doubt that the "tax" on member 'banks ranks
very high on anyone's list :for taxes to cut. I recommend that on this
matter we follow Chairman Miller's advice to the Congress and the
President and be conservative in our tax cutting-limits the "tax" cut
for banks. I suggest that this be accomplished by limiting the- payment
of interest on reserves to the revenue ·obtained by charging for Federal
Reserve services including the use of the discount window.
S. 3304 is seriously flawed but it contains, I believe, the seeds of
meaningful reform. I should like to conclude this testimony with a list
of major revisions that I would like to see in the bill. These revisions
would produce, I believe, a bill that enhances the effectiveness of monetary policy, solves the "membership problem," increases the safety of
the financial system and en:hances the competitive equality among depository institutions.
1. Impose reserve requirements on transactions accounts of all
insured depository institutions.
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(a) Exempt the first $50 million of transactions accounts from reserve requirements.
(b) Apply the same reserve requirement to all transactions accounts
including demand deposits.
( c) Impose the reserve requirement on repurchase agreements between a bank and its customers.
2. Eliminate the reserve requirements on saving and time deposits
( which does not include transaction accounts).
3. Provide standby authority for the Federal Reserve to impose
marginal reserve requirements on sales of large CD's and purchases of
Eurodollars by any depository institution with deposits over $100
million and on the commercial paper issued by its holding company.
4. Allow universal access of all insured depository institutions offering transactions accounts to all Federal Reserve services including
the discount window.
5. Institute full charging for Federal Reserve services with the same
price charge per unit of service irrespective of membership status, size,
or geopraphic location of the depository institution.
6. Authorize the Federal Reserve to pay interest on reserves in an
aggregate amount equal to the revenue from service fees and lending
at the discount window. The interest rate at the discount window would
be set equal to the average Federal funds rate in the previous week.
The CHAIRMAN. Thank you very much, Profes.sor Pierce. Mr.
Brown.
STATEMENT OF lON BROWN, STAFF ATTORNEY PUBLIC INTEREST
RESEARCH GROUP, WASHINGTON, D.C.
Mr. BROWN. Thank you, Mr. Chairman. I would like to qualify
slightly your introduction, saying that all of us are distinguished
economists.
The CHAIRMAN. Well, I recognize you are a distinguished attorney.
Mr. BROWN. I can't qualify for that distinction. But I would like to
say that a lot of my conclusions-The CHAIRMAN. Two out of three isn't bad.
Mr. BROWN. A lot of my conclusions arrived at independently are
very similar to Mr. Pierce's, so I don't feel too left out.
Generally we support some provisions of S. 3304, but feel that other
provisions are unnecessary, and feel that there is a need for additional
provisions and further study.
We think that the concept of universal reserve requirements makes
sense, and we endorse that provison of the bill, although we are not
sure at this time it is necessary to extend it to the thrift institutions.
On the other hand, we think if you have universal reserve requirements, that resolves at least for the moment the membership problem.
In fact, it makes the membership problem moot, and therefore the
payment of interest on reserves is not necessary, as a means to deal
with the membership problem.
We believe that the payment of interest on reserves is fundamentally
a question of Federal tax policy, and as such it should be dealt with
by Congress and really should not be dealt with by the Federal
Reserve Board.
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The Federal Reserve Board has ample to do in the area of monetary
policy, without having additional responsibilities in fiscal policy.
We believe that there are several unanswered and unexplored areas,
which should be looked at further before any bill is finally reported.
The first area involves needed reform of the Federal Reserve banks
themselves to end the dominance of the ban~ by their commercial
banking members. This, in the past, has been one of the primary functions of the Federal Reserve System membership and is part of the
overall review of the membership role that should be looked into.
Second, we think there is a need to further examine whether or not
there is any great public benefit in having a supervisory role for the
Federal Reserve Board, and it should be freed, from its supervisory
responsibility and concentrate more on monetary policy.
We think these two additional questions are very relevant now, because for once, and on very rare occasions this has happened, Congress
has some leverage over the Federal Reserve Board, when they feel
there is something wrong and are coming to Congress· and asking for
assistance. Before that assistance is granted, we think it is time to take
a hard look at whether or not there are not changes needed in the
Federal Reserve System.
I won't read the testimony. I will comment briefly or take brief
excerpts from it.
The first is to point out that many of the Federal Reserve Board's
claims about the adverse impact of declining membership are clearly
self-serving and should be viewed with considerable skepticism. The
reason for the fact that they are self-serving is obvious, and that is
that the size of System membership is a measure of the political power
base of the Federal Reserve Board, and the Reserve Board has a very
strong interest in increasing or at least maintaining the size of its
membership.
But nonetheless, even though we feel these claims should be viewed
with skepticism, we think there are substantial reasons for legislative
revision of the current structure of System membership.
First of all, we feel it is sound policy to diverse reserve requirements from System membership, and that is what universal reserves
would do.
Tying reserve requirements to System membership results in an unfortunate intertwining of the issue of reserve requirements with the
size of the Federal Reserve Board's political power base. Empowering
the Board to impose reserve requirements on all commercial banks,
regardless of whether they are system members, avoids this problem.
It also eliminates the need to pay interest on required reserves as a
means to entice banks to join or remain System members.
Moveover, if adjustment of reserve requirements is, in fact, a useful
monetary policy tool, a Federal Reserve Board claim that runs counter
to most mdependent research on this issue, then divorcing reserve requirements from System membership will allow the Board to adjust
reserve requirements without worrying about inducing changes in
System membership.
Universal reserve requirements for all commercial banks would
eliminate the role of the States in establishing reserve requirements.
However, this aspect of the dual banking system does not serve any
great public purpose and its loss would be a small price to pay for re-
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solving the competitive equity problem and possibly improving the
conduct of monetary policy.
All depository mstitutions, including savings and loans, mutual
savings banks, and credit unions, whether System members or not,
should have access to the Federal Reserve discount window and to Federal Reserve services. No public purpose is served by limiting access
to System members.
Service charges should be imposed on all users of Federal Reserve
services. Such explicit pricing would result in more efficient use of
these services. Moreover, if all depository institutions have access to
these services, not just System members, then the Federal Reserve
Board will not be tempted to underprice its services for the purpose
of increasing System membership, although other in1lentives for such
underpricing would remain.
If Federal Reserve Board reserve requirements were imposed on all
commercial banks, then there would be no pressing need to pay interest on required reserves. Under this approach sterile reserves would
represent a tax on commercial banks.
As I indicated before, the need and the appropriate size of that tax
is a matter for congressional determination and should not be delegated to the Federal Reserve Board.
Once reserve requirements, access to the discount window, and access to Federal Reserve services are divorced from System membership,
the apparatus of System membership under which System members
hold voting stock in the 12 Federal Reserve Banks and elect two-thirds
of the nine directors of each Federal Reserve Bank serves no public
purpose. In this situation System membership would merely identify
those State-chartered banks that choose to be supervised by the Federal Reserve Board, if a continuing Federal Reserve Board role as a
supervisor is found desirable.
Commercial bank ownership and more important, control of the
Federal Reserve Banks, biases these institutions in regard to monetary
policy in favor of commercial banks and their large corporate customers and represents a gross conflict of interest in regard to their
supervisory responsibilities. Thus, it is essential that any genuine solut-ion to the Federal Reserve membership problem remedy this underlying- bias and conflict of interest. To accomplish this,' the stock in
the Federal Reserve Banks should be retired and the Banks transformed from quasi governmental entities to administrative divisions
of the Federal Reserve Board. The Reserve Banks' boards of directors
1,hould be abolished and their Presidents appointed by either the President of the United States, with Senate confirmation, or by the Board
of Governors.
Reforming the structure of the Federal Reserve Banks, however,
does not resolve the question of whether it is appropriate for a central
hank such as the Federal Reserve, to have major bank supervision responsibilities. There are certain characteristics inherent in a central
bank that are antagonistic to bank supervision in the public interest.
In selecting Governors for the Federal Reserve Board, an important
criterion is maintaining business confidence, and thus the Board has
'.1n unavoidable bias in favor of large corporations and the banking
rn~ustry. The i~terests of consumers, labor, and minority groups receive less attent10n. As a central bank. the Federal Reserve is domi-
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nated by a large staff that is oriented toward highly technical economic
and monetary analysis and lacks a broad perspective on issues of
equity, such as civil rights, consumer affairs, community reinvestment,
and displacement.
Finally, as a central bank, the Federal Reserve has developed a
strong policy of operating in secrecy. This policy goes far beyond
that appropriate for bank supervision and unnecessarily impedes both
congressional oversight of bank supervision issues and citizen
participation.
Although the performance of all the Federal banking agencies in
the areas of consumer protection, civil rights, and community reinvestment is not satisfactory, the Federal Reserve Board's is certainly
the worst. The most dramatic evidence of this is the Board's failure
to develop an effective data collection system for enforcement of the
:fair housing laws and its current efforts to undermine the Community
Reinvestment Act.
Thus, from the perspective of consumers, minorities. and neighborhood residents, bank supervision would be improved if the supervisory role of the Federal Reserve Board were eliminated. This would
also enable the Board to devote more time to the conduct of monetary
policy.
Now I realize that there are counterarguments, arguing that the
Federal Reserve actually is more effective in implementing monetary
policy if it has some base as a bank supervisor.
One of the arguments made is the Federal Reserve can hold approval of bank holding company applications as a club to get the banks
to not extend their activities in the Eurodollar market, during periods
when the Federal Reserve Board was trying to limit the money supply.
However, I think these claims should warrant much further investigation before they are taken at face value.
They also raise serious questions as to the tradeoff between monetary policy and approval of applications is really in the public interest, or whether or not each supervisor or regulatory function should
be out in the open and should not be tied to performance in other
areas.
I also would like to comment just briefly on our strong feeling that
in terms of implementation of the Community Reinvestment Act, the
Federal Reserve has played a very negative role in that. The best evidence of that occurred yesterday when the Federal Reserve Board
denied a petition for reconsideration filed by a community organization protesting a bank holding company application. I attended that
meeting, and I was very shocked by the presentation made by the
Board staff to the Board of Governors. Because the presentation indicated several things, one, that the Board staff views the language in
the Community Reinvestment Act as basically a nullity, and that the
affirmative obligation standard set out in the act, they feel is merely a
preamble, and has no legal effect.
I also was somewhat shocked to find the staff is making misstatements of fact, and distorting the record in answering questions presented to them by the Board of Governors.
So I think there are serious problems here, and this is one of the
main reasons why we feel that ending the Federal Reserve Board's
supervisory role would be beneficial.
Thank you.
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[The complete statement of Mr. Brown follows:]
STATEMENT OF JON BBOWN, STAFF ATTORNEY, PUBLIC INTEREST RESEARCH GROUP
My name is Jonathan Brown. I am a Staff Attorney with the Public Interest
Research Group, a Ralph Nader organization. My principal assignment is to
monitor the IJ'ederal banking agencies.
·
S. 3304, the Federal Reserve Requirements Act of 1978, would authorize the
Federal Reserve Board to impose reserve requirements on transaction accounts
of all depository institutions and to pay interest on required reserve balances.
The bill would also require the Federal Reserve Board to establish fees for its
services. This legislation has been introduced and is being considered at this
time because of the ]'ederal Reserve Board's insistent protestations that declining System membership undercuts both effective implementation of monetary
policy and sound bank supervision. To some extent, the ]'ederal Reserve Board
views universal reserve requirements and payment of interest on reserves as
alternative solutions to the problem of declining membership.
More specifically, the Federal Reserve Board claims that declining System
membership undercuts the Board's ability to control the money supply, reduc~s
access to the discount window, and weakens the payments system. The Federal
Reserve Board also alleges that the resulting decline in its supervisory role
indirectly weakens its ability to implement monetary policy.
Since System memlJer loanks provide the ]'ederal Reserve Board with its political power base, the Board's claims concerning the adverse effects of declining
membership are clearly self-serving and must be viewed with considerable skepticism. Nonetheless, there are substantial reasons for a legislative revision of the
current structure of System membership.
First, it is sound public policy to divorce reserve requirements from System
membership. Tying reserve requirements to System mem!Jership results in an
unfortunate intertwining of the issue of reserve requirements with the size of
the Federal Reserve Board's political power base. Empowering the Board to impose reserve requirements on all commercial banks, regardless of whether they
are System members, avoids this problem. It also eliminates the need to pay interest on required reserves as a means to entice banks to join or remain System
members. Moreover, if adjustment of reserve requirements is in fact a useful
monetary policy tool, a Federal Reserve Board claim that runs counter to most
independent research on this issue, then divorcing reserve requirements from
System membership will allow the Board to adjust reserve requirements without
worrying about inducing changes in System membership. "Universal" reserve
requirements for all commercial banks would eliminate the role of the states in
establishing reserve requirements. However, this aspect of the dual banking system does not serve any great public purpose and its loss would be a small price
to pay for resolving the competitive equity problem and possibly improving the
conduct of monetary policy.
All depository institutions, including savings and loans, mutual savings banks,
and credit unions, whether System members or not, should have access to the
Federal Reserve discount window and to Federal Reserve services. No public
purpose is served by limiting access to System members.
Service charges should be imposed on all users of Federal Reserve servic~s.
Such explicit pricing would result in more efficient use of these services. Moreover, if all depository institutions have access to these services, not just System
members, then the Federal Reserve Board will not be tempted to underprice its
services for the purpose of increasing system membersip,. although other incentives would remain.
If Federal Reserve Board reserve requirements were imposed on all commercial banks, then there would be no pressing need to pay interest on. required
reserves. Under this approach sterile reserves would represent a tax on commercial banks. Whether this tax is appropriate and to what extent it would be
reduced or eliminated is a question for Congress to decide, not the Federal Reserve Board.
Once reserve requirements, access to the discount window, and access to Federal
Reserve services are divorced from System membership the apparatus of System
membership under which System members hold voting stock in the 12 Federal
Reserve Banks and elect two-thirds of the nine directors of each Federal Reserve
Bank serves no public purpose. In this situation system membership would
merely identify those state chartered banks that choose to be supervised by the
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Federal Reserve Board-if a continuing Federal Reserve Board role as a supervisor is found desirable.
Commercial bank ownership and more important control of the Federal Reserve Banks biases these institutions in regard to monetary policy in favor of
commercial banks and their large corporate customers and represents a gross
conflict of interest in regard to their supervisory functions. Thus, it is essential
that any genuine solution to the Federal Reserve membership problem remedy
this underlying bias and conflict of interest. To accomplish this the stock in
the Federal Reserve Banks should be retired and the Banks transformed from
quasi governmental entities to administrative divisions of the Federal Reserve
Board. The Reserve Banks' boards of directors should be abolished and their
Presidents appointed by either the President of the United States, with Senate
confirmation, or by the Board of Governors.
Reforming the structure of the Federal Reserve Banks, however, does not resolve the question of whether it is appropriate for a central bank such as the
Federal Reserve to have major bank supervision responsibilities. There are certain characteristics inherent in a central bank that are antagonistic to bank supervision in the public interest. In selecting Governors for the Federal Reserve Board
an important criterion is maintaining business confidence, and thus the Board
has an unavoidable bias in favor of large corporations and the banking industry.
The interests of consumers, labor, and minority groups receive less attention. As a
central bank, the Federal Reserve is dominated by a large staff that is oriented
toward highly technical economic and monetary analysis and lacks a broad perspective on issues of equity, such as civil rights, consumer affairs, community reinvestment and displacement. Finally, as a central bank the Federal Reserve has
developed a strong policy of operating in secrecy. This policy goes far beyond that
appropriate for bank supervision and unnecessarily impedes both Congressional
oversight of bank supervision issues and citizen participation.
Although the performance of all the federal banking agencies in the areas of
consumer protection, civil rights, and community reinvestment is not satisfactory,
the Federal Reserve Board's is certainly the worst. The most dramatic evidence
of this is the Board's failure to develop an effective data collection system for enforcement of the Fair Housing laws and its current efforts to undermine the Community Reinvestment Act. Thus, from the perspective of consumers, minorities,
and neighborhood residents, bank supervision would be improved if the supervisory role of the Federal Reserve Board were eliminated. This would also enable
the Board to devote more time to the conduct of monetary policy.
The CHAIRMAN. Well, thank you very much. This has been a very interesting panel. I think it is useful to have a public interest attorney
mixed up with economists every now and then. I think the panel this
morning establishes that.
Before I start with quastions, I would like to suggest that one way we
might consider ~oing-as kind of a first step-is first universal reserve
requirements, with exemptions, and nobody seems to really be very
much opposed to that. The Federal Reserve Board, the Treasury has
that as a first choice, the Federal Reserve Board suggested an alternative wnv of following that.
Actually the banks would, on the basis of either the Federal Reserve
Board's proposal or the Reuss proposal, in the aggregate at least, have
their earnings improved.
So that is a pracJtical possibility.
Second, charging for all services to everybody equally. Permitting
the big banks who want to compete with the Federal Reserve to come in,
encourage them to come in, and provide, in my way of thinking, a constructive competitive atmosphere that would be to the public's advantage. That is, not only charging for Federal Reserve Board services, but
correspondent bankmg services, making the whole system fully competitive that way.
Third, as Professor Pierce, argued, I thought so tellingly, access by
all depositors to the discount window, which, incidentally, combined
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with the second point I made would tend to eliminate a major reason
for being a member of the Fed. Universal reserve requirement8 would
mean membership wouldn't be necessary anyway as far as monetary
policy is concerned.
And, finally, following all of this up along the same line, eliminating
the prohibition against interest on demand deposits.
It would seem if we can achieve those ends in the next few years, we
would have a more competitive dynamic, efficient, and equitable banking system than we ha.ve now.
Professor Chandler, several witne~ have argued that membership
as such in the Federal Reserve is not necessary for the Federal Reserve
to carry out the functions of a central bank. Do you agree i
Mr. CHANDLER. I think the question of membership is of minimum
importance. The question is what kinds of reserve requirements are applicable to all banks, and the access to the discount window. Those are
two important things. If you can ·achieve those without membership,
then I have lost all interest in the membership question.
The CHAIRMAN. On the other hand, if you do not have universal reserve requirements, membership then becomes significant. If we didn't
change anything, if we permitted the present situation to continue,
with the notion of membership in the Federal Reserve continuing as
the Federal Reserve Oh.airman argues it is, do you think that would
have an adverse effect on effective monetary pohcy ~
Mr. CHANDLER. That is a serious question, because a larger and larger
part of the bank resources would be outside of the system, and not subjedt to reserve requirements. That is the major difficulty. There are all
sorts of political arguments that are made about the Federal Reserve's
political base, that sort of thing, to which I attach almost no
unportance. Perhaps they do.
But to me the question of what instruments are available for what
purposes is far more important than Fed membership.
The CHAIRMAN. I would like to ask both you and Mr. Pierce,
you are both highly respected monetary economists, and both of
you are in :favor of universal reserve requirements, at least for transaction accounts, as I understand it.
Both of you said such universal reserves would enhance monetary
management. You say this even though there is no empirical evidence
that conclusively supports or reflects the need for universal reserve requirements.
So I would like to hear your reasoning for the conclusion that uniform reserve requirements would be a desirable way to enhance monetary management and solve the membership issue. Dr. Pierce, why
don't you go first.
Mr. PIERCE. Your assertion is correct. So far as I know, there is no
empirical evidence to support the claim that the attrition of membership has materially damaged monetary policy.
There are two reasons that membership as now constituted is important. There is empirical evidence to suggest that shifts of deposits
among different sizes of banks that are members does have an effect on
the predictability of the relationship between open market operations
and money and credit. The issue is "Can the Fed figure out what the
effect of its monetary policy will be on money and credit i"
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The reasons for the Rube Goldberg reserve requirements we have
now is to attract and retain members. Great efforts were expended to
try to give a menu of reserve requirements to keep banks in the system.
Shifts of deposits among classes of banks that are members do
cause problems. Not large problems, but they cause problems in
predictability.
The second point I want to make is that as a larger and larger share
of the deposits are outside of the Federal Reserve System, then the
likelihood that the relationship between open market operations and
money and credit expansion will become less and less predictable.
I can't prove the assertion empirically, but theoretically one can
show that that is the case. I think commonsense just says that as well.
Loss of reserves through membership attrition is the func,tional equivalent of a very large reduction in reserve requirements. The function
of reserve requirements is to put a brake on expansion of money and
credit in the economy. As we have more and more deposits outside of
the banking system, then effectively the reserve requirements for the
whole hanking system are lowered as a result of that. And the relationships are less predictable.
The CHAIRMAN. On the other hand, if you make them comprehensive
and universal, you can have lower reserve requirements, isn't that true i
Mr. PIERCE. Yes, and no. I am troubled by what I view to be contradictory parts of what the Federal Reserve may do.
We need reserve requirements to make that relationship between the
open market operations and money and credit more predictable. But
the lower the reserve requirements are, even though universal, the
less predictable the relationship will be anyway.
The CHAIRMAN. I am not saying you can eliminate them or have
tiny reserve requirements. I am saying that they can be reduced if they
are universal, and then you have two things: (a) you have equity, and
(b) you have a more effective monetary system at any given level of
reserves. Obviously therefore you can get the same effect with a somewhat lower reserve requirement.
Mr. PIERCE. I think so, although I am not certain of that. That is
certainly not a theorem. It is possible that you will get more predictable relationships with universal reserve requirements, but lower
requirementsThe CHAIRMAN. How :predictable does your monetary policy have
to be i It is not very predictable. We get the chairman to come up and
Arthur Burns, who was a brilliant economist, and Chairman Miller,
who is a highly competent man come UJ:> and they are way off. They
can never come anywhere near their estimates of what the increase in
the monetary aggregates are going to be. They are about as far off as
they can get.
Mr. PIERCE. My short answer is not very important.
The CHAmMAN. OK, it is not very important.
Mr. PIERCE. I think that is right. Of all of the problems facing monetary policy, figuring out what to do and how to do it, the kind of predictrubility I have been discussing is not very high on the list. It is a
factor, and I think that if one can do something to make monetary
policy more easy to conduct, then one should.
Let me add just one point. I am afraid something may get lost in the
bills being proposed now, not S. 3304, but in the Reuss bill, for example, which addresses only commercial banks. For monetary con
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trol, one has to talk about all transactions accounts. Universal reserve
requirements really have to be universal with respect to all transactions accounts, no matter where they are.
The CHAIRMAN. We are talking about universal reserve requirements
with an exemption.
Mr. PIERCE. An exemption is OK, but what I mean is that thrift
institutions must be included. Right now their exclusion is not an
important problem. But it won't be many years before transactions
accounts at thrift institutions are very big.
The CHAIRMAN. Every witness has said that, as far as transactions
accounts are concerned, including the witness representing the thrift
institutions himself. He recognized that they had to have that for
transactions accounts.
Mr. PIERCE. I am concerned that point will get lost. I think that it
would be very unfortunate if one waits until we have these accounts
and then tries to impose reserve requirements. Politically I think that
will be very difficult, it is a lot easier to do it now.
The CHAIRMAN. Dr. Chandler?
Mr. CHANDLER. I see no objection to having an exemption of acertain minimum amount from reserve requirements, or zero reserve requirements for another certain minimum. But I have heard people
talking about setting that at $100 million per bank or financial institution. That strikes me as being clearly excessive.
The CHAIRMAN. $100 million for both demand and time deposits.
That was the House Chairman's proposal.
Mr. CHANDLER. OK. But the main point I want to make is if you set
them that high-The CHAIRMAN. The Fed was $25 million and $25 million and a
total amount Chairman Reuss suggested was $100 million.
Mr. CHANDLER. Yes. Even if it is total demand plus time plus securities sold to customers under repurchase and so on, that is getting
up to a pretty good sized bank.
The CHAIRMAN. The first $100 million would be exempt, so you
wouldn't have a cutoff period, where all of a sudden you covered all
of your deposits.
Mr. CHANDLER. Suppose we take $100 million total deposit liabilities, with everything below that exempt, then you have a real possibility here of large net shifts of funds from institutions subject
to positive reserve requirements, to zero or from zero to positive.
The CHAIRMAN. Well, yes, and we are aware of that, in fact Chairman Miller suggested that we make sure that we have in the legislation prohibitions against being able to have a holding company divide up into nothing but $100 million institutions.
Mr. CHANDLER. That is not the danger that I was referring to,
although it is real.
The CHAIRMAN. I see your point.
Mr. CHANDLER. You still get $1 million net shift from banks with a
positive reserve requirement of 7 percent to banks with a zero requirement, or vice versa.
The CHAIRMAN. Your contention is not we shouldn't have exemptions but it should not be as high as $100 million?
Mr. CHANDLER. Something below half of that, it seems to me,
yvould probably not only be acceptable, but would have a lot of political advantages anyway.
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But I would warn against raising that level too high.
The CHAIRMAN. I would like to hear your reasoning for your conclusion that the uniform reserve requirement would be a desirable
way to enhance monetary management and solve the membership
issue.
That was my fundamental question, which you haven't answered
yet.
Mr. CHANDLER. If the exemption were set low enough, so very
large amounts of funds could not be shifted from positive reserve requirements to zero, then at the margin you could have uniform level
of reserve requirements against transactions accounts, which ought
to give you a more or less constant multiplier between the reserve
base and the monetary magnitudes.
The CHAIRMAN. You said reserve requirements should be lowered,
and that would reduce the cost of idle reserves. The question I have is
how low can reserve requirements be and still be a useful monetary
tool? Also, is there a need for reserves against time and savings deposits or do you agree with Professor Pierce that reserves against
such deposits could be zero?
Mr. CHANDLER. I think both he and I would have trouble being dogmatic on that one.
The CHAIRMAN. Start with the first one, how low can reserve requirements be and still be a useful monetary tool?
Mr. CHANDLER. On transactions balances?
The CHAIRMAN. Yes.
Mr. CHANDLER. Somewhere below 10 percent, I would say in the
range of say 7 to 10 percent. That is fairly arbitrary.
The CHAIRMAN. That is fairly close to what the Federal Reserve
said 7 and 9 percent. Chairman Reuss said 6 percent. Do you think
that is too low 1
Mr. CHANDLER. I have no way of saying it is too low. As you get
to lower levels, you run into the danger that the legal reserve requirements will at certain times be below what the banks want to hold for
prudent purposes.
I would always like to have the legal reserve requirement high
enough so that at least most of the time it would be higher than
what the banks would elect to hold voluntarily. So that in fact you do
get a solid base on which to operate.
The CHAIRMAN. Professor Pierce, I would like you to comment on
Mr. Brown's very interesting charge against the Federal Reserve.
It is one that I thmk an expert like you, who is very familiar with thf.
responsibilities of the Federal Reserve, can give us some help on.
He argues that the Federal Reserve tends to overlook the interests
of consumers, labor, minority groups, and so forth, and here is what
he says, and I quote :
As a central bank, the Federal Reserve u; dominated by a large staff that
is oriented toward highly technical economic and monetary analysis and lacks
a broad perspective on issues of equity, such as civil rights, consumer affairs,
community reinvestment, and displacement. Finally, as a central bank, the
Federal Reserve has developed a strong policy of operating in secrecy. This
policy goes far beyond that appropriate for bank supervision and unnecessarily
impedes both congressional oversight of bank supervision issues and citizen
participation.
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I think that is a rather. gentle criticism, as a matter of fact. He
could have been sharper than that, and pointed out that the Federal
Reserve, of course, has its constituency among bankers. Very often
the people who are appointed to it are former bankers, and the Open
Market Committee, one of the principal policymaking arms, is composed very largely of bankers.
So that that tends to reinforce the criticism Mr. Brown makes.
What do you think of that 1
Mr. PIEROE. First, I agree that Mr. Brown's criticisms were delicately and nicely put. I also agree with them, with one exception. The
Federal Reserve does have a very large staff and a very good one.
But it has a very large number of people who are assigned to the very
problems that he described. Not all of the staff concerns itself with
monetary policy. There are hundreds of people who worry about regulatory questions at the Federal Reserve, both at the district banks
and the Federal Reserve Board.
The problem is not that the Fed is overwhelmed by tJhe specialists
who concern themselves with monetary policy, but rather that the
Fed's first interest is in monetary policy, and I think very often it views
these regulatory questions as a pa.in. I think the Fed believes very
strongly it should be in the regulatory business, and has certainly
testified to that effect, but one hears complaints, I understand you have
heard them yourself, from former members of the Fed that too much
time is spent on regulatory questions relative to monetary policy.
These complaints are indicative of the attitude of the Federal Reserve. It would rather be doing something else than worrying about
whether the statutes Mr. Brown referred to are being enforced in the
spirit in which Congress passed them. I think there is really no way
to solve that dilemma without really having the Fed get out of a lot of
regulatory areas. There is a conflict. I don't think these are people who
want to flaunt the Congress, but rather that it is viewed as a pain, to
have to do these things.
Well, one can remove that pain by giving some of those responsibilities to agencies that view it as tJheir function and their duty to enforce
these laws with great vigor.
So I agree basically with what Mr. Brown said.
The CHAIRMAN. Let me ask you further about the issue of secrecy.
David Lilly, who was a Governor of the Federal Reserve Board, wrote
me last year, and said:
I see no reason why the release of the policy directive of the OMO needs to be
delayed. Everyone should have the same access to the decisions made by the OMO.
Currently, only those brokers and dealers with large staffs monitoring Federal
Reserve policy on a daily, and in some cases hourly basis can know what monetary
policies the OMO is pursuing. This is discriminatory and gives brokers and dealers
advantage over the ordinary citizen.
· Mr. PIERCE. I agree with that. The brokers and dealers, or dealers,
I would say, all have staffs that are Fed watchers. It is a matter of
hours, probably minutes, before they have figured out that the Fed has
changed the intervention point wit'h respect to the Federal funds rate.
The general public doesn't know about a change in policy for 30 days.
Now I see no reason to keep the general public in the dark. The
secrecy does not achieve what it is intended to achieve, namely, to hide
from the market what the Fed is up to. I have never understood why
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the central bank .finds it in its interest to try to fool the public by not
disclosing immediately what it is up to. But be that is it may, it doesn't
even accomplish that goal, because the dealers are able to .figure out
quickly when the Fed changes policy.
·
After all, the Fed changes policy by buying and selling securities
from those very dealers, so it is not very difficult for them to .figure out
when the Fed has changed policy. So I agree with Mr. Lilly's position.
The CHAIRMAN. Mr. Chandleri
Mr. CHANDLER. I think there is every reason why they should make
public the policy statement 24 or 48 hours later, whatever time it takes
to prepare it. I see no reason to withhold it.
On the other hand, I do think that the Board should have privacy
in ·arriving at its policy decision. I think that the presence of large
numbers of people at the meeting, or even a few who will do a lot of
talking, would tend to inhibit discussion, frank statements of views,
and that sort of thing.
But they should make their policy statement public say 48 hours
after they arrive at it. That seems perfectly reasonable and desirable.
The CHAIRMAN. Mr. Brown, last February, as I said, former Governor Lilly wrote me after he left the Federal Reserve Board, and he
indicated ways in which he thought the system could be improved.
Those included changes in appointment of Federal Reserve Hoards of
Directors, and he said :
Only the three class C directors are chosen by the Board of Governors. The
class A and B directors are chosen by the member banks. This ostensibly gives
the member banks a larger voice in the running of the Reserve banks than the
Board of Governors. In light of the reforms made with regard to the interests to
be represented by members of the Board of Directors made by Public Law lr.>-188,
I believe it would be desirable to have both class Band class C directors selected
by the Board of Governors in Washington.
Do you have ·any views on that~
Mr. BROWN. That would definitely be a modest improvement over
the current situation. You have two-thirds of the directors selected by
the Federal Reserve Board, which are Presidentially appointed members. But I think it doesn't deal with the underlying problem, and that
is why should there be any directors who are elected by the banking
industry, when in fact those banks regulate the banking industry~
I think it is analogous to allowing the oil companies to elect members
to the Federal Power Commission, or the airlines to elect members to
the CAB. It just stands contrary to the sound principles of regulatory
·administration. I think it is an anachronism that grew out of the formation of the Federal Reserve System, the idea that the banks would
be a cooperative venture on the part of the commercial banks that comprise that district, they would buy stock in the Federal Reserve banks,
and therefore they would have ownership and should have voting
rights.
I think we have long passed the stage where there is a need to view
the Federal Reserve banks as a cooperative endeavor with commercial
banks.
I think the Federal Reserve banks should be administrative subdivisions of the Federal Reserve Board and the stock of the commercial
banks should be retired and the board of directors abolished outright.
I don't think they serve any legitimate function, other than advisory.
President Carter and many others have raised a lot of questions about
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the value of advisory committees, the way they have been handled in
most agencies.
The CHAIRMAN. Senator Sarbanes. I might say Senator Sarbanes sat
at Professor Chandler's feet a few years ago at Princeton, and it is
good to see a professor having to sit •at the feet of his former pupil.
Senator SARBANES. Mr. Chairman, I am not going to carry that
analogy very far. I have no questions, I really just came to pay my
respects to Professor Chandler from whom I feel I have learned a great
deal. I am not sure how often my colleagues here agree with that, but
I am pleased to welcome him today.
Mr. CHANDLER. Mr. Chairman, might I make a comment on one proposal, to which I am absolutely opposed, and that is that the presidents
of the Reserve banks be appointed by the President with the advice
and consent of the Senate.
I think monetary policy responsibility should be concentrated in the
Board of Governors, and there should not be another competing group
of people out there claiming Presidential and congressional approval,
who would then divide responsibility and shift it around.
I am all for anything that will concentrate responsibility in the
Board of Governors; as far as I am concerned, you can abolish the
boards of directors of the individual Reserve banks if you want to,
it would be very little loss, anyway, but this business of having a Board
of Governors in Washington and 12 Presidential appointees out in the
various Reserve banks makes no administrative sense whatever.
The CHAIRMAN. When it comes to the fundamental instrument of
monetary policy, open market operations, you have the Open Market
Committee, which has five of its members selected, as I understand it,
from the Reserve presidents, who are appointed by the-Mr. CHANDLER. You should concentrate responsibility for open
market operations in the Board of Governors.
The CHAIRMAN. Have the seven members of the Federal Reserve
Board determine open market policy instead of the 12 ~
Mr. CHANDLER. I think that would be better.
I know something about the history of the Federal Reserve, in the
days before power came to be concentrated in the Federal Reserve
Board, and I can tell you that was a disgraceful history as the 12 presidents upset the applecart time after time. I don't want to see a repetition of that.
Mr. PIERCE. Mr. Chairman, I agree with Professor Chandler. I just
want to make one additional point, or argument in favor of what he
proposed. Namely, I know there has been a lot of discussion of having
the Federal Reserve Bank presidents appointed by the President and
confirmed by the Senate. Since they sit on the FOMC, that seems somehow appropriate, in fact, it has been argued that the configuration is
unconstitutional. Be that as it may, I want to warn you that one doesn't
buy very much by such an arrangement. While it is an improvement to
have the bank presidents appointed by the President, the reason you
are not buying very much with that reform is the Federal Reserve
Board approves the budget of the Federal Reserve Banks. It is extremely difficult for a Federal Reserve Bank president to be very independent, if he knows that if he goes too far from what the Board
of Governors would like him to do, he can have his budget cut.
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It is very detailed control the Federal Reserve Board has over the
Federal Reserve banks. They are not free agents, and I don't think they
should be treated as such and accorded a Presidential appointment and
think somehow we have 12 people out there representing different parts
of the country. Such an arrangement wouldn't work as long as the
Federal Reserve Board has budgetary control over the Reserve banks.
I can't figure any way to eliminate that control.
The CHAIRMAN. You can't eliminate it. You could give Congress
control over the Federal Reserve budget.
Mr. PIERCE. You could do that.
The CHAIRMAN. They should have it.
Mr. PIERCE. But that is a separate issue, I agree with that, but it is
a separate issue. I think the easiest solution is to do what Professor
Chandler recommended, simply to have the FOMC composed of Board
members and not to have the current arrangement in which the Board
sets reserve requirements and the FOMC makes open market operation
decisions. Rather, there should be one group of people who make
monetary decisions, and that that group should be in Washington,
and it should be the Federal Reserve Board, period.
The CHAIRMAN. One role played by reserve requirements that are
j.mposed by the Federal Reserve is as clearing balances through which
transfers are made. In e:ffect they are a type of demand deposit and
collections are cleared against them.
Viewed in this manner, wouldn't it be most use:ful to consider interest on reserves, when the subject of interest on demand deposits is
discussed, not as a separate issue? I think we would have a better and
more dynamic system if we permitted interest on demand deposits.
Mr. Pierce?
Mr. PIERCE. I think they are analogous. I raised that point in my
testimony. I agree that if the Fed is going to pay interest on reserves
and charge for services, I think it is appropriate that the banks do the
same thing with respect to their customers. And to separate those two
parts would be a mistake. One ought to buy something with the payment of interest on reserves.
The CHAIRMAN. Dr. Chandler, before you answer, let me just say
that we talked a lot and the bankers are very sensitive to the fact that
they have to sterile part of their earning assets in effect by putting
them in reserves, which don't give them any return. At the same time
they benefit in a sense from the fact that they have enormous amounts
of demand deposits, usually greatly exceeding their reserves, on which
they pay no interest.
So why wouldn't it be sensible, if we are going to permit interest on
reserves, to have interest on demand deposits considered at the same
time?
Mr. CHANDLER. There has never been a decent case against payment
of interest on demand deposits. They came in under false pretenses.
The CHAIRMAN. That was in the beginning of the depression?
Mr. CHANDLER. They came in in 11:)33, in the Banking Act of 1933,
when everybody's attention was devoted to opening the banks, and
this went in without debate. It had been opposed the preceding year
when it was in the Banking Act of 1932, and didn't get through at
that time, but it slid through with everything else in 1933.
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The CHAIRMAN. So if we pay interest on reserves and don't permit
interest to be paid on demand deposits, the banks would really be
having their cake and eating it, too. It would seem, from the standpoint of the taxpayers that they lose in interest on demand deposits,
and save in no interest on reserves.
Mr. CHANDLER. I can argue the Treasury is paying through the
nose on this. The public is willing to hold demand deposits now equal
to only 13 percent of GNP whereas it was 30 percent in 1950. So
households and business firms have found all sorts of ways of economizing on demand deposits, not only by holding savings and time deposits,
but all of the other liquid assets you can think of.
This has lowered the volume of deposits, cut down the amount of
securities held by the Federal Reserve, below what it would have been
otherwise, and costs the Treasury hundreds of millions of dollars a
yerthink that is one of the least objections to the prohibition on demand deposits, but it is one.
The CHAIRMAN. You have an interesting confusion of what transactions accounts are, because the whole thing is so dynamic. You
both mentioned automatic transfer from savings to checking accounts,
that will be permitted after November 1, 1978. This new bank service would definitely give savings accounts, at least a portion of savings accounts, the characteristics of a transactions account as defined
inS.3304.
How should the question of reserves against transaction accounts in
automatic transfers be handled i Should, for example, a new category
of deposits called transaction savings be defined, with special characteristics i You are shaking your head.
Mr. PIERCE. They are a checking account with another name. Whatever reserve requirement is appropriate for conventional checking
accounts is also appropriate for the same thing with a different name,
with automatic transfer or NOW accounts, or whatever.
I would add that we are having this proliferation of these strange
accounts precisely because of the prohibition against payment of interest on demand deposits. This problem would disappear if interest
were simply paid. It wouldn't be necessary to dream up these clever
ruses that the lawyers say render an account not a demand deposit,
when the economics makes it a demand deposit.
Mr. CHANDLER. I might add to that that even if you say that these
savings accounts automatically transferable to demand are demand
dep~s1ts, which you should, you are still going to have, with this electromc funds transfer system developing, all sorts of new ways of making shifts among these different assets, quickly and very cheaply, so
that you are just going to have to watch this as the years go by and
recognize you will probably be two ste:es behind all of the time. Because a lot of very clever people with h1ghpowered computers can do
almost anything of this sort.
The CHAIRMAN. Senator Sarbanes?
Senator SARBANES. I am sure this question has already been addressed, because I know the substance of it is in both of your statements. But if we were to rationalize the reserve requirement both in
terms of to what accounts it should apply and the level of the re-
33-587 0 • 78 • 17
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quirement, what is the argument for paying interest on such revenues
instead of simply requiring them as, in e:lfect, a condition of being
ing the banking business i
Mr. PIERCE. Requiring the banks to take a certain amount of their
assets and hold them in noninterest bearing form is equivalent to a tax.
The rationale for requiring banks to hold these funds idle is for
purposes of monetary policy. But it is costly to the banks in the sense
that they could have earned interest on the funds if they had invested
them in the market.
I think as a matter of .Public policy, if a certain group is singled out
to act differently than 1t otherwise would, in the interest of public
policy, that group should be compensated.
Senator SARBANES. Except the banks have an interest in a properly
functioning monetary system.
Mr. PIERCE. No more thanlou or I. The banks just happen to be
the vehicle. I am as intereste in that as the banks are and I would
object if you passed a law saying I had to put a certain amount of my
money aside and not earn interest on it. I don't think their interest 1s
any greater with respect to the stability of the economy than anyone
else's, or any less.
No, I don't think one can argue that. And furthermore, ou get
perverse reactions--Senator SARBANES. Why don't other countries pay iU Our study
shows that hardly any other major developed country pays interest on
the reserve requirement.
Mr. PIERCE. Professor Chandler can answer that better than I can.
Very few countries have idle reserves, Senator, which I think helps
explain why that is true. You can hold them in Treasury bills, and that
is no problem.
Mr. CHANDLER. There is no problem if they hold them in Treasury
bills, but it doesn't do_ an:y good ei!her. .
.
.
.
Mr. PmRCE. That 1s right. It 1s a nomssue 1f, as m other countries,
the banks are allowed to hold the reserves in the form of, say, government securities. Then you lose the whole function of reserves as
a brake on expansion of money and credit.
We do it differently, we say hold that money idle, because it gives
us a more predictable monetary policy instrument. That is fine, I agree,
but it injures bank profits, it causes the membership problem. Why be
a member bank if you can be a nonmember-Senator SARBANES. You wouldn't have a choice as to whether you
would be a member so far as reserves are required. It would be a requirement. Why should the system operate in such a way that the
banks can choose to opt out of the operation of monetary policy i
What is the rationale for that i
Mr. PIERCE. None. But the reason that it is an issue is be<Jause it is
costly for banks to have required reserves. For monetary policy it is
needed. We need universal reserve requirem~nts. But then there is the
issue of does Congress want to tax banks in that way.
The CHAIRMAN. We don't tax banks in any other way to speak of.
They pay less taxes than any other industry.
Mr. PIERCE. I agree with that, that is true.
The CHAillCAN. Less than half.
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Mr. PIERCE. I agree. But you get a lot of resistance. For example,
the obscure issue of repurchase agreements is a way of escaping reserve requirements. It is very much in the bank's interest to find ways
to avoid reserve requirements, because it enhances their profitability.
As Professor Chandler pointed out, the regulators are always three
steps behind in trying to keep up with these clever methods of avoiding required reserves.
If interest is paid on reserves, the incentive to come up with all of
these clever methods disappears. I think interest should be paid. But
this is a terrible year to do it. It is the last item that would be on my
list of taxes to cut. And so I think one will have to wait.
Senator SARBANES. Every year would be a terrible year. I don't see
why, as is indicated by Professor Chandler's approach, if you are
going to lose some revenue, it doesn't make more sense to rationalize
the reserve requirement by reducing the percentage required. It will
still cost you revenue, but that is a better way to do it. If you can
arrive at a reasonable figure to give you the base for monetary policy,
why shouldn't every bank in effect have to meet that condition to
engage in the banking business?
Mr. PIERCE. If the Congress wants to levy that kind of excise tax,
to have a banking license, if it decides that is a proper public policy,
fine.
The CHAIRMAN. If the Senator would yield at that point, we have
always had that. It seems to me the burden of proof is on the side of
those who say required interest on reserves. In the 200-year history of
this country we have never had a situatiol). in which the central bank
has paid interest on reserves. Isn't that right? And as Senator Sarbanes points out, we can't find any, although other systems are different
than ours, in which interest is paid by the central bank or ultimately
by the taxpayer on reserves.
It seems to me a small price to pay for the advantage that bankers
have. You go back to the old system of the goldsmith, and people deposited their gold bars, and you had 100 percent reserves, you would
have to keep all of that gold there; then they developed fractional reserves, and it was a pretty good system. Now we want to in effect pay
interest on everything. I think if we are going to move to that new system, there ought to be a clear, strong case for doing so.
Mr. PIERCE. One of the cases is to charge for the services. The Fed
has rationalized not charging for services as a compensation for not
paying interest on reserves. Those services have been in existence
as long as the Fed has been in existence. If the Fed starts charging for
services, and does not pay interest on reserves, then the banks are worse
off. You have. increased the tax in effect. Maybe you want to do that.
Senator SARBANES. It depends on what the reserve requirement is.
You can change the amount of reserves that have to be held and
thereby free up a significant portion of their assets to be earning
assets and consider that a more rational way to straighten out the
system, than to maintain higher levels of reserves and then pay in,
terest on them.
If you are going to lose revenue, wouldn't that be a more-would
you put that ahead of paying the interest as the way to lose revenue?
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Mr. PIERCE. The lower the reserve requirement, the less injury to the
banks, but also the greater the chance that you will injure monetary
control. The- purpose of the reserve requirement is to make relationships between monetary policy and money and credit more predictable and stable. The lower the reserve requirement is, the less predictable and less stable the relationship. And you don't get something
for nothing in this. If the Fed reduces reserve requirements to 8 percent, money and credit would be less predictable than if reserve requirements were 20 percent.
So there is a tradeoff. The Treasury loses income in either case, because with less required reserves, there will be a loss in revenue that
way, or if you lose the revenue by having reserve requirements at a
level that is more appropriate for monetary policy, whatever the number is, and pay interest on it.
Senator SARBANES. Do you think the current level is too high for
monetary policy purposes~ Significantly too high 1
Mr. PIERCE. The reserve requirement on large banks, about 16 percent, strikes me as too high.
Senator SARBANES. Substantially too high~
:Mr. PIERCE. Yes. And it is also too complicated.
Senator SARBANES. If that is the case, I don't think your previous
reply really was on point. The question is still before you, if you are
going to lose some Treasury revenue, is the more rational way to lose
it as a first step by revising downward the reserve requirements, or by
paying interest on reserves.1
Mr. PIERCE. I am not convinced that the Fed, in taking reserve requirements from 16 percent to 8 percent on demand deposits, did the
appropriate thing. I doubt whether the Federal Reserve made the calculation to arrive at that 8 percent on the grounds of money policy. I
think it made the calculation in order to try to keep members. The Fed
tried to attract banks as much as it could by indirectly spending the
Treasury's money rather than paying interest on reserves. I think
that is unfortunate.
I think the issue ought to be faced as to what the appropriate
reserve is for monetary policy.
Senator SARBANES. That is a good point. If you pay interest on the
required reserves, you introduce a factor into the level of the required
reserve unrelated to monetary policy, that factor being that you are
paying interest and you have a chance to save money on the payment
by lowering the reserve requirement, so it seems to me it is a cleaner
way to approach the system by saying what is the level we ought to
have as a required reserve for purposes of monetary policy, and that
is a condition of doing business, unencumbered.
. If you pay interest, then you have pressure to get it lower to pay less
mterest.
Mr. PIEROE. But you now have the pressure to have lower reserve
requirements, in order to not cost the bank so much money. I don't
think you avoid that pressure one way or the other. I think the
pressure is less if you pay interest. At least from the private sector.
Senator SARBANES. I am not arguing for the present system. I am
trying to cut through it.
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Mr. PIERCE. I think the conflict is still there. The banks want low
reserve requirements as long as they don't receive interest. I don't
blame them. There is a conflict.
Mr. CHANDLER. Could I comment further on this~
First, the present system of reserve requirements are, I am sure,
considerably above the level necessary for effective monetary management. A substantial cut would not cost much in terms of efficiency
of management.
Second, the present discriminatory tax is really a disgraceful tax;
it isn't equitable by any standard. You leave out big banks that are
nonmembers, who are not taxed at all. You tax smaller banks that
are members, et cetera.
If you could move to a system of universal reserve requirements,
suppose we could solve the problem of what is the right level, whether
8 or 9 percent or what, applicable to all transactions balances, then
I think there is a good case for the Fed charging for its services it
renders, then the question of interest on required reserves becomes
much less important. Certainly not for membership reasons is it any
longer important. It may be important from a political point of view,
I am not a judge of that, in getting the reserve requirements, maybe
this is a price, a political price that has to be paid to get the reserve
requirements.
But it would still be true that even though the tax were in some
sense equitable among all of the financial institutions, it is still a tax
on financial intermediation. If the judgment is this tends to discourage
the development and use of financial institutions, I think there is
some argument for reducing the net tax by giving some interest on
required reserves, in order not to have too large a burden upon the
process of financial intermediation. And in the long run, of course,
the tax is likely to be paid by stockholders, by depositors, by borrowers, and not say some corporation.
So it seems to me that the first thing to do is to get to the point
where payment of interest on required reserves is less important.
And then to make the decision on that.
Mr. PIERCE. If I could raise a related point, I think that the evasion issue is very important. Banks have a strong incentive, and
still would even with an 8 percent reserve requirement, to spino:ff
their deposit business to their holding company in order to avoid
reserve requirements. It is perfectly possible for the finance company subsidiary of a bank holding company to issue liabilities that
are not called deposits, they would be called something else, but they
in effect would be deposits. These deposits would be outside of the
banking system, would not have any required reserves and would not
be insured. This behavior would be unfortuate, but the profit incentive is there. The company can have 8 percent reserve requirement by
simply issuing the same savings account out of the finance company
that it could issue out of the bank.
This shift would be socially undesirable. There is less regulation
:ind no insurance for liabilities of holding company subs. I think there
1s no way to keep ahead of the banks in their avoiding regulations of
this kind. They are very clever. And if you say all right~ you can't
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issue paper out of the finance company, then they will dream up
something else, some other way to do it. I think there is a social
cost involved in bringing more and more banking outside of banking.
You have a lot of that already, which reserve requirements certainly
encourage. And so one buys something with paying interest on reserves, namely, you take away some of the incentive to spin activities
off of banks.
The same phenomenon occurs with Eurodollars, there are all kinds
of examples.
The CHAIRMAN. As a practical matter, we come down to the fact
that the proposal by the Federal Reserve Board and by Chairman
Reuss both, as I understand their proposals, would not provide for
interest on reserves, would benefit the banks, their earnings would be
increased, it ·would permit a lower level of reserves, a substantial
exemption.
It would also permit a charge for services, also permit all depository institutions to have access to the Federal Reserve window, and
I think it would be a very substantial improvement without having
to get into this situation of food stamps for bankers.
Mr. PIERCE. I agree. I have been trying to make the case why
Congress should consider paying interest on reserves. I think if one
gets all of the other features and doesn't get the payment of interest
on reserves, I would be delighted, provided the bill is in the form
I suggest. I think it would be great.
The CHAIRMAN. Gentlemen. I want to thank you very much for a
most interesting morning, it was so interesting we couldn't let you
go when we should have, because we have two very distinguished witnesses to follow you.
Our next witnesses are Leland S. Prussia, executive vice president,
Bank of America, and Dr. James O'Leary, vice chairman of the U.S.
Trust Co., representing the New York Clearing House Association.
I want to apologize, gentlemen, for having detained you. I am sure
you enjoyed the testimony of the previous witnesses, too.
Mr. Prussia, you may proceed.
STATEMENT OF LELAND S. PRUSSIA, VICE CHAIRMAN AND
CASHIER, BANK OF AMERICA
Mr. PRUSSIA. Mr.. Chairman and members of the committee, I am
Leland S. Prussia, vice chairman and cashier of Bank of America.
I am very pleased to testify today on S. 3304, the Federal
Reserve Requirements Act of 1978. Because of the inequities in both
the laws and regulations governing depository institutions, there exist
significant disparities in competitive relationships among institutions.
e believe that in addressing universal reserve requirements, interest
on reserve balances, and charge for Federal Reserve services, S. 3304
would help to reduce these competitive inequities. Morevor, this proposed legislation would improve the effective management of monetary
policies. Bank of America, therefore, welcomes the opportunity to publicly support the thrust of these reform measures.
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EQUAL TREATMENT FOR EQUAL POWERS
Over the years, imbalances and distortions developed in our financial
system as legislation was enacted in a piecemeal fashion to respond to
competitive innovation. Historically, special treatment such as :higher
interest rate ceilings or a tax-exempt status was granted some institutions such as savings and loan associations and credit unions which
provided them with significant competitive advantages. However, recent innovations in the scope of permissible services such as NOW accounts and share drafts, as well as legislatively expanded powers, succeeded in creating a further competitive imbalance favoring such institutions. S. 3304 partially addresses these inequities.
Bank of America prefers to see Congress enact comprehensive financial reform based upon the principle of equal treatment-in terms of
regulations, reserves, and taxation...:...for institutions offering ·equal
services. The concept of equal treatment for equal powers permits all
financial institutions to compete on the same basis with resulting economic efficiencies and broad public benefits.
In the area of Federal Reserve membership, the inequities of the
membership burden have increased significantly over time. Member
banks pay an implicit tax, estimated by the Federal Reserve at $1.7
billion, in the form of noninterest earning cash reserves maintained
with Federal Reserve Banks. While member banks must hold idle
balances, non-member depository institutions may use their reserves to
purchase services from correspondent banks of their choice or to purchase earning assets.
Because no comprehensive reform appears currently possible, and
because of the increasing inequities of the membership burden, Bank of
America proposes the followmg program, major portions of which are
included in S. 3304
1. Concerning reserve requirements, we propose universal graduated
reserves, that would :
Be applicable on the same basis to all types of institutions offering depository services.
Be lower for smaller sized institutions.
Be equal for demand deposits and other transaction accounts.
Be extended to include time and savings accounts for all institutions where such accounts.are offered.
2. Concerning payment of interest on required reserves, we propose
that:
Interest be paid at a rate that is market determined.
One rate be paid to all institutions regardless of size.
No limit be set on the maximum aggregate interest payments.
3. Concerning charges for Federal Reserve services, we propose that
such charges :
Be made explicit for each !"ervice.
Be priced on the basis of direct and indirect costs, including
taxes and nn implicit. return on capital (to be competitive with
privately effered services).
Permit access for all institutions subject to reserves.
I would like to comment in more detail on each part of the program
I have just outlined.
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UNIVERSAL RESERVE REQUIREMENTS
Bank of America strongly supports the concept of universal reserves
contained in S. 3304. As depository institutions become more alike,
equality in regulations becomes essential. One category of financial institution, member commercial banks, should not be required to assume
a disproportionate financial burden in order to secure for the general
public such broad benefits as effective monetary policy management, an
efficient payments mechanism, and the high quality of our financial
system. Unequal reserve requirements, because they directly affect the
profitability of financial institutions, may ultimately influence an institution's willingness to offer a service or innovate a new service-to the
potential detriment of the general public.
We support the imposition of equal reserve requirements on all depository institutions-commercial banks, mutual savings banks, credit
unions, and savings and loan associations--but we prefer a more expansive approach which imposes such requirements on any institution
exercising depository powe.rs. Institutions such as finance companies,
securities brokers, and mutual funds accept deposit equivalents from
their customers. A basic tenet of universal reserve requirements is competitive equality. These deposit equivalents are substitutes for reservable accounts offered by depository institutions and they should be subjected to reserve requirements. If this equal treatment principle were
followed, the public interest would be better served by maximum competition among all participants wishing to offer financial services. In
addition, the task of monetary policy would be made easier.
Although we prefer completely equal treatment for equal powers,
there is some merit to the arguments for graduated required reserves
based upon the total deposit size of an institution as implied in S. 3304
and the Federal Reserve's proposals. Many believe the burden of required reserves maintained at the Federal Reserve falls disproportionately on small institutions. Bank of America does not desire to stifle
competition from smaller banks or other smaller financial institutions
although smaller banks on average are more profitable than larger
banks and, in many areas, do not offer the broad range of services g;enerally provided by larger banks.
In the spirit of encouraging competition from smaller institutions,
however, Bank of America supports a reduction in the lower levels of
required reserves for transaction and time and savings accounts, as
contained in S. 3304. Furthermore, with universal reserve requirements
for all depository institutions, the reserve base upon which the Federal
Reserve implements its monetary policies would be expanded considerably. The improved efficiency of policy implementation should permit
significantly lower reserve requirements. We do not support the complete exemption of small institutions from reserve requirements as contemplated in S. 3304, which permits institutions with transaction
accounts below 5 million to maintain no reserves, because all depositories should share to some degree in the burden of monetary management. We believe, however, that very low required reserves, coupled
with interest payments on those reserves, provide sufficient compensation to remove any unnecessary burden on small institutions. Because
the current city/country bank classification for determining reserve requirements is actually based on size rather than location, and because
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our proposal embraces graduated reserves based on size, we see no
reason to keep the current cumbersome city/country distinction. S. 3304
rightfully eliminates it.
We believe the very broad definition of a transaction account in S.
3304 is in the best interest of orderly :financial regulation. By granting
the authority to the Federal Reserve to de.fine transaction accounts as
new payment innovations occur, competitive equity is preserved by not
permitting avoidance of defined re~ation in this area. However, we
believe a better approach to any definitional problem with transaction
accounts or demand deposits is to eliminate any distinction between the
two and to set reserve requirements for both these accounts at one low
level. There appears to be no real basis for a distinction between demand deposits and transaction accounts, such as NOW accounts other
than to circumvent regulations. Both serve the same functions and
both represent immediately available funds. Demand deposit reserve
requirements are currently very high, while transaction account reqmrements are low or nonexistent. Logically, reserves should be the
same at one low level for all depository institutions.
Although not contemplated in S. 3304, reserve requirements on time
and savings accounts should also be universally imposed on all .financial institutions which maintain them. The expansion of powers at socalled thrift-type depository institutions, the loss of distinctions between thrift and transaction accounts, and the essential similarity of
time and savings accounts at all types of institutions argue against
any rational basis for excluding time and savings accounts from universal reserve requirements.
Implicit in our support of universal reserves is our belief that the
Federal Reserve should have the power to set reserve requirements
within legislated limits. The original Federal Reserve Act included reserve requirement lev_els as a tool of monetary policy; and if reserve requirements are truly universal, the use of this policy tool is enhanced.
Nonbank depository institutions were ignored in the original act because they were small in size and number; however, today they represent the dominant share of the public's savings and should be brought
within the orbit of monetary regulation. Additionally, the Federal Reserve is in the 'best position to evaluate the relative burden that required reserves place on different sized institutions. The Federal Reserve could, as conditions change, take appropriate action to maintain
competitive equity.
The 4-year phase-in of reserve requirements for nonmember institutions is logical to prevent unnecessary problems or hardshi1JS. We also
support the concept of nonmembers passing- reserves through member
banks or Federal home loan banks to the Federal Reserve. The uniformity of reserves for all institutions is more important than depositing directly with the Federal Reserve System. If an institution prefers not to deal directly with the Federal Reserve, there is no reason
that it should. During the hearings concerning nationwide NOW accounts, Bank of America proposed that reserves on such account.<i be
held in the form of a special Treasury security, issued solely for that
purpose, as a possible alternative to a passthrough reserve. We continue to believe that the use of special Treasury securities as a means
of holding required reserves would provide a true market return on
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such funds, promote competitive equity, and not hamper the implementation of monetary policy. We encourage the Federal Reserve to
perform a feasibility study on the use of holdings of Treasury securities as a means of satisfying reserve requirements.
The Federal Reserve should clearly have the authority to require reports from nonmember depositories as proposed in S. 3304. The increased flow of accurate information would promote more effective and
effieient implementation of monetary policy. The reporting requirement burden of member banks would be further equalized by extending these requirements to all institutions.
PAYMENT OF INTEREST ON REQUIRED RESERVES
Bank of America strongly endorses the proposed payment of interest on required reserve balances. S. 3304 ties the payment of interest to
the idea of explicit charges for Federal Reserve services, a natural link
which we previously mentioned. The payment of interest on required
reserves would reduce the competitive inequities inherent in the current system.
As discussed above, one class of :financial institutions-member commercial banks-is required to hold totally non-earning cash reserves,
which other depositories hold their reserv~ in various earning forms
( usually either correspondent balancea or securities). A comparison of
return on assets between member and nonmember banks, over time,
shows that member banks had a consistently lower rate of return. The
benefits of Federal Reserve services to niember banks do not adequately compensate them for income lost in holding idle cash reserve
balances.
Bank of America prefers that no limit be set on the maximum interest rate permitted on required reserves or on the aggregate amount tha,t
the Federal Reserve pays in interest on reserves; S. 3304 contains a
limit of the sum of seven percent of net Federal Reserve bank earnings
plus the revenues from charging for services. Either kind of restriction
would only serve to limit the intent of paying interest on required reserves, that is, to reduce the burden of membership and to promote
competitive equality among institutions. The rate that the Federal Reserve pays should be determined in the market, perhaps tied to the 3month Treasury bill rate. In any event, we oppose a flat 2-percent maximum rate, as contained in S. 3304, because of the obvious inequity.
S. 3304 permits a higher rate of interest to be paid for the first $25
million of required reserves. However, because Bank of America
favors graduated reserve requirements as a means of reducing the reserve burden of small institutions, we believe that payment of a differential rate o.f interest is neither necessary nor equitable. We urge that
all reserves earn interest at the same rate.
CHARGES FOR FEDERAL RESERVE SERVICES
We are in favor of explicit pricing for Federal Reserve services. 'fhe
current system tends to promote economic inPfficiency. There is a very
high price for access to Federal. Reserve services-membership in the
Federal Reserve System with its expensive reserve requirements-which disuades the majority of financial institutions from using these
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services directly. However, once a bank chooses to meet the access price,
that bank can use as much of the Federal Reserve services as it wants
for no additional charge. This promotes inefficient use of resoure,es because the marginal cost of providing a service is not equated to its marginal value to the user bank. Additionally, because the Federal Reserve does not charge for individual services, private sector innovation
and competition is effectively stifled.
By explicitly charging for services rendered, the Federal Reserve
also helps eliminate inequalities among banks of different sizes. The
Federal Reserve's own analysis shows that small banks have a greater
membership burden because they do not directly use Federal Reserve
services or benefits, while large banks have a smaller burden because
they use these services or benefits extensively. To the extent the Federal Reserve develops a competitive market pricing system, the
charges imposed for the currently "free" Federal Reserve services
nullify almost all the unequal burden based upon the size of a member
bank. Graduated reserve requirements can be used to eliminate any
remaining inequality.
We believe the general time frame for implementing pricing, as contained in S. 3304, is reasonable. The 1-year delay between publishing
a fee schedule and pricing guidelines, and the implementation of actual
pricing provides sufficient time to adequately comment on the proposals, as well as plan for the implementation of pricing. Also, the general list of services that are included in the pricing proposal under
various plans--coin and currency, check collection, wire transfer,
ACH, net settlement, security safekeeping, and new payment services-encourages competition by private sector firms in most cases.
Bank of America endorses a method of pricing which reflects not
only the direct and indirect costs of the Federal Reserve, but which also
includes an adjustment to reflect business income taxes and an imputed
return on capital. The largest 15 bank holing companies in the United
States, over the past 5 years, averaged a return on equity of 12 percent
and paid taxes at the rate of 53 percent of before-tax income an a tax
equivalent basis. These figures should serve as benchmarks for the
Federal Reserve in developing its pricing proposal. This approach
helps to insure that the Federal Reserve prices in the same competitive manner as a private firm. Explicit language in the legislation
is an even better guarantee that the Federal Reserve does not unfairly
underprice private sector competitors. The Federal Reserve's idea of
"providing a basic level of payment services" implies that the public
welfare requires the Federal Reserve to subsidize a given level of payment services. In the absence of any proof that the private sector
will not provide payment services at reasonable costs to all institutions,
the Federal Reserve should price on a purely competitive basis.
If truly universal reserve requirements are enacted for all institutions, Bank of America supports open access to all reservable Federal
Reserve services for all institutions, including use of the discount
window. Such universal reserves could be used for check ( or transaction instrument) clearing accounts at the Federal Reserve. If all instit11tions are not subject to universal reserves, we do not support open
access. Legislation that provides access for services based only on exnlicit Federal Reserve pricing Qr based on explicit pricing plus clearing accounts (S. 2595) does not provide for competitive equality. In
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such an eventuality, member banks would still carry a disproportionate burden by virtue o:f their reserve requirements. There would remain
the problem o:f unequal treatment :for institutions having equal powers.
SUMMARY
Bank o:f America believes firmly in the principle o:f equal treatment
for equal powers. To promote that principle, we strongly endorse universal graduated reserve requirements for all sizes of depository institutions offering financial services and all types of aooounts held. Unequal burdens based upon the size of a financial institution should be
eliminated by adopting graduated required reserves once universal
reserves are accepted. Both the payment of interest on required reserves
and pricing :for Federal Reserve services are supported as a means of
promoting competitive equity. Additionally, the pricing o:f services insures a more efficient allocation of economic resources. To do less than
establish complete competitive equality among financial institutions is
inconsistent with the whole concept of democratic government and the
fundamental ethical foundation of our society.
Also I would like to comment that I was somewhat concerned by your
observations, Senator Proxmire, about food stamps for bankers and
things like that. I have always respected you as a very competent
economist, hut .I don't think you followed the analysis all of the way
through.
If you pay interest on required reserves, and also open up the system
to greater competition, there is no reason why banks or any other
financial institutions should have any windfall profits as a result of this
system. As a consequence I think you would find enhanced competition
and you would find banks passing those earnings on required reserves
through to the customer, the general public. I think this would work
in the best interests of all.
The CHAIRMAN. You could say that if you just abolished taxes, too.
If nobody had to pay any taxes, you would have the same effect.
In view of the fact that bankers pay something like 17 percent o:f
their income in taxes compared to 34 percent :for other corporations, it
is pretty hard to see why they should have a tax cut under the present
circumstances.
Mr. PRUSSIA. If the tax cut is passed through, we have gone
through-The CHAIRMAN. If it is passed through, I would agree, I would like
to abolish corporate income taxes. I have proposed that :for the last
couple of years. The New York Times, which is a liberal publication,
also favors the abolition o:f corporate income taxes. But we don't have
it, under present circumstances i:f you are going to have any kind of
equity, it is hard to justify having a situation in which the banks have
this advantage and now we are going to give them this kind of a tax
reduction, particularly in view of the :fact that you are getting an
advantage, but even without that, if you accept the Federal Reserve's
proposal.
Mr. PRUSSIA. Advantage in what form!
The CHAIRMAN. Your reserve requirements would be greatly lowered, so the burden of :your reserve requirements would be lessened.
Mr. PRUSSIA. There 1s no reason why reserve requirements should be
as high as they are.
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The CHAIRMAN. That's right. They would be lowered under the Federal Reserve proposal, and under the House Banking Committee chairman's proposal. So you would benefit that way. You fellows want
everything. I don't blame you for wanting it. I would if I were a top
official of the biggest bank in the country.
Mr. PRUSSIA. The point I am trying to make is that it doesn't mean
our profits will be enhanced as a consequence of all of this. If you tie
these two concepts together, a lightened reserve burden and encour~ing competition ( and we don't current have as much competition m
the financial intermediary process as there should be), you will pass
the benefits accrued to the banks through to the general public and
everyone will benefit from it.
Mr. CHAIRMAN. As I say, I believe in reducing taxes very vigorously,
as well as cutting Federal spending everywhere I can. It would just
seem to me under present circumstances to reduce taxes further, when
they are already as light as they are, the case is not quite that strong.
Mr. PRUSSIA. Well, I have gone over my time.
The CHAIRMAN. Mr. O'Leary, it is good to have you back before the
committee.
Mr. O'LEARY. Senator Proxmire, it is a privilege and pleasure to be
here. Let me say by way of introduction, I am accompanied here today
by John Lee, who is executive vice president of New York Clearing
House Association, and if there are questions that you have that may
relate particularly to the operation of that institution, I am going to
let him field them.
The CHAIRMAN. All right.
STATEMENT OF DR. J'AMES O'LEARY, VICE CHAIRMAN, U.S. TRUST
CO., REPRESENTING THE NEW YORK CLEARING HOUSE ASSOCIATION, ACCOMPANIED BY J'OHN LEE, EXECUTIVE VICE PRESIDENT OF THE NEW YORK CLEARING HOUSE ASSOCIATION
Mr. O'LEARY. My name is James O'Leary. I am vice chairman of the
U.S. Trust Co. and I am appearing today as the spokesman
for the New York Clearing House Association. I appreciate this opportunity to discuss S. 3304, a bill which comes close to resolving the
persistent Federal Reserve System membership problem. I believe the
legislation can be improved, however.
The first priority of any program directed toward solving the Federal Reserve's membership problem should be a reduction in the levels
of reserves within the present statutory ranges. That can be done by
regulatory action, and the Board of Governors should do so. Statutory
ranges should also be reduced. Interest should be paid on the remaining
reserves pegged to a market rate index and the Fed should fully price
its services. We believe universal reserves for all depository'financial
institutions can only be acceptable if the total problem is addressed in
that manner.
We believe that the Federal Reserve Board could discharge its responsibilities with significantly lower reserves than are now imposed on
transaction balances and with no reserves on time deposits. Other nations have much lower reserve requirements. At an appropriate point
in the economic cycle 1:ihe Board should ,act to reduce reserves to the
lowest possible level. Present reserve requirements constitute an undue
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financial and competitive burden-much like a tax-upon member
banks of the Federal Reserve System and upon their customers. This
burden is IliOlt distributed equitably. That, clearly, is one of the reasons
why banks arn reluctant to apply for membership in the System and
why many banks have chosen to :leave the System.
We urge the Congress to reduce all of the stia.tutory .ranges. Section
103 should provide a lower range of 5 percent instead of 7 percent. But
even more important, we urge action by tihe Federal Reserve to reduce
the actual requirements imposed on member banks. This would be the
simplest, most immediate and most direct means of reducing the membership burden. Differences in resenve requirements based upon institutional type or si~ are unjustifiable and should be removed.
When we were before you last October discussing the Fed's role in
the payment mechanism, we mentioned the incongruity of the existing
Federal Reserve armn.gement. Services are provided without oost to all
depository financial institutions, but they are paid for by those banks
which have joined the Federal Reserve 8ystem. Section 106 of S. 3304
would address th.at flaw by requiring the Fed to price its services.
After the burden of membership has been sigmficantly reduced by a
reduction in reserve requirements the means by which the Federal Reserve System provides services should be placed on a rational footing.
Section 106 of this bill .requires the Fed to proceed expeditiously toward that objective. Explicit charges should be imposed for each ser:vice offered by the Federal Reserve System and those charges should reflect all the System's expenses, including the cost of capital funds employed and taxes. These pricing schedules oould be designed to take
effoot after a reasonable transition period. But as and when effective,
such explicit pricing schedules for Federal Reserve System services
should be based upon principles of equity and fairness.
Without an "unbundled" pricing structure, private financial institutions cannot compete. The public sector should not offer its services in
such a way as to prevent priva.te institutions from demonstrating their
ability to provide such services more cheaply.
Without the discipline i m ~ by explicit prices, many inefficient
practice,s are encouraged or condoned. The growth of paper cheeks provides an example of an encouragement toward inefficiency. In the decade ending in 1977 the numbers of checks processed by the Fedeml Reserve rose at almost a 9½ percent annual rate. Against other measures
of activity during the period for example, constant-dollar GNP or industrial production) this appears to be a relatively rapid growth rate.
That impression is reinforced by the knowled~e that the growth of
check issuance undoubtedly would have been impeded had check issuers
been subjected to the costs of Federal Reserve processing. Without
pricing as an inducement to change payments methods, the benefits of
new technology in the long-delayed less-check era will continue to be
slow in coming.
The direct and indirect costs to the geneml J>Ublic of funds transfer
ineffi.ciencies are undoubtedly sizable and certainly complex to estimate.
The Federal Reserve itself has estimated certain costs of providing
these services at around $250 million for 1977; the proportionate share
of general administration and support would raise this figure to $300
million. Eeven this amount does not include private-sector equivalents
of taxes and .return on investment which need to be reflected in the
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Federal Reserve's fee schedule. In any event, the total cost of providing these free sel.'IVices by the Federal Reserve in 1977 seems to have
been at least $300 million; if priced on ,a basis equivia.lent to that of
private sector firms, the figure could possibly be considerably higher.
In a.ddition, the Federal Reser:ve System daily absorbs a reported $5
billion of float for checks not presented within the time period that
funds have been credited to the depositing member. At an annual interest rate of 6 percent, this account for an additional $300 million in expenses.
This is only the beginning, but even this very rough calculation
raises the question of whether the operating services furnished are
really "worth" $300 mililon or so. The ans,wer cannot be known because
the services hruve not stood the marketplace test. That is, users have not
been required to establish a cost/benefit calculus for existing Federal
Reserve services in comparison with alternative modes of funds handling having alternative costs. An explicit pricing system would
furnish evidence on the question of how much is being wasted by current practices.
Once total reserves have been reduced ia.nd a pricing schedule has
been developed and implemented by the Federal Reserve System, hanks
holding reserves at the Federal Reserve should be paid interest on their
reserves. This would be the only fair aid equitable procedure. The rate
of interest paid on such reserves should be pegged to a market raite index. Under these conditions, the impact on Treasury revenues would be
::;mall if the tax effect of such payments is considered as well as the
recovery of operating costs by pricing Federal Reserve services. Such
modest compensation, in exchange for what have heretofore been sterile
balances held on deposit with Federal Reserve banks, is far removed
from the recently headlined "windf.all" returns predicted for members banks.
Section 301 of the bill now before you provides for payment of interest OIIl reserves. That payment should be calculated just as realistioally
as the cost of services is ooJ.cula,ted-at the actual cost, of money.
We favor the phase in provisions provided for present nonmember
institutions by section 104. In our judgment they could even be extended to 4 years instea.d 01f 3 to make the transition less abrupt.
In conclusion, we commend the Congress for a.ddressing the prob1ems
of Federal Reserve pricing and the role of Federal Reserve reserves.
These issues are likely to become increasingly critical in influencing
banks' ability to remain effective financial intermediaries in the years
to come. It oannot be emphasized too much how critical it is to put the
pieces together in the prop~r order. Reduction of reserve levels is by
for the most important step; it should come first. Unbundling and
pricing Fed services and the payment of interest on reserves logically
follow. In all these measures equal treatment should be a central element. To im~ose higher burdens on some institutions rather than others
is to discrimmate against the customers of those institutions and thereby to encourag-e the development of less efficient alternative sources of
financial services.
The CHAIRMAN. Dr. O'Leary, do you agree with Chairman Miller
that the iSffi10 of membership with respect to monetary policy, membership in the Federal Reserve, is not as essential as it used to be regarded~
Mr. O'LEARY. The issue of membership is not as essential¥
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The CHAIRMAN; Is not es essential, given the possibilities of providing say universal reserves 1 Would you agree with the preceding expert
witnes.ges, who indicated that the membership problem as far as monetary policy is concerned, would no longer be relevant if you had universal reserves.
Mr. O'LEARY. Provided they were universal reserves. I would think
the membership problem per se ic; not the heart of the matter. The
heart of the matter is the fact that there are req"4ired reserves for member banks in the Federal Reserve Syst.em, and there are not equal reserves required for other financial institutions.
The CHAIRMAN. Would you also agree with Chairman Miller that
that is an inequitable situation 1
Mr. O'LEARY. I think that is ,a very inequitable situation. Let me add
one little additional piooe of information which I think might have escaped some or at least two earlier witnesses, from the academic field.
One of the things that has come to my attention is that the whole
question of deposits has spread into the life insurance companies. In
effect today life insurance companies are selling contracts of a sort,
which are really time deposits. It shows how competitive this whole
process of deposits has spread through the whole system. I don't think
thwt is recognized.
We have recognized the fact that technology and competitive pressures have brought in the NOW accounts and brought in share
drafts-The CHAIRMAN. Is that really new1 Didn't you have insurance companies involved one way or another on the periphery in this already1
Isn't that the answer¥ In spite of this, the banks have grown very
rapidly, grown more than the economy as a whole has, and they seem
to have done an excellent job.
Mr. 0':C,EARY. I think what you are saying is, Haven't there alwa:ys
been pohcy loans, haven't there been funds left unsupplemented m
contracts with insurance companies that have paid interest~
But there is a new development. And that is that in the last 15
years, the name of the game for a financial institution, including life
insurance companies, is to be a full financial service tyoe of an organization. This has affected the insurance companies as well-The CHAIRMAN.. Of course the insurance companies would turn
around and say that two can play at that game as well as one. You are
playing their game, too, you are horning in on their operations in their
view. They may be wrong about that, not only with credit life, but in
a number of other areas, you are becoming quire competitive with the
insurance companies.
Mr. O'LEARY. Don't misunderstand me, I am not casting a stone at
the insurance companies. All I am saying is that when we recognize
that there are transaction balances out there now in the hands of noncommercial banking institutions, we better not for~t that possibly
there are some transaction balances in the hands of life insurance companies, too. It has spread that broadly.
And it makes more difficult this whole question of bein~ able to relate effectively to the money supply; it is complicated by the fact that
not only a transaction balance has spread to other typec;· of rlPpo<iitory
institutions, but they have spread even to types of institutions that we
don't ordinarily think of as being depository in nature.
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That is just a little additional complication. But I think it should
be recognized and be recognized as part of the fact that as Mr. Prussia
indicated, the financial system is extremely competitive and the competition is not only just between the banks themselves, but it is competition between a wide range of other types of financial institutions.
The CHAIRMAN. Mr. Prussia, as Chairman Miller pointed out, no
other central bank has to worry about the membership problem. And
it seems rather unfortunate that in this country the membership problem should color monetary policy at all. It shouldn't have anything to
do with it. It tends to distort it to some extent.
For that reason, isn't the fundamental answer-I know you favor
this among other things-but isn't the fundamental answer to this
universal reserves~
Mr. PRussu. Absolutely. I think you have to go back and look at
the history of how this whole system evolved, the point I was making
in _El__y testimony.
When the Federal Reserve Act was passed in 1913, the commercial
banks were by far the dominant part of the financial intermediary system. I don't remember the exact number anymore, but I would say
somewhere in the neighborhood of three-quarters of deposit balances
were carried in those banks. Other types of financial institutions were
virtually insignificant.
So it was logical to organize a system focusing on commercial banks,
focusing on required reserves for commercial banks. That system made
sense at that point in time. And partly because member commercial
banks have been shouldering this burden of carrying reserves at a high
level~ other types of innovative financial systems have grown very
rapictly. In spite of the fact that our growth has been reasonably good,
we haven't grown as fast as other types of nonbank thrift institutions,
because they don't shoulder the same kind of burden.
The CHAIRMAN. Whether we created it or not, we greatly enhanced
the emphasis on housing and on trying to channel money through the
savings institutions into housing. As you know the S. & L.'s have
pretty stern restrictions on where they can invest their money. It is
beginning to be modified and changed a little bit, but it is relatively
limited. You don't really have substantial competition from the
S. & L.'s, although they are very big in California. Your competition
is with commercial banks, is it not~
Mr. PRussu. No, sir. It is the S. & L.'s as well. We have nearly $15
billion in consumer savings and time deposits on our books, we have
nearly $6 billion in single family residential home loans on our books,
and we have almost $6 billion m consumer credit on our books. We
have an additional $1½ billion in real estate loans we have sold-The CHAIRMAN. They could say, in spite of historical developments,
they could say you are competing with them, too, because that is all
they are allowed to do, and you are moving into their territory. Not
that that is not good, that is good vigorous competition.
Mr. PRussu. Yes; this is the point. I think we ought to all be able
to compete equally with one another.
The CHAIRMAN. I think that is right. When you have similar kinds
of financial operations, then I think you ought to have similar rules.
But I think the universal reserves ought to apply to transaction accounts, transaction accounts ought to also be perceived as being in
some of these other institutions.
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Mr. PRUSSIA. And savings deposits. There fa no reason they ought
not to be regulated in the same manner.
The CHAIRMAN. Mr. O'Leary, you said universal reserve requirements for all depository institutions is acceptable only if reserve requirements are reduced, and a market rate of interest is paid on
reserves.
You are really asking for the moon. That would be a $1½ billion
paid out t.o the banks on their reserves, plus a reduction in reserve requirements. So that as Mr. Prussia said, this wouldn't really
help the banks, this would be passed on to the consumer. It would
eventually, but there is a lag here, and you can live on your lag quite
a while. This would enhance profits for a short period of time at least.
After all, in the first place, the benefits would be exactly equal, beoause the burdens are not equal now. The benefits would be to those
who made the greatest sacrifices in tJhe past, with the big banks, the big
commercial banks benefiting by universal reserves being reduced and
interest being paid on the reserves that remain. That· would enhance
the profits of both your institutions greatly, all of the clearinghouse
banks in New York and the Bank of America in the short run.
You say in the long run-well, I guess John Maynard Keynes said
"In the long run we are all dead." But in the short run, you would live
off the fat of the land.
Mr. PRUSSIA. No, sir, the competition would eliminate that very
quickly.
The CHAIRMAN. I don't know about that.
Mr. O'LEARY. I welcome that sort of question you were asking me.
May I comment on it, because I think there were a number of things
said here today that need to be commented upon.
One is how profitable is the banking system. There seems to be a
tone here that the banks are already quite profitable.
The CHAIRMAN. They are not profitable enough, I agree, they should
be more profitable.
Mr. O'LEARY. I would venture before 2 years are out, you will be
holding hearings on the adequacy of bank capital.
The CHAIRMAN. That's right, I was going to put it that way. We have
already held hearings on that, we are very concerned about 1t. There is
no question that bank capital is inadequate. I am not so sure that is the
way to solve that problem, though.
Mr. O'LEARY. But when you talk about windfalls and asking for the
moon, I think you have t.o ask that question, have the banks been able
t.o build tJhe capital base t.o carry out the necessary functions that they
have in this country W I think with the economy growing in current
dollar terms as fast as it is, I think one of the real q_uestions that this
committee is going to have to face is where is the capital going to come
from to provide the bankine: system to have the expansion it will need
t.o carry out that function effectively.
There are indications that there 1s an inadeguacy of bank capita,l, at
least some people view it that way, and there 1s some controversy over
this.
The CHAmMAN. This is shocking, there is no question •about it,
whether Arthur Burns is right or not in having a rule of thumb of
capital bei~ 8 percent of deposits, Bank of America has a.bout 3-percent capital in relation t.o its deposits-
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Mr. PRussIA. Over 3½ percent capital to assets [Four and a half percent capital to deposits].
The _CHAIRMAN. That still i~ grossly inadequate. The 10 bigge~
banks ID the country have capital ratios -0f about 5 percent. So ID
general there is no question that capital is inadequate.
That doesn't mean we should follow a policy now that will enrich
you overnight at the expense of the taxpayers.
Mr. O'LEARY. But let's go a little beyond in terms of some of the
things that were said earlier.
The CHAIRMAN. Maybe you shouldn't grow quite as fast.
Mr. O'LEARY. One of the reasons why commercial banks have been
paying relatively low taxes is because of heavy investment in taxexempt bonds.
Now frankly my own feeling is that there may be some serious
question about tax-exempt bonds, but the fact is that banks accept
lower returns on those tax-exempt bonds as a trade-off for the fact that
it reduces their taxation.
The CHAIRMAN. You are bringing tears to my eyes. Boy, lower returns; 6 percent return. I just bought some myself. You can get about
6.2 percent, perfectly safe, tax exempt. You put in a million dollars and
get $60,000 back, and don't pay a dime of tax on it. A- banker like
yourself, you can put in $100 million and get $6 million back and pay
nothing in taxes, zero.
Mr. O'LEARY. That is right, 6 percent versus 9 percent of prime loans
and 9 percent on long-term corporate bonds. So there is a sacrifice in
yield that is being taken there to take advantage of the tax exemption.
The same thing is true, some of that lower tax base is based on
leverage lea.ses, taking advantages of the investment tax credit. Well,
Congress has created the investment tax credit, and if it has an investment tax credit, tJhe way I look at it-The CHAIRMAN. I am not so sure that is such a big bonanza for the
banks. Every other corporation can take advantage of it, and does.
Mr. O'LEARY. Then I would go another step, and that is to say that
I don't think there is adequate realization of the extent to which the
reserve requirements enter into the cost to customers out there.
Mr. Prussia made this point, it was made in the earlier discussion.
But for example, it has been, it is becoming less common, for CO"l)Orations to pay for loans under less than full pricing, let's say, in terms of
the i11terest rate, with compensating balances.
Any bank in calculating the V'alue of that compensating balance,
deducts out of there the increased reserves that will come from that
compensating balance.
The CHAIRMAN. I couldn't agree with you more. Part of what we are
trying to propose here is that we explicitly price these services, and that
we provide not only interest-that was my next question which I might
address to Mr. Prussia. Why not, on interest on reserves, wait for a
bill we hope to enact promptly to permit interest to be pa.id on demand
deposits. Then you have interest :paid on correspondent balances, explicit pricing of the services provided, and you have a far more competitive system, dynamic system, ,and more efficient system. Because you
would have the premium paid on who oan do the job for the lowest cost.
Mr. PRUSSIA. We certainly wouldn't argue with that. We think
broad-scale reform would be the better way to go.
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The CHAIRMAN. The fundamental question is why shouldn't interest on reserves await the enactment of, or the repeal of, the prohibition of interest on demand deposits~
Mr. PRussIA. That is logical. We just think this is a case for equity.
If you could do all the reforms at once, it would produce a much better
system~better competition, more equitable, all of those things. But if
reform has to be done in stages, I would agree this would be the way
to go about it.
The CHAIRM:AN. You see, it is a quid pro quo. If we pay interest on
reserves, the banks want that, but interest on demand deposits, some
banks-your bank might perhaps recognize and perhaps Mr. O'Leary's
bank-but many many of the smaller banks in my St!),te and I suspect around the country are opposed to that. They consider that to be
something that would cost them money, reduce their income, and be
very difficult for them.
So that we have to put that package together, it seems to me, if we
are going to have a logical comprehensive change that makes the whole
system more competitive.
Mr. PRussIA. Right. I think universal reserve requirements are
most important. No. 2, reduction in reserve requirements would be
important. No. 3, would be eliminating some of the inequities which
are not covered in this legislation, like the quarter percent differential
in regulation Q. This would be the type of thing that would enhance
competition, and improve the system all around, as well as permit the
Federal Reserve to do a better job of monetary management. The other
things, if they can't be done all at once, we would say they have a
lower priority.
The CHAmMAN. Mr. O'Leary, you said the Federal Reserve's float
is about $5 million daily, and a 6-percent interest, and $300 million
additional expenses are both by the Federal Reserve. Who benefits
from that $300 million expenditure by the Federal Reserve!
Mr. O'LEARY. What it does is throu~h the banking system as a whole,
that float increases the availability of funds for the system.
The CHAmMAN. So the banking system as a whole benefits from that
$300 million~
.
Mr. O'LEARY. Yes, sir. Incidentally let me say I agree generally,
personally, and I think probably the clearing house banks would agree
with the idea that if there were payment of interest on reserves, that
it would be appropriate to have payment of interest on demand deposits also. On all transactions balances. So that I don't think we have
any great quarrel with that.
1'he CHAIRM:AN. Is your proposal that the Federal Reserve charge
for float indirectly by counting it -as a cost rather than directly charging the banks that now benefit directly from the float¥
Mr. O'LEARY. I would think that logically, this being one of the
services provided by the Fed, that that would be subject to some specific
service charge.
We think of it as a service being provided, having a cost; logically
then there ought to be some service charge for it.
The CHAmMAN. To get back to the broad necessity of competition.
Mr. Prussia, you said in your statement that institutions such as finance companies, securities brokers, mutual funds, accept deposit
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equivalents from their customers. You argue they should be subject
to reserve requirements.
I might agree with that. Does the deposit-taking characteristics of
these firms impair the Federal Reserve's ability to implement monetary
policy, in your view 1
Mr. PRussIA. To the e~t that they represent an increasing proportion of the total system, yes.
The CHAIRMAN. Is it at a stage now where you think it has a significant effect 9
Mr. PRUSSIA. There are all manners of de~ee. But I think in a
universal ~rve requirement system, your criteria ought to include
all deposit-like instruments and not confine yourself to those offered
by the four principal types of financial intermediaries.
The CHAIRMAN. I think that might be practical provided you had
a sufficient level of exemptions, so that you wouldn't have to try to
administer everybody.
Mr. PRUSSIA. Yes, sir.
The CHAIRMAN. If you had a $25 million or a $50 million exemption,
that might be practical.
Well, gentlemen, I want to thank you for your testimony very much.
It has been a very interesting morning for me.
Mr. PRUSSIA. May I make one more comment, Senatod I can't leave
it on the record your statement that Bank of America is undercapitalized. I think I could debate that with you, and I would like to have
the opportunity to do that with you sometime.
The CHAIRMAN. Opportunity to do what~
Mr. PRUSSIA. Debate the capitalization question.
The CHAIRMAN. You think you have ample capital~
Mr. PRussIA. We are a well-run institution, we hav~ a good record
and I think we can stand on our capital.
The CHAIRMAN. In that case, :you don't need any of these benefits
here. We are concluding this testrmony ~y saying interest on reserves
shouldn't be necessary to enhance the capital of banks.
Mr. PRUSSIA. I think we should have universal reserve requirements,
obviously. That doesn't affect the capital issue.
The CHAIRMAN. All right. The committee will stand adjourned.
[Thereupon, at 12 :10 p.m. the hearings were adjourned.]
[Additional material received for the record follows in the
appendix.]
33-587 0 • 78 • 19
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APPENDIX
II
.
.
IOAIID OF DIRICTORI
E. O. "JACK" DUNN
August 23, 1978
Cornm,H1cm1r
Georgia
Presltt.nl
OPFICE OP THI: ID!CUTIV! YICE PRESIDENT•ECONOMFST
and Chairman
HARRY E. LEONARD
Commlesioner
Oklahoma
Pre1/dent•E/ecl
DWIGHT 0. BONHAM
Examiner
Wyoming
v,ce Pres,t11nl
HARVEL C. ADAMS
Comm,s■ loner
Senator William Proxmire
Room 5241
Dirksen Senate Office Building
Washington, D.C. 20510
ArklnsH
lmmed11i.P■srPresJden!
HARRY BLOOM
Comm1nloner
Colorado
Dear Senator Proxmire:
RE:
Secretarr-T,euurer
DAVID H. NEIDITZ
Commln1oner
Connect,cut
C/la,rman-0/slrlct/
R, H. NICHOLS
Superintendent
Ohio
Chairmen-O,strict II
JOE H. HEMPHILl
Comm,uioner
Tennessee
Chairm■ n-D,str,cl/11
ARTHUR ORTIZ
Commissioner
New Mexico
Clla,rman-01slrlc!IV
TOM 0. McELOOWNEY
Ofrector
Idaho
Chairm1111-D1stric/V
W. SMOOT BRIMHALL
Commiu,oner
Ulah
Member-el-Large
WILLIAM HARRIS
Comm1ss1oner
Illinois
Member-at-Large
IXECUTIYI 0.,ICEll:I
LAWRENCE E. KREIDER
Exec111,!'t~~~,,,~~~id~ii9-
Eeonomist
ALEXANDER W. NEALE, JR.
Washington, D.C
V,ee Presldenr
S. 3304 - The Federal Reserve Requirements Act
of 1978
The Conference of State Bank Supervisors is pleased
to comment on the above proposal which would establish
and mandate universal reserve requirements for all transaction accounts which aggregate in excess of $5 million
at every depository institution; require the Federal
Reserve to impose charges for certain services offered by
the Federal Reserve banks; and authorize the payment of
interest on reserves held in Federal Reserve banks.
While the views of the Conference at this time will
be directed principally to the issue of the Federal Reserve
Board having reserve-setting authority over all depository
institutions with $5 million or more in transaction
accounts, the Conference would like the opportunity, if it
should desire to do so, to comment at a later date on other
aspects of this bill such as the paying of interest on
reserves held at the Fed, or the charging by the Fed for
services which it performs for banks.
Compulsory Universal Reserves With the Federal Reserve
S stem
The Conference is of the position that the Federal
Reserve System has made no showing that in order to effectively carry out its monetary policy responsibilities it
needs the proposed universal reserve-setting powers over
all commercial banks and other depository institutions.
In testifying before the House Committee on Banking, Finance
and Urban Affairs on August 4, 1978 on a proposal (H.R.12706)
which, like S. 3304, is designed to deal with the Fed's membership problem, CSBS pointed out that it has not been demonstrated that the decline in Fed membership was a causal
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Senator William Proxmire
August 23, 1978
Page Two
factor in faulty monetary policies during much of the period
from 1965 to 1975. The contrary view, in fact, is widely
held by a number of monetary observers from outside the
Federal Reserve System, and by some from within the System.
Declining Federal Reserve membership, if it is a problem,
is primarily of a practical political-constituency nature.
The Fed has long sought universal reserve-setting power
over depository institutions on the grounds that it is
essential for its monetary policy role. There have been a
number of studies on this issue. Many of the studies have
reflected views contrary to those of the Fed. Several such
studies were listed by then Chairman George LeMaistre of the
FDIC in his testimony before the House Banking, Currency and
Urban Affairs Committee on August 4, 1978, relative to
H.R. 12706 and related proposals.
CSBS, in 1974, commissioned a study which was conducted
by Professors Ross M. Robertson and Almarin Phillips. The
study entitled, Optional Affiliation With The Federal
Reserve System For Reserve Purposes Is Consistent With
Effective Monetary Policies, concluded that:
Major monetary policy weaknesses have been
revealed in the recent past, and a prudent
person should anticipate more in the future.
Optional affiliation of some banks with
the Federal Reserve for reserve purposes,
however, cannot be considered high on the
list of factors contributing to these
weaknesses, if eligible at all for
inclusion.
The proposal for compulsory universal affiliation for
reserve purposes is without redeeming merit from a national
interest standpoint, and Congress very wisely has consistently rejected such proposals in the past.
Levels of Member Bank Reserves
S. 3304 w·ould establish ranges of required reserves
for all transaction accounts, and for time and savings
deposits. Numerous proposals as to levels of reserves
have been made to Congressional Committees in recent weeks.
The Conference has not opposed lowering reserves for member
banks. CSBS, in fact, has consistently expressed the view
that such action of lowering reserves for member banks be
taken by the Fed.
The so-called reserve/membership problem, largely or entirely could have been solved by the Fed unilaterally, or with
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Senator William Proxmire
August 23, 1978
Page Three
readily acceptable statutory changes long ago; and the Fed
could still do so with relatively moderate reductions in
member bank reserves. The amounts of reduction needed are
not subject to statistical precision. Data developed by CSBS,
plus observations of the marketplace, however, suggests that
reserve reductions averaging one to two percentage points on
total deposits of banks not heavily involved in correspondent
banking would be adequate to halt most withdrawals caused by
high reserves. The Federal Reserve Board should be urged to
pursue such readily available solutions to its so-called
membership problem and withdraw from efforts to gain more
and more power over more and more financial institutions
with power an apparent end in itself.
Such action can be taken without the wide-sweeping proposals incorporated in S. 3304 and without adversely impacting
on the Fed's ability to discharge its monetary policy responsibilities.
This statement will not address itself to the question
of which liabilities should have lesser or greater reduction
in reserves, nor to the question of levels of reserves for
member banks which likely will not consider withdrawal;
e.g., banks heavily involved in correspondent banking. The
Conference respectfully requests the opportunity to comment
on these issues should it appear appropriate to do so at a
later date.
Positive Aspects of Withdrawal Pattern
The Fed withdrawal pattern has positive qualities.
Withdrawals to date from the Fed have strengthened the ability of the private correspondent banking system to serve the
thousands of communities of our Nation. As banks have withdrawn reserves from the Fed, nearly all such banks have
allocated part of their new-found liquidity to help pay for
more private car-respondent services. By contrast, Fed proposals for compulsory universal reserves would economically
force transfers of funds from the private correspondent
banking system into the Fed System. This would have the adverse
tendency to socialize our Nation's inter-bank system and
would also do so concealed by indirection rather than by a
revealed proposal.
Additionally, the withdrawal pattern has built-in limitations. There is a floor below which membership will not fall.
That floor is established by the fact that a large proportion
of the remaining member bank assets are now in banks that
enjoy net benefits from membership. Membership in the System
usually is one requisite to a dynamic correspondent banking
operation by individual banks. There is a strong relationship
between Fed membership and correspondent banking services.
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Senator William Proxmire
August 23, 1978
Page Four
Those banks that are heavily involved in the correspondent
banking business tend to retain membership in the System.
Only a few which have withdrawn from the Fed are heavily engaged in correspondent banking. Thus, even if membership
close to the present level is significant from monetary policy
or public interest standpoints, and the Fed has not demonstrated this to be the case, there is a floor which will assure
that a majority of commercial bank deposits remain in Fed constituent banks.
Fed Access to Data
The Conference believes that the Federal Reserve
Board should have ready access to statistical or other
data from nonmember banks or other depository institutions,
which subject is addressed in Sec. 103 of S. 3304. However,
the Conference believes there should be a demonstrated
need by the Fed for data which is essential to carrying out
its monetary policy responsibilities. While CSBS and others,
notably the FDIC, have cooperated with the Fed when a need
has been shown to exist for such data, the Conference believes
that each request for data from a bank should stand the
test of cost-benefit analysis. The Fed should not have
the unrestrained right to any and all data it might request,
or in the form it might request same. Experience suggests
that such authority could likely violate cost-benefit
principles.
Summary Comments
In summary, CSBS believes that compulsory universal
reserve requirements should not be vested in the Fed or in
the Congress. Available evidence does not support this
action as necessary for the Fed to carry out its monetary
policy role. Optional affiliation with the Fed is consistent
with sound monetary policies and should be retained. In
addition, there is a serious question as to long-term effects
of universal reserve requirements on the dual banking system.
If all banks were forced to establish their reserve policy
in accordance with the dictates of the Fed, many banks ultimately might convert to national charters, if for no other
reason than to get rid of one regulator--the State Bank
Supervisor. Should this occur, the state banking segment
of the dual banking system could become virtually meaningless, a development which we cannot believe the Congress
would support or encourage.
CSBS believes that the reserve-setting concept suggested
in this communication by the Conference would more than correct
any inequities that might now exist between groups of member
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Senator William Proxmire
August 23, 1978
Page Five
and nonmember banks, would halt withdrawal from the Fed,
and would permit effective monetary policy. At the same
time, with states retaining the authority to determine
reserves for state-chartered nonmember banks as at present,
this would avoid the possibility of damaging the decentralized banking structure.
Sincerely,
.-~twJA».1-U--
fk1A..£_
1
Lawrence E. Kreider
Executive Vice PresidentEconomist
/1 sg
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Statement of August 21, 1978
Submitted to the
Committee on Banking, Housing and Urban Affairs
United States Senate
by
Milt on Friedman
Paul Snowden Russell Distinguished Service Professor
of Economics
University of Chicago
and
Senior Research Fellow
Hoover Institution
(Stanford University)
This statement follows the order of the questions listed in the letter
from Senator William Proxmire to Dr. Milton Friedman of July 28, 1978.
A.
Federal Reserve Membership
I do not believe that a decline in Federal Reserve membership threatens
the conduct of monetary policy or control of the monetary aggregates.
Neither
does the erosion of the membership threaten the safety and soundness of the
banking system.
have long believed that it would contribute greatly to the conduct of
monetary policy to separate completely the two aspects that are combined in the
present Federal Reserve System:
first, control over monetary aggregates or of
monetary policy in general; second, relations with a particular set of commercial banks regarded as members and subject to regulation by the Reserve.
The
combination Qf these two functions in a single institution has impeded the
efficient performance of either the one or the other function.
For control of monetary aggregates the crucial requirement is simply that
the Federal Reserve have a monopoly over the issuance of high-powered money.
Given that it does so~ the control of broader monetary aggregates simply rests
on a systematic relation between them and high-powered money.
That relation
is just as close for nonmember banks as for member banks. It does not depend on
required reserves but is maintained equally by the prudential reserves that
banks feel it desirable to keep.
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8.
Reserve Requirements
1.
The most important desideratum with respect to reserve requirements
is that if there be required reserves they be the same for transactions accounts.
savings accounts, and time deposits so that shifts among such deposit categories
do not release or absorb reserves.
As to the num~rical size of the required ratio, two alternatives make
logical sense.
One is zero required reserves.
ever prudential reserves they think appropriate.
Simply allow banks to hold whatThe second is 100 percent re-
quired reserves against transactions accounts with interest paid on such reserves
anJ with complete freedom for hanks to pay interest on such accounts, and then
to require zero reserves against all other forms of accounts.
2.
It follows from what I have just said that one logical alternative is
to have mandatory reserve requirements for no financial institutions; another,
at the other logical extreme, would be to have them mandatory for all transactions accounts at 100 percent.
it
j
If some other reserve requirements are imposed,
s preferable that they be the same for all institutions offering the same
kind of deposits.
3.
That would reduce the disturbances produced by deposit shifts.
The Federal Reserve needs no flexibility to adjust reserve requirements
in order to conduct monetary policy.
On
the contrary, changes in reserve require-
ments are a clumsy and inappropriate tool for conducting monetary policy and have
done more harm than good.
C.
Payment of Interest on Reserves Held
·at the Federal Reserve Bank
1.
I have long recommended that interest be paid on reserves at the
Federal Reserve Bank at a rate of interest roughly equal to the market interest
rate on short-term money.
2.
I do not be) ieve the Federal Reserve should be given discretion in the
rate of interest to be paid on reserves.
3. The proposal here is simply a question of form; it does not matter in
the slightest whether reserves are held in the form of special Treasury securities or in the form of open-book accounts as now, provided the interest rates
paid on the two are the same.
4. At present the zero interest rate on reserves is a special tax on
member banks and their depositors. The question is whether this is a desirable
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tax.
Jf it is, it should be imposed by Congress deliberately as a matter of
policy, not be an accidental byproduct of the accidental development of monetary arrangements.
One essential point that must be emphasized is that payment of interest on reserves must be accompanied by elimination of the present prohibition of the payment of interest on demand deposits.
It would be desirable to
eliminate also all limits on interest rates that banks may pay on time and
savings deposits. In that way, interest paid on reserves would be passed
through to uepositors.
U.
Pricing of Federal Reserve Services
1.
vices at
believe the Federal Reserve should be required to price its serd
market rate, including imputed return on capital and taxes.
I see
no reason why this is an appropriate activity to be subsidized by the taxpayer.
2. lf the Federal Reserve prices its services at a market rate it is
competing with all other institutions that can provide such services, and there
is no reason why all depository institutions should not be able to get such
services from the Federal Reserve if they so desire.
3. This point raises many complex issues. Personally I am in favor of
abolishing the Federal Reserve's discount facility.
That would eliminate such
discount arrangements for hoth member banks and all other banks.
If it is not
abolished, I see no reason why all banks should not have it available to them.
I cannot close without emphasizing the crucial importance under present
circumstances of eUminating the prohibition of interest on demand deposits and
the I imit s on fotercst under Regulation Q. If the prohibition of interest on
demand deposHs had never existed or if it had been repealed long ago, there
never would have develped the proliferation of ingenious techniques for getting
around the prohibition.
There would have been no NOW accounts, no POW accounts,
no COW accounts; telephonic transfers would probably not have reared their head.
The financial structure would have developed as a much more rational and efficit~nt mechanism.
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Federal Reserve Bank of St. Louis
283
6
INTERBANK CARD ASSOCIATION • 888 SEVENTH AVENUE, NEW YORK, N.Y. 10019 • (212) 974-5700
August 24, 1978
senator william Proxmire
Chaiman
Committee on Banking, Housing
and Urban Affairs
5300 Dirksen Senate Office Building
Kashington, D.C.
Re:
S.3304, the Federal Reserve
Requirements Act of 1978
Dear Senator Proxmire:
Interbank Card Association is a not for profit membership
corporation composed of over 10,000 financial institutions which
participate in bank card programs, most notably the Master Charge
card program. Interbank soon expects to implement a debit card
program under the trade name of "SIGNET". In support of both its
Master Charge card and SIGNET card programs Interbank has established
highly sophisticated electronic transmission systems by which Interbank members interchange transaction information necessary to effectuate the bank card transactions.
We have with great interest reviewed the provisions of
S.3304, the Federal Reserve Requirements Act of 1978 and wish to
provide you with our comments specifically as to Section 106,
pricing of services.
Interbank fully agrees with the philosophy of imposing
charges for Federal Reserve services, assuming the FRB should undertake an operative role in providing electronic services. However,
in Interbank's opinion the imposition of charges raises the critical
but yet unanswered issue of whether services otherwise provided by
the private sector should be offered by government at prices which
the private sector likely cannot meet. This is especially of
concern to us as it may relate to the operations by the Federal
Reserve of (retail} electronic fund transfer services.
Interbank's position on this issue has been in the past
clear and unswerving: there is no historical, policy or business
justification for the Federal Reserve to offer free of charge services which can be/are furnished by private entities or, if priced,
computed on a non-cost related basis.
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Federal Reserve Bank of St. Louis
284
0
INTERBANK
Given what is now a reality of the Fed's development
of interregional ACHs we welcome an approach which requires pricing
of Federal Reserve services. However, we urge that Congress speak
further to the question. Our review of the letter published in
the Congressional Record of July 14 to you from Chairman Miller
raises for us fundamental and ponderous questions which we believe
Congress must now address in legislation in order to appropriately
and explicitly direct the Fed in the development of its pricing
propositions.
As the leqislative section 106 is presently composed,
congress has delegated wholly to the FRB the responsibility {or
determining the content and breadth of its pricing doctrines.
S.3304 is devoid of any Congressional statement as to the desired
values which the Board should intearate into its scheme. Inasmuch
as the pricina of Federal Reserve services undoubtedly will impact
directly en financial institutions as well as the public at large,
Congress should deliberate and offer a composite of factors to be
weighed and objectives to be attained in the endeavor. Interbank
suggests that Congress cannot be silent but rather needs to give an
expressive recitation of the elements to be considered in developing
a pricing rationale to guide the Board in this pioneering and critical assignment.
Specifically, in the creation of a pricing schedule Interbank suggests that Congress declare that the Board's pricing of
services should be computed on a fully allocated cost basis including
all, and not merely a select few, services provided by the Federal
Reserve, priced individually. That is, Federal Reserve charges
should be imposed on the total costs associated with furnishing each
service. For example, start-up costs for development and maintenance
should be cO!:lputed and figured into the service charges. This would
work to stave off inadvertent non-competitive pricing activities on
the oart of the Federal Reserve and assure that charges are realmarket based.
Left unchanneled by Congress, the Board may not price
its services as suggested here but rather, might price services at
cost or below cost level. In fact, Chairman Miller states as much by
declarina to price services based on "mature volume levels". One can
only conjecture now, and in a vacuum, as to what a mature volume
level will be ultimately. To us, this statement is mere gloss for
the Board's predeliction to price its services at a less than cost
basis. Such an approach to pricing would unquestionably create a
disincentive for the private sector to offer services provided by
the FRB.
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Federal Reserve Bank of St. Louis
285
tl
INTERBANK
In concluding its intensive study into the role of government in electronic transfer of funds, the National Commission on
Electronic Funds Transfer called for the assessment of charges fer
Federal Reserve services "on an equitable and fully allocated cost
basis". The Commission explained the consequences (using as an
example, ACH services) if such an approach was ignored:
"If the Federal Reserve does not separately
offer and price its ACH services on an
equitable and fully allocated cost basis,
potential private sector competitors will
be discouraged from entering the market."
Chapter 14 pg. 216.
Accordingly, Interbank strongly urges Congress to legislatively direct the Federal Reserve to price its services on a fully
allocated cost basis.
In the event Conaress does not adopt a recuirement of full
cost-allocation pricing; we urqe your further consideration of hew
prices will be scheduled particularly as they may be applied to any
EFT ooeration by the Federal Reserve. There are factors considered
in the Board's pricing thesis which our members find objectionable
and without any compelling business or public policy justification.
For example, we are puzzled and concerned as to the meaning of Chairman Miller's statement that charges will be assessed "by geographic
ar~a, activity, and class of work processed •.• • Without additional
explanation to the reader, it appears that high activity (large
volume users) may be accorded a favorable price differential. In our
opinion, such would have an unreasonably disproportionate impact on
the smaller financial institutions which depend on Fed services.
We also query here how the geographical distinctions will
be implemented (by Bank, Branch, or office area?) Also, may Fed
offices generate their own pricing systems sua sponte, as it were?
More specifically, Chairman Miller concedes that it may be necessary
fer "some offices" to revise their prices "to maintain competitiveness". But, with whom and how will this competitiveness be manifested
and met? If the Federal Reserve has the ability to undercut its
prices in a given market area only to be subsidized by its higher
set charqes in a non-competitive area then it would be guilty of
subsidization-for-monopoly-sake. We submit this is not the direction
Congress would have the Board follow.
As an organization anxious to compete with other payment
delivery services we are naturally resistant to what we perceive to
be a potentially government subsidized pricing scheme. 'I'he opportunity for the described scenario is clear, as would be the results.
Without Conqressional instruction otherwise the Federal Feserve would
have the market posture and artificial where-with-all to discourage
other entrants from the service providers market.
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Federal Reserve Bank of St. Louis
286
0
INTERBANK
In order to avoid the stagnation of a non-competitive
environment any pricing policy adopted by the Federal Reserve
should reflect Congressional advice and further, we urge, should
include the fully allocated costs of providing each separate service.
Ey setting forth these minimal standards Congress will be encouraging
the development of competitive private sector clearing and settlement
systems, a quintessential product of U.S. policy in this burgeoning
era of electronic banking technology. The innovative spirit characteristic of and demonstrated by the existing private sector systems
is well suited to spur the development of payment systems capable of
meeting the demands of the exacting user population and of providing
an ever-improving quality of service for the public.
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Federal Reserve Bank of St. Louis
Very truly yours,
.
(•j
;1,.
l ,:J:c);..!-1,,.:(
Amy 'Top;i, 1
Associt
Cou sel
L
287
NATIONAL ASSOCIATION OF MUTUAL SAVINGS BANKS
200 PARK AVENUE
NEW YORK, N. Y 10017
TELEPHONE 212-973-5432
SAUL B KLAMAN
C1ble Addres1·
S.v,rtg,, N•w York
August 9, 1978
The Honorable William Proxmire
Chairman
Committee on Banking, Housing,
and Urban Affairs
United States Senate
Washir,gton, D,C. 20510
Dear Mr. Chairman:
This letter is in response to your invitation of July ai
to submit the views of the savings bank industry on S. 3304. Our
comments will be addressed to the three issues which you set forth
in announcing hearings on this legislative proposal: 1. to provide
for maintenance of reserves for certain deposits held by depository
institutions; 2. to require the impos"ition of charges for certain
servi~es provided by Federal Reserve Banks; and 3. to authorize the
payment of interest on reserves held et Federal Reserve banks.
In offering these comments, it is appropriate
that no savings bank is a member of the Federal Reserve
Therefore, our industry does not have direct experience
the issues involved in these legislative proposals. On
where such experience may be crucial, our comments will
general, rather than detailed.
to point out
System.
with some of
those matters
necessarily be
1. Reserve requirements on transactions accounts for nonmel!lber
depository institutfons. It is the long-standing position of the savings
bank industry that, with regard to reserve requirements on checking, IIClW
or other types of transactions accounts, state-chartered savings banks
which are not members of the Federal Reserve System should be treated in
the same way as state-chartered nonmember comn,ercial banks. Furthnr, we
believe that required -reserves on transactions accounts ~or Stat~
chartered nonmember institutions should be set, and held, as determined
by the appropriate state authorities.
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Federal Reserve Bank of St. Louis
288
The Honorable William Proxmire
August 9, 1978
- 2 -
We believe that this position is consistent with effective
Federal Reserve monetary policy. It is difficult to imagine any industry
more sensitive than savings banks to Federal Reserve policy, as witness
the recurrence of disinterrnediation and resultant cutbacks in mortgage
lending activity at our institutions during periods of monetary restraint.
Imposition of reserve requirements on transactions accounts are clearly
unnecessary to make savings banks responsive to counter-cyclical monetary
policy and would merely add to current pressures on their earnings positions, which are already mounting as a result of recent changes in
Regulation Q deposit interest rate ceilings.
2. Payment of interest on reserves held in any Federal Reserve
bank. Although no savings banks are members of the Federal Reserve
system, we have no objections to the paym~nt of interest on reserves of
member banks.
3. Providing for pricing principles and a schedule of fees for
Federal Reserve System services. We support the concept of providing for
fees, uniform for all depository institutions, for automated clearing
house, transfer, settlement or other services offered by the Federal
Reserve. The principle of uniform fees is especially important as thrift
institutions gain third party payment powers and as electronic funds
transfer systems are developed and implemented. The availability of such
services should in no W"'-Y be contingent upon membership in the J<'ederal
Reserve System. Access to the discount window is a major advantage for
System members. If the cost3 of Federal Reserve membership are deemed to
be excessive, appropriate adjustments can be made through payment of
interest on reserves, as proposed by various legislative proposals before
th~ Committee.
I hope that these comments will be helpful.
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Federal Reserve Bank of St. Louis
Sincerely yours,
{;(>K~
Presi.dert
289
S'l'A'l'EMENT BY
BERNHARD W. ROMBERG
PRESIDENT, PAYMENT AND TELECOMMUNICATION SERVICES CORP.
INTRODUC'l'ORY·coMMENTS
My name is Bernhard Romberg and I am President of
the Payment .. and Administrative Communications Corporation .and its operating subsidiary, the Payment
and Telecommunication Services Corporation.
'l'hese
corporations, also known as the BankWire, provide
wire transfer funds payment services to the banking
industry.
I appreciate this opportunity to present
the BankWires views to the House Banking Committee on
the need for equitable pricing of operational services provided by the Federal Reserve in the payment
systems area.
First, I will describe the organization and activities
of the BankWire as a private sector provider of electronic funds transfer services.
I will then discuss
the effect of Federal Reserve activities in this area,
commenting particularly on. pricing and access.
33-587 0 • 78 • 20
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Federal Reserve Bank of St. Louis
My
290
,omments here will focus on that segment of the payments
mechanism related to wire transfers.
I will then discuss
our views on the legislative proposals being considered
by this Committee, limiting my comments on those aspects related to the charging of services provided
by the Federal Reserve.
THE BANKWIRE
The BankWire is a private corporation organized as
a business cooperative to provide banks with low
cost and efficient funds tranfer services for interbank payments.
It operates a substantial computer-
based switching system which, on an average day,
handles 18,000 communications involving over20
The Ban1<11i.n i• a p,-i.vats
secto:r bwriMBB cooperative p:t'Ol)iding r.ri.:re t,,a,,s.
fe:r 8"1'1JicsS to banks.
billion dollars in payments, thus playing an important role in the nation's payments mechanism.
The
BankWire's operations are financed completely
through charges to its users, which are based on a
standard fee of 60¢ per message.
As a business cooperative, the BankWire is owned
and managed by its member banks.
All banks using
BankWire services are members of the cooperative
and have a voice in the management of the organization.
Its 185 member banks are located in 36 states.
Over 90\ belong to the Federal Reserve and there are
members in every Federal Reserve District.
BankliiN membership ie
open to any financial
The depositinstitution providing
depository banking set'•
assets of this membership are in excess of 500 billion vices.
dollars, or more than 60 percent of the nation's commercial bank deposits.
Membership is open to any finan-
cial institution providing depository banking services.
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Federal Reserve Bank of St. Louis
291
The members elect annually a Board of Directors,
who are also senior officers of member banks, in
such a way that there is at least one director
from each Federal Reserve District, thereby assuring nationwide representation.
The BankWire's for1t1
of o:ganization has been approved by both the Federal
Reserve Board and the Comptroller of the Currency,
and its cooperative status has been approved by the
Internal Revenue Service.
The Banlcllire is indust,,y
or.lMd, fi=ed & 'lllt1Nlfled.
We wish to emphasize
that the BankWire is industry owned, industry financed, and industry managed, with membership open
to all financial depository institutions.
The BankWire of today and its predecessor organizations have been providing wire transfer services
since 1952.
BankWire I, an automated system, served
the banking industry well from 1968 until May of this
year.
In May, BankWire II, a major new computer-com-
munications system went operational and replaced the
previous system.
The specifications for BankWire II
were developed by representatives from banks--large
and small--from all over the country.
The system
The Banlcllire has been in
opemtum since issa. A
,..,., system r,ent operational in May, l9?8.
features new types of transactions and facilities
for better management of funds transfer activities.
It will also have a significant capability for batch
transmission, which can be used for inter-ACH (Automated Clearing House) requirements as well as direct
batch communications between members.
High reliability
and efficiency have been achieved through the use of the
latest in computer and communications technology.
sankWire II represents a major C0111fflitment--over 10
million dollars--by the private sector to provide
for banking'• current and future needs in interbank payments.
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Federal Reserve Bank of St. Louis
292
AND FEDERAL RESERVE
WIRE TRANSFER SERVICES
✓RICING
The Federal Reserve operates a substantial funds
transfer system, generally known as the Fedwire.
A
major--and rapidly growing--use of this system is
for third party wire transfers between commercial
banks.
Typically, these are transfers--or payments--
made from one bank to another where the payment is
2'he Fed.n.N, operaud by
the FedsraZ Resel'l)e, pl'Ovi.des thi:rd part'/! wire
t:ransfers in ccmpeti ti.on
receiving bank, the so called "third party•. Prewith the private sector.
For many banks, third
liminary results of BankWire surveys show that such
part'/f funds transfers
constitute the p1•edominant
third party transfers represent the predominant use-- use of the FedJ,Jil'fl.
to be credited to the account of a customer of the
between 60 percent and SO percent--of the Fedwire
by commercial banks.
These are transactions made
by banks on behalf of their customers and need not
involve the Federal Reserve directly.
The Federal
Reserve is thus providing services which are comparable to those which have been provided for some
time through the BankWire.
Furthermore, the
Federal Reserve is actively pursuing a program to
expand the use of the Fedwire for third party
transfers--thereby enlarging its role in an area
already served by the private sector.
As for charg~s, the Fedwire is basically free to
the banks that use it.
There is a charge for the
terminal equipment located on a bank's premises,
and a nominal charge for those fe,.. third party
transfers which are for amounts less than $1,000,
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Federal Reserve Bank of St. Louis
293
but for all practical purposes there is no charge
for the overwhelming bulk of usage.
This situation can be compared with the BankWire,
which must recover all of its CO$tS through a
charge of 60¢ per message.
As shown in Figure 1,
these costs include all communications lines, the
There i• no charge fol'
most FsdJ.li.1'11 tJ'ansfBl'B,
"'""NOB the Bank.Wire
charges 60¢ per t=fel'.
computer hardware, systems development, all salaries, general administration and overhead, working capital, as well as Federal, state, and local
taxes.
With the Fedwire, users are not charged
for any of these normal business expenses.
IMPACT OF THE FEDWIRI:
The activities of the Federal Reserve in wire
transfer services have had a profound impact on
the BankWire.
Since 1974, membership in the Bank-
Wire has declined from 230 to 185 today, or a decrease of 20 percent.
Of even greater impact has
been the decline in average daily message traffic
from 26,000 per day to the current levels of
16,000, equivalent to a 31 percent drop.
At the
same time, in talks giVen at various conferences,
the Federal Reserve has reported that usage of the
Fedwire is approximately 70,000 per day, and growing at a rate of 15 to 20 percent per year.
Surveys of present BankWire users, as well as
in-depth interviews with members who have left
the system, clearly indicate the two most
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Federal Reserve Bank of St. Louis
Bank.Wire membership and
MBage has deelined in
Naent years.
294
FIGURE l
COMPARISON OF BANKWIRE AND FEDWIRE CHARGES
COMPONENT
1.
TERMINALS
BANKWIRE
FEDWIRE
AT COST FROM
GENERALLY AT
COST FROM VENDOR
VENDOR
2.
COMMUNICATIONS LINES
3.
COMPUTER HARDWARE
4.
OPERATIONS
a . - PERSONNEL
.b. SITE
NO
INCLUDED IN
STANDARD
s.
DEVELOPMENT/REPLACEMENT
6.
MARKETING/USER LIAISON
7.
ADMINISTRATION
e.
WORKING CAPITAL
9.
TAXES
CHARGE OF
60¢
a.
b.
c.
Federal
State
Local
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Federal Reserve Bank of St. Louis
I
PER MESSAGE
CHARGE
TO
USERS
295
,1.mportant reasons for the declining use of the
BankWire.
The first of these is costs; the
second of these--which I will discuss shortly-is settlement.
The Fedwirc is free, while the
BankWire costs 60¢ per message.
With the con-
tinue.d pressure on operating costs, there is a
of the major reasons
for these decU.nes has
been the availability
of the Fed,Ji.re for no
aost t"'11lBfers.
One
natural and understandable inclination on the
part of operating personnel to take whatever
steps they can to reduce costs, and this in turn
leads to the significant diversion of traffic
from the BankWire to the Fedwire.
Declines in
traffic have been a major factor in forcing the
BankWire to increase its unit message charge,
which in turn leads to further traffic declines.
If the Fedwire were to charge properly allocated
costs, including development expenses, equipment,
and factors for the cost of capital, we have good
reason to ~xpect BankWire charges would be more
than competitive with the Fedwire.
Under such
circumstances, and if the BankWire was able to
provide settlement, we are confident that the
BankWire would ·carry a major fraction of the
third party wire transfers, which would assure
its long term viability.
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Federal Reserve Bank of St. Louis
If the Fed had to charge
property aZZocated costs,
we are confident that
the BankWi.J'e woul.d oa:n-y
a major fraction of third
party transfers.
296
ACCESS FOR SAME DAY NET SETTLEMENT
The second significant factor in the decreasing
use of the BankWire is a difference in the
settlement mechanism for funds transferred
through the Fedwire as compared to those
through the BankWire.
Because of its unique
role as a central bank, the Federal Reserve can
settle transfers from one bank to another
Th• other lllajor factor
Z4o.dinq to a dsoU.na
in Bank.Wire usage has
been a diffsrenoe in
sett1.ement meohanians.
by debiting the reserve account of the sending
bank and crediting the reserve account of the
receiving bank.
This provides "immediate
availability• of the funds transferred.
To
be competitive from a product/service standpoint,
the BankWire
needs access to this settlement
mechanism.
The BankWire membership has designed a highly
efficient means
of accomplishinq settlement,
known as "net settlement".
With net
settlement, the BankWire would accumulate totals
for the funds transfers sent and received by
each bank and then report this to the Federal
Reserve as a single net debit or credit balance
for each bank.
These balances would be posted
by the Federal Reserve to the member bank's
reserve account
on that same day.
With this
facility, the transfers through the BankWire
would provide "same day availability• with many
fewer settlement entries flowing through the
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Federal Reserve Bank of St. Louis
!!'he Bank.I/ire needs a
faciti.t:y for same day
net eetti..ent thJ.oz,gh
:ree•rw accounts to b•
abte to oonpete on a
produot basis.
297
4 ntral bank system.
This would also simplify
and facilitate present reconciliation procedures
as well as reducing peak volume bottlenecks
in the Fedwire.
Implementation of this service
requires that the BankWire have access to the Fed's
settlement system in such a way as to permit the
BankWire to be competitive with the Fedwire.
Without this same day net settlement capability,
the future viability of the BankWire as a private
sector alternative is in doubt.
It should be noted that this net settlement approach continues the role of the Federal Reserve
System in the final settlement process of the
payments mechanism without requiring each individual payment transactions to be processed over
a system operated and subsidized by the Federal
Reserve.
This approach is in accord with the
recommendations of the National Commission on
Electronic Funds Transfers in that it enhances
the development of the private sector clearing
arrangements without expanding the role of the
Federal government in the payments mechanism.
In December, 1977, the Federal Reserve announced
its intention to provide the BankWire access for
net settlement.
Since March, we have been working
with Federal Reserve System personnel to define more
precisely the operational, technical, and legal as-
spects related to such settlement.
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Federal Reserve Bank of St. Louis
It should be em-
The Bank net settZemen t approach is in
accord LJi th recommendations of the
National Corrrrrission
on EFT.
298
pbasized that, for the BankWire to be able to provide wire transfer and related payments services
which are realistically competitive with those which
are provided by the Federal Reserve, it is essential
that there be a reasonable degree of functional
paril.¥ between BankWire funds transfer services and
those available through the Fedwire,
This can be ac-
complished by having the Federal Reserve apply the
same acceptance criteria to a BankWire net settlement
statement as to any other Fedwire transaction and
promptly acknowledge the finality of such balances or
notify the BankWire that some balance is not acceptable.
Anything less than this would orevent the BanJ:•·!ire
from providing competitive capabilit1es.
With the introduction of realistic charges for all
services and by giving other providers of payment
services equitable access to facilities which are
currently unique to the Federal Reserve (because of
its central bank role), the BankWire and other organizations will be able to compete in providing efficient and innovative payment services to meet the
nationwide range of consumer and corporate needs.
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Federal Reserve Bank of St. Louis
It ia eeeentiaZ that
it be possible for
the BankWil'B to provide settlement .,hiah
pz,ovides for functional pal'i ty with the
fund,, tNnBfBl'
B/11'-
vioeB of the Fede:ro.Z
Reseroe.
299
co.MMENTS ON PROPOSED LEGISLATION
It is our fundamental conviction that any legislation
affecting the operations of the Federal Reserve
should require the Federal Reserve to charge explicit
prices for payments related se1·vices.
In particular,
such charges should apply to the wire transfer of
The Federa.Z Reserue
shouZd tiharge upZicit p>'ices for
aZZ pavments services.
funds, check collection, Automated Clearing House
services, net settlement services, and any services
related to the electronic transfer of funds.
To assure a legitimate competitive environment,
where the private sector would find it economically
feasible to provide services and create initiatives,
it is essential that the Federal Reserve, in its
pricing for services, take into full account all
direct and indirect costs incurred in providing
such services, including overhead, an allocation of
imputed costs that would take into account taxes
that would have been paid, and the return on capital that would have been provided had the payment
services been furnished by an organization in the
private sector--as well as all directly identifiable costs for operations, development, marketing
and user support services.
To do otherwise would
encourage the less efficient check payments system
rather than an electronic one.
In its pricing, the Federal Reserve certainly
should be given every opportunity to be as
competitive as possible.
JJl,Jt:
However, it should
oe permitted to use its resources
or unique positj-- as a central bank to provide
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Federal Reserve Bank of St. Louis
Federa.Z Resel'Ve
p>'icing s'houZd take
into account all
direct and indireet
costs.
300
services at artificially low costs, even if this
is done only with the declared intention of
being competitive.
If the private sector is able
to introduce services of a particular class at low
costs or is prepared to risk its capital with the
,he Federal Rese:rve
should be aZ"L<Ned
to compete as though
it were a private
sector 0'1'9anization.
hope of a long term profit, this does not mean that
the Federal Reserve or any governmental agency should
be allowed to charge less than its fully allocated
costs (including various imputed allowances), in effect using price cutting and its predominant position, to suppress competitive initiatives.
Finally, there should be no tie-in between the
charging of services and payment of interest on
reserves.
For instance, any restriction applica-
ble to a particular bank which would limit the
interest it receives on reserve balances to the
cost of services it purchases, or some absolute
or percentage relationship tied in any way to
the purchase of services would, in the private sector, be construed as an illegal "tie-in sale".
For there to be a truly competitive environment,
which would permit private sector initiatives,
it. is essential that the activities of the Federal
Reserve as a provider of payments services be
separated completely from its other activities
as a regulator of the banking industry, manager
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Federal Reserve Bank of St. Louis
The:re sho.tc be no
tie-in bett.Jeen Federal
Reseri.1e pricing t%71d
reseMJe balances.
301
of the nation's money supply, and fiscal agent
of the Federal government.
Thus, the charging
and operating practices of the Federal Reserve
shoull,'I be such that the private sector can·also
compete in providing payments services to the
Treasury and other departments of the Federal
government.
With respect to the charging for payments services
provided by the Federal Reserve, we believe that
the bill introduced by Congressman Stanton (H.R.12706)
represents sound and constructive legislation, and
encourage its favorable consideration.
The BankWi N concurs
t.•ith the pricing
p:ropo•aZs called fo1'
in B.R. l270f ..•
We do suggest
that it could be improved by further wording which
would restrict the Federal Reserve from engaging in
any pricing or other competitive practices which
would be prohibited in the private sector.
We would
also encourage more rapid implementation of the
pricing of such services, calling for these to be an-
••. but re~onrnends
faster impZementation.
nounced by July l, 1979 and implemented by January l,
1980, instead of July l, 1980 as suggested in H.R. 12706.
We are absolutely convinced that requiring the Federal
Reserve to charge fully allocated costs for its payment
services will bring about major innovations and expansions in such services which will be of far reaching
benefit to the public--both individual consumers and corporations.
There have been tremendous strides in coiuputer,
communications, and other te~hnologies which are directly
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Fetl8ral ReseMJe
pricing o,t sew-ices
.,;. ii bring about
mjol" innovations
and e:rpansions iri
se-rv·ic~s.
302
applicable to new and efficient payments services which
can meet a large variety of individual needs.
It is,
however, essential that the artificial depressant of
free payment services provided by the Federal Reserve
be eliminated.
Once users have to pay the requisite
cost-for services, then there will be a realistic
economic environment in which others can compete with
the expectation of a reasonable return.
A!te1'11ate app1'0aches
and supp Zi.ers are
needed.
Different ser-
vices will be introduced as a result of competitive innovation to meet the differing needs of the marketplace.
New businesses will be formed and private sector employ-
ment will grow.
Our economy is too complex--too dynamic--
to be served adequately by a single approach to payments-just as one type of automobile does not meet the needs of
all consumers, nor does one style of clothing meet everyone's desires.
The Federal Reserve proposal H.R. 13477 is not adequate
in that it does not provide for the pricing of Federal
H.R. Z3477 aH01vs the
possibility of con-
Reserve services.
In the Federal Reserve's July 10 press tinued government
release, the Board also suggests that it might not price
any services if its program for universal reserve requirements were enacted.
This would continue a government sub-
sidy of the payments mechanism while stifling private sector initiatives.
In summary, we truly believe that, by calling for the
Federal Reserve to charge fully allocated explicit prices
for its payments services, the Congress will be enacting
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subsidy of the paymen ts mechanism,
303
.egislation which will be of long term and far reaching
benefit to the entire economy.
This will come about be-
cause such competitive pricing will provide an environment in which the private sector can compete in providing Chargi."9 for Fedsra Z
Rese'l"IJe services
higher quality and lower cost services to the public and
the government.
It will lead to new-economic activity in
wi.lZ be of major
long term benefit to
the pub Zic and the
econo.~.
the private sector, which will also increase employment
as well as having the salutary effect of increasing
Treasury revenues from additional taxes paid by the private sector.
To prevent such charges from being punitive,
the Federal 'Reserve should alleviate the present burden of rereserves imposed on its membership.
However, any such relief
should be completely separate from, and in no way conditioned upon,. the purchase of Federal Reserve payments
services.
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304
UNIVERSAL RESERVE REQUIREMENTS, INTEREST
ON RESERVES, AND CHARGES FOR SERVICES:
A COMPARISON OF 12 CENTRAL BANKS WITH
THE FEDERAL RESERVE SYSTEM
Evan Migdail
and
Steven M. Roberts*
*Evan Migdail was an Intern with the Committee on Banking, Housing
and Urban Affairs, U. S. Senate, during the Summer of 1978 when
this paper was prepared. Steven M. Roberts is Chief Economist
for the Committee.
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305
'Ibis study has been prepared in anticipation of consideration by
the Congress of legislation ameming the Federal Reserve Act.•/ Its
purpose is to c ~ e the Federal Reserve System
am
proposed changes
in the system with the structure of Central Banks of twelve industrialized countries. The proposed changes would create universal
reserve requirements for all depository institutions, initiate payment
of interest on reserves,
am
mamate charges by the Federal Reserve
for certain banking services. These services are currency
I
am
coin
services, check collection, ~et settlanent, lwire transfer, automated clearinghouse, securities safekeeping
am any
new payment
services that the Federal Reserve should choose to provide at some
future t:1me.
It should be noted fran the outset that consideration of
banking operations abroad has long been a starting point for planning
for changes in our own banking law. In fact, the hearings
am
studies
pursuant to consideration, in 1913, of the original Federal Reserve
Act included extensive discussion of the operations of foreign
2/
central banks• -
It is hoped that consideration now of the
operations of foreign central banks will aid in evaluating the
merits of the proposals recently made by the Federal Reserve to
the Congress.
I. THE AMERICAN DUAL BANKING SYSTEM
Foreign Central Banks am the Federal Reserve System are readily
(1) 12
u.s.c.
§ 221,et seq.
(2) Hearings Before the Conmittee on Banking am Currency, United
States Senate, 63d Cong. 1st Sess.,1913 (in three volumes).
33-587 0 - 78 • 21
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306
canparable as to their technical structures. In fact,much syimnetry
is fourxi in the areas considered in this study. However, as an aid
in comparison, it is necessary to call attention to one area that is
unique to the United States, that being the American dual-banking
system.
In the United States we have both a federally controlled system
of banking arrl a state-controlled system.
On
the other harrl, the foreign
states considered, generally have a system of banking that is
totally urxier control of the central goverrment.
'Ibis difference stems from the structure of federal-state
relations in American Constitutional Iaw. The federal Congress is
not given any explicit authority over banking in the Constitution.JI
However, the Congress is given explicit authority over such matters
as the regulation of interstate COlllnerce, collection of reverues,
the raising arrl supporting of the military, and the power to coin
money arrl regulate the value of money.
At the same time, the Constitution gr-ants authority to the
Congress to do what is 'necessary arrl proper' to carry out its
explicit powers.y From this •elastic clause• the Congress has
implied certain other powers. In the context of banking, it has long
been the law that the Congress has the power to incorporate national
(3) U.S. Cons.Art.1,§ 8.
(~) U.S. Cons.Art.l,D 8,cl.18.
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Federal Reserve Bank of St. Louis
307
banks and regulate them •.21 Through the interstate canmerce power,
Congress has had the power to insure banks and exten:i credits and
loans.
Therefore, the Federal Reserve System as it was instituted was
based on "membership." Membership is obligatory for all national
banks,§/ but voluntary for state-chartered banks.I/ Currently reserve
requirements and regulations set by the Federal Reserve apply to
member banks only JI These member banks represent 40 percent of all
conmercial banks and 72 percent of total bank deposits.
This difference, going directly to the proposed legislation,
merely serves to compel the need to study foreign systems, and
does not detract f'rom the merit of such studies. However,it nust
be kept in min:l in evaluating the 1110re extensive control over
banking by other central governnents.
(5) M'Culloch v. Maryland, 17 U.S. 316 (1819).
(6) 12
(7) 12
(8) 12
u.s.c.
u.s.c.
u.s.c.
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§ 221.
§ 321.
§ 561.
308
II. 'IBE PROPOSED LEGISLATION
Proposed legislation would reql.lll'e all depository institutions,
defined as those covered by the Federal Deposit Insurance Act, the
Federal Credit Union Act, and the Federal Hane Loan Bank Act, and
the National Housing Act, to maintain reserve requirements against
their transaction accounts in amounts determined by the Federal
Reserve. This change has been requested and Justified by the Federal
Reserve Board on the theory that although state non-member banks
are required to keep reserves by state law, in
many
cases those
banks are able to hold those reserves in interest bearing fonns.
Therefore, according to the Federal Reserve Board, a degree of
inequality had occured, causing competitive inequities between federal
and state banks. By its proposal the Federal Reserve Board has said
that this competitive inequality would be reduced, and therefore,
that the withdrawl of .state banks from the system would stop. In the
past eight years, 430 member banks have left the system and only
103 noninember banks have Joined._2/
A second proposal made by the Federal Reserve Board is the payment
of interest on reserves left on deposit at Federal Reserve Banks.
Such payments are l'lOt made at this t:lme and, in fact, have never
been made in the history of the Federal Reserve System. In fact,there
is serious question as to the existing authority under the Federal
(9) Statement of G. William Miller, Chairman, Board of Governors of the
Federal Reserve System~Before the Conrnittee on Banking, Finance and
Urban Affairs of the House Of Representatives, 27 July 1978,
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Federal Reserve Bank of St. Louis
309
Reserve Act for such payments to be made without explicit authorization
by the Congroess.
F1nally, there is a proposal that would rnarxiate that the Federal
Reserve charge for the previously ern.unerated banking services. At
present, the Federal Reserve Board has legal authority to do so,~
but does not exercise this power. '!bat is, services are provided to
members without charge 1n recognition of the reserves they hold at
the Federal Reserve Banks,
Four of the foreign central banks studied 1n this paper charge
directly for banking services
and
1n the eight other systems reviewed
banking services are provided 1n part by the central bank,
am
also
by private institutions. Six central banks provide services without
charge,
am
banking
services, there is a charge for the services.
1n all instances where private institutions provide s001e
Throughout this paper the terms 'clearing'
am
'settlement ' are
used. Clearing refers to the accounting process when 1\lnis are drawn
at one bank against accounts 1n another. Settlement refers to the
process involving the actual transfer of 1\lnis.
(10) 12
u.s.c.
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§467,
310
III. FUREIGN CENTRAL BANK STRUCTURES
The attached chart shows in detail information about the
relationship between the central bank
am.
the canmercial banks within
its jurisdiction. It errumerates the reserve requirement relationship,
whether interest is paid by the central bank on reserves held with it,
whether the central bank provides bank services,
am.
on what basis.
The following material is intended as an expansion of the
information in the enclosed chart. It is compiled primarily from
information provided .bY the International Monetary Fund, Embassies
of countries studied, the FINE Study, conducted by the House
Banking Comnittee Staff, the British
am.
am.
Canadian Bankers' Association,
materials listed in the bibliogl'aphy. Most of the information is
current to 1977.
(a) Great Britain
The Bank of
Englam.,
the central bank of England
am.
Wales, is
responsible for note issue, administration of the national debt,
am.
acts as governmmt agent in certain important financial transactions
am.
adviser to the government on financial matters. 111 It is also the
J;l[':lmary body responsible for monetary policy, which it influences
through setting of the rediscount rate, open market transactions,
am. reserves
of Englam..
that llllSt be kept by all British banks with the Bank
(11) See generally British Inforniation Services, British Banking
Other Financial Institutions (1974).
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am.
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Federal Reserve Bank of St. Louis
MANDATORY
/.\11 RANKS
I
9% on d"'mand de-
Yes
None is Paid
posits;
Austria
National
Bank
7% on time, if
less than 12
months;
6% on time i f
more than 12
months.
__ ______
,
National
Bank of
Belgium
TWO TYPES
LEGAL & '10 NETARY:
Up to 20 % f or
demand dep osits;
7% for time deposits.
None - - unless
reserves are
held in the
form of govt.
bonds, in
which case the
market rate is
paid.
SERVICE
Cii!,RGES
SERVICES
PROVIDED
---·
Pro vides curre ncy, but
ch eek clearin g & other
in terbank
se rvices are
pr ovided by
pr ivate
ba nks.
None for currency services
private banks
charge for their
services.
Coi n & Curren- ro Charge
- No
a ti anal Bank
cy ;
charges fee for
on the basis Nat ional Bank
size·
of
of
pr ovides a for- settlement services;
location of
um for large
Private institubanks.
co mmercial
tions charge for
ba nks to settl e obligatioml their banking
Che ck clearing, services.
tr
1
her interban
ot ansmission,.
se rvices are
pr ovided by pri
va te, profit inst i tutions.
Yes
Differences
Jf,··.
Bank of
Canada
Current Acco'unts
12%;
Time Deposit s 4 %;
Savings 4%.
None is Paid
No - Chartered banks
only.
This exeludes
trust banks
& loan
banks.
Onl y service by
ce ntral bank
is delivery of
no te issue.
Che ck clearing
by Canadian
Ba nkers Assoc.
0th er services
ar e privately
pr ovided.
No Charge
Charge
Charge
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INTEREST OR
NO PJTEREST
GERMANY
WEST
Up to 30% for
demand depos-
DeutscheBundes
Bank
20% for time
deposits;
its;
No-Central bank
holds reserves
as interest
free current
accounts.
10% for savings; Ht all
MANDATORY
Varies ac-
cording to
size, location (ie,
proximity
to a re-
gional
central
bank) , &
credit inst's,
SF~..VICE
Al I BANKS
ill11lli.
Check clearing & settlement for
large banks
None
only; coin
& currency
services.
importance
of bank.
Used basically for
monetary
policy.
SWITZER-
LAND
Swiss
National
Bank
Reserve fu~d of
1/20 of a
None is Paid
Yes
The Bank issues bank
bank's net
notes,
profits yearly
ships cur-
Deposits for in-
No Charge
rency, safe-
flation control
keeping of
securities,
~heck clear1ng.
,
j
!
--~--··---·-1·
12½% day to day
None is Paid
liquid reserves;
consists of
Bank of
England
cash
& securi-
ties.
Minimum balance None is Paid
on cash deposit.
1½% special. cash None is Paid
reserve
Monetary cash
reserve can be
called in at
any time
Interest paid
at market
rate.
Yes
Provides currency in England & Wales.
Check clearing, wire
transmission,
and settle1
ment services are pro-•
vided by private inst's.
No charge for
shipping
currency;
Services by
private institutions
are provided
at a charge.
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MANDATORY
ALL BANKS
ITALY
Bank of
Italy
Legal reserve
fund of 1/Z0th
Yes-current
rate is 5.5%
of net ;:i.nnual
profits until
such fund
reaches 1/5 of
Yes-for all
commercial
& savings
banks.
ital.
Can be set up
to 15%-vary
Bank of
according to
France
nature, ar.--oun t
& variatio~
PROVIDED
Check clearing;
Cur:ency &_
i
No Charge
;
No Charge
!
;I
coin services
Wire transfer
Charge
I
services;
There is a
Settlement
commission
services.
I
the entire cap-
FRANCE
SERVICES
I
No
Yes
charge on this.
The Bank pro- !i 'lo Charge for
any services.
vides check
clearing,
currency &
settlement
of the ele-
services
ments of lia-
bilities to
which they
apply.
-------,f---
MEXICO
Mexico
Currently set
at 37%; two
types, 1 ega 1
& monetary.
DE11MARK
No reserves as
Bank of
Danmarks
National
Bank
such but:
Liquidity ra-
Only a portion
of this (over
50%) receives
interest.
Yes
Not Applicable
tios;
Deposits taken
at times for
monetary poli-
cy or check
clearing
Yes
Yes, at the
market rate.
Check clear-
ing, coin &
currency,
wire transmission &
settlement
services.
Check clearing & trans-
mission services; also
wire transmission.
Bank of Mexico
charges for
all services.
No Charge for
services. Only
when there is
check clearing,
a charge is
registered in
the commercial
bank's balances
with the central
bank.
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INTPEST OR
NO NJEREST
MAND~TO~Y
Al I AN S
--------.----------,,---------,------------~-GREECE
Bank of
Greece
20% private
sight & restricted;
5% of private
savings;
2nd reserves
of 20% private sight &
restricted,
3% savings.
None on first
reserves
Yes for all
commercial
banks. No
exceptions.
Central bank
provides
currency
settlement
services, &
2nd reserves
with interest
at market
rate. Currently at
9.5%.
check clearing.
Central bank
charges for
settlement &
check clearing based on a
% of the volume
transacted.
---------"f-----------+--- ----------+--------+---------+------------
JAPAN
Bank of
Japan
by
.! Varies
type of in-
stitution &
size between
1.625% &
0.125% for
time, & 2.5%
to 0.25% for
other deposits.
Banks are ciassified by size
& function, ie,
agricultural v.
savings, etc.
No interest
paid on any
reserves.
Yes-No exceptions
for any
banks.
No direct charges
Check clearfor services,
ing & sethowever, adjusttlement done
ments are made
through a
in the balances
current acof commercial
count kept
banks with Bank
with Bank of
Japan by com- of Japan.
mercial banks;·
also providing of yen,
wire transmissions, &
discounting
of bills.
315
Implementation of central bank policy in Engl.am has been effected
traditionally through informal agreements rather than by statute. However,
should there be a''breakdown of trust", the Bank of Engl.am Act of 1946
gives the Bank authority to implement the above banking policies. At
this writing, the Bank of Engl.arxi has not yet had occasion to use its
statutory authority.
British banks are broken down into four classifications. These
are Deposit, Merchant, British Overseas am Comnonwealth am the
Foreign am Consortium Banks. Crucial to the Bank of Engl.arxi's
supervision of the economy is the provision that all British banks
provide it with statistics regarding their assets am liabilities
( including reserves) , a requirement that has led to their being
called 'statistical banks.'
Since 1971 there has been a man::l.atory 12.5 percent reserve
requirement, on day-to-day eligible liabilities, for purposes of
controlling money am credit. There may also be min1mum deposits
with the Bank of Engl.am for facilitation of clearing (clearing
balances) as well as a 1.5 percent special liquidity cash reserve.
In addition, at any time the Bank of
Englam
may
call in a further
monetary reserve. Of the various types of reserves that may be
required, interest is payable only on this monetary reserve, am
would be calculated at the market rate of interest. Reserves are
required generally for the purpose of monetary control~ however,
reserves are also held so as to ensure that British banks are able to
meet their day-to-day deman:l.s of the clearing system.
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316
The Bank of
Engl.and
provides note am coin issue to
Engl.and
am
Wales at no charge for shipping. Check clearing is done by private
institutions, known as the clearing banks. By
network, the heads of each
bank
way
of a cooperative
send an accounting of checks drawn
against the other banks for clearance. Non-clearing bank members
can participate in clearing through a special agent appointed for
clearing purposes. While clearing is done by the private institutions,
the clearing banks themselves
the Bank of
Engl.and
may
maintain a clearing balance with
am clear checks by
way
of bank drafts drawn
against these balances. Settlement services are also provided by
private institutions. For these services there is a charge, as the
private clearing am settlement institutions are profit making.
It is probably valid to say that the authority of the Bank
of Englam would appear to be more narrowly drawn than that of
the Federal Reserve, but that the small rrumber of banks am the
power of moral suasion gives the Bank of Englam greater overall
day-'to--day
control of the banking system. Also, unlike the United
States, the Bank of Englam covers all banks, there being no
dual banking system.
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317
(b) Belgium
Banking in Belgium is controlled by two organizations, the
Royal Banking Comnission
am
the Bank of Belgium. 'lhe former is
responsible mostly for micro-economic policy, such as supervision
am
regulation of irrlividual banking institutions. The Bank of
Belgium performs services generally associated with central banks
such as providing coin
am
paper currency, providing settlement
facilities, holding bank reserves
am
serving as the lerrler of
last resort. It is also in charge of monetary policy. Urrler the
Belgian political structure, which is different fran the
American federal-state model, banking is controlled in large
part by Royal decree
am
is applicable to all banks.
Reserves are deposited in the Bank of Belgium as a fixed
proportion of the monetary liabilities of all banks. Generally
there is no interest payable on reserves. However, a portion of
the reserves
may
be held in the forni of goverrment borrls,
am
interest, on these borrls, is payable at the market rate.
The Bank of Belgium provides coin
am
paper currency at no
cost. Check clearing is provided by private institutions,
am
these
charge for their services. Settlement may be effected through
facilities of the Bank of Belgium, which basically consist of
facilities where officials of the few banks can meet to clear
accounts. The Bank of Belgium charges a low fee for the use of the
facility. This is easily accomplished owing to the small number
of banks in the country
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Federal Reserve Bank of St. Louis
am
the consequent ease of coordination.
318
(c) Federal Republic of Gennany
The Deutsche Burxiesbank, the post-war West German central bank
is structured :l.n a
way
s:1milar to that of the Federal Reserve Systen.
'lbere is one central bank with branches :l.n each of the eleven states
of the German Federation. The President of each of the regional
banks, along with the Board of Governors of the ma:l.n central bank
are responsible for monetary policy. The Burxiesbank has control
over all banks :l.n the Federal Republic.
There is also a Bank Supervisory Authority which oversees
bank regulatory policy :l.n coordination with the Deutsche fumesbank.
The latter can reftlse to offer its rediscounting facilities to banks
if they should violate reconmeroations of the Supervisory Authority.
The fumesbank collects statistical information from all West
German banks for the purposes of planning policy.
The basic Justification for reserve requirenents held by the
Deutsche Burxiesbank is the eff~tuatiotj. of ronetary policy. Gennany
:l.n the post-war period has been among few countries to use variable
reserve requirenents to :1mplenent its monetary policies, basically
as a check on the balance of payments and as a means of reinforcing
the official discount rate. 12/
Reserves are held as interest-free deposits with the central
bank. There are upper l:1mits on the amount of the reserve, and these
can be varied according to size of the banks, location, and :importance.
(12) M.H. deKock, Central Banldng,pp.224-226 (1974).
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319
As
far as location is concerned, proximity to a regional central bank
would be a factor 1n keeping a smaller reserve.
Settlement services are offered only to "large''banks , arxl. the
central bank also performs check clearing arxl. provides coin arxl.
paper currency. There is no charge for these services.
(d) France
The French banking system is under the supervision of two
organizations, the Bank of France arxl. the Banking Conmission. The
Banking Conmission is presided over by the Governor of the Bank of
France. It is responsible for banking arxl. reserve ratio policy at
the micro-level, whereas the Bank of France is pr:lmarily concerned
with overall econanic policy.
The Bank of France is similar 1n function to the other central
banks reviewed. It is the issuer of currency, performs clearing arxl.
settlement! services, is responsible for foreign banking arxl. IOOnetary
control, arxl. performs rniscelaneous functions on the Treasury's
behalf.
In similar fashion as the Deutsche Bundesbank, the Bank of
France has exper:l.rnented with variable reserve requirements. The
variations go to the amount arxl. nature of the liabilities to which
they apply. under French law these can be set at up to 15 percent.
The French requirements apply to all banks without exception.
The
Bank does not charge for its banking services, and no interest is
paid on reserves.
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320
(e)~
The Bank of Italy is not owned in any part by the goverrment.
Instead it is owned by shareholders, who elect all the directors,
except for the Governor, who is chosen by the directors with the
approval of the goverrment. 131 '!he shareholders are comnercial
and savings banks.
The Bank
of Italy is one of the few foreign
central banks with a pennanent office in the United States for
the study of American financial institutions. l4/
The Bank of Italy has broad authority in the areas of credit
control and monetary policy. It also perfonns typical central
banking functions such as providing currency, check clearing and
settlanent, and wire transfer services. Charges are made for the
wire transfer services, and a percentage canmission is taken on
settlements. There are private clearing houses in Italy, as is
the case in Great Britain, and the Central Bank has the power to
advance, for a period of up to ten days, .rums to facilitate
settlements between the banks and the clearing houses.
Reserves are ma.rrlatory for all ccmnerical and savings banks,
and are deposited with the Bank of Italy. These are calculated
as a percentage of deposits with a ceiling on the total accunrulation.
Interest is paid on the reserves, the current rate as of July 1978
being 5,5 percent.
(13) Id, at 307-310,
(14) Bank of Italy office is in New York City.
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Federal Reserve Bank of St. Louis
321
At t:l.mes a percentage of the reserves may also be held in
goverrment borxis or securities, as is the practice in Belgium. The
breakdown of such an arrangement is to be detennined by the Bank of
Italy arxi must allow at least 15 percent of the requirement to be
held with the Bank of Italy. Urxier these circumstances, those revenues
on deposit with the Bank of Italy would receive 5.5 percent arxi the
rest would obtain whatever yield the borxis or securities offer.
(f) Denmark
The Danish banking system is far less canplex than that of most
other countries in this study, a surprising fact because of the
comparatively large number of banks for so small a nation. While there
are three large Copenhagen banks, with over 50 percent of the total
banking business, there are also 78 irxieperxient banks. 151
Banking
in Dermark is urxier the supervision arxi control of the
Danmarks Nationalbank. The key mechanism used by the bank for the
control of monetary policy is the discount rate.
There are no reserves canparable to those required by the
other central banks. However, the central bank does have certain
requirements designed for the protection of the banking public.
The first of such requirements are liquidty ratios, consisting of
hold~ in the vaults of each bank. These are cash or easily
marketable securities. The aggregate amounts must not be less than
(15) This should be compared to Canada, below, with only twelve
institutions that are legally designated as banks.
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15 percent of a bank's conrnittments payable on demarxi or at less than
one month's notice.
Besides the liquidity ratios there are deposits taken by the
central bank for the purposes of check clearing ( clearing balances) •
The size of such balances are determined by the central bank. There
is also authority for the central bank to require additional deposits
with it for monetary purposes. In either of these two cases, any
deposits left with the central bank would receive the market rate
of interest.
Bank1ng
services such as providing currency, check clearing,
and wire transmission of funds are provided without charge.
(g) Switzerland
The Swiss National Bank, which predates the Federal Reserve by
six years, is the only note issuing bank in Switzerland. It is not
owned by the Confederation but is a public 1:lmited company with its
shares quoted on the stock exchange. About 42 percent of the issued
capital (50 percent of the total capital) is in private hands, the
rest being owned by the cantons, the cantonal banks or other public
entities. At one t:jme, as is presently the case in Great Britain,
the Swiss Bank operated on the basis of mostly informal agreements.
However, in recent years, this has yielded to the formalism of law. 161
The Bank is broken down into three departments, two in Zurich
and
the third in Berne. The se are also functionally divided in terms
(16) Peter G. Fousek, Foreign Central Banking: The Instruments of
of Monetary Policy,pp.41,45-46 (1957),
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of banking services • The services offered in Berne relate to bank
notes issue, gold control, and coordination with federal authorities.
At the two other departments there is safekeeping of securities,
clearing, collection, and settlement, discount of eligible paper,
and loan functions of the Swiss Bank. The Bank is also responsible
for monetary policy through control of the money supply and open
market operations.
Reserves are mandatory for all banks, and are of two types •
One is in the form of an interest-free deposit to fight inflation,
which the Bank
may
authorize. Such reserves are -a function of the
bank's gr-owth level and liabilities.
A second reserve is for the writing off of losses, and is
calculated, at a min:inn.un, one-twentieth of a bank's yearly profits.
The ceiling on this amount would be one-fifth of paid in capital,
or in the case of banks with no paid-in capital, one twentieth
of deposits.
The Swiss National Bank does not charge for banking services.
(h) Austria
The Bank of Austria, in similar fashion to other central banks,
performs both national economic and monetary policies, as well as the
recognized cUITency services of most central banks. However, under
the Austrian system, the central bank issues only bank notes while
coins are exclusively issued by the Ministry of Finance.
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All credit institutions 11Ust maintain reserves • These are
uniformly fixed, by law, as a percentage of liabilities, the opposite
of the neighboring German system of variable reserves. No interest
is paid on reserves.
The Bank an1 the Ministry of Finance deliver cUITency free of
charge. However, other banking services, such as check clearing,
settlement, an1 :niscellaneous /interbank exchanges are provided by
private institutions rather than by the Bank of Austria. As is
generally the case, there is a charge for the services of private
institutions.
(1) Greece
In terms of political authority of national banking organizations,
the Greek system is the exact opposite of the Federal Reserve. Here the
national government has strict control over all banks without
exceptions. All financial policy is placed in the Greek Currency
Cormlittee. The Bank of Greece has the authority to enforce adherence
by the banks to the decisions of the currency coornittee.
The Bank
of Greece is s:lmilar to the Federal Reserve in the
sense that they ·are both am:mg only five world central banks in
which the state does not have any direct share of ownership. 17/
Besides its supervisory authority over policy it performs traditional
central banking :functions such as settlement an1 check ~learing,
(17) M.H. deKock, Central Banking,pp.305-306 (1974).
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providing currency, transfer of fun::l.s, and custodian of the state's
foreign assets. The Bank charges a percentage rate fee for settlements
and check clearing services.
Reserves are held in two parts. The first is calculated at 20
percent of demand and time deposits and 5 percent of private savings.
No interest is paid on these reserves.
On
the secom reserve, which
is the same for demand and time, and 3 percent for savings,interest
is paid. Current rate is 9.5 percent. 181
(j) Mexico
The Mexican Central Bank is owned 51 percent by the Mexican
government, the renaining 49 percent held by the credit institutions
themselves. The Mexican goverrment's requirements cover all banks.
The Organic Law of the Bank of MexicJ:2/ states that the Bank's
functions are regulation of currency, clearing, management of
reserves held with it by the c011nnercial banks, supervision of
compliance by the canmercial banks of decisions of the National
Banking Conmission, and acting as financial agent of the government
in foreign transactions and loan matters.
Reserves are a major policy tool in Mexican monetary policy.
At present they are set at 37 percent of deposits. The reserves can be
divided into two parts; those taken for monetary policy and those
(18) June 1978 figure provided by Greek Embassy, Washington D.C.
(19)
Hans
Aufricht, Central Bank Legislation
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(1960).
326
for legal purposes. About one half of all reserves earn interest.
The Bank provides currency, settlement and clearing as well as
wire transmission services to the camnercial banks. There are charges
for all of these services.
(k)~
The Bank of Japan is one of the oldest
central banks, dating back to 1882.
Its orgins
are in the monetary crisis of the same year, caused by an overabundance of paper money issued by the several national banks. The
Bank
ordered the withdrawl of all issue and became the sole source
of currency. 20/
The Bank has a complex system of variable reserve requirements,
which classify banks on the basis of size and function of'.institution,
as well as type of deposit. Function classes range from savings, to
agr'icultural, to "near-banks" that perform only one banking function.
No interest is paid on any reserves.
Among its banking services is providing currency, wire trans-
mission, and discounting of bills.
No charge is made for these
services. Fbr settlement and check clearing there is no direct
charge. This is done through a system of clearing balances held by
the Bank. Adjustments are simply made in the balances to account
for transactions.
The Bank is owned 55 percent by the goverrment, the remain:l.er
by the comnercial banks. Its directors are all government appointed,
and there is no shareholder participation in management.
(20) M.H. de Kock, Central Banldng,p.7 (1974).
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(1) Canada
Gahada's banldng structure is set up so that all institutions
allowed to call themselves banks are un:ier the control or
Parliament. This is accomplished by having only twelve banks, each
required by law to be chartered by Parliament. These ha.role savings
and ccmnercial transactions.
Mortgage, trust, and loan activities
are ham.led by other institutions, !mown ccmnonly as "near-banks"
but not within the bank classification. The system has been
relatively stable. In ract, the last bank failure in Canada took
place in 1923.
The Bank or Canada does not provide the full range or services
provided by other central banks reviewed in this study. Its main
responsibility is the control or credit. As such it holds reserves
or the chartered banks in two classes or reserves. Cash reserves,
held in the rorni or deposits with the Bank or Canada are set at
present at 12 percent ror deman:i and 4 percent for time deposits.
Secondary reserves are a complex scheme or deposits in excess or the
above cash reserves. Also, on the basis or moral suasion Canadian
banks generally are advised to keep an investment in some liquid
asset. Reserves are non-interest bearing. 211
The Bank or Canada provides coin and paper currency at no
cost for shipping, However,settlement and clearing is the responsibility
or the Canadian Bankers' Association through a network or clearing
houses. The Bank or Canada assists in this to a certain degree by
supervision at the head offices or the banks and in transmitting
net clearing results to the banks. The CBA charges ror interbank services.'
(21) See Canadian Bankers' Association publications in bibliography.
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The statutory scheme of Canadian banking law provides for a
revision every ten years. In August, 1978, a revised bill entered its
secorrl reading before'Parliament. Of relevance.to the changes now
being contemplated in the United States is the provision in the
new bill for a Canadian Payments Association. 22/
The CPA would be chartered by Parliament, in much the same
way
as
the twelve chartered banks. All twelve banks would be required to join.
The purpose of this facility is to widen the scope of the clearing
23/
system am the coordinated banking in Canada.- The CPA would not
be an agent of the Canadian government.
Originally, the proposal had called for rnarrlatory reserves of all
CPA members, but it now appears that this proposal has been deleted.
All banks (but not near-banks) um.er the new legislation will still
be required to keep reserves with the Bank of Canada, but these
reserves are to be reduced by approximately 2 percent across the
board. It might also be pointed out that the near-banks do not have
access to the banking services of the Bank of Canada.
(22) Bill C-57, 26-27 Elizabeth II, 1977-78.
(23) Donald S. Macdonald (Minister of Finance), White Paper on the
Revision of Canadian Banking Legislation (1976).
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IV. CONCLUSIONS
The central banks chosen for this paper represent the banking
systems of the world's most developed, free irr:iustrial states. While
there are
many
other central banks abroad, these represented the most
advanced that could be readily studied.
Of the twelve central banks considered, eleven operate un:ier a
political systen in which the national government reaches all
banking institutions without the need for a participatory scheme that
excludes some coomercial banks. '!he twelfth nation, Ganada, merely
uses the device of nationally chartered banks exclusiveq, in order
to have Parliament supervise all banks. Therefore, whether the
reserves are variable or fixed, in all twelve nations they are
mandatory for all banks.
In every country where private institutions provide the basic
banking services s:1milar to those discussed above for the Federal
Reserve, charges are levied for the services. In the cases where the
central bank provides the basic banking services, four charge
directly
am
several other require the banks to hold clearing
balances which they adjust periodically· ·as transactions are made.
Charges are in the form of either flat fees or percentage
cOIIJllissions or both on various transactions.
Interest on reserves held by foreign central banks is not
a cOlllllOn feature. Only three nations, Greece, Italy
am Mexico
pay interest directly. Only Italy pays interest across the board
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on all reserves. Moreover, Mexico pays only on a portion of reserves
and Greece only on secomary reserves. Italy at times permits banks
to hold reserves in bonds and securities, and in such circumstances,
reserves receive the market yield.
The central bank of Belgium allows some reserves to be held in
the form of Treasury Securities. Great Britain pays interest on
emergency monetary reserves, but these reserves are not a per,nanent
feature. De!'lllark is among four nations that hold prudential, check
clearing or special monetary deposits. It is the only nation studied
paying interest on check clearing balances or special monetary
deposits.
In Belgium, West Germany, France, Mexico and Greece, banking
supervision is pursued by royal or governmental COJ!nlissions acting
in concert with the central bank.
The
cOJlnlissions deal mostly with
micro-policy, the regulation of individual banks, and leave
macro-policy, the national economic regulation, to the central
bank. However, there is a thin line separating the coorn1ss1ons and
the central banks, and in some cases, the central banks are the
enforcers of both micro and macro policy.
Finally, in Great Britain and Canada, while the central banks
do not operate in as
many
areas as the Federal Reserve, coordination
with a National Bankers' Association, and the power of moral
suasion leads to a tightly regulated banking system.
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331
BIBLIOGRAPHY
Aufricht, Hans Central Banking Legislation,(Washington;International
Monetary Fund 1961).
Aufricht, Hans Comparative Survey of Central Bank Law, (London;
Stevens and Sons 1965).
British Information Services British Banking and Other Financial
Institutions, (Dorset;Henry Ling Ltd. 1974).
canadiar'l Bankers' Association (l)Factbook (2)The Chartered Banks
Of canada (Toronto;Canadian Banker's Association (1977).
Corrmittee on Banking, CurTency and Housing, United States House of
Representatives International Banking - A Supplement to a
Compendium of Papers Prepared for the FINE Study, (Washington;
Government Printing Office, 94th Cong.2d Sess. 1976). Not
adopted by the Comnittee.
Conmittee on Banking and Currency, United States Senate Hearings
H.R. 7837, S. 2639, The Federal Reserve Act,(Washington;
Goverrment Printing Office, 63d Cong.1st Sess. 1913),
On
De Kock, M.H. Central Banking, (New York;St. Martin's Press 1974).
Financial Times Limited, Banker Research Unit Banking and Sources of
Finance in the European Ccrnmunity, (lon:ion;Financial Times
Limited 1975),
Financial Times Limited, Banker Research Unit Banking and Sources of
Finance in Switzerland, Austria, Yugoslavia and Greece,
(London;Financial Times Limited 1975).
:The Instruments of Monet
Fousek, Peter G. Forei Central
Policy, (New York;Kennikat Press 1957 •
Macdonald, Donald S. (Former Minister of Finance) White Paper on the
Revision of Canadian Banking Legislation,.(Canada; Ministry of
Supply and Services 1976).
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Federal Reserve Bank of St. Louis
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Proposed Bank Regulatory Changes And Their Effects On Ec:onomic Stability
A Position Paper
by
Anthony M. Santomero
and
Jeremy J, Siegel
September, 1978
The authors are both Associate Professors of Finance, The Wharton School,
University of Pennsylvania. They wish to acknowledge the support of the
Rodney White Center for Financial Research,
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Introduction
Recent legislative proposals submitted to Congress or presently
under discussion offer the potential of substantial changes in the
regulatory enviornment within which commercial banks operate.
Hear-
ings have centered upon the alleviation of the so-called "membership
problem" facing the Federal Reserve System.
Duri11g the discussions
of possible remedies to the decline in Fed membership a number of substantive changes in regulation have been proposed.
Earlier, it was
suggested that the improvement of Federal Reserve member's relative
posit1on could be obtained by reducing Federal reserve requirements
on deposits.
A more recent proposal involves the payment of interest
on required reserves held at regional Banks.
This proposal has been
coupled with the elimination of the 1933 prohibition on- interest on
demand deposits.
This coupling was originally viewed as a method of
transmitting some of the new found income accruing to the financial
institutions directly to their depositors.
In summary, three proposals are presently under consideration,
viz~,
(1)
a change in the required reserve ratio on member banks
(2)
interest payment on required reserves, and
(3)
interest payment on demand deposits.
In addition there is the related issue of the appropriateness of different reserve requirements both between members and non-members, and
commercial banks and other sight deposit issuers, such as NOW accounts
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(b)
Reducing reserve requirements will accentuate the disturbances
in the economy caused by a shift in the base or reserve money market
(referred to as monetary disturbances).
Such a disturbancs would occur
if commercial bank reserve behavior were to shift or tbe demand for
currency of individuals were to suddenly
(c)
change.
Paying interest on required reserves has exactly the opposite
effect of reduced reserve ratios.
It reduces monetary disturbances
while
increasing real shocks.
(d)
The payment of interest on demand deposits has a similar effect as
a reduction in reserves, as it too reduces the severity of monetary disturbances and exacerbates real distarbances.
(e)
A combined shift to positive rates of interest on
reserves and
interest on demand deposits appears to be a counterproductive move from
the standpoint of macroeconomic stability.
It has the potential of in-,
creasing the severity of both monetary and real disturbances to the economy.
(f)
A combined shift to lower reserves and positive interest rates
on demand deposits would tend to have a stabilizing effect for both disturbances.
(g)
Universal reserve requirements could be quite beneficial· to eco-
nomic stability if and only if they were instituted in conjunction with
identical definitions of reserve assets for all institutions holding transact ions balances.
(h)
Unive·rsal reserve requirements on transaction balances will cause
the economy to be slightly more stable than its present condition, given
the current definitions of required reserves and institutional arrangements
of check clearing and correspondent banking.
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Method of Analysis
The basic framework employed in our research into this question of
regulatory change is a general equilibrium model of the financial markets,
Three sectors exist in these markets, viz, (a) households, (b) banking or
financial institutions, and (c) firms,
Each sector's demands and supplies
of assets satisfy balance sheet constraints and substitution properties
that are well established in the monetary literature.
The financial
markets themselves are divided into four types of assets, viz. (a) currency,
or high powered money, (b) deposits of various types, including demand
and time accounts at all financial institutions, (c) bonds issued by firms
and the government, and (d) equity, or firm shares.
The model detennines
the rate of interest in the bond and equity markets, and the general level
of prices that are consistent with equilibrium,
As noted at the outset, however, our attention centered upon the behavior of the economy when some unexpected disturbance occurs.
Of course
if the Federal Reserve had perfect knowledge of all such disturbances, the
point would be moot, as they could offset any shifts.
In the latter case it
has been shown that the monetary authority has sufficient tools to achieve
a stable eonomy.
When the price level, and employment levels are only known
with a lag and the sources of the disturbances are not kno'Wtl, complete control
is not feasible.
In this case, the central bank can only operate to minimize
the fluctuations in the economy,
Alterations in the financial regulations
will effect the ability of the Federal Reserve to minimize the destabilizing
shocks to the economy,
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This is the essence of our study,
336
To analyze the impact of regulatory change on economic stability we
consider an exhaustive set of four distinct types of disturbances to the
economy.
These are:
(1)
a change in either the demand or supply of money.
(2)
a change in the market for equity
(3)
a change in the narket for real output
(4)
a distributional shift between institutions .issuing demand balances.
Given the present regulatory structure· a disturbance of any of the above
types will affect output or prices,
The degree of this adjustment is dic-
tated by the interrelationships between markets, and the present regulatory
structure.
Next we analyze how the variance of prices would be affected by the
proposed changes in regulations.
Here variance of price is u~ed as a
measure of stability, with output variation or some other indicator of the
stability of the underlying economy an equally valid and consistent guage._
The results of the analysis are enumerated above in the summary section._
~oncluding Remarks
We telieve our study anc its results to be particularly relevant to
the present hearings.
Our work appears to be the only analysis available
on the macroeconomic effects of the present proposals~
It presents clear
cut policy reconnnendations vis-a-vis the '"membership'' issue..
Specifically
it argues that seemingly similar approaches to the reduction of membership cost
will have different macro effects.
It seems obvious that these differences
should be recognized in any regulatory change.
Obviously we have not burdened the committee with the explicit model
that achieves these results,
However we would be happy to offer our
scholarly papers that arrive at these conclusions,
Further, any questions
you may have or discussion you may wish would be welcome by both of us.
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@FedFRASER