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Federal Reserve Bank of St. Louis

Lending Functions

Of The
Federal Reserve Banks:
A History
Board of Governors of the Federal Reserve System


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Federal Reserve Bank of St. Louis

Lending Junctions
Oflhu
Jederal Reserve/Banks:
J[ History

Library of Congress Catalogue Card Number 73-600196
Copies of this book may be obtained from Publications Services, Division of Administrative Services,
Board of Governors of the Federal Reserve System,
Washington, D.C. 20551. The price is $3.50 per
copy; in quantities of 10 or more sent to one address,


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Federal Reserve Bank of St. Louis

$3.00 each. Remittances should be made payable
to the order of the Board of Governors of the
Federal Reserve System in a form,that is collectible
at par in U.S. currency. (Stamps and coupons are
not accepted.)


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Federal Reserve Bank of St. Louis

4 History,
i of the'|
Lending*

Foreword

This book represents a revision and updating of an unpublished
version that was mimeographed in April 1961. The earlier version
was prompted by a 1955 revision of the Board's Regulation A;
the present version was prompted by the 1973 revision of that
regulation.
I make no apology for the length and technical nature of the
book nor for the seemingly disproportionate space given to longforgotten matters, such as the many Board interpretations during
the 1920's and the chapter dealing with the obsolete authority of
the Federal Reserve Banks to make working capital loans to
business. This is necessary to achieve the objective of presenting
a comprehensive history of the lending functions of the Federal
Reserve Banks.
Following tradition, I must include here a statement that, unless
otherwise indicated, any opinions expressed in this book are my
own and are not to be attributed to the Board of Governors or to
any member of the Board or its staff.


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Federal Reserve Bank of St. Louis

History
i. of the i
Lending
Functions

Table of Contents
INTRODUCTION
Statement of objective 1
Distinction between Reserve Bank loans and commercial bank
loans 1
Significance of Reserve Bank loans 3
Scope of this study 4
Arrangement 5

THE ORIGINAL DISCOUNT PROVISIONS
LEGISLATIVE HISTORY

7

Development of the Federal Reserve Act 7
Differences among the discount provisions of
various bills 8
Resolution of differences 8
The final provisions 8
BASIC PURPOSES

9

Creation of a market for commercial paper 9
Prevention of panics 10
Expansion of
business 10
Benefit to country banks 10
Lessening of speculation 11
Elastic currency 11
Secondary objectives 12

GENERAL LIMITATIONS
MATURITY

13

Introduction 13
Reasons for 90-day limitation
Days of grace 16
Regulations 16
AMOUNT
Aggregate amount

16

16

Paper of one borrower

ENDORSEMENT
Purpose


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Federal Reserve Bank of St. Louis

22

14
Agricultural paper
Demand paper 16

17

22

Waiver of protest 22
Regulatory provisions
Form and effect of endorsement 22

22

14

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Table of Contents—Continued
GENERAL LIMITATIONS Continued
NEGOTIABILITY
Regulatory requirement

23

23
Exceptions 23
Meaning of negotiability
Elimination of the requirement 24

24

DISCOUNT OF COMMERCIAL PAPER
MEANING OF "COMMERCIAL PAPER"
Intent of the original Act
Self-liquidating nature 31

27

27
Regulatory definition 28
Commercial purpose
Effect of collateral security 31
Evidence of eligibility
Change in concept as to eligibility 33
TRADE ACCEPTANCES

Separate classification for rate purposes

33

33

Nature of transaction

COMMODITY PAPER

34

34

35

35
Evidence of compliance 36
Meaning of permanent investRemoval of exclusion of permanent-investment paper 36

PAPER DRAWN FOR SPECULATIVE PURPOSES

37

PAPER DRAWN FOR TRADING IN STOCKS AND BONDS
FINANCE PAPER

CONSUMER PAPER

40

CONSTRUCTION PAPER

vi

38

39

Original exclusion from discount 39
Modification by statute
Reversal of Board's position 39


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Federal Reserve Bank of St. Louis

Form

35

PERMANENT- OR FIXED-INVESTMENT PAPER
Exclusion from discount
ments 36

30
32

41

39

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Table of Contents—Continued

AGRICULTURAL CREDITS
THE ORIGINAL ACT 43
AGRICULTURAL CREDITS ACT OF 1923
Background

44

General provisions

44

Amendments to Federal Reserve Act

NATURE OF AGRICULTURAL PAPER
Regulatory description

46

44

46

Distinguished from commercial paper
MATURITY

45

46

47

AMOUNT LIMITATIONS

48

SIGHT DRAFTS 48
FACTORS' PAPER 49
PAPER OF COOPERATIVE MARKETING ASSOCIATIONS

50

DISCOUNTS FOR FEDERAL INTERMEDIATE CREDIT BANKS

51

BANKERS' ACCEPTANCES
GENERAL CONSIDERATIONS

53

Purposes 53
Early encouragement by the Board 54
Definition 55
Acceptance
authority of member banks 56
Discounting authority of Federal Reserve Banks 57


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Federal Reserve Bank of St. Louis

••
VH

.-History*| of the I
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Functions

Table of Contents—Continued

BANKERS' ACCEPTANCES Continued
IMPORTATION AND EXPORTATION OF GOODS

58

Connection with import or export 58
Contract and shipping documents
Geographic coverage 61
DOMESTIC SHIPMENTS

59

61

Extension of law to cover domestic shipments 61
Purpose of financing
Shipping documents 62
Geographic limitation 62

62

STORAGE OF STAPLES 63
Purpose of transaction 63
Warehouse receipts and other security 63
Place of storage 64
Meaning of "readily marketable staples" 64
DOLLAR EXCHANGE
Nature and purpose 65
Designated countries 67

65

Permission to accept dollar-exchange drafts
Question regarding present legal authority

66
68

MATURITIES 69
Acceptances by member banks

69
Discount by Federal Reserve Banks
Renewals 71

AMOUNT LIMITATIONS
Acceptance by member banks

72

72

Discount by Federal Reserve Banks

LETTERS OF CREDIT AND SYNDICATE CREDITS

75

DIMINISHED IMPORTANCE OF ELIGIBILITY REQUIREMENTS


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Federal Reserve Bank of St. Louis

viii

70

76

74

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Table of Contents—Continued

REDISCOUNT OF WORLD WAR I
VETERANS' NOTES
79

ADVANCES TO MEMBER BANKS
GENERAL CONSIDERATIONS

83

Distinction between advances and rediscounts 83
Development of authority for advances 83
Original authorization 85
Limitation to paper eligible for purchase under Federal Reserve
Act 85
Limitation to paper arising from commercial or agricultural transactions 86
Endorsement of pledged paper 87
Maturity of advances 88
Increase of securities loans
during life of advance 88
Elimination of application forms and promissory notes 89

ADVANCES ON DIRECT OBLIGATIONS OF THE UNITED STATES 90
15-day advances 90

90-day advances 90
Limitation as to type of obligation
Advances at par 91

ADVANCES ON OBLIGATIONS OF GOVERNMENT AGENCIES

91

91

Summary 91
Federal intermediate credit bank obligations 92
Farm loan bonds 93
Federal Farm Mortgage Corporation bonds 94
Home Owners' Loan Corporation bonds 95
Commodity Credit Corporation certificates of interest 95
Merchant Marine bonds 96
Farmers Home Administration insured notes 96
Export-Import Bank
participation certificates 96
Notes guaranteed by Small Business Administration 97
Agency issues 97

TAX WARRANTS 98
THE GLASS-STEAGALL ACT: A BREAK WITH THE PAST 100
Emergency background


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Federal Reserve Bank of St. Louis

100

Provisions of the bill

ix

100

General purposes

101

/History*

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Functions

Table of Contents—Continued

ADVANCES TO MEMBER BANKS Continued
ADVANCES TO GROUPS OF MEMBER BANKS
Purpose and nature

103

Limitations

104

103

Effect

ADVANCES ON SATISFACTORY ASSETS

105

105

Original authorization 105
Extensions of time limit 106
Permanent authorization 107
Emergency use vel non 108
The "sound assets" concept 109
Particular types of
security 112
Maturity 113
Rate of interest 113
Proposals for liberalization 114

CREDIT FOR NONMEMBER BANKS
SUMMARY 117
CREDIT THROUGH MEDIUM OF MEMBER BANKS
Legislative history

118

Liberal interpretation of statute
Regulatory provisions

119

118

Blanket authority

121

EMERGENCY DISCOUNTS OF ELIGIBLE PAPER

121

ADVANCES O N GOVERNMENT OBLIGATIONS

122

TEMPORARY AUTHORITY FOR ADVANCES ON SOUND ASSETS


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Federal Reserve Bank of St. Louis

124

119

-. History,
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Functions

Table of Contents—Continued

LOANS TO INDIVIDUALS, PARTNERSHIPS,
AND CORPORATIONS
LOANS ON ELIGIBLE PAPER IN EMERGENCY CIRCUMSTANCES
Rejection in original Act 127
1932 amendment 127
Limitations
Board activation of authority 129
Use of authority 130
ADVANCES ON GOVERNMENT OBLIGATIONS

127
128

131

WORKING CAPITAL LOANS TO BUSINESS
ORIGIN AND PURPOSE 133
A departure from tradition


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Federal Reserve Bank of St. Louis

133
Need for the authority 134
Reserve Banks versus RFC 135
LIMITATIONS

General limitations 136
Limitations on commitments

Legislative history

136

Limitations on direct loans 138
138
Amount limitations 140

INDUSTRIAL ADVISORY COMMITTEES
SOURCE OF FUNDS

141

REGULATION S 142
TERMINATION OF AUTHORITY

XI

144

140

134

• History
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Table of Contents—Continued

V LOANS
ORIGIN AND NATURE 147
Wartime background

Executive Order 9112

149

147

Phases of the program

148

LEGAL BASIS 149
VT guarantees
150
Contract Settlement Act
Defense Production Act 151

150

ROLE OF THE FEDERAL RESERVE BANKS 152
As fiscal agents 152

As financing institutions

ROLE OF THE BOARD OF GOVERNORS
THE GUARANTEE AGREEMENT

154
154

155

FEES AND RATES 157
RELATED LEGAL PROBLEMS 158
Eligibility of V-loan paper for discount 158
Lending limits of national banks
Assignment of claims under Government contracts 159


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Federal Reserve Bank of St. Louis

INTERDISTRICT REDISCOUNTS
Legislative purpose

163

Use of the authority

xii

164

159

^History*
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Functions

Table of Contents—Continued

DISCOUNT RATES
STATUTORY PROVISIONS

167

OBJECTIVES OF DISCOUNT RATES
Uniformity of rates

168

168
Accommodation of commerce and business
Implementation of credit policies 170

LEGAL BASIS AND DISCRETIONARY NATURE
DISTRIBUTION OF AUTHORITY

169

170

171

CLASSIFICATION OF PAPER FOR RATE PURPOSES

173

Applicability to advances 173
The class-of-paper question 174
Maturities 174
Character of paper; preferential rates 174
Frequency of borrowing; progressive rates 175
Statutory basis for credit 176
Nature of borrower 177 Purpose of credit 178
TIME AND MANNER OF DETERMINATION
COMPUTATION

179

180

RELATION TO CREDIT POLICY
THE EARLY YEARS: ACCOMMODATION OF CREDIT NEEDS


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Federal Reserve Bank of St. Louis

THE 1930's: PREVENTION OF SPECULATION

182

SINCE 1951: AN INSTRUMENT OF CREDIT CONTROL

xill

181

185

-History^
Pot the $
-Lending

Table of Contents—Continued

GENERAL PRINCIPLES: A SUMMARY
STATUTORY AND REGULATORY BASIS 189
ACCOMMODATION OF COMMERCE, INDUSTRY, AND AGRICULTURE
THE REAL-BILLS DOCTRINE: AN ABANDONED PRINCIPLE
MAINTENANCE OF SOUND CREDIT CONDITIONS
INAPPROPRIATE USES OF FEDERAL RESERVE CREDIT
Speculation or investment

193

Use for profit 193
Shift in emphasis 194

195

Seasonal credit

191

192
193

Continuous borrowing

APPROPRIATE USES OF FEDERAL RESERVE CREDIT
Short-term adjustment credit

190

196

194

195

Emergency credit

196

LENDER OF LAST RESORT 197
PROTECTION OF RESERVE BANKS 197
DISCRETION OF FEDERAL RESERVE BANKS
Legislative intent

198

198
Recognition by the Board 200
Judicial confirmation
Quasi-automatic access to Federal Reserve credit 200

THE BASIC PRINCIPLE: ECONOMIC STABILITY AND GROWTH


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Federal Reserve Bank of St. Louis

xiv

201

200


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Federal Reserve Bank of St. Louis

History.
3 of thef
Lending
Functions

APPENDIXES

TEXTUAL CHANGES IN PROVISIONS
OF THE FEDERAL RESERVE ACT
203

REGULATION A AS CURRENTLY IN EFFECT
237

REGULATION C AS CURRENTLY IN EFFECT
241

RIGHTS AND LIABILITIES OF
FEDERAL RESERVE BANKS
WITH RESPECT TO DISCOUNTED PAPER
245

NOTES AND REFERENCES
249

INDEX
267

XV

Introduction

STATEMENT OF OBJECTIVE
Many scholarly treatises have been written
about the Federal Reserve System. In general,
they have dealt with the System's vital functions
in the field of monetary and credit policy or
with its important responsibilities in the field of
bank regulation and supervision. Writers on
the subject have, of course, referred to the
provisions of Federal law under which the
System operates, but usually—and naturally—
any such references have been only incidental,
or at least secondary, to economic or banking
considerations. This study is based on the reverse approach. It is not primarily concerned
with economic and banking considerations (the
writer is neither an economist nor a banker);
it is concerned primarily with legal considerations, and any references that must be made to
economic and banking matters are purely incidental and secondary.
In brief, the strictly limited objective of this
study is to trace the legal history of the lending
functions of the Federal Reserve Banks: the
nature of the original statutory authority of the
Federal Reserve Banks to make loans; the
reasons for which that authority was given to
the Reserve Banks by Congress; how and why
the authority has been changed, expanded, or
For NOTES AND REFERENCES, see p. 249.


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Federal Reserve Bank of St. Louis

modified by subsequent statutes; the nature of
regulations on this subject that have been issued
by the Board of Governors of the Federal Reserve System (generally referred to as the Federal Reserve Board, or the Board); how the
Board has interpreted the law; and how the law
has been construed and applied by the courts.
Warned by this prospectus, the non-lawyer
may, forgivably, wish to read no further. Much
of what follows may be regarded as technical
and therefore dull. Perhaps only a few will
share the writer's feeling that the legal development of the lending authority of the Federal
Reserve Banks is in many respects an intensely
interesting subject. In any event, it is conceivable that some useful purpose may be
served by this historical discussion of the
statutes, regulations, interpretations, and court
decisions that lie behind and are directly related
to the important part that the lending functions
of the Reserve Banks have played in the economy of the Nation for some 60 years.

DISTINCTION BETWEEN
RESERVE BANK LOANS AND
COMMERCIAL BANK LOANS
It is essential to preface this study with a
brief indication of the differences between loans
that are made by the Federal Reserve Banks
and those made by ordinary commercial banks.

2

HISTORY OF LENDING FUNCTIONS

In the first place, there are differences in the
manner in which Federal Reserve Banks and
commercial banks are organized and in the
purposes for which they are operated. A commercial bank may be organized by a few individuals either as a State bank or as a national
bank, depending upon whether the organizers
choose to comply with the requirements of the
applicable State banking laws or with those of
the National Bank Act, a Federal statute originally enacted in 1863. Consequently, the number of commercial banks is limited only by the
inclination of individuals to organize them and
by the willingness of the State banking authorities—in the case of State banks—and of the
Comptroller of the Currency—in the case of
national banks—to approve their organization.
Like other private ventures, the number of such
banks is influenced by public demand for their
services and by the forces of competition. As of
December 31, 1972, there were 13,928 commercial banks in the United States.
In contrast, the Federal Reserve Banks were
established by a 1913 Act of Congress known
as the Federal Reserve Act, and under that Act
their number was limited to 12, each Reserve
Bank serving a geographical district of the
country. AH national banks in the United
States are required to be stockholders; banks
organized under State laws may voluntarily
become stockholders, subject to approval by
the Board of their applications for membership
in the Federal Reserve System. As of December
31, 1972, there were 5,705 commercial banks
that were members of the System; of these,
4,613 were national banks and 1,092 were
State member banks.
Any individual or corporation may be a
stockholder of a commercial bank; the stock of
such banks normally is acquired for purposes
of investment or control. The return on an
investment of this kind depends in large part
upon the earnings received by the bank on its
loans and investments. Stock of a Federal
Reserve Bank, on the other hand, is not acquired as an investment or for control. The
ownership of such stock is merely a prerequisite
to membership in the Federal Reserve System.


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Federal Reserve Bank of St. Louis

The stock pays only a fixed statutory dividend,
regardless of the earnings of the Reserve Bank.
It does not entitle member banks to all the
rights that usually appertain to ownership of
stock in private corporations. If a Reserve Bank
should be liquidated, all of its assets—after
payment of debts, accrued dividends, and the
amounts paid in by member banks on their
stock subscriptions—would become the property of the United States. Moreover, although
member banks are authorized by the law to
participate in the election of six of the nine
directors of a Federal Reserve Bank, the affairs
of the Reserve Bank arc administered by its
directors under the supervision of the Board of
Governors of the Federal Reserve System, an
independent Government agency.
From these differences between commercial
banks and Federal Reserve Banks stems one
of the fundamental distinctions between commercial bank loans and Reserve Bank loans.
Commercial banks make loans for profit—to all
comers and for all conceivable purposes. Although loans made by the Federal Reserve
Banks bear interest, they arc made not for
profit but for a public purpose; in general they
arc made only to banks that arc members of
the Federal Reserve System. It is for this reason
that the Reserve Banks have often been called
bankers' banks.
Quite apart from differences in organization
and purpose, an important distinction between
loans made by Reserve Banks and those made
by commercial banks is that the lending operations of the Reserve Banks, often referred to
as the Federal Reserve discount window, constitute a channel through which Federal Reserve
credit policies can be implemented. When a
Reserve Bank makes a loan to a member bank,
the result is an increase in the reserves that
the member bank carries with its Reserve
Bank. Consequently, the member bank has
more funds with which to extend credit to its
own customers. Without attempting an explanation here, a Reserve Bank loan to a member
bank makes possible a multiple expansion of
credit the degree of which depends upon the
percentage of required reserves against de-

INTRODUCTION
posits prescribed by the Federal Reserve Board
at the time. It is for this reason that credit
created by Federal Reserve action, whether extended through the discount window or through
purchases of securities in the open market, is
sometimes referred to as "high-powered"
dollars.
As just indicated, Federal Reserve credit can
be provided to the banking system through
purchases by the Reserve Banks of Government obligations and other securities in the
open market. Open market operations of the
Reserve Banks, however, are conducted at
the initiative of the Reserve Banks under the direction of the Federal Open Market Committee.
They do not come within the scope of this study
since we are concerned here only with the credit
extended by the Reserve Banks to member
banks—and other borrowers—because of the
borrower's need for credit and at the borrower's
initiative.
The Reserve Banks also in effect extend
credit to their member banks when they give
credit to member banks for checks—in accordance with the Federal Reserve Banks' time
schedule—before the amount of the checks
is actually received by the collecting Reserve
Bank. This form of Federal Reserve credit is
known as "float." Again, however, it is not
within the scope of this study.

SIGNIFICANCE OF RESERVE
BANK LOANS
A discussion of the nature and purposes of
the Federal Reserve System is beyond the scope
of this study. In general, as indicated in the
preamble to the Federal Reserve Act, it may be
said that the System was the outgrowth of a
feeling that the country's financial system required a more elastic currency, a better mobilization of bank reserves, and more effective
supervision of commercial banks. It is quite
clear, however, that the so-called discount provisions of the Federal Reserve Act have been
regarded as among its most important provisions and that access to the credit facilities of
the Reserve Banks continues to be the chief


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Federal Reserve Bank of St. Louis

reason for membership in the Federal Reserve
System.
The Federal Reserve Act was based in large
part upon an intensive study of the banking
system made by a National Monetary Commission appointed by Congress. In its final report
of January 9, 1912,1 that Commission listed
17 defects in the then-existing banking system.
Six of them related to the need for a wider
market for commercial paper. The Commission
deplored the lack of adequate means available
to commercial banks for replenishing their reserves or increasing their lending powers, the
"congestion of loanable funds in great centers,"
the inability of farmers and others to secure the
credit they required, and the "marked lack of
equality in credit facilities between different
sections of the country."
Congress concurred in the Commission's
opinion that the lending authority of the proposed Federal Reserve Banks was of paramount
importance. The House Banking and Currency
Committee referred to the creation of a market
for commercial paper as one of the "essential
features of reform" - and stated that the discount function was the "fundamental business
purpose" of the legislation.3 The House committee felt that the new legislation would "entirely transform the conditions under which
paper is bought and sold, loans contracted
between banks, and funds transferred from one
part of the country to another." 4 The Senate
Banking and Currency Committee was unanimous in its opinion that one of the fundamentals
of the legislation was "the promotion of an open
discount market."a During the debates on the
bill, one Congressman referred to the discount
section as "the most important section of the
bill." 6 This feeling was reflected by the fact
that the preamble of the Act, as finally passed,
stated that one of its purposes was "to afford
means of rediscounting commercial paper."
The importance of the lending or discount
functions of the Federal Reserve Banks has
varied from time to time since 1913, depending
upon prevailing economic conditions. In the
early years of the System, these functions had
all of the significance envisaged by the framers

HISTORY OF LENDING FUNCTIONS
of the Federal Reserve Act. During the 1920's
they were particularly important as a means of
meeting the credit needs of agriculture; and
during the economic depression of the early
1930's, they were instrumental in meeting the
requirements of business enterprises. Thereafter, for a long period, the lending authority
of the Federal Reserve Banks dwindled in
importance. Between 1951 and 1959 there was
some increase in the use of the discount window. Since 1959 member banks have made
little use of their privilege of borrowing from
the Reserve Banks except during periods of
unusual stringency, as in the early weeks of
1973 when daily-average borrowings by member banks reached the highest level since the
1920's. Nevertheless, despite such marginal and
periodic use of the discount window, it constitutes an ever-available source of short-term
credit to member banks that cannot always be
provided from other sources and it can still be
used as an important, even though secondary,
instrument for the effectuation of Federal Reserve credit policies.

SCOPE OF THIS STUDY
The provisions of the original Federal Reserve Act regarding loans by the Federal Reserve Banks were relatively brief. In a few
paragraphs, section 13 of the Act merely authorized the Reserve Banks to discount for
their member banks commercial paper with
maturities of not more than 90 days, agricultural paper with maturities of not more than
6 months, and bankers' acceptances arising
from import or export transactions with maturities of not more than 3 months. Over the
years these original provisions have been expanded and supplemented by numerous amendments to the law. In 1916, acceptances growing
out of domestic shipments and the storage of
staple goods, as well as dollar-exchange acceptances, were made eligible for discount, and the
same act authorized the Reserve Banks to make
15-day advances to member banks on their own
notes secured by eligible paper or Government
bonds. The Agricultural Credits Act of 1923


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Federal Reserve Bank of St. Louis

substantially expanded the authority of the Reserve Banks to discount agricultural paper. In
1932, Congress conferred upon the Reserve
Banks new authority to make emergency discounts for individuals, partnerships, and corporations, and to make advances to member
banks on any satisfactory security, although at
a penalty rate of interest. In 1933, direct advances to individuals, partnerships, and corporations on the security of Government obligations were authorized, and the maturity of
advances to member banks on eligible paper
was increased to 90 days. The reasons for
these and many other amendments to the discount provisions of the statute, as reflected in
committee reports and congressional hearings
and debates, arc one of the major subjects of
this study.
The statutory history of the provisions of the
Federal Reserve Act relating to Reserve Bank
loans is embodied in Appendix A to this study.
By reference to that appendix, one may determine how a particular provision read in the
original Federal Reserve Act or when it was
added to that Act by subsequent statute, exactly
how the language of the provision has been
changed, if at all, by later enactments of Congress, and how the provision reads today.
Along with the development of the statutory
authority of the Reserve Banks in the lending
field, the Federal Reserve Board, acting under
authority conferred by the law, has been called
upon to issue, modify, and revise regulations
governing the exercise of that authority. The
Board's first regulation related to this subject
and, although it has been changed many times,
it is still identified as Regulation A. With each
major change in the law, the regulation has
had to be modified in one or more respects.
Sometimes the regulation has been changed to
eliminate or relax certain regulatory requirements. On a few occasions, changes have been
made to reflect shifts in Federal Reserve policy
as to the appropriate use of the discount window. An account of these regulatory changes
forms another part of the present study. The
text of the Board's present Regulation A, as
substantially revised in 1973, is set forth in

INTRODUCTION
Appendix B; the related provisions of Regulation C, regarding bankers' acceptances, constitute Appendix C.
In addition to regulations, the Board from
time to time has issued interpretations of the
provisions of the law with regard to the discounting authority of the Federal Reserve
Banks. Most of them have been published in
monthly issues of the Federal Reserve Bulletin.
Board rulings on this subject were especially
numerous during the 1920's when extensive use
was made by member banks of the discount
facilities of the Reserve Banks. Such rulings
constitute an important aspect of a legal history
of the lending functions of the Reserve Banks.
In a few instances the discount provisions of
the Federal Reserve Act have been the subject
of judicial interpretation, and to that extent
court decisions are also embraced within the
scope of this history. During the early years of
the System, the Reserve Banks were involved in
litigation growing out of questions as to the
legal rights and liabilities of parties to paper
discounted with the Reserve Banks, and while
these cases related chiefly to the general law of
negotiable paper and not to the construction of
provisions of the Federal Reserve Act, they are
briefly summarized in Appendix D.
It is with all of these phases of the legal
development of the lending authority of the
Federal Reserve Banks that the present study is
concerned. Obviously, they impinge upon the
economic aspects of the subject. It would be
most unrealistic to ignore the fact that the
purposes of the Federal Reserve Act were
essentially of an economic nature and that
changes in the law have been occasioned by
changes in economic conditions or economic
thinking. For example, it was a drop in farm
prices following World War I and an acute
demand for agricultural credit that led to
amendments to the statute in 1923 to liberalize
the authority of the Reserve Banks to discount
agricultural paper. It was a movement to promote foreign trade that led to a broadening
of the authority to discount bankers' acceptances; and it was the depression of the early
1930's that prompted drastic amendments to


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Federal Reserve Bank of St. Louis

the law to provide Federal Reserve credit to
nonmember banks and business enterprises.
Moreover, the fixing of discount rates has long
been recognized as one of the three major
instruments through which the Federal Reserve
System effectuates national credit and monetary
policies.
Nevertheless, as has already been indicated,
it is the aim of this study to tell the story of the
development of the lending functions of the
Federal Reserve Banks from the lawyer's rather
than the economist's point of view, with emphasis upon statutory provisions and their
legislative history, regulations, rulings of the
Board, and court decisions. If anything here
written suggests an opinion as to economic or
credit policy, it is wholly unintentional and, in
any event, incidental.
It should be borne in mind that this study is
intended to be a history of the System's lending
activities. As such, it is not limited to present
law and regulations; it covers all enactments
of Congress since 1913 and all regulations and
published rulings issued by the Board since
that time, even though many of them were
later repealed, revoked, or superseded. For
example, all of Chapter 11 relates to working
capital loans to business under a section of the
law that was added in 1934 and repealed in
1959.

ARRANGEMENT
A strictly chronological account of the development of the lending functions of the Federal Reserve Banks would be disconnected,
complicated, and confusing. At the same time,
it seems desirable to show how these functions
have gradually expanded over the years. Accordingly, whether rightly or wrongly, the
writer has compromised between a chronological and a topical treatment of the subject. Each
major aspect of the lending authority of the
Reserve Banks is dealt with in a separate
chapter according to the type of loan involved,
although the chapter may cover the entire
period of the System's existence, but the topics
of the various chapters are arranged roughly in
the order in which they assumed importance

HISTORY OF LENDING FUNCTIONS
chronologically. Thus, while advances on Government bonds were authorized in 1916, it
was not until 1932 that advances to member
banks—as distinguished from discounts of
eligible paper—attained real significance; consequently, the chapter dealing with such advances follows those dealing with agricultural
credits and bankers' acceptances.
In the two chapters immediately following
this introductory chapter consideration will be
given to the general nature and purposes of the
discount provisions of the original Federal


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Federal Reserve Bank of St. Louis

Reserve Act and to certain general limitations
imposed on the lending authority of the Federal
Reserve Banks. The 10 succeeding chapters
deal with the different categories of loans made
by the Reserve Banks, some of them no longer
of great significance and some no longer even
authorized by present law. The study concludes
with chapters covering discount rates and the
relation of the discount mechanism to national
credit policy and, Anally, with a summary of
general principles governing the extension of
Federal Reserve credit.

The Original Discount Provisions

LEGISLATIVE HISTORY
DEVELOPMENT OF
THE FEDERAL RESERVE ACT
With its final report of January 9, 1912, the
National Monetary Commission submitted a
draft of proposed legislation that became known
as the "Aldrich bill," after the name of the
Commission's Chairman, Nelson Aldrich. That
bill would have provided for a National Reserve
Association with authority to rediscount paper
for commercial banks. Although the Commission's plan for a central authority was later
discarded in favor of a regional system of Federal Reserve Banks, the essential feature of its
plan—the discounting of paper issued or drawn
for "agricultural, industrial, or commercial purposes"—was carried over into the Federal Reserve Act.
The bill that was eventually enacted, though
with many changes, was H.R. 7837. It was
introduced by Chairman Carter Glass of the
House Banking and Currency Committee on
August 29, 1913. Often referred to as the
For NOTES A N D REFERENCES, see p. 249.


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"Glass bill," it was reported by the House
Banking and Currency Committee on September 9, 1913, and it was passed by the House
on September 18.
The Senate Banking and Currency Committee split into two sections. On November 22,
1913, it reported two bills without recommendation. The Democratic section, headed by
Chairman Owen, reported a bill that generally
followed the Glass bill, although with some
important differences. The Republican section,
led by Senator Hitchcock, submitted a separate
draft that became known as the "Hitchcock
bill." On December 1, a substitute bill was
offered on the floor of the Senate by Senator
Owen. It was generally similar to the original
Owen bill, but it included some features of the
Glass bill. It was passed by the Senate on
December 19.
With some changes, the Owen substitute bill
was adopted by the conference committee. The
conference report was agreed to by the House
on December 22 and by the Senate on December 23. On the latter date the bill became law
with President Wilson's signature.

8

HISTORY OF LENDING FUNCTIONS

DIFFERENCES AMONG THE
DISCOUNT PROVISIONS OF
VARIOUS BILLS
Insofar as the discount provisions were concerned, the general objectives of all of the
competing bills were the same. All of them
authorized the proposed Federal Reserve
Banks to discount for member banks paper
arising out of commercial transactions, and all
provided for the discounting of acceptances
drawn to finance the importation or exportation
of goods.
In certain respects, however, the Glass,
Owen, Hitchcock, and Owen substitute bills
reflected differences, some of a minor nature
and some that gave rise to sharp debate and
controversy.
The principal differences related to (1) the
general maturity of paper eligible for discount,
(2) the kinds and maturities of bankers' acceptances that might be discounted, (3)
whether member banks should have a right to
obtain discounts, and (4) whether advances
might be made on any satisfactory securities.
With regard to maturity, the Glass bill fixed
a maximum of 90 days, but with permission
for the discounting of paper with maturities of
from 90 to 120 days in certain circumstances.
The Owen bill prescribed a maturity of not
more than 90 days, without any exceptions.
The Hitchcock bill would have allowed maturities of up to 120 days, provided that not more
than half the paper discounted for any member
bank had a maturity of more than 90 days
and provided also that no member bank had
more than $200,000 of rediscounts with maturities longer than 90 days.
With respect to bankers' acceptances, the
Glass bill permitted only the discounting of
acceptances growing out of the importation or
exportation of goods, whereas the Owen and
Hitchcock bills would have also covered acceptances drawn to finance domestic shipments
of goods. On the other hand, the Glass bill
would have permitted 6-month maturities for
acceptances, whereas the Owen bill would have
limited such maturities to 3 months and the
Hitchcock bill would have fixed a 6-month
maximum for acceptances arising from the


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importation or exportation of goods and a
4-month maximum for those arising from domestic shipments.
The Hitchcock bill would have given a member bank an absolute right to obtain discounts
up to the amount of its capital stock. Under the
other bills, the discounting of paper was left
to the discretion of the Reserve Banks, although
the Owen bill contained a provision that required the Reserve Banks to extend credit with
due regard "for the claims and demands of
other member banks."
The Owen and Hitchcock bills would have
authorized advances on the direct obligations
of member banks secured by satisfactory securities, and this authority was in the bill as it
passed the Senate. No such authority was contained in the Glass bill.

RESOLUTION OF DIFFERENCES
In one way or another, these differences
were eventually resolved. As to maturity, the
conference committee adopted the flat 90-day
maximum of the Owen bill, but with an exception of 6 months for agricultural paper. Authority to discount bankers' acceptances was
limited, as in the Glass bill, to those arising
from foreign shipments. The compulsory discount proposal and the suggestion for direct
advances on satisfactory securities were both
rejected, but only after considerable debate.
As will be seen later in this study, some of
these matters were reconsidered by Congress
in the years that followed. For example, the
proposal to authorize bankers' acceptances covering domestic shipments was adopted in 1916,
and many years later, in 1932, Congress finally
authorized direct advances to member banks
secured "to the satisfaction" of a Federal Reserve Bank, but only with a penalty rate of
interest.

THE FINAL PROVISIONS
In its final form, the original Federal Reserve
Act gave the Federal Reserve Banks authority:
(1) to discount for their member banks paper
arising out of actual commercial transactions,
that is, paper issued or drawn for agricultural,
industrial, or commercial purposes, with the

ORIGINAL DISCOUNT PROVISIONS
definition of such paper left to the determination
of the Federal Reserve Board; (2) to discount
bankers' acceptances based on the importation
or exportation of goods; and (3) to rediscount
the discounted paper of other Federal Reserve
Banks if permitted or required by the Federal
Reserve Board.
Limitations on this authority were imposed
as follows: (1) Discounted paper was required
to be endorsed by the discounting member
bank, with a waiver of demand, notice, and
protest; (2) paper discounted was required to
have a maturity at the time of discount of not
more than 90 days, except that a maturity of
not more than 6 months was allowed for agricultural paper and of not more than 3 months
for bankers' acceptances; and (3) the aggregate
amount of paper of any one borrower discounted for a member bank was limited to
10 per cent of the member bank's capital and
surplus.
All discounts were made subject to such
regulations, limitations, and restrictions as
might be prescribed by the Federal Reserve
Board. Discount rates were required to be
established from time to time by each Federal
Reserve Bank, subject to review and determination by the Board.
Incidental provisions of the Act authorized
member banks to accept paper growing out of
the importation or exportation of goods and

amended the National Bank Act to except from
the limitations imposed on the aggregate indebtedness of national banks any liabilities
"incurred under the provisions of the Federal
Reserve Act," that is, liabilities incurred on
paper discounted with the Federal Reserve
Banks.
Finally, in section 4 of the original Federal
Reserve Act, the board of directors of each
Federal Reserve Bank was required to administer the affairs of such Bank "fairly and impartially and without discrimination in favor
of or against any member bank" and to extend
to each member bank such discounts, advancements, and accommodations as might be
"safely and reasonably made with due regard
for the claims and demands of other member
banks."
These were the discount provisions of the
original Federal Reserve Act. Essentially, they
constitute the basis for the lending powers of
the Reserve Banks today, except for the important additions in later years of authority to
make advances to member banks on the security
of Government obligations or on any paper
eligible for discount or for purchase by the
Reserve Banks, authority to make advances to
member banks at a penalty interest rate on any
satisfactory security, and authority to extend
credit in exceptional circumstances to individuals, partnerships, and corporations.

BASIC PURPOSES
CREATION OF A MARKET FOR
COMMERCIAL PAPER
One of the basic purposes of the original
Federal Reserve Act, as stated in its preamble,
was "to afford means of discounting commercial
paper." The National Monetary Commission
had emphasized the need for a wider market
for commercial paper. The House Banking and
Currency Committee, in its report on the Federal Reserve bill, stated that the first fundamental feature of reform was: *


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Creation of a joint mechanism for the extension of credit to banks which possess sound
assets and which desire to liquidate them for
the purpose of meeting legitimate commercial,
agricultural, and industrial demands on the
part of their clientele.
Similarly, the Senate Banking and Currency
Committee asserted that one of the chief purposes of the legislation was to "make available
effective commercial credit for individuals engaged in manufacturing, in commerce, in

10

HISTORY OF LENDING FUNCTIONS

finance, and in business to the extent of their
just deserts"; the committee also referred to the
fundamental necessity of "establishing an open
market for liquid commercial bills, by providing
through the reserve banks a constant and unfailing market for such bills at a steady rate of
interest." 2

credit was recognized. In fact, some Congressmen feared that the discount provisions of the
bill would be inflationary. Chairman Carter
Glass of the House Banking and Currency
Committee agreed, but contended that it would
be a "wise expansion." °

BENEFIT TO COUNTRY BANKS
PREVENTION OF PANICS
With the financial panic of 1907 still fresh
in their minds, various Congressmen repeatedly
expressed the view that the discounting authority of the Federal Reserve Banks would serve to
prevent the recurrence of similar panics. Thus,
in the House, it was alleged that the Federal
Reserve bill would provide banks with "sources
of strength" in times of stress.' In the Senate,
likewise, Senator Swanson regarded the bill as
one that made "impossible another panic in
this country." *

EXPANSION OF BUSINESS
The market for commercial paper provided
by the bill was considered to be not only a
prophylactic against panics but also a means
of enabling banks in normal times to expand
their business. Congressman Phelan stated: c
* * * In times of stress, when a bank
needs cash, it can obtain it by a simple process
of rediscounting its paper with the Federal
reserve banks. Many a bank will thus be
enabled to get relief in time of serious need.
Moreover, if a bank desires to expand its
business, it may do so far beyond its present
capacity by this rediscounting process. Suppose, for instance, a bank has $1,000,000 in
deposits and $120,000 in reserves. Under such
conditions the bank can not further extend
its loans because of the legal-reserve requirements. Under such circumstances, by taking
$12,000 of its paper to the Federal reserve
banks and rediscounting it, it can increase its
reserves by $12,000. An increase in its reserves of $12,000 increases its loaning power
by $100,000. By this very simple process the
bank is enabled to increase its loans and extend its accommodations to its patrons.
It is significant to note from this statement that
the expansionary effect of Federal Reserve


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Federal Reserve Bank of St. Louis

It was felt that the creation of a market for
commercial paper through the rcdiscounting
authority of the Reserve Banks would particularly benefit the country banks. There were
some, it is true, who doubted this and believed
that country banks had very little paper that
they could discount and that, therefore, the
rediscount provisions would be "valueless" to
them.7 The majority, however, were convinced
that these provisions would result in the creation of a "competitive money market for the
country banks"; such a market would eliminate
the necessity for country banks to go to New
York for funds and thereby tend to reduce
interest rates." It was contended that the rediscount section of the bill would "come to the
relief of every small bank in the United States,"
that it would "break down the tyranny of the
money power in the great centers," " and that
the small banker, having the same discount
facilities as the big bank, would "be freed from
his dependency upon the big banks and be
able to serve his customers according to his
own judgment, subject only to reasonable
supervision by the Government board." 10
It was recognized that the traditional reluctance of banks to borrow would need to be
overcome. The House committee noted that
such a prejudice had "more or less artificially
sprung up." " Mr. Phelan conceded that banks
were "very much averse" to discounting their
paper with other banks and that such rediscounting had been regarded as "a sign of weakness"; but he believed that with the enactment
of the Federal Reserve Act, rediscounting
would be regarded, "as it should be, as an
ordinary and proper part of a bank's business." >2 Similarly, Senator Norris felt that the
prejudice of bankers against rediscounting
paper would pass away, and Senator Smoot
expressed the view that while the change would

ORIGINAL DISCOUNT PROVISIONS
be gradual, the feeling about rediscounting
would be "changed materially" if the bill should
become law.13

LESSENING OF SPECULATION
There was a general feeling at the time of the
original Federal Reserve Act that the creation
of a market for commercial paper through the
rediscounting authority of the Federal Reserve
Banks would have the incidental advantage of
tending to lessen speculation. Thus, the National Monetary Commission had described one
of the defects of the banking system as follows: "
The narrow character of our discount market, with its limited range of safe and profitable investments for banks, results in sending
the surplus money of all sections, in excess of
reserves and local demands, to New York,
where it is usually loaned out on call on Stock
Exchange securities, tending to promote dangerous speculation and inevitably leading to
injurious disturbances in reserves. * * *
Senator Owen explained how the absence of
a ready discount market had led to the use of
bank funds for stock speculation: ™
Mr. President, one of the most far-reaching
results which will follow will be the abatement of the nuisance of the national menace
of the stock-gambling operations in this country, because this measure proposes to gradually withdraw these reserves, which have
heretofore been pyramided in the three great
central reserve cities. I call the attention of
the Senate to the peculiar situation in which
a banker in a Federal reserve city finds himself. * * * He has no great public utility
bank in this country to which he can go for
credit. He has no open discount market in
this country. He can not convert quickly into
cash his liquid commercial bills. The only
place that he can get his resources quickly
in cash is upon the stock market. Therefore
these men have been forced by the conditions
surrounding them to lend money by hundreds
of millions upon the stock exchange. * * *
It was expected that the ability of banks to
obtain credit from the Reserve Banks would
help to halt the use of bank funds for specula-


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Federal Reserve Bank of St. Louis

II

tion in stocks. In addition, however, it was
deemed desirable that the new law include an
express prohibition against the rediscount by
the Reserve Banks of paper drawn for the
purpose of trading in stocks. All of the principal bills involved in the evolution of the
Federal Reserve Act contained a provision to
the effect that paper eligible for discount should
not include notes or bills "issued or drawn for
the purpose of carrying or trading in stocks,
bonds, or other investment securities." In the
Senate, an exception was made, for obvious
reasons, with respect to bonds and notes of the
United States. With this sole exception, the
injunction against discounting paper drawn for
stock investment purposes became, and has
ever since remained, a qualification on the discount authority of the Federal Reserve Banks.
It was emphasized in the debates on the
original Act that this provision had the effect
of "withdrawing the privilege of the act from
stock-exchange transactions." 16 The provision
was referred to as "one of the splendid provisions of the bill." " It was regarded as prohibiting "the resources of these reserve banks
being used for the purposes of stock speculation." »

ELASTIC CURRENCY
In addition to its deterrent effect on speculation, the creation of a market for commercial
paper was regarded as having a direct relation
to another stated purpose of the Federal Reserve Act, namely, "to furnish an elastic currency." It was expected that member banks
would obtain currency from the Federal Reserve Banks by discounting short-term commercial paper. As such paper was paid off, the
currency would automatically return to the
Federal Reserve Banks, thus causing the
amount of currency in circulation to fluctuate
with the varying needs of business, agriculture,
and commerce.
Mr. Phelan explained the relation between
the proposed discounting of commercial paper
and the elasticity of Federal Reserve notes as
follows: I!)
Based upon commercial paper as security,
these notes increase and decrease with the

12

HISTORY OF LENDING FUNCTIONS
demands of commerce. As more currency is
needed the want is supplied by the deposit of
more commercial paper as security and the
issuance of more notes. As all this paper is
of short maturity, other commercial paper
must in a short time be deposited as security
in the place of the paper which matures. As
business slackens the amount of commercial
paper diminishes and Federal reserve banks
will return Federal reserve notes to be destroyed instead of putting up new commercial
paper as security.

At another point during the House debates,
Mr. Beakes explained how the elastic quality
of a Federal Reserve note was expected to
operate: 20
* * * Its elasticity is secured in this way:
It is issued to a bank needing it when they
present as much of their current paper to be
rediscounted as they call for in currency. All
of the paper so discounted matures within
90 days, and so within 90 days as much
money will be back in the reserve banks as
was issued in currency. * * * Thus is elasticity secured in the currency of each local
community and the volume of currency outstanding expands and contracts as the business needs of each community require.
A similar concept was expressed in the
Senate by Senator Hollis: 21
* * * They [the Federal Reserve Banks]
may rediscount for member banks promissory
notes, based on genuine commercial paper,
which are payable in 90 days. * * *
Loans and rediscounts for member banks
will ordinarily be made from the funds deposited as reserves and by the Government,
but if funds are getting low any reserve bank
may apply to the reserve agent for the district for reserve notes. * * *
The Federal reserve board will pass upon
the application for reserve notes and, if it
approves the application, the reserve agent
will deliver to the reserve bank United States


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Federal Reserve Bank of St. Louis

reserve notes to the face of the commercial
paper put up with him as collateral.
The transaction will then stand as follows:
A member bank has obtained currency
from its reserve bank by rediscounting commercial paper. * * *
The reserve bank has replenished its funds
by putting up with the reserve agent, say,
$100,000 in amount of commercial paper,
and has received $100,000 in United States
reserve notes. These reserve notes are loaned
to it by the Government, and it may hold
them, loan them, or invest them. In this way
the currency is expanded, but no faster than
the needs of business require, as shown by the
amount of commercial paper offered for rediscount.
The commercial paper put up with the reserve agent as collateral for the reserve notes
will become due from time to time, and the
payers will transmit the funds through the
member banks and the reserve banks in gold,
reserve notes, or lawful money to the reserve
agent. He will take the cash, surrender the
particular piece of collateral, and lock the
proceeds up for future transactions.

SECONDARY OBJECTIVES
While it is proper to say that the primary
objective of the original discount provisions
was to provide a wider market for commercial
paper that would meet the credit needs of business and at the same time tend to lessen speculation and contribute to an elastic currency, it
should also be borne in mind that the discount
provisions of the original Federal Reserve Act
had two secondary but important objectives.
One was to afford special credit assistance to
farmers; the other was to encourage foreign
trade by establishing a market for bankers' acceptances. Both of these objectives were clearly
evidenced in the committee reports and congressional debates on the original Act. They
will be discussed in detail in subsequent chapters of this study.

General Limitations

MATURITY
The first of the general limitations has to do
with the maturity of paper eligible for discount
by the Reserve Banks. With but one exception,
the original Federal Reserve Act required all
discounted paper to have a maturity of not more
than 90 days at the time of discount. The single
exception was agricultural paper, which was
permitted to have a maturity of not more than
6 months. As will be noted in a later chapter,
this exception was made even more liberal in
1923. Another exception was provided in 1932
when the law was amended to authorize advances to member banks for periods of up to
4 months, but only at a penalty rate of interest.
In 1934 another amendment provided for working capital loans to business enterprises with
maturities as long as 5 years, but that authority
expired in 1959.
By and large, the 90-day maturity prescribed
by the original Federal Reserve Act has consistently been adhered to as the legal limitation
on the maturity of all Federal Reserve loans—
except discounts of agricultural paper—not only
with respect to rediscounts of eligible paper but
also with respect to advances to member banks

INTRODUCTION
The various types of loans made by the
Federal Reserve Banks will be considered separately in subsequent chapters, along with the
special limitations and restrictions placed by
the law upon each type of loan. There are three
general limitations, however, that might be discussed before dealing with specific limitations
applicable to particular kinds of loans. In the
first place, there are maturity limitations both
with respect to the discounting of paper and to
direct advances; second, there are limitations
as to the amount of the paper of any one person
that may be used as a basis for a Federal
Reserve loan; and, third, the law requires that
all discounted paper be endorsed by the discounting member bank. As a fourth general
limitation, all discounted paper was required
until 1970 to be negotiable. Unfortunately, consideration of these general limitations will
plunge us immediately into some of the most
complicated and technical aspects of the lending
authority of the Reserve Banks.
For NOTES AND REFERENCES, see pp. 249-51.


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Federal Reserve Bank of St. Louis

13

14

HISTORY OF LENDING FUNCTIONS

on their secured notes. In actual practice, maturities have been even shorter. Following the
general principle that member bank borrowings
should normally be only for the purpose of
temporary adjustments in their reserve positions, extensions of Federal Reserve credit are
usually made only for a period of a few days.
In subsequent chapters, more detailed attention will be given to the maturity limitations
imposed on special types of paper. At this point
it is worthwhile to consider briefly why and
how the basic 90-day limitation was adopted
by the framers of the original Federal Reserve
Act, subject to the one exception for agricultural paper.

REASONS FOR 90-DAY
LIMITATION
That the paper to be discounted by the
Federal Reserve Banks should be short-term
paper was a corollary of the premise that such
paper should arise out of actual commercial
transactions. In its report on the original Federal Reserve Act, the Owen section of the
Senate Banking and Currency Committee—
after observing that, according to European
banking practices, paper based on commercial
transactions of short maturities was regarded
as "self-liquidating" and "almost the exact
equivalent of cash"—proposed that the Reserve
Banks be permitted to discount "commercial
bills and acceptances of the qualified liquid
class." 1
The House committee report on the original
Act stated: =
* * * The limitation of business which is
proposed in the sections governing rediscounts, and the maintenance of all operations
upon a footing of relatively short time will
keep the assets of the proposed institutions in
a strictly fluid and available condition, and
will insure the presence of the means of accommodation when banks apply for loans to
enable them to extend to their clients larger
degrees of assistance in business.
In addition to enabling the Reserve Banks to
meet demands for credit, a short maturity was
considered desirable because the discounted


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Federal Reserve Bank of St. Louis

paper was expected to be the basis for an elastic
currency. It was conceded that long-term paper
might be fully as sound as short-term paper,
but it was argued that long-term paper was not
so suitable as a basis for an asset currency. On
the floor of the House, Mr. Borland stated: :I
* * * The asset currency provided for in the
Glass bill is secured upon current commercial transactions which liquidate themselves
within a comparatively short time without
undue pressure on the borrower. The difference between short-time paper and long-time
paper is not the difference in its intrinsic
soundness, but a difference in what the bankers call its liquid character.
The critical question was just how short
maturities should be in order to make the paper
liquid. Based on the practice of European
banks, the conclusion was reached that a maturity of 90 days was the most reasonable.
Senator Shafroth explained: '
* * * When we look around in the history
of the world we find that there arc banks of
this kind; that is, discount banks; and when
we find that in England the paper must run
only 28 days, when we find that in France it
runs but 26 days, when we find that in Germany it does not exceed 90 days, and that
there is no bank in the world which discounts
paper in excess of 90 days, does it not become us, in the interest of caution, to say that
until it is demonstrated the other way we had
better adhere to 90-day paper?

AGRICULTURAL PAPER
It was recognized, however, that a 90-day
maturity requirement might not be adequate in
all cases, especially with respect to agricultural
paper. Hence, in addition to 90-day maturities,
the House Banking and Currency Committee
allowed a Federal Reserve Bank to discount
paper with a maturity of up to 120 days provided (1) that its own cash reserve exceeded
one-third of its outstanding liabilities, other
than Federal Reserve notes, by an amount fixed
by the Federal Reserve Board, and (2) that
not more than half the paper discounted for

GENERAL LIMITATIONS
any particular member bank had a maturity
of more than 90 days. The committee felt that
this provision would "fulfill the requirements
of portions of the country with an extremely
long term of credit." "
In explaining the bill on the floor of the
House, Chairman Glass sought to refute the
contention that the 90-day maturity requirement would render the discount provisions of
no use to the farmer. He stated, first, that there
had been some misapprehension as to the
meaning of the 90-day provision and explained
that it did not mean the paper had to have an
original maturity of not more than 90 days
but only that it could not be discounted until
it was within 90 days of maturity; ° and, second, that even if a country bank at certain seasons should find its funds tied up in longer-term
paper, it could take advantage of the 120-day
provision of the House bill and be in a position "to take six months' paper as soon as it
was two months old to a Federal Reserve bank
and rediscount it."
Nevertheless, there were Congressmen from
the farm belt who thought that the maturities
allowed by the Glass bill were not sufficiently
long to accommodate agricultural loans.7 Mr.
Norton of North Dakota introduced an amendment to increase the normal maturity limit
from 90 to 120 days and the exceptional
maturity (when the Reserve Bank would have
reserves in excess of one-third of its liabilities)
from 120 days to 6 months. His proposal,
however, was rejected.8
In the Senate, agitation for a longer maturity
for agricultural paper met with more success.
The Owen bill was severe, requiring a 90-day
maturity at the time of discount in all cases
and with no exception. The Hitchcock bill,
however, was more liberal. It provided that discounted paper should have a maturity of not
more than 180 days, with two qualifications:
not more than half of the paper discounted for
any member bank could have a maturity of
more than 90 days, and in no case could a
member bank have more than $200,000 of
rediscounts with a maturity longer than 90
days. By way of justification, Senator Hitchcock said:"


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Federal Reserve Bank of St. Louis

15

The six months' paper is just as legitimately
a commercial paper as is the 90-day paper of
the East, where the processes of manufacturing and mercantile business are perfected in
90 days, and the man who gives his note for
90 days is able to pay it out of the proceeds
which come from the sale of his property, his
stock. In the West the man who buys cattle to
feed during the winter months and borrows
money for the purpose of buying them is not
able to meet his paper in 90 days, but at the
end of six months his paper is liquidated just
as naturally, just as fully, and just as freely
as is the mercantile and manufacturing paper
of the East. * * *
Proponents of the Owen bill defended the
90-day provision of that bill. They argued that
even the country banks would always have a
substantial amount of paper maturing within
90 days;10 that a maturity of 90 days had been
found adequate in Europe;" and that under a
special provision of the Owen bill, a bank
under certain circumstances could discount its
own 90-day obligations secured by longer-term
paper of farmers.12
These arguments failed to satisfy the farmbelt Senators. They protested that the 90-day
requirement was discriminatory against the
country banks and pointed to the fact that the
bill allowed a maturity of 6 months in the case
of foreign acceptances."
An amendment to the Owen bill proposed
by Senator Hitchcock to increase the required
maturity from 90 to 180 days was defeated.11
In the end, however, Senator Owen himself
offered an amendment to his substitute bill.
The amendment, while retaining the basic 90day limitation, permitted the discounting of
paper drawn for agricultural purposes or based
on livestock if the paper had a maturity of not
more than 6 months; the amount of such discounts was limited to a certain percentage of the
capital of the Federal Reserve Bank, which
percentage was to be fixed by the Federal
Reserve Board. This amendment was agreed to
by the Senate.15 Subsequently, it was accepted
by the conference committee and became a part
of the original Act.

16

HISTORY OF LENDING FUNCTIONS

Thus, the net effect was adoption of the 90day limitation as a general rule, with a more
liberal maturity requirement for agricultural
paper.
To avoid confusion, it is important to bear
in mind—as Carter Glass pointed out in the
debates—that the 90-day limitation applies to
the maturity of paper at the time of discount,
not to the original maturity of the paper. For
example, member banks are authorized to accept drafts and bills with maturities of up to
6 months, but bankers' acceptances not drawn
for agricultural purposes are eligible for discount by the Reserve Banks only if they have
a maturity of not more than 90 days at the time
of discount.

DAYS OF GRACE
Only one slight change has been made in
the 90-day maturity requirement since it was
originally enacted. In 1916 the requirement
was modified to exclude days of grace from
the computation of the 90-day period as well as
from the longer-maturity requirement applicable to agricultural paper.10 The amendment was
made on the recommendation of the Federal
Reserve Board, which had pointed out that
some States provided for days of grace in the
payment of obligations."

REGULATIONS
The Board's discount regulations have never
done more than paraphrase the 90-day requirement of the law itself. In 1915 the Board's
Regulation B stated simply that, to be eligible
for discount, commercial paper "must have a

maturity at the time of discount of not more
than 90 days." '" This provision was retained
in a 1916 revision of Regulation A,IB but with
an exclusion of days of grace in accordance with
the amendment to the law enacted in that year.
A similar provision was contained in Regulation
A, as revised in 1955,20 but a footnote stated
that advances to member banks are normally
made for periods of not more than 15 days.
That footnote was eliminated in 1968.21 The
1973 revision of the regulation provided that
paper eligible for discount must have "a period
remaining to maturity of not more than 90
days." It also eliminated the reference to exclusion of days of grace, but this was presumably
in the interest of simplicity and without intending to modify the statutory exclusion of days
of grace.

DEMAND PAPER
In 1917 the Board ruled that demand paper
was not eligible for discount because, at the
option of the holder, it might be held and not
presented for payment until after 90 days.2This ruling led to an amendment to the law in
1923 making demand or sight drafts eligible
for discount if drawn to finance shipments of
agricultural staples.
In 1966 the Board reconsidered and reversed
its 1917 ruling. The Board pointed out that, as
a matter of law, demand paper is due and payable on the day of issue. Therefore, it concluded that such paper satisfies the maturity
requirements of the statute and that, if it meets
other eligibility requirements, demand paper is
eligible for discount and as security for advances by the Reserve Banks.23

AMOUNT
AGGREGATE AMOUNT
Apart from special provisions with respect to
agricultural paper and bankers' acceptances,
the Federal Reserve Act has never placed any
limit upon the total amount of credit that may


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Federal Reserve Bank of St. Louis

be extended by the Reserve Banks either to any
one member bank or to all member banks.
The National Monetary Commission had
suggested in 1912 that, in order to provide a
safeguard against possible abuses, the aggregate

GENERAL LIMITATIONS
amount of paper rediscounted for any bank
should be limited to the amount of its capital
stock.-1 The framers of the Federal Reserve
Act, however, apparently believed that discounts should be limited only by the amount
of short-term commercial paper available for
discount. Mr. Glass emphatically stated that
no limitation on the aggregate amount that
could be discounted for member banks was
intended.2'"' As a matter of fact, there were
some who felt that the volume of eligible paper
available for rediscount might not be sufficient
to support the contemplated issuance of Federal Reserve notes.50
Senator Hitchcock, however, was disturbed
by the lack of any limit on the amount of paper
that the Federal Reserve Banks might discount.
He felt that there was a need for "some automatic check" on the amount of discounting and
that, without restraints, excessive discounting
might lead to inflation. He proposed, therefore,
that discounts for a member bank in excess of
its capital stock should bear a higher rate of
discount and that in no event should a Federal
Reserve Bank be permitted to discount paper
for a member bank in an amount greater than
twice the amount of the member bank's capital
stock.27 His proposed amendment for this purpose was tabled by a close vote of 37 to 31.2"
After the Glass bill had been reported in the
House, it was discovered that although no limitation on the amount of discounts had been
contemplated by the committee, the amount of
paper that a national bank could rediscount
with a Federal Reserve Bank would nevertheless be limited to the amount of its capital stock
by virtue of the existing provisions of section
5202 of the Revised Statutes. That section provided that the aggregate indebtedness of a national bank should not exceed its capital stock,
except for certain specified kinds of liabilities
such as circulating notes and liabilities to stockholders for dividends. These provisions of the
National Bank Act would therefore have effectively limited the amount of paper that national
banks could rediscount with the Federal Reserve Banks, whereas, as pointed out by Mr.
Glass, State banks that became members of the
System would not be similarly limited. It was
noted that, actually, national banks would not


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Federal Reserve Bank of St. Louis

17

be able to discount paper up to even 100 per
cent of their capital because their liability for
the unpaid part of their subscriptions to Federal
Reserve Bank stock and also their liability on
any acceptances they might make under the new
law would be liabilities within the meaning of
section 5202 of the Revised Statutes.29
In order to remove this limitation on the
ability of national banks to rediscount paper
with the Reserve Banks, an amendment was
introduced on the floor of the House by Mr.
Bulkley ™ to except from the provisions of
section 5202 of the Revised Statutes "liabilities
incurred under the provisions of sections 2, 5,
and 14 of the Federal Reserve Act"; and after
some debate the amendment was adopted.31
This provision was not contained in either the
Owen bill or the Hitchcock bill as reported in
the Senate; but it was incorporated in Senator
Owen's substitute bill and, with the language
modified to refer simply to "liabilities incurred
under the provisions of the Federal Reserve
Act," it was approved by the conference committee. It is still to be found in existing law.

PAPER OF ONE BORROWER
While the law does not limit the total amount
of discounts that may be made by the Federal
Reserve Banks, it has always included provisions restricting the amount of paper of one
obligor that may be rediscounted for any member bank. It is important to note that this
restriction relates not to the amount borrowed
from the Reserve Bank by the member bank
itself, but to the amount borrowed from the
member bank by a customer of the member
bank.
Section 13 of the original Act provided that
the aggregate amount of notes and bills bearing
the signature or endorsement of any one person,
company, firm, or corporation rediscounted for
any one bank should at no time exceed 10 per
cent of the unimpaired capital and surplus of
the member bank, but the restriction was made
inapplicable to bills of exchange "drawn in good
faith against actually existing values."
This general limitation on discounts by the
Reserve Banks of paper of one person was
considered to be in harmony with the then

18

HISTORY OF LENDING FUNCTIONS

existing provisions of section 5200 of the Revised Statutes prohibiting a national bank from
lending to any one borrower more than 10 per
cent of the national bank's capital and surplus.
However, the exception in the Federal Reserve
Act provision for bills drawn against actually
existing values was not contained in the national
bank provision. Describing it as a new feature
that had long been called for in the interest of
legitimate business transactions, the report of
the House Banking and Currency Committee
stated: 3Z
* * * Obviously when a bill of exchange is
secured by bills of lading and other documents accompanying it, it is primarily dependent for liquidation upon this unquestionably marketable wealth. There is therefore no reason for limiting the amount of the
discount to be granted by any reference to
the resources of the person applying for the
accommodation or by the capit-l and surplus
of the bank granting the discount, that being
merely a question of banking judgment, while
the bill itself is salable and will presumably
be protected at the point where it is presented.
It was soon found, however, that even the
general 10 per cent limitation was not in all
respects the same as the limitation imposed by
section 5200 of the Revised Statutes on loans
made by a national bank to one borrower. Section 5200 limited the amount of a customer's
liability "for money borrowed," whereas under
the Federal Reserve Act a bill otherwise eligible
for discount was rendered ineligible by the extra
or additional endorsement of some third person
who had already borrowed from the member
bank up to the statutory limit, even though the
obligor on the bill had not himself borrowed
up to the limit. At the Board's suggestion,33
section 13 was amended in 1916 to make the
limitation applicable to the aggregate amount
of paper bearing the signature or endorsement
of "any one borrower," rather than "any one
person, company," and so forth, thus bringing
it in line with the national bank limitation.31
Another discrepancy arose from the fact
that under an exception contained in section
5200 of the Revised Statutes, a national bank


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Federal Reserve Bank of St. Louis

could acquire "actually owned" commercial or
business paper from the same person in excess
of the 10 per cent limitation, while a Federal
Reserve Bank under section 13 of the Federal
Reserve Act could not rediscount such paper
unless it consisted of bills of exchange drawn
"against actually existing values." ••" The Board
in 1916 suggested to Congress that this provision of section 13 be amended to except actually
owned commercial and business paper, as well
as bills of exchange drawn against actually
existing values.-10 This suggestion was not acted
upon at that time. In 1917, however, when
certain provisions of section 9 of the Act were
being revised to make membership of State
banks more attractive, a new provision was
inserted in that section that conformed to the
Board's recommendation. According to this
provision, State banks joining the System would
retain their full charter and statutory rights
under State law, provided in general that no
Federal Reserve Bank could discount for a
State member bank any paper of any person
who had borrowed from such bank an amount
greater than 10 per cent of the bank's capital
and surplus. However, there were two exceptions: Bills drawn against actually existing
values or against actually owned commercial or
business paper were not to be considered as
borrowed money."
While this amendment met the Board's point
as to the exception of actually owned business
or commercial paper, it nevertheless gave rise
to a conflict between the new provision in
section 9—applicable only to State member
banks—and the old provision of section 13—
applicable ostensibly to all member banks but
actually only to national banks—with national
banks gaining an unintended advantage over
State member banks. This advantage arose for
the following reasons.
Under section 5200 of the Revised Statutes,
a national bank could make loans to a single
borrower in excess of the general 10 per cent
limit by discounting certain exceptcd types of
paper described in that section, such as notes
secured by shipping documents, warehouse receipts, and other documents covering readily
marketable staples and notes secured by bonds

GENERAL LIMITATIONS
of the United States. Consequently, a national
bank could have outstanding loans to a single
customer represented by notes of the kinds just
described in excess of the 10 per cent limitation,
and a Federal Reserve Bank, under the provision of section 13, could rediscount the paper
of that customer for the national bank up to
10 per cent of the national bank's capital and
surplus. On the other hand, because of the
language of the provision of section 9 of the
Act that had been added in 1917, if a State
member bank with the same amount of capital
and surplus had made loans to one of its customers in the same amount and represented by
the same kinds of paper, the Reserve Bank
would be prohibited from rediscounting for the
State member bank any of that customer's
paper.™
To remove this inconsistency, Congress in
1922 again amended the limitation in section 9
to provide simply that a Reserve Bank should
not discount for a State member bank the paper
of any one borrower who was liable for borrowed money to that bank "in an amount
greater than that which could be borrowed lawfully from such State bank or trust company
were it a national banking association." S9 This
meant that thereafter a State member bank that
had made loans to one borrower in excess of
its capital and surplus but on the security of, for
example, warehouse receipts covering readily
marketable staples or notes secured by Government bonds would not be precluded from offering paper of that borrower as a basis for rediscount.
Nevertheless, there were still significant discrepancies between the provisions of sections
9 and 13. In the first place, the amount limitation in section 13 was subject to only one exception—bills of exchange against actually existing
values. However, the limitation in section 9 was
clearly subject to all of the exceptions provided
in section 5200 with respect to loans by national banks to one borrower.10 This meant,
strangely enough, that paper representing loans
to a single borrower that was permitted for a national bank under section 5200 was eligible for
discount if offered by a State member bank but
was not eligible if offered by a national bank.41


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Federal Reserve Bank of St. Louis

19

In the second place, both the Comptroller of
the Currency in interpreting section 5200 and
the Federal Reserve Board in construing section
13 had held that the limitations on loans to one
borrower applied only to direct liabilities such
as those of a maker or acceptor, and not to
indirect liabilities such as those of a drawer,
endorser, or guarantor." The McFadden Act
in 1927 amended section 5200 to make its
limitations expressly applicable to the indirect
liability of a drawer, endorser, or guarantor;
but section 13 was not similarly changed.
Both of these inconsistencies were corrected
by the Act of April 12, 1930," which amended
the provision of section 13 so that, like the provision of section 9, it referred specifically to the
limitations on loans to one borrower contained
in section 5200 of the Revised Statutes. As thus
amended, section 13 stated: "
The aggregate of notes, drafts, and bills
upon which any person, copartnership, association, or corporation is liable as maker,
acceptor, indorser, drawer, or guarantor, rediscounted for any member bank, shall at no
time exceed the amount for which such person, copartnership, association, or corporation may lawfully become liable to a national
banking association under the terms of section S200 of the Revised Statutes, as amended;
Provided, however, That nothing in this paragraph shall be construed to change the character or class of paper now eligible for
rediscount by Federal reserve banks.
This provision has not been changed since
1930. Literally, it permits a member bank to
rediscount with a Federal Reserve Bank as
much paper of a single borrower as a national
bank is permitted to acquire from a single
borrower under section 5200 of the Revised
Statutes. The latter section has been amended
on a number of occasions to provide additional
exceptions to the 10 per cent limitation (there
are now 13 of them); but a discussion of the
provisions of that section is beyond the scope
of this study.
As being of historical interest, it may be
noted that in March 1919 Congress amended
section l l ( m ) of the Federal Reserve Act to
authorize the Federal Reserve Board, upon the

20

HISTORY OF LENDING FUNCTIONS

affirmative vote of five members, to permit the
Federal Reserve Banks to discount for any
member bank paper of one borrower in excess
of 10 per cent of its capital and surplus, but not
to exceed 20 per cent, if the amount exceeding
10 per cent were secured by bonds or notes, or
certificates of indebtedness of the United
States.45 Presumably, this was a postwar measure to encourage bank holdings of Government
bonds. By its own terms, the provision became
inoperative after December 31, 1920.
The Board's discount regulations in general
have paraphrased the provisions of the law
limiting the amount of paper of any one borrower that may be discounted for a member
bank, with successive revisions of Regulation A
reflecting changes in the statutory provisions.
As revised in 1955, the regulation set forth the
substance of the provisions of both section 13
and section 9 of the Federal Reserve Act: limiting the aggregate amount of paper of any one
person discounted for any member bank to the
amount for which such person could lawfully
become liable to a national bank, and forbidding a Federal Reserve Bank to discount
for any State member bank paper of any one
borrower who is liable to such bank for borrowed money in an amount greater than could
be borrowed lawfully from such bank if it
were a national bank.46
A literal reading of the law and of these
provisions of Regulation A meant that a Reserve Bank could discount for a national bank
paper of one borrower in an amount up to the
amount that the national bank was permitted to
lend to a single borrower under section 5200
of the Revised Statutes, but that a Reserve
Bank could not discount for a State member
bank any of the paper of one borrower if the
amount exceeded the amount that a national
bank could lend to a single borrower. The absurdity of this distinction was recognized by
the Board in an unpublished letter to a Federal
Reserve Bank in 1966 when, notwithstanding
the statutory provisions, the Board held that a
Reserve Bank could not "discount for any
member bank, national or State, any obligation
of a borrower who is liable to such member
bank in an amount greater than that which


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Federal Reserve Bank of St. Louis

could be borrowed lawfully from a national
bank in the circumstances of the particular
case." This position was in effect incorporated
in Regulation A by an amendment in 1970 that
provided that any member bank requesting
Reserve Bank credit shall be deemed to represent and guarantee that, except as to credit
granted under section I0(b) of the Federal
Reserve Act, "as long as the credit is outstanding no obligor on paper tendered as collateral
or for discount will be indebted to it in an
amount exceeding the limitations in section
5200 of the Revised Statutes, which for this
purpose shall be deemed to apply to State member as well as national banks." *"
Even with this amendment, the regulation
continued to provide, inconsistently, that the
aggregate amount of paper of one borrower
discounted for any member bank should at no
time exceed the amount that such person could
borrow from a national bank under section
5200 of the Revised Statutes. The general revision of Regulation A adopted by the Board in
1973 eliminated this inconsistent provision of
the regulation. It did, however, continue in
effect the language of the provision added in
1970 under which any member bank applying
for credit is deemed to guarantee that no obligor
on paper offered as collateral or for discount
will be indebted to it in an amount exceeding
the limitations prescribed by section 5200 of
the Revised Statutes.
On a number of occasions the Board has
published interpretations of the statutory limitations on the amount of paper of one borrower
that may be discounted, but only a few of the
more important need be mentioned here.
Before the limitations in section 13 of the
Federal Reserve Act were amended in 1930 to
conform to those of section 5200 of the Revised
Statutes, the only exception, as has been seen,
was that with respect to bills drawn against
actually existing values. However, when section
5200 was changed in 1919 to except paper
secured by shipping documents and bankers'
acceptances of the kinds described in section 13
of the Federal Reserve Act, the Board expressed the opinion that both of these kinds of
paper might be regarded as bills drawn against

GENERAL LIMITATIONS
actually existing values and therefore as excepted from the discount limitations of section 13.1S
Since the 1930 amendment to section 13
conforming its limitations to those prescribed
by section 5200 of the Revised Statutes, the
Board in applying section 13 has followed interpretations made by the Comptroller of the
Currency under section 5200. Thus, notes of
farmers for the purchase of agricultural implements, which had been interpreted by the
Comptroller to constitute actually owned commercial or business paper within the meaning of
section 5200, were similarly held by the Board
to be exempt from the amount limitation set
forth in section 13."
Although the limitation with respect to the
discounting of paper of a single borrower
literally applies only to rediscounts for member
banks, the Board in 1938 took the position
that, in order to comply with the spirit of the
law, a Federal Reserve Bank, in making advances to a member bank secured by eligible
paper as well as in discounting paper, should
not acquire paper upon which one person is
liable in an aggregate amount in excess of the
10 per cent limitation.50 At the same time, however, the Board expressed the opinion that
advances under section 10(b) of the Federal
Reserve Act on the security of any satisfactory
collateral should not, in view of the purposes
of that section, be subject to any limitation of
this kind. These interpretations—the applicability of the limitation to advances as well as to
rediscounts and the inapplicability of the limitation to advances under section 10(b)—were
subsequently incorporated in Regulation A. The
first interpretation was clearly justified, but
today one might question why advances under
section 10(b) to a national bank should be permitted to be secured by any paper of a single


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Federal Reserve Bank of St. Louis

21

borrower in an amount greater than that which
could be borrowed from the national bank
under section 5200 of the Revised Statutes.
In 1934 Congress amended section 9 of the
Federal Reserve Act to provide that, for purposes of membership of any State bank in the
System, the terms "capital" and "capital stock"
should include capital notes and debentures
issued by such bank and purchased by the
Reconstruction Finance Corporation (RFC). 01
On the theory that the RFC was authorized to
purchase such capital notes and debentures in
order to provide capital funds to banks, the
Board held that, for purposes of various provisions of the Act, capital notes and debentures
of a bank bought and held by the RFC should
be treated as capital stock; and that among
these provisions were those of sections 9 and 13
of the Federal Reserve Act limiting the discounted paper of one borrower to 10 per cent
of the discounting member bank's capital stock
and surplus.58
In concluding this section, it is appropriate
to observe that, quite apart from the statutory
limitations on discounting paper of one borrower, a Federal Reserve Bank, in determining
whether to discount paper for a particular member bank, may properly take into consideration
the total amount of paper of the same borrower
that has been discounted for other member
banks. In the early days of the System the
Board publicly stated that it was "both lawful
and proper" for a Reserve Bank to place an
aggregate limit on the amount of the paper of
any one borrower that it would discount for all
of its member banks, and that a policy of
declining to receive more than a certain proportion of the paper of a particular borrower was
not itself a discrimination but a general and
conservative policy applicable to all member
banks alike.03

22

HISTORY OF LENDING FUNCTIONS

ENDORSEMENT
PURPOSE
In addition to general limitations on maturity
and amount, the Federal Reserve Act imposed a
third limitation that was designed to afford the
Reserve Banks some protection against possible
loss on paper discounted by them—a requirement that the paper be endorsed by the discounting member banks.
During the debates on the original Federal
Reserve Act there was evidence of some confusion between eligibility for discount and the
soundness of the paper discounted. In general,
however, it was agreed that, even though particular paper was eligible for discount, a Reserve Bank would still have a right to determine
whether the paper was "good" and to inquire
into the solvency of the maker.54 The requirement for endorsement by the borrowing member bank was the one statutory requirement
aimed at assuring the soundness of the loan.
The report of the House Banking and Currency
Committee stated: 05
The fundamental requirement throughout
all of the discount section of the proposed bill
is that antecedent to the performance of a
service by a Federal reserve bank for a member bank which applies therefor the member
bank shall indorse or guarantee the obligations which it offers for rediscount.
During the House debates Mr. Phelan asserted that discounted paper would be "gilt-edge
paper, entirely safe" because, after passing the
scrutiny of the member bank that had made the
original loan, it must then pass the scrutiny of
the Federal Reserve Bank and, in addition, have
the endorsement of the member bank.sa

WAIVER OF PROTEST
To further protect the Reserve Banks and to
avoid trouble and expense, Congress adopted a
requirement, originally contained only in the
Hitchcock bill, that a member bank's endorsement must be accompanied by a waiver of
demand, notice, and protest. During the de-


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Federal Reserve Bank of St. Louis

bates Senator Nelson explained that if the
Reserve Banks "were in every instance required
to protest those notes it would cause them great
expense, and they would have to present them
for payment and protest them at the local bank
where they were payable." "

REGULATORY PROVISIONS
The Board's first discount regulation, in listing the requirements to be met by all paper
offered for discount, stated: 5S
First. It must be indorsed by a National
or State bank or trust company which is a
member of the Federal reserve bank to which
it is offered for rediscount.
Second. Such bank must, with its indorsement, waive demand, notice and protest.
A 1915 revision of the regulation provided
simply that discounted paper "must be indorsed
by a member bank, accompanied by a waiver
of demand, notice, and protest." 59
Among certain technical amendments made
to section 13 of the Federal Reserve Act by the
Act of September 7, 1916,*° the requirement
for endorsement was changed to provide that
paper might be discounted by a Federal Reserve
Bank "upon the indorsement of any of its member banks, which shall be deemed a waiver of
demand, notice and protest by such bank as to
its own indorsement exclusively." This meant
that the act of endorsement by a member bank
constituted, without more, a waiver of demand,
notice, and protest as to its own endorsement.
Consequently, all subsequent revisions of Regulation A have provided only that paper offered
for discount must be endorsed by a member
bank, with no specific reference to waiver of
demand, notice, and protest.

FORM AND EFFECT OF
ENDORSEMENT
With respect to the form of the required
endorsement, the Board ruled that it was sufficient if the discounted paper bore the simple

GENERAL LIMITATIONS
written endorsement of the discounting member
bank;61 and that it was even permissible for
the endorsement to be on a separate but attached piece of paper, a so-called allonge.02
As previously indicated, the purpose of the
endorsement requirement is to provide a Federal Reserve Bank with a certain measure of
protection against loss. According to the law,
the member bank's mere endorsement carries
with it a waiver by that bank of the right it
would otherwise have to deny liability in the
absence of notice, demand, and protest. The
effect is to make the member bank primarily
liable on the paper so that the Reserve Bank
does not have to proceed first against the maker
or prior endorsers. The Reserve Bank is given
the advantage of "a right to proceed against
the bank that indorses the paper." °3
It is important to observe again that endorsement by a member bank is not an essential
prerequisite to the eligibility of paper for discount; it is simply a condition precedent to the
discount of eligible paper. Thus, under the
authority to make advances to member banks
on their own notes secured by paper eligible for

23

discount or purchase by the Federal Reserve
Banks, a Reserve Bank may make such advances on notes secured by paper that is not
endorsed by the member bank.61 In such a case,
the Reserve Bank relies on the member bank's
own note; the additional endorsement of the
paper securing the note would provide no
further protection. For many years, loans by
the Reserve Banks to member banks have been
made not through the rediscounting of eligible
paper, but through advances on the notes of
member banks secured by eligible paper or by
Government securities or other securities eligible for purchase by the Reserve Banks. As a
result, the endorsement requirement of the law
no longer has any great significance.
A distinction should also be made between
endorsement as a requirement for discount and
endorsement in connection with purchases of
paper by the Reserve Banks under section 14
of the Federal Reserve Act. Under the latter
section, bills of exchange and bankers' acceptances are expressly made eligible for purchase
by the Reserve Banks with or without the endorsement of a member bank.

NEGOTIABILITY
REGULATORY REQUIREMENT

EXCEPTIONS

The law itself has never required that paper
discounted by the Federal Reserve Banks be
negotiable paper. However, one of the earliest
versions of the Board's discount regulations °F>
defined the terms "promissory note" and "draft
or bill of exchange" in language that, under the
Uniform Negotiable Instruments Law, had the
effect of prescribing negotiability as a requirement for discount; and from 1923 until 1970
Regulation A specifically provided that any
paper offered for discount "must be a negotiable
note, draft, or bill of exchange."60 This meant
not only that discounted paper had to be negotiable but also that any eligible paper offered
as security for direct advances to member banks
likewise had to meet the test of negotiability.

Only two exceptions were made to the regulatory requirement for negotiability before that
requirement was eliminated. In 1942, Regulation A was amended to except from this requirement paper evidencing war production
loans guaranteed by the War and Navy Departments and the Maritime Commission pursuant
to the V-loan program of World War II;'"
this exception was broadened in 1944 to cover
loans similarly guaranteed pursuant to the Contract Settlement Act.OiS After the war, the exception was eliminated,11" but in 1951 it was restored to make negotiability unnecessary for
paper representing defense production loans
guaranteed by Government agencies under the
Defense Production Act of 1950.™


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Federal Reserve Bank of St. Louis

24

HISTORY OF LENDING FUNCTIONS

The other exception from the negotiability
requirement related to notes evidencing loans
made pursuant to commodity loan programs of
the Commodity Credit Corporation and subject
to a commitment to purchase by that Corporation. An amendment to Regulation A providing
for such an exception was adopted by the
Board in 1949."
It .should be noted that, under section 10(b)
of the Federal Reserve Act, the Reserve Banks
may make advances to member banks on any
satisfactory security—but at a penalty interest
rate—whether paper offered as security is negotiable or nonnegotiable.

MEANING OF NEGOTIABILITY
In general, an instrument is negotiable if it
evidences an unconditional promise or order to
pay, on demand or at a fixed or determinable
future time, a certain sum of money to order
or bearer. In the final analysis, the question
whether a particular note or draft is negotiable
is a matter for determination by the courts in
the light of applicable provisions of State law.
Negotiability is governed by Article HI of the
Uniform Commercial Code, which has been
adopted in all States except Louisiana.
This is not the place for a discussion of the
various elements of negotiability. It may be
noted, however, that, in administering the discount provisions of the Federal Reserve Act,
the Board undertook during the early years of
the System to express opinions as to whether
particular instruments were negotiable and
therefore eligible for discount. In general, these
opinions related to whether the paper involved
was "unconditional," or was payable at a "fixed
or determinable" future time, or provided for
payment of a "certain" sum of money.
For example, the Board expressed the opinion that bills were not unconditional—and
therefore were nonnegotiable—if they were payable out of the proceeds of an import or export
transaction; '•- but that negotiability was not
affected either by a provision authorizing the
consignee of goods to inspect the goods before
accepting a draft covered by a bill of lading "
or by an endorsement exempting the endorser
from responsibility for the genuineness of an


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Federal Reserve Bank of St. Louis

accompanying bill of lading." With respect to
certainty of time of payment, the Board ruled
that drafts payable before a specified maturity
date after 5 days' notice were negotiable; ™
that a draft "payable on arrival of car" was not
negotiable;70 and that a note providing for
extensions of time should not be approved
because of conflicting authorities as to the
negotiability of such a note.77 As to certainty
of amount, the Board ruled that a bill payable
with collection • charges is not negotiableTR
unless it is so drawn as to show that no collection charges are to be included unless the bill
is dishonored at maturity;T0 but that negotiability is not affected by a provision for interest at a specified rate after maturity if payment is delayed.80 However, because of
conflicting court decisions, the Board in 1918
disapproved of trade acceptances that provided
for a fixed discount if paid at a certain time
before maturity.81

ELIMINATION OF THE
REQUIREMENT
When Regulation A was amended in 1942 to
remove the negotiability requirement with respect to notes evidencing guaranteed V loans,
the Board noted that the requirement of negotiability "was not a requirement of the Federal
Reserve Act but had been placed in Regulation
A as a means of protecting the Federal Reserve
Banks against certain legal disadvantages of
nonnegotiable paper." 82 In April 1970, the
Board broke with tradition and eliminated the
negotiability requirement from the regulation."1
This action was taken because of the belief
that, while negotiability of paper afforded the
Reserve Banks certain protection against loss in
the event of default, most loans were being
made in the form of advances on the notes of
member banks themselves and the Reserve
Bank could therefore proceed directly against
the member bank in the event of default; thus,
the importance of negotiability was diminished.
In any event, it was felt that negotiability does
not improve the underlying quality of the paper
offered as security and that the Reserve Banks
should not be precluded from accepting perfectly sound and otherwise eligible paper as

GENERAL LIMITATIONS
security for advances at the regular discount
rate merely because it did not meet all of the
technical requirements for negotiability. It was
understood, however, that elimination of the


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Federal Reserve Bank of St. Louis

25

regulatory requirement would not preclude a
Reserve Bank in individual cases from declining
to accept nonnegotiable paper for discount or
as collateral for advances.


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Federal Reserve Bank of St. Louis

Discount of Commercial Paper

MEANING OF "COMMERCIAL PAPER'
drawn, or the proceeds of which were to be
used, for "agricultural, industrial, or commercial purposes"; that it included paper secured by
"staple agricultural products"; and that it did
not include paper drawn for the purpose of
trading in stocks and bonds. They were also
agreed that it meant "liquid" paper and paper
with short maturities. All of these points of
agreement were written into the law. The
framers, however, made no further effort to
define commercial paper; instead, they left to
the Federal Reserve Board the authority and
responsibility for making a more specific determination of the character of paper eligible for
discount.
The report of the House Banking and Currency Committee stated: x

INTENT OF THE ORIGINAL ACT
The principal objective of the discount provisions of the original Federal Reserve Act—
to establish a market for commercial paper—
was clearly reflected in the provision of section
13 of the Act that authorized the Reserve
Banks to "discount" for their member banks
"notes, drafts, and bills of exchange issued or
drawn for agricultural, industrial, or commercial purposes, or the proceeds of which have
been used, or are to be used, for such purposes." This chapter relates to discounting of
what has generally been referred to as "commercial paper." Since agricultural paper has
been accorded special treatment by the law, it
will be considered separately.
Despite frequent statements of their purpose
to create a market for commercial paper, the
trainers of the original Act were obviously not
clear, except in a very general way, as to what
was meant by commercial paper. They were
agreed that it meant paper arising out of "actual
commercial transactions"; that it meant paper

* * * In view of the great difficulty of
defining "commercial paper," the actual definition of the same has been left to the Federal
reserve board in order that it may adjust the
definition to the practices prevailing in different parts of the country in regard to the
transaction of business and the making of
paper. * * *

For NOTES AND REFERENCES, see pp. 251-53.


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Federal Reserve Bank of St. Louis

27

28

HISTORY OF LENDING FUNCTIONS

During
clared: z

the debates, Senator Weeks

de-

We asked a dozen or fifteen banking men
to give us a definition which could limit the
kind of paper which we wanted to cover by
this definition of commercial paper, and no
one of them did it. I do not know just exactly
how the reserve board will finally conclude to
define it, but I assume they will in some form,
so that there will be no question about what
eligible paper is.

Perhaps the best effort to explain the meaning
of commercial paper was made by Mr. Phelan
in the House. After noting that it must be shorttime paper, he stated: 3
* * * Just what constitutes commercial
paper it is impossible to define closely or
strictly. The whole spirit of the bill and this
section is, however, that the funds of the reserve banks shall be applied to the activities
of business; first, because the funds of the
reserve. banks consist in large part of public
money and of reserves; and, second, because
the funds of commercial banks, both from a
scientific banking and a practical standpoint,
should be applied to commercial purposes.
The whole spirit of the bill is that the funds
of the reserve banks should be applied to the
activities of business, commerce, and agriculture. It is impossible to define in a specific
way just what notes and bills shall be eligible
for rediscount. It is clearly defined in the bill,
however, that the funds of reserve banks shall
not be diverted from the channels of production and distribution. In order that there
might be a broad and adaptable construction
put upon the terms contained in section 14
[section 13 in the Act as passed], discretion as
to their interpretation, in accordance with the
spirit of the bill, is given the Federal reserve
board. It is reasonable to believe that this
board will exercise its discretion with wisdom
and prudence.

There were a few members of Congress, such
as Mr. Wingo,4 who questioned the desirability
of allowing the Federal Reserve Board to determine what classes of paper should be eligible
for discount. The majority, however, appeared
to agree with Senator Weeks who stated that
Congress, having required that paper arise
from a commercial transaction, should "leave


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Federal Reserve Bank of St. Louis

it to the reserve board to make rules and regulations which will define the kind of paper
which shall be accepted." •'•

REGULATORY DEFINITION
The Federal Reserve Banks first opened their
doors for business on November 16, 1914. Previously, the Board had decided that since it was
not passible to formulate in advance a complete
set of regulations to govern the operations of
the Reserve Banks, it would "confine itself in
the beginning to those matters which were
deemed absolutely essential to setting the banks
in motion upon a basis of reasonable efficiency." " The matter of discounting commercial paper came first. In its first Annual
Report to Congress, the Board stated that it had
felt "that the regulations relating to discount
operations and commercial paper in general
were fundamental and that they should be prepared and issued at once." " Accordingly, in
a letter sent to the Reserve Banks on November
10, 1914," the Board outlined its views as to
initial discount policy and transmitted five separate though brief regulations relating to the
rcdiscounting of notes and bills and bankers'
acceptances.
In its circular letter to the Reserve Banks,
the Board referred to the uncertain effects of the
war in Europe (in which the United States was
not yet involved) and stated that the function
of the Federal Reserve Banks was of a twofold
character: (1) They should extend credit facilities, particularly where the prevailing abnormal conditions had created emergencies demanding prompt accommodation; and (2) they
should protect the gold holdings of the country
in order that such holdings might remain adequate to meet demands made upon them.
"While credit facilities should be liberally extended in some parts of the country," said the
Board, "it would appear advisable to proceed
with caution in districts not in need of immediate relief and to await the effect of the release
of reserves and of the changes which the credit
mechanism of the country is about to experience
before establishing a definite discount policy."
The Board expressed the belief that it would
be inadvisable to place a narrow or restrictive

DISCOUNT OF COMMERCIAL PAPER
interpretation upon the character of paper
eligible for discount. It did, however, prescribe
three basic principles for the guidance of Federal Reserve Banks and member banks: (1)
No bill should be discounted if its proceeds were
to be applied to permanent investment; (2)
maturities should be well distributed; and (3)
bills should be "essentially self-liquidating." In
explanation of the self-liquidating principle, the
Board stated that discounted paper "should
represent in every case some distinct step or
stage in the productive or distributive process—
the progression of goods from producer to consumer. The more nearly these steps approach
the final consumer the smaller will be the
amount involved in each transaction as represented by the bill, and the more automatically
self-liquidating will be its character."
The Board, in this first pronouncement on
the subject of discounting, also called attention
to the fact that single-name paper does not, like
double-name paper, show on its face the character of the transactions out of which it arose.
For this reason, the Board felt that it was incumbent upon each Reserve Bank "to insist
that the character of the business and the general status of the concern supplying such paper
should be carefully examined in order that the
discounting bank may be certain that no such
single-name paper has been issued for purposes
excluded by the act, such as investments of a
permanent or speculative nature."
As to procedure, the Board's circular letter
stated that while it was not deemed essential
that a statement of condition be attached to
each bill, it was thought advisable that, after
January 15, 1915, no paper should be discounted unless it bore on its face evidence that
it was eligible for discount; and a rubber stamp
for this purpose was suggested.
Appended to the Board's circular of November 10, 1914, was the Board's Regulation
No. 2,D which set forth in general the requirements to which all paper offered for discount
must conform. Among other things, it was required that the paper offered "shall be in the
form of notes, drafts, or bills of exchange arising
out of commercial transactions; that is, notes,
drafts, and bills of exchange issued or drawn
for agricultural, industrial, or commercial pur-


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Federal Reserve Bank of St. Louis

29

poses, or the proceeds of which have been used
or are to be used for such purposes." Without
attempting to elaborate further on the statutory
language, the Board's regulation stated only
that, under the law, paper drawn for the purpose of trading in stocks and bonds—other than
Government bonds—or drawn merely for investment purposes was excluded from eligibility.
An effort to define more specifically the character of paper eligible for discount was made
by the Board when, on January 25, 1915, it
issued a new regulation, designated as Regulation B, relating to commercial paper.10 This
regulation stated that, in order to be eligible,
a bill must be one "the proceeds of which
have been used or are to be used in producing,
purchasing, carrying, or marketing goods in
one or more of the steps of the process of production, manufacture, and distribution."
A year and a half later, in 1916, the Board
issued a new series of its regulations. Regulation B was changed to cover open market purchases. Discount operations were covered by
a revised Regulation A." It embraced not only
discounts of commercial paper but also all other
kinds of discounts under section 13 of the
Federal Reserve Act, including discounts of
agricultural paper, commodity paper, and bankers' acceptances that had previously been dealt
with in separate regulations. The new regulation, however, made no substantial change in
the general definition of commercial paper. It
followed the language of the 1915 Regulation
B already quoted except that, in referring to the
production, purchasing, carrying, or marketing
of goods, it defined the word "goods" in a footnote as including "goods, wares, merchandise,
or agricultural products, including live stock."
The regulatory statement as to the general
character of paper eligible for discount remained unchanged until 1920 when two
changes were made in Regulation A. It was
then provided that the proceeds of the paper
must be used "in the first instance" for the
purposes described, and it was expressly stated
that eligible paper included paper the proceeds
of which were used "for the purpose of carrying or trading in bonds or notes of the United
States." 12
Two further changes were made in 1923."

30

HISTORY OF LENDING FUNCTIONS

For the first time in the regulation itself, it was
required that the paper be negotiable. In addition, it was provided that the name of a party
to the underlying transaction should appear
upon the paper "as maker, drawer, acceptor,
or indorser." This requirement was eliminated
when Regulation A was revised in 1937.14 The
1937 revision also eliminated a provision excluding paper the proceeds of which were used
tofinancethird parties and expanded the definition of eligible paper to include paper the
proceeds of which were used "in meeting current operating expenses of a commercial, agricultural or industrial business." As has been
noted earlier, the negotiability requirement was
removed in 1970.
Further changes of a liberalizing nature were
made by the 1973 revision of Regulation A.
In the first place, paper the proceeds of which
are used for the "purchase of services" as well
as for the purchase of goods was made eligible
for discount. Of greater significance, this revision eliminated the long-standing prohibition
against the discounting of paper the proceeds
of which were used for permanent or fixed investments and provided only that the proceeds
must not be used "merely for the purpose of
investment, speculation, or dealing in stocks,
bonds, or other such securities, except direct
obligations of the United States." This important change will be discussed in more detail
later in this chapter.

COMMERCIAL PURPOSE
The Board's regulatory definition of commercial paper, as indicated earlier, has been
phrased in broad and general language. The
meaning of the term can be better understood
by considering particular instances in which
the Board by interpretation has determined
whether the paper offered for discount was
actually drawn for a commercial purpose.
At an early date, the Board in a published
statement1!i pointed out the distinction between
(1) paper issued or drawn for a commercial
or agricultural purpose and (2) paper the
proceeds of which have been or are to be
used for such purposes. As to the first, a note
given by the buyer of goods to the seller is a


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Federal Reserve Bank of St. Louis

note issued or drawn for a commercial purpose,
since "the purchase and sale of goods of any
character is a commercial transaction from the
standpoint of the seller,"I0 and the note is
eligible for discount as commercial paper, even
though the goods may be in the nature of
permanent orfixedinvestments. However, if the
note is not given in a purchase-and-sale transaction, then the test of eligibility is the purpose
for which the proceeds of the note are to be
used.
In any case, it is the purpose of the original
negotiation of the note that determines its
eligibility. For example, a note given to a
farmer in payment for grain purchased for
resale is commercial paper even though the
farmer subsequently discounts the note at his
bank and uses the proceeds for an agricultural
purpose, since the purpose of the original negotiation of the note was to finance the purchase
and sale of goods, a commercial transaction.17
The above principles may be illustrated by
additional particular cases. For example, notes
given by dealers in payment for mules and cattle
are commercial rather than agricultural paper.14
Similarly, the note of an irrigation company the
proceeds of which arc used for payroll and
other current purposes in connection with the
distribution of water to farmers constitutes commercial paper.19 When a railroad company, in
order to purchase supplies, accepted the draft
of the seller, the Board ruled that if the draft
were discounted by the seller or a third party
with a member bank, it would be eligible for rediscount with a Federal Reserve Bank; but if
the railroad itself discounted the draft with its
own bank, there would be a direct loan to the
railroad and the draft would be eligible for
rediscount only if the proceeds were used for
a commercial purpose.20
It seems probable that the drafters of the
original Federal Reserve Act contemplated that
commercial paper would include only paper
growing out of business transactions and would
not embrace ordinary day-to-day purchases of
goods and services by individuals for their own
use. In 1937, however, the Board took the
position that the purchase of goods, such as an
automobile or a radio, for the use of the purchaser himself constitutes a commercial trans-

DISCOUNT OF COMMERCIAL PAPER
action. The eligibility of such consumer paper
will be specifically considered in a later section
of this chapter.

SELF-LIQUIDATING NATURE
A basic concept underlying the discount provisions of the Federal Reserve Act was that
commercial paper admitted to discount should
be self-liquidating paper. In a published statement, the Board recognized this concept. It
stated that paper eligible for discount was
limited to "liquid" paper, "that is, paper which
is issued or drawn under such circumstances
that in the normal course of business there will
automatically come into existence a fund available to liquidate each piece of paper, that fund
being the final proceeds of the transaction out
of which the paper arose." ai
As an illustration, if the notes of a public
service corporation will not be liquidated within
a short time out of current assets accruing
through ordinary earnings and the borrowing
is really for capital purposes, such notes are
ineligible; but, if the notes are given for supplies necessary to enable the corporation to sell
services to the public for which the public
will pay within 30 or 60 days, the notes are
eligible for discount.22
In order to assure liquidity, the Board took
the position that at least one of the parties
to the commercial transaction out of which the
paper arises should be obligated as maker,
drawer, acceptor, or endorser.21 Unless the
proceeds will ultimately come into the hands
of a person who is liable as a party to the
paper, there is no assurance that the proceeds
of the commercial transaction will be used to
liquidate the paper. By the same token, the
Board ruled that an equitable participation in
a note could not be discounted because it did
not represent a legal claim against the maker of
the note.24

EFFECT OF COLLATERAL
SECURITY
In 1915, in its first comprehensive regulation regarding discounts of commercial paper,
the Board stated that "the pledge of goods as
security for a bill is not prohibited." 25 A more


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Federal Reserve Bank of St. Louis

31

positive statement was made in the next revision of the regulation in 1916, in which it was
provided that paper otherwise eligible "may be
secured by the pledge of goods or collateral."28
In 1920 the regulation made it clear that discounted paper could be secured by "collateral
of any nature, including paper, which is ineligible for rediscount." "
The Board emphasized in a number of interpretations that eligibility of paper for discount does not depend upon whether it is secured or upon the character of any collateral
security, but depends upon the purpose for
which the paper is drawn or its proceeds used.28
Thus, a note drawn for commercial purposes
and otherwise eligible for discount is not
rendered ineligible because it is secured by a
mortgage on real estate.29
At the same time, it was recognized that
the character of the collateral could have
a material bearing upon the acceptability of the
paper and its desirability as an investment.30
The Board at an early date upheld the right
of a Reserve Bank to refuse to discount paper
not adequately secured.31 The courts have judicially confirmed the authority of a Federal
Reserve Bank to require additional collateral,
including collateral that would not itself be
eligible for discount.32
Perhaps because the question had been raised
in the course of litigation, the Board in its 1937
revision of Regulation A expressly authorized
the Reserve Banks to require such additional
or marginal collateral as they might deem advisable or necessary for their protection.33 However, the regulation stated that a Federal Reserve Bank would be expected to consider the
general effects that its action in requiring additional collateral might have on the position of
the member bank involved, on its depositors,
and on the community, and that in general a
Reserve Bank should limit the amount of collateral it required "to the minimum consistent
with safety." Moreover, if the additional collateral exceeded 25 per cent of the amount of an
advance, the Reserve Bank was required to
explain the circumstances to the Board. This
latter requirement, however, was eliminated
when the regulation was again revised in 1955.
The regulation as revised in 1973 provides

32

HISTORY OF LENDING FUNCTIONS

merely that, in making loans, a Federal Reserve
Bank shall require only such amount of collateral as it deems necessary or advisable.

EVIDENCE OF ELIGIBILITY
In order to provide evidence of the eligibility
of paper offered for discount, the Board in its
first regulation on the subject provided that,
until January 15, 1915, a Federal Reserve Bank
might accept a statement from an officer of the
applying bank, but that after that date every
bill offered for discount should state on its face
that it was eligible for discount and should refer to the number of the credit file in the possession of the member bank, which in turn
would contain evidence of eligibility and also
full information as to the financial responsibility of the borrower. 3 ' Later, however, it was
felt that member banks needed more time to
familiarize themselves with the requirements of
the law, and the Board, therefore, permitted
the Reserve Banks to rely on a statement from
an officer of the applying member bank until
July 15, 1915.a•
After that date, member banks were required to certify in their applications for discount that the paper offered by them was issued
for one of the purposes mentioned in the statute. Also it was recommended that a member
bank maintain a credit file containing statements of the financial condition of borrowers.
If such statements were not on file, the Federal
Reserve Bank was required to satisfy itself as
to the eligibility of the paper offered for discount, and member banks were expected to use
such statement forms or identifying stamps as
the Reserve Banks might prescribe.36
When the regulation was next revised in
1916," 7 it included separate provisions regarding evidence of eligibility for promissory notes,
drafts and bills, and bankers' acceptances. For
notes, the regulation provided that the Reserve
Bank must be satisfied as to eligibility by reference to the note or otherwise; that compliance
with the prohibition against discounting paper
for fixed-investment purposes might be evidenced by a statement showing a reasonable
excess of quick assets over current liabilities;
that the member bank should certify whether
the note had been discounted for a depositor or


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Federal Reserve Bank of St. Louis

another member bank or purchased from a
nondepositor; that the bank should also certify
whether a financial statement of the borrower
was on file; that such statements must be on
file with respect to notes purchased from
sources other than a depositor or a member
bank; but that the Reserve Board could waive
such statements if the note was secured by a
warehouse, terminal, or similar receipt, or if
the aggregate of obligations of the borrower
rediscountcd at the Reserve Bank were less than
10 per cent of the member bank's capital and
not in excess of $5,000. With regard to drafts
and bills, the 1916 regulation required only
that the Reserve Bank should take necessary
steps to satisfy itself as to eligibility, unless the
draft or bill presented prima facic evidence
thereof or bore a stamp or certificate showing
that it was a trade acceptance.
These detailed requirements were repeated
in substance in the 1920 revision of Regulation
A, 3 ~ except that the Reserve Banks were expressly authorized to require financial statements in all cases; bills, drafts, and trade acceptances were required to be drawn so as to
evidence "the character of the underlying transaction" or, if they were not so drawn, eligibility
might be evidenced by a stamp or certificate.
In 1928 the provisions were expanded to require financial statements from any corporations with which the borrower was "closely
affiliated." 3 ~
In the general revision of the regulation in
1937, the provisions relating to evidence of
eligibility were considerably simplified. As
changed at that time and as carried forward
in the 1955 revision, Regulation A provided
that a Federal Reserve Bank should satisfy
itself concerning the eligibility of any paper
offered for discount; that compliance with the
fixed-investment restriction might be evidenced
by a statement showing the borrower's financial
worth and a reasonable excess of quick assets
over current liabilities; and that a Reserve Bank
might require financial statements of the parties
to the paper discounted and of any corporations
affiliated with such parties and any other information which the Reserve Bank deemed
necessary."' In the general revision of Regulation A adopted in 1973, all of these provisions

DISCOUNT OF COMMERCIAL PAPER

were eliminated and replaced by a statement
that a Reserve Bank shall require such information as it deems necessary to insure that paper
tendered as collateral or for discount is acceptable and meets any pertinent eligibility requirements.

CHANGE IN CONCEPT AS
TO ELIGIBILITY
Much that has been said in this section regarding the eligibility of paper for discount is
now ancient history. The original Federal Reserve Act was based on the concept that
Reserve Bank loans should be made only on
a short-term basis and on paper that was selfliquidating in character. This concept has
sometimes been referred to as the "real-bills
doctrine." Related to that concept was the assumption that the pledging of such paper by the
Reserve Banks as security for the issuance of
Federal Reserve notes would serve as a basis
for an elastic currency; it was expected that
the volume of such currency would expand and
contract directly in response to the varying
credit needs of the economy, as reflected by the
volume of short-term borrowings by commercial and agricultural enterprises. These
concepts, however, have long been proved obsolete. Congress itself has recognized the fact

33

by authorizing the Reserve Banks to make advances to member banks not only on the
security of eligible paper but also on the security
of obligations of the United States; moreover,
Congress has provided for the issuance of
Federal Reserve notes on the security both of
eligible paper and of Government obligations
and, in 1968, on the security of Special Drawing Rights certificates.
In view of these changes, the Board of Governors in 1963 recommended to Congress that
all of the technical eligibility requirements of
the law be repealed and that the Reserve Banks
be authorized to make advances to member
banks on any satisfactory security at the regular
discount rate.41 This proposal has been repeated by the Board in subsequent years but has
not been enacted. Nevertheless, it is clear that
the Board by interpretations of the law and
by amendments to its Regulation A has deliberately departed from the original concept
regarding the eligibility of paper as a basis for
extension of Federal Reserve loans. As an example, the elimination of the prohibition on
the discounting of permanent- or fixed-investment paper, reflected in the 1973 general revision of Regulation A, is a distinct departure
from the principle that eligible paper must be
self-liquidating.

TRADE ACCEPTANCES
SEPARATE CLASSIFICATION
FOR RATE PURPOSES
Two classes of commercial paper were
singled out by the Board in the early years of
the System as deserving preferential treatment
from the point of view of discount rates. One
was trade acceptances; the other was commodity paper. In order to distinguish them for
rate purposes, the Board at first issued separate
regulations relating to these classes of paper.
The Federal Reserve Act itself made no
mention of trade acceptances. •2 A bill does not
cease to be a bill, however, merely because it is


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Federal Reserve Bank of St. Louis

accepted; and, if otherwise eligible, such an
accepted bill growing out of a commercial
transaction is eligible for discount. 43
On July 15, 1915, the Board issued a circular u stating that it was ready to approve a
discount rate for trade acceptances "somewhat
lower than that applicable to other commercial
paper." The Board felt that this action might
"assist in developing a class of 'double-name'
paper, which has shown itself in so many countries a desirable form of investment and an
important factor in modem commercial banking
systems." The circular was accompanied by a

34

HISTORY OF LENDING FUNCTIONS

regulation ' 5 defining the term "trade acceptance," and requiring that any such acceptance
be endorsed by a member bank, have a maturity of not more than 90 days at the time
of discount, and be accepted by the purchaser
of goods sold to him by the drawer of the bill.
In 1916 a provision specifically relating to the
discounting of trade acceptances was incorporated in the Board's general regulation relating
to discounts, and the term "trade acceptance"
was there defined simply as "a draft or bill of
exchange drawn by the seller on the purchaser
of goods sold and accepted by such purchaser." l0 This definition was carried into
subsequent revisions of Regulation A until 1937
when specific reference to trade acceptances was
dropped.
While for a few years the discount rate set
for trade acceptances was lower than the rate
on other commercial paper, it became generally
the same as that for commercial paper by 1920,
and in May 1927 the practice of fixing a
separate rate for trade acceptances was discontinued.

NATURE OF TRANSACTION
As previously indicated, the Board's 1916
regulations defined a trade acceptance as a draft
or bill drawn by the seller on the purchaser of
goods and accepted by the purchaser. This
meant that the underlying transaction must
involve a sale of goods.
To constitute a sale, it is necessary that
there be a transfer of title. Thus, there is no
trade acceptance when a draft is drawn by a
supplier of building materials and accepted
by the purchaser—a building contractor—if the
contractor, under his building contract, does
not acquire title to the materials furnished or
to the building as it is being erected.41 Similarly,
goods sold under a conditional sales contract
could not be made the basis for a trade acceptance.48 However, if a lumber company
had sold lumber to a sales corporation controlled by the lumber company, the Board held
that the transaction was a sale upon which a
trade acceptance might be based, provided the
sales corporation was not merely an agent of
the lumber company formed to evade the law.49
As to what constituted goods for this pur-


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Federal Reserve Bank of St. Louis

pose, the Board followed a liberal position. It
held that a draft drawn by a publisher on the
purchaser of advertising space and accepted
by the latter was a trade acceptance on the
ground that the advertising space was goods.50
Likewise, it held that an accepted draft for the
price of electrical goods including their installation S1 and a draft given in payment for gas
sold by a gas-producing company S2 were eligible trade acceptances. The Board refused, however, to consider a draft drawn in payment for
an insurance premium ™ or drawn in payment
for labor alone '" as covering sales of goods.
As long as there is an actual sale of goods,
it does not matter whether the purchaser intends to resell the goods or to use them for
his own purposes. The Board held, therefore,
that a bill drawn by a dealer on his customer to
finance the sale of goods to the customer was
a proper trade acceptance, even though the
bill was drawn after the purchaser had failed to
remit promptly on an open account. But, the
Board felt that the use of a trade acceptance as
a means of liquidating an otherwise slow account was contrary to the primary purpose of
the trade-acceptance movement and that such
acceptances should not be encouraged."

FORM
In 1918 the Board had suggested the use
of certain standard forms of trade acceptances.66
In March 1927 the Supreme Court of the State
of Texas held that a trade acceptance was rendered nonnegotiable by a statement therein that
"the obligation of the acceptor hereof arises
out of the purchase of goods from the drawer,
maturity being in conformity with the original
terms of purchase." °7 This clause, the court
ruled, imported into the terms of the instrument an obligation arising from a collateral
transaction and thus destroyed the instrument's
negotiability. As a result of this decision, the
Board suggested in a published statement that
the clause be changed in the prevailing standard
form to provide only that the transaction giving
rise to the instrument was "the purchase of
goods by the acceptor from the drawer."68
Since that time no further statements have
been issued by the Board with regard to the
form of trade acceptances.

DISCOUNT OF COMMERCIAL PAPER

35

COMMODITY PAPER
As in the case of trade acceptances and for
similar reasons, the Board in 1915 concluded
that so-called commodity paper should be encouraged by preferential discount rates for such
paper. The Board expected that "this new class
of paper with its special rates will prove of
particular efficacy in meeting the seasonal demands for credit facilities in the crop-producing
districts."59
To distinguish such paper for rate purposes,
the Board issued a separate regulation relating
to commodity paper.00 It defined the term
"commodity paper" as "a note, draft, or bill of
exchange secured by warehouse terminal receipts, or shipping documents covering approved and readily marketable, nonperishable
staples properly insured." It provided that such
paper, in order to be eligible for discount at
the special rate, not only should comply with

all the requirements of the Board's general
regulation relating to discounts but also should
be paper on which the rate of interest or discount, including commission charged the maker,
did not exceed 6 per cent. In addition, it had
to comply with any requirements prescribed by
the Federal Reserve Bank as to warehouse receipts, shipping documents, and insurance.
Substantially similar provisions regarding
commodity paper were incorporated in the
Board's comprehensive revision of Regulation
A in 1916 B1 and were repeated in a revision
of the regulation in 1917.02 By that time, however, the discount rate on such paper had become the same as the regular rate on other
commercial paper; consequently, when the
regulation was next revised in 1920 no special
provisions with respect to commodity paper
were included.

PERMANENT- OR FIXED-INVESTMENT PAPER
EXCLUSION FROM DISCOUNT
The original Federal Reserve Act expressly
provided that paper eligible for discount should
not include paper "covering merely investments
or issued or drawn for the purpose of carrying
or trading in stocks, bonds, or other investment
securities, except bonds and notes of the Government of the United States." This provision
of the law has never been changed.
In its first circular on the subject of discounts
in November 1914, the Board stated as the first
guiding principle that no bill should be admitted
to rediscount if the proceeds had been or were
to be applied to permanent investment. The
Board explained in the accompanying regulation that the Act excluded paper covering
merely investments and that, since any funds
employed in agriculture, commerce, or industry


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Federal Reserve Bank of St. Louis

are quasi-investments, the emphasis was to be
laid on the word "merely." From this point of
view, the regulation stated, there should be
excluded all paper whose proceeds were used in
permanent or fixed investments of any kind, including investments in land, plant, machinery,
permanent improvements, or transactions of a
similar nature.63
This characterization of permanent investments was spelled out in the Board's 1915 regulation regarding discounts of commercial
paper.61 The regulation provided that no bill
would be eligible if its proceeds were used:
For permanent or fixed investments of any
kind, such as land, buildings, machinery (including therein additions, alterations, or other
permanent improvements, except such as are
properly to be regarded as costs of operation). * * *

36

HISTORY OF LENDING FUNCTIONS

In 1920 the provision was expanded to exclude
paper whose proceeds were used not only for
fixed investments, such as land, buildings, or
machinery, but "for any other capital purpose." or> In 1937 this language was modified to
refer to any other "fixed" capital purpose.*6
In this amended form the provision was continued in the 1955 revision of Regulation A.07

EVIDENCE OF COMPLIANCE
The regulatory exclusion of permanent- or
fixed-investment paper was accompanied by a
provision to the effect that compliance of discounted paper in this respect might be indicated by a statement of the borrower that
evidences "a reasonable excess of quick assets
over current liabilities." The absence of such a
statement, however, did not necessarily render
the paper ineligible for discount; the test, of
course, was whether the proceeds were actually
used for permanent- or fixed-investment purposes . ss
In this connection the Board ruled that a
note given by the buyer to the seller of goods
in payment therefor would be eligible in the
hands of the seller for discount as commercial
paper, even though the goods sold were in the
nature of a permanent investment.1"1 However,
if the proceeds of a note were to be used by the
maker to purchase articles constituting permanent investments, the note would be regarded
as ineligible.70

MEANING OF PERMANENT
INVESTMENTS
As to what constituted permanent or fixed
investments, it was clear that land and buildings
fell in the prohibited category, but the status
of machinery and equipment was not always
clear. On the one hand, the Board held that
tractors used in agricultural operations 71 and
agricultural implements that wear out rapidly T2
were not to be considered permanent or fixed
investments. On the other hand, the prohibition
was held applicable to notes given by farmers
for the purchase of silos; " notes executed by
a company furnishing motor transportation to
provide funds for the purchase of motor


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Federal Reserve Bank of St. Louis

trucks; 71 notes of a parent corporation the
proceeds of which were used to purchase automobiles for subsidiary "drive-it-yourself' companies; 7E and a note the proceeds of which
were used by the owner of property for developing or building.10
With respect to machinery, the Board in
1938 held that machinery that was purchased
by a manufacturing company and that was expected to last over a period of years or indefinitely would constitute a permanent or fixed
investment, but that there might be machinery
of a kind that, like agricultural tractors, would
wear out rapidly and would need to be replaced
within a comparatively short time.77 In other
words, the question depended upon the type of
machinery involved, as well as on other facts
and circumstances of the particular case.

REMOVAL OF EXCLUSION OF
PERMANENT-INVESTMENT PAPER
Despite the fact that Regulation A since the
early years of the System had prohibited the
discounting of paper drawn for permanent or
fixed investments, the Board in 1973 adopted a
general revision of the regulation that omitted
this prohibition.75
The original exclusion of permanent-investment paper from eligibility for discount clearly
reflected the then-prevailing theory that all
discounted paper should be self-liquidating,
that is, the real-bills theory. Actually, however,
the statute itself does not expressly and specifically prohibit the discounting of paper representing borrowings for fixed- or permanentinvestment purposes. It provides that the
Reserve Banks may discount paper arising out
of actual commercial transactions and that the
Board shall have the right to define the character of paper eligible for discount. The only
statutory limitation is that no such definition
by the Board shall include paper covering
merely investments or issued or drawn for the
purpose of carrying or trading in stocks, bonds,
or other investment securities, except bonds and
notes of the Government of the United States.
As noted earlier, the Board has held that any
purchase-and-sale transaction, regardless of the

DISCOUNT OF COMMERCIAL PAPER

nature of the goods involved, is a commercial
transaction. In this sense, the purchase of machinery or of a building for a home is a commercial transaction. Literally, the statute seems
designed only to exclude paper covering merely
investments, that is, paper representing borrowings primarily for the purpose of making a
profit, such as realizing appreciation of capital
or return in the form of interest or dividends.
Repeal of the permanent-investment prohibition in Regulation A does not make all
mortgage notes or notes given for the purchase
of machinery eligible for discount. Such notes
will still have to comply with the maturity
requirements of the law and therefore are not
eligible for discount (or as collateral for advances) until they are within 90 days of maturity. Moreover, the paper is not eligible if the
property is purchased merely for investment—
for example, for later sale at a profit.
This change in the regulation, however, has
had an important liberalizing effect because
notes drawn to pay for permanent or fixed
investments may now be regarded as representing borrowings for an eligible purpose. As noted
elsewhere in this study, the Board has taken
the position that finance paper is eligible for
discount if the proceeds are to be re-lent to
others for eligible purposes irrespective of the
maturity of such loans. Thus, in 1965 the Board
took the position that the note of a finance
company is eligible for discount if the proceeds
are to be used by thefinancecompany to finance
the purchase of consumer goods or "for other

37

purposes which are eligible within the meaning
of the Federal Reserve Act" and that, if there
is any question as to whether the proceeds are
to be used for such an eligible purpose, a
financial statement of the finance company "reflecting an excess of notes receivable which
appear eligible for rediscount (without regard
to maturity)" over total current liabilities of
the company may be taken as an indication of
eligibility.79
Following the principle of that Board ruling,
the note of a finance company or of a savings
and loan association that might be acquired by
a member bank would be eligible for discount
or as collateral for a Reserve Bank advance if
that note itself had a maturity of not more than
90 days and if the proceeds were to be used to
make loans for permanent or fixed investments,
such as the construction of a home or the purchase of machinery. In addition, repeal of the
regulatory prohibition makes it possible, in
emergency circumstances, for a Federal Reserve
Bank to extend direct credit to a home mortgage
lender subject to certain limitations prescribed
in the law. That possibility will be referred to
again in connection with the discussion of extension of Federal Reserve loans to nonmember
banks and nonbanking enterprises.
One of the desirable side effects of the repeal
of the regulatory prohibition on the discounting
of permanent-investment paper is removal of
the need for technical interpretations as to what
constitutes a permanent investment, such as
those described earlier.

PAPER DRAWN FOR SPECULATIVE PURPOSES
The statutory prohibition against the discount
of paper covering "merely" investments obviously excludes paper drawn only for speculative
purposes. In its 1915 discount regulation, the
Board provided that no bill should be eligible
for discount if its proceeds were used "for
investments of a merely speculative character,


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Federal Reserve Bank of St. Louis

whether made in goods or otherwise."so In
1916 the language was slightly changed to prohibit the discount of any paper "the proceeds
of which have been used or are to be used for
investments of a purely speculative character";" and the same language (with "transactions" substituted for "investments") was

38

HISTORY OF LENDING FUNCTIONS

included in the 1955 revision of Regulation
A.82 The present regulation requires that the
proceeds must not be used "merely for the
purpose of investment, speculation, or dealing
in stocks, bonds, or other such securities, except
direct obligations of the United States."
For example, it is customary for agricultural
products to be carried for a time in order to
accomplish orderly marketing, but the situation
is different if there is a "mere speculative withholding from the market, at a time when there

is a normal demand, in the hope ultimately of
obtaining a higher price"; and drafts drawn to
finance the growers of crops for such a purpose
cannot be considered as drawn for an agricultural purpose.81 On the other hand, when a
manufacturer of pig iron gave his note, secured
by pig iron already manufactured but held
pending delivery under contract for sale, the
note was held eligible for discount because
the sale had been made and the carrying of the
material was not for speculative purposes.*"

PAPER DRAWN FOR TRADING IN STOCKS AND BONDS
The law specifically excludes from discount
any paper issued or drawn for the purpose of
carrying or trading in stocks, bonds, or other
investment securities, with an exception, however, in favor of bonds and notes of the Government of the United States. In its earliest discount regulation,85 the Board observed that this
provision required no comment.
A provision excluding paper drawn for carrying or trading in stocks and bonds has appeared
in all revisions of Regulation A. Since 1930,
however, the regulation has made it clear that
the exception for Government bonds and notes
applies only to direct obligations of the United
States, that is, bonds, notes, Treasury bills, and
certificates of indebtedness.60
In 1918 the War Finance Corporation Act 87
authorized the Reserve Banks to discount paper
secured by obligations of the War Finance
Corporation. The Board ruled that paper drawn


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Federal Reserve Bank of St. Louis

for trading in bonds and notes of that Corporation was eligible for discount,8" and in the 1924
revision of Regulation A *• specific provisions
were included with respect to this matter. These
provisions were eliminated in 1928 when they
were no longer necessary.
Obviously, the reason why the Reserve Banks
were prohibited from extending credit on stocks
and bonds was that the Banks were intended
to assist commercial banking and not investment banking. Paper eligible for discount was
confined to self-liquidating paper arising out of
commercial rather than investment transactions.80
The exception for Government obligations
has been liberally construed.01 For a time, indeed, the Board permitted the discount of notes
of nonmember banks drawn for carrying or
trading in such obligations, provided the notes
were endorsed by a member bank."

DISCOUNT OF COMMERCIAL PAPER

39

FINANCE PAPER
ORIGINAL EXCLUSION FROM
DISCOUNT
Generally speaking, "finance paper" is paper
the proceeds of which are loaned by the obligor
to some other borrower. For many years the
Board took the position that such paper was
not commercial paper and was therefore not
eligible for discount by the Federal Reserve
Banks, even though the loan made by the
borrower to a third party was itself for a
commercial purpose.83
Following this position, the Board ruled that
the notes of cotton factors or cold storage
companies were ineligible for discount when
the proceeds were to be used by such factors
or companies for the purpose of making loans
to their customers.84 The same principle was
applied to paper of finance or credit companies M and to notes of Federal land banks
and joint-stock land banks the proceeds of
which were loaned to third persons for agricultural purposes.84
In 1920 the principle was incorporated in
Regulation A. It was expressly provided that
the Reserve Banks could not discount paper
the proceeds of which were used "for the purpose of lending to some other borrower."07

MODIFICATION BY STATUTE
In two respects the Board's position regarding finance paper was modified by statute in
1923. The Agricultural Credits Act of that year
specifically amended section 13 of the Federal
Reserve Act to provide that the paper of factors
"issued as such making advances exclusively to
producers of staple agricultural products in
their raw state shall be eligible for such discount." 8S The same statute added to the Federal Reserve Act a new section 13a that, among
other things, made eligible for discount paper
of cooperative marketing associations the proceeds of which were used for advances by such
associations to their members for agricultural
purposes. In the light of these changes in the


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Federal Reserve Bank of St. Louis

law, Regulation A was amended in 1923 to
except agricultural factors' paper and paper of
cooperative marketing associations from the
prohibition against the discount of finance
paper."
As to other kinds of finance paper, the Board
continued after 1923 to exclude such paper
from discount. Thus, it held that notes of a
warehouse company engaged in a finance business used to finance its current operating expenses l0° and notes of an insurance agency to
finance the carrying of accounts covering premiums due on insurance sold by it 101 were not
eligible for discount.

REVERSAL OF BOARD'S POSITION
In 1937, however, the Board reversed its
position with regard to the eligibility of finance
paper. As part of a comprehensive revision of
Regulation A, the provision excluding finance
paper was eliminated. The Board explained that
elimination of the provision would render eligible for discount "a large amount of paper of
commission merchants and finance companies,
including paper drawn to finance installment
sales of a commercial character."10S
Following this changed policy, the Board
made it clear that if the proceeds of paper
were advanced to some other borrower, the
paper would be eligible for discount provided
the proceeds were ultimately used by such other
borrower for a commercial, agricultural, or
industrial purpose.103 Thus, a note given to a
bank or a finance company the proceeds of
which are to be used by the maker to purchase
goods for his own use is eligible paper; in
holding to that effect, the Board pointed out
that, from a legal standpoint, there is no difference between the discounting of a note in the
hands of the seller and a direct lending by a
bank or finance company to the purchaser,
since in either case the purpose is to finance
"the final step in the distribution of goods, the
sale to the consumer."1W

40

HISTORY OF LENDING FUNCTIONS

In a 1965 ruling the Board reaffirmed its
position that notes of finance companies were
eligible for discount if they conformed to the
maturity requirement of the law and if the
proceeds were used to finance the purchase of
consumer goods or for other purposes eligible
under the Federal Reserve Act. Recognizing
that it is sometimes difficult to determine the
purposes for which individuals borrow from
finance companies, the Board prescribed a
formula that could be used in case of question:
If a financial statement of the finance company
reflects an excess of notes receivable that appear eligible for discount, without regard to
maturity, over the total current liabilities of the
finance company, this could be taken as an
indication that the note of the finance company
is eligible for discount.105
This interpretation was clarified and liberalized in certain respects in 1972. The 1965
formula for determining the eligibility of finance
company notes had referred to a financial
statement of the company reflecting an excess
of notes receivable that appear eligible for
rediscount "over total current liabilities (i.e.,
liabilities maturing within one year)." This
definition of "current liabilities" was changed to

refer to "notes due within one year" in order
to exclude a company's liabilities for such
things as salaries and taxes.
In some instances, finance companies make
what are known as direct consumer loans to
individuals when the purpose for which the
proceeds are to be used cannot easily be determined. In its 1972 interpretation the Board
stated that when information is lacking as to
whether such loans will be used for eligible
purposes, it could be assumed that 50 per cent
of such loans would be "notes receivable which
appear eligible for rediscount."
The Board also stated that the language just
quoted should be regarded as including notes
given for the purchase of mobile homes that are
acquired by a finance company from a dealerseller of such homes. Previously, questions had
been raised as to whether such notes fell within
the prohibition against the discounting of notes
drawn for permanent investments. Finally, it
was made clear that the principles of the
Board's position with respect to finance company paper were applicable to the notes of a
finance company engaged in making loans for
business and agricultural purposes as well as for
consumer loans.100

CONSUMER PAPER
Soon after the 1937 revision of Regulation A,
when it first took the position that finance paper
was eligible for discount, the Board issued an
interpretation in which it made clear that a
borrowing for the purpose of making a purchase
of goods is a borrowing for a commercial purpose whether the borrower intends to use the
goods himself or to resell them, since in such
a case the proceeds are used to finance a sale—
a commercial transaction.107 Whatever may
have been the intent of the framers of the
original Act with regard to limiting commercial
loans to ordinary business loans, this ruling of
the Board definitely reflected the view that
consumer paper is to be regarded as eligible


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Federal Reserve Bank of St. Louis

for discount. For example, the Board's ruling
referred to the eligibility of a note given to a
member bank by a householder who is to use
the proceeds to purchase household equipment,
such as radios or furniture.
If the purchase of a radio by an individual
constitutes eligible consumer paper, it is difficult to see why a note the proceeds of which
are used for the purchase of services, such as
medical services or travel advice, should not
also be considered a note given for a commer-.
cial purpose. In the general revision of Regulation A adopted by the Board in 1973, a new
provision specifically makes such paper eligible
for discount.

DISCOUNT OF COMMERCIAL PAPER

41

CONSTRUCTION PAPER

The National Housing Act of 1934 contained, along with provisions for the insurance
of certain housing mortgages, an amendment
to section 24 of the Federal Reserve Act that
provided that loans made to finance the construction of residential or farm buildings and
with maturities not exceeding 6 months should
not be considered as real estate loans subject to
the restrictions of that section on real estate
loans made by national banks, but should be
classified as "ordinary commercial loans." 10S
In addition, the amendment provided that notes
representing such loans should be eligible for
discount as commercial paper if they were
accompanied by a valid and binding agreement
—entered into by an individual, partnership,
association, or corporation acceptable to the
discounting bank—to advance the full amount
of the loan upon completion of the building.
Although not entirely clear, it may be assumed that the condition requiring an agreement by a third party to advance the full
amount of the loan at maturity was intended
not only to afford protection to the lending
bank but also to make the paper self-liquidating,
in keeping with the general concept that all
discounted commercial paper should be selfliquidating in nature.
In 1955, section 24 was amended to extend
the permissible maturity of residential and farm
construction loans from 6 months to 9
months.109 The reason given for this liberalizing
change was that the prescribed 6-month period
had proved to be unrealistically short in some
cases, and it was expected that the increase to
9 months might "serve to increase the availability of funds for the financing of short-term
residential and farm construction work." n o
In 1959 these provisions were further liberalized to provide that loans made to finance the
construction of industrial or commercial buildings and with maturities of not more than 18
months should not be considered real estate
loans subject to the limitations of section 24, if


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Federal Reserve Bank of St. Louis

accompanied by an agreement by a financially
responsible lender to advance the full amount
of the bank's loan upon completion of the
building.111 By successive amendments to section 24, the maximum maturity of construction
loans that are exempted from the limitations
on real estate loans by national banks has been
increased from time to time. At present any
such loans, if they have maturities of not more
than 60 months—whether for the construction
of industrial or commercial buildings or for the
construction of residential or farm buildings—
are not regarded as real estate loans within the
meaning of that section but as ordinary commercial loans.
In view of this liberalization of the provisions
of section 24, it might be assumed that all such
construction loans, being commercial in nature,
should be regarded as eligible for discount
under section 13 of the Federal Reserve Act.
This assumption is negatived, however, by the
fact that section 24 provides specifically that
loans for the construction of residential or farm
buildings with maturities of not more than 9
months shall be eligible for discount as commercial paper within the terms of the second
paragraph of section 13 but makes no similar
provision with respect to loans for the construction of industrial or commercial buildings.
The eligibility of residential and farm construction paper for discount by the Reserve
Banks was specifically recognized in the Board's
1937 revision of Regulation A.112 The regulation required that such paper (1) represent a
loan to finance the construction of a residential
or farm building, whether or not secured by
real estate; (2) be endorsed by the member
bank; (3) be accompanied by an agreement by
a person acceptable to the Reserve Bank to
advance the full amount of the loan upon completion of construction; and (4) mature not
more than 6 months from the date the loan
was made and not more than 90 days from the
date of discount. These provisions were re-

42

HISTORY OF LENDING FUNCTIONS

peated without change in the January 1955
revision of the regulation.113 The regulation was
not changed to reflect the 1955 statutory increase in the permissible maturity of residential
and farm construction paper from 6 months to
9 months until 1973, at which time the correction was made in the general revision of the
regulation.
As indicated, the Board's regulation requires
that a residential or farm construction loan not
only must comply with the maturity requirement
specified in section 24 but also must have a
maturity of not more than 90 days at the time
of discount. It is by no means clear that this
latter requirement is made necessary by the law.
When the original provisions for construction
loans were added to section 24 in 1934, the


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Federal Reserve Bank of St. Louis

report of the House Banking and Currency
Committee stated that the Federal Reserve Act
was being amended to permit national banks to
make such temporary loans with maturities of
not more than 6 months and to make "such
temporary paper . . . eligible for discount as
commercial paper at the Federal Reserve
Banks." 1U In view of this statement, it may be
argued that—-since the intent of Congress was
to make such paper eligible for discount if it
had a maturity at the time of discount not
in excess of that prescribed in section 24—to
superimpose a further requirement that the
paper have a maturity of not more than 90 days
at the time of discount would render unnecessary and meaningless the limitation on original
maturity.

Agricultural Credits

THE ORIGINAL ACT
Granted that the primary objective of the
discount provisions of the original Federal Reserve Act was the establishment of a market for
commercial paper, an important secondary objective was to provide a new source of credit for
agricultural purposes. In a separate section the
Act authorized national banks for the first time
to make loans on farm lands. In the discount
provisions of section 13, agricultural paper was
given special prominence in a phrase that described commercial paper as paper issued for
agricultural, industrial, or commercial purposes
(a confusing description since distinctions have
been made between commercial and agricultural paper). Moreover, the Act actually gave
preferential treatment to agricultural paper, at
least with respect to maturity limitations.
Clearly the framers felt that the Act
would provide substantial benefits to the agricultural interests of the country. In his opening
statement on the floor of the House, Mr. Glass

called particular attention to those provisions
of the bill that would bear upon "the farmer
and his welfare." ' Other Congressmen strongly
endorsed the discount provisions as promising
great aid to agriculture.2 They felt that the
paper of farmers was fully as good as so-called
commercial paper,3 even though agricultural
paper might have longer maturities.1
It was recognized that agricultural loans
normally were made for a period corresponding
to the crop season and that, consequently, the
90-day maturity limitation generally prescribed
for paper eligible for discount would not be
appropriate for such loans. The reasons for
which agricultural paper was allowed a maximum maturity of 6 months have been discussed
in detail in Chapter 3 of this study; and the
maturity requirements for such paper will be
considered further in a later section of the
present chapter.
Although, as has been noted, the original Act
specifically included paper issued for agricultural purposes in the description of paper eli-

For NOTES AND REFERENCES, see pp. 253-54.


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Federal Reserve Bank of St. Louis

43

44

HISTORY OF LENDING FUNCTIONS

gible for discount, it contained an additional
provision expressly stating that nothing in the
Act should be construed as prohibiting paper
secured by staple agricultural products from
being eligible for discount. This seemingly unnecessary provision apparently resulted from a
feeling in some quarters that, without this provision, paper drawn to finance the carrying of

agricultural products pending a higher price
might be regarded as paper drawn for speculative purposes and therefore ineligible for discount.1 Despite this provision, it appears that
the Board in 1922, as indicated in the previous
chapter, concluded that such paper would be of
a speculative nature and not eligible for discount as agricultural paper.

AGRICULTURAL CREDITS ACT OF 1923
BACKGROUND
Proposals for a long-range system of farm
credits reached legislative fruition in the enactment of the Federal Farm Loan Act in 1916.°
Following the pattern of the Federal Reserve
System, the Federal Farm Loan Act set up
12 regional Federal land banks and provided
for the voluntary formation of joint-stock land
banks and national farm loan associations. The
land banks were authorized to make farm mortgage loans with maturities of not less than 5
and not more than 40 years. The whole system
was placed under the supervision of a Federal
Farm Loan Board. No change was made in the
discounting authority of the Federal Reserve
Banks, but both the Reserve Banks and member
banks of the Federal Reserve System were
specifically authorized to buy and sell farm loan
bonds issued by the land banks.7
During World War I, farmers had little or
no financial problems. In 1920, however, when
deflation set in, farm prices dropped; and the
need for additional agricultural credit became
acute.8
In 1921 the War Finance Corporation was
revived, with authority, among other things, to
provide loans for agricultural purposes." That
Corporation made a large volume of loans to
farmers, livestock companies, and cooperative
marketing associations. However, it was only an
emergency agency, and there was a growing
sentiment in favor of a more permanent system
of farm credits to meet the intermediate credit


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Federal Reserve Bank of St. Louis

needs of the farmer—loans with maturities
shorter than the 5-year minimum maturity permitted by the Farm Loan Act and yet longer
than the 6-month maximum maturity prescribed
for the discount of agricultural paper by the
Federal Reserve Banks. The growth of this
sentiment led to the enactment of the Agricultural Credits Act of 1923.10
The chief advocates of the new farm credit
legislation in Congress were Senators Lenroot
and Capper, and Chairman McFadden of the
House Banking and Currency Committee.
Aside from Congress, the principal impetus
probably came from Eugene Meyer, at that time
Managing Director of the War Finance Corporation and later Governor of the Federal
Reserve Board. Actually, Meyer felt strongly
that the best way to help the agricultural interests was to induce more country banks to
become members of the Federal Reserve System." However, he urged the enactment of the
farm credit bill as a means of meeting the problems and difficulties that had come to the attention of the War Finance Corporation in connection with agricultural credits.12

GENERAL PROVISIONS
The Agricultural Credits Act set up 12 Federal intermediate credit banks with authority to
make agricultural and livestock loans with maturities of from 6 months to 3 years. It provided
also for the voluntary organization of national

AGRICULTURAL CREDITS
agricultural credit corporations that, under
regulations of the Comptroller of the Currency,
were authorized to make loans on agricultural
paper with a maturity of not more than 6
months and on livestock paper with a maturity
of up to 3 years; a further provision authorized
member banks of the Federal Reserve System
to purchase stock in these corporations. Such
was the new machinery provided by the statute.
In addition, certain amendments were made to
the existing farm credit provisions of the Federal Farm Loan Act and to the discount provisions of the Federal Reserve Act; the latter
are of particular interest here.

AMENDMENTS TO FEDERAL
RESERVE ACT
The general objective of the 1923 amendments to the Federal Reserve Act was to make
eligible for discount certain types of agricultural paper that previously had not been eligible, either because of the maturity limitations
or because of other limitations of the law as
they had been interpreted by the Board. The
maturity requirements were liberalized both
for agricultural paper in general and for bankers' acceptances based on agricultural transactions. Sight or demand drafts drawn to finance
domestic shipments of agricultural products
were made eligible for discount, as were drafts
of factors drawn to finance producers of staple
agricultural products. A new section—13a—
was added to the Federal Reserve Act dealing
specifically with the discounting of agricultural
paper for Federal intermediate credit banks
and cooperative marketing associations. As
stated by Senator Capper, who sponsored the
bill in the Senate, the purpose of these provisions was "to make such changes in the rules
of eligibility governing agricultural paper as
seem necessary to fit the actual requirements
of the farmer." "
In the opinion of Eugene Meyer, the amendments to the discount provisions of the Federal
Reserve Act were the most important in the
bill.14 His statement before the House Banking
and Currency Committee regarding adjustment
of the Federal Reserve System to meet changing
conditions is worthy of quotation here because


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Federal Reserve Bank of St. Louis

45

of its applicability not only to the agricultural
credit functions of the System but also to the
System's functions in general: 1S
* * * The adjustments contemplated are
in line with the experience of the last few
years, and their purpose is merely to adapt the
Federal reserve system, so far as agriculture
is concerned, to changed conditions. Those
who object to adjusting the eligibility rules of
the system to the time required for the
orderly marketing of agricultural products
under present conditions seem to fear that
the soundness of the system may be jeopardized. But the system suffers from friends as
well as from foes. Those who defend its every
act and policy and who stand for the immutability of its present law and regulations may
be as harmful as those who are extreme in
their denunciation of the part played by it
in the collapse of commodity markets and
prices. The true friends of the Federal reserve
system are those who are willing to see its
machinery adjusted along sound lines to meet
changing conditions, both in this country and
abroad.

Shortly after the enactment of the Agricultural Credits Act of 1923, the Board in a published statement reviewed and explained the
increased farm credit facilities provided by that
act. In general, the Board said that it had "so
construed and administered the law as to improve, in the highest possible degree, the credit
standing and economic position of the agricultural interests, placing at their disposal, through
its discounts for member banks and its openmarket operations, the vast resources of the
Federal reserve system to the fullest extent
permitted by the law and by the principles of
sound banking."10
Since 1923 Congress has enacted numerous
statutes to provide further credit assistance to
agriculture, including, among others, the Farm
Credit Acts of 1933 and 1937, the Federal
Farm Mortgage Corporation Act of 1934, and
the Farm Credit Act of 1971. However, no
substantial changes in the authority of the Federal Reserve Banks to discount agricultural
paper have been made since the liberalizing
amendments made by the Agricultural Credits
Act of 1923. Amendments to the law authorizing advances by the Reserve Banks to member

46

HISTORY OF LENDING FUNCTIONS

banks on the security of obligations of Federal
intermediate credit banks and other Federally
established organizations to provide agricultural credit will be discussed later.
As discussed in Chapter 3, discounts of agricultural paper are subject to the general limitations relating to endorsement and to the amount

of paper of one borrower that may be discounted for any member bank. Before discussing the one important difference between agricultural and commercial paper—the more
liberal maturity requirements applicable to
agricultural paper—it is necessary to consider
the nature of agricultural paper.

NATURE OF AGRICULTURAL PAPER
REGULATORY DESCRIPTION
The Federal Reserve Act itself did not undertake to define agricultural paper or agricultural
purposes, although it was clear that paper based
on livestock was intended to be covered by
these terms. More specific description was left
to the discretion of the Federal Reserve Board.
In 1915, in a separate regulation pertaining
to agricultural paper,17 the Board stated merely
that paper issued or drawn for agricultural
purposes or based on livestock meant paper
the proceeds of which had been used or were
to be used for agricultural purposes, "including
the breeding, raising, fattening, or marketing of
live stock." After the passage of the Agricultural Credits Act of 1923, the Board in a
revised regulation 1S more particularly referred
to paper drawn for, or the proceeds of which
were to be used for, "the production of agricultural products, the marketing of agricultural
products by the growers thereof, or the carrying
of agricultural products by the growers thereof
pending orderly marketing, and the breeding,
raising, fattening, or marketing of live stock."
The same language was used in the 1955 revision of Regulation A.10 Paper of cooperative
marketing associations was specifically declared
to constitute agricultural paper if it met certain
requirements. Otherwise, the Board has never
attempted by regulation to describe agricultural
paper in any detail, and the revision adopted in
1973 omits even the general description of such
paper indicated above.


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Federal Reserve Bank of St. Louis

DISTINGUISHED FROM
COMMERCIAL PAPER
In the early days of the System, the Board
found it necessary to issue a number of interpretations distinguishing agricultural paper
from commercial paper, in view of the more
liberal maturity requirements applicable to the
former type of paper. In general, these interpretations are still in effect.
The basic test is whether the commodity for
the purchase of which a note is given will
actually be used for agricultural purposes. Even
though the commodity itself is of an agricultural
nature, the note is not considered agricultural
paper if the purchaser does not intend to use it
for an agricultural purpose.20 Hence, purchase
of such a commodity merely for resale is not
sufficient;2I in such a case the paper must be
treated as commercial rather than agricultural
paper.22 However, as long as the commodity is
actually to be used for an agricultural purpose
by the purchaser, the note given by him may
be considered agricultural paper, whether discounted by the maker or by the seller-endorser.23 Thus, the Board ruled that notes given
for commercial fertilizer,21 tractors used in agricultural operations,50 agricultural implements,20
and the draining and tilling of farm land"
may be considered agricultural paper.
Livestock paper—that is, paper to finance
the breeding, raising, fattening, and marketing
of livestock—has always been regarded as agricultural paper.28 One of the principal purposes

AGRICULTURAL CREDITS
of the Agricultural Credits Act of 1923 was to
provide needed credit to breeders of livestock.
For this purpose, the Board held that cows,
horses, and mules are livestock.29 However,
notes given by dealers in cattle and mules are

47

commercial rather than agricultural paper,30
and the notes of a packing company given for
the purchase of livestock to be slaughtered are
not notes "based on live stock" within the
meaning of the law.31

MATURITY
The original Federal Reserve Act allowed a
maximum maturity of 6 months for agricultural
paper, as contrasted with the 90-day maturity
requirement applicable to all other types of
paper. This allowance was made with no intent
to single out agricultural paper for special favor
but simply in recognition of the fact that the
marketing of farm crops and livestock normally
requires a longer period of financing than ordinary commercial transactions. The considerations that led the framers of the original Act
to prescribe a more liberal maturity requirement
for agricultural paper than for commercial
paper have been noted in Chapter 3.
Even a 6-month maturity limitation soon
proved to be inadequate, and the Agricultural
Credits Act of 1923 increased the maturity
permitted for agricultural paper to 9 months.
Apparently this further liberalization was
prompted largely by the contention of representatives of livestock associations that the thenexisting 6-month limitation was not adequate to
provide assistance to breeders, as distinguished
from raisers, of livestock." The Senate Banking
and Currency Committee felt that the longer
period of maturity "would be helpful and was in
some cases necessary," and that such a lengthening of the maturity of agricultural paper
would in no way impair the liquid character


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essential to Federal Reserve Bank discounts.33
Congress agreed with those "in control of the
Federal reserve system" that paper having a
maturity of more than 9 months should not be
eligible for discount because the paper rediscounted by the Reserve Banks "must be selfliquidating." 3i As a safeguard, the Senate
Banking and Currency Committee inserted a
new provision prohibiting the use of paper with
maturities greater than 6 months as security
for Federal Reserve notes, unless the paper was
secured by warehouse receipts or security documents or chattel mortgages on livestock.35
In addition to increasing the maximum maturity prescribed for the discount of agricultural
paper, the Agricultural Credits Act of 1923
increased the maturity prescribed by section 13
of the Federal Reserve Act for the discount of
bankers' acceptances from 90 days to 6 months
when the acceptances were for agricultural purposes and were secured by title documents covering readily marketable staples. The Federal
Reserve Board had previously ruled that agricultural acceptances with maturities of up to
6 months could be purchased by the Federal
Reserve Banks in the open market, and Congress felt that there was no reason "why such
acceptances should not be given the full benefit
of the rediscount privilege." M

48

HISTORY OF LENDING FUNCTIONS

AMOUNT LIMITATIONS
The longer maturity permitted for agricultural paper was a departure from the orthodox
doctrine that only short-term paper should be
eligible for discount, and Congress agreed to
this departure only with a qualification. To
prevent the discounting of long-term agricultural paper in excessive amounts, the original
Federal Reserve Act provided that discounts of
such paper should be limited to a percentage
of the capital of the discounting Federal Reserve Bank, "to be ascertained and fixed by the
Federal Reserve Board."
Pursuant to this provision, the Board by
regulation limited the aggregate amount of
agricultural paper with a maturity of more than
3 months and less than 6 months that each
Federal Reserve Bank might discount to 25
per cent of the Reserve Bank's paid-in capital.37
At the same time the Board indicated that, in
those districts in which 6-month paper was
particularly required to carry through agricultural operations, the 25 per cent limit would be
increased upon request of the Reserve Banks.38
In 1916 Congress sought to make the statutory limitation more liberal by requiring it to
be based on a percentage of the assets, rather

than of the capital, of the discounting Federal
Reserve Bank.30 Still later, the Agricultural
Credits Act of 1923 authorized the Board by
regulation to limit the amount of paper with a
maturity ranging from 3 to 6 months and from
6 to 9 months that might be rcdiscounted by a
Reserve Bank. Pursuant to these changes
in the law, the Board in its 1923 revision of
Regulation A provided that there should be no
amount limitation on the discount of paper
with a maturity of more than 3 months and less
than 6 months, but that the aggregate amount
of discounted agricultural paper with a maturity of between 6 and 9 months should not
exceed 10 per cent of the total assets of a
Federal Reserve Bank.10 Although the authority
for such limitations is still in the law, the limit
fixed by the Board in 1923 was omitted from
Regulation A in 1937, and no amount limitation is now in force.
One should bear in mind, however, that
agricultural paper continues to be subject to
the same limitations on the amount of paper
of any one borrower that may be discounted for
a member bank as those that are applicable to
the discounting of other types of paper.

SIGHT DRAFTS
Drafts payable at sight or on demand do not,
of course, have any fixed maturity, and it is
possible that they may not actually be presented
for payment within 90 days, or even within 6
or 9 months. For this reason, the Board in
1917 ruled that demand paper was not eligible
for discount.41 It was the custom, however, for
many member banks during crop-moving periods to discount large volumes of sight drafts
secured by bills of lading covering the shipment
of wheat, cotton, or other agricultural products;


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Federal Reserve Bank of St. Louis

these drafts, although having no fixed maturity,
were usually paid with promptness and were
considered a liquid and desirable form of paper.
Accordingly, the Board recommended to Congress that the law be amended to make such
drafts eligible for rediscount by the Reserve
Banks under certain conditions.42
Such an amendment was made by the Agricultural Credits Act of 1923. 43 It extended the
discount privilege to bills of exchange payable
at sight or on demand if drawn to finance the

AGRICULTURAL CREDITS
domestic shipment of "nonperishable, readily
marketable staple agricultural products" and if
secured by bills of lading or other shipping
documents conveying or securing title to such
staples. The act contained the provision, however, that all such bills should be forwarded
promptly for collection and that demand for
payment should be made, with reasonable
promptness after the arrival of the staples at
their destination; and no such bill could be held
by or for the account of a Federal Reserve Bank
for more than 90 days. In discounting such
sight bills, the Reserve Banks were authorized
to compute the interest to be deducted on the
basis of the estimated life of the bill and to adjust the discount after payment of the bill to conform to its actual life. In 1928, the provision
was expanded to permit the discounting of sight
bills covering nonagricultural as well as agricultural staples and covering the exportation as
well as the domestic shipment of such staples.14
In its 1923 revision of Regulation A, the
Board followed in general the language of the
law with respect to discounts of sight or demand
bills,40 and the regulatory provisions on this
subject remained substantially the same until
1973." These provisions, however, became unnecessary in 1966 when the Board ruled that
all demand notes met the maturity requirements
of the law and therefore were eligible for discount if they met other eligibility requirements.47
In the light of this fact, the general revision
of Regulation A adopted by the Board in 1973
omitted the special regulatory provision regarding demand drafts.

49

In 1923, when the special authority for the
discount of sight or demand paper still had
significance, the Board stated that it did not
deem it advisable to formulate a comprehensive
definition of the term "readily marketable nonperishable staple" and that the Reserve Banks
should exercise their discretion in the matter.48
In specific instances, however, the Board held
that cottonseed should be,49 and cottonseed oil
should not be,50 considered readily marketable
staples for this purpose. As has been noted, the
statutory provisions were changed in 1928 to
cover nonagricultural as well as agricultural
staples. When Regulation A was revised in
1937, it carried a footnote stating that, within
the meaning of the regulation, a readily marketable staple meant "an article of commerce,
agriculture, or industry of such uses as to make
it the subject of constant dealings in ready
markets with such frequent quotations of price
as to make (a) the price easily and definitely
ascertainable and (b) the staple itself easy to
realize upon by sale at any time." 51 This
definition followed a similar definition that had
previously been adopted by the Board for the
purpose of determining the eligibility of bankers' acceptances growing out of the storage of
readily marketable staples. The scope of the
term will be considered further in the following
chapter relating to the discounting of bankers'
acceptances. The definition was omitted in the
revision of Regulation A adopted in 1973 since,
as previously indicated, that revision did not
include any provision relating specifically to the
eligibility of sight or demand drafts.

FACTORS' PAPER
At the time of the hearings on the Agricultural Credits Act of 1923, Governor Eugene
Meyer pointed out that, in addition to sight
bills, there was another class of agricultural paPer that had theretofore been ineligible for discount because of rulings of the Federal Reserve
Board. The Board had held that finance paper


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Federal Reserve Bank of St. Louis

the proceeds of which were to be loaned to third
persons was not eligible for discount. Based on
this theory, the paper of cotton factors, who
carried the cotton for their customers until it
was sold, could not be offered for discount/1Governor Meyer felt that this was a "hairsplitting" distinction.03

50

HISTORY OF LENDING FUNCTIONS

Congress apparently agreed with Governor
Meyer. The Agricultural Credits Act of 1923
amended section 13 of the Federal Reserve Act
to provide expressly that nothing in the latter
should be construed to prevent "the notes,
drafts, and bills of exchange of factors issued as
such making advances exclusively to producers
of staple agricultural products in their raw
state" from being eligible for discount. A paraphrase of this provision was incorporated in the
Board's 1923 revision of Regulation A, 54 and
a similar provision appeared in the 19SS regulation.55 It was omitted, however, from the
revision of the regulation adopted in 1973.
This provision related only to factors' paper
drawn to finance producers of agricultural products in their raw state. Thus, the Board held
that if the proceeds of a cold-storage company's
notes were to be used for making advances to

producers of eggs and poultry, the notes would
be eligible for discount, but that butter is not an
agricultural product in its raw state and that
consequently notes covering advances to those
engaged in the commercial production of butter
from cream purchased from others would not
be eligible for discount.56
Some years later, as has been noted in Chapter 4, the Board reversed its previous position
regarding the eligibility of finance paper for
discount. Since 1937, not only agricultural factors' paper but any paper the proceeds of which
are to be loaned to third persons has been
eligible for discount if the proceeds are ultimately to be used for commercial, agricultural,
or industrial purposes. Consequently, the general revision of the regulation adopted by the
Board in 1973 does not include any provision
relating specifically to factors' paper.

PAPER OF COOPERATIVE MARKETING ASSOCIATIONS
By 1923 cooperative marketing associations
had assumed considerable importance as agencies for enabling farmers to market their crops
to better advantage.57 Normally such associations were nonstock organizations whose membership consisted of the producers of the particular crop that the organization was designed
to market and to which the members delivered
their crops for sale. The commodities were
pooled according to grade, and after all of a
particular pool had been sold by the association
the proceeds were distributed pro rata to the
producers who had contributed to that pool.0*
In a number of rulings prior to 1923 °9
the Board had held that in some circumstances
notes of cooperative marketing associations
were eligible for discount as agricultural paper,
but that in other circumstances such notes were
not eligible for discount or were eligible only
as commercial paper and therefore must have
a maturity of not more than 90 days. For
example, the Board had held that notes of an
association engaged in packing and marketing


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Federal Reserve Bank of St. Louis

products that it had not grown, the proceeds of
which were used to pay current expenses and to
purchase supplies, were eligible for discount
only as commercial paper.60
The Agricultural Credits Act of 1923 recognized the essentially agricultural nature of cooperative marketing associations and, as stated
by Eugene Meyer, "swept away" technical distinctions based on the legal form in which their
paper was issued.81 A new section—13a—
added to the Federal Reserve Act provided that
notes, drafts, and bills of exchange issued or
drawn by such associations should be "deemed"
to have been issued or drawn for an agricultural
purpose if their proceeds were ( 1 ) advanced to
their members for an agricultural purpose, (2)
used to make payments to members for agri' cultural products delivered to the associations,
or (3) used to meet expenditures incurred in
connection with grading, packing, preparing
for market, or marketing of any agricultural
products handled by the associations for their
members.

AGRICULTURAL CREDITS
After the enactment of the Agricultural
Credits Act of 1923, the Board published a
revised statement of general principles regarding the discount of paper of cooperative marketing associations.62 Among other things, this
statement made it clear that the following types
of paper would be eligible for discount as agricultural paper: growers' drafts accepted by the
associations and covering deliveries of crops, if
the proceeds were used by the growers for
agricultural purposes; growers' paper used to
finance the carrying of their products for a
reasonable period incident to orderly marketing; and paper of the associations to finance
the packing and marketing of the products of
their members, to pay for products purchased

51

from their members, or to make advances to
their members for agricultural purposes.
In a revision of its Regulation A, the Board
followed the language of the amended law as
to the eligibility of paper of cooperative marketing associations for discount; however, the
regulation provided that such paper would not
be eligible if the proceeds were used to defray
expenses of organizing the association, or to
acquire warehouses, or to purchase or improve
real estate or other fixed or permanent investments.63 The 1973 revision of Regulation A
omits the paragraph dealing specifically with
paper of cooperative marketing associations,
but such paper is referred to as constituting
agricultural paper for purposes of discount.

DISCOUNTS FOR FEDERAL INTERMEDIATE CREDIT BANKS
As noted at the beginning of this chapter,
the Agricultural Credits Act of 1923 set up a
system of Federal intermediate credit banks to
make loans to farmers with maturities intermediate between the short-term credit available
through the Federal Reserve Banks and the
long-term credit obtainable from the Federal
land banks. The intermediate credit banks were
authorized to discount agricultural and livestock
paper for State and national banks, agricultural
credit corporations, livestock loan companies,
and cooperative marketing associations, and to
make direct loans to cooperative marketing
associations. The maturity of all such discounts
and advances was limited to a minimum of 6
months and to a maximum of 3 years.
In turn, the Federal intermediate credit banks
were permitted to rediscount their paper with
the Reserve Banks on the same basis on which
agricultural paper in general could be offered
for discount to the Reserve Banks. Thus, to be
eligible for discount, such paper had to be
endorsed by the intermediate credit bank and
had to have a maturity at the time of discount
of not more than 9 months, exclusive of days
of grace. In addition, the Federal Reserve


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Federal Reserve Bank of St. Louis

Board had the right to limit the amount of
paper with maturities of 3 to 6 months and of
6 to 9 months that might be rediscounted by a
Federal Reserve Bank. Furthermore, the new
law specifically provided that no Reserve Bank
should rediscount for a Federal intermediate
credit bank any note bearing the endorsement
of a nonmember State bank that was eligible
for membership in the Federal Reserve System.
This was the first instance in which the discount
facilities of the Federal Reserve Banks were
made available to any but member banks of the
Federal Reserve System.
In addition to authority to discount paper
for the intermediate credit banks, the Agricultural Credits Act of 1923 gave the Reserve
Banks authority to buy and sell debentures and
other such obligations issued by the Federal
intermediate credit banks or by the national
agricultural credit corporations provided for in
the same Act, but only subject to the same
limitations as those applicable to the purchase
and sale of farm loan bonds. Farm loan bonds,
under the Farm Loan Act of 1916, could be
bought and sold by the Reserve Banks to the
same extent as State, county, and municipal

52

HISTORY OF LENDING FUNCTIONS

bonds could be purchased pursuant to section
14(b) of the Federal Reserve Act, and that
section prescribed a maturity limitation of 6
months at the date of purchase. Finally, it may
be noted that the Agricultural Credits Act
added to section 14 of the Federal Reserve Act
a new provision authorizing the Reserve Banks
to purchase and sell in the open market acceptances of the intermediate credit banks and
the national agricultural corporations whenever
the Federal Reserve Board should declare "that
the public interest so requires." All of these
provisions relate to purchases by the Reserve
Banks rather than to the discounting and lending functions of the Banks; they are mentioned
here to indicate the extent to which Congress in
1923 provided for the use of the Federal Reserve System in facilitating the operations of
Federal intermediate credit banks and in furthering extensions of agricultural credit.
Discounts for the intermediate credit banks
were made subject to regulations and limitations
to be prescribed by the Federal Reserve Board.
In its 1923 revision of Regulation A,C4 the
Board required each Federal Reserve Bank, in
discounting paper for any intermediate credit
bank, to "give preference to the demands of its
own member banks" and to have "due regard to
the probable future needs ,of its own member
banks." In addition, a Federal Reserve Bank
was prohibited from discounting such paper
whenever its own reserves were less than 50
per cent of its aggregate liabilities for deposits
and Federal Reserve notes in circulation,05 and
the total amount discounted by all Federal
Reserve Banks at any one time for any one
intermediate credit bank was limited to the
amount of the capital and surplus of such
intermediate credit bank.
In 1928 both of these amount limitations
were made less rigid by an amendment to the
regulation allowing them to be exceeded "with
the permission of the Board." 68 In the 1937
general revision of Regulation A,67 the limitation on the aggregate amount of discounts by
all Reserve Banks for any one intermediate
credit bank was omitted altogether. In 1955
the other limitation was also omitted, primarily
because the reserves of all Federal Reserve
Banks had for some time been less than 50


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Federal Reserve Bank of St. Louis

per cent of their deposit and note liabilities and
the Board's permission would therefore be
necessary in all cases. It was specifically provided that all discounts for intermediate credit
banks should be made only with the permission
of the Board.0" The 1973 revision of Regulation
A drastically condensed the section regarding
discounts for intermediate credit banks but
without any change in substance.
In the meantime Congress amended the
law to provide the Federal intermediate credit
banks with additional facilities for "acquiring
funds through the Federal reserve system."69
The Act of May 19, 1932,70 authorized the use
of intermediate credit bank debentures as collateral for advances by the Reserve Banks to
member banks. In addition, it amended section 13a of the Federal Reserve Act to permit
the Reserve Banks to discount for the intermediate credit banks notes payable to such
banks and endorsed by them if the notes had
maturities of not more than 9 months and were
secured by paper eligible for discount by the
Reserve Banks. The purpose of the added authority to discount notes payable to the intermediate credit banks was simply to permit the
discounting of paper representing direct advances made by such banks to agricultural
associations and other financial institutions.
As explained by Chairman Stcagall of the
House Banking and Currency Committee, it
was "a piece of lost machinery in the intermediate credit banks" that the committee was
attempting to supply.
In practice, the Reserve Banks do not now
discount paper of Federal intermediate credit
banks. However, under present law the Reserve
Banks are authorized, with the permission of
the Board, to discount for any Federal intermediate credit bank (1) paper meeting the
regulatory definition of agricultural paper and
(2) notes payable to such intermediate credit
bank that represent loans made by it and that
are secured by any paper eligible for discount
by the Reserve Banks. In either case, the paper
must be endorsed by the intermediate credit
bank, must have a maturity of not more than
9 months at the time of discount, and must not
bear the endorsement of a nonmember State
bank. No amount limitation is prescribed.

Bankers'Acceptances

GENERAL CONSIDERATIONS
was proposed to give national banks express
authority to accept drafts and bills of exchange
and, in addition, to authorize the Federal
Reserve Banks to discount such acceptances,
subject in both cases to limitations on maturity
and amount.
The major purpose of these provisions was
to permit the financing of foreign business
through U.S. markets rather than through foreign markets, particularly the London market.
Mr. Phelan said: :t

PURPOSES
In authorizing extensions of Federal Reserve
credit on commercial and agricultural paper,
the original Federal Reserve Act sought to
provide a broader market for well-known existing types of paper. In contrast, the provisions
of the Act with respect to bankers' acceptances
had as their objective the development of a
market for what was then considered a new
type of commercial paper in the United States,
and it is clear that their underlying purpose was
to stimulate U.S. foreign trade.
The unimportant role of U.S. banks in the
financing of foreign trade had been deplored by
the National Monetary Commission in its 1912
report.1 When the House Banking and Currency
Committee reported the Glass bill on the Federal Reserve in 1913,2 it stated that in the
opinion of expert bankers the "acceptance form
of loan," which was very common in Europe,
could "be applied in the United States to excellent advantage." To remedy the situation, it

Taken in connection with the permission to
establish foreign branches it means that our
importers and our exporters shall no longer be
dependent upon London, and that they shall
be freed from the annual tribute which they
have been required to pay London bankers.
This purpose was more fully explained by
Senator Swanson:4
* * * This country, having no system of
acceptances in vogue by banks, has been compelled to resort to the foreign system in order
to conduct our foreign business. All of our

For NOTES AND REFERENCES, see pp. 254-57.

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54

HISTORY OF LENDING FUNCTIONS
transactions in exportation and importation of
goods is thus conducted in foreign money
centers. The bankers and their customers in
this country have to pay immense sums
annually for this accommodation. The reserve banks, by being permitted to rediscount
the acceptances of member banks, will soon
do this class of business to the great benefit of
the banks and their customers, and result in
the saving of many millions of dollars annually. * * •

The greater marketability of paper accepted
by well-known banks was emphasized by Senator Weeks in referring to the acceptance provisions of the bill: s
* * * If the merchant made a promissory
note, he might find it necessary to pay 5 per
cent for that money; but if he draws on a
well-known bank or a well-known banker, he
may be able to sell his paper on a 4 per cent
basis. * * •
For that reason, we undoubtedly will see
a lower interest rate to every man who has a
broad credit as a result of this system. That
is the kind of paper that will not only go in
our own reserve banks and be available as a
basis for circulation, but it is the kind of
paper that will give our business men a
world-wide credit.
With the financing of foreign trade in mind,
the Glass bill authorized national banks to
accept, and the Federal Reserve Banks to discount, only acceptances based upon the importation or exportation of goods. Mr. Glass
remarked during the debates in the House that
this limitation had "been complained of by
many of those who believe that its extension to
domestic operations would be highly advantageous to industry." 6 Indeed, the Senate was
opposed to the limitation; both the Owen bill
and the Hitchcock bill would have covered
acceptances growing out of domestic as well as
foreign transactions. In the conference on the
bill, however, the House conferees prevailed
and the reference to domestic shipments was
omitted.
On the very day on which the Act was finally
approved, Senator Bristow asked why the reference had been cut out and why the dealer


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Federal Reserve Bank of St. Louis

in foreign merchandise should be "given an
advantage over the dealer in domestic merchandise on exactly the same kind of paper."
Senator Owen replied that he had yielded with
"very great reluctance" on this point, but that
the House conferees had demanded its omission
on the ground "that small banks were apt to
abuse the right of selling their credit in the
way of acceptances by accepting domestic bills
in default of any accommodation they could
extend at the time because of their then resources."7 It was not until 1916 that the
acceptance provisions were broadened to cover
domestic transactions. How this came about will
be discussed later.

EARLY ENCOURAGEMENT
BY THE BOARD
Recognizing the novelty of acceptances, the
Federal Reserve Board proceeded cautiously
after the enactment of the original Federal Reserve Act. In issuing its first comprehensive
regulation on the subject, the Board in April
1915 observed: 8
* * * The acceptance is still in its infancy
in the field of American banking. How rapid
its development will be can not be foretold;
but the development itself is certain. Opportunity is given by the Federal reserve act to
assist the movement in this new direction; the
present regulations are to be regarded as a
first step and will be extended as circumstances and a reasonable regard for the other
uses and needs of the credit facilities of the
Federal reserve system may warrant.
At the same time, the Board called attention
to the highly desirable character of bankers'
acceptances and stated that they would be discounted at a preferential rate, as follows: "
The acceptance is the standard form of
paper in the world discount market and both
on this account and because of its acknowledged liquidity universally commands a
preferential rate. By reason of its being
readily marketable it is widely regarded as a
most desirable paper in the secondary reserves of banks and will help to provide an
effective substitute for the "call loan."

BANKERS' ACCEPTANCES
In the fall of 1915, when the Board amended
its regulations to relax provisions prohibiting
the renewal of acceptances, the Board declared: 10
It has been the aim of the Board to do
everything in its power to create for the
American acceptance, that is, dollar exchange
[not to be confused with dollar exchange
acceptances authorized the following year],
a dominating position in the world market.
* * * In widening somewhat the facilities
of Federal reserve banks in dealing with
American bankers' acceptances, the Board is
attempting to give the member banks a
larger opportunity for developing their sphere
of usefulness in this respect.
By the latter part of 1916, the System's policy
of encouraging bankers' acceptances began to
show results. The Board was able to say: "
There can be but little doubt that the law
permitting national banks to accept drafts
based upon foreign-trade transactions has
been a most helpful factor in the recent movement of our foreign trade. Dollar acceptances
[still not to be confused with dollar exchange
acceptances] are now becoming known in
almost all parts of the world, and are bound
to prove a most powerful instrument in promoting and facilitating the commercial relations between this country and our foreign
markets, where commercial credit has to be
extended by our exporters desirous to enter
these markets in competition with European
houses. * * •
The movement to encourage an acceptance
market continued despite the intervention of
World War I. In its Annual Report to Congress
for 1919, the Board, after noting that there was
not in this country any broad acceptance market
such as existed in London, went on to say: "
* * * The development of such a market
is necessarily a slow process and the burden
of its support has fallen during the year 1919,
as in previous years, upon the Federal Reserve Banks. This condition will doubtless
continue until banks generally begin to invest
funds temporarily idle in acceptances and
until this method of employing funds appeals
to the private investor. * * *


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In the following year, the Board reported to
Congress that "appreciable progress" had been
made in the development of a market for
bankers' acceptances and that the Federal
Reserve Banks continued to be "the greatest
influences" in that market."
These statements by the Board are significant
as indicating the attitude of the System toward
bankers' acceptances during the earlier years.
The System's policy of encouragement was
reflected in preferential discount rates. At the
same time, the novelty of acceptances in U.S.
banking was evidenced by the numerous rulings
and interpretations issued by the Board during
those years. In fact, a major part of the interpretations of the Board published in the Federal
Reserve Bulletin before 1924 related to bankers' acceptances.
After 1923, however, the emphasis placed on
bankers' acceptances gradually diminished.
Since then, there has been no change in the
law on this subject. No change has been made
in the Board's Regulation C relating to the
making of acceptances by member banks (see
Appendix C) since 1946, and provisions of
Regulation A regarding the discounting of acceptances by the Reserve Banks were drastically
condensed in the 1973 revision of that regulation. Only in recent years has interest in bankers' acceptances revived, with some evidence
of resurgence in the acceptance market.11

DEFINITION
An excellent nontechnical definition of a
banker's acceptance is set forth in the following
excerpt from an article that appeared in a 1955
issue of the Federal Reserve Bulletin, to which,
incidentally, the reader is referred for a good
summary of the development of bankers' acceptances in the United States: "
A banker's acceptance is a time bill of
exchange (frequently called a time draft)
drawn on and accepted by a banking institution. By accepting the draft the bank signifies
its commitment to pay the face amount at
maturity to anyone who presents it for payment at that time. In this way the bank
provides its name and credit and enables its

56

HISTORY OF LENDING FUNCTIONS
customer, who pays a commission to the accepting bank for this accommodation, to
secure financing readily and at a reasonable
interest cost. For investors, bankers' acceptances represent short-term private paper with
a maximum degree of safety and liquidity,
comparable to that enjoyed by Treasury bills.
Bankers' acceptances have been utilized in
the United States and abroad in part to
finance domestic transactions but primarily in
transactions related to international trade.
Buyers and sellers engaged in foreign transactions are apt to be less well known to each
other and the shipping time is longer than is
usually the case in domestic transactions.

Somewhat more legal in nature was the
definition stated by the Board in its 1915
regulations. There the term "acceptance" was
defined as: 18
* * * a draft or bill of exchange drawn to
order, having a definite maturity, and payable
in dollars, in the United States, the obligation
to pay which has been accepted by an
acknowledgement written or stamped and
signed across the face of the instrument by
the party on whom it is drawn; such agreement to be to the effect that the acceptor will
pay at maturity according to the tenor of such
draft or bill without qualifying conditions.
In a separate place, the regulation provided that
an acceptance, in order to be eligible for discount, must have been made by "a member
bank, nonmember bank, trust company, or by
some private banking firm, person, company,
or corporation engaged in the business of accepting or discounting." If it met these requirements, the acceptance was to be considered a
"banker's" acceptance.1'
The definition was simplified in the Board's
1916 revision of Regulation A. There the term
"banker's acceptance" was defined simply as
"a draft or bill of exchange of which the acceptor is a bank or trust company, or a firm,
person, company, or corporation engaged in the
business of granting bankers' acceptance
credits." 1H
Four years later the definition was changed
to make it clear that an eligible acceptance
could be payable either in the United States or


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Federal Reserve Bank of St. Louis

abroad and either in dollars or in some other
money.1" This was a reversal of the position
taken by the Board in 1915 that the instrument
must be one payable in dollars in the United
States.
The Board's present Regulation A, as drastically revised in 1973, omits any definition of
a banker's acceptance.
In construing its earlier regulatory definition,
the Board made it clear that an acceptance must
be made by the party upon which it is drawn.
For example, a draft drawn upon a land company but accepted by a bank cannot properly
be considered a banker's acceptance.80
It should be noted, however, that the definition did not require that the acceptor be a bank.
If the acceptor was in the habit of carrying on
some acceptance business, its acceptances qualified as bankers' acceptances.21 In pursuance of
the policy of developing a U.S. acceptance business, the Board in 1918 announced that acceptances of "acceptance corporations" should
be considered on the same basis as those of
prime private bankers and should not be discriminated against.22

ACCEPTANCE AUTHORITY OF
MEMBER BANKS
It seems reasonably clear that the framers of
the original Federal Reserve Act assumed that
national banks lacked authority to accept time
drafts. The House committee report stated that
the acceptance business was "a new form of
business heretofore forbidden to national
banks." 21 Mr. Phelan observed in the House
that "under our national banking laws national
banks are not permitted to accept drafts or bills
of exchange." 2* In the Senate, Senator Swanson
declared that the bill would "open up a new
field of business for our national banks."25
Following enactment of the original Act, the
Federal Reserve Board on several occasions
expressed the view that national banks had no
acceptance powers prior to 1913,26 and it appears that the Comptroller of the Currency took
the same position for many years. In 1963,
however, the Comptroller sharply reversed that
position and ruled that national banks were not
limited by the Federal Reserve Act as to the

BANKERS' ACCEPTANCES
kinds of acceptances they might make in financing credit transactions; this ruling was based
largely on the ground that the making of acceptances constituted an essential part of the
general banking powers authorized in the National Bank Act.37
Although the provisions of the original Federal Reserve Act were in terms of authorizing
any member bank to make acceptances of the
kinds therein described, they were obviously
not intended to confer any new authority upon
State member banks since State banks derive
their powers from State law. Nevertheless, the
provisions could reasonably have been interpreted as limiting State member banks, as well
as national banks, to the types of acceptances
described in the Act. Although the Act expressly provided that State banks joining the
System should retain their charter and statutory
rights as State banks, this reservation was made
subject to the provisions of the Federal Reserve
Act. In the form in which the bills passed both
Houses of Congress, the acceptance provisions
referred only to national banks; but the conference committee changed the words "national
bank" to "member bank." Although no explanation was given for this change, it seems
likely that it was intended to limit State member
banks, as well as national banks, to the making
of acceptances of the kinds specified.
Despite these considerations, the Board's
General Counsel in 1923 stated that the Board
had "always taken the position that a State
bank becoming a member of the Federal reserve
system is not limited as to the character of
acceptances which it may make by the permissive provisions of section 13." 2S At the same
time, that opinion stated that the quantitative
limitations of the Act with respect to bankers'
acceptances—limitations on the amount of acceptances for any one customer and on the,
aggregate amount of acceptances—were applicable to State member banks as well as to
national banks.
On the assumption that the provisions of
section 13 of the Federal Reserve Act limiting
we kinds and amounts of acceptances that could
be made
.
by member banks applied at least to
national banks, if not to State member banks,
we Board since 1917 has had outstanding its


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Federal Reserve Bank of St. Louis

57

Regulation C, regarding the making of bankers'
acceptances, in addition to Regulation A, governing the discounting of acceptances by the
Reserve Banks. If national banks and State
member banks are governed only by the amount
limitations of the law and not by the qualitative
limitations, it is questionable whether Regulation C continues to serve any useful purpose.

DISCOUNTING AUTHORITY OF
FEDERAL RESERVE BANKS
Whatever may be the situation as to the
authority of national banks or of State member
banks to make acceptances, the Federal Reserve Banks are authorized by section 13 of
the Federal Reserve Act to discount only
bankers' acceptances of the kinds thereinafter
described.29 Consequently, in order for any
acceptance to be eligible for discount, it must
meet all the requirements of the seventh or the
twelfth paragraph of section 13 with respect to
the acceptance authority of member banks,
those as to kind as well as those as to maturity
and amount. In addition, it must also meet two
special requirements for discount by the Reserve Bank. First, it must have a maturity at
the time of discount not less than that specified
by the statute, and this requirement as to
maturity for discount purposes must be carefully distinguished from the maturity requirements prescribed as a condition to the authority
of member banks to make acceptances. Second,
it must be endorsed "by at least one member
bank." Until 1916, an acceptance had to comply with separate limitations as to amount,
different from those imposed on the discounting authority of member banks; however, these
limitations are no longer prescribed.
Requirements as to kind, maturity, and
amount will be treated in subsequent sections
of this chapter. The requirement as to endorsement may appropriately be considered here in
connection with the general nature of the Reserve Banks' discounting authority.
As to discounts of other types of paper, the
law authorized a Federal Reserve Bank to
discount the paper if endorsed by any of "its"
member banks. An acceptance, however, was
required by the law only to be endorsed by "at

58

HISTORY OF LENDING FUNCTIONS

least one member bank." Noting the difference,
the Board in 1915 held that it was immaterial
whether the offering member bank was located
in the district of the Reserve Bank making the
discount or in some other district; in other
words, a Reserve Bank could discount bankers'
acceptances for any member bank wherever
located.30 This inconsistency prevailed until
1937 when, in revising Regulation A, the Board
provided that a banker's acceptance could be
discounted by a Federal Reserve Bank only for
one of "its member banks," though the regulation still, rather ambiguously, required the
acceptance to bear the endorsement of "a
member bank."S1 The present regulation authorizes a Reserve Bank to discount for a
member bank, which must, of course, be one
of its own members, bankers' acceptances endorsed by "the member bank." Thus, despite
the discrepancy in the law, a Reserve Bank now
may discount acceptances only for its own
member banks.
The Board's discount regulations have always
included a provision to the effect that a Federal
Reserve Bank must satisfy itself as to the eligibility of any paper offered for discount. In
the case of bankers' acceptances, however, a
special provision as to evidence of eligibility
was once considered necessary. As amended in

1916, Regulation A specifically provided that if
the bill did not itself evidence the character of
the underlying transaction, evidence of the eligibility of a banker's acceptance might consist
of a stamp or certificate affixed by the acceptor
in a form satisfactory to the Reserve Bank."
In 1937, a footnote was inserted in the regulation requiring the accepting bank to obtain
"substantiating evidence" as to the eligibility of
the underlying transaction in the case of acceptances based on import or export transactions,
but this requirement was omitted in 19SS, presumably as unnecessary. No provisions regarding evidence of eligibility of bankers' acceptances are included in the revision of the regulation adopted in 1973.
Even if legally eligible for discount, a banker's acceptance, like any other kind of eligible
paper, does not have to be discounted by the
Reserve Bank to which it is offered for discount.
The discount authority of the Reserve Banks is
not mandatory but discretionary. Thus, in an
early ruling the Board held that a draft drawn
by an American exporter upon a foreign buyer
and accepted by the buyer may be technically
eligible for discount, but that the Reserve Bank
may nevertheless, in its discretion, decline to
discount such an acceptance on the ground that
it is not a desirable investment.33

IMPORTATION AND EXPORTATION OF GOODS
CONNECTION WITH IMPORT
OR EXPORT
The original Federal Reserve Act authorized
member banks to make, and Federal Reserve
Banks to discount, only one type of banker's
acceptance: acceptances "growing out of the
importation or exportation of goods." As has
been indicated, the framers of the Act thought
of the acceptance mechanism chiefly as a means
of financing foreign trade, hoping that the acceptance authority, along with the authority
given national banks to establish foreign


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Federal Reserve Bank of St. Louis

branches, would serve to improve the position
of the United States in the world market.
Aside from the rather vague requirement
that acceptances should grow out of import or
export transactions, the law made no attempt
to describe or limit the kinds of transactions
that might give rise to eligible acceptances. In
its first regulation on the subject the Board
required only an indication (on the face of the
acceptance) that the proceeds "were used or are
to be used in connection with a transaction iD"
volving the importation or exportation of
goods."" In 1915, becoming a little more

BANKERS' ACCEPTANCES
specific, the Board changed the regulation to
require the draft to be drawn either by a commercial, industrial, or agricultural concern "directly connected" with the shipment of goods
involved or by a banker; in the latter event the
"goods" were required to be "clearly specified"
in the agreement with the acceptor. If the
acceptor were not a member bank, it had to
agree to furnish the Reserve Bank, on request,
with information as to the nature of the transaction.311 In 1916, however, the language of the
regulation was again changed, this time to
require that an accepted bill, to be eligible for
discount, "must have been drawn under a credit
opened for the purpose of conducting, or
settling accounts resulting from," one of the
three types of transactions described in the
statute.3"
The obvious intent of these early regulations
was to insure that a banker's acceptance had
some close and direct connection with an import or export transaction in order for it to be
considered as growing out of such a transaction. In a number of early rulings, the Board
sought to answer the recurring question of how
close and direct the connection ought to be.
Thus, the mere fact that a draft was secured
by an acceptance based on an import or export
transaction was held by the Board not to be
sufficient to make the draft itself eligible for
discount." Similarly, the Board ruled that an
acceptance was too remotely related to an
import or export transaction if the draft was
drawn by a domestic seller of raw materials on
a domestic manufacturer who had a contract to
export the manufactured products;38 or if the
draft was drawn by a foreign manufacturer on
a domestic bank to finance the manufacture of
goods to be shipped later to the United States;3B
or if the acceptance- was intended to finance
foreign retailers in selling goods exported from
the United States."
On the other hand, if it were clear that the
draft was actually drawn to finance an export
transaction, the Board held that the acceptance
of the draft would be eligible for discount even
though the goods had not yet been actually
shipped" or even though there had been a
delay in shipment." As a matter of fact, the
Board went so far as to hold that, if there had


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59

been a bona fide contract for the export of
goods, drafts drawn tofinancesuch export continued to be eligible throughout their life as
drafts growing out of an export transaction
even though, because of freight rates and shipping conditions, the goods were never actually
shipped abroad.13
Thus, although the Board adopted a liberal
view with respect to acceptances made prior to
shipments, it was more conservative, at least at
first, with respect to acceptances made after the
shipment was completed. In 1917, it ruled that
after goods had been imported and they were
lying on the docks, any new transaction would
be simply a domestic transaction.41 Similarly, in
1926, the Board held that a national bank could
not legally accept drafts after the underlying
import or export transactions were completed.4"'
In the following year, however, the Board concluded that these and other previous rulings
were unnecessarily strict interpretations of the
law and that the statute was susceptible of "a
more liberal interpretation which would facilitate thefinancingof our foreign trade." It ruled,
therefore, that acceptances might properly be
considered as growing out of the importation
or exportation of goods if they were drawn to
finance the sale and distribution on usual credit
terms of imported or exported goods into the
channels of trade, whether or not the bills were
accepted after the physical importation or exportation had been completed.16 This ruling
opened up a broaderfieldfor the use of bankers'
acceptances than had previously existed.47

CONTRACT AND SHIPPING
DOCUMENTS
The two things that normally afford the best
evidence that a banker's acceptance grows out
of an import or export transaction are the
existence of a contract for the shipment of
goods and the documents relating to their
shipment.
At an early date the Board held that the
accepted draft must have been drawn by, or at
the instance of, a person with a contract to export or import goods.48 However, if the goods
had been actually shipped and shipping documents were attached to the draft at the time of

60

HISTORY OF LENDING FUNCTIONS

its acceptance, the existence of a contract for
export was not essential.19
In a 1918 ruling the Board announced certain
principles to be applied in determining whether
an acceptance grew out of an export transaction
in the case of a dealer who was engaged in the
purchase of the same kind of goods for both
export and- domestic use. The agreement between such a dealer and the accepting bank was
required to show (1) that the dealer had a
contract for the export of the goods, (2) that
the amount of the drafts would not exceed the
amount involved in the export transaction, and
(3) that the proceeds of the drafts would be
used in connection with the export transaction.
In addition, it was required that the proceeds
of the sale be applied in payment of the acceptance, unless the dealer had placed the bank in
funds to meet it at maturity or had secured the
acceptance in the manner required for domestic
acceptances, that is, by shipping documents,
warehouse receipts, or similar documents securing title to readily marketable staples.50
This ruling, however, was superseded 2 years
later when the Board, in its 1920 revision of
Regulation A, undertook to specify the circumstances that must be present for an acceptance to be considered as growing out of the
importation or exportation of goods.01 The
regulation stated that it was not necessary that
shipping documents be attached or that the
drafts cover "specific goods" 5Z in existence at
the time of acceptance. But the regulation required either (1) that shipping documents be
attached when the draft was presented for acceptance, or (2) if the goods had not been
shipped, that there be a contract for their import or export within a specified and reasonable
time and that the customer agree to furnish the
accepting bank in due course with shipping documents covering the goods or with exchange
arising out of the transaction being financed.
These requirements, as interpreted by the
Board, meant that it was no longer sufficient,
as had been indicated in the 1918 ruling, for
the acceptance to be secured by documents
covering goods not intended for export; a
dealer engaged in both domestic and foreign
transactions was now required to furnish the
accepting bank with shipping documents cover-


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Federal Reserve Bank of St. Louis

ing the goods to be exported if the acceptance
was to be eligible as one growing out of an
export transaction." The regulatory provision
permitting the dealer to furnish exchange arising
out of the transaction was meant as an alternative to the furnishing of shipping documents
only in the case of import transactions.
When the regulation was next revised in
1922, the detailed provisions of the 1920 regulation with respect to the alternative necessity
for cither a contract or shipping documents, as
well as the other requirements as to import and
export transactions, were omitted. The Board
stated, however, that their elimination was only
for simplification and that the Board was not
reversing or modifying any of its previous rulings regarding acceptances growing out of the
importation or exportation of goods insofar as
they had been interpretative of the law or had
laid down broad general principles, which "as a
result of long experience in the field of international banking, [were] recognized as essential
in the proper conduct of the acceptance business." r" Apparently, the Board felt that a regulatory statement of these general principles was
no longer necessary. It observed:
Those American banking institutions which
have large demands for acceptance credits in
foreign transactions have by this time had
considerable experience in this field, and the
former detailed regulations arc no longer
thought necessary. Moreover, it is believed
that the general advancement of foreign
trade, with the resulting benefit lo the agricultural and commercial interests which are
largely dependent upon foreign markets, can
be furthered most effectually at the present
time by the substitution of this simpler regulation applicable to acceptances in export and
import transactions.

Since 1922, neither Regulation A nor Regulation C has contained any provisions describing
or limiting the import and export transactions
that may be made the basis for bankers' acceptances, except that, until 1955, Regulation A
continued to carry the general requirement that
an acceptance should be drawn under a credit
opened for the purpose of conducting or settling
accounts resulting from one of the three types
of transactions described in the law.

BANKERS' ACCEPTANCES

GEOGRAPHIC COVERAGE
Soon after the enactment of the original Act
question arose as to what was meant geographically by the phrase "importation or exportation
of goods." In 1915 the Board's General Counsel
expressed the view that it covered not only
shipments of goods between the United States
and foreign countries but also shipments between two foreign countries and shipments
between the United States and Puerto Rico, the
Canal Zone, or the Philippines." However,
because Hawaii was then an integrated territory
and subject to all laws of the United States, he
held that shipments between the United States
and Hawaii were domestic shipments and could
not, therefore, be regarded as shipments involving the importation or exportation of goods.
This, of course, was before the law was changed

61

to authorize acceptances based upon domestic
shipment of goods. (It was also, of course, long
before Hawaii became a State.)
When Regulation A was revised after the
amendments made by the Act of September 7,
1916, it specifically covered acceptances arising
out of transactions involving shipments between
the United States and any foreign country,
between the United States and any of its "dependencies or insular possessions," or between
foreign countries.56 In 1923 the regulation included mention of an additional category of
shipments—those between dependencies or insular possessions and foreign countries." The
same four categories of shipments are covered
by the Board's regulations today, although since
February 15, 1955, they have been specifically
described not in Regulation A but in Regulation
C, governing acceptances by member banks. 58

DOMESTIC SHIPMENTS

EXTENSION OF LAW TO COVER
DOMESTIC SHIPMENTS
The original Federal Reserve Act, as has
been noted, contained no authority for the making or discounting of bankers' acceptances covering domestic shipments of goods. Some members of Congress could see no good reason for
authorizing foreign but not domestic acceptances, but the majority apparently felt that, in
view of the novelty of the acceptance device in
this country, acceptances against domestic shipments might be abused by the smaller banks.
By 1916, however, sentiment had changed. The
statute was amended to authorize member
banks to accept drafts or bills "which grow out
of transactions involving the domestic shipment
of goods provided shipping documents conveying or securing title arc attached at the time of
acceptance." •"
The amendment had been recommended by
the Board in its 1915 Annual Report00 as
follows:


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Federal Reserve Bank of St. Louis

The acceptance system, provision for which
is made in foreign trade operations by the
Federal Reserve Act, should be extended to
the domestic trade in so far as relates to
documentary acceptances secured by shipping
documents or warehouse receipts, covering
readily marketable commodities or against the
pledge of goods actually sold.
There can be but little question of the
safety of such acceptances, and their use will
tend to equalize interest rates the country
over and help to broaden the discount market.
In explaining the purpose of the amendment
in Congress, Senator Owen stated: 9 1
The purpose of that is to permit a limited
use of domestic acceptances where those acceptances are covered by documents conveying or securing title to readily marketable
staples, and then confining it further, so that
the bank may not make acceptances to over
10 per cent of its paid up and unimpaired
capital stock to any particular individual,
company, firm, or corporation.* * *

62

HISTORY OF LENDING FUNCTIONS

The amount limitation referred to by the
Senator will be discussed at a later point. His
statement is significant here because it reflects
a feeling of caution in extending the law to
permit banks to make acceptances in domestic
transactions.

PURPOSE OF FINANCING
Promptly after the 1916 amendment to the
law authorizing domestic acceptances, the
Board revised its Regulation A to cover bankers' acceptances under the new authority.*2
However, the revised regulation did no more
than paraphrase the requirements of the statute
that such acceptances must grow out of the
domestic shipment of goods and that shipping
documents must be attached at the time of
acceptance.
In some early rulings the Board took the
position that, in order to be eligible, the accepted draft must have been drawn solely for
the purpose of financing the shipment and that
if the effect was merely a straight loan to the
drawer, even though secured by bills of lading,
the draft could not be eligible for acceptance.83
In other rulings the Board similarly held that
acceptances covering financing for a period
longer than the period of shipment were actually designed to provide working capital and
so were not eligible.64
In 1929, however, the Board held that when
a 90-day bill was accepted by a bank and the
proceeds were used to pay a sight draft accompanied by a bill of lading covering a shipment
of staples, the acceptance was eligible for discount even though 90 days were not required
for completion of the shipment, provided the
maturity was consistent with the "usual and
customary" credit time prevailing in the particular business.65 The Board stated that this ruling
superseded, to the extent of any inconsistencies,
previous rulings regarding the use of acceptances to furnish working capital.

SHIPPING DOCUMENTS
As a condition both to the acceptance by
member banks of drafts growing out of domestic shipments and to the discounting of such


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Federal Reserve Bank of St. Louis

acceptances by the Federal Reserve Banks, the
law requires that shipping documents "conveying or securing title" shall be "attached at the
time of acceptance." In applying this condition,
the Board has held that the term "shipping
documents" includes either an order bill of
lading or a straight bill of lading, even though
the protection afforded by a straight bill is not
absolute; but that freight receipts or mere
copies of original bills of lading arc not sufficient.66
Since the law requires attachment of shipping
documents at the time of acceptance, a draft
cannot be accepted before the bills of lading
covering a shipment have been issued.87 But
physical attachment is not necessary; it suffices
if the documents arc in the possession of the
accepting bank or its agent at the time of
acceptance.*8
Although shipping documents arc necessary
at the time of acceptance, they need not, and
normally would not, be retained by the accepting bank throughout the life of the acceptance.6*
Obviously, such documents must be surrendered
in order for the customer to consummate the
transaction involved. However, the Board once
pointed out that when the documents have to
be released after acceptance, banking prudence
requires that the accepting bank should protect
itself by obtaining cither a trust receipt or an
agreement that the proceeds of the sale will be
deposited with the bank when they become
available.70

GEOGRAPHIC LIMITATION
The 1916 amendment authorizing acceptances growing out of the domestic shipment
of goods did not define what was meant by
a domestic shipment, nor did the Board by
regulation or ruling undertake to define the
term prior to 1946. Presumably it was understood that domestic was simply the opposite
of foreign and that the amendment referred to
shipments within the United States. This was
confirmed in the Board's 1946 revision of Regulation C, when previous language referring to
domestic shipments was changed to refer to
the "shipment of goods within the United
States." "

BANKERS' ACCEPTANCES

63

STORAGE OF STAPLES
PURPOSE OF TRANSACTION
When the law was amended in 1916 to
authorize acceptances growing out of the domestic shipment of goods, an additional type
of acceptance was also authorized, namely,
acceptances "which are secured at the time of
acceptance by a warehouse receipt or other
such document conveying or securing title
covering readily marketable staples." The purpose of this third class of commercial banker's
acceptance was to facilitate the carrying of
goods held in storage pending sale, shipment, or
distribution into the process of manufacture.
If the draft, even though secured by a warehouse receipt, was actually drawn to carry
goods for speculative purposes or for an indefinite period of time without any purpose
to sell, ship, or manufacture within a reasonable
time, it was not eligible for acceptance; such a
draft was regarded by the Board as merely a
cloak to evade the limitations of the law on
the amount which a national or a State member
bank could lawfully lend to one person."
By the same token, if the real purpose of a
proposed acceptance credit based on the storage
of cotton at a mill was to provide the mill with
working capital rather than to finance the sale
of the cotton by a cotton broker to the mill or
temporary storage thereof pending sale, such
an acceptance was considered improper."
Similarly, drafts drawn to finance a manufacturer pending the manufacture and ultimate
sale of the goods as a finished product were
held ineligible for acceptance because the drafts,
although accompanied by warehouse receipts,
were not drawn to carry the goods covered by
such receipts pending a reasonably immediate
sale or distribution.'4

WAREHOUSE RECEIPTS AND
OTHER SECURITY
The statute requires that an acceptance covering the storage of readily marketable staples
°e "secured at the time of acceptance by a


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Federal Reserve Bank of St. Louis

warehouse receipt or other such document conveying or securing title" to such staples. By
regulation and interpretation the Board has laid
down certain conditions as to the form of
the security for such acceptances, the independence of the warehouseman from die borrower,
and the substitution and release of the security.
As to what constitutes a warehouse receipt
or other such document, the Board by regulation in 1920 provided that the security for the
staples involved must take the form of a
"warehouse, terminal, or other similar receipt,
conveying security title to such staples, issued
by a party independent of the customer." ™
For this purpose, chattel mortgages on cattle
were not considered security similar to a warehouse receipt.78 However, a receipt issued by
the custodian of buildings in which the staples
were stored could be treated as a warehouse
receipt."
The principal regulatory requirement was
that the warehouse receipt be issued by a party
completely independent of the borrower; otherwise the receipt would not effectively convey or
secure title to the staples. This meant that the
borrower should not be in a position to exercise
any control over the goods stored and should
not have access to the premises,78 except access
solely for the purpose of inspecting the goods."
If these conditions were met, the staples could
be stored on property owned by the customer if
they were turned over, under a bona fide lease,
to an independent warehouseman.80 However,
in a case in which the custodians and representatives of the warehouse company were
former employees of the lessor-borrower who
expected to be reemployed by the latter at the
close of the storage season, the Board held
that the requirement as to independence of the
warehouseman was not fulfilled.81 Similarly, if
the warehouse company was organized by the
customer, it must not have been simply a subterfuge to evade this requirement of the regulation.82
In 1928 Regulation A was amended to make

64

HISTORY OF LENDING FUNCTIONS

it clear that a warehouse receipt covering the
storage of readily marketable staples could be
issued "by a grain elevator or warehouse company duly bonded and licensed and regularly
inspected by State or Federal authorities with
whom all receipts for such staples and all
transfers thereof are registered and without
whose consent no staples may be withdrawn." S3
Under the statute, bankers' acceptances secured by warehouse receipts covering the storage of staples are required to be so secured
only at the time of acceptance, except that if
such acceptances or any other kinds of acceptances are made by a member bank for one
customer up to an amount exceeding 10 per
cent of the bank's capital stock and surplus,
the acceptance must remain secured throughout
its life. In other words, the law does not require
that acceptances within the 10 per cent limitation must remain secured, either with respect
to the acceptance authority of member banks
or the discounting authority of Federal Reserve
Banks. By regulation, however, the Board provided that acceptances to finance the storage
of staples, in order to be eligible for discount,
must continue to be secured throughout the
life of the acceptance by some form of security
in addition to the customer's general credit,
whether or not the acceptance exceeded 10 per
cent of the member bank's capital and surplus.84 This requirement was first included in
Regulation A in 1920.85 If the goods were
withdrawn from storage before maturity, the
regulation permitted the substitution of a trust
receipt or other similar document covering the
goods, provided the substitution was conditioned on a reasonably prompt liquidation of
the credit. To insure compliance, the regulation
provided that, when the original documents
were released, it should be required either (1)
that the proceeds be applied within a specified
time to the liquidation of the acceptance credit,
or (2) that a new document similar to the
original be substituted in a specified time.

PLACE OF STORAGE
At an early date the Board ruled that acceptances secured by the storage of staples
were eligible for discount even though the


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Federal Reserve Bank of St. Louis

staples were stored in a warehouse in a foreign
country. Such acceptances involved drafts that
were payable in dollars in the United States
and that were drawn abroad and accepted by
U.S. banks.80 In 1928 the eligibility for discount
of acceptances covering the foreign storage of
staples was expressly recognized by an amendment to Regulation A that inserted after the
word "storage" the words "in the United States
or in any foreign country." 8T

MEANING OF "READILY
MARKETABLE STAPLES"
Shortly after the law was amended in 1916
to authorize acceptances secured by the storage
of staples, the Board ruled that the term
"staples" included manufactured goods as well
as raw materials, provided the goods were nonperishable and had a wide ready market.88
Three years later the Board defined the term
"readily marketable staple" as follows: M<
A readily marketable staple may be defined
as an article of commerce, agriculture, or
industry of such uses as to make it the subject
of constant dealings in ready markets with
such frequent quotations of prices as to make
(a) the price easily and definitely ascertainable and (b) the staple itself easy to realize
upon by sale at any time.
At the same time the Board suggested that, as
a matter of prudence and protection, banks
should not consider as eligible any staple that
is so perishable as to raise doubts as to whether
its value as security can be maintained at least
for the life of the draft drawn against it.
The definition just quoted was incorporated
in Regulation A in 1920 and, surviving the
years without any change in language, it is
still set forth in a footnote in Regulation C;
however, it was omitted in the 1973 revision of
Regulation A.
In particular instances, the Board ruled that
readily marketable staples included cattle,90
coal,91 cotton and cotton yarns,92 cottonseed,93
flour,91 potatoes,03 sugar in bond,80 and wool.97
In other cases, it held that the term did not
include automobiles and automobile parts and
tires9S or whiskey or sacramental wine in
bond."

BANKERS' ACCEPTANCES

65

DOLLAR EXCHANGE
NATURE AND PURPOSE
In 1916 Paul M. Warburg, a member of the
Federal Reserve Board, made a trip to South
America. Upon his return, he wrote a letter
to Senator Robert L. Owen, then Chairman of
the Senate Banking and Currency Committee,
recommending that U.S. banks be given authority to accept drafts drawn by foreign bankers
to furnish "dollar exchange." 10° Mr. Warburg
stated that his attention had been drawn to
the fact that the means of payment employed
by the South American merchant, when settling
his obligations in Europe or in the United
States, was generally not by check but by "the
old established usage—a three months' draft on
foreign bankers, primarily British bankers."
Mr. Warburg then went on to say:
* * * If dollar exchange is to be used as
freely as sterling exchange, the foreign bankers in these South American countries must
be in a position to draw a three months' draft
on American bankers as easily as they can
draw it on British bankers.* * *
I am fully conscious of the fact that a draft
of this kind, if permitted, might be classified
as closely approaching or being a species of
the finance draft; but to the extent as above
outlined I think this draft has to be sanctioned in order to place our banks on a par
with the British banks and other foreign
banks operating in South and Central America.
If Congress will trust the Federal Reserve
Board to supervise these transactions and
keep them within proper bounds, I believe
that an amendment as here proposed would
remove a great handicap now burdening the
American banks, while any abuse of these
facilities could be stopped at any time by the
Federal Reserve Board.
Congress followed Mr. Warburg's recommendations. The Act of September 7, 1916—
the same act that authorized acceptances against
domestic shipments and storage of staples-


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Federal Reserve Bank of St. Louis

added to section 13 of the Federal Reserve Act
a new paragraph authorizing member banks
to accept drafts or bills of exchange drawn
upon them for the purpose of furnishing dollar
exchange, subject to certain limitations. It was
required that the drafts or bills must have not
more than 3 months' sight to run at time of
acceptance. It was required that they be drawn,
under regulations prescribed by the Board, by
banks or bankers in foreign countries or dependencies or insular possessions of the United
States for the purpose of furnishing dollar exchange "as required by the usages of trade"
in the respective foreign countries, dependencies, or insular possessions. The amendment
further provided that such drafts and bills might
be acquired by Federal Reserve Banks in such
amounts and subject to such regulations, restrictions, and limitations as might be prescribed by the Board. Specific limitations were
placed upon the amount of dollar-exchange
drafts that could be accepted by member banks.
In explaining the new type of acceptance in
Congress, Senator Owen said: 101
At present exchange passing from the Argentine to the United States passes through
London by sterling exchange. By this
[amendment] it is proposed to permit these
exchanges to be expressed in dollars, so as in
that way to establish a direct communication
between the South American and other foreign countries and the United States, and to
make it unnecessary, in transmitting credits,
to transmit them through London in sterling
exchange or through other European countries in terms of money of the foreign country through which the exchanges are transmitted. The purpose is to establish the dollar
exchange, so as to make the United States a
financial center for the transaction of foreign
business, and to make this country what it is
destined to be—the financial center of the
world.
Soon after the passage of the 1916 amendment, the Board noted that the custom among
foreign bankers of selling 3-month drafts in

HISTORY OF LENDING FUNCTIONS
preference to checks had originated in countries
"where the mail connections were irregular and
the foreign-exchange market was a limited one,
and where it would have been difficult for the
drawing banker to be certain that he could find
a cover against the checks drawn by him in
time to forward it by the same mail, whereas,
in drawing a three months' draft, he would feel
assured of being able to forward remittances
before his obligation fell due." 102 In areas
where these conditions did not exist, the Board
felt that dollar-exchange acceptances were not
justified.
As observed by Mr. Warburg, dollar-exchange drafts are in the nature of "finance"
drafts. Unlike the so-called commercial acceptances discussed in previous sections of this
chapter, dollar-exchange acceptances are not
directly based on underlying commercial transactions. The Board, however, has carefully
sought to limit the use of these acceptances to
the particular species of finance transaction
covered by the statute. It has held, for example,
that they may not be used merely for the
purpose of benefiting from the fact that dollar
exchange is at a premium in the country where
the drafts are drawn.108 In its 1946 revision of
Regulation C, the Board prescribed the following "purpose" limitation: 104
Any such dollar exchange draft or bill must
be drawn and accepted in good faith for the
purpose of furnishing dollar exchange as
required by the usages of trade in the country, dependency, or insular possession in
which the draft or bill is drawn. Drafts or
bills drawn merely because dollar exchange
is at a premium in the place where drawn or
for any speculative purpose or drafts or bills
commonly referred to as "finance bills" (i.e.,
which are not drawn primarily to furnish
dollar exchange) will not be deemed to meet
the requirements of this section.
In furtherance of this limitation as to purpose, the regulation also provided that the
aggregate of drafts or bills accepted by a
member bank for any one foreign bank or
banker should not exceed an amount which
the member bank would expect the foreign
bank or banker to liquidate through the proceeds of export documentary bills or from other


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Federal Reserve Bank of St. Louis

sources "reasonably available to such foreign
bank or banker arising in the normal course of
trade." 105
The principal usefulness of dollar-exchange
acceptances arose from the fact that in some
foreign countries exports of goods were subject
to seasonal variations. This form of acceptance
enabled banks in such countries to provide
dollars to their customers to finance imports
from the United States during seasonally low
export periods, such acceptances to be repaid
with dollars acquired out of the proceeds of
later exports.100 Despite their usefulness for
this purpose, however, dollar-exchange acceptances never constituted a very large proportion
of the total amount of acceptances made by
member banks under the Federal Reserve Act.

PERMISSION TO ACCEPT
DOLLAR-EXCHANGE DRAFTS
The statute does not specifically provide
that a member bank must obtain the Board's
permission before accepting dollar-exchange
drafts or that such drafts may be accepted
only when drawn by bankers in countries
designated by the Board. The law does provide,
however, that dollar-exchange drafts must be
"drawn under regulations to be prescribed"
by the Board. Pursuant to this provision, the
Board by regulation has required that a member
bank must have the Board's prior permission
before it accepts any dollar-exchange drafts
and also that a member bank may accept such
drafts only for bankers in those foreign countries that have been expressly designated by
the Board.
The Board's first regulation on this subject
was issued in September 1916 as Regulation
C.107 It provided simply that any member bank
desiring to accept drafts drawn by foreign banks
or bankers should apply to the Board for such
authority, setting forth the usages of trade in
the respective countries in which such banks or
bankers were located; that, if the Board determined that the usages of trade required, the
Board would so notify the applying bank and
publish in the Federal Reserve Bulletin the
names of the countries approved for this purpose; but that the Board reserved the right

BANKERS' ACCEPTANCES
to modify, or, on 90 days' notice, to revoke
either its approval as to the particular member
bank or its approval as to any foreign country.
In its contemporaneous revision of Regulation A,108 the Board stated that the Federal
Reserve Banks were authorized to discount
for member banks dollar-exchange acceptances
made in accordance with Regulation C.
The provisions of Regulation C as first issued,
treating together the authority of member banks
to accept dollar-exchange drafts and their authority to accept for bankers in specified foreign
countries, continued unchanged until 1946.
When the regulation was revised in that year,
the two authorities were separated.
As to the authority of member banks to
make dollar-exchange acceptances, the 1946
Regulation C provided, and continues to provide, that a member bank must file with the
Board, through the Federal Reserve Bank of
its district, an application for permission to
accept dollar-exchange drafts.109 The application need not be in any particular form, but it
must show "the present and anticipated need"
for the authority requested. The Board reserves
the right to rescind any such permission after
not less than 90 days' notice in writing to the
bank affected.

DESIGNATED COUNTRIES
Since the law permitted dollar-exchange acceptances only with respect to those countries
in which such acceptances were required by
the usages of trade, the Board felt it necessary
to assume the responsibility for determining
what particular countries met this requirement.
As already noted, in its first regulation on the
subject the Board required any member bank
a
PPlying for permission to accept dollar-exchange drafts to set forth the usages of trade in
the countries for which it desired to accept
such drafts, and the Board stated that it would
Publish in the Federal Reserve Bulletin the
names of the countries approved by it for this
purpose.
Late in 1916 the Board published examples
°f letters written by it to member banks approving and declining to approve certain foreign
countries as eligible for dollar-exchange


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Federal Reserve Bank of St. Louis

67

drafts."0 It quoted a letter declining to approve
England and France for this purpose, because
it appeared that there was "no difficulty in
securing in London or Paris cable transfers or
checks on the United States." At the same time,
it indicated that it had given approval to the
acceptance of dollar-exchange drafts for banks
or bankers in Puerto Rico, Santo Domingo,
Costa Rica, Peru, Chile, Brazil, Venezuela,
Argentina, and Bolivia. In 1918, Colombia,
Ecuador, Nicaragua, Uruguay, and Trinidad
were added to the list.111 In 1920, the following
countries were also added: British Guiana,
British Honduras, Cuba, Dutch Guiana, French
Guiana, Honduras, Panama, Paraguay, and
San Salvador.112 Up to this time, only South
and Central American countries (plus Cuba)
had been included in the list. In 1921, however,
the Board designated Australia, New Zealand,
and "other Australasian dependencies."113
Finally, in 1922, the list was expanded to include the French West Indies, Guatemala, and
the Dutch East Indies.111 No countries have
been added to the list since 1922. Also, no
countries have been removed from the list, although the reference to Santo Domingo now
refers to Haiti.
It should be noted that member banks that
have been authorized to accept dollar-exchange
drafts with respect to countries designated by
the Board at the time the authority was granted
also have authority to accept such drafts for
countries subsequently designated by the Board
without the necessity for any further permission
from the Board.115
As revised in 1946, Regulation C provided "°
that member banks having authority to accept
dollar-exchange drafts might accept such drafts
only with respect to the countries specified in
the list published by the Board, but that a
member bank desiring to accept for bankers in
countries not specified in such list might request
the Board to add such countries to the list upon
a showing that the furnishing of dollar exchange
was required by the usages of trade. The regulation also noted that the Board might at any
time, after 90 days' published notice, remove
the name of any country from such list.
As has been observed, no countries have
been added to or removed from the list since

68

HISTORY OF LENDING FUNCTIONS

1922. Extensive changes have taken place since
that time in the usages of trade in foreign
countries affecting dollar exchange; and unless
the law is construed as authorizing dollarexchange acceptances for purposes broader
than those envisaged by Mr. Warburg after his
1916 trip to South America, one may question
whether many—or any—of the countries designated by the Board before 1922 as justifying
dollar-exchange drafts actually warrant that
designation under present conditions.

QUESTION REGARDING PRESENT
LEGAL AUTHORITY
An interesting technical question has been
raised as to whether the twelfth paragraph of
section 13 of the Federal Reserve Act—the
paragraph authorizing dollar-exchange acceptances—is still an effective part of the law.
In 1952, when the U.S. Code was revised
under the auspices of the House Judiciary
Committee, the revision omitted the dollarexchange paragraph that had previously been
carried in section 373 of Title 12. A note by
the codifier stated that the provisions of this
section had been added to section 5202 of the
Revised Statutes by the Act of September 7,
1916, but had been omitted in the further
amendment made to section 5202 by the Act
of April 5, 1918. For the same reasons, the
codifier also omitted the eleventh paragraph of
section 13 of the Federal Reserve Act, relating
to the right of national banks to act as insurance
agents and real estate loan brokers, which had
previously been carried as section 92 of
Title 12.
Apparently, the basis for the codifier's omission of these provisions was as follows:
Section 13 of the original Federal Reserve
Act had amended section 5202 of the Revised
Statutes, which limited the aggregate indebtedness of national banks, by adding an exception
with respect to liabilities incurred under the
Federal Reserve Act; the amended section 5202
had been set forth in full in section 13 of the
Federal Reserve Act, although without quotation marks.
The Act of September 7, 1916, amended
section 13 of the Federal Reserve Act and, in

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Federal Reserve Bank of St. Louis

doing so, set forth the amended section in full.
However, instead of quoting the entire section
within a single set of quotation marks, the
amending act closed the quotation at the end
of what is now the eighth paragraph of section
13. The ninth paragraph, beginning without
quotation marks, then quoted section 5202 of
the Revised Statutes as it had been amended
by the original Federal Reserve Act and continued the quotation until the end of the revised
section 13, thus making it appear that the
tenth, eleventh, and twelfth paragraphs of section 13 were a part of section 5202. Those
paragraphs related, respectively, to the authority
of the Federal Reserve Board to regulate discounts by the Federal Reserve Banks, the
authority of national banks to act as insurance
agents and real estate loan brokers, and the
authority of member banks to accept dollarexchange drafts. None of these paragraphs, of
course, had any relation to the matter covered
by section 5202 of the Revised Statutes—
limitations on aggregate liabilities of national
banks.
Two years later the War Finance Corporation
Act of April 5, 1918, rewrote section 5202 in
order to except liabilities incurred under that
act from the limitation on the aggregate indebtedness of national banks. The rewritten
section—naturally enough—did not include the
material contained in the tenth, eleventh, and
twelfth paragraphs of section 13 of the Federal
Reserve Act. Nevertheless, because of the
peculiar placement of quotation marks in the
1916 amendment, the codifier of the 1952
U.S. Code concluded that the eleventh and
twelfth paragraphs of section 13 had been
repealed by the 1918 revision of section 5202.
Rather inconsistently, he did not conclude that
the tenth paragraph of section 13 had also been
repealed.
When the matter came to the attention of
the Board in 1954, Chairman Martin wrote a
letter to the House Judiciary Committee in
which, for reasons set forth in an enclosed
memorandum,117 he expressed the view that the
omitted paragraphs were still effective law
and suggested that their erroneous omission be
corrected. However, no action was taken for
this purpose.

BANKERS' ACCEPTANCES
In January 1958 when the proposed Financial Institutions Act was being considered by
the House Banking and Currency Committee,
Mr. Patman charged that a provision of the
bill that purported to amend the eleventh paragraph of section 13 of the Federal Reserve
Act, regarding the authority of national banks
to act as insurance agents, was misleading and,
indeed, was a reflection on the integrity of the
whole bill, because that paragraph had in fact
been "repealed 40 years ago." 11S This led to
a heated debate that partially contributed to
the death of the entire bill in the House committee.
The debate evoked legal memoranda in support of the continued legal effectiveness of the
eleventh paragraph of section 13 and, necessarily, also of the twelfth paragraph relating
to dollar-exchange acceptances. The record
of the hearing contained such memoranda
prepared by counsel for the advisory committee of bankers that had assisted the Senate
Banking and Currency Committee in its consideration of the bill and by the general counsel
to the House Banking and Currency Committee.1111 The record also included a letter from
the Comptroller of the Currency in support of

69

the validity of the eleventh paragraph, and the
Comptroller's letter appended the memorandum
that had been submitted by the Board in
1954.120 A memorandum from the Legislative
Reference Section of the Library of Congress,
submitted by Mr. Patman himself, lent support
to the validity of the questioned provisions of
the law, although it expressed no definite
opinion.121
When the U.S. Code was revised in 1958,
the codifier again omitted both section 373 and
section 92 of Title 12. They were omitted again
in the 1970 edition of the U.S. Code.
As was pointed out in the legal memoranda
previously mentioned, repeal of these provisions
was clearly not intended by the 1918 amendment; court decisions since 1918 have assumed
that both provisions continued in effect; and
both the Comptroller of the Currency and the
Board have acted for over 40 years on the
assumption that the provisions are still in
force. For these reasons, it seems abundantly
clear that the codifier's omission of the provisions from the U.S. Code (which, after all, is
only presumed to be the law) was an error
arising from a too literal regard for quotation
marks.

MATURITIES
ACCEPTANCES BY MEMBER
BANKS
With respect to both maturities and amounts,
the law makes a distinction between commercial
bankers' acceptances and dollar-exchange acceptances and also between the authority of
member banks to accept and the authority of
Reserve Banks to discount.
With respect to the acceptance authority of
member banks, the original Federal Reserve
Act provided that such banks might accept
drafts or bills of exchange growing out of the
importation or exportation of goods only if the
drafts or bills had "not more than six months'


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Federal Reserve Bank of St. Louis

sight to run." When additional authority for
the acceptance of drafts and bills based on
domestic shipments of goods and the storage
of staples was granted in 1916, this maturity
limitation was not changed, except to exclude
days of grace from the prescribed 6-month
period. The limitation remains the same today:
Commercial acceptances by member banks
may not have a maturity at the time of acceptance of more than 6 months, not counting
days of grace.
In its regulations on the subject, the Board
has merely restated the maturity requirement
of the law.123 In some of its early rulings, however, the Board took the position that certain

70

HISTORY OF LENDING FUNCTIONS

kinds of acceptances, particularly those covering domestic shipments of goods, should be
even more restricted as to maturity than required by the law. Thus, it held that a draft
drawn solely to finance a shipment of goods
should not have a maturity greater than that
approximating the period required for the shipment.123 However, if the draft were drawn to
finance the subsequent sale as well as the shipment of the goods, the Board held that the
maturity of the acceptance need not be limited
to the period of the shipment.121 In a 1929
ruling, the Board took the more liberal position
that, even if the shipment itself covered only
a relatively short time, the draft drawn to
finance it was eligible for acceptance if it had
a maturity consistent with the usual and customary credit time prevailing in the particular
business.125
With respect to the acceptance of dollarexchange drafts by member banks, the law
fixes a maximum maturity only half as long
as that fixed for commercial acceptances. As
has been noted, the practice of South American
bankers that had been observed by Mr. Warburg in 1916 was to draw 3-month drafts;
presumably, it was this practice that led Congress to provide that member banks should
accept only dollar-exchange drafts that have
"not more than three months' sight to run,
exclusive of days of grace."
The Board's regulations have never imposed
any additional limitations on the maturity of
dollar-exchange acceptances, nor has the Board
published any interpretations relating to this
limitation.

DISCOUNT BY FEDERAL
RESERVE BANKS
As distinguished from the 6-month maturity
requirement imposed by the original Federal
Reserve Act upon the authority of member
banks to accept drafts growing out of the
importation or exportation of goods, the Act
authorized the Federal Reserve Banks to discount such acceptances only if they had "a
maturity at the time of discount of not more
than three months." When in 1916 member


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Federal Reserve Bank of St. Louis

banks were also authorized to accept drafts
based on domestic shipments of goods and
the storage of staples, their eligibility for discount was made subject to the same maturity
requirement, although the requirement was
slightly changed at that time to refer to 3
months' "sight, exclusive of days of grace."
The Agricultural Credits Act of 1923, for
reasons noted in a previous chapter, liberalized
the maturity requirement as to agricultural
acceptances by permitting such acceptances, if
secured by warehouse receipts or other such
security documents, to have a maturity at the
time of discount of not more than 6 months.
Otherwise, no changes have been made in the
provisions of the original Federal Reserve Act
on this point. To be eligible for discount, all
bankers' acceptances—dollar exchange as well
as commercial—must have a maturity of not
more than 90 days at the time of discount,
except that agricultural acceptances may have
maturities of up to 6 months.
Although the Board has never undertaken to
limit further by regulation the maturity limitations placed by the statute on the acceptance
authority of member banks, it has done so with
respect to the maturity fixed by the law for the
discounting of bankers' acceptances. In its 1920
revision of Regulation A, the Board stated that
although acceptances might legally be discounted with maturities of up to 3 months,
nevertheless a Reserve Bank might decline to
rediscount any acceptance if its maturity "is in
excess of the usual or customary period of
credit required to finance the underlying transaction or * * * is in excess of that period
reasonably necessary to finance such transactions." 12e As has been seen, the same principle
was applied by the Board, though in published
rulings rather than regulations, to the maturity
of drafts covering domestic shipments of goods
that were eligible for acceptance by member
banks. 1 "
With respect to the discounting of acceptances based on the storage of readily marketable staples, the Board's Regulation A, as revised in 1920, stated that since the purpose of
such acceptances is to permit their temporary
holding pending sale, shipment, or distribution,

BANKERS' ACCEPTANCES
no such acceptance offered for discount should
have a maturity "in excess of the time ordinarily
necessary to effect a reasonably prompt sale,
. shipment, or distribution into the process of
manufacture or consumption."
These rules adopted in 1920 were still to be
found, unchanged, in the 1955 revision of
Regulation A, Jis but they were eliminated in
the 1973 revision of the regulation.

RENEWALS
Despite the statutory limitations on maturity,
nothing in the discount provisions of the Federal Reserve Act precludes the renewal of a
draft accepted by a member bank. However,
the draft must be such as to be eligible for
acceptance at the time of renewal. Thus, in
certain early rulings the Board held that if a
draft drawn to finance an importation or exportation of goods were renewed after the completion of the shipment, the renewal draft could
not be said to grow out of an import or export
transaction and, if eligible for acceptance at all,
it would have to be as a draft based on a
domestic storage transaction.1111 Similarly, a
draft originally secured by warehouse receipts
or bills of lading that were later released could
not, upon its renewal, be eligible for acceptance
unless the renewal draft complied at the time of
renewal with the requirements of the Board's
regulations.130
In one of its earliest regulations on the
subject, the Board specifically provided that a
wll to finance an import or export transaction
"must not be drawn or renewed after the goods
have been surrendered to the purchaser or consignee." »« A few months later, however, the
B
»ard amended this provision to make it
slightly more liberal: An exception was added
to permit renewal after surrender of the goods
for such reasonable period as may have been
agreed upon at the time of the opening of the
wedit as a condition incidental to the importation or exportation involved, provided that the
bill must not contain or be subject to any
condition whereby the holder thereof is obligated to renew the same at maturity." " J In a


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Federal Reserve Bank of St. Louis

71

press statement at the time the Board declared: "-1
This broadening of the conditions upon
which acceptances are based is intended to
comply with existing mercantile customs, and
to permit the development of the business
more freely than at present, particularly
through the use of drafts drawn in American
currency.* * *
Notwithstanding this seeming liberalization
of its attitude toward renewals after the surrender of the goods, the Board in 1919 held
generally that a renewal draft should not be
accepted if at that time the period required for
the completion of the transaction out of which
the original draft arose had elapsed.131 This
ruling was incorporated in the Board's 1920
revision of Regulation A as follows:135
• * * no renewal draft whether or not
contracted for in advance, can be eligible if
at the time of its acceptance the period required for the conclusion of the transaction
out of which the original draft was drawn
shall have elapsed.
Although this statement regarding renewals was
eliminated when the regulation was next revised
in 1922, the Board indicated that no change in
its previous rulings was intended.
In 1927, however, a much more liberal position was reflected in a published interpretation
in which the Board held that bankers' acceptances could properly be considered as growing
out of transactions involving the importation
or exportation of goods when drawn to finance
the sale and distribution of imported or exported goods into the channels of trade, whether
or not the bills were accepted after the physical
importation or exportation had been completed."6
A member bank may not unconditionally
agree in advance to accept a renewal draft,137
nor may a Federal Reserve Bank agree in advance to discount renewal acceptances."9 Eligibility for acceptance in the one case and for
discount in the other must depend upon the
circumstances existing at the time of the renewal.

72

HISTORY OF LENDING FUNCTIONS

AMOUNT LIMITATIONS
ACCEPTANCE BY MEMBER
BANKS
As in the case of the maturity limitations,
distinctions must be made (1) between limitations on the amount of drafts that a member
bank may accept and on the amount of acceptances that a Federal Reserve Bank may
discount, and (2) between so-called commercial acceptances and dollar-exchange acceptances. In addition, a third distinction must be
drawn between acceptances for one customer
and aggregate acceptances for all customers.
Beginning with the limitations on the acceptance authority of member banks, it is in
order first to consider the limitations on the
amount of commercial drafts that a member
bank may accept for one customer. No such
limitations were contained in the original Act.
By the Act of September 7, 1916, however,
section 13 of the Federal Reserve Act was
amended to provide that no member bank
should accept, whether in a foreign or a domestic transaction, for any one person, company,
firm, or corporation in an amount equal at any
one time in the aggregate to more than 10 per
cent of the bank's capital stock and surplus,
unless the bank was secured "either by attached
documents or by some other actual security
growing out of the same transaction as the
acceptance." 139 This limitation has never been
modified and is still in effect.
In construing the limitation, the Board in an
early ruling held that the "person" to which it
referred was the person who had entered into
an agreement with the member bank to protect
it against loss and to whom the bank had lent its
credit in the form of an acceptance, whether or
not such person was the drawer of the draft or
some other customer of the bank.110
In another early ruling the Board made it
plain that the limitation did not prohibit a
member bank from accepting drafts in an
amount greater than 10 per cent for one personit meant only that, if for more than 10 per cent'


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Federal Reserve Bank of St. Louis

the bank must hold some "actual security" as
to the excess.1" Within the 10 per cent limitation, the bank could properly rely on the customer's general credit.
The term "actual security" was interpreted
as including shipping documents and warehouse
receipts,112 and also a trade acceptance accepted by the drawee.113 Moreover, there was
nothing to prevent the release of the original
security for the acceptance provided that, if
the acceptance were in excess of the 10 per cent
limitation, there was a substitution of some
other actual security growing out of the same
transaction, such as warehouse receipts " ' or
new drafts with bills of lading covering the same
goods.113
In this connection, an oft-recurring question
was one that related to the circumstances under
which a trust receipt might be regarded as actual
security. In several published rulings the Board
established the principle that a trust receipt was
adequate only if it did not permit the purchaser
to retain control of the goods.118 This principle
was incorporated in the Board's 1920 revision
of Regulation C. It was specifically provided
that a trust receipt that permitted the customer
to have access to, or control over, the goods
involved would not be considered actual security for purposes of the 10 per cent limitation,
but that a bill-of-lading draft would constitute
actual security even after the documents had
been released, provided the draft was accepted
by the drawee upon or before the surrender of
the documents.117 The present Regulation C J4S
contains a substantially similar provision to the
effect that the member bank shall be and
remain secured as to the excess over 10 per cent
of its capital stock " • and surplus by attached
documents or other actual security and that a
trust receipt permitting the customer to have
access to or control over the goods will not be
considered actual security for this purpose.
In addition to a limitation on acceptances for
any one customer, the framers of the original
Federal Reserve Act felt that a limitation on

BANKERS' ACCEPTANCES
the aggregate amount of drafts that a member
bank might accept was also desirable. The Act
specifically provided that no member bank
should accept bills in an amount equal at any
time in the aggregate to more than one-half the
bank's paid-up capital stock and surplus.
Apparently, however, it was soon found that
more leeway was needed. By an amendment of
March 3, 1915,150 an exception was added to
permit a member bank to accept up to as much
as 100 per cent of its capital stock and surplus
if granted such authority by the Federal Reserve
Board under regulations applicable to all member banks regardless of capital stock and surplus.
Acting under this amendment to the law, the
Board issued a new regulation151 by which it
authorized any member bank to accept up to
100 per cent of its capital stock and surplus
under the following conditions: (1) The bank
was required to have an unimpaired surplus of
not less than 20 per cent of its paid-in capital;
(2) it was required to file a formal application
with the Federal Reserve Bank of its district
that would report to the Board on the standing
of the applicant; and (3) any such application
had to be approved by the Board, such approval
to be subject to rescission on 90 days' notice.
When the law was amended in 1916 to
authorize acceptances growing out of domestic
shipments of goods and the storage of readily
marketable staples, the provision authorizing
100 per cent acceptances with the authority of
the Board was omitted, apparently through inadvertence. In its Annual Report to Congress
for 1916, the Board recommended an amendment "to restore the provision which was by
error stricken from the Act in the amendments
of September 7, 1916, thus restoring to national
banks, with the approval of the Federal Reserve
Board, the right to accept up to 100 per cent
of their capital and surplus in transactions involving imports and exports." 15=
In accordance with the Board's recommendation, the provision was restored by the Act of
June 21, 1917,153 but with a new proviso to the
effect that the aggregate of acceptances growing
out of domestic transactions should in no event
exceed 50 per cent of a member bank's capital
stock and surplus. In other words, while the


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Federal Reserve Bank of St. Louis

73

Board might authorize a member bank to accept
drafts, both domestic and foreign, in an aggregate amount of more than 50 per cent, it could
not in any case permit the bank to accept more
than 50 per cent in domestic transactions.154
After the provision for 100 per cent acceptance authority was restored, the Board, in its
1917 revision of Regulation C, again provided
that any bank might apply for such authority if
it had surplus equal to at least 20 per cent of
its capital; but in this revision the Federal Reserve Bank with which the application was filed
was required to report to the Board not only
as to the standing of the applicant bank but
also as to whether business and banking conditions prevailing in its district warranted the
granting of the application.155
These regulatory provisions regarding the
100 per cent acceptance authority remained
substantially unchanged until 1946. When Regulation C was revised in that year, the requirement that the applicant's surplus be at least 20
per cent of its capital was omitted. The revised
regulation also omitted the specific provisions
for reports by the Federal Reserve Bank. However, a new provision stated that while the application need not be in any particular form, it
must show "the present and anticipated need of
the applicant bank for the authority requested." 15li The regulation continued, as in the
past, to reserve to the Board the right to rescind
any such authority after not less than 90 days'
notice in writing. As might naturally have been
expected, only a relatively few of the larger
banks of the country have felt it necessary to
obtain the Board's permission to accept drafts
amounting in the aggregate to more than half
their capital and surplus.
Two additional points should also be noted.
First, a member bank's own acceptances purchased by it before maturity are not to be
counted in determining the aggregate amount
of acceptances outstanding, since by purchasing
them the bank's obligation as to such acceptances is cancelled.157 Second, when a member
bank accepts commercial drafts or bills at the
request of another member bank that agrees to
put the accepting bank in funds to meet such
acceptances at maturity, drafts and bills so accepted must be considered as acceptance liabili-

74

HISTORY OF LENDING FUNCTIONS

ties of both the accepting bank and the requesting bank for purposes of the aggregate-amount
limitations of the law and the Board's regulations.158
The authority granted member banks to accept drafts drawn for the purpose of furnishing
dollar exchange, like their authority to accept
commercial drafts, is subject to limitations both
as to the amount that may be accepted for one
customer and as to the aggregate amount for
all customers. Moreover, these limitations are
separate and distinct from, and not to be included in, the amount limitations prescribed as
to commercial acceptances."9
Under the law, no member bank may accept
dollar-exchange drafts for any one bank in an
amount greater in the aggregate than 10 per
cent of the accepting bank's paid-up and unimpaired capital and surplus, unless the draft is
accompanied by documents "conveying or securing title or by some other adequate security." ™° In its Regulation C, the Board has made
it clear that the limitation refers to drafts drawn
by foreign bankers as well as by foreign banks
and that only the excess over the 10 per cent
limit must remain secured by security documents.161
As has been noted in connection with dollarexchange acceptances in general, the Board by
regulation has prescribed an additional limitation on the amount of such acceptances that
may be made for any one foreign bank or
banker, but its primary purpose is to insure that
the drafts accepted are actually for the purpose
of furnishing dollar exchange. It requires that
the aggregate of drafts and bills accepted for
any foreign bank or banker shall not exceed an
amount that the accepting member bank would
expect the foreign bank or banker to liquidate
through the proceeds of documentary bills or
other sources reasonably available to the foreign
bank or banker arising in the normal course of
trade.182
The aggregate amount of dollar-exchange
drafts that a member bank accepts and has
outstanding at any one time, as distinguished
from the amount accepted for any one foreign
bank, may not exceed 50 per cent of the bank's
capital and surplus. This limit cannot be exceeded, as may be done in the case of the


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Federal Reserve Bank of St. Louis

limitation on the aggregate amount of commercial acceptances, with the authority of the
Board. Moreover, the limitation on the aggregate amount of dollar-exchange acceptances is
separate and distinct from the aggregate limitation placed by the law on commercial acceptances.
As in the case of commercial acceptances,
dollar-exchange drafts accepted by one member
bank at the request of another must be considered as part of the acceptance liabilities of
each of such member banks for purposes of the
amount limitations on the making of dollarexchange acceptances.1**

DISCOUNT BY FEDERAL
RESERVE BANKS
Like all other paper discounted by the Federal Reserve Banks, bankers' acceptances must
comply with the general requirement that the
aggregate amount of paper rcdiscountcd for any
member bank upon which any one person is
liable as maker, acceptor, endorser, drawer, or
guarantor shall not exceed the amount for
which one person may become liable to a national bank under section 5200 of the Revised
Statutes. This means that a draft accepted by
a member bank for a particular customer cannot be eligible for discount with the Reserve
Bank if the total amount of acceptances made
for that customer and then outstanding exceeds
10 per cent of the member bank's capital and
surplus, unless, as may well be the case, the
situation is one that falls within one of the
various exceptions to section 5200 of the Revised Statutes.
In addition to this general requirement, the
Board by regulation made it a condition to the
discount of a banker's acceptance that drafts
accepted by a member bank for any one customer in excess of 10 per cent of the capital
and surplus of the accepting bank must remain
actually secured throughout the life of the acceptance.161 This requirement was, of course,
comparable to the limitation imposed by the
law and the Board's Regulation C on the
amount of drafts that a member bank might
accept for one customer. Supplementing this
requirement, Regulation A provided in a foot-

BANKERS' ACCEPTANCES
note that, in the case of acceptances in excess
of the 10 per cent limitation, such acceptances
must be secured by shipping documents, warehouse receipts, or some other actual security
growing out of the same transaction as the
acceptance, such as documentary drafts, trade
acceptances, terminal receipts, or trust receipts. If trust receipts were the security for
the draft, they were required to be such as
to provide an effective and lawful lien in favor
of the accepting bank and they could not be
considered actual security if they permitted the
customer to have access to or control over the
goods.
Apart from these limitations on the amount
of acceptances that may be discounted for one
customer, neither the law nor Regulation A
imposes any limitations on the amount of
acceptances—whether commercial or dollar exchange—that may be discounted by the Federal
Reserve Banks. Even the limitations with respect to acceptances for one customer were
omitted from the revision of the regulation
adopted in 1973. In the case of dollar-exchange
drafts, the statute provides that they "may be
acquired by Federal Reserve Banks in such
amounts * * * as may be prescribed by the
Board"; but the Board has never exercised this
authority.
It should be noted, however, that the original
Federal Reserve Act limited the aggregate
amount of acceptances that a Federal Reserve
Bank might discount for any one member bank
(as distinguished from any one customer of a
member bank) to one-half the capital stock and
surplus of the member bank. By an amendment
of March 3,1915, this limitation was liberalized
to permit the discount of acceptances for a
member bank, with the authority of the Board,

75

of up to 100 per cent of the member bank's
capital stock and surplus."5 Pursuant to this
provision, the Board by regulation gave the
Reserve Banks blanket authority to discount
acceptances for a member bank up to the
amount of its capital stock and surplus.166
At the same time—in 1915—the Board provided that bills accepted by any private banker
and rediscounted by a Federal Reserve Bank
should not exceed 5 per cent of the paid-in
capital stock of the discounting Reserve Bank,
unless the acceptances were secured by a lien
on the goods or transfer of title thereto, and
that in no event should the aggregate amount
of acceptances of any private banker to be
rediscounted by a Reserve Bank exceed 25
per cent of the Reserve Bank's paid-in capital
stock. Later in the same year these specified
limits on discounts of acceptances of private
bankers were omitted, leaving the percentages
to be fixed from time to time by the Board.107
When section 13 of the Act was amended by
the Act of September 7, 1916, the provision
limiting the amount of acceptances that might
be discounted for any member bank was
omitted. Subsequent regulations of the Board
omitted the limitations on the discounting of
acceptances of private bankers. Consequently,
the only remaining amount restrictions on the
discounting of acceptances—as distinguished
from those imposed on the acceptance powers
of member banks—were those that in general
precluded the discounting of paper accepted by
a member bank for one borrower in excess of
10 per cent of such bank's capital and surplus
unless the excess remained actually secured
throughout the life of the acceptance. As has
been noted, these restrictions were not included
in the 1973 revision of Regulation A.

LETTERS OF CREDIT AND SYNDICATE CREDITS
Although a member bank may not unconditionally agree in advance to renew outstanding
acceptances, it may enter into an agreement


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Federal Reserve Bank of St. Louis

with a customer to accept his drafts over a
specified period of time, provided they are
eligible at the time of acceptance.168 The trans-

76

HISTORY OF LENDING FUNCTIONS

action may take the form of a commercial letter
of credit issued by a bank for its customer
under which the bank agrees to honor drafts
that may be drawn under the letter.169
Because commercial letters of credit may
frequently be used to finance import or export
transactions and because large city banks are
better known abroad than small interior banks,
it sometimes happens that an interior bank will
appoint a large city bank as its agent for the
issuance of a letter of credit and the acceptance
of drafts drawn thereunder. While a national
bank is without authority to guarantee letters
of credit, the Board in 1921 held that under
such an arrangement an interior national bank
could agree unconditionally to reimburse its
agent for any moneys put out by it or to put
the agent bank in funds to meet maturing acceptances under such a letter of credit.170
Drafts accepted by the agent bank, under an
arrangement of the kind just described, at the
request of another member bank must be regarded as acceptance liabilities of both the
accepting bank and the requesting bank for
purposes of the aggregate amount limitations
discussed in a previous section of this chapter. 1 "
However, the letter of credit itself, since it is
only an agreement to make acceptances, is not
subject to the limitation prescribed by section
13 of the Federal Reserve Act on the aggregate
amount of acceptances that a member bank may

have outstanding at any one time. 1 " Nevertheless, the Board once cautioned member banks
to exercise prudence in issuing letters of credit
under which acceptances in excess of this limitation might result.
At one time, in the early days of the development of acceptances, the Board apparently
became concerned by the growth of "syndicate"
acceptance credits providing for the extension
of acceptance credits by groups of banks. It
felt called upon to publish a statement outlining
certain principles that should be followed by
accepting banks in their own interests and in
order to avoid the necessity for issuing rigid
and inflexible regulations on the subject. The
Board urged that since acceptance transactions
call for direct contact between banks and borrowers, syndicate credits should be avoided.
In addition, it stated that the duration of acceptance credits should not normally exceed 1
year and in no case 2 years; that such credits
should relate to transactions of a legitimate
commercial nature and should not be for the
purpose of furnishing working capital; that
agreements by bankers to furnish 1-ycar or
2-year credit at a definite rate of interest to
finance themselves should not be countenanced;
and that, whenever syndicates were formed to
furnish acceptance credits for more than moderate amounts, the Federal Reserve Banks
should be consulted. 1 "

DIMINISHED IMPORTANCE OF ELIGIBILITY REQUIREMENTS
The numerous technical regulatory requirements and Board interpretations with respect to
the eligibility of bankers' acceptances for discount by the Reserve Banks are of little significance today for all practical purposes. Briefly,
this is because practically all Reserve Bank
loans to member banks are now made in the
form of advances rather than by the rediscount-


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Federal Reserve Bank of St. Louis

ing of customers' paper held by the member
banks and because advances may be made on
the security of any paper eligible for purchase
by the Reserve Banks under the Federal Reserve Act. Under section 14 of tnc Act, bankers' acceptances may be purchased by the
Reserve Banks even though they are not eligible
for discount.

BANKERS' ACCEPTANCES
The first paragraph of section 14 authorizes
any Reserve Bank to purchase in the open
market "cable transfers and bankers' acceptances and bills of exchange of the kinds and
maturities by this Act made eligible for rediscount, with or without the indorsement of a
member bank." IU This language was part of
the original Act and has never been changed.
In 1923 the Board interpreted the language as
meaning that a Reserve Bank may purchase a
banker's acceptance even though it is not of
the kind or maturity made eligible for rediscount. In this connection, the Board said: ' "
At first glance, it would appear that only
bankers' acceptances of ihc kinds and maturities made eligible for rediscount could be
purchased in the open market, but, upon
careful consideration of the language of this
section, it will be found (hat the phrase "of
the kinds and maturities by this act made
eligible for rediscount" qualifies only "bills
of exchange" and docs not qualify "bankers'
acceptances." Accordingly, bankers' acceptances may, subject to the board's regulations,
be eligible for purchase in the open market
by Federal reserve banks, even though
not of the kinds and maturities made eligible
for rediscount. This construction of section
14 has been adopted by the board since 1916,
when the board first provided in its regulations that a Federal reserve bank might purchase in the open market bankers' acceptances based upon the domestic storage of
goods under contract of sale, even though
such acceptances would not be eligible for
rediscount by Federal reserve banks * * *.

As will be noted in a later chapter, Congress
1916 amended section 13 of the Federal
Reserve Act to authorize the Reserve Banks to
made direct advances to member banks on
their own promissory notes for periods of up to
15 days provided such notes were secured by
"such notes, drafts, bills of exchange, or bankers' acceptances as are eligible for rediscount or
for purchase by Federal reserve banks under the
Provisions of this Act." Consequently, following
the Board's 1923 ruling that bankers' acceptances were eligible for purchase even though
in


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Federal Reserve Bank of St. Louis

77

not eligible for discount, it became permissible
for a Reserve Bank to make an advance to a
member bank on the security of a banker's
acceptance that would have been ineligible for
rediscount. In 1933, the law was amended to
permit advances to member banks on paper
eligible for rediscount or for purchase by the
Reserve Banks for periods of up to 90 days.170
It is still conceivable, though very unlikely,
that a member bank might seek to borrow from
its Reserve Bank by offering bankers' acceptances for discount, but it is almost certain that
the member bank would apply for an advance
on the security of such a banker's acceptance.
Consequently, the technical requirements of
Regulation A with respect to the discounting
of bankers' acceptances would not be applicable.
Despite these considerations, Regulation A
continued until 1973 to include detailed provisions, both in the text and in footnotes, regarding requirements for the discounting of bankers'
acceptances. Since, for the reasons here indicated, these provisions no longer served any
practical purpose, they were replaced in the
1973 general revision of Regulation A by a
short paragraph that merely paraphrases, in
condensed language, the provisions of section
13 of the Act with respect to commercial
bankers' acceptances and dollar-exchange acceptances.
Although section 14 of the Act authorizes
the Reserve Banks to purchase in the open
market bankers' acceptances that are not eligible for discount, the regulations of the Federal
Open Market Committee provide that the Reserve Banks may purchase in the open market
only acceptances of the kinds made eligible for
purchase under the Board's Regulation B. 1 "
The Board's Regulation B, which has not been
changed since 1923, purports to govern open
market purchases by the Reserve Banks of bills
of exchange, trade acceptances, and bankers'
acceptances. One of the requirements of that
regulation is that a banker's acceptance eligible
for purchase must also be eligible for discount
under the Board's Regulation A. IJS Consequently, the present technical requirements of

78

HISTORY OF LENDING FUNCTIONS

the law and of Regulation A still have some
significance in that they are made applicable,
by virtue of the FOMC's regulations, to open
market purchases of bankers' acceptances. It is
questionable whether, as a matter of policy,
such open market purchases of acceptances
need to be made subject to such requirements.


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Federal Reserve Bank of St. Louis

In any event, this docs not change the fact that,
under the law itself, acceptances may be purchased by the Reserve Banks even though not
eligible for discount and that, therefore, incligible acceptances may be taken as collateral
security for Reserve Bank advances to member
banks.

Rediscount of
World War I Veterans'Notes

It may be a relief now to turn to a minor but
interesting development in the lending authority
of the Federal Reserve Banks. This development was significant because it represented the
first instance in which the Reserve Banks were
authorized to extend direct credit accommodations to nonmember commercial banks. This
authorization was a result of the need in the
early 1920's to provide some means of enabling
veterans of World War I to use their military
life insurance policies—called adjusted service
certificates—as a basis for obtaining loans from
banks. In order to induce banks to make such
loans, the Reserve Banks were authorized to
discount for nonmember as well as member
banks the notes of veterans secured by such
certificates.
Culminating several years of agitation for a
sh bonus or some other payment to veterans,
World War Adjusted Compensation Act of
19, 1924,1 represented something of a
compromise. It provided for the issuance of
adjusted service certificates to all veterans of
World War I; these certificates, in effect, were
20-year endowment insurance policies based in
F

general on years of military service. Each certificate was dated as of the first day of the
month in which the veteran's application for the
certificate was filed, but in no event could a
certificate be dated before January 1, 1925.
The face amount of the certificate was payable
after 20 years to the veteran or, if he died in
the meantime, to his beneficiary.
A means was provided, however, by which
the veteran could obtain cash on the basis of
his certificate, although not immediately. Section 502(b) of the act authorized any national
or State bank, after 2 years from the date of the
certificate, to make a loan to a veteran on his
own note secured by the certificate in an amount
not to exceed 90 per cent of the certificate's
current reserve value. The interest rate charged
on any such loan was limited to a rate not more
than 2 per cent above the discount rate currently charged on 90-day commercial paper by
the Federal Reserve Bank of the district. Any
bank making such a loan was specifically authorized to transfer the note to any other bank.
The provisions 2 that involved the Federal
Reserve Banks were patterned closely after the
discount provisions of section 13 of the Federal
Reserve Act. Any note representing a loan by

°r NOTES AND REFERENCES, sec p. 257.


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80

HISTORY OF LENDING FUNCTIONS

a commercial bank to a veteran on his adjusted
service certificate, if it were endorsed by a bank
and were in compliance with regulations of
the Federal Reserve Board, was made eligible
for rediscount at the Federal Reserve Bank
of the district, whether or not the bank offering
the note was a member of the Federal Reserve
System and whether or not such bank had made
the loan in the first instance or had acquired
it from another bank.
To be eligible for rediscount, however, the
note was required to have a maturity at the time
of discount of not more than 9 months, exclusive of days of grace—a requirement, it should
be noted, much more liberal than the maturity
required for the discount of commercial paper
in general.
The rate of discount charged by a Federal
Reserve Bank was required to be the same as
that charged by it in discounting 90-day commercial paper for its member banks. The Federal Reserve Board was authorized to permit or
require a Federal Reserve Bank to rediscount
such veterans' notes for any other Reserve
Bank, and in such a case the rate of rediscount
was to be fixed by the Board. Again, the law
was patterned after provisions of the Federal
Reserve Act (discussed later in this study)
regarding rediscounts between Federal Reserve
Banks.
If a veteran failed to pay a loan obtained on
his adjusted service certificate, the bank holding
his note could present it to the Director of the
Veterans' Bureau and the Director was authorized to pay the bank in full. The certificate
would then be restored by the Director to the
veteran upon receipt of the amount that had
been paid the bank, plus interest.
Since loans could not be made on the certificates until at least 2 years after January 1,
1925, it was not necessary for the Federal
Reserve System to take any immediate action.
However, on December 9, 1926, the Board
issued a regulation governing the rediscount of
notes secured by adjusted service certificates.1
At the same time, in accordance with a request
made by the Veterans' Bureau, the Board arranged for the Federal Reserve Banks to furnish


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Federal Reserve Bank of St. Louis

all banks with full information as to the legal
requirements for loans on such certificates and
for the rediscount of veterans' notes by the
Reserve Banks.
The new regulation, designated Regulation
M, consisted in large part of a restatement of
the requirements of the law. It provided, for
example, that to be eligible for discount a
veteran's note must (1) arise out of a loan
made in conformity with the law on the security
of a certificate issued to the maker; (2) be
negotiable and have a maturity at the time of
discount of not more than 9 months; (3) bear
interest at a rate not more than 2 per cent above
the discount rate; and (4) be endorsed by the
offering bank. The Reserve Bank was required
to satisfy itself as to the eligibility of the note
for discount. Along with the note, the offering
bank was obliged to submit an affidavit to the
effect that, in accordance with the law, it had
not charged any fee for the loan other than
interest and that it had notified the veteran of
the fact that the note was being rediscountcd/
Although a Reserve Bank could rediscount
such notes for nonmember as well as for member banks, it was permitted by the Board's
regulation to rediscount them only for banks
located within its district. Moreover, the regulation provided that no rediscount should be
made for any nonmember bank unless it furnished such information as the Reserve Bank
might request "in order to satisfy itself as to
the condition of such bank and the advisability
of making the rediscount for it."
In 1928, Regulation M was redesignated
Regulation G, but no change was made in its
provisions.' In 1931, however, the Adjusted
Compensation Act was amended to provide that
the loan value of an adjusted service certificate
should in no event be less than 50 per cent of
its face value and that the interest rate on loans
on such certificates should in no event exceed
4Vi per cent," and Regulation G was amended
by the Board to conform to these changes in
the law.7 In 1932 the statute was further
amended (1) to reduce the maximum interest
rate on bank loans to 3Vz per cent, and (2) to
permit banks to make loans on the certificates

WORLD WAR I VETERANS' NOTES
at any time after the date of their issuance.8
These modifications were likewise incorporated
in a revision of the Board's regulation.9
As time passed, discounts of veterans' notes
became of less and less importance. By 1939,
it appeared that the Federal Reserve Banks
held no notes secured by adjusted service certificates and that no such notes had been rediscountcd for several years. Moreover, the statute
had been amended to authorize payment of such
certificates by the Veterans' Administration at
the option of the veterans and also to authorize


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81

the Veterans' Administration to make loans on
such certificates. Since, for these reasons, it
seemed unlikely that the Reserve Banks would
be called on in the future to rediscount veterans'
notes, the Board on April 6, 1939, decided to
repeal its Regulation G relating to this matter.10
At the same time, however, the Board announced that if it should happen that any application for the discount of such a note should be
received, it would be handled in the same manner as if the provisions of Regulation G were
still in effect.


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Federal Reserve Bank of St. Louis

Advances to Member Banks

GENERAL CONSIDERATIONS
receives in its reserve account at the Reserve
Bank credit in the amount of the paper discounted, less the current rate of discount. When
the paper approaches maturity, it is returned by
the Reserve Bank to the member bank for collection, and at maturity the full amount of the
paper is charged to the member bank's reserve
account.
An advance is a simpler operation. The
member bank merely executes its own note or,
under procedures established in 1971, enters
into a continuing lending agreement, and
pledges as security paper eligible for discount
or purchase by the Reserve Banks. Interest on
the advance is paid at maturity on an accrual
basis. If the advance is not repaid at maturity,
the Reserve Bank has a direct claim against the
member and does not have to resort to the
paper pledged as security unless necessary to
satisfy that claim.

DISTINCTION BETWEEN
ADVANCES AND REDISCOUNTS
One of the most interesting chapters in the
history of the lending functions of the Federal
Reserve Banks is that relating to advances to
member banks. For many years, virtually all
lending by the Reserve Banks has taken the
form of advances rather than discounts. Both
discounts and advances are sometimes loosely
referred to as discount operations, but the legal
and procedural distinctions between the two
are clear.
In the case of a discount, credit is given by a
Reserve Bank to a member bank on the basis
of eligible paper representing loans made by the
member bank to its own customers. By eligible
paper we mean, of course, commercial or agricultural paper meeting all of the technical requirements that have been discussed in previous
chapters. Any such eligible paper that is offered
for discount is transferred to the Reserve Bank
w
'th the member bank's endorsement. No note
is executed by the member bank. The bank
p

DEVELOPMENT OF AUTHORITY
FOR ADVANCES
The original Federal Reserve Act contained
no authority for advances to member banks.

or NOTES AND REFERENCES, see pp. 257-60.


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84

HISTORY OF LENDING FUNCTIONS

In 1916 provision was made for 15-day advances on the notes of member banks secured
by Government bonds or by notes, drafts, bills
of exchange, or bankers' acceptances eligible for
discount or for purchase by the Reserve Banks.
It was not until 1932, however, that the real
trend toward advances began. The immediate
cause was the deteriorated banking situation
and the decline in the volume of eligible paper
held by member banks. Even those banks that
had ample amounts of paper eligible for discount were reluctant to use such paper as a
basis for borrowing from the Federal Reserve
Banks.
During 1932 and 1933, in an attempt to
dispel fear and create an atmosphere of confidence, Congress enacted a series of statutes
broadening the credit facilities of the Federal
Reserve Banks and making such facilities available not only to member banks but also to
nonmember banks and even to nonbanking
institutions and individuals. The first step, in
1932, was emergency authority for advances on
the security of any satisfactory assets to groups
of member banks and to individual member
banks in cases in which the member banks
had exhausted their eligible paper—although
the advances were at higher rates of interest.
Subsequently, the Reserve Banks were authorized, in unusual and exigent circumstances,
to discount eligible paper for individuals,
partnerships, and corporations.
At the time of the banking crisis in March
1933, provision was made for direct advances
to individuals, partnerships, and corporations
on the security of direct obligations of the
United States; nonmember banks were given
the privilege, though only for a short time, of
borrowing from the Reserve Banks on any
satisfactory assets. In June 1933, Congress
extended the period for which member banks
might obtain direct advances on eligible paper
from 15 to 90 days. The Banking Act of 1935
made permanent and more liberal the authority of the Reserve Banks to make advances
to member banks on satisfactory security at a
rate of interest higher than the regular discount rate.
These statutory amendments in rapid succession over a period of 3 years represented signifi-


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cant changes in the concept of the lending
functions of the Federal Reserve Banks. For
one thing, they involved an extension of the
credit facilities of the System to others than
member banks. Of more importance, these
amendments evidenced a definite departure
from the original idea that Federal Reserve
credit should be based only on self-liquidating
commercial paper that met certain technical
requirements as to eligibility; instead, greater
emphasis was placed on the soundness of the
assets offered as security, whether Government
bonds, real estate mortgages, or consumer
paper.
Additional liberalizing changes were made in
the law in the late 1960's. In 1966 obligations
issued or guaranteed by Federal agencies were
made eligible for purchase by the Reserve
Banks and therefore also eligible as collateral
for advances to member banks. In 1968 such
agency issues were made eligible as security
for advances to individuals, partnerships, and
corporations. At the same time, a technical
change made eligible as security for advances to
member banks not only notes, drafts, bills of
exchange, or bankers' acceptances that were
eligible for discount or purchase by the Reserve
Banks but also any obligations that were eligible
for purchase.
It is of interest to note that although discounting operations, as discussed in previous
chapters, have involved detailed regulations
and numerous rulings on the part of the Board,
advances have given rise to relatively few regulations or interpretations. In fact, it was not
until 1937 that the Board's Regulation A devoted a separate section to the subject of advances as distinguished from discounts. However, the predominant importance of advances
in recent years is indicated by the fact that the
revision of the regulation in 1955 for the first
time placed the section dealing with advances
ahead of the detailed and technical provisions
relating to the discount of commercial, agricultural, and industrial paper. The importance of
discounting was further downgraded by the
revision of Regulation A adopted in 1973. This
revision condensed to a minimum the regulatory provisions regarding eligibility of paper
for discount, and it provided that a Reserve

ADVANCES TO MEMBER BANKS
Bank may discount paper for a member bank
if the Reserve Bank "should conclude that a
member bank would be better accommodated
by the discount of paper than by an advance
on the security thereof."

ORIGINAL AUTHORIZATION
As previously indicated, the original Federal
Reserve Act was limited to discounts; it included no provision for advances. In its Annual
Report for 1915, the Federal Reserve Board
recommended to Congress an amendment to
authorize 15-day advances to member banks on
their own notes secured cither by eligible paper
or by Government bonds. The Board stated: 1
In order to enable member banks to obtain
prompt and economical accommodations for
periods not to exceed fifteen days, the Federal
Reserve Banks should be permitted to make
advances to member banks against their
promissory notes secured by such notes,
drafts, bills of exchange, and bankers' acceptances as the law at present permits to be
rediscounted or purchased; or against the
deposit or pledge of United States Government bonds, the purchase of which is now
permitted under the law.
The Board's recommendation was adopted
by Congress. The Act of September 7, 1916,2
among other amendments, added a new paragraph to section 13 of the Federal Reserve Act,
a paragraph that will frequently be referred to
hereinafter as "the eighth paragraph of section
13." It authorized any Federal Reserve Bank to
make advances to its member banks on their
promissory notes secured "by such notes, drafts,
bills of exchange, or bankers' acceptances as
are eligible for rediscount or for purchase by
Federal reserve banks under the provisions of
wis Act, or by the deposit or pledge of bonds
or notes of the United States." No such advance
could be made for a period exceeding 15 days,
and rates for such advances were required to be
established by the Reserve Banks, subject to
the review and determination of the Federal
Reserve Board.
The primary purpose of this amendment, as
't had been stated by the Board and as it was
kte stated by the Senate Banking and Cur-


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85

rency Committee,3 was "to facilitate the convenience of the transaction and to economize
in bookkeeping." On the floor of Congress,
Senator Owen referred to it simply as "an
administrative detail which makes more convenient the operation of the bank." 4 Many
years later, when early drafts of the Banking
Act of 1933 were being considered in Congress,
the Board similarly stated that member banks
borrowed on their 15-day notes "because of the
greater convenience both to them and to the
Federal reserve bank." s
Following the adoption of the 1916 amendment, the Board announced that it did not
consider it necessary to promulgate "any special
ruling relating to the exercise of the powers
conferred" by this amendment.8 Actually, as
previously noted, it developed that the provisions of the law regarding advances, unlike
those with respect to discounts, rarely gave rise
to the need for rulings by the Board.

LIMITATION TO PAPER
ELIGIBLE FOR PURCHASE UNDER
FEDERAL RESERVE ACT
Putting aside for the moment the specific
authority for the use of Government bonds as
collateral security for advances to member
banks, it should be noted that the 1916 amendment required that such advances be secured
"by such notes, drafts, bills of exchange, or
bankers' acceptances as are eligible for rediscount or for purchase by Federal reserve banks
under the provisions of this Act," [emphasis
added] that is, under the Federal Reserve Act.
In effect, this meant that all of the classes of
paper eligible for discount under that Act, as
discussed in previous chapters of this history,
and, in addition, all paper eligible for purchase
by the Reserve Banks under that Act (with exceptions hereinafter noted) became eligible as
collateral for advances.
The restriction of security for advances to
paper eligible for discount or purchase under
the Federal Reserve Act, however, had the
effect of excluding two types of paper. One
was notes secured by adjusted service certificates of World War I veterans, since such notes
were made eligible for discount by provisions

86

HISTORY OF LENDING FUNCTIONS

of the World War Adjusted Compensation Act
rather than by provisions of the Federal Reserve
Act.7 The other was farm loan bonds, since the
authority of the Reserve Banks to purchase
such bonds was contained not in the Federal
Reserve Act but in the Farm Loan Act of 1916.
Paper eligible for purchase by the Reserve
Banks under the Federal Reserve Act is described in section 14 of that Act. It covers,
in the first paragraph of that section, cable
transfers, bankers' acceptances, and bills of
exchange of the kinds and maturities eligible
for discount. As noted in an earlier chapter
relating specifically to bankers' acceptances, the
Board has ruled that such acceptances are
eligible for purchase even though they are not
eligible for discount; consequently, any acceptances are eligible as security for Reserve Bank
advances to member banks. Section 14 also
authorizes the purchase of direct obligations of
the United States; obligations fully guaranteed
by the United States; obligations issued or guaranteed by any agency of the United States; and
obligations issued by States and municipalities
in anticipation of the collection of taxes and
with maturities of not more than 6 months,
which are usually referred to as tax warrants.

LIMITATION TO PAPER ARISING
FROM COMMERCIAL OR
AGRICULTURAL TRANSACTIONS
Not all paper made eligible for purchase by
the Reserve Banks under the Federal Reserve
Act was also eligible as security for Reserve
Bank advances until 1968. This was because
the Board before 1968 took the position that
the reference in the eighth paragraph of section
13, as added in 1916, to "notes, drafts, bills
of exchange, * * * eligible * * * for purchase
under the Federal Reserve Act" was intended to
cover only notes arising out of commercial and
agricultural transactions. Consequently, obligations guaranteed by the United States, obligations issued by individual Government agencies,
and tax warrants of municipalities, even though
expressly eligible for purchase under section 14
of the Federal Reserve Act, were not eligible
for use as collateral for advances unless their
eligibility for such use was specifically provided


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Federal Reserve Bank of St. Louis

for by Congress. The rationale of the Board's
position before 1968 may be summarized as
follows.
Read literally, the reference to the use of
notes eligible for purchase by the Reserve Banks
that is contained in the eighth paragraph of
section 13 could be construed as covering any
notes, including bonds and debentures, issued
by Government agencies that were eligible for
purchase under section 14 of the Act. It seems
reasonably clear, however, that such a literal
construction of the eighth paragraph of section
13 would not have been warranted. In the first
place, the legislative history of that paragraph
indicates that the word "notes" as used therein
was intended to cover only notes arising out of
commercial and agricultural transactions of the
kind made eligible for discount.
As originally enacted in 1916, this paragraph
authorized 15-day advances on the security of
(1) notes, drafts, bills of exchange, or bankers'
acceptances eligible for discount or purchase,
or (2) bonds or notes of the United States.
Since bonds and notes of the United States were
already eligible for purchase under section
14(b), it would have been unnecessary to
mention them separately in section 13 if they
were covered by the words "notes * * * eligible
* * • for purchase." When the Board in its
1932 Annual Report to Congress recommended
that the maximum maturity on advances secured by paper eligible for discount or purchase
be increased from 15 to 90 days, it was clear
that the Board had in mind only ordinary commercial or agricultural paper. Thus, the Board
noted that the Reserve Banks could rediscount
"commercial or industrial paper with maturities
up to 90 days and agricultural paper with
maturities up to 9 months" and argued that an
amendment increasing the maturity on advances
secured by such paper would not "involve a
broadening in the character or class of paper
or securities which may be legally acquired by
Federal Reserve banks and would not constitute in any respect a departure from the fundamental purposes of the Federal Reserve Act."s
The Emergency Banking Act of March 9,
1933, added a new paragraph to section 13
authorizing 90-day advances to individuals,
partnerships, or corporations if secured by

ADVANCES TO MEMBER BANKS
direct obligations of the United States. Under
that paragraph, the Board took the position
that since member banks are "corporations,"
advances could be made to such banks on
Government obligations with maturities of up to
90 days. This resort to the last paragraph of
section 13 as a legal basis for 90-day advances
on Government obligations would have been
unnecessary if the word "notes" in the eighth
paragraph of section 13 were broad enough to
include notes of the United States.
Again, in 1934 Congress amended section
14(b) to authorize the purchase of bonds of
the Federal Farm Mortgage Corporation and
of the Home Owners' Loan Corporation; at
the same time it also amended the eighth paragraph of section 13 to make such bonds eligible
as security for 15-day advances to member
banks. These amendments to section 13 would
not have been necessary if such bonds were
notes within the meaning of section 13; they
would have automatically become eligible as
security for 90-day advances to member banks
by reason of the fact that they were made
eligible for purchase.
It appears that, presumably for the reasons
above indicated, the Board adopted the position
that notes of a Government agency, even though
backed by the credit of the United States and
perhaps eligible for purchase under the Federal Reserve Act, would not for that reason
alone be eligible as security for advances under
section 13. In 1960, the Board ruled that United
States Government Insured Merchant Marine
Bonds, issued under the Merchant Marine Act
of 1936, were not eligible as security for such
advances, even though such bonds were in effect
fully insured as to principal and interest by the
United States. After quoting the provision of
section 13 authorizing 90-day advances on
paper eligible for discount or purchase, the
Board concluded:9
* * * in the light of the language of the
quoted provision, its legislative history, and
the language and scope of other provisions of
the Federal Reserve Act, that the words
"notes, drafts, bills of exchange, or bankers'
acceptances" refer only to obligations arising
out of commercial or agricultural transactions. Since Merchant Marine Bonds [which


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87

are based on mortgages] are not of this character, they are not eligible as security for
advances by Federal Reserve Banks to member banks under the provisions of section 13
of the Federal Reserve Act.
The situation was completely changed in 1968
when Congress, following a recommendation
made by the Board, amended the eighth paragraph of section 13 to authorize advances to
member banks not only on the security of
"notes * * * eligible * * * for purchase" but
also on the security of any obligations eligible
for purchase under section 14 (b) of the Act.10
As a result of this amendment, all of the various
obligations made eligible for purchase under
section 14(b), including obligations fully guaranteed by the United States, obligations issued
or guaranteed by Government agencies, and tax
warrants of municipalities, became for the first
time eligible for use as collateral for advances
to member banks.
In the light of the 1968 amendment to the
law, the Board amended Regulation A, effective
November 13, 1968, to change the provisions
regarding advances to member banks by eliminating a reference to the making of such
advances "secured by such notes, drafts, bills
of exchange, or bankers' acceptances as are
eligible for discount by Federal Reserve Banks
under the provisions of this Regulation or for
purchase by such banks under the provisions
of the Federal Reserve Act" and by substituting
for this language a simple statement that "Reserve Banks may make advances to member
banks for not more than 90 days if secured
by obligations or other paper eligible under the
Federal Reserve Act for discount or purchase
by Reserve Banks." "

ENDORSEMENT OF PLEDGED
PAPER
Bills of exchange and bankers' acceptances
need not be endorsed by a member bank in
order to be eligible for purchase under section
14 of the Federal Reserve Act. Moreover, the
general requirement of section 13 that paper
offered for rediscount must be endorsed by the
offering member bank is not regarded as an
essential prerequisite of eligibility as such. For

88

HISTORY OF LENDING FUNCTIONS

these reasons, the Board in an early ruling held
that eligible paper pledged as security for advances to a member bank did not have to be
endorsed by the member bank, provided the
paper was negotiable in form.13 Since then, as
mentioned earlier in this study, the negotiability
requirement has been eliminated.

MATURITY OF ADVANCES
Although the Reserve Banks may discount
commercial paper having a maturity of up to
90 days at the time of discount and agricultural
paper with a maturity of not more than 9
months, the authority for advances, as already
noted, was originally limited by the 1916
amendment to periods of not more than 15
days. When that amendment was under consideration in Congress, question was raised as
to why the maturity was made so short; " but,
until 1933, the 15-day limitation continued in
effect for advances both on eligible paper and
on Government obligations. Although renewals
were not encouraged, the Board held that a
Federal Reserve Bank could renew the 15-day
notes of its member banks as long as it did
not obligate itself in advance to make any such
renewal.11
In 1932 the Board recommended to Congress
that the maturity limitation on advances be
increased from 15 to 90 days, pointing out that
such a liberalization "would be especially helpful to country banks." " In accordance with this
proposal, Congress by the Banking Act of 1933
amended the eighth paragraph of section 13 of
the Federal Reserve Act to authorize advances
to member banks on their secured notes for
periods of up to 90 days, but only when the
security was paper eligible for rediscount or
purchase by the Reserve Banks under the Federal Reserve Act. Advances on Government
obligations were still specifically limited to
15 days, even though such obligations were
eligible for purchase under section 14 of the
Act. As will be noted later, however, another
provision of the law, which had been added
in March 1933, was construed as authorizing
90-day advances to member banks on their


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Federal Reserve Bank of St. Louis

own notes secured by direct obligations of the
United States.
Despite the statutory extension of the period
for which advances might be made to member
banks on the security of eligible paper, such
advances have normally been extended for
periods of much less than 90 days. The principle
that member bank borrowings should ordinarily
be only for temporary periods was emphasized
when the Board's Regulation A was revised in
1955. In a foreword to the revised regulation,
it was stated that "Federal Reserve credit is
generally extended on a short-term basis"; and,
while the provision relating to advances on
eligible paper followed the law in prescribing
a maximum maturity of 90 days, a footnote to
this provision stated, "However, borrowings by
member banks arc generally for short
periods." 10 This footnote was eliminated in
1968; K but the statement remains accurate as
a matter of practice except where advances are
made to enable member banks to meet seasonal
needs and except in unusual or emergency
circumstances.

INCREASE OF SECURITIES LOANS
DURING LIFE OF ADVANCE
While Congress during the early 1930's was
seeking to instill confidence in the economy by
broadening the basis for borrowings from the
Reserve Banks, it was at the same time deeply
conscious of the fact that the use of bank
credit for speculative purposes had been one of
the major causes of bank failures. Thus, when
the Glass-Steagall bill was being debated in
February 1932, an amendment was offered to
make any advance to a member bank immediately due and payable if, during the life
of the advance, the bank should increase its
outstanding loans for the purpose of carrying
stocks and bonds. The amendment was defeated
only because Senator Glass gave assurance that
a provision to that effect was to be included in
the omnibus banking bill then pending."
An early draft of the Glass omnibus banking
bill in March 1932 10 included not only a provision, for suspending credit to member banks

ADVANCES TO MEMBER BANKS
that increased their securities loans but also a
requirement that the rate of interest on any
15-day advance to a member bank should
be 1 per cent higher than the current discount
rate. The Board strongly opposed the suggested
penalty rate on advances. It argued that the
theory underlying the suggestion, namely, that
advances had a more direct connection with
speculative activities than rediscounts, was unfounded. It pointed out that if advances "were
prohibited or made more expensive, they
[member banks] would merely substitute the
procedure of rcdiscounting eligible paper without any change in the use of the proceeds."=0
At the same time, the Board recommended
the inclusion in section 4 of the Federal Reserve
Act of a provision requiring the Reserve Banks
to keep themselves informed as to the speculative use of bank credit by their member banks
and to take such matters into consideration in
making discounts and advances. Such a provision, the Board believed, would make unnecessary the proposed provision for making any
advance immediately due and payable if the
borrowing bank increased its loans to purchase
or carry securities.
As it turned out, both provisions were included in the final version of the Banking Act
of 1933. The provision added to section 4, as
recommended by the Board, will be discussed
in a later chapter. The provision added to the
eighth paragraph of section 13 was to the effect
that if any member bank to which any advance
had been made under that paragraph should,
during the life of such advance and despite an
official warning from the Reserve Bank or the
Board, increase its outstanding loans collateraled by securities or loans to members of
stock exchanges or dealers in securities for the
purpose of purchasing or carrying stocks,
bonds, or other investment securities (other
than obligations of the United States), such
advance should be deemed immediately due
and payable. In addition, in any such case the
member bank was made ineligible to borrow
again from the Reserve Bank under this paragraph for such period as the Federal Reserve
Board should determine.


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89

This provision remains unchanged in the law
and it has given rise to no legal problems.
Following the language of the law, the Board
has taken the position that an increase in a
member bank's securities loans does not subject
it to the penalties prescribed by the provision
unless such increase takes place after the issuance of an official warning by the Reserve
Bank or the Board.21 This has been the only
published interpretation of the provision.

ELIMINATION OF APPLICATION
FORMS AND PROMISSORY
NOTES
In November 1970 the Board approved
rather drastic changes in the procedures relating
to advances to member banks: (1) elimination
of the use of formal applications for advances,
and (2) provision for the use of a continuing
lending agreement to be entered into by a
member bank in lieu of the execution of a
traditional promissory note in connection with
each borrowing.
The law had never required that member
banksfileformal application forms in requesting
Reserve Bank advances, but Regulation A had
included provisions clearly implying the need
for such applications. These provisions were
eliminated by an amendment to the regulation,
effective November 23,1970.22
At the same time, the Board amended the
regulation to eliminate references to the execution of notes by borrowing member banks. It
appeared that the law expressly required a
borrowing bank to execute a promissory note.
Nevertheless, the Board concluded that the
underlying purpose of this requirement—to
give a Reserve Bank a direct claim against a
borrowing member bank—would be equally
served by the execution of a lending agreement
under which the bank would be legally obligated
to repay all advances made pursuant to the
agreement. Moreover, a practice had developed
by which overnight advances to member banks
were frequently repaid before the receipt by
the Reserve Bank of the borrowing bank's
promissory note.

90

HISTORY OF LENDING FUNCTIONS

These changes in procedure were described
by the Board in a press release issued on
December 1, 1970, as "designed to simplify
and update present practices." They went into
effect in February 1971. Since then, continuing
lending agreements have been regarded as an

acceptable substitute for formal application
forms and promissory notes. Such agreements
include the essential terms previously included
in promissory notes, and a member bank is
unconditionally obliged to repay all advances
received under such agreements.

ADVANCES ON DIRECT OBLIGATIONS OF
THE UNITED STATES
15-DAY ADVANCES
The eighth paragraph of section 13 of the
Federal Reserve Act, as added by the Act of
September 7, 1916," authorized the Federal
Reserve Banks to make advances to member
banks on their own notes secured not only by
paper eligible for discount or purchase but also
by the "deposit or pledge of bonds or notes of
the United States." The maturity of such advances was limited to 15 days. By the Banking
Act of 1933, this paragraph was amended to
permit a maximum maturity of 90 days, instead
of 15 days, on advances secured by eligible
paper. It did not, however, similarly liberalize
the maturity restriction with respect to advances
secured by Government obligations. Thus,
under this paragraph of section 13, advances
on direct obligations of the United States with
maturities exceeding 15 days could not be
made.

90-DAY ADVANCES
Actually, there was no need for the Banking
Act of June 16, 1933, to increase the maturity
limitation on advances secured by Government
obligations. About 3 months earlier, the Emergency Banking Act of March 9, 1933,11 had
added to section 13 of the Federal Reserve Act
a new paragraph (the thirteenth and last paragraph) that had authorized advances with
maturities of up to 90 days to individuals, partnerships, and corporations on their promissory
notes secured by direct obligations of the


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Federal Reserve Bank of St. Louis

United States. Although the new paragraph did
not specifically mention member banks, it was
immediately obvious that since member banks
were corporations, they could obtain 90-day
advances on the security of Government obligations under the provisions of this paragraph.
This was made clear by a change in Regulation A in 1942. Section 2(b), which previously
had prescribed a 15-day maturity with respect
to advances to member banks on Government
obligations, was amended to provide a maximum maturity of 90 days." In a footnote it was
explained that although the eighth paragraph
of section 13 authorized advances to member
banks on Government obligations for periods
not exceeding 15 days, the last paragraph of
that section authorized advances to any individual, partnership, or corporation on direct
obligations of the United States for periods not
exceeding 90 days and that the term "corporation" included a member bank.
When the regulation was again revised i"
February 1955, the 15-day maturity limitation
on advances on Government obligations was
restored, at least in the text of the regulation."
However, it was explained in a footnote that
under the last paragraph of section 13 of the
Federal Reserve Act, a Federal Reserve Bank
had authority to make 90-day advances to fa'
dividuals, partnerships, and corporations I"1'
eluding member and nonmember banks) ° n
their notes secured by direct obligations of the

ADVANCES TO MEMBER BANKS
United States, but that advances to member
banks on the security of such obligations "are
normally for short periods of not exceeding
fifteen days."
In 1968 the regulation was amended to
provide in the text for advances to member
banks for periods of up to 90 days when
secured either by paper eligible, for discount
or by paper eligible for purchase by the Reserve
Banks, without any specific reference to advances on direct obligations of the United
States; at the same time the footnote indicating
that advances were normally made for shorter
periods was omitted."

LIMITATION AS TO TYPE
OF OBLIGATION
The eighth paragraph of section 13 of the
Federal Reserve Act, as added in 1916, referred to advances on bonds or notes of the
United States. The Banking Act of 1933
amended this language to refer to bonds, notes,
certificates of indebtedness, or Treasury bills of
the United States." Although the last paragraph
of section 13 authorized advances on "direct
obligations of the United States," the Board
construed this phrase as likewise being limited
to bonds, notes, and certificates of indebtedness,
and as not including any other types of direct
obligations of the United States. Thus, in 1960,
the Board held that although the Defense
Department was directly liable on certain deed
of trust notes, such notes were not direct obligations of the United States within the meaning
of the last paragraph of section 13. This position was based on the ground that advances
under that paragraph were subject to such
limitations, restrictions, and regulations as the

91

Board may prescribe, and that Regulation A
parenthetically defined direct obligations to
mean only bonds, notes, Treasury bills, or certificates of indebtedness of the United States.29

ADVANCES AT PAR
In its 1937 revision of Regulation A, the
Board included a provision requiring a Federal
Reserve Bank to explain to the Board the facts
and circumstances of any case in which the
amount of an advance on a member bank's note
secured by direct obligations of the United
States or by obligations fully guaranteed by the
United States was less than the face amount
of such obligations.30 However, when World
War II broke out in Europe, the Board announced that all advances by the Reserve
Banks on Government obligations would be
made at par,31 and this announcement was
repeated in 1941 when the United States
entered the war.32 This provision was omitted
in the 1955 revision of the regulation because
it was considered no longer applicable and
because its inclusion might be construed as
being inconsistent with the System's announced
policy that all advances on Government obligations would be made at par.
For many years commercial banks held large
volumes of Government obligations in their
portfolios, and by far the greatest part of
member bank borrowings from the Reserve
Banks during those years was through advances
secured by direct obligations of the United
States. In recent years, however, the volume of
"free" (that is, unpledged) Government obligations held by member banks has declined
sharply, and more and more member bank
borrowings have been secured by eligible paper.

ADVANCES ON OBLIGATIONS OF
GOVERNMENT AGENCIES
SUMMARY
Except for bonds of the War Finance CorPoration during World War I,™ only direct


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Federal Reserve Bank of St. Louis

obligations of the United States, as distinguished
from obligations of U. S. Government agencies,
were eligible as security for Reserve Bank
advances prior to 1932. After 1932 amend-

92

HISTORY OF LENDING FUNCTIONS

ments were made from time to time to the
eighth paragraph of section 13 of the Federal
Reserve Act for the purpose of specifically
making obligations of certain Government agencies eligible as security for advances under that
paragraph. In 1968 the paragraph was amended
to permit advances to member banks on any
obligations eligible for purchase by the Reserve
Banks under section 14(b) of the Federal
Reserve Act—which include all obligations
guaranteed by the United States and obligations issued or guaranteed by agencies of the
United States.

FEDERAL INTERMEDIATE
CREDIT BANK OBLIGATIONS
The Agricultural Credits Act of 1923 added
to the Federal Reserve Act a new section—13a
—which, among other things, authorized the
Reserve Banks to discount *paper for Federal
intermediate credit banks and to purchase the
debentures and other obligations of such banks.
In 1932 Congress apparently felt that the intermediate credit banks needed additional facilities for acquiring funds through the Federal
Reserve System; the Act of May 19, 1932,"
endorsed by the Farm Loan Board, the Treasury, and the Federal Reserve Board, was
designed to meet these needs. Among other
things, that act amended the eighth paragraph
of section 13 of the Federal Reserve Act so as
to authorize 15-day advances by the Reserve
Banks to member banks on their notes secured
"by the deposit or pledge of debentures or
other such obligations of Federal intermediate
credit banks which are eligible for purchase by
Federal reserve banks under section 13 (a) of
the Federal Reserve Act." 3=
In recommending the enactment of this provision the House Banking and Currency Committee, after pointing out that intermediate
credit bank debentures were already eligible
for purchase by the Federal Reserve Banks,
stated: 30
• * * * Such an amendment to the Federal
reserve act would be of great benefit to the
Federal intermediate credit banks because its


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Federal Reserve Bank of St. Louis

immediate effect would be to broaden the
market for ihc collateral trust debentures issued by the banks. These arc high-grade investments, and member banks would purchase
them in greater volume if they could be used
as a basis for temporary credit with the Federal reserve bank in the event of some
emergency or need for funds.* * *
Significantly, the committee's report went
on to say that it was not believed that the
debentures would be used for this purpose to
any great extent, but that "the fact that they
could would be very valuable in the sale of
debentures and would greatly facilitate the
operations of the Federal intermediate credit
banks in extending credit to agriculture." This
motive—to make the purchase and holding of
the debentures more attractive to banks—has
obviously been behind subsequent amendments
to the Federal Reserve Act making obligations
of other Government agencies eligible as collateral for Federal Reserve advances to member
banks.
In the course of the debates on the 1932
amendment, Chairman Stcagall of the House
Banking and Currency Committee argued that
debentures of the intermediate credit banks
were "as sound and desirable" as the commercial paper that the Reserve Banks were permitted to accept as collateral for advances
under the existing law and that the amendment
would make the debentures more desirable to
member banks and thus "reduce the interest
which is paid by fanner borrowers." nr
One persistent opponent of the amendment
was Congressman McFadden. He argued
strongly that its enactment would weaken the
security behind Federal Reserve notes. His reasons were the same as those he had previously
advanced in opposing the Glass-Steagall Act,
which a few months before had permitted Government bonds to be used as collateral security
for Federal Reserve notes. He insisted that the
amendment would "repeal the liquidity provision of the Federal reserve act, the main thing
that was the argument for the creation of the
Federal reserve act—elasticity." He contended
that the amendment was a reversion "to the

ADVANCES TO MEMBER BANKS
Government bond secured circulating medium,"
and that in this instance the bonds of the
intermediate credit system were being substituted for Government bonds.36
Despite Mr. McFadden's objections, the
amendment was passed. It became a precedent
for later enactments authorizing obligations of
certain other Government agencies to be used
as collateral for advances by the Reserve Banks
to their member banks.
The 1932 amendment authorized the pledge
of intermediate credit bank obligations as security for 15-day advances to member banks
only if they were eligible for purchase by the
Reserve Banks under section 13a of the Federal
Reserve Act. That section provided for the
purchase of such obligations only "to the same
extent and subject to the same conditions" as
those under which farm loan bonds could be
bought by the Reserve Banks. Under the Farm
Loan Act of 1916, the Reserve Banks could
buy farm loan bonds only to the same extent
and subject to the same conditions as they could
buy municipal bonds under section 14(b) of
the Federal Reserve Act. Under section 14 (b)
they were authorized to purchase only municipal bonds having maturities of not more than
6 months from the date of purchase. As the
result of this rather devious chain of references,
only obligations of intermediate credit banks
having a maturity of 6 months or less were
eligible as security for advances to member
banks. This limitation, however, is no longer
applicable because section 14(b) of the Federal Reserve Act now authorizes the Reserve
Banks to purchase obligations of any agency of
the United States—the intermediate credit
banks arc regarded as agencies of the United
States—and the eighth paragraph of section 13
permits any obligations eligible for purchase
under section 14(b) to be used as collateral
for Reserve Bank advances.
Although section 13a of the Federal Reserve
Act refers to the purchase of debentures issued
ty "a" Federal intermediate credit bank, the
law covers not only debentures issued individually by such banks but also consolidated
debentures issued by such banks together;'"1


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93

consequently, consolidated debentures, as well
as individual debentures, are eligible as security
for advances to member banks.

FARM LOAN BONDS
The Federal Farm Loan Act of 1916 expressly authorized any Federal Reserve Bank
to buy and sell farm loan bonds issued by the
Federal farm land banks to the same extent as
they were authorized to buy State, county, district, and municipal bonds under section 14 (b)
of the Federal Reserve Act.40 That section
authorized the purchase of such bonds, that is,
tax warrants, with maturities of not more than
6 months. Since the new farm loan bonds were
eligible for purchase under a statute other than
the Federal Reserve Act, they were not eligible
as collateral for advances to member banks
under the eighth paragraph of section 13 of
that Act. Moreover, the Board's General Counsel in 1917 ruled that farm loan bonds could
not be regarded as "bonds of the United States"
and were therefore not eligible for use as
collateral for advances to member banks."
In the early days of March 1933, drastic
steps had been taken to maintain the solvency
of the banks of the country. As a further step
toward economic recovery, President Roosevelt,
in a special message to Congress on March 16,
1933, recommended the enactment of an act
"to establish and maintain such a balance
between production and consumption of agricultural commodities and such conditions in
the marketing of agricultural commodities as
will give to such commodities sold by farmers
their pre-war purchasing power."42 This became known as the Agricultural Adjustment
Act.
As evidence of the urgency of the measure,
the bill was introduced in the House on March
20, reported the same day, passed by the House
on March 22, and introduced in the Senate on
March 23. Up to that point, it contained nothing
with respect to farm credits; it was concerned
primarily with the maintenance of the balance
between the production and consumption of
agricultural commodities. As reported by the

94

HISTORY OF LENDING FUNCTIONS

Senate committee, however, the bill was expanded to cover extensions of additional credit
through the farm credit system. It included a
provision for the issuance by the Federal land
banks of a special type of farm loan bonds for
a limited period of 2 years in order to enable
the land banks to expand their lending facilities.
These bonds, limited to an aggregate of $2 billion, were to be fully guaranteed as to interest
by the United States.
To insure the sale of the bonds, Senator
Frazier proposed an amendment that would
have given them the complete support of the
Federal Reserve System: If they were not sold
to the public, the Federal Reserve Board would
have been required to deliver to the Federal
Farm Loan Board an equal amount of Federal
Reserve notes. A less drastic step, however, was
finally adopted. On April 10, Senator Shipstead
introduced an amendment to the bill to make
the new farm loan bonds eligible as collateral
for advances by Federal Reserve Banks to
member banks under section 13 of the Federal Reserve Act. As finally enacted on May 12,
the statute " amended section 32 of the Federal Farm Loan Act of 1916 to authorize the
issuance of the temporary farm loan bonds
and further amended the provisions of section
13 of the Federal Reserve Act relating to
15-day advances to member banks so as to
permit such advances to be secured "by the
deposit or pledge of bonds issued pursuant to
the paragraph added to section 32 of the
Federal Farm Loan Act, as amended by section
21 of the Emergency Farm Mortgage Act of
1933."
Authority for the use of these bonds, as collateral for advances to member banks was
short lived, however. In the following month,
the Banking Act of 1933 again amended the
eighth paragraph of section 13 of the Federal
Reserve Act and at that time the provision
for the use of farm loan bonds as collateral
for 15-day advances was omitted.
Although the Reserve Banks were still authorized to purchase farm loan bonds, that
authority was not contained in the Federal
Reserve Act itself; consequently, such bonds


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Federal Reserve Bank of St. Louis

did not come within the scope of paper eligible
as collateral for advances, that is, paper eligible
for discount or purchase under the Federal
Reserve Act. However, farm loan bonds have
again become eligible as collateral for Federal
Reserve advances because they arc obligations
of the Federal land banks, which arc agencies of
the United States; the Reserve Banks are
authorized under section 14(b) of the Federal
Reserve Act to purchase obligations of Government agencies, and section 13 permits the use
of any paper eligible for purchase under section
14(b) as collateral for Federal Reserve Bank
advances.

FEDERAL FARM MORTGAGE
CORPORATION BONDS
The need for additional farm credit, which
the Act of May 12, 1933, had been designed to
meet, continued into 1934. Commercial banks
still were not satisfying the demand for farm
mortgage loans. The Federal Farm Mortgage
Corporation Act of January 31, 1934," was
intended "to supply funds for continuing on
its augmented basis the land-mortgage credit
system provided for in the Federal Farm Loan
Act and the Emergency Farm Mortgage Act of
1933." 45 It created a new agency, the Federal
Farm Mortgage Corporation, with authority to
issue bonds guaranteed by the United States.
The Federal land banks were permitted to exchange their own consolidated bonds for the
Government-guaranteed bonds of the Corporation and thus be in a position to sell the latter
and use the proceeds for making additional
farm mortgage loans.
To encourage banks to buy the bonds of the
new Corporation, the House bill would have
amended section 14 of the Federal Reserve Act
to authorize the Federal Reserve Banks to buy
and sell such bonds. As finally enacted, the
statute went further and amended both section
14 and section 13 of the Federal Reserve Act.
The Reserve Banks were authorized under
section 14 to buy and sell bonds of the Federal
Farm Mortgage Corporation having maturities
from the date of purchase of not more than

ADVANCES TO MEMBER BANKS
6 months. The eighth paragraph of section 13
was amended to authorize 15-day advances to
member banks on their notes secured "by the
deposit or pledge of Federal Farm Mortgage
Corporation bonds issued under the Federal
Farm Mortgage Corporation Act."
This authorization soon lost its significance.
By the mid-1950's very few bonds of the
Federal Farm Mortgage Corporation were outstanding.10 In recognition of this fact, the
Board's 1955 revision of Regulation A, which
previously had referred in the text to the use
of such bonds as collateral for advances to
member banks, merely referred in a footnote
to the fact that "such advances may also be
made on notes secured by the deposit or pledge
of Federal Farm Mortgage Corporation bonds
issued under the Federal Farm Mortgage Corporation Act." 17 By an Act of October 4,1961,
Congress amended paragraph 8 of section 13
of the Federal Reserve Act to eliminate the
reference to Federal Farm Mortgage Corporation bonds as collateral for Federal Reserve
advances to member banks; "• and the footnote
reference to such bonds in Regulation A was
eliminated in 1968.10

HOME OWNERS'
LOAN CORPORATION BONDS
A few months after bonds of the Farm
Mortgage Corporation were made eligible as
collateral for Federal Reserve advances, bonds
of the Home Owners' Loan Corporation
(HOLC) were given the same privilege. In
addition to making such bonds eligible for
purchase by the Federal Reserve Banks, the
Act of April 27, 1934,50 amended the eighth
paragraph of section 13 of the Federal Reserve
Act to permit 15-day advances to member
banks to be secured by "the deposit or pledge
of bonds issued under the provisions of subsection (c) of section 4 of the Home Owners'
Loan Act of 1933, as amended."
The committee reports gave no specific reason for this amendment. It appeared, however,
that the refunding of the previously issued
HOLC bonds had been retarded because they


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Federal Reserve Bank of St. Louis

95

had not been clearly guaranteed as to principal
by the United States and, being quoted below
par, they had not been acceptable to some
mortgagees at face value in exchange for
mortgages. To remedy the situation, the new
bonds were expressly and fully guaranteed as
to principal and interest by the United States."
Presumably in order to make them more attractive investments for banks, they were also
made available as a basis for Federal Reserve
credit.
During the debates, Senator Bulkley stated
that this was simply a technical provision
designed to put these bonds "on the same basis
with United States bonds in this respect.
* * * We are simply conforming to the Federal Reserve Act in giving these bonds a
technical privilege, which they ought to have
when guaranteed by the Treasury."os
In practice, the authority for the use of
HOLC bonds as security for section 13 advances to member banks proved to be of little
significance. The HOLC was dissolved on February 3, 1954," and none of its bonds are
outstanding. The reference carried in the
Board's 1937 Regulation A to the use of such
bonds as collateral for advances was omitted
when the regulation was revised in 1955.

COMMODITY CREDIT
CORPORATION CERTIFICATES
OF INTEREST
By regulation in 1949, the Board permitted
the use of one type of paper as collateral for
section 13 advances even though it was not
clearly eligible either for discount or for purchase by the Reserve Banks. As part of an
effort to encourage banks to hold notes representing loans made to producers of agricultural products pursuant to commodity loan
programs of the Commodity Credit Corporation (CCC), the Board amended its Regulation A, effective February 17, 1949, to except
such producers' notes from the negotiability
requirement of the regulation in order that they
might be eligible for rediscount. Under some of
the CCC programs, however, the producers'

96

HISTORY OF LENDING FUNCTIONS

notes were bought by CCC and held in
"pools," and certificates of interest in such
pools of notes were issued to banks. In 1917
the Board had ruled that a certificate of
interest in a note was not eligible for discount.54 Although this would suggest that certificates of interest in pools of CCC notes would
not be eligible for discount, the Board amended
Regulation A to provide "for the use of certificates of interest such as are issued by the
Commodity Credit Corporation under its cotton
loan program as security for advances made to
member banks." 5=
In 1969 the reference to the use of CCC
participation certificates as collateral for advances to member banks was omitted from
Regulation A, but at the same time the Board
added to its list of agency issues eligible as
collateral for such advances "Commodity Credit
Corporation certificates of interest in a pricesupport loan pool." 50

MERCHANT MARINE
BONDS
In 1960 the Board ruled that United States
Government Insured Merchant Marine bonds
were not eligible as collateral for Reserve Bank
advances to member banks under section 13 of
the Federal Reserve Act because, in the light
of the legislative history, the reference in the
eighth paragraph of that section to notes, drafts,
bills of exchange, or bankers' acceptances contemplated only obligations arising out of commercial or agricultural transactions, and Merchant Marine bonds were not of that character.57 This interpretation was, of course,
superseded by the 1968 amendment to the
eighth paragraph of section 13 making eligible
as collateral for Reserve Bank advances any
obligations eligible for purchase under section
14(b). On the ground that the Merchant Marine bonds constituted obligations issued or
guaranteed by a Government agency and that
they were therefore eligible for purchase, the
Board in 1968 expressly revoked its 1960
ruling holding such bonds to be ineligible for
use as collateral.58


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Federal Reserve Bank of St. Louis

FARMERS
HOME ADMINISTRATION
INSURED NOTES
In 1962 the Board considered the question
whether notes evidencing loans to farmers by
member banks that were insured by the
Farmers Home Administration were eligible
as collateral for advances under the eighth
paragraph of section 13 of the Federal Reserve
Act. The Board concluded that, while the term
"insurance" rather than the term "guarantee"
was used irr connection with such loans, they
were to be considered as fully guaranteed by
the United States within the meaning of section 14(b) of the Federal Reserve Act and
were therefore eligible for purchase by the
Reserve Banks. In addition, the Board concluded that the insured notes involved in this
case were to be distinguished from the insured
Marine bonds, which had been considered by
the Board in 1960. The latter bonds, although
technically notes, were regarded as securities
and not the kind of notes contemplated by
the eighth paragraph of section 13, whereas
the notes insured by the Farmers Home Administration were not in the category of securities.
Accordingly, the Board held that such insured
notes were eligible as security for Reserve Bank
advances to member banks under section 13.53

EXPORT-IMPORT BANK
PARTICIPATION CERTIFICATES
The Export-Import Bank of Washington issued participation certificates representing interests in loans made by that Bank. Although
the law did not give the Bank express authority
to pledge the faith or credit of the United States
to the redemption of such certificates, it did
unconditionally guarantee the payment of pnn*
cipal and interest on such certificates. On the
basis of an opinion of the Attorney General of
the United States *° to the effect that a guarantee by a Government agency is an obligation
fully binding upon the United States despite the
absence of statutory language expressly pledging its faith or credit to the redemption of the

ADVANCES TO MEMBER BANKS
guarantee, the Board in 1966 concluded that
such participation certificates were "fully guaranteed by the United States as to principal and
interest" within the meaning of section 14(b)
of the Federal Reserve Act and were therefore
eligible as collateral for advances to member
banks under the eighth paragraph of section
13."

NOTES GUARANTEED BY
SMALL BUSINESS
ADMINISTRATION
A few months later in 1966, the Board
followed the principle stated in the ExportImport Bank case when it ruled that notes
fully guaranteed by the Small Business Administration (SBA) under its Small Business
Investment Company Program were eligible
for purchase by the Reserve Banks under section 14(b) of the Federal Reserve Act and
were, therefore, eligible as collateral for advances under the eighth paragraph of section
13.62 Again, although the Small Business Investment Act did not expressly pledge the
faith or credit of the United States for the
redemption of the notes guaranteed by the
SBA, the Board relied upon the opinion of
the Attorney General previously mentioned
to the effect that a guarantee by a Government
agency is an obligation fully binding on the
United States despite the absence of statutory
language expressly pledging the faith or credit
of the Government for the redemption of the
guarantee.

AGENCY ISSUES
In 1966, section ]4(b) of the Federal Reserve Act was amended to authorize the Reserve
Banks, under regulations of the Federal Open
Market Committee, to buy and sell in the open
market "any obligation which is a direct obligation of, or fully guaranteed as to principal and
interest by, any agency of the United States."03
This authority was originally conferred for only
1
year, but in 1967 it was extended for another
year and in 1968 it was made permanent.01


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Federal Reserve Bank of St. Louis

97

The effect of this amendment to section
14(b) was to make eligible for purchase by
the Reserve Banks not only direct obligations
of the United States and obligations fully guaranteed by the United States but also any obligation issued by any agency of the United
States or fully guaranteed by any such agency,
even though such obligation would not be fully
guaranteed by the United States.
Although such agency issues were thus made
eligible for purchase by the Reserve Banks,
they were still not eligible, under Board rulings,
as collateral for Reserve Bank advances under
section 13 of the Act unless they could be regarded as notes arising out of commercial
or agricultural transactions. The situation was
changed by the 1968 amendment to the eighth
paragraph of section 13 when any obligations
eligible for purchase were made eligible as
security for advances. Since 1968, any obligation issued or fully guaranteed by any Government agency has been eligible as collateral for
section 13 advances to member banks.
Following the enactment of the 1968 legislation, the Board issued an interpretation listing
the principal agency obligations that were
eligible as collateral for Reserve Bank advances
under section 13. The list of agency obligations
was as follows: °5
(1) Federal Intermediate Credit Bank debentures
(2) Federal Home Loan Bank notes and
bonds
(3) Federal Land Bank bonds
(4) Bank for Cooperative debentures
(5) Federal National Mortgage Association
notes, debentures, and guaranteed certificates of participation
(6) Obligations of or fully guaranteed by
the Government National Mortgage
Association
(7) Merchant Marine bonds
(8) Export-Import Bank notes and guaranteed participation certificates
(9) Farmers Home Administration insured
notes
(10) Notes fully guaranteed as to principal
and interest by the Small Business Administration

98

HISTORY OF LENDING FUNCTIONS
(11) Federal Housing Administration debentures
(12) District of Columbia Armory Board
bonds
(13) Tennessee Valley Authority bonds and
notes
(14) Bonds and notes of local urban renewal
or public housing agencies fully supported as to principal and interest by
the full faith and credit of the United
States pursuant to section 302 of the
Housing Act of 1961 (42 U.S.C. 1421a
(c), 1452(c))

This list was supplemented in 1969 by the
addition of Commodity Credit Corporation
certificates of interest in a price-support loan
pool 00 and was further supplemented in 1971
by the addition of notes, debentures, and guaranteed certificates of participation of the Federal Home Loan Mortgage Corporation and
obligations of the United States Postal Service."
In 1972, on the basis of opinions of the Attorney General to the effect that they were
obligations of the United States, the Board
took the position that certain guaranty contracts entered into by the Department of Health,
Education, and Welfare and certain participation certificates issued under a Purchase Contract Program of the General Services Admin-

istration should be treated as direct obligations
of, or fully guaranteed as to principal and interest by, a U.S. agency and were eligible as security for advances to member banks.0*
The Board's 1968 interpretation made it clear
that nothing less than a full guarantee of principal and interest by a Federal agency would
make an obligation eligible as collateral for an
advance. For example, mortgage loans insured
by the Federal Housing Administration arc not
eligible because an insurance contract is not
equivalent to an unconditional guarantee and
does not fully cover interest payable on the
loan. Moreover, obligations of international institutions, such as the Intcr-Amcrican Development Bank and the International Bank for
Reconstruction and Development, arc not
eligible as such collateral because they are not
agencies of the United States.
It is interesting to note that when the PcnnCentral Transportation Company collapsed in
1971 and was placed under reorganization pursuant to Federal law, the certificates issued by
the trustees of the company were fully guaranteed by the Secretary of Transportation. Consequently, such certificates technically became
eligible as security for Reserve Bank advances
to member banks under section 13 of the Federal Reserve Act.00

TAX WARRANTS
Section 14 (b) of the Federal Reserve Act
authorizes the Reserve Banks to buy and sell
"bills, notes, revenue bonds, and warrants
with a maturity from date of purchase of not
exceeding six months, issued in anticipation of
the collection of taxes or in anticipation of
the receipt of assured revenues by any State,
county, district, political subdivision, or
municipality in the continental United States,
including irrigation, drainage, and reclamation
districts, such purchases to be made in accordance with rules and regulations prescribed
by the Board of Governors of the Federal


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Federal Reserve Bank of St. Louis

Reserve System." This language was part of the
original Federal Reserve Act and has never
been changed.
Following the enactment of the 1916 amendment to the law authorizing advances by tne
Reserve Banks to member banks on papef
eligible for rediscount or purchase by the Reserve Banks, the Board held that county &*
warrants, although eligible for purchase under
the Federal Reserve Act, were not eligible*
collateral for advances to member banks under
the eighth paragraph of section 13 of the Act,'
presumably because tax warrants were no

ADVANCES TO MEMBER BANKS
regarded as notes, drafts, or bills of exchange
within the meaning of that paragraph.
That such obligations were not regarded as
eligible security for section 13 advances was
indicated during consideration of the GlassSteagall Act of 1932, when statements were
made by Governor Meyer of the Board and
by various Congressmen to the effect that the
latter act, by authorizing advances on any
satisfactory security under the new section
10(b), would have the effect of permitting
municipal bonds to be used as collateral for
advances under that section.71 When the Board's
Regulation A was revised in 1937, it provided
that advances to member banks under section
13 must be secured by paper eligible for rediscount or for purchase by the Reserve Banks
under the provisions of the Board's Regulation
B. That regulation dealt only with the purchase
of bills of exchange and bankers' acceptances,
not with the purchase of tax obligations of
municipalities. Although the 1955 revision of
Regulation A changed this reference so that it
referred to paper eligible for purchase under
the Federal Reserve Act (as provided in the
statute), apparently this change was not intended to reflect any change in the Board's
previous position that tax-anticipation obligations of municipalities were not eligible as
collateral for advances to member banks under
section 13.
The 1968 amendment to the eighth paragraph of section 13, which has frequently been
mentioned in this chapter, had the effect of
making tax warrants that were eligible for purchase under section 14(b) also eligible as collateral for Reserve Bank advances to member
banks. That change in the law was recognized
by the Board in an interpretation that noted
specifically that the kinds of tax-anticipation
bonds and warrants described in section 14(b)
had become eligible as collateral for advances
to member banks, but only to the extent that
such obligations would be eligible for purchase


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Federal Reserve Bank of St. Louis

99

under the Board's Regulation E.72 Regulation
E, Purchase of Warrants, was adopted many
years ago and is still in effect, even though it
purports to regulate the purchase and sale of
tax warrants in the open market, a subject now
within the jurisdiction of the Federal Open
Market Committee and no longer subject to
regulation by the Board. That regulation prescribes detailed conditions that must be met in
order for warrants to be eligible for purchase by
the Reserve Banks.
In 1969 the Board amended its 1968 interpretation regarding the eligibility of tax warrants as security for Reserve Bank advances.
It eliminated the earlier requirement that in
order to be eligible as such security, warrants
had to comply with the requirements of Regulation E. It provided, however, that in each
case a Reserve Bank should satisfy itself that
sufficient tax or other assured revenues earmarked for payment of such obligations would
be available for that purpose at maturity, or
within 6 months after the date of the advance
if no maturity was stated."
One final point with respect to the use of
tax warrants as collateral for Reserve Bank
advances should be mentioned. The language
of section 14(b) literally limits the eligibility
of such warrants for purchase by the Reserve
Banks (and therefore as collateral for advances) to warrants issued by a State, county,
district, political subdivision, or municipality
in the continental United States. This would
appear to exclude warrants issued by municipalities in the State of Hawaii. However, the
fact is otherwise because, when Hawaii was
admitted to statehood in 1959, the enabling
legislation amended section 1 of the Federal
Reserve Act to define the term "the continental
United States" as the States of the United
States and the District of Columbia." Thus,
although it consists of islands in the middle of
the Pacific, Hawaii is a part of the continental
United States, at least for certain purposes.

100

HISTORY OF LENDING FUNCTIONS

THE GLASS-STEAGALL ACT: A BREAK WITH THE PAST
EMERGENCY BACKGROUND
A date of importance in the history of the
lending functions of the Federal Reserve Banks
was February 27, 1932—the date of enactment
of the Glass-Steagall Act.™ It was a brief statute
of only three sections, but one that marked a
definite change in the traditional concept of the
nature of the lending functions of the Reserve
Banks. Previously, emphasis had been placed
on compliance with more or less formal and
technical requirements regarding eligibility for
discount, in particular compliance with an
arbitrarily fixed, short maximum maturity and
a requirement for self-liquidation out of actual
commercial or agricultural transactions; thereafter, more and more emphasis was placed
upon the soundness of the paper offered as a
basis for credit.
The Glass-Steagall Act was essentially an
emergency measure. Its purposes were to restore confidence in the banking system, to halt
bank failures, to loosen credit, and to bring
currency out of hoarding. As stated by the
bill's co-author, Congressman Steagall, the
banking and credit machinery of the country
had "drifted into unhappy days." 7S An omnibus banking bill, the so-called Glass bill, was
then pending in the Senate. Designed to correct
abuses that had led to the unhappy days—use
of bank funds for speculative purposes and
participation by banks in the securities business
—that bill was to be enacted more than a year
later as the Banking Act of 1933. In the meantime, some immediate action was deemed necessary to dispel the prevailing atmosphere of uncertainty and apprehension.
The extreme urgency of the situation is indicated by the legislative progress of the GlassSteagall bill. It was introduced in both Houses
on February 11; it was reported and debated in
the Senate on Friday, February 12; on the
same day hearings were held by the House
Banking and Currency Committee; on Monday,


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Federal Reserve Bank of St. Louis

the lSth, it was passed by the House; after
further debate in the Senate on the 18th,
it was passed by that body on the following
day; and the bill was signed by the President
on the 27th. Indeed, some members of Congress complained of the shortness of time allowed for consideration of the bill."

PROVISIONS OF THE BILL
One of the three sections of the bill amended
section 16 of the Federal Reserve Act to permit
direct obligations of the United States to be
used as collateral for the issuance of Federal
Reserve notes until March 3, 1933. Previously,
such notes could be issued only against gold,
gold certificates, and eligible paper rcdiscountcd
by the Reserve Banks. Because of the shrinkage
in the amount of commercial paper offered for
discount, Federal Reserve notes then outstanding were backed to the extent of nearly 80 per
cent by gold, although the Federal Reserve
Act then required a gold reserve of only 40
per cent against outstanding Federal Reserve
notes." There were those who felt that permission for the use of Government obligations as
security for Federal Reserve notes would be
inconsistent with the original concept of an
elastic currency backed by commercial paper
rather than by Government bonds.19 The
majority, however, were willing—at least as a
temporary measure—to depart from the original concept because they believed that hoarding would be offset by an "emergency circulation of Federal reserve notes secured by
Government bonds." s o Moreover, it was felt
that this amendment would have the effect of
"turning loose" about 5800,000,000 of "f« e
gold," *» and would thereby "fortify the gold
status of the Federal reserve banks in this
period of extraordinary disturbance." "
But it is with the other two sections of the
Glass-Steagall Act that this history is
directly concerned. They permitted the

ADVANCES TO MEMBER BANKS
eral Reserve Banks for the first time, although
only in emergency situations, to extend credit
to member banks on the basis of any satisfactory assets, whether or not technically eligible
for rediscount. These sections added sections
10(a) and 10(b) to the Federal Reserve
Act. Section 10(a) authorized any Reserve
Bank, with the consent of at least five
members of the Federal Reserve Board, to
make advances to groups of five or more member banks on their promissory notes under
certain conditions, one of which was that the
bank or banks in the group that received the
proceeds had no adequate amounts of eligible
paper. Section 10(b) provided authority, until
March 3, 1933, under which a Reserve Bank
in exceptional and exigent circumstances could
make an advance to an individual member bank
on its notes secured to the satisfaction of the
Reserve Bank if the member bank had no
further eligible paper, but only at a rate of
interest at least 1 per cent higher than the
regular Reserve Bank discount rate.

GENERAL PURPOSES
The principal objective of these provisions
was to reassure banks by making it clear that
in an emergency they could use long-term
paper, such as mortgages, as a basis for borrowing from the Reserve Banks. Actually, there
was no real shortage of eligible paper among the
banks of the country as a whole. During the
hearings on the bill before the House Banking
and Currency Committee, Governor Meyer of
the Board estimated that member banks held
from $8 billion to S8Vi billion of eligible paper,
including Government bonds." The difficulty,
Governor Meyer said, was that the banks were
"timid" about borrowing. In the prevailing state
of confusion and fear, banks felt it necessary
"to keep on hand enough liquid securities or
eligible paper to respond to any contingency
that might arise" in order to meet possible
demands of their depositors.*' Senator Glass
described the situation as follows:85
* * * There is plenty of eligible assets in
the portfolios of the member banks of the
Federal reserve system * • *. The member


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Federal Reserve Bank of St. Louis

101

banks of the system, the banking community
of the United States, have ceased to function
through abject fear and have communicated
this fear to depositors.* * *
In other words, the purpose of the GlassSteagall Act was largely psychological. At another point during the debates, Senator Glass
remarked : so
* * * The chief psychological advantage
of this measure—and it is perhaps a valuable
psychological advantage—is that it gives assurance to these frightened and timid bankers
throughout the country that if they will only
respond to the requirements of commerce, if
they will only help in relieving themselves
and the country from this depression and in
doing so exhaust their eligible assets, then
and only then may they make use of their
ineligible assets.
Similarly, Senator Fletcher felt that the bill
would place banks in a position where they
could "take greater risks and make loans and
accommodate their customers to a greater extent" than they had been doing.87
Some feared that by broadening the base for
borrowing from the Reserve Banks, the bill
would be inflationary/" The Senate committee's
report, however, stated that the bill was "not
intended nor should it be used for undue inflation of the currency."S9 Similarly, the House
report expressed the belief that the bill, "without undue expansion," would result in easier
credit, which would aid in ending bank failures
and in improving business conditions generally.90 In other words, it was felt that if the
bill did cause some inflation, it would not, in
the circumstances, be an undue or improper
inflation. One Congressman put it as follows:01
If by easing credit we increase confidence
and dispel fear, we shall observe a resulting
flow into rediscount channels of hoarded rediscountable paper, with a resultant issuance
of Federal reserve notes. * * * There is
nothing inflationary in such a program, because there is no undue or unwarrantable
element in that which is normal.
There were some, indeed, who were afraid not
that banks would borrow too much under the
bill but that they would borrow too little.02

102

HISTORY OF LENDING FUNCTIONS

In any event, it was emphasized that the
provisions of the act were to be utilized only in
exceptional and emergency situations. A few,
like Senator Vandenberg, suggested that commercial practices had changed over the years;
that "Federal reserve definitions should progress with the times"; and that "sound" assets
should be eligible as a basis for Federal Reserve credit even though they "fell outside the
arbitrary limitations set up in the original Federal reserve act."9S But Governor Meyer of the
Board declared that the bill was intended to be
used only in "exceptional cases," sl and that it
would provide facilities to be availed of "in an
emergency." 9S The act itself stated in its title
that it was to provide means for meeting the
needs of member banks "in exceptional circumstances"; and the new section 10(b), authorizing advances on any satisfactory assets,
was limited to "exceptional and exigent circumstances" and was enacted to remain in
force only until March 3,1933.
The general objectives of sections 10(a) and
10(b) were summarized by the Senate Banking and Currency Committee 2 months after
their enactment when Congress was considering
a more comprehensive banking bill. That committee's report on the Glass bill, which later
became the Banking Act of 1933, contained
the following statement: 96
Within recent months there has been a very
widespread demand for some means of furnishing emergency relief to banks that are in
difficult straits. The Federal reserve system
was intended to furnish a means of mutual
aid and if properly administered was entirely adequate to the necessities of the case.
However, with conditions as they stand it is
likely that some plan whereby actual assist-


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Federal Reserve Bank of St. Louis

ance could be furnished to banks which are
willing to stand sponsor for one another and
thus enable them to clear up danger spots in
their own several communities would be helpful. We therefore suggested such a plan as an
additional means of strengthening and rendering useful the provisions of the Federal reserve system. The general plan so recommended was founded upon the idea of joint
action by clearing houses or groups of banks
in different localities designed for the purpose
of getting accommodations on their joint unsecured notes at reserve banks up to such
amount as might be held prudent; likewise,
in exigent cases, relief was provided for individual banks. Such emergency credit should
be retired as soon as possible, and therefore
it seemed best to provide severe restrictions
upon its use and duration.* * *

Although regarded in those unhappy days
of 1932 as a piece of emergency legislation,
the Glass-Steagall Act marked a turning point;
and, as it later developed, it proved to be
more than a temporary measure. The authority
for the use of Government bonds as security
for Federal Reserve notes was extended from
time to time and was finally made permanent.
Section 10(a), authorizing advances to groups
of member banks, is still on the statute books,
although it is of little practical significance for
reasons hereinafter indicated. Section 10(b),
providing for advances on satisfactory assets, is
now permanent legislation and is no longer
restricted to emergency situations, although it
still requires that a penalty rate of interest be
charged on such advances.
It is in order at this point to consider in
more detail the purposes, history, and application of these sections of the Federal Reserve
Act that relate to advances to member banks.

ADVANCES TO MEMBER BANKS

103

ADVANCES TO GROUPS OF MEMBER BANKS
PURPOSE AND NATURE
Section 10(a) of the Federal Reserve Act,87
as added by the Glass-Steagall Act of February
27, 1932, authorized any Federal Reserve Bank
to make advances to groups of five or more
member banks, subject to a number of rigid
restrictions. Its purpose was to enable several
member banks to join together in an organization like a clearing house and, as a group,
borrow from a Federal Reserve Bank funds
with which to assist a weak or failing bank
within the group.88
The report of the Senate Banking and Currency Committee stated that this section was
"intended to provide a permanent reserve for
groups of banks in periods of great distress." °9
Similarly, the House Banking and Currency
Committee described the section as affording
"a means of relief to banks that find themselves
in urgent need of accommodations when
willing to enter into joint liability." "° During
the House hearings, Governor Meyer of the
Board declared that if the provision had existed
in the previous year it might have been used in
a number of cases, since he felt that it was
certainly "to the interest of neighbors in the
banking business to save one of their number if
unliquidity is the main difficulty affecting the
condition of an important banking member of
the community."101
In general, it was contemplated that the section would be utilized by banks in a large city
in order to prevent the imminent failure of
one of their number and thus protect themselves from the possibility of similar disaster.
As to the objection that the stronger banks
would not be willing in this manner to assist a
weak bank, Senator Glass stated:102
' * * To think that as many asfivebanks
m any considerable community may not be
willing to organize themselves in a group to
avert the failure and consequent disaster of
one or more other banks in that community
is to assume that the bankers of the country


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Federal Reserve Bank of St. Louis

have not even an intelligent selfishness, because the failure of any one of the weaker
banks in any given community has its reactionary effect upon the stronger banks and,
it is readily conceivable, might bring disaster
to them also. So we provide that there may
be this species of group banking in the
populous centers, where it may readily be
employed and prove effective.
In effect, the section provided for Federal
Reserve advances of funds to a weak bank on
the security of the guarantee of the stronger
banks in the community.103 Recognizing the
general rule that national banks could not
legally guarantee the debts of others, the bill at
first specifically provided that national banks
should be authorized to endorse or guarantee
notes of other member banks evidencing loans
under this section. As the hill was finally enacted, it covered this point in broader language
applicable to all member banks; the bill authorized member banks "to obligate themselves
in accordance with the provisions of this
section."101
In keeping with its basic purpose of providing
aid to banks in dire, or nearly dire, circumstances, the section imposed no limit on the
amount that might be advanced by a Reserve
Bank103 or on the maturity of any such advance. Nor was any time limit placed on the
period during which section 10(a) should remain in effect, although the other provisions
of the Glass-Steagall Act, relating to advances
to individual member banks and the use of
Government obligations as security for Federal
Reserve notes, were limited to a period of 1
year.108 It seems clear, however, that the authority to make advances to groups of member
banks was intended as an emergency measure
to be utilized only in the exceptional case in
which a member bank had exhausted its discountable eligible paper and other banks in
the community, were willing to come to its aid
through the joint borrowing mechanism provided by this section.

104

HISTORY OF LENDING FUNCTIONS

LIMITATIONS
That loans authorized by section 10(a) of
the Federal Reserve Act would be made only
in truly emergency circumstances was insured
by the limitations imposed by its provisions.
In order for any advance to be made by a
Federal Reserve Bank under this section, nine
separate requirements were required to be met:
1. The advance had to be approved by at
least five members of the Federal Reserve
Board.107
2. The advance was required to be made to
a group of not less than five member banks,
except that it might be made to a lesser number
if the aggregate amount of their deposit liabilities was at least 10 per cent of the total
deposit liabilities of the member banks in the
Federal Reserve district. Originally, said
Senator Glass, the proposal had been for a
minimum of 10 banks, but, "in a yielding
mood," the number had been reduced to five.108
There were some, on the other hand, who saw
no reason to impose even afive-bankminimum,
and the conference committee agreed to the
exception stated above.109
3. A majority of the banks in the group
obtaining the advance were required to be independently owned and controlled. Originally,
the bill required all of the banks to be independent banks. The purpose was to prevent
holding companies from forming exclusive
groups of their own members.110 At Senator
Glass's suggestion, an amendment was adopted
to make the requirement applicable only to a
majority of the borrowing banks.
4. The most important requirement was that
the bank or banks receiving the proceeds of
the advance must have no adequate amounts of
eligible and acceptable assets available to enable
such bank or banks to obtain sufficient credit
accommodations from the Federal Reserve
Bank through rediscounts or advances other
than as provided in section lO(b). The bill at
first provided that advances could be made to
groups of banks only if such banks had
exhausted their eligible assets. The language
was changed by a Senate committee amend-


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Federal Reserve Bank of St. Louis

ment to make it clear that the requirement
applied only to the weak bank or banks that
actually received and used the proceeds of the
advance."1 If this requirement were met, the
advance could be secured by any satisfactory
assets, whether technically eligible for discount
or not, with only one exception—foreign
securities.
5. The liability of each bank in the borrowing group was limited to such proportion of
the total amount of the advance as the amount
of the deposit liabilities of that bank bore to
the aggregate deposit liabilities of alt the banks
in the group. The lawmakers were not certain
whether the banks in the group would be
jointly and severally liable to the Federal Reserve Bank,111 but Senator Robinson and Senator Glass felt that each bank would be so
liable in proportion to its deposits.lia
6. The borrowing banks were authorized to
distribute the proceeds of the advance to such
of their number and in such amounts as they
might agree upon, but the recipient banks were
required to deposit with a suitable trustee their
individual notes made in favor of the entire
group and protected by such collateral as might
be agreed upon.
7. The rate of interest charged on the advance was required to be not less than 1 per
cent above the Reserve Bank's regular discount
rate at the time of the advance.
8. Notes representing advances under this
section were not to be used as collateral security
for Federal Reserve notes issued under section
16 of the Federal Reserve Act. As previously
noted, some Congressmen in 1932 were reluctant to permit even Government obligations
to be used as security for Federal Reserve
notes; Congress clearly was not prepared to
allow notes given for emergency advances under section 10 (a) to be used for this purpose.
9. Finally, foreign securities—obligations of
foreign governments or of foreign persons or
corporations—could not be offered as collateral
security for advances under this section of the
law. The implication clearly was that any and
all other types of collateral security were permissible.

ADVANCES TO MEMBER BANKS

EFFECT
In view of the many limitations and requirements imposed with respect to group advances
under section 10(a), it is not surprising that
this authority proved to be of little significance.
Moreover, any importance the section might
otherwise have had was all but nullified by the
provisions of section 10(b) enacted at the same
time. When the conference report on the GlassSteagall bill was being considered in the House,
Chairman Stcagall recognized that in practical
effect there would be no use made of the authority available under section 10(a) by those
banks that would be permitted to apply for
loans under section 10(b). n t
Shortly after the enactment of the GlassSteagall Act, the Board announced that since

105

the advances authorized by section 10(a) were
to be made only in unusual circumstances, it
did not contemplate issuing any regulations on
the subject but would consider each request
for its consent to such an advance in the light
of the facts of the particular case.115 Actually,
no regulations ever became necessary, nor were
any rulings or interpretations issued under this
section. In short, section 10(a) was never of
any real practical significance. It would have
been repealed by the proposed Financial Institutions Act, which passed the Senate in 1957
but was allowed to die in the House Banking
and Currency Committee.116 Although still in
effect today, section 10(a) is virtually a dead
letter, overshadowed by its sister section—section 10(b).

ADVANCES ON SATISFACTORY ASSETS
ORIGINAL AUTHORIZATION
Section 10(b) of the Federal Reserve Act,
as originally added by the Glass-Steagall Act
of February 27, 1932, was intended, in the
words of Senator Glass, to provide for the
needs of the smaller country banks that were
'so detached from commercial and financial
centers as to make it exceedingly inconvenient,
if
not actually impossible, for them either to
organize into a group or readily to join an
existing group" 11T that might obtain an advance
under section 10(a) of the Act.
Briefly, the original section 10(b) authorized
any Federal Reserve Bank to make advances
to
a member bank on its notes secured to the
satisfaction of the Reserve Bank, subject to
certain limitations. As explained by Governor
Meyer of the Board, the section was designed
t0
permit the Reserve Banks to make advances
°n "adequate and safe security" in cases in
which member banks, "because of unsatisfactory business conditions, or through unusual


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Federal Reserve Bank of St. Louis

withdrawal of deposits," had reached the point
where their remaining paper, although good,
was ineligible for rediscount.118
But, as in the case of section 10(a), the
restrictions imposed by section 10(b) were
somewhat severe. In the first place, authority
to make advances under section 10(b) was
limited to a period expiring March 3, 1933.
Some felt that such a time limit was unnecessary,118 and the Senate approved an amendment
offered by Senator Thomas to extend the period
until March 3, 1934.iao However, the conference committee agreed to go back to the 1-year
limitation.121
Second, advances under the section were expressly limited to exceptional and exigent circumstances. This was a requirement that, although perhaps implicit in section 10(a), had
not been specifically prescribed as a condition
to advances to groups of banks under that
section.
Third, in order to make it clear that advances
under section 10(b) would be for the benefit of

106

HISTORY OF LENDING FUNCTIONS

small country banks,122 it was provided that
they could be made only to member banks
having a capital of not exceeding $5,000,000.
Originally, the Senate bill had fixed this capital
requirement at $500,000; an amendment on the
floor had increased it to $2,000,000; "3 the
House bill had prescribed no such capital limitation; and the conference committee, in view
of the decision to limit the period of the authority to 1 year instead of 2, agreed to compromise by permitting advances to be made to
banks with a capital of up to $5,000,000."'
Fourth, each advance under the section was
required to have the affirmative approval of not
less than five members of the Federal Reserve
Board. This corresponded to the similar requirement imposed upon group advances under
section 10(a).
Fifth, the borrowing bank was required to
have "no further eligible and acceptable assets
available to enable it to obtain adequate credit
accommodations through rediscounting at the
Federal reserve bank or any other method provided by this Act other than that provided by
section 10(a)." In other words, the member
bank must have exhausted its eligible paper.
Three additional limitations were similar to
those prescribed in connection with group advances under section 10(a): The interest rate
was required to be not less than 1 per cent
higher than the regular discount rate; notes
representing advances under the section could
not be used as collateral security for Federal
Reserve notes; and foreign securities could not
be accepted as collateral for such advances.
In addition to all of these limitations, the
Federal Reserve Board was authorized by regulation to limit and define the classes of assets
that might be accepted as security for advances
to member banks under this emergency authority.

EXTENSIONS OF TIME LIMIT
Even while the Glass-Steagall bill was under
consideration in 1932, it was recognized that
if the banking emergency continued, the authority provided by section 10(b) might have
to be extended.1" The emergency not only continued but became more acute.


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Federal Reserve Bank of St. Louis

On January 9, 1933, with banks failing at
an alarming rate, Governor Meyer wrote to
Chairman Steagall of the House Banking and
Currency Committee: ""
• * * While demands upon the Federal
reserve banks for accommodations under section I0(b) have not been large, the existence
of the authority to extend such accommodations has been a helpful factor in the disturbed situation through which we have been
passing and has enabled the Federal reserve
banks to render service to individual member
banks in a number of instances.
• ° • The Federal Reserve Board feels
that the Congress might well consider the
enactment of these provisions in permanent
form, with whatever safeguards may be
deemed appropriate as to the exercise of the
authority granted by them, but, in any event,
it is the opinion of the Board that, in view of
existing conditions, it would be highly desirable to extend such authority for at least
one year beyond March 3, 1933.

One month before the section would have
expired, Congress, by the Act of February 3,
1933, 1 " extended the time limit to March 3,
1934.
The banking crisis reached its climax on
March 4, 1933, when all banks were closed by
order of President Roosevelt. On the day the
banking holiday ended, March 9, 1933, Congress rushed to enactment an Emergency Banking Act •" in order, as Senator Glass said, to
deal with "an extraordinary and desperate situation." "»
Among other things, the Emergency Banking
Act modified section 10(b) to eliminate some
of its restrictions. The $5,000,000 capital limitation was removed, thus making advances
under this section available to any member
bank regardless of its size. The requirement for
approval of each advance by at leastfivemembers of the Board was also omitted; instead, it
was provided that advances should be made
under rules and regulations prescribed by the
Board. The prohibitions on the use of notes
representing such advances as collateral security
for Federal Reserve notes and on the use of
foreign securities as security for advances were
repealed.

ADVANCES TO MEMBER BANKS
The liberalized section, however, continued
to provide that advances should be made only
in exceptional and exigent circumstances and
only when the borrowing bank had no further
assets eligible for rediscount. It continued also
to require that the rate of interest on such
advances should be at least 1 per cent higher
than the regular discount rate.
The termination date of March 3, 1934, was
retained, but it was qualified to permit extension
for such additional period of not more than
I year as the President might prescribe.
Senator Glass observed that the provisions
of the Emergency Banking Act were "so broad
and so liberal that no friend of the Federal
Reserve System, in ordinary times, would tolerate them for a moment" and that under the bill
member banks might bring their "cats and
dogs" to the Federal Reserve Banks and have
them discounted.1'" In the House, Chairman
Steagall stated, "We have provided a simpler
and broader authority for loans by Federal
reserve banks upon securities and collateral not
eligible under the general authority of the Federal Reserve Act." m
In his fireside chat of March 12, 1933,
President Roosevelt said: l M
Remember that the essential accomplishment of the new legislation is that it makes it
possible for banks more readily to convert
their assets into cash than was the case before. [More liberal provision has been made
for banks to borrow on these assets at the
reserve banks and more liberal provision has
also been made for issuing currency on the
security of these good assets. This currency
is not fiat currency. It is issued only on adequate security—and every good bank has an
abundance of such security^
Less than a year later, on February 16,1934,
acting under the authority conferred upon him
ty the statute, the President by proclamation
extended the duration of section 10(b) for an
additional year—until March 3, 1935.133

PERMANENT AUTHORIZATION
From the time of the original enactment in
1932, there were those individuals who felt
'h the authority for advances on satisfactory


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collateral under section 10(b) should not be
merely a temporary measure but should be
made a permanent part of the law. Their views
finally prevailed after the section expired—according to its terms—in March 1935 and the
authority was re-enacted in permanent and
liberalized form by the Banking Act of 1935 on
August 23, 1935."' It is of interest to note
how this came about.
On February 5, 1935, an omnibus banking
bill had been introduced in the House; and a
similar bill was introduced in the Senate on the
following day.135 Both bills contained a provision that would have added a new paragraph to
section 13 of the Federal Reserve Act authorizing the Federal Reserve Banks, under regulations of the Board, to discount for their member
banks any commercial, agricultural, or industrial paper, and to make advances to their member banks on their promissory notes secured by
any sound assets and without charging a penalty
rate of interest. The House adopted this provision. The Senate, however, was not willing to
go so far. Instead, it approved a provision reenacting section 10(b) in the same form in
which it had previously existed but as a permanent measure and with one important liberalizing change—the omission of the requirement
that advances be made only in exceptional and
exigent circumstances. The conference committee followed the Senate version, but with two
additional liberalizing changes: The requirement that the borrowing bank must have exhausted its eligible paper was eliminated and
the penalty rate of interest was reduced from
1 per cent to one-half of 1 per cent. At the
same time, the conference committee added a
new requirement that maturities should not
exceed 4 months.
As finally enacted on August 23, 1935, and
as still in force, the revised section 10(b) provides:
Any Federal Reserve bank, under rules and
regulations prescribed by the Board of Governors of the Federal Reserve System, may
make advances to any member bank on its
time or demand notes having maturities of
not more than four months and which are
secured to the satisfaction of such Federal
Reserve bank. Each such note shall bear

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HISTORY OF LENDING FUNCTIONS
interest at a rate not less than one-half of
1 per centum per annum higher than the
highest discount rate in effect at such Federal
Reserve bank on the date of such note.

In this form the authority for advances
under this section today is subject to four
limitations: (1) Advances must be made in
accordance with such rules and regulations as
the Board may prescribe; (2) maturities may
not exceed 4 months; (3) a member bank's
note must be secured to the satisfaction of the
Reserve Bank; and (4) the interest rate must
be not less than one-half of 1 per cent higher
than the currently effective discount rate. With
regard to these limitations, the Board has prescribed no restrictive regulations; the collateral
need be satisfactory only to the Reserve Bank;
and the 4-month maturity limitation is more
liberal than the 90-day maturity limitation on
rediscounts. Hence, the only important restriction now imposed by the law on advances
under section 10(b) is the requirement for a
higher rate of interest.

EMERGENCY USE VEL NON
Despite the enactment of section lO(b) as
permanent legislation and the omission of the
provision limiting advances to exceptional and
exigent circumstances, some statements were
made in 1935 that suggested that the section
was still intended to be used only in emergencies.
Thus, during the House committee hearings,
Reserve Board Governor Eccles observed that
banks should have the assurance that all sound
assets could be liquified at the Federal Reserve
Bank "in case of an emergency."136 In the
House debates, Mr. Hancock stated that the
Federal Reserve Board should be in a position
to "consider emergencies promptly." " T Mr.
Hollister referred to the use of "the emergency
provisions." 138
On the other hand, these and similar statements can reasonably be regarded as meaning
that section 10(b) advances would be available
in emergency situations, but not that such advances could be made only in such situations.
Numerous statements were made during the


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Federal Reserve Bank of St. Louis

committee hearings and during the debates in
Congress to the effect that this section would
enable banks to meet the needs of their communities for long-term as well as short-term
funds, placing emphasis on soundness rather
than the technical form of the paper.'**
After the 1935 rc-cnactmcnt of section
10(b), the Board pointed out in a published
statement that these provisions were a recognition of the fact that the scope of the operations
of member banks had changed since 1913; that
the amount of paper technically eligible for
discount had become very small; and that a
major factor had been the development of larger
volumes of savings deposits, which permitted
banks to put their funds into long-time investments." 0 In its 1937 Annual Report, the Board
stated that changes in the law made by the
Banking Act of 1935 reflected a change in the
intention of Congress with regard to the character of assets that might be used as a basis for
Federal Reserve credit accommodations and
that under the 1937 revision of Regulation A
any sound assets could be used as a basis for
advances by Federal Reserve Banks." 1 These
statements contained no suggestion that section
10(b) advances were limited to emergency
situations; on the contrary, they clearly suggested that it was contemplated that such advances might be available at any time to member banks desiring to obtain credit on the
security of long-term paper not eligible for
discount, such as real estate mortgages.
Legally, then, the use of section 10(b) is
not restricted to emergencies. As a practical
matter, it would not normally be used except
as a last resort, since member banks usually
would not wish to pay the higher rate of interest
provided by this section unless they had no
paper eligible for rediscount or as security for
advances under section 13 at the lower discount
rate; and, generally speaking, member banks
today have ample amounts of Government obligations that in times of need they may offer as
collateral for section 13 advances. Nevertheless,
the words "normally," "usually," and "generally" have been used here for good reason.
There have been occasions, some in recent
years, when member banks in trouble did not

ADVANCES TO MEMBER BANKS
hold cither eligible paper or Government securities in amounts sufficient for use as collateral
for Reserve Bank advances at the regular discount rate, and they were compelled to borrow
under section 10(b). In addition, there arc
times when large member banks requiring overnight adjustment credit arc willing to pay the
extra rate of interest under section 10(b) rather
than go to the trouble and expense of sorting
out the paper held by them that would meet
the technical eligibility requirements prescribed
by section 13.

THE "SOUND ASSETS" CONCEPT
Even at the time of the enactment of the
original Federal Reserve Act there were some
who felt that the Federal Reserve Banks should
have authority, at least in emergencies, to make
advances to member banks not only on eligible
paper but on any good security.
In the Senate, both the Owen and Hitchcock
bills would have authorized the Federal Reserve
Banks, with the approval of the Board, to discount the direct obligations of member banks
secured by the pledge and deposit of "satisfactory securities," subject to limitations as to
amount. The Owen bill would have limited any
such direct advance to three-fourths of the value
of the securities pledged. The Hitchcock bill
imposed the same limitation and in addition
provided that the amount loaned should not
exceed the amount of the member bank's capital.
Senator Owen described this provision for
direct advances on any satisfactory security as
an emergency provision. He said: " :
* " • this bill provides, and it rightly
provides, that in case of an emergency the
Federal reserve bank, with the approval of
the Federal reserve board, may extend the
accommodation to a bank against its assets of
whatever character, provided they arc a good
security.* ° *
The provision was regarded as an answer to
those who contended that the 90-day maturity
'imitation on discounts was too short to accommodate country banks in agricultural areas.
Th
«s, Senator Pomcrcnc noted that in order


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Federal Reserve Bank of St. Louis

109

that such banks might not be at a disadvantage,
a provision had been added that would enable
a member bank to discount its own notes secured by farmers' notes of longer maturity. 1 "
The provision was in the bill as it passed the
Senate, but it was eliminated in conference.
Three years later, in 1916, the law was amended
to authorize advances to member banks on
their own notes secured by eligible paper or
Government bonds. It was not until 1932, however, that Congress in section 10 (b) of the
Act finally provided for advances to member
banks on any satisfactory collateral, and then
only at a higher rate of interest.
As first enacted in temporary and emergency
form by the Glass-Steagall Act in 1932, section
10(b) provided for advances to member banks
on their notes "secured to the satisfaction" of
the lending Reserve Bank; but the Board was
authorized by regulation to "limit and define
the classes of assets" that might be accepted
as security. This was understood to mean that
the character of assets acceptable as security
would be left entirely to regulation by the
Board 1 U or, in other words, that the nature of
such security would be "largely decided as an
administrative matter." " s Senator Glass stated
that the security could be of "any type which
the Federal reserve bank, with the approval of
the Federal Reserve Board, may by regulation
admit." " '
It was understood during consideration of
the Glass-Steagall bill that section 10(b) would
include authority for advances on tax warrants,117 and on State, county, and city bonds." 8
It was also assumed that real estate mortgages
would be eligible as collateral for such advances.119 In fact, as stated by Governor Meyer,
the collateral could include any "good security,"
with the exception of foreign securities that were
specifically barred by the statute itself."0
In the course of the debates on the GlassSteagall bill, some Congressmen criticized the
bill for not going far enough in the direction of
permitting Federal Reserve advances on any
sound assets. Mr. Williamson felt that the bill
failed to recognize "a permanent change in the
character of paper held by national and other
member banks" resulting from the fact that

110

HISTORY OF LENDING FUNCTIONS

banks had found it difficult to make a profit
without investing in long-term paper, municipal
bonds, and other securities not technically eligible for discount.151 Senator Vandenberg similarly referred to the fact that "commercial
practices" had changed since the enactment of
the Federal Reserve Act. 152
The idea that a fundamental change had
taken place in the character of paper held by
commercial banks and that, consequently, the
Reserve Banks should be authorized to lend on
the basis of sound assets rather than on shortterm, self-liquidating eligible paper gained even
greater acceptance during consideration of the
legislation that became the Banking Act of
1935.
During the House hearings on the 1935 act,
Governor Eccles recommended an amendment
to section 13 to authorize advances on any
sound assets, subject to regulations of the
Board. He asserted that this proposal would not
open the door to all kinds of paper regardless
of its soundness but that, on the contrary, it
was proposed "to place emphasis on soundness
rather than on the technical form of the paper
that is presented." 153 He pointed out that,
under the emergency provisions of section
10(b), the Board had exercised caution and
that, although credit had been extended on
ineligible assets to the extent of $300,000,000,
all but $1,500,000 had been paid back. He also
pointed out that the total volume of eligible
paper held by member banks at that time was
only about $2 billion, or less than 8 per cent
of the resources of the banks; that in periods of
"timidity" banks tended to refrain from making
loans except on paper eligible for discount; and
that banks conducting business on this theory
could not serve their communities adequately.
"Such a bank," he said, "would confine its
operations to the purchase of the most liquid
open-market paper, with the consequence that
it would neglect its local responsibilities and
would nevertheless find it difficult to earn
enough from the low returns on such paper to
cover expenses and dividends."
With respect to the traditional idea that discounted paper should be liquid, Governor
Eccles contended that many assets that were
eligible for discount because they were con-


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Federal Reserve Bank of St. Louis

sidered liquid were actually less sound than
many other assets held by banks that could not
technically qualify for discount."* He pointed
out that long-term credits had not been responsible for the depression and that short-term
credit is not necessarily sounder than long-term
credit. 1 "
As to what specific types of assets would be
permissible under his proposal. Governor
Eccles stated that he would permit the Reserve
Banks to lend "on any and all assets, real-estate
mortgages, collateral loans, bonds, or other
assets, which they considered sound, on such a
basis as they considered sound." *M
The proposal made by Governor Eccles was
not that section 10{b), which had expired by
its terms in March 1935, should be revived, but
that the existing limitations of section 13 on
paper eligible for discount and as security for
advances to member banks be completely discarded in favor of broad authority to extend
credit on any sound assets, subject only to such
regulations as the Board might prescribe. Some
members of the House committee questioned
whether, if this were the intent, the existing provisions of section 13 should not be repealed.
The Board's General Counsel, Mr. Walter
Wyatt, explained, however, that the proposed
broad authority would be construed as repealing by implication the provisions of the old
law.1'"
The House Banking and Currency Committee approved the proposal. In its report on the
bill, it said: 15<t
The purpose of this provision is to relax or
remove stringent technical limitations on the
character of paper that can be used as a basis
of borrowing from the Federal Reserve banks,
and thus to give member banks the assurance
they need so that it will be possible for them
to meet the needs of their communities for
both short-time and long-time funds. Since in
practice existing restrictions must be relaxed
whenever they become really restrictive, it is
best not to have them in the law, but to place
full regulatory responsibility on the Board,
which is always in session and in a position
to take prompt action when it is required.
Changes in the country's economic lite
notably in the methods of financing business
enterprise, have materially reduced the vol-

ADVANCES TO MEMBER BANKS
time of short-term self-liquidating paper of
the classes to which the discount privileges of
the Reserve Banks arc largely restricted by
law. In times of stress, therefore, when the
help of the Federal Reserve System has been
most urgently needed, many banks, though
holding sound assets in their portfolios, have
been devoid of the particular kinds of paper
available under the law for borrowing at the
Reserve banks.
This amendmeni, by removing many of the
technical restrictions of the present law, will
enable the Federal Reserve banks to render
belter service to their member banks in times
of need. This will not only make membership
in the Federal Reserve System much more
attractive but will encourage the member
banks to invest their savings deposits, which
arc essentially capital funds, in longer-term
loans, a course that would greatly facilitate
business recovery.
Concluding its explanation, the committee's
report made the following significant statement:
* * * Soundness of assets (a term which is
here for the first lime introduced into the
Federal Reserve Act) is a greater safeguard
to the banks than short maturity of loans or
•he particular form of the underlying transaction.
The sound-assets principle approved by the
House committee was reiterated in the House
debates on the bill. Chairman Stcagall asserted
that the liberal provisions for discounts and
advances would enable the Reserve Banks to be
conducted upon "principles of solvency rather
than technical requirements." 15" Mr. Hancock
declared that "the old idea of commercial
Paper or such paper as can be liquidated almost
overnight" had been "the greatest curse to
business activity." u o
In the Senate, as has previously been noted,
the Ecclcs proposal to replace the discount
Provisions of section 13 by a broad and simple
authority to make discounts and advances on
an
y sound assets did not prevail. During the
Senate hearings, Winthrop Aldrich and Adolph
Miller, a veteran member of the Board, opposed
the
proposai.i«i Senator Glass resisted the use
of
the term "sound assets" because brokers had
testified that brokers' loans were the soundest


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111

that could be made, and he feared that its use
might lead to the employment of Federal Reserve credit for stock speculation.182 As a consequence, the Senate decided simply to restore
the provisions of section 10(b)—which had
expired several months before—but in permanent form and without the restriction that advances be made only in exceptional and exigent
circumstances.163 However, the charging of interest at a rate higher than the rate on advances
on eligible paper was still a requirement.
Nevertheless, the liberalized version of section 10(b) approved by the Senate was as much
a departure from the orthodox theory of security for Federal Reserve Bank loans as was the
provision of the House hill for advances on
sound assets.184 In fact, although the conference
committee adopted the Senate version, there
were some who felt that the sound-asset principle had not been abandoned. When the conference report was considered in the House,
Chairman Steagall referred to the liberalized
provisions of section 10(b) as authorizing
loans "upon any security regarded sound and
satisfactory";"! and Mr. Hollister thought
that the provisions would permit loans "on
practically any reasonable assets."168
The Board itself obviously regarded the new
section 10(b) as representing congressional
approval of the sound-assets concept. In its
1937 Annual Report to Congress, the Board
stated that its recent revision of Regulation A,
in conformity with the changes made by the
Banking Act of 1935, established rules "which
in effect permit any sound assets of member
banks to be used as a basis for advances by
Federal Reserve banks." By way of elaboration,
the Board said: 16t
* * * Under the original Federal Reserve
Act the conception of therediscountfunction
of the reserve banks was limited to providing
member banks with credit on short term
paper arising out of specific commercial, industrial and agricultural transactions, particularly to meet seasonal requirements; whereas
under the more recent amendments to the
law it is provided that any assets of a member
bank which are satisfactory to areservebank
may be used as a basis for obtaining credit.

* *«

112

HISTORY OF LENDING FUNCTIONS

In formulating the revised regulation, the
Board had in mind the fact recognized by
Congress in the Banking Act of 1935 that
under our banking system member banks
carry time deposits as well as demand deposits, and, since these banks are custodians
of the funds representing the savings or capi. tal accumulation of the people, they properly
invest a part of their funds in long-time paper,
and consequently provision should be made
for using them in case of need as a basis for
advances from the Federal Reserve banks.
Experience has demonstrated that the solvency of banks is better safeguarded by careful regard to the quality of the paper that
they acquire than by strict observance of the
form that this paper takes, and that greater
emphasis on soundness and less emphasis on
form is a sound banking principle.

PARTICULAR TYPES OF
SECURITY
As has been noted, when section 10(b) was
first enacted in 1932 in its temporary form, it
was contemplated that the authority granted
by that section would permit advances to member banks on almost any type of satisfactory
security, including municipal bonds, tax warrants, and long-term real estate mortgages.
As it was in force between 1932 and 1935,
section 10(b) authorized the Board by regulation to limit and define the classes of assets
accepted as security for advances; and, as
re-enacted in permanent form by the Banking
Act of 1935, the section authorized advances
under rules and regulations prescribed by the
Board. In published rulings after 1935, the
Board made it clear that advances could be
made under this section to member banks that
had not exhausted their eligible paper and that
any such assets eligible for discount could also
be used as security for section 10(b) advances.168 In addition, the Board held that
loans insured under the National Housing Act
might be accepted as collateral for such advances.169 It was not until 1937, however, when
Regulation A was revised to reflect changes in
the law, that the Board undertook to prescribe
any regulations on this subject.


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Federal Reserve Bank of St. Louis

The 1937 regulation provided that a Federal
Reserve Bank might accept as security for a
section 10(b) advance any of certain enumerated classes of assets.1"1 These were:
1. Assets eligible as collateral for section 13
advances, that is, eligible paper and Government obligations;
2. Paper that would be technically eligible
for discount except for the fact that its maturity
was greater than that permitted for eligible
paper;
3. Investment securities eligible for purchase
by member banks under section 5136 of the
Revised Statutes;
4. Obligations representing loans on stocks
in conformity with the Board's Regulation U;
5. Obligations insured under Titles I and II
of the National Housing Act;
6. Obligations issued by Federal Home Loan
Banks or under the Federal Farm Loan Act,
regardless of maturity;
7. Revenue bonds and warrants representing
general obligations of any State or political
subdivision;
8. Obligations issued or drawn to finance,
refinance, or carry real estate that complied with
the standards for real estate loans set forth in
an appendix to the regulation; and
9. Obligations issued or drawn to finance
instalment sales that complied with the standards for instalment loans set forth in the
appendix to the regulation.
These enumerated classes of assets were not
intended to be exclusive. The regulation provided that, in addition, a Reserve Bank might
make advances on any other types of satisfactory assets if in the judgment of the Reserve
Bank the circumstances made it advisable to
do so. However, the various types of assets
enumerated in the regulation were clearly regarded as preferred kinds of security for section
10(b) advances. In its Annual Report to Congress the Board stated that the regulation listed
"certain preferred classes of assets which cover
the principal fields of financing" and indicated
that the paper so described would have "first
claim for advances." 171
In order to encourage member banks to have
their real estate loans and instalment paper in a

ADVANCES TO MEMBER BANKS
form that would make them acceptable as a
basis for advances,1- the Board set forth in an
appendix to the 1937 revision of Regulation A
certain recommended minimum standards for
observance in making such loans, as a matter
of sound banking practice.'71
When—18 years later—Regulation A was
revised in 1955, the listing of specific types of
security acceptable for section 10(b) advances
and the minimum standards for real estate and
instalment loans were both omitted, presumably
because they were considered no longer necessary and possibly because, after the passage of
tirtic, they might be misleading and inadequate.

MATURITY
In its temporary and emergency form, section
10(b) had prescribed no requirement as to
maturity. As revived and made permanent by
the Banking Act of 1935, the section provided
that notes representing advances should have
maturities of not exceeding 4 months. In the
form in which it had passed both the House and
Senate, the 1935 bill had contained no such
limitation. However, during the committee hearings Governor Ecclcs conceded that a 6-month
limitation might be reasonable; K1 and the conference committee adopted the 4-month maturity restriction.
This was, of course, a somewhat more liberal
limitation than the 90-day maturity requirement imposed by section 13 with respect to
discounts and advances under that section.
Moreover, it was recognized that advances
might be subject to renewal,175 although, as in
tn
e case of any other extensions of credit, a
Reserve Bank could not make a prior commitment to renew such advances at maturity.

RATE OF INTEREST
One requirement prescribed by section 10(b)
has effectively prevented advances under that
section from taking the place of discounts of
e
'igiblc paper and advances on the security of
Government obligations and paper eligible for
discount or purchase under the Federal Reserve
Act
- That is the requirement that any advance


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Federal Reserve Bank of St. Louis

113

made by a Federal Reserve Bank to a member
bank on its note secured by satisfactory assets
shall bear interest at a rate higher than the
"highest discount rate in effect at the Federal
Reserve bank on the date of such note."
As originally enacted in 1932, section 10(b)
required the rate on advances under that section
to be at least 1 per cent higher than the regular
discount rate. As re-enacted in permanent form
by the Banking Act of 1935, this penalty rate
was reduced to one-half of 1 per cent.
When the section was first enacted in 1932
as an emergency measure, the only discount
rates then in effect were those applicable to
discounts of eligible paper for member banks
under sections 13 and 13a and advances to
member banks on the security of eligible paper
and Government obligations under the eighth
paragraph of section 13. Subsequently, in 1932,
section 13 was amended to provide for discounts of eligible paper for individuals, partnerships, and corporations; in March 1933 it was
further amended to authorize advances to individuals, partnerships, and corporations on direct
obligations of the United States; and in 1934
Congress enacted section 13b providing for
advances to industrial and commercial businesses. Under these various special authorizations designed to revive the economy during the
depression years, the Boardfixedrates that were
higher than the regular rates on discounts for
member banks under sections 13 and 13a. The
Board took the position, however, that the
required differential between the rate on advances under section 10(b) and the discount
rate should be determined by reference to the
regular discount rate on discounts and advances
under sections 13 and 13a rather than the rates
prescribed under the other special provisions
mentioned above.1"
In accordance with this position, the 1955
revision of Regulation A specifically provided
that the rate on advances under section 10(b)
should be not less than one-half of 1 per cent
higher "than the highest rate applicable to discounts for member banks under the provisions
of sections 13 and 13a of the Federal Reserve
Act" in effect at the Reserve Bank making the
advance.1" As again revised in 1973, the regu-

114

HISTORY OF LENDING FUNCTIONS

lation meets the problem in a different manner: It provides that the rate on section
10(b) advances to member banks shall be at
least one-half of 1 per cent higher than the rate
on advances to member banks secured by obligations or other paper eligible for discount or
purchase by Reserve Banks.

PROPOSALS
FOR LIBERALIZATION
The idea espoused by the Board in 1935 that
Federal Reserve loans should be available to
member banks on the security of any sound
assets without a penalty interest rate is by no
means dead.
In its replies to the questionnaire submitted
by Senator Douglas in 1949 (Douglas Questionnaire) the Board made the following recommendation: I r s
The provision of section I (Kb) which requires an interest rate higher by at least onehalf percent per annum than the highest discount rate of the Federal Reserve Bank for
advances to member banks secured by any
satisfactory collateral other than eligible paper should be eliminated.
Fourteen years later, in 1963, Chairman
Martin, on behalf of the Board, again proposed
that the Reserve Banks be authorized to make
advances to member banks on any satisfactory
security without charging a premium or penalty
interest rate. In letters to the Banking and Currency Committees of both Houses of Congress,
he argued that the real-bills doctrine had long
been abandoned and that the test of paper
eligible as security for Federal Reserve advances should be its soundness rather than
compliance with outmoded technical requirements. In this connection, he said: 1TS
Despite changes in the character of paper
held by commercial banks and the repeated
and necessary departures from the original
concept that discounts should be based only
on short-term, self-liquidating paper, the law
continues to impose unduly restrictive requirements as to the nature and maturity of
the paper that may be discounted by the
Reserve Banks or offered as security for
advances by the Reserve Banks.


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Federal Reserve Bank of St. Louis

For many years, it has been generally recognized that the concept of an clastic currency based on short-term, self-liquidating
paper is no longer in consonance with banking
practice and the needs of ihc economy. It has
long been apparent that the narrow requirements of the law regarding "eligible paper"
serve no useful purpose and thai it would be
preferable to place emphasis on the soundness
of the paper offered as security for advances
and the appropriateness of the purposes for
which member banks borrow. The onc-ycar
paper of many bank customers that is not now
eligible for discount may be as satisfactory
collateral as ihc 90-day notes of other customers. Moreover, the nature of the collateral
provides no assurance that the borrowing
bank will use the proceeds for an appropriate
purpose.
As long as member banks hold a large
enough volume of Government securities,
they need not, of course, be particularly concerned as to the eligibility for discount with
the Reserve Banks of customers* paper held
by them. Since World War II, however, there
has been a sharp net decline in the aggregate
holdings of Government securities by member
banks. If any substantial increase in economic
activity should cause banks to reduce their
holdings of Government securities in order to
meet increased credit demands, many banks
would be obliged to tender oihcr kinds of
collateral if they should seek to obtain Federal Reserve credit.
If such a situation should develop, the
Reserve Banks could accept technically "ineligible" paper as collateral for advances to
their member banks only under section 10(b)
of the Federal Reserve Act at a rate of interest one-half of one per cent above the
regular discount rate. However, the necessity
for distinguishing between "eligible" and "ineligible" paper would give rise to cumbersome
administrative procedures that arc not warranted by the exigencies of current banking
conditions. In order to avoid these problems,
it would clearly be preferable to move in advance and to revise and up-date the law so
as to eliminate the existing restrictions wi*
respect to "eligible paper."
Bills to implement this proposal were introduced in Congress." 0 They would have repealed

ADVANCES TO MEMBER BANKS
all of the provisions of the Federal Reserve Act
regarding discounts and advances and would
have replaced them with a new section 13A
that would have authorized the Reserve Banks,
under regulations of the Board, to make advances to member banks on any satisfactory
security. Such bills were passed by the Senate
in 196S and 1967 but they never succeeded in
obtaining the approval of the House Banking
and Currency Committee.
In 1971 the Board changed its approach.
Instead of recommending comprehensive legislation like that proposed by Chairman Martin,
it suggested simply an amendment to section
10(b) of the Federal Reserve Act to eliminate
the requirement that advances to member banks
under that section should bear a rate of interest
at least one-half of 1 per cent above the regular
discount rate.1'1 Tactically, this approach may


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115

be preferable to the earlier proposal to eliminate
the various provisions of the Act relating to
discounts and advances by the Reserve Banks.
Technically, it would have certain disadvantages. For example, unlike the earlier proposal,
it would not give the System complete flexibility
in fixing discount rates and it would not eliminate the necessity for applying the traditional
technical eligibility rules with respect to emergency extensions of credit under the third paragraph of section 13 to individuals, partnerships,
and corporations—a matter to be discussed in
a subsequent chapter.
In any event, the fact remains that under
present law the Reserve Banks may make
advances to member banks at the regular discount rate only on the security of paper that
either meets technical requirements for discount
or is eligible for purchase by the Reserve Banks.


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Federal Reserve Bank of St. Louis

Credit for Nonmember Banks

SUMMARY
As of December 31, 1972, there were 14,413
commercial banks and mutual savings banks in
the United States. Of this number, 4,613 were
national banks, 1,092 were State member
banks, and 485 were mutual savings banks.
Thus, there were 8,223 State banks that were
not members of the Federal Reserve System.1
In general, but with significant exceptions,
nonmember banks are the smaller banks of the
country; their total deposits comprise only
about 22 per cent of the total deposits of all
commercial banks. Since they have not subscribed to Federal Reserve Bank stock—and
thus have not subjected themselves to the various requirements, restrictions, and limitations
•mposed by the Federal Reserve Act—they do
not directly enjoy the benefits of the System,
deluding access to the credit facilities of the
Federal Reserve Banks.
h a sense, however, all nonmember banks
^ e «i a position to obtain the advantages of
e Svs
tem indirectly. Thus, in their dealings
F

°r NOTES AND REFERENCES, see pp. 260-61.


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117

with correspondent member banks they benefit
from the services afforded by the System to such
member banks through the collection of checks
and distribution of coin and currency. In an
indirect way also, nonmember banks benefit
from extensions of Federal Reserve credit to
member banks. When the Glass-Steagall Act
of 1932 authorized the Reserve Banks to make
emergency advances to member banks on any
satisfactory security, Mr. Steagall pointed out
that while a nonmember bank could not obtain
such advances directly, it could borrow from a
national bank or a State member bank and
thereby have "its paper indirectly fed into
the Federal reserve bank and indirectly" get
the benefit of that legislation.2
Since the time of its original enactment, the
Federal Reserve Act itself has specifically provided for indirect extensions of credit to nonmember banks through the medium of member
banks if permitted by the Federal Reserve
Board. For a brief period during 1933, the
Reserve Banks were expressly authorized to
make direct advances to nonmember banks on

118

HISTORY OF LENDING FUNCTIONS

satisfactory security. These two provisions, one
permanent and one temporary, will be discussed
in subsequent sections of this chapter.
Two other provisions of the law that authorize extensions of credit to individuals, partnerships, or corporations .in limited circumstances also afford a basis for extension of
Federal Reserve credit to nonmember banks,
since such banks, of course, are corporations.
These provisions will be considered generally
in the following chapter; but insofar as they

affect nonmember banks they will be discussed
in subsequent sections of the present chapter.
Finally, nonmember banks for many years
had direct access to Federal Reserve credit to a
limited extent by virtue of the provisions of
section 13b (no longer in effect), which authorized the Reserve Banks to extend credit to
financing institutions on the basis of paper of
industrial or commercial businesses. That authority, however, will be dealt with in a separate
chapter.

CREDIT THROUGH MEDIUM OF MEMBER BANKS
LEGISLATIVE HISTORY
Section 19 of the Federal Reserve Act, which
otherwise relates to entirely different subjects,
contains one sentence that affects the discounting functions of the Federal Reserve Banks and
in particular extensions of credit to nonmember
banks. That sentence was a part of the original
Act and has never been amended. It reads:
* * * No member bank shall act as the
medium or agent of a nonmember bank in
applying for or receiving discounts from a
Federal reserve bank under the provisions of
this Act except by permission of the Federal
Reserve Board. [Emphasis supplied.]
Although stated in the form of a prohibition,
this provision, by its exception, contemplates
indirect extensions of credit to nonmember
banks whenever permitted by the Board. The
legislative history of the provision is of interest
as indicating the belief on the part of the
framers of the Act that the benefits of the Act
should be limited to member banks, but that in
some circumstances even nonmember banks
should be afforded at least indirect access to
the credit facilities of the System.
The provision was not in the Glass bill that
passed the House in 1913 nor in the originally
reported Owen bill in the Senate. It grew out


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Federal Reserve Bank of St. Louis

of a provision contained in Senator Owen's
substitute bill that broadly prohibited any member bank from extending "directly or indirectly
the benefits of this system to a nonmember
bank, except upon written permission of the
Federal reserve board, under penalty of suspension."
When the bill was under debate, Senator
Owen himself pointed out that while the broad
provisions in his substitute bill would prevent
nonmember banks "from being the beneficiaries
of a system supported by others," it might go
too far, especially in the case of small banks
that could not, under the terms of the bill, come
into the System.1 He suggested that the provision might place a "stigma of exclusion" upon
every bank that was not a member of the
System and might, in addition, have the effect
of barring such banks from all transactions with
their correspondent member banks except by
permission of the Board. He felt that this prohibition would tend to build up "a monopoly
in banking instead of stabilizing the banking
system" and would prevent thousands of banks
"from continuing their business." ' In a like
vein, Senator Weeks said that the provision had
brought forth "a general protest" from all sections of the country, and Senator Root referred
to the provision as amounting "almost to a

CREDIT FOR NONMEMBER BANKS
nonintcrcoursc provision as between the banks
forming a part of the new system and the State
banks in general." s
Senator Owen asserted that no such effect
was intended and that the provision would be
redrafted." On December 18, 1913 (5 days
before the bill was signed), he offered an
amendment limiting the provision to discounts.
As thus amended, the bill prohibited any member bank "from acting as the medium or agent
of a nonmember bank in applying for or receiving discounts." r Senator Owen explained
that this would mean that member banks
would be "at liberty to have any transactions
whatever with the nonmember banks, but that
they must not act as a medium for nonmember
banks to get loans out of Federal reserve
banks." s In this amended form the provision
passed the Senate.
The conference committee adopted the provision, but restored the exception permitting
member banks to act as the medium for discounting paper of nonmember banks "with the
permission of the Federal Reserve Board."
Thus, while reflecting an intent to limit the
discounting facilities of the Reserve Banks to
members of the System, this provision in effect
gave the Board authority to determine when
and in what circumstances those facilities might
be extended to nonmember banks indirectly
through the medium of member banks.

LIBERAL INTERPRETATION
OF STATUTE
For some years the Board took no steps to
exercise its authority to permit discounts of
nonmember bank paper through the medium
°f member banks. It did, however, adopt a
somewhat liberal interpretation of the prohibitory portion of the provision of the law in
question. It held that if a member bank in good
faith acquired notes from a nonmember bank
'nat were eligible for discount and were held as
Part of the assets of the member bank, there
w
as no objection to the discounting of such
Paper if the officers of the Reserve Bank were
satisfied that it was a bona fide transaction and


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119

that the member bank was not extending accommodations to the nonmember bank.9
During World War I, in order to facilitate
the sale of Liberty bonds, the Board expressly
authorized the Reserve Banks to discount for
nonmember banks, with the endorsement of a
member bank, notes secured by Government
obligations if the proceeds were to be used for
carrying Treasury certificates or U. S. Government bonds." Subsequently, the Board ruled
that the Reserve Banks could discount for
member banks any notes of nonmember banks
secured by Government bonds."
In 1918, still following a liberal construction
of the statutory prohibition, the Board held that
the law did not preclude the discounting for
member banks of paper bearing the signature
or endorsement of a nonmember bank 12 or of
notes endorsed without recourse by a nonmember bank."

BLANKET AUTHORITY
It was not until 1921, however, that the
Board, in a period of economic stress, gave
general authority to the Reserve Banks to discount for member banks any eligible paper
acquired from nonmember banks.1*
Two years later, in 1923, that general permission was withdrawn on the ground that the
temporary emergency that had made it necessary had passed.15 At the same time, the Board
specifically rescinded the liberal rulings previously mentioned that had permitted the discounting of paper signed or endorsed by nonmember banks. Also at the same time, the
Board undertook to set forth some general rules
on this subject:
1. No paper acquired from, or bearing the
signature or endorsement of, a nonmember
bank was to be discounted for any member
banks except with the Board's permission,
unless such paper had been bought by the
offering member bank in good faith on the
open market from some party other than the
nonmember bank.
2. Applications for the Board's permission
were required to state the facts fully and the

120

HISTORY OF LENDING FUNCTIONS

reason why the member bank felt justified in
seeking such permission.
3. As a general rule, the Board would not
give its permission in the case of any nonmember bank that was eligible for membership
in the System; the Board felt that eligible nonmember banks should join the Federal Reserve
System if they desired to participate in its
benefits.
4. However, the Board would make exceptions, for limited periods, to assist nonmember
banks in emergencies, but only until the nonmember'banks could qualify for membership.
Following this action in 1923, the Board in
some specific cases granted temporary permission for the discounting of paper of nonmember
banks. In 1926 it expressly gave general permission for the discounting of paper signed or
endorsed by a Federal intermediate credit bank
on the ground that, since such banks were not
eligible for membership in the System, such
permission was consistent with the policy announced in the Board's 1923 ruling.10
During the banking crisis of March 1933, the
Board for the second time gave blanket permission for the discounting of paper acquired from
nonmember banks. This permission continued
in effect until the revision of Regulation A in
1937, when it was allowed to terminate.
In the summer of 1966, there was what
became known as a credit crunch—a situation
in which not only nonmember commercial
banks but savings and loan associations and
mutual savings banks were subjected to unusual
deposit drains that made it difficult for them
to meet the loan demands of their customers.
To ameliorate this situation, the Board on
July 1, 1966, advised the Reserve Banks that,
as a matter of general policy, they should be
prepared to provide emergency credit facilities
to such institutions in accordance with certain
guiding principles. To implement this policy,
the Board, among other things, gave blanket
permission, pursuant to section 19(e) of the
Federal Reserve Act, for the use of assets
acquired from nonmember banks as security for
Federal Reserve advances to member banks,
whether under section 13 or section 10(b)."
This permission was limited to a period ending
on September 1,1966.


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Federal Reserve Bank of St. Louis

During a similar crunch in 1969, the Board,
for the fourth time, gave general permission for
the use of assets acquired from nonmember
banks as security for advances to member
banks. As of December 24, 1969, that permission was made effective for a period ending
April 1, 1970.ls After additional extensions,
the permission expired on August 1, 1971.
In 1972 the Board again gave blanket permission for Reserve Bank loans to member
banks for the benefit of nonmember banks but
for entirely different reasons. The Board had
amended its Regulation J, relating to the collection of checks by the Reserve Banks, to require
every bank to which checks arc sent for payment by the Reserve Banks to make payment
on the day of receipt in immediately available
funds. Previously, drawee banks had the option
of making payment for a cash letter received
from its Reserve Bank by means of drafts that
would not be collected by the Reserve Bank
until 1 or 2 days following the receipt of the
cash letter by the drawee bank; consequently,
the drawee bank enjoyed the use of the funds
represented by the cash letter for a short period
after its receipt, thus giving rise to what was
known as Federal Reserve float. This amendment to Regulation J, which, after some delay
resulting from litigation, became effective November 9, 1972, in effect deprived drawee
banks of such float with a resulting loss that
varied from bank to bank. The adverse effect
was mitigated in the case of drawee member
banks by a simultaneous amendment to the
Board's Regulation D that substantially lowered
reserve requirements for most member banks;
but, since nonmember banks arc not subject
to reserve requirements under the Federal
Reserve Act, they could not be given the same
offsetting advantage.
Shortly before the change in Regulation J
was originally scheduled to have gone into
effect, the Board sought to ameliorate its impact
upon nonmember drawee banks by providing
for extensions of Federal Reserve credit to such
banks either directly or through correspondent
member banks. To facilitate indirect extensions
of credit to nonmembers, the Board granted
blanket permission to the Reserve Banks under
section 19(e) of the Federal Reserve Act to

CREDIT FOR NONMEMBER BANKS
make advances to member banks for the benefit
of nonmember banks in order that Federal
Reserve credit could be made available to any
nonmember bank if the change in Regulation J
would "result in a significant impairment of
liquidity or impair the bank's ability to serve
its community." IB

REGULATORY PROVISIONS
Not until 1928 did Regulation A include any
specific provisions regarding loans to member
banks for the benefit of nonmember banks.20
In ils general revision of the regulation at that
time, the Board required that a member bank's
application for discount be accompanied by a
certificate to the effect cither that the paper
offered for discount had not been acquired from
a nonmember bank or that, if so acquired, the
Board's permission had been obtained. In a new
separate section, the revised regulation provided
that, except with the Board's permission, no
Federal Reserve Bank should discount paper
acquired by a member bank from a nonmember
bank or bearing the signature or endorsement
of a nonmember bank, unless the paper had
been bought by the offering bank "in good faith
on the open market from some party other than
the nonmember bank." Applications for the
Board's permission were required to state the
facts and the reasons for requesting it. Express

121

permission was granted for the discounting of
paper signed or endorsed by Federal intermediate credit banks. In effect, these provisions of
the regulation merely incorporated the substance of the 1923 and 1926 rulings of the
Board that have previously been mentioned.
As revised in 1937 51 and again in 1955,"
Regulation A continued to include the provisions first incorporated in the regulation in
1928: prohibition of discounting of nonmember
bank paper without the Board's permission,
and specific permission to discount only paper
acquired from Federal intermediate credit
banks. One change in language, however, was
made by the 1937 revision. Whereas the regulation had previously excepted paper purchased
in good faith in the open market from a party
other than the nonmember bank, the 1937
amendment provided more broadly that the
prohibition should not apply to paper purchased
in the open market or "otherwise acquired in
good faith and not for the purpose of obtaining
credit for a nonmember bank." The revision of
Regulation A adopted in 1973 condensed these
provisions, without intending any change of
substance. They now provide simply that, except with the Board's permission, no member
bank shall act as the medium or agent of a
nonmember bank—other than a Federal intermediate credit bank—in receiving credit from
a Reserve Bank.23

EMERGENCY DISCOUNTS OF ELIGIBLE PAPER
Pursuant to the statutory and regulatory provisions just discussed, nonmember banks have
been enabled, since the enactment of the Federal Reserve Act, to obtain Federal Reserve
credit indirectly through the medium of member
°ariks, subject to permission granted by the
Board, it w a s n o t u n t i i i9i2, however, that
here was any statutory authority under which
°Ifect credit could be extended to nonmember
banks by the Federal Reserve Banks—except
he
^ c i a l authority granted in 1924 to any


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Federal Reserve Bank of St. Louis

banks to discount notes of veterans of World
War I, as discussed in Chapter 7.
The Emergency Relief and Construction Act
of July 21, 1932,5' added to section 13 of the
Federal Reserve Act a new paragraph, now the
third paragraph of that section, that made it
possible for the Reserve Banks, in unusual and
exigent circumstances and with the affirmative
authority of the Federal Reserve Board, to
discount eligible paper for any individual, partnership, or corporation unable to secure ade-

122

HISTORY OF LENDING FUNCTIONS

quate credit accommodations from other banking institutions. This authority will be discussed
generally in the following chapter. At this point
it is sufficient merely to note that since a nonmember bank is a corporation, the authority is
broad enough to encompass discounts of eligible paper for nonmember banks.25
Nevertheless, when the Board on July 26,
1932—5 days after the enactment of the
provision—granted permission for discounts
under this authority and prescribed certain rules
to be followed, it was specifically stated that
for this purpose the term "corporations" should
not be considered as including banks.16 Thus,
nonmember banks were excluded from the
benefits of this authority.

As has been noted, during the credit crunches
of 1966 and 1969 the Board for temporary
periods expressly permitted advances to member banks for the benefit of nonmember banks.
At the same time, the Board also activated the
authority under the third paragraph of section
13 for extensions of Federal Reserve credit on
the basis of paper eligible for discount to nonmember deposit-type financial institutions, principally mutual savings banks and savings and
loan associations, and also to nonmember commercial banks. This authorization was never
actually utilized by any nonmember bank, and
since August 1, 1971, the authority for loans
under the third paragraph of section 13 to
nonmember institutions has not been in effect.

ADVANCES ON GOVERNMENT OBLIGATIONS
By the Emergency Banking Act of March 9,
1933," Congress added still another paragraph
to section 13 of the Federal Reserve Act under
which the Reserve Banks could extend credit to
nonmember banks. This paragraph, the thirteenth and last in section 13, as amended in
1968, authorizes advances to any individual,
partnership, or corporation for periods of not
more than 90 days on notes secured by direct
obligations of the United States or by obligations issued or fully guaranteed by U.S. agencies." Again, a discussion of this paragraph
belongs properly within the scope of the following chapter, but it needs to be mentioned here
because the term "corporation" includes a nonmember bank and nonmember banks have
used this paragraph as the basis for obtaining
direct access to the credit facilities of the Reserve Banks in emergency circumstances.
When the Emergency Banking Act of 1933
was under consideration in Congress, it was
clearly contemplated that the new thirteenth
paragraph of section 13 of the Federal Reserve
Act would permit nonmember banks to obtain
credit from the Federal Reserve Banks. Thus,


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Federal Reserve Bank of St. Louis

Senator Glass, with some reservations as to
the wisdom of the measure, stated: M
* • * It broadens—in a degree that is
almost shocking lo me—the currency and
credit facilities of the Federal Reserve Banking System, and largely extends these facilities
to State banks which arc not members of the
Federal Reserve Banking System, that have
never endured one penny of the expense of
the establishment of the system or its maintenance, and do not do so today.
Similarly, when the bill was being debated in
the House, Chairman Steagall of the House
Banking and Currency Committee declared that
any State bank could obtain an advance from
a Reserve Bank to the amount of the face value
of U.S. Government bonds offered as security.
"That," he said, "is where we have gone in
liberalizing credit and expansion." 30
When, in 1937, Regulation A was revised to
reflect changes in the law made since 1930, no
provision in the text of the regulation covered
advances to individuals, partnerships, and corporations; but in a footnote attention was called
to the fact that, under the last paragraph of

CREDIT FOR NONMEMBER BANKS
section 13 of the Federal Reserve Act, the
Reserve Banks could make advances to individuals, partnerships, or corporations "(including banks)" on the security of direct obligations
of the United States. In 1942 an amendment to
the regulation changed this footnote to state
explicitly that the term "corporation" included
an incorporated bank;" and in the same year
the Board published a ruling that made it dear
that, under the last paragraph of section 13,
advances could be made to nonmember banks
on the security of direct obligations of the
United States." Thus, although the Board had
not interpreted the reference to corporations in
the third paragraph of section 13 as applying to
nonmember banks, a similar reference in the
last paragraph of the section was explicitly
applied to cover loans to such banks.
Except in special circumstances or during
certain limited periods, advances to nonmember
banks under the last paragraph of section 13
have not been encouraged. In a footnote in the
1955 revision of Regulation A, it was stated
that while a Reserve Bank has authority under
that paragraph to make advances on Government obligations to individuals, partnerships,
and corporations, including nonmember banks,
it was "not the practice to make advances to
others than member banks except in unusual
or exigent circumstances." •"" In 1968 even this
reference to the legal authority for advances to
nonmember banks was eliminated from the
regulation," so that the regulation thereafter
contained no reference whatsoever to extension
of Federal Reserve credit to nonmember banks.
The revision of the regulation adopted in 1973,
however, contains a section expressly referring
to advances under the last paragraph of section
'3 to individuals, partnerships, and corpora-


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Federal Reserve Bank of St. Louis

123

tions on the security of direct obligations of
the United States or obligations issued or fully
guaranteed by any agency of the United States,
but the wording makes it clear that any such
extensions of credit are limited to emergency
circumstances."
Discouragement of advances to nonmember
banks under the last paragraph of section 13
has been evidenced not only by provisions of
the Board's regulation but also by the fact that,
in general, the rate charged on such advances
has been higher than the regular or basic discount rate for advances to member banks.
From September 1939 until April 1946—
just before, during, and after World War II
—advances to nonmember banks were authorized to be made at the same rate as that
fixed for loans to member banks on eligible
paper at the regular discount rate. Since 1946
the rate on advances to nonmember banks has
been substantially higher than the regular discount rate. As previously discussed, the Board
in 1972 acted to provide credit through the
discount window to nonmember banks adversely affected by changes in Regulation J.
At that time a special rate of 4'/i per cent
was established by six Reserve Banks—but
only for a temporary period of time—for advances to nonmember banks under the last
paragraph of section 13 for cases in which
nonmember banks were seriously affected by
the changes in Regulation J. This special rate
was the same as the regular rate at that time
for advances to member banks—2 per cent
less than the rate for advances in general under
the last paragraph of section 13.
In actual practice, Federal Reserve loans to
nonmember banks under the last paragraph of
section 13 have been few and far between.

124

HISTORY OF LENDING FUNCTIONS

TEMPORARY AUTHORITY FOR ADVANCES ON
SOUND ASSETS
In only one instance has Congress authorized
direct extensions of Federal Reserve credit to
nonmember banks as such, as distinguished
from advances to such banks as corporations
or as financing institutions, and that authority
was in force only for an emergency period of
one year ending March 24, 1934.
As noted in the previous chapter, the GlassSteagall Act of 1932 authorized the Federal
Reserve Banks, by the addition of section
10(b) of the Federal Reserve Act, to make
direct advances to member banks on any satisfactory security, though only on an emergency
basis and subject to certain restrictions. That
authority was somewhat liberalized by the
Emergency Banking Act of March 9, 1933.
About 2 weeks later, on March 24, 1933, 10
Congress amended the Emergency Banking Act
by adding a new section 404 under which the
Reserve Banks were authorized to make advances to nonmember banks on the same terms
as advances could be made to member banks
under section 10(b) of the Federal Reserve
Act.
This new authority, however, was severely
limited. In the first place, its effectiveness was
restricted to "the existing emergency in banking" or until the authority might be terminated
by proclamation of the President, but in no
event beyond 1 year from the date of enactment.
A Reserve Bank could make an advance to a
nonmember bank only after inspection and
approval of the collateral and a "thorough examination of the applying bank or trust company." " Each application was required to be
accompanied by the written approval of the
appropriate State banking authority and by a
statement of that authority that in its judgment
the bank was in a sound condition. As long as
it was indebted to the Reserve Bank, the borrowing bank was required to comply in all
respects with the provisions of the Federal
Reserve Act and regulations of the Board applicable to member State banks, except that in-


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Federal Reserve Bank of St. Louis

stead of subscribing to Federal Reserve Bank
stock, the bank was required to maintain during
the period of such indebtedness the reserve
balance required for member banks under section 19 of the Act.
Although this authority for advances to
nonmember banks was a limited one of short
duration, its legislative history is of interest
because it reflects both an intent to case the
banking crisis by affording credit to nonmember
banks and, at the same time, an intent to adhere
to the concept that Federal Reserve credit facilities should be limited to member banks except
in emergencies.
The disposition of Congress to permit more
liberal extensions of credit to nonmember banks
was obviously influenced by the fact that the
bars had already been lowered by the Acts of
July 21, 1932, and March 9, 1933." In the
light of the conditions that still prevailed, it
was felt that the bars should be lowered even
further to allow nonmember banks the same
access to Federal Reserve credit that member
banks enjoyed under the provisions of section
10(b) of the recently enacted Emergency
Banking Act. Mr. Stcagall believed that there
was no reason to discriminate against nonmember banks during the emergency.13 He
described the bill as permitting State nonmember banks: '"
* • • to borrow temporarily of Federal Reserve banks and to use as collateral, the same
as was provided in the legislation of last week
for member banks of the Federal Reserve
System, any security whether eligible or not
under the general provisions of the Federal
Reserve Act that may be found to be satisfactory to Federal Reserve officials * * *•
Similarly, Senator Robinson stated: "
* * • The bill gives supplemental rights
or opportunities to State banks and trus
companies to obtain direct loans from the
Federal Reserve banks on their time and
demand notes, secured to the satisfaction o

CREDIT FOR NONMEMBER BANKS
the Federal Reserve banks. • • ° It is believed that the change now proposed will tend
to place the State banks nearer on a parity
with member banks.
At the same time, it was recognized that the
privilege thus afforded to nonmember banks
was exceptional and that it should be strictly
limited. When Senator Barklcy suggested that
the requirement for approval by the State banking commissioner might be too restrictive, Senator Robinson replied that such approval was
necessary because the bill would extend "a
rather extraordinary privilege to an outside
bank—that is, a bank that is not a member of
the Federal Reserve System" and that it had
been "thought wise"' to make this requirement.i:
An interesting sidelight on the legislative
history of the Act of March 24, 1933, is the
fact that in attempting to provide the same
accommodations to nonmember banks as those
provided to member banks by section 10(b) of
the Federal Reserve Act, the bill at first referred to advances on eligible or ineligible
paper. Mr. Bccdy felt that the term "eligible
or ineligible paper" was subject to varying
interpretations. Mr. Stcagall explained that
it was intended to permit a nonmember bank
to "tender its eligible or noncligiblc paper,
and that gets all the paper it has, just as it does
with a member bank." " He pointed out that
originally section 10(b) had been limited to
advances in cases in which member banks had
no further eligible paper available and that, if
advances to nonmember banks were permitted


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Federal Reserve Bank of St. Louis

125

only on the same terms as those prescribed by
section 10(b), such banks would be enabled to
borrow only on noneligible paper.41 Eventually,
to make the point clear, the provision in question was omitted and, instead, there was included a proviso stating that loans might "be
made to any applying nonmember State bank or
trust company upon eligible security."
The limited and temporary authority for
advances to nonmember banks on any satisfactory security expired on March 24, 1934,
and has never been revived. It may be noted
that the so-called eligible paper bill recommended by the Board in 1963 not only would
have permitted Reserve Bank advances to member banks on any satisfactory security but also
would have authorized advances to any individual, partnership, or corporation secured to
the satisfaction of the lending Reserve Bank in
exigent circumstances. This authority is not
contained in the current Board proposal"
for legislation that would simply remove
the penalty rate requirement from section
10(b) of the Federal Reserve Act authorizing
advances to member banks on any satisfactory
security. If that proposal should be enacted,
nonmember banks, as at present, would have
direct access to Federal Reserve credit only
under the last paragraph of section 13 of the
Federal Reserve Act on the security of Government obligations or obligations issued or fully
guaranteed by agencies of the United States, or
under the third paragraph of section 13 on the
security of paper eligible for discount if that
paragraph is activated by the Board in unusual
and exigent circumstances.


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Federal Reserve Bank of St. Louis

Loans to Individuals/
Partnerships/ and Corporations

LOANS ON ELIGIBLE PAPER
IN EMERGENCY CIRCUMSTANCES
REJECTION IN ORIGINAL ACT
When the original Federal Reserve Act was
being considered in 1913, some members of
Congress argued that the Reserve Banks should
be permitted to discount paper for individuals
as well as for member banks, on the theory that
the System's control over discount rates would
be made that much more effective and also that
Federal Reserve credit would thereby be made
more widely available in emergencies.1 The
great majority in Congress, however, felt that
the Federal Reserve Banks should be strictly
bankers' banks, dealing only with commercial
banks and not with the general public. By the
same token, it was generally agreed that the
Reserve Banks should not compete with commercial banks by making loans to individuals.2
This concept was maintained intact until the
ea
rty 193O's when the depression created a
situation that resulted in a fundamental change
in the role of the Federal Government with
respect to loans to nonbanking institutions and
For NOTES AND REFERENCES, see pp. 261-62.


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127

individuals, and the Federal Reserve System
felt the effects of this change. As noted in the
previous chapter, the original Federal Reserve
Act provided a means for at least limited and
indirect extensions of credit to nonmember
commercial banks. Some years later, authority
was added to permit access to Federal Reserve
credit by the Federal intermediate credit banks.
It was not until 1932, however, that the Reserve
Banks were first given authority to provide
credit assistance to individuals, and that authority was very limited and was given with reservations on the part of some members of Congress,
including Carter Glass.

1932 AMENDMENT
On July 11, 1932, President Hoover vetoed
a bill to relieve unemployment through highway
construction projects because it also contained
provisions for loans to individuals by the Reconstruction Finance Corporation. The President felt that these provisions "would place the
Government in private business in such fashion
as to violate the very principle of public rela-

128

HISTORY OF LENDING FUNCTIONS

tions upon which we have builded our Nation,
and render insecure its very foundations." Such
action, he believed, "would make the Reconstruction Finance Corporation the greatest
banking and money-lending institution in all
history." 3
A new bill was introduced on the day of the
President's veto, and Senator Glass promptly
offered an amendment to authorize the Federal
Reserve Banks, in unusual and exigent circumstances, to discount eligible paper for individuals and corporations. A similar provision was
included in another bill introduced by Senator
Wagner as a substitute for the highway construction bill vetoed by the President. The
provision was retained in that bill when it
passed the Senate on July 12, although the
duration of the authority for such discounts
would have been limited to a period of 2 years.
The conference committee made three changes,
all of a liberalizing nature: The 2-year limitation was omitted, thus making the authority
permanent legislation; the authority was expanded to cover discounts for partnerships as
well as corporations and individuals; and a
prohibition against the use of paper discounted
under the provision as collateral security for
Federal Reserve notes was omitted.
The bill became law on July 2 1 , 1932.1
Thus, tucked away in a road construction
measure, authority for extension of Federal Reserve credit to individuals, partnerships, and
corporations was incorporated in the Federal
Reserve Act. That authority—with one small
change to be mentioned later—is contained in
the third paragraph of section 13 of the Act.
That paragraph which is the same as originally
enacted, reads as follows: r>
In unusual and exigent circumstances, the
Board of Governors of the Federal Reserve
System, by the affirmative vote of not less
than five members, may authorize any Federal reserve bank, during such periods as the
said board may determine, at rates established in accordance with the provisions of
section 14, subdivision (d), of this Act, to
discount for any individual, partnership, or
corporation, notes, drafts, and bills of exchange of the kinds and maturities made
eligible for discount for member banks under


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Federal Reserve Bank of St. Louis

other provisions of this Acl when such notes,
drafts, and bills of exchange arc indorsed and
otherwise secured to the satisfaction of the
Federal Reserve bank: Provided, That before
discounting any such note, draft, or bill of
exchange for an individual or a partnership
or corporation the Federal reserve bank shall
obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other
banking institutions. All such discounts for
individuals, partnerships, or corporations
shall be subject to such limitations, restrictions, -and regulations as the Board of Governors of the Federal Reserve System may
prescribe.

LIMITATIONS
As will be observed, this authority for loans
to individuals, partnerships, and corporations is
strictly limited.
First, loans may not be made by the Reserve
Banks under this authority unless the Board of
Governors, in unusual and exigent circumstances, authorizes them to do so. It should be
noted that it is activation of the authority by
the Board that is dependent upon unusual and
exigent circumstances and not the making of
individual loans once the authority is activated.
Second, activation of the authority by the
Board must have the affirmative vote of at
least five members of the Board. This is one of
the few instances in which the law requires that
action taken by the Board must be approved
by a greater majority than a quorum.
Third, if the authority is activated by the
Board, its duration may be limited to such
periods as the Board may determine.
Fourth, loans under this authority may be
made only through the discounting of paper of
the kinds and maturities made eligible for discount for member banks under other provisions
of the Federal Reserve Act. This is an important
limitation. While advances may be made to
member banks under the eighth paragraph of
section 13 on the security of any paper eligible
for discount or purchase by the Reserve Banks
or, at a higher rate of interest, on any satisfactory security under section 10(b) of the Act,
the only paper made eligible for discount for
member banks is paper arising out of actual

INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS
commercial transactions with a maturity of not
more than 90 days (under the second paragraph
of section 13) or agricultural paper with a
maturity of not more than 9 months (under
section 13a).
Nonbank financial institutions, such as savings and loan associations, ordinarily do not
hold customers' paper of the kind that would
be eligible for discount, and it is even less likely
that business enterprises would hold any substanlial amounts of such paper. There are,
however, certain possibilities. For one thing,
the note discounted for an individual, partnership, or corporation need not be one of its
customer's notes but may be its own note.
Under Regulation A, a note the proceeds of
which arc to be used for current operating
expenses of a business enterprise is eligible for
discount by a member bank. Consequently, a
business concern's own note would be eligible
for discount under the third paragraph of section ! 3 if the proceeds were to be used by it for
current operating expenses. Again, if the proceeds of a note executed by a financial institution such as a finance company or a savings and
loan association were to be used for making
loans to others for eligible purposes, that note,
under rulings of the Board heretofore mentioned, would be eligible for discount in the
hands of a member bank and hence would be
eligible as a basis for direct credit under the
third paragraph of section 13.* In any such
case, however, the note of a business enterprise
or
of a financial institution must have a matur'ty of not more than 90 days in order to be eligible for discount under that paragraph.
Fifth, whereas a member bank may discount
eligible paper with its Reserve Bank without
offering any additional security, a borrower
un
der the third paragraph of section 13 not
on
'y must present a note—its own or its customer's—that is eligible for discount but also
m
ust provide security or obtain an endorsement
toat is satisfactory to the lending Reserve Bank.
A* originally enacted, the paragraph required
foat the paper offered for discount should be
mdorscd and otherwise secured" to the satisfaction of the Reserve Bank. In 1935, on the
B
°ard's recommendation, the word "and" was
ranged to "or" so that cither an endorsement


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Federal Reserve Bank of St. Louis

129

or additional security could be accepted by the
Reserve Bank.T In any case, it seems clear that
it was the intent of Congress that loans should
be made only to creditworthy borrowers; in
other words, the Reserve Bank should be satisfied that a loan under this authority would be
repaid in due course, either by the borrower or
by resort to security or the endorsement of a
third party.
Sixth, the lending Reserve Bank must obtain
evidence that an applicant for credit under this
paragraph is unable to secure adequate credit
accommodations from other banking institutions. This is a significant limitation—one designed to assure that loans will be made only in
truly unusual and exigent circumstances.
Finally, all loans under this authority are
subject to such limitations, restrictions, and
regulations as the Board may prescribe and to
rates established in accordance with section
14(d)oftheAct.

BOARD ACTIVATION OF
AUTHORITY
Notwithstanding the restricted nature of the
authority, it was apparently felt in 1932 that,
in the economic circumstances of the time, such
authority would be used to provide needed
credit to business concerns and individuals. The
Board lost no time in implementing the statute.
Five days after its enactment, on July 26, 1932,
the Board issued a circular granting permission
to the Reserve Banks to make discounts under
the new authority for a period of 6 months
beginning August 1, 1932.8 The circular stated
that since such discounts would be made only
in unusual and exigent circumstances, the Board
did not propose to prescribe any formal regulations. However, the requirements of the law and
the procedure to be followed were outlined in
the circular.
Among other things, the circular required
that an applicant for any discount under the
new authority must submit a statement as to
the circumstances and the purpose for which
the proceeds would be used, describe the efforts
made by him to obtain credit from other banking institutions, list each bank with which the
applicant had had banking relations during the

130

HISTORY OF LENDING FUNCTIONS

previous year, provide complete credit data, and
agree to furnish additional credit information
when requested.
Upon the Federal Reserve Banks the circular
imposed a duty in each case to determine that
the applicant's financial condition and credit
standing justified the discount; that the paper
offered for discount was acceptable from a
credit standpoint and eligible from a legal
standpoint; that the security was adequate; that
there was a reasonable need; and that the applicant was unable to obtain adequate credit
accommodations from other banking institutions. The Reserve Banks were prohibited from
making any commitments to renew credits
granted by them, and, except with the Board's
permission, no Reserve Bank could discount
for any one individual or corporation paper
aggregating more than 1 per cent of the Reserve
Bank's own capital stock and surplus.
The circular included one important restriction not prescribed by the law. Although the
statute authorized discounts for corporations,
a term broad enough to include banks, the
Board's circular specifically provided that the
term should not include banks. Because of this,
nonmember banks that otherwise might have
availed themselves of this avenue of access to
Federal Reserve credit were precluded from
doing so.
The 6-month permission for discounts for
individuals, partnerships, and corporations
granted by the Board on August 1, 1932, was
extended for successive periods of 6 months
until July 31, 1936, when the permission was
allowed to terminate.9 In large part, it was
rendered unnecessary by the enactment in 1934
of section 13b of the Federal Reserve Act under
which the Reserve Banks were authorized to
make loans to business enterprises for working
capital purposes. That authority will be discussed in the next chapter.
Although the third paragraph of section 13


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Federal Reserve Bank of St. Louis

has not been reactivated by the Board since
1932 as a means of providing Federal Reserve
credit to businesses, it was activated in 1966
and again in 1969 for the purpose of meeting
possible credit needs of savings and loan associations, mutual savings banks, and nonmember
commercial banks.10

USE OF AUTHORITY
The authority for discounts in exigent circumstances for individuals, partnerships, and
corporations was an emergency authority—one
of several measures undertaken in the early
1930's to meet the need for credit during the
depression. It was used only for a short while
and only to a limited extent. Pursuant to the
activation of the authority in 1932, the Reserve
Banks, over a period of 4 years, made loans
to only 123 business enterprises aggregating
only about SI.5 million. The largest single loan
was for S300,000.
One of the reasons for the limited use of this
authority has already been noted—the enactment in 1934 of legislation authorizing working
capital loans to business enterprises. Another
was the enactment in March 1933 of legislation
authorizing advances by Reserve Banks to individuals, partnerships, and corporations on
the security of U. S. obligations, an authority to
be discussed in the following section. Moreover,
the rate established for discounts under the
1932 authority was considerably higher than
the regular discount rate;" and, though later
reduced, the rate on emergency discounts for
individuals, partnerships, and corporations,
when such discounts have been authorized,
has always been substantially higher than the
regular discount rate and higher also than the
rate on direct advances to individuals, partnerships, and corporations on the security of Government obligations under the thirteenth paragraph of section 13 of the Act.

INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS

131

ADVANCES ON GOVERNMENT OBLIGATIONS
The Emergency Banking Act of March 9,
1933,12 signed by President Roosevelt at the
height of the most critical banking situation in
the country's history, was, as stated in its enacting clause, designed to remedy a "serious emergency." It gave legal confirmation to the drastic
action taken by the President a few days earlier
in closing all banks; it provided for their reopening under licenses from the Secretary of the
Treasury; it authorized the Secretary to call in
all privately held gold and gold coin; and, along
with these and other equally drastic steps, it
briefly but explicitly authorized the Federal Reserve Banks to make advances to individuals,
partnerships, and corporations on their promissory notes secured by direct obligations of the
United States. This authority was set forth in a
new paragraph—the thirteenth—added at the
end of section 13 of the Federal Reserve Act.
Unlike the authority granted in 1932 for the
discounting of paper of individuals, partnerships, and corporations, this authority contained relatively few restrictions and limitations.
It provided only that such advances should be
made for periods not exceeding 90 days; that
they should bear interest at rates fixed by the
Reserve Banks subject to review and determination of the Board; and that they should be
subject to such limitations, restrictions, and
regulations as the Board might prescribe.
Again, like the 1932 authorization for discounts for individuals, partnerships, and corporations, the provision for direct advances on
Government obligations represented a definite
departure from the traditional concept that the
Reserve Banks should act only as bankers'
banks. Senator Glass observed that, under these
tWo
Provisions, individuals were: "
* * * permitted to do business with the Federal Reserve banks, something that has never
been done before since they were organized,
individuals who have eligible paper in their
Possession, and who can not get accommoda-


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Federal Reserve Bank of St. Louis

tion at the member bank, permitted to take it
directly to the Federal Reserve banks and be
accommodated.
Chairman Steagall of the House Banking and
Currency Committee, after stating that under
the new authority an individual could obtain
Federal Reserve credit to the amount of the
face value of Government bonds offered as
security, remarked: "That is where we have
gone in liberalizing credit expansion." "
While the Board was authorized to prescribe
restrictions and limitations, it did not do so. In
contrast to its action after the enactment of the
1932 authority to discount paper for individuals, partnerships, and corporations, the Board
did not exercise its regulatory authority to exclude banks from the scope of the term "corporations." On the contrary, as noted in the
preceding chapter, it became clear that incorporated banks, both member and nonmember,
could avail themselves of the new provision
authorizing advances to corporations. Indeed,
the thirteenth paragraph of section 13 made it
possible for advances to be made to member
banks on U.S. Government obligations for
periods of up to 90 days, in contrast to the
15-day maturity limitation on such advances
under the eighth paragraph of that section.
Since 1968, when the eighth paragraph was
amended to authorize 90-day advances to member banks on the security of any obligations
eligible for purchase by the Reserve Banks
under section 14 (b) of the Act, including obligations of the United States, it has been unnecessary to resort to the thirteenth paragraph
of section 13 as a basis for advances to member
banks on Government obligations for periods
in excess of 15 days.
In 1968, when the temporary authority of the
Reserve Banks to purchase obligations issued or
guaranteed by agencies of the United States was
made permanent, the thirteenth paragraph of
section 13 was broadened to authorize advances to individuals, partnerships, and corpo-

132

HISTORY OF LENDING FUNCTIONS

rations not only on the security of direct obligations of the United States but also on the security of such agency issues.15
It should be observed that, although conferred by an emergency statute, the authority
contained in the last paragraph of section 13 of
the Federal Reserve Act was not limited to
emergency circumstances. Perhaps the authors
of the Emergency Banking Act contemplated
that the authority would be used only under
extraordinary circumstances such as those prevailing at that time; but they did not place any
such limitation in the law. Legally, the provision
makes it possible for the Reserve Banks to
make advances under this provision in ordinary
times as well as in times of economic stress.
Actually, the authority provided by the thirteenth paragraph of section 13 has always been
regarded as being limited to unusual or exceptional circumstances. The revision of Regulation A adopted in 1973 expressly provides for
use of the authority only in emergency circumstances, and the general principles contained in
the revision contemplate advances to individuals, partnerships, and corporations only when,
in the judgment of a Reserve Bank, credit "is
not practically available from other sources and
failure to obtain such credit would adversely
affect the economy." 1B
One factor that tends to preclude any extensive use of the last paragraph of section 13
is that business enterprises—and even nonmember banks—may not hold Government securi-


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Federal Reserve Bank of St. Louis

ties in sufficient amounts to be used as security
for advances under that paragraph. Another
important factor that militates against use of
the paragraph is that the rate fixed for advances
under the paragraph has usually been substantially higher than the regular discount rate. For
instance, in early April 1973, the rate for such
advances was 7'/4 per cent, whereas the regular
rate for advances to member banks was 5 xh per
cent. As noted in the previous chapter, the rate
for advances to nonmember banks on Government securities was the same as that for similar
advances to member banks from 1939 to 1946,
and in 1972 a like concession was accorded
(by six of the Reserve Banks) to nonmember
banks adversely affected by changes in the
Board's rules regarding payment of checks
collected through the Reserve Banks. No such
rate concession has ever been given to nonbank
borrowers under the last paragraph of section
13.
Because of these deterrents—limitation to
use in emergency circumstances, the acceptance
of only Government securities as collateral for
advances, and a penalty rate of interest—very
few loans have been made to business enterprises under this authority. Nevertheless, it continues to be the only authority, except for the
even more limited authority provided by the
third paragraph of section 13, under which the
Reserve Banks, as lenders of last resort, may
provide credit directly to business enterprises or
to nonmember financial institutions.

Working Capital Loans to Business

ORIGIN AND PURPOSE
A DEPARTURE FROM
TRADITION
This chapter deals with a form of Federal
Reserve credit that is no longer authorized by
the law. Nevertheless, it should not be passed
over quickly, for it represented a significant
development in the history of the lending functions of the Federal Reserve Banks.
For more than 20 years after the enactment
of the Federal Reserve Act, the concept that
Reserve Bank loans should have relatively
short maturities was firmly entrenched. So also
was the concept that security for Reserve Bank
loans should be limited to certain types of
Paper; the only exception was for advances
under section 10(b) in 1932 and, as has been
noted, such advances were authorized only at
a
Penalty rate of interest.
These concepts were drastically modified in
1934
when Congress added to the Federal Reserve Act a new section 13b authorizing the
Reserve Banks to extend credit, either directly
F

or NOTES AND REFERENCES, see pp. 262-63.


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Federal Reserve Bank of St. Louis

133

or through commitments to financing institutions, to established business enterprises for
working capital purposes with permissible maturities of up to 5 years and without any limitations as to the type of security.1
This departure from tradition did not take
place without protest. During the debates on the
bill, Mr. Beedy deplored the fact that, in an
effort to stimulate business recovery, it had
been necessary "to bring the Federal Reserve
banks into this picture." He said: s
• * • The Federal Reserve banks, 12 in
number, which were never designed to do
business with any individual or any person,
but were banks of issue or rediscount to deal
with other banks, ought never, in my opinion,
to be put into the lending business. It is a perversion of the original purpose for which
those banks were established * * *.
Somewhat later, when the bill had been agreed
to by the conference committee and 3 days
before it was signed by the President, Mr. Beedy
again, as he put it himself, raised his "feeble
voice * * * in this hour of the Nation's crisis"
and accused the House conferees of having

134

HISTORY OF LENDING FUNCTIONS

taken "a decided step toward destroying the
character of the Reserve banks.":|
But the overriding mood of the day was to
make credit more freely available to business
through Government channels. In that atmosphere, Congress sought to provide such business credits not only through the Reserve Banks
but also through the Reconstruction Finance
Corporation (RFC), as will be noted later.

NEED FOR THE AUTHORITY
The statute grew out of evidence that business enterprises, particularly small businesses,
were unable to obtain necessary working capital
loans from the usual sources of credit. Commercial banks, with painful memories of the
1933 banking crisis and subject to more vigilant
surveillance by bank examiners, were not, so it
was alleged, meeting the needs of small business. Although the RFC had been empowered
in 1932 to make loans to banks and insurance
companies with the expectation that the money
would filter down to industry and the small
borrower, there was a feeling that this expectation had not been fulfilled because the banks
and other lending institutions had not done their
part to bring the country out of the depression.4
It was said that banks were frequently unable
or unwilling to extend industrial loans, due in
large part to the fact that bank examiners had
required them to maintain a degree of liquidity.5
On March 19, 1934, President Roosevelt
wrote to the chairmen of the Banking and Currency Committees of both Houses of Congress:
"I have been deeply concerned with the situation in our small industries. In numberless cases
their working capital has been lost or seriously
depleted."
The fact that not only commercial banks but
also Federal Reserve Banks were limited to
short-term loans and could not, therefore, adequately meet the credit needs of business was
emphasized by the Federal Reserve Board in a
letter to the Senate Banking and Currency
Committee dated April 13, 1934:
In the judgment of the Board, there exists
an undoubted need for credit facilities for
industry and commerce beyond those that
are now being supplied through the commer-


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Federal Reserve Bank of St. Louis

cial banks or that can be supplied through
the ordinary operations of the Federal Reserve System acting within the limitations of
the Federal Reserve Act. In brief, the need is
for loans to provide working capital for commerce and industry, and such loans necessarily must have a longer maturity than those
rediscountablc by Federal reserve banks.
Throughout the debates in Congress, it was
indicated repeatedly that the primary purpose
of the legislation was to assist, not just business,
but small business. Thus, Mr. Kopplcmann
declaimed: "The main purpose of this bill is
the rehabilitation of small businesses and small
industries. The small industries arc the backbone of America.""
As will be noted later, the purpose of aiding
small business was emphasized by provisions in
the bills under consideration that would have
limited the amount of any loan to $100,000.
Although this limitation was omitted in the
statute as finally adopted, it is clear that small
enterprises were expected to be its chief beneficiaries.

LEGISLATIVE HISTORY
At the outset, two principal plans for providing credit to business enterprises had competed
for consideration by Congress. One was to expand the existing lending powers of the RFC to
include power to make loans to business enterprises, and various bills for this purpose were
introduced in Congress.1 The other was a plan
for the establishment of regional credit banks
for industry under the supervision of cither the
RFC or the Federal Reserve Board." Bills to
authorize the establishment by the Federal Reserve Board of 12 credit banks for this purpose
were actually prepared in the offices of the
Federal Reserve Board and represented, at
least at that time, the mature conclusions of the
Board.9
Eventually, however, a third method of providing business credits was incorporated in a
committee print of the Senate Banking and
Currency Committee. This proposal would have
stricken provisions of the bill then under consideration to establish regional credit banks
and, instead, would have amended section 13 of

WORKING CAPITAL LOANS TO BUSINESS
the Federal Reserve Act to authorize the Reserve Banks to make working capital loans to
business. On April 28, 1934, Senator Glass
incorporated this committee print in a new bill
(S. 3487) but in the form of an addition of a
new section—13b—to the Federal Reserve Act
instead of an amendment to section 13. A few
days later, Senator Fletcher introduced another
bill authorizing the RFC to make business
loans and, subsequently, the substance of that
bill was combined with the new Glass bill. The
result was a bill authorizing business loans by
both the Reserve Banks and the RFC. On
May 12, 1934. the Senate adopted a proposal
to add to the Glass bill authorizing business
loans by the Reserve Banks a separate provision
for RFC loans to business.10 As thus amended,
that bill was approved by the Senate on May 14.
On May 23, a new RFC bill that included also
authority for business loans by the Reserve
Banks was passed by the House.
Insofar as the business loan authority of the
Reserve Banks was concerned, the bills passed
by the Senate and House differed in only one
major respect. The Senate bill authorized and
directed the Secretary of the Treasury to pay to
the Reserve Banks the sum of $139,299,557 to
aid in the making of business loans, with provision for repayment at a rate of at least 1 per
cent per annum. The House bill contained no
such provision for payments by the Treasury.
The conference committee adopted the Senate
Provision, but modified it so as to permit, but
not direct, the Treasury to make payments to
the Reserve Banks and to provide for repayments at a rate of not less than 2 per cent per
annum.
The conference report was approved in both
Houses on June 16, and the bill was signed into
law by the President on June I 9 . u
In the course of the legislative process, the
original idea of establishing 12 credit banks for
industry had been abandoned because, as Senator Glass said, "it was totally unnecessary to
set
up another banking system of 12 banks to
d
° what might be done more readily and with
greater facility by the Federal Reserve banks
themselves." •= At the same time, the question
whether business loans should be made by the
Federal Reserve Banks or by the RFC was


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Federal Reserve Bank of St. Louis

135

resolved by giving both agencies somewhat
similar, but not identical, authority in this field.

RESERVE BANKS VERSUS RFC
The fact that both the Federal Reserve Banks
and the RFC were given authority to make
business loans was not regarded as involving
any inconsistency. It was expected that such
loans would be made primarily by the Reserve
Banks and that the RFC would make them only
if they could not be obtained from a Reserve
Bank. Moreover, it was contemplated that the
Federal Reserve authority would be permanent,
whereas that of the RFC would be only temporary. (Members of Congress in 1934 could
not know that the RFC, an emergency agency,
would continue to function for another 23
years.)
In accordance with the idea that the RFC's
authority should be supplemental to that of the
Federal Reserve Banks, the bill that passed the
Senate and was reported by the House committee expressly provided that business loans were
to be made by the RFC "when credit at prevailing bank rates for the character of loans
applied for is not otherwise available at banks
or at the Federal Reserve bank of the district
in which the applicant is located." However, on
May 23, the day that the bill was passed by the
House, a floor amendment was introduced by
Mr. Beedy (who had not wanted the Reserve
Banks in the picture in the first place) to strike
out the words "or the Federal Reserve bank
of the district in which the applicant is located."
Mr. Beedy expressed the fear that "many of
these loans will never get as far as the Reconstruction Finance Corporation if they are turned
down by the Federal Reserve bank in the first
instance." His amendment was adopted." So
it was that, as finally enacted, the statute authorized business loans by the RFC when credit
was not otherwise available at banks, thereby
indicating that, despite all that had been said
earlier, the RFC's authority was not to be
merely supplemental to that of the Reserve
Banks.
Nevertheless, Chairman Steagall apparently
agreed to the Beedy amendment only because
he felt that it would not change the substance of

136

HISTORY OF LENDING FUNCTIONS

the previous provision, presumably on the
ground that the Federal Reserve Banks would
still be embraced by the word "banks." He
stated that he had no objection to the amendment because it was one "which really perfects
the language of the section." 14 Chairman
Steagall's feeling that nothing had been changed
and that the RFC would make business loans
only if they were not obtainable from the Reserve Banks was more explicitly stated when,
during the House debate on the conference
report on June 16, he answered a question as
to the procedure to be followed by a business
in seeking credit. He replied: l 5
It would apply through regular channels,
and if it did not obtain the money it would
apply to the Federal Reserve Banks, and if
the Federal Reserve Bank did not make the
loan, the application would then go to the
Reconstruction Finance Corporation, which
in this case would be in the nature of an
appellate court for loans, where applications
might be reviewed and reconsidered.
Whatever may have been the intent of Congress as to the respective roles of the Federal
Reserve Banks and the RFC, the fact is that the
1934 statute gave both agencies coordinate
authority to make loans to commercial and industrial businesses, but with certain important
differences in respect to limitations on their
authority:
1. The authority of the Reserve Banks was
permanent; that of the RFC was limited in
duration and, by the terms of the 1934 act, was
scheduled to expire on January 31, 1935.
2. The RFC could make loans only to businesses established before January 1, 1934; the
Reserve Banks could make loans to established

businesses, presumably including any established after January' J,1934.
3. The aggregate amount of loans made by
the RFC to any one borrower could not exceed
$500,000; no such limitation was placed on
loans made by the Reserve Banks.
4. The Reserve Banks could make direct
loans only in exceptional circumstances; the
RFC was not similarly restricted.
5. The RFC was authorized in general to
make loans in cooperation with banks or other
lending institutions, including authority to purchase participations; the Reserve Banks were
permitted to participate with lending institutions
only if the latter assumed at least 20 per cent
of the risk.
6. RFC loans were required to be adequately
secured and could be made only if the directors
were of the opinion that the borrower was
solvent; Reserve Bank loans were required to
be made on a reasonable and sound basis.
On the basis of this comparison, and especially in view of the temporary nature of the
RFC's authority, it might be supposed that Mr.
Steagall's expectation that the Reserve Banks
would be the primary source of business loans
would be fulfilled. Actually, time proved otherwise. Not only was the authority of the RFC
extended for many years, but the limitations on
its authority were gradually relaxed by subsequent amendments, while the limitations on the
authority of the Reserve Banks remained unchanged. As a result, the RFC came to be the
principal Federal agency for the making of
business loans, while the volume of such loans
made by the Federal Reserve Banks—at first
considerable—eventually declined to an amount
that was almost negligible.

LIMITATIONS
GENERAL LIMITATIONS
The authority granted to the Reserve Banks
by the 1934 legislation was of two different


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Federal Reserve Bank of St. Louis

kinds: ( i ) authority to make direct loans to
businesses; and (2) authority to extend credit
Co business
business enterprises
c t i i c m r l t n t indirectly
;nri;i-n/->tK> by
h v means
mrans of
ot
to
discounts for financing institutions of oblige

WORKING CAPITAL LOANS TO BUSINESS
tions of business enterprises, loans to financing
institutions on the security of such obligations,
and commitments with respect to such discounts
or loans. For convenience only, the first of
these two alternate types of authority is here
referred to as authority for direct loans and the
second as authority to make commitments.
On both types of authority the law placed
certain significant restrictions. Some were common to both direct loans and commitments;
others were in the nature of special limitations,
some applicable only to direct loans and some
applicable only to commitments. Such special
limitations will be discussed in subsequent
sections.
In the first place, it was clearly the purpose
of Congress in 1934 to provide, through both
the Reserve Banks and the RFC, credit assistance that would enable existing businesses to
get back on their feet, not to encourage the
establishment of new businesses. In the House
debates on the bill, Congressman Martin stated
that the legislation would "not provide for loans
to a new industry," but that its purpose was "to
keep old industries functioning."iri
In furtherance of this purpose, the RFC, as
noted, was authorized to make loans only to
businesses in existence before January 1, 1934.
Although the Reserve Banks were not so strictly
limited, their loans were restricted to established
industrial or commercial businesses. Perhaps, in
the light of Mr. Martin's remark, this was
meant to confine Federal Reserve loans to businesses in existence on the date of the act; but
it seems more reasonable to interpret the limitation as meaning thai a Reserve Bank could
m
akc a loan only to a business established
before the loan was made. Also, it seems fairly
clear that the word "established" was not used
m
the sense of meaning a long-established,
successful enterprise but simply in the sense of
being already in existence.17
To be eligible for aid under section 13b of
the Federal Reserve Act, a business had to be
Jtot only an established business but also an
industrial or commercial business. There is little
m the legislative history of the legislation that
throws any light on the intended scope of these
w
°rds. No published rulings of the Board
s
°ught to define industrial or commercial busi-


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Federal Reserve Bank of St. Louis

137

nesses. However, in announcing the issuance of
Regulation S under the new law, the Board
indicated that it did not propose to place any
restrictions not required by the statute upon the
making of business loans by the Federal Reserve Banks and that consequently the terms
used in the law would be liberally interpreted.
The Board stated:1S
* * * Any attempt to prescribe technical
definitions of such terms as "working capital",
"established commercial or industrial business", and "financing institutions" has been
avoided, lest it have the effect of restricting
and hampering the operations of the Federal
Reserve banks under this statute.
A major limitation placed upon the lending
authority of the Reserve Banks was that loans
should be made only to provide businesses with
"working capital." During the Senate debates
on the bill, Senator Bone proposed an amendment to strike out the reference to working
capital and instead to authorize loans "for working capital, for reducing and refinancing outstanding indebtedness if such refinancing is
concurrent with a substantial write-down of
such outstanding indebtedness, for rehabilitating and making improvements to plants, for
reopening plants not in operation on the date
this section takes effect, and for new buildings
and new machinery." " This effort to broaden
the purposes for which business loans might be
made was unsuccessful. The House was more
liberally inclined. It would have authorized
loans for the purpose of providing a business
with capital, a term broad enough to include
almost any type of loan. The conference committee, however, resolved the difference on this
point in favor of the Senate bill, limiting both
the Federal Reserve Banks and the RFC to the
making of business loans to provide working
capital. While the Board never undertook to
define the term "working capital," it is clear
from its legislative history that section 13b was
not intended to authorize the Reserve Banks to
make loans to enable businesses to refinance
outstanding indebtedness or to build, improve,
or replace plant and machinery.
Another limitation imposed by the law both
upon direct loans to businesses by the Reserve

138

HISTORY OF LENDING FUNCTIONS

Banks and upon commitments with respect to
business loans made by private financing institutions was that no such loans should have
maturities in excess of 5 years. This, however,
was a liberal limitation. Never before had the
Reserve Banks been authorized to extend credit
for such a long period. Prior to 1934, the maximum maturity permitted had been the 9-month
maturity authorized with respect to discounts of
agricultural paper for member banks.

LIMITATIONS
ON DIRECT LOANS
Subsection (a) of section 13b, relating to
direct loans by the Reserve Banks, imposed the
four limitations discussed in the preceding section: They could be made only to established
businesses, only to industrial and commercial
businesses, only for working capital purposes,
and only with maturities of not more than 5
years. Such loans were also made subject to four
additional limitations.
1. They could be made only in exceptional
circumstances when it appeared to the satisfaction of a Federal Reserve Bank that a business
was unable to obtain requisite financial assistance on a reasonable basis from the usual
sources. Obviously, this limitation was designed
to make it clear that the Reserve Banks should
not compete with commercial banks and other
private lending institutions. The Board so construed the law when, in issuing its Regulation S,
it declared: "It is expected * • * that the Federal Reserve banks will not compete with local
banks, but rather will assist and cooperate with
them in meeting local requirements for working
capital." so
2. They should be made only pursuant to
authority granted by the Federal Reserve Board.
It may have been contemplated that such authority would be granted by the Board in individual cases. However, in its Regulation S,
issued shortly after enactment of the new law,
the Board expressly authorized "every Federal
Reserve Bank, in exceptional circumstances,
until such time as the Federal Reserve Board
may revoke or modify such authority" to make
direct loans to businesses in accordance with
the provisions of the statute.11 This authority


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Federal Reserve Bank of St. Louis

was never revoked or modified. In explanation,
the Board stated: • * • in order to avoid the necessity of
having applications for such accommodations
passed on in Washington, the Board has
granted blanket authority to all Federal Reserve banks to grant such accommodations
directly on their own responsibility without
reference to Washington.
3. By the terms of the statute, a Reserve
Bank could make a direct loan only to a business located in its district. This requirement was
interpreted broadly by the Board as covering
any business having an office or place of business in the district of the lending Reserve
Bank.23
4. Although the law contained no requirement as to the security upon which loans might
be made to business enterprises, it did provide
that direct loans should be made on a reasonable and sound basis. In this connection, it may
be noted that, as in the case of their other
lending operations, the Reserve Banks were not
obliged to make a business loan even though it
might meet alt the requirements of the statute;
a Reserve Bank was free to turn down any
application if it felt, for example, that it would
not be a sound loan from a credit viewpoint.
An effort in Congress to make such loans
mandatory rather than permissive was voted
down.5*

LIMITATIONS
ON COMMITMENTS
Like direct loans, all indirect extensions of
credit to businesses through financing institutions were made subject to the general requirement that the underlying loan be one made to
an established industrial or commercial business
for working capital purposes with a maturity of
not more than 5 years. The special limitations
placed on direct loans that were discussed
in the preceding section—that the loan be one
made in exceptional circumstances, that it be
authorized by the Board, that it be to a business
located in the Federal Reserve district of the
Reserve Bank involved, and that it be made on
a reasonable and sound basis—were not made
applicable to commitments with respect to busi-

WORKING CAPITAL LOANS TO BUSINESS
ness loans made by private financing institutions. However, discounts for and purchases
from financing institutions and loans made in
participation with such institutions were made
subject to certain other special limitations.
1. The law authorized the Reserve Banks to
extend indirect financing assistance to business
enterprises only through a bank, trust company,
mortgage company, credit corporation for industry, or other financing institution. In order
to facilitate the participation of national banks
in the making of business loans under the new
law, the Comptroller of the Currency ruled that
limitations on national banks with respect to
loans to a single customer and with respect to
real estate loans did not apply to the extent
that a loan to a business enterprise was covered
by a commitment by the RFC or a Federal
Reserve Bank pursuant to the new law." The
Comptroller's ruling with respect to limitations
on real estate loans was later incorporated in
the law by the Banking Act of 1935, and was
made still more liberal. That act added to section 24 of the Federal Reserve Act a new paragraph exempting from the limitations of that
section loans made by national banks to established industrial or commercial businesses that
were in whole or in part discounted or purchased or loaned against as security by a
Federal Reserve Bank under section 13b, or
for any part of which a commitment was made
by a Reserve Bank, or in which a Reserve Bank
participated. Thus, not only that part of the
loan subject to a commitment by a Reserve
Bank but the entire loan was exempted from
limitations on real estate loans by national
banks.
There was no question that national banks
and other commercial banks qualified as financing institutions under section 13b. In addition,
the Board ruled that an investment banking firm
m
'ght be considered a financing institution if a
substantial part of its business represented provision of funds for business enterprises through
tn
c underwriting, sale, and distribution of securities.™
2. The law provided that a Reserve Bank
»uld make discounts or purchases, loans, participations, or commitments only with respect to
a
financing institution operating in its district.
c


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Federal Reserve Bank of St. Louis

139

Following the policy of liberal construction announced when Regulation S was issued, the
Board held that a Reserve Bank could discount
for a financing institution operating within its
district the obligation of an industrial or commercial business located in another Federal
Reserve district." Thus, while a direct loan
could be made by a Reserve Bank only to a
business located within its district, indirect extensions of credit could be made to businesses
located in other districts, provided the financing
institution through which the credit was extended could be regarded as operating within
the Reserve Bank's district. This ruling was
incorporated in Regulation S when the regulation was revised in 1942.=s
3. The final special limitation placed upon
participations by the Reserve Banks with privatefinancinginstitutions in extensions of credit
to business was that in all cases the financing
institution should bear at least 20 per cent of
any loss. If the obligation of a business was
acquired by a Reserve Bank from a financing
institution, the latter was required to "obligate
itself to the satisfaction of the Federal Reserve
bank for at least 20 per centum of any loss."
In lieu of such an obligation, however, the
financing institution could itself advance 20
per cent of the amount of the credit, the Reserve
Bank advancing the other 80 per cent; in that
event, these separate advances were to be considered as one advance, with repayment to be
made pro rata under regulations prescribed by
the Board. When a Federal Reserve Bank acquired from a lending institution the obligation
of a business enterprise, the law provided that
the existence and amount of any loss should be
determined in accordance with regulations of
the Board. Pursuant to this provision, Regulation S provided that a Reserve Bank should be
deemed to have sustained a loss on such an
obligation whenever its directors, after investigation, determined that the obligation or any
part of it was a loss and the Reserve Bank
charged that amount off its books. The amount
of the loss would be the amount so charged off,
plus unpaid interest. The financing institution
would then be required to reimburse the Reserve Bank for the portion of the loss for which
it had obligated itself. If there was any subse-

140

HISTORY OF LENDING FUNCTIONS

quent recovery, the financing institution and the
Reserve Bank would share pro rata in the
amount recovered.20

AMOUNT LIMITATIONS
Subsection (c) of section 13b provided that
the aggregate amount of loans, advances, discounts, purchases, and commitments made under the section by all of the Reserve Banks and
outstanding at any one time should not exceed
the combined surplus of all the Reserve Banks
as of July 1, 1934, plus all amounts paid to
the Reserve Banks by the Secretary of the
Treasury under authority of the section. The
combined surplus of the 12 Federal Reserve
Banks on July 1, 1934, was $138,383,000.
Under subsection ( e ) , the Secretary of the
Treasury was authorized to pay to the Reserve
Banks up to a total of $139,299,557. Consequently, the aggregate amount of direct loans,
advances in participation with private financing
institutions, discounts for and purchases from
such institutions, and commitments with respect
thereto that could be outstanding as of any
particular time, could theoretically be as much
as $277,682,557. Actually, the aggregate
amount of credit permitted under the new law
proved more than adequate. The greatest
amount outstanding at any one time was around
$60,000,000 late in 1935, when the volume of
operations under section 13b was at its peak.
It is to be noted that the statute itself placed

only an aggregate limit on the amount of credit
extended by all of the Federal Reserve Banks,
without specifically limiting the amount that
could be extended and outstanding by a particular Reserve Bank. By regulation, however,
the Board limited the aggregate amount of
loans, advances, discounts, purchases, and commitments that could be made by any Reserve
Bank (and outstanding at any one time) to the
surplus of that Reserve Bank as of July 1, 1934,
plus amounts paid to it by the Secretary of the
Treasury under subsection (c) of section 13b,
unless permission to exceed that limit was given
by the Board." Thus, each Reserve Bank was
in general limited to its proportionate part of
the over-all limit; but, if the need for business
loans was found to be greater in some districts
than in others, it was possible under the regulation for the Reserve Banks of those districts,
with the Board's permission, to make loans in
an amount far greater than their pro rata share
of the aggregate amount allowed by the statute
for all of the Reserve Banks.
No limitation was prescribed, cither by
statute or regulation, on the amount that a
Federal Reserve Bank could lend to any one
business enterprise, cither directly or through
private financing institutions. This is somewhat
surprising in view of the fact that the RFCs
business loan authority was made subject not
only to an aggregate limitation of S300 million
but also to a limitation of $500,000 to any one
borrower.

INDUSTRIAL ADVISORY COMMITTEES
Apparently there was some concern in Congress in 1934 that the Reserve Banks would
not be especially inclined to make loans to
business. Carter Glass observed that the President himself thought that "perhaps the Federal
Reserve bank boards were too bank-minded to
be as liberal as he could wish they would be in
treating matters of this sort." Accordingly, said
Senator Glass, the President had suggested the


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Federal Reserve Bank of St. Louis

insertion of a provision for the appointment of
an "advisory committee in each Federal Reserve district, to be composed exclusively of
active industrialists, to advise upon such
loans." "
Such a provision was included in subsection
(d) of section 13b. It provided for the establishment in each Federal Reserve district of an
advisory committee, to be appointed by ">e

WORKING CAPITAL LOANS TO BUSINESS
Reserve Bank subject to the approval and
regulations of the Federal Reserve Board, and
to consist of not less than three nor more than
five members as determined by the Board.
Each member was required to be actively engaged in some industrial pursuit within the
Federal Reserve district. Every application under section 13b was to be submitted to this
committee, which, after examination of the
business involved, would transmit the application to the Reserve Bank with the committee's
recommendation.
Implementing this provision of the statute,
the Board's Regulation S provided that each
committee should consist of five members familiar with the problems and needs of industry
and commerce in the particular district; that

141

before February 15 of each year the board of
directors of each Reserve Bank should submit
to the Board the names of members selected
for the ensuing year; that, if approved by the
Board, such members should serve for 1 year
commencing March 1; and that the committee,
after examining each application and considering the necessity and advisability of granting the
application and such other factors as it deemed
appropriate, should transmit the application to
the Reserve Bank with the committee's recommendation."
The regulation was adopted on June 26,
1934. Promptly thereafter, the names of the
first members of the industrial advisory committee in each Federal Reserve district were
announced by the Board.™

SOURCE OF FUNDS
Though not expressly stated, the law clearly
contemplated that the Federal Reserve Banks
would use their own funds in extending credit
Pursuant to section 13b. However, subsection
(c) provided that, in order to enable the Reserve Banks to extend such credit, the Secretary
of the Treasury should have authority to pay
'o each Federal Reserve Bank an amount not
'o exceed such portion of the sum of $139,299,557 as might be represented by the amount
Paid by such Reserve Bank for stock of the
Federal Deposit Insurance Corporation (FDIC).
In
a sense, this provision made possible the
r
eturn to the Reserve Banks by the Treasury of
funds that had once belonged to the Banks.
At the time the FDIC was established by the
Banking Act of 1933, the Federal Reserve
Banks were required to subscribe to stock of
c
Corporation in an amount equal to one-half
°f their respective surpluses as of January 1,
193
3 . The total amount that they were thus
Squired to turn over to the FDIC was $139," ' 5 5 7 ' By the 1934 enactment of section 13b,
that amount was made available again to the
Reserve Banks; however, all funds returned


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Federal Reserve Bank of St. Louis

were to be used only for business loans, and
the portions to be returned to the individual
Reserve Banks were to be decided by the Secretary of the Treasury.34
But the authority for such payments to the
Reserve Banks by the Treasury was subject to
certain conditions. Payment could be made to
a Federal Reserve Bank only if it executed an
agreement to hold its FDIC stock unencumbered and to pay to the United States all dividends, payments on liquidation, and other
proceeds of such stock; and if the stock itself
were pledged to the United States as security for
this agreement. In addition, the Reserve Bank
was required to agree that if such dividends,
payments, and other proceeds from the FDIC
stock in any year should not be as much as
2 per cent of the payments made to the Bank
by the Treasury, the Reserve Bank would pay
to the United States such further amount, out
of its earnings derived from the payment received from the Treasury, as would make up
the balance of the specified 2 per cent, and
would continue to make such payments until
the final liquidation of the FDIC stock.

142

HISTORY OF LENDING FUNCTIONS

Operations under section 13b never made
necessary the payment by the Treasury to the
Reserve Banks of the full amounts authorized
by the law. An agreement was entered into by
the Treasury and the Reserve Banks under
which the Treasury agreed to make payments
equal to approximately one-half of the credits
extended by the Reserve Banks through loans
and commitments under section 13b. The
amounts actually advanced by the Treasury
under this agreement aggregated about $27,546,000. No such advances were made by the
Treasury after 1937.
Pursuant to an Act of Congress approved
August 5, 1947,™ the stock of the FDIC that
had been subscribed by the Federal Reserve
Banks in 1933 was cancelled on October 7,
1947, and the amount that had been paid for
such stock ($139,299,557) was turned over to
the Treasury instead of being repaid to the
Federal Reserve Banks. Since the 2 per cent
annual payments by the Reserve Banks to the
Treasury—previously mentioned—were related
to ownership of the FDIC stock, those payments were discontinued after October 7, 1947.
Nevertheless, there was no requirement in the
law for repayment of the amounts advanced
by the Treasury, consequently, the aggregate
amounts paid by the Treasury to the Reserve
Banks under section 13b ($27,546,000) con-

tinued to be carried on the books of the Reserve Banks as "section 13b surplus" until
1958 when section 13b was repealed.
Finally, a word should be said concerning
the source of the $139,299,557 that the Secretary of the Treasury was authorized to pay to
the Federal Reserve Banks under section 13b.
The law provided that all amounts that might
be required to be expended by the Secretary
under this authority should come out of miscellaneous receipts of the Treasury created by
the increment resulting from the reduction of
the weight of the gold dollar under the President's proclamation of January 31, 1934, and
that such sum as should be required for this
expenditure should be appropriated out of such
miscellaneous receipts. Under the Gold Reserve
Act of January 30, 1934, the Reserve Banks
had been required to transfer title to all gold
coin and bullion held by them to the United
States in return for equivalent amounts in
dollars. On the next day, the President's proclamation pursuant to the Act of May 12, 1933,
reduced the weight of the gold dollar; as a
consequence, the dollar credits received by the
Reserve Banks for their gold resulted in a
substantial net profit to the U.S. Treasury.
That profit was the increment from which payments by the Treasury to the Reserve Banks
were authorized by section 13b.

REGULATION S
On June 26, 1934—7 days after the enactment of section 13b of the Federal Reserve Act
—the Board promulgated its Regulation S
under the new law. In doing so, the Board
stated::'°
In accordance with the policy of Congress
and in order to facilitate as much as possible
the performance of the new functions thus
granted to the Federal Reserve banks, the
Federal Reserve Board's regulation leaves the
broad powers granted by Congress to the
Federal Reserve banks wholly unimpaired
and prescribes no restrictions beyond those


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Federal Reserve Bank of St. Louis

prescribed in the law itself. • • • The regulations • • * contain practically nothing except an analysis of the law and an outline of
the necessary procedure.
That statement represented a fair indication
of the contents of Regulation S, which did little
more than paraphrase the requirements of the
statute and outline the procedure to be followed
by financing institutions and businesses in making applications to the Reserve Banks.
The regulation provided that each applicau"0"
by a financing institution or business should be

WORKING CAPITAL LOANS TO BUSINESS
filed with the Reserve Bank of the district in
which the principal place of business of the
applicant was located, and that the application
should then be submitted by the Reserve Bank
to the industrial advisory committee of the district. In determining whether to approve any
such application, the Reserve Bank was required to satisfy itself not only that all legal
requirements were met but also that the financial condition and credit standing of the obligor
and endorsers and the value of the security
offered, if any, justified the granting of the
accommodation.
As to transactions with financing institutions,
the regulation contained a special provision
regarding the manner of determining the existence and amount of any losses. With respect to
direct loans, the regulation granted blanket
authority to the Reserve Banks to make such
loans without referring them to the Board for
individual authorization. An industrial advisory
committee of five members was required to be
established in each Federal Reserve district.
The aggregate amount of loans and commitments made by each Federal Reserve Bank was
limited to the Reserve Bank's proportionate
part of the over-all maximum amount fixed by
the statute, except where permission to exceed
the Reserve Bank's individual limit might be
granted by the Board.
With respect to a matter not dealt with by
the statute, the regulation provided that all rates
of interest and discount established by the
Reserve Banks on section 13b loans, advances,
discounts, and purchases should be subject to
the approval of the Board. Although a discussion of rates charged on section 13b loans and
commitments is not within the scope of this
stu
dy, it may be noted that such rates, unlike
discount rates under sections 13 and 13a of
the Act, were not usually fixed at stated percentages but were generally set in terms of a


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Federal Reserve Bank of St. Louis

143

maximum and a minimum. In addition, there
was greater variation among the different Federal Reserve Banks."
Only once was Regulation S amended or
revised. In the spring of 1942, in connection
with the inauguration of the so-called V-loan
program for guaranteeing war production loans
(discussed in the following chapter), the regulation was reissued with certain changes designed
to facilitate participation by the Reserve Banks
in that program.3" As stated in a foreword to
the revised regulation, the changes were largely
of a clarifying or technical character. They were
intended to make operations more flexible. For
example, whereas the original regulation had
required an application by a financing institution to be filed with the Reserve Bank of the
district in which the applicant was located, the
revised regulation permitted the application to
be filed with the Reserve Bank of any district
in which thefinancinginstitution was operating;
it was made clear that the business being
financed by the applicant could be located in
some other district. Similarly, an application by
a business for a direct loan was permitted to be
filed with any Reserve Bank in which the business had an office or place of business instead
of only in the district in which its principal place
of business was located. Also, the previous
requirement that a Federal Reserve Bank must
satisfy itself that the financial condition and
credit standing of the obligor and endorsers and
the value of the security offered justified the
granting of the accommodation was omitted
from the revised regulation. Finally, the revised
regulation required that rates of interest and
discount should be subject to review and determination of the Board rather than to approval
by the Board—a change apparently made to
conform to the general practice with respect to
discount rates under other provisions of the
Federal Reserve Act.

144

HISTORY OF LENDING FUNCTIONS

TERMINATION OF AUTHORITY
For a period of about 18 months after the
enactment of section 13b, loans and commitments by the Federal Reserve Banks were made
in considerable volume. By the end of 1935,
1,993 applications totaling about $ 124.5 million
had been approved. In 1936, however, activity
tapered off. Only 287 applications were approved in that year and only 126 in 1937. This
decline in activity after such a favorable beginning is easily explained. The authority granted
the RFC in 1934 to make business loans had
been somewhat broader than that given the
Federal Reserve Banks, even though the RFC
was looked upon as a temporary agency. Not
only was the existence of the RFC continued,
but in 1935 its business loan authority was
liberalized.3" It was again liberalized in 1938
when maturity restrictions on RFC loans were
eliminated.10 It followed that, with less restricted authority, the RFC made more business
loans, and by the same token the Federal Reserve Banks made less. In 1938, the Board of
Governors sought to obtain some relaxation of
the limitations imposed by section 13b, but
without success.11 This was the beginning of a
long and fruitless effort to liberalize the authority of the Reserve Banks to make loans to
business enterprises.
Early in 1941, when U.S. participation in
World War II seemed imminent, bills to liberalize the authority of the Federal Reserve System
to make business loans were revived as measures to finance defense production,12 but no
action was taken by Congress for that purpose.
After Pearl Harbor, the urgency was too great
and the time too short to wait for legislative
action; as will be seen in the following chapter,
steps were taken promptly to provide financial
assistance to business enterprises engaged in
war production. Implementation of such assistance was not by statute but by an Executive
order of the President authorizing a program of
Government guarantees of loans to war contractors. Nevertheless, because of the experience of the Federal Reserve Banks in making


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Federal Reserve Bank of St. Louis

business loans under section 13b. they were
brought actively into the now guaranteed loan
program as agents for the war procurement
agencies of the Government. In addition, urgent
demands for the financing of war production
contracts stimulated activity under section 13b,
and during 1942 the Reserve Banks approved
applications under that section aggregating over
SI28 million, the peak volume for any year in
the history of their industrial loan operations.
Near the end of the war, efforts to liberalize
section 13b were renewed. In May 1944, Senator Wagner introduced a bill ' • that would have
authorized the Reserve Banks to guarantee, or
make commitments to purchase, loans made by
financing institutions to any business enterprise,
subject only to regulations of the Board and
with no statutory restrictions. Similar bills were
considered in 1945, although with some limitations." In 1947 a new bill was introduced that
would have repealed section 13b and would
have added to section 13 of the Federal Reserve
Act a provision broadly authorizing the Reserve
Banks to guarantee, up to 90 per cent, loans
made by financing institutions to business enterprises, provided that such loans had maturities
of not more than 10 years, that the aggregate
amount at any one time did not exceed the combined surplus of the Federal Reserve Banks, and
that the aggregate amount of guaranteed loans
in excess of $100,000 did not exceed half <n
the combined surplus of the Reserve Banks-'
The Board supported this proposal. '* Agan>>
however, this effort to liberalize the business
loan authority of the Reserve Banks was to no
avail.
A sharp decline in business activity in We
1949 and early 1950 gave rise to new proposals
for financing business enterprises, but it
still contemplated that the Federal Reserve
Banks would be utilized for this purpose,
though somewhat more indirectly. Active con
sideration was given to various bills to pr« vl
for Government insurance of business loans an
for the establishment of national investmen

WORKING CAPITAL LOANS TO BUSINESS
companies to make long-term loans to eligible
small business enterprises and to invest in stock
of such enterprises.'7 These bills would have
repealed section 13b of the Federal Reserve
Act and provided for investment by the Reserve
Banks in the capital of the proposed investment
companies and for regulation and supervision
of such companies by the Board. In 1951,
Senator Robertson introduced a bill '" very
similar to the 1947 bills to liberalize the authority of the Reserve Banks under section 13b.
This time, however, instead of endorsing the
proposal, the Board felt that, because of thencurrent inflationary tendencies, the proposal
should be deferred.
A complete shift in the Board's attitude
toward participation of the Federal Reserve
System in the financing of small business became evident in 1955. In May of that year the
Board endorsed the objective of a bill l!l to
establish national investment companies to
make long-term loans to business, but it questioned the wisdom of Federal Reserve participation and recommended repeal of section 13b of
the Federal Reserve Act. A similar attitude was
expressed in February 1957, when the Board
supported in principle a bill to set up national
investment companies to make long-term loans
to business, but flatly stated that the responsibility for supervision and regulation of such
companies should not be vested in the Federal
Reserve System. Again, in June 1957, Chairman Martin told the Small Business Subcommittee of the Senate Banking and Currency
Committee that the primary duty of the Federal
Reserve System was to guide monetary and
credit policy and that, in the Board's opinion,
>t would be "undesirable for the Federal Reserve to provide the capital and participate in
management functions" in the proposed small
business investment companies. At the same


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145

time, Chairman Martin suggested a "fresh
study of the small business financing problem."
In the meantime, a bill to recodify and
streamline all Federal banking laws, known as
the Financial Institutions Act, which passed the
Senate on March 21, 1957, would have had
the effect of repealing section 13b of the Federal Reserve Act/'0 However, because of opposition to certain other provisions, the bill was
allowed to die in the House Banking and Currency Committee.
In the spring of 1958, a general economic
recession gave new impetus to legislative proposals to provide financial assistance to business
enterprises. All such proposals contemplated
the repeal of section 13b of the Federal Reserve
Act. Finally, on August 21, 1958, the Small
Business Investment Company Act of 1958 was
enacted into law.11 It provided for the establishment of small business investment companies
subject to regulation by the Small Business Administration. Section 601 of the act repealed
section 13b of the Federal Reserve Act effective
one year after the date of the new act, and
section 602 required the Federal Reserve
Banks, within 60 days, to pay to the United
States the aggregate amount theretofore paid to
the Reserve Banks by the Secretary of the
Treasury under section 13b of the Federal
Reserve Act.l=
So it was that the departure from tradition
in 1934, which for a time put the Federal
Reserve Banks actively into the field of business loans, was followed by a long period of
unsuccessful legislative efforts to liberalize the
authority of the Reserve Banks in that field,
then by a complete reversal of policy aimed at
separation of the Federal Reserve from all participation in business financing, and finally by
repeal of the business loan authority of the
Federal Reserve Banks.


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V Loans

ORIGIN AND NATURE
WARTIME BACKGROUND
Strictly speaking, this chapter may not belong
in a history of the lending functions of the
Federal Reserve Banks, since it relates to loans
made primarily by commercial banks and only
minimally by Reserve Banks themselves. In a
broad sense, however, such a history would be
incomplete without a general discussion of the
active and important part that the Federal Reserve System has played in the program of
financing commonly known as the V-loan program.
Briefly, the V-loan program is a program
under which Government procurement agencies
guarantee loans made by banks and other
financial institutions to business concerns engaged in producing goods or furnishing services
necessary to the national defense both in wartime and in peacetime. Practically all of such
guarantees have been made through the Federal
Reserve Banks as fiscal agents of the Government.
For NOTES AND REFERENCES, see p. 263.


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The program was partly an outgrowth of the
efforts to liberalize the business loan authority
of the Reserve Banks, which were discussed in
the preceding chapter. As indicated, all bills in
Congress for that purpose failed of enactment,
including those introduced early in 1941 as a
means of aiding in the financing of contractors
engaged in defense production. However, the
attack on Pearl Harbor and the entry of the
United States into the war in December 1941
made the immediate financing of war contractors an essential part of the war effort. Numerous small subcontractors, because of their size
and financial condition, were unable to obtain
from commercial banks the credit that was necessary to carry out the large volume of Government contracts awarded to them.
Time did not permit the delay involved in
the enactment of new legislation. On March 26,
1942, the President by Executive order authorized the War and Navy Departments and the
U. S. Maritime Commission to make or guarantee loans to war production contractors through
the agency of the Federal Reserve Banks.1 In
issuing the order, the President emphasized that

148

HISTORY OF LENDING FUNCTIONS

its purpose was "to put working capital financing on a war basis" and that loans and guarantees would "not be made under peacetime credit
rules." a
The Executive order made the operations of
the Reserve Banks as fiscal agents subject to
supervision and regulation by the Board of
Governors. Under this authority, the Board on
April 6, 1942, promulgated its Regulation V.~
The use of the letter "V" to designate the regulation—a letter made popular by Winston
Churchill as a symbol of victory—was purely
fortuitous. It just so happened that among the
letters of the alphabet, which the Board has
customarily used in designating its regulations,
"V" was the next unused letter. From this
derived the short name given to the whole program of guaranteeing loans to defense and war
contractors.

PHASES OF THE PROGRAM
Although it originated as a wartime measure,
the V-loan program is still in effect at this
writing. Actually, it has consisted of two distinct though similar programs, one a war program that began in 1942 and the other a
peacetime defense program that began in 1950.
The wartime part of the program went
through three different phases marked by certain differences in purpose: (1) the emergency
phase from March 1942 until the fall of 1943,
during which the prime objective was to finance
war production; (2) the so-called VT period
from the fall of 1943 until the fall of 1944,
when guarantees were made not only to finance
war production contracts but also to enable
contractors to unfreeze their working capital
pending settlement of their termination claims
against the Government; and (3) the T-Ioan
phase from September 1944 until about the
middle of 1946, during which the chief purpose
was to finance contractors in converting to
peacetime operations while awaiting settlement
of their claims in connection with termination
of their war contracts.
More than 5 years after the end of the war
the V-loan program was revived by the Defense


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Federal Reserve Bank of St. Louis

Production Act of 1950 as a means of financing
contractors engaged in defense production. This
was the beginning of the peacetime part of the
program.
Both in war and in peace, however, and
despite shifts in emphasis, guaranteed loans
have been made in essentially the same manner,
that is, through the Federal Reserve Banks as
fiscal agents of the Government and pursuant
to general procedures outlined in the Board's
Regulation V.
The wartime period was. of course, the most
active part of the program. From the inception
of the program in March 1942 until the end of
September 1946. the Reserve Banks processed
8.771 guarantees aggregating nearly SlO'/s billion. Losses were relatively small and substantially less than the guarantee fees collected. As
a matter of fact, the wartime program resulted
in a net profit to the Government of about $23
million. The gratifying success of the program
was attested by a letter addressed to Chairman
Eccles of the Board by Secretary of War Kenneth Royall on March 26, 1947. on the fifth
anniversary of the program. Commenting on
the part played by the Federal Reserve Banks,
Mr. Royall's letter stated: •
The underlying philosophy of (he Executive order was. as you know, that in assisting
war production contractors through guaranteed loans the War Department should use
not only the funds already in the commercial
banks of the country, but should utilize the
existing credit machinery as well. It was to
that end that the Federal Reserve banks were
appointed the fiscal agents of the War Department.
The universal acceptance of the principle
of regulation V-loans by both the contractors
and the banks is due in no small part to the
good judgment, the skill, and the expedition
with which they have been handled by the
Federal Reserve banks. Especially appre£1'
ated were the helpful suggestions of the Re|
serve banks during the liquidation phase ol
the V and T programs which, in many respects, called for an even greater degree ot
financial management than that required m
the initial extension of credit.

V LOANS
You and the members of the Federal Reserve System who participated in this program should feel a deep satisfaction in your
contribution to this important part of the war
effort.
While not so active or exciting as the wartime
program, the peacetime V-loan program under
the Defense Production Act of 1950 has operated smoothly and successfully. Under this
part of the program, the guaranteeing agencies
had approved 1,647 applications totaling over
S3.6 billion as of June 30, 1972.
A complete account of all aspects of the Vloan program would require more space than

149

is practicable in this study of the lending functions of the Federal Reserve Banks. A full
description of the wartime period of the program may be found in the March 1946 issue
of the Federal Reserve Bulletin, beginning at
page 240. For present purposes, it will suffice
to discuss briefly those aspects of the program
that might be regarded as involving legal considerations: the legal basis for the program; the
role of the Federal Reserve System in the program; the form of the guarantee agreement;
interest rates and guarantee fees; and certain
legal problems that arose in connection with
the program.

LEGAL BASIS
EXECUTIVE ORDER 9112
Legal authority for the V-loan program was
originally based upon provisions of the First
War Powers Act of December 18, 1941." Title
II of that act gave the President power to
authorize any department of the Government
exercising functions in connection with the
conduct of the war to enter into contracts
without regard to other provisions of law,
whenever the President deemed that such action
would facilitate the prosecution of the war.
Pursuant to this broad authority, the President on March 26, 1942, issued Executive
Order 9112." authorizing the War and Navy
Departments and the Maritime Commission to
enter into contracts guaranteeing any Federal
Reserve Bank, the RFC, or any other financing
institution against loss on loans made by them
for the purpose of financing any contractor,
subcontractor, or others engaged in any business or operation that was "deemed by the War
Department, Navy Department or Maritime
Commission to be necessary, appropriate or
convenient for the prosecution of the war." The
order also authorized direct loans for the same


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Federal Reserve Bank of St. Louis

purposes. The Reserve Banks were authorized
to act as agents of the designated agencies in
carrying out the order, and the Secretary of the
Treasury was directed to designate each Federal
Reserve Bank as fiscal agent for this purpose
pursuant to provisions of section 15 of the
Federal Reserve Act.
The Executive order had been approved by
the Attorney General before it was issued.7 Its
validity was impliedly recognized by Congress
in the Supplemental National Defense Appropriations Act of April 28, 1942,S and the Independent Offices Appropriation Act of June
27, 1942,° which made funds available to the
War and Navy Departments and the Maritime
Commission for the purpose of carrying out the
provisions of the Executive order. Any doubt
as to the legality of the order was set at rest by
the Act of June 11, 1942,10 which created the
Smaller War Plants Corporation. Section 7 of
that act specifically authorized the War and
Navy Departments and the Maritime Commission "to make or participate in loans, guaranties, and commitments in accordance with
Executive Order Numbered 9112 of March 26,
1942."

150

HISTORY OF LENDING FUNCTIONS

VT GUARANTEES
In the summer of 1943, when the prospect of
ultimate military victory began to appear likely,
war contractors remembered that after the end
of World War I final settlement of claims under
cancelled war contracts had been delayed in
some instances for more than 20 years. Fearing
that a successful conclusion of the current war
might bring wholesale contract cancellations
and similar delays in the settlement of contract
claims, some contractors raised the question
whether they could continue to draw down
funds under a V loan after termination of their
war contracts. Literally, it appeared that Executive Order 9112 authorized guarantees only to
finance war production and not to finance contractors pending settlement of their cancelled
contracts.
In January 1944, the Attorney General held
that if commitments and guarantees were made
prior to the termination of all of a borrower's
war production contracts, the Executive order
was broad enough to permit funds to be advanced under such commitments and guarantees
even after termination of the borrower's contracts. However, the problem had reached a
critical point before the Attorney General's
opinion was rendered; on September 1, 1943,
the Board and the guaranteeing agencies had
approved a modified form of guarantee agreement that, in order to avoid the legal question
of authority, had provided that funds should
be available under a guarantee for termination
purposes if they were also technically available
for current war production'purposes.

CONTRACT SETTLEMENT ACT
Meanwhile, concern as to possible delays in
the settlement of contract claims upon termination of the war led to the introduction in Congress of various bills on this subject. Out of
these bills came the Contract Settlement Act of
July 1, 1944, which became effective on July
21, 1944.11 The act set up procedures designed
to provide for the prompt payment of claims
against the Government that grew out of the
cancellation of war contracts. Section 10 of the
act declared it to be the policy of the Govern-


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Federal Reserve Bank of St. Louis

ment to provide adequate financing to all war
contractors having termination claims "within
30 days after proper application therefor." To
this end, the act provided for two methods of
financing: (1) advance or partial payments and
(2) Government loans or guarantees.
As to loans and guarantees, the act specifically authorized any Government contracting
agency to guarantee any Federal Reserve Bank
or other public or private financing institution
against loss on loans made to a war contractor
"who is or has been engaged in performing any
operation deemed by such contracting agency to
be connected with or related to war production,
for the purpose of financing such war contractor
or other person in connection with or in contemplation of the termination of one or more
such war contracts or operations." Direct loans
for such purposes were also authorized. The
Federal Reserve Banks were expressly authorized, subject to regulations prescribed by the
Board of Governors with the approval of the
Director of Contract Settlement, to act on behalf
of the contracting agencies as fiscal agents of
the United States in carrying out the purposes of
the act.
On August 18, 1944, the Director of Contract Settlement prescribed procedures and policies to be followed in the guaranteeing of termination loans under the act and approved standard forms of guarantee agreement and loan
agreement to be used for that purpose.15 On
September 11, 1944. the Board revised its
Regulation V to cover guarantees under the new
program.11 In connection with the inauguration
of the new T loans, the Board issued a press
statement that indicated the difference between
the legal basis for such loans and the legal basis
for the earlier VT loans:
The T loan program is a logical extension
of the V and VT loan programs under Executive Order 9112. which provide war contractors with financing necessary f o r production.
VT loans, in use since September 1, '9|*3'
provide both production and termination
financing, but have not been available after
cancellation has taken place. T loans, which
are authorized under the Contract Settlement
Act, may be guaranteed after the borrower s
war production contracts have been tcrmi-

V LOANS
nated. However, commitments for such loans
may be guaranteed in advance of cancellation.
Thus ihc program affords war production
contractors a means of insurance against the
freezing of their working capital which might
result from sudden termination of their war
contracts.

DEFENSE PRODUCTION ACT
By 1950 the great majority of claims under
war production contracts had been settled, and
the authority for guarantees of termination
loans under the Contract Settlement Act had,
for all intents and purposes, become academic.
However, the V-loan program was revived in
that year as one of the measures provided by
the Defense Production Act of September 8,
1950, to stimulate production for national defense purposes."
Unlike Executive Order 9112 and the Contract Settlement Act, the authority contained in
the Defense Production Act was spelled out in
some detail. Section 301 of the latter act expressly gave the President power to authorize
the Departments of the Army, Navy, Air Force,
Commerce, and such other procurement agencies of the Government as he might designate,
to guarantee any public or private financing
institution (including any Federal Reserve
Bank) against loss on any loan made to finance
any contractor, subcontractor, or other person
"in connection with the performance, or in connection with or in contemplation of the termination, of any contract or other operation
deemed by the guaranteeing agency to be necessary to expedite production and deliveries or
service under Government contracts for the
procurement of materials or the performance of
services for the national defense."
As under Executive Order 9112 and the Contract Settlement Act, the Federal Reserve Banks
were expressly authorized to act as fiscal agents
of the United States on behalf of the guarantcein
g agencies. For the first time, however, it was
specifically provided in the law that the funds
necessary to carry out guarantees should be
supplied by the guaranteeing agencies; that the
Reserve Banks as fiscal agents should have no
responsibility or accountability except as such


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agents; and that the fiscal agents should be
reimbursed by the guaranteeing agencies for all
expenses and losses, including attorneys' fees
and expenses of litigation. It was further provided that all operations of the Reserve Banks
as fiscal agents should be subject to the supervision of the President and to such regulations
as he might prescribe; that the President should
be authorized to prescribe rates of interest,
guarantee and commitment fees, and regulations governing the forms and procedures to be
followed in connection with guarantees; and
that each guaranteeing agency should be authorized to use, for the purposes of such guarantees,
any funds theretofore or thereafter appropriated
or allocated to it, or becoming available to it,
for such purposes or for the purpose of meeting
"the necessities of the national defense."
The act did not mention the Board of Governors of the Federal Reserve System. However,
on the day after approval of the act, September
9, 1950, the President by Executive Order No.
10161 1"1 delegated to the Board his authority to
prescribe regulations, interest rates and guarantee fees, and forms and procedures, subject to a
requirement that the Board should first consult
with the guaranteeing agencies. At the same
time, the President expressly designated the
Federal Reserve Banks as fiscal agents of the
United States in carrying out under the act
guarantees of loans made by private financing
institutions. Finally, the Executive order designated as guaranteeing agencies not only the
Army, Navy, Air Force, and Commerce Departments but also the Departments of the
Interior and Agriculture and the General Services Administration.
The Defense Production Act was enacted as
a temporary statute. Title III, containing the
V-loan authority, was originally intended to
expire on June 30, 1951. This authority, however, was further extended by successive amendments; at this writing it is scheduled to terminate on June 30, 1974.10
The provisions of section 301 of the act
regarding guaranteed loans were amended by
the Act of June 30,1953.' 7 The amendment was
designed to clarify the availability of V loans to
finance contractors pending settlement of their

1S2

HISTORY OF LENDING FUNCTIONS

defense contracts. The language of the law was
changed to provide specifically that such guarantees might be made "for the purpose of financing any contractor, subcontractor, or other
person in connection with or in contemplation
of the termination, in the interest of the United
States, of any contract made for the national
defense." At the same time, a provision was
added to make it clear that no small business
concern, as defined in the act, should be ineligible for a guaranteed loan by reason of alternative sources of supply.
At the time of the financial collapse of the
Penn Central Transportation Company in 1970.
some consideration was given to the possibility
of governmental assistance to the company by
means of a V loan. The idea was dropped, however, and, on the contrary, Congress specifically
amended section 301 of the Defense Production
Act for the purpose of guarding against the use
of V loans as a means of preventing financial
insolvency or bankruptcy unless such an occurrence would have an adverse effect upon
defense production. A new subsection was
added to section 301 that limited the maximum
obligation of any guaranteeing agency to S20
million except with the approval of Congress,

and that prohibited the use of the V-loan
authority for the purpose of preventing the financial insolvency or bankruptcy of any person
unless the President certified that the insolvency
or bankruptcy would have a direct and substantially adverse effect upon production. A
copy of .such certification, with a detailed justification, must be transmitted to Congress at
least 10 days before any such use of the
authority.'Executive Order 10161 was subsequently affected, amended, and superseded by other Executive orders,1' but no essential change was
made in the authority delegated by the President to the Board or in the scope of the authority given to the Federal Reserve Banks to
act as fiscal agents. It should be noted, however, that, as of the present writing, the designated guaranteeing agencies are the Army.
Navy, and Air Force Departments and the Defense Supply Agency of the Defense Department; the Departments of Commerce. Interior,
and Agriculture; the General Services Administration; the Atomic Energy Commission; and
the National Aeronautics and Space Administration.

ROLE OF THE FEDERAL RESERVE BANKS
AS FISCAL AGENTS
It must always be borne in mind that the part
played by the Federal Reserve System in the
operation of the V-loan program was primarily
that of agent and coordinator. The principals
in the program were the procurement agencies
of the Government, chiefly the military departments and—during the later defense phase of
the program—the General Services Administration and the Atomic Energy Commission. It
was these agencies that guaranteed V loans.
The Reserve Banks acted only as intermediary
agents, investigating and making recommendations as to the credit aspects of applications for
guarantees, processing such applications, and


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Federal Reserve Bank of St. Louis

servicing the loans after they were made and
guaranteed.
At the outset of World War II, Executive
Order 9112 had directed the Secretary of the
Treasury to designate the Federal Reserve
Banks as fiscal agents of the United States under
provisions of section 15 of the Federal Reserve
Act. On March 31, 1942—5 days after the
Executive order was issued—the Secretary formally designated each Federal Reserve Bank as
fiscal agent for the purpose of carrying out the
order. The Contract Settlement Act of 1944
made action by the Secretary of the Treasury
unnecessary, since that act expressly authorized
the Reserve Banks to act as fiscal agents of the
United States in carrying out the provisions of

V LOANS
the act authorizing guarantees of termination
loans. Similarly, the Defense Production Act of
1950 expressly authorized the Reserve Banks to
act as fiscal agents of the United States on
behalf of any guaranteeing agency "when designated by the President"; such designation was
made by the President in section 302(b) of
Executive Order 10161. It was made plain
throughout the program that no Federal Reserve Bank should have any responsibility or
accountability except as agent for the guaranteeing agencies and that the operations of the
Reserve Banks should be subject to supervision
and regulation by the Board of Governors.
Reimbursement of the Reserve Banks for
their expenses and losses in acting as fiscal
agents was provided by the original Executive
Order 9112, and it was specifically stated that
such expenses should include attorneys' fees
, and expenses of litigation. Despite this specific
provision, a question arose in the course of the
wartime V-loan program whether a guaranteeing agency could lawfully reimburse a Reserve
Bank for attorneys' fees paid out in connection
with a guaranteed loan after the loan had been
purchased by the guaranteeing agency. The
War Department doubted its authority to do so
because section 314 of Title 5 of the U.S. Code
prohibited any Government agency other than
the Department of Justice from incurring legal
expenses in protecting the interests of the
United States. This question was eventually
settled by the Defense Production Act, which
expressly authorized reimbursement of the Reserve Banks for attorneys' fees and expenses of
litigation "notwithstanding any other provision
of law."
The procedures followed by the Reserve
Banks in executing guarantees and servicing
guaranteed loans were prescribed in considerable detail by the guaranteeing agencies and,
from the outset of the wartime V-loan program,
they were generally uniform. The Defense Production Act expressly recognized the desirability
°f procedural uniformity. It provided that the
President should prescribe regulations "govcrnIn
g the forms and procedures (which shall be
uniform to the extent practicable) to be utilized
In
connection with such guarantees." As pre-


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153

viously indicated, that authority was delegated
to the Board, to be exercised after consultation
with the heads of the guaranteeing agencies.
In accordance with this statutory injunction,
Regulation V, as revised effective September
27, 1950,-° for the first time undertook to outline the procedures to be followed in guaranteeing loans. Essentially, the prescribed procedures
were as follows:
1. A financing institution desiring a guarantee of a loan to an eligible borrower would submit its application to the Reserve Bank of its
district.
2. It would then be necessary to determine
whether the contract or other operation of the
prospective borrower to be financed by the loan
was necessary to expedite defense production or
services. This determination would be made by
a duly authorized certifying officer of the appropriate guaranteeing agency.
3. The application would then be subject to
approval either by the appropriate guaranteeing
agency in Washington or, to the extent that
authority was delegated to it, by the Federal
Reserve Bank acting on behalf of the guaranteeing agency.
4. If approval from Washington were necessary and if the application were approved by an
authorized contracting officer of the guaranteeing agency, that officer would authorize the
Reserve Bank to execute and deliver the guarantee. If the application were one that could be
approved by the Reserve Bank under delegated
authority, the Reserve Bank would approve and
execute the guarantee without reference to the
guaranteeing agency in Washington.
Early in the wartime program, the War
Department stationed liaison officers at each of
the 12 Federal Reserve Banks and also at the
Detroit Branch of the Chicago Reserve Bank
and the Los Angeles Branch of the San Francisco Reserve Bank, with authority to certify
the eligibility of the prospective borrower for a
guaranteed loan. Field representatives of the
Maritime Commission similarly furnished statements of necessity in connection with loans to
be guaranteed by the Commission. The Navy
Department, on the other hand, centralized its
V-loan operations in Washington and had no

154

HISTORY OF LENDING FUNCTIONS

such field representatives. The peacetime phase
of the program under the Defense Production
Act did not involve the volume of applications
or the element of urgency that characterized
the wartime program, and since 1950 the operations of all guaranteeing agencies have
been centralized in Washington, with no liaison
officers or representatives at the Reserve Banks.
During the wartime phase of the program,
the War Department and the Maritime Commission delegated to the Reserve Banks authority to approve guarantees up to certain
prescribed amounts without reference to Washington. No such delegations were made by the
Navy Department. Under the Defense Production Act none of the guaranteeing agencies has
delegated such authority to the Reserve Banks;
all applications are required to be submitted to
Washington for approval.
Although the Reserve Banks have been utilized by the guaranteeing agencies as field agents
for the purpose of expediting the consideration
and execution of guarantees, it should be emphasized again that a primary role of the Reserve Banks has been the investigation of the
creditworthiness of prospective guaranteed
loans. The guaranteeing agencies have relied
heavily upon the credit experience of the Reserve Banks and upon their recommendations
as to whether particular applications warranted
approval from a credit standpoint.

AS FINANCING INSTITUTIONS
In addition to acting as fiscal agents of the
United States in guaranteeing V loans made by
private financing institutions, the Federal Reserve Banks themselves acted to some extent as
lending institutions under the V-loan program.
Executive Order 9112 had authorized guarantees of loans made not only by private financing institutions but also by the Federal Reserve
Banks and the RFC. It was contemplated that
the Reserve Banks might, under section 13b of
the Federal Reserve Act, make loans to war
contractors that would be eligible for guarantees. As noted in the preceding chapter, the
Board revised its Regulation S to facilitate participation by the Reserve Banks in the V-loan
program. Actually, however, the changes made
in that regulation were largely technical and
clarifying in nature. The restrictions prescribed
by section 13b continued, as before the war, to
limit the extent to which the Reserve Banks
could extend credit to business concerns. Consequently, relatively few V loans were made to
war contractors by the Federal Reserve Banks,
and the role of the Reserve Banks as financing
institutions under the V-loan program was not
one of any considerable significance. It has become nonexistent since the repeal of section 13b
of the Federal Reserve Act effective August 21.
1959.

ROLE OF THE BOARD OF GOVERNORS
The role of the Board of Governors in the
V-loan program is fourfold in nature: (1) It
prescribes regulations governing the operations
of the Federal Reserve Banks; (2) it prescribes
guarantee fees and interest rates with respect to
guaranteed loans; (3) it prescribes the forms
and procedures to be followed; and, finally,
quite apart from any statutory authority, (4)
it acts as an over-all coordinator in the determination of general policies.


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Federal Reserve Bank of St. Louis

Throughout the program, the Board's Regulation V has been couched in the broadest
terms. As first issued in April 1942," the regulation contained general statements to the effect
that the objective of the Federal Reserve System
would be to facilitate and expedite war production by arranging for the financing of war contractors and that the Board and the Federal
Reserve Banks would cooperate in every way
possible in carrying out the provisions of Ex"

V LOANS
ecutivc Order 9112. In addition, the regulation
included brief sections relating to rates of interest and fees on guaranteed loans, maturities,
and reports by ihc Reserve Banks. That was all.
As revised effective September 11, 1944,"
Rcgulation V was, if anything, even more general in its language. Provisions as to maturities
of guaranteed loans were omitted as unnecessary (there were never any limitations placed
upon maturity, either by statute or Executive
order); references to the Contract Settlement
Act were included; and, in accordance with that
act, a new section with regard to the responsibility of the Reserve Banks and reimbursement
for expenses was added.
In the third and final revision of Regulation
V, effective September 27, 1950,=1 references
to the Defense Production Act replaced previous references to the Contract Settlement Act,
and, as noted in the preceding section of this
chapter, the regulation prescribed briefly the
procedures to be followed in guaranteeing loans.
Otherwise the regulation remained substantially
the same.
The Board's role in prescribing uniform procedures has already been discussed. Its functions in fixing fees and interest rates and in

155

prescribing forms used in connection with guaranteed loans will be considered later.
None of the applicable statutes or Executive
orders contained any reference to the Board as
a coordinating agency. Yet it was in that role
that the Board probably played its most useful
part in the program. All applications, approvals,
and other communications between the guaranteeing agencies and the Reserve Banks were
channeled through the Board. A separate Office
of War Loans—later called the Office of Defense Loans—was set up within the Board's
organization to handle V-loan matters, and that
office was continued until 1959. It was thus
possible for the Board to assist in the formulation of substantially uniform procedures and
forms. In addition, during the wartime phase,
all important questions of policy were considered and resolved at frequent meetings in the
Board's offices by a joint policy committee composed of representatives of the guaranteeing
agencies and the Board; and, when circumstances required, representatives of the Federal
Reserve Banks attended such meetings. To a
considerable degree, the success of the V-loan
program was attributable to the uniformity of
policies that resulted from these meetings.'-1

THE GUARANTEE AGREEMENT
As a legal matter, the most important aspect
°f the V-loan program was the form of guarantee agreement that constituted the contract between the guaranteeing agencies and the lending
financing institutions.
On April 10, 1942, just 4 days after the
Board promulgated Regulation V, the War
Department approved a standard form of guarantee agreement. About a month later, on May
'4, 1942, this form was superseded by a form
designed for uniform use by the Navy Department and Maritime Commission as well as the
w
a r Department. During the summer of 1942,
Negotiations for a guaranteed revolving credit to
General Motors Corporation in the amount of


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Federal Reserve Bank of St. Louis

SI billion, with more than 200 large banks
participating, gave rise to numerous questions
as to the effect of the guarantee agreement; the
result was the adoption in October 1942 of
certain special conditions, some mandatory and
some optional. On April 6, 1943, the standard
form was completely revised, incorporating
some but not all of the special conditions."
When the VT program was inaugurated in
September 1943, a special section was added to
the agreement. In June 1944, another standard
amendment was adopted. After enactment of
the Contract Settlement Act, a new form was
approved in September 1944 for use in connection with guarantees of war production loans

156

HISTORY OF LENDING FUNCTIONS

and a separate T-loan form was adopted for
guarantees of termination loans. When the program was reactivated by the Defense Production
Act of 1950, a somewhat simplified form of
guarantee agreement was put into effect, and
that form has since been amended in only two
minor respects.20 Despite these many revisions
and amendments, the guarantee agreement has
remained essentially the same throughout the
program.
The basic feature of the guarantee agreement
is a commitment by the guaranteeing agency to
purchase a specified percentage of the guaranteed loan. Such a purchase will be made, within
10 days after demand by the financing institution, at any time prior to the date of settlement
between the guarantor and the financing institution. In the early forms, the guarantor reserved
the right at its option to purchase the entire
amount of the guaranteed loan, but this right of
voluntary purchase by the guarantor later was
limited to the guaranteed portion of the loan.
The earliest standard forms provided that
losses on the guaranteed loan and expenses in
connection therewith would be shared ratably
by the guarantor and the financing institution
in accordance with their respective interests in
the loan. Since the guarantor obtained no interest in the loan unless it purchased a part of the
loan, the agreement to share losses meant nothing unless there was a purchase. In October
1942, however, the agreement was amended to
provide that regardless of whether there had
been any purchase by the guarantor, losses and
expenses would be shared by the guarantor and
the financing institution according to the guaranteed and the unguaranteed percentages of the
loan, respectively.
A large part of the guarantee agreement relates to details involved in the administration of
the guaranteed loan. In general, the agreement
makes the financing institution responsible for
administering the loan, even after a purchase by
the guarantor. However, in the event of a purchase, the guarantor, through the Federal Reserve Bank, may take over possession of the
obligation and become the holder of the obligation. The holder of the obligation, whether the
financing institution or the guarantor, is required to transmit to the other party its pro rata


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Federal Reserve Bank of St. Louis

share of all payments on the loan in accordance
with that party's interest in the loan at the time.
The agreement includes detailed and complex
provisions regarding the application of the proceeds of collateral and other assets of the borrower to payment of the guaranteed loan. Such
provisions, including "spreader" clauses, were
the subject of much discussion in connection
with revisions of the guarantee agreement; but
the technicalities of such discussions would extend far beyond the scope of this history.
Of major importance during the war were
those provisions of the guarantee agreement
that were designed to protect both the financing
institution and the borrower against the adverse
effects of cancellation of the borrower's war
production contracts. In a legal sense, these
provisions became notorious for their complexity.
To protect the financing institution, the agreement provided for an automatic increase in the
stated guaranteed percentage by the ratio that
the dollar volume of cancelled contracts of the
borrower bore to his total war production contracts. The dollar volume of contracts cancelled
after the execution of the agreement was designated as "(a)." The dollar volume of all war
contracts held by the borrower on the date of
the agreement plus those entered into by him
after that date, less payments received on all
such contracts, was designated as "(b)." The
ratio of (a) to (b) was then added to the
originally specified guaranteed percentage to
obtain the adjusted guaranteed percentage.
Thus, if the original percentage was 90 per cent
and half of the borrower's contracts were cancelled, the guaranteed percentage would be increased by 50 per cent of the unguaranteed
percentage and the adjusted guaranteed percentage would be 95 per cent.
The protection afforded the borrower by
another section of the agreement was based
upon the same ratio of cancelled contracts to
total contracts, but it took a different form. The
borrower was entitled, upon request, to a suspension of maturity and waiver of interest as
to that portion of the unpaid amount of the
guaranteed loan that bore the same ratio to the
total amount of the loan as the ratio of (a) t 0
(b). At the same time, the financing institution

V LOANS
was protected by a provision relieving it of its
obligation to pay any guarantee fee to the
guarantor for any portion of the loan on which
maturity was suspended and interest was
waived. In addition, the guarantor was required
to pay the financing institution interest on the
suspended portion of the loan.
When the T-Ioan and the 1944 V-loan forms
were adopted after passage of the Contract

157

Settlement Act, all provisions regarding adjustment of the guaranteed percentage and suspension of maturity and waiver of interest upon
cancellation of the borrower's contracts were
omitted, and, as a result, the form of guarantee
agreement was substantially simplified. No such
provisions were included in the form adopted
for use under the Defense Production Act of
1950.

FEES AND RATES
Neither the President's Executive Order 9112
of March 26, 1942, nor the Contract Settlement
Act of 1944 contained any provisions with
regard to the rates of interest on guaranteed
loans or the guarantee fees to be paid by financing institutions. However, the Board's Regulation V, as first issued in April 1942, specifically
provided that rates of interest, fees, and other
charges on guaranteed loans would be prescribed by the Board of Governors "cither specifically or by maximum limits or otherwise
* * * after consultation with the War Department, Navy Department or Maritime Commission, and with the Federal Reserve Banks."
Basically, this became the manner in which all
rates and fees were fixed throughout the V-loan
program, although under the Contract Settlement Act they were prescribed by the Board
with the concurrence of the Director of Contract Settlement instead of after consultation
with the guaranteeing agencies. The Defense
Production Act of 1950 conferred upon the
President authority to prescribe V-loan rates
and fees "either specifically or by maximum
limits or otherwise"; and this authority was
delegated by the President to the Board, to be
exercised after consultation with the heads of
'he guaranteeing agencies.
The first schedule of rates and fees was prescribed by the Board on April 9, 1942. It limited the interest rate on guaranteed loans to a
maximum of 5 per cent and provided for payment of a guarantee fee by the financing institution on a graduated scale depending upon the


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Federal Reserve Bank of St. Louis

percentage of guarantee. If the guaranteed percentage was between 91 and 100 per cent, the
financing institution paid a fee equal to 30 to 40
per cent of the loan rate; if the guaranteed percentage was between 75 and 90 per cent, the
fee was 20 to 25 per cent of the loan rate; and
if the guaranteed percentage was less than 75
per cent, the fee ranged from 10 to 20 per cent
of the loan rate.
The flexibility of the original schedule of
guarantee fees led to some bargaining and
tended to temptfinancinginstitutions to ask for
the highest percentage of guarantee with the
lowest applicable fee. As a consequence, the
schedule was revised in December 1942 2r to
provide fixed guarantee fees in all cases, depending upon the guaranteed percentage, except
that flexibility was retained for cases in which
the guaranteed percentage was 90 per cent or
more.
In May 1943 the Board set a maximum of
one-fourth of 1 per cent for any commitment
fee that might be charged a borrower by a
financing institution. When the VT phase of the
program was inaugurated in September 1943,
the maximum commitment fee was increased
to one-half of 1 per cent; but it was provided
that any such fee should be shared with the
guarantor on the same basis as interest was
required to be shared under the schedule of
guarantee fees.
After enactment of the Contract Settlement
Act, the Board on September 11,1944, reduced
the maximum interest rate to AV2 per cent and

158

HISTORY OF LENDING FUNCTIONS

prescribed a simpler schedule of guarantee
fees.28 At the same time, the maximum commitment fee was fixed at one-fourth of 1 per cent,
or a flat fee of not more than S50, but without
any requirement for sharing of the fee with the
guarantor.
When the V-loan program was revived by the
Defense Production Act, the Board prescribed a
5 per cent maximum interest rate, a one-half
of 1 per cent maximum commitment fee (to be
shared with the guarantor), and a revised
schedule of guarantee fees.29 This schedule of
rates and fees remained unchanged until May
15, 1957, when the Board increased the maximum interest rate to 6 per cent.
Effective September 27, 1966, the Board
increased the maximum interest rate to IVz

per cent, without making any changes in the
schedule of guarantee fees or in the commitment fee. It was provided, however, that in any
case in which the rate of interest on the loan
would be in excess of 6 per cent, the guarantee
fee should be computed as though the interest
rate were 6 per cent.10 In 1970, although the
maximum interest rate of 7'/i per cent was not
changed, the Board provided that a higher rate
might be charged on a particular guaranteed
loan if the guaranteeing agency should determine the loan to be necessary for the purpose of
financing a person in connection with the performance of contracts deemed by the agency to
be necessary to expedite production and deliveries or services for the procurement of materials or the performance of services for the
national defense.;l

RELATED LEGAL PROBLEMS
ELIGIBILITY OF V-LOAN PAPER
FOR DISCOUNT
The V-loan program gave rise to legal questions involving an interpretation of the discount
provisions of the Federal Reserve Act. Notes
given by borrowers under V loans, particularly
under revolving credit arrangements, ordinarily
were not negotiable; however, the Board's
Regulation A required that all paper discounted
by the Reserve Banks be negotiable. This problem was met by an amendment to Regulation A
effective September 21, 1942, that made the
negotiability requirement inapplicable to notes
subject to a guarantee by the War or Navy
Departments or the Maritime Commission pursuant to Executive Order 9112.32 This exception
was later extended to cover paper guaranteed
under T-loan guarantees pursuant to the Contract Settlement Act."1 After the end of the war,
the exception for V-loan paper was eliminated
from Regulation A;'11 but it was restored on
March 21, 1951, to remove any doubt as to the
eligibility for discount of paper acquired by
member banks in connection with V loans


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Federal Reserve Bank of St. Louis

under the Defense Production Act.1' In April
1970 this exception was removed from the
regulation as being unnecessary when the Board
eliminated the regulatory requirement concerning negotiability of paper offered for discount or
as collateral for advances.
A further question arose from the fact that a
V-loan note usually incorporated by reference
the provisions of the guarantee agreement relating to suspension of maturity in the event of
cancellation of one-fourth or more of the borrower's war contracts. Did this fact make the
note ineligible for discount on the grounds that
it had a maturity of more than 90 days? The
Board ruled that it did not, since the note remained payable at its stated maturity unless
one-fourth of the borrower's contracts were
cancelled, a contingency that might never
occur. However, any notes offered for discount
after the happening of that contingency were
held to be ineligible for discount.1"
Under a revolving credit arrangement, the
financing institution could be required, upon the
maturity of a 90-day note, to lend the same
amount for another 90 days, and the proceeds

V LOANS
of the second note could be used to pay off the
first. Again, question was raised whether a revolving credit arrangement under which loans
could be made up to a specified maximum
amount over a period of months or years would
violate the 90-day maturity requirement of section 13 of the Federal Reserve Act. The Board
ruled that since the Reserve Bank was under no
commitment to renew such notes at maturity,
notes issued under a revolving credit were not
rendered ineligible for discount."

LENDING LIMITS OF
NATIONAL BANKS
Early in the V-loan program, question arose
as to the extent to which national banks could
legally participate in the making of V loans
because of statutory limitations on the amount
that such a bank could lend to any one borrower. Because of the great volume of war production contracts that a war contractor usually
held, it was necessary in many cases for him to
seek credit in equally large amounts; and, under
section 5200 of the Revised Statutes, the most
a national bank could lend him was an amount
equal to 10 per cent of the bank's capital and
surplus. Sometimes this proved to be an obstacle
to the necessary financing.
On April 9, 1942, the Comptroller of the
Currency ruled that if the portion of a V loan
in excess of 10 per cent of a national bank's
capital and surplus was subject to a commitment to purchase within 10 days after demand
by the War or Navy Department or the Maritime Commission, the loan would not violate
section 5200.-1S It was made clear, however,
that any part of the loan not subject to such a
commitment must be within the statutory limitation.
% the Act of June 11, 1942," a new paragraph (10) was added to section 5200. It provided that the amount limitations should not
a
Pply to the extent that loans were secured or
covered "by guaranties, commitments or agreements to take over or purchase, made by any
federal Reserve bank or by the United States
or any department, bureau, board, commission,
or
establishment of the United States." This
exception, however, was subject to one condition: The guaranties, agreements, or commit-


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Federal Reserve Bank of St. Louis

159

ments were required to be unconditional and
to be performed by payment of cash or its
equivalent within 60 days after demand.
The Comptroller of the Currency was authorized to define the terms used in the statute.
On June 18, 1942, the Comptroller issued a
definition of the term "unconditional."10 In
effect, the definition stated that in order to meet
this requirement, the protection afforded to a
bank by a guarantee must not be substantially
less than it would be in the absence of any
provisions that might be regarded as conditions.
This made it necessary to determine, with respect to every revision or amendment of the
standard form of guarantee agreement, whether
it complied with exception (10) to section 5200
and the Comptroller's definition of unconditional. Thus, on successive occasions, favorable
rulings as to unconditionality were obtained
from the Comptroller with respect to the standard form of May 14, 1942,41 the special conditions added to the guarantee agreement in
October 1942, the revised standard form of
April 6, 1943,1- the so-called VT amendments
of September 1943, and the 1944 V-loan and
T-loan forms of agreement adopted in September 1944." Similarly, the revised standard form
of September 27, 1950, adopted for use under
the Defense Production Act, was held by the
Comptroller to comply with exception (10) to
section 5200, Revised Statutes,-14 as were also
certain minor amendments later made to that
form.

ASSIGNMENT OF CLAIMS UNDER
GOVERNMENT CONTRACTS
In general, the principal security taken by
financing institutions as security for V loans
was an assignment of the borrower's claims
under his war or defense production contracts
with the Government. This circumstance gave
rise to important and sometimes serious legal
problems. Thus, questions arose concerning the
priority of the claims of an assignee bank as
against those of a trustee in bankruptcy in the
case of an insolvent borrower and as against
those of a surety company on a contractor's
performance bond in the event of default by
the contractor; these questions were the subject
of various court decisions that caused consider-

160

HISTORY OF LENDING FUNCTIONS

able concern to banks participating in the Vloan program. However, it was the status of an
assignee bank's claims against the borrower as
opposed to those of the Government itself that
gave rise to the greatest difficulty. This was a
problem that did not develop until after the
reactivation of the V-loan program under the
Defense Production Act; and, since the Board
of Governors played some part in its final resolution, a brief discussion of that problem seems
justified here.
For many years before 1940, an old statute
(Rev. Stat., sec. 3477) had prohibited the
assignment of any claims against the Government. As early as 1938, the Federal Advisory
Council had recommended that the Board seek
an amendment to this statute to permit the
assignment of claims where legitimate credit
has been extended, and the Council renewed
this recommendation in the spring of 1940. In
June of that year, Chairman Eccles of the Board
urged Congress to liberalize the statute as a
means of facilitating the Government's defense
program.1" Meanwhile, the National Defense
Advisory Council (with offices in the Board's
building) was endeavoring to promote the
financing of emergency plant facilities contracts
with the Government by making such contracts
"bankable." Working in cooperation, the Defense Council and the Board drafted an amendment to the law that was enacted on October 9,
1940, and designated as the Assignment of
Claims Act of 1940.'" In brief, this act expressly
permitted the assignment to a bank or other
financing institution of moneys due or to become due from the United States under contracts providing for payments aggregating
$1,000 or more.
This act was a fortunate, ready-made aid in
the private financing of Government contractors
when the outbreak of war in 1941 converted
the defense program to a war production program. It was because of this act that, during the
wartime period of the V-loan program, banks
were able to accept assignments of contract
claims as security for V loans.
After the war, however, certain opinions
rendered by the Comptroller General raised


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Federal Reserve Bank of St. Louis

questions as to the protection afforded lending
banks by the Assignment of Claims Act. The
statute provided that contracts entered into by
the War and Navy Departments might include
"no set-off" provisions under which payments
to an assignee would not be subject to reduction
or set-off for any indebtedness of the assignor
(the borrower-contractor) to the United States
"arising independently of such contract." In
1949, the Comptroller General held that when
a contract contained a price-revision clause, any
amounts in excess of the revised contract price
could be withheld from payments to an assignee or. even more alarming, could be recovered directly from the assignee if already paid.17
Again, in 1950. the Comptroller General ruled
that claims by the Government against a contractor for unpaid social security contributions
and withheld income taxes were claims that did
not arise independently of the assigned contracts
and were therefore not subject to the no-set-off
clause."
These and similar rulings operated to deter
banks from making loans to defense contractors
on the security of assignments of contract
claims, and the revived V-loan program was
seriously retarded as a result. In an effort to
meet this problem, the form of guarantee agreement was amended in 1950 to define the term
"loss on the loan" to include any amounts
received by a financing institution and applied
to the loan that might later be recovered from
the financing institution by the United States."
However, this amendment did little to allay
those fears of financing institutions that had
been engendered by the rulings of the Comptroller General.
On February 13, 1951, the Board recommended to the Senate Banking and Currency
Committee an amendment to the Assignment
of Claims Act that was designed to remove this
impediment to the V-loan program."" This
amendment, with some modifications, was enacted on May 15, 1951." In brief, its principal
effect was to make it clear that when the noset-off clause was included in a Government
contract, an assignee financing institution was
protected against set-off of any claims by the

V LOANS
Government against the assignor on account of
renegotiation, fines, penalties, or taxes or social
security contributions, whether or not such
claims arose from, or independently of, the
assigncd contract. In addition, authority for
inclusion of the no-sct-off clause, previously


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Federal Reserve Bank of St. Louis

161

limited to the War and Navy Departments, was
extended to the Department of Defense, the
General Services Administration, the Atomic
Energy Commission, and such other departments or agencies as the President might designate.


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Federal Reserve Bank of St. Louis

Interdistrict Rediscounts

LEGISLATIVE PURPOSE
So far in this study consideration has been
given to extensions of credit by the Federal
Reserve Banks to their own member banks, to
Federal intermediate credit banks, to nonmember banks, to individuals and corporations, to
business enterprises, and, as agents for the
Government, to defense production contractors.
There remains to be considered a final recipient
of Federal Reserve credit—the Federal Reserve
Banks themselves.
Section l l ( b ) of the original Federal Reserve Act authorized and empowered the Federal Reserve Board:
To permit, or, on the affirmative vote of at
least five members of the Reserve Board to
require Federal reserve banks to rediscount
the discounted paper of other Federal reserve
banks at rates to be fixed by the Federal
Reserve Board.
This provision has never been amended; it is
•n the law today, although its presence is all
but forgotten.
The most noteworthy feature of the provision
ls
that it contemplates compulsory rediscounts
NOTES AND REFERENCES, see p. 264.


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Federal Reserve Bank of St. Louis

between Federal Reserve Banks if ordered by
the Board, a feature completely at variance with
the otherwise discretionary character of the
discounting authority of the Reserve Banks.
This element of compulsion was the cause of
considerable controversy during the debates on
the original Federal Reserve Act.
As included in the Glass bill, the provision
was phrased so as to be operative only in time
of emergency. The House Banking and Currency Committee felt that the authority of the
Board to compel rediscounts between Reserve
Banks should be subject to such restrictions as
would "unquestionably make its use sporadic
and exceptional"; and Chairman Glass suggested that the power would "rarely, if ever" be
exercised by the Board.1
The House committee compared this authority to compel interdistrict rediscounts to that by
which the head office of a central bank with
branches is enabled to "employ the resources
of one portion of the country for the advantage
of other portions or for the purpose of safeguarding them at critical times if its managers
deem such actions to be wisest." •
In further explanation of the provision's
purpose, Mr. Phelan stated: '
163

164

HISTORY OF LENDING FUNCTIONS
* * * Herein is provided a means whereby funds in one part of the country for which
there is no demand may be applied to that
part of our country which is in need. A Federal reserve bank in the Southwest, for example, has a demand for the rediscounting of
paper beyond its power to supply. At the
same time a reserve bank in the East may
have funds for which there is no immediate
demand. Under such conditions the Federal
reserve bank in the East may rediscount paper
for the reserve bank in the Southwest.* * *

The compulsory feature of the provision met
with some opposition in the House.' It was in
the Senate, however, that this feature was most
strongly opposed.
Senator Owen's bill contained no limitations
on discounts by one Federal Reserve Bank for
another. It provided only that rates on such
interdistrict rediscounts should be fixed each
week by the Board. Senator Hitchcock's version
of the bill, however, limited the use of the
authority to times of emergency; required unanimity of action by the Board; and provided for
a special rediscount rate of not more than 3
per cent above the discount rate of the accommodated Federal Reserve Bank.
Senator Burton, the chief antagonist of the
compulsory rediscount provision, regarded it as
"a frank admission of the fatal defects of the
regional system" and believed that it would
"accentuate the rivalry between sections for the
accumulation of reserves" and cause "unlimited
irritation and friction." 5 Worst of all, he argued
that under this provision no Federal Reserve
Bank "could make calculations for the care of
its customers or the utilization of its resources,
because any day it might be called upon to
transfer its funds elsewhere." In addition, he
contended that the provision might seriously
handicap the bank that would have to "take
care of foreign exchanges" if a time should
come when gold exports might make it necessary for that bank to buy foreign bills in order
to check the outflow of gold. Finally, he visualized the adverse psychological effect if it should
become known that one Federal Reserve Bank
had been compelled to borrow from another
Reserve Bank under this "obnoxious provision." 6


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Federal Reserve Bank of St. Louis

Near the close of the debates in the Senate,
Senator Newlands offered an amendment that
would have added to the provision in question,
as modified in the Owen substitute bill, another
provision authorizing the Board to require from
the Federal Reserve Banks up to one-third of
their member banks' reserves for the purpose of
enabling the Board to make advances to any
Federal Reserve Bank.7 The argument was
made that in an emergency the Board should
not be called upon to exercise the indirect
method of requiring one Reserve Bank to
rediscount paper for another, but should "have
the power itself to put these funds directly into
the reserve bank which requires aid."
Senator Burton's objections were overruled
and Senator Newlands' amendment was defeated. As finally adopted, the Board's authority
to permit or require rediscounts between Federal Reserve Banks was made subject to no
limitations or qualifications, except that compulsory rediscounts were authorized only on
the affirmative vote of at least five members of
the Board and except that the rates of interest
were required to be fixed by the Board.

USE OF THE AUTHORITY
Senator Burton's fears proved to be without
foundation. In practice such rediscounts as
were made between the Reserve Banks were
accomplished almost entirely on a voluntary
basis. Actually, the published record indicates
that, except for one occasion in 1933, interdistrict rediscounts were confined to the period
between December 1917 and late 1921.
In 1915, when it appeared that the marketing
of the cotton crop might present problems of
financing and that the southern Reserve Banks
might need to seek accommodations from the
other Reserve Banks, the Board contemplated
that interdistrict rediscounting might become
necessary. In its Annual Report for that year,
the Board said: s
The Board * * * in the exercise of the
powers conferred upon it by the Federal Reserve Act, was fully prepared to set in operation, if it should become necessary, at rates
to be fixed by it, the machinery of interbank
rediscounting, in order to make available for
Federal Reserve Banks requiring larger re-

INTERDISTRICT REDISCOUNTS
sources the available funds of other reserve
banks, the collective strength of the reserve
system as a whole being far in excess of any
demands that might reasonably be expected
to be brought to bear upon it at that time.
In preparation for this eventuality, the Board
on March 10, 1915, fixed rates to be charged
for interbank rediscounts, setting them somewhat lower than the regular discount rates then
prevailing.1'
Nevertheless, the first interbank rediscounting did not occur until December 1917. In
1918 rediscount transactions between the Reserve Banks, including voluntary purchases of
bankers' acceptances, aggregated over $660
million. All such transactions were negotiated
through the medium of the Federal Reserve
Board, but without resort to compulsion by the
Board.1"
In 1919 interbank rediscounts and purchases
totaled $2,658 million, again on a voluntary
basis. In its Annual Report for that year, the
Board stated: n
There has * * • been such a spontaneous
spirit of cooperation between the Federal Reserve Banks that all transactions suggested by
the Federal Reserve Board have been made
voluntarily, and in no case has the Board
found it necessary to exercise its statutory
authority to require such operations.
On such a basis of spontaneous cooperation,
interdistrict rediscounts were made in considerable volume throughout 1920 and 1921, tapering off toward the end of 1921. At one time or
another all of the Federal Reserve Banks were
both borrowers and lenders, depending upon
"ie credit needs of member banks in different
districts and the resulting reserve ratios of the
Reserve Banks. The relationship between interdistrict rediscounts and reserve ratios was described in the Board's 1921 Annual Report to
Congress (page 4 2 ) :
Reserve ratios of Federal Reserve Banks,
considered separately, arc closely related to
the rediscount transactions between Federal
Reserve Banks. A Federal Reserve Bank will
seek rediscount accommodations from other
reserve banks at times when its own reserve
•s insufficient, without declining to a point
below the legal minimum, to supply the credit


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Federal Reserve Bank of St. Louis

165

demands of its member banks. Reserve ratios
on the basis of reserves actually owned by a
bank are known as "actual" reserve ratios,
while reserve ratios on the basis of reserves
before interbank borrowing or lending are
referred to as "adjusted" ratios. It is the
adjusted ratio, therefore, that is an index of
the reserve position of a Federal Reserve
Bank from the standpoint of its ability to
make rediscounts for other reserve banks or
its need to apply for accommodation to other
reserve banks.
Fluctuations in the reserve positions of the
various Reserve Banks, leading to interdistrict
borrowings, resulted from special causes. Thus,
during 1920 and 1921, the Richmond, Atlanta,
St. Louis, and Dallas Districts felt the effect of
a decline in the price of cotton; the Chicago,
Minneapolis, and Kansas City Districts experienced a decline in the price of grains, wool, and
other agricultural products. Consequently, it
was the Federal Reserve Banks of these districts, under the pressure of the credit needs of
their member banks, that were the principal
borrowers from other Reserve Banks. Conversely, the New York Reserve Bank's reserve
ratio increased during the latter part of 1921
as a result of a large inflow of gold from abroad
and a marked liquidation of advances to its own
member banks, and thus that Reserve Bank
became a lending rather than a borrowing
bank.12 At other times, as during 1918, a
constant flow of Government funds from New
York to the interior of the country made it
necessary for member banks in the New York
District to borrow from the Reserve Bank in
order to replenish their reserves, and the New
York Reserve Bank had to borrow from other
Federal Reserve Banks.
Since 1921, there have been no interdistrict
rediscounts, with the exception of a single
instance in March 1933. At that time the banking crisis caused an unusual flow of bank reserves away from New York and the reserve
position of the Federal Reserve Bank of New
York sank so low as to necessitate borrowing
from other Reserve Banks in the amount of
$210 million." This was the last occasion when
section 11 (b) of the Federal Reserve Act had
any actual significance. Through allocations of
securities in the System Open Market Account,

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HISTORY OF LENDING FUNCTIONS

it has been possible to maintain a constant
equalization of the reserve ratios of all Federal
Reserve Banks so that resort to interdistrict rediscounting has been unnecessary.
As a strictly legal matter, it would no longer
be necessary for any Federal Reserve Bank to
borrow from another Reserve Bank in order to
maintain its reserve ratio. In 1965 provisions
of section 16 of the Federal Reserve Act re-


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quiring Reserve Banks to maintain reserves
against deposits were repealed, and in 1968
reserve requirements for Federal Reserve notes
as prescribed in that section were also repealed. It is still conceivable, however, that
occasions may arise when, for one reason or
another, an interdistrict rediscount under section l l ( b ) of the Act might be considered
appropriate or desirable.

Discount Rates

STATUTORY PROVISIONS
In preceding chapters references have been
made to the discount or interest rate charged on
various types of Federal Reserve credit—a
"discount" rate when the credit takes the form
of a discount of paper representing loans made
by a member bank, or an "interest" rate when
the loan is in the form of a direct advance to a
member bank on its own note. The present
chapter deals with the legal history of such
discount and interest rates, generally referred
to without distinction as discount rates. Since
its authority to fix Federal Reserve discount
rates has always been regarded as one of the
System's major instruments of credit policy, it
>s particularly necessary to emphasize again that
"us history is concerned principally with the
•egal aspects of the subject rather than its
economic aspects.
The basic provision of the law with respect
t0 d
'scount rates is to be found in section 14
of the Federal Reserve Act. That section purPorts to set forth specific powers of the Federal
Reserve Banks, although the section is entitled
F

°r NOTES AND REFERENCES, see pp. 264-65.


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167

"Open-Market Operations." Among other
things, the section presently provides that: 1
Every Federal reserve bank shall have
power:
e

*

*

*

#

(d) To establish from time to time, subject
to review and determination of the Board of
Governors of the Federal Reserve System,
rates of discount to be charged by the Federal
reserve bank for each class of paper, which
shall befixedwith a view of accommodating
commerce and business; but each such bank
shall establish such rates every fourteen days,
or oftener if deemed necessary by the Board;
Except for the last clause, this provision is
identical with the provision as it appeared in
the original Federal Reserve Act. The provision
was amended in 1920 to authorize progressive
discount rates, but that authority was repealed
in 1923.
As discussed in the preceding chapter, section
11 (b) of the original Act authorized the Federal Reserve Board to permit or require the
Reserve Banks to rediscount the discounted

168

HISTORY OF LENDING FUNCTIONS

paper of other Reserve Banks. Under this provision, which has never been changed, the rate
of interest on such rediscounts is required to be
fixed by the Board.
Since 1913, various amendments to the Act
authorizing advances to or discounts for member banks and others have included provisions
relating to thefixingof rates.
When section 13 of the Act was amended in
1916 to authorize the Federal Reserve Banks
to make advances to member banks on their
collateraled notes (as distinguished from discounts of eligible paper), it was provided that
such advances should be made "at rates to be
established by such Federal reserve banks,
subject to the review and determination of the
Federal Reserve Board"; and this provision has
not been substantially changed.2
In 1932 when sections 10(a) and 10(b)—
authorizing emergency advances to groups of
member banks and to individual member banks
—were added to the law, it was provided that
the rates on such advances should be not less
than 1 per cent above the discount rate of the
Reserve Bank at the time of any such advance.
Since that time, section 10(b) has been changed
to lower the premium rate to one-half of 1
per cent for advances under that section.3
When the Reserve Banks were authorized in
1932 to discount paper for individuals, partnerships, and corporations in unusual and exigent
circumstances, it was required that such discounts be made at rates established in accordance with the provisions of section 14(d) of
the Federal Reserve Act,1 the basic discount
rate provision quoted on page 167.
In 1933, when Congress added at the end of
section 13 of the Act a paragraph authorizing
advances to individuals, partnerships, and cor-

porations on the security of direct obligations
of the United States, such advances were required to bear interest "at rates fixed from time
to time by the Federal reserve bank, subject to
review and determination by the Board of
Governors of the Federal Reserve System";5
this language paralleled that of section 14(d).
The authority granted by section 13b of the
Act in 1934 for working capital loans to business enterprises contained no provision with
respect to interest rates; but, as will be noted,
various rates were established by the Reserve
Banks while that authority was in effect.
For the sake of completeness, two provisions
of law relating to discount rates should be mentioned here although they arc no longer in
effect. Section 11 (c) of the original Federal
Reserve Act required the Board to fix a graduated "tax" to be paid by the Reserve Banks on
deficiencies in gold reserves required to be held
by them against outstanding Federal Reserve
notes and provided further that any Reserve
Bank having any such deficiency should "add
an amount equal to said tax to the rates of
interest and discount fixed by the Federal Reserve Board." In 1933 Congress authorized the
Reserve Banks in certain circumstances to purchase obligations of the United States and provided that operations under that authority
should not require the imposition of the graduated tax on reserve deficiencies or the automatic
increase in discount rales otherwise specified in
section l l ( c ) of the Federal Reserve Act."
In 1968 the provisions of section 16 of the Act
requiring the maintenance of reserves against
Federal Reserve notes were repealed and, as
conforming amendments, the provisions of section l l ( c ) and of the 1933 legislation just
mentioned were also repealed.7

OBJECTIVES OF DISCOUNT RATES
UNIFORMITY OF RATES
It is a cardinal principle of private business,
established by centuries of custom, that one


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Federal Reserve Bank of St. Louis

who lends money is entitled to receive inter**
as compensation for the borrower's use of
lender's funds. Interest on loans is one of tn
major sources of income of commercial ban

DISCOUNT RATES
The Federal Reserve Banks, however, as
explained in the first chapter of this study, are
operated for public purposes and not for profit.
While the law makes provision for the payment
of interest on loans made by the Reserve Banks,
its primary purpose is not to enable them to
realize a profit from their lending activities.
Although it was not so clearly defined at the
outset as it was in later years, the philosophy
of the original Federal Reserve Act was that
Federal Reserve discount rates would serve as
a means of stabilizing commercial interest rates
and as a safeguard against inflation.
In 1913 uniformity in discount rates throughout the country was regarded as eminently
desirable. The National Monetary Commission
had looked forward to "absolute uniformity"
of discount rates.15 The House Banking and Currency Committee regarded the "establishment
of a more nearly uniform rate of discount
throughout the United States" as one of the
"essential features of reform."a The Senate
committee's report declared that the fixing of
rates of discount "would have a steadying effect
upon the interest rate throughout the United
States, and will enable the banks of the country
to extend accommodation at a comparatively
stable rate of interest upon a lower basis than
heretofore, because the element of hazard of
panic and of financial stringency will be removed by the proposed system." 10
In its first Annual Report to Congress after
the enactment of the statute, the Federal Reserve Board declared that "the adoption of a
fairly uniform and consistent policy to be pursued by all the [Federal Reserve] banks would
go far to insure the smooth working of the
system."» Initial discount rates were fairly
uniform. Thus, the rate on 60- to 90-day paper
was 6 per cent at seven Reserve Banks and 6Vi
Per cent at five Reserve Banks."
! i its Annual Report for 1915, the Board
observed: "
* * * Beginning at the opening of the
system with a comparatively high rate for
ordinary commercial paper and with more or
less variation between the different districts,
the reserve banks have during the year
steadily reduced the general level of discount
rates and have worked rapidly and effectively


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169

toward uniformity for the entire country. It
may not be practicable to maintain uniform
rates throughout the twelve districts, but
they should unquestionably bear a consistent
relation one to another, while a very much
greater adherence to uniformity than before
the enactment of the Federal Reserve Act will
undoubtedly be secured.
Uniformity in rates was generally maintained
in the early years of the System, and at the end
of 1923 the rate at all Reserve Banks on all
classes of paper was Wz per cent." Although
variations in rates developed in subsequent
years, in recent times uniformity has again
become the rule as the result of acceptance of
the fact that discount rates reflect not so much
regional credit conditions as national credit
policy.

ACCOMMODATION OF
COMMERCE AND BUSINESS
Uniformity in rates, however, was not the
stated objective of the Federal Reserve Act.
The original Glass bill provided that rates
should be fixed with a view to accommodating
the commerce of the country. In the Senate, the
Owen bill referred to the accommodation of
commerce and business, and the Hitchcock bill
referred in addition to the objective of promoting stability in business. The final version of
the Act followed the Owen bill, and accommodating commerce and business has ever since
remained the statutory purpose of discount
rates.
That purpose, indeed, has been carried over
to other provisions of the statute and has become one of the few objectives expressly set
forth in the Federal Reserve Act. In 1923, when
the nonstatutory Federal Open Market Investment Committee was created by the Board,
the Board laid down the principle that "the
time, manner, character, and volume of openmarket investments purchased by the Federal
reserve banks be governed with primary regard
to the accommodation of commerce and business and to the effect of such purchases or sales
on the general credit situation." 1= When the
Federal Open Market Committee was made a
statutory body in 1933, essentially the same

170

HISTORY OF LENDING FUNCTIONS

language was used in prescribing the objectives
of open market operations.10

IMPLEMENTATION OF
CREDIT POLICIES
Federal Reserve discount rates were the earliest means by which the System sought to influence general credit conditions. Along with
reserve requirements and open market operations, discount rates still constitute one of the
three major tools available to the System for
implementing credit and monetary policies.
Indeed, changes in discount rates have generally been regarded as the most dramatic
signal of shifts in System policy, and they have

had more significance in this respect since the
revival of emphasis on the discounting functions
of the Federal Reserve Banks that followed the
so-called Treasury-Federal Reserve accord in
1951.1T
It may be noted, however, that in 1968
a System committee appointed to reappraise the
Federal Reserve discount mechanism recommended, among other things, that the discount
rate should be changed more frequently in
order to maintain it at a level "reasonably close
to rates on alternative instruments of reserve
adjustment." " If this recommendation should
be put into practice, it is likely that changes in
the discount rate would tend to lose a large part
of their announcement effect.

LEGAL BASIS AND DISCRETIONARY NATURE
In a published opinion dated May 1, 1915,
the Board's General Counsel, on the basis of
Supreme Court decisions relating to national
banks, expressed the view that Congress may
delegate to the Federal Reserve Banks and the
Federal Reserve Board the power to fix discount rates without regard to State usury laws.10
The constitutional validity of the statutory
authority for fixing Federal Reserve discount
rates appears to be beyond question. It was
firmly established in 1929 by the decision of
the Circuit Court of Appeals for the Second
Circuit in the case of Raichle v. Federal Reserve
Bank of New York.20 In that case the New
York Bank was charged with wrongfully spreading propaganda concerning an alleged money
shortage, restricting the supply of credit through
open market operations, arbitrarily and unreasonably raising discount rates, and denying
rediscounts to certain member banks pending
liquidation of collateral loans. The suit was
dismissed for failure to join the Federal Reserve
Board as an indispensable party. On the merits,
however, the court upheld the Reserve Bank on
all grounds. With particular reference to discount rates, the court said, "It is not contended
that the provision for fixing rates of discount is


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unconstitutional, nor would it seem even reasonable to argue that it is, * * *."
The court also held that discount rates fixed
by the Reserve Bank, subject to review and
determination of the Board, were within the
discretion of those agencies and not subject to
judicial review. The court stated: 2I
* * * It would be an unthinkable burden
upon any banking system if its open-market
sales and discount rates were to be subject to
judicial review. Indeed, the correction of
discount rates by judicial decree seems almost
grotesque when we remember that conditions
in the money market often change from hour
to hour and the disease would ordinarily be
over long before a judicial diagnosis could
be made.
« * * »*
We can sec no basis for the contention that
it is a tort for a Federal reserve bank * *
to fix discount rates which arc unreasonably
high, or to refuse to discount eligible pap**.
even though its policy may be mistaken an
its judgment bad. The remedy sought wou
make the courts, rather than the Federal Kj
serve Board, the supervisors of the F e
reserve system and would involve a
worse than the malady. The bank, under tn

DISCOUNT RATES
supervision of the board, must determine
whether there is danger of financial stringency and whether the credit available for
"commerce and business" is sufficient or insufficient. If it proceeds in good faith through

171

open-market operations and control of discount rates to bring about a reduction of
brokers' loans, it commits no legal wrong. A
reduction of brokers' loans may best accommodate "commerce and business."

DISTRIBUTION OF AUTHORITY
In authorizing the establishment of discount
rates by the Federal Reserve Banks, subject to
review and determination of the Board, section
14(d) of the original Federal Reserve Act
clearly reflected the intent of Congress that the
System should be a regional and decentralized
system, but at the same time a system operating
under the general supervision of a single governmental agency with power to determine
questions of national policy. Nearly 40 years
later, this basic concept was expressed by Chairman Martin of the Board when, in 1952, he
stated in answer to a questionnaire by the Joint
Committee on the Economic Report that: 4 4

* The law clearly contemplates that
the establishment of discount rates shall involve joint action by the Federal Reserve
Banks and the Board of Governors of the
Federal Reserve System.* * '
In the same statement, Chairman Martin asserted the statutory authority of the Board to
make the ultimate determination of discount
rates. This position is supported by the legislative history of the statute, as well as by an
opinion of the Attorney General of the United
States.
When the House Banking and Currency
Committee reported the original Federal Reserve bill on September 9, 1913, it stated: ='
* * * The power granted in subsection
(d) to fix a rate of discount is an obvious
incident to the existence of reserve banks,
but the power has been vested in the Federal reserve board to review this rate of
discount when fixed by the local reserve
bank at its discretion. This is intended to
provide against the possibility that the local


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Federal Reserve Bank of St. Louis

bank might be establishing a dangerously
low rate of interest, which the reserve board,
familiar as it would be with credit conditions
throughout the country, would deem best to
raise.
In the Senate, Senator Owen declared that
"the final determination of the rate is put in the
hands of the Federal Reserve board," 2 1 and
that "the bank rate may be fixed by the Government board." s o Senator Shafroth pointed out
that the Board was "vested with the power to
raise or lower the rate of discount." -" In answer
to arguments that the rate should be made uniform by statute, Mr. Phelan urged that there
might be reasons for variations in the rate in
different sections of the country, but that under
the Glass bill the Board could make the rate
uniform "if ever necessary or desirable." : :
The language of the law as finally enacted
contained evidence of the intent of Congress
that final determination of rates should be
vested in the Board. Section l l ( c ) included a
provision, since repealed, to the effect that
whenever a Reserve Bank had to pay a graduated tax on its deficient reserves against Federal
Reserve notes, it must add an amount equal to
such tax to the rate of interest and discount
"fixed by the Board of Governors of the Federal
Reserve System."
Clearly, the Board itself assumed that under
the original Act it possessed the final power to
determine rates. In its first Annual Report to
Congress, in discussing discount rates, the
Board stated that it was satisfied that "at the
start and until the banks could get a firm footing
it [the Board] should act with prudence and
conservatism* * *." =N
In 1916 the legal authority of the Board to

172

HISTORY OF LENDING FUNCTIONS

overrule a Federal Reserve Bank and to determine a discount rate was put to the test. One
of the Reserve Banks had voted to increase its
rates. The Board, however, withheld its approval because the Treasury Department felt
that such an increase would adversely affect its
program for marketing Liberty Bonds and
Victory Notes. When the Treasury's financing
program was completed, the proposed increase
in rates was approved by the Board.20 In the
meantime, the Board's General Counsel had
expressed the view that the Board had legal
authority to fix rates different from those established by a Federal Reserve Bank. However,
the then-Secretary of the Treasury, Carter
Glass, requested the Attorney General of the
United States for his opinion on the question.
In making the request, Mr. Glass himself
stated that there could be "no question of the
intention of Congress to give the Federal Reserve Board complete power in the matter of
fixing the rate of discount."
In an opinion dated December 9, 1919, the
Acting Attorney General, Alex King, held that
the Board had the "right to determine what
rates of discount should be charged from time
to time by a Federal Reserve Bank, and under
their powers of review and supervision, to
require such rates to be put into effect by such
Bank." •10 In reaching this conclusion, he
pointed out that unless the Board had this
power, the words "and determination" used in
the statute would be wholly without significance.
The intent of Congress that the Board should
have final control over discount rates was confirmed by the legislative history of the Banking
Act of 1935. Early drafts of that bill would
have placed open market operations as well as
discount rates in the hands of the Board, but
with a requirement that the Board should consult with a "Federal Open Market Advisory
Committee" before the Board made "any
changes on its own initiative in the open market
policy, in the rates of interest or discount to be
charged by the Federal Reserve Banks, or in
the reserve balances required to be maintained
by member banks." [Emphasis added.] While
this provision was not adopted, there was much
discussion in Congress of the power of the


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Board over discount rates, which clearly indicated the assumption in Congress that the
Board had authority under existing law to initiate such rates.
In its report on the Banking Act of 1935, the
House Banking and Currency Committee stated
that it was essential that the Federal Reserve
Board be given the same "definite responsibility
and final authority" over open market operations "as it already possesses with respect to the
discount rates of the Federal Reserve Banks."31
The committee gave the reasons for which such
authority over discount rates was vested in the
Board:
* * * It has a national viewpoint and has
long been accustomed to considering matters
as they affect the country as a whole, without
regard to the special interests of any particular group or locality. It was created for the
purpose of supervising and coordinating the
activities by the 12 Federal Reserve Banks "in
order that they may pursue a banking policy
which shall be uniform and harmonious for
the country as a whole." " ° * It is for this
reason that the original Federal Reserve Act
gave the Federal Reserve Board final authority over discount rates.
With respect to the relative authority of the
Board and the Reserve Banks over discount
rates, Chairman Martin of the Board reasserted
the Board's power to initiate rates in his replies
to the 1952 Patman Questionnaire; at the same
time he explained how present procedures were
designed to avoid any serious conflict in this
connection. His statement is pertinent here: "
* * * Since prospective changes in rates
are ordinarily discussed in advance between
the Board and the Reserve Banks, it is only
rarely that action taken by a Federal Reserve
Bank for the setting of discount rates is not
promptly approved by the Board. On occasion, however, the Board may fail to approve
or defer its approval pending discussions ot
System credit and monetary policies an
Treasury financing policies with the ™re
dents of all Federal Reserve Banks or with
the Federal Open Market Committee. The
matter is usually discussed also with t c
Secretary of the Treasury.
,
Since the Board's authority is not limlt®
to mere approval of rates established by

DISCOUNT RATES
Reserve Banks, but includes the power to
review and determine such rates, the Board,
as previously noted, has legal authority to
initiate discount rates. However, methods
evolved through experience for the taking of
action on discount rates are calculated to
avoid the development of procedural issues
in this respect.
Despite Chairman Martin's statement regarding the avoidance of procedural issues, the Reserve Banks and the Board of Governors have
occasionally had different views as to what the
discount rate should be at a particular time, and
procedural issues have inevitably arisen. If the
board of directors of a Reserve Bank acts to
increase or decrease its existing discount rate
and such action is not agreeable to the Board,
the Board has two alternatives: (1) It can take
no action to approve the rate fixed by the
Reserve Bank, in which event the existing rate
continues in effect; or (2) it can formally act to
disapprove the rate proposed by the Reserve

173

Bank, in which event, again, the existing rate
remains unchanged. The first alternative—nonaction by the Board—could subject the Board
to the charge that it is failing to perform its
statutory responsibility of reviewing and determining discount rates established by the Reserve Banks. Consequently, in such circumstances the second alternative course of action
is usually followed, as it was on several occasions in 1971 and 1972.33
If, on the other hand, a Reserve Bank reestablishes its existing discount rate and the
Board feels that the rate should be raised or
lowered, the Board has the legal authority to
determine a new rate despite the Reserve
Bank's unwillingness to act. Such an action by
the Board, however, could involve delicate
problems of relationships between the Board
and the Reserve Banks and is avoided if at all
possible. Usually, in such circumstances, the
reluctant Reserve Bank eventually acts to establish the new rate favored by the Board.

CLASSIFICATION OF PAPER FOR RATE PURPOSES
APPLICABILITY TO ADVANCES
Section 14(d) of the Federal Reserve Act
refers to the fixing of discount rates to be
charged for each class of paper. Presumably,
this means that a Reserve Bank may not, like
a
commercial bank, establish a different rate
of discount or interest for each individual loan,
but must apply the same rate to all loans of
the same class, irrespective of the credit soundness of the loan or the general creditworthiness
of the borrower.
Two general questions arise at once: (1)
section 14(d) apply not only to discounts
under the original provisions of section 13 of
the Federal Reserve Act but also to advances
authorized by later amendments to the Act?
And (2) exactly what is meant by each class
of
paper?
The third paragraph of section 13, added in
3
2, provides that discounts for individuals,


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Federal Reserve Bank of St. Louis

partnerships, and corporations in emergency
circumstances shall be made at rates established in accordance with section 14(d) of the
Act; consequently, there can be no doubt that
the class-of-paper requirement applies to such
discounts. On the other hand, paragraphs 8
and 13 of section 13, relating respectively to
advances to member banks on paper eligible
for discount or for purchase by the Reserve
Banks and to advances to individuals, partnerships, and corporations on obligations of the
United States and Government agencies, provide only that such advances shall be made at
rates established orfixedby the Reserve Banks,
subject to review and determination by the
Federal Reserve Board; they do not, like the
third paragraph of section 13, specifically incorporate the requirements of section 14(d).
Section 10(b) of the Act requires only that
advances to member banks on any satisfactory
assets shall be at rates at least one-half of

174

HISTORY OF LENDING FUNCTIONS

1 per cent above the Reserve Bank's highest
discount rate; it contains no express provision
for the fixing of such rates by the Reserve
Banks or for their review and determination by
the Board.
Technically, it may be argued that the classof-paper requirement in section 14(d) applies
only to Reserve Bank loans that take the form
of discounts under the second paragraph of
section 13, or discounts of agricultural paper
under section 13(a), or discounts of paper for
individuals, partnerships, and corporations under the third paragraph of section 13. Such an
argument, however, would seem patently absurd. It would make no sense to assume that
Congress intended to apply the class-of-paper
requirement only to discounts and not to advances. Moreover, the requirement of section
14(d) that discount rates be established at
least every 14 days has consistently been interpreted as applying also to the rates on
advances.

ber 16, 1914) covered four maturity categories
of paper: (1) 30 days or less; (2) 30 to 60
days; (3) 60 to 90 days; and (4) over 90
days.11 The fourth category necessarily covered
only agricultural and livestock paper, since the
law itself set a maximum maturity of 90 days
for commercial paper.
In 1915 the Board adopted an additional
maturity classification for paper maturing
within iO days.1" However, after the law was
amended on September 7, 1916, to authorize
advances to member banks on their 15-day
notes secured by eligible paper or Government
obligations, the Board suggested that the Reserve Banks eliminate the 10-day maturity
classification and adopt a uniform 15-day rate
for both discounts of commercial paper and
advances on secured notes of member banks.30
Since that time, different rates have never been
established on the basis of different maturities
of paper offered for discount or as collateral
for advances.

THE CLASS-OF-PAPER QUESTION

CHARACTER OF PAPER;
PREFERENTIAL RATES

The second and more difficult general question relates to the meaning of the term "class
of paper." Does it mean that different rates may
be fixed only on the basis of differences in the
nature of the paper, for example, agricultural
or commercial paper? Does it permit the fixing
of different rates on the basis of maturities,
the nature of the borrower, or the purposes
for which the proceeds of the Reserve Bank
loan will be used? This point will be discussed in subsequent sections of this chapter.
For now, it suffices to note that the Board
apparently has followed a liberal construction
of the authority to fix different rates for different classes of paper. The so-called eligible
paper bill recommended by the Board in 1963
would have removed all question on this point
by expressly permitting the establishment of
different rates on any reasonable basis.

MATURITIES
In the early years of the System it was clearly
assumed that different rates could properly be
fixed on the basis of different maturities. The
first rates approved by the Board (on Novem-


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Federal Reserve Bank of St. Louis

Along with the maturity classifications, there
also developed during the early years of the
System additional classifications of paper based
on the special nature of the paper involved.
Certain kinds of paper were considered to be
entitled to preferential rates, that is, rates lower
than those charged for ordinary commercial
paper of the same maturities.
Trade acceptances with maturities of 90 days
or less and commodity paper maturing within
6 months were the first classes of paper to be
accorded preferential rates.17 During World
War I, notes secured by Government obligations were given preferential rate treatment/
Bankers' acceptances, considered the most
liquid of all investments, were also determined
to be entitled to a substantial rate preference.3'
In general, such preferential rates did not
long continue. The preferred rate for commodity paper was merged with the ordinary rate
in 1917.in Nevertheless, in that year the number
of categories of paper for discount rate purposes
—according to both maturities and character
of paper—had reached a total of 13. tt
April 1917 an attempt at standardization oi

DISCOUNT RATES
rates was made, and the number of categories
was reduced to eight." For many years, however, the structure of discount rates was complicated by the effort of the System to fix rates for
different classes of paper both according to maturities and according to the nature of the
paper itself.

FREQUENCY OF BORROWING;
PROGRESSIVE RATES
The amount or frequency of borrowing by
a particular member bank obviously does not
have any relation to the class of paper representing such borrowing; consequently, excessive
borrowing alone is not a justification for a
higher discount rate. This fact was a cause for
concern to the SystoGl shortly after World War
I during a period of credit expansion when
some member banks were borrowing heavily
from the Reserve Banks.
The Board considered this problem in its
Animal Report for 1919. It observed that, although the law imposed no specific limitation
on the amount of borrowings by member banks
at the Federal Reserve Bank, there was at least
an implied potential limitation in the provision
of section 4 of the Act requiring that credit
accommodations be extended "with due regard
to the claims of other member banks." It was
felt that if all member banks should seek accommodations proportionate to those sought by a
few, a Federal Reserve Bank would not be able
to meet the demands of all of its member banks.
The Board noted, however, that the situation
could not be met by charging higher rates to
excessive borrowers, because section 14(d) required rates to be fixed for each class of paper.
^ stated that there was no authority in the
law: 42
* * * for establishing graduated rates based
upon the total borrowings of a member bank,
and consequently when it becomes necessary
to advance the discount rate in order to curb
the demands of those banks rediscounting
with the Federal Reserve Banks in very large
amounts, the same rate would have to apply
to the moderate requirements of other member banks who may rediscount with the Federal Reserve Banks infrequently and never
excessively. Thus the application of rate


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Federal Reserve Bank of St. Louis

175

advances as a corrective or deterrent to certain banks tends to raise the level of current
rates to all.
To meet this problem, the Board recommended an amendment to section 14(d) so as
to permit a Reserve Bank, with the Board's
approval, to determine by uniform rule applicable to all its member banks the "normal
maximum discount line" of each member bank
and to fix "graduated rates on an ascending
scale to apply equally and ratably to all its
member banks rediscounting amounts in excess
of the normal line so determined." In this way
the Board felt it would be possible to reduce
excessive borrowings without raising the basic
rate.
Congress promptly adopted the Board's recommendation. By an Act of April 13, 1920,43
the following language was added to section
14(d) of the Federal Reserve Act immediately
after the original language authorizing the establishment of discount rates for each class of
paper with a view to accommodating commerce
and business:
and which, subject to the approval, review,
and determination of the Federal Reserve
Board, may be graduated or progressed on
the basis of the amount of the advances and
discount accommodations extended by the
Federal reserve bank to the borrowing bank.
Four Reserve Banks adopted the progressive
rates." Three of them determined the basic
discount line as being an amount equal to 2V£
times a sum equal to 65 per cent of the reserve
balance of a member bank, plus its paid-in
Federal Reserve Bank stock; the fourth fixed
the basic line as the combined capital and surplus of the member bank. In all four instances,
discounts in excess of the basic line were made
subject to a progressive rate of one-half of 1
per cent, in addition to the normal rate, for
each 25 per cent by which the amount of the
discount exceeded the basic line.
While some beneficial results followed the
adoption of the progressive rates at these four
Reserve Banks, the Board conceded that the
results were not as effective as the flat 7 per
cent rate established by other Reserve Banks
in June 1920. As a matter of fact, one of the
four progressive-rate Reserve Banks abandoned

176

HISTORY OF LENDING FUNCTIONS

the plan on November 1, 1920, and adopted
the flat 7 per cent rate.15
In 1921 excessive borrowings declined substantially. Whereas the ratio of total borrowings
of all member banks to their aggregate discount
line was 78 per cent on May 20, 1920, the
ratio at the end of 1921 was only 37 per cent.1"
The decline apparently resulted from large imports of gold, the general recession of business,
and a decline in prices.
Presumably, the graduated-ratc authority
was no longer considered necessary. It was repealed by the Act of March 4, 1923,17 which
restored section 14(d) of the Federal Reserve
Act to its original form. However, the enactment of the 1920 amendment and its repeal
in 1923 apparently evidenced the intent of
Congress that, in the absence of such specific
statutory authority for graduated rates, there
is no basis in the law for fixing discount rates
according to the extent to which a member
bank makes use of the credit facilities of the
Federal Reserve Banks. Moreover, in the absence of specific statutory authority, the fixing
of higher discount rates for continuous borrowers would seem to sanction an abuse of the
lending facilities of the Federal Reserve Banks.
As indicated in a subsequent chapter, continuous borrowing is not regarded as an appropriate use of Federal Reserve credit.

STATUTORY BASIS FOR CREDIT
During the first few years of the System's
existence, differentiation in rates was based, as
has been noted, on maturities and nature of
paper; for a short period in 1920 and 1921, a
further differentiation was made on the basis of
amount of borrowings. After 1921, however,
the principal basis for different rates was simply
the type of credit extended, as determined by its
statutory source; in recent years the maturity or
character of the paper offered as a basis for
Federal Reserve credit has had little or no bearing on the rate of discount or interest charged.
In contrast to the 13 different rates that prevailed in early 1917—according to maturities
and nature of paper—there was only one rate
(4'/i per cent) for all classes and maturities of
paper at the end of 1923.l<! A single classification for rate purposes prevailed until 1932, al-


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Federal Reserve Bank of St. Louis

though the rate varied to some extent at different times among the different Federal Reserve
Banks. Thus, at the end of 1931, the only discount rate was that for commercial and agricultural paper under sections 13 and 13a, a rate
of 3Vi per cent at 10 Reserve Banks and 4
per cent at 2 Reserve Banks; by January 25,
1932, a uniform rate of 3'/i per cent was in
effect at all Federal Reserve Banks.
Differences in rates, however, were the result
of the enactment of provisions for special types
of credit during the depression years of the early
1930's. Thus, when section 10(b), authorizing
advances to member banks on any satisfactory
security, was enacted in February 1932, all
Federal Reserve Banks fixed a separate rate of
5Vz per cent for advances under that section.
This action was made necessary by the new
provision itself, because at that time the law required the rate to be at least 1 per cent higher
than the regular discount rate. In 1935, the
law was amended to require a penalty rate of at
least one-half of 1 per cent on advances under
section 10(b). and since then the Reserve
Banks have automatically established a rate for
such advances that is one-half of 1 per cent
above the regular discount rate.
In July 1932 when Congress enacted the
third paragraph of section 13 to authorize emergency discounts for individuals, partnerships,
and corporations, a rate of 6 per cent was fixed
by all of the Reserve Banks for such discounts.
When authority for discounts under that paragraph was activated by the Board in 1966, the
Board indicated that if resort to the authority
should appear imminent, the Reserve Banks
might wish to establish the same rate as that
fixed for advances under the thirteenth paragraph of section 13—a rate higher than the
regular discount rate. Similarly, when the authority was again activated in 1969, the Board
suggested that the rate should be the same as
that for advances under the thirteenth paragraph; but the Board went on to suggest that
the latter rate be fixed at 7Vi per cent—a rate
1 Vi per cent above the regular discount rate
for advances to member banks. Neither in 19°
nor in 1969 was the third paragraph of section
13 actually used as a means of extending credi
to individuals, partnerships, or corporations

DISCOUNT RATES
and so no rate was ever fixed for discounts
under that paragraph. However, it has always
been understood that if any rate should be
fixed, it would, as in 1932, be considerably
higher than the regular rate for discounts and
advances for member banks under section 13.
In 1933 the addition of the last paragraph
of section 13, authorizing advances on Government obligations to individuals, partnerships,
and corporations, gave rise to a new rate applicable to such advances, again somewhat
higher than the regular discount rate. As will
be noted later, however, there have been times
since 1933 when the rate on advances under
that paragraph to nonmember banks has been
the same as the rate for advances to member
banks on Government obligations, that is, the
regular discount rate.
In June 1934 new authority for direct and
indirect extensions of credit to commercial and
industrial businesses provided by section 13b of
the Federal Reserve Act (discussed in Chapter
11) called for the establishment of five separate
rates under that section: an interest rate on
loans to businesses made directly or in participation with financing institutions; rates on discounts for and purchases from financing institutions, one for that portion of the loan for which
the financing institution was obligated and one
for the remaining portion of the loan; and rates
on commitments to make loans to businesses
andfinancinginstitutions.
During World War II a preferential rate was
established for advances to member banks on
Government obligations under section 13; and,
under the last paragraph of that section, a rate
wasfixedfor advances to nonmember banks on
Government obligations lower than the rate set
for advances to others—nonbanking corporations, individuals, and partnerships—under that
paragraph.
The result of these developments was that
during World War II there was again a multiple
rate structure, with differentials based upon the
statutory source of the credit, together with a
Preference for advances on Government obligations to both member and nonmember banks.
Thus, at the end of 1942 there were different
rates for advances to member banks on Government obligations; discounts and advances for


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Federal Reserve Bank of St. Louis

177

member banks under sections 13 and 13a on
security other than Government obligations;
advances to member banks under section 10 (b);
advances to nonmember banks on Government
obligations; advances to individuals, partnerships, and corporations other than banks on
Government obligations; and, as previously
indicated, five different rates on loans and commitments under section 13b.49
After the end of the war the preferential rate
on advances to member banks under section 13
on the security of Government obligations was
eliminated and so also was the lower rate
charged on advances to nonmember banks on
Government obligations under the last paragraph of section 13. Effective August 21, 1959,
section 13b of the Act, relating to loans and
commitments to businesses, was repealed. As a
result, only three different rates were left: the
basic or regular rate fixed for discounts and
advances for member banks under sections 13
and 13a; the rate for advances to member banks
on any satisfactory assets under section 10(b),
automatically fixed at one-half of 1 per cent
above the regular discount rate; and the rate for
advances to individuals, partnerships, and corporations—including nonmember banks—on
the security of Government obligations under
the last paragraph of section 13. Of these rates,
which differ according to the provisions of law
under which Reserve Bank loans are made, the
most significant, of course, has always been
the regular rate for discounts and advances for
member banks under sections 13 and 13a.

NATURE OF BORROWER
Although, in general, differentiation in rates
is now based upon the statutory source of lending authority, it should be noted that even for
Reserve Bank loans under a particular statutory
authority there may be different rates according
to the nature of die borrower. As has been
seen, during World War II advances to nonmember banks on the security of Government
obligations under the last paragraph of section
13 were allowed to be made at a lower rate of
interest than advances to others under the same
paragraph on the same type of security. In
September 1972, when the Board acted to mitigate any possible hardships that might be suf-

178

HISTORY OF LENDING FUNCTIONS

fered by nonmember banks because of amendments to the Board's Regulation J, the Board
indicated that the Reserve Banks should be
prepared to provide credit to such banks on
substantially the same terms as those applicable
to member banks. It specifically referred to the
possibility of direct extensions of credit to nonmember banks under the last paragraph of
section 13 and expressed the view that the rate
paid by a nonmember bank in such a case
should be no higher than the rate applicable to
member banks under paragraph 8 of section 13,
that is, the regular discount rate. In accordance
with this suggestion, six of the Reserve Banks
established a special rate of 4V£ per cent for
such advances to nonmember banks—the same
as the regular discount rate for member banks
and 2 per cent less than the rate established for
all other advances under the last paragraph of
section 13. 00
Although the third paragraph of section 13,
relating to discounts of eligible paper for individuals, partnerships, and corporations in emergency circumstances, has not been utilized since
1936, it was activated by the Board in 1966
and again in 1969 as a possible means through
which Reserve Bank credit might be extended
to nonmember deposit-type institutions such as
savings and loan associations and mutual savings banks, as well as to nonmember commercial banks. No rate was fixed for such discounts
on either of those occasions, although in 1969
the Board suggested to the Reserve Banks, as
previously noted, that if it appeared that any
loans were to be made under that paragraph,
the rate should be the same as that for advances
under the last paragraph of section 13. It is
conceivable that, in certain emergency circumstances, the System may be called upon as a
lender of last resort to provide credit under the
third paragraph of section 13 for business enterprises as well as nonmember financial institutions. In such a situation, it is possible that the
System might find it appropriate to charge different rates for loans to different types of borrowers, for example, a higher rate for a loan to


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Federal Reserve Bank of St. Louis

a nonfinancial business enterprise than for a
loan to a financial institution such as a savings
and loan association.
Such a differentiation in rates according to
the nature of the borrower could be regarded as
not being in conformity with the apparent intent
of section 14(d) of the Act that different rates
may be established only for different classes of
paper. On the other hand, plausible arguments
can be made in support of the conclusion that
a loan under the third paragraph of section 13
to an aircraft manufacturer is essentially different from a loan under that paragraph to a
savings and loan association, even though the
collateral security may be the same.

PURPOSE OF CREDIT
If a differentiation in rates according to the
nature of the borrower seems somewhat remote
from a differentiation according to class of
paper, one might suppose that the fixing of different rates according to the purpose of the
Reserve Bank loan would be even more remote.
Nevertheless, such a differentiation according to
purpose of the credit was made in 1972. The
Board anticipated possible hardships upon some
nonmember banks because of changes in Regulation J requiring payment of checks in immediately available funds on the day of presentation. Therefore, it suggested, and half of
the Reserve Banks concurred in, the establishment of a special rate to be charged on advances to nonmember banks on the security of
Government obligations under the last paragraph of section 13. But this rate was to be
used only when the change in Regulation J
would result in a significant impairment of the
liquidity of a nonmember bank or would impair
its ability to serve its community. Thus, even
though such advances would be made on the
same type of security (Government obligations)
as any other advances to other types of corporations, a preferential rate was given not only
on the basis of the nature of the borrower hut
also according to the purpose of the loan.

DISCOUNT RATES

179

TIME AND MANNER OF DETERMINATION
Aside from the graduated-rates amendment
of 1920, which was repealed 3 years later, the
only amendment that has been made to section
14(d) since the enactment of the Federal Reserve Act was the addition of the following
language by the Banking Act of 1935: "but
each such [Federal Reserve] bank shall establish such rates every fourteen days, or oftener
if deemed necessary by the Board." 01
The legislative history of this amendment
throws no light on its intent. The amendment
was not contained in the bill that passed the
House on May 9, 1935. It first appeared in section 205 of the bill that was reported by the
Senate Banking and Currency Committee. That
committee's report stated only: °3
* * * Section 205 also amends existing
law with respect to rates of discount to be
established by the Federal Reserve banks,
providing that such rate shall be established
every 14 days or oftener if deemed necessary
by the Board of Governors of the Federal
Reserve System.
There was no reference to the provision in the
Senate debates. The conference report of August 17,1935," merely mentioned the provision
without explanation.
Presumably—and one is limited to presumptions—the purpose of this amendment was to
provide assurance that the Federal Reserve
Banks and the Board would give more constant
and regular attention to discount rates and to
the need for changing such rates than had been
the practice in the past. Whether so frequent a
review of discount rates should be mandatory
•nay be open to question; but, as the law now
stands, the board of directors of each Reserve
Bank must establish the discount rate every 14
days and the Board must review and determine
the rate so established. Unless credit policy at
the time suggests the need for a change in the
rate, the practice is for each Reserve Bank to
establish the same rate as that previously established and for the Board to approve the reestablishment of the existing rate.


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Federal Reserve Bank of St. Louis

It may be noted that while section 14(d)
literally refers only to discount rates, the procedure prescribed by that section for the fixing
of rates every 14 days has been applied in practice not only to discount rates but also to interest rates established for advances to member
banks and others under the eighth and thirteenth paragraphs of section 13 and section
10(b)oftheAct.
In his replies to the Patman Questionnaire
in 1952, Chairman Martin of the Board made
the following statement regarding the procedure that was followed in determining discount
rates: "
At the present time, the procedure for the
setting of discount rates, as it has evolved
over the years, is generally as follows:
Each Friday the Board considers all actions
taken by the Federal Reserve Banks during
the preceding week to establish discount rates,
usually action toreestablishthe existing rates.
The possible desirability of any prospective
change in discount rates is usually considered
in advance by the Board with the Presidents
of the Federal Reserve Banks and the Federal
Open Market Committee in the light of
changing credit conditions, including the
Government's financing needs and current
trends in the economy generally. Whenever it
is determined that as a matter of policy there
should be a change in rates, action to establish
such a ctiange usually is taken uniformly by
the boards of directors (or executive committees) of the several Federal Reserve Banks
at their next meetings following such determination. Thus, in August 1950, after consultation between the Board and the Federal
Open Market Committee, as one measure for
restraining credit and monetary expansion, a
discount rate of VA percent—initially proposed by the Federal Reserve Bank of New
York—Was established at all of the Federal
Reserve Banks and that rate prevailed at the
end of 1951.
In accordance with the procedures established many years ago, as previously indicated, whenever discount rates are changed,

180

HISTORY OF LENDING FUNCTIONS
the action is announced simultaneously by
the Board and the Reserve Bank at the end
of the day on which the Board acts and the
new rates are made effective on the next
business day following the day of the announcement.

In general, the procedure described by Mr.
Martin prevails at the time of this writing. How-

ever, the Board no longer considers rates only
on Friday of each week; normally, it acts on
rates established by the Reserve Banks promptly
after receipt of advice of a Reserve Bank's
action. In addition, changes in rates are usually
made effective on the day after the Board's
action whether or not that happens to be a business day.

COMPUTATION
As has been noted, the Federal Reserve Act
authorizes both discounts and advances, with
discounts subject to a discount rate and advances subject to an interest rate. Until 1971,
however, interest on all Reserve Bank loans,
advances as well as discounts, was computed
on a discount basis; that is, interest was deducted at the time the loan was made. If the
member bank repaid a borrowing before maturity, it received a rebate of a portion of the
interest deducted when the loan was made.
Most of the Reserve Banks computed the rebate
at the rate at which the advance was made, but
some Reserve Banks followed a practice of
computing the rebate at the rate prevailing at
the time of the rebate if the discount rate at that
time was less than it was at the time the advance
was made.
Since February 1971 interest on advances by
the Reserve Banks has been computed on an
accrual basis and paid at the time of repayment
of the loan. In addition, any changes in the
discount rate are made immediately applicable
to all outstanding borrowings." With this
change in the method of computing interest, the
need for a rebate in the event of payment before
maturity no longer exists. It should be noted in
passing that computation of interest on an accrual basis rather than on a discount basis results in a small mathematical advantage to the


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Federal Reserve Bank of St. Louis

borrowing member bank. For this reason, although legally a member bank could still discount eligible paper with its Federal Reserve
Bank, it seems unlikely that it would ever wish
to do so.
Interest on Reserve Bank loans is computed
for the period of the loan on the basis of 365
days to the year." If the maturity date falls on
a Sunday or a holiday, the computation follows
applicable State law relating to such cases."
In the early days of the System, when the
applicable discount rate depended upon the
maturity of the paper, questions sometimes
arose that would not arise under present law.
For example, in 1916 when 90-day paper carried a higher rate than 30-day paper, question
was raised as to the applicable rate in a case
in which the paper discounted had a maturity
of 90 days at the time of discount but in which
the member bank, by a side agreement, had
agreed to repurchase the paper in 30 days. The
Board's Counsel ruled that the 90-day rate was
nevertheless applicable/1" Again, a question
arose as to the rate of rebate in a case in which
a 90-day loan was prepaid within 30 days of
maturity. It was held that the rebate should be
at the lower rate prevailing for paper running
the same length of time as the unexpired term
rather than at the higher 90-day rate charged
when the loan was made.58

Relation to Credit Policy

THE EARLY YEARS: ACCOMMODATION OF CREDIT NEEDS
Although this study is not primarily concerned with the economic aspects of the lending
functions of the Federal Reserve Banks, it is
nevertheless appropriate to consider briefly how
the law and the Board's regulations have reflected changes in the concept of the role of the
discount mechanism as an instrument of credit
and monetary control.
The original Federal Reserve Act contained
little, if any, suggestion that the discount function would be employed as a tool for implementing credit policies in the sense in which it
is considered as such a tool today. There was
no mention of any such objective in the title of
the Act. It is true that one of the stated purposes was to afford means of rediscounting commercial paper, but it appears that this purpose
w
as related not to the control of general credit
conditions but rather to the meeting of the
particular credit needs of business and commerce.
As indicated earlier, one of the principal aims
°f the Act was to create a market for short-term
p

or NOTES AND REFERENCES, see p. 265.


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Federal Reserve Bank of St. Louis

181

commercial paper. Section 14 (d) of the Act
provided that discount rates should be fixed
"with a view of accommodating commerce and
business." The key word was accommodation
rather than regulation of credit.
In keeping with this purpose, emphasis was
placed in the early years of the System not upon
regulation of the amount or kinds of credit
extended by member banks themselves but
upon the ability of the Reserve Banks to assist
member banks in meeting their credit requirements in normal and extraordinary times. Thus,
in its first Annual Report to Congress, the
Board stated that it was necessary to enlist "the
hearty cooperation of all the member banks"
in "the adoption of a discount policy which
would prevent the accumulated strength of the
[Federal Reserve] banks from being dissipated
and protect their resources from being used to
finance operations not calculated to add to the
strength or solidity of general banking conditions." ' In its 1919 Annual Report, the Board
similarly stated that the Federal Reserve Banks
should not encourage rediscounting for the sake
of profit, "but that their own resources should

182

HISTORY OF LENDING FUNCTIONS

be kept liquid and their reserve position
strong." 2
Very plainly, the Board did not consider the
discounting authority of the Reserve Banks as
a means of controlling the credit policies of
member banks. In its 1921 Annual Report, the
Board emphasized that the System had "no control over member bank loans" and pointed out
that there was "nothing in the Federal Reserve
Act which gives either the Federal Reserve
Board or a Federal Reserve Bank any control
over the loan policy of any member bank." 3
The Board observed that there was "a very
general popular misconception" in this respect
and that some member banks in declining loans
had used the Reserve Banks as a buffer. It was
true, the Board said, that a Reserve Bank might
have occasion to call the attention of certain
member banks to their "large discount lines,"
but "in no case within the knowledge of the
Federal Reserve Board has any Federal Reserve
Bank undertaken to say to a member bank what
particular loans it should call or ask to have
reduced." *
Some shift away from this concept was evident in 1923 when the Board reported to Con-

gress that, "by maintaining constant, close, and
direct contact with the loan policies and operations of its member banks, through examination
or otherwise, a reserve bank can do much by
other means than changes in discount rates to
establish an effective supervision and control of
the credit released by it to its member banks." 'This was an early expression of the concept of
direct pressure that became more explicit in
the late 1920's. However, it appears that, at
least prior to 1933, the influence exercised by
the System through the discounting function
over the credit policies of member banks was
considered only as something "akin in many
respects to the bank examinations function" of
the System • rather than as a means of regulating national credit conditions or controlling
the lending policies of member banks. As previously indicated, major emphasis was placed
upon the furnishing of necessary credit assistance to different segments of the economy: the
establishment of a market for commercial paper
in the early years; credit to agriculture and
stimulation of foreign trade through discounting of bankers' acceptances in the 1920's; and
assistance to businesses in the early 1930's.

THE 1930's: PREVENTION OF SPECULATION
The original Federal Reserve Act contemplated that Federal Reserve credit should be
based on short-term commercial paper and not
on paper drawn for investment or speculative
purposes. Section 13 specifically excluded paper
"covering merely investments or issued or
drawn for the purpose of carrying or trading in
stocks, bonds, or other investment securities."
However, the original Act contained no express
statement that one of its purposes was to prevent member banks from diverting their own
funds into speculative channels; the original
objective was simply to limit Federal Reserve
discounts to self-liquidating commercial paper,
excluding paper drawn for purposes of investment alone.


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Federal Reserve Bank of St. Louis

In 1929 both the Board and the Reserve
Banks became seriously concerned about the
volume of bank credit that was being used for
the purchase of stocks and for speculative purposes. There was a sharp difference of opinion,
however, as to how the problem should be met
The Reserve Banks, particularly the New York
Reserve Bank, favored an increase in the discount rate; the Board, on the other hand, insisted on a program of direct pressure, that is.
closing the discount window to member banks
that appeared to be extending credit for speculative purposes. In the end, the Board agreed
to a discount rate increase; but it was this crisis,
according to some historians of the s y s t *j n '
that marked a shift of power from the New

RELATION TO CREDIT POLICY
York Reserve Bank to the Federal Reserve
Board.
The stock market debacle of 1929 and the
ensuing banking crisis of 1933 focused even
greater attention on the dangers inherent in
the investment practices of commercial banks.
The Banking Act of 1933 sought to prevent
recurrence of similar situations by various
amendments that were designed to restrict investments by banks in stocks and other securities. Thus, the 1933 act prohibited national
banks and State member banks of the Federal
Reserve System from dealing in investment
securities (subject to certain exceptions) or
from purchasing any corporate stocks except
as specifically authorized by law. The same act
required member banks to divorce themselves
from securities companies and prohibited interlocking directorates between such companies
and member banks. Member banks were prohibited from paying any interest on demand
deposits, a practice that had enabled large banks
in New York and other financial centers to
attract deposits of country banks—funds that
the city banks had used for investment in speculative securities. Finally, the Banking Act of
1933 added three provisions to the Federal
Reserve Act relating to the discount functions
of the Reserve Banks that were specifically
aimed at preventing speculative practices on
the part of member banks. These three amendments merit particular attention here.
One of the amendments was to subsection
(m) of section 11 of the Act, a paragraph that
has had an interesting history because of the
various different matters that have been covered by it over many years.8 The 1933 amendment revised this paragraph to authorize the
Board to limit the amount of loans that might
he made by member banks on the security of
stock or bond collateral. The Board was given
power to fix, for each Federal Reserve district,
the percentage of individual bank capital and
surplus that could be represented by loans on
stock or bond collateral made by member
banks, with a flat prohibition against the making
°f such loans to any one borrower in excess of
10 per cent of a member bank's capital and
SUr
plus. Th e Board was authorized to change
the percentage from time to time, but it was


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Federal Reserve Bank of St. Louis

183

expressly made the duty of the Board to establish such percentages "with a view to preventing
the undue use of bank loans for the speculative
carrying of securities." Finally, the Board was
empowered to direct any member bank to refrain from further increasing its loans on stock
or bond collateral for any period up to 1 year
"under penalty of suspension of all rediscount
privileges at Federal reserve banks."
This amendment went far beyond the original
concept that Federal Reserve Banks should not
indirectly encourage speculation by discounting
paper drawn for investment or speculative purposes; it attempted to restrain directly the making of speculative loans by member banks, regardless of the nature of the paper that might be
offered by them as a basis of rediscount by the
Reserve Banks. If a member bank persisted in
making speculative loans, it was made subject
to suspension of all rediscount privileges.
This provision for curbing speculative loans
by member banks is still in effect, although it
was amended by the Banking Act of 1935 to
make loans on U.S. Government obligations
subject to the more liberal percentage limitation prescribed by section 5200 of the Revised
Statutes rather than the 10 per cent limitation
fixed for loans on other securities.8
Another amendment made by the Banking
Act of 1933 added certain new provisions to
the eighth paragraph of section 13 of the Federal Reserve Act relating to advances to member banks on their secured promissory notes; it
was desiped to restrain speculative loans by
member banks. The amendment *° provided
that if, during the life of any such advance and
after a warning by the Reserve Bank or the
Board, a member bank should increase its
loans secured by stocks or other securities or
its loans to dealers in securities, such advance
should become immediately due and payable
and the member bank should be "ineligible as a
borrower at the reserve bank" for such period
as the Board should determine. Exceptions were
made with respect to loans on Government
obligations and temporary carrying loans to
facilitate the purchase or delivery of securities
offered for public subscription.
A third amendment—the most important for
the purpose of preventing speculative bank

184

HISTORY OF LENDING FUNCTIONS

loans—grew out of a recommendation made
by the Board in a letter to the chairman of the
Senate Banking and Currency Committee,
dated March 29, 1932." In that letter the
Board stated: "
Member banks as a rule do not borrow to
relend, but to make up deficiencies in reserves
arising from withdrawals of deposits or from
other causes. It is therefore usually impossible
to say that a loan to a member bank is
granted for this or that specific purpose. However, it would be possible to determine
whether the loan and investment policies of
a bank are inconsistent with the purposes of
the Federal reserve act, and, if so, to refuse
accommodation to such bank or in aggravated
cases to suspend it from the privilege of using
the system's credit facilities.
To accomplish this end, the Board recommended an amendment to section 4 of the
Federal Reserve Act, and the language suggested by the Board appeared in the Banking
Act of 1933 as finally enacted.
The eighth paragraph of section 4, from the
time of the original enactment of the Federal
Reserve Act, had provided that the directors of
each Federal Reserve Bank should administer
the affairs of the Reserve Bank fairly and impartially and without discrimination against any
member bank or banks and that the directors
should extend to each member bank "such
discounts, advancements, and accommodations
as may be safely and reasonably made with
due regard for the claims and demands of other
member banks." To this language the 1933
amendment added language requiring that due
regard be given also to "the maintenance of
sound credit conditions, and the accommodation of commerce, industry, and agriculture."
In addition, the amendment authorized the
Federal Reserve Board to prescribe regulations
further defining the conditions under which
discounts, advancements, and accommodations
might be extended to member banks. The
amendment then added the following significant
provisions: ™
* * * Each Federal Reserve bank shall
keep itself informed of the general character
and amount of the loans and investments of
its member banks with a view to ascertaining


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Federal Reserve Bank of St. Louis

whether undue use is being made of bank
credit for the speculative carrying of or
trading in securities, real estate, or commodities, or for any other purpose inconsistent
with the maintenance of sound credit conditions; and, in determining whether to grant
or refuse advances, rediscounts or other credit
accommodations, the Federal reserve bank
shall give consideration to such information.
The chairman of the Federal reserve bank
shall report to the Federal Reserve Board any
such undue use of bank credit by any member
bank,' together with his recommendation.
Whenever, in the judgment of the Federal
Reserve Board, any member bank is making
such undue use of bank credit, the Board
may, in its discretion, after reasonable notice
and an opportunity for a hearing, suspend
such bank from the use of the credit facilities
of the Federal Reserve System and may
terminate such suspension or may renew it
from time to time.

With reference to the section of the 1933 act
that added these provisions, the report of the
Senate Banking and Currency Committee stated
that that section: "
* * * places general restrictions upon the
operating policy of Federal reserve banks
with the intent to limit them to the extension
of credit for ordinary business purposes and
to make plain that their resources are not to
be used to support speculation. The Reserve
Board is given power to oversee and direct
such use of the resources of banks.
In explaining these provisions on the floor of
the Senate, Senator Glass observed that some
Federal Reserve Banks might be reluctant to
inquire as to what member banks were doing
with funds borrowed from the Reserve Bank
and that neither the Reserve Banks nor the
Board had any control over a member bank
while it was not seeking Federal Reserve credit.
He pointed out, however, that under the new
provisions "the instant a member bank wants
to recoup itself at the Federal Reserve BanK,
it is the business of the Federal Reserve Bank to
know the reason why." He then stated: "
* • • in this section we require a
j j
reserve bank to keep itself informed and w^
require the agent of the Federal R«erV

RELATION TO CREDIT POLICY
Board at that bank to keep the Federal
Reserve Board informed. If at any time it
shall appear that the member bank seeking
the privileges of the Federal reserve bank
is inordinately extended in stock-market
transactions or unsound and unsafe loans, we
empower the Federal Reserve Board, upon
due notice and hearing, to suspend the facilities of the Federal reserve bank to that
offending bank.
Similarly, in the House, Chairman Steagall
of the Banking and Currency Committee declared: "
We propose to see to it that hereafter the
credit facilities of the Federal Reserve System
shall be devoted primarily to the purposes to
which that great act was dedicated at the
outset.
*****
Amendment of the Federal Reserve Act is
made to provide for supervision by Federal
Reserve banks to see whether any member
bank is making undue use of its funds for

185

speculative purposes. If such is found to be
the case the Federal Reserve bank is empowered to suspend such member bank from
the privilege of rediscounting.
The three 1933 amendments to the Federal
Reserve Act—to section l l ( m ) , section 13,
and section 4—had a common objective: to
place upon the Board and the Reserve Banks a
responsibility for seeing that member banks did
not engage in undue use of their funds for
speculative purposes, with suspension of their
rediscounting privilege as the penalty. The significance of the 1933 amendments lies in the
fact that they contemplated the exercise by the
Federal Reserve System of a direct influence
upon the credit policies of member banks, in
contrast to the earlier concept that the lending
authority of the Reserve Banks was intended
only to accommodate the credit requirements
of member banks with but incidental effect
upon the lending practices of the member banks
themselves.

SINCE 1951: AN INSTRUMENT OF CREDIT CONTROL
So far in this chapter it has been suggested
that in the early years of the System, particularly in the 1920's, the lending functions of
the Federal Reserve Banks were related to
credit policy primarily as a means of enabling
member banks to supply the credit needs of
commerce and agriculture, and that in the
1930's such functions were aimed primarily at
the prevention of speculative loans by member
banks. It would be wholly inaccurate, however,
to assume that there was any clear line of demarcation between the two periods: The idea
of preventing speculative loans was not lacking
during the 1920's; and the Banking Act of
1933, despite its preoccupation with speculative
lending practices, did not contemplate that the
Reserve Banks should not still seek to accommodate commerce and agriculture, as well as
business enterprises, through the exercise of
'heir lending powers. It would be equally wrong


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to assume from the heading of the present section that the lending functions of the Reserve
Banks were regarded as a tool of credit control
only after 1951. As in the two previous sections,
the heading is meant only to indicate a shift in
emphasis.
The importance of the discount powers of the
Reserve Banks in affecting general credit conditions was clearly recognized in the early years
of the System. In its first Annual Report the
Board declared that "the question of a discount
policy immediately became urgent."17 Even
then, the Board contemplated that the System
should be prepared to exert its influence to
protect the economy against both inflation and
deflation. Thus, the Board stated:18
The ready availability of its resources is of
supreme importance in the conduct of a
Reserve Bank. Only then can it become a
safe and at the same time flexible instrument

186

HISTORY OF LENDING FUNCTIONS
of guidance and control, a regulator of interest rates and conditions. Only then will it
constantly carry the promise of being able to
protect business against the harmful stimulus
and consequences of ill-advised expansions of
credit on the one hand, or against the menace
of unnatural restrictions and unnecessary contractions on the other, with exorbitant rates
of interest and artificial stringencies.

Nevertheless, the System was mainly concerned in the early years with affording necessary credit to commerce and agriculture; and
the concern in the 1930's with prevention of
speculative loans was not based upon the idea
of using the discount mechanism as a means of
influencing the money supply in general.
From the early 1930's until about 1952,
member bank borrowings from the Reserve
Banks were relatively small, at times almost
insignificant; consequently, the lending functions of the Reserve Banks had little effect upon
national credit policy during that period. The
reasons for lack of borrowings during those
years were set forth in the Board's reply to the
Patman Questionnaire in 1952: 19 principally,
the volume of excess reserves held by member
banks as the result of a large inflow of gold
and a slack demand for bank credit, the open
market policy of the System during World
War II that provided the banking system
with ample reserves, and the strong liquidity
position of member banks as a result of their
large holdings of Government securities.
The situation began to change after World
War II. The rapid expansion of private bank
credit during the postwar years brought about a
reduction in over-all bank liquidity, with more
frequent occasions for borrowings by member
banks from their Federal Reserve Banks.20
The chief factor, however, in the revival of
the importance of the discount mechanism as an
instrument of credit policy was the TreasuryFederal Reserve accord of March 1951, when
the System ceased to purchase Government
bonds in order to support their prices.21 Before
that time, member banks, in view of the steady
prices of Government obligations, had been
able to adjust their reserve positions through
sales of such obligations, which they had held
in large volume since World War II; after the


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Federal Reserve Bank of St. Louis

accord, they frequently found it more profitable to borrow from the Reserve Banks. The
effect was described in the Board's 1951 Annual Report as follows: —
The closer relationship of short-term market rates to the discount rate was an important factor in a greater use of the Federal Reserve discount window in making temporary
adjustments of member bank reserve positions. When the Federal Reserve, by refraining from open market purchases of Government securities, limits the availability of reserves through the open market, a member
bank that has temporary need for additional
reserves has a choice of borrowing from the
Federal Reserve at the discount rate or selling
Treasury bills or other securities at interest
rates determined in the market. Depending on
the excess reserve position of other banks,
the bank may also have the choice of borrowing such funds through the Federal funds
market, at a rate determined in this market.
* * * As the year progressed, increasing
numbers of member banks elected to borrow
from the Federal Reserve in meeting shortages of reserve funds. This development reflected re-establishment of the discount function as a complement to open market
operations in Federal Reserve influence on
monetary and credit conditions.
The increased importance of the discount
mechanism in relation to credit policy was
emphasized in the Board's reply to the Patman
Questionnaire in 1952. The Board pointed out
that the reluctance of member banks to be
continually in debt to the Federal Reserve made
the discount mechanism a potentially powerful
influence in affecting general credit conditions,
especially when used in conjunction with other
measures of credit and monetary policy. Describing the complementary workings of open
market operations and discount policy, the
Board stated: "
When occasion makes it desirable from the
standpoint of over-all credit and monetary
objectives, the System can make it necessary
for an increasing number of member banks to
rely temporarily on borrowing from the Reserve Banks. It can accomplish this by decreasing the availability of reserve funds t>y
such means as open market sales of Govern-

RELATION TO CREDIT POLICY
ment securities or the imposition of higher
reserve requirements. When such an increase
in member bank recourse to borrowing occurs, usually accompanied by a rise in the
volume of rediscounts, the System is put in a
position to exert an additional restrictive influence on the expansion of bank reserves and
of bank credit generally by increasing the cost
of member bank borrowing, that is, by raising
the discount rate.
Concluding its discussion of the subject, the
Board told the Patman subcommittee that the
"discount mechanism is an important instrument of Federal Reserve policy."
Greater resort by member banks to Federal
Reserve discounts after the 1951 accord resulted in the focusing of more attention upon
the discount functions of the Reserve Banks
than had existed since the 192O's. Renewed
interest in the subject impelled the Board to
revise its Regulation A in 1955. In a foreword
to the revised regulation, the Board explicitly
recognized the role of the discount mechanism
as one of the three major instruments of credit
policy. Thus, the first two paragraphs of that
foreword read: u
A principal function of the Federal Reserve Banks under the law is to provide
credit assistance to member banks, through
advances and discounts, in order to accommodate commerce, industry, and agriculture.
This function is administered in the light of
the basic objective which underlies all Federal Reserve credit policy, i.e., the advancement of the public interest by contributing to
the greatest extent possible to economic stability and growth.
The Federal Reserve System promotes this
objective largely by influencing the availability and cost of credit through action affecting the volume and cost of reserves available to the member banks. Through open
market operations and through changes in
reserve requirements of member banks, the
Federal Reserve may release or absorb reserve funds in accordance with the credit and
monetary needs of the economy as a whole.
An individual member bank may also obtain
reserves by borrowing from its Federal Reserve Bank at a discount rate which is raised
or lowered from time to time to adjust to the
credit and economic situation. The effects of


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Federal Reserve Bank of St. Louis

187

borrowing from the Federal Reserve Banks
by individual member banks are not localized,
as such borrowing adds to the supply of reserves of the banking system as a whole.
Therefore, use of the borrowing facility by
member banks has an important bearing on
the effectiveness of System credit policy.
The role of the discount function as an
instrument of monetary policy "under presentday conditions" was fully and clearly described
in the Board's Annual Report to Congress for
1957." At certain periods, and for specific
member banks, the lending authority of the
Federal Reserve Banks still serves the purpose
for which it was originally intended—the accommodation of the needs of business and
commerce. It can still be used as a means of
restraining speculative lending practices on the
part of member banks, although not so effectively when member banks are not borrowing
extensively from the Reserve Banks. In recent
years, however, and especially since 1951, the
discount mechanism has been most important
as a complement to open market operations in
the effectuation of monetary policy.
One episode will serve to illustrate the use of
the discount window as a tool of monetary
policy. In the latter part of 1966, the Board
concluded that credit-financed business spending "had tended toward unsustainable levels
and had added appreciably to current inflationary pressures." On September 1, 1966, at the
Board's suggestion, the president of each Reserve Bank sent a letter to each member bank
in his district urging restraint in the making of
business loans. The letter also said that this
objective would be "kept in mind by the Federal
Reserve Banks in their extensions of credit to
member banks through the discount window."26
Here was a new form of direct pressure like
that exerted in 1929, but this time it was used
not to prevent speculative loans by member
banks but to discourage loans to businesses.
This effort was abandoned in December 1966
when it was announced that, because of changes
in credit conditions, the special discount arrangements set forth in the letter of September 1
had been terminated.
The 1968 Report of a System Committee
stated that discounting of paper by the Reserve
Banks can "serve as an important adjunct to

188

HISTORY OF LENDING FUNCTIONS

open market operations in the implementation
of monetary policy." -7 One of the results of
that committee's recommendations was the
Board's adoption in 1973 of a complete revision
of its Regulation A. In a section relating to


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Federal Reserve Bank of St. Louis

general principles, the regulation states that
the effects of borrowings by member banks
from their Reserve Banks do not remain localized but have "an important bearing on overall
monetary and credit conditions." !S

General Principles: A Summary

STATUTORY AND REGULATORY BASIS

Throughout this study attention has been
focused principally on legislation and on regulations and interpretations of the Board with
respect to various types of Reserve Bank loans.
This chapter describes briefly some of the general principles that have governed the lending
operations of the Reserve Banks. It provides,
in effect, a partial summary of this history.
In the law itself, Congress has set forth some
—but not very comprehensive—policy guidelines. It has indicated that Reserve Bank loans
are designed to accommodate commerce, industry, and agriculture; that they should be made
with due regard for the maintenance of sound
credit conditions; that ordinarily they should
have short maturities; that the proceeds of such
F

or NOTES AND REFERENCES, see p. 266.


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Federal Reserve Bank of St. Louis

189

loans should not be used for speculative purposes; and that in exceptional or emergency
circumstances loans may be made not only to
member banks but also to nonmember banks
and even to individuals, partnerships, and corporations.
These statutory principles have been reflected in regulations and rulings of the Board,
and from time to time the Board has articulated
additional principles or guidelines to be followed in administration of the Federal Reserve
discount window. In its 1955 revision of Regulation A, the Board for the first time sought to
state general principles governing Reserve Bank
loans. These principles are restated, but with
different emphasis, in a section of the 1973
revision of the regulation.

190

HISTORY OF LENDING FUNCTIONS

ACCOMMODATION OF COMMERCE, INDUSTRY,
AND AGRICULTURE
As indicated in the preceding chapter, it has
always been a fundamental though very general
principle that the lending authority of the Reserve Banks is to be used for the purpose of
accommodating commerce, industry, and agriculture. One of the purposes of the Federal
Reserve Act, as stated in its title, was "to afford
a means of rediscounting commercial paper."
Section 13 of the original Act provided, and
still provides,1 that a Reserve Bank "may discount notes, drafts, and bills of exchange arising
out of actual commercial transactions; that is,
notes, drafts, and bills of exchange issued or
drawn for agricultural, industrial, or commercial purposes, or the proceeds of which have
been used, or are to be used, for such purposes." Section 14(d) of the Act provided, and
still provides,2 that discount rates "shall be
fixed with a view of accommodating commerce
and business."
In 1933, what is now the eighth paragraph of
section 4 of the A c t 3 was amended to reflect
certain guidelines regarding Reserve Bank lending to member banks. One of the guidelines was
that Reserve Bank loans should be made "with
due regard for * * * the accommodation of
commerce, industry, and agriculture."
In the foreword to the 1955 revision of Regulation A, the Board stated: *
A principal function of the Federal Reserve
Banks under the law is to provide credit
assistance to member banks, through advances and discounts, in order to accommodate commerce, industry, and agriculture.
The 1973 revision similarly provides: "
Extending credit to member banks to accommodate commerce, industry, and agriculture is a principal function of Reserve Banks.
In the early years of the System, the ability
of the Reserve Banks to accommodate commerce, industry, and agriculture was limited by
the fact that the law authorized loans only to
member banks, by the Board's adherence to


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Federal Reserve Bank of St. Louis

the real-bills doctrine, and by narrow interpretations of what constituted paper drawn for
agricultural, industrial, or commercial purposes.
Fortunately, the real-bills doctrine was soon
discarded and both Congress and the Board in
later years acted to enable the Reserve Banks to
play a much more expanded role in accommodating the needs of the economy.
In the 1920's, amendments to the law gave
the Reserve Banks broader scope in providing
credit assistance to agriculture and in developing a market for bankers' acceptances. Congress
also authorized advances to member banks on
U.S. Government obligations as well as on
commercial paper. In the 1930's, the depression
gave rise to radical departures from the original
philosophy of the law, as reflected by amendments authorizing loans to member banks on
any satisfactory security (though at a higher
rate) and extensions of credit to nonmember
banks, business enterprises, and to individuals,
partnerships, and corporations in general.
Within statutory limits, the Board has taken
actions over the years to liberalize requirements
as to the types of paper that arc eligible for
discount or as collateral for Federal Reserve
Bank advances. For example, while the framers
of the original Act undoubtedly considered
commercial paper to be only that paper arising
out of what they termed business transactions,
the Board in 1937 took the position that any
purchase and sale of goods, including the purchase of automobiles or radios by individuals,
was a commercial transaction. In addition to
such consumer paper, the Board also held,
contrary to its earlier position, that finance
paper, that is, paper the proceeds of which were
to be re-lent to third persons, could likewise be
regarded as eligible for discount. In its 1973
revision of Regulation A, the Board has treated
even real estate mortgages and other permanent
investment paper as commercial paper eligiWe
for discount if it meets statutory maturity requirements and if the proceeds are not used
merely for investment.

GENERAL PRINCIPLES: A SUMMARY

191

THE REAL-BILLS DOCTRINE:
AN ABANDONED PRINCIPLE
The original Federal Reserve Act reflected a
belief that only short-term, self-liquidating
paper should be eligible as a basis for Federal
Reserve credit. It was felt that this was necessary to assure the liquidity of commercial banks.
It was also believed that the pledging of such
paper as security for the issuance of Federal
Reserve notes would guarantee an elastic currency; it was expected that the volume of currency would expand and contract directly in
response to the varying credit needs of the
economy as reflected by the volume of shortterm borrowings by commercial and agricultural
enterprises. For these reasons, the Board expounded the principle that all paper offered for
discount should be essentially self-liquidating;
in other words, that it "should represent in
every case some distinct step in the production
or distribution process—the progression of
goods from producer to consumer." •
It was not long before this philosophy—the
real-bills doctrine—underwent drastic erosion.
The story of the demise of the doctrine was told
in the Board's letter of August 21, 1963, to
Congress recommending legislation to authorize Reserve Bank loans on any satisfactory
security. That letter stated:
The principle that Federal Reserve credit
should be extended only on the basis of
short-term, self-liquidating paper was departed from as early as 1916, during the First
World War, when the law was amended to
authorize the Reserve Banks to make 15-day
advances to member banks, not only on the
security of "eligible paper" but also on the
security of direct obligations of the United
States. A more significant departure occurred
in 1932, when Congress authorized the Reserve Banks to make advances to member
banks in exceptional and unusual circumstances on any security satisfactory to the
Reserve Banks, although at a penalty rate of
interest. This authority, at first temporary,
was made permanent in 1935, and it is no
longer limited to exceptional and unusual


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Federal Reserve Bank of St. Louis

circumstances, although such advances continue to carry a penalty rate of interest.
The concept that limitation of discounts to
short-term, self-liquidating paper would serve
automatically to regulate the volume of Federal Reserve notes in circulation has also been
breached by amendments to the law and has
been refuted by experience. In 1932, Congress authorized the issuance of Federal Reserve notes on the security of Government
obligations in addition to eligible paper and
gold. This authority was originally of a temporary nature, but it was made permanent in
1945. The volume of Federal Reserve notes
today fluctuates with the changing demands
of the economy without regard to the nature
of the paper offered as collateral for Federal
Reserve credit or pledged as security for
Federal Reserve notes.
Each of these legislative changes took place
during a period of economic stress that served
to make clear the inadequacy of the original
framework for Federal Reserve credit extension. The credit needs of American businessmen, farmers, and consumers were evolving
in many ways that could not be adequately
handled by the old instrument of short-term,
commercial-type paper; and the rapid growth
of both private and Governmental economic
activity generated credit requirements far in
excess of those that could be supported by the
relatively small volume of "eligible paper."
Despite changes in the character of paper
held by commercial banks and the repeated
and necessary departures from the original
concept that discounts should be based only
on short-term, self-liquidating paper, the law
continues to impose unduly restrictive requirements as to the nature and maturity of
the paper that may be discounted by the
Reserve Banks or offered as security for advances by the Reserve Banks.
For many years, it has been generally recognized that the concept of an elastic currency based on short-term, self-liquidating
paper is no longer in consonance with banking practice and the needs of the economy.

192

HISTORY OF LENDING FUNCTIONS
It has long been apparent that the narrow
requirements of the law regarding "eligible
paper" serve no useful purpose and that it
would be preferable to place emphasis on the
soundness of the paper offered as security for
advances and the appropriateness of the
purposes for which member banks borrow.
The one-year paper of many bank customers
that is not now eligible for discount may be
as satisfactory collateral as the 90-day notes
of other customers. Moreover, the nature of
the collateral provides no assurance that the
borrowing bank will use the proceeds for an
appropriate purpose.

Despite the Board's recommendation, repeated in subsequent years, the law has not
been changed to repeal the vestiges of the

real-bills doctrine. The principle of that doctrine
has been rejected and it is now recognized that
the soundness of paper offered as a basis for
Reserve Bank credit is more important than
compliance with maturity requirements and
limitations as to the nature of the transactions
giving rise to the paper. The principle has been
rejected, but these requirements and limitations
continue to inhibit the ability of the Reserve
Banks to extend credit to member banks in
order to accommodate commerce, industry, and
agriculture. Only if a member bank is willing
or compelled by circumstances to pay a higher
rate of interest may a Reserve Bank extend
credit, under section 10(b) of the Federal Reserve Act, without regard to such requirements
and limitations.

MAINTENANCE OF SOUND CREDIT CONDITIONS
As was soon demonstrated by experience
during the early years of the System, one of the
difficulties with the real-bills doctrine was that
the discounting by the Reserve Banks of shortterm, self-liquidating paper growing out of productive commercial transactions gave no assurance that the credit extended to member banks
would actually be used by them for productive
purposes.7 The Board became concerned during
the 1920's by the apparent fact that member
banks were using the proceeds of Reserve Bank
loans for speculative purposes, and efforts were
made through direct pressure to make certain
that the proceeds of such loans were being used
for appropriate purposes.
Thus, a new general principle emerged: Federal Reserve credit, regardless of the nature of
the paper offered for discount, should not be
used in a manner inconsistent with the maintenance of sound credit conditions. This principle was reflected in amendments made by the
Banking Act of 1933 to the eighth paragraph
of section 4 of the Federal Reserve Act. It was
provided that, in extending credit to its member
banks, each Reserve Bank should give due regard not only to the accommodation of com-


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Federal Reserve Bank of St. Louis

merce, industry, and agriculture but also to the
maintenance of sound credit conditions. In
addition, but along the same line, each Reserve
Bank was required to "keep itself informed of
the general character and amount of the loans
and investments of its member banks with a
view to ascertaining whether undue use is being
made of bank credit for the speculative carrying
of or trading in securities, real estate, or commodities, or for any other purpose inconsistent
with the maintenance of sound credit conditions." In determining whether to grant credit
accommodations, the Reserve Bank was required to give consideration to such information. If the Board of Governors found that any
member bank was making undue use of bank
credit, the Board was authorized, after opportunity for hearing, to suspend such bank from
use of the credit facilities of the System."
Reflecting the intent of the 1933 amendments
to the law, the Board in its 1955 revision of
Regulation A stated that, in determining
whether to extend credit, a Reserve Bank
should give due regard to "the purpose of the
credit and to its probable effects upon the maintenance of sound credit conditions, both as to

GENERAL PRINCIPLES: A SUMMARY
the individual institution and the economy generally." As revised in 1973, the regulation notes
that the law requires every Reserve Bank to
keep itself informed of the general character
and amount of the loans and investments of its
member banks with a view to ascertaining

193

whether undue use is being made of bank credit
for any purpose "inconsistent with the maintenance of sound credit conditions" and that, in
determining whether to extend credit, the Reserve Bank shall give consideration to such
information.

INAPPROPRIATE USES OF FEDERAL RESERVE CREDIT
SPECULATION OR INVESTMENT
As has been indicated, amendments to the
Federal Reserve Act in 1933 made explicit the
principle that Federal Reserve credit should not
be used by member banks for speculative purposes. This principle, of course, has been recognized since the earliest days of the System. For
example, in 1923, referring to the Federal Reserve discount window, the Board stated: •
It is not a system of credit for either investment or speculative purposes * * *. The
exclusion of the use of Federal reserve credit
for speculative and investment purposes and
its limitation to agricultural, industrial, or
commercial purposes thus clearly indicates
the nature of the tests which are appropriate
as guides in the extension of Federal reserve
credit.
Even though the proceeds of Federal Reserve
Bank loans are not used for purely speculative
purposes, they are not to be used merely for
investment purposes or for the purpose of
trading in securities other than obligations of
the United States. Section 13 of the original
Federal Reserve Act expressly provided that
while the Board should have the right to define
the character of paper eligible for discount, no
such definition should include paper covering
"merely investments or issued or drawn for the
Purpose of carrying or trading in stocks, bonds,
or other investment securities, except bonds and
notes of the Government of the United States."
This provision is still in the law."
It has been noted in an earlier chapter that,
as a corollary of the real-bills doctrine, the
Board until 1973 had always prohibited Reserve


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Federal Reserve Bank of St. Louis

Bank loans on paper drawn to cover permanent
or fixed investments, such as real estate, buildings, or machinery. This position was reversed
in the revision of Regulation A adopted in 1973.
Under that revision, fixed- or permanent-investment paper is regarded as commercial paper
eligible as collateral for Federal Reserve credit
provided the proceeds are not to be used merely
for investment purposes and provided, of
course, that the paper meets applicable maturity
requirements.

USE FOR PROFIT
Federal Reserve credit should not be used by
a member bank in order to take advantage of
differential rates, for example, a difference between the discount rate and the bank's own
lending rates. In 1928 the Board stated: "It is
a generally recognized principle that reserve
bank credit should not be used for profit,
* * *_"

ii

This principle was recognized by the Board
in its 1955 revision of Regulation A. The revised regulation provided that, in considering a
request for credit accommodation, a Reserve
Bank should consider whether the borrowing
member bank "is borrowing principally for the
purpose of obtaining a tax advantage or profiting from rate differentials." The reference to
borrowing for a tax advantage grew out of a
situation during the early 1950's in which member banks were borrowing from their Reserve
Banks in order to avoid higher taxes under the
then-existing excess profits tax. In fact, it was
primarily this development that prompted the
Board to revise its regulation in 1955 in order

194

HISTORY OF LENDING FUNCTIONS

to include a statement of principles regarding
the proper use of Federal Reserve credit.
In recent years, with the rapid development
of the Federal funds market, it has been the
policy of the System to discourage member
banks from being net sellers of Federal funds
while borrowing from a Reserve Bank. As
stated in the Report of a System Committee
in July 1968, this restriction is intended "to
preclude a large day-to-day retailing operation
in Federal Reserve credit obtained through
the discount window." "

CONTINUOUS BORROWING
In an earlier chapter it was noted that in
1920 the Federal Reserve Act was amended to
provide for progressive discount rates as a
deterrent to continuous borrowings by member
banks. Although that expedient was not effective and the amendment was later repealed, the
System has consistently emphasized a policy of
discouraging continuous borrowings. The reasons for that policy were set forth in the Board's
1926 Annual Report." In 1952 Chairman
Martin stated that "continuous indebtedness to
the Reserve Banks should be avoided." " When
Regulation A was revised in 19SS, it contained
a statement that, under "ordinary circumstances, the continuous use of Federal Reserve
credit by a member bank over a considerable
period of time is not regarded as appropriate." 1S
One of the reasons for the policy against
continuous borrowing apparently has been that
it could be inconsistent with the provisions of
paragraph 8 of section 4 of the Federal Reserve
Act that require the board of directors of a
Reserve Bank to administer the Bank's affairs
"fairly and impartially and without discrimination in favor of or against any member bank
or banks" and, in extending credit accommodations, to give due regard to "the claims and
demands of other member banks." Presumably,
it was felt that continued and excessive loans to
a particular member bank "would not be fair
to the other member banks which may be active
competitors of the borrowing member bank." "
Another reason for the policy against continuous borrowing is that it could impair the
ability of the borrowing member bank in case of


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Federal Reserve Bank of St. Louis

insolvency to meet its obligations to depositors;
in other words, it would not be consistent with
prudent banking practice. Still another reason
for the policy is that extended borrowings by a
member bank from its Reserve Bank would in
effect constitute a use of Federal Reserve credit
as a substitute for the member bank's capital.
Thus, the 1973 revision of Regulation A states,
as a general principle, that "Federal Reserve
credit is not a substitute for capital and ordinarily is not available for extended periods."
It should be noted that this principle is qualified by the word "ordinarily" and that, as indicated later, it is not intended to preclude borrowings for extended periods in order to meet
unusually long seasonal needs of member banks
or to assist member banks in emergency
circumstances.

SHIFT IN EMPHASIS
The principles just discussed with respect to
inappropriate uses of Federal Reserve credit are
still being followed. Nevertheless, there has
been evidence in recent years of a tendency to
place less emphasis on inappropriate borrowings and to give greater emphasis to the use of
Federal Reserve credit for appropriate purposes.
When Regulation A was revised in 1955,
one of the objectives was to reinforce a limited
use of the discount window; at that time most
member banks were in heavily liquid positions,
and it was felt that banks should resort to Reserve Bank credit only on a short-term basis
when other sources of funds fell short of their
appropriate needs.17 Thus, although the revision
referred briefly to extension of Federal Reserve
credit on a short-term basis to enable a member
bank to adjust its asset position when necessary
and to the availability of such credit for longer
periods to meet unusual situations, it emphasized the fact that access to the discount window
was a privilege of membership and that continuous use of Federal Reserve credit, as well as
borrowing to obtain a tax advantage or to profit
from rate differentials, was inappropriate.
The 1968 Report of a System Committee
evidenced a subtle change in attitude. It began
with a statement that the redesign of the discount window proposed by that committee ha

GENERAL PRINCIPLES: A SUMMARY
as its chief objective "increased use of the
discount window." IS In 1968 member banks
were in a much less liquid position than they
had been in 1955, and the revision of Regulation A that grew out of the committee's recommendations included more liberal provisions

195

for seasonal credit for extended periods of time.
In brief, the 1968 proposal, as well as the 1973
revision of the regulation, reflected an intent to
encourage greater use of the discount window.
Further indications of this shift in policy will be
mentioned in later sections of this chapter.

APPROPRIATE USES OF FEDERAL RESERVE CREDIT
SHORT-TERM
ADJUSTMENT CREDIT
As a general principle, one of the most appropriate uses of Federal Reserve credit is to
enable member banks to make short-term adjustments in their reserve positions. The 1968
Report of a System Committee stated that "one
of the basic functions of the Federal Reserve
System has been to provide temporary additions
to commercial bank reserves through loans to
member banks, in order to cushion the process
of adjustment within the financial mechanism." »
The foreword to the 1955 revision of Regulation A provided:
Federal Reserve credit is generally extended on a short-term basis to a member
bank in order to enable it to adjust its asset
position when necessary because of developments such as a sudden withdrawal of deposits or seasonal requirements for credit
beyond those which can reasonably be met
by use of the bank's own resources.
The revision of the regulation adopted in 1973
contemplates that loans to member banks to
meet seasonal requirements for credit might be
on a longer-term basis than ordinary adjustment credit loans. With respect to adjustment
credits, the regulation provides:
Federal Reserve credit is available on a
short-term basis to a member bank, under
such rules as may be prescribed, to such
extent as may be appropriate to assist such
bank in meeting temporary requirements for
funds or to cushion more persistent outflows


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Federal Reserve Bank of St. Louis

of funds pending an orderly adjustment of the
bank's assets and liabilities.
Since the beginning of the System, it has been
contemplated that each Federal Reserve extension of credit normally will mature over a short
period of time. The original Act authorized the
discounting of commercial paper for member
banks only if it had a maturity of not more than
90 days at the time of discount. Under subsequent amendments to the Act, advances to
member banks in general may be made only for
periods of not more than 90 days. An exception
has been made with respect to agricultural
paper, which, under present law, is eligible for
discount if it has a maturity of not more than
9 months at the time of discount.
It has already been noted that amendments to
the law have authorized loans to member banks
on any satisfactory security for periods up to
4 months, but only at a penalty interest rate.
Loans with maturities of up to 5 years to commercial and industrial businesses were authorized in 1934 but that authority was repealed
in 1958.
In general, therefore, advances to member
banks at the discount rate may not be made
with maturities of more than 90 days. Moreover, a Reserve Bank cannot legally commit
itself to renew a loan at maturity although
it may indicate that it will give sympathetic
consideration to a requested renewal in certain
circumstances.
Even though loans may be made to member
banks for up to the maximum maturity permitted by the law, it has been the policy of the
System to limit maturities according to the

196

HISTORY OF LENDING FUNCTIONS

individual bank's circumstances; as a matter of
general practice, loans to member banks for
adjustment purposes usually are made to mature in less than 30 days, with renewals as
necessary. Also as a matter of practice, some
member banks, particularly the larger banks,
prefer to keep the maturity of their borrowings
to 1 or 2 days in order to have flexibility in
managing their reserve accounts.

SEASONAL CREDIT
As previously indicated, the 1955 revision of
Regulation A stated that Federal Reserve credit
would be extended on a short-term basis in
order to enable a member bank to adjust its
asset position when necessary because of developments such as a sudden withdrawal of
deposits or seasonal requirements for credit
beyond those that could reasonably be met by
use of the bank's own resources. That language
would suggest that all Reserve Bank loans to
meet the seasonal credit requirements of member banks are for short periods of time.
In 1968, however, the System Committee
studying the discount mechanism proposed that
arrangements be permitted under which seasonal credit accommodations might be extended
to a member bank for such period of time as
would be necessary to enable the bank to meet
such needs. This is another instance in which
the Board's attitude in recent years toward use
of the discount window apparently has become
more liberal than the attitude reflected in 1955.
The recommendations of the System Committee in 1968 with respect to a seasonal borrowing privilege were reflected in the revision
of Regulation A adopted by the Board in 1973.
Under the new regulation, Federal Reserve
credit is available to a member bank that "lacks
reasonably reliable access to national money
markets" in order to assist it in meeting seasonal
needs if the credit is arranged in advance and
if the Reserve Bank is satisfied that such needs
will persist for at least eight consecutive weeks.
The revision contemplates that, although a Reserve Bank could not make an advance for
more than 90 days, it would normally be pre-


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Federal Reserve Bank of St. Louis

pared to consider further credit extensions if the
member bank's seasonal needs should persist
beyond that period. As a limitation upon such
a seasonal borrowing privilege, the new regulation limits seasonal credit in ordinary circumstances to the amount by which the borrowing
bank's seasonal needs exceed 5 per cent of its
average total deposits in the preceding calendar
year.

EMERGENCY CREDIT
In addition to short-term adjustment credit
and longer-term seasonal credit, it is an accepted principle that a Reserve Bank may extend credit to a member bank in unusual or
emergency situations and, if need be for that
purpose, for extended periods of time. The
1968 Report of a System Committee stated
that the Federal Reserve System "has a clear
responsibility to lend to member banks in both
isolated and widespread emergency situations"
and that this constitutes one of the benefits of
Federal Reserve membership.20
The 1955 revision of Regulation A stated
that Federal Reserve credit was available "when
necessary in order to assist member banks in
meeting unusual situations, such as may result
from national, regional, or local difficulties or
from exceptional circumstances involving only
particular member banks." Similarly, the revision of the regulation adopted in 1973 states
as a general principle that "Federal Reserve
credit is available to assist member banks in
unusual or emergency circumstances such as
may result from national, regional, or local
difficulties or from exceptional circumstances
involving only a particular member bank."
It has been recognized that in most cases in
which member banks require emergency credit
from the Reserve Banks, the credit will be
required for a period longer than would be
permitted under the ordinary rules of the discount window. Even so, if the member bank s
difficulties arise from an internal problem, it
may be necessary for the Reserve Bank to
arrange a daily maturity for the loan so that it
may follow the member bank's progress
throughout the borrowing span.

GENERAL PRINCIPLES: A SUMMARY

197

LENDER OF LAST RESORT
The original Federal Reserve Act contemplated that Federal Reserve credit would be
extended only to member banks, although a
provision of the Act apparently envisaged the
possibility of indirect extension of credit to a
nonmember bank through the medium of a
member bank if approved by the Board.
Over the years, as has been noted in this
study, the Act has been amended to authorize
the Reserve Banks to make loans directly to
individuals, partnerships, and corporations on
the security of U.S. Government and agency
obligations or, in exigent or unusual circumstances, on the security of paper that would be
eligible for discount in the hands of a member
bank. The nature of these special authorizations
has been discussed in detail in earlier chapters.
As noted, the authority to make direct loans
to business enterprises and any other corporations in unusual or exigent circumstances was
utilized for several years during the 193O's,
although not to any great extent. In 1966 and
again in 1969, the Board took measures under
which the Reserve Banks were placed in a
position, if it became necessary, to extend credit
directly to nonmember banks and other depositary-type financial institutions such as savings and loan associations.
In recent years, it has become customary to
refer to the Federal Reserve System as the
lender of last resort to all segments of the
economy. Thus, the 1968 System Committee
Report stated: "

The role of the Federal Reserve as the
"lender of last resort" to other financial sectors of the economy may, under justifiable
circumstances, require loans to institutions
other than member banks. The apparent general approval of recent instances of lending
and offering to lend to nonmember institutions has strengthened the belief that the
System's ability to carry out this function
should be readily available for use when
needed. In contrast to the case of member
banks, however, justification for Federal Reserve assistance to nonmember institutions
must be in terms of the probable impact of
failure on the economy's financial structure.
It would be most unusual for the failure of a
single institution or small group of institutions to have such significant repercussions as
to justify Federal Reserve action.

The 1955 revision of Regulation A, while
referring to extensions of credit to member
banks in exceptional circumstances, contained
no reference to the extension of emergency
credit to others. In contrast, the revision of the
regulation adopted in 1973 expressly provides
for the extension of Federal Reserve credit to
individuals, partnerships, and corporations in
emergency circumstances on the security of
U.S. Government obligations if, in a Reserve
Bank's judgment, "credit is not practicably
available from other sources and failure to
obtain such credit would adversely affect the
economy."

PROTECTION OF RESERVE BANKS
Although the Reserve Banks are organized
and operated for public purposes and not for
profit, their operations are nevertheless like
those of commercial banks to the extent that


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Federal Reserve Bank of St. Louis

they have stockholders and directors and are
expected to conduct their business on a sound
basis. Their loans are made on a businesslike
basis—with interest and with security.

198

HISTORY OF LENDING FUNCTIONS

The discount provisions of the original Federal Reserve Act required—and still require—
that paper offered by member banks for discount be endorsed by the borrowing member
bank, thus affording the lending Reserve Bank
recourse against the member bank.22 When the
law was amended to authorize advances to
member banks on their own notes, such advances were required to be secured, at first by
paper eligible for discount or Government obligations and later by any paper eligible for
discount or for purchase by the Reserve Banks.
In 1932 the Reserve Banks were authorized to
make advances to member banks on any security satisfactory to the lending Reserve Bank.
Loans to individuals, partnerships, or corporations must be secured by obligations of the
United States or agencies of the United States
if credit is extended under the thirteenth paragraph of section 13; or if, under that paragraph,
emergency loans are made on eligible paper,
the paper must be endorsed or otherwise secured to the satisfaction of the Reserve Bank.
In brief, it has always been understood that
the Reserve Banks should make only loans that
are adequately secured. At one time the Board's
Regulation A specifically authorized the Reserve Banks to require additional collateral
when deemed desirable. The 1955 revision,
however, stated that a Reserve Bank in general
should limit such collateral to "the minimum
consistent with safety," and the 1973 revision

provides that a Reserve Bank should "require
only such amount of collateral as it deems necessary or desirable."
The Board's regulation until recent years
required that commercial or agricultural paper
offered for discount or as collateral for advances
should be negotiable. Although some added
protection was afforded by negotiability, this
requirement was eliminated in 1970, partly in
recognition of the increasing practice of making
interest on notes dependent on changes in the
prime rate—a practice that made the notes
nonncgotiablc in a technical sense. Shortly
afterward, the Board amended its regulation to
permit advances to member banks pursuant to
lending agreements already in effect without the
execution of a traditional promissory note in
connection with each advance.
From these changes in practice emerged the
concept that the Reserve Banks, while they
should make only sound and well-secured loans,
should be allowed to extend credit, in the public
interest, without having to take all possible
precautions to avoid loss. In some instances,
it may be difficult to ascertain how far a Reserve
Bank should go in extending credit to member
banks (or to others) when the borrower is in
a difficult situation and the Reserve Bank would
be subject to possible loss. In such cases, there
is a delicate balance between avoidance of loss
and the desirability of preserving the financial
stability of the borrower.

DISCRETION OF FEDERAL RESERVE BANKS

LEGISLATIVE INTENT
A fundamental principle underlying the lending authority of the Federal Reserve Banks is
that this authority is purely discretionary. A
Reserve Bank is not obliged or required to
extend credit in any particular case, even though
the loan may be for a purpose contemplated by
the law and may be secured by eligible paper.


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Federal Reserve Bank of St. Louis

The Reserve Bank may refuse to make a loan
if it is not satisfied as to the soundness of the
loan or if it believes that the loan would result
in an improper use of Federal Reserve credit
that would be inconsistent with the general
principles heretofore mentioned. In the final
analysis, the decision in each case rests in the
judgment of the Federal Reserve Bank.

GENERAL PRINCIPLES: A SUMMARY
So well established is the discretionary nature
of the lending authority of the Reserve Banks
that it is now almost impossible to believe that
the framers of the original Federal Reserve Act
came very close to making it mandatory. Senator Hitchcock, who led the minority section of
the Senate Banking and Currency Committee,
had urged that a member bank should be
entitled as of right to obtain discounts at least
up to the amount of its capital stock.23 In support of this proposal, it was argued that if the
lending authority were discretionary, a Reserve
Bank might refuse to extend credit for any of
the plausible reasons that bankers are in the
habit of giving; :t that if a member bank were
required to carry reserves with its Federal Reserve Bank, it was only right that it should be
entitled to discounts in time of need up to the
amount of its capital stock; M and finally, that
mandatory discounting of eligible paper would
insure an adequate supply of the new Federal
Reserve currency that was expected to be issued
on the basis of such paper.26
In opposition to these arguments, the majority section of the Senate committee led by
Senator Owen pointed out that "many unlooked-for conditions" might arise that would
make it unwise to compel the Reserve Banks to
discount paper in particular cases even though
legally eligible for discount;27 also, that the
eligibility of paper offered for discount should
be only the first step and that the law should
not take away from the directors of a Reserve
Bank the right to investigate the soundness of
that paper.5" In answer to arguments that compulsory discounting would prevent discrimination between member banks, advocates of the
Owen bill pointed to the provision of that bill
that required the directors of each Reserve
Bank to administer its affairs "fairly and impartially and without discrimination in favor of
or against any member bank or banks." Senator
Shafroth explained: *•
• • * We thought that [the compulsory
discount provision of the Hitchcock bill] was
too extreme a provision; it was thought wise
that there might be conditions of the bank
that would not justify the discounting of its


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Federal Reserve Bank of St. Louis

199

paper. For that reason we put in a clause,
which to a large extent is advisory to them,
but which, nevertheless, indicates the policy
that should be pursued by them in making
these discounts where they fairly can.
Senator Pomerene likewise felt that the provision of the Owen bill would adequately prevent discrimination.30 He, as well as Senator
Owen, pointed out that, in view of this provision, any member bank that felt it had been
discriminated against could appeal to the Federal Reserve Board. In this connection, Senator
Owen made the following succinct statement
regarding the contemplated relationship between the Board and the Federal Reserve
Banks: "
I take it that the Federal reserve board,
under its general supervisory control of the
system, would have a right to hear such a
complaint, to call the attention of the board
of directors to the complaint, and exact of
them fair treatment of the member bank who
might have been discriminated against; but I
do not take it that the Federal reserve board
would pass upon the question of the security
or upon the particular transaction or take it
out of the hands of the local board. It would
only instruct them to discharge their duty
properly under the provisions of the bill.
In the end, Senator Hitchcock's amendment
to substitute his compulsory-discount provision
for the Owen bill's nondiscrimination provision
was defeated by a close vote of 37 to 31. 32
The provision of the Owen bill was accepted
by the conference committee and became a part
of the original Act.
In keeping with its rejection of the Hitchcock
proposal for mandatory discounts, Congress has
deliberately used permissive language in provisions of the Federal Reserve Act relating to
this subject. For example, the word "may" is
used in those provisions that deal with discounts
of commercial and agricultural paper, discounts
of bankers' acceptances, advances on Government obligations, and advances under section
lO(b) on any satisfactory security. Moreover,
the Supreme Court of the United States has
stated that the word "may," as used in the Federal Reserve Act, is not to be construed as

200

HISTORY OF LENDING FUNCTIONS

"shall," since "throughout the act the distinction
is clearly made between what the Board and the
reserve banks 'shall' do and what they 'may'
do." 3:i In this connection, it is significant that
when the eighth paragraph of section 4 of the
Federal Reserve Act was amended by the Banking Act of 1933, the language of that paragraph
relating to extensions of Federal Reserve credit
was rephrased to change the word "shall" to
"may."

RECOGNITION BY THE BOARD
The principle that the Federal Reserve
Banks must exercise their own judgment and
discretion in deciding whether to discount paper
for member banks was recognized by the Federal Reserve Board in the early years of the
System. In 1920 the Board ruled that, even
though paper might be legally eligible for discount, a Federal Reserve Bank was under no
obligation to discount such paper, but might
accept it or refuse it "in the exercise of its discretionary power." 31 In the same year the
Board held that, although a banker's acceptance
might be technically eligible for discount, a
Federal Reserve Bank might, in its discretion,
decline to discount the acceptance on the ground
that it was not a desirable investment.3'1
The Board's 1955 revision of Regulation A
specifically referred to access to the Federal
Reserve discount window as "a privilege of
membership in the Federal Reserve System"
and stated that applications for credit accommodation are considered by a Reserve Bank "in
the light of its best judgment" in conformity
with the principles stated in the regulation and
with the provisions of the law.

JUDICIAL CONFIRMATION
In 1929 the discretion of the Reserve Banks
in granting discount accommodations was judicially confirmed by a Federal Circuit Court of
Appeals. In Raichle v. Federal Reserve Bank of
New York,3" suit had been brought to enjoin
the Reserve Bank from engaging in open market operations, declining to discount eligible
paper, and raising the discount rate. Specifically,
it was charged that the Reserve Bank had


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Federal Reserve Bank of St. Louis

wrongfully refused to discount paper for certain
member banks unless they liquidated loans to
brokers. The suit was dismissed because the
Federal Reserve Board, as an indispensable
party, had not been joined. The court pointed
out, however, that a Federal Reserve Bank "is
not under any compulsion to rediscount eligible
paper, for the words of the act in respect to
rcdiscounling arc wholly permissive." With respect to the charge that the Reserve Bank had
wrongfully coerced member banks to call collateral loans by refusing to discount eligible
paper for such banks, the court declared: "Such
a refusal was not a wrong, because no provision
of the act requires the [Federal Reserve] bank
to discount unless so ordered by the Board."
[Emphasis in original.] The court's use of the
words "unless so ordered by the Board" could
be misleading. The only provision of law under
which a Reserve Bank may be ordered by the
Board to extend credit is that contained in
section 11 (b) of the Federal Reserve Act,
which authorizes the Board to require a Reserve Bank to rediscount the discounted paper
of another Reserve Bank. As a matter of law,
the Board cannot require any Reserve Bank to
make loans to member banks or to individuals,
partnerships, and corporations.

QUASI-AUTOMATIC ACCESS TO
FEDERAL RESERVE CREDIT
In July 1968 a System Committee proposed a
redesign of the Federal Reserve discount window, a major feature of which was a suggestion
that member banks be given a "basic borrowing
privilege." Under that proposal, a Reserve
Bank would extend credit on a virtually automatic basis to member banks within certain
limitations on amounts and frequency of borrowing. It was contemplated that such an arrangement would enable member banks to use
the discount window more readily when they
needed funds for short-term adjustment purposes and that this privilege would be particularly attractive to the great majority of small
member banks that were making no recourse
to the discount window." This proposal, however, has not been implemented by the Board.

GENERAL PRINCIPLES: A SUMMARY

201

THE BASIC PRINCIPLE:
ECONOMIC STABILITY AND GROWTH
Underlying all of the general principles discussed in this chapter is the basic objective
of utilizing Federal Reserve credit facilities to
assure a sound financial system and to promote
economic stability and growth.
Thus, the foreword to the Board's 1955 revision of Regulation A stated, with respect to
the discount function of the Reserve Banks,
that it "is administered in the light of the
basic objective which underlies all Federal Reserve credit policy, i.e., the advancement of the
public interest by contributing to the greatest
extent possible to economic stability and
growth."
The revision of Regulation A adopted in
1973 specifically states that the lending functions of the System "are conducted with due
regard to the basic objectives of the Employment Act of 1946 and the maintenance of a
sound and orderly financial system."
To sum up, the lending functions of the
Reserve Banks, like all other functions of the


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Federal Reserve Bank of St. Louis

Federal Reserve System, are in the nature of
a public trust to be exercised always in the
interest of the general welfare. No better statement of this principle can be found than that
contained in the Board's first Annual Report
to Congress, for the year 1914, when, in discussing the "place and function of the Federal
Reserve Banks in our banking and credit system," the Board said: 3S
* * * It [a Federal Reserve Bank] should
at all times be a steadying influence, leading
when and where leadership is requisite, but
never allowing itself to become an instrument
for the promotion of the selfish interest of
any private or sectional group, be their aims
and methods open or disguised. It should
never be lost to sight that the Reserve Banks
are invested with much of the quality of a
public trust. They were created because of the
existence of certain common needs and interests, and they should be administered for
the common welfare—for the good of all.


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Federal Reserve Bank of St. Louis

Textual Changes in Provisions
of the Federal Reserve Act

EXPLANATION
sion of an intervening paragraph or paragraphs
not affected by an amendment.

The following compilation sets forth provisions
relating to the lending functions of the Federal
Reserve Banks as contained in the original
Federal Reserve Act or in later amendments
to that Act and indicates textual changes in
such provisions made by amendatory statutes.

"Original Act" means the Federal Reserve Act
of December 23, 1913 (38 Stat. 251).

Italics indicate new language inserted or added
°y amendments; cancelled words indicate old
language stricken out.

A bracketed number preceding a paragraph of
a section of the Act indicates the number of
the corresponding paragraph, if any, contained
in that section as of May 1, 1973.

Three asterisks indicate the omission of lanfiuage of a paragraph not changed by a particular amendment; five asterisks indicate the omis-

A bracketed citation at the end of a paragraph
indicates where the paragraph, if still in force,
may be found in the United States Code.


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Federal Reserve Bank of St. Louis

203

204

HISTORY OF LENDING FUNCTIONS


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Federal Reserve Bank of St. Louis

SECTION 4
Original Act
[6]

Every Federal reserve bank shall be conducted under the supervision and control of a board of directors. (12 t'.S.C. § 3011
[7] The board of directors shall perform the duties usually appertaining to the office of directors of banking associations and all
such duties as are prescribed by law. [ 12 I'.S.C. § 301 ]
[8] Said board shall administer the affairs of said bank fairly and
impartially and without discrimination in favor of or against any
member bank or banks and shall, subject to the provisions of law
and the orders of the Federal Reserve Board* extend to each member bank such discounts, advancements and accommodations as
may be safely and reasonably made with due regard for the claims
and demands of other member banks.
Act of June 16,1933 (48 Stat. 162) :
[8]

Said board of directors shall administer the affairs of said bank
fairly and impartially and without discrimination in favor of or
against any member bank or banks and skftH may, subject to the
provisions of law and the orders of the Federal Reserve Board,
extend to each member bank such discounts, advancements, and
accommodations as may be safely and reasonably made with due
regard for the claims and demands of other member banks, the
maintenance of sound credit conditions, and the accommodation of
commerce, industry, and agriculture. The Federal Reserve Board
may prescribe regulations further defining within the limitations of
this Act the conditions under which discounts, advancements, and
the accommodations may be extended to member banks. Each Federal reserve bank shall keep itself informed of the general character
and amount of the loans and investments of its member banks with
a view to ascertaining whether undue use is being made of bank
credit for the speculative carrying of or trading in securities, real
estate, or commodities, or for any other purpose inconsistent with
the maintenance of sound credit conditions; and, in determining
whether to grant or refuse advances, rediscounts or other credit accommodations, the Federal reserve bank shall give consideration to
such information. The chairman of the Federal reserve bank shall
report to the Federal Reserve Board any such undue use of bank credit
by any member bank, together with his recommendation. Whenever,
in the judgment of the Federal Reserve Board, any member bank is
making such undue use of bank credit, the Board may, in its discretion, after reasonable notice and an opportunity for a hearing, suspend
such bank from the use of the credit facilities of the Federal Reserve
System and may terminate such suspension or may renew it from
time to time. [ 12 U.S.C. § 301 ]
* The Banking Act of 1935 provided that sifter the dote of that Art the words "Federal
Reserve Board", wherever they formerly appeared i n the Federal Reserve Act or other acts
of Congress, were chanRed to read "Board of Governors of the Federal Reserve System."

FR ACT: TEXTUAL CHANGES
SECTION 9
Act of June 21,1917 (40 Stat. 232):
I 13 ]

* • * Subject to the provisions of this Act and to the
regulations of the board made pursuant thereto, any bank becoming a member of the Federal Reserve System shall retain its full
charter and statutory rights as a State bank or trust company,
and may continue to exercise all corporate powers granted it by
the State in which it was created, and shall be entitled to all privileges of member banks: Provided, however, That no Federal reserve bank shall be permitted to discount for any State bank or
trust company notes, drafts, or bills of exchange of any one borrower who is liable for borrowed money to such State bank or
trust company in an amount greater than ten per centum of the
capital and surplus of such State bank or trust company, but the
discount of bills of exchange drawn against actually existing value
and the discount of commercial or business paper actually owned
by the person negotiating the same shall not be considered as
borrowed money within the meaning of this section. The Federal
reserve bank, as a condition of the discount of notes, drafts, and
bills of exchange for such State bank or trust company, shall require a certificate or guaranty to the effect that the borrower is
not liable to such bank in excess of the amount provided by this
section, and will not be permitted to become liable in excess of this
amount while such notes, drafts, or bills of exchange are under
discount with the Federal reserve bank.

Act of July 1,1922 (42 Stat. 821):
[13]

* * * Subject to the provisions of this Act and to the regulations of the board made pursuant thereto, any bank becoming
a member of the Federal Reserve System shall retain its full
charter and statutory rights as a State bank or trust company,
and may continue to exercise all corporate powers granted it by
the State in which it was created, and shall be entitled to all
privileges of member banks: Provided, however, That no Federal reserve bank shall be permitted to discount for any State
bank or trust company notes, drafts, or bills of exchange of any
one borrower who is liable for borrowed money to such State
bank or trust company in an amount greater than tea pep
eestwa el &e capital ea4 ewpte* «4 eaea State few* e* 4wet
company, feat the diooount ef feSfe el eseaeage d*ftwa againot
aetwafly exartiftg ^atee ead the diacount el commercial eg h*mnesepapep aetnaHy ewaed by the peraee negotiating &e same
shall ae* fee conoidorod as feewewed flseaey fl4ta» the moaning
el this oootion that which could be borrowed lawfully from such
State bank or trust comvanv were it a national banking association. • • •


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(12 U.S.C. §330]

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SECTION 10(a)
Act of February 27,1932 (47 Stat. 56):
[I]

Sec. 10. (a) Upon receiving the consent of not less than five
members of the Federal Reserve Board, any Federal reserve bank
may make advances, in such amount as the board of directors of
such Federal reserve bank may determine, to groups of five or
more member banks within its district, a majority of them independently owned and controlled, upon their time or demand promissory notes, provided the bank or banks which receive the proceeds of such advances as herein provided have no adequate
amounts of eligible and acceptable assets available to enable such
bank or banks to obtain sufficient credit accommodations from
the Federal reserve bank through rediscounts or advances other
than as provided in section 10(b). The liability of the individual
banks in each group must be limited to such proportion of the
total amount advanced to such group as the deposit liability of the
respective banks bears to the aggregate deposit liability of all
banks in such group, but such advances may be made to a lesser
number of such member banks if the aggregate amount of their
deposit liability constitutes at least 10 per centum of the entire
deposit liability of the member banks within such district. Such
banks shall be authorized to distribute the proceeds of such loans
to such of their number and in such amount as they may agree
upon, but before so doing they shall require such recipient banks
to deposit with a suitable trustee, representing the entire group,
their individual notes made in favor of the group protected by
such collateral security as may be agreed upon. Any Federal
reserve bank making such advance shall charge interest or discount thereon at a rate not less than 1 per centum above its discount rate in effect at the time of making such advance. No such
note upon which advances are made by a Federal reserve bank
under this section shall be eligible under section 16 of this Act as
collateral security for Federal reserve notes. [ 12 U.S.C. § 347a]

[2]

No obligations of any foreign government, individual, partnership, association, or corporation organized under the laws thereof
shall be eligible as collateral security for advances under this
section. [12 U.S.C. § 347a]
[3] Member banks are authorized to obligate themselves in accordance with the provisions of this section. [12 U.S.C. § 347a]
SECTION 10(b)

Act of February 27, 1932 (47 Stat. 56):
[1]

Sec. 10. (b) Until March S, 19SS, and in exceptional and exigent
circumstances, and when any member bank, having a capital of not
exceeding $5,000,000, has no further eligible and acceptable assets

FR ACT: TEXTUAL CHANGES

available to enable it to obtain adequate credit accommodations
through rediscounting at the Federal reserve bank or any other
method provided by this Act other than that provided by section
10(a), any Federal reserve bank, subject in each case to
affirmative action by not less than five members of the Federal
Reserve Board, may make advances to such member bank on its
time or demand promissory notes secured to the satisfaction of
such Federal reserve bank: Provided, That (1) each such note
shall bear interest at a rate not less than 1 per centum per annum
higher than the highest discount rate in effect at such Federal
reserve bank on the date of such note; (2) the Federal Reserve
Board may by regulation limit and define the classes of assets
which may be accepted as security for advances made under authority of this section; and (S) no note accepted for any such advance shall be eligible as collateral security for Federal reserve
notes.
No obligations of any foreign government, individual, partnership, association, or corporation organized under the laws thereof
shall be eligible as collateral security for advances under this
section.
Act of February 3,1933 (47 Stat. 794):
[1]

SEC. 10. (b) Until March 3, +93* 1934, and in exceptional and
exigent circumstances, and when any member bank, having a
capital of not exceeding $5,000,000, has no further eligible and
acceptable assets available to enable it to obtain adequate credit
accommodations through rediscounting at the Federal reserve
bank or any other method provided by this Act other than that
provided by section 10 (a), any Federal reserve bank, subject in
each case to affirmative action by not less than five members of
the Federal Reserve Board, may make advances to such member
bank on its time or demand promissory notes secured to the
satisfaction of such Federal reserve bank: Provided, That (1)
each such note shall bear interest at a rate not less than 1 per
centum per annum higher than the highest discount rate in effect
at such Federal reserve bank on the date of such note; (2) the
Federal Reserve Board may by regulation limit and define the
classes of assets which may be accepted as security for advances
made under authority of this section; and (3) no note accepted
for any such advance shall be eligible as collateral security for
Federal reserve notes.

Act of March 9,1933 (48 Stat. 1):
[1]

SEC. 10t(b). Watil March 87 WMy e»el i/n exceptional and exigent circumstances, and when any member bank? having «
eepitel ei mi exceeding 86,000;000, has no further eligible and
acceptable assets available to enable it to obtain adequate credit


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HISTORY OF LENDING FUNCTIONS


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Federal Reserve Bank of St. Louis

accommodations through rediscounting at the Federal reserve
bank or any other method provided by this Act other than that
provided by section 10(a), any Federal reserve bank, oubjcet in
eaefe. ease *e affirmative actionfey«e* iesa than five members ef
under rules and regulations prescribed by the Federal Reserve
Board, may make advances to such member bank on its time
or demand promiooory notes secured to the satisfaction of such
Federal reserve bank*. Provided; Tfea* ft) e£ach such note shall
bear interest at a rate not less than 1 per centum per annum
higher than the highest discount rate in effect at such Federal
reserve bank on the date of such note-}. {3) tfee Federal Reserve
.D U l t r a

XIIUJr VJ* lUgUJIXlIUIt

TTTTTT© TOTTX UU1IIIU

LIIU LHHwUU t7T

UJJLIJ

which may fee accepted es occuritj' #e* advaneca made under
ciutfionty Or 1*1119 Qcotion j Qnu (07 1^0 fiot© ftocopt*oo IOPftnysiion

advance ahaUfeeeligible ae collateral occurity fef Federal reserve
notes: No advance shall be made under this section after March 3,
1934, or after the expiration of such additional period not exceeding
one year as the President may prescribe.
£?e obligationa ef any foreign government, individual partner
ohip, aooociation, ev corporation organiacd wtder ike iwwe thereof
ohallfeeeligible as collateral oceurit-y ley advanced wmle* tfeis
Act of August 23, 1935 (49 Stat. 684):
[1]

SEC. 10(b). fe cjiccptional a»4 exigent eiroumotancca, and
when a»y member feaRk feas «e further eiigifele a«4 acceptable
aoacto available te enable k *o obtain adequate ered4* ttoeomniedationo through rediacounting a* -tfee Federal rencrvo bank er
a«y etfeef method provided fey tfeis Aet ©tfeer «^a» that f»eyidedfeyocction 4e(a)7 a^ny Federal rReserve bank, under rules
and regulations prescribed by the Federal Reoorve Board of
Governors of the Federal Reserve System, may make advances to
eaefe. any member bank on its time or demand notes having
maturites of not more than four months and which ar,e secured to
the satisfaction of such Federal r.Reserve bank. Each such note
shall bear interest at a rate not less than one-half of 1 per centum
per annum higher than the highest discount rate in effect at
such Federal *.ffeserve bank on the date of such note. No advaftee sfeattfeemade «ftdep tfeb oection afte* Marefe »y 4934r <w
ftfte* 4&e expiration of SMeh additional perietl «et exceeding eae
yeap as 4fee Prcoidcnt may prcoeribe.
[12 U.S.C. § 317b]
SECTION 11

Original Act:
[1]

SEC. 11. The Federal Reserve Board shall be authorized and
empowered: f 12 U.S.C. § 248]

FR ACT: TEXTUAL CHANGES

[3J

(b) To permit, or, on the affirmative vote of at least five members of the Reserve Board to require Federal reserve banks to rediscount the discounted paper of other Federal reserve banks at
rates of interest to be fixed by the Federal Reserve Board.
112 u.&.C § 24S(b) ]
[4] (c) To suspend for a period not exceeding thirty days, and from
time to time to renew such suspension for periods not exceeding
fifteen days, any reserve requirements specified in this Act: Provided, That it shall establish a graduated tax upon the amounts
by which the reserve requirements of this Act may be permitted
to fall below the level hereinafter specified: And provided further,
That when the gold reserve held against Federal reserve notes
falls below forty per centum, the Federal Reserve Board shall
establish a graduated tax of not more than one per centum per
annum upon such deficiency until the reserves fall to thirty-two
and one-half per centum, and when said reserve falls below thirtytwo and one-half per centum, a tax at the rate increasingly of not
less than one and one-half per centum per annum upon each two
and one-half per centum or fraction thereof that such reserve falls
below thirty-two and one-half per centum. The tax shall be paid by
the reserve bank, but the reserve bank shall add an amount equal to
said tax to the rates of interest and discount fixed by the Federal
Reserve Board.

Act of September 7, 1916 (39 Stat. 752):
[14J

(m) Upon the affirmative vote of not less than five of its members
the Federal Reserve Board shall have power, from time to time, by
general ruling, covering all districts alike, to permit member banks to
carry in the Federal reserve banks of their respective districts any portion of their reserves now required by section nineteen of this Act to
be held in their own vaults.

Act of March 3, 1919 (40 Stat. 1314, 1315):
[14]

(m) Upon the affirmative vote of not less than five of its members the Federal Reserve Board shall have powerr front tm*e -toT'inftOy tjy gencftti ptningr covering ftH (HstriGt'O &iiKof to permit mem

her fea»k»1» eaffy 4» the- Federal reserve banks «f their respective
thetneto any portion ef time reocrvco Hew- required by section aiaetee« ef 44MS Aet to fee heJ4 « their -ewa vaults to discount for any
member bank notes, drafts, or bills of exchange bearing the signature
or endorsement of any one borrower in excess of the amount permitted
by section nine and section thirteen of this Act, but in no case to exceed
twenty per centum of the member bank's capital and surplus: Provided,
however, That all such notes, drafts, or bilk of exchange discounted
for any member bank in excess of the amount permitted under such
sections shall be secured by not less than a like face amount of bonds or
notes of the United States issued since April twenty-fourth, nineteen


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HISTORY OF LENDING FUNCTIONS


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Federal Reserve Bank of St. Louis

hundred and seventeen, or certificates of indebtedness of the United
States: Provided further, That the provisions of this subsection (m)
shall not be operative after December thirty-first, nineteen hundred and
twenty.
Act of February 27, 1921 (41 Stat. 1146):
[14]

(m) Upon the affirmative vote of not less than five of its members, the Federal Reserve Board shall have power to permit Federal
reserve banks to discount for any member bank notes, drafts, or
bills of exchange bearing the signature or endorsement of any one
borrower in excess of the amount permitted by section nine 9 and
section thirteen 13 of this Act, but in no case to exceed twenty SO
per centum of the member bank's capital and surplus: Provided,
however, That all such notes, drafts, or bills of exchange discounted
for any member bank in excess of the amount permitted under such
sections shall be secured by not less than a like face amount of
bonds or notes of the United States issued since April twenty fourth,
nineteen hundred ami oevcntecnr 24, 1917, for which the borrower
shall in good faith prior to January 1, 1921, have paid or agreed to
pay not less than the full face amount thereof, or certificates of indebtedness of t»e United States: Provided further, That the provisions of this subsection (m) shall not be operative after December
thirty first, maeteen IHM4I«4 wtd twenty October 31, 1921.

Act of June 16, 1933 (48 Stat. 162, 167):
[14]

(m) Upon the affirmative vote of not less than -five- six of its
members;- the Federal Reserve Board shall have power to pepmit
Federal rocorvo banks i» discount fe* any member bank notoer
«F feiite ef exchange bearing the oignoturc -BF endoraomont
borrowor m oxooec of 4h«- amount permitted 4»y ocetioHo xn vmts a c t j irtTL tit RT9 ??U(H" V J trJttrtrCTi TBTT |TU» t t i i w u t i '

«l th»mombor-bwtj^a e«f»itol B,&4 mrplue: Provided, however, T-htA
«ti Bueh aetcB, dfftfto, m feitieef exchange diiwuiintcd for any memher beak m oxecno «f *}»«• amount permitted under »*H4* eectiona
oOftii o© OOOUPOQ &y "ftOt JC60 vtlfttl ft llKC IflCC fkniOUHb t t l tMJtlCltl O r
Tinf nn nf f)i/> TI^^^J

G*«4.«« z

~J *±lnjnn \

nmtj\

OJ

t n i *?

tn

ilUUUJ T7T uaivf C711IVUU OUllUU iWOtTCTT ENflvt? /TjTTtt £ i f x*TTTy I V
* w DO PFO W C F BflQll if! ^OOu I (lit-1) pWOI*1 x©1 »7ftWUftfy xr l v c l f ftflVC

^F &EPCCu *© •pfty fto* lco& viiftn tflc lull face amount thcrcoif w

tificoteo -ef mdebtcdncoe «(• the tWted Stete«« Provided farther?
¥hat 4he provieiona «f *W& aubocotion (m) «kaH -nefc be operative
after October Hj ^Si- fix from time to time for each Federal reserve
district the percentage of individual bank capital and surplus which
may be represented by loans secured by stock or bond collateral made
by member banks within such district, but no such loan shall be made
by any such bank to any person in an amount in excess of 10 per centum
of the unimpaired capital and surplus of such bank. Any percentage so
fixed by the Federal Reserve Board shall be subject to change from
time to time upon ten days' notice, and it shall be the duty of the Board

FR ACT: TEXTUAL CHANGES
to establish such percentages with a view to presenting the undue use
of bank loans for the speculative carrying of securities. The Federal
Reserve Board shaU have power to direct any member bank to refrain
from further increase of its loans secured by stock or bond collateral for
any period up to one year under penalty of suspension of all rediscount
privileges at Federal reserve banks.
Aci of August 23, 1935 (49 Stat 684, 713):
[14]

(m) Upon the affirmative vote of not less than six of its members the Federal- Rocorvo Board of Governors of the Federal Reserve
System shall have power to fix from time to time for each Federal
reserve district the percentage of individual bank capital and surplus which may be represented by loans secured by stock or bond
collateral made by member banks within such district, but no such
loan shall be made by any such bank to any person in an amount
in excess of 10 per centum of the unimpaired capital and surplus
of such bank; Provided, That with respect to loans represented by
obligations in the form of notes secured by not less than a like amount
of bonds or notes of the United Slates issued since April 24, 1917, certificates of indebtedness of the United States, Treasury bills of the
United Stales, or obligations fully guaranteed both as to principal and
interest by the United States, such limitation of 10 per centum on loans
to any person shall not apply, but Slate member banks shall be subject
to the same limitations and conditions as are applicable in the case of
national banks under paragraph (8) of section 6200 of the Revised
Statutes, as amended {U. S. C, Supp. VII, title 12, sec. 84). Any
percentage so fixed by the Federal Rocorvo Board of Governors of
the Federal Reserve System shall be subject to change from time
to time upon ten days' notice, and it shall be the duty of the Board
to establish such percentages with a view to preventing the undue
use of bank loans for the speculative carrying of securities. The
Federal RoDorvo Board of Governors of the Federal Reserve System
shall have power to direct any member bank to refrain from further
increase of its loans secured by stock or bond collateral for any
period up to one year under penalty of suspension of all rediscount
privileges at Federal reserve banks.

Act of June 12, 1945 (59 Stat. 237):
[4]

(c) * * * And provided further, That when the geW- reserve
held against Federal reserve notes falls below ferty- 25 per centum,
the Board of Governors of the Federal Reserve System shall establish a graduated tax of not more than em / per centum per annum
upon such deficiency until the reserves fall to thirty-two «ftd wtebftif 20 per centum, and when said reserve falls below thirty• twe
£^4 one half 20 per centum, a tax at the rate increasingly of not
less than em «H«1 one half 1 1/2 per centum per annum upon each
twe <H«J WU' half 2 1/2 per centum or fraction thereof that such
reserve falls below thirty twe awd one half 20 per centum. The tax


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HISTORY OF LENDING FUNCTIONS


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Federal Reserve Bank of St. Louis

shall be paid by the *tfeserve bank, but the p/iJeserve bank shall
add an amount equal to said tax to the rates of interest and discount fixed by the Board of Governors of the Federal Reserve
System.
Act of September 9, 1959 (73 Stat. 487, 488):
[14]

(m) * * * Provided, That with respect to loans represented
by obligations m the lf>H« «rf notcn secured by not less than a like
amount of bonds or notes of the United States issued since
April 24, 1917, certificates of indebtedness of the United States,
Treasury bills of the United States, or obligations fully guaranteed both as to principal and interest by the United States, such
limitations of 10 per centum on loans to any person shall not
apply, but State member banks shall be subject to the same limitations and conditions as arc applicable in the case of national banks
under paragraph (8) of section 5200 of the Revised Statutes, as
amended (U.S.C., Supp. VII, title 12, sec. 84). * * *
112 U.S.C. §248(in)]

Act of March 18, 1968 (82 Stat. 50):
[4]

(c) To suspend for a period not exceeding thirty days, and from
time to time to renew such suspension for periods not exceeding
fifteen days, any reserve requirements specified in this Act-!
Provided, That tt nhn.ll e.*tabli.<hftgratkitt Uti tft* »f*m the amounts
by- which the reserve requirement:* *4 44H* A<»t mnyfeepermitted
t» f«4i below the level hereinafterrt|K'fifietl-iAH4 prowled further,
l O l o i

TV 11 P i t

| |\pi

I'f

if f c l*Vll

I I f 1 I l\

n i f H t'-- * *

TJ**JT. J I JT. . . . ^ I

TTTTTD ^TTTCTT LI1U I L.1V.I I T5 TTnTT CICI1111'111 Jr \j\i\.t

im, . n m i j t

|W1 I J l l *

II t I X. «' I I T \.' T"**.^- «™

below 3© per w n t u m , 44te Board *4 Governors «tf 44te
Tt-wcrvc Sy.ntem nhall c.<tnbli.<h ft griwhinted t«H* «f « o t more

4- pev eetitum per annum upon ;Hieh defifk'iiey »»tH *4M> rc.'ci'
fall to 39 pa* centum, «t«4 when ;*»H4 I't-.x-rve ftttt^ below 39
pcntum, « tftsft*44w* » t e inert-tmcly »f «trt I m t4«m + 4-/3
v , ^ i n u n i

pCT

TTTTTTTmT

U jmil

I l i t 11

— T / "S

J^t X

I tMll'Ufft

t 7 r I f I I I . Ll*'*«

thereof ti«rt rtm4t rcnervc fftHr» below 39 -p*** centum. ¥i*e tftx »kftH
feepftkifey 44te Itc;<crvo bank ; t»trt 44wi Ue;U'fve bank s4tftH «tkl ft«
amount etttial *« H«t44 ttn* +« *4*e i-tttw «>f in(oi'O;'t ft«d discount
fixedfey*b« Boni'il «rf Governors «f the Federal Keocrvc System••
[12 U.S.C. §24S(c)]
SECTION 13
Original Act
[2]

Upon the indorsement of any of its member banks, with a
waiver of demand, notice and protest by such bank, any Federal
reserve bank may discount notes, drafts, and bills of exchange
arising out of actual commercial transactions; that is, notes,
drafts, and bills of exchange issued or drawn for agricultural, in-

FR ACT: TEXTUAL CHANGES

[6]

[5]

[7]

[9]

[10]

dustrial, or commercial purposes, or the proceeds of which have
been used, or are to be used, for such purposes, the Federal Reserve Board to have the right to determine or define the character of the paper thus eligible for discount, within the meaning of
this Act. Nothing in this Act contained shall be construed to prohibit such notes, drafts, and bills of exchange, secured by staple
agricultural products, or other goods, wares, or merchandise from
being eligible for such discount; but such definition shall not include notes, drafts, or bills covering merely investments or issued
or drawn for the purpose of carrying or trading in stocks, bonds, or
other investment securities, except bonds and notes of the Government of the United States. Notes, drafts, and bills admitted to
discount under the terms of this paragraph must have a maturity
at the time of discount of not more than ninety days: Provided,
That notes, drafts, and bills drawn or issued for agricultural purposes or based on live stock and having a maturity not exceeding six months may be discounted in an amount to be limited to a
percentage of the capital of the Federal reserve bank, to be ascertained and fixed by the Federal Reserve Board.
Any Federal reserve bank may discount acceptances which are
based on the importation or exportation of goods and which have
a maturity at time of discount of not more than three months, and
indorsed by at least one member bank. The amount of acceptances so discounted shall at no time exceed one-half the paid-up
capital stock and surplus of the bank for which the rediscounts
are made.
The aggregate of such notes and bills bearing the signature or
indorsement of any one person, company, firm, or corporation rediscounted for any one bank shall at no time exceed ten per
centum of the unimpaired capital and surplus of said bank; but
this restriction shall not apply to the discount of bills of exchange
drawn in good faith against actually existing values.
Any member bank may accept drafts or bills of exchange drawn
upon it and growing out of transactions involving the importation
or exportation of goods having not more than six months sight to
run; but no bank shall accept such bills to an amount equal at any
time in the aggregate to more than one-half its paid-up capital
stock and surplus.
Section fifty-two hundred and two of the Revised Statutes of
the United States is hereby amended so as to read as follows:
No national banking association shall at any time be indebted,
or in any way liable, to an amount exceeding the amount of its
capital stock at such time actually paid in and remaining undiminiehed by losses or otherwise, except on account of demands of
the nature following:
Fifth. Liabilities incurred under the provisions of the Federal
Reserve Act.
The rediscount by any Federal reserve bank of any bills receivable and of domestic and foreign bills of exchange, and of


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HISTORY OF LENDING FUNCTIONS


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Federal Reserve Bank of St. Louis

acceptances authorized by this Act, shall be subject to such restrictions, limitations, and regulations as may be imposed by the
Federal Reserve Board.
Act of March 3,1915 (38 Stat. 958):
[6]

Any Federal reserve bank may discount acceptances which
are based on the importation or exportation of goods and which
have a maturity at time of discount of not more than three
months? and indorsed by at least one member bank. The
amount of acceptances so discounted shall at no time exceed onehalf the paid up and unimpaired capital stock and surplus of
the bank for which the rediscounts are made, except by authority
of the Federal Reserve Board, under such general regulations as
said board may prescribe, but not to exceed the capital stock and
surplus of such bank.
•

[7]

•

•

•

•

Any member bank may accept drafts or bills of exchange drawn
upon it and growing out of transactions involving the importation or exportation of goods having not more than six months'
sight to run; but no bank shall accept such bills to an amount
equal at any time in the aggregate to more than one-half of its
paid-up and unimpaired capital stock and surplus, except by
authority of the Federal Reserve Board, under such general regula~
tions as said board may prescribe, but not to exceed the capital stock
and surplus of such bank, and such regulations shall apply to all
banks alike regardless of the amount of capital stock and surplus.

Act of September 7,1916 (39 Stat. 752):
[2]

Upon the indorsement of any of its member banks, w*tfe which
shall be deemed a waiver of demand, notice and protest by such
bank as to its own indorsement exclusively, any Federal reserve
bank may discount notes, drafts, and bills of exchange arising
out of actual commercial transactions; that is, notes, drafts, and
bills of exchange issued or drawn for agricultural, industrial, or
commercial purposes, or the proceeds of which have been used,
or are to be used, for such purposes, the Federal Reserve Board
to have the right to determine or define the character of the
paper thus eligible for discount, within the meaning of this Act.
Nothing in this Act contained shall be construed to prohibit
such notes, drafts, and bills of exchange, secured by staple agricultural products, or other goods, wares, or merchandise from
being eligible for such discount; but such definition shall not include notes, draft*, or bills covering merely investments or issued
or drawn for the purpose of carrying or trading in stocks, bonds,
or other investment securities, except bonds and notes of the
Government of the United States. Notes, drafts, and bills admitted to discount under the terms of this paragraph must have

FR ACT: TEXTUAL CHANGES
a maturity at the time of discount of not more than ninety days,
exclusive of days of grace: Provided, That notes, drafts, and bills
drawn or issued for agricultural purposes or based on live stock
and having a maturity not exceeding six months, exclusive of
days of grace, may be discounted in an amount to be limited to a
percentage of the capital assets of the Federal reserve bank, to
be ascertained and fixed by the Federal Reserve Board.
[5] The aggregate of such notes, drafts, and bills bearing the signature or indorsement of any one borrower, whether a person, company, firm, or corporation, rediscounted for any one bank shall
at no time exceed ten per centum of the unimpaired capital and
surplus of said bank; but this restriction shall not apply to the
discount of bills of exchange drawn in good faith against actually
existing values.
[6] Any Federal reserve bank may discount acceptances w&efe
are ba3od ©a the importation er exportation el geeds &B4 of the
kinds hereinafter described, which have a maturity at the time
of discount of not more than three months1 tight, exclusive of
days of grace, and which are indorsed by at least one member
bank. 3%e amount el aeeoptaneco ae dioeountod ebaH a* ae
time e*eee4 one half tfee paid-op *R4 unimpaired eapital eteek
ftHu dUPpiUd Or tUO DGLQEC TO¥ WulOtt Tad POulSOOUOtQ ftfO filftuOj
QTEO&DV "j

UUWJwTIvJr 0 1 T l W 3r"6«Orftl TX©9©TTT5 XTQBTQJ TEXXCTGIT S u O f i

general rcgulationa as said bea*d may- preooribo, but set te
exeeed the capital otoek aad- aurplua el aaeh bank.
[7] Any member bank may accept drafts or bills of exchange
drawn upon it having not more than six months' sight to run, exclusive of days of grace, «nd growing which grow out of transactions
involving the importation or exportation of goods b*vi»g set
mere tbas sis montha' sight te rvm; or which grow out of transactions invoking the domestic shipment of goods provided skipping
documents conveying or securing title are attached at the time of
acceptance; or which are secured at the time of acceptance by a
warehouse receipt or other such document conveying or securing title
covering readily marketable staples. No member bank shall accept,
whether in a foreign or domestic transaction, for any one person,
company, firm, or corporation to an amount equal at any time in
the aggregate to more than ten per cent of its paid-up and unimpaired
capital stock and surplus unless the bank is secured either by attached documents or by some other actual security growing out of the
same transaction as the acceptance b«t and no bank shall accept
such bills to an amount equal at any time in the aggregate to
more than one-half of its paid-up and unimpaired capital stock
and surplus; eseept by authority el « » ftxfc*al Resewe ©ea*^
«*efe geaeffd rogulationo m said beafd- may proooribo, bttt
g
g
k
t
k bk
d
te eseeed tfee capital etoek *ad swpk» et seek beaky
rogulationa shftH apply te «B backs alike rogardlcoa ef the
el capital steek as4
[8] Any Federal reserve bank may make advances to its member


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banks on their promissory notes for a period not exceeding fifteen
days at rates to be established by such Federal reserve banks,
subject to the review and determination of the Federal Reserve
Board, provided such promissory notes are secured by such notes,
drafts, bills of exchange, or bankers' acceptances as are eligible
for rediscount or for purchase by Federal reserve banks under the
provisions of this Act, or by the deposit or pledge of bonds or
notes of the United States.
•

•

•

•

•

[10]

The discount and rediscount and the purchase and sale by any
Federal reserve bank of any bills receivable and of domestic and
foreign bills of exchange, and of acceptances authorized by this
Act, shall be subject to such restrictions, limitations, and regulations as may be imposed by the Federal Reserve Board.

[12]

Any member bank may accept drafts or bills of exchange
drawn upon it having not more than three months' sight to run,
exclusive of days of grace, drawn under regulations to be prescribed by the Federal Reserve Board by banks or bankers in
foreign countries or dependencies or insular possessions of the
United States for the purpose of furnishing dollar exchange as
required by the usages of trade in the respective countries, dependencies, or insular possessions. Such drafts or bills may be
acquired by Federal reserve banks in such amounts and subject
to such regulations, restrictions, and limitations as may be prescribed by the Federal Reserve Board: Provided, however, That
no member bank shall accept such drafts or bills of exchange referred to * this paragraph for any one bank to an amount exceeding in the aggregate ten per centum of the paid-up and unimpaired
capital and surplus of the accepting bank unless the draft or bill
of exchange is accompanied by documents conveying or securing
title or by some other adequate security: Provided further, That
no member bank shall accept such drafts or bills in an amount
exceeding at any time the aggregate of one-half of its paid-up and
unimpaired capital and surplus.

Act of June 21, 1917 (40 Stat. 232):
[7]

Any member bank may accept drafts or bills of exchange drawn
upon it having not more than six months* sight to run, exclusive
of days of grace, which grow out of transactions involving the
importation or exportation of goods; or which grow out of transactions involving the domestic shipment of goods provided shipping
documents conveying or securing title are attached at the time of
acceptance; or which are secured at the time of acceptance by a
warehouse receipt or other such document conveying or securing
title covering readily marketable staples. No member bank shall
accept, whether in a foreign or domestic transaction, for any one

FR ACT: TEXTUAL CHANGES
person, company, firm, or corporation to an amount equal at any
time in the aggregate to more than ten per centum of its paid-up
and unimpaired capital stock and surplus, unless the bank is
secured either by attached documents or by some other actual
security growing out of the same transaction as the acceptance;
and no bank shall accept such bills to an amount equal at any
time in the aggregate to more than one-half of its paid-up and
unimpaired capital stock and surplus: Provided, however, That
the Federal Reserve Board, under such general regulations as it
may prescribe, which shall apply to all banks alike regardless of
the amount of capital stock and surplus, may authorize any member bank to accept such bills to an amount not exceeding at any
time in the aggregate one hundred per centum of its paid-up and
unimpaired capital stock and surplus: Provided, further, That the
aggregate of acceptances growing out of domestic transactions
shall in no event exceed fifty per centum of such capital stock
and surplus. |12 U.S.C. §372]
Act of March 4,1923 (42 Stat. 1454) :
[2]

* * * Nothing in this Act contained shall be construed to prohibit such notes, drafts, and bills of exchange, secured by staple
agricultural products, or other goods, wares, or merchandise from
being eligible for such discount, and the notes, drafts, and bills of
exchange of factors issued as such making advances exclusively to
producers of staple agricultural products in their raw state shall be
eligible for such discount; but such definition shall not include
notes, drafts, or bills covering merely investments or issued or
drawn for the purpose of carrying or trading in stocks, bonds,
or other investment securities, except bonds and notes of the
Government of the United States. Notes, drafts, and bills admitted to discount under the terms of this paragraph must have
a maturity at the time of discount of not more than ninety 90 days,
exclusive of days el grace* Provided, ¥feat notes, drafts aed
biHs draw** e* iaaued for agricultural purpoooo e* baocd ea S*e
eieefe aad beting a maturity ae4 exceeding s k montha, cxoluoivo
et days el gffteer »H>y be diooounted m aa aBae«B* te be faa&ed
t e a porocntttgo el 4he assets el *fee federal pesefve baafe? *» be
ooocrtaiaed and feted by the £ede*al Rcoorvo Beard.
112 U.S.C. §343]
[4]
Upon the indorsement of any of its member banks, which shaU
be deemed a waiver of demand, notice, and protest by such bank
as to Us own indorsement exclusively, and subject to regulations
and limitations to be prescribed by the Federal Reserve Board,
any Federal reserve bank may discount or purchase bills of exchange payable at sight or on demand which are drawn to finance
the domestic shipment of nonperishable, readily marketable staple
agricultural products and are secured by bills of lading or other
shipping documents conveying or securing title to such staples:
Provided, That all such bills of exchange shall be forwarded


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promptly for collection, and demand for payment shall be made
with reasonable promptness after the arrival of such staples at
their destination: Provided further, That no such bill shall in any
event be held by or for the account of a Federal reserve bank for a
period in excess of 90 days. In discounting such bills Federal
reserve banks may compute the interest to be deducted on the
basis of the estimated life of each bill and adjust the discount after
payment of such bills to conform to the actual life thereof.
•

[6]

•

•

•

•

Any Federal reserve bank may discount acceptances of the
kinds hereinafter described, which have a maturity at the time
of discount of not more than three montha' 90 days' sight, exclusive of days of grace, and which are indorsed by at least one
member bank; Provided, That such acceptances if drawn for an
agricultural purpose and secured at the time of acceptance by warehouse receipts or other such documents conveying or securing title
covering readily marketable staples may be discounted with a maturity at the time of discount of not more than six months' sight
exclusive of days of grace.

Act of May 29, 1928 (45 Stat. 975): 112 V.S.C. § 34G|
[4] Upon the indorsement of any of its member banks, which shall
be deemed a waiver of demand, notice, and protest by such bank
as to its own indorsement exclusively, and subject to regulations
and limitations to be prescribed by the Federal Reserve Board,
any Federal reserve bank may discount or purchase bills of
exchange payable at sight or on demand which are drawn *e
finance grow out of the domestic shipment or the exportation of
nonperishable, readily marketable otaplo agricultural produoto
and other staples and are secured by bills of lading or other shipping documents conveying or securing title to such staples: Provided, That all such bills of exchange shall be forwarded promptly
for collection, and demand for payment shall be made with reasonable promptness after the arrival of such staples at their
destination: Provided further, That no such bill shall in any
event be held by or for the account of a Federal reserve bank for
a period in excess of SO ninety days. In discounting such bills
Federal reserve banks may compute the interest to be deducted
on the basis of the estimated life of each bill and adjust the discount after payment of such bills to conform to the actual life
thereof. [12 U.S.C. §344]
Act of April 12, 1930 (46 Stat. 162):
[5] The aggregate of s«eb notes, drafts, and bills fee«4»g *fee sig»etwe ef indorsement el e»y e»e borrower, whether tt pcroon,
company, firm, er corporation upon which any person, copartnership, association, or corporation is liable as maker, acceptor, indorser,

drawer, or guarantor, rediscounted for any ene member bank, shall
at no time exceed 4e» pe* centum ef {he unimpaired capital d

FR ACT: TEXTUAL CHANGES
p
ef said bftaki fe«t *feis fe9teietie» afeftH a«* fkpply t© ^ e
disown* «tfeiHaef exchange drawa m geed faith agama* aetttaHy
existing vahiea iAe amount for which such person, copartnership,
association, or corporation may lawfully become liable to a national
banking association under the terms of section 5200 of the Revised
Statutes, as amended: Provided, however, That nothing in this
paragraph shall be construed to change the character or class of
paper now eligible for rediscount by Federal reserve banks.
112 U.S.C. §345)
Act of May 19,1932 (47 Stat. 1S9):
[8]

Any Federal reserve bank may make advances to its member
banks on their promissory notes for a period not exceeding fifteen
days at rates to be established by such Federal reserve banks,
subject to the review and determination of the Federal Reserve
Board, provided such promissory notes are secured by such
notes, drafts, bills of exchange, or bankers' acceptances as are
eligible for rediscount or for purchase by Federal reserve banks
under the provisions of this Act, or by the deposit or pledge of
bonds or notes of the United States, or by the deposit or pledge
of debentures or other such obligations of Federal intermediate credit
banks which are eligible for purchase by Federal reserve banks
under section ISfa) of this Act.

Act of July 21,1932 (47 Stat. 709):
[3]

In unusual and exigent circumstances, the Federal Reserve
Board, by the affirmative vote of not less than five members, may
authorize any Federal reserve bank, during such periods as the
said board may determine, at rates established in accordance with
the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts,
and bills of exchange of the kinds and maturities made eligible
for discount for member banks under other provisions of this Act
when such notes, drafts, and bills of exchange are indorsed and
otherwise secured to the satisfaction of the Federal reserve bank:
Provided, That before discounting any such note, draft, or bill of
exchange for an individual or a partnership or corporation the
Federal reserve bank shall obtain evidence that such individual,
partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts
for individuals, partnerships, or corporations shall be subject to
such limitations, restrictions, and regulations as the Federal Reserve Board may prescribe.

Act of March 9,1933 (48 Stat. 1):
[13]

Subject to such limitations, restrictions and regulations as the
Federal Reserve Board may prescribe, any Federal reserve bank
may make advances to any individual, partnership or corporation


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on the promissory notes of such individual, partnership or corporation secured by direct obligations of the United States. Such
advances shall be made for periods not exceeding 90 days and shall
bear interest at rates fixed from time to time by the Federal reserve bank, subject to the revieiv and determination of the Federal
Reserve Board.
Act of May 12, 1933 (48 Stat. 31):
[8]

Any Federal reserve bank may make advances to its member
banks on their promissory notes for a period not exceeding fifteen
days at rates to be established by such Federal reserve banks,
subject to the review and determination of the Federal Reserve
Board, provided such promissory notes are secured by such notes,
drafts, bills of exchange, or bankers' acceptances as are eligible for
rediscount or for purchase by Federal reserve banks under the
provisions of this Act, or by the deposit or pledge of bonds or
notes of the United States, or by the deposit or pledge of debentures or other such obligations of Federal intermediate credit
banks which are eligible for purchase by Federal reserve banks
under section 13 (a) of this Act, or by the deposit or pledge of
bonds issued pursuant to the paragraph added to section 32 of the
Federal Farm Loan Act, as amended by section 81 of the Emergency Farm Mortgage Act of 1933.

Act of June 16,1933 (48 Stat. 162):
[8]

Any Federal reserve bank may make advances for periods
not exceedingfifteendays to its member banks on their promissory
notes for a period »©tr exceeding fifteen days at rates to be eatab
fehed fey saefe Federal rcacrvc banks, oubjeefe te the fewew ane*
determination el the Federal Reoervc Board; provided seefe
promiaoory Rotco a*e secured by sraefe notea7 drafta, feiHfl el e*ohange, eg bankcra' accoptanoca tts are eligible lep rcdiocount er
fe* purchaoc fey Federal reserve banka undop the provioiono ef
tfeis A«tj er fey the deposit or pledge of bonds e*, notes, certificates
of indebtedness, or Treasury bills of the United States, or by the
deposit or pledge of debentures or other such obligations of
Federal intermediate credit banks which are eligible for purchase
by Federal reserve banks under section 13(a) of this Act?; and
any Federal reserve bank may make advances for periods not exceeding ninety days to its member banks on their promissory notes
secured by such notes, drafts, bills of exchange, or bankers' acceptances as are eligible for rediscount or for purchase by Federal reserve banks under the provisions of this Act er by -the
dopooit er pledge el bonds iooucd purouanfc te tfee paragraph
added *e acotiea S3 el tfee ¥eaera4 Fa«» kea» Aety as amended
fey section 34- el tfee Emcrgenoy £aw» Mortgage Aefc el 4083.
All such advances shall be made at rates to be established by such

FR ACT: TEXTUAL CHANGES
Federal reserve banks, such rates to be subject to the review and
determination of the Federal Reserve Board. If any member bank
to which any such advance has been made shall, during the life or
continuance of such advance, and despite an official warning of the
reserve bank of the district or of the Federal Reserve Board to the
contrary, increase its outstanding loans secured by collateral in the
form of slocks, bonds, debentures, or other such obligations, or loans
made to members of any organized stock exchange, investment house,
or dealer in securities, upon any obligation, note, or bill, secured or
unsecured, for the purpose of purchasing and/or carrying stocks,
bonds, or other investment securities (except obligations of the
United States) such advance shall be deemed immediately due and
payable, and such member bank shall be ineligible as a borrower at
the reserve bank of the district under the provisions of this paragraph
for such period as the Federal Reserve Board shall determine: Provided, That no temporary carrying or clearance loans made solely
for the purpose of facilitating the purchase or delivery of securities
offered for public subscription shall be included in the loans referred
to in this paragraph.

Act of January 31,1934 (48 Stat. 344):
[8]

Any Federal reserve bank may make advances for periods not
exceeding fifteen days to its member banks on their promissory
notes secured by the deposit or pledge of bonds, notes, certificates
of indebtedness, or Treasury bills of the United States, or by the
deposit or pledge of debentures or other such obligations of Federal intermediate credit banks which are eligible for purchase by
Federal reserve banks under section 13 (a) of this Act, or by the
deposit or pledge of Federal Farm Mortgage Corporation bonds
issued under the Federal Farm Mortgage Corporation Act; and

any Federal reserve bank may make advances for periods not
exceeding ninety days to its member banks on their promissory
notes secured by such notes, drafts, bills of exchange, or bankers'
acceptances as are eligible for rediscount or for purchase by Federal reserve banks under the provisions of this Act. * * *
Act of April 27,1934 (48 Stat. 643):
[8]

Any Federal reserve bank may make advances for periods not
exceeding fifteen days to its member banks on their promissory
notes secured by the deposit or pledge of bonds, notes, certificates
of indebtedness, or Treasury bills of the United States, or by the
deposit or pledge of debentures or other such obligations of Federal intermediate credit banks which are eligible for purchase by
Federal reserve banks under section 13 (a) of this Act, or by the
deposit or pledge of Federal Farm Mortgage Corporation bonds
issued under the Federal Farm Mortgage Corporation Act, or by
the deposit or pledge of bonds issued under the provisions of sub-


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section (c) of section 4 of the Home Owners' Loan Act of 193S,
as amended; and any Federal reserve bank may make advances
for periods not exceeding ninety days to its member banks on their
promissory notes secured by such notes, drafts, bills of exchange,
or bankers' acceptances as are eligible for rediscount or for purchase by Federal reserve banks under the provisions of this Act.
• »•
Act of June 19,1934 (48 Stat. 1105):
[9] • • •
Tenth. Liabilities incurred under the proinsions of section
13b of the Federal Reserve Act. [ 12 U.S.C. § S2 ]
Act of August 23,1935 (49 Stat. 684):
[3] In unusual and exigent circumstances, the Federal Rcaervo
Board of Governors of the Federal Reserve System, by the affirmative
vote of not less than five members, may authorize any Federal
reserve bank, during euch periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual,
partnership, or corporation, notes, drafts, and bills of exchange
of the kinds and maturities made eligible for discount for member
banks under other provisions of this Act when such notes,
drafts, and bills of exchange are indorsed aad- or otherwise secured
to the satisfaction of the Federal r.Reserve bank: Provided, That
before discounting any such note, draft, or bill of exchange for an
individual or a partnership or corporation the Federal reserve
bank shall obtain evidence that such individual, partnership, or
corporation is unable to secure adequate credit accommodations
from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such
limitations, restrictions, and regulations as the Federal Rcoorvo
Board of Governors of the Federal Reserve System may prescribe.
[12 U.S.C. §343]
Act of September 21,1968 (82 Stat 856):
[8]

• • • and any Federal reserve bank may make advances for
periods not exceeding ninety days to its member banks on their
promissory notes secured by such notes, drafts, bills of exchange, or
bankers' acceptances as are eligible for rediscount or for purchase
by Federal reserve banks under the provisions of this Act, or secured
by such obligations as are eligible for purchase under section H(b) of

this Act. * * • 112 U.S.C. §347]

[13]

Subject to such limitations, restrictions and regulations as the
Board of Governors of the Federal Reserve System may prescribe,
any Federal reserve bank may make advances to any individual,

FR ACT: TEXTUAL CHANGES
partnership or corporation on the promissory notes of such individual, partnership or corporation secured by direct obligations of the
United States or by any obligation which is a direct obligation of, or
fully guaranteed as to principal and interest by, any agency of the

Untied States. Such advances shall be made for periods not exceeding
90 days and shall bear interest at rates fixed from time to time by
the Federal reserve bank, subject to the review and determination
of the Board of Governors of the Federal Reserve System
112 T.S.C. § 347c]
SECTION 13a
Act of March 4,1923 (42 Stat. 1454):
[1J

Sec. 13a. Upon the indorsement of any of its member banks,
which shall be deemed a waiver of demand, notice, and protest by
such bank as to its own indorsement exclusively, any Federal reserve bank may, subject to regulations and limitations to be prescribed by the Federal Reserve Board, discount notes, drafts, and
bills of exchange issued or drawn for an agricultural purpose, or
based upon live stock, and having a maturity, at the time of discount, exclusive of days of grace, not exceeding nine months, and
such notes, drafts, and bills of exchange may be offered as collateral security for the issuance of Federal reserve notes under the
provisions of section 16 of this Act: Provided, That notes, drafts,
and bills of exchange with maturities in excess of six months shall
not be eligible as a basis for the issuance of Federal reserve notes
unless secured by warehouse receipts or other such negotiable documents conveying or securing title to readily marketable staple
agricultural products or by chattel mortgage upon live stock which
is being fattened for market. 112 U.S.C. § 348]
[2]
That any Federal reserve bank may, subject to regulations and
limitations to be prescribed by the Federal Reserve Board, rediscount such notes, drafts, and bills for any Federal Intermediate
Credit Bank, except that no Federal reserve bank shall rediscount
for a Federal Intermediate Credit Bank any such note or obligation which bears the indorsement of a nonmember State bank or
trust company which is eligible for membership in the Federal
reserve system, in accordance with section 9 of this Act.
[3]
Any Federal reserve bank may also buy and sell debentures and
other such obligations issued by a Federal Intermediate Credit
Bank or by a National Agricultural Credit Corporation, but only
to the same extent as and subject to the same limitations as those
upon which it may buy and sell bonds issued under Title I of the
Federal Farm Loan Act. 112 U.S.C. § 350]
[4]
Notes, drafts, bills of exchange or acceptances issued or drawn
by cooperative marketing associations composed of producers of
agricultural products shall be deemed to have been issued or drawn
for an agricultural purpose, within the meaning of this section, if


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the proceeds thereof have been or arc to be advanced by such association to any members thereof for an agricultural purpose, or
have been or are to be used by such association in inaking payments to any members thereof on account of agricultural products
delivered by such members to the association, or if such proceeds
have been or are to be used by such association to meet expenditures incurred or to be incurred by the association in connection
with the grading, processing, packing, preparation for viarkct, or
marketing of any agricultural product handled by such association
for any of its members: Provided, That the express enumeration
in this paragraph of certain classes of paper of cooperative marketing associations as eligible for rediscount shall not be construed
as rendering ineligible any other class of paper of such associations
which is now eligible for rediscount. 112 C.S.C. vj 3.">I ]
[5] The Federal Reserve Board may, by regulation, limit to a percentage of the assets of a Federal reserve bank the amount of
notes, drafts, acceptances, or bills having a maturity in excess of
three months, but not exceeding six months, exclusive of days
of grace, which may be discounted by such bank, and the amount
of notes, drafts, bills, or acceptances having a maturity in excess of
six months, but not exceeding nine months, which may be rcdiscounted by such bank. |12 U.S.C. S352]
Act of May 19, 1932 (47 Stat. 159):
[2]

That any Federal reserve bank may, subject to regulations and
limitations to be prescribed by the Federal Reserve Board, rediscount such notes, drafts, and bills for any Federal Intermediate
Credit Bank, except that no Federal reserve bank shall rediscount
for a Federal Intermediate Credit Bank any such note or obligation which bears the indorsement of a nonmember State bank or
trust company which is eligible for membership in the Federal
reserve system, in accordance with section 9 of this Act. Any
Federal reserve bank may also, subject to regulations and
limitations to be prescribed by the Federal Reserve Board, discount notes payable to and bearing the indorsement of any Federal intermediate credit bank, covering loans or advances made by
such bank pursuant to the provisions of section 202 (a) of Title II
of the Federal Farm Loan Act, as amended (U. S. C, title 12, ch.
8, sec. 1031), which have maturities at the time of discount of not
more than nine months, exclusive of days of grace, and which are
secured by notes, drafts, or bills of exchange eligible for rediscount
by Federal Reserve banks. [12 U.S.C. § 349)
SECTION 13b

Act of June 19, 1934 (48 Stat. 1105):
Sec. 13b. (a) In exceptional circumstances, when it appears to
the satisfaction of a Federal Reserve bank that an established
industrial or commercial business located in its district is unable


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FR ACT: TEXTUAL CHANGES

to obtain requisite financial assistance on a reasonable basis from
the usual sources, the Federal Reserve bank, pursuant to authority
granted by the Federal Reserve Board, may make loans to, or
purchase obligations of, such business, or may make commitments
with respect thereto, on a reasonable and sound basis, for the
purpose of providing it with working capital, but no obligation
shall be acquired or commitment made hereunder with a maturity
exceeding five years.
(b) Each Federal Reserve bank shall also have power to discount
for, or purchase from, any bank, trust company, mortgage company, credit corporation for industry, or other financing institution operating in its district, obligations having maturities not
exceeding five years, entered into for the purpose of obtaining
working capital for any such established industrial or commercial
business; to make loans or advances direct to any such financing
institution on the security of such obligations; and to make commitments with regard to such discount or purchase of obligations
or with respect to such loans or advances on the security thereof,
including commitments made in advance of the actual undertaking
of such obligations. Each such financing institution shall obligate
itself to the satisfaction of the Federal Reserve bank for at least
20 per centum of any loss which may be sustained by such bank
upon any of the obligations acquired from such financing institution, the existence and amount of any such loss to be determined
m accordance with regulations of the Federal Reserve Board:
Provided, That in lieu of such obligation against loss any such
financing institution may advance at least 20 per centum of such
working capital for any established industrial or commercial business without obligating itself to the Federal Reserve bank against
loss on the amount advanced by the Federal Reserve bank: Provided, however, That such advances by the financing institution
and the Federal Reserve bank shall be considered as one advance,
and repayment shall be made pro rata under such regulations as
the Federal Reserve Board may prescribe.
(c) The aggregate amount of loans, advances, and commitments
of the Federal Reserve banks outstanding under this section at
any one time, plus the amount of purchases and discounts under
this section held at the same time, shall not exceed the combined
surplus of the Federal Reserve banks as of July 1, 1984, plus all
amounts paid to the Federal Reserve banks by the Secretary of
the Treasury under subsection (e) of this section, and all operations of the Federal Reserve banks under this section shall be
subject to such regulations as the Federal Reserve Board may
prescribe.
(d) For the purpose of aiding the Federal Reserve banks in
carrying out the provisions of this section, there is hereby established in each Federal Reserve district an industrial advisory committee, to be appointed by the Federal Reserve bank subject to the
approval and regulations of the Federal Reserve Board, and to be
composed of not less than three nor more than five members as

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Federal Reserve Bank of St. Louis

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determined by the Federal Reserve Board. Each member of such
committee shall be actively engaged in some industrial pursuit
within the Federal Reserve district in which the committee is
established, and each such member shall serve without compensation but shall be entitled to receive from the Federal Reserve
bank of such district his necessary expenses while engaged in the
business of the committee, or a per diem allowance in lieu thereof
to be fixed by the Federal Reserve Board. Each application for
any such loan, advance, purchase, discount, or commitment shall
be submitted to the appropriate committee and, after an examina~
tion by it of the business with respect to which the application
is made, the application shall be transmitted to the Federal Reserve bank, together with the recommendation of the committee,
(e) In order to enable the Federal Reserve banks to make the
loans, discounts, advances, purchases, and commitments provided
for in this section, the Secretary of the Treasury, upon the date
this section takes effect, is authorized, under such rules and regulations as he shall prescribe, to pay to each Federal Reserve bank
not to exceed such portion of the sum of $139,299,557 as may be
represented by the par value of the holdings of each Federal Reserve bank of Federal Deposit Insurance Corporation stock, upon
the execution by each Federal Reserve bank of its agreement (to
be endorsed on the certificate of such stock) to hold such stock
unencumbered and to pay to the United States all dividends, all
payments on liquidation, and all other proceeds of such stock, for
which dividends, payments, and proceeds the United States shall
be secured by such stock itself up to the total amount paid to each
Federal Reserve bank by the Secretary of the Treasury under this
section. Each Federal Reserve bank, in addition, shall agree that,
in the event such dividends, payments, and other proceeds in any
calendar year do not aggregate 2 per centum of the total payment
made by the Secretary of the Treasury, under this section, it will
pay to the United States in such year such further amount, if any,
up to 2 per centum of the said total payment, as shall be covered
by the net earnings of the bank for that year derived from the use
of the sum so paid by the Secretary of the Treasury, and that for
said amount so due the United States shall have a first claim
against such earnings and stock, and further that it will continue
such payments until the final liquidation of said stock by the
Federal Deposit Insurance Corporation. The sum so paid to each
Federal Reserve bank by the Secretary of the Treasury shall become a part of the surplus fund of such Federal Reserve bank
within the meaning of this section. All amounts required to be
expended by the Secretary of the Treasury in order to carry out
the provisions of this section shall be paid out of the miscellaneous
receipts oj the Treasury created by the increment resulting from
the reduction of the weight of the gold dollar under the President's
proclamation of January 31, 1934; and there is hereby appropriated, out of such receipts, such sum as shall be required for such
purpose.

FR ACT: TEXTUAL CHANGES
Act of August 23,193S (49 Stat. 684):
(e) In order to enable the Federal Reserve banks to make the
loans, discounts, advances, purchases, and commitments provided for in this section, the Secretary of the Treasury, «pe» *fee
tlftte *bie section tekes effcet on and after June 19, 1934, is authorized, under such rules and regulations as he shall prescribe,
to pay to each Federal Reserve bank not to exceed such portion
of the sum of §139,299,557 as may be represented by tfee pap
value ef tbe holdings el eaefe Federal Rcocrvo fea«k ef- Federal
Dcpoait Insurance Corporation otock the amount paid by each
Federal Reserve bank for stock of the Federal Deposit Insurance

Corporation, upon the execution by each Federal Reserve bank
of its agreement (to be endorsed on the certificate of such stock)
to hold such stock unencumbered and to pay to the United
States all dividends, all payments on liquidation, and all other
proceeds of such stock, for which dividends, payments, and proceeds the United States shall be secured by such stock itself up
to the total amount paid to each Federal Reserve bank by the
Secretary of the Treasury under this section. * * *
Act of August 21, 1958 (72 Stat. 689):
[The above cited Act repealed section 13b of the Federal Reserve
Act, effective August 21, 1959, with the stipulation that such repeal
would not affect the power of any Federal Reserve bank to carry
out, or protect its interest under, any agreement theretofore made or
transaction entered into in carrying on operations under that
section.]

SECTION 14
Original Act:
[1] SEC. 14. Any Federal reserve bank may, under rules and regulations prescribed by the Federal Reserve Board, purchase and sell
in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals, cable
transfers and bankers' acceptances and bills of exchange of the
kinds and maturities by this Act made eligible for rediscount, with
or without the indorsement of a member bank. [12 U.S.C. §353]
[2] Every Federal reserve bank shall have power: |12 U.S.C. §354]

[3]

(b) To buy and sell, at home or abroad, bonds and notes of
the United States, and bills, notes, revenue bonds, and warrants
with a maturity from date of purchase of not exceeding six
months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county,


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district, political subdivision, or municipality in the continental
United States, including irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and
regulations prescribed by the Federal Reserve Board;
[4]
(c) To purchase from member banks and to sell, with or without its indorsement, bills of exchange arising out of commercial
transactions, as hereinbefore defined; 112 l.'.S.C. S 3361
[5]
(d) To establish from time to time, subject to review and determination of the Federal Reserve Board, rates of discount to be
charged by the Federal reserve bank for each class of paper,
which shall be fixed with a view of accommodating commerce and
business;
Act of April 13, 1920 (41 Stat. 550):
[5]
(d) To establish from time to time, subject to review and
determination of the Federal Reserve Board, rates of discount
to be charged by the Federal reserve bank for each class of
paper, which shall be fixed with a view of accommodating commerce and business-} and which, subject to the approval, review,
and determination of the Federal Reserve Board, may be graduated
or progressed on the basis of the amount of the advances and discount accommodations extended by the Federal reserve bank to
the borrowing bank.
Act of March 4,1923 (42 Stat. 1454):
[5]

(d) To establish from time to time, subject to review and determination of the Federal Reserve Board, rates of discount to
be charged by the Federal reserve bank for each class of paper,
which shall be fixed with a view of accommodating commerce
and business; a»4 which; oubjeet to the approval, review^ a*d
determination el -the federal Reserve Board, «*ty fee graduated
ee progrc33cd eft -tfee feaaia ef -tfee amount ef- +fee advancea end
diaoount acoommodationa extended by *be Federal rcoorvc bank
te the borrowing bank.
* * * * *
[7] ff) To purchase and sell in the open market, either from or
to domestic banks, firms, corporations, or individuals, acceptances
of Federal Intermediate Credit Banks and of National Agricultural Credit Corporations, whenever the Federal Reserve Board
shall declare that the public interest so requires. | 12 U.S.C. § 359]
Act of January 31,1934 (48 Stat. 344):
[3]

(b) To buy and sell, at home or abroad, bonds and notes of the
United States, bonds of the Federal Farm Mortgage Corporation
having maturities from date of purchase of not exceeding six
months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued

FR ACT: TEXTUAL CHANGES
in anticipation of the collection of taxes or in anticipation of the
receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States,
including irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Federal Reserve Board;
Act of April 27,1934 (48 Stat. 643):
[3]

(b) To buy and sell, at home or abroad, bonds and notes of
the United States, bonds of the Federal Farm Mortgage Corporation having maturities from date of purchase of not exceeding
six months, bonds issued under the provisions of subsection (c)
of section 4 of the Home Owners' Loan Act of 1933, as amended,
and having maturities from date of purchase of not exceeding six
months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in
anticipation of the collection of taxes or in anticipation of the receipt of assured revenue by any State, county, district, political
subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Federal Reserve Board;

Act of August 23, 1935 (49 Stat. 684):
[3]

(b) To buy and sell, at home or abroad, bonds and notes of
the United States, bonds of the Federal Farm Mortgage Corporation having maturities from date of purchase of not exceeding six
months, bonds issued under the provisions of subsection (c) of
section 4 of the Home Owners' Loan Act of 1933, as amended, and
having maturities from date of purchase of not exceeding six
months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued
in anticipation of the collection of taxes or in anticipation of the
receipt of assured revenues by any State, county, district, political
subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Federal Rcacrvo Board of Governors of the Federal
Reserve System: Provided, That any bonds, notes, or other obligations which are direct obligations of the United States or which are
fully guaranteed by the United States as to principal and interest
may be bought and sold without regard to maturities but only in the
open market;
* • • • •

[5]

(d) To establish from time to time, subject to review and determination of the federal Rooorve Board of Governors of the
Federal Reserve System, rates of discount to be charged by the
Federal reserve bank for each class of paper, which shall be


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fixed with a view of accommodating commerce and business;
but each such bank shall establish such rates every fourteen days,
or oftener if deemed necessary by the Board; 112 U.S.C. § 357]
Act of March 27,1942 (56 Stat. 176):
[3] (b) * * * Provided, That any bonds, notes, or other obligations which are direct obligations of the United States or which
are fully guaranteed by the United States as to principal and
interest may be bought and sold without regard to maturities
bttfc ealy either in the open market or directly from or to the United
States; but all such purchases and sales shall be made in accordance
with the provisions of section 12A of this Act and the aggregate
amount of such obligations acquired directly from the United States
which is held at any one time by the twelve Federal reserve banks
shall not exceed 85,000,000,000.
[NOTE.—The above amendment was originally made by Title IV of the Second
War Powers Act of March 27, 1942, to remain in force only until December 31, 1944;
but the termination date of Title IV of that Act and therefore of the amendment
to section 14(b) of the Federal Reserve Act was extended by the Act of December 20, 1944 (58 Stat. 827) until December 31, 1945, was further extended by the
Act of December 28, 1945 (59 Stat. 658) until June 30, 1946, and was further
extended by the Act of June 29, 1946 (60 Stat. 354) until March 31, 1947. On the
latter date the amendment ceased to have effect and consequently section 14 (b) of
the Federal Reserve Act after March 31, 1947 read as it had read prior to enactment of the Act of March 27, 1942, until the enactment of the Act of April 28, 1947
(61 Stat. 56) as set forth below.]

Act of April 28,1947 (61 Stat. 56):
[3]

(b) * * * Provided, That, notwithstanding any other provision
of this Act, (1) until July 1, 1960, any bonds, notes, or other obligations which are direct obligations of the United States or
which are fully guaranteed by the United States as to principal
and interest may be bought and sold without regard to maturities W t only either in the open market or directly from or to the
United States; but all such purchases and sales shall be made in
accordance with the provisions of section 12A of this Act and the
aggregate amount of such obligations acquired directly from the
United States which is held at any one time by the twelve Federal
Reserve banks shall not exceed 86,000,000,000; and (8) after June
30, 1950, any bonds, notes, or other obligations which are direct
obligations of the United Stales or which are fully guaranteed by
the United States as to principal and interest may be bought and
sold without regard to maturities but only in the open market.
The Board of Governors of the Federal Reserve System shall include
in their annual report to Congress detailed information with respect
to direct purchases and sales from or to the United States under the
provisions of the preceding proviso.

Act of June 30,1950 (64 Stat. 307):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1952 in place of reference to the year 1950.]

FR ACT: TEXTUAL CHANGES
Act of June 23, 1952 (66 Stat. 154):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1954 in place of reference to the year 1952.]

Act of June 29, 1954 (68 Stat. 329):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1956 in place of reference to the year 1954.]

Act of June 25, 1956 (70 Stat. 339):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1958 in place of reference to the year 1956.]

Act of June 30, 1958 (72 Stat. 261):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1960 in place of reference to the year 1958.]

Act of July 1, 1960 (74 Stat. 295):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1962 in place of reference to the year I960.]

Act of October 4, 1961 (75 Stat. 773):
[3]

(b) To buy and sell, at home or abroad, bonds and notes of
the United States, bond;) »f 4ke Federal Farm Mortgage
portttion having nmturitiet) from duto (4 purchano el wet exceeding
» « months, bonds issued under the provisions of subsection (c) of
section 4 of the Home Owners' Loan Act of 1933, as amended,
and having maturities from date of purchase of not exceeding six
months, * * *.

Act of June 28, 1962 (76 Stat. 112):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1964 in place of reference to the year 1962.]

Act of June 30, 1964 (78 Stat. 235):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1966 in place of reference to the year 1964.]

Act of June 30, 1966 (80 Stat. 235):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1968 in place of reference to the year 1966.]


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Act of September 21, 1966 (80 Stat. 823, 82S):

made permanent.)

[3]

(b) (1) To buy and sell, at home or ubroad, bonds and notes of the
United States, bonds issued under the provisions of subsection (c)
of section 4 of the Home Owners' Loan Act of 1933, as amended,
and having maturities from date of purchase of not exceeding six
months, and bills, notes, revenue bonds, and warrants with a
maturity from date of purchase of not exceeding six months, issued
in anticipation of the collection of taxes or in anticipation of the
receipt of assured revenues by any State, county, district, political
subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the Federal Reserve System:
Provided, That, notwithstanding any other provision of this Act,
(1) until July 1, 1968, any bonds, notes, or other obligations which
are direct obligations of the United States or which are fully guaranteed by the United States as to principal and interest may be
bought and sold without regard to maturities either in the open
market or directly from or to the United States; but all such purchases and sales shall be made in accordance with the provisions of
section 12A of this Act and the aggregate amount of such obligations
acquired directly from the United States which is held at any one
time by the twelve Federal Reserve banks shall not exceed
85,000,000,000; and (2) after June 30, 1968, any bonds, notes, or
other obligations which are direct obligations of the United States
or which are fully guaranteed by the United States as to principal
and interest may be bought and sold without regard to maturities
but only in the open market. The Board of Governors of the Federal
Reserve System shall include in their annual report to Congress
detailed information witli respect to direct purchnscs and sales from
or to the United States under the provisions of the preceding proviso.
(3?) To buy and sell in the open market, wider the direction and
regulations of the Federal Open Market Committee, any obligation
which is a direct obligation of, or fully guaranteed as to principal and
interest by, any agency of the United States. [12 U.S.C. § 355]

Act of May 4, 1968 (82 Stat. 113):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1970 in place of reference to the year 1968.1

Act of July 31, 1970 (84 Stat. 668):
[3]

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1971 in place of reference to the year 1970.]

FR ACT: TEXTUAL CHANGES
Act of July 2, 1971 (85 Stat. 100):
[3)

[The above-cited Act extended the authority contained in the
proviso in this paragraph by substituting, in two places, reference
to the year 1973 in place of reference to the year 1971.]
SECTION 19

Original Act:
[<•>]

o • • No member bank shall act as the medium or agent
of a nonmember bank in applying for or receiving discounts from a
Federal reserve bank under the provisions of this Act except by
permission of the Federal Reserve Board. [12 U.S.C. § 374]
SECTION 24

Act of June 27, 1934 (48 Stat. 1246):
[3]

Loans made to finance the construction of residential or farm
buildings and having maturities of not to exceed six months,
whether or not secured by a mortgage or similar Ken on the real
estate upon which the residential or farm building is being constructed, shall not be considered as loans secured by real estate
within the meaning of this section but shall be classed as ordinary
commercial loans: Provided, That no national banking association
shall invest in, or be liable on, any such loans in an aggregate
amount in excess of 50 per centum of its actually paid-in and
unimpaired capital. Notes representing such loans shall be eligible
for discount as commercial paper within the terms of the second
paragraph of section 13 of the Federal Reserve Act, as amended,
if accompanied by a valid and binding agreement to advance the
full amount of the loan upon the completion of the building
entered into by an individual, partnership, association, or corporation acceptable to the discounting bank.

Act of August 11,1955 (69 Stat. 633) :
[3]

Loans made to finance the construction of residential or farm
buildings and having maturities of not to exceed sis nine months,
whether or not secured by a mortgage or similar lien on the real
estate upon which the residential or farm building is being constructed, shall not be considered as loans secured by real estate
within the meaning of this section but shall be classed as ordinary commercial loans: * * *

Act of September 9, 1959 (73 Stat. 487) :
[3]

Loans made to finance the construction of industrial or commercial buildings and having maturities of not to exceed eighteen


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months where there is a valid and binding agreement entered into
by a financially responsible lender to advance the full amount of
the bank's loan upon the completion of the buildings and loans
made to finance the construction of residential or farm buildings

and having maturities of not to exceed nine months, whether
©j* ft©t SCCrirCu « j *• II1QrtcQfiTO Or nfnnttf TXVTT OTT tile rcftr ©HTO^C

upon which the reaidential er farm building is feeing eeaotruotcd, shall not be considered as loans secured by real estate
within the meaning of this section but shall be classed as ordinary commercial loans whether or not secured by a mortgage or
similar lien on the real estate upon which the building or build-

ings are being constructed: Provided, That no national banking
association shall invest in, or be liable on, any such loans in an
aggregate amount in excess of 59 100 per centum of its actually
paid-in and unimpaired capital plus 100 per centum of its unimpaired surplus fund. Notes representing auoh loans made under
this section to finance the construction of residential or farm buildings and having maturities of not to exceed nine months shall be
eligible for discount as commercial paper within the terms of the
second paragraph of section 13 of the Federal Reaerve this Acty
«s amended, if accompanied by a valid and binding agreement
to advance the full amount of the loan upon the completion of
the building entered into by an individual, partnership, association, or corporation acceptable to the discounting bank.
Act of September 28,1962 (76 Stat. 662):
[3]

Loans made to finance the construction of industrial or commercial buildings and having maturities of not to exceed eighteen
months where there is a valid and binding agreement entered
into by a financially responsible lender to advance the full
amount of the bank's loan upon the completion of the buildings
and loans made to finance the construction of residential or
farm buildings and having maturities of not to exceed BtM
eighteen months, shall not be considered as loans secured by real
estate within the meaning of this section but shall be classed as
ordinary commercial loans whether or not secured by a mortgage or similar lien on the real estate upon which the building
or buildings are being constructed: Provided, That no national
banking association shall invest in, or be liable on, any such loans
in an aggregate amount in excess of 100 per centum of its actually
paid-in and unimpaired capital plus 100 per centum of its unimpaired surplus fund. * * *

Act of August 10, 1965 (79 Stat 451, 465):
[3]

Loans made to finance the construction of industrial or commercial buildings and having maturities of not to exceed eighteen
twenty-four months where there is a valid and binding agreement
entered into by a financially responsible lender to advance the

FR ACT: TEXTUAL CHANGES
full amount of the bank's loan upon the completion of the buildings and loans made to finance the construction of residential or
farm buildings and having maturities of not to exceed oightoon
twenty-four months, shall not be considered as loans secured by
real estate within the meaning of this section but shall be classed
as ordinary commercial loans whether or not secured by a mortgage or similar lien on the real estate upon which the building or
buildings are being constructed: Provided, That no national banking association shall invest in, or be liable on, any such loans in
an aggregate amount in excess of 100 per centum of its actually
paid-in and unimpaired capital plus 100 per centum of its unimpaired surplus fund. * * *
Act of August 1, 1968 (82 Stat. 476, 518, 609):
[3]

Loans made to finance the construction of industrial or commercial buildings and having maturities of not to exceed twenty four
thirty-six months where there is a valid and binding agreement
entered into by a financially responsible lender to advance the full
amount of the bank's loan upon the completion of the buildings and
loans made to finance the construction of residential or farm buildings and having maturities of not to exceed twenty fo«r thirty-six
months, shall not be considered as loans secured by real estate
within the meaning of this section but shall be classed as ordinary
commercial loans whether or not secured by a mortgage or similar
lien on the real estate upon which the building or buildings are being
constructed: Provided, That no national banking association shall
invest in, or be liable on, any such loans in an aggregate amount in
excess of 100 per centum of its actually paid-in and unimpaired
capital plus 100 per centum of its unimpaired surplus fund. * * *

Act of July 24, 1970 (84 Stat. 450, 462):
\'A\

Loans made to finance the construction of industrial or commercial buildings and having maturities of not to exceed thirty aix
•sixty months where there is a valid and binding agreement entered
into by a financially responsible lender to advance the full amount
of the bank's loan upon the completion of the buildings and loans
made to finance the construction of residential or farm buildings
and having maturities of not to exceed thirty aix sixty months,
shall not be considered as loans secured by real estate within the
meaning of this section but shall be classed as ordinary commercial
loans whether or not secured by a mortgage or similar lien on the
real estate upon which the building or buildings are being constructed: Provided, That no national banking association shall
invest in, or be liable on, any such loans in an aggregate amount in
excess of 100 per centum of its actually paid-in and unimpaired
capital plus 100 per centum of its unimpaired surplus fund. * * *
[12 U.S.C. §371]


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Regulation A as Currently in Effect

REGULATION A
(12 CFR 201)
As revised effective April 19, 1973, and in effect May 1, 1973

EXTENSIONS OF CREDIT BY
FEDERAL RESERVE BANKS

meet the particular needs of individual member
banks.
(b) Effect on overall monetary and credit conditions. The lending functions of the Federal Reserve System are conducted with due regard to
the basic objectives of the Employment Act of
1946 and the maintenance of a sound and orderly
financial system. These basic objectives are promoted by influencing the overall volume and cost
of credit through actions affecting the volume and
cost of reserves to member banks. Borrowing by
individual member banks, at a rate of interest
adjusted from time to time in accordance with
general economic and money market conditions,
has a direct impact on the reserve positions of the
borrowing banks and thus on their ability to meet
the needs of their customers. However, the effects
of such borrowing do not remain localized but

SECTION 201.1—AUTHORITY AND SCOPE
This Part is issued under section 13 and other
provisions of the Federal Reserve Act and relates
to extensions of credit by Federal Reserve Banks.
SECTION 201.2—GENERAL PRINCIPLES
(a) Accommodation of credit needs of individual banks. Extending credit to member banks
to accommodate commerce, industry, and agriculture is a principal function of Reserve Banks.
While open market operations and changes in
member bank reserve requirements are important
means of affecting the overall supply of bank reserves, the lending function of the Reserve Banks
's an effective method of supplying reserves to


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HISTORY OF LENDING FUNCTIONS

have an important bearing on overall monetary
and credit conditions.
(c) Short-term adjustment credit. Federal Reserve credit is available on a short-term basis to a
member bank, under such rules as may be prescribed, to such extent as may be appropriate to
assist such bank in meeting temporary requirements for funds or to cushion more persistent
outflows of funds pending an orderly adjustment
of the bank's assets and liabilities.
(d) Seasonal credit. Federal Reserve credit is
available for longer periods to assist a member
bank that lacks reasonably reliable access to national money markets in meeting seasonal needs
for funds arising from a combination of expected
patterns of movement in its deposits and loans.
Such credit will ordinarily be limited to the
amount by which the member bank's seasonal
needs exceed 5 per cent of its average total deposits in the preceding calendar year and will be
available if (1) the member bank has arranged
in advance for such credit for the full period, as
far as possible, for which the credit is expected
to be required, and (2) the Reserve Bank is
satisfied that the member bank's qualifying need
for funds is seasonal and will persist for at least
eight consecutive weeks. In making such arrangements for seasonal credit, a Reserve Bank may
agree to extend such credit for a period of up to
90 days,1 subject to compliance with applicable
requirements of law at the time such credit is
extended. However, in the event that a member
bank's seasonal needs should persist beyond such
period, the Reserve Bank will normally be prepared to entertain a request by the member bank
for further credit extensions under the seasonal
credit arrangement.
(e) Emergency credit for member banks. Federal Reserve credit is available to assist member
banks in unusual or emergency circumstances such
as may result from national, regional, or local
difficulties or from exceptional circumstances involving only a particular member bank.
(f)
serve
ships,
banks

Emergency credit for others. Federal Recredit is available to individuals, partnerand corporations that are not member
in emergency circumstances in accordance

1
As provided in the law and in this Part, the maturity
of advances to member banks is limited to 90 days,
except as provided in §201,3(b) of this Part.


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with §201.7 of this Part if, in the judgment of the
Reserve Bank involved, credit is not practicably
available from other sources and failure to obtain
such credit would adversely affect the economy.
(g) Credit for capital purposes. Federal Reserve credit is not a substitute for capital and
ordinarily is not available for extended periods.
(h) Compliance with law and regulation. All
credit extended pursuant to this Part must comply
with applicable requirements of law and of this
Part. Among other things, the law requires each
Reserve Bank (I) to keep itself informed of the
general character and amount of the loans and
investments of its member banks with a view to
ascertaining whether undue use is being made of
bank credit for the speculative carrying of or trading in securities, real estate, or commodities or
for any other purpose inconsistent with the maintenance of sound credit conditions and (2) to
give consideration to such information in determining whether to extend credit.
SECTION 201.3—ADVANCES TO MEMBER
BANKS
(a) Advances on obligations or eligible paper.
Reserve Banks may make advances to member
banks for not more than 90 days if secured by
obligations or other paper eligible under the Federal Reserve Act for discount or purchase by Reserve Banks.
(b) Advances on other security. A Reserve
Bank may make advances to a member bank for
not more than four months if secured to the
satisfaction of the Reserve Bank, whether or not
secured in conformity with §201.3(a), but the
rate on such advances shall be at least one-half
of one per cent per annum higher than the rate
applicable to advances made under §2O1.3(a).
SECTION 201.4—DISCOUNTS FOR
MEMBER BANKS
If a Reserve Bank should conclude that a member bank would be better accommodated by the
discount of paper than by an advance on the
security thereof, it may discount for such member bank any paper endorsed by the member bank
and meeting the following requirements:
(a) Commercial or agricultural paper. A note,
draft, or bill of exchange issued or drawn or tne

REGULATION A
proceeds of which have been or are to be used
(1) in producing, purchasing, carrying, or marketing goods in the process of production, manufacture, or distribution, (2) for the purchase of
services, (3) in meeting current operating expenses of a commercial, agricultural, or industrial
business, or (4) for the purpose of carrying or
trading in direct obligations of the United States;
provided that (i) such paper has a period remaining to maturity of not more than 90 days, except
that agricultural paper (including paper of cooperative marketing associations) may have a
period remaining to maturity of not more than
nine months and (ii) the proceeds of such paper
have not been and are not to be used merely for
the purpose of investment, speculation, or dealing
in stocks, bonds, or other such securities, except
direct obligations of the United States.
(b) Bankers1 acceptances. A banker's acceptance (1) arising out of an importation or exportation or domestic shipment of goods or the storage
of readily marketable staples or (2) drawn by a
bank in a foreign country or dependency or
insular possession of the United States for the
purpose of furnishing dollar exchange; provided
that such acceptance complies with applicable
requirements of section 13 of the Federal Reserve
Act.
(c) Construction paper. A note representing a
loan made to finance construction of a residential
or farm building, whether or not secured by a lien
upon real estate, which matures not more than
nine months from the date the loan was made and
has a period remaining to maturity of not more
than 90 days, if accompanied by an agreement
requiring some person acceptable to the Reserve
Bank to advance the full amount of the loan upon
completion of such construction.
SECTION 201.5—GENERAL
REQUIREMENTS
(a) Information. A Reserve Bank shall require
such information as it deems necessary to insure
'hat paper tendered as collateral or for discount
is acceptable and meets any pertinent eligibility
requirements and that the credit granted is used
consistently with this Part.
(b) Amount of collateral. A Reserve Bank shall
require only such amount of collateral as it deems
necessary or advisable.


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(c) Indirect credit for nonmember banks. Except with the permission of the Board of Governors, no member bank shall act as the medium
or agent of a nonmember bank (other than a
Federal Intermediate Credit bank) in receiving
credit from a Reserve Bank and, in the absence
of such permission, a member bank applying for
credit shall be deemed to represent and guarantee
that it is not so acting.
(d) Limitation as to one obligor. Except as to
credit granted under §201.3(b), a member bank
applying for credit shall be deemed to certify or
guarantee that as long as the credit is outstanding
no obligor on paper tendered as collateral or for
discount will be indebted to it in an amount exceeding the limitations in section 3200 of the
Revised Statutes (12 U.S.C. §84), which for this
purpose shall be deemed to apply to State member
as well as national banks.
SECTION 201.6—FEDERAL
INTERMEDIATE CREDIT BANKS
A Reserve Bank may discount for any Federal
Intermediate Credit bank (1) agricultural paper,
or (2) notes payable to and bearing the endorsement of such Federal Intermediate Credit bank
covering loans or advances made under subsections (a) and (b) of §2.3 of the Farm Credit
Act of 1971 (12 U.S.C. §2074) which are secured
by paper eligible for discount by Reserve Banks.
Any paper so discounted shall not have a period
remaining to maturity of more than nine months
or bear the endorsement of a nonmember State
bank.
SECTION 201.7—EMERGENCY CREDIT
FOR OTHERS
In emergency circumstances a Reserve Bank
may extend credit for periods of not more than 90
days to individuals, partnerships, and corporations
(other than member banks) on the security of
direct obligations of the United States or any
obligations which are direct obligations of, or
fully guaranteed as to principal and interest by,
any agency of the United States, at such rate in
excess of the rate in effect at the Reserve Bank
for advances under §201.3(a) as its board of
directors may establish subject to review and
determination of the Board of Governors.


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Regulation C as Currently in Effect

REGULATION C
(12 CFR 203)
As revised effective August 31, 1946, and in effect May 1, 1973

ACCEPTANCE BY MEMBER BANKS OF DRAFTS
OR BILLS OF EXCHANGE *

SECTION 203.0-SCOPE OF PART

This part is based upon and issued pursuant to various provisions of
the Federal Reserve Act, particularly the provisions of the seventh and
twelfth paragraphs of section 13 of such Act, the texts of which are
published in the appendix hereto. This part relates to the acceptance
by member banks of drafts or bills of exchange. Provisions governing
the eligibility of bankers' acceptances of member banks for discount by
the Federal Reserve Banks are contained in Part 201 of this chapter;
and provisions governing the purchase of bankers' acceptances by the
Federal Reserve Banks are contained in Part 202 of this chapter.

• The text correspond, to the Code of Federal Regulations. Title 12. Chapter II, Part 203:
cited as 12 CFR 203.


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SECTION 203.1-^ACCEPTANCE OF COMMERCIAL DRAFTS OR BILLS
(a) Authority.—Any member bank may accept drafts or bills of
exchange drawn upon it which grow out of any of the following transactions (referred to in this part as "commercial drafts or bills"):
(1) The importation or exportation of goods, that is, the shipment of goods between the United States and any foreign country,
or between the United States and any of its dependencies or insular
possessions, or between dependencies or insular possessions and
foreign countries, or between foreign countries; l
(2) The shipment of goods within the United States, provided
shipping documents conveying or securing title are attached or
are in the physical possession of the accepting bank or its agent
at the time of acceptance;
(3) The storage in the United States or in any foreign country
of readily marketable staples: - Provided, That the draft or bill of
exchange is secured at the time of acceptance by a warehouse
receipt or other such document conveying or securing title covering
such readily marketable staples.3
{b) Maturity.—No member banks shall accept any commercial
draft or bill unless -\t the date of its acceptance sucli draft or bill has
not more than six months to run, exclusive of days of grace.
(c) Acceptances for one person.—No member bank shall accept
commercial drafts or bills, whether in a foreign or domestic transaction,
for any one person, company, firm, or corporation in an amount equal
at any time in the aggregate to more than 10 per cent of its paid-up
and unimpaired capital stock and surplus, unless the bank be and
remain secured as to the amount in excess of such 10 per cent limitation by either attached documents or some other actual security growing out of the same transaction as the acceptance; but a trust receipt
which permits the customer to have access to or control over the
goods will not be considered "actual security" within the meaning of
this paragraph.
(d) Limitation on aggregate amount.—No member bank shall
accept commercial drafts or bills in an amount equal at any time in
the aggregate to more than 50 per cent of its paid-up and unimpaired
capital stock and surplus; except that, with the permission of the Board
of Governors of the Federal Reserve System as provided in paragraph
(e) of this section, any such member bank may accept such drafts or
1
A member bank accepting any commercial draft or bill growing out of a transaction of the
kinds described in 5203.1 (a) (1) will be expected to obtain before acceptance and retain In Itn
files satisfactory evidence, documentary or otherwise, showing the nature of the transactions
underlying the credit extended.
' A readily marketable staple within the meaning of this part means an article of commerce, agriculture, or industry, of such uses as to make it the subject of constant dealings in
ready markets with such frequent quotations of price as to make (o) the price easily and
definitely ascertainsble. and (6) the staple itself easy to realize upon by sale at any time.
»It should be noted that pursuant to Part 201 and 202 of this chapter Federal Reserve Banks
may neither discount nor purchase bills arising out of the storage of readily marketable
staples unless the acceptor remains secured throughout the life of the bill.

REGULATION C

bills in an amount not exceeding at any time in the aggregate 100 per
cent of its paid-up and unimpaired capital stock and surplus (hereinafter referred to as "authority to accept commercial drafts or bills up
to 100 per cent"); but in no event may the aggregate amount of such
acceptances growing out of domestic transactions exceed 50 per cent of
such capital and surplus. Commercial drafts or bills accepted by
another bank, whether domestic or foreign, at the request of a member
bank which agrees to put such other bank in funds to meet such acceptances at maturity shall be considered as part of the acceptance
liabilities of the member bank requesting such acceptances as well as
of such other bank, if a member bank, within the meaning of the
limitations prescribed in this section.
(e) Authority to accept up to 100 per cent.— (1) Any member
bank desiring authority to accept commercial drafts or bills up to 100
per cent shall file with the Board of Governors, through the Federal
Reserve Bank of its district, an application for permission to exercise
such authority. Such application need not be made in any particular
form, but shall show the present and anticipated need of the applicant
bank for the authority requested.
(2) The Board of Governors may at any time rescind any authority
granted by it pursuant to this section after not less than 90 days'
notice in writing to the bank affected.
SECTION 203.2--ACCEPTANCE OF DRAFTS OK BILLS TO FURNISH
DOLLAR EXCHANGE
(a) Authority.— (1) Any member bank, after obtaining the permission of the Board of Governors, may accept drafts or bills of exchange drawn upon it by banks or bankers in foreign countries or
dependencies or insular possessions of the United States for the purpose
of furnishing dollar exchange (referred to in this part as "dollar exchange drafts or bills") as required by the usages of trade in the respective countries, dependencies, or insular possessions, subject to the
conditions set forth in this section. Any member bank desiring to
obtain such permission shall file with the Board of Governors through
the Federal Reserve Bank of its district an application for such permission. Such application need not to be in any particular form but
shall show the present and anticipated need for the authority requested.
(2) The Board of Governors may at any time rescind any permission granted by it pursuant to this section after not less than 90 days'
notice in writing to the bank affected.
(6) Countries with respect to which dollar exchange drafts or
bills may be accepted.—(1) Any such foreign country or dependency
or insular possession of the United States must be one of those specified
in a list published by the Board of Governors for the purposes of this
part, with respect to which the Board of Governors has found that the
usages of trade are such as to justify banks or bankers therein in drawing on member banks for the purpose of furnishing dollar exchange.


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Any member bank desiring to place itself in position to accept drafts
or bills of exchange from a country, dependency, or insular possession
not specified in such list may request the Board of Governors through
the Federal Reserve Bank of its district to add such country, dependency, or insular possession to the list upon a showing that the
furnishing of dollar exchange is required by the usages of trade therein.
(2) The Board of Governors may at any time after 90 days' published notice, remove from such list the name of any country, dependency, or insular possession, contained therein.
(c) Purpose of transaction.— (1) Any sucli dollar-exchange draft
or bill must be drawn and accepted in good faith for the purpose of
furnishing dollar exchange as required by the usages of trade in the
country, dependency, or insular possession in which the draft or bill
is drawn. Drafts or bills drawn merely because dollar exchange is
at a premium in the place where drawn or for any speculative purpose
or drafts or bills commonly referred to as "finance bills" (i.e., which
are not drawn primarily to furnish dollar exchange) will not be deemed
to meet the requirements of this section.
(2) The aggregate of drafts or bills accepted by such member bank
for any one foreign bank or banker shall not exceed an amount which
the member bank would expect such foreign bank or banker to liquidate within the terms of the agreements under which the drafts or bills
were accepted, through the proceeds of export documentary bills or
from other sources reasonably available to such foreign bank or
banker arising in the normal course of trade.
(d) Maturity.—Such member bank shall not accept any dollar
exchange draft or bill unless at the date of its acceptance it has not
more than three months to run, exclusive of days of grace.
(e) Acceptances for one hank or banker.—Such member bank
shall not accept dollar exchange drafts or bills for any one bank or
banker in an amount exceeding in the aggregate 10 per cent of the
paid-up and unimpaired capital and surplus of the accepting bank,
unless it be and remain secured as to the amount in excess of such
10 per cent limitation by documents conveying or securing title or by
some other adequate security.
(/) Limitation on aggregate amount.—Such member bank shall
not accept dollar exchange drafts or bills in an amount exceeding at
any one time in the aggregate 50 per cent of its paid-up and unimpaired capital and surplus. This limitation is separate and distinct
from and not included in the limitations prescribed by § 203.1 {d)
with respect to acceptances of commercial drafts or bills. Dollar
exchange draft or bills accepted by another bank, whether domestic
or foreign, at the request of a member bank which agrees to put
such other bank in funds to meet such acceptances at maturity
shall be considered as part of the acceptance liabilities of the member
bank requesting such acceptances as well as of such other bank, if a
member bank, within the meaning of the limitations prescribed in this
section.

Rights and Liabilities of
Federal Reserve Banks
with Respect to Discounted Paper

In the course of the foregoing history of the
development of the lending functions of the
Federal Reserve Banks, mention has been made
of certain cases in which the courts have had
occasion to construe the provisions of law and
regulations relating to such functions. In addition, there have been a number of court decisions pertaining to the right of the Reserve
Banks to realize upon the paper discounted or
offered as collateral when the borrowing member bank becomes insolvent or, for other
reasons, fails to repay the loan made by the
Reserve Bank. These decisions have turned not
upon interpretation of the law or regulations
but on issues of general law regarding negotiable instruments that would be equally applicable to loans by commercial banks. However, for the sake of completeness, the more
important of these court decisions are summarized briefly in this appendix.

dorsement of the discounted paper, becomes
primarily liable to the Reserve Bank, thus giving
the Reserve Bank the right to proceed directly
against the member bank rather than against
the obligor on the paper discounted. However,
if the member bank is insolvent, the Reserve
Bank's right of recourse against the member
bank is of little value. It is for this reason
that the cases hereinafter mentioned usually
revolved around the right of the Reserve Bank
to enforce the discounted paper against the
original obligor.
The most obvious defense to suit by a Reserve Bank against the obligor on discounted
paper would be the fact of payment by the
obligor. In several cases, this defense was made
when the obligor had in fact paid his note to
the member bank that had later discounted it
with the Reserve Bank. In general, however,
the courts have held that this defense will not
prevent recovery by the Reserve Bank, as a
holder of the paper in due course, if the obligor
made payment to the member bank without
demanding production of the paper representing his loan and if the member bank did not act
as agent for the Reserve Bank in receiving such
payment.
In a 1926 Texas case, Federal Reserve Bank
of Dallas v. Hanna, 287 S. W. 274, it was held

In general, litigation resulting from efforts
by the Reserve Banks to realize on paper discounted for member banks involved questions
relating to the validity of defenses made by the
obligor on such paper, that is, the person who
originally gave the paper to the member bank
as evidence of a loan made by that bank. In
Chapter 3 of this study, it was noted that a
borrowing member bank, by virtue of its en-


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HISTORY OF LENDING FUNCTIONS

that there was a reasonable inference that the
member bank acted as agent for the Reserve
Bank in receiving payment and that, therefore,
the question of agency was properly submitted
to a jury. Ten years later, a Federal court held
that the question was not one for a jury, despite
evidence of a practice under which notes
pledged with the Reserve Bank were sent to
the borrowing member bank for collection. In
the case of Federal Reserve Bank of Richmond
v. Kalin, 81 Fed. (2) 1003 ( C C A . 4th,
1936), the court concluded that since the
Reserve Bank and the member bank were
separate corporate entities, "no agency exists
on the part of one to act in behalf of the other,
except such as arises from contractual relationships sufficient to establish agency between
any other banks." This case was followed in a
1937 New Jersey case, Federal Reserve Bank
of Philadelphia v. Gettleman, 189 Atl. 86 (N.J.
1937), in which the court stated:
Ordinarily, in the case of negotiable paper,
the person answerable does not pay the original payee if he is not in possession of the
note, except at his own risk. * * * No
agency to collect arises from the fact that
payee bank was a member of the Federal
Reserve Bank of Philadelphia * * *.
In the same year, however, the Federal
District Court for the District of New Jersey
held, as in the Hanna case, that the facts were
sufficient to imply a custom under which the
member bank acted as agent for the Reserve
Bank in receiving payment on the discounted
note and to justify submission of the agency
question to a jury. Federal Reserve Bank of
Philadelphia v. Algar, 22 Fed. Supp. 168 (D.C.
N.J. 1937), aff'd. 100 Fed. (2) 941 ( C C A .
3d, 1939), cert, den., 307 U. S. 631 (1939).
Next to the defense of payment, the most
frequent defense to liability on a discounted
note has been that the maker had sufficient
funds on deposit with the discounting member
bank to pay the note; in other words, a defense
of set-off. In general, such a defense has been
held not to prevail against a Federal Reserve
Bank that had acquired the note by way of
discount.


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Thus, in a 1923 Washington case, the maker
of the discounted note asserted a right of setoff of his deposit with a failed member bank,
predicating his claim on the ground that the
Reserve Bank held collateral in excess of the
indebtedness of the member bank and that, on
the theory of "marshalling of assets," the Reserve Bank should have had recourse to such
collateral first. The court, however, ruled that
the deposit liability of the failed bank to the
maker of the note could not be set off against
the note held by the Reserve Bank. Williams v.
Duke, 125 Wash. 250, 215 Pac. 372.
A similar position was taken by the United
States Supreme Court in 1925 when the maker
of the discounted note claimed that the Reserve
Bank should have presented the note for payment to the bank at which it was payable and
with which the maker had a deposit sufficient
to pay the note. Since the maker had expressly
waived protest, notice, and diligence in collecting, the Court held that the Reserve Bank was
not bound to present the note at the bank at
which payable. However, the Court also rejected the theory of marshalling of assets, holding that the Reserve Bank could enforce the
note without waiting to determine whether
other collateral held by it was sufficient to cover
the indebtedness of the discounting member
bank. Sowell v. Federal Reserve Bank of
Dallas, 268 U. S. 449.
Despite this decision of the Supreme Court,
a Mississippi court in 1934 gave recognition
to marshalling of assets in the light of the particular circumstances. In this case, the Reserve
Bank knew of the maker's right of set-off of
his deposit with the member bank. The court
held that, because of principles of equity and
fair dealing, the Reserve Bank should have
resorted first to collateral held by it against
which no defenses of set-off existed before it
resorted to the defendant's notes and that, therefore, the marshalling of assets theory should
apply. Dilworth v. Federal Reserve Bank of
St. Louts, 170 Miss. 373, 154 So. 535 (1934).
Nevertheless, there were still later court decisions that denied the right of the obligor on
a note given to a member bank and later dis-

RIGHTS AND IIABHITIES OF FR BANKS
counted with a Federal Reserve Bank to set off
his deposit with the failed member bank against
his liability on the note. Federal Reserve Bank
of Richmond v. Duffy, 210 N. C. 598, 188
S. E. 82 (1936); Federal Reserve Bank of
Boston v. Gray-United Stores, 194 N. E. 709
(Mass. 1935).
In addition to efforts to set off deposits in
the discounting member bank, obligors on discounted paper have offered other defenses
against suits by Federal Reserve Banks on such
paper, which also have been in the nature of
set-off or counterclaim. In one case, for example, the maker of two discounted notes
alleged that he had received no consideration
for one of the notes and that he was entitled
to a counterclaim for the other note. The court
held, however, that these defenses were not
available against the Federal Reserve Bank as a
holder of the notes in due course. Federal
Reserve Bank of Richmond v. Atmore, 200
N.C.437, 157 S.E. 129(1931).
In another case, a note executed by a city
in renewal of a note previously given to a
member bank for money borrowed to retire
city bonds was held enforceable by a Federal
Reserve Bank as a bona fide holder in due
course even though the city had no authority to
issue negotiable notes. Federal Reserve Bank
of Atlanta v. Panama City, 87 Fed. (2) 677
( C C A . 5th, 1937).
Again, when the maker of the discounted
note claimed that the member bank had
evaded the usury law, it was held that this claim
could not be made against a Federal Reserve
Bank that took the note as a holder in due
course. Federal Reserve Bank of Richmond
v. Jones, 205 N. C. 648, 172 S. E. 185 (1934).
Similarly, when the maker, a married woman,
alleged that she had executed a note as surety
for her husband's debt and that the note was
still in possession of the member bank, it was
ruled that the bank held the note only as agent
of the Reserve Bank for collection and that she
could not assert her defense against the Reserve Bank as a holder in due course. Federal
Reserve Bank of Atlanta v. Haynie, 46 Ga.

App.522, 168 S.E. 112(1933).


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In Bragg v. Federal Reserve Bank of Richmond, 164 Va. 30, 178 S. E. 680 (1935),
Government bonds deposited with a member
bank were pledged by the latter as security for
a Federal Reserve Bank loan. When the member bank later failed, the estate of the deceased
owner of the bonds brought suit against the
Reserve Bank for recovery of the bonds, alleging that they had been deposited with the
member bank for safekeeping only. The court
held that the evidence was not sufficient to
show that the bonds had been deposited merely
for safekeeping and that, in any event, recovery
was barred by the fact that the Reserve Bank
was a holder of the bonds in due course.
On the other hand, when a draft was sent
by the seller of goods to a member bank for collection only and the bank discounted the draft
with a Reserve Bank and both the member
bank and the Reserve Bank knew that the
member bank was insolvent, it was held that
the Reserve Bank was not a bona fide holder
in due course. Federal Reserve Bank of San
Francisco v. Idaho Grimm Alfalfa Seed Growers Association, 8 Fed. (2) 922 ( C C A . 9th,
1925), cert, den., 270 U. S. 646 (1926). Similarly, when a Reserve Bank sold certain stock
that had been pledged with it by a member
bank that later became insolvent and knew at
the time of the sale that an attorney for the
member bank had a valid lien on the stock, it
was held that the Reserve Bank was guilty
of conversion and that the attorney was entitled
to assert his claim. It was only because the
plaintiff had not alleged with certainty the
value of the stock and proved that he had been
injured by its sale that a judgment for the
plaintiff in the lower court was reversed. Hansbrough v. D. W. Standrod & Co., 49 Idaho
216,286 Pac. 923 (1930).
In a few instances, the obligor on the discounted paper has set up a defense based upon
an offsetting claim against the Federal Reserve
Bank itself rather than the discounting member
bank. Thus, the Hansbrough case last cited
gave rise to further litigation in which the
Reserve Bank sued Hansbrough, the attorney
for the member bank, on a mortgage note and

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HISTORY OF LENDING FUNCTIONS

the attorney claimed that the Reserve Bank
had agreed to release the mortgage in consideration of the attorney's assignment of his
interest in a judgment for attorney's fees against
the member bank. The Reserve Bank contended that since the judgment for attorney's
fees had been modified on appeal, there was
a failure of consideration. However, the court
held for the attorney on the ground that the
modification of the judgment had not affected
the merits and that the interest assigned to the
Reserve Bank was still sufficient to constitute
a valuable consideration. Federal Reserve
Bank of San Francisco v. Hansbrough, 49
Idaho 747,292 Pac. 222 (1930).
In another case, the maker of a discounted
note alleged that the Reserve Bank had violated its verbal agreement with respect to pasturing cattle on the defendant's land. Despite
arguments of the Reserve Bank that newly
discovered evidence should be considered in
mitigation of damages resulting from violation
of the verbal agreement, judgment for the de-


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fendant was affirmed. Federal Reserve Bank of
Dallas v. Upton, 34 N. M. 509, 285 Pac. 494
(1930).
The cases briefly mentioned here will suffice
to illustrate the nature of the questions that
have been the subject of litigation arising from
efforts of Federal Reserve Banks to enforce
payment of paper discounted by member banks
or given by member banks as collateral for
Reserve Bank loans. The cases cited are in no
sense intended to be exhaustive. Among others
that might have been mentioned, the reader
is referred to Federal Reserve Bank of Rich-

mond v. Crothers, 289 Fed. 777 (CCA. 4th,
1923); Federal Reserve Bank of Richmond v.
Meadows, 201 N. C. 832, 160 S. E. 757
(1931); Federal Reserve Bank of New York

v. Palin, 79 Fed. (2) 539 (CCA. 2d, 1935);
Federal Reserve Bank of Philadelphia v. Ocean

City, 84 Fed. (2) 657 (CCA. 3d, 1936),
cert, den., 299 U. S. 584; Federal Reserve Bank
of Philadelphia v. Levy, 97 Fed. (2) 50

(CCA. 3d, 1938).

jiHislory.

£ of the •§
Lending

Notes and References
INTRODUCTION
Senate Doc. 243, 62d Cong., 2d Sess.
House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 11.
/</.. p. 48.

Id., p. 51.

Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.
(Nov. 22, 1913), p. 7.
Mr. Tribble, 50 Congressional Record 5044.

THE ORIGINAL DISCOUNT PROVISIONS
50 Congressional Record 5998.
Mr. Neeley, 50 Congressional Record 4844. At
another point, Mr. Beakes said: "Speculation is
largely guarded against, as these reserve banks
will not rediscount for their member banks paper
secured by stocks and bonds, the usual method
of securing money for Wall Street gambling." (50
Congressional Record 4906)
Mr. Thompson, 50 Congressional Record 5012.
Senator Swanson, 51 Congressional Record 430.
50 Congressional Record 4675. To the same general effect were statements by Messrs. Wilson (50
Congressional Record 4854), Saunders (50 Congressional Record 4880), and Stephens (50 Congressional Record 4923,4924).
50 Congressional Record 4905.
51 Congressional Record 782.

House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 16.
Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.
(Nov. 22, 1913), pp. 7, 8.
50 Congressional Record 4880, 4906,4924.
51 Congressional Record 430.
50 Congressional Record 4678.
50 Congressional Record 4802.
Mr. Towner, 50 Congressional Record 4897.
Mr. McKellar, 50 Congressional Record 4830.
Mr. Callaway, 50 Congressional Record 4868.
Mr. Kennedy, 50 Congressional Record 4929.
House Rep. No. 69, Sept. 9, 1913, p. 51.
50 Congressional Record 4678.
51 Congressional Record 533.
Report of National Monetary Commission,
Senate Doc. 243, 62d Cong., 2d Sess. (Jan. 9,
1912), p. 8.

GENERAL LIMITATIONS
with maturities of up to 90 days if guaranteed by
the local national reserve association. (Report of
National Monetary Commission, p. 22)
House Rep. No. 69, Sept. 9, 1913, p. 48.
50 Congressional Record 4647. Later in the debates, Mr. Phelan also undertook to dispel this
"misapprehension." (50 Congressional Record
4675)
See, for example, statements by Mr. Stephens of
Mississippi (50 Congressional Record 4924) and
Mr. Thompson of Oklahoma (50 Congressional
Record 5007).
50 Congressional Record 5053.

Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.
(Nov. 22,1913), p. 26.
House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 18. Similarly, Mr. Phelan during the
debates in the House explained that the purpose
of the maturity limitation was to prevent the
assets of the Reserve Banks from becoming "tied
up." (50 Congressional Record 4675)
50 Congressional Record 4731.
51 Congressional Record 1056. The National
Monetary Commission, also following European
practice, had recommended a maturity of 28
days but with provision for the discount of paper


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Federal Reserve Bank of St. Louis

249

tHistory-i

f of thc%
^Lending'

Notes and References—Continued
50 Congressional Record 6016, 6017.
Senator Pomerene, 51 Congressional Record 523,
1055.
Senator Shafroth, 51 Congressional Record 1056.
51 Congressional Record 523, 1055.
51 Congressional Record 613, 1055.
51 Congressional Record 1063.
51 Congressional Record 1144.
Act of Sept. 7, 1916 (39 Stat. 752).
Letter from Board to Senate Banking and Currency Committee, Mar. 10, 1916, Senate Rep. No.
481, 64th Cong., 1st Sess. (May 18, 1916), p. 10.
1915 Federal Reserve Bulletin 37 (hereinafter
referred to as Bulletin).
Reg. A, Series of 1916, § I(a) (1916 Bulletin
530).
Reg. A, 1955, § 3(a)(4) (1955 Bulletin 10).
Reg. A, as amended Nov. 13, 1968, § 201.2(a)
(196S Bulletin 1012).
1917 Bulletin 378.
1966 Bulletin 506.
Report of National Monetary Commission, p. 37.
50 Congressional Record 5065.
See statement by Senator Weeks, 51 Congressional Record 469. This fear was later proved to
be unfounded; banks soon found that a substantial portion of their paper was eligible for discount. (Annual Report of the Federal Reserve
Board, 1915, p. 10; hereinafter referred to as
Annual Report)
51 Congressional Record 1063.
51 Congressional Record 1076.
50 Congressional Record 5071.
50 Congressional Record 5047.
50 Congressional Record 5065.
House Rep. No. 69, Sept. 9, 1913, p. 52.
Letter to Senate Banking and Currency Committee, Mar. 10, 1916, Senate Rep. No. 481, 64th
Cong., 1st Sess. (May 18,1916), p. 9.
Act of Sept. 7, 1916 (39 Stat. 752).
1916 Bulletin 274.
Letter to Senate Banking and Currency Committee, Mar. 10, 1916, Senate Rep. No. 481, 64"th
Cong., 1st Sess. (May 18, 1916), p. 9.
Act of June 21, 1917 (40 Stat. 232). In addition,
the amendment provided that, as a condition of
discount, the Reserve Bank should require the
State member bank to submit a certificate that the
borrower was not liable to such bank in excess of
the amount presented.
Letter from Board to Senate Banking and Currency Committee, set forth in Senate Rep. No.
73, 67th Cong., 1st Sess. (May 25, 1921).
Act of July 1, 1922 (42 Stat. 821).
Government bonds had been excepted from the
10 per cent limit of §5200 of the Act of


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Federal Reserve Bank of St. Louis

250

Sept. 24, 1918 (40 Stat. 967), and paper secured
by shipping documents, bankers' acceptances, and
readily marketable staples by the Act of Oct. 22,
1919 (41 Stat. 296). The section had been further
liberalized by the McFadden Act of Feb. 25, 1927
(44 Stat. 1229).
House Rep. No. 753, 71st Cong., 2d Sess. (Feb.
25, 1930), p. 1.
Id., p. 2; 1924 Bulletin 275.
46 Stat. 162.
The proviso was added because a similar provision had been stricken from the McFadden bill
3 years earlier as the result of opposition aroused
by the "unwarranted contention" that the amendment was intended to change the character of
paper eligible for discount. The Banking and
Currency Committees in 1930 declared that there
was no basis for this feeling but that the proviso
was added "in order to anticipate any similar
objection." (Senate Rep. No. 308, 71st Cong., 2d
Sess. (Apr. 2, 1930); House Rep. No. 753, 71st
Cong., 2d Sess. (Feb. 25, 1930))
Act of Mar. 3,1919 (40 Stat. 1314).
Reg. A, 1955, § 3(j) (1955 Bulletin 12).
Reg. A, as amended Nov. 23, 1970, 5 201.4(a)
(1970 Bulletin 940).
1919 Bulletin 1055.
1930 Bulletin 453.
1938 Bulletin 571.
Act of June 16, 1934 (48 Stat. 971).
1934 Bulletin 749.
1920 Bulletin 278.
Senator Weeks, 51 Congressional Record 1074.
House Rep. No. 69, Sept. 9, 1913, p. 48.
50 Congressional Record 4675.
51 Congressional Record 523.
Reg. No. 2, 1914 (1914 Annual Report 59).
Reg. B, Series of 1915, § I(a) (1915 Bulletin 37).
39 Stat. 752.
1916 Bulletin 524.
1916 Bulletin 610. Although this is true in most
States, there may be some States in which such
allonges are not considered sufficient.
Federal Reserve Bank of Minneapolis v. First
National Bank, 277 Fed. 300 (D.C.S.D., 1921).
1916/?H//<?///I685.

„,,

Reg. A, Series of 1916, §§ IV(a) and V(a) (1916
Bulletin 531).
Reg. A, 1955, § 3(a) (1) (1955 Bulletin 10).
Reg. A, 1937, as amended Sept. 28, 1942, § l(n)
(1942 Bulletin 989).
1944 Bulletin 879.
1949 Bulletin 247.
1951 Bulletin 391.
1949 Bulletin 247.
1915 Bulletin 21.

^History;
#of lhe»fs
'Lending-

Notes and References—Continued
1919 Bulletin 472.
1917 Bulletin 457.
1917 Bulletin 291.
1915 Bulletin 219.
1918 Bulletin 870.
1917 Bulletin 880.

1918flnMe/m745.
1917 J7n/to//t 200.
1918 Bulletin 871.
1942 Annual Report 98.
1970 Bu/fe/fii 444.

DISCOUNT OF COMMERCIAL PAPER
\916 Bulletin 66.
Lucas v. Federal Reserve Bank of Richmond, 50
Fed. (2d) 617 ( C C A . 4th, 1932) (1932 Bulletin
452).
Reg. A, 1937 (1937 Bulletin 987).
Regs. 3 and 4, 1914 (set forth in 1914 Annual
Report 60).
Reg. A, Series of 1915 (1915 Bulletin 36).
The Board later made it clear that its regulation
did not require a member bank to maintain a
borrower's financial statement on file. (1915
Bulletin 213)
Reg. A, Series of 1916 (1916 Bulletin 530).
1920 Bulletin 1180.
Reg. A, Series of 1928, § IV(b) (1928 Bulletin
64).
Reg. A, 1937, §§ l(h) and 3(b) (1937 Bulletin
985, 987); for similar provisions of 1955 regulation, see 1955 Bulletin 12, 13.
1963 Annual Report 198.
By a court decision it was made plain that the
Federal Reserve Act had no effect upon the character of a trade acceptance or the rights of the
parties thereto. (Stafford v. Hill, 53 Calif. App.
337, 200 Pac. 33 (1921))
1917 Bulletin 116.
Circular No. 16, Series of 1915 (1915 Bulletin
216).
Reg. P, Series of 1915 (1915 Bulletin 217).
Reg. A, Series of 1916, § V(a) (1916 Bulletin
531).
1919 Bulletin 565.
1919 Bulletin 964. This ruling was incorporated in
a footnote to Regulation A in 1920, which stated
that "a consignment of goods or a conditional sale
of goods can not be considered 'goods sold'."
(1920 Bulletin 1180)
1918 Bulletin 33.
1917 Bulletin 114, 116.
1918 Bulletin 310.
1918 Bulletin 435.
1918 Bulletin 309.

House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 48.
51 Congressional Record 1074.
50 Congressional Record 4675.
50 Congressional Record 5046.
51 Congressional Record 1074.
/</.. p. 9.
Circular No. 13, 1914 (set forth in 1914 Annual
Report 182).
1914 Annual Report 58.
1915B«//c»/i37.
1916 Bulletin 531.
Reg. A, Series of 1920, § H(a) (1920 Bulletin
1180).
Reg. A, Series of 1923, § II(a) (1923 Bulletin
893).
Reg. A, effective Oct. 1, 1937 (1937 Bulletin
984).
1920 Bulletin 1302.
Many years later, in 1937, the Board adopted the
broader view that a note given by the purchaser
of goods is commercial paper even in the hands
of the buyer and regardless of whether the goods
are bought for resale or for use by the buyer.
(1937 Bulletin 1190)
1921 Bulletin 1199.
1915 Bulletin 212.
1920 Bulletin 949.
1918 Bulletin 91 A.
1921 Bulletin 1079.
1917 Bulletin 949.
1921 Bulletin 1079.
19(7 Bulletin 949.
Reg. B, Series of 1915 (1915 Bulletin 37).
Reg. A, Series of 1916 (1916 Bulletin 531).
Reg. A, Series of 1920 (1920 Bulletin 1180).
See 1915 Bulletin 72; 1917 Bulletin 456; 1918
Bulletin 108; 1921 Bulletin 1314; 1925 Bulletin
737.
1917 Bulletin 458.
1922 Bulletin 931.


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251

History;
''>:• of Ihc %
* Lending

Notes and References—Continued
1919 Bulletin 565. However, as previously indicated, it was permissible for the draft to include
the cost of labor in installing goods sold. (Reg. A,
Series of 1920, § VI(a), footnote 1; 1920 Bulletin
1180)
1918 Bulletin 30.
1918 Bulletin 636.
Lane Company v. Crum, 291 S.W. 1084 (1927
Bulletin 510).
1927 Bulletin 510. Subsequently, in 1928, another
Texas court held that a trade acceptance was
negotiable even though it stated that the obligation of the acceptor arose out of the purchase
of goods from the drawer (American Exchange
National Bank v. Steeley, 10 S.W. (2d) 1038;
1929 Bulletin 157). The court distinguished this
case from the Lane Company case on the ground
that in the earlier case the statement on the acceptance required reference to the collateral
transaction in order to determine maturity, while
in the instant case this was not necessary, the
instrument being an unqualified promise to pay
at a certain time.
Circular No. 17, Series of 1915 (1915 Bulletin
310).
Reg. Q, Series of 1915 (1915 Bulletin 310).
Reg. A, Series of 1916, § VII (1916 Bulletin
532).
Reg. A, Series of 1917, § VII (1917 Bulletin
540).
Reg. No. 2, 1914 (1914 Annual Report 59).
Reg. B, Series of 1915, §II(b)(l) (1915 Bulletin
37).
Reg. A, Series of 1920, §II(b) (1920 Bulletin
1180).
Reg. A, 1937, 8 l(a)(2) (1937 Bulletin 984).
Reg. A, 1955, § 3(a)(2) (1955 Bulletin 10).
1915 Bulletin 73; 1921 Bulletin 546.
1920 Bulletin 699; 1921 Bulletin 191.
1920 Bulletin 1301; 1921 Bulletin 191.
1918 Bulletin 309.
1916 Bulletin 67.
1918 Bulletin 971.
1921 Bulletin 191.
1926 Bulletin 585.
1920 Bulletin 699.
1938 Bulletin 86.
Reg. A, 1973 (Appendix B).
1965 Bulletin 1409.
Reg. B, Series of 1915, § II(b)(2) (1915 Bulletin
Reg. A, Series of 1916, § II(c) (1916 Bulletin
531).
Reg. A, 1955, § 3(a)(3) (1955 Bulletin 10).
1922 Bulletin 932.
1915 Bulletin 127.
1914 Annual Report 59.
The present provision is contained in Reg A
1973, § 201.4(a) (Appendix B).


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Federal Reserve Bank of St. Louis

ICO
101

100
110

Approved Apr. 5, 1918 (40 Stat. 506); subsequently amended by Acts of Nov. 21, 1918,
Mar. 3, 1919, and Aug. 24, 1921.
1924 Bulletin 277.
Reg. A, Series of 1924, §§ I(c), II(a) (1924 Bulletin 705).
See 1916 Bulletin 587.
1917 Bulletin 158, 197.
1918 Bulletin 743; rescinded later, see 1924 Bulletin 81.
The Board previously had only discouraged the
discount of paper of finance companies. (1915
Bulletin 72) Whether particular paper was finance
or commercial paper was a matter, the Board
held, for determination by the Reserve Bank.
(1919 Bulletin 1054)
1919 Bulletin 1054; 1920 Bulletin 162, 1176; 1921
Bulletin 308.
1918 Bulletin 197.
1920 Bulletin 609.
Reg. A, Series of 1920, § II(c) (1920 Bulletin
1180).
Act of Mar. 4, 1923 (42 Stat. 1454).
Reg. A, Series of 1923, 5 H(b) (1923 Bulletin
893). Under the first of these provisions, the
Board held that notes of a factor the proceeds of
which are loaned to producers of eggs, poultry,
and butter were eligible for discount. (1926 Bulletin 251)
1926 Bulletin 665.
1930 Bulletin 746.
1937 Annual Report 31.
1917 Bulletin 1190.
Ibid. See also 1938 Bulletin 86, regarding the
eligibility for discount of notes of afinancecompany. Similarly, when the proceeds of a loan by
a member bank to a credit union are used by the
latter to make loans for "eligible" purposes, the
note representing the loan to the credit union is
eligible for discount. (1939 Bulletin 361)
1965 Bulletin 1409.
1972 Bulletin 279.
1937 Bulletin 1190.
Act of June 27, 1934, 5 505(b) (48 Stat. 1246).
Sec. 24 of the Federal Reserve Act is to be
found in 12 U.S.C. § 371.
Act of Aug. 11, 1955 (69 Stat. 634).
House Banking and Currency Committee Rep. No.
1349, 84th Cong., 1st Sess. (July 22, 1955), P- 2See also Senate Banking and Currency Committee
Rep. No. 399, 84th Cong., 1st Sess. (May 27,
Act of Sept. 9, 1959 (Pub. Law 86-251, 86th
Cong.). The report of the House Banking Mia
Currency Committee (House Rep. No. 693, 86tn
Cong., 1st Sess., July 21, 1959) pointed out that
in such cases a national bank making such a loan
relied upon the "take-out" commitment raner
than the underlying real estate security and tnai

252

i History>
^ of t h e *
Lending

Notes and References—Continued
therefore such loans should be classed as commercial rather than real estate loans. The committee felt that the amendment would "permit national banks to make safe and desirable loans of
this type which they may not now make, and will
eliminate a competitive disadvantage which they
now have vis-a-vis State banks in many States."
The amendment had been recommended in 1956
by the Comptroller of the Currency for similar
reasons (see Study of Banking Laws, committee
print of Senate Banking and Currency Commit-

tee, 84th Cong., 2d Sess. (Oct. 12, 1956), pp. 4 9 51); and it had been included in the proposed
Financial Institutions Act, which had passed the
Senate in 1957 (S. 1451, 85th Cong., 1st Sess.)
but had failed to pass the House.
Reg. A, 1937, § l ( c ) (1937 Bulletin 985).
Reg. A, 1955, § 3(d) (1955 Bulletin 12).

House Banking and Currency Committee Report
on H.R. 9620, House Rep. No. 1922, 73d Cong.,
2d Sess. (June 4, 1934), p. 4.

AGRICULTURAL CREDITS
50 Congressional Record 4647.

See, for example, statements by Mr. Harrison (50
Congressional Record 4729), Mr. Moss (50 Congressional Record 4774), and Mr. Neeley (50
Congressional Record 4845).
50 Congressional Record 4846.
51 Congressional Record 613.
Mr. Tribble stated that Mr. Glass had so construed the bill as originally reported. (50 Congressional Record 5045) There were some who asserted that the provision was approved only after
a "hard struggle" in the Democratic caucus and
in the face of Class's opposition. (50 Congressional Record 5009, 5022, 5045)
Act of July 17, 1916 (39 Stat. 360).
The Reserve Banks were authorized to buy and
sell such bonds to the same extent that they
could purchase and sell municipal bonds under
§ 14(b) of the Federal Reserve Act. Sec. 14(b)
permitted (and still permits) the purchase
and sale of municipal bonds having maturities of
not more than 6 months. Member banks were
given blanket authority by the Farm Loan Act to
buy and sell farm loan bonds. The provisions of
the Farm Loan Act were superseded by the comprehensive Farm Credit Act of Dec. 10, 1971, but
the authorities above mentioned were continued.
(12U.S.C. 2158)
See discussion during the congressional debates on
the Agricultural Credits Act of 1923; 64 Congressional Record 1742, 1746.
41 Stat. 1084.
Mar. 4, 1923 (42 Stat. 1454).
The Banking and Currency Committees agreed
that it was desirable to encourage more country
banks to join the System (Senate Rep. No. 998,
67th Cong., 4th Sess. (Jan. 8, 1923), p. 8; House
Rep. No. 1712, 67th Cong., 4th Sess. (Feb. 24,
1923), p. 19). A proposal to increase dividends


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Federal Reserve Bank of St. Louis

253

paid on Federal Reserve Bank stock was finally
abandoned as not being a substantial inducement
to membership (House Rep. No. 1712, p. 19).
However, the Agricultural Credits Act sought to
make membership more attractive by somewhat
liberalizing capital requirements, and a joint congressional committee was assigned the task of
considering what measures might be taken to
increase membership.
House hearings on S. 4280, 67th Cong., 4th Sess.
(Jan. 31, Feb. 2-19, 1923), p. 1.
64 Congressional Record 1758.
House hearings on S. 4280, Jan. 31,1923, p. 1.
Id., p. 62.
1923 Bulletin 913.
Reg. C, Series of 1915 (1915 Bulletin 38).
Reg. A, Series of 1923, § VI(a) (1923 Bulletin
893).
Reg. A, 1955, § 3(e) (1955 Bulletin 12).
1918 Bulletin 310.
1916 Bulletin 526.
1918 Bulletin 1118.
1918 Bulletin 310, 312.
1915 Bulletin 75.
1918 Bulletin 309.
1916 Bulletin 67.
1918 Bulletin 743. But the note of an irrigation
company is commercial rather than agricultural
paper, even though all of its customers are farmers. (1921 Bulletin 964)
1916 Bulletin 679; 1917 Bulletin 378.
1916 Bulletin 112; 1915 Bulletin 72.
1915 Bulletin 212.
1917 Bulletin 616.
Statement by Senator Capper, 64 Congressional
Record 1757.
Senate Rep. No. 998, 67th Cong., 4th Sess.
(Jan. 8, 1923), p. 7.
64 Congressional Record 4903.

a»

History ,=

r; of the<jj1
Lending
Functions

Notes and References—Continued
Eugene Meyer felt that this restriction was unimportant because of the large reserves available to
the Reserve Banks. (Hearings on S. 4280, 67th
Cong., 3d and 4th Sess. (Apr.-May 1922 and
Jan.-Feb. 1923), p. 60)
Senate Rep. No. 998, 67th Cong., 4th Sess. (Jan.
8, 1923), p. 7.
Reg. No. 5 (1914 Annual Report 61).
Circular No. 13, 1914 (1914 Annual Report 184).
Act of Sept. 7, 1916 (39 Stat. 752). See statement by Senator Owen, 53 Congressional Record
11002.
Reg. A, Series of 1923, § VI(e) (1923 Bulletin
893).
1917 Bulletin 378.
1923 Bulletin 911. See statement by Senator Platt
during hearings on S. 4280, 67th Cong., 3d and
4th Sess. (Apr.-May 1922 and Jan.-Feb. 1923),
p. 104; also Senate Rep. No. 998, 67th Cong.,
4th Sess. (Jan. 8, 1923), p. 6.
Act of Mar. 4, 1923 (42 Stat. 1454).
Act of May 29,1928 (45 Stat. 975).
Reg. A, Series of 1923, § VII (1923 Bulletin
894).
Reg. A, 1955, § 3(b) (1955 Bulletin 11).
1966 Bulletin 506.
1924 Bulletin 276.
1925 Bulletin 737.
1926 Bulletin 854.
Reg. A, 1937, § l(b) (1937 Bulletin 984).
Hearings on S. 4280, 67th Cong., 3d and 4th
Sess. (Apr.-May 1922 and Jan.-Feb. 1923), p.
60.
Id., p. 74.

Reg. A, Series of 1923, § VIII (1923 Bulletin
894).
Reg. A, 1955, § 3(g) (1955 Bulletin 12).
1926 Bulletin 251.
1923 Bulletin 911. For statement by Eugene
Meyer regarding development of such associations, see hearings on S. 4280 before House Banking and Currency Committee, 67th Cong., 3d and
4th Sess. (Apr.-May 1922 and Jan.-Feb. 1923),
p. 61.
1923 Bulletin 999.
See summary of such rulings in 1922 Bulletin
1044.
1921 Bulletin 1312.
Hearings on S. 4280 before House Banking and
Currency Committee, 67th Cong., 3d and 4th
Sess. (Apr.-May 1922 and Jan.-Feb. 1923), p.
61.
1923 Bulletin 999.
Reg. A, Series of 1923, § VI(b) (1923 Bulletin
893). See also Reg. A, 1955, §3(f) (1955 Bulletin 12).
Reg. A, Series of 1923, § VI(d) (1923 Bulletin
894).
This limitation was not applicable, however,
when paper of a Federal intermediate credit
bank was rcdiscounted at a Federal Reserve Bank
by a member bank. (1926 Bulletin 252)
1928 Bulletin 777.
1937 Bulletin 984.
Reg. A, 1955, § 6(a) (1955 Bulletin 14).
75 Congressional Record 8860.
47 Stat. 159.

BANKERS' ACCEPTANCES
Report of National Monetary Commission, Senate Doc. 243, 62d Cong., 2d Sess. (Jan. 9, 1912),
p. 28.
House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 49.
50 Congressional Record 4678.
51 Congressional Record 434.
51 Congressional Record 469.
50 Congressional Record 4647.
51 Congressional Record 1470.
Circular No. 11, Series of 1915 (1915 Bulletin
44).
Ibid.
Press statement, Sept. 10, 1915 (1915 Bulletin
312).


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Federal Reserve Bank of St. Louis

1916 Bulletin 591.
1919 Annual Report 22.
1920 Annual Report SO.
See article on "Bankers' Acceptance Financing in
the United States," 1955 Bulletin 482.
Ibid. See also Wilbert Ward and Henry Harfield,
Bank Credits and Acceptances (4th ed.; N.Y.:
Ronald Press Co., 1958), p. 88.
Reg. J, Series of 1915, § I (1915 Bulletin 45).
Id., § IV(b).
Reg. A, Series of 1916 (1916 Bulletin 532).
Reg. A, Scries of 1920 (1920 Bulletin 1180).
1916 Bulletin 112.
1915 Bulletin 362.
1918 Bulletin 634.

254

,'Hisloryf
ffaf the -|
^Lending'/
Functions

Notes and References—Continued
House Rep. No. 69, Sept. 9, 1913, p. 49.
50 Congressional Record 4676.
51 Congressional Record 434.
Sec. for example. 1921 Bulletin 547, 816.
12 C.F.R. 7.7420.
1923 Bulletin 319.
1923 Bulletin 316-19.
1915 JW/rfin98.
Reg. A, 1937, § 6(b) (1937 Bulletin 988).
1916 Bulletin 532. In 1928 the Board published
suggested forms of certificates evidencing eligibility of bankers' acceptances. (1928 Bulletin 517)
1920 Bulletin 386.
Reg. No. 6, Nov. 10, 1914 (1914 Annual Report
61).
Reg. J, Scries of 1915 (1915 Bulletin 45).
Reg. A, Scries of 1916 (1916 Bulletin 532).
1917 Bulletin 28.
1915 Bulletin 276.
1918 Bulletin 976.
1929 Bulletin 294,
1920 Bulletin 162.
1916 Bulletin 458.
1916 Bulletin 12.
1917 Bulletin 30.
1926 Bulletin 854.
1927 Bulletin 860.
Sec "Bankers' Acceptance Financing in the
United States," 1955 Bulletin 482.
1915 Bulletin 276; 1918 Bulletin 435.
1920 Bulletin 162; 1921 Bulletin 419. The Board
also ruled that it was immaterial whether or not
the goods had been actually sold at the time of
acceptance, if the accepting bank was reasonably
sure that the draft was drawn to finance the shipment and the proceeds would be used for that
purpose. (1917 Bulletin 527)
1918 Bulletin 438.
Reg. A, Series of 1920, § B ( b ) ( l ) (1920 Bulletin
1180).
The Board had previously ruled that there was no
need for identification of the goods at the time
of acceptance (1915 Bulletin 405; 1917 Bulletin
527). Nor were there any limitations on the kinds
of goods that might be involved. The Board ruled
that gold bullion and gold coin were "goods" for
this purpose. (1917 Bulletin 29)
1921 Bulletin 70.
1922 Bulletin 433.
1915B////«/n91.
Reg. A, Series of 1916, § B(c) (1916 Bulletin
532).
Reg. A, Series of 1923, SX (1923 Bulletin 892,
894).
Reg. C, 1946, § l ( a ) (Appendix C ) .
Act of Sept. 7,1916 (39 Stat. 752).
1915 Annual Report 22. Later, on Mar. 10, 1916,


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Federal Reserve Bank of St. Louis

the Board recommended the amendment to the
Senate Banking and Currency Committee. See
Senate Banking and Currency Rep. No. 481, 64th
Cong., lstSess. (May 18,1916), p. 9.
53 Congressional Record 11001.
Reg. A, Series of 1916, § B(c) (1916 Bulletin
532).
1917 Bulletin 380.
1920 Bulletin 1301; 1921 Bulletin 1312.
1929 Bulletin 811.
1921 Bulletin 191. Nor is an acceptance agreement, which purports to assign certain collateral
security but does not specifically mention any
security as assigned, sufficient to qualify as a
shipping document. (1918 Bulletin 311) '
1919 Bulletin 471.
1917 Bulletin 765; 1918 Bulletin 971, 972. Eventually, this principle was incorporated in the
Board's Regulation C. See Reg. C, as revised
Aug. 31, 1946, § l ( a ) ( 2 ) (Appendix C).
1918 Bulletin 634.
1919 Bulletin 254.
Reg. C, 1946, § l ( a ) ( 2 ) (Appendix C). Some
lawyers have questioned this interpretation,
arguing that domestic shipments may properly
cover shipments within a foreign country. (See
Ward and Harfield, Bank Credits and Acceptances (1958), p. 100.)
1919 Bulletin 858.
1922 Bulletin 52.
1920 Bulletin 66.
Reg. A, Series of 1920 (1920 Bulletin 1181).
1918 Bulletin 437, 871.
1918 Bulletin 636.
1918 Bulletin 31; 1918 Bulletin 634; 1921 Bulletin 963.
1926 Bulletin 666.
1923 Bulletin 1194; 1926 Bulletin 666.
1933 Bulletin 188.
1918 Bulletin 31; also 1918 Bulletin 862.
Reg. A, Series of 1928, as amended, §XI(3)
(1928 Bulletin 777).
1923 Bulletin 316.
Reg. A, Series of 1920, § B(b)(3) (1920 Bulletin
1181). The requirement was repeated in Reg. A,
as revised effective Feb. 15, 1955, footnote 8
(1955 Bulletin 11); but it was eliminated in the
1973 revision.
1919 Bulletin 740; 1924 Bulletin 638.
Reg. A, Series of 1928, § XI(3) (1928 Bulletin
66).
1916 Bulletin 523.
1919 Bulletin 652.
1918 Bulletin 309.
1923 Bulletin 1194.
1917 Bulletin 30; 1916 Bulletin 523.
1925 Bulletin 737.

255

i History.
f-.of thc%

Lending'

Functions

Notes and References—Continued

101
102

105
100

ICO
110
111
113

114
113

110
120
121

1*7
1ZS

1915 Bulletin 126.
39Stat. 752;12U.S.C. §372.
1919 Bulletin 143.
1919 Bulletin 364.
1917 Bulletin 286.
1920 Bulletin 1065.
1922 Bulletin 52.
1919 Bulletin 254, 468.
1917 Bulletin 286, 881; 1919 Bulletin 254; 1921
Bulletin 1313.
Reg- C, Series of 1920 (1920 Bulletin 1182). The
condition as to control of the goods was strictly
applied. Even when the customer held a trust
receipt as agent for the bank for the sole purpose
of diverting the cars carrying the goods to a warehouse, it was concluded that the customer would
have some control of the goods. (1921 Bulletin
1313)
Reg.C, 1946, § l(c) (Appendix C).
In 1934 the Board held that, for the purpose of
this limitation, capital stock included capital notes
and debentures legally issued by a State member
bank and purchased by the Reconstruction Finance Corporation. (1934 Bulletin 749)
38 Stat. 958. In its report on this amendment, the
House Banking and Currency Committee, headed
by Carter Glass, stated that the Reserve Bank
Organization Committee, on its tour of the
country, had found that there were a number of
State banks that desired to become members of
the System but were deterred by the restrictions
of § 13 of the Federal Reserve Act and that
they might become members if this amendment
were approved. (House Rep. No. 1165, 63d
Cong., 2d Sess. (Sept. 24, 1914))
Reg. K, Series of 1915 (1915 Bulletin 46).
1916 Annual Report 28.
40 Stat. 232.
See 1918 Bulletin 1119.
Reg. C, Series of 1917 (1917 Bulletin 542).
Reg.C, 1946, § l(e) (Appendix C).
1916 Bulletin 397.
Reg. C, 1946, § l(d) (Appendix C).
1917 Bulletin 528.
Federal Reserve Act, § 13, «| 12; 12 U.S.C. § 373.
Reg. C, 1946, § 2(e) (Appendix C).

1916 Bulletin 523.
1917 Bulletin 614.
1918 Bulletin 520.
1918 Bulletin 636.
1920 Bulletin 65; 1921 Bulletin 699.
1920 Bulletin 494; 1921 Bulletin 419.
Senate committee report on H.R. 13391, Senate
Rep. No. 481, 64th Cong., 1st Sess. (May 18,
1916), p. 10.
53 Congressional Record 11002.
1916 Bulletin 666.
1920 Bulletin 835.
Reg. C, 1946, § 2 ( c ) ( l ) (Appendix C).
/</., §2(c)(2).
See "Bankers' Acceptance Financing in the United
States," 1955 Bulletin 482.
1916 Bulletin 534.
1916 Bulletin 532.
Reg. C, 1946, § 2(a) (Appendix C).
1916 Bulletin 666.
1918 Bulletin 938.
1920 Bulletin 1175. Obviously, "San Salvador"
referred to the country of Salvador rather than
the city of San Salvador.
1921 Bulletin 188.
1922 Bulletin 50, 680.
1918 Bulletin 938; 1922 Bulletin 680.
1946 Bulletin 997.
See hearings on S. 1451 and H.R. 7026 before the
House Committee on Banking and Currency, Part
2, 85th Cong., 2d Sess. (Jan. 14-Feb. 7, 1958),
p. 1036.
Id., p. 989.
Id., pp. 1010, 1065.
Id., p. 1036.
Id., p. 1063.
See present Reg. C, § l(b) (Appendix C).
1917 Bulletin 690; 1923 Bulletin 158.
1917 Bulletin 690; 1921 Bulletin 815.
1929 Bulletin 811.
Reg. A, Series of 1920, SB(c)(2) (1920 Bulletin
1181).
1921 Bulletin 815; 1922 Bulletin 52.
Reg. A, 1955, § 3(c), footnote 10 (1955 Bulletin
11).
1917 Bulletin 30; 1921 Bulletin 699; 1926 Bulletin 854.
1920 Bulletin 66.
Reg. J, Series of 1915 (1915 Bulletin 45).
Reg. R, Series of 1915 (1915 Bulletin 311).
Sept. 10, 1915 (1915 Bulletin 312).
1919 Bulletin 858.
Reg. A, Series of 1920 (1920 Bulletin 1181).
1927 Bulletin 860.
1921 Bulletin 963.


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Federal Reserve Bank of St. Louis

Id., §2(c)(2).

W.,§2(f).
Reg. A, 1955, § 2(c) (1955 Bulletin 11).
38 Stat. 958.
Reg. J, Series of 1915 (1915 Bulletin 45).
Reg. R, Series of 1915 (1915 Bulletin 310).
1915 Bulletin 269.
For a discussion of the nature and form of letters
of credit, see 1921 Bulletin 158, 410, 681, 926.

256

•f History;,
± of the is
Lending"

Notes and References—Continued

1921 Bulletin 547.
Reg. C, 1946, § l ( d ) (Appendix C ) ; also 1915

Bulletin

12 U.S.C. § 353.
1923 Bulletin 317.
Act of June 16, 1933 (48 Stat. 162).
12C.F.R. §270.7(b).
12 C.F.R. § 202.2.

311.

1921 Bulletin 816.
1918 Bulletin 257.

REDISCOUNT OF WORLD WAR I VETERANS' NOTES
1928 Bulletin 74.
Act of Feb. 27, 1931 (46 Stat. 1429).
1931 Bulletin 161.
Act of July 21,1932 (47 Stat. 724).
1932 Bulletin 598.
1939 Bulletin 361.

43 Stat. 125.
Set forth in 1927 Bulletin 33.
Reg. M, Series of 1926 (1927 Bulletin 30).
The Board held that such a note was not eligible
for discount if the requisite notice to the veteran
had been waived. (1931 Bulletin 538)

ADVANCES TO MEMBER BANKS
Letter to Senate Banking and Currency Committee, Mar. 29, 1932. (1932 Bulletin 213) The Federal Advisory Council also opposed the proposed
penalty rate on 15-day advances. (1932 Bulletin
224)
1933 Bulletin 499.
1970 Bulletin 940.
39 Stat. 752.
48 Stat. 7.
1942 Bulletin 302.
1955 Bulletin 9.
1968 Bulletin 1012.
This change was technically unnecessary because
a 1929 amendment to the Second Liberty Bond
Act of 1917 had provided that, for purposes of
the Federal Reserve Act, bonds and notes of the
United States should be deemed to include certificates of indebtedness and Treasury bills (Act of
June 17,1929; 46 Stat. 19).
1960 Bulletin 858.
1937 Bulletin 987.
1939 Annual Report 6.
1941 Annual Report 1.
War Finance Corporation Act of Apr. 5, 1918
(40 Stat. 506). Reference to the use of such
bonds as collateral for Federal Reserve advances

1915 Annual Report 22. Subsequently, the Board
recommended specific language (1916 Bulletin
324), which was adopted by Congress without
change.
39 Stat. 752.
Senate Banking and Currency Committee Rep.
No. 481, 64th Cong., 1st Sess., (May 18, 1916),
p. 9.
53 Congressional Record 11001, 11002.
Letter to Senate Banking and Currency Committee, Mar. 29, 1932 (1932 Bulletin 213).
1916 Bulletin 513.
1927 Bulletin 29.
1932 Annual Report 25-31, 216.
1960 Bulletin 151.
Act of Sept. 21, 1968 (82 Stat. 856).
1968 Bulletin 1012.
1916 Bulletin 685.
53 Congressional Record 11001.
1917 Bulletin 765, 879.
Letter to Senate Banking and Currency Committee, Mar. 29, 1932 (1932 Bulletin 206).
Reg. A, 1955, S 2 ( b ) (1955 Bulletin 9 ) .
1968 Bulletin 1012.
75 Congressional Record 4324.
S.4115.


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Federal Reserve Bank of St. Louis

257

• History*

j ; of the §
Lending'
Functions

Notes and References—Continued
was contained in the Board's 1920 revision of
Regulation A (1920 Bulletin 1179), but it was
omitted in the 1928 revision of the regulation.
47 Stat. 159.
Previously, in December 1931, a bill to permit
such debentures to be used as collateral for § 13
advances had been introduced by Senator Vandenberg but had failed to pass.
House Rep. No. 1125, 72d Cong., 1st Sess.
(Apr. 25, 1932), pp. 4, 5.
75 Congressional Record 10368.
75 Congressional Record 10369.
This was made clear by a provision of the Act of
Aug. 19, 1937 (50 Stat. 718; 12 U.S.C. § 1040).
Act of July 17, 1916 (39 Stat. 380). The Farm
Loan Act provision was superseded by a provision
of the Farm Credit Act of 1971 that specifies
that "any Federal Reserve Bank may buy and
sell" bonds, debentures, or other obligations issued under the authority of that act to the same
extent and subject to the same limitations placed
upon the purchase and sale by such Banks of
State, county, district, and municipal bonds under
§ 14(b) of the Federal Reserve Act (12 U.S.C.
§2158).
1918 Bulletin 33.
House Committee on Agriculture Rep. No. 6,
73d Cong., 1st Sess. (Mar. 20, 1933), p. 2.
48 Stat. 31.
48 Stat. 344.
House Committee on Agriculture Rep. No. 279,
73d Cong., 2d Sess. (Jan. 12, 1934), p. 1.
Less than $200,000 as of June 30, 1960.
Reg. A, 1955, § 2(a), footnote 2 (1955 Bulletin
10).
75 Stat. 773.
1968 Bulletin 1012.
48 Stat. 643.
House Rep. No. 1075, 73d Cong., 2d Sess.
(Mar. 26, 1934), p. 4.
78 Congressional Record 4807.
Pursuant to Act of June 30, 1953 (67 Stat. 121).
1917 Bulletin 949.
1949 Bulletin 247.
1969 Bulletin 354.

I960 Bulletin 151.
1968 Bulletin 1012.
1962 Bulletin 690.
42 Opinions of Attorney General, No 1, ADI". 14
v
1961.
1966 Bulletin 188.
1966 Bulletin 340.
Act of Sept. 21, 1966 (80 Stat. 825).
Acts of Sept. 21, 1967 (81 Stat. 226) and
Sept. 21, 1968 (82 Stat. 856).
1968 Bulletin 1012.
1969 Bulletin 355.


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Federal Reserve Bank of St. Louis

258

1971 Bulletin 399.
1972 Bulletin 983.
1971 Bulletin 399.
1916 Bulletin 609. It was pointed out that while
bonds of the United States were mentioned both
in § 13 and § 14(b), municipal tax obligations
were mentioned in the latter but not in the former
section.
Thus, during the hearings on the Glass-Steagall
bill. Governor Meyer stated that if § 10(b)
were adopted, "banks would be freer to use their
resources to buy warrants, knowing that in case of
need they could borrow on them under exceptional circumstances" (Hearings on H-R. 9203,
72d Cong., 1st Scss. (Feb. 12, 1932), p. 19).
During the debates, Senator Kcan similarly indicated that the bill would permit the use of
municipal bonds as collateral for advances in
exceptional circumstances. (75 Congressional
Record 4310) Previously, in December 1931,
Senator Vandenberg had introduced a bill (S.
546) that would have made revenue bonds
specifically eligible as collateral for advances to
member banks under § 13 of the Federal Reserve
Act, but that bill was never enacted.
1968 Bulletin 1013.
1969 Bulletin 150.
Act of June 25, 1959 (73 Stat. 142).
47 Stat. 56.
75 Congressional Record 3963.
For example, Mr. Shannon (75 Congressional
Record 3983); Mr. McFadden (75 Congressional
Recond 3986); Senator Couzcns (75 Congressional Record 4053).
House Committee on Banking and Currency Rep.
No. 475, 72d Cong., 1st Sess. (Feb. 13, 1932),
p. 2.
Mr. McFadden, 75 Congressional Record 3986.
Senator Robinson, 75 Congressional Record 4223.
In the House, Mr. Stafford said: 'This bill could
not be justified in normal times, because some of
the security that is offered for Federal reserve
notes, though perfectly sound, is not of liquid
character, such as bonds and mortgages. But hard
cases require exceptional treatment. I justify this
only as a temporary expedient ***." (75 Congressional Record 3981)
75 Congressional Record 3966.
Senate Banking and Currency Committee RepNo. 237, 72d Cong., 1st Sess. (Feb. 12, 1932),
p. 2.
Hearings on H.R. 9203, Feb. 12, 1932, p. 15.
Later, the Board reported that, as of Dec. 31,
1931, member banks held $4,694 million of Government bonds and $2,573 million of eligible
commercial paper. (1932 Bulletin 142)
Mr. Steagall, 75 Congressional Record 3964.
75 Congressional Record 4136.

:• History,

1 of the I
Lending
Functions

Notes and References—Continued
75 Congressional Record 4137. Senator Wolcott
likewise thought the measure would cause banks
to stop "hoarding" eligible paper and make more
loans. (75 Congressional Record 4143)
75 Congressional Record 4242.
Mr. LaGuardia, 75 Congressional Record 3970.
Senate Rep. No. 237, 72d Cong., 1st Sess.
(Feb. 12, 1932).
House Rep. No. 475, 72d Cong., 1st Sess.
(Feb. 13, 1932).
Mr. Bcedy, 75 Congressional Record 3980.
See statement by Secretary of the Treasury Ogden
Mills during hearings on H.R. 9203, Feb. 12,
1932, p. 23.
75 Congressional Record 4228. Similarly, Mr.
Williamson felt that a liberalization of the eligibility rules should be made permanent legislation.
(75 Congressional Record 3972)
Hearings on H.R. 9203, Feb. 12, 1932, p. 18.
Id., p. 3.
Senate Rep. No. 584 on S. 4412, 72d Cong., 1st
Sess. (Apr. 22, 1932), p. 12.
12 U.S.C. « 347a.
Mr. Slcagall, 75 Congressional Record 3964.
Senate Rep. No. 237, 72d Cong., 1st Sess.
(Feb. 12, 1932), p. 2.
House Rep. No. 475, 72d Cong., 1st Sess.
(Feb. 13, 1932).
Hearings on H.R. 9203, Feb. 12, 1932, p. 3.
75 Congressional Record 4135.
Said Mr. Strong: "It will permit the banks that
have no eligible paper to get together and guarantee each other's paper." (75 Congressional Record
3965)
Sec 75 Congressional Record 4315.
Senator Glass stated: "No limitation is put upon
the amount of credit that may thus be obtained
at a Federal reserve bank. That is left altogether
within the discretion of the directors of the reserve bank •**." (75 Congressional Record
4135)
The House bill (H.R. 9203) had limited § 10(a)
to a period of 1 year, like § 10(b), although some
Congressmen felt that neither section should be
so limited. (75 Congressional Record 3966) On
the other hand, the Senate bill, while limiting
the duration of § 10(b), placed no time limit on
5 10(a), and some Senators were unable to see
why both sections should not be enacted for only
a temporary period. (75 Congressional Record
4318)
As passed by the House on Feb. 16, 1932, the bill
would have required the consent of a majority of
the Board; the Senate bill, passed on Feb. 19,
required the consent of six members; the conference committee in effect followed the House
version since the Board had eight members then.


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Federal Reserve Bank of St. Louis

259

la

123

US

130

75 Congressional Record 4134.
House Rep. No. 607, 72d Cong., 1st Sess.
(Feb. 25, 1932), p. 4.
75 Congressional Record 4321.
See 75 Congressional Record 4315. Senator Reed
was not satisfied that this change made the matter
clear; he suggested that since all the banks in the
group initially would receive the proceeds, the
provision should refer to the "recipient" bank or
banks as later mentioned in the section. (75
Congressional Record 4322)
See hearings on H.R. 9203, Feb. 12, 1932, p. 9;
also comments by Senator Norris during the debates, 75 Congressional Record 4317.
75 Congressional Record 4317, 4318.
75 Congressional Record 4785.
1932 Bulletin 180.
S. 1451, 85th Cong. In its recommendation to the
Senate Banking and Currency Committee regarding this matter, the Board stated:
"*** As far as is known, no advances were
ever made by the Reserve banks under this
authority. One reason presumably was that the
same time Congress enacted section 10(b) of the
Federal Reserve Act authorizing advances to any
individual member bank on any 'satisfactory
security.' In the circumstances it seems reasonably
clear that the authority contained in section
10(a) serves no useful purpose and should be
repealed." (Study of the Banking Laws, committee print of Senate Banking and Currency
Committee, 84th Cong., 2d Sess. (Oct. 12, 1956),
p. 90)
75 Congressional Record 4135.
Hearings on H.R. 9203, Feb. 12,1932, p. 3.
For example, Gov. Meyer, hearings on H.R.
9203, p. 9; Mr. Burtness, 75 Congressional Record 3966.
75 Congressional Record 4333. Senator Glass opposed this amendment because he felt that psychologically it was unwise to suggest that the
emergency would last for 2 years.
75 Congressional Record 4786.
75 Congressional Record 4262. At an earlier
point, a capital limitation of $2 million had been
contemplated.
75 Congressional Record 4315.
75 Congressional Record 4786.
Mr. Strong, 75 Congressional Record 3966.
House Rep. No. 1928, 72d Cong., 2d Sess.
(Jan. 27,1933), p. 3.
47 Stat. 794.
48Stat. 1.
77 Congressional Record 56.
77 Congressional Record 57.
77 Congressional Record 79.
1933 Bulletin 122.

History;;
"/of the 4
Lcnding
Functions

Notes and References—Continued

ISO
151
1=2
IE3
13*

1934 Bulletin 182.
49 Stat. 684.
H.R. 5357; S. 1715.
Hearings on H-R. 5357, Mar. 4, 1935, p. 184.
79 Congressional Record 6739.
79 Congressional Record 13707.
For example, Gov. Eccles, House committee
hearings, Mar. 4, 1935, p. 184; House Banking
and Currency Committee Rep. No. 742, 74th
Cong., 1st Sess. (Apr. 19, 1935), p. 11; Mr.
Hancock, 79 Congressional Record 6739.
1935 Bulletin 560.
1937 Annual Report 206.
50 Congressional Record 5999.
51 Congressional Record 523.
Gov. Meyer, hearings on H.R. 9203, p. 9.
Mr. Busby, 75 Congressional Record 3973.
75 Congressional Record 4135.
Gov. Meyer, hearings on H.R. 9203, p. 19.
Mr. Strong, Feb. 15, 1932, 75 Congressional Record 3965.
Ibid.; also Mr. Stafford, 75 Congressional Record
3981.
Hearings on H.R. 9203, pp. 9, 10.
75 Congressional Record 3972.
75 Congressional Record 4228.
Hearings on H.R. 5357, Mar. 4, 1935, p. 183.
Id., p. 289.
Id., p. 405.
Id., p. 387.
Id., p. 453.
House Rep. No. 742, 74th Cong., 1st Sess.
(Apr. 19, 1935), p. 11.
79 Congressional Record 6718.
79 Congressional Record 6736.
Hearings on S. 1715, May 15, 1935, pp. 410, 701.
Id., p. 296; 79 Congressional Record 11825.
Senate Rep. No. 1007, 74th Cong., 1st Sess.
(July 2,1935), p. 11.
Senator Adams stated: "This provision constitutes a fundamental departure from the theory
heretofore prevailing as to the character of securities acceptable by Federal Reserve Banks." (79
Congressional Record 4988)

79 Congressional Record 13706.
79 Congressional Record 13707.
1937 Annual Report 206.
1936 Bulletin 624.
1936 Bulletin 548.
Reg. A, 1937, § 2(d) (1937 Bulletin 986).
1937 Annual Report 207.
Ibid.
1937 Bulletin 989, 990. As to real estate loans,
the minimum standards were: a first lien on improved real estate; compliance with the amount
and maturity requirements of § 24 of the Federal
Reserve Act; and maintenance by the member
bank of an appraisal of the real estate, an adequate description of the property, evidence of
title, evidence of no tax delinquency, and such
other information as the circumstances might
render advisable. As to instalment loans, the
standards were: security by a first lien in the
nature of a chattel mortgage, conditional sales
contract, or similar instrument; goods of such a
nature that in the event of resale the sum realized
would be greater than the amount necessary to
liquidate the obligation; and reasonable steps by
member banks to satisfy themselves that payments
and other requirements would be met.
Hearings on H.R. 5357, Mar. 18, 1935, pp. 387,
406.
Id., p. 387.
1935 Bulletin 771.
Reg. A, 1955, § 2(c) (1955 Bulletin 10).
Joint committee print of statements submitted to
Subcommittee on Monetary, Credit, and Fiscal
Policies, Senate Doc. 132, 81st Cong., 2d Sess.
(Nov. 7, 1949), p. 58.
Letters to the chairmen of the Banking and Currency Committees of the Congress, Aug. 21, 1963.
(See also discussion in 1963 Bulletin 1235.)
For example, S. 1559, 89th Cong., 1st Sess.
(1965); S. 966, 90th Cong., 1st Sess. (1967).
1971 Annual Report 211. A bill to implement the
Board's new proposal was introduced in the Senate as S. 1951, 92d Cong., 1st Sess. (May 26,
1971).

CREDIT FOR NONMEMBER BANKS
1972 Annual Report 254.
75 Congressional Record 4786. During the House
committee hearings on the bill, Gov. Meyer of
the Board stated that the bill was not intended to


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Federal Reserve Bank of St. Louis

provide credit to nonmember banks but that they
would benefit indirectly. (Hearings on H.R. 9203,
Feb. 12, 1932, p. 7)
51 Congressional Record 958.

260

History
€ of the*
Lending
Functions

Notes and References—Continued
Id., p. 1035.
Id., p. 1119.
Ibid.
Id., p. 1145.
Id., p. 1146.
1915 Bulletin 213.
1917 Annual Report 5.
1918 Bulletin 743.
1918 Bulletin 520.
1918 Bulletin 745.
1921 Bulletin 963.
1923 Bulletin 891. The rescission was effective
June 26, 1923.
1926 Bulletin 252.
1966 Annual Report 91.
I 9 6 9 * / / f
Sec Board press release of Oct. 24, 1972. The text
of the amendment to Reg. J was published in
1972 fl«//r///i 650.
Reg. A, Scries of 1928, §5111(2) and IX (1928
Bulletin M, 65).
1937 Bulletin 987.
1955 Bulletin 13.
Reg. A, 1973, § 201.5(c) (see Appendix B).
47 Stat. 709.
A year later, both Senator Gloss and Senator
Barklcy referred to this authority as including
authority to discount paper for State banks on
the ground that they were corporations. (77 Congressional Record 249, 333)
1932 Bulletin 519.
48 Stat. 1.
12U.S.C. §347c.
77 Congressional Record 56.

77 Congressional Record 79.
1942 Bulletin 302.
1942 Bulletin 207.
1955 Bulletin 9.
1968 Bulletin 1012.
Reg. A, 1973, § 201.7 (see Appendix B).
48 Stat. 20.
The act specifically covered banks and trust
companies not only in the States but in any territory or possession of the United States or the
Canal Zone. This clarification was added by the
Senate Banking and Currency Committee. (Senate Rep. No. 4, 73d Cong., 1st Sess. (Mar. 13,
1933))
Thus, Senator Glass observed that the pending
proposal had already been covered "in a larger
degree" by the Act of July 21, 1932, under which
individuals, partnerships, and corporations, including nonmember banks, could in an emergency
discount paper with the Reserve Banks. (77 Congressional Record 249) Senator Robinson pointed
out that under the Act of Mar. 9, 1933, loans
could be made to nonmember banks on Government bonds. (77 Congressional Record 332)
77 Congressional Record 631.
77 Congressional Record 601.
77 Congressional Record 332.
77 Congressional Record 333. Senator Kean
offered an amendment to eliminate this requirement, but it was rejected. (77 Congressional
Record 335)
77 Congressional Record 603.
77 Congressional Record 633.
1972 Annual Report 197.

LOANS TO INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS
Senator Crawford, 51 Congressional Record 612.
Thus, Mr. Phelan stated that the Reserve Banks
would not compete with commercial banks and
would "make no loans and receive no deposits
from individuals." (50 Congressional Record
4673) The Glass bill as reported expressly provided that the Reserve Banks would deal only
with the Government and depositing member
banks. (50 Congressional Record 5063) Although
this provision was not adopted, it was clearly
understood that loans to individuals would be
"contrary to the whole spirit and purpose of the
law." (50 Congressional Record 5063)
For text of the veto message, see 75 Congressional Record 15040.
47 Stat. 715.


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Federal Reserve Bank of St. Louis

261

12 U.S.C. § 343.
1965 Bulletin 1409; 1972 Bulletin 279. Under the
1973 revision of Reg. A, it appears that the note
of a lending institution would be eligible as collateral for a Reserve Bank advance if the proceeds of the note were used to make home mortgage loans regardless of their maturities.
49 Stat. 684.
1932 Bulletin 518.
See 1933 Bulletin 95; 1934 Bulletin 485; 1935
Bulletin 473; 1936 Bulletin 123.
1966 Annual Report 91; 1969 Annual Report 92.
For example, in May 1933, the rate was 6 per
cent as compared with the regular rate of 3V4 or
3 per cent. (1933 Bulletin 428)
48 Stat. 1.

iHistoryj

p of the7%
Lending'
Functions

Notes and References—Continued
u
14

"

77 Congressional Record 57.
77 Congressional Record 79.

"

Act of Sept. 21, 1968 (82 Stat. 856); 12 U.S.C.
§ 347c.
Reg. A, 1973, § 201.2(f) (Appendix B).

WORKING CAPITAL LOANS TO BUSINESS
Act of June 19, 1934 (48 Stat. 1105).
78 Congressional Record 927'5.
78 Congressional Record 12234.
Mr. O'Connor, 78 Congressional Record 9273.
Mr. Martin, 78 Congressional Record 9274.
78 Congressional Record 9286.
S. 2867, 73d Cong.; H.R. 8734, 73d Cong.
S. 2946, 73d Cong.; S. 3101, 73d Cong.
Letter from Board to Senator Fletcher, chairman
of the Senate Banking and Currency Committee,
dated Apr. 13, 1934.
78 Congressional Record 8718.
48 Stat. 1105.
78 Congressional Record 7908.
78 Congressional Record 9396.
78 Congressional Record 9396.
78 Congressional Record 12233.
78 Congressional Record 9274.
Mr. Dirkscn, who questioned the need for many
of the limitations, asked rhetorically what was
meant by an established business: "Is it one that
makes money now under depressed conditions,
or is it a business that has been actually in operation for a number of years, irrespective of
whether it is established in the sense that successful men so often use the word 'established'?" (78
Congressional Record 9276)
1934 Bulletin 489.
78 Congressional Record 8718.
1934 Bulletin 430.
Reg. S, § III(b) (1934 Bulletin 491).
1934 Bulletin 489. This statement regarding the
blanket authority granted for direct loans was
reiterated in a foreword to Reg. S when it was
revised in 1942 (1942 Bulletin 428).
See Reg. S, §§ 2(a) and 2(c) (1942 Bulletin
429).
78 Congressional Record 9398.
1934 Bulletin 752.
1934 Bulletin 675.
1934 Bulletin 675.
1942 Bulletin 428.
Reg. S, § l(c) (1942 Bulletin 428).
Reg. S, S 4 (1942 Bulletin 430).
78 Congressional Record 7908.
Reg. S, § 3 (1942 Bulletin 430).


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Federal Reserve Bank of St. Louis

1934 Bulletin 510.
As the bill passed the Senate, the Secretary would
have been "directed" to make such payments to
the Reserve Banks. The conference committee
adopted the House bill provision, which merely
authorized the making of such payments.
P.L. 363, 80th Cong. (1947 Bulletin 980).
1934 Bulletin 489.
The first § 13b rates were published in 1934
Bulletin 618. On direct loans the rates were fixed
at from 4 to 6 per cent at the Federal Reserve
Banks of Boston, New York, and Philadelphia;
at from 5 to 6 per cent at Chicago, Dallas, and
San Francisco; at 5>/i per cent at St. Louis; and
at 6 per cent at the other Reserve Banks. For
transactions with financing institutions, varying
rates were established on the port'0" f o r w h i c n
the financing institution was obligated and on the
remaining portion. On commitments to make
advances, the commitment charge varied from
one-half of 1 per cent to between 1 and 2 per
cent. These originaj rates on § 13b loans, participations, and commitments were changed on numerous occasions in subsequent years.
1942 Bulletin 427.
Act of Jan. 31, 1935 (49 Stat. 4).
Act of Apr. 13, 1938 (52 Stat. 212).
S. 2759, introduced in July 1939, would have
eliminated restrictions in § 13b. S. 2998 m
October 1939 would have established an Industrial Loan Corporation with liberal lending
authority. Both bills were sponsored by Senator
Mead.
S. 877, S. 939.
„.S. 1918, 78th Cong., 2d Sess. (May 15, 1944).
An identical bill in the House was H.R. 4804.
S. 511, Senator Wagner, Feb. 12, 1945; H.K.
591, Mr. Spence, Jan. 3, 1945. Together, these
bills were known as the Wagner-Spence bill.
S. 408, Senator Tobey, Jan. 27, 1947.
June 3, 1947, hearings, p. 297, et scq.
The principal bills were S. 2975 (Senator Mahoney, Feb. 2, 1950); S. 3625 (Senator Lucas >,
H.R. 8565 (Mr. Spence); and H-R. 8566 (Mr.
Patman). The last three were introduced on
May 19, 1950.

262

:.- History;
ij?of the**
'Lending
Functions

Notes and References—Continued
ever, that small business investment companies
might make use, wherever practicable, of the
advisory services of the Federal Reserve System,
and the Reserve Banks were authorized to act as
depositories or fiscal agents for such companies.

S. 1647.
S.381.
S. 1451, 85th Cong.
72 Stat. 689; 15 U.S.C. §§ 661, el seq.
1958 Bulletin 1059. The new law provided, how-

V LOANS
1946 Bulletin 242.
This revision of the form was published in 1943
Bulletin 379.
One related to the meaning of the term "loss on
the loan" (1951 Bulletin 20); the other defined
"defense production contract" (1951 Bulletin
149).
1943 Bulletin 12.
1944 Bulletin 879.
1950 Bulletin 1283.
1966 Bulletin 1617.
1970 Bulletin 517.
1942 Bulletin 989.
1944 Bulletin 879.
1949 Bulletin 247.
1951 Bulletin 391.
1942 Bulletin 1079.
Ibid.
1942 Bulletin 534.
56 Stat. 356 (1942 Bulletin 635).
1942 Bulletin 640.
1942 Bulletin 641.
1943 Bulletin 389.
1944 Bulletin 962.
1950 Bulletin 1308.
Hearings on S. 2998 and S. 3839, June 12 and
14, 1940, p. 21.
54 Stat. 1029.
B-84138, May 17, 1949 (unpublished decision).
B-72929, May 18, 1950 (unpublished decision).
1951 Bulletin 20.
Senate Banking and Currency Committee Rep.
No. 217, 82d Cong., 1st Sess. (Apr. 11, 1951),
p. 4.
65 Stat. 41; 31 U.S.C. §203 (1951 Bulletin 508).

See discussion of the origin of the V-loan program in "Financing War Production and Contract
Terminations under Regulation V," 1946 Bulletin
240.
1942 Bulletin 299.
1942 Bulletin 425.
The text of this letter was quoted in hearings before the Senate Banking and Currency Committee
in April 1947 when Chairman Eccles appeared
in support of a bill to liberalize § 13 of the Federal Reserve Act.
55 Stat. 838.
1942 Bulletin 299.
1946 Bulletin 241.
56 Stat. 226 (1942 Bulletin 533).
56 Stat. 419 (1942 Bulletin 640).
56 Stat. 355 (1942 Bulletin 635).
58 Stat. 649 (1944 Bulletin 753).
1944 Bulletin 876.
1944 Bulletin 877.
64 Stat. 800 (1950 Bulletin 1158).
1950 Bulletin 1301.
50 U.S.C. Appendix, § 2166(a).
67 Stat. 129 (1953 Bulletin 948).
Act of Aug. 15, 1970 (84 Stat. 799); 50 U.S.C.
Appendix, §2091 (e).
E.O. 10161 was superseded by E.O. 10480
(Aug. 14, 1953). That order, as amended and as
presently in effect, is set forth in a note to 50
U.S.C. Appendix, § 2153.
1950 Bulletin 1307.
1942 Bulletin 425.
1944 Bulletin 877.
1950 Bulletin 1307.


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263

./History*
Sofihe^f
:
Lending

Notes and References—Continued

INTERDISTRICT REDISCOUNTS
50 Congressional Record 4645.
House Rep. No. 69, 63d Cong., 1st Sess. (Sept.
9, 1913), p. 45.
50 Congressional Record 4675. See also statement
by Mr. Harrison, 50 Congressional Record 4729.
50 Congressional Record 4818.
51 Congressional Record 667.
51 Congressional Record 669.

51 Congressional Record 1192.
1915 Annual Report 8.
1915 Annual Report 29, note.
1918 Annual Report 3.
1919 Annual Report 5.
1921 Annual Report 42, 43.
1933 Bulletin 211.

DISCOUNT RATES
12 U.S.C. § 357.
See 12 U.S.C. § 347.
12U.S.C. §§ 347a, 347b.
12 U.S.C. § 343.
12 U.S.C. § 347c.
31 U.S.C. S821.
Act of Mar. 18, 1968 (82 Stat. 50).
Report of National Monetary Commission, Senate Doc. 243, 62d Cong., 2d Sess. (Jan. 9, 1912),
p. 23.
House Rep. No. 69, 63d Cong., 1st Sess.
(Sept. 9, 1913), p. 11.
Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.
(Nov. 22, 1913), p. 23.
1914 Annual Report 10.
1914 Annual Report 203.
1915 Annual Report 5.
1923 Annual Report 64.
1923 Annual Report 16.
Act of June 16, 1933 (48 Stat. 168); 12 U.S.C.
§263.
See 1957 Annual Report 8, 9. See also discussion
of the effect of the accord on pages 186 and 187
(Chapter XV).
"Report of a System Committee," Reappraisal
of the Federal Reserve Discount Mechanism,
1971, Vol. 1, p. 21. (Initially prepared and published in July 1968; hereinafter referred to as
1968 Report of a System Committee)
1915 Bulletin 24.
34 Fed. (2d) 910.
34 Fed. (2d) 915.
"Monetary Policy and the Management of the
Public Debt" (committee print of the Joint Com-


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Federal Reserve Bank of St. Louis

a

"

264

mittee on the Economic Report, Senate Doc. 123,
Part 1, 82d Cong., 2d Sess. (Feb. 20, 1952),
p. 279; hereinafter referred to as 1952 Patman
Questionnaire).
House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,
1913), p. 53.
50 Congressional Record 4996.
50 Congressional Record 5995.
50 Congressional Record 6024.
50 Congressional Record 4673.
1914 Annual Report 10.
1952 Patman Questionnaire 276.
32 Opinions of Attorney General, No. 81.
House Banking and Currency Committee Rep.
No. 742, 74th Cong., 1st Sess. (Apr. 19, 1935),
p. 9.
1952 Patman Questionnaire 279.
See 1971 Annual Report 74, 82, 87; 1972 Annual
Report 97.
1914 Annual Report 203.
1915 Animal Report 27-29.
1916 Bulletin 513.
1915 Annual Report 27-29.
1917 Annual Report 10.
1918 Annual Report 19.
1917 Annual Report 11.
1917 Bulletin 235, 241.
1919 Annual Report 71.
41 Stat. 550.
Kansas City (April 19), Dallas (May 21), St.
Louis (May 26), and Atlanta (May 31). (1920
Annual Report 58)
1920 Annual Report 59.
1920 Annual Report 66.

; History.
* of theS*
-Lending'
Functions

Notes and References—Continued

42 Slat. 1454.
1923 Annual Report 64. For a time after the
enactment of the Agricultural Credits Act of
1923, some Reserve Banks fixed a slightly higher
rate for long-term agricultural paper, but this
differential did not long continue.
1942 Bulletin 1204.
Board letter to Federal Reserve Banks, Sept. 18,
1972.
49 Slat. 684.

Senate Rep. No. 1007, 74th Cong., 1st Sess.
(July 2, 1935), p. 13.
Conference Rep. No. 1822, 74th Cong., 1st Sess.
(Aug. 17, 1935), p. 51.
1952 Patman Questionnaire 278.
Board press release, Dec. 1, 1970.
1917 Bulletin 951; 1918 Bulletin 109, 744; 1924
Bulletin 639.
1918 Bulletin 108.
1916 Bulletin 461.
1915 Bulletin 308.

RELATION TO CREDIT POLICY
12 U.S.C. § 301 (48 Stat. 163).
Senate Rep. No. 584 on S. 4412, 72d Cong., 1st
Sess. (Apr. 22, 1932), p. 13. A similar statement
was contained in the Report of the Senate Banking and Currency Committee on S. 1631, May 15,
1933, p. 13, and also in the Report of the House
Banking and Currency Committee, May 19, 1933.
75 Congressional Record 9885.
77 Congressional Record 3835, 3836. Also
referring to these provisions, Mr. Kopplemann
stated that "one of the chief purposes" was to
prevent "undue diversion of bank funds into
speculative operations." (77 Congressional Record 3907)
1914 Annual Report 10.
1914 Annual Report 17.
1952 Patman Questionnaire 393, 394.
1952 Patman Questionnaire 395.
For a description of the accord, see 1951 Annual
Report 3-8.
1951 Annual Report 5, 6. See also 1957 Annual
Report 9.
1952 Patman Questionnaire 395.
1955 Bulletin 8.
1957 Annual Report 7-16.
1966 Annual Report 102.
1968 Report of a System Committee 6.
Reg. A, 1973, § 201.2(b) (see Appendix B).

1914 Annual Report 7.
1919 Annual Report 68.
1921 Annual Report 95.
1921 Annual Report 96.
1923 Annual Report 3.
1928 Annual Report 9.
Sec, for example, Milton Friedman and Anna
Jacobson Schwartz, A Monetary History of the
United States, 1867-1960 (Princeton University
Press, 1963), pp. 254, 255.
12 U.S. § 248(m), as amended by Act of June 16,
1933 (48 Stat. 167).
Act of Aug. 23, 1935 (49 Stat. 684). Sec. 5200
of the Revised Statutes subjects Government
obligations to a 15 per cent limitation (except as
permitted by the Comptroller of the Currency)
in addition to the usual 10 per cent limitation on loans by national banks to one borrower.
In 1958 the Comptroller by regulation raised the
limit on loans on Government obligations to
100 per cent of a national bank's capital and surplus, and this limit carries over to loans by State
member banks on Government obligations by
reason of the provisions of § 11 (m) of the Federal Reserve Act.
Act of June 16,1933, § 9 (48 Stat. 180).
See 1932 Bulletin 206.
Id., p. 208.


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iHistory-;
f of the^
-Lending

Notes and References—Continued

GENERAL PRINCIPLES: A SUMMARY
Id., p. 1.
Id., p. 7.
Id., p. 17.
Id., p. 18.
12 U.S.C. § 343.
For text of his proposal, see Senate Rep. No. 133,
63d Cong., 1st Sess. (Nov. 22, 1913).
51 Congressional Record 523.
51 Congressional Record 529. Senator Hitchcock
emphasized the fact that the paper discounted
would in all cases be "good" paper. (51 Congressional Record 1064)
51 Congressional Record 765.
50 Congressional Record 6026. See also 51 Congressional Record 667.
51 Congressional Record 1073.
51 Congressional Record 859.
51 Congressional Record 525, 843.
51 Congressional Record 859.
51 Congressional Record 1076.
Farmers and Merchants Bank v. Federal Reserve
Bank of Richmond, 262 U.S. 649, 663 (1923).
\920 Bulletin 1303.
1920 Bulletin 386.
34 Fed. (2d) 910 (CCA. 2d., 1929).
1968 Report of a System Committee 10.
1914 Annual Report 17.

12 U.S.C. § 343.
12 U.S.C. § 357.
12 U.S.C. § 301.
Reg. A, 1955 (1955 Bulletin 8).
Reg. A, 1973, § 201.2(a) (see Appendix B).
Circular No. 13 (1914 Annual Report 183).
Clay J. Anderson, "Evolution of the Role and the
Functioning of the Discount Mechanism," Reappraisal of the Federal Reserve Discount
Mechanism, 1971, Vol. 1, p. 136.
These provisions are still in effect. (12 U.S.C.
S301) The Banking Act of 1933 also contained
provisions precluding Reserve Bank advances to
any member bank that, after a warning by its
Reserve Bank or by the Board, had increased its
loans on securities.
1923 Annual Report 33.
12 U.S.C. §343.
1928 Annual Report 8.
1968 Report of a System Committee 13.
1926 Annual Report 4.
1952 Patman Questionnaire 395.
Foreword to Reg. A, as revised effective Feb. 15,
1955 {1955 Bulletin 9).
1926 Annual Report 4.
1968 Report of a System Committee 6, 8, and
15.


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/History/

ft of theiji
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Index
Acceptances {See Bankers' acceptances)
Adjusted service certificates, discount of notes secured
by {See Veterans' notes, discount)
Advances to member banks:
Amount limitation, 21
Application forms, elimination, 89
Authority, general development, 83-85
Eligible paper, advances secured by, 85
Endorsement of pledged paper, 87
Federal intermediate credit bank debentures as collateral, 52
Glass-Steagall Act, 100-02
Government agency obligations, advances on:
Agencies of United States, obligations issued or
guaranteed by, 97
Commodity Credit Corporation certificates of
interest, 95
Export-Import Bank participation certificates, 96
Farm loan bonds, 93, 94
Farmers Home Administration insured notes, 96
Federal Farm Mortgage Corporation bonds, 94
Federal intermediate credit bank obligations, 52, 92
Home Owners' Loan Corporation bonds, 95
Merchant Marine bonds, 96
Small Business Administration, notes guaranteed
by, 97
War Finance Corporation bonds, 91
Groups of member banks:
Board of Governors, approval, 104
Eligible assets, requirement for lack, 104
Interest rate, 104
Limitations, 104
Purposes, 103
Use of authority, 105
Maturity limitations in general, 88
Note of borrowing bank, elimination, 89
Paper eligible for purchase, advances on:
Commercial and agricultural transactions, limitation to paper based on, 86
Federal Reserve Act, limitation to purchases
under, 85
Obligations eligible. 87
Original authorization, 85
Rediscounts, distinguished from, 83
Satisfactory security, advances on:
Authority:
Board of Governors, 106
Extensions, 106, 107
Liberalization, proposals, 114,115
Original authorization, 105
Permanent authorization, 107
Interest rate, 106, 113
Limitations:
Emergency use, 108
Exceptional and exigent circumstances, 105
General, 105, 106
Maturity, 113
Sound assets concept, 109
Types of security, 112
Securities loans, increase during advance, 88
States and municipalities, advances on
obligations, 98


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Federal Reserve Bank of St. Louis

Advances to member banks—Continued
Tax warrants, 98
U.S. obligations, advances on:
Maturity, 90
Original authorization, 90
Par, advances at, 91
Types of obligations, 91
Agency issues, advances on, 97
Agricultural paper:
Agricultural Credits Act of 1923, 44
Amount limitations, 48
Commercial paper, distinguished from, 46
Cooperative marketing associations, discount of
paper of, 45,46,50
Definition, 46
Demand drafts covering agricultural
products, 45, 48
Factors' paper, 49
Farm Loan Act of 1916,44
Federal intermediate credit banks, discount of paper
of, 45, 51
Federal Reserve Act, original, intent, 43
Livestock paper, 46
Maturity, 47
Staple agricultural products, paper secured by, 44
War Finance Corporation, agricultural loans by, 44
Amount limitations:
Advances to member banks, 21
Aggregate amount for single member bank, 17,21
Agricultural paper, 48
Bankers' acceptances {See Bankers' acceptances)
Capital notes and debentures included in
determining, 21
Federal intermediate credit banks, discounts
for, 51,52
National banks, total indebtedness, 17
One-borrower paper, S17-21
Regulatory provisions, 20
Application forms, 89
Bankers' acceptances:
Amount limitations:
Commercial acceptances by member
banks, 72, 73
Discount by Reserve Banks, 74,75
Dollar-exchange acceptances by member
banks, 74
Definition, 55
Discount by Reserve Banks:
Diminished importance, 76
Eligibility requirements in general, 57
Endorsement, 57
Evidence of eligibility, 58
Discounting authority, purposes, 53
Dollar-exchange acceptances:
Authority of member banks, 56,57
Countries designated by Board, 67
Legal authority, 68
Member banks, permission for acceptance by, 66
Purpose, 65
Usage of trade, 67

267

History.
; of the *•
Lending

Index—Continued
Commodity Credit Corporation, advances on certificates, 95
Commodity paper, 35
Construction paper, 41
Consumer paper, 30, 40
Cooperative marketing associations, discount of
paper, 45, 46, 50
Court decisions:
Discount rates, 170
Discretion of Reserve Banks in extending
credit. 200
Rights and liabilities of Reserve Banks as to discounted paper, 245-48
Trade acceptances, form, 34
Credit policy:
Commerce and business, accommodation of
needs, 181
Credit control generally, discounts as instrument
of, 185
Direct pressure through discount window, 182, 187
Member bank credit policies, relation of
discounts, 182
Sound credit conditions, maintenance, 184
Speculative loans, prevention. 182-85

Bankers* acceptances—Continued
Domestic transactions:
Extension of law to cover, 61
Federal Reserve Act, original, 54
Geographic limitation, 62
Purpose of financing, 62
Shipping documents, 62
Encouragement by Board, 54
Export and import transactions:
Connection of acceptance with transaction, 58
Contract, necessity, 59, 60
Federal Reserve Act, original, 54
Geographic coverage, 61
Shipping documents, 60
Foreign trade, objective of financing, 53
Letters of credit, 75
Maturity:
Commercial acceptances by member banks, 69
Discount by Reserve Banks, 70
Dollar-exchange acceptances by member
banks ,70
Federal Reserve Act, original, 8, 9
Renewals, 71
Member banks, acceptances by:
National banks, authority, 56, 57
State member banks, authority, 57
National Monetary Commission Report, 53
Storage of staples:
Place, 64
Purpose of transaction, 63
Readily marketable staples, meaning, 64
Security, 63
Warehouse receipts, 63
Syndicate credits, 75
Bankers' banks, Reserve Banks as, 2
Business, loans to (See Individuals, partnerships, and
corporations; Working capital loans to business)

Days of grace, 16
Demand paper, discount. 16, 48
Direct pressure, 182, 187
Discount and interest rates:
Advances to member banks, 173
Attorney General of United States, opinions, 171
Class of paper, meaning, 174
Classification of paper for purposes of; 173-78
Commerce and business, accommodation, 169
Computation, 180
Constitutionality, 170
Court decision upholding authority, 170
Credit policies, use in implementing, 170
Different rates according to:
Borrower, 177
Character of paper, 174
Frequency of borrowing, 175
Maturity of paper, 174
Purpose of credit, 178
Statutory source of credit, 176
Discretionary nature, 170
Distinction between, 167
Distribution of authority between Reserve Banks
and Board, 171-73
Eligible paper, 167
Federal Reserve Banks, establishment by, 171
Government obligations, preferential rate, 174
Graduated rates, 175
Groups of member banks, 104
Individuajs, partnerships, and corporations, 168, 176
Interdistrict rediscounts, 163, 168
Legal basis, 170
Nonmember banks, 177, 178
Objectives, 168
Preferential rates, 174
Procedures for establishment, 179
Progressive rates, 175

Commercial banks:
Loans by, distinguished from Reserve Bank loans, I
Number, 2
Commercial paper, discount:
Agricultural paper, distinguished from, 46
Collateral security, effect, 31
Commercial purpose, meaning, 30
Commodity paper, 35
Construction paper, 41
Consumer paper, 30, 40
Current operating expenses, paper drawn for, 30
Definition, 27, 28
Eligibility, evidence, 32
Finance paper (See Finance paper)
Intent of original Act, 27
Permanent or fixed investment paper (See Permanent investment paper)
Real-bills doctrine, 33
Regulatory definition, 28
Self-liquidating character, 29, 31
Speculation, paper drawn for, 37, 182
Stocks and bonds, paper drawn for trading in, 38
Trade acceptances (See Trade acceptances)


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Federal Reserve Bank of St. Louis

268

History,
; of lhe?V
Lending

Index—Continued
Discount and interest rates—Continued
Rebates, 180
Review and determination by Board, 171-73
Satisfactory security, 106, 113
Statutory provisions, 167
Tax on deficient Reserve Bank reserves to be added
to, 168
Time of establishment, 179
Uniformity, 168
V loans, 157
Veterans' notes, 80
Working capital loans to business, 143
Discount functions in general, importance, 3
Dollar-exchange acceptances (See Bankers'
acceptances)

Federal Reserve Act, original—Continued
Regulation by Board, 9
Reluctance of banks to borrow, 10
Satisfactory security on advances, 8
Speculation, intent to lessen, 11
Federal Reserve Banks:
Advances to:
Businesses (See Individuals, partnerships, and
corporations; Working capital loans to business)
Individuals, partnerships, and corporations (See
Individuals, partnerships, and corporations)
Member banks (See Advances to member banks)
Nonmember banks (See Nonmember banks)
Discounts for:
Federal intermediate credit banks (See Agricultural paper)
Individuals, partnerships, and corporations (Sec
Individuals, partnerships, and corporations)
Member banks (See Agricultural paper; Bankers'
acceptances; Commercial paper, discount)
Nonmember banks (See Nonmember banks)
Other Federal Reserve Banks (See Interdistrict
rediscounts)
Organization, 2
Federal Reserve credit, principles governing:
Basic borrowing privilege, proposal, 200
Capital, not to be used as substitute for, 194
Commerce, industry, and agriculture, accommodation, 190
Continuous borrowing, policy against, 194
Discretion of Reserve Banks, 198-200
Economic stability and growth, promotion, 201
Emergency credits, 196
Lender of last resort, 197
Maturities, 195
Privilege of membership, 200
Profit, use for, 193
Real-bills doctrine, 191
Right to, 8, 200
Seasonal credits, 196
Security, adequate, requirement for, 198
Short-term adjustments, use for, 195
Sound credit conditions, maintenance, 192
Soundness of Reserve Bank loans, 197, 198
Speculation, credit not to be used for, 193
Finance company paper, 39, 40
Finance paper:
Eligibility for discount, 30, 39
Factors' paper, 39, 49
Regulatory provisions, 39
Float, as extension of credit, 3

Eligible paper:
Advances on (See Advances to member banks)
Discount (Sec Agricultural paper; Bankers' acceptances*. Commercial paper, discount)
Eligible paper bill, proposal by Board, 114
Emergency credits:
Member banks, 108,196
Nonbanking organizations, 127-32,197
Nonmember banks, 117-25, 197
Endorsement:
Bankers' acceptances, 57, 58
Eligibility for discount, relation to, 23
Form and effect, 22
In general, 22, 23
Purpose, 23
Regulatory provisions, 22
Export-Import Bank, advances on certificates, 96
Factors' paper, 39,49
Farm loan bonds, purchase by Reserve Banks, 93
Farmers Home Administration, advances on insured
notes, 96
Federal Farm Mortgage Corporation bonds,
advances, 94
Federal intermediate credit banks:
Acceptances, purchase by Reserve Banks, 52
Discount of paper, 45, 51
Establishment, 44
Obligations, purchase by Reserve Banks, 51
Federal Reserve Act, original:
Agricultural credit, intent to provide, 43
Aldrich bill, 7
Amount limitations, 9
Bankers' acceptances, 8, 9,12
Bills, comparison, 8,9
Business expansion as purpose, 10
Country banks, benefit, 10
Discount rates, impartial administration, 9
Elastic currency as purpose, 11
Farmers, purpose of assisting, 12
Impartial administration of discounts, 9
Market for commercial paper as purpose, 9
Maturities under, 8
Purposes, 9-12
Rediscounts between Reserve Banks, 9


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Federal Reserve Bank of St. Louis

Glass-Steagall Act of 1932,100
Government obligations, paper drawn for trading
in, 38
Groups of member banks, advances to (See Advances
to member banks)
High-powered dollars, Reserve Bank credit as, 3
Home Owners' Loan Corporation bonds, advances, 95

269

,-Historyj

f of the |
Lending*
Functions

Index—Continued
Nonmember banks—Continued
Discount of eligible paper in emergencies:
Authorization by Board, 122
Original authorization, 121
Government obligations, advances on:
Emergency circumstances, limitation, 123
Interest rate, 123
Original authorization, 122
Regulatory provisions, 123
Indirect access to Reserve Bank credit, 117
Satisfactory security, temporary authority for advances on, 124
Veterans' notes, rediscount with Reserve Bank (See
Veterans' notes, discount)

Individuals, partnerships, and corporations:
Discount of eligible paper for:
Authority:
Board of Governors, 128-30
Use, 130
Current operating expenses, note drawn for, 129
Endorsement, 129
Federal Reserve Act, original, rejection by, 127
Finance company note, 129
Inability to obtain credit from other banks, 129
Legislative history, 127, 128
Limitations:
General, 128
Unusual and exigent circumstances, 128
Regulation by Board, 129
Savings and loan association note, 129
Security satisfactory to Reserve Bank, 129
Government obligations, advances on:
Agencies of United States, 131, 132
Emergency circumstances, limitation, 132
Interest rate, 131
Legislative history, 131
Maturity, 131
Member banks as corporations, 131
Regulation by Board, 131
Use of authority, 132
Individuals, Reserve Bank loans, 127
Industrial loans (See Working capital loans to
business)
Interdistrict rediscounts:
Compulsory feature, 163
Purpose, 163
Use of authority, 164
Interest rates (See Discount and interest rates)

Open market operations of Reserve Banks, 3
Partnerships, loans to (See Individuals, partnerships,
and corporations)
Permanent investment paper:
Discount, eligibility, 35-37
Evidence of compliance, 36
Permanent investments, meaning, 36
Regulatory provisions, 35-37
Protest, waiver, 22
Readily marketable staples (See Bankers' acceptances)
Real-bills doctrine, 33, 191
Reconstruction Finance Corporation, loans to business
by, 135
Right to Federal Reserve credit, 8, 200
Securities loans, increase, while Federal Reserve advance outstanding, 88
Sight drafts, 45, 48
Small Business Administration, advances on notes
guaranteed by, 97
Speculative purposes:
Federal Reserve Act, original, 11
Paper drawn for, 37, 193
Stocks and bonds, paper drawn for trading in, 38

Lender of last resort, 197
Letters of credit, 75
Livestock paper, discount, 46
Maturities:
Advances to member banks, 88
Bankers' acceptances (See Bankers' acceptances)
Discounted paper:
Agricultural paper, 14,47
Days of grace, 16
Demand paper, 16,48
90-day limitation, reasons, 14
Regulatory provisions, 16
Federal Reserve Act, original, 9
General summary, 13
Individuals, partnerships, and corporations, advances to, 131
Merchant Marine bonds, advances, 96
Municipal obligations, advances, 98

Trade acceptances:
Definition, 34
Form, 34
Rate of discount, separate classification, 33
Underlying transaction, nature, 34
VS. obligation, advances on {See Advances to member banks; Nonmember banks)
V loans:
Assignment of Claims Act, 159-61
Background, 147
Board of Governors, role, 154
Contract Settlement Act, 150
Coordination by Board, 155
Defense Production Act, 151
Delegation of authority to Reserve Banks, 154
Discounting of V-loan paper, 158
Executive Orders:
9112,147-^9
10161,151

National Monetary Commission Report, 3
Negotiability, 23-25
Nonmember banks:
Credit through medium of member banks:
Authorization by Board, 119-21
Interpretation, liberal, 119
Legislative history, 118
Regulatory provisions, 121


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Federal Reserve Bank of St. Louis

270

! History;;.
j of the^ ;
'Lending-

Index—Continued
V loans—Continued
Fees and rates;
Board of Governors, determination, 157, 158
Commitment fee, 157, 158
Guarantee fees, 157
Interest rate, 157, 158
Financing institutions, Reserve Banks as, 154
Fiscal agents, Reserve Banks as, 152
Guarantee agreement:
Administration of loan, 156
Cancellation of contracts, protection against, 156
Collateral, application, 156
Commitment to purchase, 156
Losses, sharing, 156
Standard form, 155-57
Guaranteeing agencies, 147, 151, 152
Legal basis, 149
Liaison officers, 153
National banks, lending limits, 159
Operations, volume, 148
Phases of program, 148
Procedures, 153
Regulation V, 148, 153
Reimbursement of Reserve Banks, 153
Security, assignment of contract claims as, 159-61
Settlement of contracts, loans to finance, 150
VT guarantees, 150
Veterans' notes, discount:
Endorsement, 80
Maturity, 80
Nonmember banks, discount for, 79
Rate, 80
Regulation by Board, 80
Termination of authority, 81
World War Adjusted Compensation Act, 79


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Federal Reserve Bank of St. Louis

War Finance Corporation, advances
on bonds, 91
War production loans {See V loans)
Warehouse receipts, 63
Working capital loans to business:
Authority:
Board of Governors, 138
Liberalization, proposals, 144
Need, 134
Reconstruction Finance Corporation, comparison, 135,136
Termination, 144
Use, 144
Financing institutions, participation, 139
Funds, source, 141
Industrial advisory committees, 140
Interest rates, 143
Legislative history, 134
Limitations:
Amount, 140
Commitments, 138, 139
Direct loans, 138
Established businesses only, 137
Exceptional circumstances, 138
Industrial or commercial businesses, 137
Maturity, 138
Location of:
Business, 138
Financing institution, 143
Losses, sharing by financing institution, 139
Purposes, 134
Regulation by Board, 142,143
Security, 138
Treasury Department, payments, 141,142

271