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Member Bank Reserves

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Report of Federal Reserve System
Committee on Bank Reserves







November 11, 1931
Mr. John U. Calkins, Chairman
Conference of Governors of Federal Reserve Banks
Dear Sir:
I
arn pleased to submit herewith the report of the Committee on Bank
Reserves of the Federal Eeserve System covering the reserve requirements
of member banks. In this report the Committee discusses in full its find­
ings with respect to the operation of the present system of reserve re­
quirements and presents definite recommendations for their improvement.
There is presented at the end of the report a draft of an amendment to
Section 19 of the Federal Eeserve Act embodying the plan for reserve re­
quirements proposed by the Committee . Recommendations of the Committee
for necessary changes in the Board's regulations are presented in the
body of the report. The proposals contained in this report were -unani­
mously adopted with the single exception that one vote was cast in favor
of 13 per cent of gross deposits and against 15 per cent of gross deposits
as the maximum reserve which any member bank might be required to carry
under the proposed reserve requirements.
The Committee's terms of reference were incorporated in the follow­
ing resolution passed by the Governors' Conference, on December 12, 1929"That it is the sense of the conference that the subject
of bank reserves is one of the utmost significance, requiring
the most careful scientific study by experts devoting their
entire time to the matter with a view of drafting a report to
the Federal Eeserve Board, proposing such amendments to the
law or regulations as in their judgment may be necessary to
remove any present inequalities or defects and to establish
bank reserves throughout the country on a more logical or ef­
fective basis than now appears to be possible under present
laws, State and Federal.”
Following the adoption of this resolution, you, as Chairman of the
Governors' Conference, after consultation with Governor Young of the
Federal Reserve Board, appointed the following committee:




Mr. Ira Clerk, Deputy Governor, Federal Reserve Bank of San
Francisco
Mr. M. J . Fleming, Deputy Governor, Federal Reserve Bank of
Cleveland
Mr. L. R. Rounds, Deputy Governor, Federal Reserve Bank of
New York
Mr. E. A. Goldenweiser, Director of the Division of Research
and Statistics, Federal Reserve Board

-2-

Mr. E. L. Smead, Chief, Division of Bank Operations,
Federal Reserve Board
The Committee held its first meeting in Washington, on February
26 , 1930. At that time it chose Mr. E. L. Smead to act as chairman,
Messrs. E. L. Smead, E. A. Goldenweiser, and L. R. Rounds as an Ex­
ecutive Committee to act on matters of administration in the absence
of the full committee, and Mr, W. W. Riefler of the Board's Division
of Research and Statistics to act as Executive Secretary of the Com­
mittee.
The report here submitted concludes the major work of the Commit­
tee under its terms of reference. In addition, the Committee has under
investigation the operation of reserve requirements of nonmember banks,
and the feasibility of placing the same reserve requirements on all
banks, both member and nonmember. This might be done by a specific
Federal law setting minimum standards for reserve requirements at all
banks or by a law requiring all banks to take out Federal charters.
It has also contemplated taking up the reserve requirements of the
Federal reserve banks. Under this latter head, the Committee might
study several problems before the system, such as the relation of re­
serve requirements to the gold supply, the advisability of simplifying
the currency of the country, and the advisability of changes in the
present collateral requirements for Federal reserve notes. These sub­
jects the Committee stands ready to consider if so directed by the Fed­
eral Reserve Board. Inasmuch as this report completes the major part
of the Committee's work, however, and complies with the more direct
terras of its reference, the Committee may be discharged at this time
if it is deemed advisable.
In making the recommendations submitted in this report, the Com­
mittee respectfully calls attention to a special report which it sub­
mitted on May 27 , 1931» carrying the following recommendation:
"That it should be the duty of a National bank
examiner to include in his examination report of a
bank, its time and its net demand deposit liabilities
on which reserves are required for one day of each
month since its previous examination, the day of the
month being selected at random.”
This recommendation was made in response to a specific request of the
Federal Reserve Board, and applies to present requirements. The Com­
mittee wishes it understood, however, that the spirit of this recom­
mendation applies to the reserve requirements proposed by the Commit­
tee as well as those at present in effect.
Prior to the submission of these recommendations, the Committee
considered the subject in detail at four separate meetings lasting







-3several days each. These were held in February 1930> i-n December
1930, in May 1931, and in October 1931also discussed its pro­
posals informally and confidentially with the Federal Reserve Board,
with officers of each Federal reserve hank, and with a special com­
mittee on reserves representing the American Bankers Association and
the Reserve City 3 ankers Association. In these discussions, the
principal recommendations which the Committee now makes met with a
cordial and frequently enthusiastic reception, with the single ex­
ception that the proposal to count vault cash as reserve met objec­
tion at one Federal reserve bank. This general approval was given,
however, with the understanding that the persons consulted would be
free to change their position on any part of the Committee's report
after they had time to study it in detail.
In conclusion, the Committee wishes to express its gratitude for
the cordial cooperation which it has received in preparing material
for its report, both from the Board's organizations, and from the
Federal reserve banks. Particular mention is due to Ur. Walter Wyatt,
Counsel of the Federal Reserve Board, for help in drafting the pro­
posed amendment to Section 19 and in gathering information on reserve
requirements under State laws; to Messrs. J. E. Eorbett and J; R. Van
Fossen, of the Board's Division of Bank Operations, for aid in com­
piling numerous statistics relating to reserve requirements; to Miss
Aryness Joy of the Board's Division of Research and Statistics for
the collection, compilation, and interpretation of statistics relating
to changes in the volume of currency held by banks as vault cash, and
to changes in the demand for currency due to the growing use of checks
for payroll purposes; and, finally, to Miss Eleanor Eanford, also of
the Board's Division of Research and Statistics, for general supervi­
sion of studies of nonmerrber ban].’
; reserve requirements, and, also, for
supervision of investigations of the effects which the proposals here
presented will have on the reserves carried by individual member banks.
This report is also being submitted to the Federal Reserve Board.
Very truly yours,

E. L. Smead, Chairman
Federal Reserve System Committee on Bank Reserves







REPORT OF THE COMMITTEE ON BANK RESERVES
OP THE FEDERAL RESERVE SYSTEM
Members of the Committee
E. L. Smead, Chief, Division of Bank Operations, Federal
Reserve Board, Chairman
Ira Clerk, Deputy Governor, Federal Reserve Bank of San
Francisco
M. J. Fleming, Deputy Governor, Federal Reserve Bank of
Cleveland
E. A. Goldenweiser, Director, Division of Research and
Statistics, Federal Reserve Board
L. R. Rounds, Deputy Governor, Federal Reserve Bank of
New York

W. W. Riefler, Division of Research and Statistics,
Federal r.es^irve Board, Executive Secretary
Terms of Reference
The subject of bank reserves is one of the
utmost importance, requiring the most care­
ful scientific study by experts devoting
their entire time to the matter with a view
of drafting a report to the Federal Reserve
Board, proposing such amendments to the law
or regulations as in their judgment may be
necessary to remove any present inequalities
or defects and to establish bank reserves
throughout the country on a more logical or
effective basis than now appears to be pos­
sible under present laws, State and Federal.
(Resolution adopted at the conference of
Governors of the Federal reserve banks, De­
cember 12, 1929 .)

SUMMARY OF COMMITTEE RECOMMENDATIONS
In accordance with its terms of reference, the Committee has examined the
operation of present legal requirements governing the reserves held by member
banks and submits herewith definite recommendations for their improvement.
These requirements are established by the Federal Reserve Act and apply to all
banks, both State and national, which are members of the Federal reserve sys­
tem.

Changes in the law recommended by the Committee are submitted at the end

of this report in the form of a proposed amendment to Section 19 of the Federal
Reserve Act.

In the event this amendment is adopted, Regulation D of the Fed­

eral Reserve Board will have to be modified to meet the changes proposed in the
law.

Modifications recommended by the Committee are discussed in the body of

the report.
Defects of present reserve requirements
In the opinion of the Committee, our present system of legal requirements
for member bank reserves has never functioned effectively since its inception
in 191^.

It has not operated to relate the expansion of member bank credit to

the needs of trade and industry, nor has it adequately reflected changes in the
volume and activity of member bank credit.

Furthermore, the Committee also

finds that present requirements for reserves are inequitable and unfair as be­
tween individual member banks and groups of member banks and do not adequately
take into account genuine differences in the character of banking in which a
member bank may be engaged.
The Committee takes the position that it is 110 longer the primary function
of legal reserve requirements to assure or preserve the liquidity of the indi­
vidual member bank.

The maintenance of liquidity is necessarily the responsi­

bility of bank management and is achieved by the individual bank when an ade­
quate proportion of its portfolio consists of assets that can be readily con­
verted into cash.




Since the establishment of the Federal reserve system, the
-2-

-3liquidity of an individual bank is more adequately safeguarded by the presence
of the Federal reserve banks, which were crgraiized for the purpose, among
others, of increasing the liquidity of member banks by providing for the re­
discount of their eligible papei’
j than by the possession of legal reserves.
The two main functions of legal requirements for member bank reserves under
our present banking structure are, first, to operate in the direction of sound
credit conditions by exerting an influence on changes in the volume of bank
credit, and, secondly, to provide the federal reserve banks with sufficient
resources to enable then to pursue an effective banking and credit policy.
Since the volume of member bank credit needed to meet the legitimate needs of
trade and industry depends on the rate at which credit is being used as well
as on its aggregate amount, it is essential for the excrcise of a sound con­
trol that legal requirements differentiate in operation between highly active
deposits and deposits of a less active character.

Requirements for reserves

should also be equitable in their incidence, simple in administration, and,
so far as possible, not susceptible of abuse.
Similar principles underlie the. present reserve law, which in requiring
lower reserves against time deposits than against demand deposits, and lower
reserves against the demand deposits of country banks than against the demand
deposits of reserve and central reserve city banks may have been expected to
impose higher reserves on more active deposits than on less active dex>osits.
Notwithstanding the fact, however, that existing requirements '.^ould appear to
be so arranged as to make reserve requirements vary with the volume and activ­
ity of deposits, experience shows that since 191 ^- and especially since 1922
the proportion of primary reserves held by member banks has steadily declined
in relation to the volume of member bank deposits and to their activity.
This outcome has been the result of defects in the definition of re­
serves, in the method of determining liabilities against which reserves must




be carried, and in the classification of "banks and of deposits for reserve pur­
poses.

The exclusion of vault cash from required reserves of member "banks in

1917 has been followed by a reduction in the vault cash holdings of some city
banks to a minimum; the rule that amounts due from banks may be deducted only
from amounts due to banks has tended to decrease reserves in times of business
activity and to increase reserves in times of depression, and the establishment
of a low reserve against time deposits in 191 ^ has facilitated the growth of
bank credit without a corresponding growth in reserves.

Even if these particu­

lar defects in the present system of reserves had not existed, however, the
rapid increase in the turnover of demand deposits which has occurred in recent
years would still have tended to prevent reserve requirements from increasing
in proportion to the growth in the effective use of credit by the customers of
member banks.
Proposals of the Committee
Before deciding to recommend fundamental changes looking toward the estab­
lishment of a new basis for calculating required reserves, the Committee made
every effort to frame provisions designed to correct the existing situation
thro'ugh modifications in the classification of cities for reserve purposes and
in the classification of deposits subject to reserve, including a more string­
ent definition of time deposits.

As these proposals were studied, however, it

became more and more evident that they would not be effective and that an en­
tirely new approach to the reserve problem was necessary.
The Committee proposes, consequently, to abolish completely the classifi­
cation of deposits into time and demand deposits, and the classification of
member banks according to their location, into central reserve city banks, re­
serve city banks, and country banks.

Instead, the Committee recommends that

all member banks and all deposits be treated alike for reserve purposes, and
that the formula used in calculating reserve requirements take into account




_p;_
j
directly, instead of i n d i r e c t l y as in the existing law, the activity as well as
the volume of the deposits held by each individual member bank, without regard
to the location of the bank or the terms of withdrawal on which the deposits
are technically held.

To accomplish this, the Committee proposes that each

member bank be required to hold a reserve equivalent to (a) 5 P er cent of its
total net deposits, plus (b)

^0 per cent of the average daily withdrawals actu­

ally made from all of its deposit accounts.

These withdraivals, which are shown

by debit entries on the books of member banks, are the only real test of the
activity of a deposit account and furnish the only basis by which that activity
can be equitably and effectively reflected in requirements for reserves.

Under

this proposal, therefore, each deposit will carry a total reserve based on its
activity as well as on its amount.

A totally inactive deposit will carry a

total reserve of only 5 Per cent, while a deposit balance which is checked out
on the average once a week w i l l carry a total reserve equivalent to 12 per cent
of its amount.

For the average member bank the total reserve under the pro­

posed formula will be equivalent to about 8 per cent of its deposits.

To pre­

vent this formula from imposing too great a burden in extreme cases, the recom­
mendations of the Committee also provide that in no case shall the aggregate
reserve required of a bank exceed 15 per cent of its gross deposits.
The Committee proposes to include in legal reserves, in addition to the
funds which member banks have on deposit with their Federal reserve bank, their
vault cash, with certain limitations, as both classes of funds contribute to
the strength of the reserve banks and have a direct effect on the reserve sys­
tem' s control of changes in member bank credit.

It proposes, also, to place

country member banks on a parity with city banks with respect to deductions
from deposit accounts by permitting banks in calculating net deposits subject
to reserve to deduct balances due from member banks and items in process of
collection from total deposits instead of from balances due to banks alone as




is the practice at present.
Volume of reserves
The Committee feels that the existing volume of reserves is sufficient at
the present time to provide the reserve bank?? with the funds they require to
perform their functions.

Its proposals, consequently, do not contemplate a

change in the total amount of reserves.

They are intended rather to change

the nature of fluctuations in the volume of reserves and to iron out inequit­
able features in their distribution among the member banks.
A comparison of the reserve requirements proposed by the Committee ?/ith
present and past requirements is presented in the following table:




SUMMARY OF PAST, PRESENT, AND PROPOSES PRESERVE HSIff/iTSCEiTS FOR MEMBER BANKS
Classification
Reserve held in the foitn of—
Reserve required against
of tanks
A. Reserve requirements of national banks prior to the enactment of the Federal

Central reserve
city banks
Reserve city
banks
Country banks

total net deposits

in vault

in vault or on deposit
with designated corre­
spondent banks

25i

all

none

25$
....... .. M .... .

1/2
_ . _ 2 13—

________

i /2
j/fi..._

..... ...

distribution of reserves ~as to.become .effective in 2To"eiriber 1917.)
net
on deposit
in vau '.t or on
time
in
depoci'- with
demand
with F. R. vault
deposits
bank
deposits
F. E. bank
Central reserve
city banks
1 S$
6/18
5/18
7/18
5$
Reserve city
U /15
banks
15$
5$
5/15
6/15
5/12
Country banks
U /12
12$
.... 3/12 _ ....
...... 5 $ ... .
C. Reserve reauirfsments of member banks at present
time
I net demand
on deposit with F. R. bank
deposits
deposits
Central reserve
city banks
all
I
13$
3$
Reserve city
10$
all
banks
3$
Country banks
all
7$........ ...... 3$ ..... .
D. Reserve requiresments proposed by the Comrrittee on Bank Reserves
] total net daily average
in vault or on
deposits
debits to de­
on deposit
deposit with
posit ac­
both demand
with F. R. bank
IT.
3. bank
counts
and time
Member banks
in vicinity
of F. R.
banks or
k /3
branches
50$
5$
1/5
All other mem­
ber banks
50&
2 b...
.M.____
.. 3/5
The calculation of net deposits subject to reserve has varied from time to
time. At present, net demand deposits include total demand deposits of individuals,
corporations, etc., plus the excess, if any, of demand deposits due other banks
over items in process of collection and funds held on deposit with other banks.
Under the proposed plan, net deposits subject to reserve would include total depos­
its, both demand and time, less items in process of collection and deposits with
other member banks in the United States.
TJ. S. Government deposits, which have been exempted from reserve requirements
since 1917 t would require reserve under the proposed formula the same as all other
deposits.
Vault cash eligible for reserve excluded national bank notes, Federal reserve
notes, and Federal reserve bank notes prior to 1917 • Since 1917, no vault cash has
been eligible as reserve. Under the proposed plan all kinds of currency and cash
issued or coined under authority of the laws of the United States which are held
in the vaults of member banks would be eligible to count as reserve.



-8Failure of Existing He serve Bear,.;, rsments
In the opinion of the Committee, the principal purposes served "by legal
requirements for member bank reserves are, first, to help to regulate the vol­
ume of credit at member banks in accordance with the legitimate credit needs of
trade and industry, and, secondly, to insure that the Federal reserve banks at
all times have resources adequate to their responsibilities.

The Committee

does not believe that it is the purpose of legal requirements for reserves to
insure the liquidity of individual member banks, nor that it is posthole for
legal reserve requirements to accomplish this purpose.
Liquidity

For many years, the maintenance of liquid assets available to meet with­
drawals was regarded as the principal function of commercial bank reserves.
Nevertheless, prior to 1$)1^, when central reserve city national banks in this
country were required to hold vault cash reserves as large as 25 per cent of
both time and demand deposits they were forced to suspend payments at times of
banking strain.

The inauguration of the Federal Reserve System with its pro­

visions for the mobilization of banking reserves and for the rediscount of mem­
ber bank paper was a recognition of the fact that a commercial bank does not
guarantee its liquidity by maintaining its legal reserves.

To the extent that

the member banks since 191 ^ have remained liquid through periods of unprece­
dented banking strain, they have been able to do so not because of the legal
reserves that they have carried, but largely because they have been able by
borrowing at the reserve banks to convert their eligible assets into cash.
The effect of this borrowing, furthermore, has not been confined to paper
which is eligible for rediscount at the reserve banks.

The .mere fact that the

reserve banks stand ready to lend on eligible paper has helped to maintain a
ready market for all types of sound bank assets.

Under present conditions,

therefore, in which member bank reserve balances cover onlj 7 Per cent of their




-9deposit liabilities, it is clear that the liquidity of the average ir dividual
member bank can be more adequately guaranteed by the possession of a substantial
portfolio of eligible paper or of other assets readily convertible into cash in
the market than by any practicable increase in its requirements for legal
reserves.
As our banking system is now organized, legal requirements for member bank
reserves contribute to the security of bank depositors by providing the reserve
banks with funds available for assisting banks in emergencies and by adding
strength to the whole banking system through the exercise of credit control
rather than through determining the volume of reserves held by individual member
banks.

In order to be able to utilize the strength of the reserve banks in emer­

gencies, however, it is essential that the individual member bank maintain an
adequate portfolio of sound assets readily convertible into cash, and, particu­
larly, of assets eligible for rediscount at the reserve banks.
Control of credit
The most important function served by member bank reserve requirements is
the control of credit.

This function has a bearing on the liquidity of bank

credit, for, in the nature of things, bank credit is most liquid when credit
conditions are sound, and unsound credit conditions do not usually develop un­
less the banking community in general has expanded its credit beyond the needs
of trade and industry.

The overexpansion of credit may take a particular form,

such as excessive loans on farm lands, on urban real estate, or on securities,
or it may be more general applying to a wide range of bankable assets.

Whatever

its form, it has the effect of temporarily inflating the general purchasing
power of the community and also of raising for a time the market value of bank
assets beyond their intrinsic worth.

It is the function of reserve requirements

to restrain such overexpansion by making it necessary for banks to provide for
additional reserves before they expand their credit.

To perform this function

adequately, however, it is essential that reserve requirements reflect both the



-10volume and the activity of credit outstanding, for unsound credit conditions
can develop either out of an excessive volume of hank credit in relation to the
needs of trade and industry or out of an excessive use of a given amount of
credit.

Credit could be expanded indefinitely, for example, without any infla­

tionary effect whatever, provided the bank deposits thus created were never
drawn upon to effect an exchange of goods or services.

Conversely, it is pos­

sible for an unsound credit situation to develop without an increase in the
volume of deposits, but merely out of an increase in their activity.

Usually,

unsound credit conditions are accompanied by an increase both in the volume and
in the activity of deposits.

In 1928 and 1929, however, during the most ex­

travagant phases of the stock market boom, excessive credit demands were re­
flected in an increase in borrowings from non-banking lenders, and an unprece­
dented increase in the activity of bank deposits, without an increase in their
total volume.

Reserve requirements, consequently, failed completely during

those crucial years to act as a brake on the unsound use of credit.
Progressive diminution of member bank reserves under present requirements
Between 191^- and 1931» the period covered by our present system of reserve
requirements, total net deposits of member banks increased from $ 7,500 million
to $32,000 million, or more than 3 OO per cent in less than two decades.

Some

of this increase reflects the accession of State banks to membership in the
Federal Reserve System, but the greater part reflects the expansion of member
bank credit.

While war financing and the huge inflow of gold which followed

the war constituted the immediate driving force back of much of this expansion,
it was facilitated by a progressive reduction in effective member bank require­
ments for reserves.

Thus, member banks actually hold at the present time about

$2,900 million of reserves against $32,000 million of net deposits.

This in­

cludes both the legal reserves which they hold with the Federal reserve banks
and cash which they hold in their vaults.




If the vault cash reserve require­

— 1 JL* *

ments of national tanks prior to 19lH had been retained in the federal Eeserve
Act up to the present time, member hanks would now be required to hold about
$4,^00 million in reserves instead of $2,900 million.

This means that in the

aggregate total reserve requirements of member banks are now about J,b per cent
less in proportion to their deposits than they were before the Federal Eeserve
Act was passed.

It is clear, consequently, that the large expansion of member

bank credit since 191 *+ has been facilitated by a progressive diminution in re­
serve requirements as well as by large imports of gold.

Without this diminu­

tion member banks would have needed in order to expand their credit to its
present volume additional Federal reserve bank credit to the extent of $1,500
million.

By applying to the reserve banks for this additional credit, the mem­

ber banks would have correspondingly increased the effectiveness of reserve
bank credit policy.
Of the total decrease of $1,500 million in present requirements as com­
pared with prewar requirements, about one-half reflects the effect of the
amendment which removed vault cash from required reserves in 1917 > while the
remainder reflects in part the lowering of reserve requirements by the original
Federal Eeserve Act, and in part, the rapidly decreasing proportion of member
bank deposits which have been classified as demand deposits since the inaugura­
tion of a lower reserve on time deposits in 191^.

This decrease has occurred,

moreover, during a time when the average turnover of all deposits has increased,
indicating that differentials in reserves as between time and demand deposits
and as between demand deposits at city and country banks have not effectively
registered changes in the activity of deposits or in the use of member bank
credit by the community.

Such figures as are available for earlier years in­

dicate that the average turnover of bank deposits in this country increased
steadily from 191^- up to 1929* Between 1925 and 1929> alone, estimates made
for the Committee indicate that the rate of turnover of the average dollar




-12-

WR CENT




PERCENT

-13deposited in member banks increased from 24 times a year to 33 times a year,
notwithstanding the fact that 64 cents of this dollar was classified as a de­
mand deposit in 1925 as against 59 cents in 1929Failure of existing requirements to reflect credit developments
In the accompanying chart there is portrayed the extent to which exist­
ing legal requirements for reserves have failed to reflect credit developments
at member banks in recent years.

The upper line reflects movements in the

total dollar volume of transactions vhich pass through the deposit accounts
of customers of member banks. The middle line shows member bank time and net
demand deposits combined and reflects movements in the total volume of member
bank deposit liabilities.

The bottom line shows the reserve balances which

member banks have maintained with the Federal reserve banks.

During the

period covered by the chart all the legal reserves have been held in this form.
The lines are plotted as index members with January 1924 equal to 100.
This chart brings out the failure of member bank reserve balances under
our present reserve requirements to reflect fundamental changes in the demand
for credit.

In the first year shown on the chart, 1924, the total volume of

debits or check payments made through member bank accounts was low reflecting
a relatively inactive business situation.

Member bank requirements for re­

serves, however, increased in 1924 more rapidly than in any other year shown
on the chart because the inactive local demand for fimds throughout the coun­
try caused banks to redeposit funds with their correspondent banks in the
larger cities, which were required to hold reserves of 10 or 13 per cent
against these funds.

As a consequence, an inactive demand for funds from

trade and industry in 1924 vias reflected in a sharp increase both in member
bank deposits and in member bank requirements for reserves.

Daring 1925 and

1926 , on the contrary, when business became more active, these redeposited
funds were withdrawn from correspondent banks and loaned directly in the




-14market, with the result that aggregate requirements for reserves remained for
two years at about the level of December 192'+ failing completely to reflect an
increase in the market demand for funds.
The failure of reserve requirements to reflect fundamental changes in the
demand for funds and to operate in such a manner as to bring these changes under
control became a major factor in the credit situation in 1928 and 1929 when an
extraordinary demand for funds from the stock market was met without an in­
crease in reserve requirements of member banks.

In fact, the aggregate legal

requirements of member banks for reserves were about $75 trillion lower in Sep­
tember 1929 at the very peak of the stock market boom than in December 1927,
despite a situation in intervening months in which the demand for stock exchange
loans was sufficient to require brokers to increase their borrowing by over
$l+,000 million at rates which in some months averaged nearly 10 per cent.

This

situation arose because corporations and other non-banking lenders, seeking to
profit by high rates, drew upon their balances with member banks and loaned
funds in huge volume directly to brokers, permitting an extraordinary demand
for credit to be met without any increase in the deposits against which member
banks were required to maintain reserves.

The activity of these deposits in­

creased rapidly, however, as is shown by the chart.

Had reserve l-equirements

reflected the activity of deposits, this sharp increase in turnover of deposit
accounts, which helped materially to finance speculative developments in 1928
and 1929 , would have caused an equally sharp increase in member bank require­
ments for reserves, and this increase in turn would have acted as a powerful
restraint against unsound credit developments.
Vault cash
After reviewing member bank operations during recent years, the Committee
is convinced that the removal of vault cash from required reserves in 1917 has
had undesirable consequences that were not foreseen at the time.




Prior to 1917.

-15member banks in central reserve cities were required to hold aggregate reserves
equal to IS per cent of their demand deposits, the corresponding percentages
for reserve city and country member banks being 15 and 12 per cent respective­
ly.

At the same time, the requirement against time deposits was 5 P er cent at

all classes of member banks.

Part of these reserves were held as balances with

the reserve banks and part as cash in the vaults of the member banks.

Federal

reserve notes and national bank notes held by member banks, however, could not
be counted as legal reserves.

Under the 1917 amendment, reserve requirements

against demand deposits were reduced by 5 per cent and against time deposits
by 2 per cent at all classes of banks, and at the same time member banks were
required to hold all of their legal reserves on deposit with the Federal re­
serve banks.
The main purpose of the 19^-7 vault cash amendment was to concentrate the
gold holdings of the country in the Federal reserve banks.

Up to that time,

member banks had been required to hold their vault cash reserves in gold or
lawful money, with the result that the monetary gold resources of the country
were only partially mobilized in the Federal reserve banks, a large proportion
being absorbed in the form of circulating notes held by the member banks and
the public . The 1917 amendment corrected this situation by removing the in­
ducement for member banks to hold their vault cash in the form of gold rather
than Federal reserve notes and so permitted the mobilization of gold in the
Federal reserve banks.
In addition to concentrating the gold resources of the country in the
Federal reserve banks, however, the 1917 vault cash amendment incidentally
opened the door for a gradual diminution in the actual reserves of the member
banks.

In the last lU years, the amendment has permitted a reduction in aggre­

gate reserves, amounting at the present time to over $7^0 million.

Had this

amendment not been passed, consequently, member banks today would be required,




-16other things being equal, to hold aggregate reserves more than $~JQ0 million
larger than their present legal reserves plus their holdings of vault cash.
These additional reserve requirements would have exercised a wholesome re­
straint during the boom period which culminated in 1929 and the policy pur­
sued by the Federal Reserve System would have been much more effective had
the member banks at that time been f orced to borrow this additional ijOO
million from the Federal reserve banks.
Between June 1917 > before the new requirements went into effect, and
June 1930» ne,t demand plus time deposits of member banks increased from
$ 12,000 million to $32,000 million, but holdings of vault cash at the same
time decreased from about $800 million to less than $500 million.

By making

progressive economies in their use of vault cash at a time of rapid increase
in their deposit liabilities, member banks were able to reduce their cash
holdings to less than 3

cent of their net demand plus time deposits by

1919 . to less than 2 per cent by I92U, and to less than lj per cent by 1930 The chart shows that this reduction has been especially marked at large city
banks.

In New York City member bank holdings of vault cash in June 1930 were

equal to -f- of one per cent of their net demand plus time deposits and to less
than one per cent of their net demand deposits alone.
Part of this decline reflects a reduction in the operating requirements
of banks for vault cash.

The American public has widespread banking facilities

and is thoroughly educated in the use of checks.

Their demand for pocket cur­

rency, consequently, is relatively small since its use is limited largely to
transactions in which currency is the only convenient method of payment.

In

recent years there has also taken nlace a rapid increase in the use of checks
for wage payments which has materially reduced the demand for cash for indus­
trial payrolls.

While this substitution of checks for currency may reflect a

socially desirable development, it does not constitute a logical or valid




-17-

percent




PERCENT

4

-18reason for a reduction in the reserve requirements of member banks since the
effect upon business activity and upon the position of the individual member
bank is the same whether a depositor's account is drawn upon to make payments
by check or by currency.
By no means all of the economies in the use of cash which member banks
have been able to effect since 1917 . however, reflect the substitution of
checks for currency in making payments.

On the contrary, a special study of

the daily vault cash holdings of member banks has shown definitely that loca­
tion in the vicinity of a Federal reserve bank or branch is the largest single
factor accounting for the reduction in member bank holdings of cash.

This in­

vestigation showed that member banks situated close enough to Federal reserve
banks or their branches to be able to deposit surplus currency at the reserve
banks or to obtain additional currency supplies from the reserve banks within
a few minutes, maintained vault cash holdings equal on the average to only
I.3S per cent of their net demand deposits.

This group of member banks holds

about sixty per cent of the total deposits of all member banks.
During the same period, the remaining member banks held vault cash
equivalent to 4.6U per cent of their net demand deposits, or more than three
times the proportion that was held by member banks close to the reserve banks.
The investigation also showed that member banks located within short distances
of cities where Federal reserve banks or branches are located, held as high a
proportion of vault cash, on the average, as country member banks, which be­
cause of their inaccessible location ordinarily cannot receive additional sup­
plies of currency until one or two days after it has been ordered.

The amount

of vault cash reserves which member banks find it necessary to hold at the
present time, therefore, depends mainly 011 whether or not they are located in
the immediate vicinity of the reserve banks.

If they are close enough, they

can deposit with the reserve banks for credit to their reserve balance a




-19large proportion of the vault cash which their business would otherwise re­
quire them to hold.
The 1917 amendment eliminating vault cash from legal reserves, conse­
quently, has had two unfortunate effects.

First, it has materially reduced

the total reserve requirements of member hanks and thus further facilitated
expansion of bank credit at a time when huge gold imports arising out of
war and postwar disturbances were already placing difficulties in the way
of the effective administration of the country's credit resources.

Second,

these reductions in aggregate reserve requirements have not been equally
available to all member banks but have particularly favored those banks
which are located in close geographical proximity to the Federal reserve
banks.

As these member banks are classified as reserve or central reserve

city banks, the amendment has had the practical effect of reducing or elim­
inating differentials in reserve requirements between different types of
banks which are .justified by the character of their business.

Up to 1917i

time deposits required the same reserve of 5 per cent at all types of banks,
while net demand deposits required a reserve of 12 per cent at country
banks as compared with 15 per cent at reserve city banks and IS per cent at
central reserve city banks.

These differentials were maintained after the

1917 amendment in the form of a 3 per cent reserve against time deposits at
all classes of banks and a required reserve excluding vault cash against
net demand deposits of 7 per cent, 10 per cent, and 13 per cent at the dif­
ferent classes of banks.

However, when the amount of vault cash which mem­

ber banks find they must actually hold under normal conditions is taken
into account, and a 3 per cent reserve against their time deposits is al­
lowed, it appears that central reserve city member banks now hold lU per
cent in reserve against their net demand deposits in contrast to 12 per
cent at both reserve city and country member banks.



In other words, in its

-20practical effect, the 1917 amendment in addition to reducing reserves against
time deposits from 5 to 3 Per cent at all member banks reduced reserves
against net demand deposits from IS to lU per cent at central reserve city
banks, and from 15 to 12 per cent at reserve city banks, while country banks
received no reduction whatever in their requirement against demand deposits.
The present classification of cities for reserve purposes, therefore, does
not function equitably.
The purpose of the 1917 amendment to mobilize reserves could have been
accomplished without this diminution in total reserve requirements of member
banks by retaining the reserve ratios of the original Federal Beserve Act and
at the same time permitting member banks to count Federal reserve notes as
part of their legal vault reserve.

Federal reserve notes are a liability of

the Federal reserve banks, just as the present legal reserve balances of mem­
ber banks are a liability of the Federal reserve banks.

Of the two types of

liabilities, furthermore, those evidenced by Federal reserve notes which are
a first lien on all assets of the Federal reserve banks and in addition are
an obligation of the United States Government are the more strongly secured.
In recommending, consequently, that the legal reserves of member banks include
all kinds of currency and coin as well as balances on deposit with the Federal
reserve banks, the Committee provides a plan which retains the advantages of
a mobilized reserve and

also

avoids the possibility that member bank re­

serves will be further diminished through economies in the use of vault cash.
Time deposits
The Committee is also convinced on the basis of the system's experience
that there is no practicable way of defining time deposits and demand deposits
without opening the doors to evasions of the intent of the law.

The general

.principle underlying the existing classification, namely, that more active
deposits should carry higher reserves, the Committee believes to be sound.




-21Experience has shown, however, that the methods by which this principle is
now applied have permitted evasions, which cannot in practice be remedied
so long as lower requirements for reserves on time deposits furnish a con­
stant incentive to member banks to classify as time deposits accounts which
are essentially of an active character.
Deposits classified as time deposits have grown rapidly at member banks
since 191^•

In that year, when national banks were required to maintain the

same reserve against all of their deposits, they held only about $ 1,200
million in time deposits.

Following the lowering of reserve requirements

against these deposits, time deposits increased steadily and amounted to
about $8,700 million at national banks alone in 1930*

During the same period,

time deposits of non-national commercial banks, including both State member
and nonmember banks, increased from about $2,800 million to $ 10,200 million
and savings deposits of mutual and stock savings banks from $U,S 00 million
to $10,500 million.

The percentage increase in time or savings deposits for

national banks during the period was over 600 per cent, for non-national com­
mercial banks over 250 per cent, and for savings banks &20 per cent.

Con­

sidering all of our commercial banks together, both State and national, time
and savings deposits have increased from less than one-fourth of total de­
posits in 191 ^ to nearly Uo per cent in 1930 * In 191 *+. furthermore, these
commercial banks held about U 5 per cent of the total time deposits of the
country; while by 1930 that proportion had grown to about 65 per cent.

Of

the total increase in time deposits in the interval more than 70 per cent
was concentrated at commercial banks.

3y 1930 more than one-third of all

member bank deposits consisted of time deposits and nearly one-half of the
time deposits of the country were held by member banks.
While there have been other factors in the growth of time deposits, it
is clear that the introduction of a lower reserve on such deposits has




-22encouraged the growth of savings deposits at commercial banks, in part at
the expense of the growth of deposits at specialized savings institutions,
with the result that some of our so-called commercial member banks now
operate largely with funds that are classified as time or savings deposits.
Prom the point of view of bank reserves, however, the problem to determine
is not the extent to which member banks have competed more effectively with
other banks for the savings deposit business of the countx-y, but the extent
to which member banks, because of the low reserve against time deposits,
have been induced to classify as time deposits, deposits that are essential­
ly demand in character.

It has been repeatedly asserted in recent years

that this reclassification of deposits rather than effective competition on
the part of member banks for savings deposits, has been responsible for a
substantial part of the growth in time deposits at member banks.
While it is the opinion of the Committee that the greater -oortion of
time deposits held by member banks, particularly country member banks,
represent

funds which are genuine savings deposits, the Committee is con­

vinced that a significant- part- of these deposits, especially in metropoli­
tan centers, are not in the nature of savings, but have a considerable
velocity of turnover, and should be classified as demand deposits and
carry corresponding^ larger reserves.

The volume of such deposits is

sufficient to constitute a major departure from the principles underlying
present reserve requirements.

A special investigation conducted in May

1931 revealed the fact that out of $ 13,000 million of time deposits held
by member banks at that time, $ 3,000 million consisted of individual ac­
counts with balances in excess of $ 25 ,000. Even though these accounts may
consist of inactive deposits with a low turnover, they are not the typical
small savings accounts for the accommodation of which the low reserve
against time deposits was primarily instituted.




Of the $3»000 million held

-23in these large individual accounts, 27 per cent were held in accounts
evidenced by savings passbooks, 2]4 per cent in accounts evidenced by cer­
tificates of deposit, and U 9 per cent in other types of time accounts,
chiefly open book accounts payable in more than 30 days or subject to an
agreement by the depositor at the time of deposit to give 30 days notice
before withdrawal.
A further violation of the intent of the law has grown up in certain
localities where, to meet the competition of State savings banks, some
member banks have devised a special savings account on which checks may
be drawn without the presence of the depositor at the bank.

These accounts

are evidenced by savings passbooks in which the bank reserves the right to
require thirty days' notice before making payment on a ’
Withdrawal.

When

the account is opened, a duplicate savings passbook is issued, the original
being held by the depositor and brought up to date from time to time, while
the duplicate is left with the bank, which enters therein the amount of
each withdrawal at the time checks on these accounts are presented for pay­
ment.

So far as the Committee can ascertain, this practice of permitting

withdrawals from savings accounts by check without presentation of the
passbook has not, as yet, spread widely.

An investigation of the turnover

of these so-called savings accounts indicates that they are less active on
the whole than demand accounts in the same banks, but much more active
than other time accounts.

They are, furthermore, no less active than ac­

counts classified as demand deposits in mwiy sections of the country.
In the opinion of the Committee even the existence of a low rate of
turnover in time deposit accounts would not necessarily mean that the
present system of reserves is functioning in accordance with the intent of
the law.

It is not necessary to classify deposits incorrectly in order to

reduce reserve requirements under existing conditions.




With only a three

-2 b -

per cent reserve required against time deposits, there is an inducement
for member banks to persuade or permit commercial customers to classify
a large part of their working accounts as time deposits and then to per­
mit a very rapid turnover on that small part of these accounts that re­
main in the demand deposit classification.

In such cases, the customers'

aggregate deposits constitute the working balance, but all of the checks
are cleared through the demand accounts, with the consequence that rela­
tive inactivity in time accounts is balanced by a corresponding increase
in the activity of the demand balances.

While it is impossible to as­

certain the extent to which this practice has influenced the growth of
time deposits at member banks in recent years, it is known that the turn­
over of demand accounts has increased rapidly.

There has also been a

growth in the volume and number of time deposit accounts maintained by
corporations.

While both of these developments have reflected, in part

at least, other factors than the effect of the three per cent reserve on
time deposits, this reserve requirement, has facilitated the movement and
has undoubtedly been a factor in the decrease of the ratio between total
bank reserves and the outstanding volume of bank credit.
These conditions the Committee is convinced cannot be effectively
remedied so long as lower reserve requirements on time deposits offer an
inducement for evasion . Some improvement might be effected by limiting
the total amount of time deposits which a bank could hold for the account
of any one depositor to a fixed amount, but the net effect of the lim­
itation would probably be small.

It would not prevent depositors from

splitting up larger time accounts among several member banks, and might
also encourage further abuses by inducing large depositors to open ac­
counts in the names of employees and others, the passbooks or certifi­
cates of deposit evidencing such accounts being assigned to the real




owner of the funds after the deposits are made.

Such devices would go far to

nullify as well the effects of another suggested restriction which the Com­
mittee has had under consideration, namely, that the number or amount of with­
drawals permitted from a single time deposit account be limited during a
stated period.

Limitation on the number of checks drawn might reduce the ap­

parent activity of a single account, but would be completely ineffective to
the extent that it induced depositors to split their existing time deposit
accounts into several accounts and thereby multiply the number of checks
which could be legally drawn each month.

It has also been suggested that the

definition of time deposits carried in the Federal Eeserve Act be made more
stringent so as to require the presence of the depositor at the bank each
time a withdrawal is permitted or to prohibit in all cases withdrawals from
these accounts except after thirty days' notice.

Entirely apart from the an­

noyance and inconvenience which such restrictions would entail to many time
depositors, they could be effectively nullified if banks adopted more gen­
erally the practice of making loans on savings passbooks to depositors wish­
ing to make an immediate withdrawal.

Such loans, which can be made to the

depositor either in person or through an agent, are secured by the time de­
posit account, and entail no loss to the depositor unless the rate of in­
terest charged on the loan is in excess of that paid by the bank on the de­
posit.

Hone of these suggestions, furthermore, offers a remedy for the

situation which arises when a depositor splits his balance into a small and
extremely active demand deposit account and into a time deposit account
which is theoretically inactive but which in practice constitutes the bal­
ance that justifies the bank in carrying the companion demand deposit.
Activity of demand deposits
Studies by the Committee of the effectiveness, from the reserve point
of view, of the present grouping of member banks into central reserve city




-25banks, reserve city banks, and country banks, have convinced it that this
classification does not, in actual operation, result in an equitable and
economically sound distribution of reserve?.

While it is true that, on

the average, the activity of deposits is much higher in New York Citv than
elsewhere in the country, and also that the a c t i v i t y of deposits at re­
serve city banks is higher on the average than at country banks, there re­
mains within these general averages a great diversity in deposit activity
both between cities and between banks in the same city.

In numerous small

cities, where reserve requirements are those of country banks, deposit ac­
tivity is materially higher than in many reserve bank cities, while in some
country towns the activity of demand deposits is apparently as low or lower
than the activity of time deposits at many city banks.

Within cities,

moreover, the same divergence occurs between the activity of deposits at
neighboring banks.

There are individual member banks in USevr York City

carrying 13 per cent reserves against deposits that are less active than
those of many country banks carrying a 7 Pe^ cent reserve.

It is not pos­

sible, in fact, to arrive at any classification of banks based on size of
cities or their location which will reflect with accuracy the average ac­
tivity of demand deposits at individual member banks.

Since it is the

Committee's conviction that the reserve of an individual bank should fluc­
tuate with changes in the volume of transactions financed by its deposits
and that in the country as a whole aggregate reserves should change with
the volume of business done, it is n e c e s s a r y in order to accomplish this
purpose to discard completely the present system of basing reserve require­
ments on the location of banks and to adopt instead a reserve formula
which v/ill take direct account of the activity of each individual bank’
s
deposits.




-27Committee Recommendations
The Committee recommends, therefore, that the reserves required to be
carried by each individual member bank be determined, first, on the basis
of the total volume of deposits held by the bank irrespective of whether
they are held by city or country banks or whether they are classified as
time deposits or demand deposits, and, secondly, on the basis of the actual
activity of these deposits, that is, the actual dollar volume of charges
which are made to these accounts.

More specifically, the Committee proposes

that each bank be required to hold a reserve equivalent to 5 Per cent of its
net deposits plus 50 per cent of the average daily debits or charges made
to these deposit accounts on the books of the bank.

As already indicated

the reserves thus determined a.re to include both cash in vault and collected
balances with the Federal reserve bank.

For a bonk with stationary deposits,

this is equivalent to a total reserve of 5 Per cent; for a bank with depos­
its which turn over once a month, it is equivalent to a reserve slightly
under 7 per cent of total net deposits; while for a bank with an average
turnover of once a week, the total reserve is about 12 per cent of total
net deposits.
This formula will eliminate all of the classifications of deposits at
present used to determine required reserves.

It makes no distinction be­

tween a deposit classified as a time deposit and a deposit classified as a
demand deposit and so avoids all of the complications which have accompanied
the attempts of the Federal Reserve Board to define time deposits.

The

formula, furthermore, eliminates the distinction between demand deposits
held by banks classified as central reserve city banks, reserve city banks,
and country banks, and so avoids the problem of determining which cities
should properly be classified as central reserve or reserve cities for
reserve purposes.




The formula automatically distinguishes between these

-28cities, nevertheless, since the average member bank in a central reserve
city, where the turnover of deposits is higher, will be required to carry
larger reserves than the average bank in a reserve city or the average
country member bank which has a low rate of turnover.

The proposed formula

also distributes the total volume of reserves more effectively and more
equitably among member banks, because in the central reserve cities high
reserves will be carried only by such banks as have active deposits, while
banks in these cities having less active deposits, that is, banks whose
business resembles more closely that of a country bank, will be required
to carry reserves equivalent to those of a country bank.

At the same time,

the active country bank engaged in business different from its neighbors
and more nearly resembling that of a city bank will be required to carry
reserves equivalent to those carried by a city bank.
This formula, therefore, by basing reserve requirements directly on
the volume and activity of the deposits of the individual member bank,
places each member bank on an effective parity with respect to the type of
banking business in which it is engaged, and achieves in practice those
distinctions which theoretically should but actually do not result from the
present classification of cities and deposits for reserve purposes.
Deductions from deposit accounts
The Committee recommends that net deposits subject to a five per cent
reserve be determined by subtracting from gross deposits the sum of all
balances due from member banks in the United States and their domestic
branches and all checks in process of collection and other cash items
payable upon presentation in the United States.

This recommendation dif­

fers from present practice with respect both to the deposits from which
deductions are permitted and the items which member banks are permitted
to deduct.




-29At the present time, the law states that deductions may only be made
from "balances due to other banks," that is, deposits held by one member
bank to the credit of another bank.

'These balances include, according to

the present Regulations of the Federal Reserve Board, all amounts due to
banks, bankers and trust companies, and certified, cashiers' and treasurers'
checks outstanding.
This provision has given rise to widespread protest, especially from
country banks which are not in a position to take advantage of deductible
items because they hold little or no amounts due to banks from which to sub­
tract them.

The city banks, on the other hand, holding, because of their

correspondent relationships, large balances due to other banks, have been
able to decrease their deposits subject to reserve by the full amount of
their deductible items.

At the present time, this factor is equivalent to

about one per cent on the average in the required reserves against net de­
mand deposits of country banks, that is, the aggregate reserves held by
country member banks against net demand deposits are in effect equal to S
per cent, rather than J per cent, if an adjustment is made for their inabil­
ity to utilize items now deducted from deposits by banks in large cities.
In making its recommendation the Committee also noted the fact that
the present provision governing deductions permits many city member banks
to carry bankers' balances without thereby increasing their requirements
for reserves, since a bank with deductible items normally in excess of its
balances due to banks can accept bankers' deposits up to the point where
this excess no longer exists without increasing the reserves which it must
hold.

In recommending that deductions be made from gross deposits, conse­

quently, the Committee provides for a more equitable treatment of country
member banks and also provides a formula by which any bank which increases
its balances due to other banks will thereby increase its resex-'ve require


-30raents.
The Committee also recommends a new definition of items which may be
deducted from gross deposits.

At present, these items are defined in the

law as balances due "from other banks."

This phrase has been construed by

the Federal Reserve Board to include items with Federal reserve banks in
process of collection, amounts due from banks and trust companies in the
United States, balances payable in dollars due from foreign branches of
other American banks, and exchanges for clearing house and other checks on
local banks.

In effect, consequently, deductible items now include all

funds deposited with other banks in this country, dollar balances deposited
with branches of other American banks abroad, and the bulk of checks and
other items in process of collection.
The Committee recommends that this definition of deductible items be
changed to include only "balances due from other member banks and their
branches in the United States" and "all checks in process of collection and
other cash items payable upon presentation in the United States."

The prin­

ciple which the Committee has followed in making these recommendations is
that, insofar as it is administratively practicable, the aggregate body of
reserves maintained by member banks should reflect changes in the volume and
use of member bank credit by the public, since it is the public's use of
credit which has a direct relationship to the volume of the country's
business.

Aggregate reserves should not, as a matter of principle, be af­

fected by purely interbank transactions which do not directly reflect the
public use of credit, but, instead, changes in transactions between banks
which are on a large scale in our banking system because of the large num­
ber of unit banks.

A system of reserve requirements would not be sound

under which aggregate reserves might decrease during the next decade solely
as a result of some change in our bank relationships which would materially




reduce the volume or proportion of interbank deposits now held by member
banks.

Tht? proposal advanced by the Committee avoids this contingency

since the aggregate neb deposits of member banks s'ib.ject to reserve will
not be affected by changes in the volume of balances kept by one member
bank with another.

Under this recommendation, also, the individual mem­

ber bank ’
vaich is responsible for the maintenance of reserves against a
member bank deposit will be that bank which lends it to the public, i.e.,
an interior member tank rill only hold reserves against those deposits on
its books which it lends or invests directly with the public.

If it

passes the deposit on to another member bank in the form of an interbank
deposit, it will hold no reserve against it since it will be able to de­
duct this amount from its gross deposits.

The bank which will receive

this interbank deposit and loan the funds involved back to the public,
however, will be the one that vail be responsible for the reserve which
must be maintained against it.
Reserves on U . S . Government deposits
The recommendations of the Committee make no exceptions with respect
to deposits of the U. S. Government, but treat these deposits for reserve
purposes the same as any other deposits.

The Committee recomraends the re­

peal of the 1917 amendments which relieved these deposits from reserves
as an inducement to member banks to participate to the fullest extent in
war financing.

The fact that deposits are secured by the pledge of govern­

ment or other securities does not constitute a valid reason for their ex­
emption from reserve requirements.

A bank as a matter of necessity must

have assets to cover and secure all of its deposit liabilities, but this
fact does not relieve a bank from its responsibility to maintain adequate
reserves.

The security of a deposit has nothing to do with the reserve

that should be carried against it.



The banks have the use of their U. S.

-32Government deposits the same as of any other deposits and it is equitable,
therefore, that these deposits should contribiite to the reserve fund in
the same relative proportion.
Operation of proposed formula in recent years
This resume of the principles aid evidence upon which the Committee
has proceeded in formulating its recommendations indicates that under the
system of reserves proposed requirements for reserves will be more equit­
ably apportioned among the member banks.

It is even more important, how­

ever, that the proposed formula exert a constructive influence toward the
preservation of sound credit conditions.

Unsound credit developments arise

usually during periods of prosperity when the public is optimistic and
both bankers and borrowers are likely to overestimate the value of collat­
eral which is offered to banks as a basis for loans.

Such conditions are

reflected usually both by an increased demand for bank credit and by init
creased activity in the deposit balances of those individuals or corpora­
tions which deal in the commodities, securities, or services that are ac­
quiring a speculative value.

Thus, the speculative value of farm lands,

which accompanied the prosperity of agriculture during the war, was re­
flected both in a sharp increase in the activity of deposit accounts at
agricultural banks and ir. a kenvy demand for credit secured by farm mort­
gages at inflated values.

So, also, the prosperity which prevailed in

this country during recent years, was accompanied by a widespread boom
in urban real estate, by speculation in Florida real estate, and finally
by an inflation in common stock trices, each of which was reflected in
unsound demands for bank credit at inflated speculative values and in a
larger than average increase in the activity of deposits at those banks
whose customers were becoming heavily involved in these speculative sit­
uations.




In the boom which ended in 1920, the increase in deposit

-33activity was widespread, but the greatest relative increase occurred at
the center of farm land and commodity speculation in the Middle West.
In the boom, which ended in 1929. on the other hand, the greatest in­
creases in deposit activity occurred in New York City and other large
Eastern cities, where speculation in common stocks was most active.
No formula for determining member bank reserves can prevent these
speculative situations from recurring, but the proposed formula will
operate to check their growth and help to bring them under control.
It will increase requirements for reserves sharply at those individual
member banks whose customers are at the center of an incipient specula­
tive movement, and so set in motion forces of a restraining nature at
the focal point of disturbance.
ferent forms.

These forces will probably take dif­

3ankers whose requirements for reserves increase sharply

as a result of these activities will find their lending power reduced
somewhat and so will be less inclined to finance speculative develop­
ments.

Customers with highly active accounts will proba?oly be expected

to maintain larger deposit balances, or else the member banks will in­
stitute service charges based on the activity of accounts.

The forces

set in motion by the proposed formula, consequently, will make it more
difficult for an unsound development to obtain credit, will increase
the amount of credit needed to finance the development, or will increase
its cost of operation . The restraining effect of these forces, moreover,
will be concentrated almost wholly on speculative credit developments,
since the reserves required under the proposed formula will not be such
as to affect adversely banks holding the working balances of soundly
financed commercial enterprises.

Very few ordinary business accounts

turn over more rapidly than once a week, in which case the effective re­
quired reserve under the proposed formula will equal no more than 12 per



cent.

This is no larger than the average mo u n t nor.' held in cash arid at

the reserve banks on all net demand deposit balances at reserve city and
country member banks.
In the banking situation as a whole, the effect of the proposed formu­
la on the demand for loans at the reserve banks will be to strengthen Fed­
eral reserve policy and thus to exert an influence toward sounder credit
conditions.

This is illustrated in the chart which compares aggregate mem­

ber bank holdings of reserves and vault cash under present requirements
during the past seven years with an estimate of the aggregate reserves
which the formula proposed by the Committee would have produced.

It will

be noted that, while under the present formula aggregate reserves did not
increase between December 192*+ and the summer of 1927. under the proposed
formula they would have increased by nearly $300 million during the same
period.

The greatest contrast between the effect of the two formulas on

general credit conditions, however, would have appeared during the years
1928, 1929. and 1930*

The failure of present requirements for reserves

to exert any influence of restraint in the presence of abnormal credit de­
mands in 1928 and 1929 has been discussed earlier in this report.

There

it was pointed out that aggregate reserves did not reflect the increased
use of credit in 1928 and 1929 , or exercise a restraint over its growth
because no increase in reserve requirements accompanied the large increase
in brokers' loans which, owing to high call money rates, were supplied by
interior banks, corporations, and others out of funds previously held on
deposit with the larger city banks.

Our present system of reserve require­

ments thus facilitated an expansion of credit at a time when the situation
called for strong restraint.

It was also pointed out that in 1930, after

the break in the stock market boom, these same factors acted to increase
reserve requirements.




At that time rates on security loans fell below




-35-

MEMBER BANK RESERVE REQUIREMENTS
UNDER DEBIT FORMULA

-36rates on deposits in consequence of a diminished demand .for credit in the
market, and both corporations and interior 'banks converted funds previously
loaned to brokers into deposits at city banks against which reserves were
required.
The chart shows that requirements based directly on the activity of
member bank accounts as well as on their volume, in accordance with the
proposed formula, would have acted in the direction of sounder credit con­
ditions during these years.

In 1928 and 1929, an increase in aggregate re­

serves under this formula would have acted to check sharply an excessive
use of credit for stock market trading, while in 1930 a corresponding de­
crease in requirements for reserves would have acted to ease credit condi­
tions.

In all three years, consequently, changes in required reserves

would have supplemented the open market policy of the Federal Reserve
System, since, in 1928 and 1929. restraint would have been exerted on the
market by increased member bank requirements for reserves, as well as by
sales of securities by the Federal reserve banks, and in 1930 . the easing
effect of purchases of securities by the reserve banks would have been
supported by a decrease in member bank requirements for reserves.
Practicability of proposed requirements
The Committee believes that the proposed system of reserve requirements
is not only sound in principle, equitable as between the member banks, and
constructive in its influence on credit conditions, but that it is also
simple to administer and not susceptible of abuses such as those which have
grown up around the existing provisions granting a low reserve for time de­
posits.

The Committee has canvassed the administrative difficulties which

may arise under the proposed system and also the possibility that once in­
troduced it will not operate in the manner expected.




-37Inauguration of any new system of reserves such as that r>ropcsed will
require the careful preparation of report forms and of instructions govern­
ing their use for the guidance of member banks.

Cnee placed in operation,

however, there should be fewer opportunities for administrative difficulties
to arise under the proposed system of reserves than under present require­
ments.

In the first place, there are avoided all of the problems attending

the classification of member banks for reserve purposes into central re­
serve city, reserve city, and country banks, and also the classification
by member banks of their deposits into time deposits and demand deposits.
Under the Committee's proposals, the reserves required of a member
bank will depend, first, on its net deposits which are to be determined by
subtracting from its gross deposits its balances with other member banks
and its items in process of collection, and, secondly, on its total debits
to deposit accounts.

None of the items used in determining these amounts

is difficult for the member banks to obtain from their books or for the
bank examiner to check.

Determination of daily requirements for reserves,

consequently, should be greatly simplified as compared with present re­
quirements .
The Committee proposes, moreover, to simplify the problem of main­
taining reserves by establishing a system of averaging, by which member
banks will know dafinitely in advance their requirements for reserves and
thus be in a position to provide the reserves called for under the require­
ments.
Since the activity of a bank's deposits on any given day or in any
given week is not a reliable indicator of the real activity of its ac­
counts or of the reserves which, should be held against them, the Commit­
tee recommends that in the event the proposed formula is adopted the Fed­
eral Reserve Board issue a regulation providing that that part of a bank's




-33reserve which is based on the activity of its deposits, shall represent

50 per cent of its average daily debits to deposit accounts during the
eight weeks preceding its current reserve computation period.

In other

words, the reserve against deposit activity would not be based on current
operations, but on the activity which a member bank might properly expect
on the basis of its past eight weeks' experience.

Fnile there \7ill be

individual cases when this experience is not borne out, investigation
has indicated that a period of eight weeks is sufficiently long on the
average to give a satisfactory record of the activity to be expected from
a deposit account without at the same time removing requirements for re­
serves too far from current banking developments.

On the basis of this

eight weeks' daily average, each member bank would know at the beginning
of each reserve computation period the exact amount of reserves against
activity which it would be required to hold during that period.

The Com­

mittee recommends that the 5 per cent reserve required on net deposits be
computed against net deposits held at the close of the preceding day as
at present.

The actual volume of reserves held would not have to equal

these requirements each day, however, since member banks would have com­
plied with the law if their reserves during a given reserve computation
period were substantially maintained and were equal on the average to
their average reserve requirements.

Changes recommended by the Committee

in the length of reserve computation periods are discussed later in this
report.
The proposed requirements, consequently, should be more simple to
administer than present requirements.
ceptible of abuse.

They should also prove less sus­

The Committee is aware that banks, when their require­

ments for reserves will depend directly on their activity, will make an
effort to hold down the turnover of their accounts, and the Committee



-39expects some resultant decrease in total debits to deposit accounts.
There is likely to be some decrease in the turnover of correspondent
bank accounts, for example, and a corresponding increase in the use of
the check collection facilities of the reserve banks sincj correspond­
ent banks will find extremely active balances of other banks less at­
tractive to hold than at the present time.

There may also be some in­

crease in the use that brokers make of the clearing facilities of the
organized security exchanges which will be reflected in a correspond­
ing decrease in the volume of transactions cleared through member bank
accounts.

Both of these developments will probably reduce somewhat the

volume of debits to deposit accounts on which the calculations of the
Committee are based.

On the other hand, the effect of this reduction

in total required reserves will probably be offset somewhat by an in­
crease in reserves held against member bank deposits since under the
proposed formula member banks will probably require customers having
highly active accounts to increaso their deposit balances.

Any net

change in aggregate reserves resulting from these operations should not,
therefore, be sufficient in volume to affect seriously the functioning
of the proposed system once it is effectively placed in operation.
Distribution of reserves 'under ^proposed system
To check its calculations of the distribution of reserves under
the proposed reserve formula, the Committee requested all member banks
to report for each day of May 1931 the items on their books which are
necessary to calculate their legal requirements for reserves under the
plan recommended by the Committee.

The following computations based

on these reports include figures for eighty per cent of the member banks
holding ninety-six per cent of total member bank reserves.




-1(0For these hanks as a whole, the proposed formula would have pro­
duced during May 1931 reserves in vault and in the reserve barks equiva­
lent to 99*7 Per cent of their actual required reserves plus vault cash
under present requirements, i.e., for the member hanks as a whole, the
total body of reserves would be the same under either formula.

This is

in keeping with the intent of the Committee, as previously stated, of
selecting a formula which would produce at the time of transition the
same aggregate body of reserves as is now held under the present law.
Of the total reserves produced under the proposed law, 56 per cent
would represent the 5 per cent reserve which would be required to be
held against total net deposits, and HU per cent the reserve required
against activity of deposit accounts at the rate of 50 per cent of aver­
age daily debits.

For member banks as a whole, total reserves including

vault cash would be J .8 per cent of their gross deposits, and 8.9 per
cent of their net deposits.

The average turnover of net deposits in

May was at a rate of a little over twice a month.
Of the 6,308 member banks included in the tabulation, the aggregate
reserves held by 3 *3^3> or 8^.1 per cent of the total, would be reduced
under the proposed formula, while those of 3^9 banks, or 5*5 Per cent of
the total, would be essentially unchanged, and those of 636 banks, or
10.H per cent of the total, would be increased,

ifost of the banks whose

reserves would be reduced are small country banks which now find it
necessary to carry a relatively large volume of vault cash, but this
group also includes a number of banks in central reserve and reserve
cities which are now required to hold high reserves against demand de­
posits, the turnover of which is relatively low.

Of this group of 5,303

member banks, 808 on the basis of May 1931 figures would receive a reduc­
tion of 10 per cent or less in required reserves under the new formula,




-411,247 a reduction of between 11 and 20 per cent, 1,637 a reduction of
between 21 and 30 per cent, l,l6g a reduction of between J>1 and 40 per
cent, and V+3 a reduction of more than 40 per cent.

Ifore than 90 per

cent of the member banks in the San Francisco, St. Louis, Atlanta, Kan­
sas City, and Dallas Federal reserve districts would have some redaction
in their reserves tinder the proposed formula.

In the Minneapolis, Chi­

cago, and Cleveland districts, reductions would occur at from 80 to 90
per cent of the meniber banks, and in the Boston, Philadelphia, and Rich­
mond districts at from 73 to SO per cent.

In the New York district only

65 per cent of the member banks would be in a jjosition to reduce their
aggregate holdings of reserves.

These reductions reflect largely the

fact that under present requirements, member banks located at a distance
from the reserve banks must hold more vault cash than more conveniently
situated banks.
M>st of the increased reserves under the new formula would be
carried by the large active meniber banks situated in cities where Fed­
eral reserve banks or branches are located.

These are the banks where

the proportion of aggregate reserves to total credit outstanding has de­
creased most rapidly in recent years, because their location has permit­
ted them to reduce their holdings of vault cash to a minimum.

In addi­

tion, this group includes in many instances banks with a large proportion
of deposits now classified as time deposits, and, also, the larger money
market banks of the country which hold the exceptionally active demand
balances of other banks and of brokers and dealers in securities.

Of

the 656 member banks in this group as a whole, the increase in total re­
quired reserves would be less than 10 per cent in the case of 366 banks,
between 11 and 20 per cent in the case of 1 S2 banks, between 21 and 30
per cent in the case of 64 banks, and more than 30 per cent in the case




-42of only ^

"banks.

About 23 per cent of the member banks in the New York

district would have some increase in reserves as compared with less than
2 per cent in the Dallas district.
This test of the formula shows that the reserve plan recommended by
the Committee would produce the total volume of reserves expected and
would, distribute these reserves more equitably among the member banks, by
restoring differentials in reserves held to the proportion justified by
the activity of deposits, and, by removing advantages now obtained solely
from geographical location which enables a member bank to maintain messen­
ger contact with the cash facilities of its Federal reserve bank.
Limitation of

.

reserve to 15 per cent of gross deposits

The Committee has also tested the effect of its proposed limitation
of the maximum reserve which a member bank may be required to carry under
its formula to 15 per cent of its gross deposits.

The purpose of this

limitation is to prevent the new requirements from becoming prohibitive
in isolated cases where banks have specialized in accounts that turn over
at a much higher rate than ordinary business deposits.

These accounts

consist mostly of brokers' balances and balances at stock yard banks.
During Ifey 1931 only two member banks would have been affected by this
maximum limitation.

In the summer and fall of 1929 when stock market

speculation was reflected in an extremely high rate of deDosit activity
in New York City, it is estimated that the limitation r/ould have been ef­
fective in the case of not more than 15 member banks.

The number of mem­

ber banks with sufficient deposit activity to be affected bjr the maximum
limitation, consequently, is small.
This maximum limit is based upon gross deposits rather than net de­
posits because barks holding highly active accounts necessarily hold also
a large volume of uncollected checks.



The net deposit in an abnormally

-In­
active account is small, since it is computed by subtracting all of the
checks on other hanks deposited by a customer from his gross deposit.
A maximum limitation based upon net deposits, therefore, would not pro­
duce anything like adequate reserves and would defeat the "'hole purpose
of the Committee's proposal which is directed toward making active de­
posit accounts carry the largest reserves.
Limitations on amoimts of vault cash included in reserves
In order to assure that each member hank will at all times main­
tain an adequate deposit "balance with its Federal reserve bank, the Com­
mittee proposes to limit the amount of vault cash which a member hank
may include in its legal reserve.

It recommends that member banks lo­

cated in the vicinity of a Federal reserve bank or branch be required
to hold four-fifths of their total legal reserve in the form of a de­
posit balance with their Federal reserve bank.

These are the member

banks which do not need to hold a large volume of vault cash since they
can obtain quickly additional currency from their Federal reserve banks.
In the case of member banks not so situated, the Committee recommends
that reserves held as deposit balances with the reserve banks comprise
at least two-fifths of total legal requirements for reserves.
A test of the effect of these limitations in Way 193- indicated
that they would have permitted about JO per cent of the member banks
to count as legal reserves all of the vault cash which they held at that
time.

About 30 per cent of the member banks, however, held more curren­

cy last May than they would have been permitted to count as legal re­
serves under the formula recommended.

The total amount of this excess

vault cash was in the neighborhood of $^0 million for all the member
banks affected, and did not constitute an appreciable burden for the
great majority of these banks.




-44Kinds of vault cash eligible for reserves
The Committee recommends that banks be permitted to count as re­
serves all kinds of cash now in circulation.

It also recommends that

in computing reserves cash in transit between a member bank and its
Federal reserve bank bo counted as the equivalent of cash in vault.
Debits subject to reserve
The Committee recommends that debits subject to reserve shall in­
clude all debits to all accounts included in gross deposits, except
charges resulting from the payment of certified, cashiers' or other of­
ficers' checks.

The exception of debits resulting from, the payment of

certified checks is dxie to the fact that a debit entry is made at the
time of certification.

The second debit made when these checks are

finally paid should not, therefore, also be included in the reserve com­
putation since to do so would involve duplication.

Debits resulting

from the payment of cashiers' and other officers' checks are also ex­
cepted, because they represent either transactions similar to certified
check transactions, or else payments made by member banks on their own
account.

Such payments do not represent the use of member bank credit

by the public and should not be subject to reserve.
Administration and enforcement of reserve requirements
At the request of the Committee, the counsel of the Federal Reserve
Board has prepared a draft of an amendment to Section 19 of the Federal
Reserve Act embodying the recommendations of the Committee for the new
system of member bank reserve requirements discussed above.

This draft,

which appears at the end of this report, repeats certain provisions in
the present law which are not concerned directly with member bank re­
serves but are included in the u-oposed amendment in order to facilitate
the legislative drafting ox the bill.




These provisions, which are

_u5carried in paragraph (m) of the nroposed amendment, have not been consid­
ered by the Committee and make no changes in the wording of the present
Act.
It is the purpose of the Committee to make the determination and en­
forcement of the reserve requirements recommended in the draft as simple
as possible.

The Committee recommends, consequently, that Regulation D

of the.Federal Reserve Board be changed to permit member banks located in
the vicinity of a Federal reserve bank or branch to compute their reserves
over a period of one week, and other member banks over a period of four
weeks.

Within these reserve computation periods, the Committee recommends

that member banks be permitted to average their daily holdings of reserves
against their daily reserve requirements, provided they are not continu­
ously deficient for thz*ee or more consecutive business days if they are
located in the vicinity of a Federal reserve bank or branch, or for six or
more consecutive business days, if they are not so located.

Ifember banks

with consecutive deficiencies for three or six days respectively would lose
the privilege of averaging their reserves during the entire reserve computa­
tion period in which they were continuously deficient, and pay a penalty to
their Federal reserve banks for all actual deficiencies occurring during
such period.

The Committee also recommends that the Board amend its regula­

tion to permit a Federal reserve bank, with the consent of the Federal Re­
serve Board, to require any member bank in its district to maintain re­
serves each day in accordance with requirements for that day.

The purpose

of this recommendation is to provide a method for dealing with individual
member banks which flagrantly abuse the privilege of averaging their re­
serves against their requirements.
At the present time, a member bank is prohibited from declaring div­
idends or making new loans while its reserves are deficient and is required




-46to pay a penalty to its Federal reserve "bank on all average deficiencies
in its reserves within a reserve computation period.

If it declares div­

idends or makes new loans on any day or at any time when its reserves are
deficient, it violates the law and its directors are presumably liable for
all losses accruing to the bank therefrom.

This provision, the Committee

thinks, is too drastic in its present form, since it is almost impossible
for a member bank to tell whether its reserves are deficient or not at any
given time during the day when a hew loan application is under considera­
tion.

The Committee would modify this provision, consequently, to read

that "if any member bank shall fail for thirty consecutive calendar days
to maintain the reserves required by this section, it shall not declare or
pay any dividend, or make any new loan or investment until its reserves
are restored to the amount required."

This means that only a definite

failure to maintain reserves over a period will make directors personally
liable for losses arising from violation of the law, and not technical
deficiencies in reserves that may arise from a variety of circumstances
at any time during the ordinary course of bank operations.

The Committee

also recommends that the Federal Reserve Board provide in its regulation
for the notification of the directors of a delinquent member bank in ad­
vance of the 30-day period specified in the proposed law, such notifica­
tion to state that their bank is incurring continued deficiencies and
that unless steps are taken to correct the situation the directors will
become subject to the penalties prescribed in the Federal Reserve Act
for violation of the law.




—l f 7 —

The Committee would also modify the provision governing penalties to be
paid by member banks for reserve deficiencies.

At the present time penalties

for deficiencies in a member bank's reserve are assessed by its Federal re­
serve bank at a rate of 2 per cent per annum above its current rediscount rate.
In some Federal reserve districts, a progressively higher penalty rate is as­
sessed for reserve deficiencies prevailing over long periods.

The Committee

recommends that the provision relating to progressive penalties be eliminated
from the Federal Eeserve Board's regulation, since in most cases progressive
rates are incurred by member banks not as the result of negligence or indif­
ference but as the consequence of conditions that make compliance with require­
ments difficult if not impossible.

The Committee also feels that when discount

rates are below 4 per cent the present penalty rate is too low to prevent mem­
ber banks from becoming negligent with respect to their reserves.

It, there­

fore, recommends that the penalty rate be 2 per cent above the discount rate
on 90~day commercial paper but that in no case shall such penalty rate be less
than 6 per cent.
Effective six months after enactment
In event the proposed amendment to Section 19 of the Federal Eeserve Act
is adopted, the Committee recommends that a six month period be allowed before
changes in reserve requirements become effective.
E. L. Smead, Chairman
Ira Clerk
M. J. Fleming
E. A. Goldenweiser
L. R. Rounds
W. W. Riefler, Executive Secretary



- ‘1

;

A BILL
To amend Section 1$ of the Federal Soserve Act, and for other purposes.
BE IT ENACTED BY THE SENATE ASD HOUSE OF REPRESENTATIVES OF THE UNITED STATES
OF AMERICA IN CONGRESS ASSEMBLED, That Section 19 of the Federal Reserve Act
(United States Code, Title 12, Sections kGl to H66, inclusive, and Section 37^).
as amended, be further amended and reenacted to read as follows:
"BANK RESERVES
"Section 19-

(a)

Each member bank shall establish and maintain reserves

equal to five per centum (5$>) of the amount of its net deposits, plus fifty per
centum (50$) of the amount of its average daily debits to deposit accounts; but,'
in no event, shall the aggregate reserves required to be maintained by any member
bank exceed fifteen per centum (15$) of its gross deposits.
"(b)

Each member bank located in the vicinity of a Federal reserve bank or

branch thereof shall maintain not less than four-fifths of its total required re­
serves in the form of a reserve balance cn deposit with the Federal reserve bank,
and every other member bank shall maintain not less than two-fifths of its total
required reserves in the form of a reserve balance on deposit with the Federal re­
serve bank.

The remainder of the total required reserves of each member bank,

over and above the amount required to be maintained in the form of a reserve bal­
ance on deposit with the Federal reserve bank, may, at the option of such member
bank, consist of a reserve balance on deposit with the Federal reserve bank, or
of cash owned by such member bank either in its actual possession or in transit
between such member bank and the Federal reserve bank.
"(c)

The term 'gross deposits,1 within the meaning of this section, shall

include all deposit liabilities of any member bank whether or not immediately
available for withdrawal by the depositor, all liabilities for certified checks,
cashiers', treasurers' and other officers' checks, cash letters of credit, travel­
ers' checks, and all other similar liabilities, as further defined and specified




-U9by the Federal Reserve Board:

Provided, however, That the term 'gross deposits'

shall not include any liability of a foreign branch.
"(d)

The term 'net deposits, 1 as used in this section, shall mean the amount

of the gross deposits of any member bank, as above defined and as further defined
by the Federal Reserve Board, minus the sum of (l) all balances due to such member
bank from other member banks in the United States and their domestic branches, and
(2 ) checks and other cash items in process of collection which are payable immedi­
ately upon presentation in the United States, within the meaning of these terms as
further defined by the Federal Reserve Board.
" (e)

The term 'average daily debits to deposit accounts,' as used in this

section, shall mean the average daily amount of checks, drafts, and other items
debited or charged by any member bank to any and all accounts included in gross de­
posits as above defined and as further defined by the Federal Reserve Board, except
charges resulting from the payment of certified checks and cashiers', treasurers'
and other officers' checks.
"(f)

The term 'cash,' within the meaning of this section, shall include all

kinds of currency and coin issued or coined under authority of the laws of the
United States.
"(g)

The term 'reserve balance,' as used in this section, shall mean a mem­

ber bank's actual net balance on the books of the Federal reserve bank representing
funds available for reserve purposes under regulations prescribed by the Federal
Reserve Board.
"(h)

The term 'vicinity of a Federal reserve bank or branch thereof,' as used

in this section, shall mean the city in which a Federal reserve bank or branch
thereof is located, unless otherwise defined by the Federal Reserve Board.
"(i)

With respect to each member bank, the term "’
Federal reserve bank,' as

used in this section, shall mean the Federal reserve bank of the district in which




-50-

such member bank is located.
" (j)

The Federal Reserve Board is authorized and empowered to prescribe

regulations defining further the various terms used in this Act, fixing r>eriods
over which reserve requirements and actual reserves may be averaged, determining
the methods by which reserve requirements and actual reserves shall be computed,
and prescribing penalties for deficiencies in reserves.

Such regulations and all

other regulations of the Federal Reserve 3oard shall have the force and effect of
law and the courts shall take judicial notice of them.
" (k)

Subject to such regulations and penalties as may be prescribed by the

Federal Reserve Board, any member bank may draw against or otherwise utilize its
reserves for the purpose of meeting existing liabilities:

Provided, however. That

if any member bank shall fail for thirty consecutive calendar days to maintain the
reserves required by this section, it shall not declare or pay any dividend or
make any new loan or investment until its reserves are restored to the amount re­
quired by this section.
"(l)

All penalties for deficiencies in reserves incurred under regulations

prescribed by the Federal Reserve Board pursuant to the provisions of this Act
shall be paid to the Federal reserve bank by the member bank against which they
are assessed.
"(m)

No member bank shall keep on deposit with any State bank or trust

company which is not a member bank a sum in excess of ten per centum of its own
paid-up capital and surplus.

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.
"(n)

National banks, or banks organized under local laws, located in Alaska

or in a dependency or insular possession or any part of the United States outside
of the continental United States may remain nonmember banks, and shall in that




-51event maintain the reserves and comply v'ith all the other conditions provided "by
law regulating them prior to the enactment of the Federal Reserve Act; or said
"banks may, with the consent of the Federal Reserve 3oard, "become member banks of
any one of the Federal reserve districts, and shall in that event take stock, main­
tain reserves, and be subject to all the other provisions of this Act.
" (o)

The provisions of Section 7 °f the First Liberty Bond Act, approved

April 2U,1917» Section 8 of the Second Liberty Bond Act, approved September 24,
1917. and Section 8 of the Third Liberty Bond Act, approved April 4, 19 I8 (U. S.
Code, Title 3 1 . Section 771) which exempt deposits of public moneys by the United
States in designated depositaries from the reserve requirements of this Act and
all other acts or parts of acts in conflict with this Act are hereby repealed only
in so far as they are in conflict with the provisions of this Act."
Section 2.

This Act shall become effective six months after its approval by

the President of the United States.